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 March 31, 2009




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 jurisdiction
              of
      incorporation or organization)
            (I.R.S.
      Employer
              Identification
      No.)3169
      Red Hill Avenue, Costa Mesa, CA
            92626(Address
      of principal executive)
            (Zip
      Code)




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




N/A


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




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


Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).Yes   ̈    No  x
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
  Large
      accelerated filer  x
              Accelerated
      filer   ̈
              Non-accelerated
      filer   ̈
              Smaller
      reporting company   ̈
  Indicate
by check mark whether the registrant is a shell company (as defined in Exchange
Act Rule 12b-2). Yes   ̈    No  x
  Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.


Class
            Outstanding
      as of April 20, 2009Common
      Stock, $0.01 par value
            25,792,697
      Shares




Exhibit
Index on Page 30
















CERADYNE,
INC.




INDEX




PAGE NO.PART I.
              FINANCIAL
      INFORMATIONItem 1.
              Unaudited Consolidated Financial
      Statements
              
              
              3Consolidated Balance Sheets – March 31, 2009 and
      December 31, 2008
              
              
              3Consolidated Statements of Income –Three months
      ended March 31, 2009 and 2008
              
              
              4Consolidated Statements of Cash Flows – Three months
      ended March 31, 2009 and 2008
              
              
              5Notes to Consolidated Financial
    Statements
              
              
              6-21Item 2.
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              
              
              22-31Item 3.
              Quantitative and Qualitative Disclosures About Market
      Risk
              
              
              32-33Item 4.
              Controls and Procedures
              
              
              33-34PART II.
              OTHER INFORMATIONItem 1.
              Legal Proceedings
              
              
              34-35Item 1A.
              Risk Factors
              
              
              35Item 2.
              Unregistered Sales of Equity Securities and Use of
      Proceeds
              
              
              35Item 3.
              Not applicable
              
              
              36Item 4.
              Not applicable
              
              
              36Item 5.
              Not applicable
              
              
              36Item 6.
              Exhibits
              
              
              36SIGNATURE
              
              
              37





2
 Table of Contents


CERADYNE,
INC.


FORM
10-Q


FOR
THE QUARTER ENDED


March
31, 2009




PART
I. FINANCIAL INFORMATION




Item 1.
            Unaudited Consolidated
      Financial Statements




CERADYNE,
INC.


CONSOLIDATED BALANCE SHEETS


(Amounts in
thousands, except per share data)


March
      31,
                                                                2009
                                                              
                                                              
                                                              December
      31,
                                                                2008(Unaudited)CURRENT
      ASSETSCash
      and cash equivalents
                                                              
                                                              $
                                                              201,190
                                                              
                                                              
                                                              $
                                                              215,282Restricted
      cash
                                                              
                                                              
                                                              2,702
                                                              
                                                              
                                                              
                                                              2,702Short-term
      investments
                                                              
                                                              
                                                              29,383
                                                              
                                                              
                                                              
                                                              6,140Accounts
      receivable, net of allowances for doubtful accounts of
      approximately$664
      and $686 at March 31, 2009 and December 31, 2008,
    respectively
                                                              
                                                              
                                                              59,568
                                                              
                                                              
                                                              
                                                              64,631Other
      receivables
                                                              
                                                              
                                                              4,482
                                                              
                                                              
                                                              
                                                              5,316Inventories,
      net
                                                              
                                                              
                                                              99,588
                                                              
                                                              
                                                              
                                                              101,017Production
      tooling, net
                                                              
                                                              
                                                              13,342
                                                              
                                                              
                                                              
                                                              14,563Prepaid
      expenses and other
                                                              
                                                              
                                                              23,119
                                                              
                                                              
                                                              
                                                              24,170Deferred
      tax asset
                                                              
                                                              
                                                              13,249
                                                              
                                                              
                                                              
                                                              11,967TOTAL
      CURRENT ASSETS
                                                              
                                                              
                                                              446,623
                                                              
                                                              
                                                              
                                                              445,788PROPERTY,
      PLANT AND EQUIPMENT, net
                                                              
                                                              
                                                              246,252
                                                              
                                                              
                                                              
                                                              251,928LONG
      TERM INVESTMENTS
                                                              
                                                              
                                                              23,039
                                                              
                                                              
                                                              
                                                              24,434INTANGIBLE
      ASSETS, net
                                                              
                                                              
                                                              82,489
                                                              
                                                              
                                                              
                                                              84,384GOODWILL
                                                              
                                                              
                                                              44,915
                                                              
                                                              
                                                              
                                                              45,324OTHER
      ASSETS
                                                              
                                                              
                                                              2,388
                                                              
                                                              
                                                              
                                                              2,669TOTAL
      ASSETS
                                                              
                                                              $
                                                              845,706
                                                              
                                                              
                                                              $
                                                              854,527




CURRENT
      LIABILITIESAccounts
      payable
                                                                      
                                                                      $
                                                                      21,260
                                                                      
                                                                      
                                                                      $
                                                                      22,954Accrued
      expenses
                                                                      
                                                                      
                                                                      22,014
                                                                      
                                                                      
                                                                      
                                                                      21,999Income
      taxes payable
                                                                      
                                                                      
                                                                      1,910
                                                                      
                                                                      
                                                                      
                                                                      -TOTAL CURRENT LIABILITIES
                                                                      
                                                                      
                                                                      45,184
                                                                      
                                                                      
                                                                      
                                                                      44,953LONG-TERM
      DEBT
                                                                      
                                                                      
                                                                      103,631
                                                                      
                                                                      
                                                                      
                                                                      102,631EMPLOYEE
      BENEFITS
                                                                      
                                                                      
                                                                      18,680
                                                                      
                                                                      
                                                                      
                                                                      19,088OTHER
      LONG TERM LIABILITIES
                                                                      
                                                                      
                                                                      41,888
                                                                      
                                                                      
                                                                      
                                                                      41,816DEFERRED
      TAX LIABILITY
                                                                      
                                                                      
                                                                      6,079
                                                                      
                                                                      
                                                                      
                                                                      7,045TOTAL
      LIABILITIES
                                                                      
                                                                      
                                                                      215,462
                                                                      
                                                                      
                                                                      
                                                                      215,533COMMITMENTS
      AND CONTINGENCIES (Note 14)SHAREHOLDERS’
      EQUITYCommon
      stock, $0.01 par value, 100,000,000 authorized, 25,792,697 and 25,830,374
      shares issued and outstanding at March 31, 2009 and December 31, 2008,
      respectively
                                                                      
                                                                      
                                                                      259
                                                                      
                                                                      
                                                                      
                                                                      259Additional
      paid in capital
                                                                      
                                                                      
                                                                      163,210
                                                                      
                                                                      
                                                                      
                                                                      163,291Retained
      earnings
                                                                      
                                                                      
                                                                      462,449
                                                                      
                                                                      
                                                                      
                                                                      461,741Accumulated
      other comprehensive income
                                                                      
                                                                      
                                                                      4,326
                                                                      
                                                                      
                                                                      
                                                                      13,703TOTAL
      SHAREHOLDERS’ EQUITY
                                                                      
                                                                      
                                                                      630,244
                                                                      
                                                                      
                                                                      
                                                                      638,994TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
                                                                      
                                                                      $
                                                                      845,706
                                                                      
                                                                      
                                                                      $
                                                                      854,527




See
accompanying condensed notes to Consolidated Financial
Statements


3
 Table of Contents




CERADYNE, INC.


CONSOLIDATED
STATEMENTS OF INCOME


(Amounts
in thousands, except per share data)




Three
      Months Ended March 31,2009
                                                                                            
                                                                                            
                                                                                            2008(Unaudited)NET
      SALES
                                                                                            
                                                                                            $
                                                                                            99,772
                                                                                            
                                                                                            
                                                                                            $
                                                                                            188,537COST
      OF GOODS SOLD
                                                                                            
                                                                                            
                                                                                            76,862
                                                                                            
                                                                                            
                                                                                            
                                                                                            117,008Gross
      profit
                                                                                            
                                                                                            
                                                                                            22,910
                                                                                            
                                                                                            
                                                                                            
                                                                                            71,529OPERATING
      EXPENSESSelling
                                                                                            
                                                                                            
                                                                                            7,044
                                                                                            
                                                                                            
                                                                                            
                                                                                            7,855General
      and administrative
                                                                                            
                                                                                            
                                                                                            9,753
                                                                                            
                                                                                            
                                                                                            
                                                                                            11,815Research
      and development
                                                                                            
                                                                                            
                                                                                            3,472
                                                                                            
                                                                                            
                                                                                            
                                                                                            3,00720,269
                                                                                            
                                                                                            
                                                                                            
                                                                                            22,677Income
      from operations
                                                                                            
                                                                                            
                                                                                            2,641
                                                                                            
                                                                                            
                                                                                            
                                                                                            48,852OTHER
      INCOME (EXPENSE):Royalty
      income
                                                                                            
                                                                                            
                                                                                            -
                                                                                            
                                                                                            
                                                                                            
                                                                                            31Interest
      income
                                                                                            
                                                                                            
                                                                                            728
                                                                                            
                                                                                            
                                                                                            
                                                                                            2,709Interest
      expense
                                                                                            
                                                                                            
                                                                                            (2,085
                                                                                            )
                                                                                            
                                                                                            
                                                                                            (2,014
                                                                                            )Miscellaneous
                                                                                            
                                                                                            
                                                                                            (107
                                                                                            )
                                                                                            
                                                                                            
                                                                                            1,132(1,464
                                                                                            )
                                                                                            
                                                                                            
                                                                                            1,858INCOME
      BEFORE PROVISION FOR INCOME TAXES
                                                                                            
                                                                                            
                                                                                            1,177
                                                                                            
                                                                                            
                                                                                            
                                                                                            50,710PROVISION
      FOR INCOME TAXES
                                                                                            
                                                                                            
                                                                                            469
                                                                                            
                                                                                            
                                                                                            
                                                                                            18,359NET
      INCOME
                                                                                            
                                                                                            $
                                                                                            708
                                                                                            
                                                                                            
                                                                                            $
                                                                                            32,351BASIC
      INCOME PER SHARE
                                                                                            
                                                                                            $
                                                                                            0.03
                                                                                            
                                                                                            
                                                                                            $
                                                                                            1.19DILUTED
      INCOME PER SHARE
                                                                                            
                                                                                            $
                                                                                            0.03
                                                                                            
                                                                                            
                                                                                            $
                                                                                            1.18WEIGHTED
      AVERAGE SHARES OUTSTANDING:BASIC
                                                                                            
                                                                                            
                                                                                            25,822
                                                                                            
                                                                                            
                                                                                            
                                                                                            27,150DILUTED
                                                                                            
                                                                                            
                                                                                            26,033
                                                                                            
                                                                                            
                                                                                            
                                                                                            27,407
































































See
accompanying condensed notes to Consolidated Financial
Statements


4
 Table of Contents




CERADYNE, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Amounts
in thousands)




Three
      Months Ended March 31,2009
                    
                    
                    2008(Unaudited)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                    
                    $
                    708
                    
                    
                    $
                    32,351ADJUSTMENTS
      TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING
      ACTIVITIES:Depreciation
      and amortization
                    
                    
                    9,465
                    
                    
                    
                    8,803Non-cash
      interest expense on convertible debt
                    
                    
                    1,001
                    
                    
                    
                    945Deferred
      income taxes
                    
                    
                    (1,545
                    )
                    
                    
                    (269
                    )Stock
      compensation
                    
                    
                    865
                    
                    
                    
                    630Loss
      on marketable securities
                    
                    
                    104
                    
                    
                    
                    147(Gain)
      loss on equipment disposal
                    
                    
                    (12
                    )
                    
                    
                    1Change
      in operating assets and liabilities:Accounts
      receivable, net
                    
                    
                    4,613
                    
                    
                    
                    (2,679
                    )Other
      receivables
                    
                    
                    680
                    
                    
                    
                    (1,207
                    )Inventories
                    
                    
                    (356
                    )
                    
                    
                    (2,412
                    )Production
      tooling
                    
                    
                    1,173
                    
                    
                    
                    1,708Prepaid
      expenses and other assets
                    
                    
                    1,040
                    
                    
                    
                    253Accounts
      payable and accrued expenses
                    
                    
                    (1,222
                    )
                    
                    
                    4,597Income
      taxes payable
                    
                    
                    1,717
                    
                    
                    
                    16,087Other
      long term liabilities
                    
                    
                    72
                    
                    
                    
                    123Employee
      benefits
                    
                    
                    275
                    
                    
                    
                    337NET
      CASH PROVIDED BY OPERATING ACTIVITES
                    
                    
                    18,578
                    
                    
                    
                    59,415CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property, plant and equipment
                    
                    
                    (7,711
                    )
                    
                    
                    (18,554
                    )Changes
      in restricted cash
                    
                    
                    -
                    
                    
                    
                    (18
                    )Purchases
      of marketable securities
                    
                    
                    (24,583
                    )
                    
                    
                    -Proceeds
      from sales and maturities of marketable securities
                    
                    
                    1,340
                    
                    
                    
                    18,094Proceeds
      from sale of equipment
                    
                    
                    14
                    
                    
                    
                    -NET
      CASH USED IN INVESTING ACTIVITIES
                    
                    
                    (30,940
                    )
                    
                    
                    (478
                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from issuance of stock due to exercise of options and vesting of
      restricted stock units
                    
                    
                    5
                    
                    
                    
                    195Excess
      tax benefit due to exercise of stock options
                    
                    
                    -
                    
                    
                    
                    171Shares
      repurchased
                    
                    
                    (832
                    )
                    
                    
                    (30,313
                    )Other
                    
                    
                    -
                    
                    
                    
                    (126
                    )NET
      CASH USED IN FINANCING ACTIVITIES
                    
                    
                    (827
                    )
                    
                    
                    (30,073
                    )EFFECT
      OF EXCHANGE RATES ON CASH AND EQUIVALENTS
                    
                    
                    (903
                    )
                    
                    
                    1,799INCREASE
      (DECREASE) IN CASH AND CASH EQUIVALENTS
                    
                    
                    (14,092
                    )
                    
                    
                    30,663CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
                    
                    
                    215,282
                    
                    
                    
                    155,103CASH
      AND CASH EQUIVALENTS, END OF PERIOD
                    
                    $
                    201,190
                    
                    
                    $
                    185,766SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW ACTIVITIES:Interest
      paid
                    
                    $
                    7
                    
                    
                    $
                    1Income
      taxes paid
                    
                    $
                    627
                    
                    
                    $
                    3,386




See
accompanying condensed notes to Consolidated Financial
Statements


5
 Table of Contents




CERADYNE, INC.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


MONTHS
ENDED MARCH 31, 2009


(Unaudited)




1.
            Basis of
      Presentation




The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring adjustments) considered necessary
for a fair statement have been included. Operating results for the three months
ended March 31, 2009 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2009.




The
balance sheet at December 31, 2008 has been derived from the audited financial
statements at that date, but does not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for complete financial statements. For further information,
refer to the Consolidated Financial Statements and Notes to Financial Statements
included in Ceradyne’s Annual Report on Form 10-K for the year ended December
31, 2008. 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.




Share-based
compensation expense recognized under SFAS 123(R) for the three months ended
March 31, 2009 was $0.9 million compared to $0.6 million for the three months
ended March 31, 2008, which was related to stock options and restricted stock
units.




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 for the three months ended March 31, 2009 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 provisions of SFAS 123 and
(ii) compensation expense for the share-based payment awards granted
subsequent to December 31, 2005, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123(R). As share-based
compensation expense recognized in the Consolidated Statements of Income for the
three months ended March 31, 2009 is based on awards ultimately expected to
vest, it has been reduced for estimated forfeitures.




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




The
Company was authorized to grant options for up to 2,362,500 shares under its
1994 Stock Incentive Plan. The Company has granted options for 2,691,225 shares
and has had cancellations of 396,911 shares through March 31, 2009. There are no
remaining stock options available to grant under this plan. The options granted
under this plan generally became exercisable over a five-year period for
incentive stock options and six months for nonqualified stock options and have a
maximum term of ten years.




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




The
Company may grant options and Units for up to 1,125,000 shares under the 2003
Stock Incentive Plan. The Company has granted options for 475,125 shares and
Units for 477,476 shares under this plan through March 31, 2009. There have been
cancellations of  81,475 shares associated with this plan through
March 31, 2009. The options under this plan have a life of ten
years.




During
the three months ended March 31, 2009 and 2008, the Company issued Units to
certain directors, officers and employees with weighted average grant date fair
values and Units issued as indicated in the table below. Pursuant to SFAS
123(R), the Company records compensation expense for the amount of the grant
date fair value on a straight line basis over the vesting period.


6
 Table of Contents




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




Three
      Months Ended March 31,2009
                                              
                                              
                                              2008Share-based
      compensation expense recognized:General
      and administrative, options
                                              
                                              $
                                              71
                                              
                                              
                                              $
                                              115General
      and administrative, restricted stock units
                                              
                                              
                                              793
                                              
                                              
                                              
                                              515Related
      deferred income tax benefit
                                              
                                              
                                              (345
                                              )
                                              
                                              
                                              (228
                                              )Decrease
      in net income
                                              
                                              $
                                              519
                                              
                                              
                                              $
                                              402Decrease
      in basic earnings per share
                                              
                                              $
                                              0.02
                                              
                                              
                                              $
                                              0.01Decrease
      in diluted earnings per share
                                              
                                              $
                                              0.02
                                              
                                              
                                              $
                                              0.01




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




As of
March 31, 2009, there was $0.7 million of total unrecognized compensation cost
related to 25,875 non-vested outstanding stock options, with a per share
weighted average value of $20.74. The unrecognized expense is anticipated to be
recognized on a straight-line basis over a weighted average period of 0.7 years.
In addition, the aggregate intrinsic value of stock options exercised was
$22,000 and $499,000 for the three months ended March 31, 2009 and
2008.




As of
March 31, 2009, there was approximately $11.0 million of total unrecognized
compensation cost related to non-vested Units granted under the 2003 Stock
Incentive Plan. That cost is expected to be recognized over a weighted average
period of  3.6  years.




The
following is a summary of stock option activity:




Three
      Months Ended
                                      March
      31, 2009Number
      of
                                      Options
                                    
                                    
                                    Weighted
                                      Average
                                      Exercise
                                      PriceOutstanding,
      December 31, 2008
                                    
                                    
                                    462,900
                                    
                                    
                                    $
                                    12.14Options
      granted
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    -Options
      exercised
                                    
                                    
                                    (1,150
                                    )
                                    
                                    $
                                    4.58Options
      cancelled
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    -Outstanding,
      March 31, 2009
                                    
                                    
                                    461,750
                                    
                                    
                                    $
                                    12.24Exercisable,
      March 31, 2009
                                    
                                    
                                    435,875
                                    
                                    
                                    $
                                    11.73





The
following is a summary of Unit activity:





Three
      Months Ended
                                      March 31,2009Number of
                                      Units
                                    
                                    
                                    Weighted
                                      Average Grant
                                      Fair
      ValueNon-vested
      Units at  December 31, 2008
                                    
                                    
                                    271,264
                                    
                                    
                                    $
                                    45.90Granted
                                    
                                    
                                    82,000
                                    
                                    
                                    $
                                    19.81Vested
                                    
                                    
                                    (5,450
                                    )
                                    
                                    $
                                    41.46Forfeited
                                    
                                    
                                    (17,610
                                    )
                                    
                                    $
                                    54.26Non-vested
      Units at March 31, 2009
                                    
                                    
                                    330,204
                                    
                                    
                                    $
                                    39.05








7
 Table of Contents


The
following table summarizes information regarding options outstanding and options
exercisable at March 31, 2009:




Outstanding
                                            
                                            
                                            ExercisableRange
      of Exercise Prices
                                            
                                            
                                            Number of
                                              Options
                                            
                                            
                                            Average
                                              Remaining
                                              Contractual
                                              Life
      (Years)
                                            
                                            
                                            Weighted
                                              Average
                                              Exercise
                                              Price
                                            
                                            
                                            Aggregate
                                              Intrinsic
                                              Value
                                              (000s)
                                            
                                            
                                            Number of
                                              Options
                                            
                                            
                                            Average
                                              Remaining
                                              Contractual
                                              Life
      (Years)
                                            
                                            
                                            Weighted
                                              Average
                                              Exercise
                                              Price
                                            
                                            
                                            Aggregate
                                              Intrinsic
                                              Value
                                              (000s)$1.44 - $2.81
                                            
                                            
                                            
                                            900
                                            
                                            
                                            
                                            0.47
                                            
                                            
                                            $
                                            1.61
                                            
                                            
                                            $
                                            15
                                            
                                            
                                            
                                            900
                                            
                                            
                                            
                                            0.47
                                            
                                            
                                            $
                                            1.61
                                            
                                            
                                            $
                                            15$2.98 - $4.58
                                            
                                            
                                            
                                            212,825
                                            
                                            
                                            
                                            2.84
                                            
                                            
                                            $
                                            4.12
                                            
                                            
                                            $
                                            2,982
                                            
                                            
                                            
                                            212,825
                                            
                                            
                                            
                                            2.84
                                            
                                            
                                            $
                                            4.12
                                            
                                            
                                            $
                                            2,982$10.53 - $16.89
                                            
                                            
                                            
                                            122,025
                                            
                                            
                                            
                                            4.44
                                            
                                            
                                            $
                                            16.89
                                            
                                            
                                            $
                                            151
                                            
                                            
                                            
                                            122,025
                                            
                                            
                                            
                                            4.44
                                            
                                            
                                            $
                                            16.89
                                            
                                            
                                            $
                                            151$18.80 - $24.07
                                            
                                            
                                            
                                            126,000
                                            
                                            
                                            
                                            5.47
                                            
                                            
                                            $
                                            21.51
                                            
                                            
                                            $
                                            -
                                            
                                            
                                            
                                            100,125
                                            
                                            
                                            
                                            5.41
                                            
                                            
                                            $
                                            21.71
                                            
                                            
                                            $
                                            -461,750
                                            
                                            
                                            
                                            3.98
                                            
                                            
                                            $
                                            12.24
                                            
                                            
                                            $
                                            3,148
                                            
                                            
                                            
                                            435,875
                                            
                                            
                                            
                                            3.87
                                            
                                            
                                            $
                                            11.73
                                            
                                            
                                            $
                                            3,148







The
following table summarizes information regarding Units outstanding at March 31,
2009:







OutstandingRange
      of Grant Prices
                                        
                                        
                                        Number of
                                          Units
                                        
                                        
                                        Average
                                          Remaining
                                          Contractual
                                          Life
      (Years)
                                        
                                        
                                        Weighted
                                          Average
                                          Grant
                                          Fair
      Value$19.78
      - $22.68
                                        
                                        
                                        
                                        103,800
                                        
                                        
                                        
                                        3.99
                                        
                                        
                                        $
                                        20.34$37.41 - $39.43
                                        
                                        
                                        
                                        106,326
                                        
                                        
                                        
                                        3.94
                                        
                                        
                                        $
                                        38.62$42.28
      - $45.70
                                        
                                        
                                        
                                        55,638
                                        
                                        
                                        
                                        3.69
                                        
                                        
                                        $
                                        44.49$52.47
      - $62.07
                                        
                                        
                                        
                                        29,020
                                        
                                        
                                        
                                        2.46
                                        
                                        
                                        $
                                        58.79$66.35
      - $81.18
                                        
                                        
                                        
                                        35,420
                                        
                                        
                                        
                                        2.82
                                        
                                        
                                        $
                                        70.43330,204
                                        
                                        
                                        
                                        3.66
                                        
                                        
                                        $
                                        39.05






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.


8
 Table of Contents




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




Had this
estimated Stock-Based Charge been reflected, as and when incurred, in the
Company’s results of operations for prior years, the impact on net income for
Ceradyne’s fiscal years ended December 31 would have been a reduction of
$21,000 in 1997, a reduction of $45,000 in 1998, a reduction of $47,000 in 1999,
a reduction of $104,000 in 2000, a reduction of $269,000 in 2001, a reduction of
$74,000 in 2002, a reduction of $347,000 in 2003, a reduction of $0.6 million in
2004, and a reduction of $324,000 in 2005. As of March 31, 2009, the total
remaining incremental stock-based compensation charge related to these stock
option grants that are expected to vest in future periods with a revised
accounting measurement date is immaterial. There was no impact on revenue or net
cash provided by operating activities as a result of the estimated compensation
charge.




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




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




4.Net Income Per
      Share




Basic net
income per share is computed by dividing income available to common stockholders
by the weighted average number of common shares outstanding. Diluted net income
per share is computed by dividing income available to common stockholders by the
weighted average number of common shares outstanding plus the effect of any
dilutive stock options and restricted stock units using the treasury stock
method and the net share settlement method for the convertible debt. During the
three months ended March 31, 2009 and 2008, the average trading price of the
Company’s stock did not exceed the conversion price of the convertible
debt.




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







Three
      Months Ended
                                  March
      31,2009
                                
                                
                                2008Weighted
      average number of shares outstanding
                                
                                
                                25,821,573
                                
                                
                                
                                27,149,984Dilutive
      stock options
                                
                                
                                211,621
                                
                                
                                
                                256,516Dilutive
      restricted stock units
                                
                                
                                -
                                
                                
                                
                                -Number
      of shares used in fully diluted computations
                                
                                
                                26,033,194
                                
                                
                                
                                27,406,500




9
 Table of Contents


5.
            Composition of Certain
      Financial Statement Captions




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




Inventories
are valued at the lower of cost (first in, first out) or market. Inventory costs
include the cost of material, labor and manufacturing overhead. The following is
a summary of the inventory components as of March 31, 2009 and December 31, 2008
(in thousands):




March
      31, 2009
                                    
                                    
                                    December
      31, 2008Raw
      materials
                                    
                                    $
                                    17,755
                                    
                                    
                                    $
                                    18,377Work-in-process
                                    
                                    
                                    45,703
                                    
                                    
                                    
                                    45,180Finished
      goods
                                    
                                    
                                    36,130
                                    
                                    
                                    
                                    37,460$
                                    99,588
                                    
                                    
                                    $
                                    101,017




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




March
      31, 2009
                                      
                                      
                                      December
      31, 2008Land
                                      
                                      $
                                      16,671
                                      
                                      
                                      $
                                      17,073Buildings
      and improvements
                                      
                                      
                                      94,762
                                      
                                      
                                      
                                      97,234Machinery
      and equipment
                                      
                                      
                                      204,103
                                      
                                      
                                      
                                      202,963Leasehold
      improvements
                                      
                                      
                                      8,338
                                      
                                      
                                      
                                      8,241Office
      equipment
                                      
                                      
                                      26,084
                                      
                                      
                                      
                                      26,175Construction
      in progress
                                      
                                      
                                      15,466
                                      
                                      
                                      
                                      13,469365,424
                                      
                                      
                                      
                                      365,155Less
      accumulated depreciation and amortization
                                      
                                      
                                      (119,172
                                      )
                                      
                                      
                                      (113,227
                                      )$
                                      246,252
                                      
                                      
                                      $
                                      251,928




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







March
      31, 2009
                                                    
                                                    
                                                    December
      31, 2008Gross
                                                      Amount
                                                    
                                                    
                                                    Accumulated
                                                      Amortization
                                                    
                                                    
                                                    Net
                                                      Amount
                                                    
                                                    
                                                    Gross
                                                      Amount
                                                    
                                                    
                                                    Accumulated
                                                      Amortization
                                                    
                                                    
                                                    Net
                                                      AmountAmortizing
      Intangible AssetsBacklog
                                                    
                                                    $
                                                    1,270
                                                    
                                                    
                                                    $
                                                    1,270
                                                    
                                                    
                                                    $
                                                    -
                                                    
                                                    
                                                    $
                                                    1,795
                                                    
                                                    
                                                    $
                                                    1,795
                                                    
                                                    
                                                    $
                                                    -Developed
      technology
                                                    
                                                    
                                                    42,719
                                                    
                                                    
                                                    
                                                    4,093
                                                    
                                                    
                                                    
                                                    38,626
                                                    
                                                    
                                                    
                                                    42,489
                                                    
                                                    
                                                    
                                                    3,106
                                                    
                                                    
                                                    
                                                    39,383Tradename
                                                    
                                                    
                                                    1,110
                                                    
                                                    
                                                    
                                                    342
                                                    
                                                    
                                                    
                                                    768
                                                    
                                                    
                                                    
                                                    1,110
                                                    
                                                    
                                                    
                                                    302
                                                    
                                                    
                                                    
                                                    808Customer
      relationships
                                                    
                                                    
                                                    46,604
                                                    
                                                    
                                                    
                                                    5,567
                                                    
                                                    
                                                    
                                                    41,037
                                                    
                                                    
                                                    
                                                    46,604
                                                    
                                                    
                                                    
                                                    4,465
                                                    
                                                    
                                                    
                                                    42,139Non-compete
      agreement
                                                    
                                                    
                                                    500
                                                    
                                                    
                                                    
                                                    500
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    500
                                                    
                                                    
                                                    
                                                    500
                                                    
                                                    
                                                    
                                                    -Non-amortizing
      tradename
                                                    
                                                    
                                                    2,058
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    2,058
                                                    
                                                    
                                                    
                                                    2,054
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    2,054Total
                                                    
                                                    $
                                                    94,261
                                                    
                                                    
                                                    $
                                                    11,772
                                                    
                                                    
                                                    $
                                                    82,489
                                                    
                                                    
                                                    $
                                                    94,552
                                                    
                                                    
                                                    $
                                                    10,168
                                                    
                                                    
                                                    $
                                                    84,384




The
estimated useful lives for intangible assets are:








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





Amortization
of definite-lived intangible assets will be approximately (in thousands): $7,336
in fiscal year 2009, $7,033 in fiscal year 2010, $7,502 in fiscal year 2011,
$7,981 in fiscal year 2012 and $8,966 in fiscal year 2013.




10
 Table of Contents


The roll
forward of the goodwill balance by segment during the three months ended March
31, 2009 is as follows (in thousands):




ACO
                                                    
                                                    
                                                    Semicon
                                                    
                                                    
                                                    Thermo
                                                    
                                                    
                                                    ESK
                                                    
                                                    
                                                    Canada
                                                    
                                                    
                                                    Boron
                                                    
                                                    
                                                    TotalBalance
      at December 31, 2008
                                                    
                                                    $
                                                    2,608
                                                    
                                                    
                                                    $
                                                    603
                                                    
                                                    
                                                    $
                                                    10,331
                                                    
                                                    
                                                    $
                                                    9,699
                                                    
                                                    
                                                    $
                                                    3,832
                                                    
                                                    
                                                    $
                                                    18,251
                                                    
                                                    
                                                    $
                                                    45,324Translation
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    (409
                                                    )
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    (409
                                                    )Balance
      at March 31, 2009
                                                    
                                                    $
                                                    2,608
                                                    
                                                    
                                                    $
                                                    603
                                                    
                                                    
                                                    $
                                                    10,331
                                                    
                                                    
                                                    $
                                                    9,290
                                                    
                                                    
                                                    $
                                                    3,832
                                                    
                                                    
                                                    $
                                                    18,251
                                                    
                                                    
                                                    $
                                                    44,915





6.
            Stock
      Repurchases





During
the three months ended March 31, 2009, the Company repurchased and retired
50,000 shares of its common stock at an aggregate cost of $0.8 million under a
stock repurchase program authorized in 2008 by the Company’s Board of
Directors.  During the year ended December 31. 2008, the Company
repurchased and retired 1,578,237 shares of its common stock at an aggregate
cost of $44.7 million. The Company is authorized to repurchase an additional
$54.5 million for a total of $100.0 million.





7.
            Fair Value
      Measurements





On
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements” (“SFAS 157”) as it relates to recurring financial assets and
liabilities. This new standard addresses how companies should measure fair value
when they are required to use a fair value measure for recognition or disclosure
purposes under generally accepted accounting principles. On January 1, 2009, the
Company adopted SFAS 157 for nonfinancial assets and nonfinancial
liabilities that are recognized or disclosed at fair value in the financial
statements on a nonrecurring basis in accordance with the deferral provisions of
FASB Staff Position FAS 157-2. The adoption in 2009 did not have a significant
impact on the financial statements.
  FAS 157
requires that assets and liabilities carried at fair value be classified and
disclosed in one of the following three categories:





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




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




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





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




For recognition purposes, on a
recurring basis, the Company measures available for sale short-term and
long-term investments at fair value. Short-term investments hadan aggregate fair valueof $29.4 million atMarch 31, 2009and $6.1 million at
December 31, 2008. The fair value of these investments is determined using
quoted prices in active markets. Long-term investments, comprising auction rate
securities, hadan
aggregate fair valueof
$23.0 million atMarch 31, 2009and $24.4 million at
December 31, 2008. During thethree monthsendedMarch 31, 2009 and 2008, the Company recognized pre-tax
chargesof $104,000 and
$147,000, respectively,
due to other-than-temporary reductions in the value of its investments in
auction rate securities. The Company also recognized pre-taxcharges of $1.3 million and
$2.4 million againstother comprehensive income during thethree monthsendedMarch 31, 2009 and 2008,respectively, due to temporary
reductions in the value of its investments in auction rate securities.
Cumulatively to date, the Company has incurred $8.1 millionin pre-tax charges due to
other-than-temporary reductions in the value of its investments in auction rate
securities and pre-tax temporary impairment charges against other comprehensiveincome of
$9.9 million.The
Company’s investments in auction rate securities represent interests in
insurance securitizations supported by pools of residential and commercial
mortgages, asset backed securities and other structured credits relating to the
credit risk of various bond guarantors. These auction rate securities were
intended to provide liquidity via an auction process that resets the applicable
interest rate at predetermined calendar intervals, allowing investors to either
roll over their holdings or gain immediate liquidity by selling such interests
at par. During the second half of the year 2007, through2008and through the first quarter of
2009, the auctions for
these securities failed. As a result of current negative conditions in the
global credit markets, auctions for the Company’s investment in these securities
have recently failed to settle on their respective settlement dates.
Consequently, the investments are not currently liquid through the normal
auction process and may be liquid if a buyer is found outside the auction
process.
  11
 Table of Contents
 Prior to June 30, 2008, the
Company was able to determine the fair value of its investments in auction rate
securities using a market approach valuation technique based on Level 2
inputs that did not require significant adjustment. Since June 30, 2008,
the market demand for auction rate securities has declined significantly due to
the complexity of these instruments, the difficulty of determining the values of
some of the underlying assets, declines in the issuer’s credit quality and
disruptions in the credit markets. AtMarch 31, 2009, the Company determined that the
market for its investments in auction rate securities and for similar securities
was not active since there were few observable or recent transactions for these
securities or similar securities. The Company’s investments in auction rate
securities were classified within Level 3 of the fair value hierarchy
because the Company determined that significant adjustments using unobservable
inputs were required to determine fair value as ofMarch 31, 2009.




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




·
              Probability
      of earning maximum rate until
maturity


·
              Probability
      of passing auction at some point in the
future


·
              Probability
      of default at some point in the future (with appropriate loss severity
      assumptions)


The Company determined that the
appropriate risk-free discount rate (before risk adjustments) used to discount
the contractual cash flows of its auction rate securities ranged from0.5% to 3.2%,
basedon the term
structure of the auction rate security. Liquidity risk premiums are used to
adjust the risk-free discount rate for each auction rate security to reflect
uncertainty and observed volatility of the current market environment. This risk
of nonperformance has been captured within the probability of default and loss
severity assumptions noted above. The risk-adjusted discount rate, which
incorporates liquidity risk, appropriately reflects the Company’s estimate of
the assumptions that market participants would use (including probability
weighted inputs noted above) to estimate the selling price of the asset at the
measurement date.
  In determining whether the decline in
value of the ARS investments was other-than-temporary, the Company considered
several factors including, but not limited to, the following: (1) the
reasons for the decline in value (credit event, interest related or market
fluctuations); (2) the Company’s ability and intent to hold the investments
for a sufficient period of time to allow for recovery of value; (3) whether
the decline is substantial; and (4) the historical and anticipated duration
of the events causing the decline in value. The evaluation for
other-than-temporary impairments is a quantitative and qualitative process,
which is subject to various risks and uncertainties. The risks and uncertainties
include changes in the credit quality of the securities, changes in liquidity as
a result of normal market mechanisms or issuer calls of the securities, and the
effects of changes in interest rates.




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




At March
31, 2009, the Company had no derivative financial instruments.




12
 Table of Contents


Assets
measured at fair value on a recurring basis include the following as of March
31, 2009:




Fair
      Value Measurements at March 31, 2009 Using(In
      thousands)
                                                                    
                                                                    Quoted
      Prices in Active Markets
                                                                      (Level
      1)
                                                                    
                                                                    
                                                                    Significant
      Other Observable Inputs
                                                                      (Level
      2)
                                                                    
                                                                    
                                                                    Significant
      Unobservable Inputs
                                                                      (Level
      3)
                                                                    
                                                                    
                                                                    Total
      Carrying Value at
                                                                      March
      31, 2009Cash
      and cash equivalents (including restricted cash)
                                                                    
                                                                    $
                                                                    203,892
                                                                    
                                                                    
                                                                    $
                                                                    -
                                                                    
                                                                    
                                                                    $
                                                                    -
                                                                    
                                                                    
                                                                    $
                                                                    203,892Short
      term investments
                                                                    
                                                                    
                                                                    29,383
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    29,383Long
      term investments
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    23,039
                                                                    
                                                                    
                                                                    
                                                                    23,039Other
      long term financial asset
                                                                    
                                                                    
                                                                    1,186
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    1,186





Fair
      Value Measurements at December 31, 2008 Using(In
      thousands)
                                
                                Quoted
      Prices in Active Markets
                                  (Level
      1)
                                
                                
                                Significant
      Other Observable Inputs
                                  (Level
      2)
                                
                                
                                Significant
      Unobservable Inputs
                                  (Level
      3)
                                
                                
                                Total
      Carrying Value at
                                  December
      31, 2008Cash
      and cash equivalents (including restricted cash)
                                
                                $
                                217,984
                                
                                
                                $
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                217,984Short
      term investments
                                
                                
                                6,140
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                6,140Long
      term investments
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                24,434
                                
                                
                                
                                24,434Other
      long term financial asset
                                
                                
                                1,355
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1,355





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





Three
      Months Ended March 31,2009
                              
                              
                              2008Balance
      at beginning of period
                              
                              $
                              24,434
                              
                              
                              $
                              38,089Unrealized
      loss included in net earnings
                              
                              
                              (104
                              )
                              
                              
                              (147
                              )Unrealized
      loss included in other comprehensive income
                              
                              
                              (1,291
                              )
                              
                              
                              (2,378
                              )Balance
      at end of period
                              
                              $
                              23,039
                              
                              
                              $
                              35,564





On an
annual recurring basis, the Company is required to use fair value measures when
measuring plan assets of the Company’s pension plans. As the Company elected to
adopt the measurement date provisions of SFAS No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement Plans”, as of
January 1, 2007, the Company was required to determine the fair value of
the Company’s pension plan assets as of December 31, 2008. The fair value
of pension plan assets was $6.4 million at December 31, 2008. These
assets are valued in highly liquid markets.


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


For
disclosure purposes, the Company is required to measure the fair value of
outstanding debt on a recurring basis. The fair value of outstanding debt is
determined using quoted prices in active markets. The fair value of long-term
debt, based on quoted market prices, was $96.4 million at March 31, 2009
and $83.2 million at December 31, 2008.
  13
 Table of Contents


8.
            Recent Accounting
      Pronouncements




In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations”
(“SFAS 141R”) which establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree. The statement also provides guidance for recognizing
and measuring the goodwill acquired in the business combination and determines
what information to disclose to enable users of the financial statement to
evaluate the nature and financial effects of the business combination.
SFAS 141R is effective for financial statements issued for fiscal years
beginning after December 15, 2008. The Company adopted this standard on
January 1, 2009 which did not have an impact on its financial position, results
of operations or cash flows as there have been no acquisitions that have been
consummated after January 1, 2009.




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”).
SFAS 160 introduces significant changes in the accounting and reporting for
business acquisitions and noncontrolling interest ("NCI") in a subsidiary. SFAS
160 also changes the accounting for and reporting for the deconsolidation of a
subsidiary. Companies are required to adopt the new standard for fiscal years
beginning after January 1, 2009. The Company adopted this standard on January 1,
2009 which did not have an impact on its financial position, results of
operations or cash flows as the Company owns 100% of its subsidiaries and there
has been no deconsolidation of a subsidiary after January 1, 2009.


In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities - an amendment of FASB Statement No. 133” (“SFAS 161”),
which changes the disclosure requirements for derivative instruments and hedging
activities. Entities are required to provide enhanced disclosures about (a) how
and why an entity uses derivative instruments, (b) how derivative instruments
and related hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
The Company adopted this standard on January 1, 2009 which did not have an
impact on its financial position, results of operations or cash flows as there
were no derivative instruments or hedging activities after January 1,
2009.
  In June
2008, the FASB issued FSP Emerging Issues Task Force (EITF) No. 03-6-1,
“Determining Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities.” Under the FSP, unvested share-based payment awards
that contain rights to receive nonforfeitable dividends (whether paid or unpaid)
are participating securities, and should be included in the two-class method of
computing EPS. The Company adopted this standard on January 1, 2009 which did
not have an impact on its financial position, results of operations or cash
flows as the unvested share-based awards do not contain rights to receive
nonforfeitable dividends.




In April
2008, FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets”
(“FSP No. FAS 142-3”) was issued which provides for additional considerations to
be used in determining useful lives and requires additional disclosure regarding
renewals. The Company adopted this standard on January 1, 2009 which did not
have a significant impact on its financial position, results of operations or
cash flows.




In April
2009, the FASB issued the three new accounting standards which are required to
be adopted no later than periods ending after June 15, 2009. The Company is
currently evaluating the impact of the following:




i.)   FASB
Staff Position FAS 157-4, “Determining Whether a Market Is Not Active and a
Transaction Is Not Distressed”  (“FSP FAS 157-4”) provides guidelines
for making fair value measurements more consistent with the principles presented
in SFAS 157. FSP FAS 157-4 provides additional authoritative guidance in
determining whether a market is active or inactive, and whether a transaction is
distressed, is applicable to all assets and liabilities (i.e. financial and
nonfinancial) and will require enhanced disclosures.




ii.)   FASB
Staff Position FAS 115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments” provides additional guidance to provide
greater clarity about the credit and noncredit component of an
other-than-temporary impairment event and to improve presentation and disclosure
of other than temporary impairments in the financial statements.




iii.)   FASB
Staff Position FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of
Financial Instruments” amends FASB Statement No. 107, “Disclosures about Fair
Value of Financial Instruments”, to require disclosures about fair value of
financial instruments in interim as well as in annual financial statements. This
FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require
those disclosures in all interim financial statements.




14
 Table of Contents


9.
            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.





In May
2008, FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible
Debt Instruments That May be Settled in Cash upon Conversion (Including Partial
Cash Settlement)” (“FSP APB 14-1”) was issued which specifies that issuers of
such instruments should separately account for the liability and equity
components in a manner that will reflect the issuer’s nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. The
Company adopted FSP APB 14-1 as of January 1, 2009, and the adoption impacted
the historical accounting for the Notes, and in accordance with the Statement
resulted in the following retrospective changes in long-term debt, debt issuance
costs (included in other noncurrent assets), deferred tax liability, additional
paid in capital and retained earnings:





(in
      Thousands)
                        
                        Net
      Increase (Decrease)Long
      -Term
                          Debt
                        
                        
                        Debt
      Issuance Costs
                        
                        
                        Deferred
      Tax Liability
                        
                        
                        Additional
      Paid In Capital
                        
                        
                        Retained
      EarningsAllocation
      of long term debt proceeds and issuance costs
                          to
      equity component on issuance date
                        
                        $
                        (29,261
                        )
                        
                        $
                        (1,018
                        )
                        
                        $
                        11,015
                        
                        
                        $
                        17,228
                        
                        
                        $
                        -Cumulative
      retrospective impact from amortization of
                          discount
      on liability component and debt issuance costs
                        
                        
                        7,009
                        
                        
                        
                        385
                        
                        
                        
                        (2,584
                        )
                        
                        
                        -
                        
                        
                        
                        (4,040
                        )Cumulative
      retrospective impact at January 1, 2008
                        
                        
                        (22,252
                        )
                        
                        
                        (633
                        )
                        
                        
                        8,431
                        
                        
                        
                        17,228
                        
                        
                        
                        (4,040
                        )Retrospective
      impact from amortization of discount on
                          liablity
      component and debt issuance costs during the year
                        
                        
                        3,883
                        
                        
                        
                        163
                        
                        
                        
                        (1,450
                        )
                        
                        
                        -
                        
                        
                        
                        (2,270
                        )Cumulative
      retrospective impact at December 31, 2008
                        
                        $
                        (18,369
                        )
                        
                        $
                        (470
                        )
                        
                        $
                        6,981
                        
                        
                        $
                        17,228
                        
                        
                        $
                        (6,310
                        )





The
adoption of FSP APB 14-1 also resulted in increased interest expense of
approximately $0.9 million and decreased net income by $0.5 million for the
three months ended March 31, 2008. The retrospective impact to earnings per
share was a decrease of $0.02 for the three months ended March 31,
2008. The Company expects to file a Form 8-K in May 2009 to reflect the
adoption of FSP APB 14-1 for the 2008, 2007 and 2006 financial statements. As a
result of the adoption of FSP APB 14-1, interest expense for the three months
ended March 31, 2009 includes non-cash interest expense from amortization of the
discount on the liability component of $1.0 million and amortization of debt
issuance costs of $110,000 which reduced net income by $0.7 million and earnings
per share by $0.03 for the three months ended March 31,
2009.


As of
March 31, 2009 and December 31, 2008, long-term debt and the equity component
(recorded in additional paid in capital, net of income tax benefit) associated
with FSP APB 14-1 comprised the following (in thousands):





March
      31, 2009
                                    
                                    
                                    December
      31, 2008Long-term
      debtPrincipal
      amount
                                    
                                    $
                                    121,000
                                    
                                    
                                    $
                                    121,000Unamortized
      discount
                                    
                                    
                                    (17,369
                                    )
                                    
                                    
                                    (18,369
                                    )Net
      carrying amount
                                    
                                    $
                                    103,631
                                    
                                    
                                    $
                                    102,631Equity
      component, net of income tax benefit
                                    
                                    $
                                    17,228
                                    
                                    
                                    $
                                    17,228





The
discount on the liability component of long-term debt is being amortized using
the effective interest method based on an annual effective rate of 7.5%, which
represented the market interest rate for similar debt without a conversion
option on the issuance date, through December 2012, which coincides with the
first date that holders of the Notes can exercise their put option as discussed
below. The amount of interest expense recognized relating to both the
contractual interest coupon and the amortization of the discount on the
liability component for the three months ended March 31, 2009 and 2008 was $1.9
million and $1.8 million, respectively.




Interest
on the Notes is payable on December 15 and June 15 of each year,
commencing on June 15, 2006. The Notes are convertible into 17.1032 shares
of Ceradyne’s common stock for each $1,000 principal amount of the Notes (which
represents a conversion price of approximately $58.47 per share), subject to
adjustment. The Notes are convertible only under certain circumstances,
including if the price of the Company’s common stock reaches specified
thresholds, if the Notes are called for redemption, if specified corporate
transactions or fundamental changes occur, or during the 10 trading days prior
to maturity of the Notes. The Company may redeem the Notes at any time after
December 20, 2010, for a price equal to 100% of the principal amount plus
accrued and unpaid interest, including contingent interest (as described below),
if any, up to but excluding the redemption date. As of March 31, 2009, the
principal amount of the Notes exceeded the hypothetical if-converted value as
the conversion price was higher than the average market price of the Company’s
common stock.




15
 Table of Contents


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




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




The
Company is obligated to pay contingent interest to the holders of the Notes
during any six-month period from June 15 to December 14 and from
December 15 to June 14, commencing with the six-month period beginning
December 20, 2010 and ending on June 14, 2011, if the average trading
price of the note for the five trading day period ending on the third trading
day immediately preceding the first day of the relevant contingent interest
period equals $1,200 (120% of the principal amount of a note) or more. The
amount of contingent interest payable per note for any relevant contingent
interest period shall equal 0.25% per annum of the average trading price of
a note for the five trading day period ending on the third trading day
immediately preceding the first day of the relevant contingent interest period.
This contingent interest payment feature represents an embedded derivative.
However, based on the de minimus value associated with this feature, no value
has been assigned at issuance and at March 31, 2009.




On or
prior to the maturity date of the Notes, upon the occurrence of a fundamental
change, under certain circumstances, the Company will provide for a make whole
amount by increasing, for the time period described herein, the conversion rate
by a number of additional shares for any conversion of the Notes in connection
with such fundamental change transactions. The amount of additional shares will
be determined based on the price paid per share of Ceradyne’s common stock in
the transaction constituting a fundamental change and the effective date of such
transaction. This make whole premium feature represents an embedded derivative.
Since this feature has no measurable impact on the fair value of the Notes and
no separate trading market exists for this derivative, the value of the embedded
derivative was determined to be de minimus. Accordingly, no value has been
assigned at issuance or at March 31, 2009.




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




In
December 2005, the Company established a new unsecured $10.0 million line of
credit. As of March 31, 2009, there were no outstanding amounts on the line of
credit. However, the available line of credit at March 31, 2009 has been reduced
by outstanding letters of credit in the aggregate amount of $1.8 million. The
interest rate on the credit line was 1.1% as of March 31, 2009, which is based
on the LIBOR rate for a period of one month, plus a margin of 0.6
percent.




Pursuant
to the bank line of credit, the Company is subject to certain covenants, which
include, among other things, the maintenance of specified minimum amounts of
tangible net worth and quick assets to current liabilities ratio. At March 31,
2009, the Company was in compliance with these covenants.




16
 Table of Contents


10.
            Disclosure About
      Segments of an Enterprise and Related
  Information




The
Company serves its markets and manages its business through six operating
segments, each of which has its own manufacturing facilities and administrative
and selling functions. The financial information for all segments is presented
below (in thousands):





Three
      Months Ended March 31,2009
                                                                                            
                                                                                            
                                                                                            2008Revenue from External
    CustomersAdvanced
      Ceramic Operations (ACO)
                                                                                            
                                                                                            $
                                                                                            56,250
                                                                                            
                                                                                            
                                                                                            $
                                                                                            129,987ESK
      Ceramics
                                                                                            
                                                                                            
                                                                                            23,586
                                                                                            
                                                                                            
                                                                                            
                                                                                            39,276Semicon
      Associates
                                                                                            
                                                                                            
                                                                                            2,076
                                                                                            
                                                                                            
                                                                                            
                                                                                            2,269Thermo
      Materials
                                                                                            
                                                                                            
                                                                                            16,211
                                                                                            
                                                                                            
                                                                                            
                                                                                            17,303Ceradyne
      Canada
                                                                                            
                                                                                            
                                                                                            313
                                                                                            
                                                                                            
                                                                                            
                                                                                            2,562Boron
                                                                                            
                                                                                            
                                                                                            6,049
                                                                                            
                                                                                            
                                                                                            
                                                                                            5,032Inter-segment
      elimination
                                                                                            
                                                                                            
                                                                                            (4,713
                                                                                            )
                                                                                            
                                                                                            
                                                                                            (7,892
                                                                                            )Total
                                                                                            
                                                                                            $
                                                                                            99,772
                                                                                            
                                                                                            
                                                                                            $
                                                                                            188,537Depreciation and
    AmortizationACO
                                                                                            
                                                                                            $
                                                                                            2,599
                                                                                            
                                                                                            
                                                                                            $
                                                                                            2,487ESK
      Ceramics
                                                                                            
                                                                                            
                                                                                            3,138
                                                                                            
                                                                                            
                                                                                            
                                                                                            3,051Semicon
      Associates
                                                                                            
                                                                                            
                                                                                            93
                                                                                            
                                                                                            
                                                                                            
                                                                                            89Thermo
      Materials
                                                                                            
                                                                                            
                                                                                            1,348
                                                                                            
                                                                                            
                                                                                            
                                                                                            1,278Ceradyne
      Canada
                                                                                            
                                                                                            
                                                                                            310
                                                                                            
                                                                                            
                                                                                            
                                                                                            243Boron
                                                                                            
                                                                                            
                                                                                            1,977
                                                                                            
                                                                                            
                                                                                            
                                                                                            1,655Total
                                                                                            
                                                                                            $
                                                                                            9,465
                                                                                            
                                                                                            
                                                                                            $
                                                                                            8,803Segment Income (Loss) before Provision for Income
      TaxesACO
                                                                                            
                                                                                            $
                                                                                            4,247
                                                                                            
                                                                                            
                                                                                            $
                                                                                            42,745ESK
      Ceramics
                                                                                            
                                                                                            
                                                                                            (4,389
                                                                                            )
                                                                                            
                                                                                            
                                                                                            2,626Semicon
      Associates
                                                                                            
                                                                                            
                                                                                            234
                                                                                            
                                                                                            
                                                                                            
                                                                                            482Thermo
      Materials
                                                                                            
                                                                                            
                                                                                            3,632
                                                                                            
                                                                                            
                                                                                            
                                                                                            3,086Ceradyne
      Canada
                                                                                            
                                                                                            
                                                                                            (769
                                                                                            )
                                                                                            
                                                                                            
                                                                                            666Boron
                                                                                            
                                                                                            
                                                                                            (1,753
                                                                                            )
                                                                                            
                                                                                            
                                                                                            484Inter-segment
      elimination
                                                                                            
                                                                                            
                                                                                            (25
                                                                                            )
                                                                                            
                                                                                            
                                                                                            621Total
                                                                                            
                                                                                            $
                                                                                            1,177
                                                                                            
                                                                                            
                                                                                            $
                                                                                            50,710Segment AssetsACO
                                                                                            
                                                                                            $
                                                                                            392,274
                                                                                            
                                                                                            
                                                                                            $
                                                                                            410,481ESK
      Ceramics
                                                                                            
                                                                                            
                                                                                            209,922
                                                                                            
                                                                                            
                                                                                            
                                                                                            240,810Semicon
      Associates
                                                                                            
                                                                                            
                                                                                            6,046
                                                                                            
                                                                                            
                                                                                            
                                                                                            5,913Thermo
      Materials
                                                                                            
                                                                                            
                                                                                            98,064
                                                                                            
                                                                                            
                                                                                            
                                                                                            74,462Ceradyne
      Canada
                                                                                            
                                                                                            
                                                                                            21,139
                                                                                            
                                                                                            
                                                                                            
                                                                                            24,017Boron
                                                                                            
                                                                                            
                                                                                            118,261
                                                                                            
                                                                                            
                                                                                            
                                                                                            70,214Total
                                                                                            
                                                                                            $
                                                                                            845,706
                                                                                            
                                                                                            
                                                                                            $
                                                                                            825,897Expenditures for PP&EACO
                                                                                            
                                                                                            $
                                                                                            1,184
                                                                                            
                                                                                            
                                                                                            $
                                                                                            497ESK
      Ceramics
                                                                                            
                                                                                            
                                                                                            1,424
                                                                                            
                                                                                            
                                                                                            
                                                                                            11,454Semicon
      Associates
                                                                                            
                                                                                            
                                                                                            51
                                                                                            
                                                                                            
                                                                                            
                                                                                            84Thermo
      Materials
                                                                                            
                                                                                            
                                                                                            4,793
                                                                                            
                                                                                            
                                                                                            
                                                                                            4,376Ceradyne
      Canada
                                                                                            
                                                                                            
                                                                                            100
                                                                                            
                                                                                            
                                                                                            
                                                                                            2,036Boron
                                                                                            
                                                                                            
                                                                                            159
                                                                                            
                                                                                            
                                                                                            
                                                                                            107Total
                                                                                            
                                                                                            $
                                                                                            7,711
                                                                                            
                                                                                            
                                                                                            $
                                                                                            18,554





17
 Table of Contents


Three
      Months Ended March 31,2009
                                                                
                                                                
                                                                2008Percentage of U.S. net sales from external
      customersACO
                                                                
                                                                
                                                                55
                                                                %
                                                                
                                                                
                                                                65
                                                                %ESK
      Ceramics
                                                                
                                                                
                                                                2
                                                                %
                                                                
                                                                
                                                                2
                                                                %Semicon
      Associates
                                                                
                                                                
                                                                2
                                                                %
                                                                
                                                                
                                                                1
                                                                %Thermo
      Materials
                                                                
                                                                
                                                                7
                                                                %
                                                                
                                                                
                                                                4
                                                                %Ceradyne
      Canada
                                                                
                                                                
                                                                0
                                                                %
                                                                
                                                                
                                                                1
                                                                %Boron
                                                                
                                                                
                                                                2
                                                                %
                                                                
                                                                
                                                                2
                                                                %Total
      percentage of U.S. net sales from external customers
                                                                
                                                                
                                                                68
                                                                %
                                                                
                                                                
                                                                75
                                                                %Percentage of foreign net sales from external
      customersACO
                                                                
                                                                
                                                                2
                                                                %
                                                                
                                                                
                                                                3
                                                                %ESK
      Ceramics
                                                                
                                                                
                                                                18
                                                                %
                                                                
                                                                
                                                                15
                                                                %Semicon
      Associates
                                                                
                                                                
                                                                0
                                                                %
                                                                
                                                                
                                                                0
                                                                %Thermo
      Materials
                                                                
                                                                
                                                                8
                                                                %
                                                                
                                                                
                                                                5
                                                                %Ceradyne
      Canada
                                                                
                                                                
                                                                0
                                                                %
                                                                
                                                                
                                                                1
                                                                %Boron
                                                                
                                                                
                                                                4
                                                                %
                                                                
                                                                
                                                                1
                                                                %Total
      percentage of foreign net sales from external customers
                                                                
                                                                
                                                                32
                                                                %
                                                                
                                                                
                                                                25
                                                                %Percentage of total net sales from
      external customersACO
                                                                
                                                                
                                                                57
                                                                %
                                                                
                                                                
                                                                68
                                                                %ESK
      Ceramics
                                                                
                                                                
                                                                20
                                                                %
                                                                
                                                                
                                                                17
                                                                %Semicon
      Associates
                                                                
                                                                
                                                                2
                                                                %
                                                                
                                                                
                                                                1
                                                                %Thermo
      Materials
                                                                
                                                                
                                                                15
                                                                %
                                                                
                                                                
                                                                9
                                                                %Ceradyne
      Canada
                                                                
                                                                
                                                                0
                                                                %
                                                                
                                                                
                                                                2
                                                                %Boron
                                                                
                                                                
                                                                6
                                                                %
                                                                
                                                                
                                                                3
                                                                %Total
      percentage of total net sales from external customers
                                                                
                                                                
                                                                100
                                                                %
                                                                
                                                                
                                                                100
                                                                %







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




Three
      Months Ended March 31,2009
                                  
                                  
                                  2008Armor
                                  
                                  $
                                  49,815
                                  
                                  
                                  $
                                  115,572Automotive
                                  
                                  
                                  1,971
                                  
                                  
                                  
                                  4,022Orthodontics
                                  
                                  
                                  2,482
                                  
                                  
                                  
                                  2,733Industrial
                                  
                                  
                                  1,982
                                  
                                  
                                  
                                  7,660$
                                  56,250
                                  
                                  
                                  $
                                  129,987




11.
            Pension and Other
      Post-retirement Benefit Plans




The
Company provides pension benefits to its employees in Germany. These pension
benefits are rendered for the time after the retirement of the employees by
payments into legally independent pension and relief facilities. They are
generally based on length of service, wage level and position in the company.
The direct and indirect obligations comprise obligations for pensions that are
already paid currently and expectations for those pensions payable in the
future. The Company has four separate plans in Germany: a) Pensionskasse -
Old; b) Pensionskasse - New; c) Additional Compensation Plan; and d) Deferred
Compensation Plan. For financial accounting purposes, the Additional and
Deferred Compensation Plans are accounted for as single-employer defined benefit
plans, Pensionskasse - Old is a multiemployer defined benefit plan and the
Pensionskasse - New is a defined contribution plan. The Company also provides
pension benefits to its employees of Ceradyne Boron Products located in Quapaw,
Oklahoma. There are two defined benefit retirement plans, one for eligible
salaried employees and one for hourly employees. The benefits for the salaried
employee plan are based on years of credited service and compensation. The
benefits for the hourly employee plan are based on stated amounts per year of
service.




18
 Table of Contents


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




Three Months Ended March
      31,2009
                                  
                                  
                                  2008Service
      cost
                                  
                                  $
                                  169
                                  
                                  
                                  $
                                  144Interest
      cost
                                  
                                  
                                  290
                                  
                                  
                                  
                                  275Expected
      return on plan assets
                                  
                                  
                                  (124
                                  )
                                  
                                  
                                  (200
                                  )Amortization
      of unrecognized loss
                                  
                                  
                                  67
                                  
                                  
                                  
                                  -Net
      periodic benefit cost
                                  
                                  $
                                  402
                                  
                                  
                                  $
                                  219




12.
            Financial
      Instruments




The
Company occasionally enters into foreign exchange forward contracts to reduce
earnings and cash flow volatility associated with foreign exchange rate changes
to allow management to focus its attention on its core business operations.
Accordingly, the Company enters into contracts which change in value as foreign
exchange rates change to economically offset the effect of changes in value of
foreign currency assets and liabilities, commitments and anticipated foreign
currency denominated sales and operating expenses. The Company enters into
foreign exchange forward contracts in amounts between minimum and maximum
anticipated foreign exchange exposures, generally for periods not to exceed one
year. These derivative instruments are not designated as accounting hedges.
There were no derivative financial instruments as of March 31,
2009.




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




13.
            Income
      Taxes




The
Company has adopted FASB Interpretation No. 48 (“FIN 48”), “Accounting for
Uncertainty in Income Taxes”, and it is the Company's policy to classify accrued
interest and penalties as part of the accrued FIN 48 liability and record the
expense in the provision for income taxes.





Components
of the required reserve at March 31, 2009 and December 31, 2008 are as follows
(in thousands):





March
      31, 2009
                              
                              
                              December
      31, 2008Federal,
      state and foreign unrecognized tax benefits (“UTBs”)
                              
                              $
                              7,482
                              
                              
                              $
                              7,227Interest
                              
                              
                              2,085
                              
                              
                              
                              1,903Federal/State
      Benefit of Interest
                              
                              
                              (649
                              )
                              
                              
                              (580
                              )Total
      reserve for UTBs
                              
                              $
                              8,918
                              
                              
                              $
                              8,550





It is
anticipated that any change in the above UTBs will impact the effective tax
rate. For UTBs that exist at March 31, 2009, the Company anticipates there will
be a reduction of approximately $3.2 million in the next twelve months. At March
31, 2009, the 2003 through 2008 years are open and subject to potential
examination in one or more jurisdictions. The Company is currently under federal
income tax examinations for the 2005 through 2007 tax years and under state
income tax examinations for the tax years 2003 through 2005.





Income
taxes are determined using an annual effective tax rate, which generally differs
from the United States federal statutory rate, primarily because of state taxes
and research and development tax credits. The Company recognizes deferred tax
assets and liabilities for temporary differences between the financial and tax
reporting of the Company's assets and liabilities, along with net operating loss
and credit carry forwards.




19
 Table of Contents


14.
            Commitments and
      Contingencies




The
Company leases certain of its manufacturing facilities under noncancelable
operating leases expiring at various dates through June 2013. The Company
incurred rental expense under these leases of $0.8 million and $0.7 million for
the three months ended March 31, 2009 and 2008, respectively. The approximate
minimum rental commitments required under existing noncancelable leases as of
March 31, 2009 are as follows (in thousands):






2009
                                                
                                                $
                                                2,3432010
                                                
                                                
                                                2,8222011
                                                
                                                
                                                9662012
                                                
                                                
                                                4422013
                                                
                                                
                                                151Thereafter
                                                
                                                
                                                8$
                                                6,732




In
August, September and December 2006, shareholder derivative lawsuits were filed
in the California Superior Court for Orange County, purportedly on behalf of
Ceradyne against various current and former officers and directors of the
Company relating to alleged backdating of stock options. Each state court
complaint alleged claims for breach of fiduciary duty, abuse of control, gross
mismanagement, waste of corporate assets, unjust enrichment, accounting,
rescission, constructive trust, and violations of California Corporations Code.
All state court actions have been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Orange County Superior Court, Case No.
06−CC−00156.




In
September and December 2006, shareholder derivative lawsuits were filed in the
United States District Court for the Central District of California, purportedly
on behalf of Ceradyne against various current and former officers and directors
of the Company relating to alleged backdating of stock options. All federal
court actions have been consolidated into one case, designated, In re Ceradyne,
Inc. Derivative Litigation, Master File No. SA CV 06−919 JVS. The consolidated
federal action alleges, pursuant to a first amended consolidated complaint filed
on September 17, 2007,  claims for violations of Section 10(b) of the
Securities Exchange Act and Rule 10b-5 thereunder, violations of Section 14(a)
of the Securities Exchange Act, violations of Section 20(a) of the Securities
Exchange Act, insider selling under the California Corporations Code, as well as
common law claims for accounting, breach of fiduciary duty, aiding and abetting
breaches of fiduciary duty, unjust enrichment, rescission and
waste.




The
plaintiffs in both the state and federal actions seek to require the individual
defendants to rescind stock options they received which have an exercise price
below the closing price of the 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.




On
October 26, 2007, the Company and the individual defendants filed motions to
dismiss the first amended consolidated complaint in the federal action. In
December 2007, plaintiffs filed a second amended consolidated
complaint.




In
summary, there are currently two shareholder derivative actions pending which
contain substantially similar allegations.  The cases filed in the Orange
County Superior Court have been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Orange County Superior Court, Case No.
06−CC−00156. The cases filed in the United States District Court for the Central
District of California have all been consolidated into one case, designated, In
re Ceradyne, Inc. Derivative Litigation, Master File No. SA CV 06−919
JVS.




On
September 26, 2008, all of the parties to the two derivative actions entered
into a memorandum of understanding agreeing in principle to a proposed global
settlement of these derivative actions. On November 28, 2008, the parties filed
a stipulation of settlement with the federal court. The proposed settlement
calls for the Company to adopt certain corporate governance reforms and payment
by the Company’s insurance carriers of $1.125 million in attorney’s fees to the
plaintiffs’ attorneys, without any payment by Ceradyne or the other defendants,
and for dismissal of the actions with prejudice. The Company and the individual
defendants have denied and continue to deny any and all allegations of
wrongdoing in connection with this matter, but believe that given the
uncertainties and cost associated with litigation, the settlement is in the best
interests of the Company, its stockholders, and the individual defendants. On
January 9, 2009, the federal court granted preliminary approval of the
settlement and set a final approval hearing of May 18, 2009.




20
 Table of Contents


The
proposed settlement is conditioned upon final court approval after notice to
Ceradyne’s shareholders and expiration of the time for appeal from any order of
the Court approving the settlement. There can be no assurance that the final
settlement will be obtained.




A class
action lawsuit was filed on March 23, 2007, in the California Superior
Court for Orange County, in which it is asserted that the
representative plaintiff, a former Ceradyne employee, and the putative
class members, were not paid overtime at an appropriate overtime rate. The
complaint alleges that the purportedly affected employees should have had their
regular rate of pay for purposes of calculating overtime, adjusted to reflect
the payment of a bonus to them for the four years preceding the filing of the
complaint. The complaint further alleges that a waiting time penalty should be
assessed for the failure to timely pay the correct overtime payment.
Ceradyne has filed an answer denying the material allegations of the
complaint.  The motion for class certification was heard on November 13,
2008 and class certification was granted. On January 6, 2009, the court entered
an order certifying the class. We believe that the lawsuit is
without merit on the basis that our bonus policy is discretionary
and is not of the type that is subject to inclusion in the regular hourly rate
for purposes of calculating overtime, and we intend to vigorously defend
this action.






15.
            Comprehensive
      Income




Comprehensive
income encompasses all changes in equity other than those arising from
transactions with stockholders, and consists of net income, currency translation
adjustments, pension adjustments and unrealized net gains and losses on
investments classified as available-for-sale. Comprehensive income is net income
adjusted for changes in unrealized gains and losses on marketable securities and
foreign currency translation.




Comprehensive
income was (in thousands):




Three
      Months Ended March 31,2009
                                
                                
                                2008Net
      income
                                
                                $
                                708
                                
                                
                                $
                                32,351Foreign
      currency translation
                                
                                
                                (8,569
                                )
                                
                                
                                17,072Unrealized
      loss on investments
                                
                                
                                (808
                                )
                                
                                
                                (1,443
                                )Comprehensive
      income
                                
                                $
                                (8,669
                                )
                                
                                $
                                47,980





21
 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 14 “Commitments and Contingencies” of the Notes to
Consolidated Financial Statements, in this Item 2 “Management’s Discussion
and Analysis of Financial Condition and Results of Operations,” and in Part II,
Item 1A under the caption “Risk Factors.” Reference is also made to the
risks and uncertainties described in the Company’s Annual Report on Form 10-K
for the fiscal year ended December 31, 2008, 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, zirconium diboride and fused silica, which are used in
      manufacturing armor and a broad range of industrial products
      and  consumer products;




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




•
            durable,
      reduced friction, ceramic diesel engine
  components;




•
            functional
      and frictional coatings primarily for automotive
    applications;




•
            translucent
      ceramic orthodontic brackets;




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




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




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




•
            fused
      silica powders for precision investment casting (PIC) and ceramic
      crucibles;




•
            neutron
      absorbing materials, structural and non-structural, in combination with
      aluminum metal matrix composite that serve as part of a barrier system for
      spent fuel wet and dry storage in the nuclear industry, and non-structural
      neutron absorbing materials for use in the transport of nuclear fresh fuel
      rods;




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




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




•
            ceramic
      bearings and bushings for oil drilling and fluid handling
      pumps.




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





22
 Table of Contents


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




Segment
revenues (in millions):


Three Months Ended March
      31,2009
                                  
                                  
                                  2008Advanced
      Ceramic Operations
                                  
                                  $
                                  56.3
                                  
                                  
                                  $
                                  130.0ESK Ceramics
                                  
                                  
                                  23.6
                                  
                                  
                                  
                                  39.3Semicon
      Associates
                                  
                                  
                                  2.1
                                  
                                  
                                  
                                  2.3Thermo
      Materials
                                  
                                  
                                  16.2
                                  
                                  
                                  
                                  17.3Ceradyne
      Canada
                                  
                                  
                                  0.3
                                  
                                  
                                  
                                  2.6Boron
                                  
                                  
                                  6.0
                                  
                                  
                                  
                                  5.0Inter-segment
      elimination
                                  
                                  
                                  (4.7
                                  )
                                  
                                  
                                  (8.0
                                  )Total
      revenue from external customers
                                  
                                  $
                                  99.8
                                  
                                  
                                  $
                                  188.5




Segment
income before provision for taxes (in millions):


Advanced
      Ceramic Operations
                                      
                                      $
                                      4.3
                                      
                                      
                                      $
                                      42.7ESK Ceramics
                                      
                                      
                                      (4.4
                                      )
                                      
                                      
                                      2.6Semicon
      Associates
                                      
                                      
                                      0.2
                                      
                                      
                                      
                                      0.5Thermo
      Materials
                                      
                                      
                                      3.6
                                      
                                      
                                      
                                      3.1Ceradyne
      Canada
                                      
                                      
                                      (0.8
                                      )
                                      
                                      
                                      0.7Boron
                                      
                                      
                                      (1.7
                                      )
                                      
                                      
                                      0.5Inter-segment
      elimination
                                      
                                      
                                      -
                                      
                                      
                                      
                                      0.6Total
      segment income before provision for taxes
                                      
                                      $
                                      1.2
                                      
                                      
                                      $
                                      50.7




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





Defense
                                      
                                      
                                      52.3
                                      %
                                      
                                      
                                      62.7
                                      %Industrial
                                      
                                      
                                      39.1
                                      
                                      
                                      
                                      30.1Automotive/Diesel
                                      
                                      
                                      5.5
                                      
                                      
                                      
                                      5.4Commercial
                                      
                                      
                                      3.1
                                      
                                      
                                      
                                      1.8Total
                                      
                                      
                                      100.0
                                      %
                                      
                                      
                                      100.0
                                      %





The
principal factor contributing to our growth in sales from 2002 through 2007 was
increased demand by the U.S. military for ceramic body armor that protects
soldiers, which was driven primarily by military conflicts such as those in Iraq
and Afghanistan. Our sales also increased from 2004 through 2007 because of our
acquisition of ESK Ceramics in August 2004, our acquisition of Minco, Inc.
in July 2007, our acquisition of EaglePicher Boron, LLC in August 2007, which we
renamed Boron Products, LLC, and the recent expansion of our operations into
China. Our sales declined in 2008 and in the first quarter of 2009 primarily
because of a reduction in shipments of body armor.





Our sales
of body armor, as well as other armor components for defense applications,
declined by $65.9 million for the three months ended March 31, 2009 compared to
the same period of 2008. We expect that body armor sales for the year ended 2009
will decline compared to the full year of 2008.




As a
result of the ESK acquisition, we believe that we are the only ceramic body
armor manufacturer with a vertically integrated approach of designing much of
our key equipment and controlling the manufacturing process from the principal
raw material powder to finished product.




23
 Table of Contents


Our Minco
operation manufactures fused silica powders for a wide range of industrial
applications and is a key supplier of this raw material to our Thermo Materials
division. Our Boron Products operation produces the boron isotope 10B. This
isotope is a strong neutron absorber and is used for both nuclear waste
containment and nuclear power plant neutron radiation critical control. Boron
Products also produces complementary chemical isotopes used in the normal
operation and control of nuclear power plants, and the boron isotope 11B, which
is used in the semiconductor manufacturing process as an additive to
semiconductor grade silicon as a “doping” agent and where ultra high purity
boron is required.




In June
2008, we purchased certain assets and technology related to proprietary
technical ceramic bearings used for “down hole” oil drilling and for coal bed
methane pumps and steam assisted oil extraction pumps. These assets and the
intellectual property were acquired from a privately-owned business located in
Greenwich, Rhode Island. This operation, which we now call Ceradyne Bearing
Technology, has been relocated to our Lexington, Kentucky, facility. These
bearings and pumps incorporate ceramic parts supplied by our ESK Ceramics
subsidiary.




In August
2008, we acquired SemEquip, Inc., a late-stage startup technology company
located in Billerica, Massachusetts. SemEquip develops and markets “cluster
molecules” such as B18H22 for use
in the ion implantation of boron (B) in the manufacturing of semiconductors.
SemEquip owns a portfolio of approximately 130 issued patents and pending patent
applications.




In the
fourth quarter of 2008, we completed our final deliveries of the current
generation of ESAPI (enhanced small arms protective inserts) body armor for the
U.S. Army under the $747.5 million adjusted value Indefinite Delivery/Indefinite
Quantity (ID/IQ) contract awarded to us in August 2004.





In
October 2008, we were awarded an ID/IQ contract by the U.S. Army for the next
ballistic threat generation of ceramic body armor plates, called XSAPI, as well
as for the current generation ESAPI plates. The total amount of this contract is
$2.37 billion and covers a period of approximately five years. The U.S. Army can
order one or both types of plates over the five year life of the contract.
However, we anticipate that the government will order either XSAPI or ESAPI, but
not both. Therefore, the total amount of this ID/IQ award likely will not exceed
$1.1 billion over the life of the contract. Two of our competitors were awarded
similar ID/IQ contracts. We expect that government orders under these contracts
will be split among the three successful bidders, so the potential orders we may
receive under our contract will likely be less than the $1.1 billion possible
total amount. At the same time this ID/IQ contract was awarded to us, we also
received an initial delivery order for “first article testing” for both XSAPI
and ESAPI armor plates valued at approximately $0.9 million. We have shipped all
“first article testing” plates and they have been successfully tested by the
government. In October 2008, we also received a production delivery order under
this ID/IQ contract for $72.2 million, but this order was subsequently withdrawn
by the U.S. Army when a competitor protested the award. The protest was recently
resolved and on March 31, 2009, we received a revised first production delivery
order under this ID/IQ contract for $76.8 million for XSAPI ceramic body armor
plates to be delivered from April 2009 to December 2009, with early delivery
allowed.




With the
recent growth of military operations in Afghanistan, the U.S. military has shown
more interest in procuring body armor that weighs less than the current XSAPI
body armor plates while being able to defeat similar ballistic threats. We are
developing products designed to meet the lighter weight objectives, but there is
no assurance that we will be successful.




Based on
our current backlog and anticipated orders for ceramic body armor and the level
of sales to date in 2009, we expect our shipments of ceramic body armor to be
lower in fiscal year 2009 than in 2008. Moreover, government contracts typically
may be cancelled by the government at any time without penalty. For the next
several quarters, and perhaps longer, demand for ceramic body armor is likely to
be the most significant factor affecting our sales.





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





Our
ESK Ceramics subsidiary produces boron carbide powder, which serves as a
starter ceramic powder in the manufacture of our lightweight ceramic body armor.
The lower demand for body armor has negatively impacted inter-segment sales of
boron carbide powder by our ESK Ceramics subsidiary to our Advanced Ceramic
Operations division in the first three months of 2009 and we expect that this
trend will continue for the remainder of this year.




24
 Table of Contents


Our order
backlog was $177.2 million as of March 31, 2009 and $262.7 million as of March
31, 2008. Orders for ceramic body armor represented approximately $94.9 million,
or 53.5%, of the total backlog as of March 31, 2009 and $171.4 million, or
65.2%, of the total backlog as of March 31, 2008. We expect that substantially
all of our order backlog as of March 31, 2009 will be shipped during 2009. Our
order backlog at March 31, 2009 includes the $76.8 million delivery order
mentioned above, which was received on March 31 2009.




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




Had this
estimated Stock-Based Charge been reflected, as and when incurred, in the
Company’s results of operations for prior years, the impact on net income for
Ceradyne’s fiscal years ended December 31 would have been a reduction of
$21,000 in 1997, a reduction of $45,000 in 1998, a reduction of $47,000 in 1999,
a reduction of $104,000 in 2000, a reduction of $269,000 in 2001, a reduction of
$74,000 in 2002, a reduction of $347,000 in 2003, a reduction of $0.6 million in
2004, and a reduction of $324,000 in 2005. As of March 31, 2009, 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.




25
 Table of Contents


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




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




Change in Accounting for
Convertible Debt




In May
2008, FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible
Debt Instruments That May be Settled in Cash upon Conversion (Including Partial
Cash Settlement)” (“FSP APB 14-1”) was issued which specifies that issuers of
such instruments should separately account for the liability and equity
components in a manner that will reflect the issuer’s nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. The
Company adopted FSP APB 14-1 as of January 1, 2009, and the adoption impacted
the historical accounting for the Notes, and in accordance with the Statement
resulted in the following retrospective changes in long-term debt, debt issuance
costs (included in other noncurrent assets), deferred tax liability, additional
paid in capital and retained earnings:





(in
      Thousands)
                          
                          Net
      Increase (Decrease)Long-Term
                            Debt
                          
                          
                          Debt
      Issuance Costs
                          
                          
                          Deferred
      Tax Liability
                          
                          
                          Additional
      Paid In Capital
                          
                          
                          Retained
      EarningsAllocation
      of long term debt proceeds and issuance costs
                            to
      equity component on issuance date
                          
                          $
                          (29,261
                          )
                          
                          $
                          (1,018
                          )
                          
                          $
                          11,015
                          
                          
                          $
                          17,228
                          
                          
                          $
                          -Cumulative
      retrospective impact from amortization of
                            discount
      on liability component and debt issuance costs
                          
                          
                          7,009
                          
                          
                          
                          385
                          
                          
                          
                          (2,584
                          )
                          
                          
                          -
                          
                          
                          
                          (4,040
                          )Cumulative
      retrospective impact at January 1, 2008
                          
                          
                          (22,252
                          )
                          
                          
                          (633
                          )
                          
                          
                          8,431
                          
                          
                          
                          17,228
                          
                          
                          
                          (4,040
                          )Retrospective
      impact from amortization of discount on
                            liablity
      component and debt issuance costs during the year
                          
                          
                          3,883
                          
                          
                          
                          163
                          
                          
                          
                          (1,450
                          )
                          
                          
                          -
                          
                          
                          
                          (2,270
                          )Cumulative
      retrospective impact at December 31, 2008
                          
                          $
                          (18,369
                          )
                          
                          $
                          (470
                          )
                          
                          $
                          6,981
                          
                          
                          $
                          17,228
                          
                          
                          $
                          (6,310
                          )





The
adoption of FSP APB 14-1 also resulted in increased interest expense of
approximately $0.9 million and decreased net income by $0.5 million for the
three months ended March 31, 2008. The retrospective impact to earnings per
share was a decrease of $0.02 for the three months ended March 31,
2008. The Company expects to file a Form 8-K in May 2009 to reflect the
adoption of FSP APB 14-1 for the 2008, 2007 and 2006 financial statements. As a
result of the adoption of FSP APB 14-1, interest expense for the three months
ended March 31, 2009 includes non-cash interest expense from amortization of the
discount on the liability component of $1.0 million and amortization of debt
issuance costs of $110,000 which reduced net income by $0.7 million and earnings
per share by $0.03 for the three months ended March 31,
2009.





Results of Operations for
the Three Months Ended March 31, 2009 and 2008




Net Sales. Our net sales
for the three months ended March 31, 2009 were $99.8 million, a decrease of
$88.7 million, or 47.1%, from $188.5 million of net sales in the corresponding
quarter of the prior year. The primary reasons for the decline in sales was
reduced demand for body armor as well as other armor components for defense
contractors and the decline in industrial demand for our products manufactured
and sold by our subsidiary, ESK Ceramics.




Net sales
for our Advanced Ceramic Operations division for the three months ended March
31, 2009 were $56.3 million, a decrease of $73.7 million, or 56.7%, from $130.0
million of net sales in the corresponding quarter of the prior year. The primary
reason for the decrease was a decline in shipments of ceramic body armor as well
as other armor components for defense contractors. The primary reason for the
decline in shipments was the delay in receiving the first production delivery
order of XSAPI from the U.S. Army. We received the delivery order on March 31,
2009 and began to make shipments associated with it during April 2009. Net sales
of ceramic body armor in the first quarter of 2009 were $46.3 million, a
decrease of  $64.2 million, or 58.1%, from $110.5 million in the first
quarter of 2008.




Net sales
for our automotive/diesel component product line for the three months ended
March 31, 2009 were $2.0 million, a decrease of $2.0 million, or 50.9%, from
$4.0 million in the corresponding quarter of the prior year. The primary reason
for this decrease was that our heavy duty diesel truck business has been
negatively affected by trucking companies’ inability to secure financing to
purchase new trucks and the decline in the transportation industry as a result
of the severe economic contraction during the last quarter of 2008 and the first
quarter of 2009. Net sales of our orthodontic brackets product line for the
three months ended March 31, 2009 were $2.5 million, a decrease of $251,000, or
9.2%, from $2.7 million in the corresponding quarter of the prior year. The
decrease was due to lower demand for Clarity®
orthodontic brackets which we believe was caused by a weakened
economy.




26
 Table of Contents


Our ESK
Ceramics subsidiary had net sales for the three months ended March 31, 2009 of
$23.6 million, a decrease of $15.7 million, or 39.9%, from $39.3 million in the
corresponding quarter of the prior year. Approximately $3.4 million of the
decrease in net sales is attributable to the lower value of the Euro versus the
U.S. dollar during the three months ended March 31, 2009, as sales denominated
in Euros are translated into U.S. dollars for financial reporting purposes.
Sales of industrial products for the three months ended March 31, 2009 were
$15.2 million, a decrease of $9.7 million, or 38.9%, from $24.8 million in the
corresponding quarter of the prior year. On a constant currency basis, sales of
industrial products for the quarter ended March 2009 decreased by $2.2 million.
This decrease was the result of lower demand, primarily the result of a severe
economic contraction in the first quarter of 2009, for fluid handling parts,
industrial wear parts and metallurgy parts. Sales of defense products for the
three months ended March 31, 2009 were $4.3 million, a decrease of $3.3 million,
or 43.5%, from $7.6 million in the corresponding quarter of the prior year.
On a constant currency basis, sales of defense products decreased by $0.5
million for the quarter ended March 31, 2009. Included in sales of defense
products for the three months ended March 31, 2009 were inter-segment sales
of  $3.8 million compared to $6.3 million in the prior year. The
decrease of $2.5 million in inter-segment sales was due to a reduction in demand
for boron carbide powder used in body armor plates manufactured by our Advanced
Ceramic Operations division. Sales of automotive/diesel products for the three
months ended March 31, 2009 were $3.5 million, a decrease of $2.6 million, or
41.9%, from $6.1 million in the corresponding quarter of the prior year. On a
constant currency basis, sales of automotive/diesel products decreased by $0.6
million for the quarter ended March 31, 2009. Decreased demand caused by the
recent economic contraction resulted in a reduction in sales of automobiles by
automotive original equipment manufacturers which accounted for the decreased
sales. Sales of commercial products, consisting of boron nitride for the
cosmetics industry for the three months ended March 31, 2009 were $0.6 million,
a decrease of $135,000, or 19.4%, from $0.7 million in the corresponding prior
year period. The decrease was the result of lower value of the Euro versus the
U.S. dollar during the three months ended March 31, 2009.





Our
Semicon Associates division had net sales for the three months ended March 31,
2009 of $2.1 million, a decrease of $193,000, or 8.5%, from $2.3 million in the
corresponding quarter of the prior year. The decrease in sales reflects lower
shipments of microwave cathodes due to the recent economic
contraction.




Our
Thermo Materials division had net sales for the three months ended March 31,
2009 of $16.2 million, a decrease of $1.1 million, or 6.3%, from $17.3 million
in the corresponding quarter of the prior year. The decrease was due to reduced
demand for industrial products, consisting of castables and refractory products,
and for our products for the precision investment casting industry. Shipments of
these products decreased by $2.9 million in the first quarter of 2009. This
decrease was offset by higher sales of crucibles to the solar energy market due
to continued penetration of our products into the growing solar energy market.
Shipments of crucibles used in the manufacture of photovoltaic cells increased
to $8.9 million, an increase of $1.5 million, or 20.6%, from $7.4 million in the
corresponding prior year period. Of this increased amount, $1.3 million in sales
came from shipments from our new manufacturing facility in Tianjin, China. Sales
to the defense industry for the three months ended March 31, 2009 were $1.9
million, an increase of $316,000, or 20.1%, from $1.6 million when compared to
the corresponding prior year period.




Our
Ceradyne Canada subsidiary had net sales for the three months ended March 31,
2009 of $313,000, a decrease of $2.2 million, or 87.8%, from $2.6 million in the
corresponding quarter of the prior year, reflecting reduced demand for our
Boral® product
line and metal matrix composite products.




Our Boron
business segment comprises SemEquip, Inc., which we acquired on August 11, 2008,
and Ceradyne Boron Products, which we acquired on August 31, 2007. Total net
sales for this segment were $6.0 million, an increase of $1.0 million, or 20.2%,
from $5.0 million in the corresponding quarter of the prior year. The increase
in sales resulted from $2.1 million of increased shipments to the nuclear power
industry in the first quarter of 2009 compared to the corresponding quarter of
the prior year. This increase was offset by lower shipments to the semiconductor
industry of $0.7 million and $0.6 million of industrial chemical sales.
SemEquip, Inc., which was not included in our results of the first quarter of
2008, contributed $196,000 of sales. The sales contribution from SemEquip is not
expected to be significant in 2009.




27
 Table of Contents


Gross Profit. Our gross
profit for the three months ended March 31, 2009 was $22.9 million, a decrease
of $48.6 million, or 68.0%, from $71.5 million in the corresponding prior year
quarter. As a percentage of net sales, gross profit was 23.0% for the three
months ended March 31, 2009 compared to 37.9% for the corresponding prior year
quarter. The decrease in gross profit was the result of lower body armor
shipments, lower production volumes of industrial products caused by reduced
demand brought on by the recent sharp economic contraction resulting in an
increase of unabsorbed manufacturing overhead expenses, and sales
mix.




Our
Advanced Ceramic Operations division posted gross profit for the three months
ended March 31, 2009 of $13.2 million, a decrease of $38.2 million, or 74.2%,
from $51.4 million in the corresponding prior year quarter. As a percentage of
net sales, gross profit was 23.5% for the three months ended March 31, 2009,
compared to 39.6% for the corresponding prior year quarter. The primary reasons
for the decrease in gross profit were lower volumes of production of body armor
products resulting in an increase of unabsorbed body armor manufacturing
overhead expenses, and sales mix caused by shipments of lower gross margin SAPI
body armor products compared to the corresponding prior period. Additionally,
contributing to the decrease in gross profit for the three months ended March
31, 2009 were severance expenses of $390,000 due to the reduction in work force
during February and March 2009.




Our
ESK Ceramics subsidiary had gross profit for the three months ended March
31, 2009 of $3.2 million, a decrease of $7.3 million, or 69.8%, from $10.5
million in the corresponding prior year quarter. As a percentage of net sales,
gross profit was 13.5% for the three months ended March 31, 2009, compared to
26.8% for the three months ended March 31, 2008. The decrease in gross profit as
a percentage of net sales for the three months ended March 31, 2009 was the
result of an unfavorable sales mix due to lower sales of ceramic powder for
armor applications and an increase in unabsorbed manufacturing overhead expenses
caused by lower production volumes and reduced demand for our products as a
result of the recent economic contraction. Additionally, contributing to the
decrease in gross profit for the three months ended March 31, 2009 were
severance expenses of $197,000 due to the reduction in work force during
the quarter ended March 31, 2009.




Our
Semicon Associates division had gross profit for the three months ended March
31, 2009 of $0.6 million, a decrease of $241,000, or 30.4%, from $0.8 million in
the corresponding quarter of the prior year. As a percentage of net sales, gross
profit was 26.6% for the three months ended March 31, 2009, compared to 34.9%
for the corresponding prior year period.  Decreased sales of higher
margin parts from our microwave cathode product line, when compared to the
corresponding prior year period, and an increase in scrap expenses contributed
to the decrease in gross profit and gross profit as a percentage of net sales
for the for the three months ended March 31, 2009.




Our
Thermo Materials division had gross profit for the three months ended March 31,
2009 of $5.8 million, an increase of $101,000 or 1.8%, from $5.7 million in the
corresponding prior year quarter. As a percentage of net sales, gross profit was
36.0% for the three months ended March 31, 2009 compared to 33.1% for the
corresponding prior year quarter. The increase in gross profit as a percentage
of sales for the three months ended March 31, 2009 was primarily due to sales
mix and improved yields in the production of crucibles.




Our
Ceradyne Canada subsidiary had negative gross profit for the three months ended
March 31, 2009 of $428,000, a decrease of $1.5 million, from $1.1 million in the
corresponding quarter of the prior year, reflecting the decline in sales and
production of our Boral® and
other metal matrix composite product lines. The resulting lower production
volumes during the first quarter caused an increase in unabsorbed manufacturing
overhead expenses compared to the corresponding prior year quarter.




Our Boron
business segment comprises SemEquip, Inc., which we acquired on August 11, 2008,
and Ceradyne Boron Products, which we acquired on August 31, 2007. This segment
had gross profit for the three months ended March 31, 2009 of $0.6 million, a
decrease of $1.2 million, or 69.5%, from $1.8 million in the corresponding
quarter of the prior year. As a percentage of net sales, gross profit was 9.2%
for the three months ended March 31, 2009, compared to 36.3% for the
corresponding prior year period. Of this gross profit, Ceradyne Boron Products
was responsible for $1.6 million while SemEquip recorded a gross loss of $1.0
million. The primary reason for the decrease in gross profit of this segment was
a poorer sales mix of products sold by Ceradyne Boron Products due to the
reduction in higher gross margin products to the semiconductor industry which is
experiencing an industry wide economic slowdown, compared to the corresponding
prior year quarter and the negative gross margin of $1.0 million from SemEquip.
The SemEquip loss was caused by low sales volume resulting in unabsorbed fixed
manufacturing overhead. SemEquip’s financial results were not included in our
financial results for the first quarter of 2008 as they were only included in
our consolidated results financial results commencing August 2008. Ceradyne
Boron Products incurred $82,000 in severance expenses in the three months ended
March 31, 2009 which also caused a reduction in gross profit and gross profit as
a percentage of sales.




28
 Table of Contents


Selling Expenses. Our
selling expenses for the three months ended March 31, 2009 were $7.0 million, a
decrease of $0.9 million, or 10.3%, from $7.9 million in the corresponding prior
year quarter. Selling expenses, as a percentage of net sales, increased from
4.2% for the three months ended March 31, 2008 to 7.1% of net sales for the
three months ended March 31, 2009. The primary reasons for the increase in sales
expense as a percentage of sales were the large reduction in sales during the
three months ended March 31, 2009 when compared to the prior year quarter.
Selling expenses were reduced due to layoffs of personnel and reduced travel and
entertainment.




General and Administrative
Expenses. Our general and administrative expenses for the three
months ended March 31, 2009 were $9.8 million, a decrease of $2.0 million, or
17.5%, from $11.8 million in the corresponding prior year quarter. General and
administrative expenses, as a percentage of net sales, increased from 6.3% for
the three months ended March 31, 2008 to 9.8% for the three months ended March
31, 2009. The primary reason for the decrease was a reduction in work force and
related reduction in salaries and benefits, and a reduction in bonuses due to
lower pre-tax income during the first quarter of 2009 when compared to the prior
year quarter.




Research and Development
Expenses. Our research and development expenses for the three months
ended March 31, 2009 were $3.5 million, an increase of $465,000, or 15.5%, from
$3.0 million in the corresponding prior year quarter. Research and development
expenses, as a percentage of net sales, increased from 1.6% of net sales for the
three months ended March 31, 2008 to 3.5% of net sales for the three months
ended March 31, 2009. The primary reason for the increase of research and
development expenses for the three months ended March 31, 2009 compared to the
corresponding prior periods was the increase in armor research and development
expenses at our Advanced Ceramics Operation due to further testing and
development of our XSAPI products.




Other Income
(Expense). Our net other income (expense) for the three months ended
March 31, 2009 was $1.5 million of expense, a decrease of $3.3 million, from
$1.9 million of income in the corresponding prior year quarter. The primary
reasons for the decrease was a reduction in interest income of $2.0 million due
to lower interest rates earned on investments and a reduction in gains on
foreign currency from $1.3 million in the corresponding prior year quarter
compared to a $16,000 loss this quarter.




Income before Provision for Income
Taxes. Our income before provision for income taxes for the three
months ended March 31, 2009 was $1.2 million, a decrease of $49.5 million, or
97.7%, from $50.7 million in the corresponding prior year quarter.




Our
Advanced Ceramic Operations division’s income before provision for income taxes
for the three months ended March 31, 2009 was $4.2 million, a decrease of $38.5
million, or 90.1%, from $42.7 million in the corresponding prior year
quarter.  The decrease in income before provision for income taxes for
both the three months ended March 31, 2009 was due to lower sales of body armor
and an increase in unabsorbed manufacturing overhead expenses due to under
utilized capacity.




Our
ESK Ceramics subsidiary incurred a loss before provision for income taxes
for the three months ended March 31, 2009 of $4.4 million, a decrease of $7.0
million, from $2.6 million of income before provision for income taxes in the
corresponding prior year quarter. The decrease in income before provision for
income taxes was due sharply lower sales volume, an increase in unabsorbed
manufacturing overhead expenses due to under utilized capacity and a weaker
sales mix.




Our
Semicon Associates division’s income before provision for income taxes for the
three months ended March 31, 2009 was $234,000, a decrease of $248,000, or
51.5%, from $482,000 in the corresponding prior year quarter. The decrease in
income before provision for income taxes for the for the three months ended
March 31, 2009 was primarily caused by an unfavorable sales mix caused by lower
sales of microwave cathode products, which have higher gross margins, and
increased lower production yields compared to the corresponding prior year
period.




Our
Thermo Materials division’s income before provision for income taxes for the
three months ended March 31, 2009 was $3.6 million, an increase of $0.5
million, or 17.7%, from $3.1 million in the corresponding prior year quarter.
The increase in income before provision for income taxes in was due to sales
mix, improved yields in the production of crucibles, while offset by reduced
sales of other industrial products when compared to the corresponding prior year
period.




Our
Ceradyne Canada subsidiary incurred a loss before provision for income taxes for
the three months ended March 31, 2009 of $0.8 million, a decrease of $1.4
million, from $0.7 million of income before provision for income taxes in the
corresponding prior year quarter. The decrease in income before provision for
income taxes in the three months ended March 31, 2009 was due to decreased
shipments of our Boral®product
line.




29
 Table of Contents


Our Boron
business segment comprises SemEquip, Inc., which we acquired on August 11, 2008,
and Ceradyne Boron Products, which we acquired on August 31, 2007. The loss
before provision for income taxes for this segment for the three months ended
March 31, 2009 was $1.8 million, a decrease of $2.2 million from $484,000 of
income before provision for income taxes for the three months ended March 31,
2008. The primary reasons for the loss was the loss before provision for income
taxes from SemEquip of $2.1 million and an unfavorable sales mix at our Ceradyne
Boron Products subsidiary caused by a reduction of sales of gas products to the
semiconductor industry which is experiencing an industry wide slowdown in
business activity and lower sales resulting in unabsorbed fixed manufacturing
overhead expenses.




Income Taxes. Our
provision for income taxes for the three months ended March 31, 2009 was
$469,000, a decrease of $17.9 million, or 97.4%, from $18.4 million in the
corresponding prior year period. The effective income tax rate for the three
months ended March 31, 2009 was 39.8% compared to 36.2% in the corresponding
prior year period. The higher effective tax rate in the current period primarily
resulted from the accrual of interest on our liability for tax uncertainties
which represented a relatively larger proportion of income before income taxes
compared to the prior year period.




Liquidity and Capital
      Resources




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




Our net
cash position decreased by $14.1 million during the three months ended March 31,
2009 compared to a $30.7 million increase during the three months ended March
31, 2008. For the three months ended March 31, 2009, cash flow provided by
operating activities amounted to $18.6 million compared to $59.4 million during
the three months ended March 31, 2008. The primary factors contributing to the
decrease in cash flow from operating activities in the three months ended March
31, 2009 were net income of $0.7 million in the current period, compared to
$32.3 million in the prior year period, or a net reduction of $31.6 million and
there was an increase in income taxes payable of only $1.7 million in the
current period, compared to a $16.1 million increase in the prior year period.
These decreases in operating cash flow were partially offset by a reduction in
accounts receivable of $4.6 million in the current period, compared to an
increase of $2.7 million in the prior year period.




Investing
activities consumed $30.9 million of cash during the three months ended March
31, 2009. We spent $7.7 million for the purchase of property, plant and
equipment and $24.6 million on purchases of marketable securities. These
expenditures were partially offset by $1.3 million of proceeds from sales and
maturities of marketable securities.




Financing
activities during the three months ended March 31, 2009 consumed $0.8 million.
During the three months ended March 31, 2009, we purchased and retired 50,000
shares of our common stock at an aggregate cost of $0.8 million under a stock
repurchase program authorized by our Board of Directors. To date, we have
purchased 1,628,237 at an aggregate cost of $45.5 million since
the  repurchase program began in March 2008. We are authorized to use
up to an additional $54.5 million to repurchase and retire shares of our common
stock under this  $100.0 million repurchase program.




The
negative effect of exchange rates on cash and cash equivalents of $0.9 million
for the three months ended March 31, 2009 was due to our investments in our
German subsidiary, ESK Ceramics, and in our Chinese subsidiary, Ceradyne
(Tianjin) Technical Ceramics., Ltd.




During
December 2005, we issued $121.0 million principal amount of 2.875% senior
subordinated convertible notes due December 15, 2035.


As of
March 31, 2009 and December 31, 2008, long-term debt and the equity component
(recorded in additional paid in capital, net of income tax benefit) associated
with FSP APB 14-1 comprised the following (in thousands):





March
      31, 2009
                                    
                                    
                                    December
      31, 2008Long-term
      debtPrincipal
      amount
                                    
                                    $
                                    121,000
                                    
                                    
                                    $
                                    121,000Unamortized
      discount
                                    
                                    
                                    (17,369
                                    )
                                    
                                    
                                    (18,369
                                    )Net
      carrying amount
                                    
                                    $
                                    103,631
                                    
                                    
                                    $
                                    102,631Equity
      component, net of income tax benefit
                                    
                                    $
                                    17,228
                                    
                                    
                                    $
                                    17,228







The
discount on the liability component of long-term debt is being amortized using
the effective interest method based on an annual effective rate of 7.5%, which
represented the market interest rate for similar debt without a conversion
option on the issuance date, through December 2012, which coincides with the
first date that holders of the Notes can exercise their put option as discussed
below. The amount of interest cost recognized relating to both the
contractual interest coupon and the amortization of the discount on the
liability component for the three months ended March 31, 2009 and 2008 was $1.9
million and $1.8 million, respectively.




30
 Table of Contents


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




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




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




We are
obligated to pay contingent interest to the holders of the notes during any
six-month period from June 15 to December 14 and from December 15
to June 14, commencing with the six-month period beginning
December 20, 2010 and ending on June 14, 2011, if the average trading
price of the note for the five trading day period ending on the third trading
day immediately preceding the first day of the relevant contingent interest
period equals $1,200 (120% of the principal amount of a note) or more. The
amount of contingent interest payable per note for any relevant contingent
interest period shall equal 0.25% per annum of the average trading price of
a note for the five trading day period ending on the third trading day
immediately preceding the first day of the relevant contingent interest period.
This contingent interest payment feature represents an embedded derivative.
However, based on the de minimus value associated with this feature, no value
has been assigned at issuance and at March 31, 2009.





In
December 2005, we established a new unsecured $10.0 million line of credit. As
of March 31, 2009, there were no outstanding amounts on the line of credit.
However, the available line of credit at March 31, 2009 has been reduced by
outstanding letters of credit in the aggregate amount of $1.8 million. The
interest rate on the credit line is based on the LIBOR rate for a period of one
month, plus a margin of 0.625 percent, which equaled 1.1% as of March 31,
2009.





Pursuant
to the bank line of credit, we are subject to certain covenants, which include,
among other things, the maintenance of specified minimum amounts of tangible net
worth and quick assets to current liabilities ratio. At March 31, 2009, we were
in compliance with these covenants.




Our cash,
cash equivalents, restricted cash and short-term investments totaled $233.3
million at March 31, 2009, compared to $224.1 million at December 31, 2008.
At March 31, 2009, we had working capital of $401.4 million, compared to $400.8
million at December 31, 2008. Our cash position includes amounts
denominated in foreign currencies. The repatriation of cash balances from our
ESK Ceramics subsidiary does not result in additional tax costs while
repatriation of cash balances from our China Tianjin subsidiary results in an
additional 15% tax. There is no accrual for this tax as we don’t have plans to
repatriate any cash balances. We believe that our current cash and cash
equivalents on hand and cash available from the sale of short-term investments,
cash available from additional borrowings under our revolving line of credit and
cash we expect to generate from operations will be sufficient to finance our
anticipated capital and operating requirements for at least the next 12 months.
With respect to the auction rate securities, or ARS, for which we have
recorded temporary reductions, we have the intent and ability to hold the ARS
until recovery of fair value, which may be maturity or earlier if called or
liquidity is restored in the market. See Note 7 to the Consolidated Financial
Statements included in Item 1 of this report for more information.




Our
anticipated capital requirements primarily relate to the planned expansion of
our manufacturing facilities in China. We also may utilize cash, and, to the
extent necessary, borrowings from time to time to acquire other businesses,
technologies or product lines that complement our current products, enhance our
market coverage, technical capabilities or production capacity, or offer growth
opportunities.




Our
material contractual obligations and commitments as of March 31, 2009 include a
$7.5 million reserve for unrecognized tax benefits. The reserve is classified as
long term liabilities on our Consolidated Balance Sheet as of March 31,
2009.




31
 Table of Contents


Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk




We are
exposed to market risks related to fluctuations in interest rates on our debt.
We routinely monitor our risks associated with fluctuations in currency exchange
rates and interest rates. We address these risks through controlled risk
management that may, in the future, include the use of derivative financial
instruments to economically hedge or reduce these exposures. We do not enter
into foreign exchange contracts for speculative or trading purposes. Currently,
we do not utilize interest rate swaps. Our investments in marketable securities
consist primarily of high-grade corporate and government securities with
maturities of less than two years. Investments purchased with an original
maturity of three months or less are considered cash equivalents.





Our long
term investments at March 31, 2009 included $23.0 million of auction rate
securities. To date, the Company has incurred $9.9 million in pre-tax charges
against other comprehensive income and pre-tax other than temporary impairment
charges of $8.1 million related to auction rate securities. Our investments in
auction rate securities represent interests in insurance securitizations
supported by pools of residential and commercial mortgages, asset backed
securities and other structured credits relating to the credit risk of various
bond guarantors. These auction rate securities were intended to provide
liquidity via an auction process that resets the applicable interest rate at
predetermined calendar intervals, allowing investors to either roll over their
holdings or gain immediate liquidity by selling such interests at par. During
the second half of the year 2007, during 2008 and during the first quarter of
2009, the auctions for these securities failed. As a result of current negative
conditions in the global credit markets, auctions for our investment in these
securities have recently failed to settle on their respective settlement dates.
Consequently, the investments are not currently liquid through the normal
auction process and may be liquid if a buyer is found outside the auction
process.





Prior to
June 30, 2008, we were able to determine the fair value of its investments in
auction rate securities using a market approach valuation technique based on
Level 2 inputs that did not require significant adjustment. Since June 30, 2008,
the market demand for auction rate securities has declined significantly due to
the complexity of these instruments, the difficulty of determining the values of
some of the underlying assets, declines in the issuer’s credit quality and
disruptions in the credit markets. At March 31, 2009, we determined that the
market for its investments in auction rate securities and for similar securities
was not active since there were few observable or recent transactions for these
securities or similar securities. Our investments in auction rate securities
were classified within Level 3 of the fair value hierarchy because we determined
that significant adjustments using unobservable inputs were required to
determine fair value as of March 31, 2009.





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





·
            Probability
      of earning maximum rate until
maturity


·
            Probability
      of passing auction at some point in the
future


·
            Probability
      of default at some point in the future (with appropriate loss severity
      assumptions)





We
determined that the appropriate risk-free discount rate (before risk
adjustments)used to
discount the contractual cash flowsof its auction rate
securities ranged from 0.5 to 3.2 percent, based on the term structure of the
auction rate security.  Liquidity risk premiums are used to adjust the
risk-free discount rate for each auction rate security to reflect uncertainty
and observed volatility of the current market environment. This risk of
nonperformance has been captured within the probability of default and loss
severity assumptions noted above. The risk-adjusted discount rate, which
incorporates liquidity risk, appropriately reflects our estimate of the
assumptions that market participants would use (including probability weighted
inputs noted above) to estimate the selling price of the asset at the
measurement date.





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




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




We
occasionally enter into foreign exchange forward contracts to reduce earnings
and cash flow volatility associated with foreign exchange rate changes to allow
our management team to focus its attention on its core business operations.
Accordingly, we enter into contracts which change in value as foreign exchange
rates change to economically offset the effect of changes in value of foreign
currency assets and liabilities, commitments and anticipated foreign currency
denominated sales and operating expenses. We enter into foreign exchange forward
contracts in amounts between minimum and maximum anticipated foreign exchange
exposures, generally for periods not to exceed one year. These derivative
instruments are not designated as accounting hedges. We did not have any
outstanding foreign exchange forward contracts at March 31, 2009.




Given the
inherent limitations of forecasting and the anticipatory nature of the exposures
intended to be hedged, there can be no assurance that such programs will offset
more than a portion of the adverse financial impact resulting from unfavorable
movements in either interest or foreign exchange rates. In addition, the timing
of the accounting for recognition of gains and losses related to mark-to-market
instruments for any given period may not coincide with the timing of gains and
losses related to the underlying economic exposures and, therefore, may
adversely affect our operating results and financial position and cash
flows.




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




Our debt
is comprised of $121.0 million of a convertible note with a fixed coupon
rate of 2.875%. The fair value of long-term debt was $96.4 million and is based
on quoted market prices at March 31, 2009.




Approximately
31.6% of our revenues for the three months ended March 31, 2009 were derived
from operations outside the United States. Overall, we are a net recipient of
currencies other than the U.S. dollar and, as such, we benefit from a weaker
dollar and are adversely affected by a stronger dollar relative to major
currencies worldwide. Accordingly, changes in exchange rates, and in particular
a strengthening of the U.S. dollar, may negatively affect net sales, gross
profit, and net income from our subsidiary, ESK Ceramics, as expressed in U.S.
dollars. This would also negatively impact our consolidated reported
results.




Item 4.
            Controls and
Procedures




Review
      of Historical Stock Option Grant
  Procedures




In July
2006, the Company voluntarily initiated a review of its historical stock option
grant practices and related accounting treatment. The review was conducted by a
special committee comprised of three independent members of the 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 stock unit 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 Notes to Consolidated Financial Statements.




Evaluation
      of Disclosure Controls and
Procedures




We
carried out an evaluation, under the supervision and with the participation of
our principal executive officer and principal financial officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of March 31, 2009 (the end of the period covered by this report).
Based on this evaluation, our principal executive officer and principal
financial officer concluded that our current disclosure controls and procedures
(as defined in Rules 13a-15(e) and Rule 15d-15(e) under the Securities Exchange
Act of 1934) are effective.




33
 Table of Contents


Changes in Internal Control
over Financial Reporting


Our
management evaluated our internal control over financial reporting and there
have been no changes during the fiscal quarter ended March 31, 2009 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




In
August, September and December 2006, shareholder derivative lawsuits were filed
in the California Superior Court for Orange County, purportedly on behalf of
Ceradyne against various current and former officers and directors of the
Company relating to alleged backdating of stock options. Each state court
complaint alleged claims for breach of fiduciary duty, abuse of control, gross
mismanagement, waste of corporate assets, unjust enrichment, accounting,
rescission, constructive trust, and violations of California Corporations Code.
All state court actions have been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Orange County Superior Court, Case No.
06−CC−00156.




In
September and December 2006, shareholder derivative lawsuits were filed in the
United States District Court for the Central District of California, purportedly
on behalf of Ceradyne against various current and former officers and directors
of the Company relating to alleged backdating of stock options. All federal
court actions have been consolidated into one case, designated, In re Ceradyne,
Inc. Derivative Litigation, Master File No. SA CV 06−919 JVS. The consolidated
federal action alleges, pursuant to a first amended consolidated complaint filed
on September 17, 2007,  claims for violations of Section 10(b) of the
Securities Exchange Act and Rule 10b-5 thereunder, violations of Section 14(a)
of the Securities Exchange Act, violations of Section 20(a) of the Securities
Exchange Act, insider selling under the California Corporations Code, as well as
common law claims for accounting, breach of fiduciary duty, aiding and abetting
breaches of fiduciary duty, unjust enrichment, rescission and
waste.




The
plaintiffs in both the state and federal actions seek to require the individual
defendants to rescind stock options they received which have an exercise price
below the closing price of the 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.




On
October 26, 2007, the Company and the individual defendants filed motions to
dismiss the first amended consolidated complaint in the federal action. In
December 2007, plaintiffs filed a second amended consolidated
complaint.




In
summary, there are currently two shareholder derivative actions pending which
contain substantially similar allegations.  The cases filed in the Orange
County Superior Court have been consolidated into one case, designated, In re
Ceradyne, Inc. Derivative Litigation, Orange County Superior Court, Case No.
06−CC−00156. The cases filed in the United States District Court for the Central
District of California have all been consolidated into one case, designated, In
re Ceradyne, Inc. Derivative Litigation, Master File No. SA CV 06−919
JVS.




On
September 26, 2008, all of the parties to the two derivative actions entered
into a memorandum of understanding agreeing in principle to a proposed global
settlement of these derivative actions. On November 28, 2008, the parties filed
a stipulation of settlement with the federal court. The proposed settlement
calls for the Company to adopt certain corporate governance reforms and payment
by the Company’s insurance carriers of $1.125 million in attorney’s fees to the
plaintiffs’ attorneys, without any payment by Ceradyne or the other defendants,
and for dismissal of the actions with prejudice. The Company and the individual
defendants have denied and continue to deny any and all allegations of
wrongdoing in connection with this matter, but believe that given the
uncertainties and cost associated with litigation, the settlement is in the best
interests of the Company, its stockholders, and the individual defendants. On
January 9, 2009, the federal court granted preliminary approval of the
settlement and set a final approval hearing of May 18, 2009.




The
proposed settlement is conditioned upon final court approval after notice to
Ceradyne’s shareholders and expiration of the time for appeal from any order of
the Court approving the settlement. There can be no assurance that the final
settlement will be obtained.


34
 Table of
Contents




Daniel Vargas, Jr. v.
Ceradyne, Inc., Orange County Superior Court, Civil Action No.
07CC01232:





The
Vargas Litigation is a class action in which it is asserted that the
representative Plaintiff, a former Ceradyne employee, and the putative class
members, were not paid overtime at an appropriate overtime rate. The complaint
alleges that the purportedly affected employees should have had their “regular
rate of pay”, for purposes of calculating overtime, adjusted to reflect the
payment of a bonus to them for the four years preceding the filing of the
complaint, on or about March 23, 2007. The complaint further alleges that a
waiting time penalty should be assessed for the failure to timely pay the
correct overtime payment. Ceradyne filed an answer denying the material
allegations of the complaint. The motion for class certification was heard on
November 13, 2008 and class certification was granted. On January 6, 2009, the
court entered an order certifying the class. We believe that the lawsuit is
without merit on the basis that our bonus policy is discretionary and is not of
the type that is subject to inclusion in the regular hourly rate for purposes of
calculating overtime, and we intend to vigorously defend this
action.






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, 2008.




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





The
following table sets forth information regarding shares of our common stock that
we repurchased during the first quarter ended March 31, 2009.





Issuer
Purchases of Equity Securities




Period
                      
                      (a)
                        Total
      Number of Shares Purchased
                      
                      
                      (b)
                        Average
      Price Paid per Share
                      
                      
                      (c)
                        Total
      Number of Shares Purchased as Part of Publicly Announced Plans or Programs
                      
                      
                      (d)
                        Maximum
      Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased
      Under the Plans or ProgramsMonth
      No. 1(January
      1 to January 31, 2009)
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      1,578,237
                      
                      
                      $
                      55,294,808Month
      No. 2(February
      1 to February 28, 2009)
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      1,578,237
                      
                      
                      $
                      55,294,808Month
      No. 3(March
      1 to March 31, 2009)
                      
                      
                      50,000
                      
                      
                      $
                      16.65
                      
                      
                      
                      1,628,237
                      
                      
                      $
                      54,462,330Total
                      
                      
                      50,000
                      
                      
                      $
                      16.65
                      
                      
                      
                      1,628,237
                      
                      
                      $
                      54,462,330




(1)
            On
      March 4, 2008, we announced that our board had authorized the repurchase
      of up to $100.0 million of our common stock in open market transactions,
      including block purchases, or in privately negotiated transactions. We did
      not set a time limit for completion of this repurchase program, and we may
      suspend or terminate it at any
time.




35
 Table of Contents
 
  Item 3. Defaults Upon Senior
      Securities
  Not
      applicable.
  Item 4. Submission of Matters
      to a Vote of Security
Holders
  Not
      applicable.
  Item 5. Other
Information
  Not
applicable.
  Item 6. Exhibits
  (a)  Exhibits:




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.







36
 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: April
      28, 2009
            
            By:
            /s/
      JERROLD J. PELLIZZONJerrold
      J. PellizzonVice
      President
              Chief
      Financial Officer
              (Principal
      Financial and Accounting Officer)








37
 Table of Contents





Index to
Exhibits




Exhibit
            Description31.1
            Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
            Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
            Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.32.2
            Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002.







38