-----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, U0pHWjGm06MibowbkrVQAlHB3Ub3uWgSlv73Q74fd3QOPazANK8Bc/1o42qXAJ6T HBFnymCDo1/Oa75tmp576Q== /in/edgar/work/0001012870-00-005798/0001012870-00-005798.txt : 20001115 0001012870-00-005798.hdr.sgml : 20001115 ACCESSION NUMBER: 0001012870-00-005798 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000930 FILED AS OF DATE: 20001114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MERCURY INTERACTIVE CORPORATION CENTRAL INDEX KEY: 0000867058 STANDARD INDUSTRIAL CLASSIFICATION: [7372 ] IRS NUMBER: 770224776 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-22350 FILM NUMBER: 767628 BUSINESS ADDRESS: STREET 1: 1325 BORREGAS AVE CITY: SUNNYVALE STATE: CA ZIP: 94089 BUSINESS PHONE: 4088225200 MAIL ADDRESS: STREET 1: 1325 BORREGAS AVENUE CITY: SUNNYVALE STATE: CA ZIP: 94089 10-Q 1 0001.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______. Commission File Number : 0-22350 MERCURY INTERACTIVE CORPORATION (Exact name of registrant as specified in its charter) Delaware 77-0224776 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1325 Borregas Avenue, Sunnyvale, California 94089 (Address of principal executive offices) Registrant's telephone number, including area code: (408) 822-5200 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such a shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO The number of shares of Registrant's Common Stock outstanding as of October 31, 2000 was 80,891,684. 1 MERCURY INTERACTIVE CORPORATION INDEX
Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets - September 30, 2000 and December 31, 1999 3 Condensed Consolidated Statements of Operations - Three and nine months ended September 30, 2000 and 1999 4 Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2000 and 1999 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds 18 Item 4. Exhibits and Reports on Form 8-K 18 SIGNATURE 19 INDEX TO EXHIBITS 20
2 PART I. FINANCIAL INFORMATION - ----------------------------- Item 1. Financial Statements MERCURY INTERACTIVE CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) (unaudited)
September 30, December 31, 2000 1999 ------------- ------------ ASSETS Current assets: Cash and cash equivalents $331,276 $113,346 Short-term investments 286,045 57,981 Trade accounts receivable, net 47,129 40,399 Other receivables 12,505 6,325 Prepaid expenses and other assets 18,987 16,702 -------- -------- Total current assets 695,942 234,753 Long-term investments 155,130 15,555 Property and equipment, net 59,377 46,910 Other assets, net 13,968 - -------- -------- $924,417 $297,218 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 10,111 $ 8,469 Accrued liabilities 55,579 33,433 Income taxes payable 28,070 19,945 Deferred revenue 68,653 35,840 ------- -------- Total current liabilities 162,413 97,687 Convertible subordinated notes 500,000 - -------- -------- Total liabilities 662,413 97,687 -------- -------- Stockholders' equity: Common stock 162 156 Capital in excess of par value 173,707 148,826 Notes receivable from issuance of stock (6,408) (5,090) Accumulated other comprehensive loss (1,232) (1,242) Retained earnings 95,775 56,881 -------- -------- Total stockholders' equity 262,004 199,531 -------- -------- $924,417 $297,218 ======== ========
See accompanying notes to condensed consolidated financial statements 3 MERCURY INTERACTIVE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (unaudited)
Three months ended Nine months ended September 30, September 30, ---------------------- ------------------------ 2000 1999 2000 1999 --------- --------- ---------- ---------- Revenue: License $ 54,200 $ 33,500 $ 144,700 $ 87,400 Service 25,300 14,000 64,800 40,200 --------- --------- --------- --------- Total revenue 79,500 47,500 209,500 127,600 --------- --------- --------- --------- Cost of revenue: License 5,152 2,040 11,788 5,546 Service 6,942 4,548 17,480 12,421 --------- --------- --------- --------- Total cost of revenue 12,094 6,588 29,268 17,967 --------- --------- --------- --------- Gross profit 67,406 40,912 180,232 109,633 --------- --------- ---------- ---------- Operating expenses: Research and development 8,132 6,554 23,692 17,656 Marketing and selling 38,995 22,275 106,867 62,266 General and administrative 4,766 3,182 12,223 8,469 --------- --------- --------- --------- Total operating expenses 51,893 32,011 142,782 88,391 --------- --------- --------- --------- Income from operations 15,513 8,901 37,450 21,242 Other income, net 5,332 1,542 11,168 4,101 --------- --------- --------- --------- Income before provision for income taxes 20,845 10,443 48,618 25,343 Provision for income taxes 4,169 2,297 9,724 5,535 --------- --------- --------- --------- Net income $ 16,676 $ 8,146 $ 38,894 $ 19,808 ========= ========= ========= ========= Net income per share (basic) $ 0.21 $ 0.11 $ 0.49 $ 0.26 ========= ========= ========= ========= Net income per share (diluted) $ 0.18 $ 0.09 $ 0.42 $ 0.23 ========= ========= ========= ========= Weighted average common shares (basic) 80,263 76,796 79,571 75,541 ========= ========= ========= ========= Weighted average common shares and equivalents (diluted) 92,533 85,920 91,674 84,345 ========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements 4 MERCURY INTERACTIVE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Nine months ended September 30, ------------------------------------- 2000 1999 ------------ ------------ Cash flows from operating activities: Net income $ 38,894 $ 19,808 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 6,479 4,195 Changes in assets and liabilities: Trade accounts receivable, net (6,730) (2,893) Other receivables (6,180) (1,267) Prepaid expenses and other assets (2,285) (1,472) Accounts payable 1,642 864 Accrued liabilities 22,146 8,237 Income taxes payable 8,125 2,244 Deferred revenue 32,813 7,308 --------- --------- Net cash provided by operating activities 94,904 37,024 --------- --------- Cash flows from investing activities: Purchases of investments, net (367,639) (58,262) Acquisition of property and equipment, net (18,429) (9,573) --------- --------- Net cash used in investing activities (386,068) (67,835) --------- --------- Cash flows from financing activities: Issuance of convertible subordinated notes 500,000 - Issuance of common stock, net of related notes receivable 23,569 15,248 Debt issuance costs (14,485) - --------- --------- Net cash provided by financing activities 509,084 15,248 --------- --------- Effect of exchange rate changes on cash 10 (225) --------- --------- Net increase (decrease) in cash and cash equivalents 217,930 (15,788) Cash and cash equivalents at beginning of period 113,346 96,836 --------- --------- Cash and cash equivalents at end of period $331,276 $ 81,048 ========= =========
See accompanying notes to condensed consolidated financial statements 5 MERCURY INTERACTIVE CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. The unaudited financial information furnished herein reflects all adjustments, consisting only of normal recurring adjustments, that in the opinion of management are necessary to fairly state the Company's consolidated financial position, the results of its operations, and its cash flows for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's audited financial statements for the year ended December 31, 1999, included in the 1999 Form 10-K. The condensed consolidated statements of operations for the three and nine months ended September 30, 2000 are not necessarily indicative of results to be expected for the entire fiscal year ending December 31, 2000. Certain previously reported amounts have been reclassified to conform with the current quarter financial statement presentation. 2. The effective tax rate for the three and nine months ended September 30, 2000 differs from statutory tax rates principally because of special reduced taxation programs sponsored by the government of Israel. 3. Earnings per share are calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 128, "Earnings per Share," ("SFAS 128"). SFAS 128 requires the reporting of both basic earnings per share, which is the weighted-average number of common shares outstanding, and diluted earnings per share, which is the weighted-average number of common shares outstanding and all dilutive potential common shares outstanding. For the three and nine months ended September 30, 2000 and 1999, dilutive potential common shares outstanding reflects shares issuable under the Company's stock option plans. The following table summarizes the Company's earnings per share computations for the three and nine months ended September 30, 1999 and 2000 (in thousands, except per share amounts):
Three months ended Nine months ended September 30, September 30, -------------------- ---------------------- 2000 1999 2000 1999 -------- -------- -------- ----------- Numerator: Net income $ 16,676 $ 8,146 $ 38,894 $ 19,808 Denominator: Denominator for basic net income per share - weighted average shares 80,263 76,796 79,571 75,541 Incremental common shares attributable to shares issuable under employee stock plans 12,270 9,124 12,103 8,804 _______ _______ ________ _______ Denominator for diluted net income per share - weighted average shares 92,533 85,920 91,674 84,345 ------- ------- ------- ------- Net income per share - basic $ 0.21 $ 0.11 $ 0.49 $ 0.26 ------- ------- ------- ------- Net income per share - diluted $ 0.18 $ 0.09 0.42 $ 0.23 ------- ------- ------- -------
There were 32,000 options and 82,000 options considered anti-dilutive at September 30, 2000 and September 30, 1999, respectively. These options were considered anti-dilutive because the options' exercise price was greater than the average fair market value of the Company's common stock for the periods then ended. The 4,494,400 shares of common stock from outstanding convertible subordinated notes issued in 2000 was not included in diluted earnings per share because the assumed conversion would be antidilutive. 4. The Company reports components of comprehensive income in its annual consolidated statements of stockholders' equity. Comprehensive income consists of net income and foreign currency translation adjustments. The Company's total comprehensive income was as follows:
Three months ended Nine months ended September 30, September 30, ------------------------------- ------------------------------- 2000 1999 2000 1999 ------------- ------------- ------------- ------------- Net income $ 16,676 $ 8,146 $ 38,894 $ 19,808 Other comprehensive income (loss) 128 158 10 (225) ------------- ------------- ------------- ------------- Comprehensive income $ 16,804 $ 8,304 $ 38,904 $ 19,583 ============= ============= ============= =============
6 5. The Company has three reportable operating segments made up of the Americas, Europe, and the Rest of the World, which includes Israel. These segments are organized, managed and analyzed geographically and operate in one industry segment: the development, marketing, and selling of integrated performance management solutions. The Company evaluates operating segment performance based primarily on net revenues and certain operating expenses. The Company's products are marketed and sold internationally through the Company's subsidiaries and through indirect distribution channels such as system integrators, distributors and value-added resellers. Financial information for the Company's operating segments is summarized below for the three and nine months ended September 30, 2000 and 1999:
Three months ended Nine months ended September 30, September 30, ------------------------------- ------------------------------- 2000 1999 2000 1999 ------------- ------------- ------------- ------------- Net revenue to third parties: Americas....................................... $ 54,100 $ 31,600 $ 142,600 $ 84,800 Europe......................................... 18,100 11,700 49,000 32,800 Rest of the World.............................. 7,300 4,200 17,900 10,000 ------------- ------------- ------------- ------------- Consolidated................................ $ 79,500 $ 47,500 $ 209,500 $ 127,600 ============= ============= ============= =============
September 30, December 31, 2000 1999 ------------- ------------- Identifiable assets: Americas.................................................................... $ 767,038 $ 200,854 Europe...................................................................... 15,826 25,389 Rest of the World........................................................... 141,553 70,975 ------------- ------------- Consolidated........................................................... $ 924,417 $ 297,218 ============= =============
Sales through the United Kingdom subsidiary accounted for 10% and 11% of the consolidated net revenue to unaffiliated customers for the three and nine months ended September 30, 1999, respectively, and less than 10% for both the three and nine months ended September 30, 2000. Operations located in Israel accounted for 13% and 22% of the consolidated identifiable assets at September 30, 2000 and December 31, 1999, respectively. No other subsidiary represented 10% or more of the related consolidated amounts for the periods presented. 6. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133") that requires companies to record derivative financial instruments on their balance sheets as assets or liabilities measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be recorded depending on the use of the derivative instrument and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. In June 1999, the FASB issued Statement of Financial Accounting Standard No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133," ("SFAS 137") that amends SFAS 133 to be effective for all fiscal quarters of fiscal years beginning after June 15, 2000. In June 2000, the Financial Accounting Standards Board issued SFAS No. 138 "Accounting for Derivative Instruments and Hedging Activities--An Amendment of FASB No. 133," ("SFAS 138"). SFAS 138 amends the accounting and reporting standards for certain derivatives and hedging activities such as net settlement contracts, foreign currency translations and intercompany derivatives. The Company will adopt SFAS 133 in its quarter ending March 31, 2001. The adoption of SFAS 133, SFAS 137 and SFAS 138 is not expected to have a material effect on the Company's results of operations, financial position or cash flows. 7. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB 101") which provides guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures 7 related to revenue recognition policies. The adoption of SAB 101 has not had and is not expected to have a material effect on the Company's results of operations, financial position or cash flows. 8. In March 2000, the Financial Accounting Standards Board issued Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44 clarifies the application of Accounting Practice Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") regarding (a) the definition of employee for purposes of applying APB 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions in this Interpretation cover specific events that occur after either December 15, 1998, or January 12, 2000. The Company's adoption of the provisions of FIN 44 that were effective as of December 15, 1998 and January 12, 2000 and were implemented effective July 1, 2000 have not had a material effect on the Company's results of operations, financial position or cash flows. The Company is currently evaluating the impact of the remaining provisions of FIN 44 on its results of operations, financial position and cash flows. 9. In July 2000, the Company issued $500,000,000 in convertible subordinated notes. The notes mature on July 1, 2007 and bear interest at a rate of 4.75% per annum, payable semiannually on January 1 and July 1 of each year. The notes are convertible into shares of the Company's common stock at any time prior to maturity at a conversion price of approximately $111.25 per share, subject to adjustment under certain conditions. The notes may be redeemed, in whole or in part, by the Company at any time on or after July 1, 2003. Accrued interest to the redemption date will be paid by the Company in each redemption. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. In some cases, forward-looking statements are identified by words such as "believes," "anticipates," "expects," "intends," "plans," "will," "may" and similar expressions. In addition, any statements that refer to our plans, expectations, strategies or other characterizations of future events or circumstances are forward-looking statements. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in "Risk Factors." Our business may have changed since the date hereof, and we undertake no obligation to update the forward-looking statements in this Quarterly Report on Form 10-Q. Results of Operations Revenue License revenue increased 62% to $54.2 million for the three months ended September 30, 2000 from $33.5 million for the three months ended September 30, 1999. License revenue increased 66% to $144.7 million for the nine months ended September 30, 2000 from $87.4 million for the nine months ended September 30, 1999. Our growth in license revenue is attributable primarily to growth in license fees from LoadRunner, WinRunner and TestDirector products as well as revenues from our new application performance management and hosted e-service business products. Service revenue increased 81% to $25.3 million for the three months ended September 30, 2000 from $14.0 million for the three months ended September 30, 1999. Service revenue increased 61% to $64.8 million for the nine months ended September 30, 2000 from $40.2 million for the nine months ended September 30, 1999. The increase in our service revenue was primarily due to the renewal of maintenance contracts and increased training and consulting engagements. We expect that service revenue will continue to increase in absolute dollars as long as our customer base continues to grow. Cost of revenue License cost of revenue, as a percentage of license revenue, increased to 10% for the three months ended September 30, 2000 from 6% in the three months ended September 30, 1999. License cost of revenue, as a percentage of license revenue, increased to 8% for the nine months ended September 30, 2000 from 6% for the nine 8 months ended September 30, 1999. The increased license cost of revenue as a percentage of license revenue for the three months ended September 30, 2000 was primarily due to the investment in our hosted e-service business infrastructure. Service cost of revenue, as a percentage of service revenue, was 27% for both the three and nine months ended September 30, 2000, respectively, compared to 32% and 31% for the three and nine months ended September 30, 1999, respectively. Service cost of revenue consists primarily of costs of providing customer technical support, training and consulting. Service cost of revenue as a percentage of service revenue may vary based on the degree of outsourcing of training and consulting and the profitability of individual consulting engagements. Research and development Research and development was $8.1 million, or 10% of total revenue, and $23.7 million, or 11% of total revenue for three and nine months ended September 30, 2000, respectively, compared to $6.6 million and $17.7 million, or 14% of total revenue for the three and nine months ended September 30, 1999, respectively. The increase in absolute dollars in the three and nine months ended September 30, 2000 reflected an increase in spending due to growth in research and development headcount. Research and development expense in 1999 includes royalty expense for obligations to the government of Israel for sales of products developed under government-funded research grants. We did not have royalty expense under these agreements in the three and nine months ended September 30, 2000. Royalty expense amounted to approximately $1.1 million and $2.7 million for the three and nine months ended September 30, 1999, respectively. As of September 30, 2000, we had no outstanding royalty obligations. We have not applied for, nor do we anticipate applying for, any additional grants from the government of Israel. Marketing and selling Marketing and selling expenses were $39.0 million, or 49% of total revenue, and $106.9 million, or 51% of total revenue, for the three and nine months ended September 30, 2000, respectively, compared to $22.3 million, or 47% of total revenue, and $62.3 million, or 49% of total revenue, for the three and nine months ended September 30, 1999, respectively. The increase in marketing and selling expenses was primarily due to increased commission expense attributable to the higher revenue level, an increase in personnel-related costs reflecting the growth in sales and marketing headcount, and increased spending on marketing programs. We expect marketing and selling expenses to increase in absolute dollars as total revenue increases, but these expenses may vary as a percentage of revenue. General and administrative General and administrative expenses were $4.8 million and $12.2 million, or 6% of total revenue, for the three and nine months ended September 30, 2000, respectively, compared to $3.2 million and $8.5 million, or 7% of total revenue for the three and nine months ended September 30, 1999, respectively. The increase in absolute dollar spending reflected increased staffing and related spending necessary to manage and support our growth. Other income, net Other income, net consists primarily of interest income and foreign exchange gains and losses. The increase in other income, net to $5.3 million and $11.2 million for the three and nine months ended September 30, 2000, respectively, from $1.5 million and $4.1 million for the three and nine months ended September 30, 1999, respectively, reflected primarily interest income from the proceeds of the July 2000 convertible subordinated notes, net of interest expense on the notes. Provision for income taxes We have structured our operations in a manner designed to maximize income in Israel where tax rate incentives have been extended to encourage foreign investments. The tax holidays and rate reductions which we will be able to realize under programs currently in effect expire at various dates through 2007. Future provisions for 9 taxes will depend upon the mix of worldwide income and the tax rates in effect for various tax jurisdictions. See "--Risk Factors--We are subject to the risk of increased taxes." Net income We reported net income of $16.7 million and $38.9 million for the three and nine months ended September 30, 2000, respectively, compared to net income of $8.1 million and $19.8 million for the three and nine months ended September 30, 1999, respectively. Liquidity and Capital Resources At September 30, 2000, our short-term and long-term investments consisted of investments in high-quality financial, government and corporate securities. Cash, cash equivalents and investments increased to $772.5 million at September 30, 2000, from $186.9 million at December 31, 1999. In July 2000, we raised net proceeds of $486.3 million from issuance of $500.0 million of 4.75% convertible subordinated notes. During the nine months ended September 30, 2000, we generated approximately $94.9 million from operations due primarily to profits from operations and an increase in deferred revenue and accrued liabilities. Our primary investing activities were net purchases of investments for the nine months ended September 30, 2000 of $367.6 million compared to $58.3 million for nine months ended September 30, 1999. We also purchased property and equipment, net of disposals, in the amount of $18.4 million during the nine months ended September 30, 2000 compared to $9.6 million for the nine months ended September 30, 1999. During the nine months ended September 30, 2000, we spent approximately $2.5 million for construction of research and development facilities in Israel. We expect to spend an additional $11.0 to $12.0 million to complete the construction of the second Israel facility. During the nine months ended September 30, 2000, we also spent approximately $11.0 million on the purchase and renovation of our second headquarters building in Sunnyvale, California. We expect to spend approximately $1.0 million to complete the renovation of this building. Our primary financing activity consisted of issuance of the convertible subordinated notes and issuances of common stock under our employee stock option and purchase plans, net of notes receivable issued and collected, in the amount of $23.6 million during the nine months ended September 30, 2000. Assuming there is no significant change in our business, we believe that our current cash and investment balances and cash flow from operations will be sufficient to fund our cash needs for at least the next twelve months. We also expect to satisfy our financing requirements through the incurrence of debt from time to time. We anticipate using net proceeds from the convertible subordinated notes for working capital and other general corporate purposes, including financing growth, product development and capital expenditures. Should the opportunity arise, we may also use a portion of the net proceeds to fund acquisitions of, or investments in, businesses, partnerships, products or technologies that complement or expand our businesses. Risk Factors In addition to the other information included in this Quarterly Report on Form 10-Q, the following risk factors should be considered carefully in evaluating us and our business. Our future success depends on our ability to respond to rapid market and technological changes by introducing new products and services and to continually improve the performance, features and reliability of our existing products and services and respond to competitive offerings. The market for our software products and services is characterized by: . rapidly changing technology; . frequent introduction of new products and services and enhancements to existing products and services by our competitors; 10 . increasing complexity and interdependence of Internet related applications; . changes in industry standards and practices; and . changes in customer requirements and demands. To maintain our competitive position, we must continue to enhance our existing software testing and application performance management products and to develop new products and services, functionality and technology that address the increasingly sophisticated and varied needs of our prospective customers. The development of new products and services, and enhancement of existing products and services, entail significant technical and business risks and require substantial lead-time and significant investments in product development. If we fail to anticipate new technology developments, customer requirements or industry standards, or if we are unable to develop new products and services that adequately address these new developments, requirements and standards in a timely manner, our products may become obsolete, our ability to compete may be impaired and our revenues could decline. We expect our quarterly revenues and operating results to fluctuate, which may cause the price of our stock and therefore any outstanding convertible subordinated notes, to decline. Our revenues and operating results have varied in the past and are likely to vary significantly from quarter to quarter in the future. These fluctuations are due to a number of factors, many of which are outside of our control, including: . fluctuations in demand for and sales of our products and services; . our success in developing and introducing new products and services and the timing of new product and service introductions; . our ability to introduce enhancements to our existing products and services in a timely manner; . the introduction of new or enhanced products and services by our competitors and changes in the pricing policies of these competitors; . the discretionary nature of our customers' purchase and budget cycles; . the amount and timing of operating costs and capital expenditures relating to the expansion of our business; . deferrals by our customers of orders in anticipation of new products or services or product or service enhancements; and . the mix of our domestic and international sales, together with fluctuations in foreign currency exchange rates. In addition, the timing of our license revenues is difficult to predict because our sales cycles are typically short and can vary substantially from product to product, service to service and customer to customer. We base our operating expenses on our expectations regarding future revenue levels. As a result, if total revenues for a particular quarter are below our expectations, we could not proportionately reduce operating expenses for that quarter. We have experienced seasonality in our revenues and earnings, with the fourth quarter of the year typically having the highest revenue and earnings for the year and higher revenue and earnings than the first quarter of the following year. We believe that this seasonality results primarily from the budgeting cycles of our customers and from the structure of our sales commission program. Due to these and other factors, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. If our operating results are below the expectations of investors or securities analysts, the price of our common stock, and therefore any outstanding convertible subordinated notes, could decline. 11 We expect to face increasing competition in the future, which could cause reduced sales levels and result in price reductions, reduced gross margins or loss of market share. The market for our testing and application performance management products and services is extremely competitive, dynamic and subject to frequent technological changes. There are few substantial barriers to entry in our market. In addition, the rapid growth and use of the Internet for e- business is a recent and emerging phenomenon. The Internet has reduced barriers so that other companies may compete with us in the testing and application performance management markets. As a result of the increased competition, our success will depend, in large part, on our ability to identify and respond to the needs of potential customers, and to new technological and market opportunities, before our competitors identify and respond to these needs and opportunities. We may fail to respond quickly enough to these needs and opportunities. In the market of solutions for testing of applications, our principal competitors include Compuware, Radview, Rational Software, RSW (a division of Teradyne) and Segue Software. In the new and rapidly changing market for application performance management solutions, our competitors include providers of hosted services such as BMC Software, Keynote Systems and Service Metrics (a division of Exodus Communications), and emerging application service providers ("ASPs") such as Freshwater Software. In addition, we face potential competition in this market from existing providers of testing solutions such as Segue. Finally, in both the market for testing solutions and the market for application performance management solutions, we face potential competition from established providers of systems and network management software such as Computer Associates. The software industry is increasingly experiencing consolidation, and this could increase the resources available to our competitors and the scope of their product offerings. For example, in 2000 Keynote Systems acquired Velogic, Inc., a provider of load testing services and BMC Software acquired Evity, Inc., a provider of Internet management services. Our competitors and potential competitors may undertake more extensive marketing campaigns, adopt more aggressive pricing policies or make more attractive offers to distribution partners and to employees. If we fail to maintain our existing distribution channels and develop additional channels in the future, our revenues will decline. We derive a substantial portion of our revenues from sales of our products through distribution channels such as system integrators and value-added resellers. We expect that sales of our products through these channels will continue to account for a substantial portion of our revenues for the foreseeable future. We also have private labeling arrangements with ASPs and an enterprise software company who incorporate our products and services into their offerings. We may not experience increased revenues from these new channels, which could harm our business. The loss of one or more of our system integrators, value-added resellers or ASPs, or any reduction or delay in their sales of our products and services could result in reductions in our revenue in future periods. In addition, our ability to increase our revenue in the future depends on our ability to expand our indirect distribution channels. Our dependence on indirect distribution channels presents a number of risks, including: . many of our system integrators, value-added resellers and ASPs can cease marketing our products and services with limited or no notice and with little or no penalty; . our system integrators, value-added resellers and ASPs may not be able to effectively sell any new products and services that we may introduce; . we may not be able to replace existing or recruit additional system integrators, value-added resellers and ASPs if we lose any of our existing ones; . our system integrators, value-added resellers and ASPs may also offer competitive products and services from third parties; . we may face conflicts between the activities of our indirect channels and our direct sales and marketing activities; and . our system integrators, value-added resellers and ASPs may not give priority to the marketing of our products and services as compared to our competitors' products. 12 In March 1999, we entered into an agreement with Tivoli Systems, a subsidiary of IBM, for the joint development and marketing of a family of products for enterprise application performance management, incorporating elements of our technology, which would be marketed and sold only by Tivoli. Tivoli may not succeed in developing and selling these new products. Under this agreement, we agreed that until October 2002, we would not license this technology to any other party for purposes of developing a product similar to any developed under this agreement. In addition, we agreed that until October 2002, we would not enter into technology relationships to create similar products with specified competitors of Tivoli as long as Tivoli continues to agree to pay annual minimum royalties. In September 2000, Tivoli notified us that it would no longer pay the annual minimum royalties set forth in the agreement and therefor the restrictions on us regarding entering into agreements with Tivoli's competitors expired. We depend on strategic relationships and business alliances for continued growth of our business. Our development, marketing and distribution strategies rely increasingly on our ability to form strategic relationships with software and other technology companies. These business relationships often consist of cooperative marketing programs, joint customer seminars, lead referrals and cooperation in product development. Many of these relationships are not contractual and depend on the continued voluntary cooperation of each party with us. Divergence in strategy, change in focus, or competitive product offerings by any of these companies may interfere with our ability to develop, market, sell or support our products, which in turn could harm our business. Further, if these companies enter into strategic alliances with other companies or are acquired, they could reduce their support of our products. Our existing relationships may be jeopardized if we enter into alliances with competitors of our strategic partners. In addition, one or more of these companies may use the information they gain from their relationship with us to develop or market competing products. If we are unable to manage our growth, our business may be harmed. Since 1991, we have experienced significant annual increases in revenue, employees and a number of product and service offerings. This growth has placed and, if it continues, will place a significant strain on our management and our financial, operational, marketing and sales systems. If we cannot manage our growth effectively, our business, competitive position, operating results and financial condition could suffer. Although we are implementing a variety of new or expanded business and financial systems, procedures and controls, including the improvement of our sales and customer support systems, the implementation of these systems, procedures and controls may not be completed successfully, or may disrupt our operations. Any failure by us to properly manage these transitions could impair our ability to attract and service customers and could cause us to incur higher operating costs and experience delays in the execution of our business plan. The success of our business depends on the efforts and abilities of our senior key personnel. We depend on the continued service and performance of our senior management and other key personnel. We do not have long term employment agreements with any of our key personnel. The loss of any of our executive officers or other key employees could hurt our business. If we cannot hire qualified personnel, our ability to manage our business, develop new products and increase our revenues will suffer. We believe that our ability to attract and retain qualified personnel at all levels in our organization is essential to the successful management of our growth. In particular, our ability to achieve revenue growth in the future will depend in large part on our success in expanding our direct sales force and in maintaining a high level of technical consulting, training and customer support. There is substantial competition for experienced personnel in the software and technology industry. If we are unable to retain our existing key personnel or attract and retain additional qualified individuals, we may from time to time experience inadequate levels of staffing to perform services for our customers. As a result, our growth could be limited due to our lack of capacity to develop and market our products to our customers. We depend on our international operations for a substantial portion of our revenues. Sales to customers located outside the United States have historically accounted for a significant percentage of our revenue and we anticipate that such sales will continue to be a significant percentage of our revenue. As a percentage of our total revenues, sales to customers outside the United States were approximately 32% for both the three and nine months ended September 30, 2000, respectively, and 33% and 34% for the three and nine months ended September 30, 1999, respectively. In addition, we have substantial research and development operations in Israel. We face risks associated with our international operations, including: . changes in taxes and regulatory requirements; 13 . difficulties in staffing and managing foreign operations; . reduced protection for intellectual property rights in some countries; . the need to localize products for sale in international markets; . longer payment cycles to collect accounts receivable in some countries; . seasonal reductions in business activity in other parts of the world in which we operate; . political and economic instability; and . economic downturns in international markets. Any of these risks could harm our international operations and cause lower international sales. For example, some European countries already have laws and regulations related to technologies used on the Internet that are more strict than those currently in force in the United States. Any or all of these factors could cause our business to be harmed. Because our research and development operations are primarily located in Israel, we may be affected by volatile economic, political and military conditions in that country and by restrictions imposed by that country on the transfer of technology. Our operations depend on the availability of highly- skilled scientific and technical personnel in Israel. Our business also depends on trading relationships between Israel and other countries. In addition to the risks associated with international sales and operations generally, our operations could be adversely affected if major hostilities involving Israel should occur or if trade between Israel and its current trading partners were interrupted or curtailed. These risks are compounded due to the restrictions on our ability to manufacture or transfer outside of Israel any technology developed under research and development grants from the government of Israel, without the prior written consent of the government of Israel. If we are unable to obtain the consent of the government of Israel, we may not be able to take advantage of strategic manufacturing and other opportunities outside of Israel. We have, in the past, obtained royalty-bearing grants from various Israeli government agencies. In addition, we participate in special Israeli government programs that provide significant tax advantages. The loss of or any material decrease in these tax benefits could negatively affect our financial results. We are subject to the risk of increased taxes. We have structured our operations in a manner designed to maximize income in Israel where tax rate incentives have been extended to encourage foreign investment. Our taxes could increase if these tax rate incentives are not renewed upon expiration or tax rates applicable to us are increased. Tax authorities could challenge the manner in which profits are allocated among us and our subsidiaries, and we may not prevail in any such challenge. If the profits recognized by our subsidiaries in jurisdictions where taxes are lower became subject to income taxes in other jurisdictions, our worldwide effective tax rate would increase. Our financial results may be negatively impacted by foreign currency fluctuations. Our foreign operations are generally transacted through our international sales subsidiaries. As a result, these sales and related expenses are denominated in currencies other than the U.S. Dollar. Because our financial results are reported in U.S. Dollars, our results of operations may be harmed by fluctuations in the rates of exchange between the U.S. Dollar and other currencies, including: . a decrease in the value of Pacific Rim or European currencies relative to the U.S. Dollar, which would decrease our reported U.S. Dollar revenue, as we generate revenues in these local currencies and report the related revenues in U.S. Dollars; and . an increase in the value of Pacific Rim, European or Israeli currencies relative to the U.S. Dollar, which would increase our sales and marketing costs in these countries and would increase research and development costs in Israel. 14 We attempt to limit foreign exchange exposure through operational strategies and by using forward contracts to offset the effects of exchange rate changes on intercompany trade balances. This requires us to estimate the volume of transactions in various currencies. We may not be successful in making these estimates. If these estimates are overstated or understated during periods of currency volatility, we could experience material currency gains or losses. Our ability to successfully implement our business strategy depends on the continued growth of the Internet. In order for our business to be successful, the Internet must continue to grow as a medium for conducting business. However, as the Internet continues to experience significant growth in the number of users and the complexity of Web-based applications, the Internet infrastructure may not be able to support the demands placed on it or the performance or reliability of the Internet might be adversely affected. Security and privacy concerns may also slow the growth of the Internet. Because our revenues ultimately depend upon the Internet generally, our business may suffer as a result of limited or reduced growth. Any future company acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert the attention of our management. We have acquired, and in the future we may acquire or make investments in other companies with similar products and technologies. For example, in November 1999, we completed our acquisition of Conduct Ltd. In the event of any future acquisitions or investments, we could: . issue stock that would dilute the ownership of our then-existing stockholders; . incur debt; . assume liabilities; . incur amortization expense related to goodwill and other intangible assets; or . incur large write-offs. If we fail to achieve the financial and strategic benefits of past and future acquisitions, our operating results will suffer. Acquisitions and investments involve numerous other risks, including: . difficulties integrating the acquired operations, technologies or products with ours; . failure to achieve targeted synergies; . unanticipated costs and liabilities; . diversion of management's attention from our core business; . adverse effects on our existing business relationships with suppliers and customers or those of the acquired organization; . difficulties entering markets in which we have no or limited prior experience; and . potential loss of key employees, particularly those of the acquired organizations. The price of our common stock and therefore the price of our notes may fluctuate significantly, which may result in losses for investors and possible lawsuits. The market price for our common stock has been and may continue to be volatile. For example, during the 52-week period ended October 31, 2000, the closing prices of our common stock as reported on the Nasdaq National Market ranged from a high of $156.75 to a low of $40.20. We expect our stock price to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include: . actual or anticipated variations in our quarterly operating results; . announcements of technological innovations or new products or services by us or our competitors; . announcements relating to strategic relationships or acquisitions; 15 . changes in financial estimates or other statements by securities analysts; . changes in general economic conditions; . conditions or trends affecting the software industry and the Internet; and . changes in the economic performance and/or market valuations of other software and high-technology companies. Because of this volatility, we may fail to meet the expectations of our stockholders or of securities analysts at some time in the future, and our stock price could decline as a result. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many high technology companies. These fluctuations have often been unrelated or disproportionate to the operating performance of these companies. Any negative change in the public's perception of software or Internet software companies could depress our stock price regardless of our operating results. If we fail to adequately protect our proprietary rights and intellectual property, we may lose a valuable asset, experience reduced revenues and incur costly litigation to protect our rights. We rely on a combination of patents, copyrights, trademarks, service marks and trade secret laws and contractual restrictions to establish and protect our proprietary rights in our products and services. We will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect unauthorized use of our intellectual property. Despite our precautions, it may be possible for unauthorized third parties to copy our products and use information that we regard as proprietary to create products that compete with ours. Some license provisions protecting against unauthorized use, copying, transfer and disclosure of our licensed programs may be unenforceable under the laws of certain jurisdictions and foreign countries. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the United States. To the extent that we increase our international activities, our exposure to unauthorized copying and use of our products and proprietary information will increase. In many cases, we enter into confidentiality or license agreements with our employees and consultants and with the customers and corporations with whom we have strategic relationships and business alliances. No assurance can be given that these agreements will be effective in controlling access to and distribution of our products and proprietary information. Further, these agreements do not prevent our competitors from independently developing technologies that are substantially equivalent or superior to our products. Litigation may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation like this, whether successful or unsuccessful, could result in substantial costs and diversions of our management resources, either of which could seriously harm our business. Third parties could assert that our products and services infringe their intellectual property rights, which could expose us to litigation that, with or without merit, could be costly to defend. We may from time to time be subject to claims of infringement of other parties' proprietary rights. We could incur substantial costs in defending ourselves and our customers against these claims. Parties making these claims may be able to obtain injunctive or other equitable relief that could effectively block our ability to sell our products in the United States and internationally and could result in an award of substantial damages against us. In the event of a claim of infringement, we may be required to obtain licenses from third parties, develop alternative technology or to alter our products or processes or cease activities that infringe the intellectual property rights of third parties. If we are required to obtain licenses, we cannot be sure that we will be able to do so at a commercially reasonable cost, or at all. Defense of any lawsuit or failure to obtain required licenses could delay shipment of our products and increase our costs. In addition, any such lawsuit could result in our incurring significant costs or the diversion of the attention of our management. Defects in our products may subject us to product liability claims and make it more difficult for us to achieve market acceptance for these products, which could harm our operating results. Our products may contain errors or "bugs" that may be detected at any point in the life of the product. Any future product defects discovered after shipment of our products could result in loss of revenues and a delay in the market acceptance of these products that could adversely impact our future operating results. 16 In selling our products, we frequently rely on "shrink wrap" or "click wrap" licenses that are not signed by licensees. Under the laws of various jurisdictions, the provisions in these licenses limiting our exposure to potential product liability claims may be unenforceable. We currently carry errors and omissions insurance against such claims, however, we cannot provide assurance that this insurance will continue to be available on commercially reasonable terms, or at all, or that this insurance will provide us with adequate protection against product liability and other claims. In the event of a products liability claim, we may be found liable and required to pay damages which would seriously harm our business. We have adopted anti-takeover defenses that could delay or prevent an acquisition of our company, including an acquisition that would be beneficial to our stockholders. Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no present plans to issue shares of preferred stock. Furthermore, certain provisions of our Certificate of Incorporation and of Delaware law may have the effect of delaying or preventing changes in our control or management, which could adversely affect the market price of our common stock. Substantial leverage and debt service obligations may adversely affect our cash flow. In July 2000, we completed an offering of convertible subordinated notes with a principal amount of $500.0 million. We now have a substantial amount of outstanding indebtedness, primarily the convertible subordinated notes. There is the possibility that we may be unable to generate cash sufficient to pay the principal of, interest on and other amounts due in respect of our indebtedness when due. Our leverage could have significant negative consequences, including: . increasing our vulnerability to general adverse economic and industry conditions; . requiring the dedication of a substantial portion of our expected cash flow from operations to service our indebtedness, thereby reducing the amount of our expected cash flow available for other purposes, including capital expenditures; and . limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete. Item 3. Quantitative and Qualitative Disclosures About Market Risk Interest rate risk. Our exposure to market rate risk for changes in interest rates is limited to our investment portfolio. Derivative financial instruments are not a part of our investment policy. We place our investments with high quality issuers and, by policy, limit the amount of credit exposure to any one issuer or issue. In addition, we have classified all of our investments as "held to maturity." This classification does not expose the consolidated statements of income or balance sheet to fluctuation in interest rates. At September 30, 2000, $331.3 million, or 43%, of our cash, cash equivalents and investment portfolio carried a maturity of less than 90 days, and $617.3 million, or 80%, carried a maturity of less than one year. All investments mature, by policy, in less than two years. Foreign currency risk. A portion of our business is conducted in currencies other than the U.S. Dollar. Our operating expenses in each of these countries are in the local currencies, which mitigates a significant portion of the exposure related to local currency revenues. We have entered into forward foreign exchange contracts to hedge amounts denominated in foreign currencies due from certain subsidiaries, mainly Europe and the Pacific Rim, against fluctuations in exchange rates. We have not entered into forward foreign exchange contracts for speculative or trading purposes. Our accounting policies for these contracts are based on our designation of the contracts as hedging transactions. The criteria we use for designating a contract as a hedge considers the contract's effectiveness in reducing risk by matching hedging instruments to underlying transactions. Gains and losses on forward foreign exchange contracts are recognized in income in the same period as gains and losses on the underlying transactions. 17 The effect of an immediate 10% change in exchange rates would not have a material impact on our operating results or cash flows. PART II. OTHER INFORMATION - -------------------------- Item 2. Changes in Securities and Use of Proceeds (c) Recent Sales of Unregistered Securities. 1. In July 2000, we issued $500.0 million in aggregate principal amount of our 4.75% convertible subordinated notes, due July 2007. Net proceeds to Mercury of this offering were approximately $486.3 million. The debentures are convertible into the Company's common stock at $111.25 per share, subject to certain adjustments. The initial purchasers of our debentures were Goldman, Sachs & Co., Chase Securities Inc. and Deutsche Bank Securities Inc. The debentures were issued pursuant to the exemption from registration provided for by Section 4(2) of the Securities Act of 1933, as amended. Item 4. Exhibits and Reports on Form 8-K (a) 27.1 - Financial Data Schedule. (b) Reports on Form 8-K On July 3, 2000, we filed a Current Report on Form 8-K relating to our completion of our offering of up to $500.0 million in principal amount in convertible subordinated notes. 18 SIGNATURE - --------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MERCURY INTERACTIVE CORPORATION (Registrant) Dated: November 14, 2000 By: /s/ Sharlene Abrams ----------------------------------------------- Sharlene Abrams, Chief Financial Officer, Vice President of Finance and Administration (Duly Authorized Officer and Principal Financial and Accounting Officer) 19 INDEX TO EXHIBITS - ----------------- Exhibit Sequentially No. Description Numbered Page - ---------- ----------- ------------- 27.1 Financial Data Schedule 21 20 EX-27.1 2 0002.txt FINANCIAL DATA SCHEDULE
5 1,000 3-MOS 9-MOS DEC-31-2000 DEC-31-2000 JUL-01-2000 JAN-01-2000 SEP-30-2000 SEP-30-2000 331,276 331,276 441,175 441,175 55,252 55,252 8,123 8,123 0 0 695,942 695,942 85,949 85,949 26,572 26,572 924,417 924,417 162,413 162,413 500,000 500,000 0 0 0 0 162 162 261,842 261,842 924,417 924,417 54,200 144,700 79,500 209,500 5,152 11,788 12,094 29,268 51,893 142,782 0 0 5,938 5,938 20,845 48,618 4,169 9,724 16,676 38,894 0 0 0 0 0 0 16,676 38,894 .21 .49 .18 .42
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