10-K 1 form10-k.htm CERADYNE, INC. - 2011 FORM 10-K form10-k.htm


 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

 
FORM 10-K 

(Mark One)
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2011
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to            
 
Commission file number 000-13059 

(Exact name of registrant as specified in its charter) 


 

Delaware
33-0055414
(State or other jurisdiction of Incorporation or organization)
(I.R.S. Employer Identification No.)
3169 Red Hill Avenue, Costa Mesa, California
92626
(Address of principal executive offices)
(Zip Code)
 
(714) 549-0421
(Registrant’s telephone number, including area code) 


Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class:
Name of Each Exchange on Which Registered:
Common Stock, par value $0.01 per share
The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act: None 

    Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.    YES  x    NO  ¨
 
Indicate by check mark whether the registrant is not required to file reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934.    YES  ¨    NO  x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  x    No  ¨    
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
    Large accelerated filer  x
Accelerated filer  ¨
Non-accelerated filer  ¨
Smaller reporting company  ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
 
The aggregate market value of registrant’s common stock held by non-affiliates as of June 30, 2011 (the last business day of registrant’s most recently completed second fiscal quarter) was approximately $910.1 million.
 
As of February 5, 2012, there were 24,194,539 shares of registrant’s Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant’s definitive proxy statement for its annual meeting of stockholders to be held on May 16, 2012 are incorporated by reference into Part III of this Form 10-K.
 


 
 

 

TABLE OF CONTENTS
     
Page
 
 
 
PART I
      3  
            ITEM 1.
Business
    3  
            ITEM 1A.
Risk Factors
    25  
            ITEM 1B.
Unresolved Staff Comments
    33  
            ITEM 2.
Properties
    33  
            ITEM 3.
Legal Proceedings
    34  
            ITEM 4.
Mine Safety Disclosures
    34  
           
PART II
      35  
            ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    35  
            ITEM 6.
Selected Financial Data
    36  
            ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    37  
            ITEM 7A.
Quantitative and Qualitative Disclosures About Market Risk
    59  
            ITEM 8.
Financial Statements and Supplementary Data
    61  
            ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
    61  
            ITEM 9A.
Controls and Procedures
    61  
            ITEM 9B.
Other information
    61  
           
PART III
      62  
            ITEM 10.
Directors, Executive Officers and Corporate Governance
    62  
            ITEM 11.
Executive Compensation
    62  
            ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    62  
            ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
    62  
            ITEM 14.
Principal Accountant Fees and Services
    62  
           
PART IV
      63  
            ITEM 15.
Exhibits and Financial Statement Schedules
    63  
         
            FINANCIALS
    F-1  


 
2

 

PART I
 
NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “plan,” “assume” or other similar expressions, or negatives of those expressions, although not all forward-looking statements contain these identifying words. All statements contained in this report regarding our future strategy, future operations, projected financial position, estimated future revenues, projected costs, future prospects, the future of our industries and results that might be obtained by pursuing management’s current plans and objectives are forward-looking statements.
 
You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date of the filing of this report. New risks and uncertainties arise from time to time, and it is impossible for us to predict these matters or how they may affect us. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such difference might be significant and materially adverse to our security holders.
 
We have identified some of the important factors that could cause future events to differ from our current expectations and they are described in this report in Item 1A under the caption “Risk Factors,” in Item 7 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in Item 7A under the caption “Quantitative and Qualitative Disclosures About Market Risk,” all of which you should review carefully.
 
ITEM 1. BUSINESS
 
Introduction
 
We develop, manufacture and market advanced technical ceramic products, ceramic powders and components for defense, industrial, energy, automotive/diesel and commercial applications.
 
In many high performance applications, products made of advanced technical ceramics meet specifications that similar products made of metals, plastics or traditional ceramics cannot achieve. Advanced technical ceramics can withstand extremely high temperatures, combine hardness with light weight, are highly resistant to corrosion and wear, and often have excellent electrical capabilities, special electronic properties and low friction characteristics.
 
Our products include:
 
 
lightweight ceramic armor for soldiers and other military applications;
 
 
ceramic industrial components for erosion and corrosion resistant applications;
 
 
ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium hexaboride, zirconium diboride and fused silica, which are used in manufacturing armor and a broad range of industrial products and  consumer products;
 
 
evaporation boats for metallization of materials for food packaging and other products;
 
 
durable, reduced friction, ceramic diesel engine components;
 
 
functional and frictional coatings primarily for automotive applications;
 
 
translucent ceramic orthodontic brackets;
 
 
ceramic crucibles for melting silicon in the photovoltaic solar cell manufacturing process;
 
 
ceramic-impregnated dispenser cathodes for microwave tubes, lasers and cathode ray tubes;
 
 
specialty glass compositions for solar, electronic, industrial and health care markets;
 
 
ceramic missile radomes (nose cones) for the defense industry;
 
 
fused silica powders for precision investment casting (PIC);
 
 
neutron absorbing materials, structural and non-structural, in combination with aluminum metal matrix composite that serve as part of a barrier system for spent fuel wet and dry storage in the nuclear industry, and non-structural neutron absorbing materials for use in the transport of nuclear fresh fuel rods;
 
 
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nuclear chemistry products for use in pressurized water reactors and boiling water reactors;
 
 
boron dopant chemicals for semiconductor silicon manufacturing and for ion implanting of silicon wafers;
 
 
ceramic bearings and bushings for oil drilling and fluid handling pumps;
 
 
ceramic micro-reactors used to process chemicals;
 
 
PetroCeram® ceramic sand filters for oil and gas recovery; and
 
 
enhanced combat helmets for soldiers.

Our customers include the U.S. government, prime government contractors, companies engaged in solar energy, oil and natural gas exploration and nuclear energy, and industrial, automotive, diesel and commercial manufacturers in both domestic and international markets.
 
The principal factor contributing to our growth in sales from 2002 through 2007 was increased demand by the U.S. military for ceramic body armor that protects soldiers, which was driven primarily by military conflicts such as those in Iraq and Afghanistan. This demand was driven by recognition of the performance and life saving benefits of utilizing advanced technical ceramics in lightweight body armor. Our sales declined in 2008 primarily because of a reduction in shipments of body armor. Our sales declined in 2009 primarily because of a continued reduction in shipments of body armor and also due to a decline in sales of our industrial, automotive/diesel and commercial market product lines due to the severe economic recession. In 2010, sales of body armor continued to decline. However, sales from energy related products grew by 61.6% in 2010 when compared to 2009. Most of this growth in energy sales was generated by sales of our ceramic crucibles used in the production of photovoltaic cells for solar panels. Our sales increased in 2011, due to additional shipments of body armor, an increase of sales to the nuclear industry and the reporting of operating results from VIOX Corporation which we acquired on January 3, 2011. Additionally, sales of industrial products continued to increase, particularly at our ESK Ceramics subsidiary.
 
Commencing in 2004, several strategic acquisitions also have contributed to our sales growth. These include our acquisition of ESK Ceramics in August 2004, our acquisition of Minco, Inc. in July 2007, our acquisition of EaglePicher Boron, LLC in August 2007, which we renamed Boron Products, LLC, and our acquisition of VIOX Corporation on January 3, 2011.
 
To illustrate the impact of body armor, energy-related products, and our acquisitions, the following table shows our sales from body armor, energy-related products, from our acquisitions, and from all other sources for each of the years 2002 through 2011 (in millions).

   
2011
   
2010
   
2009
   
2008
   
2007
   
2006
   
2005
   
2004
   
2003
   
2002
 
Sales from body armor
  $ 193.8     $ 70.4     $ 170.0     $ 385.0     $ 535.3     $ 479.4     $ 199.5     $ 120.3     $ 58.2     $ 26.2  
Sales from energy products:
                                                                               
    Gross sales from energy products
    129.0       99.9       62.2       57.7       20.9       11.9       9.8       5.3       2.5       1.7  
    Less sales from energy products
    included in acquired companies
    (66.2 )     (28.5 )     (24.5 )     (11.4 )     (4.5 )     (3.2 )     (3.2 )     (0.7 )     -       -  
Sales from energy products due to organic growth
    62.8       71.4       37.7       46.3       16.4       8.7       6.6       4.6       2.5       1.7  
Sales from acquired companies
    254.5       191.1       136.8       177.1       142.6       110.2       109.8       36.0       -       -  
All other sales
    60.9       70.0       56.1       71.8       62.5       64.6       52.4       54.7       40.8       33.3  
Total sales
  $ 572.0     $ 402.9     $ 400.6     $ 680.2     $ 756.8     $ 662.9     $ 368.3     $ 215.6     $ 101.5     $ 61.2  
 
Sales of ceramic body armor represented the majority, and most volatile, portion of our defense business, rising from approximately $26.2 million, or 42.8% of our total sales in 2002, to a peak of approximately $535.3 million, or 70.7% of our total sales in 2007, and then declining to approximately $193.8 million, or 33.9% of our total sales in 2011. Shipments of the first generation of ceramic body armor, known as small arms protective inserts, or SAPI, began before 2002 and accelerated rapidly with the onset of the war in Afghanistan in 2002 and thereafter the war in Iraq. Shipments of the second generation of ceramic body armor, known as enhanced small arms protective inserts, or ESAPI, began in 2005. The military’s subsequent decision to deploy ESAPI body armor “full fleet,” that is, to replace all SAPI body armor with the new ESAPI body armor, and the introduction in 2006 of enhanced side ballistic inserts, known as ESBI, which protect the sides of the soldier’s torso, resulted in continued growth in our sales of ceramic body armor, ultimately reaching our peak sales of body armor in 2007. Once “full fleet” was achieved, our sales of body armor began a steady decline which continued through 2010.
 
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 In October 2008, we were awarded an Indefinite Delivery/Indefinite Quantity, or ID/IQ, contract by the U.S. Army for the next ballistic threat generation of ceramic body armor plates, called XSAPI, as well as for the current generation ESAPI plates. This five-year contract has a maximum value of $2.37 billion and allows the U.S. Army to order either XSAPI or ESAPI body armor from us.
 
In March 2011, we announced the receipt of a delivery order for approximately $56.6 million for ESAPI ceramic body armor plates and the receipt of a delivery order for approximately $36.0 million for XSAPI ceramic body armor plates. In July 2011, we announced the receipt of a delivery order for approximately $36.2 million for ESAPI ceramic body armor plates. All three of these delivery orders were issued under the October 2008 ID/IQ contract. Through December 31, 2011, we have received delivery orders under the October 2008 ID/IQ contract totaling $278.4 million. Of this amount, we have shipped $258.3 million of body armor through December 31, 2011 and we expect to ship the balance of approximately $20.1 million in 2012. With less than two years remaining under this ID/IQ contract, the war in Iraq concluded, and the war in Afghanistan winding down, we expect that the total amount of body armor that we ultimately ship under this contract will be substantially less than the maximum amount.
 
In September 2011, we were awarded a three-year ID/IQ contract for ESAPI ceramic armor plates from Defense Logistics Agency Troop Support group. This purchasing group services the United States Army, Navy, Air Force and Marine Corps. This award was in response to our bid to the Defense Supply Center Philadelphia (DSCP) in response to their requirement for a three-year sustainment order for the replacement of body armor inserts. Simultaneously with the receipt of this award, we received an initial delivery order for $127.3 million for ESAPI ceramic body armor plates with the initial delivery in the first quarter of 2012, continuing through the remainder of 2012 with estimated completion by March 31, 2013. This ID/IQ contract includes options for additional deliveries of up to $127.3 million in each of the second and third years. Initial comments from the contracting officer of the U.S. Military indicate that the 2013 ESAPI order will be similar to the 2012 order, but this is a preliminary estimate with no guarantee.
 
In October 2011, we announced the receipt of a delivery order for approximately $6.9 million for ceramic body armor plates from the United States Special Operations Command. We expect to ship this order during 2012 and complete the delivery of it during the third quarter of 2012.
 
For 2012 and for the next several years, we expect that our sales of body armor will continue, but generally at more moderate levels than in the past. We will continue to bid on Foreign Military Sales (FMS) for the first generation of SAPI body armor through our existing ID/IQ contract with Aberdeen Proving Grounds.
 
Although we believe that demand for ceramic body armor will continue for many years, the quantity and timing of government orders depends on a number of factors outside of our control, such as the amount of U.S. defense budget appropriations, positions and strategies of the current U.S. government, the level of international conflicts and the deployment of armed forces. Moreover, ceramic armor contracts generally are awarded in an open competitive bidding process and may be cancelled by the government at any time without penalty. Therefore, our future level of sales of ceramic body armor will depend on our ability to successfully compete for and retain this business.
 
 The following acquisitions resulted from a strategy to grow and expand our non-defense business through the selective acquisition of companies and product lines closely related to our core competency in advanced technical ceramics and materials, as well as to expand our defense business with complementary product lines on an opportunistic basis.
 
We acquired ESK Ceramics in August 2004. Based in Kempten, Germany, ESK Ceramics manufactures industrial technical ceramic powders and advanced technical ceramic products. This acquisition provided us with both a broad line of non-defense products, and it assured us of a supply of boron carbide powder, which serves as a starter ceramic powder in the manufacture of our lightweight ceramic body armor. ESK Ceramics also produces evaporation boats for metallization, functional and frictional coatings utilized in the automotive and textile industries, high performance pump seals, fluid handling, refractory products, ceramic micro-reactors used to process chemicals, ceramic powders used in cosmetics, and ceramic sand filters used in oil and natural gas recovery.
 
In June 2006, we purchased the assets and technology related to the Boral® line of aluminum metal matrix composites that serve as part of a barrier system for spent fuel storage in the nuclear industry. We moved these assets to our Ceradyne Canada facility in Chicoutimi, Quebec, Canada. This product line is now included in our Boron operating segment.
 
Minco, Inc., which we acquired in July 2007, is included in our Thermo Materials operating segment. Based in Midway, Tennessee, Minco manufactures fused silica powders for a wide range of industrial applications. The fused silica powder manufactured by Minco is a key raw material that our Thermo Materials division uses to manufacture missile radomes (nose cones) and ceramic crucibles that our customers use for melting silicon in the photovoltaic solar cell manufacturing process. Minco’s fused silica powders are also used by its customers for precision investment casting applications.
 
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We acquired EaglePicher Boron, LLC in August 2007. This subsidiary, which we renamed Boron Products, LLC, is included in our Boron operating segment and produces the boron isotope 10B. This isotope is a strong neutron absorber and is used for both nuclear waste containment and nuclear power plant neutron radiation critical control. Boron Products also produces complementary chemical isotopes used in the normal operation and control of nuclear power plants. The boron isotope 11B is used in the semiconductor manufacturing process as an additive to semiconductor grade silicon as a “doping” agent and where ultra-high purity boron is required.
 
In June 2008, we purchased certain assets and technology related to proprietary technical ceramic bearings used for “downhole” oil drilling and for coal bed methane pumps and steam assisted oil extraction pumps. This technology and product line, which we include in our Advanced Ceramic Operations operating segment, are located in our Lexington, Kentucky, facility. These bearings incorporate ceramic parts supplied by our ESK Ceramics subsidiary.
 
In August 2008, we acquired SemEquip, Inc., a late-stage startup technology company located in Billerica, Massachusetts. SemEquip develops and markets “cluster molecules” such as B18H22 for use in the ion implantation of boron (B) in the manufacture of semiconductors. SemEquip, which we include in our Boron operating segment, owns a portfolio of  37 issued and 22 pending U.S. patents, and corresponding issued and pending patents in several foreign countries.
 
In June 2009, we acquired substantially all of the business and assets and all technology and intellectual property related to ballistic combat and non-combat helmets of Diaphorm Technologies, LLC, based in Salem, New Hampshire. Based on this technology, we submitted a proposal to the U.S. Marine Corps Systems Command in June 2009 in response to a solicitation for the procurement of Enhanced Combat Helmets (ECH), which are intended to provide substantially increased levels of protection compared to combat helmets now in use. In late July 2009, in response to our proposal, the U.S. Marine Corps System Command awarded us a contract for up to a maximum of 246,840 helmets. After an extended period of testing, we received an order for First Article Test helmets, which we delivered in January and February 2011. Upon additional testing it was determined by the Government that further testing needed to occur due to variations discovered in its test procedures and protocols. Ceradyne received a second order for First Article Test helmets, which we delivered in October 2011. Those helmets are now in the final stages of First Article Testing by the U.S. Government.
 
Our strategy regarding this acquisition is to combine our successful track record in body armor programs with the proprietary helmet-forming technologies acquired from Diaphorm to create a world class manufacturer of Enhanced Combat Helmets.
 
We acquired VIOX Corporation on January 3, 2011. Located in Seattle, Washington, VIOX develops, manufactures and markets specialty glass compositions for a wide range of electronic, industrial and health care markets. VIOX is included in our Advanced Ceramic Operations operating segment. VIOX has developed a specialty glass formulation for polycrystalline silicon photovoltaic solar applications. VIOX customers add electrically conducting powdered metals such as silver or aluminum to the VIOX powdered specialty glass. Many of the ultimate solar users of VIOX glass are also customers for Ceradyne’s high purity ceramic solar crucibles.
 
To meet increasingly higher performance standards, advanced technical ceramics have stringent technical manufacturing requirements. We have designed and customized our facilities and capital equipment to enhance our advanced technical ceramic manufacturing processes. We have also implemented lean manufacturing initiatives to lower costs and drive further efficiencies in our manufacturing processes, and have expanded our facilities in China to add manufacturing capacity for the production of ceramic crucibles.
 
We conduct our operations through four operating segments: our Advanced Ceramic Operations division, our ESK Ceramics subsidiary, our Thermo Materials division, and our Boron segment. Our assets are managed by segment regardless of their physical location and are not reviewed on a geographic basis by our chief operating decision maker. Prior to October 2010, we reported our operations through six operating segments. To more accurately reflect our current operations, executive reporting structure and organization, and internal reporting we modified our segment structure and reporting to reflect that we operate through four operating segments each led by a different senior executive who reports directly to our Chief Executive Officer. The changes made to arrive at the four segments from the six previous segments were that the former Semicon Associates segment is now included in the Advanced Ceramics Operations segment and the former Ceradyne Canada segment is now included in the Boron segment. All of the financial data for 2010 and 2009 have been changed to reflect four segments. For additional financial information concerning our segments, please refer to Note 8 of the Notes to Consolidated Financial Statements that are included in this report.
 
6

 
 
Advanced Technical Ceramics
 
Evolving customer requirements in solar cell manufacturing, industrial processing, military systems, oil and natural gas exploration, microwave electronics, automotive/diesel engine products and orthodontics have generated a demand for high performance materials with properties not readily available in metals, plastics or traditional ceramics. The following table compares favorable typical properties of selected advanced technical ceramics with those of other selected materials.
 
Materials
 
Melting Point
(Degrees
Fahrenheit)
 
Hardness
(Vickers
Scale)
 
Chemical
Resistance
to Acids
 
Electrical
Properties
 
Density
(Grams
per Cubic
Centimeter)
Advanced technical ceramics
 
2,500 to 6,900
 
Up to 3,200
 
Excellent
 
From excellent insulators to conductors
 
2.5 to 4.5
High strength alloy steel
 
2,500 to 2,700
 
Up to 900
 
Fair
 
Conductors
 
7.0 to 9.0
High performance plastics
 
275 to 750
 
Up to 10
 
     Good to Excellent 
 
Good to excellent insulators
 
1.0 to 2.0
 
Ceramics such as earthenware, glass, brick and tile have been made for centuries and are still in common use today. The inertness and lasting qualities of ceramics are illustrated by artifacts uncovered intact in modern times. Almost all traditional ceramics, including those of ancient times, were based on clay. In the last fifty years, significant advances have been made in ceramic technology by applying specialized manufacturing processes to produce synthetic ceramic powders.
Developments in aluminum oxide and other oxides resulted in ceramics that were excellent electrical insulators and were capable of withstanding high temperatures. In addition, industry advancements in ceramic material science have led to the development of a class of ceramics that are generally non-oxides, such as carbides, borides and nitrides. These non-oxide ceramics generally have mechanical properties that exceed those of oxide ceramics developed in prior periods. Collectively, these developments resulted in the ability to manufacture ceramics with great strength at elevated temperatures and reduced fragility, historically a primary limitation of ceramics. The products that have emerged from these advances are known as advanced technical (or structural) ceramics.
 
The properties of advanced technical ceramics present a compelling case for their use in a wide array of modern applications. However, to meet increasingly higher performance standards, advanced technical ceramics have stringent technical manufacturing requirements. First, manufacturers must start with fine synthetic ceramic powders of very high and consistent quality that are produced using a highly technical and specialized manufacturing process. Few suppliers of these high quality starting powders exist today and not all of these suppliers can consistently produce starting powders of the necessary quality and consistency in the volumes required by ceramic manufacturers. Second, the specialized equipment required to manufacture advanced technical ceramics must often be custom designed and is not readily available, requiring a significant investment in capital equipment and facilities to allow volume production. Manufacturing costs associated with the production of these ceramics are higher than those of the materials they replace. A portion of these costs is related to the need for diamond grinding finished components to exacting tolerances. To accelerate the use of advanced technical ceramics as a direct replacement for metals, plastics or traditional ceramics, these manufacturing costs need to be reduced. Cost reduction efforts include the production of blanks or feed stock to “near net shape” configurations in order to reduce the amount of diamond grinding needed. Manufacturers are also seeking to reduce costs through the use of high volume automated processing and finishing equipment and techniques, and to achieve economies of scale in areas such as powder processing, blank fabrication, firing, finishing and inspection.
 

 
7

 
 
Our Solution
 
We develop, manufacture and market advanced technical ceramic products, ceramic powders and components for defense, industrial, energy, automotive/diesel and commercial applications. The table on the following pages illustrates some of the solutions we have designed to meet market opportunities and demands.
 
Market Opportunity
 
Demands of the Market
 
Our Solution
Defense
         
Lightweight ceramic body armor and boron carbide powders
 
Due to the proliferation of automatic weapons in tactical operations and terrorist conflicts, it has become necessary for vests or other armor to stop machine gun bullets while being light enough in weight to allow freedom of movement without undue fatigue.
 
We have developed lightweight bullet resistant ceramic body armor solutions, including SAPI (small arms protective inserts), ESAPI (enhanced small arms protective inserts), ESBI (enhanced side ballistic inserts) and other systems. These products generally consist of hot pressed Ceralloy® 546 (boron carbide) or hot pressed Ceralloy® 146 (silicon carbide) and other ceramic coupled with backings such as Dyneema®, Spectra Shield® or Kevlar® purchased from third parties. Our subsidiary, ESK Ceramics, is a major manufacturer of boron carbide powders, which are used by us and our competitors to manufacture lightweight ceramic body armor.
         
Lightweight ceramic armor for military ground-based vehicles, boats and aircraft
 
Military ground-based vehicles, boats and aircraft require protection against automatic weapons. Weight, cost and vehicle compatibility are critical technical parameters.
 
We have developed a series of lightweight, cost effective ceramic armor systems and attachment mechanisms that have multi-hit protection at various threat levels and can be added to an existing vehicle or designed into new vehicles, boats and aircraft.
         
Missile radomes (nose cones)
 
Defensive tactical missile systems such as the PAC-3 (Patriot Advanced Capability)  are designed to fly at extremely high velocities, survive tight turning radii and operate in severe weather conditions. These operating conditions preclude the use of conventional polymer materials for radomes.
 
We have developed advanced technical ceramic radomes made of fused silica ceramics which meet certain specifications of these tactical defensive missile systems, and have developed a modified silicon nitride radomes for more demanding requirements. We have also established a precision diamond grinding capability to finish these radomes.
         
Lightweight ballistic rated helmets that provide increased protection for our troops.
 
In order to meet survivability goals without affecting the soldier’s functionality, improvements in head gear are needed for soldiers. Unfortunately, combat helmets have only seen small incremental improvements during the last twenty years.
 
The ballistic material, generally thermo-set Aramid based, used in these legacy helmets have remained very similar and have reached their maximum performance.
 
 
 
We are manufacturing and demonstrating the new ECH (Enhanced Combat Helmet) that offers over a 35% improvement against fragmentation threats for the U.S. Marines and Army.
 
This is accomplished by utilizing new thermoplastic UHMWPE (Ultra High Molecule Weight Poly Ethylene) materials recently developed by both DSM and Honeywell which offer improved ballistic performance at lighter weights vs. thermo-set Aramids.  
 
Our proprietary Seamless BallisticTM processing technique enhances the performance of the ballistic material while cost effectively manufacturing it to the required  protective helmet shape and meeting other legacy specifications of the U.S. military for head gear protection.
 

 
8

 
Market Opportunity
 
Demands of the Market
 
Our Solution
Industrial
Advanced ceramic structural parts
 
Applications such as high performance pump seals, blast nozzles, chemical processing, and pulp and paper manufacturing, require components with corrosion and wear resistant properties, mechanical strength, hardness, favorable friction properties and the ability to withstand extreme temperature fluctuations.
 
We have developed products for each of these applications which have excellent wear resistant properties, lightness, hardness and the ability to withstand extremely high temperatures. We manufacture these products using primarily our EKasic® silicon carbide, silicon nitride and boron carbide ceramic.
         
Boron compounds and metallurgy
 
Increasing productivity requirements in primary industries are met with boron nitride powders, which are used as high temperature lubricants and release agents. As filler material in polymers and silicones, boron nitride is used for heat conducting and insulating films in the electronic industry. Aluminum and steel foundries increasingly require consumables with longer lifetimes to improve their overall efficiencies.
 
In the aluminum extrusion industry, boron nitride powder, spray or suspension is used as a release agent to keep the hot metal away from the extrusion die. In furnace and high temperature applications it is used as an insulation sleeve or support for graphite heaters. Boron nitride’s largely inert behavior towards molten metals makes it an ideal material for applications in direct contact with such materials. We supply break rings for horizontal continuous casting and side-dams for thin strip casting. We also supply high density and high purity silicon nitride products for aluminum foundries worldwide.
         
Evaporation boats
 
Packaging materials used for snack and other food products are often lined with an aluminum coating to preserve shelf life. The coating, or metallization, process requires a tool, called an evaporation boat, which can withstand the high temperature and corrosiveness of molten aluminum.
 
We have developed evaporation boats, typically made using boron nitride/titanium diboride, that can withstand direct contact with highly corrosive liquids, such as melted aluminum. These evaporation boats are used in the metallization of various surfaces, including paper, plastic and glass.
         
Industrial equipment requiring critical protection against severe wear or corrosion
 
Failure of industrial equipment is often caused by premature wearing out of surfaces due to abrasive action. An example is paper making equipment where the pulp slurry runs at 5,000 feet per minute.
 
Sintered reaction bonded silicon nitride (SRBSN) industrial wear parts are designed to replace hard metal or oxide ceramic wear surfaces, resulting in greater productivity, quality and longer uptime.
 
Our proprietary advanced technical ceramic side dams are used in the production of steel in the continuous casting process.

 
9

 


  Market Opportunity     Demands of the Market     Our Solution
Materials for precision investment casting
 
The precision metal casting market is demanding lower cost, thinner molds and faster mold build times.
 
We have developed fused silica refractory blends that enable the production of highly efficient, single-use mold systems for precision investment casting (PIC).
         
Ceramic bearings, bushings and seals for fluid handling
 
In order to make an effective transition in fluid handling pumps from the pump itself to the exterior, it is necessary to have an interface with excellent friction and erosion and corrosion properties.
 
We have developed a number of primarily silicon carbide compositions and shapes for a wide variety of precision components for use in contact with rotational elements in fluid handling pumps. These are produced primarily by our ESK Ceramics subsidiary in Kempten, Germany.
         
In converting silicon wafers to semiconductors, it is necessary to introduce atoms of the element boron into the silicon matrix
 
The market has developed and generally utilizes technology known as ion implantation. Starting materials used in ion implantation such as BF3 have been generally utilized for many years. However, as the requirements for higher current semiconductor chips increase and the number of chips per unit area on the silicon wafer increases, there is a need for ion implantation which improves the manufacturing throughput of high boron content in semiconductor chips.
 
Our acquisition of SemEquip, Inc. in August 2008 brought to Ceradyne the intellectual property for the “cluster” molecule B18H22 as well as other cluster molecules. These materials are designed to increase the productivity of the ion implantation technology in part due to the large numbers of atoms such as boron.
 
 
Energy
 
Photovoltaic (solar cell) manufacturing requiring crucibles for melting silicon
 
 
 
 
Specially designed heavy duty sand screens
 
 
Specially designed heavy duty bearings
 
 
 
Specialty glass compounds for photovoltaic solar applications.
 
In order to produce cost effective solar cell components, it is necessary to melt silicon in a crucible or vessel that will be able to contain the molten silicon yet not allow unwanted chemicals to contaminate the melt.
 
It is necessary to filter sand grains, small particles and proppants during oil and natural gas drilling operations.
 
 
It is necessary to maintain the position and integrity of heavy duty rotational shafts in downhole oil drilling and/or water pumps in severe environments.
 
Solar Cell surfaces require metallization coatings which contain glass compounds to improve the efficiency of free electron transport.
 
We have developed a high purity fused silica ceramic crucible (receptacle) which is being used by many photovoltaic cell manufacturers in their silicon melting operation in order to produce polycrystalline silicon. We also manufacture the fused silica powders that are a key material for the production of our ceramic crucibles.
 
We developed a series of proprietary designs for heavy duty ceramic sand screens which increase the productivity of an oil or natural gas drill site by reducing premature failures during operations.
 
In June 2008, we acquired a series of proprietary designs for heavy duty “stacked bearings” and bushings which utilize our advanced technical ceramic sliding surface interface.
 
We have designed a series of proprietary glass compounds for solar cell surface paste coating used by photovoltaic cell manufacturers to improve the efficiency of their cells.

 
10

 


  Market Opportunity     Demands of the Market     Our Solution
Radioactive waste management and nuclear chemistry products
 
Increasing stockpiles of radioactive nuclear waste require materials that can be used to safely transport and store items such as spent nuclear fuel rods. New and existing nuclear power plants also require materials capable of containing neutron radiation during day-to-day operations.
 
 
The boron atom in boron carbide powder is able to capture neutrons, thus reducing the radioactive risk associated with transportation and storage of nuclear waste. Our Boral® product line, which consists of a hot-rolled sheet containing a core of uniformly distributed boron carbide and aluminum particles that are enclosed within layers of pure aluminum, forms a solid and effective barrier for the storage of nuclear waste.
 
We also manufacture the boron isotope 10B in its pure form. This isotope is a strong neutron absorber and is used for both nuclear waste containment and nuclear power plant neutron radiation critical control. We also produce complementary chemical isotopes used in the normal operation and control of nuclear power plants.
 
Automotive/Diesel
         
Heavy-duty diesel truck engines
 
In order to achieve diesel engine life of 500,000 miles or more without major maintenance, and to meet current environmental requirements, it may be necessary to replace metal engine components with longer lasting, lighter weight, lower friction ceramic parts at acceptable unit costs.
 
Our SRBSN ceramic cam rollers replace conventional steel cam rollers in order to allow diesel engines to run at higher internal pressures and thus meet environmental and other requirements.
         
Wear-resistant functional and frictional coatings, surface engineered components
 
Engines generate extreme vibration during operation that can cause components joined by nuts and bolts to loosen. Traditionally, locknut washers have been used for this application.
 
Our wear-resistant functional and frictional coatings utilizing entrapped hard particles, primarily diamonds, are applied to shims in lieu of using locknut washers. These coatings increase the static friction coefficient and minimize the effects of vibration and allow more economic and efficient designs of engines, particularly in the auto industry.
         
Commercial
         
Orthodontic brackets
 
Traditional stainless steel orthodontic brackets are often considered unsightly. Substitute clear plastic materials can be weak and may stain. Some orthodontic patients prefer aesthetically pleasing brackets which can be affixed to each tooth to support the arch wire.
 
Our translucent ceramic orthodontic brackets are inert, reveal the color of the patient’s teeth, and allow the orthodontist to correct the patient’s bite. Our marketing partner, 3M Unitek, sells this translucent ceramic bracket under the brand name Clarity™.

 
11

 
  Market Opportunity     Demands of the Market     Our Solution
BORONEIGE® boron nitride powder
 
The cosmetic industry utilizes very fine, white, silky, smooth powders as a base for a wide range of products including lipstick, eye shadow, facial creams, rouge and other related products. There is an increasing demand for these base materials which can make up to forty percent of the end product. Generally, the requirements include white color, controlled chemistry and surface area.
 
Boron nitride, which is made by our ESK Ceramics subsidiary, is a well controlled micro structure white powder. The use of our unique boron nitride called BORONEIGE® is anticipated to grow as the availability of the base powders and the use of various cosmetic products increase.
 
 
         
Specialty glass compounds for health care applications
 
Bioactive glass compounds in orthopedic, wound care and various oral applications greatly enhance the body’s natural growth and healing processes.
 
We produce bioactive glass compounds used for bone growth, tooth strengthening and wound care.
 
Our Competitive Strengths
 
We believe that several aspects of our company provide us a competitive advantage in the markets we serve, including the following:
 
Broad Technical Expertise in Ceramic Material Science. Since the founding of our company in 1967, our core business has been researching, developing, designing, manufacturing and marketing advanced technical ceramic products. Specifically, our expertise is in a class of ceramics known as non-oxide structural ceramics. Many of our staff are technically trained, including 148 employees with degrees in ceramic engineering or related sciences, of which 32 have Ph.D. degrees. We have continuously sought to develop and manufacture innovative ceramic products not only for the markets that we currently serve but to identify and apply our experience and capabilities to emerging markets and applications. For example, our expertise allows us to develop ceramic armor products expeditiously and manufacture them on a significant scale.
 
Proprietary Equipment and Manufacturing Processes. The specialized equipment required to manufacture ceramic powders and advanced technical ceramics must often be custom designed and is not readily available. Over the past several decades, we have designed and constructed a substantial array of highly specialized and customized equipment and manufacturing processes, including our hot press lines and furnaces. We believe our custom equipment and manufacturing processes allow us to meet the high volume demands of our customers in the markets that we serve.
 
Vertically Integrated Manufacturer. We are a vertically integrated manufacturer of lightweight ceramic body armor and other ceramic products such as crucibles for photovoltaic solar cell manufacturing. Our ESK Ceramics subsidiary manufactures boron carbide powder—the key raw material used in the production of our body armor. ESK Ceramics has been a supplier of boron carbide powder to us for over 30 years. We form the boron carbide powder into ceramic armor plates using our own furnaces and hot presses. We then apply backing materials purchased from third parties to the plates to complete a ceramic body armor system ready to ship to our customers. Owning a source of our principal raw material, together with our manufacturing capacity at our Lexington, Kentucky plant, should allow us to fulfill current and anticipated demand for our ceramic body armor, while enabling us to manage our costs, product yields and high quality standards. Our acquisition of Minco, Inc. in 2007 provided Ceradyne with its own source of fused silica ceramic powders, which are the primary raw material in the manufacturing of crucibles (receptacles) used in the manufacturing of photovoltaic solar cells. The crucibles are used as the container for melting large (450 kilogram) ingots of silicon. Recently, we internally developed a proprietary hard ceramic coating designed to act as a barrier between the molten silicon and the Ceradyne crucible.
 
Strong Position in Multiple Markets. We maintain a strong position in many of the markets that we serve. We believe that we are the leading supplier of lightweight ceramic personnel armor products to the U.S. government based on the history of orders that the U.S. government has issued. We further believe that we supply a significant portion of products in many of the markets we serve including: boron carbide powders; translucent ceramic orthodontic brackets; ceramic missile radomes, commonly known as nose cones for the PAC-3 missile program; sintered reaction bonded silicon nitride, which we call SRBSN, for industrial and automotive applications; evaporation boats used to apply the metallic coating to packaging materials; and wear resistant functional and frictional coatings for the automotive industry. We believe that our leadership position in ceramic body armor and in many of the other markets that we serve provides us with a key advantage in securing new and continuing business. Additionally, we believe that our EKasic® (silicon carbide) product line of industrial pump seals and bearings allows us to be a leader in fluid handling products.
 
12

 
 
Key Customer Relationships. We have longstanding relationships with many of our significant customers in the defense, industrial, energy, automotive/diesel and commercial markets that we serve, which have enhanced our ability to obtain business over time. For example, for more than 20 years we have sold our advanced technical ceramic products to various agencies of the U.S. government. Since 2003, we have derived a significant portion of our revenues from the Army, Marines, Air Force and other branches of the U.S. military. We possess significant knowledge of the applicable purchasing requirements and product specifications within each of the branches of the U.S. military that we serve, and we believe that we have established an excellent reputation with key individuals within each branch.
 
Experienced Management Team and Entrepreneurial Culture. Our success is attributable in large part to the extensive knowledge and experience of our management team and key personnel. Our executive management team has substantial experience in advanced technical ceramic materials science and our Chief Executive Officer and our President of North American Operations each has more than 30 years of experience in the ceramics industry. Our management team has demonstrated its ability to identify, execute and integrate strategic acquisitions. Moreover, we believe that the entrepreneurial culture that has been fostered at Ceradyne since 1967 enhances our ability to develop innovative products for the markets that we serve.
 
Our Business Strategy
 
Our goal is to create value for our stockholders by profitably developing, manufacturing and selling advanced technical ceramic components to customers in existing and new markets where there is a need for new materials that will increase the efficiency, productivity and life of our customers’ end products. Key elements of our strategy for achieving this goal include:
 
Capitalizing on Opportunities in the Defense Market. The current geopolitical climate, terrorist threats and heightened international conflicts such as those in Iraq and Afghanistan, have been the primary factors driving demand for our defense products. Our defense marketing and sales efforts emphasize sales of ceramic body armor for military personnel to the U.S. government and, with the authorization of the U.S. government, to foreign allies of the United States. We also intend to expand our lightweight ceramic armor products to address additional body armor applications, such as enhanced combat helmets as well as new defense applications in vehicles, boats and aircraft.
 
Continuing to Increase our Non-Defense Revenue Base. We plan to continue to grow our non-defense customer base, primarily through promoting existing products to new customers, developing new products for new and existing customers and through strategic acquisitions. We focus on educating our current and potential customers on the advantages of our advanced technical ceramics compared to alternative solutions, and assisting them in developing advanced technical ceramic components for existing or new products and applications. Our technical and marketing staff educates our customers through direct sales visits, by preparing technical papers and product literature, and by participating in technical conferences, trade shows and exhibitions. Based on these efforts, we believe there is an opportunity to further expand the use of advanced technical ceramic products. For example, we are working with companies in the aluminum industry on utilizing ceramic materials in their next generation smelting production processes that have the potential to reduce the cost of producing aluminum. We also intend to further increase our customer, product and market base by converting certain advanced technical ceramics, originally developed for defense applications, to industrial and commercial applications. In addition to organically growing our product portfolio and market reach, we plan to continue to identify strategic acquisition opportunities that broaden our product lines within industrial and commercial markets. For example, a key strategic reason for our acquisitions of ESK Ceramics, the Boral® product line, Minco, Inc., EaglePicher Boron, LLC. SemEquip, Inc., and VIOX Corporation, as well as the expansion of our operations into Canada and China, were to further increase our non-defense revenue base.
 
Our acquisition of SemEquip, Inc. in August 2008 is intended to allow us to broaden our participation and position us to participate in future semiconductor markets. SemEquip’s development of cluster molecules such as B18H22 may be a key in the manufacture of next generation high current semiconductor devices. Our acquisition in June 2008 of certain assets and intellectual property related to heavy duty “stacked bearings” and bushings provides Ceradyne with a new product line of relatively large, rugged ceramic bearings and bushings. These components will be used in severe environments such as “downhole” oil drilling and submersible fluid handling pumps. Our acquisition of VIOX Corporation in January 2011 is intended to broaden our product offerings in the solar energy market. Manufacturers of polycrystalline silicon photovoltaic solar cells use VIOX’ specialty glass formulation to increase the energy efficiency of the solar wafer.
 
13

 
 
Identifying New Products and Markets. We intend to identify new products and markets to meet evolving customer requirements for high performance materials. Due to the special properties of the advanced technical ceramics we produce, we believe there are numerous applications and markets for such materials. Our research and development efforts have identified several new applications for advanced technical ceramics in both existing markets, such as the defense industry, and new markets, including the energy, metals production and chemical industries. Such new applications include lightweight ceramic armor for military vehicles, boats and aircraft; ceramic components that have the potential to facilitate extraction of oil from oil sands on a cost-effective basis; ceramic materials that have the potential to reduce significantly the cost of producing molten aluminum; chemical micro reactors, heat exchangers and hydraulic trim valves produced with our proprietary technology that have the potential to provide an economical substitute for steel in extreme environments; storage containers made with our boron carbide powder that have the potential to be used for long-term containment of nuclear waste from nuclear power plants; and small complicated ceramic components made using our injection molding technology that have the potential to be used as medical implants. We also expect to continue to benefit from the addition of ESK Ceramics’ expertise in ceramic powders and products, which has expanded the scope and scale of our product development efforts.
 
Investing to Improve our Gross Margins and Manufacturing Efficiencies. We focus on cost containment, productivity enhancements and manufacturing efficiencies as a means to drive earnings growth. We have implemented lean manufacturing initiatives, such as Demand Flow® Technology and 5-S plus Safety in order to reduce inventories, scrap and queue times and to increase productivity. Additionally, we continue to evaluate opportunities to employ automation and dedicated work cells to expand our in-line production efficiency. We also continue to seek ways to reduce our manufacturing costs by evaluating opportunities to relocate or expand manufacturing operations within the United States as well as internationally. For example, in 2004, we began expanding our high energy-utilization manufacturing processes at our new Lexington, Kentucky facility, where the cost of electricity, which comprises a significant portion of our cost of product sales, is substantially lower than in California. We plan to evaluate strategic manufacturing relationships in international markets, including joint ventures or acquisitions, particularly in low cost manufacturing areas such as China. We completed the construction in June 2007, of a new approximately 98,000 square foot facility in Tianjin, China for the manufacture of ceramic crucibles which are used for melting silicon in the photovoltaic solar cell manufacturing process. We increased this capacity by constructing a second approximately 218,000 square foot facility in Tianjin, China for the manufacture of ceramic crucibles, which was completed in January 2011. We also plan to develop strategic relationships with other manufacturing companies or key customers whose expertise or financial resources can assist us in accomplishing our objectives. We initiated a major improvement to our data and information technology systems with the implementation of SAP enterprise software applications. It is our intention to integrate the use of SAP software throughout our Company with a target completion date of December 2012.
 
Market Applications and Products
 
Our products are sold into five principal markets or sectors of the economy: defense, industrial, energy, automotive/diesel and commercial. The following is a description of our principal products by market application:
 
Defense
 
Lightweight Ceramic Armor. We have developed and currently manufacture lightweight ceramic armor capable of protecting against threats as great as 12.7 millimeter armor piercing machine gun bullets. Compared to traditional steel armor plates, our ceramic armor systems offer weight savings as great as 40%. Using hot pressed Ceralloy® ceramic, our armor plates are laminated with either Spectra Shield®, Dyneema®, Kevlar™, fiberglass, custom hybrid laminates or aluminum, and formed into a wide variety of shapes, structures and components. Initially, our manufactured ceramic armor was used principally for military helicopter crew seats and airframe panels. We are now also a major supplier of lightweight ceramic body armor for the U.S. military, and lightweight ceramic armor for military helicopters. We are also a supplier of armor systems for military vehicles.
 
ECH Helmets. We manufacture a new enhanced combat helmet (ECH) that offers over 35% improvement compared to existing helmets. By utilizing new thermoplastic UHMWPE (Ultra High Molecule Weight Poly Ethylene) materials with our proprietary Seamless BallisticTM processing technique we offer a helmet with much improved ballistic performance at lighter weights.
 
Boron Carbide Powders. We manufacture boron carbide powder, which is the principal raw material used in the production of our lightweight ceramic body armor. Our ESK Ceramics subsidiary is one of the world’s leading manufacturers of this material. ESK Ceramics has been a supplier of boron carbide powder to us for over 30 years and periodically supplies our ceramic body armor competitors.
 
Missile Radomes (Nose Cones). We manufacture conical shaped, precision machined ceramic radomes which are designed for the front end of defensive missiles. These radomes are used where missile velocities are high and operating environments are severe, and the thermal shock and erosion resistance, high strength and microwave transparency properties of advanced technical ceramics are required. Our ceramic radomes are used on the PAC-3 (Patriot Advanced Capability) missile and various future missile system prototypes.
 
14

 
 
Industrial
 
Fluid Handling/Wear Parts. We supply products made primarily of our EKasic® silicon carbide, silicon nitride and boron carbide, which have excellent wear resistant properties, lightness, hardness, and can withstand extremely high temperatures. Products furnished are used in high performance pump seals, bearings for fluid handling, blast nozzles and chemical processing.
 
Boron Compounds and Metallurgy Ceramics. Boron nitride powders have excellent release properties and are highly resistant to wear and corrosion. These powders are used in the forming and bending of glass, as an additive in refractory materials, and as a lubricant for aluminum extrusion. Our silicon nitride products have excellent thermal shock resistance and temperature stability up to 2,200° Fahrenheit. These products are used for transportation of liquid aluminum, for use in low and high pressure casting and in liquid aluminum processes.
 
Evaporation Boats. Our evaporation boats are used in the metallization of various surfaces such as plastic, paper or glass. Metallization is a process based on the deposition of a metallic vapor under vacuum to coat a substrate surface with a thin layer of aluminum, zinc, copper or silver. The preferred metal for the metallizing process is aluminum. Evaporation boats have direct contact with highly corrosive molten metal alloys and are made out of a boron nitride/titanium diboride composite material. These products provide packaging manufacturers the ability to apply vaporized aluminum to packaging material that as a finished product helps to preserve and maintain the shelf life of food products.
 
Industrial Wear Components. Our industrial wear components are made primarily of our Ceralloy® 147 sintered reaction bonded silicon nitride (SRBSN). These SRBSN ceramic components are generally incorporated in high wear areas of industrial machinery where severe abrasive conditions would otherwise wear out vital components. Our wear resistant parts are used to replace parts made of materials such as tungsten carbide or ceramics such as aluminum oxide. Applications include paper making equipment, abrasive blasting nozzles, metal cutting tool inserts as well as custom products.
 
Ceramic-Impregnated Dispenser Cathodes. We manufacture ceramic-impregnated dispenser cathodes for microwave tubes used in radar, satellite communications, electronic countermeasures and other applications. Dispenser cathodes, when heated, provide a stream of electrons which are magnetically focused into an electron beam. Microwave dispenser cathodes are primarily composed of a porous tungsten matrix impregnated with ceramic oxide compounds. The use of ceramic-impregnated cathodes reduces the amount of energy necessary to create a high level of electron emissions. Our ceramic-impregnated cathodes are also used in ion lasers and cathode ray tubes.
 
Tempered Glass Furnace Components and Metallurgical and Industrial Tooling. Fused silica ceramic does not, to any material extent, expand when heated or contract when cooled. This material is therefore used for industrial tooling components and molds where complicated shapes and dimensions are maintained over a wide range of temperatures. Such applications include forming and shaping titanium metal used in aircraft manufacture. Other applications take advantage of fused silica’s excellent thermal shock resistance and inertness when in contact with glass. We have the capability to make fused silica ceramic rollers up to 14 feet in length used in glass tempering furnaces.
 
Precision Ceramics. We manufacture a variety of hot pressed Ceralloy® ceramic compositions that are precision diamond ground to exacting tolerances, primarily for microwave tube applications. The interior cavities of microwave tubes often require microwave absorbing ceramic components capable of operating at elevated temperatures and in high vacuums.
 
Boron Isotopes for Semiconductors. We produce the boron isotope 11B, which is used in the semiconductor manufacturing process as an additive to semiconductor grade silicon as a “doping” agent and where ultra high purity boron is required. With our acquisition of SemEquip, Inc. in August 2008, we now produce the cluster boron molecule B18H22 for next generation semiconductor devices.
 
Precision Investment Casting Products. We manufacture fused silica grains and powder products that are used in precision investment casting (PIC), a highly sophisticated manufacturing process used to make a wide range of precision dimensioned castings for a broad base of different industries. The process requires low expansion materials for one time use in the casting process. Our products include proprietary blends that reduce our customers’ cast and cycle time. 
 
 
15

 
Energy
 
Fused Silica Ceramic Crucibles. We manufacture fused silica ceramic crucibles, or receptacles, which are used in the fabrication of polycrystalline silicon for photovoltaic solar cells that convert sunlight into electricity. These crucibles are designed to withstand high temperatures and thermal shock when in contact with molten silicon, without contaminating the melt. In 2008, we introduced a proprietary hard ceramic coating to line the crucible’s interior.
 
Boron Isotopes and Molecules for the Nuclear Industry. We enrich and manufacture the boron isotope 10B which is a material that is used by the nuclear power industry. The 10B isotope is critical to the safe operations of the U.S. nuclear power industry, waste storage, and the stability and safe-keeping of nuclear weapons.
 
Radioactive Waste Management. Boron carbide powder has a high cross-section for capturing neutrons, making it an ideal material for the management of radioactive nuclear waste from nuclear power plants. Typical applications include use in neutron absorbing parts, such as control rods in nuclear power plants, and nuclear shielding in the storage and transportation of nuclear waste materials. Our Boral® product line, which consists of a rolled sheet containing a core of uniformly distributed boron carbide and aluminum particles that is enclosed within layers of pure aluminum, forms a solid and effective barrier for the storage of nuclear waste. We also produce the boron isotope 10B. This isotope is a strong neutron absorber and is used for both nuclear waste containment and nuclear power plant neutron radiation critical control.
 
Sand Screens. We have developed  and manufacture ceramic sand screens for heavy duty rugged ceramic screen for downhole oil and gas drilling. The unique designs are intended to extend the life of sand screen equipment by reducing premature failures during operations. The sand screens filter out sand, small particles and proppants during drilling operations.
 
Heavy Duty Bearings. In June 2008, we acquired the proprietary rights for a series of heavy duty rugged ceramic bearing components for downhole oil drilling and various water pump applications. The unique designs are intended to extend the life of drilling equipment by reducing premature failures during operations.
 
Specialty Glass Compounds. We have designed a series of proprietary glass compounds for solar cell surface paste coating used by photovoltaic cell manufacturers to improve the efficiency of their cells.
 
Automotive/Diesel
 
Wear-Resistant Functional and Frictional Coatings. We manufacture our EKagrip® Foils for wear-resistant functional and frictional coatings for fastener applications utilizing entrapped hard particles, primarily diamonds. This product line increases the static friction coefficient, minimizes the effects of vibration and allows more economic and efficient designs of engines, particularly in the auto industry.
 
Diesel Engine Components. We have been manufacturing ceramic cam rollers for heavy-duty diesel engines since 1999, and now have production contracts to supply cam rollers to several major engine companies. We expect that sales of these cam rollers will begin to decline in 2013 when new U.S. environmental regulations take effect for off-highway applications. We also supply fuel system manufacturers with components for diesel fuel pumps. In addition, we are engaged in development projects with a number of other diesel engine and fuel pump systems manufacturers worldwide for various ceramic components.
 
Commercial
 
Ceramic Orthodontic Brackets. In orthodontics, to correct a patient’s tooth alignment, usually a small stainless steel bracket is attached to each tooth. These brackets provide a guide to the archwire, which is the wire that sets into each bracket. The cosmetic appearance of this metal is often considered unattractive. Together with 3M Unitek, we have developed a ceramic bracket which 3M Unitek markets to orthodontists under the brand names Clarity™ and Clarity SL™. The translucency of this ceramic bracket, together with the classic ceramic properties of hardness, chemical inertness and imperviousness, result in a cosmetic substitute for traditional stainless steel brackets. These brackets reveal the natural color of the patient’s teeth while performing the structural functions of traditional stainless steel brackets.
 
BORONEIGE® Boron Nitride Powder. We manufacture and market to the cosmetic industry a very fine, white, silky, smooth powder called BORONEIGE®,which is used as a base for a wide range of products including lipstick, eye shadow, facial creams, rouge and other related products.
 
Specialty glass compounds. We produce bioactive glass compounds used for bone growth, tooth strengthening and wound care.
 


 
16

 
 
Operating Segments and Facilities
 
We serve our markets through four segments with manufacturing facilities in several locations across the United States, one in Canada, two in China, one in Europe, and one in India. The following table includes a summary of our facilities and products comprising our four operating segments. For financial information concerning our segments, please refer to Note 8 of the Notes to Consolidated Financial Statements.
 
Operating Segment and Facility Location
 
Products
     
Ceradyne Advanced Ceramic Operations
           Costa Mesa and Irvine, California(1)                                            
    Approximately 216,000 square feet
 
Defense Applications:
•  Lightweight ceramic armor
•  Enhanced combat helmets
 
     
           Lexington, Kentucky(2)
           Approximately 150,000 square feet
 
           Wixom, Michigan(3)
           Approximately 29,000 square feet
 
Industrial Applications:
•  Ceralloy® 147 SRBSN wear parts
•  Precision ceramics
•  Ceramic-impregnated dispenser cathodes for microwave tubes, lasers
    and cathode ray tubes
 
           Salem, New Hampshire(4)
           Approximately 16,000 square feet
 
Mountain Green, Utah(5)
Approximately 18,000 square feet
 
Bangalore, India(6)
Approximately 21,000 square feet
 
Seattle, Washington(7)
Approximately 40,000 square feet
 
 
Energy Applications
•  Ceramic bearings and bushings
•  Specialty glass compounds for photovoltaic solar applications
 
Automotive/Diesel Applications:
        •  Ceralloy® 147 SRBSN automotive/diesel engine parts
 
Commercial Applications:
•  Ceramic orthodontic brackets
•  Components for medical devices
•  Specialty glass compounds for health care products
 
     
ESK Ceramics
 
           Kempten, Germany(8)
Approximately 599,000  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
•  High performance fluid handling  pump seals
 
Automotive/Diesel Applications:
•  EKagrip® functional and frictional coatings
 
Commercial Applications:
•  BORONEIGE® boron nitride powder for cosmetics
 
Energy Applications:
•  PetroCeram® sand filters
    •  TETRABOR® nuclear powders
Ceradyne Thermo Materials
 
           Scottdale and Clarkston, Georgia(9)
Approximately 225,000 square feet
 
Tianjin, China(10)
Approximately 316,000 square feet
 
           Midway, Tennessee(11)
Approximately 105,000 square feet
 
Defense Applications:
•  Missile radomes (nose cones)
•  High purity fused silica used to manufacture missile radomes (nose cones)
 
Industrial Applications:
•  Glass tempering rolls
•  Metallurgical tooling
•  Castable and other fused silica products
•  Turbine components used in aerospace applications
 
Energy Applications
•  Crucibles for photovoltaic solar cell applications
•  High purity fused silica used to manufacture crucibles
 
 
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Boron
 
       Quapaw, Oklahoma(12)
       Approximately 128,000 square feet
 
           Chicoutimi, Quebec, Canada(13)
           Approximately 86,000 square feet
Energy Applications:
     •  Nuclear chemistry products for use in pressurized water reactors and boiling water reactors
     •  Radioactive containment for use in spent fuel transport and storage
     •  Burnable poisons for coating of uranium fuel pellets
 •   Boral® structural neutron absorbing materials
 •   Metal matrix composite structures
 
Industrial Applications:
     •   Cluster molecules such as B18H22 for ion implantation for next generation
          P-dopants
     •   Advanced ion source materials for the manufacture of logic and memory chips
 
   
 
(1)
We have leases on our facilities in Costa Mesa, California, aggregating approximately 99,000 square feet, all of which expire in October 2012, with an option to renew it for one additional year. We own our 40,000 square foot facility in Irvine, California. Also in Irvine, California, we lease a 76,000 square foot facility under a lease that expires in October 2012, with an option to renew it for one additional year.
(2)
We own two facilities, containing 35,000 square feet and 115,000 square feet, in Lexington, Kentucky.
(3)
We have a lease on our Wixom, Michigan facility which expires in April 2014.
(4)
We have a lease on our Salem, New Hampshire facility which expires in March 2015.
(5)
We have a lease on our Mountain Green, Utah facility which expires in March 2012. We do not intend to renew it. These operations will be transferred to our Salem, New Hampshire facility.
(6)
We have a lease on our Bangalore, India facility which expires in June 2014.
(7)
We have a lease on our Seattle, Washington facility which expires in December 2013.
(8)
We own our facility in Kempten, Germany, as well as the 28-acre property on which our facility is located.
(9)
We own an 85,000 square foot facility in Scottdale, Georgia, as well as the five-acre property on which our facility is located. We lease facilities totaling approximately 140,000 square feet in Clarkston, Georgia. The leases on two of these facilities expire in June 2013. We are currently in negotiations to extend the leases on the other facilities.
(10)
We own two facilities in Tianjin, China, one containing approximately 98,000 square feet, as well as the four-acre property on which our facility is located, and the second containing approximately 218,000 square feet, as well as the thirteen-acre property on which this facility is located.
(11)
We own our facility in Midway, Tennessee as well as the 40-acre property on which our facility is located.
(12) 
We own our facility in Quapaw, Oklahoma as well as the 155-acre property on which our facility is located.
(13)
We own our facility in Chicoutimi, Quebec, Canada, as well as the seven-acre property on which our facility is located.

 
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Sales, Marketing and Customers
 
Each of our four operating segments maintains a separate sales and marketing force promoting its individual products.  As of December 31, 2011 we had 103 employees directly involved in sales and marketing, including 52 sales and marketing personnel located outside the United States. We also have agreements with manufacturers’ representatives in foreign countries who are compensated as a percent of sales in their territory. We distribute our principal products directly to our customers using our own sales force and independent manufacturers’ representatives. Sales to customers located outside the United States represented approximately 45.4% of our net sales in 2011, 51.7% in 2010, and 33.9% in 2009.
 
We continue to explore various domestic and international relationships to increase our sales and market penetration. We seek long-term relationships such as multi-year agreements or exclusive relationships with our customers to achieve a more consistent and predictable flow of orders and shipments.
 
We sell products and components to the U.S. government and government agencies, as well as to government contractors, original equipment manufacturers and to end users. The U.S. government and government agencies collectively represented approximately 37.6% of our net sales in 2011, 17.5% in 2010 and 40.8% in 2009. As of December 31, 2011 and 2010, there were no other external customers that accounted for 10% or more of our revenue.
 
We sell our translucent ceramic orthodontic brackets, commonly known as braces, only to 3M Unitek. Sales to 3M Unitek represented approximately 1.6% of our net sales in 2011, 2.1% in 2010 and 2.4% in 2009. In December 2005, we entered into a new supply agreement with 3M Unitek that expires in December 2013. This new agreement replaced our original, March 1986 joint development and supply agreement with 3M Unitek. 3M Unitek is a major manufacturer of stainless steel orthodontic brackets and, early in our relationship, shared with us the functional specifications and properties which ceramic brackets would be required to satisfy. With this information and our experience with translucent ceramics in defense applications, we developed, and in 1987 began manufacturing, translucent ceramic brackets. Under the original supply agreement, 3M Unitek was required to purchase ceramic orthodontic brackets exclusively from Ceradyne until September 2007. Under the terms of the new agreement, 3M Unitek will continue to purchase 100% of their Clarity and Transcend brand ceramic orthodontic product lines exclusively from us for as long as 3M Unitek continues to sell such products. The new agreement further stipulates that 3M Unitek must purchase from Ceradyne at least 50% of the ceramic orthodontic brackets 3M Unitek requires for next generation designs, which it introduced in 2007.
 
Manufacturing Processes
 
We employ a number of advanced technical ceramic manufacturing processes that enable us to deliver high quality products designed to meet specific customer requirements. The processes used to manufacture our principal products are described below.
 
Hot Pressing. Our hot pressing process is generally used to fabricate ceramic shapes for lightweight ceramic armor. We have designed and constructed induction heated furnaces capable of operating at temperatures exceeding 4,000°F in inert atmospheres at pressures up to 5,000 pounds per square inch. With this equipment, we can fabricate parts more than 26 inches in diameter, which is considered large for advanced technical ceramics. Using multiple cavity dies and special tooling, we can produce a number of parts in one furnace during a single heating and pressing cycle.
 
Our raw materials are fine powders procured from our ESK Ceramics subsidiary, as well as from several outside suppliers. After we process them, the powders are either loaded directly into the hot pressing molds or are shaped into pre-forms prior to loading into the hot pressing molds. The powders are placed in specially prepared graphite tooling, most of which we machine to shape. Heat and pressure are gradually applied to the desired level, carefully maintained and finally reduced. The furnace is then removed from the press and allowed to cool, permitting the press to be used with another furnace. For most products, this cycle takes approximately 20 hours. The resultant ceramic product generally has mechanical, chemical and electrical properties of a quality approaching theoretical limits. Almost all products, other than armor, are then finished by diamond grinding to meet precise dimensional specifications.
 
Ceramic Powders (Boron Carbide TETRABOR®, Boron Nitride, Titanium Diboride, Calcium Hexaboride, Zirconium Diboride). We purchase raw materials like carbon, boric acid and oxides from outside vendors. These raw materials are converted into the final formulation in large high temperature processes using an arc furnace. After the resultant material is cooled, it is broken down into fine particulates that are then purified through a chemical treatment. The next process is the production and classification of various grain sizes. The manufacturing processes result in a very high and consistent quality powder. The resulting finished ceramic powder products are used in a wide range of applications, such as ceramics and powders for abrasives, armor, neutron absorption and refractories.
 
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Sintering and Reaction Bonding of Silicon Nitride (SRBSN). The sintering of reaction bonded silicon nitride results in our Ceralloy® 147 SRBSN, which is used in industrial and automotive/diesel applications. This SRBSN process begins with relatively inexpensive high purity elemental silicon (Si) powders, which contrasts sharply with some other competitors’ manufacturing techniques which start with relatively more expensive silicon nitride (Si3N4) powders.
 
After additives are incorporated by milling and spray drying, the silicon powders are formed into shapes through conventional ceramic processing such as dry pressing. These shapes are then fired in a nitrogen atmosphere which converts the silicon part to a silicon nitride part. At this step (reaction bonding), the silicon nitride is pressure sintered in an inert atmosphere increasing the strength of the component threefold. As a result of SRBSN processing, the ceramic crystals grow in an intertwining “needle-like” fashion which we have named NeedleLok™. The NeedleLok™ structure results in a strong, tough, high fracture energy part. This process can be used to produce extremely high production volumes of parts due to the use of conventional pressing processes.
 
Manufacture of Translucent Ceramics (Transtar®). We produce translucent aluminum oxide (Transtar®) components primarily for use as orthodontic ceramic brackets. We purchase the high purity powders from outside vendors and process them using dedicated conventional ceramic mechanical dry presses. The formed blanks are then fired in a segregated furnace in a hydrogen atmosphere at over 3,000°F until the ceramics enter into a mechanically strong, translucent condition. These fired translucent brackets then have certain critical features diamond ground into them. The next step is a proprietary treatment of the bonding side in order to permit a sound mechanical seal when bound to the patient’s teeth. In the final step we furnace braze a stainless steel channel into each archwire slot which has been previously diamond ground into the bracket.
 
Functional Coatings (Surface Engineered). Our functional coatings are formed by the deposition of hard particles, primarily diamonds, in a nickel layer on steel, aluminum or titanium. We purchase the hard particles—sized between nanometers and 60µm—from outside vendors and customize these raw materials through chemical treatment. Before being coated, the metal parts are chemically cleaned and deburred. The final product is manufactured by an electroless nickel coating process with simultaneous embedding of hard particle grains. The final step is the hardening of the nickel surface by a heat treatment process up to 660°F.
 
Evaporation Boats (LaserMet®, DiMet®, TriMet®, FlashMet®). Evaporation boats are ceramic sintered parts consisting of titanium diboride/boron nitride and other nitride compositions for our TriMet® product. These components, in the form of ceramic powders, are milled and conditioned. The key forming process is hot pressing, which results in solid sintered billets. From these sintered billets, the evaporation boats are machined with proprietary processes to various types and shapes.
 
Sintered Parts. For the production of sintered parts, we either buy raw materials like silicon carbide from outside vendors or use our own ceramic powders. With our specific developed processes, we condition the ceramic powders by incorporating additives, milling, and spray drying into ready-to-press powders. We then utilize the processing steps of forming, green machining, sintering and final machining as the materials are transformed into various shapes. We utilize a broad range of technological processes and equipment to accomplish this. Examples of these processes include cold isostatic pressing, axial dry pressing, injection molding, extrusion molding, pressure sintering, hot pressing, hot isostatic pressing and pressureless sintering.
 
Diamond Grinding. Many of our advanced technical ceramic products must be finished by diamond grinding because of their extreme hardness. Our finished components typically are machined to tolerances of ±.001 inch and occasionally are machined to tolerances up to ±.0001 inch. To a very limited extent, we also perform diamond grinding services for customers independent of our other manufacturing processes to specifications provided by the customer. Our diamond grinding facilities can perform surface grinding, diameter grinding, ultrasonic diamond grinding, diamond lapping, diamond slicing and honing. The equipment includes manual, automatic and computer numerically controlled, or CNC, grinders. We have specially adapted the CNC grinders for precision grinding of ceramic contours to exacting tolerances.
 
Sintering of Fused Silica Ceramics. Sintering of fused silica ceramics is the process we use to fabricate fused silica ceramic shapes for applications in crucibles for use in the manufacturing of photovoltaic solar cells, metallurgical tooling, missile radomes (nose cones) and other industrial uses. To fabricate fused silica ceramic shapes, fused silica powders are made into unfired shapes through slip casting or other ceramic forming processes. These unfired “green” shapes are fired at temperatures up to 2,500°F. The final shapes are often marketed in the “as fired” condition or, in some cases, precision diamond ground to achieve specific dimensional tolerances or surface finishes required by certain customers.
 
Injection Molding. Certain markets, like medical device components, require ceramic shapes that are small, highly configured and held to tight dimensional tolerances. Many of these can only be produced by the injection molding process. At the present time these powders tend to be oxide ceramics, primarily zirconia, alumina and/or blends thereof that we mix in house. The ceramic powder is then blended with organic ingredients that constitute a proprietary binder system. The resultant feedstock allows us to process the material through a standard injection-molding machine into a precision mold designed by us.
 
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Boron Carbide and Aluminum Metal Matrix Composites. For the production of metal matrix composite materials, we hot press relatively large ingots of aluminum and boron carbide. These ingots are subsequently either extruded or rolled and then cut into the final configuration. For the production of Boral®, we acquire an extruded aluminum material into which we place a proprietary mixture of aluminum and boron carbide powder. We roll this material into thin sheets of shield material, which can then be cut into numerous sizes.
 
Boron Isotopes. We use gravity to separate natural boron material into the two isotopes of boron, 10B and 11B through the use of a large tower. We then convert these isotopes into specific molecules requested by our customers, such as boric acid, zirconium diboride, boron trifluoride or boron metal. We employ a broad range of technological equipment and processes to produce the isotopically enriched molecule of choice.
 
High Purity Fused Silica. To produce our fused silica powder products, we melt washed quartz sand into large ingots using an electric arc melting process and then crush the ingots into powder products using various crushing, grinding, milling, and size separation equipment. The melting process transforms the quartz raw material into fused silica glass. The phase transformation that occurs during the melting process results in a finished product whose thermal expansion is much less than that of the quartz sand raw material. 
 
Raw Materials
 
The starting raw materials for our manufacturing operations are generally fine, synthetic powders available from several domestic and foreign sources, including our subsidiary, ESK Ceramics. ESK Ceramics supplied 704 tons of boron carbide powder and silicon carbide to us in 2011, 340 tons in 2010 and 670 tons in 2009. We have owned ESK Ceramics since August 23, 2004. Our Minco, Inc. subsidiary, which we acquired on July 10, 2007, supplies us with high purity fused silica powders. Other raw materials, such as the backing material for ceramic armor, graphite, and metal components are readily available from several commercial sources.
 
Quality Control
 
We make our products to a number of exacting specifications. In order to meet both internal quality criteria and customer requirements, we implement a number of quality assurance programs such as in-process statistical process control (SPC). We implement these quality programs separately at each of our manufacturing locations and in different ways depending on the processes. The results of these well deployed programs assist us in understanding and predicting limited exposure to non-conforming products.
 
Our Advanced Ceramic Operations, ESK Ceramics, Boron Products, Minco and Thermo Materials facilities have received ISO 9001 Certification. Semicon Associates and SemEquip, Inc. are ISO 9000 compliant.
 
Engineering and Research
 
Our engineering and research efforts consist of application engineering in response to customer requirements, in addition to new materials and product development aimed at creating demand for new products. Our efforts create new products, modify existing products to fit specific customer needs and result in developing enhanced ceramic processes.
 
We allocate costs associated with application engineering and research between cost of product sales and research and development expense. Application engineering efforts devoted to specific customer orders generally are recognized as cost of product sales, while the balance of engineering and research costs is included in research and development and expensed as incurred. Our research and development expenses were approximately $12.4 million in 2011, $11.7 million in 2010, and $12.3 million in 2009.
 
Competition
 
Our products compete with advanced technical ceramic products and powders from other companies, as well as with high strength steel alloys and plastic products. When competing with other advanced technical ceramic products and powders, we believe the principal competitive factors are manufacturing capacity and the ability to deliver products, price, product performance, material specifications, application engineering capabilities, customer support and reputation. Some of our competitors include ArmorWorks, The Protective Group, Ceramtec, the Armor Holdings and Cercom subsidiaries of BAE Systems, CoorsTek, Denka, Momentive Performance Materials, Hitachi, HC Starck, Kyocera’s Industrial Ceramics Group, Morgan, Saint Gobain, Kennametal, Spectra-Mat, UK Abrasives, Vesuvius, C-E Minerals, NHTC, Holtec, Nukem and General Electric. Many of our current or potential competitors have greater financial, marketing and technical resources than we do. We cannot guarantee that we will be able to compete successfully against our current or future competitors. If we fail to compete successfully, there could be material adverse effects on our business, financial condition and results of operations. In many applications we also compete with manufacturers of non-ceramic materials. When competing with high strength steel alloys and plastic products, we may not be able to compete effectively when price is a primary consideration, because our products are typically more expensive as a result of higher manufacturing costs associated with the production of advanced technical ceramics.
 
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Backlog
 
We record an item as backlog when we receive a contract, purchase order or other notification indicating the number of units to be purchased, the purchase price, specifications, delivery requirements and other customary terms and conditions. Our backlog was  approximately $284.9 million as of December 31, 2011 and approximately $185.8 million as of December 31, 2010. We expect that substantially all of our backlog as of December 31, 2011 will be shipped during 2012.
 
Patents, Licenses and Trademarks
 
We rely primarily on trade secrecy to protect compositions and processes that we believe are proprietary. In certain cases, the disclosure of information concerning such compositions or processes in issuing a patent could be competitively disadvantageous. However, our management believes that patents are important for technologies where trade secrecy alone is not a reliable source of protection. Accordingly, we have applied for, or have been granted, several U.S. patents relating to compositions, products or processes that our management believes are proprietary, including lightweight ceramic armor.
 
We have been issued two U.S. patents relating to translucent ceramics for orthodontic brackets. The first of these two patents expired in September 2007, and the second patent expires in October 2013. We co-invented and co-own these patents with 3M Unitek. Together with 3M Unitek, we have granted licenses to companies whose ceramic orthodontic brackets infringe our joint patents. These companies pay both of us royalties based on sales of their orthodontic ceramic brackets for the remaining life of the patents.
 
In addition to the above, we have been issued 61 U.S. patents, 140 foreign patents and have 138 patents pending and have applied for corresponding foreign patents in various foreign countries. Of the number of patents indicated above, our ESK Ceramics subsidiary has 10 U.S. patents pending and 48 foreign patents pending, and our SemEquip subsidiary has 37 U.S. patents and 22 U.S. patents pending, as well as corresponding issued and pending patents in several foreign countries. The proprietary coarse grained silicon carbide materials, including silicon carbide materials with graphite inclusions, are protected by patents in Europe, the United States, Canada and Japan. These patents expire in 2017. Other patents also relate to sintered silicon carbide materials, the earliest expiring in 2014. Another patent for evaporation boats has been issued in Europe, the United States, Canada and Japan. This patent expires in 2019. Other patents relate to Ekagrip® friction enhancing coatings, the earliest expiring in 2018. Other patents relate to titanium diboride materials, boron nitride materials and coatings and composite ceramic materials.
 
The patents issued to our SemEquip subsidiary relate to its ion source and method of making semiconductor devices. SemEquip's pending patent applications relate to its ion source, semiconductor devices and synthesis of the molecular cluster source feed material, octadecaborane, B18H22, used in its ion source.
 
The patents we acquired from Diaphorm Technologies, LLC in June 2009 include the apparatus and methods for producing helmets.
 
“Ceralloy®,” the name of our technical ceramics, “Ceradyne®” and the Ceradyne logo, comprising the stylized letters “CD®,” are our major trademarks registered in the United States and various foreign countries. We also have other trademarks, including “Transtar®,” “Semicon®,” “Thermo®,” “Defender®,” “NeedleLok®,” “Thermo-Sil®,” “BORAL®,” “BoroBond®,” “BorAluminum®,” “BORTEC™,” “Mohawk™,” “Design (Defender) ®, ” “R.A.D.A.R. ™,” and “Ramtech®”. The ESK Ceramics logo, and ESK Ceramics’ major product trademarks, including “TETRABOR®”, “EKasic®”, “DiMet®”, “TriMet®”, “MYCROSINT®”, “EKagrip®”, “BORONID®”, PetroCeram®, “EKamold®”, “LaserMet®”, “EllipsoMet®”, “EKatherm®”, “BORONEIGE®” and “EKathemis®”are registered in Germany and many countries worldwide. The Minco logo, consisting of an ingot design featuring the word “Minco” in the center of the ingot, is registered in the United States. “SEMEQUIP®”, “CLUSTERION®”, “CLUSTERCARBON®”, and “CLUSTERBORON®”, are registered trademarks in the United States; “CLUSTERION® is also registered in Taiwan and China; and “CLUSTERBORON®” is also registered in Japan, South Korea and Taiwan and China. “Diaphorm®” and “Fiber-Tuned®” are registered trademarks in the United States and “Seamless Ballistic®” is registered in the United States, Madrid and Singapore and pending registration has been applied for in many countries worldwide. “Max Pro-Armor”, Application Number 77/306,318 has been allowed. PetroCeram®, the trademark for our products marketed to the oil and natural gas exploration industry, is registered in the U.S., Saudi Arabia, Russia, Iran, China, Canada, UAE, Norway, Algeria and the European Union.
 
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Employees
 
As of December 31, 2011 we had 2,112, employees, including 148 employees with undergraduate or graduate degrees in ceramic engineering or related sciences. Of these total employees, 1,595 were in manufacturing, 212 were in engineering and research, 103 were in sales and marketing, and 177 were in general management, finance and administration. We also use temporary labor in some of our production operations. We generally consider our relationship with employees to be excellent. None of our U.S.-based employees are represented by labor unions. The employees of ESK Ceramics have elected a work council, an entity which represents employees and is entitled to information and co-determination rights under German law. We consider our relationship with the work council to be good.
 
Availability of SEC Filings
 
We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. You can read our SEC filings over the Internet at the SEC’s website at http://www.sec.gov. We also make our SEC filings available free of charge through our Internet website as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. Our website address is www.ceradyne.com. The reference to our website address does not constitute incorporation by reference into this report of the information contained at that site.
 
EXECUTIVE OFFICERS OF CERADYNE
 
Our executive officers and their ages as of February 16, 2012 are as follows:
 
Name
 
  Age
 
Position
Joel P. Moskowitz
    72  
Chairman of the Board, Chief Executive Officer and President
           
David P. Reed
    57  
Vice President, and President of North American Operations and Assistant Corporate Secretary
           
Jerrold J. Pellizzon
    58  
Chief Financial Officer and Corporate Secretary
           
Thomas Jüngling
    48  
Vice President, and President of ESK Ceramics
           
Bruce R. Lockhart
    49  
Vice President, and President of Thermo Materials
           
Jeffrey J. Waldal
    47  
Vice President, and President of Semicon Associates
           
Thomas A. Cole
    65  
   Vice President, Business Development
           
Terry M. Hart
    55  
   Vice President, Human Resources
 
Joel P. Moskowitz co-founded our predecessor company in 1967. He served as our President from 1974 until January 1987, and has served as our President since September 1987. In addition, Mr. Moskowitz has served as our Chairman of the Board and Chief Executive Officer since 1983. Mr. Moskowitz currently serves on the Board of Trustees of Alfred University. Mr. Moskowitz obtained a B.S. in Ceramic Engineering from Alfred University in 1961 and an M.B.A. from the University of Southern California in 1967.
 
David P. Reed joined us in November 1983, and has served as a Vice President since January 1988. In February 2005, Mr. Reed was appointed to the newly created position of President of North American Operations, with responsibility for all the company’s business units located in North America. Mr. Reed’s focus has been and will continue to be on lightweight ceramic armor systems. Prior to joining us, Mr. Reed served as Manager, Process Engineering for the Industrial Ceramic Division of Norton Co. from 1980 to 1983. Mr. Reed obtained a B.S. in Ceramic Engineering from Alfred University in 1976 and an M.S. in Ceramic Engineering from the University of Illinois in 1977.
 
Jerrold J. Pellizzon joined us in September 2002 and serves as our Chief Financial Officer and Corporate Secretary. Prior to joining us, Mr. Pellizzon was Chief Executive Officer of DrSoy Nutrition, Inc., a developer of soy protein based food products, from 2000 until 2002. From 1994 through 2000, Mr. Pellizzon served as Chief Operating Officer and Chief Financial Officer of Met-Rx Substrate Technologies. From 1984 to 1993, Mr. Pellizzon was Chief Financial Officer for Breton Construction, Inc., and served on their executive committee and board of directors. Prior to 1984, Mr. Pellizzon held executive and management positions at Duke Timber Construction/Tobin Steel Company and was employed as a C.P.A. in public accounting. Mr. Pellizzon obtained his B.S. in Economics from UCLA in 1975.
 
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Thomas Jüngling joined us in July 2005 as Director of Business Development and Technology Integration and has served as Chief Technology Officer since January 2006. In September 2007, Mr. Jüngling was promoted to President of our ESK Ceramics subsidiary, and he was appointed a Vice President of Ceradyne in December 2007. Prior to joining us, Mr. Juengling was Business Unit Manager at Inovan GmbH & Co. KG, Germany. From 1996 to 2004, Mr. Jüngling held various positions at Elektroschmelzwerk, Kempten GmbH (ESK Ceramics) and Wacker-Chemie GmbH, Germany. Mr. Jüngling obtained his Diploma in Mechanical Engineering in 1988 and his PhD in Engineering (Material Science) in 1992, both from the University of Karlsruhe, Germany. 
 
Bruce R. Lockhart joined our Thermo Materials division as its President in September of 2001, and was appointed a Vice President of Ceradyne in February 2003. Prior to joining us, Mr. Lockhart had 16 years of varied experience in the ceramic industry, the majority of which was with Thermal Ceramics Inc., a provider of products for engineered heat management solutions. Mr. Lockhart received a B.S. in Ceramic Engineering from Clemson University in 1985 and an M.B.A. from Clemson University in 1990.
 
Jeffrey J. Waldal joined our Semicon Associates division in 1995 as a quality manager, and was promoted to manufacturing manager in 1997 and to President of Semicon in 1999. Mr. Waldal was elected as a Vice President in February 2003. He is currently responsible for the operations, finances and marketing at Semicon Associates. Mr. Waldal began his career as senior materials technician at United Technologies—Pratt & Whitney Aircraft. He was employed for eight years at Ladish Company, Inc. as quality supervisor and quality manager. Mr. Waldal currently serves on the board of directors as Chairman for Kentucky Manufacturing Assistance Center and is a member of the University of Kentucky College of Engineering Dean’s Advisory Council. Mr. Waldal obtained a degree in Non-Destructive Testing from Hutchinson Technology Institute in 1984, a B.A. in Business Management from the University of Kentucky in 1995, and an M.B.A. from Eastern Kentucky University in 1998.
 
Thomas A. Cole joined Ceradyne when we acquired Minco, Inc. in July 2007. He had been serving as Minco's President and Chief Executive Officer since 2000. He was appointed Ceradyne's Vice President of Business Development in March 2008. Mr. Cole's early career was with Corning Inc. for 17 years in various manufacturing and operating roles mostly in technical ceramics and advanced refractories. He left Corning in 1987 when he participated in a buyout of Corning’s Corhart Refractories Division and since then was engaged in fixing troubled businesses and selling them. He successfully completed the cycle with seven companies over the last twenty years before joining Ceradyne. Mr. Cole received a B.S. from the College of Ceramics at Alfred University in 1969 and an M.B.A. from the University of Buffalo in 1971.
 
Terry M. Hart joined Ceradyne in 1998 as manager, Human Resources and was promoted to Director of Human Resources in 2007 and subsequently to Corporate Vice President in 2010. She is currently responsible for all Human Resource functions. Ms. Hart began her career as a workers compensation/payroll administrator at Sears for eight years. She continued as a payroll/personnel administrator at C.A.R.E. Systems, Inc. and was employed there for three years. She was employed for six years at Lockheed-Martin as manager, Human Resources/Payroll and Administrative Services. She was employed for three years at PCI as manager, Human Resources.  Ms. Hart obtained a certificate of Human Resources Management from the University of California, Irvine in 1992, and attended the California State University, Fullerton in 1998 with an emphasis in Business Administration.
 
Our officers are appointed by and serve at the discretion of our Board of Directors.

 
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ITEM 1A. RISK FACTORS
 
This Annual Report on Form 10-K contains forward-looking statements, as described at page 3 of this report under the caption “Note Regarding Forward-Looking Statements.” We believe that the risks described below are the most important factors which may cause our actual future results of operations to differ materially from the results projected in the forward-looking statements.
 
Risks Related to Our Business
 
A substantial portion of our revenues is derived from the sale of defense related products, primarily ceramic body armor. If demand for ceramic body armor declines, if federal budget appropriations involving our products are reduced, if we fail to obtain new government contracts or delivery orders under existing contracts, or if existing government contracts or orders are cancelled, our revenues, profit and cash flow will be materially and adversely affected.
 
In recent years, a substantial portion of our revenues has been derived from the sale of defense related products, particularly ceramic body armor, either directly or indirectly to the U.S. government. The sale of defense related products represented 39.4% of our revenues in 2011, 29.1% in 2010 and 49.6% in 2009. We anticipate that a substantial portion of our revenues for the foreseeable future will continue to come from sales of defense related products. Our dependence on defense related business, and on sales of ceramic armor in particular, entails several risks, including those described below.
 
 Our defense business is highly sensitive to changes in national and international defense and budget priorities. For example, in the years 2003 through 2007, our revenues from the sale of ceramic body armor increased significantly due to the U.S. military’s acceleration of its program to equip its soldiers with ceramic body armor systems, in part, because of the war in Iraq. In 2008, however, demand for ceramic body armor began to decline due in part to the reduction in hostilities in Iraq and because most combat troops were already equipped with the current generation of ceramic body armor, known as ESAPI. The outlook for ceramic body armor in 2012 is favorable because in September 2011, we were awarded a three-year ID/IQ contract for ESAPI ceramic armor plates from Defense Logistics Agency Troop Support group with a first year order for 300,000 ESAPI. The outlook beyond 2012 is uncertain for several reasons, including uncertainty regarding the rate at which U.S. troops will be withdrawn from Afghanistan, and the rate at which the U.S. military will proceed with implementing the next ballistic threat generation of ceramic body armor plates, known as XSAPI (discussed further below) or a generation that will be lighter than the current version. Demand for ceramic body armor could decline further from 2012 levels for a variety of reasons, including a lessening of conflicts in the Middle East and other high risk areas, or a reduction in U.S. defense budget appropriations. If that were to occur, our revenues from the sale of defense related products would be reduced and our profit and cash flow could be materially and adversely affected.
 
Many defense contracts are awarded in an open competitive bidding process, and our past success in winning government contracts does not guarantee that we will win any new contracts in the future. Our success depends upon our ability to successfully compete for and retain such government contracts. If we, or if prime contractors for which we are a subcontractor, fail to win any future bids, or if we are unable to replace business lost upon cancellation, expiration or completion of a contract, our revenues, profit and cash flow from the sale of defense related products would be reduced.
 
Moreover, government contracts typically may be cancelled by the government at any time without penalty, other than our right to be reimbursed for certain expenses and inventory. If the U.S. government were to cancel any of our government contracts, our revenues, profit and cash flow would be reduced.
 
In October 2008, we were awarded an Indefinite Delivery/Indefinite Quantity (ID/IQ) contract by the U.S. Army for the next ballistic threat generation of ceramic body armor plates, known as XSAPI, as well as for the current generation of ESAPI plates. This five-year contract has a maximum value of $2.3 billion. However, we anticipate that the government will order either XSAPI or ESAPI, but not both. Therefore, the total amount of this ID/IQ award likely will not exceed $1.1 billion over the life of the contract. One of our competitors was awarded a similar ID/IQ contract. We expect that government orders under these contracts will be split among ourselves and our competitor, so our sales under our contract will likely be less than the $1.1 billion possible total amount.
 
Moreover, we believe we will not receive significant additional delivery orders for XSAPI as the U.S. has shown more interest in procuring body armor that weighs less than the current ESAPI and XSAPI body armor inserts while being able to defeat similar ballistic threats. We are currently developing ESAPI and XSAPI designs that weigh 10% to 15% less than the current designs and will offer these to the U.S. Army and other Department of Defense users once these designs meet the current requirements. There is no assurance that we will be successful with these lighter weight designs.
 
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For the next several quarters, demand for ceramic body armor is likely to be the most significant factor affecting our sales.
 
Although we believe that demand for ceramic body armor will continue for many years, the quantity and timing of government orders depends on a number of factors outside of our control, such as the amount of U.S. defense budget appropriations, positions and strategies of the current U.S. government, the level of international conflicts and the deployment of armed forces. Our future level of sales of ceramic body armor will depend on our ability to successfully compete for and retain this business.
 
If we are not successful in obtaining and retaining sufficient new body armor business to keep our manufacturing capacity utilized, we may be required to record impairment charges for the reduction in value of our fixed assets devoted to manufacturing body armor. If this were to occur, our earnings would be reduced in the period we incur the impairment charge.
 
If the performance requirements for ceramic body armor are modified by the U.S. military, we may incur delays or additional costs to change the design of our product, or we may not be able to satisfy the new requirements with our existing ceramic materials and processes. If this were to occur, our costs could increase and our revenues, profit and cash flow would decline.
 
The ceramic body armor we manufacture must comply with stringent performance specifications established by the U.S. military, such as weight and the level of ballistic protection it must provide, and these specifications may be modified by the military in new procurements, as well as under existing contracts. For example, 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. The change to this new design resulted in production delays and increased costs to us during the first quarter of 2005 as we developed new designs to meet the revised requirement and experienced manufacturing inefficiencies. In the future, the U.S. military may make additional changes to the performance requirements for body armor, and we may experience delays or additional costs to satisfy the new requirements, or we may be unable to meet the new requirements at all with our existing ceramic materials and processes. If this were to occur, our revenues from ceramic body armor would decline and our profitability would suffer.
 
If demand for our products declines, we may have inefficient or under-utilized capacity, and our gross margins, profit and cash flow may suffer.
 
In response to the increased demand for ceramic body armor for military personnel and cam rollers for diesel engines, as well as our other products, we added significant manufacturing capacity since early 2002.
 
Demand for our products, particularly ceramic armor and cam rollers, may not remain at levels sufficient to utilize all of our manufacturing capacity. Much of our manufacturing facilities and production equipment, such as our furnaces and hot presses, are special purpose in nature and cannot be adapted easily to make other products. Also, a substantial amount of the boron carbide powder produced by ESK Ceramics is currently used by us and our competitors to make ceramic body armor. If the demand for ceramic body armor declines substantially from current levels, ESK Ceramics may have significant under-utilized capacity for boron carbide powder. Therefore, a substantial decline in demand for our ceramic body armor or cam rollers could result in significant excess manufacturing capacity, which would result in under absorption of overhead expense and reduced profit, and we may be required to record impairment charges for the reduction in value of our fixed assets devoted to manufacturing these products. If this were to occur, our earnings would be reduced in the period we incur the impairment charge.
 
We have been manufacturing ceramic cam rollers for heavy-duty diesel engines since 1999, and now have production contracts to supply cam rollers to several major engine companies. We expect that sales of these cam rollers will begin to decline in 2013 when new U.S. environmental regulations take effect for off-highway applications. Additionally the costs to produce cam rollers has increased over the years, one reason being the decline in sales. However in 2010 several efforts were successfully made to increase pricing of these components.
 
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If we fail to increase our non-defense revenue, and if the demand for ceramic body armor decreases, our revenues, profit and cash flow will be materially and adversely affected.
 
In 2011, 39.4% of our revenues were from sales of defense-related products. Because our dependence on defense-related products exposes us to significant risks, part of our business strategy is to continue to increase our non-defense revenue base by identifying new products and markets for our advanced technical ceramics, and by increasing sales to our existing non-defense customers. Our ability to execute this strategy successfully depends, in part, on our ability to increase market acceptance of our advanced technical ceramics as a replacement for materials such as metals, plastics and traditional ceramics. While advanced technical ceramics have certain advantages over other materials, such as the ability to withstand extremely high temperatures and combining hardness with light weight, they are more expensive to produce. As a result, the market for advanced technical ceramic products may be limited to high-end applications where price is not a critical competitive factor, where the characteristics of advanced technical ceramics may justify the higher costs compared to other materials or where other materials are not suitable. Due to these limitations on the market for advanced technical ceramics, the market for our products may not grow as we anticipate and we may not be able to increase our non-defense revenue base. If we are unable to execute this strategy, and if the demand for ceramic body armor decreases, our revenues, profit and cash flow will be materially and adversely affected.
 
A significant reduction or elimination of government subsidies and economic incentives or change in government policies may have a material adverse effect on our ceramic crucible business and prospects.
 
Our ceramic crucibles are used by several photovoltaic cell manufacturers for melting silicon in order to produce polycrystalline silicon wafers used in photovoltaic solar cells. Demand for our ceramic crucibles depends substantially on government incentives aimed to promote greater use of solar power. In many countries in which we currently sell our ceramic crucibles, the solar power markets, particularly the market of on-grid photovoltaic solar systems, would not be commercially viable without government incentives. This is because the cost of generating electricity from solar power currently exceeds, and we believe will continue to exceed for the foreseeable future, the costs of generating electricity from conventional or non-solar renewable energy sources. The scope of the government incentives for solar power depends, to a large extent, on political and policy developments relating to environmental concerns in a given country, which could lead to a significant reduction in or a discontinuation of the support for renewable energies in those countries. Federal, state and local governmental bodies in many of our customers’ key markets, most notably Germany, Italy, Spain, the United States, France, South Korea, Taiwan, India, Japan and China have provided subsidies and economic incentives in the form of rebates, tax credits and other incentives to end users, distributors, system integrators and manufacturers of solar power products to promote the use of solar energy in on-grid applications and to reduce dependency on other forms of energy. Policy shifts could reduce or eliminate these government economic incentives altogether. If that were to occur, sales of our ceramic crucibles could decline substantially.
 
Growth in our operations may strain our resources, and if we fail to successfully manage potential future growth, we could incur higher operating costs and delays in the production of our products, which could result in reduced revenues, profit and cash flow.
 
The introduction of new products and recent acquisitions of other businesses, are placing, and will continue to place, a significant strain on our operational, financial and managerial resources and personnel. To effectively manage potential future growth, we must continue to:
 
 
add manufacturing capacity and personnel;
 
 
implement and improve our operational, financial and management information systems;
 
 
develop the management skills of our managers and supervisors;
 
 
add new management personnel; and
 
 
train, motivate and manage our employees.
 
Any failure to effectively manage growth could result in increased operating costs and delays in the development and production of our products. If this occurs, our revenues, profit and cash flow could decline.
 
We may generate less profit than expected or even lose money on our fixed price government contracts.
 
Most of our government contracts provide for a predetermined, fixed price for the products we sell regardless of the costs we incur. When making proposals for fixed-price contracts, we must rely on our ability to accurately estimate our costs and ability to manufacture and deliver the products on time and at a reasonable profit. Our actual production costs may, however, exceed forecasts due to unanticipated delays or increased cost of materials, components, labor, capital equipment or other factors. As a result, we may incur losses on fixed price contracts that we had expected to be profitable, or such contracts may be less profitable than we expected, which could have a material adverse effect on our business, financial condition and results of operations.
 
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Our business is subject to various laws and regulations favoring the U.S. government’s contractual position, and our failure to comply with such laws and regulations could harm our operating results and prospects.
 
As a contractor to the U.S. government, we must comply with laws and regulations relating to the formation, administration and performance of federal government contracts that affect how we do business with our customers and may impose added costs on our business. These rules generally favor the U.S. government’s contractual position. For example, these regulations and laws include provisions that allow unsuccessful bidders to protest or challenge contracts we have been awarded, and allow the government to unilaterally terminate, reduce or modify our government contracts.
 
The accuracy and appropriateness of certain costs and expenses used to substantiate our direct and indirect costs for the U.S. government under fixed-price contracts are subject to extensive regulation and audit by the Defense Contract Audit Agency, an agency of the U.S. Department of Defense. Responding to governmental audits, inquiries or investigations may involve significant expense and divert management’s attention. Our failure to comply with these or other laws and regulations could result in contract termination, suspension or debarment from contracting with the federal government, civil fines and damages and criminal prosecution and penalties. Any of these consequences could have a material adverse effect on our business, financial condition, results of operations and liquidity.
 
We currently depend entirely on 3M Unitek for sales of our ceramic orthodontic brackets. If we are unable to maintain our existing level of business with 3M Unitek our revenues, profit and cash flow from this product line will decline.
 
We sell our ceramic orthodontic brackets exclusively to 3M Unitek under a supply agreement with 3M Unitek that expires in December 2013. Under the terms of this agreement, 3M Unitek is required to purchase their Clarity and Transcend brand ceramic orthodontic product lines exclusively from us for as long as 3M Unitek continues to sell those products. This agreement further stipulates that 3M Unitek must purchase from Ceradyne at least 50% of the ceramic orthodontic brackets 3M Unitek requires for next generation designs, which it introduced in 2007. Except under limited circumstances, Ceradyne is not permitted to sell ceramic orthodontic brackets to any other customers under this agreement. As a result of our agreement with 3M Unitek, our revenue from ceramic orthodontic brackets is dependent entirely upon 3M Unitek. 3M Unitek also offers traditional stainless steel orthodontic brackets. We cannot guarantee that 3M Unitek will devote substantial marketing efforts to the sale of our ceramic orthodontic brackets, or that 3M Unitek will not reassess its commitment to our product. If 3M Unitek fails to actively market our ceramic orthodontic brackets or decides to promote a competing product over ours, this could cause the sales of our ceramic orthodontic brackets to decline.
 
Moreover, the first of our two patents for our ceramic orthodontic brackets, which we jointly own with 3M Unitek, expired in September 2007; the second one expires in October 2013. Consequently, we may not be able to prevent third parties from manufacturing and selling competitive ceramic orthodontic brackets. Ceramic orthodontic brackets manufactured and sold by third parties may be less expensive than ours and may cause sales of our ceramic orthodontic brackets to decline either as a result of pricing pressure or loss of market share.
 
In addition, the future success of our ceramic orthodontic brackets depends on our ability to maintain and increase market acceptance for our product compared to other competitive solutions, including traditional stainless steel brackets and newer products such as transparent plastic orthodontic aligners, synthetic sapphire brackets and other ceramic brackets. If 3M Unitek reduces its purchases of ceramic orthodontic brackets from us or if competitive products gain market share, the sales of our ceramic orthodontic brackets may decline, resulting in a decrease in our revenues, profit and cash flow.
 
Our business is subject to risks associated with doing business outside the United States.
 
Shipments to customers outside of the United States accounted for approximately 45.4% of our sales in 2011, 51.7% of our sales in 2010 and 33.9% of our sales in 2009. Our ESK Ceramics subsidiary is located in Germany. Its sales to customers located outside of the United States represented approximately 77.4% of its total sales during 2011, approximately 95.6% of its total sales during 2010, and approximately 74.7% of its total sales during 2009.
 
We anticipate that international shipments will account for a significant portion of our sales for the foreseeable future. Therefore, the following risks associated with international business activities could have material adverse effects on our performance:
 
 
burdens to comply with multiple and potentially conflicting foreign laws and regulations, including export requirements, tariffs and other barriers, health and safety requirements, and unexpected changes in any of these factors;
 
 
difficulty in staffing and managing international operations;
 
 
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differences in intellectual property protections;
 
 
difficulty in obtaining export licenses from the U.S. government for sales of our defense-related products;
 
 
potentially adverse tax consequences due to overlapping or differing tax structures;
 
 
fluctuations in currency exchange rates especially the Euro; and
 
 
risks associated with operating a business in a potentially unstable political climate.
 
We have traditionally invoiced our sales from the United States to customers in foreign countries in U.S. dollars. Consequently, if the U.S. dollar becomes more expensive relative to the currencies of our foreign customers, the price of our products that we export from the United States to those countries will rise and our sales into those countries may fall. In addition, in the future, we may be required to denominate foreign sales in the local currencies of our customers. In that case, if the U.S. dollar were to become more expensive relative to the currencies of our foreign customers, we would receive fewer U.S. dollars for each unit of foreign currency that we receive when our customers pay us. Therefore, a more expensive U.S. dollar would cause us to incur losses upon the conversion of accounts receivable denominated in foreign currencies. Such losses could harm our results of operations.
 
Our ESK Ceramics subsidiary, located in Kempten, Germany invoices approximately 76.3% of its sales in Euros. ESK Ceramics’ sales to customers located in the United States are invoiced in U.S. dollars. If the Euro becomes more expensive relative to the currencies of ESK Ceramics’ customers located outside the European Union, the price of its products sold to customers in those countries will rise and its sales into those countries may fall.
 
We may make future acquisitions which may be difficult to integrate, divert management resources, result in unanticipated costs, or dilute our stockholders.
 
Part of our continuing business strategy is to make acquisitions of, or investments in, companies, products or technologies that complement our current products, enhance our market coverage, technical capabilities or production capacity, or offer growth opportunities. Future acquisitions could pose numerous risks to our operations, including:
 
 
we may have difficulty integrating the purchased operations, technologies or products;
 
 
we may incur substantial unanticipated integration costs;
 
 
assimilating the acquired businesses may divert significant management attention and financial resources from our other operations and could disrupt our ongoing business;
 
 
acquisitions could result in the loss of key employees, particularly those of the acquired operations;
 
 
we may have difficulty retaining or developing the acquired businesses’ customers;
 
 
acquisitions could adversely affect our existing business relationships with suppliers and customers;
 
 
we may fail to realize the potential cost savings or other financial benefits and/or the strategic benefits of the acquisitions; and
 
 
we may incur liabilities from the acquired businesses for infringement of intellectual property rights or other claims, and we may not be successful in seeking indemnification for such liabilities or claims.
 
In connection with these acquisitions or investments, we could incur debt, amortization expenses related to intangible assets, large and immediate write-offs, assume liabilities, or issue stock that would dilute our current stockholders’ percentage of ownership. We may not be able to complete acquisitions or integrate the operations, products or personnel gained through any such acquisition without a material adverse effect on our business, financial condition and results of operations.
 
The cost of electricity is a significant portion of our cost of product sales. An increase in the cost of electricity may cause our profit margins to decline.
 
Electricity is essential for the production of our products and comprises a significant portion of our cost of product sales. The cost of electricity for our manufacturing operations in the United States, Europe and China was approximately $19.2 million during 2011, approximately $14.7 million during 2010, and approximately $12.7 million during 2009. Over the last several years, the cost of electricity from utility companies has increased, particularly in California. During the fourth quarter of 2010, we closed our hot press manufacturing operation in Costa Mesa, California as a result of reduced demand for ceramic body armor solutions and the high cost of doing business in the State, especially the high cost of electricity, which is integral to our manufacturing operations. We consolidated all hot press operations into our existing manufacturing plant in Lexington, Kentucky. We recognized a restructuring charge of $3.5 million during the year ended December 31, 2010 to write down the value of long-lived assets associated with the closure of the hot press manufacturing operation in Costa Mesa, California.
 
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Management utilizes utility industry specialists and consultants to help manage and implement strategies to minimize annual price increases at its Advanced Ceramic Operations’ facilities located in California. For other locations in the United States and Germany, management’s strategy is to enter into long term contracts to obtain fixed price increases in order to increase its ability to accurately forecast future energy costs and ensure a stable cost structure. Fluctuations in the cost of electricity affect our ability to accurately forecast future energy costs and consequently our profitability. If the cost of electricity were to increase substantially, our gross profit margins may decline.
 
We may not be able to adequately safeguard our intellectual property rights and trade secrets from unauthorized use, and we may become subject to claims that we infringe on others’ intellectual property rights.
 
We rely on a combination of patents, trade secrets, trademarks, and other intellectual property laws, nondisclosure agreements with employees and customers and other protective measures to preserve our proprietary rights to our products and production processes. These measures afford only limited protection and may not preclude competitors from developing products or processes similar or superior to ours. Moreover, the laws of certain foreign countries do not protect intellectual property rights to the same extent as the laws of the United States.
 
Although we implement protective measures and intend to defend our proprietary rights, these efforts may not be successful. From time to time, we may litigate within the United States or abroad to enforce our issued or licensed patents, to protect our trade secrets and know-how or to determine the enforceability, scope and validity of our proprietary rights and the proprietary rights of others. Enforcing or defending our proprietary rights could be expensive, requires management’s attention and might not bring us timely or effective relief.
 
Furthermore, third parties may assert that our products or processes infringe their patent rights. Our patents may be challenged, invalidated or circumvented. Although there are no pending or threatened intellectual property lawsuits against us, we may face litigation or infringement claims in the future. Infringement claims could result in substantial costs and diversion of our resources even if we ultimately prevail. A third party claiming infringement may also obtain an injunction or other equitable relief, which could effectively block the distribution or sale of allegedly infringing products. Although we may seek licenses from third parties covering intellectual property that we are allegedly infringing, we may not be able to obtain any such licenses on acceptable terms, if at all.
 
Our ability to operate effectively could be impaired if we were to lose the services of our key personnel, or if we are unable to recruit qualified managers and key personnel in the future.
 
Our success depends on the continued service of our management team and key personnel, including Joel P. Moskowitz, our Chairman and Chief Executive Officer and President; David P. Reed, our Vice President, and President of North American Operations; Jerrold J. Pellizzon, our Chief Financial Officer and Corporate Secretary; and Thomas Jüngling, the President of our ESK Ceramics subsidiary. Mr. Moskowitz was diagnosed with non-Hodgkin’s lymphoma in October 2004. He completed chemotherapy treatments in January 2005, and his current diagnosis indicates that the non-Hodgkin’s lymphoma is in remission.
 
If Mr. Moskowitz becomes unable to continue working due to health reasons, or if one or more of these individuals were to resign or otherwise terminate their employment with us, we could experience a loss of sales, delays in new product development and diversion of management resources, and we may have difficulty replacing any of these individuals. We do not have employment agreements or key person insurance on any of our executive employees.
 
Competition for qualified managers and key personnel is intense and we may not be able to recruit and retain such personnel. If we are unable to retain our existing managers and employees or hire and integrate new personnel, we may experience operating inefficiencies, production delays and reduced profitability.
 
Our manufacturing facilities are subject to a number of operational risks, including hazards associated with ceramic manufacturing and natural disasters, any of which could have a material adverse impact on our productivity and results of operations.
 
Due to the nature of our business, we are exposed to hazards associated with ceramic manufacturing, such as:
 
 
accidents or mechanical failure;
 
 
fires or explosions of furnaces; and
 
 
employee exposure to extreme temperatures or hazardous substances.
 
 
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In addition, the location of our facilities exposes us to potential earthquakes and other natural disasters. These hazards may cause personal injury, loss of life and damage to property, which could lead to a substantial interruption or suspension of operations, potential loss of customers and sales, government fines and lawsuits by injured persons. Any such consequences could have an adverse effect on the productivity and profitability of a particular manufacturing facility or on us as a whole.
 
Defects in our products could harm our reputation for quality products, increase our operating expenses, reduce sales of our products and impact cash flow.
 
Our products have in the past contained, and may in the future contain, errors or defects that may be detected at any point in the life of the products. Such errors could result in delays in shipping and sales during the period required for their correction and additional expense associated with their reworking or replacement. Our ability to receive additional shipment orders from the U.S. government is reliant on our ability to pass first article testing of new designs. Real or perceived defects in our products may result in product returns, loss of sales, delays in market acceptance, injury to our reputation and increased warranty costs, which could reduce our sales and profit. For example, in March 2002, the U.S. government notified us that several lots of our SAPI lightweight ceramic body armor failed to pass ballistics re-verification tests. As a result, we stopped production of our SAPI product, modified the design of our product and resumed shipping approximately four months later. In addition, we agreed to correct or replace at our expense all supplies of our SAPI product sales that did not meet the original contractual requirements.
 
If we are unable to compete successfully against current and future competitors, our revenues could decline.
 
Our products compete with advanced technical ceramic products from other companies, as well as with high strength steel alloys and plastic products.
 
When competing with other advanced technical ceramic products, we believe the principal competitive factors are:
 
 
manufacturing capacity and the ability to deliver products;
 
 
price;
 
 
product performance;
 
 
material specifications;
 
 
application engineering capabilities;
 
 
customer support; and
 
 
reputation.

When competing with high strength steel alloys and plastic products, we may not be able to compete effectively when price is a primary consideration, because our products are typically more expensive as a result of higher manufacturing costs associated with the production of advanced technical ceramics.
 
Some of our competitors include Armor Works, The Protective Group, Ceramtec, the Armor Holdings and Cercom subsidiaries of BAE Systems, CoorsTek, Denka, Momentive Performance Materials, Hitachi, HC Starck, Kyocera’s Industrial Ceramics Group, Morgan, Saint Gobain, Kennametal, Spectra-Mat, UK Abrasives, Vesuvius, C-E Minerals, NHTC, Holtec, Nukem and General Electric. Many of our current or potential competitors have greater financial, marketing and technical resources than we do. If we fail to compete successfully against our current or future competitors, our revenues, profit and cash flow could decline.
 
Uninsured losses arising from third party claims brought against us could result in payment of substantial damages, which would decrease our cash reserves and could harm our profit and cash flow.
 
Our products are used in applications where the failure to use our products properly or their malfunction could result in serious bodily injury or death. We may not have adequate insurance to cover the payment of any potential claim related to such injuries or deaths. Insurance coverage may not continue to be available to us or, if available, may be at a significantly higher cost.
 
We are subject to extensive government regulation, and our failure or inability to comply with these regulations could subject us to penalties and result in a loss of our government contracts, which could reduce our revenues, profit and cash flow.
 
 
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We must comply with and are affected by various government regulations that impact our operating costs, profit margins and our internal organization and operation of our business. Furthermore, we have production contracts with governmental entities and are subject to additional rules, regulations and approvals applicable to government contractors. We are also subject to routine audits to assure our compliance with these requirements. Our failure to comply with these regulations, rules and approvals could result in the imposition of penalties and the loss of our government contracts and disqualification as a U.S. government contractor. As a result, our revenues, profit and cash flow could be reduced.
 
In addition, a number of our employees involved with defense related business are required to obtain security clearances from the U.S. government. Our business may suffer if we or our employees are unable to obtain the security clearances that are required.
 
Like other companies operating internationally, we are subject to the Foreign Corrupt Practices Act and other laws which prohibit improper payments to foreign governments and their officials by U.S. and other business entities. Violations of the Foreign Corrupt Practices Act may result in severe criminal penalties, which could have a material adverse effect on our business, financial condition, results of operations and liquidity.
 
If we fail to comply with environmental laws and regulations, we could incur an increase in our operating costs and a decrease in our profit and cash flow.
 
We are subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous materials used to manufacture our products. Authorities could impose fines, suspend production, alter our manufacturing processes, or stop our operations if we do not comply with these regulations.
 
Until 1997, we produced certain products using beryllium oxide, which is highly toxic in powder form. This powder, if inhaled, can cause chronic beryllium disease in a small percentage of the population. We have been sued in the past by former employees and by employees of one of our customers and by their family members alleging that they had contracted chronic beryllium disease as a result of exposure to beryllium oxide powders used in our products. The last of these claims was settled in 2002, and all of these claims have been dismissed without our incurring material liability. We may not, however, be able to avoid future liability to persons who may allege that they contracted chronic beryllium disease as a result of exposure to the beryllium oxide we used in prior years.
 
Any failure to comply with current or subsequently enacted environmental statutes and regulations could subject us to liabilities, fines or the suspension of production. Furthermore, any claims asserted against us in the future related to exposure to beryllium oxide powder may not be covered by insurance. Even if covered, the amount of insurance may be inadequate to cover any adverse judgment.
 
Fines and other punishments imposed on us for environmental violations and expenses we incur to remedy or comply with environmental regulations and future liability for incidences of chronic beryllium disease contracted by employees or employees of customers would decrease our cash reserves and could harm our profitability.
 
Our long term investments are subject to risks which may cause losses and affect the liquidity of these investments.
 
Our long term investments at December 31, 2011 included $15.0  million of auction rate securities which is net of the cumulative to date pre-tax impairment and pre-tax other than temporary impairment charges. Cumulatively to date, we have incurred $4.7 million in pre-tax charges due to other-than-temporary reductions in the value of our investments in auction rate securities, realized losses of $8.8 million from sales of auction rate securities and pre-tax temporary impairment charges of $3.0 million reflected in other comprehensive income. Our investments in auction rate securities represent interests in insurance securitizations collateralized by pools of residential and commercial mortgages, asset backed securities and other structured credits relating to the credit risk of various bond guarantors that mature at various dates from June 2021 through July 2052. These auction rate securities were intended to provide liquidity via an auction process which is scheduled every 28 days, that resets the applicable interest rate, allowing investors to either roll over their holdings or gain immediate liquidity by selling such interests at par. Interest rates are capped at a floating rate of one month LIBOR plus additional spread ranging from 1.25% to 4.00% depending on prevailing rating. During the second half of the year 2007, through 2011, the auctions for these securities failed. As a result of current negative conditions in the global credit markets, auctions for our investment in these securities have recently failed to settle on their respective settlement dates. Consequently, investments are not currently liquid through the normal auction process and may be liquidated if a buyer is found outside the auction process. Although the auctions have failed, we continue to receive underlying cash flows in the form of interest income from the investments in auction rate securities. As of December 31, 2011, the fair value of our investments in auction rate securities was below cost by approximately $7.8 million. The fair value of the auction rate securities has been below cost for more than one year. If they remain illiquid and a buyer is not found outside the auction process, the value of these securities may decline further.
 
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We review impairments associated with our auction rate securities each reporting period to determine the classification of the impairment as “temporary” or “other-than-temporary.” A temporary impairment charge results in an unrealized loss being recorded in the other comprehensive income component of stockholders’ equity. Such an unrealized loss does not reduce net income for the applicable accounting period because the loss is not viewed as other-than-temporary. We believe that a portion of the impairment of our auction rate securities investments is temporary and a portion is other-than-temporary.
 
Risks Related to our Common Stock
 
Our stock price has been volatile, and the value of an investment in our common stock may decline.
 
The market price and trading volume of our common stock has been subject to significant volatility, and this trend may continue. The value of our common stock may decline regardless of our operating performance or prospects. Factors affecting our market price include:
 
 
 •
initiation of coverage by securities analysts, securities analysts’ buy/sell recommendations and any expressed beliefs of securities analysts regarding our business prospects or estimated trading multiples;
 
 
 •
our perceived prospects;
 
 
 •
variations in our operating results and whether we have achieved our key business targets;
 
 
 •
the limited number of shares of our common stock available for purchase or sale in the public markets;
 
 
 •
sales or purchases of large blocks of our stock;
 
 
 •
changes in, or our failure to meet, our earnings estimates;
 
 
 •
differences between our reported results and those expected by investors and securities analysts;
 
 
 •
decreases in our trading multiples on an absolute basis or relative to comparable companies;
 
 
 •
announcements of new contracts by us or our competitors;
 
 
 •
market reaction to any future acquisitions, joint ventures or strategic investments announced by us or our competitors;
 
 
 •
developments in the financial markets;
 
 
 •
market reaction to any adverse publicity or news stories; and
 
 
 •
general economic, political or stock market conditions.
 
Recent events have caused stock prices for many companies, including ours, to fluctuate in ways unrelated or disproportionate to their operating performance. The general economic, political and stock market conditions that may affect the market price of our common stock are beyond our control. The market price of our common stock at any particular time may not remain the market price in the future. In the past, securities class action litigation has been instituted against companies following periods of volatility in the market price of their securities. Any such litigation, if instituted against us, could result in substantial costs and a diversion of management’s attention and resources.
 
Delaware law may delay or prevent a change in control, and may discourage bids for our common stock at a premium over its market price.
 
We are subject to the provisions of section 203 of the Delaware General Corporation Law. These provisions prohibit large stockholders, in particular a stockholder owning 15% or more of the outstanding voting stock, from consummating a merger or combination with a corporation unless this stockholder receives board approval for the transaction or 66 2/3% of the shares of voting stock not owned by the stockholder approve the merger or transaction. These provisions of Delaware law may have the effect of delaying, deferring or preventing a change in control, and may discourage bids for our common stock at a premium over its market price.
 
ITEM 1B. UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
 
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ITEM 2. PROPERTIES
 
We serve our markets through four operating segments with manufacturing facilities in several locations across the United States, one in Canada, two in China, one in Europe and one in India. Please see the table under the caption “Operating Segments and Facilities” in Item 1 of this report for a summary of our facilities and products comprising our four operating segments.
 
ITEM 3. LEGAL PROCEEDINGS

Ceradyne is from time to time involved in various legal proceedings that are incidental to its business. However, to management’s knowledge, there currently are no material pending legal proceedings involving Ceradyne of any of its subsidiaries. 
 
ITEM 4. MINE SAFETY DISCLOSURES
 
Not applicable.
 


 
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PART II
 
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock is traded on the NASDAQ Stock Market under the symbol “CRDN.” The following table shows the high and low closing sale prices for our common stock as reported by the NASDAQ Stock Market during the calendar quarters indicated:
 
   
High
   
Low
 
Year Ended December 31, 2010
           
First Quarter
  $ 24.21     $ 19.25  
Second Quarter
  $ 23.58     $ 19.97  
Third Quarter
  $ 25.71     $ 19.85  
Fourth Quarter
  $ 31.79     $ 22.63  
                 
Year Ended December 31, 2011
               
First Quarter
  $ 46.04     $ 31.61  
Second Quarter
  $ 49.40     $ 36.22  
Third Quarter
  $ 38.44     $ 24.91  
Fourth Quarter
  $ 35.48     $ 26.32  
 
As of February 9, 2012, there were 333 holders of record of our common stock.
 
Prior to 2012, we had not declared or paid any cash dividends on our common stock. On February 16, 2012, we announced that our Board of Directors had declared our initial cash dividend in the amount of $0.15 per share of common stock, payable on March 20, 2012 to shareholders of record as of the close of business on March 6, 2012. It is our current intention that we will declare and pay a similar cash dividend on a quarterly basis, although our Board reserves discretion to suspend or discontinue cash dividends at any time.

    We did not sell any equity securities during the year ended December 31, 2011 that were not registered under the Securities Act of 1933.
 
On March 4, 2008, we announced that our board of directors had authorized the repurchase and retirement of up to $100 million of our common stock in open market transactions, including block purchases, or in privately negotiated transactions. We completed the $100 million of purchases under this authorization in September 2011. On August 31, 2011, we announced that our board of directors had authorized the repurchase and retirement of up to an additional $100 million of our common stock in open market transactions, including block purchases, or in privately negotiated transactions. We did not set a time limit for completion of this repurchase program, and we may suspend or terminate it at any time. We did not repurchase any shares of our common stock during the quarter ended December 31, 2011. Consequently we have $100.0 million remaining under this authorization.

 
35

 

 
ITEM 6. SELECTED FINANCIAL DATA
 
The following selected consolidated financial data as of December 31, 2007, 2008 and 2009 and for the years ended December 31, 2007 and 2008 are derived from our audited consolidated financial statements for those periods, which are not included in this report. The selected consolidated financial data as of December 31, 2010 and 2011 and for the years ended December 31, 2009, 2010 and 2011 are derived from our audited consolidated financial statements which are included in this report beginning on page F-1. The following data is qualified in its entirety by and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and the related notes included elsewhere in this report.
 
   
Year Ended December 31,
 
   
2011(1)
   
2010
   
2009(2)
   
2008(3)
   
2007(4)
 
   
(amounts in thousands, except per share data)
 
Statement of Income Data:
                             
Net sales
  $ 571,982     $ 402,938     $ 400,575     $ 680,197     $ 756,835  
Cost of product sales
    365,337       295,078       298,956       414,885       450,787  
Gross profit
    206,645       107,860       101,619       265,312       306,048  
Operating expenses:
                                       
Selling, general and administrative
    74,325       61,940       65,643       75,120       67,718  
Research and development
    12,446       11,692       12,258       14,782       17,552  
Restructuring - plant closure and severance
    914       3,505       12,924       -       -  
Acquisition related (credits) charges
    (17,298 )     1,567       (768 )     9,824       -  
Goodwill impairment
    7,797       -       3,832       -       -  
Total operating expenses
    78,184       78,704       93,889       99,726       85,270  
Income from operations
    128,461       29,156       7,730       165,586       220,778  
                                         
Other income (expense):
                                       
Interest income
    3,991       5,355       4,091       7,553       12,394  
Interest expense
    (6,620 )     (6,247 )     (7,119 )     (7,876 )     (7,618 )
Gain on early extinguishment of debt
    -       -       1,881       -       -  
Gain (loss) on auction rate securities
    630       (978 )     (5,187 )     (5,870 )     (2,114 )
Miscellaneous, net
    1,494       1,085       (979 )     1,511       (311 )
Total other income (expense)
    (505 )     (785 )     (7,313 )     (4,682 )     2,351  
Income before provision (benefit) for income taxes
    127,956       28,371       417       160,904       223,129  
Provision (benefit) for income taxes
    44,068       (905 )     (8,098 )     56,424       80,946  
Net income
  $ 83,888     $ 29,276     $ 8,515     $ 104,480     $ 142,183  
Net income per share:
                                       
Basic
  $ 3.41     $ 1.16     $ 0.33     $ 3.95     $ 5.22  
Diluted
  $ 3.38     $ 1.15     $ 0.33     $ 3.91     $ 5.13  
Weighted average number of common shares outstanding:
                                       
Basic
    24,614       25,191       25,684       26,446       27,252  
Diluted
    24,786       25,370       25,802       26,689       27,732  
       
   
As of December 31,
 
Balance Sheet Data:
    2011       2010       2009       2008       2007  
Cash, cash equivalents and short term investments
  $ 275,047     $ 246,296     $ 239,820     $ 221,422     $ 184,685  
Working capital
    379,154       414,414       406,207       400,835       353,923  
Total assets
    948,131       865,313       849,704       854,527       782,654  
Current portion of long-term debt
    89,294       -       -       -       -  
Total long-term debt
    -       85,599       82,163       102,631       98,748  
Stockholders’ equity
    708,698       652,209       649,717       638,994       591,817  
 
(1)
The operations of VIOX Corporation have been consolidated with ours since January 3, 2011.
(2)
The operations of Diaphorm have been consolidated with ours since June 1, 2009.
(3)
The operations of SemEquip, Inc. have been consolidated with ours since August 11, 2008.
(4)
The operations of Minco, Inc. have been consolidated with ours since July 10, 2007. The operations of Ceradyne Boron Products have been consolidated with ours since September 1, 2007.
 
 
36

 
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Data,” and our consolidated financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. We base these statements on assumptions that we consider reasonable. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors discussed in “Note Regarding Forward-Looking Statements,” “Item 1A—Risk Factors,” and elsewhere in this report.
 
Overview
 
We develop, manufacture and market advanced technical ceramic products, ceramic powders and components for defense, industrial, energy, automotive/diesel and commercial applications. Our products include:
 
 
  •
lightweight ceramic armor for soldiers and other military applications;
 
 
  •
ceramic industrial components for erosion and corrosion resistant applications;
 
 
  •
ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium hexaboride, zirconium diboride and fused silica, which are used in manufacturing armor and a broad range of industrial products and  consumer products;
 
 
  •
evaporation boats for metallization of materials for food packaging and other products;
 
 
  •
durable, reduced friction, ceramic diesel engine components;
 
 
  •
functional and frictional coatings primarily for automotive applications;
 
 
  •
translucent ceramic orthodontic brackets;
 
 
  •
ceramic-impregnated dispenser cathodes for microwave tubes, lasers and cathode ray tubes;
 
 
  •
specialty glass compositions for solar, electronic, industrial and health care markets;
 
 
  •
ceramic crucibles for melting silicon in the photovoltaic solar cell manufacturing process;
 
 
  •
ceramic missile radomes (nose cones) for the defense industry;
 
 
  •
fused silica powders for precision investment casting (PIC);
 
 
  •
neutron absorbing materials, structural and non-structural, in combination with aluminum metal matrix composite that serve as part of a barrier system for spent fuel wet and dry storage in the nuclear industry, and non-structural neutron absorbing materials for use in the transport of nuclear fresh fuel rods;
 
 
  •
nuclear chemistry products for use in pressurized water reactors and boiling water reactors;
 
 
  •
boron dopant chemicals for semiconductor silicon manufacturing and for ion implanting of silicon wafers;
 
 
  •
ceramic bearings and bushings for oil drilling and fluid handling pumps;
 
 
  •
ceramic micro-reactors used to process chemicals;
 
 
  •
PetroCeram® sand filters for oil and gas recovery; and
 
 
  •
enhanced combat helmets for soldiers.
 
Our customers include the U.S. government, prime government contractors, companies engaged in solar energy, oil and natural gas exploration and nuclear energy, and large industrial, automotive, diesel and commercial manufacturers in both domestic and international markets.
 
Prior to October 2010, we reported our operations through six operating segments. To more accurately reflect our current operations, executive reporting structure and organization, and internal reporting we modified our segment structure and reporting to reflect that we operate through four operating segments, each led by a different senior executive who reports directly to our Chief Executive Officer. The changes made to arrive at the four segments from the six previous segments were that the former Semicon Associates segment is now included in the Advanced Ceramic Operations segment and the former Ceradyne Canada segment is now included in the Boron segment. All of the financial data for 2010 and 2009 have been changed to reflect four segments.
 
37

 
 
The following table includes a summary of our products by applications and locations as of December 31, 2011 for our four segments:
 
Operating Segment and Facility Location
 
Products
Ceradyne Advanced Ceramic Operations
 
          Costa Mesa and Irvine, California
          Approximately 216,000 square feet
 
          Lexington, Kentucky
          Approximately 150,000 square feet
 
         Wixom, Michigan
          Approximately 29,000 square feet
 
          Salem, New Hampshire
          Approximately 16,000 square feet
 
Mountain Green, Utah
Approximately 18,000 square feet
 
Bangalore, India
Approximately 21,000 square feet
 
Seattle, Washington
Approximately 40,000 square feet
 
 
Defense Applications:
•  Lightweight ceramic armor
•  Enhanced combat helmets
 
 
Industrial Applications:
•  Ceralloy® 147 SRBSN wear parts
•  Precision ceramics
•  Ceramic-impregnated dispenser cathodes for microwave tubes, lasers and
    cathode ray tubes
 
Energy Applications:
•  Ceramic bearings and bushings
•  Specialty glass compounds for photovoltaic solar applications
 
   Automotive/Diesel Applications:
•  Ceralloy® 147 SRBSN automotive/diesel engine parts
 
Commercial Applications:
•  Ceramic orthodontic brackets
•  Components for medical devices
•  Specialty glass compounds for health care products
 
     
ESK Ceramics
 
          Kempten, Germany
          Approximately 599,000 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
•  High performance fluid handling pump seals
 
Energy Applications:
•  PetroCeram® sand filters
•  TETRABOR® nuclear powders
 
Automotive/Diesel Applications:
•  EKagrip® functional and frictional coatings
 
Commercial Applications:
•  BORONEIGE® boron nitride powder for cosmetics
 
     
Ceradyne Thermo Materials
 
          Scottdale and Clarkston, Georgia
Approximately 225,000 square feet
 
Tianjin, China
Approximately 316,000 square feet
 
          Midway, Tennessee
Approximately 105,000 square feet
 
Defense Applications:
•  Missile radomes (nose cones)
•  High purity fused silica used to manufacture missile radomes (nose cones)
 
Industrial Applications:
•  Glass tempering rolls
•  Metallurgical tooling
•  Castable and other fused silica products
•  Turbine components used in aerospace applications
 
 
Energy Applications:
•  Crucibles for photovoltaic solar cell applications
•  High purity fused silica used to manufacture crucibles
 
     
 

 
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Boron
 
          Quapaw, Oklahoma
Approximately 128,000 square feet
 
Chicoutimi, Quebec, Canada
          Approximately 86,000 square feet
 
 
 
 
 
Energy Applications:
•  Nuclear chemistry products for use in pressurized water reactors and boiling water reactors
•  Radioactive containment for use in spent fuel transport and storage
•  Burnable poisons for coating of uranium fuel pellets
•  Boral® structural neutron absorbing materials
•  Metal matrix composite structures
 
Industrial Applications:
•  Cluster molecules such as B18H22 for ion implantation for next
    generation P-dopants
•  Advanced ion source materials for the manufacture of logic and memory chips
 

    The tables below show, for each of our four segments, revenues and income before provision for income taxes in the periods indicated.
 
Segment revenues (in millions):

   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Advanced Ceramic Operations
  $ 277.5     $ 152.6     $ 221.8  
ESK Ceramics
    163.6       130.7       105.1  
Thermo Materials
    98.9       98.8       66.1  
Boron
    55.4       35.0       29.0  
Inter-segment elimination
    (23.4 )     (14.2 )     (21.4 )
Total revenue from external customers
  $ 572.0     $ 402.9     $ 400.6  
 
Segment income (loss) from operations and income before taxes (in millions):

   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Advanced Ceramic Operations
  $ 60.3     $ (23.1 )   $ 25.0  
ESK Ceramics
    30.8       21.1       (21.5 )
Thermo Materials
    20.0       34.0       14.7  
Boron
    16.9       (2.4 )     (11.0 )
Inter-segment elimination
    0.5       (0.4 )     0.5  
Total segment income from operations
    128.5       29.2       7.7  
Other expense
    (0.5 )     (0.8 )     (7.3 )
Total income before provision for taxes 
  $ 128.0     $ 28.4     $ 0.4  
 
We categorize our products into five market applications or sectors of the general economy. The tables below show the amount of sales (in millions) and the percentage contribution of our total sales to external customers of each market application or sector of the economy in the different time periods.
 
39

 
 
Sales by Market Application (in millions):

   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Defense
  $ 225.3     $ 117.3     $ 198.7  
Industrial
    163.2       138.6       102.7  
Energy
    129.0       99.9       62.2  
Automotive/Diesel
    40.1       35.9       25.2  
Commercial
    14.4       11.2       11.8  
Total
  $ 572.0     $ 402.9     $ 400.6  
 
Percentage Contribution of Sales by Market Application:
 
   
Year Ended December 31,
 
   
2011
   
2010
   
2009
 
Defense
    39.4 %     29.1 %     49.6 %
Industrial
    28.6       34.4       25.6  
Energy
    22.5       24.8       15.5  
Automotive/Diesel
    7.0       8.9       6.3  
Commercial
    2.5       2.8       3.0  
Total
    100.0 %     100.0 %     100.0 %
 
The principal factor contributing to our growth in sales from 2002 through 2007 was increased demand by the U.S. military for ceramic body armor that protects soldiers, which was driven primarily by military conflicts such as those in Iraq and Afghanistan. This demand was driven by recognition of the performance and life saving benefits of utilizing advanced technical ceramics in lightweight body armor. Our sales declined in 2008 primarily because of a reduction in shipments of body armor. Our sales declined in 2009 primarily because of a continued reduction in shipments of body armor and also due to a decline in sales of our industrial, automotive/diesel and commercial market product lines due to the severe economic recession. In 2010, sales of body armor continued to decline. However, sales from energy related products grew by 61.6% in 2010 when compared to 2009. Most of this growth in energy sales was generated by sales of our ceramic crucibles used in the production of photovoltaic cells for solar panels. Additionally, sales of industrial and automotive/diesel products rebounded sharply, particularly at our ESK Ceramics subsidiary. In 2011, our sales increased due to higher shipments of  body armor due to the increased demand for ESAPI body armor, an increase of sales to the nuclear industry, and continuing growth of sales at our ESK Ceramics subsidiary. Commencing in 2004, several strategic acquisitions, which are described below, have also contributed to our sales growth.
 
To illustrate the impact of body armor, energy-related products and our acquisitions, the following table shows our sales from body armor, from energy-related products, from our acquisitions, and from all other sources for each of the years 2002 through 2011 (in millions).

   
2011
   
2010
   
2009
   
2008
   
2007
   
2006
   
2005
   
2004
   
2003
   
2002
 
Sales from body armor
  $ 193.8     $ 70.4     $ 170.0     $ 385.0     $ 535.3     $ 479.4     $ 199.5     $ 120.3     $ 58.2     $ 26.2  
Sales from energy products:
                                                                               
 Gross sales from energy
 products
    129.0       99.9       62.2       57.7       20.9       11.9       9.8       5.3       2.5       1.7  
 Less sales from energy products
 included in acquisitions
    (66.2 )     (28.5 )     (24.5 )     (11.4 )     (4.5 )     (3.2 )     (3.2 )     (0.7 )     -       -  
Sales from energy products due
     to organic growth
    62.8       71.4       37.7       46.3       16.4       8.7       6.6       4.6       2.5       1.7  
Sales from acquisitions
    254.5       191.1       136.8       177.1       142.6       110.2       109.8       36.0       -       -  
All other sales
    60.9       70.0       56.1       71.8       62.5       64.6       52.4       54.7       40.8       33.3  
Total sales
  $ 572.0     $ 402.9     $ 400.6     $ 680.2     $ 756.8     $ 662.9     $ 368.3     $ 215.6     $ 101.5     $ 61.2  
 
 
40

 

Sales of ceramic body armor represented the majority, and most volatile, portion of our defense business, rising from approximately $26.2 million, or 42.8% of our total sales in 2002, to a peak of approximately $535.3 million, or 70.7% of our total sales in 2007, and then declining to approximately $193.8 million, or 33.9% of our total sales in 2011.Shipments of the first generation of ceramic body armor, known as small armed protective inserts, or SAPI, began before 2002 and accelerated rapidly with the onset of the war in Afghanistan in 2002 and thereafter the war in Iraq. Shipments of the second generation of ceramic body armor, known as enhanced small armed protective inserts, or ESAPI, began in 2005. The military’s subsequent decision to deploy ESAPI body armor “full fleet,” that is, to replace all SAPI body armor with the new ESAPI body armor, and the introduction in 2006 of enhanced side ballistic inserts, known as ESBI, which protect the sides of the soldier’s torso, resulted in continued growth in our sales of ceramic body armor, ultimately reaching our peak sales of body armor in 2007. Once “full fleet” was achieved, our sales of body armor began a steady decline which continued through 2010.
 
In October 2008, we were awarded an Indefinite Delivery/Indefinite Quantity, or ID/IQ, contract by the U.S. Army for the next ballistic threat generation of ceramic body armor plates, called XSAPI, as well as for the current generation ESAPI plates. This five-year contract has a maximum value of $2.37 billion and allows the U.S. Army to order either XSAPI or ESAPI body armor from us. Through December 31, 2011, we have shipped $258.3 million of body armor against delivery orders received by us under this ID/IQ contract, and we expect to ship an additional $20.1 million under existing orders during 2012. With less than three years remaining under this ID/IQ contract and the war in Iraq concluded and the war in Afghanistan winding down, we expect that the total amount of body armor that we ultimately ship under this contract will be substantially less than the maximum amount.
 
For 2012 and for the next several years, we expect that our sales of body armor will continue, but at more moderate levels than in the past. We believe there will continue to be a viable replacement business for body armor inserts that is procured through the Defense Supply Center Philadelphia (DSCP) and directly through the Army. We will also continue to bid on Foreign Military Sales (FMS) for the first generation of SAPI body armor through our existing ID/IQ contract with Aberdeen Proving Grounds.
 
Although we believe that demand for ceramic body armor will continue for many years, the quantity and timing of government orders depends on a number of factors outside of our control, such as the amount of U.S. defense budget appropriations, positions and strategies of the current U.S. government, the level of international conflicts and the deployment of armed forces. Moreover, ceramic armor contracts generally are awarded in an open competitive bidding process and may be cancelled by the government at any time without penalty. Therefore, our future level of sales of ceramic body armor will depend on our ability to successfully compete for and retain this business.
 
The following acquisitions resulted from a strategy to grow and expand our non-defense business through the selective acquisition of companies and product lines closely related to our core competency in advanced technical ceramics and materials, as well as to expand our defense business with complementary product lines on an opportunistic basis.
 
We acquired ESK Ceramics in August 2004.  Based in Kempten, Germany, ESK Ceramics manufactures industrial technical ceramic powders and advanced technical ceramic products. This acquisition provided us with both a broad line of non-defense products, and it assured us of a supply of boron carbide powder, which serves as a starter ceramic powder in the manufacture of our lightweight ceramic body armor. The lower demand for body armor in 2008 through 2010 has negatively impacted inter-segment sales of boron carbide powder by our ESK Ceramics subsidiary to our Advanced Ceramic Operations division.
 
In June 2006, we purchased the assets and technology related to the Boral® line of aluminum metal matrix composites that serve as part of a barrier system for spent fuel storage in the nuclear industry. We moved these assets to our Ceradyne Canada facility in Chicoutimi, Quebec, Canada. This product line is now included in our Boron operating segment.
 
Minco, Inc., which we acquired in July 2007, is included in our Thermo Materials operating segment. Based in Midway, Tennessee, Minco manufactures fused silica powders for a wide range of industrial applications. The fused silica powder manufactured by Minco is a key raw material that our Thermo Materials division uses to manufacture missile radomes (nose cones) and ceramic crucibles that our customers use for melting silicon in the photovoltaic solar cell manufacturing process.
 
We acquired EaglePicher Boron, LLC in August 2007.  This subsidiary, which we renamed Boron Products, LLC, is included in our Boron operating segment and produces the boron isotope 10B. This isotope is a strong neutron absorber and is used for both nuclear waste containment and nuclear power plant neutron radiation critical control. Boron Products also produces complementary chemical isotopes used in the normal operation and control of nuclear power plants. The boron isotope 11B is used in the semiconductor manufacturing process as an additive to semiconductor grade silicon as a “doping” agent and where ultra high purity boron is required.
 
In June 2008, we purchased certain assets and technology related to proprietary technical ceramic bearings used for “down hole” oil drilling and for coal bed methane pumps and steam assisted oil extraction pumps. This technology and product line, which we include in our Advanced Ceramic Operations operating segment, are located in our Lexington, Kentucky, facility. These bearings incorporate ceramic parts supplied by our ESK Ceramics subsidiary.
 
41

 
 
In August 2008, we acquired SemEquip, Inc., a late-stage startup technology company located in Billerica, Massachusetts. SemEquip develops and markets “cluster molecules” such as B18H22 for use in the ion implantation of boron (B) in the manufacture of semiconductors. SemEquip, which we include in our Boron operating segment, owns a portfolio of  37 issued and 22 pending U.S. patents, and corresponding issued and pending patents in several foreign countries. In November 2011, SemEquip licensed its cluster ion implant hardware technology on a non-exclusive basis to a key customer. In connection with the license, SemEquip transferred its hardware related assets to the licensee and reduced its workforce which included production, research and development, and support staff in Billerica, Massachusetts. SemEquip will continue to market its cluster ion chemistry to the semiconductor industry. We recognized a restructuring charge of $0.9 million in 2011 primarily for severance and related compensation associated with the headcount reduction, most of which was paid in 2011.
 
In June 2009, we acquired substantially all of the business and assets and all technology and intellectual property related to ballistic combat and non-combat helmets of Diaphorm Technologies, LLC, based in Salem, New Hampshire. Based on this technology, we submitted a proposal to the U.S. Marine Corps Systems Command in June 2009 in response to a solicitation for the procurement of Enhanced Combat Helmets (ECH), which are intended to provide substantially increased levels of protection compared to combat helmets now in use. In late July 2009, in response to our proposal, the U.S. Marine Corps System Command awarded us a contract for up to a maximum of 246,840 helmets. After an extended period of testing, we received an order for First Article Test helmets, which we delivered in January and February 2011. Upon additional testing it was determined by the Government that further testing was needed due to variations discovered in its test procedures and protocols. Ceradyne received a second order for First Article Test helmets, which we delivered for testing in October 2011. Those helmets are now in the final stages of First Article Testing by the U.S. Government. Our strategy regarding this acquisition is to combine our successful track record in body armor programs with the proprietary helmet-forming technologies acquired from Diaphorm to create a world class manufacturer of Enhanced Combat Helmets.
 
We acquired VIOX Corporation on January 3, 2011. Located in Seattle, Washington, VIOX develops, manufactures and markets specialty glass compositions for a wide range of electronic, industrial and health care markets. VIOX is included in our Advanced Ceramic Operations operating segment. VIOX has developed a specialty glass formulation for polycrystalline silicon photovoltaic solar applications. VIOX’ customers add electrically conducting powdered metals such as silver or aluminum to the VIOX powdered specialty glass. Many of the ultimate solar users of VIOX’ glass are also customers for Ceradyne’s high purity ceramic solar crucibles.
 
Our order backlog was $284.9 million as of December 31, 2011 and $185.8 million as of December 31, 2010. Orders for ceramic armor (encompassing body, vehicle and other miscellaneous armor) represented approximately $175.9 million, or 61.7% of the total backlog as of December 31, 2011 and $83.4 million, or 44.9% of the total backlog as of December 31, 2010. Of the total ceramic armor, orders for ceramic body armor amounted to approximately $168.5 million, or 59.1% of the total backlog as of December 31, 2011 and $78.4 million, or 42.2% of the total backlog as of December 31, 2010. We expect that substantially all of our order backlog as of December 31, 2011 will be shipped during 2012.
 
Our sales to customers located in the United States have varied in recent years, representing $312.4 million, or 54.6% of net sales in 2011, $194.5 million, or 48.3% of net sales in 2010, and $264.8 million, or 66.1% of net sales in 2009. Our sales to customers located outside of the United States represented $259.6 million, or 45.4% of net sales in 2011, $208.4 million, or 51.7% of net sales in 2010, and $135.8 million, or 33.9% of net sales in 2009. We currently have sales offices in Germany, China, England and Canada as well as commissioned independent sales representatives in other parts of Europe and Asia. Of our sales to customers located outside the United States, 41.2% were denominated in U.S. dollars during 2011.
 
Net Sales. Our net sales consist primarily of revenues from the sale of products, which we recognize when an agreement of sale exists, the product has been delivered according to the terms of the sales order and collection is reasonably assured. We may reduce revenue with reserves for sales returns. Allowances for sales returns, which are recorded at the time revenue is recognized, are based upon historical sales returns. We did not include a sales return provision at December 31, 2011, 2010 and 2009 because our historical experience with sales returns leads us to conclude that no allowance for sales returns is necessary.
 
We do not record a warranty reserve on the sale of our products. For our largest product line, body armor, all of which is sold to the U.S. government, each lot of body armor is tested at an independent laboratory and the lot cannot be released for shipment to the U.S. government until positive test results are received by both the U.S. government and us. For our non-body armor sales, we have experienced minimal claims from these types of sales. Additionally, due to the inherent nature, strength, durability and structural properties of ceramics, as well as a rigid quality control program that includes, for some of our customers, having the customer accept quality test results prior to shipment, we do not believe a warranty reserve is necessary.
 
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Cost of Product Sales. Our cost of product sales includes the cost of materials, direct labor expenses and manufacturing overhead expenses. Our business requires us to maintain a relatively high fixed manufacturing overhead. As a result, our gross profit, in absolute dollars and as a percentage of net sales, is greatly impacted by our sales volume and the corresponding absorption of fixed manufacturing overhead expenses. Additionally, because many of our products are customized, we are frequently required to devote resources to sustaining engineering expenses associated with production efforts, which we also include in cost of product sales.
 
The cost of electricity comprises a significant portion of our cost of product sales. Our high electricity utilization is a direct result of the use of high temperature furnaces to hot press ceramic body armor inserts and to produce sintered silicon nitride (“Si3N4”) for industrial products. Several years ago, we recognized the need to mitigate the cost of electricity and in 2003 we embarked on a plan to move production from California to Lexington, Kentucky. To date, we have moved all of our Si3N4 furnaces to Kentucky and have established three new hot press lines in Kentucky. During the fourth quarter of 2010, we closed our hot press manufacturing operation in Costa Mesa, California as a result of reduced demand for ceramic body armor and the high cost of doing business in the State, especially the high cost of electricity, which is integral to our manufacturing operations. The electricity cost in Kentucky is more stable than California because of the presence of coal fired power plants. The price of electricity in Kentucky has been stable for the past three years and is projected by our supplier to continue to be stable over the next few years. We have a policy of locating new production facilities that require high levels of electricity in regions of the world that have either available hydroelectric or coal fired power plants.
 
The cost of electricity for our manufacturing operations in the United States, Canada, Europe, China and India was approximately $19.2 million, or 5.3% as a percentage of cost of product sales in 2011, $14.7 million, or 5.0% as a percentage of cost of product sales in 2010, and approximately $12.7 million, or 4.2% as a percentage of cost of product sales in 2009. Management utilizes utility industry specialists and consultants to help manage and implement strategies to minimize annual energy price increases at our all our facilities. These strategies may include entering into long term contracts to obtain fixed price increases in order to increase our ability to accurately forecast future energy costs and ensure a stable cost structure. Fluctuations in the cost of electricity affect our ability to accurately forecast future energy costs and consequently our profitability. If the cost of electricity were to increase substantially, our gross profit margins may decline.
 
With regard to significant costs for raw materials that impact our gross margins, we rely on two critical materials to make ceramic body armor: boron carbide powder, which is the principal raw material used in the production of ceramic armor plates, and an ultra-high molecular weight polyethylene textile material, which we laminate to the surface of the ceramic armor plates and is readily available from multiple suppliers. We obtain substantially all of our boron carbide powder from our subsidiary, ESK Ceramics, which has been a supplier of boron carbide powder to us for over 30 years. Boron carbide is made from borax and boric acid through a complicated furnace process. Historically, these raw material products have not experienced significant price and supply instability and consequently we have been able to obtain sufficient quantities of boron carbide material from ESK Ceramics. We have further identified a second source of boron carbide from a supplier that utilizes crude boron carbide from China and does the finishing in the United States. The crude boron carbide from China is inexpensive and offers a method to mitigate any internal cost increases at ESK Ceramics through the use of lower cost China material as part of the ESK Ceramics’ raw material mix.
 
Selling, General and Administrative Expenses. Our selling expenses consist primarily of salaries and benefits for direct sales and marketing employees, commissions for direct sales employees and for independent sales representatives, trade show expenses, rent for our sales offices, product literature, and travel and entertainment expenses. Our general and administrative expenses consist primarily of employee salaries and benefits, employee bonuses, which are computed quarterly and accrued in the quarter earned, professional service fees, rent for facilities and expenses for information technology.
 
Research and Development Expenses. Our research and development expenses consist primarily of employee salaries and benefits, materials and supplies related to ongoing application engineering in response to customer requirements for future products, and the research and development of new materials technology and products. These costs are expensed as incurred.
 
 
 
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Results of Operations
 
The following table sets forth certain income and expense items from our financial statements for the years ended December 31, 2011, 2010 and 2009 expressed as a percentage of net sales.

   
Year Ended December 31,
 
   
    2011
   
    2010
   
    2009
 
Net sales
    100.0 %     100.0 %     100.0 %
Cost of product sales
    63.9       73.2       74.6  
Gross profit
    36.1       26.8       25.4  
Operating expenses:
                       
Selling, general and administrative
    13.0       15.4       16.4  
Research and development
    2.2       2.9       3.1  
Restructuring - plant closure and severance
    0.2       0.9       3.2  
Acquisition related (credits) charges
    (3.0 )     0.4       (0.2 )
Goodwill impairment
    1.4             1.0  
Income from operations
    22.5       7.2       1.9  
Other income (expense)
    (0.1 )     (0.2 )     (1.8 )
Income before provision for income taxes
    22.4       7.0       0.1  
Net income
    14.7 %     7.2 %     2.1 %
 
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
 
Net Sales
 
Our total net sales for the years ended December 31, 2011 and 2010 were as follows (dollars in millions):
 
   
2011
   
2010
 
Net sales
  $ 572.0     $ 402.9  
Increase in net sales
  $ 169.1     $ 2.3  
Percentage change in net sales
    42.0 %     0.6 %
 
Sales increased in 2011in all five market applications, particularly in defense products. The principal factors contributing to this growth included renewed purchasing of ceramic body armor by the U.S. military, continued growth in sales of our ESK Ceramics operating segment, increased sales to the nuclear industry, the sales contribution from VIOX Corporation and the continued rebound of the economy in general.
 
Overall, net sales for the year ended December 31, 2011 of our defense related products were $225.3 million, an increase of $108.0 million, or 92.0%, from $117.3 million in the prior year as shipments of body armor were sharply higher due to increased demand from the U.S. military for ESAPI body armor. Sales for the year ended December 31, 2011 of energy products amounted to $129.0 million, an increase of $29.1 million, or 29.1%, from $99.9 million in the prior year as sales to the nuclear industry increased by $17.0 million and we included sales of $15.1 million to the energy markets from VIOX Corporation for the first time this year as they were acquired on January 3, 2011. These increases in sales to the energy markets were offset by a decline of $5.2 million in sales of ceramic crucibles to the solar energy industry.  Sales for the year ended December 31, 2011 of industrial products amounted to $163.2 million, an increase of $24.6 million, or 17.8%, from $138.6 million in the prior year.
 
Sales of automotive/diesel products for the year ended December 31, 2011 were $40.1 million, an increase of $4.2 million, or 11.7%, from $35.9 million in the prior year. Sales to the automotive/diesel market represented 7.0% of sales for the year ended December 31, 2011 and 8.9% of sales for the year ended December 31, 2010.
 
Our net sales of commercial products for the year ended December 31, 2011 were $14.4 million, an increase of $3.2 million, or 28.8%, from $11.2 million in the prior year.
 
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    Our Advanced Ceramic Operations segment had net sales for the year ended December 31, 2011 and 2010 as follows (dollars in millions):
   
2011
   
  2010
 
Net sales
  $ 277.5     $ 152.6  
Increase (decrease) in net sales
  $ 124.9     $ (69.2 )
Percentage change in net sales
    81.9 %     (31.2 %)
 
Contributing to the increase of $124.9 million in sales during for the twelve months ended December 31, 2011 were higher shipments of ceramic body armor that totaled $193.8 million, an increase of $123.4 million, or 175.2%, from $70.4 million in 2010. The primary reason for the increase was an increase in demand for shipments of ESAPI armor plates. This increase in body armor sales during the twelve month period ended December 31, 2011 was partially offset by a decrease in sales of vehicle armor. We shipped $2.6 million of vehicle armor for the twelve months ended December 31, 2011, a decrease of $19.9 million, or 88.2%, from $22.5 million in 2010. The decline was caused by a lack of orders of armor for the MRAP All Terrain Vehicle (M-ATV) and the High Mobility Multipurpose Wheeled Vehicle (HMMWV or Humvee) during the twelve months ended December 31, 2011 compared to 2010.
 
As of January 3, 2011, the date of acquisition, we began to include the financial results of VIOX Corporation in the Advanced Ceramic Operations segment. VIOX sales amounted to $20.3 million during the twelve months ended December 31, 2011.
 
 Our ESK Ceramics segment had net sales for the year ended December 31, 2011 and 2010 as follows (dollars in millions):
 
   
2011
   
2010
 
Net sales
  $ 163.6     $ 130.7  
Increase (decrease) in net sales
  $ 32.9     $ 25.6  
Percentage change in net sales
    25.1 %     24.4 %
 
On a constant currency basis, sales for the year ended December 31, 2011 were $157.3 million, an increase of $26.6 million, or 20.3% from the prior year. We computed sales on a constant currency basis by calculating 2010 sales in actual Euros and applying a monthly average foreign exchange rate during 2010 of the Euro to the U.S. dollar sales during 2011, which was then compared to 2011 actual sales in U.S. dollars. Sales of industrial products for the year ended December 31, 2011 were $91.1million, an increase of $1.8 million, or 2.0%, from $89.3 million in the prior year. This increase was the result of a higher demand for fluid handling products, an increase in shipments of industrial parts for the packaging industry and an increase in shipments of composite coatings. Sales of defense products for the twelve months ended December 31, 2011 were $30.2 million, an increase of $17.5 million, or 137.1%, from $12.7 million in the prior year. Included in sales of defense products for the twelve months ended December 31, 2011 were inter-segment sales of $20.1 million compared to $12.0 million in the prior year. The increase of $8.2 million in inter-segment sales was due to an increase in demand for boron carbide powder used in body armor plates manufactured by our Advanced Ceramic Operations division. Sales of automotive/diesel products for the twelve months ended December 31, 2011 were $29.7 million, an increase of $3.9 million, or 15.0%, from $25.8 million in the prior year. Increased demand from automotive original equipment manufacturers accounted for the increase in sales. Sales of oil and gas products for the twelve months ended December 31, 2011 were $6.5 million, an increase of $2.3 million, or 54.4%, from $4.2 million in the prior year as we gained additional distribution to new customers in the oil services industry.
 
Our Thermo Materials segment had net sales for the year ended December 31, 2011 and 2010 as follows (dollars in millions):
 
   
2011
   
2010
 
Net sales
  $ 98.9     $ 98.8  
Increase (decrease) in net sales
  $ 0.1     $ 32.7  
Percentage change in net sales
    0.1 %     49.5 %
 
Sales were approximately unchanged for the twelve months ended December 31, 2011 compared to 2010. Sales of ceramic crucibles used in the manufacture of photovoltaic cells for the solar industry were $62.0 million, a decrease of $5.2 million, or 7.8%, from $67.2 million in the prior year. Sales during the first half of 2011 were strong but declined significantly over the course of the year. The decrease was due to a pronounced slowdown of demand in the solar energy market due to a reduction of government subsidies for the installation of solar panels and a buildup of an inventory of solar cells and solar wafers in distribution channels. Sales to the defense industry for the twelve months ended December 31, 2011 were $12.1 million, an increase of $0.9 million, or 8.1%, from $11.2 million when compared to the prior year. The increase was due to higher shipments of ceramic missile radomes. Sales of precision investment casting products were $36.5 million, an increase of $6.4 million, or 21.3%, from $30.1 million in the prior year. The increase was the result of the recovery of the domestic market for precision investment casting and price increases to customers.
 
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Our Boron segment had net sales for the year ended December 31, 2011 and 2010 as follows (dollars in millions):
 
   
2011
   
2010
 
Net sales
  $ 55.4     $ 35.0  
Increase (decrease) in net sales
  $ 20.4     $ 6.0  
Percentage change in net sales
    58.3 %     20.9 %
 
The primary reasons for this increase in 2011 net sales were sales to the nuclear industry that totaled $41.7 million, an increase of $18.9 million, or 82.9% compared to $22.8 million in the prior year. Of the $18.9 million increase in sales to the nuclear industry, $8.7 million was in connection with the construction of two nuclear power plants located in Finland and France. Sales to the semiconductor industry were $10.4 million, an increase of $1.1 million, or 12.0%, from $9.3 million in the prior year.
 
Gross Profit
 
Our total gross profit for the years ended December 31, 2011 and 2010 were as follows (dollars in millions):
 
   
2011
   
2010
 
Gross profit
  $ 206.6     $ 107.9  
Increase (decrease) in gross profit
  $ 98.7     $ 6.3  
Gross profit percentage
    36.1 %     26.8 %
 
The increase in gross profit and gross profit as a percentage of net sales in the year ended December 31, 2011 were caused primarily by an improved sales mix, especially by increased sales of body armor, an increase in gross profit at our ESK segment due to increased sales and operating leverage and the pass through of price increases on certain industrial product lines at our ACO and ESK segments, and an increase in gross profit at our Boron segment due to increased sales to the nuclear industry and resulting increase in operating leverage. Our body armor product line was responsible for $68.9 million, or 69.7% of the total increase in gross profit during the year ended December 31, 2011.
 
Our Advanced Ceramics Operation segment had total gross profit for the years ended December 31, 2011 and 2010 as follows (dollars in millions):
 
   
2011
   
2010
 
Gross profit
  $ 90.6     $ 16.0  
Increase (decrease) in gross profit
  $ 74.6     $ (45.6 )
Gross profit percentage
    32.6 %     10.6 %
 
The primary reasons for the increase in gross profit and gross profit as a percentage of net sales in 2011 were higher volumes of production of body armor and industrial products resulting in increased absorption of manufacturing overhead expenses.
 
Our ESK Ceramics segment had total gross profit for the years ended December 31, 2011 and 2010 as follows (dollars in millions):
 
   
2011
   
2010
 
Gross profit
  $ 54.4     $ 39.7  
Increase (decrease) in gross profit
  $ 14.7     $ 25.2  
Gross profit percentage
    33.2 %     30.4 %
 
The increase in gross profit and gross profit as a percentage of net sales in 2011 were the result of price increases to customers for certain product lines, a favorable sales mix, a decrease in unabsorbed manufacturing overhead expenses caused by higher production volumes, and higher sales of all product lines due to increased demand for our products as a result of the recent slight economic rebound.
 
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Our Thermo Materials segment had total gross profit for the years ended December 31, 2011 and 2010 as follows (dollars in millions):
 
   
2011
   
2010
 
Gross profit
  $ 37.6     $ 44.5  
Increase (decrease) in gross profit
  $ (6.9 )   $ 22.0  
Gross profit percentage
    38.0 %     45.1 %
 
Gross profit decreased during the twelve month period ended December 31, 2011 primarily because of the decrease in unit sales and production of crucibles and a decline in unit sales prices due to pricing pressure from customers. Gross profit  from the sales of crucibles during the first half of 2011 was strong but declined significantly over the course of the year due to a pronounced slowdown of demand in the solar energy market. During the twelve month period ended December 31, 2011, we incurred temporary quality issues relating to the production of our ceramic crucibles that resulted in increased scrap charges which reduced gross profit by $6.3 million and also reduced gross profit as a percentage of sales. These temporary quality issues were corrected as of mid-June 2011. We opened a new plant in China for the production of crucibles during February 2011 and incurred start-up expenses of approximately $1.1 million during the twelve month period ended December 31, 2011.
 
 Our Boron segment had total gross profit for the years ended December 31, 2011 and 2010 as follows (dollars in millions):
 
   
2011
   
2010
 
Gross profit
  $ 23.6     $ 8.0  
Increase (decrease) in gross profit
  $ 15.6     $ 5.6  
Gross profit percentage
    42.6 %     22.9 %
 
The increases in gross profit and gross profit as a percentage of sales during the twelve month period ended December 31, 2011, were the result of higher sales to the semiconductor and nuclear industries, a favorable sales mix and improved absorption of fixed manufacturing costs.
 
Selling, General and Administrative Expenses. Our selling, general and administrative expenses for the years ended December 31, 2011 and 2010 were as follows (dollars in millions):
 
   
2011
   
  2010
 
Selling, general and administrative expenses
  $ 74.3     $ 61.9  
Increase (decrease) in selling, general and administrative expenses
  $ 12.4     $ (3.7 )
Percentage change in selling, general and administrative
    20.0 %     (5.6 %)
Selling, general and administrative expenses; percentage of net sales
    13.0 %     15.4 %
 
For the twelve months ended December 31, 2011, the increase of $12.4 million over the same period last year was caused by an increase of $1.3 million in information technology expenses, an increase of $2.0 million due to the acquisition of VIOX Corporation which we included in our results beginning in 2011, an increase of $6.4 million in personnel expenses caused by a larger headcount of employees and employee bonuses due to the improved financial performance, increased selling expenses of $2.3 million and an increase of $2.9 million of general and administrative expenses associated with our new plant in China.
 
 Research and Development Expenses. Our research and development expenses for the years ended December 31, 2011 and 2010 were as follows (dollars in millions):
 
   
2011
   
        2010
 
Research and development expenses
  $ 12.4     $ 11.7  
Increase (decrease) in research and development expenses
  $ 0.8     $ (0.6 )
Percentage change in research and development expenses
    6.4 %     (4.6 %)
Research and development as a percentage of net sales
    2.2 %     2.9 %
 
The primary reasons for the increase in research and development expenses were the addition in headcount and related personnel and travel expenses.
 
Restructuring – Plant Closure and Severance. Our restructuring – plant closure and severance expenses for the years ended December 31, 2011 and 2010 were as follows (dollars in millions):
 
   
2011
   
        2010
 
Restructuring - plant closure and severance
  $ 0.9     $ 3.5  
Increase (decrease) in restructuring – plant closure and severance
  $ (2.6 )   $ (9.4 )
Percentage change in restructuring - plant closure and severance
    (73.9 %)     (72.9 %)
Restructuring - plant closure and severance as a percentage of net sales
    0.2 %     0.9 %
 
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We recorded pre-tax restructuring and severance charges of $0.9 million for the year ended December 31, 2011 in connection with the closing of our SemEquip facility in Billerica, Massachusetts. We made this decision to close this facility in connection with a strategic decision to change SemEquip’s business model from developing and marketing both cluster ion implant hardware and the cluster ion chemistry, to licensing the ion implant hardware and marketing only the cluster ion chemistry. In November 2011, SemEquip licensed its cluster ion implant  hardware technology on a non-exclusive basis to a key customer and reduced its workforce which included production, research and development, and support staff in Billerica, Massachusetts.  Accordingly, the Company recognized a restructuring charge of $0.9 million in 2011 primarily for severance and related compensation associated with the headcount reduction. This decision was consistent with our ongoing objective to lower the costs of our operations.
 
Acquisition Related Charges. Our acquisition related charges for the years ended December 31, 2011 and 2010 were as follows (dollars in millions):
 
   
2011
   
     2010
 
Acquisition related charges
  $ (17.3 )   $ 1.6  
Increase (decrease) in acquisition related charges
  $ (18.9 )