<PAGE>

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

                                   FORM 10-K

 [X]   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
       OF 1934
       For the Fiscal Year Ending December 31, 1997

 [_]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934 (No fee required)
       For the transition period from _______ to _______

                          Commission File No. 0-13059

                                CERADYNE, INC.
                                --------------
            (Exact name of Registrant as specified in its charter)

                Delaware                              33-0055414
     -------------------------------         -------------------------------
     (State or other jurisdiction of           (I.R.S. Employer Identifica-
      incorporation or organization)                  tion Number)

              3169 Red Hill Avenue, Costa Mesa, California 92626
              --------------------------------------------------
                   (Address of principal executive offices)

      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.
YES  [X]    NO  [_]

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]

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 5,
1998 was $35,096,587.

As of March 5, 1998, the number of shares of the registrant's Common Stock
outstanding was 7,963,459.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement for its 1998 Annual Meeting of
Stockholders are incorporated by reference into Part III.
<PAGE>

                                    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.  The Company's 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
"Certain Factors that May Affect the Company's Business and Future Results," and
in "Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations."

Item 1.  Business
         --------

Introduction

Ceradyne, Inc. ("Ceradyne" or the "Company") develops, manufactures and markets
advanced technical ceramic products and components for industrial, defense,
consumer and microwave 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 on the
development of new applications and markets, domestic and international, for its
advanced technical ceramic technology, while continuing to serve its historical
customer base which continues to account for a substantial portion of the
Company's business.

From revenues of $25.6 million in 1987, the Company's revenues declined to a
low of $15.9 million in 1993.  Management believes that the Company's financial
recovery commenced in the fourth quarter of 1994 due to an increase in new
bookings and the divestiture of an historically unprofitable operation.
Revenues began to increase in the third quarter of 1994, and have continued to
increase during the years ended December 31, 1995,  1996 and 1997.

The Company continues to derive a substantial portion of its revenues from its
traditional products, such as 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 have
represented a growing share of its business.  Examples of these newer products
include (i) large corrosion resistant ceramic components sold to a wide range of
semiconductor equipment manufacturers; (ii) lightweight ceramic armor vests for
military personnel; (iii) a modified 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", (iv)
wear resistant components for industrial machinery, such as paper making
equipment, made from the Company's Ceralloy(R) 147 silicon nitride advanced
technical ceramic; and (v) missile nose cones or radomes for the defense
industry.

The Company has a strategic relationship with the Ford Motor Company, pursuant
to which Ford has acquired a 15.2% equity interest in the Company, and
transferred ceramic-related technology to the

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<PAGE>

Company with a long-term objective of developing ceramic components for
automobile engines. The Company's efforts in automotive and diesel applications
are still in the experimental stage and the Company's ability to generate
significant revenues from these applications is uncertain and may not occur for
several years, if at all.

Industry Background

Developments in industrial processing, military systems, microwave electronics,
consumer electronics 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.

<TABLE>
<CAPTION>
                               MELTING
                                POINT           HARDNESS           CHEMICAL                                DENSITY
                              (DEGREES          (VICKERS          RESISTANCE           ELECTRICAL           (GMS
    MATERIALS                FAHRENHEIT)         SCALE)            TO ACIDS            PROPERTIES          PER CC)
====================================================================================================================
<S>                        <C>               <C>              <C>                  <C>                    <C>
Advanced technical                                                                  From conductors to
 ceramics                  2,500 to 6,900    1,600 to 7,000        Excellent       excellent insulators   2.5 to 4.5
--------------------------------------------------------------------------------------------------------------------
High strength alloy
 steel                     2,500 to 2,700      250 to 900            Fair               Conductors        7.0 to 9.0
--------------------------------------------------------------------------------------------------------------------
High performance                                                    Good to         Good to excellent
 plastics                    275 to 750          5 to 10           Excellent            insulators        1.0 to 2.0
====================================================================================================================
</TABLE>

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 industry that has emerged
from these advances is 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 are 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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The automobile industry is particularly sensitive to initial as well as life
cycle costs.  Although the current state of the art of advanced technical
ceramics suggests potential automotive acceptance, the cost factors currently
will not permit automobile related production.  The industry goal is to bring
advanced technical ceramics' costs down as close as possible to the cost of
equivalent current metal parts.

Ceradyne Strategy

The Company's strategy is to capitalize on its existing technologies, developed
originally for defense and aerospace applications, to broaden its product and
customer base through increased marketing efforts both domestically and
internationally.  The Company is focusing on additional customer opportunities
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 hired Andre Ezis in
January 1997 to fill the newly created position of Vice President, Research and
Development.  Mr. Ezis has been hiring additional staff to support the materials
research and development required to move rapidly into opportunities in the
semiconductor equipment and automotive business segments.

Ceradyne seeks to increase sales of its traditional products primarily through
expanded domestic and global marketing efforts. Examples of these products and
market applications include:

 .  Lightweight ceramic armor for military applications.

 .  Industrial ceramics utilizing fused silica ceramics for the glass tempering
   and steel making markets.

 .  Microwave cathodes, microwave absorbing Ceralloy(R) ceramics and samarium
   cobalt magnets for use in microwave power tubes in communications, radar and
   electronic countermeasure applications.

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
assurance, 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 "Certain Factors That May
Affect the Company's Business and Future Results".  The following table
illustrates these newer and planned products and the markets for which they are
intended.

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<TABLE>
<CAPTION>
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      MARKET OPPORTUNITY                  TECHNICAL DEMANDS OF MARKET                  CERADYNE'S STRATEGIC RESPONSE
<S>                                   <C>                                   <C>
---------------------------------------------------------------------------------------------------------------------------------
                                                         INDUSTRIAL
---------------------------------------------------------------------------------------------------------------------------------
Corrosion resistant non oxide         The industry has historically used    Ceradyne has created a new business unit called
ceramics for use as semiconductor     silicon metal, quartz, and aluminum   "Semiconductor Equipment Components" and has begun
equipment chamber components that     oxide ceramics to fabricate chamber   supplying high density and high purity nitride and
handle wafers.                        components. Next generation           carbide ceramics to several equipment suppliers.  A
                                      equipment may have operating          newly created R & D group is attempting to develop
                                      conditions that may deteriorate       compositions tailored  to each equipment
                                      currently used materials in some      manufacturer's environment.
                                      sections.

Wear resistant components required    Failure of industrial equipment       Ceralloy 147 Sintered Reaction Bonded Silicon
on the rubbing or cutting surfaces    is often caused by premature          Nitride (SRBSN) industrial wear parts and cutting
of industrial machinery, such as in   wearing out of surfaces due to        tool inserts are designed to replace hard metal or
paper making equipment,               abrasive action. Examples             even oxide ceramic wear surfaces, resulting in great
centrifuges, and cutting tool         include paper making where the pulp   productivity, quality and longer "uptime."
inserts.                              slurry runs at 5000 feet per minute,
                                      or in metal cutting where as much as
                                      .125 inch depth of cut are removed
                                      in a single pass.

---------------------------------------------------------------------------------------------------------------------------------
                                                             DEFENSE
---------------------------------------------------------------------------------------------------------------------------------
Lightweight armor for military  and   As tactical conflicts as well as      Ceralloy 546 (boron carbide) or Ceralloy 146
law enforcement personnel.            terrorist and other activities        (silicon carbide) backed with Kevlar(TM), Spectra(TM)
                                      result in the increased use of        or other laminates are designed to provide lightweight
                                      automatic weapons, it has become      ballistic protection greater than Kevlar alone at an
                                      necessary to stop bullets as great    acceptable weight.
                                      as a .50 caliber machine gun
                                      round. However, vests or other
                                      armor must be light enough in
                                      weight to allow freedom of
                                      movement without undue fatigue.

Missile nose cones (radomes).         Next generation tactical missiles     The Company's advanced technical ceramic radomes are
                                      (Standard Missile Block IV and PAC-   designed to address demanding specifications of next
                                      3) will be required to fly at         generation missile nose cones.
                                      extremely high velocities, tight
                                      turning radii, and severe weather
                                      conditions. These operating
                                      conditions may preclude the use of
                                      conventional polymer materials.
---------------------------------------------------------------------------------------------------------------------------------
                                                            CONSUMER
---------------------------------------------------------------------------------------------------------------------------------
Orthodontic brackets.                 Traditional stainless steel           Ceradyne's Transtar translucent orthodontic
                                      orthodontic ceramic brackets are      brackets are inert, pick up the color of the
                                      often considered unsightly.           patient's teeth and allow the orthodontist to
                                      Substitute clear plastic materials    correct the patient's bite.  The Company and its
                                      can be weak and may stain. Some       marketing partner, 3M/Unitek, introduced an enhanced
                                      orthodontic patients prefer           version of this ceramic bracket in 1996, which is
                                      aesthetically pleasing brackets       marketed by Unitek under the brand name "Clarity".
                                      which can be affixed to each tooth
                                      to support the archwire.
---------------------------------------------------------------------------------------------------------------------------------
                                                          AUTOMOTIVE
---------------------------------------------------------------------------------------------------------------------------------
Automobile internal combustion        In order to achieve diesel engine     Ceradyne's Ceralloy 147 SRBSN is a candidate for a
engine and diesel engine valve        life of one million miles and         variety of engine components including bucket tappet
train and other engine components.    automobile engine life of over        inserts, engine valves, clevis pins and fuel
                                      100,000 miles without major           injection pump parts.  The Company is in prototype
                                      maintenance, it may be necessary to   development of parts for Detroit Diesel Corp.,
                                      replace metal engine components with  Caterpillar Inc., and Ford Motor Company.  Volume
                                      longer lasting, lighter weight,       production orders may not occur for several years,
                                      higher temperature resistant parts    if at all, and will depend on significant cost
                                      at acceptable unit costs.             reduction and other factors.
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                                       4
<PAGE>

As part of the Company's strategy, management intends to 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 "Certain Factors That May Affect
the  Company's Business and Future Results".

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 Product 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 of $10 million in
the Company in exchange for Common Stock which eventually resulted in an
ownership interest in Ceradyne of approximately 15%.  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 developing
components for automobile engines.  Through fiscal 1997, Ford has contributed to
the Company, on a cost sharing basis, a total of $4.2 million in cash and
equipment under this joint development program. The technology acquired from
Ford and the efforts of this joint development program have led to the
development of Ceradyne's Ceralloy(R) 147 sintered reaction bonded silicon
nitride (SRBSN) advanced technical ceramic, from which the Company now produces
a line of industrial wear components and has made prototype parts for evaluation
and testing in internal combustion and diesel engines.

3M/Unitek Orthodontic Bracket Joint Program.  In 1986, Ceradyne entered into a
joint development and supply agreement with 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.

                                       5
<PAGE>

Market Applications

The Company's products can be categorized by the principal market applications
they address: (i) industrial, (ii) defense, (iii) consumer, (iv) microwave tube
products and (v) automotive.  These markets accounted for approximately 37.5%,
18.4%, 9.3%, 33.7% and 1.1%, respectively, of net sales for the year ended
December 31, 1995, 31.3%, 27.9%, 11.9%, 28.5%, and .4%, respectively, of net
sales for the year ended December 31, 1996, and 43.6%, 13.8%, 17.1%, 21.4%, and
4.1%, respectively, of net sales for the year ended December 31, 1997.

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(R) 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
and can making equipment, abrasive blasting nozzles as well as custom
applications.

Semiconductor Equipment Components.  This is a new market that may offer
Ceradyne growth opportunities. The equipment used to make semiconductor devices
(wafers) is extremely advanced and the newest generation has operating
environments that are harsh enough to severely limit the life of the traditional
ceramic and metal components.  Ceradyne is positioned to offer a new generation
of non oxide ceramics which have exceptional corrosion resistance.

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.  Therefore, it is used to produce
industrial tooling 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 manufacture of aircraft.
Other applications take advantage of fused silica's excellent thermal shock
resistance and inertness when in contact with glass. These applications include
components for equipment used in the fabrication of flat plate and tempered
glass or contoured shapes such as automobile windshields.  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.  Although armor has progressed through the centuries
from animal skin shields to metal armored suits, to Kevlar(TM) vests (for light
arms), to heavy steel plate, the requirements for light weight and maximum
projectile stopping capability vary little.  Ceradyne has developed and is
producing lightweight ceramic armor capable of protecting against threats as
great as .50 caliber armor piercing machine gun bullets at 50% of the equivalent
steel plate weight.  Utilizing hot pressed Ceralloy(R) ceramic, the Company's
armor plates are laminated with either Kevlar(TM), Spectra(TM) or fiberglass and
formed into a wide variety of shapes, structures and components.  To date,
ceramic armor manufactured by the Company has been used principally for military
helicopter crew seats and

                                       6
<PAGE>

airframe panels. The Company currently supplies ceramic armor systems for the
following helicopter programs: the Blackhawk helicopter manufactured by Sikorsky
Aircraft, the Apache helicopter manufactured by McDonnell-Douglas Helicopters,
Inc., the Cobra helicopter manufactured by the Bell Helicopter division of
Textron Inc., and the Sea King helicopter manufactured by Westland Helicopters.
The Company believes it is a leader in producing lightweight ceramic armor for
military helicopters. See "Certain Factors That May Affect the Company's
Business and Future Results".

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, the Company reported that a U.S.
government agency had selected Ceradyne to provide certain ceramic armor
products over a multi-year period.  The initial award for product demonstration
models was signed Friday, February 27, 1998.  The Ceradyne proposal totaled in
excess of $100 million (at the maximum quantity) over a 5 year period.  There
can be no assurances as to the exact quantities or deliveries under this
program, which are at the discretion of the government.

Missile Nose Cones (Radomes). The Company produces conical shaped, precision
machined ceramic components, which are designed to be mounted by its customers
on the front end of tactical missiles.  These nose cones, or radomes, are
designed for applications where the velocities and operating environments are
severe enough that the thermal shock and erosion resistance, high strength and
microwave transparency properties of advanced technical ceramics are required.
Revenues from sales of radomes have not been material to date.  However, radomes
manufactured by the Company have been qualified for the Standard Missile Block
IV missile program and are currently undergoing early testing for the PAC-3
missile program.

  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(R).  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,

                                       7
<PAGE>

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(R)
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, more efficient and more durable engines for heavy duty diesel
trucks and automobiles creates additional opportunities for advanced technical
ceramics.  For instance, the Company believes that if engines could be produced
using certain advanced technical ceramic components, they could be lighter and
longer lasting than those using metal components and could operate at higher
temperatures, 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 these potential benefits,
industry-wide efforts are being made to develop advanced technical ceramic
technology to replace critical steel components in diesel and automobile
engines.

Ceradyne has provided a limited number of prototype parts made of Ceralloy(R)
147 SRBSN materials for evaluation and testing in internal combustion and diesel
engines.  Ceradyne has no production contracts to produce any ceramic components
for automotive or diesel engine use. However, Ceradyne is engaged in a joint
development program with Ford to develop ceramic components for automobile
engines, and with a heavy-duty diesel engine manufacturer to develop silicon
nitride engine valves and clevis pins for diesel 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
high quality levels.  The Company believes that use of ceramic components in
high volume production automobile or diesel engines will not occur for several
years, if at all.  See "Certain Factors That May Affect the Company's Business
and Future Results".

  Other

Utilizing its advanced technical ceramics technologies and facilities, the
Company also manufactures a number of other products related to the foregoing
markets, such as dispenser cathodes for ion laser applications, samarium cobalt
permanent magnets for motors and instruments, and other precision advanced
technical ceramics.  None of these products provides a material amount of
revenue to the Company.

                                       8
<PAGE>

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 10 employees directly involved in marketing and 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 26%, 20% and 20% of total net sales in fiscal years 1995, 1996 and
1997, respectively.

Generally, the Company sells components to prime 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.  See "Certain Factors That May Affect the Company's Business and
Future Results".   No customer accounted for more than 10% of total net sales in
fiscal 1995, and DLA Finance Center, which purchases Ceradyne armor from the
Company, accounted for approximately 17% of the Company's total net sales for
fiscal 1996.  For 1997, 3M/Unitek accounted for 17% of net sales.

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.

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 degrees(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 as 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 preforms 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, about 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.

                                       9
<PAGE>

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 degrees(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 degrees(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(R) 147 SRBSN, which is
used in industrial and automotive applications. Ceradyne 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 (Si\\3\\N\\4\\)
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 three fold.  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(R)).  Ceradyne produces
translucent aluminum oxide (Transtar(R)) 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 1800 degrees(C) until the ceramics enter to a strong translucent
condition. These fired aesthetic appearing 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.

                                       10
<PAGE>

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 SmCo\\5\\ or Sm\\2\\Co\\17\\ 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 degrees(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
implemented separately at each of Ceradyne's three manufacturing locations.
Thermo Materials Division received its ISO 9002 Certification in 1997, and the
other two divisions are in the process of  ISO certification.

Engineering and Research

Ceradyne's engineering and research efforts consist primarily of application
engineering in response to customer requirements.  These efforts are directed to
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 internally-funded research to
improve and reduce the cost of production and to develop new products.  Costs
associated with application engineering and internally-funded research are
generally expensed as incurred and are included in cost of product sales. Costs
associated with Company-funded research were approximately $400,000, $400,000
and $380,000 in 1995, 1996 and 1997, respectively.

Competition

Ceradyne competes on the basis of product performance, material specifications,
application 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

                                       11
<PAGE>

technological, manufacturing and marketing strengths. Some of Ceradyne's
competitors often 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, Mc Danel Refractories, Cercom, Coors Ceramics Company,
Spectromat, 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 "Certain Factors That May Affect the Company's Business and
Future Results".

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, 1997 was approximately $18.6 million,
consisting of $14.4 million of firm scheduled orders and $4.2 million of
unexercised options.  This compared to December 31, 1996 ending total backlog of
approximately $21.7 million consisting of $11.2 million of firm scheduled orders
and $10.5 million of unexercised options.  Typically, firm orders are scheduled
to be shipped within 12 to 18 months from receipt of order.  Included in
unexercised options as of December 31, 1995 and 1996 was a government option for
approximately $6.1 million which expired in March 1997 without being exercised.

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 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
"Certain Factors That May Affect the Company's Business and Future Results", and
"Strategic Relationships".

Ceradyne has been issued two U.S. patents and has one patent pending relating to
its CRT ceramic-impregnated dispenser cathode and has applied for corresponding
foreign patents in various foreign countries.  The earliest of these patents
expires in 2006.

Through its association with Ford, Ceradyne acquired in excess of 80 U.S.
patents, of which 26 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".

                                       12
<PAGE>

"Ceralloy(R)," the name of Ceradyne's technical ceramics, "Ceradyne(R)" and the
Ceradyne logo, comprising the stylized letters "CD(R)", 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(R)",
"Semicon(R)", "Thermo(R)", "Isomolded(R)" and "NeedleLok(TM)".

Employees

At December 31, 1997, Ceradyne employed approximately 290 persons, including 14
employees with undergraduate or graduate degrees in ceramic engineering.
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.

  Certain Factors That May Affect the Company's Business and Future Results

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.  The Company's 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:

History of Operating Losses

For the fiscal years ended December 31, 1995, 1996 and 1997, the Company
returned to profitability after sustaining net losses from fiscal 1987 through
fiscal 1994 totaling approximately $21.4 million.  The Company's operating
losses resulted from a number of factors, including a decline in revenues due in
part to reduced government spending on defense related products, which
historically have represented the majority of the Company's business and are
expected to represent a substantial portion of the Company's business in the
foreseeable future.  Also contributing to the Company's losses was a decline in
sales of the Company's translucent ceramic orthodontic bracket, from peak
revenues of $6.2 million in fiscal 1988 to $.4 million in fiscal 1994, due in
part to excess inventory levels accumulated by the Company's exclusive
distributor of this product, Unitek Corporation, a subsidiary of Minnesota
Mining & Mfg. Co. ("3M/Unitek"), and also in part to resistance by some
orthodontists to use the product because of technical problems experienced with
earlier versions of the bracket.  To maintain profitability and achieve revenue
growth, the Company must, among other things, successfully address new
opportunities for armor applications, including the development of capacity to
successfully manufacture ceramic body armor in volume; achieve significant sales
of the recently introduced new version of its translucent orthodontic bracket
product, which is marketed by 3M/Unitek under the brand name "Clarity"; develop
the capacity to successfully manufacture semiconductor equipment components in
volume at acceptable profit margins; and continue to upgrade its technologies
and commercialize products and services incorporating such technologies.  There
can be no assurance, however, that the Company will be able to sustain or
improve its level of profitability in the future.

Importance of New Products; Limited Volume Manufacturing Experience for Products
Under Development

The Company believes that its future prospects will depend to a large extent on
the success of products which currently provide little revenue or which are
still under development.  These products include, in particular, semiconductor
equipment components, lightweight ceramic armor vests for military personnel,
improved versions of the Company's translucent ceramic orthodontic bracket, and
ceramic

                                       13
<PAGE>

components for automobile and diesel engines. In the latter half of 1996, the
Company introduced a new version of its translucent ceramic orthodontic bracket
called Clarity, which is designed to improve the performance and market
acceptance of this product. The Clarity bracket is more difficult and costly to
produce than earlier versions of this bracket and there can be no assurance that
the Company will be able to produce this version in high volume at acceptable
yields or that the new design will achieve market acceptance or result in
increased sales of this product. The Company's efforts in producing ceramic
components for automobile and diesel engines are still in the experimental
stage, with future success substantially dependent on achieving significant cost
reductions and developing high volume manufacturing capability while maintaining
high quality levels. Furthermore, lead times for the introduction of new
materials and components into production automobiles are typically several
years. The market for ceramic automotive and diesel components is new and
evolving, and advanced technical ceramics are not currently used in any
significant automotive applications. Accordingly, demand and market acceptance
for such products are subject to a high level of uncertainty. As a result of
these factors, the Company believes that the use of ceramic components in high
volume production automobile or diesel engines cannot be predicted and will not
occur for several years, if at all.

Management of Growth

The Company is experiencing a period of new product introductions that have
placed, and will continue to place, a significant strain on its resources,
including personnel. The Company believes that future growth is significantly
dependent on introductions of other new products applying the Company's core
advanced technical ceramics technologies.  The Company expects that management
of this transition will continue to place a strain on the Company's management,
operational and financial resources.  The Company's ability to manage growth
effectively, particularly given the increasingly international scope of its
operations, will require it to add manufacturing capacity and personnel,
continue to implement and improve its operational, financial and management
information systems as well as to develop the management skills of its managers
and supervisors, and to train, motivate and manage its employees.  These demands
are expected to require the addition of new management personnel and the
development of additional expertise by existing management personnel.  The
Company's failure to effectively manage growth could have a material adverse
effect on the Company's results of operations.

Dependence on Key Personnel

The Company's future success depends in large part on the continued service of
Joel P. Moskowitz, its Chairman, Chief Executive Officer and President, and a
principal stockholder of the Company, as well as other principal members of its
management, the loss of whose services could have a material adverse effect upon
the business and financial condition of the Company.  The company is also
dependent on other key personnel, and on its ability to continue to attract,
retain and motivate highly qualified personnel.  The competition for such
employees is intense, and there can be no assurance that the Company will be
able to recruit and retain such personnel.  Mr. Moskowitz has an employment
agreement with the Company which expires in July 1999, but no other employee has
an agreement for a specified term of employment with the Company.

Competition

The markets for applications of advanced technical ceramics are competitive.
The Company believes the principal competitive factors in these markets are
product performance, material specifications,

                                       14
<PAGE>

application engineering capabilities, customer support, reputation and price.
Many of the Company's competitors, both domestic and international, have greater
financial, marketing and technical resources than Ceradyne. The Company's
competitors often 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, Mc Danel Refractories, Cercom, Coors Ceramics Company,
Spectromat, and others. In many applications the Company also competes with
manufacturers of non-ceramic materials. There can be no assurance that the
Company will be able to compete successfully against its current or future
competitors or that competition will not have a material adverse effect on the
Company's results of operations and financial condition.

Environmental Concerns

The Company is subject to a variety of environmental regulations relating to the
use, storage, discharge and disposal of hazardous materials.  In the past,
certain of the Company's products were produced using beryllium oxide, which is
highly toxic in powder form.  This powder, if inhaled, can cause chronic
beryllium disease ("CBD") in a small percentage of the population.  In recent
years the Company has been sued by several former employees and a family member
of one such former employee alleging that they had contracted CBD as a result of
exposure to beryllium oxide powders used in the Company's products. Several of
these claims have been settled without material liability to the Company, but
several lawsuits are still pending.  See "Item 3. Legal Proceedings".  There can
be no assurance that the Company will avoid liability to persons who contract
CBD as a result of exposure to beryllium oxide while employed with the Company.
While the Company believes that it is in material compliance with all existing
applicable environmental statues and regulations, any failure by the Company to
comply with statutes and regulations presently existing or enacted in the future
could subject it to liabilities or the suspension of production.  Furthermore,
there can be no assurance that claims against the Company related to exposure to
beryllium oxide powder will be covered by insurance or that, if covered, the
amount of insurance will be sufficient to cover any potential adverse judgment.

Dependence on United States Government and Risk of Contract Termination

Of the Company's $17.3 million total backlog at December 31, 1997, approximately
$3.1 million, or approximately 18% represents orders for defense applications.
Some of the contracts for helicopter armor are directly or indirectly with
agencies of the United States government.  The Company anticipates that it will
continue to depend heavily on direct or indirect sales to government agencies
for a significant percentage of the Company's revenues for the foreseeable
future.  In recent years, budgets of many government agencies have been reduced,
causing certain customers and potential customers for the Company's products to
re-evaluate their needs.  Such budget reductions are expected to continue over
at least the next several years.  However, in the first quarter of 1998, a U.S.
government agency has selected Ceradyne to provide certain ceramic armor
products over a multi-year period.  The initial award for product demonstration
models was signed Friday, February 27, 1998.  The Ceradyne proposal totaled in
excess of $100 million (at the maximum quantity) over a 5 year period.  There
can be no assurances as to the exact quantities or deliveries under this
program, which are at the discretion of the government.

Under U.S. law, the Company's defense-related contracts may be canceled for
convenience at any time without cause by the government, with reimbursement to
the Company only for its actual expenses incurred.  The Company has, in the
past, experienced the cancellation of a significant government order, which had
a material adverse effect on the Company's operating results.  There can be no

                                       15
<PAGE>

assurance that the Company will not experience similar cancellations in the
future, and any such cancellations could adversely affect the Company's
operating results.

Reliance on 3M/Unitek Relationship

The Company developed its translucent ceramic orthodontic bracket pursuant to a
joint development agreement with 3M/Unitek, and sells this product only to
3M/Unitek pursuant to an exclusive marketing agreement which expires in 2007.
Consequently, the Company depends entirely on the marketing and sales efforts of
3M/Unitek for the sales of this product.  The Company also depends on customer
and technical feedback from 3M/Unitek for the design of improvements to the
bracket.  Early versions of this product were not well accepted by some
orthodontists due in part to resistance to change from using traditional
stainless steel brackets and to certain technical problems experienced by some
users of the earlier versions of the Company's translucent ceramic orthodontic
bracket.  These problems included difficulty in the removal, or debonding, of
the bracket from the tooth, breakage of brackets during the treatment process
more often than experienced with stainless steel brackets, and slower movement
of the metal arch wire through the ceramic brackets, resulting in longer
treatment times than with stainless steel brackets.  Designs introduced in
October 1996 under the 3M/Unitek brand name "Clarity" are intended to improve
certain features of earlier versions of the bracket, but there can be no
assurance that these new products will completely eliminate the previous
problems or receive wide market acceptance.  Furthermore, no assurance can be
given that 3M/Unitek will devote substantial marketing efforts to sales of the
Company's orthodontic products, or that it will not re-assess its commitment to
the Company's technologies or develop its own competitive technology.  Any
failure by 3M/Unitek to actively market the Company's orthodontic product, or
any failure of such product to achieve market acceptance, would materially and
adversely impact the Company's prospects and results of operations.

Dependence on International Sales

Shipments to customers outside of the United States accounted for approximately
26%, 20% and 20% of the Company's sales in fiscal 1995, 1996, and 1997,
respectively. The Company anticipates that international shipments will continue
to account for a significant portion of its sales.  Certain of these revenues
have been derived from sales to foreign government agencies and may be subject
to risks similar to those set forth in "Dependence on United States Government
and Risk of Contract Termination," set forth above.

There are a number of risks inherent in the Company's international business
activities, including unexpected changes in regulatory requirements, tariffs and
other trade barriers, longer account receivable payment cycles, potentially
adverse tax consequences, and the burdens of compliance with foreign laws.
Additionally, the Company does not engage in hedging activities to protect
against the risk of currency fluctuations.  Fluctuations in currency exchange
rates could cause sales denominated in U.S. dollars to become relatively more
expensive to customers in a particular country, leading to a reduction in sales
or profitability in that country.  Furthermore, future international activity
may result in foreign currency denominated sales which may result in gains and
losses on the conversion to U.S. dollars of accounts receivable and accounts
payable arising from international operations which may contribute significantly
to fluctuations in the Company's results of operations.  The Company
historically has denominated export sales in United States dollars.  There can
be no assurance, however, that the aforementioned factors will not have an
adverse effect on the revenues from the Company's future international sales
and, consequently, the Company's results of operations.  Some of

                                       16
<PAGE>

the Company's products may not be exported to certain foreign countries without
an export license obtained from the United States government. The Company has,
and may in the future, experience difficulty in obtaining licenses to export its
products to certain countries. Failure to obtain such licenses could have a
material adverse effect on the Company's sales and prospects. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business-Ceradyne Strategy" and "-Marketing and Customers".

Protection of Intellectual Property

The Company relies on a combination of patents, trade secrets, trademarks, and
other intellectual property law, nondisclosure agreements and other protective
measures to preserve its proprietary rights pertaining to its products and
production processes.  Such protection, however, may not preclude competitors
from developing products or processes similar or superior to the Company's.  In
addition, the laws of certain foreign countries do not protect intellectual
property rights to the same extent as the laws of the United States.  Although
the Company continues to implement protective measures and intends to defend its
proprietary rights, there can be no assurance that these efforts will be
successful.  Furthermore, there can be no assurance that the Company's products
or processes are not in violation of the patent rights of third parties, or that
any of the Company's patents will not be challenged, invalidated or
circumvented.

Item 2.  Facilities
         ----------

The Company serves its markets from three manufacturing facilities across the
United States.  The Company's West Coast operations, located in Costa Mesa,
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.  These three facilities
comprise approximately 74,000, 35,000 and 85,000 square feet, respectively.  The
Company's Costa Mesa and Scottdale facilities are held under long-term leases
which expire in October 2000 and December 2000, respectively.  The Company owns
its Lexington, Kentucky facilities.

                                       17
<PAGE>

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

<TABLE>
<CAPTION>
========================================================================================================
          FACILITY LOCATION                                           PRODUCTS
--------------------------------------------------------------------------------------------------------
<S>                                         <C>
Costa Mesa, California                      . Semiconductor Equipment Components
  Approximately 74,000 square feet          . Lightweight ceramic armor
                                            . Orthodontic ceramic brackets
                                            . Ceralloy(R) 147 SRBSN wear parts
                                            . Precision ceramics
                                            . Ceralloy(R) 147 SRBSN diesel/automotive engine parts (R&D)
--------------------------------------------------------------------------------------------------------
Lexington, Kentucky                         . Microwave ceramic-impregnated dispenser cathodes
  Approximately 35,000 square feet          . Ion laser ceramic-impregnated dispenser cathodes
                                            . Samarium cobalt magnets
--------------------------------------------------------------------------------------------------------
Scottdale, Georgia                          . Glass tempering rolls (fused silica ceramics)
  Approximately 85,000 square feet          . Metallurgical tooling (fused silica ceramics)
                                            . Missile radomes (fused silica ceramics)
                                            . Castable and other fused silica product
========================================================================================================
</TABLE>

Item 3.  Legal Proceedings
         -----------------

The Company is, from time to time, involved in various legal and other
proceedings that relate to the ordinary course of operating its business,
including, but not limited to, employment-related actions and workers'
compensation claims.

In October 1995 the Company was served with a complaint that was filed by four
persons and the spouses of those persons, who are/were employed by one of the
Company's customers.  The complaint, filed in the United States District Court,
Eastern District of Tennessee, alleges that the employees contracted chronic
beryllium disease as a result of their exposure, during the course of their
employment with the Company's customer, to beryllium-containing products sold by
Ceradyne.  The complaint seeks compensatory damages in the amount of $3.0
million for each of the four plaintiffs who were employed by the Company's
customer, compensatory damages of $1.0 million each for the two spouses, and
punitive damages in the amount of $5.0 million.  The case is in the early stages
of discovery.  Based upon information currently available, the Company believes
that the plaintiffs' claims are without merit and that the resolution of this
matter will not have a material adverse effect on the financial condition or
operations of the Company.   Defense of this case has been tendered to the
Company's insurance carriers, some of whom are providing a defense subject to a
reservation of rights.  There can be no assurance, however, that this claim or
any of the claims related to exposure to beryllium oxide will be covered by
insurance, or that, if covered, the amount of insurance will be sufficient to
cover any potential judgment.

In February 1997 the Company was served with a complaint that was filed by a
former employee of one of the Company's customers and his wife.  The complaint,
filed in the United States District Court, Eastern District of Tennessee,
alleges that the husband contracted chronic beryllium disease as a result of his
exposure to beryllium-containing products sold by Ceradyne.  The complaint seeks
compensatory damages in the amount of $5.0 million for the husband, $1.0 million
for the wife, and punitive damages in the amount of $10.0 million.  The Company
believes that the plaintiffs' claims are without merit and that the resolution
of this matter will not have a material adverse effect on the financial
condition or operations of the Company.  Defense of this case has been tendered
to the Company's insurance carriers, some of which are providing a defense
subject to a reservation of rights.

                                       18
<PAGE>

There can be no assurances, however, that this claim will be covered by
insurance, or that, if covered, the amount of insurance will be sufficient to
cover any potential judgment.

In July 1997 the Company was served with a complaint filed by an employee of one
of the Company's former parent companies and landlords.  The complaint, filed in
the Los Angeles County Superior Court on behalf of the employee by his wife,
alleges that the husband contracted chronic beryllium disease as a result of his
exposure to beryllium through Ceradyne's products, equipment and premises.  The
complaint seeks unspecified damages against the Company, its officers and its
directors.  The Company believes that the plaintiff's claims are without merit
and that the resolution of this matter will not have a material adverse effect
on the financial condition or operations of the Company.  Defense of this case
has been tendered to the Company's insurance carriers, some of which are
providing defense and indemnification subject to a reservation of rights.  There
can be no assurances, however, that this claim will be covered by insurance, or
that, if covered, the amount of insurance will be sufficient to cover any
potential judgment.

In August 1997 the Company was served with a complaint filed by a former
employee of one of the Company's customers and his wife.  The complaint, filed
in the United States District Court, Eastern District of Tennessee, alleges that
the husband contracted chronic berylliium disease as a result of his exposure to
beryllium-containing products sold by Ceradyne.  The complaint seeks
compensatory damages in the amount of $5.0 million for the husband, $1.0 million
for the wife, and punitive damages in the amount of $10.0 million.  The Company
believes that the plaintiffs' claims are without merit and that the resolution
of this matter will not have a material adverse effect on the financial
condition or operations of the Company.  Defense of this case has been tendered
to the Company's insurance carriers, some of which are providing defense and
indemnification subject to a reservation of rights.  There can be no assurances,
however, that this claim will be covered by insurance, or that, if covered, the
amount of insurance will be sufficient to cover any potential judgment.

Item 4.   Submission of matters to a vote of security holders
          ---------------------------------------------------

  Not applicable

                                       19
<PAGE>

                                   MANAGEMENT

Executive Officers of the Registrant.

  The executive officers of the Company as of March 28, 1998 are as follows:

         Name               Age                        Position
         ----               ---                        --------
Joel P. Moskowitz.....       58      Chairman of the Board, President and Chief
                                     Executive Officer

Earl E. Conabee.......       60      Vice President, and Director of Marketing
                                     at Thermo Materials

Andre Ezis............       55      Vice President, Research and Development

Howard F. George......       53      Vice President, Finance; Chief Financial
                                     Officer and Secretary

Donald A. Kenagy......       56      Vice President, and President of Thermo
                                     Materials

David P. Reed.........       43      Vice President, and General Manager of
                                     Advanced Technical Ceramics

  Joel P. Moskowitz co-founded the Company's predecessor in 1967. He served as
President of the Company from 1974 until January 1987, and from September 1987
to the present. Mr. Moskowitz currently serves as Chairman of the Board,
President and Chief Executive Officer of the Company, which positions he has
held since 1983.  Mr. Moskowitz currently serves on the Board of Trustees of
Alfred University.  Mr. Moskowitz obtained a B.S. in Ceramic Engineering from
Alfred University in 1961 and an M.B.A. from the University of Southern
California in 1966.

  Earl E. Conabee joined the Company in July 1985, and has served as Vice
President of the Company since June 1986.  Mr. Conabee serves as Vice President
of Marketing for the Company's Thermo Materials division, where he is
responsible for the overall marketing and sales effort for fused silica
ceramics.  Prior to joining the Company, Mr. Conabee served as General Manager
of Ceramatec, a manufacturer of technical ceramics, from 1983 to 1985, and as
Director of Refinery Operations for Englehard Minerals Corporation from 1973 to
1983.  Mr. Conabee obtained a B.S. in Ceramic Engineering from Alfred University
in 1960.

  Andre Ezis was appointed to the position of Vice President, Research and
Development in January, 1997.  Prior to joining Ceradyne, Mr. Ezis was Vice
President of Research and Development at Cercom, Inc. for the period of 11
years.  From 1970 to 1986, Mr. Ezis was with Ford Motor Company at its Research
Science Center.  Mr. Ezis earned a B.S. in Ceramic Engineering in 1966 at Ohio
State University, and a M.S. in Nuclear Engineering in  1969 also from Ohio
State University.

  Howard F. George was appointed to the positions of Vice President, Finance;
Chief Financial Officer, and Corporate Secretary in December 1995.  Prior to
joining Ceradyne, Mr. George was Chief Financial Officer of Richmond Technology,
Inc. and Chief Operating Officer of its subsidiary, Static Control Services from
1992 to 1995.  From 1990 to 1992, Mr. George was Vice President of Finance for
Sunset Richards, a subsidiary of Hanson, PLC.  Mr. George earned his B.A.
degree in Business and Economics in 1970 at California State University
Long Beach, and an MBA from Pepperdine University, Malibu in 1980.

                                       20
<PAGE>

  Donald A. Kenagy joined the Company in December 1986 when the Company acquired
Thermo Materials, and has served as Vice President of the Company since July
1991.  Mr. Kenagy is currently President of the Company's Thermo Materials
division, and as such is responsible for the operations, finances and marketing
of Thermo Materials.  Mr. Kenagy joined Thermo Materials in 1972.  Mr. Kenagy
received a B.S. in Ceramic Technology from Penn State in 1963, an M.S. in
Metallurgy from the Massachusetts Institute of Technology in 1965, and a Met.
Eng. degree from MIT in 1968.

  David P. Reed joined the Company in November 1983, and has served as Vice
President since January 1988.  Mr. Reed is responsible for the operations,
finances and marketing of the Company's Costa Mesa, California operations.
Prior to joining the Company, Mr. Reed served as Manager, Process Engineering
for the Industrial Ceramic Division of Norton Co. from 1980 to 1983. Mr. Reed
obtained a B.S. in Ceramic Engineering from Alfred University in 1976 and an
M.S. in Ceramic Engineering from the University of Illinois in 1978.

Officers serve at the discretion of the Board of Directors except for Mr.
Moskowitz, who serves pursuant to a five-year employment agreement which expires
in July 1999.

                                       21
<PAGE>

                                     PART II

Item 5.   Market for the Registrant's Common Equity and Related
          -----------------------------------------------------
          Stockholder Matters
          -------------------

The Company's Common Stock is traded on the Nasdaq National Market under the
symbol CRDN. The following table sets forth for the calendar quarters indicated
the high and low closing sale prices per share on the National Market as
reported by Nasdaq.  As of January 2, 1998, the Company had approximately 535
record holders of its Common Stock.

<TABLE>
<CAPTION>
                                  High              Low
                                  ----              ---
<S>                               <C>               <C>

Year ended December 31, 1996
     First Quarter.............    9 1/4             5 3/4
     Second Quarter............   11 3/4             8 3/8
     Third Quarter.............   11 3/8             7 5/8
     Fourth Quarter............   10 1/4             6

Year ended December 31, 1997
     First Quarter.............    9  1/8            5 7/8
     Second Quarter  ..........    6  3/8            4 1/4
     Third Quarter.............    9  5/8            4 5/8
     Fourth Quarter............    6 31/64           3 3/4
</TABLE>

The present policy of Ceradyne is to retain earnings for the operation and
expansion of its business.  Ceradyne has never paid cash dividends, and
management does not anticipate that it will do so in the foreseeable future.

The Company did not sell any equity securities during the year ended December
31, 1997 that were not registered under the Securities Act of 1933.

                                       22
<PAGE>

Item 6.   Selected Financial Data
          -----------------------

Statements of Operations Data: (Amounts in thousands, except per share data)
-----------------------------

<TABLE>
<CAPTION>
                                                                    December 31,
                                        --------------------------------------------------------------------
                                           1997          1996           1995          1994          1993
                                        -----------   -----------   ------------   -----------   -----------
<S>                                     <C>           <C>           <C>            <C>           <C>
Net Sales                                  $28,693       $28,212        $23,404       $17,996       $15,987
Cost of product sales                       23,274        21,065         16,948        15,867        14,589
                                           -------       -------        -------       -------       -------
Gross profit                                 5,419         7,147          6,456         2,099         1,398
                                           -------       -------        -------       -------       -------

Operating expenses:
Selling                                      1,515         1,571          1,492         1,502         1,372
General & administrative                     3,660         3,137          2,748         2,535         2,595
                                           -------       -------        -------       -------       -------
                                             5,175         4,708          4,240         4,037         3,967
                                           -------       -------        -------       -------       -------
Income (loss) from operations                  244         2,439          2,216        (1,938)       (2,569)

Other income (expense):
Other income                                   265         1,890            265           366          (212)
Interest expense                              (134)         (162)          (342)         (294)         (240)
                                           -------       -------        -------       -------       -------

Income (loss) before provision
 (benefit) for income taxes                    375         4,167          2,139        (1,866)       (2,597)
Provision (benefit) for income taxes        (1,675)          127             50          ----          ----
                                           -------       -------        -------       -------       -------
      Net income (loss)                    $ 2,050       $ 4,040        $ 2,089       $(1,866)      $(2,597)
                                           =======       =======        =======       =======       =======

Basic income (loss) per share              $   .26       $   .52        $   .32       $  (.30)      $  (.42)
                                           =======       =======        =======       =======       =======
Diluted income (loss) per share            $   .26       $   .51        $   .32       $  (.30)      $  (.42)
                                           =======       =======        =======       =======       =======
Weighted average shares
   outstanding                               8,035         7,985          6,607         6,238         6,169

Balance Sheet Data:
------------------
                                                                   December 31,
                                           ----------------------------------------------------------------
                                             1997          1996           1995          1994          1993
                                             ----          ----           ----          ----          ----
Working capital                            $15,327       $15,892        $13,216       $ 5,053       $ 5,630
Total assets                                29,017        28,398         24,880        16,862        18,130
Long-term obligations                          ---           ---            555           905         1,367
Shareholder's equity                        26,760        24,440         19,852        11,602        13,443
</TABLE>

                                       23
<PAGE>

Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         -----------------------------------------------------------------------
         of Operations
         -------------

Overview

The Company's technology was developed primarily for defense and aerospace
applications, which have historically represented and continue to represent a
substantial portion of its business. Utilizing this historical base, the Company
has transitioned over several years to a more balanced product offering,
including industrial, consumer, microwave tube products, automotive, and defense
applications.

From a high of $25.6 million in 1987, the Company's revenues declined to a low
of $15.9 million in 1993.  Management believes that the Company's financial
recovery commenced in the fourth quarter of 1994 due to an increase in new
bookings and the divestiture of an historically unprofitable operation.
Revenues began to increase in the third quarter of 1994, and have continued to
increase during the years ended December 31, 1995, 1996 and 1997.  There can be
no assurances, however, that the Company's revenue or profit will continue to
increase in the future.

The Company's cost of product sales includes the cost of materials, direct labor
expenses and manufacturing overhead expenses.  The Company's business requires
that it maintain a relatively high fixed manufacturing overhead.  As a result,
the Company's gross profit, in absolute dollars and as a percentage of net
sales, is greatly impacted by the Company's sales volume and the corresponding
absorption of fixed manufacturing overhead expenses.  Furthermore, due to the
customized nature of many of its products, the Company is frequently required to
devote resources to sustaining engineering expenses, which are also included in
cost of product sales and are generally expensed as incurred.

                                       24
<PAGE>

Results of Operations

The percentage relationships to net sales of certain income and expense items
for the three years ended December 31, 1997 are contained in the following
table.

<TABLE>
<CAPTION>

                                            Year Ended December 31,
                                          ---------------------------
                                           1997      1996      1995
                                          -------   -------   -------
<S>                                       <C>       <C>       <C>
Net Sales                                 100.00%   100.00%   100.00%
Cost of product sales                      81.11     74.67     72.41
                                          ------    ------    ------

 Gross Profit                              18.89     25.33     27.59
                                          ------    ------    ------

Operating Expenses:
 Selling                                    5.28      5.57      6.37
 General & Administration                  12.76     11.11     11.75
                                          ------    ------    ------
                                           18.04     16.68     18.12
                                          ------    ------    ------
Income from operations                       .85      8.65      9.47
Other income (expenses):
 Other income                                .93      6.69      1.13
 Interest expense                           (.47)     (.57)    (1.46)
                                          ------    ------    ------
                                             .46      6.12     (0.33)
                                          ------    ------    ------

Income before provision
(benefit) for income taxes                  1.31     14.77      9.14
Provision (benefit) for income taxes       (5.83)      .45       .21
                                          ------    ------    ------

Net income                                  7.14%    14.32%     8.93%
                                          ======    ======    ======
</TABLE>

                                       25
<PAGE>

Years Ended December 31, 1997 and 1996.

Net Sales.  Net sales for the year ending December 31, 1997 were $28.7 million,
a modest increase of $.5 million, or 1.7%, compared to the prior year.  Key
elements of the 1997 product mix compared to 1996 reflects the following:
Structural ceramics for semiconductor equipment, a virtually new product line,
increased from $.l million in 1996 to $2.3 million in 1997.  The introduction of
"Clarity" orthodontic ceramic brackets resulted in sales of $4.9 million in
1997, a 118% increase over 1996.  This increase was due to increasing product
acceptance by orthodontists and the requirement by Ceradyne's customer, Unitek
(a Division of 3M), to meet its inventory levels.  Armor sales decreased to $3.4
million in 1997 from $7.5 million in 1996 due to a decline in lightweight
ceramic armor vest shipments caused by the government's decision to not exercise
its option for $6.1 million, which lapsed in March 1997.  Sales of the company's
cathodes for use in television and related uses fell to $.25 million from $1.1
million in 1996.  Management believes that the potential for large scale
production of its cathodes for television and related applications may not
materialize in the near future, if at all.

International sales have and are expected to continue to be an important part of
the Company's business, representing 20% of the Company's net sales for the
period ending December 31, 1997, and is the same percentage as for the prior
year.  The decrease in international shipments for cathodes for television from
the Semicon Associates Division has been offset by an increase of international
shipments for fused silica ceramics by the Thermo Materials Division.

Gross Profit.  The Company's gross profit was $5.4 million, or 18.9% of net
sales, for the year ended December 31, 1997, compared to $7.1 million, or 25.3%
of net sales, for the year ended December 31, 1996.  The decrease in gross
profit for the year ended December 31, 1997 as compared to the prior year was
$1.7 million or 24.2%.  The major reason for the decrease in gross profit was an
adjustment of approximately $1.6 million to write off inventory and establish
inventory reserves related to product lines at Semicon Associates Division in
Kentucky.  Management has determined that obsolete inventory in the cathode
product line, and the CRT ceramic-impregnated dispenser cathode for television
applications, needs to be reserved in the amount of $.8 million.  Of this
amount, $.5 million relates to inventory related to a contract with a Korean
manufacturer.  Management does not believe that this contract will be fully
executed and is in discussions with the Korean customer.  Also, a write down of
$.9 million resulting from net realizable value analyses was recorded in the
cathode product line.  The Company has shifted production among different
product lines and now buys certain assemblies, which were previously
manufactured in house, from outside sources.

Except for the above adjustments, the gross profit change was slight between the
2 years. The orthodontic ceramic product line had increased gross profit because
of a sales volume increase of over 118%, and better process yields over the
prior year.  The industrial product line also showed improvement in its process
yields over the prior year.  The above increases were offset by decreases in
gross profit by the semiconductor product line which experienced initial start
up costs and low production yields.  Also, the armor product line had a lower
profit margin in 1997 than in 1996 because of sales volume decreases which did
not absorb as much of the Company's fixed overhead as in the prior year.

Selling expenses were $1.5 million for the year ended December 31, 1997, a
decrease of $56,000 from the comparable period of the prior year.  This decrease
was primarily due to reduced commission expense.

                                       26
<PAGE>

General and administrative expenses were $3.6 million for the year ended
December 31, 1997, a $483,000  increase from the comparable period of the prior
year.  The increases were primarily due to  legal fees associated with a
litigation settlement, and to a write off of an account receivable from a Far
East customer.

Other Income and Expense.  Other income was $265,000 for the year ended December
31, 1997 compared to $1,890,000 for the year ended December 31, 1996.  The
decrease was mainly attributable to last year's reimbursement of $.2 million
from an insurance carrier for legal expenses, and a settlement with an insurance
carrier which netted approximately $1.3 million to the Company.

Interest Expense.  For the year ended December 31, 1997 interest expense was
$134,000, a 17.3% decrease over the comparable period of the prior year,
primarily attributable to a decrease in debt.

Income Taxes.  The Company, in conformance with its adopted Statement of
Financial Accounting Standard (SFAS) No. 109, "Accounting for Income Taxes", has
reversed a portion of the valuation allowance previously established applicable
to the net deferred tax asset.  The income tax benefit resulting from the
reversal results from the Company's recent history of profitable operations.
The Company has available net operating loss carryforwards of approximately
$11.6 million as of December 31, 1997 for federal income tax purposes.

Net Income.  Reflecting all of the matters discussed above, net income was
$2,050,000 (or $.26 per share) for the year ended December 31, 1997 compared to
a net income of $4,040,000 (or $.51 per share) for the prior year.

Year 2000 Disclosure.  Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates.  This inability to recognize or
properly treat the Year 2000 may cause the company's systems and applications to
process critical financial and operational information incorrectly.  The company
continues to assess the impact of the Year 2000 issue on its reporting systems
and operations.

The company is currently in the process of investigating whether its internal
accounting systems and other operational systems are Year 2000 compliant.  A new
software system which is Year 2000 compliant was installed at the Corporate
Headquarters and at the West Coast operations of Advanced Technical Ceramics in
1996.  The Company expects to effect the conversion of its internal accounting
system at its Kentucky and Georgia divisions to such upgraded software in 1998
and 1999.  The costs associated with these conversions are approximately
$150,000.  However, there can be no assurance that certain of the Company's
internal computer systems or networks or those of its key vendors and
distributors will not be adversely affected by such Year 2000 issues, which
could have a material adverse effect on the Company's business, operating
results or financial condition.

                                       27
<PAGE>

Years Ended December 31, 1996 and 1995.

Net Sales.  Net sales for the year ended December 31, 1996 were $28.2 million,
which represents a 20.5% or a $4.8 million increase in net sales over the
corresponding period of the prior year.  Highlighting the increase in sales of
$4.8 million for year ended December 31, 1996 was lightweight ceramic armor,
which accounted for 46% of the increase in sales.  Industrial products accounted
for 34% of the sales increase, primarily components for paper making equipment
and centrifuges.  Microwave cathodes and ceramic-impregnated dispenser cathodes
for large screen television and high definition television (HDTV) accounted for
16% of the sales increase.  Orthodontic products contributed 4% of the sales
increase; this was mainly due to the late introduction of the new "Clarity"
ceramic orthodontic bracket by our marketing partner, 3M's Unitek division, in
the third quarter of 1996.  However, the initial demand for the new "Clarity"
product did surpass the Company's production capability; therefore, Ceradyne
hired additional personnel, and invested in equipment to increase production of
this product line in the fourth quarter of 1996.

International sales have and are expected to continue to be an important part of
the Company's business, representing 20% of the Company's net sales for the
period ending December 31, 1996, down from 26% for the comparable period of the
prior year.  The decrease in 1996 was due primarily to the completion in 1995 of
a contract for ceramic armor shipped to a United Kingdom customer; partially
offset by increased international shipments of ceramic-impregnated dispenser
cathodes for large screen television and high definition television (HDTV), and
other ceramic products for the glass making industry.

Gross Profit.  The Company's gross profit increased to $7.1 million, or 25.3% of
net sales, for the year ended December 31, 1996, compared to $6.5 million, or
27.8% of net sales, for the year ended December 31, 1995.  The increase in gross
profit for the year ended December 31, 1996 as compared to the prior year was
$.6 million or 10.7%.  The Company's sales volume for the year ended December
31, 1996, versus the prior year, had a favorable impact on absorbing fixed
manufacturing overhead, and as a result, the Company's gross profit, in absolute
dollars was impacted positively.  Highlighting the products that contributed to
gross profit increases were armor products and other advanced technical
products.  The armor products contributed to the gross profit because of
betterment in yields due to a continuing favorable volume during the year.
Other advanced technical products had record shipments, combined with a
favorable product mix, such as semiconductor equipment chamber components that
handle wafers, paper industry ceramic products and centrifuge ceramic
components.

However, as a percentage of net sales, there was a decrease of 2.5% in gross
profit over the prior year, and the reason for the decrease was that early in
the first quarter of 1997, management determined that manufacturing processes
and resulting complexities in the cost accounting methodology created an over
valuation of inventory among certain of the product lines at the Semicon
Association Division.  Therefore, an adjustment was made to write down work-in-
process inventory by $595,000, and to reserve an additional $300,000 for excess
inventory for year ended December 31, 1996.

Selling expenses were $1.6 million for the year ended December 31, 1996, an
increase of .5% from the comparable period of the prior year.  This increase was
mainly due to commission expense related to increased sales volume.

General and administrative expenses were $3.1 million for the year ended
December 31,1996, a 14.2% increase from the comparable period of the prior year.
This increase was primarily due to the

                                       28
<PAGE>

payment of employee incentive bonuses indexed to the Company's profitability
during the year ended December 31, 1996.

Other Income and Expense.  Other income increased to $1,890,000 for the year
ended December 31, 1996 compared to $265,000 for the year ended December 31,
1995.  The increase of $1,625,000 was mainly attributable to: Royalty income
from orthodontic sales of approximately $118,000; interest income of $140,000
from cash deposits on hand; a reimbursement of $164,000 from an insurance
carrier for legal expenses, and an insurance settlement the Company favorably
negotiated in litigation brought against an insurance carrier netted $1.3
million to the Company.

Interest Expense.  For the year ended December 31, 1996 interest expense was
$162,000, a 52.3% decrease over the comparable period of the prior year,
primarily attributable to a decrease in debt of approximately $1.2 million from
the prior year.

Income Taxes.  The Company made a $127,000 provision for income taxes for the
year ended December 31, 1996, due to the alternative minimum tax (AMT).  For
both Federal and State tax purposes, only 90% of the Company's income before
income taxes may be offset by the available net operating losses carryforward of
approximately $11.7 million due to the assessment of alternative minimum income
taxes.

Net Income.  Reflecting all of the matters discussed above, record net income
was $4,040,000 (or $.51 per share) for the year ended December 31, 1996 compared
to a net income of $2,089,000 (or $.32 per share) for the prior year.

Liquidity and Capital Resources

The Company generally meets its operating and capital requirements for cash flow
from operating activities and borrowings under its credit facilities.

In November, 1997 the Company terminated its revolving credit agreement with an
asset based lender, and entered into a revolving credit agreement with Comerica
Bank.  The new credit facility amount remains at $4,000,000 and no collateral
will be required of the Company.  During the transition of changing financial
institutions, the Company paid off its short term minimum borrowing requirement
debt of $1,000,000.  As of December 31, 1997 there had been no borrowing under
the new credit facility.

Management believes that its current cash and cash equivalents on hand, as well
as cash generated from operations and the ability to borrow under the existing
credit facility, will be sufficient to finance anticipated capital and operating
requirements for at least the next 12 months.

Item 8.  Consolidated Financial Statements and Supplementary Data
         --------------------------------------------------------

The Consolidated Financial Statements and Supplementary Data commence at page 36
of this report and an index thereto in included in Part IV, Item 14 of this
report.

Item 9.  Changes in and Disagreements with Accountants on Accounting and
         ---------------------------------------------------------------
         Financial Disclosure
         --------------------

Not applicable

                                       29
<PAGE>

                                    PART III

Item 10.   Directors and Executive Officers of the Registrant
           --------------------------------------------------

Information in response to this item (except for certain information concerning
officers included in Part I herein) is incorporated by reference from the
registrant's definitive proxy statement to be filed with the Commission within
120 days after the close of registrant's fiscal year.

Item 11.   Executive Compensation
           ----------------------

Information in response to this item is incorporated by reference from the
registrant's definitive proxy statement to be filed with the Commission within
120 days after the close of registrant's fiscal year.

Item 12.   Security Ownership of Certain Beneficial Owners and Management
           --------------------------------------------------------------

Information in response to this item is incorporated by reference from the
registrant's definitive proxy statement to be filed with the Commission within
120 days after the close of registrant's fiscal year.

Item 13.   Certain Relationships and Related Transactions
           ----------------------------------------------

Information in response to this item is incorporated by reference from the
registrant's definitive proxy statement to be filed with the Commission within
120 days after the close of registrant's fiscal year.

                                       30
<PAGE>

                                 PART IV

Item 14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K
           ---------------------------------------------------------------

(a) List of documents filed as part of this report:

    (1) Financial Statements:                                        Page
        ---------------------                                        ----

      Report of Independent Public Accountants                          35
      Consolidated Balance Sheets at December 31, 1997 and 1996      36-37
      Consolidated Statements of Operations for                         38
        the Years Ended December 31, 1997, 1996 and 1995
      Consolidated Statements of Stockholders Equity for                39
        the Years Ended December 31, 1997, 1996, and 1995
      Consolidated Statements of Cash Flows for the Years ended      40-41
        December 31, 1997, 1996 and 1995
      Notes to Consolidated Financial Statements                     42-53

    (2) Financial Statement Schedules:
        ------------------------------

    Schedule VIII -- Valuation and Qualifying Accounts               54

    All other schedules are omitted since the required information is not
    present or is not present in amounts sufficient to require submission of the
    schedule, or because the information required is included in the
    Consolidated Financial Statements and Notes thereto.

(b) The following reports on Form 8-K were filed during the last quarter of the
    fiscal year ended  December 31, 1997:

    None

(c) List of Exhibits

    3.1  Certificate of Incorporation of the Registrant.  Incorporated herein
         by reference to Exhibit 3.1 to the Registrant's Registration Statement
         on Form 8-B.

    3.2  Bylaws of Registrant.  Incorporated herein by reference to Exhibit 3.2
         to the Registrant's Form 10-Q Report for the period ended June 30,
         1996.

    3.3  Amendment to Bylaws of Registrant, adopted April 29, 1996. Incorporated
         herein by reference to Exhibit 3.3 to the Registrant's Form 10-Q Report
         for the period ended June 30, 1996.

    4.1  Form of Representatives' Common Stock Purchase Warrant. Incorporated
         herein by reference to Exhibit 4.1 to the Registrant's Registration
         Statement on Form S-1 (File No. 33-62345).

                                       31
<PAGE>

10.1*    Ceradyne, Inc. 1983 Stock Option Plan as amended and restated. (Incor-
         porated by reference from Exhibit 10.13 to the Company's Registration
         Statement on Form S-1 (File No. 2-99930) filed on September 25, 1985
         (the "1985 S-1").

10.2     Lease between Trico Rents and the Registrant dated March 23, 1984,
         covering premises located at 235 Paularino Avenue, Costa Mesa,
         California.  Incorporated herein by reference to Exhibit 10.14 to the
         Registration Statement on Form S-1 (File No. 2-90821).

10.3     Lease covering premises located at 3169-A Red Hill Avenue, Costa Mesa,
         California dated October 28, 1985. Incorporated herein by reference to
         Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the
         fiscal year ended December 31, 1995.

10.4     Stock Sales Agreement between the Registrant and Ford Motor Company
         dated March 11, 1986.  Incorporated herein by reference to Exhibit
         10.31 to the Registrant's Annual Report on Form 10-K for the fiscal
         year ended December 31, 1995.

10.5     Agreement between certain shareholders of the Registrant and Ford Motor
         Company dated March 11, 1986. Incorporated herein by reference to
         Exhibit 10.32 to the Registrant's Annual Report on Form 10-K for the
         year ended December 31, 1985.

10.6     Stock Purchase Agreement between Ceradyne Advanced Products, Inc., the
         Registrant and Ford Motor Company dated March 11, 1986. Incorporated
         herein by reference to Exhibit 10.33 to the Registrant's Annual Report
         on Form 10-K for the fiscal year ended December 31, 1985.

10.7     Patent and Technology Transfer Agreement between Ford Motor Company and
         Ceradyne Advanced Products, Inc. dated March 11, 1986.  Incorporated
         herein by reference to Exhibit 10.34 to the Registrant's Annual Report
         on Form 10-K for the fiscal year ended December 31, 1985.

10.8     License Agreement between the Registrant and Ceradyne Advanced
         Products, Inc. dated March 11, 1986. Incorporated herein by reference
         to Exhibit 10.35 to the Registrant's Annual Report on Form 10-K for the
         fiscal year ended December 31, 1985.

10.9     License Agreement between Ford Motor Company and the Registrant dated
         March 11, 1986. Incorporated herein by reference to Exhibit 10.36 to
         the Registrant's Annual Report on Form 10-K for the fiscal year ended
         December 31, 1985.

10.10    Joint Development Agreement between the Registrant and Ford Motor
         Company dated March 11, 1986. Incorporated herein by reference to
         Exhibit 10.37 to the Registrant's Annual Report on Form 10-K for the
         fiscal year ended December 31, 1985.

10.11    Lease dated March 31, 1986 covering premises located at 3163 Red Hill
         Avenue, Costa Mesa, California. Incorporated herein by reference to
         Exhibit 10.45 to the Registrant's Annual Report on Form 10-K for the
         fiscal year ended December 31, 1986.

                                       32
<PAGE>

10.12    Lease dated August 5, 1986 covering premises located at 225 Paularino
         Avenue, Costa Mesa, California. Incorporated herein by reference to
         Exhibit 10.46 to the Registrant's Annual Report on Form 10-K for the
         fiscal year ended December 31, 1986.

10.13    Short-form Memorandum of Lease Assignment dated December 15, 1986, and
         Lease dated June 23, 1980, covering premises located at 3449 Church
         Street, Scottdale, Georgia. Incorporated herein by reference to Exhibit
         10.47 to the Registrant's Annual Report on Form 10-K for the fiscal
         year ended December 31, 1986.

10.14*   Amendment dated June 3, 1986 to the Ceradyne, Inc. 1983 Stock Option
         Plan. Incorporated herein by reference to Exhibit 10.50 to the
         Registrant's Annual Report on Form 10-K for the fiscal year ended
         December 31, 1986.

10.15*   Amendment dated March 16, 1987 to the Ceradyne, Inc. 1983 Stock Option
         Plan. Incorporated herein by reference to Exhibit 10.51 to the
         Registrant's Annual Report on Form 10-K for the fiscal year ended
         December 31, 1986.

10.16    Joint Development and Agreement dated March 28, 1986 between Unitek
         Corporation and the Registrant, and First and Second Amendments
         thereto.  Incorporated herein by reference to Exhibit 10.52 to the
         Registrant's Annual Report on Form 10-K for the fiscal year ended
         December 31, 1986.

10.17*   Amendment dated April 30, 1987 to the Ceradyne, Inc. 1983 Stock Option
         Plan. Incorporated herein by reference to Exhibit 10.56 to the
         Registrant's Registration Statement on Form 8-B.

10.18*   Employment Agreement entered into as of July 5, 1994 by and between
         Joel P. Moskowitz and the Registrant. Incorporated herein by reference
         to Exhibit 10.30 to the Registrant's Annual Report on Form 10-K for the
         fiscal year ended December 31, 1994.

10.19*   Ceradyne, Inc. 1994 Stock Incentive Plan. Incorporated herein by
         reference to Exhibit 10.31 to the Registrant's Annual Report on Form
         10-K for the fiscal year ended December 31, 1994.

10.20*   Amendment No. 1 to the Ceradyne, Inc. 1994 Stock Incentive Plan.
         Incorporated herein by reference to Exhibit 4.2 to Registrant's
         Registration Statement on Form S-8 (File No. 33-61675).

10.21*   Ceradyne, Inc. 1995 Employee Stock Purchase Plan.  Incorporated herein
         by reference to Exhibit 4.1 to Registrant's Registration Statement on
         Form S-8 (File No. 33-61677).

10.22    Amendment No. 2, dated June 5, 1995, to Lease between Trico Rents and
         the Registrant covering premises located at 235 Paularino Avenue,
         Costa Mesa, California. Incorporated herein by reference to Exhibit
         10.32 to the Registrant's Registration Statement on Form S-1 (File No.
         33-62345).

                                       33
<PAGE>

10.23   Amendment No. 2, dated June 5, 1995, to Lease covering premises located
        at 3169-A Red Hill Avenue, Costa Mesa, California. Incorporated herein
        by reference to Exhibit 10.33 to the Registrant's Registration Statement
        on Form S-1 (File No. 33-62345).

10.24   Amendment No. 2, dated June 5, 1995, to Lease dated March 31, 1986
        covering premises located at 3163 Red Hill Avenue, Costa Mesa,
        California.   Incorporated herein by reference to Exhibit 10.34 to the
        Registrant's Registration Statement on Form S-1 (File No. 33-62345).

10.25   Amendment No. 2, dated June 5, 1995, to Lease dated August 5, 1986
        covering premises located at 225 Paularino Avenue, Costa Mesa,
        California. Incorporated herein by reference to Exhibit 10.35 to the
        Registrant's Registration Statement on Form S-1 (File No. 33-62345).

10.26*  Amendment No. 2 to the Ceradyne, Inc. 1994 Stock Incentive Plan
        incorporated herein by reference to Exhibit 10.36 to the Registrant's
        Annual report on Form 10-K for the fiscal year ended December 31, 1996.

10.27   Amendment No. 3 to the Ceradyne, Inc. 1994 Stock Incentive Plan.
        Incorporated herein by reference to Exhibit 4.4 to Registrant's
        Registration Statement on Form S-8 (File No. 33-31679).

21.1    Subsidiaries of the Registrant. Incorporated herein by reference to
        Exhibit 23.2 to the Registrant's Statement on Form S-1 (File No. 33-
        62345).

23.1    Consent of Arthur Andersen LLP.

27.1    Financial Data Schedule.

  *     Each of these exhibits constitutes a management contract, compensatory
        plan, or arrangement required to be filed as an exhibit to this Report
        pursuant to Item 14(c) of this Report.

                                       34
<PAGE>

                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
                   ----------------------------------------


To Ceradyne, Inc.

We have audited the accompanying balance sheets of CERADYNE, INC. (a Delaware
corporation) and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position Ceradyne, Inc. and subsidiaries as
of December 31, 1997 and 1996, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1997 in
conformity with generally accepted accounting principles.

Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index of
financial statements is presented for purposes of complying with the Securities
and Exchange Commission's rules and are not a required part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in our audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.


                                        /s/ ARTHUR ANDERSEN LLP
                                        ARTHUR ANDERSEN LLP

Orange County, California
March 18, 1998


                                      35
<PAGE>

                                CERADYNE, INC.
                                --------------
                          CONSOLIDATED BALANCE SHEETS
                          --------------------------
                          DECEMBER 31, 1997 AND 1996
                          --------------------------

                                    ASSETS
                                    ------
                            (Amounts in thousands)

<TABLE>
<CAPTION>
                                                                1997      1996
                                                              -------   -------
<S>                                                           <C>       <C>
CURRENT ASSETS:
 Cash and cash equivalents                                    $ 3,569   $ 4,643
 Accounts receivable, net of allowances of
  approximately $179 and $125 for doubtful
  accounts in 1997 and 1996, respectively                       4,685     4,854
 Other receivables                                                 96     1,397
 Inventories                                                    7,366     7,756
 Production tooling                                               882       538
 Prepaid expenses and other                                       716       401
                                                              -------   -------
   Total current assets                                        17,314    19,589
                                                              -------   -------


PROPERTY, PLANT AND EQUIPMENT, at cost
 Land                                                             422       422
 Buildings and improvements                                     1,825     1,825
 Lease rights                                                   2,659     2,659
 Machinery and equipment                                       18,456    15,718
 Leasehold improvements                                         1,629     1,278
 Office equipment                                               2,001     1,829
 Construction in progress                                         401       600
                                                              -------   -------
                                                               27,393    24,331
  Less--Accumulated depreciation and amortization              19,427    18,073
                                                              -------   -------
                                                                7,966     6,258
                                                              -------   -------
COSTS IN EXCESS OF NET ASSETS ACQUIRED,
 net of accumulated amortization of $1,751 and $1,595 in
 1997 and 1996, respectively                                    1,923     2,079
                                                              -------   -------

OTHER ASSETS, net of accumulated amortization of
 $592 and $565 in 1997 and 1996, respectively                   1,814       472
                                                              -------   -------

   Total assets                                               $29,017   $28,398
                                                              =======   =======

</TABLE>


                  The accompanying notes are an integral part
                     of these consolidated balance sheets.

                                       36
<PAGE>

                                 CERADYNE, INC.
                                 --------------

                          CONSOLIDATED BALANCE SHEETS
                          ---------------------------

                           DECEMBER 31, 1997 AND 1996
                           --------------------------

                      LIABILITIES AND STOCKHOLDERS' EQUITY
                      ------------------------------------
                   (Amounts in thousands, except share data)
<TABLE>
<CAPTION>

                                                            1997        1996
                                                          ---------   ---------
<S>                                                       <C>         <C>
CURRENT LIABILITIES:
 Current portion of long-term debt                        $    ---    $  1,000
 Accounts payable                                            1,197       1,662
 Accrued expenses:
  Payroll and payroll related                                  622         662
  Other                                                        168         373
                                                          --------    --------
     Total current liabilities                               1,987       3,697
                                                          --------    --------

LONG-TERM DEBT                                                 ---         ---
                                                          --------    --------

DEFERRED REVENUE                                               270         261
                                                          --------    --------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
 Common stock, $.01 par value:
  Authorized--12,000,000 shares
  Outstanding--7,963,459 and 7,901,790 shares
  in 1997 and 1996, respectively                            37,408      37,138
 Accumulated deficit                                       (10,648)    (12,698)
                                                          --------    --------

     Total stockholders' equity                             26,760      24,440
                                                          --------    --------

     Total liabilities and stockholders' equity           $ 29,017    $ 28,398
                                                          ========    ========

</TABLE>



                  The accompanying notes are an integral part
                     of these consolidated balance sheets.

                                       37
<PAGE>

                                 CERADYNE, INC.
                                 --------------

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     -------------------------------------

              FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
              ----------------------------------------------------

                 (Amounts in thousands, except per share data)
<TABLE>
<CAPTION>

                                            1997       1996       1995
                                            ----       ----       ----
<S>                                       <C>        <C>        <C>

NET SALES                                 $28,693    $28,212    $23,404

COST OF PRODUCT SALES                      23,274     21,065     16,948
                                          -------    -------    -------

   Gross profit                             5,419      7,147      6,456
                                          -------    -------    -------

OPERATING EXPENSES:
 Selling                                    1,515      1,571      1,492
 General and administrative                 3,660      3,137      2,748
                                          -------    -------    -------

                                            5,175      4,708      4,240
                                          -------    -------    -------

   Income from operations                     244      2,439      2,216
                                          -------    -------    -------

OTHER INCOME (EXPENSE):
 Other income, net                            265      1,890        265
 Interest expense                            (134)      (162)      (342)
                                          -------    -------    -------
                                              131        728        (77)
                                          -------    -------    -------

   Income before provision (benefit)
    for income taxes                          375      4,167      2,139

PROVISION (BENEFIT) FOR INCOME
  TAXES                                    (1,675)       127         50
                                          -------    -------    -------

   Net income                             $ 2,050    $ 4,040    $ 2,089
                                          =======    =======    =======

BASIC INCOME PER SHARE                    $   .26    $   .52    $   .32
                                          =======    =======    =======

DILUTED INCOME PER SHARE                  $   .26    $   .51    $   .32
                                          =======    =======    =======
</TABLE>
                  The accompanying notes are an integral part
                       of these consolidated statements.

                                       38
<PAGE>

                                CERADYNE, INC.
                                --------------

                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                ------------------------------------------------

             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, and 1995
             -----------------------------------------------------

                   (Amounts in thousands, except share data)

<TABLE>
<CAPTION>


                                     Common Stock
                                 ------------------
                                  Number               Accumulated
                                 of Shares   Amount      Deficit
                                ----------  -------   ------------
<S>                             <C>         <C>       <C>
BALANCE, December 31, 1994      6,243,734    $30,429     $(18,827)

 Issuance of common stock          13,090         22          ---
 Exercise of stock options         78,800        205          ---
 Public offering                1,380,000      5,934          ---
 Net income                           ---        ---        2,089
                                ---------    -------     --------

BALANCE, December 31, 1995      7,715,624     36,590      (16,738)

 Issuance of common stock          25,521        147          ---
 Exercise of stock options        160,645        401          ---
 Net Income                           ---        ---        4,040
                                ---------    -------     --------

BALANCE, December 31, 1996      7,901,790     37,138      (12,698)


 Issuance of common stock          37,469        202          ---
 Exercise of stock options         24,200         68          ---
 Net Income                           ---        ---        2,050
                                ---------    -------     --------

BALANCE, December 31, 1997      7,963,459    $37,408     $(10,648)
                                =========    =======     ========

</TABLE>



                  The accompanying notes are an integral part
                       of these consolidated statements.

                                       39
<PAGE>

                                CERADYNE, INC.
                                --------------

                     CONSOLIDATED STATEMENTS OF CASH FLOW
                     ------------------------------------

             FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
             ----------------------------------------------------

                            (Amounts in thousands)

<TABLE>
<CAPTION>


                                                            1997       1996       1995
                                                          --------   --------   --------
<S>                                                       <C>        <C>        <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income                                               $ 2,050    $ 4,040    $ 2,089

  Adjustments to reconcile net income to net cash
   provided by operating activities:
    Depreciation and amortization                            1,361      1,284      1,532

  Changes in operating assets and liabilities:
   (Increase) decrease in accounts receivable, net             169     (1,095)      (868)
   (Increase) decrease in other receivables                  1,301     (1,385)        (6)
   (Increase) decrease in inventories                          390     (1,007)    (1,013)
   (Increase) in production tooling                           (344)      (172)      (123)
   (Increase) in prepaid expenses and other assets          (1,683)       (78)      (302)
   Increase (decrease) in accounts payable                    (465)        20       (288)
   Increase (decrease) in accrued expenses                    (245)        66         84
   Increase (decrease) in deferred revenue                       9        ---       (250)
                                                          --------   --------    -------

          Net cash provided by operating activities          2,543      1,673        855
                                                           -------    -------    -------

CASH FLOWS FROM INVESTING ACTIVITIES:

 Purchases of property, plant and equipment                 (2,887)    (2,641)    (1,019)
                                                          --------    -------    -------

          Net cash used in investing activities             (2,887)    (2,641)    (1,019)
                                                          --------    -------    -------

</TABLE>
                  The accompanying notes are an integral part
                       of these consolidated statements.

                                       40
<PAGE>

                                CERADYNE, INC.
                                --------------

                                     - 2 -
<TABLE>
<CAPTION>


                                                                      1997       1996       1995
                                                                    --------   --------   --------
<S>                                                                 <C>        <C>         <C>

CASH FLOWS FROM FINANCING ACTIVITIES:
 Proceeds from issuance of common stock, ne  t                      $   270    $   548     $6,161
 Net borrowing (payments) on long-term debt                          (1,000)    (1,156)       222
                                                                    -------    -------     ------

     Net cash provided by (used in) financing activities               (730)      (608)     6,383
                                                                    -------    -------     ------

Increase (decrease) in cash and cash equivalents                     (1,074)    (1,576)     6,219

 Cash and cash equivalents, beginning of period                       4,643      6,219        ---
                                                                    -------    -------     ------

 Cash and cash equivalents, end of period                           $ 3,569    $ 4,643     $6,219
                                                                    =======    =======     ======


SUPPLEMENTAL DISCLOSURES OF CASH FLOW
 INFORMATION:

 Interest paid                                                      $   134    $   150     $  342
                                                                    =======    =======     ======
 Income taxes paid                                                  $    33    $   177     $   21
                                                                    =======    =======     ======
</TABLE>


                  The accompanying notes are an integral part
                       of these consolidated statements.

                                       41
<PAGE>

                                CERADYNE, INC.
                                --------------

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                  ------------------------------------------

                       DECEMBER 31, 1997, 1996 AND 1995
                       --------------------------------


1.  Summary of Significant Accounting Policies
    ------------------------------------------

    a.  Principles of Consolidation and Nature of Operations
        ----------------------------------------------------

    The consolidated financial statements include the financial statements of
    Ceradyne, Inc. (a Delaware Corporation), and its subsidiaries. Ceradyne,
    Inc. and its subsidiaries are collectively referred to herein as the
    Company. All significant intercompany accounts and transactions have been
    eliminated.

    The Company develops, manufactures and markets advanced technical ceramic
    products and components for industrial, defense, consumer and microwave
    applications. The products are sold primarily to industrial, consumer, and
    defense concerns globally.

    b.  Cash and Cash Equivalents
        -------------------------

    The Company considers all highly liquid investments with an initial maturity
    of three months or less when purchased to be cash equivalents.

    c.  Accounts Receivable
        -------------------

    The allowance for doubtful accounts includes management's estimate of the
    amount expected to be lost on specific accounts and for losses on other as
    yet unidentified accounts included in accounts receivable. In estimating the
    potential losses on specific accounts, management relies on in-house
    prepared analysis and review of other available information. The amounts the
    Company will ultimately realize could differ from the amounts assumed in
    arriving at the allowance for doubtful accounts in the accompanying
    financial statements.

                                       42
<PAGE>

    d. Inventories
       -----------

    Inventories are valued at the lower of cost (first-in, first-out) or market.
    Allowances for obsolete inventory are based on management's estimate of the
    amount considered obsolete based on specific reviews of inventory items. In
    estimating the allowance, management relies on its knowledge of the industry
    as well as its current inventory levels. The amounts the Company will
    ultimately realize could differ from amounts estimated by management.
    Inventory costs include the cost of material, labor and manufacturing
    overhead. The following is a summary of inventory by component:

<TABLE>
<CAPTION>
                                   December 31,
                            ------------------------
                                1997          1996
                            -----------   ----------
        <S>                 <C>           <C>
        Raw materials         $3,338,000   $2,742,000
        Work-in-process        3,617,000    4,531,000
        Finished goods           411,000      483,000
                              ----------   ----------
                            $  7,366,000   $7,756,000
                            ============   ==========
</TABLE>

    e.  Property, Plant and Equipment
        -----------------------------

    Depreciation and amortization of property, plant and equipment are provided
    using the straight-line method over the following estimated useful lives:

              Buildings and improvements   20 years
              Lease rights                 Term of lease and renewal option
              Machinery and equipment      3 to 12 years
              Leasehold improvements       Term of lease
              Office equipment             5 years

    Maintenance, repairs and minor renewals are charged to expense as incurred.
    Repairs and maintenance expense was $708,000, $598,000, and $414,000 in
    1997, 1996 and 1995, respectively. Additions and improvements are
    capitalized. When assets are disposed of, the applicable costs and
    accumulated depreciation and amortization are removed from the accounts and
    any resulting gain or loss is included in the results of operations.

    f.  Sales Recognition
         -----------------

    Sales are recorded as of the date shipments are made to, or goods are
    accepted by, customers for production contracts. Revenue is recognized using
    the percentage-of-completion method for cost plus fixed fee, government
    sponsored, and research and development contracts. For the years ending
    December 31, 1997, 1996 and 1995, revenues from cost plus fixed fee
    contracts were less than 10 percent of net sales.

    g.  Deferred Revenue
        ----------------

    In September 1994, the Company entered into an agreement which waived a
    minimum production per quarter requirement as well as a minimum rework lot
    quantity for the translucent ceramic bracket. In consideration for entering
    into this modification, the Company received a cash fee of $250,000 which
    was amortized to other income in 1995.

                                       43
<PAGE>

    In September 1994, the Company finalized an agreement to manufacture and
    supply a specific cathode to a third party at reduced prices. In
    consideration for entering into this contract, the Company received a cash
    fee of $261,000. The fee was deferred in the financial statements and was
    recognized over the life of the agreement once shipments commence. At
    December 31, 1997, all of the fee has been recognized.

    In November 1997, Ford Motor Company contributed $270,000 for the year 1998
    to the Joint Product Development Program (see Note 9). The Company will
    amortize this amount to other revenue during 1998.

    h.  Net Income Per Share
        --------------------

    The Company accounts for net income per share in accordance with SFAS No.
    128 "Earnings Per Share". Basic net income per share is computed by dividing
    income available to common stockholders by the weighted average number of
    common shares outstanding. Diluted net income per share is computed by
    dividing income available to common stockholders by the weighted average
    number of common shares outstanding plus the effect of any dilutive stock
    options and common stock warrants. The following is a summary of the number
    of shares entering into the computation of net income per common and common
    equivalent share:

<TABLE>
<CAPTION>

                                                                December 31,
                                                      -----------------------------------
                                                        1997        1996         1995
                                                      ----------  ----------  -----------
<S>                                                   <C>         <C>         <C>
           Weighted average number of
            shares outstanding                         7,931,000   7,807,000   6,497,000
           Dilutive stock options and common stock
            warrants                                     104,000     178,000     110,000
                                                       ---------   ---------  ----------

           Number of shares used in
            diluted computation                        8,035,000   7,985,000   6,607,000
                                                       =========   =========   =========
</TABLE>

    i.  Costs in Excess of Net Assets Acquired
        --------------------------------------

    As prescribed by Statement of Financial Accounting Standards (SFAS) No. 121,
    "Accounting for the Impairment of Long-lived Assets and for Long-lived
    Assets to be Disposed of," the Company assesses the recoverability of its
    long-lived assets (including goodwill) by determining whether the asset
    balance can be recovered over the remaining depreciation or amortization
    period through projected undiscounted future cash flows. Cash flow
    projections, although subject to a degree of uncertainty, are based on
    trends of historical performance and management's estimate of future
    performance, giving consideration to existing and anticipated competitive
    and economic conditions. There were no impairment charges in any of the
    three years in the period ended December 31, 1997.

                                       44
<PAGE>

    j.  Deferred Start-up Costs
        -----------------------

    Start-up costs incurred to establish the technological feasibility of a new
    product to be sold or otherwise marketed are charged to expense in the
    period incurred. Costs incurred subsequent to establishing technological
    feasibility but prior to commercial sales to customers are capitalized and
    amortized over one year from the startup completion date. During the year
    ended December 31, 1997, $338,000 of deferred startup costs from prior
    product lines were expensed. Also, during the year ended December 31, 1997,
    there was $252,000 incurred in deferred costs capitalized for the
    semiconductor product line, and this will be amortized over one year from
    the production startup completion.

    k.  Use of Estimates
        ----------------

    The preparation of financial statements in accordance with generally
    accepted accounting principles requires management to make estimates and
    assumptions that affect the reported amounts of assets and liabilities and
    disclosure of contingent assets and liabilities at the date of the financial
    statements. Actual results could differ from those estimates.

    l.  Engineering and Research
        ------------------------

    Costs associated with application engineering and internally-funded research
    are expensed as incurred and are included in cost of product sales. Costs
    associated with Company-funded research were approximately $380,000,
    $400,000 and $400,000 in 1997, 1996 and 1995.

    m.  Stock Based Compensation Plans
        ------------------------------

    Effective January 1, 1996, the Company adopted the disclosure provisions of
    SFAS No. 123, "Accounting for Stock-Based Compensation". At a minimum, SFAS
    No. 123 requires the Company to disclose pro forma net income and earnings
    per share as if the fair value based accounting method of SFAS No. 123 had
    been used to account for stock-based compensation. These disclosures are
    included in Note 6.

    n.  Fair Value of Financial Instruments
        -----------------------------------

    The carrying value of accounts receivable and trade payables approximates
    the fair value due to their short-term maturities. The carrying value of the
    Company's line of credit is considered to approximate fair market value as
    the interest rates of these instruments are based predominately on variable
    reference rates.

    o.  Environmental Liabilities and Expenditures
        ------------------------------------------

    Accruals for environmental matters are recorded in operating expenses when
    it is probable that a liability has been incurred and the amount of the
    liability can be reasonably estimated.

                                       45
<PAGE>

    p.  New Accounting Pronouncements
        -----------------------------

    In June 1997, FASB issued SFAS No. 130, "Reporting Comprehensive Income".
    This Statement requires that all items that meet the definition of
    components of comprehensive income be reported in a financial statement for
    the period in which they are recognized. Components of comprehensive income
    include revenues, expenses, gains, and losses that under generally accepted
    accounting principles are included in comprehensive income but excluded from
    net income. This Statement is effective for fiscal years beginning after
    December 15, 1997. Management believes that adoption of this Statement will
    not have a material effect on the Company's consolidated financial
    statements.


    In June 1997, FASB also issued SFAS No. 131, "Disclosures about Segments of
    an Enterprise and Related Information". This Statement requires that a
    public business enterprise report financial and descriptive information
    about its reportable operating segments. Financial information is required
    to be reported on the same basis that it is used internally for evaluating
    segment performance and deciding how to allocate resources to segments. This
    Statement is effective for fiscal years beginning after December 15, 1997.
    Management believes that the adoption of this Statement will not have a
    material effect on the Company's consolidated financial statements.

    q.  Reclassifications
        -----------------

    Certain reclassifications have been made in the 1996 and 1995 statements to
    conform with the 1997 presentation.

2.  Debt and Bank Borrowing Arrangements
    ------------------------------------

    Debt consisted of the following at December 31, 1997 and 1996:

<TABLE>
<CAPTION>
                                                                    1997        1996
                                                                    ----        ----
     <S>                                                            <C>         <C>
     Credit facility bearing
      interest at the institution's prime rate
      (8.25 percent at December 31, 1996)
      plus 2.0 percent; and interest at institution's
      prime rate (8.25 percent at December 31, 1997)
      less .50 percent

         Revolving line of credit                                  $   0        $1,000,000
                                                                   =====        ==========

     Less-current portion                                              0         1,000,000
                                                                   -----        ----------
     Long-term debt                                                $   0        $        0
                                                                   =====        ==========
</TABLE>

In November, 1997 the Company terminated its revolving credit agreement with an
asset based lender, and entered into a revolving credit agreement with Comerica
Bank. The new credit facility amount remains at $4,000,000 and no collateral
will be required of the Company. During the transition of changing financial
institutions, the Company paid off its short-term minimum borrowing requirement
debt of $1,000,000. As of December 31, 1997 there had been no borrowing under
the new credit facility.

                                       46
<PAGE>

3.  Income Taxes
    ------------

The provision (benefit) for income taxes is comprised of the following:

<TABLE>
<CAPTION>

                                    1997     1996    1995
                                  --------   -----   -----
<S>                               <C>        <C>     <C>

    Current                       $    33    $ 127   $  50
    Deferred                       (1,708)     ---     ---
                                  -------    -----   -----
                                  $(1,675)   $ 127   $  50
                                  ========   =====   =====
</TABLE>

The Company's deferred tax asset at December 31, 1997 relates primarily to its
tax net operating loss carryforwards, which total approximately $11.6 million
and expire as follows:
<TABLE>
<CAPTION>

           <S>                                    <C>
            2003                                 $ 2,242,000
            2004                                   3,015,000
            2005                                     161,000
            2006                                     218,000
            2007                                   1,093,000
            2008                                   2,050,000
            2009                                   1,828,000
            2010                                     969,000
                                                  ----------
                                                 $11,576,000
                                                 ===========

The components of the Company's deferred tax asset as of December 31, 1997 and 1996 are as follows:

                                                         December 31,
                                                         -----------
                                                      1997           1996
                                                      ----           ----
           Inventory adjustments                   $  583,000    $   438,000
           Contingency reserves                           ---        112,000
           Deferred revenue                           108,000        105,000
           Vacation accrual                           112,000        152,000
           Bad debt allowance                          72,000         50,000
           Net operating loss and tax credit
            carryforwards                           4,630,000      4,694,000
           Other                                      (83,000)       104,000
                                                   ----------    -----------
                                                    5,422,000      5,655,000
           Valuation allowance                      3,714,000     (5,655,000)
                                                   ----------    -----------
             Net deferred tax asset                $1,708,000    $       ---
                                                   ==========    ===========
</TABLE>

                                       47
<PAGE>

The effective income tax rate for the years ended December 31, 1997,1996 and
1995 differs from the Federal statutory income tax rate due to the following
items:

<TABLE>
<CAPTION>

                                                                              December 31
                                                                ---------------------------------------
                                                                   1997           1996           1995
                                                                -----------    -----------    ----------
<S>                                                            <C>             <C>            <C>
       Income before taxes                                      $   375,000    $ 4,167,000    $2,139,000
                                                                -----------    -----------    ----------
       Provision for income taxes at federal
       statutory rate                                               128,000      1,417,000       727,000
       Increases (decreases) in tax resulting from:
          Utilization of net operating loss carryforwards           (95,000)    (1,389,000)     (711,000)
          Reduction of valuation allowance                       (1,846,000)           ---           ---
          Other, including state taxes                              138,000         99,000        34,000
                                                                -----------    -----------    ----------
       Provision (benefit) for income taxes                      (1,675,000)       127,000        50,000
                                                                -----------    -----------    ----------
       Effective tax rate                                          (446.67)%          3.05%         2.34%
                                                                ===========    ===========    ==========
</TABLE>
4. Commitments and Contingencies
   -----------------------------

a.  Operating Lease Obligations
    ---------------------------

    The Company leases certain of its manufacturing facilities under
    noncancelable operating leases expiring at various dates through March 2001.
    One of the facility leases is subject to a 4 percent annual escalation
    clause. The Company incurred rental expense under these leases of $620,000,
    $596,000 and $837,000 in 1997, 1996 and 1995, respectively. The approximate
    minimum rental commitments required under existing noncancelable leases as
    of December 31, 1997 are as follows:

                    1998      $  667,000
                    1999         682,000
                    2000         589,000
                    2001          20,000
                              ----------
                              $1,958,000
                              ==========

    b.  Employment Agreement
        --------------------

    The Company has an employment agreement with the Chief Executive Officer
    which expires on July 5, 1999. In addition to a base salary, the agreement
    provides for a bonus to be determined by the Compensation Committee of the
    Board of Directors. No maximum compensation limit exists. The compensation
    expense in 1997, 1996 and 1995 was $249,000, $196,000 and $167,000,
    respectively.

    c.  Legal Proceedings
        -----------------

    The Company is, from time to time, involved in various legal and other
    proceedings that relate to the ordinary course of operating its business,
    including, but not limited to, employment-related actions and workers'
    compensation claims.

    In October 1995 the Company was served with a complaint that was filed by
    four persons and the spouses of those persons, who are/were employed by one
    of the Company's customers. The

                                       48
<PAGE>

    complaint, filed in the United States District Court, Eastern District of
    Tennessee, alleges that the employees contracted chronic beryllium disease
    as a result of their exposure, during the course of their employment with
    the Company's customer, to beryllium-containing products sold by Ceradyne.
    The complaint seeks compensatory damages in the amount of $3.0 million for
    each of the four plaintiffs who were employed by the Company's customer,
    compensatory damages of $1.0 million each for the two spouses, and punitive
    damages in the amount of $5.0 million. The case is in the early stages of
    discovery. Based upon information currently available, the Company believes
    that the plaintiffs' claims are without merit and that the resolution of
    this matter will not have a material adverse effect on the financial
    condition or operations of the Company. Defense of this case has been
    tendered to the Company's insurance carriers, some of whom are providing a
    defense subject to a reservation of rights. There can be no assurance,
    however, that this claim or any of the claims related to exposure to
    beryllium oxide will be covered by insurance, or that, if covered, the
    amount of insurance will be sufficient to cover any potential judgment.

    In February 1997 the Company was served with a complaint that was filed by a
    former employee of one of the Company's customers and his wife. The
    complaint, filed in the United States District Court, Eastern District of
    Tennessee, alleges that the husband contracted chronic beryllium disease as
    a result of his exposure to beryllium-containing products sold by Ceradyne.
    The complaint seeks compensatory damages in the amount of $5.0 million for
    the husband, $1.0 million for the wife, and punitive damages in the amount
    of $10.0 million. The Company believes that the plaintiffs' claims are
    without merit and that the resolution of this matter will not have a
    material adverse effect on the financial condition or operations of the
    Company. Defense of this case has been tendered to the Company's insurance
    carriers, some of which are providing a defense subject to a reservation of
    rights. There can be no assurances, however, that this claim will be covered
    by insurance, or that, if covered, the amount of insurance will be
    sufficient to cover any potential judgment.

    In July 1997 the Company was served with a complaint filed by an employee of
    one of the Company's former parent companies and landlords. The complaint,
    filed in the Los Angeles County Superior Court on behalf of the employee by
    his wife, alleges that the husband contracted chronic beryllium disease as a
    result of his exposure to beryllium through Ceradyne's products, equipment
    and premises. The complaint seeks unspecified damages against the Company,
    its officers and its directors. The Company believes that the plaintiff's
    claims are without merit and that the resolution of this matter will not
    have a material adverse effect on the financial condition or operations of
    the Company. Defense of this case has been tendered to the Company's
    insurance carriers, some of which are providing defense and indemnification
    subject to a reservation of rights. There can be no assurances, however,
    that this claim will be covered by insurance, or that, if covered, the
    amount of insurance will be sufficient to cover any potential judgment.

    In August 1997 the Company was served with a complaint filed by a former
    employee of one of the Company's customers and his wife. The complaint,
    filed in the United States District Court, Eastern District of Tennessee,
    alleges that the husband contracted chronic berylliium disease as a result
    of his exposure to beryllium-containing products sold by Ceradyne. The
    complaint seeks compensatory damages in the amount of $5.0 million for the
    husband, $1.0 million for the wife, and punitive damages in the amount of
    $10.0 million. The Company believes that the plaintiffs' claims are without
    merit and that the resolution of this matter will not have a material
    adverse effect on the financial condition or operations of the Company.
    Defense of this case has been

                                       49
<PAGE>

    tendered to the Company's insurance carriers, some of which are providing
    defense and indemnification subject to a reservation of rights. There can be
    no assurances, however, that this claim will be covered by insurance, or
    that, if covered, the amount of insurance will be sufficient to cover any
    potential judgment.

5.  Segment and Customer Information
    --------------------------------

The Company operates solely in the development, manufacture and sale of advanced
technical ceramics. In the years ended December 31, 1997, 1996 and 1995, export
sales were approximately $5,727,000, $5,677,000 and $6,179,000, respectively.

For the year ended December 31, 1997, one customer accounted for 17% of net
sales.  For the year ended December 31, 1996, another customer accounted for 17%
of sales.  For the year ended December 31, 1995, no customer accounted for more
than 10% of net sales.

6. Stock Options
   -------------

The Company has a stock option plan, the 1994 Stock Incentive Plan and an
employee stock purchase plan, the 1995 Employee Stock Purchase Plan.  The
Company had a 1994 Employee Stock Purchase Plan which expired on July 31, 1995.
The Company accounts for these plans under APB Opinion No. 25, under which no
compensation cost has been recognized.  Had compensation cost for these plans
been determined consistent with FASB Statement No. 123, the Company's net income
and earnings per share would have been reduced to the following pro forma
amounts:

<TABLE>
<CAPTION>

                                                  1997        1996         1995
                                                  ----        ----         ----
<S>                              <C>           <C>          <C>          <C>
    Net Income:                   As Reported   $2,050,000   $4,040,000   $2,089,000
                                  Pro Forma      1,888,000    3,794,000    1,962,000

    Basic income per share        As Reported   $      .26   $      .52   $      .32
                                  Pro Forma            .24          .49          .30

    Diluted income per share      As Reported   $      .26   $      .51   $      .32
                                  Pro Forma     $      .23   $      .48   $      .30

</TABLE>

Because the Statement No. 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
Additionally, the 1997, 1996 and 1995 pro forma amounts include $23,000, $48,000
and $36,000, respectively, related to the purchase discount offered under the
1995 Employee Stock Purchase Plan in 1997 and 1996, respectively, and the 1994
Employee Stock Purchase Plan in 1995.

The Company may sell up to 100,000 shares of stock to its full-time employees
under the 1995 Employee Stock Purchase Plan. The Company has sold 22,004 and
13,694 shares in 1997 and 1996, respectively, under the 1995 Employee Stock
Purchase Plan. Employees may purchase shares at the lower of 85 percent of the
quoted market value of the shares as determined on the first or last day of

                                       50
<PAGE>

the plan year. The weighted average fair value of shares sold in 1997, 1996 and
1995 was $4.63, $4.75 and $2.00, respectively.

The Company may grant options for up to 550,000 shares under the 1994 Stock
Incentive Plan.  The Company has granted options of 463,200 shares through
December 31, 1997.  Options are granted at or above the fair market value at the
date of grant and generally become exerciseable over a five-year period.

A summary of the status of the Company's stock option plan at December 31, 1995,
1996 and 1997 and changes during the years then ended is presented in the table
and narrative below:

<TABLE>
<CAPTION>


                                                     Weighted Average
                                          Shares     Exercise  Price
                                         ---------   ----------------
<S>                                      <C>         <C>

     OUTSTANDING, December 31, 1994       472,200               $2.47

     Granted                              154,200                4.79
     Exercised                            (78,800)               2.55
     Canceled                              (5,400)               2.47
                                         --------               -----
     OUTSTANDING, December 31, 1995       542,200                3.01
                                         --------               -----

     Granted                               25,000                6.92
     Exercised                           (160,645)               2.74
     Canceled                             (22,505)               2.46
                                         --------               -----
     OUTSTANDING, December 31, 1996       384,050                3.56
                                         --------               -----

     Granted                              139,500                6.14
     Exercised                            (23,900)               2.85
     Cancelled                            (33,800)               4.98
                                         --------               -----
     OUTSTANDING, December 31, 1997       465,850               $4.26
                                         ========               =====
</TABLE>

Of the 465,850 options outstanding at December 31, 1997, 248,650 have exercise
prices between $2.00 and $4.375, with a weighted average exercise price of
$2.78, and a weighted average remaining contractual life of six years.  The
remaining 217,200 options have exercise prices between $4.75 and $7.375, with a
weighted average exercise price of $5.97, and a weighted average remaining
contractual life of nine years.

The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 1997, 1996, and 1995, respectively:  risk free
interest rates of  6.38, 6.29 and 5.91 percent; expected lives for 1997, 1996
and 1995 of 7 years; expected volatility of 57.43, 57.20 and 58.46 percent.  The
assumed dividend yield in 1997, 1996 and 1995 is zero percent.

                                       51
<PAGE>

7. Supplemental Retirement Plan
   ----------------------------

In December 1988 the Board of Directors of the Company approved the adoption of
a supplemental retirement plan (Ceradyne SMART 401(K) Plan) in which
substantially all employees are eligible to participate after completing one
year of employment.  Participation in the Plan is voluntary.  An employee may
elect to contribute up to seven percent (7%) of the employee's pretax
compensation as a basic contribution.  The Company may contribute any amount
which the Board of Directors annually determines appropriate.  Company
contributions fully vest and are nonforfeitable after the participant has
completed five years of service.  During the years ended December 31, 1997,
1996, and 1995, the related expense was approximately $116,000, $117,000, and
$92,000,  respectively.

The Company's contribution is in the form of shares of its common stock.  The
number of shares to be contributed will be determined by dividing the total
Company match for the Plan year by the higher of the market value per share of
common stock as of the end of that Plan year (December 31), or the audited book
value per share of common stock as of the end of that Plan year.  The member's
cash contributions may be invested, at their discretion, in one or all of the
following:  (1) Fixed Income Fund, (2) Bond and Mortgage Fund, (3) International
Stock Fund, or (4) Equity Fund.  The member can elect to allocate the
accumulated and future contributions to their accounts among these funds in
increments of 10 percent.

The Company has reserved 250,000 shares of its common stock for possible
issuance under the Plan.  At December 31, 1997, 151,914 shares were available
for issuance under the Plan.

8. Interim Financial Information (unaudited)
   -----------------------------------------

The results by quarter for 1997 and 1996 are as follows:
<TABLE>
<CAPTION>

                                             Quarter Ending
                                             --------------
                        March 31,      June 30,      September 30,   December 31,
                           1997          1997            1997            1997
                           ----          ----            ----            ----
<S>                     <C>            <C>           <C>             <C>
Net sales               $6,621,000      $7,280,000      $7,100,000     $7,692,000
Net income                 284,000         759,000         508,000        499,000
Diluted income per
 share-                 $      .04      $      .10      $      .06     $      .06
                        ==========      ==========      ==========     ==========


                                             Quarter Ending
                                             --------------
                         March 31,       June 30,      September 30,   December 31,
                           1996            1996            1996            1996
                        ----------      ----------      ----------     ----------

Net sales               $6,329,000      $6,991,000      $7,385,000     $7,507,000
Net income                 765,000         951,000       1,084,000      1,240,000
Diluted income per
 share-                 $      .10      $      .12      $      .14     $      .15
                        ==========      ==========      ==========     ==========

</TABLE>

                                       52
<PAGE>

9. Joint Venture and Joint Development Agreement
   ---------------------------------------------

On March 11, 1986, the Company sold 526,316 shares of its common stock to Ford
Motor Company (Ford) for a gross sales price of $10,000,000.  In addition, Ford
and the Company formed a joint venture, Ceradyne Advanced Products, Inc. (CAPI),
in which the Company acquired a 20 percent interest for $200,000.  Ford
contributed certain technology in exchange for its 80 percent interest in the
joint venture.  The Company granted Ford an option to put Ford's 80 percent
interest in the joint venture to the Company in exchange for 608,020 shares of
the Company's common stock.  Ford granted the Company an option to call Ford's
80 percent interest in the joint venture in exchange for 680,983 shares of the
Company's common stock.

On February 13, 1988, the Company exercised its call option and issued 680,983
shares of its common stock to Ford.  The value of the shares issued ($2,043,000)
was allocated to the technology acquired and is being amortized over a 20 year
period utilizing the purchase method of accounting (see Note 1).

Ford and the Company have also entered into a joint development program to
develop a prototype production facility to produce ceramics with automotive
applications.  Under the terms of the joint development agreement, Ford and the
Company share equally in the cost of this project.  For the years ending
December 31, 1997, 1996 and 1995, Ford agreed to contribute $275,000, $275,000
and $200,000, respectively, which have been reflected as a reduction of the
expenses incurred or a reduction in the capitalized value of the fixed assets
acquired for this project in the accompanying consolidated financial statements.
Included in accounts receivable on the accompanying consolidated balance sheets
is $69,000 due from Ford related to this agreement as of December 31, 1996.
There were no amounts due as of December 31, 1997.

                                       53
<PAGE>

               SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS
               -------------------------------------------------

                            (Amounts in thousands)
<TABLE>
<CAPTION>


                            Balance    Charged                 Balance
                              at       to Costs                  at
                           Beginning     and                   End of
Description                of Period   Expenses   Deductions   Period
--------------             ---------   --------   ----------   -------
<S>                        <C>         <C>        <C>          <C>
For the Year Ending
December 31, 1997:
------------------

Allowance for
doubtful
accounts
 receivable                 $125         $134        $ 80         $179
                            ====         ====        ====         ====
For the Year Ending
December 31, 1996:
------------------

Allowance for
doubtful
accounts
receivable                  $150         $  0        $ 25         $125
                            ====         ====        ====         ====


For the Year Ending
December 31, 1995:
------------------

Allowance for
doubtful
accounts
receivable                  $199         $ 34        $ 83         $150
                            ====         ====        ====         ====
</TABLE>


                                       54

<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

March 31, 1998      CERADYNE, INC.

                         By    /s/Joel P. Moskowitz
                               -----------------------
                               Joel P. Moskowitz
                               Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.


/s/Joel P. Moskowitz             Chairman of the Board,     March 31, 1998
-----------------------------    Chief Executive Officer,
Joel P. Moskowitz                President and Director
                                 (Principal executive
                                 officer)

/s/Howard F. George              Chief Financial Officer    March 31, 1998
-----------------------------    (Principal financial
Howard F. George                 and accounting officer)


/s/Leonard M. Allenstein         Director                   March 31, 1998
-----------------------------
Leonard M. Allenstein

/s/Richard A. Alliegro           Director                   March 31, 1998
-----------------------------
Richard A. Alliegro

/s/Frank Edelstein               Director                   March 31, 1998
-----------------------------
Frank Edelstein

/s/Peter Beardmore               Director                   March 31, 1998
-----------------------------
Peter Beardmore

/s/Melvin A. Shader              Director                   March 31, 1998
-----------------------------
Melvin A. Shader

/s/Milton L. Lohr                Director                   March 31, 1998
-----------------------------
Milton L. Lohr

                                       55