##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
 
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2008
 Or
 o
    
    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
(State or other jurisdiction 
of incorporation or organization)
    
    33-0055414
(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)
 þ o
  Large accelerated filer þ
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company o
 o þ
  Class
    
    Outstanding as of October 17, 2008Common Stock, $0.01 par value
    
    26,273,911 Shares




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##### 



INDEX
 PAGE NO.PART I. FINANCIAL INFORMATIONItem 1. Unaudited Consolidated Financial Statements
    
    
    3Consolidated Balance Sheets  September 30, 2008 and December 31, 2007
    
    
    3Consolidated Statements of Income  Three and Nine Months Ended September 30, 2008
and 2007
    
    
    4Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2008 and 2007
    
    
    5Notes to Consolidated Financial Statements
    
    
    6-24Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25-35Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    35-37Item 4. Controls and Procedures
    
    
    37PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    38Item 1A. Risk Factors
    
    
    39Item 2. Not applicable
    
    
    39Item 3. Not applicable
    
    
    39Item 4. Not applicable
    
    
    39Item 5. Not applicable
    
    
    39Item 6. Exhibits
    
    
    39SIGNATURE
    
    
    40Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2
   2




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##### Table of Contents



CERADYNE, INC.
FORM 10-Q
FOR THE QUARTER ENDED
SEPTEMBER 30, 2008
 
 PART I. FINANCIAL INFORMATION
 
 Item 1. Unaudited Consolidated Financial Statements
 CERADYNE, INC.
 
 CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)CURRENT ASSETSCash and cash equivalents
    
    $
    204,486
    
    
    $
    155,103Restricted cash
    
    
    2,699
    
    
    
    2,660Short-term investments
    
    
    7,900
    
    
    
    29,582Accounts receivable, net of allowances for doubtful accounts of $1,038
and $792 at September 30, 2008 and December 31, 2007, respectively
    
    
    64,138
    
    
    
    85,346Other receivables
    
    
    8,360
    
    
    
    5,704Inventories, net
    
    
    101,039
    
    
    
    92,781Production tooling, net
    
    
    13,997
    
    
    
    16,632Prepaid expenses and other
    
    
    29,880
    
    
    
    12,391Deferred tax asset
    
    
    12,816
    
    
    
    12,455TOTAL CURRENT ASSETS
    
    
    445,315
    
    
    
    412,654PROPERTY, PLANT AND EQUIPMENT, net
    
    
    252,461
    
    
    
    243,892LONG TERM INVESTMENTS
    
    
    29,489
    
    
    
    38,089INTANGIBLE ASSETS, net
    
    
    84,491
    
    
    
    37,578GOODWILL
    
    
    46,484
    
    
    
    46,848OTHER ASSETS
    
    
    3,731
    
    
    
    4,225TOTAL ASSETS
    
    $
    861,971
    
    
    $
    783,286CURRENT LIABILITIESAccounts payable
    
    $
    29,156
    
    
    $
    35,990Accrued expenses
    
    
    26,492
    
    
    
    22,483Income taxes payable
    
    
    788
    
    
    
    258TOTAL CURRENT LIABILITIES
    
    
    56,436
    
    
    
    58,731LONG-TERM DEBT
    
    
    121,000
    
    
    
    121,000EMPLOYEE BENEFITS
    
    
    14,102
    
    
    
    13,650OTHER LONG TERM LIABILITY
    
    
    41,501
    
    
    
    4,985DEFERRED TAX LIABILITY
    
    
    5,677
    
    
    
    6,291TOTAL LIABILITIES
    
    
    238,716
    
    
    
    204,657COMMITMENTS AND CONTINGENCIES (Note 15)SHAREHOLDERS EQUITYCommon stock, $0.01 par value,
100,000,000 authorized, 26,273,611 and
27,318,530 shares issued and outstanding
at September 30, 2008 and December 31,
2007, respectively
    
    
    264
    
    
    
    272Additional paid-in capital
    
    
    154,430
    
    
    
    185,702Retained earnings
    
    
    446,798
    
    
    
    361,301Accumulated other comprehensive income
    
    
    21,763
    
    
    
    31,354TOTAL SHAREHOLDERS EQUITY
    
    
    623,255
    
    
    
    578,629TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    861,971
    
    
    $
    783,286
   3




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CERADYNE, INC.
 
 CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Unaudited)
    
    
    (Unaudited)NET SALES
    
    $
    167,746
    
    
    $
    191,606
    
    
    $
    541,258
    
    
    $
    565,408COST OF GOODS SOLD
    
    
    101,082
    
    
    
    115,819
    
    
    
    327,504
    
    
    
    335,125Gross profit
    
    
    66,664
    
    
    
    75,787
    
    
    
    213,754
    
    
    
    230,283OPERATING EXPENSESSelling
    
    
    8,443
    
    
    
    6,872
    
    
    
    24,966
    
    
    
    19,617General and administrative
    
    
    11,703
    
    
    
    11,280
    
    
    
    35,208
    
    
    
    30,218Acquisition related charge
    
    
    9,783
    
    
    
    
    
    
    
    9,783
    
    
    
    Research and development
    
    
    4,527
    
    
    
    5,680
    
    
    
    10,979
    
    
    
    13,56134,456
    
    
    
    23,832
    
    
    
    80,936
    
    
    
    63,396INCOME FROM OPERATIONS
    
    
    32,208
    
    
    
    51,955
    
    
    
    132,818
    
    
    
    166,887OTHER INCOME (EXPENSE):Royalty income
    
    
    5
    
    
    
    30
    
    
    
    65
    
    
    
    105Interest income
    
    
    1,772
    
    
    
    3,281
    
    
    
    6,273
    
    
    
    9,542Interest expense
    
    
    (1,026
    )
    
    
    (1,094
    )
    
    
    (3,130
    )
    
    
    (3,154
    )Miscellaneous
    
    
    (2,581
    )
    
    
    (103
    )
    
    
    (1,908
    )
    
    
    54(1,830
    )
    
    
    2,114
    
    
    
    1,300
    
    
    
    6,547INCOME BEFORE PROVISION FOR INCOME TAXES
    
    
    30,378
    
    
    
    54,069
    
    
    
    134,118
    
    
    
    173,434PROVISION FOR INCOME TAXES
    
    
    10,979
    
    
    
    21,419
    
    
    
    48,621
    
    
    
    64,392NET INCOME
    
    $
    19,399
    
    
    $
    32,650
    
    
    $
    85,497
    
    
    $
    109,042BASIC INCOME PER SHARE
    
    $
    0.74
    
    
    $
    1.20
    
    
    $
    3.22
    
    
    $
    4.00DILUTED INCOME PER SHARE
    
    $
    0.73
    
    
    $
    1.16
    
    
    $
    3.18
    
    
    $
    3.93WEIGHTED AVERAGE SHARES OUTSTANDING:BASIC
    
    
    26,272
    
    
    
    27,304
    
    
    
    26,568
    
    
    
    27,231DILUTED
    
    
    26,563
    
    
    
    28,052
    
    
    
    26,888
    
    
    
    27,766
   4




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CERADYNE, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
 Nine Months EndedSeptember 30,2008
    
    
    2007(Unaudited)CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    85,497
    
    
    $
    109,042ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY
OPERATING ACTIVITIES:Depreciation and amortization
    
    
    30,122
    
    
    
    17,948Deferred income taxes
    
    
    421
    
    
    
    (2,014
    )Stock compensation
    
    
    2,233
    
    
    
    1,842Loss on marketable securities
    
    
    3,545
    
    
    
    Loss on equipment disposal
    
    
    125
    
    
    
    794Change in operating assets and
liabilities (net of effect of businesses acquired):Accounts receivable, net
    
    
    22,680
    
    
    
    (12,995
    )Other receivables
    
    
    (3,597
    )
    
    
    (1,735
    )Inventories, net
    
    
    (5,079
    )
    
    
    (16,927
    )Production tooling, net
    
    
    2,597
    
    
    
    1,480Prepaid expenses and other assets
    
    
    (18,005
    )
    
    
    (1,167
    )Accounts payable and accrued expenses
    
    
    (5,456
    )
    
    
    (4,418
    )Income taxes payable
    
    
    549
    
    
    
    (11,042
    )Other long term liability
    
    
    10,350
    
    
    
    6,964Employee benefits
    
    
    1,014
    
    
    
    1,237NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    126,996
    
    
    
    89,009CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property, plant and equipment
    
    
    (35,938
    )
    
    
    (28,343
    )Changes in restricted cash
    
    
    (39
    )
    
    
    (2,633
    )Purchases of marketable securities
    
    
    
    
    
    
    (363,317
    )Proceeds from sales and maturities of marketable securities
    
    
    21,700
    
    
    
    397,912Cash paid for acquisitions, net of cash received
    
    
    (26,855
    )
    
    
    (98,606
    )Proceeds from sale of equipment
    
    
    24
    
    
    
    NET CASH USED IN INVESTING ACTIVITIES
    
    
    (41,108
    )
    
    
    (94,987
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from issuance of stock due to exercise of options
    
    
    302
    
    
    
    603Proceeds from issuance of stock for stock plans
    
    
    
    
    
    
    1,085Excess tax benefit due to exercise of stock options
    
    
    287
    
    
    
    4,133Shares repurchased
    
    
    (34,919
    )
    
    
    Other
    
    
    
    
    
    
    48NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES
    
    
    (34,330
    )
    
    
    5,869EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
    
    
    (2,175
    )
    
    
    1,708INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    49,383
    
    
    
    1,599CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
    
    155,103
    
    
    
    13,547CASH AND CASH EQUIVALENTS, END OF PERIOD
    
    $
    204,486
    
    
    $
    15,146SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES:Interest paid
    
    $
    1,744
    
    
    $
    1,756Income taxes paid
    
    $
    62,692
    
    
    $
    67,286
   5




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Basis of Presentation
    Share Based Compensation
         6




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Share-based compensation expense recognized:General and administrative, options
    
    $
    112
    
    
    $
    176
    
    
    $
    345
    
    
    $
    552General and administrative, restricted stock units
    
    
    728
    
    
    
    479
    
    
    
    1,887
    
    
    
    1,290Related deferred income tax benefit
    
    
    (305
    )
    
    
    (259
    )
    
    
    (810
    )
    
    
    (683
    )Decrease in net income
    
    $
    535
    
    
    $
    396
    
    
    $
    1,422
    
    
    $
    1,159Decrease in basic earnings per share
    
    $
    0.02
    
    
    $
    0.01
    
    
    $
    0.05
    
    
    $
    0.04Decrease in diluted earnings per share
    
    $
    0.02
    
    
    $
    0.01
    
    
    $
    0.05
    
    
    $
    0.04
     Nine Months EndedSeptember 30, 2008WeightedAverageNumber of
    
    
    ExerciseOptions
    
    
    PriceOutstanding, December 31, 2007
    
    
    497,325
    
    
    $
    12.04Options granted
    
    
    
    
    
    $
    Options exercised
    
    
    (24,525
    )
    
    $
    8.63Options cancelled
    
    
    (3,750
    )
    
    $
    15.05Outstanding, September 30, 2008
    
    
    469,050
    
    
    $
    12.20Exercisable, September 30, 2008
    
    
    443,175
    
    
    $
    11.70
  Nine Months EndedSeptember 30, 2008WeightedAverage GrantUnits
    
    
    Fair ValueNon-vested Units at December 31, 2007
    
    
    149,759
    
    
    $
    52.94Granted
    
    
    168,076
    
    
    $
    40.54Vested
    
    
    (38,191
    )
    
    $
    47.69Forfeited
    
    
    (2,400
    )
    
    $
    63.16Non-vested Units at September 30, 2008
    
    
    277,244
    
    
    $
    46.04
  7




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##### Table of Contents



Outstanding
    
    
    ExercisableAverage
    
    
    Weighted
    
    
    Aggregate
    
    
    
    
    
    
    Average
    
    
    Weighted
    
    
    AggregateRemaining
    
    
    Average
    
    
    Intrinsic
    
    
    
    
    
    
    Remaining
    
    
    Average
    
    
    IntrinsicNumber of
    
    
    Contractual
    
    
    Exercise
    
    
    Value
    
    
    Number of
    
    
    Contractual
    
    
    Exercise
    
    
    ValueRange of Exercise Prices
    
    Options
    
    
    Life (Years)
    
    
    Price
    
    
    (000s)
    
    
    Options
    
    
    Life (Years)
    
    
    Price
    
    
    (000s)$1.44  $2.81
    
    
    3,150
    
    
    
    1.22
    
    
    $
    1.61
    
    
    $
    31,800
    
    
    
    3,150
    
    
    
    1.22
    
    
    $
    1.61
    
    
    $
    110$2.98  $4.58
    
    
    214,275
    
    
    
    4.09
    
    
    $
    4.12
    
    
    $
    6,972
    
    
    
    214,275
    
    
    
    4.09
    
    
    $
    4.12
    
    
    $
    6,972$10.53  $16.89
    
    
    125,625
    
    
    
    5.69
    
    
    $
    16.89
    
    
    $
    2,484
    
    
    
    125,625
    
    
    
    5.69
    
    
    $
    16.89
    
    
    $
    2,484$18.80  $24.07
    
    
    126,000
    
    
    
    6.72
    
    
    $
    21.51
    
    
    $
    1,908
    
    
    
    100,125
    
    
    
    6.66
    
    
    $
    21.71
    
    
    $
    1,497469,050
    
    
    
    5.20
    
    
    $
    12.20
    
    
    $
    11,474
    
    
    
    443,175
    
    
    
    5.10
    
    
    $
    11.70
    
    
    $
    11,063
  Average
    
    
    WeightedRemaining
    
    
    AverageNumber of
    
    
    Contractual
    
    
    GrantRange of Grant Prices
    
    Units
    
    
    Life (Years)
    
    
    Fair Value$21.46  $22.68
    
    
    21,800
    
    
    
    1.65
    
    
    $
    22.34$37.41  $39.43
    
    
    112,576
    
    
    
    4.47
    
    
    $
    38.55$42.28  $45.7
    
    
    63,838
    
    
    
    4.13
    
    
    $
    44.49$52.47  $62.07
    
    
    42,030
    
    
    
    2.93
    
    
    $
    58.87$66.35  $81.18
    
    
    37,000
    
    
    
    3.33
    
    
    $
    70.88277,244
    
    
    
    3.78
    
    
    $
    46.04
 Acquisitions
 Acquisition of SemEquip, Inc.
    8




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##### Table of Contents



Cash consideration paid to SemEquip stockholders
    
    $
    23,315Accrued purchase consideration
    
    
    26,166Direct transaction fees and expenses
    
    
    1,867Total purchase price
    
    $
    51,348
  
 Cash
    
    $
    2,192Inventories
    
    
    3,574Accounts receivable, net
    
    
    446Other current assets
    
    
    276Property, plant and equipment
    
    
    1,071Intangible assets
    
    
    48,189Accounts payable and other liabilities
    
    
    (3,685
    )Non-current deferred tax liability, net of $17.8 million deferred tax asset (see Note 14)
    
    
    (715
    )Net assets acquired
    
    $
    51,348
     
    
    SemEquip historical operating margins and performance of comparable publicly traded entities
    
    Number of customers and SemEquip market share
    
    Contractual and non-contractual relationships with large customers, and
    
    Patents held
   9




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,
    
    
    September 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net sales
    
    $
    168,108
    
    
    $
    192,530
    
    
    $
    544,039
    
    
    $
    568,610Net income (1) (2)
    
    
    18,711
    
    
    
    24,805
    
    
    
    81,652
    
    
    
    96,427Basic income per share
    
    $
    0.71
    
    
    $
    0.91
    
    
    $
    3.07
    
    
    $
    3.54Diluted income per share
    
    $
    0.70
    
    
    $
    0.88
    
    
    $
    3.04
    
    
    $
    3.47
 
 (1)
    
    The unaudited pro forma information for the three and nine months
ended September 30, 2008 includes the $9.8 million pre-tax acquisition
related compensation charge associated with a pre-closing commitment
by SemEquip to pay incentive compensation to several of its employees
and advisors, which has been recognized in the Companys historical
results of operations for these periods. The unaudited pro forma
information for the three and nine months ended September 30, 2008
include pro forma adjustments to reflect a $57,000 pre-tax increase
and a $398,000 pre-tax increase in amortization expense related to
managements estimate of the fair value of intangible assets acquired
in the SemEquip acquisition.(2)
    
    The unaudited pro forma information for the three and nine months
ended September 30, 2007 includes a pro forma adjustment to recognize
the $9.8 million pre-tax acquisition related compensation charge
associated with a pre-closing commitment by SemEquip to pay incentive
compensation to several of its employees and advisors. The unaudited
pro forma information for the three and nine months ended
September 30, 2007 also include pro forma adjustments to reflect a
$171,000 pre-tax increase and a $512,000 pre-tax increase in
amortization expense related to managements estimate of the fair
value of intangible assets acquired as the result of the SemEquip
acquisition, respectively. Asset Purchase  Proprietary Technical Ceramic Bearing Technology
   Cash
    
    $
    3,750Transaction costs
    
    
    115Total purchase price
    
    $
    3,865Fair value of assets acquired:Fixed assets
    
    $
    29Customer relationships
    
    
    120Developed technology
    
    
    3,716Total fair value of assets acquired
    
    $
    3,865
 Review of Historical Stock Option Grant Procedures Share Based Compensation
   10




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Materiality
   11




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##### Table of Contents



5.
    
    Net Income Per Share
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Weighted average number of shares outstanding
    
    
    26,271,812
    
    
    
    27,304,227
    
    
    
    26,568,011
    
    
    
    27,230,846Dilutive stock options
    
    
    261,487
    
    
    
    292,885
    
    
    
    256,585
    
    
    
    291,988Dilutive restricted stock units
    
    
    30,066
    
    
    
    27,544
    
    
    
    63,655
    
    
    
    41,626Dilutive contingent convertible debt common
shares
    
    
    
    
    
    
    427,201
    
    
    
    
    
    
    
    201,865Number of shares used in fully diluted computations
    
    
    26,563,365
    
    
    
    28,051,857
    
    
    
    26,888,251
    
    
    
    27,766,325
 Composition of Certain Financial Statement Captions
  
 September 30, 2008
    
    
    December 31, 2007Raw materials
    
    $
    18,990
    
    
    $
    22,772Work-in-process
    
    
    49,449
    
    
    
    46,853Finished goods
    
    
    32,600
    
    
    
    23,156$
    101,039
    
    
    $
    92,781
 
 September 30, 2008
    
    
    December 31, 2007Land
    
    $
    17,262
    
    
    $
    15,086Buildings and improvements
    
    
    96,045
    
    
    
    88,906Machinery and equipment
    
    
    198,568
    
    
    
    179,998Leasehold improvements
    
    
    8,427
    
    
    
    8,897Office equipment
    
    
    23,537
    
    
    
    19,975Construction in progress
    
    
    15,794
    
    
    
    16,880359,633
    
    
    
    329,742Less accumulated depreciation and amortization
    
    
    (107,172
    )
    
    
    (85,850
    )$
    252,461
    
    
    $
    243,892
  12




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##### Table of Contents



September 30, 2008
    
    
    December 31, 2007Gross
    
    
    Accumulated
    
    
    Net
    
    
    Gross
    
    
    Accumulated
    
    
    NetAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountAmortizing Intangible AssetsBacklog
    
    $
    1,795
    
    
    $
    1,795
    
    
    $
    
    
    
    $
    1,795
    
    
    $
    1,795
    
    
    $
    Developed technology
    
    
    40,964
    
    
    
    2,415
    
    
    
    38,549
    
    
    
    11,617
    
    
    
    1,666
    
    
    
    9,951Tradename
    
    
    1,110
    
    
    
    261
    
    
    
    849
    
    
    
    1,110
    
    
    
    142
    
    
    
    968Customer relationships
    
    
    46,604
    
    
    
    4,506
    
    
    
    42,098
    
    
    
    25,230
    
    
    
    947
    
    
    
    24,283Non-compete agreement
    
    
    500
    
    
    
    459
    
    
    
    41
    
    
    
    500
    
    
    
    178
    
    
    
    322Non-amortizing tradename
    
    
    2,054
    
    
    
    
    
    
    
    2,054
    
    
    
    2,054
    
    
    
    
    
    
    
    2,054Total
    
    $
    94,027
    
    
    $
    9,536
    
    
    $
    84,491
    
    
    $
    42,306
    
    
    $
    4,728
    
    
    $
    37,578
  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
  
 ACO
    
    
    Semicon
    
    
    Thermo
    
    
    ESK
    
    
    Canada
    
    
    Boron
    
    
    TotalDecember 31, 2007
    
    $
    2,608
    
    
    $
    603
    
    
    $
    11,378
    
    
    $
    10,176
    
    
    $
    3,832
    
    
    $
    18,251
    
    
    $
    46,848Foreign Currency Translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (364
    )
    
    
    
    
    
    
    
    
    
    
    (364
    )September 30, 2008
    
    $
    2,608
    
    
    $
    603
    
    
    $
    11,378
    
    
    $
    9,812
    
    
    $
    3,832
    
    
    $
    18,251
    
    
    $
    46,484
 Stock Repurchases
  Fair Value Measurements
        13




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##### Table of Contents




    
    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)
      14




---



##### Table of Contents



Fair Value Measurements at September 30, 2008UsingSignificantQuoted Prices
    
    
    Other
    
    
    Significant
    
    
    Total Carryingin Active
    
    
    Observable
    
    
    Unobservable
    
    
    Value atMarkets
    
    
    Inputs
    
    
    Inputs
    
    
    September 30,(In thousands)
    
    (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    2008Cash and cash equivalents (including restricted cash)
    
    $
    207,185
    
    
    $
    
    
    
    $
    
    
    
    $
    207,185Short term investments
    
    
    7,900
    
    
    
    
    
    
    
    
    
    
    
    7,900Long term investments
    
    
    
    
    
    
    
    
    
    
    29,489
    
    
    
    29,489Other long-term financial asset
    
    $
    1,797
    
    
    $
    
    
    
    $
    
    
    
    $
    1,797
    Recent Accounting Pronouncements
 
   15




---



##### Table of Contents



Convertible Debt and Credit Facility
     16




---



##### Table of Contents



Disclosure About Segments of an Enterprise and Related Information
 10
  17




---



##### Table of Contents



Operating Segment and Facility Location
    
    ProductsCeradyne Advanced Ceramic Operations
    
    Defense Applications:    Lightweight ceramic armorCosta Mesa and Irvine, California(1)
    
    Industrial Applications:Approximately 240,000 square feet
    
        Ceralloy® 147 SRBSN wear parts
    Precision ceramicsLexington, Kentucky(2)
    
    Automotive/Diesel Applications:Approximately 115,000 square feet
    
        Ceralloy® 147 SRBSN automotive/diesel engine partsWixom, Michigan(3)
    
    Commercial Applications:Approximately 29,000 square feet
    
        Clarity®ceramic orthodontic brackets    Components for medical devicesESK Ceramics
    
    Defense Applications:    Boron carbide powders for body armorKempten, Germany(4)Approximately 548,000 square feet
    
    Industrial Applications:Bazet, France(5)
    
        Ceramic powders: boron carbide, boron nitride, titanium
diboride, calcium hexaboride and zirconium diborideApproximately 88,000 square feet
    
        Silicon carbide parts    Evaporation boats for the packaging industry    High performance pump sealsAutomotive/Diesel Applications:    EKagrip® functional and frictional coatingsCommercial Applications:   BORONEIGE® boron nitride powder for cosmeticsCeradyne Semicon Associates
    
    Industrial Applications:Lexington, Kentucky(6)
Approximately 35,000 square feet
    
        Ceramic-impregnated dispenser cathodes for microwave tubes,
lasers and cathode ray tubes    Samarium cobalt magnetsCeradyne Thermo Materials
    
    Defense Applications:Scottdale and Clarkston, Georgia(7)
Approximately 225,000 square feet
    
        Missile radomes (nose cones)
    High purity fused silica used to manufacture missile radomes (nose cones)Tianjin, China(8)
    
    Industrial Applications:Approximately 98,000 square feetMidway, Tennessee(9)
Approximately 105,000 square feet
    
        Glass tempering rolls
    Metallurgical tooling
    Castable and other fused silica products
    Crucibles for photovoltaic solar cell applications
    Turbine components used in aerospace applicationsCeradyne Canada
    
    Industrial Applications:Chicoutimi, Quebec, Canada(10)
Approximately 86,000 square feet
    
        Boral® structural neutron absorbing materials
    Metal matrix composite structures
  18




---



##### Table of Contents



Operating Segment and Facility Location
    
    ProductsBoron
    
    Industrial Applications:Quapaw, Oklahoma(11)
    
    Nuclear Applications:Approximately 128,000 square feetNorth Billerica, Massachusetts(12)
Approximately 26,000 square feet
    
        Nuclear chemistry products for use in pressurized water reactors and boiling water reactors
    Radioactive containment for use in spent fuel transport and
storage
    Burnable poisons for coating of uranium fuel pelletsSemiconductor Applications:    P-dopants for silicon manufacturing
    P-dopants for ion implanting of silicon wafers
    Development of cluster ion implantation sub-systems
    Advanced ion source materials for the manufacture of
logic and memory chips
 
 (1)
    
    We have leases on our facilities in Costa Mesa, California, aggregating approximately 99,000
square feet, all of which expire in October 2010. We own our 40,000 square foot facility in
Irvine, California. In Irvine, California, we occupy a 24,000 square foot facility under a
lease that expires in April 2009 and a 76,000 square foot facility under a lease that expires
in April 2011.(2)
    
    We own our facility in Lexington, Kentucky.(3)
    
    We have a lease on our Wixom, Michigan facility which expires in April 2010.(4)
    
    We own our facility in Kempten, Germany, as well as the 22-acre property on which our
facility is located.(5)
    
    We own our facility in Bazet, France, as well as the four-acre property on which our facility
is located.(6)
    
    We own our facility in Lexington, Kentucky, as well as the five-acre property on which our
facility is located.(7)
    
    We own an 85,000 square foot facility in Scottdale, Georgia, as well as the five-acre
property on which our facility is located. We have a lease on our 140,000 square foot facility
in Clarkson, Georgia which expires in June 2013.(8)
    
    We own our facility in Tianjin, China, as well as the four-acre property on which our facility is located.(9)
    
    We own our facility in Midway, Tennessee as well as the 40-acre property on which our facility is located.(10)
    
    We own our facility in Chicoutimi, Quebec, Canada, as well as the seven-acre property on which our facility is located.(11)
    
    We own our facility in Quapaw, Oklahoma as well as the 155-acre property on which our
facility is located.(12)
    
    We lease our facility in North Billerica, Massachusetts.  19




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Revenue from External CustomersACO
    
    $
    110,115
    
    
    $
    145,881
    
    
    $
    359,438
    
    
    $
    447,069ESK Ceramics
    
    
    38,032
    
    
    
    39,009
    
    
    
    122,961
    
    
    
    121,463Semicon Associates
    
    
    2,264
    
    
    
    1,640
    
    
    
    6,609
    
    
    
    6,021Thermo Materials
    
    
    20,675
    
    
    
    10,250
    
    
    
    59,707
    
    
    
    18,534Ceradyne Canada
    
    
    91
    
    
    
    1,389
    
    
    
    4,899
    
    
    
    3,172Boron
    
    
    4,308
    
    
    
    2,114
    
    
    
    14,548
    
    
    
    2,114Inter-segment elimination
    
    
    (7,739
    )
    
    
    (8,677
    )
    
    
    (26,904
    )
    
    
    (32,965
    )Total
    
    $
    167,746
    
    
    $
    191,606
    
    
    $
    541,258
    
    
    $
    565,408Depreciation and AmortizationACO
    
    $
    3,134
    
    
    $
    2,303
    
    
    $
    8,125
    
    
    $
    6,880ESK Ceramics
    
    
    3,434
    
    
    
    2,839
    
    
    
    9,944
    
    
    
    7,801Semicon Associates
    
    
    465
    
    
    
    92
    
    
    
    640
    
    
    
    261Thermo Materials
    
    
    1,465
    
    
    
    1,087
    
    
    
    4,051
    
    
    
    1,732Ceradyne Canada
    
    
    256
    
    
    
    177
    
    
    
    749
    
    
    
    529Boron
    
    
    3,300
    
    
    
    745
    
    
    
    6,613
    
    
    
    745Total
    
    $
    12,054
    
    
    $
    7,243
    
    
    $
    30,122
    
    
    $
    17,948Segment Income (Loss) before Provision for Income TaxesACO
    
    $
    35,400
    
    
    $
    52,332
    
    
    $
    121,598
    
    
    $
    165,611ESK Ceramics
    
    
    (79
    )
    
    
    2,103
    
    
    
    5,302
    
    
    
    10,446Semicon Associates
    
    
    341
    
    
    
    78
    
    
    
    1,079
    
    
    
    577Thermo Materials
    
    
    6,815
    
    
    
    (30
    )
    
    
    15,833
    
    
    
    492Ceradyne Canada
    
    
    (344
    )
    
    
    (342
    )
    
    
    362
    
    
    
    (2,430
    )Boron
    
    
    (12,836
    )
    
    
    (84
    )
    
    
    (12,503
    )
    
    
    (84
    )Inter-segment elimination
    
    
    1,081
    
    
    
    12
    
    
    
    2,447
    
    
    
    (1,178
    )Total
    
    $
    30,378
    
    
    $
    54,069
    
    
    $
    134,118
    
    
    $
    173,434Segment AssetsACO
    
    $
    388,521
    
    
    $
    382,112
    
    
    $
    388,521
    
    
    $
    382,112ESK Ceramics
    
    
    231,745
    
    
    
    202,587
    
    
    
    231,745
    
    
    
    202,587Semicon Associates
    
    
    6,008
    
    
    
    5,458
    
    
    
    6,008
    
    
    
    5,458Thermo Materials
    
    
    91,234
    
    
    
    62,999
    
    
    
    91,234
    
    
    
    62,999Ceradyne Canada
    
    
    22,548
    
    
    
    19,568
    
    
    
    22,548
    
    
    
    19,568Boron
    
    
    121,915
    
    
    
    73,098
    
    
    
    121,915
    
    
    
    73,098Total
    
    $
    861,971
    
    
    $
    745,822
    
    
    $
    861,971
    
    
    $
    745,822Expenditures for Property, Plant & EquipmentACO
    
    $
    1,780
    
    
    $
    2,071
    
    
    $
    4,247
    
    
    $
    6,658ESK Ceramics
    
    
    3,266
    
    
    
    4,502
    
    
    
    18,609
    
    
    
    9,510Semicon Associates
    
    
    391
    
    
    
    134
    
    
    
    508
    
    
    
    312Thermo Materials
    
    
    2,383
    
    
    
    5,763
    
    
    
    9,042
    
    
    
    10,863Ceradyne Canada
    
    
    275
    
    
    
    412
    
    
    
    1,761
    
    
    
    1,000Boron
    
    
    1,507
    
    
    
    
    
    
    
    1,771
    
    
    
    Total
    
    $
    9,602
    
    
    $
    12,882
    
    
    $
    35,938
    
    
    $
    28,343
  20




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Percentage of U.S. net sales from external customersACO
    
    
    62
    %
    
    
    74
    %
    
    
    63
    %
    
    
    77
    %ESK Ceramics
    
    
    3
    %
    
    
    2
    %
    
    
    2
    %
    
    
    2
    %Semicon Associates
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Thermo Materials
    
    
    4
    %
    
    
    3
    %
    
    
    4
    %
    
    
    1
    %Ceradyne Canada
    
    
    0
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Boron
    
    
    1
    %
    
    
    1
    %
    
    
    2
    %
    
    
    1
    %Total percentage of U.S. net sales from external customers
    
    
    71
    %
    
    
    82
    %
    
    
    73
    %
    
    
    83
    %Percentage of foreign net sales from external customersACO
    
    
    3
    %
    
    
    2
    %
    
    
    3
    %
    
    
    2
    %ESK Ceramics
    
    
    17
    %
    
    
    14
    %
    
    
    16
    %
    
    
    14
    %Semicon Associates
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Thermo Materials
    
    
    8
    %
    
    
    2
    %
    
    
    7
    %
    
    
    1
    %Ceradyne Canada
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Boron
    
    
    1
    %
    
    
    0
    %
    
    
    1
    %
    
    
    0
    %Total percentage of foreign net sales from external customers
    
    
    29
    %
    
    
    18
    %
    
    
    27
    %
    
    
    17
    %Percentage of total net sales from external customersACO
    
    
    65
    %
    
    
    76
    %
    
    
    66
    %
    
    
    79
    %ESK Ceramics
    
    
    20
    %
    
    
    16
    %
    
    
    18
    %
    
    
    16
    %Semicon Associates
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Thermo Materials
    
    
    12
    %
    
    
    5
    %
    
    
    11
    %
    
    
    2
    %Ceradyne Canada
    
    
    0
    %
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Boron
    
    
    2
    %
    
    
    1
    %
    
    
    3
    %
    
    
    1
    %Total percentage of total net sales from external customers
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Armor
    
    $
    99,887
    
    
    $
    136,658
    
    
    $
    328,371
    
    
    $
    421,062Automotive
    
    
    4,912
    
    
    
    2,806
    
    
    
    13,382
    
    
    
    7,069Orthodontics
    
    
    2,148
    
    
    
    2,547
    
    
    
    8,136
    
    
    
    8,042Industrial
    
    
    3,168
    
    
    
    3,870
    
    
    
    9,549
    
    
    
    10,896$
    110,115
    
    
    $
    145,881
    
    
    $
    359,438
    
    
    $
    447,069
 Pension and Other Post-retirement Benefit Plans
   21




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Service cost
    
    $
    140
    
    
    $
    126
    
    
    $
    423
    
    
    $
    351Interest cost
    
    
    253
    
    
    
    146
    
    
    
    764
    
    
    
    340Expected return on plan assets
    
    
    (174
    )
    
    
    (59
    )
    
    
    (522
    )
    
    
    (59
    )Amortization of unrecognized gain
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    44Net periodic benefit cost
    
    $
    219
    
    
    $
    228
    
    
    $
    665
    
    
    $
    676
 Financial Instruments
   Income Taxes
   September 30, 2008
    
    
    December 31, 2007Federal, state and foreign UTBs
    
    $
    6,392
    
    
    $
    4,556Interest
    
    
    1,359
    
    
    
    679Federal/State Benefit of Interest
    
    
    (514
    )
    
    
    (250
    )Total reserve for UTBs
    
    $
    7,237
    
    
    $
    4,985
    22




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##### Table of Contents



Commitments and Contingencies
 
 2008
    
    $
    1,6342009
    
    
    2,9972010
    
    
    2,5862011
    
    
    7422012
    
    
    285Thereafter
    
    
    99$
    8,343
       23




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##### Table of Contents



Comprehensive Income
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net income
    
    $
    19,399
    
    
    $
    32,650
    
    
    $
    85,497
    
    
    $
    109,042Foreign currency translation
    
    
    (23,139
    )
    
    
    9,260
    
    
    
    (6,515
    )
    
    
    13,590Unrealized gain (loss) on investments
    
    
    (1,582
    )
    
    
    42
    
    
    
    (3,076
    )
    
    
    48Comprehensive income
    
    $
    (5,322
    )
    
    $
    41,952
    
    
    $
    75,906
    
    
    $
    122,680
  24




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Preliminary Note Regarding Forward-Looking Statements
  Overview
  
    
    lightweight ceramic armor for soldiers and other military applications;
    
    ceramic industrial components for erosion and corrosion resistant applications;
    
    ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium
hexaboride, and zirconium diboride, which are used in manufacturing armor and a broad
range of industrial products; and BORONEIGE® boron nitride powder for cosmetic 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 industrial applications and ceramic crucibles;
    
    neutron absorbing materials, structural and non-structural, in combination with
aluminum metal matrix composites that serve as part of a barrier system for spent fuel wet
and dry storage in the nuclear industry, and non-structural neutron absorbing materials
for use in the transport of nuclear fresh fuel rods;
    
    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;
    
    technical ceramic bearings for down hole oil drilling and for coal bed methane
pumps and steam assisted oil extraction pumps; and
    
    cluster ion implantation sub-systems and advanced ion source materials for the
manufacture of logic and memory chips.
   25




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Defense
    
    
    60.8
    %
    
    
    72.6
    %
    
    
    62.0
    %
    
    
    75.8
    %Industrial
    
    
    31.1
    
    
    
    21.6
    
    
    
    30.2
    
    
    
    18.6Automotive/Diesel
    
    
    6.4
    
    
    
    4.2
    
    
    
    5.9
    
    
    
    3.9Commercial
    
    
    1.7
    
    
    
    1.6
    
    
    
    1.9
    
    
    
    1.7Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
      26




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##### Table of Contents



Review of Historical Stock Option Grant Procedures
       27




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Results of Operations for the Three and Nine Months Ended September 30, 2008 and 2007
 Net Sales.
  ®
 ®
  28




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29




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® ®
  Gross Profit. ®
      30




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® ®
  Selling Expenses.
   31




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General and Administrative Expenses.
  Acquisition Related Charge.
 Research and Development Expenses.
 Other Income (Expense).
  Income before Provision for Income Taxes.
  32




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®
  Income Taxes.
  33




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Liquidity and Capital Resources
            34




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
   35




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
    
    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)
     36




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Item 4. Controls and Procedures
 Review of Historical Stock Option Grant Procedures
   Evaluation of Disclosure Controls and Procedures
  Changes in Internal Control over Financial Reporting
   37




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PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
       Daniel Vargas, Jr. v. Ceradyne, Inc., Orange County Superior Court, Civil Action No.
07CC01232 :
   38




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Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. 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.
  39




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CERADYNE, INC.Date: October 28, 2008
    By:
    /s/ JERROLD J. PELLIZZONJerrold J. PellizzonVice President
Chief Financial Officer
(Principal Financial and Accounting Officer)  40




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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.
  41