Portfolio Review Portfolio Review PresentationPresentation

September 18, 2006September 18, 2006

Student Managed Investment Portfolio – Franklin & Marshall CollegeStudent Managed Investment Portfolio – Franklin & Marshall College

Josh WelkJosh WelkYaman TasdivarYaman Tasdivar

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Table of ContentsTable of Contents

SectionSection PagePage

I.I. Overview of CeradyneOverview of Ceradyne 2 2

II.II. Risks Specific to Ceradyne’s BusinessRisks Specific to Ceradyne’s Business 5 5

III.III. History of Ceradyne within SMIP PortfolioHistory of Ceradyne within SMIP Portfolio 8 8

IV.IV. Ceradyne Financial PerformanceCeradyne Financial Performance 10 10

V.V. DCF Valuation AnalysisDCF Valuation Analysis 14 14

VI.VI. Recent NewsRecent News 17 17

VII.VII. Investment SummaryInvestment Summary 19 19

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Overview of CeradyneOverview of Ceradyne

Section ISection I

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Business SummaryBusiness Summary

“Ceradyne defines itself as an advanced technical ceramic company serving a broad array of defense, industrial, automotive/diesel and commercial markets.” – Joel P. Moskowitz, CEO

Ceradyne, Inc. engages in the development, manufacture, and marketing of technical ceramic products, powders, and components for defense, industrial, automotive/diesel, and commercial applications in the United States. The company’s products comprise lightweight ceramic armor for soldiers and other military applications; ceramic industrial components for erosion and corrosion resistant applications; and ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium hexaboride, and zirconium diboride, which are used in manufacturing armor and various industrial products. In addition, it offers evaporation boats for metallization of materials for food packaging and other products; ceramic diesel engine components; functional and frictional coatings primarily for automotive applications; translucent ceramic orthodontic brackets; ceramic impregnated dispenser cathodes for microwave tubes, lasers, and cathode ray tubes; ceramic crucibles for melting silicon in the photovoltaic solar cell manufacturing process; and ceramic missile radomes for the defense industry. It serves primarily the U.S. government and prime government contractors, as well as industrial, automotive/diesel, and commercial manufacturers in domestic and international markets. Ceradyne was co-founded by Joel P. Moskowitz in 1967 and is based in Costa Mesa, California.

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ProductsProducts

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Risks Specific to Risks Specific to

Ceradyne’s BusinessCeradyne’s Business

Section IISection II

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Specific RisksSpecific Risks

• A substantial portion of Ceradyne’s revenues is derived from the sale of defense related products. The largest consumer of Ceradyne’s products is the U.S. Government and Military. There are not many other consumers in the market for defense related products, causing concern about Ceradyne’s ability to profit if it loses a significant portion of it government contracts.

• The U.S. Military has considered revising performance requirements for ceramic body armor. If this happens, Ceradyne’s existing inventory value could be significantly impaired and it would have to undertake higher research and development costs in order to design a new product to meet the increased requirements.

• Ceradyne does not have a diverse supplier base, leading to some concern that it could be forced to accept higher supply prices.

• Joel P. Moskowitz has been a key figure in Ceradyne’s rapid growth and he is approaching retirement age, leading to concern about the direction and vision of the company once he steps down.

Due to the nature of its business, Ceradyne faces numerous risks that could significantly Due to the nature of its business, Ceradyne faces numerous risks that could significantly impact future performance.impact future performance.Due to the nature of its business, Ceradyne faces numerous risks that could significantly Due to the nature of its business, Ceradyne faces numerous risks that could significantly impact future performance.impact future performance.

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External Forces on the IndustryExternal Forces on the Industry

The Ceramic Products The Ceramic Products and Components Industryand Components Industry

The Ceramic Products and Components Industry faces substantial external pressures.The Ceramic Products and Components Industry faces substantial external pressures.The Ceramic Products and Components Industry faces substantial external pressures.The Ceramic Products and Components Industry faces substantial external pressures.

Abundance of WarAbundance of War

Military Budget

Military Budget

Legislatio

n Changes

Legislatio

n Changes

Product Failure Liability

Product Failure Liability

High Supply Costs

High Supply Costs

Change in

Technolo

gy

Change in

Technolo

gy

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History of Ceradyne History of Ceradyne within within

SMIP PortfolioSMIP Portfolio

Section IIISection III

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CRDN Performance in SMIPCRDN Performance in SMIP

Ceradyne has been one of the top performing equities within the SMIP portfolio.Ceradyne has been one of the top performing equities within the SMIP portfolio.Ceradyne has been one of the top performing equities within the SMIP portfolio.Ceradyne has been one of the top performing equities within the SMIP portfolio.

• SMIP bought Ceradyne at $22.77 a share in April 2005. • SMIP currently owns 225 shares and has held CRDN for 16 months.• Ceradyne’s total purchase cost was $5124. It’s current market value

is $10,064, an increase of $4940. That is equal to a 96% return.• Cerdayne is SMIP’s third largest position, trailing only Exxon Mobil

and Caremark.• Ceradyne has not issued any dividends or split its stock since SMIP

bought it in 2005.• Ceradyne had traded up to $63.84 a share while SMIP owned it but

has fallen back down, settling in currently in the low-to-mid $40 range.

• During the summer of 2006, Executive Board members had discussions on whether or not to sell Ceradyne because of its options accounting troubles. The vote was two to two. Positives are its growth potential. Negatives are its risk vs. reward tradeoff.

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Ceradyne Financial Ceradyne Financial PerformancePerformance

Section IVSection IV

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Financial Performance MetricsFinancial Performance Metrics

$45.3$61.2

$101.5

$215.6

$368.3

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

$350.0

$400.0

2001 2002 2003 2004 2005

$12.5 $13.1

$29.3

$69.1

$131.1

$0.0

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

$140.0

2001 2002 2003 2004 2005

Sales

$0.21$0.14

$0.51

$1.12

$1.84

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

$1.40

$1.60

$1.80

$2.00

2001 2002 2003 2004 2005

Earnings Per Share

Gross Profit

$28.1 $35.7

$104.2

$199.9

$276.4

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

2001 2002 2003 2004 2005

Year End Backlog

The following performance metrics are important in depicting Ceradyne’s growth.The following performance metrics are important in depicting Ceradyne’s growth.The following performance metrics are important in depicting Ceradyne’s growth.The following performance metrics are important in depicting Ceradyne’s growth.

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Historical Ratio AnalysisHistorical Ratio Analysis

Ceradyne Ratio Analysis

For the Fiscal Year Ending Dec. 31, 2001 2002 2003 2004 20052006 LTM

Profitability

Return on Assets % 6.5% 4.8% 13.3% 12.9% 13.7% 20.1%

Return on Capital % 7.4% 5.8% 16.0% 15.9% 16.3% 24.3%

Return on Equity % 10.8% 6.5% 17.3% 24.9% 24.3% 36.7%

Margin Analysis

Gross Margin % 27.5% 21.4% 28.9% 32.0% 35.6% 38.3%

SG&A Margin % 15.3% 11.5% 10.1% 10.4% 11.3% 9.8%

EBITDA Margin % 15.3% 11.3% 20.0% 23.9% 26.4% 29.9%

EBITA Margin % 10.3% 6.5% 16.8% 20.4% 22.2% 26.7%

EBIT Margin % 9.9% 6.5% 16.8% 20.1% 22.2% 26.7%

Earnings from Cont. Ops Margin % 8.9% 4.4% 11.1% 12.8% 12.7% 16.6%

Net Income Margin % 8.9% 4.4% 11.1% 12.8% 12.7% 16.6%

Net Income Avail. for Common Margin % 8.9% 4.4% 11.1% 12.8% 12.7% 16.6%

Normalized Net Income Margin % 6.7% 4.2% 10.6% 12.7% 12.4% 16.1%

Levered Free Cash Flow Margin % (20.9%) (4.7%) (3.8%) 38.2% 1.1% NA

Unlevered Free Cash Flow Margin % (20.6%) (8.3%) (1.3%) (16.7%) 2.1% NA

Asset Turnover

Total Asset Turnover 1.0x 1.2x 1.3x 1.0x 1.0x 1.2x

Fixed Asset Turnover 3.3x 3.5x 4.4x 2.3x 2.3x 3.1x

Accounts Receivable Turnover 6.2x 6.2x 6.7x 6.4x 7.0x NA

Inventory Turnover 2.9x 3.1x 4.4x 4.5x 4.2x NA

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Historical Ratio Analysis cont’d.Historical Ratio Analysis cont’d.

Ceradyne Ratio Analysis

For the Fiscal Year Ending Dec. 31, 2001 2002 2003 2004 20052006 LTM

Short Term Liquidity

Current Ratio 4.0x 3.4x 5.2x 2.4x 5.9x 4.9x

Quick Ratio 1.3x 1.2x 3.4x 1.2x 3.7x 1.9x

Cash from Ops. to Curr. Liab. 0.1x 0.2x 1.1x 0.6x 0.5x NA

Avg. Days Sales Out. 58.7 59.3 54.5 57.2 52.4 NA

Avg. Days Inventory Out. 126.5 116.3 83.6 80.7 87.7 NA

Avg. Days Payable Out. 34.0 39.7 41.0 45.2 40.1 NA

Avg. Cash Conversion Cycle 151.2 135.9 97.1 92.7 100.1 NA

Long Term Solvency

Total Debt/Equity 0.7% 5.9% NA 88.4% 48.3% 37.5%

Total Debt/Capital 0.6% 5.6% NA 46.9% 32.6% 27.3%

LT Debt/Equity 0.4% 0.1% NA 80.4% 48.3% 37.5%

LT Debt/Capital 0.4% 0.1% NA 42.7% 32.6% 27.3%

Total Liabilities/Total Assets 17.3% 22.1% 16.7% 57.3% 41.8% 38.8%

EBIT / Interest Exp. 172.0x 38.9x 531.2x 26.1x 8.8x 16.5x

EBITDA / Interest Exp. 267.5x 67.7x 635.2x 31.0x 10.5x 18.5x

(EBITDA-CAPEX) / Interest Exp. NM 13.0x 251.1x 15.1x 8.3x 18.5x

Total Debt/EBITDA 0.0x 0.4x NA 2.3x 1.2x 0.8x

Net Debt/EBITDA NM 0.3x NM 2.0x 0.2x NM

Altman Z Score 6.8 NA NA NA 6.8 NA

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DCF Valuation AnalysisDCF Valuation Analysis

Section VSection V

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Ceradyne Model Assumptions

For the Fiscal Year Ending Dec. 31, 2006 2007 2008 2009 2010 2011

INCOME STATEMENT

Sales Growth 65.0% 50.0% 35.0% 17.0% 10.0% 3.0%Cost of Goods Sold/Sales 60.3% 59.3% 58.3% 57.3% 56.3% 55.3%R&D/Sales 4.0% 4.0% 4.0% 4.0% 4.0% 4.0%SG&A/Sales 11.3% 11.3% 11.3% 11.3% 11.3% 11.3%Dep&Amort/Avge PP&E and Intang. 8.8% 8.8% 8.8% 8.8% 8.8% 8.8%Interest Expense/Avge Debt 7.7% 7.7% 7.7% 7.7% 7.7% 7.7%Non-Operating Income/Sales 0.2% 0.2% 0.2% 0.2% 0.2% 0.2%Effective Tax Rate 35.5% 35.6% 35.7% 35.9% 36.0% 36.1%Minority Interest/After Tax Income 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Other Income/Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Ext. Items & Disc. Ops./Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Pref. Dividends/Avge Pref. Stock 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

BALANCE SHEET

Working Capital

Ending Operating Cash/Sales 27.0% 27.0% 27.0% 27.0% 27.0% 27.0%Ending Receivables/Sales 16.4% 16.4% 16.4% 16.4% 16.4% 16.4%Ending Inventories/COGS 29.9% 29.9% 29.9% 29.9% 29.9% 29.9%Ending Other Current Assets/Sales 7.9% 7.9% 7.9% 7.9% 7.9% 7.9%Ending Accounts Payable/COGS 10.5% 10.5% 10.5% 10.5% 10.5% 10.5%Ending Taxes Payable/Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Ending Other Current Liabs/Sales 5.3% 5.3% 5.3% 5.3% 5.3% 5.3%

Other Operating Assets

Ending Net PP&E/Sales 41.6% 41.6% 41.6% 41.6% 41.6% 41.6%Ending Investments/Sales 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Ending Intangibles/Sales 4.2% 4.2% 4.2% 4.2% 4.2% 4.2%Ending Other Assets/Sales 1.7% 1.7% 1.7% 1.7% 1.7% 1.7%

Other Operating Liabilities

Other Liabilities/Sales 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%Deferred Taxes/Sales 1.2% 1.2% 1.2% 1.2% 1.2% 1.2%

Financing

Current Debt/Total Assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Long-Term Debt/Total Assets 28.1% 28.1% 28.1% 28.1% 28.1% 28.1%Minority Interest/Total Assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Preferred Stock/Total Assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Dividend Payout Ratio 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

DCF Model AssumptionsDCF Model Assumptions

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DCF Model SummaryDCF Model Summary

CRDN September 15, 2006 Closing Price: $44.73

Ceradyne Model Valuation Summary

Valuation Parameters

Cost of Equity Capital 13.46%

Contingent Claims on Common Equity $0

Date of Valuation 9/17/2006

Splits Dilution Factor 0

Cost of Debt 4.27%

Cost of Preferred Stock 0.00%

DCF Valuation Estimated Share Price $43.38

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Recent NewsRecent News

Section VISection VI

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Recent Headlines on CeradyneRecent Headlines on Ceradyne

• Ceradyne upgraded by Wachovia – 9/15/06• Ceradyne Receives $9.1 Million Order From Department of

Defense for Protective Armor Inserts – 9/12/06• Ceradyne Receives $13.3 Million Order From U.S. Army for

Ceramic Body Armor – 9/11/06• Ceradyne Receives Nasdaq Delisting Warning Because of

Delinquency in Regulatory Filings – 8/21/06• Ceradyne Receives Mack Trucks Order Prototype Lightweight

Ceramic Armored Truck Cab – 8/8/06• Ceradyne Conducting an Ongoing Internal Investigation Into Its

Stock Options Accounting – 8/21/06• Ceradyne Considered a Potential Home Run Stock by Motley Fool

– 8/10/06

Ceradyne has found itself in the headlines within the past few months for both good and Ceradyne has found itself in the headlines within the past few months for both good and bad reasons.bad reasons.Ceradyne has found itself in the headlines within the past few months for both good and Ceradyne has found itself in the headlines within the past few months for both good and bad reasons.bad reasons.

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Investment SummaryInvestment Summary

Section VIISection VII

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Ceradyne SummaryCeradyne Summary

POSITIVES• Ceradyne has substantial growth potential and is trading at 14x PE

multiple. Its trading multiples are the lowest in a while.• Ceradyne continues to diversify its product line to hedge against risk of

losing U.S. Government contracts.• Ceradyne continues to beat earnings estimates and shows no signs of

slowing down, creating strong stock performance potential.

NEGATIVES• Ceradyne is delinquent in its regulatory filings because of an internal

accounting investigation into stock options.• Numerous companies have been faced with the same problems recently. It

seems inevitable that a restatement will occur. The question becomes, how big?

• The constant issue is risk vs. reward and whether or not Ceradyne’s growth potential compensates for maintaining a position amidst accounting concerns

Ceradyne has been a top performer for SMIP and the question becomes, is it time to take Ceradyne has been a top performer for SMIP and the question becomes, is it time to take gains, hold the position, or is this an opportunity to buy more?gains, hold the position, or is this an opportunity to buy more?Ceradyne has been a top performer for SMIP and the question becomes, is it time to take Ceradyne has been a top performer for SMIP and the question becomes, is it time to take gains, hold the position, or is this an opportunity to buy more?gains, hold the position, or is this an opportunity to buy more?