10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED June 30, 2003

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM              TO             .

Commission File Number : 0-22350

MERCURY INTERACTIVE CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	77-0224776
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

1325 Borregas Avenue, Sunnyvale, California 94089

(Address of principal executive offices)

Registrant’s telephone number, including area code: (408) 822-5200

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such a shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).    YES  x    NO  ¨

The number of shares of Registrant’s Common Stock outstanding as of July 31, 2003 was 86,250,772.

MERCURY INTERACTIVE CORPORATION

TABLE OF CONTENTS

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Unaudited Financial Statements
	Condensed Consolidated Balance Sheets—June 30, 2003 and December 31, 2002	3
	Condensed Consolidated Statements of Operations—Three and six months ended June 30, 2003 and 2002	4
	Condensed Consolidated Statements of Cash Flows—Six months ended June 30, 2003 and 2002	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	36
Item 4.	Controls and Procedures	37
PART II.	OTHER INFORMATION
Item 2.	Changes in Securities and Use of Proceeds	38
Item 4.	Submission of Matters to a Vote of Stockholders	38
Item 6.	Exhibits and Reports on Form 8-K	39
Signatures		40
Certifications

2

MERCURY INTERACTIVE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

	June 30, 2003			December 31, 2002
ASSETS
Current assets:
Cash and cash equivalents	$	820,042		$	349,123
Short-term investments		147,369			178,123
Trade accounts receivable, net		83,516			93,095
Prepaid expenses and other assets		54,232			46,548
Total current assets		1,105,159			666,889
Long-term investments		274,290			137,954
Property and equipment, net		89,454			88,516
Investments in non-consolidated companies		15,363			15,952
Debt issuance costs, net		16,680			6,037
Goodwill		130,378			113,327
Intangible assets, net		4,761			2,548
Restricted cash		6,000			6,000
Interest rate swap		20,216			17,378
Other assets		18,141			21,133
Total assets	$	1,680,442		$	1,075,734
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	12,623		$	12,292
Accrued liabilities		74,747			71,414
Income taxes payable		73,781			70,502
Short-term deferred revenue		153,052			135,338
Total current liabilities		314,203			289,546
Convertible notes		819,718			316,972
Long-term deferred revenue		40,914			24,048
Total liabilities		1,174,835			630,566
Stockholders’ equity:
Common stock		172			169
Additional paid-in capital		277,576			254,218
Treasury stock		(16,082	)		(16,082	)
Notes receivable from issuance of common stock		(8,609	)		(11,055	)
Unearned stock-based compensation		(740	)		(1,296	)
Accumulated other comprehensive loss		(2,728	)		(1,725	)
Retained earnings		256,018			220,939
Total stockholders’ equity		505,607			445,168
Total liabilities and stockholders’ equity	$	1,680,442		$	1,075,734

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

MERCURY INTERACTIVE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Revenues:
License fees	$	48,004		$	44,863		$	92,790		$	89,584
Subscription fees		22,487			12,337			41,761			23,616
Total product revenues		70,491			57,200			134,551			113,200
Maintenance fees		38,745			29,280			74,330			56,930
Professional service fees		8,820			7,520			19,560			14,370
Total revenues		118,056			94,000			228,441			184,500
Costs and expenses:
Cost of license and subscription		6,757			6,551			13,307			12,896
Cost of maintenance		2,829			2,884			5,508			5,720
Cost of professional services		7,460			5,527			14,080			9,825
Marketing and selling		55,806			46,548			108,491			91,965
Research and development		13,120			10,296			24,709			20,920
General and administrative		9,722			7,949			18,822			15,392
Amortization of unearned stock-based compensation		195			303			384			667
Acquisition related charges		1,280			—			1,280			—
Restructuring, integration and other related charges		917			—			917			(537	)
Amortization of intangible assets		699			639			1,157			1,278
Total costs and expenses		98,785			80,697			188,655			158,126
Income from operations		19,271			13,303			39,786			26,374
Interest income		8,820			9,494			16,378			17,554
Interest expense		(4,921	)		(6,208	)		(9,921	)		(11,921	)
Other (expense) income, net		(1,458	)		6,171			(1,689	)		9,954
Income before provision for income taxes		21,712			22,760			44,554			41,961
Provision for income taxes		4,777			4,740			9,475			8,781
Net income	$	16,935		$	18,020		$	35,079		$	33,180
Net income per share (basic)	$	0.20		$	0.21		$	0.41		$	0.40
Net income per share (diluted)	$	0.19		$	0.20		$	0.39		$	0.38
Weighted average common shares (basic)		85,610			83,817			85,322			83,502
Weighted average common shares and equivalents (diluted)		90,506			88,164			89,945			88,227

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

MERCURY INTERACTIVE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Six months ended June 30,
	2003			2002
Cash flows from operating activities:
Net income	$	35,079		$	33,180
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,143			7,676
Sales reserve		(1,236	)		294
Unrealized gain on interest rate swap		(92	)		—
Amortization of intangible assets		1,157			1,278
Amortization of unearned stock-based compensation		384			667
Gain on early retirement of debt		—			(11,610	)
Loss on investments in non-consolidated companies		1,339			411
Write-off of in-process research and development		1,280			—
Deferred income taxes		1,076			—
Changes in assets and liabilities:
Trade accounts receivable		13,157			7,497
Prepaid expenses and other assets		(2,558	)		(7,705	)
Accounts payable		(308	)		454
Accrued liabilities		1,048			4,224
Income taxes payable		2,061			7,633
Deferred revenue		30,883			18,989
Net cash provided by operating activities		91,413			62,988
Cash flows from investing activities:
Maturity of investments		1,180,168			116,529
Purchases of investments		(1,285,356	)		(214,014	)
Increase in restricted cash		—			(6,000	)
Purchases of investments in non-consolidated companies		(750	)		(1,500	)
Cash paid in conjunction with the acquisition of Performant, net		(21,925	)		—
Acquisition of property and equipment, net		(7,633	)		(3,779	)
Net cash used in investing activities		(135,496	)		(108,764	)
Cash flows from financing activities:
Proceeds from issuance of convertible notes, net		488,198			—
Proceeds from issuance of common stock under stock option and employee stock purchase plans		23,533			14,247
Collection of notes receivable from issuance of common stock		2,446			873
Retirement of convertible subordinated notes		—			(64,640	)
Net cash provided by (used in) financing activities		514,177			(49,520	)
Effect of exchange rate changes on cash		825			443
Net increase (decrease) in cash and cash equivalents		470,919			(94,853	)
Cash and cash equivalents at beginning of period		349,123			248,297
Cash and cash equivalents at end of period	$	820,042		$	153,444

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

MERCURY INTERACTIVE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1—OUR SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

The accompanying condensed consolidated financial statements include the accounts of Mercury Interactive Corporation and its subsidiaries. We have subsidiaries in the US, Canada, and Brazil (Americas), Europe, the Middle East, and Africa (EMEA), Asia Pacific (APAC), and Japan. All significant intercompany accounts and transactions have been eliminated.

These interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information, and the rules and regulations of the Securities and Exchange Commission for interim condensed consolidated financial statements and accounting policies, consistent, in all material respects, with those applied in preparing our audited consolidated financial statements included in our annual report on Form 10-K for the fiscal year ended December 31, 2002. The unaudited financial information furnished herein reflects all adjustments, consisting only of normal recurring adjustments, that in our opinion are necessary to fairly state our consolidated financial position, the results of operations, and cash flows for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with our audited financial statements for the year ended December 31, 2002, included in the 2002 Form 10-K. The condensed consolidated statements of operations for the three and six months ended June 30, 2003 are not necessarily indicative of results to be expected for the entire fiscal year ending December 31, 2003.

Guarantees

In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34 (FIN No. 45). The Interpretation requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. The Interpretation also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The accounting requirements for the initial recognition of guarantees are applicable on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for all guarantees outstanding, regardless of when they were issued or modified, during the first quarter of fiscal 2003. The adoption of FIN No. 45 did not have a material effect on our condensed consolidated financial statements. The following is a summary of the agreements that we have determined are within the scope of FIN No. 45:

As permitted under Delaware law, we have agreements whereby our officers and directors are indemnified for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. The term of the indemnification period is for the officer’s or director’s term in such capacity. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a director and officer insurance policy that limits our exposure and enables us to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. All of these indemnification agreements were grandfathered under the provisions of FIN No. 45 as they were in effect prior to December 31, 2002. Accordingly, we have no liabilities recorded for these agreements as of June 30, 2003.

We enter into standard indemnification agreements in the ordinary course of business. Pursuant to these agreements, we indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally our business partners, subsidiaries and/or customers, in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. We have not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is insignificant. Accordingly, we have no liabilities recorded for these agreements as of June 30, 2003.

We may, at our discretion and in the ordinary course of business, subcontract the performance of any of our services. Accordingly, we enter into standard indemnification agreements with our customers, whereby we are indemnified for other acts, such as personal property damage, of our subcontractors. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have general and umbrella insurance policies that enable us to recover a portion of any amounts paid. We have not incurred significant costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is insignificant. Accordingly, we have no liabilities recorded for these agreements as of June 30, 2003.

6

When, as part of an acquisition, we acquire all of the stock or all of the assets and liabilities of a company, we assume the liability for certain events or occurrences that took place prior to the date of acquisition. Obligations relating to acquisitions made before December 31, 2002 were grandfathered under the provisions of FIN No. 45. We are not aware of any potential obligations arising as a result of acquisitions made subsequent to December 31, 2002 and we are therefore unable to determine the maximum potential payments we could be required to make for such obligations at this time. Accordingly, we have no liabilities recorded for these types of agreements as of June 30, 2003.

We have arrangements with certain vendors whereby we guarantee employee expenses. The term is from execution of the arrangement until cancellation and payment of any outstanding amounts. We would be required to pay any unsettled employee expenses upon notification from the vendor. The maximum potential amount of future payments we could be required to make under these indemnification agreements is insignificant. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as of June 30, 2003.

We warrant that our software products will perform in all material respects in accordance with our standard published specifications in effect at the time of delivery of the licensed products to the customer for the life of the product. Additionally, we warrant that our maintenance services will be performed consistent with generally accepted industry standards through completion of the agreed upon services. If necessary, we would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history, however, we have not incurred significant expense under our product or services warranties. As a result, we believe the estimated fair value on these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as of June 30, 2003.

Financial instruments with characteristics of both liabilities and equity

In the second quarter of 2003, we adopted Statement of Financial Accounting Standards (SFAS) No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement modifies the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new statement requires that those instruments be classified as liabilities in the statements of financial position. The adoption of this statement did not require us to make any reclassifications in our condensed consolidated financial statements.

Revenue recognition

In the second quarter of 2003, we adopted Emerging Issues Task Force (EITF) No. 00-21, Revenue Arrangements with Multiple Deliverables. EITF No. 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue-generating activities. The adoption of this EITF did not have a material impact on our condensed consolidated financial statements.

Stock-based compensation

We account for stock-based compensation for our employees using the intrinsic value method presented in Accounting Principles Board (APB) Statement No. 25, Accounting for Stock Issued to Employees, and related interpretations, and comply with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and with the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure Amendment of SFAS No. 123. Under APB No. 25, compensation expense is based on the difference, as of the date of the grant, between the fair value of our stock and the exercise price. We account for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. We do not issue stock options to non-employees.

Pro forma information regarding net income and earnings per share is required by SFAS No. 123. This information is required to be determined as if we had accounted for our employee stock option and employee stock purchase plans under the fair value method of SFAS No. 123, as amended by SFAS No. 148.

7

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee compensation (in thousands, except per share amounts):

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Net income, as reported	$	16,935		$	18,020		$	35,079		$	33,180
Add:
Unearned stock-based compensation expense included in reported net income		195			303			384			667
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(33,127	)		(30,932	)		(65,582	)		(61,254	)
Pro forma net loss	$	(15,997	)	$	(12,609	)	$	(30,119	)	$	(27,407	)
Net income per share (basic), as reported	$	0.20		$	0.21		$	0.41		$	0.40
Net loss per share (basic), pro forma	$	(0.19	)	$	(0.15	)	$	(0.35	)	$	(0.33	)
Net income per share (diluted), as reported	$	0.19		$	0.20		$	0.39		$	0.38
Net loss per share (diluted), pro forma	$	(0.19	)	$	(0.15	)	$	(0.35	)	$	(0.33	)

We calculate stock-based compensation expense under the fair value based method for shares issued pursuant to the 1998 ESPP plan based upon actual shares issued, except for the period since the most recent purchase in February 2003. We estimate the number of shares issuable under the 1998 ESPP plan based upon actual contributions made by employees for the period from February 16 through June 30, 2003 and the lower of the fair market value of our common stock on February 16 and June 30, 2003.

We amortize stock-based compensation expense using the straight-line method over the remaining vesting periods of the related options, which is generally four years for non-qualified and incentive stock options. Stock-based employee compensation expense determined under the fair value based method for non-qualified options issued pursuant to the stock option plans are tax affected. Stock-based employee compensation expense determined under the fair value based method for incentive stock options issued pursuant to the stock option plans and shares issued pursuant to the 1998 ESPP plan are not tax affected.

The fair value of options and shares issued pursuant to the stock option and the 1998 ESPP plans at the grant date were estimated using the Black-Scholes model with the following weighted average assumptions for the three and six months ended June 30, 2003 and 2002:

	Stock option plans				ESPP				Stock option plans				ESPP
	Three months ended June 30,								Six months ended June 30,
	2003		2002		2003		2002		2003		2002		2003		2002
Expected life (years)	4.00		4.00		0.50		0.50		4.00		4.00		0.50		0.50
Risk-free interest rate	2.61	%	4.49	%	0.94	%	3.29	%	2.96	%	4.38	%	2.17	%	3.84	%
Volatility	89	%	90	%	89	%	90	%	89	%	90	%	89	%	90	%
Dividend yield	None		None		None		None		None		None		None		None

        The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. We use projected volatility rates, which are based upon historical volatility rates trended into future years. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our options. Based upon the above assumptions, the weighted average fair valuation per share of options granted under the stock option plans during the three and six months ended June 30, 2003 was $24.29 and $21.20, respectively. The weighted average fair valuation per share of options granted under the stock option plans during the three and six months ended June 30, 2002 was $22.45 and $20.10, respectively. The weighted average fair valuation per share of options granted under the 1998 ESPP plan during the three and six months ended June 30, 2003 was $14.03 and $11.28, respectively. The weighted average fair valuation per share of options granted under the 1998 ESPP plan during the three and six months ended June 30, 2002 was $13.89 and $13.54, respectively.

8

Acquisition related charges

We expense as incurred all costs associated with in-process research and development.

Restructuring, integration and other related charges

We expense as incurred all restructuring, integration and other related charges including direct integration costs, unfavorable lease charges, severance charges, and on-going bonus plans for the retention of key employees from acquisitions.

Advertising expense

We expense the costs of producing advertisements at the time production occurs, and expense the cost of communicating advertising in the period during which the advertising space or airtime is used. For the three and six months ended June 30, 2003, advertising expenses totaled $2.8 million and $5.1 million, respectively. For the three and six months ended June 30, 2002, advertising expenses totaled $0.9 million and $1.6 million, respectively.

Reclassifications

Certain reclassifications have been made to June 30, 2002 balances in order to conform to the June 30, 2003 presentation, namely the break out of maintenance and professional service fee revenue, costs and expenses, interest income and interest expense. The condensed consolidated statement of cash flows has also been modified to conform to the current year presentation, namely the reclassification between sales reserve and trade accounts receivable, proceeds from issuance of common stock and collection of notes receivable from issuance of common stock, as well as the change in presentation of restricted cash from financing activities to investing activities.

Certain changes have been made to diluted net income per share and diluted weighted average common shares to conform to current period presentation.

Recent accounting pronouncements

In January 2003, the FASB issued Interpretation No. 46 (FIN No. 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, which relates to the identification of, and financial reporting for, variable-interest entities (VIEs). FIN No. 46 applies to new entities that are created after January 31, 2003, as well as to existing VIEs no later than the beginning of the first interim or annual reporting period that starts after July 1, 2003. We are currently evaluating the impact of the adoption on our financial position and results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments Hedging Activities. This statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS No. 133. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the condensed consolidated statement of cash flows. The provisions of this standard are effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, except as stated below, all provisions of this statement should be applied prospectively. The provisions of this statement that relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003 should continue to be applied in accordance with their respective effective dates. In addition, certain provisions relating to forward purchases or sales of when-issued securities or other securities that do not yet exist should be applied to existing contracts as well as new contracts entered into after June 30, 2003. We do not expect the adoption of SFAS No. 149 will have a material impact on our financial position and results of operations.

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NOTE 2—SALES RESERVE

Our license agreements and reseller agreements do not offer our customers or vendors the unilateral right to terminate or cancel the contract and receive a cash refund. In addition, the terms of our license agreements do not offer customers price protection.

We do provide for sales returns based upon estimates of potential future credits, warranty cost of product and services, and write-offs of bad debts related to current period product revenue. We analyze historical credits, historical bad debts, current economic trends, average deal size, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales reserve. Revenue for the period is reduced to reflect the sales reserve provision.

The following table summarizes changes in our sales reserve during the three and six months ended June 30, 2003 and 2002 (in thousands):

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Sales reserve:
Beginning balance	$	6,599		$	7,017		$	7,431		$	6,334
Increase (decrease) in sales reserve (reduction/(increase) in revenues)		(829	)		(745	)		(1,236	)		294
Write-off of accounts receivable against reserve		(518	)		(641	)		(957	)		(995	)
Currency translation adjustments		60			97			74			95
Ending balance	$	5,312		$	5,728		$	5,312		$	5,728

NOTE 3—GOODWILL AND INTANGIBLE ASSETS

In May 2003, in conjunction with our acquisition of Performant, we acquired goodwill and intangible assets. See Note 5 for a full description of our acquisition activities.

The changes in the carrying amount of goodwill for the six months ended June 30, 2003 are as follows (in thousands):

Balance at December 31, 2002	$	113,327
Acquisition of Performant		17,051
Balance at June 30, 2003	$	130,378

Changes in the carrying amount of intangible assets are as follows (in thousands):

	June 30, 2003						December 31, 2002
	Gross Carrying Amount		Accumulated Amortization		Net		Net
Intangible assets:
Existing technology	$	5,520	$	2,810	$	2,710	$	1,807
Patents and core technology		2,400		1,159		1,241		741
Employment agreements		720		80		640		—
Customer contracts and other		230		60		170		—
Total intangible assets	$	8,870	$	4,109	$	4,761	$	2,548

The weighted average amortization period of existing technology, patents, and core technology is 40 months, employment agreements is 18 months, and customer contracts and other intangible assets is 32 months. The total weighted average amortization period of all intangible assets is 39 months. The aggregate amortization expense of intangible assets was $0.7 million and $1.2 million for the three and six months ended June 30, 2003 and $0.6 million and $1.3 million for the three and six months ended June 30, 2002. The estimated total amortization expense of intangible assets is $2.7 million for 2003, $1.8 million for 2004, $0.6 million for 2005 and 2006, and $0.2 million for 2007.

NOTE 4—LONG-TERM DEBT

In July 2000, we issued $500.0 million in Convertible Subordinated Notes (2000 Notes). The 2000 Notes mature on July 1, 2007 and bear interest at a rate of 4.75% per annum, payable semiannually on January 1 and July 1 of each year. The 2000 Notes are subordinated in right of payment to all of our future senior debt. The 2000 Notes are convertible into shares of our common stock at any time prior to maturity at a conversion price of approximately $111.25 per share, subject to adjustment under certain conditions. We may redeem the 2000 Notes, in whole or in part, at any time on or after July 1, 2003. Accrued interest to the redemption date will be paid by us in any such redemption. From December 2001 through June 30, 2002, we retired $200.0 million face value of the 2000 Notes.

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In connection with the issuance of our 2000 Notes, we incurred $14.6 million of issuance costs, which primarily consisted of investment banker fees, legal, and other professional fees. Through the first six months of 2002, in conjunction with the retirement of a portion of our 2000 Notes we wrote-off $3.8 million of debt issuance costs. No costs were written off during the last six months of 2002 or the first six months of 2003. The remaining costs are being amortized using a straight-line method over the remaining term of the 2000 Notes. Amortization expense related to the issuance costs was $0.4 million and $0.8 million for both the three and six months ended June 30, 2003 and 2002, respectively. At June 30, 2003 and December 31, 2002, net debt issuance costs associated with our 2000 Notes were $5.3 million and $6.0 million, respectively.

In April 2003, we issued $500.0 million of Zero Coupon Convertible Notes (2003 Notes) Due 2008 in a private offering. The 2003 Notes do not bear interest, have a zero yield to maturity and will be convertible into our common stock at a conversion price of $51.69. Holders of the 2003 Notes may convert their 2003 Notes only if the sale price of our common stock reaches specified thresholds or if specified corporate transactions have occurred. Upon conversion, we have the right to deliver cash instead of shares of our common stock. We may not redeem the 2003 Notes prior to their maturity.

In connection with the issuance of our 2003 Notes, we incurred $11.8 million of issuance costs, which primarily consisted of investment banker fees, legal, and other professional fees. These costs are being amortized using a straight-line method over the term of the 2003 Notes. Amortization expense related to the issuance costs was $0.4 million for the three and six months ended June 30, 2003. At June 30, 2003, net debt issuance costs were $11.4 million.

NOTE 5—ACQUISITION

On May 5, 2003, we acquired all of the outstanding stock and assumed the unvested stock options of Performant, a provider of Java 2 Enterprise Edition (J2EE) diagnostics software. Performant’s technology pinpoints performance problems at the application code level reducing the cost and time required to optimize J2EE applications. The Performant acquisition allows our customers to diagnose J2EE performance issues across the application delivery and management cycle from application delivery to operations. The joint offerings of Mercury and Performant products optimize the performance levels of J2EE applications and accelerate the adoption of J2EE as an environment for business critical applications.

The total purchase price was $22.4 million and consisted of cash consideration of $21.9 million, net of cash acquired of $0.3 million and transaction costs of $0.5 million. The total purchase price was allocated, based upon a third party valuation, as follows (in thousands):

Tangible assets	$	270
Deferred tax asset		2,800
Liabilities assumed		(1,190	)
Deferred tax liability		(1,180	)
Existing technology		1,620
In-process research and development (IPR&D)		1,280
Patents and core technology		800
Employment agreements		720
Customer contracts and related relationships		150
Order backlog		80
Goodwill		17,051
Total purchase price	$	22,401

In accordance with GAAP, we recorded a deferred tax asset of $2.8 million for the acquired deferred tax assets relating to net operating loss and tax credit carryforwards for tax purposes acquired in the acquisition. In addition, a deferred tax liability of $1.2 million was recorded for the difference between the assigned values and the tax bases of the intellectual property assets acquired in the acquisition.

The weighted average amortization period of existing technology, patents and core technology, and customer contracts and related relationships is 48 months, employment agreements is 18 months, and order backlog is 3 months. The total weighted average amortization period of all intangible assets is 41 months. All intangible assets will be amortized on a straight-line basis over their useful lives. Amortization expense for the three and six months ended June 30, 2003 was $0.2 million. The estimated total amortization expense associated with acquired Performant intangible assets is $0.6 million for the remainder of 2003, $1.0 million for 2004, $0.6 million for 2005 and 2006, and $0.2 million for 2007.

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In conjunction with the acquisition of Performant, we recorded a $1.3 million charge for acquired IPR&D during the second quarter of 2003 because technological feasibility had not been established and no future alternative uses existed. The IPR&D charge is included as “Acquisition related charges” in our condensed consolidated statements of operations for the three and six months ended June 30, 2003. The acquired IPR&D is related to the development of the Microsoft version of the diagnostics software or .Net version. The value of IPR&D is determined through the discounted cash flow approach. The expected future cash flow attributable to the in-process technology was discounted at 29%, taking into account the percentage of completion of approximately 46%, the rate technology changes in the industry, product life cycles, the future markets, and various projects’ stage of development. The project is currently expected to be completed within the next 6 to 12 months and the estimated costs to complete the project are insignificant during that time.

In conjunction with the acquisition of Performant, we recorded unearned stock-based compensation totaling $0.3 million associated with approximately 9,300 unvested stock options that we assumed. The options assumed were valued using the fair value of our common stock on the date of acquisition, which was $35.19. During the three and six months ended June 30, 2003, amortization of unearned stock-based compensation associated with these options was insignificant. We expect to amortize insignificant amounts through 2007, which is over the remaining vesting periods of the related options.

The transaction was accounted for as a purchase and, accordingly the operating results of Performant have been included in our accompanying condensed consolidated statements of operations from the date of acquisition. The following unaudited pro forma information presents the combined results of Mercury Interactive and Performant as if the acquisition had occurred as of the beginning of 2002, after applying certain adjustments, including amortization of intangible assets and unearned stock-based compensation and interest income, net of related tax effects. IPR&D of $1.3 million has been excluded from the following presentation(in thousands, except per share amounts):

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Net revenues	$	118,071	$	94,135	$	228,572	$	184,680
Net income	$	17,164	$	16,543	$	33,718	$	29,973
Net income per share (basic)	$	0.20	$	0.20	$	0.40	$	0.36
Net income per share (diluted)	$	0.19	$	0.19	$	0.38	$	0.34

In conjunction with the acquisition of Performant, we committed to a license agreement for technology. The agreement was entered into in August 2000 and remains in effect until April 2018. The total estimated commitment is approximately $0.2 million, although the maximum commitment could reach approximately $0.8 million.

In conjunction with the acquisition of Performant, we entered into a milestone bonus plan related to certain research and development activities. The plan entitles each eligible employee to receive bonuses, in the form of cash payments, based on the achievement of certain performance milestones by applicable target dates through November 2004. The commitment will be earned equally over time as milestones are achieved and expensed as acquisition related charges. The maximum payments under the plan are $5.5 million. We recorded $0.9 million as “Restructuring, integration and other related charges” in our condensed consolidated statements of operations for the three and six months ended June 30, 2003 associated with the milestone bonus plan.

NOTE 6—NET INCOME PER SHARE

Earnings per share is calculated in accordance with the provisions of SFAS No. 128, Earnings per Share. SFAS No. 128 requires the reporting of both basic earnings per share, which is the weighted-average number of common shares outstanding, and diluted earnings per share, which includes the weighted-average number of common shares outstanding and all dilutive potential common shares outstanding, using the treasury stock method. For the three and six months ended June 30, 2003 and 2002, dilutive potential common shares outstanding reflects shares issuable under our stock option plans.

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The following table summarizes our earnings per share computations for the three and six months ended June 30, 2003 and 2002 (in thousands, except per share amounts):

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Numerator:
Net income	$	16,935	$	18,020	$	35,079	$	33,180
Denominator:
Denominator for basic net income per share—weighted average shares		85,610		83,817		85,322		83,502
Incremental common shares attributable to shares issuable under employee stock option plans		4,896		4,347		4,623		4,725
Denominator for diluted net income per share—weighted average shares		90,506		88,164		89,945		88,227
Net income per share (basic)	$	0.20	$	0.21	$	0.41	$	0.40
Net income per share (diluted)	$	0.19	$	0.20	$	0.39	$	0.38

For the three and six months ended June 30, 2003, options to purchase approximately 9,123,700 and 9,617,100 shares of common stock with a weighted average price of $54.26 and $53.33, respectively, were considered anti-dilutive because the options’ exercise price was greater than the average fair market value of our common stock for the period then ended. For the three and six months ended June 30, 2002, options to purchase approximately 9,797,300 and 9,563,600 shares of common stock with a weighted average price of $54.46 and $54.96, respectively, were considered anti-dilutive. For both the three and six months ended June 30, 2003 and 2002, common stock reserved for issuance upon conversion of our 2000 Notes for approximately 2,696,700 shares were not included in diluted earnings per share because the conversion would be anti-dilutive. The 2003 Notes would only be included if our common stock price reaches $51.69 per share and if we elect to settle in stock instead of cash. In this case, 9,673,050 shares would be included in both the basic and diluted weighted average common shares and equivalents for the net income per share calculation.

NOTE 7—INCOME TAXES

The effective tax rate for the three and six months ended June 30, 2003 and 2002 differs from statutory tax rates principally because of our participation in taxation programs in Israel. This tax structure is dependent upon continued reinvestment in our Israeli operations. Other factors that cause the effective tax rate and statutory tax rates to differ include the non-deductibility of charges for amortization of intangible assets, stock-based compensation, and in-process research and development.

NOTE 8—COMPREHENSIVE INCOME

We report components of comprehensive income in our annual consolidated statements of shareholders’ equity. Comprehensive income consists of net income and foreign currency translation adjustments. Total comprehensive income for the three and six months ended June 30, 2003 and 2002 is as follows (in thousands):

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Net income	$	16,935		$	18,020		$	35,079		$	33,180
Foreign currency translation adjustments		(1,123	)		(683	)		(1,003	)		98
Comprehensive income	$	15,812		$	17,337		$	34,076		$	33,278

NOTE 9—SUPPLEMENTAL CASH FLOW DISCLOSURES

Supplemental cash flow disclosures for the six months ended June 30, 2003 and 2002 are as follows (in thousands):

	Six months ended June 30,
	2003		2002
Supplemental disclosure:
Cash paid during the year for income taxes, net of refunds of $30 and $0, respectively	$	4,835	$	910
Cash paid during the year for interest expense	$	12,333	$	10,160

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NOTE 10—DERIVATIVE FINANCIAL INSTRUMENTS

We comply with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The standard requires us to recognize all derivatives on the condensed consolidated balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through the condensed consolidated statements of operations. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings, or recognized in other comprehensive income (loss) until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. The accounting for gains or losses from changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship, as well as on the type of hedging relationship.

We have entered into forward contracts to hedge foreign currency denominated receivables due from certain Americas, EMEA, APAC, and Japan subsidiaries and foreign branches against fluctuations in exchange rates. We have not entered into forward contracts for speculative or trading purposes. The criteria used for designating a forward contract as a hedge considers its effectiveness in reducing risk by matching hedging instruments to underlying transactions. Gains and losses on forward contracts are recognized in other income in the same period as gains and losses on the underlying transactions. We had outstanding forward contracts with notional amounts totaling $22.1 million and $17.5 million at June 30, 2003 and December 31, 2002, respectively. The forward contracts in effect at June 30, 2003 mature at various dates through December 2003 and are hedges of certain foreign currency transaction exposures in the Australian Dollar, British Pound, Canadian Dollar, Euro, Japanese Yen, Norwegian Kroner, Singapore Dollar, South African Rand, and Swiss Franc. The unrealized net gain on our forward contracts for the three and six months ended June 30, 2003 was $0.4 million and $0.2 million, respectively. The unrealized net loss on our forward contracts for the three and six months ended June 30, 2002 was $0.4 million and $0.8 million, respectively.

We utilize forward exchange contracts of one fiscal-month duration to offset various non-functional currency exposures. Currencies hedged under this program include the Australian Dollar, Canadian Dollar, British Pound, Euro, Israeli Shekel, and Swedish Kroner. Increases or decreases in the value of these non-functional currency assets are offset by gains and losses on the forward exchange contracts to mitigate the risk associated with foreign exchange market fluctuations.

In January 2002 and February 2002, we entered into two interest rate swaps with respect to $300.0 million of our 2000 Notes. In November 2002, we terminated our January and February interest rate swaps with Goldman Sachs Capital Markets, L.P. (GSCM) and replaced them with a single interest rate swap in order to improve the overall effectiveness of our interest rate swap arrangement. The November interest rate swap is designated as an effective hedge of the change in the fair value attributable to the London Interbank Offering Rate (LIBOR rate) relating to $300.0 million of our 2000 Notes. The objective of the swap is to convert the 4.75% fixed interest rate on the 2000 Notes to a variable interest rate based on the 6-month LIBOR rate plus 46.0 basis points. Beginning in January 2003, the variable interest rate on the swap was modified so that it is now based on the 3-month LIBOR rate plus 48.5 basis points. The gain or loss from changes in the fair value of the interest rate swap is expected to be highly effective at offsetting the gain or loss from changes in the fair value attributable to changes in the LIBOR rate throughout the life of the 2000 Notes. The interest rate swap creates a market exposure to changes in the LIBOR rate. Under the terms of the swap, we are required to provide initial collateral in the form of cash or cash equivalents to GSCM in the amount of $6.0 million as continuing security for our obligations under the swap (irrespective of movements in the value of the swap) and from time to time additional collateral can change hands between Mercury Interactive and GSCM as swap rates and equity prices fluctuate. We accounted for the initial collateral and any additional collateral as restricted cash on our condensed consolidated balance sheets. If the price of our common stock exceeds the original conversion or redemption price of the 2000 Notes, we will be required to pay the fixed rate of 4.75% and receive a variable rate on the $300.0 million principal amount of the 2000 Notes. If we call the 2000 Notes at a premium (in whole or in part), or if any of the holders of the 2000 Notes elected to convert the 2000 Notes (in whole or in part), we will be required to pay a variable rate and receive the fixed rate of 4.75% on the principal amount of such called or converted 2000 Notes.

Our interest rate swap qualifies under SFAS No. 133 as a fair-value hedge. We record the fair value of our interest rate swap and the change in the fair value of the underlying 2000 Notes attributable to changes in the LIBOR rate on our condensed consolidated balance sheets, and we record the ineffectiveness arising from the difference between the two fair values in our condensed consolidated statements of operations as other income (expense). At June 30, 2003 and December 31, 2002, the fair value of the swap was approximately $20.2 million and $17.4 million, respectively, and the change in the fair value of our 2000 Notes attributable to changes in the LIBOR rate during the period resulted in an increase to the carrying value of our 2000 Notes of $19.7 million and $17.0 million, respectively. The difference was recorded in other income as the unrealized gain on interest rate swap for the three and six months ended June 30, 2003 and 2002. At June 30, 2003 and December 31, 2002, our total restricted cash associated with the swap was $6.0 million.

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We are exposed to credit exposure with respect to GSCM as counterparty under the swap. However, we believe that the risk of such credit exposure is limited because GSCM is an affiliate of a major US investment bank and because its obligations under the swap are guaranteed by the Goldman Sachs Group L.P.

For the three and six months ended June 30, 2003, we have recorded interest expense of $1.3 million and $2.8 million, respectively, and interest income of $3.6 million and $7.1 million, respectively, as a result of our interest rate swap and our prior interest rate swaps for the 2002 period. For the three and six months ended June 30, 2002, we recorded interest expense of $2.0 million and $3.6 million, respectively, and interest income of $3.9 million and $6.7 million, respectively, as a result of our interest rate swap and our prior interest rate swaps for the 2002 period. Our net interest expense, including the interest paid on our 2000 Notes, was $1.3 million and $2.8 million for the three and six months ended June 30, 2003, respectively, and $2.3 million and $5.2 million for the three and six months ended June 30, 2002, respectively.

NOTE 11—ROYALTY AGREEMENT

On June 30, 2003, we entered into a non-exclusive agreement to license technology from Motive Communications. The agreement is non-transferable, except in the case of a merger, acquisition, spin-out or other transfer of all or substantially all of the business, stock or assets to which the agreement relates. The licensed technology will be combined with other existing Mercury products, which should be generally available within six months from the effective date of this agreement. The agreement is in effect until December 31, 2005 with an election to renew and an option to purchase a fully paid up, perpetual license to the technology prior to July 1, 2008. We have committed to royalty payments totaling $15.0 million, which will be paid through June 15, 2004.

NOTE 12—SEGMENT AND GEOGRAPHIC REPORTING

We have four reportable operating segments: the Americas, EMEA, APAC, and Japan. The Americas includes Brazil, Canada and the United States. EMEA includes Belgium, Denmark, Finland, France, Germany, Holland, Israel, Italy, Luxembourg, Norway, South Africa, Spain, Sweden, Switzerland, and the United Kingdom. APAC includes Australia, China, Hong Kong, Korea, and Singapore. These segments are organized, managed, and analyzed geographically and operate in one industry segment: the development, marketing, and selling of integrated application delivery (formerly known as testing and deployment) and application management (formerly known as application performance management or APM) solutions. Our chief decision makers evaluate operating segment performance based primarily on net revenues and certain operating expenses.

Financial information for our operating segments is as follows for the three and six months ended June 30, 2003 and 2002 (in thousands):

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Net revenues to third parties:
Americas	$	74,474	$	61,600	$	143,303	$	123,100
EMEA (including UK of $13,579, $9,265, $27,319 and $18,197, respectively)		35,908		26,600		69,266		50,800
APAC		5,332		3,745		10,097		5,977
Japan		2,342		2,055		5,775		4,623
Total	$	118,056	$	94,000	$	228,441	$	184,500

	June 30, 2003		December 31, 2002
Property and equipment, net:
Americas	$	56,582	$	54,553
EMEA (including Israel of $28,622 and $29,280, respectively)		31,412		32,367
APAC		1,078		1,170
Japan		382		426
Total	$	89,454	$	88,516

International sales represented 37% of our total revenues for both the three and six months ended June 30, 2003 and 34% and 33% of our total revenues for the three and six months ended June 30, 2002. The subsidiary located in the United Kingdom accounted for 12% of the consolidated net revenues to unaffiliated customers for both the three and six months ended June 30, 2003 and 10% for both the three and six months ended June 30, 2002. Operations located in Israel accounted for 21% and 27% of the consolidated identifiable assets at June 30, 2003 and December 31, 2002, respectively.

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Although we operate in one industry segment, our chief decision makers evaluate net revenues based on the components of application delivery and application management. Accordingly, the following tables present revenues for application delivery and management for the three and six months ended June 30, 2003 and 2002 (in thousands):

	Three months ended June 30,
	2003						2002
	Application Delivery		Application Management		Total		Application Delivery		Application Management		Total
Revenues:
License fees	$	45,370	$	2,634	$	48,004	$	42,337	$	2,526	$	44,863
Subscription fees		9,152		13,335		22,487		4,446		7,891		12,337
Total product revenues		54,522		15,969		70,491		46,783		10,417		57,200
Maintenance fees		36,881		1,864		38,745		28,078		1,202		29,280
Service fees		7,995		825		8,820		7,282		238		7,520
Total revenues	$	99,398	$	18,658	$	118,056	$	82,143	$	11,857	$	94,000

	Six months ended June 30,
	2003						2002
	Application Delivery		Application Management		Total		Application Delivery		Application Management		Total
Revenues:
License fees	$	87,982	$	4,808	$	92,790	$	85,046	$	4,538	$	89,584
Subscription fees		17,616		24,145		41,761		8,224		15,392		23,616
Total product revenues		105,598		28,953		134,551		93,270		19,930		113,200
Maintenance fees		70,627		3,703		74,330		54,685		2,245		56,930
Service fees		18,232		1,328		19,560		13,780		590		14,370
Total revenues	$	194,457	$	33,984	$	228,441	$	161,735	$	22,765	$	184,500

NOTE 13—SUBSEQUENT EVENT

On June 9, 2003, we signed a non-binding agreement to acquire Kintana. Kintana is a privately-held company which designs, develops and supports software which digitizes and integrates IT business processes from demand to production, enabling real-time decision-making and execution for strategic projects. Under the terms of the merger agreement, we will issue a mix of cash and stock, with a value of approximately $225.0 million to acquire all of Kintana’s outstanding stock. In addition, we will assume all of Kintana’s unvested employee stock options. The transaction is expected to close in August 2003.

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Item 2. 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 “Management’s Discussion and Analysis of Financial Condition and Results of Operations—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 application delivery products in 1991. Since 1991, we have introduced a variety of solutions for application delivery (formerly known as testing and deployment) and application management (formerly known as application performance management or APM). Today’s enterprise is critically dependent on IT-delivered systems and applications that automate business processes to meet business requirements. These needs place IT in the relatively new role as a business-critical function and put IT management under enormous pressure to operate like a business. Business Technology Optimization (BTO) is an emerging new business strategy that enables companies to optimize and align business and technology performance to meet key business objectives. Mercury Interactive is the leading provider of BTO products and services, providing an integrated approach to application delivery and management solutions that enable customers to optimize the quality of their IT-delivered services, align IT execution with business goals, and reduce spending throughout their IT infrastructure.

Results of Operations

The following table sets forth, as a percentage of total revenue, certain condensed consolidated statements of operations data for the periods indicated. These operating results are not necessarily indicative of the results for any future period.

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Revenues:
License fees	41	%	48	%	41	%	48	%
Subscription fees	19		13		18		13
Total product revenues	60		61		59		61
Maintenance fees	33		31		32		31
Professional service fees	7		8		9		8
Total revenues	100		100		100		100
Costs and expenses:
Cost of license and subscription	6		7		6		7
Cost of maintenance	3		3		2		3
Cost of professional services	6		6		6		5
Marketing and selling	47		50		47		50
Research and development	11		11		11		11
General and administrative	8		8		8		9
Amortization of unearned stock-based compensation	—		—		—		—
Acquisition related charges	1		—		1		—
Restructuring, integration and other related charges	1		—		1		—
Amortization of intangible assets	1		1		1		1
Total costs and expenses	84		86		83		86
Income from operations	16		14		17		14
Interest income	7		10		7		10
Interest expense	(4	)	(7	)	(3	)	(6	)
Other (expense) income, net	(1	)	7		(1	)	5
Income before provision for income taxes	18		24		20		23
Provision for income taxes	4		5		5		5
Net income	14	%	19	%	15	%	18	%

Certain reclassifications have been made for the three and six months ended June 30, 2002 in order to conform to the June 30, 2003 presentation, namely the break out of maintenance and professional service fee revenue, costs and expenses, interest income and interest expense.

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Business Model

Revenue consists of fees for the license and subscription of our software products, maintenance fees, and professional service fees. License revenue is comprised of license fees charged for the use of our products licensed under perpetual or multiple year arrangements (perpetual licenses) in which the fair value of the license fee is separately determinable from maintenance and/or professional services. Subscription revenue, including managed service revenue, represents license fees to use one or more software products, and to receive maintenance support (such as hotline support and updates) for a limited period of time. Since subscriptions include bundled products and services, both product and service revenue is generally recognized ratably over the term. Maintenance revenue is comprised of fees charged for post contract customer support which are determinable based upon vendor specific evidence of fair value. Professional service revenue is comprised of fees charged for product training and consulting services which are determinable based upon vendor specific evidence of fair value.

Due to the different treatment of subscription and perpetual licenses under applicable accounting rules, each type of license has a different impact on our condensed consolidated financial statements. When a customer buys a subscription license, the majority of the revenue will be recorded as deferred revenue on our condensed consolidated balance sheet. The amount recorded as deferred revenue is equal to the portion of the license fee that has been invoiced or paid but not recognized as revenue. Deferred revenue is reduced as revenue is recognized. Under perpetual licenses (and some multi-year arrangements for which separate vendor specific objective evidence exists for undelivered elements), a high proportion of all license revenue is recognized in the quarter that the product is delivered, with relatively little recorded as deferred revenue. Therefore, an order for a subscription license will result in significantly lower current-period revenue than an equal-sized order under perpetual licenses. Conversely, an order for a subscription license will result in higher revenues recognized in future periods than an equal-sized order for a perpetual license.

Our license revenue in any given quarter is dependent upon the volume of perpetual orders shipped during the quarter and the amount of subscription revenue amortized from deferred revenue and, to a small degree, recognized on subscription orders received during the quarter. We set our revenue targets for any given period based, in part, upon an assumption that we will achieve a certain level of orders and a certain license mix of perpetual licenses and subscription licenses. The precise mix of orders is subject to substantial fluctuation in any given quarter or multiple quarter periods, and the actual mix of licenses sold affects the revenue we recognize in the period. If we achieve the target level of total orders but are unable to achieve our target license mix, we may not meet our revenue targets (if we deliver more-than-expected subscription licenses) or may exceed them in the mix of domestic and international sales, together with fluctuations in foreign exchange rates (if we deliver more-than-expected perpetual licenses). If we achieve the target license mix but the overall level of orders is below the target level, then we may not meet our revenue targets. In 2002, we effected a change in the mix of software license types to a higher percentage of subscription licenses, especially for our application management products. We believe that this shift will continue in the future, as more of our products are offered and as more of our customers license our products on a subscription basis. This shift may cause us to experience a decrease in recognized revenue, as well as continued growth of deferred revenue, in the near term.

Cost of license and subscription includes direct costs to produce and distribute our products, such as costs of materials, product packaging and shipping, equipment depreciation and production personnel; and costs associated with our managed services business, including personnel related costs, fees to providers of internet bandwidth and related infrastructure (ISP fees) and depreciation expense of managed services equipment. Cost of maintenance includes direct costs of providing product customer support, largely consisting of personnel costs and related expenses; and the cost of providing upgrades to our subscription customers. We have not broken out the costs associated with licenses or subscriptions because these costs cannot be separated between license and subscription cost of revenue. Cost of professional services includes the direct costs of providing product training and consulting, largely consisting of personnel costs and related expenses. License and subscription, maintenance, and professional services costs also include allocated facility expenses and information technology infrastructure costs.

The cost associated with subscription licenses, which include the cost of products and services, are expensed as incurred over the subscription term. In addition, we defer the portion of our commission expense related to subscription licenses and amortize the expense over the subscription term. See Critical Accounting Policies for a full description of our estimation process for accrued liabilities.

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Revenues

License fees

License fee revenue was $48.0 million for the three months ended June 30, 2003 compared to $44.9 million for the three months ended June 30, 2002, an increase of 7%. This increase in license fee revenue of $3.1 million was primarily attributable to an increase in application delivery license fee revenue. License fee revenue was $92.8 million for the six months ended June 30, 2003 compared to $89.6 million for the six months ended June 30, 2002, an increase of 4%. This increase in license fee revenue of $3.2 million was primarily attributable to an increase in application delivery license fee revenue. We expect our license fee revenue to remain relatively flat in absolute dollars in 2003.

Subscription fees

Subscription fee revenue was $22.5 million for the three months ended June 30, 2003 compared to $12.3 million for the three months ended June 30, 2002, an increase of 83%. This increase in subscription fee revenue of $10.2 million was primarily attributable to an increase of $4.7 million in application delivery subscription fee revenue and an increase of $5.5 million in application management subscription fee revenue resulting from our continuous effort to shift to a subscription business model. Subscription fee revenue was $41.8 million for the six months ended June 30, 2003 compared to $23.6 million for the six months ended June 30, 2002, an increase of 77%. This increase in subscription fee revenue of $18.2 million was primarily attributable to an increase of $9.4 million in application delivery subscription fee revenue and an increase of $8.8 million in application management subscription fee revenue resulting from our continuous effort to shift to a subscription business model. We expect sales of our subscription licenses and services to continue to increase in absolute dollars in 2003.

Product revenue

Product revenue was $70.5 million for the three months ended June 30, 2003 compared to $57.2 million for the three months ended June 30, 2002, an increase of 23%. Product revenue was $134.6 million for the six months ended June 30, 2003 compared to $113.2 million for the six months ended June 30, 2002, an increase of 19%. These increases in product revenue are primarily attributable to increases in subscription fee revenue, as we continue to shift to a subscription revenue model, as more of our products are offered and as more of our customers license products on a subscription basis. We expect our product revenue to continue to increase in absolute dollars in 2003.

Maintenance fees

Maintenance fee revenue was $38.7 million for the three months ended June 30, 2003 compared to $29.3 million for the three months ended June 30, 2002, an increase of 32%. This increase in maintenance fee revenue of $9.4 million was primarily attributable to an increase of $8.8 million in application delivery maintenance fee revenue and an increase of $0.6 million in application management maintenance fee revenue. Maintenance fee revenue was $74.3 million for the six months ended June 30, 2003 compared to $56.9 million for the six months ended June 30, 2002, an increase of 31%. This increase in maintenance fee revenue of $17.4 million was primarily attributable to an increase of $15.9 million in application delivery maintenance fee revenue and an increase of $1.5 million in application management maintenance fee revenue. We expect our maintenance fee revenue to continue to increase in absolute dollars in 2003.

Professional service fees

Professional service fee revenue was $8.8 million for the three months ended June 30, 2003 compared to $7.5 million for the three months ended June 30, 2002, an increase of 17%. This increase in professional service fee revenue of $1.3 million was primarily attributable to an increase of $0.7 million in application delivery professional service fee revenue and an increase of $0.6 million in application management professional service fee revenue. Professional service fee revenue was $19.6 million for the six months ended June 30, 2003 compared to $14.4 million for the six months ended June 30, 2002, an increase of 36%. This increase in professional service fee revenue of $5.2 million was primarily attributable to an increase of $4.5 million in application delivery professional service fee revenue and an increase of $0.7 million in application management professional service fee revenue. We expect our professional service fee revenue to continue to increase in absolute dollars in 2003.

International sales

International sales represented 37% of our total revenues for both the three and six months ended June 30, 2003 and 34% and 33% of our total revenues for the three and six months ended June 30, 2002. Our international revenues increased 35% in absolute dollars in the three months ended June 30, 2003, compared to 2002, primarily due to an increase in sales performance and foreign currency fluctuations in EMEA of $9.3 million, APAC of $1.6 million, and Japan of $0.3 million. Our international revenue increased 39% in absolute dollars in the six months ended June 30, 2003, compared to 2002, primarily due to an increase in sales performance and foreign currency fluctuations in EMEA of $18.5 million, APAC of $4.1 million, and Japan of $1.2 million.

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Costs and expenses

Cost of license and subscription

Cost of license and subscription was $6.8 million for the three months ended June 30, 2003, or 6% of total revenues, compared to $6.6 million for the three months ended June 30, 2002, or 7% of total revenues. Cost of license and subscription was $13.3 million for the six months ended June 30, 2003, or 6% of total revenues, compared to $12.9 million for the six months ended June 30, 2002, or 7% of total revenues. Based upon our revenue growth as described in “Revenues,” we expect cost of license and subscription to continue to increase in absolute dollars in 2003.

Cost of maintenance

Cost of maintenance was $2.8 million for the three months ended June 30, 2003, or 3% of total revenues, compared to $2.9 million for the three months ended June 30, 2002, or 3% of total revenues. Cost of maintenance was $5.5 million for the six months ended June 30, 2003, or 2% of total revenues, compared to $5.7 million for the six months ended June 30, 2002, or 3% of total revenues. Based upon our revenue growth as described in “Revenues,” we expect cost of maintenance to remain relatively flat in absolute dollars in 2003.

Cost of professional services

Cost of professional services was $7.5 million for the three months ended June 30, 2003, or 6% of total revenues, compared to $5.5 million for the three months ended June 30, 2002, or 6% of total revenues. The absolute dollar increase of $2.0 million was primarily attributable to an increase in personnel-related costs due to an increased number of employees. Cost of professional services was $14.1 million for the six months ended June 30, 2003, or 6% of total revenues, compared to $9.8 million for the six months ended June 30, 2002, or 5% of total revenues. The absolute dollar increase of $4.3 million was primarily attributable to an increase in personnel-related costs due to an increased number of employees. Based upon our revenue growth as described in “Revenues,” we expect cost of professional service to continue to increase in absolute dollars in 2003.

Marketing and selling

Marketing and selling expense consists of employee salaries and related costs, sales commissions, marketing programs, and allocated facility expenses and information technology infrastructure costs. Marketing and selling expense was $55.8 million for the three months ended June 30, 2003, or 47% of total revenues, compared to $46.5 million for the three months ended June 30, 2002, or 50% of total revenues. The absolute dollar increase of $9.3 million was primarily attributable to an increase of $5.3 million in personnel-related costs due to an increased number of employees, an increase of $2.1 million in marketing programs, an increase of $1.2 million in commissions resulting from increased sales, and an increase of $0.6 million for a selling event. These increases in marketing and selling expenses were offset by a decrease of $1.0 million in facilities expenses. Marketing and selling expense was $108.5 million for the six months ended June 30, 2003, or 47% of total revenues, compared to $92.0 million for the six months ended June 30, 2002, or 50% of total revenues. The absolute dollar increase of $16.5 million was primarily attributable to an increase of $11.5 million in personnel-related costs due to an increase number of employees, an increase of $4.2 million in marketing programs, an increase of $0.8 million in commissions resulting from increased sales, and an increase of $0.8 million in IT infrastructure expenses. These increases in marketing and selling expenses were offset by a decrease of $1.3 million in facilities expenses. Based upon our revenue growth as described in “Revenues,” we expect marketing and selling expenses to remain relatively flat in absolute dollars in 2003.

Research and development

Research and development expense consists of costs associated with the development of new products, enhancements of existing products, and quality assurance procedures; research and development expense is comprised primarily of employee salaries and related costs, consulting costs, equipment depreciation and allocated facility expenses and information technology infrastructure costs. Research and development expense was $13.1 million for the three months ended June 30, 2003, or 11% of total revenues, compared to $10.3 million for the three months ended June 30, 2002, or 11% of total revenues. The absolute dollar increase of $2.8 million was primarily attributable to an increase of $1.74 million in personnel-related costs due to an increased number of employees and an increase of $0.9 million resulting from the appreciation of the Israeli Shekel to the US dollar. Research and development expense was $24.7 million for the six months ended June 30, 2003, or 11% of total revenues, compared to $20.9 million for the six months ended June 30, 2002, or 11% of total revenues. The absolute dollar increase of $3.8 million was primarily attributable to an increase of $3.1 million in personnel-related costs due to an increased number of employees, an increase of $0.6 million in IT infrastructure expenses, and an increase of $0.4 million resulting from the appreciation of the Israeli Shekel to the US dollar. Based upon our product development plan, we expect research and development expense to continue to increase in absolute dollars in 2003.

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General and administrative

General and administrative expense consists of employee salaries and related costs associated with administration and management, as well as allocated facility expenses and information technology infrastructure costs. General and administrative expense was $9.7 million for the three months ended June 30, 2003, or 8% of total revenues, compared to $7.9 million for the three months ended June 30, 2002, or 8% of total revenues. The absolute dollar increase of $1.8 million was primarily attributable to an increase in personnel-related costs due to an increased number of employees. General and administrative expense was $18.8 million for the six months ended June 30, 2003, or 8% of total revenues, compared to $15.4 million for the six months ended June 30, 2002, or 9% of total revenues. The absolute dollar increase of $3.4 million was primarily attributable to an increase in personnel-related costs due to an increased number of employees. Based upon our revenue growth as described in “Revenues,” we expect general and administrative expenses to continue to increase in absolute dollars in 2003.

Amortization of unearned stock-based compensation

During the second quarter of 2001, in connection with the acquisition of Freshwater, we recorded unearned stock-based compensation totaling $10.4 million associated with approximately 140,000 unvested stock options that we assumed. The options assumed were valued using the fair market value of our common stock on the date of acquisition, which was $74.21. We also recorded stock-based compensation expense of $0.3 million in conjunction with the third quarter of 2001 restructuring. The options were valued using the fair market value of our stock on the date of accelerated vesting, which was a weighted average of $32.92. Through December 31, 2002, we reduced unearned stock-based compensation by $6.3 million due to the termination of certain employees. During the six months ended June 30, 2003, we further reduced unearned stock-based compensation associated with the Freshwater acquisition by $0.4 million. During the second quarter of 2003, in connection with the acquisition of Performant, we recorded unearned stock-based compensation totaling $0.3 million associated with approximately 9,300 unvested stock options that we assumed. The options assumed were valued using the fair value of our common stock on the date of acquisition, which was $35.19. Amortization of unearned stock-based compensation was $0.2 million for the three months ended June 30, 2003 compared to $0.3 million for the three months ended June 30, 2002. Amortization of unearned stock-based compensation was $0.4 million for the six months ended June 30, 2003 compared to $0.7 million for the six months ended June 30, 2002. We expect to amortize on average $0.1 million per quarter through 2004 and insignificant amounts through the first quarter of 2007, which is the remaining vesting periods of the related options.

Acquisition related charges

In May 2003, in conjunction with the acquisition of Performant, we recorded a $1.3 million charge for acquired IPR&D because technological feasibility had not been established and no future alternative uses existed. See Note 5 to the condensed consolidated financial statements for a full description of our acquisition.

Restructuring, integration and other related charges

In May 2003, in conjunction with the acquisition of Performant, we entered into a milestone bonus plan related to certain research and development activities. The plan entitles each eligible employee to receive bonuses, in the form of cash payments, based on the achievement of certain performance milestones by applicable target dates through November 2004. The commitment will be earned over time as milestones are achieved and expensed as restructuring, integration and other related charges in our condensed consolidated statements of operations. The maximum payments under the plan are $5.5 million. For the three and six months ended June 30, 2003, we recorded $0.9 million as restructuring, integration and other related charges in our condensed consolidated statements of operations associated with the milestone bonus plan. We do not expect other additional integration charges to have a significant impact on our financial position and results of operations.

During the six months ended June 30, 2002, we recorded a benefit of $0.5 million. The benefit resulted from a reversal in the first quarter of 2002 of cash charges resulting from the cancellation of a marketing event for which we were able to use the deposit toward another event.

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Amortization of intangible assets

Amortization of intangible assets was $0.7 million for the three months ended June 30, 2003 compared to $0.6 million for the three months ended June 30, 2002. Amortization of intangible assets was $1.2 million for the six months ended June 30, 2003 compared to $1.3 million for the six months ended June 30, 2002. In May 2001, we acquired all of the outstanding securities of Freshwater for cash consideration of $146.6 million. In connection with this acquisition, we assumed net assets of $2.4 million and recorded a deferred tax liability of $3.0 million. The purchase price included $0.8 million for the fair value of approximately 13,000 assumed Freshwater vested stock options, as well as direct acquisition costs of $0.5 million. The allocation of the purchase price resulted in an excess of purchase price over net tangible assets acquired of $148.1 million. This was allocated, based on a third party valuation, $2.1 million to workforce, $5.5 million to purchased technology and $140.5 million to goodwill. The intangible assets are being amortized on a straight-line basis over 3 years.

In May 2003, we acquired all of the outstanding stock and assumed the unvested stock options of Performant. The total purchase price was $22.4 million and consisted of cash consideration of $21.9 million, net of cash acquired of $0.3 million and transaction costs of $0.5 million. The total purchase price was allocated, based upon a third party valuation, as follows (in thousands):

Tangible assets	$	270
Deferred tax asset		2,800
Liabilities assumed		(1,190	)
Deferred tax liability		(1,180	)
Existing technology		1,620
In-process research and development (IPR&D)		1,280
Patents and core technology		800
Employment agreements		720
Customer contracts and related relationships		150
Order backlog		80
Goodwill		17,051
Total purchase price	$	22,401

In accordance with GAAP, we recorded a deferred tax asset of $2.8 million for the acquired deferred tax assets relating to net operating loss and tax credit carryforwards for tax purposes acquired in the acquisition. In addition, a deferred tax liability of $1.2 million was recorded for the difference between the assigned values and the tax bases of the IP assets acquired in the acquisition.

The weighted average amortization period of existing technology, patents and core technology, and customer contracts and related relationships is 48 months, employment agreements is 18 months, and order backlog is 3 months. The total weighted average amortization period of all intangible assets is 41 months. All intangible assets will be amortized on a straight-line basis over their useful lives. Amortization expense for the three and six months ended June 30, 2003 was $0.2 million. The estimated total amortization expense associated with acquired Performant intangible assets is $0.6 million for the remainder of 2003, $1.0 million for 2004, $0.6 million for 2005 and 2006, and $0.2 million for 2007.

Other income, net

Interest income

Interest income was $8.8 million for the three months ended June 30, 2003, or 7% of total revenues, compared to $9.5 million for the three months ended June 30, 2002, or 10% of total revenues. The absolute dollar decrease of $0.7 million was primarily attributable to a reduction of $0.4 million in interest income due to lower interest rates and a reduction of $0.3 million in interest income associated with our February 2002 interest rate swap which was included in interest income until the January and February 2002 swaps were merged into one in November 2002. Interest income was $16.4 million for the six months ended June 30, 2003, of 7% of total revenues, compared to $17.6 million for the six months ended June 30, 2002, or 10% of total revenues. The absolute dollar decrease of $1.2 million was primarily attributable to a reduction of $1.6 million in interest income due to lower interest rates offset by an increase in interest income of $0.4 million associated with our February 2002 interest rate swap which was included in interest income until the January and February 2002 swaps were merged into one in November 2002.

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Interest expense

Interest expense was $4.9 million for the three months ended June 30, 2003, or 4% of total revenues, compared to $6.2 million for the three months ended June 30, 2002, or 7% of total revenues. The absolute dollar decrease of $1.3 million was primarily attributable to) a decrease of $0.7 million in interest expense associated with our interest rate swap due to lower LIBOR rates and a change in the interest rate spread between the January 2002 swap and the merged November 2002 swap and a decrease of $0.6 million in interest expense associated with the retirement of our Convertible Subordinated Notes (2000 Notes. Interest expense was $9.9 million for the six months ended June 30, 2003, or 4% of total revenues, compared to $11.9 million for the six months ended June 30, 2002, or 6% of total revenues. The absolute dollar decrease of $2.0 million was primarily attributable to a decrease of $1.2 million in interest expense associated with the retirement of our 2000 Notes and a decrease of $0.8 million in interest expense associated with our interest rate swap due to lower LIBOR rates and a change in the interest rate spread between the January 2002 swap and the merged November 2002 swap.

Other (expense) income, net

Other expense, net was $1.5 million for the three months ended June 30, 2003, or 1% of total revenues, compared to other income, net of $6.2 million for the three months ended June 30, 2002, or 7% of total revenues. The absolute dollar decrease of $7.7 million was primarily attributable to a reduction of $7.0 million on gains on early retirement of our 2000 Notes and an increase of losses of $0.4 million on our investments in non-consolidated companies. Other expense, net was $1.7 million for the six months ended June 30, 2003, or 1% of total revenues, compared to other income, net of $10.0 million for the six months ended June 30, 2002, or 5% of total revenues. The absolute dollar decrease of $11.7 million was primarily attributable to a reduction of $11.6 million on gains on early retirement of our 2000 Notes and an increase in losses of $0.9 million on our investments in non-consolidated companies. These decreases in other income were offset by an increase of $1.4 million in interest income associated with notes receivable from issuance of common stock to foreign employees under stock option plans.

Provision for income taxes

Historically, our operations resulted in a significant amount of 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 2013. Future provisions for taxes will depend upon the mix of worldwide income and the tax rates in effect for various tax jurisdictions. The effective tax rates for the three and six months ended June 30, 2003 and 2002 differ from statutory tax rates principally because of our participation in taxation programs in Israel. We intend to continue to increase our investment in our Israeli operations consistent with our overall tax strategy. Other factors that cause the effective tax rate and statutory tax rates to differ include the non-deductibility of charges for amortization of intangible assets, stock-based compensation and in-process research and development. US income taxes and foreign withholding taxes were not provided for on undistributed earnings for certain non-US subsidiaries. We intend to invest these earnings indefinitely in operations outside the US.

In 2002, we sold the economic rights of Freshwater’s intellectual property to our Israeli subsidiary. As a result of this intellectual property sale, we have recorded a current tax payable and a prepaid tax asset in the amount of $25.5 million, which is being amortized to income tax expense in our condensed consolidated statements of operations over eight years, which approximates the period over which the expected benefit is expected to be realized. At June 30, 2003 and December 31, 2002, we have a prepaid tax asset of $20.7 million and $22.3 million, respectively.

Liquidity and Capital Resources

At June 30, 2003, our principal source of liquidity consisted of $1.2 billion of cash and investments, compared to $665.2 million at December 31, 2002. The June 30, 2003 balance included $147.4 million of short-term and $274.3 million of long-term investments in high quality financial, government, and corporate securities. The increase in cash and investments from June 30, 2003, compared to December 31, 2002 was primarily due to cash proceeds from the issuance of our Zero Coupon Convertible Notes (2003 Notes), cash generated from operations, cash received from issuance of common stock under our stock option and employee stock purchase plans, and collection of notes receivable from issuance of common stock, offset by cash used for capital expenditures and other investments. During the six months ended June 30, 2003, we generated $91.4 million of cash from operating activities, compared to $63.0 million during the six months ended June 30, 2002. The increase in cash from operations during the six months of 2003 compared to the six months of 2002 was due primarily to a decrease in the trade accounts receivable balances resulting from improved cash collections and an increase in the deferred revenue balances, as well as an increase in net income.

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During the six months ended June 30, 2003, our investing activities consisted of a cash payment in conjunction with the acquisition of Performant for $21.9 million and purchases of property and equipment of $7.6 million. We have two buildings in Sunnyvale that we purchased but have not yet renovated. Should we decide to renovate these buildings, the estimated renovation costs will be approximately $5.0 million. We have committed to make additional capital contributions to a private equity fund totaling $8.3 million and we expect to pay approximately $5.3 million through March 31, 2004 as capital calls are made.

During the six months ended June 30, 2003, our primary financing activities consisted of cash proceeds from the issuance of the 2003 Notes of $488.2 million, cash proceeds of $23.5 million from common stock issued under our employee stock option and stock purchase plans, and collection of notes receivable from issuance of common stock of $2.4 million.

In July 2000, we raised $485.4 million from the issuance of our 2000 Notes with an aggregate principal amount of $500.0 million. The 2000 Notes mature on July 1, 2007 and bear interest at a rate of 4.75% per annum, payable semiannually on January 1 and July 1 of each year. The 2000 Notes are subordinated in right of payment to all of our future senior debt. The 2000 Notes are convertible into shares of our common stock at any time prior to maturity at a conversion price of approximately $111.25 per share, subject to adjustment under certain conditions. We may redeem our 2000 Notes, in whole or in part, at any time on or after July 1, 2003. Accrued interest to the redemption date will be paid by us in any such redemption. During the year ended December 31, 2002, we paid $65.8 million including accrued interest of $1.2 million to retire $77.5 million face value of our 2000 Notes, which resulted in a gain on early retirement of debt of $11.6 million. From December 2001 through June 30, 2002, we retired $200.0 million face value of our 2000 Notes. No 2000 Notes were retired during the last six months of 2002 or during the first six months of 2003. As a result of the retirement, our interest expense resulting from our 2000 Notes decreased during 2003.

In April 2003, we issued $500.0 million of the 2003 Notes in a private offering. The 2003 Notes do not bear interest, have a zero yield to maturity and will be convertible into our common stock at a conversion price of $51.69. Holders of the 2003 Notes may convert their 2003 Notes only if the sale price of our common stock reaches specified thresholds or if specified corporate transactions have occurred. Upon conversion, we have the right to deliver cash instead of shares of our common stock. We may not redeem the 2003 Notes prior to their maturity. In connection with the issuance of our 2003 Notes, we incurred $11.8 million of issuance costs, which primarily consisted of investment banker fees, legal and other professional fees. These costs are being amortized using a straight-line method over the term of the 2003 Notes. Amortization expense related to the issuance costs was $0.4 million for the three and six months ended June 30, 2003. At June 30, 2003, net debt issuance costs were $11.4 million.

During the six months ended June 30, 2003, a significant portion of our cash inflows was generated by our operations. Because our operating results may fluctuate significantly, as a result of decreases in customer demand or decreases in the acceptance of our future products and services, our ability to generate positive cash flow from operations may be impacted.

In May 2003, in conjunction with the acquisition of Performant, we committed to a license agreement for technology. The agreement was entered into in August 2000 and remains in effect until April 2018. The total estimated commitment is approximately $0.2 million, although the maximum commitment could reach approximately $0.8 million.

In June 2003, we entered into a non-exclusive agreement to license technology from Motive Communications. The agreement is non-transferable, except in the case of a merger, acquisition, spin-out or other transfer of all or substantially all of the business, stock or assets to which the agreement relates. The licensed technology will be combined with other existing Mercury products, which should be generally available within six months from the effective date of this agreement. The agreement is in effect until December 31, 2005 with an election to renew and an option to purchase a fully paid up, perpetual license to the technology prior to July 1, 2008. We have committed to royalty payments totaling $15.0 million, which will be paid through June 15, 2004.

We lease facilities for sales offices in the US and foreign locations under non-cancelable operating leases that expire through 2010. Certain of these leases contain renewal options. In addition, we lease certain equipment under various leases with lease terms ranging from month-to-month up to one year.

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Future payments due under debt, lease and royalty agreements at June 30, 2003 are as follows (in thousands):

	Zero Coupon Senior Convertible Notes due 2008 (2003 Notes)		4.75% Convertible Subordinated Notes due 2007 (2000 Notes)(a)		Non- Cancelable Operating Leases		Royalty Agreements		Total
2003	$	—	$	—	$	4,783	$	12,660	$	17,443
2004		—		—		6,195		4,610		10,805
2005		—		—		4,034		10		4,044
2006		—		—		2,297		10		2,307
2007		—		300,000		1,686		10		301,696
Thereafter		500,000		—		2,720		110		502,830
Total	$	500,000	$	300,000	$	21,715	$	17,410	$	839,125

(a) Assuming we do not retire additional 2000 Notes during 2003 and interest rates stay consistent, we will make interest payments net of our interest rate swap of approximately $2.4 million during the remainder of 2003; approximately $4.8 million in 2004, 2005, and 2006; and approximately $2.4 million during 2007. The face value of our 2000 Notes differs from our book value. See Note 10 to the condensed consolidated financial statements.

In 2002, we effected a change in the mix of software license types to a higher percentage of subscription licenses, especially for our application management products. During the three and six months ended June 30, 2003, the amount of application delivery products licensed on a subscription basis increased. This shift does not impact our collections cycle as cash is generally received within 30-60 days from the invoice date, depending upon the region. Our quarterly operating results are affected by the mix of license types entered into in connection with the sale of products. As revenue associated with our subscription licenses is generally recognized ratably over the term of the license, the shift in mix will also result in deferred revenue becoming a larger component of our cash provided by operations. We believe that the shift to a subscription revenue model will continue in the future, as more of our products are offered and as more of our customers license products on a subscription basis. This shift may cause us to experience a decrease or a lower rate of growth in recognized revenue, as well as continued growth in deferred revenue, in the near term.

In the future, we expect cash will continue to be generated from our operations. We do not expect to spend significant amounts of additional cash to acquire property and equipment in the near term and therefore the level of cash used in investing activities to acquire property and equipment should not significantly change from that used in 2002. We do, however, currently plan to reinvest our cash generated from operations in new short and long term investments in high quality financial, government and corporate securities or other investments, consistent with past investment practices, and therefore net cash used in investing activities may increase. Cash could be used in the future to invest in acquisitions, or strategic investments, or repurchase additional debt or equity.

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.

Critical Accounting Policies

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our condensed consolidated financial statements. The SEC has defined the most critical accounting policies as the ones that are most important to the portrayal of our financial condition and results, and require us to make our most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.

Our critical accounting policies are as follows:

• revenue recognition;

• estimating valuation allowances and accrued liabilities;

• valuation of long-lived assets, goodwill and other intangible assets;

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• accounting for income taxes;

• accounting for non-consolidated companies; and

• accounting for unearned stock-based compensation.

We discuss these policies further, as well as the estimates and judgments involved. We also have other key accounting policies. We believe that these other policies either do not generally require us to make estimates and judgments that are as difficult or as subjective, or it is less likely that they would have a material impact on our reported results of operations for a given period.

Revenue recognition

We have made significant judgments related to revenue recognition; specifically, in connection with each transaction involving our arrangements, we must evaluate whether our fee is “fixed or determinable” and we must assess whether “collectibility is probable”. These judgments are discussed below.

The fee is fixed or determinable

With respect to each arrangement, we must make a judgment as to whether the arrangement fee is fixed or determinable. If the fee is fixed or determinable, then revenue is recognized upon delivery of software (assuming other revenue recognition criteria are met). If the fee is not fixed or determinable, then the revenue recognized in each quarter (subject to application of other revenue recognition criteria) will be the lesser of the aggregate of amounts due and payable or the amount of the arrangement fee that would have been recognized if the fees had been fixed or determinable.

A determination that an arrangement fee is fixed or determinable also depends upon the payment terms relating to such an arrangement. Our customary payment terms are generally within 30-60 days of the invoice date, depending upon the region. Arrangements with payment terms extending beyond the customary payment terms are considered not to be fixed or determinable. A determination of whether the arrangement fee is fixed or determinable is particularly relevant to revenue recognition on perpetual licenses.

Collectibility is probable

In order to recognize revenue, we must make a judgment of the collectibility of the arrangement fee. Our judgment of the collectibility is applied on a customer-by-customer basis. We generally sell to customers for which there is a history of successful collection. If we determine that collection of a fee is not probable (the customer does not have a successful collection history with us), we defer the fee and recognize revenue at the time collection becomes probable, which is generally upon receipt of cash.

Estimating valuation allowances and accrued liabilities

The preparation of condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reported period. Use of estimates and assumptions include, but are not limited to, the sales reserve and prepaid commissions.

We must make estimates of potential future credits, warranty cost of product and services, and write-offs of bad debts related to current period product revenue. We analyze historical credits, historical bad debts, current economic trends, average deal size, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales reserve. Revenue for the period is reduced to reflect the sales reserve provision. As a percentage of current period revenues, changes against sales reserve were insignificant in both the three and six months ended June 30, 2003 and the year ended December 31, 2002. Significant management judgments and estimates must be made and used in connection with establishing the sales reserve in any accounting period. Material differences may result in the amount and timing of our revenues for any period if we make different judgments or utilize different estimates. At June 30, 2003 and December 31, 2002, the provision for sales reserve was $5.3 million and $7.4 million, respectively.

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We are required to make estimates of the future sales commission expense associated with our revenues that will be recognized in future periods. We analyze historical commission rates, composition of the future revenue and expected timing of revenue recognition of such future amounts. We make significant judgments and estimates in connection with establishing the prepaid commission in any accounting period. Material differences may result in the amount and timing of our sales commission expense for any period if we make different judgments or utilize different estimates. At June 30, 2003 and December 31, 2002, prepaid commission was $16.2 million and $13.6 million, respectively.

Valuation of long-lived and other intangible assets and goodwill

We assess the impairment of identifiable intangible assets and property, plant and equipment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We are also required to perform an annual impairment review of goodwill and potentially more frequently if circumstances change. Factors we consider important which could trigger an impairment review include the following:

• significant underperformance relative to expected historical or projected future operating results;

• significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

• significant negative industry or economic trends;

• significant decline in our stock price for a sustained period; and

• our market capitalization relative to net book value.

We completed the preliminary assessment of goodwill during the first quarter of 2002 and performed an annual impairment review during the fourth quarter and did not record an impairment charge.

When we determine that the carrying value of intangibles, long-lived assets or goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure this impairment based on a projected discounted cash flow. Net intangible assets and long-lived assets was $94.2 million and $91.1 million at June 30, 2003 and December 31, 2002, respectively. Goodwill was $130.4 million and $113.3 million at June 30, 2003 and December 31, 2002, respectively.

Accounting for income taxes

As part of the process of preparing our condensed consolidated financial statements we are required to estimate our income tax expense in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our condensed consolidated balance sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the condensed consolidated statements of operations. In addition, to the extent that we are unable to continue to reinvest a substantial portion of our profits in our Israeli operations, we may be subject to additional tax rate increases in the future. Our taxes could increase if these tax rate incentives are not renewed upon expiration, tax rates applicable to us are increased, authorities challenge our tax strategy, or are impacted by new laws or rulings.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a valuation allowance for the entire portion of the net operating losses related to the income tax benefits arising from the exercise of employees’ stock options that will be credited directly to stockholders’ equity in the future. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to increase or reduce our valuation allowance, which could materially impact our financial position and results of operations.

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Accounting for non-consolidated companies

From time to time, we make venture capital investments in early stage private companies and private equity funds for business and strategic purposes. These investments are accounted for under the cost method, as we do not have the ability to exercise significant influence over these companies’ operations. We are closely monitoring our investments for impairment and will record reductions in carrying values if and when necessary. The evaluation process is based on information that we request from these privately held companies. This information is not subject to the same disclosure regulations as US public companies, and as such, the basis for these evaluations is subject to the timing and the accuracy of the data received from these companies. As part of this evaluation process, our review includes, but is not limited to, a review of each company’s cash position, recent financing activities, financing needs, earnings/revenue outlook, operational performance, management/ownership changes, and competition. If we determine that the carrying value of a company is at an amount below fair value, or if a company has completed a financing based on a valuation significantly lower than our initial investment, it is our policy to record a reserve and the related write-down is recorded as an investment loss on our condensed consolidated statements of operations. Estimating the fair value of non-marketable equity investments in early-stage technology companies is inherently subjective and may contribute to significant volatility in our reported results of operations.

At June 30, 2003, we had invested $15.4 million, net in early stage private companies and private equity funds. In addition, we have committed to make capital contributions to a private equity fund totaling $8.3 million and we expect to pay approximately $5.3 million through March 31, 2004 as capital calls are made. If the companies in which we have made investments do not complete initial public offerings or are not acquired by publicly traded companies or for cash, we may not be able to sell these investments. In addition, even if we are able to sell these investments we cannot assure that we will be able to sell them at a gain or even recover our investment. The potential decline in the NASDAQ National Market and the market prices of publicly traded technology companies will adversely affect our ability to realize gains or a return of our capital on many of these investments. For the year ended December 31, 2002, we recorded losses of $3.4 million, $1.5 million and $0.4 million, respectively, on three of our investments in non-consolidated companies. For the three and six months ended June 30, 2003, we recorded losses of $0.6 million on one of our investments in non-consolidated companies and $0.6 million, $0.5 million and $0.2 million on three of our investments in non-consolidated companies, respectively. In calculating the loss to be recorded, we took into account the latest valuation of each of the portfolio companies based on recent sales of equity securities to outside third party investors.

Accounting for unearned stock-based compensation

We account for stock-based compensation for our employees using the intrinsic value method presented in APB No. 25, Accounting for Stock Issued to Employees, and related interpretations, and comply with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, and with the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure Amendment of SFAS No. 123. Under APB No. 25, compensation expense is based on the difference, as of the date of the grant, between the fair value of our stock and the exercise price. Unearned stock-based employee compensation cost is reflected in net income, as some options granted under those plans had an exercise price less than the fair value of the underlying common stock on the date of grant.

We amortize stock-based compensation using the straight-line method over the remaining vesting periods of the related options, which is generally four years. Pro forma information regarding net income and earnings per share is required by SFAS No. 123. This information is required to be determined as if we had accounted for employee stock options and stock purchase plans under the fair value method of SFAS No. 123, as amended by SFAS No. 148.

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee compensation (in thousands, except per share amounts):

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Net income, as reported	$	16,935		$	18,020		$	35,079		$	33,180
Add:
Unearned stock-based compensation expense included in reported net income		195			303			384			667
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(33,127	)		(30,932	)		(65,582	)		(61,254	)
Pro forma net loss	$	(15,997	)	$	(12,609	)	$	(30,119	)	$	(27,407	)
Net income per share (basic), as reported	$	0.20		$	0.21		$	0.41		$	0.40
Net loss per share (basic), pro forma	$	(0.19	)	$	(0.15	)	$	(0.35	)	$	(0.33	)
Net income per share (diluted), as reported	$	0.19		$	0.20		$	0.39		$	0.38
Net loss per share (diluted), pro forma	$	(0.19	)	$	(0.15	)	$	(0.35	)	$	(0.33	)

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The fair value of options and shares issued pursuant to the option plans and the Employee Stock Purchase Plan (ESPP) at the grant date were estimated using the Black-Scholes model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including the expected stock price volatility. We use projected volatility rates, which are based upon historical volatility rates trended into future years. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our options.

The effects of applying pro forma disclosures of net income and earnings per share are not likely to be representative of the pro forma effects on net income and earnings per share in the future years for the following reasons the number of future shares to be issued under these plans is not known and the assumptions used to determine the fair value can vary significantly.

In the 2003 Annual Meeting of the Stockholders, a proposal on researching the impact of option expensing was put on the ballot. The stockholders voted for the proposal and the Board of Directors is currently reviewing this matter.

Recent Accounting Pronouncements

See Note 1 to the condensed consolidated financial statements for a full description of recent accounting pronouncements.

Risk Factors

In addition to the other information included in this Quarterly Report on Form 10-Q, the following risk factors should be considered carefully in evaluating our business and us.

Our future success may be impaired if we cannot respond to rapid market and technological changes by introducing new products and services and continually improving the performance, features and reliability of our existing products and services and responding to competitive offerings. The market for our software products and services is characterized by:

• rapidly changing technology;

• frequent introduction of new products and services and enhancements to existing products and services by our competitors;

• increasing complexity and interdependence of our 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 products, like our software application management and delivery products and services and to develop new products and services, functionality and technology that address the increasingly sophisticated and varied needs of our prospective customers. The development of new products and services, and enhancement of existing products and services, entail significant technical and business risks and require substantial lead-time and significant investments in product development. If we fail to anticipate new technology developments, customer requirements or industry standards, or if we are unable to develop new products and services that adequately address these new developments, requirements and standards in a timely manner, our products and services may become obsolete, our ability to compete may be impaired and our revenue could decline.

We expect our quarterly revenue and operating results to fluctuate, and it is difficult to predict our future revenue and operating results. Our revenue and operating results have varied in the past and are likely to vary significantly from quarter to quarter in the future. These fluctuations are due to a number of factors, many of which are outside of our control, including:

• fluctuations in demand for, and sales of, our products and services;

• our success in developing and introducing new products and services and the timing of new product and service introductions;

• our ability to introduce enhancements to our existing products and services in a timely manner;

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• changes in economic conditions affecting our customers or our industry;

• changes in the mix of products or services sold in a quarter;

• changes in the mix of perpetual, term or subscription licenses sold in a quarter;

• fluctuations in the number of large orders in a quarter;

• uncertainties related to the integration of products, services, employees and operations of acquired companies;

• the introduction of new or enhanced products and services by our competitors and changes in the pricing policies of these competitors;

• the discretionary nature of our customers’ purchase and budget cycles and changes in their budgets for software and related purchases;

• the amount and timing of operating costs and capital expenditures relating to the expansion of our business;

• deferrals by our customers of orders in anticipation of new products or services or product enhancements; and

• the mix of our domestic and international sales, together with fluctuations in foreign currency exchange rates.

In addition, the timing of our product 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. Because of the timing of larger orders and customer buying patterns, we may not learn of shortfalls in revenue or earnings or other failures to meet market expectations until late in a particular quarter. As a result, if total revenue for a particular quarter is below our expectations, we could not proportionately reduce operating expenses for that quarter.

We have experienced seasonality in our revenue 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, to a lesser extent, from the structure of our sales commission program. We expect this seasonality to continue in the future.

Due to these factors, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. If our operating results are below the expectations of investors or securities analysts, the trading prices of our securities could decline.

Our revenue targets are dependent on mix of orders in a particular quarter. Our license revenue in any given quarter is dependent upon the volume of perpetual orders shipped during the quarter and the amount of subscription revenue amortized from deferred revenue and, to a small degree, recognized on subscription orders received during the quarter. We set our revenue targets for any given period based, in part, upon an assumption that we will achieve a certain level of orders and a certain license mix of perpetual licenses and subscription licenses. The precise mix of orders is subject to substantial fluctuation in any given quarter or multiple quarter periods, and the actual mix of licenses sold affects the revenue we recognize in the period. If we achieve the target level of total orders but are unable to achieve our target license mix, we may not meet our revenue targets (if we deliver more-than-expected subscription licenses) or may exceed them (if we deliver more-than-expected perpetual licenses). In addition, if we achieve the target license mix but the overall level of orders is below the target level, then we will not meet our revenue targets. In 2002, we effected a change in the mix of software license types to a higher percentage of subscription licenses and that shift continued in the first quarter of 2003 with a larger percentage of testing subscription licenses. We believe that this shift will continue in the future, as more of our products are offered and as more of our customers license our products on a subscription basis. This shift may cause us to experience a decrease in recognized revenue, as well as continued growth of deferred revenue, in the near term. In addition, while subscription licenses represent a potential source of renewable license revenue, there is also the risk that customers will not renew their licenses at the end of a term.

Economic, political and market conditions may adversely affect demand for our products and services. Our customers’ decisions to purchase our products and services are discretionary and subject to their internal budgets and purchasing processes. We believe that the ongoing slowdown in the economy and the weakening of business conditions have caused and may continue to cause customers to reassess their immediate technology needs, lengthen their purchasing decision-making processes, require more senior level internal approvals of purchases and defer purchasing decisions, and accordingly, have reduced and could reduce demand in the future for our products and services. In addition, the war on terrorism and the potential for other hostilities in various parts of the world have caused political uncertainties and volatility in the financial markets. Under these circumstances, there is a risk that our existing and potential customers may decrease spending for our products and services. If demand for our products and services is reduced, our revenue growth rates will be adversely affected.

        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 application management and delivery products and services is extremely competitive, dynamic and subject to frequent technological change. There are few substantial barriers of entry in our market. The Internet has further reduced these barriers of entry, allowing other companies to compete with us in our 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 application delivery solutions, our principal competitors include Compuware, Empirix, Rational Software (acquired by IBM Software Group), and Segue Software. In the new and rapidly changing market for application management solutions, our principal competitors include established providers of systems and network management software such as BMC Software, Computer Associates, HP OpenView, a division of Hewlett-Packard, and Tivoli, a division of IBM, and providers of hosted services such as Keynote Systems, and emerging companies. Additionally, we face potential competition in this market from existing providers of application delivery solutions such as Segue Software and Compuware.

We believe that the principal competitive factors affecting our market are:

• price and cost effectiveness;

• product functionality;

• product performance, including scalability and reliability;

• quality of support and service; and

• company reputation.

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Although we believe that our products and services currently compete favorably with respect to these factors, the market for application management and delivery are new and rapidly evolving. We may not be able to maintain our competitive position, and could lead to a decrease in our revenues. The software industry is increasingly experiencing consolidation and this could increase the resources available to our competitors and the scope of their product offerings. For example, our testing competitor Rational Software was recently acquired by IBM Software Group, which has substantially greater financial and other resources than we have. 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 revenue could decline. We derive a substantial portion of our revenue from sales of our products and services through distribution channels, such as systems integrators or value-added resellers. We generally expect that sales of our products through these channels will continue to account for a substantial portion of our revenue for the foreseeable future. We may not experience increased revenue from new channels and may see a decrease from our existing channels, which could harm our business.

The loss of one or more of our systems integrators or value-added resellers, or any reduction or delay in their sales of our products and services could result in reductions in our revenue in future periods. In early 2003, we signed an agreement with SAP AG that allows it to resell our line of products for use with SAP systems, directly and through its subsidiaries and distributors. In addition, our ability to increase our revenue in the future depends on our ability to expand our indirect distribution channels.

Our dependence on indirect distribution channels presents a number of risks, including:

• each of our systems integrators or value-added resellers can cease marketing our products and services with limited or no notice and with little or no penalty;

• our existing systems integrators or value-added resellers may not be able to effectively sell any new products and services that we may introduce;

• we may not be able to replace existing or recruit additional systems integrators or value-added resellers, if we lose any of our existing ones;

• our systems integrators or value-added resellers may also offer competitive products and services;

• we may face conflicts between the activities of our indirect channels and our direct sales and marketing activities; and

• our systems integrators or value-added resellers may not give priority to the marketing of our products and services as compared to our competitors’ products.

The continued growth of our business may be adversely affected if we fail to form and maintain strategic relationships and business alliances. 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.

Our increasing efforts to sell enterprise-wide software products and services could expose us to revenue variations and higher operating costs. We increasingly focus our efforts on sales of enterprise-wide solutions, which consist of our entire Optane product suite and related professional services, and managed services, rather than on the sale of component products. As a result, each sale requires substantial time and effort from our sales and support staff as well as involvement by our professional services and managed services organizations and our systems integrator partners. Large individual sales, or even small delays in customer orders, can cause significant variation in our revenues and results of operations for a particular period. The timing of large orders is usually difficult to predict and, like many software and services companies, many of our customers typically complete transactions in the last month of a quarter.

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If we are unable to manage rapid changes, our operating results could be adversely affected. We have, in the past, experienced significant growth in revenue, employees and number of product and service offerings and we believe this growth may resume. This growth has placed a significant strain on our management and our financial, operational, marketing and sales systems. We are implementing a variety of new or expanded business and financial systems, procedures and controls, including the improvement of our sales and customer support systems. The implementation of these systems, procedures and controls may not be completed successfully, or may disrupt our operations. Any failure by us to properly manage these transitions could impair our ability to attract and service customers and could cause us to incur higher operating costs and experience delays in the execution of our business plan. We have also in the past experienced reductions in revenue and that has required us to rapidly reduce costs. If we fail to reduce staffing levels when necessary, our costs would be excessive and our business and operating results could be adversely affected.

The success of our business depends on the efforts and abilities of our senior management and other key personnel. We depend on the continued services and performance of our senior management and other key personnel. We do not have long term employment agreements with any of our key personnel. The loss of any of our executive officers or other key employees could hurt our business. The loss of senior personnel can result in significant disruption to our ongoing operations, and new senior personnel must spend a significant amount of time learning our business and our systems in addition to performing their regular duties.

Our international sales and operations subject us to risks that can adversely affect our revenue and operating results. Sales to customers located outside the US have historically accounted for a significant percentage of our revenue and we anticipate that such sales will continue to be a significant percentage of our revenue. As a percentage of our total revenue, sales to customers outside the US were 37% in both the three and six months ended June 30, 2003 and 34% and 33% in the three and six months ended June 30, 2002. We face risks associated with our international operations, including:

• changes in tax laws 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 reduce our international sales. For example, some countries in Europe, the Middle East and Africa already have laws and regulations related to technologies used on the Internet that are more strict than those currently in force in the US. 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 political, economic, and military conditions in that country and by restrictions imposed by that country on the transfer of technology. Our operations depend on the availability of highly skilled scientific and technical personnel in Israel. Our business also depends on trading relationships between Israel and other countries. In addition to the risks associated with international sales and operations generally, our operations could be adversely affected if major hostilities involving Israel should occur or if trade between Israel and its current trading partners were interrupted or curtailed.

These risks are compounded due to the restrictions on our ability to manufacture or transfer outside of Israel any technology developed under research and development grants from the government of Israel without the prior written consent of the government of Israel. If we are unable to obtain the consent of the government of Israel, we may not be able to take advantage of strategic manufacturing and other opportunities outside of Israel.

We are subject to the risk of increased taxes if tax rate incentives in Israel are altered or if there are other changes in tax laws or rulings. Historically, our operations resulted in a significant amount of 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. In addition, to the extent that we are unable to continue to reinvest a substantial portion of our profits in our Israeli operations, we may be subject to additional tax rate increases in the future.

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Other factors that could increase our effective tax rate include the effect of changing economic conditions, business opportunities, and changes in tax laws and rulings. We have in the past and may continue in the future to retire amounts outstanding under our 2000 Notes. To the extent that these repurchases are completed below the par value of the 2000 Notes, we may generate a taxable gain from these repurchases. These gains may result in an increase in our effective tax rate. Merger and acquisition activities, if any, could result in nondeductible expenses which may increase our effective tax rate. Our worldwide effective tax rate could be increased to the extent we are impacted by new tax laws or rulings.

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 US dollar. Because our financial results are reported in US dollars, our results of operations may be harmed by fluctuations in the rates of exchange between the US dollar and other currencies, including:

• a decrease in the value of currencies in Europe, the Middle East and Africa or in the Asia Pacific and Australia regions relative to the US dollar, which would decrease our reported US dollar revenue, as we generate revenue in these local currencies and report the related revenue in US dollars; and

• an increase in the value of currencies in Europe, the Middle East and Africa or in the Asia Pacific and Australia regions, or Israel relative to the US 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.

Acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert the attention of our management and investments may become impaired and require us to take a charge against earnings. In June 2003 we announced that we had signed a non-binding agreement to acquire Kintana. In addition, in May 2003 we announced that we had acquired Performant, and in May 2001 we acquired Freshwater Software. We also have minority investments in early stage private companies and private equity funds of $15.4 million at June 30, 2003. We may acquire or make investments in other companies and technologies. For the year ended December 31, 2002, we recorded losses of $3.4 million, $1.5 million and $0.4 million, respectively, on three of our investments in non-consolidated companies. For the three and six months ended June 30, 2003, we recorded losses of $0.6 million on one of our investments in non-consolidated companies and $0.6 million, $0.5 million and $0.2 million on three of our investments in non-consolidated companies, respectively. In calculating the loss to be recorded, we took into account the latest valuation of each of the portfolio companies based on recent sales of equity securities to outside third party investors. In addition, we have committed to make capital contributions to a private equity fund totaling $8.3 million and we expect to pay approximately $5.3 million through March 31, 2004 as capital calls are made. We are closely monitoring the financial health of the other private companies in which we hold minority equity investments. If we determine in accordance with our standard accounting policies that an impairment has occurred, then additional losses would be recorded. In the event of any future acquisitions or investments, we could:

• issue stock that would dilute the ownership of our then-existing stockholders;

• incur debt;

• assume liabilities;

• incur charges for the impairment of the value of investments or acquired assets; or

• incur amortization expense related to intangible assets.

If we fail to achieve the financial and strategic benefits of past and future investments or acquisitions, including our recent agreement to acquire Kintana, 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;

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• 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.

If we fail to adequately protect our proprietary rights and intellectual property, we may lose a valuable asset, experience reduced revenue and incur costly litigation to protect our rights. We rely on a combination of patents, copyrights, trademarks, service marks and trade secret laws and contractual restrictions to establish and protect our proprietary rights in our products and services. We will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect unauthorized use of our intellectual property. Despite our precautions, it may be possible for unauthorized third parties to copy our products and services and use information that we regard as proprietary to create products and services that compete with ours. Some license provisions protecting against unauthorized use, copying, transfer and disclosure of our licensed programs may be unenforceable under the laws of certain jurisdictions and foreign countries. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the US. 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 addition, we are not significantly dependent on any of our patents.

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, whether successful or unsuccessful, could result in substantial costs and diversions of our management resources, which could result in lower revenue or higher operating costs.

Third parties could assert that our products and services infringe their intellectual property rights, which could expose us to litigation that, with or without merit, could be costly to defend. We may from time to time be subject to claims of infringement of other parties’ proprietary rights. We could incur substantial costs in defending ourselves and our customers against these claims. Parties making these claims may be able to obtain injunctive or other equitable relief that could effectively block our ability to sell our products in the US 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.

If we fail to obtain or maintain early access to third-party software, our future product development may suffer. Software developers have, in the past, provided us with early access to pre-generally available versions of their software in order to have input into the functionality and to ensure that we can adapt our software to exploit new functionality in these systems. Some companies, however, may adopt more restrictive policies in the future or impose unfavorable terms and conditions for such access. These restrictions may result in high research and development costs for us in connection with the enhancement and modification of our existing products and the development of new products or may prevent us from being able to develop products which will work with such new systems which could 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. We have adopted a Preferred Shares Rights Agreement (which we refers to as our Shareholder Rights Plan) on July 5, 1996, as amended. In connection with the Shareholder Rights Plan, our Board of Directors declared and paid a dividend of one preferred share purchase right for each share of our common stock outstanding on July 15, 1996. In addition, each share of common stock issued after July 15, 1996 was issued, or will be issued, with an accompanying preferred stock purchase right. Because the rights may substantially dilute the stock ownership of a person or group attempting to take us over without the approval of our board of directors, the Shareholder Rights Plan could make it more difficult for a third party to acquire us (or a significant percentage of our outstanding capital stock) without first negotiating with our board of directors regarding such acquisition.

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Our board of directors also 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.

In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which will prohibit us from engaging in a business combination with an interested stockholder for a period of three years after the date that the person became an interested stockholder unless, subject to certain exceptions, the business combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner.

Furthermore, certain provisions of our Amended and Restated Certificate of Incorporation may have the effect of delaying or preventing changes in our control or management, which could adversely affect the market price of our common stock.

Leverage and debt service obligations for $800.0 million in outstanding Notes may adversely affect our cash flow. On April 29, 2003 we issued the 2003 Notes, with a principal amount of $500.0 million, in a private placement, and in July 2000, we completed the offering of the 2000 Notes with a principal amount of $500.0 million. From December 2001 through June 30, 2002, we retired $200.0 million face value of the 2000 Notes. We continue to carry a substantial amount of outstanding indebtedness, primarily the 2000 Notes and the 2003 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 acquisitions; and

• limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete.

In November 2002, we entered into an interest rate swap with Goldman Sachs Capital Markets, L.P. (GSCM) with respect to $300.0 million of our 2000 Notes. This interest rate swap could expose us to greater interest expense for our 2000 Notes.

In addition, the 2003 Notes would be included in our diluted net income per share calculation if our common stock price reaches $51.69 per share and if we elect to settle in stock instead of cash. In this case, 9,673,050 shares would be included in both the basic and diluted weighted average common shares and equivalents.

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 July 31, 2003, the closing sales prices of our common stock as reported on the Nasdaq National Market ranged from a high of $44.45 to a low of $15.74. We expect our stock price to be subject to fluctuations as a result of a variety of factors, including factors beyond our control. These factors include:

• actual or anticipated variations in our quarterly operating results;

• announcements of technological innovations or new products or services by us or our competitors;

• announcements relating to strategic relationships, acquisitions or investments;

• changes in financial estimates or other statements by securities analysts;

• changes in general economic conditions;

• terrorist attacks, and the effects of war;

• conditions or trends affecting the software industry and the Internet;

• changes in the rating of our notes or other securities; and

• changes in the economic performance and/or market valuations of other software and high-technology companies.

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Because of this volatility, we may fail to meet the expectations of our stockholders or of securities analysts at some time in the future, and the trading prices of our securities could decline as a result. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many high-technology companies. These fluctuations have often been unrelated or disproportionate to the operating performance of these companies. Any negative change in the public’s perception of software or Internet software companies could depress our stock price regardless of our operating results. Because the Notes are convertible into shares of our common stock, volatility or depressed prices for our common stock could have a similar effect on the trading price of the Notes. Holders who receive common stock upon conversion also will be subject to the risk of volatility and depressed prices of our common stock. In addition, the existence of the Notes may encourage short selling in our common stock by market participants because the conversion of the Notes could depress the price of our common stock.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market rate risk includes the risk of changes in interest rates. 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.” At June 30, 2003, $820.0 million, or 66% of our cash, cash equivalents and investment portfolio have a maturity of less than 90 days, and an additional $147.4 million, or 12% carried a maturity of less than one year. All investments mature, by policy, in less than three years. Information about our investment portfolio is presented in the table below, which states notional amounts and related weighted-average interest rates by year of maturity (in thousands):

	June 30,						Thereafter			Total			Fair Value
	2004			2005
Cash equivalents:
Fixed rate	$	512,428		$	—		$	—		$	512,428		$	512,429
Weighted average rate		1.18	%		—			—			1.18	%		—
Investments:
Fixed rate	$	387,945		$	76,470		$	197,820		$	662,235		$	665,981
Weighted average rate		2.15	%		2.49	%		2.39	%		2.26	%		—
Total investments	$	900,373		$	76,470		$	197,820		$	1,174,663		$	1,178,410
Weighted average rate		1.60	%		2.49	%		2.39	%		1.79	%		—

Our long-term investments include $240.6 million of government agency instruments, which have callable provisions and accordingly may be redeemed by the agencies should interest rates fall below the coupon rate of the investments.

The fair value of our 2000 Notes fluctuates based upon changes in the price of our common stock, changes in interest rates and changes in our creditworthiness. The fair market value of the 2000 Notes at June 30, 2003 was $295.9 million while the face value was $300.0 million while the book value was $319.7 million. The fair value of our 2003 Notes fluctuates based upon changes in the price of our common stock and changes in our creditworthiness. The fair market value of the 2003 Notes at June 30, 2003 was $499.0 million while the face value and the book value was $500.0 million. See Note 10 to the condensed consolidated financial statements.

In November 2002, we entered into an interest rate swap with Goldman Sachs Capital Markets, L.P. See Note 10 to the condensed consolidated financial statements for a full description of our derivative financial instruments and related accounting policies.

A portion of our business is conducted in currencies other than the US 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 revenue.

36

From time to time, we make venture capital investments in early stage private companies and private equity funds for business and strategic purposes. At June 30, 2003, we had invested $15.4 million in private companies. In addition, we have committed to make capital contributions to a private equity fund totaling $8.3 million and we expect to pay approximately $5.3 million through March 31, 2004 as capital calls are made. If the companies in which we have made investments do not complete initial public offerings or are not acquired by publicly traded companies or for cash, we may not be able to sell these investments. In addition, even if we are able to sell these investments we cannot assure that we will be able to sell them at a gain or even recover our investment. The potential decline in the NASDAQ National Market and the market prices of publicly traded technology companies will adversely affect our ability to realize gains or a return of our capital on many of these investments. For the year ended December 31, 2002, we recorded losses of $3.4 million, $1.5 million and $0.4 million, respectively, on three of our investments in non-consolidated companies. For the three and six months ended June 30, 2003, we recorded losses of $0.6 million on one of our investments in non-consolidated companies and $0.6 million, $0.5 million and $0.2 million on three of our investments in non-consolidated companies, respectively. In calculating the loss to be recorded, we took into account the latest valuation of each of the portfolio companies based on recent sales of equity securities to outside third party investors.

Item 4. Controls and Procedures

(a) Disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report, have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were adequate and designed to ensure that material information related to us and our consolidated subsidiaries would be made known to them by others within these entities.

(b) Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rule 13a-15 or 15d-15 that occurred during the period covered by this quarterly report, or to our knowledge in other factors, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

37

PART II

Item 2. Changes in Securities and Use of Proceeds

In April 2003, we issued $500.0 million in aggregate principal amount of Zero Coupon Senior Convertible Notes, due May 2008 (the 2003 Notes). The 2003 Notes were issued to UBS Warburg LLC (the Initial Purchaser), in reliance on the exemption from registration afforded by Section 4(2) of the Securities Act of 1933, as amended (the Securities Act) and subsequently resold by the Initial Purchaser to “qualified institutional buyers” (as defined in Rule 144A) in reliance on Rule 144A in transactions exempt from the registration requirements of the 1933 Act. We incurred $11.8 million of issuance costs, which primarily consisted of investment banker fees, legal, and other professional fees. The net proceeds to us of this offering were approximately $488.2 million, which shall be used for general corporate purposes, including potential acquisitions.

The 2003 Notes are our senior unsecured debt and will rank on a parity with all of our other existing and future senior unsecured debt and prior to all subordinated debt. The 2003 Notes are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.

The holders of the 2003 Notes may convert the 2003 Notes into 19.3461 shares of our common stock, subject to adjustment, per $1,000 principal amount of the 2003 Notes, under the following circumstances if the sale price of our common stock reaches specified thresholds or if specified corporate transactions have occurred. This rate results in an initial conversion price of $51.69 per share. Upon conversion, we will have the right to deliver cash in lieu of shares of our common stock. If we undergo a fundamental change prior to maturity of the 2003 Notes, holders of the 2003 Notes may require us to repurchase the 2003 Notes at 100% of the principal amount of the notes.

We have filed an initial registration statement under the Securities Act to permit registered resales of the 2003 Notes and the common stock issuable upon conversion of the 2003 Notes. The initial registration statement is not yet effective.

Item 4. Submission of Matters to a Vote of Stockholders

(a) The 2003 Annual Meeting of the Stockholders of Mercury Interactive Corporation was held at The Ritz-Carlton New York, Battery Park, Two West Street, New York, New York 10004 at 10:00 a.m. on Thursday, May 15, 2003.

(b) At the annual meeting, the following seven persons were elected to the Company’s Board of Directors, constituting all members of the Board of Directors.

Nominee	For	Withheld
Amnon Landan	74,028,446	2,458,630
Kenneth Klein	75,286,154	1,200,922
Igal Kohavi	74,675,201	1,811,875
Clyde Ostler	75,017,057	1,470,019
Yair Shamir	74,607,231	1,879,845
Giora Yaron	75,223,825	1,263,251
Anthony Zingale	75,319,133	1,167,943

(c) The following additional proposals were considered at the annual meeting with their results according to the respective vote of the stockholders:

PROPOSAL 2—Withdrawn.

PROPOSAL 3—Withdrawn.

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PROPOSAL 4—Ratify the appointment of PricewaterhouseCoopers LLP as independent accountants for the fiscal year ending December 31, 2003.

For	Against	Abstentions (1)	Broker Non-Votes (1)
74,139,466	1,950,268	399,342	0

PROPOSAL 5—Stockholder proposal on Option Expensing.

For	Against	Abstentions (1)	Broker Non-Votes (1)
34,575,578	31,509,797	986,383	9,415,318

PROPOSAL 6—Stockholder proposal on Indexed Options.

For	Against	Abstentions (1)	Broker Non-Votes (1)
8,721,969	57,797,793	564,496	9,402,818

(1) Both abstentions and broker non-votes are counted as present for the purpose of determining the presence of a quorom. Broker non-votes, however, are not counted as shares present and entitled to be voted with respect to the matter on which the broker has expressly not voted. Thus, broker non-votes do not affect the outcome of any of the matters being voted on at the annual meeting.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

10.1 Agreement and Plan of Merger among Kintana, Inc., Mercury Interactive Corporation, Kanga Merger Corporation, Kanga Acquisition L.L.C. and Raj Jain, as Stockholders’ Representative, dated as of June 9, 2003

10.2 Form of Directors’ and Officers’ Indemnification Agreement

31.1 Certification of the Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2 Certification of the Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(b) Reports on Form 8-K

We furnished the following Current Report on Form 8-K during the quarter ended June 30, 2003:

We furnished a Current Report on Form 8-K dated April 16, 2003, announcing earnings for the quarter ended March 31, 2003 and attached a press release related thereto.

We furnished a Current Report on Form 8-K dated April 24, 2003, announcing the issuance of $500.0 million of Zero Coupon Senior Convertible Notes Due 2008 and attached a press release related thereto.

We furnished a Current Report on Form 8-K dated May 12, 2003, announcing the acquisition of Performant, Inc. and attached a press release related thereto.

We furnished a Current Report on Form 8-K dated June 10, 2003, announcing the definitive agreement to acquire Kintana, Inc. and attached a press release related thereto.

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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

(Registrant)

Dated: August 14, 2003

By:	/s/ DOUGLAS P. SMITH
	Douglas P. Smith,
	Executive Vice President and Chief Financial Officer
	Principal Financial Officer
By:	/s/ BRYAN J. LEBLANC
	Bryan J. LeBlanc,
	Vice President, Finance
	Principal Acounting Officer

40

EX-10.1

Exhibit 10.1

Execution Copy

AGREEMENT AND PLAN OF MERGER

dated as of

June 9, 2003

among

KINTANA, INC.,

MERCURY INTERACTIVE CORPORATION,

KANGA MERGER CORPORATION,

KANGA ACQUISITION L.L.C.

AND

RAJ JAIN, AS STOCKHOLDERS’ REPRESENTATIVE

TABLE OF CONTENTS

		PAGE
ARTICLE 1
DEFINITIONS
Section 1.01 .	Definitions	1
ARTICLE 2
THE MERGERS
Section 2.01 .	Mergers	11
Section 2.02 .	Conversion of Shares	11
Section 2.03 .	Surrender and Payment	12
Section 2.04 .	Dissenting Shares	13
Section 2.05 .	Stock Options	13
Section 2.06 .	Adjustments	14
Section 2.07 .	Withholding Rights	14
Section 2.08 .	Escrow	14
Section 2.09 .	Lost Certificates	15
ARTICLE 3
THE SURVIVING CORPORATION
Section 3.01 .	Certificate of Incorporation	15
Section 3.02 .	Bylaws	15
Section 3.03 .	Directors and Officers	15
ARTICLE 4
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
Section 4.01 .	Corporate Existence and Power	15
Section 4.02 .	Corporate Authorization	16
Section 4.03 .	Governmental Authorization	16
Section 4.04 .	Non-Contravention	16
Section 4.05 .	Capitalization	17
Section 4.06 .	Subsidiaries	18
Section 4.07 .	Financial Statements	19
Section 4.08 .	Absence of Certain Changes	19
Section 4.09 .	No Undisclosed Liabilities	21
Section 4.10 .	Compliance with Laws and Court Orders	21
Section 4.11 .	Agreements, Contracts and Commitments	21
Section 4.12 .	Litigation	23
Section 4.13 .	Finders’ Fees	23
Section 4.14 .	Opinion Of Financial Advisor	23
Section 4.15 .	Tax Representations	23
Section 4.16 .	Employee Matters and Employment Benefit Plans	25
Section 4.17 .	Title Of Properties; Absence Of Liens And Encumbrances; Condition Of Equipment	27

Section 4.18 .	Products	27
Section 4.19 .	Intellectual Property	27
Section 4.20 .	Insurance Coverage	30
Section 4.21 .	Licenses and Permits	31
Section 4.22 .	Receivables	31
Section 4.23 .	Environmental Matters	31
Section 4.24 .	Certain Interests	32
Section 4.25 .	Customers; Suppliers	32
Section 4.26 .	Books And Records	32
ARTICLE 5
REPRESENTATIONS AND WARRANTIES OF PARENT
Section 5.01 .	Corporate Existence and Power	33
Section 5.02 .	Corporate Authorization	33
Section 5.03 .	Governmental Authorization	33
Section 5.04 .	Non-Contravention	34
Section 5.05 .	SEC Filings	34
Section 5.06 .	Financing	34
Section 5.07 .	Common Stock	35
Section 5.08 .	Litigation	35
ARTICLE 6
COVENANTS OF THE COMPANY
Section 6.01 .	Conduct of the Company	35
Section 6.02 .	Stockholder Approval	38
Section 6.03 .	No Solicitation; Other Offers	38
Section 6.04 .	Access to Information	39
Section 6.05 .	Tax Matters	39
Section 6.06 .	401(k)	40
Section 6.07 .	Notices of Certain Events	40
Section 6.08 .	Consents; Good Standings	40
Section 6.09 .	Company Cash	40
Section 6.10 .	Excise Tax Matters	41
Section 6.11 .	Capitalization Information	41
Section 6.12 .	Stock Options	41
ARTICLE 7
COVENANTS OF PARENT
Section 7.01 .	Obligations Of Merger Subsidiary I	41
Section 7.02 .	Benefits; Prior Service; Section 16	42
Section 7.03 .	Indemnification; Insurance	42
Section 7.04 .	Listing Notifications	43
Section 7.05 .	Form S-8	43
Section 7.06 .	Material Announcements	43
ARTICLE 8
COVENANTS OF PARENT AND THE COMPANY

ii

Section 8.01 .	Reasonable Efforts	43
Section 8.02 .	Certain Filings	44
Section 8.03 .	Public Announcements	44
Section 8.04 .	Further Assurances	44
Section 8.05 .	Notification Of Certain Matters	44
Section 8.06 .	California Permit; Registered Offering	45
Section 8.07 .	Tax Free Reorganization	46
Section 8.08 .	Stock Certificates	46
ARTICLE 9
CONDITIONS TO THE MERGER
Section 9.01 .	Conditions to Obligations of Each Party	46
Section 9.02 .	Conditions to the Obligations of Parent and Merger Subsidiary I	47
Section 9.03 .	Conditions to Obligations of the Company	49
Section 9.04 .	Conditions to Obligations Of Parent And the Surviving Corporation With Respect To The Second Merger.	49
ARTICLE 10
SURVIVAL OF REPRESENTATION AND WARRANTIES; INDEMNIFICATION
Section 10.01 .	Survival Of Representation And Warranties	50
Section 10.02 .	Indemnification	50
Section 10.03 .	Defense Of Claims	52
Section 10.04 .	Stockholders’ Representative	53
ARTICLE 11
TERMINATION
Section 11.01 .	Termination	54
Section 11.02 .	Effect of Termination	55
ARTICLE 12
MISCELLANEOUS
Section 12.01 .	Notices	56
Section 12.02 .	Amendments; No Waivers	57
Section 12.03 .	Expenses	57
Section 12.04 .	Successors and Assigns	58
Section 12.05 .	Governing Law	58
Section 12.06 .	Jurisdiction	58
Section 12.07 .	WAIVER OF JURY TRIAL	58
Section 12.08 .	Counterparts; Effectiveness; Benefit	58
Section 12.09 .	Entire Agreement	59
Section 12.10 .	Captions	59
Section 12.11 .	Severability	59
Section 12.12 .	Specific Performance	59
Section 12.13 .	No Implied Representation	59

iii

INDEX TO EXHIBITS

Exhibit A	Forms of Voting Agreements
Exhibit B	Form of Non-Competition and Non-Solicitation Agreement
Exhibit C	Form of Escrow Agreement
Exhibit D	Form of Stockholders’ Representative Agreement
Exhibit E	Form of Opinion of Counsel to the Company
Exhibit F	Form of Opinion of Counsel to Parent
INDEX TO ANNEXES
Annex A	List of Persons executing Voting Agreement
Annex B	List of Persons executing Non-Competition and Non-Solicitation Agreement
Annex C	Amended and Restated Certificate of Incorporation of the Surviving Corporation
Annex D	Series A Preference Value Calculation

AGREEMENT AND PLAN OF MERGER

AGREEMENT AND PLAN OF MERGER dated as of June 9, 2003, among Kintana, Inc., a Delaware corporation (the “Company”), Mercury Interactive Corporation, a Delaware corporation (“Parent”), Kanga Merger Corporation, a Delaware corporation and a wholly-owned subsidiary of Parent (“Merger Subsidiary I”), Kanga Acquisition L.L.C., a Delaware limited liability company and a wholly-owned subsidiary of Parent (“Merger Subsidiary II”) and Raj Jain, as Stockholders’ Representative.

WHEREAS, upon the terms and subject to the conditions of this Agreement and in accordance with Delaware Law, Parent and the Company will enter into a business combination transaction pursuant to which Merger Subsidiary I will merge with and into the Company (the “Merger”), with Surviving Corporation then merging with and into Merger Subsidiary II.

WHEREAS, the Board of Directors of the Company (i) has determined that the business combination transaction is consistent with and in furtherance of the long-term business strategy of the Company and fair to, and in the best interests of, the Company and its stockholders and has approved and adopted this Agreement and the transactions contemplated by this Agreement and (ii) has recommended the approval and adoption of this Agreement by the stockholders of the Company.

WHEREAS, pursuant to the Merger, among other things, all of the issued and outstanding shares of capital stock of the Company shall be converted into the right to receive consideration consisting of cash and shares of Parent Common Stock (as defined herein) as set forth in Article 2 hereof.

WHEREAS, concurrently with the execution of this Agreement, and as a condition and inducement to Parent’s, Merger Subsidiary I’s and Merger Subsidiary II’s willingness to enter into this Agreement, each Person listed on Annex A hereto shall enter into a Voting Agreement in the form attached hereto as Exhibit A (the “Voting Agreement”) and each of the individuals listed on Annex B hereto shall enter into a Non-Competition and Non-Solicitation Agreement in the form attached hereto as Exhibit B (the “Non-Competition and Non-Solicitation Agreement”).

WHEREAS, the Company, on the one hand, and Parent, Merger Subsidiary I and Merger Subsidiary II, on the other hand, desire to make certain representations, warranties, covenants and other agreements in connection with the Merger.

NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements herein contained, and intending to be legally bound hereby, Parent, Merger Subsidiary I, Merger Subsidiary II and the Company hereby agree as follows:

ARTICLE 1

DEFINITIONS

Section 1.01. Definitions. (a) The following terms, as used herein, have the following meanings:

“Acquisition Proposal” means, other than the transactions contemplated by this Agreement, any offer, proposal or inquiry by a Third Party relating to, or any indication of

interest by a Third Party in, (i) any acquisition or purchase, direct or indirect, of any amount in excess of 30% of the consolidated assets of the Company and its Subsidiaries or any amount in excess of 30% of any class of equity or voting securities of the Company or any of its Subsidiaries, (ii) any tender offer (including a self-tender offer) or exchange offer that, if consummated, would result in any Third Party beneficially owning any amount in excess of 30% of any class of equity or voting securities of the Company or any of its Subsidiaries or (iii) a merger, consolidation, share exchange, business combination, sale of substantially all the assets of the Company, reorganization, recapitalization, liquidation, dissolution or other similar transaction involving the Company.

“Additional Options” means additional option grants that may be made by the Company prior to the Effective Time pursuant to Section 6.12 or to new employees as set forth on Schedule 6.01(e)(iv).

“Adjusted Stock Value” means the product obtained by multiplying:

(A) the quotient obtained by dividing one hundred million dollars ($100,000,000) by the Minimum Parent Average Closing Price, by

(B) the Parent Average Closing Price Per Share (without regard to the existence of a Minimum Parent Average Closing Price).

“Adjustment Amount” means the difference equal to (A) one hundred million dollars ($100,000,000) minus, (B) the Adjusted Stock Value.

“Affiliate” means, with respect to any Person, any other Person directly or indirectly controlling, controlled by or under common control with such Person.

“Aggregate Exercise Price” means the aggregate exercise price of the options (taking into account the Repricing) to purchase shares of Company Common Stock outstanding as of the date of this Agreement as listed on Schedule 4.05(b) to the Company Disclosure Letter.

“Business Day” means a day other than a Saturday, Sunday or any day on which commercial banks in San Francisco, California are authorized or required by law to close.

“California Law” means the California Corporations Code.

“California Permit” shall mean a permit from the California Commission of Corporations obtained pursuant to Section 25121 of the California Corporate Securities Law of 1968.

“Cash Proportion” means the difference equal to (A) one minus (B) the Stock Proportion.

“Code” means the Internal Revenue Code of 1986.

“Common Cash Amount” means the quotient obtained by dividing:

(A) the product obtained by multiplying (i) the Common Value by (ii) the Cash Proportion, by

2

(B) the Outstanding Common Equivalents.

“Common Conversion Number” means the quotient obtained by dividing:

(A) the product obtained by multiplying (i) the Common Value, by (ii) the Stock Proportion, by

(B) the product obtained by multiplying (i) the Parent Average Closing Price Per Share by (ii) the Outstanding Common Equivalents.

“Common Value” means the difference equal to (A) the Remaining Value minus (B) the Option Value.

“Company Cash” means, as of any date, the amount of cash and cash equivalents of the Company as of such date, but reduced by (i) the amount of any proceeds received from the exercise of Company Stock Options after the date of this Agreement and prior to the Effective Time and (ii) the amount of any proceeds received from the repayment of loans to be repaid as set forth on Schedule 9.02(m).

“Company Balance Sheet” means the balance sheet of the Company as of December 31, 2002 and the footnotes thereto.

“Company Balance Sheet Date” means December 31, 2002.

“Company Common Stock” means the shares of Common Stock, $0.001 par value per share, of the Company.

“Delaware Law” means the General Corporation Law of the State of Delaware.

“Environmental Laws” means any federal, state, local or foreign law (including, without limitation, common law), treaty, judicial decision, regulation, rule, judgment, order, decree, injunction, permit or governmental restriction or requirement or any agreement with any governmental authority or other third party, relating to human health and safety, the environment or to pollutants, contaminants, wastes or chemicals or any toxic, radioactive, ignitable, corrosive, reactive or otherwise hazardous substances, wastes or materials.

“Environmental Permits” means all permits, licenses, franchises, certificates, approvals and other similar authorizations of governmental authorities relating to or required by Environmental Laws and affecting, or relating in any way to, the business of the Company or any of its Subsidiaries as currently conducted.

“ERISA” means the Employee Retirement Income Security Act of 1974.

“ERISA Affiliate” of any entity means any other entity that, together with such entity, would be treated as a single employer under Section 414 of the Code.

“Escrow Amount” means an amount in cash equal to 15% of the Total Merger Value.

“Escrow Holdback” means the Pro Rata Share of the Escrow Amount.

“HSR Act” means the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

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“Intellectual Property Rights” means (i) inventions reduced to practice or made the subject of one or more pending patent applications, (ii) national and multinational statutory invention registrations, patents and patent applications (including all reissues, divisions, continuations, continuations-in-part, extensions and reexaminations thereof) registered or applied for in the United States and all other nations throughout the world, (iii) trademarks, service marks, trade dress, logos, and trade names (whether or not registered) in the United States and all other nations throughout the world, including all registrations and applications for registration of the foregoing and all goodwill associated therewith, (iv) copyrights (whether or not registered) and registrations and applications for registration thereof in the United States and all other nations throughout the world, including all moral rights, renewals, extensions, reversions or restorations associated with such copyrights, now or hereafter provided by law, regardless of the medium of fixation or means of expression, (v) rights in computer software (including source code, object code, firmware, operating systems and specifications), (vi) non-patentable inventions the confidentiality of which have been maintained, rights in trade secrets and, to the extent protectable as trade secrets or proprietary information, business information (including confidential pricing and cost information, business and marketing plans and customer and supplier lists) and know-how (including confidential manufacturing and production processes and techniques and research and development information), (vii) rights in industrial designs (whether or not registered), (viii) rights in databases and data collections, (ix) all rights to obtain and rights to apply for patents, and to register trademarks and copyrights, (x) all rights in all of the foregoing provided by treaties, conventions and common law and (xi) all rights to sue or recover and retain damages and costs and attorneys’ fees for past, present and future infringement or misappropriation of any of the foregoing.

“Interim Balance Sheet” means the unaudited balance sheet of the Company for the period ending April 30, 2003.

“Interim Balance Sheet Date” means April 30, 2003.

“Knowledge” of any Person that is not an individual means the actual knowledge of such Person’s officers after reasonable inquiry of the principal employee or employees of the Company responsible for the relevant functional area.

“Licensed Intellectual Property Rights” means all Intellectual Property Rights owned by a Person other than the Company or its Subsidiaries and licensed or sublicensed to either the Company or its Subsidiaries.

“Lien” means, with respect to any property or asset, any mortgage, lien, pledge, charge, security interest, encumbrance or other adverse claim, limitation or restriction of any kind in respect of such property or asset other than (i) non-exclusive licenses of Intellectual Property Rights granted to end user customers by the Company or its Subsidiaries in the ordinary course, (ii) Liens for Taxes not yet due and payable, (iii) municipal and zoning ordinances, easements for public utilities and such imperfections of title and encumbrances, if any, that do not materially interfere with the present use of the Property. For purposes of this Agreement, a Person shall be deemed to own subject to a Lien any property or asset that it has acquired or holds subject to the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement relating to such property or asset.

“Material Adverse Effect” means, with respect to any Person, a material adverse effect on the condition (financial or otherwise), business (including the continued operation thereof in accordance with past practice), assets or results of operations of such Person and its Subsidiaries,

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taken as a whole; provided, however, that the following shall not be deemed to constitute a Material Adverse Effect: (i) any change or effect resulting from the transactions contemplated by this Agreement or any agreement or other instrument entered into in connection herewith; or (ii) any change or effect resulting from general economic or industry conditions which do not disproportionately affect the Company or its Subsidiaries.

“Material Announcement” means any scheduled or reasonably foreseeable material announcement by Parent, including but not limited to a quarterly earnings announcement or pre-announcement.

“Merger Cash” means the sum of (A) one hundred twenty five million dollars ($125,000,000) plus (B) the Aggregate Exercise Price minus (C) the amount of the Transaction Expenses; provided, however, that the Merger Cash shall be reduced if required by Section 6.09.

“Merger Consideration” means the consideration payable to holders of Company Common Stock, Preferred Stock and Redeemable Preferred Stock pursuant to Sections 2.02 (a)-(d) below.

“Merger Share Value” means the difference equal to (A) one hundred million dollars ($100,000,000) minus (B) the Option Value; provided, however, that in the event that the Parent Average Closing Price Per Share is less than the Minimum Parent Average Closing Price, and the Company does not deliver a Termination Intent Notice, the Total Merger Value shall be reduced by the Adjustment Amount.

“1933 Act” means the Securities Act of 1933, as amended.

“1934 Act” means the Securities Exchange Act of 1934.

“officer” of any Person means any executive officer of such Person.

“Option Exchange Ratio” means the quotient obtained by dividing:

(A) the Option Value by

(B) the product obtained by multiplying (i) the number of Outstanding Options by (ii) the Parent Average Closing Price Per Share.

“Option Portion” means the quotient obtained by dividing:

(A) the Outstanding Options by

(B) the sum of the Outstanding Common Equivalents plus the Outstanding Options.

“Option Value” means the product obtained by multiplying (A) the Remaining Value by (B) the Option Portion.

“Outstanding Common Equivalents” means the sum of Outstanding Common plus the Outstanding Series A Preferred.

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“Outstanding Common” means the shares of Company Common Stock issued and outstanding at the Effective Time.

“Outstanding Options” means all of the stock options to purchase shares of Company Common Stock outstanding at the Effective Time, excluding the Additional Options.

“Outstanding Redeemable Preferred” means the shares of Redeemable Preferred issued and outstanding at the Effective Time.

“Outstanding Series A Preferred” means the shares of Series A Preferred Stock issued and outstanding at the Effective Time.

“Outstanding Series B Preferred” means the shares of Series B Preferred Stock and Series B-1 Preferred Stock issued and outstanding at the Effective Time.

“Owned Intellectual Property Rights” means all Intellectual Property Rights owned by either the Company or its Subsidiaries.

“Parent Average Closing Price Per Share” means the Parent Average Price Per Share at the Effective Time, provided that:

(i) if the Parent Average Closing Price Per Share is less than the quotient obtained by dividing (A) the Parent Average Signing Price Per Share by (B) 1.15, then the Parent Average Closing Price Per Share shall be such quotient (“Minimum Parent Average Closing Price”); or

(ii) if the Parent Average Closing Price Per Share is greater than the quotient obtained by dividing (A) the Parent Average Signing Price Per Share by (B) 0.85, then the Parent Average Closing Price Per Share shall be such quotient (“Maximum Parent Average Closing Price”).

“Parent Average Price Per Share” means the average closing price of Parent Common Stock as printed in the Wall Street Journal for each of the 15 trading days up to and including the second trading day preceding such date (the “Measurement Period”); provided that (i) the Measurement Period shall not include any trading days that are within two trading days before any Material Announcement, and (i) in the event a Material Announcement is made during a Measurement Period, the Measurement Period shall be canceled and shall restart from the beginning of the second trading day following that Material Announcement and shall continue to run for the next 15 trading days.

“Parent Average Signing Price Per Share” means $37.99.

“Parent Common Stock” means shares of common stock, $0.002 par value, of Parent, including any associated preferred stock purchase rights.

“Person” means an individual, corporation, partnership, limited liability company, association, trust or other entity or organization, including a government or political subdivision or an agency or instrumentality thereof.

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“Pre-Closing Tax Period” means any Tax period ending on or before the Effective Time; and, with respect to a Tax period that begins on or before the Effective Time and ends thereafter, the portion of such Tax period ending on the Effective Time.

“Preferred Stock” means collectively the shares of Series A Preferred Stock, Series B Preferred Stock and Series B-1 Preferred Stock.

“Pro Rata Share” means, with respect to a holder of Shares, the quotient obtained by dividing (A) the Value Received by that holder by (B) the aggregate Value Received by all holders of Shares.

“Redeemable Preferred Cash Amount” means the quotient obtained by dividing (A) the product obtained by multiplying (i) the Redeemable Preferred Value multiplied by (ii) the Cash Proportion by (B) the Outstanding Redeemable Preferred.

“Redeemable Preferred Conversion Number” means the quotient obtained by dividing (A) the product of the Redeemable Preferred Value multiplied by the Stock Proportion by (B) the product of the Parent Average Closing Price Per Share multiplied by the Outstanding Redeemable Preferred.

“Redeemable Preferred Value” means that amount equal to the product of (A) the number of shares of Outstanding Redeemable Preferred multiplied by (B) $3.0908 plus all accrued and unpaid dividends with respect to each share of Outstanding Redeemable Preferred.

“Redeemable Preferred” means the shares of Redeemable Preferred Stock, $0.001 par value, of the Company.

“Remaining Value” means the difference equal to (A) the Total Merger Value minus (B) the sum of (i) the Redeemable Preferred Value plus (ii) the Series A Preference Value plus (iii) the Series B Value.

“SEC” means the Securities and Exchange Commission.

“Series A Cash Amount” means the sum of (A) the Series A Preference Cash plus (B) the Common Cash Amount.

“Series A Conversion Number” means the sum of (A) the Series A Preference Stock plus (B) the Common Conversion Number.

“Series A Preference Cash” means the quotient obtained by dividing (A) the product of the Series A Preference Value multiplied by the Cash Proportion by (B) the Outstanding Series A Preferred.

“Series A Preferred Stock” means the Convertible Participating Preferred Stock, $0.001 par value per share, of the Company.

“Series A Preference Value” means that amount equal to the product obtained by multiplying (A) the Outstanding Series A Preferred by (B) the sum of $1.5454 plus the Series A Additional Liquidation Preference (as defined in Section A.4. (a)(ii) of Article IV of the Company’s Amended and Restated Certificate of Incorporation, it being expressly understood that as of the date of this Agreement, this amount is approximately $2.10 and that the Additional

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Options shall not be included in making any of the computations required under Section A. 4. (a)(ii) for purposes of calculating the Series A Additional Liquidation Preference (as defined in such Section A. 4. (a)(ii) of Article IV) and as illustrated on Annex D).

“Series A Preference Stock” means the quotient obtained by dividing (A) the product of the Series A Preference Value multiplied by the Stock Proportion by (B) the product of the Parent Average Closing Price Per Share multiplied by the Outstanding Series A Preferred.

“Series B Cash Amount” means the quotient obtained by dividing (A) the product obtained by multiplying (i) the Series B Value by the Cash Proportion by (B) the Outstanding Series B Preferred.

“Series B Conversion Number” means the quotient obtained by dividing (A) the product obtained by multiplying the Series B Value by the Stock Proportion by (B) the product obtained by multiplying the Parent Average Closing Price Per Share by the Outstanding Series B Preferred.

“Series B Preferred Stock” means the Series B Convertible Participating Preferred Stock, $0.001 par value per share, of the Company.

“Series B Value” means that amount equal to the product obtained by multiplying (A) the Outstanding Series B Preferred by (B) $17.38.

“Series B-1 Preferred Stock” means the Series B-1 Convertible Participating Preferred Stock, $0.001 par value per share, of the Company.

“Shares” means the Company Common Stock, the Redeemable Preferred and the Preferred Stock, collectively.

“Stock Proportion” means the quotient obtained by dividing (A) the Merger Share Value by (B) the difference of the Total Merger Value minus the Option Value.

“Stockholders’ Representative” shall be Raj Jain.

“Stockholders’ Representatives Agreement” means the agreement between the Company, the Stockholders’ Representative and TA Associates, Inc., dated June 9, 2003, attached hereto as Exhibit D.

“Subsidiary” means, with respect to any Person, any entity of which securities or other ownership interests having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions are at any time directly or indirectly owned by such Person.

“Superior Proposal” means any bona fide, unsolicited written Acquisition Proposal for all or substantially all of the outstanding shares of Company Stock on terms that the Board of Directors of the Company determines in good faith by a majority vote, after considering the advice of a financial advisor of nationally recognized reputation and taking into account all the terms and conditions of the Acquisition Proposal, including any break-up fees, expense reimbursement provisions and conditions to consummation, are more favorable and provide greater value to the Company’s stockholders than as provided hereunder and for which financing,

8

to the extent required, is then fully committed or reasonably determined to be available by the Board of Directors of the Company.

“Tax” means (i) any tax, governmental fee or other like assessment or charge of any kind whatsoever (including, but not limited to, withholding on amounts paid to or by any Person), together with any interest, penalty, addition to tax or additional amount imposed by any governmental authority (a “Taxing Authority”) responsible for the imposition of any such tax (domestic or foreign), and any liability for any of the foregoing as transferee, (ii) in the case of the Company or any Subsidiary of the Company, liability for the payment of any amount of the type described in clause (i) as a result of being or having been before the Effective Time a member of an affiliated, consolidated, combined or unitary group, or by virtue of applicable law or by virtue of any agreement or arrangement with a Taxing Authority that would impose liability on one Person for the payment of any Tax liability of another Person, and (iii) liability of the Company or any Subsidiary of the Company for the payment of any amount as a result of being party to any Tax Sharing Agreement or with respect to the payment of any amount imposed on any person of the type described in (i) or (ii) as a result of any existing express or implied agreement or arrangement (including, but not limited to, an indemnification agreement or arrangement).

“Tax Asset” means any net operating loss, net capital loss, investment tax credit, foreign tax credit, charitable deduction or any other credit or tax attribute that could be carried forward or back to reduce Taxes (including without limitation deductions and credits related to alternative minimum Taxes).

“Tax Sharing Agreements” means all existing agreements or arrangements (whether or not written) binding the Company or any Subsidiary of the Company that provide for the allocation, apportionment, sharing or assignment of any item of income, gain, deduction, credit or loss or any Tax liability or benefit, in each case, for the purpose of determining any person’s Tax liability.

“Third Party” means any Person as defined in this Agreement or in Section 13(d) of the 1934 Act, other than Parent or any of its Affiliates.

“Total Merger Value” means the sum of (A) the Merger Cash plus (B) one hundred million dollars ($100,000,000); provided, however, that in the event that the Parent Average Closing Price Per Share is less than the Minimum Parent Average Closing Price, and the Company does not deliver a Termination Intent Notice, the Total Merger Value shall be reduced by the Adjustment Amount.

“Transaction Expenses” means the reasonably documented fees and expenses incurred by the Company’s legal counsel, auditors, investment bankers, financial advisors and consultants incurred with respect to this Agreement and the transactions contemplated hereby.

“Value Received” the sum of (A) the cash received by a holder of Shares pursuant to Section 2.02 plus (B) the product of the aggregate number of shares of Parent Common Stock received by such holder pursuant to Section 2.02 multiplied by the Parent Average Closing Price Per Share.

“Warrant” means each unexpired and unexercised outstanding warrant to purchase Company Common Stock, Series B Preferred Stock or Series B-1 Preferred Stock, as applicable.

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Any reference in this Agreement to a statute shall be to such statute, as amended from time to time, and to the rules and regulations promulgated thereunder.

(b) Each of the following terms is defined in the Section set forth opposite such term:

Term	Section
Basket Amount	Section 10.02
Certificates	Section 2.03
Change of Recommendation	Section 6.03
Closing	Section 2.01
Company Acquisition	Section 12.03
Company Disclosure Schedule	Article 4
Company Securities	Section 4.05
Company Stockholder Meeting	Section 6.02
Company Stock Options	Section 2.05
Company Stock Option Plan	Section 2.05
Company Subsidiary Securities	Section 4.06
Contested Claim	Section 10.02
Effective Time	Section 2.01
Employee Agreements	Section 4.19
Employee Plans	Section 4.16
End Date	Section 11.01
Escrow Account	Section 2.08
Escrow Agent	Section 2.08
Escrow Agreement	Section 2.08
Escrow Fund	Section 2.08
Excess Borrowing	Section 6.09
Exchange Agent	Section 2.03
Final Award	Section 10.02
GAAP	Section 4.07
Governmental Authority	Section 9.01
Indemnified Parties	Section 7.03
Indemnifying Party	Section 10.02
J.A.M.S.	Section 10.02
Letter Agreement	Section 6.04
Loan Limit	Section 6.01
Loss	Section 10.02
Material Agreement	Section 4.11
Merger	Recitals
Multiemployer Plan	Section 4.16
Non-Competition and Non-Solicitation Agreement	Recitals
Parent Indemnified Parties	Section 10.02
Parent SEC Documents	Section 5.05
Permits	Section 4.21
Pre-Closing Date	Section 11.01
Proxy Materials	Section 6.02
Registration Statement	Section 8.06
Repricing	Section 6.01
Return	Section 4.15
Schedule	Article 4
Stockholder	Section 2.03

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Term	Section
Surviving Corporation	Section 2.01
Termination Intent Notice	Section 11.01
Top-Up Notice	Section 11.01
Voting Agreement	Recitals
WARN Act	Section 4.16

ARTICLE 2

THE MERGERS

Section 2.01. Mergers. (a) At the Effective Time, Merger Subsidiary I shall be merged with and into the Company in accordance with Delaware Law, whereupon the separate existence of Merger Subsidiary I shall cease, and the Company shall be the surviving corporation (the “Surviving Corporation”). Immediately following the Merger, the Surviving Corporation will be merged with and into Merger Subsidiary II (the “Second Merger”).

(b) As soon as practicable after satisfaction or, to the extent permitted hereunder, waiver of all conditions to the Merger, the Company and Merger Subsidiary I will file an agreement of merger with the Secretary of State of the State of Delaware and make all other filings or recordings required by Delaware Law in connection with the Merger. The Merger shall become effective at such time (the “Effective Time”) as the agreement of merger is accepted by the Secretary of State of the State of Delaware or at such later time as is specified in the agreement of merger. Immediately prior to the filing of the agreement of merger, a closing (the “Closing”) will be held at the offices of Davis Polk & Wardwell, 1600 El Camino Real, Menlo Park, California 94025 (or such other place as the parties may agree). Immediately following the Effective Time, the Second Merger shall become effective at such time as the agreement of merger relating to the Second Merger is accepted by the Secretary of State of the State of Delaware.

Section 2.02. Conversion of Shares. At the Effective Time:

(a) each share of Redeemable Preferred shall be converted into the right to receive (x) an amount of cash, without interest, equal to the Redeemable Preferred Cash Amount, and (y) a number of Shares of Parent Common Stock equal to the Redeemable Preferred Conversion Number;

(b) each share of Outstanding Series A Preferred shall be converted into the right to receive, (a) an amount of cash, without interest, equal to the Series A Cash Amount, and (b) a number of shares of Parent Common Stock equal to the Series A Conversion Number;

(c) each share of Outstanding Series B Preferred and Series B-1 Preferred Stock shall be converted into the right to receive (a) an amount of cash, without interest; equal to the Series B Cash Amount, and (b) a number of shares of Parent Common Stock equal to the Series B Conversion Number;

(d) each share of Outstanding Common shall be converted into the right to receive, (a) an amount of cash, without interest, equal to the Common Cash Amount, and (b) a number of shares of Parent Common Stock equal to the Common Conversion Number;

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(e) each Share held by the Company as treasury stock or owned by Parent or any of its Subsidiaries immediately prior to the Effective Time shall be canceled, and no payment shall be made with respect thereto; and

(f) each share of common stock of Merger Subsidiary outstanding immediately prior to the Effective Time shall be converted into and become one share of common stock of the Surviving Corporation with the same rights, powers and privileges as the shares so converted and shall constitute the only outstanding shares of capital stock of the Surviving Corporation.

Notwithstanding the foregoing, the parties hereto acknowledge and agree that the Escrow Amount shall be deducted from the cash payable to each Share based on the Pro Rata Share of the Escrow Amount as set forth in Section 2.08.

Section 2.03. Surrender and Payment. (a) Parent will act as exchange agent (the “Exchange Agent”) for the purpose of exchanging certificates representing Shares (the “Certificates”) for the Merger Consideration (less the Escrow Holdback). Immediately following the Effective Time, Parent will make available the Merger Consideration (less the Escrow Holdback) to be paid in respect of the Shares. At the Effective Time or promptly thereafter, Company stockholders (each, a “Stockholder” collectively, the “Stockholders”) will surrender the Certificates to the Exchange Agent for cancellation together with a letter of transmittal and instructions (which shall specify that the delivery shall be effected, and risk of loss and title shall pass, only upon proper delivery of the Certificates to the Exchange Agent) for use in such exchange. The parties agree that any Stockholder that delivers Certificates, together with such letter of transmittal and instructions at the Effective Time, shall receive at the Effective Time certificates (without restrictive legends or other restrictions on transfer other than restrictions imposed by applicable law) evidencing the shares of Parent Common Stock issuable to such Stockholder pursuant to Section 2.02.

(b) Each holder of Shares that have been converted into the right to receive the Merger Consideration less the Escrow Holdback will be entitled to receive, upon surrender to the Exchange Agent of a Certificate, together with a properly completed letter of transmittal, the Merger Consideration less the Escrow Holdback payable for each Share represented by such Certificate. All such funds shall be paid to the holders of Shares by wire transfer to accounts specified in their respective letters of transmittal or, upon the request of any such holder, by check. Until so surrendered, each such Certificate shall represent after less the Effective Time for all purposes only the right to receive such Merger Consideration less the Escrow Holdback.

(c) If any portion of the Merger Consideration less the Escrow Holdback is to be paid to a Person other than the Person in whose name the surrendered Certificate is registered, it shall be a condition to such payment that the Certificate so surrendered shall be properly endorsed or otherwise be in proper form for transfer and that the Person requesting such payment shall pay to the Exchange Agent any transfer or other taxes required as a result of such payment to a Person other than the registered holder of such Certificate or establish to the satisfaction of the Exchange Agent that such tax has been paid or is not payable.

(d) After the Effective Time, there shall be no further registration of transfers of Shares. If, after the Effective Time, Certificates are presented to the Surviving Corporation, they shall be canceled and exchanged for the Merger Consideration less the Escrow Holdback provided for, and in accordance with the procedures set forth, in this Article 2.

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(e) Any portion of the Merger Consideration (less the Escrow Holdback) made available to the Exchange Agent pursuant to Section 2.03(a) (and any interest or other income earned thereon) that remains unclaimed by the holders of Shares twenty (20) Business Days after the Effective Time shall be returned to Parent, upon demand, and any such holder who has not exchanged Shares for the Merger Consideration less the Escrow Holdback in accordance with this Section 2.03 prior to that time shall thereafter look only to Parent for payment of the Merger Consideration less the Escrow Holdback in respect of such Shares without any interest thereon. Notwithstanding the foregoing, Parent shall not be liable to any holder of Shares for any amount paid to a public official pursuant to applicable abandoned property, escheat or similar laws. Immediately prior to such time when amounts remaining unclaimed by holders of Shares would otherwise escheat to or become property of any governmental authority, such unclaimed amounts shall become, to the extent permitted by applicable law, the property of Parent free and clear of any claims or interest of any Persons previously entitled thereto.

(f) Any portion of the Merger Consideration made available to the Exchange Agent pursuant to Section 2.03(a) to pay for Shares for which appraisal rights have been perfected shall be returned to Parent, upon demand.

Section 2.04. Dissenting Shares. Notwithstanding Section 2.02, Shares outstanding immediately prior to the Effective Time and held by a holder who has not voted in favor of the Merger or consented thereto in writing and who has demanded appraisal for such Shares in accordance with Delaware Law or California Law shall not be converted into a right to receive the Merger Consideration, but the holder thereof shall only be entitled to such rights as are provided by Delaware Law or California Law, unless such holder fails to perfect, withdraws or otherwise loses its right to appraisal. If, after the Effective Time, such holder fails to perfect, withdraws or loses its right to appraisal, such Shares shall be treated as if they had been converted as of the Effective Time into a right to receive the Merger Consideration less the Escrow Holdback. The Company shall give Parent prompt notice of any demands received by the Company for appraisal of Shares, and Parent shall have the right to participate in all negotiations and proceedings with respect to such demands. Except with the prior written consent of Parent, the Company shall not make any payment with respect to, or settle or offer to settle, any such demands.

Section 2.05. Stock Options. (a) Except as provided in Section 2.05(c), all options (the “Company Stock Options”) outstanding at the Effective Time under the Company’s 1997 Equity Incentive Plan and the U.K. Option Scheme (defined below) (collectively, the “Company Stock Option Plan”), shall, at the Effective Time and by virtue of the Merger and without any action on the part of the holder thereof, be assumed by Parent. Each Company Stock Option so assumed by Parent under this Agreement shall continue to have, and be subject to, substantially similar terms and conditions to those set forth in the Company Stock Option Plan or as provided in the respective option agreement immediately prior to the Effective Time, except that (i) each Company Stock Option will be exercisable for that number of whole shares of Parent Common Stock equal to the product of the number of shares of Company Common Stock that were issuable upon exercise of such Company Stock Option immediately prior to the Effective Time multiplied by the Option Exchange Ratio, rounded down to the nearest whole number of shares of Parent Common Stock; and (ii) the per share exercise price for the shares of Parent Common Stock issuable upon exercise of such assumed Company Stock Option will be equal to the quotient determined by dividing the exercise price per share of Company capital stock at which such Company Option was exercisable immediately prior to the Effective Time by the Option Exchange Ratio, rounded up to the nearest whole cent. It is the intention of the parties hereto that the Company Stock Options assumed by Parent following the Effective Time pursuant to this

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Section will, to the extent permitted by applicable law, qualify as incentive stock options as defined in Section 422 of the Code, to the extent any such Company Stock Options qualified as incentive stock options immediately prior to the Effective Time.

(b) As soon as practicable after the Effective Time, Parent shall deliver to each holder of an outstanding Company Stock Option an appropriate notice setting forth such holder’s rights pursuant thereto. Parent shall take all corporate action necessary to reserve for issuance a sufficient number of shares of Parent Common Stock for delivery upon exercise of assumed Company Stock Options pursuant to the terms set forth in this Section.

(c) All Company Stock Options that by their terms terminate upon a change of control, unless exercised prior to the Effective Time, shall terminate at the Effective Time.

(d) If any shares of Company Common Stock outstanding immediately prior to the Effective Time 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 the Company, then, at Parent’s option and in Parent’s sole discretion, the Merger Consideration in respect of such shares shall be received by the holder thereof over time upon satisfaction of the vesting requirements associated with the applicable restricted stock schedule.

Section 2.06. Adjustments. If, during the period between the date of this Agreement and the Effective Time, any change in the outstanding Shares shall occur, including by reason of any reclassification, recapitalization, stock split or combination, exchange or readjustment of Shares, or stock dividend thereon with a record date during such period, the Merger Consideration, the Escrow Holdback, and any other amounts payable pursuant to this Agreement shall be appropriately adjusted.

Section 2.07. Withholding Rights. Each of the Surviving Corporation and Parent shall be entitled to deduct and withhold from the consideration otherwise payable to any Person pursuant to this Article 2 such amounts as it is required to deduct and withhold with respect to the making of such payment under any provision of federal, state, local or foreign tax law. If the Surviving Corporation or Parent, as the case may be, so withholds amounts, such amounts shall be treated for all purposes of this Agreement as having been paid to the holder of the Shares in respect of which the Surviving Corporation or Parent, as the case may be, made such deduction and withholding.

Section 2.08. Escrow. At the Effective Time, Parent shall withhold from the Merger Cash otherwise payable with respect to Shares, an aggregate amount of cash equal to the Escrow Amount. The Escrow Amount shall be allocated to each of the holders of Shares based on such holder’s Pro Rata Share of the Escrow Amount. Prior to or simultaneously with the Effective Time, the Stockholders’ Representative and Parent shall enter into an escrow agreement (the “Escrow Agreement”) with an escrow agent selected by Parent and reasonably acceptable to the Stockholders’ Representative (the “Escrow Agent”) substantially in the form of Exhibit C hereto. Pursuant to the terms of the Escrow Agreement, at the Effective Time Parent shall deposit the Escrow Amount into an escrow account, which account is to be managed by the Escrow Agent (the “Escrow Account”). Distributions of any money from the Escrow Account shall be governed by the terms and conditions of the Escrow Agreement (any money in the Escrow Account being referred to as the “Escrow Fund”). The parties acknowledge and agree that (i) any amount distributed by the Escrow Agent from the Escrow Account to the Stockholders pursuant to the terms of the Escrow Agreement shall be treated, for U.S. federal income tax purposes, as additional consideration paid to the Stockholders for their Shares pursuant to the

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Merger as and when such amount is distributed, and (ii) a portion of each such distribution shall be treated as a payment of interest in accordance with Section 483 of the Code.

Section 2.09. Lost Certificates. If any Certificate shall have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the Person claiming such Certificate to be lost, stolen or destroyed and, if required by the Surviving Corporation, the posting by such Person of a bond, in such reasonable amount as the Surviving Corporation may direct, as indemnity against any claim that may be made against it with respect to such Certificate, the Exchange Agent will pay, in exchange for such lost, stolen or destroyed Certificate, the Merger Consideration (less the Escrow Holdback) to be paid in respect of the Shares represented by such Certificate, as contemplated by this Article 2.

ARTICLE 3

THE SURVIVING CORPORATION

Section 3.01. Certificate of Incorporation. The certificate of incorporation of the Company in effect at the Effective Time shall be the certificate of incorporation of the Surviving Corporation until amended in accordance with applicable law, provided that, at the Effective Time, such certificate of incorporation shall be amended as set forth in Annex C.

Section 3.02. Bylaws. The bylaws of Merger Subsidiary I in effect at the Effective Time shall be the bylaws of the Surviving Corporation until amended in accordance with applicable law.

Section 3.03. Directors and Officers. From and after the Effective Time, until successors are duly elected or appointed and qualified in accordance with applicable law, (i) the directors of Merger Subsidiary I at the Effective Time shall be the directors of the Surviving Corporation and (ii) the officers of Merger Subsidiary I at the Effective Time shall be the officers of the Surviving Corporation.

ARTICLE 4

REPRESENTATIONS AND WARRANTIES OF THE COMPANY

The Company hereby represents and warrants to Parent that each of the statements contained in this Article 4 are true and complete, except as otherwise provided herein and except as specifically disclosed in the schedules attached hereto (each, a “Schedule” and together, the “Company Disclosure Schedule”). Each exception set forth in the Company Disclosure Schedule and each other reference to this Agreement set forth in the Company Disclosure Schedule is identified by reference to, or has been grouped under a heading referring to, a specific individual section of this Agreement.

Section 4.01. Corporate Existence and Power. The Company is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware and has all corporate powers and authority to carry on its business as now conducted. Schedule 4.01(a) contains a complete and accurate list of every jurisdiction in which the Company is qualified to do business. The Company is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction where failure to be so qualified would have a Material Adverse Effect on the Company. The Company has heretofore made available to Parent true and

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complete copies of the certificate of incorporation and bylaws of the Company as currently in full force and effect. The Company is not in violation of any of the provisions of its certificate of incorporation or bylaws. The Company shall amend its certificate of incorporation immediately prior to the Effective Time as set forth in Schedule 4.01(b). As of the date of this Agreement, the Company has received agreements from its Stockholders holding sufficient votes to approve such amendment.

Section 4.02. Corporate Authorization. (a) The execution, delivery and performance by the Company of this Agreement and the Escrow Agreement and the consummation by the Company of the transactions contemplated hereby and thereby are within the Company’s corporate powers and have been duly authorized by the Company’s Board of Directors. The affirmative vote of the holders of (i) a majority of the outstanding Shares (if required by law), (ii) two-thirds of the outstanding shares of Company Common Stock (if required by law), and (iii) two-thirds the outstanding shares of each class of the Preferred Stock and the Redeemable Preferred are the only votes of the holders of any of the Company’s capital stock necessary in connection with the consummation of the Merger. The Company has received, prior to the date of this Agreement, the affirmative consent to the terms of this Agreement of at least two-thirds of the holders of outstanding shares of each class of Preferred Stock and the Redeemable Preferred. Subject to approval of this Agreement and the Escrow Agreement, upon signing, by the Stockholders of the Company, and assuming due authorization, execution and delivery by the other parties hereto and thereto, this Agreement and the Escrow Agreement, upon signing, will constitute valid and binding agreements of the Company enforceable in accordance with their terms, except as the enforceability may be subject to the effect, if any, of (i) applicable bankruptcy and other similar laws affecting the rights of creditors generally, (ii) rules of law governing specific performance, injunctive relief and other equitable remedies and (iii) the enforceability of provisions requiring indemnification in connection with the offering, issuance or sale of securities.

(b) At a meeting duly called and held the Company’s Board of Directors has (i) unanimously (with Anthony Zingale abstaining) determined that this Agreement is advisable, and that the Merger is fair to and in the best interests of the Stockholders and (ii) unanimously (with Anthony Zingale abstaining) approved and adopted this Agreement and the Merger.

Section 4.03. Governmental Authorization. The execution, delivery and performance by the Company of this Agreement and the Escrow Agreement and the consummation by the Company of the transactions contemplated hereby and thereby require no action on the part of the Company by or in respect of, or filing with, any governmental body, agency, official or authority, domestic, foreign or supranational, other than (i) the filing of a certificate of merger with respect to the Merger with the Delaware Secretary of State and appropriate documents with the relevant authorities of other states in which Company is qualified to do business, (ii) compliance with any applicable requirements of the 1933 Act, the 1934 Act, and any other applicable securities laws, whether state or foreign, (iii) such filings as may be required under the HSR Act, (iv) obtaining the California Permit and (v) any actions or filings the absence of which would not be reasonably expected to be, individually or in the aggregate, material to the Company or to materially impair the ability of the Company to consummate the transactions contemplated by this Agreement.

Section 4.04. Non-Contravention. The execution, delivery and performance by the Company of this Agreement and the Escrow Agreement and the consummation of the transactions contemplated hereby and thereby do not and will not (i) contravene, conflict with, or result in any violation or breach of any provision of the certificate of incorporation or bylaws of the Company or any of its Subsidiaries, (ii) assuming compliance with the matters referred to in

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Section 4.03, contravene, conflict with, or result in a violation or breach of any provision of any applicable law, statute, ordinance, rule, regulation, judgment, injunction, order or decree, (iii) require any material consent or similar action by any Person under, constitute a default, or an event that, with or without notice or lapse of time or both, could become a default, under, or cause or permit the termination, cancellation, acceleration or other change of any right or obligation or the loss of any benefit to which the Company or any of its Subsidiaries is entitled under any provision of any Material Agreement or any license, franchise, permit, certificate, approval or other similar authorization affecting, or relating in any way to, the assets or business of the Company and its Subsidiaries or (iv) result in the creation or imposition of any Lien on any asset of the Company or any of its Subsidiaries, except for such contraventions, conflicts and violations referred to in clause (ii) and for such failures to obtain any such consent or other action, defaults, terminations, cancellations, accelerations, changes, losses or Liens referred to in clauses (iii) and (iv) that would not be reasonably expected to be, individually or in the aggregate, material to the Company or materially to impair the ability of the Company to consummate the actions contemplated by this Agreement.

Section 4.05. Capitalization. (a) The authorized capital stock of the Company consists of (i) 100,000,000 shares of Company Common Stock, (ii) 1,391,212 shares of Redeemable Preferred Stock, (iii) 2,782,424 shares of Series A Preferred Stock, (iv) 3,897,737 shares of Series B Preferred Stock, and (v) 900,000 shares of Series B-1 Preferred Stock. There are outstanding (i) 28,990,914 shares of Common Stock (ii) 1,391,212 Redeemable Preferred Stock, (iii) 2,782,424 shares of Series A Preferred Stock, (iv) 3,883,349 shares of Series B Preferred Stock, and (v) 433,198 shares of Series B-1 Preferred Stock. There are outstanding Warrants to purchase 825,834 shares of Company Common Stock, 14,388 shares of Series B Preferred Stock and 14,386 shares of Series B-1 Preferred Stock. As of the date hereof, the shares of Redeemable Preferred Stock are not convertible into shares of Company Common Stock, each share of Series A Preferred is convertible into 1 share of Company Common Stock, each share of Series B Preferred is convertible into 1.1111 shares of Company Common Stock and each share of Series B-1 Preferred is convertible into 3.581 shares of Company Common Stock. The Company capital stock and Warrants are, as of the date of this Agreement, held by the Persons and in the amounts set forth in Schedule 4.05, with the latest known addresses of such Persons indicated thereon. No Subsidiary of the Company owns any Company capital stock. All outstanding shares of the Company are duly authorized, validly issued, fully paid and non-assessable and not subject to preemptive rights created by statute, the certificate of incorporation or bylaws of the Company or any agreement to which the Company is a party or by which it is bound and have been issued in compliance in all material respects with federal and state securities laws. Except as set forth on Schedule 4.05(a), each Warrant was duly and validly issued and was issued in compliance in all material respects with federal and state securities laws, the Company capital stock issuable upon exercise of each Warrant has been duly reserved and, upon exercise, would be validly issued, fully paid and non-assessable. There are no declared or accrued unpaid dividends with respect to any shares of the Company Common Stock or the Company Preferred Stock other than the Redeemable Preferred Stock. The Company has no other capital stock authorized, issued or outstanding. The Company has heretofore delivered to Parent true and complete copies of each Warrant and any and all agreements to grant a warrant.

(b) The Company has reserved 9,160,506 and 160,000 shares of Company Common Stock for issuance to employees, directors and consultants pursuant to the 1997 Equity Incentive Plan, as amended to the date hereof, and the ChainLink Technologies Company Share Option Scheme for its United Kingdom subsidiary (the “UK Option Scheme”, together with the 1997 Equity Incentive Plan, the “Company Stock Option Plan”), respectively, of which 5,409,405 and 20,000 shares are subject to outstanding unexercised options as of the date hereof,

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respectively, of which 3,115,943 and 16,770 shares are vested as of the date hereof, respectively, 120,583 options will be accelerated as a result of the transactions contemplated by this Agreement, respectively, and 412,403 and 133,490 shares remain available for future grant as of the date hereof, respectively. Schedule 4.05(b)(i) of the Company Disclosure Schedule sets forth each Company Stock Option outstanding, the grant date and number of shares of Company Common Stock subject to such option, the exercise price of such option, the vesting schedule for such option, including the extent vested to date and whether and to what extent the exercisability of such option will be accelerated as a result of the transactions contemplated by this Agreement (indicating the circumstances that may cause such acceleration), the date on which such option expires and whether and to what extent such option qualifies as an incentive stock option as defined in Section 422 of the Code. Schedule 4.05(b)(i) shall also indicate each portion of a Company Stock Option that has been repriced, and each such portion of a repriced option shall by its terms terminate at the Effective Time. The Company has provided to Parent the name and, to the Knowledge of the Company, address of the holder of each such option. Except for the Company Stock Options, the Warrants, the Outstanding Series A Preferred, the Outstanding Series B Preferred and the Outstanding Redeemable Preferred outstanding as of the date hereof, there are no options, warrants, calls, rights, commitments or agreements of any character, written or oral, to which the Company is a party or by which it is bound obligating the Company to issue, deliver, sell, repurchase or redeem, or cause to be issued, delivered, sold, repurchased or redeemed, any securities of the Company or obligating the Company 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. No outstanding Company capital stock is subject to vesting or forfeiture or rights of repurchase by the Company. Schedule 4.05(b)(ii) of the Company Disclosure Schedule sets forth as of the date hereof the name of the holder of any Company Common Stock subject to vesting, the number of shares of Company Common Stock subject to vesting and the vesting schedule for such Company Common Stock, including the extent vested to date and whether and to what extent the vesting of such shares of Company Common Stock will be accelerated as a result of the transactions contemplated by this Agreement (indicating the circumstances that may cause such acceleration). There are no outstanding or authorized stock appreciation, dividend equivalent, phantom stock, profit participation, or other similar rights with respect to the Company or any of its securities. There are no voting trusts, proxies, or other agreements or understandings with respect to the voting stock of the Company or any other matters involving any securities of the Company, other than the Voting Agreements. The Company has heretofore delivered or made available to Parent true and complete copies of each Company Stock Option and any and all agreements to grant a Company Stock Option.

(c) Except as set forth in this Section 4.05, there are no outstanding (i) shares of capital stock or voting securities of the Company, (ii) securities of the Company convertible into or exchangeable for shares of capital stock or voting securities of the Company or (iii) options, warrants or other rights to acquire from the Company or other obligation of the Company to issue, any capital stock, voting securities or securities convertible into or exchangeable for capital stock or voting securities of the Company (the items in clauses (i), (ii) and (iii) being referred to collectively as the “Company Securities”). Except as set forth in the certificate of incorporation, there are no outstanding obligations of the Company or any of its Subsidiaries to repurchase, redeem or otherwise acquire any of the Company Securities.

Section 4.06. Subsidiaries. (a) Each Subsidiary of the Company is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, has all corporate powers and authority to carry on its business as now conducted. Each such Subsidiary is duly qualified to do business as a foreign corporation and is in good standing in each jurisdiction where failure to be so qualified would have, individually or the

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aggregate, a Material Adverse Effect on the Company and such Subsidiary, taken as a whole. No Subsidiary is in violation of any of the provisions of its articles or certificates of incorporation or bylaws. Schedule 4.06 sets forth for each Subsidiary its name, jurisdiction of incorporation or other organization and all jurisdictions in which it is authorized to do business.

(b) All of the outstanding shares of capital stock of, or other voting securities or ownership interests in, each Subsidiary of the Company is owned by the Company, directly or indirectly, free and clear of any Lien and free of any other limitation or restriction (including any restriction on the right to vote, sell or otherwise dispose of such capital stock or other voting securities or ownership interests). There are no outstanding (i) securities of the Company or any of its Subsidiaries convertible into or exchangeable for shares of capital stock or other voting securities or ownership interests in any Subsidiary of the Company or (ii) options or other rights to acquire from the Company or any of its Subsidiaries, or other obligation of the Company or any of its Subsidiaries to issue, any capital stock or other voting securities or ownership interests in, or any securities convertible into or exchangeable for any capital stock or other voting securities or ownership interests in, any Subsidiary of the Company (the items in clauses (i) and (ii) being referred to collectively as the “Company Subsidiary Securities”). There are no outstanding obligations of the Company or any of its Subsidiaries to repurchase, redeem or otherwise acquire any of the Company Subsidiary Securities.

Section 4.07. Financial Statements. The audited balance sheets as of December 31, 2002, 2001 (as restated) and 2000 and related audited statements of income and cash flows for each of the years ended December 31, 2002, 2001 (as restated) and 2000 and unaudited consolidated interim financial statements for the four months ended April 30, 2003 (subject to normal reconciling adjustments) of the Company provided to Parent and attached hereto as Schedule 4.07 fairly present, in conformity with generally accepted accounting principles (“GAAP”) applied on a consistent basis (except as may be indicated in the notes thereto), the consolidated financial position of the Company and its consolidated Subsidiaries as of the dates thereof and their consolidated results of operations and cash flows for the periods then ended (subject only to normal year-end adjustments and an absence of footnotes in the case of any unaudited interim financial statements).

Section 4.08. Absence of Certain Changes. Since the Company Balance Sheet Date, the business of the Company and its Subsidiaries has been conducted in the ordinary course consistent with past practices and there has not been:

(a) any event, occurrence, development or state of circumstances or facts that has had or would reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect on the Company;

(b) any declaration, setting aside or payment of any dividend or other distribution with respect to any shares of capital stock of the Company, or any repurchase, redemption or other acquisition by the Company or any of its Subsidiaries of any outstanding shares of capital stock or other securities of, or other ownership interests in, the Company or any of its Subsidiaries;

(c) any amendment of any material term of any outstanding security of the Company or any of its Subsidiaries, other than as contemplated by this Agreement;

(d) as of the date of this Agreement, any incurrence, assumption or guarantee by the Company or any of its Subsidiaries of any indebtedness for borrowed money;

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(e) any creation or other incurrence by the Company or any of its Subsidiaries of any material Lien on any material asset;

(f) any making of any loan, advance or capital contributions to or investment in any Person, except for reasonable advances to employees and consultants for travel and business expenses in the ordinary course of business consistent with past practices;

(g) any damage, destruction or other casualty loss (whether or not covered by insurance) affecting the business or assets of the Company or any of its Subsidiaries that has had or could reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect on the Company;

(h) any transaction or commitment made, or any contract or agreement entered into, by the Company or any of its Subsidiaries relating to its assets or business (including the acquisition or disposition of its assets) or any relinquishment by the Company or any of its Subsidiaries of any contract or other right, in either case, material to the Company and its Subsidiaries, taken as a whole, other than in the ordinary course of business.

(i) any change in any method of accounting, method of tax accounting or accounting principles or practice by the Company or any of its Subsidiaries, except for any such change required by reason of a concurrent change in GAAP;

(j) any (i) grant of any severance or termination pay to (or amendment to any existing arrangement with) any director, officer or employee of the Company or any of its Subsidiaries, (ii) increase in benefits payable to any director, officer or employee of the Company or any of its Subsidiaries under any existing severance or termination pay policies or employment agreements, (iii) entering into any employment, deferred compensation or other similar agreement (or any amendment to any such existing agreement) with any director, officer or employee of the Company or any of its Subsidiaries, (iv) establishment, adoption or amendment (except as required by applicable law) of any collective bargaining, bonus, profit-sharing, thrift, pension, retirement, deferred compensation, compensation, stock option, restricted stock or other benefit plan or arrangement covering any director, officer or employee of the Company or any of its Subsidiaries, or (v) increase in compensation, bonus or other benefits payable to any director, officer or employee of the Company or any of its Subsidiaries other than bonuses to be paid in connection with the transactions contemplated by this Agreement as set forth in the side letter dated the date hereof between the Company and Parent;

(k) any material labor dispute, other than routine individual grievances, or any activity or proceeding by a labor union or representative thereof to organize any employees of the Company or any of its Subsidiaries, which employees were not subject to a collective bargaining agreement at the Company Balance Sheet Date, or any lockouts, strikes, slowdowns, work stoppages or threats thereof by or with respect to such employees;

(l) any Tax election made or changed, any annual Tax accounting period changed, any method of Tax accounting adopted or changed, any amended Tax Returns or claims for Tax refunds filed, any closing agreement entered into, any Tax claim, audit or assessment settled, or any right to claim a Tax refund, offset or other reduction in Tax liability surrendered; or

(m) material change in its practices relating to pricing or royalties set or charged by the Company to its customers or licensees or, any notification made to the Company of a material change in pricing or royalties set or charged by licensors to the Company;

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(n) any capital expenditure, or commitment for a capital expenditure, for additions or improvements to property, plant and equipment that, other than as set forth in the Company’s capital spending plan which has been made available to Parent; or

(o) agreement by the Company or any officer thereof or any written agreement by an employee of the Company in their capacities as such to do any of the things described in the preceding clauses (a) through (n) (other than negotiations with Parent and its representatives regarding the transactions contemplated by this Agreement).

Section 4.09. No Undisclosed Liabilities. There are no liabilities or obligations of the Company or any of its Subsidiaries of any kind whatsoever, whether accrued, contingent, absolute, determined, determinable or otherwise, and there is no existing condition, situation or set of circumstances that the Company believes would reasonably be expected to result in such a liability or obligation, other than:

(a) liabilities or obligations disclosed and provided for in the Company Balance Sheet or in the notes thereto or incurred in the ordinary course of business since the Company Balance Sheet Date,

(b) liabilities or obligations incurred in the ordinary course of business consistent with past practices since the Company Balance Sheet Date that would not reasonably be expected to have, individually or in the aggregate, a Material Adverse Effect on the Company; and

(c) liabilities or obligations under this Agreement or the transactions contemplated hereby.

Section 4.10. Compliance with Laws and Court Orders. The business of the Company and each of its Subsidiaries is and has at all times since 2000 been conducted in material compliance with, and to the Knowledge of the Company is not under investigation with respect to and has not been threatened to be charged with or given notice of any material violation of, any applicable law, statute, ordinance, rule, regulation, judgment, injunction, order or decree.

Section 4.11. Agreements, Contracts and Commitments. (a) Neither the Company nor any of its Subsidiaries is a party to or bound by:

(i) any lease or sublease (whether of real or personal property) providing for annual rentals of $50,000 or more;

(ii) any agreement for the purchase or license of materials, supplies, goods, services, equipment or other tangible or intangible assets providing for either (A) annual payments by the Company or its Subsidiaries of $50,000 or more or (B) aggregate payments by the Company or its Subsidiaries of $100,000 or more;

(iii) any license, sales, distribution or other similar agreement (other than agreements with end user customers entered into in the ordinary course of business) providing for the sale or license by the Company or any of its Subsidiaries of software, materials, supplies, goods, services, equipment or other assets that provides for either (A) annual payments to the Company or its Subsidiaries of $50,000 or more or (B) aggregate payments to the Company and the Subsidiaries of $100,000 or more;

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(iv) any partnership, joint venture, alliance, agency, dealer, sales representative, marketing, distribution, original equipment manufacturer, value added reseller, remarketer, joint marketing, channel partner or other similar agreement or arrangement;

(v) any agreement, contract or commitment relating to the acquisition or disposition of any business (whether by merger, sale of stock, sale of assets or otherwise);

(vi) any agreement relating to indebtedness for borrowed money or the deferred purchase price of property (in either case, whether incurred, assumed, guaranteed or secured by any asset), except any such agreement with an aggregate outstanding principal amount not exceeding $50,000 and which may be prepaid on not more than 30 days notice without the payment of any penalty;

(vii) except for end-user licenses granted to customers by the Company or its Subsidiaries in the ordinary course of business consistent with past practices, any material option (other than employee stock options), license or franchise;

(viii) any software development agreement or other agreement for development or authorship of products and services for the Company or any of its Subsidiaries other than agreements with employees and consultants entered into by Company or its Subsidiaries in the ordinary course of business;

(ix) any agreement that limits the freedom of the Company or any Subsidiary to compete in any line of business or with any Person or in any geographic area or which could reasonably be expected to so limit the freedom of the Company or any Subsidiary after the Effective Time;

(x) any mortgages, indentures, loans or credit agreements, security agreements or other written agreements or instruments relating to the borrowing of money or extension of credit, other than those mortgages, indentures, loans or credit agreements, security agreements or other agreements or instruments that are not, individually or in the aggregate, material to the Company or any Subsidiary of the Company;

(xi) any agreement with any Affiliate of the Company (or any Subsidiary), with any director or officer of the Company or any of its Subsidiaries, or with any “associate” or any member of the “immediate family” (as such terms are respectively defined in Rules 12b-2 and 16a-1 of the 1934 Act) of any such director or officer; or

(xii) other than Employee Agreements and standard offer letters, any employment or consulting agreement, contract or commitment with an employee or individual consultant or salesperson or consulting or sales agreement, contract or commitment with a firm or other organization;

(xiii) any agreement with severance, change in control or similar arrangements, that will result in any obligation (absolute or contingent) of the Company or any Subsidiary to make any payment as a result of the consummation of the Merger, termination of employment or both;

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(xiv) any agreement or plan, including, without limitation, any stock option plan, stock appreciation rights plan or stock purchase plan, any of the benefits of which will be increased, or the vesting of benefits of which will be accelerated, as a result of the consummation of the Merger or the value of any of the benefits of which will be calculated on the basis of the Merger; or

(xv) any other agreement, commitment, arrangement or plan not made in the ordinary course of business that is material to the Company and its Subsidiaries, taken as a whole other than agreements with end user customers entered into in the ordinary course of business, involving annual payments to the Company and its Subsidiaries in excess of $100,000.

(b) Each agreement, contract, plan, lease, arrangement or commitment disclosed or required to be disclosed pursuant to this Section 4.11 is referred to as a “Material Agreement” and is a valid and binding agreement of the Company or its Subsidiaries, as the case may be, and is in full force and effect with respect to the Company or any Subsidiary of the Company and, to the Knowledge of the Company, each other party thereto, and none of the Company, any Subsidiary of the Company or, to the Knowledge of the Company, any other party thereto is in default or breach in any material respect under the terms of any such Material Agreement, and, to the Knowledge of the Company, no event or circumstance has occurred that, with notice or lapse of time or both, would reasonably be expected to constitute a material event of default thereunder. True and complete copies of each such agreement, have been made available to Parent.

Section 4.12. Litigation. There is no material action, suit, investigation or proceeding (or, to the Knowledge of the Company, any reasonable basis therefor) pending against, or, to the Knowledge of the Company, threatened against or affecting, the Company or any of its Subsidiaries, or, to the Knowledge of the Company pending or threatened against or affecting any present or former officer, director or employee of the Company or any of its Subsidiaries or any other Person in each case if determined adversely could reasonably be expected to result in a material liability to the Company or any of their respective properties or that in any manner challenges or seeks to prevent, enjoin, alter or materially delay the Merger or any of the other transactions contemplated hereby before any court or arbitrator or before or by any governmental body, agency or official, domestic, foreign or supranational.

Section 4.13. Finders’ Fees. Except for Credit Suisse First Boston, as set forth on Schedule 4.13, there is no investment banker, broker, finder or other intermediary that has been retained by or is authorized to act on behalf of the Company or any of its Subsidiaries who might be entitled to any fee or commission from the Company or any of its Affiliates in connection with the transactions contemplated by this Agreement.

Section 4.14. Opinion Of Financial Advisor. The Company has received the opinion of Credit Suisse First Boston, financial advisor to the Company, to the effect that, as of the date of this Agreement, the Merger Consideration is fair to the Company’s stockholders from a financial point of view.

Section 4.15. Tax Representations. The Company represents and warrants to Parent as of the date hereof and as of the Effective Time that:

(a) Filing and Payment. Except as set forth on Schedule 4.15(a), (i) all material Tax returns, statements, reports and forms (including estimated tax or information returns and reports) required to be filed with any Taxing Authority with respect to any Pre Closing Tax Period by or

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on behalf of the Company or any Subsidiary (collectively, the “Returns”), have, to the extent required to be filed on or before the date hereof, been filed when due in accordance with all applicable laws; (ii) as of the time of filing, the Returns were true and complete in all material respects; and (iii) all Taxes shown as due and payable on the Returns that have been filed have been timely paid, or withheld and remitted to the appropriate Taxing Authority. For purposes of this representation only, (i) a Return shall be considered to be material if it reflects, reflected, or would, if properly filed, have reflected, a Tax liability in excess of $25,000 and (ii) a Return shall not be treated as true and complete in all material respects if any inaccuracies or omissions on such Return, in the aggregate, results, resulted or would result in an understatement or underpayment of Tax in excess of $25,000.

(b) Financial Records. Except as set forth on Schedule 4.15(b), the charges, accruals and reserves for Taxes with respect to the Company and its Subsidiaries reflected on the books of the Company and its Subsidiaries (excluding any provision for deferred income taxes reflecting either differences between the treatment of items for accounting and income tax purposes or carry forwards) are adequate to cover material Tax liabilities accruing through the date hereof and as of the Effective Time. For purposes of this representation only, a Tax liability shall be considered material if it is in excess of $25,000.

(c) Procedure and Compliance. Except as set forth on Schedule 4.15(c), (i) the income and franchise Tax Returns of Company and its Subsidiaries through the Tax year ended December 31, 2002 have been examined and closed or are Returns with respect to which the applicable period for assessment under applicable law, after giving effect to extensions or waivers, has expired; and (ii) to the Company’s Knowledge there is no claim, audit, action, suit, proceeding or investigation now pending or threatened against or with respect to Company or its Subsidiaries in respect of any Tax or Tax Asset.

(d) Taxing Jurisdictions. Schedule 4.15(d) a list of all jurisdictions (whether foreign or domestic) in which the Company or any of its Subsidiaries currently files (or is required to file) Returns.

(e) Tax Sharing, Consolidation and Similar Arrangements. Except as set forth on Schedule 4.15(e), (i) neither the Company nor any Subsidiary has been a member of an affiliated, consolidated, combined or unitary group other than one of which the Company was the common parent, or made any election or participated in any arrangement whereby any Tax liability or any Tax Asset of the Company or any Subsidiary was determined or taken into account for Tax purposes with reference to any Tax liability or any Tax Asset of any other person; and (ii) neither the Company nor any Subsidiary has entered into any agreement or arrangement with any Taxing Authority with regard to the Tax liability of the Company or any Subsidiary affecting any Tax period for which the applicable statute of limitations, after giving effect to extensions or waivers, has not expired.

(f) Certain Elections, Agreements and Arrangements. Except as set forth on Schedule 4.15(f), (i) no election has been made under Treasury Regulations Section 301.7701-3 or any similar provision of Tax law to treat the Company or any Subsidiary as an association, corporation or partnership; (ii) none of the Company or any Subsidiary is disregarded as an entity for Tax purposes; (iii) during the five-year period ending on the date hereof, none of the Company or any Subsidiary was a distributing corporation or a controlled corporation in a transaction intended to be governed by Section 355 of the Code; and (iv) none of the Company, any Subsidiary, or any other person on behalf of the Company or any Subsidiary, has entered into any agreement or consent pursuant to Section 341(f) of the Code.

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(g) Property and Leases. Except as set forth on Schedule 4.15(g), (i) none of the Company or any Subsidiary owns an interest in real property in any jurisdiction in which a Tax is imposed, or the value of the interest is reassessed, on the transfer of an interest in real property and which treats the transfer of an interest in an entity that owns an interest in real property as a transfer of the interest in real property and (ii) none of the property owned by the Company or any Subsidiary is “tax-exempt use property” within the meaning of Section 168(h) of the Code.

Section 4.16. Employee Matters and Employment Benefit Plans. (a) Schedule 4.16(a) contains a correct and complete list identifying each “employee benefit plan”, as defined in Section 3(3) of ERISA, each employment, severance or similar contract, plan, arrangement or policy and each other plan or arrangement (written or oral), other than standard employee offer letters, providing for compensation, bonuses, profit-sharing, stock option or other stock related rights or other forms of incentive or deferred compensation, vacation benefits, insurance (including any self-insured arrangements), health or medical benefits, employee assistance program, disability or sick leave benefits, workers’ compensation, supplemental unemployment benefits, severance benefits and post-employment or retirement benefits (including compensation, pension, health, medical or life insurance benefits) which is maintained, administered or contributed to by the Company or any of its Affiliates and covers any employee or former employee of the Company or any of its Subsidiaries, and with respect to which the Company or any of its Subsidiaries has any material liability. Copies of such plans (and, if applicable, related trust or funding agreements or insurance policies) and all amendments thereto and written interpretations thereof have been made available to Parent together with the most recent annual report (Form 5500 including, if applicable, Schedule B thereto) and tax return (Form 990) prepared in connection with any such plan or trust. Such plans are referred to collectively herein as the “Employee Plans”.

(b) Neither the Company nor any ERISA Affiliate nor any predecessor thereof sponsors, maintains or contributes to, or has in the past sponsored, maintained or contributed to, any Employee Plan subject to Title IV of ERISA.

(c) Neither the Company nor any ERISA Affiliate nor any predecessor thereof contributes to, or has in the past contributed to, any multiemployer plan, as defined in Section 3(37) of ERISA (a “Multiemployer Plan”).

(d) Each Employee Plan that is intended to be qualified under Section 401(a) of the Code is so qualified and has been so qualified during the period since its adoption. The Company has made available to Parent copies of the most recent Internal Revenue Service determination or opinion letters with respect to each such Employee Plan or has a remaining period of time to apply for such determination or opinion letter. Each Employee Plan has been maintained in material compliance with its terms and with the requirements prescribed by any and all statutes, orders, rules and regulations, including but not limited to ERISA and the Code, which are applicable to such Employee Plan. No material events have occurred with respect to any Employee Plan that could result in payment or assessment by or against the Company of any material excise taxes under Sections 4972, 4975, 4976, 4977, 4979, 4980B, 4980D, 4980E or 5000 of the Code.

(e) The consummation of the transactions contemplated by this Agreement will not (either alone or together with any other event) entitle any employee, former employee or independent contractor of the Company or any of its Subsidiaries to severance pay, bonus or retirement or accelerate the time of payment or vesting or trigger any payment of funding (through a grantor trust or otherwise) of compensation or benefits under, increase the amount

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payable or trigger any other material obligation pursuant to, any Employee Plan or any other employment or benefit arrangement.

(f) There is no contract, plan or arrangement (written or otherwise) covering any employee or former employee of the Company or any of its Subsidiaries that could give rise to the payment of any amount that would not be deductible pursuant to the terms of Section 280G or 162(m) of the Code.

(g) Neither the Company nor any of its Subsidiaries has any liability in respect of post-employment or post-retirement health, medical or life insurance benefits for retired, former or current employees of the Company or its Subsidiaries except as required under Section 4980B of the Code. No condition exists that would prevent the Company or any of its Subsidiaries from amending or terminating any Employee Plan providing health or medical benefits in respect of any active employee of the Company or any of its Subsidiaries.

(h) All contributions and payments accrued under each Employee Plan, determined in accordance with prior funding and accrual practices, as adjusted to include proportional accruals for the period ending as of the date hereof, have been discharged and paid on or prior to the date hereof except to the extent reflected as a liability on the Company Balance Sheet.

(i) There has been no amendment to, written interpretation or announcement (whether or not written) by the Company or any of its Affiliates relating to, or change in employee participation or coverage under, an Employee Plan which could increase materially the expense of maintaining such Employee Plan above the level of the expense incurred in respect thereof for the fiscal year ended December 31, 2002.

(j) Neither the Company nor any of its Subsidiaries is a party to or subject to, or is currently negotiating in connection with entering into, any collective bargaining agreement or other contract or understanding with a labor union or organization.

(k) There is no action, suit, investigation, audit or proceeding pending against or involving or, to the Knowledge of the Company, threatened against or involving, any Employee Plan before any court or arbitrator or any state, federal or local governmental body, agency or official.

(l) The Company and its Subsidiaries are in material compliance with all currently applicable laws respecting employment and employment practices, terms and conditions of employment and wages and hours, and are not engaged in any unfair labor practice. There is no unfair labor practice complaint pending or, to the Knowledge of the Company, threatened against the Company or any of its Subsidiaries before the National Labor Relations Board.

(m) Neither the Company nor any of its Subsidiaries has engaged in any workforce reduction within the last 90 days which, alone or when aggregated with any other workforce reduction before or after the date hereof, would trigger obligations under the Worker Adjustment and Retraining Notification Act (the “WARN Act”), or any similar state or local laws regulating layoffs or employment terminations, with respect to its employees.

(n) The Company has made available to Parent a true and complete list of the names, titles (if applicable), annual salaries or wage rates and other compensation of all employees of the Company and its Subsidiaries. The Company has no Knowledge that any of its officers or any other key employee (as previously identified to Parent and listed on Schedule 4.16(n) hereto) of

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the Company and its Subsidiaries currently intends to resign or retire as a result of the transactions contemplated by this Agreement.

Section 4.17. Title Of Properties; Absence Of Liens And Encumbrances; Condition Of Equipment. (a) The Company and its Subsidiaries do not own any real property, and have never owned any real property. Schedule 4.17 sets forth a list of all real property currently leased by the Company or any of its Subsidiaries, the name of the lessor and the date of the lease and each amendment thereto and, with respect to any current lease, the aggregate annual rental and/or other fees payable under any such lease and the term and renewal provisions of such lease. All such leases are in full force and effect and enforceable by the Company or its Subsidiaries, and there is not, under any of such leases, any existing material default by the Company or its Subsidiaries or, to the Knowledge of the Company, by the other party thereto or material event of default (or event which with notice or lapse of time, or both, would constitute such a default). The Company has heretofore made available to Parent true and complete copies of all such leases.

(b) The Company or its Subsidiaries have good and marketable title to, or, in the case of leased properties and tangible assets, valid leasehold interests in, all of the tangible assets shown on the Company Balance Sheet, free and clear of any Liens, except as reflected in the Company Balance Sheet.

(c) All material items of equipment included in such assets shown on the Company Balance Sheet are, in the aggregate and in all material respects, in good operating condition, regularly and properly maintained, subject to normal wear and tear.

Section 4.18. Products. Each of the products produced, sold or licensed by the Company or its Subsidiaries is, and at all times up to and including the sale thereof, conforms in all material respects to any promises or affirmations of fact made on the container or label for such product or in connection with its sale. None of the Company’s or its Subsidiaries’ products contains defects that would reasonably be expected to materially impair such product’s value or use by customers.

Section 4.19. Intellectual Property. (a) Schedule 4.19(a) contains a true and complete list of patents, registered copyrights, registered trademarks, registered service marks, Internet domain names and any applications for registrations for any of the foregoing, and any material Licensed Intellectual Property Rights (including all software that is distributed as “free software”, “open source software” or under a similar licensing or distribution model), specifying as to each such Intellectual Property Right, as applicable, (i) the owner of such Intellectual Property Right, (ii) the jurisdictions by or in which such Intellectual Property Right has been issued or registered or in which an application for such issuance or registration has been filed and (iii) the registration or application numbers thereof. Schedule 4.19(a) contains a true and complete list of (A) all licenses or sublicenses by the Company or its Subsidiaries of the Owned Intellectual Property Rights (other than end user licenses entered into in the ordinary course of the business of the Company or its Subsidiaries) and (B) all agreements for the license to the Company or its Subsidiaries of any Licensed Intellectual Property Right (other than licenses to generally available commercial software not included in products distributed by the Company or its Subsidiaries but including all software that is distributed as “free software”, “open source software” or under a similar licensing or distribution model) specifying the (x) the date of any license or agreement and (y) the identity of all parties thereto.

(b) The Licensed Intellectual Property Rights and the Owned Intellectual Property Rights together constitute all of the Intellectual Property Rights necessary to conduct the business

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of the Company and its Subsidiaries as currently conducted by the Company or any of its Subsidiaries. There exist no restrictions on the disclosure, use or transfer of the Owned Intellectual Property Rights (other than non-exclusive licenses granted by the Company or its Subsidiaries to end users in the ordinary course of business). The consummation of the transactions contemplated by this Agreement will not alter, impair or extinguish any Owned Intellectual Property Rights or material Licensed Intellectual Property Rights.

(c) Except pursuant to written agreements entered into by the Company or its Subsidiaries with end users in the ordinary course of business (copies of which have been made available to Parent), neither the Company nor any of its Subsidiaries have given an indemnity in connection with any Intellectual Property Right to any Person.

(d) None of the Company and its Subsidiaries has infringed, misappropriated or otherwise violated any Intellectual Property Right of any Third Party. There is no claim, action, suit, investigation or proceeding pending against, or, to the Knowledge of the Company, threatened against the Company or any of its Subsidiaries (i) based upon, or challenging or seeking to deny or restrict, the rights of the Company or any of its Subsidiaries in any of the Owned Intellectual Property Rights and the Licensed Intellectual Property Rights, (ii) alleging that the use by the Company and its Subsidiaries of the Owned Intellectual Property Rights or the Licensed Intellectual Property Rights or any services provided, processes used or products manufactured, used, imported, sold, marketed or license by the Company or any of its Subsidiaries do or may misappropriate, infringe or otherwise violate any Intellectual Property Right of any Third Party or breached any obligation owed to a Third Party with respect to such party’s Intellectual Property Rights or (iii) alleging that the Company or any of its Subsidiaries have infringed, misappropriated or otherwise violated any Intellectual Property Right of any Third Party. Except as set forth in Schedule 4.19(d), the Company has not received any offer for a license of intellectual property, including but not limited to patent rights, from any Third Party in connection with an allegation by such Third Party that the Company or its Subsidiaries has misappropriated or infringed any of the Intellectual Property Rights of such Third Party.

(e) The Owned Intellectual Property Rights, and the use, reproduction, modification, distribution, licensing, sublicensing, sale of any Owned Intellectual Property Rights by Company or its licensees, does not and will not infringe or misappropriate any copyright, patent, trade secret, trademark, service mark, trade name, trade dress, or moral right of any Person. To the Knowledge of Company, without investigation, the Licensed Intellectual Property Rights that form a part of any Company product offered for sale or license, and the use, reproduction, modification, distribution, licensing, sublicensing, or sale of such Licensed Intellectual Property Rights by the Company or its licensees in accordance with the license agreements for such Licensed Intellectual Property Rights, as set forth on Schedule 4.19(a), does not and will not infringe or misappropriate any copyright, patent, trade secret, trademark, service mark, trade name, trade dress, or moral right of any Person.

(f) None of the Owned Intellectual Property Rights material to the operation of the business of the Company and its Subsidiaries has been adjudged invalid or unenforceable in whole or part, and, to the Knowledge of the Company, all such Owned Intellectual Property Rights are valid and enforceable.

(g) The Company and its Subsidiaries hold all right, title and interest in and to all Owned Intellectual Property Rights and all of the Company’s and its Subsidiaries’ rights to use the Licensed Intellectual Property Rights, free and clear of any Lien (other than restrictions contained in license agreements for the Licensed Intellectual Property Rights as set forth on

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Schedule 4.19(a)). In each case where a patent or patent application, trademark registration or trademark application, service mark registration or service mark application, or copyright registration or copyright application included in the Owned Intellectual Property is held by assignment, the assignment has been duly recorded with the governmental authority from which the patent or registration issued or before which the application or application for registration is pending. The Company and its Subsidiaries have taken all actions reasonably necessary to maintain and protect any material Owned Intellectual Property Rights, including payment of applicable maintenance fees and filing of applicable statements of use.

(h) To the Knowledge of the Company, no Person has infringed, misappropriated, breached or otherwise violated any material Owned Intellectual Property Right. The Company and its Subsidiaries have taken reasonable steps in accordance with normal industry practice to maintain the confidentiality of all of the Company’s and its Subsidiaries’ material trade secrets included in the Owned Intellectual Property Rights. None of the Owned Intellectual Property Rights of the Company or any of its Subsidiaries that are material to the business or operation of the Company or any of its Subsidiaries and the value of which to the Company or any of its Subsidiaries is contingent upon maintaining the confidentiality thereof, has been disclosed other than pursuant to written confidentiality agreements.

(i) All software source code listings that are part of any material Owned Intellectual Property Rights are documented in accordance with prevailing industry standards.

(j) None of the registered trademarks or service marks, applications for trademarks and applications for service marks included in the Owned Intellectual Property Rights that are material to the business or operation of the Company or any of its Subsidiaries have been the subject of an opposition or cancellation procedure. None of the patents and patent applications included in the Owned Intellectual Property Rights that are material to the business or operation of the Company or any Subsidiary have been the subject of an interference, protest, public use proceeding or Third Party reexamination request.

(k) The Company has taken reasonable and customary steps to protect the Company’s rights in confidential information and trade secrets of the Company that are material to the business or operation of the Company or any of its Subsidiaries or provided by any other person to the Company subject to written confidentiality and non-disclosure obligations and to obtain ownership of all works of authorship and inventions made by its employees, consultants and contractors and which are material to the Company’s or its Subsidiaries’ business or the purpose of the retention, as the case may be. Without limiting the foregoing, the Company has, and enforces, a policy requiring each employee who contributes to the development of the Company’s material Intellectual Property Rights to execute proprietary information, confidentiality and assignment agreements substantially in the form of the Company’s standard forms (the forms of which have been provided to Parent) (“Employee Agreements”), and no current or former employee of the Company has refused to sign the Employee Agreements.

(l) No parties other than the Company or its Subsidiaries possess any current or contingent rights to any source code that is part of the Owned Intellectual Property Rights other than in connection with any software escrow arrangement entered into between the Company and its customers in the ordinary course of business pursuant to a written agreement, in the form of or substantially similar to the Company’s standard form of software escrow agreement (the form of which has been provided to Parent).

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(m) Schedule 4.19(m) lists all parties (including contractors and consultants) who have created any material portion of, the Owned Intellectual Property Rights, other than employees of Company whose work product was created by them entirely within the scope of their employment by Company and constitutes works made for hire owned by Company. Company has secured from all parties who have created any material portion of the Owned Intellectual Property Rights valid and enforceable written assignments or licenses of any such work or other rights to Company and has made available true and complete copies of such assignments or licenses to Parent or its counsel.

(n) Schedule 4.19(n) includes a true and complete list of support and maintenance agreements relating to Owned Intellectual Property to which Company is a party including the identity of the parties and the respective dates of such agreements (other than, in each case, support or maintenance provided by the Company to end users in the ordinary course of business.

(o) Company has obtained written agreements from all employees and third parties with whom Company has shared confidential proprietary information concerning Company Intellectual Property Rights (i) of the Company that are material to the business or operation of the Company or any of its Subsidiaries or (ii) received from others which Company is obligated to treat as confidential, which agreements require such employees and third parties to keep such information confidential for a reasonable period of time.

(p) Except as set forth on Schedule 4.19(p), none of the Company’s software products contains any computer code: (i) designed to harm in any manner the operation of such software, or any other associated software, firmware, hardware, computer system or network (sometimes referred to as “viruses” or “worms”); (ii) that would disable such software or impair in any way its operation based on the elapsing of a period of time, advancement of a particular date (sometimes referred to as “time bombs,” “time locks,” or “drop dead” devices) or (iii) that would permit the Company or any third party to access such software to intentionally cause any harmful, malicious procedures, routines or mechanisms which would cause the software to cease functioning or to damage or corrupt data, storage media, programs, equipment or communications.

(q) Except as set forth on Schedule 4.19(q), the Owned Intellectual Property Rights shall not contain any software code that contains, or is derived in any manner (in whole or in part) from, any software that is distributed under any of the following licenses or distribution models, or licenses or distribution models similar to any of the following: GNU’s General Public License (GPL) or Lesser/Library GPL (LGPL).

Section 4.20. Insurance Coverage. Schedule 4.20 contains a complete and accurate list of, and the Company has made available to Parent true and complete copies of, all insurance policies relating to the assets, business, operations, employees, officers or directors of the Company and its Subsidiaries. There is no claim by the Company or any of its Subsidiaries pending under any of such policies as to which coverage has been denied or disputed by the underwriters of such policies or in respect of which such underwriters have reserved their rights. All premiums payable under all such policies have been timely paid and the Company and its Subsidiaries have otherwise complied fully with the material terms and conditions of all such policies. Such policies of insurance (or other policies providing substantially similar insurance coverage) have been in effect since 2001 and remain in full force and effect. The Company has no Knowledge of any threatened termination of, material premium increase with respect to, or material alteration of coverage under, any of such policies. Such policies are of the type and in amounts customarily carried by Persons conducting businesses similar to those of the Company

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or any of its Subsidiaries. The Company and its Subsidiaries shall after the Effective Time continue to have coverage under such policies and bonds with respect to events occurring prior to the Effective Time.

Section 4.21. Licenses and Permits. The Company and each of its Subsidiaries hold all material licenses, franchises, permits, certificates, approvals or other similar authorizations that are necessary to conduct its business as currently conducted (the “Permits”). The Permits are valid and in full force and effect. Neither the Company nor any Subsidiary is in material default under, and neither the Company nor any of its Subsidiaries has received any notice that any condition exists that with notice or lapse of time or both would reasonably be expected to constitute a material default under, the Permits. None of the Permits will be terminated or materially impaired or become terminable, in whole or in part, as a result of the transactions contemplated hereby.

Section 4.22. Receivables. (a) The Company has made available to Parent a list of all accounts receivable of the Company and its Subsidiaries as of April 30, 2003, along with a statement of days elapsed since invoice.

(b) All accounts, notes receivable and other receivables arising out of or relating to the business of the Company and its Subsidiaries as of the Company Balance Sheet Date or Interim Balance Sheet Date have been included in the Company Balance Sheet and Interim Balance Sheet and all reserves for doubtful accounts reflected thereon were taken in accordance with GAAP applied on a consistent basis. No person has any Lien on any such accounts receivable and, to the Company’s Knowledge, no request or agreement for deduction or discount has been made with respect to any such accounts receivable.

Section 4.23. Environmental Matters. (a) Except as set forth in Schedule 4.23:

(i) during the period that the Company and its Subsidiaries have leased their respective properties or operated any facilities, no material notice, notification, demand, request for information, citation, summons or order has been received, no material complaint has been filed, no penalty has been assessed, and no material investigation, action, claim, suit, proceeding or review is pending or, to the Knowledge of the Company, is threatened by any governmental entity or other Person relating to or arising out of any Environmental Law;

(ii) during the period that the Company and its Subsidiaries have leased their respective properties or operated any facilities, the Company and its Subsidiaries are and have been in compliance in all material respects with all Environmental Laws and all Environmental Permits; and

(iii) there are no material liabilities of or relating to the Company or any of its Subsidiaries of any kind whatsoever, whether accrued, contingent, absolute, determined, determinable or otherwise arising under or relating to any Environmental Law, and to the Knowledge of the Company there are no facts, conditions, situations or set of circumstances that could reasonably be expected to result in or be the basis for any material liability arising under or relating to any Environmental Law.

(b) There has been no environmental investigation, study, audit, test, review or other analysis conducted of which the Company has Knowledge in relation to the current or prior business of the Company or any of its Subsidiaries or any property or facility now or previously

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owned or leased by the Company or any of its Subsidiaries that has not been delivered to Parent at least five days prior to the date hereof.

(c) Neither the Company nor any of its Subsidiaries owns, leases or operates or has owned, leased or operated any real property, or conducts or has conducted any operations, in New Jersey or Connecticut.

Section 4.24. Certain Interests. (a) To the Knowledge of the Company, none of the Stockholders of the Company or their Subsidiaries or any officer or director of the Company and no member of such person’s “immediate family” (as such term is defined in Rule 16a-1 of the 1934 Act):

(i) has been an officer, director or stockholder of any significant supplier or customer of the Company, or of any company which holds, directly or indirectly, 50% or more of the outstanding shares of any such supplier or customer, provided, however, that the ownership of securities representing not more than 1% of the outstanding voting power of any supplier or customer, and which are listed on any national securities exchange or traded actively in the national over-the-counter market, shall not be deemed to be a “stockholder” as long as the person owning such securities has no other significant connection or relationship with such supplier or customer;

(ii) is a party to or has a direct or indirect material financial interest in any license, partnership or alliance agreement with the Company or any of its Subsidiaries other than pursuant to the Company’s sales, bonus or other compensation plan;

(iii) owns, directly or indirectly, in whole or in part, or has any other interest in any material tangible or intangible property which the Company or any of its Subsidiaries owns (except for any such ownership or interest resulting from the ownership of securities in a public company or pursuant to its normal rights as a stockholder of the Company); or

(iv) has outstanding any indebtedness to the Company or any of its Subsidiaries.

(b) Except as set forth on Schedule 4.24 and except for the payment of employee or director compensation in the ordinary course of business, the Company does not have any liability or any other material obligation of any nature whatsoever to any stockholder of the Company or any affiliate thereof or to any officer or director of the Company, or to the Knowledge of the Company, to any immediate relative or spouse (or immediate relative of such spouse) of any such officer or director.

Section 4.25. Customers; Suppliers. Schedule 4.25 sets forth the names of the 50 most significant customers (by dollar amount of sales) of the Company and its Subsidiaries for the year ended December 31, 2002, and the period from January 1, 2003 through April 30, 2003, and the dollar amount of sales for each such customer during such periods. There has been no material degradation in the quality of the relationship of the Company with any such significant customer, it being understood that such customers are typically under no obligation to purchase any additional products or services from the Company.

Section 4.26. Books And Records. The books of account and other financial records of the Company have been maintained in accordance with sound business practices, including the

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maintenance of an adequate system of internal controls to provide reasonable assurances that: (i) transactions are executed in accordance with management’s general or specific authorization; and (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP. The minute books of the Company contain records of all corporate action taken by the stockholders, the Board of Directors and any committees of the Board of Directors of the Company. At the Closing, all of those books and records will be in the possession of the Company or their attorneys. The Company has made available all of these books, records and accounts to Parent or its representatives.

ARTICLE 5

REPRESENTATIONS AND WARRANTIES OF PARENT

Parent represents and warrants to the Company that:

Section 5.01. Corporate Existence and Power. Each of Parent, Merger Subsidiary I and Merger Subsidiary II is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation and has all corporate powers and all governmental licenses, authorizations, permits, consents and approvals required to carry on its business as now conducted, except for those licenses, authorizations, permits, consents and approvals the absence of which would not have, individually or in the aggregate, a Material Adverse Effect on Parent. Since the date of its incorporation, neither Merger Subsidiary I nor Merger Subsidiary II has engaged in any activities other than in connection with or as contemplated by this Agreement or in connection with arranging any financing required to consummate the transactions contemplated hereby.

Section 5.02. Corporate Authorization. The execution, delivery and performance by Parent, Merger Subsidiary I and Merger Subsidiary II of this Agreement and the Escrow Agreement and the consummation by Parent, Merger Subsidiary I and Merger Subsidiary II of the transactions contemplated hereby and thereby are within the corporate powers of Parent, Merger Subsidiary I and Merger Subsidiary II and have been duly authorized by all necessary corporate action. This Agreement and the Escrow Agreement constitute valid and binding agreements of each of Parent, Merger Subsidiary I and Merger Subsidiary II enforceable against Parent, Merger Subsidiary I and Merger Subsidiary II in accordance with their terms.

Section 5.03. Governmental Authorization. The execution, delivery and performance by Parent, Merger Subsidiary I and Merger Subsidiary II of this Agreement and the consummation by Parent, Merger Subsidiary I and Merger Subsidiary II of the transactions contemplated hereby require no action by or in respect of, or filing with, any governmental body, agency, official or authority, domestic, foreign or supranational, other than (i) the filing of a certificate of merger with respect to the Merger with the Secretary of State of the State of Delaware and appropriate documents with the relevant authorities of other states in which Parent is qualified to do business, (ii) compliance with any applicable requirements of the HSR Act, (iii) compliance with any applicable requirements of the 1933 Act, the 1934 Act and any other applicable securities or takeover laws, whether state or foreign, and (iv) any actions or filings the absence of which could not be reasonably expected to have, individually or in the aggregate, a Material Adverse Effect on Parent or materially to impair the ability of Parent, Merger Subsidiary I and Merger Subsidiary II to consummate the transactions contemplated by this Agreement.

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Section 5.04. Non-Contravention. The execution, delivery and performance by Parent, Merger Subsidiary I and Merger Subsidiary II of this Agreement and the consummation by Parent and Merger Subsidiary I of the transactions contemplated hereby do not and will not (i) contravene, conflict with, or result in any violation or breach of any provision of the certificate of incorporation or bylaws of Parent or the certificate of incorporation or bylaws of Merger Subsidiary I or Merger Subsidiary II, (ii) assuming compliance with the matters referred to in Section 5.03, contravene, conflict with, or result in any violation or breach of any provision of any law, rule, regulation, judgment, injunction, order or decree, or (iii) require any material consent or other action by any Person under, constitute a material default, or an event that, with or without notice or lapse of time or both, could become a material default, under, or cause or permit the termination, cancellation, acceleration or other change of any right or obligation or the loss of any material benefit to which the Company or any of its Subsidiaries is entitled under any provision of any agreement filed as an exhibit to the Parent SEC Documents, or any material license, franchise, permit, certificate, approval or other similar authorization affecting, or relating to, the material assets or business of Parent except for such contraventions, conflicts and violations referred to in clause (ii) and for such failures to obtain any such consent or other action, defaults, terminations, cancellations, accelerations, changes or losses referred to in clause (iii) that would not be reasonably expected to have, individually or in the aggregate, a Material Adverse Effect on Parent or materially to impair the ability of Parent, Merger Subsidiary I and Merger Subsidiary II to consummate the transactions contemplated by this Agreement.

Section 5.05. SEC Filings. (a) Parent has timely filed with or furnished to the SEC, and has made available to the Company, all forms, exhibits, reports, statements, schedules, registration statements and other documents required to be filed or furnished with the SEC under the 1934 Act since March 31, 2003 and its proxy statement and related materials as required by Regulation 14A under the 1934 Act for the annual meeting of stockholders for the fiscal year ended December 31, 2002 (the documents referred to in this Section 5.05, collectively, the “Parent SEC Documents”).

(b) As of its filing date or date of furnishing (and, in the case of a proxy statement, on the date of mailing), each Parent SEC Document (including, without limitation, any financial statements or schedules included therein) complied in all material respects with the applicable requirements of the 1934 Act.

(c) As of its filing date or date of furnishing (and, in the case of a proxy statement, on the date of mailing), each Parent SEC Document (including, without limitation, any financial statements or schedules included therein) did not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements made therein, in the light of the circumstances under which they were made, not misleading.

(d) The financial statements (including the related notes) of Parent included in the Parent SEC Documents were prepared in accordance with GAAP during the periods involved (except as may be indicated in the notes thereto) and fairly present (subject in the case of unaudited statements to normal, recurring and year-end audit adjustments) in all material respects the consolidated financial position of Parent as of the dates thereof and the consolidated results of its operations and cash flows for the periods indicated.

Section 5.06. Financing. Parent has, sufficient cash, available lines of credit or other sources of immediately available funds to enable it to complete the transactions contemplated by this Agreement and to pay all related fees and expenses pursuant to the Merger. Parent does not

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need to obtain the consent of any Third Party to fulfill its obligations hereunder with respect to payment of the Merger Consideration.

Section 5.07. Common Stock. The authorized capital stock of Parent consists of 5,000,000 shares of preferred stock and 240,000,000 shares of Parent Common Stock. As of April 30, 2003, there were issued and outstanding (i) no shares of preferred stock, (ii) 85,426,113 shares of Parent Common Stock, and (iii) 6,305,760 shares reserved for issuance upon exercise of options, warrants and other securities convertible into or exercisable for, Parent Common Stock. The shares of Parent Common Stock to be issued as part of the Merger Consideration have been duly authorized and, when issued and delivered in accordance with the terms of this Agreement, will have been validly issued and will be fully paid and nonassessable and the issuance thereof is not subject to any preemptive or other similar right.

Section 5.08. Litigation. As of the date of this Agreement, there is no material action, suit, investigation or proceeding (or, to the Knowledge of Parent, any material basis therefor) pending against, or, to the Knowledge of Parent, threatened against or affecting Parent, that in any manner challenges or seeks to prevent, enjoin, alter or materially delay the Merger or any of the other transactions contemplated hereby before any court or arbitrator or before or by any governmental body, agency or official, domestic, foreign or supranational.

ARTICLE 6

COVENANTS OF THE COMPANY

The Company agrees that:

Section 6.01. Conduct of the Company. Except as contemplated by this Agreement, or with the prior written consent of Parent, from the date hereof until the Effective Time, the Company and its Subsidiaries shall conduct their business in the ordinary course consistent with past practice and in compliance in all material respects with all applicable laws and regulations, pay their debts and Taxes when due subject to good faith disputes over such debts or Taxes, pay or perform other material obligations when due, and use all commercially reasonable efforts consistent with past practices and policies to (i) preserve intact their present business organization, (ii) maintain the properties in good operating condition, (iii) keep available the services of their present officers, employees and contractors (except with respect to officers, employees or contractors that will not be retained by Parent) and (iv) preserve their relationships with customers, suppliers, licensors, licensees and others with which they have business dealings. Except as otherwise permitted under this Agreement, the Company shall manage its working capital in the ordinary course of business, consistent with past business practices or as otherwise mutually determined by Parent and the Company. Without limiting the generality of the foregoing, from the date hereof until the Effective Time, without the prior written consent to Parent, the Company shall not and shall not permit any of its Subsidiaries to:

(a) adopt or propose any change to its certificate of incorporation or bylaws, other than as specifically permitted or contemplated by this Agreement;

(b) except for the issuance of Shares upon the exercise of Company Stock Options or Warrants outstanding as of the date of this Agreement in accordance with their terms or the conversion of its currently outstanding Preferred Stock, the proposed repricing of currently vested stock options (the “Repricing”) as set forth on Schedule 6.01(b), grants to new employees set

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forth on Schedule 6.01(e)(iv) using guidelines provided by Parent and the Additional Options (other than grants to new employees), issue, sell, pledge, dispose of, grant, encumber, or authorize the issuance, sale, pledge, disposition, grant or encumbrance of, (i) any shares of its capital stock of any class, or any options, warrants, convertible securities or other rights of any kind to acquire any shares of such capital stock, or any other ownership interest (including, without limitation, any phantom interest), of the Company or its Subsidiaries, or (ii) any material assets of the Company or any Subsidiary;

(c) declare, set aside, make or pay any dividend or other distribution, payable in cash, stock, property or otherwise, with respect to any of its capital stock other than accrued but unpaid dividends with respect to the Redeemable Preferred;

(d) reclassify, combine, split, subdivide or redeem, purchase, repurchase or otherwise acquire, directly or indirectly, any of its capital stock;

(e) (i) acquire (including, without limitation, by merger, consolidation, or acquisition of stock or assets) any interest in any corporation, partnership, other business organization or any division thereof or any assets;

(ii) incur any indebtedness for borrowed money or issue any debt securities or assume, guarantee or endorse, or otherwise as an accommodation become responsible for, the obligations of any person, or make any loans or advances, except for indebtedness incurred in the ordinary course of business and consistent with past practice not to exceed $1,000,000 (the “Loan Limit”) and except as permitted by Section 6.09;

(iii) authorize or enter into any agreements or commitments with respect to any capital expenditure in excess of $200,000 in the aggregate;

(iv) hire, employ, contract or enter into any agreement with any new employees or independent contractors other than (x) with respect to replacement of existing employees, and (y) as set forth in Schedule 6.01(e)(iv);

(v) shorten or lengthen the customary payment terms or other terms of any contracts with customers;

(vi) incur any other liabilities other than in the ordinary course of business, consistent with past practice;

(vii) enter into or amend any contract, agreement, commitment or arrangement that, if fully performed, would not be permitted under this Section 6.01(e).

(f) increase the compensation payable or to become payable to its officers or employees, or grant any severance or termination pay to, or enter into any employment or severance agreement with, any director, officer or other employee of the Company or any of its Subsidiaries, or establish, adopt, enter into or amend any collective bargaining, bonus, profit sharing, thrift, compensation, stock option, restricted stock, pension, retirement, deferred compensation, employment, termination, severance or other plan, agreement, trust, fund, policy or arrangement for the benefit of any director, officer or employee, provided that, (i) the Company may grant bonuses to be paid in connection with the transactions contemplated by this Agreement as set forth in the side letter dated the date hereof from the Company to Parent, (ii) the Company may provide additional compensation or severance to certain employees of the

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Company as identified in Schedule 6.01(f) provided that each such employee executes a general release in a form reasonably satisfactory to Parent and (iii) the Repricing;

(g) enter into any licensing, distribution, sponsorship, advertising, merchant program or other similar contracts, agreements, or obligations, other than end-user license and maintenance contracts and agreements with customers in the ordinary course of business consistent with past practice;

(h) transfer or license to any person or entity or otherwise extend, amend or modify in any material respect any Intellectual Property Rights of the Company, other than such items as are done in the ordinary course of business consistent with past practice;

(i) (A) take any action to cause, or fail to take any material action to prevent, the accelerated vesting and exercisability of the Company Stock Options except as provided herein, by the terms of such Company Stock Options or the employment agreement or arrangements of the employee disclosed to Parent or (B) otherwise amend any Company Stock Option to reduce the exercise price thereof except in connection with the Repricing;

(j) take any action, other than actions in the ordinary course of business and consistent with past practice, with respect to accounting policies or procedures except for any such action required by a concurrent change in GAAP;

(k) merge or consolidate with any other Person;

(l) sell, lease, license or otherwise dispose of any material subsidiary or material amount of assets, securities or property except pursuant to existing contracts or commitments which have been disclosed to Parent;

(m) enter into any lease, contract or agreement with regard to real property other than (i) renewals of existing leases on a month to month basis on terms similar to such existing leases and (ii) new month to month leases for sales offices entered into in the ordinary course consistent with past practices;

(n) enter into any non-compete agreement or other material restriction on any of their respective businesses following the Effective Time;

(o) enter into any agreement or commitment the effect of which would be to grant to a third party following the Merger any actual or potential right of license of any material Intellectual Property Rights owned by the Company or any of its Subsidiaries other than end-user customer contracts in the ordinary course of business;

(p) permit any insurance policy naming it as a beneficiary or a loss payee to be cancelled or terminated unless such insurance policy is replaced with a substantially equivalent policy;

(q) take any action that would reasonably be expected to make any representation and warranty of the Company hereunder inaccurate in any material respect at, or as of any time prior to, the Effective Time or omit to take any action reasonably expected to be necessary to prevent any such representation or warranty from being inaccurate in any material respect at any such time; and

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(r) agree or commit to do any of the foregoing.

Section 6.02. Stockholder Approval. (a) The Company’s certificate of incorporation shall be amended as set forth in Schedule 4.01(b) immediately prior to the Effective Time. The Company has previously obtained all necessary approvals by its Stockholders for such amendment.

(b) The Company shall cause a meeting of its Stockholders (the “Company Stockholder Meeting”) to be duly called and held as soon as reasonably practicable for approval and adoption of this Agreement and the Merger. The Board of Directors of the Company shall recommend approval and adoption of this Agreement and the Merger by the Company’s Stockholders. In connection with such meeting, the Company will (i) promptly prepare and thereafter mail to the Stockholders as promptly as reasonably practicable a proxy statement and all other proxy materials required by law for such meeting (the “Proxy Materials”), (ii) use all commercially reasonable efforts to obtain all necessary approvals by its Stockholders of this Agreement and the transactions contemplated hereby and (iii) otherwise comply with all applicable legal requirements. The Company may, in lieu of holding the Company Stockholder Meeting, obtain the requisite approval of its Stockholders by written consent.

Section 6.03. No Solicitation; Other Offers. (a) Neither the Company nor any of its Subsidiaries shall, nor shall the Company or any of its Subsidiaries authorize, and the Company and its Subsidiaries shall use all reasonable efforts to prevent, any of its or their officers, directors, employees, investment bankers, attorneys, accountants, consultants or other agents or advisors to, directly or indirectly, (i) solicit, initiate or take any action to facilitate or encourage the submission of any Acquisition Proposal, (ii) enter into or participate in any discussions or negotiations with, furnish any non-public information relating to the Company or any of its Subsidiaries (other than as to the existence of these provisions) or afford access to the business, properties, assets, books or records of the Company or any of its Subsidiaries to, otherwise knowingly cooperate in any way with, or knowingly assist, participate in, facilitate or encourage any effort by any Third Party to make an Acquisition Proposal, or (iii) enter into any agreement with respect to an Acquisition Proposal.

(b) Notwithstanding the foregoing, the Board of Directors of the Company, directly or indirectly through advisors, agents or other intermediaries, may (i) engage in negotiations or discussions with any Third Party that, without prior solicitation by or negotiation with the Company, has made a bona fide Acquisition Proposal that the Board of Directors of the Company has in good faith concluded (following consultation with its outside legal counsel and its financial advisor), is a Superior Proposal and is from a person reasonably capable of consummating such Acquisition Proposal, (ii) furnish to such Third Party nonpublic information relating to the Company or any of its Subsidiaries pursuant to an appropriate confidentiality agreement (a copy of which shall be provided for informational purposes only to Parent), (iii) following receipt of such Superior Proposal, fail to make, withdraw, or modify in a manner adverse to Parent its recommendation to its stockholders referred to in Section 6.02 hereof (“Change of Recommendation”) and/or (iv) take any action that any court of competent jurisdiction orders the Company to take, but in each case referred to in the foregoing clauses (i) through (iv) only if the Board of Directors of the Company determines in good faith, after consulting with outside legal counsel to the Company, that it is required to take such action in order to comply with its fiduciary duties under applicable law.

(c) The Board of Directors of the Company shall not take any of the actions referred to in clauses (i) through (iv) of the preceding subsection unless the Company shall have delivered to

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Parent a prior written notice advising Parent that it intends to take such action, and the Company shall continue to advise Parent of any material developments after taking such action. In addition, the Company shall notify Parent promptly (but in no event later than 24 hours) after receipt by the Company (or any of its advisors) of any Acquisition Proposal, any indication that a Third Party is considering making an Acquisition Proposal or of any request for information relating to the Company or any of its Subsidiaries or for access to the business, properties, assets, books or records of the Company or any of its Subsidiaries by any Third Party that may be considering making, or has made, an Acquisition Proposal. The Company shall provide such notice orally and in writing and shall identify the Third Party making, and the material terms and conditions of, any such Acquisition Proposal, indication or request. The Company shall keep Parent fully informed, on a reasonably current basis, of the status and material details of any such Acquisition Proposal, indication or request. The Company shall, and shall cause its Subsidiaries and the advisors, employees and other agents of the Company and any of its Subsidiaries to, cease immediately and cause to be terminated any and all existing activities, discussions or negotiations, if any, with any Third Party conducted prior to the date hereof with respect to any Acquisition Proposal and shall use all commercially reasonable efforts to cause any such Party (or its agents or advisors) in possession of confidential information about the Company that was furnished by or on behalf of the Company to return or destroy all such information.

(d) Notwithstanding anything to the contrary contained in this Agreement, unless this Agreement shall be terminated in accordance with its terms, (i) the Company shall be obligated to call, give notice of, convene and hold the Company Stockholders’ Meeting regardless of the commencement, disclosure, announcement or submission to it of any Acquisition Proposal or of any Change of Recommendation, and (ii) the Company shall not submit to the vote of its stockholders any Acquisition Proposal, or propose to do so until after the Company Stockholder meeting or the termination of this Agreement.

Section 6.04. Access to Information. From the date hereof until the Effective Time and subject to applicable law and the Letter Agreement dated as of May 27, 2003 between the Company and Parent (the “Letter Agreement”), the Company shall (i) give Parent, its counsel, financial advisors, auditors and other authorized representatives reasonable access (during normal business hours and upon reasonable notice) to the offices, properties, books, work papers, assets, contracts and records of the Company and the Subsidiaries (including access to perform physical examinations, (ii) furnish to Parent, its counsel, financial advisors, auditors and other authorized representatives such financial and operating data created by the Company in the ordinary course of its business and other information as such Persons may reasonably request and (iii) instruct the employees, counsel, financial advisors, auditors and other authorized representatives of the Company and its Subsidiaries to cooperate with Parent in its investigation of the Company and its Subsidiaries. The Company agrees to provide to Parent and its accountants, counsel and other representatives copies of internal financial statements (including returns and supporting documentation), when available, upon request as promptly as practicable consistent with the Company’s past practice. Any investigation pursuant to this Section shall be conducted in such manner as not to interfere unreasonably with the conduct of the business of the Company and its Subsidiaries. No information or Knowledge obtained by Parent in any investigation pursuant to this Section shall affect or be deemed to modify any representation or warranty made by the Company hereunder.

Section 6.05. Tax Matters. Without the prior written consent of Parent, none of the Company or any of its Subsidiaries shall, to the extent it may affect or relate to the Company or any Subsidiary, make or change any Tax election, change any annual Tax accounting period, adopt or change any method of Tax accounting, file any amended Return, enter into any closing

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agreement, settle any Tax claim, audit or assessment, surrender any right to claim a Tax refund, offset or other reduction in Tax liability, consent to any extension or waiver of the limitations period applicable to any Tax claim or assessment or take or omit to take any other action, if any such action or omission would have the effect of materially increasing the Tax liability or materially reducing any Tax Asset of the Company, any of its Subsidiaries, Parent or any Affiliate of Parent.

Section 6.06. 401(k). The Company shall terminate, effective as of the day immediately preceding the Effective Time, any and all 401(k) plans sponsored or maintained by the Company or any of its Subsidiaries unless Parent provides written notice to the Company prior to the Effective Time that any such 401(k) plan shall not be terminated. At the Closing, Parent shall receive from the Company evidence that the Company’s 401(k) plan(s) have been terminated pursuant to resolutions of the Company’s or any of its Subsidiaries’ Board of Directors (the form and substance of such resolutions shall be subject to review and reasonable approval of Parent), effective as of the day immediately preceding the Effective Time.

Section 6.07. Notices of Certain Events. The Company shall promptly notify Parent of:

(a) any notice or other communication from any Person alleging that the consent of such Person is or may be required in connection with the transactions contemplated by this Agreement;

(b) any notice or other communication from any governmental or regulatory agency or authority in connection with the transactions contemplated by this Agreement; and

(c) any actions, suits, claims, investigations or proceedings commenced or, to its Knowledge, threatened against, relating to or involving or otherwise affecting the Company or any of its Subsidiaries that, if pending on the date of this Agreement, could have been required to have been disclosed pursuant to Section 4.12, Section 4.15, Section 4.16, Section 4.19 or Section 4.23, as the case may be, or that relate to the consummation of the transactions contemplated by this Agreement.

Section 6.08. Consents; Good Standings. The Company shall use all commercially reasonable efforts to obtain the consents, waivers, assignments and approvals as may be required from third parties in connection with the transactions contemplated hereby, including without limitation those listed on Schedule 6.08. The Company shall use all commercially reasonable efforts to obtain good standing in each jurisdiction listed in Schedule 4.01(a), and to qualify to do business and obtain good standing in the State of Washington.

Section 6.09. Company Cash. No later than two Business Days prior to the Effective Time, the Company shall notify Parent in writing of its estimate of the Company Cash to be held by the Company immediately prior to the Effective Time. To the extent that the additional compensation and severance payments paid or to be paid to employees as set forth on Schedule 6.01(f) exceed the sum of the Company Cash as of the Effective Time plus the Loan Limit, the Company shall be required either (i) to reduce such additional compensation and severance payments to an amount equal to the sum of the Company Cash at the Effective Time plus the Loan Limit or (ii) to incur additional indebtedness above the Loan Limit up to an amount sufficient to pay such additional compensation and severance payments (the amount of such additional indebtedness above the Loan Limit is referred to as the “Excess Borrowing”);

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provided, however, that the Merger Cash shall be reduced by the amount of such Excess Borrowing.

Section 6.10. Excise Tax Matters. Prior to the Effective Time, the Company shall endeavor to obtain the approval of more than 75% of disinterested Stockholders with respect to all potential 280G benefits that are or may be payable to any disqualified individual in connection with or as a result of the Merger.

Section 6.11. Capitalization Information. The Company shall deliver to Parent on a date that is two Business Days prior to the Effective Time a complete and accurate schedule as of such date of delivery certified by the Company that sets forth as of such date and at the Effective Time, a complete and accurate schedule as of the Effective Time certified by the Company that sets forth as of the Effective Time, in each case, the following: (i) the Outstanding Series A Preferred, (ii) the Outstanding Series B Preferred, (iii) the Outstanding Series B-1 Preferred, (iv) the Outstanding Redeemable Preferred, (v) the Outstanding Common, (vi) the number of vested Outstanding Options, (vii) the number of unvested Outstanding Options, (viii) the average exercise price of the vested and unvested Outstanding Options, (ix) the name of the holder of each Outstanding Option, the grant date and number of shares of Company Common Stock subject to such option, the exercise price of such option, the vesting schedule for such option, including the extent vested to the Effective Time and whether and to what extent the exercisability of such option will be accelerated as a result of the consummation of the transactions contemplated by this Agreement (indicating the circumstances that may cause such acceleration), and the date on which such option expires, and (x) the name of the holder of any Company Common Stock subject to vesting, the number of shares of Company Common Stock subject to vesting and the vesting schedule for such Company Common Stock, including the extent vested to the Effective Time and whether and to what extent the vesting of such shares of Company Common Stock will be accelerated as a result of the consummation of the transactions contemplated by this Agreement (indicating the circumstances that may cause such acceleration). The Company will make available to Parent, prior to the Effective Time, a copy of each stock option agreement, each restricted stock agreement and all other agreements pursuant to which the Company has granted Company Stock Options, Company Common Stock or any other type of award under the Option Plan or such other documentation of such agreements as is reasonably satisfactory to Parent. The Company shall use all commercially reasonable efforts to ensure satisfaction of all obligations under the Voting Agreements by the Stockholders parties thereto, including full exercise of any Warrants held by such Stockholders.

Section 6.12. Stock Options. Subject to receipt of approval by the stockholders of the Company to any required increase in the number of shares reserved under the Company’s Stock Option Plan, the Company agrees to grant Additional Options to such employees of the Company and in such amounts as requested by Parent.

ARTICLE 7

COVENANTS OF PARENT

Parent agrees that:

Section 7.01. Obligations Of Merger Subsidiary I. Parent will take all action necessary to cause Merger Subsidiary I to perform its obligations under this Agreement and to consummate the Merger on the terms and conditions set forth in this Agreement.

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Section 7.02. Benefits; Prior Service; Section 16. (a) From and after the Effective Time, the Company’s employees who continue employment with Parent or its subsidiaries shall be provided with employee benefits that, in the aggregate, are substantially comparable to those provided to employees of Parent who are similarly situated. Parent shall cause such employees of the Company and its subsidiaries to be credited with service with the Company and each of its subsidiaries for purposes of eligibility and vesting under each employee benefit plan maintained by Parent or its subsidiaries after the Effective Time to the extent of their service with the Company. To the extent permitted by the terms of Parent’s plans, Parent shall cause any and all pre-existing condition limitations, eligibility waiting periods and evidence of insurability requirements under any group health plans to be waived with respect to such Company employees and their eligible dependents, to the extent such limitations, waiting periods or evidence would not have applied under the Company plan, and shall provide them with credit for any co-payments, deductibles, and offsets (or similar payments) prior to the Effective Time for purposes of satisfying any applicable deductible, out-of-pocket, or similar requirements under any employee benefit plans of Parent in which they are eligible to participate after the Effective Time.

(b) The Board of Directors of Parent, or a committee of two or more Non-Employee Directors thereof (as such term is defined for purposes of Rule 16b-3 under the Exchange Act), and provided that the Company delivers to Parent the Section 16 Information (as defined below) in a timely fashion, shall adopt resolutions prior to the Effective Time of the Merger, providing that the acquisition by the Parent Insiders (as defined below) of Parent Common Stock and Parent Options, in each case pursuant to the transactions contemplated hereby, are intended to be, to the extent legally permissible, exempt from liability under Section 16(b) of the Exchange Act. Such resolutions shall comply with the approval conditions of Rule 16b-3 under the Exchange Act and no-action letters issued thereunder for purposes of such Section 16(b) exemption. “Parent Insiders” shall mean those officers and directors of Company who will be subject to the reporting requirement of Section 16(b) of the Exchange Act with respect to Parent following the Effective Time of the Company. “Section 16 Information” shall mean information regarding the Company Insiders, the number of shares of Company capital stock held by each such Company Insider and expected to be exchanged for Parent Common Stock in connection with the Company Merger, and the number and description of the Company Options held by each such Company Insider and expected to be converted into option to purchase Parent Common Stock in connection with the Merger.

Section 7.03. Indemnification; Insurance. (a) From and after the Effective Time, Parent will cause the Surviving Corporation to fulfill and honor in all respects the obligations of Company (or any predecessor corporation) pursuant to (i) each indemnification agreement between Company and its directors or officers in effect immediately prior to the Effective Time (the “Indemnified Parties”) and (ii) any indemnification provision under the Company’s certificate of incorporation and bylaws as in effect on the date hereof. The certificate of incorporation and bylaws of the Surviving Corporation will contain provisions with respect to exculpation and indemnification that are at least as favorable to the Indemnified Parties as those contained in the Company’s certificate of incorporation and bylaws as in effect on the date hereof, which provisions will not be amended, repealed or otherwise modified for a period of six years from the Effective Time in any manner that would adversely affect the rights thereunder of any Indemnified Party or of individuals who, immediately prior to the Effective Time, were employees or agents of Company, unless such modification is required by law.

(b) For a period of six years after the Effective Time, Parent will cause the Surviving Corporation to maintain in effect, directors’ and officers’ liability insurance covering those persons who are currently covered by the Company’s directors’ and officers’ liability insurance

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policy on terms comparable to those applicable to the current directors and officers of the Company; provided, however, that in no event will the Surviving Corporation be required to expend in excess of 150% of the annual premium currently paid by Company for such coverage (the “Current Annual Premium Amount”) (but shall in any event provide and maintain such coverage as is available for such 150% of such annual premium). The Current Annual Premium Amount is set forth in Schedule 4.20 of the Company Disclosure Schedule.

(c) The provisions of this Section shall survive consummation of the Merger and are (i) intended to be for the benefit of, and will be enforceable by, each of the Indemnified Parties and (ii) in addition to, and not in substitution for, any other rights to indemnification or contribution that any such Indemnified Party may have by contract or otherwise.

Section 7.04. Listing Notifications. Parent shall timely prepare and submit to Nasdaq any notice or other document or instrument required to be filed with or submitted to Nasdaq with respect to the shares of Parent Common Stock issuable in connection with the Merger prior to the Effective Time.

Section 7.05. Form S-8. Parent agrees to file with the SEC as soon as practicable following the Effective Time (but in no event later than 15 Business Days after the Effective Time) a registration statement on Form S-8 under the Securities Act covering, to the extent applicable, the shares of Parent Common Stock to be issued upon the exercise of Company Stock Options of the Company assumed by Parent. Parent agrees to cause shares of Parent Common Stock to be issued upon exercise of Company Stock Options of the Company assumed by Parent to be authorized for listing on the national securities exchange on which the Parent Common Stock is listed.

Section 7.06. Material Announcements. Parent shall not plan or, except as may be required by applicable law or any listing agreement with or regulations of any national securities exchange, Parent shall not make a Material Announcement within two Business Days after the Effective Time other than any such announcement with respect to this Agreement and the transactions contemplated hereby.

ARTICLE 8

COVENANTS OF PARENT AND THE COMPANY

The parties hereto agree that:

Section 8.01. Reasonable Efforts. Subject to the terms and conditions of this Agreement, Company and Parent will use all commercially reasonable efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary, proper or advisable under applicable laws and regulations to consummate the transactions contemplated hereby, to obtain all necessary waivers, consents and approvals, to effect all necessary registrations and filings and to remove any injunctions or other impediments or delays, legal or otherwise, in order to consummate and make effective the transactions contemplated by this Agreement for the purpose of securing to the parties hereto the benefits contemplated by this Agreement; provided, however, that Parent shall not be legally required to agree to any divestiture by Parent or any of Parent’s Subsidiaries or Affiliates or by the Company or any of its Subsidiaries or Affiliates of shares of capital stock or of any business, assets or property of Parent or its Subsidiaries or Affiliates or of the Company or its Subsidiaries or Affiliates, or the imposition of any material limitation on the

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ability of any of them to conduct their businesses or to own or exercise control of such assets, properties and stock. In furtherance and not in limitation of the foregoing, if required, each of Parent and Company agrees to make an appropriate filing of a Notification and Report Form pursuant to the HSR Act with respect to the transactions contemplated hereby as promptly as practicable and in any event within ten Business Days of the date hereof and to supply as promptly as practicable any additional information and documentary material that may be requested pursuant to the HSR Act and to take all other actions necessary to cause the expiration or termination of the applicable waiting periods under the HSR Act as soon as practicable. Each of Parent and the Company shall use all commercially reasonable best efforts to resolve such objections, if any, as may be asserted by any Governmental Entity with respect to the transactions contemplated by this Agreement under the HSR Act, the Sherman Act, as amended, the Clayton Act, as amended, the Federal Trade Commission Act, as amended, and any other federal, state or foreign statutes, rules, regulations, orders or decrees that are designed to prohibit, restrict or regulate actions having the purpose or effect of monopolization or restraint of trade.

Section 8.02. Certain Filings. The Company and Parent shall cooperate with one another (i) in determining whether any action by or in respect of, or filing with, any governmental body, agency, official, or authority is required, or any actions, consents, approvals or waivers are required to be obtained from parties to any material contracts, in connection with the consummation of the transactions contemplated by this Agreement and (ii) in using all commercially reasonable efforts to take such actions or make any such filings, furnishing information required in connection therewith and seeking timely to obtain any such actions, consents, approvals or waivers.

Section 8.03. Public Announcements. Parent and the Company will consult with each other before issuing any press release or making any public statement with respect to this Agreement or the transactions contemplated hereby and, except as may be required by applicable law or any listing agreement with any national securities exchange, will not issue any such press release or make any such public statement prior to such consultation.

Section 8.04. Further Assurances. At and after the Effective Time, the officers and directors of the Surviving Corporation will be authorized to execute and deliver, in the name and on behalf of the Company or Merger Subsidiary I, any deeds, bills of sale, assignments or assurances and to take and do, in the name and on behalf of the Company or Merger Subsidiary I, any other actions and things to vest, perfect or confirm of record or otherwise in the Surviving Corporation any and all right, title and interest in, to and under any of the rights, properties or assets of the Company acquired or to be acquired by the Surviving Corporation as a result of, or in connection with, the Merger.

Section 8.05. Notification Of Certain Matters. Each party shall give prompt notice to the other parties hereto of (i) the occurrence or non-occurrence of any event, the occurrence or non-occurrence of which is likely to cause any representation or warranty of such party contained in this Agreement to be untrue or inaccurate in any material respect at or prior to the Effective Time, (ii) any failure in any material respect of such party to comply with or satisfy in any material respect any covenant, condition or agreement to be complied with or satisfied by it hereunder, (iii) any notice or other communication from any Person alleging that the consent of such Person is or may be required in connection with the transactions contemplated by this Agreement, (iv) any notice or other communication from any governmental or regulatory agency or authority in connection with the transactions contemplated by this Agreement, and (v) any actions, suits, claims, investigations or proceedings commenced or, to its Knowledge threatened against, relating to or involving or otherwise affecting the Company or any of its Subsidiaries

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that, if pending on the date of this Agreement, would have been required to have been disclosed pursuant to Section 4.12 or that relate to the consummation of the transactions contemplated by this Agreement; provided, however, that the delivery of any notice pursuant to this Section shall not limit or otherwise affect any remedies available to the party receiving such notice; and provided further, however, that no disclosure by the Company pursuant to this Section 8.05 shall be deemed to amend or supplement any Schedule hereto or prevent or cure any misrepresentations, breach of warranty or breach of covenant.

Section 8.06. California Permit; Registered Offering. (a) As promptly as practicable after the execution of this Agreement, Parent shall prepare the necessary documents and apply to obtain a California Permit so that the issuance of the Parent Common Stock in the Merger shall be exempt from registration under the 1933 Act, by virtue of the exemption from registration contained in Section 3(a)(10) thereof; provided, however, that Parent shall use all commercially reasonable efforts to prepare and file the application to obtain a California Permit within 15 days after the later of (i) execution of this Agreement and (ii) the date on which the Company has furnished to Parent materials in conformity with the requirements of such application. The Company shall cooperate with, and provide information to, Parent in connection with Parent’s application for the California Permit, including such Proxy Materials, financial statements and other information with respect to the Company as are required to be filed therewith. The Company and Parent will respond to any comments from the California Commissioner of Corporations and use all commercially reasonable efforts to have the California Permit granted as soon as practicable after such filing. None of the information supplied by the Company to Parent, the California Commissioner of Corporations or any representative thereof in connection with the California Permit application or any other document prepared to comply with federal or state securities laws shall contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements contained therein, in the light of the circumstances under which they were made, not misleading. None of the information supplied by Parent to the Company, the California Commissioner of Corporations or any representative thereof in connection with the California Permit application or any other document prepared to comply with federal or state securities laws shall contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements contained therein, in the light of the circumstances under which they were made, not misleading.

(b) If a California Permit cannot be issued for any reason, or is not issued on or before the date that is 75 days after the date of the initial filing of the application to obtain a California Permit, then the parties hereto shall take all action necessary to permit the delivery of Parent Common Stock pursuant to the Merger to be accomplished by means of registration of such Parent Common Stock on a Registration Statement on Form S-4 (or another appropriate form) (the “Registration Statement”) under the 1933 Act. If the Parent Common Stock will be issued pursuant to an effective Registration Statement, each of Parent and the Company shall cooperate to prepare and file, and Parent shall prepare and file, the Registration Statement with the SEC as promptly as is reasonably practicable and each of Parent and the Company shall cooperate to, and shall, use all commercially reasonable efforts to have the Registration Statement declared effective by the SEC as promptly as practicable and to maintain the effectiveness of the Registration Statement through the Effective Time. Parent shall advise the Company promptly after it receives notice of (i) the Registration Statement being declared effective or any supplement or amendment thereto being filed with the SEC, (ii) the issuance of any stop order in respect of the Registration Statement, and (iii) the receipt of any correspondence, comments or requests from the SEC in respect of the Registration Statement. Each of Parent and Company shall also cooperate to, and shall, take such other reasonable actions (other than qualifying to do business in any jurisdiction in which it is not so qualified) required to be taken under any

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applicable state securities laws in connection therewith. Parent will pay all customary expenses in connection with the Registration Statement, including, without limitation, registration fees, legal and accounting fees, listing fees, transfer agent fees and printing and mailing costs related to the Registration Statement. None of the information supplied by the Company to Parent for inclusion in the Registration Statement shall contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements contained therein, in the light of the circumstances under which they were made, not misleading. None of the information supplied by Parent for inclusion in the Registration Statement shall contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements contained therein, in the light of the circumstances under which they were made, not misleading. The Registration Statement and prospectus included therein shall comply as to form with the provisions of the 1933 Act.

Section 8.07. Tax Free Reorganization. The parties intend to adopt this Agreement and the Merger as a plan of reorganization under Section 368 of the Code. If (a) Parent receives written notice from the Company on the Closing Date that the Sellers intend to treat the Merger and the Second Merger as a reorganization under Section 368 of the Code and (b) either (X) the Company receives an opinion from Fenwick & West LLP to the effect that the Merger and Second Merger will be treated as a reorganization under Section 368 of the Code or (Y) Parent determines, in good faith, that there is a reasonable basis for such treatment, then (i) the parties shall not take any position on any tax return inconsistent with this Section 8.07 and (ii) from and after the Effective Time, neither Parent, Sub nor the Company shall take any action that could reasonably be expected to cause the Mergers not to be treated as a reorganization within the meaning of Section 368 of the Code.

Section 8.08. Stock Certificates. Parent shall have certificates evidencing the Parent Common Stock payable to those Stockholders that have so requested available for delivery at the Closing, subject to such Stockholder completing any letter of transmittal or stock transfer documentation with respect to the shares of Company Common Stock or Preferred Stock held by such Stockholder.

ARTICLE 9

CONDITIONS TO THE MERGER

Section 9.01. Conditions to Obligations of Each Party. The obligations of each party to this Agreement to consummate the Merger are subject to the satisfaction at or prior to the Effective Time of the following conditions:

(a) This Agreement and the Merger shall have been approved and adopted by the Stockholders in accordance with Delaware Law and California Law and the Company’s certificate of incorporation.

(b) No provision of any applicable law or regulation and no judgment, injunction, order or decree issued by any court or governmental body having competent jurisdiction shall prohibit the consummation of the Merger.

(c) All actions by or in respect of, or filings with, any governmental body, agency, official or authority, domestic, foreign or supranational, required to permit the consummation of the Merger shall have been taken, made or obtained.

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(d) No claim, action, suit, arbitration, inquiry, proceeding or investigation by or before any United States, federal, state or local or any foreign government, governmental, regulatory or administrative authority, agency or commission or any court, tribunal or judicial or arbitral body (each, a “Governmental Authority”) shall have been threatened by, or commenced before, any Governmental Authority against either the Company or Parent, seeking to restrain or materially and adversely alter the transactions contemplated hereby which is reasonably likely to render it impossible or unlawful to consummate the transactions contemplated by this Agreement or which could reasonably be expected to have a Material Adverse Effect on the Company or Parent.

(e) There shall not be instituted or pending any action or proceeding (or any investigation or other inquiry that would reasonably be expected to result in such action or proceeding) before any Governmental Authority, or by any other Person, domestic, foreign or supranational, before any court or governmental authority or agency of competent jurisdiction, domestic, foreign or supranational, seeking to restrain, prohibit or otherwise interfere with the ownership or operation by Parent or any of its Subsidiaries of all or any material portion of the business or assets of the Company or any of its Subsidiaries or of Parent or any of its Subsidiaries, or to compel Parent or any of its Subsidiaries or Affiliates to dispose of or hold separate all or any material portion of the business or assets of the Company or any of its Subsidiaries, or of Parent or any of its Subsidiaries.

(f) Any applicable waiting period under the HSR Act relating to the transactions contemplated hereby shall have expired or been terminated.

(g) The issuance of the shares of Parent Common Stock in the Merger shall either be exempt from registration pursuant to the exemption contained in Section 3(a)(10) of the 1933 Act or be registered under the 1933 Act.

Section 9.02. Conditions to the Obligations of Parent and Merger Subsidiary I. The obligations of Parent and Merger Subsidiary I to consummate the Merger are subject to the satisfaction of the following further conditions, any of which may be waived, in writing, exclusively by Parent:

(a) The representations and warranties of the Company set forth in this Agreement, disregarding all qualifications and exceptions contained therein relating to materiality or Material Adverse Effect or any similar standard or qualification, shall be true and correct at and as of the Effective Time as if made at and as of such date (except for representations and warranties which address matters only as of a specified date, which representations and warranties shall be true and correct with respect to the specified date), except where the failure of such representations and warranties to be true and correct would not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect on the Company. Parent and Merger Subsidiary I shall have received a certificate signed by the Chief Executive Officer and Chief Financial Officer of the Company to the foregoing effect.

(b) The Company shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by it at or prior to the Effective Time and the Stockholders parties to the Voting Agreements shall have performed or complied in with all agreements and covenants required by the Voting Agreements to be performed or complied with by them at or prior to the Effective Time. Parent and Merger Subsidiary I shall have received a certificate signed by the Chief Executive Officer and Chief Financial Officer of the Company to the foregoing effect.

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(c) Parent shall have received an opinion of Fenwick & West LLP, counsel to the Company, dated the Effective Time in substantially the form attached hereto as Exhibit E. In rendering such opinion, such counsel may rely upon certificates of public officers, as to matters governed by the laws of jurisdictions other than Delaware, California or the Federal laws of the United States of America, upon opinions of counsel reasonably satisfactory to Parent, and, as to matters of fact, upon certificates of officers of the Company or any of its Subsidiaries, copies of which opinions and certificates shall be contemporaneously delivered to Parent.

(d) The Company shall have received all consents, authorizations or approvals from the governmental agencies referred to in Section 4.03, in each case in form and substance reasonably satisfactory to Parent, and no such consent, authorization or approval shall have been revoked.

(e) The Voting Agreements executed and delivered to Parent by the individuals listed on Annex A hereto shall be in full force and effect immediately prior to the Effective Time, and each of the Non-Competition and Non-Solicitation Agreements executed and delivered to Parent by the individuals listed on Annex B on the date of this Agreement hereto shall be in full force and effect immediately prior to the Effective Time.

(f) Parent shall have received certified certificate of incorporation and bylaws, and good standing certificates in respect of the Company and its Subsidiaries and certified board resolutions in respect of the transactions contemplated hereby, all in form and substance reasonably satisfactory to Parent.

(g) The amendments to the Company’s certificate of incorporation as set forth in Schedule 4.01(b) shall have been filed with the Secretary of State of the State of Delaware and shall be in full force and effect.

(h) Parent shall have received a certificate signed by the Chief Financial Officer of the Company setting forth the Transaction Expenses incurred with respect to this Agreement and the transactions contemplated hereby. The Company and Company’s legal counsel, auditors, investment bankers and financial advisors shall have agreed to the amounts set forth in such certificate. Any additional Transaction Expenses exceeding the amounts set forth in such certificate shall be considered a Loss pursuant to Section 10.02 and shall be paid out of the Escrow Fund in accordance with the provisions set forth in Section 10.02.

(i) The Company shall have delivered a certification pursuant to Treasury Regulations Sections 1.897-2(h) and 1.1445-2(c), signed by the Company and dated not more than 30 days prior to the Effective Time to the effect that the Company is not nor has it been within 5 years of the date of the certification a “United States real property holding corporation” as defined in Section 897 of the Code.

(j) No Material Adverse Effect on the Company shall have occurred since the date hereof and be continuing.

(k) The Company shall have obtained each consent identified in Schedule 6.08 hereto.

(l) Dissenting Shares shall comprise not more than 7.5% of the Shares outstanding immediately prior to the Effective Time.

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(m) The outstanding loans to the employees and officers of the Company set forth on Schedule 9.02(m) shall have been repaid prior to or at the Effective Time.

(n) Parent shall have received a certificate signed by the Chief Financial Officer of the Company setting forth the Company Cash held by the Company on the day prior to the Effective Time.

Section 9.03. Conditions to Obligations of the Company. The obligation of the Company to consummate the Merger is subject to the satisfaction of the following further conditions, any of which may be waived, in writing, exclusively by the Company:

(a) The representations and warranties of Parent and Merger Subsidiary I set forth in this Agreement, disregarding all qualifications and exceptions contained therein relating to materiality or Material Adverse Effect or any similar standard or qualification, shall be true and correct at and as of the Effective Time as if made at and as of such date, except where the failure of such representations and warranties to be true and correct would not, singly or in the aggregate, reasonably be expected to have a Material Adverse Effect on Parent. The Company shall have received a certificate signed by a duly authorized officer of Parent to the foregoing effect.

(b) Parent and Merger Subsidiary I shall have performed or complied in all material respects with all agreements and covenants required by this Agreement to be performed or complied with by it on or prior to the Effective Time, and the Company shall have received a certificate with respect to the foregoing signed on behalf of Parent, with respect to the covenants of Parent, by a duly authorized officer of Parent and a certificate with respect to the foregoing signed on behalf of Merger Subsidiary I, with respect to the covenants of Merger Subsidiary I, by a duly authorized officer of Merger Subsidiary I.

(c) The Company shall have received an opinion of Davis Polk & Wardwell, counsel to Parent, dated the Effective Time, in substantially the form attached hereto as Exhibit F. In rendering such opinion, such counsel may rely upon certificates of public officers as to matters governed by the laws of jurisdictions other than Delaware, California or the Federal laws of the United States of America, upon opinions of counsel reasonably satisfactory to Parent, and, as to matters of fact, upon certificates of officers of the Company or any of its Subsidiaries, copies of which opinions and certificates shall be contemporaneously delivered to Parent.

Section 9.04. Conditions to Obligations Of Parent And the Surviving Corporation With Respect To The Second Merger.

(a) Parent and the Surviving Corporation shall not be required to consummate the Second Merger unless Parent shall have received an opinion of Davis Polk & Wardwell and the Company shall have received an opinion of Fenwick & West LLP, each to the effect that, if the consummation of the Merger and the Second Merger does not qualify as a reorganization under Section 368 of the Code, the transactions would be treated for U.S. federal income tax purposes as a “qualified stock purchase” of the Company’s stock by Parent within the meaning of Section 338 of the Code followed by a liquidation of the Company under Section 332 of the Code.

(b) Parent and the Surviving Corporation shall not be required to consummate the Second Merger if Parent receives written consent from the Stockholders’ Representative not to consummate the Second Merger, which consent shall not be unreasonably withheld.

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ARTICLE 10

SURVIVAL OF REPRESENTATION AND WARRANTIES; INDEMNIFICATION

Section 10.01. Survival Of Representation And Warranties. The Company’s representations and warranties contained in this Agreement shall survive the Effective Time until the first anniversary of the Effective Time; provided that the representation and warranties set forth in Sections 4.02, 4.05, 4.13, 4.15 and 4.16(a)-(k) shall survive the Effective Time until the second anniversary of the Effective Time. If written notice of a claim has been given in accordance with Section 10.01(a) and (c) prior to the expiration of the applicable survival period of the representations and warranties by the party seeking indemnification to the party from whom indemnification is sought (which notice shall indicate with reasonable specificity the amount and nature of the claim and the representation on which it is based), then the relevant representations and warranties shall survive as to such claim until such claim has been finally resolved. All of Parent’s and Merger Subsidiary’s representations and warranties contained herein or in any instrument delivered pursuant to this Agreement shall terminate at the Effective Time.

Section 10.02. Indemnification. (a) Subject to Section 10.02(g), Parent and its Affiliates (including, after the Effective Time, the Surviving Corporation and its Subsidiaries), officers, directors, employees, agents, successors and assigns (collectively, the “Parent Indemnified Parties”) shall be indemnified and held harmless by the Stockholders of the Company, but solely out of the Escrow Fund for (i) any and all liabilities (including, without limitation, Taxes resulting from a breach of the provisions of Section 4.15), losses, damages, claims, costs and expenses, interest, awards, judgments and penalties (including, without limitation, reasonable attorneys’ and consultants’ fees and expenses and including any such expenses incurred in connection with investigating, defending against or settling any such claims) suffered or incurred by them, including, without limitation, in connection with any action brought or otherwise initiated by any of them arising out of or resulting from the breach of any representation or warranty (without giving effect to any qualification as to materiality or Material Adverse Effect contained therein in determining the amount of any loss) made by the Company in this Agreement; and (ii) any liabilities, costs, expenses (including, without limitation, reasonable expenses of investigation and attorneys’ fees), losses, damages, assessments, settlements or judgments arising out of or incident to the matters described in Schedules 10.02(a)(i) and 10.02(a)(ii) (the sum of (i) and (ii) a “Loss”), provided, however that a Loss shall not include amounts actually received by the Company in respect of insurance. The aggregate amount of Losses for which the Parent Indemnified Parties may receive indemnification pursuant to this Agreement shall not exceed the amount of the Escrow Fund.

(b) Any Parent Indemnified Party seeking indemnification from another party hereto (the “Indemnifying Party”) under this Section shall give the Escrow Agent and the Stockholders’ Representative, notice of any matter which such Parent Indemnified Party has determined has given rise to a right of indemnification under this Agreement promptly after the Parent Indemnified Party becomes aware of such matter and, prior to the expiration of the applicable representations and warranties as set forth in this Section 10.02, stating the amount of the Loss incurred or that is reasonably anticipated to incur, and method of computation thereof, containing a reference to the specific provisions of this Agreement in respect of which such right of indemnification is claimed or arises and specifying in reasonable detail the individual items of such Loss and the nature of the claim to which such Loss relates; provided that the failure to give such notice shall not in any way affect the indemnification obligations set forth in this Article unless the Indemnifying Party is materially prejudiced by such failure. All fees, expenses and Losses of the Parent Indemnified Party in connection with any matter for which indemnity may

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be sought shall be reimbursed from the Escrow Account in accordance with the Escrow Agreement.

(c) If the Stockholders’ Representative shall not have objected to the amount claimed by the Parent Indemnified Party for indemnification from the Escrow Fund with respect to any Loss in accordance with the procedures set forth herein and in the Escrow Agreement and the Stockholders’ Representative and the Parent Indemnified Party shall have, subsequent to the giving of such notice, mutually agreed that the Parent Indemnified Party is entitled to indemnification from the Escrow Fund for a specified amount and shall have so jointly notified the Escrow Agent and the Escrow Agent shall have received joint written instructions from the Stockholders’ Representative and the Parent Indemnified Party, the Escrow Agent shall deliver to the Parent Indemnified Party funds from the Escrow Fund in respect of any amount determined to be owed to the Parent Indemnified Party under this Section in accordance with the Escrow Agreement.

(d) If the Stockholders’ Representative delivers notice of its disagreement as to the indemnification requested by the Parent Indemnified Party from the Escrow Fund (a “Contested Claim”), then such Contested Claim will be resolved by either (i) a written settlement agreement executed by Parent and the Stockholders’ Representative and provided to the Escrow Agent or (ii) in the absence of such a written settlement agreement within 30 days of such notice of disagreement, by binding arbitration between the Stockholders’ Representative and Parent in accordance with the terms and provisions of this Section 10.02 (d).

(e) Parent and Company agree that any Contested Claim will be submitted to mandatory, final and binding arbitration before J.A.M.S./ENDISPUTE or its successor (“J.A.M.S.”), pursuant to the United States Arbitration Act, 9 U.S.C., Section 1 et seq. and that any such arbitration will be conducted in Santa Clara County, California. Either Parent or the Stockholders’ Representative may commence the arbitration process called for by this Agreement by filing a written demand for arbitration with J.A.M.S. and giving a copy of such demand to each of the other parties to this Agreement. The arbitration will be conducted in accordance with the provisions of J.A.M.S.’ Streamlined Arbitration Rules and Procedures in effect at the time of filing of the demand for arbitration, subject to the provisions of this Section 10.02(e). The parties will cooperate with J.A.M.S. and with each other in promptly selecting an arbitrator from J.A.M.S.’s panel of neutrals, and in scheduling the arbitration proceedings in order to fulfill the provisions, purposes and intent of this Agreement. The parties covenant that they will participate in the arbitration in good faith, and that they will share in its costs in accordance with subparagraph (i) below. The provisions of this Section 10.02(e) may be enforced by any court of competent jurisdiction, and the party seeking enforcement will be entitled to an award of all costs, fees and expenses, including attorneys’ fees, to be paid by the party against whom enforcement is ordered. Judgment upon the award rendered by the arbitrator may be entered in any court having competent jurisdiction.

(i) Parent on the one hand, and the Stockholders (through the Stockholders’ Representative), on the other hand, will bear the expense of deposits and advances required by the arbitrator in equal proportions, but either party may advance such amounts, subject to recovery as an addition or offset to any award. The arbitrator will determine the party who is the prevailing party and the party who is the non-prevailing party. The non-prevailing party will pay all reasonable costs, fees and expenses related to the arbitration, including reasonable fees and expenses of attorneys, accountants and other professionals incurred by the prevailing party, the fees of each arbitrator and the administrative fee of the arbitration proceedings. If such an award would result in

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manifest injustice, however, the arbitrator may apportion such costs, fees and expenses between the parties in such manner as the arbitrator deems just and equitable.

(ii) Except as may be otherwise expressly provided herein, for any Contested Claim submitted to arbitration, the burden of proof will be as it would be if the claim were litigated in a judicial proceeding governed by Delaware law exclusively.

(iii) Upon the conclusion of any arbitration proceedings hereunder, the arbitrator will render findings of fact and conclusions of law and a final written arbitration award (which with respect to monetary compensation for damages (other than with respect to costs as set forth in clause (i)) shall not exceed the amount of the claim) setting forth the basis and reasons for any decision reached (the “Final Award”) and will deliver such documents to the Stockholders’ Representative and Parent, together with a signed copy of the Final Award. The Final Award will constitute a conclusive determination of all issues in question, binding upon the Stockholders, the Stockholders’ Representative and Parent, and will include an affirmative statement to such effect.

(iv) The Stockholders’ Representative, Parent and the arbitrator will conclude each arbitration hereunder as promptly as possible for the Contested Claim being arbitrated.

(v) The arbitrator chosen in accordance with these provisions will not have the power to alter, amend or otherwise affect the terms of these arbitration provisions or the provisions of this Agreement.

(f) In all matters relating to this Section, the Stockholders’ Representative shall be the only party entitled to assert the rights of the Stockholders, and the Stockholders’ Representative shall perform all of the obligations of the Stockholders hereunder. Parent shall be entitled to rely on all statements, representations and decisions of the Stockholders’ Representative.

(g) Notwithstanding anything else in this Agreement, the Indemnified Parties shall not be entitled to recover under this Section with respect to any breach of representations and warranties, unless the aggregate amount of Losses arising out of all such breaches of representations and warranties exceeds $1,000,000 (the “Basket Amount”), at which time the Indemnified Parties shall be entitled to recover from the Escrow Account the full amount of all such Losses without regard to the limitations set forth in this Section 10.02(g); provided that (i) any Losses arising out of the matters described in Schedule 10.02(a)(i) shall be recoverable from the first dollar and not subject to the Basket Amount, and (ii) any Losses arising out of the matters described in Schedule 10.02(a)(ii) shall not be subject to the Basket Amount and shall be reasonable only to the extent that the Losses arising out of such matters exceed $150,000.

(h) The indemnification and dispute resolution procedures provided by this Article (including with respect to arbitration of Contested Claims) shall be the sole and exclusive remedy available to Parent and its Affiliates after the Effective Time for any claim related to this Agreement or the transactions contemplated hereby, except with respect to claims arising out of fraud, criminal activity or the willful breach of covenants by a party hereto.

Section 10.03. Defense Of Claims. In connection with any claim giving rise to indemnity hereunder resulting from or arising out of any claim or legal proceeding by a third party, Parent shall give the Stockholders’ Representative prompt notice of such claim and the Stockholders’ Representative on behalf of the Indemnifying Party at its cost and expense (the sole

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source of satisfaction of such cost and expense shall be the Escrow Account pursuant to the terms of the Escrow Agreement) and with counsel reasonably satisfactory to the Parent Indemnified Party may, upon written notice to the Parent Indemnified Party, assume the defense of any such claim or legal proceeding if (i) the Escrow Account is comprised of sufficient financial resources to defend against such third-party claim and fulfill the Indemnifying Party’s highest reasonably likely Losses with respect to such claim or legal proceeding, (ii) the third-party claim does not seek an injunction or other equitable relief against or adversely affecting a Parent Indemnified Party, (iii) the Indemnifying Party acknowledges in writing its obligation to indemnify the Parent Indemnified Party against any Losses that may result from the third-party claim (subject to the sufficiency of the funds in the Escrow Account), and (iv) the Indemnifying Party agrees in writing not to settle such claim or proceeding without the prior written consent of the Parent Indemnified Party, which consent shall not be unreasonably withheld. If the Stockholders’ Representative so assumes, the Parent Indemnified Party shall be entitled to participate in (but not control) the defense of any such action, with its counsel at its own expense; provided, however, that if there are one or more legal defenses available to the Parent Indemnified Party that conflict with those available to the Indemnifying Party, or the Indemnifying Party fails to take reasonable steps necessary to defend diligently the claim after receiving written notice from the Parent Indemnified Party that it reasonably believes that the Indemnifying Party has failed to do so, the Parent Indemnified Party may assume the defense of such claim; and provided, further, that the Parent Indemnified Party may not settle such claim without the prior written consent of the Indemnifying Party, which consent may not be unreasonably withheld. If the Parent Indemnified Party assumes the defense of the claim, the Parent Indemnified Party shall be reimbursed out of the Escrow Account pursuant to the terms of the Escrow Agreement on a quarterly basis, provided a notice of such claim is first provided and resolved in accordance with Section 10.02, for reasonable fees and expenses of counsel retained by the Parent Indemnified Party and the Indemnifying Party shall be entitled to participate in (but not control) the defense of such claim, with its counsel at its own expense; provided, however, that the Parent Indemnified Party shall not be reimbursed for fees and expenses of more than one separate firm. If the Indemnifying Party thereafter seeks to question the manner in which the Parent Indemnified Party defended such third party claim or the amount or nature of any such settlement, the Indemnifying Party shall have the burden to prove, by a preponderance of the evidence, that the Parent Indemnified Party did not defend or settle such third-party claim in a reasonably prudent manner. The parties agree to render, without compensation, to each other such assistance as they may reasonably require of each other and to cooperate in good faith with each other, including providing such documents and records as may be pertinent and the time and attention of such personnel as may reasonably be necessary, in order to ensure the proper and adequate defense of any action, suit or proceeding, whether or not subject to indemnification hereunder.

Section 10.04. Stockholders’ Representative. By virtue of their approval of the Merger, the Stockholders appoint the Stockholders’ Representative as representative of the Stockholders and as the attorney-in-fact and agent for and on behalf of each Stockholder with respect to claims for Losses under Article 10. The Stockholders’ Representative will take any and all actions and make any decisions required or permitted to be taken by the Stockholders’ Representative under this Agreement and the Stockholders’ Representative Agreement in compliance with the Stockholders’ Representative Agreement, including the exercise of the power to: (a) agree to, negotiate, enter into settlements and compromises of, demand arbitration of, and comply with orders of courts and awards of arbitrators with respect to, such claims for Losses; (b) arbitrate, resolve, settle or compromise any Contested Claim made pursuant to Article 10; and (c) take all actions necessary in the judgment of the Stockholders’ Representative for the accomplishment of the foregoing. The Stockholders’ Representative will have authority and power to act on behalf

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of each Stockholder with respect to the disposition, settlement or other handling of all claims for Losses under Article 10 and all rights or obligations arising under Article 10. In performing the functions specified in this Agreement, the Stockholders’ Representative will not be liable to any Stockholder in the absence of willful misconduct, to extent permitted by applicable law, on the part of the Stockholders’ Representative. The Stockholders will severally, but not jointly, on a pro rata basis, indemnify the Stockholders’ Representative and hold him harmless against any loss, liability or expense incurred without willful misconduct, to extent permitted by applicable law, on the part of the Stockholders’ Representative and arising out of or in connection with the acceptance or administration of his duties hereunder. If the Stockholders’ Representative shall die, become disabled or otherwise be unable to fulfill his responsibilities as representative of the Stockholders, then the Stockholders shall, within ten days after such death or disability, appoint a successor representative and, promptly thereafter, shall notify Parent and the Escrow Agent of such successor. The Stockholders’ Representative shall have the right to recover from the Escrow Fund, prior to any distribution to the Stockholders equal to any reasonable fees, costs and expenses in connection with the acceptance and administration of the Stockholders’ Representative duties hereunder.

ARTICLE 11

TERMINATION

Section 11.01. Termination. This Agreement may be terminated and the Merger may be abandoned at any time prior to the Effective Time (notwithstanding any approval of this Agreement by the Stockholders of the Company):

(a) by mutual written agreement of the Company and Parent;

(b) by either the Company or Parent, if:

(i) there shall be any law or regulation that makes acceptance for payment of, and payment for, the Shares pursuant to the Merger illegal or otherwise prohibited or any judgment, injunction, order or decree of any court or governmental body having competent jurisdiction enjoining Merger Subsidiary, Company or Parent from consummating the Merger and such judgment, injunction, order or decree shall have become final and nonappealable;

(ii) the Closing has not occurred by 5:00 P.M., California time, on September 30, 2003 or November 30, 2003 if a Registration Statement is filed (the “End Date”), or such later date as the Company and Parent may agree, provided, however, that the Company may extend the End Date to the extent the Measurement Period is restarted as a result of a Material Announcement; provided, further, that the right to terminate this Agreement under Section 11.01(b)(ii) shall not be available to any party whose breach of any provision of this Agreement results in the failure of the Merger to be consummated by such time; or

(iii) this Agreement shall not have been approved and adopted in accordance with Delaware Law by the Company’s stockholders at the Company Stockholder Meeting (or any adjournment thereof) or by written consent in lieu of the Company Stockholder Meeting;

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(c) by Parent, if as permitted by Section 6.03(b)(iii), the Board of Directors of the Company shall have failed to make or withdrawn, or modified in a manner adverse to Parent, its approval or recommendation of this Agreement or the Merger, or shall have failed to call the Company Stockholder Meeting in accordance with Section 6.02; provided that the Company shall have paid any amounts due pursuant to Section 12.03(b) in accordance with the terms, and at the times, specified therein.

(d) by Parent, if (i) a breach of or failure to perform any representation, warranty, covenant or agreement on the part of the Company set forth in this Agreement shall have occurred that would cause the condition set forth in Section 9.02(a) or (c) not to be satisfied, and such condition is incapable of being satisfied by the End Date, or (ii) the Company shall have willfully and materially breached its obligations under Sections 6.02(b) or 6.03;

(e) by the Company, if a breach of or failure to perform any representation, warranty, covenant or agreement on the part of the Parent or Merger Subsidiary I set forth in this Agreement shall have occurred that would cause the conditions set forth in Sections 9.03(a) or (b) and not to be satisfied, and such condition is incapable of being satisfied by the End Date;

(f) by the Company, if the Parent Average Price Per Share at the Effective Time is less than the Minimum Parent Average Closing Price, provided that

(i) the Company shall have given notice to Parent (the “Termination Intent Notice”) that the Company intends to terminate this Agreement, such notice to be delivered in person at the location where the Closing is to take place no later than 2:00 p.m. Menlo Park, California time on the business day prior to the date of the Closing (the “Pre-Closing Date”); and

(ii) if the Company delivers a Termination Intent Notice, Parent shall have the right to avoid the termination by giving notice to the Company (the “Top-up Notice”) that Parent elects either to (i) substitute cash in lieu of the stock portion of the Merger Consideration, or (ii) agree that the Parent Average Closing Price Per Share shall be the Parent Average Price Per Share without regard to the Minimum Parent Average Closing Price. The Top-up Notice shall be delivered in person to the Company at the location where the Closing is to take place no later than 8:00 p.m. Menlo Park, California time on the Pre-Closing Date. If Parent has not delivered a Top-up Notice by the above deadline, and the Company and Parent have not otherwise reached an agreement regarding the Parent Average Closing Price Per Share, this Agreement shall terminate. If Parent does deliver a Top-up Notice, or if the Company and Parent otherwise agree, the Parent Average Closing Price Per Share shall be as set forth in the Top-Up Notice or such price as the Company and Parent may agree.

The party desiring to terminate this Agreement pursuant to this Section 11.01 shall give notice of such termination to the other party.

Section 11.02. Effect of Termination. If this Agreement is terminated pursuant to Section 11.01, this Agreement shall become void and of no effect with no liability on the part of any party (or any stockholder, director, officer, employee, agent, consultant or representative of such party) to the other party hereto, provided that, if such termination shall result from the willful failure of either party to perform a covenant hereof, such party shall be fully liable for any and all liabilities and damages incurred or suffered by the other party as a result of such failure.

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The provisions of Section 8.03, Section 12.03, Section 12.05, Section 12.06 and Section 12.07 shall survive any termination hereof pursuant to Section 11.01.

ARTICLE 12

MISCELLANEOUS

Section 12.01. Notices. All notices, requests and other communications to any party hereunder shall be in writing (including facsimile transmission) and shall be given or made (and shall deemed to have been duly given or made upon receipt) by delivery in person, by cable, telecopy, facsimile, telegram, telex or courier or by registered or certified mail (postage prepaid, return receipt requested) to the respective parties at the following addresses (or at such other address for a party as shall be specified in a notice given in accordance with this Section 12.01 or as provided in Section 11.01(f)):

if to Parent or Merger Subsidiary, to:

Susan J. Skaer

Mercury Interactive Corporation

1325 Borregas Avenue

Sunnyvale, California 94089

Fax: 408-822-5320

with a copy to:

David W. Ferguson

Davis Polk & Wardwell

1600 El Camino Real

Menlo Park, California 94025

Fax: 650-752-2114

if to the Company, to:

Bryan Plug

Kintana, Inc.

1314 Chesapeake Terrace

Sunnyvale, California 94089

Fax: 408-752-8460

with a copy to:

Dennis DeBroeck

Fenwick & West LLP

Silicon Valley Center

801 California Street

Mountain View, California 94041

Fax: 650-938-5200

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or such other address or facsimile number as such party may hereafter specify for the purpose by notice to the other parties hereto. All such notices, requests and other communications shall be deemed received on the date of receipt by the recipient thereof if received prior to 5 p.m. in the place of receipt and such day is a Business Day in the place of receipt. Otherwise, any such notice, request or communication shall be deemed not to have been received until the next succeeding Business Day in the place of receipt.

Section 12.02. Amendments; No Waivers. (a) Any provision of this Agreement may be amended or waived prior to the Effective Time if, but only if, such amendment or waiver is in writing and is signed, in the case of an amendment, by each party to this Agreement or, in the case of a waiver, by each party against whom the waiver is to be effective, provided that, after the adoption of this Agreement by the stockholders of the Company and without their further approval, no such amendment or waiver shall reduce the amount or change the kind of consideration to be received in exchange for the Shares.

(b) No failure or delay by any party in exercising any right, power or privilege hereunder shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies herein provided shall be cumulative and not exclusive of any rights or remedies provided by law.

Section 12.03. Expenses. (a) Except as otherwise provided herein, all costs and expenses incurred in connection with this Agreement shall be paid by the party incurring such cost or expense.

(b) If this Agreement is terminated by Parent or the Company pursuant to Section 11.01(b)(ii), Section 11.01(b)(iii) or Section 11.01(c), the Company shall promptly, but in no event later than two days after the date of such termination or as otherwise provided below, pay Parent (by wire transfer of immediately available funds), a fee equal to the sum of $6,750,000 and reasonably documented fees and expenses (including reasonable fees and expenses of counsel) incurred by Parent and Merger Subsidiary I in connection with this Agreement and the transactions contemplated hereby, such fees and expenses not to exceed $400,000; provided that in the case of termination of this Agreement pursuant to Section 11.01(b)(ii) or Section 11.01(b)(iii) (i) such payment shall be made only if (A) following the date of this Agreement and prior to the termination of this Agreement, the Company has received an Acquisition Proposal and (B) within 12 months following the termination of this Agreement, either a Company Acquisition (as defined below) is consummated, or the Company enters into an agreement providing for a Company Acquisition and such Company Acquisition is later consummated with the Person (or another Person controlling, controlled by, or under common control with, such Person) with whom such agreement was entered into (regardless of when such consummation occurs if the Company has entered into such agreement within such 12 month period), and (ii) such payment shall be made promptly, but in no event later than two days after the consummation of such Company Acquisition (regardless of when such consummation occurs if the Company has entered into such agreement within such 12 month period).

“Company Acquisition” means any of the following transactions (other than the transactions contemplated by this Agreement: (i) the Company merges with or into, or is acquired, directly or indirectly, by merger, consolidation, business combination, recapitalization, liquidation, dissolution or similar transaction, by, a Third Party; (B) a Third Party, directly or indirectly, acquires more than 50% of the total assets of the Company and its Subsidiaries, taken as a whole; (C) a Third Party, directly or indirectly, acquires more than 50% of the outstanding

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shares of Company capital stock; or (D) the Company adopts or implements a plan of liquidation, recapitalization or share repurchase relating to more than 50% of the outstanding shares of Company capital stock or an extraordinary dividend relating to more than 50% of such outstanding shares or 50% of the assets of the Company and its Subsidiaries, taken as a whole.

(c) The Company acknowledges that the agreements contained in this Section are an integral part of the transactions contemplated by this Agreement and that, without these agreements, Parent and Merger Subsidiary I would not enter into this Agreement. Accordingly, if the Company fails promptly to pay any amount due to Parent pursuant to this Section, it shall also pay any costs and expenses incurred by Parent or Merger Subsidiary I in connection with a legal action to enforce this Agreement that results in a judgment against the Company for such amount.

Section 12.04. Successors and Assigns. The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, provided that no party may assign, delegate or otherwise transfer any of its rights or obligations under this Agreement without the consent of each other party hereto, except that Parent or Merger Subsidiary may transfer or assign, in whole or from time to time in part, to one or more of their Affiliates, the right to enter into the transactions contemplated by this Agreement, but any such transfer or assignment will not relieve Parent or Merger Subsidiary of its obligations hereunder.

Section 12.05. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, without regard to the conflicts of law rules of such state.

Section 12.06. Jurisdiction. Any suit, action or proceeding seeking to enforce any provision of, or based on any matter arising out of or in connection with, this Agreement or the transactions contemplated hereby may be brought in any federal court located in the Northern District of the State of California or any California state court located in Santa Clara County, and each of the parties hereby consents to the jurisdiction of such courts (and of the appropriate appellate courts therefrom) in any such suit, action or proceeding and irrevocably waives, to the fullest extent permitted by law, any objection that it may now or hereafter have to the laying of the venue of any such suit, action or proceeding in any such court or that any such suit, action or proceeding brought in any such court has been brought in an inconvenient form. Process in any such suit, action or proceeding may be served on any party anywhere in the world, whether within or without the jurisdiction of any such court. Without limiting the foregoing, each party agrees that service of process on such party as provided in Section 12.01 shall be deemed effective service of process on such party.

Section 12.07. WAIVER OF JURY TRIAL. EACH OF THE PARTIES HERETO HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATED TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY.

Section 12.08. Counterparts; Effectiveness; Benefit. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement shall become effective when each party hereto shall have received counterparts hereof signed by all of the other parties hereto. No provision of this Agreement is intended to confer any rights, benefits, remedies, obligations, or liabilities hereunder upon any Person other than the parties hereto and

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their respective successors and assigns, except with respect to the Indemnified Parties under Section 7.03.

Section 12.09. Entire Agreement. This Agreement, the Letter Agreement, each Voting Agreement, each Non-Competition and Non-Solicitation and the Escrow Agreement constitute the entire agreement between the parties with respect to the subject matter of this Agreement and supersedes all prior agreements and understandings, both oral and written, between the parties with respect to the subject matter of this Agreement.

Section 12.10. Captions. The captions herein are included for convenience of reference only and shall be ignored in the construction or interpretation hereof.

Section 12.11. Severability. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction or other authority to be invalid, void, unenforceable, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner materially adverse to any party. Upon such a determination, the parties shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner in order that the transactions contemplated hereby be consummated as originally contemplated to the fullest extent possible.

Section 12.12. Specific Performance. The parties hereto agree that irreparable damage would occur if any provision of this Agreement were not performed in accordance with the terms hereof and that the parties shall be entitled to an injunction or injunctions to prevent breaches of this Agreement or to enforce specifically the performance of the terms and provisions hereof in any federal court located in the Northern District of the State of California or any California state court located in Santa Clara County, in addition to any other remedy to which they are entitled at law or in equity.

Section 12.13. No Implied Representation. Parent and the Company acknowledge that, except as expressly provided in Articles 3 and 4, none of the parties is making any representations or warranties of any kind, express or implied.

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IN WITNESS WHEREOF, the parties hereto have caused this Agreement and Plan of Merger to be duly executed by their respective authorized officers as of the day and year first above written.

KINTANA, INC.
By:	/s/    Bryan Plug
	Name:    Bryan Plug
	Title:    CEO
MERCURY INTERACTIVE CORPORATION
By:	/s/    David J. Murphy
	Name:    David J. Murphy
	Title:    VP, Corporate Development
KANGA MERGER CORPORATION
By:	/s/    Susan J. Skaer
	Name:    Susan J. Skaer
	Title:    VP, General Counsel & Secretary
KANGA ACQUISITION L.L.C.
By:	/s/    Susan J. Skaer
	Name:    Susan J. Skaer
	Title:    VP, General Counsel & Secretary
STOCKHOLDERS’ REPRESENTATIVE RAJ JAIN
By:	/s/    Raj Jain
	Name:    Raj Jain

EX-10.2

Exhibit 10.2

INDEMNIFICATION AGREEMENT

This indemnification Agreement (“Agreement”) is made as of this      day of                  200    , by and between Mercury Interactive Corporation, a Delaware corporation (the “Company”), and                                                       (“Indemnitee”).

WHEREAS, the Company and Indemnitee recognize the difficulty in obtaining directors’ and officers’ liability insurance, the cost of such insurance and the limited scope of coverage of such insurance;

WHEREAS, the Company and Indemnitee further recognize the substantial increase in corporate litigation in general, subjecting officers and directors to expensive litigation risks at the same time as the availability and coverage of liability insurance has been severely limited;

WHEREAS, Indemnitee does not regard the current protection available as adequate under the present circumstances, and Indemnitee and other officers and directors of the Company may not be willing to continue to serve as officers and directors without additional protection; and

WHEREAS, the Company desires to attract and retain the services of highly qualified individuals, such as Indemnitee, to serve as officers and directors of the Company and to indemnify its officers and directors so as to provide them with the maximum protection permitted by law.

NOW, THEREFORE, the Company and Indemnitee hereby agree as follows:

1. Indemnification.

(a) Third Party Proceedings. The Company shall indemnify and hold harmless Indemnitee if Indemnitee was or is a party or is threatened to be made a party to, or is involved in any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the Company) by reason of the fact that Indemnitee is or was a director, officer, employee or agent of the Company, or any subsidiary of the Company, by reason of any action or inaction on the part of Indemnitee while an officer or director or by reason of the fact that Indemnitee is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement (if such settlement is approved in advance by the Company, which approval shall not be unreasonably withheld) actually and reasonably incurred by Indemnitee in connection with the investigation, defense, settlement or appeal of such action, suit or proceeding if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, and, with respect to any criminal action or proceeding, had no reasonable cause to believe Indemnitee’s conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, in itself, create a presumption that (i)

Indemnitee did not act in good faith and in a manner which Indemnitee reasonably believed to be in or not opposed to the best interests of the Company, or (ii) with respect to any criminal action or proceeding, Indemnitee had reasonable cause to believe that Indemnitee’s conduct was unlawful.

(b) Proceedings By or in the Right of the Company. The Company shall indemnify and hold harmless Indemnitee if Indemnitee was or is a party or is threatened to be made a party to, or is involved in any threatened, pending or completed action, suit or proceeding by or in the right of the Company or any subsidiary of the Company to procure a judgment in its favor by reason of the fact that Indemnitee is or was a director, officer, employee or agent of the Company, or any subsidiary of the Company, by reason of any action or inaction on the part of Indemnitee while an officer or director or by reason of the fact that Indemnitee is or was serving at the request of the Company as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees) and, to the fullest extent permitted by law, amounts paid in settlement, in each case to the extent actually and reasonably incurred by Indemnitee in connection with the investigation defense, settlement or appeal of such action, suit or proceeding if Indemnitee acted in good faith and in a manner Indemnitee reasonably believed to be in or not opposed to the best interests of the Company and its stockholders, except that no indemnification shall be made in respect of any claim, issue or matter as to which Indemnitee shall have been finally adjudicated by court order or judgment to be liable to the Company in the performance of Indemnitee’s duty to the Company and its stockholders unless and only to the extent that the court in which such action or proceeding is or was pending shall determine upon application that, in view of all the circumstances of the case, Indemnitee is fairly and reasonably entitled to indemnity for expenses and then only to the extent that the court shall determine. Notwithstanding an other provision of this Agreement, the Indemnitee shall not be indemnified hereunder for any expenses or amounts paid in settlement with respect to any action to recover short-swing profits under Section 16(b) of the Securities Exchange Act of 1934, as amended.

(c) Mandatory Payment of Expenses. To the extent that Indemnitee has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Subsections (a) and (b) of this Section 1 or in defense of any claim, issue or matter therein, Indemnitee shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred by Indemnitee in connection therewith.

2. Expenses; Indemnification Procedure.

(a) Advancement of Expenses. The Company shall advance all expenses incurred by Indemnitee in connection with the investigation, defense, settlement or appeal of any civil or criminal action or proceeding referenced in Section 1(a) or (b) hereof (but not amounts actually paid in settlement of any such action or proceeding). Indemnitee hereby undertakes to repay such amounts advanced only if, and to the extent that, it shall ultimately be determined that Indemnitee is not entitled to be indemnified by the Company as authorized hereby, in the Company’s Certificate of Incorporation or By-laws, or by statute or otherwise. The advances to be made hereunder shall be paid by the Company to Indemnitee within twenty (20) days following delivery of a written request therefor by Indemnitee to the Company.

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(b) Notice/Cooperation by Indemnitee. Indemnitee shall, as a condition precedent to his right to be indemnified under this Agreement, give the Company notice in writing as soon as practicable of any claim made against Indemnitee for which indemnification will be sought under this Agreement. Notice to the Company shall be directed to the Chief Executive Officer of the Company at the address shown on the signature page of this Agreement (or such other address as the Company shall designate in writing to Indemnitee). Notice shall be deemed received three business days after the date postmarked if sent by domestic certified or registered mail, properly addressed; otherwise notice shall be deemed received when such notice shall actually be received by the Company. In addition, Indemnitee shall give the Company such information and cooperation as it may reasonably require and as shall be within Indemnitee’s power.

(c) Procedure. Any indemnification and advances provided for in Section 1 and Section 2 shall be made no later than forty-five (45) days after receipt of the written request of Indemnitee. If a claim under this Agreement, under any statute, or under any provision of the Company’s Certificate of Incorporation or Bylaws providing for indemnification, is not paid in full by the Company within forty-five (45) days after a written request for payment thereof has first been received by the Company, Indemnitee may, but need not, at any time thereafter bring an action against the Company to recover the unpaid amount of the claim and, subject to Section 12 of this Agreement, Indemnitee shall also be entitled to be paid for the expenses (including attorneys’ fees) of bringing such action. It shall be a defense to any such action (other than an action brought to enforce a claim for expenses incurred in connection with any action or proceeding in advance of its final disposition) that Indemnitee has not met the standards of conduct which make it permissible under applicable law for the Company to indemnify Indemnitee for the amount claimed, but the burden of proving such defense shall be on the Company and Indemnitee shall be entitled to receive interim payments of expenses pursuant to Subsection 2(a) unless and until such defense may be finally adjudicated by court order or judgment from which no further right of appeal exists. It is the parties’ intention that if the Company contests Indemnitee’s right to indemnification, the question of Indemnitee’s right to indemnification shall be for the court to decide, and neither the failure of the Company (including its Board of Directors, any committee or subgroup of the Board of Directors, independent legal counsel, or its stockholders) to have made a determination that indemnification of Indemnitee is proper in the circumstances because Indemnitee has met the applicable standard of conduct required by applicable law, nor an actual determination by the Company (including its Board of Directors, any committee or subgroup of the Board of Directors, independent legal counsel, or its stockholders) that Indemnitee has not met such applicable standard of conduct, shall create a presumption that Indemnitee has or has not met the applicable standard of conduct.

(d) Notice to Insurers. If, at the time of the receipt of a notice of a claim pursuant to Section 2(b) hereof, the Company has director and officer liability insurance in effect, the Company shall give prompt notice of the commencement of such proceeding to the insurers in accordance with the procedures set forth in the respective policies. The Company shall thereafter take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnitee, all amounts payable as a result of such proceeding in accordance with the terms of such policies.

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(e) Selection of Counsel. In the event the Company shall be obligated under Section 2(a) hereof to pay the expenses of any proceeding against Indemnitee, the Company, if appropriate, shall be entitled to assume the defense of such proceeding, with counsel approved by Indemnitee, which approval shall not be unreasonably withheld, upon the delivery to Indemnitee of written notice of its election so to do. After delivery of such notice, approval of such counsel by Indemnitee and the retention of such counsel by the Company, the Company will not be liable to Indemnitee under this Agreement for any fees of counsel subsequently incurred by Indemnitee with respect to the same proceeding, provided that (i) Indemnitee shall have the right to employ his counsel in any such proceeding at Indemnitee’s expense; and (ii) if (A) the employment of counsel by Indemnitee has been previously authorized by the Company, (B) Indemnitee shall have reasonably concluded that there may be a conflict of interest between the Company and Indemnitee in the conduct of any such defense, or (C) the Company shall not, in fact, have employed counsel to assume the defense of such proceeding, then the fees and expenses of Indemnitee’s counsel shall be at the expense of the Company.

3. Additional Indemnification Rights; Nonexclusivity.

(a) Scope. Notwithstanding any other provision of this Agreement, the Company hereby agrees to indemnify the Indemnitee to the fullest extent permitted by law, notwithstanding that such indemnification is not specifically authorized by the other provisions of this Agreement, the Company’s Certificate of Incorporation, the Company’s Bylaws or by statute. In the event of any change, after the date of this Agreement, in any applicable law, statute or rule which expands the right of a Delaware corporation to indemnify a member of its Board of Directors, an officer or other corporate agent, such changes shall be ipso facto, within the purview of Indemnitee’s rights and Company’s obligations, under this Agreement. In the event of any change in any applicable law, statute or rule which narrows the right of a Delaware corporation to indemnify a member of its Board of Directors, an officer or other corporate agent, such changes, to the extent not otherwise required by such law, statute or rule to be applied to this Agreement shall have no effect on this Agreement or the parties’ rights and obligations hereunder.

(b) Nonexclusivity. The indemnification provided by this Agreement shall not be deemed exclusive of any rights to which Indemnitee may be entitled under the Company’s Certificate of Incorporation, its Bylaws, any agreement, any vote of stockholders or disinterested Directors, the Delaware General Corporation Law, or otherwise, both as to action in Indemnitee’s official capacity and as to action in another capacity while holding such office. The indemnification provided under this Agreement shall continue as to Indemnitee for any action taken or not taken while serving in an indemnified capacity even though he may have ceased to serve in such capacity at the time of any action, suit or other covered proceeding.

4. Partial Indemnification and Contribution. If Indemnitee is entitled under any provision of this Agreement to indemnification by the Company for some or a portion of the expenses, judgments, fines, penalties or liabilities of any type whatsoever actually or reasonably incurred by him in the investigation, defense, appeal or settlement of any civil or criminal action or proceeding, but not, however, for the total amount thereof, the Company shall nevertheless

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indemnify Indemnitee for the portion of such expenses, judgments, fines, penalties or liabilities of any type whatsoever to which Indemnitee is entitled.

5. Mutual Acknowledgement. Both the Company and Indemnitee acknowledge that in certain instances, Federal law or applicable public policy may prohibit the Company from indemnifying its directors and officers under this Agreement or otherwise. Indemnitee understands and acknowledges that the Company has undertaken or may be required in the future to undertake with the Securities and Exchange Commission to submit the question of indemnification to a court in certain circumstances for a determination of the Company’s right under public policy to indemnify Indemnitee.

6. Officer and Director Liability Insurance. The Company may, from time to time, make the good faith determination whether or not it is practicable for the Company to obtain and maintain a policy or policies of insurance with reputable insurance companies providing the officers and directors of the Company with coverage for losses from wrongful acts, or to ensure the Company’s performance of its indemnification obligations under this Agreement. Among other considerations, the Company will weigh the costs of obtaining such insurance coverage against the protection afforded by such coverage. In all policies of director and officer liability insurance, Indemnitee shall be named as an insured in such a manner as to provide Indemnitee the same rights and benefits as are accorded to the most favorably insured of the Company’s directors, if Indemnitee is a director; or of the Company’s officers, if Indemnitee is not a director of the Company, but is an officer; or of the Company’s key employees, if Indemnitee is not an officer or director, but is a key employee. Notwithstanding the foregoing, the Company shall have no obligation to obtain or maintain such insurance if the Company determines in good faith that such insurance is not reasonably available, if the premium costs for such insurance are disproportionate to the amount of coverage provided, if the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or if Indemnitee is covered by similar insurance maintained by a subsidiary or parent of the Company. However, the Company’s decision whether or not to adopt and maintain such insurance shall not affect in any way its obligations to indemnify Indemnitee under this Agreement or otherwise.

7. Severability. Nothing in this Agreement is intended to require or shall be construed as requiring the company to do or fail to do any act in violation of applicable law. The Company’s inability, pursuant to court order, to perform its obligations under this Agreement shall not constitute a breach of this Agreement. The provisions of this Agreement shall be severable as provided in this Section 7. If this Agreement or any portion hereof shall be invalidated on any ground by any court of competent jurisdiction, then the Company shall nevertheless indemnify Indemnitee to the full extent permitted by any applicable portion of this Agreement that shall not have been invalidated, and the balance of this Agreement not so invalidated shall be enforceable in accordance with its terms.

8. Exceptions. Any other provision herein to the contrary notwithstanding, the Company shall not be obligated pursuant to the terms of this Agreement:

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(a) Excluded Acts. To indemnify Indemnitee for any acts or omissions or transactions from which a director may not be relieved of liability under the applicable law.

(b) Claims Initiated by Indemnitee. To indemnify or advance expenses to Indemnitee with respect to proceedings or claims initiated or brought voluntarily by Indemnitee and not by way of defense, except with respect to proceedings brought to establish or enforce a right to indemnification under this Agreement or any other statute or law, but such indemnification or advancement of expenses may be provided by the Company in specific cases if the Board of Directors has approved the initiation or bringing of such suit.

(c) Lack of Good Faith. To indemnify Indemnitee for any expenses incurred by the Indemnitee with respect to any proceeding instituted by Indemnitee to enforce or interpret this Agreement, if a court of competent jurisdiction determines that each of the material assertions made by the Indemnitee in such proceeding was not made in good faith or was frivolous.

(d) Insured Claims. To indemnify Indemnitee for expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes or penalties, and amounts paid in settlement) which have been paid directly to Indemnitee by an insurance carrier under a policy of officers’ and directors’ liability insurance maintained by the Company.

(e) Claims Under Section 16(b). To indemnify Indemnitee for expenses and the payment of profits arising from the purchase and sale by Indemnitee of securities in violation of Section 16(b) of the Securities Exchange Act of 1934, as amended, or any similar successor statute.

9. Construction of Certain Phrases.

(a) For purposes of this Agreement, references to the “Company” shall include, in addition to the resulting corporation, any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence had continued, would have had power and authority to indemnify its directors, officers, and employees or agents, so that if Indemnitee is or was a director, officer, employee or agent of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, Indemnitee shall stand in the same position under the provisions of this Agreement with respect to the resulting or surviving corporation as Indemnitee would have with respect to such constituent corporation if its separate existence had continued.

(b) For purposes of this Agreement, references to “other enterprises” shall include employee benefit plans; references to “fines” shall include any excise taxes assessed on Indemnitee with respect to an employee benefit plan; and references to “serving at the request of the Company” shall include any service as a director, officer, employee or agent of the Company which imposes duties on, or involves services by, such director, officer, employee or agent with respect to an employee benefit plan, its participants, or beneficiaries; and if Indemnitee acted in

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good faith and in a manner Indemnitee reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan, Indemnitee shall be deemed to have acted in a manner “not opposed to the best interests of the Company” as referred to in this Agreement.

10. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall constitute an original.

11. Successors and Assigns. This Agreement shall be binding upon the Company and its successors and assigns, and shall inure to the benefit of Indemnitee and Indemnitee’s estate, heirs, legal representatives and assigns.

12. Attorneys’ Fees. In the event that any action is instituted by Indemnitee under this Agreement to enforce or interpret any of the terms hereof, Indemnitee shall be entitled to be paid all costs and expenses, including reasonable attorneys’ fees, incurred by Indemnitee with respect to such action, unless as a part of such action, the court of competent jurisdiction determines that each of the material assertions made by Indemnitee as a basis for such action were not made in good faith or were frivolous. In the event of an action instituted by or in the name of the Company under this Agreement or to enforce or interpret any of the terms of this Agreement, Indemnitee shall be entitled to be paid all costs and expenses, including reasonable attorneys’ fees, incurred by Indemnitee in defense of such action (including with respect to Indemnitee’s counterclaims and cross-claims made in such action), unless as a part of such action the court determines that each of Indemnitee’s material defenses to such action were made in bad faith or were frivolous.

13. Notice. All notices, requests, demands and other communications under this Agreement shall be in writing and shall be deemed duly given (i) if delivered by hand and acknowledged in writing as received by the addressee, on the date of such receipt, or (ii) if mailed by domestic certified or registered mail with postage prepaid, on the third business day after the date postmarked. Addresses for notice to either party are as shown on the signature page of this Agreement, or as subsequently modified by written notice.

14. Consent to Jurisdiction. The Company and Indemnitee each hereby irrevocably consent to the jurisdiction of the courts of the State of Delaware for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement and agree that any action instituted under this Agreement shall be brought only in the state courts of the State of Delaware.

15. Choice of Law. This Agreement shall be governed by and its provisions construed in accordance with the laws of the State of Delaware, as applied to contracts between Delaware residents entered into and to be performed entirely within Delaware.

16. Subrogation. In the event of payment under this Agreement, the Company shall be subrogated to the extent of such payment to all of the rights of recovery of Indemnitee, who shall execute all documents required and shall do all acts that may be necessary to secure such rights and to enable to corporation effectively to bring suit to enforce such rights.

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17. Continuation of Indemnification. All agreements and obligations of the Company contained herein shall continue during the period that Indemnitee is a director, officer or agent of the Company and shall continue thereafter so long as Indemnitee shall be subject to any possible claim or threatened, pending or completed action, suit or proceeding, whether civil, criminal, arbitrational, administrative or investigative, by reason of the fact that Indemnitee was serving in the capacity referred to herein.

18. Amendment and Termination. This Agreement constitutes the entire agreement between the parties hereto with respect to the subject matter hereof. All prior negotiations, agreements and understandings between the parties with respect thereto are superseded hereby. Subject to Section 17, no amendment, modification, termination or cancellation of this Agreement shall be effective unless in writing signed by both parties hereto.

[SIGNATURE PAGE FOLLOWS]

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IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written.

MERCURY INTERACTIVE CORPORATION
By:
	Susan J. Skaer
Title:	Vice President, General Counsel
Address:	1325 Borregas Avenue
	Sunnyvale, CA 94089

AGREED TO AND ACCEPTED:

INDEMNITEE:

Address:

EX-31.1

Exhibit 31.1

CERTIFICATION OF CEO PURSUANT TO SECURITIES EXCHANGE ACT

RULES 13A – 14 AND 15D – 14 AS ADOPTED

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Amnon Landan, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Mercury Interactive Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 14, 2003

/s/ Amnon Landan

Amnon Landan

President, Chief Executive Officer and Chairman of the Board

EX-31.2

Exhibit 31.2

CERTIFICATION OF CFO PURSUANT TO SECURITIES EXCHANGE ACT

RULES 13A – 14 AND 15D – 14 AS ADOPTED

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Douglas P. Smith, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Mercury Interactive Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 14, 2003

/s/ Douglas P. Smith

Douglas P. Smith

Executive Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF CEO PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

The certification set forth below is being submitted in connection with this quarterly report on Form 10-Q (the Report) for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the Exchange Act) and Section 1350 of Chapter 63 of Title 18 of the United States Code.

I, Amnon Landan, the Chief Executive Officer of Mercury Interactive Corporation, certify that, to the best of my knowledge:

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Mercury Interactive Corporation.

Date: August 14, 2003

/s/ Amnon Landan

Amnon Landan

President, Chief Executive Officer and Chairman of the Board

EX-32.2

Exhibit 32.2

CERTIFICATION OF CFO PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

The certification set forth below is being submitted in connection with this quarterly report on Form 10-Q (the Report) for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the Exchange Act) and Section 1350 of Chapter 63 of Title 18 of the United States Code.

I, Douglas P. Smith, the Chief Financial Officer of Mercury Interactive Corporation, certify that, to the best of my knowledge:

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Mercury Interactive Corporation.

Date: August 14, 2003

/s/ Douglas P. Smith

Douglas P. Smith

Executive Vice President and Chief Financial Officer