Mercury Falling?

Tony Zingale spent much of 2004 having his arm twisted by good friend and then-CEO of Mercury Interactive (MERQE) Amnon Landan. They had known each other for years, even before Zingale was appointed to Mercury's board in 2002. Landan wanted him to sign on as president and chief operating officer -- or, as Landan joked at the time, not be No. 2, but the No. 1.5 guy.

Mercury was well on its way to reaching $1 billion in annual sales, and the market was shifting fast for a company that also was a Wall Street darling.

SHOCKING NEWS. The idea was that Zingale, a seasoned technology executive, would assume day-to-day operations while Landan, an entrepreneur at heart, would remain the technical visionary and the outfit's face on Wall Street.

It was a safe assumption that Zingale would eventually take over. But on Nov. 2, that ascension happened sooner than anyone could have expected.

Mercury announced that an internal investigation turned up 49 instances of stock-option manipulation -- stunning news that was followed by the swift dismissal of Landan, CFO Douglas Smith, and general counsel Susan Skaer. All three were aware of, took part in, and benefited from the practice, Mercury said, summing up the findings of an investigation that began in June.

SLATHER OF QUESTIONS. The stock fell 27%, closing at $25.66 on the day the news broke, and at least six analysts downgraded the stock. "I like Mercury from a fundamental standpoint and I like the management team, but the biggest concern is how much deeper this situation gets," says John Rizzuto, director of infrastructure software research at investment bank Lazard Capital Markets, who downgraded the stock and cut its price target to $20 from $40 on the news. "There's just a lot of uncertainty."

A week later, most of that uncertainty remains: Will customers get spooked as the outfit enters its crucial fourth quarter? Will Mercury be able to stave off a Nasdaq delisting when it meets with the organization on Nov. 15? Will criminal investigations and shareholder lawsuits follow? What will the restated financials reveal? And now that the price has been knocked down, will Mercury be bought?

In his first face-to-face interview since the news broke, Zingale says he doesn't know -- or can't share -- many of the answers (see BW Online, 11/9/05, "Mercury's Zingale: 'Gotta Move On'"). But the excitable Silicon Valley veteran, who resembles John Travolta, isn't sitting still. On the day the news broke, he spent more than 20 hours talking to Wall Street and employees. He spent much of the next two days on the phone with customers and potential customers.

ACCENTUATING THE POSITIVE. Zingale continues to juggle the three constituencies: Towards the end of this week, he'll fly to New York to talk with investors, before heading to Tel Aviv on Sunday to meet with Mercury's shaken Israeli staff -- the roots of the company and those most loyal to Landan.

Mercury employs 3,000 people. Of those, 750 are based in Israel. Then, on the way back to Mercury's Mountain View (Calif.) headquarters, Zingale will stop in Europe to meet with customers. "(Part One) is shock," he says of his reaction to the investigation's findings. "Part Two is really just trying to understand what was going through those people's heads. I knew Amnon and Doug really well. But...I'm a realist, and quickly it's like, 'Are you done, Tony? Because guess what? Now they're all looking to you.'"

Zingale's game plan, first and foremost, is to play on Mercury's strengths. The company makes software that helps in the vetting and testing of crucial software applications, ensuring that businesses can count on them when they're needed. Mercury gets about two-thirds of sales from the so-called automated software quality market, which IDC says will rise to $1.9 billion in 2009 from $780 million in 2004.

NEW LINES. Demand for its products helped Mercury grow at a time when other software vendors were shrinking. Sales more than doubled in 2004, to $685 million, from $307 million in 2000. But the pace was hard to maintain as Mercury dominated the market.

That's why, two years ago, the company shifted strategy. It aimed to begin selling a wide range of products aimed at corporate chief investment officers, rather than mainly individual, niche products to IT department execs. Mercury unveiled a new suite of products that reflects that shift at a conference in Las Vegas in October, 2005.

The biggest product launch in Mercury's history, it included some 21 new products and represented a $500 million technology investment. "We connected the pieces for them and showed evidence and had customers talk about it," Zingale says. "We took them to see Elton John too and that helped."

MORE DEALS TO STUMBLE? Zingale will need to work all the harder to keep the pieces connected for customers. Results in the past two quarters disappointed investors. Growth was still good by enterprise software standards: Second-quarter earnings rose 7% and revenue climbed 30%. But Mercury's grip on some of the big, multimillion dollar deals had started to slip, Rizzuto says.

With the company's credibility in question, more deals could founder, Rizzuto adds. "Anyone who's going to spend more than seven figures with a company is going to be worried about something like this," he says. And as the market leader, Mercury was known for pricing its software at a premium. Customers now have added reason to look at competitors, Compuware and Computer Associates (CA), says Derrick Wood of Pacific Growth Equities.

Another potential concern for customers: Now that it has lost one-third of its value, is Mercury a prime take-over candidate? An industry source says "everybody" is eyeing Mercury, including Hewlett-Packard (HPQ), EMC (EMC), Symantec (SYMC), and Computer Associates. International Business Machines (IBM) also has been mentioned as a potential suitor.

"WENT THROUGH HELL." Before the scandal the company was seen as too pricey. Now, it's cheaper, but would-be buyers are concerned about liability and further investigations related to the option manipulation. "The business fundamentals are being dragged down," the source says. "Employees are leaving, they're losing customers, the financial statements are questionable, and there will be shareholder lawsuits. These are all question marks. It's a rough deal to do."

Going it alone suits the feisty Zingale just fine. Once he gets back from his jet-setting, he'll work with new CFO David Murphy to restate past years' finances, announce third-quarter earnings, which have been postponed indefinitely, and come up with fourth-quarter and 2006 forecasts -- all the while trying to boost morale and keep customers calm. It's hardly an enviable position, but one for which a former boss, Joe Costello, says Zingale is ideal. Costello was CEO of Cadence Design Systems (CDNS), where Zingale worked for a decade.

Zingale was Costello's "right-hand guy" when Cadence reported the worst quarter in its history and weathered the infamous Avanti lawsuit, when several former employees stole intellectual property and set up a competing business. "We went through hell together," Costello remembers. "He kept people motivated and communicated what was going on inside and outside of the company. The truth is, I remember him more in the hard times than the good times."

TOUGH JOB. Back in December, 2004, as he negotiated with Landon, what finally swayed Zingale to take the job at Mercury was the opportunity to do something "big." Zingale, 50, knew whatever he did next would be his last job before retiring to spend time with his wife and three kids, ski, golf, and watch football.

"I sat down with all my venture buddies and the private-equity guys and looked at all this garbage," he says. "I knew if I was going to do one more thing it had to be big and had to be cool."

Nearly a year later, the corner office might not look quite so inviting. But if Zingale can guide Mercury through its current storm and keep customers from jumping ship -- or at least do a good job of selling the company -- the job will certainly be big.


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