- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2011

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

For the transition period from to

Commission File No. 000-13059

(Exact name of Registrant as specified in its charter)

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

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

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

N/A

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

Large accelerated filer ¨

Accelerated filer x

Non-accelerated filer ¨

Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).

Yes ¨ No x

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

Class		Outstanding as of October 21, 2011
Common Stock, $0.01 par value		24,199,008 Shares

Exhibit Index on Page 34

CERADYNE, INC.

INDEX

		PAGE NO.
PART I.	FINANCIAL INFORMATION

Item 1.	Unaudited Consolidated Financial Statements		3

	Consolidated Balance Sheets – September 30, 2011 and December 31, 2010		3

	Consolidated Statements of Income – Three and Nine Months Ended September 30, 2011 and 2010		4

	Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2011 and 2010		5

	Notes to Consolidated Financial Statements		6-19

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		20-30

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		31

Item 4.	Controls and Procedures		32

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings		33

Item 1A.	Risk Factors		33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		33

Item 3.	Not applicable		34

Item 4.	Not applicable		34

Item 5.	Not applicable		34

Item 6.	Exhibits		34

SIGNATURE			35

CERADYNE, INC.

FORM 10-Q

FOR THE QUARTER ENDED

September 30, 2011

P ART I. FINANCIAL INFORMATION

Item 1.

Unaudited Consolidated Financial Statements

CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)

	September 30, 2011		December 31, 2010
	(Unaudited)
CURRENT ASSETS
Cash and cash equivalents	$	31,541	$	53,436
Short-term investments		227,477		192,860
Accounts receivable, net of allowances of $2,408 and $685 at September 30, 2011 and December 31, 2010, respectively		71,541		53,019
Other receivables		12,478		17,553
Inventories, net		110,473		94,258
Production tooling, net		22,486		10,037
Prepaid expenses and other		38,838		38,653
Deferred tax asset		8,636		6,808
TOTAL CURRENT ASSETS		523,470		466,624

PROPERTY, PLANT AND EQUIPMENT, net		246,826		243,681
LONG TERM INVESTMENTS		15,997		26,187
INTANGIBLE ASSETS, net		102,068		83,475
GOODWILL		51,019		43,219
OTHER ASSETS		2,118		2,127
TOTAL ASSETS	$	941,498	$	865,313

CURRENT LIABILITIES
Accounts payable	$	30,281	$	25,738
Accrued expenses		31,958		24,603
Income taxes payable		5,297		1,869
TOTAL CURRENT LIABILITIES		67,536		52,210
LONG-TERM DEBT		88,341		85,599
EMPLOYEE BENEFITS		22,556		22,269
OTHER LONG TERM LIABILITY		57,589		41,902
DEFERRED TAX LIABILITY		11,164		11,124
TOTAL LIABILITIES		247,186		213,104

COMMITMENTS AND CONTINGENCIES (Note 13)
SHAREHOLDERS’ EQUITY
Common stock, $0.01 par value, 100,000,000 authorized, 24,163,124 and 24,713,126 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively		242		247
Additional paid-in capital		122,120		141,973
Retained earnings		562,667		499,532
Accumulated other comprehensive income		9,283		10,457
TOTAL SHAREHOLDERS’ EQUITY		694,312		652,209
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	941,498	$	865,313

See accompanying condensed notes to Consolidated Financial Statements

CERADYNE, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	(Unaudited)						(Unaudited)
NET SALES	$	147,974		$	91,766		$	443,452		$	302,219
COST OF GOODS SOLD		94,248			68,150			278,679			227,392
Gross profit		53,726			23,616			164,773			74,827
OPERATING EXPENSES
Selling, general and administrative		19,251			14,418			57,545			43,947
Acquisition related charge (credit)		702			31			2,124			(88	)
Research and development		2,974			2,613			9,255			8,731
Restructuring - plant closure and severance		-			-			-			7
		22,927			17,062			68,924			52,597
INCOME FROM OPERATIONS		30,799			6,554			95,849			22,230

OTHER INCOME (EXPENSE):
Interest income		1,069			935			2,744			2,562
Interest expense		(1,721	)		(1,518	)		(4,838	)		(4,713	)
Gain (loss) on auction rate securities		-			-			-			(978	)
Miscellaneous		1,081			(917	)		1,671			493
		429			(1,500	)		(423	)		(2,636	)
INCOME BEFORE PROVISION FOR INCOME TAXES		31,228			5,054			95,426			19,594
PROVISION FOR INCOME TAXES		10,819			517			32,291			3,504
NET INCOME	$	20,409		$	4,537		$	63,135		$	16,090
BASIC INCOME PER SHARE	$	0.83		$	0.18		$	2.55		$	0.64
DILUTED INCOME PER SHARE	$	0.82		$	0.18		$	2.52		$	0.63
WEIGHTED AVERAGE SHARES OUTSTANDING:
BASIC		24,556			24,960			24,764			25,329
DILUTED		24,811			25,141			25,029			25,506

See accompanying condensed notes to Consolidated Financial Statements

CERADYNE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

	Nine Months Ended September 30,
	2011			2010
	(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	63,135		$	16,090
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation and amortization		29,438			26,979
Amortization of bond premium		827			273
Non cash interest expense on convertible debt		2,742			2,550
Deferred income taxes		556			1,376
Stock compensation		3,150			2,994
Loss on marketable securities		87			978
Loss on equipment disposal		245			510
Change in operating assets and liabilities (net of effect of businesses acquired):
Accounts receivable, net		(15,813	)		2,855
Other receivables		5,535			(5,534	)
Inventories, net		(13,329	)		15,132
Production tooling, net		(7,064	)		506
Prepaid expenses and other assets		(4,945	)		483
Accounts payable and accrued expenses		11,043			2,480
Income taxes payable		3,532			(106	)
Other long term liability		3,353			(1,063	)
Employee benefits		633			386
NET CASH PROVIDED BY OPERATING ACTIVITIES		83,125			66,889
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(23,833	)		(30,665	)
Changes in restricted cash		-			3,130
Purchases of marketable securities		(78,607	)		(119,956	)
Proceeds from sales and maturities of marketable securities		47,757			4,489
Cash paid for acquisitions		(27,673	)		-
Proceeds from sale of equipment		1,440			465
NET CASH USED IN INVESTING ACTIVITIES:		(80,916	)		(142,537	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of stock due to exercise of options		1,033			224
Excess tax benefit due to exercise of stock options		2,018			7
Shares repurchased		(25,775	)		(14,837	)
NET CASH (USED) IN FINANCING ACTIVITIES		(22,724	)		(14,606	)
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS		(1,380	)		268
DECREASE IN CASH AND CASH EQUIVALENTS		(21,895	)		(89,986	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		53,436			122,154
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	31,541		$	32,168

See accompanying condensed notes to Consolidated Financial Statements

CERADYNE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

(Unaudited)

1.	Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) 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 presentation have been included. Operating results for the nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

The balance sheet at December 31, 2010 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. For further information, refer to the Consolidated Financial Statements and Notes to Financial Statements included in Ceradyne’s annual report on Form 10-K for the year ended December 31, 2010.

2.	Share Based Compensation

Share-based compensation expense for the three and nine months ended September 30, 2011 was $1.2 million and $3.1 million, respectively, which was related to restricted stock units only as the Company did not have any share-based compensation expense for stock options. This compared to $1.0 million and $3.0 million for the three and nine months ended September 30, 2010, respectively.

Share-based compensation expense is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Forfeitures are estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is based on historical rates. Share-based compensation expense recognized in the Company’s Consolidated Statements of Income for the three and nine month periods ended September 30, 2011 includes (i) compensation expense for share-based payment awards granted prior to, but not yet vested as of January 1, 2006, based on the estimated grant-date fair value and (ii) compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the estimated grant-date fair value. Since share-based compensation expense recognized in the Consolidated Statements of Income for the three and nine month periods ended September 30, 2011 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 397,811 shares through September 30, 2011. There are no remaining stock options available to grant under this plan. The options granted under this plan generally became exercisable over a five-year period for incentive stock options and six months for nonqualified stock options and have a maximum term of ten years.

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

The Company may grant options and Units for up to 1,875,000 shares under the 2003 Stock Incentive Plan. The Company has granted options for 475,125 shares and Units for 869,865 shares under this plan through September 30, 2011. There have been cancellations of 118,809 shares associated with this plan through September 30, 2011. The options under this plan have a life of ten years.

During the three and nine months ended September 30, 2011 and 2010, 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. The Company records compensation expense for the amount of the grant date fair value on a straight line basis over the vesting period.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Share-based compensation expense recognized:
General and administrative, options	$	-		$	-		$	-		$	41
General and administrative, restricted stock units		1,120			1,019			3,150			2,960
Related deferred income tax benefit		(446	)		(406	)		(1,255	)		(1,196	)
Decrease in net income	$	674		$	613		$	1,895		$	1,805
Decrease in basic earnings per share	$	0.03		$	0.02		$	0.08		$	0.07
Decrease in diluted earnings per share	$	0.03		$	0.02		$	0.08		$	0.07

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

As of September 30, 2011, all stock options were vested, consequently there was no unrecognized compensation cost related to them. The aggregate intrinsic value of stock options exercised was $4.3 million and $200,000 for the nine months ended September 30, 2011 and 2010, respectively.

As of September 30, 2011, there was approximately $9.8 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 3.0 years.

The following is a summary of stock option activity:

	Nine Months Ended September 30, 2011
	Number of Options			Weighted Average Exercise Price
Outstanding, December 31, 2010		428,000		$	12.28
Options exercised		(160,100	)	$	6.45
Outstanding, September 30, 2011		267,900		$	15.76
Exercisable, September 30, 2011		267,900		$	15.76

The following is a summary of Unit activity:

	Nine Months Ended September 30, 2011
	Number of Units			Weighted Average Grant Date Fair Value
Non-vested Units at December 31, 2010		399,684		$	28.40
Granted		109,834		$	42.12
Forfeited		(7,234	)	$	28.74
Vested		(131,757	)	$	31.50
Non-vested Units at September 30, 2011		370,527		$	31.36

The following table summarizes information regarding options outstanding and options exercisable at September 30, 2011:

		Outstanding and Exercisable
Range of Grant Prices		Number of Options		Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Aggregate Intrinsic Value (000s)
	$2.98 - $4.58		57,600		0.96	$	3.44	$	1,351
	$16.90 - $18.80		118,700		2.09	$	17.05	$	1,168
	$21.50 - $22.67		91,600		2.90	$	21.85	$	462
			267,900		2.12	$	15.76	$	2,981

The following table summarizes information regarding Units outstanding at September 30, 2011:

		Outstanding
Range of Grant Prices		Number of Units		Average Remaining Contractual Life (Years)		Weighted Average Grant Date Fair Value
$	16.53 - $31.69		203,307		2.31	$	21.46
$	35.67 - $39.43		56,800		2.71	$	37.43
$	40.73 - $45.70		100,600		3.48	$	44.79
$	52.47 - $62.07		4,600		0.43	$	55.90
$	66.35 - $81.18		5,220		0.73	$	70.42
			370,527		2.65	$	31.36

3.	Net Income Per Share

Basic net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding plus the effect of any dilutive stock options and Units using the treasury stock method and the net share settlement method for the convertible debt. During the three and nine months ended September 30, 2011 and 2010, the average trading price of the Company’s stock did not exceed the conversion price of the convertible debt, therefore there was no impact to the calculation of diluted shares.

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 September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Weighted average number of shares outstanding		24,556,283		24,960,446		24,763,653		25,329,282
Dilutive stock options		205,001		180,768		218,643		176,377
Dilutive restricted stock units		50,105		-		46,986		-
Dilutive contingent convertible debt common shares		-		-		-		-
Number of shares used in fully diluted computations		24,811,389		25,141,214		25,029,282		25,505,659

The following are the number of shares not included in the fully diluted computation pertaining to restricted stock units as their impact would be anti-dilutive.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Anti-dilutive restricted stock units		171,220		206,682		141,220		236,682

4.	Composition of Certain Financial Statement Captions

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, 2011 and December 31, 2010 (in thousands):

	September 30, 2011		December 31, 2010
Raw materials	$	6,339	$	9,459
Work-in-process		65,216		49,825
Finished goods		38,918		34,974
	$	110,473	$	94,258

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

	September 30, 2011			December 31, 2010
Land	$	18,865		$	18,902
Buildings and improvements		117,600			97,076
Machinery and equipment		231,262			209,334
Leasehold improvements		8,428			8,401
Office equipment		37,299			32,269
Construction in progress		14,582			37,286
		428,036			403,268
Less accumulated depreciation and amortization		(181,210	)		(159,587	)
	$	246,826		$	243,681

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

	September 30, 2011						December 31, 2010
	Gross Amount		Accumulated Amortization		Net Amount		Gross Amount		Accumulated Amortization		Net Amount
Amortizing Intangible Assets
Backlog	$	1,826	$	1,826	$	-	$	1,826	$	1,826	$	-
Developed technology		70,757		7,192		63,565		50,530		5,387		45,143
Tradename		4,110		659		3,451		1,110		571		539
Customer relationships		47,604		15,203		32,401		47,604		12,087		35,517
Non-compete agreement		1,100		725		375		500		500		-
Non-amortizing tradename		2,276		-		2,276		2,276		-		2,276
Total	$	127,673	$	25,605	$	102,068	$	103,846	$	20,371	$	83,475

The estimated useful lives for intangible assets are:

Identified Intangible Asset		Estimated Useful Life in Years or Months
Developed technology		10 years – 20 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): $5,011 for the balance of fiscal year 2011, $7,914 in fiscal year 2012, $9,777 in fiscal year 2013, $12,569 in fiscal year 2014 and $15,726 in fiscal year 2015.

The roll forward of the goodwill balance by segment during the nine months ended September 30, 2011 is as follows (in thousands):

	Advanced Ceramic Operations		Thermo		ESK		Boron			Total

Goodwill	$	5,311	$	10,331	$	9,326	$	22,083		$	47,051
Accumulated impairment losses		-		-		-		(3,832	)		(3,832	)
Balance at December 31, 2010		5,311		10,331		9,326		18,251			43,219
Acquisition of VIOX Corporation		7,797		-		-		-			7,797
Translation and other		-		-		3		-			3
Goodwill		13,108		10,331		9,329		22,083			54,851
Accumulated impairment losses		-		-		-		(3,832	)		(3,832	)
Balance at September 30, 2011	$	13,108	$	10,331	$	9,329	$	18,251		$	51,019

The Company is required to test annually whether the estimated fair value of its reporting units is sufficient to support the goodwill assigned to those reporting units; the Company performs the annual test in the fourth quarter. The Company is also required to test goodwill for impairment before the annual test if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount, such as a significant adverse change in the business climate. The Company determined that a test of goodwill for impairment was not required as of September 30, 2011.

5.	Stock Repurchases

During the nine months ended September 30, 2011, the Company repurchased and retired 842,934 shares of its common stock at an aggregate cost of $25.8 million under a stock repurchase program authorized in 2008 by the Company’s Board of Directors. From the inception of this stock purchase program, the Company has repurchased and retired 3,842,305 shares of its common stock at an aggregate cost of $100.0 million. On August 30, 2011, the Company’s Board of Directors authorized another stock repurchase program of up to $100.0 million of the Company’s common stock. There is no time limit for completion of this repurchase program and it may be suspended or terminated at any time.

6.	Fair Value Measurements

The Company measures fair value and provides required disclosures about fair value measurements as it relates to financial and nonfinancial assets and liabilities in accordance with a framework specified by GAAP. This framework addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP. The framework also includes additional guidance to provide greater clarity about the credit and noncredit component of an other-than-temporary impairment event.

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

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

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

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

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

For recognition purposes, on a recurring basis, the Company measures available for sale short-term and long-term investments at fair value. Short-term investments had an aggregate fair value of $227.5 million at September 30, 2011 and $192.9 million at December 31, 2010. The fair value of these investments is determined using quoted prices in active markets. Long-term investments at September 30, 2011 and December 31, 2010 were comprised as follows:

	September 30, 2011		December 31, 2010
Auction rate securities	$	14,954	$	15,789
Corporate bonds		1,043		10,398
	$	15,997	$	26,187

The fair value of corporate bonds is determined using quoted prices in active markets. The fair value of long-term investments in auction rate securities is 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.

There were no losses from other than temporary reductions in the fair value of investments in auction rate securities during the three months ended September 30, 2011 and 2010. The Company recognized a pre-tax decrease of $0.9 million in other comprehensive income during the three months ended September 30, 2011 and a pre-tax decrease of $61,000 in other comprehensive income during the three months ended September 30, 2010, due to temporary changes in the fair value of its investments in auction rate securities.

There were no losses from other than temporary reductions in the fair value of investments in auction rate securities during the nine months ended September 30, 2011. During the nine months ended September 30, 2010, the Company recognized a net pre-tax loss of $1.0 million from auction rate securities. Included in the net pre-tax loss of $1.0 million from auction rate securities is a $2.1 million charge for other than temporary impairment losses, partially offset by a realized gain of $1.1 million as a result of proceeds of $3.5 million from the sales of auction rate securities in excess of the cost basis of $2.4 million. The Company recognized a net pre-tax decrease of $0.8 million in other comprehensive income during the nine months ended September 30, 2011 and a pre-tax increase of $107,000 which increased other comprehensive income during the nine months ended September 30, 2010, due to temporary changes in the fair value of its investments in auction rate securities.

Cumulatively to date, the Company has incurred $9.2 million in pre-tax charges due to other-than-temporary reductions in the value of its investments in auction rate securities, realized losses of $4.9 million from sales of auction rate securities and pre-tax temporary impairment charges of $3.1 million reflected in other comprehensive income. The Company’s investments in auction rate securities represent interests in insurance securitizations collateralized by pools of residential and commercial mortgages, asset backed securities and other structured credits relating to the credit risk of various bond guarantors that mature at various dates from June 2021 through July 2052. These auction rate securities were intended to provide liquidity via an auction process which is scheduled every 28 days, that resets the applicable interest rate, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. Interest rates are capped at a floating rate of one month LIBOR plus additional spread ranging from 1.25% to 4.00% depending on prevailing rating. During the second half of the year 2007, through 2008, 2009, 2010 and through September 30, 2011, the auctions for these securities failed. As a result of current negative conditions in the global credit markets, auctions for the Company’s investment in these securities have recently failed to settle on their respective settlement dates. Consequently, the investments are not currently liquid through the normal auction process and may be liquidated if a buyer is found outside the auction process. Although the auctions have failed, the Company continues to receive underlying cash flows in the form of interest income from the investments in auction rate securities. As of September 30, 2011, the fair value of the Company’s investments in auction rate securities was below cost by approximately $12.3 million. The fair value of the auction rate securities has been below cost for more than one year.

Beginning in the third quarter of 2008 and at September 30, 2011, the Company determined that the market for its investments in auction rate securities and for similar securities continued to be inactive since there were few observable or recent transactions for these securities or similar securities. The Company’s investments in auction rate securities were classified within Level 3 of the fair value hierarchy because the Company determined that significant adjustments using unobservable inputs were required to determine fair value as of September 30, 2011 and December 31, 2010.

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 0.1% to 3.1%, 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. This risk of nonperformance has been captured within the probability of default and loss severity assumptions noted above. The risk-adjusted discount rate, which incorporates liquidity risk, appropriately reflects the Company’s estimate of the assumptions that market participants would use (including probability weighted inputs noted above) to estimate the selling price of the asset at the measurement date.

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

Assets (liabilities) measured at fair value on a recurring basis include the following as of September 30, 2011 and December 31, 2010 (in thousands):

	Three Months Ended September 30, 2011 Using
(In thousands)	Quoted Prices in Active Markets (Level 1)			Quoted Prices in Active Markets (Level 2)		Quoted Prices in Active Markets (Level 3)		Total Carrying Value at September 30, 2011
Cash and cash equivalents	$	31,541		$	-	$	-	$	31,541
Short term investments:
Investment funds – debt securities		215,447			-		-		215,447
Corporate bonds		12,030			-		-		12,030
Total short term investments		227,477			-		-		227,477
Long term investments:
Auction rate securities		-			-		14,954		14,954
Corporate bonds		1,043			-		-		1,043
Total long term investments		1,043			-		14,954		15,997
Other long-term financial asset		839			-		-		839
Derivative financial instrument (included accrued expenses in the balance sheet)		(1,481	)		-		-		(1,481	)

	Three Months Ended December 31, 2010 Using
(In thousands)	Quoted Prices in Active Markets (Level 1)		Quoted Prices in A ctive Markets (Level 2)		Quoted Prices in Active Markets (Level 3)		Total Carrying Value at December 31, 2010
Cash and cash equivalents	$	53,436	$	-	$	-	$	53,436
Short term investments:
Investment funds – debt securities		171,462		-		-		171,462
Corporate bonds		21,398		-		-		21,398
Total short term investments		192,860		-		-		192,860
Long term investments:
Auction rate securities		-		-		15,789		15,789
Corporate bonds		10,398		-		-		10,398
Total long term investments		10,398		-		15,789		26,187
Other long-term financial asset		1,335		-		-		1,335
Derivative financial instrument (included accrued expenses in the balance sheet)		49		-		-		49

Activity in long term investments (Level 3) was as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Balance at beginning of period	$	15,848		$	15,746		$	15,789		$	20,019
Proceeds from sales of auction rate securities		-			-			-			(3,463	)
Realized gain included in net earnings		-			-			-			1,052
Unrealized gain (loss) included in net earnings		-			-			-			(2,030	)
Unrealized gain (loss) included in other comprehensive income		(894	)		(61	)		(835	)		107
Balance at end of period	$	14,954		$	15,685		$	14,954		$	15,685

The Company recorded a liability for contingent consideration as part of the purchase price for the acquisition of VIOX Corporation at the estimated fair value of $11.5 million as of January 3, 2011. The contingent consideration arrangement requires the Company to pay the former owners of VIOX Corporation an earnout agreed upon amount, depending on the achievement of certain revenue and operating profit performance goals, with the earnout period ending 30 months after the acquisition date. The fair value of the contingent consideration arrangement was estimated based on expected revenue and operating profit during the earnout period and the discounted future cash payments that result from the calculation of the earnout as specified in the purchase agreement. The fair value of the earnout is based on significant inputs that are unobservable in the market, which is a Level 3 input. Key assumptions include a discount rate of 20 percent and estimated revenues and operating profit during the earnout period. The Company performs a quarterly revaluation of contingent consideration and records the change as a component of operating income. During the three months and nine months ended September 30, 2011, the change in the fair value of this contingent consideration liability was $0.6 million and $1.7 million, respectively, based on an estimated fair value of $13.2 million as of September 30, 2011. See Note 15 for additional information regarding this acquisition.

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. The fair value of long-term debt, based on quoted market prices, was $94.0 million at September 30, 2011 and $93.1 million at December 31, 2010.

7.	Recent Accounting Pronouncements

In January 2010, the FASB issued revised authoritative guidance that requires more robust disclosures about the different classes of assets and liabilities measured at fair value, the valuation techniques and inputs used, the activity in Level 3 fair value measurements, and the transfers between Levels 1, 2 and 3. This guidance was adopted on January 1, 2010 except for the disclosures about purchases, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosure requirements were adopted on January 1, 2011. The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.

In December 2010, the FASB issued authoritative guidance that amended the disclosure requirements for supplementary pro forma related to business combinations. The amendments specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company adopted this guidance on January 1, 2011 and the amended disclosure requirements will be included in consolidated financial statements as applicable for the year ended December 31, 2011.

In May 2011, the FASB issued new guidance which changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and IFRS. This new guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is to be applied prospectively. The Company anticipates that the adoption of this standard in the first quarter of 2012 will not materially expand its consolidated financial statement footnote disclosures.

In June 2011, the FASB issued new guidance which eliminates the option to report other comprehensive income and its components in the statement of changes in equity. This new guidance requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance is to be applied retrospectively. The Company anticipates that the adoption of this standard in the first quarter of 2012 may materially change the presentation of its consolidated financial statements.

In September 2011, the FASB issued Accounting Standards Update No. 2011-09, “Compensation — Retirement Benefits — Multiemployer Plans (Subtopic 715-80),” (“ASU 2011-09”). ASU 2011-09 requires that employers provide additional separate disclosures for multiemployer pension plans and multiemployer other postretirement benefit plans. The additional quantitative and qualitative disclosures will provide users with more detailed information about an employer’s involvement in multiemployer pension plans. The Company anticipates that the adoption of this standard will expand its footnote disclosures in the consolidated financial statements and will not have a material impact on its consolidated financial statements for the year ending December 31, 2011.

In September 2011, the FASB issued Accounting Standards Update No. 2011-08, “Intangibles — Goodwill and Other (Topic 350),” (“ASU 2011-08”). ASU 2011-08 allows entities to first assess qualitatively whether it is necessary to perform the two-step goodwill impairment test. If an entity believes, as a result of its qualitative assessment, that it is more likely than not that the fair value of a reporting period is less than its carrying amount, the quantitative two-step goodwill impairment test is required. An entity has the unconditional option to bypass the qualitative assessment and proceed directly to performing the first step of the goodwill impairment test. This guidance is effective in the first quarter of 2012. The Company anticipates that the adoption of this standard will not have a material impact on its consolidated financial statements and footnote disclosures. The Company does not intend to make an early adoption of this standard.

8.	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. The Company subsequently repurchased $27.9 million of the Notes during 2009 which reduced the outstanding principal amount to $93.1 million. Since the Notes are convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement), the Company separately accounts for the liability and equity components of the Notes in a manner that reflects the Company’s nonconvertible debt borrowing rate as interest cost is recognized.

As of September 30, 2011 and December 31, 2010, long-term debt and the equity component (recorded in additional paid in capital, net of income tax benefit), determined in accordance with the accounting guidance for convertible debt, comprised the following (in thousands):

	September 30, 2011			December 31, 2010
Long-term debt
Principal amount	$	93,100		$	93,100
Unamortized discount		(4,759	)		(7,501	)
Net carrying amount	$	88,341		$	85,599
Equity component, net of income tax benefit	$	16,399		$	16,399

The discount on the liability component of long-term debt is being amortized using the effective interest method based on an annual effective rate of 7.5%, which represented the market interest rate for similar debt without a conversion option on the issuance date, through December 2012, which coincides with the first date that holders of the Notes can exercise their put option as discussed below.

Interest expense on the Notes for the three and nine months ended September 30, 2011 and 2010 included the following (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Contractual interest coupon	$	673	$	673	$	2,003	$	2,003
Non-cash amortization of discount on the liability component		947		881		2,742		2,550
Non-cash amortization of debt issuance costs		96		92		283		272
	$	1,716	$	1,646	$	5,028	$	4,825

Interest on the Notes is payable on December 15 and June 15 of each year, commencing on June 15, 2006. The Notes are convertible into 17.1032 shares of Ceradyne’s common stock for each $1,000 principal amount of the Notes (which represents a conversion price of approximately $58.47 per share), subject to adjustment. The conversion rate will be adjusted upon the occurrence of events that affect Ceradyne’s outstanding common stock, such as the issuance of our common stock or other securities as a dividend distribution to holders of our common stock, a subdivision or combination of our common stock, a recapitalization, reclassification or change of our common stock, or a consolidation or merger involving Ceradyne, as a result of which our common stock would be converted into, or exchanged for, stock, other securities or other property. Generally, the conversion rate would be adjusted as of the effective time of such transaction, such that the Notes would then be convertible into the kind and amount of shares of stock, other securities or other property, that a holder of a number of shares of common stock equal to the conversion rate prior to such transaction would have owned or been entitled to receive upon such transaction. The conversion rate will also be adjusted under certain circumstances to provide for a make whole premium, as described below.

The Notes are convertible only under certain circumstances, including (a) during a calendar quarter if the closing price of the Company’s common stock for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding calendar quarter is more than 120% of the then effective conversion price, (b) during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Notes for each day of that period was less than 98% of the product of the closing price for our common stock for each day of that period and the then applicable conversion rate, (c) if the Notes are called for redemption, (d) if specified corporate transactions or fundamental changes occur, or (e) during the ten trading days prior to maturity of the Notes.

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

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

The Company is obligated to pay contingent interest to the holders of the Notes during any six-month period from June 15 to December 14 and from December 15 to June 14, commencing with the six-month period beginning December 20, 2010 and ending on June 14, 2011, if the average trading price of the note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period equals $1,200 (120% of the principal amount of a note) or more. The criteria for paying contingent interest was not achieved during this period. 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 or at September 30, 2011.

On or prior to the maturity date of the Notes, upon the occurrence of a fundamental change, under certain circumstances, the Company will provide for a make whole amount by increasing, for the time period described herein, the conversion rate by a number of additional shares for any conversion of the Notes in connection with such fundamental change transactions. The amount of additional shares will be determined based on the price paid per share of Ceradyne’s common stock in the transaction constituting a fundamental change and the effective date of such transaction. This make whole premium feature represents an embedded derivative. Since this feature has no measurable impact on the fair value of the Notes and no separate trading market exists for this derivative, the value of the embedded derivative was determined to be de minimus. Accordingly, no value has been assigned at issuance or at September 30, 2011.

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 an unsecured $10.0 million line of credit which will expire on May 1, 2014. As of September 30, 2011, there were no outstanding amounts on the line of credit. However, the available line of credit at September 30, 2011 has been reduced by outstanding letters of credit in the aggregate amount of $4.9 million. The interest rate on the credit line was 1.2% as of September 30, 2011 which was based on the LIBOR rate for a period of one month, plus a fixed margin of 1.0%.

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 net income and liquidity. The Company was in compliance with all covenants at September 30, 2011.

During the nine months ended September 30, 2011, the Company capitalized interest of approximately $198,000 in connection with the construction of its new manufacturing plant in Tianjin, China. During the nine months ended September 30, 2010, the Company capitalized interest of approximately $205,000 in connection with the construction of its new manufacturing plant in Tianjin, China.

9.	Disclosure About Segments of an Enterprise and Related Information

The Company changed the measure of segment profitability during the third quarter of 2010 from “income (loss) before provision for income taxes” to “income (loss) from operations” as this measure is most relied upon by the chief operating decision maker for assessing performance of each segment and for deciding how to allocate resources. This was an operational change as the income (loss) from operations as used by the chief operating decision maker is a more accurate measure of the operational performance of each segment.

The Company serves its markets and manages its business through four operating segments, each of which has its own manufacturing facilities and administrative and selling functions.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Revenue from External Customers
Advanced Ceramic Operations	$	74,041		$	28,277		$	217,308		$	123,740
ESK Ceramics		39,904			32,134			125,907			94,843
Thermo Materials		24,229			26,458			84,635			69,818
Boron		13,356			9,194			32,716			23,153
Inter-segment elimination		(3,556	)		(4,297	)		(17,114	)		(9,335	)
Total	$	147,974		$	91,766		$	443,452		$	302,219

Depreciation and Amortization
Advanced Ceramic Operations	$	2,364		$	2,069		$	7,749		$	6,898
ESK Ceramics		3,249			3,158			9,665			9,417
Thermo Materials		2,078			1,522			5,853			4,559
Boron		2,071			1,991			6,171			6,105
Total	$	9,762		$	8,740		$	29,438		$	26,979

Segment Income (Loss) from Operations and Income Before Provision for Income Taxes
Advanced Ceramic Operations	$	14,622		$	(9,311	)	$	45,677		$	(10,241	)
ESK Ceramics		6,973			6,351			23,979			13,704
Thermo Materials		5,966			8,938			22,886			21,925
Boron		2,106			1,040			2,832			(2,467	)
Inter-segment elimination		1,132			(464	)		475			(691	)
Income from Operations		30,799			6,554			95,849			22,230
Other Income (Expense)		429			(1,500	)		(423	)		(2,636	)
Income before Provision for Income Taxes	$	31,228		$	5,054		$	95,426		$	19,594

Segment Assets
Advanced Ceramic Operations	$	462,544		$	400,008		$	462,544		$	400,008
ESK Ceramics		178,058			185,682			178,058			185,682
Thermo Materials		173,245			135,995			173,245			135,995
Boron		127,651			128,130			127,651			128,130
Total	$	941,498		$	849,815		$	941,498		$	849,815

Expenditures for Property, Plant & Equipment
Advanced Ceramic Operations	$	1,495		$	1,885		$	4,971		$	5,478
ESK Ceramics		1,722			429			3,704			1,416
Thermo Materials		1,687			8,708			11,353			21,374
Boron		1,831			330			3,805			2,397
Total	$	6,735		$	11,352		$	23,833		$	30,665


Percentage of U.S. net sales from external customers
Advanced Ceramic Operations	43	%	28	%	41	%	37	%
ESK Ceramics	4	%	4	%	6	%	5	%
Thermo Materials	1	%	8	%	4	%	5	%
Boron	6	%	6	%	4	%	4	%
Total percentage of U.S. net sales from external customers	54	%	46	%	55	%	51	%

Percentage of foreign net sales from external customers
Advanced Ceramic Operations	7	%	2	%	6	%	4	%
ESK Ceramics	22	%	28	%	22	%	25	%
Thermo Materials	14	%	20	%	15	%	18	%
Boron	3	%	4	%	2	%	2	%
Total percentage of foreign net sales from external customers	46	%	54	%	45	%	49	%

Percentage of total net sales from external customers
Advanced Ceramic Operations	50	%	30	%	47	%	41	%
ESK Ceramics	26	%	32	%	28	%	30	%
Thermo Materials	15	%	28	%	19	%	23	%
Boron	9	%	10	%	6	%	6	%
Total percentage of total net sales from external customers	100	%	100	%	100	%	100	%

The following is revenue by product line for the Advanced Ceramic Operations segment (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
Armor	$	52,917	$	15,332	$	159,293	$	88,477
Automotive		2,563		3,036		7,712		7,794
Energy		6,644		-		19,769		2,117
Commercial (Orthodontics)		1,974		2,086		5,764		6,289
Industrial		9,943		7,823		24,770		19,063
	$	74,041	$	28,277	$	217,308	$	123,740

10.	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.

Components of net periodic benefit costs under these defined benefit plans were as follows (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Service cost	$	198		$	188		$	591		$	571
Interest cost		339			306			1,014			924
Expected return on plan assets		(139	)		(132	)		(417	)		(396	)
Amortization of unrecognized (gain) loss		(11	)		(4	)		(33	)		(12	)
Net periodic benefit cost	$	387		$	358		$	1,155		$	1,087

11.	Financial Instruments

The Company occasionally 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. The Company had outstanding foreign exchange forward contracts with a notional value of 43.0 million Euros at September 30, 2011.

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.

12.	Income Taxes

The Company classifies accrued interest and penalties as part of the accrued liability for uncertain tax positions and records the corresponding expense in the provision for income taxes.

Components of the required reserve at September 30, 2011 and December 31, 2010 are as follows (in thousands):

	September 30, 2011			December 31, 2010
Federal, state and foreign unrecognized tax benefits (“UTBs”)	$	1,737		$	806
Interest		243			144
Federal/State Benefit of Interest		(97	)		(59	)
Total reserve for UTBs	$	1,883		$	891

It is anticipated that any change in the above UTBs will impact the effective tax rate. At September 30, 2011, the 2009 and 2010 years are open and subject to potential examination in one or more jurisdictions. The Company does not anticipate any significant release of UTBs within the next twelve months.

Effective January 1, 2008, the Company was granted an income tax holiday for our manufacturing facility in China. The tax holiday allows for tax-free operations through December 31, 2009, followed by operations at a reduced income tax rate of 12.5% on the profits generated in 2010 through 2012, with a return to the full statutory rate of 25% for periods thereafter. As a result of the tax holiday in China, income tax expense for the three months ended September 30, 2011 and 2010 was reduced by $393,000 and $0.7 million, respectively, and income tax expense for the nine months ended September 30, 2011 and 2010 was reduced by $1.7 million and $1.7 million, respectively.

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, research and development tax credits and the income tax holiday in China. The Company recognizes deferred tax assets and liabilities for temporary differences between the financial and tax reporting of the Company's assets and liabilities, along with net operating loss and credit carry forwards.

13.	Commitments and Contingencies

The Company leases certain of its manufacturing facilities under noncancelable operating leases expiring at various dates through 2015. The Company incurred rental expense under these leases of $2.8 million and $2.4 million for the nine months ended September 30, 2011 and 2010, respectively. The approximate minimum rental commitments required under existing noncancelable leases as of September 30, 2011 are as follows (in thousands):

2011	$	934
2012		3,051
2013		2,066
2014		925
2015		434
Thereafter		364
	$	7,774

A class action lawsuit was filed on April 8, 2011, in the California Superior Court for Orange County (Civil Action No. 30-2011-00465269), in which it was asserted that the representative plaintiff, a former Ceradyne employee, and the putative class members, were not provided with meal and rest periods in accordance with California law, and were not paid overtime at an appropriate overtime rate. The Company removed the case to the Federal District Court for the Central District of California in Santa Ana, Case No. 8:11-cv-00778-CJC-MLG. The Company thereafter met and conferred related to a motion to dismiss as required by local rules and Plaintiff agreed to dismiss a significant portion of the Complaint. In an amended Complaint, Plaintiff has alleged that certain terminated employees from the fourth quarter of 2009 to the present were not paid the full amount of their overtime on a bonus paycheck given to them after they were terminated. Plaintiff also claims he is entitled to additional overtime because he was required to perform some work during his meal breaks. The Company disputes such contentions and is aggressively defending the claims. While the posture of the case is such that it is indeterminable as to the outcome at this time, Plaintiff only alleges actual unpaid overtime of $8,000 for the entire purported class. The Plaintiff alleges waiting time penalties for this putative class, but such award is contingent upon a showing that Ceradyne intentionally withheld pay from the purported Plaintiffs, which is simply not the case.

14.	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 September 30,					Nine Months Ended September 30,
	2011			2010		2011			2010
Net income	$	20,409		$	4,537	$	63,135		$	16,090
Foreign currency translation		(14,613	)		18,700		2,006			(7,074	)
Unrealized gain (loss) on investments		(3,186	)		344		(3,180	)		306
Comprehensive income	$	2,610		$	23,581	$	61,961		$	9,322

15.	Acquisition of VIOX Corporation

On January 3, 2011, the Company acquired 100% of Seattle, Washington based specialty glass company, VIOX Corporation (“VIOX”). The purchase price consists of $26.0 million in cash paid at closing, plus a post-closing adjustment of $1.7 million that was paid in March 2011. In addition, the Company is obligated to pay contingent consideration of up to a maximum of $22.0 million, based on VIOX achieving certain sales diversification and earnings targets during the 30-month period following the closing. As of the acquisition date, the estimated value of the contingent consideration was $11.5 million which was accrued as additional purchase consideration. VIOX is a 40-year-old corporation that develops, manufactures and markets specialty glass compositions for a wide range of electronic, industrial and health care markets. The Company will record the purchase of VIOX using the acquisition method of accounting and will recognize the assets acquired and liabilities assumed at their fair values as of the date of the acquisition. The results of operations of VIOX will be included in the Company's consolidated results of operations beginning with the date of the acquisition. The Company has made an election to treat the acquisition as an asset purchase for income tax purposes under Internal Revenue Code Section 338 (“Section 338 Election”). As a result of the Section 338 Election, the Company accrued an additional liability of $0.8 million which is payable to the former stockholders of VIOX.

This transaction has been accounted for under the acquisition method of accounting. Under this method, assets acquired and liabilities assumed are recorded at the date of acquisition at their respective fair values.

The total purchase price of the VIOX acquisition on January 3, 2011 was as follows (in thousands):

Cash consideration paid	$	27,673
Accrued contingent purchase consideration		11,521
Section 338 Election liability to former VIOX stockholders		775
Total purchase price	$	39,969

The above purchase price has been allocated based on the fair values of assets acquired and liabilities assumed as follows (in thousands):

Accounts receivable, net	$	2,385
Inventories		2,702
Other current assets		706
Property, plant and equipment		3,490
Intangible assets		23,600
Goodwill		7,797
Other noncurrent assets		1,269
Accounts payable and other liabilities		(1,980	)
	$	39,969

The purchase price allocation is based on a fair market valuation of acquired intangible assets, inventory and property, plant and equipment. Of the $23.6 million of acquired intangible assets, $20.0 million was assigned to technology-based intangible assets that have a useful life of approximately 20 years, non-amortizable trade name of $3.0 million and $0.6 million was assigned to non-compete agreements with a useful life of three years. The amounts assigned to intangible assets were based on management’s estimate of the fair value. The technology-based intangible assets comprise trade secrets used in manufacturing process and related customer relationships which have been valued together as complementary assets with similar useful lives due to the long-term nature of the manufacturing processes inherent in the trade secrets, VIOX’ historical pattern of customer retention and VIOX’ ability to attract new customers with its manufacturing processes. The technology-based intangible assets are both transferable and separable from the acquired assets.

Identification and allocation of value to the identified intangible assets was based on the acquisition method of accounting. 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 take into consideration the effects of competition, regulatory changes and possible obsolescence. The useful lives of technology-based intangible assets were based on the number of years in which net cash flows have been projected.

Assumptions used in forecasting cash flows for each of the identified intangible assets included consideration of VIOX’ historical operating margins and performance of comparable publicly traded entities; number of customers and VIOX’ market share; contractual and non-contractual relationships with large customers and patents held.

The goodwill resulting from the VIOX acquisition is included with the Advanced Ceramic Operations segment and resulted primarily from intellectual property and other intangibles acquired that do not qualify for separate recognition. Goodwill will not be amortized but is subject to an ongoing assessment for impairment. For tax purposes, the goodwill will not be tax deductible.

As of January 3, 2011, the date of acquisition, the Company began to include the financial results of VIOX Corporation in the Advanced Ceramic Operations segment. VIOX sales amounted to $6.6 million for the three months ended September 30, 2011 and $18.4 million during the nine months ended September 30, 2011.

The historical results of the operations acquired from VIOX were not material to the Company’s consolidated results of operations in current and prior periods. Therefore, proforma disclosures are not necessary.

Item 2. Management’s 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 13 “Commitments and Contingencies” of the Notes to Consolidated Financial Statements, in this Item 2 “Management’s 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 Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, as filed with the Securities and Exchange Commission, in Item 1A under the caption “Risk Factors,” and in Item 7 under the caption “Management’s 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, energy, automotive/diesel and commercial applications. Our products include:

•

lightweight ceramic armor for soldiers and other military applications;

•

ceramic industrial components for erosion and corrosion resistant applications;

•

ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium hexaboride, zirconium diboride and fused silica, which are used in manufacturing armor and a broad range of industrial products and consumer products;

•

evaporation boats for metallization of materials for food packaging and other products;

•

durable, reduced friction, ceramic diesel engine components;

•

functional and frictional coatings primarily for automotive applications;

•

translucent ceramic orthodontic brackets;

•

ceramic-impregnated dispenser cathodes for microwave tubes, lasers and cathode ray tubes;

•

ceramic crucibles for melting silicon in the photovoltaic solar cell manufacturing process;

•

specialty glass compositions for solar, electronic, industrial and health care markets;

•

ceramic missile radomes (nose cones) for the defense industry;

•

fused silica powders for precision investment casting (PIC);

•

neutron absorbing materials, structural and non-structural, in combination with aluminum metal matrix composite 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;

•

nuclear chemistry products for use in pressurized water reactors and boiling water reactors;

•

boron dopant chemicals for semiconductor silicon manufacturing and for ion implanting of silicon wafers;

•

ceramic bearings and bushings for oil drilling and fluid handling pumps;

•

ceramic micro-reactors used to process chemicals;

•

PetroCeram ® ceramic sand screens for oil and gas recovery; and

•

enhanced combat helmets for soldiers.

Our customers include the U.S. government, prime government contractors, companies engaged in solar energy, oil and natural gas exploration and nuclear energy, and large industrial, automotive, diesel and commercial manufacturers in both domestic and international markets.

The tables below show, for each of our four operating segments, revenues and income (loss) from operations in the periods indicated.

Segment revenues (in millions):

	Three Months Ended September 30,									Nine Months Ended September 30,
	2011			2010			Change			2011			2010			Change
Advanced Ceramic Operations	$	74.0		$	28.3			161.8	%	$	217.4		$	123.7			75.6	%
ESK Ceramics		39.9			32.1			24.2	%		125.9			94.8			32.8	%
Thermo Materials		24.2			26.5			(8.4	%)		84.6			69.8			21.2	%
Boron		13.4			9.2			45.3	%		32.7			23.2			41.3	%
Inter-segment elimination		(3.5	)		(4.3	)		(17.2	%)		(17.1	)		(9.3	)		83.3	%
Total	$	148.0		$	91.8			61.3	%	$	443.5		$	302.2			46.7	%

Segment operating income (loss) (in millions):

	Three Months Ended September 30,								Nine Months Ended September 30,
	2011		2010			Change			2011		2010			Change
Advanced Ceramic Operations	$	14.6	$	(9.3	)		n/m	*	$	45.7	$	(10.2	)		n/m
ESK Ceramics		7.0		6.4			9.8	%		24.0		13.7			75.0	%
Thermo Materials		6.0		8.9			(33.3	%)		22.9		21.9			4.4	%
Boron		2.1		1.0			102.5	%		2.8		(2.5	)		n/m
Inter-segment elimination		1.1		(0.4	)		n/m			0.4		(0.7	)		n/m
Total	$	30.8	$	6.6			369.9	%	$	95.8	$	22.2			331.2	%

* Not meaningful

We categorize our products into five market applications. The tables below show our sales by market application and the percentage contribution to our total sales of each market application in the different time periods.

Sales by Market Application (in millions):

	Three Months Ended September 30,							Nine Months Ended September 30,
	2011		2010		Change			2011		2010		Change
Defense	$	59.1	$	18.7		216.8	%	$	179.9	$	98.2		83.2	%
Industrial		42.5		31.3		35.4	%		126.8		96.8		30.9	%
Energy		33.2		29.7		11.8	%		98.2		71.6		37.3	%
Automotive/Diesel		10.2		9.5		8.3	%		30.2		27.1		11.3	%
Commercial		3.0		2.6		13.6	%		8.4		8.5		(1.4	%)
Total	$	148.0	$	91.8		61.3	%	$	443.5	$	302.2		46.7	%

Percentage Contribution:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Defense		40.0	%		20.4	%		40.5	%		32.5	%
Industrial		28.7			34.2			28.6			32.0
Energy		22.4			32.3			22.2			23.7
Automotive/Diesel		6.9			10.3			6.8			9.0
Commercial		2.0			2.8			1.9			2.8
Total		100.0	%		100.0	%		100.0	%		100.0	%

The principal factor contributing to our growth in sales from 2002 through 2007 was increased demand by the U.S. military for ceramic body armor that protects soldiers, which was driven primarily by military conflicts such as those in Iraq and Afghanistan. This demand was driven by recognition of the performance and life saving benefits of utilizing advanced technical ceramics in lightweight body armor. Our sales declined in 2008 primarily because of a reduction in shipments of body armor. Our sales declined in 2009 primarily because of a continued reduction in shipments of body armor and also due to a decline in sales of our industrial, automotive/diesel and commercial market product lines due to the severe economic recession. In 2010, sales of body armor continued to decline. However, sales from energy related products grew by 61.6% in 2010 when compared to 2009. Most of this growth in energy sales was generated by sales of our ceramic crucibles used in the production of photovoltaic cells for solar panels. Additionally, sales of industrial and automotive/diesel products rebounded sharply in 2010, particularly at our ESK Ceramics subsidiary.

Commencing in 2004, several strategic acquisitions also have contributed to our sales growth. These include our acquisition of ESK Ceramics in August 2004, our acquisition of Minco, Inc. in July 2007, our acquisition of EaglePicher Boron, LLC in August 2007, which we renamed Boron Products, LLC, and our acquisition of VIOX Corporation on January 3, 2011.

VIOX Corporation, located in Seattle, Washington, develops, manufactures and markets specialty glass compositions for a wide range of electronic, industrial and health care markets. VIOX has developed a specialty glass formulation for polycrystalline silicon photovoltaic solar applications. VIOX’ customers add electrically conducting powdered metals such as silver or aluminum to the VIOX powdered specialty glass. Many of the ultimate solar users of VIOX’ glass are also customers for Ceradyne’s high purity ceramic solar crucibles. VIOX is included in our Advanced Ceramic Operations operating segment. We began to consolidate and report their operations with ours as of January 3, 2011.

To illustrate the impact of body armor, energy-related products, and our acquisitions, the following table shows our sales from body armor, energy-related products, from our acquisitions, and from all other sources for each of the years 2002 through 2010 (in millions).

	2010			2009			2008			2007			2006			2005			2004			2003		2002
Sales from body armor	$	70.4		$	170.0		$	385.0		$	535.3		$	479.4		$	199.5		$	120.3		$	58.2	$	26.2
Sales from energy products:
Gross sales from energy products		99.9			62.2			57.7			20.9			11.9			9.8			5.3			2.5		1.7
Less sales from energy products included in acquisitions		(28.5	)		(24.5	)		(11.4	)		(4.5	)		(3.2	)		(3.2	)		(0.7	)		-		-

Sales from energy products due to organic growth		71.4			37.7			46.3			16.4			8.7			6.6			4.6			2.5		1.7
Sales from acquisitions		191.1			136.8			177.1			142.6			110.2			109.8			36.0			-		-
All other sales		70.0			56.1			71.8			62.5			64.6			52.4			54.7			40.8		33.3

Total sales	$	402.9		$	400.6		$	680.2		$	756.8		$	662.9		$	368.3		$	215.6		$	101.5	$	61.2

Sales of ceramic body armor represented the majority, and most volatile, portion of our defense business, rising from approximately $26.2 million, or 42.8% of our total sales in 2002, to a peak of approximately $535.3 million, or 70.7% of our total sales in 2007, and then declining to approximately $70.4 million, or 17.5% of our total sales in 2010. Shipments of the first generation of ceramic body armor, known as small armed protective inserts, or SAPI, began before 2002 and accelerated rapidly with the onset of the war in Afghanistan in 2002 and thereafter the war in Iraq. Shipments of the second generation of ceramic body armor, known as enhanced small armed protective inserts, or ESAPI, began in 2005. The military’s subsequent decision to deploy ESAPI body armor “full fleet,” that is, to replace all SAPI body armor with the new ESAPI body armor, and the introduction in 2006 of enhanced side ballistic inserts, known as ESBI, which protect the sides of the soldier’s torso, resulted in continued growth in our sales of ceramic body armor, ultimately reaching our peak sales of body armor in 2007. Once “full fleet” was achieved, our sales of body armor began a steady decline.

In October 2008, we were awarded an Indefinite Delivery/Indefinite Quantity, or ID/IQ, contract by the U.S. Army for the next ballistic threat generation of ceramic body armor plates, called XSAPI, as well as for the current generation ESAPI plates. This five-year contract has a maximum value of $2.37 billion and allows the U.S. Army to order either XSAPI or ESAPI body armor from us.

In March 2011, we announced the receipt of a delivery order for approximately $56.6 million for ESAPI ceramic body armor plates and the receipt of a delivery order for approximately $36.0 million for XSAPI ceramic body armor plates. In July 2011, we announced the receipt of a delivery order for approximately $36.2 million for ESAPI ceramic body armor plates. All three of these delivery orders were issued under the October 2008 ID/IQ contract. Through September 30, 2011, we have received delivery orders under the October 2008 ID/IQ contract totaling $278.4 million. Of this amount, we have shipped $223.9 million of body armor through September 30, 2011; we expect to ship an additional $43.1 million during 2011, and we expect to ship the balance of approximately $11.3 million in 2012. With less than three years remaining under this ID/IQ contract and the wars in Iraq and Afghanistan winding down, we expect that the total amount of body armor that we ultimately ship under this contract will be substantially less than the maximum amount.

In September 2011, we were awarded a three-year ID/IQ contract for ESAPI ceramic armor plates from Defense Logistics Agency Troop Support group. This purchasing group services the United States Army, Navy, Air Force and Marine Corps. This award was in response to our bid to the Defense Supply Center Philadelphia (DSCP) in response to their requirement for a three-year sustainment order for the replacement of body armor inserts. Simultaneously with the receipt of this award, we received an initial delivery order for $127.3 million for ESAPI ceramic body armor plates with the initial delivery in the first quarter of 2012, continuing through the remainder of 2012 with estimated completion by March 31, 2013. This ID/IQ contract includes options for additional deliveries of up to $127.3 million in each of the second and third years.

In October 2011, we announced the receipt of a delivery order for approximately $6.9 million for ceramic body armor plates from the United States Special Operations Command. We expect to ship this order during 2012 and complete the delivery of it during the third quarter of 2012.

For 2012 and for the next several years, we expect that our sales of body armor will continue, but generally at more moderate levels than in the past. We will continue to bid on Foreign Military Sales (FMS) for the first generation of SAPI body armor through our existing ID/IQ contract with Aberdeen Proving Grounds.

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, positions and strategies of the current U.S. government, the level of international conflicts and the deployment of armed forces. Moreover, ceramic armor contracts generally are awarded in an open competitive bidding process and may be cancelled by the government at any time without penalty. Therefore, our future level of sales of ceramic body armor will depend on our ability to successfully compete for and retain this business.

New orders for the three and nine months ended September 30, 2011 were $272.0 million and $612.5 million, respectively, compared to $110.8 million and $304.0 million, respectively, for the same periods last year. Orders for ceramic body armor for the three and nine months ended September 30, 2011 were approximately $174.7 million and $282.8 million, respectively, compared to $18.9 million and $32.0 million, respectively, for the same periods last year.

Our order backlog was $354.9 million as of September 30, 2011 and $136.3 million as of September 30, 2010. The backlog for ceramic body armor represented approximately $208.7 million, or 58.8%, of the total backlog as of September 30, 2011 and $26.1 million, or 19.2%, of the total backlog as of September 30, 2010. We expect that substantially all of our order backlog as of September 30, 2011 will be shipped during the next 12 months.

For the next several quarters, demand for ceramic body armor is likely to be the most significant factor affecting our sales. We expect sales of body armor will be slightly lower in 2012 than in 2011.

Results of Operations for the Three and Nine Months Ended September 30, 2011 and 2010

Net Sales

Our total net sales for the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Net Sales	$	148.0		$	91.8		$	443.5		$	302.2
Increase (decrease) in net sales	$	56.2		$	(16.2	)	$	141.3		$	(0.8	)
Percentage change in net sales		61.3	%		(15.0	%)		46.7	%		(0.3	%)

Sales continued their strong rebound in the nine months ended September 30, 2011, especially in our products for defense, industrial and energy applications, although sales and orders of ceramic crucibles to the solar industry slowed in the later part of the second quarter of 2011 and continued that trend during the third quarter of 2011. The principal factors contributing to this growth included renewed purchasing of ceramic body armor by the U.S. military, continued growth in sales of our ESK Ceramics operating segment, the sales contribution from VIOX Corporation which we began to consolidate and report the results of their operations with ours as of January 3, 2011, and the continued rebound of the economy in general.

Advanced Ceramic Operations Segment

Our Advanced Ceramic Operations segment had net sales for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Net Sales	$	74.0		$	28.3		$	217.3		$	123.7
Increase (decrease) in net sales	$	45.7		$	(34.1	)	$	93.6		$	(51.6	)
Percentage change in net sales		161.8	%		(54.7	%)		75.6	%		(29.4	%)

Contributing to the increase of $45.7 million in sales during the three months ended September 30, 2011 were higher shipments of ceramic body armor that totaled $50.2 million, an increase of $43.0 million, or 601.2%, from $7.2 million in the same period last year. For the nine months ended September 30, 2011, shipments of ceramic body armor amounted to $152.2 million, an increase of $95.8 million, or 170.1%, from $56.4 million in the same period last year. The primary reasons for the increase in shipments of ceramic body armor were an increase in demand for shipments of ESAPI armor plates. This increase in body armor sales during the three and nine month periods ended September 30, 2011 was partially offset by a decrease in sales of vehicle armor. We shipped $0.7 million of vehicle armor for the three months ended September 30, 2011, a decrease of $3.8 million, or 85.4%, from $4.5 million for the same period last year and $2.0 million of vehicle armor for the nine months ended September 30, 2011, a decrease of $20.0 million, or 90.8%, from $22.0 million for the nine months ended September 30, 2010. The decline was caused by a lack of orders of armor for the MRAP All Terrain Vehicle (M-ATV) and the High Mobility Multipurpose Wheeled Vehicle ( HMMWV or Humvee ) during the nine months ended September 30, 2011 compared to the same period last year.

As of January 3, 2011, the date of acquisition, we began to include the financial results of VIOX Corporation in the Advanced Ceramic Operations segment. VIOX sales amounted to $6.6 million for the three months ended September 30, 2011 and $18.4 million during the nine months ended September 30, 2011.

ESK Ceramics Segment

Our ESK Ceramics segment had net sales for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Net Sales	$	39.9		$	32.1		$	125.9		$	94.8
Increase (decrease) in net sales	$	7.8		$	4.1		$	31.1		$	19.2
Percentage change in net sales		24.2	%		14.9	%		32.8	%		25.4	%

On a constant currency basis, sales for the three months ended September 30, 2011 were $37.2 million, an increase of $5.0 million, or 15.7%, from the corresponding quarter of the prior year. Sales of industrial products for the three months ended September 30, 2011 were $22.5 million, an increase of $2.8 million, or 14.0%, from $19.7 million in the corresponding quarter of the prior year. This increase was the result of a higher demand for fluid handling products, an increase in shipments of industrial parts for the metallurgy industry and an increase in shipments of industrial wear parts. Sales of defense products for the three months ended September 30, 2011 were $6.2 million, an increase of $2.6 million, or 71.2%, from $3.6 million in the corresponding quarter of the prior year. Included in sales of defense products for the three months ended September 30, 2011 were inter-segment sales of $2.9 million compared to $3.0 million in the prior year. Sales of automotive/diesel products for the three months ended September 30, 2011 were $7.7 million, an increase of $1.3 million, or 19.6%, from $6.4 million in the corresponding quarter of the prior year. Increased demand from automotive original equipment manufacturers accounted for the increase in sales.

On a constant currency basis, sales for the nine months ended September 30, 2011 were $119.4 million, an increase of $24.5 million, or 25.8%, from the corresponding prior year period. Sales of industrial products for the nine months ended September 30, 2011 were $71.1 million, an increase of $11.8 million, or 19.8%, from $59.3 million in the corresponding prior year period. This increase was the result of a higher demand for fluid handling products, an increase in shipments of industrial parts for the packaging industry and an increase in shipments of composite coatings. Sales of defense products for the nine months ended September 30, 2011 were $21.5 million, an increase of $12.6 million, or 141.9%, from $8.9 million in the corresponding prior year period. Included in sales of defense products for the nine months ended September 30, 2011 were inter-segment sales of $14.5 million compared to $7.9 million in the prior year period. The increase of $6.6 million in inter-segment sales was due to an increase in demand for boron carbide powder used in body armor plates manufactured by our Advanced Ceramic Operations division. Sales of automotive/diesel products for the nine months ended September 30, 2011 were $22.5 million, an increase of $3.1 million, or 16.2%, from $19.4 million in the corresponding prior year period. Increased demand from automotive original equipment manufacturers accounted for the increase in sales.

Thermo Materials Segment

Our Thermo Materials segment had net sales for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Net Sales	$	24.2		$	26.5		$	84.6		$	69.8
Increase (decrease) in net sales	$	(2.3	)	$	10.9		$	14.8		$	21.8
Percentage change in net sales		(8.4	%)		69.5	%		21.2	%		45.5	%

During the three months ended September 30, 2011, the decrease in sales at our Thermo Materials segment was due to lower shipments of crucibles to the solar energy market and lower shipments of ceramic missile radomes to the defense industry. Sales of crucibles used in the manufacture of photovoltaic cells for the three months ended September 30, 2011 were $15.3 million, a decrease of $1.2 million, or 7.5%, from $16.5 million in the corresponding period a year ago. The decrease was due to a pronounced slowdown of demand in the solar energy market due to a reduction of government subsidies for the installation of solar panels. Sales to the defense industry for the three months ended September 30, 2011 were $2.6 million, a decrease of $2.5 million, or 48.7%, from $5.1 million when compared to the corresponding prior year period.

Sales of crucibles used in the manufacture of photovoltaic cells for the nine months ended September 30, 2011 were $57.6 million, an increase of $15.5 million, or 37.0%, from $42.1 million in the corresponding period a year ago. Sales to the defense industry for the nine months ended September 30, 2011 were $7.8 million, a decrease of $5.1 million, or 39.4%, from $12.9 million when compared to the corresponding prior year period.

Boron Segment

Our Boron segment had net sales for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Net Sales	$	13.4		$	9.2		$	32.7		$	23.2
Increase (decrease) in net sales	$	4.2		$	3.2		$	9.5		$	3.3
Percentage change in net sales		45.3	%		52.0	%		41.3	%		16.8	%

Our Boron business segment comprises the business units Ceradyne Boron Products, SemEquip, Inc. and Ceradyne Canada. A major contribution to the increase in sales of this segment during the three months ended September 30, 2011, was from Ceradyne Canada. Sales from our Ceradyne Canada business unit for the three months ended September 30, 2011were $5.4 million, an increase of $3.5 million, or 181.7%, from $1.9 million in the prior year period. For the nine months ended September 30, 2011, sales of this unit were $7.4 million, an increase of $4.1 million, or 125.9%, from $3.3 million compared to the corresponding prior year period. This increase for both periods was the result of higher shipments to the nuclear industry from our Boral product line. For the nine months ended September 30, 2011, our sales from Ceradyne Boron Products business unit were $22.6 million, an increase of $3.4 million, or 17.6%, from $19.2 million in the prior year period. The increase in the sales for this business unit during the nine month period ended September 30, 2011was the result of higher shipments to the nuclear industry.

Gross Profit

Our total gross profit for the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Gross profit	$	53.7		$	23.6		$	164.8		$	74.8
Increase (decrease) in gross profit	$	30.1		$	(5.0	)	$	90.0		$	(0.4	)
Gross profit percentage		36.3	%		25.7	%		37.2	%		24.8	%

Several factors caused the increase in gross profit during both the three and nine month periods ended September 30, 2011. These factors include substantially higher sales of body armor resulting in improved operating leverage and increased absorption of manufacturing overhead expenses, selected price increases in industrial product lines and an improved sales mix. Our body armor product line was responsible for $24.4 million, or 81.2% of the total increase in gross profit during the three months ended September 30, 2011, and $59.8 million, or 66.5% of the total increase in gross profit for the nine month period ended September 30, 2011.

Advanced Ceramic Operations Segment

Our Advanced Ceramic Operations segment had total gross profit for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Gross profit	$	24.3		$	(1.7	)	$	74.0		$	13.0
Increase (decrease) in gross profit	$	26.0		$	(19.4	)	$	61.0		$	(33.9	)
Gross profit percentage		32.9	%		(6.1	%)		34.0	%		10.5	%

The primary reasons for the increase in gross profit and gross profit as a percentage of net sales for the three and nine months ended September 30, 2011 were higher volumes of production of body armor and industrial products resulting in an increase of absorbed manufacturing overhead expenses, lower scrap rates incurred in the production of body armor, and improved sales mix caused by shipments of higher gross margin ESAPI body armor products compared to the same periods in the prior year.

ESK Ceramics Segment

Our ESK Ceramics segment had total gross profit for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Gross profit	$	13.0		$	10.6		$	41.7		$	27.8
Increase (decrease) in gross profit	$	2.4		$	6.5		$	13.9		$	17.9
Gross profit percentage		32.6	%		33.0	%		33.1	%		29.3	%

Gross profit and gross profit as a percentage of sales increased during the nine month period ended September 30, 2011 due to an increase in manufacturing production, which generated better absorption of manufacturing overhead expenses. Additionally, decreases in scrap rates, some product line price increases and a favorable sales mix contributed to the increase in gross profit.

Thermo Materials Segment

Our Thermo Materials segment had total gross profit for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Gross profit	$	10.0		$	11.6		$	36.2		$	29.5
Increase (decrease) in gross profit	$	(1.6	)	$	5.7		$	6.7		$	12.0
Gross profit percentage		41.1	%		43.9	%		42.8	%		42.3	%

Gross profit decreased for the three months ended September 30, 2011 primarily because of the decrease in unit sales and production of crucibles and a decline in unit sales prices due to pricing pressure from customers. During the nine month period ended September 30, 2011, we incurred temporary quality issues relating to the production of our ceramic crucibles that resulted in increased scrap charges which reduced gross profit by $4.5 million and also reduced gross profit as a percentage of sales. These temporary quality issues were corrected as of mid-June 2011. We opened a new plant in China for the production of crucibles during February 2011 and incurred start-up expenses of approximately $0.3 million and $1.0 million during the three and nine months ended September 30, 2011, respectively.

Boron Segment

Our Boron segment had total gross profit for the three and nine months ended September 30, 2011 and 2010 as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Gross profit	$	5.3		$	3.6		$	12.4		$	5.3
Increase (decrease) in gross profit	$	1.7		$	2.7		$	7.1		$	4.3
Gross profit percentage		39.8	%		39.1	%		38.0	%		22.7	%

The increases in gross profit and gross profit as a percentage of sales in the three and nine months ended September 30, 2011 were the result of higher sales to the semiconductor and nuclear industries, a favorable sales mix and improved absorption of fixed manufacturing costs.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses for the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Selling, general and administrative expenses	$	19.3		$	14.4		$	57.5		$	43.9
Increase (decrease) in selling, general and administrative expenses	$	4.9		$	(3.1	)	$	13.6		$	(7.7	)
Percentage change in selling, general and administrative expenses		33.5	%		(17.8	%)		30.9	%		(14.9	%)
Selling, general and administrative expenses as a % of net sales		13.0	%		15.7	%		13.0	%		14.5	%

Although total selling, general and administrative expenses increased 33.5% and 30.9% during the three and nine months ended September 30, 2011, compared to the same periods in 2010, respectively, it declined as a percentage of net sales, due to the 61.3% and 46.7% year-over-year growth in the Company’s net sales during the three and nine months ended September 30, 2011, respectively.

For the three months ended September 30, 2011, the increase of $4.9 million in selling, general and administrative expenses over the same period last year was caused by an increase of $0.8 million in information technology expenses, an increase of $0.5 million due to the acquisition of VIOX Corporation in January 2011, an increase of $1.9 million in personnel expenses caused by a larger headcount of employees and larger employee bonuses due to the improved financial performance, increased selling expenses of $0.9 million, an increase of $0.5 million of additional general and administrative expenses associated with our new plant in China and an increase in legal fees of $0.2 million.

For the nine months ended September 30, 2011, the increase of $13.6 million over the same period last year was caused by an increase of $1.9 million in information technology expenses, an increase of $1.7 million due to the acquisition of VIOX Corporation, an increase of $5.6 million in personnel expenses caused by a larger headcount of employees and employee bonuses due to the improved financial performance, increased selling expenses of $1.7 million, an increase of $2.2 million of additional general and administrative expenses associated with our new plant in China and an increase in legal fees of $0.5 million.

Research and Development Expenses

Our research and development expenses for the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Research and development expenses	$	3.0		$	2.6		$	9.3		$	8.7
Increase (decrease) in research and development expenses	$	0.4		$	(0.3	)	$	0.6		$	(0.8	)
Percentage change in research and development expenses		13.8	%		(8.7	%)		6.0	%		(8.2	%)
Research & development expenses as a percentage of net sales		2.0	%		2.8	%		2.1	%		2.9	%

Acquisition Related Charge (Credit)

Our acquisition related charges and credits for the three and nine months ended September 30, 2011 and 2010 were as follows (dollars shown in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Acquisition related charges and credits	$	0.7		$	0.0		$	2.1		$	(0.1	)
Increase (decrease) in acquisition related charges and credits	$	0.7		$	0.8		$	2.2		$	0.7
Percentage change in acquisition related charges and credits		n/m	*		n/m			n/m			(88.9	%)
Acquisition charges and credits as a percentage of net sales		0.5	%		0.0	%		0.5	%		0.0	%
* Not meaningful

During the three and nine months ended September 30, 2011 and 2010, we recorded acquisition-related charges of $0.7 million and $2.1 million, respectively, to reflect the fair value of contingent purchase price consideration for SemEquip, Inc., acquired in 2008, Diaphorm Technologies, LLC, acquired in 2009 and VIOX Corporation, acquired on January 3, 2011.

Other Income (Expense)

Our net other income (expense) for the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Other income (expense)	$	0.4		$	(1.5	)	$	(0.4	)	$	(2.6	)
Increase (decrease) in other income (expense)	$	1.9		$	1.1		$	2.2		$	2.7
Percentage change in other income (expense)		n/m			(41.6	%)		(84.0	%)		(50.6	%)
Other income (expense) as percentage of net sales		0.3	%		(1.6	%)		(0.1	%)		(0.9	%)

Net other income (expense) during the three months ended September 30, 2011 increased by $1.9 million because we recognized a gain from foreign currency transactions of $0.7 million compared to a loss of $0.4 million during the same period last year and we were reimbursed $0.8 million for legal fees during the third quarter concerning a workers compensation matter .

Net other income (expense) during the nine months ended September 30, 2011 increased by $2.2 million because in the comparable period last year we recognized a loss on sales of securities of $1.0 million compared to a loss of $85,000 in this year. We also incurred $0.9 million of foreign tax withholding last year compared to none this year, we were reimbursed $0.8 million for legal fees concerning a workers compensation matter and we have an increase in discounts from early payments to vendors of $0.3 million this year compared to just $3,000 during the corresponding period last year.

Income Taxes

Our provision for income taxes for the three and nine months ended September 30, 2011 and 2010 were as follows (dollars in millions):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Provision for income taxes	$	10.8		$	0.5		$	32.3		$	3.5
Increase (decrease) in provision for income taxes	$	10.3		$	(0.9	)	$	28.8		$	4.1
Percentage change in provision for income taxes		n/m			(63.8	%)		821.5	%		n/m
Provision for income taxes as a percentage of net sales		7.3	%		0.6	%		7.3	%		1.2	%
Effective tax rate		34.6	%		10.2	%		33.8	%		17.9	%

The increase in the provision for income taxes for both the three and nine months ended September 30, 2011 and 2010 reflect higher levels of income before income taxes compared to the corresponding periods last year. The effective tax rate for both the three and nine month periods ended September 30, 2011 was higher compared to the same periods last year because a greater portion of our pre-tax income was generated by operating units other than our China operations, where we enjoy a lower tax rate than the average of other countries.

Liquidity and Capital Resources

We generally have met our operating and capital requirements with cash flow from operating activities and borrowings under our credit facility.

The following tables present selected financial information and statistics as of September 30, 2011 and December 31, 2010 and for the three and nine months ended September 30, 2011 and 2010 (in millions):

	September 30, 2011		December 31, 2010
Cash, cash equivalents and short term investments	$	259.0	$	246.3
Accounts receivable, net	$	71.5	$	53.0
Inventories	$	110.5	$	94.3
Working capital	$	455.9	$	414.4

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2011			2010			2011		2010
Operating cash flow	$	24.7		$	16.9		$	83.1	$	66.9
Increase (decrease) in cash, cash equivalents and short term investments	$	(14.2	)	$	(13.5	)	$	12.7	$	17.9

During the nine months ended September 30, 2011, we generated $83.1 million of cash from operations compared to $66.9 million for the nine months ended September 30, 2010. The $83.1 million of cash flow from operations during 2011 is primarily comprised of net income totaling $63.1 million, with $37.0 million of non-cash charges included therein, offset by an increase in working capital of $21.0 million resulting from increased sales and production. During the nine months ended September 30, 2011, we invested $27.7 million to purchase VIOX Corporation, based in Seattle, Washington. We also invested $23.8 million to expand manufacturing capacity in selected product lines. We purchased $78.6 million of marketable securities while we received $47.8 million from proceeds and maturities of marketable securities. During the nine months ended September 30, 2011, we repurchased and retired 842,934 shares of our common stock at an aggregate cost of $25.8 million under a stock repurchase program authorized in 2008 by our Board of Directors. To date, we have purchased and retired a cumulative total of 3,842,305 shares at an aggregate cost of $100.0 million. In August 2011, we announced that our board of directors had authorized the repurchase and retirement of up to an additional $100.0 million of our common stock in open market transactions, including block purchases, or in privately negotiated transactions. Our net cash at September 30, 2011 decreased by $21.9 million as compared to a $90.0 million decrease during the nine months ended September 30, 2010.

During December 2005, we issued $121.0 million principal amount of 2.875% senior subordinated convertible notes due December 15, 2035. During 2009, we purchased and retired an aggregate of $27.9 million principal amount of our convertible debt for $23.2 million, which reduced the outstanding balance of the notes to $93.1 million. We have not purchased any of the notes since 2009. Since the notes are convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement), we separately account for the liability and equity components of the notes in a manner that reflects the nonconvertible debt borrowing rate as interest cost is recognized.

As of September 30, 2011 and December 31, 2010, long-term debt and the equity component (recorded in additional paid in capital, net of income tax benefit) associated with the adoption in 2009 of the accounting guidance for convertible debt comprised the following (in thousands):

	September 30, 2011			December 31, 2010
Long-term debt
Principal amount	$	93,100		$	93,100
Unamortized discount		(4,759	)		(7,501	)
Net carrying amount	$	88,341		$	85,599
Equity component, net of income tax benefit	$	16,399		$	16,399

The discount on the liability component of long-term debt is being amortized using the effective interest method based on an annual effective rate of 7.5%, which represented the market interest rate for similar debt without a conversion option on the issuance date, through December 2012, which coincides with the first date that holders of the notes can exercise their put option as discussed below.

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 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, if any, up to but excluding the repurchase date. For further information regarding the notes, refer to Note 8 of Notes to Consolidated Financial Statements included in this Form 10-Q.

In December 2005, we established an unsecured $10.0 million line of credit which will expire on May 1, 2014. As of September 30, 2011, there were no outstanding amounts on the line of credit. However, the available line of credit at September 30, 2011 has been reduced by outstanding letters of credit in the aggregate amount of $4.9 million. The interest rate on the credit line was 1.2% as of September 30, 2011 which was based on the LIBOR rate for a period of one month, plus a fixed margin of 1.0%. In June 2011, we established an unsecured $5.0 million line of credit which will expire on January 1, 2012. As of September 30, 2011, there were no outstanding amounts on the line of credit. The interest rate on the credit line was 1.2% as of September 30, 2011 which was based on the LIBOR daily floating, plus a fixed margin of 1.0%. We use these lines of credit for letters of credits for insurance purposes.

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 liquidity and profitability and annual net income. At September 30, 2011, we were in compliance with these covenants.

Our cash, cash equivalents, and short-term investments totaled $259.0 million at September 30, 2011, compared to $246.3 million at December 31, 2010. At September 30, 2011, we had working capital of $455.9 million, compared to $414.4 million at December 31, 2010. Our cash position includes amounts denominated in foreign currencies. The amount of cash held in foreign currencies was $21.9 million and $17.0 million at September 30, 2011 and December 31, 2010, respectively. The repatriation of cash balances from our ESK Ceramics subsidiary does not result in additional tax costs. 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. Our anticipated capital requirements primarily relate to the normal replacement and some expansion of our manufacturing facilities at ESK Ceramics and the completion of our new manufacturing facility 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. From time to time, we may utilize cash to repurchase our common stock or our convertible debt.

Our material contractual obligations and commitments as of September 30, 2011 include a $1.7 million reserve for unrecognized tax benefits. The reserve is classified in Other Long Term Liabilities on our Consolidated Balance Sheet as of September 30, 2011.

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.

Our long term investments at September 30, 2011 included $15.0 million of auction rate securities. Cumulatively to date, the Company has incurred $9.2 million in pre-tax losses from its investments in auction rate securities, realized losses of $4.9 million from the sale of auction rate securities and pre-tax temporary impairment charges against other comprehensive income of $3.1 million. The Company’s investments in auction rate securities represent interests in insurance securitizations collateralized by pools of residential and commercial mortgages, asset backed securities and other structured credits relating to the credit risk of various bond guarantors that mature at various dates from June 2021 through July 2052. These auction rate securities were intended to provide liquidity via an auction process which is scheduled every 28 days, that resets the applicable interest rate, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. Interest rates are capped at a floating rate of one month LIBOR plus additional spread ranging from 1.25% to 4.00% depending on prevailing rating. During the second half of the year 2007, through 2008, 2009, 2010 and through September 30, 2011, the auctions for these securities failed. As a result of current negative conditions in the global credit markets, auctions for the Company’s investment in these securities failed to settle on their respective settlement dates. Consequently, the investments are not currently liquid through the normal auction process and may be liquidated if a buyer is found outside the auction process. Although the auctions have failed, the Company continues to receive underlying cash flows in the form of interest income from the investments in auction rate securities. As of September 30, 2011, the fair value of the Company’s investments in auction rate securities was below cost by approximately $12.3 million. The fair value of the auction rate securities has been below cost for more than one year.

Beginning in the third quarter of 2008 and at September 30, 2011, the Company determined that the market for its investments in auction rate securities and for similar securities continued to be inactive since there were few observable or recent transactions for these securities or similar securities. The Company’s investments in auction rate securities continued to be 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, 2011 and December 31, 2010.

•		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)

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 had an outstanding foreign exchange forward contract at September 30, 2011 for 43.0 million Euros.

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 $93.1 million of a convertible note with a fixed coupon rate of 2.875% (“Notes”). The fair value of long-term debt was $94.0 million and is based on quoted market prices at September 30, 2011.

Approximately 46.6% of our revenues for the nine months ended September 30, 2011 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

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, 2011 (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

During 2011, we continued our phase implementation of SAP ® enterprise software application with the implementation of the system for our Advanced Ceramic Operations segment. Our management believes that the implementation of this system will improve and enhance our internal control over financial reporting. The implementation of this system and the resulting changes to the internal control over financial reporting processes are substantially completed. There have been no other changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.

OTHER INFORMATION

Item 1.

Legal Proceedings

Item 1A. Risk Factors

There have been no significant changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth information regarding shares of our common stock that we repurchased during the three months ended September 30, 2011.

Issuer Purchases of Equity Securities

Period	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
July 1 to July 31, 2011		100,150	$	32.60		3,199,521	$	18,621,603
August 1 to August 31, 2011		371,100	$	29.79		3,570,621	$	107,565,169
September 1 to September 30, 2011		271,684	$	27.85		3,842,305	$	100,000,000
Total		742,934	$	29.46

(1)

On March 4, 2008, we announced that our board of directors had authorized the repurchase and retirement of up to $100 million of our common stock in open market transactions, including block purchases, or in privately negotiated transactions. We completed the $100 million of purchases under this authorization in September 2011. On August 31, 2011, we announced that our board of directors had authorized the repurchase and retirement of up to an additional $100 million of our common stock in open market transactions, including block purchases, or in privately negotiated transactions. We did not set a time limit for completion of this repurchase program, and we may suspend or terminate it at any time.

Item 3.		Defaults Upon Senior Securities
		Not applicable.
Item 4.		[Removed and Reserved]
Item 5.		Other Information
		Not applicable.

Item 6. Exhibits
(a) Exhibits
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Schema Document
101.CAL		XBRL Taxonomy Calculation Linkbase Document
101.LAB		XBRL Taxonomy Label Linkbase Document
101.PRE		XBRL Taxonomy Presentation Linkbase Document

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.

	CERADYNE, INC.

Date: October 25, 2011	By:	/s/ JERROLD J. PELLIZZON
		Jerrold J. Pellizzon
		Vice President Chief Financial Officer (Principal Financial and Accounting Officer)

Index to Exhibits

Exhibit		Description
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002.
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Schema Document
101.CAL		XBRL Taxonomy Calculation Linkbase Document
101.LAB		XBRL Taxonomy Label Linkbase Document
101.PRE		XBRL Taxonomy Presentation Linkbase Document