Mercury Interactive Disclosure Suggests Options Damage Not Priced-In to Stocks

Excerpt from our One Page Annotated Wall Street Journal Summary (which you can get emailed to you every morning by signing up here):

Mercury Interactive Gets SEC Warning Of Possible Charges

• Summary: The SEC sent Wells notices, signifying the likelihood of civil-securities charges, against three Mercury Interactive (MERQ) directors relating to options backdating. Mercury Interactive was one of the first companies caught in the options scandal, and recently restated its financial results for 1992-2004, including restating the 2003 profit of $41.5 million into a loss of $62.6 million. The cost of the option mess to Mercury is not limited to the restatements and potential damages and penalties; the companay said its legal and accounting bill for the clean up will likely be about $70 million, and its failure to file financial results on time triggered a $7.1 million payment to creditors. Mercury's future earnings could be hit in two additional ways: the reclassification of past stock options as "variable" awards makes them subject to detrimental accounting treatment that could impact future earnigns, and options-related tax problems reduced the tax-loss carry-forwards that Mercury can use in future years.
• Comment on related stocks/ETFs: This article is significant because it highlights the multi-faceted financial impact of the options scandal on the companies involved: damages, penalties, restatements, accounting and legal fees, higher future stock-related costs and lower tax-loss carry-forwards. These costs could significantly lower the future earnings of the companies involved. Additionally, we haven't yet seen any high profile management resignations or dismissals. Arguably the full extent of the potential damage is not yet priced-in to the stocks involved. Here's the full list of stocks involved in the options scandal, and therefore at further risk.