Mercury Interactive ( MERQ) is looking more and more like a takeover target. The tipoffs: The troubled, system software maker has put golden parachutes in place for its CEO and CFO in the event of a change in ownership and its 30% run-up in share value.

According to filings with the Securities and Exchange Commission, Mercury this week entered into an agreement with CFO Dave Murphy that provides for a severance of two years' base salary and target bonus (100% of base), continued benefits and accelerated vesting of options if he is terminated by a new owner.

CEO Anthony Zingale was awarded a similar agreement in February.

Meanwhile, shares of Mercury, which was delisted by the Nasdaq and removed from the S&P 500 in the midst of an ugly accounting scandal, continue to appreciate. On Jan. 4, its last day in the big leagues, shares of Mercury closed at $27.88; on Friday, Mercury closed at $36.50, a gain of 31%.

Merrill Lynch analyst Kash Rangan mentioned the filings in a note to clients published Friday, and concluded: "These agreements indicate the possibility that the company may be sold." Merrill Lynch has an investment banking relationship with Mercury.

Mercury's well-regarded software is used to test, develop and optimize applications and information systems at large businesses. Potential acquirers, says IDC analyst Stephen Elliot, include Hewlett-Packard ( HPQ), SAP ( SAP)and storage giant EMC ( EMC).

While EMC sounds rather far afield, it's worth remembering that CEO Joe Tucci has been broadening the company's addressable market through acquisitions for some time. Last year, EMC puts its toe in the network management business by acquiring privately held Smarts for $260 million. Mercury would deepen that expertise and give it access to a large and ultraloyal customer base.

However, it would be rather expensive, even for cash-rich EMC. Mercury's market cap is about $3.12 billion, while EMC's largest buys to date were Documentum for $1.7 billion and Legato for $1.4 billion.

Mercury is restating financial results after a special board committee found that several executives benefited from a program to favorably price options grants. CEO Amnon Landan, CFO Douglas Smith and general counsel Susan Skaer resigned after the findings. Mercury subsequently missed a deadline to restate quarters that may have been affected by the options issue and was delisted.

The company declined to answers questions on the employment agreement or its progress restating earnings.

H-P's Funny Money

Ever since Hewlett-Packard brought in Mark Hurd to replace fallen star Carly Fiorina, the company and its new CEO have been on something of a honeymoon with Wall Street. But an analysis by Sanford Bernstein analyst Tony Sacconaghi suggests that some marriage counseling may be in order.

Simply put, the veteran analyst says H-P has inflated its non-GAAP earnings by excluding $4.76 billion in charges over the last three years -- charges that other companies would include. Without the exclusions, he says, H-P's earnings would have been almost 40% lower in 2005, 16% lower in 2004 and 36% lower in 2003.

The excluded charges fall into two categories: restructuring costs at $2.6 billion, and the amortization of acquired intangibles at $1.8 billion. The money hasn't simply disappeared, of course, and is reflected in reported GAAP earnings. But because many investors and analysts focus on non-GAAP earnings, anything that inappropriately boosts those profits -- and therefore valuations -- is misleading.

H-P, Sacconaghi says, has taken one-time restructuring charges in each of its last 12 quarters.

"The restructuring charges have occurred so consistently, they appear to be part of its normal course of business," he wrote this week. "By contrast, IBM ( IBM) includes significant ongoing workforce reductions expense every year in its earnings, and has absorbed over $1 billion in workforce restructuring charges in the last three years." Sanford Bernstein does not have an investment banking business.

H-P did not return calls asking for comment on the issue, but according to Sacconaghi, the company "has indicated that it would include ongoing workforce reductions in its reported earnings."

Sacconaghi estimates that most of the excluded charges for the amortization of acquired intangibles relate to the Compaq acquisition. He notes that H-P "is not unique amongst companies that have undergone large acquisitions, in declining to expense items such as brand equity or intellectual property.

Oracle, for example, will likely exclude on the same basis the equivalent of 2 cents a share in charges from its non-GAAP earnings when it reports third-quarter financials on Monday, says Charles Di Bona, who covers software for Bernstein. In a recent note, Di Bona said he objects strongly to the practice, but says the 2-cent charge has been added back to the non-GAAP estimates collected by First Call.

The issue is a fairly complex one. If an intangible asset such as brand equity depreciates over time, how should it be treated?

Charles Mulford, a professor of accounting at the Georgia Institute of Technology, argues that it should be expensed like any other cost of an ongoing business. "If a company benefits from acquired revenue, it should expense the items that allowed it to earn that revenue," he said during an interview.

Others would argue that because an acquisition is generally a one-time event, expenses generated by the acquisition also are extraordinary and therefore excludable.

In any case, there's no suggestion by either analyst that H-P or Oracle are treating their GAAP earnings incorrectly. But Gary Lutin, an investment banker and corporate governance advocate, says H-P's accounting practices "make it very difficult for ordinary investors to understand their earnings. And that's wrong."

Sacconaghi, he adds, "is doing exactly what analysts should be doing."


An upbeat analyst day and a modest boost to guidance this week weren't enough to convince investors that Brocade's ( BRCD) still-cheap shares continue to harbor more value.

Brocade, which makes hardware used in storage networks, has had a great run this year, appreciating by about 43%. Of course, that run-up followed last year's plunge when the stock hit a 52-week low of $3.34. Even with a sharp after-hours boost during Jim Cramer's "Mad Money" show Thursday evening, the stock is trading at only $6.09.

The company ratcheted up sales guidance for the fiscal year to a range of $665 million to $680 million from a range of $660 million to $672 million. The company also raised expectations for gross margins to 56% to 58% from 55% to 57%. Even so, that's a decline in margins from 60% in the last quarter.

Goldman Sachs analyst Laura Conigliaro began a note on the analyst day with praise for the San Jose, Calif.,-based company, saying "Brocade's outlook has become more positive as it should benefit from several tailwinds driving top line growth and fewer overhangs to impede its progress relative to last year."

But her praise quickly turned faint, as she cited the company's sharp gains this year and its multiple of 20 times her 2006 estimates. "Multiple expansion from here should be minimal," she concluded.

Conigliaro was not alone in her skepticism; other analysts published similar notes, and save for the bump after Cramer's mention, due in part to the newly hot market for storage, the stock stayed flat in the days after the meeting.

TechWeek Scorecard
Index Closing Change
Nasdaq Composite 2306 1.9%
Philadelphia Semiconductor 496 -1.2%
Goldman Sachs Software 170 1.8%
TSC Internet 219 1.9%

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