-----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, A0ANjD3/Gv+X2Q9K9Caa+SIrb/nzIEN0Sd6iqRqMJIEJDE72Uo42TR8NSb/9jUTi 3QC553CD0mCYtLh4XECXnQ== 0001012870-01-500831.txt : 20010516 0001012870-01-500831.hdr.sgml : 20010516 ACCESSION NUMBER: 0001012870-01-500831 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20010331 FILED AS OF DATE: 20010515 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-Q SEC ACT: SEC FILE NUMBER: 000-22350 FILM NUMBER: 1636656 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 d10q.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 MARCH 31, 2001 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______. Commission File Number : 0-22350 MERCURY INTERACTIVE CORPORATION (Exact name of registrant as specified in its charter) Delaware 77-0224776 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1325 Borregas Avenue, Sunnyvale, California 94089 (Address of principal executive offices) Registrant's telephone number, including area code: (408) 822-5200 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such a shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO The number of shares of Registrant's Common Stock outstanding as of April 30, 2001 was 82,615,000. MERCURY INTERACTIVE CORPORATION INDEX Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets - March 31, 2001 and December 31, 2000 3 Condensed Consolidated Statements of Operations - Three months ended March 31, 2001 and 2000 4 Condensed Consolidated Statements of Cash Flows - Three months ended March 31, 2001 and 2000 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 4. Exhibits and Reports on Form 8-K 17 SIGNATURE 18 INDEX TO EXHIBITS 19 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements MERCURY INTERACTIVE CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands)
March 31, December 31, 2001 2000 (unaudited) (audited) ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 306,351 $ 226,387 Short-term investments 330,430 402,356 Trade accounts receivable, net 56,803 62,989 Other receivables 12,379 13,233 Prepaid expenses and other assets 21,945 21,316 ----------- ----------- Total current assets 727,908 726,281 Long-term investments 160,642 153,623 Property and equipment, net 86,958 82,895 Other assets, net 18,055 13,576 ----------- ----------- Total assets $ 993,563 $ 976,375 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 11,768 $ 12,931 Accrued liabilities 42,994 58,942 Income taxes payable 26,869 23,797 Deferred revenue 82,102 77,673 ----------- ----------- Total current liabilities 163,733 173,343 Convertible subordinated notes 500,000 500,000 ----------- ----------- Total liabilities 663,733 673,343 ----------- ----------- Stockholders' equity: Common stock 163 162 Capital in excess of par value 200,200 190,232 Notes receivable from issuance of stock (7,276) (7,528) Accumulated other comprehensive loss (987) (1,415) Retained earnings 137,730 121,581 ----------- ----------- Total stockholders' equity 329,830 303,032 ----------- ----------- $ 993,563 $ 976,375 =========== ===========
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 March 31, ------------------------------- 2001 2000 ------------- ------------- Revenues: License $ 61,200 $ 42,000 Service 29,500 18,400 ------------- ------------- Total revenues 90,700 60,400 ------------- ------------- Cost of revenues: License 6,159 2,906 Service 7,597 4,828 ------------- ------------- Total cost of revenues 13,756 7,734 ------------- ------------- Gross profit 76,944 52,666 ------------- ------------- Operating expenses: Research and development 9,309 7,100 Marketing and selling 47,716 32,538 General and administrative 5,017 3,397 ------------- ------------- Total operating expenses 62,042 43,035 ------------- ------------- Income from operations 14,902 9,631 Other income, net 5,284 2,608 ------------- ------------- Income before provision for income taxes 20,186 12,239 Provision for income taxes 4,037 2,448 ------------- ------------- Net income $ 16,149 $ 9,791 ============= ============= Net income per share (basic) $ 0.20 $ 0.12 ============= ============= Net income per share (diluted) $ 0.18 $ 0.11 ============= ============= Weighted average common shares (basic) 81,408 78,943 ============= ============= Weighted average common shares and equivalents (diluted) 90,941 91,208 ============= =============
See accompanying notes to condensed consolidated financial statements 4 MERCURY INTERACTIVE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Three months ended March 31, ---------------------------------- 2001 2000 ----------- ----------- Cash flows from operating activities: Net income $ 16,149 $ 9,791 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,837 1,607 Changes in assets and liabilities: Trade accounts receivable, net 6,186 2,391 Other receivables 854 1,143 Prepaid expenses and other assets (629) (414) Accounts payable (1,163) (133) Accrued liabilities (15,948) (2,551) Income taxes payable 3,072 2,115 Deferred revenue 4,429 15,163 Net cash provided by operating activities 15,787 29,112 ----------- ----------- Cash flows from investing activities: Proceeds from (purchases of) investments, net 64,907 (29,307) Net investment in nonconsolidated companies (5,000) - Acquisition of property and equipment, net (6,379) (4,181) ----------- ----------- Net cash provided (used) in investing activities 53,528 (33,488) ----------- ----------- Cash flows from financing activities: Issuance of common stock, net of related notes receivable 10,221 9,112 ----------- ----------- Net cash provided by financing activities 10,221 9,112 ----------- ----------- Effect of exchange rate changes on cash 428 (60) ----------- ----------- Net increase in cash and cash equivalents 79,964 4,676 Cash and cash equivalents at beginning of period 226,387 113,346 ----------- ----------- Cash and cash equivalents at end of period $ 306,351 $ 118,022 =========== ===========
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, 2000, included in the 2000 Form 10-K. The condensed consolidated statements of operations for the three months ended March 31, 2001 are not necessarily indicative of results to be expected for the entire fiscal year ended December 31, 2001. 2. The effective tax rate for the three months ended March 31, 2001 differs from statutory tax rates principally because of special reduced taxation programs sponsored by the government of Israel. 3. Earnings per share are calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 requires the reporting of both basic earnings per share, which is the weighted-average number of common shares outstanding, and diluted earnings per share, which includes the weighted-average number of common shares outstanding and all dilutive potential common shares outstanding, using the treasury stock method. For the three months ended March 31, 2001 and 2000, dilutive potential common shares outstanding reflects shares issuable under the Company's stock option plans. The following table summarizes the Company's earnings per share computations for the three months ended March 31, 2000 and 2001 (in thousands, except per share amounts): Three months ended March 31, ------------------ 2001 2000 -------- -------- Numerator: Net income $ 16,149 $ 9,791 ======== ======== Denominator: Denominator for basic net income per share - weighted average shares 81,408 78,943 Incremental common shares attributable to shares issuable under employee stock plans 9,533 12,265 -------- -------- Denominator for diluted net income per share - weighted average shares 90,941 91,208 ======== ======== Net income per share - basic $ 0.20 $ 0.12 ======== ======== Net income per share - diluted $ 0.18 $ 0.11 ======== ======== At March 31, 2001, options to purchase 551,550 shares of common stock with an average price of $97.66 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 period then ended. At March 31, 2000 there were no options considered anti-dilutive. The 4,494,400 shares of common stock reserved for issuance upon conversion of the outstanding convertible subordinated notes issued in 2000 were not included in diluted earnings per share because the assumed conversion would be antidilutive. 6 4. The Company reports components of comprehensive income in its annual consolidated statements of shareholders' equity. Comprehensive income consists of net income and foreign currency translation adjustments. The Company's total comprehensive income was as follows (in thousands): Three months ended March 31, -------------------------- 2001 2000 ---------- ----------- Net income $ 16,149 $ 9,791 Other comprehensive income (loss) 428 (60) Comprehensive income $ 16,577 $ 9,731 ========== =========== 5. The Company has three reportable operating segments including the Americas, Europe, and the Rest of the World. 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. Financial information for the Company's operating segments is summarized below for the three months ended March 31, 2001 and 2000 (in thousands):
Three months ended March 31, ----------------------------- 2001 2000 ------------ ------------ Net revenues to third parties: Americas....................................................................... $ 61,200 $ 41,200 Europe......................................................................... 21,700 13,900 Rest of the World.............................................................. 7,800 5,300 Consolidated................................................................ $ 90,700 $ 60,400 ============ ============
March 31, December 31, 2001 2000 -------------- -------------- Identifiable assets: Americas.............................................................. $ 804,472 $ 808,583 Europe................................................................ 36,225 21,538 Rest of the World..................................................... 152,866 146,254 Consolidated....................................................... $ 993,563 $ 976,375 ============== ==============
The subsidiary located in the United Kingdom accounted for 11% and 7% of the consolidated net revenue to unaffiliated customers for the three months ended March 31, 2001 and March 31, 2000, respectively. Operations located in Israel accounted for 14% and 13% of the consolidated identifiable assets at March 31, 2001 and December 31, 2000, respectively. No other subsidiary represented 10% or more of the related consolidated amounts for the periods presented. 6. The Company adopted Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 137 and SFAS 138, in the first fiscal quarter of 2001. SFAS 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities, and requires that all derivatives, including foreign currency exchange contracts, be recognized on the balance sheet at fair value. Changes in the fair value of derivatives that do not qualify for hedge treatment must be recognized currently in earnings. All of the Company's derivative financial instruments are recorded at their fair value in other current assets. The transition adjustment upon adoption of SFAS 133 was not material. The Company has entered into forward foreign exchange contracts ("forward contracts") to hedge foreign currency denominated receivables due from certain European and Pacific Rim Subsidiaries against fluctuations in exchange rates. The Company does not enter into forward contracts for speculative or trading purposes. The criteria used for designating a forward contract as a hedge considers its effectiveness in reducing risk by matching hedging instruments to underlying transactions. Gains and losses on forward contracts are recognized in other income in the same 7 period as gains and losses on the underlying transactions. The Company had outstanding forward contracts with notional amounts totaling approximately $16.8 million and $13.0 million at March 31, 2001 and December 31, 2000, respectively. The open forward contracts at March 31, 2001 mature at various dates through March 2002 and are hedges of certain foreign currency transaction exposures in the Australian Dollar, British Pound, Danish Krone, French Franc, Euro, German Mark, Norwegian Kroner, Japanese Yen and Swedish Krona. The unrealized net gain on the Company's forward contracts for the three months ended March 31, 2001 was approximately $826 thousand. 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 46% to $61.2 million for the three months ended March 31, 2001 from $42.0 million for the three months ended March 31, 2000. Our growth in license revenue is attributable primarily to growth in license fees from LoadRunner, WinRunner and TestDirector products as well as revenue from our new Application Performance Management (APM) and Managed Service Provider (MSP) offerings. Service revenue increased 60% to $29.5 million for the three months ended March 31, 2001 from $18.4 million for the three months ended March 31, 2000. The increase in service revenue is a result of new maintenance contracts accompanying the growth in license revenue as well as renewals of existing maintenance contracts. We expect that service revenue will continue to increase in absolute dollars as long as our customer base continues to grow. Cost of revenue License cost of revenue includes cost of materials, product packaging, equipment depreciation, production personnel and costs associated with our MSP. License cost of revenue, as a percentage of license revenue, increased to 10% for the three months ended March 31, 2001 from 5% for the three months ended March 31, 2000. The increase was primarily due to additional personnel, depreciation of capital equipment, and Internet service fees for our MSP business. Service cost of revenue consists primarily of costs of providing customer technical support, training and consulting. Service cost of revenue increased to $7.6 million for the three months ended March 31, 2001 compared to $4.8 million for the three months ended March 31, 2000. Service cost of revenue, as a percentage of service revenue, was 26% for both the three months ended March 31, 2001 and 2000. The absolute dollar increase in service cost of revenue was primarily due to an increase in personnel-related costs reflecting growth in customer support and consulting headcount and an increase in training and consulting outsourcing expense. Service cost of revenue as 8 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 expense consists primarily of costs associated with the development of new products, enhancements of existing products, and quality assurance procedures, and is comprised primarily of employee salaries and related costs, consulting costs, equipment depreciation and facilities expenses. For the three months ended March 31, 2001, research and development was $9.3 million, or 10% of total revenue, compared to $7.1 million, or 12% of total revenue for the three months ended March 31, 2000. The increase in absolute dollars of research and development spending in the three months ended March 31, 2001 reflected an increase in spending due to growth in research and development headcount and increased personnel related costs including salaries and fringe benefits of research and development engineers. Marketing and selling Marketing and selling expense consists primarily of employee salaries and related costs, sales commissions, facilities expenses and marketing programs. Marketing and selling expenses were $47.7 million, or 53% of total revenue for the three months ended March 31, 2001, compared to $32.5 million, or 54% of total revenue for the three months ended March 31, 2000. The absolute dollar increase in marketing and selling expenses was primarily due to increased commission expense attributable to the higher revenue level, an increase in personnel-related costs reflecting the growth in sales and marketing headcount, including the increase in sales headcount related to our cybersales organization and APM business, 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 expense consists primarily of employee salaries and costs related to executive and finance personnel. General and administrative expenses were $5.0 million, or 6% of total revenue for the three months ended March 31, 2001, compared to $3.4 million or 6% of total revenue for the three months ended March 31, 2000. The increase in absolute dollar spending reflected increased staffing and associated costs necessary to manage and support our growing operations. 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 for the three months ended March 31, 2001, from $2.6 million for the three months ended March 31, 2000, reflected primarily increased interest income from the proceeds of the issuance of 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 2010. Future provisions for taxes will depend upon the mix of worldwide income and the tax rates in effect for various tax jurisdictions. Liquidity and Capital Resources At March 31, 2001, our principal source of liquidity consisted of $797.4 million of cash and investments compared to $782.4 million at December 31, 2000. The March 31, 2001 balance included $636.8 million of short-term and $160.6 million of long-term investments in high quality financial, government, and corporate securities. During the three months ended March 31, 2001, we generated approximately $15.8 million cash from operations primarily from our net income. 9 Our primary investing activities consisted of purchases of property and equipment in the amount of $6.4 million during the three months ended March 31, 2001. This included $1.6 million for the renovation of headquarters buildings in Synnyvale, California as well as $600,000 for the construction of research and development facilities in Israel. We expect to spend an additional $6.0 million to complete the renovation of our newly purchased buildings in Sunnyvale, California, and expect to spend an additional $8.0 million to complete the construction of the Israel facilities. Our investing activities also consisted of $5.0 million of venture capital investments made in private companies. We have committed to make additional capital contributions totaling $15.0 million and we expect to pay approximately $10.0 million over the next twelve months as capital calls are made. Our primary financing activity consisted of issuances of common stock under our employee stock option and stock purchase plans. During the three months ended March 31, 2001, we received $10.2 million from the issuance of common stock, net of notes receivable collected from issuance of common stock. Assuming there is no significant change in our business, we believe that our current cash and investment balances and cash flow from operations will be sufficient to fund our cash needs for at least the next twelve months. We also expect to satisfy our financing requirements through the incurrence of debt from time to time. 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 continually improving the performance, features and reliability of our existing products and services and responding to competitive offerings. Our business will suffer if we do not successfully respond to rapid technological changes. The market for our software products is characterized by: . rapidly changing technology; . frequent introduction of new products and services and enhancements to existing products and services by our competitors; . increasing complexity and interdependence of Web-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 services 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, and it is difficult to predict our future revenues and operating results. 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; 10 . 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 and changes in their budgets for software and Web-related purchases; . changes in economic conditions affecting our customers or our industry; . 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 enhancements; and . the mix of our domestic and international sales, together with fluctuations in foreign currency exchange rates. In addition, the timing of our license revenues is difficult to predict because our sales cycles are typically short and can vary substantially from product to product and customer to customer. We base our operating expenses on our expectations regarding future revenue levels. As a result, if total revenues for a particular quarter are below our expectations, we could not proportionately reduce operating expenses for that quarter. We have experienced seasonality in our revenues and earnings, with the fourth quarter of the year typically having the highest revenue and earnings for the year and higher revenue and earnings than the first quarter of the following year. We believe that this seasonality results primarily from the budgeting cycles of our customers and from the structure of our sales commission program. We expect this seasonality to continue in the future. In addition, our customers' decisions to purchase our products and services are discretionary and subject to their internal budgets and purchasing processes. A slowdown in the economy may cause customers to reassess their immediate technology needs and to defer purchasing decisions, and accordingly could reduce demand for our products and services. 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 trading prices of our securities could decline. We expect to face increasing competition in the future, which could cause reduced sales levels and result in price reductions, reduced gross margins or loss of market share. The market for our testing and application performance management products and services is extremely competitive, dynamic and subject to frequent technological changes. There are few substantial barriers of entry in our market. In addition, the use of the Internet for a growing range of Web applications is a recent and emerging phenomenon. The Internet lowers the barriers of entry, allowing other companies to compete with us in the testing and application performance management markets. As a result of the increased competition, our success will depend, in large part, on our ability to identify and respond to the needs of potential customers, and to new technological and market opportunities, before our competitors identify and respond to these needs and opportunities. We may fail to respond quickly enough to these needs and opportunities. In the market for solutions for testing of applications, our principal competitors include Compuware, Empirix, Radview, Rational Software, 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 companies such as Freshwater Software. In addition, we face potential competition in this market from existing providers of testing solutions such as Segue Software. 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. Our competitors and potential competitors may 11 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 systems integrators, value-added resellers, ASPs, ISPs or ISVs. We expect that sales of our products through these channels will continue to account for a substantial portion of our revenues for the foreseeable future. We have also entered into private labelling arrangements with ASPs and an enterprise software company who incorporate our products and services into theirs. We may not experience increased revenues from these new channels, which could harm our business. The loss of one or more of our systems integrators, value-added resellers, ASPs, ISPs or ISVs, 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: . each of our systems integrators, value-added resellers, ASPs, ISPs or ISVs can cease marketing our products and services with limited or no notice and with little or no penalty; . our existing systems integrators, value-added resellers, ASPs, ISPs or ISVs 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 systems integrators, value-added resellers, ASPs, ISPs or ISVs if we lose any of our existing ones; . our systems integrators, value-added resellers, ASPs, ISPs or ISVs 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 systems integrators, value-added resellers, ASPs, ISPs or ISVs may not give priority to the marketing of our products and services as compared to our competitors' products. In March 1999, we entered into an agreement with Tivoli Systems, a subsidiary of IBM, for the joint development and marketing of a family of products for enterprise application performance management, incorporating elements of our technology, which would be marketed and sold only by Tivoli. Under this agreement, we agreed that as long as Tivoli continued to pay minimum royalties, 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 we would not enter into technology relationships to create similar products with specified competitors of Tivoli as long as Tivoli continued to agree to pay minimum royalties. In October 2000, Tivoli elected not to continue paying their required minimum royalties and the exclusive provisions of this agreement terminated. Tivoli continues to have the rights to market and sell these elements of our technology on a non-exclusive basis. Tivoli has since communicated to us that it has released a new version of the APM product that does not contain our technology, and has therefore discontinued the sale of the old version with our technology. We depend on strategic relationships and business alliances for continued growth of our business. Our development, marketing and distribution strategies rely increasingly on our ability to form strategic relationships with software and other technology companies. These business relationships often consist of cooperative marketing programs, joint customer seminars, lead referrals and cooperation in product development. Many of these relationships are not contractual and depend on the continued voluntary cooperation of each party with us. Divergence in strategy or change in focus by, or competitive product offerings by, any of these companies may interfere with our ability to develop, market, sell or support our products, which in turn could harm our business. Further, if these companies enter into strategic alliances with other companies or are acquired, they could reduce their support of our products. Our existing relationships may be jeopardized if we enter into alliances with 12 competitors of our strategic partners. In addition, one or more of these companies may use the information they gain from their relationship with us to develop or market competing products. If we are unable to manage our growth, our business may be harmed. Since 1991, we have experienced significant annual increases in revenue, employees and number of product and service offerings. This growth has placed and, if it continues, will place a significant strain on our management and our financial, operational, marketing and sales systems. If we cannot manage our growth effectively, our business, competitive position, operating results and financial condition could suffer. Although we are implementing a variety of new or expanded business and financial systems, procedures and controls, including the improvement of our sales and customer support systems, the implementation of these systems, procedures and controls may not be completed successfully, or may disrupt our operations. Any failure by us to properly manage these transitions could impair our ability to attract and service customers and could cause us to incur higher operating costs and experience delays in the execution of our business plan. The success of our business depends on the efforts and abilities of our senior management and other key personnel. We depend on the continued services 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 33% and 32% for the three months ended March 31, 2001 and 2000, respectively. In addition, we have substantial research and development operations in Israel. We face risks associated with our international operations, including: . changes in taxes and regulatory requirements; . difficulties in staffing and managing foreign operations; . reduced protection for intellectual property rights in some countries; . the need to localize products for sale in international markets; . longer payment cycles to collect accounts receivable in some countries; . seasonal reductions in business activity in other parts of the world in which we operate; . political and economic instability; and . economic downturns in international markets. Any of these risks could harm our international operations and cause lower international sales. For example, some European countries already have laws and regulations related to technologies used on the Internet that are more strict than those currently in force in the United States. Any or all of these factors could cause our business to be harmed. 13 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. 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. Acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert the attention of our management. We may acquire or make investments in other companies and technologies. 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; 14 . assume liabilities; . incur expenses for the impairment of the value of investments or acquired assets; . incur amortization expense related to intangible assets; or . incur large write-offs. If we fail to achieve the financial and strategic benefits of past and future acquisitions or investments, 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 may fluctuate significantly, which may result in losses for investors and possible lawsuits. The market price for our common stock has been and may continue to be volatile. For example, during the 52-week period ended April 27, 2001, 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 $31.875. 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, acquisitions or investments; . 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 the trading prices of our securities 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, trademark, service mark 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 15 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 abroad and could result in an award of substantial damages against us. In the event of a claim of infringement, we may be required to obtain licenses from third parties, develop alternative technology or to alter our products or processes or cease activities that infringe the intellectual property rights of third parties. If we are required to obtain licenses, we cannot be sure that we will be able to do so at a commercially reasonable cost, or at all. Defense of any lawsuit or failure to obtain required licenses could delay shipment of our products and increase our costs. In addition, any such lawsuit could result in our incurring significant costs or the diversion of the attention of our management. Defects in our products may subject us to product liability claims and make it more difficult for us to achieve market acceptance for these products, which could harm our operating results. Our products may contain errors or "bugs" that may be detected at any point in the life of the product. Any future product defects discovered after shipment of our products could result in loss of revenues and a delay in the market acceptance of these products that could adversely impact our future operating results. In selling our products, we frequently rely on "shrink wrap" or "click wrap" licenses that are not signed by licensees. Under the laws of various jurisdictions, the provisions in these licenses limiting our exposure to potential product liability claims may be unenforceable. We currently carry errors and omissions insurance against such claims, however, we cannot assure you 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 product liability claim, we may be found liable and required to pay damages which would seriously harm our business. We have adopted anti-takeover defenses that could delay or prevent an acquisition of our company, including an acquisition that would be beneficial to our stockholders. Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no present plans to issue shares of preferred stock. Furthermore, certain provisions of our Certificate of Incorporation and of Delaware law may have the effect of delaying or preventing changes in our control or management, which could adversely affect the market price of our common stock. Leverage and debt service obligations may adversely affect our cash flow. In July 2000, we completed an offering of convertible subordinated notes with a principal amount of $500 million. We now have a substantial amount of outstanding indebtedness, primarily the convertible subordinated notes. There is the possibility that we 16 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 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 sheets to fluctuation in interest rates. At March 31, 2001, $458.8 million, or 58%, of our cash, cash equivalents and investment portfolio carried a maturity of less than 90 days, and $636.8 million, or 80%, carried a maturity of less than one year. All investments mature, by policy, in less than three years. The fair value of the convertible subordinated debentures fluctuates based upon changes in the price of our common stock, changes in interest rates, and our credit worthiness. 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 ("forward contracts") to hedge foreign currency denominated receivables due from certain European and Pacific Rim subsidiaries against fluctuations in exchange rates. We have not entered into forward 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 forward contract as a hedge considers its effectiveness in reducing risk by matching hedging instruments to underlying transactions. Gains and losses on forward contracts are recognized in other income in the same period as gains and losses on the underlying transactions. The effect of an immediate 10% change in exchange rates would not have a material impact on our operating results or cash flows. From time to time, we make investments in private companies, particularly private companies that are strategic partners or customers of ours. As of March 31, 2001, we had invested $5.0 million in private companies. In addition, we have committed to make capital contributions to a venture capital fund totaling $15.0 million and we expect to pay approximately $10.0 million over the next twelve months as capital calls are made. If the companies in which we have made investments do not complete initial public offerings or are not acquired by publicly traded companies, we may not be able to sell these investments. In addition, even if we are able to sell these investments we cannot assure that we will be able to sell them at a gain or even recoup our investment. The recent general decline in the Nasdaq Stock Market and the market prices of publicly traded technology companies, as well as any further declines in the future, will adversely affect our ability to realize gains or a return of our capital on many of these investments. PART II. OTHER INFORMATION Item 4. Exhibits and Reports on Form 8-K (a) No reports on Form 8-K were filed during the three months ended March 31, 2001. 17 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MERCURY INTERACTIVE CORPORATION (Registrant) Dated: May 15, 2001 By: /s/ Sharlene Abrams --------------------------------------- Sharlene Abrams, Chief Financial Officer and Vice President of Finance and Administration 18 -----END PRIVACY-ENHANCED MESSAGE-----