-----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, Mc69BjCqJ+2SsDF0/YCBNKB+uKgsNk+OcpdbNeniZNDKDIAf2LEDSkUeq7yHuicK 9MRh59iis86CFSmEd4MPvQ== 0001012870-00-001508.txt : 20000323 0001012870-00-001508.hdr.sgml : 20000323 ACCESSION NUMBER: 0001012870-00-001508 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000322 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-K405 SEC ACT: SEC FILE NUMBER: 000-22350 FILM NUMBER: 575290 BUSINESS ADDRESS: STREET 1: 1325 BORREGAS AVENUE CITY: SUNNYVALE STATE: CA ZIP: 94089 BUSINESS PHONE: (408) 822-5200 MAIL ADDRESS: STREET 1: 1325 BORREGAS AVENUE CITY: SUNNYVALE STATE: CA ZIP: 94089 10-K405 1 FORM 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. for the fiscal year ended December 31, 1999 [_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. ---------------- Commission File Number: 0-22350 MERCURY INTERACTIVE CORPORATION (Exact name of registrant as specified in its charter) Delaware 77-0224776 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.)
1325 Borregas Avenue, Sunnyvale, CA 94089 (Address of principal executive offices) (408) 822-5200 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.002 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such a shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $7,625,566,441 as of February 29, 2000, based upon the closing sale price reported for that date on the Nasdaq National Market. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive for other purposes. The number of shares of Registrant's Common Stock outstanding as of February 29, 2000 was 79,123,906. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for Registrant's 2000 Annual Meeting of Stockholders to be held May 24, 2000 are incorporated by reference in Part III of this Annual Report on Form 10-K. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS
Page ---- PART I Item 1. Business...................................................... 3 General....................................................... 3 Products and Hosted Solutions................................. 4 Research and Development...................................... 7 Marketing, Sales and Support.................................. 7 Competition................................................... 9 Patents, Trademarks and Licenses.............................. 9 Personnel..................................................... 10 Item 2. Properties.................................................... 11 Item 3. Legal Proceedings............................................. 11 Item 4. Submission of Matters to a Vote of Security Holders........... 11 PART II Market for the Registrant's Common Equity and Related Item 5. Stockholder Matters........................................... 12 Item 6. Selected Consolidated Financial Data.......................... 13 Management's Discussion and Analysis of Financial Condition Item 7. and Results of Operations..................................... 14 Item 7a. Quantitative and Qualitative Disclosures about Market Risk.... 25 Item 8. Financial Statements and Supplementary Data................... 25 Changes in and Disagreements with Accountants on Accounting Item 9. and Financial Disclosure...................................... 25 PART III Item 10. Directors and Executive Officers of the Registrant............ 26 Item 11. Executive Compensation........................................ 26 Security Ownership of Certain Beneficial Owners and Item 12. Management.................................................... 26 Item 13. Certain Relationships and Related Transactions................ 26 PART IV Exhibits, Financial Statement Schedules and Reports on Form 8- Item 14. K............................................................. 27
2 This Annual Report on Form 10-K 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 Annual Report on Form 10-K. PART I Item 1. Business General We are the leading provider of integrated performance management solutions that enable businesses to test and monitor their Internet applications. Our software products and hosted services help e-businesses enhance the user experience by improving the performance, availability, reliability and scalability of their Web sites. By using our solutions to identify and assess performance problems, e-businesses can increase their ability to attract and retain customers, and improve their competitive advantage. Our customers represent a wide range of industries including Internet companies such as Amazon.com, America Online, Ameritrade, E*Trade, Healtheon/WebMD, HomeGrocer.com, Jobs.com, ShopLink.com and WingspanBank.com; Internet infrastructure providers such as Ariba, Broadbase, Broadvision, i2 Technologies and Oracle; and Fortune 1000 enterprises such as Apple Computer, Caterpillar, Cisco Systems, Ford Motor Co. and Walmart. Our integrated performance management solutions address these requirements, enabling customers to more quickly identify and correct problems before users experience them. Our products include load testing, functional testing and test management products that automate the testing of Internet and other applications, as well as Web performance monitoring products that monitor and measure Web site performance from the end-user's perspective and alert our customers to performance problems. Our hosted Web performance monitoring and load testing services provide out-sourced testing and monitoring services. Specifically, our products consist of: . Load testing products that stress applications under real-world conditions to predict systems' behavior, scalability and performance and to identify and isolate problems; . Functional testing products that help ensure that e-commerce and other applications operate as expected; . Test process management products that organize and manage the testing process to determine application readiness; . Web performance monitoring products that monitor sites in real time and alert operations groups to performance problems before users experience them; . Hosted Web performance monitoring services that proactively monitor Web sites in real time; and . Hosted load testing services that identify bottlenecks and capacity constraints before a Web site goes live. We collaborate with a number of e-business software companies such as Allaire, Ariba, BEA, Bluestone, Broadvision, Calico Commerce, CommerceQuest, DoubleClick, IBM, Selectica, Silverstream, Sun-Netscape 3 Alliance and Vignette. These collaborations allow us to ensure that our performance management solutions are optimized for use with their product offerings. In addition, many of these collaborations allow us to conduct joint marketing programs and joint seminars and participate in their user conferences. On November 30, 1999, we acquired Conduct Ltd., an Israeli-based provider of software for monitoring network performance. We plan to integrate Conduct's technology into our products to provide root cause analysis and to enable our customers to more readily pinpoint performance bottlenecks. We issued approximately 408,000 shares of common stock in exchange for all of Conduct's outstanding capital stock (including outstanding Conduct stock options and warrants that we assumed). In February 2000, we formed a wholly-owned subsidiary to offer our hosted Web site performance monitoring service, Topaz ActiveWatch, and our hosted Web site load testing service, Load Runner Active Test. We believe our ASP subsidiary will complement our existing offerings by providing a cost- effective solution that allows customers to quickly meet their needs without dedicating significant time and internal resources. Products and Hosted Solutions We offer a comprehensive, integrated solution for application testing and Web performance monitoring. Our software products and hosted e-services enable our customers to test and monitor their Web sites and other applications. These solutions include functional testing, load testing and test management products that automate the testing of e-commerce applications as well as Web performance monitoring offerings that measure end-user experience of Web sites in production. Our hosted e-services provide outsourced testing and monitoring, complementing our product offerings by providing a cost-effective solution that allows customers to quickly meet their needs without dedicating significant time and internal resources. 4 Our current products and hosted solutions consist of the following:
Date of Typical List Price Solution Name Solution Description Introduction Range* ------------- -------------------- ------------ ------------------ Testing Solutions Load Testing Astra LoadTest......... Stress testing for Web December 1996 $9,995 for 50 virtual applications users LoadRunner............. Automated multi-user November 1993 $40,000-$50,000 for load testing for Web, package simulating client server and 50 users enterprise applications LoadRunner ActiveTest.. Hosted Web site stress January 2000 $15,000 for 100 testing virtual users (3 iterations) Functional Testing Astra QuickTest........ Functional testing for May 1998 $2,995 per copy Web applications WinRunner.............. Automated functional June 1993 $4,995-$10,000 per application testing for user Web, client server and enterprise applications XRunner................ Automated functional 1991 $10,000-$15,000 per application testing for user UNIX, X-Window Test Management Astra SiteManager...... Visual Web site October 1996 No charge management tool TestDirector........... Automated test November 1994 $12,000 for server management system for QA plus 5 users, workgroups additional users for $495 each Monitoring Solutions Topaz.................. Web application October 1999 $2,495/month for performance monitoring 5 monitoring transactions Topaz ActiveWatch...... Hosted performance October 1999 $3,750/month for monitoring 5 monitoring transactions
- -------- * List prices vary within the ranges shown according to system configuration and country where purchased. In addition, actual license prices may vary from list prices. Testing Solutions Astra LoadTest Astra(R) LoadTest is an easy-to-use load testing tool that tests the scalability and performance of Web applications. With Astra LoadTest, users can emulate the traffic of thousands of real users to identify and isolate bottlenecks and optimize user experience. Astra LoadTest was initially released in 1996. LoadRunner LoadRunner(R) is a load testing tool that predicts system behavior and performance. It exercises an entire enterprise infrastructure by emulating thousands of users to identify and isolate problems. LoadRunner's integrated real-time monitors enable organizations to minimize test cycles, optimize performance and accelerate application deployment. LoadRunner is available for Windows, Window 95, Windows NT, UNIX and Remote Terminal Emulation (RTE). LoadRunner was initially released in 1993. 5 LoadRunner ActiveTest LoadRunner ActiveTest(TM) is the hosted load testing service that can conduct full-scale testing of Web sites in as little as 24 hours. By emulating the behavior of thousands of users against a staging server, it identifies bottlenecks and capacity constraints before going live. Using this hosted offering allows customers with minimal hardware, personnel or technical expertise to achieve rapid results. LoadRunner ActiveTest was initially introduced in 2000. Astra QuickTest Astra QuickTest(TM) is an icon-based tool for testing the functionality of dynamically changing Web applications. By replacing traditional scripts with icons, it records and represents user actions visually to simplify and accelerate testing. By mirroring end user behavior, Astra QuickTest creates interactive customizable tests that simplify and shorten the testing cycle. Astra QuickTest is designed specifically for deploying reliable e-business applications. Astra QuickTest was initially released in 1998. WinRunner WinRunner(R) is an enterprise functional testing tool that verifies that applications work as expected. By capturing, verifying and replaying user interactions automatically, WinRunner identifies defects and ensures that business processes work flawlessly and remain reliable throughout the lifecycle. WinRunner is available for Windows 3.1, Windows 95 and Windows NT platforms. WinRunner was initially released in 1993. XRunner XRunner(R) automates functional testing to ensure X-Window-based applications work as expected. It records business processes into test scripts, supports script enhancements as the application is developed or updated, executes scripts, reports results and enables script reusability throughout an application's lifecycle. XRunner was initially released in 1991. Astra SiteManager Astra SiteManager(TM) is a comprehensive visual Web site management tool that is designed to meet the challenges faced by Webmasters, Internet professionals and business managers of rapidly growing Web sites. Astra SiteManager automatically schedules and performs scans of an entire Web site-- highlighting functional areas with color-coded links and URLs--to create a complete visual map of a Web site. Astra SiteManager was initially released in 1996. TestDirector TestDirector(R) is an integrated enterprise application for organizing and managing the entire testing process. It enables all members of the IT organization to coordinate their testing efforts and control testing projects at every step of the quality cycle, from test planning through execution to defect management. TestDirector was initially released in 1994. Monitoring Solutions Topaz Topaz(TM) is a Web application performance management solution that allows customers to monitor the performance of their Web sites on a 24x7 basis to ensure a positive end-user experience. By proactively monitoring sites in real time, Topaz alerts operations groups of performance problems before users experience them. Topaz was initially released in 1999. 6 Topaz ActiveWatch Topaz ActiveWatch(TM) is a hosted service that monitors Web site performance. Using this hosted offering allows customers with minimal hardware, personnel or technical expertise to achieve rapid results. Topaz ActiveWatch was initially introduced in 1999. Research and Development Since our inception in 1989, we have made substantial investments in research and product development. We believe that our success will depend in large part on our ability to maintain and enhance our current product line, develop new products, maintain technological competitiveness and meet changing customer requirements. In addition to the teams developing Web testing and performance monitoring products and services, we maintain an advanced research group that is responsible for exploring new directions and applications of core technologies, migrating new technologies into the existing product lines and maintaining research relationships outside Mercury both within industry and academia. The research and development group also maintains relationships with third-party software vendors and with all major hardware vendors on whose platforms our products operate. Key development engineers are rotated to assignments in customer support positions in our major markets for periods ranging from three months to two years. This improves feedback from current customers and strengthens ties between the Customer Support Organization and the research and development group. Our primary research and development group is located near Tel Aviv, Israel. Performing research and development in Israel offers a number of strategic advantages. Our Israeli engineers typically hold advanced degrees in computer- related disciplines. Operation in Israel has allowed us to enjoy tax incentives and research subsidies from the government of Israel. Geographic proximity to Europe, a strategic market for Mercury, offers another key advantage. As of December 31, 1999, our research and development group consisted of 226 employees. Our net research and development expenses were $23.5 million in 1999, $16.9 million in 1998 and $11.3 million in 1997. We anticipate that we will continue to commit substantial resources to research and development. If we are not able to continue to introduce new products and product enhancements that address the changing needs of our customers, our business would be seriously harmed. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Factors." Marketing, Sales and Support We distribute our products and offer our services both directly, through our growing sales force, and indirectly, through our relationships with system integrators and value-added resellers. Direct Sales We sell our products primarily through our direct sales organization. We employ technically proficient salespeople and highly skilled field application engineers capable of serving the sophisticated needs of prospective customers. As of December 31, 1999, our direct sales organization consisted of 328 employees. We have 19 sales and support centers throughout the United States. Internationally, our subsidiaries operate 21 sales and support offices located in Canada, Brazil, Europe, Israel, South Africa and the Pacific Rim. We also market our products through international distributors in some markets. International sales represented 34% of our total revenues in 1999, 35% in 1998 and 36% in 1997, respectively. We expect that in future periods, international sales will continue to account for a significant portion of our total revenue. Our international operations and sales present a number of risks. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Factors." 7 Indirect Distribution Channels We derive a substantial portion of our revenue from sales of our products through indirect distribution channels such as system integrators and value- added resellers, including Andersen Consulting, Computer Sciences Corporation, Ernst & Young, IBM Global Services, IXL, Inventa, Oracle, Primix Solutions, Technology Builders Inc, Viant and ZEFER. A significant portion of our international sales are derived from sales through distributors. We have recently begun targeting new distribution channels to complement our traditional direct and indirect channel. Our Astra family of products is now offered through our cyber sales program over the Internet. We have also entered into private-labelling arrangements with ASPs that incorporate our products and services into theirs. 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. In addition, we recently entered into agreements with two ASPs, Breakaway and Conxion, under which they offer our hosted Web performance monitoring services under their own names. We expect that sales of our products through indirect distribution channels will continue to account for a substantial portion of our revenues for the foreseeable future. Our dependence on these channels presents a number of risks. Each of our system integrators, value-added resellers and ASPs can cease marketing our products and services with limited or no notice and with little or no penalty. Our current system integrators, value-added resellers and ASPs may not continue to offer our products and services, and we may not be able to recruit additional or replacement system integrators, value-added resellers and ASPs. The loss of one or more of our system integrators, value- added resellers and ASPs could reduce our revenues. Our system integrators, value-added resellers and ASPs also offer competitive products manufactured by third parties. Our system integrators, value-added resellers and ASPs may not give priority to the marketing of our products over competitors' products. Finally, we may face conflicts between our indirect channels and our directs sales and marketing activities. Customer Support We believe that strong customer support is crucial to both the initial marketing of our products and maintenance of customer satisfaction, which in turn enhances our reputation and generates repeat orders. In addition, we believe that the customer interaction and feedback involved in our ongoing support functions provide us with information on market trends and customer requirements that is critical to future product development efforts. Pre-sales support is provided by sales personnel and post-sales support is provided by our Customer Support Organization through training and consulting engagements and renewable annual maintenance contracts. As of December 31, 1999, our Customer Support Organization consisted of 171 employees. The maintenance contracts provide for technical and emergency support as well as software upgrades, on an if and when available basis. When our local sales and support offices are unable to solve a problem, our engineers and product developers in Israel work with the support personnel. By taking advantage of time differences, we can provide support around the clock, ensuring prompt resolution of problems. Pricing We license our software to customers under non-exclusive license agreements that restrict use of the products to internal purposes at a specified site. We typically license software products to either allow up to a set number of users to access the software on a network at any one time, using any workstation attached to that network, or to allow use of the software on designated computers or workstations. In addition, our hosted services and some of our products are priced based on usage, such as the number of transactions monitored or number of virtual users emulated per day. Our products are priced to encourage customers to purchase multiple products and licenses because our cost to support a one-user configuration is almost the same as a multiple-user configuration. License fees depend on 8 the product licensed, the number of users of the product licensed and the country in which such licenses are sold, as international prices tend to be higher than United States prices. Sales to our indirect sales channels, which are intended for resale to end users, are made at varying discounts off of our list prices, generally based on the sales volume of the indirect sales channels. In addition, we sell annual maintenance contracts that include on- site customer support and upgrades, generally for 18% of the license purchase price. Training and consulting revenues are generated on a time and expense basis. Competition The market for testing and performance monitoring products and services is highly competitive. There are few substantial barriers to entry in our market, and the Internet has further lowered these barriers to entry for other companies to compete with us in the testing and application performance management markets. As a result of the increased competition, our success will depend, in large part, on our ability to identify and respond to the needs of potential customers, and to new technological and market opportunities, before our competitors identify and respond to these needs and opportunities. We may fail to respond quickly enough to these needs and opportunities. In the market for solutions for testing of applications, our competitors include Compuware, Radview, Rational Software, RSW (a division of Teradyne) and Segue Software. In the new and rapidly changing market for application performance management, our competitors include providers of hosted services such as Keynote Systems and Service Metrics (a division of Exodus Communications), and emerging application providers such as Freshwater. In addition, we face potential competition in this market from existing providers of testing solutions such as Segue. Finally, in both the market for testing solutions and the market for application performance management solutions, we face potential competition from established providers of systems and network management software such as BMC Software and Computer Associates. We believe that the principal competitive factors affecting our market are: . product functionality; . product performance, including scalability and reliability; . price and cost-effectiveness; . quality of support and service; and . company reputation. Although we believe that our products currently compete favorably with respect to these factors, the market for Web performance management applications is new and rapidly evolving. We may not be able to maintain our competitive position, and competitive pressure could seriously harm our business. Patents, Trademarks and Licenses We currently rely upon a combination of trademark, patent, copyright, service mark, and trade secret laws and contractual restrictions to establish and protect proprietary rights in our products and services. The source code for our products is protected both as a trade secret and as an unpublished copyrighted work. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our products or technology without authorization. In addition, the laws of various countries in which our products may be sold may not protect our products and intellectual property rights to the same extent as the laws of the United States. Our competitors may independently develop technologies that are substantially equivalent or superior to our technology. Because the software industry is characterized by rapid technological change, we believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements, name recognition and reliable product maintenance are more important to establishing and maintaining a technology leadership position than the various legal protections of our technology. 9 We hold six patents for elements contained in some of our products, and we have filed several other U.S. and foreign patent applications on various elements of our products. Our patent applications may not result in issued patents and, if issued, such patents may not be upheld if challenged. Although we believe that our products and other proprietary rights do not infringe upon the proprietary rights of third parties, third parties may assert intellectual property infringement claims against us in the future. Any such claims may result in costly, time-consuming litigation and may require us to enter into royalty or cross-license arrangements. Personnel As of December 31, 1999, we had a total of 857 employees, of which 362 were based in the Americas and 495 were based internationally. Of the total, 548 were engaged in marketing, sales and related customer support services, 226 were in research and development, and 83 were in general and administrative and operations support functions. Our success depends in significant part upon the performance of our senior management and certain key employees. Competition for highly skilled employees, including sales, technical and management personnel, is intense in the software and technology industry. We may not be able to recruit and retain key sales, technical and managerial employees. Our failure to attract, assimilate or retain highly qualified sales, technical and managerial personnel could seriously harm our business. None of our employees is represented by a labor union, and we have never experienced any work stoppages. Our executive officers as of March 1, 2000 are as follows:
Name Age Position ---- --- -------- Amnon Landan..... 41 President, Chief Executive Officer and Chairman of the Board of Directors Kenneth Klein.... 40 Chief Operating Officer Sharlene Abrams.. 42 Chief Financial Officer and Vice President of Finance and Administration Moshe Egert...... 35 President of European Operations
Mr. Amnon Landan has served as our President and Chief Executive Officer since February 1997, has served as Chairman of the Board of Directors since July 1999, and has been a director since February 1996. From October 1995 to January 1997, he served as President, and from March 1995 to September 1995 he served as President of North American Operations. He served as Chief Operating Officer from August 1993 until March 1995. From December 1992 to August 1993, he served as our Vice President of Operations and from June 1991 to December 1992, he served as Vice President of Research and Development. From November 1989 to June 1991, he served with us in various technical positions. Mr. Kenneth Klein has served as our Chief Operating Officer since January 2000. He served as President of North American Operations from July 1998 until December 1999. From April 1995 to July 1998 he served as Vice President of North American Sales. From May 1992 to March 1995, he served as our Western Area Sales Manager. From March 1990 to May 1992, Mr. Klein served as Regional Sales Manager for Interactive Development Environments, a CASE tool company. Mr. Klein has served as a director of Tumbleweed Communications Corp. since February 2000. Ms. Sharlene Abrams has served as our Chief Financial Officer and President of Finance and Administration since November 1993. From 1988 to November 1993, Ms. Abrams was employed at Price Waterhouse LLP, most recently as a senior manager. Between 1978 and 1988, Ms. Abrams held various finance and accounting positions in other public companies and in public accounting. She is a certified public accountant. Mr. Moshe Egert has served as our President of European Operations since July 1999. From July 1996 to June 1999, he served as our Vice President of European Operations. From February 1994 to June 1996, he served 10 as our Director of European Marketing. From October 1990 through January 1994, he served with us in several management and technical positions. Item 2. Properties We are headquartered in Sunnyvale, California in a 55,000 square foot building that we own. In 1999, we purchased a 50,500 square foot building in Sunnyvale, which will become a second headquarters facility. Our research and development activities are conducted by our subsidiary in Israel in a 120,000 square foot building that we own. During 1999, we purchased an additional parcel of land in Israel. Our field sales and support operations occupy leased facilities in 20 locations in the United States, one location in Canada, one location in Brazil, 12 locations in Europe, one location in Israel, one location in South Africa and five locations in the Pacific Rim. We believe that our existing sales and support facilities are adequate for our current needs. Item 3. Legal Proceedings There are presently no legal proceedings pending, other than routine litigation incidental to our business, to which we are a party or to which any of our properties is subject. Item 4. Submission of Matters to a Vote of Security Holders (a) A special meeting of our stockholders was held at our offices at 1325 Borregas Avenue, Sunnyvale, California 94089 on December 16, 1999 at 10:00 a.m. (b) At that meeting, the following matter was voted upon and approved with the number of votes cast for, against or withheld as set forth in the columns set forth below the matter. PROPOSAL 1--Ratification and approval of the amendment of the Amended and Restated 1999 Stock Option Plan to automatically increase each year the aggregate number of shares reserved for issuance under our Amended and Restated 1999 Stock Option Plan by 4% of the common stock and equivalents outstanding as of January 1 of each year starting in 2000 and ending in 2003.
Broker For Against Abstentions Non-Votes --- ------- ----------- --------- 14,523,285 13,463,324 120,552 10,286,424
11 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters Market for Common Stock Our common stock is traded publicly on the Nasdaq National Market under the trading symbol "MERQ." The following table presents, for the periods indicated, the high and low sales prices of our common stock as reported on the Nasdaq National Market.
High Low ------ ------ Year Ended December 31, 1998 First Quarter............................................... $ 9.57 $ 6.10 Second Quarter.............................................. 11.16 7.82 Third Quarter............................................... 11.44 7.88 Fourth Quarter.............................................. 15.82 5.29 Year Ended December 31, 1999 First Quarter............................................... $19.97 $10.75 Second Quarter.............................................. 19.94 10.50 Third Quarter............................................... 34.41 17.31 Fourth Quarter.............................................. 55.13 30.94
The prices shown in the table above reflect the two-for-one splits of our common stock, each of which were distributed as stock dividends to our stockholders, on February 26, 1999 and February 11, 2000. Holders of Record On February 29, 2000, there were approximately 30,600 holders of record of our common stock. Because many of these shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. Dividends We have never declared or paid any cash dividends on our common stock. We currently intend to retain earnings for use in our business and do not anticipate paying any cash dividends in the foreseeable future. 12 Item 6. Selected Consolidated Financial Data(1)
Year ended December 31, ----------------------------------------- 1999 1998 1997 1996 1995 -------- -------- ------- ------- ------- (in thousands, except per share amounts) Statements of Operations Data: Revenue: License........................... $130,900 $ 84,450 $56,683 $43,270 $32,765 Service........................... 56,800 36,550 20,017 11,280 6,685 -------- -------- ------- ------- ------- Total revenue................... 187,700 121,000 76,700 54,550 39,450 -------- -------- ------- ------- ------- Cost of revenue: License........................... 7,736 6,291 4,351 3,419 2,626 Service........................... 18,642 11,757 6,225 3,240 1,887 -------- -------- ------- ------- ------- Total cost of revenue........... 26,378 18,048 10,576 6,659 4,513 -------- -------- ------- ------- ------- Gross profit........................ 161,322 102,952 66,124 47,891 34,937 -------- -------- ------- ------- ------- Operating expenses: Research and development, net..... 23,484 16,907 11,333 9,670 6,523 Write off of in-process research and development and related expenses......................... -- -- 5,500 -- 7,700 Marketing and selling............. 88,609 57,243 37,073 29,426 21,361 General and administrative........ 11,242 8,466 6,642 4,178 3,911 Settlement of litigation.......... -- -- -- 2,600 2,000 Merger related expenses........... 2,000 -- -- -- -- -------- -------- ------- ------- ------- Total operating expenses........ 125,335 82,616 60,548 45,874 41,495 -------- -------- ------- ------- ------- Income (loss) from operations....... 35,987 20,336 5,576 2,017 (6,558) Other income, net................... 6,026 4,640 3,083 3,375 2,277 -------- -------- ------- ------- ------- Income (loss) before provision for income taxes....................... 42,013 24,976 8,659 5,392 (4,281) Provision for income taxes.......... 8,869 5,451 2,927 1,157 970 -------- -------- ------- ------- ------- Net income (loss)................... $ 33,144 $ 19,525 $ 5,732 $ 4,235 $(5,251) ======== ======== ======= ======= ======= Net income (loss) per share (basic)(2)......................... $ 0.44 $ 0.28 $ 0.09 $ 0.07 $ (0.09) ======== ======== ======= ======= ======= Net income (loss) per share (diluted)(2)....................... $ 0.39 $ 0.25 $ 0.08 $ 0.06 $ (0.09) ======== ======== ======= ======= ======= Weighted average common shares (basic)(2)......................... 76,112 70,654 65,494 63,634 55,788 ======== ======== ======= ======= ======= Weighted average common shares and equivalents (diluted)(2)........... 85,208 78,818 68,458 66,254 55,788 ======== ======== ======= ======= =======
December 31, -------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- Balance Sheet Data: Working capital.................... $137,066 $ 97,288 $ 87,733 $ 78,046 $ 75,475 Total assets....................... $297,218 $204,686 $143,663 $117,625 $112,820 Stockholders' equity............... $199,531 $146,408 $112,120 $ 99,048 $ 92,616
- -------- (1) All historical information has been restated to reflect the acquisition of Conduct Ltd. on November 30, 1999, which was accounted for as a pooling of interests. (2) All share and per share information gives effect to our two-for-one stock split distributed to our stockholders as a stock dividend on February 11, 2000. 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion 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 these forward-looking statements. Overview We were incorporated in 1989, and began shipping automated software testing products in 1991. Since 1991, we introduced a number of new products, and new versions of existing products, including products and versions designed for e- business applications. We believe that a majority of customers that licensed our products in 1999 are using these products to test and monitor their Web applications. Recently, we began offering hosted load testing and monitoring services for Web applications. On November 30, 1999 we acquired Conduct Ltd., an Israeli-based provider of software for monitoring network performance. We issued approximately 408,000 shares of common stock in exchange for all of Conduct's outstanding capital stock (including outstanding Conduct stock options and warrants that we assumed). We accounted for the transaction as a pooling of interests, and all prior periods presented in our financial statements have been restated to reflect this transaction. Results of Operations The following table sets forth, as a percentage of total revenue, certain consolidated statements of operations data for the periods indicated. These operating results are not necessarily indicative of the results for any future period.
Year ended December 31, ---------------- 1999 1998 1997 ---- ---- ---- Revenue:.................................................. License................................................. 70% 70% 74% Service................................................. 30 30 26 --- --- --- Total revenue......................................... 100 100 100 --- --- --- Cost of revenue: License................................................. 4 5 6 Service................................................. 10 10 8 --- --- --- Total cost of revenue................................. 14 15 14 --- --- --- Gross profit.............................................. 86 85 86 --- --- --- Operating expenses: Research and development, net........................... 13 14 15 Write off of in-process research and development and related expenses....................................... -- -- 7 Marketing and selling................................... 47 47 48 General and administrative.............................. 6 7 9 Merger related expenses................................. 1 -- -- --- --- --- Total operating expenses.............................. 67 68 79 --- --- --- Income from operations.................................... 19 17 7 Other income, net......................................... 3 4 4 --- --- --- Income before provision for income taxes.................. 22 21 11 --- --- --- Provision for income taxes................................ 5 5 4 --- --- --- Net income ............................................... 17% 16% 7% --- --- ---
14 Revenue License revenue increased to $130.9 million in 1999 from $84.5 million in 1998 and $56.7 million in 1997. Our growth in license revenue is attributable primarily to growth in license fees from the LoadRunner, WinRunner and TestDirector products, particularly for use by customers to test e-business applications. Service revenue increased to $56.8 million or 30% of total revenue in 1999 from $36.6 million or 30% of total revenue in 1998 and $20.0 million or 26% of total revenue in 1997. The absolute dollar increase in service revenue in 1999 compared to 1998 and 1997 was primarily due to the renewal of maintenance contracts. We expect that service revenue will continue to increase in absolute dollars as long as our customer base continues to grow. Cost of revenue License cost of revenue as a percentage of license revenue decreased to 6% in 1999 from 7% in 1998 and 8% in 1997. License cost of revenue includes cost of production personnel, product packaging and amortization of capitalized software development costs. The decrease in license cost of revenue as a percentage of license revenue in 1999 primarily reflected flat absolute dollar amortization of capitalized software development costs during each of the three years. Service cost of revenue increased to $18.6 million in 1999 from $11.8 million in 1998 and $6.2 million in 1997. As a percentage of service revenue, it increased to 33% in 1999 from 32% in 1998 and 31% in 1997. Service cost of revenue consists primarily of costs of providing customer technical support, training and consulting. The increased service cost of revenue in 1999 as compared to 1998 was primarily due to an increase in personnel-related costs of $4.2 million reflecting growth in customer support headcount from 126 at December 31, 1998 to 171 at December 31, 1999 and a $2.2 million increase in training and consulting out-sourcing expense. Research and development, net For the year ended December 31, 1999, research and development, net was $23.5 million, or 13% of total revenue, an increase from $16.9 million, or 14% of total revenue in 1998, and $11.3 million, or 15% of total revenue in 1997. The increase in absolute dollars in 1999 as compared to 1998 reflected an increase in spending of $4.1 million due to growth in research and development headcount from 166 at December 31, 1998 to 226 at December 31, 1999, as well as $1.6 million of research grants received in 1998 from the Israeli Office of the Chief Scientist, as compared to no grants received in 1999. In September of 1997, we acquired technologies from Dixon Software Technology that we integrated into our load-testing products. As a result of this purchase, in the third quarter of 1997, we recorded a one-time charge for write off of in-process research and development and related expenses of $5.5 million. Research and development expense is reported net of research grants received from the government of Israel, and includes royalty expense for obligations to the government of Israel for sales of products developed under government- funded research. No grants were obtained from the Office of the Chief Scientist in the Israeli Ministry of Industry and Trade during 1999. Research grants received amounted to $1.6 million in 1998 and $2.1 million in 1997. We were not obligated to repay these grants; however, we agreed to pay royalties at rates ranging from 2% to 5% of product sales resulting from the research, up to the amount of the grants obtained and for certain grants up to 150% of the grants obtained. Royalty expense under these agreements amounted to approximately $2.7 million for each of the years ended December 31, 1999 and 1998, and $1.6 million for the year ended December 31, 1997. As of December 31, 1999, we had no outstanding royalty obligations. We have not applied for, nor do we anticipate applying for, any future grants from the Office of the Chief Scientist. During 1999 and 1998, no software development costs were capitalized because the costs incurred subsequent to achieving technological feasibility and before the general release of our products were not 15 significant. We capitalized $500,000 of software development costs during the year ended December 31, 1997. Amortization charges included in cost of license revenues were $585,000 in 1999 and $600,000 in each of 1998 and 1997. In conjunction with the technology acquisition in 1997, we wrote off approximately $250,000 of capitalized development costs as obsolete. At December 31, 1999, we did not have any capitalized software development costs. At December 31, 1998 we had a net balance of capitalized software development costs of $585,000. Marketing and selling Marketing and selling expenses were $88.6 million, or 47% of total revenue, in 1999, compared to $57.2 million, or 47% of total revenue, in 1998 and $37.1 million, or 48% of total revenue, in 1997. The increase in expenses in 1999 as compared to 1998 was primarily due to an increase in personnel-related costs of $14.6 million reflecting growth in headcount from 265 at December 31, 1998 to 377 at December 31, 1999, an increase in sales commissions of $4.8 million attributable to higher revenue, an increase in facilities and related costs of $1.8 million and an increase in spending on marketing programs of $7.5 million. 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 increased to $11.2 million, or 6% of total revenue in 1999, from $8.5 million, or 7% of total revenue in 1998 and $6.6 million, or 9% of total revenue in 1997. The increase in expenses in 1999 as compared to 1998 was primarily due to an increase in personnel-related costs of $1.6 million reflecting growth in headcount from 53 at December 31, 1998 to 70 at December 31, 1999. Other income, net Other income, net consists primarily of interest income and foreign exchange gains and losses. The increase in other income, net to $6.0 million in 1999 from $4.6 million in 1998 reflected increased interest income on higher average cash and investment balances. Provision for income taxes We have structured our operations in a manner designed to maximize income in Israel where tax rate incentives have been extended to encourage foreign investments. The tax holidays and rate reductions which we will be able to realize under programs currently in effect expire at various dates through 2007. Future provisions for taxes will depend upon the mix of worldwide income and the tax rates in effect for various tax jurisdictions. See Note 4 of Notes to Consolidated Financial Statements and "--Risk Factors--We are subject to the risk of increased taxes." We calculated the 1999 tax provision without the benefit of Conduct's pre- acquisition net operating losses because we may not be able to offset these losses against our future income. Merger related expenses In connection with the acquisition of Conduct, we incurred merger-related expenses of approximately $2.0 million, primarily relating to legal and accounting expenses, severance and the write-off of redundant facilities and equipment. Net income We reported net income of $33.1 million in 1999, compared to net income of $19.5 million in 1998 and $5.7 million in 1997. 16 Liquidity and Capital Resources At December 31, 1999, our principal source of liquidity consisted of $186.9 million of cash and investments compared to $130.7 million at December 31, 1998 and $92.4 million at December 31, 1997. The December 31, 1999 balance included $137.1 million of short-term and $15.6 million of long-term investments in high quality government and corporate securities. During 1999, we generated $61.1 million cash from operating activities, compared to $39.5 million in 1998 and $17.1 million in 1997. The increase in 1999 compared to 1998 was due primarily to an increase in net income and increases in accounts payable and accrued liabilities. Our primary investing activities were net purchases of investments in 1999 of $39.7 million compared to net proceeds from investments of $1.3 million in 1998 and $512,000 in 1997. We also purchased property and equipment, which totaled $23.9 million in 1999, $15.0 million in 1998 and $11.9 million in 1997. Of these amounts, we spent $8.2 million in 1999, and $1.5 million 1998, for purchase and renovation of our headquarters buildings in Sunnyvale, California. We expect to spend an additional $3.5 million to complete the construction in California. We spent $5.6 million in 1999, and $5.7 million in 1998, on construction of a new research and development facility in Israel. Also in 1999, we spent $2.7 million to purchase additional land in Israel for anticipated future expansion. Our primary financing activity consisted of issuances of common stock under our stock option and stock purchase plans. Proceeds from issuance of stock under these plans, net of notes receivable issued and collected from issuance of stock, amounted to $20.4 million in 1999, $14.4 million in 1998 and $7.7 million in 1997. Assuming there is no significant change in our business, we believe that our current cash and investment balances and cash flow from operations will be sufficient to fund our cash needs for at least the next twelve months. We also expect to satisfy our financing requirements through the incurrence of debt from time to time. As of December 31, 1999, we did not have any debt outstanding. We currently plan to issue up to $500,000,000 in principal amount of convertible subordinated notes. If we complete this transaction, our leverage will increase significantly. We may not succeed in completing this transaction. New Accounting Pronouncements In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 is effective for the financial statements of years beginning after December 15, 1998. SOP 98-1 provides guidance over accounting for computer software developed or obtained for internal use including the requirement to capitalize specified costs and amortization of such costs. We adopted the provisions of SOP 98-1 in our fiscal year ended December 31, 1999. Adoption did not have a material effect on our financial statements. In March 1998, the AICPA issued Statement of Position 98-4, "Deferral of Effective Date of a Provision of SOP 97-2" ("SOP 98-4"). SOP 98-4 defers for one year the application of certain provisions of Statement of Position 97-2 "Software Revenue Recognition" ("SOP 97-2"). Different informal and non- authoritative interpretations of certain provisions of SOP 97-2 have arisen and, as a result, the AICPA issued Statement of Position 98-9, "Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions" ("SOP 98-9") in December 1998 which is effective for periods beginning after March 15, 1999. SOP 98-9 extends the effective date of SOP 98- 4 and provides additional interpretive guidance. The adoption of SOP 97-2, SOP 98-4 and SOP 98-9 did not have a material effect on our results of operations, financial position or cash flows. In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133--an amendment of FASB Statement No. 133" ("SFAS 137"). SFAS 137 17 defers for one year the application of Statement of Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") to all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. The adoption of SFAS 133 and SFAS 137 have not had and are not expected to have a material effect on our results of operations, financial position or cash flows. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB 101") which provides guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. We believe that the impact of SAB 101 will not have a material effect on our results of operations, financial position or cash flows. Risk Factors In addition to the other information included in this Annual Report on Form 10-K, the following risk factors should be considered carefully in evaluating us and our business. Our future success depends on our ability to respond to rapid market and technological changes by introducing new products and to continually improve the performance, features and reliability of our existing products and respond to competitive offerings. Our business will suffer if we do not successfully respond to rapid technological changes. The market for our software products is characterized by: . rapidly changing technology; . frequent introduction of new products and enhancements to existing products by our competitors; . increasing complexity and interdependence of Internet related applications; . changes in industry standards and practices; and . changes in customer requirements and demands. To maintain our competitive position, we must continue to enhance our existing software testing and application performance management products and to develop new products and services, functionality and technology that address the increasingly sophisticated and varied needs of our prospective customers. The development of new products and services, and enhancement of existing products and services, entail significant technical and business risks and require substantial lead-time and significant investments in product development. If we fail to anticipate new technology developments, customer requirements or industry standards, or if we are unable to develop new products and services that adequately address these new developments, requirements and standards in a timely manner, our products may become obsolete, our ability to compete may be impaired and our revenues could decline. We expect our quarterly revenues and operating results to fluctuate, which may cause the price of our stock and the notes to decline. Our revenues and operating results have varied in the past and are likely to vary significantly from quarter to quarter in the future. These fluctuations are due to a number of factors, many of which are outside of our control, including: . fluctuations in demand for and sales of our products and services; . our success in developing and introducing new products and the timing of new product introductions; . our ability to introduce enhancements to our existing products in a timely manner; . the introduction of new or enhanced products by our competitors and changes in the pricing policies of these competitors; . the discretionary nature of our customers' purchase and budget cycles; 18 . the amount and timing of operating costs and capital expenditures relating to the expansion of our business; . deferrals by our customers of orders in anticipation of new products or product enhancements; and . the mix of our domestic and international sales, together with fluctuations in foreign currency exchange rates. In addition, the timing of our license revenues is difficult to predict because our sales cycles are typically short and can vary substantially from product to product and customer to customer. We base our operating expenses on our expectations regarding future revenue levels. As a result, if total revenues for a particular quarter are below our expectations, we could not proportionately reduce operating expenses for that quarter. We have experienced seasonality in our revenues and earnings, with the fourth quarter of the year typically having the highest revenue and earnings for the year and higher revenue and earnings than the first quarter of the following year. We believe that this seasonality results primarily from the budgeting cycles of our customers and from the structure of our sales commission program. We expect this seasonality to continue in the future. Due to these and other factors, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. If our operating results are below the expectations of investors or securities analysts, the price of our common stock, and therefore the notes, could decline. We expect to face increasing competition in the future, which could cause reduced sales levels and result in price reductions, reduced gross margins or loss of market share. The market for our testing and application performance management products and services is extremely competitive, dynamic and subject to frequent technological changes. There are few substantial barriers to entry in our market. In addition, the rapid growth and use of Internet for e- business is a recent and emerging phenomenon. The Internet lowers the barriers to entry for other companies to compete with us in the testing and application performance management markets. As a result of the increased competition, our success will depend, in large part, on our ability to identify and respond to the needs of potential customers, and to new technological and market opportunities, before our competitors identify and respond to these needs and opportunities. We may fail to respond quickly enough to these needs and opportunities. In the market for solutions for testing of applications, our principal competitors include Compuware, Radview, Rational Software, RSW (a division of Teradyne) and Segue Software. In the new and rapidly changing market for application performance management solutions, our competitors include providers of hosted services such as Keynote Systems and Service Metrics (a division of Exodus Communications), and emerging application providers such as Freshwater. In addition, we face potential competition in this market from existing providers of testing solutions such as Segue. Finally, in both the market for testing solutions and the market for application performance management solutions, we face potential competition from established providers of systems and network management software such as BMC Software and Computer Associates. The software industry is increasingly experiencing consolidation, and this could increase the resources available to our competitors and the scope of their product offerings. Our competitors and potential competitors may undertake more extensive marketing campaigns, adopt more aggressive pricing policies or make more attractive offers to distribution partners and to employees. If we fail to maintain our existing distribution channels and develop additional channels in the future, our revenues will decline. We derive a substantial portion of our revenues from sales of our products through distribution channels such as system integrators, value-added resellers. We expect that sales of our products through these channels will continue to account for a substantial portion of our revenues for the foreseeable future. We have also entered into private 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. 19 The loss of one or more of our system integrators, value-added resellers or ASPs, or any reduction or delay in their sales of our products and services could result in reductions in our revenue in future periods. In addition, our ability to increase our revenue in the future depends on our ability to expand our indirect distribution channels. Our dependence on indirect distribution channels presents a number of risks, including: . each of our system integrators, value-added resellers and ASPs can cease marketing our products and services with limited or no notice and with little or no penalty; . our existing system integrators, value-added resellers and ASPs may not be able to effectively sell any new products and services that we may introduce; . we may not be able to replace existing or recruit additional system integrators, value-added resellers and ASPs if we lose any of our existing ones; . our system integrators, value-added resellers and ASPs also offer competitive products and services from third parties; . we may face conflicts between the activities of our indirect channels and our direct sales and marketing activities; and . our system integrators, value-added resellers and ASPs may not give priority to the marketing of our products and services as compared to our competitors' products. In March 1999, we entered into an agreement with Tivoli Systems, a subsidiary of IBM, for the joint development and marketing of a family of products for enterprise application performance management, incorporating elements of our technology, which would be marketed and sold only by Tivoli. Under this agreement, we agreed that until October 2002, we will not license this technology to any other party for purposes of developing a product similar to any developed under this agreement. In addition, we agreed that until October 2002, we will not enter into technology relationships to create similar products with specified competitors of Tivoli as long as Tivoli continues to agree to pay minimum royalties. These restrictions may limit our ability to enter into new private labelling relationships. In addition, Tivoli may not succeed in developing and selling these new products. We depend on strategic relationships and business alliances for continued growth of our business. Our development, marketing and distribution strategies rely increasingly on our ability to form strategic relationships with software and other technology companies. These business relationships often consist of cooperative marketing programs, joint customer seminars, lead referrals and cooperation in product development. Many of these relationships are not contractual and depend on the continued voluntary cooperation of each party with us. Divergence in strategy or change in focus by, or competitive product offerings by, any of these companies may interfere with our ability to develop, market, sell or support our products, which in turn could harm our business. Further, if these companies enter into strategic alliances with other companies or are acquired, they could reduce their support of our products. Our existing relationships may be jeopardized if we enter into alliances with competitors of our strategic partners. In addition, one or more of these companies may use the information they gain from their relationship with us to develop or market competing products. If we are unable to manage our growth, our business may be harmed. Since 1991, we have experienced significant annual increases in revenue, employees and number of product and service offerings. This growth has placed and, if it continues, will place a significant strain on our management and our financial, operational, marketing and sales systems. If we cannot manage our growth effectively, our business, competitive position, operating results and financial condition could suffer. Although we are implementing a variety of new or expanded business and financial systems, procedures and controls, including the improvement of our sales and 20 customer support systems, the implementation of these systems, procedures and controls may not be completed successfully, or may disrupt our operations. Any failure by us to properly manage these transitions could impair our ability to attract and service customers and could cause us to incur higher operating costs and experience delays in the execution of our business plan. The success of our business depends on the efforts and abilities of our senior key personnel. We depend on the continued services and performance of our senior management and other key personnel. We do not have long 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 anticipates 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 34% in 1999, 35% in 1998 and 36% in 1997. In addition, we have substantial research and development operations in Israel. We face risks associated with our international operations, including: . changes in taxes and regulatory requirements; . difficulties in staffing and managing foreign operations; . reduced protection for intellectual property rights in some countries; . the need to localize products for sale in international markets; . longer payment cycles to collect accounts receivable in some countries; . seasonal reductions in business activity in other parts of the world in which we operate; . political and economic instability; and . economic downturns in international markets. Any of these risks could harm our international operations and cause lower international sales. For example, some European countries already have laws and regulations related to technologies used on the Internet that are more strict than those currently in force in the United States. Any or all of these factors could cause our business to be harmed. Because our research and development operations are primarily located in Israel, we may be affected by volatile economic, political and military conditions in that country and by restrictions imposed by that country on the transfer of technology. Our operations depend on the availability of highly- skilled and relatively low-cost scientific and technical personnel in Israel. Our business also depends on trading relationships between Israel and other countries. In addition to the risks associated with international sales and operations generally, our operations could be adversely affected if major hostilities involving Israel should occur or if trade between Israel and its current trading partners were interrupted or curtailed. 21 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. Our recent acquisition and any future acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert the attention of our management. We have acquired, and in the future we may acquire or make investments in other companies with similar products and technologies. For example, in November 1999, we completed our acquisition of Conduct Ltd. In the event of any future acquisitions or investments, we could: . issue stock that would dilute the ownership of our then-existing stockholders; . incur debt; . assume liabilities; 22 . incur amortization expense related to goodwill and other intangible assets; or . incur large write-offs. If we fail to achieve the financial and strategic benefits of past and future acquisitions, our operating results will suffer. Acquisitions and investments involve numerous other risks, including: . difficulties integrating the acquired operations, technologies or products with ours; . failure to achieve targeted synergies; . unanticipated costs and liabilities; . diversion of management's attention from our core business; . adverse effects on our existing business relationships with suppliers and customers or those of the acquired organization; . difficulties entering markets in which we have no or limited prior experience; and . potential loss of key employees, particularly those of the acquired organizations. The price of our common stock 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 March 17, 2000, the closing prices of our common stock as reported on the Nasdaq National Market ranged from a high of $132.13 to a low of $10.94. We expect our stock price to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include: . actual or anticipated variations in our quarterly operating results; . announcements of technological innovations or new products or services by us or our competitors; . announcements relating to strategic relationships or acquisitions; . changes in financial estimates or other statements by securities analysts; . changes in general economic conditions; . conditions or trends affecting the software industry and the Internet; and . changes in the economic performance and/or market valuations of other software and high-technology companies. Because of this volatility, we may fail to meet the expectations of our stockholders or of securities analysts at some time in the future, and our stock price could decline as a result. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many high technology companies. These fluctuations have often been unrelated or disproportionate to the operating performance of these companies. Any negative change in the public's perception of software or Internet software companies could depress our stock price regardless of our operating results. If we fail to adequately protect our proprietary rights and intellectual property, we may lose a valuable asset, experience reduced revenues and incur costly litigation to protect our rights. We rely on a combination of patents, copyrights, 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 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 23 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 sand 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 products liability claim, we may be found liable and required to pay damages which would seriously harm our business. We have adopted anti-takeover defenses that could delay or prevent an acquisition of our company, including an acquisition that would be beneficial to our stockholders. Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no present plans to issue shares of preferred stock. Furthermore, certain provisions of our Certificate of Incorporation and of Delaware law may have the effect of delaying or preventing changes in our control or management, which could adversely affect the market price of our common stock. 24 Leverage and debt service obligations may adversely affect our cash flow. Upon completion of the currently proposed offering of up to $500,000,000 principal amount of convertible subordinated notes, we will have a substantial amount of outstanding indebtedness, primarily the notes. There is the possibility that we may be unable to generate cash sufficient to pay the principal of, interest on and other amounts due in respect of our indebtedness when due. Our leverage could have significant negative consequences, including: . increasing our vulnerability to general adverse economic and industry conditions; . requiring the dedication of a substantial portion of our expected cash flow from operations to service our indebtedness, thereby reducing the amount of our expected cash flow available for other purposes, including capital expenditures; and . limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete. Item 7a. Quantitative and Qualitative Disclosures about Market Risk Interest rate risk. Our exposure to market rate risk for changes in interest 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 statement of income or balance sheet to fluctuation in interest rates. At December 31, 1999, $113.3 million, or 61%, of our cash, cash equivalents and investment portfolio carried at a maturity of less than 90 days, and $171.3 million, or 92% carried a maturity of less than one year. All investments mature, by policy, in less than two years. The effect of a 10% rate decline would not be material on the portfolio. Information about our investment portfolio is presented in Note 1 to the Consolidated Financial Statements included in this Annual Report on Form 10-K and is incorporated herein by reference. Foreign currency risk. A portion of our business is conducted in currencies other than the U.S. Dollar. Our operating expenses in each of these countries are in the local currencies, which mitigates a significant portion of the exposure related to local currency revenues. We have entered into forward foreign exchange contracts to hedge amounts due from select subsidiaries denominated in foreign currencies, mainly Europe and the Pacific Rim, against fluctuations in exchange rates. We have not entered into forward foreign exchange contracts for speculative or trading purposes. Our accounting policies for these contracts are based on our designation of the contracts as hedging transactions. The criteria we use for designating a contract as a hedge considers the contract's effectiveness in reducing risk by matching hedging instruments to underlying transactions. Gains and losses on forward foreign exchange contracts are recognized in income in the same period as gains and losses on the underlying transactions. The effect of an immediate 10% change in exchange rates would not have a material impact on our operating results or cash flows. At December 31, 1999, we had outstanding forward foreign exchange contracts to sell $10.7 million in currencies with a fair value of $10.6 million. Item 8. Financial Statements and Supplementary Data Financial statements required pursuant to this Item are presented beginning on page F-1 of this report. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure During the 24 month period preceding December 31, 1999 we neither changed accountants nor had disagreements with our accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope and procedures. 25 PART III Certain information required by Part III is omitted from this Annual Report on Form 10-K because we will file a definitive proxy statement within 120 days after the end of our fiscal year pursuant to Regulation 14A for our annual meeting of stockholders, currently scheduled for May 24, 2000, and the information included in the proxy statement is incorporated herein by reference. Item 10. Directors and Executive Officers of the Registrant The information concerning our officers required by this Item is incorporated by reference to the section of Part I of this Annual Report on Form 10-K entitled "Item 1. Business--Personnel." The information concerning our directors required by this Item is incorporated by reference to the information under the heading "Election of Directors--Nominees" in our proxy statement. Item 11. Executive Compensation The information required by this Item is incorporated by reference to our proxy statement under the heading "Executive Compensation." Item 12. Security Ownership of Certain Beneficial Owners and Management The information required by this Item is incorporated by reference to our proxy statement under the heading "Security Ownership of Certain Beneficial Owners and Management." Item 13. Certain Relationships and Related Transactions The information required by this Item is incorporated by reference to our proxy statement under the heading "Certain Transactions." 26 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) The following documents are filed as a part of this report: 1. Financial Statements. The following financial statements of Mercury Interactive Corporation are filed as a part of this report:
Page ---- Report of Independent Accountants..................................... F-1 Consolidated Balance Sheets at December 31, 1999 and 1998............. F-2 Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997.................................................. F-3 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1999, 1998 and 1997..................................... F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997.................................................. F-5 Notes to Consolidated Financial Statements............................ F-6
2. Schedules The following financial statement schedule is filed as part of this Form 10- K: Schedule II--Valuation and Qualifying Accounts for the Three Years Ended December 31, 1999 Financial statement schedules not listed above have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 3. Exhibits
Exhibit Number Description ------- ----------- 3.1(1) Certificate of Incorporation of Registrant, as amended and restated to date. 3.2(7) Certificate of Amendment of the Restated Certificate of Incorporation. 3.3(1) By-laws of Registrant, as amended to date. 10.1(6),(2) 1989 Stock Option Plan and forms of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement. 10.2(1) Form of Directors' and Officers' Indemnification Agreement. 10.3(6),(2) Form of 1998 Employee Stock Purchase Plan and form of Agreements. 10.4(1) 401(k) Plan. 10.5(2),(3) 1994 Directors' Stock Option Plan and form of Agreements. 10.6(4) Preferred Share Purchase Rights Agreement. 10.7(5) 1996 Supplemental Stock Plan. 10.10(6),(2) 1999 Stock Option Plan 10.11(8) Form of Change of Control Agreements entered into by the Company with the Chairman, the Chief Executive Officer, the Chief Financial Officer, Chief Operating Officer and the President of European Operations. 10.12(4) Amendment to Rights Agreement dated March 31, 1999. 10.13 Share Exchange Agreement among the Company, Conduct, Ltd., Conduct Software Technologies, Inc. and the shareholders of Conduct, Ltd. dated November 23, 1999. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accountants.
27
Exhibit Number Description ------- ----------- 24.1 Power of Attorney (see page 29). 27.1 Financial Data Schedule.
- -------- (1) Exhibits 3.1, 3.3, 10.2, and 10.4 are incorporated by reference to Exhibits 3.3, 3.4, 10.2, and 10.12, respectively, filed in response to Item 16(a), "Exhibits," of the Registrant's Registration Statement on Form S-1, as amended (File No. 33-68554), which was declared effective on October 29, 1993. (2) Designates management contract or compensatory plan arrangements required to be filed as an exhibit of this Annual Report on Form 10-K. (3) Exhibit 10.5 is incorporated by reference to Exhibit 10.1 filed with the Form 10-Q for the three month period ended September 30, 1994. (4) Exhibit 10.6 is incorporated by reference to the Exhibit 1 to the Company's Form 8-A, filed with the Securities and Exchange Commission on July 9, 1996, as amended by Amendment No. 1 to Form 8-A filed with the SEC on April 2, 1999. (5) Exhibit 10.7 is incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-8, No. 333-09913, filed with the Securities and Exchange Commission on August 9, 1996. (6) Exhibits 10.1, 10.3, and 10.10 are incorporated by reference to Exhibits 4.1, 4.3, and 4.2, respectively, filed with the Company's Registration Statement on Form S-8, No. 333-62125, filed with the Securities and Exchange Commission on August 24, 1998. (7) Exhibit 3.3 is incorporated by reference to Exhibit 4.1 filed with the Company's Registration Statement on Form S-3, No. 333-95097, filed with the Securities and Exchange Commission on January 20, 2000. (8) Exhibit 10.10 is incorporated by reference to Exhibit 10.26 filed with the Form 10-K for the year ended December 31, 1999. (b) Reports on Form 8-K No report on Form 8-K was filed during the fourth quarter of the year ended December 31, 1999. 28 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant, Mercury Interactive Corporation, a corporation organized and existing under the laws of the State of Delaware, has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Mercury Interactive Corporation Dated: March 20, 2000 By: /s/ Sharlene Abrams __________________________________ Sharlene Abrams, Chief Financial Officer, Vice President of Finance and Administration KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints jointly and severally, Amnon Landan and/or Sharlene Abrams and each one of them, his or her attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.
Signature Title Date --------- ----- ---- /s/ Amnon Landan President, Chief Executive March 20, 2000 ____________________________________ Officer Amnon Landan (Principal Executive Officer) and Chairman of the Board of Directors /s/ Sharlene Abrams Chief Financial Officer, Vice March 20, 2000 ____________________________________ President, Finance and Sharlene Abrams Administration (Principal Financial and Accounting Officer) /s/ Igal Kohavi Director March 20, 2000 ____________________________________ Igal Kohavi /s/ Yair Shamir Director March 20, 2000 ____________________________________ Yair Shamir /s/ Giora Yaron Director March 20, 2000 ____________________________________ Giora Yaron
29 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Mercury Interactive Corporation In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) present fairly, in all material respects, the financial position of Mercury Interactive Corporation and its subsidiaries (the "Company") at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 14(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP San Jose, California January 20, 2000, except as to Note 9, which is as of February 11, 2000. F-1 MERCURY INTERACTIVE CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
December 31, ------------------ 1999 1998 -------- -------- ASSETS Current assets: Cash and cash equivalents................................ $113,346 $ 96,836 Short-term investments................................... 57,981 13,130 Trade accounts receivable (net of allowance for doubtful accounts and sales returns of $5,533 and $3,623)........ 40,399 27,903 Other receivables........................................ 6,325 6,012 Prepaid expenses and other current assets................ 16,702 11,685 -------- -------- Total current assets................................... 234,753 155,566 Long-term investments...................................... 15,555 20,697 Property and equipment, net................................ 46,910 28,423 -------- -------- $297,218 $204,686 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable......................................... $ 8,469 $ 4,422 Accrued liabilities...................................... 33,433 18,236 Income taxes payable..................................... 19,945 11,498 Deferred revenue......................................... 35,840 24,122 -------- -------- Total current liabilities.............................. 97,687 58,278 -------- -------- Commitments and contingencies (Note 5) Stockholders' equity: Common stock, par value $.002 per share, 120,000 shares authorized; 78,090 and 73,990 shares issued and outstanding............................................. 156 148 Capital in excess of par value........................... 148,826 128,428 Notes receivable from issuance of stock.................. (5,090) (5,130) Accumulated other comprehensive loss..................... (1,242) (775) Retained earnings........................................ 56,881 23,737 -------- -------- Total stockholders' equity............................. 199,531 146,408 -------- -------- $297,218 $204,686 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-2 MERCURY INTERACTIVE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
Year ended December 31, ------------------------- 1999 1998 1997 -------- -------- ------- Revenue: License............................................ $130,900 $ 84,450 $56,683 Service............................................ 56,800 36,550 20,017 -------- -------- ------- Total revenue.................................... 187,700 121,000 76,700 -------- -------- ------- Cost of revenue: License............................................ 7,736 6,291 4,351 Service............................................ 18,642 11,757 6,225 -------- -------- ------- Total cost of revenue............................ 26,378 18,048 10,576 -------- -------- ------- Gross profit ........................................ 161,322 102,952 66,124 -------- -------- ------- Operating expenses: Research and development, net...................... 23,484 16,907 11,333 Write off of in-process research and development and related expenses.............................. -- -- 5,500 Marketing and selling.............................. 88,609 57,243 37,073 General and administrative......................... 11,242 8,466 6,642 Merger related expenses............................ 2,000 -- -- -------- -------- ------- Total operating expenses......................... 125,335 82,616 60,548 -------- -------- ------- Income from operations............................... 35,987 20,336 5,576 Other income, net.................................... 6,026 4,640 3,083 -------- -------- ------- Income before provision for income taxes............. 42,013 24,976 8,659 Provision for income taxes........................... 8,869 5,451 2,927 -------- -------- ------- Net income........................................... $ 33,144 $ 19,525 $ 5,732 ======== ======== ======= Net income per share (basic)......................... $ 0.44 $ 0.28 $ 0.09 ======== ======== ======= Net income per share (diluted)....................... $ 0.39 $ 0.25 $ 0.08 ======== ======== ======= Weighted average common shares (basic)............... 76,112 70,654 65,494 ======== ======== ======= Weighted average common shares and equivalents (diluted)........................................... 85,208 78,818 68,458 ======== ======== =======
The accompanying notes are an integral part of these consolidated financial statements. F-3 MERCURY INTERACTIVE CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
Capital Notes in receivable Retained Accumulated Common stock excess from earnings/ other ------------- of par issuance accumulated comprehensive Stockholders' Comprehensive Shares Amount value of stock deficit loss equity income (loss) ------ ------ -------- ---------- ----------- ------------- ------------- ------------- Balance at December 31, 1996................... 64,226 $128 $100,539 -- $(1,520) $ (99) $ 99,048 Net income.............. -- -- -- -- 5,732 -- 5,732 $ 5,732 Currency translation adjustments............ -- -- -- -- -- (325) (325) (325) ------- Comprehensive income.... $ 5,407 ======= Stock issued under stock option and employee stock purchase plans... 2,728 6 7,560 -- -- -- 7,566 Pooling of interests acquisition............ -- -- 99 -- -- -- 99 ------ ---- -------- ------- ------- ------- -------- Balance at December 31, 1997................... 66,954 134 108,198 -- 4,212 (424) 112,120 Net income.............. -- -- -- -- 19,525 -- 19,525 19,525 Currency translation adjustments............ -- -- -- -- -- (351) (351) (351) ------- Comprehensive income.... $19,174 ======= Stock issued under stock option and employee stock purchase plans... 6,300 12 16,266 (5,130) -- -- 11,148 Pooling of interests acquisition............ 736 2 3,964 -- -- -- 3,966 ------ ---- -------- ------- ------- ------- -------- Balance at December 31, 1998................... 73,990 148 128,428 (5,130) 23,737 (775) 146,408 Net income.............. -- -- -- -- 33,144 -- 33,144 33,144 Currency translation adjustments............ -- -- -- -- -- (467) (467) (467) ------- Comprehensive income.... $32,677 ======= Collection of notes receivable............. -- -- -- 387 -- -- -- Stock issued under stock option and employee stock purchase plans... 4,100 8 20,398 (347) -- -- 20,446 ------ ---- -------- ------- ------- ------- -------- Balance at December 31, 1999................... 78,090 $156 $148,826 $(5,090) $56,881 $(1,242) $199,531 ====== ==== ======== ======= ======= ======= ========
The accompanying notes are an integral part of these consolidated financial statements. F-4 MERCURY INTERACTIVE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net income..................................... $ 33,144 $ 19,525 $ 5,732 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization.................. 6,063 4,223 3,775 Loss on retirement of property and equipment... 121 -- -- Deferred income taxes.......................... (2,802) (1,840) 270 Changes in assets and liabilities: Trade accounts receivable.................... (12,349) (4,006) (7,240) Other receivables............................ (428) (4,034) (730) Prepaid expenses and other current assets.... (3,277) (1,879) 857 Accounts payable............................. 4,076 803 1,923 Accrued liabilities.......................... 16,164 5,309 5,141 Income taxes payable......................... 8,688 8,373 2,485 Deferred revenue............................. 11,718 13,030 4,936 -------- -------- -------- Net cash provided by operating activities.. 61,118 39,504 17,149 -------- -------- -------- Cash flows from investing activities: Maturity of investments........................ 28,616 35,128 35,640 Purchases of investments....................... (68,325) (33,826) (35,128) Acquisition of property and equipment, net..... (23,897) (15,040) (11,927) Capitalization of software development costs .. -- -- (500) -------- -------- -------- Net cash used in investing activities...... (63,606) (13,738) (11,915) -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock, net.... 20,406 19,494 7,665 Notes receivable from issuance of stock........ (347) (5,130) -- Notes receivable collected from issuance of stock......................................... 387 -- -- -------- -------- -------- Net cash provided by financing activities .......................................... 20,446 14,364 7,665 -------- -------- -------- Effect of exchange rate changes on cash.......... (1,448) (585) (28) -------- -------- -------- Net increase in cash............................. 16,510 39,545 12,871 Cash and cash equivalents at beginning of year... 96,836 57,291 44,420 -------- -------- -------- Cash and cash equivalents at end of year......... $113,346 $ 96,836 $ 57,291 ======== ======== ======== Supplemental Disclosure: Cash paid during the year for income taxes....... $ 1,354 $ 1,365 $ 2,083
The accompanying notes are an integral part of these consolidated financial statements. F-5 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES Mercury Interactive Corporation (the "Company") develops, markets and supports performance management solutions that enable businesses to test and monitor their Internet and other applications. The Company operates in one industry segment. (See Note 7 for geographic reporting.) No customer accounted for more than 10% of revenue in 1999, 1998 or 1997. The Company acquired Conduct Ltd. on November 30, 1999, which was accounted for as a pooling of interests. The consolidated financial statements for each of the three years ended December 31, 1999, 1998 and 1997 and the accompanying notes reflect the results of operations as if the acquired entity was a wholly owned subsidiary since its inception (see Note 8). Basis of presentation The Company has a wholly owned research and development and sales subsidiary incorporated in Israel and sales subsidiaries in Brazil, Canada, Europe, South Africa and the Pacific Rim for marketing, distribution and support of products. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. In January 2000, the Company's Board of Directors approved a two-for-one split of the Company's common stock, which was distributed as a stock dividend to the Company's stockholders, on February 11, 2000. All share and per share amounts reflect the effect of the split. Management Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Foreign currency translation The functional currency of the Company's subsidiary in Israel is the U.S. dollar. Assets and liabilities in Israel are translated at year-end exchange rates, except for property and equipment, which is translated at historical rates. Revenues and expenses are translated at average exchange rates in effect during the year, except for costs related to those balance sheet items, which are translated at historical rates. Foreign currency translation gains and losses, which have not been material to date for this subsidiary, are included in the consolidated statement of operations. The functional currencies of all other subsidiaries are the local currencies. Accordingly, all assets and liabilities of these subsidiaries are translated at the current exchange rate at the end of the period and revenues and costs at average exchange rates in effect during the period. The gains and losses from translation of these subsidiaries' financial statements are recorded directly into a separate component of stockholders' equity. Net gains and losses resulting from foreign exchange transactions were not significant during any of the periods presented. The Company enters into forward foreign exchange contracts to hedge foreign currency denominated intercompany payables against fluctuations in exchange rates. The Company does not enter into forward foreign exchange contracts for speculative or trading purposes. The criteria used for designating a contract as a hedge considers the contract's effectiveness in reducing risk by matching hedging instruments to underlying transactions. Gains and losses on forward foreign exchange contracts are recognized in income in the same period as gains and losses on the underlying transactions. At December 31, 1999, the Company had outstanding forward foreign exchange contracts to sell $10.7 million in currencies with a fair value of $10.6 million. F-6 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Cash and cash equivalents The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Short-term and long-term investments The Company considers all investments with remaining maturities of less than one year to be short-term investments and all investments with remaining maturities greater than one year to be long-term investments. In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company has categorized its marketable securities as "held to maturity" securities. The investments, which all have contractual maturities of less than two years, are carried at cost plus accrued interest. Realized gains or losses are determined based on the specific identification method and are reflected in other income. The portfolio of short-term and long-term investments (including cash and cash equivalents) consisted of the following (in thousands):
December 31, ----------------- Investment Type 1999 1998 --------------- -------- -------- Cash and interest bearing demand deposits................. $ 34,275 $ 21,655 Corporate debt securities................................. 86,593 56,472 Municipal securities...................................... 52,670 50,936 U.S. treasury and agency securities....................... 13,344 1,600 -------- -------- Total................................................. $186,882 $130,663 ======== ========
Revenue recognition Revenues are derived from product licensing fees, and from maintenance support services, training and consulting. Revenue from product licensing fees is recognized upon shipment and resolution of any material vendor obligations. Products shipped, for which material vendor obligations exist, are recorded as deferred revenue. Service revenue from customer maintenance fees for ongoing customer support and product updates is recognized ratably over the period of the contract. Payments for maintenance fees are generally made in advance, are nonrefundable and are classified as deferred revenue. Revenues for training and consulting services are recognized as the services are provided. Property and equipment Property and equipment are stated at cost. Depreciation and amortization are provided using the straight-line method over the estimated economic lives of assets, which are five to seven years for office furniture and equipment, three to five years for computers and related equipment, four to ten years for leasehold improvements, or the term of the lease, whichever is shorter, and thirty years for buildings. Long-lived assets The Company evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS 121"). SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. No such impairments have been identified to date. The Company assesses the impairment of long-lived assets when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. F-7 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Research and development In accordance with Statement of Financial Accounting Standards No. 86, "Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed," all costs incurred to establish the technological feasibility of a computer product to be sold, leased or otherwise marketed are expensed as research and development costs. Costs incurred subsequent to the establishment of technological feasibility, and prior to the general release of the product to the public are capitalized. Amortization of capitalized software development costs is provided on a product-by-product basis using the straight-line method over the estimated economic life of the products of two years. In 1999 and 1998, no software development costs were capitalized because the costs incurred subsequent to achieving techological feasibility and prior to the general release of the products were not significant. The Company capitalized $500,000 of software development costs during the year ended December 31, 1997. Amortization charges included in cost of license revenues were $585,000 in 1999 and $600,000 in each of 1998 and 1997. In conjunction with the technology acquisition in 1997 approximately $250,000 of capitalized development costs were written off as obsolete in the year ended December 31, 1997. At December 31, 1999, the Company did not have any capitalized software development costs. At December 31, 1998, the net balance of capitalized software development costs was $585,000. Research and development expense is reported net of research grants received from the government of Israel, and includes royalty expense for obligations to the government of Israel for sales of products developed under government- funded research. No grants were obtained from the Office of the Chief Scientist in the Israeli Ministry of Industry and Trade ("the Chief Scientist") during 1999. Research grants received amounted to $1.6 million in 1998 and $2.1 million in 1997. The Company was not obligated to repay these grants; however, the Company agreed to pay royalties at rates ranging from 2% to 5% of product sales resulting from the research, up to the amount of the grants obtained and for certain grants up to 150% of the grants obtained. Royalty expense under these agreements amounted to approximately $2.7 million for each of the years ended December 31, 1999 and 1998, and $1.6 million for the year ended December 31, 1997. As of December 31, 1999, the Company had no outstanding royalty obligations. The Company has not applied for, nor does it anticipate applying for, any future Chief Scientist grants. Stock-based compensation The Company accounts for stock-based compensation using the intrinsic value method presented in Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" and related interpretations. The Company's policy is to grant options with an exercise price equal to the quoted market price of its stock on the grant date. Accordingly, no compensation cost has been recognized in the statements of operations. Additional pro forma disclosure is provided as required under Statement of Financial Accounting Standard No. 123 ( "SFAS 123"), "Accounting for Stock- based Compensation" (see Note 3). Concentration of risks Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash equivalents, investments and accounts receivable. The Company invests primarily in money market accounts and marketable securities and places its investments with high quality financial, government or corporate institutions. Accounts receivables are derived from sales to customers located primarily in the U.S., Canada, Europe, Pacific Rim and Israel. The Company performs ongoing credit evaluations of its customers and to date has not experienced any material losses. F-8 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Net income per share Earnings per share are calculated in accordance with the provisions of Statement of Accounting Standards No. 128, "Earnings per Share," ("SFAS 128"). SFAS 128 requires the reporting of both basic earnings per share, which is the weighted-average number of common shares outstanding, and diluted earnings per share, which includes the weighted-average common shares outstanding and all dilutive potential common shares outstanding. For the years ended December 31, 1999, 1998 and 1997, dilutive potential common shares outstanding reflects shares issuable under our stock option plans. Share and per share amounts reflect the effect of the two-for-one stock split distributed to stockholders on February 11, 2000. The following table summarizes the Company's earnings per share computations for the years ended December 31, 1997, 1998 and 1999 (in thousands, except per share amounts):
Earnings Net Average per income shares share ------- ------- -------- December 31, 1997: Basic earnings per share.......................... $ 5,732 65,494 $0.09 Dilutive adjustments.............................. -- 2,964 ------- ------ Diluted earnings per share........................ $ 5,732 68,458 $0.08 ------- ------ December 31, 1998: Basic earnings per share.......................... $19,525 70,654 $0.28 Dilutive adjustments.............................. -- 8,164 ------- ------ Diluted earnings per share........................ $19,525 78,818 $0.25 ------- ------ December 31, 1999: Basic earnings per share.......................... $33,144 76,112 $0.44 Dilutive adjustments.............................. -- 9,096 ------- ------ Diluted earnings per share........................ $33,144 85,208 $0.39 ======= ======
At December 31, 1999, 1998, and 1997, options to purchase a total of 504,000 shares of common stock with an average exercise price of $38.50, 280,000 shares of common stock with an average exercise price of $9.62, and 941,092 shares of common stock with an average exercise price of $4.83, respectively, are considered anti-dilutive because the options' exercise price was greater than the average fair market value of our common stock for the years then ended. Reclassifications Certain previously reported amounts have been reclassified to conform to the 1999 consolidated financial statement presentation. Comprehensive Income Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This statement requires that all items recognized under accounting standards as components of comprehensive earnings be reported in an annual financial statement that is displayed with the same prominence as other annual financial statements. Comprehensive income has been included in the Consolidated Statement of Stockholders' Equity for all periods. Segment Reporting Effective January 1998, the Company adopted Statement of Financial Accounting Standard No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards F-9 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) for the manner in which public companies report information about operating segments in annual and interim financial statements. Information related to geographic segments is included in Note 7. New Accounting Pronouncements In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 98-1, "Accounting for the Cost of Computer Software Developed or Obtained for Internal Use"("SOP 98-1"). SOP 98- 1 is effective for the financial statements for years beginning after December 15, 1998. SOP 98-1 provides guidance over accounting for computer software developed or obtained for internal use including the requirement to capitalize specified costs and amortization of such costs. The Company adopted the provisions of SOP 98-1 in its fiscal year ending December 31, 1999. Adoption did not have a material effect on the financial statements. In March 1998, the AICPA issued Statement of Position 98-4, "Deferral of Effective Date of a Provision of SOP 97-2 ("SOP 98-4"). SOP 98-4 defers for one year the application of certain provisions of Statement of Position 97-2 "Software Revenue Recognition ("SOP 97-2"). Different informal and non- authoritative interpretations of certain provisions of SOP 97-2 have arisen and, as a result, the AICPA issued Statement of Position 98-9, "Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions" ("SOP 98-9") in December 1998 which is effective for periods beginning after March 15, 1999. SOP 98-9 extends the effective date of SOP 98- 4 and provides additional interpretive guidance. The adoption of SOP 97-2, SOP 98-4 and SOP 98-9 have not had a material effect on the results of operations, financial position or cash flows. In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133--an amendment of FASB Statement No. 133" ("SFAS 137"). SFAS 137 defers for one year the application of Statement of Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") to all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. The adoption of SFAS 133 and SFAS 137 have not had and are not expected to have a material effect on the results of operations, financial position or cash flows. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," ("SAB 101") which provides guidance on the recognition, presentation, and disclosure of revenue in financial statements filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. Management believes the impact of SAB 101 will not have a material effect on the results of operations, financial position or cash flows. F-10 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 2--FINANCIAL STATEMENT COMPONENTS
December 31, ------------------ 1999 1998 -------- -------- (in thousands) Other receivables: Government grants receivables............................ $ -- $ 400 Employee receivables..................................... 2,625 1,014 Income taxes receivable.................................. 2,178 2,618 Other receivables........................................ 1,522 1,980 -------- -------- $ 6,325 $ 6,012 ======== ======== Prepaid expenses and other current assets: Prepaid compensation..................................... $ 6,579 $ 5,717 Deferred income taxes, net............................... 4,642 1,840 Other.................................................... 5,481 4,128 -------- -------- $ 16,702 $ 11,685 ======== ======== Property and equipment, net: Land and buildings....................................... $ 35,245 $ 18,311 Computers and equipment.................................. 23,558 18,039 Office furniture and equipment........................... 5,829 4,481 Leasehold improvements................................... 2,888 2,934 -------- -------- 67,520 43,765 Less: Accumulated depreciation and amortization.......... (20,610) (15,342) -------- -------- $ 46,910 $ 28,423 ======== ======== Accrued liabilities: Payroll and accrued commissions (including payroll taxes).................................................. $ 16,751 $ 5,939 Vacation and severance................................... 4,299 3,457 Sales tax................................................ 3,270 2,820 Royalties................................................ 1,596 2,177 Merger related expenses.................................. 937 -- Other.................................................... 6,580 3,843 -------- -------- $ 33,433 $ 18,236 ======== ========
Year ended December 31, ---------------------- 1999 1998 1997 ------ ------ ------ (in thousands) Other income, net: Interest income....................................... $6,480 $4,741 $3,521 Foreign exchange losses and other..................... (454) (101) (438) ------ ------ ------ $6,026 $4,640 $3,083 ====== ====== ======
F-11 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 3--COMMON STOCK In August 1989, the Company adopted a stock option plan (the "1989 Plan"). Options granted under the 1989 Plan are for periods not to exceed ten years. For holders of 10% or more of the total combined voting power of all classes of the Company's stock, options may not be granted at less than 110% of the fair value of the common stock at the date of grant and the option term may not exceed 5 years. Incentive stock option grants under the 1989 Plan must be at exercise prices no less than 100% of the fair market value and non- statutory stock option grants under the 1989 Plan must be at exercise prices no less than 85% of the fair market value of the stock on the date of grant. Options are immediately exercisable but all shares purchased upon exercise of options are subject to repurchase by the Company until vested. Options generally vest over a period of four years. In August 1998, the stockholders reserved an additional 1,200,000 shares of common stock for issuance upon exercise of stock options to be granted under this plan. In August 1998, the stockholders adopted the 1999 Stock Option Plan (the "1999 Plan") to replace the 1989 Plan, effective on the expiration of the term of such plan in August 1999. The Company reserved 900,000 shares of common stock for issuance upon exercise of stock options to be granted under this plan. The provisions of the 1999 Plan regarding option term, grant price, exercise price, and vesting period are identical to those of the 1989 Plan except that all options granted under the 1999 Plan must be at exercise prices no less than 100% of the fair market value. In December 1999, the stockholders approved an automatic increase in the aggregate number of shares reserved for issuance under the 1999 Plan by 4% of the common stock and equivalents outstanding as of January 1 of each year starting in 2000 and ending in 2003. In May 1996, the Company adopted a stock option plan solely for grants to employees of its subsidiaries located outside the United States (the "Supplemental Plan"). The Company reserved 2,000,000 shares of common stock for issuance upon exercise of stock options to be granted under this plan. The provisions of the Supplemental Plan regarding option term, grant price, exercise price, and vesting period is identical to those of the Plan. The following table presents the combined activity of the 1989 Plan, the 1999 Plan and the Supplemental Plan for the years ended December 31, 1997, 1998 and 1999 (shares in thousands):
Options outstanding ------------------------ Options Weighted available Number of average for grant shares exercise price --------- --------- -------------- Balance outstanding at December 31, 1996.................................. 56 12,500 $ 2.82 Additional shares authorized........... 2,992 -- -- Options granted........................ (4,268) 4,268 2.97 Options canceled....................... 1,252 (1,252) 3.00 Options exercised...................... -- (2,124) 2.41 ------ ------ Balance outstanding at December 31, 1997.................................. 32 13,392 2.92 Additional shares authorized........... 4,466 -- -- Options granted........................ (5,320) 5,320 6.49 Options canceled....................... 930 (930) 4.41 Options exercised...................... -- (6,080) 2.72 ------ ------ Balance outstanding at December 31, 1998.................................. 108 11,702 4.49 Additional shares authorized........... 7,857 -- -- Options granted........................ (4,871) 4,871 16.02 Options canceled....................... 945 (945) 6.38 Options exercised...................... -- (3,612) 4.42 ------ ------ Balance outstanding at December 31, 1999................................... 4,039 12,016 $ 9.07 ====== ======
F-12 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table presents weighted average price and remaining contractual life information about significant option groups outstanding under the above plans at December 31, 1999 (shares in thousands):
Options outstanding Options exercisable --------------------------------------------- -------------------------------- Weighted average remaining Number Range of Number contractual life Weighted average exercisable Weighted average Exercise Prices outstanding (yr.) exercise price at 12/31/99 exercise price --------------- ----------- ---------------- ---------------- ----------- ---------------- $ 0.08- 3.19............ 3,061 5.46 $ 2.78 2,044 $ 2.85 $ 3.38- 6.32............ 4,015 8.07 5.73 1,359 5.65 $ 8.10-12.03............ 3,691 9.01 11.55 192 8.89 $15.50-45.47............ 1,249 9.81 28.09 4 19.57 ------ ----- 12,016 7.87 $ 9.07 3,599 $ 4.24 ====== =====
In October 1998, the Company issued notes receivable of $5.1 million to its officers and key employees in connection with the purchase of common stock. The notes bear interest at 5%, are secured by the shares purchased, and require quarterly interest payments. The full amount of the notes and the final interest payment are due no later than December 31, 2000. Directors' Stock Option Plan On August 3, 1994, the Board of Directors adopted the 1994 Directors' Stock Option Plan (the "Directors' Plan"). The Company reserved 2,000,000 shares of Common Stock for issuance upon exercise of stock options to be granted during the ten year term of the Directors' Plan. Only outside directors may be granted options under the Directors' Plan. The Plan provided for an initial option grant of 25,000 shares to the Company's outside directors as of August 3, 1994 or upon initial election to the Board of Directors after August 3, 1994. In addition, the plan provided for automatic annual grants of 5,000 shares upon re-election of the individual to the Board of Directors. In August 1998, the stockholders agreed to amend the Directors' plan to increase the number of shares granted to 50,000 shares as an initial grant to new non- employee directors, 10,000 shares as the annual grant to continuing non- employee directors of the Corporation, and to provide for a one-time grant of 25,000 shares to the non-employee directors of the Corporation who were serving as directors of the Corporation as of August 14, 1998. The option term shall be ten years, and options shall be exercisable while such person remains a director. The exercise price shall be 100% of fair market value on the date of grant. The initial option grants vest 20% annually for each director on the date of each Annual Meeting of Stockholders of the Company after the date of grant of such option. The annual option grants shall vest in full on the fifth anniversary following each individual's re-election to the Board of Directors. F-13 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table presents the activity for the Directors' Plan for the years ended December 31, 1997, 1998 and 1999 (shares in thousands):
Options outstanding Options ----------------------- available Number of Weighted for grant shares average price --------- --------- ------------- Balance outstanding at December 31, 1996................................... 1,520 360 $ 3.26 Options granted......................... (60) 60 3.07 Options canceled........................ -- -- -- Options exercised....................... -- (40) 2.29 ----- ---- Balance outstanding at December 31, 1997................................... 1,460 380 3.33 Options granted......................... (360) 360 9.70 Options canceled........................ -- -- -- Options exercised....................... -- (160) 3.81 ----- ---- Balance outstanding at December 31, 1998................................... 1,100 580 7.14 Options granted......................... (60) 60 15.50 Options canceled........................ -- -- -- Options exercised....................... -- (140) 7.96 ----- ---- Balance outstanding at December 31, 1999................................... 1,040 500 $ 7.91 ===== ====
The following table presents weighted average price and remaining contractual life information about significant option groups outstanding under the Directors' Plan at December 31, 1999 (shares in thousands):
Options outstanding Options exercisable -------------------------------------------------- ---------------------------- Weighted average Number Range of Number remaining Weighted average exercisable Weighted average Exercise prices outstanding contractual life(yr.) exercise price at 12/31/99 exercise price --------------- ----------- --------------------- ---------------- ----------- ---------------- $ 2.28-$ 3.38........... 140 6.47 $ 3.06 20 $2.28 $ 5.28-$ 8.66........... 120 6.99 6.75 -- -- $ 9.91-$ 9.91........... 180 8.62 9.91 -- -- $15.50-$15.50........... 60 9.40 15.50 -- -- --- --- 500 7.72 $ 7.91 20 $2.28 === ===
Employee Stock Purchase Plans In October 1993, the Board of Directors and stockholders adopted the Employee Stock Purchase Plan (the "1993 ESPP") and reserved 2,000,000 shares for issuance. Under the plan, employees were granted the right to purchase shares of common stock at a price per share that was the lesser of: (i) 85% of the fair market value of the shares at the participant's entry date into the two-year offering period, or (ii) the fair market value at the end of each six-month segment within such offering period. The 1993 ESPP was terminated in February 1998. In August 1998, the stockholders adopted the 1998 Employee Stock Purchase Plan (the "1998 ESPP") to replace the 1993 ESPP and the reservation of 1,300,000 shares for issuance thereunder. Under the 1998 ESPP, employees are granted the right to purchase shares of common stock at a price per share that is the lesser of (i) 85% of the fair market value of the shares at the participant's entry date into the six month offering period, or (ii) 85% of the fair market value of the shares at the end of the six month offering period. During 1999, 1998 and 1997, approximately 345,000, 84,000 and 560,000 shares, respectively, were purchased under our Employee Stock Purchase Plans. F-14 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Pro Forma Disclosure The Company has adopted the disclosure provisions only of SFAS 123 and will continue to account for its stock option plans in accordance with the provisions of APB 25. Accordingly, no compensation cost has been recognized for the option plans or the ESPP. Pursuant to the requirements of SFAS 123, the following are pro forma net income (loss) and net income (loss) per share for 1999, 1998 and 1997, as if the compensation costs for the option plans and the ESPP had been determined based on the fair value at the grant date for grants in 1999, 1998 and 1997, consistent with the provisions of SFAS 123:
1999 1998 1997 ------- ------ ----- Pro forma net income (loss) (in thousands)............ $13,895 $7,882 $(379) Pro forma net income (loss) per share (basic)......... 0.18 0.11 (0.01) Pro forma net income (loss) per share (diluted)....... 0.16 0.10 (0.01)
The fair value of options and shares issued pursuant to the option plans and the ESPP at the grant date were estimated using the Black-Scholes model with the following weighted average assumptions:
Option plans ESPP ---------------- ---------------- 1999 1998 1997 1999 1998 1997 ---- ---- ---- ---- ---- ---- Expected life (years)....................... 4.00 4.00 5.00 0.50 0.50 0.50 Risk-free interest rate..................... 5.01% 5.22% 6.10% 5.06% 4.90% 5.36% Volatility.................................. 83% 83% 86% 83% 83% 86% Dividend yield.............................. None None None None None None
The weighted fair value per share of options granted under the 1989 Plan, the 1999 Plan and Supplemental Plan during the years ended December 31, 1999, 1998 and 1997 were $10.12, $4.13 and $2.12, respectively. The weighted fair value per share of options granted under the Directors' Plan during the years ended December 31, 1999, 1998 and 1997 were $9.84, $6.13, and $2.18, respectively. NOTE 4--INCOME TAXES Income (loss) before income taxes consists of the following (in thousands):
Year ended December 31, ---------------------- 1999 1998 1997 ------- ------- ------ Domestic................................................ $ 9,357 $ 6,239 $ (284) Foreign................................................. 32,656 18,737 8,943 ------- ------- ------ $42,013 $24,976 $8,659 ======= ======= ======
F-15 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The provision for income taxes comprises the following (in thousands):
Year ended December 31, ------------------------ 1999 1998 1997 ------- ------- ------ Current:............................................ Federal........................................... $ 5,375 $ 5,322 $1,222 State............................................. 931 350 355 Foreign........................................... 5,365 1,619 1,080 ------- ------- ------ Total Current................................... 11,671 7,291 2,657 ------- ------- ------ Deferred: Federal........................................... (2,681) (1,756) 193 State............................................. (121) (84) 77 Foreign........................................... -- -- -- ------- ------- ------ Total Deferred.................................. (2,802) (1,840) 270 ------- ------- ------ Total tax expense................................... $ 8,869 $ 5,451 $2,927 ======= ======= ======
Deferred tax assets consist of the following (in thousands):
December 31, ---------------- 1999 1998 ------- ------- Accruals and reserves...................................... $ 3,644 $ 1,821 Net operating loss carryforwards........................... 1,856 1,336 Other...................................................... 998 19 ------- ------- 6,498 3,176 Valuation allowance........................................ (1,856) (1,336) ------- ------- Deferred tax assets, net................................. $ 4,642 $1,840 ======= =======
The Company has provided a valuation allowance for the years ended December 31, 1999 and 1998 for net operating loss carryforwards in foreign jurisdictions, for which realization of future benefit is uncertain. Management believes it is more likely than not that future operations will generate sufficient taxable income to realize the December 31, 1999 deferred tax assets, net. The provision for income taxes differs from the amount obtained by applying the statutory federal income tax rate to income before taxes as follows (in thousands):
December 31, ------------------------- 1999 1998 1997 ------- ------- ------- Provision at federal statutory rate............. $14,705 $ 8,492 $ 2,944 State tax, net of federal tax benefit........... 527 350 549 Foreign rate differentials from U.S. statutory rate........................................... (8,234) (5,288) (2,739) Non-utilized net operating losses and credits... 3,625 2,826 2,722 Tax-exempt interest............................. (640) (409) (756) Other........................................... (1,114) (520) 207 ------- ------- ------- $ 8,869 $ 5,451 $ 2,927 ======= ======= =======
Income taxes are not provided for the undistributed earnings of the Company's foreign subsidiaries because it is management's intention to reinvest such earnings in its foreign operations. F-16 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Company's Israeli facilities have been granted the status of an "Approved Enterprise" under the Israeli law for the Encouragement of Capital Investments, 1959, as amended. An Approved Enterprise is eligible for significant tax rate reductions for several years following the first year in which there is Israeli taxable income (after consideration of tax losses carried forward). The Company realized tax savings of approximately $6.3 million, $5.2 million, and $4.2 million in 1999, 1998 and 1997, respectively, as a result of this tax holiday. Because the Israeli subsidiary currently has five overlapping Approved Enterprise plans, the tax holidays and rate reductions which the Company will be able to realize in future years are expected to extend until 2007. The Company had US federal net operating loss carryforwards of approximately $23.1 million as of December 31, 1999, expiring through the year 2019. The net operating losses are attributable to stock option compensation deductions. Accordingly, any tax benefit realized upon utilization of these net operating loss carryforwards will be accounted for as additions to Capital in Excess of Par Value. For the year ended December 31, 1999 the Company had California net operating loss carryforwards of approximately $4.4 million available to reduce future income subject to income taxes. If not utilized, the California net operating losses will expire through the year 2004. The 1999 tax provision was calculated without the benefit of Conduct's pre- acquisition losses because the realization of any future tax benefit is uncertain. NOTE 5--COMMITMENTS AND CONTINGENCIES Royalty Commitments Research and development expense is reported net of research grants received from the government of Israel, and includes royalty expense for obligations to the government of Israel for sales of products developed under government- funded research. No grants were obtained from the Office of the Chief Scientist in the Israeli Ministry of Industry and Trade ("the Chief Scientist") during 1999. Research grants received amounted to $1.6 million in 1998 and $2.1 million in 1997. The Company was not obligated to repay these grants; however, the Company agreed to pay royalties at rates ranging from 2% to 5% of product sales resulting from the research, up to the amount of the grants obtained and for certain grants up to 150% of the grants obtained. Royalty expense under these agreements amounted to approximately $2.7 million for each of the years ended December 31, 1999 and 1998, and $1.6 million for the year ended December 31, 1997. As of December 31, 1999, the Company had no outstanding royalty obligations. The Company has not applied for, nor does it anticipate applying for, any future Chief Scientist grants. Lease commitments The Company leases facilities for sales offices in the U.S. and foreign locations under non-cancelable operating leases that expire from 2000 through 2004. Certain of these leases contain renewal options. The Company leases certain equipment and vehicles under various leases with lease terms ranging from month-to-month up to one year. Future minimum payments under the facilities and equipment leases with non-cancelable terms in excess of one year are as follows as of December 31, 1999 (in thousands): 2000.............................. $3,101 2001.............................. 2,397 2002.............................. 1,555 2003.............................. 569 2004.............................. 229 ------ Total............................. $7,851 ======
F-17 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Total rent expense under operating leases amounted to $2.8 million, $2.0 million, and $1.6 million for the years ended December 31, 1999, 1998 and 1997, respectively. NOTE 6--RELATED PARTIES At December 31, 1999, the Company held seven notes receivable with balances totaling $5.1 million from its officers and key employees. These notes arose from transactions occurring on October 5, 1998 whereby the Company loaned its key employees money to purchase an aggregate of 886,428 shares of our common stock at the then fair market value. These notes, which bear interest at the rate of 5% per annum, mature on December 31, 2000. Interest on the notes is due quarterly, with the principal amount and final interest payment being payable in full no later than the maturity date. If the officer or key employee's employment is terminated prior to January 1, 2001, the unpaid portion of the note would become payable in full. These notes are collateralized by the shares purchased. The receivable is shown on the balance sheets as a reduction in equity. NOTE 7--GEOGRAPHIC REPORTING
Year ended December 31, -------------------------- 1999 1998 1997 -------- -------- -------- (in thousands) Net revenue to third parties: North America.................................. $123,900 $ 78,797 $ 49,354 Europe......................................... 49,700 33,140 21,223 Rest of the World.............................. 14,100 9,063 6,123 -------- -------- -------- Consolidated................................. $187,700 $121,000 $ 76,700 ======== ======== ======== Identifiable assets: North America.................................. $200,854 $161,751 $111,561 Europe......................................... 25,389 14,388 11,656 Rest of the World.............................. 70,975 28,547 20,446 -------- -------- -------- Consolidated................................. $297,218 $204,686 $143,663 ======== ======== ========
The subsidiary located in the United Kingdom accounted for 12% and 11% of the consolidated net revenue to unaffiliated customers for the years ended December 31, 1999 and 1998, respectively. Operations located in Israel accounted 23% and 19% of the consolidated identifiable assets at December 31, 1999 and 1998, respectively. In 1997, no subsidiary represented 10 percent or more of the related consolidated amounts. NOTE 8--ACQUISITIONS On September 30, 1997, the Company acquired technologies from Dixon Software Technology, an unrelated company, for $4.5 million and related acquisition costs of $1.0 million. As a result of this purchase, in the third quarter of 1997, the Company recorded a one-time charge for write off of in-process research and development and related expenses of $5.5 million. On November 30, 1999, the Company acquired Conduct Ltd. Under terms of the agreement, approximately 408,000 shares of the Company's common stock were issued in exchange for all issued and outstanding convertible preferred and common shares of Conduct, and assumption of all outstanding Conduct stock options, warrants and other securities. The transaction was accounted for as a pooling of interests in the year ended December 31, 1999; therefore, all prior periods presented have been restated to include Conduct in operations since its inception. F-18 MERCURY INTERACTIVE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Since its inception, Conduct Ltd. has not recorded any revenues. The net income for the separate companies and the combined amounts presented in the consolidated financial statements follow (in thousands).
Year ended December 31, ----------------------- 1999 1998 1997 ------- ------- ------ (in thousands) Net Income (loss): Mercury Interactive Corporation...................... $33,144 $21,805 $6,707 Conduct Ltd.......................................... -- (2,280) (975) ------- ------- ------ $33,144 $19,525 $5,732 ======= ======= ======
NOTE 9--SUBSEQUENT EVENTS In January 2000, the Company declared a two-for-one stock split in the form of a stock dividend. One additional share of common stock has been issued for each share of common stock held by shareholders of record as of January 28, 2000. New shares were distributed on February 11, 2000. All per share data contained herein have been restated to reflect the increased number of shares outstanding. F-19 UNAUDITED QUARTERLY FINANCIAL DATA
Quarter ended ------------------------------------------------------------------- Dec. Sept. June Dec. Sept. June 31, 30, 30, March 31, 31, 30, 30, March 31, 1999 1999 1999 1999 1998 1998 1998 1998 ------- ------- ------- --------- ------- ------- ------- --------- (in thousands, except per share amounts) Revenue: License............... $43,500 $33,500 $29,300 $24,600 $28,200 $21,550 $19,100 $15,600 Service............... 16,600 14,000 13,200 13,000 12,800 9,050 8,100 6,600 ------- ------- ------- ------- ------- ------- ------- ------- Total revenue....... 60,100 47,500 42,500 37,600 41,000 30,600 27,200 22,200 ------- ------- ------- ------- ------- ------- ------- ------- Cost of revenue: License............... 2,190 2,040 1,870 1,636 1,867 1,545 1,550 1,329 Service............... 5,181 4,948 4,441 4,072 3,864 2,959 2,600 2,334 ------- ------- ------- ------- ------- ------- ------- ------- Total cost of revenue............ 7,371 6,988 6,311 5,708 5,731 4,504 4,150 3,663 ------- ------- ------- ------- ------- ------- ------- ------- Gross profit............ 52,729 40,512 36,189 31,892 35,269 26,096 23,050 18,537 ------- ------- ------- ------- ------- ------- ------- ------- Operating expenses: Research and development, net....... 5,828 6,554 5,866 5,236 5,274 4,463 3,907 3,263 Marketing and selling... 27,123 21,975 20,380 19,131 18,085 14,338 13,753 11,067 General and administrative......... 3,033 3,082 2,797 2,330 2,440 2,116 1,963 1,947 Merger related expenses............... 2,000 -- -- -- -- -- -- -- ------- ------- ------- ------- ------- ------- ------- ------- Total operating expenses........... 37,984 31,611 29,043 26,697 25,799 20,917 19,623 16,277 ------- ------- ------- ------- ------- ------- ------- ------- Income from operations.. 14,745 8,901 7,146 5,195 9,470 5,179 3,427 2,260 Other income, net....... 1,925 1,542 1,406 1,153 1,610 1,227 947 856 ------- ------- ------- ------- ------- ------- ------- ------- Income before provision for income taxes....... 16,670 10,443 8,552 6,348 11,080 6,406 4,374 3,116 Provision for income taxes.................. 3,334 2,297 1,840 1,398 2,332 1,405 1,008 706 ------- ------- ------- ------- ------- ------- ------- ------- Net income.............. $13,336 $ 8,146 $ 6,712 $ 4,950 $ 8,748 $ 5,001 $ 3,366 $ 2,410 ======= ======= ======= ======= ======= ======= ======= ======= Net income per share (basic)................ $ 0.17 $ 0.11 $ 0.09 $ 0.07 $ 0.12 $ 0.07 $ 0.05 $ 0.04 ======= ======= ======= ======= ======= ======= ======= ======= Net income per share (diluted).............. $ 0.15 $ 0.09 $ 0.08 $ 0.06 $ 0.11 $ 0.06 $ 0.04 $ 0.03 ======= ======= ======= ======= ======= ======= ======= ======= Weighted average common shares (basic)......... 77,824 76,796 75,394 74,434 73,352 70,692 69,880 68,708 ======= ======= ======= ======= ======= ======= ======= ======= Weighted average common shares (diluted)....... 87,974 85,920 83,804 83,310 80,584 79,008 78,380 77,604 ======= ======= ======= ======= ======= ======= ======= =======
F-20 SCHEDULE II MERCURY INTERACTIVE CORPORATION VALUATION AND QUALIFYING ACCOUNTS For the Three Years Ended December 31, 1999 (In thousands)
Additions Balance at Charged to Deductions Balance at Beginning Costs and Bad Debts End of Description of Period Expenses Charged Off Period ----------- ---------- ---------- ----------- ---------- Reserve for sales returns and doubtful accounts receivable: December 31, 1999.............. $3,623 $4,485 $2,575 $5,533 December 31, 1998.............. $1,878 $2,943 $1,198 $3,623 December 31, 1997.............. $1,136 $1,927 $1,185 $1,878
EX-10.13 2 SHARE EXCHANGE AGREEMENT EXHIBIT 10.13 ================================================================================ SHARE EXCHANGE AGREEMENT among: MERCURY INTERACTIVE CORPORATION a Delaware corporation; CONDUCT LTD an Israeli corporation; CONDUCT SOFTWARE TECHNOLOGIES, INC. a California corporation; and THE CONDUCT SHAREHOLDERS and THE CONDUCT NOTEHOLDERS ----------------------------- Dated as of November 24, 1999 ----------------------------- ================================================================================ SHARE EXCHANGE AGREEMENT This SHARE EXCHANGE AGREEMENT ("Agreement") is made and entered into as of November 24, 1999, by and among: Mercury Interactive Corporation, a Delaware corporation ("Mercury"); Conduct Ltd., an Israeli corporation ("Conduct"); Conduct Software Technologies, Inc., a California corporation and wholly-owned subsidiary of Conduct (the "Subsidiary"); the shareholders of Conduct Ltd., as identified on Exhibit A (the "Conduct Shareholders"); and the Conduct --------- Noteholders. Certain capitalized terms used in this Agreement are defined in Exhibit B. - --------- Recitals A. Mercury, Conduct and the Conduct Shareholders intend to effect an exchange of all of the issued and outstanding capital shares of Conduct for newly issued shares of Mercury common stock. B. This Agreement contemplates a transaction in which Mercury will acquire all of the outstanding capital shares of Conduct for stock of Mercury in a taxable purchase of stock. C. This Agreement has been adopted and approved by the respective boards of directors of Mercury, Conduct and Subsidiary. Agreement The parties to this Agreement agree as follows: SECTION 1. DESCRIPTION OF TRANSACTION 1.1 Exchange of Shares. Upon the terms and subject to the conditions set forth in this Agreement, at the Closing, Mercury agrees to issue 408,000 shares of common stock of Mercury (the "Mercury Stock") in exchange for all outstanding Conduct ordinary shares and preferred shares (the "Conduct Capital Shares"), all outstanding Convertible Promissory Notes and all outstanding options and warrants to purchase Conduct Capital Shares and the Conduct Shareholders agree to assign and transfer to Mercury in exchange for the Mercury Stock all outstanding Conduct Capital Shares. Thereupon, Conduct will be a wholly-owned subsidiary of Mercury and the corporate existence of Conduct, with all its purposes, powers and objects, shall continue unaffected and unimpaired. 1.2 Escrow of Mercury Stock. At the Closing, Mercury shall segregate from the Mercury Stock issuable hereunder such number of shares of Mercury Stock as is equal to 10% of the shares of Mercury Stock to be issued to Conduct Shareholders at the Closing represented by one stock certificate issued in the name of the Escrow Agent and cause such stock to be deposited with and U.S. Bank Trust National Association to act as escrow agent (the "Escrow Agent"), under the escrow agreement in the form attached hereto as Exhibit C. --------- 1.3 Closing. The consummation of the transactions contemplated by this Agreement (the "Closing") shall take place at the offices of General Counsel Associates LLP, 1891 Landings Drive, Mountain View, CA 94043 at 5:00 p.m. on November 30, 1999 (provided that all other conditions set forth in Sections 7 and 8 have been satisfied or waived) or on such other date as is mutually agreed upon by Conduct and Mercury. (The date on which the Closing actually takes place is referred to in this Agreement as the "Closing Date."). 1.4 Deliveries at Execution and Closing. (a) Contemporaneously with the execution and delivery of this Agreement: (i) Mercury, the Escrow Agent, the Conduct Shareholders and the Shareholders' Agent are entering into an Escrow Agreement in the form of Exhibit C (the "Escrow Agreement"); - --------- (ii) Mercury and each of David Barzilai and Sharon Azulai are amending the Employment Agreements between Subsidiary and each of them as set forth in the Amendment to their respective Employment Agreements in the form of Exhibit D; - --------- (iii) Conduct shall deliver to Mercury a certificate pursuant to which Conduct represents and warrants to Mercury that attached to such certificate are resolutions duly adopted by the unanimous consent of the Board of Directors approving the Agreement and the transactions contemplated by this Agreement; and (b) Mercury shall deliver to Conduct a certificate pursuant to which Mercury represents and warrants to Conduct that attached to such certificate are resolutions duly adopted by unanimous consent of the Board of Directors approving the Agreement and the transactions contemplated by this Agreement. (c) At the Closing: (i) the Conduct Shareholders shall deliver to Mercury (x) the share certificates representing one hundred percent of the outstanding Conduct Capital Shares, duly endorsed share transfer deeds signed by each of Conduct's Shareholders (and if the Conduct Shareholder is not an individual, such deed shall be approved by the entity's lawyer as binding upon the entity) and witnessed regarding the transfer of shares of such Conduct Shareholder to Mercury; and (ii) the officers and directors of Conduct and Subsidiary shall resign from their positions as officers and directors of Conduct; and (iii) Mercury shall deliver the Mercury Stock in accordance with Sections 1.5(a) and 1.5(g), shall make the cash payments for fractional shares specified in Section 1.5(f). (d) All actions and transactions occurring at the Closing shall be deemed to take place simultaneously and no transaction shall be deemed to have been completed or any document delivered until all such transactions have been completed and all required documents delivered. 1.5 Articles of Association; Directors and Officers. 2 (a) The Articles of Association of Conduct shall be amended and restated as of the Closing in a form satisfactory to Mercury. (b) The directors and officers of Conduct and Subsidiary immediately after the Closing shall be those Persons designated by Mercury in its sole discretion. 1.6 The Exchange. (a) At the Closing, by virtue of the terms of this Agreement and without any further action on the part of Mercury, Conduct or any Conduct Shareholder: (i) First: (1) each share of Series A Preferred of Conduct (the "Series A Preferred") outstanding immediately prior to the Closing shall be exchanged into: (A) a fraction of a share of Mercury Stock (as defined below) (y) having a numerator equal to $0.286 (representing the liquidation preference of each share of Series A Preferred under Conduct's Articles of Association plus any declared but unpaid dividends), and (z) having a denominator equal to the Mercury Average Stock Price ("the Series A Liquidation Amount"); plus (B) the Applicable Fraction (defined below) of a share of the common stock of Mercury; (2) each share of Series B Preferred of Conduct (the "Series B Preferred") outstanding immediately prior to the Closing shall be exchanged into: (A) a fraction of a share of Mercury Stock (as defined below), in each case (y) having a numerator equal to $0.865 (representing the liquidation preference of each share of Series B Preferred under Conduct's Articles of Association plus any declared but unpaid dividends), and (z) having a denominator equal to the Mercury Average Stock Price ("the Series B Liquidation Amount"); and (B) the Applicable Fraction of a share of Mercury Stock; (ii) Thereafter, (1) each share of the ordinary shares of Conduct (the "Conduct Ordinary Shares") outstanding immediately prior to the C losing shall be exchanged into the Applicable Fraction (as defined below) of a share of the common stock (par value $0.002 per share) of Mercury ("Mercury Stock"). The "Applicable Fraction" shall be the fraction (A) having a numerator equal to 408,000 less the Aggregate Preferred Stock Liquidation Preference (if any) and (B) having a denominator equal to the Fully Diluted Number of Conduct Capital Shares; (2) each share of the Conduct Preferred Shares outstanding immediately prior to the Closing (in addition to the amounts set forth above in Subsection 1.6(a)(i)) shall be exchanged into the Applicable Fraction of a share of the Mercury Stock. 3 (iii) all calculations under this Section 1.6(a) shall be rounded to the nearest one thousandth (1/1,000th); and (iv) subject only to Section 1.6(c), in no case shall the number of shares of Mercury Stock issued under this Section 1.6(a) to the Conduct Shareholders, when added to the shares of Mercury Stock issuable to the holders of options and warrants to purchase Conduct Capital Shares under Section 1.7, exceed 408,000 shares. (b) Notwithstanding anything to the contrary contained in this Agreement, a portion of the shares of Mercury Stock issued in the transactions contemplated by this Agreement shall be delivered into escrow and held as specified in Section 1.8 hereof. (c) In the event Mercury at any time or from time to time between the date of this Agreement and the Closing declares or pays any dividend on Mercury Stock payable in Mercury Stock or in any right to acquire Mercury Stock, or effects a subdivision of the outstanding shares of Mercury Stock into a greater number of shares of Mercury Stock (by stock dividends, combinations, splits, recapitalizations and the like), or in the event the outstanding shares of Mercury Stock shall be combined or consolidated, by reclassification or otherwise, into a lesser number of shares of Mercury Stock, then the Applicable Fraction shall be appropriately adjusted. (d) The shares of Mercury Stock to be issued in the transaction shall be characterized as "restricted securities" for purposes of Rule 144 under the Securities Act, and each certificate representing any of such shares shall bear a legend identical or similar in effect to the following legend (together with any other legend or legends required by applicable state securities laws or otherwise): "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 (THE "ACT") AND MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED, ASSIGNED, PLEDGED OR HYPOTHECATED UNLESS REGISTERED UNDER THE ACT OR UNLESS AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE ACT IS AVAILABLE." (e) If any Conduct Capital Shares outstanding immediately prior to the Closing are unvested or are subject to a repurchase option, risk of forfeiture or other condition under any applicable restricted stock purchase agreement or other agreement with Conduct, then the shares of Mercury Stock issued in exchange for such Conduct Capital Shares will also be unvested and subject to the same repurchase option, risk of forfeiture or other condition, and the certificates representing such shares of Mercury Stock may accordingly be marked with appropriate legends. (f) No fractional shares of Mercury Stock shall be issued in connection with the transactions contemplated by this Agreement, and no certificates for any such fractional shares shall be issued. In lieu of such fractional shares, any holder of capital shares of Conduct 4 who would otherwise be entitled to receive a fraction of a share of Mercury Stock (after aggregating all fractional shares of Mercury Stock issuable to such holder) shall, upon surrender of such holder's stock certificate(s) representing capital shares of Conduct, be paid in cash the dollar amount (rounded to the nearest whole cent), without interest, determined by multiplying such fraction by the Mercury Average Stock Price. In no case shall any holder of capital shares of Conduct be entitled to receive cash in an amount equal to or greater than the value of one share of Mercury Stock. (g) Mercury shall be entitled to deduct and withhold from any consideration payable or otherwise deliverable to any holder or former holder of Conduct Capital Shares pursuant to this Agreement such amounts as Mercury may be required to deduct or withhold therefrom under the Internal Revenue Code of 1986, as amended (the "Code") or under any provision of state, local or foreign tax law. To the extent such amounts are so deducted or withheld, such amounts shall be treated for all purposes under this Agreement as having been paid to the Person to whom such amounts would otherwise have been paid. (h) The shares of Mercury Stock issued upon surrender for exchange of shares of Conduct Capital Shares in accordance with the terms of this Agreement shall be deemed to have been fully paid and issued in full satisfaction of all rights pertaining to such shares. 1.7 Stock Options, Warrants and Convertible Promissory Notes. (a) At the Closing, each option to purchase capital shares of Conduct that is then outstanding, whether vested or unvested (a "Conduct Option"), shall be assumed by Mercury in accordance with the terms (as in effect as of the date of this Agreement) of the stock option agreement by which such Conduct Option is evidenced. At the Closing, all rights with respect to Conduct Capital Shares under outstanding Conduct Options shall be converted into rights with respect to Mercury Stock. Accordingly, from and after the Closing, (i) each Conduct Option assumed by Mercury may be exercised solely for shares of Mercury Stock, (ii) the number of shares of Mercury Stock subject to each such assumed Conduct Option shall be equal to the number of Conduct Capital Shares that were subject to such Conduct Option immediately prior to the Closing multiplied by the Applicable Fraction, rounded down to the nearest whole number of shares of Mercury Stock, (iii) the per share exercise price for the Mercury Stock issuable upon exercise of each such assumed Conduct Option shall be determined by dividing the exercise price per share of Conduct Capital Shares subject to such Conduct Option, as in effect immediately prior to the Closing, by the Applicable Fraction, and rounding the resulting exercise price up to the nearest whole cent and (iv) all restrictions on the exercise of each such assumed Conduct Option shall continue in full force and effect, and the term, exercisability, vesting schedule and other provisions of such Conduct Option shall otherwise remain unchanged; provided, however, that each such assumed Conduct Option shall, in accordance with its terms, be subject to further adjustment as appropriate to reflect any stock split, reverse stock split, stock dividend, recapitalization or other similar transaction effected by Mercury after the Closing. It is the intention of the parties that Conduct Options so assumed by Mercury qualify, to the maximum extent permissible following the Closing, as incentive stock options as defined in Section 422 of the Code to the extent such options qualified as incentive stock options prior to the Closing, or as options granted pursuant to the provisions of section 102 of the Israeli Income 5 Tax Ordinance (new version) 1961 (the "Ordinance") and any regulations, rules, orders or procedures promulgated thereunder, including the Income Tax Rules (Tax benefits in Stock Issuance to Employees) 5349-1989 (the "Rules"), as appropriate. Conduct and Mercury shall take all action that may be necessary to effectuate the provisions of this Section 1.7. As soon as is reasonably practicable following the Closing, Mercury will send to each holder of an assumed Conduct Option a written notice setting forth (i) the number of shares of Mercury Stock subject to such assumed Conduct Option and (ii) the exercise price per share of Mercury Stock issuable upon exercise of such assumed Conduct Option. Mercury shall file with the SEC, within 10 days after the Closing, a registration statement on Form S-8 registering the exercise of any Conduct Options assumed by Mercury pursuant to this Section 1.7. (b) Immediately prior to the Closing, each warrant to purchase Conduct Capital Shares that is then outstanding (a "Conduct Warrant"), shall terminate according to its terms. (c) Immediately prior to the Closing, each Conduct Noteholder hereby agrees to convert all Conduct Convertible Promissory Notes held by such holder into such number of Conduct Series B Preferred Shares as is equal to the amount of outstanding principal divided by $0.865. 1.8 Exchange of Certificates; Escrow Shares. (a) At the Closing, each Conduct Shareholder shall surrender to Mercury all certificates representing shares of Conduct Ordinary Shares or Conduct Preferred Shares, as appropriate, for cancellation, together with an executed share transfer deed duly endorsed and witnessed in blank by such holder and such other documents as may be reasonably required by Mercury. As soon as practicable after the Closing, Mercury shall (i) deliver to each Conduct Shareholder who has surrendered its, his or her certificates formerly representing Conduct Capital Shares in compliance with the preceding sentence a certificate representing 90 percent of the number of whole shares of Mercury Stock that such Conduct Shareholder has the right to receive pursuant to the provisions of Section 1.6 and (ii) deliver to the escrow agent under the Escrow Agreement in the form of Exhibit C hereto (the "Escrow Agreement"), on behalf --------- the Conduct Shareholders, a certificate representing 10 percent of the number of whole shares of Mercury Stock that each Conduct Shareholder has the right to receive pursuant to the provisions of Section 1.6 represented by one stock certificate issued in the name of the Escrow Agent (the "Escrow Shares"). In determining the number of whole shares that represent 90 percent of the number of shares of Mercury Stock to which each Conduct Shareholder is entitled pursuant to Section 1.6, Mercury shall round up to the nearest whole number of shares, and in determining the number of Escrow Shares to which such Conduct Shareholder is entitled pursuant to Section 1.6, Mercury shall round down to the nearest whole number. If any shares of Mercury Stock are to be issued in the name of a person other than the person in whose name Conduct Stock Certificate surrendered in exchange therefor is registered, it shall be a condition to the issuance of such shares that (i) the certificate(s) so surrendered shall be transferable, and shall be properly assigned, endorsed or accompanied by appropriate stock powers, (ii) such transfer shall otherwise be proper and (iii) the person requesting such transfer shall pay Mercury, or its exchange agent, any transfer or other taxes payable by reason of the foregoing or establish to the 6 satisfaction of Mercury that such taxes have been paid or are not required to be paid. If any Conduct share certificate shall have been lost, stolen or destroyed, Mercury may, in its discretion and as a condition precedent to the issuance of any certificate representing Mercury Stock, require the owner of such lost, stolen or destroyed Company share certificate to provide an appropriate affidavit with respect to such Company share certificate. (b) No dividends or other distributions declared or made with respect to Mercury Stock with a record date after the Closing shall be paid to the holder of any unsurrendered Conduct share certificate with respect to the shares of Mercury Stock represented thereby, and no cash payment in lieu of any fractional share shall be paid to any such holder, until such holder surrenders such Company Stock Certificate in accordance with this Section 1.8 (at which time such holder shall be entitled receive all such dividends and distributions and such cash payment payable subsequent to the Closing but prior to the surrender of such Company Stock Certificate.). 1.9 Tax Consequences. For United States federal income tax purposes and the Israeli Income Tax Ordinance, the transactions contemplated by this Agreement are intended to constitute a taxable sale of Conduct shares to Mercury. 1.10 Accounting Treatment. For accounting purposes, the transaction is intended to be treated as a "pooling of interests." 1.11 Further Action. If, at any time after the Closing, any further action is determined by Mercury to be necessary or desirable to carry out the purposes of this Agreement or to vest Conduct or Mercury with full right, title and possession of and to all rights and property of Conduct, the officers and directors of Conduct and Mercury shall be fully authorized (in the name of Conduct and otherwise) to take such action. SECTION 2. REPRESENTATIONS AND WARRANTIES OF CONDUCT AND SUBSIDIARY Except as set forth in the Disclosure Schedule attached hereto as Exhibit ------- E, Conduct and, Subsidiary jointly and severally represent and warrant, to - - Mercury that the representations and warrants set forth below are true and correct as of the date of the Agreement and will be correct and complete as of the Closing Date (as though made then and as though the Closing Date were substituted for the date of this Agreement), as follows: 2.1 Due Organization; Subsidiaries; Etc. (a) Conduct is a corporation duly organized, validly existing and in good standing under the laws of Israel, and Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of the state of California. Conduct and the Subsidiary each have all necessary power and authority: (i) to conduct its business in the manner in which its business is currently being conducted; (ii) to own and use its assets in the manner in which its assets are currently owned; and (iii) to perform its obligations in all material respects under all Material Contracts by which it is bound. 7 (b) Except as set forth on Part 2.1(b) neither Conduct nor Subsidiary have conducted any business under or otherwise used, for any purpose or in any jurisdiction, any fictitious name, assumed name, trade name or other name. (c) Neither Conduct nor Subsidiary is, and has not been, required to be qualified, authorized, registered or licensed to do business as a foreign corporation in any jurisdiction, except where the failure to be so qualified, authorized, registered or licensed would not have a Material Adverse Effect on Conduct. (d) Part 2.1(d) of the Disclosure Schedule accurately sets forth (i) the names of the members of Conduct's and Subsidiary's board of directors, and (ii) the names and titles of Conduct's and Subsidiary's officers. Neither Conduct's nor Subsidiary's board of directors has ever established any committees, other than the Conduct Compensation Committee and the Audit Committee. (e) Conduct has no subsidiaries, other than Subsidiary, and has never owned, beneficially or otherwise, any shares or other securities of, or any direct or indirect interest of any nature in, any other Entity. 2.2 Articles of Association and Bylaws; Records. Conduct has delivered to Mercury accurate and complete copies of: (a) Conduct's articles of association and Subsidiary's articles of incorporation and bylaws, including all amendments thereto; (b) the share records of Conduct and Subsidiary and (c) the minutes and other records of the meetings and other proceedings (including any actions taken by written consent or otherwise without a meeting) of the shareholders of Conduct and Subsidiary and the board of directors of Conduct and the Subsidiary. There have been no meetings or other proceedings or actions of the shareholders of Conduct or Subsidiary or the board of directors of Conduct or Subsidiary in which any material action took place that are not fully reflected in such minutes or other records. There has not been any material violation of any of the provisions of Conduct's articles of association or Subsidiary's articles of incorporation or bylaws or of any resolution adopted by Conduct's or Subsidiary's shareholders or Conduct's or Subsidiary's board of directors. The books of account, stock records, minute books and other records of Conduct and Subsidiary are accurate, up-to-date and complete in all material respects, and have been maintained in accordance with all applicable material Legal Requirements. 2.3 Capitalization, Etc. (a) The authorized capital shares of Conduct consist of (i) 14,371,965 ordinary shares, of which 3,911,875 shares are issued and outstanding as of the date of this Agreement and (ii) 7,349,285 Preferred Shares, 2,096,250 of which are designated as Series A Preferred, 2,096,250 of which are issued and outstanding as of the date of this Agreement, and 5,253,035 of which are designated Series B Preferred Stock, 4,625,000 of which are issued and outstanding as of the date of this Agreement. The authorized capital stock of Subsidiary consists of 1,000 shares of common stock, of which 100 shares are issued and outstanding as of the date of this Agreement and all of which are owned by Conduct. Exhibit A to this Agreement sets forth the names of Conduct's --------- Shareholders as of the date of this Agreement and the number of 8 Conduct Ordinary Shares and Conduct Preferred Shares owned of record by each of such Conduct Shareholders as of the date of this Agreement. Conduct has reserved an additional 1,875,000 Conduct Ordinary Shares for issuance under its 1998 Share Option Plan (the "Option Plan") to employees, advisory board members, officers or directors of, or consultants to, Conduct, of which options to acquire 739,063 Ordinary Shares have been granted and are outstanding as of the date of this Agreement (and 8,125 have been exercised at the date hereof). Part 2.3(a)(1) of the Disclosure Schedule sets forth a true and complete list as of the date hereof of all holders of outstanding Conduct Options, including the number of Conduct Ordinary Shares subject to each such Conduct Option, the exercise and vesting schedule, and the exercise price per share. Conduct has reserved an additional 628,035 shares of Conduct Series B Preferred Stock for issuance pursuant to outstanding warrants as of the date of this Agreement to purchase shares of Conduct Series B Preferred Stock and pursuant to convertible unsecured promissory notes. Part 2.3(a)(2) of the Disclosure Schedule sets forth the names of Conduct's warrant holders as of the date of this Agreement and the number of shares issuable upon exercise of outstanding warrants as of the date of this Agreement and the names of the Conduct Noteholders, the aggregate principal amounts of such notes and the number of shares issuable upon conversion in full of such note as of the date of this Agreement. (b) All of the outstanding Conduct Ordinary Shares and Conduct Preferred Shares have been duly authorized and validly issued and are fully paid and nonassessable. Except as set forth on Part 2.3(b), there are no preemptive rights applicable to any capital shares of Conduct or Subsidiary. (c) Except as identified in Section 2.3(a), as of the date of this Agreement, there is no: (i) outstanding subscription, option, call, warrant or right (whether or not currently exercisable) to acquire any shares of the capital shares or other securities of Conduct or Subsidiary; or (ii) outstanding security, instrument or obligation that is or may become convertible into or exchangeable for any shares of the capital shares or other securities of Conduct or Subsidiary. (d) No capital shares or other securities have been repurchased, redeemed or otherwise reacquired by Conduct. (e) All outstanding Conduct Capital Shares have been issued in compliance with (i) all applicable securities laws and other applicable Legal Requirements, and (ii) all requirements set forth in applicable Contracts. 2.4 Financial Statements. (a) Conduct has delivered to Mercury the following financial statements and notes (collectively, the "Conduct Financial Statements"): (i) the audited consolidated balance sheets of Conduct as of December 31, 1998, 1997 and 1996, and the related audited consolidated statements of income, statements of shareholders' equity and statements of cash flows of Conduct for the years then ended, together with the notes thereto; and 9 (ii) the unaudited consolidated balance sheet of Conduct as of September 30, 1999 (the "Unaudited Interim Balance Sheet"), and the related unaudited consolidated statement of income of Conduct for the nine months then ended. (b) Conduct Financial Statements are accurate and complete in all material respects and present fairly the financial position of Conduct as of the respective dates thereof and the results of operations and cash flows of Conduct for the periods covered thereby. Conduct Financial Statements have been prepared in accordance with generally accepted accounting principles applied on a consistent basis throughout the periods covered (except that the financial statements referred to in Section 2.4(a)(ii) do not contain footnotes and are subject to normal and recurring year-end audit adjustments, which will not, individually or in the aggregate, be material in magnitude). 2.5 Absence of Changes. Except as set forth in Part 2.5 of the Disclosure Schedule, and except with respect to the actions contemplated by this agreement since September 30, 1999: (a) there has not been any material adverse change in Conduct's or Subsidiary's business, condition, assets, liabilities, operations or financial performance, and no event has occurred that will, or could reasonable be expected tohave a Material Adverse Effect on Conduct; (b) there has not been any material loss, damage or destruction to, or any interruption in the use of, any of Conduct's or Subsidiary's assets (whether or not covered by insurance); (c) Neither Conduct nor Subsidiary has declared, accrued, set aside or paid any dividend or made any other distribution in respect of any capital shares, and has not repurchased, redeemed or otherwise reacquired any capital shares or other securities; (d) Neither Conduct nor Subsidiary has sold, issued or authorized the issuance of (i) any capital shares or other security, (ii) any option, call, warrant or right to acquire, or otherwise relating to, any capital shares or any other security, or (iii) any instrument convertible into or exchangeable for any capital shares or other security; (e) Neither Conduct nor Subsidiary has made any capital expenditure which individually exceeds $10,000 or, when added to all other capital expenditures made by Conduct since September 30, 1999, exceeds $25,000 in the aggregate; (f) Neither Conduct nor Subsidiary has (i) entered into or permitted any of the assets owned or used by it to become bound by any Material Contract (as defined in Section 2.10(a)), or (ii) amended or prematurely terminated, or waived any material right or remedy under any Material Contract to which it is or was a party or under which it has or had any rights or obligations; (g) Neither Conduct nor Subsidiary has (i) acquired, leased or licensed any right or other assets from any other Person (other than immaterial rights or other immaterial assets acquired, leased or licensed by Conduct from other Persons in the ordinary course of 10 business and consistent with Conduct's past practices), (ii) sold, assigned or otherwise disposed of, or leased or licensed, any right or other asset to any other Person (other than immaterial rights or other immaterial assets disposed of or leased or licensed by Conduct to other Persons in the ordinary course of business and consistent with Conduct's past practices), or (iii) waived or relinquished any right (other than immaterial rights waived or relinquished by Conduct in the ordinary course of business and consistent with Conduct's past practices); (h) Neither Conduct nor Subsidiary has written off as uncollectible, or established any extraordinary reserve with respect to, any account receivable or other indebtedness; (i) Neither Conduct nor Subsidiary has made any pledge of any of its assets or otherwise permitted any of its assets to become subject to any Encumbrance, except for pledges of immaterial assets made in the ordinary course of business and consistent with Conduct's past practices; (j) Neither Conduct nor Subsidiary has (i) lent money to any Person, or (ii) incurred or guaranteed any indebtedness for borrowed money; (k) Neither Conduct nor Subsidiary has (i) established, adopted or amended any Employee Benefit Plan, or (ii) made any profit-sharing or similar payment to any of its directors, officers or employees; (l) Neither Conduct nor Subsidiary has materially changed any of its methods of accounting or accounting practices in any respect; (m) Neither Conduct nor Subsidiary has made any Tax election; (n) Neither Conduct nor Subsidiary has commenced or settled any material Legal Proceeding; (o) Neither Conduct nor Subsidiary has entered into any material transaction or taken any other material action outside the ordinary course of business or inconsistent with its past practices; and (p) Conduct has not agreed or committed to take any of the actions referred to in clauses "(c)" through "(o)" above. 2.6 Title to Assets. (a) Except as set forth in Part 2.6(a) of the Disclosure Schedule, Conduct owns, and has good, valid and marketable title to, all material assets purported to be owned by it, including: (i) all material assets reflected on the Unaudited Interim Balance Sheet (except for those disposed of in the ordinary course of business since September 30, 1999); (ii) all material assets referred to in Parts 2.8 and 2.9 of the Disclosure Schedule and all of Conduct's rights under the Contracts identified in Part 2.10(a) of the Disclosure Schedule; and (iii) all other material assets reflected in Conduct's books and records as being owned by Conduct. Except as 11 set forth in Part 2.6(a) of the Disclosure Schedule, all of said material assets are owned by Conduct free and clear of any liens or other Encumbrances, except for (i) any lien for current taxes not yet due and payable, and (ii) minor liens that have arisen in the ordinary course of business and that do not (in any case or in the aggregate) materially detract from the value of the assets subject thereto or materially impair the operations of Conduct. (b) Part 2.6(b) of the Disclosure Schedule identifies all assets that are being leased or licensed to Conduct, except for (i) any equipment being leased to Conduct under a standard operating lease requiring annual payments by Conduct of less than $12,000, and (ii) any software being licensed to Conduct under any third party software license generally available to the public at a total cost of less than $10,000. 2.7 Bank Accounts; Receivables; Customers. (a) Part 2.7(a) of the Disclosure Schedule provides accurate and complete information (including account numbers, type of account and names of all individuals authorized to draw on or make withdrawals from each account) with respect to each account maintained by or for the benefit of Conduct or Subsidiary at any bank or other financial institution. (b) Except as set forth in Part 2.7(b) of the Disclosure Schedule, all existing accounts receivable of Conduct or Subsidiary (including those accounts receivable reflected on the Unaudited Interim Balance Sheet that have not yet been collected and those accounts receivable that have arisen since September 30, 1999 and have not yet been collected) (i) represent valid obligations of customers of Conduct or Subsidiary arising from bona fide transactions entered into in the ordinary course of business, and (ii) no request or agreement for deduction or discount has been made with respect to any amounts receivable. (c) Part 2.7(c) of the Disclosure Schedule (i) identifies and provides an accurate and complete breakdown of the revenues received from each customer or other Person that accounted for more than 5% of the revenues of Conduct in the fiscal year ended December 31, 1998 and the nine months ending September 30, 1999. and (ii) identifies each customer that is obligated to make payments to Conduct in an aggregate amount exceeding $25,000 per year. Conduct has not received any notice or other communication indicating that any customer or other Person identified in Part 2.7(c) of the Disclosure Schedule intends or expects to cease dealing with Conduct or to effect a material reduction in the volume of business transacted by such Person with Conduct below historical levels: except where the termination or modification of such customer relationship would not, individually or in to aggregate, have a Material Adverse Effect on the Conduct or Subsidiary 2.8 Equipment; Leasehold. (a) The equipment owned or leased by Conduct and Subsidiary is, taken as a whole, adequate for the uses to which it is being put, is in good condition and repair (ordinary wear and tear excepted) and is adequate for the conduct of Conduct's business in the manner in which such business is currently being conducted. 12 (b) Neither Conduct nor Subsidiary owns any real property or any interest in real property, except for the leasehold created under the real property leases identified in Part 2.8(b) of the Disclosure Schedule. 2.9 Proprietary Assets. (a) Part 2.9(a)(1) of the Disclosure Schedule sets forth, with respect to each Conduct Proprietary Asset that has been registered, recorded or filed with any Governmental Body or with respect to which an application has been filed with any Governmental Body, (i) a brief description of such Conduct Proprietary Asset, and (ii) the names of the jurisdictions covered by the applicable registration, recordation, filing or application. Part 2.9(a)(2) of the Disclosure Schedule identifies the Conduct Proprietary Assets owned by Conduct or Subsidiary as set forth in the product brochures or the product specifications attached as Part 2.9(a)(2) of the Disclosure Schedule. Part 2.9(a)(3) of the Disclosure Schedule identifies and provides a brief description of each Conduct Proprietary Asset that is owned by any other Person and that is licensed to or used by Conduct or Subsidiary (except for any Conduct Proprietary Asset that is licensed to Conduct or Subsidiary under any third party software license that (1) is generally available to the public at a cost of less than $5,000, and (2) imposes no future monetary obligation on Conduct or Subsidiary) and identifies the license agreement or other agreement under which such Conduct Proprietary Asset is being licensed to or used by Conduct or Subsidiary. Except as set forth in Part 2.9(a)(4) of the Disclosure Schedule, Conduct has good, valid and marketable title to all of the Conduct Proprietary Assets identified in Parts 2.9(a)(1) and 2.9(a)(2) of the Disclosure Schedule, free and clear of all liens and other Encumbrances, and has a valid right to use all Proprietary Assets identified in Part 2.9(a)(3) of the Disclosure Schedule. Except as set forth in Part 2.9(a)(5) of the Disclosure Schedule, neither Conduct nor Subsidiary is obligated to make any payment to any Person for the use of any Conduct Proprietary Asset. Except as set forth in Part 2.9(a)(6) of the Disclosure Schedule, Conduct is free to use, modify, copy, distribute, sell, license or otherwise exploit each of the Conduct Proprietary Assets on an exclusive basis (other than Conduct Proprietary Assets consisting of software licensed to Conduct or Subsidiary under third party licenses generally available to the public, with respect to which Conduct's rights are not exclusive). (b) Conduct and Subsidiary have taken all reasonable measures and precautions necessary to protect and maintain the confidentiality and secrecy of all Conduct Proprietary Assets (except Conduct Proprietary Assets whose value would be unimpaired by public disclosure), and otherwise to maintain and protect the value of all Conduct Proprietary Assets. Except as set forth in Part 2.9(b) of the Disclosure Schedule, neither Conduct nor Subsidiary have disclosed nor delivered nor permitted to be disclosed or delivered to any Person, and, no Person, to the Company's and Subsidiary's Knowledge (other than Conduct or Subsidiary), has access to or has any rights with respect to, the source code, or any portion or aspect of the source code, of any Conduct Proprietary Asset. (c) To Conduct and Subsidiary's Knowledge, none of Conduct Proprietary Assets infringes or conflicts with any Proprietary Asset owned or used by any other Person. Except as set forth in Part 2.9(c) of the Disclosure Schedule, to Conduct and Subsidiary's Knowledge, neither Conduct nor Subsidiary is infringing, misappropriating or making any 13 unlawful use of, and neither Conduct nor Subsidiary has at any time infringed, misappropriated or made any unlawful use of, or received any written notice or other communication of any actual, alleged, possible or potential infringement, misappropriation or unlawful use of, any Proprietary Asset owned or used by any other Person. Except as set forth in Part 2.9(c) of the Disclosure Schedule, to Conduct and Subsidiary's Knowledge, no other Person is infringing, misappropriating or making any unlawful use of, and no Proprietary Asset owned or used by any other Person infringes or conflicts with, any Conduct Proprietary Asset. (d) Conduct Proprietary Assets constitute all the Proprietary Assets necessary to enable Conduct to conduct its business in the manner in which such business is currently being conducted. Except as set forth in Part 2.9(d) of the Disclosure Schedule, (i) neither Conduct nor Subsidiary has licensed any of Conduct Proprietary Assets to any Person on an exclusive basis, and (ii) neither Conduct nor Subsidiary has entered into any covenant not to compete or Contract limiting its ability to exploit fully any of the Conduct Proprietary Assets or to transact business in any market or geographical area or with any Person. (e) Except as set forth in Part 2.9(e) of the Disclosure Schedule, all current and former employees of Conduct and Subsidiary, and all current and former consultants and independent contractors to Conduct and Subsidiary, have executed and delivered to Conduct or Subsidiary, as applicable, written agreements (containing no exceptions to or exclusions from the scope of their coverage) that are substantially identical to the form of Employee Invention Assignment and Confidentiality Agreement attached to Part 2.9(e) of the Disclosure Schedule. (f) Except as set forth in Part 2.9(f) of the Disclosure Schedule, neither Conduct nor Subsidiary has entered into and is not bound by any Contract under which any Person has the right to distribute or license, on a commercial basis, any Conduct Proprietary Asset including source code, object code, or any versions, modifications or derivative works of source code or object code in any Conduct Proprietary Asset. (g) To Conduct's and Subsidiary's Knowledge, each computer program and other item of software owned by Conduct or Subsidiary is Year 2000 Compliant. To Conduct and Subsidiary's Knowledge, each computer program and other item of software that has been designed, developed, sold, installed, licensed or otherwise made available by Conduct or Subsidiary to any Person is Year 2000 Compliant. As used in this Section 2.9(g), "Year 2000 Compliant" means, with respect to a computer program or other item of software (i) the functions, calculations, and other computing processes of the program or software (collectively, "Processes") perform in a consistent and correct manner without interruption regardless of the date on which the Processes are actually performed and regardless of the date input to the applicable computer system, whether before, on, or after January 1, 2000; (ii) the program or software accepts, calculates, compares, sorts, extracts, sequences, and otherwise processes date inputs and date values, and returns and displays date values, in a consistent and correct manner regardless of the dates used whether before, on, or after January 1, 2000; (iii) the program or software accepts and responds to year input, if any, in a manner that resolves any ambiguities as to century in a defined, predetermined, and appropriate manner; (iv) the program or software stores and displays date information in ways that are unambiguous as to the determination of the century; and (v) leap years will be determined by the following standard (A) if dividing the year 14 by 4 yields an integer, it is a leap year, except for years ending in 00, but (B) a year ending in 00 is a leap year if dividing it by 400 yields an integer. 2.10 Contracts. (a) Part 2.10(a) of the Disclosure Schedule identifies each Conduct Contract that constitutes a "Material Contract." (For purposes of this Agreement, each of the following (and each other Contract that is material to the business of Conduct and Subsidiary taken together as a whole) shall be deemed to constitute a "Material Contract": (i) any Contract relating to the employment or engagement of, or the performance of services by, any employee, consultant or independent contractor (other than offer letters which do not contain any payments to an employee which become due upon termination of employment); (ii) any Contract relating to the acquisition, transfer, use, development, sharing or license of any technology or any Proprietary Asset (except for Contracts with respect to any Proprietary Asset that is licensed to Conduct or Subsidiary under any third party software license that (1) is generally available to the public at a cost of less than $5,000, and (2) imposes no future monetary obligation on Conduct or Subsidiary); (iii) any Contract imposing any restriction on Conduct's or Subsidiary's right or ability (A) to compete with any other Person, (B) to acquire any product or other asset or any services from any other Person, to sell any product or other asset to or perform any services for any other Person or to transact business or deal in any other manner with any other Person, or (C) to develop or distribute any technology; (iv) any Contract creating or involving any agency relationship, distribution arrangement or franchise relationship; (v) any Contract creating or relating to the creation of any material Encumbrance with respect to any material asset owned or used by Conduct or Subsidiary; (vi) any Contract involving or incorporating any guaranty, any pledge, any performance or completion bond, any indemnity, any right of contribution or any surety arrangement; (vii) any Contract creating or relating to any partnership or joint venture or any sharing of revenues, profits, losses, costs or liabilities; (viii) any Contract relating to the purchase or sale of any product or other asset by or to, or the performance of any services by or for, any Related Party (as defined in Section 2.19); (ix) any Contract to which any Governmental Body is a party or under which any Governmental Body has any rights or obligations, or involving or directly or indirectly benefiting any Governmental Body (including any subcontract or other Contract between Conduct and any contractor or subcontractor to any Governmental Body); (x) any Contract entered into outside the ordinary course of business or inconsistent with Conduct's past practices; 15 (xi) any written Contract between Conduct and Subsidiary; (xii) any Contract that has a term of more than 90 days and that may not be terminated by Conduct or Subsidiary (without penalty) within 90 days after the delivery of a termination notice by Conduct or Subsidiary; and (xiii) any Contract (not otherwise identified in clauses "(i)" through "(xii)" of this sentence) that contemplates or involves (A) the payment or delivery of cash or other consideration in an amount or having a value in excess of $25,000 in the aggregate, or (B) the performance of services having a value in excess of $25,000 in the aggregate. (b) Conduct has delivered or made available to Mercury accurate and complete copies of all Contracts identified in Part 2.10(a) of the Disclosure Schedule, including all amendments thereto. Each Contract identified in Part 2.10(a) of the Disclosure Schedule is valid and in full force and effect, and is enforceable by Conduct or Subsidiary in accordance with its terms, subject to (i) laws of general application relating to bankruptcy, insolvency and the relief of debtors, and (ii) rules of law governing specific performance, injunctive relief and other equitable remedies. (c) Except as set forth in Part 2.10(c) of the Disclosure Schedule: (i) Neither Conduct nor Subsidiary has committed any material breach or default under any Conduct Contract, and, to the Knowledge of Conduct and Subsidiary, no other Person has committed any material breach or default under any Conduct Contract; (ii) to the Knowledge of Conduct and Subsidiary, no event has occurred, and no circumstance or condition exists, that (with or without notice or lapse of time) will, or could reasonably be expected to, (A) result in a material violation or breach of any of the provisions of any Conduct Contract, (B) give any Person the right to declare a default or exercise any remedy under any Conduct Contract, (C) give any Person the right to accelerate the maturity or performance of any Conduct Contract, or (D) give any Person the right to cancel, terminate or materially modify any Conduct Contract; (iii) Neither Conduct nor Subsidiary has received any written notice or other communication regarding (i) any material violation or breach of, or default under, any Conduct Contract, or (ii) any termination of any material Conduct Contract; and (iv) Neither Conduct nor Subsidiary has waived any of its material rights under any Contract. 16 (d) No Person is renegotiating, or has the right to renegotiate, any amount paid or payable to Conduct or Subsidiary under any Conduct Contract or any other term or provision of any Conduct Contract. (e) The Contracts identified in Part 2.10(a) of the Disclosure Schedule collectively constitute all of the Material Contracts necessary to enable Conduct and Subsidiary to conduct the business in the manner in which the business is currently being conducted. 2.11 Liabilities. (a) Neither Conduct nor Subsidiary has accrued, contingent or other liabilities of any nature, either matured or unmatured (whether or not required to be reflected in financial statements in accordance with generally accepted accounting principles, and whether due or to become due), except for: (i) liabilities identified as such in the "liabilities" column of the Unaudited Interim Balance Sheet; (ii) liabilities incurred in the ordinary course of business (and in compliance with this Agreement) since the date of the Unaudited Interim Balance Sheet; (iii) liabilities for future performance under existing Material Contracts (iv) accounts payable or accrued salaries that have been incurred by Conduct or Subsidiary since September 30, 1999 in the ordinary course of business and consistent with Conduct's past practices; (v) the liabilities identified in Part 2.11(a) of the Disclosure Schedule; (vi) transaction expenses incurred in connection with this Agreement and (vii) liabilities (other than those provided for separately in sections (i), (ii), (iii), (iv), (v) and (vi) of this Section 2.11) which do not exceed $10,000, individually or in the aggregate. (b) Part 2.11(b) of the Disclosure Schedule provides an accurate and complete breakdown of: (i) all accounts payable of Conduct and Subsidiary as of September 30, 1999, (ii) all notes payable of Conduct or Subsidiary and all indebtedness of Conduct or Subsidiary for borrowed money, (iii) all customer deposits and other deposits held by Conduct or Subsidiary as of September 30, 1999; and (iv) deferred revenue, warranty or obligations to deliver services, support or upgrades. 2.12 Compliance with Legal Requirements. Except as set forth in Part 2.12 of the Disclosure Schedule, Conduct and Subsidiary each is, in substantial compliance with each Legal Requirement that is applicable in any material respect to the conduct of its business or the ownership of its assets. No event has occurred, and no condition or circumstance exists, that might (with or without notice or lapse of time) constitute or result directly or indirectly in a material violation by Conduct or Subsidiary of, or a failure in any material respect on the part of Conduct or Subsidiary to comply with, any material Legal Requirement. Except as set forth in Part 2.12 of the Disclosure Schedule, neither Conduct nor Subsidiary has ever received any written notice or other communication from any Governmental Body regarding any actual or possible material violation of, or failure to comply with, any material Legal Requirement. 2.13 Governmental Authorizations. Part 2.13 of the Disclosure Schedule identifies each Governmental Authorization held by Conduct or Subsidiary, and Conduct has delivered to Mercury accurate and complete copies of all Governmental Authorizations identified in Part 2.13 of the Disclosure Schedule. The Governmental Authorizations identified in Part 2.13 of the 17 Disclosure Schedule are valid and in full force and effect, and collectively constitute all Governmental Authorizations necessary to enable Conduct and Subsidiary to conduct the business in the manner in which their business is currently being conducted except such Governmental Authorizations that no Governmental Body has demanded to be obtained or of which Conduct and Subsidiary are unaware, or which the failure to obtain if required, would not have a Material Adverse Effect on Conduct or Subsidiary. Conduct and Subsidiary each is in compliance with the material terms and requirements of the respective Governmental Authorizations identified in Part 2.13 of the Disclosure Schedule. Neither Conduct nor Subsidiary has ever received any written notice or other written communication from any Governmental Body regarding (a) any material violation of or failure to comply with any material term or requirement of any Governmental Authorization, or (b) any revocation, withdrawal, suspension, cancellation, termination or modification of any Governmental Authorization. 2.14 Tax Matters. (a) Except as set forth in Part 2.14(a) of the Disclosure Schedule, all material Tax Returns required to be filed by or on behalf of Conduct or Subsidiary with any Governmental Body on or before the date hereof (the "Conduct Returns") (i) have been filed in a timely manner, and (ii) to Conduct's and Subsidiary's Knowledge, have been accurately and completely prepared in any material respect in compliance with all applicable Legal Requirements. All material amounts shown on Conduct Returns to be due on or before the date hereof have been paid. Conduct has delivered to Mercury accurate and complete copies of all Conduct Returns filed since the date of Conduct's incorporation. (b) Except as set forth in Part 2.14(b) of the Disclosure Schedule, each Tax required to have been paid, or claimed by any Governmental Body to be payable, by Conduct or Subsidiary (whether pursuant to any Tax Return or otherwise) has been to the extent material duly paid in full on a timely basis. Any Tax required to have been withheld or collected by Conduct or Subsidiary has been duly withheld and collected on a timely basis; and (to the extent required) each such Tax has been paid to the appropriate Governmental Body on a timely basis or adequately reserved in the Conduct financial statements. (c) Conduct Financial Statements fully accrue all actual and contingent material liabilities for Taxes with respect to all periods through the dates thereof in accordance with generally accepted accounting principles. Conduct has established, in the ordinary course of business and consistent with its past practices, reserves adequate for the payment of all Taxes for the period from September 30, 1999 through the date hereof. (d) No Conduct Return relating to income Taxes has ever been examined or audited by any Governmental Body. Except as set forth in Part 2.14(d) of the Disclosure Schedule, there has been no examination or audit of any Conduct Return, and no such examination or audit has been proposed or scheduled by any Governmental Body. Conduct has delivered to Mercury accurate and complete copies of all audit reports and similar documents (to which Conduct has access) relating to Conduct Returns. No extension or waiver of the limitation 18 period applicable to any of Conduct Returns has been granted (by Conduct, Subsidiary or any other Person), and no such extension or waiver has been requested from Conduct. (e) No claim or Legal Proceeding is pending or to the Knowledge of Conduct or Subsidiary has been threatened against or with respect to Conduct or Subsidiary in respect of any Tax. There are no unsatisfied liabilities for Taxes (including liabilities for interest, additions to tax and penalties thereon and related expenses) with respect to any notice of deficiency or similar document received by Conduct or Subsidiary. There are no liens for Taxes upon any of the assets of Conduct, except liens for current Taxes not yet due and payable. Subsidiary has not entered into or become bound by any agreement or consent pursuant to Section 341(f) of the Code. Subsidiary has not been, and will not be, required to include any adjustment in taxable income for any tax period (or portion thereof) pursuant to Section 481 or 263A of the Code or any comparable provision under state or foreign Tax laws as a result of transactions or events occurring, or accounting methods employed, prior to the date hereof. Conduct will not be required to include any adjustment in its taxable income for any tax period (or portion thereof) as a result of transactions or events occurring, or accounting methods employed, prior to the date hereof. (f) There is no agreement, plan, arrangement or other Contract covering any employee or independent contractor or former employee or independent contractor of Subsidiary that, considered individually or considered collectively with any other such Contracts, will, or could reasonably be expected to, give rise directly or indirectly to the payment of any amount that would not be deductible pursuant to Section 280G or Section 162 of the Code. Neither Conduct or Subsidiary is, and has never been, a party to or bound by any tax indemnity agreement, tax sharing agreement, tax allocation agreement or similar Contract. (g) Except as set forth in Part 2.14(g) of the Disclosure Schedule, since Conduct's incorporation, (i) no Governmental Body has asserted any claim or otherwise made any allegation that Conduct or Subsidiary has failed or may have failed to pay any sales tax, use tax or similar Tax, and (ii) neither Conduct or Subsidiary has engaged in any discussions or negotiations with any Governmental Body, and has not sent any written communication to or received any written communication from any Governmental Body, in connection with any possible failure on the part of Conduct or Subsidiary to pay any sales tax, use tax or similar Tax. (h) Subsidiary has disclosed on its federal income Tax Returns all positions taken therein that could give rise to a substantial understatement of federal income Tax within the meaning of Code (S)6662. Subsidiary (A) has not been a member of an affiliated group filing a consolidated federal income Tax Return and (B) does not have any Liability for the Taxes of any other Person under Reg. (S)1.1502-6 (or any similar provision of state, local, or foreign law), as a transferee or successor, by contract, or otherwise. (i) Conduct has not been required to file a United States federal income tax return or any state income tax return for any year. Conduct has had no income which is effectively connected with a US trade or business under Code section 864. Except as set forth in Part 2.14(i) of the Disclosure Schedule, Conduct is not a party to an Advance Pricing Agreement (or any similar agreement under foreign law) and all transactions between Conduct and 19 Subsidiary (and any other commonly controlled parties) have been in accordance with the arm's length standard in compliance with Code section 482 and the treasury regulations thereunder. 2.15 Employee and Labor Matters; Benefit Plans. (a) Part 2.15(a) of the Disclosure Schedule contains a list of all employees of Conduct or Subsidiary as of the date of this Agreement, and correctly reflects their salaries, any other compensation payable to them (including compensation payable pursuant to bonus, deferred compensation or commission arrangements), their dates of employment and their positions and their vacation accruals as of September 30, 1999. Neither Conduct or Subsidiary is, and has never been, a party to any collective bargaining contract or other Contract with a labor union involving any of its employees. (b) To the Knowledge of Conduct or Subsidiary, there is no employee of Conduct or Subsidiary who is not fully available to perform work because of disability or other leave, except as set forth in Part 2.15(b). The employment of each employee of Conduct or Subsidiary is terminable by Conduct or Subsidiary at will. Conduct has made available copies of all employee manuals and handbooks, disclosure materials, policy statements and other materials relating to the employment of the current employees of Conduct and Subsidiary. (c) Part 2.15(c) of the Disclosure Schedule identifies each bonus, deferred compensation, incentive compensation, stock purchase, stock option, severance pay, termination pay, hospitalization, medical, insurance, supplemental unemployment benefits, profit-sharing, pension or retirement plan, program or agreement (individually referred to as a "Plan" and collectively referred to as the "Plans") sponsored, maintained, contributed to or required to be contributed to by Conduct or Subsidiary for the benefit of any current or former employee of Conduct or Subsidiary. (d) Except as set forth in Parts 2.15(c) or 2.15(d) of the Disclosure Schedule, neither Conduct nor Subsidiary maintains, sponsors or contributes to, and has not at any time in the past maintained, sponsored or contributed to, any employee pension benefit plan (as defined in Section 3(2) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") , which applies to such employees, whether or not excluded from coverage under specific Titles or Merger Subtitles of ERISA and as required pursuant to the Israeli Severance Payment Law - 1963, applicable collective agreements and extension orders) for the benefit of employees or former employees of Conduct or Subsidiary (a "Pension Plan"). (e) Except as set forth in Parts 2.15(c) or 2.15(e) of the Disclosure Schedule, neither Conduct or Subsidiary maintains, sponsors or contributes to any employee welfare benefit plan (as defined in Section 3(1) of ERISA, whether or not excluded from coverage under specific Titles or Merger Subtitles of ERISA) for the benefit of employees or former employees of Conduct or Subsidiary (a "Welfare Plan") except for those Welfare Plans described in Part 2.15(e) of the Disclosure Schedule, none of which is a multiemployer plan (within the meaning of Section 3(37) of ERISA). (f) With respect to each Plan, Conduct has delivered to Mercury: 20 (i) an accurate and complete copy of such Plan (including all amendments thereto); (ii) an accurate and complete copy of the annual report (if required under ERISA) with respect to such Plan for each of 1997 and 1998; (iii) an accurate and complete copy of (A) the most recent summary plan description, together with each Summary of Material Modifications (if required under ERISA) with respect to such Plan, and (B) each material employee communication relating to such Plan; (iv) if such Plan is funded through a trust or any third party funding vehicle, an accurate and complete copy of the trust or other funding agreement (including all amendments thereto) and accurate and complete copies the most recent financial statements thereof; (v) accurate and complete copies of all Contracts relating to such Plan, including service provider agreements, insurance contracts, minimum premium contracts, stop-loss agreements, investment management agreements, subscription and participation agreements and recordkeeping agreements; and (vi) an accurate and complete copy of the most recent determination, opinion, notification, or advisory letter received from the Internal Revenue Service with respect to such Plan (if such Plan is intended to be qualified under Section 401(a) of the Code). (g) Except with respect to each other, neither Conduct nor Subsidiary is and has never been required to be treated as a single employer with any other Person under Section 4001(b)(1) of ERISA or Section 414(b), (c), (m) or (o) of the Code. Neither Conduct or Subsidiary has ever been a member of an "affiliated service group" within the meaning of Section 414(m) of the Code. Neither Conduct or Subsidiary has ever made a complete or partial withdrawal from a "multiemployer plan" (as defined in Section 3(37) of ERISA) resulting in "withdrawal liability" (as defined in Section 4201 of ERISA), without regard to subsequent reduction or waiver of such liability under either Section 4207 or 4208 of ERISA. (h) Neither Conduct or Subsidiary has any plan or commitment to create any additional Welfare Plan or any Pension Plan, or to modify or change any existing Welfare Plan or Pension Plan (other than to comply with applicable law). (i) No Welfare Plan provides death, medical or health benefits (whether or not insured) with respect to any current or former employee of Conduct or Subsidiary after any such employee's termination of service (other than (i) benefit coverage mandated by applicable law, including coverage provided pursuant to Section 4980B of the Code, (ii) deferred compensation benefits accrued as liabilities on the Unaudited Interim Balance Sheet, and (iii) benefits the full cost of which are borne by current or former employees of Conduct or Subsidiary (or their beneficiaries)). 21 (j) With respect to each of the Welfare Plans constituting a group health plan within the meaning of Section 4980B(g)(2) of the Code, the provisions of Section 4980B of the Code ("COBRA") have been complied with in all material respects. (k) Each of the Plans has been operated and administered in all material respects in accordance with applicable Legal Requirements, including ERISA and the Code. (l) Each of the Plans intended to be qualified under Section 401(a) of the Code has either received a favorable determination, opinion, notification or advisory letter from the Internal Revenue Service with respect to each such plan as to its qualified status under the Code, or has remaining a period of time under applicable Treasury regulations or IRS pronouncements in which to apply for such a letter, and neither Conduct nor Subsidiary is aware of any reason why any such determination letter should be revoked. (m) Except as set forth in Part 2.15(m) of the Disclosure Schedule, neither the execution, delivery or performance of this Agreement, nor the consummation of the transactions contemplated by this Agreement, will result in any bonus payment, golden parachute payment, severance payment or other payment to any current or former employee or director of Conduct or Subsidiary (whether or not under any Plan), or materially increase the benefits payable under any Plan, or result in any acceleration of the time of payment or vesting of any such benefits. (n) Except as set forth in Part 2.15(n) of the Disclosure Schedule, Conduct and Subsidiary are in compliance in all material respects with all applicable Legal Requirements and Contracts relating to employment, employment practices, employee compensation, wages, bonuses and terms and conditions of employment. (o) Conduct and Subsidiary have good labor relations, and, except as set forth in Part 2.15(o) of the Disclosure Schedule, neither Conduct nor Subsidiary has any Knowledge of any facts indicating that (i) the consummation of the transactions contemplated by this Agreement will have a material adverse effect on Conduct's or Subsidiary's labor relations, or (ii) any of Conduct's or Subsidiary's employees intends to terminate his or her employment with Conduct or Subsidiary, as applicable. To the Knowledge of Conduct and Subsidiary no employee of Conduct or Subsidiary is a party to or is bound by any confidentiality agreement, noncompetition agreement or other Contract (with any Person) that may have an adverse effect on (A) the performance by such employee of any of his duties or responsibilities as an employee of Conduct or Subsidiary, or (B) the business or operations of Conduct and Subsidiary. 2.16 Environmental Matters. To Conduct's Knowledge, Conduct is and has at all times been in compliance with all applicable Israeli environmental laws and regulations. There is no pending or, to Conduct's Knowledge, threatened Legal Proceeding alleging violation of, or requesting compliance by Conduct with, Israeli environmental laws and regulations. 2.17 Sale of Products; Performance of Services. (a) Except as set forth in Part 2.17(a) of the Disclosure Schedule, to Conduct's and Subsidiary's Knowledge, each product, system, program, Proprietary Asset or other asset designed, developed, manufactured, assembled, sold, installed, repaired, licensed or 22 otherwise made available by Conduct or Subsidiary to any Person: (i) conformed and complied in all material respects with the terms and requirements of any applicable warranty or other Contract and with all material applicable Legal Requirements; and (ii) was free of any bug, virus, design defect or other defect or deficiency at the time it was sold or otherwise made available, other than any immaterial bug or similar defect that would not adversely affect in any material respect such product, system, program, Proprietary Asset or other asset (or the operation or performance thereof). (b) To Conduct's and Subsidiary's Knowledge, all installation services, design services, development services, programming services, repair services, maintenance services, support services, training services, upgrade services and other services that have been performed by Conduct or Subsidiary were performed properly and in conformity in all material respects with the terms and requirements of all applicable warranties and other Contracts and with all material applicable Legal Requirements. (c) Neither Conduct nor Subsidiary will incur or otherwise become subject to any material Liability arising directly or indirectly from (i) any product, system, program, Proprietary Asset or other asset designed, developed, manufactured, assembled, sold, installed, repaired, licensed or otherwise made available by Conduct or Subsidiary, or (ii) any installation services, design services, development services, programming services, repair services, maintenance services, support services, training services, upgrade services or other services performed by Conduct or Subsidiary. (d) Except as set forth in Part 2.17(d) of the Disclosure Schedule, no customer or other Person has ever asserted or, to Conduct's or Subsidiary's Knowledge, threatened to assert any claim against Conduct or Subsidiary (i) under or based upon any warranty provided by or on behalf of Conduct or Subsidiary, or (ii) under or based upon any other warranty relating to any product, system, program, Proprietary Asset or other asset designed, developed, manufactured, assembled, sold, installed, repaired, licensed or otherwise made available by Conduct or Subsidiary or any services performed by Conduct or Subsidiary. To the Knowledge of Conduct and Subsidiary, no material event has occurred, and no condition or circumstance exists, that might (with or without notice or lapse of time) give rise to or serve as a basis for the assertion of any such claim. 2.18 Insurance. Part 2.18 of the Disclosure Schedule identifies each insurance policy maintained by, at the expense of or for the benefit of Conduct and Subsidiary. Conduct has delivered to Mercury accurate and complete copies of the insurance policies identified in Part 2.18 of the Disclosure Schedule. Each of the insurance policies identified in Part 2.18 of the Disclosure Schedule is in full force and effect. 2.19 Related Party Transactions. Except as set forth in Part 2.19 of the Disclosure Schedule and except for this agreement and the transactions contemplated hereby: (a) no Related Party has, and no Related Party has at any time had any material indirect interest in any material asset used in or otherwise relating to the business of Conduct or Subsidiary; (b) no Related Party is, or has at any time been, indebted to Conduct or Subsidiary; (c) no Related Party has entered into, or has had any material financial interest in, any material Contract, transaction or business 23 dealing involving Conduct or Subsidiary. For purposes of this Section 2.19, each of the following shall be deemed to be a "Related Party": (i) each of the Conduct Shareholders; (ii) each individual who is, or who has at any time been an officer or director of Conduct or Subsidiary; (iii) each individual who is, or who at any time been a member of the immediate family of any of the individuals referred to in clauses "(i)" and "(ii)" above; (iv) any trust or other Entity (other than Conduct) in which any one of the individuals referred to in clauses "(i)", "(ii)" and "(iii)" above holds (or in which more than one of such individuals collectively hold), beneficially or otherwise, a material voting, proprietary or equity interest; and (v) as defined in Section 96A of the Israeli Companies Ordinance-1983. 2.20 Legal Proceedings; Orders. (a) Except as set forth in Part 2.20(a) of the Disclosure Schedule, there is no pending Legal Proceeding, and (to the Knowledge of Conduct and Subsidiary ) no Person has threatened to commence any Legal Proceeding: (i) that involves Conduct, Subsidiary or any of the assets owned or used by Conduct or Subsidiary; or (ii) that challenges, or that may have the effect of preventing, delaying, making illegal or otherwise interfering with, the transactions contemplated by this Agreement. To the Knowledge of Conduct and Subsidiary except as set forth in Part 2.20(a) of the Disclosure Schedule, no material event has occurred, and no claim, dispute or other condition or circumstance exists, that will, or that could reasonably be expected to, give rise to or serve as a basis for the commencement of any such material Legal Proceeding. (b) Except as set forth in Part 2.20(b) of the Disclosure Schedule, no material Legal Proceeding has ever been commenced by, and no material Legal Proceeding has ever been pending against, Conduct or Subsidiary. (c) There is no order, writ, injunction, judgment or decree to which Conduct or Subsidiary, or any of the assets owned or used by Conduct or Subsidiary, is subject. To the Knowledge of Conduct and Subsidiary, none of the Conduct Principal Shareholders is subject to any order, writ, injunction, judgment or decree that relates to Conduct's business or to any of the assets owned or used by Conduct or Subsidiary. To the Knowledge of Conduct and Subsidiary, no officer or other employee of Conduct or Subsidiary is subject to any order, writ, injunction, judgment or decree that prohibits such officer or other employee from engaging in or continuing any conduct, activity or practice relating to Conduct's business. 2.21 Authority; Binding Nature of Agreement. Conduct or Subsidiary each have the absolute and unrestricted right, power and authority to enter into and to perform its obligations under this Agreement and under each other agreement, document or instrument referred to in or contemplated by this Agreement to which Conduct or Subsidiary is or will be a party; and the execution, delivery and performance by Conduct and Subsidiary of this Agreement and of each such other agreement, document and instrument have been duly authorized by all necessary action on the part of Conduct, Subsidiary and each of their boards of directors. This Agreement and each other agreement, document and instrument referred to in or contemplated by this Agreement to which Conduct or Subsidiary is a party constitutes, assuming the due authorization, execution and delivery hereof by Mercury and subject to the filings and approvals specified in Section 7 hereof, the legal, valid and binding obligation of Conduct or Subsidiary, as 24 applicable, enforceable against Conduct or Subsidiary, as applicable, in accordance with its terms, subject to (i) laws of general application relating to bankruptcy, insolvency and the relief of debtors, and (ii) rules of law governing specific performance, injunctive relief and other equitable remedies. 2.22 Non-Contravention; Consents. Except as set forth in Part 2.22 of the Disclosure Schedule and except for Breaches which could not reasonably be expected to have a Material Adverse Effect on Conduct or Subsidiary, neither (1) the execution, delivery or performance of this Agreement or any other agreement, document or instrument referred to in or contemplated by this Agreement, nor (2) the consummation of the transactions contemplated by this Agreement or any such other agreement, document or instrument, will directly or indirectly (with or without notice or lapse of time): (a) contravene, conflict with or result in a violation of (i) any of the provisions of Conduct's articles of association or (ii) Subsidiary's articles of incorporation or bylaws, or (ii) any resolution adopted by Conduct's or Subsidiary's shareholders or Conduct's or Subsidiary's board of directors; (b) contravene, conflict with or result in a violation of, or give any Governmental Body or other Person the right to challenge any of the transactions contemplated by this Agreement or to exercise any remedy or obtain any relief under, any Legal Requirement or any order, writ, injunction, judgment or decree to which Conduct or Subsidiary, or any of the assets owned or used by Conduct or Subsidiary, is subject; (c) contravene, conflict with or result in a violation of any of the terms or requirements of, or give any Governmental Body the right to revoke, withdraw, suspend, cancel, terminate or modify, any Governmental Authorization that is held by Conduct or Subsidiary or that otherwise relates to Conduct's business or to any of the assets owned or used by Conduct or Subsidiary; (d) contravene, conflict with or result in a material violation or breach of, or result in a material default under, any provision of any material Contract, or give any Person the right to (i) declare a default or exercise any remedy under any Contract, (ii) accelerate the maturity or performance of any Contract, or (iii) cancel, terminate or modify any Contract; or (e) result in the imposition or creation of any lien or other Encumbrance upon or with respect to any asset owned or used by Conduct or Subsidiary (except for minor liens that will not, in any case or in the aggregate, materially detract from the value of the assets subject thereto or materially impair the operations of Conduct or Subsidiary). Neither Conduct nor Subsidiary is, nor will be, required to make any filing with or give any notice to, or to obtain any Consent from, any Person in connection with (x) the execution, delivery or performance of this Agreement or any other agreement, document or instrument referred to in or contemplated by this Agreement, or (y) the consummation of the transactions contemplated by this Agreement or contemplated by any other agreement, document or instrument referred to in or contemplated by this Agreement except for (A) filings with the Israel 25 Investment Center of the Israeli Ministry of Trade & Industry, (B) filings with the Chief Scientist of the Israeli Ministry of Trade & Industry, (C) the approval of the General Director of the Antitrust Authority in Israel, (D) approval of Israeli Income Tax Authorities as specified in Section 6.8 below, and (E) such other consents, approvals, orders, authorizations, registrations, declarations and filings, the failure of which to be obtained or made would not have, individually or in the aggregate, a Material Adverse Effect on Conduct or Subsidiary. 2.23 Approved Enterprise. Except as set forth in Part 2.23, Conduct has complied in all material respects with the terms and conditions as specified in the letter of approval dated December 29, 1996 and September 8, 1999, from the Israeli Investment Center of the Ministry of Industry and Trade for an investment program and the terms of the Encouragement of Capital Investments law-1959, issued to it. 2.24 Chief Scientist. Except as set forth in Part 2.24 of the Disclosure Schedule, Conduct has complied in all material respects with the terms and conditions as specified in the letter of approval dated March 19, 1997, from the Chief Scientist of the Israeli Ministry of Industry and Trade and the terms of the Encouragement of Industrial Research and Development Law - 1984. 2.25 No Brokers. Except as set forth in Part 2.25, none of Conduct nor Subsidiary has agreed or become obligated to pay to any Person, or has taken any action that might result in any Person claiming to be entitled to receive, any brokerage commission, finder's fee or similar commission or fee in connection with any of the transactions contemplated by this Agreement. 2.26 Full Disclosure. This Agreement (including the Disclosure Schedule) does not contain any representation, warranty or information that is false or misleading with respect to any material fact. Section 3. Representations and Warranties of Conduct Shareholders The Conduct Shareholders each, severally and not jointly, represent and warrant to Mercury that on the date hereof and as of the Closing, as though made at the Closing, as follows: 3.1 Ownership of Conduct Capital Shares. Such Conduct Shareholder is the sole record and beneficial owner of the Conduct Capital Shares designated as being owned by the Conduct Shareholder opposite his, her or its name in Exhibit ------- A to this Agreement. Such Conduct Capital Shares are not subject to any Liens - - or to any rights of first refusal of any kind, and such Conduct Shareholder has not granted any rights to purchase such Conduct Capital Shares to any other person or entity. Such Conduct Shareholder has the sole right to transfer such Conduct Capital Shares to Mercury. Such Conduct Capital Shares constitute all of the Conduct Capital Shares owned, beneficially or of record, by such Conduct Shareholder. and such Conduct Shareholder has no options, warrants or other rights to acquire Conduct Capital Shares. At the Closing, in exchange for the Mercury Stock issued pursuant to Sections 1.1 and 1.5 hereof, Mercury will receive good title to such Conduct Capital Shares, subject to no Liens retained, granted or permitted by such Conduct Shareholder or Conduct. Such Conduct Shareholder hereby waivers its Right of First Refusal and Right of Co-Sale with respect to the shares held by 26 other Conduct Shareholders as set forth in the Conduct Articles of Association as currently in effect. 3.2 Tax Matters. Such Conduct Shareholder has had an opportunity to review with his own tax advisors the tax consequences to the Conduct Shareholder of the transactions contemplated by this Agreement. Such Conduct Shareholder understands that he must rely solely on his advisors and not on any statements or representations by Mercury, Conduct, Subsidiary or any of their agents. Such Conduct Shareholder understands that he (and not Mercury, Conduct, or Subsidiary) shall be responsible for his, her or its own tax liability that may arise as a result of the transactions contemplated by this Agreement. 3.3 Authority. Such Conduct Shareholder has all requisite power and authority to enter into this Agreement and to consummate the transactions contemplated hereby. This Agreement has been duly executed and delivered by such Conduct Shareholder, and, assuming the due authorization, execution and delivery by the other parties hereto, constitutes the valid and binding obligation of such Conduct Shareholder, enforceable in accordance with its terms, except as such enforceability may be limited by principles of public policy and subject to the laws of general application relating to bankruptcy, insolvency and the relief of debtors and to rules of law governing specific performance, injunctive relief or other equitable remedies. 3.4 No Conflict. The execution and delivery by such Conduct Shareholder of this Agreement and the consummation of the transactions contemplated hereby will not conflict with any material mortgage, indenture, lease, contract or other agreement or instrument, permit, concession, franchise or license to which such Conduct Shareholder or any of his, her or its properties or assets is subject, or any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to such Conduct Shareholder or his, her or its properties or assets. 3.5 Exemption from Registration. Such Conduct Shareholder is aware (i) that the Mercury Stock to be issued to Conduct Shareholder in the transactions contemplated by this Agreement will not be registered immediately and will not be issued pursuant to a registration statement under the Securities Act, but will instead be issued in reliance on the exemption from registration set forth in Section 4(2) of the Act and in Regulation D under the Act, and (ii) that neither the transactions contemplated by this Agreement nor the issuance of such Mercury Stock has been approved or reviewed by the SEC or by any other governmental agency. 3.6 No Immediate Resale. Such Conduct Shareholder is aware that, because the Mercury Stock to be issued in the transactions contemplated by this Agreement will not be registered immediately under the Act, such Mercury Stock cannot be resold unless such Mercury Stock is registered under the Act or unless an exemption from registration is available. Conduct Shareholder is also aware that while Mercury has agreed to file a registration statement promptly after the Closing with respect to the Mercury Stock to be issued to Conduct Shareholder in the transactions contemplated by this Agreement pursuant to the terms of a Registration Rights Agreement among Mercury and the Conduct Shareholders, there may be times that such registration statement would be unavailable for use by Conduct Shareholder to sell his or her shares. If the registration statement is unavailable then the provisions of Rule 144 under the Act will permit resale of the Mercury Stock to be issued to Conduct Shareholder in the transactions 27 contemplated by this Agreement only under limited circumstances, and such Mercury Stock must be held by Conduct Shareholder for at least one year before it can be sold pursuant to Rule 144. 3.7 Investment Intent. The Mercury Stock to be issued to Conduct Shareholder in the transactions contemplated by this Agreement will be acquired by Conduct Shareholder for investment and for his own account, and not with a view to, or for resale in connection with, any unregistered distribution thereof. 3.8 Adequate Investigation. Conduct Shareholder has received, reviewed and considered all the information Conduct Shareholder considers necessary to enable Conduct Shareholder to make an informed decision to invest in Mercury Stock, including the Mercury SEC Documents (defined below). 3.9 Sophisticated Investor. Conduct Shareholder (either by himself or in conjunction with his representative) is knowledgeable, sophisticated and experienced in making, and is qualified to make, decisions with respect to investments in securities presenting investment decisions like that involved in Conduct Shareholder's contemplated investment in the Mercury Stock to be issued in the transactions contemplated by this Agreement. Conduct Shareholder understands and has fully considered the risks of acquiring and owning Mercury Stock and further understands that: (i) an investment in Mercury Stock is a speculative investment which involves a high degree of risk and is suitable only for an investor who is able to bear the economic consequences of losing his or her entire investment; and (ii) there are substantial restrictions on the transferability of the Mercury Stock to be issued in the transactions contemplated by this Agreement, and, accordingly, it may not be possible for Conduct Shareholder to liquidate his investment in such Mercury Stock (in whole or in part) in the case of emergency. Conduct Shareholder is able: (1) to hold the Mercury Stock that he is to receive in the transactions contemplated by this Agreement for a substantial period of time; and (2) to afford a complete loss of his investment in such Mercury Stock. 3.10 Legends; Stop Transfer Orders. Conduct Shareholder understands that stop transfer instructions will be given to Mercury's transfer agent with respect to the Mercury Stock to be issued to Conduct Shareholder in the transactions contemplated by this Agreement, and that there will be placed on the certificate or certificates representing such Mercury Stock a legend identical or similar in effect to the following legend (together with any other legend or legends required by applicable state securities laws or otherwise): "THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 (THE "ACT") AND MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED, ASSIGNED, PLEDGED OR HYPOTHECATED UNLESS REGISTERED UNDER THE ACT OR UNLESS AN EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE ACT IS AVAILABLE." 28 Section 4. Representations and Warranties of Mercury Mercury represents and warrants to Conduct, Subsidiary and the Conduct Shareholders as follows: 4.1 Corporate Status. Mercury is a corporation duly organized, validly existing and in good standing under, the laws of the State of Delaware. 4.2 SEC Filings; Financial Statements. (a) Mercury has filed all required reports, schedules, forms, statements and other documents with the SEC since January 1, 1995 (the "Mercury SEC Documents"). Mercury has delivered or otherwise made available to the Conduct Shareholders accurate and complete copies (excluding copies of exhibits) of each report, registration statement (on a form other than Form S-8) and definitive proxy statement filed by Mercury with the SEC between January 1, 1999 and the date of this Agreement. As of the time it was filed with the SEC (or, if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing): (i) each of the Mercury SEC Documents complied in all material respects with the applicable requirements of the Securities Act or the Exchange Act (as the case may be); and (ii) none of the Mercury SEC Documents contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary in order to make the statements therein, in the light of the circumstances under which they were made, not misleading. (b) The consolidated financial statements contained in the Mercury SEC Documents: (i) complied as to form in all material respects with the published rules and regulations of the SEC applicable thereto; (ii) were prepared in accordance with generally accepted accounting principles applied on a consistent basis throughout the periods covered, except as may be indicated in the notes to such financial statements and (in the case of unaudited statements) as permitted by Form 10-Q of the SEC, and except that unaudited financial statements may not contain footnotes and are subject to normal and recurring year-end audit adjustments (which will not, individually or in the aggregate, be material in magnitude); and (iii) fairly present the consolidated financial position of Mercury and its subsidiaries as of the respective dates thereof and the consolidated results of operations of Mercury and its subsidiaries for the periods covered thereby. 4.3 Authority; Binding Nature of Agreement. Mercury has the absolute and unrestricted right, power and authority to perform its obligations under this Agreement and under each other agreement, document or instrument referred to in or contemplated by this Agreement to which Mercury is or will be a party; and the execution, delivery and performance by Mercury of this Agreement and under each other agreement, document or instrument referred to in or contemplated by this Agreement to which Mercury is or will be a party has been duly authorized by all necessary action on the part of Mercury and its board of directors. This Agreement and each other agreement, document or instrument referred to in or contemplated by this Agreement to which Mercury is or will be a party constitutes the legal, valid and binding obligation of Mercury, enforceable against Mercury in accordance with its terms, subject to (i) laws of general application relating to bankruptcy, insolvency and the relief of debtors, and (ii) rules of law governing specific performance, injunctive relief and other equitable remedies. 29 4.4 Consents and Approvals; No Violations. There is no requirement applicable to Mercury to make any filing with, or to obtain any permit, authorization, consent or approval of any Governmental Body as a condition to the execution, delivery or performance by Mercury of this Agreement or any other agreement, document or instrument referred to in or contemplated by this Agreement, or the lawful consummation by Mercury of the transactions contemplated by this Agreement, except for (A) the approval of the General Director of the Antitrust Authority in Israel, (B) filings with the Israel Investment Center of the Israeli Ministry of Trade & Industry, (C) filings with the Chief Scientist of the Israeli Ministry of Trade & Industry, (D) the approval of Israeli Income Tax Authorities set forth in Section 6.8 below, and (E) such other consents, approvals, orders, authorizations, registrations, declarations and filings, the failure of which to be obtained or made would not have, individually or in the aggregate, a Material Adverse Effect on Mercury. Neither the execution, delivery or performance of this Agreement by Mercury or any other agreement, document or instrument referred to in or contemplated by this Agreement nor the consummation by Mercury of the transactions contemplated by this Agreement or any such other agreement, document or instrument will directly or indirectly (with or without notice or lapse of time) (i) contravene, conflict with or result in any breach of any provision of the Certificate of Incorporation or Bylaws of Mercury or any resolution adopted by Mercury's shareholders or board of directors, (ii) contravene, conflict with or result in a material breach or default (or give rise to any right of termination, cancellation or acceleration) under any of the terms, conditions or provisions of any material note, bond, mortgage, indenture, license agreement, lease or other material contract, instrument or obligation to which Mercury is a party or by which any of its assets may be bound, (iii) contravene, conflict with or result in violation in any material respects any statute, rule, regulation, order, writ, injunction or decree or any other Government Authorization applicable to Mercury or any of its material assets, where the consequences of any and all such breaches, defaults and violations would, in the aggregate, have a material and adverse effect on the business, operations or financial condition of Mercury taken as a whole, (iv) contravene, conflict with or result in a violation of, or give any Governmental Body or other Person the right to challenge any of the transactions contemplated by this Agreement or to exercise any remedy or obtain any relief under any Legal Requirement or any order, writ, injunction, judgement or decree, or (v) result in the creation of any material (individually or in the aggregate) liens, charges or Encumbrances on any of the assets of Mercury. Mercury is aware that in order to obtain the approval of the Chief Scientist of the Israeli Ministry of Trade & Industry, it will be required to deliver to the Chief Scientist certain undertakings substantially in the form attached as Exhibit J. As promptly as practicable after the date hereof, and in --------- any event prior to the Closing, Mercury will sign and deliver such form to the Chief Scientist. 4.5 Valid Issuance. Subject to Section 1.5(e), the Mercury Stock to be issued in the transactions contemplated by this Agreement will, when issued in accordance with the provisions of this Agreement, be validly issued, fully paid and nonassessable, and free of Encumbrances, issued in compliance with all Legal Requirements and free of restriction on transfer other than restrictions pursuant to this Agreement and under applicable securities laws. 30 SECTION 5. Certain Covenants 5.1 Access and Investigation. (a) During the period from the date of this Agreement through the Closing Date (the "Pre-Closing Period"), Conduct shall: (a) provide Mercury and Mercury's Representatives with reasonable access to Conduct's and Subsidiary's personnel and assets and to all existing books, records, tax returns, work papers and other documents and information relating to Conduct and Subsidiary; and (b) provide Mercury and Mercury's Representatives with copies of such existing books, records, tax returns, work papers and other documents and information relating to Conduct and Subsidiary, and with such additional financial, operating and other data and information regarding Conduct and Subsidiary, as Mercury may reasonably request. (b) During the Pre-Closing Period, Mercury shall: (a) provide Conduct and Conduct's Representatives with reasonable access to Mercury's personnel and assets and to all existing books, records, tax returns, work papers and other documents and information relating to Mercury; and (b) provide Conduct and Conduct's Representatives with copies of such existing books, records, tax returns, work papers and other documents and information relating to Mercury, and with such additional financial, operating and other data and information regarding Mercury, as Conduct may reasonably request. (c) All information provided during the Pre-Closing Period by Mercury or Conduct to the other or the other's Representatives in connection with any investigation hereunder or pursuant to the negotiation and execution of this Agreement and the consummation of the transactions contemplated hereby shall be subject to the provisions of the Mutual Nondisclosure Agreement between Mercury and Conduct dated as of September 29, 1999 (the "Nondisclosure Agreement"), which shall remain in full force and effect. Except for information set forth in the Disclosure Schedule or the attachments thereto, no information obtained in any investigation shall effect or be deemed to modify any representation or warranty contained in this Agreement. 5.2 Operation of the Business of Conduct. Without the prior written consent of Mercury during the Pre-Closing Period, and except as otherwise contemplated or permitted by this Agreement: (a) Conduct and Subsidiary shall each use its best effort to conduct its business and operations in the ordinary course and in substantially the same manner as such business and operations have been conducted prior to the date of this Agreement, shall pay its debts and Taxes when due (subject to good faith disputes, if any, over such debts and Taxes), and shall pay or perform its other material obligations when due; (b) Conduct and Subsidiary shall each use commercially reasonable efforts to (i) preserve intact its current business organization, (ii) keep available the services of its current officers and employees and (iii) maintain its relations and good will with all suppliers, 31 customers, landlords, creditors, employees and other Persons having business relationships with Conduct; (c) Conduct and Subsidiary shall not declare, accrue, set aside or pay any dividend or make any other distribution in respect of any capital shares; (d) Conduct and Subsidiary shall not repurchase, redeem or otherwise reacquire any capital shares or other securities other than pursuant to Contracts in effect as of the date of this Agreement; (e) Except for Conduct Capital Shares issued upon the exercise of options and warrants to purchase Conduct Capital Shares and any convertible promissory notes outstanding on the date of this Agreement and upon the conversion of Conduct Preferred Shares, neither Conduct nor Subsidiary shall sell, issue or authorize the issuance of (i) any capital shares or other security, (ii) any option or right to acquire any capital shares or other security or (iii) any instrument convertible into or exchangeable for any capital shares or other security; (f) Conduct shall not amend its articles of association or the articles of incorporation or bylaws of Subsidiary, or effect or permit Conduct or Subsidiary to become a party to any Acquisition Transaction, recapitalization, reclassification of shares, stock split, reverse stock split or similar transaction; (g) Conduct and Subsidiary shall not form any subsidiary or acquire any equity interest or other interest in any other Entity; (h) Neither Conduct nor Subsidiary shall (i) establish, adopt or amend any employee benefit plan, (ii) pay any bonus or make any profit-sharing payment, severance (except as required by applicable law), cash incentive payment or similar payment to, increase the amount of the wages, salary, commissions, fringe benefits or other compensation or remuneration payable to, any of its directors, officers or employees, or accelerate the vesting of any Conduct Option or any Conduct Capital Shares subject to vesting or (iii) hire any new employee or terminate any current employee; (i) Neither Conduct nor Subsidiary shall change any of its methods of accounting or accounting practices; (j) Neither Conduct nor Subsidiary shall make any Tax election; (k) Neither Conduct nor Subsidiary shall commence or settle any Legal Proceeding, except as required by applicable law; (l) Neither Conduct nor Subsidiary shall enter into any license agreement with respect to or otherwise transfer any rights to any Conduct Proprietary Asset, or except in the ordinary course of business enter into any license with respect to any Proprietary Asset of any other person or entity; 32 (m) Neither Conduct nor Subsidiary shall enter into or amend any Contract pursuant to which any other party is granted marketing, distribution or similar rights of any type or scope with respect to any products or technology of Conduct or Subsidiary; (n) Neither Conduct nor Subsidiary shall amend or otherwise modify or violate the terms of any of Conduct Contracts set forth or described in the Disclosure Schedule; (o) Neither Conduct nor Subsidiary shall incur any indebtedness for borrowed money (other than indebtedness to trade creditors in the ordinary course of business) or guarantee any such indebtedness or issue or sell any debt securities or guarantee any debt securities of others; (p) Neither Conduct nor Subsidiary shall grant any loans to others (other than advances of employee travel expenses in the ordinary course of business consistent with past practices) or purchase debt securities of others or amend the terms of any outstanding loan agreement; (q) Neither Conduct nor Subsidiary shall revalue any of its assets, including without limitation writing down the value of inventory or writing off notes; (r) Other than obligations existing as of the date of this Agreement, neither Conduct nor Subsidiary shall pay, discharge or satisfy, in an amount in excess of $25,000 (in any one case) or $100,000 (in the aggregate), any claim, liability or obligation (absolute, accrued, asserted or unasserted, contingent or otherwise); (s) No Conduct Shareholder shall transfer any Conduct Capital Shares to any other Person; and (t) Neither Conduct nor Subsidiary nor any Conduct Shareholder shall agree or commit to take any of the actions described in clauses "(c)" through "(s)" above. 5.3 Notification; Updates to Disclosure Schedule. (a) During the Pre-Closing Period, Conduct shall promptly notify Mercury in writing of: (i) the discovery by Conduct or Subsidiary of any event, condition, fact or circumstance that occurred or existed on or prior to the date of this Agreement and that caused or constitutes an inaccuracy in or breach of any representation or warranty made by Conduct or Subsidiary in this Agreement; (ii) any event, condition, fact or circumstance that occurs, arises or exists after the date of this Agreement and that would cause or constitute an inaccuracy in or breach of any representation or warranty made by Conduct or Subsidiary in this Agreement if (A) such representation or warranty had been made as of the time of the occurrence, existence or discovery of such event, condition, fact or circumstance or (B) such event, condition, fact or circumstance had occurred, arisen or existed on or prior to the date of this Agreement; (iii) any breach of any covenant or obligation of Conduct or Subsidiary; and (iv) any event, condition, fact or circumstance that would make the timely satisfaction of any of the conditions set forth in Section 7 impossible or unlikely. Notification in accordance with this Section 5.3(a) shall not 33 affect Conduct's or Subsidiary's liability for breach of any such representation, warranty or covenant under this Agreement. (b) During the Pre-Closing Period, Mercury shall promptly notify Conduct in writing of: (i) the discovery by Mercury of any event, condition, fact or circumstance that occurred or existed on or prior to the date of this Agreement and that caused or constitutes an inaccuracy in or breach of any representation or warranty made by Mercury in this Agreement; (ii) any event, condition, fact or circumstance that occurs, arises or exists after the date of this Agreement and that would cause or constitute an inaccuracy in or breach of any representation or warranty made by Mercury in this Agreement if (A) such representation or warranty had been made as of the time of the occurrence, existence or discovery of such event, condition, fact or circumstance or (B) such event, condition, fact or circumstance had occurred, arisen or existed on or prior to the date of this Agreement; (iii) any breach of any covenant or obligation of Mercury; and (iv) any event, condition, fact or circumstance that would make the timely satisfaction of any of the conditions set forth in Section 8 impossible or unlikely. Notification in accordance with this Section 5.3(b) shall not affect Mercury's liability for breach of any such representation, warranty or covenant under this Agreement. 5.4 No Negotiation. During the Pre-Closing Period, Conduct, Subsidiary and the Conduct Shareholders shall not, and shall not permit any of their Representatives to: (a) solicit any proposal or offer from any Person (other than Mercury) for or relating to a possible Acquisition Transaction; or (b) participate in any negotiations or enter into any agreement with, or provide any information to or cooperate with, any Person (other than Mercury) relating to or in connection with a possible Acquisition Transaction or any other transaction which would alter the equity ownership of Conduct. In addition to the foregoing, if Conduct receives prior to the Closing or the termination of this Agreement any offer, proposal, or request relating to any of the above, Conduct shall immediately notify Mercury thereof, including information as to the identity of the offeror or the party making any such offer or proposal and the specific terms of such offer or proposal, as the case may be, and such other information related thereto as Mercury may reasonably request. SECTION 6. Additional Covenants of the Parties 6.1 Filings and Consents. As promptly as practicable after the execution of this Agreement, each party to this Agreement (a) shall make all filings, if any, and give all notices, if any, required to be made and given by such party in connection with the transactions contemplated by this Agreement and (b) shall use all commercially reasonable efforts to obtain all Consents, if any, required to be obtained (pursuant to any applicable Legal Requirement or Contract, or otherwise) by such party in connection with the transactions contemplated by this Agreement. Without limiting the foregoing, the parties shall promptly (i) apply for and obtain the approvals of the Chief Scientist of the Israel, Ministry of Trade and Industry, the Investment Center of the Israeli Ministry of Trade and Industry, the Israeli Income Tax Authorities and the Israeli General Director of the Antitrust Authority and (ii) provide notices of to holders of Conduct Warrants. 34 6.2 Reservation of Authorized Common Stock. Mercury shall also reserve a sufficient number of Common Stock for issuance upon exercise of assumed options of Conduct. 6.3 Nasdaq Listing. As promptly as practicable after the date hereof, and in any event prior to the Closing, Mercury shall use its best efforts to cause the shares of the Mercury Stock to be issued pursuant to this Agreement to be included on Nasdaq, subject to notice of official issuance thereof. 6.4 Public Announcements . Except as required by applicable law, Mercury, in its sole discretion, shall determine the form, timing and contents of announcements and disclosures regarding the proposed transaction; provided, -------- however, prior to any such announcement, Mercury shall afford Conduct a - ------- reasonable opportunity to review and comment on any such announcement or disclosure. 6.5 Best Efforts. During the Pre-Closing Period, Conduct, Subsidiary and Mercury shall each use their best efforts to cause the conditions set forth in Sections 7 and 8 to be satisfied before November 30, 1999. 6.6 Employee Matters. Mercury and Conduct shall use commercially reasonable efforts to recruit each key employee of Conduct or Subsidiary to continue at-will employment with Conduct or Subsidiary after the Closing. Those employees of Conduct or Subsidiary that continue to be employees of Mercury or any of its affiliates, including Conduct or Subsidiary, following the Closing shall upon the closing be eligible to participate in Mercury's health, vacation, employee stock purchase, 401(k) and other plans, to the same extent as comparably situated employees of Mercury and shall receive credit under Mercury's benefit plans for time served as an employee of Conduct or Subsidiary. 6.7 Additional Shareholders. Conduct shall notify Mercury of any exercises or cancellations of options or warrants or conversions of convertible promissory notes after the date of this Agreement until the Closing. Conduct shall use its best efforts to cause each such Person who exercises a Conduct Option or Conduct Warrant or converts a Conduct Convertible Promissory Note to become parties to this Agreement (the "New Conduct Shareholders"). Any such New Conduct Shareholders may be added as parties to this Agreement as set forth in Section 11.12 hereof. Any such New Conduct Shareholder who executes this Agreement and shall be considered "Conduct Shareholders" for all purposes of this Agreement. 6.8 Qualified Option Plan. As promptly as practicable after the date hereof, and in any event prior to the Closing, Mercury shall use its best efforts to obtain approval of the Israeli Income Tax Authorities for the qualification of the options of Conduct assumed by Mercury pursuant to this Agreement as Options granted pursuant to the provisions of section 102 of the Israeli Income Tax Ordinance (new version) 1961 (the "Ordinance") and any regulations, rules, orders or procedures promulgated thereunder, including the Income Tax Rules (Tax benefits in Stock Issuance to Employees) 5349-1989 (the "Rules"). 35 6.9 Indemnification of Directors and Officers . For a period of six years from the Closing Date, Mercury shall, and shall cause Conduct to, fulfill and honor in all respects all rights to indemnification existing in favor of the directors and officers of Conduct, as provided in and subject to the terms of Conduct's Articles of Association (as in effect as of the date of this Agreement) and pursuant to any resolutions of Conduct or Subsidiary provided that (a) the indemnified party has met any applicable standard of conduct to qualify for such indemnification and (b) the basis of the claim against such indemnified party does not otherwise constitute a breach of any of the representations or warranties made by, or covenants to be performed by, Conduct under this Agreement. This Section 6.9 shall survive the consummation of the transactions contemplated hereby, is intended to benefit and may be enforced by the directors and officers of Conduct, and shall be binding on all successors and assigns of Mercury and Conduct. 6.10 Private Placement. Mercury and Conduct shall each take all steps necessary or desirable, utilize all commercially reasonable efforts and cooperate with one another in every way to have the issuance of the shares of Mercury Stock to be issued in the transactions contemplated by this Agreement qualify for one of the exemptions from registration under the Securities Act provided in Regulation D promulgated thereunder, including the retention of a purchaser representative, if necessary. 6.11 Registration Statements. (a) Mercury will prepare and file with the SEC a registration statement on Form S-3 in accordance with the terms of the Registration Rights Agreement. (b) Mercury will, within 10 days after the Closing, prepare and file with the SEC a registration statement on Form S-8, in connection with the issuance of the Mercury Stock with respect to the assumed Conduct Options and maintain the effectiveness of such registration statement thereafter for so long as any such options remain outstanding. SECTION 7. Conditions Precedent to Obligations of Mercury The obligations of Mercury to effect the transactions contemplated by this Agreement are subject to the satisfaction (or waiver by Mercury), at or prior to the Closing, of each of the following conditions: 7.1 Accuracy of Representations. Each of the representations and warranties made by Conduct, Subsidiary and the Conduct Shareholders in this Agreement shall have been accurate as of the date of this Agreement. In addition, the representations and warranties of Conduct, Subsidiary and the Conduct Shareholders contained in this Agreement shall be true and correct in all material respects on and as of the Closing except for changes contemplated by this Agreement and except for those representations and warranties which address matters only as of a particular date (which shall remain true and correct as of such particular date), with the same force and effect as if made on and as of the Closing except in such cases (other than the representations in Sections 2.2, 2.3, 2.21, 3.1 and 3.4) where the failure to be so true and correct would not have a Material Adverse Effect on Conduct. Mercury shall have received a certificate 36 with respect to the foregoing signed on behalf of Conduct and Subsidiary by two of the respective executive officers or legally authorized signatories of each of Conduct and Subsidiary. 7.2 Performance of Covenants. All of the covenants and obligations that Conduct is required to comply with or to perform at or prior to the Closing shall have been complied with and performed in all material respects, except where the failure to have performed or complied with such covenants and obligations has not had a Material Adverse Effect on Conduct, or Mercury's ownership and control thereof, after the Closing. 7.3 Agreements and Documents. Mercury shall have received the following agreements and documents, each of which shall be in full force and effect: (a) an Escrow Agreement in the form of Exhibit C hereto, executed by --------- the Shareholders' Agent on behalf of the Conduct Shareholders; (b) written resignations of all directors of Conduct and Subsidiary, effective as of the Closing Date (c) a legal opinion of Tida Shamir & Co., Advocates substantially in the form of Exhibit F-1 hereto ----------- (d) a legal opinion of Wilson Sonsini Goodrich & Rosati, PC, substantially in the form of Exhibit F-2 hereto; ----------- (e) evidence of the termination effective at or prior to the Closing of the distribution agreement dated February 27, 1996 between Forval Creative Inc. and Conduct; (f) the other documents specified in Section 1.4 hereof; and (g) Each of Mercury and Conduct shall have received a letter from the respective accounting firms set forth below, dated as of the Closing, as follows: (i) A letter from Arthur Andersen LLP, independent accountants for Conduct, and addressed to Conduct, reasonably satisfactory in form and substance to Mercury and PricewaterhouseCoopers LLP, independent accountants for Mercury, to the effect that, after reasonable investigation, the independent accountants for Conduct are not aware of any fact concerning the transactions contemplated by this Agreement or any of the shareholders or affiliates of Conduct that could preclude Mercury from accounting for the transactions contemplated by this Agreement as a "pooling of interests" in accordance with generally accepted accounting principles, Accounting Principles Board Opinion No. 16 and all published rules, regulations and policies of the SEC. (ii) A letter from PricewaterhouseCoopers LLP, independent accountants for Mercury, and addressed to Mercury, reasonably satisfactory in form and substance to Mercury, to the effect that, after reasonable investigation, that PricewaterhouseCoopers LLP concurs with Mercury management's conclusion that as of the Closing Date, no conditions exist that would preclude Mercury from accounting for the 37 transactions contemplated by this Agreement as a "pooling of interests", in each case in accordance with generally accepted accounting principles, Accounting Principles Board Opinion No. 16 and all published rules, regulations and policies of the SEC. 7.4 Affiliate Pooling Agreements. Each of the persons or entities listed on Schedule 7.4 attached to this Agreement shall have executed and delivered an Affiliate Pooling Agreement with Mercury in the form of Exhibits G-1 or G-2 ------------ -- attached hereto (collectively the "Affiliate Pooling Agreements"), regarding compliance with requirements for accounting treatment of the transactions contemplated by this Agreement as a pooling of interests. 7.5 Consents. All Consents required to be obtained (pursuant to any applicable Legal Requirement or Contract, or otherwise) in connection with the transactions contemplated by this Agreement have been obtained, including the approvals of the Israeli General Director of Antitrust Authority, the Chief Scientist of the Israeli Ministry of Trade and Industry, the Investment Center of the Israeli Ministry of Trade and Industry and of the Israeli Income Tax Authorities for the qualification of the options of Conduct assumed by Mercury pursuant to this Agreement as Options granted pursuant to the provisions of section 102 of the Israeli Income Tax Ordinance (new version) 1961 (the "Ordinance") and any regulations, rules, orders or procedures promulgated thereunder, including the Income Tax Rules (Tax benefits in Stock Issuance to Employees) 5349-1989 (the "Rules"). 7.6 No Restraints. No temporary restraining order, preliminary or permanent injunction or other order preventing the consummation of the transactions contemplated by this Agreement shall have been issued by any court of competent jurisdiction and remain in effect, and there shall not be any Legal Requirement enacted or deemed applicable to the transactions contemplated by this Agreement that makes consummation of the transactions contemplated by this Agreement illegal. 7.7 Conduct Warrants. If the Closing occurs less than 20 days after the notice required under the Conduct Warrants is delivered to the holders of Conduct Warrants, the holders of Conduct Warrants shall have delivered written waivers of such notice to Mercury. 7.8 Additional Shareholders. Conduct shall have caused each New Conduct Shareholder to become a party to this Agreement. SECTION 8. Conditions Precedent to Obligations of Conduct The obligations of Conduct to effect the transactions contemplated by this Agreement are subject to the satisfaction (or waiver), at or prior to the Closing, of the following conditions: 8.1 Accuracy of Representations. Each of the representations and warranties made by Mercury in this Agreement shall have been accurate as of the date of this Agreement. In addition, the representations and warranties of Mercury contained in this Agreement shall be true and correct in all material respects on and as of the Closing except for changes contemplated by this Agreement and except for those representations and warranties which address matters only as of a particular date (which shall remain true and correct as of such particular date), with the 38 same force and effect as if made on and as of the Closing except in such cases where the failure to be so true and correct would not have a Material Adverse Effect on Mercury. Conduct shall have received a certificate with respect to the foregoing signed on behalf of Mercury by the Chief Financial Officer of Mercury. 8.2 Performance of Covenants. All of the covenants and obligations that Mercury are required to comply with or to perform at or prior to the Closing shall have been complied with and performed in all material respects, except where the failure to have performed or complied with such covenants and obligations has not had a Material Adverse Effect on Mercury. 8.3 Agreements and Documents. Conduct shall have received the following documents. (a) a Registration Rights Agreement in the form of Exhibit H hereto, --------- executed by Mercury; (b) an Escrow Agreement in the form of Exhibit C hereto, executed by --------- Mercury; (c) A legal opinion of General Counsel Associates LLP substantially in the form of Exhibit I hereto. (d) An undertaking towards the Chief Scientist in the form of Exhibit J hereto, executed by Mercury. 8.4 Consents. All Consents required to be obtained (pursuant to any applicable Legal Requirement or Contract, or otherwise) in connection with the transactions contemplated by this Agreement have been obtained, including the approvals of the Israeli Antitrust Authority, the Chief Scientist of the Israeli Ministry of Trade and Industry, the Investment Center of the Israeli Ministry of Trade and Industry. 8.5 Nasdaq Listing. The shares of Mercury Stock to be issued in the transactions contemplated by this Agreement shall have been approved for listing (subject to notice of issuance) on the Nasdaq National Market. 8.6 No Restraints. No temporary restraining order, preliminary or permanent injunction or other order preventing the consummation of the transactions contemplated by this Agreement shall have been issued by any court of competent jurisdiction and remain in effect, and there shall not be any Legal Requirement enacted or deemed applicable to the transactions contemplated by this Agreement that makes consummation of the transactions contemplated by this Agreement illegal. SECTION 9. TERMINATION 39 9.1 Termination Events. This Agreement may be terminated prior to the Closing: (a) by Mercury if (i) any representation or warranty of Conduct or Subsidiary contained in Section 2 was incorrect in any material respect when made such that the condition set forth in Section 7.1 would not be satisfied; (ii) any representation or warranty of the Conduct Shareholders contained in Section 3 was incorrect in any material respect when made such that the condition set forth in Section 7.1 would not be satisfied; or (iii) if (x) any of Conduct's covenants contained in this Agreement shall have been breached in any material respect; (y) such breach has not been cured within 15 days after written notice thereof is delivered by Mercury to Conduct; provided, however, that no cure period shall apply if such breach is not capable of cure; and (z) as a result of such breach, the condition set forth in Section 7.2 would not be satisfied; (b) by Conduct if any representation or warranty of Mercury contained in Section 4 was incorrect in any material respect when made such that the condition set forth in Section 8.1 would not be satisfied, or if: (i) any of Mercury's covenants contained in this Agreement shall have been breached in any material respect; (ii) such breach has not been cured within 15 days after written notice thereof is delivered by Conduct to Mercury; provided, however, that no cure period shall apply if such breach is not capable of cure; and (iii) as a result of such breach, the condition set forth in Section 8.2 would not be satisfied; (c) by Mercury if the Closing has not taken place on or before March 1, 2000 (other than as a result of any failure on the part of Mercury to comply with or perform any covenant or obligation of Mercury set forth in this Agreement or in any other agreement or instrument delivered to Conduct); (d) by Conduct if the Closing has not taken place on or before March 1, 2000 (other than as a result of the failure on the part of Conduct to comply with or perform any covenant or obligation set forth in this Agreement or in any other agreement or instrument delivered to Mercury); (e) by the mutual written consent of Mercury and Conduct. (f) by Conduct if Mercury common stock trades on the Nasdaq National Market at an amount lower than $36 per share (appropriately adjusted for stock splits, recapitalizations and the like) at any time prior to the Closing. 9.2 Termination Procedures. If Mercury wishes to terminate this Agreement pursuant to Section 9.1(a) or Section 9.1(c), Mercury shall deliver to Conduct a written notice stating that Mercury is terminating this Agreement and setting forth a brief description of the basis on which Mercury is terminating this Agreement. If Conduct wishes to terminate this Agreement pursuant to Section 9.1(b) or Section 9.1(d) or Section 9.1(f), Conduct shall deliver to Mercury a notice, in writing, stating that Conduct is terminating this Agreement and setting forth a brief description of the basis on which it is terminating this Agreement. 9.3 Effect of Termination. If this Agreement is terminated pursuant to Section 9.1, all further obligations of the parties under this Agreement shall terminate; provided, however, that: (a) none of the parties shall be relieved of any obligation or liability arising from any prior 40 willful breach by such party of any provision of this Agreement; and (b) the parties shall, in all events, remain bound by and continue to be subject to the provisions set forth in Sections 6.2, 11 and this Section 9.3 and in the Nondisclosure Agreement. Section 10. Indemnification, Etc. 10.1 Survival of Representations, Etc. The representations and warranties made by Conduct, Subsidiary, Conduct Shareholders and Mercury in this Agreement shall survive the Closing and shall expire upon the earlier of (i) one year from the date of the Closing or (ii) the issuance by Mercury's regularly employed independent public accountants of audited financial statements and accompanying audit report covering thirty days of combined operations of Mercury and Conduct ending after the Closing Date (the "Termination Date"). Upon the expiration of the representations and warranties of Conduct, Subsidiary, Conduct Shareholders and Mercury, all liability of the parties with respect to any breach of such representation or warranties shall thereupon be extinguished except to the extent a claim for breach shall have been made prior to such expiration. The pre-closing covenants of Conduct and Mercury contained in this Agreement shall terminate as of the Closing. 10.2 Indemnification. (a) Indemnification by Conduct Shareholders. From and after the Closing Date (but subject to Section 10.1), the Conduct Shareholders who shall have received Mercury Stock pursuant to Section 1.5 (the "Shareholder Indemnitors"), shall (pro rata in accordance with their interest in the Escrow Fund) hold harmless and indemnify each of the Indemnitees from and against, and shall compensate and reimburse each of the Indemnitees for, any Damages which are suffered or incurred by any of the Indemnitees or to which any of the Indemnitees may otherwise become subject (regardless of whether or not such Damages relate to any third-party claim) and which arise from or as a direct or indirect result of, or are directly or indirectly connected with: (i) any inaccuracy in or Breach of any representation or warranty made by Conduct, Subsidiary or Conduct Shareholders in this Agreement or the Disclosure Schedule(ii) any breach of any covenant or obligation of Conduct, Subsidiary or the Conduct Shareholders; or (iii) any Legal Proceeding relating to any Breach referred to in clause "(i)" or "(ii)" of this sentence. (b) Indemnification by Mercury. From and after the Closing Date (but subject to Section 10.1), Mercury shall hold harmless and indemnify each Conduct Shareholder from and against, and shall compensate and reimburse each of the Conduct Shareholders for, any Damages which are suffered or incurred by any of the Conduct Shareholders or to which any of the Conduct Shareholders may otherwise become subject (regardless of whether or not such Damages relate to any third-party claim) and which arise from or as a direct or indirect result of, or are directly or indirectly connected with: (i) any inaccuracy in or Breach of any representation or warranty made by Mercury in this Agreement ; (ii) any breach of any covenant or obligation of Mercury; or (iii) any Legal Proceeding relating to any Breach referred to in clause "(i)" or "(ii)" of this sentence. Notwithstanding anything to the contrary, Mercury shall be under no obligation to deal directly with individual Conduct Shareholders in connection with the indemnity provided to the Conduct Shareholders under this Section 10 but shall only be 41 obligated to respond to notices from, and to provide notices to, and otherwise deal only with, the Shareholders' Agent, who shall have exclusive authority to act for purposes of the indemnification provided by Mercury under this Section 10 on behalf of all of the Conduct Shareholders. (c) Damages to Conduct. If Conduct or Subsidiary suffers or otherwise becomes subject to any Damages, then (without limiting any of the rights of Conduct as an Indemnitee) Mercury shall also be deemed, by virtue of its ownership of the shares of Conduct, to have suffered Damages. (d) Deductible. The Shareholder Indemnitors shall not be required to make any indemnification, compensation or reimbursement payment pursuant to Section 10.2(a) until such time as the total amount of all Damages that have been directly incurred by Mercury as a result of a breach of this Agreement by Conduct exceeds $50,000. (If the total amount of such Damages exceeds $50,000, then Mercury shall be entitled to be indemnified only for the portion of such Damages exceeding $50,000.) Mercury shall not be required to make any indemnification, compensation or reimbursement payment pursuant to Section 10.2(b) until such time as the total amount of all Damages that have been directly incurred by the Conduct Shareholders as a result of a breach of this Agreement by Mercury exceeds $50,000. (If the total amount of such Damages exceeds $50,000, then the Conduct Shareholders shall be entitled to be indemnified against only for the portion of such Damages exceeding $50,000.) 10.3 Exclusive Remedy; Limitations. Absent fraud, willful misrepresentation, or willful deceit, from and after the Closing, recourse of the Indemnitees to the Escrow Amount in the Escrow Fund shall be the sole and exclusive remedy of the Indemnitees for Damages relating to any claim relating to this Agreement provided, however, that nothing in this Section 10 shall limit an individual Conduct Shareholder's liability with respect to a Breach of a representation or warranty made by such Conduct Shareholder in Section 3.1 of this Agreement. Absent fraud, willful misrepresentation, or willful deceit, from and after the Closing, the maximum liability of Mercury to the Conduct Shareholders for Damages relating to any Breach of any representation, warranty, covenant or agreement contained in this Agreement shall be limited to an amount equal to the value of the number of shares placed in the Escrow Fund multiplied by the closing sales price of a share of Mercury common stock price as reported on the Nasdaq National Market on the Closing Date. 10.4 No Contribution. Each Conduct Shareholder waives, acknowledges and agrees that he shall not have and shall not exercise or assert (or attempt to exercise or assert), any right of contribution, right of indemnity or other similar right or remedy against Conduct or Subsidiary or any officer or director or counsel of Conduct or Subsidiary in connection with any actual or alleged inaccuracy in or other Breach of any representation, warranty, covenant or obligation set forth in this Agreement. 10.5 Defense of Third Party Claims against Indemnitees. In the event of the assertion or commencement by any Person of any claim or Legal Proceeding (whether against Conduct or Subsidiary, against any other Indemnitee or against any other Person) with respect to which any of the Conduct Shareholders may become obligated to indemnify, hold harmless, pay, 42 compensate or reimburse any Indemnitee pursuant to this Section 10, (i) Mercury, as soon as practicable after it receives written notice of any such claim or Legal Proceeding, shall notify the Shareholders' Agent of such claim or Legal Proceeding (it being understood that the failure to notify the Shareholders' Agent shall not in any way limit the rights of the Indemnitees under this Agreement except to the extent that such failure materially prejudices the defenses available to the Shareholders' Agent), and (ii) Mercury shall have the right, at its election, to assume the defense of such claim or Legal Proceeding; provided, however, that notwithstanding the foregoing if the maximum exposure (as reasonably determined by Mercury) to all Indemnitees in such claim or Legal Proceeding, together with the maximum exposure (as reasonably determined by Mercury) under all claims or Legal Proceedings that may then already be pending involving exposure to the Indemnitees under this Section 10, does not exceed the value of the shares placed in the Escrow Fund (with such shares being deemed to have a per share value equal to Mercury Average Stock Price), or if Mercury does not within a reasonable period of time assume the defense of such claim or Legal Proceeding, then the Shareholders' Agent may assume the defense of such claim or Legal Proceeding. If the Shareholders' Agent assumes the defense of any such claim or Legal Proceeding: (a) the Shareholders' Agent shall proceed to defend such claim or Legal Proceeding in a diligent manner with counsel reasonably satisfactory to Mercury; (b) Mercury shall make available to the Shareholders' Agent any non- privileged documents and non-privileged materials in the possession of Mercury that (c) the Shareholders' Agent shall keep Mercury informed of all material developments and events relating to such claim or Legal Proceeding; (d) Mercury shall have the right to participate in the defense of such claim or Legal Proceeding at its own expense; (e) the Shareholders' Agent shall not settle, adjust or compromise such claim or Legal Proceeding without the prior written consent of Mercury (which consent shall not be unreasonably withheld); and (f) Mercury may at any time assume the defense of such claim or Legal Proceeding if (i) the Shareholders' Agent shall fail to comply with any of its obligations under this Section 10.5 (including its obligation to defend any claim or Legal Proceeding in a diligent manner), or (ii) Mercury, after consultation with its counsel, reasonably determines that the control of the defense by the Shareholders' Agent would give rise to a conflict of interest. If Mercury proceeds with the defense of any such claim or Legal Proceeding on its own: (i) the Conduct Shareholders shall make available to Mercury any documents and materials in the possession or control of any of the Conduct Shareholders that may be necessary to the defense of such claim or Legal Proceeding; 43 (ii) Mercury shall keep the Shareholders' Agent informed of all material developments and events relating to such claim or Legal Proceeding; and (iii) Mercury shall have the right to settle, adjust or compromise such claim or Legal Proceeding with the consent of the Shareholders' Agent; provided, however, that the Shareholders' Agent shall not unreasonably withhold such consent. 10.6 Defense of Third Party Claims against Conduct Shareholders. In the event of the assertion or commencement by any Person of any claim or Legal Proceeding with respect to which Mercury may become obligated to indemnify, hold harmless, pay, compensate or reimburse any Conduct Shareholder pursuant to this Section 10, (i) the Shareholders' Agent, as soon as practicable after it receives written notice of any such claim or Legal Proceeding, shall notify Mercury of such claim or Legal Proceeding (it being understood that the failure to notify Mercury shall not in any way limit the rights of the Conduct Shareholders under this Agreement except to the extent such failure materially prejudices the defenses available to Mercury), and (ii) the Shareholders' Agent shall have the right, at its election, to assume the defense of such claim or Legal Proceeding; provided, however, that notwithstanding the foregoing if the maximum exposure (as reasonably determined by the Shareholders' Agent) to the Conduct Shareholders in such claim or Legal Proceeding, together with the maximum exposure (as reasonably determined by the Shareholders' Agent) under all claims or Legal Proceedings that may then already be pending involving exposure to the Conduct Shareholders under this Section 10, does not exceed the value of the amount set forth in the second sentence of Section 10.3, or if the Shareholders' Agent does not within a reasonable period of time assume the defense of such claim or Legal Proceeding, then Mercury may assume the defense of such claim or Legal Proceeding. The parties shall thereafter proceed in the manner provided in Section 10.5 with the roles of Mercury and the Shareholders' Agent reversed. 10.7 Exercise of Remedies by Indemnitees Other Than Mercury. No Indemnitee (other than Mercury or any successor thereto or assign thereof) shall be permitted to assert any indemnification claim or exercise any other remedy under this Agreement unless Mercury (or any successor thereto or assign thereof) shall have consented to the assertion of such indemnification claim or the exercise of such other remedy. Section 11. Miscellaneous Provisions 11.1 Shareholders' Agent. The Conduct Shareholders irrevocably appoint David Barzilai as their agent in connection with the transactions contemplated by Section 10 of this Agreement, the Registration Rights Agreement and the Escrow Agreement (the "Shareholders' Agent"), and David Barzilai hereby accepts his appointment as the Shareholders' Agent. Mercury shall be entitled to deal with the Shareholders' Agent on all matters relating to Section 10, the Registration Rights Agreement and the Escrow Agreement, and shall be entitled to rely on any document executed or purported to be executed on behalf of the Shareholder Indemnitors by the Shareholders' Agent, and on any other action taken or purported to be taken on behalf of the Shareholder Indemnitors by the Shareholders' Agent, as fully binding upon such Shareholder 44 Indemnitor. If the Shareholders' Agent shall die, become disabled or otherwise be unable to fulfill his responsibilities as agent of the Shareholder Indemnitors, then the Shareholder Indemnitors shall, within ten days after such death or disability, appoint a successor agent and, promptly thereafter, shall notify Mercury of the identity of such successor. Any such successor shall become the "Shareholders' Agent" for purposes of this Section 11.1. If for any reason there is no Shareholders' Agent at any time, all references herein to the Shareholders' Agent shall be deemed to refer to the Shareholder Indemnitors. 11.2 Further Assurances. Each party hereto shall execute and cause to be delivered to each other party hereto such instruments and other documents, and shall take such other actions, as such other party may reasonably request (prior to, at or after the Closing) for the purpose of carrying out or evidencing any of the transactions contemplated by this Agreement. 11.3 Fees and Expenses. Each party to this Agreement shall bear and pay all fees, costs and expenses (including legal fees and accounting fees) that have been incurred or that are incurred by such party in connection with the transactions contemplated by this Agreement; provided, however, if the transactions contemplated by this Agreement are consummated, all fees, costs and expenses incurred by Conduct and the Conduct Shareholders in connection with the transactions contemplated by this Agreement shall be paid by Mercury, it being understood that if fees, costs and expenses incurred by Conduct and the Conduct Shareholders shall exceed $250,000, then Mercury shall be entitled to be indemnified from the Escrow Fund against only the portion of such fees, costs and expenses exceeding $250,000. 11.4 Attorneys' Fees. If any action or proceeding relating to this Agreement or the enforcement of any provision of this Agreement is brought against any party hereto, the prevailing party shall be entitled to recover reasonable attorneys' fees, costs and disbursements (in addition to any other relief to which the prevailing party may be entitled). 11.5 Notices. Any notice or other communication required or permitted to be delivered to any party under this Agreement shall be in writing and shall be deemed properly delivered, given and received when delivered (by hand, by registered mail, by courier or express delivery service or by facsimile) to the address or facsimile telephone number set forth beneath the name of such party below (or to such other address or facsimile telephone number as such party shall have specified in a written notice given to the other parties hereto): if to Mercury: Mercury Interactive Corporation 1325 Borregas Avenue Sunnyvale, California 94089 Attention: Sharlene Abrams Telephone No.: (408) 822-5247 Facsimile: (408) 822-5507 45 with a copy to: -------------- General Counsel Associates LLP 1891 Landings Drive Mountain View, CA 94043 Attention: Susan J. Skaer, Esq. Telephone: (650) 428-3900 Facsimile: (650) 428-3901 if to Conduct: Conduct, Ltd. c/o Conduct Software Technologies, Inc. 2350 Mission College Blvd., Suite 705 Santa Clara, CA 95054 Attention: David Barzilai Telephone: 408-982-8200 Facsimile: 408-982-8202 with a copy to: -------------- Wilson, Sonsini, Goodrich & Rosati, PC 650 Page Mill Road Palo Alto, CA 94304-1050 Attention: Neil Wolff, Esq. Jon P. Layman, Esq. Telephone: (650) 493-9300 Facsimile: (650) 493-6811 And to: ------ Tida Shamir & Co., Advocates 3A Jabotinsky Street Ramat Gam 52520, Israel Attention: Tida Shamir, Esq. Telephone: 972-3-613-7979 Facsimile: 972-3-613-7969 46 If to the Shareholders' Agent or any of the Shareholder Indemnitors: David Barzilai 923 Kintyre Way Sunnyvale, CA 94087 Telephone: 408-730-2567 11.6 Headings. The underlined headings contained in this Agreement are for convenience of reference only, shall not be deemed to be a part of this Agreement and shall not be referred to in connection with the construction or interpretation of this Agreement. 11.7 Counterparts. This Agreement may be executed in several counterparts, each of which shall constitute an original and all of which, when taken together, shall constitute one agreement. 11.8 Governing Law; Venue. This Agreement shall be construed in accordance with, and governed in all respects by, the internal laws of the State of California (without giving effect to principles of conflicts of laws). In any action between the parties arising out of or relating to this Agreement or any of the transactions contemplated by this Agreement: (a) each of the parties irrevocably and unconditionally consents and submits to the exclusive jurisdiction and venue of the state and federal courts located in the County of Santa Clara, State of California; (b) if any such action is commenced in a state court, then, subject to applicable law, no party shall object to the removal of such action to any federal court located in the Northern District of California; (c) each of the parties irrevocably consents to service of process by first class certified mail, return receipt requested, postage prepaid, to the address at which such party is to receive notice in accordance with Section 11.5. 11.9 Successors and Assigns. This Agreement shall be binding upon each of the parties hereto and each of their respective successors and assigns, if any. This Agreement shall inure to the benefit of: Conduct; the Conduct Shareholders; Mercury; and the respective successors and assigns, if any, of the foregoing. No party may assign any of its rights, or delegate any of its obligations, under this Agreement without the prior written consent of the other parties. 11.10 Remedies Cumulative; Specific Performance. The rights and remedies of the parties hereto shall be cumulative (and not alternative). The parties to this Agreement agree that, in the event of any breach or threatened breach by any party to this Agreement of any covenant, obligation or other provision set forth in this Agreement for the benefit of any other party to this Agreement, such other party shall be entitled (in addition to any other remedy that may be available to it) to (a) a decree or order of specific performance or mandamus to enforce the observance and performance of such covenant, obligation or other provision and (b) an injunction restraining such breach or threatened breach. 11.11 Waiver. No failure on the part of any Person to exercise any power, right, privilege or remedy under this Agreement, and no delay on the part of any Person in exercising any power, right, privilege or remedy under this Agreement, shall operate as a waiver of such 47 power, right, privilege or remedy; and no single or partial exercise of any such power, right, privilege or remedy shall preclude any other or further exercise thereof or of any other power, right, privilege or remedy. No Person shall be deemed to have waived any claim arising out of this Agreement, or any power, right, privilege or remedy under this Agreement, unless the waiver of such claim, power, right, privilege or remedy is expressly set forth in a written instrument duly executed and delivered on behalf of such Person; and any such waiver shall not be applicable or have any effect except in the specific instance in which it is given. 11.12 Amendments. This Agreement may not be amended, modified, altered or supplemented other than by means of a written instrument duly executed and delivered on behalf of all of the parties hereto; provided, however, that any amendment to this Agreement which solely adds New Conduct Shareholders as parties shall not require any approval by any of the parties and may be effected by adding additional signature pages and additional Exhibit A pages hereto. 11.13 Severability. In the event that any provision of this Agreement, or the application of any such provision to any Person or set of circumstances, shall be determined to be invalid, unlawful, void or unenforceable to any extent, the remainder of this Agreement, and the application of such provision to Persons or circumstances other than those as to which it is determined to be invalid, unlawful, void or unenforceable, shall not be impaired or otherwise affected and shall continue to be valid and enforceable to the fullest extent permitted by law. 11.14 Parties in Interest. Except for the provisions of Sections 1.7 and 6.9 (which are intended to benefit and are enforceable by the persons referred to therein), none of the provisions of this Agreement is intended to provide any rights or remedies to any Person other than the parties hereto, and their respective successors and assigns, if any. 11.15 Entire Agreement. This Agreement and the other agreements referred to herein set forth the entire understanding of the parties hereto relating to the subject matter hereof and thereof and supersede all prior agreements and understandings among or between any of the parties relating to the subject matter hereof and thereof; provided, however, that the Nondisclosure Agreement shall not be superseded by this Agreement and shall remain in effect in accordance with its terms until the earlier of (a) the Closing Date or (b) the date on which such Nondisclosure Agreement is terminated in accordance with its terms. 11.16 Construction. (a) For purposes of this Agreement, whenever the context requires: the singular number shall include the plural, and vice versa; the masculine gender shall include the feminine and neuter genders; the feminine gender shall include the masculine and neuter genders; and the neuter gender shall include the masculine and feminine genders. (b) The parties hereto agree that any rule of construction to the effect that ambiguities are to be resolved against the drafting party shall not be applied in the construction or interpretation of this Agreement. 48 (c) As used in this Agreement, the words "include" and "including," and variations thereof, shall not be deemed to be terms of limitation, but rather shall be deemed to be followed by the words "without limitation." (d) Except as otherwise indicated, all references in this Agreement to "Sections", "Schedules" and "Exhibits" are intended to refer to Sections of this Agreement and Schedules and Exhibits to this Agreement. 49 EXHIBITS Exhibit A - Conduct Shareholders Exhibit B - Certain definitions Exhibit C - Form of Escrow Agreement Exhibit D - Form of Amendment to Employment Agreements Exhibit E - Conduct Disclosure Schedule Exhibit F-1 - Tida Shamir & Co., Ltd, Advocates Legal Opinion Exhibit F-2 - Wilson Sonsini Goodrich & Rosati, Professional Corporation Legal Opinion Exhibit G1 - Conduct Affiliate Pooling Agreement Exhibit G2 - Mercury Affiliate Pooling Agreement Exhibit H - Registration Rights Agreement Exhibit I - General Counsel Associates LLP Legal Opinion Exhibit J - Undertaking for Chief Scientist
50 The parties hereto have caused this Agreement to be executed and delivered as of November 24, 1999. -- MERCURY INTERACTIVE CORPORATION /s/ Sharlene Abrans ------------------------------- Name: Sharlene Abrans -------------------------- Title: CFO ------------------------- CONDUCT LTD. ------------------------------- Name:__________________________ Title:_________________________ CONDUCT SHAREHOLDERS' AGENT _______________________________ David Barzilai The parties hereto have caused this Agreement to be executed and delivered as of November , 1999. MERCURY INTERACTIVE CORPORATION -------------------------------- Name:___________________________ Title:__________________________ CONDUCT LTD. /s/ D. Barzilai -------------------------------- Name: D. Barzilai --------------------------- Title: Director -------------------------- CONDUCT LTD. /s/ S. Azulai -------------------------------- Name: S. Azulai --------------------------- Title: Director -------------------------- CONDUCT SOFTWARE, TECHNOLOGIES, INC. /s/ D. Barzilai -------------------------------- Name: D. Barzilai --------------------------- Title: President and CEO -------------------------- CONDUCT SOFTWARE, TECHNOLOGIES, INC. /s/ S. Azulai -------------------------------- Name: S. Azulai --------------------------- Title: CTO -------------------------- CONDUCT SHAREHOLDERS' AGENT /s/ D. Barzilai -------------------------------- D. Barzilai Conduct Ltd. Page 1 of 2 (List of All Current Shareholders - Alphabetic) Exhibit A - ---------
Total % of Shareholder Class/Series Name Shares Class Series - ------------------------------------------------------------------------------------------------------------------------------- Issac Applbaum All (As if converted) 18,079 0.1700 ORDINARY SHARES 674 0.0172 SERIES A PREFERRED SHARES 17,405 0.8303 Sharon Azulai All (As if converted) 885,966 8.3321 ORDINARY SHARES 885,966 22.6481 David Barzilai All (As if converted) 885,965 8.3321 ORDINARY SHARES 885,965 22.6481 David J. Blumberg All (As if converted) 112,551 1.0585 ORDINARY SHARES 4,194 0.1072 SERIES A PREFERRED SHARES 108,357 5.1691 Casin 1997 Chartible Trust UTA dated 1/28/97 All (As if converted) 150,104 1.4117 ORDINARY SHARES 5,594 0.1430 SERIES B PREFERRED SHARES 144,510 3.1245 The Cassin Foundation All (As if converted) 120,083 1.1293 ORDINARY SHARES 4,475 0.1144 SERIES B PREFERRED SHARES 115,608 2.4996 Donald L. Lucas, SUCCTTEE, Donald L. Lucas Profit All (As if converted) 270,184 2.5410 Sharing Trust ORDINARY SHARES 10,068 0.2574 SERIES B PREFERRED SHARES 260,116 5.6241 Forval Creative, Inc. All (As if converted) 1,814,491 17.0645 ORDINARY SHARES 67,616 1.7285 SERIES A PREFERRED SHARES 1,746,875 83.3333 Investee Clali Trust Company, Ltd. All (As if converted) 8,125 0.0764 ORDINARY SHARES 8,125 0.2077 Ran Levy All (As if converted) 925,243 8.7015 ORDINARY SHARES 925,243 23.6522 RWI Group II, L.P. All (As if converted) 600,410 5.6466 ORDINARY SHARES 22,374 0.5720 SERIES B PREFERRED SHARES 578,036 12.4981 Sand Hill Financial Company All (As if converted) 300,204 2.8233 ORDINARY SHARES 11,187 0.2860 SERIES B PREFERRED SHARES 289,017 6.2490 Santa Clara University All (As if converted) 60,040 0.5647 ORDINARY SHARES 2,237 0.0572 SERIES B PREFERRED SHARES 57,803 1.2498 Tida Shamir, Adv (FBO Sharon Azulai) All (As if converted) 450,538 4.2371 ORDINARY SHARES 450,538 11.5172 Tida Shamir, Adv (FBO David Barzilai) All (As if converted) 450,538 4.2371 ORDINARY SHARES 450,538 11.5172 Tida Shamir All (As if converted) 45,341 0.4264 ORDINARY SHARES 45,341 1.1591 St. Francis Growth Fund All (As if converted) 30,025 0.2824 ORDINARY SHARES 1,119 0.0286 SERIES B PREFERRED SHARES 28,906 0.6250 Saint Mary's College of California All (As if converted) 30,025 0.2824 ORDINARY SHARES 1,119 0.0286 SERIES B PREFERRED SHARES 28,906 0.6250 Gil Sudai All (As if converted) 54,780 0.5152 ORDINARY SHARES 2,041 0.0522
Report Date: 11/16/99 Conduct Ltd. Page 2 of 2 Date Printed: 11/16/99 (List of All Current Shareholders - Alphabetic)
Total % of Shareholder Class/Series Name Shares Class Series - ---------------------------------------------------------------------------------------------------------------------------- Telos Venture Partners, L.P. All (As if converted) 2,402,367 22.5932 ORDINARY SHARES 89,523 2.2885 SERIES B PREFERRED SHARES 2,312,844 50.0074 Teton Capital Company All (As if converted) 810,553 7.6229 ORDINARY SHARES 30,205 0.7721 SERIES B PREFERRED SHARES 780,348 16.8724 Roy Twersky All (As if converted) 87,096 0.8191 ORDINARY SHARES 3,246 0.0830 SERIES A PREFERRED SHARES 83,850 4.0000 Unicycle Trading Company All (As if converted) 90,392 0.8501 ORDINARY SHARES 3,368 0.0861 SERIES A PREFERRED SHARES 87,024 4.1514 Bert L. Zaccaria All (As if converted) 30,025 0.2824 ORDINARY SHARES 1,119 0.0286 SERIES B PREFERRED SHARES 28,906 0.6250 ----------------------- No. of Shareholders: 24 TOTALS: All (As if converted) 10,633,125 100.0000 No. of Shareholders: 24 ORDINARY SHARES 3,911,875 100.0000 No. of Shareholders: 6 SERIES A PREFERRED SHARES 2,096,250 100.0000 No. of Shareholders: 11 SERIES B PREFERRED SHARES 4,625,000 100.0000
EXHIBIT B --------- CERTAIN DEFINITIONS For purposes of the Agreement (including this Exhibit B): --------- Acquisition Transaction. "Acquisition Transaction" means any transaction involving: (a) the sale, license, disposition or acquisition of all or substantially all of the business or assets of Conduct (taken as a whole) or Mercury (taken as a whole), as the case may be; (b) the issuance, disposition or acquisition of capital shares or other equity securities of Conduct or Mercury, as the case may be, constituting more than 50% of the outstanding voting securities of Conduct or Mercury, as the case may be; or (c) any merger, consolidation, business combination, reorganization or similar transaction involving Conduct or Mercury, as the case may be. Aggregate Preferred Stock Liquidation Preference. "Aggregate Preferred Stock Liquidation Preference" means the aggregate number of shares of Mercury Stock issuable pursuant to Section 1.5(a)(i) and Section 1.5(a)(ii) of the Agreement. Agreement. "Agreement" shall mean the Share Exchange Agreement to which this Exhibit B is attached (including the Disclosure Schedule), as it may be --------- amended from time to time. Breach. There shall be deemed to be a "Breach" of a representation, warranty, covenant, obligation or other provision if there is or has been any material inaccuracy in or breach of, or any failure to comply with or perform, such representation, warranty, covenant, obligation or other provision. Conduct Capital Shares. "Conduct Capital Shares" means the shares of Conduct Ordinary Shares and the Conduct Preferred Shares. Conduct Contract. "Conduct Contract" shall mean any Contract: (a) to which Conduct or Subsidiary is a party; (b) by which Conduct, Subsidiary or any of either of their assets is or may become bound or under which Conduct or Subsidiary has, or may become subject to, any obligation; or (c) under which Conduct or Subsidiary has or may acquire any right or interest. Conduct Convertible Promissory Note. "Conduct Convertible Promissory Note" means the outstanding Conduct convertible unsecured promissory notes in the aggregate principal amounts listed in Part 2.3(a)(2) of the Disclosure Schedule. Conduct Noteholders. "Conduct Noteholders" means the holders of the Conduct Convertible Promissory Notes listed in Part 2.3(a)(2) of the Disclosure Schedule. Conduct Preferred Shares. "Conduct Preferred Shares" means the shares of Series A Preferred and the Series B Preferred of Conduct. Conduct Proprietary Asset. "Conduct Proprietary Asset" shall mean any Proprietary Asset owned by or licensed to Conduct or Subsidiary or otherwise used by Conduct or Subsidiary. Consent. "Consent" shall mean any approval, consent, ratification, permission, waiver or authorization (including any Governmental Authorization). Contract. "Contract" shall mean any written, oral or other agreement, contract, subcontract, lease, understanding, instrument, note, warranty, insurance policy, benefit plan, or legally binding commitment or undertaking of any nature which has any continuing obligation or liability after the Closing. Damages. "Damages" shall include any loss, damage, injury, decline in value, lost opportunity, Liability, claim, demand, settlement, judgment, award, fine, penalty, Tax, fee (including reasonable attorneys' fees), charge, cost (including costs of investigation) or expense of any nature. Disclosure Schedule. "Disclosure Schedule" shall mean the schedule (dated as of the date of the Agreement) delivered to Mercury on behalf of the Conduct Shareholders. Employee Benefit Plan. "Employee Benefit Plan" shall have the meaning specified in Section 3(3) of ERISA. Encumbrance. "Encumbrance" shall mean any lien, pledge, hypothecation, charge, mortgage, security interest, encumbrance, claim, infringement, interference, option, right of first refusal, preemptive right, community property interest or restriction of any nature (including any restriction on the voting of any security, any restriction on the transfer of any security or other asset, any restriction on the receipt of any income derived from any asset, any restriction on the use of any asset and any restriction on the possession, exercise or transfer of any other attribute of ownership of any asset). Entity. "Entity" shall mean any corporation (including any non-profit corporation), general partnership, limited partnership, limited liability partnership, joint venture, estate, trust, company (including any limited liability company or joint stock company), firm or other enterprise, association, organization or entity. Exchange Act. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. Fully Diluted Number of Conduct Capital Shares. "Fully Diluted Number of Conduct Capital Shares" means the sum of (i) the aggregate number of shares of Conduct Ordinary Shares, Series A Preferred and Series B Preferred outstanding immediately prior to the Closing, plus (ii) the aggregate number of shares of Conduct Ordinary Shares issuable upon the exercise of any option to purchase Conduct Ordinary Shares outstanding immediately prior to the Closing, regardless of whether such option is exercisable as of the Closing. Governmental Authorization. "Governmental Authorization" shall mean any: (a) permit, license, certificate, franchise, permission, clearance, registration, qualification or authorization issued, granted, given or otherwise made available by or under the authority of any Governmental Body or pursuant to any Legal Requirement; or (b) right under any Contract with any Governmental Body. Governmental Body. "Governmental Body" shall mean any: (a) nation, state, commonwealth, province, territory, county, municipality, district or other jurisdiction of any nature; (b) federal, state, local, municipal, foreign or other government; or (c) governmental or quasi-governmental authority of any nature (including any governmental division, department, agency, commission, instrumentality, official, organization, unit, body or Entity and any court or other tribunal). Knowledge. An individual shall be deemed to have "Knowledge" of a particular fact or other matter if: (a) such individual is actually aware of such fact or other matter; or (b) a prudent individual would be expected to become aware of such fact or other matter in normal scope of performing his duties. Conduct shall be deemed to have "Knowledge" of a particular fact or other matter if any officer or director level employee of Conduct or Subsidiary has Knowledge of such fact or other matter. Mercury shall be deemed to have "Knowledge" of a particular fact or other matter if any officer of Mercury has Knowledge of such fact or other matter. Indemnitees. "Indemnitees" shall mean the following Persons: (a) Mercury; (b) Mercury's current and future affiliates (including Conduct); (c) the respective Representatives of the Persons referred to in clauses "(a)" and "(b)" above; and (d) the respective successors and assigns of the Persons referred to in clauses "(a)", "(b)" and "(c)" above; provided, however, that the Conduct Shareholders shall not be deemed to be "Indemnitees." Legal Proceeding. "Legal Proceeding" shall mean any action, suit, litigation, arbitration, proceeding (including any civil, criminal, administrative, investigative or appellate proceeding), hearing, inquiry, audit, examination or investigation commenced, brought, conducted or heard by or before, or otherwise involving, any court or other Governmental Body or any arbitrator or arbitration panel. Legal Requirement. "Legal Requirement" shall mean any federal, state, local, municipal, foreign or other law, statute, constitution, principle of common law, resolution, ordinance, code, edict, decree, rule, regulation, ruling or requirement issued, enacted, adopted, promulgated, implemented or otherwise put into effect by or under the authority of any Governmental Body. Liability. "Liability" means any debt, obligation, duty or liability of any nature (including any unknown, undisclosed, unmatured, unaccrued, unasserted, contingent, indirect, conditional, implied, vicarious, derivative, joint, several or secondary liability), regardless of whether such debt, obligation, duty or liability would be required to be disclosed on a balance sheet prepared in accordance with generally accepted accounting principles and regardless of whether such debt, obligation, duty or liability is immediately due and payable. Material Adverse Effect. A violation or other matter will be deemed to have a "Material Adverse Effect" on Conduct and Subsidiary if such violation or other matter would have a material adverse effect on Conduct's business, condition, assets, liabilities, operations or financial performance. Mercury Stock. "Mercury Stock" shall mean the common stock, par value $.002 per share, of Mercury. Mercury Average Stock Price. "Mercury Average Stock Price" means the average of the closing sale prices of a share of Mercury Stock as reported on the Nasdaq National Market for the ten trading days ending on the first trading day immediately preceding the date of this Agreement. Person. "Person" shall mean any individual, Entity or Governmental Body. Proprietary Asset. "Proprietary Asset" shall mean any: (a) patent, patent application, trademark (whether registered or unregistered), trademark application, trade name, fictitious business name, service mark (whether registered or unregistered), service mark application, copyright (whether registered or unregistered), copyright application, maskwork, maskwork application, trade secret, know-how, customer list, franchise, system, computer software, source code, computer program, invention, design, blueprint, engineering drawing, proprietary product, technology, proprietary right or other intellectual property right or intangible asset; or (b) right to use or exploit any of the foregoing. Representatives. "Representatives" shall mean officers, directors, employees, agents, attorneys, accountants, advisors and representatives. SEC. "SEC" shall mean the United States Securities and Exchange Commission. Securities Act. "Securities Act" shall mean the Securities Act of 1933, as amended. Tax. "Tax" shall mean any tax (including any income tax, franchise tax, capital gains tax, gross receipts tax, value-added tax, surtax, excise tax, ad valorem tax, transfer tax, stamp tax, sales tax, use tax, property tax, business tax, withholding tax or payroll tax), levy, assessment, tariff, duty (including any customs duty), deficiency or fee, and any related charge or amount (including any fine, penalty or interest), imposed, assessed or collected by or under the authority of any Governmental Body. Tax Return. "Tax Return" shall mean any return (including any information return), report, statement, declaration, estimate, schedule, notice, notification, form, election, certificate or other document or information filed with or submitted to, or required to be filed with or submitted to, any Governmental Body in connection with the determination, assessment, collection or payment of any Tax or in connection with the administration, implementation or enforcement of or compliance with any Legal Requirement relating to any Tax. EXHIBIT C TO SHARE EXCHANGE AGREEMENT ESCROW AGREEMENT This Escrow Agreement (the "Escrow Agreement") is entered into as of November 24, 1999, by and among Mercury Interactive Corporation, a Delaware corporation ("Mercury"), each of the Conduct Shareholders of Conduct Ltd. identified on Attachment A (the "Conduct Shareholders"), David Barzilai (the "Conduct Shareholders' Agent") and U.S. Bank Trust National Association (the "Escrow Agent"). Recitals A. Mercury, the Conduct Shareholders and Conduct Ltd., an Israeli corporation ("Conduct"), Conduct Software Technologies, Inc., a California corporation and wholly-owned subsidiary of Conduct (the "Subsidiary") are entering into an Share Exchange Agreement of even date herewith (the "Exchange Agreement"), pursuant to which the Conduct Shareholders are exchanging all of their outstanding capital shares of Conduct for shares of common stock of Mercury, after which, Conduct will be a wholly-owned subsidiary of Mercury. B. The Exchange Agreement contemplates the establishment of an escrow arrangement to secure the indemnification and other obligations of the Conduct Shareholders under the Exchange Agreement. Agreement The parties, intending to be legally bound, agree as follows: 1. Defined Terms. Capitalized terms used in this Escrow Agreement and not otherwise defined shall have the meanings given to them in the Exchange Agreement. 2. Escrow and Indemnification. (a) Shares and Stock Powers Placed in Escrow. At the Closing: (i) Mercury shall issue an aggregate of 38,789 shares of Mercury Stock, evidenced by one stock certificate of Mercury issued in the name of the Escrow Agent, evidencing the shares of Mercury Stock to be held in escrow in accordance with this Agreement. The shares of Mercury Stock being held in escrow pursuant to this Agreement (the "Escrow Shares") shall constitute an escrow fund (the "Escrow Fund") with respect to the indemnification obligations of the Conduct Shareholders under the Exchange Agreement. The Escrow Fund shall be held as a trust fund and shall not be treated as the property of Mercury nor subject to any lien, attachment, trustee process or any other judicial process of any creditor of any Conduct Shareholder or of any party hereto. The Escrow Agent agrees to accept delivery of the Escrow Fund and to hold the Escrow Fund in an escrow account (the "Escrow Account") subject to the terms and conditions of this Agreement. (b) Voting of Escrow Shares. The Escrow Agent shall agree to vote the Escrow Shares as directed by the Conduct Shareholders. 1. (c) Dividends, Etc. Any cash, securities or other property distributable (whether by way of dividend, stock split or otherwise) in respect of or in exchange for any Escrow Shares shall be held by the Escrow Agent in the Escrow. At the time any Escrow Shares are required to be released from the Escrow to any Person pursuant to this Escrow Agreement, any cash, securities or other property previously distributed in respect of or in exchange for such Escrow Shares shall be released from the Escrow to such Person. (d) Transferability. The interests of the Conduct Shareholders in the Escrow and in the Escrow Shares shall not be assignable or transferable, other than by operation of law. No transfer of any of such interests by operation of law shall be recognized or given effect until Mercury and the Escrow Agent shall have received written notice of such transfer. (e) Fractional Shares. No fractional shares of Mercury Stock shall be retained in or released from the Escrow pursuant to this Escrow Agreement. In connection with any release of Escrow Shares from the Escrow, Mercury and the Escrow Agent shall be permitted to "round down" or to follow such other rounding procedures as Mercury or the Escrow Agent reasonably determines to be appropriate in order to avoid retaining any fractional share in the Escrow and in order to avoid releasing any fractional share from the Escrow. 3. Conduct Shareholder Agent. (a) Power of Attorney. Effective as of the Closing, David Barzilai is hereby appointed as agent and attorney-in-fact (the "Conduct Shareholder Agent") for each Conduct Shareholder, for and on behalf of Conduct Shareholders, to give and receive notices and communications, to authorize delivery to Mercury of shares of Mercury Stock from the Escrow Fund in satisfaction of claims by Mercury, to object to such deliveries, to agree to, negotiate, enter into settlements and compromises of, and demand arbitration and comply with orders of courts and awards of arbitrators with respect to such claims, and to take all actions necessary or appropriate in the judgment of the Conduct Shareholder Agent for the accomplishment of the foregoing. Such agency may be changed by the Conduct Shareholders prior to the Closing, and after the Closing by the former Conduct Shareholders as of the Closing from time to time upon not less than thirty (30) days prior written notice to Mercury; provided that the Conduct Shareholder Agent may not be removed unless holders of a two-thirds interest of the Escrow Fund agree to such removal. Any vacancy in the position of Conduct Shareholder Agent may be filled by approval of the holders of a majority in interest of the Escrow Fund. No bond shall be required of the Conduct Shareholder Agent, and the Conduct Shareholder Agent shall not receive compensation for his or her services. Notices or communications to or from the Conduct Shareholder Agent shall constitute notice to or from each of the Conduct Shareholders. (b) Indemnification of the Conduct Shareholder Agent. The Conduct Shareholder Agent shall not be liable for any act done or omitted hereunder as Conduct Shareholder Agent while acting in good faith and in the exercise of reasonable judgment. The Conduct Shareholders on whose behalf the Escrow Amount was contributed to the Escrow Fund shall severally indemnify the Conduct Shareholder Agent and hold the Conduct Shareholder Agent harmless against any loss, liability or expense incurred without negligence or bad faith on the part of the Conduct Shareholder Agent and arising out of or in connection with the acceptance or administration of the Conduct Shareholder Agent's duties hereunder, including the reasonable fees and expenses of any legal counsel retained by the Conduct Shareholder Agent. 2. (c) Actions of the Conduct Shareholder Agent. A decision, act, consent or instruction of the Conduct Shareholder Agent shall constitute a decision of all the Conduct Shareholders for whom a portion of the Escrow Amount otherwise issuable to them are deposited in the Escrow Fund and shall be final, binding and conclusive upon each of such Conduct Shareholders, and the Escrow Agent and Mercury may rely upon any such decision, act, consent or instruction of the Conduct Shareholder Agent as being the decision, act, consent or instruction of each and every such Conduct Shareholder. The Escrow Agent and Mercury are hereby relieved from any liability to any person for any acts done by them in accordance with such decision, act, consent or instruction of the Conduct Shareholder Agent. 4. Administration of Escrow Account. Except as otherwise provided herein, the Escrow Agent shall administer the Escrow Account as follows: (a) If any Indemnitee has or claims to have incurred or suffered Damages for which it is or may be entitled to indemnification, compensation or reimbursement under Section 10 of the Exchange Agreement, once the aggregate of such Damages exceeds $50,000, such Indemnitee may, on or prior to the Termination Date, deliver a claim notice (a "Claim Notice") signed by any Authorized Officer (as defined below) of Mercury (an "Officer's Certificate") to the Conduct Shareholders' Agent and to the Escrow Agent. Each Claim Notice shall state that such Indemnitee believes that there is or has been a breach of a representation, warranty or covenant or other provision contained in the Exchange Agreement or that such Indemnitee is otherwise entitled to indemnification, compensation or reimbursement under the Exchange Agreement and contain a brief description of the circumstances supporting such Indemnitee's belief that there is or has been such a breach or that such Indemnitee is so entitled to indemnification, compensation or reimbursement and shall, to the extent possible, contain a non-binding, preliminary estimate of the amount of Damages such Indemnitee claims to have so incurred or suffered (the "Claimed Amount"). For purposes hereof, the term Authorized Officer shall refer to each of Mercury's Chief Executive Officer, President and Chief Financial Officer. (b) Within 30 business days after delivery of a Claim Notice, the Conduct Shareholders' Agent may deliver to the Indemnitee who delivered the Claim Notice and to the Escrow Agent a written response (the "Response Notice") in which the Conduct Shareholders' Agent: (i) agrees that Escrow Shares having a "Stipulated Value" (as defined below) equal to the full Claimed Amount may be released from the Escrow Account to the Indemnitee; (ii) agrees that Escrow Shares having a Stipulated Value equal to part, but not all, of the Claimed Amount (the "Agreed Amount") may be released from the Escrow Account to the Indemnitee; or (iii) indicates that no part of the Claimed Amount may be released from the Escrow Account to the Indemnitee. Any part of the Claimed Amount that is not to be released to the Indemnitee shall be the "Contested Amount." If a Response Notice is not delivered by the Conduct Shareholders' Agent to the Indemnitee and the Escrow Agent within such 30 business-day period, the Conduct Shareholders' Agent shall be deemed to have agreed that Escrow Shares having a Stipulated Value equal to the full Claimed Amount may be released to the Indemnitee from the Escrow Account, but only to the extent such Claimed Amount exceeds $50,000. (c) If the Conduct Shareholders' Agent in the Response Notice agrees that Escrow Shares having a Stipulated Value equal to the full Claimed Amount may be released from the Escrow Account to the Indemnitee, or if a Response Notice is not delivered in accordance with Section 3(b), the Escrow Agent shall promptly following the receipt of the Response Notice (or, if a Response Notice is not duly delivered, promptly following the 3. expiration of the 30 business-day period referred to in Section 3(b)), deliver to such Indemnitee such Escrow Shares, but only to the extent such Claimed Amount exceeds $50,000. (d) If the Conduct Shareholders' Agent in the Response Notice agrees that Escrow Shares having a Stipulated Value equal to part, but not all, of the Claimed Amount may be released from the Escrow Account to the Indemnitee, the Escrow Agent shall promptly following the receipt of the Response Notice deliver to such Indemnitee Escrow Shares having a Stipulated Value equal to the Agreed Amount, but only to the extent such Agreed Amount exceeds $50,000. (e) If any Response Notice indicates that there is a Contested Amount, the Conduct Shareholders' Agent and the Indemnitee shall attempt in good faith to resolve the dispute related to the Contested Amount. If the Indemnitee and the Conduct Shareholders' Agent shall resolve such dispute, a settlement agreement shall be signed by the Indemnitee and the Conduct Shareholders' Agent and sent to the Escrow Agent, who shall upon receipt thereof, release Escrow Shares from the Escrow Account in accordance with such agreement, but only to the extent the amount of such settlement exceeds $50,000. (f) If the Conduct Shareholders' Agent and the Indemnitee are unable to resolve the dispute relating to any Contested Amount within 30 business days after the delivery of the Claim Notice, then the claim described in the Claim Notice shall be settled by binding arbitration in the County of Santa Clara in the State of California in accordance with the Commercial Arbitration Rules then in effect of the American Arbitration Association (the "AAA Rules"). Arbitration will be conducted by three arbitrators; one selected by Mercury, one selected by the Conduct Shareholders' Agent and the third selected by the first two arbitrators. The parties agree to use all reasonable efforts to cause the arbitration hearing to be conducted within 60 calendar days after the appointment of the last of the three arbitrators and to use all reasonable efforts to cause the arbitrators' decision to be furnished within 95 calendar days after the appointment of the last of the three arbitrators. The arbitrators' decision shall relate solely to whether the Indemnitee is entitled to recover the Contested Amount (or a portion thereof), and the portion of such Contested Amount the Indemnitee is entitled to recover and to which party is the prevailing party in the arbitration. The final decision of the arbitrators shall be furnished to the Conduct Shareholders' Agent, the Indemnitee and the Escrow Agent in writing and shall constitute a conclusive determination of the issue in question, binding upon the Conduct Shareholders' Agent, the Conduct Shareholders, the Indemnitee and the Escrow Agent and shall not be contested by any of them. The non-prevailing party (as determined by the arbitrator) in any arbitration shall pay the reasonable expenses (including attorneys' fees) of the prevailing party and the fees and expenses associated with the arbitration (including the arbitrators' fees and expenses) ), provided, however, that if the non-prevailing party is the Conduct Shareholders such expenses may only be recovered from the Escrow Fund. (g) The Escrow Agent shall release Escrow Shares from the Escrow Account in connection with any Contested Amount within five (5) business days after the delivery to it of: (i) a copy of a settlement agreement executed by the Indemnitee and the Conduct Shareholders' Agent setting forth instructions to the Escrow Agent as to the number of Escrow Shares, if any, to be released from the Escrow Account, with respect to such Contested Amount; or (ii) a copy of the award of the arbitrators referred to and as provided in Section 3(f) setting forth instructions to the Escrow Agent as to the number of Escrow Shares, if any, to be released from the Escrow Account, with respect to such Contested Amount. 4. 5. Release of Escrow Fund. If any Escrow Shares are to be released to any Indemnitee pursuant to this Escrow Agreement, the Escrow Agent shall be entitled to use a Stock Power held in the Escrow, and to take such other actions as the Escrow Agent determines to be necessary or advisable, to release and transfer Escrow Shares to such Indemnitee. Within five business days after the Termination Date, the Escrow Agent shall distribute to the Conduct Shareholders all of the Escrow Shares then held in escrow; provided, however, that notwithstanding the foregoing, if, prior to the Termination Date, any Indemnitee has given a Claim Notice containing a claim which has not been resolved prior to the Termination Date in accordance with Section 3, the Escrow Agent shall retain in the Escrow Account after the Termination Date Escrow Shares having a Stipulated Value equal to 100% of the Claimed Amount or Contested Amount, as the case may be, with respect to all claims which have not then been resolved. To the extent that upon such release any of the Escrow Shares being distributed remain subject to the terms of Share Restriction Agreements to which any of the Conduct Shareholders are a party ("SRAs"), then the Escrow Agent shall be directed by Mercury to distribute such Escrow Shares to the Corporate Secretary of Mercury (or any other or successor escrow agent under such SRAs as designated by Mercury) to be held under the terms of such SRAs. 6. Valuation of Escrow Shares, Etc. (a) Stipulated Value. For purposes of this Escrow Agreement, the "Stipulated Value" of each Escrow Share means the closing sale price of a share of Mercury Stock as reported on the Nasdaq National Market on the Closing Date of the transactions contemplated by the Exchange Agreement. (b) Stock Splits. All numbers contained in, and all calculations required to be made pursuant to, this Escrow Agreement shall be adjusted as appropriate to reflect any stock split, reverse stock split, stock dividend or similar transaction effected by Mercury after the date hereof. 7. Fees and Expenses. The fees of the Escrow Agent, including (i) the normal costs of administering the Escrow as set forth on the Fee Schedule attached hereto as Attachment B and (ii) all fees and costs associated with the ------------ Escrow Agent's administration of Indemnification Claims, shall be paid by Mercury. In the event that the Escrow Agent renders any service hereunder not provided for herein or there is any assignment of any interest in the subject matter of the Escrow or modification hereof, the Escrow Agent shall be reasonably compensated for such extraordinary services by the party that is responsible for or requests such services. 8. Limitation of Escrow Agent's Liability. (a) The Escrow Agent undertakes to perform such duties as are specifically set forth in this Escrow Agreement only and shall have no duty under any other agreement or document notwithstanding their being referred to herein or attached hereto as an exhibit. The Escrow Agent shall not be liable except for the performance of such duties as are specifically set forth in this Escrow Agreement, and no implied covenants or obligations shall be read into this Escrow Agreement against the Escrow Agent. The Escrow Agent shall incur no liability with respect to any action taken by it or for any inaction on its part in reliance upon any notice, direction, instruction, consent, statement or other document believed by it to be genuine and duly 5. authorized, nor for any other action or inaction except for its own willful misconduct or negligence. In all questions arising under this Escrow Agreement, the Escrow Agent may rely on the advice of counsel, and for anything done, omitted or suffered in good faith by the Escrow Agent based upon such advice the Escrow Agent shall not be liable to anyone. The Escrow Agent shall not be required to take any action hereunder involving any expense unless the payment of such expense is made or provided for in a manner reasonably satisfactory to it. (b) Mercury hereby agrees to indemnify the Escrow Agent for, and hold it harmless against, any loss, liability or expense incurred without negligence or willful misconduct on the part of Escrow Agent, arising out of or in connection with its carrying out of its duties hereunder. This right of indemnification shall survive the termination of this Escrow Agreement, and the resignation of the Escrow Agent. The costs and expenses of enforcing this right of indemnification shall also be paid by Mercury. (c) If any controversy arises between the Parties to this Agreement, or with any other Party, concerning the subject matter of this Agreement, its terms or conditions that are not resolved pursuant to Section 4 hereof, Escrow Agent will not be required to determine the controversy or to take any action regarding it. Escrow Agent may hold all documents and funds and may wait for settlement of any such controversy by final appropriate legal proceedings or other means as, in Escrow Agent's discretion, Escrow Agent may require, despite what may be set forth elsewhere in this Agreement. In such event, Escrow Agent will not be liable for interest or damage. Furthermore, Escrow Agent may at its option, file an action of interpleader requiring the Parties to answer and litigate any claims and rights among themselves. Escrow Agent is authorized to deposit with the clerk of the court all documents and funds held in escrow, except all costs, expenses, charges and reasonable attorney fees incurred by Escrow Agent due to the interpleader action and which the Parties jointly and severally agree to pay. Upon initiating such action, Escrow Agent shall be fully released and discharged of and from all obligations and liability imposed by the terms of this Agreement. 9. Termination. This Escrow Agreement shall terminate upon the earlier of: (i) the first anniversary of the Closing Date; (ii) the filing with the SEC of Mercury's Form 10-K containing audited financial statements and accompanying audit report of combined operations of Mercury and Conduct ending after the Closing; or (iii) the issuance by Mercury's regularly employed independent public accountants of audited financial statements and accompanying audit report covering thirty days of combined operations of Mercury and Conduct ending after the Closing Date (the "Termination Date"). 10. Successor Escrow Agent; Automatic Succession. (a) In the event the Escrow Agent becomes unavailable or unwilling to continue as escrow agent under this Escrow Agreement, the Escrow Agent may resign and be discharged from its duties and obligations hereunder by giving its written resignation to the parties to this Escrow Agreement. Such resignation shall take effect not less than 30 calendar days after it is given to all parties hereto. Mercury may appoint a successor Escrow Agent only with the consent of the Conduct Shareholders' Agent (which consent shall not be unreasonably withheld or delayed). The Escrow Agent shall act in accordance with written instructions from Mercury as to the transfer of the Escrow Fund to a successor escrow agent. 6. (b) Any company into which the Escrow Agent may be merged or with which it may be consolidated, or any company to whom Escrow Agent may transfer a substantial amount of its global escrow business, shall be the successor of Escrow Agent without the execution or filing of any paper of any further act on the part of any of the parties hereof, anything herein to the contrary notwithstanding. 11. Miscellaneous. (a) Notices. Any notice or other communication required or permitted to be delivered to any party under this Agreement shall be in writing and shall be deemed properly delivered, given and received when delivered (by hand, by registered mail, by courier or express delivery service or by facsimile) to the address or facsimile telephone number set forth beneath the name of such party below (or to such other address or facsimile telephone number as such party shall have specified in a written notice given to the other parties hereto): if to the Conduct Shareholders' Agent: David Barzilai 923 Kintyre Way Sunnyvale, CA 94087 Telephone: 408-730-2567 with a copy to: -------------- Wilson Sonsini Goodrich & Rosati, Professional Corporation 650 Page Mill Road Palo Alto, CA 94304-1050 Attention: Neil Wolff, Esq. Jon P. Layman, Esq. Telephone: (650) 493-9300 Facsimile: (650) 493-6811 And to: ------ Tida Shamir & Co., Advocates 3A Jabotinsky Street Ramat Gam 52520, Israel Attention: Tida Shamir, Esq. Telephone: 972-3-613-7979 Facsimile: 972-3-613-7969 if to Mercury: Mercury Interactive Corporation 1325 Borregas Avenue Sunnyvale, California 94089 Attention: Sharlene Abrams Telephone No.: (408) 822-5247 Facsimile: (408) 822-5507 7. with a copy to: -------------- General Counsel Associates LLP 1891 Landings Drive Mountain View, CA 94043 Attention: Susan J. Skaer, Esq. Telephone: (650) 428-3900 Facsimile: (650) 428-3901 if to the Escrow Agent: U.S. Bank Trust National Association One California Street, 4th Floor San Francisco, CA 94111 Attention: Ann Gatsby Fax: (415) 273-4590 Tel: (415) 273-4532 (b) Counterparts. This Escrow Agreement may be executed in several counterparts, each of which shall constitute an original and all of which, when taken together, shall constitute one agreement. (c) Governing Law; Venue. This Escrow Agreement shall be construed in accordance with, and governed in all respects by, the laws of the State of California without giving effect to principles of conflicts of laws. Any legal action or other legal proceeding relating to this Escrow Agreement or the enforcement of any provision of this Escrow Agreement may be brought or otherwise commenced in any state or federal court located in the County of Santa Clara, California. Each party to this Escrow Agreement: (i) expressly and irrevocably consents and submits to the jurisdiction of each state and federal court located in the County of Santa Clara, California (and each appellate court located in the County of Santa Clara, California) in connection with any such legal proceeding; (ii) agrees that each state and federal court located in the County of Santa Clara, California shall be deemed to be a convenient forum; and (iii) agrees not to assert (by way of motion, as a defense or otherwise), in any such legal proceeding commenced in any state or federal court located in the County of Santa Clara, California, any claim that such party is not subject personally to the jurisdiction of such court, that such legal proceeding has been brought in an inconvenient forum, that the venue of such proceeding is improper or that this Escrow Agreement or the subject matter of this Escrow Agreement may not be enforced in or by such court. Nothing contained in this Section 10(c) shall be deemed to limit or otherwise affect the right of any party hereto to commence any legal proceeding or otherwise proceed against any other party hereto in any other forum or jurisdiction. (d) Successors and Assigns. This Escrow Agreement shall be binding upon: the Conduct Shareholders and their respective personal representatives, executors, administrators, estates, heirs, successors and assigns (if any); and Mercury and its successors and assigns (if any). This Escrow Agreement shall inure to the benefit of: the Conduct Shareholders; Mercury; the other Indemnitees; and the respective successors and assigns (if any) of the foregoing. Mercury may freely assign any or all of its rights under this Escrow Agreement, in 8. whole or in part, to any other Person without obtaining the consent or approval of any other party hereto or of any other Person. None of the Conduct Shareholders or the Conduct Shareholders' Agent shall be permitted to assign any of his rights or delegate any of his obligations under this Escrow Agreement without Mercury's prior written consent. (e) Waiver. No failure on the part of any Person to exercise any power, right, privilege or remedy under this Escrow Agreement, and no delay on the part of any Person in exercising any power, right, privilege or remedy under this Escrow Agreement, shall operate as a waiver of such power, right, privilege or remedy; and no single or partial exercise of any such power, right, privilege or remedy shall preclude any other or further exercise thereof or of any other power, right, privilege or remedy. No Person shall be deemed to have waived any claim arising out of this Escrow Agreement, or any power, right, privilege or remedy under this Escrow Agreement, unless the waiver of such claim, power, right, privilege or remedy is expressly set forth in a written instrument duly executed and delivered on behalf of such Person; and any such waiver shall not be applicable or have any effect except in the specific instance in which it is given. (f) Amendments. This Escrow Agreement may not be amended, modified, altered or supplemented other than by means of a written instrument duly executed and delivered on behalf of Mercury, the Conduct Shareholders' Agent and the Escrow Agent. (g) Severability. In the event that any provision of this Escrow Agreement, or the application of any such provision to any Person or set of circumstances, shall be determined to be invalid, unlawful, void or unenforceable to any extent, the remainder of this Escrow Agreement, and the application of such provision to Persons or circumstances other than those as to which it is determined to be invalid, unlawful, void or unenforceable, shall not be impaired or otherwise affected and shall continue to be valid and enforceable to the fullest extent permitted by law. (h) Entire Agreement. This Escrow Agreement sets forth the entire understanding of the parties relating to the subject matter hereof and thereof and supersede all prior agreements and understandings among or between any of the parties relating to the subject matter hereof and thereof. (i) Construction. For purposes of this Escrow Agreement, whenever the context requires: the masculine gender shall include the feminine and neuter genders; the feminine gender shall include the masculine and neuter genders; and the neuter gender shall include the masculine and feminine genders. The parties hereto agree that any rule of construction to the effect that ambiguities are to be resolved against the drafting party shall not be applied in the construction or interpretation of this Escrow Agreement. As used in this Escrow Agreement, the words "include" and "including," and variations thereof, shall not be deemed to be terms of limitation, but rather shall be deemed to be followed by the words "without limitation." Except as otherwise indicated, all references in this Escrow Agreement to "Sections" and "Attachments" are intended to refer to Sections of this Escrow Agreement and Attachments to this Escrow Agreement. [Remainder of Page Intentionally Left Blank] 9. IN WITNESS WHEREOF, the parties have duly executed this Escrow Agreement as of the day and year first above written. MERCURY INTERACTIVE CORPORATION By: ________________________________ Title: _____________________________ Conduct Shareholders' Agent Name: ______________________________ ESCROW AGENT U.S. BANK TRUST NATIONAL ASSOCIATION _____________________________________ By: _________________________________ Title: ______________________________ 10. SIGNATURE PAGE TO THE ESCROW AGREEMENT AMONG MERCURY INTERACTIVE CORPORATION, THE CONDUCT SHAREHOLDER AGENT, THE ESCROW AGENT AND THE CONDUCT SHAREHOLDERS OF CONDUCT, LTD. CONDUCT SHAREHOLDER: ____________________________________________ Signature By: Title:_______________________________________ Print or Type Name: Address:____________________________________ ____________________________________ ATTACHMENT A LIST OF CONDUCT SHAREHOLDERS Name of Conduct Shareholder No. of Escrow Shares - --------------------------- -------------------- Isaac Applbaum 58 Sharon Azulai 2,584 David Barzilai 2,584 David J. Blumberg 364 Cassin 1997 Charitable Trust UTA dated 1/28/97 582 The Cassin Foundation 466 Donald L. Lucas, SUCCTTEE, Donald L. Lucas, Profit Sharing Trust dtd 1/1/84 1,501 Forval Creative, Inc. 5,870 Investec Clali Trust Company Ltd. 24 Ran Levy 2,699 RWI Group II, L.P. 2,782 Sand Hill Financial Company 1,165 Santa Clara University 233 Tida Shamir, Adv. (FBO Sharon Azulai) 1,314 Tida Shamir, Adv. (FBO David Barzalai) 1,314 Tida Shamir 132 St. Francis Growth Fund 116 Saint Mary's College of California 116 Silicon Valley Bank 196 Gil Sudai 177 Telos Venture Partners, L.P. 10,678 Teton Capital Company 3,144 Roy Twersky 282 Unicycle Trading Company , a Nevada Limited Partnership 292 Bert L. Zaccaria 116 - -------------------------------------------------------------------------------------------- TOTALS: 38,789
ATTACHMENT B U.S. BANK CORPORATE TRUST SERVICES Schedule of Fees for Mercury Interactive Corporation/Conduct Ltd. Escrow Services ACCEPTANCE FEE 010 The acceptance fee includes the review of all documents, initial $2,000.00 set-up of the account, and other reasonably required services up to and including the closing. This is a one-time fee, payable at inception. ADMINISTRATION/AGENT FEES Annual account administration fee covers the normal duties of the escrow agent associated with the management of the account. Administration fees are payable in advance and will not be prorated. 470 Depository Escrow Agent $1,000.00 TRANSACTION FEES 880 Disbursement/Draw Charge per item disbursed. Includes the $20.00 wire or check fee. 100 Trades-Open Market/Directed $100.00 Charge per trade to buy or sell permitted investments. This excludes U.S. Bank Investment transactions. 101 Receipts $20.00 Charge per item received. INDIRECT OUT OF POCKET Charge for miscellaneous expenses such as fax, messenger service, overnight mail, stationery, and postage (excluding large mailings). 166 This charge is applied against your total Administration/Agent Fees, and will be prorated. 3%
EXTRAORDINARY SERVICES Charge for duties or responsibilities of an unusual nature not provided for in the indenture or otherwise set forth in this schedule. A reasonable charge will be made based on the nature of the service and the responsibility involved. These charges will be billed as a flat fee or our hourly rate then in effect, at our option. Final account acceptance is subject to review of documents. Fees are based on our understanding of the transaction and are subject to revision if the structure is changed. In the event this transaction does not close, any related out-of-pocket expenses will be billed to you at cost. Fees for any services not specifically covered will be based on appraisal of services rendered. With general reference to all of our charges, it should be understood that they are subject to adjustment from time to time, upon written notification. The fees in this schedule are terms under which you agree to do business. Closing the transaction constitutes agreement to this fee schedule, as does payment of the invoice received after subsequent fee adjustment notification. Absent your instructions to sweep or otherwise invest balances, no interest, earnings, or other compensation for uninvested balances will be paid to you. Dated: November 4, 1999 Confidential EXHIBIT D TO SHARE EXCHANGE AGREEMENT AMENDMENT NO. 1 TO EMPLOYMENT AGREEMENT --------------------------------------- This Agreement is made this _______ day of November, 1999 (the "Agreement"), by and between Mercury Interactive Corporation, a Delaware corporation ("Mercury"), with its principal offices at 1325 Borregas Avenue, Sunnyvale, CA 94089, Conduct Software Technologies, Inc. and _____________ (the "Employee"). BACKGROUND ---------- Employee is and will be employed by Conduct Software Technologies, Inc., a California corporation and wholly-owned subsidiary ("Subsidiary") of Conduct Ltd. ("Conduct"), pursuant to that certain Conduct Software Technologies, Inc. Employment Agreement, entered into as of January 22, 1998 (the "Employment Agreement"). A. Pursuant to a Share Exchange Agreement, dated as of November _____, 1999, among Mercury, Subsidiary, Conduct, and the shareholders of Conduct (the "Exchange Agreement"), it is contemplated that the shareholders of Conduct will exchange all of their capital shares of Conduct for shares of Common Stock of Mercury. B. As provided for in the Exchange Agreement, Mercury shall assume the Employment Agreement and the other agreements between the Employee and Conduct and/or Subsidiary listed in the Disclosure Schedule which is attached to the Exchange Agreement as Exhibit E thereto (the "Other Employee Agreements") upon the closing date of the Exchange Agreement (the "Closing Date"). C. Employee, Subsidiary and Mercury, as a sole owner of all of the outstanding capital shares of Conduct, desire that, upon the Closing Date, the Employment Agreement be amended as hereinafter provided. NOW, THEREFORE, in consideration of the covenants and promises contained in this Agreement, Mercury, Subsidiary and Employee hereto agree to amend the Employment Agreement, as of the Closing Date, as follows: AMENDED EMPLOYMENT TERMS 1. Title. Section 1(a) of the Employment Agreement is hereby amended such ----- that Employee's title shall be _______ and Employee shall report to ______________. Employee, Subsidiary and Mercury agree that nothing contemplated by this Agreement or the Exchange Agreement, including but not limited to the assumption by Employee of a new title or position, shall constitute a termination of Employee's employment, with or without cause or otherwise, under the Employment Agreement or any Other Employee Agreements. 2. Salary. Section 2(a) of the Employment Agreement is hereby amended such ------ that Employee's base salary shall be _________ which shall be paid to Employee during the term of the Employment Agreement in accordance with Mercury's regular payroll practices. All payments shall be subject to all applicable taxes required to be withheld by Subsidiary pursuant to federal, state or local law. 3. Severance. The severance payment provided pursuant to Section 13 of the --------- Employment Agreement is hereby amended to equal twelve months of Employee's then current base salary (rather than five months) and, if such severance payment is required to be paid, shall be paid in twelve equal monthly installments (rather than five equal monthly installments). Employee shall be entitled to receive severance paymentsonly if Employee's employment is terminated prior to the expiration of the Term (as hereinafter defined) without Cause. 4. Cause. The definition of "Cause" set forth at Section 13(a) of the ----- Employment Agreement and as set forth in any Other Employee Agreements is hereby amended in each such agreement to read as follows: "Cause" means (x) any act of personal dishonesty taken by Employee in ----- connection with Employee's responsibilities as an employee and intended to result in substantial personal enrichment; (y) Employee being convicted of a felony; or (z) a willful act by Employee which constitute gross misconduct and which is injurious to Mercury, Conduct or Subsidiary. 5. Non-Competition. The terms and conditions of Section 14(a) of the --------------- Employment Agreement (Non-Competition) shall apply to Employee from the Closing Date until the second anniversary of such date (the "Non-Compete Period"). In addition to not competing with the business of Conduct during the Non-Compete Period, Employee shall also not compete with Mercury's testing or application performance management business during the Non-Compete Period. 6. Term. The term of the Employment Agreement shall be for the Non-Compete ---- Period (the "Term") subject to Subsidiary's right to terminate Employee's employment prior to the expiration of the Term for any reason or no reason whatsoever, provided, however, that if Employee's employment is terminated prior -------- to the expiration of the Term, Employee shall have the right to receive severance payments to the extent provided for in the Employment Agreement, as amended herein. 7. Expenses and Relocation Costs. Employee agrees and acknowledges that all ----------------------------- expenses owed to Employee pursuant to Employee's rights as set forth in Section 4(b) of the Employment Agreement and all moving and relocation expenses owed to Employee as set forth in Section 5 of the Employment Agreement have been reimbursed by Subsidiary to Employee prior to the Closing Date. Employee agrees that he is not 2 entitled to reimbursement for any costs and expenses which he incurs on or following the Closing Date which are otherwise reimbursable under sections 4(b) and 5 of the Employment Agreement. Subsidiary has no claim for reimbursement for any relocation costs and expenses under Section 5 of the Employment Agreement. 8. Prior Employment Agreement. Employee agrees and acknowledges that the -------------------------- Employment Agreement between Employee and Conduct dated on or about December 28, 1995 has been terminated and is no longer of any force or effect and Employee has been paid in full any and all amounts due and owing under such agreement. 9. Mercury Employee Proprietary Information Agreement. As a condition of the -------------------------------------------------- continuation employment with Subsidiary, Employee agrees to execute and deliver Mercury's standard form of Employee Proprietary Information Agreement ("Mercury Proprietary Information Agreement"). To the extent that the rights or obligations of Employee or Mercury or Subsidiary under the Mercury Proprietary Information Agreement differ with Employee's or Subsidiary's rights or obligations under the Employment Agreement or any other Agreement, the terms of the Mercury Proprietary Information Agreement shall govern. 10. No Other Changes. Except for the specific amendments to the terms and ---------------- conditions of the Employment Agreement and the Other Employee Agreements expressly noted in this Agreement, all other terms and conditions of such agreements shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the date and year first above written. CONDUCT SOFTWARE TECHNOLOGIES, INC. By: ______________________________ Title: ____________________________ EMPLOYEE _________________________________ Address: ______________________ _______________________ 3 EXHIBIT F-1 TO SHARE EXCHANGE AGREEMENT LEGAL OPINION OF TIDA SHAMIR&CO., ADVOCATES To: Mercury Interactive Corporation 1325 Borregas Avenue Sunnyvale, California 94089 Reference is made to the Share Exchange Agreement, dated as of November 24, 1999, complete with all listed exhibits thereto, by and among: Mercury Interactive Corporation, a Delaware corporation ("Mercury"), Conduct Ltd., an Israeli corporation ("Conduct"); Conduct Software Technologies, Inc., a California corporation and wholly-owned subsidiary of Conduct (the "Subsidiary"); and the shareholders of Conduct Ltd. (the "Conduct Shareholders") (the "Exchange Agreement"), pursuant to which the Conduct Shareholders are exchanging all of their outstanding capital shares of Conduct for shares of common stock of Mercury, after which Conduct will be a wholly-owned subsidiary of Mercury. This opinion is rendered to you pursuant to Section 7.3(c) of the Exchange Agreement, and capitalized terms used but not defined herein shall have the meanings given to them in the Exchange Agreement. We have acted as counsel to Conduct in connection with the Exchange Agreement. The opinion hereinafter expressed is subject to the following qualifications: 1. We are members of the Bar of the State of Israel and are not expressing an opinion as to any matter relating to the laws other than the laws of the State of Israel as the same are in force on the date hereof and have not, for the purpose of giving this opinion, made any investigation of the laws of any other jurisdiction including, without limitation, the laws of the State of California or the laws of the United States of America Any issue which may arise with respect to this opinion will be resolved in Israel according to the laws of the State of Israel. 2. We have made such legal and factual examinations and inquiries as we have deemed advisable or necessary for the purposes of rendering this opinion, and we are also relying upon (without any independent investigation or review thereof) on the legal opinions of other counsels of Conduct or Subsidiary. In addition, we have examined and are relying upon (without any independent investigation or review thereof) the truth and accuracy, at all relevant times, of statements, covenants, representations and warranties contained in such documents and other instruments related to the formation, organization and operations of Conduct provided to us by certain of Conduct's officers as we deemed necessary or appropriate in order to enable us to express this opinion. We have also assumed that the representations and warranties as to factual matters made by all parties to the Exchange Agreement and pursunat thereto are true, correct and complete. 3. In rendering an opinion on matters set forth, we have assumed (without any independent investigation or review thereof) the genuineness of all signatures, the legal capacity of all natural persons, the authenticity of all documents submitted to us as originals and the conformity to original documents of all documents submitted to us as copies and the authenticity of the originals of such documents. In making our examination of documents executed by corporate or other entities other than Conduct, we have assumed (without any independent investigation or review thereof) that such entities had the power, corporate or other, to enter into and perform all obligations thereunder and have also assumed (without any independent investigation or review thereof), the due authorization by all requisite action, corporate or other, and due execution and delivery by such entities on such documents and the validity and binding effect thereof. As to any facts material to this opinion we did not independently establish or verify, we have relied upon statements and representations of Conduct and others. 4. As used in this opinion, the expression "to our knowledge" or similar language, with reference to matters of fact, means that we have examined the documents made available to us by Conduct and that we made inquiries of officers of Conduct, and, based upon such examination and inquiries, we find no reason to believe that the opinions expressed herein, with respect to such matters of fact, are incorrect; but we have made no independent factual investigation or review with respect to the existence or absence of any such facts, other than such inquiries, for the purpose of rendering this opinion, and no inference as to our knowledge of the existence or absence of any fact should be drawn from our representations of Conduct of the rendering of the opinion set forth below. 5. This opinion is based on the facts existing on the date hereof and of which we are aware. 6. This opinion is subject to and is qualified by limitations and constraints of any applicable bankruptcy, insolvency, reorganiztion, moratorium, arrangement, fraudulent conveyance or other similar laws now or hereunder in effect of general application relating to or affecting the rights of creditors generally. 7. This opinion is subject to and is qualified by limitations and constraints and the effect of judicial decisions which may permit the introduction of extrinsic evidence to modify the terms or the interpretation of the Exchange Agreement or the exhibits thereto. No assurance can be given that future legislative, judicial or administrative changes, on either a prospective or retroactive basis, would not adversely affect the accuracy of the opinion expressed herein. 8. This opinion is subject to and is qualified by limitations and constraints and the enforceability of provisions of the Exchange Agreement or the exhibits thereto expressly or by implication waiving broadly or vaguely, rights granted by law where such waivers are against public policy. Based upon and subject to the foregoing, and subject to the qualifications hereinafter appearing and to any factual matters, documents or events not disclosed to us and except as set forth in the Exchange Agreement or the exhibits thereto, and subject to the Closing of the Exchange Agreement, we advise you that in our opinion: 1. Conduct is a corporation validly existing and in good standing under the laws of Israel. 2. Conduct has the corporate power and authority to enter into and perform the Exchange Agreement, and Conduct has taken all necessary corporate action to authorize the execution, delivery and performance of the Exchange Agreement. 3. The Exchange Agreement has been duly executed and delivered by Conduct and constitutes the legal, valid and binding obligation of Conduct enforceable against Conduct in accordance with its terms. 4. As of the date hereof, the authorized share capital of Conduct consists of 14,371,965 Ordinary Shares, and 7,349,285 Preferred Shares, of which 2,096,250 shares are designated Series A Preferred and 5,253,035 shares are designated Series B Preferred. As of the date hereof, 3,911,875 Ordinary Shares are issued and outstanding, 2,096,250 Series A Preferred Shares are issued and outstanding and 4,625,000 Series B Preferred Shares are issued and outstanding. Conduct has no other capital shares authorized, issued or outstanding. Conduct has reserved 1,875,000 Ordinary Shares for issuance to employees and consultants pursuant to its 1998 Share Option Plan, of which options to acquire 739,063 Ordinary Shares have been granted, at the date hereof, of which 8,125 have been exercised at the date hereof.. Conduct has reserved 628,035 Series B Preferred Shares for issuance pursuant to outstanding warrants, at the date hereof, and pursuant to convertible promissory notes. Conduct has not reserved any additional Series B Preferred Shares for the Noteholders to be able to convert the interest of the convertible promissory notes, nor for exercise of the warrants, if the loan secured by such warrants is not repaid before December 16, 1999, 5. All outstanding Conduct capital shares are duly authorized, validly issued, and, to our knowledge, fully paid and non-assessable, and, except as set forth in the Disclosure Schedule, not subject to preemptive rights created by statute, the Articles of Association of Conduct or any agreement listed on the Disclosure Schedule to which Conduct is a party or by which Conduct is bound and which is governed and construed under the laws of the State of Israel and all such shares have been issued in compliance with applicable Israeli securities laws. To our knowledge, except as set forth in the Disclosure Schedule, there are no options, warrants, calls, rights, commitments or agreements of any character, written or oral, to which Conduct is a party or by which it is bound obligating Conduct to issue, deliver, sell, repurchase or redeem, or cause to be issued, delivered, sold, repurchased or redeemed, any capital shares of Conduct or obligating Conduct to grant, extend, accelerate the vesting of, change the price of, otherwise amend or enter into any such option, warrant, call, right, commitment or agreement. 6. Except as set forth in the Disclosure Schedule and except for Breaches which could not reasonably be expected to have a Material Adverse Effect on Conduct, the execution, delivery and performance of the Exchange Agreement and the consummation of the transactions therein contemplated do not result in a breach or violation of any of the terms or provisions of, or constitute a default under, (a) any provision of the Articles of Association of Conduct, (b) to our knowledge any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Conduct, or its properties or assets and known to us, or (c) except with respect to any consents required under any Material Contract listed on the Disclosure Schedule to which Conduct is a party (or by which it is bound) and which is governed and construed under the laws of the State of Israel. 7. To our knowledge, there is no proceeding or litigation pending or threatened (a) against Conduct, or (b) which might adversely affect the ability of Conduct to execute, deliver and perform the Exchange Agreement or to consummate the transactions contemplated thereby or which challenges or seeks to prevent, enjoin, alter or delay any such transaction. 8. To our knowledge, neither the execution nor delivery of the Exchange Agreement, the consummation of any of the transactions contemplated thereby nor compliance with or fulfillment of the terms, conditions and provisions thereof as of the date hereof will require the approval, consent, authorization or act of, or the making by Conduct of any declaration, filing or registration with, any Person, except (i) as set forth in Section 2.22 of the Exchange Agreement, (ii) such approvals, consents and authorizations as have previously been obtained, and (iii) such other approvals, consents, authorizations, registrations, declarations and filings the failure of which to be obtained or made would not, individually or in the aggregate, have a Material Adverse Effect on Conduct, materially impair the ability of Conduct to perform its obligations under the Exchange Agreement or prevent the consummation of any of the transactions contemplated by the Exchange Agreement. The opinion set forth (i) is subject to the assumption that Mercury has duly and validly authorized, executed and delivered the Exchange Agreement and (ii) assumes that there are no agreements, understandings or negotiations between Conduct or Subsidiary or any of the Conduct Shareholders and Mercury that would modify the respective rights of the parties under the Exchange Agreement. We express no opinion if the transactions contemplated by the Exchange Agreement are not consummated in accordance with the terms of the Exchange Agreement and without waiver or breach of any material provision thereof or if all representations, warranties, statements and assumptions upon which we relied are not true and accurate at all relevant times. In the event any one of the statements, representations, warranties or assumptions upon which we have relied to issue this opinion is incorrect, inaccurate, incomplete, breached or ineffective, our opinion might be adversely affected and might not be relied upon. We express no opinion as to remedies available to Mercury in respect of material violations or breaches of the Exchange Agreement by Conduct which are the direct and proximate result of material violations or breaches of the Exchange Agreement by Mercury. This opinion is rendered solely to Mercury in connection with the Closing under the Exchange Agreement and the transactions contemplated thereby. This opinion is not to be used, relied on, circulated, quoted or otherwise referred to for any other purpose or by any person who is not a member of the management of Mercury or any other entity, without our expressed prior written consent. In particular, this opinion is not to be used, relied on, circulated, quoted or otherwise referred to in connection with the proposal to treat the transactions contemplated by the Exchange Agreement as a pooling of interests for accounting purposes. This opinion speaks only as of its date, and we disclaim any express or implied undertaking or obligation to advise of any subsequent change of law or fact (even though the change may affect the legal analysis, a legal conclusion or an informational confirmation in this opinion letter). Very truly yours, Tida Shamir & Co., Advocates EXHIBIT F-2 TO SHARE AGREEMENT LEGAL OPINION OF WILSON SONSINI GOODRICH & ROSATI, PC All capitalized terms used but not defined herein shall have the meanings given to them in the Share Exchange Agreement [Subject to customary qualifications and exceptions] 1. Subsidiary is a corporation validly existing and in good standing under the laws of the State of California. 2. Subsidiary has the corporate power and authority to enter into and perform the Agreement. Subsidiary has taken all necessary corporate action to authorize the execution, delivery and performance of the Agreement. 3. The Agreement has been duly executed and delivered by Subsidiary and constitutes the legal, valid and binding obligation of Subsidiary enforceable against Subsidiary in accordance with its terms. 4. The authorized capital stock of Subsidiary consists of 1,000 shares of authorized Common Stock of which 100 shares are issued and outstanding. Subsidiary has no other capital shares authorized, issued or outstanding. 5. All outstanding shares of Subsidiary capital stock are duly authorized, validly issued, fully paid and non-assessable, not subject to preemptive rights created by statute, the Articles of Incorporation or Bylaws of Subsidiary or any agreement listed on the Disclosure Schedule to which Subsidiary is a party or by which it is bound. 6. The execution, delivery and performance of the Agreement and the consummation of the transactions therein contemplated do not result in a breach or violation of any of the terms or provisions of, or constitute a default under, (a) any provision of the Articles of Incorporation and Bylaws of Subsidiary, (b) to our knowledge any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Subsidiary, or its properties or assets, or (c) except with respect to any consents required under the Contracts, any Material Contract listed on the Disclosure Schedule to which Subsidiary is a party or by which it is bound. 7. To our knowledge, there is no proceeding or litigation pending or threatened (a) against Conduct or Subsidiary, or (b) which might adversely affect the ability of Conduct or Subsidiary to execute, deliver and perform the Agreement or to consummate the transactions contemplated thereby or which challenges or seeks to prevent, enjoin, alter or delay any such transaction. EXHIBIT G-1 TO THE SHARE EXCHANGE AGREEMENT CONDUCT AFFILIATE POOLING AGREEMENT dated as of November 30, 1999, between MERCURY INTERACTIVE CORPORATION, a Delaware corporation ("Mercury"), and the undersigned shareholder (the "Shareholder") of CONDUCT LTD., an Israeli corporation ("Conduct"), who is a signatory hereto. Simultaneously with the execution and delivery of this Agreement, Mercury, Conduct, Conduct Software Technologies, Inc., a California corporation and wholly-owned subsidiary of Conduct ("Subsidiary"), the shareholders of Conduct (the "Conduct Shareholders") have entered into a Share Exchange Agreement (the "Exchange Agreement"), providing for, among other things, the Conduct Shareholders receiving newly issued shares of common stock of Mercury in exchange for all outstanding shares of capital stock of Conduct, all outstanding Convertible Promissory Notes and all outstanding options and warrants to purchase shares of Conduct stock, in the manner provided in the Exchange Agreement, after which Conduct will be a wholly-owned subsidiary of Mercury (the "Exchange"). The transactions contemplated by the Exchange Agreement are intended to be accounted for as a pooling of interests pursuant to Opinion No. 16 of the Accounting Principals Board. All capitalized terms used but not defined herein shall have the meanings ascribed thereto in the Exchange Agreement. NOW, THEREFORE, in consideration of the mutual benefits to be derived from the Exchange and of the mutual covenants contained in this Agreement, the parties agree as follows: 1. Transfer Restrictions. --------------------- (a) The Shareholder may be deemed to be an "affiliate" of Conduct within the meaning of Rule 145 promulgated under the Securities Act of 1933, as amended (the "Securities Act"), and Accounting Series Release No. 130, as amended ("Release No. 130"), Accounting Series Release No. 135 and Staff Accounting Bulletin No. 76 of the Securities and Exchange Commission (the "Commission"), although nothing contained herein should be construed as an admission thereof nor as a waiver of any right Shareholder may have to object to any claim that Shareholder is such an affiliate on or after the date hereof. (b) The Shareholder shall not sell, exchange, transfer, pledge, distribute, make any gift or otherwise dispose of or grant any option, establish any "short" or put-equivalent position with respect to or enter into any similar transaction (through derivatives or otherwise) or otherwise reduce his risk relative to any Mercury Shares until such time after the Closing as financial results covering at least 30 days of the combined operations of Conduct and Mercury after the Closing have been published, within the meaning of Release No. 130, by Mercury in an effective registration statement, Annual Report on Form 10-K, Quarterly Report on Form 10-Q or Current Report on Form 8-K filed with the Securities and Exchange Commission, or any publicly disclosed quarterly earnings report or press release or other authorized public disclosure by Mercury that includes the combined results of operations of Mercury and Conduct. Mercury, at its discretion, may cause stop transfer orders to be placed with its transfer agent with respect to certificates for the Mercury Shares. (c) During the period described in Section 1(b) above, subject to providing written notice to Mercury and the other restrictions set forth below, and to the extent permitted under the "pooling of interests" accounting rules and applicable securities laws, Shareholder will be permitted to sell up to 10% of Mercury Shares held by Shareholder or to make charitable contributions or bona fide gifts of the Mercury Shares received by Shareholder, subject to the same restrictions. Such sales or other transfer shall subject to an aggregate limitation on sales and other transfers for all affiliates of Conduct and Mercury of not more than 1% of the number of shares of outstanding Common Stock of Mercury. Prior to making any such sale , charitable contributions or gifts, Shareholder will obtain Mercury's prior written approval. Shareholder shall give Mercury not less than five (5) business days notice prior to making any sales, charitable contributions or gifts as contemplated under this Section 1(c), Shareholder will provide any information reasonably requested by Mercury or Mercury's accounting firm regarding such sale, charitable contribution or give, and Shareholder will refrain from making such sales, charitable contributions or gifts if Shareholder does not obtain Mercury's prior written approval. Mercury may withhold such approval if Mercury determines, after consultation with its accounting firm, that such transaction could preclude the Exchange from being accounted for as a "pooling of interests." The 10% of Mercury Shares shall be calculated in accordance with SEC Accounting Series Release No. 135 as amended by Staff Accounting Bulletin No. 76. (d) Notwithstanding anything to the contrary contained in this Agreement, the Shareholder may transfer Mercury Shares to a trust established for the benefit of the Shareholder and/or for the benefit of one or more members of the Shareholder's family, or make a bona fide gift of Mercury Shares to one or more members of the Shareholder's family, provided that in the case of a transfer or gift pursuant to this Section 1, a transferee of such shares agrees to be bound by the limitations set forth in this Agreement. 2. Beneficial Ownership of Stock. Except as set forth on the last page of ----------------------------- this Agreement, Shareholder does not beneficially own or hold voting power over: (i) any shares of Mercury common stock or any other equity securities of Mercury or any options, warrants or other rights to acquire any equity securities of Mercury; or (ii) any capital shares of Conduct or any options, warrants or other rights to acquire any equity securities of Conduct. 3. Notices. Any notice or other communication required or permitted to be ------- delivered to any party under this Agreement shall be in writing and shall be deemed properly delivered, given and received when delivered (by hand, by registered mail, by courier or express delivery service or by facsimile) to the address or facsimile telephone number set forth beneath the name of such party below (or to such other address or facsimile telephone number as such party shall have specified in a written notice given to the other parties hereto): -2- (a) if to Mercury : Mercury Interactive Corporation 1325 Borregas Avenue Sunnyvale, California 94089 Attention: Sharlene Abrams Telephone No.: (408) 822-5247 Facsimile: (408) 822-5507 with a copy to: -------------- General Counsel Associates LLP 1891 Landings Drive Mountain View, CA 94043 Attention: Susan J. Skaer, Esq. Telephone: (650) 428-3900 Facsimile: (650) 428-3901 (b) if to the Shareholder, to the address set forth below the Shareholder's signature on the last page of this Agreement. 4. Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall be an original, but all of which together shall constitute one and the same agreement. 5. Entire Agreement. This Agreement, the Exchange Agreement, the ---------------- Exhibits thereto and any other document delivered in connection therewith contain the entire understanding of the parties hereto in respect of the subject matter hereof, and supersede all prior negotiations and understandings, oral or written, between the parties with respect to the subject matter hereof. 6. Attorney's Fees. In the event of any legal action or proceeding --------------- to enforce or interpret the provisions of this Agreement, the prevailing party shall be entitled to reasonable attorneys' fees, whether or not the proceeding results in a final judgment. 7. Successors and Assigns. This Agreement shall be enforceable by, ---------------------- and shall inure to the benefit of and be binding upon, the parties and their respective successors and assigns. As used herein, the term "successors and assigns" shall mean, where the context so permits, heirs, executors, administrators, trustees and successor trustees and personal and other representatives. 8. Governing Law. This Agreement shall be governed by and construed ------------- in accordance with the laws of the State of California applicable to contracts made and to be performed therein. -3- 9. Effect Of Headings. The section headings herein are for ------------------ convenience only and shall not affect the construction or interpretation of this Agreement. 10. Third Party Reliance. Counsel to and accountants for the parties -------------------- shall be entitled to rely upon this Agreement. 11. Effectiveness of Agreement. This Agreement shall become -------------------------- effective at the Closing. In the event that the Exchange Agreement shall be terminated in accordance with Section 9.1 of the Exchange Agreement, this Agreement shall simultaneously therewith cease and terminate and be of no further force or effect and no party hereunder shall have any rights or obligations of any nature whatsoever hereunder. IN WITNESS WHEREOF, the parties hereto have caused this Conduct Affiliate Pooling Agreement to be executed and delivered as of the date first above written. MERCURY INTERACTIVE CORPORATION. By: ----------------------------- Name: Title: -4- SIGNATURE PAGE TO THE CONDUCT AFFILIATE POOLING AGREEMENT BETWEEN MERCURY INTERACTIVE CORPORATION AND THE SHAREHOLDER SHAREHOLDER --------------------------------- (Signature) --------------------------------- (Print Name) --------------------------------- (Print Title)* --------------------------------- (Print Name of Company)* --------------------------------- (Print Address) --------------------------------- (Print Fax Number) _____________________________ * Leave blank if individual. Number of shares of Mercury common stock beneficially owned by Shareholder: ______________________________________________________ Number of shares of Mercury common stock subject to options beneficially owned by Shareholder: ________________________________________ Number of shares of Conduct ordinary and/or preferred shares beneficially owned by Shareholder: ____________________________________________ Number of shares of Conduct ordinary shares subject to options beneficially owned by Shareholder: __________________________________________ -5- EXHIBIT G-2 TO THE SHARE EXCHANGE AGREEMENT MERCURY AFFILIATE POOLING AGREEMENT dated as of November 30, 1999, between MERCURY INTERACTIVE CORPORATION., a Delaware corporation ("Mercury"), and the undersigned shareholder (the "Shareholder") of MERCURY who is a signatory hereto. Simultaneously with the execution and delivery of this Agreement, Mercury, Conduct, Conduct Software Technologies, Inc., a California corporation and wholly-owned subsidiary of Conduct ("Subsidiary"), the shareholders of Conduct (the "Conduct Shareholders") have entered into a Share Exchange Agreement (the "Exchange Agreement"), providing for, among other things, the Conduct Shareholders receiving newly issued shares of common stock of Mercury in exchange for all outstanding shares of capital stock of Conduct, all outstanding Convertible Promissory Notes and all outstanding options and warrants to purchase shares of Conduct stock, in the manner provided in the Exchange Agreement, after which Conduct will be a wholly-owned subsidiary of Mercury (the "Exchange"). The transactions contemplated by the Exchange Agreement are intended to be accounted for as a pooling of interests pursuant to Opinion No. 16 of the Accounting Principals Board. All capitalized terms used but not defined herein shall have the meanings ascribed thereto in the Exchange Agreement. NOW, THEREFORE, in consideration of the mutual benefits to be derived from the Exchange and of the mutual covenants contained in this Agreement, the parties agree as follows: 1. Transfer Restrictions. --------------------- (a) The Shareholder may be deemed to be an "affiliate" of Mercury within the meaning of Rule 145 promulgated under the Securities Act of 1933, as amended (the "Securities Act"), and Accounting Series Release No. 130, as amended ("Release No. 130"), Accounting Series Release No. 135 and Staff Accounting Bulletin No. 76 of the Securities and Exchange Commission (the "Commission"), although nothing contained herein should be construed as an admission thereof nor as a waiver of any right Shareholder may have to object to any claim that Shareholder is such an affiliate on or after the date hereof. (b) The Shareholder has not sold, exchanged, transferred, pledged, disposed of or otherwise reduced his risk, relative to any shares of or options to purchase shares of common stock, $.002 par value, of Mercury (the "Mercury Shares") beneficially owned by the Shareholder during the 30-day period prior to the Closing (as defined in the Exchange Agreement). (c) The Shareholder shall not sell, exchange, transfer, pledge, distribute, make any gift or otherwise dispose of or grant any option, establish any "short" or put-equivalent position with respect to or enter into any similar transaction (through derivatives or otherwise) or dispose of or otherwise reduce his risk relative to any Mercury Shares until such time after the Closing as financial results covering at least 30 days of the combined operations of Conduct and Mercury after the Closing have been published, within the meaning of Release No. 130, by Mercury in an effective registration statement, Annual Report on Form 10-K, Quarterly Report on Form 10-Q or Current Report on Form 8-K filed with the Securities and Exchange Commission, or any publicly disclosed quarterly earnings report or press release or other authorized public disclosure by Mercury that includes the combined results of operations of Mercury and Conduct. Mercury, at its discretion, may cause stop transfer orders to be placed with its transfer agent with respect to certificates for the Mercury Shares. Notwithstanding the foregoing, Shareholder will not be prohibited by the foregoing from selling or disposing of shares so long as such sale or disposition is in accordance with the "de minimis" test set forth in SEC Staff Accounting Bulletin No. 76. (d) During the period described in Section 1(c) above, subject to providing written notice to Mercury and the other restrictions set forth below, and to the extent permitted under the "pooling of interests" accounting rules and applicable securities laws, Shareholder will be permitted to sell up to 10% of Mercury Shares held by Shareholder or to make charitable contributions or bona fide gifts of the Mercury Shares owned by Shareholder, subject to the same restrictions. Such sales or other transfer shall subject to an aggregate limitation on sales and other transfers for all affiliates of Conduct and Mercury of not more than 1% of the number of shares of outstanding Common Stock of Mercury. Prior to making any such sale, charitable contributions or gifts, Shareholder will be required to obtain Mercury's prior written approval. Shareholder shall give Mercury not less than five (5) business days notice prior to making any sales, charitable contributions or gifts as contemplated under this Section 1(d), Shareholder will provide any information reasonably requested by Mercury or Mercury's accounting firm regarding such sale, charitable contribution or give, and Shareholder will refrain from making such sales, charitable contributions or gifts if Shareholder does not obtain Mercury's prior written approval. Mercury may withhold such approval it it determines, after consultation with its accounting firm, that such transaction could preclude the Exchange from being accounted for as a "pooling of interests." The 10% of Mercury Shares shall be calculated in accordance with SEC Accounting Series Release No. 135 as amended by Staff Accounting Bulletin No. 76. (e) Notwithstanding anything to the contrary contained in this Agreement, the Shareholder may transfer Mercury Shares to a trust established for the benefit of the Shareholder and/or for the benefit of one or more members of the Shareholder's family, or make a bona fide gift of Mercury Shares to one or more members of the Shareholder's family, provided that in the case of a transfer or gift pursuant to this Section 1, a transferee of such shares agrees to be bound by the limitations set forth in this Agreement. 2. Beneficial Ownership of Stock. Except as set forth on the last page of ----------------------------- this Agreement, Shareholder does not beneficially own or hold voting power over any shares of Mercury common stock or any other equity securities of Mercury or any options, warrants or other rights to acquire any equity securities of Mercury. 3. Notices. Any notice or other communication required or permitted to be ------- delivered to any party under this Agreement shall be in writing and shall be deemed properly delivered, -2- given and received when delivered (by hand, by registered mail, by courier or express delivery service or by facsimile) to the address or facsimile telephone number set forth beneath the name of such party below (or to such other address or facsimile telephone number as such party shall have specified in a written notice given to the other parties hereto): (a) if to Mercury : Mercury Interactive Corporation 1325 Borregas Avenue Sunnyvale, California 94089 Attention: Sharlene Abrams Telephone No.: (408) 822-5247 Facsimile: (408) 822-5507 with a copy to: -------------- General Counsel Associates LLP 1891 Landings Drive Mountain View, CA 94043 Attention: Susan J. Skaer, Esq. Telephone: (650) 428-3900 Facsimile: (650) 428-3901 (b) if to the Shareholder, to the address set forth below the Shareholder's signature on the last page of this Agreement. 4. Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall be an original, but all of which together shall constitute one and the same agreement. 5. Entire Agreement. This Agreement, the Exchange Agreement, the ---------------- Exhibits thereto and any other document delivered in connection therewith contain the entire understanding of the parties hereto in respect of the subject matter hereof, and supersede all prior negotiations and understandings, oral or written, between the parties with respect to the subject matter hereof. 6. Attorney's Fees. In the event of any legal action or proceeding --------------- to enforce or interpret the provisions of this Agreement, the prevailing party shall be entitled to reasonable attorneys' fees, whether or not the proceeding results in a final judgment. 7. Successors and Assigns. This Agreement shall be enforceable by, ---------------------- and shall inure to the benefit of and be binding upon, the parties and their respective successors and assigns. As used herein, the term "successors and assigns" shall mean, where the context so -3- permits, heirs, executors, administrators, trustees and successor trustees and personal and other representatives. 8. Governing Law. This Agreement shall be governed by and construed ------------- in accordance with the laws of the State of California applicable to contracts made and to be performed therein. 9. Effect Of Headings. The section headings herein are for ------------------ convenience only and shall not affect the construction or interpretation of this Agreement. 10. Third Party Reliance. Counsel to and accountants for the parties -------------------- shall be entitled to rely upon this Agreement. 11. Effectiveness of Agreement. This Agreement shall become -------------------------- effective at the Closing. In the event that the Exchange Agreement shall be terminated in accordance with Section 9.1 of the Exchange Agreement, this Agreement shall simultaneously therewith cease and terminate and be of no further force or effect and no party hereunder shall have any rights or obligations of any nature whatsoever hereunder. IN WITNESS WHEREOF, the parties hereto have caused this Mercury Affiliate Pooling Agreement to be executed and delivered as of the date first above written. MERCURY INTERACTIVE CORPORATION. By: ------------------------------------- Name: Title: -4- SIGNATURE PAGE TO THE MERCURY AFFILIATE POOLING AGREEMENT BETWEEN MERCURY INTERACTIVE CORPORATION AND THE SHAREHOLDER SHAREHOLDER -------------------------------------------------- (Signature) -------------------------------------------------- (Print Name) -------------------------------------------------- (Print Title)* -------------------------------------------------- (Print Name of Company)* -------------------------------------------------- -------------------------------------------------- -------------------------------------------------- (Print Address) -------------------------------------------------- (Print Fax Number) _______________________ * Leave blank if individual. Number of shares of Mercury common stock beneficially owned by Shareholder: ______________________________________________________ Number of shares of Mercury common stock subject to options beneficially owned by Shareholder: ________________________________________ -5- EXHIBIT H TO SHARE EXCHANGE AGREEMENT REGISTRATION RIGHTS AGREEMENT This REGISTRATION RIGHTS AGREEMENT, is made as of November 30, 1999, (the "Agreement"), by and among, MERCURY INTERACTIVE CORPORATION a Delaware Corporation ("Mercury") and the Conduct Shareholders (as listed on Schedule A attached hereto) of Conduct Ltd., an Israeli corporation ("Conduct"). WHEREAS, Mercury, Conduct, Conduct Software Technologies, Inc., a California corporation and wholly-owned subsidiary of Conduct, and the Conduct Shareholders have entered into a Share Exchange Agreement, dated as of November 24, 1999 (the "Exchange Agreement"). Upon the consummation of the transactions contemplated by the Exchange Agreement, the Conduct Shareholders are to receive shares of common stock of Mercury ("Mercury Stock") in exchange for their shares of capital stock of Conduct. Accordingly, it is contemplated that Conduct Shareholder will receive shares of Mercury Stock at the Closing. Mercury Stock to be so issued has not been registered under the Securities Act of 1933, as amended ("Securities Act") in reliance upon the exemption therefrom contained in Section 4(2) of the Securities Act. In consideration of the premises and the mutual representations, warranties and covenants herein contained, the parties hereto have agreed and do hereby agree as follows: 1. Registration Rights. ------------------- 1.1 Certain Definitions. As used in this Section 1, the following ------------------- terms shall have the following respective meanings: (a) The term "Commission" means the Securities and Exchange Commission; (b) The term "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, or any similar federal statute and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time. (c) The term "Form S-3" will refer to the registration statement of the same name (including successors thereto) prepared for filing with the Commission; (d) The term "Holder" means any holder of outstanding Registrable Securities who acquired such Registrable Securities in a transaction or series of transactions not involving any public offering, including any Permitted Transferee of the Conduct Shareholders as defined in Section 1.6 of this Agreement; (e) The terms "register", "registered" and "registration" refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act and the declaration or ordering of the effectiveness of such registration statement; (f) The term "Registrable Securities" means (i) all shares of Mercury Stock issued to the Conduct Shareholders pursuant to the Exchange Agreement and (ii) any other shares of capital stock issued as (or issuable upon the exercise or conversion of any warrant, right or other security that is issued as) a dividend, stock split, recapitalization or other distribution with respect to, or in exchange for or replacement of, any of Mercury's Registrable Securities; provided, however, that such shares of Common Stock referred to in -------- ------- (i) and (ii) above shall only be treated as Registrable Securities if and so long as they have not been (A) sold to or through a broker or dealer or underwriter in a public distribution or a public securities transaction, or (B) sold in a transaction exempt from the registration and prospectus delivery requirements of the Securities Act under Section 4(1) thereof so that all transfer restrictions and restrictive legends with respect thereto are removed upon the consummation of such sale; (b) The term "Restricted Securities" means the securities of --------------------- Mercury Stock being issued in the transactions contemplated by the Exchange Agreement; and (c) The term "Securities Act" means the Securities Act of 1933, as amended. 1.2 Registration on Form S-3. As promptly as practicable after (and ------------------------ in any event within 45 days of)the Closing (as defined in the Exchange Agreement), Mercury will file a registration statement to register (whether or not required by law to do so) the Registrable Securities, under the Securities Act and will use its best efforts to have such registration statement become effective as promptly as practicable after it is filed and to keep such registration statement effective for the lesser of one year or until all of the Holders have informed Mercury in writing that the distribution of their Registrable Securities has been completed; provided, that, each of the Conduct -------- ---- Shareholders agree, by acquisition of the Mercury Stock, that, upon receipt of any notice from Mercury of (i) the happening of any event which makes any statements made in the registration statement or related prospectuses filed pursuant to this Section 1, or any documents incorporated or deemed to be incorporated therein by reference, untrue in any material respect or which requires the making of any changes in such registration statement or prospectus so that, in the case of such registration statement it will not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make, the statements therein not misleading, and that in the case of the prospectus, it will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading or (ii) that, in the reasonable and good faith judgment of Mercury's Board of Directors, it is advisable to suspend use of the prospectus for a discrete period of time due to undisclosed material pending corporate developments, the Conduct Shareholders will forthwith discontinue, for a period not to exceed thirty (30) days, disposition of such Mercury Stock covered by such registration statement or prospectus until the Conduct Shareholders are advised in writing by Mercury that use of the applicable prospectus may be resumed, and have received copies of any additional or supplemental filings that are incorporated or deemed to be incorporated by reference in such prospectus. Mercury shall use all reasonable efforts to insure that the use of the prospectus may be resumed as soon as practicable, and in any event shall not be entitled to require the Conduct Shareholders to suspend use of any prospectus for more than two non-consecutive thirty (30) day periods in any twelve month period. Mercury hereby represents that it is presently eligible to utilize Form S-3 for the purpose of registering the resale of Registrable Securities. Mercury agrees that it will: (a) As promptly as practicable after it is necessary to do so, prepare and file with the Commission such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement, and use its best efforts to cause each such amendment to become effective as promptly as practicable after it is filed, as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement. (b) A reasonable number of days prior to filing any registration statement, prospectus or amendment or supplement thereto with the Commission, furnish a copy of such registration statement, prospectus or amendment or supplements to each Holder participating in such registration for such Holder's review. (c) Furnish to each Holder participating in the registration such number of prospectuses, preliminary prospectuses, final prospectuses and such other documents as such Holder may reasonably request in order to facilitate the public sale or other disposition of the Registrable Securities being sold by such Holder. (d) Notify each Holder, (A) of the time when such registration statement has become effective, and (B) at any time when a prospectus is required to be delivered under the Securities Act in connection with such registration statement (1) of the happening of any event as a result of which such registration statement, such prospectus, any prospectus supplement or any document incorporated by reference in any of the foregoing contains an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they are made, not misleading or (2) that Mercury is in possession of material information that it deems advisable not to disclose in a registration statement. (e) Advise each Holder promptly after Mercury shall receive notice or obtain knowledge thereof, of the issuance of any stop order by the Commission suspending the effectiveness of such registration statement or the initiation or threatening of any proceeding for such purpose and promptly use its reasonable efforts to prevent the issuance of any stop order or to obtain its withdrawal (at the earliest practicable date) if such stop order should be issued. (f) Apply for listing and use its best efforts to list the Registrable Securities being registered on any national securities exchange on which a class of Mercury's equity securities is listed or, if Mercury does not have a class of equity securities listed on a national securities exchange, apply for qualification and use its best efforts to qualify the Registrable Securities being registered for inclusion on the automated quotation system of the National Association of Securities Dealers, Inc. (g) Use its best efforts to file with the Commission in a timely manner all reports and other documents required of Mercury under the Securities Act and the Securities Exchange Act of 1934, as amended. (h) Cooperate when requested by Holder in the qualification of the Mercury Stock under the blue sky laws of such jurisdiction as Holder may designate and during the period in which the Form S-3 is effective, in keeping such qualifications in good standing under said blue sky laws, provided, -------- however, that Mercury shall not be obligated to file any general consent to - ------- service of process or to qualify as a foreign corporation in any jurisdiction in which it is not so qualified. 1.3 Registration and Selling Expenses. --------------------------------- (a) For purposes of this Section 1, "Registration Expenses" means all expenses incurred in connection with any registration, qualification or compliance pursuant to this Section 1, including, without limitation, all registration, filing and qualification fees, printing expenses, fees and disbursements of counsel for Mercury, expenses of any special audits incidental to or required by such registration and all fees and disbursements of one counsel to the selling Holder in connection therewith. "Selling Expenses" means all underwriting discounts and selling commissions applicable to the sale of Registrable Securities. (b) All Registration Expenses incurred in connection with any registration proceedings pursuant to Section 1.2 will be borne by Mercury. 1.4 Information by Holder. The Holder of Registrable Securities --------------------- included in any registration will furnish to Mercury such information regarding such Holder and the distribution proposed by such Holder as Mercury may reasonably request in writing in connection with the registration referred to in this Section 1. In connection with the preparation and filing of the registration statement under the Securities Act pursuant to this Agreement, Mercury will give Holder and its counsel and accountants, the opportunity to participate in the preparation of such registration statement, each prospectus included therein or filed with the Commission, and each amendment thereof or supplement thereto, and will give each of them such access to its books and records and such opportunities to discuss the business of Mercury with its officers and the independent public accountants who have certified its financial statements as shall be necessary, in the opinion of such Holder's counsel, to conduct a reasonable investigation within the meaning of the Securities Act. 1.5 Transfer of Registration Rights. The registration rights granted ------------------------------- to Holder under this Section 1 are not transferable to any other person or entity, except by operation of law or to a family member of Holder or to a trust for the benefit of Holder or a family member of Holder or to a partner or other affiliate of Holder (a "Permitted Transferee"). 1.6 Indemnification. --------------- (a) To the extent permitted by law, Mercury will, and does hereby undertake to, indemnify and hold harmless each Holder, each of its heirs, successors and assigns, any underwriter, and each person who controls Holder or any underwriter within the meaning of Section 15 of the Securities Act, against all expenses, claims, losses, damages and liabilities (or actions in respect thereof), including settlement of any litigation, commenced or threatened, to which they may become subject under the Securities Act, the Exchange Act, or other federal or state law, arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any registration statement, prospectus (preliminary or final), or other document or amendments thereto, or arising out of or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading, or arising out of or any violation by Mercury of any federal, state or common law rule or regulation applicable to Mercury and relating to action or inaction required of Mercury in connection with any such registration, qualification or compliance, and will reimburse each such Holder, each of its officers, directors and partners, and each person controlling such Holder, each such underwriter and each person who controls any such underwriter, for any legal and any other expenses reasonably incurred in connection with investigating, preparing or defending any such claim, loss, damage, liability or action, provided that Mercury will not be liable in any such case to the extent that any such claim, loss, damage, liability or expense arises out of or is based on any untrue statement or omission or alleged untrue statement or omission, made in reliance upon and in conformity with written information furnished to Mercury by an instrument executed by such Holder or underwriter expressly for use in connection with such registration. (b) To the extent permitted by law, each Holder will severally (but not jointly), indemnify and hold harmless Mercury, each of its directors and officers, agents and employees, each underwriter, if any, of Mercury's securities covered by such a registration statement, each person who controls Mercury or such underwriter within the meaning of Section 15 of the Securities Act, and each other such Holder, each of its successors and assigns, its officers, directors and partners and each person controlling such Holder within the meaning of Section 15 of the Securities Act, against all claims, losses, damages and liabilities (or actions in respect thereof to which they may become subject) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any such registration statement, prospectus, offering circular or other document, or amendments thereto, or any omission (or alleged omission) to state therein a material fact required to be stated therein in light of the circumstances in which they were made, or necessary to make the statements therein, not misleading, and will reimburse Mercury, such Holders, such directors, officers, persons, underwriters or control persons for any legal or any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action, in each case to the extent, but only to the extent, that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in such registration statement, prospectus, or other document in reliance upon and in conformity with written information furnished to Mercury by an instrument executed by such Holder expressly for use in connection with such registration; provided, however, that the obligations of such Holders hereunder shall be limited to an amount equal to the proceeds to each such Holder of Registrable Securities, from the sale of such Registrable Securities as contemplated herein. (c) Promptly after receipt by an indemnified party under this Section 1.7 of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 1.7, notify the indemnifying party of the commencement thereof; but the omission so to notify the indemnifying party will not relieve it from any liability which it may have to any indemnified party otherwise than under this Section 1.7. In case any such action is brought against any indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party; provided, however, that if the defendants in any such action include both ----------------- the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be one or more legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnifying party shall not have the right to direct the defense of such action on behalf of such indemnified party or parties and such indemnified party or parties shall have the right to select separate counsel to defend such action on behalf of such indemnified party or parties. After notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof and approval by such indemnified party of counsel appointed to defend such action, the indemnifying party will not be liable to such indemnified party under this Section 1.7 for any legal or other expenses, other than reasonable costs of investigation, subsequently incurred by such indemnified party in connection with the defense thereof, unless (i) the named parties to any such action include both the indemnified party and the indemnifying party and the representation of both parties by the same counsel would be inappropriate due to a conflict of interest between or (ii) the indemnifying party does not promptly retain counsel satisfactory to the indemnified party or (iii) the indemnifying party has authorized the employment of counsel for the indemnified party at the expense of the indemnifying party. It is understood, however, that in connection with such action the indemnifying party shall not be liable for the expenses of more than one separate counsel (in addition to local counsel) in any one action or separate but substantially similar actions in the same jurisdiction arising out of the same general allegations or circumstances unless the indemnified parties in good faith are advised by their counsel that there is an actual or potential conflict of interest among the indemnified parties. After such notice from the indemnifying party to such indemnified party, the indemnifying party will not be liable for the costs and expenses of any settlement of such action effected by such indemnified party without the consent of the indemnifying party. (d) In circumstances in which the indemnity agreement provided for in the preceding paragraphs of this Section 1.7 is unavailable or insufficient, for any reason, to hold harmless an indemnified party in respect of any losses, claims, damages or liabilities (or actions in respect thereof), each indemnifying party, in order to provide for just and equitable contribution, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect (i) the relative benefits received by the indemnifying party or parties on the one hand and the indemnified party on the other from the offering of the Registrable Securities or (ii) if the allocation provided by the foregoing clause (i) is not permitted by applicable law, not only such relative benefits but also the relative fault of the indemnifying party or parties on the one hand and the indemnified party on the other in connection with the statements or omissions or alleged statements or omissions that resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative fault of the parties shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the indemnifying party or the indemnified party, the parties' relative intents, knowledge, access to information and opportunity to correct or prevent such statement or omission, and any other equitable considerations appropriate in the circumstances. The liability of each Holder under this Section 1.7 shall not exceed an amount equal to the net proceeds received by such Holder from the sale of Registrable Securities pursuant to the registration statement. 1.7 Amendments and Waivers. This Agreement may be amended, modified, ---------------------- supplemented or waived only upon the written agreement of the party against whom enforcement of such amendment, modification, supplement or waiver is sought. 1.8 Rule 144 Reporting. With a view to making available the benefits ------------------ of certain rules and regulations of the Commission which may at any time permit the sale of the Restricted Securities to the public without registration, Mercury agrees to use all reasonable efforts to: (a) Make and keep public information available, as those terms are understood and defined in Rule 144 under the Securities Act, at all times; (b) File with the Commission in a timely manner all reports and other documents required of Mercury under the Securities Act and the Exchange Act; and (c) Furnish to the Holder, so long as Holder owns any Registrable Securities, forthwith upon request a written statement as to its compliance with the applicable requirements of said Rule 144 and the Securities Act and the Securities Exchange Act; Mercury shall provide forthwith upon written request a copy of the most recent annual or quarterly report of Mercury, and such other reports and documents of Mercury as Holder may reasonably request in availing itself of any rule or regulation of the Commission allowing Holder to sell any such securities without registration. 1.9 Notices. Except as otherwise provided in this Agreement, any ------- notice or other communication required or permitted to be delivered to any party under this Agreement shall be in writing and shall be deemed properly delivered, given and received when delivered (by hand, by registered mail, by courier or express delivery service or by facsimile) to the address or facsimile telephone number set forth beneath the name of such party below (or to such other address or facsimile telephone number as such party shall have specified in a written notice given to the other parties hereto): (a) if to Mercury : Mercury Interactive Corporation 1325 Borregas Avenue Sunnyvale, California 94089 Attention: Sharlene Abrams Telephone No.: (408) 822-5247 Facsimile: (408) 822-5507 with a copy to: -------------- General Counsel Associates LLP 1891 Landings Drive Mountain View, CA 94043 Attention: Susan J. Skaer, Esq. Telephone: (650) 428-3900 Facsimile: (650) 428-3901 (b) If to the Conduct Shareholders: To the address set forth beside each such Conduct Shareholder's signature on the signature page attached hereto. with copies to: -------------- Conduct, Ltd. c/o Conduct Software Technologies, Inc. 2350 Mission College Blvd., Suite 705 Santa Clara, CA 95054 Attention: David Barzilai Telephone: 408-982-8200 Facsimile: 408-982-8202 Wilson Sonsini Goodrich & Rosati, Professional Corporation 650 Page Mill Road Palo Alto, CA 94304-1050 Attention: Neil J. Wolff , Esq. Jon P. Layman, Esq. Telephone: (650) 493-9300 Facsimile: (650) 493-6811 All such notices, requests, consents and other communications shall be deemed to have been given when received. 1.10 Miscellaneous. -------------- (a) Subject to the foregoing, this Agreement shall be binding upon and inure to the benefit of and be enforceable by the parties hereto and the respective successors, personal representatives and assigns of the parties hereto, whether so expressed or not. If any person or entity shall acquire Registrable Securities from any Holder, in any manner, whether by operation of law or otherwise, such transferee shall promptly notify Mercury and such Registrable Securities acquired from such Holder shall be held subject to all of the terms of this Agreement, and by taking and holding such Registrable Securities such person shall be entitled to receive the benefits of and be conclusively deemed to have agreed to be bound by and to perform all of the terms and provisions of this Agreement. If the Mercury shall so request, any such successor or assign shall agree in writing to acquire and hold the Registrable Securities acquired from such Holder subject to all of the terms hereof. (b) This Agreement (with the documents referred to herein or delivered pursuant hereto) embodies the entire agreement and understanding between the parties hereto and supersedes all prior agreements and understandings relating to the subject matter hereof. (c) This Agreement shall be construed and enforced in accordance with and governed by the laws of the State of California without giving effect to the conflicts of law principles thereof. (d) The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning hereof. All section references are to this Agreement unless otherwise expressly provided. (e) This Agreement may be executed in any number of counterparts, each of which shall be an original, but all of which together shall constitute one instrument. (f) Any term or provision of this Agreement which is invalid or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement or affecting the validity or enforceability of any of the terms or provisions of this Agreement in any other jurisdiction. (g) The parties hereto acknowledge that there would be no adequate remedy at law if any party fails to perform any of its obligations hereunder, and accordingly agree that each party, in addition to any other remedy to which it may be entitled at law or in equity, shall be entitled to injunctive relief, including specific performance, to enforce such obligations without the posting of any bond, and, if any action should be brought in equity to enforce any of the provisions of this Agreement, none of the parties hereto shall raise the defense that there is an adequate remedy at law. (h) Each party hereto shall do and perform or cause to be done and performed all such further acts and things and shall execute and deliver all such other agreements, certificates, instruments, and documents as any other party hereto reasonably may request in order to carry out the intent and accomplish the purposes of this Agreement and the consummation of the transactions contemplated hereby. (i) If any action or proceeding relating to this Agreement or the enforcement of any provision of this Agreement is brought against any party hereto, the prevailing party shall be entitled to recover reasonable attorneys' fees, costs and disbursements (in addition to any other relief to which the prevailing party may be entitled). IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date set forth above. Mercury Interactive Corporation By: ----------------------------------------- Name: ------------------------------------ Title: ----------------------------------- SIGNATURE PAGE TO THE REGISTRATION RIGHTS AGREEMENT AMONG MERCURY INTERACTIVE CORPORATION AND THE SHAREHOLDERS OF CONDUCT LTD. Conduct Shareholder: --------------------------------------------- Signature By: ------------------------------------------ Title: --------------------------------------- Print or Type Name: -------------------------- Address: ------------------------------------- ------------------------------------- SCHEDULE A CONDUCT LTD. SHAREHOLDERS - -------------------------------------------------------------------------------- Name of Conduct Shareholder No. of Shares of Mercury Stock - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- EXHIBIT I TO SHARE EXCHANGE AGREEMENT LEGAL OPINION OF GENERAL COUNSEL ASSOCIATES LLP [All capitalized terms used but not defined herein shall have the meanings given to them in the Share Exchange Agreement] [Subject to customary qualifications and exceptions] 1. Mercury is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. 2. Mercury has the corporate power and authority to enter into and perform the Exchange Agreement, and has taken all necessary corporate action to authorize the execution, delivery and performance of the Exchange Agreement. 3. The Exchange Agreement has been duly executed and delivered by Mercury and constitutes the legal, valid and binding obligation of Mercury enforceable Mercury in accordance with its terms. 4. The execution, delivery and performance of the Exchange Agreement by Mercury and the consummation of the transactions therein contemplated do not result in a breach or violation of any of the terms or provisions of, or constitute a default under, (a) any provision of Mercury's Restated Certificate of Incorporation or Amended and Restated By-laws, or (b) to our knowledge any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Mercury, or its properties or assets. EXHIBIT J For: The Research Committee The Office of the Chief Scientist P.O.B. 2197 Jerusalem --------- RELATING TO PROJECT FILE NO. 21036 SUBJECT OF RESEARCH SiteRunner (Coyote) - Network Management Software ------------------------------------------------- Undertaking ----------- We, the undersigned of Mercury Interactive Corporation ; having by -------------------------------------------- an agreement on committed to buy all the outstanding shares of ----------------- Conduct Ltd. in return for shares in Mercury Interactive Corp. - ------------- ------------------------ Recognizing that Conduct Ltd. Research and Development Project, as referred ------------ to above, is currently being financially supported by the Government of the State of Israel through the Office of the Chief Scientist under The Encouragement of Research and Development in Industry Law 5744-1984 (hereinafter: the law) and the regulations pursuant to the law. Recognizing that the law places strict constraints on the transfer of know-how and/or production rights, making all such transfer subject to the absolute discretion of the Research Committee of the Office of the Chief Scientist, acting in accordance with the aims of the law, and requiring that any such transfer receive the prior written approval of the Research Committee. HEREBY UNDERTAKE, To observe strictly all the requirements of the law as well as the regulations issued pursuant to the law as applied to Conduct Ltd. and as directed by ------------ the Research Committee, in particular those requirements stipulated under Section 19 of the law relating to the prohibition on the transfer of know-how and/or production rights. November 10, 1999 /s/ - ----------------- ------------------------------- Date Signature of Authorized Company Representative and Company Seal November 30, 1999 Conduct Ltd. 2 Habarzel Street Tel Aviv, 69710, Israel Re: Share Exchange Agreement dated as of November 24, 1999, among Mercury --------------------------------------------------------------------- Interactive Corporation, Conduct Ltd., Conduct Software Technologies, Inc. -------------------------------------------------------------------------- and the Conduct Shareholders. ----------------------------- Ladies and Gentlemen: We refer to the Share Exchange Agreement dated as of November 24, 1999 (the "Exchange Agreement"), among Mercury Interactive Corporation, a Delaware corporation ("Mercury"), Conduct Ltd., an Israeli corporation ("Conduct"), Conduct Software Technologies, Inc., a California corporation and a wholly owned subsidiary of Conduct ("Subsidiary"), and the shareholders of Conduct (the "Conduct Shareholders"), pursuant to which the Conduct Shareholders are exchanging all of their outstanding capital shares of Conduct for shares of common stock of Mercury, after which Conduct will be a wholly-owned subsidiary of Mercury. We have served as counsel to Mercury in connection with the Exchange Agreement and the transactions contemplated thereby. Each capitalized term used but not defined herein shall have the meaning ascribed thereto in the Exchange Agreement. For the purpose of rendering this opinion, we have examined, among other documents, an original copy of the executed Exchange Agreement. We have been furnished and we have relied in giving this opinion as to various questions of fact material to this opinion upon (i) the Secretary's Certificate of Mercury being delivered to you concurrently herewith, and (ii) an Officer's Certificate of Mercury with respect to certain factual matters. As to matters of fact relevant to this opinion, we have relied solely upon (i) our examination of the certificates referred to in the preceding sentence, (ii) the representations and warranties of Mercury set forth in the Exchange Agreement and (iii) the representations and warranties made by representatives of Mercury to us. We have made no attempt to verify the accuracy of any of such information, representations or warranties or to determine the existence or non- existence of any other Conduct Ltd. November 30, 1999 Page 2 factual matters, nor have we caused the search of any docket of any court, tribunal, agency or any other record of any governmental agency or third party. Whenever a statement herein is qualified by the phrases "known to us" or "to our knowledge," or similar phrases, it is intended to indicate that, during the course of our representation of the Company in this transaction, no information that would give us current actual knowledge of the inaccuracy of such statement has come to the attention of those attorneys presently in this firm who have rendered legal services in connection with the representation described in the introductory paragraph of this opinion letter. However, we have not undertaken any independent investigation or review to determine the accuracy of any such statement, and any limited inquiry undertaken by us during the preparation of this opinion letter should not be regarded as such an investigation or review; no inference as to our knowledge of any matters bearing on the accuracy of any such statement should be drawn from the fact of our representation of the Company. This opinion is limited solely to the federal laws of the United States of America, the laws of the State of California and the General Corporation Law of the State of Delaware as those laws are in effect as of the date hereof, and we express no opinion as to the laws of any other state or jurisdiction (including, but not limited to, ordinances, regulations or practices or any county, city or other local government agency or body within the State of California) or any other laws of the State of Delaware. Pursuant to Section 8.3(c) of the Exchange Agreement, and subject to the assumptions, limitations and qualifications herein set forth, we are of the opinion that: 1. Mercury is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. 2. Mercury has the corporate power and authority to enter into and perform the Exchange Agreement and has taken all necessary corporate action to authorize the execution, delivery and performance of the Exchange Agreement. 3. The Exchange Agreement has been duly executed and delivered by Mercury and constitutes the legal, valid and binding obligation of Mercury enforceable against Mercury in accordance with its terms. 4. The execution, delivery and performance of the Exchange Agreement by Mercury and the consummation of the transactions therein contemplated do not result in a breach or violation of any of the terms or provisions of, or constitute a default under, (a) any provision of Mercury's Restated Certificate of Incorporation or Amended and Conduct Ltd. November 30, 1999 Page 3 Restated By-laws, or (b) to our knowledge any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to Mercury, or its properties or assets. For purposes of rendering the foregoing opinions, we have made, without further inquiry as to their accuracy or completeness, the following assumptions: (a) We have assumed the authenticity of all documents submitted to us as originals, the genuineness of all signatures on original documents, the legal capacity of all natural persons and the conformity with the original documents of any copies thereof submitted to us for our examination. (b) We have assumed the due authorization, execution and delivery of the Exchange Agreement and all of the other instruments and agreements contemplated thereby by the parties thereto (other than Mercury) and that such agreement and all of the other instruments and agreements contemplated thereby constitute the legally valid and binding obligations of the parties thereto (other than Mercury), enforceable against such parties in accordance with their respective terms. (c) We have assumed compliance by you with any and all applicable laws with which you are required to comply relating to or affecting the matters and actions contemplated by the Exchange Agreement and all of the other instruments and agreements contemplated thereby. (d) We have assumed that the Exchange Agreement has not been further amended or modified, or been terminated or revoked in any respect, and that it remains in full force and effect as of the date hereof, and that none of the other instruments and agreements contemplated thereby has been amended, modified, terminated or revoked in any respect, and that each remains in full force and effect as of the date hereof. The opinion set forth above are subject to the following: (a) Our opinion is subject to the effect of any applicable bankruptcy, insolvency, fraudulent conveyance, fraudulent transfer and equitable subordination, reorganization, moratorium or similar law affecting creditors' rights generally, and to the effect of general principles of equity, including (without limitation) concepts of materiality, reasonableness, estoppel, good faith and fair dealing (regardless whether considered in a proceeding in equity or at law). We express no opinion as to the availability of equitable remedies. (b) Certain rights, remedies and waivers set forth in the Exchange Agreement (including but not limited to the indemnification and severability provisions) Conduct Ltd. November 30, 1999 Page 4 may be unenforceable, in whole or in part, but the inclusion of such provisions does not affect the validity of such agreement taken as a whole. (c) We express no opinion as to compliance with the antifraud provisions of applicable securities laws. This opinion is given as of the date hereof and we disclaim any obligation to advise you of any fact, circumstance, event or changes or developments in law or the facts that may occur after the date hereof which may affect the conclusions reached herein. This opinion is being delivered solely for the benefit of the persons to whom it is addressed and may not be quoted, filed with any governmental authority or other regulatory agency or otherwise circulated or utilized for any other purpose without our prior written consent. Very Truly Yours, GENERAL COUNSEL ASSOCIATES LLP EX-21.1 3 SUBSIDIARIES OF REGISTRANT EXHIBIT 21.1 SUBSIDIARIES OF REGISTRANT Mercury Interactive (Israel) Limited, incorporated under the laws of Israel Mercury Interactive (UK) LTD., incorporated under the laws of the United Kingdom Mercury Interactive France SARL, incorporated under the laws of France Mercury Interactive GmbH, incorporated under the laws of Germany Mercury Interactive (Europe) BV, incorporated under the laws of The Netherlands Mercury Interactive Canada Inc., incorporated under the laws of Canada Mercury Interactive Japan K.K., incorporated under the laws of Japan Mercury Interactive (Australia) Pty Ltd., incorporated under laws of Australia Mercury Interactive Asia Pte LTD., incorporated under the laws of Singapore Mercury Interactive (Belgium)--Benelux Branch, registered under the laws of Belgium Mercury Interactive Brasil Limitada, incorporated under the laws of Brazil Mercury Interactive NORDIC AB, incorporated under the laws of Sweden Mercury Interactive Srl, incorporated under the laws of Italy Mercury Interactive Aps, incorporated under the laws of Denmark Mercury Interactive SA (Pty) Ltd., incorporated under the laws of South Africa Mercury Interactive (China) Limited, incorporated under the laws of Hong Kong Mercury Interactive B.V., incorporated under the laws of the Netherlands Conduct Software Technologies, Inc., incorporated under the laws of California Conduct Ltd., incorporated under the laws of Israel Quicksilver Interactive Corporation, incorporated under the laws of Delaware EX-23.1 4 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 33-71018, 33-74728, 33-95178, 333-09913, 333- 27951, 333-62125, 333-81401 and 333-94837) of Mercury Interactive Corporation of our report dated January 20, 2000, except as to the stock split described in Note 9, which is as of February 11, 2000, relating to the financial statements and financial statement schedule which appears in this Form 10-K. PricewaterhouseCoopers LLP San Jose, California March 17, 2000 EX-27.1 5 >FINANCIAL DATA SCHEDULE
5 1,000 YEAR YEAR DEC-31-1999 DEC-31-1998 JAN-01-1999 JAN-01-1998 DEC-31-1999 DEC-31-1998 113,346 96,836 73,536 33,827 45,932 31,526 (5,533) (3,623) 0 0 234,753 155,566 67,520 43,765 (20,610) (15,342) 297,218 204,686 97,687 58,278 0 0 0 0 0 0 156 148 199,375 146,260 297,218 204,686 130,900 84,450 187,700 121,000 7,736 6,291 26,378 18,048 125,335 82,616 0 0 0 0 42,013 24,976 8,869 5,451 33,144 19,525 0 0 0 0 0 0 33,144 19,525 0.44 0.28 0.39 0.25
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