4. Debt and Bank Borrowing Arrangements; Convertible Note and Common Stock Offerings

During December 2005, the Company completed a public offering of 2,070,000 shares of common stock at a price to the public of $43.31 per share. The Company received net proceeds of approximately $84.6 million from this offering after deducting offering expenses and underwriting discounts of $5.0 million. Concurrent with the common stock offering, during December 2005, the Company issued $121.0 million of 2.875% senior subordinated convertible notes (“Notes”) due December 15, 2035.

During the year ended December 31, 2009, the Company purchased an aggregate of $27.9 million principal amount of the Notes on the open market at a purchase price of $23.2 million. The carrying amount of the Notes purchased was $24.1 million and the estimated fair value of the Notes exclusive of the conversion feature was $21.8 million. The difference between the carrying amount of $24.1 million and the estimated fair value of $21.8 million was recognized as a gain of $2.3 million upon early extinguishment of debt, which was partially offset by write off of associated unamortized debt issuance costs of $392,000, resulting in a net gain of $1.9 million. The difference between the estimated fair value of $21.8 million and the purchase price of $23.2 million was $1.4 million and was charged to additional paid-in capital. The Company has $26.8 million remaining of the original $50.0 million authorization to repurchase and retire part of the outstanding Notes. Cash flow from operating activities in the statement of cash flows for the year ended December 31, 2009 includes $3.0 million of the purchase price that was attributable to the payment of accreted interest on the convertible debt discount and the remaining $20.2 million is presented as repayments of convertible debt in cash flow from financing activities. There were no repurchases during the years ended December 31, 2011 and December 2010.

As of December 31, 2011and 2010, long-term debt and the equity component (recorded in additional paid in capital, net of income tax benefit), determined in accordance with the accounting guidance for convertible debt, comprised the following (in thousands):

	December 31, 2011			December 31, 2010
Long-term debt
Principal amount	$	93,100		$	93,100
Unamortized discount		(3,806	)		(7,501	)
Net carrying amount		89,294			85,599
Current portion of long-term debt		89,294			-
Noncurrent portion of long-term debt	$	-		$	85,599

Equity component, net of income tax benefit	$	16,399		$	16,399

The discount on the liability component of long-term debt is being amortized using the effective interest method based on an annual effective rate of 7.5%, which represented the market interest rate for similar debt without a conversion option on the issuance date, through December 2012, which coincides with the first date that holders of the Notes can exercise their put option as discussed below.

Interest expense on the Notes, excluding capitalized interest, for the years ended December 31, 2011, 2010 and 2009 included the following (in thousands):

	For the Years Ended December 31,
	2011		2010		2009
Contractual interest coupon	$	2,676	$	2,677	$	3,058
Non-cash amortization of discount on the liability component		3,694		3,436		3,641
Non-cash amortization of debt issuance costs		380		364		399
	$	6,750	$	6,477	$	7,098

Interest on the Notes is payable on December 15 and June 15 of each year, commencing on June 15, 2006. The Notes are convertible into 17.1032 shares of Ceradyne's common stock for each $1,000 principal amount of the Notes (which represents a conversion price of approximately $58.47 per share), subject to adjustment. The conversion rate will be adjusted upon the occurrence of events that affect Ceradyne's outstanding common stock, such as the issuance of our common stock or other securities as a dividend distribution to holders of our common stock, a subdivision or combination of our common stock, a recapitalization, reclassification or change of our common stock, or a consolidation or merger involving Ceradyne, as a result of which our common stock would be converted into, or exchanged for, stock, other securities or other property. Generally, the conversion rate would be adjusted as of the effective time of such transaction, such that the Notes would then be convertible into the kind and amount of shares of stock, other securities or other property, that a holder of a number of shares of common stock equal to the conversion rate prior to such transaction would have owned or been entitled to receive upon such transaction. The conversion rate will also be adjusted under certain circumstances to provide for a make whole premium, as described below.

The Notes are convertible only under certain circumstances, including (a) during a calendar quarter if the closing price of the Company's common stock for at least twenty trading days in the thirty consecutive trading days ending on the last trading day of the preceding calendar quarter is more than 120% of the then effective conversion price, (b) during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Notes for each day of that period was less than 98% of the product of the closing price for our common stock for each day of that period and the then applicable conversion rate, (c) if the Notes are called for redemption, (d) if specified corporate transactions or fundamental changes occur, or (e) during the ten trading days prior to maturity of the Notes.

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

The Notes contain put options, which may require the Company to repurchase in cash all or a portion of the Notes on December 15, 2012, December 15, 2015, December 15, 2020, December 15, 2025, and December 15, 2030 at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased plus accrued and unpaid interest, including contingent interest (as described below), if any, up to but excluding the repurchase date. The Company reclassified its long term debt consisting of its outstanding Notes, as short-term debt because the Note holders have the right to demand repayment on December 15, 2012.

The Company is obligated to pay contingent interest to the holders of the Notes during any six-month period from June 15 to December 14 and from December 15 to June 14, commencing with the six-month period beginning December 20, 2010 and ending on June 14, 2011, if the average trading price of the note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period equals $1,200 (120% of the principal amount of a note) or more. The amount of contingent interest payable per note for any relevant contingent interest period shall equal 0.25% per annum of the average trading price of a note for the five trading day period ending on the third trading day immediately preceding the first day of the relevant contingent interest period. 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 or at December 31, 2011. There has been no contingent interest obligation for any applicable six-month period through December 31, 2011.

On or prior to the maturity date of the Notes, upon the occurrence of a fundamental change, under certain circumstances, the Company will provide for a make whole amount by increasing, for the time period described herein, the conversion rate by a number of additional shares for any conversion of the Notes in connection with such fundamental change transactions. The amount of additional shares will be determined based on the price paid per share of Ceradyne's common stock in the transaction constituting a fundamental change and the effective date of such transaction. This make whole premium feature represents an embedded derivative. Since this feature has no measurable impact on the fair value of the Notes and no separate trading market exists for this derivative, the value of the embedded derivative was determined to be de minimus. Accordingly, no value has been assigned at issuance or at December 31, 2011.

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

In December 2005, the Company established an unsecured $10.0 million line of credit (“2005 LOC”) which will expire on May 1, 2014. As of December 31, 2011, there were no outstanding amounts on the 2005 LOC. However, the available line of credit at December 31, 2011 has been reduced by outstanding letters of credit in the aggregate amount of $4.2 million. The fixed interest rate on the 2005 LOC was 1.3% as of December 31, 2011. In June 2011, the Company established a separate unsecured $5.0 million line of credit (“2011 LOC”) that was increased to $7.0 million on December 19, 2011 and will mature on April 1, 2013. The Company expects to renew the 2011 LOC at that time for multiple years. As of December 31, 2011, there were no outstanding amounts on the 2011 LOC. However, the available line of credit at December 31, 2011 has been reduced by outstanding letters of credit in the aggregate amount of $1.9 million. The interest rate on the 2011 LOC was 1.3% as of December 31, 2011 which was based on the LIBOR rate for a period of one month, plus a margin of 1.0% percent. In the first quarter of 2012, the Company will finalize the transfer of the outstanding letters of credit under the 2005 LOC to the 2011 LOC and close the 2005 LOC.

Pursuant to the line of credit agreements, the Company is subject to certain covenants, which include, among other things, the maintenance of specified minimum amounts of net income and liquidity. The Company was in compliance with all covenants at December 31, 2011.

Pursuant to the 2005 LOC agreement, the Company is subject to certain covenants, which include, among other things, the maintenance of specified minimum amounts of net income and liquidity. The Company was in compliance with all covenants at December 31, 2011.

During the year ended December 31, 2010, the Company capitalized interest of approximately $445,000 in connection with the construction of its new manufacturing plant in Tianjin, China.

On February 16, 2012, the Company announced that our Board of Directors had declared our initial cash dividend in the amount of $0.15 per share of common stock, payable on March 20, 2012 to shareholders of record as of the close of business on March 6, 2012. It is the Company's current intention that it will declare and pay a similar cash dividend on a quarterly basis, although its Board reserves discretion to suspend or discontinue cash dividends at any time.