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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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|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, 2006

Or



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

For the transition period from  to

Commission
File No. 000-13059



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CERADYNE, INC.

(Exact name of Registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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 is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ̈Accelerated filer  x                Non-accelerated filer ̈

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

Yes ̈No  x

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



|                             |  |                                 
|---------------------------- |  | --------------------------------
|Class                        |  | Outstanding as of April 28, 2006
|Common Stock, $.01 par value |  | 26,824,459 Shares               



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Exhibit Index on Page 27



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CERADYNE, INC.

INDEX



|          |  |                                                                                              |  |         
|--------- |  | -------------------------------------------------------------------------------------------- |  | --------
|          |  |                                                                                              |  | PAGE NO.
|PART I.   |  | FINANCIAL INFORMATION                                                                        |  |         
|          |  |                                                                                             
|Item 1.   |  | Unaudited Condensed Consolidated Financial Statements                                        |  | 3       
|          |  |                                                                                             
|          |  | Condensed Consolidated Balance Sheets  March 31, 2006 and December 31, 2005                 |  | 3-4     
|          |  |                                                                                             
|          |  | Condensed Consolidated Statements of Income - Three months Ended March 31, 2006 and 2005     |  | 5       
|          |  |                                                                                             
|          |  | Condensed Consolidated Statements of Cash Flows  Three Months Ended March 31, 2006 and 2005 |  | 6       
|          |  |                                                                                             
|          |  | Condensed Notes to Consolidated Financial Statements                                         |  | 7-18    
|          |  |                                                                                             
|Item 2.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations        |  | 19-24   
|          |  |                                                                                             
|Item 3.   |  | Quantitative and Qualitative Disclosures About Market Risk                                   |  | 24      
|          |  |                                                                                             
|Item 4.   |  | Controls and Procedures                                                                      |  | 24-25   
|          |  |                                                                                             
|PART II.  |  | OTHER INFORMATION                                                                            |  |         
|          |  |                                                                                             
|Item 1.   |  | Legal Proceedings                                                                            |  | 25      
|          |  |                                                                                             
|Item 1A.  |  | Risk Factors                                                                                 |  | 25      
|          |  |                                                                                             
|Item 2.   |  | Not applicable                                                                               |  | 25      
|          |  |                                                                                             
|Item 3.   |  | Not applicable                                                                               |  | 25      
|          |  |                                                                                             
|Item 4.   |  | Not applicable                                                                               |  | 25      
|          |  |                                                                                             
|Item 5.   |  | Not applicable                                                                               |  | 25      
|          |  |                                                                                             
|Item 6.   |  | Exhibits                                                                                     |  | 25      
|          | 
|SIGNATURE |  | 26                                                                                          



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CERADYNE, INC.

FORM 10-Q

FOR THE QUARTER ENDED

March 31, 2006

PART I.  FINANCIAL INFORMATION



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

CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS

ASSETS

(Amounts in thousands)



|                                                                                                                                                  |  |                |         |                   |   |        
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | ----------------- | - | -------
|                                                                                                                                                  |  | March 31, 2006 |         | December 31, 2005
|                                                                                                                                                  |  | (Unaudited)   
|CURRENT ASSETS                                                                                                                                    |  |                |         |                   |   |        
|Cash and cash equivalents                                                                                                                         |  | $              | 57,864  |                   | $ | 91,542 
|Short-term investments                                                                                                                            |  |                | 67,635  |                   |   | 7,839  
|Accounts receivable, net of allowances for doubtful accounts of approximately $568 and $545 at March 31, 2006 and December 31, 2005,
respectively |  |                | 67,515  |                   |   | 57,174 
|Other receivables                                                                                                                                 |  |                | 1,702   |                   |   | 3,309  
|Inventories                                                                                                                                       |  |                | 77,645  |                   |   | 66,318 
|Production tooling, net                                                                                                                           |  |                | 20,368  |                   |   | 14,102 
|Prepaid expenses and other                                                                                                                        |  |                | 9,808   |                   |   | 8,592  
|Deferred tax asset                                                                                                                                |  |                | 6,554   |                   |   | 6,341  
|                                                                                                                                                  |  |                |         |                   |   |        
|TOTAL CURRENT ASSETS                                                                                                                              |  |                | 309,091 |                   |   | 255,217
|                                                                                                                                                  |  |                |         |                   |   |        
|PROPERTY, PLANT & EQUIPMENT, net                                                                                                                  |  |                | 158,605 |                   |   | 153,259
|INTANGIBLE ASSETS, net                                                                                                                            |  |                | 6,110   |                   |   | 6,034  
|GOODWILL                                                                                                                                          |  |                | 9,410   |                   |   | 9,265  
|OTHER ASSETS                                                                                                                                      |  |                | 6,225   |                   |   | 6,418  
|                                                                                                                                                  |  |                |         |                   |   |        
|TOTAL ASSETS                                                                                                                                      |  | $              | 489,441 |                   | $ | 430,193
|                                                                                                                                                  |  |                |         |                   |   |        

See accompanying condensed notes to Consolidated Financial Statements



3



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CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS EQUITY

(Amounts in thousands, except share
data)



|                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                   |  | March 31, 2006 |         |   | December 31, 2005 |  
|                                                                                                                                                                   |  | (Unaudited)    |        
|CURRENT LIABILITIES                                                                                                                                                |  |                |         |   |                   |   |         |  
|Accounts payable                                                                                                                                                   |  | $              | 40,474  |   |                   | $ | 23,311  |  
|Accrued expenses                                                                                                                                                   |  |                | 13,840  |   |                   |   | 11,878  |  
|Income taxes payable                                                                                                                                               |  |                | 18,388  |   |                   |   | 7,719   |  
|                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|TOTAL CURRENT LIABILITIES                                                                                                                                          |  |                | 72,702  |   |                   |   | 42,908  |  
|LONG-TERM DEBT, NET OF CURRENT PORTION                                                                                                                             |  |                | 121,000 |   |                   |   | 121,000 |  
|EMPLOYEE BENEFITS                                                                                                                                                  |  |                | 11,834  |   |                   |   | 11,229  |  
|DEFERRED TAX LIABILITY                                                                                                                                             |  |                | 4,492   |   |                   |   | 4,536   |  
|                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|TOTAL LIABILITIES                                                                                                                                                  |  |                | 210,028 |   |                   |   | 179,673 |  
|COMMITMENTS AND CONTINGENCIES SHAREHOLDERS EQUITY                                                                                                                 |  |                |         |   |                   |   |         |  
|Common stock, $.01 par value, 40,000,000 authorized; 26,815,344 and 26,795,774 shares issued and outstanding at March 31, 2006 and December
31, 2005, respectively |  |                | 292     |   |                   |   | 292     |  
|Additional paid in capital                                                                                                                                         |  |                | 169,621 |   |                   |   | 170,430 |  
|Retained earnings                                                                                                                                                  |  |                | 113,245 |   |                   |   | 88,632  |  
|Deferred compensation                                                                                                                                              |  |                |        |   |                   |   | (1,506  | )
|Accumulated other comprehensive loss                                                                                                                               |  |                | (3,745  | ) |                   |   | (7,328  | )
|                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|TOTAL SHAREHOLDERS EQUITY                                                                                                                                         |  |                | 279,413 |   |                   |   | 250,520 |  
|                                                                                                                                                                   |  |                |         |   |                   |   |         |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                         |  | $              | 489,441 |   |                   | $ | 430,193 |  
|                                                                                                                                                                   |  |                |         |   |                   |   |         |  

See accompanying condensed notes to Consolidated Financial Statements



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CERADYNE, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share data)



|                                         |  |                              |         |   |      |   |        |  
|---------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------ | -
|                                         |  | THREE MONTHS ENDED March 31, |        
|                                         |  | 2006                         |         |   | 2005 |  
|                                         |  | (Unaudited)                  |        
|NET SALES                                |  | $                            | 136,347 |   |      | $ | 69,791 |  
|COST OF PRODUCT SALES                    |  |                              | 82,362  |   |      |   | 47,894 |  
|                                         |  |                              |         |   |      |   |        |  
|Gross profit                             |  |                              | 53,985  |   |      |   | 21,897 |  
|OPERATING EXPENSES                       |  |                              |         |   |      |   |        |  
|Selling                                  |  |                              | 5,774   |   |      |   | 4,799  |  
|General and administrative               |  |                              | 6,996   |   |      |   | 4,545  |  
|Research and development                 |  |                              | 2,522   |   |      |   | 1,861  |  
|                                         |  |                              |         |   |      |   |        |  
|                                         |  |                              | 15,292  |   |      |   | 11,205 |  
|                                         |  |                              |         |   |      |   |        |  
|Income from operations                   |  |                              | 38,693  |   |      |   | 10,692 |  
|                                         |  |                              |         |   |      |   |        |  
|OTHER INCOME (EXPENSE):                  |  |                              |         |   |      |   |        |  
|Royalty income                           |  |                              | 30      |   |      |   | 30     |  
|Interest income                          |  |                              | 1,057   |   |      |   | 108    |  
|Interest expense                         |  |                              | (1,028  | ) |      |   | (1,371 | )
|Miscellaneous                            |  |                              | (9      | ) |      |   | 226    |  
|                                         |  |                              |         |   |      |   |        |  
|                                         |  |                              | 50      |   |      |   | (1,007 | )
|Income before provision for income taxes |  |                              | 38,743  |   |      |   | 9,685  |  
|PROVISION FOR INCOME TAXES               |  |                              | 14,130  |   |      |   | 3,700  |  
|                                         |  |                              |         |   |      |   |        |  
|NET INCOME                               |  | $                            | 24,613  |   |      | $ | 5,985  |  
|                                         |  |                              |         |   |      |   |        |  
|BASIC INCOME PER SHARE                   |  | $                            | 0.92    |   |      | $ | 0.24   |  
|                                         |  |                              |         |   |      |   |        |  
|DILUTED INCOME PER SHARE                 |  | $                            | 0.90    |   |      | $ | 0.24   |  
|                                         |  |                              |         |   |      |   |        |  
|WEIGHTED AVERAGE SHARES OUTSTANDING:     |  |                              |         |   |      |   |        |  
|BASIC                                    |  |                              | 26,801  |   |      |   | 24,494 |  
|DILUTED                                  |  |                              | 27,385  |   |      |   | 24,930 |  

See accompanying condensed notes to Consolidated Financial Statements



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CERADYNE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)



|                                                                                  |  |                              |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | THREE MONTHS ENDED March 31, |        
|                                                                                  |  | 2006                         |         |   | 2005 |  
|                                                                                  |  | (Unaudited)                  |        
|CASH FLOWS FROM OPERATING ACTIVITIES:                                             |  |                              |         |   |      |   |         |  
|Net income                                                                        |  | $                            | 24,613  |   |      | $ | 5,985   |  
|ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: |  |                              |         |   |      |   |         |  
|Depreciation and amortization                                                     |  |                              | 4,097   |   |      |   | 3,689   |  
|Deferred income taxes                                                             |  |                              | (34     | ) |      |   | 333     |  
|Stock compensation                                                                |  |                              | 275     |   |      |   |        |  
|Change in operating assets and liabilities, net of acquisitions:                  |  |                              |         |   |      |   |         |  
|Accounts receivable, net                                                          |  |                              | (10,040 | ) |      |   | 4,521   |  
|Other receivables                                                                 |  |                              | 1,638   |   |      |   | 1,589   |  
|Inventories                                                                       |  |                              | (10,572 | ) |      |   | (13,139 | )
|Production tooling                                                                |  |                              | (6,355  | ) |      |   | (1,565  | )
|Prepaid expenses and other assets                                                 |  |                              | (824    | ) |      |   | 228     |  
|Accounts payable and accrued expenses                                             |  |                              | 18,866  |   |      |   | 2,934   |  
|Income taxes payable                                                              |  |                              | 10,378  |   |      |   | 490     |  
|Tax benefit due to exercise of stock options                                      |  |                              |        |   |      |   | 67      |  
|Employee benefits                                                                 |  |                              | 319     |   |      |   | 213     |  
|                                                                                  |  |                              |         |   |      |   |         |  
|NET CASH PROVIDED BY OPERATING ACTIVITIES                                         |  |                              | 32,361  |   |      |   | 5,345   |  
|                                                                                  |  |                              |         |   |      |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                             |  |                              |         |   |      |   |         |  
|Purchases of property, plant and equipment                                        |  |                              | (6,903  | ) |      |   | (4,768  | )
|Purchases of short-term investments                                               |  |                              | (59,796 | ) |      |   | 1,177   |  
|Additional costs of acquisition                                                   |  |                              |        |   |      |   | (605    | )
|                                                                                  |  |                              |         |   |      |   |         |  
|NET CASH USED IN INVESTING ACTIVITIES                                             |  |                              | (66,699 | ) |      |   | (4,196  | )
|                                                                                  |  |                              |         |   |      |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                             |  |                              |         |   |      |   |         |  
|Proceeds from issuance of stock due to exercise of options                        |  |                              | 57      |   |      |   | 50      |  
|Payments on long-term debt                                                        |  |                              |        |   |      |   | (275    | )
|Reduction in bank line of credit                                                  |  |                              |        |   |      |   | (3,369  | )
|Excess tax benefit due to exercise of stock options                               |  |                              | 365     |   |      |   |        |  
|Other                                                                             |  |                              | (52     | ) |      |   | (87     | )
|                                                                                  |  |                              |         |   |      |   |         |  
|NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                               |  |                              | 370     |   |      |   | (3,681  | )
|                                                                                  |  |                              |         |   |      |   |         |  
|EFFECT OF EXCHANGE RATES ON CASH AND EQUIVALENTS                                  |  |                              | 290     |   |      |   | (223    | )
|                                                                                  |  |                              |         |   |      |   |         |  
|DECREASE IN CASH AND CASH EQUIVALENTS                                             |  |                              | (33,678 | ) |      |   | (2,755  | )
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                    |  |                              | 91,542  |   |      |   | 4,521   |  
|                                                                                  |  |                              |         |   |      |   |         |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                          |  | $                            | 57,864  |   |      | $ | 1,766   |  
|                                                                                  |  |                              |         |   |      |   |         |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES:                                 |  |                              |         |   |      |   |         |  
|Interest paid                                                                     |  | $                            | 6       |   |      | $ | 1,278   |  
|Income taxes paid                                                                 |  | $                            | 3,392   |   |      | $ | 2,717   |  
|                                                                                  |  |                              |         |   |      |   |         |  

See accompanying condensed notes to Consolidated Financial Statements



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CERADYNE, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2006

(Unaudited)



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

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

The balance sheet at March 31, 2006 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes
required by generally accepted accounting principles for complete financial statements. For further information, refer to the Consolidated Financial Statements and Notes to Financial Statements included in Ceradynes Annual Report on Form 10-K
for the year ended December 31, 2005.



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

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

The Company adopted SFAS 123(R) using the modified prospective application transition method, which requires the application
of the accounting standard as of January 1, 2006, the first day of the Companys fiscal year 2006. The Companys Consolidated Financial Statements as of and for the three months ended March 31, 2006 reflect the impact of SFAS
123(R). In accordance with this transition method, the Companys Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized
under SFAS 123(R) for the three months ended March 31, 2006 was $149,000, which was related to stock options.

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

Share-based compensation expense recognized during the current period is based on the value of the portion of share-based payment awards that is ultimately expected to
vest. SFAS 123(R) requires forfeitures to be estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is based on historical rates. Share-based compensation expense
recognized in the Companys Consolidated Statements of Income for the first quarter of fiscal 2006 includes (i) compensation expense for share-based payment awards granted prior to, but not yet vested as of January 1, 2006, based on
the grant-date fair value estimated in accordance with the pro forma provisions of SFAS 123 and (ii) compensation expense for the share-based payment



7



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awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). As
share-based compensation expense recognized in the Consolidated Statement of Income for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. In the Companys pro forma
information required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

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

Share-based compensation expense reduced the Companys results of operations as follows:



|                                             |  |                                                               |     
|-------------------------------------------- |  | ------------------------------------------------------------- | ----
|                                             |  | March 31, 2006 Dollars in thousands, except per share amounts
|Share-based compensation expense recognized: |  |                                                               |     
|General and administrative                   |  | $                                                             | 149 
|Related deferred income tax benefit          |  |                                                               | 54  
|                                             |  |                                                               |     
|Decrease in net income                       |  | $                                                             | 95  
|                                             |  |                                                               |     
|Decrease in basic earnings per share         |  | $                                                             | 0.01
|                                             |  |                                                               |     
|Decrease in diluted earnings per share       |  | $                                                             | 0.01
|                                             |  |                                                               |     

The amounts above include the impact of recognizing compensation expense related to non-qualified stock options.
Compensation expense related to Restricted Stock Units (RSUs) was recognized before implementation of SFAS 123(R). Compensation for RSUs totaled $126,000 for the first quarter ended March 31, 2006 and is included in general and
administrative. There was no compensation expense related to RSUs for the first quarter ended March 31, 2005.

The following table illustrates the
effect on net income and earnings per share for the three months ended March 31, 2005, as if the Company had applied the fair value recognition provisions of SFAS 123, as amended by SFAS No. 148, Accounting for Stock-Based
CompensationTransition and Disclosure (SFAS 148):



|                                                                                                                                                |  |                                   |      
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------- | -----
|                                                                                                                                                |  | Three Months Ended March 31, 2005
|Net income, as reported                                                                                                                         |  | $                                 | 5,985
|Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax
effects |  |                                   | 364  
|                                                                                                                                                |  |                                   |      
|Pro forma net income                                                                                                                            |  | $                                 | 5,621
|                                                                                                                                                |  |                                   |      
|Net income per share:                                                                                                                           |  |                                   |      
|Basic - as reported                                                                                                                             |  | $                                 | 0.24 
|                                                                                                                                                |  |                                   |      
|Basic - pro forma                                                                                                                               |  | $                                 | 0.23 
|                                                                                                                                                |  |                                   |      
|Diluted - as reported                                                                                                                           |  | $                                 | 0.24 
|                                                                                                                                                |  |                                   |      
|Diluted - pro forma                                                                                                                             |  | $                                 | 0.23 
|                                                                                                                                                |  |                                   |      



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

The Company was authorized to grant options for up to 2,362,500 shares under its 1994 Stock Incentive Plan. The Company has
granted options for 2,691,225 shares and has had cancellations of 394,886 shares through December 31, 2005. There are no remaining stock options available to grant under this plan. The options granted under this plan were granted at an exercise
price at or above the fair market value of the Companys common stock at the date of grant, and generally became exercisable over a five-year period for incentive stock options and six months for nonqualified stock options.

The Company may grant options and restricted stock units for up to 1,125,000 shares under the 2003 Stock Incentive Plan. The Company has granted options for 475,125
shares under this plan through March 31, 2006. There have been cancellations of 12,000 shares associated with this plan through March 31, 2006. Options are granted at or above the fair market value at the date of grant and generally
become exercisable over a five-year period for incentive stock options and six months for nonqualified options. The options under both plans have a life of ten years.

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

The following is a summary of stock option activity:



|                                 |  |                   |   |  |                                 |       |  
|-------------------------------- |  | ----------------- | - |  | ------------------------------- | ----- | -
|                                 |  | Number of Options |   |  | Weighted Average Exercise Price |      
|Outstanding at December 31, 2005 |  | 977,870           |   |  | $                               | 8.73  |  
|Options granted                  |  |                  |   |  |                                 |      |  
|Options exercised                |  | (19,560           | ) |  | $                               | (2.91 | )
|Options cancelled                |  |                  |   |  | $                               |      |  
|                                 |  |                   |   |  |                                 |       |  
|Outstanding at March 31, 2006    |  | 958,310           |   |  | $                               | 8.84  |  
|                                 |  |                   |   |  |                                 |       |  
|Exercisable at March 31, 2006    |  | 603,185           |   |  | $                               | 7.06  |  

The following table summarizes information regarding options outstanding and options exercisable at March 31,
2006:



|                         |  |                   |  |                                            |  |                                 |       |                                  |   |                   |  |                                 |  |                                  |       |  |   |       
|------------------------ |  | ----------------- |  | ------------------------------------------ |  | ------------------------------- | ----- | -------------------------------- | - | ----------------- |  | ------------------------------- |  | -------------------------------- | ----- |  | - | ------
|                         |  | Outstanding       |  | Exercisable                               
|Range of Exercise Prices |  | Number of Options |  | Average Remaining Contractual Life (Years) |  | Weighted Average Exercise Price |       | Aggregate Intrinsic Value (000s) |   | Number of Options |  | Weighted Average Exercise Price |  | Aggregate Intrinsic Value (000s)
|$1.44 - $2.81            |  | 212,375           |  | 5.72                                       |  | $                               | 2.09  |                                  | $ | 11,042            |  | 148,025                         |  | $                                | 2.06  |  | $ | 7,701 
|$2.98 - $3.23            |  | 333,760           |  | 5.52                                       |  | $                               | 3.14  |                                  | $ | 17,004            |  | 254,560                         |  | $                                | 3.11  |  | $ | 12,976
|$10.53                   |  | 178,250           |  | 7.44                                       |  | $                               | 10.53 |                                  | $ | 7,763             |  | 108,725                         |  | $                                | 10.53 |  | $ | 4,735 
|$18.80 - $24.07          |  | 233,925           |  | 8.43                                       |  | $                               | 21.84 |                                  | $ | 7,543             |  | 91,875                          |  | $                                | 21.94 |  | $ | 2,953 
|                         |  |                   |  |                                            |  |                                 |       |                                  |   |                   |  |                                 |  |                                  |       |  |   |       
|Total                    |  | 958,310           |  | 6.63                                       |  | $                               | 8.84  |                                  | $ | 43,352            |  | 603,185                         |  | $                                | 7.06  |  | $ | 28,365
|                         |  |                   |  |                                            |  |                                 |       |                                  |   |                   |  |                                 |  |                                  |       |  |   |       



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As of March 31, 2006, there was $1.9 million of total unrecognized compensation cost related to 355,125 non-vested
outstanding stock options, with a per share weighted average value of $7.04. The unrecognized expense is anticipated to be recognized over a weighted average period of 3.1 years. In addition, the aggregate intrinsic value of stock options exercised
in the first quarter ended March 31, 2006 was $1.0 million.

The 2003 Stock Incentive Plan was amended in 2005 to allow the issuance of restricted
stock units to eligible employees and non-employee directors. Restricted stock units are payable in shares of the Companys common stock upon vesting. For directors, the 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.

During the first quarter ended
March 31, 2006, the Company issued 39,550 restricted stock units to certain officers and employees with a grant date fair value of $62.07 per share determined by the closing price of the common stock on the issuance date of March 6, 2006.
Each Unit represents the right to receive one share of the Companys Common Stock when the Unit vests. The Company records compensation expense for the amount of the grant date fair value over the period which the restrictions lapse. There were
no outstanding Units as of March 31, 2005. During the quarter ended March 31, 2006, unrecognized compensation cost was reclassified in the Companys Consolidated Balance Sheet from deferred compensation to additional paid in capital
in connection with the adoption of SFAS 123(R).

The following table presents a summary of the status of the Companys restricted stock units as of
December 31, 2005, and changes during the three months ended March 31, 2006:



|                                      |  |             |  |                                 |      
|------------------------------------- |  | ----------- |  | ------------------------------- | -----
|                                      |  | Units(000s) |  | WeightedAverage GrantFair Value
|Non-vested units at December 31, 2005 |  | 77,000      |  | $                               | 22.44
|Granted                               |  | 39,550      |  | $                               | 62.07
|Forfeited                             |  |            |  | $                               |     
|                                      |  |             |  |                                 |      
|Non-vested units at March 31, 2006    |  | 116,550     |  | $                               | 35.89
|                                      |  |             |  |                                 |      

As of March 31, 2006, there was approximately $3.8 million of total unrecognized compensation cost related to
non-vested restricted stock units granted under the 2003 Stock Incentive Plan. That cost is expected to be recognized over a weighted average period of 4.6 years. Compensation expense related to restricted stock units was $126,000 for the three
months ended March 31, 2006. There were no outstanding units as of March 31, 2005.



|3. | Net Income Per Share
|-- | --------------------

Basic net income per share is computed by
dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing net income available to common stockholders by the weighted average number of
common shares outstanding plus the effect of any dilutive stock options, and restricted stock units (using the treasury stock method) and the convertible debt (using the net share settlement method, which is anti-dilutive).

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



|                                                  |  |                              |  |       
|------------------------------------------------- |  | ---------------------------- |  | ------
|                                                  |  | Three Months Ended March 31,
|                                                  |  | 2006                         |  | 2005  
|Weighted average number of shares outstanding     |  | 26,801                       |  | 24,494
|Dilutive stock options and restricted stock units |  | 584                          |  | 436   
|                                                  |  |                              |  |       
|Number of shares used in diluted computations     |  | 27,385                       |  | 24,930
|                                                  |  |                              |  |       

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



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|4. | Composition of Certain Financial Statement Captions
|-- | ---------------------------------------------------

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



|                  |  |                |        |                   |   |       
|----------------- |  | -------------- | ------ | ----------------- | - | ------
|                  |  | March 31, 2006 |        | December 31, 2005
|Raw materials     |  | $              | 22,024 |                   | $ | 17,643
|Work-in-process   |  |                | 35,575 |                   |   | 28,832
|Finished goods    |  |                | 20,046 |                   |   | 19,843
|                  |  |                |        |                   |   |       
|Total inventories |  | $              | 77,645 |                   | $ | 66,318
|                  |  |                |        |                   |   |       

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



|                                               |  |                |         |   |                   |   |         |  
|---------------------------------------------- |  | -------------- | ------- | - | ----------------- | - | ------- | -
|                                               |  | March 31, 2006 |         |   | December 31, 2005 |  
|Land                                           |  | $              | 9,248   |   |                   | $ | 9,085   |  
|Buildings and improvements                     |  |                | 51,908  |   |                   |   | 49,607  |  
|Machinery and equipment                        |  |                | 119,089 |   |                   |   | 116,284 |  
|Leasehold improvements                         |  |                | 13,736  |   |                   |   | 13,605  |  
|Office equipment                               |  |                | 10,527  |   |                   |   | 9,130   |  
|Construction in progress                       |  |                | 6,999   |   |                   |   | 4,158   |  
|                                               |  |                |         |   |                   |   |         |  
|                                               |  | $              | 211,507 |   |                   | $ | 201,869 |  
|Less accumulated depreciation and amortization |  |                | (52,902 | ) |                   |   | (48,610 | )
|                                               |  |                |         |   |                   |   |         |  
|                                               |  | $              | 158,605 |   |                   | $ | 153,259 |  
|                                               |  |                |         |   |                   |   |         |  

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



|                         |  |                |       |                         |   |           |  |             |       |                         |   |           |  |   |     |  |   |      
|------------------------ |  | -------------- | ----- | ----------------------- | - | --------- |  | ----------- | ----- | ----------------------- | - | --------- |  | - | --- |  | - | -----
|                         |  | March 31, 2006 |       | December 31, 2005      
|                         |  | GrossAmount    |       | AccumulatedAmortization |   | NetAmount |  | GrossAmount |       | AccumulatedAmortization |   | NetAmount
|Intangible assets:       |  |                |       |                         |   |           |  |             |       |                         |   |           |  |   |     |  |   |      
|Backlog                  |  | $              | 525   |                         | $ | 525       |  | $           |      |                         | $ | 525       |  | $ | 525 |  | $ |     
|Developed technology     |  |                | 4,500 |                         |   | 444       |  |             | 4,056 |                         |   | 4,327     |  |   | 347 |  |   | 3,980
|                         |  |                |       |                         |   |           |  |             |       |                         |   |           |  |   |     |  |   |      
|                         |  |                | 5,025 |                         |   | 969       |  |             | 4,056 |                         |   | 4,852     |  |   | 872 |  |   | 3,980
|Non-amortizing tradename |  |                | 2,054 |                         |   |          |  |             | 2,054 |                         |   | 2,054     |  |   |    |  |   | 2,054
|                         |  |                |       |                         |   |           |  |             |       |                         |   |           |  |   |     |  |   |      
|Total inventories        |  | $              | 7,079 |                         | $ | 969       |  | $           | 6,110 |                         | $ | 6,906     |  | $ | 872 |  | $ | 6,034
|                         |  |                |       |                         |   |           |  |             |       |                         |   |           |  |   |     |  |   |      

Amortization of definite-lived intangible assets will be approximately $504,000 in each of the fiscal years 2006
through 2009.



|5. | Recent Accounting Pronouncements
|-- | --------------------------------

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

In December 2004, the FASB issued SFAS No. 153, Exchange of Nonmonetary Assets-an amendment of APB Opinion No. 29, which amends Opinion 29 to eliminate the exception for nonmonetary exchanges of
similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS 153 defines a nonmonetary exchange as having commercial substance if the future cash flow of the
entity is expected to change significantly as a result of the exchange. This Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005.



11



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##### Table of Contents

The Company adopted this standard in the third quarter of fiscal year 2005. Adoption of this standard did not have a material effect on the Companys
financial position, results of operations or cash flow.

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



|6. | Convertible Debt and Credit Facility
|-- | ------------------------------------

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

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

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

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

The Company is obligated to pay contingent interest
to the holders of the Notes during any six-month period from June 15 to December 14 and from December 15 to June 14, commencing with the six-month period beginning December 20, 2010 and ending on June 14, 2011, if the
average trading price of the note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period equals $1,200 (120% of the principal amount of a note) or more. The
amount of contingent interest payable per note for any relevant contingent interest period shall equal 0.25% per annum of the average trading price of a note for the five trading day period ending on the third trading day immediately preceding
the first day of the relevant contingent interest period.

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 minimis. Accordingly, no value has been assigned at issuance or at March 31, 2006.



12



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##### Table of Contents

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

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

In December 2005, the Company established a new unsecured $10.0 million line of credit. As of March 31, 2006, there were no outstanding amounts on the line of credit. However, the available line of credit at
March 31, 2006 has been reduced by an outstanding letter of credit in the amount of $2.3 million. The interest rate on the credit line is based on the LIBOR rate for a period of one month, plus a margin of one percent, which equaled 5.8% as of
March 31, 2006.

Pursuant to the bank line of credit, the Company is subject to certain covenants, which include, among other things, the maintenance
of specified minimum amounts of tangible net worth and quick assets to current liabilities ratio. At March 31, 2006, the Company was in compliance with these covenants.



|7. | Disclosure About Segments of an Enterprise and Related Information
|-- | ------------------------------------------------------------------

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

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



|                                                                                                                       |  |                                                                                                                                                                                                                                                                                                
|---------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Facility Location                                                                                                      |  | Products                                                                                                                                                                                                                                                                                       
|                                                                                                                       | 
|Ceradyne Advanced Ceramic Operations                                                                                   |  | Defense Applications:       Lightweight ceramic armor                                                                                                                                                                                                                                         
|                                                                                                                       | 
|Costa Mesa, Irvine and San Diego, California(1) Approximately 212,000 square feet                                      |  | Industrial Applications:       Ceralloy® 147 SRBSN wear parts       Precision
ceramics                                                                                                                                                                                                       
|                                                                                                                       | 
|Lexington, Kentucky(2) Approximately 115,000 square feet                                                               |  | Automotive/Diesel Applications:       Ceralloy® 147 SRBSN automotive/diesel engine parts                                                                                                                                                                                                      
|                                                                                                                       | 
|Wixom, Michigan(3) Approximately
29,000 square feet                                                                    |  | Commercial Applications:       Ceramic orthodontic brackets       Components for medical devices                                                                                                                                                                                             
|                                                                                                                       | 
|ESK Ceramics  Kempten, Germany(4) Approximately 544,000 square
feet  Bazet, France(5) Approximately 88,000 square feet |  | Defense Applications:       Boron carbide powders for body armor  Industrial Applications:       Ceramic
powders: boron carbide, boron nitride, titanium diboride, calcium hexaboride and zirconium diboride       Silicon carbide parts       Evaporation boats for the packaging industry



13



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|                                                                                                 |  |                                                                                                                                                                                                                                                        
|------------------------------------------------------------------------------------------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Facility Location                                                                                |  | Products                                                                                                                                                                                                                                               
|                                                                                                 |  |       High performance pump seals  Automotive/Diesel Applications:       EKagrip® functional and frictional coatings                                                                                                                                 
|                                                                                                 | 
|Ceradyne Semicon Associates Lexington, Kentucky(6) Approximately 35,000 square feet              |  | Industrial Applications:       Ceramic-impregnated dispenser cathodes for microwave tubes, lasers and cathode ray tubes       Samarium cobalt magnets                                                                                                
|                                                                                                 | 
|Ceradyne Thermo Materials  Scottdale and Clarkston, Georgia(7) Approximately 132,000
square feet |  | Defense Applications:       Missile radomes (nose cones)  Industrial Applications:       Glass
tempering rolls       Metallurgical tooling       Castable and other fused silica products       Crucibles for photovoltaic solar cell applications

---

|(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. We also have a lease on our 23,000 square foot facility in Irvine that expires in April 2009, and we have a month to month lease on our 40,000 square foot facility in Irvine. We have a lease on our 10,000 square
foot facility in San Diego, California which expires in December 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



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



|                                                 |  |                              |         |      |   |         |  
|------------------------------------------------ |  | ---------------------------- | ------- | ---- | - | ------- | -
|                                                 |  | Three Months Ended March 31, |        
|                                                 |  | 2006                         |         | 2005 |  
|Revenue from External Customers                  |  |                              |         |      |   |         |  
|ACO                                              |  | $                            | 102,241 |      | $ | 38,324  |  
|ESK Ceramics                                     |  |                              | 28,547  |      |   | 26,486  |  
|Semicon Associates                               |  |                              | 2,342   |      |   | 1,941   |  
|Thermo Materials                                 |  |                              | 3,217   |      |   | 3,040   |  
|                                                 |  |                              |         |      |   |         |  
|Total                                            |  | $                            | 136,347 |      | $ | 69,791  |  
|                                                 |  |                              |         |      |   |         |  
|Depreciation and Amortization                    |  |                              |         |      |   |         |  
|ACO                                              |  | $                            | 1,690   |      | $ | 1,317   |  
|ESK Ceramics                                     |  |                              | 2,069   |      |   | 2,062   |  
|Semicon Associates                               |  |                              | 92      |      |   | 100     |  
|Thermo Materials                                 |  |                              | 246     |      |   | 210     |  
|                                                 |  |                              |         |      |   |         |  
|Total                                            |  | $                            | 4,097   |      | $ | 3,689   |  
|                                                 |  |                              |         |      |   |         |  
|Segment Income before Provision for Income Taxes |  |                              |         |      |   |         |  
|ACO                                              |  | $                            | 34,314  |      | $ | 8,122   |  
|ESK Ceramics                                     |  |                              | 3,744   |      |   | 1,410   |  
|Semicon Associates                               |  |                              | 542     |      |   | 222     |  
|Thermo Materials                                 |  |                              | 143     |      | $ | (69     | )
|                                                 |  |                              |         |      |   |         |  
|Total                                            |  | $                            | 38,743  |      | $ | 9,685   |  
|                                                 |  |                              |         |      |   |         |  
|Segment Assets                                   |  |                              |         |      |   |         |  
|ACO                                              |  | $                            | 300,353 |      | $ | 123,224 |  
|ESK Ceramics                                     |  |                              | 168,962 |      |   | 172,764 |  
|Semicon Associates                               |  |                              | 6,457   |      |   | 6,043   |  
|Thermo Materials                                 |  |                              | 13,669  |      |   | 13,076  |  
|                                                 |  |                              |         |      |   |         |  
|Total                                            |  | $                            | 489,441 |      | $ | 315,107 |  
|                                                 |  |                              |         |      |   |         |  
|Expenditures for PP&E                            |  |                              |         |      |   |         |  
|ACO                                              |  | $                            | 5,236   |      | $ | 3,099   |  
|ESK Ceramics                                     |  |                              | 1,152   |      |   | 686     |  
|Semicon Associates                               |  |                              | 57      |      |   | 80      |  
|Thermo Materials                                 |  |                              | 458     |      |   | 903     |  
|                                                 |  |                              |         |      |   |         |  
|Total                                            |  | $                            | 6,903   |      | $ | 4,768   |  
|                                                 |  |                              |         |      |   |         |  



15



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|                                                                 |  |                              |         |   |      |   |        |  
|---------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | ------ | -
|                                                                 | 
|                                                                 |  | Three months Ended March 31, |        
|                                                                 |  | 2006                         |         |   | 2005 |  
|U.S. Net Sales                                                   |  |                              |         |   |      |   |        |  
|ACO                                                              |  |                              | 73      | % |      |   | 51     | %
|ESK Ceramics                                                     |  |                              | 6       | % |      |   | 7      | %
|Semicon Associates                                               |  |                              | 1       | % |      |   | 2      | %
|Thermo Materials                                                 |  |                              | 1       | % |      |   | 3      | %
|                                                                 |  |                              |         |   |      |   |        |  
|Total                                                            |  |                              | 81      | % |      |   | 63     | %
|                                                                 |  |                              |         |   |      |   |        |  
|Foreign Net Sales                                                |  |                              |         |   |      |   |        |  
|ACO                                                              |  |                              | 2       | % |      |   | 4      | %
|ESK Ceramics                                                     |  |                              | 15      | % |      |   | 30     | %
|Semicon Associates                                               |  |                              | 1       | % |      |   | 1      | %
|Thermo Materials                                                 |  |                              | 1       | % |      |   | 2      | %
|                                                                 |  |                              |         |   |      |   |        |  
|Total                                                            |  |                              | 19      | % |      |   | 37     | %
|                                                                 |  |                              |         |   |      |   |        |  
|Total Net Sales                                                  |  |                              |         |   |      |   |        |  
|ACO                                                              |  |                              | 75      | % |      |   | 55     | %
|ESK Ceramics                                                     |  |                              | 21      | % |      |   | 37     | %
|Semicon Associates                                               |  |                              | 2       | % |      |   | 3      | %
|Thermo Materials                                                 |  |                              | 2       | % |      |   | 5      | %
|                                                                 |  |                              |         |   |      |   |        |  
|Total                                                            |  |                              | 100     | % |      |   | 100    | %
|                                                                 |  |                              |         |   |      |   |        |  
|                                                                
|The following is revenue by product line for ACO (in thousands): | 
|                                                                 | 
|                                                                 |  | Three Months Ended March 31, |        
|                                                                 |  | 2006                         |         |   | 2005 |  
|Armor                                                            |  | $                            | 93,166  |   |      | $ | 29,215 |  
|Automotive                                                       |  |                              | 4,126   |   |      |   | 3,635  |  
|Orthodontics                                                     |  |                              | 2,284   |   |      |   | 2,666  |  
|Industrial                                                       |  |                              | 2,665   |   |      |   | 2,808  |  
|                                                                 |  |                              |         |   |      |   |        |  
|                                                                 |  | $                            | 102,241 |   |      | $ | 38,324 |  
|                                                                 |  |                              |         |   |      |   |        |  



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|8. | Pension Plans
|-- | -------------

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



|                                  |  |                                  |      |   |                                  |   |      |  
|--------------------------------- |  | -------------------------------- | ---- | - | -------------------------------- | - | ---- | -
|                                  |  | Three Months EndedMarch 31, 2006 |      |   | Three Months EndedMarch 31, 2005 |  
|Service cost                      |  | $                                | 518  |   |                                  | $ | 347  |  
|Interest cost                     |  |                                  | 433  |   |                                  |   | 407  |  
|Expected return on plan assets    |  |                                  | (508 | ) |                                  |   | (415 | )
|Amortization of unrecognized gain |  |                                  | 22   |   |                                  |   | 4    |  
|                                  |  |                                  |      |   |                                  |   |      |  
|Net periodic benefit cost         |  | $                                | 465  |   |                                  | $ | 343  |  
|                                  |  |                                  |      |   |                                  |   |      |  

Contributions made by the Company were $177,000 for the three months ended March 31 2006 and $154,000 for the
three months ended March 31, 2005.



|9. | Commitments and Contingencies
|-- | -----------------------------

The Company leases certain of its
manufacturing facilities under noncancelable operating leases expiring at various dates through October 2015. The Company incurred rental expense under these leases of $579,000 and $451,000 for the three months ended 2006 and 2005, respectively. The
approximate minimum rental commitments required under existing noncancelable leases as of March 31, 2006 are as follows (in thousands):



|           |  |   |      
|---------- |  | - | -----
|2006       |  | $ | 1,577
|2007       |  |   | 2,029
|2008       |  |   | 1,930
|2009       |  |   | 1,708
|Thereafter |  |   | 2,676
|           |  |   |      
|           |  | $ | 9,920
|           |  |   |      

From time to time, the Company is involved in legal proceedings incidental to its business. The Company believes
that pending actions, individually and in the aggregate, will not have a material adverse effect on its financial condition, results of operations or cash flows, and that adequate provision has been made for the resolution of such actions and
proceedings.



|10. | 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.



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Comprehensive income for the three months ended March 31, 2006 and 2005 was (in thousands):



|                                             |  |                                  |        |   |                                  |   |        |  
|-------------------------------------------- |  | -------------------------------- | ------ | - | -------------------------------- | - | ------ | -
|                                             |  | Three Months EndedMarch 31, 2006 |        |   | Three Months EndedMarch 31, 2005 |  
|Net income                                   |  | $                                | 24,613 |   |                                  | $ | 5,985  |  
|Foreign currency translation, net of tax     |  |                                  | 3,635  |   |                                  |   | (6,510 | )
|Unrealized losses on investments, net of tax |  |                                  | (52    | ) |                                  |   | (87    | )
|                                             |  |                                  |        |   |                                  |   |        |  
|Comprehensive income                         |  | $                                | 28,196 |   |                                  | $ | (612   | )
|                                             |  |                                  |        |   |                                  |   |        |  



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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

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 Note 9, Commitments and Contingencies, of Condensed
Notes to Consolidated Financial Statements of this report, and in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2005, as filed with the Securities and Exchange Commission, under Item 1A, Risk
Factors, and Item 7-Managements Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We develop, manufacture and market advanced technical ceramic products, ceramic powders and components for defense, industrial,
automotive/diesel and commercial applications. Our products include:



| |  |  | lightweight ceramic armor for soldiers and other military applications;
| | - |  | -----------------------------------------------------------------------



| |  |  | ceramic industrial components for erosion and corrosion resistant applications;
| | - |  | -------------------------------------------------------------------------------



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



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



| |  |  | durable, reduced friction, ceramic diesel engine components;
| | - |  | ------------------------------------------------------------



| |  |  | functional and frictional coatings primarily for automotive applications;
| | - |  | -------------------------------------------------------------------------



| |  |  | translucent ceramic orthodontic brackets;
| | - |  | -----------------------------------------



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



| |  |  | ceramic crucibles for melting silicon in the photovoltaic solar cell manufacturing process; and
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | ceramic missile radomes (nose cones) for the defense industry.
| | - |  | --------------------------------------------------------------

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

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



|                  |  |                            |   |  |       |  
|----------------- |  | -------------------------- | - |  | ----- | -
|                  |  | Three Months EndedMarch 31 |  
|                  |  | 2006                       |   |  | 2005  |  
|Defense           |  | 79.0                       | % |  | 46.0  | %
|Industrial        |  | 13.0                       |   |  | 15.8  |  
|Automotive/Diesel |  | 6.0                        |   |  | 31.0  |  
|Commercial        |  | 2.0                        |   |  | 7.2   |  
|                  |  |                            |   |  |       |  
|Total             |  | 100.0                      | % |  | 100.0 | %
|                  |  |                            |   |  |       |  

The principal factors contributing to our recent growth in sales are increased demand by the U.S. military for
ceramic body armor that protects soldiers and our acquisition of ESK Ceramics in August 2004. The operations of ESK Ceramics have been consolidated with ours since September 1, 2004.

Military conflicts in Iraq and Afghanistan, as well as an increasingly unstable geopolitical climate and the heightened risk of international conflicts, have resulted in
increased orders for our ceramic body armor in each year



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since 2001. We were awarded an Indefinite Delivery/Indefinite Quantity contract by the U.S. Army in August 2004 with a maximum value of $461.0 million.
Through March 2006, seven delivery orders totaling approximately $334.8 million have been issued to us under this contract. We have also received a number of other orders for ceramic body armor, not covered by the Indefinite Delivery/Indefinite
Quantity contract, from the Army and other branches of the U.S. military. In January 2006, we received our first production order for enhanced side ballistic inserts, referred to as ESBI, or side plates, which are designed to protect the side areas
of a soldiers torso when used in conjunction with our ESAPI ceramic body armor plates. This delivery order, which totals $70.0 million, was issued to us by the U.S. Army. Based on our current backlog, we expect our shipments of ceramic body
armor to be higher in fiscal year 2006 than in 2005. However, unless we receive additional orders under existing contracts or are successful in obtaining new contracts for ceramic body armor, our shipments of ceramic body armor will decline
materially in 2007 from levels we expect to achieve in 2006. Moreover, government contracts typically may be cancelled by the government at any time without penalty. For the next several quarters, and perhaps longer, demand for ceramic body armor is
likely to be the most significant factor affecting our sales.

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

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

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

Our order backlog was
approximately $294.8 million as of March 31, 2006, compared to approximately $186.7 million as of March 31, 2005. Orders for ceramic armor represented approximately $236.2 million, or 80.2% of the total backlog as of March 31, 2006,
and approximately $133.0 million, or 71.2% of the total backlog as of March 31, 2005. We expect that substantially all of our order backlog as of March 31, 2006 will be shipped during the next 12 months.

Results of Operations for the Three months Ended March 31, 2006

Net Sales. Our net sales for the three months ended March 31, 2006 were $136.3 million, an increase of $66.5 million, or 95.4%, from
$69.8 million in the corresponding quarter of the prior year.

Net sales for our Advanced Ceramic Operations division for the three months ended
March 31, 2006 were $102.2 million, an increase of $63.9 million, or 166.8% from the $38.3 million in the corresponding quarter of the prior year. The primary reason for this improvement was the shipment of $93.2 million of
ceramic body and other armor components for defense customers, an increase of $64.0 million, or 218.9%, from the $29.2 million of ceramic armor shipments in the first quarter of 2005. This increase in net sales of armor was due to an increase in
demand for lightweight body armor for military personnel, caused by in part the U.S. militarys change from SAPI to ESAPI armor plates. Net sales for our automotive/diesel component product line were $4.1 million, an increase of $491,000,
or 13.5%, from the $3.6 million in the corresponding quarter of the prior year. The primary reason for this increase is that our customers are producing more heavy-duty diesel truck engines due to an increase in orders for diesel trucks. Net sales
of our orthodontic brackets product line were $2.3 million, a decrease $382,000 or 14.3%, from net sales of $2.7 million in the corresponding quarter of the prior year.



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Our ESK Ceramics subsidiary had net sales for the three months ended March 31, 2006 of $28.5 million, an
increase of $2.0 million, or 7.8% from the $26.5 million in the corresponding quarter of the prior year. Increased sales of ceramic powder to the armor market was the main contributing factor.

Our Semicon Associates division had net sales for the three months ended March 31, 2006 of $2.3 million, an increase of $401,000, or 20.7%, from the
$1.9 million in the corresponding quarter of the prior year, reflecting higher sales of microwave cathodes during the current quarter versus the same quarter last year.

Our Thermo Materials division had net sales for the three months ended March 31, 2006 of $3.2 million, an increase of $177,000, or 5.8%, from the $3.0 million in the corresponding quarter of the prior
year, reflecting higher sales to defense customers during the current quarter versus the same quarter last year.

Gross Profit. Our gross profit was
$54.0 million for the three months ended March 31, 2006, an increase of $32.1 million, or 146.5% from $21.9 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 39.6% for the three months
ended March 31, 2006, compared to 31.4% for the corresponding prior year period. The increase in gross profit as a percentage of net sales in the three months ended March 31, 2006 was the result of increased sales of body armor which has
substantially higher gross margins than the average of our other products, higher operating leverage resulting from increased body armor sales, application of improved manufacturing techniques and greater throughput in our hot press furnaces. Also
contributing to the increase in gross profit, were higher yields and productivity, specifically at our Lexington, Kentucky hot press facility. We also utilized and completed the installation of improved manufacturing techniques at our hot press
facilities in both Costa Mesa and Lexington that allowed more ceramic body armor plates to be produced during a press run than in previous quarters.

Our
Advanced Ceramic Operations division posted gross profit of $41.6 million for the three months ended March 31, 2006, an increase of $28.3 million, or 213.8%, from $13.3 million in the corresponding prior year quarter. As a
percentage of net sales, gross profit was 40.7% for the three months ended March 31, 2006, compared to 34.6% for the corresponding prior year quarter. The reasons for the increase in gross profit and gross profit as a percentage of sales were
consistent with those reasons described in the preceding paragraph.

Our ESK Ceramics subsidiary had a gross profit of $10.9 million for the three
months ended March 31, 2006, an increase of $3.1 million, or 39.3%, from $7.8 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 38.2% for the three months ended March 31, 2006,
compared to 29.6% for the corresponding prior year quarter. The increase in gross profit as a percentage of net sales for the three months ended March 31, 2006 was the result of increased sales of ceramic powders for armor applications, which
carries a substantially higher gross margin than the average of our other products. Improved yields and higher operating leverage also contributed to this increase.

Our Semicon Associates division had gross profit of $0.8 million for the three months ended March 31, 2006, an increase of $378,000, or 91.1%, compared to $415,000 in the prior year quarter. As a percentage of
net sales, gross profit was 33.9% for the three months ended March 31, 2006, compared to 21.4% for the corresponding prior year quarter. Improved production rates and higher yields for the production of microwave cathodes contributed to this
increase.

Our Thermo Materials division had gross profit of $0.7 million, an increase of $285,000, or 73.8% from $386,000 in the corresponding prior year
quarter. As a percentage of net sales, gross profit was 20.9% for the three months ended March 31, 2006, compared to 12.7% for the corresponding prior year quarter. Increased gross profits in the crucible product line contributed to the
increase in gross profits for the three months ended March 31, 2006.

Selling Expenses. Our selling expenses were $5.8 million for the
three months ended March 31, 2006, an increase of $1.0 million, or 20.3%, from $4.8 million in the corresponding prior year quarter. Selling expenses, as a percentage of net sales, decreased from 6.9% for the three months ended
March 31, 2005 to 4.2% for the three months ended March 31, 2006 primarily due to the substantial increase in net sales of body armor, which requires significantly lower selling expenses per dollar of sales than our other products.

General and Administrative Expenses. General and administrative expenses for the three months ended March 31, 2006 were $7.0 million, an
increase of $2.5 million, or 53.9%, from $4.5 million in the corresponding prior year quarter. An increase in the amount of bonuses accrued as a result of increased operating profits was the primary reason for this increase. General and
administrative expenses, as a percentage of net sales, decreased from 6.5% for the three months ended March 31, 2005 to 5.1% of net sales for the three months ended March 31, 2006.



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Research and Development. Research and development expenses for the three months ended March 31, 2006 were
$2.5 million, an increase of $0.6 million, or 35.5%, from $1.9 million in the corresponding prior year quarter. Research and development expenses, as a percentage of net sales, decreased from 2.7% for the three months ended
March 31, 2005 to 1.8% of net sales for the three months ended March 31, 2006.

Other Income (Expense). Other income for the three months
ended March 31, 2006 was $1.1 million, an increase of $0.7 million, or 196.2%, compared to $364,000 in the corresponding quarter of 2005. The increase was due primarily to higher interest income received from investing higher cash balances
in short-term marketable securities.

Interest Expense. Our interest expense for the three months ended March 31, 2006 was $1.0 million, a
decrease of $343,000, or 25.0%, from $1.4 million in the corresponding prior year quarter. The decrease was due to the repayment in December 2005 of our credit facility consisting of a term loan and line of credit, which had a higher interest rate
than the convertible debt that we issued in December 2005 to replace it.

Income before Provision for Income Taxes. Our income before provision for
income taxes for the three months ended March 31, 2006 was $38.7 million, an increase of $29.0 million, or 300.0%, from $9.7 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, 2006 was $34.3 million, an
increase of $26.2 million, or 322.5%, from $8.1 million in the corresponding prior year quarter.

Our ESK Ceramics subsidiarys income
before provision for income taxes for the three months ended March 31, 2006 was $3.7 million, an increase of $2.3 million, or 165.5%, from $1.4 million in the corresponding prior year quarter

Our Semicon Associates divisions income before provision for income taxes for the three months ended March 31, 2006 was $0.5 million, an increase of $320,000,
or 144.1%, from $222,000 in the corresponding prior year quarter.

Our Thermo Materials divisions income before provision for income taxes for the
three months ended March 31, 2006 was $143,000, an increase of $212,000, compared to a loss of $69,000 before provision for income taxes in the corresponding prior year quarter.

Income Taxes. For the three months ended March 31, 2006, we had a provision for taxes of $14.1 million, an increase of $10.4 million, or 281.9%, from $3.7 million in the corresponding prior
year quarter. The effective income tax rate for the three months ended March 31, 2006 was 36.5% compared to 38.2% in the corresponding prior period. The first quarter reduction in the effective tax rate was the result of higher than previously
estimated research and development credits and higher extra territorial income exclusions.

Liquidity and Capital
Resources

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

Our net cash position decreased by $33.7 million during the three months ended
March 31, 2006, compared to a $2.8 million decrease during the three months ended March 31, 2005. For the three months ended March 31, 2006, cash flow provided by operating activities amounted to $32.4 million compared to
$5.3 million during the three months ended March 31, 2005. The primary factors contributing to cash flow from operating activities during the three months ended March 31, 2006 were net income of $24.6 million, depreciation and amortization
of $4.1 million, an increase in accounts payable and accrued expenses of $18.9 million, and an increase in income tax payable of $ 10.4 million. Also, contributing to the increase in cash flow from operating activities was a decrease in
other receivables of $1.6 million and an increase in accruals for employee benefits that added an aggregate of $319,000. These contributions were offset in part by increases in accounts receivable of $10.0 million, increases in inventories of
$10.6 million, increased levels of production tooling of $6.4 million, and increases in other assets and prepaid expenses of $0.8 million. The increases in inventory and tooling were due to the increase in sales and production to support
the growth of the ACO segment.



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We used $66.7 million of our cash for investing activities, including $6.9 million for capital expenditures and
$59.8 million for purchases of short-term investments. A majority of our capital expenditures was for equipment to add armor manufacturing capacity primarily at our Lexington, Kentucky hot press facility and improve productivity.

Financing activities provided cash of $370,000, generated by the tax benefit due to exercises of stock options of $365,000. The effect of exchange rates on cash and cash
equivalents due to our investment in ESK Ceramics was $290,000.

During December 2005, the Company issued $121.0 million of 2.875% senior subordinated
convertible notes (Notes) due December 15, 2035. We received net proceeds of approximately $116.8 million from the Notes offering after deducting offering expenses and underwriting discounts of $4.2 million.

Interest on the Notes is payable on December 15 and June 15 of each year, commencing on June 15, 2006. The Notes are convertible into 17.1032 shares of
our common stock for each $1,000 principal amount of the Notes (which represents a conversion price of approximately $58.47 per share), subject to adjustment. The Notes are convertible only under certain circumstances, including if the price of our
common stock reaches, or the trading price of the Notes falls below, specified thresholds, if the Notes are called for redemption, if specified corporate transactions or fundamental 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.

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

In December 2005, the Company established a new unsecured $10.0 million line of credit. As of March 31, 2006, there were no outstanding amounts on the line of credit.
However, the available line of credit at March 31, 2006 has been reduced by an outstanding letter of credit in the amount of $2.3 million. The interest rate on the credit line is based on the LIBOR rate for a period of one month, plus a margin of
one percent, which equaled 5.8% as of March 31, 2006.

Pursuant to the bank line of credit, the Company is subject to certain covenants, which include,
among other things, the maintenance of specified minimum amounts of tangible net worth and quick assets to current liabilities ratio. At March 31, 2006, the Company was in compliance with these covenants.

Our cash, cash equivalents and short-term investments totaled $125.5 million at March 31, 2006, compared to $99.4 million at December 31, 2005. At
March 31, 2006, we had working capital of $236.4 million, compared to $211.4 million at December 31, 2005. Our cash position includes amounts denominated in foreign currencies, and the repatriation of those cash balances from our
ESK Ceramics subsidiary does not result in additional tax costs. We believe that our current cash and cash equivalents on hand, cash available from the sale of short-term investments, cash available from additional borrowings under our revolving
line of credit and cash we expect to generate from operations will be sufficient to finance our anticipated capital and operating requirements for at least the next 12 months. We also may utilize cash, and to the extent necessary, borrowings from
time to time to acquire other businesses, technologies or product lines that complement current products, enhance our market coverage, technical capabilities or production capacity, or offer growth opportunities. We have no present commitments or
agreements for any material acquisitions.



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|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

We are
exposed to market risks related to fluctuations in interest rates on our debt. We routinely monitor our risks associated with fluctuations in currency exchange rates and interest rates. We address these risks through controlled risk management that
may, in the future, include the use of derivative financial instruments to economically hedge or reduce these exposures. We do not enter into foreign exchange contracts for speculative or trading purposes. Currently, we do not utilize interest rate
swaps.

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

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

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

Our debt is primarily 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 $133.7 million and
is based on quoted market prices at March 31, 2006.

Overall, we are a net recipient of currencies other than the U.S. dollar and, as such, we benefit
from a weaker dollar and are adversely affected by a stronger dollar relative to major currencies worldwide. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may negatively affect net sales, gross profit,
and net income from our subsidiary, ESK Ceramics, as expressed in U.S. dollars. This would also negatively impact our consolidated reported results.

Approximately 19% of our revenues for the three months ended March 31, 2006 were derived from operations outside the United States. Our acquisition of ESK Ceramics provided additional revenues that were derived outside the United
States. Therefore, we are subject to fluctuations in sales and earnings reported in U.S. dollars as a result of changing currency exchange rates.



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

Evaluation of Disclosure Controls and
Procedures

As of the end of the period covered by this report, 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. Based on this evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934) were effective.



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##### 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, 2006 that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART
II. OTHER INFORMATION



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

From time to time, the Company is involved in
legal proceedings incidental to its business. The Company believes that pending actions, individually and in the aggregate, will not have a material adverse effect on its financial condition, results of operations or cash flows, and that adequate
provision has been made for the resolution of such actions and proceedings.



|Item 1A. | Risk Factors
|-------- | ------------

There have been no significant changes to the risk
factors disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2005.



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



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



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



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



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



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



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



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##### 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: May 10, 2006 |  |  |  | By:            |  | /s/ JERROLD J. PELLIZZON
|                   |  |  |  |                |  |                          |  | Jerrold J. Pellizzon                                                               
|                   |  |  |  |                |  |                          |  | Vice President Chief Financial
Officer (Principal Financial and Accounting Officer)



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##### Table of Contents

Index to Exhibits



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



27