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November 14, 2001

MERCURY INTERACTIVE CORPORATION (MERQ)
Quarterly Report (SEC form 10-Q)
Item 2. Management`s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. In some cases, forward-looking statements are identified by words such as "believes," "anticipates," "expects," "intends," "plans," "will," "may" and similar expressions. In addition, any statements that refer to our plans, expectations, strategies or other characterizations of future events or circumstances are forward-looking statements. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in "Risk Factors." Our business may have changed since the date hereof, and we undertake no obligation to update the forward-looking statements in this Quarterly Report on Form 10-Q.

Results of Operations

Revenue -

License revenue decreased 6% to $51.2 million for the three months ended September 30, 2001 from $54.2 million for the three months ended September 30, 2000. The decrease in license revenue for the three months ended September 30, 2001 was primarily attributable to a decrease in license fees from testing products due to the worldwide economic slow down and the adverse impact on business of the terrorist activities of September 11, 2001. License revenue increased 23% to $178.5 million for the nine months ended September 30, 2001 from $144.7 million for the nine months ended September 30, 2000. Our growth in license revenue was attributable primarily to growth in license fees from testing products as well as revenue from our APM/MSP offerings.

Service revenue increased 30% to $32.8 million for the three months ended September 30, 2001 from $25.3 million for the three months ended September 30, 2000. Service revenue increased 42% to $92.2 million for the nine months ended September 30, 2001 from $64.8 million for the nine months ended September 30, 2000. The increase in service revenue was a result of renewals of existing maintenance contracts. We expect that service revenue will continue to increase in absolute dollars as long as our customer base continues to grow.

Cost of revenue -

License cost of revenue includes cost of materials, product packaging, equipment depreciation, production personnel and costs associated with our MSP business. License cost of revenue increased to $5.9 million and $18.0 million for the three and nine months ended September 30, 2001, respectively, compared to $5.2 million and $11.8 million for the three and nine months ended September 30, 2000. License cost of revenue, as a percentage of license revenue, increased to 12% and 10% for the three and nine months ended September 30, 2001, respectively, from 10% and 8% for the three and nine months ended September 30, 2000, respectively. The increase was primarily due to additional headcount and personnel-related costs and Internet service fees for our MSP business.

Service cost of revenue consists primarily of costs of providing customer technical support, training and consulting. Service cost of revenue increased to $7.2 million and $22.9 million for the three and nine months ended September 30, 2001, respectively, compared to $6.9 million and $17.5 million for the three and nine months ended September 30, 2000. Service cost of revenue, as a percentage of service revenue, decreased to 22% and 25% for the three months ended September 30, 2001 and 2000, respectively. Service cost of revenue, as a percentage of service revenue was 27% for both the nine months ended September 30, 2001 and 2000, respectively. The absolute dollar increase in service cost of revenue was primarily due to an increase in personnel-related costs reflecting growth in customer support headcount partially offset by a decrease in training and consulting outsourcing expense. Service cost of revenue as a percentage of service revenue may vary based on the degree of outsourcing of training and consulting and the profitability of individual consulting engagements.

Research and development

Research and development expense consists primarily of costs associated with the development of new products, enhancements of existing products and quality assurance procedures, and is comprised primarily of



employee salaries and related costs, consulting costs, equipment depreciation and facilities expenses. Research and development expense was $9.3 million and $28.1 million, or 11% and 10% of total revenue for the three and nine months ended September 30, 2001, respectively, compared to $8.1 million and $23.7 million, or 10% and 11% of total revenue for the three and nine months ended September 30, 2000, respectively. The increase in absolute dollars of research and development spending in the three and nine months ended September 30, 2001 reflected an increase in spending due to growth in research and development headcount resulting in increased personnel-related costs.

Marketing and selling -

Marketing and selling expense consists primarily of employee salaries and related costs, sales commissions, facilities expenses and marketing programs. Marketing and selling expense was $45.2 million and $142.0 million or 54% and 52% of total revenue for the three and nine months ended September 30, 2001, compared to $39.0 million and $106.9 million, or 49% and 51% of total revenue for the three and nine months ended September 30, 2001 and 2000, respectively. The absolute dollar increase in marketing and selling expenses was primarily due to an increase in personnel-related costs reflecting growth in sales and marketing headcount, including the increase in sales headcount related to our cybersales organization and APM business, and increased spending on facilities and marketing programs. The increase in selling and marketing expenses as a percentage of revenue reflected lower than expected revenues due to the worldwide economic slow down and the adverse impact on business of the terrorist activities on September 11, 2001. Commission expenses for the three months ended September 30, 2001 decreased due to lower revenue levels as compared to the three months ended September 30, 2000. We expect marketing and selling expenses to increase in absolute dollars if total revenue increases, but these expenses may vary as a percentage of revenue.

General and administrative

General and administrative expense consists primarily of employee salaries and costs related to executive and finance personnel. General and administrative expense was $5.6 million and $16.7 million or 7% and 6% of total revenue for the three and nine months ended September 30, 2001, compared to $4.8 million and $12.2 million, or 6% of total revenue for both the three and nine months ended September 30, 2001 and 2000, respectively. The increase in absolute dollar spending reflected increased staffing and associated costs necessary to manage and support our operations.

Amortization of stock-based compensation

In connection with the acquisition of Freshwater, we recorded unearned stock-based compensation totaling $10.4 million associated with 140,000 unvested stock options assumed. We reduced unearned compensation of $3.1 million due to the termination of certain employees in conjunction with the third quarter restructuring. Amortization of unearned stock-based compensation for the three and nine months ended September 30, 2001 was $934,000 and $1.5 million, respectively. We expect to amortize approximately $600,000 per quarter over the remaining vesting periods of the related options.

Restructuring, integration and other related charges

During the third quarter of 2001, in connection with management`s plan to reduce costs and improve operating efficiencies, we recorded restructuring charges of $4.4 million, consisting of $2.9 million for headcount reductions, $1.1 million for the cancellation of a marketing event, and $400,000 for professional services and consolidation of facilities. Headcount reductions consisted of a reduction in force of approximately 140 employees, or approximately 8% of our worldwide workforce.

Total cash outlays associated with the restructuring are expected to be $4.2 million. The remaining $0.2 million of restructuring costs consists of non-cash charges for asset write-offs. During the third quarter of 2001, cash outlays used for restructuring costs were $2.8 million. The majority of the remaining cash outlays of $1.4 million, which include severance costs and fees associated with the cancellation of a marketing event, are expected to occur in the fourth quarter of 2001.

In conjunction with the acquisition of Freshwater, we recorded a charge for certain nonrecurring restructuring



and integration costs of $946,000 during the second quarter of 2001. The charge included costs for consolidation of facilities, employee severance, fixed asset write-offs and systems and process integration. We expect all costs associated with the charge to be paid by the end of the fourth quarter of 2001.

Amortization of goodwill and other intangible assets -

On May 21, 2001, we acquired all of the outstanding securities of Freshwater Software, Inc. ("Freshwater"), a provider of eBusiness monitoring and management solutions. We acquired Freshwater for cash consideration of $146.1 million. The purchase price was allocated to tangible assets of $6.9 million and assumed liabilities of $4.5 million. The purchase price included $849,000 for the fair value of 13,000 assumed Freshwater vested stock options, as well as direct acquisition costs of $529,000. 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 $7.6 million to workforce and purchased technology and $140.5 million to goodwill, including $3.0 million of goodwill for deferred tax benefits associated with the workforce and purchased technology. The goodwill and other intangible assets are being presently amortized on a straight-line basis over 3 years. Amortization expense for the three and nine months ended September 30, 2001 was $12.5 million and $17.8 million, respectively. We expect to amortize approximately $12.0 million in the fourth quarter of 2001.

The transaction was accounted for as a purchase and, accordingly, the operating results of Freshwater have been included in our accompanying consolidated financial statements from the date of acquisition. If the purchase had occurred at the beginning of each period, our consolidated net revenues would have been $84.0 million, $275.1 million, $82.0 million and $215.9 million for the three and nine months ended September 30, 2001 and 2000, respectively; net income (loss) would have been ($7.1) million, ($6.4) million, $1.6 million and $(6.2) million for the three and nine months ended September 30, 2001 and 2000, respectively; and earnings (loss) per share would have been $(0.09), ($0.08), $0.16 and $0.54 for the three and nine months ended September 30, 2001 and 2000, respectively.

Other income, net -

Other income, net consists primarily of interest income, interest expense related to our convertible subordinated notes, and foreign exchange gains and losses. The decrease in other income, net to $1.4 million from $5.3 million and $9.6 million from $11.2 million for the three and nine months ended September 30, 2001 and 2000, respectively, reflected primarily lower interest rates.

Provision for income taxes

We have structured our operations in a manner designed to maximize income in Israel where tax rate incentives have been extended to encourage foreign investments. The tax holidays and rate reductions which we will be able to realize under programs currently in effect expire at various dates through 2012. 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 rate for the three and nine months ended September 30, 2001 differs from statutory tax rates principally because of the non-deductibility of charges for amortization of goodwill and other intangible assets and stock-based compensation, and special reduced taxation programs by the government of Israel.

Liquidity and Capital Resources

At September 30, 2001, our principal source of liquidity consisted of $660.8 million of cash and investments compared to $782.4 million at December 31, 2000. The September 30, 2001 balance included $240.0 million of short-term and $237.6 million of long-term investments in high quality financial, government, and corporate securities. During the nine months ended September 30, 2001, we generated approximately $53.7 million cash from operations, primarily from our net income.

For the nine months ended September 30, 2001, our investing activities consisted of net cash paid in conjunction with the Freshwater acquisition of $144.0 million, investments made in non-consolidated companies of $18.9 million and purchases of property and equipment of $19.3 million offset by proceeds from investments of $78.4 million. We have committed to make additional capital contributions to a private equity fund totaling $12.0 million. Our purchases of property and equipment



included $2.3 million for the renovation of headquarters buildings in Sunnyvale, as well as, $3.1 million for the construction of research and development facilities in Israel. We expect to spend an additional $5.0 million to complete the renovation of our buildings in Sunnyvale and expect to spend an additional $5.5 million to complete the construction of the Israel facilities.

Our primary financing activity consisted of issuances of common stock under our employee stock option and stock purchase plans, net of notes receivable collected from issuance of common stock of $23.5 million. Our financing activities also consisted of the purchase of treasury stock of $16.1 million.

In July 2000, we raised $485.4 million from the issuance of convertible subordinated notes with an aggregate principal amount of $500.0 million. The notes mature on July 1, 2007 and bear interest at a rate of 4.75% per annum, payable semiannually on January 1 and July 1 of each year. The notes are subordinated in right of payment to all of our future senior debt. The 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 notes, in whole or in part, at any time on or after July 1, 2003.

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.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board released Statements of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"), and No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). FAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, establishes specific criteria for the recognition of intangible assets separately from goodwill, and requires unallocated negative goodwill to be written off immediately as an extraordinary gain. SFAS 142 requires that goodwill and indefinite lived intangible assets will no longer be amortized, goodwill and intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and the amortization period of intangible assets with finite lives will no longer be limited to forty years. SFAS 142 is effective for fiscal years beginning after March 15, 2001. We will adopt SFAS 142 during its fiscal year ended December 31, 2002. The impact of the implementation of SFAS 142 will require us to reclassify our balance sheet to show the composition of the Freshwater goodwill and other intangible assets that were acquired in May 2001. The implementation will also require us to discontinue amortization of our goodwill and other intangibles after December 31, 2001 and to evaluate the intangibles for impairment on an annual basis.

In August 2001, the FASB issued SFAS No. 143 ("SFAS 143"), "Accounting for Asset Retirement Obligations." This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement applies to all entities. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations or lessees. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 25, 2002. We expect that the initial application of SFAS 143 will not have an impact on our financial statements.

In October 2001, the FASB issued SFAS No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-lived Assets." The objectives of SFAS 144 are to address significant issues relating to the implementation of FASB Statement 121 ("SFAS 121"), "Accounting for the Impairment of Long-lived assets to be Disposed of," and to develop a single accounting model, based on the framework established by SFAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. Although SFAS 144 supercedes SFAS 121, it retains some fundamental provisions of SFAS 121. SFAS 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. We expect that the initial application of SFAS 144 will not have a material impact on our financial statements.

Risk Factors

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



Our future success depends on our ability to respond to rapid market and technological changes by introducing new products and services and continually improving the performance, features and reliability of our existing products and services and responding to competitive offerings. Our business will suffer if we do not successfully respond to rapid technological changes. The market for our software products 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 Web-related applications;

. changes in industry standards and practices; and

. changes in customer requirements and demands.

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

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

. fluctuations in demand for and sales of our products and services;

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

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

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

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

. the discretionary nature of our customers` purchase and budget cycles and changes in their budgets for software and Web-related purchases;

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

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

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




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

In addition, the timing of our license revenues is difficult to predict because our sales cycles are typically short and can vary substantially from product to product and customer to customer. We base our operating expenses on our expectations regarding future revenue levels. As a result, if total revenues for a particular quarter are below our expectations, we could not proportionately reduce operating expenses for that quarter.

We have experienced seasonality in our revenues and earnings, with the fourth quarter of the year typically having the highest revenue and earnings for the year and higher revenue and earnings than the first quarter of the following year. We believe that this seasonality results primarily from the budgeting cycles of our customers and from the structure of our sales commission program. We expect this seasonality to continue in the future. In addition, our customers` decisions to purchase our products and services are discretionary and subject to their internal budgets and purchasing processes. We believe that the slowdown in the economy, the terrorist activity on September 11, 2001, and the ensuing declaration of the war on terrorism has caused and may continue to cause customers to reassess their immediate technology needs and to defer purchasing decisions, and accordingly has reduced and could reduce demand in the future for our products and services.

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

We expect to face increasing competition in the future, which could cause reduced sales levels and result in price reductions, reduced gross margins or loss of market share. The market for our testing and application performance management products and services is extremely competitive, dynamic and subject to frequent technological changes. There are few substantial barriers of entry in our market. In addition, the use of the Internet for a growing range of Web applications is a recent and emerging phenomenon. The Internet lowers the barriers of entry, allowing other companies to compete with us in the testing and application performance management markets. As a result of the increased competition, our success will depend, in large part, on our ability to identify and respond to the needs of potential customers, and to new technological and market opportunities, before our competitors identify and respond to these needs and opportunities. We may fail to respond quickly enough to these needs and opportunities.

In the market for solutions for testing of applications, our principal competitors include Compuware, Empirix, Radview, Rational Software, and Segue Software. In the new and rapidly changing market for application performance management solutions, our competitors include providers of hosted services such as BMC Software, Keynote Systems and Service Metrics (a division of Exodus Communications), and emerging companies. In addition, we face potential competition in this market from existing providers of testing solutions such as Segue Software and Compuware. Finally, in both the markets for testing solutions and for application performance management solutions, we face competition from established providers of systems and network management software such as Computer Associates and Tivoli, a division of IBM.

The software industry is increasingly experiencing consolidation and this could increase the resources available to our competitors and the scope of their product offerings. Our competitors and potential competitors may undertake more extensive marketing campaigns, adopt more aggressive pricing policies or make more attractive offers to distribution partners and to employees.

If we fail to maintain our existing distribution channels and develop additional channels in the future, our revenues will decline. We derive a substantial portion of our revenues from sales of our products through distribution channels such as systems integrators, value-added resellers, ASPs, ISPs or ISVs. We expect that sales of our products through these channels will continue to account for a substantial portion of our revenues for the foreseeable future. We have also entered into private labeling arrangements with ASPs who incorporate our products and services into theirs. We may not experience increased revenues from these new channels, which could harm our business.



The loss of one or more of our systems integrators, value-added resellers, ASPs, ISPs or ISVs, or any reduction or delay in their sales of our products and services could result in reductions in our revenue in future periods. In addition, our ability to increase our revenue in the future depends on our ability to expand our indirect distribution channels.

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

. each of our systems integrators, value-added resellers, ASPs, ISPs or ISVs can cease marketing our products and services with limited or no notice and with little or no penalty;

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

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

. our systems integrators, value-added resellers, ASPs, ISPs or ISVs may also offer competitive products and services from third parties;

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

. our systems integrators, value-added resellers, ASPs, ISPs or ISVs may not give priority to the marketing of our products and services as compared to our competitors` products.

We depend on strategic relationships and business alliances for continued growth of our business. Our development, marketing and distribution strategies rely increasingly on our ability to form strategic relationships with software and other technology companies. These business relationships often consist of cooperative marketing programs, joint customer seminars, lead referrals and cooperation in product development. Many of these relationships are not contractual and depend on the continued voluntary cooperation of each party with us. Divergence in strategy or change in focus by, or competitive product offerings by, any of these companies may interfere with our ability to develop, market, sell or support our products, which in turn could harm our business. Further, if these companies enter into strategic alliances with other companies or are acquired, they could reduce their support of our products. Our existing relationships may be jeopardized if we enter into alliances with competitors of our strategic partners. In addition, one or more of these companies may use the information they gain from their relationship with us to develop or market competing products.

If we are unable to manage repaid changes in our business, our business may be harmed. Since 1991 and 2000, we have experienced significant annual increases in revenue, employees and number of product and service offerings. This growth has placed and, if it continues, will place a significant strain on our management and our financial, operational, marketing and sales systems. Recently we reduced our headcount, if we cannot manage rapid changes in our business environment effectively, our business, competitive position, operating results and financial condition could suffer. Although we are implementing a variety of new or expanded business and financial systems, procedures and controls, including the improvement of our sales and customer support systems, the implementation of these systems, procedures and controls may not be completed successfully, or may disrupt our operations. Any failure by us to properly manage these transitions could impair our ability to attract and service customers and could cause us to incur higher operating costs and experience delays in the execution of our business plan. Conversely, 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. For example, in November 2001, we announced that Douglas Smith had been appointed as our new Executive Vice President and Chief Financial Officer, replacing Sharlene Abrams.

If we cannot hire qualified personnel, our ability to manage our business, develop new products and increase our revenues will suffer. We believe that our ability to attract and retain qualified personnel at all levels in our organization is essential to the successful management of our growth. In particular, our ability to achieve revenue growth in the future will depend in large part on our success in expanding our direct sales force and in maintaining a high level of technical consulting, training and customer support. There is substantial competition for experienced personnel in the software and technology industry. If we are unable to retain our existing key personnel or attract and retain additional qualified individuals, we may from time to time experience inadequate levels of staffing to perform services for our customers. As a result, our growth could be limited due to our lack of capacity to develop and market our products to our customers.

We depend on our international operations for a substantial portion of our revenues. Sales to customers located outside the United States have historically accounted for a significant percentage of our revenue and we anticipate that such sales will continue to be a significant percentage of our revenue. As a percentage of our total revenues, sales to customers outside the United States were 37% and 35% for the three and nine months ended September 30, 2001 and 32% for both the three and nine months ended September 30, 2000, respectively. In addition, we have substantial research and development operations in Israel. We face risks associated with our international operations, including:

. changes in taxes and regulatory requirements;

. difficulties in staffing and managing foreign operations;

. reduced protection for intellectual property rights in some countries;

. the need to localize products for sale in international markets;

. longer payment cycles to collect accounts receivable in some countries;

. seasonal reductions in business activity in other parts of the world in which we operate;

. political and economic instability; and

. economic downturns in international markets.

Any of these risks could harm our international operations and cause lower international sales. For example, some European countries already have laws and regulations related to technologies used on the Internet that are more strict than those currently in force in the United States. Any or all of these factors could cause our business to be harmed.

Because our research and development operations are primarily located in Israel, we may be affected by volatile economic, political and military conditions in that country and by restrictions imposed by that country on the transfer of technology. Our operations depend on the availability of highly skilled scientific and technical personnel in Israel. Our business also depends on trading relationships between Israel and other countries. In addition to the risks associated with international sales and operations generally, our operations could be adversely affected if major hostilities involving Israel should occur or if trade between Israel and its current trading partners were interrupted or curtailed.

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



the past, obtained royalty-bearing grants from various Israeli government agencies. In addition, we participate in special Israeli government programs that provide significant tax advantages. The loss of, or any material decrease in, these tax benefits could negatively affect our financial results.

We are subject to the risk of increased taxes. We have structured our operations in a manner designed to maximize income in Israel where tax rate incentives have been extended to encourage foreign investment. Our taxes could increase if these tax rate incentives are not renewed upon expiration or tax rates applicable to us are increased. Tax authorities could challenge the manner in which profits are allocated among us and our subsidiaries, and we may not prevail in any such challenge. If the profits recognized by our subsidiaries in jurisdictions where taxes are lower became subject to income taxes in other jurisdictions, our worldwide effective tax rate would increase.

Our financial results may be negatively impacted by foreign currency fluctuations. Our foreign operations are generally transacted through our international sales subsidiaries. As a result, these sales and related expenses are denominated in currencies other than the U.S. Dollar. Because our financial results are reported in U.S. Dollars, our results of operations may be harmed by fluctuations in the rates of exchange between the U.S. Dollar and other currencies, including:

. a decrease in the value of Pacific Rim or European currencies relative to the U.S. Dollar, which would decrease our reported U.S. Dollar revenue, as we generate revenues in these local currencies and report the related revenues in U.S. Dollars; and

. an increase in the value of Pacific Rim, European or Israeli currencies relative to the U.S. Dollar, which would increase our sales and marketing costs in these countries and would increase research and development costs in Israel.

We attempt to limit foreign exchange exposure through operational strategies and by using forward contracts to offset the effects of exchange rate changes on intercompany trade balances. This requires us to estimate the volume of transactions in various currencies. We may not be successful in making these estimates. If these estimates are overstated or understated during periods of currency volatility, we could experience material currency gains or losses.

Our ability to successfully implement our business strategy depends on the continued growth of the Internet. In order for our business to be successful, the Internet must continue to grow as a medium for conducting business. However, as the Internet continues to experience significant growth in the number of users and the complexity of Web-based applications, the Internet infrastructure may not be able to support the demands placed on it or the performance or reliability of the Internet might be adversely affected. Security and privacy concerns may also slow the growth of the Internet. Because our revenues ultimately depend upon the Internet generally, our business may suffer as a result of limited or reduced growth.

Acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value or divert the attention of our management. We may acquire or make investments in other companies and technologies. In the event of any future acquisitions or investments, we could:

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

. incur debt;

. assume liabilities;

. incur expenses for the impairment of the value of investments or acquired assets;

. incur amortization expense related to intangible assets; or

. incur large write-offs.




If we fail to achieve the financial and strategic benefits of past and future acquisitions or investments, our operating results will suffer. Acquisitions and investments involve numerous other risks, including:

. difficulties integrating the acquired operations, technologies or products with ours;

. failure to achieve targeted synergies;

. unanticipated costs and liabilities;

. diversion of management`s attention from our core business;

. adverse effects on our existing business relationships with suppliers and customers or those of the acquired organization;

. difficulties entering markets in which we have no or limited prior experience; and

. potential loss of key employees, particularly those of the acquired organizations.

The price of our common stock may fluctuate significantly, which may result in losses for investors and possible lawsuits. The market price for our common stock has been and may continue to be volatile. For example, during the 52-week period ended October 31, 2001, the closing prices of our common stock as reported on the Nasdaq National Market ranged from a high of $134.13 to a low of $18.71. 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, bio-terrorism and the war on terrorism;

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

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

Because of this volatility, we may fail to meet the expectations of our stockholders or of securities analysts at some time in the future, and the trading prices of our securities could decline as a result. In addition, the stock market has experienced significant price and volume fluctuations that have particularly affected the trading prices of equity securities of many high-technology companies. These fluctuations have often been unrelated or disproportionate to the operating performance of these companies. Any negative change in the public`s perception of software or Internet software companies could depress our stock price regardless of our operating results.

If we fail to adequately protect our proprietary rights and intellectual property, we may lose a valuable asset, experience reduced revenues and incur costly litigation to protect our rights. We rely on a combination of patents, copyrights, trademarks, service marks and trade secret laws and contractual restrictions to establish and protect our proprietary rights in our products and services. We will not be able to protect our intellectual property if we are unable to enforce our rights or if we do not detect unauthorized use of our intellectual property. Despite our precautions, it may be possible for unauthorized third parties to copy our products and use information that we regard as proprietary to create products that compete with ours. Some license provisions protecting against



unauthorized use, copying, transfer and disclosure of our licensed programs may be unenforceable under the laws of certain jurisdictions and foreign countries. Further, the laws of some countries do not protect proprietary rights to the same extent as the laws of the United States. To the extent that we increase our international activities, our exposure to unauthorized copying and use of our products and proprietary information will increase.

In many cases, we enter into confidentiality or license agreements with our employees and consultants and with the customers and corporations with whom we have strategic relationships and business alliances. No assurance can be given that these agreements will be effective in controlling access to and distribution of our products and proprietary information. Further, these agreements do not prevent our competitors from independently developing technologies that are substantially equivalent or superior to our products.

Litigation may be necessary in the future to enforce our intellectual property rights and to protect our trade secrets. Litigation, whether successful or unsuccessful, could result in substantial costs and diversions of our management resources, either of which could seriously harm our business.

Third parties could assert that our products and services infringe their intellectual property rights, which could expose us to litigation that, with or without merit, could be costly to defend. We may from time to time be subject to claims of infringement of other parties` proprietary rights. We could incur substantial costs in defending ourselves and our customers against these claims. Parties making these claims may be able to obtain injunctive or other equitable relief that could effectively block our ability to sell our products in the United States and abroad and could result in an award of substantial damages against us. In the event of a claim of infringement, we may be required to obtain licenses from third parties, develop alternative technology or to alter our products or processes or cease activities that infringe the intellectual property rights of third parties. If we are required to obtain licenses, we cannot be sure that we will be able to do so at a commercially reasonable cost, or at all. Defense of any lawsuit or failure to obtain required licenses could delay shipment of our products and increase our costs. In addition, any such lawsuit could result in our incurring significant costs or the diversion of the attention of our management.

Defects in our products may subject us to product liability claims and make it more difficult for us to achieve market acceptance for these products, which could harm our operating results. Our products may contain errors or "bugs" that may be detected at any point in the life of the product. Any future product defects discovered after shipment of our products could result in loss of revenues and a delay in the market acceptance of these products that could adversely impact our future operating results.

In selling our products, we frequently rely on "shrink wrap" or "click wrap" licenses that are not signed by licensees. Under the laws of various jurisdictions, the provisions in these licenses limiting our exposure to potential product liability claims may be unenforceable. We currently carry errors and omissions insurance against such claims, however, we cannot assure you that this insurance will continue to be available on commercially reasonable terms, or at all, or that this insurance will provide us with adequate protection against product liability and other claims. In the event of a product liability claim, we may be found liable and required to pay damages which would seriously harm our business.

We have adopted anti-takeover defenses that could delay or prevent an acquisition of our company, including an acquisition that would be beneficial to our stockholders. Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. We have no present plans to issue shares of preferred stock. Furthermore, certain provisions of our Certificate of Incorporation and of Delaware law may have the effect of delaying or preventing changes in our control or management, which could adversely affect the market price of our common stock.

Leverage and debt service obligations may adversely affect our cash flow. In July 2000, we completed an offering of convertible subordinated notes with a principal amount of $500.0 million. We now have a substantial amount of outstanding indebtedness, primarily the convertible subordinated notes. There is the possibility that we may be unable to generate cash sufficient to pay the principal of, interest on and other amounts due in respect of our



indebtedness when due. Our leverage could have significant negative consequences, including:

. increasing our vulnerability to general adverse economic and industry conditions;

. requiring the dedication of a substantial portion of our expected cash flow from operations to service our indebtedness, thereby reducing the amount of our expected cash flow available for other purposes, including capital expenditures; and

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

Ich stell es erstmal nur so rein.

mfg siscoinvestor

[siscoinvestor]

sorry,
text falschem Wert zugeordnet. aua.