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Executives

Joel Moskowitz - Chairman and CEO

Jerry Pellizzon - CFO

David Reed - President of North America Operations

Marc King - President of Ceradyne Armor Systems

Michael Kraft - VP of Nuclear, Semiconductor Business Units

Cary Okawa - Corporate Controller of Ceradyne

Analysts

Pierre Maccagno - Needham & Company& Company

Al Kaschalk - Wedbush Morgan Securities

Gary Liebowitz - Wachovia Securities

Josephine Millward - Stanford Group Company

Jiwon Lee - Sidoti & Company

Tim Quillin - Stephens Inc.

Gib Dunham

Dan Mickelborough

Brian Butler - Friedman, Billings, Ramsey & Co.

Alan Robinson - RBC Capital Markets

Larsh Schwartz

Ferat Ongoren - Citigroup Global Markets

Don Littlewood - Littlewood Burke

Peter Karr

Ceradyne Inc. (CRDN) Q2 2008 Earnings Call July 25, 2008 11:00 AM ET

Operator

Ladies and gentlemen thank you for standing by. Welcome to Ceradyne 2008 second quarter results conference call. (Operator Instructions).

Hosting Ceradyne call today is Joel Moskowitz, the company's Chairman and Chief Executive Officer, who is accompanied by Jerry Pellizzon, Chief Financial Officer; David Reed, President of North America Operations; Marc King, President of Ceradyne Armor Systems; and Michael Kraft, Vice President of Nuclear, Semiconductor Business Units, and Cary Okawa, Corporate Controller of Ceradyne.

Before I turn the call over to Mr. Moskowitz, the company has requested that I read the following statement. The matters discussed in the conference call may include forward-looking statements regarding future events and future performance of Ceradyne that involve risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are described in.

I would now like to turn the conference over to Mr. Moskowitz. Please go ahead, sir.

Joel Moskowitz

Good morning everybody. I am certainly glad that you could join us for the second quarter and six months, 2008, financial results.

As [Simarian] just said regarding our Safe Harbor statement, the risks and uncertainties as described in the company's Annual Report on the Form 10-K for the fiscal year ended December 31, 2007, as filed with the Securities and Exchange Commission. I'd also like to remind you that a recording is being made of this conference call.

Earlier today which has been our protocol for quite a while now, before the open of the market, we released the following press release. What I'll do is I'll review this, what we said, and then I am going to turn it over to Jerry Pellizzon for a few minutes to give you some further details on the financial aspects of things. And then we'll open it to Q&A.

When we came in this morning, most of us were in pretty early. We had a problem with our servers being down for Internet and for our e-mails. And in case there is a break in these communications, we have arranged for an alternative phone call. Hopefully, we'll be able to get through to the call without any technical difficulties.

We put out the release today and we stated that our sales in the second quarter, just ended, were $185 million, that was down slightly from $185.4 million in the second quarter last year. Our net income for the second quarter in 2008 had decreased to $33.2 million or $1.25 per diluted share. That compared to $38.3 million or $1.38 per fully diluted share last year in the second quarter of '07.

Fully diluted average shares outstanding this year '08, were 26,539,000. That was lower than last year, 27,000,786 for the same period. The lower average shares outstanding currently is due primarily to the repurchase of approximately 1,128,000 shares under the company's stock repurchase program, which we announced on March 4; 2008.

Our gross profit margins, based on a percentage of sales, were 40.8% for the second quarter, now that compared to 41.7% in the second quarter last year. Our provision for income taxes was 36.3% in Q2, '08, that compared to 35.9% last year for the second quarter. Now looking at the six months ending June 30th, our sales were $373.5 million, that was down slightly from the $373.8 million in the same period last year.

Our net income for the first six months of '08 was ($66.1 million or $2.45 17:08) for fully diluted share, that was on 26,984,000 shares. Now that was down from last year, which was $76.4 million, or $2.77 for fully diluted share on increased shares a year ago of 27,585,000.

The gross margins for the six months in '08 was 39.4% of net sales, that compared to 41.3% for the same period six months of 2007. And a provision for income taxes was 36.3% in the first six months of '08, that compared to 36% same period last year.

Our new orders, new bookings for the second quarter of '08 were $145.4 million, that was up when compared to $55.3 million for the same period last year. And for the six months, new bookings were $357.3 million, that was also up compared to last years $231.7 million for the same period.

Our ending backlog as of June 30, 2008, was $223.3 million that compared to last year, June 30, 2007 of $202.4 million. Now the press release went on to have a quote for myself, pointing out that in the first half we continued to implement our strategy, which is of global diversification in markets and products, while continuing our commitment to lightweight ceramic personnel armor, as well as what we perceive as an emerging vehicle armor requirement. And we went on to state some of the events that occurred in the last quarter, and which support that statement.

First, we announced on June 6 that we had acquired a new technology, at least new for Ceradyne, in oil drilling bearing intellectual property and patents, which has to do with a proprietary technical ceramic bearing solution for down whole oil drilling. This technology utilizes silicon carbide advanced technical ceramics which are produced by the company's German subsidiary, ESK Ceramics. We also stated that we've hired one of the investors of this new product line, Russell Ide, Jr. who has now joined Ceradyne.

The second point is that, we reiterated that on July 9, 2008, Ceradyne announced that it had signed a definitive agreement and plan of merger to acquire SemEquip Incorporated, who are in North Billerica, Massachusetts. Now that deal is anticipated to be completed sometime in August, it's pending SemEquip shareholder approval.

SemEquip is a leader in the development of what are known as cluster ion implantation sub-systems for semiconductors and advanced ion sourced chemicals for the manufacture of logic and memory chips. This includes a particular molecule which is known as a cluster boron. For those interested in the chemistry of it, it's B18, 18 boron atoms and 22 hydrogen atoms, and maybe later on we can talk a little bit about what does all that means.

And that, the B part of that, the boron, we'll use our enriched boron isotope which is known as 11B. The interesting thing about it is that we are the ones who make 11B, in our Quapaw, Oklahoma operation known as Ceradyne boron products. So when this deal is done we are probably going to have a teleconference dedicated solely on explaining what this company is and why we did this deal.

Thirdly, we've now signed an agreement to acquire in China, not so far from our current facilities in Tianjin, an additional 13.7 acres of land, and we're going to build out a very large facility on that, it will about 330,000 square feet. Initially about half of it will be for the solar ceramic crucibles which I believe everyone is familiar with that we're making for the manufacture of photovoltaic, polycrystalline silicon solar cells. We will probably begin building this later this year, and we don't anticipate it will be up and running until sometime probably in the third quarter of 2009.

On the press release, we went further on repeating our guidance and then modifying it. We repeated that in February 26th, and again in April 25th, we had provided a wide range of guidance of $715 million to $836 million of sales, and earnings range from $4.55 to $5.05. And we explained that the reason for this large range was that at the time we were working on delivering the BULL which is now referred to as MRAP II combat vehicles we had gotten an order for those, and as well as we had just submitted our proposal on the XSAPI/ESAPI which is the body armor.

And so we determined that if we had no BULL, we would be at the lower end of the range. And at the high end of the range it includes everything in the lower end of the range which included XSAPI and anticipation of an XSAPI order which we still do not have, although you will see that we do anticipate that we will receive one, as I go on through the rest of this review. And the higher end included everything, and included some portion of our orders.

However, we now have recently received information on both the XSAPI/ESAPI five-year proposal, as well as, the MRAP II BULL testing status. Based on that information we're able to provide you the following revised guidance.

First of all, based on information we believe to be accurate, Ceradyne has qualified both its ESAPI, as well its XSAPI lightweight ceramic body armor systems for the upcoming ID/IQ (indefinite delivery, indefinite quantity) five-year procurement. In anticipation of an award this quarter, we are planning to ship product in Q4 '08 and those numbers are included in our projections.

Secondly, based on informal input regarding testing of the Team BULL MRAP II, remember that's a Team of Ceradyne Oshkosh Truck and Ideal Innovations, we believe we have successfully passed the most critical ballistic survivability and mobility requirements.

We also continue to believe that the BULL's anti-EFP, Explosively Formed Penetrator performance plus its independent suspension providing offroad requirement result in a combat vehicle that may be suited for specific theatres.

However, based on shifting requirements, we also now believe the government currently plans to purchase the smaller, more mobile MRAPs, and so therefore, we do not believe it will be a significant 2008 BULL delivery order against the current ID/IQ contract. Therefore, we have modified in our revised guidance without a top end that assumes that we are not going to be making any BULL deliveries in 2008.

When you put those numbers together, plus the fact that we had better than expected first half 2008 performance, we ended up with the following guidance for all of 2008. Sales now are $740 million to $750 million, with an earnings range projected to go from $4.70 to $4.80 per diluted share.

At one point, when we put out the initial announcement on the signing of the agreement to acquire SemEquip, you may recall that we stated that we would have to take a charge of between $9 million and $11 million pre-tax assuming that the SemEquip deal closes in the third quarter, and the numbers that I stated above the revised guidance does not include that particular charge.

That concludes my reviewing what I hope all of you already have, and I think maybe Jerry would like to make some comments on some of the financial aspects of Q2 in the six months. Jerry?

Jerry Pellizzon

Thank you, Joel. Good morning everybody. As a note we filed our 10-Q for the second quarter very early this morning with the SEC, so it's www.sec.gov, you can review a copy of that.

The revenue diversification trend that began in Q3 2007, continued into this quarter and of course, into the first half of the year, and that trend is that the percentage of our total revenue from defense is declining and has been replaced with more sales from the industrial and automotive diesel sectors of our business due to both, organic growth and acquisitions that we made in 2007.

For example, for the first six months of 2008, the percentage of revenue from defense declined to 63% of revenues, while it was actually 77.3% of revenues compared with the same period in 2007. With sales as Joel mentioned, just about flat during the two periods. Essentially the results of the first half of 2008 reflect that a large decline in body armor revenue of $61.4 million was just about fully offset by a combination of organic revenue growth and revenue from acquisitions.

Revenue contributed by our two acquisitions completed in the third quarter of 2007, namely Minco and Boron products, contributed $25.3 million of sales for the first six months of 2008. While organic growth which are originating from sales of ceramic crucibles used for melting silicon and the manufacturing photovoltaic cells increased by about $15 million in the first six months of 2008 compared to 2007, which was about $3 million. Of that $15 million, $11 million came from our new manufacturing facility in Tianjin, China which opened in June of 2007.

The other notable increases in organic growth were the ESK's industrial sales increased by $10.4 million. Our vehicle armor sales increased by $4.5 million during the six months. Our automotive sales increased by $4.2 million. And sales to the nuclear industry increased by $3 million.

So even though income from operations declined by $14.3 million over the two periods, we delivered a very healthy 26.9% operating margin and our annualized pre-tax return on capital was slightly above 26%. So, not so bad.

There is the fact that the SG&A expenses related to the incremental revenue are generally higher than those attributable to body armor. So, we are not quite able to replace body armor revenue dollar for dollar in terms of equivalent profit margins. In general, the results of the first six months of '08 reflect our strategy of expanding our business through internal growth and strategic acquisitions.

For some numbers, free cash flow which is defined as net income plus depreciation and amortization less CapEx and including the impact of working capital amounted to $55.6 million for the first six months of '08 compared to $49 million in the comparable period last year.

EBITDA, earnings before income, interest taxes, depreciation and amortization for the six months ended June 30, 2008, was $119.7 million compared to $128 million during the same period last year.

I note depreciation for the period, this six-month period, was $18 million compared to $10.7 million for the same period last year. Our CapEx amounted to $27.6 million. We'll spend about $50 million to $55 million for the year. And that $27.6 for the first six months compared to $15.5 million in the comparable period last year.

As far as internally generated working capital and collecting our cash, our DSOs are 33 days, compared to 32 days. So we are still very low on that basis also. Joel?

Joel Moskowitz

Thanks, Jerry. And now as we've done in the past, I hope everybody can hear us because we are getting some feedback here. But, we'll somehow get through this. We are going to go right into the Q&A period.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question will go through the line of Pierre Maccagno.

Pierre Maccagno - Needham & Company& Company

Good morning Joel, Jerry, David and Mike. Congratulations on the quarter. You came out above consensus.

Joel Moskowitz

Thank you, Pierre.

Pierre Maccagno - Needham & Company

So, I wanted to do ask you about the XSAPI. Now what type of run rate are you expecting at this point starting in the fourth quarter? And also do you expect this to ramp up from the fourth quarter into 2009?

Joel Moskowitz

I'll let Dave who is on top of all these aspects take that question.

David Reed

Good morning, Pierre.

Pierre Maccagno - Needham & Company

Good morning.

David Reed

We don't really know what the rate will be. The government has been a little slower than we thought in getting the award out. We are still hopeful that they will make awards in the August time period. We put in our plan, the numbers that have been presented, 12,000 sets per month for the fourth quarter of this year. And we don't have a plan for significant growth from that in '08 at this point. So, we're looking at '09 to be flat at that number right now. But, we'll know a lot more in about five weeks.

Pierre Maccagno - Needham & Company

Are you assuming with that about a 50% market share or do you think that the market itself comes down a little bit?

David Reed

Well, we don't know for sure. We've heard that the government will look initially to field XSAPI for the theatre forces and depending how long they choose to do that their run rate could be anywhere between 15,000 sets all the way to 25,000 sets per month. So we're targeting about somewhere in the high-teens with us getting 12 of it. So yeah, that's kind of a close estimate.

Pierre Maccagno - Needham & Company

Okay. So there could be some upside I mean, if the government comes in?

David Reed

It's possible.

Pierre Maccagno - Needham & Company

Okay. And then, some clarification on the BORONEIGE here in the note you say about your comment, the government is planning to purchase more mobile MRAPs. So, would you be able to supply these smaller MRAPs or would it be a competitor?

Joel Moskowitz

Well, I'll let Marc handle that question since he came in from Washington. Marc?

Marc King

Hey, good morning, Pierre.

Pierre Maccagno - Needham & Company

Hi.

Marc King

The situation on MRAPs is changing almost on a daily basis now. Because of a shift in mission priorities and requirements as I'm sure you are aware from news reporting, the shift to an emphasis in the theatre in Afghanistan is asking for smaller, more mobile MRAPs. At the current time, there are some smaller ones within the current series of MRAPs that the government has been purchasing but even those don't really meet the theatre requirements that are being asked for currently at the theatre. There are some initiatives underway to acquire, test and possibly deploy other solutions that would better be suited for the type of terrain that's encountered in Afghanistan specifically. I can't give you details because of ongoing agreements not to disclose too much information. However, I can tell you that we'd be recalcitrant if we weren't participating in those types of initiatives at this point in time, we are doing that. Hopefully, we'll have more information for you later.

Pierre Maccagno - Needham & Company

Okay. If that was the case in all your work on the current model, would that be of any use or --?

Marc King

I would submit to you that the BULL as it was tested currently met or exceeded all of the requirements for the MRAP II specification as it was issued by the government. That information is on file with the government. They have validated everything that they went out to look for in the initial MRAP II requirements. Now as always, that was one year ago, the shifting situation, both tactically and strategically for the war has caused them to have to shift some of their priorities.

However, even though we are not anticipating a BULL purchase immediately because they now have a fully tested and certified solution, and we hold a $12.5 billion ID/IQ five-year contract. The contract has not been terminated, the contract remains open and the department has the option at any point in time of executing another delivery order against that contract.

So at this point, we don't think they will place an order, but they can come at any time and say, we have a new requirement that looks for this type of vehicle. In addition to that, there has been some international interest in the vehicle that continues to be developed as a market opportunity.

Pierre Maccagno - Needham & Company

Okay, thanks for the clarification. And just my last question, gross margins for the fourth quarter were up and what drove that?

Jerry Pellizzon

We had some productivity increases that came through Pierre during the quarter, enhancements in some of our manufacturing units. And we had a slightly different product mix that also helped us.

Pierre Maccagno - Needham & Company

Okay, thank you.

Operator

And your next question will go through the line of Al Kaschalk.

Al Kaschalk - Wedbush Morgan Securities

Good morning, guys.

Joel Moskowitz

Hi, Al.

Al Kaschalk - Wedbush Morgan Securities

Real strong execution there on the margin front which is where I'd like to maybe start with my first question. Are you seeing any pressure from the military side of the business for ASPs or what has traditionally been around the 40% level on the gross margin side?

Joel Moskowitz

Well, I'll take that. First, we don't want to get into the specifics because we have not gotten a contract yet on the XSAPI/ESAPI. These are always fixed price contracts. Our margins are a little bit higher with total because remember, we are completely vertical integrated. And at least to-date and we anticipate as we go forward, no one makes the ceramic as well as the total system. So I don't want to go into too much specifics.

Al Kaschalk - Wedbush Morgan Securities

Sure, Joel my question --

Joel Moskowitz

If there are pressures, they are brought on by ourselves looking to get a bigger piece of the action.

Al Kaschalk - Wedbush Morgan Securities

Sure. Let me try to restate my question. The consolidated margins were very strong in the quarter gross, and one would think as you're diversifying away from a vertically integrated business and rolling in a couple of other acquisitions that may not have the revenue ramp yet, but could arguably be a little bit better margin business that would have dipped a little bit. So I'm just trying to square up my assumptions or expectations relative to the very good execution on the quarter.

Joel Moskowitz

Well, we have some exceptional margins as you know in the solar area.

Al Kaschalk - Wedbush Morgan Securities

Yeah.

Joel Moskowitz

And that's covering an awful lot. The other areas, remember we expect the margin decrease as vehicles become more important but they haven't yet, so you don't see that yet. And I would say that the total package, even though we don't break it out is being influenced strongly by the surge in crucibles. And whether that continues or not, we'll have to see we're putting in an awful big facility in China. In anticipation, we're also worried about the supply of silicon metal going forward for our customers. Even though if you read the reports on it, it's going to be probably go maybe from a huge imbalance with demand exceed supply, and then if everybody confess we're going to make silicon which is not us, comes on-stream that should be cured within the next six to eight months.

Al Kaschalk - Wedbush Morgan Securities

Following on the previous question on production rates, ESAPI, are you still at the same level you were? Do you see any changes there over the next six to 12 months?

Jerry Pellizzon

That's a little uncertain, Al. We have orders that roughly the 25,000 sets per month through the end of November right now. The army has not made it clear how much longer they will run at that rate and when they will switch over to an X-version of that. So, hopefully they will give a little bit more insight into that in the next couple of months.

Al Kaschalk - Wedbush Morgan Securities

This is similar to ESAPI/XSAPI, it's potentially or likely it could be a transition, but we'll get some additional data points down the road from here.

Jerry Pellizzon

Well its likely there will be a transition because in the past they have never allowed the soldier to have one level of protection on the chest and back and a lesser level on the side. So, we expected that would go to one level of protection.

Al Kaschalk - Wedbush Morgan Securities

Okay. Joel, and maybe this is more for Marc as well, but in terms of shift in mission in terms of Afghanistan versus Iraq, would you characterize that as a more of a positive or less or is it neutral in terms of the impact on your business or potential business on the vehicle side?

Marc King

Well, at this point I would submit to you that right at this point it's probably a neutral with a tendency toward a positive because of an opportunity to introduce some additional vehicle designs that hadn't been considered previously. We are working through those opportunities now. Again, it will become clearer to us as the tactical mission expands in the Afghan theatre. The commanders will provide feedback to the various organizations in the United States that look at acquiring this type of equipment. That feedback will be fed out to the contractors, the contractors will respond. We are in that loop and we'll have an opportunity to provide solutions that we think meet the commander's needs in the field. So it's another new opportunity to look at something slightly different than what was going on in Iraq. The mission is different, the frame is different, and the threat is slightly different. So it goes from a neutral to a positive as we continue to expand that mission.

Joel Moskowitz

Yeah, the one thing Al you may have read is that, the roads in Afghanistan particularly are in terrible condition. And the one, I've always felt that the partnership with Oshkosh with the MTVR chassis really gave us a leg up, because it has six wheels, it has independent suspension. And being on road is like being off road in Afghanistan. That remains to be seen, what that will mean, but you do know there have been issues of the smaller MRAPs having accidents. Even in Iraq there is a lot of information on the Internet on that where some Americans have been killed actually by being trapped with the rollovers. So who knows?

It certainly has to be looked at. As Marc said, it's an opportunity. If they need more off road, see the current MRAP spec, it's not for significant off road capabilities even though we provided it with our BULL, a vehicle.

Al Kaschalk - Wedbush Morgan Securities

So, I guess that the takeaway here for all of us is that luckily successful testing, you haven't been disqualified, there is an ID/IQ contract, its five years, and the opportunity still presents itself that you could win something?

Joel Moskowitz

That's exactly correct.

David Reed

And for the sake of our projections, for now we're not putting any numbers in.

Al Kaschalk - Wedbush Morgan Securities

That's great. Thank you very much.

Joel Moskowitz

Sure.

Operator

And your next question will go through the line of Gary Liebowitz.

Gary Liebowitz - Wachovia Securities

Good morning, gentlemen.

Joel Moskowitz

Hi, Gary.

Gary Liebowitz - Wachovia Securities

Hi. Joel, can you just maybe follow-up on a prior question about the margins in the ACO segment. They are up 200 basis points from the first quarter and from the fourth quarter of '07 on lower volume. And you talked about some productivity improvements. Can you give us some color on that? And where you think margins are going in that business for the rest of the year on the lower volume?

Joel Moskowitz

Let David tackle that, it's just all under his responsibility.

David Reed

Well, I think the best way to look at that Gary is that we've got a great team on the manufacturing side. Ken Morris and his crowd in the armor side have just continued to lean out the operations both in hot press and assembly. So, even though the volume has dropped with some of the stretch out on body armor, we've been able to improve the yields in both of those operations and to take out some of the costs associated with some of the raw materials and also with some of the support products that go in there. So, that's been great.

And on the other side, Bruce Lockhart and his team in thermal materials have just done fantastic on the crucibles. And again, have brought out some of the cost and the new facility in China was laid out to perfection the way we want it to always be, and they've just streamlined that. So, those two have been the major contributors to that improvement.

Gary Liebowitz - Wachovia Securities

Okay. And your second half outlook for ACO, I mean, could you sustain these mid-30s margins as you do this transition?

David Reed

Well, I certainly hope so. The XSAPI effort is always a new product. It brings a lot of uncertainty with it. But, as I said we have a excellent team, we've had quite a bit of time to work on the hot pressing of the ceramic for the XSAPI, we feel pretty good about that. But I am also a realist; there is always issues with start up. So, I think we'll be able to keep in the range we just discussed.

Gary Liebowitz - Wachovia Securities

Okay. And then one for Joel if I may, Joel can you talk about your cash deployment priorities; it looks like during the quarter you really slow down the share buybacks for next to nothing in the month of June. How are you weighing buybacks now versus other opportunities such as acquisitions?

Joel Moskowitz

Well, you are correct in your observations. We didn't buy very much back as the stock started getting up to 40 and now it's over 40. So we still have, as you could see from the balance sheet, close to a $0.25 billion in cash and near cash. We're evaluating that. It's not the highest priority as we start moving up in stock price. We are committed to the SemiEquip deal and that we'll use on closing a little bit more than $25 million. And then we're going to be expanding our facilities to make the B18H22, we're going to put in what I hope will be the most modern facility for making semiconductor chemicals. We are going to do that in Quapaw, Oklahoma.

And last time, I think I'd kind of mentioned that we were looking at a number of acquisitions. I referred to one small one, and kind of that was the acquisition of the Drilling Bearings, I referred to one that was the kind of a medium for Ceradyne which is SemiEquip, which is not done, but we anticipate it will. And I referred to a larger one which I didn't refer to again this time, we're still working on it. That would use a good part of our cash if it materialized, which would probably not be clear till the end of the year.

So, our general feeling is we started keeping our powder dry. Jerry has been right on the mark as far as generating close to $10 million a month, and we are very pragmatic. We like right now, look to people are bringing us deals, the prices are getting a little softer, cash talks and we have cash, and I would say that we're still looking for acquisitions. If I had to determine the different options for cash it would be through acquisitions and expansions.

Gary Liebowitz - Wachovia Securities

Thank you, it's very helpful.

Joel Moskowitz

You're welcome.

Operator

(Operator Instructions). And your next question will go to the line of Josephine Millward.

Josephine Millward - Stanford Group Company

Good morning, everybody.

Joel Moskowitz

Good morning, Josephine.

Josephine Millward - Stanford Group Company

Great quarter. Can you give us a little more color on what's contributing to the $25 million increase in the lower end of your guidance? Is it more certainty from XSAPI or other areas of business are doing better than you expected?

Joel Moskowitz

As I said, the first half we consider to really be good, really solid. I mean we didn't have any real numbers from vehicles, the BULL was all in testing, and R&D, and yet our numbers were higher than we had projected. And so, if you take our first half and flip it, assume we'll do about the second half, you are sort of in the same ballpark as we are. And so, the heart of the increase was simply that we really did better. You could see that our bookings were higher in a lot of areas. We don't go into such minor detail, but we had in Germany, they are doing much more now in the silicon carbide seals and bushings.

For plane old, they wouldn't want me to call a plane old but it's a very mature product market for fluid handling, and we've been recognized now in Europe by the biggest suppliers as the number one vendor. And we're expanding our facility in Bazet, France, which is a little operation that wasn't doing all that well and now they are doing much better. We expect them to be profitable for the year as recently as last week we increased our CapEx on diamond machining. And so we are very pleased with that. And we might have gone up higher but what they said is so.

We haven't made a lot of XSAPI, except for prototypes and the submission of the first article and all of that. And so if we're counting on our shot in the Q4, we want to be a little more comfortable that we'll have the same kind of good yields that we're having now. So the increase as you correctly stated is simply, primarily based on our performance in the first half.

Jerry Pellizzon

Let me just give you a little more color on some other units. Thermo itself outperformed our plan, both here domestically and in China. We also had Canada that did well as opposed to last year where they were struggling a bit. And even though we had such a decline in body armor revenue, I think the points that Dave indicated contributed to maintaining our margins there. And so those three also contributed besides the things that Joel mentioned.

Josephine Millward - Stanford Group Company

Great. So mostly from a better than expected first half, that gives you more confidence for Q2 at similar run rates in the second half?

Jerry Pellizzon

Yeah, that's the way you should look at it.

Josephine Millward - Stanford Group Company

Okay. Hey, this might be a question for Dave and Marc, I'm hearing that the Army might do a combination XSAPI and lighter ESAPI buying. If that's how it plays out, how do you think that might impact your body armor business going forward? How would that change your 12,000 sets a month assumption for XSAPI?

David Reed

I haven't heard that Josephine in terms of a lighter. Do you mean as a proportion of the buy?

Josephine Millward - Stanford Group Company

Right. I mean, I know it probably hasn't been decided yet but my understanding is the Army might be contemplating a combination buy. So possibly an improved version of the XSAPI and improved version of the ESAPI, just trying to get your take on how that would play out if they were to move forward with that?

David Reed

Well, that won't play out at all because in the solicitation they only asked for a regular ESAPI and XSAPI. So whatever people qualify, it is what they will looking for. They could always come out once they make awards and ask for engineering change proposals, but they did not ask for in the solicitation nor were they provided bids for an improved or lighter version of the ESAPI. And I think their emphasis really is to get the improved level of protection from the XSAPI, not necessarily a lighter ESAPI because that wouldn't address the new threat in the battlefield.

Josephine Millward - Stanford Group Company

Okay. So you think it's going to be a purely XSAPI buy?

David Reed

Well, there may be some trailing ESAPI awards for that transition period, I don't know what their total requirement is. But I think the long-term play is for the XSAPI.

Josephine Millward - Stanford Group Company

Great, thanks for that. And I know I'm running out of time, but if you could give us an update on the solar businesses and when you expect the new oil drilling technology to contribute to your revenues in the future? Thank you.

Jerry Pellizzon

I'll take that. Actually, to tell you the truth I read the prospectus from GT Solar, the company that make the furnaces. And the reason they went public yesterday, the reason that's of interest to us is that there are leader in this field and we have to design our crucibles to fit into their furnaces. And what I like, I found very interesting was in all their words they quoted their markets for polysilicon, it's having grown 47% a year, and very high percentage of that in the poly, they also in their risk factors clearly pointed out the same thing that I said earlier.

There has got to be more silicon coming on-stream, now we expect that. The giants like Volker and Hemlock and others have announced it and a lot of smaller companies have announced it. And so if even half of those people come through that won't be an issue. So we are building the new factory. Remember, the numbers are this; we have about 100,000 feet now in Tianjin. I just said we're going to put in 330,000 square feet which is a triple, although only about half of that will be for the crucibles and we're doing a lot of work in Atlanta.

So I don't want to go into a lot of details because we don't break that out separately per say, its part of Ceradyne thermo materials. I have a concern in the short run regarding silicon, but so far so good. And even this IPO yesterday, although it doesn't affect Ceradyne Inc. particularly, half of their future business looks like the new equipment to make silicon, not to make the silicon starting material, not to make the Poly. So I'm very up on solar and all the data now keeps coming out more and more and more and more that the prices will be going down, not because of us, but because of the price of silicon.

Regarding oil, I've spent personally, a lot of time now, in the last eight weeks in Canada and its enormous what's going on. Ceradyne had a exhibit in Calgary, I think a week or so ago. It's called the Oil Sands conference. And they gave a lecture there. So they need 100,000 rough nets up in the Alberta province, to me and the materials, they expect to triple their output of oil up to, I think 3 million to 4 million barrels a day over the next 15 to 20 years. Hopefully, we'll play a very important role.

Right now our work on the gas end, I mean the oil's end is minimal. But we think by the end of next year, we'll go from less than a few million dollars a year to tens of millions of dollars run rate at the end of '09. And we're prepared to do that, most of the product coming out of our Lexington, Kentucky facility.

Regarding the new acquisitions, that's very speculative, our sales are very well now less than $1 million. The product is phenomenal. Ask me that question, Josephine, in about, maybe even the next quarter and I'll give you a better answer.

Josephine Millward - Stanford Group Company

Great, thank you.

Operator

And your next question will go through the line of Michael French.

Michael French - Morgan Joseph & Co. Inc

Good morning, gentlemen.

Joel Moskowitz

Good morning, Michael.

Michael French - Morgan Joseph & Co. Inc

Congratulations on a great quarter.

Joel Moskowitz

Thanks.

Michael French - Morgan Joseph & Co. Inc

First question, can you address, I guess this is for Marc, specifically how RAMTECH might be impacted by changes in mission requirements. As they look at the long-term armor strategy, how this is going to fit in?

Marc King

Good morning, Mike. Actually on our L pass armor designs and the incorporation of our RAMTECH technology, there really is no direct impact. I can tell you that in about 45 days we'll deliver our first set of armor that is designed of our L pass materials. Now that will go to a major OEM and begin immediately being tested at the army's test center as part of an overall test of vehicle capabilities, the armor being an intricle component in that test to test its durability over the long period of time. The materials are also now being used in a number of other variations.

For testing, it's been looked at by a number of OEMs for testing, and also was recently used in some test evaluated viability as part of the emerging JLTV program for one of the OEMs that defined for that program. That testing went very well and we had no reason to anticipate anything else because of the prior testing of it. But, they wanted to test it again and found that it performed extremely well.

So we are very optimistic that our armor development efforts in the area of lightweight composite armors is moving ahead quiet nicely, and a derivative coming off that is additional lightweight armor systems used in test now with ARL, our chief scientist is busily at work with ARL in a cooperative research and development agreement to try and bring online even lighter, more effective solutions for some of the most lethal threats on the battlefield. He's been up there for over a week now testing materials.

And again, we received some very positive results back but we're still mostly testing materials, we are moving ahead with some of the OEMs, again in the secrecy agreements that we have with these folks prevent me from going into anymore detail. I know you'd like to have the detail but unfortunately, I'm kind of constrained at this point because of competitive issues that the OEMs don't want to discuss. But they are turning this material into product now, applying it on vehicle systems, and they are using it in testing for the army customer and for the marine core customer.

So we are moving very rapidly in the right direction. We just need to have again some patience to see how things test out now. All of this again is being done in the competitive environment. They are looking at other choices and solutions about where we had the opportunity to go head-to-head with other solutions, we have managed to emerge on top and very gratified by the results both of our armor development and our vehicle design team back in Western Michigan who has done an outstanding job in incorporating this material into a usable design that the OEMs can then apply. I hope that answers your question.

Michael French - Morgan Joseph & Co. Inc

Yes, it does. It sounds like its progressing well, thank you. And, next one on the BULL, the outstanding contract that's out there, it's a five-year. What does that create for you in the way of obligations because (inaudible) you have to deliver if the two years from now show up in an order?

Marc King

Yes, you're correct. It does create an obligation for us that leaves us in a position to be prepared at any point in time to start a production effort for the BULL. We are aware of that. We will hold that contingency in our hip pocket. Once as you know what the assignment of the ID/IQ contract, also came a DX rating for that contract. So, if we had to get into the materials acquisition mode very quickly, we have the advantage of a DX rated contract now which we didn't have prior to the award of that contract which gives us a very high priority to the acquisition of materials which we could do on a very expedited basis with our team partners, Oshkosh Truck and Ideal Innovations understand the implications of this. And again, we'll just sit by here and wait and see what the customer wants to do.

Anybody with any BOD experience in their background knows that this situation could change at any point in time. They can come back. We know for a fact that they liked what they saw with the BULL, they've even cherry picked some of the system designs that we incorporated into the BULL that are being used to improve some of the existing MRAPs already deployed into the field. But, that's a normal course for them to do after doing the extensive testing that they did on the BULL, and it might add the BULL has probably been tested more than any other MRAP system that they've acquired to-date.

It never exceeded each and every one of their expectations. There were some design changes conducted during the testing. Each of those changes has been applied. And I could add at this point that there is even discussion about doing some additional testing to make sure that the design package is fully validated sitting on the shelf and ready to go, so that if the commanders decide that this is something they want, we're ready to start producing in a moments notice, and no further testing would be required at that time.

Michael French - Morgan Joseph & Co. Inc

Okay. And just a quick one on the XSAPI. Dave, I think you mentioned that you're expecting at least the initial order to look at volumes that would cover the theatre and the if run rate you are talking about they could fill that win a year or so. So, what are you expecting to hear from them in terms of total demand?

David Reed

I think we'll just have to let that play out, Michael. I don't think anybody can make that prediction at this time. You know in the past whenever they've made a switch they have not wanted to have mixed inventory among all the active and reserve troops. So they've usually made the decision long-term to change into the most modern design. So, that's what we are hoping and expecting. But you never can tell that. So our initial goal is to get as much of the initial rollout of the product as we can, and then to work with the army to transition all of the army and marines over to that new design.

Michael French - Morgan Joseph & Co. Inc

Okay, very good. Thank you, gentlemen, and good luck.

Operator

And your next question will go through the line of Jiwon Lee.

Jiwon Lee - Sidoti & Company

Good morning.

Joel Moskowitz

Good morning, Jiwon.

Jiwon Lee - Sidoti & Company

Thanks for clearing the air on the MRAP II front. My only question is on China. As much as you could, could you give us a little more color or your plan on your new China capacity that may not be tied to the BULL itself?

Joel Moskowitz

Well, yes. We are already manufacturing a particular component for ultrasound equipment that uses user electric ceramic. And we're doing that in our current facility, and it's working out pretty well. And we are very seriously looking at moving some high volume more labor intensive components from Germany. I mentioned this whole product line of these fluid handling components and we're looking to put in the other half of the facility, ESK operations.

We are also looking to expand, remember, when we bought Minco last year, we said we bought it because of our whole plan for vertical integration, namely we make the high purity fused silica powder in Tennessee and we ship it to Atlanta, and they make the product in Atlanta or they in turn ship it to China. We may not have focused that much on is that, that is not what mostly they do there. Mostly they make precision investment casting, ceramics for casting in the lost wax process of steel and aluminum. And the market in turn is huge, and we are participating in that almost insignificantly.

And so we are thinking of putting a Minco operation fused silica in order to service not only solar, but also what we refer to as PIC, Precision Investment Casting.

Jiwon Lee - Sidoti & Company

That's very helpful. Thank you.

Operator

And your next question will go through the line of Tim Quillin.

Tim Quillin - Stephens Inc.

Hi, good morning.

Joel Moskowitz

Good morning, Tim.

Tim Quillin - Stephens Inc.

Just a question regarding guidance. It looks like in terms of revenue guidance, you're assuming that quarterly revenue is roughly flat with where you were in 2Q? And just with respect to XSAPI is the assumption that the XSAPI volumes merely replace current ESAPI production levels, and that overall body armor revenue is roughly the same as where you were in 2Q?

Joel Moskowitz

Yeah, I think that's right, Tim. As I said, the side plate business we have is already booked solid through the end of November. We'll probably get releases in the fall to fill out the year and that's just one more month. And so we are looking at the ESAPI to be replaced by the XSAPI, at roughly the same kind of run rate we have now for ESAPI in the fourth quarter.

Tim Quillin - Stephens Inc.

Okay and just in terms of margin assumptions, so your EPS guidance presumes lower EPS in the second half of the year than you've had in the first half of the year which is really a function of lower margins and where would that come? Where would you think that you might have lower margins in the second half of the year than you've had in the first half? Thanks.

Jerry Pellizzon

Tim, we've made the assumption that we're going to have some start up issues that we'll have to work through in XSAPI. And that as the start up of any new major product line like that, we don't expect that it will run at the same margins as the very mature ESAPI program.

Tim Quillin - Stephens Inc.

Okay. Thank you.

Operator

And your next question will go through the line of Gib Dunham.

Gib Dunham

Good morning. I have two questions. The first, it relates just to the words I think of the SemEquip deal, you refer to the approval or needing the approval of shareholders and it's a private company, so I was just confused, what has to happen there and will there be any holdup or why would they need to approve it if it's a private company, I assume you already have that approval?

Joel Moskowitz

I will let Michael handle that.

Michael Kraft

Gib, hello, this is Michael. You're right, this is a privately-held company, but they do have several series of financing and those shareholders have to approve the merger. So it is a merger. It's an acquisition of assets and in that process there is a vote that typically takes 30 days and we anticipate that should close in the mid-August timeframe.

Gib Dunham

Okay. And then my second question relates to your non-military business. You were a little vague on giving guidance for the drilling revenue on opportunity going forward and for the solar opportunity, I'm sorry, the SemEquip opportunity going forward. The question is, what would your non-military business be as a percent of revenue at the end of '09 or maybe kind of a run rate level?

Joel Moskowitz

Well, the only thing that we said in our last year is that our target is to have a 50-50 product mix, 50% defense and 50% non-defense, right now we're still about a 65%, 62% defense.

Gib Dunham

Right.

Joel Moskowitz

So, sometime and our target for the 50-50 mix was 2010. That's where we stand now subject to whether we achieve that and subject to acquisitions.

Gib Dunham

Still, if I can connect the dots, it sounds like these two acquisitions will add maybe not meaningfully but somewhat to the company in the next 12 months?

Joel Moskowitz

Yes.

Gib Dunham

Okay. Thank you so much.

Operator

And your next question will go through the line of [Dan Mickelborough].

Dan Mickelborough

My questions most have been answered. Can you just let us know what the CapEx spending was for the first half of the year?

Joel Moskowitz

Sure it was 27.6.

Dan Mickelborough

Okay, good quarter. Thanks guys.

Operator

Okay. Next question will go through the line of Brent Reed.

Brian Butler - Friedman, Billings, Ramsey & Co.

Hi, this is actually Brian Butler. How are you guys doing?

Joel Moskowitz

Brian, how are you?

Brian Butler - Friedman, Billings, Ramsey & Co.

Good, just one question to follow-up on the ESAPI. Is there going to be any ESAPI production in the fourth quarter that's outside I guess the army's requirements, only special forces or I guess it is not even ESAPI, but anything along the line of the SPEAR body armor, can you give us some sense to what that might be in the fourth quarter?

Jerry Pellizzon

Yeah, we have some continuing sales. We have an ongoing contract with Defense Supply Center, Philadelphia. So there is the opportunity for another release that would bring some of that order into the fourth quarter. And we have a large four-year contract with the special ops. They continue to make releases on that. So we expect to make some SPEAR plates and also some of the side plate program for the special ops. So, yeah, that's part of the mix. It's not nearly as large as the army portion of our business, but it's a significant plate for us and we expect those orders to come through, Brian.

Brian Butler - Friedman, Billings, Ramsey & Co.

Thanks.

Joel Moskowitz

Before we go to the next question because we keep getting additional people, we usually try to limit this to an hour. We'll go for anybody on the call now, we'll take and no additional ones Simarian.

Operator

Okay. Right now you have six participants left in queue. You want to take all six?

Joel Moskowitz

Yeah, we'll take six.

Operator

Okay. Your next question will go to the line of [Peter Karr].

Peter Karr

Yeah, just quickly, do you anticipate any future contribution from the nuclear waste containment items that you were anticipating producing?

Joel Moskowitz

Michael?

Michael Kraft

Hello Peter, this is Michael. Yes, we definitely expect to have future contributions. We do have a growth plan in nuclear, as you know it's a growing market, that's why we are putting some resources in that area. So, yeah, the answer is yes, we certainly see future contributions there.

Peter Karr

Any timeframe?

David Reed

Well, it's contributing now Peter. It will continue to increase in the next two years. I think our two-year revenue plan is going to be at about 15 million two years out. So, it will continue to grow.

Peter Karr

All right. Thank you.

Operator

Okay. And the next question will go to Alan Robinson.

Alan Robinson - RBC Capital Markets

Good morning. My question relates to the proposed SemEquip acquisition. I understand that the $25 million acquisition costs maybe increased by up to $100 million I guess in milestone payments. Can you give us an idea of the most likely timeline for these additional payments? Are they likely to be linear over the 15-year period or back or front-end loaded? Thanks.

Jerry Pellizzon

You should go back to the original release, Alan. It's all based on sales. There is a cap, I think of, what, 12 years?

David Reed

About 15.5 to 16 years.

Jerry Pellizzon

So, it's all based on sales. They get a lot more in the front two years and then it goes down to 5.5% of sales until it gets to $125 million total or the numbers of years expire.

Alan Robinson - RBC Capital Markets

All right, I'll check that. Thank you.

Jerry Pellizzon

Sure.

Operator

And the next question goes to [Larsh Schwartz].

Larsh Schwartz

Hey Joel, congratulations, nice quarter.

Joel Moskowitz

Thank you very much Larsh.

Larsh Schwartz

One of the things that you haven't touched on at all which you did in your Annual Report is the opportunity in the aluminum. And over the last couple of years it seems to me that there has been a very, very large increase in the significance of carbon dioxide reduction, and I'm wondering if that's accelerating if you want to talk at all about what kind of reduction do you get in carbon dioxide by using the process that you're working on and any updates as far as timing?

Joel Moskowitz

Briefly, aluminum continues to be very important to Ceradyne. This is the smelting of aluminum. The manufacture of aluminum from the mineral bauxite, where we anticipate that we'll be able replace carbon electrodes with our electrically conducted Titanium Diboride. Actually we shift several millions of dollars in the first half on that just on prototype. So it's gotten past hundreds of thousands of dollars. And I've said in our Annual Report the opportunity could be a $1 billion plus market, I still feel that way and we're continuing to work on it.

The purpose of using titanium diboride to replace carbon is three-fold. First, you reduce the amount of electricity by as much as 20%. Second, you decrease the carbon dioxide emissions, and I'll get to the percentages in a minute. And thirdly, we believe although it's been too early that we will increase productivity, increase cell life. On the CO2, currently when you make aluminum you put out more carbon dioxide than you do aluminum. And this is a serious problem in today's world, particularly with the focus on greenhouse gases and global warming.

So the answer to your question, Larsh, is not absolutely clear because it depends how much you substitute. The reason you get carbon dioxide is because the oxygen that comes off with the mineral grabs on to the carbon from the electrode. So if you change the electrode to titanium diboride, it goes from being a polluter to being a rainforest. You put out oxygen, not CO2. So there will be a reduction, whether it goes to zero or not depends on how much they use of ours and that gets into a little too much technology for this conversation.

Larsh Schwartz

Okay, thank you very much.

Joel Moskowitz

Okay, Larsh.

Operator

Okay. And the next question go to the line of Ferat Ongoren.

Ferat Ongoren - Citigroup Global Markets

Hey, Joel.

Joel Moskowitz

Hi, Ferat, how are you?

Ferat Ongoren - Citigroup Global Markets

Good, yourself?

Joel Moskowitz

Okay, thank you.

Ferat Ongoren - Citigroup Global Markets

A quick one, maybe for Dave, given the delays we had on the ESAPI and XSAPI side, I mean, what's the visibility? You're talking about may be an August order. What's the visibility on that front? And then the second question is, as you kind of look at the forward quarter, third quarter, I mean is that going to be lighter than second quarter in terms of deliveries given, we don't have XSAPI yet?

David Reed

I think the likelihood of the order is very strong now. The delay really was associated with the trying to allow everyone who wanted to participate both in the rigid version and the flexible version of XSAPI to give them the opportunity to do it and the shift to do testing at a government lab, ATC did the testing. So, those things combined to stretch out the program. The testing is all done for us. So that was the main hurdle to get through. Now it's really in the hands of the contracting officer, so they are just working with the army to put out their contracts to the people that have qualified. So I don't see any more reason to think that will delay.

And as I said earlier, I think the second half will be very similar to the first half. We were stretched out and at a lower run rate of products for the army and we picked kind of that lower run rate for the fourth quarter. We're solid through the end of the third quarter at what we've been doing already. We've got most of the fourth quarter with the side plates filled up, and we have some other orders for special ops in Philadelphia that looks pretty solid. So really, it's just the timing on that XSAPI and we should know in about three, four weeks of how we are doing.

Ferat Ongoren - Citigroup Global Markets

Got it. And then, since you know the results of testing, are we going to have new players in the game or is that going to be kind of the competitors you had in the existing contract?

Joel Moskowitz

I don't have any insight into that Ferat, I just know how we did.

Ferat Ongoren - Citigroup Global Markets

Got it. Okay. And a final one, maybe for Joel, what's the revenue impact of the SemEquip deal maybe for this year and then for '09? And thanks for the questions, thanks for the answers.

Joel Moskowitz

Yeah, Michael?

Michael Kraft

Well, Ferat, we're going to have a call after the close. As you know it's not an acquisition that we closed, so I really can't answer that question but we'll address that when we have a specific call probably in the mid-August timeframe.

Ferat Ongoren - Citigroup Global Markets

Got it, but it is in the guidance, right?

Jerry Pellizzon

It's not in the guidance, Ferat, this is Jerry.

Ferat Ongoren - Citigroup Global Markets

Okay, okay. Thank you very much.

Operator

And your final question will go through the line of Don Littlewood.

Don Littlewood - Littlewood Burke

Well, most of mine got answered here after I entered the queue. I do want to complement you though on the way you're expanding beyond the armor. It really is impressive and the vertical nature of it really makes everybody feel good.

Joel Moskowitz

Thank you, Don.

Don Littlewood

Okay, that's it. Thanks.

Joel Moskowitz

All right. Okay. Simarian, let's wrap it up.

Operator

Okay. You can go ahead with any closing remarks if you have any.

Joel Moskowitz

No, I think this has been a lengthy Q&A.

Operator

Okay.

Joel Moskowitz

And I think that everybody has a pretty good stand though.. Now we just have to perform.

Operator

Okay. No problem. That does conclude today's conference call. At this time you may now all disconnect.

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