Certain Factors That May Affect the Company's Business and Future Results
This annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. The Company's actual results may differ
materially from the results projected in the forward-looking statements.
Factors that might cause such a difference include, but are not limited to, the
We Have a History of Losses Although We Have Been Profitable Since Fiscal Year
We were profitable in fiscal 1995, 1996, 1997 and 1998, after losing
approximately $21.4 million during fiscal years 1987 through 1994. A number of
factors caused our losses. Foremost was a decline in revenues due in part to
reduced government spending on defense-related products. In the past, these
products represented the majority of our business. We expect defense-related
products to represent a substantial portion of our business in the foreseeable
future. Therefore, future declines in government defense-related expenditures
may adversely affect our future profitability.
Past losses were also caused by declines in sales of our translucent ceramic
orthodontic bracket, from peak revenues of $6.2 million in 1988 to $.4 million
in 1994. Sales of this bracket declined in part because our exclusive bracket
distributor, Unitek Corporation, a subsidiary of Minnesota Mining & Mfg. Co.,
had accumulated excess inventory levels. Sales also declined because technical
problems caused some orthodontists to resist using earlier versions of the
To maintain profitability and achieve revenue growth, we must, among other
. develop the capacity to manufacture ceramic body armor in volume and to
address other opportunities for the use of our ceramics in armor
. sell significant amounts of the newest version of our translucent
orthodontic bracket product, marketed by Unitek under the brand name
. develop the capacity to successfully manufacture semiconductor equipment
components in volume and at acceptable profit margins; and
. continue to upgrade our technologies and commercialize products and
services incorporating such technologies.
If we do not successfully manage the factors that led to our losses, if we fail
to develop, manufacture and market profitable, high-quality ceramic products, or
if factors beyond our control reduce sales or profitability, we may not improve,
or even sustain, our current profitability.
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
. semiconductor equipment components;
. lightweight ceramic armor vests for military personnel; and
. 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 the experimental stage. To successfully
produce these components, we must significantly lower manufacturing costs and
develop high volume manufacturing capabilities while maintaining component
quality. If we meet our production goals, it typically takes several years to
introduce new materials and components into production automobiles. Thus,
demand for these products and our ability to service such demand are subject to
a high degree of uncertainty.
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 letter of
intent for the production of diesel engine components made from Ceradyne's
Ceralloy 147-lN sintered reaction bonded silicon nitride (SRBSN). We expect to
begin production late in the first quarter of 1999 and to ship approximately $1
million annually starting in the second quarter of 1999. Contingent upon our
1999 performance, including meeting certain customer quality and delivery
milestones, we anticipate significantly higher sales volumes in the year 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, particularly given the increasingly international
scope of our operations, 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 us that expires in July 1999, 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.
The Advanced Technical Ceramics Markets Are Highly Competitive
The markets for applications of advanced technical ceramics are competitive. We
believe the principal competitive factors in these matters are:
. product performance;
. material specifications;
. application engineering capabilities
. customer support
. reputation; and
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, Spectromat, and
others. No 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
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
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 could have material adverse effects on our business, operating results
and financial condition.
We were recently notified by the United States Environmental Protection Agency
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. We are currently investigating whether we are entitled to reimbursement
for this cost under our insurance policies.
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 $17.0 million backlog of orders as of December 31, 1998. Of this
amount, approximately $8.5 million, or 50%, represents orders for defense
applications. These orders are closely tied to the level of U.S. defense
spending. Certain contracts for helicopter armor 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. 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
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
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 arch wire through the ceramic brackets,
resulting in longer treatment times than with stainless steel brackets.
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 1996, 20% in 1997, and 10% in 1998. 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
. burdens of 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
. 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
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
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