-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TKfYRALWH+oNV1kogyQeMhj9Vm0s4/WxHQLuE8oTOhJs9OxXCOwcfTgW1C4cQuMn vQouFtjmgK0772RwFt3eew== 0001017062-00-000831.txt : 20000331 0001017062-00-000831.hdr.sgml : 20000331 ACCESSION NUMBER: 0001017062-00-000831 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CERADYNE INC CENTRAL INDEX KEY: 0000018937 STANDARD INDUSTRIAL CLASSIFICATION: ABRASIVE ASBESTOS & MISC NONMETALLIC MINERAL PRODUCTS [3290] IRS NUMBER: 330055414 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-13059 FILM NUMBER: 586487 BUSINESS ADDRESS: STREET 1: 3169 RED HILL CITY: COSTA MESA STATE: CA ZIP: 92626 BUSINESS PHONE: 7145490421 MAIL ADDRESS: STREET 2: 3169 RED HILL CITY: COSTA MESA STATE: CA ZIP: 92626 10-K405 1 FORM 10-K FOR PERIOD ENDING 12/31/1999 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, 1999 [_] 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 3, 2000 was $49,902,624. As of March 3, 2000, the number of shares of the registrant's Common Stock outstanding was 8,099,048. DOCUMENTS INCORPORATED BY REFERENCE: None PART I This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results may differ materially from the results projected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Item 1 - Business," including the section therein entitled "Risk Factors," and in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations." Item 1. Business -------- Introduction Ceradyne, Inc. ("Ceradyne" or the "Company") develops, manufactures and markets advanced technical ceramic products and components for industrial, defense, consumer and microwave applications. In many high performance applications, products made of advanced technical ceramics meet specifications that similar products made of metals or plastics cannot achieve. Advanced technical ceramics can withstand extremely high temperatures, combine hardness with light weight, are highly resistant to corrosion and wear, and have excellent electrical insulation capability and other special electronic properties. Ceradyne's technology was originally developed primarily for defense and aerospace applications which have historically represented a substantial portion of its business. However, the Company has diversified its product lines on the development of new applications and markets, domestic and international, for its advanced technical ceramic technology, while continuing to serve its historical customer base which continues to account for a substantial portion of the Company's business. The Company continues to derive a substantial portion of its revenues from its traditional products, such as lightweight ceramic armor for military helicopters and microwave tube products. However, newer products developed or being developed by the Company for defense, industrial and consumer applications have represented a growing share of its business. Examples of these newer products include (i) large corrosion resistant ceramic components sold to semiconductor equipment manufacturers; (ii) lightweight ceramic armor vests for military personnel; (iii) a modified translucent ceramic orthodontic bracket, which is sold to Unitek Corporation, a subsidiary of 3M, under an exclusive marketing agreement and marketed by Unitek under its brand name "Clarity", (iv) wear resistant components for industrial machinery, such as paper making equipment, made from the Company's Ceralloy(R) 147 silicon nitride advanced technical ceramic; (v) missile nose cones or radomes for the defense industry, (vi) advanced technical ceramic components used on diesel engines, and (vii) lightweight ceramic applique armor for ground combat vehicles. The Company has a strategic relationship with the Ford Motor Company, pursuant to which Ford acquired a 14.9% equity interest in the Company, and transferred ceramic-related technology to the Company with a long-term objective of developing ceramic components for automobile engines. The Company's efforts in automotive applications are still in an early stage. However, in 1999 the Company obtained orders for and commenced shipments of "cam rollers" for a major diesel manufacturer. 1 Industry Background Developments in industrial processing, military systems, microwave electronics, consumer electronics, automotive and 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.
MELTING POINT HARDNESS CHEMICAL DENSITY (DEGREES (VICKERS RESISTANCE ELECTRICAL (GMS MATERIALS FAHRENHEIT) SCALE) TO ACIDS PROPERTIES PER CC) ==================================================================================================================== 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 Good to excellent plastics 275 to 750 5 to 10 insulators 1.0 to 2.0 ====================================================================================================================
Ceramics such as earthenware, glass, brick and tile have been made for centuries and are still in common use today. The inertness and lasting qualities of ceramics are illustrated by the artifacts uncovered intact in modern times. Almost all traditional ceramics, including those of ancient times, were based on clay. In recent years, significant advances have been made in ceramic technology through the application of specialized processes to produce man-made ceramic powders. In the 1950's and 1960's, developments in aluminum oxide and other oxides provided ceramics that were excellent electrical insulators and were capable of withstanding high temperatures. In the 1970's, these and other developments resulted in the ability to manufacture advanced technical ceramics with great strength at elevated temperatures and reduced brittleness, historically a primary limitation of ceramics. The industry that has emerged from these advances is known as advanced technical (or structural) ceramics. The properties of advanced technical ceramics present a compelling case for their use in a wide array of applications. However, manufacturing costs associated with the production of these materials need to be reduced in order to accelerate the use of advanced technical ceramics as a direct replacement for metals, plastics or other ceramics. A portion of these costs are related to the need for diamond grinding finished components to exacting tolerances. Industry cost reduction efforts have included the production of blanks or feed stock to "near net shape" configurations, thus reducing the need for final finishing. Manufacturers are also seeking to reduce costs through the use of high volume automated processing and finishing equipment and techniques, and to achieve economies of scale in areas such as powder processing, blank fabrication, firing, finishing and inspection. The automobile industry is particularly sensitive to initial as well as life cycle costs. Although the current state of the art of advanced technical ceramics suggests potential automotive acceptance, the cost factors currently will not permit automobile related production. The industry goal is to reduce advanced technical ceramics costs as close as possible to the cost of equivalent current metal parts. 2 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 opportunities for existing products, and on emerging markets and products which require or can benefit from the physical, chemical or electronic properties of advanced technical ceramics. To support this strategy, the Company'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. Examples of these products and market applications include: . Lightweight ceramic armor for military applications. . Industrial ceramics utilizing fused silica ceramics for the glass tempering and steel making markets. . Microwave cathodes, microwave absorbing Ceralloy(R) ceramics and samarium cobalt magnets for use in microwave power tubes in communications, radar and electronic countermeasure applications. In addition to the Company's strategy to leverage its existing technologies, the Company expects much of its future growth to come from products which are currently in early production or still in development. There can be no assurance, however, that products still under development will be successfully completed, or that any of these newer products, including those already in production, will achieve wide market acceptance. See "Rick Factors". The following table illustrates these newer and planned products and the markets for which they are intended. 3
- ------------------------------------------------------------------------------------------------------------------------------------ MARKET OPPORTUNITY TECHNICAL DEMANDS OF MARKET CERADYNE'S STRATEGIC RESPONSE - ------------------------------------------------------------------------------------------------------------------------------------ INDUSTRIAL - ------------------------------------------------------------------------------------------------------------------------------------ Corrosion resistant non-oxide ceramics The industry has historically used Ceradyne has created a business unit for use as semiconductor equipment silicon metal, quartz, and aluminum called "Semiconductor Equipment chamber components that handle wafers. oxide ceramics to fabricate chamber Components" and has begun supplying high components. Next generation equipment density and high purity nitride and may have operating conditions that may carbide ceramics to several equipment deteriorate currently used materials in suppliers. The R & D group is attempting some sections. to develop compositions tailored to each equipment manufacturer's environment. Wear resistant components required on Failure of industrial equipment is often Ceralloy(R) 147 Sintered Reaction Bonded the rubbing or cutting surfaces of caused by premature wearing out of Silicon Nitride (SRBSN) industrial wear industrial machinery, such as in paper surfaces due to abrasive action. parts and cutting tool inserts are making equipment, centrifuges, and Examples include paper making where the designed to replace hard metal or even cutting tool inserts. pulp slurry runs at 5000 feet per oxide ceramic wear surfaces, resulting minute, or in metal cutting where as in great productivity, quality and much as .125 inch depth of cut are longer "uptime". removed in a single pass. - ------------------------------------------------------------------------------------------------------------------------------------ DEFENSE - ------------------------------------------------------------------------------------------------------------------------------------ Lightweight armor for military and law As tactical conflicts as well as Ceralloy 546(R) (boron carbide) or enforcement personnel. terrorist and other activities result in Ceralloy(R) 146 (silicon carbide) backed the increased use of automatic weapons, with Kevlar(TM), Spectra(TM) or other it has become necessary to stop bullets laminates are designed to provide as great as a .50 caliber machine gun lightweight ballistic protection greater round. However, vests or other armor must than Kevlar alone at an acceptable be light enough in weight to allow weight. freedom of movement without undue fatigue. Missile nose cones (radomes). Next generation defensive missiles The Company's advanced technical ceramic (Standard Missile Block IV and Block IVA radomes are designed to address demanding and Patriot PAC-3) will be required to specifications of next generation missile fly at extremely high velocities, tight nose cones. turning radii, and severe weather conditions. These operating conditions may preclude the use of conventional polymer materials. Lightweight applique armor for The increased necessity for worldwide New armor development initiatives at ground combat vehicles. military police actions and rapid Ceradyne are focused on low cost, durable response peacekeeping missions is modular armor kit technologies that can driving the military vehicle force to be added to many different vehicles. lightweight systems that are air Multi-hit protection is provided against transportable. These vehicles must 7.62mm, 12.7mm and 14.5mm armor piercing provide armor protection beyond their ammunition. original design specification, which can only be met through the addition of lightweight modular armor 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 increased by over 30% in 1999. - ------------------------------------------------------------------------------------------------------------------------------------ AUTOMOTIVE - ------------------------------------------------------------------------------------------------------------------------------------ Automobile internal combustion In order to achieve diesel engine life Ceradyne's Ceralloy(R) 146 SRBSN is a engine and diesel engine valve of one million miles and automobile candidate for a variety of engine train and other engine components. engine life of over 125,000 miles components including cam rollers, bucket without major maintenance, it may be tappet inserts, engine valves, clevis necessary to replace metal engine pins and fuel pump parts. The Company is components with longer lasting, lighter in production of parts for Detroit weight, higher temperature resistant Diesel Corp., and prototype development ceramic parts at acceptable unit costs. with other heavy duty diesel engine manufacturers and Ford Motor Company. Volume production orders have occurred in 1999, and the Company seeks to increase this product line in the future. - ------------------------------------------------------------------------------------------------------------------------------------
4 As part of the Company's strategy, management intends to establish additional sales representative and distributor relationships, particularly in international markets. The Company will also seek to develop strategic product development or marketing relationships with other manufacturing companies or key customers whose expertise, marketing or financial resources will assist the Company in accomplishing these objectives. See "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 Product Development Program. Ceradyne completed a series of transactions with the Ford Motor Company ("Ford") in March 1986 with a long-term objective of developing ceramic components for automobiles. Key to this venture was the transfer of technology developed by Ford relating to technical ceramics, including a portfolio of United States and corresponding foreign patents and patent applications, and the investment of $10 million in the Company in exchange for Common Stock which eventually resulted in an ownership interest in Ceradyne of approximately 14.9%. 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. Through fiscal 1999, Ford has contributed to the Company, on a cost sharing basis, a total of $4.8 million in cash and equipment under this joint development program. The technology acquired from Ford and the efforts of this joint development program have led to the development of Ceradyne's Ceralloy(R) 147 sintered reaction bonded silicon nitride (SRBSN) advanced technical ceramic, from which the Company now produces a line of industrial wear components and has made prototype parts for evaluation and testing in internal combustion and diesel engines. 3M/Unitek Orthodontic Bracket Joint Program. In 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 Market Applications The Company's products can be categorized by the principal market applications they address: (i) industrial, (ii) defense, (iii) consumer, (iv) microwave tube products and (v) automotive. These markets accounted for approximately 43.6%, 13.8%, 17.1%, 21.4%, and 4.1%, respectively, of net sales for the year ended December 31, 1997, 46.2%, 14.0%, 16.0%, 22.8%, and 1.0%, respectively, of net sales for the year ended December 31, 1998, and 37.7%, 20.7%, 18.6%, 21.0%, and 2.0%, respectively, of net sales for the year ended December 31, 1999. Set forth below is a description of the Company's principle products itemized by market: Industrial Industrial Wear Components. Ceradyne's industrial wear components are made primarily of its Ceralloy(R) 147 sintered reaction bonded silicon nitride (SRBSN). These SRBSN ceramic components are generally incorporated in industrial machinery where severe abrasive conditions exist which wear out vital components. The Ceradyne wear resistant parts are used to replace conventional wear materials such as tungsten carbide or ceramics such as alumina or zirconia. Often these parts are incorporated in high wear areas at the original equipment manufacturer's plant. Applications include metal cutting tool inserts, paper and can making equipment, abrasive blasting nozzles as well as custom applications. Semiconductor Equipment Components. This is a market that may offer Ceradyne growth opportunities. The equipment used to make semiconductor devices (wafers) is extremely advanced and the newest generation has operating environments that are harsh enough to severely limit the life of the traditional ceramic and metal components. Ceradyne is positioned to offer a new generation of non oxide ceramics which have exceptional corrosion resistance. Tempered Glass Furnace Components and Metallurgical and Industrial Tooling. Fused silica ceramic is a ceramic which does not materially expand when heated, nor materially contract when cooled. Therefore, it is used to produce industrial tooling and molds where complicated shapes and dimensions must be maintained over a wide range of temperatures. Such applications include the forming and shaping of titanium metal, used in the manufacturing of aircraft. Other applications take advantage of fused silica's excellent thermal shock resistance and inertness when in contact with glass. These applications include components for equipment used in the fabrication of flat plate and tempered glass or contoured shapes such as automobile windshields. Fused silica ceramic shapes of up to 14 feet in length are produced in the Company's facility located near Atlanta, Georgia. Defense Lightweight Ceramic Armor. Although armor has progressed through the centuries from animal skin shields to metal armored suits, to Kevlar(TM) vests (for light armor), to heavy steel plates, the requirements for light weight and maximum projectile stopping capability vary little. Ceradyne has developed and currently produces lightweight ceramic armor capable of protecting against threats as great as .50 caliber armor piercing machine gun bullets. Compared to traditional steel armor plates, Ceradyne's ceramic armor systems offer weight savings as great as 50% for .50 caliber and 75% for 7.62mm armor piercing projectiles. Utilizing hot pressed Ceralloy(R) ceramic, the Company's armor plates are laminated with either Kevlar(TM), Spectra(TM) or fiberglass and formed 6 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 currently supplies ceramic armor systems for the following helicopter programs: the Blackhawk helicopter manufactured by Sikorsky Aircraft, the Apache helicopter manufactured by Boeing, Inc., the Cobra helicopter manufactured by the Bell Helicopter division of Textron Inc., and the Sea King helicopter manufactured by Westland Helicopters. The Company believes it is a leader in producing lightweight ceramic armor for military helicopters. See "Risk Factors". 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. Ceradyne received its first production order under this program in October 1998 in the amount of $2.4 million, and the second order was in June, 1999 for $4.2 million. Shipments of these orders began in the fourth quarter of 1999. The government has indicated that total orders over the 5-year life of this program could exceed $100 million. However, there can be no assurances as to the exact quantities or deliveries under this program because the government is not required to purchase any minimum amount and all orders are at the full discretion of the government. Missile Nose Cones (Radomes). The Company produces conical shaped, precision machined ceramic components which are designed to be mounted by its customers on the front end of defensive missiles. These nose cones, or radomes, are designed for applications where the velocities and operating environments are severe enough that the thermal shock and erosion resistance, high strength and microwave transparency properties of advanced technical ceramics are required. 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. Consumer Ceramic Orthodontic Brackets. In the orthodontic process of correcting a patient's tooth alignment, typically small (about 1/4") stainless steel brackets are adhered to each individual tooth in order to serve as a guide to the archwire which is the wire that sets into each bracket. The cosmetic appearance of all this metal is often considered quite unattractive. Ceradyne, together with its marketing partner, 3M/Unitek, have developed and are marketing ceramic orthodontic brackets made of Ceradyne's translucent ceramic, Transtar(R). The translucency of this ceramic bracket, together with the classic ceramic properties of hardness, chemical inertness and imperviousness, have resulted in a cosmetic substitute for traditional stainless steel brackets. These products are generally sold as aesthetic alternatives to conventional metal brackets and have been in production since 1987. Ceradyne and 3M/Unitek introduced a new enhanced ceramic bracket called "Clarity" in October of 1996. This product has patent protection and offers new features which improve the bracket's strength and functionality, compared to earlier designs manufactured by the Company. Comments from orthodontists who have purchased Clarity brackets have been positive. The Company believes Clarity brackets offer the orthodontist a more robust product that will minimize treatment and chair time while providing superior aesthetic appearance. 7 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, more efficient and more durable engines for heavy duty diesel trucks and automobiles creates additional opportunities for advanced technical ceramics. For instance, the Company believes that if engines could be produced using certain advanced technical ceramic components, they could be lighter and longer lasting than those using metal components and could operate at higher temperatures, with reduced cooling and lubrication requirements. As a result, engines would use less fuel, achieve more complete combustion, thereby reducing emissions, and be less costly to maintain. Because of these potential benefits, industry-wide efforts are being made to develop advanced technical ceramic technology to replace critical steel components in diesel and automobile engines. Ceradyne has provided a number of prototype parts made of Ceralloy(R) 147 SRBSN materials for evaluation and testing in internal combustion and diesel engines. In the fourth quarter of 1998, the Company received a letter of intent for the production of diesel engine components made from Ceradyne's Ceralloy(R) 147-31N sintered reaction bonded silicon nitride (SRBSN). Production began in the third quarter 1999 and shipments are expected to be $1 million during the first 12 months after shipments commence. Contingent upon Ceradyne's performance, including meeting certain customer quality and delivery milestones, the Company expects to receive orders for significantly higher volumes in the future. Ceradyne, in the fourth quarter of 1999, began preproduction qualification of a component for a high pressure fuel pump which is used in light duty diesel engines. The Company expects production to begin in mid-2000. Also, 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 high quality levels. See "Rick Factors". 8 Other Utilizing its advanced technical ceramics technologies and facilities, the Company also manufactures a number of other products related to the foregoing markets, such as dispenser cathodes for ion laser applications, samarium cobalt permanent magnets for motors and instruments, and other precision advanced technical ceramics. None of these products provide a material amount of revenue to the Company. Marketing and Customers Each of Ceradyne's three manufacturing locations maintains an autonomous sales and marketing force promoting their individual products. The Company has more than 10 employees directly involved in marketing, including a Marketing Manager located in the United Kingdom who was hired in February, 2000, and has agreements with manufacturers' representatives in the United States and other countries who are compensated as a percent of sales in their territory. Ceradyne is focusing much of its marketing effort outside the United States through direct involvement of senior management personnel from the Company's U.S. facilities in concert with local manufacturing representatives. Revenues from export sales represented approximately 20% of total net sales in 1997, 16% in 1998 and 11% in 1999. 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. See "Risk Factors". For years ended December 31, 1997, 1998 and 1999, 3M/Unitek accounted for approximately 17%, 16%, and 18%, respectively, of net sales. One other customer, CPI, Inc., accounted for approximately 11% of net sales for year ended December 31, 1998. The Company continues to explore various domestic and international marketing, and other relationships to increase its sales and market penetration. Furthermore, Ceradyne is attempting to create long-term relationships with its customers to promote a smoother, more predictable flow of orders and shipments by entering into multi-year agreements or exclusive relationships where possible. Manufacturing Processes Ceradyne has a number of manufacturing processes which are dedicated to specific products and markets. These processes and the product applications are described below. Hot Pressing. The Company's hot pressing process is generally used to fabricate ceramic shapes for lightweight ceramic armor and semiconductor equipment components. Ceradyne has developed and constructed induction heated furnaces capable of operating at temperatures exceeding 4000 (degrees) Fahrenheit 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 9 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) Fahrenheit. 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 400 (degrees) Fahrenheit. 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 (Si3N4) powders. After additives are incorporated by milling and spray drying, the silicon powders are formed into shapes through conventional ceramic processing such as dry pressing. These shapes are then fired in a nitrogen atmosphere which converts the silicon part to a silicon nitride part. At this step (reaction bonding), the silicon nitride is pressure sintered in an inert atmosphere increasing the strength of the component three fold. As a result of SRBSN processing, the ceramic crystals grow in an intertwining "needle-like" fashion which the Company has named NeedleLok(TM). Ceradyne's NeedleLok(TM) structure results in a tough, high fracture energy part. The process is economical due to the low cost of the starting powders and can be used to produce extremely high production volumes of parts due to the use of conventional pressing processes. 10 Fabrication of Translucent Ceramics (Transtar(R)). Ceradyne produces translucent aluminum oxide (Transtar(R)) components primarily for use as orthodontic ceramic brackets. The high purity powders are purchased from outside vendors and processed by dedicated conventional ceramic mechanical dry presses. The formed blanks are then fired in a segregated furnace in a hydrogen atmosphere at 1800 (degrees) Celsius until the ceramics enter into a strong translucent condition. These fired aesthetic appearing brackets then have certain critical features diamond ground into them. The final step is a proprietary treatment of the bonding side in order to permit a sound mechanical seal when bound to the patient's teeth. 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 (plus or minus) .001 inch and occasionally are machined to tolerances up to (plus or minus) .0001 inch. To a limited extent, the Company also performs diamond grinding services for customers independently of its other manufacturing processes to specifications provided by the customer. The Company's diamond grinding department can perform surface grinding, diameter grinding, ultrasonic diamond grinding, diamond lapping, diamond slicing and honing. The equipment includes manual, automatic and computer numerically controlled (CNC) grinders. The CNC grinders have been specially adapted by the Company for precision grinding of ceramic contours to exacting tolerances. Fabrication of Samarium Cobalt Permanent Magnets. The fabrication of samarium cobalt permanent magnets results in various magnet shapes which are primarily used in microwave tube applications. The Company procures premixed samarium cobalt powder either as SmCo5 or Sm2Co17 compositions. The powders are then milled and formed into the final configuration by pressing in a magnetic field using a specially designed magnet press. These "pre-fire" or "green" magnets are then sintered at 2000 (degrees) Fahrenheit in helium or vacuum. The magnets may then be subsequently diamond ground and characterized as to each individual magnet's strength. Raw Materials. The starting raw materials for Ceradyne's manufacturing operations are generally fine, man-made powders available from several domestic and foreign sources. The raw materials, such as Kevlar(TM), graphite, metal components and ceramic powders are readily available from several commercial sources. Quality Control. Ceradyne products are made to a number of exacting specifications. In order to meet both internal quality criteria and customer requirements, the Company has implemented a number of quality assurance and in- process statistical process control programs. These quality programs are implemented separately at each of Ceradyne's three manufacturing locations. Thermo Materials Division in Scottdale, Georgia received its ISO 9002 Certification in 1997. Advanced Ceramic Operations in Costa Mesa, California received its ISO 9001 Certification in 1998. Engineering and Research Ceradyne's engineering and research efforts consist primarily of application engineering in response to customer requirements and to a Research and Development Department to focus on new materials technology. 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 internally-funded research to improve and reduce the cost of production and to develop new products. Costs associated with 11 application engineering and internally-funded research are generally expensed as incurred and are included in cost of product sales, or in Research and Development expense. Costs associated with Company-funded research were approximately $380,000 in 1997, $728,000 in 1998 and $878,000 in 1999. The totals consist of $344,000 and $597,000 from the Research and Development Department, and $384,000 and $281,000 from the Application Engineering Department for the years ended December 31, 1998 and 1999, respectively. Competition Ceradyne competes on the basis of product performance, material specifications, application engineering capabilities, customer support, reputation and price. Competitive pressures vary in each specific product market, depending on the product and program. In many instances, the competitors are well-known companies with greater financial, marketing and technical resources than Ceradyne. Ceradyne intends to continue to focus on selected business areas in which it can exploit its 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, McDanel Refractories, Cercom, Coors Ceramics Company, 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". 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, 1999 was approximately $23.7 million, consisting of $21.1 million of firm scheduled orders and $2.6 million of unexercised options. As of December 31, 1998 total backlog approximated $17.0 million consisting of $13.9 million of firm scheduled orders and $3.1 million of unexercised options. Typically, firm orders are scheduled to be shipped within 12 to 18 months from receipt of order. Patents, Licenses and Trademarks The Company relies primarily on trade secrecy to protect compositions and processes that it believes are proprietary. In certain cases, the disclosure of information concerning such compositions or 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 12 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". Through its association with Ford, Ceradyne acquired in excess of 80 U.S. patents, of which 13 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 17 U.S. patents and has 4 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)", "Isomolded(R)", and "NeedleLok(TM) ". Employees At December 31, 1999, Ceradyne employed approximately 350 persons, including 14 employees with undergraduate or graduate degrees in ceramic engineering or material sciences. Management considers its employee relations to be excellent. The Company has not experienced difficulty in attracting personnel. None of the Company's employees are represented by a labor union. Risk Factors This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our actual results may differ materially from the results projected in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, the following: We 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 and diesel engines. We are developing ceramic automotive and diesel 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 not currently used in any significant automotive applications. It is possible that such applications will never emerge. Even if a market emerges, our efforts to produce ceramic components for automobile and diesel 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 13 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. Nevertheless, we believe that such a market will emerge eventually and that we will be well-positioned to capitalize on it. We have received a Purchase Order for the production of diesel engine components made from Ceradyne's Ceralloy(R) 147-31N sintered reaction bonded silicon nitride (SRBSN). Production began late in the third quarter of 1999. Ceradyne expects to ship approximately $1 million annually starting in the third quarter of 1999. Ceradyne also received Purchase Orders for preproduction qualification of a component for a high pressure fuel pump. Production is expected to begin by mid-2000. Failure to Manage Our Growth Could Adversely Affect Us Our current 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 introduce new products that apply our core advanced technical ceramic technologies. Managing this transition to new products 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. In addition, although Mr. Moskowitz has an employment agreement with the Company that expires in July 2001, no other employee has an agreement for a specified term of employment with Ceradyne. 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. 14 The Advanced Technical Ceramics Markets Are Highly Competitive The markets for applications of advanced technical ceramics are competitive. We believe the principle 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, McDanel Refractories, Cercom, Coors Ceramics Company, Spectra-Mat, and others. Not only do we compete with many large companies, but each of our product lines competes 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. In recent years, we have been sued by former employees and a family member of a former employee alleging that they had contracted chronic beryllium disease as a result of exposure to beryllium oxide powders used in our products. We settled several of these claims without incurring material liability, but several lawsuits are still pending. We cannot guaranty that we will avoid future liability to persons who allege that they contracted chronic beryllium disease as a result of exposure to beryllium oxide utilized by Ceradyne. 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, claims asserted against us related to exposure to beryllium oxide powder may not be covered by insurance. Even if covered, the amount of insurance may be inadequate to cover any adverse judgment. 15 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 $23.7 million backlog of orders as of December 31, 1999. Of this amount, approximately $9.8 million, or 41%, 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. In recent years, the budgets of many government agencies have been reduced, causing some of our customers and potential customers to re-evaluate their needs. However, this trend was partially arrested in the first quarter of 1998. A U.S. government agency selected Ceradyne to provide certain ceramic armor products over a 5-year period. We received our first production order under this program in October 1998 in the amount of $2.4 million, and the second order was in June, 1999 for $4.2 million. The government has indicated that it may order as much as $100 million or more in products from us over the 5-year life of this program, but there is no minimum amount that the government is required to purchase and all orders are at the full discretion of the government. 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 also depend on customer and technical feedback from Unitek for the design of improvements to the bracket. Some orthodontists were reluctant to use early versions of this product. They preferred using traditional stainless steel brackets and were wary of certain technical problems associated with earlier versions of our ceramic bracket. These problems included: . difficulty in removing, or debonding, the bracket from the tooth; . breakage of brackets during the treatment process more often than experience with stainless steel brackets; and . slower movement of the metal archwire through the ceramic brackets, resulting in longer treatment times than with stainless steel brackets. 16 Designs introduced in October 1996 under the Unitek brand name "Clarity" are intended to improve certain features of earlier versions of the bracket, but we cannot guaranty that these new products will completely eliminate the aforementioned problems or will receive wide market acceptance. Furthermore, 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, or such brackets fail to achieve market acceptance, 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 20% of our sales in 1997, 16% in 1998, and 11% in 1999. 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. . 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 all of 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. 17 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 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 three manufacturing facilities across the United States. The Company's Advanced Ceramic Operations, located in Costa Mesa, California, primarily produces armor and orthodontic products, components for semiconductor equipment, and houses the Company's SRBSN research and development activities. The Company's cathode development and production are handled through its Semicon Associates division located in Lexington, Kentucky. Fused silica products, including missile radomes, are produced at the Company's Thermo Materials division located in Scottdale, Georgia. These three facilities comprise approximately 74,000, 35,000 and 85,000 square feet, respectively. The Company's Costa Mesa and Scottdale facilities are held under long-term leases which expire in October 2000, with a 5 year renewal option to October 2005, and December 2005, respectively. The Company owns its Lexington, Kentucky facilities. 18 Ceradyne's manufacturing structure is summarized in the following table:
=================================================================================================================================== FACILITY LOCATION PRODUCTS - ----------------------------------------------------------------------------------------------------------------------------------- Advanced Ceramic Operations . Semiconductor Equipment Components Costa Mesa, California . Lightweight ceramic armor Approximately 74,000 square feet . Orthodontic ceramic brackets . Ceralloy(R) 147 SRBSN wear parts . Precision ceramics . Ceralloy(R) 147 SRBSN diesel/automotive engine parts (R&D) - ----------------------------------------------------------------------------------------------------------------------------------- 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 product ====================================================================================================================================
Item 3. Legal Proceedings ----------------- The Company is, from time to time, involved in various legal and other proceedings that relate to the ordinary course of operating its business, including, but not limited to, employment-related actions and workers' compensation claims. In October 1995, February 1997, August 1997, February 1999, and December 1999, the Company, along with others, was served with six different complaints that were filed by nine former employees of one of the Company's customers, and eight spouses. The complaints, filed in the United States District Court, Eastern District of Tennessee, allege that the customers' employees contracted chronic beryllium disease as a result of their exposure to beryllium-containing products sold by Ceradyne and others. One complaint seeks compensatory damages in the amount of $3.0 million for the four husbands, $1.0 million for the four spouses, and punitive damages in the amount of $5.0 million. Four other complaints each seek compensatory damages in the amount of $5.0 million for four husbands, $1.0 million for the spouses, and punitive damages in the amount of $10.0 million. The final complaint seeks compensatory damages in the amount of $5.0 million for an individual and punitive damages in the amount of $10.0 million. The Company believes that the plaintiffs' claims are without merit and that the resolution of these matters will not have a material adverse effect on the financial condition or operations of the Company. Defense of these cases has been tendered to the Company's insurance carriers, some of which are providing a defense subject to a reservation of rights. There can be no assurances, however, that these claims will be covered by insurance, or that, if covered, the amount of insurance will be sufficient to cover any potential judgments. We were notified by the United States Environmental Protection Agency in December, 1998 that Ceradyne is a responsible party in the federal Superfund cleanup of the Casmalia Disposal Site located in Santa Barbara County, California. The notification states that Ceradyne, along with approximately 10,000 other companies, has been designated as a de minimus waste generator due to the relatively small quantity of the waste disposed at the Casmalia Disposal Site. We properly disposed of this waste material in the 1970s and 1980s. However, waste materials disposed at the Casmalia Disposal Site have leaked into the water table. Under federal law, all parties who have disposed of waste materials at the Casmalia Site must pay their proportional share of the cost of the cleanup effort. In the fourth quarter of 1998, we recorded an expense in the amount of $0.2 million 19 as the estimated amount of our share of the cleanup costs. After negotiations with the EPA, the final settlement was $0.1 million and was paid in December, 1999. Item 4. Submission of matters to a vote of security holders --------------------------------------------------- Not applicable 20 MANAGEMENT Executive Officers of the Registrant. The executive officers of the Company as of March l, 2000 are as follows:
Name Age Position - ------------------- ----- --------------------------------------------- Joel P. Moskowitz.. 60 Chairman of the Board, President and Chief Executive Officer Earl E. Conabee.... 62 Vice President, and Director of Marketing at Thermo Materials Garry DeBoer....... 63 Vice President, and Consultant of Semicon Associates Howard F. George... 55 Vice President Finance, Chief Financial Officer and Secretary Donald A. Kenagy... 58 Vice President, and President of Thermo Materials David P. Reed...... 45 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. Garry DeBoer joined the Company as President of its Semicon Associates Division in September 1997, and has served as Vice President of the Company since February 1999. Since September 1999, Mr. DeBoer is serving Semicon Associates as a Marketing Consultant. Mr. DeBoer attended Newark College of Engineering, majoring in Metallurgy. He has spent most of his career in the field of microwave electronics, used primarily in military defense systems and commercial satellite communications. For the past twenty-five years prior to joining the Company, Mr. DeBoer was employed by Varian Associates and Communications and Power Industries in various Senior Technical and Management positions, and also served as Manager of Commercial Products for CPI's Traveling Wave Tube Product Division. 21 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. 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. Donald A. Kenagy joined the Company in December 1986 when the Company acquired Thermo Materials, and has served as Vice President of the Company since July 1991. Mr. Kenagy is currently President of the Company's Thermo Materials division, and as such is responsible for the operations, finances and marketing of Thermo Materials. Mr. Kenagy joined Thermo Materials in 1972. Mr. Kenagy received a B.S. in Ceramic Technology from Penn State in 1963, an M.S. in Metallurgy from the Massachusetts Institute of Technology in 1965, and a Met. Eng. degree from MIT in 1968. David P. Reed joined the Company in November 1983, and has served as Vice President since January 1988. Mr. Reed is responsible for the operations, finances and marketing of the Company's Costa Mesa, California operations. Prior to joining the Company, Mr. Reed served as Manager, Process Engineering for the Industrial Ceramic Division of Norton Co. from 1980 to 1983. Mr. Reed obtained a B.S. in Ceramic Engineering from Alfred University in 1976 and an M.S. in Ceramic Engineering from the University of Illinois in 1978. Officers serve at the discretion of the Board of Directors except for Mr. Moskowitz, who serves pursuant to a two year employment agreement which expires in July 2001. 22 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, 1999, the Company had approximately 487 record holders of its Common Stock.
High Low ------ ------- Year ended December 31, 1998 First Quarter............. 8 1/8 3 5/8 Second Quarter............ 7 1/2 4 1/2 Third Quarter............. 5 9/16 3 Fourth Quarter............ 5 1/8 3 1/8 Year ended December 31, 1999 First Quarter............. 4 3 1/8 Second Quarter............ 4 3/4 3 Third Quarter............. 5 3 17/32 Fourth Quarter............ 5 1/2 3 1/2
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, 1999 that were not registered under the Securities Act of 1933. 23 Item 6. Selected Financial Data ----------------------- Statements of Operations Data: (Amounts in thousands, except per share data) - ----------------------------- Year Ended December 31, -----------------------
1999 1998 1997 1996 1995 ------------ ------------ ------------ ------------ ------------ Net sales $30,382 $26,279 $28,693 $28,212 $23,404 Cost of product sales 23,674 21,292 23,274 21,065 16,948 ------- ------- ------- ------- ------- Gross profit 6,708 4,987 5,419 7,147 6,456 ------- ------- ------- ------- ------- Operating expenses: Selling 1,480 1,494 1,515 1,571 1,492 General & administrative 3,400 3,239 3,660 3,137 2,748 Research and development 597 344 --- --- --- ------- ------- ------- ------- ------- 5,477 5,077 5,175 4,708 4,240 ------- ------- ------- ------- ------- Income (loss) from operations 1,231 ( 90) 244 2,439 2,216 Other income (expense): Other income 344 382 265 1,890 265 Interest expense (16) --- (134) (162) (342) ------- ------- ------- ------- ------- Income before provision (benefit) for income taxes 1,559 292 375 4,167 2,139 Provision (benefit) for income taxes (44) 10 (1,675) 127 50 ------- ------- ------- ------- ------- Net income $ 1,603 $ 282 $ 2,050 $ 4,040 $ 2,089 ======= ======= ======= ======= ======= Basic income per share $ .20 $ .04 $ .26 $ .52 $ .32 ======= ======= ======= ======= ======= Diluted income per share $ .20 $ .04 $ .26 $ .51 $ .32 ======= ======= ======= ======= ======= Weighted average shares outstanding 8,189 8,068 8,035 7,985 6,607 Balance Sheet Data: December 31, - ------------------- ------------ 1999 1998 1997 1996 1995 ----------- ----------- ----------- ----------- ----------- Working capital $15,156 $15,051 $15,327 $15,892 $13,216 Total assets 32,893 29,493 29,017 28,398 24,880 Long-term obligations 358 --- --- --- 555 Stockholder's equity $29,137 $27,352 $26,760 $24,440 $19,852
24 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 generally expensed as incurred. Results of Operations The percentage relationships to net sales of certain income and expense items for the three years ended December 31, 1999 are contained in the following table.
Year Ended December 31, --------------------------- 1999 1998 1997 ------- ------- ------- Net sales 100.00% 100.00% 100.00% Cost of product sales 77.92 81.02 81.11 ------ ------ ------ Gross profit 22.08 18.98 18.89 ------ ------ ------ Operating expenses: Selling 4.87 5.69 5.28 General & administration 11.19 12.33 12.76 R&D 1.97 1.30 --- ------ ------ ------ 18.03 19.32 18.04 ------ ------ ------ Income (loss) from operations 4.05 (.34) .85 Other income 1.14 1.45 .93 Interest expense (.05) --- (.47) ------ ------ ------ Income before provision (benefit) for income taxes 5.14 1.11 1.31 Provision (benefit) for income taxes (.14) .04 (5.83) ------ ------ ------ Net income 5.28% 1.07% 7.14% ====== ====== ======
25 Years Ended December 31, 1999 and 1998 Net Sales. Net sales for the year ended December 31, 1999 were $30.4 million, an increase of $4.1 million, or 16% 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 $3.7 million over the prior year. Contributing to the increase was armor products due to increasing demand for protective armor vests and helicopter wing panels. Orthodontic brackets also contributed to the increase over the prior year due to the increased demand by orthodontists for the "Clarity" orthodontic brackets. The automotive product line had increased demand over the prior year due to a new order for advanced technical ceramic components by a major diesel engine manufacturer. Additionally, sales of structural ceramics for semiconductor equipment increased over the prior year period because of the continued improvement in the semiconductor industry. The Company has also engaged in new research contracts in 1999 for the development of new structural ceramic components with the U.S. Government. However, the above product line sales increases were slightly offset from the prior year due to reduced demand for wear resistant components used on capital equipment machinery and oil exploration ceramic components. Additionally, the Company's Semicon Associates Division in Lexington, Kentucky, posted a sales increase of $.4 million as compared to the prior year period. The increase was mainly due to price increases and, to a lesser degree, the introduction of extended cathode assemblies. The Company's Thermo Materials Division in Scottdale, Georgia posted a slight sales increase over the prior year. International sales have and continue to be an important part of the Company's business, representing 11% of the Company's net sales for the period ended December 31, 1999. This compares to 16% of net sales in the comparable prior year period. The decrease was mainly attributable to domestic increases in the armor and orthodontic product lines. Gross Profit. The Company's gross profit was $6.7 million, or 22% of net sales, for the year ended December 31, 1999, compared to $5.0 million, or 19% of net sales, for the comparable prior year. The increase in gross profit for the year ended December 31, 1999 as compared to the prior year was $1.7 million or 35%. All of the major product lines at the Company's Advanced Ceramic Operations in Costa Mesa, California, except for wear resistant components, had an increase in gross profit as compared to the prior year period. This result was due to higher volume and higher capacity utilization resulting in favorable cost absorption. Hence, the favorable variance compared to the prior year period was $1.2 million. Gross profit for Semicon Associates in Lexington, Kentucky, had a favorable variance over the comparable prior year period of $.4 million. The increase in the gross profit can be attributed to slightly higher production yields and price increases. Gross profit for Thermo Materials in Scottdale, Georgia, posted a favorable variance of $.1 million compared to the prior year period. 26 Research and Development Expenses. Research and development expenses were approximately $.6 million for the year ended December 31, 1999 as compared to $.35 million for the prior year. The Company established a new research and development department in 1998 to focus on new materials technology. The expenses incurred related to salaries, travel, outside services, materials and small tools. 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 internally-funded research are generally expensed as incurred and are included in cost of product sales. Selling Expenses. Selling expenses were $1.5 million for the years ended December 31, 1999 and 1998. Increases in salaries and travel expenses were offset by a reduction in commission expense for the current year over the prior comparable period. General and Administrative Expenses. General and administrative expenses were $3.4 million for the year ended December 31, 1999, a $.2 million increase from the prior year. The key elements for the increase between the years was a favorable settlement with a customer in the prior year resulting in net proceeds of $.4 million. However, this was offset in the prior year by a non-recurring charge of $.2 million related to legal fees. For the current year, increases in salaries, consultant, and travel expenses were offset by a favorable settlement in the final payment for the superfund cleanup of the Casmalia Disposal Site in Santa Barbara County, California. Other Income. Other income was approximately $.3 million for the year ended December 31, 1999 compared to $.4 million for the prior year. The significant difference for the decrease was the reduction of interest income due to lower cash balances in the current year. Interest Expense. Interest expense was $16,000 for the year ended December 31, 1999 compared to none in the prior year. The increase was caused by entering into a capital equipment loan in 1999. Income Taxes. The Company has recorded a $44,000 net benefit for income tax for the year ended December 31,1999. The net benefit is the result of a refund of Federal and State taxes from the prior year for $83,000. This was offset by a current year provision of $39,000. It is anticipated that the Company will utilize all of the Federal net operating loss carryforwards in the year 2001. Net Income. Reflecting all of the matters discussed above, net income was $1,603,000 (or $.20 per share basic and diluted) for the year ended December 31, 1999 compared to a net income of $282,000 (or $.04 per share basic and diluted) for the prior year. Years Ended December 31, 1998 and 1997. Net Sales. Net sales for the year ended December 31, 1998 were $26.3 million, a decrease of $2.4 million, or 8.4%, compared to the prior year. The decrease in sales is primarily related to the Advanced Ceramic Operations in Costa Mesa, California. Lightweight armor sales decreased due to delays in new government production releases. Wear resistant component sales decreased because of the downturn in capital equipment shipments, and the low price of crude oil reduced the demand for exploration components. Orthodontic bracket sales decreased because the Company's customer increased its inventory levels in 1997 due to the introduction of the new "Clarity" orthodontic bracket, and reduced the level of inventory in 1998 because of "just in time" inventory 27 practices. Structural ceramics for semiconductor equipment decreased from the comparable prior year net sales because of the world-wide downturn in the semiconductor industry. The Company's Semicon Associates Division in Lexington, Kentucky posted a decrease in net sales of approximately $.1 million from the prior comparable period. This was mainly caused by reduced demand for the first three quarters of 1998 (as compared to the same period in the comparable prior year), for dispenser cathodes and samarium cobalt permanent magnets. However, for the 4th Quarter 1998, demand for these products increased over the comparable prior year's fourth quarter due to replacement parts procurement. The Company's Thermo Materials Division in Scottdale, Georgia posted an increase in net sales from the prior comparable period by approximately $.75 million. The increase is due to missile radome shipments that are a result of the prior year pilot production and an increase in fused silica ceramic components due to an aggressive sales effort. Also, and to a lesser extent, net sales increased due to the purchase of the Masrock and Fusil Foam assets and business from Harbison Refractories Company. This was a small asset acquisition that the Company completed in the 4th Quarter of 1998. International sales have and continue to be an important part of the Company's business, representing 16% of the Company's net sales for the period ended December 31, 1998. This compares to 20% of net sales in the comparable prior year period. Gross Profit. The Company's gross profit was $5.0 million, or 19.0% of net sales, for the year ended December 31, 1998, compared to $5.4 million, or 18.9% of net sales, for the comparable prior year. The decrease in gross profit for the year ended December 31, 1998 as compared to the prior year was $.4 million or 8.0%. All of the major product lines at the Company's Advanced Ceramic Operations in Costa Mesa, California had decreases in gross profit as compared to the prior year period due to lower volume and lower capacity utilization resulting in unfavorable overhead absorption. This resulted in a gross profit decrease of $2.3 million as compared to the prior year. Another key element that contributed to the decrease was the charge of approximately $.3 million for start-up costs associated with the semiconductor product line. Gross profit for Semicon Associates in Lexington, Kentucky had an increase of $1.8 million from the comparable prior year period. The reason for the increase was that in the prior year an adjustment of approximately $1.7 million to write off inventory and to reduce inventory carrying amounts to net realizable values was recorded. Gross profit for Thermo Materials in Scottdale, Georgia increased approximately $.4 million from the comparable prior year period. The increase was the result of increased volume, production yields, and greater capacity utilization. Research and Development Expenses. Research and development expenses were approximately $.35 million for the year ended December 31, 1998. The Company established a new research and development department in 1998 to focus on new materials technology. The expenses incurred related to salaries, travel, outside services, materials and small tools. 28 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 internally-funded research are generally expensed as incurred and are included in cost of product sales. Selling Expenses. Selling expenses were $1.5 million for the years ended December 31, 1998 and 1997. Increases in direct salaries and travel expenses were offset by a reduction in commission expense for the current year over the prior comparable period. General and Administrative Expenses. General and administrative expenses were $3.2 million for the year ended December 31, 1998, a $.4 million decrease from the prior year. The key elements for the decrease between the years was a non- recurring charge in the prior year of $.2 million related to legal fees associated with a legal settlement, coupled with a favorable settlement with a customer in the current year resulting in net proceeds of $.4 million. The above decreases in expenses from the prior year were offset by a non-recurring charge of $.2 million in the current year's 4th quarter. This charge was the result of written notification from the United States Environmental Protection Agency that the Company was a responsible party in the Superfund cleanup of the Casmalia Disposal Site in Santa Barbara County, CA. The notification states that Ceradyne, along with approximately 10,000 other parties, has been designated as "de minimus" waste generator due to the relatively small quantities of its waste disposal. The Company properly disposed of this waste material in the 1970's and 1980's, however the Casmalia Disposal Site leaked into the water table. Thus the waste generators must pay their share of the cost of the cleanup effort. Other Income and Expense. Other income was approximately $.4 million for the year ended December 31, 1998 compared to $.3 million for the prior year. The significant difference for the increase was the reduction of non-operational miscellaneous expense that was incurred in the prior year. Interest Expense. The Company had no interest expense for the year ended December 31, 1998. The prior year had interest expense of $134,000. The reason for the decrease is the payment of all debt outstanding in the prior year. Income Taxes. The Company has recorded $10,000 provision for income tax for the year ended December 31,1998. The Company in the prior year reversed a portion of the previously established valuation allowance, primarily related to net operating losses from prior years to offset tax provisions at statutory rates. Net Income. Reflecting all of the matters discussed above, net income was $282,000 (or $.04 per share basic and diluted) for the year ended December 31, 1998 compared to a net income of $2,050,000 (or $.26 per share basic and diluted) for the prior year. Year 2000 Disclosure. Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. This inability to recognize or properly treat the Year 2000 may cause the Company's systems and applications to process critical financial and operational information incorrectly. The Company has and continues to assess any impact of the Year 2000 issue on its reporting systems and operations. 29 The Company did not experience any Year 2000 issues within or outside the Company in the millennium change or the leap year day of February 29, 2000. The costs associated with getting prepared for Year 2000 issues were as previously stated, approximately $150,000. Also, the Company has not experienced any unusual patterns or trends from the Year 2000 issue. 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. In November 1997, the Company entered into a revolving credit agreement with Comerica Bank. The credit facility amount remains at $4,000,000 as of year ended December 31, 1999 and no collateral is required of the Company. As of December 31, 1999 there had been no borrowing under this credit facility. 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. Management believes that its current cash and cash equivalents on hand, as well as cash generated from operations and the ability to borrow under the existing credit facility, will be sufficient to finance anticipated capital and operating requirements for at least the next 12 months. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Currently, the Company does not have any instruments that would qualify as derivatives under SFAS No. 133. Accordingly, the Company does not believe SFAS No. 133 will have a material impact on the Company's financial position, results of operations, or liquidity at the current time. 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, 1999. 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 1999 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. 30 As of December 31, 1999, the Company's debt consisted of a $458,000 capital equipment loan at a fixed interest rate of 8.18% due June 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 maturities. 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 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..... 60 Chairman of the Board, President and Chief Executive Officer Leonard M. Allenstein. 61 Director Richard A. Alliegro... 69 Director Peter Beardmore....... 63 Director Frank Edelstein....... 74 Director Milton L. Lohr........ 74 Director Melvin A. Shader...... 74 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. Leonard M. Allenstein has served on the Board of Directors of the Company since 1983. Mr. Allenstein has been a private investor and businessman for several years. Mr. Allenstein was a founder and general partner of Bristol Restaurants, which owns and operates restaurants in the Southern California area, from 1978 until December 1986. 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. Dr. Peter Beardmore is the Director of the Chemical and Physical Sciences Laboratory of Ford Motor Company. He has been associated with Ford since 1966. Dr. Beardmore has a B. MET. in Metallurgy from the University of Sheffield, and a Ph.D. in Metallurgy from the University of Liverpool. Dr. Beardmore was elected to the Board of Directors of the Company in 1996. 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 32 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. 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 the President of Defense Development Corporation, a defense-related research and development company. Mr. Lohr previously 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 President 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. Melvin A. Shader has served on the Board of Directors of the Company since 1984. Dr. Shader retired in 1991 from TRW, Inc., where he was Vice President, Business Development and Vice President, International at the Space and Defense Sector of TRW, Inc. Dr. Shader had been with TRW, Inc. since 1970. From 1969 to 1970, Dr. Shader was Director of Planning in the Information Network Division of Computer Sciences Corp. From 1954 to 1968, he was an executive with International Business Machines Corp. 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 of the Company's Common Stock, if necessary, for the election of Ford's nominee. Dr. Peter Beardmore is Ford's current representative. Officers serve at the discretion of the Board of Directors except for Mr. Moskowitz, who serves pursuant to a two-year employment agreement which expires in July 2001. 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, 1999, its officers, directors and greater than ten percent beneficial owners complied with all Section 16(a) filing requirements. 33 Item 11. Executive Compensation ---------------------- Summary Compensation Table - -------------------------- The following table shows certain information concerning the compensation of the Chief Executive Officer and five other most highly compensated executive officers of the Company whose aggregate compensation for services in all capacities rendered during the year ended December 31, 1999 exceeded $100,000 (collectively, the "Named Executive Officers"):
Long Term Compensation ------------- Securities Name & Annual Compensation Underlying - ----- ------------------------------------ Options Principal Position Year Salary Bonus (# of Shares) - ---------------------- -------- ----------- ----------- ------------- Joel P. Moskowitz 1999 $240,085 $16,027 - Chairman of the 1998 228,191 - - Board, Chief 1997 212,988 19,976 - Executive Officer and President Earl E. Conabee 1999 $106,872 - - Vice President 1998 101,220 - 4,000 1997 96,731 - 2,000 Gerhart D. DeBoer(1) 1999 $106,068 11,000 5,000 Vice President 1998 102,270 - 5,000 1997 36,705 - 20,000 Howard F. George 1999 $104,327 - - Vice President 1998 101,062 - 5,000 1997 94,300 $ 6,210 - Donald A. Kenagy 1999 $108,350 - 5,000 Vice President 1998 103,142 - 4,000 1997 98,411 - 2,000 David P. Reed 1999 $132,919 - 5,000 Vice President 1998 121,295 - 10,000 1997 118,056 $24,594 13,500
(1)Mr. DeBoer's employment with the Company commenced in September 1997. 34 Option Grants in Last Fiscal Year - --------------------------------- The following table sets forth certain information concerning grants of options to each of the Named Executive Officers during the year ended December 31, 1999. In addition, in accordance with the rules and regulations of the Securities and Exchange Commission, the following table sets forth the hypothetical gains or "option spreads" that would exist for the options. Such gains are based on assumed rates of annual compound stock appreciation of 5% and 10% from the date on which the options were granted over the full term of the options. The rates do not represent the Company's estimate or projection of future Common Stock prices, and no assurance can be given that any appreciation will occur or that the rates of annual compound stock appreciation assumed for the purposes of the following table will be achieved. Potential Realizable Value at Assumed Annual Percent of Rates of Stock Price Total Options Appreciation for Granted to Exercise Option Term(2) Options Granted Employees in Price Expiration -------------- Name (# of Shares)(1) Fiscal Year ($/Share) Date 5%($) 10%($) - ---- ---------------- ------------- -------- ---------- ----- ----- Joel P. Moskowitz - - - - - - David P. Reed 5,000 4.3% 3.250 1/08/09 10,220 25,898 5,000 4.3% 3.531 9/23/09 11,103 28,138 Howard F. George - - - - - - Earl E. Conabee - - - - - - Donald A. Kenagy 5,000 4.3% 3.250 1/08/09 10,220 25,898 Gerhart D. DeBoer 5,000 4.3% 3.250 2/08/09 10,220 25,898
- -------------- (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 for Mr. DeBoer, whose options have a term of two years and became exercisable on October 30, 1999. (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. 35 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, 1999 by the Named Executive Officers, the number of shares covered by both exercisable and unexercisable options as of December 31, 1999 and the value of unexercised in-the-money options held by the Named Executive Officers as of December 31, 1999:
Value of Unexercised Number of Securities Underlying In-the-Money Options at No. of Shares Unexercised Options at Fiscal Year-End Fiscal Year-End(1) Acquired on Value -------------------------------------- ---------------------------- Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable ---- ----------- -------- ---------------- ---------------- ----------- ------------- Joel P. Moskowitz -- -- -- -- -- -- David P. Reed 2,500 $6,875 38,400 27,100 $109,249 $42,439 Howard F. George -- -- 21,000 9,000 3,500 14,000 Earl E. Conabee 3,000 8,250 1,600 4,400 1,400 5,600 Donald A. Kenagy -- -- 6,600 9,400 11,400 21,850 Gerhart D. DeBoer -- -- 30,000 -- 35,155 --
(1) Based upon the closing price of the Common Stock on December 31, 1999, as reported by the Nasdaq National Market ($4.563 per share). 36 Employment Agreement - -------------------- In July 1994, the Company entered into a five-year employment agreement with Mr. Moskowitz, pursuant to which he will serve as Chairman of the Board of Directors, Chief Executive Officer and President of the Company. In February, 2000, the agreement was extended to July, 2001. Effective February 23, 2000, Mr. Moskowitz' base annual salary under this agreement was increased to $259,000. Under the agreement, if Mr. Moskowitz' employment is terminated by the Company (other than as a result of death, incapacity or for "good cause" as defined in the agreement) or if Mr. Moskowitz elects to resign for "good reason" (as defined in the agreement), Mr. Moskowitz will be entitled to receive severance pay in an amount equal to his annual base salary, at the rate in effect on the date of termination, payable on normal pay dates for the remainder of the term of the agreement. "Good reason" includes a "change in control" of the Company, a removal of Mr. Moskowitz from any of his current positions with the Company without his consent, or a material change in Mr. Moskowitz' duties, responsibilities or status without his consent. A "change in control" of the Company shall be deemed to occur if (1) there is a consolidation or merger of the Company where the Company is not the surviving corporation and the shareholders prior to such transaction do not continue to own at least 80% of the common stock of the surviving corporation, (2) there is a sale of all, or substantially all, of the assets of the Company, (3) the stockholders approve a plan for the liquidation or dissolution of the Company, (4) any person becomes the beneficial owner, directly or indirectly, of 30% or more of the Company's outstanding Common Stock or (5) if specified changes in the composition of the Company's Board of Directors occur. 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 1999, a fee of $500 per month plus $1000 for each Board meeting attended was paid to each non- employee director other than the Ford representative, Dr. Beardmore, who did not receive a fee. Compensation Committee Interlocks and Insider Participation - ----------------------------------------------------------- The Board of Directors has established Audit, Compensation and Stock Option 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. Beardmore, Edelstein, Alliegro, Shader and Lohr. The Audit Committee meets with the Company's independent public accountants to review the Company's financial condition and internal accounting controls. This committee is composed of Messrs. Edelstein, Beardmore, Shader and Lohr. The Stock Option Committee is composed of Mr. Moskowitz and Dr. Beardmore. This committee administers the Company's 1994 Stock Incentive Plan and the 1995 Employee Stock Purchase Plan. Dr. Beardmore is serving as Ford's representative on the Board of Directors. 37 Item 12. Security Ownership of Certain Beneficial Owners and Management -------------------------------------------------------------- The following table sets forth information as of March 3, 2000, 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 1,163,110 14.4% 3169 Redhill Avenue Costa Mesa, CA 92626 Ford Motor Company 1,207,299 14.9% The American Road Dearborn, MI 48121 Dimensional Fund Advisors, Inc. 544,900 (2) 6.7% 1299 Ocean Ave., 11th Floor Santa Monica, CA 90401 Leonard M. Allenstein 115,000 (3) 1.4% Richard A. Alliegro 24,500 (4) * Earl E. Conabee 31,184 (5) * Dr. Peter Beardmore - - Garhart D. DeBoer 30,000 (6) * Frank Edelstein 45,400 (7) * Donald A. Kenagy 19,195 (8) * Melvin A. Shader 28,000 (9) * Milton L. Lohr 25,000 (10) * David P. Reed 64,067 (11) * Howard F. George 21,557 (12) * All current executive 1,567,013 19.4% officers and directors as a group (12 persons above)
38 * 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) Based on information contained in a statement on Schedule 13G dated February 14, 2000, 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. (3) Includes 25,000 shares subject to options held by Mr. Allenstein which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (4) Includes 20,000 shares subject to options held by Mr. Alliegro which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (5) Includes 6,000 shares subject to options held by Mr. Conabee which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (6) Includes 30,000 shares subject to options held by Mr. DeBoer which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (7) Includes 27,500 shares subject to options held by Mr. Edelstein which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (8) Includes 8,400 shares subject to options held by Mr. Kenagy which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (9) Includes 15,000 shares subject to options held by Dr. Shader which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (10) Includes 25,000 shares subject to options held by Mr. Lohr which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (11) Includes 42,100 shares subject to options held by Mr. Reed which are currently exercisable or will become exercisable within 60 days of March 3, 2000. (12) Includes 21,000 shares subject to options held by Mr. George which are currently exercisable or will become exercisable within 60 days of March 3, 2000. 39 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 and Ford owns a total of 1,207,299 shares of the Company's Common Stock. The Company and Ford also entered into a joint development agreement which includes a commitment by Ford to contribute up to $5,000,000, on a matching value basis with Ceradyne, for the development by Ceradyne of technical ceramic products oriented towards the automotive market. Through December 31, 1999, Ford has contributed to the Company, on a cost sharing basis, a total of $4.8 million in cash and equipment under this joint development program. 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. 40 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, 1999 and 1998 47-48 Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997 49 Consolidated Statements of Stockholders Equity for the Years Ended December 31, 1999, 1998, and 1997 50 Consolidated Statements of Cash Flows for the Years ended December 31, 1999, 1998 and 1997 51-52 Notes to Consolidated Financial Statements 53-65 (2) Financial Statement Schedules: ------------------------------ Schedule VIII -- Valuation and Qualifying Accounts 66 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, 1999: 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. 4.1 Form of Representatives' Common Stock Purchase Warrant. Incorporated herein by reference to Exhibit 4.1 to the Registrant's Registration Statement on Form S-1 (File No. 33-62345). 41 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"). 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. 42 10.12 Lease dated August 5, 1986 covering premises located at 225 Paularino Avenue, Costa Mesa, California. Incorporated herein by reference to Exhibit 10.46 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986. 10.13 Short-form Memorandum of Lease Assignment dated December 15, 1986, and Lease dated June 23, 1980, covering premises located at 3449 Church Street, Scottdale, Georgia. Incorporated herein by reference to Exhibit 10.47 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986. 10.14* Amendment dated June 3, 1986 to the Ceradyne, Inc. 1983 Stock Option Plan. Incorporated herein by reference to Exhibit 10.50 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986. 10.15* Amendment dated March 16, 1987 to the Ceradyne, Inc. 1983 Stock Option Plan. Incorporated herein by reference to Exhibit 10.51 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986. 10.16 Joint Development 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). 43 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 10.28 to the Registrant's Annual report on Form 10-K for the fiscal year ended December 31, 1998. 21.1 Subsidiaries of the Registrant. Incorporated herein by reference to Exhibit 23.2 to the Registrant's Statement on Form S-1 (File No. 33-62345). 23.1 Consent of Arthur Andersen LLP. 27.1 Financial Data Schedule. * Each of these exhibits constitutes a management contract, compensatory plan, or arrangement required to be filed as an exhibit to this Report pursuant to Item 14(c) of this Report. 44 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, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Ceradyne, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. the schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and 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 ARTHUR ANDERSEN LLP Orange County, California March 3, 2000 45 CERADYNE, INC. -------------- CONSOLIDATED BALANCE SHEETS --------------------------- DECEMBER 31, 1999 AND 1998 --------------------------
ASSETS ------ (Amounts in thousands) 1999 1998 ---- ---- CURRENT ASSETS: Cash and cash equivalents $ 1,407 $ 2,870 Accounts receivable, net of allowances of approximately $39 and $92 for doubtful accounts in 1999 and 1998, respectively 5,837 4,381 Other receivables 98 167 Inventories 8,452 7,520 Production tooling 1,343 1,104 Prepaid expenses and other 1,147 880 -------- -------- Total current assets 18,284 16,922 -------- -------- PROPERTY, PLANT AND EQUIPMENT: Land 422 422 Buildings and improvements 1,825 1,825 Machinery and equipment 23,462 20,664 Leasehold improvements 1,870 1,723 Office equipment 2,456 2,210 Construction in progress 700 103 -------- -------- 30,735 26,947 Less--Accumulated depreciation and amortization (19,733) (18,090) -------- -------- 11,002 8,857 -------- -------- COSTS IN EXCESS OF NET ASSETS ACQUIRED, net of accumulated amortization of $2,071 and $1,908 in 1999 and 1998, respectively 1,846 2,009 -------- -------- OTHER ASSETS, net of accumulated amortization of $645 and $618 in 1999 and 1998, respectively 1,761 1,705 -------- -------- Total assets $ 32,893 $ 29,493 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. 46 CERADYNE, INC. -------------- CONSOLIDATED BALANCE SHEETS --------------------------- DECEMBER 31, 1999 AND 1998 -------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ (Amounts in thousands, except share data)
1999 1998 -------- --------- CURRENT LIABILITIES: Current maturities of long-term debt $ 100 $ --- Accounts payable 2,214 1,084 Accrued expenses: Payroll and payroll related 665 553 Other 149 234 ------- -------- Total current liabilities 3,128 1,871 ------- -------- LONG-TERM DEBT, less current maturities 358 --- ------- -------- DEFERRED REVENUE 270 270 ------- -------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Common stock, $.01 par value: Authorized--12,000,000 shares Outstanding--8,095,848 and 8,054,838 shares in 1999 and 1998, respectively 37,900 37,718 Accumulated deficit (8,763) (10,366) ------- -------- Total stockholders' equity 29,137 27,352 ------- -------- Total liabilities and stockholders' equity $32,893 $ 29,493 ======= ========
The accompanying notes are an integral part of these consolidated balance sheets. 47 CERADYNE, INC. -------------- CONSOLIDATED STATEMENTS OF OPERATIONS ------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 ---------------------------------------------------- (Amounts in thousands, except per share data)
1999 1998 1997 -------- -------- -------- NET SALES $30,382 $26,279 $28,693 COST OF PRODUCT SALES 23,674 21,292 23,274 ------- ------- ------- Gross profit 6,708 4,987 5,419 ------- ------- ------- OPERATING EXPENSES: Selling 1,480 1,494 1,515 General and administrative 3,400 3,239 3,660 Research and development 597 344 --- ------- ------- ------- 5,477 5,077 5,175 ------- ------- ------- Income (loss) from operations 1,231 (90) 244 ------- ------- ------- OTHER INCOME (EXPENSE): Other income 344 382 265 Interest expense (16) --- (134) ------- ------- ------- 328 382 131 ------- ------- ------- Income before provision (benefit) for income taxes 1,559 292 375 PROVISION (BENEFIT) FOR INCOME TAXES (44) 10 (1,675) ------- ------- ------- Net income $ 1,603 $ 282 $ 2,050 ======= ======= ======= BASIC INCOME PER SHARE $.20 $.04 $.26 ======= ======= ======= DILUTED INCOME PER SHARE $.20 $.04 $.26 ======= ======= ======= WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: Basic 8,070 8,005 7,931 ======= ======= ======= Diluted 8,189 8,068 8,035 ======= ======= =======
The accompanying notes are an integral part of these consolidated statements. 48 CERADYNE, INC. -------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ----------------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 ---------------------------------------------------- (Amounts in thousands, except share data)
Common Stock ------------ Number Accumulated of Shares Amount Deficit --------- ------ ------- BALANCE, December 31, 1996 7,901,790 $37,138 $(12,698) Issuance of common stock 37,469 202 --- Exercise of stock options 24,200 68 --- Net income --- --- 2,050 --------- ------- -------- BALANCE, December 31, 1997 7,963,459 37,408 (10,648) Issuance of common stock 50,179 197 --- Exercise of stock options 41,200 113 --- Net income --- --- 282 --------- ------- -------- BALANCE, December 31, 1998 8,054,838 37,718 (10,366) Issuance of common stock 30,741 154 --- Exercise of stock options 10,269 28 --- Net income --- --- 1,603 --------- ------- -------- BALANCE, December 31, 1999 8,095,848 $37,900 $ (8,763) ========= ======= ========
The accompanying notes are an integral part of these consolidated statements. 49 CERADYNE, INC. -------------- CONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------- FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 ---------------------------------------------------- (Amounts in thousands)
1999 1998 1997 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,603 $ 282 $ 2,050 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,835 1,505 1,361 Changes in operating assets and liabilities: (Increase) decrease in accounts receivable, net (1,456) 304 169 Decrease (increase) in other receivables 69 (71) 1,301 (Increase) decrease in inventories (932) (154) 390 Increase in production tooling (239) (222) (344) Increase in prepaid expenses and other assets (352) (324) (1,683) Increase (decrease) in accounts payable 1,130 (113) (465) Increase (decrease) in accrued expenses 27 (3) (245) Increase in deferred revenue --- --- 9 ------- ------- ------- Net cash provided by operating activities 1,685 1,204 2,543 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property, plant and equipment (3,788) (2,213) (2,887) ------- ------- ------- Net cash used in investing activities (3,788) (2,213) (2,887) ------- ------- -------
The accompanying notes are an integral part of these consolidated statements. 50 CERADYNE, INC. -------------- CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued) ------------------------------------- (Amounts in thousands)
1999 1998 1997 -------- ------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock $ 182 $ 310 $ 270 Borrowings on long-term debt 500 --- (1,000) Payments on long-term debt (42) --- --- ------- ------ ------- Net cash provided by (used in) financing activities 640 310 (730) ------- ------ ------- Decrease in cash and cash equivalents (1,463) (699) (1,074) Cash and cash equivalents, beginning of period 2,870 3,569 4,643 ------- ------ ------- Cash and cash equivalents, end of period $ 1,407 $2,870 $ 3,569 ------- ------ ------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 16 $ --- $ 134 ======= ====== ======= Income taxes paid $ 39 $ 10 $ 33 ======= ====== =======
The accompanying notes are an integral part of these consolidated statements. 51 CERADYNE, INC. -------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ DECEMBER 31, 1999 ----------------- 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 ----------- 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, ----------------------- 1999 1998 ---------- ---------- Raw materials $4,454,000 $4,098,000 Work-in-process 3,198,000 2,413,000 Finished goods 800,000 1,009,000 ---------- ---------- $8,452,000 $7,520,000 ========== ==========
52 e. Property, Plant and Equipment ----------------------------- Depreciation and amortization of property, plant and equipment are provided using the straight-line method over the following estimated useful lives: Buildings and improvements 20 years Machinery and equipment 3 to 12 years Leasehold improvements Term of lease Office equipment 5 years Maintenance, repairs and minor renewals are charged to expense as incurred. Repairs and maintenance expense approximated $720,000, $729,000, and $708,000 in 1999, 1998 and 1997, respectively. Additions and improvements are capitalized. When assets are disposed of, the applicable costs and accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is included in the results of operations. f. Sales Recognition ----------------- Sales are recorded as of the date shipments are made, or goods are accepted by customers for production contracts. g. Deferred Revenue ---------------- In October 1999, Ford Motor Company contributed $270,000 for the year 2000 to the Joint Product Development Program (see Note 9 on Page 64). The Company will fully amortize this amount to revenue during 2000. In 1998 and 1997, Ford Motor Company also contributed $270,000 for each year. The Company has fully amortized these amounts to revenue during 1998 and 1999. h. Net Income Per Share -------------------- The Company accounts for net income per share in accordance with SFAS No. 128 "Earnings Per Share". Basic net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding plus the effect of any dilutive stock options and common stock warrants using the treasury stock method. 53 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, --------------------------------- 1999 1998 1997 --------- --------- --------- Weighted average number of shares outstanding 8,070,225 8,005,000 7,931,000 Dilutive stock options and common stock warrants 119,174 63,000 104,000 --------- --------- --------- Number of shares used in diluted computation 8,189,399 8,068,000 8,035,000 ========= ========= =========
i. 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 goodwill) by determining whether the asset balance can be recovered over the remaining depreciation or amortization period through projected undiscounted future cash flows. Cash flow projections, although subject to a degree of uncertainty, are based on trends of historical performance and management's estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions. There were no impairment charges in any of the three years in the period ended December 31, 1999. j. Deferred Start-up and Preproduction Engineering ----------------------------------------------- In April 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-Up Activities", effective for fiscal years beginning after December 15, 1998. This statement requires cost of start-up activities and organization costs to be expensed as incurred. Prior to the effective date, the Company incurred and amortized approximately $252,000 of deferred start-up costs related to the semiconductor product line during the year ended December 31, 1998. 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 supply arrangement should be expenses as incurred. The effect of adoption will be immaterial to the Company's financial statements. In 1998, the Company capitalized $188,000 in pre-production 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 $172,000 as of December 31, 1999 will be amortized during the year 2000. 54 k. Use of Estimates ---------------- The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. l. Engineering and Research ------------------------ 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 $597,000 as of December 31, 1999 compared to $344,000 in the prior year. In addition, the Company has historically 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 $281,000, $384,000 and $380,000 in 1999, 1998 and 1997, respectively. m. Stock Based Compensation Plans ------------------------------ Effective January 1, 1996, the Company adopted the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". At a minimum, SFAS No. 123 requires the Company to disclose pro forma net income and earnings per share as if the fair value based accounting method of SFAS No. 123 had been used to account for stock-based compensation. These disclosures are included in Note 7. n. Fair Value of Financial Instruments ----------------------------------- The carrying value of accounts receivable and trade payables approximates the fair value due to their short-term maturities. The carrying value of the Company's line of credit is considered to approximate fair market value as the interest rates of these instruments are based predominately on variable reference rates. 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. o. Environmental Liabilities and Expenditures ------------------------------------------ Accruals for environmental matters are recorded in operating expenses when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. In the fourth quarter of 1998, the Company recorded approximately $178,000 as an accrual for the written notification from the United States Environmental Protection Agency that the Company was a responsible party in the Superfund cleanup of the Casmalia Disposal Site in Santa Barbara County, CA. The notification states that Ceradyne, along with approximately 10,000 other parties, have been designated as "de minimus" waste generators due to the relatively small quantities of their waste disposal. The Company properly disposed of this waste material in the 1970's and 1980's, however the Casmalia Disposal Site leaked into the water table. Thus the waste generators must pay their share of the cost of the cleanup effort. After review and 55 negotiation, the EPA reduced the charge to $112,000. The amount was paid in full in December, 1999. p. New Accounting Pronouncements ----------------------------- In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Currently, the Company does not have any instruments that would qualify as derivatives under SFAS No. 133. Accordingly, the Company does not believe SFAS No. 133 will have a material impact on the Company's financial position, results of operations, or liquidity at the current time. 2. Debt and Bank Borrowing Arrangements ------------------------------------ In November, 1997 the Company entered into a revolving credit agreement with Comerica Bank. The credit facility amount remains at $4,000,000 as of year ended December 31, 1999 and no collateral is required of the Company. As of December 31, 1999 there had been no borrowing under this credit facility. 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. The equipment serves as the collateral for the loan. Long Term Debt -------------- Capital equipment loan bearing interest at $ 458,000 8.18% APR, as of December 31, 1999. Payable in monthly installments of $8,333 expiring July 2004. Less: current portion (100,000) -------- Long term debt $ 358,000 ======== 3. Income Taxes ------------ The provision (benefit) for income taxes is comprised of the following for the year ended December 31: 1999 1998 1997 ---- ---- ---- Current $(44,000) $10,000 $ 33,000 Deferred --- --- (1,708,000) -------- ------- ----------- $(44,000) $10,000 $(1,675,000) ======== ======= =========== 56 The Company's deferred tax asset at December 31, 1999 relates primarily to its tax net operating loss carryforwards, which total approximately $10.6 million and expire as follows: 2003 $ 634,000 2004 3,015,000 2005 161,000 2006 218,000 2007 1,093,000 2008 2,050,000 2009 1,828,000 2012 1,620,000 ----------- $10,619,000 =========== The components of the Company's deferred tax asset as of December 31, 1999 and 1998 are as follows: December 31, ------------ 1999 1998 ---- ---- Inventory adjustments $ 264,000 $ 246,000 Contingency reserves --- 71,000 Vacation accrual 104,000 91,000 Bad debt allowance 16,000 36,000 Net operating loss and tax credit carryforwards 4,248,000 4,961,000 Other 67,000 (81,000) ----------- ----------- 4,699,000 5,324,000 Valuation allowance (2,991,000) (3,699,000) ----------- ----------- Net deferred tax asset $ 1,708,000 $ 1,625,000 =========== =========== The deferred tax asset is classified in other assets at December 31, 1999 and 1998. Management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax asset as reduced by the valuation allowance. The effective income tax rate for the years ended December 31, 1999, 1998 and 1997 differs from the Federal statutory income tax rate due to the following items:
December 31, ------------ 1999 1998 1997 ---- ---- ---- Income before taxes $1,559,000 $292,000 $ 375,000 ---------- -------- ----------- Provision for income taxes at federal statutory rate 530,060 99,280 127,500 State income taxes 75,612 14,162 18,188 Reduction of valuation allowance (708,000) (15,000) (1,846,000) Other 58,328 (88,442) 25,312 ---------- -------- ----------- Provision (benefit) for income taxes $ (44,000) $ 10,000 $(1,675,000) ========== ======== =========== Effective tax rate (2.82)% 3.42% (446.67)% ========== ======== ===========
57 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 2005. The Company incurred rental expense under these leases of $653,433, $667,000 and $620,000 in 1999, 1998 and 1997, respectively. The approximate minimum rental commitments required under existing noncancelable leases as of December 31, 1999 are as follows: 2000 $ 648,456 2001 673,160 2002 698,819 2003 725,461 2004 753,129 2005 781,870 ---------- $4,280,895 ========== b. Employment Agreement -------------------- The Company has an employment agreement with the Chief Executive Officer which expires 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 1999, 1998 and 1997 was $256,112, $231,111 and $232,964, respectively. c. Legal Proceedings ----------------- The Company is, from time to time, involved in various legal and other proceedings that relate to the ordinary course of operating its business, including, but not limited to, employment-related actions and workers' compensation claims. In October 1995, February 1997, August 1997, February 1999, and December 1999, the Company, along with others, was served with six different complaints that were filed by nine former employees of one of the Company's customers, and eight spouses. The complaints, filed in the United States District Court, Eastern District of Tennessee, allege that the customers' employees contracted chronic beryllium disease as a result of their exposure to beryllium-containing products sold by Ceradyne and others. One complaint seeks compensatory damages in the amount of $3.0 million for the four husbands, $1.0 million for the four spouses, and punitive damages in the amount of $5.0 million. Four other complaints each seek compensatory damages in the amount of $5.0 million for four husbands, $1.0 million for the spouses, and punitive damages in the amount of $10.0 million. The final complaint seeks compensatory damages in the amount of $5.0 million for an individual and punitive damages in the amount of $10.0 million. The Company believes that the plaintiffs' claims are without merit and that the resolution of these matters will not have a material adverse effect on the financial condition or operations of the Company. Defense of these cases has been tendered to the Company's insurance carriers, some of which are providing a defense subject to a reservation of rights. There can be no assurances, however, that these claims will 58 be covered by insurance, or that, if covered, the amount of insurance will be sufficient to cover any potential judgments. We were notified by the United States Environmental Protection Agency in December, 1998 that Ceradyne is a responsible party in the federal Superfund cleanup of the Casmalia Disposal Site located in Santa Barbara County, California. The notification states that Ceradyne, along with approximately 10,000 other companies, has been designated as a de minimus waste generator due to the relatively small quantity of the waste disposed at the Casmalia Disposal Site. We properly disposed of this waste material in the 1970s and 1980s. However, waste materials disposed at the Casmalia Disposal Site have leaked into the water table. Under federal law, all parties who have disposed of waste materials at the Casmalia Site must pay their proportional share of the cost of the cleanup effort. In the fourth quarter of 1998, we recorded an expense in the amount of $0.2 million as the estimated amount of our share of the cleanup costs. After negotiations with the EPA, the final settlement was $0.1 million and was paid in December, 1999. 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, 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:
=================================================================================================================================== FACILITY LOCATION PRODUCTS - ----------------------------------------------------------------------------------------------------------------------------------- Advanced Ceramic Operations . Semiconductor Equipment Components Costa Mesa, California . Lightweight ceramic armor Approximately 74,000 square feet . Orthodontic ceramic brackets . Ceralloy(R) 147 SRBSN wear parts . Precision ceramics . Ceralloy(R) 147 SRBSN diesel/automotive engine parts (R&D) 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 product ====================================================================================================================================
59 Ceradyne, Inc. Segment Statement of Operations for the Years Ended December 31, 1999, 1998, and 1997 (amounts in thousands)
Advanced Ceramic Ops Semicon Associates Thermo Materials TOTAL -------------------- ------------------- ---------------- ----- - ------------------------------------------------------------------------------------------------------------------------------------ 1999 1998 1997 1999 1998 1997 1999 1998 1997 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ Revenue from $17,839 $14,176 $17,202 $6,385 $5,995 $ 6,134 $6,158 $6,108 $5,357 $30,382 $26,279 $28,693 External ------- ------- ------- ------ ------ ------- ------ ------ ------ ------- ------- ------- Customers Depreciation $ 1,272 $ 992 $ 843 $ 347 $ 301 $ 293 $ 216 $ 212 $ 225 $ 1,835 $ 1,505 $ 1,361 and ------- ------- ------- ------ ------ ------- ------ ------ ------ ------- ------- ------- Amortization Segment Income $ 762 $ 37 $ 2,356 $ 395 $ (114) $(2,045) $ 402 $ 369 $ 64 $ 1,559 $ 292 $ 375 (loss) before ------- ------- ------- ------ ------ ------- ------ ------ ------ ------- ------- ------- provision (benefit) for income taxes Segment Assets $23,196 $19,960 $19,403 $5,877 $6,398 $ 6,362 $3,820 $3,135 $3,252 $32,893 $29,493 $29,017 ------- ------- ------- ------ ------ ------- ------ ------ ------ ------- ------- ------- Expenditures $ 2,989 $ 1,827 $ 2,306 $ 322 $ 272 $ 479 $ 477 $ 114 $ 102 $ 3,788 $ 2,213 $ 2,887 for Segment ------- ------- ------- ------ ------ ------- ------ ------ ------ ------- ------- ------- Assets of PP&E --------------------------------------------------------------------------------------------------------------------
Segment Statement for Net Sales by Area for the Years Ended December 31, 1999, 1998, and 1997 (in %)
Advanced Ceramic Ops Semicon Associates Thermo Materials TOTAL -------------------- ------------------ ---------------- ----- - ------------------------------------------------------------------------------------------------------------------------------------ 1999 1998 1997 1999 1998 1997 1999 1998 1997 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ U.S. Net Sales 54% 47% 53% 18% 18% 14% 17% 19% 13% 89% 84% 80% Western Europe 3% 4% 4% 2% 3% 3% 1% 2% 3% 6% 9% 10% Net Sales Asia Net Sales 1% 1% 1% 1% 2% 4% 2% 1% --- 4% 4% 5% Israel Net --- 2% 1% --- --- --- --- --- --- --- 2% 1% Sales Canada Net 1% --- --- --- --- --- --- 1% 1% 1% 1% 1% Sales Other --- --- 1% --- --- --- --- --- 2% --- --- 3% ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Total Net Sales 59% 54% 60% 21% 23% 21% 20% 23% 19% 100% 100% 100% ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ==== ---------------------------------------------------------------------------------------------------------------------
60 For fiscal year 1999, one customer accounted for approximately 18% of net consolidated sales. For fiscal year 1998, two customers accounted for approximately 16% and 11% of net consolidated sales. For fiscal year 1997, one customer accounted for approximately 17% of net consolidated sales. 6. Comprehensive Income -------------------- Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income" which established standards for the reporting and display of comprehensive income and its components in financial statements. Comprehensive income generally represents all changes in stockholder's equity except those resulting from investments by and distributions to owners. Currently, no difference exists between the Company's net income and its comprehensive net income. 7. 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 FASB Statement No. 123, the Company's net income and earnings per share would have been reduced to the following pro forma amounts: 1999 1998 1997 ---- ---- ---- Net income: As reported $1,603,000 $282,000 $2,050,000 Pro forma $1,276,320 $ 97,371 $1,888,000 Basic income per share As reported $ .20 $ .04 $ .26 Pro forma .16 .01 .24 Diluted income per share As reported $ .20 $ .04 $ .26 Pro forma .16 .01 .23 Because the Statement No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. Additionally, the 1999, 1998 and 1997 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 100,000 shares of stock to its full-time employees under the 1995 Employee Stock Purchase Plan. The Company has sold 26,793, 24,162 and 22,004 shares in 1999, 1998 and 1997, 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. The weighted average fair value of shares sold in 1999, 1998 and 1997 was $3.876, $3.93 and $4.63, respectively. The Company may grant options for up to 650,000 shares under the 1994 Stock Incentive Plan. The Company has granted options for 757,700 and has had cancellations of 125,205 shares through December 31, 1999. Options are granted at or above the fair market value at the date of grant and 61 generally become exercisable over a five-year period. A summary of the status of the Company's stock option plan at December 31, 1997, 1998 and 1999 and changes during the years then ended is presented in the table and narrative below: Weighted Average Shares Exercise Price -------- ----------------- OUTSTANDING, December 31, 1996 384,050 $ 3.56 ======= ====== Granted 139,500 6.14 Exercised (23,900) 2.85 Canceled (33,800) 4.98 ------- ------ OUTSTANDING, December 31, 1997 465,850 $ 4.26 ======= ====== Granted 128,500 $ 4.41 Exercised (41,200) (2.75) Canceled (55,000) (5.92) ------- ------ 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 ======= ====== Of the 628,550 options outstanding at December 31, 1999, 402,850 have exercise prices between $2.00 and $4.375, with a weighted average exercise price of $3.11, and a weighted average remaining contractual life of five years. The remaining 225,700 options have exercise prices between $4.75 and $7.375, with a weighted average exercise price of $5.76, and a weighted average remaining contractual life of nine years. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1999, 1998, and 1997, respectively: risk free interest rates of 6.51, 5.40 and 6.38 percent; expected life for 1999, 1998 and 1997 of 7 years; expected volatility of 65.06, 94.87 and 57.43 percent. The assumed dividend yield in 1999, 1998 and 1997 is zero percent. 8. Supplemental Retirement Plan ---------------------------- In December 1988 the Board of Directors of the Company approved the adoption of a supplemental retirement plan (Ceradyne SMART 401(k) Plan) in which substantially all employees are eligible to participate after completing 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 $10,000 in 1999, whichever is less) of the employee's pretax compensation as a basic contribution. The exception to this rule are the highly compensated employees ($80,000 and above) who are limited to 7% of 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, 1999, 1998, and 1997, the related Company contribution was approximately $14,300, $42,000 and $116,000, respectively. 62 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 one or all of the following: (1) Fixed Income Fund, (2) Bond and Mortgage Fund, (3) International Stock Fund, or (4) Equity Fund. The member can elect to allocate the accumulated and future contributions to their accounts among these funds in increments of 10 percent. The Company has reserved 250,000 shares of its common stock for possible issuance under the Plan. At December 31, 1999, 121,949 shares were available for issuance under the Plan. 9. Joint Venture and Joint Development Agreement --------------------------------------------- On March 11, 1986, the Company sold 526,316 shares of its common stock to Ford Motor Company (Ford) for a gross sales price of $10,000,000. In addition, Ford and the Company formed a joint venture, Ceradyne Advanced Products, Inc. (CAPI), in which the Company acquired a 20 percent interest for $200,000. Ford contributed certain technology in exchange for its 80 percent interest in the joint venture. The Company granted Ford an option to put Ford's 80 percent interest in the joint venture to the Company in exchange for 608,020 shares of the Company's common stock. Ford granted the Company an option to call Ford's 80 percent interest in the joint venture in exchange for 680,983 shares of the Company's common stock. On February 13, 1988, the Company exercised its call option and issued 680,983 shares of its common stock to Ford. The value of the shares issued ($2,043,000) was allocated to the technology acquired and is being amortized over a 20 year period utilizing the purchase method of accounting. Ford and the Company have also entered into a joint development program to develop a prototype production facility to produce ceramics with automotive applications. Under the terms of the joint development agreement, Ford and the Company share equally in the cost of this project. For the years ending December 31, 1999, 1998 and 1997, Ford has contributed $270,000 in each year which have been reflected as revenue in the accompanying consolidated financial statements. 10. Interim Financial Information (unaudited) ----------------------------------------- The results by quarter for 1999 and 1998 are as follows:
Quarter Ending -------------- March 31, June 30, September 30, December 31, 1999 1999 1999 1999 -------------- ---------- ------------- ------------ Net sales $6,305,000 $7,331,000 $7,810,000 $8,936,000 Net income 48,000 401,000 496,000 658,000 Diluted income per share- $ .01 $ .05 $ .06 $ .08 ========== ========== ========== ==========
63
Quarter Ending -------------- March 31, June 30, September 30, December 31, 1998 1998 1998 1998 ---------- ---------- ------------- ------------- Net sales $7,341,000 $6,342,000 $6,290,000 $6,305,000 Net income 483,000 326,000 44,000 (571,000) Diluted income per share- $ .06 $ .04 $ .01 $ (.07) ========== ========== ========== ==========
64 SCHEDULE VIII - 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, 1999: - ------------------ Allowance for doubtful accounts receivable $ 92 $ 77 $130 $39 ==== ==== ==== === For the Year Ending December 31, 1998: - ------------------ Allowance for doubtful accounts receivable $179 $ 55 $142 $92 ==== ==== ==== === For the Year Ending December 31, 1997: - ------------------ Allowance for doubtful accounts receivable $125 $134 $ 80 $179 ==== ==== ==== ====
65 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 30, 2000 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 30, 2000 - ---------------------------- Chief Executive Officer, Joel P. Moskowitz President and Director (Principle executive officer) /s/ Howard F. George Chief Financial Officer March 30, 2000 - ---------------------------- (Principle financial Howard F. George and accounting officer) /s/ Leonard M. Allenstein Director March 30, 2000 - ---------------------------- Leonard M. Allenstein /s/ Richard A. Alliegro Director March 30, 2000 - ---------------------------- Richard A. Alliegro /s/ Frank Edelstein Director March 30, 2000 - ---------------------------- Frank Edelstein /s/ Peter Beardmore Director March 30, 2000 - ---------------------------- Peter Beardmore /s/ Melvin A. Shader Director March 30, 2000 - ---------------------------- Melvin A. Shader /s/ Milton L. Lohr Director March 30, 2000 - ---------------------------- Milton L. Lohr 66 EX-23.1 2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K, into the Company's previously filed Registration Statement File No. 333-31679 and Registration Statement File No. 33-61677. /s/ ARTHUR ANDERSEN LLP ----------------------- ARTHUR ANDERSEN LLP Orange County, California March 27, 2000 EX-27.1 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM 10K-YEAR ENDED DECEMBER 31, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENT. 1,000 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 1,407 0 5,837 98 8,452 18,284 30,735 19,733 32,893 3,128 0 0 0 37,900 0 32,893 30,382 30,382 23,674 22,115 0 0 0 1,559 (44) 0 0 0 0 1,603 .20 .20
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