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Options-Granting Scandal Provides a Boom for Accountants, Attorneys

More public companies are taking a close look at how they granted stock options to executives in the wake of an ongoing investigation into the practice by the Securities and Exchange Commission.

Practically every public firm is reviewing the issue, said Gary Sutton, a director on the boards of six companies and local author.

“Everybody who is public is probably doing an internal review, and everybody that has been caught (backdating their options) will have to restate their earnings,” Sutton said.

The practice of granting stock options in lieu of cash compensation was widespread during the Internet-related technology boom in the late 1990s.

Some companies were giving executives an even nicer perk by dating the granting options when the share price was depressed.

The lower exercise price would allow executives to take a higher profit when the options for shares were exercised and sold at market prices.

In May, Applied Micro Circuits Corp., a maker of silicon chips used in telecom networks, said it was conducting an internal investigation of its stock option granting.

Within a few weeks, it said the SEC was investigating the matter.

Later, AMCC disclosed it had been issued a subpoena from the U.S. attorney’s office in Northern California. AMCC moved its headquarters to Sunnyvale from San Diego last year.

AMCC said the U.S. attorney’s office in Northern California this month was withdrawing its subpoena, but said the U.S. attorney’s office in San Diego said it was continuing its investigation.

AMCC said the Nasdaq stock exchange sent a letter warning that it may be delisted because it hasn’t filed its quarterly financial reports on time.

The company has delayed its required filings because its audit committee is still investigating option granting practices.

ViaSat Inc. of Carlsbad, a maker of satellite communications equipment, said it conducted an internal review into the option granting issue and decided to take a $700,000 charge to correct financial results going back 10 years.

ViaSat said no option grants to officers or directors were misdated. However, it said certain errors associated with the options granted mainly to “new nonexecutive employees during the 10-year period from December 1996 to June 30, 2006, were identified.”

ViaSat took the $700,000, or 2 cents per share, in charges on its first quarter ended June 30, but said the financial impact of the corrections is immaterial.

Just how prevalent is the practice of amending dates on stock options?

Sutton said sources at all of the Big Four accounting firms said they’ve set up special committees that are “doing nothing but reviewing their clients’ stock option plans.”

“That tells you it’s pretty widespread,” he said.

To ensure they’re in the clear, many companies are hiring outside attorneys to conduct an internal review of their option practices. At minimum, those reviews could cost $20,000 to $30,000.

“But if they find something wrong, then (the costs) start to escalate,” Sutton said.

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WFI Buys Defense Contractor:

WFI, formerly called Wireless Facilities Inc., a provider of telecom network equipment and services, said it is buying Madison Research Corp., an Alabama defense technology contractor, for $69 million.

The acquisition, expected to close by Sept. 30, follows WFI’s plan to expand its government business, said Chief Executive Officer Eric DeMarco.

“MRC is a particularly ideal fit for WFI because of its very deep relationships across a number of military agencies and because of its existing, high-valued contract vehicles,” he said.

Among customers of MRC are the U.S. Army, Air Force and National Aeronautics and Space Administration, better known as NASA.

MRC has some 375 employees working in 15 states on some 85 contracts, including 15 within the federal government and 10 foreign nations, according to WFI.

WFI earlier reported it had a net loss of $600,000 on revenue of $86.2 million for the second quarter, compared with a net profit of $3.3 million on revenue of $95.3 million for 2005.

For the six months, WFI posted a loss of $1.4 million on revenue of $170.1 million. That compared with a profit of $6.9 million on revenue of $186 million for the first six months of 2005.

The company cited $800,000 in stock compensation charges it took beginning in January as a reason for its red ink.

Traded on Nasdaq under the ticker WFII, shares closed Aug. 21 at $2.05, and have ranged from $1.85 to $7.25, but have been on a long slide beginning about 10 months ago.

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Overland Storage Ends Outsourcing:

Overland Storage, a locally based maker of data storage devices and software, has stopped outsourcing manufacturing and brought back production to Kearny Mesa.

Lack of quality control was the main reason behind the decision, said spokeswoman Cynthia Bond.

“We were unhappy with the quality we were getting and we were unable to achieve the cost savings that we anticipated,” Bond said.

Overland has rehired some 50 employees for the production line, and would likely hire at least 16 more, she said.

Last year, Overland Storage laid off 75 workers as a result of contracting for manufacturing to a firm in South Dakota.

In other news, Overland reported a loss of $18.3 million on revenue of $209 million for the fiscal year ended June 30, compared with a net profit of $4.6 million on revenue of $235.7 million for the 2005 fiscal year.

In the financial report, Overland blamed problems at the outsourcing facility for a $13.7 million decrease in fourth-quarter sales.

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Javo Sales Rise 200 Percent:

Javo Beverage Co. Inc., a Vista provider of coffee and tea drinks to the food service industry, said it sustained a second-quarter loss of $6.1 million on revenue of $3.17 million, with sales rising 200 percent from the like period of 2005. The net loss of the comparable quarter was $1.2 million.

Part of the recent loss was the result of a non-cash expense of $5.1 million related to an exchange by the holders of promissory notes for preferred stock. Preferred stock is not convertible to common and has no voting rights.

The exchange eliminated $13.4 million in principle and $3.9 million in accrued interest.

CEO Cody Ashwell said the conversion of long-term debt improves the balance sheet, achieves positive net worth and accelerates the company path to profitability.

Traded under JAVO on the Over-the-Counter Bulletin Board, shares closed Aug. 22 at $1.80 and ranged from 20 cents to $2.38 in the past 52 weeks.

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Mad Catz CFO Departs:

Usually when a company decides to jettison someone, it makes oblique references such as “will pursue other interests.”

Mad Catz said recently that Chief Financial Officer Cyril Talbott III resigned to accept a position “with a privately held company outside the interactive entertainment industry.”

Mad Catz, based in Mission Valley, makes accessories such as joysticks for computer games.

The company reported this month that it had a loss of $876,000 on revenue of $18.1 million for its first quarter ended June 30. That compared with a loss of $2.1 million on revenue of $14.8 million for the like period of 2005.

Traded under MCZ on the American Stock Exchange, shares closed Aug. 22 at 40 cents and ranged from 30 to 99 cents in the past 52 weeks.

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Petco Posts Lower Results:

Petco Animal Supplies Inc., which announced its sale to two private equity firms last month, reported net income of $9.9 million for its second quarter, or nearly half the $18 million in net income for the like period of 2005.

Revenues were up 10 percent to $531 million from the same quarter a year earlier, while same-store sales increased 3.4 percent.

This month, about three weeks after announcing a buyout by Leonard Green & Partners and the Texas Pacific Group for $1.8 billion, Petco disclosed it received a higher offer from an entity identified only as another pet supply company. The buyer is widely viewed as PetSmart Inc., the Phoenix pet supplies retailer that is larger than Petco.

According to regulatory filings, the competitor’s bid was $33 per share, which would have put the aggregate price for Petco to more than $2 billion.

The two equity firms’ offer was $29 per share, plus outstanding debt of about $120 million.

Petco said in the filings that its board determined the lower offer to be better because selling to an industry competitor would have triggered a lengthy antitrust review, causing potential damage to the business and the firm’s stock price.

Petco’s debt was reviewed this month for possible downgrade by Moody’s Investors Service, prompted by intended sale.

Moody’s said it would review all the consequences for going private to see whether the change on the cost of debt would increase.

The sale still requires approval by Petco shareholders, but is expected to close by Dec. 31.

Leonard Green and the Texas Pacific Group are the same entities that brought Petco private in 2000. Two years later, it arranged an initial public offering valued at $600 million.

Traded on Nasdaq under PETC, shares closed at $28.03 on Aug. 22, and ranged from $18 to $28.55 in the past 52 weeks.

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Send any news of San Diego public companies to Mike Allen at

mallen@sdbj.com

. He can be reached at (858) 277-6359.

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