##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-Q



---



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

For the quarterly period ended September 30, 2006

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



---

CERADYNE, INC.

(Exact name of Registrant as specified in its charter)



---



|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 33-0055414                         
|(State or other jurisdictionof incorporation or organization) |  | (I.R.S. EmployerIdentification 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 is a large
accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ̈Accelerated filer  x                Non-accelerated filer ̈

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

Yes ̈No  x

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



|                             |  |                                   
|---------------------------- |  | ----------------------------------
|Class                        |  | Outstanding as of October 25, 2006
|Common Stock, $.01 par value |  | 27,001,622 Shares                 

Exhibit Index on Page 29



---



---

##### Table of Contents

CERADYNE, INC.

INDEX



|          |  |                                                                                                       |  |         
|--------- |  | ----------------------------------------------------------------------------------------------------- |  | --------
|          |  |                                                                                                       |  | PAGE NO.
|PART I.   |  | FINANCIAL INFORMATION                                                                                 |  |         
|          |  |                                                                                                      
|Item 1.   |  | Unaudited Condensed Consolidated Financial Statements                                                 |  | 3       
|          |  |                                                                                                      
|          |  | Condensed Consolidated Balance Sheets  September 30, 2006 and December 31, 2005                      |  | 3-4     
|          |  |                                                                                                      
|          |  | Condensed Consolidated Statements of Income  Three and Nine months Ended September 30, 2006 and 2005 |  | 5       
|          |  |                                                                                                      
|          |  | Condensed Consolidated Statements of Cash Flows  Nine months Ended September 30, 2006 and 2005       |  | 6       
|          |  |                                                                                                      
|          |  | Condensed Notes to Consolidated Financial Statements                                                  |  | 7-18    
|          |  |                                                                                                      
|Item 2.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                 |  | 19-26   
|          |  |                                                                                                      
|Item 3.   |  | Quantitative and Qualitative Disclosures About Market Risk                                            |  | 26      
|          |  |                                                                                                      
|Item 4.   |  | Controls and Procedures                                                                               |  | 27      
|          |  |                                                                                                      
|PART II.  |  | OTHER INFORMATION                                                                                     |  |         
|          |  |                                                                                                      
|Item 1.   |  | Legal Proceedings                                                                                     |  | 27      
|          |  |                                                                                                      
|Item 1A.  |  | Risk Factors                                                                                          |  | 28      
|          |  |                                                                                                      
|Item 2.   |  | Not applicable                                                                                        |  | 28      
|          |  |                                                                                                      
|Item 3.   |  | Not applicable                                                                                        |  | 28      
|          |  |                                                                                                      
|Item 4.   |  | Not applicable                                                                                        |  | 28      
|          |  |                                                                                                      
|Item 5.   |  | Not applicable                                                                                        |  | 28      
|          |  |                                                                                                      
|Item 6.   |  | Exhibits                                                                                              |  | 28      
|          | 
|SIGNATURE |  | 29                                                                                                   



2



---

##### Table of Contents

CERADYNE, INC.

FORM 10-Q

FOR THE QUARTER ENDED

SEPTEMBER 30, 2006

PART I. FINANCIAL INFORMATION



|Item 1. | Unaudited Condensed Consolidated Financial Statements
|------- | -----------------------------------------------------

CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS

ASSETS

(Amounts in thousands)



|                                                                                                                                                        |  |                   |         |                  |   |        
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ---------------- | - | -------
|                                                                                                                                                        |  | September 30,2006 |         | December 31,2005
|                                                                                                                                                        |  | (Unaudited)      
|CURRENT ASSETS                                                                                                                                          |  |                   |         |                  |   |        
|Cash and cash equivalents                                                                                                                               |  | $                 | 59,983  |                  | $ | 91,542 
|Short-term investments                                                                                                                                  |  |                   | 115,524 |                  |   | 7,839  
|Accounts receivable, net of allowances for doubtful accounts of approximately $1,071 and $545 at September 30, 2006 and December 31,
2005, respectively |  |                   | 68,062  |                  |   | 57,174 
|Other receivables                                                                                                                                       |  |                   | 3,078   |                  |   | 3,309  
|Inventories, net                                                                                                                                        |  |                   | 72,662  |                  |   | 66,318 
|Production tooling, net                                                                                                                                 |  |                   | 22,005  |                  |   | 14,102 
|Prepaid expenses and other                                                                                                                              |  |                   | 10,702  |                  |   | 8,592  
|Deferred tax asset                                                                                                                                      |  |                   | 7,040   |                  |   | 6,341  
|                                                                                                                                                        |  |                   |         |                  |   |        
|TOTAL CURRENT ASSETS                                                                                                                                    |  |                   | 359,056 |                  |   | 255,217
|                                                                                                                                                        |  |                   |         |                  |   |        
|PROPERTY, PLANT & EQUIPMENT, net                                                                                                                        |  |                   | 175,291 |                  |   | 153,259
|INTANGIBLE ASSETS, net                                                                                                                                  |  |                   | 12,032  |                  |   | 6,034  
|GOODWILL                                                                                                                                                |  |                   | 9,678   |                  |   | 9,265  
|OTHER ASSETS                                                                                                                                            |  |                   | 5,813   |                  |   | 6,418  
|                                                                                                                                                        |  |                   |         |                  |   |        
|TOTAL ASSETS                                                                                                                                            |  | $                 | 561,870 |                  | $ | 430,193
|                                                                                                                                                        |  |                   |         |                  |   |        

See accompanying condensed notes to Consolidated Financial Statements



3



---

##### Table of Contents

CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS EQUITY

(Amounts in thousands, except share
data)



|                                                                                                                                                                        |  |                   |         |                  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | ---------------- | - | ------- | -
|                                                                                                                                                                        |  | September 30,2006 |         | December 31,2005 |  
|                                                                                                                                                                        |  | (Unaudited)       |        
|CURRENT LIABILITIES                                                                                                                                                     |  |                   |         |                  |   |         |  
|Accounts payable                                                                                                                                                        |  | $                 | 30,728  |                  | $ | 23,311  |  
|Accrued expenses                                                                                                                                                        |  |                   | 28,743  |                  |   | 11,878  |  
|Income taxes payable                                                                                                                                                    |  |                   | 5,623   |                  |   | 7,719   |  
|                                                                                                                                                                        |  |                   |         |                  |   |         |  
|TOTAL CURRENT LIABILITIES                                                                                                                                               |  |                   | 65,094  |                  |   | 42,908  |  
|LONG-TERM DEBT                                                                                                                                                          |  |                   | 121,000 |                  |   | 121,000 |  
|EMPLOYEE BENEFITS                                                                                                                                                       |  |                   | 12,921  |                  |   | 11,229  |  
|DEFERRED TAX LIABILITY                                                                                                                                                  |  |                   | 5,206   |                  |   | 4,536   |  
|                                                                                                                                                                        |  |                   |         |                  |   |         |  
|TOTAL LIABILITIES                                                                                                                                                       |  |                   | 204,221 |                  |   | 179,673 |  
|COMMITMENTS AND CONTINGENCIES                                                                                                                                           |  |                   |         |                  |   |         |  
|SHAREHOLDERS EQUITY                                                                                                                                                    |  |                   |         |                  |   |         |  
|Common stock, $.01 par value, 100,000,000 authorized, 27,001,622 and 26,795,774 shares issued and outstanding at September 30, 2006 and
December 31, 2005, respectively |  |                   | 294     |                  |   | 292     |  
|Additional paid in capital                                                                                                                                              |  |                   | 175,094 |                  |   | 170,430 |  
|Retained earnings                                                                                                                                                       |  |                   | 179,296 |                  |   | 88,632  |  
|Deferred compensation                                                                                                                                                   |  |                   |        |                  |   | (1,506  | )
|Accumulated other comprehensive loss                                                                                                                                    |  |                   | 2,965   |                  |   | (7,328  | )
|                                                                                                                                                                        |  |                   |         |                  |   |         |  
|TOTAL SHAREHOLDERS EQUITY                                                                                                                                              |  |                   | 357,649 |                  |   | 250,520 |  
|                                                                                                                                                                        |  |                   |         |                  |   |         |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                              |  | $                 | 561,870 |                  | $ | 430,193 |  
|                                                                                                                                                                        |  |                   |         |                  |   |         |  

See accompanying condensed notes to Consolidated Financial Statements



4



---

##### Table of Contents

CERADYNE, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share data)



|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|---------------------------------------- |  | ------------------------------ | ------- | - | ----------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                         |  | Three MonthsEndedSeptember 30, |         |   | Nine MonthsEndedSeptember 30, |  
|                                         |  | 2006                           |         |   | 2005                          |   |        | 2006 |  |   | 2005    |  
|                                         |  | (Unaudited)                    |         |   | (Unaudited)                   |  
|NET SALES                                |  | $                              | 185,796 |   |                               | $ | 94,406 |      |  | $ | 484,159 |   |  | $ | 254,100 |  
|COST OF PRODUCT SALES                    |  |                                | 115,265 |   |                               |   | 59,576 |      |  |   | 295,962 |   |  |   | 164,823 |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|Gross profit                             |  |                                | 70,531  |   |                               |   | 34,830 |      |  |   | 188,197 |   |  |   | 89,277  |  
|OPERATING EXPENSES                       |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|Selling                                  |  |                                | 5,678   |   |                               |   | 5,015  |      |  |   | 17,368  |   |  |   | 15,309  |  
|General and administrative               |  |                                | 8,744   |   |                               |   | 5,442  |      |  |   | 26,117  |   |  |   | 15,179  |  
|Research and development                 |  |                                | 2,532   |   |                               |   | 2,037  |      |  |   | 7,731   |   |  |   | 5,641   |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|                                         |  |                                | 16,954  |   |                               |   | 12,494 |      |  |   | 51,216  |   |  |   | 36,129  |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|Income from operations                   |  |                                | 53,577  |   |                               |   | 22,336 |      |  |   | 136,981 |   |  |   | 53,148  |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|OTHER INCOME (EXPENSE):                  |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|Royalty income                           |  |                                | 30      |   |                               |   | 32     |      |  |   | 90      |   |  |   | 92      |  
|Interest income                          |  |                                | 1,753   |   |                               |   | 93     |      |  |   | 4,355   |   |  |   | 265     |  
|Interest expense                         |  |                                | (1,023  | ) |                               |   | (1,872 | )    |  |   | (3,081  | ) |  |   | (4,987  | )
|Miscellaneous                            |  |                                | (257    | ) |                               |   | 4      |      |  |   | (377    | ) |  |   | 171     |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|                                         |  |                                | 503     |   |                               |   | (1,743 | )    |  |   | 987     |   |  |   | (4,459  | )
|Income before provision for income taxes |  |                                | 54,080  |   |                               |   | 20,593 |      |  |   | 137,968 |   |  |   | 48,689  |  
|PROVISION FOR INCOME TAXES               |  |                                | 17,158  |   |                               |   | 7,254  |      |  |   | 47,304  |   |  |   | 17,965  |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|NET INCOME                               |  | $                              | 36,922  |   |                               | $ | 13,339 |      |  | $ | 90,664  |   |  | $ | 30,724  |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|BASIC INCOME PER SHARE                   |  | $                              | 1.37    |   |                               | $ | 0.54   |      |  | $ | 3.37    |   |  | $ | 1.25    |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|DILUTED INCOME PER SHARE                 |  | $                              | 1.34    |   |                               | $ | 0.53   |      |  | $ | 3.31    |   |  | $ | 1.23    |  
|                                         |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|WEIGHTED AVERAGE SHARES OUTSTANDING:     |  |                                |         |   |                               |   |        |      |  |   |         |   |  |   |         |  
|BASIC                                    |  |                                | 27,000  |   |                               |   | 24,586 |      |  |   | 26,887  |   |  |   | 24,530  |  
|DILUTED                                  |  |                                | 27,461  |   |                               |   | 25,092 |      |  |   | 27,372  |   |  |   | 25,006  |  

See accompanying condensed notes to Consolidated Financial Statements



5



---

##### Table of Contents

CERADYNE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)



|                                                                                      |  |                                |          |   |      |   |         |  
|------------------------------------------------------------------------------------- |  | ------------------------------ | -------- | - | ---- | - | ------- | -
|                                                                                      |  | NINE MONTHSENDED September 30, |         
|                                                                                      |  | 2006                           |          |   | 2005 |  
|                                                                                      |  | (Unaudited)                    |         
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                 |  |                                |          |   |      |   |         |  
|Net income                                                                            |  | $                              | 90,664   |   |      | $ | 30,724  |  
|ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES:     |  |                                |          |   |      |   |         |  
|Depreciation and amortization                                                         |  |                                | 13,165   |   |      |   | 11,143  |  
|Deferred income taxes                                                                 |  |                                | 135      |   |      |   | 2,328   |  
|Stock compensation                                                                    |  |                                | 3,346    |   |      |   | 239     |  
|Loss on equipment disposal                                                            |  |                                | 158      |   |      |   |        |  
|Change in operating assets and liabilities, net of acquisitions:                      |  |                                |          |   |      |   |         |  
|Accounts receivable, net                                                              |  |                                | (8,742   | ) |      |   | 1,564   |  
|Other receivables                                                                     |  |                                | (444     | ) |      |   | 454     |  
|Inventories                                                                           |  |                                | (3,770   | ) |      |   | (24,291 | )
|Production tooling                                                                    |  |                                | (6,751   | ) |      |   | (3,974  | )
|Prepaid expenses and other assets                                                     |  |                                | (2,376   | ) |      |   | (297    | )
|Accounts payable and accrued expenses                                                 |  |                                | 22,826   |   |      |   | 5,822   |  
|Income taxes payable                                                                  |  |                                | (2,489   | ) |      |   | (3,839  | )
|Tax benefit due to exercise of stock options                                          |  |                                |         |   |      |   | 668     |  
|Employee benefits                                                                     |  |                                | 878      |   |      |   | 804     |  
|                                                                                      |  |                                |          |   |      |   |         |  
|NET CASH PROVIDED BY OPERATING ACTIVITIES                                             |  |                                | 106,600  |   |      |   | 21,345  |  
|                                                                                      |  |                                |          |   |      |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                 |  |                                |          |   |      |   |         |  
|Purchases of property, plant and equipment                                            |  |                                | (27,597  | ) |      |   | (15,203 | )
|Purchases of short-term investments                                                   |  |                                | (107,685 | ) |      |   | 2,197   |  
|Acquisition of a business, net of cash acquired                                       |  |                                | (6,605   | ) |      |   |        |  
|Additional costs of acquisition                                                       |  |                                |         |   |      |   | (1,505  | )
|                                                                                      |  |                                |          |   |      |   |         |  
|NET CASH USED IN INVESTING ACTIVITIES                                                 |  |                                | (141,887 | ) |      |   | (14,511 | )
|                                                                                      |  |                                |          |   |      |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                 |  |                                |          |   |      |   |         |  
|Proceeds from issuance of stock due to exercise of options and restricted stock units |  |                                | 871      |   |      |   | 742     |  
|Proceeds from issuance of stock for stock plans                                       |  |                                | 828      |   |      |   | 1,208   |  
|Payments on long-term debt                                                            |  |                                |         |   |      |   | (825    | )
|Reduction in bank line of credit                                                      |  |                                |         |   |      |   | (7,533  | )
|Tax benefit due to exercise of stock options                                          |  |                                | 1,129    |   |      |   |        |  
|Other                                                                                 |  |                                | (125     | ) |      |   | (73     | )
|                                                                                      |  |                                |          |   |      |   |         |  
|NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                                   |  |                                | 2,703    |   |      |   | (6,481  | )
|                                                                                      |  |                                |          |   |      |   |         |  
|EFFECT OF EXCHANGE RATES ON CASH AND EQUIVALENTS                                      |  |                                | 1,025    |   |      |   | (766    | )
|                                                                                      |  |                                |          |   |      |   |         |  
|DECREASE IN CASH AND CASH EQUIVALENTS                                                 |  |                                | (31,559  | ) |      |   | (413    | )
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                        |  |                                | 91,542   |   |      |   | 4,521   |  
|                                                                                      |  |                                |          |   |      |   |         |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                              |  | $                              | 59,983   |   |      | $ | 4,108   |  
|                                                                                      |  |                                |          |   |      |   |         |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES:                                     |  |                                |          |   |      |   |         |  
|Interest paid                                                                         |  | $                              | 1,712    |   |      | $ | 5,059   |  
|Income taxes paid                                                                     |  | $                              | 49,774   |   |      | $ | 19,640  |  
|                                                                                      |  |                                |          |   |      |   |         |  

See accompanying condensed notes to Consolidated Financial Statements



6



---

##### Table of Contents

CERADYNE, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2006

(Unaudited)



|1. | Basis of Presentation
|-- | ---------------------

The accompanying unaudited consolidated
financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair
statement have been included. Operating results for the nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006.

The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date, but does not include all of the information and
footnotes required by generally accepted accounting principles 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, 2005.



|2. | Share Based Compensation
|-- | ------------------------

See Note 3 below for information
concerning an internal investigation into our stock option grant practices for the period of 1997 through June 30, 2006. The information in this Note 2 is qualified by reference to the information set forth in Note 3 to the extent applicable.

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment,
(SFAS 123(R)) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options based on estimated fair values. SFAS 123(R)
supersedes the Companys previous accounting under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) for periods beginning in fiscal 2006. In March 2005, the SEC issued
Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective application transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Companys
fiscal year 2006. The Companys Consolidated Financial Statements as of and for the nine months ended September 30, 2006 reflect the impact of SFAS 123(R). In accordance with this transition method, the Companys Consolidated
Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized under SFAS 123(R) for the three and the nine months ended September 30, 2006
was $398,000 and $1.1 million, respectively which was related to stock options and restricted stock units. Additionally, a pretax stock-based compensation charge of approximately $2.2 million was taken in the nine months ended September 30,
2006. See further discussion in Note 3.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the grant-date using an
option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Companys Consolidated Statements of Income. Prior to the adoption of SFAS
123(R), the Company accounted for share-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation (SFAS 123). Under the intrinsic value method, no share-based compensation expense related to stock options had been recognized in the Companys Consolidated Statements of Operations on the basis that the exercise
price of the Companys stock options granted to employees and directors equaled the fair market value of the underlying stock at the grant-date. Specifically, the Companys original accounting was based upon the understanding that options
were granted with no intrinsic value. However, as described in Note 3, the Company now believes that certain options were granted with a positive intrinsic value.

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



7



---

##### Table of Contents

on awards ultimately expected to vest, it has been reduced for estimated forfeitures. In the Companys pro forma information required under SFAS 123 for
the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

On November 10, 2005, the Financial Accounting Standards
Board (FASB) issued FASB Staff Position No. SFAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (SFAS 123(R)-3). The alternative transition method includes a
simplified method to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and
Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123(R). The Company has elected to adopt the provisions of SFAS 123(R)-3.

The Company maintains the 1994 Stock Incentive Plan and 2003 Stock Incentive Plan. The 1995 Employee Stock Purchase Plan ended in December 2005.

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 395,336 shares through September 30, 2006. There are no remaining stock options available to grant under this plan. The options granted under this plan were granted at an exercise price at or above the fair market value of
the Companys common stock at the date of grant, and generally became exercisable over a five-year period for incentive stock options and nine months for nonqualified stock options.

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

The Company may grant options and restricted stock units for up to 1,125,000 shares under the 2003 Stock Incentive Plan. The
Company has granted options for 475,125 shares and restricted stock units for 134,550 shares under this plan through September 30, 2006. There have been cancellations of 19,000 shares associated with this plan through September 30,
2006. The options under both plans have a life of ten years.

During the quarter ended September 30, 2006, the Company issued 7,000 restricted stock
units to certain officers and employees with a grant date fair value of $42.28 per share determined by the closing price of the common stock on the issuance date of August 28, 2006. During the first quarter ended March 30, 2006, the
Company issued 39,550 restricted stock units to certain officers and employees with a grant date fair value of $62.07 per share determined by the closing price of the common stock on the issuance date of March 6, 2006. During the second quarter
ended June 30, 2006, the Company issued 11,000 restricted stock units to certain officers and employees with a grant date fair value of $45.67 per share determined by the closing price of the common stock on the issuance date of June 6,
2006. Each restricted stock unit represents the right to receive one share of the Companys Common Stock when the Unit vests. The Company records compensation expense for the amount of the grant date fair value on a straight-line basis over the
period during which the restrictions lapse. During the first quarter 2006, unrecognized compensation cost was reclassified in the Companys Consolidated Balance Sheet from deferred compensation to additional paid in capital in connection with
the adoption of SFAS 123(R).

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



|                                                   |  |                                |      |   |                               |   |      |      |  |   |        |   |  |   |      |  
|-------------------------------------------------- |  | ------------------------------ | ---- | - | ----------------------------- | - | ---- | ---- |  | - | ------ | - |  | - | ---- | -
|                                                   |  | Three Months EndedSeptember 30 |      |   | Nine Months EndedSeptember 30 |  
|                                                   |  | 2006                           |      |   | 2005                          |   |      | 2006 |  |   | 2005   |  
|Share-based compensation expense recognized:       |  |                                |      |   |                               |   |      |      |  |   |        |   |  |   |      |  
|General and administrative, options                |  | $                              | 199  |   |                               | $ |     |      |  | $ | 2,779  |   |  | $ | 110  |  
|General and administrative, restricted stock units |  |                                | 234  |   |                               |   | 92   |      |  |   | 567    |   |  |   | 129  |  
|Related deferred income tax benefit                |  |                                | (137 | ) |                               |   | (32  | )    |  |   | (1,167 | ) |  |   | (88  | )
|                                                   |  |                                |      |   |                               |   |      |      |  |   |        |   |  |   |      |  
|Decrease in net income                             |  | $                              | 296  |   |                               | $ | 60   |      |  | $ | 2,179  |   |  | $ | 151  |  
|                                                   |  |                                |      |   |                               |   |      |      |  |   |        |   |  |   |      |  
|Decrease in basic earnings per share               |  | $                              | 0.01 |   |                               | $ | 0.00 |      |  | $ | 0.08   |   |  | $ | 0.01 |  
|                                                   |  |                                |      |   |                               |   |      |      |  |   |        |   |  |   |      |  
|Decrease in diluted earnings per share             |  | $                              | 0.01 |   |                               | $ | 0.00 |      |  | $ | 0.08   |   |  | $ | 0.01 |  
|                                                   |  |                                |      |   |                               |   |      |      |  |   |        |   |  |   |      |  

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



8



---

##### Table of Contents

The following table illustrates the effect on net income and earnings per share for the three and the nine months ended
September 30, 2005, as if the Company had applied the fair value recognition provisions of SFAS 123, as amended by SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure (SFAS 148)
(Dollars in thousands, except per share amounts):



|                                                                                                                                          |  |                                      |        |                                     |   |       
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | ----------------------------------- | - | ------
|                                                                                                                                          |  | Three Months EndedSeptember 30, 2005 |        | Nine Months EndedSeptember 30, 2005
|Net income, as reported                                                                                                                   |  | $                                    | 13,339 |                                     | $ | 30,724
|Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax
effects |  |                                      | 99     |                                     |   | 602   
|                                                                                                                                          |  |                                      |        |                                     |   |       
|Pro forma net income                                                                                                                      |  | $                                    | 13,240 |                                     | $ | 30,122
|                                                                                                                                          |  |                                      |        |                                     |   |       
|Net income per share:                                                                                                                     |  |                                      |        |                                     |   |       
|Basic - as reported                                                                                                                       |  | $                                    | 0.54   |                                     | $ | 1.25  
|                                                                                                                                          |  |                                      |        |                                     |   |       
|Basic - pro forma                                                                                                                         |  | $                                    | 0.54   |                                     | $ | 1.23  
|                                                                                                                                          |  |                                      |        |                                     |   |       
|Diluted - as reported                                                                                                                     |  | $                                    | 0.53   |                                     | $ | 1.23  
|                                                                                                                                          |  |                                      |        |                                     |   |       
|Diluted - pro forma                                                                                                                       |  | $                                    | 0.53   |                                     | $ | 1.20  
|                                                                                                                                          |  |                                      |        |                                     |   |       

The Company calculates expected volatility based on historical data of the Companys common stock. The
risk-free interest rate assumption is based upon an observed interest rate appropriate for the term of the Companys employee stock options. The dividend yield assumption is based on the Companys intent not to issue a dividend under its
dividend policy. The expected holding period assumption was estimated based on historical experience.

The following is a summary of stock option and
restricted stock unit activity:



|                                  |  |                  |   |  |                              |      
|--------------------------------- |  | ---------------- | - |  | ---------------------------- | -----
|                                  |  | Number ofOptions |   |  | WeightedAverageExercisePrice
|Outstanding at December 31, 2005  |  | 977,870          |   |  | $                            | 9.93 
|Options granted                   |  |                 |   |  | $                            |     
|Options exercised                 |  | (176,660         | ) |  | $                            | 6.68 
|Options cancelled                 |  | (6,450           | ) |  | $                            | 22.60
|                                  |  |                  |   |  |                              |      
|Outstanding at September 30, 2006 |  | 794,760          |   |  | $                            | 10.55
|                                  |  |                  |   |  |                              |      
|Exercisable at September 30, 2006 |  | 553,635          |   |  | $                            | 9.87 



|                                                        |  |                       |   |  |                                 |      
|------------------------------------------------------- |  | --------------------- | - |  | ------------------------------- | -----
|                                                        |  | Restricted StockUnits |   |  | WeightedAverage GrantFair Value
|Non-vested restricted stock units at December 31, 2005  |  | 77,000                |   |  | $                               | 22.44
|Granted                                                 |  | 57,550                |   |  | $                               | 56.53
|Vested                                                  |  | (16,450               | ) |  | $                               | 22.68
|Forfeited                                               |  | (1,000                | ) |  | $                               | 22.46
|                                                        |  |                       |   |  |                                 |      
|Non-vested restricted stock units at September 30, 2006 |  | 117,100               |   |  | $                               | 39.19
|                                                        |  |                       |   |  |                                 |      

As of September 30, 2006, there was $1.8 million of total unrecognized compensation cost related to 241,125
non-vested outstanding stock options, with a per share weighted average value of $12.11. The unrecognized expense is anticipated to be recognized on a straight-line basis over a weighted average period of 2.5 years. In addition, the aggregate
intrinsic value of stock options exercised for the nine months ended September 30, 2006 was $7.4 million.

As of September 30, 2006, there was
approximately $4.2 million of total unrecognized compensation cost related to non-vested restricted stock units granted under the 2003 Stock Incentive Plan. That cost is expected to be recognized over a weighted average period of 4.1 years.



9



---

##### Table of Contents

The following table summarizes information regarding options outstanding and options exercisable at September 30,
2006:



|                         |  |                  |  |                                         |  |                              |       |                               |   |                  |  |                                         |  |                              |  |                               |       |  |   |       
|------------------------ |  | ---------------- |  | --------------------------------------- |  | ---------------------------- | ----- | ----------------------------- | - | ---------------- |  | --------------------------------------- |  | ---------------------------- |  | ----------------------------- | ----- |  | - | ------
|                         |  | Outstanding      |  | Exercisable                            
|Range of Exercise Prices |  | Number ofOptions |  | AverageRemainingContractualLife (Years) |  | WeightedAverageExercisePrice |       | AggregateIntrinsicValue(000s) |   | Number ofOptions |  | AverageRemainingContractualLife (Years) |  | WeightedAverageExercisePrice |  | AggregateIntrinsicValue(000s)
|$1.44 - $2.81            |  | 38,850           |  | 3.07                                    |  | $                            | 1.87  |                               | $ | 1,717            |  | 33,000                                  |  | 2.54                         |  | $                             | 1.82  |  | $ | 1,460 
|$2.98 - $4.58            |  | 383,635          |  | 5.17                                    |  | $                            | 3.80  |                               | $ | 16,217           |  | 288,685                                 |  | 4.88                         |  | $                             | 3.96  |  | $ | 12,155
|$10.53 - $16.89          |  | 175,100          |  | 6.94                                    |  | $                            | 14.74 |                               | $ | 5,486            |  | 128,750                                 |  | 6.94                         |  | $                             | 15.59 |  | $ | 3,925 
|$18.80 - $24.07          |  | 197,175          |  | 7.92                                    |  | $                            | 21.67 |                               | $ | 4,810            |  | 103,200                                 |  | 7.88                         |  | $                             | 21.82 |  | $ | 2,503 
|                         |  |                  |  |                                         |  |                              |       |                               |   |                  |  |                                         |  |                              |  |                               |       |  |   |       
|Total                    |  | 794,760          |  | 6.14                                    |  | $                            | 10.55 |                               | $ | 28,230           |  | 553,635                                 |  | 5.78                         |  | $                             | 9.87  |  | $ | 20,043
|                         |  |                  |  |                                         |  |                              |       |                               |   |                  |  |                                         |  |                              |  |                               |       |  |   |       



|3. | Review of Historical Stock Option Grant Procedures
|-- | --------------------------------------------------

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

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

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

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

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



10



---

##### Table of Contents

Had this estimated Stock-Based Charge been reflected, as and when incurred, in the Companys results of operations
for prior years, the impact on net income for Ceradynes fiscal years ended December 31 would have been a reduction of $21,000 in 1997, a reduction of $45,000 in 1998, a reduction of $47,000 in 1999, a reduction of $104,000 in 2000, a
reduction of $269,000 in 2001, a reduction of $74,000 in 2002, a reduction of $347,000 in 2003, a reduction of $611,000 in 2004, and a reduction of $324,000 in 2005. As of September 30, 2006, the total remaining incremental stock-based
compensation charge related to these stock option grants that are expected to vest in future periods with a revised accounting measurement date is immaterial. There was no impact on revenue or net cash provided by operating activities as a result of
the estimated compensation charge.

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

Stock options that were
granted during the period of January 1997 through September 2003 with an exercise price less than the fair market value of the common stock on the revised measurement date and which were not vested as of December 31, 2004, may constitute
deferred compensation under Section 409A of the Internal Revenue Code. For those options that were still outstanding at June 30, 2006, the Company expects to modify the terms of the options so that the affected option holders will be able
to avoid the adverse tax consequences imposed by Section 409A. The Company may decide to compensate employees for adverse tax consequences they suffer as a result of the revised measurement dates due to Section 409A or otherwise. However,
a final decision on this matter will not be made until the Department of the Treasury issues final regulations related to Section 409A of the Internal Revenue Code, which is expected to occur later this year. Any such compensation that the
Company elects to make to the employees for any negative tax effects would be recorded at the time that a decision is made as to this matter. However, the Company does not expect such additional compensation to be material.

In August 2006, the current members of Ceradynes Board of Directors and all current executive officers amended all unexercised stock options they hold which have
an exercise price that is less than the price of the Companys common stock on the actual date of grant, by increasing the exercise price to an amount equal to the closing price of the common stock as of the actual grant date. The amendment to
the unexercised stock options did not result in additional compensation expense.



|4. | Net Income Per Share
|-- | --------------------

Basic net income per share is computed by
dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing net 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 convertible debt (using the net share settlement method, which is anti-dilutive).

The following is a summary of the number of shares used for the computation of net income per common and potential common shares (in thousands):



|                                              |  |                                 |  |                                |  |        |  |       
|--------------------------------------------- |  | ------------------------------- |  | ------------------------------ |  | ------ |  | ------
|                                              |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30,
|                                              |  | 2006                            |  | 2005                           |  | 2006   |  | 2005  
|Weighted average number of shares outstanding |  | 27,000                          |  | 24,586                         |  | 26,887 |  | 24,530
|Dilutive stock options                        |  | 439                             |  | 506                            |  | 433    |  | 476   
|Dilutive restricted stock units               |  | 22                              |  |                               |  | 52     |  |      
|                                              |  |                                 |  |                                |  |        |  |       
|Number of shares used in diluted computations |  | 27,461                          |  | 25,092                         |  | 27,372 |  | 25,006
|                                              |  |                                 |  |                                |  |        |  |       

The number of shares outstanding and earnings per share have been adjusted to reflect the three-for-two stock
split in the form of a 50% stock dividend distributed on January 18, 2005.



|5. | Acquisitions
|-- | ------------

On June 30, 2006, the Company completed the
purchase of certain assets and technology related to the Boral® product line
of AAR Manufacturing, Inc., a subsidiary of AAR Corp. The purchase price for the acquisition was approximately $6.6 million consisting of all cash. The Company considers this to be an immaterial acquisition.



11



---

##### Table of Contents

The purchase price was allocated as follows (in thousands):



|                                                           |  |   |      
|---------------------------------------------------------- |  | - | -----
|AAR Manufacturing, Inc.                                    |  |  
|Net tangible assets                                        |  | $ | 644  
|Customer relationships (estimated useful life of 10 years) |  |   | 5,961
|                                                           |  |   |      
|Total purchase price                                       |  | $ | 6,605
|                                                           |  |   |      



|6. | Composition of Certain Financial Statement Captions
|-- | ---------------------------------------------------

Inventories
are valued at the lower of cost (first in, first out) or market. Inventory costs include the cost of material, labor and manufacturing overhead. The following is a summary of the inventory components as of September 30, 2006 and
December 31, 2005 (in thousands):



|                  |  |                   |        |                  |   |       
|----------------- |  | ----------------- | ------ | ---------------- | - | ------
|                  |  | September 30,2006 |        | December 31,2005
|Raw materials     |  | $                 | 18,040 |                  | $ | 17,643
|Work-in-process   |  |                   | 34,239 |                  |   | 28,832
|Finished goods    |  |                   | 20,383 |                  |   | 19,843
|                  |  |                   |        |                  |   |       
|Total inventories |  | $                 | 72,662 |                  | $ | 66,318
|                  |  |                   |        |                  |   |       

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



|                                               |  |                   |         |   |                  |   |         |  
|---------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                               |  | September 30,2006 |         |   | December 31,2005 |  
|Land                                           |  | $                 | 9,890   |   |                  | $ | 9,085   |  
|Buildings and improvements                     |  |                   | 60,280  |   |                  |   | 49,607  |  
|Machinery and equipment                        |  |                   | 132,200 |   |                  |   | 116,284 |  
|Leasehold improvements                         |  |                   | 14,350  |   |                  |   | 13,605  |  
|Office equipment                               |  |                   | 12,009  |   |                  |   | 9,130   |  
|Construction in progress                       |  |                   | 8,544   |   |                  |   | 4,158   |  
|                                               |  |                   |         |   |                  |   |         |  
|                                               |  |                   | 237,273 |   |                  |   | 201,869 |  
|Less accumulated depreciation and amortization |  |                   | (61,982 | ) |                  |   | (48,610 | )
|                                               |  |                   |         |   |                  |   |         |  
|                                               |  | $                 | 175,291 |   |                  | $ | 153,259 |  
|                                               |  |                   |         |   |                  |   |         |  

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



|                         |  |                    |        |                         |   |           |  |             |        |                         |   |           |  |   |     |  |   |      
|------------------------ |  | ------------------ | ------ | ----------------------- | - | --------- |  | ----------- | ------ | ----------------------- | - | --------- |  | - | --- |  | - | -----
|                         |  | September 30, 2006 |        | December 31, 2005      
|                         |  | GrossAmount        |        | AccumulatedAmortization |   | NetAmount |  | GrossAmount |        | AccumulatedAmortization |   | NetAmount
|Intangible assets:       |  |                    |        |                         |   |           |  |             |        |                         |   |           |  |   |     |  |   |      
|Backlog                  |  | $                  | 525    |                         | $ | 525       |  | $           |       |                         | $ | 525       |  | $ | 525 |  | $ |     
|Developed technology     |  |                    | 4,819  |                         |   | 646       |  |             | 4,173  |                         |   | 4,327     |  |   | 347 |  |   | 3,980
|Customer relationships   |  |                    | 5,961  |                         |   | 156       |  |             | 5,805  |                         |   |          |  |   |    |  |   |     
|                         |  |                    |        |                         |   |           |  |             |        |                         |   |           |  |   |     |  |   |      
|                         |  |                    | 11,305 |                         |   | 1,327     |  |             | 9,978  |                         |   | 4,852     |  |   | 872 |  |   | 3,980
|Non-amortizing tradename |  |                    | 2,054  |                         |   |          |  |             | 2,054  |                         |   | 2,054     |  |   |    |  |   | 2,054
|                         |  |                    |        |                         |   |           |  |             |        |                         |   |           |  |   |     |  |   |      
|Total intangible assets  |  | $                  | 13,359 |                         | $ | 1,327     |  | $           | 12,032 |                         | $ | 6,906     |  | $ | 872 |  | $ | 6,034
|                         |  |                    |        |                         |   |           |  |             |        |                         |   |           |  |   |     |  |   |      

Amortization of definite-lived intangible assets will be approximately $1.1 million in each of the fiscal years
2006 through 2009. The changes in goodwill for the nine months ended September 30, 2006 were solely due to foreign exchange.



|7. | Recent Accounting Pronouncements
|-- | --------------------------------

In November 2004, SFAS
No. 151, Inventory Costs-an amendment of ARB No. 43, Chapter 4, was issued. This Statement amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company adopted this standard in the first quarter of
fiscal year 2006. Adoption of this standard did not have a material impact on the Companys consolidated financial position, results of operations or cash flow.



12



---

##### Table of Contents

In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary Assets-an amendment of APB Opinion
No. 29, which amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS 153
defines a nonmonetary exchange as having commercial substance if the future cash flow of the entity is expected to change significantly as a result of the exchange. This Statement is effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The Company adopted this standard in the third quarter of fiscal year 2005. Adoption of this standard did not have a material effect on the Companys financial position, results of operations or cash
flow.

In December 2004, the FASB issued SFAS No. 154, Accounting Changes and Error Correctionsa replacement of APB Opinion
No. 20 and FASB Statement No. 3 (SFAS 154). SFAS 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle. SFAS 154 requires that a voluntary change in accounting principle
be applied retrospectively with all prior period financial statements presented using the new accounting principle. SFAS 154 is effective for accounting changes and corrections of errors in fiscal years beginning after December 15, 2005. The
Company adopted this standard in the first quarter of fiscal year 2006. Adoption of this standard did not have a material impact on the Companys consolidated financial position, results of operations or cash flow.

In June 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. FIN 48 prescribes detailed guidance for the financial
statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. Tax positions must meet a
more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. FIN 48 will be effective for fiscal years beginning after December 15, 2006 (our fiscal year 2007) and the
provisions of FIN 48 will be applied to all tax positions under Statement No. 109 upon initial adoption. The cumulative effect of applying the provisions of this interpretation will be reported as an adjustment to the opening balance of
retained earnings for that fiscal year. The Company is currently evaluating the potential impact of FIN 48 on its consolidated financial statements.

In
June 2006, the Emerging Issues Task Force (EITF) issued EITF 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net
Presentation) to clarify diversity in practice on the presentation of different types of taxes in the financial statements. The Task Force concluded that, for taxes within the scope of the issue, a company may adopt a policy of presenting
taxes either gross within revenue or net. That is, it may include charges to customers for taxes within revenues and the charge for the taxes from the taxing authority within cost of sales, or, alternatively, it may net the charge to the customer
and the charge from the taxing authority. If taxes subject to EITF 06-3 are significant, a company is required to disclose its accounting policy for presenting taxes and the amounts of such taxes that are recognized on a gross basis. The guidance in
this consensus is effective for the first interim reporting period beginning after December 15, 2006 (the first quarter of our fiscal year 2007). We do not expect the adoption of EITF 06-3 will have a material impact on our results of
operations, financial position or cash flow.

In September 2006, Staff Accounting Bulletin (SAB) 108 was released. The bulletin establishes an
approach that requires quantification of financial statement errors based on the effects of the error on each of the companys financial statements and the related financial statement disclosures. SAB 108 is effective for interim periods which
are part of fiscal years ending on or after November 15, 2006. The Company does not expect the adoption of this standard to have any impact on its consolidated financial statements.

In September 2006, the FASB issued SFAS 157 Fair Value Measurement (SFAS 157) which defines fair value, establishes a framework for measuring fair value and expanded disclosures about fair
value measurement. Companies are required to adopt the new standard for fiscal periods beginning after November 15, 2007. The Company is evaluating the impact of this standard and currently does not expect it to have a significant impact on its
consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other
Postretirement Plans (SFAS No. 158). SFAS No. 158 requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and recognize as a
component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. SFAS No. 158 also requires additional
disclosures in the notes to financial statements. SFAS No. 158 is effective as of the end of fiscal years ending after December 15, 2006. The Company is currently assessing the impact of SFAS No. 158 on its consolidated financial statements.



|8. | Convertible Debt and Credit Facility
|-- | ------------------------------------

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

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

With respect to each $1,000 principal amount of the Notes surrendered for conversion, the Company will deliver the conversion value to holders as follows: (1) an amount in cash equal to the lesser of (a) the aggregate conversion
value of the



13



---

##### Table of Contents

notes to be converted and (b) $1,000, and (2) if the aggregate conversion value of the Notes to be converted is greater than the $1,000, an amount
in shares or cash equal to such aggregate conversion value in excess of $1,000.

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

The Company is obligated to pay contingent interest to the holders of the Notes during any six-month period from June 15 to December 14 and from December 15 to June 14, commencing with the six-month period beginning
December 20, 2010 and ending on June 14, 2011, if the average trading price of the note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period equals
$1,200 (120% of the principal amount of a note) or more. The amount of contingent interest payable per note for any relevant contingent interest period shall equal 0.25% per annum of the average trading price of a note for the five trading day
period ending on the third trading day immediately preceding the first day of the relevant contingent interest period. This contingent interest payment feature represents an embedded derivative. However, based on the de minimus value associated with
this feature, no value has been assigned at issuance and at September 30, 2006.

On or prior to the maturity date of the Notes, upon the occurrence of
a fundamental change, under certain circumstances, the Company will provide for a make whole amount by increasing, for the time period described herein, the conversion rate by a number of additional shares for any conversion of the Notes in
connection with such fundamental change transactions. The amount of additional shares will be determined based on the price paid per share of Ceradynes common stock in the transaction constituting a fundamental change and the effective date of
such transaction. This make whole premium feature represents an embedded derivative. Since this feature has no measurable impact on the fair value of the Notes and no separate trading market exists for this derivative, the value of the embedded
derivative was determined to be de minimus. Accordingly, no value has been assigned at issuance or at September 30, 2006.

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.

On December 19, 2005, the Company repaid the balance of its term loan of $108.9 million and $9.8 million of its line of credit, and approximately $0.1 million of accrued interest, using the net proceeds from the Notes and proceeds from
its concurrent public offering of its common stock. The Company retired the credit facility. As a result of the termination of the term loan, the Company wrote off the remaining unamortized debt issuance costs of approximately $2.6 million in the
fourth quarter of 2005.

In December 2005, the Company established a new unsecured $10.0 million line of credit. As of September 30, 2006, there were
no outstanding amounts on the line of credit. However, the available line of credit at September 30, 2006 has been reduced by an outstanding letter of credit in the amount of $3.8 million. The interest rate on the credit line is based on the
LIBOR rate for a period of one month, plus a margin of one percent, which equaled 6.3% as of September 30, 2006.

Pursuant to the bank line of credit,
the Company is subject to certain covenants, which include, among other things, the maintenance of specified minimum amounts of tangible net worth and quick assets to current liabilities ratio. At September 30, 2006, the Company was in
compliance with these covenants.



|9. | Disclosure About Segments of an Enterprise and Related Information
|-- | ------------------------------------------------------------------

The Company serves its markets and manages its business through five operating segments, each of which has its own manufacturing facilities and administrative and selling functions. The Companys Advanced Ceramic Operations, located in
Costa Mesa, Irvine, and San Diego, California, Lexington, Kentucky and Wixom, Michigan, primarily produces armor and orthodontic products, diesel engine parts, components for semiconductor equipment, and houses the Companys sintered reaction
bonded silicon nitride (SRBSN) research and development activities. The Companys cathode development and production are handled through its Semicon Associates division located in Lexington, Kentucky. Fused silica products, including missile
radomes, are produced at the Companys Thermo Materials division located in Scottdale and Clarkson, Georgia. The Companys ESK Ceramics operation is located in Kempten, Germany and Bazet, France. This subsidiary produces ceramic powders,
including boron carbide powder for ceramic body armor, evaporation boats for metallization, functional and frictional coatings utilized in the automotive and textile industries, high performance pump seals, bearings for fluid handling, and
refractory products. The Company added a fifth operating segment in June 2006, when its newly formed subsidiary, Ceradyne Canada, acquired certain assets, including a building, equipment and technology, related to the production of structural
neutron absorbing materials. The building and operations of Ceradyne Canada are located in Chicoutimi, Canada.



14



---

##### Table of Contents

Ceradynes five segment facilities and products are summarized in the following table:



|                                                                                     |  |                                                                                                                                                                                                           
|------------------------------------------------------------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Operating Segment and Facility Location                                              |  | Products                                                                                                                                                                                                  
|                                                                                     | 
|Ceradyne Advanced Ceramic Operations                                                 |  | Defense Applications:        Lightweight ceramic armor                                                                                                                                                   
|                                                                                     | 
|Costa Mesa, Irvine and San Diego, California(1) Approximately 289,000 square feet    |  | Industrial Applications:        Ceralloy® 147 SRBSN wear parts        Precision ceramics                                                                                                                
|                                                                                     | 
|Lexington, Kentucky(2) Approximately 115,000 square feet                             |  | Automotive/Diesel Applications:       Ceralloy® 147 SRBSN automotive/diesel engine parts                                                                                                                 
|Wixom, Michigan(3) Approximately 29,000 square feet                                  |  | Commercial Applications:        Ceramic orthodontic brackets        Components for
medical devices                                                                                                      
|                                                                                     | 
|ESK Ceramics                                                                         |  | Defense Applications:        Boron carbide powders for body armor                                                                                                                                        
|                                                                                     | 
|Kempten, Germany(4) Approximately 544,000 square feet                                |  | Industrial Applications:        Ceramic powders: boron carbide, boron nitride, titanium diboride, calcium hexaboride
and zirconium diboride                                                              
|                                                                                     | 
|Bazet, France(5) Approximately 88,000 square feet                                    |  |       Silicon carbide parts        Evaporation boats
for the packaging industry        High performance pump seals  Automotive/Diesel Applications:        EKagrip® functional and frictional coatings
|                                                                                     | 
|Ceradyne Semicon Associates  Lexington, Kentucky(6) Approximately
35,000 square feet |  | Industrial Applications:        Ceramic-impregnated dispenser cathodes for microwave tubes, lasers and cathode ray
tubes        Samarium cobalt magnets                                                 
|                                                                                     | 
|Ceradyne Thermo Materials                                                            |  | Defense Applications:        Missile radomes (nose cones)                                                                                                                                                
|                                                                                     | 
|Scottdale and Clarkston, Georgia(7) Approximately 132,000 square feet                |  | Industrial Applications:        Glass tempering rolls Metallurgical tooling        Castable and other
fused silica products        Crucibles for photovoltaic solar cell applications                 
|                                                                                     | 
|Ceradyne Canada  Chicoutimi, Canada(8) Approximately
86,000 square feet              |  | Industrial Applications:        Boral® structural neutron absorbing materials 
      Metal matrix composite structures                                                                                  

---

|(1) | We have leases on our facilities in Costa Mesa, California, aggregating approximately 99,000 square feet, all of which expire in October 2010. We own a 40,000 square foot
facility in Irvine, California. We also lease in Irvine, California: a 24,000 square foot facility that expires in April 2009, a 76,000 square foot facility that expires in April 2011, and we have a month to month lease on a 40,000 square foot
facility. We have a lease on our 10,000 square foot facility in San Diego, California, which expires in December 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | We own our facility in Lexington, Kentucky.
|--- | -------------------------------------------



|(3) | We have a lease on our Wixom, Michigan facility, which expires in April 2010.
|--- | -----------------------------------------------------------------------------



|(4) | We own our facility in Kempten, Germany, as well as the 22-acre property on which our facility is located.
|--- | ----------------------------------------------------------------------------------------------------------



15



---

##### Table of Contents

|(5) | We own our facility in Bazet, France, as well as the four-acre property on which our facility is located.
|--- | ---------------------------------------------------------------------------------------------------------



|(6) | We own our facility in Lexington, Kentucky, as well as the five-acre property on which our facility is located.
|--- | ---------------------------------------------------------------------------------------------------------------



|(7) | We have a lease on our 85,000 square foot facility in Scottdale, Georgia, which expires in December 2015. We have a lease on our 47,000 square foot facility in Clarkston, Georgia,
which expires in May 2009.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(8) | We own our facility in Chicoutimi, Canada, as well as the seven-acre property on which our facility is located.
|--- | ---------------------------------------------------------------------------------------------------------------

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



|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|------------------------------------------------------- |  | ------------------------------ | ------- | ----------------------------- | ---- | - | ------- |  | - | ------- | - |  | - | ------- | -
|                                                        |  | Three Months EndedSeptember 30 |         | Nine Months EndedSeptember 30 |     
|                                                        |  | 2006                           |         |                               | 2005 |   | 2006    |  |   | 2005    |  
|Revenue from External Customers                         |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|ACO                                                     |  | $                              | 152,482 |                               |      | $ | 63,558  |  | $ | 383,368 |   |  | $ | 158,766 |  
|ESK Ceramics                                            |  |                                | 26,504  |                               |      |   | 26,204  |  |   | 82,462  |   |  |   | 80,744  |  
|Semicon Associates                                      |  |                                | 2,150   |                               |      |   | 1,676   |  |   | 6,838   |   |  |   | 5,418   |  
|Thermo Materials                                        |  |                                | 4,175   |                               |      |   | 2,968   |  |   | 11,006  |   |  |   | 9,172   |  
|Ceradyne Canada                                         |  |                                | 485     |                               |      |   |        |  |   | 485     |   |  |   |        |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Total                                                   |  | $                              | 185,796 |                               |      | $ | 94,406  |  | $ | 484,159 |   |  | $ | 254,100 |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Depreciation and Amortization                           |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|ACO                                                     |  | $                              | 1,975   |                               |      | $ | 1,458   |  | $ | 5,494   |   |  | $ | 4,108   |  
|ESK Ceramics                                            |  |                                | 2,276   |                               |      |   | 1,948   |  |   | 6,558   |   |  |   | 6,042   |  
|Semicon Associates                                      |  |                                | 90      |                               |      |   | 85      |  |   | 272     |   |  |   | 280     |  
|Thermo Materials                                        |  |                                | 103     |                               |      |   | 247     |  |   | 626     |   |  |   | 713     |  
|Ceradyne Canada                                         |  |                                | 215     |                               |      |   |        |  |   | 215     |   |  |   |        |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Total                                                   |  | $                              | 4,659   |                               |      | $ | 3,738   |  | $ | 13,165  |   |  | $ | 11,143  |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Segment Income (Loss) before Provision for Income Taxes |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|ACO                                                     |  | $                              | 47,746  |                               |      | $ | 18,086  |  | $ | 123,194 |   |  | $ | 41,563  |  
|ESK Ceramics                                            |  |                                | 6,001   |                               |      |   | 2,310   |  |   | 13,155  |   |  |   | 6,840   |  
|Semicon Associates                                      |  |                                | 337     |                               |      |   | 130     |  |   | 1,246   |   |  |   | 525     |  
|Thermo Materials                                        |  |                                | 293     |                               |      |   | 67      |  |   | 694     |   |  |   | (239    | )
|Ceradyne Canada                                         |  |                                | (297    | )                             |      |   |        |  |   | (321    | ) |  |   |        |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Total                                                   |  | $                              | 54,080  |                               |      | $ | 20,593  |  | $ | 137,968 |   |  | $ | 48,689  |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Segment Assets                                          |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|ACO                                                     |  | $                              | 350,028 |                               |      | $ | 144,089 |  | $ | 350,028 |   |  | $ | 144,089 |  
|ESK Ceramics                                            |  |                                | 172,313 |                               |      |   | 163,133 |  |   | 172,313 |   |  |   | 163,133 |  
|Semicon Associates                                      |  |                                | 6,220   |                               |      |   | 5,914   |  |   | 6,220   |   |  |   | 5,914   |  
|Thermo Materials                                        |  |                                | 17,395  |                               |      |   | 12,902  |  |   | 17,395  |   |  |   | 12,902  |  
|Ceradyne Canada                                         |  |                                | 15,914  |                               |      |   |        |  |   | 15,914  |   |  |   |        |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Total                                                   |  | $                              | 561,870 |                               |      | $ | 326,038 |  | $ | 561,870 |   |  | $ | 326,038 |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Expenditures for PP&E                                   |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|ACO                                                     |  | $                              | 3,039   |                               |      | $ | 3,835   |  | $ | 13,127  |   |  | $ | 9,070   |  
|ESK Ceramics                                            |  |                                | 2,079   |                               |      |   | 1,368   |  |   | 4,495   |   |  |   | 4,312   |  
|Semicon Associates                                      |  |                                | 69      |                               |      |   | 23      |  |   | 228     |   |  |   | 185     |  
|Thermo Materials                                        |  |                                | 888     |                               |      |   | 293     |  |   | 1,741   |   |  |   | 1,636   |  
|Ceradyne Canada                                         |  |                                | 6       |                               |      |   |        |  |   | 8,006   |   |  |   |        |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  
|Total                                                   |  | $                              | 6,081   |                               |      | $ | 5,519   |  | $ | 27,597  |   |  | $ | 15,203  |  
|                                                        |  |                                |         |                               |      |   |         |  |   |         |   |  |   |         |  



16



---

##### Table of Contents

|                   |  |                                |   |  |                               |   |  |      |   |  |      |  
|------------------ |  | ------------------------------ | - |  | ----------------------------- | - |  | ---- | - |  | ---- | -
|                   |  | Three Months EndedSeptember 30 |   |  | Nine Months EndedSeptember 30 |  
|                   |  | 2006                           |   |  | 2005                          |   |  | 2006 |   |  | 2005 |  
|U.S. Net Sales     |  |                                |   |  |                               |   |  |      |   |  |      |  
|ACO                |  | 80                             | % |  | 61                            | % |  | 78   | % |  | 57   | %
|ESK Ceramics       |  | 3                              | % |  | 12                            | % |  | 4    | % |  | 11   | %
|Semicon Associates |  | 1                              | % |  | 1                             | % |  | 1    | % |  | 2    | %
|Thermo Materials   |  | 2                              | % |  | 2                             | % |  | 1    | % |  | 2    | %
|Ceradyne Canada    |  | 0                              | % |  | 0                             | % |  | 0    | % |  | 0    | %
|                   |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total              |  | 86                             | % |  | 76                            | % |  | 84   | % |  | 72   | %
|                   |  |                                |   |  |                               |   |  |      |   |  |      |  
|Foreign Net Sales  |  |                                |   |  |                               |   |  |      |   |  |      |  
|ACO                |  | 2                              | % |  | 3                             | % |  | 2    | % |  | 3    | %
|ESK Ceramics       |  | 12                             | % |  | 20                            | % |  | 13   | % |  | 24   | %
|Semicon Associates |  | 0                              | % |  | 0                             | % |  | 0    | % |  | 0    | %
|Thermo Materials   |  | 0                              | % |  | 1                             | % |  | 1    | % |  | 1    | %
|Ceradyne Canada    |  | 0                              | % |  | 0                             | % |  | 0    | % |  | 0    | %
|                   |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total              |  | 14                             | % |  | 24                            | % |  | 16   | % |  | 28   | %
|                   |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total Net Sales    |  |                                |   |  |                               |   |  |      |   |  |      |  
|ACO                |  | 82                             | % |  | 64                            | % |  | 80   | % |  | 60   | %
|ESK Ceramics       |  | 15                             | % |  | 32                            | % |  | 17   | % |  | 35   | %
|Semicon Associates |  | 1                              | % |  | 1                             | % |  | 1    | % |  | 2    | %
|Thermo Materials   |  | 2                              | % |  | 3                             | % |  | 2    | % |  | 3    | %
|Ceradyne Canada    |  | 0                              | % |  | 0                             | % |  | 0    | % |  | 0    | %
|                   |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total              |  | 100                            | % |  | 100                           | % |  | 100  | % |  | 100  | %
|                   |  |                                |   |  |                               |   |  |      |   |  |      |  

Note: Foreign sales for ESK Ceramics are sales to non-U.S. countries including the principal countries of
Germany, France, Denmark and Italy.

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



|             |  |                                  |         |                                 |   |        |  |      |         |  |   |        
|------------ |  | -------------------------------- | ------- | ------------------------------- | - | ------ |  | ---- | ------- |  | - | -------
|             |  | Three months Ended September 30, |         | Nine months Ended September 30,
|             |  | 2006                             |         | 2005                            |   | 2006   |  | 2005
|Armor        |  | $                                | 141,899 |                                 | $ | 54,939 |  | $    | 353,501 |  | $ | 131,830
|Automotive   |  |                                  | 4,277   |                                 |   | 4,101  |  |      | 13,077  |  |   | 12,087 
|Orthodontics |  |                                  | 2,738   |                                 |   | 2,315  |  |      | 7,685   |  |   | 7,462  
|Industrial   |  |                                  | 3,568   |                                 |   | 2,203  |  |      | 9,105   |  |   | 7,387  
|             |  |                                  |         |                                 |   |        |  |      |         |  |   |        
|             |  | $                                | 152,482 |                                 | $ | 63,558 |  | $    | 383,368 |  | $ | 158,766
|             |  |                                  |         |                                 |   |        |  |      |         |  |   |        



|10. | Pension Plans
|--- | -------------

In connection with the acquisition of ESK Ceramics
in August 2004, the Company sponsors a defined benefit pension plan in Germany related to its ESK Ceramics employees. Components of net periodic benefit cost under this plan were (in thousands):



|                                  |  |                    |      |   |                   |   |      |                   |  |   |                   |   |  |   |        |  
|--------------------------------- |  | ------------------ | ---- | - | ----------------- | - | ---- | ----------------- |  | - | ----------------- | - |  | - | ------ | -
|                                  |  | Three Months Ended |      |   | Nine Months Ended |  
|                                  |  | September 30,2006  |      |   | September 30,2005 |   |      | September 30,2006 |  |   | September 30,2005 |  
|Service cost                      |  | $                  | 553  |   |                   | $ | 365  |                   |  | $ | 1,617             |   |  | $ | 1,058  |  
|Interest cost                     |  |                    | 464  |   |                   |   | 415  |                   |  |   | 1,354             |   |  |   | 1,224  |  
|Expected return on plan assets    |  |                    | (558 | ) |                   |   | (385 | )                 |  |   | (1,616            | ) |  |   | (1,197 | )
|Amortization of unrecognized gain |  |                    | 20   |   |                   |   | 4    |                   |  |   | 62                |   |  |   | 11     |  
|                                  |  |                    |      |   |                   |   |      |                   |  |   |                   |   |  |   |        |  
|Net periodic benefit cost         |  | $                  | 479  |   |                   | $ | 399  |                   |  | $ | 1,417             |   |  | $ | 1,096  |  
|                                  |  |                    |      |   |                   |   |      |                   |  |   |                   |   |  |   |        |  



17



---

##### Table of Contents

Contributions made by the Company were $452,000 and $454,000, respectively, for the nine months ended September 30,
2006 and 2005.



|11. | Commitments and Contingencies
|--- | -----------------------------

The Company leases certain of its
manufacturing facilities under noncancelable operating leases expiring at various dates through October 2015. The Company incurred rental expense under these leases of $2.0 million and $1.4 million for the nine months ended 2006 and 2005,
respectively. The approximate minimum rental commitments required under existing noncancelable leases as of September 30, 2006 are as follows (in thousands):



|           |  |   |       
|---------- |  | - | ------
|2006       |  | $ | 637   
|2007       |  |   | 2,459 
|2008       |  |   | 2,382 
|2009       |  |   | 2,179 
|Thereafter |  |   | 3,318 
|           |  |   |       
|           |  | $ | 10,975
|           |  |   |       

On August 11, 2006, a shareholder derivative complaint was filed in the California Superior Court for Orange
County by Fritz J. Moennighoff, Case Number 06-CC-00156. On August 25, 2006, a shareholder derivative complaint was filed in the California Superior Court for Orange County by Larry Menning, Case Number 06-CC-00175. On August 28, 2006, a
shareholder derivative complaint was filed in the California Superior Court for Orange County by Rhoda Kubrick, Case Number 06-CC-00176. On September 19, 2006, a shareholder derivative complaint was filed in the California Superior Court for
Orange County by John King, Case Number 06-CC-00193. All four complaints were brought purportedly on behalf of the Company against certain of the Companys current and former directors and executive officers. The complaints assert claims for,
among other things, breaches of fiduciary duty by directors and executive officers related to backdating of stock options. The complaints seek to require the individual defendants to rescind stock options they received which have an exercise price
below the closing price of the Companys common stock on the date of grant, to disgorge the proceeds of options exercised, to reimburse the Company for damages of an unspecified amount, and also seek certain equitable relief, attorneys
fees and costs. The plaintiff in the Kubrick case requested voluntary dismissal of her complaint in the Superior Court on or before September 29, 2006, and filed a substantially identical complaint on September 29, 2006, in the United
States District Court for the Central District of California, Case No. SA CV 06-919 JVS (PJWx). The plaintiff in the King case requested voluntary dismissal of his complaint in the Superior Court on or before September 29, 2006, and filed a
substantially identical complaint on September 29, 2006, in the United States District Court for the Central District of California, Case No. SA CV 06-920 JVS (PJWx). The Superior Court granted the plaintiffs requests for dismissal of the
Kubrick and King cases on October 18, 2006. We intend to take all appropriate action in response to these lawsuits. The impact of the outcome of these lawsuits is undeterminable at this time.



|12. | 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 for the three and nine months ended September 30, 2006 and 2005 was (in thousands):



|                                   |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |         |  
|---------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ------ | ----------------- |  | - | ----------------- | - |  | - | ------- | -
|                                   |  | Three Months Ended |        |   | Nine Months Ended |  
|                                   |  | September30, 2006  |        |   | September30, 2005 |   |        | September30, 2006 |  |   | September30, 2005 |  
|Net income                         |  | $                  | 36,922 |   |                   | $ | 13,339 |                   |  | $ | 90,664            |   |  | $ | 30,724  |  
|Foreign currency translation       |  |                    | (1,169 | ) |                   |   | (265   | )                 |  |   | 10,418            |   |  |   | (17,134 | )
|Unrealized (losses) on investments |  |                    | (54    | ) |                   |   | (44    | )                 |  |   | (126              | ) |  |   | (72     | )
|                                   |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |         |  
|Comprehensive income               |  | $                  | 35,699 |   |                   | $ | 13,030 |                   |  | $ | 100,956           |   |  | $ | 13,518  |  
|                                   |  |                    |        |   |                   |   |        |                   |  |   |                   |   |  |   |         |  



18



---

##### Table of Contents

|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 11 Commitments and Contingencies of the Condensed 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, 2005, 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 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, and zirconium diboride, which are used in manufacturing armor and a broad range of
industrial 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;
| | - |  | --------------------------------------------------------------



| |  |  | structural neutron absorbing materials; and
| | - |  | -------------------------------------------



| |  |  | metal matrix composite structures.
| | - |  | ----------------------------------

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

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



|                  |  |                                |   |  |                               |   |  |       |   |  |       |  
|----------------- |  | ------------------------------ | - |  | ----------------------------- | - |  | ----- | - |  | ----- | -
|                  |  | Three Months EndedSeptember 30 |   |  | Nine Months EndedSeptember 30 |  
|                  |  | 2006                           |   |  | 2005                          |   |  | 2006  |   |  | 2005  |  
|Defense           |  | 78.2                           | % |  | 64.5                          | % |  | 76.1  | % |  | 56.8  | %
|Industrial        |  | 15.5                           |   |  | 25.3                          |   |  | 16.9  |   |  | 31.4  |  
|Automotive/Diesel |  | 4.8                            |   |  | 7.7                           |   |  | 5.4   |   |  | 8.9   |  
|Commercial        |  | 1.5                            |   |  | 2.5                           |   |  | 1.6   |   |  | 2.9   |  
|                  |  |                                |   |  |                               |   |  |       |   |  |       |  
|Total             |  | 100.0                          | % |  | 100.0                         | % |  | 100.0 | % |  | 100.0 | %
|                  |  |                                |   |  |                               |   |  |       |   |  |       |  

The principal factors contributing to our recent growth in sales are increased demand by the U.S. military for
ceramic body armor that protects soldiers.



19



---

##### Table of Contents

Military conflicts in Iraq and Afghanistan, as well as an increasingly unstable geopolitical climate and the heightened
risk of international conflicts, have resulted in increased orders for our ceramic body armor in each year since 2001. We were awarded an Indefinite Delivery/Indefinite Quantity contract by the U.S. Army in August 2004 with a maximum value of $461.0
million. Through October 2006, twelve delivery orders totaling approximately $391.1 million have been issued to us under this contract. We have also received a number of other orders for ceramic body armor, not covered by the Indefinite
Delivery/Indefinite Quantity contract, from the Army and other branches of the U.S. military. In January 2006, we received our first production order for enhanced side ballistic inserts, referred to as ESBI, or side plates, which are designed to
protect the side areas of a soldiers torso when used in conjunction with our ESAPI ceramic body armor plates. This delivery order, which totals $70.0 million, was issued to us by the U.S. Army. In June 2006, we were awarded an Indefinite
Delivery/Indefinite Quantity contract by the U.S. Army with a maximum value of $611.7 million for ESBI plates. Through October 2006, two delivery orders totaling approximately $63.2 million have been issued to us under this contract. Based on our
current backlog, we expect our shipments of ceramic body armor to be higher in fiscal year 2006 than in 2005. However, unless we receive additional orders under existing contracts or are successful in obtaining new contracts for ceramic body armor,
our shipments of ceramic body armor will decline materially in 2007 from levels we expect to achieve in 2006. Moreover, government contracts typically may be cancelled by the government at any time without penalty. For the next several quarters, and
perhaps longer, demand for ceramic body armor is likely to be the most significant factor affecting our sales.

Although we believe that demand for ceramic
body armor will continue for many years, the quantity and timing of government orders depend on a number of factors outside of our control, such as the amount of U.S. defense budget appropriations and the level of international conflicts. Moreover,
ceramic armor contracts generally are awarded in an open competitive bidding process. Therefore, our future level of sales of ceramic body armor will depend on our ability to successfully compete for and retain this business.

During the quarter ended March 31, 2005, the U.S. military directed us to modify the specifications of the lightweight ceramic body armor that we had been
manufacturing, from the version commonly referred to as SAPI (small arms protective insert), to a revised requirement commonly referred to as ESAPI (enhanced small arms protective insert). The revised requirement is more difficult to manufacture
than the SAPI version. We have developed five new designs to meet the revised requirement, all of which have been approved by the government, and we intend to continue to develop additional, improved armor designs. During the quarter ended
September 30, 2006, nearly all of the body armor we shipped consisted of our new designs that meet the revised requirement.

Our ESK Ceramics
subsidiary produces boron carbide powder, which serves as a starter ceramic powder in the manufacture of our lightweight ceramic body armor. Owning this source of our principal raw material, together with the recent and ongoing expansion of our
manufacturing capacity for ceramic armor at our new Lexington, Kentucky plant and in our Irvine, California facility, should allow us to fulfill current and anticipated demand for our ceramic body armor.

Our order backlog was approximately $209.1 million as of September 30, 2006, compared to approximately $189.6 million as of September 30, 2005. Orders for
ceramic armor represented approximately $182.3 million, or 87.2% of the total backlog as of September 30, 2006, and approximately $136.6 million, or 72.1% of the total backlog as of September 30, 2005. We expect that substantially all of
our order backlog as of September 30, 2006 will be shipped during the next 12 months.

Review of Historical Stock
Option Grant Procedures

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

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

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



20



---

##### Table of Contents

the accounting measurement date was incorrect in all but one case. The proper accounting measurement date was the date the unanimous written consent was
signed by the members of the Stock Option Committee.

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

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

Had this estimated Stock-Based Charge been reflected, as and when incurred, in the Companys results of operations for prior years, the impact on net income for Ceradynes fiscal years ended December 31 would have been a
reduction of $21,000 in 1997, a reduction of $45,000 in 1998, a reduction of $47,000 in 1999, a reduction of $104,000 in 2000, a reduction of $269,000 in 2001, a reduction of $74,000 in 2002, a reduction of $347,000 in 2003, a reduction of $611,000
in 2004, and a reduction of $324,000 in 2005. As of June 30, 2006, the total remaining incremental stock-based compensation charge related to these stock option grants that are expected to vest in future periods with a revised accounting
measurement date is immaterial. There was no impact on revenue or net cash provided by operating activities as a result of the estimated compensation charge.

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

Stock options that were granted during the period of January 1997 through September 2003 with an exercise price less than the fair market value of the
common stock on the revised measurement date and which were not vested as of December 31, 2004, may constitute deferred compensation under Section 409A of the Internal Revenue Code. For those options that were still outstanding at
June 30, 2006, the Company expects to modify the terms of the options so that the affected option holders will be able to avoid the adverse tax consequences imposed by Section 409A. The Company may decide to compensate employees for
adverse tax consequences they suffer as a result of the revised measurement dates due to Section 409A or otherwise. However, a final decision on this matter will not be made until the Department of the Treasury issues final regulations related
to Section 409A of the Internal Revenue Code, which is expected to occur later this year. Any such compensation that the Company elects to make to the employees for any negative tax effects would be recorded at the time that a decision is made
as to this matter. However, the Company does not expect such additional compensation to be material.

In August 2006, the current members of
Ceradynes Board of Directors and all current executive officers amended all unexercised stock options they hold which have an exercise price that is less than the price of the Companys common stock on the actual date of grant, by
increasing the exercise price to an amount equal to the closing price of the common stock as of the actual grant date.

Results of Operations for the Three and Nine Months Ended September 30, 2006

Net Sales. Our net sales for the three months
ended September 30, 2006 were $185.8 million, an increase of $91.4 million, or 96.8%, from $94.4 million of net sales in the corresponding quarter of the prior year. Net sales for the nine months ended September 30, 2006 were $484.2
million, an increase of $230.1 million, or 90.5%, from $254.1 million of net sales in the corresponding prior year period.



21



---

##### Table of Contents

Net sales for our Advanced Ceramic Operations division for the three months ended September 30, 2006 were $152.5
million, an increase of $88.9 million, or 139.9% from the $63.6 million in the corresponding quarter of the prior year. The primary reason for this improvement was the shipment of $141.9 million of ceramic body and other armor components for defense
customers, an increase of $87.0 million, or 158.3% from the $54.9 million of ceramic armor shipments in the third quarter of 2005. This increase in net sales of lightweight body armor for military personnel was caused by delivery of orders that were
received in the fourth quarter of 2005, first quarter and second quarter of 2006 from the U.S. Department of Defense. Net sales for our automotive/diesel component product line were $4.3 million, an increase of $171,000, or 4.2%, from the $4.1
million in the corresponding quarter of the prior year. The primary reason for this increase is that our customers are producing more heavy-duty diesel truck engines due to an increase in orders. Net sales of our orthodontic brackets product line
were $2.7 million, an increase of $426,000, or 18.4%, from net sales of $2.3 million in the corresponding quarter of the prior year.

For the nine month
period ended September 30, 2006, net sales for the Advanced Ceramic Operations division were $383.4 million, an increase of $224.6 million, or 141.5% from the $158.8 million in the corresponding prior year period. The primary reason for this
improvement was the shipment of $353.5 million of ceramic body and other armor components for defense customers, an increase of $221.7 million, or 168.1%, from the $131.8 million of ceramic armor shipments in the corresponding prior year period.
This increase in net sales of lightweight body armor for military personnel was caused by delivery of orders that were received in the fourth quarter of 2005, first quarter and second quarter of 2006 from the U.S. Department of Defense. Net sales
for our automotive/diesel component product line were $13.1 million, an increase of $1.1 million, or 8.4%, from the $12,0 million in the corresponding prior year period. The primary reason for this increase is that our customers are producing
more heavy-duty diesel truck engines due to an increase in orders as a result of forward buying due to impending 2007 increased emission standards. Net sales of our orthodontic brackets product line were $7.7 million, an increase of $228,000, or
3.1%, from net sales of $7.5 million in the corresponding prior year period. This was the result of a more aggressive sales and marketing plan by our customer.

Our ESK Ceramics subsidiary had net sales for the three months ended September 30, 2006 of $26.5 million, an increase of $300,000, or 1.1%, from the $26.2 million in the corresponding quarter of the prior year. An increase in sales of
ceramic powder to the armor market, net of intercompany sales to Ceradyne, was the main contributing factor. For the nine months ended September 30, 2006, net sales for ESK Ceramics were $82.5 million, an increase of $1.8 million, or 2.1% from
the $80.7 million in the corresponding prior year period. An increase in sales of ceramic powder to the armor market was the main contributing factor.

Our
Semicon Associates division had net sales for the three months ended September 30, 2006 of $2.2 million, an increase of $474,000 or 28.3%, from the $1.7 million in the corresponding quarter of the prior year. For the nine months ended
September 30, 2006, net sales for Semicon Associates were $6.8 million, an increase of $1.4 million or 26.2%, from the $5.4 million in the corresponding prior year period. The increase in sales reflects higher shipments of microwave and laser
cathodes in 2006 versus 2005.

Our Thermo Materials division posted net sales for the three months ended September 30, 2006 of $4.2 million, an
increase of $1.2 million, or 40.7%, from the $3.0 million in the corresponding quarter of the prior year. For the nine months ended September 30, 2006, net sales for the Thermo Materials division were $11.0 million, an increase of $1.8 million,
or 20.0%, from the $9.2 million in the corresponding prior year period. The increase was due to an increase in sales of crucibles used in the manufacture of photovoltaic cells for the solar energy markets and increased sales of components for
defense applications.

Our Ceradyne Canada subsidiary, which commenced operations in July 2006, had net sales for the three months ended September 30,
2006 of $485,000.

Gross Profit. Our gross profit was $70.5 million for the three months ended September 30, 2006, an increase of $35.7
million, or 102.5%, from $34.8 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 38.0% for the three months ended September 30, 2006, compared to 36.9% for the corresponding prior year period. For
the nine months ended September 30, 2006, our gross profit amounted to $188.2 million, an increase of $98.9 million, or 110.8%, from $89.3 million in the corresponding prior year period. As a percentage of net sales, gross profit was 38.9% for
the nine months ended September 30, 2006, compared to 35.1% for the corresponding prior year period. The increase in gross profit and gross profit as a percentage of sales was a result of increased sales, improved sales mix, higher operating
leverage and a reduction in the cost of boron carbide, a key raw material used in the production of body armor. In January 2005, we commenced operations of our Lexington, Kentucky hot press facility where we produce ceramic armor plates. During the
nine months ended September 30, 2005, we incurred start up and training expenses that were significantly reduced during the nine months ended September 30, 2006. The reduction of these expenses caused gross profit to increase.



22



---

##### Table of Contents

Our Advanced Ceramic Operations division posted gross profits of $56.5 million for the three months ended
September 30, 2006, an increase of $31.9 million, or 129.7%, from $24.6 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 37.0% for the three months ended September 30, 2006, compared to 38.7%
for the corresponding prior year quarter. For the nine months ended September 30, 2006, gross profit for the Advanced Ceramic Operations division was $148.9 million, an increase of $89.3 million, or 149.8%, from $59.6 million in the
corresponding prior year period. As a percentage of net sales, gross profit was 38.9% for the nine months ended September 30, 2006, compared to 37.6% for the corresponding prior year period. The reasons for the increase in gross profit for the
nine months ended September 30, 2006 and gross profit as a percentage of sales are consistent with those reasons described in the preceding paragraph. The reduction in gross profit as a percentage of net sales for the three months ended
September 30, 2006 was due to increased scrap rates in body armor due to operator errors during furnace runs at our Lexington plant, increases in the amount of inventory recognized as obsolete and expensed during the quarter due to product
design changes and inventory count adjustments as a result of regular cycle count adjustments. To reduce future operator errors, we have added programmable logic controllers to the furnaces.

Our ESK Ceramics subsidiary had gross profit of $12.9 million for the three months ended September 30, 2006, an increase of $3.6 million or 38.7%, compared to $9.3
million in the prior year quarter. As a percentage of net sales, gross profit was 35.0% for the three months ended September 30, 2006, compared to 35.5% for the corresponding prior year quarter. For the nine months ended September 30,
2006, gross profits for ESK Ceramics was $35.3 million, an increase of $8.0 million, or 29.2%, from $27.3 million in the corresponding prior year period. As a percentage of net sales, gross profit was 32.0% for the nine months ended
September 30, 2006, compared to 29.8% for the corresponding prior year period. The increase in gross profit and gross profit as a percentage of sales for the nine months ended September 30, 2006 was a result of an improved sales mix, as well as
increased sales by our Advanced Ceramic Operations division of products containing boron carbide purchased from ESK Ceramics. Because intercompany sales are eliminated in our consolidated financial statements, the gross profit related to sales of
boron carbide powder by our ESK Ceramics subsidiary to our Advanced Ceramic Operations division are not recognized by ESK Ceramics until the finished product containing the powder is shipped by our Advanced Ceramic Operations division to its
customers.

Our Semicon Associates division had gross profit of $0.6 million, for the three months ended September 30, 2006, an increase of $200,000,
or 56.8%, compared to $352,000 in the prior year quarter. As a percentage of net sales, gross profit was 25.7% for the three months ended September 30, 2006, compared to 21.0% for the corresponding prior year quarter. For the nine months ended
September 30, 2006, gross profit for the Semicon Associates division was $2.0 million, an increase of $0.9 million or 71.1%, from $1.1 million in the corresponding prior year period. As a percentage of net sales, gross profit was 28.6% for the
nine months ended September 30, 2006, compared to 21.1% for the corresponding prior year period. The increase in gross profit and gross profit as a percentage of sales was primarily due to an improved sales mix caused by higher sales of
crucibles and increasing Defense revenues.

Our Thermo Materials division had gross profit of $0.9 million for the three months ended September 30,
2006, an increase of $280,000, or 47.8%, from $0.6 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 20.7% for the three months ended September 30, 2006, compared to 19.7% for the corresponding
prior year quarter. For the nine months ended September 30, 2006, gross profit for the Thermo Materials division was $2.3 million, an increase of $1.1 million or 93.7%, compared to $1.2 million in the prior year period. As a percentage of net
sales, gross profit was 21.0% for the nine months ended September 30, 2006 compared to 13.0% for the corresponding prior year period. The improvements in gross profit and gross profit as a percentage of sales were primarily due to lower sales
of fused silica and casting product lines which have lower gross margins and an increase in the sales of crucibles which have higher gross margins.

Our
Ceradyne Canada subsidiary, which commenced operations in July 2006, had gross loss for the three months ended September 30, 2006 of $261,000. As a percentage of net sales, gross profit loss was 53.8% for the three months ended
September 30, 2006. For the nine months ended September 30, 2006, the gross profit loss was $285,000. As a percentage of net sales, gross profit loss was 58.8% for the nine months ended September 30, 2006. The loss was caused by
operational start up expenses.

Selling Expenses. Our selling expenses were $5.7 million for the three months ended September 30, 2006, an
increase of $0.7 million, or 13.2%, from $5.0 million in the corresponding prior year quarter. Selling expenses, as a percentage of net sales, decreased from 5.3% for the three months ended September 30, 2005 to 3.1% of net sales for the three
months ended September 30, 2006. For the nine months ended September 30, 2006, selling expenses were $17.4 million, an increase of $2.1 million, or 13.4%, from $15.3 million in the corresponding prior year period. Selling expenses, as a
percentage of net sales, decreased from 6.0% for the nine months ended September 30, 2005 to 3.6% for the corresponding current year period. The decrease in selling expenses as a percentage of net sales was due to higher armor sales that did
not require a proportional increase in selling expenses. Increases in the number of employees and related personnel expenses primarily accounted for the increase in selling expenses for the three and nine months ended September 30, 2006.



23



---

##### Table of Contents

General and Administrative Expenses. General and administrative expenses for the three months ended
September 30, 2006 were $8.7 million, an increase of $3.3 million, or 60.7%, from $5.4 million in the corresponding prior year quarter. General and administrative expenses, as a percentage of net sales, decreased from 5.8% for the three months
ended September 30, 2005 to 4.7% of net sales for the three months ended September 30, 2006. For the nine months ended September 30, 2006, general and administrative expenses were $26.1 million, an increase of $10.9 million, or 72.1%,
from $15.2 million in the nine months ended September 30, 2005. General and administrative expenses, as a percentage of net sales, decreased from 6.0% for the nine months ended September 30, 2005 to 5.4% of net sales for the nine months
ended September 30, 2006. The primary reason for the decrease in general and administrative expenses as a percentage of net sales was higher armor sales that did not require a proportional increase in general and administrative expenses. The
reason for the increase in general and administrative expenses for the nine months ended September 30, 2006 was a non-cash charge of $2.2 million in the second quarter based on the results of our Special Committees review of our
historical stock option practices, including our underlying option grant documentation and procedures, as described in more detail above under the caption Overview  Review of Historical Stock Option Grant Procedures, and a related
charge for payroll tax and penalties of $1.2 million. Increases in the number of employees and related personnel expenses including increased bonus accruals as a result of the Companys higher operating profits accounted for the remaining
increase in general and administrative expenses.

Research and Development. Research and development expenses for the three months ended
September 30, 2006 were $2.5 million, an increase of $0.5 million, or 24.3%, from $2.0 million in the corresponding prior year quarter. Research and development expenses, as a percentage of net sales, decreased from 2.2% for the three months
ended September 30, 2005 to 1.4% of net sales for the three months ended September 30, 2006. For the nine months ended September 30, 2006, research and development expenses were $7.7 million, an increase of $2.1 million, or 37.1%,
from $5.6 million in the corresponding prior year period. Research and development expenses, as a percentage of net sales, decreased from 2.2% for the nine months ended September 30, 2005 to 1.6% of net sales for the nine months ended
September 30, 2006. The primary reason for the decrease in research and development expenses as a percentage of net sales was higher armor sales that did not require a proportional increase in research and development expenses. Increases in
research and development expenditures for next generation body armor products and the continuing development of vehicle armor primarily accounted for the increase in research and development expenses for the three and nine months ended
September 30, 2006.

Other Income. Other income, including royalty income, interest income and miscellaneous for the three months ended
September 30, 2006 was $1.5 million, an increase of $1.4 million, or 1082.9%, compared to $129,000 in the corresponding quarter of 2005. Other income for the nine months ended September 30, 2006 was $4.1 million, an increase of $3.6
million, or 670.5%, compared to $0.5 million in the corresponding prior year period. The increase was due primarily to higher interest income received from investing higher cash balances in short-term marketable securities.

Interest Expense. Our interest expense for the three months ended September 30, 2006 was $1.0 million, a decrease of $0.9 million, or 45.4%, compared to $1.9
million in the corresponding prior year period. Interest expense for the nine months ended September 30, 2006 was $3.1 million, a decrease of $1.9 million or 38.2%, compared to $5.0 million in the corresponding prior year period. The decrease
was due to the repayment in December 2005 of our credit facility consisting of a term loan and line of credit, which had a higher interest rate than the convertible debt that we issued in December 2005 to replace it.

Income before Provision for Income Taxes. Our income before provision for income taxes for the three months ended September 30, 2006 was $54.1 million, an
increase of $33.5 million, or 162.6%, from $20.6 million in the corresponding prior year quarter. For the nine months ended September 30, 2006, income before provision for income taxes was $138.0 million, an increase of $89.3 million, or
183.4%, from the $48.7 million in the corresponding prior year period.

Our Advanced Ceramic Operations divisions income before provision for income
taxes for the three months ended September 30, 2006 was $47.7 million, an increase of $29.6 million, or 164.0%, from $18.1 million in the corresponding prior year quarter. For the nine months ended September 30, 2006, the Advanced Ceramic
Operations divisions income before provision for income taxes was $123.2 million, an increase of $81.6 million, or 196.4%, from $41.6 million in the corresponding prior year period. The increase in income before provision for income taxes for
both the three and nine months ended September 30, 2005 was due primarily to higher sales of body armor and a reduction of start up and training expenses in our Lexington, Kentucky hot press facility compared to the first nine months of last
year.

Our ESK Ceramics subsidiarys income before provision for income taxes for the three months ended September 30, 2006 was $6.0 million, an
increase of $3.7 million, or 159.8%, from $2.3 million in the corresponding prior year quarter. For the nine months ended September 30, 2006, ESK Ceramics income before provision for income taxes was $13.2 million, an increase of $6.4
million, or 92.3%, from $6.8 million in the corresponding prior year period. The increase in gross profit and gross profit as a percentage of sales was a result of an improved sales mix, as well as increased sales by our Advanced Ceramic Operations
division of products containing boron carbide purchased from ESK Ceramics. Because intercompany sales are eliminated in our consolidated financial statements, the gross profit related to sales of boron carbide powder by our



24



---

##### Table of Contents

ESK Ceramics subsidiary to our Advanced Ceramic Operations division are not recognized by ESK Ceramics until the finished product containing the powder is
shipped by our Advanced Ceramic Operations division to its customers.

Semicon Associates income before provision for income taxes for the three months
ended September 30, 2006 was $337,000, an increase of $207,000, or 159.2%, from $130,000 in the corresponding prior year quarter. For the nine months ended September 30, 2006, Semicon Associates income before provision for income taxes was
$1.2 million, an increase of $0.7 million, or 136.9%, from $0.5 million in the corresponding prior year period. The increase in income before provision for income taxes for the nine months ended September 30, 2006 was a result of higher sales
of microwave and laser cathodes and increased manufacturing operating leverage while other operating expenses remained relatively constant.

Thermo
Materials income before provision for income taxes for the three months ended September 30, 2006 was $293,000, an increase of $226,000, or 337.3% from $67,000 in the corresponding prior year quarter. For the nine months ended
September 30, 2006, Thermo Materials income before provision for income taxes was $0.7 million, an increase of $0.9 million, from a loss before provision for income taxes of $239,000 in the corresponding prior year period. The increase in
income before provision for income taxes for the three and the nine months ended September 30, 2006 was primarily due to an improved sales mix caused by higher sales of crucibles and increasing Defense revenues.

Income Taxes. We had a combined federal and state tax rate of 31.7% for the three months ended September 30, 2006, resulting in a provision for taxes of
$17.2 million, an increase of $9.9 million, or 136.5%, from $7.3 million, or 35.2% in the corresponding prior year quarter. Our provision for income taxes for the nine months ended September 30, 2006 was $47.3 million, an increase of $29.3
million, or 163.3%, from the $18.0 million in the corresponding prior year period. The effective income tax rate for the nine months ended September 30, 2006 was 34.3% compared to 36.9% in the corresponding prior year period. The decrease in
the effective tax rate results from a lower state tax rate due to apportionment outside of California, increases in domestic production activities deductions and extraterritorial income related deductions.

Liquidity and Capital Resources

We
generally have met our operating and capital requirements with cash flow from operating activities, borrowings under our bank credit facility, and proceeds from the sale of shares of our common stock.

Our net cash position decreased by $31.6 million during the nine months ended September 30, 2006, compared to a $413,000 decrease during the nine months ended
September 30, 2005. For the nine months ended September 30, 2006, cash flow provided by operating activities amounted to $106.6 million compared to $21.3 million during the nine months ended September 30, 2005. The primary
factors contributing to cash flow from operating activities during the nine months ended September 30, 2006 were net income of $90.7 million, depreciation and amortization of $13.2 million, stock compensation of $3.3 million, and
increase in accounts payable and accrued expenses of $22.8 million. These contributions were offset by increases in accounts receivable of $8.7 million, other receivables of $444,000, inventories of $3.8 million, production tooling of
$6.8 million and prepaid expenses and other assets of $2.4 million. The increases in accounts receivable, inventory, tooling and accounts payable were due to the increase in sales and production to support the growth of the ACO segment.

We used $141.9 million of our cash for investing activities, including $27.6 million for capital expenditures, acquisition of a product line and
related assets for $6.6 million and $107.7 million for purchases of short-term investments. Capital expenditures included an $8.0 million capital expenditure for a building and equipment in Canada to enable us to enter into the manufacture and
marketing of structural neutron absorbing materials and metal matrix composites.

Financing activities provided cash of $2.7 million, primarily generated
by the exercises of stock options of $0.9 million and issuance of stock for the employer matching contribution to our 401(k) plan of $0.8 million and tax benefit due to options exercised of $1.1 million. During December 2005, the Company issued
$121.0 million of 2.875% senior subordinated convertible notes (Notes) due December 15, 2035. We received net proceeds of approximately $116.8 million from the Notes offering after deducting offering expenses and underwriting
discounts of $4.2 million.

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.



25



---

##### Table of Contents

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.

On
December 19, 2005, we repaid the existing balance of our term loan of $108.9 million and $9.8 million of our line of credit, and approximately $0.1 million of accrued interest, using a portion of the net proceeds from our concurrent sale of
senior subordinated convertible Notes and common stock. As a result of the early repayment of the term loan, we wrote off the remaining unamortized debt issuance costs of approximately $2.6 million in the fourth quarter of 2005.

In December 2005, the Company established a new unsecured $10.0 million line of credit. As of September 30, 2006, there were no outstanding amounts on the line of
credit. However, the available line of credit at September 30, 2006 has been reduced by an outstanding letter of credit in the amount of $3.8 million. The interest rate on the credit line is based on the LIBOR rate for a period of one month,
plus a margin of one percent, which equaled 6.3% as of September 30, 2006.

Pursuant to the bank line of credit, the Company is subject to certain
covenants, which include, among other things, the maintenance of specified minimum amounts of tangible net worth and quick assets to current liabilities ratio. At September 30, 2006, the Company was in compliance with these covenants.

Our cash, cash equivalents and short-term investments totaled $175.5 million at September 30, 2006, compared to $99.4 million at
December 31, 2005. At September 30, 2006, we had working capital of $294.0 million, compared to $212.3 million at December 31, 2005. Our cash position includes amounts denominated in foreign currencies, and the repatriation
of those 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, 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. 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 current products, enhance our market coverage, technical capabilities or production capacity, or offer growth opportunities. We
have no present commitments or agreements for any material acquisitions.



|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.

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 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



26



---

##### Table of Contents

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 measure the financial statements of our foreign subsidiaries using the local currency as the functional currency. Assets and liabilities of these subsidiaries are
translated at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at the rates of exchange prevailing during the year. Translation adjustments resulting from this process are included in stockholders
equity. Gains and losses from foreign currency transactions are included in other income, miscellaneous.

Our debt is comprised of $121.0 million of a
convertible note with a fixed coupon rate of 2.875%. The fair value of long-term debt was $104.5 million and is based on quoted market prices at September 30, 2006.

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.

Approximately 16.0% of our revenues for the nine months ended September 30, 2006 were derived from
operations outside the United States. Our acquisition of ESK Ceramics provided additional revenues that were derived outside the United States. Therefore, we are subject to fluctuations in sales and earnings reported in U.S. dollars as a result of
changing currency exchange rates.



|Item 4. | Controls and Procedures
|------- | -----------------------

Review of Historical Stock Option
Grant Procedures

In July 2006, the Company voluntarily initiated a review of its historical stock option grant practices and related accounting
treatment. The review was conducted by a special committee comprised of three independent members of the Companys Board of Directors, with the assistance of independent legal counsel and forensic accounting experts. This review has been
completed and the special committee presented its report to the Companys Board of Directors. It was the finding of the special committee that control deficiencies that led to the Company utilizing incorrect measurement dates for stock option
grants had been corrected subsequent to September 2003. The special committee did not propose any recommendations for improvements in the current process of granting stock options and restricted share awards as a result of its investigation.

Additional information regarding the special committees review is provided in this report in Note 3 of the Condensed Notes to Financial Statements.

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as
of September 30, 2006 (the end of the period covered by this report). Based on this evaluation, taking into account the items discussed above in this Item 4, our principal executive officer and principal financial officer concluded that
our current disclosure controls and procedures (as defined in Rules 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934) are effective.

Changes in Internal Control over Financial Reporting

Our management evaluated our internal control over financial reporting and
there have been no changes during the fiscal quarter ended September 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

On August 11, 2006, a shareholder
derivative complaint was filed in the California Superior Court for Orange County by Fritz J. Moennighoff, Case Number 06-CC-00156. On August 25, 2006, a shareholder derivative complaint was filed in the California Superior Court for Orange
County by Larry Menning, Case Number 06-CC-00175. On August 28, 2006, a shareholder derivative complaint was filed in the California Superior Court for Orange County by Rhoda Kubrick, Case



27



---

##### Table of Contents

Number 06-CC-00176. On September 19, 2006, a shareholder derivative complaint was filed in the California Superior Court for Orange County by John King,
Case Number 06-CC-00193. All four complaints were brought purportedly on behalf of the Company against certain of the Companys current and former directors and executive officers. The complaints assert claims for, among other things, breaches
of fiduciary duty by directors and executive officers related to backdating of stock options. The complaints seek to require the individual defendants to rescind stock options they received which have an exercise price below the closing price of the
Companys common stock on the date of grant, to disgorge the proceeds of options exercised, to reimburse the Company for damages of an unspecified amount, and also seek certain equitable relief, attorneys fees and costs. The plaintiff in
the Kubrick case requested voluntary dismissal of her complaint in the Superior Court on or before September 29, 2006, and filed a substantially identical complaint on September 29, 2006, in the United States District Court for the Central
District of California, Case No. SA CV 06-919 JVS (PJWx). The plaintiff in the King case requested voluntary dismissal of his complaint in the Superior Court on or before September 29, 2006, and filed a substantially identical complaint on
September 29, 2006, in the United States District Court for the Central District of California, Case No. SA CV 06-920 JVS (PJWx). The Superior Court granted the plaintiffs requests for dismissal of the Kubrick and King cases on
October 18, 2006. We intend to take all appropriate action in response to these lawsuits. The impact of the outcome of these lawsuits is undeterminable at this time.



|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, 2005.



|Item 2. | Not applicable
|------- | --------------



|Item 3. | Not applicable
|------- | --------------



|Item 4. | Not applicable
|------- | --------------



|Item 5. | Not applicable
|------- | --------------



|Item 6. | Exhibits
|------- | --------



| | (a) | Exhibits:
| | --- | ---------



|     |  |                                                                                                    
|---- |  | ---------------------------------------------------------------------------------------------------
|31.1 |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|     | 
|31.2 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|     | 
|32.1 |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|     | 
|32.2 |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



28



---

##### Table of Contents

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: November 1, 2006 |  |  |  | By:            |  | /s/ JERROLD J. PELLIZZON
|                       |  |  |  |                |  |                          |  | Jerrold J. Pellizzon                        
|                       |  |  |  |                |  |                          |  | Vice President                              
|                       |  |  |  |                |  |                          |  | Chief Financial Officer                     
|                       |  |  |  |                |  |                          |  | (Principal Financial and Accounting Officer)



29



---

##### Table of Contents

Index to Exhibits



|        |  |                                                                                                    
|------- |  | ---------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                        
|31.1    |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|        | 
|31.2    |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|        | 
|32.1    |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|        | 
|32.2    |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



30