<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, 2001

_    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. 000-13059

                                 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 4,
2002 was $69,482,960.

As of March 4, 2002, the number of shares of the registrant's Common Stock
outstanding was 8,456,205.

DOCUMENTS INCORPORATED BY REFERENCE:  None

<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. Forwarding-looking statements inherently are
subject to risks and uncertainties, some of which we cannot predict or quantify.
Our actual results may differ materially from the results projected in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed in "Item 1 - Business," including the
section therein entitled "Risk Factors," and in "Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations." You
generally can identify forward-looking statements by the use of forward-looking
terminology such as "believes," "may," "will," "expects," "intends,"
"estimates," "anticipates," "plans," "seeks," or "continues," or the negative
thereof or variations thereon or similar terminology.

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

Introduction

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

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

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

                                       1

<PAGE>

Industry Background

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

The following table compares certain favorable properties of selected advanced
technical ceramics commonly used by the Company with those of other selected
materials.

<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 excellent
plastics                   275 to 750          5 to 10    Good to 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 products that have emerged
from these advances are known as advanced technical (or structural) ceramics.

The properties of advanced technical ceramics present a compelling case for
their use in a wide array of applications. However, manufacturing costs
associated with the production of these materials need to be reduced in order to
accelerate the use of advanced technical ceramics as a direct replacement for
metals, plastics or other ceramics. A portion of these costs is related to the
need for diamond grinding finished components to exacting tolerances. Industry
cost reduction efforts have included the production of blanks or feed stock to
"near net shape" configurations, thus reducing the need for final finishing.
Manufacturers are also seeking to reduce costs through the use of high volume
automated processing and finishing equipment and techniques, and to achieve
economies of scale in areas such as powder processing, blank fabrication,
firing, finishing and inspection.

                                       2

<PAGE>

Ceradyne Strategy

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

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

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

                                       3

<PAGE>

<TABLE>
<CAPTION>
  ----------------------------------------------------------------------------------------------------------------------------------
       MARKET OPPORTUNITY                      TECHNICAL DEMANDS OF MARKET                     CERADYNE'S STRATEGIC RESPONSE
  ----------------------------------------------------------------------------------------------------------------------------------

                                                       INDUSTRIAL
  ----------------------------------------------------------------------------------------------------------------------------------
  <S>                                 <C>                                                  <C>
  Corrosion resistant non-oxide       The industry has historically used silicon metal,    Ceradyne is supplying high density and
  ceramics for use as semiconductor   quartz, and aluminum oxide ceramics to fabricate     high purity nitride and carbide ceramic
  equipment chamber components that   chamber components. Next generation equipment        components to the semiconductor wafer
  handle wafers.                      may have operating conditions that may deteriorate   processing equipment companies.
                                      currently used materials in some sections.           Ceradyne's R&D group is continually
                                                                                           working with semiconductor equipment
                                                                                           suppliers to tailor Ceradyne's ceramic
                                                                                           materials to meet new equipment
                                                                                           requirements.

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

                                                        DEFENSE
  ----------------------------------------------------------------------------------------------------------------------------------
  Lightweight armor for military      As tactical conflicts as well as terrorist and       Ceradyne has developed IMP/ACT(TM)
  personnel.                          other activities result in the increased use of      (Improved Multihit Protection/Advanced
                                      automatic weapons, it has become necessary to        Composite Technology) to improve the
                                      stop bullets as great as a .50 caliber machine       performance of Ceralloy(R) 546 (boron
                                      gun round. However, vests or other armor must        carbide) in body armor and other military
                                      be light enough in weight to allow freedom of        applications. Further research is focused
                                      movement without undue fatigue.                      on flexible armor solutions utilizing
                                                                                           Ceralloy(R) 146 (silicon carbide) and
                                                                                           Ceralloy(R) 147 (silicon nitride).

  Missile nose cones (radomes).       Next generation defensive missiles (Standard         The Company's advanced technical ceramic
                                      Missile Block IV and Block IVA and Patriot PAC-3)    radomes are designed to address demanding
                                      will be required to fly at extremely high            specifications of next generation missile
                                      velocities, tight turning radii, and severe          nose cones.
                                      weather conditions. These operating conditions
                                      may preclude the use of conventional polymer
                                      materials.

 Lightweight applique armor           The increased necessity for worldwide military       New armor development initiatives at
 for ground combat vehicles.          police actions and rapid response peacekeeping       Ceradyne are focused on a low cost,
                                      missions is driving the military vehicle             durable modular armor kit technology
                                      force to lightweight systems that are air            called Ramtech(TM)that can be added to
                                      transportable. These vehicles must provide           many different vehicles.  Multi-hit
                                      armor protection beyond their original design        protection is provided against 7.62mm,
                                      specification, which can only be met through         12.7mm and 14.5mm armor piercing
                                      the addition of lightweight modular armor            ammunition.
                                      applique.
  ----------------------------------------------------------------------------------------------------------------------------------

                                                     CONSUMER
  ----------------------------------------------------------------------------------------------------------------------------------
  Orthodontic brackets                Traditional stainless steel orthodontic              Ceradyne's Transtar translucent
                                      ceramic brackets are often considered                orthodontic brackets are inert, pick up
                                      unsightly.  Substitute clear plastic                 the color of the patient's teeth and
                                      materials can be weak and may stain.                 allow the orthodontist to correct the
                                      Some orthodontic patients prefer                     patient's bite.  The Company and its
                                      aesthetically pleasing brackets which                marketing partner, 3M/Unitek, introduced
                                      can be affixed to each tooth to support              an enhanced version of this ceramic
                                      the archwire.                                        bracket in 1996, which is marketed by
                                                                                           Unitek under the brand name "Clarity".
                                                                                           Shipments of orthodontic brackets in 2000
                                                                                           increased from the prior year period. The
                                                                                           Company has recently introduced a new
                                                                                           Clarity prescription known as "MBT".

  ----------------------------------------------------------------------------------------------------------------------------------

                                                     AUTOMOTIVE
  ----------------------------------------------------------------------------------------------------------------------------------
  Heavy duty diesel engine            In order to achieve diesel engine life               Ceradyne's Ceralloy(R) 147 SRBSN is a
  valve train components              of one million miles and automobile engine           candidate for a variety of engine
  and high-pressure fuel pump         life of over 125,000 miles without major             components including cam rollers, fuel
  components.                         maintenance, it may be necessary to replace          pump parts and other wear components.
                                      metal engine components with longer lasting,         The Company is in production of cam
                                      lighter weight, higher temperature resistant         rollers for diesel engines and rollers
                                      ceramic parts at acceptable unit costs.              for fuel pumps. Ceradyne continues
                                                                                           prototype development with a number of
                                                                                           engine and fuel systems manufacturers
                                                                                           worldwide to expand the application of
                                                                                           its cam roller products.
  ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                                        4

<PAGE>

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

Strategic Relationships

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

Ford Motor Company Joint Development Program. Ceradyne completed a series of
transactions with the Ford Motor Company ("Ford") in March 1986 with a long-term
objective of developing ceramic components for automobiles. Key to this venture
was the transfer of technology developed by Ford relating to technical ceramics,
including a portfolio of United States and corresponding foreign patents and
patent applications, and the investment by Ford of $10 million in the Company in
exchange for Common Stock which eventually resulted in an ownership interest in
Ceradyne of approximately 14.6%. Ford and the Company also entered into a joint
development program pursuant to which Ceradyne has been applying its experience
and expertise in technical ceramics to develop this technology into commercial
products with a view to eventually develop components for automobile engines.
The technology acquired from Ford and the efforts of this joint development
program have led to the development of Ceradyne's Ceralloy(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 a line of
components for use in diesel engines and fuel pumps. As of March 15, 2002 Ford's
ownership interest in Ceradyne is 12.2%.

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

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

                                        5

<PAGE>

Market Applications

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

                                     ------------------------------------
                                            Year Ended December 31,
                                     ------------------------------------
                                         2001        2000            1999
                                     ------------------------------------

      -------------------------------------------------------------------
      Industrial                          33%         34%            38%
      -------------------------------------------------------------------

      -------------------------------------------------------------------
      Defense                             29%         33%            21%
      -------------------------------------------------------------------

      -------------------------------------------------------------------
      Consumer                            18%         14%            18%
      -------------------------------------------------------------------

      -------------------------------------------------------------------
      Microwave Tube Products             17%         16%            21%
      -------------------------------------------------------------------

      -------------------------------------------------------------------
      Automotive                           3%          3%             2%
      -------------------------------------------------------------------

      -------------------------------------------------------------------
      TOTAL                              100%        100%           100%
      -------------------------------------------------------------------


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
making equipment, abrasive blasting nozzles as well as custom applications.

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

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

                                       6

<PAGE>

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

     Defense

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

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

On March 2, 1998, a U.S. government agency selected Ceradyne to provide certain
ceramic armor products over a multi-year period. The multi-year contract
provides for total orders over the 6 year life of the program which could exceed
$100 million. Through December 31, 2001, the Company has received production
orders under this program totaling $23 million. However, there can be no
assurances as to the exact quantities or deliveries under this program as the
government is not required to purchase any minimum amount and all orders are at
the full discretion of the government. Additionally, in 2001, Ceradyne received
further new firm orders for body armor products under a new contract worth in
excess of $13 million, all of which is scheduled to ship during the first seven
months of 2002.

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

                                       7

<PAGE>

     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(TM) brackets have been
positive. The Company believes Clarity(TM) brackets offer the orthodontist a
more robust product that will minimize treatment and chair time while providing
superior aesthetic appearance.

     Microwave Tube Products

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

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

Precision Ceramics. Ceradyne produces a wide variety of hot pressed Ceralloy(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, cleaner burning, more efficient and more durable engines for
heavy-duty diesel trucks and automobiles creates additional opportunities for
advanced technical ceramics. The Company believes that if engines could be
produced using certain advanced technical ceramic components, they could be
lighter and last longer than those using metal components, and could operate at
higher temperatures and pressures with reduced cooling and lubrication
requirements. As a result, engines would use less fuel, achieve more complete
combustion thereby reducing emissions, and be less costly to maintain. Because
of these potential benefits, industry wide efforts are being made to replace

                                       8

<PAGE>

selected metal components in heavy-duty diesel engines and fuel pumps with
advanced technical ceramic components.

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

Marketing and Customers

Each of Ceradyne's three manufacturing locations maintains an autonomous sales
and marketing force promoting their individual products. The Company has more
than 12 employees directly involved in marketing, including a marketing manager
located in the United Kingdom who was hired in February, 2000, and a sales
manager located in Beijing, China, who was hired in January 2001. The Company
also has agreements with manufacturers' representatives in the United States and
other countries who are compensated as a percent of sales in their territory.
Ceradyne is focusing much of its marketing effort outside the United States
through direct involvement of senior management personnel from the Company's
U.S. facilities in concert with local manufacturing representatives. Revenues
from export sales represented approximately 11% of total net sales in 1999, 13%
in 2000 and 16% in 2001.

Generally, the Company sells components to contractors or original equipment
manufacturers. To a lesser extent, Ceradyne sells its products directly to the
end user. The Company sells its translucent ceramic orthodontic brackets only to
3M/Unitek pursuant to an exclusive marketing agreement with that customer. Sales
to 3M/Unitek represented approximately 18% of total net sales in 1999, 14% in
2000, and 18% in 2001. See "Risk Factors--Sales of Our Ceramic Orthodontic
Brackets Depend on Our Exclusive Marketing and Sales Relationship with Unitek, a
Division of 3M Corporation."

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

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

                                       9

<PAGE>

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 (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, approximately 20
hours are required to perform this cycle. The resultant ceramic product
generally has mechanical, chemical and electrical properties of a quality
approaching that only theoretically obtainable. Almost all products are then
finished by diamond grinding to meet precise dimensional specifications.

Sintering of Fused Silica Ceramics. Sintering of fused silica ceramics is the
process Ceradyne uses to fabricate fused silica ceramic shapes for applications
in glass tempering furnaces, metallurgical tooling and other industrial uses. To
fabricate fused silica ceramic shapes, fused silica powders are made into
unfired shapes through slip casting or other ceramic compaction processes. These
unfired "green" shapes are fired as they move through a continuously operated
150 foot long tunnel kiln at temperatures up to 2500(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's SRBSN is based on
technology acquired from Ford. See "Strategic Relationships". This SRBSN process
begins with relatively inexpensive high purity elemental silicon (Si) powders,
which contrasts sharply with most other competitors' manufacturing techniques
which start with relatively more expensive silicon nitride (Si\\3\\N\\4\\)
powders.

                                       10

<PAGE>

After additives are incorporated by milling and spray drying, the silicon
powders are formed into shapes through conventional ceramic processing such as
dry pressing. These shapes are then fired in a nitrogen atmosphere which
converts the silicon part to a silicon nitride part. At this step (reaction
bonding), the silicon nitride is pressure sintered in an inert atmosphere
increasing the strength of the component threefold. As a result of SRBSN
processing, the ceramic crystals grow in an intertwining "needle-like" fashion
which the Company has named NeedleLokTM. Ceradyne's NeedleLokTM 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
3272(Degrees)F until the ceramics enter into a strong translucent condition.
These fired aesthetic brackets then have certain critical features diamond
ground into them. The final step is a proprietary treatment of the bonding side
in order to permit a sound mechanical seal when bound to the patient's teeth.

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

Fabrication of Samarium Cobalt Permanent Magnets. The fabrication of samarium
cobalt permanent magnets results in various magnet shapes which are primarily
used in microwave tube applications. The Company procures premixed samarium
cobalt powder either as 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 KevlarTM, 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. The
Company's Thermo Materials Division in Scottdale, Georgia received its ISO 9002
Certification in

** means plus or minus

                                       11

<PAGE>

1997. The Company's Advanced Ceramic Operations in Costa Mesa, California
received its ISO 9001 Certification in 1998.

Engineering and Research

Ceradyne's engineering and research efforts consist of applications engineering
in response to customer requirements, in addition to new materials and product
development performed by its Research and Development Department. These efforts
are directed toward the creation of new products, the modification of existing
products to fit specific customer needs, or the development of enhanced ceramic
process technology. The Company is also engaged in research to develop new
products. Costs associated with application engineering and research are
generally expensed as incurred and are included in cost of product sales, or in
Research and Development expense. Costs associated with research were
approximately $1,580,000 in 2001, $1,610,000 in 2000 and $878,000 in 1999. The
totals consist of $1,083,000, $1,252,000 and $597,000 from the Research and
Development Department, and $497,000, $358,000 and $281,000 from the Engineering
Department (included in cost of product sales) for the years ended December 31,
2001, 2000 and 1999, respectively.

Competition

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

Backlog

Ceradyne records an item as backlog when it receives a contract or purchase
order indicating the number of units to be purchased, the purchase price,
specifications and other customary terms and conditions. Ceradyne customarily
includes unexercised options as a separate item in its backlog because the
purchase orders are given on the basis of the total order, including options.
Total backlog as of December 31, 2001 was approximately $28.1 million,
consisting of $26.4 million of firm scheduled orders and $1.7 million of
unexercised options. As of December 31, 2000 total backlog approximated $26.7
million, consisting of $26.0 million of firm scheduled orders and $.7 million of
unexercised options. Typically, firm orders are scheduled to be shipped within
12 to 18 months from receipt of order.

                                       12

<PAGE>

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 "Risk
Factors--We May Be Adversely Affected If We Are Unable To Adequately Safeguard
Our Intellectual Property or If We Infringe Others' Intellectual Property."

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

In addition to the above, Ceradyne has been issued 18 U.S. patents and has 6
patents pending and has applied for corresponding foreign patents in various
foreign countries. The earliest of these patents expires in 2002.

"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)", "Netshape(R)", "Defender(R)", "NeedleLok(TM)", and
"Ramtech(TM)".

Employees

At December 31, 2001, Ceradyne employed approximately 463 persons versus 405 in
the prior year. Management considers its employee relations to be excellent. The
Company has not experienced difficulty in attracting personnel. None of the
Company's employees are represented by a labor union.

                                  RISK FACTORS

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

                                       13

<PAGE>

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

Recently we have experienced a substantial increase in orders for ceramic armor
vests for military personnel and for cam rollers for diesel engines. We
currently expect that demand for these products will require us to increase our
production of ceramic armor vests in 2002 by approximately four fold over 2001,
and increase production of cam rollers in 2002 by approximately ten fold over
2001. During 2001, we invested in capital expenditures to increase production
capacity for these two products, and we expect to make additional capital
expenditures in 2002 to further expand our capacity. Even with these additions
to production capacity there can be no assurance that we will be able to
manufacture the required quantities of these products in a timely manner or on a
profitable basis. In order to successfully satisfy customer demand for these
products while achieving acceptable profits, we must:

     .  Add manufacturing capacity and personnel;

     .  Achieve significant manufacturing cost reductions; and

     .  Improve product yields.

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

     We Must Successfully Develop and Market New Products; We Have Limited
Volume Manufacturing Experience for Products Under Development

Our future prospects will depend to a large extent on the success of products
which currently provide little revenue or which remain under development. These
products include:

     .  semiconductor equipment components;
     .  ceramic components for automobile engines.

The semiconductor industry has been flat for the past year; however, we are
supplying high density and high purity nitride and carbide ceramic components to
the semiconductor wafer processing equipment companies. Our Research and
Development group is continually working with semiconductor equipment suppliers
to tailor our ceramic materials to meet new equipment requirements.
Approximately 4% of our revenue for the year ended December 31, 2001 was derived
from advanced technical ceramic components shipped to semiconductor equipment
companies.

We are developing ceramic automotive engine components based on our belief that
a significant market for these products will emerge. However, predicting future
demand for such components is fraught with uncertainties. This is a new and
evolving market and advanced technical ceramics are

                                       14

<PAGE>

not currently used in any significant automobile applications. It is possible
that such applications will never emerge.

Even if a market emerges, our efforts to produce ceramic components for
automobile engines remain in an early stage. To successfully produce these
components, we must significantly lower manufacturing costs and develop high
volume manufacturing capabilities while maintaining component quality. If we
meet our production goals, it typically takes several years to introduce new
materials and components into production automobiles. Thus, demand for these
products and our ability to service such demand are subject to a high degree of
uncertainty.

     Failure to Manage Our Growth Could Adversely Affect Us

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

To effectively manage growth, we must:

    . add manufacturing capacity and personnel;
    . continue to implement and improve our operational, financial and
      management information systems;
    . develop the management skills of our managers and supervisors;
    . add new management personnel and improve the expertise of existing
      management personnel; and
    . train, motivate and manage our employees.

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

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

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

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

                                       15

<PAGE>

     The Advanced Technical Ceramics Markets Are Highly Competitive

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

   .  product performance;
   .  material specifications;
   .  application engineering capabilities;
   .  customer support;
   .  reputation; and
   .  price

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

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

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

     We Could Be Liable for Violations of Environmental Laws and Regulations

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

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

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

                                       16

<PAGE>

by insurance. Even if covered, the amount of insurance may be inadequate to
cover any adverse judgment.

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

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

We have a $28.1 million backlog of orders as of December 31, 2001. Of this
amount, approximately $11.1 million, or 40%, represents orders for defense
applications. These orders are closely tied to the level of U.S. defense
spending. Certain contracts for armor or radomes are directly or indirectly with
agencies of the United States government. Moreover, we anticipate that a
significant percentage of our revenues for the foreseeable future will derive
from direct or indirect sales to government agencies.

Under U.S. law, defense-related contracts may be canceled by the government for
convenience at any time and without cause. If that happens, we receive
reimbursement only for the expenses we actually incurred. Any such cancellations
could have material adverse effects on our business, operating results and
financial condition.

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

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

     We Depend on Our International Sales; We are Subject to Risks Associated
with Operating in International Markets

Shipments to customers outside of the United States accounted for approximately
11% of our sales in 1999, 13% in 2000, and 16% in 2001. We anticipate that
international shipments will account for a significant portion of our sales for
the foreseeable future. Therefore, the following risks associated with
international business activities could have material adverse effects on our
performance:

   .  burdens to comply with multiple and potentially conflicting foreign laws
      and regulations, including export requirements, tariffs and other
      barriers, health and safety requirements, and unexpected changes in any
      of the foregoing;

                                       17

<PAGE>

   .  difficulty in obtaining export licenses from the U.S. government;
   .  differences in intellectual property protections;
   .  longer accounts receivable payment cycles;
   .  potentially adverse tax consequences due to overlapping or differing tax
      structures;
   .  fluctuations in currency exchange rates; and
   .  risks associated with sales to foreign government agencies similar to the
      risks associated with dealing with U.S. government agencies.

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

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

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

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

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

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

Furthermore, there can be no assurance that our products or processes are not in
violation of the patent rights of third parties, or that any of our patents will
not be challenged, invalidated or circumvented. Although there are no pending or
threatened intellectual property lawsuits against

                                       18

<PAGE>

us, we may face litigation or infringement claims in the future. Infringement
claims could result in substantial costs and diversion of our resources even if
we ultimately prevail. A third party claiming infringement may also obtain an
injunction or other equitable relief, which could effectively block the
distribution or sale of allegedly infringing products. Although we may seek
licenses from third parties covering intellectual property that we are allegedly
infringing, we cannot guarantee that any such licenses could be obtained on
acceptable terms, if at all.

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

Item 2.  Properties
         ----------

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

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

<TABLE>
<CAPTION>
==============================================================================================

                    FACILITY LOCATION                          PRODUCTS
----------------------------------------------------------------------------------------------
<S>                                           <C>
  Advanced Ceramic Operations            . Semiconductor Equipment Components
  Costa Mesa and Irvine,  California     . Lightweight ceramic armor
    Approximately 126,000 square feet    . Orthodontic ceramic brackets
                                         . Ceralloy(R) 147 SRBSN wear parts
                                         . Precision ceramics
                                         . Ceralloy(R) 147 SRBSN diesel/automotive engine parts
                                         . Research and Development

----------------------------------------------------------------------------------------------

  Semicon Associates                     . Microwave ceramic-impregnated dispenser cathodes
  Lexington, Kentucky                    . Ion laser ceramic-impregnated dispenser cathodes
    Approximately 35,000 square feet     . Samarium cobalt magnets

----------------------------------------------------------------------------------------------

  Thermo Materials                       . Glass tempering rolls (fused silica ceramics)
  Scottdale, Georgia                     . Metallurgical tooling (fused silica ceramics)
    Approximately 85,000 square feet     . Missile radomes (fused silica ceramics)
                                         . Castable and other fused silica products
==============================================================================================
</TABLE>

                                       19

<PAGE>

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.

From October 1995 through November 2000, the Company, along with other
companies, was served with eight different complaints that were filed by eleven
former employees of one of the Company's customers, and eight spouses. The
complaints, all filed in the United States District Court, Eastern District of
Tennessee, alleged that the customers' employees contracted chronic beryllium
disease as a result of their exposure to beryllium-containing products sold by
Ceradyne and other companies. As of December 7, 2001, all of these cases had
been terminated without liability to Ceradyne; summary judgment in favor of
Ceradyne was granted in seven cases, and the other one case was dismissed
voluntarily by the plaintiff without prejudice to file the suit in the future.

On December 21, 2001, the Company was served with a complaint filed by the
Company's insurance carrier in the Superior Court of California in Santa Ana,
California. The complaint seeks a declaration that the Company is obligated to
reimburse the insurance carrier for defense expenses that the insurance carrier
has or will pay on behalf of the Company's prior lessor. The lessor was sued by
an employee of the Company alleging he contracted chronic beryllium disease
while employed at the lessor's facility in the 1980's. The Company's insurance
carrier has or will pay the lessor's defense costs under a reservation of rights
to seek reimbursement from the Company if it is determined by the Court that the
Company's insurance carrier is not obligated to pay.

The Company believes that the insurance carrier's claim is without merit and is
vigorously defending against this claim. The case is in the early stage of
discovery and no trial date has been set. The complaint does not state the
amount of legal expenses for which reimbursement is sought, but the Company
believes that the resolution of this matter will not have a material adverse
effect on the financial condition or operations of the Company.

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

         Not applicable.

                                       20

<PAGE>

                                   MANAGEMENT

Executive Officers of the Registrant.

     The executive officers of the Company as of March l5, 2002 are as follows:

           Name             Age                      Position
--------------------------  ---                      --------
Joel P. Moskowitz ........   62     Chairman of the Board, President and Chief
                                    Executive Officer
Earl E. Conabee ..........   64     Vice  President, and Director of Marketing
                                    at Thermo Materials
Howard F. George .........   57     Vice President Finance, Chief Financial
                                    Officer and Secretary
David P. Reed ............   47     Vice President, and General Manager of
                                    Advanced Ceramic Operations

     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.

     Howard F. George joined the Company in December 1995 and serves in the
positions of Vice President Finance, Chief Financial Officer, and Corporate
Secretary. 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. Prior to
the above, Mr. George has had management positions at Advanced Controls, Inc.,
Bausch & Lomb, Inc., and TRW, Inc. 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.

     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.

                                       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 December 31, 2001, the Company had approximately 426
record holders of its Common Stock.

                                        High                      Low
                                        ----                      ---
Year ended December 31, 2001
         First Quarter                  10.06                     6.63
         Second Quarter                  9.42                     6.95
         Third Quarter                   8.53                     6.45
         Fourth Quarter                 11.43                     8.10

Year ended December 31, 2000
         First Quarter                   9.88                     4.38
         Second Quarter                 11.75                     6.63
         Third Quarter                  10.50                     7.50
         Fourth Quarter                  9.50                     5.88


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, 2001 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>
                                                                       Years Ended December 31,
                                                                       ------------------------

                                                    2001         2000          1999           1998          1997
                                                    ----         ----          ----           ----          ----
<S>                                               <C>          <C>           <C>            <C>           <C>
Net sales                                         $45,339      $45,930       $30,382        $26,279       $28,693
Cost of product sales                              32,852       33,743        23,674         21,292        23,274
                                                  -------      -------       -------        -------       -------
Gross profit                                       12,487       12,187         6,708          4,987         5,419
                                                  -------      -------       -------        -------       -------

Operating expenses:
Selling                                             2,036        1,605         1,480          1,494         1,515
General and administrative                          4,897        4,456         3,400          3,239         3,660
Research and development                            1,083        1,252           597            344           ---
                                                  -------      -------       -------        -------       -------
                                                    8,016        7,313         5,477          5,077         5,175
                                                  -------      -------       -------        -------       -------
Income (loss) from operations                       4,471        4,874         1,231            (90)          244

Other income (expense):
Other income                                          392          357           344            382           265
Interest expense                                      (26)         (34)          (16)           ---          (134)
                                                  -------      -------       -------        -------       -------
                                                      366          323           328            382           131
                                                  -------      -------       -------        -------       -------
Income before provision (benefit) for
   income taxes                                     4,837        5,197         1,559            292           375
Provision (benefit) for income taxes                  808          104           (44)            10        (1,675)
                                                  -------      -------       -------        -------       -------
      Net income                                  $ 4,029      $ 5,093       $ 1,603        $   282       $ 2,050
                                                  =======      =======       =======        =======       =======

Basic net income per share                        $  0.48      $  0.62       $  0.20        $  0.04       $  0.26
                                                  =======      =======       =======        =======       =======
Diluted net income per share                      $  0.46      $  0.61       $  0.20        $  0.04       $  0.26
                                                  =======      =======       =======        =======       =======
Weighted average shares
   Outstanding--diluted                             8,713        8,395         8,189          8,068         8,035

<CAPTION>
Balance Sheet Data:                                                        December 31,
-------------------                                                        ------------

                                                   2001          2000          1999          1998           1997
                                                   ----          ----          ----          ----           ----
<S>                                               <C>          <C>           <C>            <C>           <C>
Working capital                                   $23,167      $20,883       $15,156        $15,051       $15,327
Total assets                                       47,951       38,463        32,893         29,493        29,017
Long-term obligations                                 158          258           358            ---           ---
Stockholders' equity                              $39,657      $34,989       $29,137        $27,352       $26,760
</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,
semiconductor, and defense applications.

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 expensed as incurred.

The Company is in the process of experiencing significant volume increases at
Advanced Ceramic Operations in Costa Mesa, California. Facility expansion and
the increases in production personnel will put pressure on gross profit margins
in the start-up period, particularly the first quarter of 2002.

Results of Operations

The percentage relationships to net sales of certain income and expense items
for the three years ended December 31, 2001, 2000 and 1999 are contained in the
following table.

                                                    Years Ended December 31
                                                    -----------------------
                                              2001          2000           1999
                                              ----          ----           ----
Net sales                                    100.00%       100.00%       100.00%
Cost of product sales                         72.46         73.47         77.92
                                            -------       -------       -------
Gross profit                                  27.54         26.53         22.08
                                            -------       -------       -------

Operating expenses:
Selling                                        4.49          3.49          4.87
General & administrative                      10.80          9.70         11.19
Research & Development                         2.39          2.73          1.97
                                            -------       -------       -------
                                              17.68         15.92         18.03
                                            -------       -------       -------

Income  from operations                        9.86         10.61          4.05
Other income                                    .86           .78          1.14
Interest expense                               (.05)         (.07)         (.05)
                                            -------       -------       -------

Income before provision
  for income taxes                            10.67         11.32          5.14
Provision (benefit) for income taxes           1.78           .23          (.14)
                                            -------       -------       -------

Net income                                     8.89%        11.09%         5.28%
                                            =======       =======       =======

                                       24

<PAGE>

Years Ended December 31, 2001 and 2000

Net Sales. Net sales for the year ended December 31, 2001 were $45.3 million, a
decrease of $.6 million, or 1.3% compared to the prior year.

Advanced Ceramic Operations in Costa Mesa, California, had a decrease in sales
for the year ended December 31, 2001 of $.2 million as compared to the year ago
period. The sales decrease was mainly in ceramic armor for defense customers due
to the delay of armor vest orders, which were not received until late in the
fourth quarter. Also, sales of semiconductor products decreased from the prior
year because of the downturn in this industry. However, these sales decreases
were nearly offset by growth in orthodontic products due to an increasing demand
by orthodontists for our translucent ceramic brackets. Also, sales increased for
the Research and Development contracts awarded by the Department of Defense over
the prior year.

The Company's Semicon Associates Division in Lexington, Kentucky, posted a sales
increase of $.5 million. Increases were mainly due to demand by the Company's
customers for dispenser cathodes, which are used in microwave tubes for radar
and satellite communications. In addition, sales increases were due to modest
price increases and a contract award from the Department of Defense.

Additionally, the Company's Thermo Materials Division in Scottdale, Georgia,
posted a sales decrease of $.9 million as compared to the prior year period. The
decrease in sales was mainly caused by less demand for fused silica products due
to downsizing domestically by the glass, steel and aluminum making industries.

International sales have been, and are expected to be, an important part of the
Company's business, representing 16% of total sales for the year ended 2001 as
compared to 13% in 2000. The reasons for the increase were due to the Company's
relatively new sales efforts in England and China, and increases in armor
components for Israel.

Gross Profit. The Company's gross profit was $12.5 million, or 28% of net sales,
for the year ended December 31, 2001, compared to $12.2 million, or 27% of net
sales, for the prior year. The increase in gross profit for the year ended
December 31, 2001 as compared to the prior year was $.3 million or 2%.

The Company's Advanced Ceramic Operations in Costa Mesa, California, posted
gross profit of $9.2 million compared to $8.4 million, or a 10% increase over
the prior year. The favorable results were mainly due to higher volume of parts
and higher capacity utilization resulting in economies of scale. However, the
Company recently leased a new facility containing approximately 41,000 square
feet, most of which will be used for manufacturing, and it will take time to
absorb this additional capacity and realize the same level of economies of scale
as were achieved in 2001. Moreover, the Company is experiencing poor product
yields and other manufacturing inefficiencies as production capacities are being
increased to meet rising demand for personal armor and diesel engine components.
Consequently, gross profit margins are expected to decrease in the first six
months of 2002 as compared to 2001, but gradually improve thereafter. However,
gross profit dollars are expected to be higher in 2002 as compared to 2001
because of increases in sales volume.

                                       25

<PAGE>

Semicon Associates in Lexington, Kentucky, posted gross profit of $2.4 million,
compared to $1.7 million, or a 41% increase over the prior year. The increase
over the prior year is attributed to better quality and process control and
greater capacity utilization and is being partially funded by a contract
award from the Department of Defense. The mission of this Department of Defense
Production Act Title III Program is to create assured, affordable and
commercially viable production capabilities for items essential for national
defense. Additionally, modest price increases were contributing factors. The
Company expects the trend of gross profit as a percent of sales to stabilize.

Thermo Materials in Scottdale, Georgia, posted gross profit of $.9 million,
compared to $2.1 million, or a 57% decrease over the prior year. The decreases
were attributable to lower production volume and to a process control problem in
fused silica products. The process control concern has subsequently been
corrected by diligent testing of raw materials.

Selling Expenses. Selling expenses were $2.0 million for the year ended December
31, 2001, as compared to $1.6 million in the prior year. Salary and personnel
increases, commissions and travel account for the increased selling expenses.

General and Administrative Expenses. General and administrative expenses were
$4.9 million for the year ended December 31, 2001, a $.4 million increase from
the prior year. Salary and personnel increases accounted primarily for the
increased expenses.

Research and Development Expenses. Research and development expenses were
approximately $1.1 million for the year ended December 31, 2001, as compared to
$1.3 million for the prior year. The expenses incurred for both years are
related to wages for engineering, technicians and production personnel,
materials, outside services, small tools and travel. Approximately $.9 million
of Research and Development cost is in Cost of Sales due to Small Business
Innovation Research (SBIR) grants, which are recorded as sales.

In addition, the Company historically has and continues to engage in application
engineering and internally funded research to improve and reduce the cost of
production and to develop new products. The costs associated with application
engineering and research are expensed as incurred and are included in cost of
product sales.

Other Income. Other income was $392,000 and $357,000 for the years ended 2001
and 2000, respectively. An increase in royalty income over the prior year due to
greater demand for orthodontic brackets and miscellaneous scrap income was
partially offset by a decrease in interest income due to less cash reserves.

Interest Expense. Interest expense was $26,000 for the year ended December 31,
2001, compared to $34,000 in the prior year.

Income Taxes. The Company made a fourth quarter year-to-date adjustment to its
tax provision based upon the pre-tax income for the full year of 2001. The
Company used a combined Federal and State tax rate of 16.7% for the twelve
months ended December 31, 2001, resulting in a provision for taxes of $808,000.
Because the Company used an estimated combined tax rate of 25% for the nine
months ended September 30, 2001, which resulted in a tax provision of
$1,034,000, the Company reported a tax provision credit in the fourth quarter of
$226,000. The decrease in the tax provision was the result of decreasing gross
profit in the fourth quarter, mainly

                                       26

<PAGE>

from the tardiness in armor orders received late in the fourth quarter for
Advanced Ceramic Operations.

Net Income. Reflecting all of the matters discussed above, net income was $4.0
million (or $0.48 per share basic and $0.46 diluted) for the year ended December
31, 2001 compared to a net income of $5.1 million (or $.62 per share basic and
$.61 per share diluted) for the prior year.

Years Ended December 31, 2000 and 1999

Net Sales. Net sales for the year ended December 31, 2000 were $45.9 million, an
increase of $15.5 million, or 51% compared to the prior year.

The increase in sales was primarily attributable to the Company's Advanced
Ceramic Operations in Costa Mesa, California. This increase was approximately
$13.4 million over the prior year. The major increase was in armor products due
to increasing demand for protective body armor by the U.S. military services.
The industrial/automotive products recorded strong increases in sales, mainly
due to demand for ceramic cam rollers for diesel engines. Additionally,
orthodontic products contributed to the increase over the prior year due to
continually increased demand by orthodontists for the Clarity(TM) orthodontic
brackets.

The Company's Semicon Associates Division in Lexington, Kentucky, posted a sales
increase of $.8 million, or 13% over the prior year. Increases were mainly due
to demand by the Company's customers for dispenser cathodes, which are used in
microwave tubes for radar and satellite communications. In addition, sales
increases were due to modest price increases.

Additionally, the Company's Thermo Materials Division in Scottdale, Georgia,
posted a sales increase of $1.3 million, or 22% over the prior year. The
increases were attributable to demand from a major customer because of their low
fused silica inventory. Also contributing was an increase in demand from
existing and new customers for the fused silica product line that the Company
acquired from Harbison Walker Refractories Company in 1998. There were slight
increases in the defense sector for ceramic missile radomes for the Patriot
PAC-3 and Standard Missile Block IV and Block IVA programs. Furthermore, a new
product line for high purity fused silica ceramic crucibles for melting silicon
for incorporation into photovoltaic cells for energy production had slight sales
increases over the prior year initial startup.

International sales have been, and are expected to be, an important part of the
Company's business, representing 13% of total sales for the year ended 2000 as
compared to 11% in 1999. In April 2000, the Company opened a European sales and
marketing office located in England and hired a new European marketing director.
Also, in January 2001, the Company opened its sales and marketing office in
Beijing, China and hired a new director for this location.

Gross Profit. The Company's gross profit was $12.2 million, or 27% of net sales,
for the year ended December 31, 2000, compared to $6.7 million, or 22% of net
sales, for the prior year. The increase in gross profit for the year ended
December 31, 2000 as compared to the prior year was $5.5 million or 82%.

The Company's Advanced Ceramic Operations in Costa Mesa, California, posted
gross profit of $8.4 million compared to $4.2 million, or a 100% increase over
the prior year. The favorable

                                       27

<PAGE>

results were mainly due to higher volume and higher capacity utilization
resulting in economies of scale.

Semicon Associates in Lexington, Kentucky, posted gross profit of $1.7 million,
compared to $1.1 million, or a 55% increase over the prior year. The increase
over the prior year is attributed to higher volume and greater capacity
utilization. Additionally, price increases and improvements in production yields
were contributing factors.

Thermo Materials in Scottdale, Georgia, posted gross profit of $2.1 million,
compared to $1.4 million, or a 50% increase over the prior year. The increases
were attributable to volume and the product mix of larger quantities yielding
better manufacturing efficiencies than in the prior year.

Selling Expenses. Selling expenses were $1.6 million for the year ended December
31, 2000, as compared to $1.5 million in the prior year. Increases in salaries,
travel expenses, product literature, consulting, and the addition of a new
marketing director in the United Kingdom contributed to the increase in selling
expenses over the prior year.

General and Administrative Expenses. General and administrative expenses were
$4.5 million for the year ended December 31, 2000, a $1.1 million increase from
the prior year. Approximately 42% of the increase was attributable to the
increase in employee bonuses which was charged to general and administrative
expense. Bonuses were resumed in the year 2000 because of the increased
profitability of the Company. The other increases involved two additional
personnel at the Thermo Materials division, investor relations consulting fees,
salary increases and fringe benefits.

Research and Development Expenses. Research and development expenses were
approximately $1.3 million for the year ended December 31, 2000, as compared to
$.6 million for the prior year. The expenses incurred for both years are related
to wages for engineering, technicians and production personnel, materials,
outside services, small tools and travel. The increased expenses over the prior
year are directly related to the Company being awarded $2.4 million in Small
Business Innovation Research (SBIR) grants in 2000 for military ceramic armor
systems and microwave ceramics.

In addition, the Company historically has and continues to engage in application
engineering and internally funded research to improve and reduce the cost of
production and to develop new products. The costs associated with application
engineering and research are expensed as incurred and are included in cost of
product sales.

Other Income. Other income was $.36 million and $.34 million for the years ended
2000 and 1999, respectively. An increase in interest income over the prior year
due to greater cash reserves was offset by a decrease in royalty income.

Interest Expense. Interest expense was $34,000 for the year ended December 31,
2000, compared to $16,000 in the prior year. The increase was caused by having a
capital equipment loan in place for the full year in 2000, as compared to
partial year in 1999.

Income Taxes. The Company has recorded a $104,000 provision for income tax for
the year ended December 31, 2000. The Company's net deferred tax asset of $1.7
million at December 31, 2000 relates primarily to its tax net operating loss
carryforwards, which total approximately $5.2 million.

                                       28

<PAGE>

The Company expects to use its remaining net operating loss carryforward in
2001. (See Note 3 of Notes to Consolidated Financial Statements).

Net Income. Reflecting all of the matters discussed above, net income was $5.1
million (or $0.62 per share basic and $0.61 diluted) for the year ended December
31, 2000 compared to a net income of $1.6 million (or $.20 per share basic and
diluted) for the prior year.

Accounting Policies

Our significant accounting policies are summarized in Note 1 to the Consolidated
Financial Statements. In applying those policies, estimates and judgments affect
the amounts at which accounts receivable and inventory and certain liabilities
are recorded and the useful lives of property and equipment.

We apply our accounting policies on a consistent basis. As circumstances change,
they are considered in our estimates and judgments, and future changes in
circumstances could result in changes in amounts at which assets and liabilities
are recorded. They could also affect the estimated useful levels of property and
equipment, which could result in changes in depreciation expense or write offs
or write downs of such assets.

Liquidity and Capital Resources

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

The Company has a $4,000,000 revolving credit agreement with Comerica Bank. As
of December 31, 2001, there had been no borrowings under this credit facility.
However, in the first quarter of 2002, the credit line was used for operation
needs. Under a separate credit facility with Comerica Bank, the Company entered
into a $500,000 capital equipment loan agreement during the third quarter of
1999. The term of the loan is for 60 months with no prepayment penalty and as of
December 31, 2001, this loan balance is $258,000.

The Company's net cash balance decreased by $5.6 million during the year ended
December 31, 2001, compared to a net increase of $5.2 million in the prior year.
The largest component of this change was the Company's investment of $7.0
million in machinery, equipment and leasehold improvements in 2001, compared to
$2.4 million in 2000, to expand production capacity, primarily at the Company's
Advanced Ceramic Operations in Costa Mesa, California. Another major use of cash
was $6.4 million increase in inventories in 2001, compared to the prior year
period, as the Company manufactured products and has raw materials and
work-in-process for production orders to be shipped in the first quarter of
2002.

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 facilities, will be sufficient to finance anticipated capital and
operating requirements for at least the next 12 months.

                                       29

<PAGE>

New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at their fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction and, if it is, the type of hedge transaction. In June 1999,
the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133". SFAS No.
137 delays the effective date of SFAS No. 133 to fiscal years beginning after
June 15, 2000. In June 2000, the FASB issued SFAS No. 138, "Accounting for
Certain Derivative Instruments and Certain Hedging Activities - an amendment of
FASB Statement No. 133". SFAS No. 138 is effective concurrent with the delayed
effective date of SFAS No. 133. SFAS No. 138 amends the accounting and reporting
standards for certain derivative instruments and certain hedging activities. The
Company adopted SFAS Nos. 133, 137 and 138 on January 1, 2001. The adoption did
not have a material impact, as the Company does not currently hold any
derivative instruments.

In June 2001, the FASB issued SFAS No. 141, "Business Combinations". This
Statement addresses financial accounting and reporting for business combinations
and supersedes APB Opinion No. 16, "Business Combinations," and SFAS No. 38,
"Accounting for Preacquisition Contingencies of Purchased Enterprises". All
business combinations in the scope of this Statement are to be accounted for
using one method, the purchase method. We will adopt SFAS 141 for all business
combinations initiated after June 30, 2001.

Also in June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets and supersedes APB Opinion No. 17,
"Intangible Assets". This pronouncement addresses, among other things, how
goodwill and other intangible assets should be accounted for after they have
been initially recognized in the financial statements. Goodwill would no longer
be amortized but would be assessed at least annually for impairment using a fair
value methodology. We will adopt this statement for all goodwill and other
intangible assets acquired after June 30, 2001 and for all existing cost in
excess of net assets acquired (goodwill) and other intangible assets beginning
January 1, 2002. Upon adoption of this standard on January 1, 2002, we will
cease recording amortization of goodwill, which is expected to increase gross
income in 2002 by approximately $200,000, or approximately $0.01 per diluted
share after tax. Other than ceasing the amortization of goodwill, we do not
anticipate that the adoption of SFAS 142 will have a significant effect on our
financial position nor the results of our operations, as we do not currently
anticipate any impairment charges for existing goodwill.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 addresses the financial accounting
and reporting for the impairment of long-lived assets and for long-lived assets
to be disposed of and is effective for fiscal years beginning after December 15,
2001. This statement supersedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of"; however, it
retains the fundamental provision of SFAS No. 121 for (i) recognition and
measurement of the impairment of long-lived assets to be held and used and (ii)
measurement of long-lived assets to be disposed of by sale. This statement also
supersedes the accounting and reporting provisions of

                                       30

<PAGE>

APB Opinion No. 30, "Reporting the Results of Operations--Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for the disposal of a segment of
a business. The Company does not believe SFAS No. 144 will have a material
impact on the Company's financial position or results of operations.

Item 7A. Quantitative and Qualitative Disclosure About Market Risk
         ---------------------------------------------------------

The Company is exposed to market risks related to fluctuations in interest rates
on its debt. Currently, the Company does not utilize interest rate swaps,
forward or option contracts on foreign currencies or commodities, or other types
of derivative financial instruments. The purpose of the following analysis is to
provide a framework to understand the Company's sensitivity to hypothetical
changes in interest rates as of December 31, 2000. Many of the statements
contained in this section are forward looking and should be read in conjunction
with the Company's disclosures under the heading "Risk Factors".

The Company utilized debt financing during 2001 primarily for the purpose of
acquiring manufacturing equipment. For fixed rate debt, changes in interest
rates generally affect the fair market value of the debt instrument, but not the
Company's earnings or cash flows. The Company does not have an obligation to
prepay fixed rate debt prior to maturity, and as a result, interest rate risk
and changes in fair market value should not have a significant impact on the
fixed rate debt until the Company would be required to refinance such debt. The
fair market value estimates for debt securities are based on discounting future
cash flows utilizing current rates offered to the Company for debt of the same
type and remaining maturity.

As of December 31, 2001, the Company's debt consisted of a $258,000 capital
equipment loan at a fixed interest rate of 8.18% due July 28, 2004. The carrying
amount is a reasonable estimate of fair value as the rate of interest paid on
the note approximates the current rate available for financing with similar
terms and maturity.

We do not have any significant foreign currency risk. Sales to foreign
distributors are all denominated in U.S. dollars.

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

The Consolidated Financial Statements and Supplementary Data commence at page 47
of this report and an index thereto is included in Part IV, Item 14 of this
report on page 42.

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

Not applicable.

                                       31

<PAGE>

                                    PART III

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

     Information regarding executive officers of the Company is included in Part
I of this report.

     The Directors of the Company are as follows:

                Name                  Age               Position
                -----                 ---               --------
         Joel P. Moskowitz ........    62   Chairman of the Board, President and
                                            Chief Executive Officer
         Richard A. Alliegro ......    71   Director
         Eduard Bagdasarian .......    37   Director
         Frank Edelstein ..........    76   Director
         Wilford D. Godbold, Jr. ..    62   Director
         Christopher Johnson ......    36   Director
         Milton L. Lohr ...........    76   Director

     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 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.

     Richard A. Alliegro has served on the Board of Directors of the Company
since 1992. Mr. Alliegro retired from Norton Company in 1990 after 33 years,
where his last position was Vice President, Refractories and Wear, for Norton's
Advanced Ceramics operation. He served as President of Lanxide Manufacturing
Co., a subsidiary of Lanxide Corporation, from May 1990 to February 1993. Mr.
Alliegro currently is the owner of AllTec Consulting, Inc., a ceramic technology
consulting firm. Mr. Alliegro obtained B.S. and M.S. degrees in Ceramic
Engineering from Alfred University in 1951 and 1952, respectively, and serves as
a member of the Board of Trustees of that university.

     Eduard Bagdasarian was appointed to the Board of Directors on February 25,
2002 to fill the vacancy created by the resignation of Leonard Allenstein. He is
Managing Director and Chief Operating Officer of the investment banking firm of
Barrington Associates, where he has been employed since 1989. Mr. Bagdasarian
chairs Barrington Associates' Executive Committee and serves on its Board of
Directors. Mr. Bagdasarian is a registered General and Financial Principal with
the NASD. He is a graduate of UCLA with a degree in Business/Economics.

     Frank Edelstein has served on the Board of Directors of the Company since
1984. Mr. Edelstein has been a Vice President of Stone Creek Capital, Inc., an
investment banking firm, since November 1986. From 1979 to November 1986, he was
Chairman of the Board of International Central Bank & Trust Company, which was
acquired by Continental Insurance Co. in July 1983. Mr. Edelstein is currently a
director of Arkansas Best Corp. and IHOP Corp.

                                       32

<PAGE>

     Wilford D. Godbold, Jr. has been a member of the Board of Directors of the
Company since July 2000. Mr. Godbold is currently a private investor. From 1982
to 1998, Mr. Godbold was employed by Zero Corporation, a manufacturer of
packaging systems for the electronics industry, where he served as President and
Chief Executive Officer from 1984 to 1998. From 1966 to 1982, he was engaged in
the private practice of law with Gibson Dunn & Crutcher, specializing in mergers
and acquisitions, corporate finance and general corporate law. Mr. Godbold holds
an A.B. degree in Political Science from Stanford University, and a J.D. from
UCLA Law School. Mr. Godbold is a director of Sempra Energy and K2, Inc.

     Christopher Johnson was appointed to the Board of Directors on February 25,
2002 to fill the vacancy created by the resignation of Paul Blumberg, Ford's
previous representative on Ceradyne's Board. Mr. Johnson is Technology Venture
Fund Manager of Ford Motor Company. Mr. Johnson manages Ford Motor Company's
strategic venture capital fund and has led various financial transactions
involving third parties, and is involved with Ford-related venture technology
concepts. Mr. Johnson has worked for Ford Motor Company since 1998. Prior to
Ford Motor Company, Mr. Johnson worked for Aeroquip Corporation for eleven years
as Director of New Business Planning. Mr. Johnson is on the Board of Directors
of several technology companies where Ford has an investment. He has a degree in
Business Administration from the University of Toledo and an MBA from the
University of Michigan with emphasis in international business and strategy.

     Milton L. Lohr served as a Director of the Company from 1986 until October
1988, when he resigned to accept a position as Deputy Undersecretary of Defense
for Acquisitions. He held that position until May 1989 and was re-elected as a
Director of the Company in July 1989. Mr. Lohr is currently a partner of L. F.
Global Investments, LLC, a San Diego based financial institution with activities
in money management funds, venture capital and asset management coupons. He
served as the first Deputy Under Secretary for Acquisitions in both the Reagan
and Bush administrations, with responsibility to assist in overseeing the
Department of Defense's major acquisition programs as well as exercising
oversight of international programs and U.S. Arms Control Compliance activities.
He also served as U.S. Acquisition Representative to the NATO Conference of
National Armament Directors and provided leadership guiding U.S. armament
cooperative programs, and in developing and establishing policy initiatives
aimed at promoting cooperation on major weapon systems and technology among the
NATO Allies. He also served on the Four Power Group with members from the U.K.,
France, Germany and the U.S. Mr. Lohr previously held the position of President
of Defense Development Corporation, a defense-related research and development
company from 1990 to 1993. Mr. Lohr also held the position of Senior Vice
President of Titan Systems, a defense-related research and development company,
from 1986 to 1988, and was founder and CEO of Defense Research Corporation, a
defense consulting firm, from 1983 to 1986. Mr. Lohr served from 1969 to 1983 as
Executive Vice-President of Flight Systems, Inc., a firm engaged in aerospace
and electronic warfare systems. Mr. Lohr has over thirty-five years experience
in government positions and aerospace and defense management. He currently
serves as a panel member of the President's Science Advisory Committee, a member
of the Office of the Secretary of Defense, Army Science Board, as well as other
ad hoc government related assignments.

Directors are elected annually and hold office until the next annual meeting of
stockholders and until their successors have been elected and qualified. The
Company has agreed to nominate a representative of Ford for election as a
Director pursuant to an agreement made in March 1986, pursuant to which
agreement Ford acquired a total of 1,207,299 shares of the Company's Common
Stock. Joel P. Moskowitz and members of his family have agreed to vote a portion
of their shares

                                       33

<PAGE>

of the Company's Common Stock, if necessary, for the election of Ford's nominee.
Mr. Christopher Johnson is Ford's current representative. Officers serve at the
discretion of the Board of Directors. Compliance with Section 16(a) of the
Securities Exchange Act of 1934

     Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file with the Securities
and Exchange Commission ("SEC") initial reports of ownership and reports of
changes in ownership of Common Stock and other equity securities of the Company.
Officers, directors and greater than ten percent shareholders are required by
SEC regulations to furnish the Company with copies of all Section 16(a) forms
they file.

     To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company and written representations that no other
reports were required during the fiscal year ended December 31, 2001, its
officers, directors and greater than ten percent beneficial owners complied with
all Section 16(a) filing requirements.

                                       34

<PAGE>

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

Summary Compensation Table
--------------------------

The following table shows certain information concerning the compensation of the
Chief Executive Officer and the other most highly compensated executive officers
of the Company whose aggregate compensation for services in all capacities
rendered during the year ended December 31, 2001 exceeded $100,000
(collectively-the "Named Executive Officers"):



                                                                    Long Term
                                      Annual Compensation         Compensation
                                      -------------------         ------------
                                                                   Securities
Name &                                                             Underlying
-------                                                             Options
Principal Position               Year       Salary       Bonus    # of Shares)
------------------               ----       ------       -----    ------------

Joel P. Moskowitz                2001      $274,923     $48,915       50,000
Chairman of the Board,           2000       259,000      51,970            -
Chief Executive                  1999       240,085      16,027            -
Officer
and President



Earl E. Conabee                  2001      $118,540           -        2,500
Vice President                   2000       113,000           -        2,000
                                 1999       106,872           -            -


Howard F. George                 2001      $117,193     $ 8,856        2,500
Vice President and               2000       104,327       8,545        2,000
ChiefFinancial Officer           1999       101,062           -            -



David P. Reed                    2001      $151,846     $41,985        5,000
Vice President                   2000       143,000      37,905       10,000
                                 1999       132,919           -       10,000

                                       35

<PAGE>

Option Grants in Last Fiscal Year
---------------------------------

      The following table sets forth certain information concerning grants of
options to each of the Named Executive Officers during the year ended December
31, 2001. In addition, in accordance with the rules and regulations of the
Securities and Exchange Commission, the following table sets forth the
hypothetical gains or "option spreads" that would exist for the options. Such
gains are based on assumed rates of annual compound stock appreciation of 5% and
10% from the date on which the options were granted over the full term of the
options. The rates do not represent the Company's estimate or projection of
future Common Stock prices, and no assurance can be given that any appreciation
will occur or that the rates of annual compound stock appreciation assumed for
the purposes of the following table will be achieved.

<TABLE>
<CAPTION>
                                                                                             Potential Realizable
                                                                                           Value at Assumed Annual
                                            Percent of                                       Rates of Stock Price
                                            Total Options                                       Appreciation for
                                            Granted to         Exercise                         Option Term/(2)/
                       Options Granted      Employees in         Price      Expiration        ----------------
Name                   (# of Shares)/(1)/   Fiscal Year       ($/Share)        Date          5%($)          10%($)
----                   ------------------   -----------       ---------        ----          -----          ------
<S>                    <C>                  <C>               <C>           <C>            <C>             <C>
Joel P. Moskowitz           50,000             29.5%             6.70        09/06/11       210,680        533,904
Earl E. Conabee              2,500              1.5%             6.70        09/06/11        10,534         26,696
Howard F. George             2,500              1.5%             6.31        12/20/10         9,921         25,141
David P. Reed                5,000              3.0%             6.70        09/06/11        21,068         53,390
</TABLE>

________________
/(1)/    The per share exercise price of all options granted is the fair market
         value of the Company's Common Stock on the date of grant. Options have
         a term of 10 years and become exercisable in five equal installments,
         each of which vests at the end of each year after the grant date,
         except that the option granted to Mr. Moskowitz became fully vested
         three months after the date of grant.

/(2)/    The potential realizable value is calculated from the exercise price
         per share, assuming the market price of the Company's Common Stock
         appreciates in value at the stated percentage rate from the date of
         grant to the expiration date. Actual gains, if any, are dependent on
         the future market price of the Common Stock.

                                       36

<PAGE>

Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
--------------------------------------------------------------------------
Values
------

         The following table sets forth certain information regarding option
exercises during the year ended December 31, 2001 by the Named Executive
Officers, the number of shares covered by both exercisable and unexercisable
options as of December 31, 2001 and the value of unexercised in-the-money
options held by the Named Executive Officers as of December 31, 2001:

<TABLE>
<CAPTION>
                                                                                                  Value of Unexercised
                                                        Number of Securities Underlying          In-the-Money Options at
                                                     Unexercised Options at Fiscal Year-End       Fiscal Year-End /(1)/
                                                     --------------------------------------       ---------------------
                       No. of Shares
                        Acquired on      Value
        Name             Exercise     Realized/(2)/   Exercisable             Unexercisable    Exercisable    Unexercisable
        ----             --------     ------------    -----------             -------------    -----------    -------------
<S>                    <C>             <C>           <C>                      <C>              <C>           <C>
Joel P. Moskowitz           ---            ---          50,000                      ---         $228,500         $    ---
Earl E. Conabee             ---            ---           2,000                     5,700        $ 10,015         $ 18,523
Howard F. George            ---            ---          29,300                     5,200        $185,629         $ 17,966
David P. Reed               ---            ---          53,300                    24,700        $405,923         $110,755
</TABLE>


/(1)/  Based upon the closing price of the Common Stock on December 31, 2001, as
       reported by the Nasdaq National Market ($11.27 per share).

/(2)/  Represents the closing sale price of the Common Stock on the date of
       exercise, less the exercise price per share, multiplied by the number of
       shares acquired.

                                       37

<PAGE>

Compensation of Directors
-------------------------

     Directors are paid fees for their services on the Board of Directors in
such amounts as are determined from time to time by the Board. During 2001, a
fee of $500 per month plus $1,000 for each Board meeting attended was paid to
each non-employee director other than the Ford representative, who did not
receive a fee.

     In addition, non-employee directors, other than the Ford representative,
receive stock options from time-to-time under the Company's 1994 Stock Incentive
Plan. During 2001, options to purchase 5,000 shares were granted to each of
Messrs. Allenstein, Alliegro, Bagdasarian, Edelstein, Godbold and Lohr. Each
option vests in full three months after the date of grant, has a term of 10
years, and an exercise price equal to the fair market value of the Common Stock
on the date of grant.

Compensation Committee Interlocks and Insider Participation
-----------------------------------------------------------

     The Board of Directors has established Audit and Compensation Committees.
The Compensation Committee's function is to review and make recommendations to
the Board regarding executive officers' compensation. This committee is composed
of Messrs, Edelstein, Alliegro, and Lohr. The Audit Committee meets with the
Company's independent public accountants and with management to review the
Company's financial statements, the scope of the annual audit, internal
accounting controls, and recommends to the Board the selection of the
independent public accountants. This committee is composed of Messrs, Alliegro,
Edelstein, Godbold and Lohr.

                                       38

<PAGE>

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

     The following table sets forth information as of March 15, 2002 regarding
the beneficial ownership of the common stock of the Company by (i) each person
or group known by the Company to be the beneficial owner of more than 5% of the
outstanding shares of common stock, (ii) each of the directors of the Company,
(iii) each of the executive officers named in the Summary Compensation Table,
and (iv) all current executive officers and directors of the Company as a group.

                 Name of                Amount and Nature of          Percent
             Beneficial Owner          Beneficial Ownership/(1)/      of Class
             ----------------          -------------------------      --------

Joel P. Moskowitz                                   1,213,110  /(2)/    14.4%
3169 Redhill Avenue
Costa Mesa, CA 92626

Ford Motor Company                                  1,027,300           12.2%
The American Road
Dearborn, MI 48121

Dimensional Fund Advisors, Inc.                       562,500  /(3)/     6.7%
1299 Ocean Ave., 11/th/ Floor
Santa Monica, CA 90401

Pequot Capital Management, Inc.                       499,000  /(4)/     5.9%
500 Nyala Farm Rd.
Westport, CT 06880

David P. Reed                                          90,017  /(5)/     1.1%

Frank Edelstein                                        59,400  /(6)/       *

Milton L. Lohr                                         37,000  /(7)/       *

Howard F. George                                       35,057  /(8)/       *

Richard A. Alliegro                                    33,000  /(9)/        *

Earl E. Conabee                                        14,325 /(10)/       *

Wilford D. Godbold, Jr.                                16,000 /(11)/       *

Eduard Bagdasarian                                      5,000 /(12)/       *

Christopher Johnson                                         -              -

                                       39

<PAGE>

All current executive                                   1,502,909 /(13)/   17.9%
officers and directors as a
group (10 persons)

*        Less than 1%


/(1)/    Except as otherwise noted, the beneficial owners have sole voting and
         investment powers with respect to the shares indicated, subject to
         community property laws where applicable.

/(2)/    Includes 50,000 shares subject to options held by Mr. Moskowitz which
         are currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(3)/    Based on information contained in a statement on Schedule 13G dated
         January 30, 2002, as filed with the Securities and Exchange Commission.
         As stated in such Schedule 13G, all shares are held on behalf of
         advisory clients of Dimensional Fund Advisors, Inc., which disclaims
         beneficial ownership of such shares.

/(4)/    Based upon information contained in a statement dated February 14, 2002
         as filed with the Securities and Exchange Commission. As stated in such
         Schedule 13G, all shares are held on behalf of advisory clients of
         Pequot Capital Management, Inc., which disclaims beneficial ownership
         of such shares.

/(5)/    Includes 57, 000 shares subject to options held by Mr. Reed which are
         currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(6)/    Includes 39,500 shares subject to options held by Mr. Edelstein which
         are currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(7)/    Includes 37,000 shares subject to options held by Mr. Lohr which are
         currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(8)/   Includes 29,300 shares subject to options held by Mr. George which are
         currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(9)/   Includes 32,000 shares subject to options held by Mr. Alliegro which
         are currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(10)/   Includes 500 shares subject to options held by Mr. Conabee which are
         currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(11)/   Includes 15,000 shares subject to options held by Mr. Godbold which are
         currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(12)/   Includes 5,000 shares subject to options held by Mr. Bagdasarian which
         are currently exercisable or will become exercisable within 60 days of
         March 15, 2002.

/(13)/   Includes 265,300 shares subject to options which are currently
         exercisable or will become exercisable within 60 days of March 15,
         2002.

                                       40

<PAGE>

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

         On March 11, 1986, the Company sold 526,316 shares of its Common Stock
to Ford Motor Company ("Ford") at a price of $19.00 per share, for a total
purchase price of $10,000,000. At the same time, the Company and Ford created a
new corporation, Ceradyne Advanced Products, Inc. ("CAPI"), and entered into
agreements involving a broad-based technology transfer, licensing and joint
development program. Under the agreements, Ford contributed technology and a
portfolio of United States and foreign patents relating to technical ceramics to
CAPI in exchange for 80% of CAPI's capital stock, and Ceradyne acquired the
remaining 20% of CAPI in exchange for $200,000. The technology and patents
contributed by Ford were developed in the Ford Research Laboratories over a
15-year period. Under the March 11, 1986 agreements, the Company was granted an
option to acquire Ford's 80% interest in CAPI in exchange for an additional
680,983 shares of Ceradyne Common Stock, which the Company exercised effective
February 12, 1988. As a result, Ceradyne now owns 100% of CAPI. The Company and
Ford also entered into a joint development agreement, under which Ford agreed to
contribute on a matching value basis with Ceradyne, for the development by
Ceradyne of technical ceramic products oriented towards the automotive market.

         So long as Ford continues to own 5%, or more, of the Company's
outstanding common stock, Ceradyne has agreed to use its best efforts to cause
one person designated by Ford to be elected a member of the Ceradyne Board of
Directors and, under certain circumstances in the event the Company issues
additional shares of its Common Stock in a public or private transaction, to
permit Ford to purchase, at the same price and terms upon which sold by the
Company in such transaction, additional shares of Ceradyne Common Stock to
enable Ford to maintain its percentage ownership of the Company.

         In connection with the sale of stock to Ford, Joel P. Moskowitz,
Chairman of the Board, Chief Executive Officer and President of the Company, and
members of his immediate family agreed to vote shares of the Company's Common
Stock owned by them in favor of the election of Ford's nominee to the Board of
Directors. However, they may first vote that number of shares that is necessary
to assure the election of Joel P. Moskowitz as a Director of the Company, and
any shares that are not necessary to assure the election of Mr. Moskowitz and a
Ford nominee to the Board of Directors may be voted by them without restriction.

                                       41

<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                          46
         Consolidated Balance Sheets at December 31, 2001 and 2000         47-48
         Consolidated Statements of Operations for the Years Ended
             December 31, 2001, 2000 and 1999                              49
         Consolidated Statements of Stockholders' Equity for the Years
             Ended December 31, 2001, 2000, and 1999                       50
         Consolidated Statements of Cash Flows for the Years Ended
             December 31, 2001, 2000 and 1999                              51-52
         Notes to Consolidated Financial Statements                        53-66

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

     Schedule II -- Valuation and Qualifying Accounts                      67

     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, 2001:

     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 Registrant 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.

   10.1* Ceradyne, Inc. 1983 Stock Option Plan as amended and restated.
         Incorporated 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").

                                       42

<PAGE>

   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
         Registrant's 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, 1985.

   10.4  Stock Sale 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, 1985.

   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.

   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.

                                       43

<PAGE>

   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 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).

   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).

                                       44

<PAGE>

   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. 333-31679).

   10.28* Amendment No. 4 to the Ceradyne, Inc. 1994 Stock Incentive Plan.
          Incorporated herein by reference to Exhibit 10.29 to the Registrant's
          Annual Report on Form 10-K for the fiscal year ended December 31,
          1998.

   10.29* Amendment No. 5 to the Ceradyne, Inc. 1994 Stock Incentive Plan.
          Incorporated herein by reference to Exhibit 10.29 to the Registrant's
          annual report on Form 10-K for the fiscal year ended December 31,
          2000.

   10.30* Amendment No. 6 to the Ceradyne, Inc. 1994 Stock Incentive Plan.
          Incorporated herein by reference to Exhibit 4.7 to the Registrant's
          Registration Statement on Form S-8 (File No. 333-64094).

   10.31  Amendment No. 1 to the Ceradyne, Inc. 1995 Employee Stock Purchase
          Plan. Incorporated herein by reference to Exhibit 4.2 to the
          Registrant's Registration Statement on Form S-8 (File No. 333-64078).

   10.32  Lease between EMC Associates and the Registrant dated December 7,
          2001, covering premises located at 17466 Daimler Avenue, Irvine,
          California.

   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.

   99.1   Letter regarding representations received from Arthur Andersen LLP.

   *      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.

                                       45

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



To the Stockholders and Directors
 of Ceradyne, Inc.:


We have audited the accompanying consolidated balance sheets of Ceradyne, Inc.
(a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and
the related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted
in the United States. 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 of Ceradyne, Inc. and subsidiaries
as of December 31, 2001 and 2000, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2001, in
conformity with accounting principles generally accepted in the United States.

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 is 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


Orange County, California
February 27, 2002

                                       46

<PAGE>

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

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

                           DECEMBER 31, 2001 AND 2000
                           --------------------------

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

<TABLE>
<CAPTION>
                                                                           2001             2000
                                                                           ----             ----
<S>                                                                     <C>              <C>
CURRENT ASSETS:
  Cash and cash equivalents                                             $  1,017         $  6,656
  Accounts receivable, net of allowances for
    doubtful accounts of $101 and $84
    in 2001 and 2000, respectively                                         8,305            6,290
  Other receivables                                                          215               63
  Inventories, net                                                        14,581            8,193
  Production tooling                                                       2,889            1,655
  Prepaid expenses and other                                               1,689              795
                                                                           1,728              447
                                                                        --------        ---------
          Total current assets                                            30,424           24,099
                                                                        --------         --------


PROPERTY, PLANT AND EQUIPMENT:
  Land                                                                       422              422
  Buildings and improvements                                               1,851            1,825
  Machinery and equipment                                                 30,126           25,450
  Leasehold improvements                                                   3,224            2,280
  Office equipment                                                         3,291            2,975
  Construction in progress                                                 1,067              197
                                                                        --------         --------
                                                                          39,981           33,149
    Less--Accumulated depreciation and amortization                      (23,965)         (21,751)
                                                                        --------         --------
                                                                          16,016           11,398
                                                                        --------         --------
COSTS IN EXCESS OF NET ASSETS ACQUIRED,
  net of accumulated amortization of $2,406 and $2,239 in
  2001 and 2000, respectively                                              1,511            1,678
                                                                        --------         --------

DEFERRED TAX ASSET                                                           ---            1,261

OTHER ASSETS, net of accumulated amortization of
  $698 and $671 in 2001 and 2000, respectively                               ---               27
                                                                        --------         --------

          Total assets                                                  $ 47,951         $ 38,463
                                                                        ========         ========
</TABLE>

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

                                       47

<PAGE>

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

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

                           DECEMBER 31, 2001 AND 2000
                           --------------------------

                      LIABILITIES AND STOCKHOLDERS' EQUITY
                      ------------------------------------
                    (Amounts in thousands, except share data)

                                                             2001        2000
                                                             ----        ----
CURRENT LIABILITIES:
  Current maturities of long-term debt                     $    100    $    100
  Accounts payable                                            5,361       1,953
  Accrued expenses:
    Payroll and payroll related                               1,320         914
    Other                                                       476         249
                                                           --------    --------
          Total current liabilities                           7,257       3,216
                                                           --------    --------

LONG-TERM DEBT, less current maturities                         158         258
                                                           --------    --------

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

DEFERRED TAX LIABILITY                                          609         ---
                                                           --------    --------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
    Common stock, $.01 par value:
        Authorized--12,000,000 shares
        Outstanding--8,402,705 and 8,288,142 shares
         in 2001 and 2000, respectively                      39,298      38,659
    Retained earnings (deficit)                                 359      (3,670)
                                                           --------    --------

          Total stockholders' equity                         39,657      34,989
                                                           --------    --------

          Total liabilities and stockholders' equity       $ 47,951    $ 38,463
                                                           ========    ========

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

                                       48

<PAGE>

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

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

              FOR THE YEARS ENDED DECEMBER 31, 2001 , 2000 AND 1999
              -----------------------------------------------------
                  (Amounts in thousands, except per share data)

<TABLE>
<CAPTION>
                                                          2001           2000           1999
                                                          ----           ----           ----
<S>                                                   <C>            <C>            <C>
NET SALES                                             $  45,339      $  45,930      $  30,382

COST OF PRODUCT SALES                                    32,852         33,743         23,674
                                                      ---------      ---------      ---------

          Gross profit                                   12,487         12,187          6,708
                                                      ---------      ---------      ---------

OPERATING EXPENSES:
  Selling                                                 2,036          1,605          1,480
  General and administrative                              4,897          4,456          3,400
  Research and development                                1,083          1,252            597
                                                      ---------      ---------      ---------

                                                          8,016          7,313          5,477
                                                      ---------      ---------      ---------

          Income from operations                          4,471          4,874          1,231
                                                      ---------      ---------      ---------

OTHER INCOME (EXPENSE):
  Royalty Income                                            165            148            200
  Interest Income                                           186            209            144
  Miscellaneous                                              41            ---            ---
  Interest Expense                                          (26)           (34)           (16)
                                                      ---------      ---------      ----------
                                                            366            323            328
                                                      ---------      ---------      ---------

          Income before provision (benefit)
            for income taxes                              4,837          5,197          1,559

PROVISION (BENEFIT) FOR INCOME
    TAXES                                                   808            104            (44)
                                                      ---------      ---------      ----------

          Net income                                  $   4,029      $   5,093      $   1,603
                                                      =========      =========      =========

BASIC NET INCOME PER SHARE                            $    0.48      $    0.62      $    0.20
                                                      =========      =========      =========

DILUTED INCOME PER SHARE                              $    0.46      $    0.61      $    0.20
                                                      =========      =========      =========

WEIGHTED AVERAGE NUMBER OF
    COMMON SHARES OUTSTANDING:
          Basic                                           8,345          8,212          8,070
                                                      =========      =========      =========
          Diluted                                         8,713          8,395          8,189
                                                      =========      =========      =========
</TABLE>

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

                                       49

<PAGE>

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

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

              FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
              ----------------------------------------------------
                    (Amounts in thousands, except share data)

<TABLE>
<CAPTION>
                                              Common Stock
                                              ------------
                                                                     Retained         Total
                                        Number                       Earnings      Stockholders'
                                       of Shares         Amount      (Deficit)        Equity
                                       ---------         ------      ---------        ------
<S>                                    <C>              <C>          <C>           <C>
BALANCE, December 31, 1998              8,054,838       $37,718      $(10,366)        $27,352

  Issuance of common stock                 30,741           154           ---             154
  Exercise of stock options                10,269            28           ---              28
  Net income                                  ---           ---         1,603           1,603
                                       ----------       -------      --------         -------

BALANCE, December 31, 1999              8,095,848        37,900        (8,763)        $29,137

  Issuance of common stock                 64,304           190           ---             190
  Exercise of stock options               127,990           569           ---             569
  Net income                                  ---           ---         5,093           5,093
                                       ----------       -------      --------         -------

BALANCE, December 31, 2000              8,288,142        38,659        (3,670)        $34,989
                                       ----------       -------      --------         -------

  Issuance of common stock                 60,863           409           ---             409
  Exercise of stock options                53,700           230           ---             230
  Net income                                  ---           ---         4,029           4,029
                                       ----------       -------      --------         -------

BALANCE, December 31, 2001              8,402,705       $39,298      $    359         $39,657
                                       ==========       =======      ========         =======
</TABLE>

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

                                       50

<PAGE>

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

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                      -------------------------------------

              FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
              ----------------------------------------------------
                             (Amounts in thousands)

<TABLE>
<CAPTION>
                                                                2001               2000            1999
                                                                ----               ----            ----
<S>                                                           <C>               <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income                                                  $  4,029          $  5,093         $  1,603

  Adjustments to reconcile net income to net cash
     provided by operating activities:
        Depreciation and amortization                            2,485             2,212            1,835
        Gain on sale of equipment                                  (12)              ---              ---

     Changes in operating assets and liabilities:
        Accounts receivable, net                                (2,015)             (453)          (1,456)
        Other receivables                                         (152)               35               69
        Inventories                                             (6,388)              259             (932)
        Production tooling                                      (1,234)             (312)            (239)
        Prepaid expenses and other assets                         (305)              352             (352)
        Accounts payable                                         3,408              (261)           1,130
        Accrued expenses                                           633               349               27
        Deferred revenue                                           270              (270)             ---
                                                              --------          --------         --------

          Net cash provided by operating activities                719             7,004            1,685
                                                              --------          --------         --------

CASH FLOWS FROM INVESTING ACTIVITIES:

  Purchases of property, plant and equipment                    (6,965)           (2,414)          (3,788)
  Proceeds from sale of equipment                                   68               ---              ---
                                                              --------          --------         --------

          Net cash used in investing activities                 (6,897)           (2,414)          (3,788)
                                                              --------          --------         --------
</TABLE>

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

                                       51

<PAGE>

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

               CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued)
               -------------------------------------
                             (Amounts in thousands)

<TABLE>
<CAPTION>
                                                             2001             2000             1999
                                                             ----             ----             ----
<S>                                                        <C>              <C>              <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of common stock                   $    409         $    190         $    154
  Proceeds from exercise of stock options                       230              569               28
  Borrowings on long-term debt                                  ---              ---              500
  Payments on long-term debt                                   (100)            (100)             (42)
                                                           --------         ---------        --------

      Net cash provided by financing activities                 539              659              640
                                                           --------         --------         --------

  (Decrease) increase in cash and cash equivalents           (5,639)           5,249           (1,463)

  Cash and cash equivalents, beginning of year                6,656            1,407            2,870
                                                           --------         --------         --------

  Cash and cash equivalents, end of year                   $  1,017         $  6,656         $  1,407
                                                           --------         --------         --------

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
  INFORMATION:

    Interest paid                                          $     26         $     34         $     16
                                                           ========         ========         ========
    Income taxes paid                                      $    253         $     78         $     39
                                                           ========         ========         ========
</TABLE>

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

                                       52

<PAGE>

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

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

                                DECEMBER 31, 2001
                                -----------------

 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 uncollectable on specific accounts and 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.

     d.  Inventories, Net
         ----------------

     Inventories are valued at the lower of cost (first-in, first-out) or
     market. The write down of inventory for obsolete items is 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 inventories
     by component:

                                                  December 31,
                                                  ------------
                                             2001              2000
                                             ----              ----
                Raw materials           $  8,143,000       $ 4,815,000
                Work-in-process            5,616,000         2,800,000
                Finished goods               822,000           578,000
                                        ------------       -----------
                                        $ 14,581,000       $ 8,193,000
                                        ============       ===========

                                       53

<PAGE>

     e.  Production Tooling
         ------------------

     The Company's production tooling primarily consists of graphite tooling
     used in the manufacturing and furnacing processes. This tooling is being
     amortized over three to nine months.

     f.  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
           Machinery and equipment      3 to 12 years
           Office equipment             5 years
           Leasehold improvements       Shorter of 10 years or the term of Lease

     Maintenance, repairs and minor renewals are charged to expense as incurred.
     Repairs and maintenance expense approximated $1,061,000, $965,000, and
     $720,000 in 2001, 2000 and 1999, 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.
     Depreciation expense approximated $2,291,000, $2,018,000 and $1,645,000 in
     2001, 2000 and 1999, respectively.

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

     The cost in excess of net assets acquired (goodwill) amount presented on
     the financial statements primarily resulted from the acquisition of the
     Company's divisions. The acquisitions were accounted for as purchases and
     were valued based on the estimated fair value of the assets acquired and
     liabilities assumed with respect to each acquisition at the dates of
     acquisition. Goodwill represents the excess of cost over the fair value of
     assets acquired. Prior to January 1, 2002, the goodwill was amortized using
     the straight-line method between 20 and 27 years. As of January 1, 2002,
     new accounting pronouncement SFAS 142 will be applied. See footnote 1.q.,
     New Accounting Pronouncements. The Company periodically assesses the
     recoverability of goodwill for any impairment.

     h.  Sales Recognition
         -----------------

     The Company recognizes sales as of the date shipments are made and title
     passes to the customer. Shipping and handling costs billed to a customer
     are recorded as sales and cost of product sales.

                                       54

<PAGE>

     i.  Deferred Revenue
         ----------------

     In October 2001, Ford Motor Company contributed $270,000 for 2002 to the
     Joint Product Development Program. The Company will amortize this amount to
     revenue during 2002. In January 2001 and October 1999 and 1998, Ford also
     contributed $270,000 for each year and the Company fully amortized these
     amounts to revenue during 2001, 2000 and 1999.

     j.  Net Income 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 using the treasury stock method.

     The following is a summary of the number of shares entering into the
     computation of net income per common and common equivalent share:

                                                       December 31,
                                                       -----------
                                             2001          2000          1999
                                             ----          ----          ----

         Weighted average number of
             shares outstanding             8,344,874    8,211,568    8,070,225
         Dilutive stock options               368,160      183,769      119,174
                                            ---------    ---------    ---------

         Number of shares used in
             diluted computation            8,713,034    8,395,337    8,189,399
                                            =========    =========    =========

     k.  Accounting for Long-Lived Assets
         --------------------------------

     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 costs in excess of net assets acquired) 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 ended December 31, 2001, 2000 and 1999.

     l.  Pre-Production Engineering
         --------------------------

     Effective for design and development costs incurred after December 31,
     1999, the Emerging Issues Task Force (EITF) released issue No. 99-5,
     "Accounting for Pre-Production Costs Related to Long Term Supply
     Arrangements". The task force reached a consensus that design and
     development costs for products to be sold under long-term

                                       55

<PAGE>

     supply arrangement should be expenses as incurred. The effect of adoption
     was immaterial to the Company's financial statements.

     In 1998, the Company capitalized $188,000 in pre-production engineering
     costs relating to a new government contract for the armor vest product
     line. In November 1999, the company commenced shipments of the product and
     began to amortize these costs. The remaining amount capitalized of $172,000
     was completely amortized by March 31, 2000.

     m.  Use of Estimates
         ----------------

     The preparation of financial statements in accordance with accounting
     principles generally accepted in the United States 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.

     n.  Engineering and Research
         ------------------------

     The costs associated with application engineering and internally-funded
     research are expensed as incurred and are included in cost of product sales
     or other operating expenses. The Company established a new research and
     development department in 1998 to focus on new materials technology. Costs
     associated with the research and development department were $1,083,000,
     $1,252,000, and $597,000 for years ended December 31, 2001, 2000 and 1999,
     respectively. In addition, the Company historically has and continues to
     engage in application engineering and internally funded research to improve
     and reduce the cost of products and to develop new products. Costs
     associated with the engineering department were approximately $497,000,
     $358,000 and $281,000 in 2001, 2000 and 1999, respectively, and are
     included in cost of product sales.

     o.  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 unused line of credit is considered to approximate fair
     market value, as the interest rates of these instruments are based
     predominately on variable reference rates. The carrying value of the
     Company's long-term debt is a reasonable estimate of fair value as the rate
     of interest paid on the note approximates the current rate available for
     financing with similar terms and maturities.

     p.  Income Taxes
         ------------

     The Company accounts for income taxes using the asset and liability
     approach. Under this approach, deferred taxes are determined based on the
     differences between the financial statements and the tax bases using rates
     as enacted in tax laws. A valuation allowance is established if it is "more
     likely than not" that all or a portion of the deferred tax asset will not
     be realized.

                                       56

<PAGE>

     q.  New Accounting Pronouncements
         -----------------------------

     In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
     No. 133, "Accounting for Derivative Instruments and Hedging Activities".
     SFAS No. 133 requires that all derivative instruments be recorded on the
     balance sheet at their fair value. Changes in the fair value of derivatives
     are recorded each period in current earnings or other comprehensive income,
     depending on whether a derivative is designed as part of a hedge
     transaction and, if it is, the type of hedge transaction. In June 1999, the
     FASB issued SFAS No. 137, "Accounting for Derivative Instruments and
     Hedging Activities - Deferral of the Effective Date of FASB Statement No.
     133". SFAS No. 137 delays the effective date of SFAS No. 133 to fiscal
     years beginning after June 15, 2000. In June 2000, the FASB issued SFAS No.
     138, "Accounting for Certain Derivative Instruments and Certain Hedging
     Activities - an amendment of FASB Statement No. 133". SFAS No. 138 is
     effective concurrent with the delayed effective date of SFAS No. 133. SFAS
     No. 138 amends the accounting and reporting standards for certain
     derivative instruments and certain hedging activities. The Company adopted
     SFAS Nos. 133, 137 and 138 on January 1, 2001. The adoption did not have a
     material impact, as the Company does not currently hold any derivative
     instruments.

     In June 2001, the FASB issued SFAS No. 141, "Business Combinations." This
     Statement addresses financial accounting and reporting for business
     combinations and supersedes APB Opinion No. 16, "Business Combinations,"
     and SFAS No. 38, "Accounting for Preacquisition Contingencies of Purchased
     Enterprises". All business combinations in the scope of this Statement are
     to be accounted for using one method, the purchase method. The Company
     adopted SFAS 141 for all business combinations initiated after June 30,
     2001.

     Also in June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
     Intangible Assets". SFAS 142 addresses financial accounting and reporting
     for acquired goodwill and other intangible assets and supersedes APB
     Opinion No. 17, "Intangible Assets". This pronouncement addresses, among
     other things, how goodwill and other intangible assets should be accounted
     for after they have been initially recognized in the financial statements.
     Goodwill would no longer be amortized but would be assessed at least
     annually for impairment using a fair value methodology. The Company adopted
     this statement for all goodwill and other intangible assets acquired after
     June 30, 2001 and for all existing goodwill and other intangible assets
     beginning January 1, 2002. Upon adoption of this standard on January 1,
     2002 the Company will cease recording amortization of goodwill, which is
     expected to increase gross income in 2002 by approximately $200,000 or
     approximately $0.01 per diluted share after tax. Other than ceasing the
     amortization of goodwill, the Company does not anticipate that the adoption
     of SFAS 142 will have a significant effect on the financial position or the
     results of operations, as the Company does not currently anticipate any
     impairment charges for existing goodwill.

     In August 2001, the FASB issued SFAS No. 144, "Accounting for the
     Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses the
     financial accounting and reporting for the impairment of long-lived assets
     and for long-lived assets to be disposed of and is effective for fiscal
     years beginning after December 15, 2001. This statement supersedes SFAS No.
     121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
     Assets to be Disposed Of"; however, it retains the fundamental provision of
     SFAS No. 121 for (i) recognition and measurement of the impairment of
     long-lived assets to be held and used and (ii)

                                       57

<PAGE>

     measurement of long-lived assets to be disposed of by sale. This statement
     also supersedes the accounting and reporting provisions of APB Opinion No.
     30, "Reporting the Results of Operations--Reporting the Effects of Disposal
     of a Segment of a Business, and Extraordinary, Unusual and Infrequently
     Occurring Events and Transactions" for the disposal of a segment of a
     business. The Company does not believe SFAS No. 144 will have a material
     impact on the Company's financial position or results of operations.

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

In November 1997, the Company entered into a revolving credit agreement with
Comerica Bank. The unused credit facility amount remains at $4,000,000 as of
December 31, 2001.

The Company entered into a $500,000 capital equipment loan agreement during the
third quarter of 1999. The capital equipment loan bears interest at a fixed
interest rate of 8.18%, as of December 31, 2001, and is payable in monthly
installments of $8,333 expiring July 2004. There is no prepayment penalty on the
loan. The equipment serves as the collateral for the loan. Pursuant to the loan,
the Company is subject to certain covenants, which include, among other things,
the maintenance of minimum net worth, minimum ratio of quick assets to current
liabilities, and maximum ratio of total liabilities to net worth.

Future scheduled capital equipment loan payments are as follows:

     Year Ending December 31:

                    2002          $100,000
                    2003           100,000
                    2004            58,000
                                  --------
                                  $258,000
                                  ========

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

The provision (benefit) for income taxes is comprised of the following for the
year ended December 31:

                           2001         2000          1999
                           ----         ----          ----

     Current             $167,000     $104,000      $(44,000)
     Deferred             641,000          ---           ---
                         --------     --------      --------
                         $808,000     $104,000      $(44,000)
                         ========     ========      ========

The Company's deferred tax asset (liability) of $1.1 million at December 31,
2001 relates primarily to its tax net operating loss carryforwards, which total
approximately $2.0 million and expire as follows:

              2009                       $   380,000
              2010                         1,620,000
                                         -----------
                                         $ 2,000,000
                                         ===========

                                       58

<PAGE>

The components of the Company's deferred tax asset (liability) as of December
31, 2001 and 2000 are as follows:


                                                             December 31,
                                                             ------------
                                                         2001          2000
                                                         ----          ----
              Current asset:
                Inventory adjustments                 $  379,000     $  299,000
                Vacation accrual                         121,000        113,000
                Bad debt allowance                        47,000         33,000
                Net operating loss and tax credit
                  carryforwards                        1,129,000            ---
                Other                                     52,000          2,000
                                                      ----------     ----------
                                                      $1,728,000     $  447,000
                                                      ----------     ----------

              Noncurrent (liability) asset:
                Depreciation and amortization         $ (609,000)    $   42,000
                Net operating loss and tax credit
                  carryforwards                              ---      2,371,000
              Valuation allowance                            ---     (1,152,000)
                                                      ----------     ----------
                                                      $ (609,000)    $1,261,000
                                                      ===========    ==========

The effective income tax rate for the years ended December 31, 2001, 2000 and
1999 differs from the Federal statutory income tax rate due to the following
items:

<TABLE>
<CAPTION>
                                                                        December 31,
                                                                        ------------
                                                          2001              2000             1999
                                                          ----              ----             ----
       <S>                                           <C>                <C>              <C>
       Income before taxes                           $   4,837,000      $ 5,197,000      $  1,559,000
                                                     -------------      -----------      ------------

       Provision for income taxes at federal
          statutory rate (34%)                           1,644,580        1,766,980           530,060
       State income taxes, net of federal benefit          234,595          252,055            75,612
       Reduction of valuation allowance                 (1,152,000)      (1,839,000)         (708,000)
       Other                                                80,825          (76,035)           58,328
                                                     --------------     -----------      ------------
       Provision (benefit) for income taxes          $     808,000      $   104,000      $    (44,000)
                                                     =============      ===========      ============
       Effective tax rate                                    16.70%            2.00%            (2.82)%
                                                             =====             ====             =====
</TABLE>

                                       59

<PAGE>

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 October
      2015. The Company incurred rental expense under these leases of $792,458,
      $691,365 and $653,433 for the years ended 2001, 2000 and 1999,
      respectively. The approximate minimum rental commitments required under
      existing noncancelable leases as of December 31, 2001 are as follows:

                   2002               $1,113,000
                   2003                1,171,000
                   2004                1,225,000
                   2005                1,148,000
                   2006                  544,000
                   Thereafter          2,593,000
                                      ----------
                                      $7,794,000

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

      The Company had an employment agreement with its Chief Executive Officer
      which expired on July 5, 2001. 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. Compensation
      expense pursuant to this agreement in 2001, 2000 and 1999 was $323,838,
      $310,970 and $256,112, 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.

      From October 1995 through November 2000, the Company, along with other
      companies, was served with eight different complaints that were filed by
      eleven former employees of one of the Company's customers, and eight
      spouses. The complaints, all filed in the United States District Court,
      Eastern District of Tennessee, alleged that the customers' employees
      contracted chronic beryllium disease as a result of their exposure to
      beryllium-containing products sold by Ceradyne and other companies. As of
      December 7, 2001, all of these cases had been terminated without liability
      to Ceradyne; summary judgment in favor of Ceradyne was granted in seven
      cases, and the other one case was dismissed voluntarily by the plaintiff
      without prejudice to file the suit in the future.

      On December 21, 2001, the Company was served with a complaint filed by the
      Company's insurance carrier in the Superior Court of California in Santa
      Ana, California. The complaint seeks a declaration that the Company is
      obligated to reimburse the insurance carrier for defense expenses that the
      insurance carrier has or will pay on behalf of the Company's prior lessor.
      The lessor was sued by an employee of the Company alleging he contracted
      chronic beryllium disease while employed at the lessor's facility in the
      1980's. The Company's

                                       60

<PAGE>

     insurance carrier has or will pay the lessor's defense costs under a
     reservation of rights to seek reimbursement from the Company if it is
     determined by the Court that the Company's insurance carrier is not
     obligated to pay.

     The Company believes that the insurance carrier's claim is without merit
     and is vigorously defending against this claim. The case is in the early
     stage of discovery and no trial date has been set. The complaint does not
     state the amount of legal expenses for which reimbursement is sought, but
     the Company believes that the resolution of this matter will not have a
     material adverse effect on the financial condition or operations of the
     Company.

5.   Disclosure About Segments of Enterprise and Related Information
     ---------------------------------------------------------------

The Company serves its markets and manages its business through three divisions,
each of which has its own manufacturing facilities and administrative and
selling functions. The Company's Advanced Ceramic Operations, located in Costa
Mesa and Irvine, California, primarily produces armor and orthodontic products,
components for semiconductor equipment, and houses the Company's SRBSN research
and development activities. The Company's cathode development and production are
handled through its Semicon Associates division located in Lexington, Kentucky.
Fused silica products, including missile radomes, are produced at the Company's
Thermo Materials division located in Scottdale, Georgia.

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

<TABLE>
<CAPTION>
==================================================================================================

                   FACILITY LOCATION                              PRODUCTS
--------------------------------------------------------------------------------------------------
<S>                                         <C>
 Advanced Ceramic Operations                . Semiconductor Equipment Components
 Costa Mesa and Irvine, California          . Lightweight ceramic armor
   Approximately 126,000 square feet        . Orthodontic ceramic brackets
                                            . Ceralloy(R) 147 SRBSN wear parts
                                            . Precision ceramics
                                            . Ceralloy(R) 147 SRBSN diesel/automotive engine parts
                                            . Research and Development
--------------------------------------------------------------------------------------------------

 Semicon Associates                         . Microwave ceramic-impregnated dispenser cathodes
 Lexington, Kentucky                        . Ion laser ceramic-impregnated dispenser cathodes
   Approximately 35,000 square feet         . Samarium cobalt magnets

--------------------------------------------------------------------------------------------------

 Thermo Materials                           . Glass tempering rolls (fused silica ceramics)
 Scottdale, Georgia                         . Metallurgical tooling (fused silica ceramics)
   Approximately 85,000 square feet         . Missile radomes (fused silica ceramics)
                                            . Castable and other fused silica products
==================================================================================================
</TABLE>

                                       61

<PAGE>

                                 Ceradyne, Inc.
               Segment Statement of Operations for the Years Ended
                        December 31, 2001, 2000, and 1999
                             (amounts in thousands)

<TABLE>
<CAPTION>
                     Advanced Ceramic Ops         Semicon  Associates          Thermo Materials                  TOTAL
                     --------------------         -------------------          ----------------                  -----
---------------------------------------------------------------------------------------------------------------------------------
                   2001      2000      1999      2001     2000     1999     2001     2000     1999      2001      2000      1999
---------------------------------------------------------------------------------------------------------------------------------
<S>              <C>       <C>       <C>       <C>       <C>      <C>      <C>      <C>      <C>      <C>       <C>       <C>
Revenue from     $31,026   $31,250   $17,839   $ 7,709   $7,191   $6,385   $6,604   $7,489   $6,158   $45,339   $45,930   $30,382
                 -------   -------   -------   -------   ------   ------   ------   ------   ------   -------   -------   -------
 External
 Customers
Depreciation     $ 1,641   $ 1,564   $ 1,272   $   451   $  362   $  347   $  393   $  286   $  216   $ 2,485   $ 2,212   $ 1,835
                 -------   -------   -------   -------   ------   ------   ------   ------   ------   -------   -------   -------
 and
 Amortization
Segment          $ 3,754   $ 3,389   $   762   $ 1,493   $  895   $  395   $ (410)  $  913   $  402   $ 4,837   $ 5,197   $ 1,559
                 -------   -------   -------   -------   ------   ------   ------   ------   ------   -------   -------   -------
 Income (loss)
 before
 provision
 (benefit) for
 income taxes
Segment          $35,398   $27,298   $23,196   $ 6,575   $5,994   $5,877   $5,978   $5,171   $3,820   $47,951   $38,463   $32,893
                 -------   -------   -------   -------   ------   ------   ------   ------   ------   -------   -------   -------
 Assets
Expenditures     $ 5,746   $ 1,211   $ 2,989   $   384   $  394   $  322   $  835   $  809   $  477   $ 6,965   $ 2,414   $ 3,788
                 -------   -------   -------   -------   ------   ------   ------   ------   ------   -------   -------   -------
 for Segment
 Assets of
 PP&E
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>

The following is revenue by product line for Advanced Ceramic Operations for the
year ended December 31,

                                             2001        2000        1999
                                             ----        ----        ----
                        Semiconductor      $ 1,667     $ 2,407     $ 2,113
                        Armor               12,446      14,489       4,772
                        Orthodontics         7,992       6,511       5,623
                        Other                8,921       7,843       5,331
                                           -------     -------     -------
                                           $31,026     $31,250     $17,839


                     Segment Statement of Net Sales by Area
                               for the Years Ended
                        December 31, 2001, 2000, and 1999
                                     (in %)

<TABLE>
<CAPTION>
                    Advanced Ceramic Ops         Semicon  Associates         Thermo Materials                TOTAL
                    --------------------         -------------------         ----------------                -----
---------------------------------------------------------------------------------------------------------------------------
                  2001     2000      1999      2001     2000     1999     2001     2000     1999     2001     2000     1999
---------------------------------------------------------------------------------------------------------------------------
<S>               <C>      <C>       <C>       <C>      <C>      <C>      <C>      <C>      <C>     <C>      <C>      <C>
U.S. Net           60%      63%       54%       14%      12%      18%      10%      12%      17%      84%      87%      89%
Sales
Western             4%       3%        3%        2%       2%       2%       1%       1%       1%       7%       6%       6%
Europe Net
Sales
Asia Net            1%       1%        1%        1%       1%       1%       3%       2%       2%       5%       4%       4%
Sales
Israel Net          3%       1%      ---       ---      ---      ---      ---      ---      ---        3%       1%     ---
Sales
Canada Net        ---      ---         1%      ---        1%     ---        1%       1%     ---        1%       2%       1%
Sales
Other             ---      ---       ---       ---      ---      ---      ---      ---      ---      ---      ---      ---
                 -----    -----     -----     -----    -----    -----    -----    -----    -----    -----    -----    -----
Total Net          68%      68%       59%       17%      16%      21%      15%      16%      20%     100%     100%     100%
                 =====    =====     =====     =====    =====    =====    =====    =====    =====    =====    =====    =====
Sales
                 ----------------------------------------------------------------------------------------------------------
</TABLE>

One customer accounted for approximately 18%, 14% and 18% of net sales for the
years ended 2001, 2000 and 1999, respectively.

                                       62

<PAGE>

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
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 SFAS No. 123, the Company's net income and earnings per share
would have been reduced to the following pro forma amounts:

<TABLE>
<CAPTION>
                                                  2001          1999          1998
                                                  ----          ----          ----
<S>                                            <C>           <C>           <C>
     Net income:                As reported    $4,029,000    $5,093,000    $1,603,000
                                Pro forma      $3,385,000    $4,696,000     1,276,000

     Basic income per share     As reported       $0.48         $0.62         $0.20
                                Pro forma         $0.41         $0.57         $0.16

     Diluted income per share   As reported       $0.46         $0.61         $0.20
                                Pro forma         $0.39         $0.56         $0.16
</TABLE>

Because the SFAS 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
2001, 2000 and 1999 pro forma net income include immaterial amounts related to
the purchase discount offered under the 1995 Employee Stock Purchase Plan.

The Company may sell up to 250,000 shares of stock to its full-time employees
under the 1995 Employee Stock Purchase Plan. The Company has sold 21,765 shares,
27,925 shares and 26,793 shares in 2001, 2000 and 1999, 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 the plan year. As of December 31, 2001, the Company has 113,657
shares available under the 1995 Employee Stock Purchase Plan. The weighted
average fair value of shares sold in 2001, 2000 and 1999 was $6.88, $3.88 and
$3.88, respectively.

The Company may grant options for up to 950,000 shares under the 1994 Stock
Incentive Plan. The Company has granted options for 1,035,100 shares and has had
cancellations of 143,705 shares through December 31, 2001. Options are granted
at or above the fair market value at the date of grant and generally become
exercisable over a five-year period for Incentive Options and three months for
Non-Qualified Options.

                                       63

<PAGE>

A summary of the status of the Company's stock option plan at December 31, 1999,
2000 and 2001 and changes during the years then ended is presented in the table
and narrative below:

                                                     Weighted Average
                                         Shares      Exercise  Price
                                         ------      ---------------
OUTSTANDING, December 31, 1998           498,150        $   4.24
                                        ========        ========

   Granted                               151,000        $   3.39
   Exercised                             (10,200)          (2.63)
   Canceled                              (10,400)          (4.66)
                                        --------        --------
   OUTSTANDING, December 31, 1999        628,550        $   4.06
                                        ========        ========

   Granted                               107,900        $   6.83
   Exercised                            (127,990)          (4.23)
   Canceled                              (11,000)          (4.16)
                                        --------        --------
   OUTSTANDING, December 31, 2000        597,460        $   4.57
                                        ========        ========

   Granted                               169,500        $   6.83
   Exercised                             (53,700)           4.00
   Canceled                               (7,500)           4.84
                                        --------        --------
   OUTSTANDING, December 31, 2001        705,760        $   5.15
                                        ========        ========

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 2001, 2000, and 1999, respectively: risk free
interest rates of 4.92, 5.76 and 6.51 percent; expected life for 2001, 2000 and
1999 of 7 years; expected volatility of 64.97, 66.53 and 65.06 percent. The
assumed dividend yield in 2001, 2000 and 1999 is zero percent.

Of the 705,760 options outstanding at December 31, 2001, 300,900 have exercise
prices between $2.00 and $4.38, with a weighted average exercise price of $3.17,
and a weighted average remaining contractual life of six years. The remaining
404,860 options have exercise prices between $4.75 and $7.62, with a weighted
average exercise price of $6.53, and a weighted average remaining contractual
life of eight years.

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

In December 1988 the Board of Directors of the Company approved the adoption of
a supplemental retirement plan, the Ceradyne SMART 401(k) Plan (the Plan), in
which substantially all employees are eligible to participate after completing
90 days of employment. Participation in the Plan is voluntary. An employee may
elect to contribute up to fifteen percent (15% or the maximum deferred tax
amount of $10,500 in 2001, whichever is less) 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, 2001, 2000
and 1999, the related Company contribution was $259,024, $82,052 and $14,601,
respectively.

                                       64

<PAGE>

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
participants' cash contributions may be invested, at their discretion, in
several funds. 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, 2001, 64,966 shares were available for
issuance under the Plan.

8.   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 have 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.

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. Ford contributed $270,000 for
each of the years ended December 31, 2001, 2000 and 1999. In addition, Ford
contributed $270,000 in October 2001 for fiscal year 2002.

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

The results by quarter for 2001 and 2000 are as follows:

<TABLE>
<CAPTION>
                                 Quarter Ending
                                 --------------

                          March 31, 2001    June 30, 2001   September 30, 2001   December 31, 2001
                          --------------    -------------   ------------------   -----------------
<S>                          <C>              <C>                  <C>                 <C>
    Net Sales                $11,949,000      $11,137,000          $10,178,000         $12,075,000
    Gross Profit               3,826,000        3,293,000            2,801,000           2,567,000
    Net Income                 1,189,000        1,257,000              658,000             925,000
    Diluted Income per
      Share                  $      0.14      $      0.14          $      0.08         $      0.10
</TABLE>

                                       65

<PAGE>

<TABLE>
<CAPTION>
                                           Quarter Ending
                                           --------------

                          March 31, 2000    June 30, 2000   September 30, 2000   December 31, 2000
                          --------------    -------------   ------------------   -----------------
<S>                          <C>              <C>                  <C>                 <C>
    Net Sales                $11,148,000      $11,699,000          $11,493,000         $11,590,000
    Gross Profit               2,885,000        3,164,000            3,230,000           2,908,000
    Net Income                 1,156,000        1,338,000            1,409,000           1,190,000
    Diluted Income per
      Share                  $      0.14      $      0.16          $      0.17         $      0.14
</TABLE>

                                       66

<PAGE>

                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                 -----------------------------------------------

                             (Amounts in thousands)


                                  Balance      Charged                   Balance
                                    at         to Costs                    at
                                 Beginning       and                     End of
Description                      of Period     Expenses    Deductions    Period
-----------                      ---------     --------    ----------    ------

For the Year Ending
December 31, 2001:
------------------

Allowance for
 doubtful
 accounts receivable                  $ 84        $ 57         $ 40        $101
                                      ====        ====         ====        ====

For the Year Ending
December 31, 2000:
------------------

Allowance for
 doubtful
 accounts receivable                  $ 39        $134         $ 89       $  84
                                      ====        ====         ====       =====

For the Year Ending
December 31, 1999:
------------------

Allowance for
 doubtful
 accounts receivable                  $ 92        $ 77         $130       $  39
                                      ====        ====         ====       =====

                                       67

<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 27, 2002              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 27, 2002
     --------------------           Chief Executive Officer,
     Joel P. Moskowitz              President and Director
                                    (Principle executive
                                    officer)


     /s/Howard F. George            Chief Financial Officer       March 27, 2002
     -------------------            (Principle financial
     Howard F. George               and accounting officer)


     /s/Richard A. Alliegro         Director                      March 27, 2002
     ----------------------
     Richard A. Alliegro

     /s/Eduard Bagdasarian          Director                      March 27, 2002
     ---------------------
     Eduard Bagdasarian

     /s/Frank Edelstein             Director                      March 27, 2002
     ------------------
     Frank Edelstein

     /s/Wilford D. Godbold, Jr.     Director                      March 27, 2002
     --------------------------
     Wilford D. Godbold, Jr.

     /s/Christopher D. Johnson      Director                      March 27, 2002
     -------------------------
     Christopher D. Johnson

     /s/Milton L. Lohr              Director                      March 27, 2002
     --------------------
     Milton L. Lohr

                                       68

<PAGE>

                                  Exhibit Index

Exhibit No.   Description
-----------   -----------

10.32         Lease between EMC Associates and the Registrant dated December 7,
              2001, covering premises located at 17466 Daimler Avenue, Irvine,
              California

23.1          Consent of Arthur Andersen LLP

99.1          Letter regarding representations received from Arthur Andersen LLP