-----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, UXcCXpZ2cUPDAYULTKNAQ5hMd0B780VoSUXjobTfGsdv656OEP8ie16tgyRS0dJu PL8Nz6cuUyEkFUU9IILmRQ== 0001012870-98-002925.txt : 19981118 0001012870-98-002925.hdr.sgml : 19981118 ACCESSION NUMBER: 0001012870-98-002925 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 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: 98751147 BUSINESS ADDRESS: STREET 1: 470 POTRERO AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 BUSINESS PHONE: 4085239900 MAIL ADDRESS: STREET 1: 470 POTRERO AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 10-Q 1 FORM 10-Q FOR QUARTER ENDED 09/30/1998 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, 1998 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, 1998 was 17,658,085. MERCURY INTERACTIVE CORPORATION INDEX PART 1. FINANCIAL INFORMATION
Page No. -------- Item 1. Financial Statements: Condensed Consolidated Balance Sheets - September 30, 1998 and December 31, 1997 3 Condensed Consolidated Statements of Operations - Three and nine months ended September 30, 1998 and 1997 4 Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 1998 and 1997 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 15 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Stockholders 16 Item 5. Other Information 17 Item 6. 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)
September 30, December 31, 1998 1997 (unaudited) (audited) ------------- ------------ ASSETS Current assets: Cash and cash equivalents $ 70,382 $ 57,211 Short-term investments 48,554 31,357 Trade accounts receivable 19,527 23,782 Government grants and other receivables 3,179 3,606 Inventories 214 252 Other current assets 7,364 2,954 ------- ------- Total current assets 149,220 119,162 Long-term investments --- 3,771 Property and equipment, net 27,537 19,292 Other assets 735 1,185 ------- ------- $ 177,492 $ 143,410 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,248 $ 4,045 Accrued liabilities 17,664 15,411 Deferred revenue 21,361 10,967 ------- ------- Total current liabilities 43,273 30,423 ------- ------- Commitments and contingencies Stockholders' equity: Common stock 35 33 Capital in excess of par value 116,730 107,800 Cumulative translation adjustment (602) (424) Retained earnings 18,056 5,578 ------- ------- Total stockholders' equity 134,219 112,987 ------- ------- $ 177,492 $ 143,410 ======= =======
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 Sept 30, Sept 30, 1998 1997 1998 1997 ---- ---- ---- ---- Revenue: License $ 21,550 $ 14,300 $ 56,250 $ 37,883 Service 9,050 5,300 23,750 14,617 ------- ------ ------- ------- Total revenue 30,600 19,600 80,000 52,500 ------- ------ ------- ------- Cost of revenue: License 1,545 1,073 4,266 2,969 Service 2,959 1,520 8,051 4,346 ------- ------ ------- ------- Total cost of revenue 4,504 2,593 12,317 7,315 ------- ------ ------- ------- Gross profit 26,096 17,007 67,683 45,185 ------- ------ ------- ------- Operating expenses: Research and development, net 4,098 2,970 10,777 8,454 Write off of in-process research and development and related expenses --- 5,500 --- 5,500 Marketing and selling 14,146 9,154 38,508 25,502 General and administrative 2,042 1,786 5,790 4,779 ------- ------ ------- ------- Total operating expenses 20,286 19,410 55,075 44,235 ------- ------ ------- ------- Income (loss) from operations 5,810 (2,403) 12,608 950 Other income, net 1,214 816 2,989 2,371 ------- ------ ------- ------- Income (loss) before provision for income taxes 7,024 (1,587) 15,597 3,321 Provision for income taxes 1,405 683 3,119 1,664 ------- ------ ------- ------- Net income (loss) $ 5,619 $ (2,270) $ 12,478 $ 1,657 ======= ====== ======= ======= Net income (loss) per share (basic) $ 0.32 $ (0.14) $ 0.72 $ 0.10 ======= ====== ======= ======= Net income (loss) per share (diluted) $ 0.29 $ (0.14) $ 0.64 $ 0.10 ======= ====== ======= ======= Weighted average common shares (basic) 17,488 16,433 17,255 16,279 ======= ====== ======= ======= Weighted average common shares and equivalents (diluted) 19,557 16,433 19,369 17,138 ======= ====== ======= =======
See accompanying notes to condensed consolidated financial statements --------------------------------------------------------------------- 4 MERCURY INTERACTIVE CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited)
Nine months ended Sept 30, 1998 1997 ---- ---- Net cash provided by operating activities $ 29,435 $ 12,974 Cash flows from investing activities: Investment proceeds, net (13,426) 122 Acquisition of property and equipment (11,592) (10,075) Capitalization of software development costs - (400) ------- ------- Net cash used in investing activities (25,018) (10,353) ------- ------- Cash flows from financing activities: Proceeds from issuance of common stock 8,932 4,041 ------- ------- Net cash provided by financing activities 8,932 4,041 ------- ------- Effect of exchange rate changes on cash (178) (347) ------- ------- Net increase in cash and cash equivalents 13,171 6,315 Cash and cash equivalents at beginning of period 57,211 44,337 ------- ------- Cash and cash equivalents at end of period $ 70,382 $ 50,652 ======= =======
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, 1997, included in the 1997 Form 10-K. The condensed consolidated statement of operations for the nine months ended September 30, 1998 is not necessarily indicative of results to be expected for the entire fiscal year ending December 31, 1998. 2. The effective tax rate for the nine months ended September 30, 1998 differs from statutory tax rates principally because of special reduced taxation programs sponsored by the government of Israel. 3. The Company obtained grants for research and development from the Office of the Chief Scientist in the Israeli Ministry of Industry and Trade in the amounts of $369,000 and $1.6 million in the quarter and the nine months ended September 30, 1998, respectively, and $1.1 million in the nine months ended September 30, 1997. These grants are accounted for using the cost reduction method, under which research and development expenses are decreased by the amounts of the grants. The Company is not obligated to repay these grants; however, it has agreed to pay royalties at rates ranging from 2% to 5% of product sales resulting from the research, up to the amount of the grants obtained and, for certain grants, up to 150% of the grants obtained. Royalty expense under these agreements amounted to approximately $715,000 and $1.8 million for the quarter and the nine months ended September 30, 1998, respectively, and $307,000 and $1.2 million for the quarter and the nine months ended September 30, 1997, respectively. As of September 30, 1998, the Company is committed to pay, if and when incurred, approximately $3.6 million in royalties. 4. Earnings per share are calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 128, "Earnings per Share," (SFAS 128). SFAS 128 requires the Company to report both basic earnings per share, which is the weighted-average number of common shares outstanding, and diluted earnings per share, which includes the weighted- average common shares outstanding and all dilutive potential common shares outstanding. For the quarters ended September 30, 1998 and 1997, 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 quarters and the nine months ended September 30, 1997 and 1998:
Three months ended Nine months ended Sept 30, Sept 30, 1998 1997 1998 1997 ---- ---- ---- ---- Net income (loss) for basic and diluted earnings per share $ 5,619 $ (2,270) $ 12,478 $ 1,657 ======= ======= ======= ======= Weighted average shares 17,488 16,433 17,255 16,279 Effect of dilutive securities 2,069 - 2,114 859 ------- ------- ------- ------- Adjusted weighted average shares 19,557 16,433 19,369 17,138 ------- ------- ------- ------- Net income (loss) per share (basic) $ 0.32 $ (0.14) $ 0.72 $ 0.10 ======= ======= ======= ======= Net income (loss) per share (diluted) $ 0.29 $ (0.14) $ 0.64 $ 0.10 ======= ======= ======= =======
At September 30, 1998, there were no options considered anti-dilutive. At September 30, 1997, options to purchase a total of 106,677 shares of common stock with an average exercise price of $19.00 were considered anti- dilutive because the options' exercise price was greater than the average fair market value of the Company's common stock for the quarter then ended. 6 5. Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement requires that all items recognized under accounting standards as components of comprehensive earnings be reported in an annual financial statement that is displayed with the same prominence as other annual financial statements. This Statement also requires that an entity classify items of other comprehensive earnings by their nature in an annual financial statement. Net exchange gains or losses resulting from the translation of assets and liabilities of foreign subsidiaries, except those in highly inflationary economies, are accumulated in a separate section of stockholders' equity titled, "Cumulative translation adjustment." Also included are the effects of exchange rate changes on the intercompany transactions of a long-term investment nature. An analysis of this account follows:
Three months ended Nine months ended September 30, September 30, 1998 1997 1998 1997 ---- ---- ---- ---- Opening balance $(363) $(375) $(424) $ (99) Translation adjustments (239) (71) (178) (347) ----- ----- ----- ----- Ending balance $(602) $(446) $(602) $(446) ===== ===== ===== =====
6. In June 1998, the Financial Accounting Standards Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments and for hedging activities and is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not expect the adoption of SFAS 133 to have a material impact on the Company's results of operations. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management's Discussion and Analysis of Financial Condition and Results of Operations contains descriptions of the Company's expectations regarding future trends affecting its business. These forward looking statements and other forward looking statements made elsewhere in this document are made in reliance upon the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Please read the section below titled "Factors that may affect future results" to review conditions which the Company believes could cause actual results to differ materially from those contemplated by the forward looking statements. Forward-looking statements include, but are not limited to, those items identified with a footnote symbol /1/. The Company undertakes no obligation to update the information contained herein. RESULTS OF OPERATIONS REVENUE License revenue increased 51% to $21.6 million during the third quarter of 1998 from $14.3 million in the third quarter of 1997. License revenue increased 48% to $56.3 million during the nine months ended September 30, 1998 from $37.9 million during the nine months ended September 30, 1997. The Company's growth in license revenue reflected growth in license fees from the LoadRunner, WinRunner and Test Director products, particularly for use by customers to test Year 2000 remediation applications and electronic business and enterprise resource planning application deployments. License revenue in the third quarter of 1998 also benefited in absolute dollars from increased productivity from the Company's alternate distribution channels, such as referral partners, system integrators and value added resellers. Service revenue increased to $9.1 million or 30% of total revenue in the third quarter of 1998 from $5.3 million or 27% of total revenue in the third quarter of 1997 and increased to $23.8 million, or 30% of total revenue in the nine months ended September 30, 1998, from $14.6 million, or 28% of total revenue in the nine months ended September 30, 1997. This increase of service revenue in 1998 compared to 1997 was primarily due to the renewal of maintenance contracts and an increase in training and consulting revenue. The Company expects that service revenue will continue to increase in absolute dollars as long as the Company's customer base continues to grow./1/ North American revenue in the quarter and the nine months ended September 30, 1998 represented 66% and 63%, respectively, of total revenue. International revenue in the quarter and the nine months ended September 30, 1998 represented 34% and 37%, respectively, of total revenue. The Company expects international revenue to continue to increase in absolute dollars, however, achievement of these results cannot be assured./1/ COST OF REVENUE License cost of revenue, as a percentage of license revenue, was 7% and 8% in the quarter and the nine months ended September 30, 1998, respectively, compared to 8% in both the quarter and the nine months ended September 30, 1997. License cost of revenue includes cost of production personnel, product packaging and amortization of capitalized software development costs. Service cost of revenue, as a percentage of service revenue was 33% and 34% in the quarter and the nine months ended September 30, 1998, respectively, compared to 29% and 30% in the quarter and the nine months ended September 30, 1997, respectively. Service cost of revenue consists primarily of costs of providing customer technical support, training and consulting. The increased service cost of revenue in the quarter and the nine months ended September 30, 1998 reflected increased outsourcing of training and consulting. ________________________________ /1/ Forward looking statement 8 RESEARCH AND DEVELOPMENT Research and development, net was $4.1 million and $10.8 million, or 13% of total revenue for the quarter and the nine months ended September 30, 1998, respectively, compared to $3.0 million and $8.5 million, or 15% and 16% of total revenue for the quarter and the nine months ended September 30, 1997, respectively. The increase in spending in absolute dollars reflected increased personnel costs from headcount growth and increased research and development consulting costs. The Company obtained grants for research and development from the Office of the Chief Scientist in the Israeli Ministry of Industry and Trade in the amounts of $369,000 and $1.6 million in the quarter and the nine months ended September 30, 1998, respectively, and $1.1 million in the nine months ended September 30, 1997. These grants are accounted for using the cost reduction method, under which research and development expenses are decreased by the amounts of the grants. The Company is not obligated to repay these grants; however, it has agreed to pay royalties at rates ranging from 2% to 5% of product sales resulting from the research, up to the amount of the grants obtained and, for certain grants, up to 150% of the grants obtained. Royalty expense under these agreements amounted to approximately $715,000 and $1.8 million for the quarter and the nine months ended September 30, 1998, respectively, and $307,000 and $1.2 million for the quarter and the nine months ended September 30, 1997, respectively. As of September 30, 1998, the Company is committed to pay, if and when incurred, approximately $3.6 million in royalties. During the quarter and the nine months ended September 30, 1998, the Company did not capitalize any software development costs. The Company capitalized $100,000 and $400,000 in the quarter and the nine months ended September 30, 1997, respectively, in accordance with Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." Amortization charges included in cost of license revenues were $150,000 and $450,000 for the quarter and the nine months ended September 30, 1998 and 1997, respectively. At September 30, 1998 and December 31, 1997, the Company had a balance in capitalized software development costs of approximately $735,000 and $1.2 million, respectively. The Company intends to continue making significant expenditures on research and development to develop new products and expand the platforms and operating systems on which its products are offered./1/ While the Company believes that these current research and development expenditures will be beneficial in the long term development of its business, there can be no assurances that the development of products will be successful or will not be rendered obsolete by future technology acquisitions or developments./1/ Research and development expenditures are incurred substantially in advance of related revenue and in some cases do not result in the generation of revenue. MARKETING AND SELLING Marketing and selling expenses were $14.1 million, or 46% of total revenue, and $38.5 million, or 48% of total revenue, in the quarter and the nine months ended September 30, 1998, respectively, compared to $9.2 million, or 47% of total revenue, and $25.5 million, or 49% of total revenue, in the quarter and the nine months ended September 30, 1997, respectively. The increase in absolute dollars in marketing and selling expense was primarily due to an increase in commission expense attributable to the higher revenue level and other personnel-related costs reflecting the growth in sales headcount. The Company expects marketing and selling expenses to increase in absolute dollars as total revenue increases, but such expenses may vary as a percentage of revenue./1/ GENERAL AND ADMINISTRATIVE General and administrative expenses were $2.0 million and $5.8 million, or 7% of total revenue, in both the quarter and the nine months ended September 30, 1998, respectively, compared to $1.8 million and $4.8 million, or 9% of total revenue, in both the quarter and the nine months ended September 30, 1997, respectively. The increase in absolute dollars reflected increased personnel and information systems costs. ________________________________ /1/ Forward looking statement 9 OTHER INCOME, NET Other income, net consists primarily of interest income and foreign exchange gains and losses. The increase in other income, net to $1.2 million and $3.0 million for the quarter and the nine months ended September 30, 1998, respectively, from $816,000 and $2.4 million for the quarter and the nine months ended September 30, 1997, respectively, reflected increased interest income on higher average cash and investment balances in the quarter and the nine months ended September 30, 1998. PROVISION FOR INCOME TAXES The Company participates in special programs sponsored by the government of Israel relating to taxation, contributing to significant lower income tax expense than expected based on the U.S. federal income tax rate. Future provisions for taxes will depend upon the mix of worldwide income and the tax rates in effect for various tax jurisdictions. NET INCOME The Company reported net income of $5.6 million and $12.5 million in the quarter and the nine months ended September 30, 1998, respectively, compared to net loss of $2.3 million and net income of $1.7 million in the quarter and the nine months ended September 30, 1997, respectively. The Company's operating expenses are based, in part, on its expectations of future revenues, and expenses are generally incurred in advance of revenues. The Company plans to continue to expand and increase its operating expenses to support anticipated revenue growth./1/ If revenue does not materialize in a quarter as expected, the Company's results from operations for the quarter are likely to be materially adversely affected. Net income may be disproportionately affected by a reduction in revenue because only a small portion of the Company's expenses varies with its revenue. INFLATION Inflation has not had a significant impact on the Company's operating results to date. YEAR 2000 The approach of Year 2000 presents significant issues for many computer systems, since much of the software in use today may not accurately process data beyond 1999. The Company is in the process of conducting an internal review of most of its internal corporate headquarters computer systems and software ("IT Systems") including finance, human resources, Intranet applications, payroll systems and customer support organization systems to determine their Year 2000 compliance. As part of this process, the Company is contacting vendors of its relevant internal corporate headquarters IT Systems to determine potential exposure to Year 2000 issues and will be obtaining written assurance from such vendors regarding Year 2000 compliance. Although the Company believes that most of its principal internal corporate headquarters IT Systems are Year 2000 compliant, the Company has not yet made an assessment of the status of other property and equipment not directly associated with information systems. At this time, the Company has not determined the state of compliance of certain third-party suppliers of services such as phone companies, long distance carriers, financial institutions and electric companies. The failure of any one of these third-party suppliers could severely disrupt the Company's ability to carry on its business as well as disrupt the business of the Company's customers. The Company is beginning the process of polling these companies in order to determine contingency plans. ________________________________ /1/ Forward looking statement 10 Failure of the Company to provide Year 2000 compliant business solutions to its customers or to receive such business solutions from its suppliers could result in liability to the Company or otherwise have a material adverse effect on the Company's business, results of operations, financial condition and prospects. Furthermore, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase products and services such as those offered by the Company, which could result in a material adverse effect on the Company's business, results of operations and financial condition. The Company could be affected through disruptions in the operation of the enterprises with which the Company interacts or from general widespread problems or an economic crisis resulting from noncompliant Year 2000 systems. Despite the Company's efforts to address the Year 2000 effect on its internal systems and business operations, such effect could result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. The Company has just begun the process of developing a contingency plan to respond to any of the foregoing consequences of internal and external failures to be Year 2000 compliant. In selling its products, the Company frequently relies on "shrink wrap" licenses that are not signed by licensees. The provisions in such licenses limiting the Company's exposure to potential product liability claims may therefore be unenforceable under the laws of certain jurisdictions. Further, the Company's license agreements typically contain a representation that the software is Year 2000 compliant through its description of specifically how the Company's products process the Year 2000 calendar dates. While the Company believes its products are Year 2000 compliant, the risk of Year 2000 noncompliance claims may increase as December 31, 1999 approaches and passes. The Company currently carries errors and omissions insurance against such claims, however, there can be no assurance that such insurance will continue to be available on acceptable terms, if at all, or that such insurance will provide the Company with adequate protection against any such claims. Although the Company has not experienced any product liability or other Year 2000 claims to date, the sale and support of products by the Company may entail the risk of such claims. A significant product liability claim against the Company would have a material adverse effect upon the Company's business, financial condition and results of operations. FACTORS THAT MAY AFFECT FUTURE RESULTS The Company operates in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. The following section lists some, but not all, of those risks and uncertainties which may have a material adverse effect on the Company's business, financial condition or results of operations. This section should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto included in Part I - Item 1 of this Quarterly Report on Form 10-Q and the audited Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 1997, contained in the Company's 1997 Form 10-K. The Company has identified certain forward-looking statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations with a footnote symbol /1/. The Company may also make oral forward looking statements from time to time. Actual results may differ materially from those projected in any such forward looking statements due to a number of factors, including those set forth below and elsewhere in this Form 10-Q. The market for software products is generally characterized by rapidly changing technology, frequent new product introductions and changes in customer requirements which can render existing products obsolete or unmarketable. The Company believes that a major factor in its future success will be its ability to continue to develop and introduce in a timely and cost-effective manner enhancements to its existing products and new products that will gain market acceptance. There can be no assurance that the Company will be able to identify, develop, manufacture, market or support new products or enhancements successfully, that any such new products or enhancements will gain market acceptance, or that the Company will be able to respond effectively to technological changes. There can be no assurance that the Company will not encounter technical or other difficulties that could delay introduction of new products in the future. If the Company is unable to introduce new products or enhancements and respond to industry changes on a timely basis, its business could be materially adversely affected. 11 The market for automated software testing products is relatively new and not well penetrated. Marketing and sales techniques in the automated software testing marketplace, as well as the bases for competition, are not well established. There can be no assurance that the market for automated software testing products will continue to expand or that the Company's products will be accepted in any expanded market. Although the Company believes that the current trend toward increased use of automated software testing will continue, there can be no assurance that the automated software testing market will enjoy continued growth./1/ The Company's current products and products under development are limited in number and concentrated exclusively in the automated software testing market. The life cycles of the Company's products are difficult to estimate due, in large measure, to the recent emergence of the Company's market as well as the unknown future effect of product enhancements and competition. Price reductions or declines in demand for the Company's software testing products, whether as a result of competition, technological change or otherwise, would have a material adverse effect on the Company's results of operations or financial position. The Company may from time to time experience significant fluctuation in quarterly operating results due to a variety of factors. Such fluctuations in quarterly operating results may occur in the future due to many factors, some of which are outside of the Company's control. Products are generally shipped as orders are received, and, consequently, quarterly sales and operating results depend primarily on the volume and timing of orders received during the quarter, which are difficult to forecast. In particular, the Company has historically received a substantial portion of its orders at the end of a quarter, up to the last few days of a quarter. If an unanticipated order shortfall occurs at the end of a quarter, the Company's operating results for the quarter could be materially adversely affected. In addition, product orders are affected by the buying patterns of customers. The buying trends of customers are further impacted by internal budgetary considerations relating to Year 2000 remediation or Euro conversion efforts. A significant portion of the Company's operating expenses are relatively fixed, and planned expenditures are based on sales forecasts. All of the foregoing may result in unanticipated quarterly earning shortfalls or losses. Accordingly, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. The market for software products, in general, is highly competitive. The Company continues to face direct competition mainly from well established, publicly-held companies. There could be a material adverse effect on the Company's results of operations or financial position if any of the major software manufacturers, which have significantly greater resources than the Company, decided to devote substantial resources to entering the software testing market or if there is an increase in developing testing utilities internally by the Company's customers or potential customers. A variety of external and internal factors could materially adversely affect the Company's ability to compete. These include the relative functionality, price, performance and reliability of the products offered by the Company and its competitors, the timing and success of new product development or enhancement efforts of the Company and its competitors, and the effectiveness of the marketing and sales efforts of the Company and its competitors. There can be no assurance that the Company will be able to compete successfully in the future or that competitive pressures will not materially adversely affect the Company's business. The Company has derived a substantial portion of its revenues from sales of its products through alternate distribution channels such as referral partners, system integrators, and value-added resellers. The Company expects that sales of its products through its alternate distribution channels will continue to account for a substantial portion of its revenues for the foreseeable future. Each of the Company's system integrators and value added resellers can cease marketing the Company's products with limited notice and with little or no penalty. There can be no assurance that the Company's system integrators and value added resellers will continue to offer the Company's products or that the Company will be able to recruit additional or replacement system integrators and value added resellers. The loss of one or more of the Company's major system integrators and value added resellers could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's system integrators and value added resellers also offer competitive products manufactured by third parties. There can be no assurance that the Company's system integrators and value added resellers will give priority to the marketing of the Company's products as compared to its competitors' products. Any reduction or delay in sales of the Company's ________________________________ /1/ Forward looking statement 12 products by its system integrators and value added resellers could have a material adverse effect on the Company's business, financial condition and results of operations. Sales to customers located outside the United States have historically accounted for a significant percentage of revenue and the Company anticipates that such sales will continue to be a significant percentage of the Company's total revenue./1/ Accordingly, such factors as currency fluctuations, political and economic instability and trade restrictions could have a negative impact on the Company's financial performance. Certain of the Company's sales are made in currencies other than the U.S. Dollar and its financial results are reported in U.S. Dollars. Fluctuations in the rates of exchange between the U.S. Dollar and other currencies may have a material adverse effect on the Company's results of operations and financial position. The Company attempts to limit these exposures through operational strategies and, on a limited basis, by using foreign currency forward contracts to offset the effects of exchange rate changes on intercompany trade payables. The Company's stock price, has been and will continue to be, subject to significant volatility. Past financial performance should not be considered a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods. If revenues or earnings in any quarter fail to meet expectations of the investment community, there could be an immediate and significant impact on the Company's stock price. In addition, the Company's stock price may be impacted by broader market trends that are unrelated to the Company's operating results. As part of its growth strategy, the Company may, from time to time, acquire or invest in complementary businesses, products or technologies. While there are currently no commitments with respect to any particular acquisition or investment, the Company's management frequently evaluates the strategic opportunity available related to complimentary businesses, products or technologies. The process of integrating an acquired company's business into the Company's operations may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for the ongoing development of the Company's business. Moreover, there can be no assurance that the anticipated benefits of any acquisition or investment will be realized. Future acquisitions or investments by the Company could result in potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities, amortization expenses related to goodwill and other intangible assets, any of which could materially adversely affect the Company's operating results and financial condition. Since its inception, the Company has obtained royalty-bearing grants from various Israeli government agencies. There can be no assurances that the Company will be awarded such grants in the future or that if such grants are made available in the future, that the Company will choose to accept them. Termination or substantial reduction of such grants or changes in revenue classification could have a material adverse effect on the Company. The terms of certain grants prohibit the manufacture of products developed under these grants outside of Israel and the transfer of technology developed pursuant to the terms of these grants to any person, without the prior written consent of the government of Israel. As a result, if the Company is unable to obtain the consent of the government of Israel, the Company may not be able to take advantage of strategic manufacturing and other opportunities outside of Israel. Since 1991, the Company has experienced significant annual increases in revenue. This growth has placed and, if it continues, will place a significant strain on the Company's management, resources and operations. To accommodate its recent growth, the Company has been implementing a variety of new or expanded business and financial systems, procedures and controls, including the improvement of its accounting and other internal management systems. There can be no assurance that the implementation of such systems, procedures and controls can be completed successfully, or without disruption of the Company's operations. If the Company's growth continues, the Company will be required to hire and integrate substantial numbers of new employees. The market has become increasingly competitive both in the United States and internationally and may require the Company to pay higher salaries. The Company's failure to manage growth effectively could have a material adverse effect on the Company's results of operations or financial position. ________________________________ /1/ Forward looking statement 13 The Company's success depends to a significant extent on the performance of its senior management and certain key employees. Competition for highly skilled employees, including sales, technical and management personnel, is intense in the computer industry. The Company's failure to attract additional qualified employees or to retain the services of key personnel could materially adversely affect the Company's business. The Company currently relies on a combination of trademark, copyright and trade secret laws and contractual provisions to protect its proprietary rights in its products. The Company presently has no registered copyrights. The Company holds three patents for elements contained in certain of its products, and it has filed several other U.S. and foreign patent applications on various elements of its products. There can be no assurance that any of the Company's patent applications will result in an issued patent or that, if issued, such patent would be upheld if challenged. There can be no assurance that the Company's competitors will not independently develop technologies that are substantially equivalent or superior to the Company's technology. There can also be no assurance that the measures taken by the Company to protect its propriety rights will be adequate to prevent misappropriation of the technology or independent development by others of similar technology. In addition, the laws of various countries in which the Company's products may be sold may not protect the Company's products and intellectual property rights to the same extent as the laws of the United States. There can be no assurance that third parties will not assert intellectual property infringement claims against the Company or that any such claims will not require the Company to enter into royalty or cross-license arrangements or result in costly litigation. In selling its products, the Company frequently relies on "shrink wrap" licenses that are not signed by licensees. The provisions in such licenses limiting the Company's exposure to potential product liability claims may therefore be unenforceable under the laws of certain jurisdictions. Further, the Company's license agreements typically contain a representation that the software is Year 2000 compliant through its description of specifically how the Company's products process the Year 2000 calendar dates. While the Company believes its products are Year 2000 compliant, the risk of Year 2000 noncompliance claims may increase as December 31, 1999 approaches and passes. The Company currently carries errors and omissions insurance against such claims, however, there can be no assurance that such insurance will continue to be available on acceptable terms, if at all, or that such insurance will provide the Company with adequate protection against any such claims. Although the Company has not experienced any product liability or other Year 2000 claims to date, the sale and support of products by the Company may entail the risk of such claims. A significant product liability claim against the Company could have a material adverse effect upon the Company's business, financial condition and results of operations. The approach of Year 2000 presents significant issues for many computer systems, since much of the software in use today may not accurately process data beyond 1999. The Company is in the process of conducting an internal review of most of its internal corporate headquarters computer systems and software ("IT Systems") including finance, human resources, Intranet applications, payroll systems and customer support organization systems to determine their Year 2000 compliance. As part of this process, the Company is contacting vendors of its relevant internal corporate headquarters IT Systems to determine potential exposure to Year 2000 issues and will be obtaining written assurance from such vendors regarding Year 2000 compliance. Although the Company believes that most of its principal internal corporate headquarters IT Systems are Year 2000 compliant, the Company has not yet made an assessment of the status of other property and equipment not directly associated with information systems. At this time, the Company has not determined the state of compliance of certain third-party suppliers of services such as phone companies, long distance carriers, financial institutions and electric companies. The failure of any one of these third-party suppliers could severely disrupt the Company's ability to carry on its business as well as disrupt the business of the Company's customers. The Company is beginning the process of polling these companies in order to determine contingency plans. Failure of the Company to provide Year 2000 compliant business solutions to its customers or to receive such business solutions from its suppliers could result in liability to the Company or otherwise have a material adverse effect on the Company's business, results of operations, financial condition and prospects. Furthermore, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to correct or patch their current software systems for Year 2000 14 compliance. These expenditures may result in reduced funds available to purchase products and services such as those offered by the Company, which could result in a material adverse effect on the Company's business, results of operations and financial condition. The Company could be affected through disruptions in the operation of the enterprises with which the Company interacts or from general widespread problems or an economic crisis resulting from noncompliant Year 2000 systems. Despite the Company's efforts to address the Year 2000 effect on its internal systems and business operations, such effect could result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. The Company has just begun the process of developing a contingency plan to respond to any of the foregoing consequences of internal and external failures to be Year 2000 and leap year compliant. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of those assets and liabilities at the date of the financial statements and the recorded amounts of expenses during the reporting period. A change in the facts and circumstances surrounding these estimates could result in a change to the estimates and impact future operating results. LIQUIDITY AND CAPITAL RESOURCES At September 30, 1998, the Company's short-term investments consisted of investments in high-quality financial, government and corporate securities. Cash, cash equivalents and investments increased to $118.9 million at September 30, 1998, from $92.3 million at December 31, 1997. During the nine months ended September 30, 1998, the Company generated approximately $29.4 million from operations due primarily to profits from operations, collection of trade receivables and an increase in deferred revenue. In addition, during the nine months ended September 30, 1998, the Company received $8.9 million from the issuance of Common Stock under the employee stock option and stock purchase plans. During the nine months ended September 30, 1998, the Company's primary investing activities were purchases of property and equipment totaling $11.6 million. This included $1.1 million for construction of a new research and development facility in Israel. The Company expects to spend an additional $2.6 million to complete construction of this facility before relocating its Israel subsidiary there in 1999. Assuming there is no significant change in the Company's business, the Company believes that its current cash and investment balances and cash flow from operations, will be sufficient to fund the Company's cash needs for at least the next twelve months./1/ ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has an investment portfolio of fixed income securities that are classified as "held to maturity" securities. These securities, like all fixed income instruments, are subject to interest rate risk and will decline in value if market interest rates increase. The Company attempts to limit this exposure by investing primarily in short-term securities and holding securities to maturity. ________________________________ /1/ Forward looking statement 15 MERCURY INTERACTIVE CORPORATION PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS (a) The Special Meeting of the Stockholders (the "Meeting") of Mercury Interactive Corporation was held at the Company's offices at 1325 Borregas Avenue, Sunnyvale, California 94089 on August 14, 1998 at 10:00 a.m. (b) The following proposals were considered at the Meeting with their results according to the respective vote of the stockholders: PROPOSAL 1 - To ratify and approve the adoption of the 1998 Employee Stock Purchase Plan to replace the 1993 Employee Stock Purchase Plan and the reservation of 325,000 shares for issuance thereunder. For 15,639,470 Against 140,517 Abstain 19,926 PROPOSAL 2 - To ratify and approve the reservation of an additional 300,000 shares of Common Stock for issuance under the Amended and Restated 1989 Stock Option Plan. For 9,317,570 Against 6,462,942 Abstain 19,401 PROPOSAL 3 - To ratify and approve the adoption of the 1999 Stock Option Plan to replace the Amended and Restated 1989 Stock Option Plan, effective on the expiration of the term of such plan in August 1999, and the reservation of 225,000 shares for the issuance thereunder. For 9,669,122 Against 6,108,065 Abstain 22,726 PROPOSAL 4 - To ratify and approve the amendment of the 1994 Directors' Stock Option Plan to increase the number of shares granted as an initial grant to new non-employee directors and an annual grant to continuing non- employee directors of the Corporation, and to provide for a one-time grant to the non-employee directors of the Corporation who are serving as directors of the Corporation as of the date of this Special Meeting of Stockholders. For 11,604,592 Against 4,169,849 Abstain 25,472 16 ITEM 5. OTHER INFORMATION Stockholder proposals related to the Company's 1999 Annual Meeting of Stockholders, but submitted outside the processes of Rule 14a-8 under the Securities Exchange Act of 1934, must be received by the company prior to March 6, 1999 in order to withhold authority of management proxies to use their discretionary voting authority with respect to any such proposal. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) 3.1 - Certificate of Amendment of the Restated Certificate of Incorporation (b) 27.1 - Financial Data Schedule. (c) No reports on Form 8-K were filed during the quarter ended September 30, 1998. 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. Date: November 13, 1998 MERCURY INTERACTIVE CORPORATION (Registrant) /s/ Sharlene Abrams ------------------------------------ Sharlene Abrams Vice-President of Finance and Administration, Chief Financial Officer and Secretary (Principal Financial and Accounting Officer) 18 INDEX TO EXHIBITS ----------------- Exhibit Description No. 3.1 Certificate of Amendment of the Restated Certificate of Incorporation 27.1 Financial Data Schedule 19 EX-3.1 2 CERTIFICATE OF AMENDMENT OF INCORPORATION EXHIBIT 3.1 CERTIFICATE OF AMENDMENT OF RESTATED CERTIFICATE OF INCORPORATION Mercury Interactive Corporation, a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That at a meeting of the Board of Directors of Mercury Interactive Corporation, resolutions were duly adopted setting forth a proposed amendment of the Certificate of Incorporation of said corporation, declaring said amendment to be advisable and calling a meeting of the stockholders of said corporation for consideration thereof. The resolution setting forth the proposed amendment is as follows: RESOLVED: that the Restated Certificate of Incorporation of this corporation by amended by changing the first paragraph of the Article thereof numbered III so that, as amended said first paragraph of said Article shall be and read as follows: "This corporation is authorized to issue two classes of stock to be designated, respectively, "Common Stock" and "Preferred Stock". The total number of shares which the corporation is authorized to issue is Sixty-five Million (65,000,000) shares. Sixty Million (60,000,000) shares shall be Common Stock and Five Million (5,000,000) shares shall be Preferred Stock, each with a par value of $.002 per share." SECOND: That thereafter, pursuant to resolution of its Board of Directors, a meeting of the stockholders of said corporation was duly called and held, upon notice in accordance with Section 222 of the General Corporation Law of the state of Delaware at which meeting the necessary number of share as required by statue were voted in favor of the amendment. THIRD: That said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, Mercury Interactive Corporation has caused this certificate to be signed by Amnon Landan, its Chief Executive Officer, and Sharlene Abrams, its Secretary, this 20/th/ day of May, 1998. By: /s/ Amnon Landan ----------------------------- Chief Executive Officer Attest: /s/ Sharlene Abrams --------------------- Secretary EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1998 JUL-01-1998 SEP-30-1998 70,382 48,554 22,213 2,686 214 149,220 41,494 (13,957) 171,492 43,273 0 0 0 35 134,184 177,492 30,600 30,600 4,504 4,504 20,286 0 0 7,024 1,405 5,619 0 0 0 5,619 .32 .29
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