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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission File No. 000-13059

Registrant’s telephone number, including area code:  (714) 549-0421

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
 (Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

The aggregate market value (based on the closing price at which stock was sold) of the voting shares held by non-affiliates of the registrant as of March 17, 2003 was $57,594,241.

As of March 17, 2003, the number of shares of the registrant’s Common Stock outstanding was 8,577,734.

DOCUMENTS INCORPORATED BY REFERENCE:  None

PART I

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forwarding-looking statements inherently are subject to risks and uncertainties, some of which we cannot predict or quantify.  Our actual results may differ materially from the results projected in the forward-looking statements.  Factors that might cause such a difference include, but are not limited to, those discussed in “Item 1 - Business,” including the section therein entitled “Risk Factors,” and in “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  You generally can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “may,” “will,” “expects,” “intends,” “estimates,” “anticipates,” “plans,” “seeks,” or “continues,” or the negative thereof or variations thereon or similar terminology.

Item 1.     Business

Introduction

Ceradyne, Inc. (“Ceradyne” or the “Company”) develops, manufactures and markets advanced technical ceramic products and components for industrial, defense, consumer, microwave communications and automotive applications.  In many high performance applications, products made of advanced technical ceramics meet specifications that similar products made of metals or plastics cannot achieve.  Advanced technical ceramics can withstand extremely high temperatures, combine hardness with light weight, are highly resistant to corrosion and wear, and have excellent electrical insulation capability and other special electronic properties.

Ceradyne’s technology was originally developed primarily for defense and aerospace applications which have historically represented a substantial portion of its business.  However, the Company has diversified its product lines based on the development of new ceramic materials’ applications for domestic and international markets.  The Company continues to serve its historical customer base which accounts for a substantial portion of Ceradyne’s business.

The Company derives a portion of its revenues from its traditional products, lightweight ceramic armor for military helicopters and microwave tube products.  However, newer products developed or being developed by the Company for defense, industrial and consumer applications represent an increasing share of its business.  Examples of these newer products include (i) lightweight ceramic armor vests for military personnel; (ii) a translucent ceramic orthodontic bracket, which is sold to Unitek Corporation, a subsidiary of 3M, under an exclusive marketing agreement and marketed by Unitek under its brand name “Clarity”, (iii) silicon nitride advanced technical ceramic components (cam rollers) used in diesel engines, (iv) wear resistant components for industrial machinery, such as paper making equipment, made from the Company’s Ceralloy^® 147 silicon nitride advanced technical ceramic;  (v) missile nose cones or radomes for the defense industry, (vi) large corrosion resistant ceramic components sold to semiconductor equipment manufacturers and (vii) supplying lightweight ceramic armor systems components which will be incorporated into the Ford Lincoln Town Car Ballistic Protection Series (BPS).

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Industry Background

Developments in industrial processing, military systems, microwave electronics, consumer electronics, automotive/diesel engine products, and orthodontics have generated a demand for high performance materials with certain properties not readily available in metals or plastics.  In certain high performance applications, this demand has been met by products made of advanced technical ceramics.

The following table compares certain favorable properties of selected advanced technical ceramics commonly used by the Company 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 the artifacts uncovered intact in modern times.  Almost all traditional ceramics, including those of ancient times, were based on clay.  In recent years, significant advances have been made in ceramic technology through the application of specialized processes to produce man-made ceramic powders.  In the 1950’s and 1960’s, developments in aluminum oxide and other oxides provided ceramics that were excellent electrical insulators and were capable of withstanding high temperatures.  In the 1970’s, these and other developments resulted in the ability to manufacture advanced technical ceramics with great strength at elevated temperatures and reduced brittleness, 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 applications.  However, manufacturing costs associated with the production of these materials need to be reduced in order to accelerate the use of advanced technical ceramics as a direct replacement for metals, plastics or other ceramics.  A portion of these costs is related to the need for diamond grinding finished components to exacting tolerances.  Industry cost reduction efforts have included the production of blanks or feed stock to “near net shape” configurations, thus reducing the need for final finishing.  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.

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Ceradyne Strategy

The Company’s strategy is to capitalize on its existing technologies, developed originally for defense and aerospace applications, and to broaden its product and customer base through increased marketing efforts, both domestically and internationally.  The Company is focusing on additional customer requirements for existing products, and on emerging markets and products which require or can benefit from the physical, chemical or electronic properties of advanced technical ceramics.  To support this strategy, the Company’s Advanced Ceramic Operations in Costa Mesa, California created a new Research & Development Department in early 1998 to focus on new materials’ technology.

Ceradyne seeks to increase sales of its traditional products primarily through expanded domestic and global marketing efforts.  In 2000, Ceradyne established a European Sales Office in England and in early 2001 an Asian Sales Office in Beijing, China.  The European office will concentrate its sales efforts in the area of industrial applications and lightweight ceramic armor for military applications.  The China office will concentrate its sales efforts in the area of industrial ceramics, utilizing fused silica ceramics for the glass tempering and metal forming markets.

Approximately 77% of the Company’s sales and production originate at its west coast facility in Costa Mesa, California. The Company is seeking to reduce its operating and production costs including energy, logistics, occupancy and other costs incurred in California by establishing a manufacturing center and relocating some of its California production operations to an area in the United States that is less expensive. The Company is presently investigating a relocation strategy that would enable it to effectively move some of its operations out of California.

The Company is attempting to reduce its production costs and levels of work in process and finished goods inventory by implementing and employing Demand Flow® Technology (DFT). DFT is a scalable, mathematically-based business strategy, specifically designed to allow manufacturers to respond faster and more efficiently to the needs of their customers and the marketplace. Its primary purpose is to increase the flow of goods in a manufacturing environment to lower costs and gain efficiencies.

In addition to the Company’s strategy to leverage its existing technologies, the Company expects much of its future growth to come from products which are currently in early production or still in development. There can be no assurances, however, that products still under development will be successfully completed, or that any of these newer products, including those already in production, will achieve wide market acceptance.  See “Risk Factors”.  The following table illustrates these newer and planned products and the markets for which they are intended.

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As part of the Company’s strategy, management has and intends to further establish additional sales representative and distributor relationships, particularly in international markets.  The Company will also seek to develop strategic product development or marketing relationships with other manufacturing companies or key customers whose expertise, marketing or financial resources will assist the Company in accomplishing these objectives.  See “Risk Factors”.

Strategic Relationships

The Company has established two strategic relationships which have been, and the Company expects will continue to be, important factors in the Company’s efforts to develop and expand its advanced technical ceramic technology into new products and markets.  These relationships are described below.

Ford Motor Company Joint Development Program.  Ceradyne completed a series of transactions with the Ford Motor Company (“Ford”) in March 1986 with a long-term objective of developing ceramic components for automobiles.  Key to this venture was the transfer of technology developed by Ford relating to technical ceramics, including a portfolio of United States and corresponding foreign patents and patent applications, and the investment by Ford of $10 million in the Company in exchange for Common Stock which eventually resulted in an ownership interest in Ceradyne of approximately 14.6%.  Ford and the Company also entered into a joint development program pursuant to which Ceradyne has been applying its experience and expertise in technical ceramics to develop this technology into commercial products with a view to eventually develop components for automobile engines.  The technology acquired from Ford and the efforts of this joint development program have led to the development of Ceradyne’s Ceralloy^® 147 sintered reaction bonded silicon nitride (SRBSN) advanced technical ceramic, from which the Company now produces a line of industrial wear components and has a line of components for use in diesel engines and fuel pumps.  In January 2003, Ford sold its entire remaining ownership interest in Ceradyne of 927,300 shares to mutual funds and private investment funds associated with Needham & Company, Inc. The Company continues to maintain a good relationship with Ford and has been selected by Ford to supply lightweight ceramic armor system components which will be incorporated into the Lincoln Town Car Ballistic Protection Series.

3M/Unitek Orthodontic Bracket Joint Program.  In March 1986, Ceradyne entered into a joint development and supply agreement with Unitek Corporation, a subsidiary of Minnesota Mining and Mfg (“3M/Unitek”) for the development of a translucent ceramic bracket for orthodontic appliances commonly known as braces.  Under this agreement, 3M/Unitek, which is a major manufacturer of stainless steel orthodontic brackets, provided Ceradyne with information regarding the functional specifications and properties which ceramic brackets would be required to satisfy.  Based on this information and utilizing its experience with translucent ceramics originally produced by Ceradyne for defense electronic countermeasure applications, Ceradyne developed, and in 1987 began manufacturing, translucent ceramic brackets.  These brackets cosmetically blend with the natural color of the patient’s teeth while performing the structural functions formerly performed by traditional stainless steel brackets.

Ceradyne and 3M/Unitek have obtained and jointly own two United States patents covering the basic use of translucent ceramics for an orthodontic bracket. 3M/Unitek has an exclusive right to market brackets based on this technology until 2007.

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Market Applications

The Company’s products can be categorized by the table below which represents principal market applications they address in percent of total sales.

Set forth below is a description of the Company’s principal products itemized by market:

     Industrial

Industrial Wear Components. Ceradyne’s industrial wear components are made primarily of its Ceralloy® 147 sintered reaction bonded silicon nitride (SRBSN).  These SRBSN ceramic components are generally incorporated in industrial machinery where severe abrasive conditions exist which wear out vital components.  The Ceradyne wear resistant parts are used to replace conventional wear materials such as tungsten carbide or ceramics such as alumina or zirconia.  Often these parts are incorporated in high wear areas at the original equipment manufacturer’s plant.  Applications include metal cutting tool inserts, paper making equipment, abrasive blasting nozzles as well as custom applications.

Semiconductor Equipment Components.  The equipment used to make semiconductor wafers is extremely advanced and the newest generation has operating environments that are harsh enough to limit the life of the traditional ceramic and metal components.  Ceradyne offers the industry non-oxide ceramics that have exceptional corrosion resistance and other key properties, such as high thermal conductivity, that are essential to the manufacture of high quality semiconductor wafers. 

Tempered Glass Furnace Components and Metallurgical and Industrial Tooling.  Fused silica ceramic is a ceramic which does not materially expand when heated, nor materially contract when cooled.  It is used to produce industrial tooling components and molds where complicated shapes and dimensions must be maintained over a wide range of temperatures.  Such applications include the forming and shaping of titanium metal, used in the manufacturing of aircraft.  Other applications take advantage of fused silica’s excellent thermal shock resistance and inertness when in contact with glass. These include components for equipment used in the fabrication of flat plate and tempered glass, such as tempering

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furnace rollers, and contoured shapes such as automobile windshields and architectural glass.  Fused silica ceramic shapes of up to 14 feet in length are produced in the Company’s facility located near Atlanta, Georgia.

     Defense

Lightweight Ceramic Armor.  Ceradyne has developed and currently produces lightweight ceramic armor capable of protecting against threats as great as 14.5mm armor piercing machine gun bullets.  Compared to traditional steel armor plates, Ceradyne’s ceramic armor systems offer weight savings as great as 75% for 7.62mm, 12.7mm and 14.5mm armor piercing projectiles.  Utilizing hot pressed Ceralloy^® ceramic, the Company’s armor plates are laminated with either Kevlar^TM, Spectra^TM, fiberglass, zylon or custom hybrid laminates and formed into a wide variety of shapes, structures and components.  Historically, ceramic armor manufactured by the Company has been used principally for military helicopter crew seats and airframe panels.  The Company believes it is a leader in producing lightweight ceramic armor for military helicopters.  Recently, Ceradyne has become a major supplier of lightweight ceramic body armor for the U.S. Army, and is rapidly expanding in new areas that require protection, including ground combat vehicles, marine craft and architectural infrastructure.  See “Risk Factors—We Must Successfully Increase Manufacturing Capacity and Improve Product Yields or Our Gross Margins and Profitability May Suffer.”

The Company received its first production contract for ceramic armor vests for military personnel in January 1995.  This order, from the Defense Logistics Agency of the United States Government, was for $3.5 million in vests, which the Company shipped during 1996. 

On March 2, 1998, a U.S. government agency selected Ceradyne to provide certain ceramic armor products over a multi-year period.  The multi-year contract provides for total orders over the 6 year life of the program which could exceed $100 million. The Company was notified in September 2002 that the contract would be extended for at least two more years into 2005. Through December 31, 2002, the Company has received production orders under this program totaling $30 million.  However, there can be no assurances as to the exact quantities or deliveries under this program as the government is not required to purchase any minimum amount and all orders are at the full discretion of the government.  Additionally, in 2002, Ceradyne received further new firm orders for body armor products under two new contracts worth approximately $12.7 million, all of which are scheduled to ship during the first seven months of 2003.

Missile Nose Cones (Radomes). The Company produces conical shaped, precision machined ceramic components which are designed for the front end of defensive missiles.  These nose cones, or radomes, are used where the velocities and operating environments are severe and the thermal shock and erosion resistance, high strength and microwave transparency properties of advanced technical ceramics are required.  Radomes manufactured by the Company have been qualified for the Standard Missile Block IV and Block IVA missile program and for the Patriot PAC-3 missile program.  The PAC-3 missile is now in the low rate production phase.

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     Consumer

Ceramic Orthodontic Brackets. In the orthodontic process of correcting a patient’s tooth alignment, typically small (about ¹/4’’) stainless steel brackets are adhered to each individual tooth in order to serve as a guide to the archwire which is the wire that sets into each bracket. The cosmetic appearance of all this metal is often considered quite unattractive.  Ceradyne, together with its marketing partner, 3M/Unitek, have developed and are marketing ceramic orthodontic brackets made of Ceradyne’s translucent ceramic, Transtar^®.  The translucency of this ceramic bracket, together with the classic ceramic properties of hardness, chemical inertness and imperviousness, have resulted in a cosmetic substitute for traditional stainless steel brackets.  These products are generally sold as aesthetic alternatives to conventional metal brackets and have been in production since 1987.  Ceradyne and 3M/Unitek introduced a new enhanced ceramic bracket called “Clarity” in October of 1996.  This product has patent protection and offers new features which improve the bracket’s strength and functionality, compared to earlier designs manufactured by the Company.  Comments from orthodontists who have purchased Clarity™ brackets have been positive. The Company believes Clarity™ brackets offer the orthodontist a more robust product that will minimize treatment and chair time while providing superior aesthetic appearance.

     Microwave Tube Products

Microwave Ceramic-Impregnated Dispenser Cathodes.  The Company manufactures ceramic-impregnated dispenser cathodes which are used in microwave tubes for applications in radar, satellite communications, electronic countermeasures and other uses.  Dispenser cathodes, when heated, provide the stream of electrons which are magnetically focused into an electron beam.  Microwave frequency signals which interact with this beam of electrons are substantially increased in power. Microwave dispenser cathodes are primarily composed of a porous tungsten matrix impregnated with ceramic oxide compounds.

Samarium Cobalt Permanent Magnets.  The Company’s samarium cobalt magnets are sold as components primarily for microwave tube applications.  Electron beams in microwave tubes generated by the dispenser cathodes described above can be controlled by the magnetic force provided by these powerful permanent magnets.  The magnets are generally small sub-components of microwave traveling wave tubes.

Precision Ceramics.  Ceradyne produces a wide variety of hot pressed Ceralloy^® ceramic compositions, precision diamond ground to close tolerances, primarily for microwave tube applications.  The interior cavities of microwave tubes often require ceramic components capable of operating at elevated temperatures and in high vacuums.

     Automotive Market

Internal Combustion and Diesel Engine Components.  The demand for higher performance, cleaner burning, more efficient and more durable engines for heavy-duty diesel trucks and automobiles creates additional opportunities for advanced technical ceramics.  The Company believes that if engines could be produced using certain advanced technical ceramic components, they could be lighter and last longer than those using metal components, and could operate at higher temperatures and pressures with reduced cooling and lubrication requirements.  As a result, engines would use less fuel, achieve more complete combustion thereby reducing emissions, and be less costly to maintain.  Because of

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these potential benefits, industry wide efforts are being made to replace selected metal components in heavy-duty diesel engines and fuel pumps with advanced technical ceramic components.

Ceradyne has produced a number of prototype parts made from Ceradyne’s Ceralloy® 147 silicon nitride for evaluation and testing in internal combustion and diesel engines.  Ceradyne has been producing cam rollers for heavy-duty diesel engines since 1999, and now has sole source contracts with two major engine companies.  Ceradyne also has a sole source contract with a fuel systems manufacturer for components for a light duty diesel fuel pump.  In addition, Ceradyne has development projects in place with a number of engine and fuel systems manufacturers world wide for various ceramic components.  Furthermore, Ceradyne is engaged in a joint development program with Ford to develop ceramic components for automobile engines.  Ford is not obligated to purchase any minimum quantities of components developed under this program and Ceradyne’s efforts in this area are still in the experimental stage with future success greatly dependent on achieving cost reductions while maintaining a high quality level.

Ceramic armor system components for Ford Motor Company. The demand for ballistic protection vehicles has been growing due to ever increasing geopolitical threats. The Company has been selected by Ford Motor Company to supply lightweight ceramic armor systems components which will be incorporated into the Lincoln Town Car Ballistic Protection Series (BPS). The components supplied by Ceradyne will incorporate technology and ballistic protection similar to that developed by the Company for several defense related applications. The introduction of this car culminates two years of working with a Ford-assembled team of experts in ballistic steel, ballistic grade windows and ‘run flat’ tires. Ford is the only domestic original equipment manufacturer (OEM) of armored vehicles, and the Lincoln Town Car BPS is the only armored automobile that provides protection from powerful handgun and high-power rifle rounds compared to only hand gun level protection offered by others. 

Marketing and Customers

Each of Ceradyne’s three manufacturing locations maintains an autonomous sales and marketing force promoting their individual products.  The Company has more than 12 employees directly involved in sales and marketing, including a marketing manager located in the United Kingdom who was hired in February, 2000, and a sales manager located in Beijing, China, who was hired in January 2001.  The Company also has agreements with manufacturers’ representatives in the United States and other countries who are compensated as a percent of sales in their territory. Ceradyne is focusing much of its marketing effort outside the United States through direct involvement of senior management personnel from the Company’s U.S. facilities in concert with local manufacturing representatives.  Revenues from export sales represented approximately 13% in 2000, 16% in 2001 and 11% in 2002.

Generally, the Company sells components to contractors or original equipment manufacturers.  To a lesser extent, Ceradyne sells its products directly to the end user.  The Company sells its translucent ceramic orthodontic brackets only to 3M/Unitek pursuant to an exclusive marketing agreement with that customer.  Sales to 3M/Unitek represented approximately 14% of total net sales in 2000, 18% in 2001, and 12% in 2002.  See “Risk Factors—Sales of Our Ceramic Orthodontic Brackets Depend on Our Exclusive Marketing and Sales Relationship with Unitek, a Division of 3M Corporation.”

The Company continues to explore various domestic and international marketing, and other relationships to increase its sales and market penetration.  Furthermore, Ceradyne is attempting to create long-term relationships with its customers to promote a smoother, more predictable flow of orders and shipments by entering into multi-year agreements or exclusive relationships where possible.

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Manufacturing Processes

Ceradyne has a number of manufacturing processes which are dedicated to specific products and markets.  These processes and the product applications are described below.

Hot Pressing.  The Company’s hot pressing process is generally used to fabricate ceramic shapes for lightweight ceramic armor and semiconductor equipment components.  Ceradyne has developed and constructed induction heated furnaces capable of operating at temperatures exceeding 4000 °F in inert atmospheres at pressures up to 5000 lbs. per square inch.  This equipment enables Ceradyne to fabricate parts more than 26 inches in diameter, which is considered large for advanced technical ceramics.  Through the use of multiple cavity dies and special tooling, the Company can produce a number of parts in one furnace during a single heating and pressing cycle.

Ceradyne procures its raw materials (fine powders) from several outside suppliers.  After processing by the Company, the powders are either loaded directly into the hot pressing molds or are shaped into pre-forms prior to loading into the hot pressing molds.  The powders are placed in specially prepared graphite tooling, most of which is produced by Ceradyne.  Heat and pressure are gradually applied to the desired level, carefully maintained and finally reduced.  The furnace is removed from the press while cooling to permit the press to be used with another furnace.  For most products, approximately 20 hours are required to perform this cycle.  The resultant ceramic product generally has mechanical, chemical and electrical properties of a quality approaching that only theoretically obtainable.  Almost all products are then finished by diamond grinding to meet precise dimensional specifications.

Sintering of Fused Silica Ceramics.  Sintering of fused silica ceramics is the process Ceradyne uses to fabricate fused silica ceramic shapes for applications in glass tempering furnaces, metallurgical tooling and other industrial uses.  To fabricate fused silica ceramic shapes, fused silica powders are made into unfired shapes through slip casting or other ceramic compaction processes.  These unfired “green” shapes are fired as they move through a continuously operated 150 foot long tunnel kiln at temperatures up to 2500 °F.  The final shapes are often marketed in the “as fired” condition or, in some cases, precision diamond ground to achieve specific dimensional tolerances or surface finishes required by certain customers.  See “Business, Manufacturing Processes-Diamond Grinding”.

Ceramic-Impregnated Dispenser Cathode Fabrication.  Ceramic-impregnated dispenser cathode fabrication is used to produce cathodes for microwave power tube applications.  To produce ceramic-impregnated dispenser cathodes, both tungsten metal powders and ceramic powders are used.  The tungsten metal powders are isostatically pressed in polymer tooling, removed and fired in special atmospheres at temperatures in excess of 4000 °F.  The tungsten billets are machined into precision shapes with exacting tolerances.  The tungsten machined shapes are impregnated with a ceramic composite and fired at high temperatures in special atmospheres.  The ceramic impregnated components are assembled and furnace brazed.

Final processing includes the insertion of a metal heating element within a ceramic insulating compound and the addition of an extremely thin layer of precious metals to the surface.  The Company’s final quality inspection often includes a test of the cathode’s electron emitting capabilities at normal operating temperatures. 

Sintering and Reaction Bonding of Silicon Nitride.  The sintering of reaction bonding silicon nitride results in the Company’s Ceralloy^® 147 SRBSN, which is used in industrial and automotive

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applications.  Ceradyne’s SRBSN is based on technology acquired from Ford. See “Strategic Relationships”.  This SRBSN process begins with relatively inexpensive high purity elemental silicon (Si) powders, which contrasts sharply with most other competitors’ manufacturing techniques which start with relatively more expensive silicon nitride (Si₃N₄) powders.

After additives are incorporated by milling and spray drying, the silicon powders are formed into shapes through conventional ceramic processing such as dry pressing.  These shapes are then fired in a nitrogen atmosphere which converts the silicon part to a silicon nitride part.  At this step (reaction bonding), the silicon nitride is pressure sintered in an inert atmosphere increasing the strength of the component threefold.  As a result of SRBSN processing, the ceramic crystals grow in an intertwining “needle-like” fashion which the Company has named NeedleLok^TM.  Ceradyne’s NeedleLok^TM structure results in a tough, high fracture energy part.  The process is economical due to the low cost of the starting powders and can be used to produce extremely high production volumes of parts due to the use of conventional pressing processes.

Fabrication of Translucent Ceramics (Transtar^®).  Ceradyne produces translucent aluminum oxide (Transtar^®) components primarily for use as orthodontic ceramic brackets.  The high purity powders are purchased from outside vendors and processed by dedicated conventional ceramic mechanical dry presses.  The formed blanks are then fired in a segregated furnace in a hydrogen atmosphere at 3272 °F until the ceramics enter into a strong translucent condition.  These fired aesthetic brackets then have certain critical features diamond ground into them.  The final step is a proprietary treatment of the bonding side in order to permit a sound mechanical seal when bound to the patient’s teeth.

Diamond Grinding. Many of Ceradyne’s advanced technical ceramic products must be finished by diamond grinding because of their extreme hardness.  The Company’s finished components typically are machined to tolerances of ±.001 inch and occasionally are machined to tolerances up to ±.0001 inch. To a limited extent, the Company also performs diamond grinding services for customers independently of its other manufacturing processes to specifications provided by the customer.  The Company’s diamond grinding department can perform surface grinding, diameter grinding, ultrasonic diamond grinding, diamond lapping, diamond slicing and honing.  The equipment includes manual, automatic and computer numerically controlled (CNC) grinders.  The CNC grinders have been specially adapted by the Company for precision grinding of ceramic contours to exacting tolerances.

Fabrication of Samarium Cobalt Permanent Magnets.  The fabrication of samarium cobalt permanent magnets results in various magnet shapes which are primarily used in microwave tube applications.  The Company procures premixed samarium cobalt powder either as SmCo₅ or Sm₂Co₁₇ compositions. The powders are then milled and formed into the final configuration by pressing in a magnetic field using a specially designed magnet press.  These “pre-fire” or “green” magnets are then sintered at 2000 °F in helium or vacuum.  The magnets may then be subsequently diamond ground and characterized as to each individual magnet’s strength.

Raw Materials.  The starting raw materials for Ceradyne’s manufacturing operations are generally fine, man-made powders available from several domestic and foreign sources. The raw materials, such as Kevlar^TM, graphite, metal components and ceramic powders are readily available from several commercial sources.

Quality Control.  Ceradyne products are made to a number of exacting specifications.  In order to meet both internal quality criteria and customer requirements, the Company has implemented a number of quality assurance and in-process statistical process control programs.  These quality programs are

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implemented separately at each of Ceradyne’s three manufacturing locations.  The Company’s Thermo Materials Division in Scottdale, Georgia received its ISO 9001 Certification in 1997.  The Company’s Advanced Ceramic Operations in Costa Mesa, California received its ISO 9001 Certification in 1998. Both Certifications have been renewed.

Engineering and Research

Ceradyne’s engineering and research efforts consist of applications engineering in response to customer requirements, in addition to new materials and product development performed by its Research and Development Department.  These efforts are directed toward the creation of new products, the modification of existing products to fit specific customer needs, or the development of enhanced ceramic process technology.  The Company is also engaged in research to develop new products.  Costs associated with application engineering and research are generally expensed as incurred and are included in cost of product sales, or in Research and Development expense. Costs associated with research were approximately $3,610,000 in 2002, $1,580,000 in 2001 and $1,610,000 in 2000.  The totals consist of $2,080,000, $1,083,000, and $1,252,000 from the Research and Development Department, and $1,530,000, $497,000 and $358,000 from the Engineering Department (included in cost of product sales) for the years ended December 31, 2002, 2001 and 2000, respectively.

Competition

Ceradyne competes on the basis of product performance, material specifications, applications engineering capabilities, customer support, reputation and price.  Competitive pressures vary in each specific product market, depending on the product and program.  In many instances, the competitors are well-known companies with greater financial, marketing and technical resources than Ceradyne. Ceradyne intends to continue to focus on selected business areas in which it can exploit its technological, manufacturing and marketing strengths.  Some of Ceradyne’s competitors are divisions of larger companies, with each of Ceradyne’s product lines subject to completely different competitors.  Some of the competitors of the Company include Kyocera Corporation’s Industrial Ceramics Group, Vesuvius, Cercom, CoorsTek, Inc., Spectra-Mat, Armor Holdings, Inc., and others.  In many applications, the Company also competes with manufacturers of non-ceramic materials.  For future automotive applications, there is a wide range of both current and potential domestic and international competitors.  See “Risk Factors—The Advanced Technical Ceramic Markets are Highly Competitive.”

Backlog

Ceradyne records an item as backlog when it receives a contract or purchase order indicating the number of units to be purchased, the purchase price, specifications and other customary terms and conditions.  Ceradyne customarily includes unexercised options as a separate item in its backlog because the purchase orders are given on the basis of the total order, including options.  Total backlog as of December 31, 2002 was approximately $35.7 million, consisting of $34.3 million of firm scheduled orders and $1.4 million of unexercised options.  As of December 31, 2001 total backlog approximated $28.1 million, consisting of $26.4 million of firm scheduled orders and $1.7 million of unexercised options.  Typically, firm orders are scheduled to be initially shipped within 12 to 18 weeks from receipt of order.

Patents, Licenses and Trademarks

The Company relies primarily on trade secrecy to protect compositions and processes that it believes are proprietary.  In certain cases, the disclosure of information concerning such compositions or

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processes in issuing a patent could be competitively disadvantageous.  However, management believes that patents are important for technologies where trade secrecy alone is not a reliable source of protection.  Accordingly, Ceradyne has applied for, or has been granted, several United States patents relating to compositions, products or processes that management believes are proprietary, including lightweight ceramic armor.

Two U.S. patents have been issued to the Company relating to translucent ceramics for orthodontic brackets.  The earliest of these patents expires in 2007.  These patents are co-invented and co-owned by Ceradyne and 3M/Unitek.  Ceradyne and 3M/Unitek have granted licenses to eight companies whose ceramic orthodontic brackets infringe the Ceradyne-3M/Unitek patents, wherein those companies pay royalties to Ceradyne and 3M/Unitek based on sales of their orthodontic ceramic brackets for the remaining life of the patents.  See “Risk Factors—We May Be Adversely Affected If We Are Unable To Adequately Safeguard Our Intellectual Property or If We Infringe Others’ Intellectual Property.”

Through its association with Ford, Ceradyne acquired in excess of 80 U.S. patents, of which 4 are still active, and corresponding foreign patents and applications relating to technical ceramics for automotive technology.  The last of these patents will expire in August 2007.  See “Strategic Relationships”.

In addition to the above, Ceradyne has been issued 16 U.S. patents and has 6 patents pending and has applied for corresponding foreign patents in various foreign countries.  The earliest of these patents expires in 2004.

“Ceralloy^®”, the name of Ceradyne’s technical ceramics, “Ceradyne^®” and the Ceradyne logo, comprising the stylized letters “CD^®”, are major trademarks of the Company which have been registered in the United States and various foreign countries.  The Company also has other trademarks, including “Transtar^®”, “Semicon^®”, “Thermo^®”, “Netshape^®”, “Defender^®”, “NeedleLok™”, and “Ramtech™”.

Employees

At December 31, 2002, Ceradyne employed approximately 435 persons versus 463 in the prior year.  The Company utilizes temporary labor in some of its production operations. Management considers its employee relations to be excellent.  The Company has not experienced difficulty in attracting personnel.  None of the Company’s employees are represented by a labor union.

RISK FACTORS

This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our actual results may differ materially from the results projected in the forward-looking statements.  Factors that might cause such a difference include, but are not limited to, the following:

     We Depend Upon Sales to Agencies of the United States Government; We Face the Risk That a Key Government Contract May be Terminated

We have a $35.7 million backlog of orders as of December 31, 2002.  Of this amount, approximately $24.4 million, or 68%, represents orders for defense applications, primarily ceramic armor plates for military personnel.  These orders are closely tied to the level of U.S. defense spending.  Certain

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contracts for ceramic armor or radomes are directly or indirectly with agencies of the United States government.  Moreover, we anticipate that a significant percentage of our revenues for the foreseeable future will derive from direct or indirect sales to government agencies.

Recently, the U.S. military has been accelerating its program to equip its ground-based combat personnel with ceramic body armor systems. We believe the U.S. military's requirements for ceramic armor plates will continue for an indefinite period of time. However, demand for ceramic armor plates may decline when the number of body armor systems shipped is sufficient to equip front-line troops, if conflicts in the Middle East and other high risk areas subside, or if U.S. defense budget appropriations are reduced. Furthermore, we must win future orders in an open, competitive government bid process to maintain our current level of business.

Under U.S. law, defense-related contracts may be canceled by the government for convenience at any time and without cause. If contracts are cancelled, we receive reimbursement only for the expenses we actually incurred.  Any such cancellations could have material adverse effects on our business, operating results and financial condition. We also operate in a geopolitical climate that is very sensitive and potentially volatile and could contribute to a disruption of orders and production.

     We Must Successfully Increase Manufacturing Capacity and Improve Product Yields or Our Gross Margins and Profitability May Suffer

Recently we have experienced a substantial increase in orders for ceramic armor vests for military personnel and for cam rollers for diesel engines.  We currently expect that demand for these products will require us to increase our production of ceramic armor vests in 2003 over 2002, and increase production of cam rollers in 2003 over 2002.  During 2002, we invested in capital expenditures to increase production capacity for these two products, and we expect to make additional capital expenditures in 2003 to further expand our capacity.  Even with these additions to production capacity there can be no assurance that we will be able to manufacture the required quantities of these products in a timely manner or on a profitable basis.  In order to successfully satisfy customer demand for these products while achieving acceptable profits, we must:

We have experienced inefficiencies inherent with the rapid ramp up in our manufacturing volumes that put pressure on our gross profit margins in 2002, particularly in the first quarter.  For 2003, we expect gross profit margins to gradually improve as we increase our product yields, manufacturing efficiencies and production processes.  However, there can be no assurance that the gross profit margins we ultimately achieve on higher volumes of these products will be comparable to our historical gross profit margins, especially in the automotive product line of ceramic cam rollers for diesel engines.

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The increase in orders for ceramic armor vests for military personnel and cam rollers for diesel engines, as well as the introduction of new products, is placing, and will continue to place, a significant strain on our resources and personnel.  To continue our growth, we must increase our production capacity for our existing products and introduce new products that apply our core advanced technical ceramic technologies.  Managing this growth will strain our operational, financial and managerial resources into the foreseeable future.

To effectively manage growth, we must:

Any failure to effectively manage growth could have material adverse effects on our business, operating results and financial condition.

     We Are Considering Relocating Some of Our California Operations; the Move Would Be Expensive and, if Not Managed Properly, Could Adversely Affect Our Business

Ceradyne’s goal is to be a low cost producer of its products. However, certain costs of our California operations continue to increase. The costs of energy, rental of production facilities and logistics are

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cheaper in other parts of the United States. Consequently, we are investigating the relocation of some of our California manufacturing operations to a location outside of California. Managing this relocation effort will put pressures on our operational, financial and managerial resources.

To effectively manage this relocation effort, we must:

The relocation will involve substantial expense, including capital expenditures, and could disrupt operations. Any failure to effectively manage this relocation effort could have material adverse effects on our business, operating results and financial condition.

     We Depend on Joel P. Moskowitz and Our Other Key Personnel

Our success largely depends on the continued service of our principal managers.  Many of these managers, and in particular Joel P. Moskowitz, who is Chairman, Chief Executive Officer and President, and a principal stockholder of Ceradyne, would be extremely difficult to replace.  We also depend on other key personnel, and our ability to attract, motivate and retain highly qualified personnel.

Competition for skilled employees is intense and there can be no assurance that we will be able to recruit and retain such personnel.  If we are unable to retain our existing managers and employees or hire and integrate new employees, it could have material adverse effects on our business, operating results and financial condition.

     The Advanced Technical Ceramics Markets Are Highly Competitive

The markets for applications of advanced technical ceramics are competitive.  We believe the principal competitive factors in these matters are:

At present, while we believe that we compete favorably with respect to these factors, this may change.  If we fail to address our competitive challenges, there could be material adverse effects on our business, financial condition and results of operations.

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Our competitors include divisions of larger companies and manufacturers of non-ceramic materials.  Many of these competitors, both domestic and international, have greater financial, marketing and technical resources than we do.  Our primary competitors include Kyocera Corporation’s Industrial Ceramics Group, Vesuvius, Cercom, CoorsTek, Inc., Spectra-Mat, Armor Holdings, Inc., and others.  Not only do we compete with many large companies, but each of our product lines compete with completely different companies.

We cannot guaranty that we will be able to compete successfully against our current or future competitors or that competition will not have material adverse effects on our business, operating results and financial condition.

     We Could Be Liable for Violations of Environmental Laws and Regulations

We are subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous materials used to manufacture our products.  Authorities could impose fines, suspend production, alter our manufacturing processes, or stop our operations if we do not comply with these regulations.

In the past, we produced certain products using beryllium oxide, which is highly toxic in powder form.  This powder, if inhaled, can cause chronic beryllium disease in a small percentage of the population.  We have been sued in the past by former employees and by employees of one of our customers and by their family members alleging that they had contracted chronic beryllium disease as a result of exposure to beryllium oxide powders used in our products.  All of these claims have been dismissed without incurring material liability.  We cannot guaranty that we will avoid future liability to persons who may allege that they contracted chronic beryllium disease as a result of exposure to beryllium oxide utilized by Ceradyne in prior years.

While we believe we are in material compliance with all applicable environmental statutes and regulations, any failure to comply with current or subsequently enacted statutes and regulations could subject us to liabilities, fines or the suspension of production.  Furthermore, any claims asserted against us in the future related to exposure to beryllium oxide powder may not be covered by insurance.  Even if covered, the amount of insurance may be inadequate to cover any adverse judgment.

Fines and other punishments imposed in connection with environmental violations and expenses related to remediation or compliance with environmental regulations and future liability for incidences of chronic beryllium disease contracted by employees or employees of customers could have material adverse effects on our business, operating results and financial condition.

     Sales of our Ceramic Orthodontic Brackets Depend on Our Exclusive Marketing and Sales Relationship with Unitek, a Division of 3M Corporation

We developed our translucent ceramic orthodontic bracket pursuant to a joint development agreement with Unitek.  We sell this product only to Unitek pursuant to an exclusive marketing agreement, which expires in 2007.  Consequently, our sales of this product depend entirely on Unitek’s marketing and sales efforts.  We cannot guaranty that Unitek will devote substantial marketing efforts to sales of our orthodontic products, or that Unitek will not reassess its commitment to our technologies or develop its own competitive technologies.  If Unitek fails to actively market our orthodontic brackets, there may be material adverse effects on our business, operating results and financial condition.

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     Our International Sales are Subject to Risks Associated with Operating in International Markets

Shipments to customers outside of the United States accounted for approximately 13% of our sales in 2000, 16% in 2001, and 11% in 2002.  We anticipate that international shipments will account for a portion of our sales for the foreseeable future.  Therefore, the following risks associated with international business activities could have material adverse effects on our performance:

We have traditionally invoiced our foreign sales in U.S. dollars.  Accordingly, we do not currently engage in foreign currency hedging transactions that could protect against the risk of currency fluctuations.  This approach could pose risks.  If the U.S. dollar were to become more expensive relative to the currencies of our foreign customers, the price of our products in those countries rises and our sales into those countries, or our profitability within those countries, may fall.

Future international activity may require that we denominate foreign sales in the local currencies of our customers.  In that case, if the U.S. dollar were to become more expensive relative to the currencies of our foreign customers, we would receive fewer U.S. dollars for each unit of foreign currency that we receive when our customers pay us. Therefore, a more expensive U.S. dollar would cause us to incur losses upon the conversion of accounts receivable denominated in foreign currencies.  Such losses could harm our results of operations.

We cannot export some of our products to certain foreign countries without an export license obtained from the U.S. government. We have experienced difficulty in obtaining licenses to export our products to certain countries.  Similar difficulties may arise again in the future.  If any of the above risks emerge, there may be material adverse effects on our business, operating results and financial condition.

     We May be Adversely Affected If We Are Unable to Adequately Safeguard Our Intellectual Property or If We Infringe on Other’s Intellectual Property

We rely on a combination of patents, trade secrets, trademarks, and other intellectual property law, nondisclosure agreements and other protective measures to preserve our proprietary rights to our products and production processes.  These measures afford only limited protection and may not preclude competitors from developing products or processes similar or superior to ours.  Moreover, the laws of certain foreign countries do not protect intellectual property rights to the same extent as the laws of the United States.

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Although we implement protective measures and intend to defend our proprietary rights, there can be no assurance that these efforts will succeed.  We may have to litigate within the United States or abroad to enforce patents issued or licensed to us, to protect trade secrets or know-how owned by us or to determine the enforceability, scope and validity of our proprietary rights and the proprietary rights of others.  Enforcing or defending our proprietary rights could be expensive and might not bring us timely and effective relief.

Furthermore, there can be no assurance that our products or processes are not in violation of the patent rights of third parties, or that any of our patents will not be challenged, invalidated or circumvented.  Although there are no pending or threatened intellectual property lawsuits against us, we may face litigation or infringement claims in the future.  Infringement claims could result in substantial costs and diversion of our resources even if we ultimately prevail.  A third party claiming infringement may also obtain an injunction or other equitable relief, which could effectively block the distribution or sale of allegedly infringing products.  Although we may seek licenses from third parties covering intellectual property that we are allegedly infringing, we cannot guarantee that any such licenses could be obtained on acceptable terms, if at all.

If we fail to adequately protect our intellectual property, or if we face claims for infringement on the intellectual property of third parties, there may be material adverse effects on our business, operating results, and financial condition.

     We Depend on Ford Motor Company to Sell and Market the Ballistic Protection Series that contains our products. We are Subject to Risks Associated with the Marketing and Sales of these Vehicles.

We rely entirely on the Ford Motor Company’s efforts to sell and market its Lincoln Town Car Ballistic Protection Series (BPS). There can be no assurance that this product will sell in the quantities or levels that Ford has forecasted. Nor is there any assurance that the style and design of this car will be popular with the public. We cannot guaranty that Ford will devote substantial marketing efforts to promote the sales of this product or that Ford will not reassess its commitment to our ceramic technologies or develop its own competitive technologies.  If Ford fails to actively market Lincoln Town Car Ballistic Protection Series, there may be costs that we would be required to expense thus impacting our business and operating results.

Item 2.     Properties

The Company serves its markets from manufacturing facilities in three locations across the United States.  The Company’s Advanced Ceramic Operations, located in Costa Mesa and Irvine, California, primarily produces armor and orthodontic products, components for semiconductor equipment, and houses the Company’s SRBSN research and development activities.  The Company’s cathode development and production are handled through its Semicon Associates division located in Lexington, Kentucky.  Fused silica products, including missile radomes, are produced at the Company’s Thermo Materials division located in Scottdale, Georgia.  The facilities at these locations comprise approximately 126,000, 35,000 and 85,000 square feet, respectively.  The Company’s Costa Mesa, Irvine and Scottdale facilities are held under leases which expire in October 2005, January 2007, and October 2015, respectively.  The Company owns its Lexington, Kentucky facility, which is on a five acre property with room for expansion. The Company is considering realigning its manufacturing facilities and moving part of its California operation to a location outside of California.

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Ceradyne’s manufacturing structure is summarized in the following table: