UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
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For the quarterly period ended September 30, 2008
Or
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF
1934
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For the transition period from
to
Commission File No. 000-13059
CERADYNE, INC.
(Exact name of Registrant as specified in its charter)
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Delaware
(State or other jurisdiction
of incorporation or organization)
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33-0055414
(I.R.S. Employer
Identification No.)
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3169 Red Hill Avenue, Costa Mesa, CA
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92626
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(Address of principal executive)
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(Zip Code)
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Registrants 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):
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Large accelerated filer
þ
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Accelerated filer
o
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Non-accelerated filer
o
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Smaller reporting company
o
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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 issuers classes of common stock, as of
the latest practicable date.
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Class
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Outstanding as of October 17, 2008
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Common Stock, $0.01 par value
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26,273,911 Shares
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Exhibit Index on Page 41
CERADYNE, INC.
FORM 10-Q
FOR THE QUARTER ENDED
SEPTEMBER 30, 2008
PART I. FINANCIAL INFORMATION
Item 1.
Unaudited Consolidated Financial Statements
CERADYNE, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
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September 30,
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December 31,
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2008
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2007
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(Unaudited)
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CURRENT ASSETS
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Cash and cash equivalents
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$
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204,486
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$
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155,103
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Restricted cash
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2,699
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2,660
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Short-term investments
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7,900
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29,582
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Accounts receivable, net of allowances for doubtful accounts of $1,038
and $792 at September 30, 2008 and December 31, 2007, respectively
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64,138
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85,346
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Other receivables
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8,360
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5,704
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Inventories, net
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101,039
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92,781
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Production tooling, net
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13,997
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16,632
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Prepaid expenses and other
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29,880
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12,391
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Deferred tax asset
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12,816
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12,455
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TOTAL CURRENT ASSETS
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445,315
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412,654
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PROPERTY, PLANT AND EQUIPMENT, net
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252,461
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243,892
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LONG TERM INVESTMENTS
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29,489
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38,089
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INTANGIBLE ASSETS, net
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84,491
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37,578
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GOODWILL
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46,484
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46,848
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OTHER ASSETS
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3,731
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4,225
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TOTAL ASSETS
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$
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861,971
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$
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783,286
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CURRENT LIABILITIES
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Accounts payable
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$
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29,156
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$
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35,990
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Accrued expenses
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26,492
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22,483
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Income taxes payable
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788
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258
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TOTAL CURRENT LIABILITIES
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56,436
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58,731
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LONG-TERM DEBT
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121,000
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121,000
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EMPLOYEE BENEFITS
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14,102
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13,650
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OTHER LONG TERM LIABILITY
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41,501
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4,985
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DEFERRED TAX LIABILITY
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5,677
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6,291
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TOTAL LIABILITIES
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238,716
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204,657
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COMMITMENTS AND CONTINGENCIES (Note 15)
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SHAREHOLDERS EQUITY
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Common stock, $0.01 par value,
100,000,000 authorized, 26,273,611 and
27,318,530 shares issued and outstanding
at September 30, 2008 and December 31,
2007, respectively
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264
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272
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Additional paid-in capital
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154,430
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185,702
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Retained earnings
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446,798
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361,301
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Accumulated other comprehensive income
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21,763
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31,354
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TOTAL SHAREHOLDERS EQUITY
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623,255
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578,629
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TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
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$
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861,971
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$
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783,286
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See accompanying condensed notes to Consolidated Financial Statements
3
CERADYNE, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
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Three Months Ended
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Nine Months Ended
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September 30,
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September 30,
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2008
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2007
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2008
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2007
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(Unaudited)
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(Unaudited)
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NET SALES
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$
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167,746
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$
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191,606
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$
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541,258
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$
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565,408
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COST OF GOODS SOLD
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101,082
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115,819
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327,504
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335,125
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Gross profit
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66,664
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75,787
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213,754
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230,283
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OPERATING EXPENSES
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Selling
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8,443
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6,872
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24,966
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19,617
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General and administrative
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11,703
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11,280
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35,208
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30,218
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Acquisition related charge
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9,783
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9,783
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Research and development
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4,527
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5,680
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10,979
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13,561
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34,456
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23,832
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80,936
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63,396
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INCOME FROM OPERATIONS
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32,208
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51,955
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132,818
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166,887
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OTHER INCOME (EXPENSE):
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Royalty income
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5
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30
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65
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105
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Interest income
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1,772
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3,281
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6,273
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9,542
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Interest expense
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(1,026
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)
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(1,094
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)
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(3,130
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)
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(3,154
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)
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Miscellaneous
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(2,581
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)
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(103
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)
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(1,908
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)
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54
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(1,830
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)
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2,114
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1,300
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6,547
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INCOME BEFORE PROVISION FOR INCOME TAXES
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30,378
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54,069
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134,118
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173,434
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PROVISION FOR INCOME TAXES
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10,979
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21,419
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48,621
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64,392
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NET INCOME
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$
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19,399
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$
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32,650
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$
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85,497
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$
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109,042
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BASIC INCOME PER SHARE
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$
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0.74
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$
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1.20
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$
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3.22
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$
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4.00
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DILUTED INCOME PER SHARE
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$
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0.73
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$
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1.16
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$
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3.18
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$
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3.93
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WEIGHTED AVERAGE SHARES OUTSTANDING:
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BASIC
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26,272
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|
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27,304
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26,568
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|
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27,231
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DILUTED
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26,563
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|
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|
28,052
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|
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26,888
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27,766
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See accompanying condensed notes to Consolidated Financial Statements
4
CERADYNE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
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Nine Months Ended
|
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September 30,
|
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|
2008
|
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|
2007
|
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(Unaudited)
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CASH FLOWS FROM OPERATING ACTIVITIES:
|
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|
|
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Net income
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$
|
85,497
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|
$
|
109,042
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ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:
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Depreciation and amortization
|
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30,122
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17,948
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|
Deferred income taxes
|
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|
421
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|
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|
(2,014
|
)
|
Stock compensation
|
|
|
2,233
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|
|
|
1,842
|
|
Loss on marketable securities
|
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3,545
|
|
|
|
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Loss on equipment disposal
|
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|
125
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|
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|
794
|
|
Change in operating assets and
liabilities (net of effect of businesses acquired):
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Accounts receivable, net
|
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22,680
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|
|
|
(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
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)
|
|
|
(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
|
|
|
|
|
|
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NET CASH PROVIDED BY OPERATING ACTIVITIES
|
|
|
126,996
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|
|
|
89,009
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CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
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Purchases of property, plant and equipment
|
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(35,938
|
)
|
|
|
(28,343
|
)
|
Changes in restricted cash
|
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|
(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
5
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 Ceradynes 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
Companys 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 Companys 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.
6
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 Companys 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
|
|
|
|
|
|
|
|
|
|
7
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. SemEquips 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.
8
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 managements 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):
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
|
|
(1)
|
|
The unaudited pro forma information for the three and nine months
ended September 30, 2008 includes the $9.8 million pre-tax acquisition
related compensation charge associated with a pre-closing commitment
by SemEquip to pay incentive compensation to several of its employees
and advisors, which has been recognized in the Companys historical
results of operations for these periods. The unaudited pro forma
information for the three and nine months ended September 30, 2008
include pro forma adjustments to reflect a $57,000 pre-tax increase
and a $398,000 pre-tax increase in amortization expense related to
managements estimate of the fair value of intangible assets acquired
in the SemEquip acquisition.
|
|
(2)
|
|
The unaudited pro forma information for the three and nine months
ended September 30, 2007 includes a pro forma adjustment to recognize
the $9.8 million pre-tax acquisition related compensation charge
associated with a pre-closing commitment by SemEquip to pay incentive
compensation to several of its employees and advisors. The unaudited
pro forma information for the three and nine months ended
September 30, 2007 also include pro forma adjustments to reflect a
$171,000 pre-tax increase and a $512,000 pre-tax increase in
amortization expense related to managements estimate of the fair
value of intangible assets acquired as the result of the SemEquip
acquisition, respectively.
|
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 Companys Board of Directors, with the assistance of
independent legal counsel and forensic accounting experts. The scope of the Special
Committees review included all stock options granted by the Company from January 1997 through
September 2003. The Special Committee has completed its review.
10
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 Companys Stock Option Committee until a later date. There were a total of 23
grant dates from January 1997 through September 2003. The Companys 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 individuals 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 Companys
results of operations for prior years, the impact on net income for Ceradynes 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 Ceradynes 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 Companys 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.
11
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 Companys
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 Companys 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 Companys 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
|
|
|
|
|
|
|
|
|
12
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 Companys 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.
13
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 Companys 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 Companys
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 issuers 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 Companys 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
Companys 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 Companys
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.
14
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 Companys 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 Companys 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 Companys 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.
15
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
entitys 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 SECs
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 Companys 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 issuers 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 Companys 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 Companys current
financial statements. The application of the provisions of FSP 157-3 did not materially affect the
Companys 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 Ceradynes 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 Companys 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.
16
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 Ceradynes 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 Companys
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 Companys SRBSN research and development activities. The
Companys 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 Companys Thermo Materials division
located in Scottdale and Clarkston, Georgia. The Companys 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 Companys 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 Companys 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.
17
Ceradynes 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
|
|
|
|
|
|
Automotive/Diesel Applications:
|
Approximately 115,000 square feet
|
|
Ceralloy
®
147 SRBSN automotive/diesel engine parts
|
|
|
|
|
|
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
|
|
|
|
Approximately 548,000 square feet
|
|
Industrial Applications:
|
|
|
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)
|
|
|
|
|
|
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
|
18
|
|
|
Operating Segment and Facility Location
|
|
Products
|
|
|
|
Boron
|
|
Industrial Applications:
|
|
|
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
|
|
|
|
(1)
|
|
We have leases on our facilities in Costa Mesa, California, aggregating approximately 99,000
square feet, all of which expire in October 2010. We own our 40,000 square foot facility in
Irvine, California. In Irvine, California, we occupy a 24,000 square foot facility under a
lease that expires in April 2009 and a 76,000 square foot facility under a lease that expires
in April 2011.
|
|
(2)
|
|
We own our facility in Lexington, Kentucky.
|
|
(3)
|
|
We have a lease on our Wixom, Michigan facility which expires in April 2010.
|
|
(4)
|
|
We own our facility in Kempten, Germany, as well as the 22-acre property on which our
facility is located.
|
|
(5)
|
|
We own our facility in Bazet, France, as well as the four-acre property on which our facility
is located.
|
|
(6)
|
|
We own our facility in Lexington, Kentucky, as well as the five-acre property on which our
facility is located.
|
|
(7)
|
|
We own an 85,000 square foot facility in Scottdale, Georgia, as well as the five-acre
property on which our facility is located. We have a lease on our 140,000 square foot facility
in Clarkson, Georgia which expires in June 2013.
|
|
(8)
|
|
We own our facility in Tianjin, China, as well as the four-acre property on which our facility is located.
|
|
(9)
|
|
We own our facility in Midway, Tennessee as well as the 40-acre property on which our facility is located.
|
|
(10)
|
|
We own our facility in Chicoutimi, Quebec, Canada, as well as the seven-acre property on which our facility is located.
|
|
(11)
|
|
We own our facility in Quapaw, Oklahoma as well as the 155-acre property on which our
facility is located.
|
|
(12)
|
|
We lease our facility in North Billerica, Massachusetts.
|
19
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12.
Pension and Other Post-retirement Benefit Plans
The Company provides pension benefits to its employees in Germany. These pension benefits are
rendered for the time after the retirement of the employees by payments into legally independent
pension and relief facilities. They are generally based on length of service, wage level and
position in the company. The direct and indirect obligations comprise obligations for pensions that
are already paid currently and expectations for those pensions payable in the future. The Company
has four separate plans in Germany: a) Pensionskasse Old; b) Pensionskasse New; c) Additional
Compensation Plan; and d) Deferred Compensation Plan. For financial accounting purposes, the
Additional and Deferred Compensation Plans are accounted for as single-employer defined benefit
plans, Pensionskasse Old is a multiemployer defined benefit plan and the Pensionskasse New is a
defined contribution plan. The Company also provides pension benefits to its employees of Ceradyne
Boron Products located in Quapaw, Oklahoma. There are two defined benefit retirement plans, one for
eligible salaried employees and one for hourly employees. The benefits for the salaried employee
plan are based on years of credited service and compensation. The benefits for the hourly employee
plan are based on stated amounts per year of service.
21
Components of net periodic benefit costs under these plans were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Service cost
|
|
$
|
140
|
|
|
$
|
126
|
|
|
$
|
423
|
|
|
$
|
351
|
|
Interest cost
|
|
|
253
|
|
|
|
146
|
|
|
|
764
|
|
|
|
340
|
|
Expected return on plan assets
|
|
|
(174
|
)
|
|
|
(59
|
)
|
|
|
(522
|
)
|
|
|
(59
|
)
|
Amortization of unrecognized gain
|
|
|
|
|
|
|
15
|
|
|
|
|
|
|
|
44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost
|
|
$
|
219
|
|
|
$
|
228
|
|
|
$
|
665
|
|
|
$
|
676
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13.
Financial Instruments
The Company enters into foreign exchange forward contracts to reduce earnings and cash flow
volatility associated with foreign exchange rate changes to allow management to focus its attention
on its core business operations. Accordingly, the Company enters into contracts which change in
value as foreign exchange rates change to economically offset the effect of changes in value of
foreign currency assets and liabilities, commitments and anticipated foreign currency denominated
sales and operating expenses. The Company enters into foreign exchange forward contracts in amounts
between minimum and maximum anticipated foreign exchange exposures, generally for periods not to
exceed one year. These derivative instruments are not designated as accounting hedges. We did not
have any outstanding foreign exchange forward contracts at September 30, 2008.
The Company measures the financial statements of its foreign subsidiaries using the local currency
as the functional currency. Assets and liabilities of these subsidiaries are translated at the
exchange rate on the balance sheet date. Revenues, costs and expenses are translated at the rates
of exchange prevailing during the year. Translation adjustments resulting from this process are
included in stockholders equity. Gains and losses from foreign currency transactions are included
in other income, miscellaneous.
14.
Income Taxes
The Company has adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes
(FIN 48), effective January 1, 2007. The adoption of FIN 48 resulted in no change to the reserve
for unrecognized tax benefits (UTBs) that existed under FASB No. 5 at December 31, 2006. As such,
there is no change recorded to retained earnings as a result of the adoption. It is the Companys
policy to classify accrued interest and penalties as part of the accrued FIN 48 liability and
record the expense in the provision for income taxes.
Components of the required reserve at September 30, 2008 and December 31, 2007 are as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008
|
|
|
December 31, 2007
|
|
Federal, state and foreign UTBs
|
|
$
|
6,392
|
|
|
$
|
4,556
|
|
Interest
|
|
|
1,359
|
|
|
|
679
|
|
Federal/State Benefit of Interest
|
|
|
(514
|
)
|
|
|
(250
|
)
|
|
|
|
|
|
|
|
Total reserve for UTBs
|
|
$
|
7,237
|
|
|
$
|
4,985
|
|
|
|
|
|
|
|
|
In accordance with the provisions of FIN 48, this reserve is included in other long term
liabilities.
It is anticipated that any change in the above UTBs will impact the effective tax rate. For UTBs
that exist at September 30, 2008, the Company anticipates there will be a reduction of
approximately $0.9 million in the next twelve months. At September 30, 2008, the 2003 through 2007
years are open and subject to potential examination in one or more jurisdictions. The Company is
currently under federal, state and foreign income tax examinations for the tax years 2003 through
2005.
22
Income taxes are determined using an annual effective tax rate, which generally differs from the
United States federal statutory rate, primarily because of state taxes and research and development
tax credits. The Company recognizes deferred tax assets and liabilities for temporary differences
between the financial reporting basis and the tax basis of the Companys assets and liabilities,
along with net operating loss (NOL) and credit carryforwards. The Company recognized a deferred
tax asset of $17.8 million in the quarter ended September 30, 2008 for the expected tax benefit from a NOL carryforward of approximately
$45.7 million acquired in connection with the acquisition of SemEquip. The acquired NOL carryforward is subject to potential
utilization restrictions as a result of the ownership change, which is currently being evaluated by
the Company, and any unused amounts will begin to expire in 2020. At this time, the Company has
determined that it is more likely than not that the tax benefit from the NOL carryforward will be
realized. Accordingly, no valuation allowance has been established against the deferred tax asset
for the NOL carryforward. However, as the potential utilization restrictions are still being
evaluated by the Company, the final determination of such restrictions, if any, could result in an
adjustment to the SemEquip purchase price allocation in the future. The Company expects to
complete this evaluation by the end of 2008.
15.
Commitments and Contingencies
The Company leases certain of its manufacturing facilities under noncancelable operating leases
expiring at various dates through June 2013. The Company incurred rental expense under these leases
of $2.1 million each for the nine months ended September 30, 2008 and 2007. The approximate minimum
rental commitments required under existing noncancelable leases as of September 30, 2008 are as
follows (in thousands):
|
|
|
|
|
2008
|
|
$
|
1,634
|
|
2009
|
|
|
2,997
|
|
2010
|
|
|
2,586
|
|
2011
|
|
|
742
|
|
2012
|
|
|
285
|
|
Thereafter
|
|
|
99
|
|
|
|
|
|
|
|
$
|
8,343
|
|
|
|
|
|
In August, September and December 2006, shareholder derivative lawsuits were filed in the
California Superior Court for Orange County, purportedly on behalf of Ceradyne against various
current and former officers and directors of the Company relating to alleged backdating of stock
options. Each state court complaint alleged claims for breach of fiduciary duty, abuse of control,
gross mismanagement, waste of corporate assets, unjust enrichment, accounting, rescission,
constructive trust, and violations of California Corporations Code. All state court actions have
been consolidated into one case, designated, In re Ceradyne, Inc. Derivative Litigation, Orange
County Superior Court, Case No. 06-CC-00156.
In September and December 2006, shareholder derivative lawsuits were filed in the United States
District Court for the Central District of California, purportedly on behalf of Ceradyne against
various current and former officers and directors of the Company relating to alleged backdating of
stock options. All federal court actions have been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Master File No. SA CV 06-919 JVS. The consolidated federal
action alleges, pursuant to a first amended consolidated complaint filed on September 17, 2007,
claims for violations of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder,
violations of Section 14(a) of the Securities Exchange Act, violations of Section 20(a) of the
Securities Exchange Act, insider selling under the California Corporations Code, as well as common
law claims for accounting, breach of fiduciary duty, aiding and abetting breaches of fiduciary
duty, unjust enrichment, rescission and waste.
The plaintiffs in both the state and federal actions seek to require the individual defendants to
rescind stock options they received which have an exercise price below the closing price of the
Companys common stock on the date of grant, to disgorge the proceeds of options exercised, to
reimburse the Company for damages of an unspecified amount, and also seek certain equitable relief,
attorneys fees and costs.
On October 26, 2007, the Company and the individual defendants filed motions to dismiss the first
amended consolidated complaint in the federal action. In December 2007, plaintiffs filed a second
amended consolidated complaint.
In summary, there are currently two shareholder derivative actions pending which contain
substantially similar allegations. The cases filed in the Orange County Superior Court have been
consolidated into one case, designated, In re Ceradyne, Inc. Derivative Litigation, Orange County
Superior Court, Case No. 06-CC-00156. The cases filed in the United States District Court for the
Central District of California have all been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Master File No. SA CV 06-919 JVS.
23
On September 26, 2008, all of the parties to the two derivative actions entered into a memorandum
of understanding agreeing in principle to a proposed global settlement of these derivative actions.
The parties have filed a stipulation with the federal court to submit a final stipulation of
settlement by November 28, 2008. The proposed settlement calls for the Company to
adopt certain corporate governance reforms and payment by the Companys insurance carriers of
$1.125 million in attorneys fees to the plaintiffs attorneys, without any payment by Ceradyne or
the other defendants, and for dismissal of the actions with prejudice. The proposed settlement is
conditioned upon the parties reaching agreement on a stipulation of settlement, final court
approval after notice to Ceradynes shareholders and expiration of the time for appear from any
order of the Court approving the settlement. There can be no assurance that the final settlement
will be obtained.
A class action lawsuit was filed on March 23, 2007, in the California Superior Court for Orange
County, in which it is asserted that the representative plaintiff, a former Ceradyne employee, and
the putative class members, were not paid overtime at an appropriate overtime rate. The complaint
alleges that the purportedly affected employees should have had their regular rate of pay, for
purposes of calculating overtime, adjusted to reflect the payment of a bonus to them for the four
years preceding the filing of the complaint. The complaint further alleges that a waiting time
penalty should be assessed for the failure to timely pay the correct overtime payment. Ceradyne
filed an answer denying the material allegations of the complaint. A motion for class certification
was filed on or about August 11, 2008. Ceradyne has filed an opposition claiming that there are no
common questions of fact that can be generalized across the class. Ceradyne has also opposed the
motion on the basis that the Plaintiff has not established his suitability as a class
representative, particularly because he is a former employee whose interests conflict with the
current employees. The hearing is presently scheduled for November 13, 2008. In addition to the
arguments against class certification, we believe that the action itself is without merit because
our bonus policy is discretionary and is not of the type that is subject to inclusion in the
regular hourly rate for purposes of calculating overtime, and we intend to vigorously defend this
action.
16.
Comprehensive Income
Comprehensive income encompasses all changes in equity other than those arising from transactions
with stockholders, and consists of net income, currency translation adjustments, pension
adjustments and unrealized net gains and losses on investments classified as available-for-sale.
Comprehensive income is net income adjusted for changes in unrealized gains and losses on
marketable securities and foreign currency translation.
Comprehensive income was (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net income
|
|
$
|
19,399
|
|
|
$
|
32,650
|
|
|
$
|
85,497
|
|
|
$
|
109,042
|
|
Foreign currency translation
|
|
|
(23,139
|
)
|
|
|
9,260
|
|
|
|
(6,515
|
)
|
|
|
13,590
|
|
Unrealized gain (loss) on investments
|
|
|
(1,582
|
)
|
|
|
42
|
|
|
|
(3,076
|
)
|
|
|
48
|
|
|
|
|
|
|
|
|
|
|
|
|
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Comprehensive income
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$
|
(5,322
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)
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$
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41,952
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$
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75,906
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$
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122,680
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24
Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations
Preliminary Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains statements which may constitute forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities and Exchange Act of 1934. One generally can identify forward-looking statements by the
use of forward-looking terminology such as believes, may, will, expects, intends,
estimates, anticipates, plans, seeks, or continues, or the negative thereof, or
variations thereon, or similar terminology. Forward-looking statements regarding future events and
the future performance of the Company involve risks and uncertainties that could cause actual
results to differ materially. Reference is made to the risks and uncertainties which are described
in this report in Note 15 Commitments and Contingencies of the Notes to Consolidated
Financial Statements, in this Item 2 Managements Discussion and Analysis of Financial Condition
and Results of Operations, and in Part II, Item 1A under the caption Risk Factors. Reference is
also made to the risks and uncertainties described in the Companys Annual Report on Form 10-K for
the fiscal year ended December 31, 2007, as filed with the Securities and Exchange Commission, in
Item 1A under the caption Risk Factors, and in Item 7 under the caption Managements Discussion
and Analysis of Financial Condition and Results of Operations.
Overview
We develop, manufacture and market advanced technical ceramic products, ceramic powders and
components for defense, industrial, automotive/diesel and commercial applications. Our products
include:
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lightweight ceramic armor for soldiers and other military applications;
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ceramic industrial components for erosion and corrosion resistant applications;
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ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium
hexaboride, and zirconium diboride, which are used in manufacturing armor and a broad
range of industrial products; and BORONEIGE
®
boron nitride powder for cosmetic products;
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evaporation boats for metallization of materials for food packaging and other
products;
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durable, reduced friction, ceramic diesel engine components;
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functional and frictional coatings primarily for automotive applications;
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translucent ceramic orthodontic brackets;
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ceramic-impregnated dispenser cathodes for microwave tubes, lasers and cathode ray
tubes;
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ceramic crucibles for melting silicon in the photovoltaic solar cell manufacturing
process;
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ceramic missile radomes (nose cones) for the defense industry;
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fused silica powders for industrial applications and ceramic crucibles;
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neutron absorbing materials, structural and non-structural, in combination with
aluminum metal matrix composites that serve as part of a barrier system for spent fuel wet
and dry storage in the nuclear industry, and non-structural neutron absorbing materials
for use in the transport of nuclear fresh fuel rods;
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nuclear chemistry products for use in pressurized water reactors and boiling water
reactors;
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boron dopant chemicals for semiconductor silicon manufacturing and for ion implanting of
silicon wafers;
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technical ceramic bearings for down hole oil drilling and for coal bed methane
pumps and steam assisted oil extraction pumps; and
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cluster ion implantation sub-systems and advanced ion source materials for the
manufacture of logic and memory chips.
|
Our customers include the U.S. government, prime government contractors and large industrial,
automotive, diesel and commercial manufacturers in both domestic and international markets.
25
We categorize our products into four market applications. The table below shows the percentage
contribution to our total sales of each market application in the different time periods.
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Three Months Ended
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Nine Months Ended
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September 30,
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September 30,
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2008
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2007
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2008
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2007
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Defense
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60.8
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%
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72.6
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%
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62.0
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%
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75.8
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%
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Industrial
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31.1
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21.6
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30.2
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18.6
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Automotive/Diesel
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6.4
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4.2
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5.9
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3.9
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Commercial
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1.7
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1.6
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1.9
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1.7
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Total
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100.0
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%
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100.0
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%
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|
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100.0
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%
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|
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100.0
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%
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The principal factors contributing to our growth in sales from 2001 through 2007 were increased
demand by the U.S. military for ceramic body armor that protects soldiers and our acquisitions of
ESK Ceramics in August 2004, Minco, Inc. in July 2007 and Eagle Picher Boron, LLC in August 2007,
which was renamed Ceradyne Boron Products. However, year-over-year sales of body armor declined in
each of the first three quarters of 2008, and are expected to remain below the prior year level in
the fourth quarter of 2008. Our sales of body armor, as well as other armor components for defense
applications, declined by $93.2 million in the first nine months of 2008 compared to the same
period of 2007. This decline in defense product revenues was significantly offset, however, by
revenues contributed by our two acquisitions completed in the third quarter of 2007 and by internal
growth in sales of ceramic crucibles used for melting silicon in the manufacture of photovoltaic
solar cells. The combined sales contributed by Minco and Boron Products in the first nine months of
2008 were $36.4 million, and sales of ceramic crucibles, including crucibles manufactured in our
new factory in Tianjin, China, increased by $23.4 million in the first nine months of 2008 compared
to 2007. The operating expenses associated with these acquired businesses are higher than those
attributable to body armor. The results of the first nine months of 2008 reflect our strategy of
expanding our business through internal growth and strategic acquisitions with an emphasis on
increasing our non-defense business.
Military conflicts in Iraq and Afghanistan, as well as an increasingly unstable geopolitical
climate and the heightened risk of international conflicts, have resulted in increased shipments of
our ceramic body armor in each of the years from 2001 through 2007. We were awarded an Indefinite
Delivery/Indefinite Quantity (ID/IQ) contract by the U.S. Army in August 2004 with an adjusted
maximum value of $747.5 million from an original estimated contract value of $461.0 million.
Through June 2008, we received sixteen delivery orders equaling the contract amount. We completed
the delivery of this adjusted contract amount in September 2008. We have also received a number of
other orders for ceramic body armor, not covered by the ID/IQ contract, from the Army and other
branches of the U.S. military. In January 2006, we received our first production order for Enhanced
Side Ballistic Inserts (ESBI), or side plates, which are designed to protect the side areas of a
soldiers torso when used in conjunction with our Enhanced Small Arms Protective Inserts (ESAPI),
or ceramic body armor plates. This delivery order, which totaled $70.0 million, was issued to us by
the U.S. Army. In June 2006, we were awarded an ID/IQ contract by the U.S. Army with a maximum
value of $611.7 million for ESBI plates. Through September 2008, ten delivery orders totaling
approximately $447.1 million have been issued to us under this contract.
In October 2008, we received an ID/IQ contract for the next ballistic threat generation of ceramic
body armor plates, called XSAPI, as well as for the current generation ESAPI plates from the U.S.
Army RDECOM, Aberdeen Proving Grounds, Maryland. The total amount of this contract is $2.37 billion
and covers a period of approximately five years. The U.S. Army can order one or both types of
plates over the five year life of the contract. At the same time this ID/IQ contract was awarded to
us, we also received an initial delivery order for first article testing for both XSAPI and ESAPI
armor plates valued at approximately $0.9 million. We expect, however, that future orders issued
under this ID/IQ contract will be primarily for XSAPI armor plates, which likely would result in
total orders under this five-year procurement being less than the full $2.37 billion contract
amount. The contract provides for a minimum of 500 sets (including front and back plates) per year
to a maximum of 240,000 sets per year. Shortly after receiving the ID/IQ contract and delivery
order for first article testing plates, we received the first production delivery order under
this ID/IQ contract for $72.2 million to be delivered from February 2009 to February 2010, with
early delivery allowed. However, on October 27, 2008, the U.S. Army issued a stop work order
instructing us to stop all work on the $72.2 million production delivery order for a period of 120
days, but not on the delivery order for first article testing plates. We believe that the stop
work order is attributable to a protest filed by a competitor after the Army issued the first
production delivery order. We anticipate that this protest will be resolved before the end of the
120-day stop work period.
Based on our current backlog and anticipated orders for ceramic body armor and the level of sales
to date in 2008, we expect our shipments of ceramic body armor to be lower in fiscal year 2008 than
in 2007. We also expect shipments of ceramic body armor to be lower in fiscal year 2009 than in
2008. Moreover, government contracts typically may be cancelled by the government at any time
without penalty. For the next several quarters, and perhaps longer, demand for ceramic body armor
is likely to be the most significant factor affecting our sales.
26
Although we believe that demand for ceramic body armor will continue for many years, the quantity
and timing of government orders depends on a number of factors outside of our control, such as the
amount of U.S. defense budget appropriations and the level of international conflicts. Moreover,
ceramic armor contracts generally are awarded in an open
competitive bidding process. Therefore, our future level of sales of ceramic body armor will depend
on our ability to successfully compete for and retain this business.
Our ESK Ceramics subsidiary produces boron carbide powder, which serves as a starter ceramic powder
in the manufacture of our lightweight ceramic body armor. Owning this source of our principal raw
material, together with the recent expansion of our manufacturing capacity for ceramic armor at our
Lexington, Kentucky plant and in our Irvine, California facility, should allow us to fulfill
current and anticipated demand for our ceramic body armor. The lower demand for body armor has
negatively impacted inter-segment sales of boron carbide powder by our ESK Ceramics subsidiary to
our Advanced Ceramic Operations division in the first nine months of 2008.
Our order backlog was $174.9 million as of September 30, 2008 and $173.1 million as of September
30, 2007. Orders for ceramic body armor represented approximately $136.6 million, or 78.1%, of the
total backlog as of September 30, 2008 and $147.9 million, or 85.5%, of the total backlog as of
September 30, 2007. We expect that substantially all of our order backlog as of September 30, 2008
will be shipped during 2008. Our order backlog at September 30, 2008 does not include the $72.2
million delivery order mentioned above, which was received in October 2008.
Review of Historical Stock Option Grant Procedures
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 Companys Board of Directors, with the assistance of
independent legal counsel and forensic accounting experts. The scope of the Special Committees
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 Companys Stock Option Committee until a later date. There were a total of 23
grant dates from January 1997 through September 2003. The Companys 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
individuals 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 were 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.
27
Had this estimated Stock-Based Charge been reflected, as and when incurred, in the Companys
results of operations for prior years, the impact on net income for Ceradynes 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, 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 Ceradynes 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 Companys 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.
Results of Operations for the Three and Nine Months Ended September 30, 2008 and 2007
Net Sales.
Our net sales for the three months ended September 30, 2008 were $167.7 million, a
decrease of $23.9 million, or 12.5%, from $191.6 million of net sales in the corresponding quarter
of the prior year. Net sales for the nine months ended September 30, 2008 were $541.3 million, a
decrease of $24.1 million, or 4.3%, from $565.4 million in the corresponding prior year period.
Net sales for our Advanced Ceramic Operations division for the three months ended September 30,
2008 were $110.1 million, a decrease of $35.8 million, or 24.5%, from $145.9 million of net sales
in the corresponding quarter of the prior year. The primary reason for the decrease was a decline
in shipments of ceramic body armor as well as other armor components for defense contractors. Net
sales of ceramic body armor in the third quarter of 2008 were $94.4 million, a decrease of $37.4
million, or 28.4%, from $131.8 million in the third quarter of 2007. In February 2008, the U.S.
Army reduced their monthly demand of approximately 22,500 ESAPI body armor sets from us to
approximately 12,500 sets per month, as they approached their targeted goal of 960,000 total sets
of ESAPI received from all suppliers since 2005. This targeted goal of shipments was met by the end
of September 2008. Thereafter, the U.S. Army will request shipments of the next ballistic threat
generation of body armor, called XSAPI under the $2.37 billion ID/IQ contract we received in
October 2008. In October 2008, we received our first XSAPI production delivery order of $72.2
million. In addition, we received orders for SAPI ceramic body armor plates totaling $39.2 million
in September 2008 which are scheduled for shipment late in the fourth quarter of 2008.
Net sales for our automotive/diesel component product line for the three months ended September 30,
2008 were $4.9 million, an increase of $2.1 million, or 75.2%, from $2.8 million in the
corresponding quarter of the prior year. The primary reason for this increase was our customers
included our automotive/diesel components in their off road vehicles in 2008 compared to 2007 when
they were not included in these types of vehicles. Production of heavy-duty diesel truck engines in
2007 was less than usual due to forward buying in 2006 in anticipation of increased emission
standards that became effective in 2007. Net sales of our orthodontic brackets product line for
the three months ended September 30, 2008 were $2.1 million, a decrease of $398,000, or 15.6%,
from $2.5 million in the corresponding quarter of the prior year. The decrease was due to lower
demand for Clarity
®
orthodontic brackets which we believe was caused by a softening
economy.
Net sales for our Advanced Ceramic Operations division for the nine months ended September 30, 2008
were $359.4 million, a decrease of $87.7 million, or 19.6%, from $447.1 million in the
corresponding period of the prior year. This decline reflects lower demand, primarily for body
armor, as well as other armor components for defense applications. Net sales of ceramic body armor
for the nine months ended September 30, 2008 were $308.8 million, a decrease of $100.7 million, or
24.6%, from $409.5 million in the corresponding prior year period. Net sales for our
automotive/diesel component product line for the nine months ended September 30, 2008 were $13.4
million, an increase of $6.3 million, or 89.4%, from $7.1 million in the corresponding prior year
period. This increase reflects the increased production of heavy-duty diesel truck engines by our
customers as described above. Net sales of our orthodontic brackets product line for the nine
months ended September 30, 2008 were $8.1 million, an increase of $95,000, or 1.2%, from $8.0
million in the corresponding prior year period. The
increase was attributed to sales of $1.2 million of a new version of our orthondontic bracket
product line, partially offset by a decline in Clarity
®
orthodontic bracket sales.
28
Our ESK Ceramics subsidiary had net sales for the three months ended September 30, 2008 of $38.0
million, a decrease of $1.0 million, or 2.5%, from $39.0 million in the corresponding quarter of
the prior year. Approximately $2.1 million of the net sales of $38.0 million is attributable to the
higher value of the Euro versus the U.S. dollar during the three months ended September 30, 2008 as
sales denominated in Euros are translated into U.S. dollars for financial reporting purposes. Sales
of industrial products for the three months ended September 30, 2008 were $25.5 million, an
increase of $2.0 million, or 8.3%, from $23.5 million in the corresponding quarter of the prior
year. This increase was the result of a higher demand for fluid handling parts, industrial wear
parts and metallurgy parts. Sales of defense products for the three months ended September 30, 2008
were $6.0 million, a decrease of $3.7 million, or 38.2%, from the $9.7 million in the corresponding
quarter of the prior year. Included in sales of defense products for the three months ended
September 30, 2008 were inter-segment sales of $5.8 million compared to $8.2 million in the prior
year. The decrease of $2.4 million in inter-segment sales was due to a reduction in demand for
boron carbide powder used in body armor protection by our Advanced Ceramic Operations division.
Sales of automotive/diesel products for the three months ended September 30, 2008 were $5.8
million, an increase of $0.6 million, or 10.9%, from $5.2 million in the corresponding quarter of
the prior year. Increased demand from automotive original equipment manufacturers accounted for the
increased sales. Sales of commercial products, consisting of boron nitride for the cosmetic
industry, began in 2007, and for the three months ended September 30, 2008 were $0.8 million, an
increase of $0.2 million, or 37.9%, from $0.6 in the corresponding prior year period.
For the nine months ended September 30, 2008, net sales for ESK Ceramics were $123.0 million, an
increase of $1.5 million, or 1.2%, from $121.5 million in the corresponding prior year period.
Approximately $9.6 million of the net sales of $123.0 million is attributable to the higher value
of the Euro versus the U.S. dollar during the nine months ended September 30, 2008 as sales
denominated in Euros are translated into U.S. dollars for financial reporting purposes.
Additionally, the high value of the Euro versus the U.S. dollar caused our ESK Ceramics products to
be less competitive than products denominated in U.S. dollars resulting in a negative impact on ESK
Ceramics export sales. Sales of industrial products for the nine months ended September 30, 2008
were $78.5 million, an increase of $10.1 million, or 14.7%, from $68.4 million in the
corresponding prior year period. This increase was the result of a higher demand for fluid
handling, industrial wear parts and metallurgy parts. Sales of defense products for the nine months
ended September 30, 2008 were $23.8 million, a decrease of $12.5 million, or 34.6%, from $36.3
million in the prior year. Included in sales of defense products for the nine months ended
September 30, 2008 were inter-segment sales of $21.5 million, a decrease of $12.5 million compared
to $32.5 million in the prior year. This decrease was due to a reduction in demand of boron carbide
at our Advanced Ceramic Operations division. Sales of automotive/diesel products for the nine
months ended September 30, 2008 were $18.6 million, an increase of $3.5 million, or 22.7%, from
$15.1 million in the prior year period. Increased demand from automotive original equipment
manufacturers accounted for the increased sales. Sales of commercial products, consisting of boron
nitride for the cosmetic industry, for the nine months ended September 30, 2008 were $2.2 million,
an increase of $0.6 million, or 32.5% from $1.6 million in the prior year period.
Our Semicon Associates division had net sales for the three months ended September 30, 2008 of $2.3
million, an increase of $0.7 million, or 38.0%, from $1.6 million in the corresponding quarter of
the prior year. For the nine months ended September 30, 2008, net sales for Semicon Associates were
$6.6 million, an increase of $0.6 million, or 9.8%, from $6.0 million in the corresponding prior
year period. The increases in both periods reflect higher shipments of microwave cathodes.
Our Thermo Materials division had net sales for the three months ended September 30, 2008 of $20.7
million, an increase of $10.4 million, or 110.6%, from $10.3 million in the corresponding quarter
of the prior year. The increase was primarily due to higher penetration of the growing solar energy
market. Shipments of crucibles used in the manufacture of photovoltaic cells increased to $10.7
million, an increase of $8.5 million, or 387.1%, from $2.2 million in the third quarter a year ago.
Of this increased amount, $8.2 million in sales came from shipments from our new manufacturing facility in Tianjin, China.
Sales to the defense industry during the three months ended September 30, 2008 were $1.7 million,
an increase of $0.6 million, or 46.3%, from $1.1 million when compared to the corresponding prior
year period.
For the nine months ended September 30, 2008, net sales for Thermo Materials were $59.7 million, an
increase of $41.2 million, or 229.8%, from $18.5 million in the corresponding prior year period.
Two factors primarily account for this increase: first, the increased penetration of the growing
solar energy market. Shipments of crucibles used in the manufacture of photovoltaic cells increased
to $29.3 million, an increase of $23.4 million, or 393.4%, from $5.9 million during the nine months
ended September 30, 2008. Of this increased amount, $19.2 million came from our new manufacturing
facility in Tianjin, China. Second, Minco, Inc., which we acquired in July 2007, contributed $22.1
million of net sales for the nine months ended September 30, 2008, compared to $5.8 million in the
same period last year. Sales to the defense industry
during the nine months ended September 30, 2008 were $3.2 million, an increase of $0.8 million, or
34.0%, from $2.4 million when compared to the corresponding prior year period.
29
Our Ceradyne Canada subsidiary had net sales for the three months ended September 30, 2008 of
$91,000, a decrease of $1.3 million, or 93.4%, from $1.4 million in the corresponding quarter of
the prior year, reflecting reduced demand for our Boral
®
product line and metal matrix
composite products. For the nine months ended September 30, 2008, net sales for Ceradyne Canada
were $4.9 million, an increase of $1.7 million, or 54.4%, from $3.2 million for the corresponding
prior year period. Overall higher demand for our Boral
®
product line by the nuclear
power industry in the first half of 2008 contributed to the increase in year to date net sales.
Our Boron business segment comprises SemEquip, Inc., which we acquired on August 11, 2008, and
Ceradyne Boron Products, which we acquired on August 31, 2007. Total net sales for this segment
were $4.3 million for the three months ended September 30, 2008 and $14.5 million for the nine
months ended September 30, 2008. Most of the sales in both the three and nine month periods were
from Ceradyne Boron Products which had net sales of $4.1 million, an increase of $2.0 million, or
92.5%, from $2.1 million in the three months ended September 30, 2008 and net sales of $14.3
million, an increase of $12.2 million, or 576.9%, from $2.1 million for the nine months ended
September 30, 2008. The increased sales resulted from the inclusion of net sales of Ceradyne Boron
Products for the entire three and nine months ended September 30, 2008, which are not comparable to
the prior year periods as the acquisition occurred on August 31, 2007. The sales contribution from
the SemEquip acquisition is not expected to be significant in 2008.
Gross Profit.
Our gross profit for the three months ended September 30, 2008 was $66.7 million, a
decrease of $9.1 million, or 12.0%, from $75.8 million in the corresponding prior year quarter. As
a percentage of net sales, gross profit was 39.7% for the three months ended September 30, 2008
compared to 39.6% for the corresponding prior year quarter. For the nine months ended September 30,
2008, our gross profit was $213.8 million, a decrease of $16.5 million, or 7.2%, from $230.3
million in the prior year. As a percentage of net sales, gross profit was 39.5% for the nine months
ended September 30, 2008 compared to 40.7% for the corresponding prior year period. The decrease in
gross profit was the result primarily of lower volumes of production of body armor at our Advanced
Ceramic Operations division, lower volumes of production of boron carbide powder and continuing
pricing pressure for evaporation boats for the packaging industry produced at our ESK subsidiary,
lower volumes of production of chemicals and reduced yields at our Ceradyne Boron Products
subsidiary and lower volumes of production of Boral
®
neutron absorbing materials at our
Canadian subsidiary, Ceradyne Canada. Gross profit for the nine months ended September 30, 2008,
included $8.7 million of gross profit from the two businesses we acquired in the third quarter of
2007, Ceradyne Boron Products and Minco, Inc.
Our Advanced Ceramic Operations division posted gross profit for the three months ended September
30, 2008 of $47.3 million, a decrease of $13.9 million, or 22.6%, from $61.2 million in the
corresponding prior year quarter. As a percentage of net sales, gross profit was 43.0% for the
three months ended September 30, 2008, from 41.9% for the corresponding prior year quarter. The
improvement in gross profit as a percentage of net sales resulted from a reduction in cost of
materials and an improvement in manufacturing processes and production rates even as we adjust to
the decrease in production volumes from lower body armor demand.
For the nine months ended September 30, 2008, gross profit for the Advanced Ceramic Operations
division was $150.7 million, a decrease of $38.7 million, or 20.5%, from $189.4 million in the
corresponding prior year period. As a percentage of net sales, gross profit was 41.9% for the nine
months ended September 30, 2008 compared to 42.4% for the corresponding prior year period. For the
nine months ended September 30, 2008, the primary reason gross profit decreased was lower volumes
of production of body armor products compared to the corresponding prior period. Additionally, the
nine months ended September 30, 2008 included severance expenses of $386,000 due to the reduction
in work force during February and September 2008.
Our ESK Ceramics subsidiary had gross profit for the three months ended September 30, 2008 of $9.4
million, a decrease of $2.2 million, or 18.5%, from $11.6 million in the corresponding prior year
quarter. As a percentage of net sales, gross profit was 24.8% for the three months ended September
30, 2008, compared to 29.7% for the three months ended September 30, 2007. The decrease in gross
profit as a percentage of net sales for the three months ended September 30, 2008 was the result of
an unfavorable sales mix due to lower sales of ceramic powder for armor applications and more
competitive pricing for the sales of evaporation boats and surface engineered products.
For the nine months ended September 30, 2008, gross profit for ESK Ceramics was $31.9 million, a
decrease of $5.7 million, or 15.1%, from $37.6 million in the prior comparable period. As a
percentage of net sales, gross profit was 26.0% for the nine months ended September 30, 2008,
compared to 31.0% for the nine months ended September 30, 2007. The decrease in gross profit as a
percentage of net sales in the nine month period ended September 30, 2008 was the result of an
unfavorable sales
mix due to lower sales of ceramic powder for armor applications and more competitive pricing for
the sales of evaporation boats.
30
Our Semicon Associates division had gross profit for the three months ended September 30, 2008 of
$0.7 million, an increase of $390,000, or 141.8%, from $275,000 in the corresponding quarter of
the prior year. As a percentage of net sales, gross profit was 29.4% for the three months ended
September 30, 2008, compared to 16.8% for the corresponding prior year period. For the nine months
ended September 30, 2008, gross profit for Semicon Associates was $2.0 million, an increase of $0.8
million, or 67.2%, from $1.2 million in the corresponding prior year period. As a percentage of net
sales, gross profit was 30.4% for the nine months ended September 30, 2008 compared to 20.0% for
the corresponding prior year period. Increased sales of higher margin parts from our microwave
cathode product line, when compared to the corresponding prior year periods, contributed to the
increase in gross profit and gross profit as a percentage of net sales for the three and nine
months ended September 30, 2008.
Our Thermo Materials division had gross profit for the three months ended September 30, 2008 of
$9.4 million, an increase of $7.2 million, or 329.6%, from $2.2 million in the corresponding prior
year quarter. As a percentage of net sales, gross profit was 45.3% for the three months ended
September 30, 2008 compared to 21.4% for the corresponding prior year quarter. The increase in
gross profit as a percentage of sales for the three months ended September 30, 2008 was primarily
due to sales mix and improved yields in the production of crucibles. For the nine months ended
September 30, 2008, Thermo Materials had gross profit of $24.2 million, an increase of $20.1
million, or 494.9%, from $4.1 million in the prior year period. As a percentage of net sales, gross
profit was 40.5% for the nine months ended September 30, 2008 compared to 21.9% for the
corresponding prior year period. The improvements in gross profit and gross profit as a percentage
of sales were primarily due to an increase in the sales of crucibles, which have higher gross
margins compared to Thermo Materials other products.
Our Ceradyne Canada subsidiary had negative gross profit for the three months ended September 30,
2008 of $467,000, an increase of $436,000 from a gross loss of $31,000 in the corresponding
quarter of the prior year, reflecting the decline in sales of our Boral
®
product line.
For the nine months ended September 30, 2008, Ceradyne Canada had gross profit of $1.4 million, an
increase of $2.8 million, from a negative gross profit of $1.4 million in the prior year period.
The improvements in gross profit during the nine months ended September 30, 2008 were primarily due
to an increase in the sales of our Boral
®
product line during the first half of 2008.
Our Boron business segment comprises SemEquip, Inc., which we acquired on August 11, 2008, and
Ceradyne Boron Products, which we acquired on August 31, 2007. This segment had a negative gross
profit of $0.7 million for the three months ended September 30, 2008. Of this negative gross
profit, Ceradyne Boron was responsible for $196,000 and SemEquip accounted for the balance of the
$0.5 million negative gross profit. For the nine months ended September 30, 2008, total gross
profit of this segment was $2.4 million, an increase of $1.8 million from $0.6 million for the nine
months ended September 30, 2008. The primary reason for the large increase in gross profit of
Ceradyne Boron Products for the nine months ended September 30, 2008 was that their corresponding
prior year to date financial results were only included in our consolidated results financial
results commencing September 1, 2007. Ceradyne Borons gross loss of $196,000 during the for the
three months ended September 30, 2008 was caused by low sales volume resulting in low absorption of
fixed manufacturing overhead and an unfavorable sales mix caused by a reduction of sales of gas
products sold to the semiconductor industry which is experiencing an industry wide slowdown.
SemEquip, Inc. had a gross loss for the three months ended September 30, 2008 of $0.6 million. The
loss was caused by low sales volume resulting in unabsorbed fixed manufacturing overhead.
Selling Expenses.
Our selling expenses for the three months ended September 30, 2008 were $8.4
million, an increase of $1.5 million, or 22.9%, from $6.9 million in the corresponding prior year
quarter. Selling expenses, as a percentage of net sales, increased from 3.6% for the three months
ended September 30, 2007 to 5.0% of net sales for the three months ended September 30, 2008. The
primary reasons for the increases were that selling expenses at our ESK Ceramics subsidiary, which
constitute a relatively large portion of the total, are denominated in Euros and increase when
translated into dollars at lower exchange rates, $1.1 million of selling expenses due to the
inclusion of the results of our Ceradyne Boron Products subsidiary commencing September 1, 2007,
and $198,000 of selling expenses due to the inclusion of the results of our recently acquired
SemEquip, Inc. subsidiary.
For the nine months ended September 30, 2008, selling expenses were $25.0 million, an increase of
$5.4 million, or 27.3%, from $19.6 million in the corresponding prior year period. Selling
expenses, as a percentage of net sales, increased from 3.5% for the nine months ended September 30,
2007 to 4.6% of net sales for the nine months ended September 30, 2008. The primary reasons for the
increase were the negative impact of exchange rates on the dollar, $3.2 million of selling expenses
due to the inclusion of the results of our Ceradyne Boron Products subsidiary commencing September
1, 2007, and an
increase in selling expenses of $461,000 due to the inclusion of the results of our Minco, Inc.
subsidiary commencing July 10, 2007. Increases in the number of employees and related personnel
expenses also contributed to the increase in selling expenses for the nine months ended September
30, 2008.
31
General and Administrative Expenses.
Our general and administrative expenses for the three months
ended September 30, 2008 were $11.7 million, an increase of $423,000, or 3.8%, from $11.3 million
in the corresponding prior year quarter. General and administrative expenses, as a percentage of
net sales, increased from 5.9% for the three months ended September 30, 2007 to 7.0% for the three
months ended September 30, 2008. The primary reason for the increase was $0.7 million of general
and administrative expenses incurred by SemEquip, Inc. which we acquired on August 11, 2008.
Increases in general and administrative expenses were offset by a reduction in bonuses due to lower
pre-tax income for the three months ended September 30, 2008 compared to the corresponding prior
year period.
For the nine months ended September 30, 2008, general and administrative expenses were $35.2
million, an increase of $5.0 million, or 16.5%, from $30.2 million in the corresponding prior year
period. General and administrative expenses, as a percentage of net sales, increased from 5.3% for
the nine months ended September 30, 2007 to 6.5% for the nine months ended September 30, 2008. The
primary reasons for these increases were $0.7 million in general and administrative expenses from
the inclusion of the results of our SemEquip, Inc. subsidiary, which we acquired in August 2008,
$2.0 million of general and administrative expenses incurred by our Ceradyne Boron Products and
Minco subsidiaries, which we acquired in the third quarter of 2007, increased professional fees and
depreciation on information technology infrastructure, and the negative impact of translating Euro
denominated ESK Ceramics expenses into dollars.
Acquisition Related Charge.
We incurred an acquisition-related compensation charge of $9.8 million
for the three and nine months ended September 30, 2008 associated with a pre-closing commitment by
SemEquip, Inc. for incentive compensation for several of its employees and advisors. This $9.8
million charge includes $1.7 million of cash paid by Ceradyne at closing, and the balance
represents the discounted present value of the portion of the estimated contingent consideration
payable as incentive compensation to these employees and advisors over 15 years. For additional
information regarding this acquisition, see Note 3 of Notes to Condensed Consolidated Financial
Statements included in Part I of this report.
Research and Development Expenses.
Our research and development expenses for the three months ended
September 30, 2008 were $4.5 million, a decrease of $1.2 million, or 20.3%, from $5.7 million in
the corresponding prior year quarter. Research and development expenses, as a percentage of net
sales, decreased from 3.0% of net sales for the three months ended September 30, 2007 to 2.7% of
net sales for the three months ended September 30, 2008. For the nine months ended September 30,
2008, research and development expenses were $11.0 million, a decrease of $2.6 million, or 19.0%,
from $13.6 million in the corresponding prior year period. Research and development expenses, as a
percentage of net sales, decreased from 2.4% of net sales for the nine months ended September 30,
2007 to 2.0% of net sales for the nine months ended September 30, 2008. The primary reason for the
decrease of research and development expenses for the three and nine months ended September 30,
2008 compared to the corresponding prior periods was the reduction of vehicle armor research and
development expenses at our Michigan facility. Part of the resources at this research and
development facility were shifted to production of armored vehicles during the first half of 2008
which caused the expenses to be recorded in cost of sales
due to production of prototype vehicles.
Other Income (Expense).
Our net other income (expense) for the three months ended September 30,
2008 was $1.8 million of expense, a decrease of $3.9 million, from $2.1 million of income in the
corresponding prior year quarter resulting from a charge of $3.0 million due to an
other-than-temporary reduction in the value of our investments in auction rate securities and a
decrease of $1.5 million in interest income received on investments due to lower short term
interest rates, offset by gains on foreign currency transactions of $0.5 million.
Our net other income for the nine months ended September 30, 2008 was $1.3 million, a decrease of
$5.2 million, or 80.1%, from $6.5 million for the nine months ended September 30, 2007. The reasons
for the decrease were a reduction in interest income received on investments due to lower short
term interest rates and a charge of $3.5 million due to an other-than-temporary reduction in the
value of our investments in auction rate securities, partially offset by gains on foreign currency
transactions of $1.6 million. Interest expense was $1.0 million, a decrease of $68,000, or 6.2%,
from $1.1 million for the three months ended September 30, 2008 and $3.1 million, a decrease of
$24,000, or 0.8%, from $3.2 million for the nine months ended September 30, 2008, virtually
unchanged from the prior year periods.
Income before Provision for Income Taxes.
Our income before provision for income taxes for the
three months ended September 30, 2008 was $30.4 million, a decrease of $23.7 million, or 43.8%,
from $54.1 million in the corresponding prior year quarter. For the nine months ended September 30,
2008, income before provision for income taxes was $134.1 million, a decrease of $39.3 million, or
22.7%, from $173.4 million for the nine months ended September 30, 2007.
32
Our Advanced Ceramic Operations divisions income before provision for income taxes for the three
months ended September 30, 2008 was $35.4 million, a decrease of $16.9 million, or 32.4%, from
$52.3 million in the corresponding prior year quarter. For the nine months ended September 30,
2008, income before provision for income taxes was $121.6 million, a decrease of $44.0 million, or
26.6%, from $165.6 million for the nine months ended September 30, 2007. The decrease in income
before provision for income taxes for both the three and nine month periods ended September 30,
2008 was due primarily to lower sales of body armor.
Our ESK Ceramics subsidiary incurred a loss before provision for income taxes for the three months
ended September 30, 2008 of $79,000, a decrease of $2.2 million, or 103.8%, from $2.1 million of
income before provision for net income in the corresponding prior year quarter. For the nine months
ended September 30, 2008, income before provision for income taxes was $5.3 million, a decrease of
$5.1 million, or 49.2%, from $10.4 million in the corresponding prior year period. The decrease in
income before provision for income taxes was due to the negative economic impact on our export
sales due to the higher value of the Euro versus the U.S. dollar, an unfavorable sales mix due to
lower sales of ceramic powder for armor applications, and higher personnel costs in connection with
selling, general and administrative expenses.
Our Semicon Associates divisions income before provision for income taxes for the three months
ended September 30, 2008 was $341,000, an increase of $263,000, or 337.2%, from $78,000 in the
corresponding prior year quarter. For the nine months ended September 30, 2008 income before
provision for income taxes was $1.1 million, an increase of $0.5 million, or 87.0%, from $0.6
million in the corresponding prior year period. The increase in income before provision for income
taxes for the three and nine months ended September 30, 2008 was primarily caused by a favorable
sales mix of microwave cathode products, which have higher gross margins, compared to the
corresponding prior year period.
Our Thermo Materials divisions income before provision for income taxes for the three months ended
September 30, 2008 was $6.8 million, an increase of $30,000, or 0.0%, from $30,000 in the
corresponding prior year quarter. For the nine months ended September 30, 2008, income before
provision for income taxes was $15.8 million, an increase of $15.3 million, or 3,268.7%, from
$492,000 in the corresponding prior year period. The increase in income before provision for
income taxes in both periods was due to sales mix, improved yields in the production of crucibles,
substantially higher sales of crucibles when compared to the corresponding prior year period, and
the contribution of income before provision for income taxes by our Minco, Inc. subsidiary, which
we acquired on July 10, 2007.
Our Ceradyne Canada subsidiary incurred a loss before provision for income taxes for the three
months ended September 30, 2008 of $344,000, an increase of $2,000, from a loss of $342,000 in
the corresponding prior year quarter. For the nine months ended September 30, 2008, the income
before provision for income taxes was $362,000, an increase of $2.8 million from a loss of $2.4
million in the corresponding prior year period. The increase in income before provision for income
taxes in the nine months ended September 30, 2008 was due to increased shipments of our Boral
®
product line.
Our Boron business segment comprises SemEquip, Inc., which we acquired on August 11, 2008, and
Ceradyne Boron Products, which we acquired on August 31, 2007. The loss before provision for income
taxes for this segment was $12.8 million for the three months ended September 30, 2008 compared to
$84,000 of loss before provision for income taxes in the corresponding prior year quarter, an
increase of $12.9 million. Loss before provision for income taxes for this segment was $12.5
million for the nine months ended September 30, 2008 compared to $84,000 of loss before provision
for income taxes in the corresponding prior year period, an increase of $12.6 million. The primary
reasons for the losses in 2008 were pre-tax charge of $9.8 million in the third quarter of 2008 for
compensation expenses incurred in connection with the acquisition of SemEquip, Inc., an unfavorable
sales mix at our Ceradyne Boron Products subsidiary caused by a reduction of sales of gas products
sold to the semiconductor industry which is experiencing an industry wide slowdown in business
activity and lower sales resulting in unabsorbed fixed manufacturing overhead expenses.
Income Taxes.
We had a combined federal and state tax rate of 36.1% for the three months ended
September 30, 2008 resulting in a provision for taxes of $10.9 million, a decrease of $10.5
million, or 48.7%, from $21.4 million in the corresponding prior year quarter. Our effective tax
rate was 35.9% for the three months ended September 30, 2007. Our provision for income taxes for
the nine months ended September 30, 2008 was $48.6 million, a decrease of $15.8 million, or 24.5%,
from $64.4 million in the corresponding prior year period. The effective income tax rate for the
nine months ended September 30, 2008 was 36.3% compared to 37.1% in the corresponding prior year
period.
33
Liquidity and Capital Resources
We generally have met our operating and capital requirements with cash flow from operating
activities, borrowings under our credit facility, and proceeds from the sale of shares of our
common stock.
Our net cash position increased by $49.4 million during the nine months ended September 30, 2008
compared to a $1.6 million increase during the nine months ended September 30, 2007. For the nine
months ended September 30, 2008, cash flow provided by operating activities amounted to $127.0
million compared to $89.0 million during the nine months ended September 30, 2007. The primary
factors contributing to cash flow from operating activities in the nine months ended September 30,
2008, were net income of $85.5 million, and adjustments of non-cash amounts related to depreciation
and amortization of $30.1 million and stock compensation of $2.2 million. Additional factors
contributing to the increase in cash flow provided by operating activities were a reduction in
accounts receivable of $22.7 million, a decrease in production tooling supplies of $2.6 million, an
increase of $10.4 million in other long term liabilities due primarily to the accrual of the
pre-acquisition commitment by SemEquip, Inc. to pay incentive compensation to several of its
employees and advisors, and an increase of $1.0 million in the accrual for employee benefits. These
increases in cash provided by operating activities were offset by an increase in other receivables
of $3.6 million as a result of higher levels of utility deposits and tax deposits from our ESK
Ceramics subsidiary, an increase in inventories of $5.1 million, an increase in prepaid expenses
and other assets of $18.0 million due to estimated quarterly income tax installment deposits, and a
reduction in accounts payable and accrued expenses of $5.5 million.
Investing activities consumed $41.1 million of cash during the nine months ended September 30,
2008. This included $26.9 million for acquisitions, comprising $23.0 million (net of $2.2 million
cash received) for the acquisition of SemEquip, Inc. and $3.9 for the acquisition of certain assets
and developed technology related to proprietary technical ceramic bearing patents and intellectual
property. We also spent $35.9 million for the purchase of property, plant and equipment. Included
in this amount is $9.9 million for the purchase of land and buildings to expand our production
capacity at our ESK Ceramics subsidiarys plant in Kempten, Germany. These expenditures were
partially offset by $21.7 million of proceeds from sales and maturities of marketable securities.
Financing activities during the nine months ended September 30, 2008 consumed $34.3 million. During
the nine months ended September 30, 2008, we purchased and retired 1,128,237 shares of our common
stock at an aggregate cost of $34.9 million under a stock repurchase program authorized by our
Board of Directors. We are authorized to repurchase and retire an additional $65.1 million for a
total of $100.0 million.
The negative effect of exchange rates on cash and cash equivalents of $2.2 million during the nine
months ended September 30, 2008 was due to our investment in our German subsidiary, ESK Ceramics,
and in our Chinese subsidiary, Ceradyne (Tianjin) Technical Ceramics., Ltd.
During December 2005, we issued $121.0 million principal amount of 2.875% senior subordinated
convertible 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 our 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 our common stock reaches, or the trading price of the notes falls below, specified
thresholds, if the notes are called for redemption, if specified corporate transactions or
fundamental change occur, or during the 10 trading days prior to maturity of the notes. We 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, we 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 us 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, to
but excluding the repurchase date.
We are 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.
34
In December 2005, we 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, we are 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, we were in compliance with these covenants.
Our cash, cash equivalents, restricted cash and short-term investments totaled $215.1 million at
September 30, 2008, compared to $187.3 million at December 31, 2007. At September 30, 2008, we had
working capital of $388.9 million, compared to $353.9 million at December 31, 2007. Our cash
position includes amounts denominated in foreign currencies. The repatriation of cash balances from
our ESK Ceramics subsidiary does not result in additional tax costs while repatriation of cash
balances from our China Tianjin subsidiary results in an additional 15% tax. We believe that our current cash
and cash equivalents on hand and cash available from the sale of short-term investments, cash
available from additional borrowings under our revolving line of credit and cash we expect to
generate from operations will be sufficient to finance our anticipated capital and operating
requirements for at least the next 12 months. With respect to the ARS that have had temporary
reductions, we have the intent and ability to hold the ARS until recovery of fair value, which may
be maturity or earlier if called or liquidity is restored in the market. See Note 8 to the
Consolidated Financial Statements included in Item 1 for more information. Our anticipated capital
requirements primarily relate to the expansion of our manufacturing facilities in China. We also
may utilize cash, and, to the extent necessary, borrowings from time to time to acquire other
businesses, technologies or product lines that complement our current products, enhance our market
coverage, technical capabilities or production capacity, or offer growth opportunities.
In June 2008, we completed the purchase of certain assets and developed technology related to
proprietary technical ceramic bearings used for down hole oil drilling and for coal bed methane
pumps and steam assisted oil extraction pumps. This intellectual property was acquired from a
privately-owned business located in Greenwich, Rhode Island. We paid approximately $3.9 million for
this acquisition, and 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 3% of net sales of these bearings for the life of the patents or approximately 17
years.
In August 2008, we completed the acquisition of SemEquip, Inc. 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. SemEquips technologies enable the utilization of cluster
beam ion implantation for manufacturing advanced integrated circuits at low cost and high
throughput rates. Under the agreement, we paid $25.0 million in cash at closing. We used a portion
of our existing cash to make this payment. In addition, we may pay contingent consideration of up
to $100.0 million in cash during the 15-year period following completion of the acquisition based
upon revenues achieved over that period by SemEquip. As a result of a pre-closing commitment by
SemEquip to pay incentive compensation to several of its employees and advisors, $1.7 million of
the $25.0 million we paid at closing was distributed on the closing date, and we will pay a portion
of the future contingent consideration, as compensation to the employees and advisors to whom
SemEquip made a pre-closing commitment. This incentive compensation did not increase the total
consideration we paid for the acquisition, but it required us to record a pre-tax accounting charge
of $9.8 million in the quarter ended September 30, 2008.
Our material contractual obligations and commitments as of September 30, 2008 include a $7.2
million reserve for unrecognized tax benefits. The reserve is classified as long term liabilities
on our Consolidated Balance Sheet as of September 30, 2008.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks related to fluctuations in interest rates on our debt. We routinely
monitor our risks associated with fluctuations in currency exchange rates and interest rates. We
address these risks through controlled risk management that may, in the future, include the use of
derivative financial instruments to economically hedge or reduce these exposures. We do not enter
into foreign exchange contracts for speculative or trading purposes. Currently, we do not utilize
interest rate swaps. Our investments in marketable securities consist primarily of high-grade
corporate and government securities with
maturities of less than two years. Investments purchased with an original maturity of three months
or less are considered cash equivalents.
35
Our long term investments at September 30, 2008 included $29.5 million of auction rate securities
net of a pre-tax temporary impairment charge of $5.1 million against other comprehensive income and
a pre-tax other than temporary impairment charge of $3.5 million against earnings, both incurred
during the nine months ended September 30, 2008. To date, we have
incurred $5.8 million in
pre-tax charges against other comprehensive income and pre-tax other than temporary impairment
charges of $5.7 million related to auction rate securities. Our 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 our 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, we were 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 issuers credit quality and
disruptions in the credit markets. At September 30, 2008, we determined that the market for our
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. Our investments
in auction rate securities were classified within Level 3 of the fair value hierarchy because we
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:
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Probability of passing auction at some point in the future
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Probability of default at some point in the future (with appropriate loss severity
assumptions)
|
We determined that the appropriate risk-free discount rate (before risk adjustments) used to
discount the contractual cash flows of our 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 our 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 ARS investments was other-than-temporary,
we 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) our
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,
we have the intent and ability
to hold the ARS investments until recovery of fair value, which may be maturity or earlier if
called, and therefore do not consider these unrealized losses to be other-than-temporary.
We enter into foreign exchange forward contracts to reduce earnings and cash flow volatility
associated with foreign exchange rate changes to allow our management team to focus its attention
on its core business operations. Accordingly, we enter into contracts which change in value as
foreign exchange rates change to economically offset the effect of changes in value of foreign
currency assets and liabilities, commitments and anticipated foreign currency denominated sales and
operating expenses. We enter into foreign exchange forward contracts in amounts between minimum and
maximum anticipated foreign exchange exposures, generally for periods not to exceed one year. These
derivative instruments are not designated as accounting hedges. We did not have any outstanding
foreign exchange forward contracts at September 30, 2008.
36
Given the inherent limitations of forecasting and the anticipatory nature of the exposures intended
to be hedged, there can be no assurance that such programs will offset more than a portion of the
adverse financial impact resulting from unfavorable movements in either interest or foreign
exchange rates. In addition, the timing of the accounting for recognition of gains and losses
related to mark-to-market instruments for any given period may not coincide with the timing of
gains and losses related to the underlying economic exposures and, therefore, may adversely affect
our operating results and financial position and cash flows.
We measure the financial statements of our foreign subsidiaries using the local currency as the
functional currency. Assets and liabilities of these subsidiaries are translated at the exchange
rate on the balance sheet date. Revenues, costs and expenses are translated at the rates of
exchange prevailing during the year. Translation adjustments resulting from this process are
included in stockholders equity. Gains and losses from foreign currency transactions are included
in other income, miscellaneous.
Our debt is comprised of $121.0 million of a convertible note with a fixed coupon rate of 2.875%.
The fair value of long-term debt was $111.6 million and is based on quoted market prices at
September 30, 2008.
Approximately 27.0% of our revenues for the nine months ended September 30, 2008 were derived from
operations outside the United States. Overall, we are a net recipient of currencies other than the
U.S. dollar and, as such, we benefit from a weaker dollar and are adversely affected by a stronger
dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in
particular a strengthening of the U.S. dollar, may negatively affect net sales, gross profit, and
net income from our subsidiary, ESK Ceramics, as expressed in U.S. dollars. This would also
negatively impact our consolidated reported results.
Item 4.
Controls and Procedures
Review of Historical Stock Option Grant Procedures
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 Companys Board of Directors, with the assistance of
independent legal counsel and forensic accounting experts. This review has been completed and the
special committee presented its report to the Companys Board of Directors. It was the finding of
the special committee that control deficiencies that led to the Company utilizing incorrect
measurement dates for stock option grants had been corrected subsequent to September 2003. The
special committee did not propose any recommendations for improvements in the current process of
granting stock options and restricted stock unit awards as a result of its investigation.
Additional information regarding the special committees review is provided in this report in Note
4 of the Notes to Consolidated Financial Statements.
Evaluation of Disclosure Controls and Procedures
We carried out an evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the design and operation
of our disclosure controls and procedures as of September 30, 2008 (the end of the period covered
by this report). Based on this evaluation, our principal executive officer and principal financial
officer concluded that our current disclosure controls and procedures (as defined in Rules
13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934) are effective.
Changes in Internal Control over Financial Reporting
Our management evaluated our internal control over financial reporting and there have been no
changes during the fiscal quarter ended September 30, 2008 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
37
PART II. OTHER INFORMATION
Item 1.
Legal Proceedings
In August, September and December 2006, shareholder derivative lawsuits were filed in the
California Superior Court for Orange County, purportedly on behalf of Ceradyne against various
current and former officers and directors of the Company relating to alleged backdating of stock
options. Each state court complaint alleged claims for breach of fiduciary duty, abuse of control,
gross mismanagement, waste of corporate assets, unjust enrichment, accounting, rescission,
constructive trust, and violations of California Corporations Code. All state court actions have
been consolidated into one case, designated, In re Ceradyne, Inc. Derivative Litigation, Orange
County Superior Court, Case No. 06-CC-00156.
In September and December 2006, shareholder derivative lawsuits were filed in the United States
District Court for the Central District of California, purportedly on behalf of Ceradyne against
various current and former officers and directors of the Company relating to alleged backdating of
stock options. All federal court actions have been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Master File No. SA CV 06-919 JVS. The consolidated federal
action alleges, pursuant to a first amended consolidated complaint filed on September 17, 2007,
claims for violations of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder,
violations of Section 14(a) of the Securities Exchange Act, violations of Section 20(a) of the
Securities Exchange Act, insider selling under the California Corporations Code, as well as common
law claims for accounting, breach of fiduciary duty, aiding and abetting breaches of fiduciary
duty, unjust enrichment, rescission and waste.
The plaintiffs in both the state and federal actions seek to require the individual defendants to
rescind stock options they received which have an exercise price below the closing price of the
Companys common stock on the date of grant, to disgorge the proceeds of options exercised, to
reimburse the Company for damages of an unspecified amount, and also seek certain equitable relief,
attorneys fees and costs.
On October 26, 2007, the Company and the individual defendants filed motions to dismiss the first
amended consolidated complaint in the federal action. In December 2007, plaintiffs filed a second
amended consolidated complaint.
In summary, there are currently two shareholder derivative actions pending which contain
substantially similar allegations. The cases filed in the Orange County Superior Court have been
consolidated into one case, designated, In re Ceradyne, Inc. Derivative Litigation, Orange County
Superior Court, Case No. 06-CC-00156. The cases filed in the United States District Court for the
Central District of California have all been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Master File No. SA CV 06-919 JVS.
On September 26, 2008, all of the parties to the two derivative actions entered into a memorandum
of understanding agreeing in principle to a proposed global settlement of these derivative actions.
The parties have filed a stipulation with the federal court to submit a final stipulation of
settlement by November 28, 2008. The proposed settlement calls for the Company to adopt certain
corporate governance reforms and payment by the Companys insurance carriers of $1.125 million in
attorneys fees to the plaintiffs attorneys, without any payment by Ceradyne or the other
defendants, and for dismissal of the actions with prejudice. The proposed settlement is conditioned
upon the parties reaching agreement on a stipulation of settlement, final court approval after
notice to Ceradynes shareholders and expiration of the time for appear from any order of the Court
approving the settlement. There can be no assurance that the final settlement will be obtained.
Daniel Vargas, Jr. v. Ceradyne, Inc., Orange County Superior Court, Civil Action No.
07CC01232
:
The Vargas Litigation is a class action in which it is asserted that the representative Plaintiff,
a former Ceradyne employee, and the putative class members, were not paid overtime at an
appropriate overtime rate. The complaint alleges that the purportedly affected employees should
have had their regular rate of pay, for purposes of calculating overtime, adjusted to reflect the
payment of a bonus to them for the four years preceding the filing of the complaint, on or about
March 23, 2007. The complaint further alleges that a waiting time penalty should be assessed for
the failure to timely pay the correct overtime payment. Ceradyne filed an answer denying the
material allegations of the complaint. A motion for class certification was filed on or about
August 11, 2008. Ceradyne has filed an opposition claiming that there are no common questions of
fact that can be generalized across the class. Ceradyne has also opposed the motion on the basis
that the Plaintiff has not established his suitability as a class representative, particularly
because he is a former employee whose interests conflict with the current employees. The hearing is
presently scheduled for November 13, 2008. In addition to the arguments against class
certification, we believe that the action itself is without merit because our bonus policy is
discretionary and is not of the type that is subject to inclusion in the regular hourly rate for
purposes of calculating overtime, and we intend to vigorously defend this action.
38
Item 1A.
Risk Factors
There have been no significant changes to the risk factors disclosed in the Companys Annual Report
on Form 10-K for the year ended December 31, 2007.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
Item 3.
Defaults Upon Senior Securities
Not applicable.
Item 4.
Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5.
Other Information
Not applicable.
Item 6.
Exhibits
(a) Exhibits:
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31.1
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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31.2
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Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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32.1
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Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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32.2
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Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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39
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
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CERADYNE, INC.
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Date: October 28, 2008
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By:
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/s/ JERROLD J. PELLIZZON
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Jerrold J. Pellizzon
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Vice President
Chief Financial Officer
(Principal Financial and Accounting Officer)
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40
Index to Exhibits
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Exhibit
|
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Description
|
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31.1
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Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
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31.2
|
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Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
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32.1
|
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Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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32.2
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Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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41
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