Wednesday, November 01, 2006

Nice 'N Easy

Have you seen those cute "Life Is Good" T-shirts? I can’t understand how anyone can wear them; I’m sure that the moment I walk out the door in a T-shirt that says “Life Is Good” I will (a) get run over by a Mr. Softee truck and spend my last seconds on earth listening to that song, (b) be recruited to appear on a new reality show called "I Dated 100 Congressmen" or (c) realize I’m having one of those anxiety dreams where I’m out in public wearing nothing but a T-shirt.

But if I had stock in Ceradyne, Inc. I might put on a "Life is Good" shirt anyway. Here’s a company whose third quarter net income nearly tripled over third quarter 2005. Why? Because Ceradyne makes body armor, which the U.S. military seems at long last to have adopted as a fashion statement.

Unfortunately, Ceradyne’s management had to take a break from counting the bucks to file an 8-K about a little matter of stock option grants. But the 8-K and the press release that accompanied it only skim the surface. To get the full flavor you have to read the notes to the 10-Q, filed today.

Ceradyne's story supports my view that the popularity of backdating can be explained by its elegant simplicity. Until 2003 the company bestowed the power to grant options on a Stock Option Committee with just two members. One was CEO Joel Moskowitz. The other was a "non-management director," not always the same one. (Hey, at least it wasn't a one-person committee).

From 1997 through 2003, this esteemed committee approved 23 option grants, 22 of which were backdated. It didn't even bother to hold meetings, but approved the grants by "unanimous consent in lieu of meeting." This is where you write down some resolutions on a piece of paper and get all the committee members to sign it, which legally substitutes for a real meeting and saves on doughnuts.

There are two dates to keep in mind here: Earlier Date When the Stock Price Was Nice and Low and Later Date When the Consent Was Actually Signed. Whenever Moskowitz felt like it (Later Date), he and the other guy would sign a consent that said something like: "Resolved, that X, Y and Z shall be granted a bunch of options." Although the company’s account of events is artfully fudged, it appears the consents were simply backdated so it looked like they were signed on Earlier Date, which the company then treated as the grant date for all official purposes. Beautifully simple.

Unfortunately the accountants spoiled everyone’s fun by insisting that Later Date was the real grant date, so Ceradyne will take a $3.4 million charge. But with the war doubling their third-quarter sales to over $185 million, "Life Is Still Looking Pretty Peachy" at Ceradyne. As long as no one "Cuts and Runs."