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 March 31, 2010




Or




 ̈
            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   ̈    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 “small
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 April 22, 2010Common
      Stock, $0.01 par value
            25,434,497
      Shares




Exhibit
Index on Page 34













CERADYNE,
INC.




INDEX





PAGE NO.PART I.
            FINANCIAL
      INFORMATIONItem 1.
            Unaudited
      Consolidated Financial Statements
            
            
            3Consolidated
      Balance Sheets – March 31, 2010 and December 31, 2009
            
            
            3Consolidated
      Statements of Income – Three Months Ended March 31, 2010 and
      2009
            
            
            4Consolidated
      Statements of Cash Flows – Three Months Ended March 31, 2010 and
      2009
            
            
            5Notes
      to Consolidated Financial Statements
            
            
            6-19Item 2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            
            20-29Item 3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            
            30-31Item 4.
            Controls
      and Procedures
            
            
            31PART II.
            OTHER
      INFORMATIONItem 1.
            Legal
      Proceedings
            
            
            32Item 1A.
            Risk
      Factors
            
            
            32Item 2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            
            32Item 3.
            Not
      applicable
            
            
            32Item 4.
            Not
      applicable
            
            
            32Item 5.
            Exhibits
            
            
            32SIGNATURE
            
            
            33





2


CERADYNE,
INC.


FORM
10-Q


FOR
THE QUARTER ENDED


March
31, 2010




PART I. FINANCIAL
INFORMATION




Item 1.
            Unaudited Consolidated
      Financial Statements




CERADYNE,
INC.


CONSOLIDATED
BALANCE SHEETS


(Amounts in
thousands, except share data)


March
      31,
              2010
            
            
            December
      31, 2009(Unaudited)CURRENT
      ASSETSCash
      and cash equivalents
            
            $
            133,767
            
            
            $
            122,154Restricted
      cash
            
            
            -
            
            
            
            3,130Short-term
      investments
            
            
            118,277
            
            
            
            117,666Accounts
      receivable, net of allowances for doubtful accounts of
$749and
      $851 at March 31, 2010 and December 31, 2009, respectively
            
            
            59,552
            
            
            
            53,269Other
      receivables
            
            
            20,063
            
            
            
            11,424Inventories,
      net
            
            
            89,517
            
            
            
            100,976Production
      tooling, net
            
            
            10,449
            
            
            
            12,006Prepaid
      expenses and other
            
            
            16,278
            
            
            
            19,932Deferred
      tax asset
            
            
            12,874
            
            
            
            13,796TOTAL
      CURRENT ASSETS
            
            
            460,777
            
            
            
            454,353PROPERTY,
      PLANT AND EQUIPMENT, net
            
            
            231,180
            
            
            
            239,322LONG
      TERM INVESTMENTS
            
            
            19,612
            
            
            
            20,019INTANGIBLE
      ASSETS, net
            
            
            87,696
            
            
            
            89,409GOODWILL
            
            
            43,307
            
            
            
            43,880OTHER
      ASSETS
            
            
            2,687
            
            
            
            2,721TOTAL
      ASSETS
            
            $
            845,259
            
            
            $
            849,704




CURRENT
      LIABILITIESAccounts
      payable
            
            $
            23,399
            
            
            $
            24,683Accrued
      expenses
            
            
            23,766
            
            
            
            23,463TOTAL
      CURRENT LIABILITIES
            
            
            47,165
            
            
            
            48,146LONG-TERM
      DEBT
            
            
            82,990
            
            
            
            82,163EMPLOYEE
      BENEFITS
            
            
            20,786
            
            
            
            21,769OTHER
      LONG TERM LIABILITY
            
            
            39,229
            
            
            
            39,561DEFERRED
      TAX LIABILITY
            
            
            9,151
            
            
            
            8,348TOTAL
      LIABILITIES
            
            
            199,321
            
            
            
            199,987COMMITMENTS
      AND CONTINGENCIES (Note 15)SHAREHOLDERS’
      EQUITYCommon
      stock, $0.01 par value, 100,000,000 authorized, 25,434,497 and 25,401,005
      shares issued and outstanding at March 31, 2010 and December 31, 2009,
      respectively
            
            
            256
            
            
            
            254Additional
      paid-in capital
            
            
            158,245
            
            
            
            157,679Retained
      earnings
            
            
            475,246
            
            
            
            470,256Accumulated
      other comprehensive income
            
            
            12,191
            
            
            
            21,528TOTAL
      SHAREHOLDERS’ EQUITY
            
            
            645,938
            
            
            
            649,717TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
            
            $
            845,259
            
            
            $
            849,704














See
accompanying condensed notes to Consolidated Financial
Statements


3




CERADYNE,
INC.


CONSOLIDATED
STATEMENTS OF INCOME


(Amounts
in thousands, except per share data)





Three
      Months Ended
              March
      31,2010
            
            
            2009(Unaudited)NET
      SALES
            
            $
            110,038
            
            
            $
            99,772COST
      OF GOODS SOLD
            
            
            84,672
            
            
            
            76,185Gross
      profit
            
            
            25,366
            
            
            
            23,587OPERATING
      EXPENSESSelling
            
            
            5,855
            
            
            
            6,907General
      and administrative
            
            
            8,042
            
            
            
            9,722Acquisition
      related credit
            
            
            (88
            )
            
            
            -Research
      and development
            
            
            2,944
            
            
            
            3,378Restructuring
      - severance
            
            
            7
            
            
            
            93916,760
            
            
            
            20,946INCOME
      FROM OPERATIONS
            
            
            8,606
            
            
            
            2,641OTHER
      INCOME (EXPENSE):Interest
      income
            
            
            899
            
            
            
            728Interest
      expense
            
            
            (1,586
            )
            
            
            (2,085
            )Loss
      on auction rate securities
            
            
            (1,927
            )
            
            
            (104
            )Miscellaneous
            
            
            529
            
            
            
            (3
            )(2,085
            )
            
            
            (1,464
            )INCOME
      BEFORE PROVISION FOR INCOME TAXES
            
            
            6,521
            
            
            
            1,177PROVISION
      FOR INCOME TAXES
            
            
            1,531
            
            
            
            469NET
      INCOME
            
            $
            4,990
            
            
            $
            708BASIC
      INCOME PER SHARE
            
            $
            0.20
            
            
            $
            0.03DILUTED
      INCOME PER SHARE
            
            $
            0.20
            
            
            $
            0.03WEIGHTED
      AVERAGE SHARES OUTSTANDING:BASIC
            
            
            25,411
            
            
            
            25,822DILUTED
            
            
            25,585
            
            
            
            26,033


























See
accompanying condensed notes to Consolidated Financial
Statements


4




CERADYNE,
INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Amounts in
thousands)


Three
      Months Ended
              March
      31,2010
            
            
            2009(Unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
            
            $
            4,990
            
            
            $
            708ADJUSTMENTS
      TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING
      ACTIVITIES:Depreciation
      and amortization
            
            
            9,178
            
            
            
            9,465Non
      cash interest expense on convertible debt
            
            
            827
            
            
            
            1,001Deferred
      income taxes
            
            
            174
            
            
            
            (1,545
            )Stock
      compensation
            
            
            964
            
            
            
            865Loss
      on marketable securities
            
            
            1,927
            
            
            
            104Loss
      (gain) on equipment disposal
            
            
            4
            
            
            
            (12
            )Change
      in operating assets and liabilities (net of effect of businesses
      acquired):Accounts
      receivable, net
            
            
            (7,035
            )
            
            
            4,613Other
      receivables
            
            
            (8,863
            )
            
            
            680Inventories,
      net
            
            
            9,672
            
            
            
            (356
            )Production
      tooling, net
            
            
            1,498
            
            
            
            1,173Prepaid
      expenses and other assets
            
            
            3,300
            
            
            
            1,040Accounts
      payable and accrued expenses
            
            
            (134
            )
            
            
            (1,222
            )Income
      taxes payable
            
            
            -
            
            
            
            1,717Other
      long term liability
            
            
            (328
            )
            
            
            72Employee
      benefits
            
            
            140
            
            
            
            275NET
      CASH PROVIDED BY OPERATING ACTIVITES
            
            
            16,314
            
            
            
            18,578CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property, plant and equipment
            
            
            (6,851
            )
            
            
            (7,711
            )Changes
      in restricted cash
            
            
            3,130
            
            
            
            -Purchases
      of marketable securities
            
            
            (344
            )
            
            
            (24,583
            )Proceeds
      from sales and maturities of marketable securities
            
            
            12
            
            
            
            1,340Proceeds
      from sale of equipment
            
            
            284
            
            
            
            14NET
      CASH USED IN INVESTING ACTIVITIES
            
            
            (3,769
            )
            
            
            (30,940
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuance of stock due to exercise of options
            
            
            24
            
            
            
            5Excess
      tax benefit due to exercise of stock options
            
            
            7
            
            
            
            -Shares
      repurchased
            
            
            -
            
            
            
            (832
            )NET
      CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
            
            
            31
            
            
            
            (827
            )EFFECT
      OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
            
            
            (963
            )
            
            
            (903
            )INCREASE
      (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            11,613
            
            
            
            (14,092
            )CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            122,154
            
            
            
            215,282CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            133,767
            
            
            $
            201,190SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW ACTIVITIES:Interest
      paid
            
            $
            4
            
            
            $
            7Income
      taxes paid
            
            $
            1,369
            
            
            $
            627



















See
accompanying condensed notes to Consolidated Financial
Statements


5







CERADYNE,
INC.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


MARCH 31,
2010


(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 three months ended March 31, 2010 are not necessarily indicative
of the results that may be expected for the year ending December 31,
2010.




The
balance sheet at December 31, 2009 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, 2009.




2.
            Share Based
      Compensation




Share-based
compensation expense for the three months ended March 31, 2010 was $1.0 million,
which was related to stock options and restricted stock units. This compared to
$0.9 million for the three months ended March 31, 2009.




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 month period ended March 31, 2010 includes compensation
expense for share-based payment awards based on the estimated grant-date fair
value. Since share-based compensation expense recognized in the Consolidated
Statements of Income for the three month period ended March 31, 2010 is based on
awards ultimately expected to vest, it has been reduced for estimated
forfeitures.




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




The
Company was authorized to grant options for up to 2,362,500 shares under its
1994 Stock Incentive Plan. The Company has granted options for 2,691,225 shares
and has had cancellations of 396,911 shares through March 31, 2010. 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, the Units typically vest annually
over five years following the date of their issuance.




The
Company may grant options and Units for up to 1,125,000 shares under the 2003
Stock Incentive Plan. The Company has granted options for 475,125 shares and
Units for 686,986 shares under this plan through March 31, 2010. There have been
cancellations of 99,575 shares associated with this plan through March 31, 2010.
The options under this plan have a life of ten years.




During
the three months ended March 31, 2010 and 2009, 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.


6


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







Three
      Months Ended
              March
      31,2010
            
            
            2009Share-based
      compensation expense recognized:General
      and administrative, options
            
            $
            30
            
            
            $
            71General
      and administrative, restricted stock units
            
            
            934
            
            
            
            793Related
      deferred income tax benefit
            
            
            (384
            )
            
            
            (345
            )Decrease
      in net income
            
            $
            580
            
            
            $
            519Decrease
      in basic earnings per share
            
            $
            0.02
            
            
            $
            0.02Decrease
      in diluted earnings per share
            
            $
            0.02
            
            
            $
            0.02




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





As of
March 31, 2010, there was $13,000 of total unrecognized compensation cost
related to 6,000 non-vested outstanding stock options, with a weighted average
value of $19.24 per share. The unrecognized expense is anticipated to be
recognized on a straight-line basis over a weighted average period of one month.
In addition, the aggregate intrinsic value of stock options exercised was
$130,000 and $22,000 for the three months ended March 31, 2010 and
2009.




As of
March 31, 2010, there was approximately $10.6 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:





Three Months Ended
              March 31,2010Number of
              Options
            
            
            Weighted
      Average
              Exercise
              PriceOutstanding,
      December 31, 2009
            
            
            454,400
            
            
            $
            12.37Options
      granted
            
            
            -
            
            
            $
            -Options
      exercised
            
            
            (6,350
            )
            
            $
            3.47Options
      cancelled
            
            
            -
            
            
            $
            -Outstanding,
      March 31, 2010
            
            
            448,050
            
            
            $
            12.50Exercisable,
      March 31, 2010
            
            
            442,050
            
            
            $
            12.41





The
following is a summary of Unit activity:





Three Months Ended
              March 31,2010Number
      of
              Units
            
            
            Weighted
      Average
              Grant
      Fair ValueNon-vested
      Units at December 31, 2009
            
            
            363,924
            
            
            $
            32.47Granted
            
            
            93,160
            
            
            $
            23.95Forfeited
            
            
            (200
            )
            
            $
            22.68Vested
            
            
            (45,460
            )
            
            $
            31.40Non-vested
      Units at March 31, 2010
            
            
            411,424
            
            
            $
            30.66





7


The
following table summarizes information regarding options outstanding and options
exercisable at March 31, 2010:





Outstanding
            
            ExercisableRange
      of
              Exercise
      Prices
            
            Number of
              Options
            
            Average
              Remaining
              Contractual
              Life
      (Years)
            
            Weighted
              Average
              Exercise
              Price
            
            Aggregate
              Intrinsic
              Value
              (000s)
            
            Number of
              Options
            
            Average
              Remaining
              Contractual
              Life
      (Years)
            
            Weighted
              Average
              Exercise
              Price
            
            Aggregate
              Intrinsic
              Value
              (000s)$
            2.98 - $4.58
            
            
            200,025
            
            
            1.82
            
            $
            4.14
            
            $
            3,714
            
            
            200,025
            
            
            1.82
            
            $
            4.14
            
            $
            3,714$
            10.53 - $16.89
            
            
            122,025
            
            
            3.45
            
            $
            16.89
            
            $
            710
            
            
            122,025
            
            
            3.45
            
            $
            16.89
            
            $
            710$
            18.80 - $24.07
            
            
            126,000
            
            
            4.47
            
            $
            21.51
            
            $
            150
            
            
            120,000
            
            
            4.44
            
            $
            21.63
            
            $
            130448,050
            
            
            3.01
            
            $
            12.50
            
            $
            4,574
            
            
            442,050
            
            
            2.98
            
            $
            12.41
            
            $
            4,554





The
following table summarizes information regarding Units outstanding at March 31,
2010:





OutstandingRange
      of Grant Prices
            
            
            Number of
              Units
            
            
            Average
              Remaining
              Contractual
              Life
      (Years)
            
            
            Weighted
              Average
              Grant
              Fair
      Value$
            16.53
      - $25.37
            
            
            
            256,860
            
            
            
            3.35
            
            
            $
            21.29$
            37.41 - $39.43
            
            
            
            80,084
            
            
            
            2.99
            
            
            $
            38.60$
            42.28
      - $45.70
            
            
            
            38,700
            
            
            
            3.01
            
            
            $
            44.52$
            52.47
      - $62.07
            
            
            
            15,510
            
            
            
            1.54
            
            
            $
            58.27$
            66.35
      - $81.18
            
            
            
            20,270
            
            
            
            1.92
            
            
            $
            70.56411,424
            
            
            
            3.11
            
            
            $
            30.66







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 restricted stock units using the treasury stock
method and the net share settlement method for the convertible debt. During the
three months ended March 31, 2010 and 2009, 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
              March
      31,2010
            
            
            2009Weighted
      average number of shares outstanding
            
            
            25,410,976
            
            
            
            25,821,573Dilutive
      stock options
            
            
            156,182
            
            
            
            211,621Dilutive
      restricted stock units
            
            
            18,211
            
            
            
            -Dilutive
      contingent convertible debt common shares
            
            
            -
            
            
            
            -Number
      of shares used in fully diluted computations
            
            
            25,585,369
            
            
            
            26,033,194




Not
included in the number of shares used in the fully diluted computation for the
three months ended March 31, 2010 and 2009 are 254,424 and 330,204 shares,
respectively, pertaining to restricted stock units as their impact would be
anti-dilutive.


8




Composition of Certain
Financial Statement Captions




The
Company holds certain cash balances that are restricted as to use. The
restricted cash at December 31, 2009 was used as collateral for the Company’s
partially self insured workers compensation policy. The restricted cash was
released during the three months ended March 31, 2010 as it was replaced by
using a letter of credit as collateral.




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 March 31, 2010 and December 31, 2009
(in thousands):





March
      31, 2010
            
            
            December
      31, 2009Raw
      materials
            
            $
            5,958
            
            
            $
            12,219Work-in-process
            
            
            46,291
            
            
            
            46,334Finished
      goods
            
            
            37,268
            
            
            
            42,423$
            89,517
            
            
            $
            100,976




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





March
      31, 2010
            
            
            December
      31, 2009Land
            
            $
            18,743
            
            
            $
            19,320Buildings
      and improvements
            
            
            97,160
            
            
            
            100,861Machinery
      and equipment
            
            
            209,059
            
            
            
            214,552Leasehold
      improvements
            
            
            9,478
            
            
            
            9,473Office
      equipment
            
            
            29,296
            
            
            
            29,807Construction
      in progress
            
            
            11,712
            
            
            
            6,083375,448
            
            
            
            380,096Less
      accumulated depreciation and amortization
            
            
            (144,268
            )
            
            
            (140,774
            )$
            231,180
            
            
            $
            239,322




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





March
      31, 2010
            
            
            December
      31, 2009Gross
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              Amount
            
            
            Gross
              Amount
            
            
            Accumulated
              Amortization
            
            
            Net
              AmountAmortizing
      Intangible AssetsBacklog
            
            $
            1,831
            
            
            $
            1,831
            
            
            $
            -
            
            
            $
            1,864
            
            
            $
            1,864
            
            
            $
            -Developed
      technology
            
            
            50,436
            
            
            
            4,673
            
            
            
            45,763
            
            
            
            50,752
            
            
            
            4,378
            
            
            
            46,374Tradename
            
            
            1,110
            
            
            
            476
            
            
            
            634
            
            
            
            1,110
            
            
            
            445
            
            
            
            665Customer
      relationships
            
            
            47,604
            
            
            
            8,602
            
            
            
            39,002
            
            
            
            46,604
            
            
            
            7,671
            
            
            
            39,933Non-compete
      agreement
            
            
            500
            
            
            
            500
            
            
            
            -
            
            
            
            500
            
            
            
            500
            
            
            
            -Non-amortizing
      tradename
            
            
            2,297
            
            
            
            -
            
            
            
            2,297
            
            
            
            2,437
            
            
            
            -
            
            
            
            2,437Total
            
            $
            103,778
            
            
            $
            16,082
            
            
            $
            87,696
            
            
            $
            104,267
            
            
            $
            14,858
            
            
            $
            89,409





The
estimated useful lives for intangible assets are:





Identified Intangible Asset
            
            Estimated Useful Life in Years or
      MonthsDeveloped
      technology
            
            10
      years – 12.5 yearsTradename
            
            10
      yearsCustomer
      relationships
            
            10
      years – 12.5 yearsBacklog
            
            1
      month – 3 monthsNon-compete
      agreement
            
            15
      months





Amortization
of definite-lived intangible assets will be approximately (in thousands): $6,975
in fiscal year 2010, $6,920 in fiscal year 2011, $7,367 in fiscal year 2012,
$8,321 in fiscal year 2013 and $9,847 in fiscal year 2014.


9


The roll
forward of the goodwill balance by segment during the three months ended March
31, 2010 is as follows (in thousands):




ACO
            
            
            Semicon
            
            
            Thermo
            
            
            ESK
            
            
            Boron
            
            
            TotalBalance
      at December 31, 2009Goodwill
            
            $
            4,708
            
            
            $
            603
            
            
            $
            10,331
            
            
            $
            9,987
            
            
            $
            18,251
            
            
            $
            43,880Translation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (573
            )
            
            
            -
            
            
            
            (573
            )Balance
      at March 31, 2010Goodwill
            
            $
            4,708
            
            
            $
            603
            
            
            $
            10,331
            
            
            $
            9,414
            
            
            $
            18,251
            
            
            $
            43,307







At
December 31, 2009, the Company’s market capitalization was below its net book
value. Based on a control factor that was considered and the discounted cash
flows used in management’s assessment, an impairment to goodwill was not
warranted at December 31, 2009.




At March
31, 2010, the Company's market capitalization was less than its total
stockholders' equity. The Company considers this decline to be temporary and
based on general economic conditions, therefore no interim test of goodwill is
required. 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 March
31, 2010.




4.
            Stock
      Repurchases





During
the three months ended March 31, 2010, the Company did not repurchase any of its
common stock. Under a stock repurchase program authorized in 2008 by the
Company’s Board of Directors, the Company is authorized to repurchase an
additional $45.5 million for a total of $100.0 million.




5.
            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. On April 1, 2009, the
Company adopted new recognition principles which provided 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
      liabilitiesLevel 2:  observable
      market based inputs or unobservable inputs that are corroborated by market
      dataLevel 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 $118.3 million at March 31, 2010 and $117.7
million at December 31, 2009. The fair value of these investments is
determined using quoted prices in active markets. Long-term investments,
comprising auction rate securities, had an aggregate fair value of
$19.6 million at March 31, 2010 and $20.0 million at December 31,
2009.
  10
 During
the three months ended March 31, 2010 the Company recognized pre-tax charges of
$1.9 million due to other-than-temporary reductions in the value of its
investments in auction rate securities associated with the credit risk component
of the other-than-temporary impairment. During the three months ended March 31,
2009 the Company recognized pre-tax charges of $104,000 due to
other-than-temporary reductions in the value of its investments in auction rate
securities. The Company also recognized
a pre-tax increase of $1.5 million in other comprehensive income during the
three months ended March 31, 2010 and a pre-tax charge of $1.9 million which
reduced other comprehensive income during the three months ended March 31, 2009,
due to temporary changes in the value of its investments in auction rate
securities.
  Cumulatively to date, the Company has
incurred $12.8 million in pre-tax charges due to other-than-temporary reductions
in the value of its investments in auction rate securities, a realized loss of
$2.3 million from the sale of auction rate securites in 2009 and pre-tax
temporary impairment charges of $1.0 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
and through March 31, 2010, 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 March 31, 2010,
the fair value of the Company’s investments in auction rate securities was below
cost by approximately $13.8 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 March 31, 2010, 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 March 31, 2010 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 0.5% to
5.0%, 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.




11


Assets
measured at fair value on a recurring basis include the following as of March
31, 2010 (in thousands):


Fair
      Value Measurements at
              March
      31, 2010 UsingQuoted
      Prices in Active Markets
              (Level
      1)
            
            
            Significant
      Other Observable Inputs
              (Level
      2)
            
            
            Significant
      Unobservable Inputs
              (Level
      3)
            
            
            Total
      Carrying Value at
              March
      31, 2010Cash
      and cash equivalents (including restricted cash)
            
            $
            133,767
            
            
            $
            -
            
            
            $
            -
            
            
            $
            133,767Short
      term investments
            
            
            118,277
            
            
            
            -
            
            
            
            -
            
            
            
            118,277Long
      term investments
            
            
            -
            
            
            
            -
            
            
            
            19,612
            
            
            
            19,612Assets
      held by defined benefit pension plans
            
            
            -
            
            
            
            7,061
            
            
            
            -
            
            
            
            7,061Other
      long term financial asset
            
            $
            2,012
            
            
            
            -
            
            
            
            -
            
            
            $
            2,012





Fair
      Value Measurements at
              December
      31, 2009 UsingQuoted
      Prices in Active Markets
              (Level
      1)
            
            
            Significant
      Other Observable Inputs
              (Level
      2)
            
            
            Significant
      Unobservable Inputs
              (Level
      3)
            
            
            Total
      Carrying Value at
              December
      31, 2009Cash
      and cash equivalents (including restricted cash)
            
            $
            125,284
            
            
            $
            -
            
            
            $
            -
            
            
            $
            125,284Short
      term investments
            
            
            117,666
            
            
            
            -
            
            
            
            -
            
            
            
            117,666Long
      term investments
            
            
            -
            
            
            
            -
            
            
            
            20,019
            
            
            
            20,019Assets
      held by defined benefit pension plans
            
            
            -
            
            
            
            6.857
            
            
            
            -
            
            
            
            6,857Other
      long term financial asset
            
            $
            1,962
            
            
            
            -
            
            
            
            -
            
            
            $
            1,962


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


Three
      Months EndedMarch
      31,2010
            
            
            2009Balance
      at beginning of period
            
            $
            20,019
            
            
            $
            24,434Unrealized
      loss included in net earnings
            
            
            (1,927
            )
            
            
            (104
            )Unrealized
      gain (loss) included in other comprehensive income
            
            
            1,520
            
            
            
            (1,291
            )Balance
      at end of period
            
            $
            19,612
            
            
            $
            23,039


On an
annual recurring basis as of December 31 of each fiscal year, the Company is
required to use fair value measures when measuring plan assets of the Company’s
pension plans. The Company’s most recent determination of the fair value of
pension plan assets was $6.9 million at December 31, 2009. These
assets are valued in highly liquid markets. Fair value measurement of the plan
assets was based on significant other observable inputs (Level
2).


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


12


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 $89.4 million at March 31, 2010
and $87.5 million at December 31, 2009.


6.
            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 is
effective for interim and annual reporting periods beginning after December 15,
2009 (which is January 1, 2010 for the Company) except for the disclosures about
purchases, sales, issuances, and settlements in the roll forward activity in
Level 3 fair value measurements. Those disclosures are effective for fiscal
years beginning after December 15, 2010, and for interim periods within those
fiscal years (which is January 1, 2011 for the Company). Early application is
encouraged. The revised guidance was adopted as of January 1, 2010. The adoption
of this guidance did not have a material impact on the Company’s consolidated
financial position, results of operations and cash flows.




7.
            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
March 31, 2010 and December 31, 2009, 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):


March
      31, 2010
            
            
            December
      31, 2009Long-term
      debtPrincipal
      amount
            
            $
            93,100
            
            
            $
            93,100Unamortized
      discount
            
            
            (10,110
            )
            
            
            (10,937
            )Net
      carrying amount
            
            $
            82,990
            
            
            $
            82,163Equity
      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 for the three months ended March 31, 2010 includes
non-cash interest expense from amortization of the discount on the liability
component of $0.8 million and amortization of debt issuance costs of $89,000.
Interest expense for the three months ended March 31, 2009 included non-cash
interest expense from amortization of the discount on the liability component of
$1.0 million and amortization of debt issuance costs of $111,000. The amount of
interest expense recognized relating to both the contractual interest coupon and
the amortization of the discount on the liability component was $1.5 million and
$1.9 million for the three months ended March 31, 2010 and 2009,
respectively.




Interest
on the Notes is payable on December 15 and June 15 of each year,
commencing on June 15, 2006. The Notes are convertible into 17.1032 shares
of Ceradyne’s common stock for each $1,000 principal amount of the Notes (which
represents a conversion price of approximately $58.47 per share), subject to
adjustment. The Notes are convertible only under certain circumstances,
including if the price of the Company’s common stock reaches specified
thresholds, if the Notes are called for redemption, if specified corporate
transactions or fundamental changes occur, or during the 10 trading days prior
to maturity of the Notes. The Company may redeem the Notes at any time after
December 20, 2010, for a price equal to 100% of the principal amount plus
accrued and unpaid interest, including contingent interest (as described below),
if any, up to but excluding the redemption date. As of March 31, 2010, the
principal amount of the Notes exceeded the hypothetical if-converted value as
the conversion price was higher than the average market price of the Company’s
common stock.




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.


13




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




The
Company is obligated to pay contingent interest to the holders of the Notes
during any six-month period from June 15 to December 14 and from
December 15 to June 14, commencing with the six-month period beginning
December 20, 2010 and ending on June 14, 2011, if the average trading
price of the note for the five trading day period ending on the third trading
day immediately preceding the first day of the relevant contingent interest
period equals $1,200 (120% of the principal amount of a note) or more. The
amount of contingent interest payable per note for any relevant contingent
interest period shall equal 0.25% per annum of the average trading price of
a note for the five trading day period ending on the third trading day
immediately preceding the first day of the relevant contingent interest period.
This contingent interest payment feature represents an embedded derivative.
However, based on the de minimus value associated with this feature, no value
has been assigned at issuance or at March 31, 2010.




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 March 31, 2010.




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. For the three months ended March 31, 2010, there were no outstanding
amounts on the line of credit. However, the available line of credit at March
31, 2010 has been reduced by outstanding letters of credit in the aggregate
amount of $4.9 million. The interest rate on the credit line was 1.25% as of
March 31, 2010, which is based on the LIBOR rate for a period of one month, plus
a margin of 1.0 percent.




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
liquidity and profitability and annual net income. At March 31, 2010, the
Company was in compliance with these covenants.




8.
            Disclosure About
      Segments of an Enterprise and Related
  Information




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


14


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





Three
      Months Ended March 31,2010
            
            
            2009Revenue from External
    CustomersAdvanced
      Ceramic Operations
            
            $
            51,829
            
            
            $
            56,250ESK
      Ceramics
            
            
            31,748
            
            
            
            23,586Semicon
      Associates
            
            
            2,259
            
            
            
            2,076Thermo
      Materials
            
            
            22,174
            
            
            
            16,211Ceradyne
      Canada
            
            
            333
            
            
            
            313Boron
            
            
            6,186
            
            
            
            6,049Inter-segment
      elimination
            
            
            (4,491
            )
            
            
            (4,713
            )Total
            
            $
            110,038
            
            
            $
            99,772Depreciation and
    AmortizationAdvanced
      Ceramic Operations
            
            $
            2,348
            
            
            $
            2,599ESK
      Ceramics
            
            
            3,303
            
            
            
            3,138Semicon
      Associates
            
            
            84
            
            
            
            93Thermo
      Materials
            
            
            1,345
            
            
            
            1,348Ceradyne
      Canada
            
            
            341
            
            
            
            310Boron
            
            
            1,757
            
            
            
            1,977Total
            
            $
            9,178
            
            
            $
            9,465Segment Income (Loss) before Provision for Income
      TaxesAdvanced
      Ceramic Operations
            
            $
            2,059
            
            
            $
            4,247ESK
      Ceramics
            
            
            2,071
            
            
            
            (4,389
            )Semicon
      Associates
            
            
            214
            
            
            
            234Thermo
      Materials
            
            
            4,477
            
            
            
            3,632Ceradyne
      Canada
            
            
            (886
            )
            
            
            (769
            )Boron
            
            
            (1,220
            )
            
            
            (1,753
            )Inter-segment
      elimination
            
            
            (194
            )
            
            
            (25
            )Total
            
            $
            6,521
            
            
            $
            1,177Segment AssetsAdvanced
      Ceramic Operations
            
            $
            411,180
            
            
            $
            392,274ESK
      Ceramics
            
            
            192,166
            
            
            
            209,922Semicon
      Associates
            
            
            5,695
            
            
            
            6,046Thermo
      Materials
            
            
            107,995
            
            
            
            98,064Ceradyne
      Canada
            
            
            16,866
            
            
            
            21,139Boron
            
            
            111,357
            
            
            
            118,261Total
            
            $
            845,259
            
            
            $
            845,706Expenditures for Property, Plant &
      EquipmentAdvanced
      Ceramic Operations
            
            $
            1,312
            
            
            $
            1,184ESK
      Ceramics
            
            
            487
            
            
            
            1,424Semicon
      Associates
            
            
            188
            
            
            
            51Thermo
      Materials
            
            
            3,389
            
            
            
            4,793Ceradyne
      Canada
            
            
            46
            
            
            
            100Boron
            
            
            1,429
            
            
            
            159Total
            
            $
            6,851
            
            
            $
            7,711





15


Three
      Months Ended March 31,2010
            
            
            2009Percentage of U.S. net sales from external
      customersAdvanced
      Ceramic Operations
            
            
            46
            %
            
            
            55
            %ESK
      Ceramics
            
            
            3
            %
            
            
            2
            %Semicon
      Associates
            
            
            2
            %
            
            
            2
            %Thermo
      Materials
            
            
            5
            %
            
            
            7
            %Ceradyne
      Canada
            
            
            0
            %
            
            
            0
            %Boron
            
            
            2
            %
            
            
            2
            %Total
      percentage of U.S. net sales from external customers
            
            
            58
            %
            
            
            68
            %Percentage of foreign net sales from external
      customersAdvanced
      Ceramic Operations
            
            
            2
            %
            
            
            2
            %ESK
      Ceramics
            
            
            24
            %
            
            
            18
            %Semicon
      Associates
            
            
            0
            %
            
            
            0
            %Thermo
      Materials
            
            
            13
            %
            
            
            8
            %Ceradyne
      Canada
            
            
            0
            %
            
            
            0
            %Boron
            
            
            3
            %
            
            
            4
            %Total
      percentage of foreign net sales from external customers
            
            
            42
            %
            
            
            32
            %Percentage of total net sales from
      external customersAdvanced
      Ceramic Operations
            
            
            48
            %
            
            
            57
            %ESK
      Ceramics
            
            
            27
            %
            
            
            20
            %Semicon
      Associates
            
            
            2
            %
            
            
            2
            %Thermo
      Materials
            
            
            18
            %
            
            
            15
            %Ceradyne
      Canada
            
            
            0
            %
            
            
            0
            %Boron
            
            
            5
            %
            
            
            6
            %Total
      percentage of total net sales from external customers
            
            
            100
            %
            
            
            100
            %







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





Three
      Months Ended March 31,2010
            
            
            2009Armor
            
            $
            43,349
            
            
            $
            49,815Automotive
            
            
            2,528
            
            
            
            1,971Orthodontics
            
            
            2,172
            
            
            
            2,482Industrial
            
            
            3,780
            
            
            
            1,982$
            51,829
            
            
            $
            56,250




9.
            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.


16




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




Three
      Months Ended March 31,2010
            
            
            2009Service
      cost
            
            $
            200
            
            
            $
            169Interest
      cost
            
            
            318
            
            
            
            290Expected
      return on plan assets
            
            
            (132
            )
            
            
            (124
            )Amortization
      of unrecognized (gain) loss
            
            
            (6
            )
            
            
            67Net
      periodic benefit cost
            
            $
            380
            
            
            $
            402




10.
            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 did not have any outstanding foreign exchange forward contracts at March
31, 2010.




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.




11.
            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 March 31, 2010 and December 31, 2009 are as follows
(in thousands):





March
      31, 2010
            
            
            December
      31, 2009Federal,
      state and foreign unrecognized tax benefits (“UTBs”)
            
            $
            1,568
            
            
            $
            1,817Interest
            
            
            230
            
            
            
            216Federal/State
      Benefit of Interest
            
            
            (90
            )
            
            
            (85
            )Total
      reserve for UTBs
            
            $
            1,708
            
            
            $
            1,948





It is
anticipated that any change in the above UTBs will impact the effective tax
rate. At March 31, 2010, the 2005 through 2008 years are open and subject to
potential examination in one or more jurisdictions. The Company is currently
under a federal income tax examination for the 2008 tax year. 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 March 31, 2010
and 2009 was reduced by $485,000 and $0.6 million, respectively, or $0.02 and
$0.02 per fully diluted share, 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.


17




12.
            Commitments and
      Contingencies




The
Company leases certain of its manufacturing facilities under noncancelable
operating leases expiring at various dates through June 2014. The Company
incurred rental expense under these leases of $0.8 million for the three months
ended March 31, 2010 and 2009. The approximate minimum rental commitments
required under existing noncancelable leases as of March 31, 2010 are as follows
(in thousands):





2010
            
            $
            2,7022011
            
            
            1,9952012
            
            
            1,4072013
            
            
            1,0342014
            
            
            925Thereafter
            
            
            268$
            8,331





A class
action lawsuit was filed on March 23, 2007, in the California Superior
Court for Orange County, in which it was asserted that the
representative plaintiff, a former Ceradyne employee, and the putative
class members, were not paid overtime at an appropriate overtime rate. The
complaint alleges that the purportedly affected employees should have had their
regular rate of pay for purposes of calculating overtime adjusted to reflect the
payment of a bonus to them for the four years preceding the filing of the
complaint, up to the present time. The complaint further alleges that a waiting
time penalty should be assessed for the failure to timely pay the correct
overtime payment. The Company filed an answer denying the material allegations
of the complaint. The motion for class certification was heard on November 13,
2008 and class certification was granted. On January 6, 2009, the court entered
an order certifying the class. The Company contends that
the lawsuit is without merit on the basis that the bonuses
that have been paid are discretionary and not of the type that are subject to
inclusion in the regular hourly rate for purposes of calculating overtime. After
a request for review by the Court of Appeal of the decision to grant class
certification, a day-long mediation before a third-party neutral mediator, and
an evaluation of the cost of litigation and the financial exposure in the case,
the Company agreed to provide a settlement fund of $1.25 million to resolve all
issues in the litigation. The settlement specifically states that neither party
is admitting to liability or lack thereof. The Company believed that based upon
the cost of further defense and the exposure in the case, it was best to settle
the matter. The Court has granted final approval of the settlement. A third
party administrator contacted class members concerning their respective recovery
and their rights to opt-out. The final settlement payment amount of
approximately $1.3 million was paid in full during the first quarter ended March
31, 2010 and included approximately $50,000 of payroll taxes. Settlement checks
have been distributed to the class members by the third party
administrator. Any checks that are not cashed or that are returned to the
administrator within 60 days from the date of the check will revert back to the
Company.
  During
the quarter ended March 31, 2010, the Company reached an agreement in principle
to settle a claim for $1.2 million pertaining to ballistic tests of armored
wing assemblies subject to the negotiation and execution of a mutually
acceptable settlement agreement and release. The Company previously established
a reserve of $1.0 million for this matter during the three months ended
September 30, 2009 and increased it by $200,000, with a corresponding charge to
general and administrative expenses, during the three months ended March 31,
2010. The tentative settlement expires on June 22, 2010. The Company
believes that a final settlement agreement will be signed prior to the
expiration date of the tentative settlement agreement.




13.
            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, net of tax was (in thousands):





Three
      Months Ended March 31,2010
            
            
            2009Net
      income (loss)
            
            $
            4,990
            
            
            $
            708Foreign
      currency translation
            
            
            (10,158
            )
            
            
            (8,569
            )Unrealized
      gain on investments
            
            
            821
            
            
            
            (808
            )Comprehensive
      income (loss)
            
            $
            (4,347
            )
            
            $
            (8,669
            )




18


14.
            Restructuring – Plant
      Closure and Severance





In May
2009, the Company announced that, in accordance with the French legal process,
its ESK Ceramics France subsidiary (“ESK France”) is presenting to the local
employees’ representatives a plan for closing its manufacturing plant in Bazet,
France. The plant was closed in December 2009 and, as a result, ESK France
reduced its workforce by 97 employees, primarily composed of manufacturing,
production and additional support staff at the plant. This action was
implemented as a cost-cutting measure to eliminate losses that were incurred at
this facility due to the recent severe economic contraction and is consistent
with Ceradyne’s ongoing objective to lower the costs of its manufacturing
operations. This manufacturing facility was an 88,000 square foot building owned
by ESK France that has been used to support the production of various industrial
ceramic products. We transferred production of these products to our German
subsidiary, ESK Ceramics GmbH & Co. KG (“ESK Ceramics”) in Kempten, Germany.
Affected employees were eligible for a severance package that included severance
pay, continuation of benefits and outplacement services. Pre-tax charges
relating to this corporate restructuring also included accelerated depreciation
of fixed assets and various other costs to close the plant.


ESK
Ceramics recorded pre-tax charges totaling $12.2 million in connection with the
Bazet restructuring and plant closure, which comprised $10.3 million for
severance, termination of contracts and other shutdown costs that was reported
as Restructuring - plant closure and severance in Operating Expenses and $1.9
million for accelerated depreciation of fixed assets that was reported in Cost
of Goods Sold in the year ended December 31, 2009. The severance charge was
recognized as a postemployment benefit as the Company’s obligation related to
employees' rights to receive compensation for future absences was attributable
to employees' services already rendered, the obligation relates to rights that
legally vest, payment of the compensation is probable, and the amount could be
reasonably estimated based on local statutory requirements. The Company also
incurred other severance costs in connection with headcount reductions in the
United States and Germany of $2.7 million during the year ended December 31,
2009.





Activities
in the restructuring charges accrual balances during the three months ended
March 31, 2010 were as follows (in thousands):





Balance at
              December
      31,
              2009
            
            
            Costs
              Incurred
            
            
            Cash
              Payments
            
            
            Non-Cash
              Adjustments
            
            
            Balance at
              March
      31,
              2010Severance,
      retention bonuses and other one-time termination benefits
            
            $
            5,525
            
            
            $
            7
            
            
            $
            (2,317
            )
            
            $
            (266
            )
            
            $
            2,949Termination
      of redundant supplier contracts
            
            
            110
            
            
            
            -
            
            
            
            (32
            )
            
            
            (32
            )
            
            
            46Legal
      fees and other shutdown costs
            
            
            608
            
            
            
            -
            
            
            
            (254
            )
            
            
            (26
            )
            
            
            328$
            6,243
            
            
            $
            7
            
            
            $
            (2,603
            )
            
            $
            (324
            )
            
            $
            3,323




15.
            Subsequent
      Events




Management
of the Company has assessed the impact of subsequent events and has concluded
that there were no such events that require adjustment to the Consolidated
Financial Statements or disclosure in the Notes to the ConsolidatedFinancial
Statements.




19


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, 2009, 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, automotive/diesel and commercial
applications. Our products include:







•
            lightweight
      ceramic armor and enhanced combat helmets 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;•
            ceramic
      missile radomes (nose cones) for the defense industry;•
            fused
      silica powders for precision investment casting (PIC) and ceramic
      crucibles;•
            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; and•
            ceramic
      bearings and bushings for oil drilling and fluid handling
      pumps.




Our
customers include the U.S. government, prime government contractors and large
industrial, automotive, diesel and commercial manufacturers in both domestic and
international markets.





The
tables below show, for each of our six segments, revenues and income before
provision for income taxes in the periods indicated.




Segment
revenues (in millions):


Three
      Months Ended
              March
      31,2010
            
            
            2009Advanced
      Ceramic Operations
            
            $
            51.8
            
            
            $
            56.3ESK
      Ceramics
            
            
            31.7
            
            
            
            23.6Semicon
      Associates
            
            
            2.2
            
            
            
            2.1Thermo
      Materials
            
            
            22.2
            
            
            
            16.2Ceradyne
      Canada
            
            
            0.3
            
            
            
            0.3Boron
            
            
            6.2
            
            
            
            6.0Inter-segment
      elimination
            
            
            (4.4
            )
            
            
            (4.7
            )Total
            
            $
            110.0
            
            
            $
            99.8




Segment
income (loss) before provision for taxes (in millions):


Advanced
      Ceramic Operations
            
            $
            2.1
            
            
            $
            4.3ESK
      Ceramics
            
            
            2.1
            
            
            
            (4.4
            )Semicon
      Associates
            
            
            0.2
            
            
            
            0.2Thermo
      Materials
            
            
            4.5
            
            
            
            3.6Ceradyne
      Canada
            
            
            (0.9
            )
            
            
            (0.8
            )Boron
            
            
            (1.3
            )
            
            
            (1.7
            )Inter-segment
      elimination
            
            
            (0.2
            )
            
            
            -Total
            
            $
            6.5
            
            
            $
            1.2




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


20





Three
      Months Ended March31,2010
            
            
            2009Sales
            
            
            %
            
            
            Sales
            
            
            %Defense
            
            $
            45.7
            
            
            
            41.6
            
            
            $
            52.3
            
            
            
            52.3Industrial
            
            
            52.0
            
            
            
            47.2
            
            
            
            39.0
            
            
            
            39.1Automotive/Diesel
            
            
            9.4
            
            
            
            8.6
            
            
            
            5.5
            
            
            
            5.5Commercial
            
            
            2.9
            
            
            
            2.6
            
            
            
            3.0
            
            
            
            3.1Total
            
            $
            110.0
            
            
            
            100.0
            %
            
            $
            99.8
            
            
            
            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 also increased from 2004 through 2007 because of 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 the recent expansion of our operations into
China. 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
October 2008, we were awarded an 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. To date, we have received one delivery order under
this ID/IQ contract in March 2009 for $76.8 million of XSAPI ceramic body armor
plates. This deliver order was increased to $81.4 million because of price
increases on products shipped during 2010. We have shipped
$60.3 million against this order through March 31, 2010, and expect to complete
delivery of the remaining $21.1 million under this order during the quarter
ending June 30, 2010.




21


Based on
informal discussions with U.S. Army personnel, we believe the U.S. Army has
decided that the current XSAPI weight from all suppliers, although in compliance
with the weight limitations specified in the ID/IQ contract, is too heavy for
use in the current military campaign in Afghanistan, and therefore the Army will
only purchase a contingency quantity of 120,000 sets, which will be issued to
the field if the ballistic threat that the XSAPI plate defeats becomes more
prevalent. Consequently, unless the U.S. Army changes its position, we do not
expect any additional orders for the current version of XSAPI ceramic body armor
plates.




We are
currently developing ESAPI and XSAPI designs that weigh 10% to 15% less than the
current designs and will offer these to the U.S. Army and other Department of
Defense users once these designs meet the current ballistic requirements. There
is no assurance that we will be successful with these lighter weight
designs.




We do
have qualified lightweight body armor inserts that are viable for the
Afghanistan campaign and these designs have been offered to the Army and the
Marines. These designs offer significant weight savings at a reduced level of
protection from the currently fielded ESAPI design. The Army and the Marines
have shown interest in these designs and we continue to pursue these
opportunities but there is no assurance that we will be successful.




We
believe there will continue to be a viable replacement business for body armor
inserts that is procured through the Defense Supply Center Philadelphia (DSCP)
and Ceradyne expects continued procurements for replacement inserts during 2010.
We will also continue to bid on Foreign Military Sales (FMS) for the first
generation of inserts called Small Arms Protective Inserts (SAPI) 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.





Our
ESK Ceramics subsidiary produces boron carbide powder, which serves as a
starter ceramic powder in the manufacture of our lightweight ceramic body armor.
The lower demand for body armor has negatively impacted inter-segment sales of
boron carbide powder by our ESK Ceramics subsidiary to our Advanced Ceramic
Operations division in the first three months of 2010 and we expect that this
trend will continue for the remainder of this year.





New
orders for the three months ended March 31, 2010 were $105.7 million, compared
to $150.7 million for the same period last year. Orders for ceramic body armor
for the three months ended March 31, 2010 were approximately $6.0 million,
compared to $94.9 for the same period last year.





Our order
backlog was $130.8 million as of March 31, 2010 and $177.2 million as
of  March 31, 2009. The backlog for ceramic body armor represented
approximately $25.6 million, or 19.6%, of the total backlog as of March 31, 2010
and $101.6 million, or 57.3%, of the total backlog as of March 31, 2009. We
expect that substantially all of our order backlog as of March 31, 2010 will be
shipped during 2010.




Based on
our current backlog and anticipated orders for ceramic body armor and the level
of sales to date in 2010, we expect our shipments of ceramic body armor to be
lower in fiscal year 2010 than in 2009. For the next several quarters, and
perhaps longer, demand for ceramic body armor is likely to be the most
significant factor affecting our sales. However, we believe that sales of our
industrial products will increase for the year ended Decmeber 31, 2010, and will
partially offset the decline in body armor sales.


Results of Operations for
the Three Months Ended March 31, 2010 and 2009




Net Sales. Our net sales
for the three months ended March 31, 2010 were $110.0 million, an increase of
$10.2 million, or 10.3%, from $99.8 million of net sales in the corresponding
quarter of the prior year.




22


Net sales
for our Advanced Ceramic Operations division for the three months ended March
31, 2010 were $51.8 million, a decrease of $4.5 million, or 7.9%, from $56.3
million of net sales in the corresponding quarter of the prior year. Net sales
of ceramic body armor in the first quarter of 2010 were $30.9 million, a
decrease of $15.4 million, or 33.2%, from $46.3 million in the first quarter of
2009. The primary reasons for the decline in shipments of ceramic body armor
were a reduction in shipments of SAPI armor plates of $15.4 million from $25.6
million during the first quarter of 2009 compared to only $10.2 million in the
first quarter of 2010, and a decline of $13.4 million in shipments of ceramic
body armor to the U.S. Army Special Forces from $13.7 million during the first
quarter of 2009 compared to only $300,000 in the first quarter of 2010.
Partially offsetting this decrease were $12.1 million in shipments of XSAPI
ceramic body armor during the first quarter of 2010, compared to no XSAPI
shipments in the first quarter of 2009. We received our first production order
for XSAPI plates on March 31, 2009 under the ID/IQ contract discussed above
under “Overview,” and commenced shipments during April 2009.




The
decline in body armor sales was somewhat offset by an increase in sales of
vehicle armor. Net vehicle armor sales for the three months ended March 31, 2010
were $8.3 million, an increase of $6.7 million, or 431.3%, from $1.6 million in
the corresponding period of the prior year. Increased shipments of armor for the
MRAP All Terrain Vehicle (M-ATV) and the High Mobility Multipurpose Wheeled
Vehicle(HMMWV or Humvee)during the three
months ended March 31, 2010 were the main reasons for this
improvement.




Net sales
for our automotive/diesel component product line for the three months ended
March 31, 2010 were $2.5 million, an increase of $0.5 million, or 28.1%, from
$2.0 million in the corresponding quarter of the prior year. The primary reason
for this improvement in sales was an increase in unit prices on shipments made
during the three months ended March 31, 2010. The recent events in the
automotive/diesel industry have not had a material impact on our results of
operations or liquidity.




Net sales
of our orthodontic brackets product line for the three months ended March 31,
2010 were $2.2 million, a decrease of $310,000, or 12.5%, from $2.5 million in
the corresponding quarter of the prior year. The decrease was due to lower
market acceptance for a newer version of Clarity®
orthodontic brackets and a build up of inventory at our sole customer of older
versions of other orthodontic brackets.




Our ESK
Ceramics subsidiary had net sales for the three months ended March 31, 2010 of
$31.7 million, an increase of $8.1 million, or 34.6%, from $23.6 million in the
corresponding quarter of the prior year. On a constant currency basis, sales for
the three months ended March 31, 2010 were $30.2 million, an increase of $6.6
million from the corresponding quarter of the prior year. Sales of industrial
products for the three months ended March 31, 2010 were $21.8 million, an
increase of $6.7 million, or 43.9%, from $15.2 million in the corresponding
quarter of the prior year. This increase was the result of a higher demand for
industrial parts for the packaging industry, an increase in shipments of
metallurgy parts, an increase in shipments of industrial wear parts and an
increase in shipments of boron nitride ceramic powders due to the recent
economic increase in the industrial sector of the economy compared to the severe
economic recession during the corresponding quarter last year. Sales of defense
products for the three months ended March 31, 2010 were $2.3 million, a decrease
of $2.0 million, or 46.5%, from $4.3 million in the corresponding quarter of the
prior year. Included in sales of defense products for the three months ended
March 31, 2010 were inter-segment sales of $2.1 million compared to $3.8 million
in the prior year. The decrease of $1.7 million in inter-segment sales was due
to a reduction 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 three months ended March 31, 2010 were $6.9
million, an increase of $3.4 million, or 94.6%, from $3.5 million in the
corresponding quarter of the prior year. Increased demand from automotive
original equipment manufacturers accounted for the increase in
sales.




Our
Semicon Associates division had net sales for the three months ended March 31,
2010 of $2.3 million, an increase of $183,000, or 8.8%, from $2.1 million in the
corresponding quarter of the prior year. This improvement in sales reflects
higher shipments of microwave cathodes to the defense industry.




Our
Thermo Materials division had net sales for the three months ended March 31,
2010 of $22.2 million, an increase of $6.0 million, or 36.8%, from $16.2 million
in the corresponding quarter of the prior year. The increase was due to higher
shipments of crucibles to the solar energy market, increased sales of precision
investment cast products and refractory products due to the improvement in the
industrial sector of the economy compared to the severe recession during the
corresponding quarter last year. Sales of crucibles used in the manufacture of
photovoltaic cells for the three months ended March 31, 2010 were $12.8 million,
an increase of $3.9 million, or 43.5%, from $8.9 million in the corresponding
period a year ago. The increase was due to continued increasing demand in the
solar energy market. Sales to the defense industry for the three months ended
March 31, 2010 were $2.1 million, an increase of $254,000, or 13.4%, from $1.9
million when compared to the corresponding prior year period.


Our
Ceradyne Canada subsidiary had net sales for the three months ended March 31,
2010 of $333,000, an increase of $20,000, or 6.4%, from $313,000 in the
corresponding quarter of the prior year, as sales of metal matrix composites
increased, which offset a decline in sales of our Boral®
product line.




Our Boron
business segment comprises SemEquip, Inc. and Ceradyne Boron Products. Total net
sales of our Boron business segment for the three months ended March 31, 2010
were $6.2 million, an increase of $137,000, or 2.3%, from $6.0 million compared
to the corresponding quarter of the prior year. Almost all of the sales in the
three month period ended March 31, 2010 were from Ceradyne Boron Products, which
had net sales of $6.0 million, an increase of $118,000, or 2.0%, from $5.9
million in the three months ended March 31, 2009. The sales contribution from
SemEquip is not expected to be significant in 2010.




23


Gross Profit. Our gross
profit for the three months ended March 31, 2010 was $25.4 million, an increase
of $1.8 million, or 7.5%, from $23.6 million in the corresponding prior year
quarter. As a percentage of net sales, gross margin was 23.1% for the three
months ended March 31, 2010 compared to 23.6% for the corresponding prior year
quarter. The increase in gross profit was primarily the result of an increase in
gross profit from higher sales of ceramic crucibles by our Thermo Materials
business segment and an increase in gross profit from sales of automotive and
industrial parts and ceramics powders by our ESK Ceramics business segment these
increases were partially offset by lower body armor shipments at our Advanced
Ceramic Operations division and an increase in scrap expenses in the production
of body armor.  Also contributing to the increase in gross profits
were increases in production volumes at our Thermo and ESK segments which
resulted in a decrease of unabsorbed manufacturing overhead expenses compared to
the corresponding period last year. The cost of electricity, which is critical
in the manufacturing process to produce advanced technical ceramics, has been
stable.




Our
Advanced Ceramic Operations division posted gross profit for the three months
ended March 31, 2010 of $9.4 million, a decrease of $4.2 million, or 31.3%, from
$13.6 million in the corresponding prior year quarter. As a percentage of net
sales, gross margin was 18.1% for the three months ended March 31, 2010, which
decreased from 24.2% as a percentage of net sales in the corresponding prior
year quarter. The primary reasons for the decrease in gross profit were lower
volumes of production of body armor products resulting in an increase of
unabsorbed body armor manufacturing overhead expenses and higher scrap rates
incurred in the production of body armor.




Our
ESK Ceramics subsidiary had gross profit for the three months ended March
31, 2010 of $7.4 million, an increase of $4.0 million, or 119.7%, from $3.4
million in the corresponding prior year quarter. As a percentage of net sales,
gross margin was 23.3% for the three months ended March 31, 2010, compared to
14.3% for the three months ended March 31, 2009. The increase in gross margin as
a percentage of net sales for the three months ended March 31, 2010 was the
result of increasing sales in our industrial and automotive sectors due to an
increase in demand for our products as a result of recent economic growth
compared to the corresponding period last year, the closing of our costly
production facility in Bazet, France, during 2009 and a decrease in unabsorbed
manufacturing overhead expenses caused by higher production
volumes.




Our
Semicon Associates division had gross profit for the three months ended March
31, 2010 of $0.6 million, which was unchanged, compared to the corresponding
quarter of the prior year. As a percentage of net sales, gross margin was 27.8%
for the three months ended March 31, 2010, compared to 26.6% for the
corresponding prior year period. During the three month period ended March 31,
2010, increased sales of higher margin parts from our microwave cathode product
line compared to the corresponding prior year period, contributed to the
increase in gross margin as a percentage of net sales.




Our
Thermo Materials division had gross profit for the three months ended March 31,
2010 of $7.8 million, an increase of $2.0 million, or 33.8%, from $5.8 million
in the corresponding prior year quarter. As a percentage of net sales, gross
margin was 35.3% for the three months ended March 31, 2010 compared to 36.0% for
the corresponding prior year quarter. The increase in gross profit was caused by
the increase in sales of crucibles.




Our
Ceradyne Canada subsidiary had negative gross profit for the three months ended
March 31, 2010 of $0.6 million, an increase of $146,000 from a negative gross
profit of $428,000 in the corresponding quarter of the prior year. For the three
months ended March 31, 2010, gross profit decreased due to an increase of
unabsorbed manufacturing overhead expenses and increases in scrap expenses in
connection with the production of metal matrix composites.





Our Boron
business segment comprises SemEquip, Inc. and Ceradyne Boron Products. This
segment had gross profit for the three months ended March 31, 2010 of $0.9
million, an increase of $268,000, or 41.9%, from $0.6 million in the
corresponding quarter of the prior year. SemEquip, Inc. reduced their negative
gross profit during the three months to $434,000 from $1.0 million in the
corresponding quarter of the prior year due to an expense and work force
reduction program. Ceradyne Boron Products had gross profit for the three months
ended March 31, 2010 of $1.3 million, a decrease of $273,000, or 16.9%, from
$1.6 million in the corresponding period of the prior year. The reduced profit
was caused by an increase in expenses and idle time due to the planned shut down
of their production towers due to a maintenance, refurbishment and upgrade
program.




Selling Expenses. Our
selling expenses for the three months ended March 31, 2010 were $5.9 million, a
decrease of $1.0 million, or 15.2%, from $6.9 million in the corresponding prior
year quarter. Selling expenses, as a percentage of net sales, decreased from
6.9% for the three months ended March 31, 2009 to 5.3% of net sales for the
three months ended March 31, 2010. The primary reason for the decrease in
selling expenses for the three month period ended March 31, 2010 was a reduction
in the number of sales employees and related personnel expenses.




24


General and Administrative
Expenses. Our general and administrative expenses for the three
months ended March 31, 2010 were $8.0 million, a decrease of $1.7 million, or
17.3%, from $9.7 million in the corresponding prior year quarter. General and
administrative expenses, as a percentage of net sales, decreased from 9.7% for
the three months ended March 31, 2009 to 7.3% for the three months ended March
31, 2010. Decreases in general and administrative expenses were generated by
reductions in headcount and by a reduction in professional service fees for the
three months ended March 31, 2010 compared to the corresponding prior year
period.




Restructuring
–  Severance. We recorded pre-tax severance charges of $0.9
million for the three months ended March 31, 2009 and incur only $7,000
of charges during the three month period ended March 31, 2010.


Acquisition Related Charge
(Credit). We incurred an acquisition-related compensation charge of $9.8
million for the three months ended September 30, 2008 associated with a
pre-closing commitment by SemEquip, Inc. for incentive compensation for several
of its employees and advisors. This $9.8 million charge included $1.7 million of
cash paid by Ceradyne at closing, and the balance represents the discounted
present value of the portion of the estimated contingent consideration payable
as incentive compensation to these employees and advisors over 15 years. During
the third quarter of 2009, we revised the estimated future sales and earnings of
SemEquip, which caused a $0.8 million reduction in this acquisition liability
and a credit to pre-tax earnings for the three and nine months ended September
30, 2009. During the first quarter of 2010, we again revised the estimated
future sales and earnings of SemEquip, which caused an $88,000 reduction in this
acquisition liability and a corresponding credit to pre-tax earnings for the
three months ended March 31, 2010.




Research and Development
Expenses. Our research and development expenses for the three months
ended March 31, 2010 were $2.9 million, a decrease of $434,000, or 12.8%, from
$3.4 million in the corresponding prior year quarter. Research and development
expenses, as a percentage of net sales, decreased from 3.4% of net sales for the
three months ended March 31, 2009 to 2.7% of net sales for the three months
ended March 31, 2010.




Other Income
(Expense). Our net other income (expense) for the three months ended
March 31, 2010 was $2.1 million of expense, an increase of $0.6 million, from
$1.5 million of expenses in the corresponding prior year quarter. The primary
reason for this change was a $1.9 million charge in the current quarter for an
other-than-temporary impairment charge from our investments in auction rate
securities. Offsetting this charge, was a $0.5 million reduction in interest
expense due to a lower outstanding amount of our convertible bond from $121.0
million in the first quarter of 2009 compared to the present stated outstanding
amount of $93.1 million, $0.5 million of gains from foreign currency
transactions, and an increase in interest income of $171,000 due to higher cash
balances during the three month period ended March 31, 2010 compared to the
corresponding period last year.




Income before Provision for Income
Taxes. Our income before provision for income taxes for the three
months ended March 31, 2010 was $6.5 million, an increase of $5.3 million, or
454.0%, from $1.2 million of income before provision for income taxes in the
corresponding prior year quarter.




The
primary reasons for the increase in the income before provision for income taxes
for the three months ended March 31, 2010 were increases in sales of
ceramic crucibles to the solar industry, increase in sales of vehicle armor, an
increase of sales of industrial and automotive products at our ESK Ceramics
business segment, a reduction in unabsorbed manufacturing overhead due to higher
production volumes mainly at the ESK Ceramics and Thermo Materials business
segments and the favorable comparison to the first quarter in 2009 when we
incurred $0.9 in severance expenses which we did not incur during the three
months ended March 31, 2010.


Our
Advanced Ceramic Operations division’s income before provision for income taxes
for the three months ended March 31, 2010 was $2.1 million, a decrease of $2.1
million, or 51.5%, from $4.2 million of income before provision for income taxes
in the corresponding prior year quarter. The decrease in income before provision
for income taxes for the three month period ended March 31, 2010 was due to
substantially lower sales of body armor, underabsorbed manufacturing overhead
expenses because of lower volumes of production of body armor and higher scrap
rates incurred in the production of body armor.




Our
ESK Ceramics subsidiary’s income before provision for income taxes for the
three months ended March 31, 2010 was $2.1 million, an increase of $6.5 million,
from a loss before provision for income taxes of $4.4 million in the
corresponding prior year quarter. For the three months ended March 31, 2010, the
primary causes of the increase in income before provision for income taxes were
increased sales in this subsidiary’s industrial and automotive sectors due to an
increase in demand as a result of recent economic growth compared to the
corresponding period last year, the closing our costly production facility in
Bazet, France during 2009, and a decrease in unabsorbed manufacturing overhead
expenses caused by higher production volumes.




25


Our
Semicon Associates division’s income before provision for income taxes for the
three months ended March 31, 2010 was $214,000, a decrease of $20,000, or 8.5%,
from $234,000 of income before provision for income taxes in the corresponding
prior year quarter. The decrease in income before provision for income taxes for
the three months ended March 31, 2010 was primarily caused by a loss on the bulk
sale of inventory for our magnet product line which we will be
exiting.




Our
Thermo Materials division’s income before provision for income taxes for the
three months ended March 31, 2010 was $4.5 million, an increase of $0.9 million,
or 23.3%, from $3.6 million of income before provision for income taxes in the
corresponding prior year quarter. The increase in income before provision for
income taxes was due to higher shipments of crucibles when compared to the
corresponding prior year period, and an increase in sales of refractory and
industrial products due to improved overall economic conditions whem compared to
the corresponding prior year period.




Our
Ceradyne Canada subsidiary incurred a loss before provision for income taxes for
the three months ended March 31, 2010 of $0.9 million, an increase of $117,000,
or 15.2%, from a loss before provision for income taxes of $0.8 million in the
corresponding prior year quarter. The increase in the loss before provision for
income taxes was due to an increase of unabsorbed manufacturing overhead
expenses and increases in scrap expenses in connection with the production of
metal matrix composites.




Our Boron
business segment’s loss before provision for income taxes for the three months
ended March 31, 2010 was $1.2 million, a decrease of $0.6 million, or 30.4%,
from a loss before provision for income taxes of $1.8 million in the
corresponding prior year quarter. The improvement in the performance of this
segment was attributable to the decrease in the loss before provision for income
taxes at SemEquip, Inc. of $0.8 million because of an expense reduction program
and a reduction in work force. This was offset by a reduction in income before
provision for income taxes at Ceradyne Boron Products for the three months ended
March 31, 2010, of $253,000 due to expenses and idle time incurred due to the
planned shut down of their production towers due to a maintenance, refurbishment
and upgrade program.




Income Taxes. We had a
combined federal and state tax rate of 23.5% for the three months ended March
31, 2010 resulting in a provision for income taxes of $1.5 million, an increase
of $1.0 million, or 226.4%, from $469,000 provision for income taxes in the
corresponding prior year quarter.Our effective tax rate
was 39.8% for the three months ended March 31, 2009. The lower effective tax
rate in the three month period ended March 31, 2010, when compared to the same
periods last year, resulted from a higher proportion of our expected full year
pre-tax income originating from our operations in China where we have a lower
tax rate than in 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 table presents selected financial information and statistics as
of  March 31, 2010 and December 31, 2009 and for the three months
ended March 31, 2010 and 2009 (in thousands):





March
      31, 2010
            
            
            December
      31, 2009Cash and cash
      equivalents
            
            $
            133,767
            
            
            $
            122,154Short
      term investments
            
            
            118,277
            
            
            
            117,666Accounts
      receivable, net
            
            
            59,552
            
            
            
            53,269Inventories,
      net
            
            
            89,517
            
            
            
            100,976Working
      capital
            
            
            413,611
            
            
            
            406,207For
      the Three Months EndedMarch
      31, 2010
            
            
            March
      31, 2009Quarterly
      operating cash flow
            
            $
            16,314
            
            
            $
            18,578




During
the three months ended March 31, 2010, we generated $16.3 million of cash from
operations compared to $18.6 million for the three months ended March 31, 2009.
The $16.3 million of cash flow from operations during 2010 is primarily
comprised of net income totaling $5.0 million, with $13.1 million of non cash
charges included therein. We invested $6.9 million to expand manufacturing
capacity in selected product lines. In an effort to increase yield, as of March
31, 2010 we eliminated the restrictions on $3.1 million of cash. As a result,
our net cash at March 31, 2010 increased by $11.6 million as compared to a $14.1
million decrease during the three months ended March 31, 2009.




26


Investing
activities consumed $3.8 million of cash during the three months ended March 31,
2010. We invested $0.3 million for the purchase of marketable securities as we
extended the maturities of our investments in an attempt to increase our return.
We also spent $6.9 million for the purchase of property, plant and equipment.
These expenditures for investing activities were partially offset by an increase
of $3.1 million due to the release of the restrictions on certain
cash.




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 reducing the outstanding balance of the Notes
to $93.1 million.


As of
March 31, 2010 and December 31, 2009, 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):





March
      31, 2010
            
            
            December
      31, 2009Long-term
      debtPrincipal
      amount
            
            $
            93,100
            
            
            $
            93,100Unamortized
      discount
            
            
            (10,110
            )
            
            
            (10,937
            )Net
      carrying amount
            
            $
            82,990
            
            
            $
            82,163Equity
      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 for the three months ended March 31, 2010 includes
non-cash interest expense from amortization of the discount on the liability
component of $0.8 million and amortization of debt issuance costs of $89,000.
Interest expense for the three months ended March 31, 2009 includes non-cash
interest expense from amortization of the discount on the liability component of
$1.0 million and amortization of debt issuance costs of $111,000. The amount of
interest expense recognized relating to both the contractual interest coupon and
the amortization of the discount on the liability component was $1.5 million and
$1.9 million for the three months ended March 31, 2010 and 2009,
respectively.


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




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




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




We are
obligated to pay contingent interest to the holders of the notes during any
six-month period from June 15 to December 14 and from December 15
to June 14, commencing with the six-month period beginning
December 20, 2010 and ending on June 14, 2011, if the average trading
price of the note for the five trading day period ending on the third trading
day immediately preceding the first day of the relevant contingent interest
period equals $1,200 (120% of the principal amount of a note) or more. The
amount of contingent interest payable per note for any relevant contingent
interest period shall equal 0.25% per annum of the average trading price of
a note for the five trading day period ending on the third trading day
immediately preceding the first day of the relevant contingent interest period.
This contingent interest payment feature represents an embedded derivative.
However, based on the de minimus value associated with this feature, no value
has been assigned at issuance and at March 31, 2010.





27


In
December 2005, we established an unsecured $10.0 million line of credit. As of
March 31, 2010, there were no outstanding amounts on the line of credit.
However, the available line of credit at March 31, 2010 has been reduced by
outstanding letters of credit in the amount of $4.9 million. The interest rate
on the credit line is based on the LIBOR rate for a period of one month, plus a
margin of 1.0%, which equaled 1.25% as of March 31, 2010.





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 March 31, 2010, we were in
compliance with these covenants.




Our cash,
cash equivalents, restricted cash and short-term investments totaled $252.0
million at March 31, 2010, compared to $243.0 million at December 31, 2009.
At March 31, 2010, we had working capital of $413.6 million, compared to $406.2
million at December 31, 2009. Our cash position includes amounts
denominated in foreign currencies. The repatriation of cash balances from our
ESK Ceramics subsidiary does not result in additional tax costs. 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 expansion of our manufacturing facilities in China. The total expected
capital expenditures for the new facility in China is approximately $34.0
million. The cumulative amount spent as of March 31, 2010 was $4.7 million, of
which $2.4 million was spent during the three months ended March 31, 2010. We
anticipate spending an additional $27.6 million during the remainder of fiscal
year 2010 and $1.7 million in fiscal year 2011 to complete this capital
expenditure. Funding for the new facility in China is being provided by cash
flow generated from sales of ceramic crucibles in China, any remaining funding
requirement will be supported by available cash in the U.S. 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 March 31, 2010 include a
$1.7 million reserve for unrecognized tax benefits. The reserve is classified as
long term liabilities on our Consolidated Balance Sheet as of March 31,
2010.


28




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 March 31, 2010 included $19.6 million of auction rate
securities. Cumulatively to date, the Company has incurred $12.8 million in
pre-tax losses from its investments in auction rate securities, a realized loss
of $2.3 million from the sale of auction rate securites in 2009 and pre-tax
temporary impairment charges against other comprehensive income of
$1.0 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
and through March 31, 2010, 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 March 31, 2010,
the fair value of the Company’s investments in auction rate securities was below
cost by approximately $13.8 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 March 31, 2010, 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 March 31, 2010 and December 31, 2009.


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 0.5% to 5.0%, 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.


29


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.


We enter
into foreign exchange forward contracts to reduce earnings and cash flow
volatility associated with foreign exchange rate changes to allow our management
team to focus its attention on its core business operations. Accordingly, we
enter into contracts which change in value as foreign exchange rates change to
economically offset the effect of changes in value of foreign currency assets
and liabilities, commitments and anticipated foreign currency denominated sales
and operating expenses. We enter into foreign exchange forward contracts in
amounts between minimum and maximum anticipated foreign exchange exposures,
generally for periods not to exceed one year. These derivative instruments are
not designated as accounting hedges. We did not have any outstanding foreign
exchange forward contracts at March 31, 2010.




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 $89.4 million and
is based on quoted market prices at March 31, 2010.




Approximately
42.8% of our revenues for the three months ended March 31, 2010 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 March 31, 2010 (the end of the period covered by this report).
Based on this evaluation, our principal executive officer and principal
financial officer concluded that our current disclosure controls and procedures
(as defined in Rules 13a-15(e) and Rule 15d-15(e) under the Securities Exchange
Act of 1934) are effective.




Changes in Internal Control
over Financial Reporting


Our
management evaluated our internal control over financial reporting and there
have been no changes during the fiscal quarter ended March 31, 2010 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.


30




PART
      II. OTHER INFORMATION






Item 1.
            Legal
      Proceedings




A class
action lawsuit was filed on March 23, 2007, in the California Superior
Court for Orange County, in which it was asserted that the
representative plaintiff, a former Ceradyne employee, and the putative
class members, were not paid overtime at an appropriate overtime rate. The
complaint alleges that the purportedly affected employees should have had their
regular rate of pay for purposes of calculating overtime adjusted to reflect the
payment of a bonus to them for the four years preceding the filing of the
complaint, up to the present time. The complaint further alleges that a waiting
time penalty should be assessed for the failure to timely pay the correct
overtime payment. Ceradyne filed an answer denying the material allegations
of the complaint. The motion for class certification was heard on November 13,
2008 and class certification was granted. On January 6, 2009, the court entered
an order certifying the class. Ceradyne contends that the lawsuit is
without merit on the basis that the bonuses that have been paid are
discretionary and not of the type that are subject to inclusion in the regular
hourly rate for purposes of calculating overtime. After a request for review by
the Court of Appeal of the decision to grant class certification, a day-long
mediation before a third-party neutral mediator, and an evaluation of the cost
of litigation and the financial exposure in the case, Ceradyne agreed to provide
a settlement fund of $1.25 million to resolve all issues in the litigation. The
settlement specifically states that neither party is admitting to liability or
lack thereof. Ceradyne believed that based upon the cost of further defense and
the exposure in the case, it was best to settle the matter. The Court has
granted final approval of the settlement. A third party administrator
contacted class members concerning their respective recovery and their rights to
opt-out. The final settlement payment amount of approximately $1.3 million was
paid in full during the first quarter ended March 31, 2010 and included
approximately $50,000 of payroll taxes. Settlement checks have been distributed
to the class members by the third party administrator. Any checks that are not
cashed or that are returned to the administrator within 60 days from the date of
the check will revert back to Ceradyne.





During
the quarter ended March 31, 2010, Ceradyne reached an agreement in
principle to settle a claim for $1.2 million pertaining to ballistic tests
of armored wing assemblies subject to the negotiation and execution of a
mutually acceptable settlement agreement and release. Ceradyne previously
established a reserve of $1.0 million for this matter during the three months
ended September 30, 2009 and increased it by $200,000, with a corresponding
charge to general and administrative expenses, during the three months ended
March 31, 2010. The tentative settlement expires on June 22, 2010. Ceradyne
believes that a final settlement agreement will be signed prior to the
expiration date of the tentative settlement agreement.




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, 2009.




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


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 did not set a time limit for completion of this repurchase
program, and we may suspend or terminate it at any time. We did not repurchase
any shares of our common stock during the quarter ended March 31, 2010. As of
March 31, 2010, we have $45.5 million remaining under this
authorization.




Item 3.
            Defaults Upon Senior
      Securities











Item 4.
            Other
      Information




Not
applicable.




Item 5.
            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.


31


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: April
      27, 2010
            
            By:
            /s/
      JERROLD J. PELLIZZONJerrold
      J. PellizzonVice
      President
              Chief
      Financial Officer
              (Principal
      Financial and Accounting Officer)





32


Index to
Exhibits





Exhibit
            Description31.1
            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.














33