Foolish Forecast: Ceradyne's Slip Is Showing

Fresh off a dramatic Q3 earnings miss -- its first in five years of reporting -- high-tech potter Ceradyne (Nasdaq: CRDN) tries to get back on the horse next week. But will Tuesday's Q4 and full-year 2007 report mark a return to Ceradyne's old form, or will it slip again?

What analysts say:

• Buy, sell, or waffle? Eleven analysts cover Ceradyne: Six buys, five holds.
• Revenue. On average, they're looking for just 4% sales growth to $186 million...
• Earnings. ... and a 6% slide in profits to $1.30 per share.

What management says:
Ceradyne made plenty of news this past quarter. Most recently, we saw Oshkosh (NYSE: OSK) place an order for Ceradyne's new "B-Kit prototype armor kit" -- presumably to be used on the companies' joint offering to build next-generation BULL MRAPs (mine-resistant, ambush-protected vehicles) for the Pentagon's consideration as an alternative to offerings from General Dynamics (NYSE: GD), Force Protection (Nasdaq: FRPT), BAE, and Navistar.

Last month, Ceradyne announced a trio of contracts, including a high-profile deal to supply ceramic armor inserts to the federal UNICOR prison industries concern. Another was a more workaday contract to manufacture pump seals for an industrial customer. And the third was a massive $400 million order to provide yet more ceramic armor to the U.S. Special Forces -- just the latest (if biggest) in a string of similar military contract wins.

What management does:
All of which suggests there's some hope that last quarter's disappointment was just a bump in the road toward ever-improving margins at Ceradyne. As the table below shows, it's been a long road indeed:

Margins	6/06	9/06	12/06	3/07	6/07	9/07
Gross	38.3%	38.5%	39.4%	39.7%	40.3%	40.7%
Operating	26.5%	27.7%	29.1%	29.6%	30.4%	30%
Net	16.4%	17.8%	19.4%	19.8%	20.5%	19.7%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Other than the slew of contracts announced, what else does Ceradyne have up its sleeve? In a post-earnings-disaster conference call back in November, management rolled off a list of non-military revenue drivers that it's lining up to replace any future decline in military spending. From diesel engine parts, to photovoltaic silicon crucibles, to nuclear waste containers, to new products used in smelting bauxite (the raw material that firms like Alcoa turn into aluminum), Ceradyne seems intent on finding ever more uses for high-tech ceramics -- and ever more ways to replenish its revenue stream.

The key concern at this point is whether revenue from such products will hold the same lofty margins you see in the table above. Management confirmed that overall, the new projects should yield margins approximating what it's already been getting. But that leaves more than a little wiggle room, in my view. My advice: Watch revenue trends at this one closely. Watch margin trends even closer.

For more details on developments over the past few months, read:

• Ceradyne's a Li'l Less Fine
• Ceradyne Gets a Tat
• Quick Take: Ceradyne Delivers on a Promise
• Ceradyne Gives a One-Two Punch