CRDN Ceradyne, Inc. (MM)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

Or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File No. 000-13059

CERADYNE, INC.

(Exact name of Registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		33-0055414 (I.R.S. Employer Identification No.)

3169 Red Hill Avenue, Costa Mesa, CA		92626
(Address of principal executive)		(Zip Code)

Registrant’s telephone number, including area code (714) 549-0421

N/A
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class		Outstanding as of October 17, 2008
Common Stock, $0.01 par value		26,273,911 Shares

Exhibit Index on Page 41

 

 

CERADYNE, INC.

INDEX

		PAGE NO.
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Consolidated Financial Statements			3
Consolidated Balance Sheets — September 30, 2008 and December 31, 2007			3
Consolidated Statements of Income — Three and Nine Months Ended September 30, 2008 and 2007			4
Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2008 and 2007			5
Notes to Consolidated Financial Statements			6-24
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			25-35
Item 3. Quantitative and Qualitative Disclosures About Market Risk			35-37
Item 4. Controls and Procedures			37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			38
Item 1A. Risk Factors			39
Item 2. Not applicable			39
Item 3. Not applicable			39
Item 4. Not applicable			39
Item 5. Not applicable			39
Item 6. Exhibits			39
SIGNATURE			40
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

CERADYNE, INC.
FORM 10-Q
FOR THE QUARTER ENDED
SEPTEMBER 30, 2008

PART I. FINANCIAL INFORMATION

Item 1. Unaudited Consolidated Financial Statements

CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)

		September 30,				December 31,
		2008				2007
		(Unaudited)
CURRENT ASSETS
Cash and cash equivalents		$	204,486			$	155,103
Restricted cash			2,699				2,660
Short-term investments			7,900				29,582
Accounts receivable, net of allowances for doubtful accounts of $1,038 and $792 at September 30, 2008 and December 31, 2007, respectively			64,138				85,346
Other receivables			8,360				5,704
Inventories, net			101,039				92,781
Production tooling, net			13,997				16,632
Prepaid expenses and other			29,880				12,391
Deferred tax asset			12,816				12,455
TOTAL CURRENT ASSETS			445,315				412,654
PROPERTY, PLANT AND EQUIPMENT, net			252,461				243,892
LONG TERM INVESTMENTS			29,489				38,089
INTANGIBLE ASSETS, net			84,491				37,578
GOODWILL			46,484				46,848
OTHER ASSETS			3,731				4,225
TOTAL ASSETS		$	861,971			$	783,286
CURRENT LIABILITIES
Accounts payable		$	29,156			$	35,990
Accrued expenses			26,492				22,483
Income taxes payable			788				258
TOTAL CURRENT LIABILITIES			56,436				58,731
LONG-TERM DEBT			121,000				121,000
EMPLOYEE BENEFITS			14,102				13,650
OTHER LONG TERM LIABILITY			41,501				4,985
DEFERRED TAX LIABILITY			5,677				6,291
TOTAL LIABILITIES			238,716				204,657
COMMITMENTS AND CONTINGENCIES (Note 15)
SHAREHOLDERS’ EQUITY
Common stock, $0.01 par value, 100,000,000 authorized, 26,273,611 and 27,318,530 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively			264				272
Additional paid-in capital			154,430				185,702
Retained earnings			446,798				361,301
Accumulated other comprehensive income			21,763				31,354
TOTAL SHAREHOLDERS’ EQUITY			623,255				578,629
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	861,971			$	783,286

See accompanying condensed notes to Consolidated Financial Statements

CERADYNE, INC.

CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(Unaudited)								(Unaudited)
NET SALES		$	167,746			$	191,606			$	541,258			$	565,408
COST OF GOODS SOLD			101,082				115,819				327,504				335,125
Gross profit			66,664				75,787				213,754				230,283
OPERATING EXPENSES
Selling			8,443				6,872				24,966				19,617
General and administrative			11,703				11,280				35,208				30,218
Acquisition related charge			9,783				—				9,783				—
Research and development			4,527				5,680				10,979				13,561
			34,456				23,832				80,936				63,396
INCOME FROM OPERATIONS			32,208				51,955				132,818				166,887
OTHER INCOME (EXPENSE):
Royalty income			5				30				65				105
Interest income			1,772				3,281				6,273				9,542
Interest expense			(1,026	)			(1,094	)			(3,130	)			(3,154	)
Miscellaneous			(2,581	)			(103	)			(1,908	)			54
			(1,830	)			2,114				1,300				6,547
INCOME BEFORE PROVISION FOR INCOME TAXES			30,378				54,069				134,118				173,434
PROVISION FOR INCOME TAXES			10,979				21,419				48,621				64,392
NET INCOME		$	19,399			$	32,650			$	85,497			$	109,042
BASIC INCOME PER SHARE		$	0.74			$	1.20			$	3.22			$	4.00
DILUTED INCOME PER SHARE		$	0.73			$	1.16			$	3.18			$	3.93
WEIGHTED AVERAGE SHARES OUTSTANDING:
BASIC			26,272				27,304				26,568				27,231
DILUTED			26,563				28,052				26,888				27,766

See accompanying condensed notes to Consolidated Financial Statements

CERADYNE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)

		Nine Months Ended
		September 30,
		2008				2007
		(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	85,497			$	109,042
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation and amortization			30,122				17,948
Deferred income taxes			421				(2,014	)
Stock compensation			2,233				1,842
Loss on marketable securities			3,545				—
Loss on equipment disposal			125				794
Change in operating assets and liabilities (net of effect of businesses acquired):
Accounts receivable, net			22,680				(12,995	)
Other receivables			(3,597	)			(1,735	)
Inventories, net			(5,079	)			(16,927	)
Production tooling, net			2,597				1,480
Prepaid expenses and other assets			(18,005	)			(1,167	)
Accounts payable and accrued expenses			(5,456	)			(4,418	)
Income taxes payable			549				(11,042	)
Other long term liability			10,350				6,964
Employee benefits			1,014				1,237
NET CASH PROVIDED BY OPERATING ACTIVITIES			126,996				89,009
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment			(35,938	)			(28,343	)
Changes in restricted cash			(39	)			(2,633	)
Purchases of marketable securities			—				(363,317	)
Proceeds from sales and maturities of marketable securities			21,700				397,912
Cash paid for acquisitions, net of cash received			(26,855	)			(98,606	)
Proceeds from sale of equipment			24				—
NET CASH USED IN INVESTING ACTIVITIES			(41,108	)			(94,987	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock due to exercise of options			302				603
Proceeds from issuance of stock for stock plans			—				1,085
Excess tax benefit due to exercise of stock options			287				4,133
Shares repurchased			(34,919	)			—
Other			—				48
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES			(34,330	)			5,869
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS			(2,175	)			1,708
INCREASE IN CASH AND CASH EQUIVALENTS			49,383				1,599
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			155,103				13,547
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	204,486			$	15,146
SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES:
Interest paid		$	1,744			$	1,756
Income taxes paid		$	62,692			$	67,286

See accompanying condensed notes to Consolidated Financial Statements

CERADYNE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2008
(Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement have been included. Operating results for the nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the Consolidated Financial Statements and Notes to Financial Statements included in Ceradyne’s Annual Report on Form 10-K for the year ended December 31, 2007.

Certain reclassifications have been made to the 2007 financial statements to conform to the 2008 presentation.

2. Share Based Compensation

See Note 4 below for information concerning an internal investigation into our stock option grant practices for the period of 1997 through June 30, 2006.

Share-based compensation expense recognized under Statement of Financial Accounting Standards No. 123(R) (“SFAS 123(R)”) for the three and nine months ended September 30, 2008 was $0.8 million and $2.2 million respectively, which was related to stock options and restricted stock units. This compared to $0.7 million and $1.8 million for the three and nine months ended September 30, 2007.

Share-based compensation expense is based on the value of the portion of share-based payment awards that is ultimately expected to vest. SFAS 123(R) requires forfeitures to be estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is based on historical rates. Share-based compensation expense recognized in the Company’s Consolidated Statements of Income for the three and nine month periods ended September 30, 2008 includes (i) compensation expense for share-based payment awards granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS 123 and (ii) compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). As share-based compensation expense recognized in the Consolidated Statements of Income for the three and nine month periods ended September 30, 2008 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures.

The Company maintains the 1994 Stock Incentive Plan and 2003 Stock Incentive Plan.

The Company was authorized to grant options for up to 2,362,500 shares under its 1994 Stock Incentive Plan. The Company has granted options for 2,691,225 shares and has had cancellations of 396,911 shares through September 30, 2008. There are no remaining stock options available to grant under this plan. The options granted under this plan generally became exercisable over a five-year period for incentive stock options and six months for nonqualified stock options and have a maximum term of ten years.

The 2003 Stock Incentive Plan was amended in 2005 to allow the issuance of Restricted Stock Units (the “Units”) to eligible employees and non-employee directors. The Units are payable in shares of the Company’s common stock upon vesting. For directors, the Units vest annually over three years on the anniversary date of their issuance. For officers and employees, the Units vest annually over five years on the anniversary date of their issuance.

The Company may grant options and Units for up to 1,125,000 shares under the 2003 Stock Incentive Plan. The Company has granted options for 475,125 shares and Units for 395,476 shares under this plan through September 30, 2008. There have been cancellations of 72,525 shares associated with this plan through September 30, 2008. The options under this plan have a life of ten years.

During the three and nine months ended September 30, 2008 and 2007, the Company issued Units to certain directors, officers and employees with weighted average grant date fair values and Units issued as indicated in the table below. Pursuant to SFAS 123(R), the Company records compensation expense for the amount of the grant date fair value on a straight line basis over the vesting period.

Share-based compensation expense reduced the Company’s results of operations as follows (dollars in thousands, except per share amounts):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Share-based compensation expense recognized:
General and administrative, options		$	112			$	176			$	345			$	552
General and administrative, restricted stock units			728				479				1,887				1,290
Related deferred income tax benefit			(305	)			(259	)			(810	)			(683	)
Decrease in net income		$	535			$	396			$	1,422			$	1,159
Decrease in basic earnings per share		$	0.02			$	0.01			$	0.05			$	0.04
Decrease in diluted earnings per share		$	0.02			$	0.01			$	0.05			$	0.04

The amounts above include the impact of recognizing compensation expense related to non-qualified stock options.

As of September 30, 2008, there was $0.8 million of total unrecognized compensation cost related to 25,875 non-vested outstanding stock options, with a per share weighted average fair value of $20.74. The unrecognized expense is anticipated to be recognized on a straight-line basis over a weighted average period of 1.2 years. In addition, the aggregate intrinsic value of stock options exercised was $0.6 million and $7.9 million for the nine months ended September 30, 2008 and 2007.

As of September 30, 2008, there was approximately $11.4 million of total unrecognized compensation cost related to non-vested Units granted under the 2003 Stock Incentive Plan. That cost is expected to be recognized over a weighted average period of 3.8 years.

The following is a summary of stock option activity:

		Nine Months Ended
		September 30, 2008
						Weighted
						Average
		Number of				Exercise
		Options				Price
Outstanding, December 31, 2007			497,325			$	12.04
Options granted			—			$	—
Options exercised			(24,525	)		$	8.63
Options cancelled			(3,750	)		$	15.05
Outstanding, September 30, 2008			469,050			$	12.20
Exercisable, September 30, 2008			443,175			$	11.70

The following is a summary of Unit activity:

		Nine Months Ended
		September 30, 2008
						Weighted
						Average Grant
		Units				Fair Value
Non-vested Units at December 31, 2007			149,759			$	52.94
Granted			168,076			$	40.54
Vested			(38,191	)		$	47.69
Forfeited			(2,400	)		$	63.16
Non-vested Units at September 30, 2008			277,244			$	46.04

The following table summarizes information regarding options outstanding and options exercisable at September 30, 2008:

		Outstanding																Exercisable
						Average				Weighted				Aggregate								Average				Weighted				Aggregate
						Remaining				Average				Intrinsic								Remaining				Average				Intrinsic
		Number of				Contractual				Exercise				Value				Number of				Contractual				Exercise				Value
Range of Exercise Prices		Options				Life (Years)				Price				(000s)				Options				Life (Years)				Price				(000s)
$1.44 – $2.81			3,150				1.22			$	1.61			$	31,800				3,150				1.22			$	1.61			$	110
$2.98 – $4.58			214,275				4.09			$	4.12			$	6,972				214,275				4.09			$	4.12			$	6,972
$10.53 – $16.89			125,625				5.69			$	16.89			$	2,484				125,625				5.69			$	16.89			$	2,484
$18.80 – $24.07			126,000				6.72			$	21.51			$	1,908				100,125				6.66			$	21.71			$	1,497
			469,050				5.20			$	12.20			$	11,474				443,175				5.10			$	11.70			$	11,063

The following table summarizes information regarding Units outstanding at September 30, 2008:

						Average				Weighted
						Remaining				Average
		Number of				Contractual				Grant
Range of Grant Prices		Units				Life (Years)				Fair Value
$21.46 – $22.68			21,800				1.65			$	22.34
$37.41 – $39.43			112,576				4.47			$	38.55
$42.28 – $45.7			63,838				4.13			$	44.49
$52.47 – $62.07			42,030				2.93			$	58.87
$66.35 – $81.18			37,000				3.33			$	70.88
			277,244				3.78			$	46.04

3. Acquisitions

Acquisition of SemEquip, Inc.

On August 11, 2008, the Company completed the acquisition of SemEquip, Inc. (“SemEquip”) pursuant to a merger of SemEquip with a wholly-owned subsidiary of Ceradyne. SemEquip is a leader in the development of cluster ion implantation sub-systems and advanced ion source materials for the manufacture of logic and memory chips. SemEquip’s technologies enable the utilization of cluster beam ion implantation for manufacturing advanced integrated circuits at low cost and high throughput rates. Ceradyne paid $25.0 million in cash at closing, of which $1.7 million was distributed as incentive compensation to several SemEquip employees and advisors as described below, and incurred direct transaction fees and expenses of $1.9 million. Ceradyne used a portion of its existing cash to make these payments. In addition, Ceradyne will pay contingent consideration of up to $100.0 million in cash during the 15-year period following completion of the merger based upon revenues achieved over that period by SemEquip. The $1.7 million portion of the closing date consideration paid to SemEquip employees and advisors and a portion of the contingent consideration to be paid by Ceradyne over 15 years relates to a pre-closing commitment by SemEquip to pay incentive compensation to several of its employees and advisors. This incentive compensation will not increase the total consideration Ceradyne will pay for the acquisition, but it required Ceradyne to record a $9.8 million pre-tax compensation charge during the quarter ended September 30, 2008. The preliminary net value of fair value of assets acquired and liabilities assumed exceeded the total amount of the purchase price paid. As the Company may be required to pay contingent consideration in the future, the Company accrued an additional $26.2 million of purchase consideration to represent the difference between the net fair value of assets acquired and liabilities assumed and the purchase price paid.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” the acquisition has been accounted for under the purchase method of accounting. Under the purchase method of accounting, the assets acquired and liabilities assumed are recorded at the date of acquisition at their respective fair values.

The total purchase price of the SemEquip acquisition was as follows (in thousands):

Cash consideration paid to SemEquip stockholders		$	23,315
Accrued purchase consideration			26,166
Direct transaction fees and expenses			1,867
Total purchase price		$	51,348

The above purchase price has been allocated based on the fair values of assets acquired and liabilities assumed.

The purchase price has been allocated as follows (in thousands):

Cash		$	2,192
Inventories			3,574
Accounts receivable, net			446
Other current assets			276
Property, plant and equipment			1,071
Intangible assets			48,189
Accounts payable and other liabilities			(3,685	)
Non-current deferred tax liability, net of $17.8 million deferred tax asset (see Note 14)			(715	)
Net assets acquired		$	51,348

The purchase price allocation is preliminary, pending completion of the valuation of acquired intangible assets, filing of final income tax returns and completion of the evaluation of potential utilization restrictions on the acquired net operating loss (“NOL”) carryforward as further discussed in Note 14. The final valuation may change the allocation of the purchase price, which could affect the fair value assigned to the assets and liabilities and could result in a change to the unaudited pro forma information presented below. Of the $48.2 million of acquired intangible assets, $26.9 million was assigned to developed technology rights that have a useful life of approximately 10 years and $21.3 million was assigned to customer relationships with a useful life of approximately 10 years. The amounts assigned to intangible assets were based on management’s preliminary estimate of the fair value. Developed technology rights recorded in connection with the acquisition of SemEquip were established as intangible assets under paragraph 39 of SFAS 141 as the underlying technologies are legally protected by patents covering the alternative ion implantation process using “cluster boron” technology. The developed technology rights are both transferable and separable from the acquired entity.

Identification and allocation of value to the identified intangible assets was based on the provisions of SFAS No. 141. The fair value of the identified intangible assets was estimated by performing a discounted cash flow analysis using the “income” approach. This method includes a forecast of direct revenues and costs associated with the respective intangible assets and charges for economic returns on tangible and intangible assets utilized in cash flow generation. Net cash flows attributable to the identified intangible assets are discounted to their present value at a rate commensurate with the perceived risk. The projected cash flow assumptions considered contractual relationships, customer attrition, eventual development of new technologies and market competition.

The estimates of expected useful lives were based on guidance from SFAS No. 141 and take into consideration the effects of competition, regulatory changes and possible obsolescence. The useful lives of technology rights were based on the number of years in which net cash flows have been projected. The useful lives of customer relationships were estimated based upon the length of the contracts currently in place and probability-based estimates of contract renewals in the future.

Assumptions used in forecasting cash flows for each of the identified intangible assets included consideration of the following:

	•		SemEquip historical operating margins and performance of comparable publicly traded entities
	•		Number of customers and SemEquip market share
	•		Contractual and non-contractual relationships with large customers, and
	•		Patents held

The results of operations of SemEquip have been included in the accompanying consolidated statements of operations from the acquisition date. The following unaudited pro forma information assumes the SemEquip acquisition occurred at the beginning of each period presented below. Accordingly, pro forma adjustments have been included in the information below for disclosure purposes only. These unaudited pro forma results have been prepared for informational purposes only and do not purport to represent what the results of operations would have been had the SemEquip acquisition occurred as of the date indicated, nor of future results of operations. The unaudited pro forma results for three and nine months ended September 30, 2008 and September 30, 2007 were as follows (amounts in table in thousands, except per share data):

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2008				2007				2008				2007
Net sales		$	168,108			$	192,530			$	544,039			$	568,610
Net income (1) (2)			18,711				24,805				81,652				96,427
Basic income per share		$	0.71			$	0.91			$	3.07			$	3.54
Diluted income per share		$	0.70			$	0.88			$	3.04			$	3.47

Asset Purchase — Proprietary Technical Ceramic Bearing Technology

In June 2008, the Company completed the purchase of certain assets and developed technology related to proprietary technical ceramic bearings. These patented bearings are used for “down hole” oil drilling and for coal bed methane pumps and steam assisted oil extraction pumps. The purchase price was approximately $3.9 million in cash, which included $115,000 of transaction costs. In addition, the Company will make future payments of (1) $250,000 upon the relocation of certain key employees; (2) up to an additional $2.0 million if certain revenue milestones are achieved, and (3) a royalty of three percent of net sales of these bearings for the life of the acquired patents. The Company considers this acquisition to be immaterial.

In accordance with SFAS No. 141, the acquisition has been accounted for under the purchase method of accounting. The following table summarizes the components of the purchase price (in thousands):

Cash		$	3,750
Transaction costs			115
Total purchase price		$	3,865
Fair value of assets acquired:
Fixed assets		$	29
Customer relationships			120
Developed technology			3,716
Total fair value of assets acquired		$	3,865

4. Review of Historical Stock Option Grant Procedures Share Based Compensation

In July 2006, the Company voluntarily initiated a review of its historical stock option grant practices and related accounting treatment. The review was conducted by a Special Committee comprised of three independent members of the Company’s Board of Directors, with the assistance of independent legal counsel and forensic accounting experts. The scope of the Special Committee’s review included all stock options granted by the Company from January 1997 through September 2003. The Special Committee has completed its review.

Until September 2003, stock option grants generally were approved by unanimous written consents signed by the members of the Stock Option Committee of the Board of Directors. Throughout this period, the Stock Option Committee consisted of the CEO and one other non-management Director. The date specified as the grant date in each unanimous written consent was used (i) to determine the exercise price of the options and (ii) as the accounting measurement date.

The review found that from January 1997 through September 2003, the date selected by management as the grant date and accounting measurement date was the date specified in the unanimous written consent, but that, in all but one case, the unanimous written consents were not prepared, approved or executed by the Company’s Stock Option Committee until a later date. There were a total of 23 grant dates from January 1997 through September 2003. The Company’s CEO was responsible for selecting the grant dates and followed a consistent practice of seeking low grant prices and he was unaware of the accounting implications of the method he used. Therefore, the use of the date specified in the unanimous written consent as the accounting measurement date was incorrect in all but one case. The proper accounting measurement date was the date the unanimous written consent was signed by the members of the Stock Option Committee.

Based upon information gathered during the review by independent legal counsel, the Special Committee and the Board of Directors have concluded that, while the Company applied an option price date selection practice that resulted in the use of incorrect accounting measurement dates for options granted between January 1997 and September 2003, the accounting errors resulting from the use of incorrect measurement dates were not the product of any deliberate or intentional misconduct by the Company or its executives, staff or Board of Directors. However, as a result of using revised measurement dates for options granted from January 1997 through September 2003, the Company recorded a charge in the second quarter ended June 30, 2006 of $3.4 million ($2.3 million after income taxes) pertaining to the years ended December 31, 1997 to 2005 and the six months ended June 30, 2006 (the “Stock-Based Charge”). The Stock-Based Charge was included as a component of general and administrative expenses in the consolidated statements of income as this is where the affected individual’s normal compensation costs are recorded. The Stock-Based Charge includes non-cash compensation expense of $2.2 million ($1.4 million after income taxes) primarily related to stock option grants made during the period from January 1997 through September 2003 that should have been measured as compensation cost at the actual stock option grant dates, and subsequently amortized to expense over the vesting period for each stock option grant. The Stock-Based Charge also includes $1.2 million ($0.9 million after income taxes) of estimated additional employment and other taxes that are expected to become payable.

From September 2003 to February 2005, all stock option grants have been approved at meetings held by the Stock Option Committee, and, since February 2005, all stock option grants have been approved at meetings held by the Compensation Committee of the Board of Directors. The dates of these meetings have been used correctly as the accounting measurement date for all stock options granted since September 2003.

Had this estimated Stock-Based Charge been reflected, as and when incurred, in the Company’s results of operations for prior years, the impact on net income for Ceradyne’s fiscal years ended December 31 would have been a reduction of $21,000 in 1997, a reduction of $45,000 in 1998, a reduction of $47,000 in 1999, a reduction of $104,000 in 2000, a reduction of $269,000 in 2001, a reduction of $74,000 in 2002, a reduction of $347,000 in 2003, a reduction of $0.6 million in 2004, and a reduction of $324,000 in 2005. As of September 30, 2008, the total remaining incremental stock-based compensation charge related to these stock option grants that are expected to vest in future periods with a revised accounting measurement date is immaterial. There was no impact on revenue or net cash provided by operating activities as a result of the estimated compensation charge.

The Company does not believe that a restatement of its prior-period financial statements is required for the Stock-Based Charge. Based on the materiality guidelines contained in SEC Staff Accounting Bulletin No. 99, Materiality (“SAB 99”), the Company believes that the Stock-Based Charge is not material to any of the individual prior periods affected and the aggregate Stock-Based Charge is not material to the results for the year ended December 31, 2006.

Prior to December 31, 2006, the current members of Ceradyne’s Board of Directors, all current executive officers and all other employees of the Company amended all unexercised stock options they held which had an exercise price that is less than the price of the Company’s common stock on the actual date of grant, by increasing the exercise price to an amount equal to the closing price of the common stock as of the actual grant date. The Company has reimbursed and will continue to reimburse all non-executive officer employees for the increase in the exercise price for the modified options as they vest. Such reimbursement has not been and will not be material.

5.

Net Income Per Share

Basic net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding plus the effect of any dilutive stock options and restricted stock units using the treasury stock method and the net share settlement method for the convertible debt. During the three and nine month periods ended September 30, 2007, the average trading price of the Company’s stock exceeded the conversion price of the convertible debt. However, during the three and nine month periods ended September 30, 2008, the average trading price of the Company’s stock did not exceed the conversion price of the convertible debt. The potential common shares that would be contingently issueable upon the conversion of the debt are included in the number of shares used in fully diluted computations.

The following is a summary of the number of shares entering into the computation of net income per common and potential common shares:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Weighted average number of shares outstanding			26,271,812				27,304,227				26,568,011				27,230,846
Dilutive stock options			261,487				292,885				256,585				291,988
Dilutive restricted stock units			30,066				27,544				63,655				41,626
Dilutive contingent convertible debt common shares			—				427,201				—				201,865
Number of shares used in fully diluted computations			26,563,365				28,051,857				26,888,251				27,766,325

6. Composition of Certain Financial Statement Captions

The Company holds certain cash balances that are restricted as to use. The restricted cash is used as collateral for the Company’s partially self insured workers compensation policy.

Inventories are valued at the lower of cost (first in, first out) or market. Inventory costs include the cost of material, labor and manufacturing overhead. The following is a summary of the inventory components as of September 30, 2008 and December 31, 2007 (in thousands):

		September 30, 2008				December 31, 2007
Raw materials		$	18,990			$	22,772
Work-in-process			49,449				46,853
Finished goods			32,600				23,156
		$	101,039			$	92,781

Property, plant and equipment are recorded at cost and consists of the following (in thousands):

		September 30, 2008				December 31, 2007
Land		$	17,262			$	15,086
Buildings and improvements			96,045				88,906
Machinery and equipment			198,568				179,998
Leasehold improvements			8,427				8,897
Office equipment			23,537				19,975
Construction in progress			15,794				16,880
			359,633				329,742
Less accumulated depreciation and amortization			(107,172	)			(85,850	)
		$	252,461			$	243,892

The components of intangible assets are as follows (in thousands):

		September 30, 2008												December 31, 2007
		Gross				Accumulated				Net				Gross				Accumulated				Net
		Amount				Amortization				Amount				Amount				Amortization				Amount
Amortizing Intangible Assets
Backlog		$	1,795			$	1,795			$	—			$	1,795			$	1,795			$	—
Developed technology			40,964				2,415				38,549				11,617				1,666				9,951
Tradename			1,110				261				849				1,110				142				968
Customer relationships			46,604				4,506				42,098				25,230				947				24,283
Non-compete agreement			500				459				41				500				178				322
Non-amortizing tradename			2,054				—				2,054				2,054				—				2,054
Total		$	94,027			$	9,536			$	84,491			$	42,306			$	4,728			$	37,578

The estimated useful lives for intangible assets are:

Identified Intangible Asset		Estimated Useful Life in Years or Months
Developed technology		10 years – 12.5 years
Tradename		10 years
Customer relationships		10 years – 12.5 years
Backlog		1 month – 3 months
Non-compete agreement		15 months

Amortization of definite-lived intangible assets will be approximately (in thousands): $6,644 in fiscal year 2008, $6,976 in fiscal year 2009, $6,746 in fiscal year 2010, $7,301 in fiscal year 2011 and $7,996 in fiscal year 2012.

The roll forward of the goodwill balance by segment for the nine months ended September 30, 2008 is as follows (in thousands):

		ACO				Semicon				Thermo				ESK				Canada				Boron				Total
December 31, 2007		$	2,608			$	603			$	11,378			$	10,176			$	3,832			$	18,251			$	46,848
Foreign Currency Translation			—				—				—				(364	)			—				—				(364	)
September 30, 2008		$	2,608			$	603			$	11,378			$	9,812			$	3,832			$	18,251			$	46,484

7. Stock Repurchases

During the nine months ended September 30, 2008, the Company repurchased and retired 1,128,237 shares of its common stock at an aggregate cost of $34.9 million under a stock repurchase program authorized by the Company’s Board of Directors. The Company is authorized to repurchase an additional $65.1 million for a total of $100.0 million.

8. Fair Value Measurements

On January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). This new standard addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. In accordance with FASB Staff Position FAS 157-2, Effective Date of SFAS. 157, the Company deferred the adoption of SFAS 157 for one year for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis.

SFAS 157 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1: quoted market prices in active markets for identical assets and liabilities

Level 2: observable market based inputs or unobservable inputs that are corroborated by market data

Level 3: unobservable inputs that are not corroborated by market data

The carrying value of cash and cash equivalents, accounts receivable and trade payables approximates the fair value due to their short-term maturities.

For recognition purposes, on a recurring basis, the Company measures available for sale short-term and long-term investments at fair value. Short-term investments had an aggregate fair value of $7.9 million at September 30, 2008 and $29.6 million at December 31, 2007. The fair value of these investments is determined using quoted prices in active markets. Long-term investments, comprising auction rate securities, had an aggregate fair value of $29.5 million at September 30, 2008 and $38.1 million at December 31, 2007. During the three and nine months ended September 30, 2008, the Company recognized pre-tax charges of $3.0 million and $3.5 million, respectively, due to other-than-temporary reductions in the value of its investments in auction rate securities. The Company also recognized pre-tax charges of $2.7 million and $5.1 million against other comprehensive income during the three and nine months ended September 30, 2008, respectively, due to temporary reductions in the value of its investments in auction rate securities. Cumulatively to date, the Company has incurred $5.7 million in pre-tax charges due to other-than-temporary reductions in the value of its investments in auction rate securities and pre-tax temporary impairment charges against other comprehensive income of $5.8 million. The Company’s investments in auction rate securities represent interests in insurance securitizations supported by pools of residential and commercial mortgages, asset backed securities and other structured credits relating to the credit risk of various bond guarantors. These auction rate securities were intended to provide liquidity via an auction process that resets the applicable interest rate at predetermined calendar intervals, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. During the second half of the year 2007 and the first nine months of 2008, the auctions for these securities failed. As a result of current negative conditions in the global credit markets, auctions for the Company’s investment in these securities have recently failed to settle on their respective settlement dates. Consequently, the investments are not currently liquid through the normal auction process and may be liquid if a buyer is found outside the auction process.

Prior to June 30, 2008, the Company was able to determine the fair value of its investments in auction rate securities using a market approach valuation technique based on Level 2 inputs that did not require significant adjustment. Since June 30, 2008, the market demand for auction rate securities has declined significantly due to the complexity of these instruments, the difficulty of determining the values of some of the underlying assets, declines in the issuer’s credit quality and disruptions in the credit markets. At September 30, 2008, the Company determined that the market for its investments in auction rate securities and for similar securities was not active since there were few observable or recent transactions for these securities or similar securities. The Company’s investments in auction rate securities were classified within Level 3 of the fair value hierarchy because the Company determined that significant adjustments using unobservable inputs were required to determine fair value as of September 30, 2008.

An auction rate security is a type of structured financial instrument where its fair value can be estimated based on a valuation technique that includes the present value of future cash flows (principal and interest payments), review of the underlying collateral and considers relevant probability weighted and risk adjusted observable inputs and minimizes the use of unobservable inputs. Probability weighted inputs included the following:

	•		Probability of earning maximum rate until maturity
	•		Probability of passing auction at some point in the future
	•		Probability of default at some point in the future (with appropriate loss severity assumptions)

The Company determined that the appropriate risk-free discount rate (before risk adjustments) used to discount the contractual cash flows of its auction rate securities ranged from 1.2 to 4.8 percent, based on the term structure of the auction rate security. Liquidity risk premiums are used to adjust the risk-free discount rate for each auction rate security to reflect uncertainty and observed volatility of the current market environment. The risk of nonperformance has been captured within the probability of default and loss severity assumptions noted above. The risk-adjusted discount rate, which incorporates liquidity risk, appropriately reflects the Company’s estimate of the assumptions that market participants would use (including probability weighted inputs noted above) to estimate the selling price of the asset at the measurement date.

In determining whether the decline in value of the auction rate securities (“ARS”) investments was other-than-temporary, the Company considered several factors including, but not limited to, the following: (1) the reasons for the decline in value (credit event, interest related or market fluctuations); (2) the Company’s ability and intent to hold the investments for a sufficient period of time to allow for recovery of value; (3) whether the decline is substantial; and (4) the historical and anticipated duration of the events causing the decline in value. The evaluation for other-than-temporary impairments is a quantitative and qualitative process, which is subject to various risks and uncertainties. The risks and uncertainties include changes in the credit quality of the securities, changes in liquidity as a result of normal market mechanisms or issuer calls of the securities, and the effects of changes in interest rates.

With respect to the ARS that have had temporary reductions, the Company has the intent and ability to hold the ARS investments until recovery of fair value, which may be maturity or earlier if called, and therefore does not consider these unrealized losses to be other-than-temporary.

At September 30, 2008, the Company had no derivative financial instruments.

Assets measured at fair value on a recurring basis include the following as of September 30, 2008:

		Fair Value Measurements at September 30, 2008
		Using
						Significant
		Quoted Prices				Other				Significant				Total Carrying
		in Active				Observable				Unobservable				Value at
		Markets				Inputs				Inputs				September 30,
(In thousands)		(Level 1)				(Level 2)				(Level 3)				2008
Cash and cash equivalents (including restricted cash)		$	207,185			$	—			$	—			$	207,185
Short term investments			7,900				—				—				7,900
Long term investments			—				—				29,489				29,489
Other long-term financial asset		$	1,797			$	—			$	—			$	1,797

On a nonrecurring basis, the Company is required to use fair value measures when measuring plan assets of the Company’s pension plans. As the Company elected to adopt the measurement date provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, as of January 1, 2007, the Company was required to determine the fair value of the Company’s pension plan assets as of December 31, 2007. The fair value of pension plan assets was $8.9 million at December 31, 2007. These assets are valued in highly liquid markets.

Additionally, on a recurring basis, the Company uses fair value measures when analyzing asset impairment. Long-lived tangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization periods, their carrying values are reduced to estimated fair value. Estimated fair value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. During the fourth quarter of each year, the Company evaluates goodwill and indefinite-lived intangibles for impairment using the income approach. The income approach is a valuation technique under which estimated future cash flows are discounted to their present value to calculate fair value. When analyzing indefinite-lived intangibles for impairment, the Company uses a relief from royalty method which calculates the cost savings associated with owning rather than licensing the trade name, applying an assumed royalty rate within the Company’s discounted cash flow calculation.

For disclosure purposes, the Company is required to measure the fair value of outstanding debt on a recurring basis. The fair value of outstanding debt is determined using quoted prices in active markets. Long-term debt is reported at amortized cost in accordance with SFAS No. 107, “Disclosure about Fair Value of Financial Instruments.” The fair value of long-term debt, based on quoted market prices, was $111.6 million at September 30, 2008 and $128.7 million at December 31, 2007.

9. Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141R, “Business Combinations ” (“SFAS 141R”) which establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations the Company engages in will be recorded and disclosed following existing generally accepted accounting principles (“GAAP”) until January 1, 2009. The Company does not expect SFAS No. 141R to have a significant impact on its consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions the Company consummates after the effective date. The Company is evaluating the impact of this standard on future acquisitions and currently does not expect it to have a significant impact on its financial position, results of operations or cash flows.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 introduces significant changes in the accounting and reporting for business acquisitions and noncontrolling interest (“NCI”) in a subsidiary. SFAS 160 also changes the accounting for and reporting for the deconsolidation of a subsidiary. Companies are required to adopt the new standard for fiscal years beginning after January 1, 2009. The Company is evaluating the impact of this standard and currently does not expect it to have a significant impact on its financial position, results of operations or cash flows.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“SFAS 161”), which changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Companies are required to adopt SFAS 161 for fiscal years beginning after November 15, 2008. The Company is currently evaluating the impact of this standard and currently does not expect it to have a significant impact on its financial position, results of operations or cash flows.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” The statement is intended to improve financial reporting by identifying a consistent hierarchy for selecting accounting principles to be used in preparing financial statements that are prepared in conformance with generally accepted accounting principles. Unlike Statement on Auditing Standards (SAS) No. 69, “The Meaning of Present in Conformity With GAAP,” FAS No. 162 is directed to the entity rather than the auditor. The statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (PCAOB) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with GAAP,” and is not expected to have any impact on the Company’s results of operations, financial condition or liquidity.

In May 2008, FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP No. APB 14-1”) was issued which specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the issuer’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP No. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is not permitted. The Company is currently evaluating the impact of this standard which will reduce reported earnings upon adoption.

In June 2008, the FASB issued FSP Emerging Issues Task Force (EITF) No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” Under the FSP, unvested share-based payment awards that contain rights to receive nonforfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing EPS. The FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those years, and is not expected to have a significant impact on the Company’s results of operations, financial condition or cash flows.

In April 2008, FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. FAS 142-3”) was issued which provides for additional considerations to be used in determining useful lives and requires additional disclosure regarding renewals. FSP No. FAS 142-3 is effective for fiscal years beginning after December 15, 2008. Early adoption is not permitted. The Company is currently evaluating the impact of this standard.

In October 2008, the FASB issued FSP SFAS No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active”, (“FSP 157-3”), to clarify the application of the provisions of SFAS 157 in an inactive market and how an entity would determine fair value in an inactive market. FSP 157-3 was effective upon issuance and applies to the Company’s current financial statements. The application of the provisions of FSP 157-3 did not materially affect the Company’s results of operations or financial condition as of and for the three and nine months ended September 30, 2008.

10. Convertible Debt and Credit Facility

During December 2005, the Company issued $121.0 million of 2.875% senior subordinated convertible notes (“Notes”) due December 15, 2035.

Interest on the Notes is payable on December 15 and June 15 of each year, commencing on June 15, 2006. The Notes are convertible into 17.1032 shares of Ceradyne’s common stock for each $1,000 principal amount of the Notes (which represents a conversion price of approximately $58.47 per share), subject to adjustment. The Notes are convertible only under certain circumstances, including if the price of the Company’s common stock reaches specified thresholds, if the Notes are called for redemption, if specified corporate transactions or fundamental changes occur, or during the 10 trading days prior to maturity of the Notes. The Company may redeem the Notes at any time after December 20, 2010, for a price equal to 100% of the principal amount plus accrued and unpaid interest, including contingent interest (as described below), if any, up to but excluding the redemption date.

With respect to each $1,000 principal amount of the Notes surrendered for conversion, the Company will deliver the conversion value to holders as follows: (1) an amount in cash equal to the lesser of (a) the aggregate conversion value of the Notes to be converted and (b) $1,000, and (2) if the aggregate conversion value of the Notes to be converted is greater than $1,000, an amount in shares or cash equal to such aggregate conversion value in excess of $1,000.

The Notes contain put options, which may require the Company to repurchase in cash all or a portion of the Notes on December 15, 2012, December 15, 2015, December 15, 2020, December 15, 2025, and December 15, 2030 at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased plus accrued and unpaid interest, including contingent interest (as described below), if any, up to but excluding the repurchase date.

The Company is obligated to pay contingent interest to the holders of the Notes during any six-month period from June 15 to December 14 and from December 15 to June 14, commencing with the six-month period beginning December 20, 2010 and ending on June 14, 2011, if the average trading price of the note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period equals $1,200 (120% of the principal amount of a note) or more. The amount of contingent interest payable per note for any relevant contingent interest period shall equal 0.25% per annum of the average trading price of a note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period. This contingent interest payment feature represents an embedded derivative. However, based on the de minimus value associated with this feature, no value has been assigned at issuance and at September 30, 2008.

On or prior to the maturity date of the Notes, upon the occurrence of a fundamental change, under certain circumstances, the Company will provide for a make whole amount by increasing, for the time period described herein, the conversion rate by a number of additional shares for any conversion of the Notes in connection with such fundamental change transactions. The amount of additional shares will be determined based on the price paid per share of Ceradyne’s common stock in the transaction constituting a fundamental change and the effective date of such transaction. This make whole premium feature represents an embedded derivative. Since this feature has no measurable impact on the fair value of the Notes and no separate trading market exists for this derivative, the value of the embedded derivative was determined to be de minimus. Accordingly, no value has been assigned at issuance or at September 30, 2008.

The Company utilizes a convertible bond pricing model and a probability weighted valuation model, as applicable, to determine the fair values of the embedded derivatives noted above.

In December 2005, the Company established a new unsecured $10.0 million line of credit. As of September 30, 2008, there were no outstanding amounts on the line of credit. However, the available line of credit at September 30, 2008 has been reduced by an outstanding letter of credit in the amount of $1.3 million. The interest rate on the credit line is based on the LIBOR rate for a period of one month, plus a margin of 0.625 percent, which equaled 4.6% as of September 30, 2008.

Pursuant to the bank line of credit, the Company is subject to certain covenants, which include, among other things, the maintenance of specified minimum amounts of tangible net worth and quick assets to current liabilities ratio. At September 30, 2008, the Company was in compliance with these covenants.

11. Disclosure About Segments of an Enterprise and Related Information

The Company serves its markets and manages its business through six operating segments, each of which has its own manufacturing facilities and administrative and selling functions. The Company’s Advanced Ceramic Operations, located in Costa Mesa and Irvine, California, Lexington, Kentucky and Wixom, Michigan primarily produces armor, orthodontic products, diesel engine parts, components for semiconductor equipment, and houses the Company’s SRBSN research and development activities. The Company’s cathode development and production are handled through its Semicon Associates division located in Lexington, Kentucky. Fused silica products, including missile radomes and crucibles for photovoltaic solar cell applications are produced at the Company’s Thermo Materials division located in Scottdale and Clarkston, Georgia. The Company’s manufacturing facility in Tianjin, China produces fused silica crucibles, and is part of the Thermo Materials operating segment. Minco, Inc., which Ceradyne acquired on July 10, 2007, also is included in the Thermo Materials operating segment. Minco manufactures fused silica, which is a primary raw material used in products manufactured by our Thermo Materials division. The Company’s ESK Ceramics subsidiary is located in Kempten, Germany and Bazet, France. This subsidiary produces ceramic powders, including boron carbide powder for ceramic body armor, evaporation boats for metallization, functional and frictional coatings utilized in the automotive and textile industries, high performance pump seals, fluid handling, refractory products and ceramic powders used in cosmetics. The Company’s Ceradyne Canada subsidiary acquired certain assets in June 2006, including a building, equipment and technology, related to the production of structural neutron absorbing materials for use in the storage of spent nuclear rods. The building and operations of Ceradyne Canada are located in Chicoutimi, Quebec, Canada. The Boron segment comprises Boron Products, LLC, acquired in August 2007, which conducts business as Ceradyne Boron Products and SemEquip, Inc, which was acquired in August 2008. Ceradyne Boron Products owns certain assets, including approximately 155 acres and several buildings, equipment and technology, related to the production of the boron isotope ¹⁰ B. This isotope is a strong neutron absorber and is used for both nuclear waste containment and nuclear power plant neutron radiation control. Ceradyne Boron Products also produces complementary chemical isotopes used in the normal operation and control of nuclear power plants. SemEquip develops cluster ion implantation sub-systems and advanced ion source materials for the manufacture of logic and memory chips.

Ceradyne’s six segment facilities and products are summarized in the following table:

Operating Segment and Facility Location		Products
Ceradyne Advanced Ceramic Operations		Defense Applications:
		•     Lightweight ceramic armor
Costa Mesa and Irvine, California (1)		Industrial Applications:
Approximately 240,000 square feet		•     Ceralloy ® 147 SRBSN wear parts     •     Precision ceramics
Lexington, Kentucky (2)		Automotive/Diesel Applications:
Approximately 115,000 square feet		•     Ceralloy ® 147 SRBSN automotive/diesel engine parts
Wixom, Michigan (3)		Commercial Applications:
Approximately 29,000 square feet		•     Clarity ® ceramic orthodontic brackets
		•     Components for medical devices
ESK Ceramics		Defense Applications:
		•     Boron carbide powders for body armor
Kempten, Germany (4)
Approximately 548,000 square feet		Industrial Applications:
Bazet, France (5)		•     Ceramic powders: boron carbide, boron nitride, titanium diboride, calcium hexaboride and zirconium diboride
Approximately 88,000 square feet		•     Silicon carbide parts
		•     Evaporation boats for the packaging industry
		•     High performance pump seals
		Automotive/Diesel Applications:
		•     EKagrip ® functional and frictional coatings
		Commercial Applications:
		•    BORONEIGE ® boron nitride powder for cosmetics
Ceradyne Semicon Associates		Industrial Applications:
Lexington, Kentucky (6)      Approximately 35,000 square feet		•     Ceramic-impregnated dispenser cathodes for microwave tubes, lasers and cathode ray tubes
		•     Samarium cobalt magnets
Ceradyne Thermo Materials		Defense Applications:
Scottdale and Clarkston, Georgia (7)      Approximately 225,000 square feet		•     Missile radomes (nose cones)     •     High purity fused silica used to manufacture missile radomes (nose cones)
Tianjin, China (8)		Industrial Applications:
Approximately 98,000 square feet      Midway, Tennessee (9)      Approximately 105,000 square feet		•     Glass tempering rolls     •     Metallurgical tooling     •     Castable and other fused silica products     •     Crucibles for photovoltaic solar cell applications     •     Turbine components used in aerospace applications
Ceradyne Canada		Industrial Applications:
Chicoutimi, Quebec, Canada (10)      Approximately 86,000 square feet		•     Boral ® structural neutron absorbing materials     •     Metal matrix composite structures

Operating Segment and Facility Location		Products
Boron		Industrial Applications:
Quapaw, Oklahoma (11)		Nuclear Applications:
Approximately 128,000 square feet      North Billerica, Massachusetts (12)      Approximately 26,000 square feet		•     Nuclear chemistry products for use in pressurized water reactors and boiling water reactors     •     Radioactive containment for use in spent fuel transport and storage     •     Burnable poisons for coating of uranium fuel pellets
		Semiconductor Applications:
		•     P-dopants for silicon manufacturing     •     P-dopants for ion implanting of silicon wafers     •     Development of cluster ion implantation sub-systems     •     Advanced ion source materials for the manufacture of logic and memory chips

The financial information for all segments is presented below (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Revenue from External Customers
ACO		$	110,115			$	145,881			$	359,438			$	447,069
ESK Ceramics			38,032				39,009				122,961				121,463
Semicon Associates			2,264				1,640				6,609				6,021
Thermo Materials			20,675				10,250				59,707				18,534
Ceradyne Canada			91				1,389				4,899				3,172
Boron			4,308				2,114				14,548				2,114
Inter-segment elimination			(7,739	)			(8,677	)			(26,904	)			(32,965	)
Total		$	167,746			$	191,606			$	541,258			$	565,408
Depreciation and Amortization
ACO		$	3,134			$	2,303			$	8,125			$	6,880
ESK Ceramics			3,434				2,839				9,944				7,801
Semicon Associates			465				92				640				261
Thermo Materials			1,465				1,087				4,051				1,732
Ceradyne Canada			256				177				749				529
Boron			3,300				745				6,613				745
Total		$	12,054			$	7,243			$	30,122			$	17,948
Segment Income (Loss) before Provision for Income Taxes
ACO		$	35,400			$	52,332			$	121,598			$	165,611
ESK Ceramics			(79	)			2,103				5,302				10,446
Semicon Associates			341				78				1,079				577
Thermo Materials			6,815				(30	)			15,833				492
Ceradyne Canada			(344	)			(342	)			362				(2,430	)
Boron			(12,836	)			(84	)			(12,503	)			(84	)
Inter-segment elimination			1,081				12				2,447				(1,178	)
Total		$	30,378			$	54,069			$	134,118			$	173,434
Segment Assets
ACO		$	388,521			$	382,112			$	388,521			$	382,112
ESK Ceramics			231,745				202,587				231,745				202,587
Semicon Associates			6,008				5,458				6,008				5,458
Thermo Materials			91,234				62,999				91,234				62,999
Ceradyne Canada			22,548				19,568				22,548				19,568
Boron			121,915				73,098				121,915				73,098
Total		$	861,971			$	745,822			$	861,971			$	745,822
Expenditures for Property, Plant & Equipment
ACO		$	1,780			$	2,071			$	4,247			$	6,658
ESK Ceramics			3,266				4,502				18,609				9,510
Semicon Associates			391				134				508				312
Thermo Materials			2,383				5,763				9,042				10,863
Ceradyne Canada			275				412				1,761				1,000
Boron			1,507				—				1,771				—
Total		$	9,602			$	12,882			$	35,938			$	28,343

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Percentage of U.S. net sales from external customers
ACO			62	%			74	%			63	%			77	%
ESK Ceramics			3	%			2	%			2	%			2	%
Semicon Associates			1	%			1	%			1	%			1	%
Thermo Materials			4	%			3	%			4	%			1	%
Ceradyne Canada			0	%			1	%			1	%			1	%
Boron			1	%			1	%			2	%			1	%
Total percentage of U.S. net sales from external customers			71	%			82	%			73	%			83	%
Percentage of foreign net sales from external customers
ACO			3	%			2	%			3	%			2	%
ESK Ceramics			17	%			14	%			16	%			14	%
Semicon Associates			0	%			0	%			0	%			0	%
Thermo Materials			8	%			2	%			7	%			1	%
Ceradyne Canada			0	%			0	%			0	%			0	%
Boron			1	%			0	%			1	%			0	%
Total percentage of foreign net sales from external customers			29	%			18	%			27	%			17	%
Percentage of total net sales from external customers
ACO			65	%			76	%			66	%			79	%
ESK Ceramics			20	%			16	%			18	%			16	%
Semicon Associates			1	%			1	%			1	%			1	%
Thermo Materials			12	%			5	%			11	%			2	%
Ceradyne Canada			0	%			1	%			1	%			1	%
Boron			2	%			1	%			3	%			1	%
Total percentage of total net sales from external customers			100	%			100	%			100	%			100	%

The following is revenue by product line for ACO (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Armor		$	99,887			$	136,658			$	328,371			$	421,062
Automotive			4,912				2,806				13,382				7,069
Orthodontics			2,148				2,547				8,136				8,042
Industrial			3,168				3,870				9,549				10,896
		$	110,115			$	145,881			$	359,438			$	447,069