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Article by DailyStocks_admin    (04-07-08 02:55 AM)

The Daily Magic Formula Stock for 04/07/2008 is Ceradyne Inc. According to the Magic Formula Investing Web Site, the ebit yield is 27% and the EBIT ROIC is 50-75%.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

Introduction

We develop, manufacture and market advanced technical ceramic products, ceramic powders and components for defense, industrial, 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 insulation 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, and zirconium diboride, which are used in manufacturing armor and a broad range of industrial products; and BORONEIGE ® boron nitride powder for cosmetic products;

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

• durable, reduced friction, ceramic diesel engine components;

• functional and frictional coatings primarily for automotive applications;

• translucent ceramic orthodontic brackets;

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

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

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

• fused silica powders for industrial applications and ceramic crucibles;

• neutron absorbing materials, structural and non-structural, in combination with aluminum metal matrix 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; and

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

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

The principal factor contributing to our recent growth in sales is increased demand by the U.S. military for ceramic body armor that protects soldiers. This increased demand has been driven by a growing recognition of the performance and life saving benefits of utilizing advanced technical ceramics in lightweight body armor. In addition, the market for ceramic body armor increased further beginning in 2006 with the introduction of enhanced side ballistic inserts, known as ESBI, which protect the side areas of the soldier’s torso. Recent military conflicts in Iraq and Afghanistan, as well as an increasingly unstable geopolitical climate and the heightened risk of international conflicts, have resulted in increased orders for these products. We believe that our ability to produce and deliver large quantities of ceramic body armor has led to increased orders for our products. However, shipments and orders for the current generation ESAPI (enhanced small arms protective inserts) body armor for the U.S. Army, which represented 40.3% of our total revenues in 2007 and 57.0% of our total body armor shipments in 2007 may end in 2008. We believe we will continue to supply ESAPI body armor to other U.S. military customers besides the U.S. Army throughout 2008. In response to a solicitation notice from the U.S. Army regarding the next ballistic threat generation of body armor, known as XSAPI, we submitted our quotation for this procurement in February 2008. Government contracts for ceramic armor generally are awarded in an open competitive bidding process. Our future level of sales of ceramic body armor will depend on the U.S. military’s continued demand for these products and our ability to successfully compete for and retain this business.

Our sales also increased from 2004 through 2007 because of our acquisition of ESK Ceramics on August 23, 2004, our acquisition of Minco, Inc. on July 10, 2007 and our acquisition of EaglePicher Boron, LLC on August 31, 2007. The operations of ESK Ceramics have been consolidated with ours since September 1, 2004. The operations of Minco, Inc. have been consolidated with ours since July 10, 2007, and the operations of EaglePicher Boron have been consolidated since September 1, 2007.

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

Our new Minco operation manufactures fused silica powders for a wide range of industrial applications and is a key supplier of this raw material to our Thermo Materials division. EaglePicher Boron, LLC, which we have renamed Boron Products, LLC, produces the boron isotope 10 B. This isotope is a strong neutron absorber and is used for both nuclear waste containment and nuclear power plant neutron radiation critical control. Our Boron Products subsidiary produces complementary chemical isotopes used in the normal operation and control of nuclear power plants. Boron Products also produces the boron isotope 11 B, 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. We anticipate that Boron Products will further strengthen our entry, announced during 2006, into the nuclear waste containment and other nuclear power plant related ceramic materials markets.

We believe that numerous applications for ceramic products and technology have the potential to drive long-term growth of our business. Examples of applications for which we have developed or are currently developing products include:


• lightweight ceramic armor for military vehicles, boats and aircraft;

• ceramic components that have the potential to facilitate the 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;

• high purity fused silica ceramic crucibles used by several photovoltaic cell manufacturers in their silicon melting operation in order to produce polycrystalline silicon storage containers;

• 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.

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 are expanding our facilities to add manufacturing capacity.

In July 2007, we entered into an agreement with Ideal Innovations, Inc. and Oshkosh Truck Corporation to further develop, produce and market an armored military vehicle we call the Bull tm . The Bull tm armored vehicle is intended to address the increasing need for protection from improvised explosive devices known as IED’s, mine blasts and high-threat, explosively formed projectiles, known as EFP’s, and will be built on a combat-proven Oshkosh Truck chassis. The Bull tm armored solution, conceived by Ideal Innovations in 2005 and developed with Ceradyne in 2006, has been tested by the Army Test Center, Aberdeen, Maryland, and demonstrated to be capable of protecting vehicle occupants against IED, EFP and mine blast threats. It is designed to meet current IED threats, and is intended to withstand the increasingly prevalent and higher EFP threats now faced by the U.S. military. In September 2007, in response to a solicitation notice from the U.S. military regarding Mine Resistant Ambush Protected Vehicles II Enhanced Vehicle Competition, known as MRAP II, we, together with Ideal Innovations and Oshkosh Truck, submitted a quotation and delivered both a 6-person and a 10-person MRAP II vehicle named the Bull tm , to the U.S. Army Aberdeen Test Center for further service evaluation. In December 2007, the U.S. government awarded a delivery order totaling $18.1 million to Ideal Innovations, Ceradyne and Oshkosh Truck for several 6-person versions and targets of the Bull tm armored vehicle to be used for further government testing. Ideal Innovations is the prime contractor and we are a sub contractor to Ideal Innovations. Whether we receive additional orders for the Bull tm armored vehicle will depend upon the success of these tests, the U.S. military’s need and funding for MRAP II armored vehicles, the results of testing of a competitor’s MRAP II armored vehicle, and whether our pricing for the Bull tm armored vehicle is competitive.

Ceradyne’s design and production contribution to the Bull tm armored vehicle program is based on our experience and expertise learned over many years in developing ceramic armor systems for military helicopters, ground-based vehicles and boats. Due to the ballistic threat level that MRAP II armored vehicles are required to meet, the current design of the Bull tm armored vehicle does not include any ceramic armor.

lthough we are engaged in development of ceramic armor systems to use on future versions of the Bull tm armored vehicle, we do not know when or if a ceramic armor solution will be available or whether it would be acceptable to the U.S. military.

We conduct our operations through six operating segments: our Advanced Ceramic Operations division, our ESK Ceramics subsidiary, our Semicon Associates division, our Thermo Materials division, our Ceradyne Canada subsidiary and our Boron Products subsidiary.

Advanced Technical Ceramics

Evolving customer requirements in industrial processing, military systems, 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.

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.

Our Solution

We develop, manufacture and market advanced technical ceramic products, ceramic powders and components for defense, industrial, 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.

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 121 employees with degrees in ceramic engineering or related sciences, of which 24 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 proprietary equipment and manufacturing processes allow us to meet the high volume demands of our customers in the markets that we serve.

Vertically Integrated Body Armor Manufacturer. We are a vertically integrated manufacturer of lightweight ceramic body armor. 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 the recent expansion of 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.

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 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 and Arrow missile programs; 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.

Key Customer Relationships. We have longstanding relationships with many of our significant customers in the defense, industrial, 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 the majority 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, our President of North American Operations and our Vice President of Operations each has more than 25 years of experience in the ceramics industry. Our management team has demonstrated its ability to identify, execute and integrate strategic acquisitions into our business through our acquisitions of ESK Ceramics in August 2004, Quest Technology in May 2004, a boron carbide/aluminum cladding product line known as Boral ® in June 2006, and Minco, Inc. and EaglePicher Boron, LLC in 2007. 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 as well as new defense applications in vehicles, boats and aircraft. In response to a solicitation notice from the U.S. military, we have developed a new generation of body armor that is capable of withstanding higher ballistic threats than current versions with approximately the same product weight. We submitted our quotation for this procurement in February 2008.

Recently, we have applied our armor systems experience and expertise, learned over many years in developing and manufacturing ceramic armor for military helicopters, ground-based vehicles and boats, to develop, together with Ideal Innovations, Inc., a ground-based armored vehicle we call the Bull tm . The Bull tm armored vehicle is designed to address the increasing need, particularly in Iraq, for protection from improvised explosive devices, known as IED’s, mine blasts and high-threat, explosively formed projectiles, known as EFP’s. To address the potentially large demand for these armored military vehicles, we have entered into a teaming agreement with Ideal Innovations and Oshkosh Truck Corporation to further develop, produce and market the Bull tm armored vehicle, which will be built on a combat-proven Oshkosh Truck chassis.

In September 2007, in response to a solicitation notice from the U.S. military regarding Mine Resistant Ambush Protected Vehicles II Enhanced Vehicle Competitive, known as MRAP II, we, together with Ideal Innovations and Oshkosh Truck, submitted a quotation and delivered both a 6-person and a 10-person version of the Bull tm armored vehicle to the U.S. Army Aberdeen Test Center for further service evaluation. In December 2007, the U.S. military awarded a delivery order totaling $18.1 million to Ideal Innovations, Ceradyne and Oshkosh Truck for several 6-person versions and targets of the Bull tm armored vehicle to be used for further government testing. Whether we receive additional orders for the Bull tm armored vehicle will depend upon the success of these tests, the U.S. military’s need and funding for MRAP II armored vehicles, the results of testing of a competitor’s MRAP II armored vehicle, and whether our pricing for the Bull tm armored vehicle is competitive.

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 and developing new products for new and existing customers. 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 highly trained 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 3M Unitek on developing the next generation of translucent ceramic orthodontic brackets. We also 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. and EaglePicher Boron, LLC., as well as the expansion of our operations into Canada and China, were to further increase our non-defense revenue base.

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 Mexico and 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 plan to increase this capacity and will start construction during 2008 of an approximately 200,000 square foot facility in Tianjin, China for the manufacture of ceramic crucibles. 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.

Market Applications and Products

Our products are sold into four principal markets: defense, industrial, 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 tm , 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 we produce lightweight ceramic armor for military helicopters.

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 also 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) and the Arrow Missile.

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. 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 1,200° Centigrade. 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 liquid 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.

COMPENSATION

2006 and 2007 Executive Officer Compensation Elements

Cash Compensation

As noted above, over the past three years our Compensation Committee has sought to adjust the components of cash compensation by increasing base salaries, imposing maximum limits on cash bonuses, and adjusting the relative mix of the two. Based in part on survey information provided by Hewitt Associates LLC, a human resources consulting firm, as described at page 7 above, the Compensation Committee has gradually increased base salaries, and for 2007 has targeted its recommendations for total cash compensation, consisting of base salary and bonus, at the median level of the survey group of companies. The Compensation Committee has targeted total 2007 compensation, consisting of base salary, bonus and equity-based compensation, at the 75th percentile of the survey group of companies. The Compensation Committee believes that base salaries should be more in line with industry norms to better assure competitive levels of cash compensation in the event the Company’s amount of profits levels off or declines in the future. Therefore, it has increased the levels of base salary relative to total cash compensation. At the same time, the Compensation Committee believes that a meaningful portion of total cash compensation should remain tied to the profitability of the Company.

(1) Effective as of March 23, 2007, Mr. Kraft’s responsibilities and title changed to Vice President Nuclear and Semiconductor Business Units.

(2) Compensation earned by Dr. Hartl is paid in Euros. His base salary was 136,180 Euros in 2006 and will be 138,624 Euros in 2007. The amounts shown in the table for Dr. Hartl represent the dollar equivalent value based on the average exchange rate during 2006, which was 1.2597 Euros per dollar.

(1) Cash bonuses for Mr. Moskowitz, Mr. Pellizzon, Mr. Reed and Mr. Kraft were capped at an amount equal to 150% of each officer’s annual base salary in 2006.

(2) Cash bonuses for Mr. Moskowitz, Mr. Pellizzon and Mr. Reed are capped at an amount equal to 100% of each officer’s annual base salary in 2007.

(3) The cash bonus for Mr. Kraft is capped at an amount equal to 45% of his annual base salary in 2007.

(4) The amounts shown in the table for Dr. Hartl represent the dollar equivalent value based on the average exchange rate during 2006, which was 1.2597 Euros per dollar.

(5) The cash bonus for Dr. Hartl is capped at an amount equal to 150% of his annual base salary for that year.

Equity-Based Compensation

We have used stock option grants as a form of long-term compensation since 1983. Until approximately 2003, when our revenues and profits began to increase dramatically, as described above, our stock generally was not actively traded and the price stayed within a relatively narrow range. Consequently, stock options did not provide much incentive compensation prior to 2003. When our stock price began to increase dramatically in 2003, employees who were granted stock options in earlier years suddenly realized substantial gains on their options. However, the Compensation Committee was concerned that newly granted stock options may not provide the same level of increase in value in the future, and therefore may not serve the intended purpose of providing incentive compensation. This is because stock options have value to the employee only if the price of the stock is higher on the date of exercise than it was on the date of grant.

During 2004, the Financial Accounting Standards Board and the Securities and Exchange Commission adopted new rules that require that public companies reflect in their income statement over the time period the options vest, an amount of compensation expense related to stock options based on certain assumptions calculated on the date of grant. These rules are set forth in Statement of Financial Accounting Standards No. 123R (“SFAS 123R”) Share Based Compensation , and are described in Note 10 to our financial statements in our 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission. SFAS 123R was effective for Ceradyne commencing January 1, 2006. Under the accounting rules in effect prior to January 1, 2006, there was no financial statement expense required for stock options granted at an exercise price equal to or higher than the closing price of the underlying stock on the date of grant.

Partly based on the new accounting rules for stock options and the concerns of the Compensation Committee regarding the incentive value of stock options, as noted above, the Company in 2005 amended its 2003 Stock Incentive Plan to authorize the grant of restricted stock units, in addition to traditional stock options. This amendment was approved by our stockholders in May 2005. A restricted stock unit (“RSU”) is similar, in many respects, to a stock option, except that there is no exercise price. Each RSU represents the right to receive one share of common stock of the Company when the RSU vests, without payment of any exercise price. For accounting purposes, the value of an RSU, which is the closing price of a share of our stock on the date of grant of the RSU, is expensed and reflected in our income statement ratably over the period the RSU vests.

Commencing in May 2005, after the stockholders approved the amendment to the 2003 Stock Incentive Plan, the Compensation Committee began awarding RSUs to executive officers, rather than stock options. The reasons for this are threefold: Even if the price of our stock declines after the date of grant, RSUs will still have some value when they vest, unlike stock options. RSUs would still serve as an incentive to employees to improve Company performance, which hopefully would be reflected in a higher price of our stock, but they would not lose all of their value merely because the price of our stock might decline below the price on the date of grant, which could be caused by stock market conditions or the economy as a whole, and not by the performance of Ceradyne. Secondly, accounting treatment associated with RSUs would no longer be a deterrent, because the accounting treatment for both RSUs and stock options would be similar commencing January 1, 2006. Lastly, because there is no exercise price required when RSUs vest, contrasted with stock options, the intrinsic value of an RSU when it vests is greater than the intrinsic value of a stock option when it vests. For this reason, the Compensation Committee determined that it would grant fewer RSUs to each officer than the number of stock options that would have been granted based on historical practices. This policy would result in fewer shares being outstanding, resulting in less dilution to stockholders, and would allow the number of shares remaining available under our 2003 Stock Incentive Plan to last longer. RSUs granted to officers vest over five years at the rate of 20% of the units as of each anniversary of the date of grant. This is the same rate of vesting that applies to stock options we have granted in the past.

Compensation of our Named Executive Officers

The amount of each component of compensation established for the named executive officers is based on a number of factors. These factors include company performance, individual performance, compensation paid by companies comparable in size to Ceradyne, input from Hewitt Associates LLC, the recommendations of our Chief Executive Officer, Joel P. Moskowitz, and a review of the prior compensation history of each executive officer. Some of these factors are discussed above. Other factors applicable to each named executive officer are discussed below.

Mr. Moskowitz founded Ceradyne in 1967 and continues to serve the Company full time as our Chairman, Chief Executive Officer and President. The Compensation Committee considers Mr. Moskowitz to be largely responsible for the success the Company has achieved, and to be one of our most important employees. Because he has responsibility for the entire Company, his cash bonus is based on consolidated pre-tax profits.

Mr. Pellizzon has been our Chief Financial Officer since September 2002. He has guided the Company through several financing transactions, the significant acquisition of ESK Ceramics in 2004 and several smaller acquisitions, and with the implementation of internal controls and procedures necessary to comply with complex new financial and accounting requirements imposed by the Sarbanes-Oxley Act of 2002. Because he has responsibility for the entire Company, his cash bonus is also based on consolidated pre-tax profits.

Mr. Reed has been an employee of Ceradyne since November 1983. He is responsible for all of North American operations, which includes our largest operating segment, our Advanced Ceramic Operations, or ACO. Our ACO division manufactures ceramic body armor, which is the reason for most of our dramatic growth since 2002. Mr. Reed is largely responsible for this success. Because he has responsibility for all North American operations, his cash bonus is based on a percentage of the pre-tax profits of all North American-based operating segments.

Effective March 23, 2007, Mr. Kraft’s title changed to Vice President Nuclear and Semiconductor Business Units. He will have responsibility for this new business segment, which we established during 2006. This business segment will focus primarily on developing and manufacturing products for containment of nuclear waste, and currently is small relative to the rest of our Company. Due to the change in his responsibilities, Mr. Kraft’s base salary will remain unchanged in 2007 and his cash bonus will be based on pre-tax operating income of our Advanced Ceramic Operations division, up to a maximum of 45% of his base salary.

Dr. Hartl is responsible for our ESK Ceramics subsidiary, which we acquired in August 2004. He joined ESK Ceramics in 1998. Dr. Hartl’s compensation is based on an arrangement that existed at the time we acquired ESK Ceramics. His long-term equity-based compensation, however, is determined by our Compensation Committee.

MANAGEMENT DISCUSSION FROM LATEST 10K

Overview

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


• lightweight ceramic armor for soldiers and other military applications;

• ceramic industrial components for erosion and corrosion resistant applications;

• ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium hexaboride, and zirconium diboride, which are used in manufacturing armor and a broad range of industrial products; and BORONEIGE ® boron nitride powder for cosmetic products;

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

• durable, reduced friction, ceramic diesel engine components;

• functional and frictional coatings primarily for automotive applications;

• translucent ceramic orthodontic brackets;

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

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

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

• fused silica powders for industrial applications and ceramic crucibles;

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

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

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

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

We conduct our operations primarily through six operating segments. The following table includes a summary of our products by applications for our six segments.

The principal factors contributing to our recent growth in sales are increased demand by the U.S. military for ceramic body armor that protects soldiers and our acquisition of ESK Ceramics in August 2004. The operations of ESK Ceramics have been consolidated with ours since September 1, 2004. In addition, the market for ceramic body armor increased further in 2006 with the introduction of enhanced side ballistic inserts, known as ESBI, which protect the side of the soldier’s torso.

Military conflicts in Iraq and Afghanistan, as well as an increasingly unstable geopolitical climate and the heightened risk of international conflicts, have resulted in increased orders for our ceramic body armor in each year since 2001. We were awarded an Indefinite Delivery/Indefinite Quantity contract by the U.S. Army in August 2004 with an adjusted maximum value of $747.5 million from an original estimated contract value of $461.0 million. Through February 2008, we received sixteen delivery orders equaling the contract amount. We expect to complete the delivery of this adjusted contract amount during 2008. We have also received a number of other orders for ceramic body armor, not covered by the Indefinite Delivery/Indefinite Quantity contract, from the Army and other branches of the U.S. military. In January 2006, we received our first production order for ESBI, or side plates, which are designed to protect the side areas of a soldier’s torso when used in conjunction with our ESAPI ceramic body armor plates. This delivery order, which totaled $70.0 million, was issued to us by the U.S. Army. In June 2006, we were awarded an Indefinite Delivery/Indefinite Quantity contract by the U.S. Army with a maximum value of $611.7 million for ESBI plates. Through February 2008, 6 delivery orders totaling approximately $310.8 million have been issued to us under this contract. Based on our current backlog for ceramic body armor, we expect our shipments of ceramic body armor to be lower in fiscal year 2008 than in 2007. Moreover, government contracts typically may be cancelled by the government at any time without penalty. For the next several quarters, and perhaps longer, demand for ceramic body armor is likely to be the most significant factor affecting our sales.

In response to a solicitation notice from the U.S. Army regarding the next ballistic threat generation of body armor, we submitted our quotation for this procurement in February 2008. This procurement, like most government procurements for ceramic body armor, will be awarded in an open competitive bidding process. We cannot be certain when the military will make awards under this procurement, or whether or to what extent we will be one of the successful bidders.

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 and the level of international conflicts. Moreover, ceramic armor contracts generally are awarded in an open competitive bidding process. Therefore, our future level of sales of ceramic body armor will depend on the U.S. military’s continued demand for these products and our ability to successfully compete for and retain this business.

In July 2007 we entered into an agreement with Ideal Innovations, Inc. and Oshkosh Truck Corporation to further develop, produce and market an armored military vehicle we call the Bull tm . The Bull tm armored vehicle is intended to address the increasing need for protection from improvised explosive devices, known as IEDs, mine blasts and high-threat, explosively formed projectiles, known as EFPs, and will be built on a combat-proven Oshkosh Truck chassis. The Bull tm armored solution, conceived by Ideal Innovations in 2005 and developed with Ceradyne in 2006, has been tested by the Army Test Center, Aberdeen, Maryland, and demonstrated to be capable of protecting vehicle occupants against IED, EFP and mine blast threats. It is designed to meet current IED threats, and is intended to withstand the increasingly prevalent and higher EFP threats now faced by the U.S. military. In September 2007, in response to a solicitation notice from the U.S. military regarding Mine Resistant Ambush Protected Vehicles II Enhanced Vehicle Competitive, known as MRAP II, we, together with Ideal Innovations and Oshkosh Truck, submitted a quotation and delivered both a 6-person and a 10-person MRAP II vehicle named the Bull tm , to the U.S. Army Aberdeen Test Center for further service evaluation. In December 2007, the U.S. government awarded a delivery order totaling $18.1 million to Ideal Innovations, Ceradyne and Oshkosh Truck for several 6-person versions and targets of the Bull tm armored vehicle to be used for further government testing. Ideal Innovations is the prime contractor and we are a sub-contractor to Ideal Innovations. Whether we receive additional orders for the Bull tm armored vehicle will depend upon the success of these tests, the U.S. military’s need and funding for MRAP II armored vehicles, the results of testing of a competitor’s MRAP II armored vehicle, and whether our pricing for the Bull tm armored vehicle is competitive.

Ceradyne’s design and production contribution to the Bull tm armored vehicle program is based on our experience and expertise learned over many years in developing ceramic armor systems for military helicopters, ground-based vehicles and boats. Due to the ballistic threat level that MRAP II armored vehicles are required to meet, the current design of the Bull tm armored vehicle does not include any ceramic armor. Although we are engaged in development of ceramic armor systems to use on future versions of the Bull tm armored vehicle, we do not know when or if a ceramic armor solution will be available or whether it would be acceptable to the U.S. military.

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

Our order backlog was $238.9 million as of December 31, 2007 and $344.3 million as of December 31, 2006. Orders for ceramic armor represented approximately $179.5 million, or 75.1% of the total backlog as of December 31, 2007 and $285.5 million, or 82.9% of the total backlog as of December 31, 2006. We expect that substantially all of our order backlog as of December 31, 2007 will be shipped during 2008.

Our sales to customers located outside of the United States have varied in recent years, representing $136.2 million, or 18.0% of net sales in 2007, $105.7 million, or 15.9% during 2006 and $96.1 million, or 26.1% in 2005. 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, 31.2% were denominated in U.S. dollars during 2007.

Net Sales. Our net sales consist primarily of revenues from the sale of products, which we recognize when an agreement of sale exists, product delivery and acceptance has occurred, and collection is reasonably assured.

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, which we also include in cost of product sales.

The cost of electricity comprises a significant portion of our cost of product sales. In 2004, we began expanding our high-energy utilization silicon nitride manufacturing operations at our new facility in Lexington, Kentucky, where costs, particularly for electricity and occupancy, are lower than in California. We have increased our manufacturing capacity for the production of body armor plates by adding three hot press lines at this new facility. We chose this facility for the location of the hot press expansion for the same reasons: lower cost of electricity and occupancy. The cost of electricity for our manufacturing operations in the United States and Europe was approximately $13.5 million, or 3.0% as a percentage of cost of product sales in 2007, approximately $11.1 million, or 2.8% as a percentage of cost of product sales in 2006, and approximately $8.4 million, or 3.0% as a percentage of cost of product sales in 2005.

Selling 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.

General and Administrative 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, and the research and development of new materials technology and products. These costs are expensed as incurred.

Results of Operations

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net Sales. Our net sales for the year ended December 31, 2007 were $756.8 million, an increase of $93.9 million, or 14.2%, from $662.9 million in the corresponding prior year period.

Our Advanced Ceramic Operations division had net sales for the year ended December 31, 2007 of $587.3 million, an increase of $58.6 million, or 11.1% from the $528.7 million in the prior year. The primary reason for this improvement was the shipment of $551.3 million of ceramic body and other armor components for defense customers, an increase of $63.1 million, or 12.9% from the $488.2 million of net sales in the prior year due to increased demand from the U.S. Department of Defense. Net sales for our automotive/diesel component product line, including cam rollers, were $11.0 million, a decrease of $6.0 million, or 35.6%, from the $17.0 million in the prior year. The primary reasons for this decrease were that our customers produced less heavy-duty diesel truck engines in 2007 and two of our customers replaced some of our ceramic cam Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net Sales. Our net sales for the year ended December 31, 2007 were $756.8 million, an increase of $93.9 million, or 14.2%, from $662.9 million in the corresponding prior year period.

Our Advanced Ceramic Operations division had net sales for the year ended December 31, 2007 of $587.3 million, an increase of $58.6 million, or 11.1% from the $528.7 million in the prior year. The primary reason for this improvement was the shipment of $551.3 million of ceramic body and other armor components for defense customers, an increase of $63.1 million, or 12.9% from the $488.2 million of net sales in the prior year due to increased demand from the U.S. Department of Defense. Net sales for our automotive/diesel component product line, including cam rollers, were $11.0 million, a decrease of $6.0 million, or 35.6%, from the $17.0 million in the prior year. The primary reasons for this decrease were that our customers produced less heavy-duty diesel truck engines in 2007 and two of our customers replaced some of our ceramic cam rollers with cheaper steel products. Net sales of our orthodontic brackets product line were $10.6 million, an increase of $229,000, or 2.2%, from the $10.4 million in the prior year.

Our ESK Ceramics subsidiary had net sales for the year ended December 31, 2007 of $160.6 million, an increase of $12.4 million, or 8.4% from the $148.2 million in the prior year. Approximately $7.9 million of this increase is attributable to a higher value of the Euro versus the U.S. dollar in 2007 compared to 2006. Sales of industrial products for the year ended December 31, 2007 were $92.6 million, an increase of $14.0 million, or 17.9% from the $78.6 million in the prior year. This increase was the result of a higher demand for fluid handling and industrial wear parts. Sales of automotive/diesel products for the year ended December 31, 2007 were $20.7 million, an increase of $3.4 million, or 20.0% from the $17.3 million in the prior year. This was caused by sales to new original equipment manufacturer (OEM) customers in 2007. Sales of defense products for the year ended December 31, 2007 were $45.2 million, a decrease of $7.1 million, or 13.5% from the $52.3 million in the prior year. Included in sales of defense products for the year ended December 31, 2007 were inter-segment sales of $40.7 million compared to $40.4 million in the prior year. The decrease was due to a decrease of $7.4 million in sales of boron carbide powder to third parties in the defense industry for the year ended December 31, 2007, partially offset by an increase of $300,000 in sales of boron carbide powder to our Advanced Ceramic Operations division. Third parties purchased less boron carbide powder in 2007 because their sales of ceramic body armor declined.

Our Semicon Associates division had net sales for the year ended December 31, 2007 of $8.0 million, a decrease of $1.1 million or 12.1% from the $9.1 million in the prior year The decrease in sales reflects lower shipments of microwave and laser cathodes of $0.7 million and $300,000 of magnets in 2007 when compared to 2006.

Our Thermo Materials division had net sales for the year ended December 31, 2007 of $32.0 million, an increase of $17.0 million, or 113.2%, from the $15.0 million in the prior year. The increase was due to an increase of $4.7 million in sales of crucibles used in the manufacture of photovoltaic cells for the solar energy markets. Of this increase, $2.1 million was from sales of crucibles manufactured by our new crucible operation in China to customers located in China. Also contributing $12.1 million of the increase in sales was the consolidation of our acquisition, Minco, Inc., as of July 10, 2007. Offsetting these increases were a decline in sales to the defense industry and a reduction in sales of ceramic rollers to the glass industry.

Our Ceradyne Canada subsidiary, which commenced operations in July 2006, had net sales for the year ended December 31, 2007 of $3.9 million, an increase of $1.5 million, or 62.8% from the $2.4 million in the prior year. The increase was due to a full year of operations in 2007 compared to only six months in 2006, and an increase in sales of metal matrix composite products.

Our Ceradyne Boron subsidiary, which we acquired on August 31, 2007, had net sales for the four month period ended December 31, 2007 of $7.8 million.

Gross Profit. Our gross profit was $306.0 million for the year ended December 31, 2007, an increase of $45.1 million, or 17.3% from $260.9 million in the prior year. As a percentage of net sales, gross profit was 40.4% for the year ended December 31, 2007, compared to 39.4% for the prior year. The increase in gross profit as a percentage of net sales in the year ended December 31, 2007 was the result of increased sales, particularly of body armor, improved sales mix and higher operating leverage. The increase in gross profit was primarily caused by the increase in body armor sales and the inclusion of our acquisitions during 2007 of Minco, Inc. and Ceradyne Boron Products in our consolidated results of operations.

Our Advanced Ceramic Operations division posted gross profit of $247.8 million for the year ended December 31, 2007, an increase of $38.1 million, or 18.2% from $209.7 million in the prior year. As a percentage of net sales, gross profit was 42.2% for the year ended December 31, 2007, compared to 39.7% for the prior year. The primary reasons for the increase in gross profit and gross profit as a percentage of net sales were increased sales of body armor, improved sales mix and higher operating leverage.

Our ESK Ceramics subsidiary had a gross profit of $48.4 million, or 30.1% of net sales, for the year ended December 31, 2007, compared to gross profit of $47.7 million, or 32.2% of net sales, for the year ended December 31, 2006. The decrease in gross profit as a percentage of net sales in the year ended December 31, 2007 was the result of increased labor and electricity expenses, continued price reductions in our evaporation boat business due to competitive forces and a reduction in higher margin armor sales to external customers.

Our Semicon Associates division had gross profit of $1.9 million for the year ended December 31, 2007, a decrease of $0.6 million, or 23.9% from $2.5 million in the prior year. As a percentage of net sales, gross profit was 24.0% for the year ended December 31, 2007, compared to 27.8% for the prior year. The decrease in gross profit and in gross profit as a percentage of net sales in the year ended December 31, 2007 were due primarily to sales returns and losses in our magnet business and lower sales of microwave and laser cathodes resulting in higher per unit manufacturing expenses.

Our Thermo Materials division had gross profit of $7.7 million for the year ended December 31, 2007, an increase of $4.5 million or 141.5% compared to $3.2 million in the prior year. As a percentage of net sales, gross profit was 24.8% for the year ended December 31, 2007, compared to 21.1% for the prior year. The improvements in gross profit and gross profit as a percentage of sales were primarily due to lower sales of fused silica and casting product lines which have lower gross margins and an increase in the sales of crucibles which have higher gross margins. Also contributing $2.3 million of the increase in gross profit was the consolidation of our new acquisition, Minco, Inc., as of July 10, 2007.

Our Ceradyne Canada subsidiary, which commenced operations in July 2006, had a gross loss for the year ended December 31, 2007 of $1.9 million, an increase in the gross loss of $1.3 million, or 226.6% from the $0.6 million gross loss in the prior year. The increase in the gross loss was caused by the continuation of start up expenses and higher scrap rates.

Our Ceradyne Boron subsidiary, which we acquired on August 31, 2007, contributed $2.9 million of gross profit for the four month period ended December 31, 2007.

Selling Expenses. Our selling expenses were $26.9 million for the year ended December 31, 2007, an increase of $4.0 million, or 17.4%, from $22.9 million in the prior year. Selling expenses, as a percentage of net sales, increased from 3.5% for the year ended December 31, 2006 to 3.6% of net sales for the year ended December 31, 2007. The increase in selling expenses as a percentage of net sales was due to higher personnel expenses that could not be offset by price increases to customers. Increases in the number of employees and related personnel expenses and an additional $1.2 million of selling expenses from the consolidations of our acquisitions of Minco, Inc. as of July 10, 2007 and Ceradyne Boron Products as of September 1, 2007 primarily accounted for the increase in selling expenses for the year ended December 31, 2007.

General and Administrative Expenses. Our general and administrative expenses for the year ended December 31, 2007 were $40.8 million, an increase of $5.5 million, or 15.6% from $35.3 million in the year ended December 31, 2006. General and administrative expenses, as a percentage of net sales, increased from 5.3% for the year ended December 31, 2006 to 5.4% of net sales for the year ended December 31, 2007. Contributing $3.1 million to the increase in general and administrative expenses for the year ended December 31, 2007 was the consolidation of our 2007 acquisitions of Minco, Inc. and Ceradyne Boron Products. Also contributing to the increase in general and administrative expenses for the year ended December 31, 2007 were increases in the number of employees and related personnel expenses, including increased bonus accruals as a result of the Company’s higher operating profits. The comparison to the prior year was favorably impacted by a non-cash charge of $2.2 million in the second quarter of 2006 based on the results of our Special Committee’s review of our historical stock option practices, including our underlying option grant documentation and procedures, as described in more detail above under the caption “Overview — Review of Historical Stock Option Grant Procedures,” and a related charge for payroll tax and penalties of $1.2 million.

Research and Development Expenses. Our research and development expenses for the year ended December 31, 2007 were $17.6 million, an increase of $7.7 million, or 77.1%, from $9.9 million in the prior year. Research and development expenses, as a percentage of net sales, increased from 1.5% for the year ended December 31, 2006 to 2.3% of net sales for the year ended December 31, 2007. The primary reason for these increases were development of next generation body armor products and the continuing development of combat vehicle armor.

Other Income (Expense). Our net other income for the year ended December 31, 2007 was $5.8 million, compared to net other income of $1.8 million in the prior year. The primary reason for the increase was an increase in interest income received from investing higher cash balances in short-term marketable securities. Offsetting this was a charge of $2.1 million for impairment due to the other than temporary reduction in the value of our investments in auction rate securities. Interest expense was $4.2 million in the year ended December 31, 2007, compared to $4.1 million in the prior year.

Income before Provision for Income Taxes. Our income before provision for income taxes for the year ended December 31, 2007 was $226.5 million, an increase of $31.9 million or 16.4% from the $194.6 million in the prior year.

Our Advanced Ceramic Operations division’s income before provision for income taxes for the year ended December 31, 2007 was $212.7 million, an increase of $35.7 million or 20.1%, from $177.0 million in the prior year. The increase in income before provision for income taxes for the year ended December 31, 2007 was a result of higher sales of body armor and an increase in gross margins as a result of improved sales mix and higher operating leverage.

Our ESK Ceramics subsidiary’s income before provision for income taxes for the year ended December 31, 2007 was $13.4 million, a decrease of $3.9 million, or 22.7% from $17.3 million in the prior year. The decrease in income before provision for income taxes for the year ended December 31, 2007 was the result of increased labor and electricity expenses, higher selling expenses due to increases in the number of employees and related personnel expenses, higher research and development expenses because of the development of next generation ceramic powders for body armor products, and the negative impact of the exchange rate of the Euro when compared to the U.S. dollar.

Our Semicon Associates division’s income before provision for income taxes for the year ended December 31, 2007 was $1.1 million, a decrease of $449,000, or 28.4%, from $1.6 million in the prior year. The decrease in income before provision for income taxes for the year ended December 31, 2007 was a result of lower sales of our microwave and laser cathodes products resulting in higher per unit manufacturing expenses, and sales returns and losses in our magnet business.

Our Thermo Materials division’s income before provision for income taxes for the year ended December 31, 2007 was $2.3 million, an increase of $1.4 million, or 161.5%, from $0.9 million in the prior year. The increase in income before provision for income taxes for the year ended December 31, 2007 was primarily due to a sales mix change due to lower sales of fused silica and casting product lines which have lower gross margins and an increase in the sales of crucibles which have higher gross margins. Also contributing to the increase in income before provision for income taxes for the year ended December 31, 2007 was $166,000 of operating profit from our new acquisition, Minco, Inc.

Our Ceradyne Canada subsidiary’s loss before provision for income taxes for the year ended December 31, 2007 was $3.0 million, an increase of $2.4 million, or 347.2%, in from $0.7 million in the prior year. The increase in the loss before provision for income taxes for the year ended December 31, 2007 was caused by the continuation of start up expenses, higher scrap rates and lower sales resulting in higher per unit expenses.

Our Ceradyne Boron Product subsidiary’s income before provision for income taxes for the year ended December 31, 2007 was $0.7 million.

Income Taxes. Our provision for income taxes for the year ended December 31, 2007 was $82.3 million, an increase of $16.1 million, or 24.4% from the $66.2 million in the prior year. The effective income tax rate for the year ended December 31, 2007 was 36.3% compared to 34.0% in the corresponding prior year period. The increase in the effective tax rate results from higher state tax rates due to apportionment of more sales inside of California and decreases in extraterritorial income related deductions. These increases to the effective tax rate were partially offset by an increase in the manufacturing deduction.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Results of Operations for the Three and Nine Months Ended September 30, 2007 and 2006
Net Sales. Our net sales for the three months ended September 30, 2007 were $191.6 million, an increase of $5.8 million, or 3.1%, from $185.8 million of net sales in the corresponding quarter of the prior year. Net sales for the nine months ended September 30, 2007 were $565.4 million, an increase of $81.2 million, or 16.8%, from $484.2 million in the corresponding prior year period. During the three months ended September 30, 2007, sales recorded from acquisitions during the quarter contributed $7.5 million to the increase in consolidated net sales, which was partially offset by decreases in sales of body armor.
Net sales for our Advanced Ceramic Operations division for the three months ended September 30, 2007 were $145.9 million, a decrease of $6.6 million, or 4.3%, from $152.5 million of net sales in the corresponding quarter of the prior year. The primary reason for the decrease was a decline in shipments of ceramic body armor and other armor components for defense contractors in the amount of $5.2 million, or 3.7%, to $136.7 million from the $141.9 million of ceramic armor shipments in the third quarter of 2006. Net sales for our automotive/diesel component product line were $2.8 million, a decrease of $1.5 million, or 34.4%, from $4.3 million in the corresponding quarter of the prior year. The primary reason for this decrease is that in 2006 our customers produced more heavy-duty diesel truck engines than in 2007 due to forward buying in 2006 in anticipation of increased emission standards that became effective in 2007. Additionally, we are aware that some of our customers are designing new engines that do not include our cam rollers and, as a result, we expect that sales of cam rollers will decline in 2007 compared to 2006. Net sales of our orthodontic brackets product line were $2.5 million, a decrease of $192,000, or 7.0%, from net sales of $2.7 million in the corresponding quarter of the prior year.
Net sales for our Advanced Ceramic Operations division for the nine months ended September 30, 2007 were $447.1 million, an increase of $63.7 million, or 16.6% from $383.4 million in the corresponding period of the prior year. The primary reason for this improvement was the shipment of $421.1 million of ceramic body and other armor components for defense customers, an increase of $67.6 million, or 19.1%, from $353.5 million in the corresponding prior year period. This increase in net sales is due to increased demand from the U.S. Department of Defense as compared to the nine months ended September 30, 2006. Net sales for our automotive/diesel component product line, including cam rollers, were $7.1 million, a decrease of $6.0 million, or 45.9%, from $13.1 million in the corresponding prior year period. The primary reason for this decrease is that in 2006 our customers produced more heavy-duty diesel truck engines than in 2007 due to forward buying in 2006 in anticipation of increased emission standards that became effective in 2007. Net sales of our orthodontic brackets product line were $8.0 million, an increase of $355,000, or 4.6%, from $7.7 million in the corresponding prior year period. This was the result of an increase in sales incentive plans deployed by our customer in the markets it serves.
Our ESK Ceramics subsidiary had net sales for the three months ended September 30, 2007 of $39.0 million, an increase of $2.0 million, or 5.6%, from $37.0 million in the corresponding quarter of the prior year. Approximately $1.7 million of this increase is attributable to a higher value of the Euro versus the U.S. dollar during the three months ended September 30, 2007 compared to the corresponding quarter of the prior year. Sales of industrial products for the three months ended September 30, 2007 were $23.5 million, an increase of $3.6 million, or 18.0%, from $19.9 million in the corresponding quarter of the prior year. This increase was the result of a higher demand for industrial wear parts from the textile industry. Sales of automotive/diesel products for the three months ended September 30, 2007 were $5.2 million, an increase of $0.5 million, or 11.6%, from $4.7 million in the corresponding quarter of the prior year. Increased demand from automotive original equipment manufacturers accounted for the increased sales. Sales of commercial products, consisting of boron nitride for the cosmetic industry began in 2007, and for the three months ended September 30, 2007 were $0.6 million. Sales of defense products for the three months ended September 30, 2007 were $9.7 million, a decrease of $2.6 million, or 21.3%, from the $12.4 million in the corresponding quarter of the prior year. Included in sales of defense products for the three months ended September 30, 2007 were inter-segment sales of $8.2 million compared to $10.5 million in the prior year. The decrease of $2.3 million in inter-segment sales was due to a reduction in demand of boron carbide at our Advanced Ceramic Operations division. In addition there was a decrease of $427,000 in sales of defense products to third parties for the three months ended September 30, 2007.
For the nine months ended September 30, 2007, net sales for ESK Ceramics were $121.5 million, an increase of $11.1 million, or 10.0%, from $110.4 million in the corresponding prior year period. Approximately $3.3 million of this increase is attributable to a higher value of the Euro versus the U.S. dollar during the nine months ended September 30, 2007 compared to the corresponding prior year period. Sales of industrial products for the nine months ended September 30, 2007 were $68.4 million, an increase of $10.3 million, or 17.8%, from $58.1 million in the corresponding prior year period. This increase was the result of a higher demand for fluid handling, metallurgy and industrial wear parts. Sales of automotive/diesel products for the nine months ended September 30, 2007 were $15.1 million, an increase of $1.9 million, or 14.8%, from $13.2 million in the prior year. Further market penetration into more automobile original equipment manufacturers with more sales of surfaced engineered parts was the primary cause of this increase. Sales of commercial products, consisting of boron nitride for the cosmetic industry, for the nine months ended September 30, 2007 were $1.6 million. Sales of defense products for the nine months ended September 30, 2007 were $36.3 million, a decrease of $2.8 million, or 7.2%, from $39.1 million in the prior year. Included in sales of defense products for the nine months ended September 30, 2007 were inter-segment sales of $32.5 million compared to $27.9 million in the prior year. The increase of $4.6 million was due to an increase in demand of boron carbide at our Advanced Ceramic Operations division which was offset by a decrease of $7.4 million in sales to third parties in the defense industry for the nine months ended September 30, 2007. This decrease was due to a reduction in demand for boron carbide from competitors of our Advanced Ceramic Operations division.
Our Semicon Associates division had net sales for the three months ended September 30, 2007 of $1.6 million, a decrease of $0.6 million, or 23.7%, from $2.2 million in the corresponding quarter of the prior year. For the nine months ended September 30, 2007, net sales for Semicon Associates were $6.0 million, a decrease of $0.8 million, or 11.9%, from $6.8 million in the corresponding prior year period, reflecting lower shipments of magnets and cathodes for cathode ray tubes.
Our Thermo Materials division had net sales for the three months ended September 30, 2007 of $10.2 million, an increase of $6.0 million, or 145.5%, from $4.2 million in the corresponding quarter of the prior year. For the nine months ended September 30, 2007, net sales for Thermo Materials were $18.5 million, an increase of $7.5 million, or 68.4%, from $11.0 million in the corresponding prior year period. We acquired Minco, Inc. on July 10, 2007, which contributed $5.8 million of external sales during the three months ended September 30, 2007. For the three months ended September 30, 2007, the balance of the increase in sales of our Thermo Materials division was due to an increase in sales of crucibles used in the manufacture of photovoltaic cells for the solar energy markets of $488,000, or 27.9%, when compared to the same period last year. Offsetting this increase were declines in sales of $0.6 million, or 38.8%, to the defense industry. For the nine months ended September 30, 2007, in addition to the sales contribution of $5.8 million from sales by Minco, sales of crucibles increased $1.7 million, or 40.4%, when compared to the same period last year. Offsetting this increase was a decline in sales to the defense industry of $447,000, or 11.8%.
Our Ceradyne Canada subsidiary, which commenced operations in July 2006, had net sales of $1.4 million for the three months ended September 30, 2007, an increase of $0.9 million, or 186.4%, from $485,000 in the corresponding quarter of the prior year. For the nine months ended September 30, 2007, net sales of Ceradyne Canada were $3.2 million, an increase of $2.7 million, or 554.0%, from the $485,000 for the corresponding prior year period. Net sales at our Ceradyne Canada subsidiary include nine months of operations in 2007, compared to only two months of operations in 2006. In addition, sales during both periods were adversely affected by the relocation of production equipment to Canada. Sales in 2007 were adversely affected by a a delay in qualifying for Nuclear Quality Assurance Certification.
Our Ceradyne Boron Products subsidiary, which we acquired on August 31, 2007, had sales of $2.1 million for the one month ended September 30, 2007.
Gross Profit. Our gross profit was $75.8 million for the three months ended September 30, 2007, an increase of $5.3 million or 7.5%, from $70.5 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 39.6% for the three months ended September 30, 2007 compared to 38.0% for the corresponding prior year quarter. For the nine months ended September 30, 2007, our gross profit was $230.3 million, an increase of $42.1 million, or 22.4%, from $188.2 million in the prior year. As a percentage of net sales, gross profit was 40.7% for the nine months ended September 30, 2007 compared to 38.9% for the corresponding prior year period. The increase in gross profit as a percentage of net sales was the result of improved manufacturing production rates in our armor assembly areas compared to the corresponding prior year quarter. Gross profit during the three and nine months ended September 30, 2007 included $1.5 million of gross profit from the two businesses we acquired in the third quarter of 2007, Ceradyne Boron Products and Minco, Inc.
Our Advanced Ceramic Operations division posted gross profit of $61.2 million for the three months ended September 30, 2007 an increase of $4.7 million, or 8.3%, from $56.5 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 41.9% for the three months ended September 30, 2007, compared to 37.0% for the corresponding prior year quarter. For the nine months ended September 30, 2007, gross profit for the Advanced Ceramic Operations division was $189.4 million, an increase of $40.5 million, or 27.2%, from $148.9 million in the corresponding prior year period. As a percentage of net sales, gross profit was 42.4% for the nine months ended September 30, 2007 compared to 38.9% for the corresponding prior year period. For both the three and nine months ended September 30, 2007, the reasons for the increase in gross profit and gross profit as a percentage of net sales were improved manufacturing production rates and lower workers compensation costs.
Our ESK Ceramics subsidiary had gross profit of $11.6 million for the three months ended September 30, 2007, a decrease of $1.1 million, or 8.7%, from $12.7 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 29.7% for the three months ended September 30, 2007, compared to 34.3% for the three months ended September 30, 2006. The decrease in gross profit as a percentage of net sales for the three months ended September 30, 2007 was the result of an unfavorable sales mix due to lower sales of ceramic powder for armor applications and more competitive pricing for the sales of evaporation boats.
For the nine months ended September 30, 2007, gross profit for ESK Ceramics was $37.6 million, an increase of $1.5 million, or 4.1% as compared to $36.1 million in the prior comparable period. As a percentage of net sales, gross profit was 31.0% for the nine months ended September 30, 2007, compared to 32.7% for the nine months ended September 30, 2006. The decrease in gross profit as a percentage of net sales in the nine month period ended September 30, 2007 was the result of an unfavorable sales mix due to lower sales of ceramic powder for armor applications and more competitive pricing for the sales of evaporation boats.
Our Semicon Associates division had gross profit of $275,000 for the three months ended September 30, 2007, a decrease of $277,000, or 50.2%, compared to $0.6 million in the corresponding quarter of the prior year. As a percentage of net sales, gross profit was 16.8% for the three months ended September 30, 2007, compared to 25.7% for the corresponding prior year period. For the nine months ended September 30, 2007, gross profit for Semicon Associates was $1.2 million, a decrease of $0.8 million, or 38.5%, from $2.0 million in the corresponding prior year period. As a percentage of net sales, gross profit was 20.0% for the nine months ended September 30, 2007 compared to 28.6% for the corresponding prior year period. The decrease in gross profit and in gross profit as a percentage of net sales in the nine month period ended September 30, 2007 was due primarily to reduced sales, unfavorable product mix, higher expenses related to the production of magnets and higher spending for repairs and maintenance.
Our Thermo Materials division had gross profit of $2.2 million for the three months ended September 30, 2007, an increase of $1.3 million, or 153.3%, from $0.9 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 21.4% for the three months ended September 30, 2007 compared to 20.7% for the corresponding prior year quarter. The increase in gross profit as a percentage of sales for the three months ended September 30, 2007 was primarily due to sales mix and improved yields in the production of crucibles. During the three months ended September 30, 2007, our Minco, Inc. subsidiary, acquired on July 10, 2007, contributed gross profit of $0.9 million, but this was substantially offset by higher cost of goods sold on inventory purchased in the acquisition for the step-up of inventory to fair value of $0.7 million. For the nine months ended September 30, 2007, Thermo Materials had gross profit of $4.1 million, an increase of $1.8 million, or 75.9%, compared to $2.3 million in the prior year period. As a percentage of net sales, gross profit was 21.9% for the nine months ended September 30, 2007, compared to 21.0% for the corresponding prior year period. The improvements in gross profit and gross profit as a percentage of sales were primarily due to an increase in the sales of crucibles, which have higher gross margins compared to Thermo Materials’ other products.
Our Ceradyne Canada subsidiary, which commenced operations in July 2006, had a gross loss of $31,000 for the three months ended September 30, 2007 and a gross loss of $1.4 million for the nine months ended September 30, 2007. The loss was caused by under absorbed manufacturing overhead due to lower than budgeted sales caused by a delay in qualifying for Nuclear Quality Assurance Certification.
Our Ceradyne Boron Products subsidiary, which we acquired on August 31, 2007, had gross profit of $0.6 million for the one month ended September 30, 2007. During this period, gross profit was decreased by higher cost of goods sold inventory purchased in the acquisition for the step-up of inventory to fair value of $357,000.

Selling Expenses. Our selling expenses were $6.9 million for the three months ended September 30, 2007, an increase of $1.2 million or 21.0%, from $5.7 million in the corresponding prior year quarter. Selling expenses, as a percentage of net sales, increased from 3.1% for the three months ended September 30, 2006 to 3.6% of net sales for the three months ended September 30, 2007. The primary reasons for the increase of $1.2 million were severance expenses of $0.8 million incurred in connection with the termination of the president of ESK Ceramics in the quarter ended September 30, 2007, the negative impact of exchange rates on the dollar, and $212,000 of selling expenses due to the inclusion of the results of the Minco, Inc. acquisition. For the nine months ended September 30, 2007, selling expenses were $19.6 million, an increase of $2.2 million, or 12.9%, from $17.4 million in the corresponding prior year period. Selling expenses, as a percentage of net sales, decreased from 3.6% for the nine months ended September 30, 2006 to 3.5% of net sales for the nine months ended September 30, 2007. The decrease in selling expenses as a percentage of net sales was due to the inclusion of operations of our recent acquisitions of Ceradyne Boron Products and Minco from their respective dates of acquisition for the three months ended September 30, 2007. These acquisitions contributed $7.9 million of sales but only $212,000 of sales expenses. The primary reasons for the increase of $2.2 million in sales expenses in the nine months ended September 30, 2007, compared to the prior period were severance expenses of $0.8 million incurred in connection with the termination of the president of ESK Ceramics in the quarter ended September 30, 2007, and increases in the number of employees and related personnel expenses primarily accounted for the increase in selling expenses for the nine months ended September 30, 2007.
General and Administrative Expenses. Our general and administrative expenses for the three months ended September 30, 2007 were $11.3 million, an increase of $2.6 million, or 29.0%, from $8.7 million in the corresponding prior year quarter. General and administrative expenses, as a percentage of net sales, increased from 4.7% for the three months ended September 30, 2006 to 5.9% for the three months ended September 30, 2007. The primary reasons for the increase were the reporting of $1.5 million of general and administrative expenses contributed by our recent acquisitions, $0.5 million of general and administrative expenses in connection with the start up of our China facility that we did not have in the nine months ended September 30, 2006 and the negative impact of exchange rates on the dollar. For the nine months ended September 30, 2007, general and administrative expenses were $30.2 million, an increase of $4.1 million, or 15.7%, from $26.1 million in the corresponding prior year period. General and administrative expenses, as a percentage of net sales, decreased from 5.4% for the nine months ended September 30, 2006 to 5.3% for the nine months ended September 30, 2007. Increases in the number of employees and related personnel expenses, termination expenses discussed above, increased bonus accruals as a result of the Company’s higher operating profits, start up expenses for our China facility, and higher expenses for information technology accounted for the increase in general and administrative expenses. Also, contributing to the increase was the recording of $1.5 million of general and administrative expenses as a result of our acquisitions of Ceradyne Boron Products and Minco from their respective dates of acquisition for the three months ended September 30, 2007.
Research and Development Expenses. Our research and development expenses for the three months ended September 30, 2007 were $5.7 million, an increase of $3.2 million, or 124.3%, from $2.5 million in the corresponding prior year quarter. Research and development expenses, as a percentage of net sales, increased from 1.4% of net sales for the three months ended September 30, 2006 to 3.0% of net sales for the three months ended September 30, 2007. For the nine months ended September 30, 2007, research and development expenses were $13.6 million, an increase of $5.9 million, or 75.4%, from $7.7 million in the corresponding prior year period. Research and development expenses, as a percentage of net sales, increased from 1.6% of net sales for the nine months ended September 30, 2006 to 2.4% of net sales for the nine months ended September 30, 2007. The primary reason for the increased research and development expenses were expenditures for body armor and combat vehicle armor development, particularly for producing and delivering the Bull ™ armored vehicle in response to a solicitation notice from the U.S. Military regarding a Mine Resistant Ambush Protected Vehicles (MRAP) II Enhanced Vehicle.
Other Income (Expense). Our net other income for the three months ended September 30, 2007 was $2.1 million, an increase of $1.6 million, or 320.3%, compared to $0.5 million in the corresponding prior year quarter. Other income for the nine months ended September 30, 2007 was $6.5 million, an increase of $5.6 million, or 563.3%, compared to net other income of $1.0 million for the nine months ended September 30, 2006. The primary reason for the change was an increase in interest income received from investing higher cash balances in short-term marketable securities. Interest expense was $1.1 million for the three months ended September 30, 2007 and $3.2 million for the nine months ended September 30, 2007, virtually unchanged from the prior year periods.
Income before Provision for Income Taxes. Our income before provision for income taxes for the three months ended September 30, 2007 was $54.1 million, virtually unchanged from the corresponding prior year quarter. For the nine months ended September 30, 2007, income before provision for income taxes was $173.4 million, an increase of $35.4 million, or 25.7%, from $138.0 million for the nine months ended September 30, 2006.
Our Advanced Ceramic Operations division’s income before provision for income taxes for the three months ended September 30, 2007 was $52.3 million, an increase of $4.6 million, or 9.6%, compared to $47.7 million in the corresponding prior year quarter. For the nine months ended September 30, 2007, income before provision for income taxes was $165.6 million, an increase of $42.4 million, or 34.4%, from $123.2 million for the nine months ended September 30, 2006. The increase in income before provision for income taxes for the nine months ended September 30, 2007 was a result of higher sales of body armor, improved manufacturing production rates in our armor assembly areas and a reduction of start up and training expenses in our Lexington, Kentucky hot press facility, compared to the nine months ended September 30, 2006. Offsetting these improvements were higher research and development expenses for armor products.
Our ESK Ceramics subsidiary’s income before provision for income taxes for the three months ended September 30, 2007 was $2.1 million, a decrease of $3.7 million, or 63.6%, compared to $5.8 million in the corresponding prior year quarter. For the nine months ended September 30, 2007 income before provision for income taxes was $10.4 million, a decrease of $3.6 million, or 25.4%, from $14.0 million in the corresponding prior year period. The decrease in income before provision for income taxes was due to an unfavorable sales mix due to lower sales of ceramic powder for armor applications, severance expenses, higher research and development expenses in connection with new ceramic powders for armor applications and other new products, and higher personnel costs in connection with selling, general and administrative expenses.
Our Semicon Associates division’s income before provision for income taxes for the three months ended September 30, 2007 was $78,000, a decrease of $259,000, or 76.9%, from $337,000 in the corresponding prior year quarter. For the nine months ended September 30, 2007 income before provision for income taxes was $0.6 million, a decrease of $0.6 million, or 53.7%, from $1.2 million in the corresponding prior year period. The decrease in income before provision for income taxes for the nine months ended September 30, 2007 was due primarily to reduced sales of laser cathodes and magnets, unfavorable product mix, higher expenses related to the production of magnets and higher spending for repairs and maintenance.
Our Thermo Materials division’s loss before provision for income taxes for the three months ended September 30, 2007 was $30,000, a decrease of $323,000 from income before provision for taxes of $293,000 in the corresponding prior year quarter. For the nine months ended September 30, 2007 income before provision for income taxes was $492,000 million, a decrease of $202,000, or 29.1%, from $0.7 million in the corresponding prior year period. The decrease in income before provision for income taxes for the nine months ended September 30, 2007 was primarily due to start up expenses in China in connection with the new crucible plant that opened in June 2007.
Our Ceradyne Canada subsidiary’s loss before provision for income taxes for the three months ended September 30, 2007 was $342,000, an increase of $45,000, or 15.2%, from $297,000 in the corresponding prior year quarter. For the nine months ended September 30, 2007, the loss before provision for income taxes was $2.4 million, an increase of $2.1 million, or 657.0%, from $321,000 in the corresponding prior year period. Ceradyne Canada commenced operations in July 2006 so the comparison of the nine months ended September 30, 2007 is comparable to only three months activity in 2006. The loss was caused by operational start up expenses, the relocation of production equipment to Canada and the low absorption of manufacturing overhead due to lower than budgeted sales caused by a delay in qualifying for Nuclear Quality Assurance Certification.
Our Ceradyne Boron Products subsidiary, which we acquired on August 31, 2007, had a loss before provision for income taxes of $84,000 for the three months ended September 30, 2007 and for the nine months ended September 30, 2007. The loss includes a reduction in gross profit caused by higher cost of goods sold on inventory purchased in the acquisition for the step-up of inventory to fair value of $357,000 and included in general and administrative expenses was $377,000 for the amortization of backlog in connection with the acquisition.
Income Taxes. We had a combined federal and state tax rate of 39.6% for the three months ended September 30, 2007 resulting in a provision for taxes of $21.4 million, an increase of $4.2 million, or 24.8%, from the $17.2 million in the corresponding prior year quarter. Included in the increase was an out of period after tax adjustment of $2.9 million due to an under accrual of state income taxes related to the apportionment factor. Our provision for income taxes for the nine months ended September 30, 2007 was $64.4 million, an increase of $17.1 million, or 36.1%, from the $47.3 million in the corresponding prior year period. The effective income tax rate for the nine months ended September 30, 2007 was 37.1% compared to 34.3% in the corresponding year period. For the three and nine months ended September 30, 2007, the increase in the effective income tax rates was a result of higher state income taxes and the out of period after tax adjustment of $2.9 million discussed above.
Liquidity and Capital Resources
We generally have met our operating and capital requirements with cash flow from operating activities, borrowings under our credit facility, and proceeds from the sale of shares of our common stock.
Our net cash position increased by $1.6 million during the nine months ended September 30, 2007 compared to a $31.6 million decrease during the nine months ended September 30, 2006. For the nine months ended September 30, 2007, cash flow provided by operating activities amounted to $89.0 million compared to $106.6 million during the nine months ended September 30, 2006. The primary factors contributing to cash flow from operating activities in the nine months ended September 30, 2007, were net income of $109.0 million, and adjustments of non-cash amounts related to depreciation and amortization of $17.9 million, a decrease in cash of $2.0 million due to a change in deferred income taxes, and stock compensation of $1.8 million. Additional factors contributing to the increase in cash flow provided by operating activities were an increase of $7.0 million in other long term liabilities due to an increase in the reserve for unrecognized tax benefits, a decrease in production tooling of $1.5 million, and an increase of $1.2 million in employee benefits liability. These increases in cash provided by operating activities were partially offset by an increase in accounts receivable of $13.0 million due to higher sales and slower collections from customers, an increase in other receivables of $1.7 million, an increase in inventories of $16.9 million, primarily as a result of higher production levels of body armor at our Advanced Ceramic Operations segment, an increase in prepaid expenses and other assets of $1.2 million, a reduction in accounts payable and accrued expenses of $4.4 million and a reduction in income taxes payable of $11.0 million, due to payments of income tax installments.
Investing activities consumed $95.0 million of cash during the nine months ended September 30, 2007. This included $98.6 million for the purchase of EaglePicher Boron, LLC and Minco, Inc., $28.3 million for the purchase of property, plant and equipment and the allocation of $2.6 million of cash to a restricted status. This was offset by a $34.6 million increase in the amount of excess cash balances invested in short-term securities.
Financing activities during the nine months ended September 30, 2007 provided net cash of $5.9 million, primarily generated by the exercise of stock options of $0.6 million, the issuance of stock for the employer matching contribution to our 401(k) plan of $1.1 million and a tax benefit of $4.1 million due to the exercise of stock options. The effect of exchange rates on cash and equivalents due to our investment in ESK Ceramics was $1.7 million.
During December 2005, we issued $121.0 million principal amount of 2.875% senior subordinated convertible notes due December 15, 2035.
Interest on the notes is payable on December 15 and June 15 of each year, commencing on June 15, 2006. The notes are convertible into 17.1032 shares of our common stock for each $1,000 principal amount of the notes (which represents a conversion price of approximately $58.47 per share), subject to adjustment. The notes are convertible only under certain circumstances, including if the price of our common stock reaches, or the trading price of the notes falls below, specified thresholds, if the notes are called for redemption, if specified corporate transactions or fundamental change occur, or during the 10 trading days prior to maturity of the notes. We may redeem the notes at any time after December 20, 2010, for a price equal to 100% of the principal amount plus accrued and unpaid interest, including contingent interest (as described below), if any, up to but excluding the redemption date.
With respect to each $1,000 principal amount of the notes surrendered for conversion, we will deliver the conversion value to holders as follows: (1) an amount in cash equal to the lesser of (a) the aggregate conversion value of the notes to be converted and (b) $1,000, and (2) if the aggregate conversion value of the notes to be converted is greater than $1,000, an amount in shares or cash equal to such aggregate conversion value in excess of $1,000.
The notes contain put options, which may require us to repurchase in cash all or a portion of the notes on December 15, 2012, December 15, 2015, December 15, 2020, December 15, 2025, and December 15, 2030 at a repurchase price equal to 100% of the principal amount of the notes to be repurchased plus accrued and unpaid interest, including contingent interest (as described below), if any, to but excluding the repurchase date.
We are obligated to pay contingent interest to the holders of the notes during any six-month period from June 15 to December 14 and from December 15 to June 14, commencing with the six-month period beginning December 20, 2010 and ending on June 14, 2011, if the average trading price of the note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period equals $1,200 (120% of the principal amount of a note) or more. The amount of contingent interest payable per note for any relevant contingent interest period shall equal 0.25% per annum of the average trading price of a note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period. This contingent interest payment feature represents an embedded derivative. However, based on the de minimus value associated with this feature, no value has been assigned at issuance and at September 30, 2007.
In December 2005, we established a new unsecured $10.0 million line of credit. As of September 30, 2007, there were no outstanding amounts on the line of credit. However, the available line of credit at September 30, 2007 has been reduced by an outstanding letter of credit in the amount of $1.5 million. The interest rate on the credit line is based on the LIBOR rate for a period of one month, plus a margin of one percent, which equaled 6.2% as of September 30, 2007.
Pursuant to the bank line of credit, we are subject to certain covenants, which include, among other things, the maintenance of specified minimum amounts of tangible net worth and quick assets to current liabilities ratio. At September 30, 2007, we were in compliance with these covenants.
Our cash, cash equivalents, restricted cash and short-term investments totaled $173.7 million at September 30, 2007, compared to $204.1 million at December 31, 2006. At September 30, 2007, we had working capital of $366.1 million, compared to $332.1 million at December 31, 2006. Our cash position includes amounts denominated in foreign currencies, and the repatriation of those cash balances from our ESK Ceramics subsidiary does not result in additional tax costs. We believe that our current cash and cash equivalents on hand and cash available from the sale of short-term investments, cash available from additional borrowings under our revolving line of credit and cash we expect to generate from operations will be sufficient to finance our anticipated capital and operating requirements for at least the next 12 months. Our anticipated capital requirements primarily relate to the expansion of our manufacturing facilities in both the United States and Germany. We also may utilize cash, and, to the extent necessary, borrowings from time to time to acquire other businesses, technologies or product lines that complement our current products, enhance our market coverage, technical capabilities or production capacity, or offer growth opportunities.

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