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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

or

Commission File No. 000-13059

CERADYNE, INC.

(Exact name of Registrant as specified in its charter)

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

N/A

(Former name, former address and former fiscal year, if changed since last report)

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

Yes ¨                                                  No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Page 1 of 25 Pages

CERADYNE, INC.

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CERADYNE, INC.

FORM 10-Q

FOR THE QUARTER ENDED

June 30, 2003

The Financial Statements included herein have been prepared by Ceradyne, Inc. (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information normally included in the Financial Statements prepared in accordance with accounting principles generally accepted in the United States has been omitted pursuant to such rules and regulations. However, the Company believes the disclosures are adequate to make the information presented not misleading. All adjustments have been made which are, in the opinion of management, necessary to a fair statement of the results of the interim periods presented. The Financial Statements should be read in conjunction with the Financial Statements and notes thereto included in the Company’s Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 on Form 10-K for the fiscal year ended December 31, 2002, as filed with the Securities and Exchange Commission on March 31, 2003.

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CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS

ASSETS

(Amounts in thousands)

See accompanying condensed notes to Consolidated Financial Statements

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CERADYNE, INC.

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND SHAREHOLDERS’ EQUITY

(Amounts in thousands, except share data)

See accompanying condensed notes to Consolidated Financial Statements

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CERADYNE, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except share data)

See accompanying condensed notes to Consolidated Financial Statements

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CERADYNE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

See accompanying condensed notes to Consolidated Financial Statements

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CERADYNE, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2003

(Unaudited)

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three-month and the six-month periods ended June 30, 2003 are not necessarily indicative of the results that may be expected for the year ended December 31, 2003.

The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

For further information, refer to the Consolidated Financial Statements and Notes to Financial Statements included in Ceradyne’s Annual Report on Form 10-K for the year ended December 31, 2002.

Inventories are valued at the lower of cost (first in, first out) or market. Inventory costs include the cost of material, labor and manufacturing overhead. The following is a summary of the inventory components as of June 30, 2003 and December 31, 2002 (in thousands):

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In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The provisions of this statement are effective for exit or disposal activities initiated after December 31, 2002. The application of this statement did not have a significant impact on the Company’s consolidated financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“Interpretation”). This Interpretation elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also requires that at the time a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions of the Interpretation apply on a prospective basis to guarantees issued or modified after December 31, 2002. The application of this statement did not have an impact on the Company’s consolidated financial statements.

Basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted net income per share is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding plus the effect of any dilutive stock options and common stock warrants using the treasury stock method.

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

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In addition to the capital equipment loan, the Company also has a bank line of credit. The Company may borrow up to $7,500,000 with interest on borrowings charged at one-half percentage point below the bank’s prime rate. The bank’s prime rate was 4.00 percent at June 30, 2003. The bank line of credit had an outstanding balance at June 30, 2003 of approximately $1,615,000. Pursuant to the bank line of credit, the Company is subject to certain covenants, which include, among other things, the maintenance of tangible net worth, quick assets to current liabilities ratio, and total liabilities to tangible net worth ratio. At June 30, 2003, the Company was in compliance with these covenants. The line of credit is collateralized by substantially all of the Company’s assets and is payable on demand.

The Company applies the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for stock-based compensation; therefore, no compensation expense has been recognized for its fixed stock option plans as options are granted at fair market value based upon the closing price on the grant date. The Company has adopted the disclosure requirements for SFAS No. 123, “Accounting for Stock-Based Compensation”. On December 31, 2002, the FASB issued SFAS No. 148, “Accounting for Stock Based Compensation-Transition and Disclosure,” which amends SFAS No. 123. SFAS No. 148 requires more prominent and frequent disclosures about the effects of stock-based compensation, which the Company adopted in the year ended December 31, 2002. Accordingly, if compensation expense for the Company’s stock options had been recognized, based upon the fair value of awards granted, the Company’s net income and earnings per share would have been reduced to the following pro forma amounts:

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There were no options granted during the first quarter ended March 31, 2003 and options for 15,000 shares were granted in the second quarter ended June 30, 2003.

The pro forma amounts were estimated using the Black-Scholes option-pricing model with the following assumptions:

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. The Company’s options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate.

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The Company serves its markets and manages its business through three divisions, each of which has its own manufacturing facilities and administrative and selling functions. The Company’s Advanced Ceramic Operations, located in Costa Mesa and Irvine, California, primarily produces armor and orthodontic products, diesel engine parts, components for semiconductor equipment, and houses the Company’s sintered reaction bonded silicon nitride (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:

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Ceradyne, Inc.

Segment Disclosures

(Amounts in thousands)

Three Months Ended June 30,

The following is revenue by product line for Advanced Ceramic Operations for the quarter ended June 30:

Six Months Ended June 30,

The following is revenue by product line for Advanced Ceramic Operations for the six months ended June 30:

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Three Months Ended June 30,

Six Months Ended June 30,

From time to time, the Company is involved in legal proceedings incidental to its business. The Company believes that pending actions, individually and in the aggregate, will not have a material adverse effect on its financial condition, results of operations or cash flows, and that adequate provision has been made for the resolution of such actions and proceedings.

The U.S. Government Defense Logistics Agency (DLA) notified the Company on March 27, 2002, that 3 lots of Ceradyne’s small arms protective inserts (SAPI) for lightweight ceramic armor shipped in January 2002 failed to pass ballistics “reverification” tests by the Government’s designated independent commercial testing laboratory. During the period of December 2001 through March 27, 2002, the Company had shipped approximately $5.1 million under its existing contract with the DLA. Subsequent to March 27, 2002, the DLA directed the independent testing laboratory to perform “reverification” testing and $3.4 million of the shipments were not in testing compliance.

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When notified of these issues on March 27, 2002, the Company voluntarily stopped producing its original SAPI design and actively worked with the Government to understand the quality and testing issues and to resolve the status and disposition of the SAPI plates in question. The Company completed the development of a modified design for its ceramic SAPI armor plates. Independently performed tests by the Government’s designated testing laboratory of the modified design have been successful and the “first article” (initial production parts) of this modified design was approved in June 2002.

On August 7, 2002, the Company signed an amendment to the contract with the Government regarding certain of the SAPI plates shipped in December 2001, and the first quarter 2002. The amendment requires that the Company correct or replace at its expense all supplies of the product that did not meet the original contractual requirements. The warranty items were delivered over the period from October 2002 through June 2003. The Company estimated the cost to rework and upgrade the SAPI plates at approximately $650,000 and set up a warranty reserve in that amount, recorded in the second quarter ended June 30, 2002 against cost of product sales. Upon completion of the cost to rework and upgrade the SAPI plates during the second quarter ended June 30, 2003, there was a remaining warranty reserve amount of $148,000 that was credited to cost of product sales.

Changes in the product warranty accrual for the six months ended June 30, 2003 were as follows:

During July 2003, the Company completed a public offering of 1,725,000 shares of newly issued common stock, and an additional 345,000 shares of common stock by a selling stockholder, at a public price of $17.50 per share. The Company received from the sale of 1,725,000 shares, after underwriting discount and selling expenses, net proceeds of approximately $27.8 million. The Company used a portion of the net proceeds to repay outstanding debt, and will use a portion of the net proceeds to expand production capacity and to purchase machinery and equipment while the remaining balance will be used for working capital and other general corporate purposes. The Company did not receive any proceeds from the sale of shares by the selling stockholder.

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Preliminary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains statements which may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. One generally can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “may,” “will,” “expects,” “intends,” “estimates,” “anticipates,” “plans,” “seeks,” or “continues,” or the negative thereof, or variations thereon, or similar terminology. Forward-looking statements regarding future events and the future performance of the Company involve risks and uncertainties that could cause actual results to differ materially. Reference is made to the risks and uncertainties which are described in Note 9, “Commitments and Contingencies”, of Condensed Notes to Consolidated Financial Statements on page 14 of this report, and in the section captioned “Risk Factors” in the Company’s Prospectus dated July 1, 2003 as filed with the Securities and Exchange Commission.

Results of Operations for the Three and Six Months Ended June 30, 2003

Reference is made to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002, for an analysis and detailed discussion of the Company’s financial condition and results of operations for the period covered by that report.

Net Sales.    Our net sales for the three months ended June 30, 2003 were $22.1 million, an increase of $7.5 million, or 51.2%, from $14.6 million of net sales in the corresponding quarter of the prior year. Net sales for the six months ended June 30, 2003 were $41.3 million, an increase of $12.0 million, or 40.9%, from $29.3 million of net sales in the corresponding period of the prior year.

Net sales for our Advanced Ceramic Operations division for the three months ended June 30, 2003 were $17.8 million, an increase of $6.5 million, or 58.1%, from the $11.3 million in the corresponding quarter of the prior year. The primary reason for this improvement was an increase of $6.7 million, or 115.2%, in net sales of ceramic body armor for defense customers, from the $5.8 million of net sales in the second quarter of 2002. This increase in net sales of lightweight body armor for military personnel was caused by delivery of orders that were received in the fourth quarter 2002 and the first quarter 2003 from the U.S. Department of Defense. Net sales for our orthodontic brackets product line were $2.1 million, an increase of $271,000, or 14.7%, from net sales of $1.8 million in the corresponding quarter of the prior year. Net sales for our automotive/diesel component product line were $960,000, a decrease of $0.5 million, or 33.3%, from the $1.5 million in the corresponding quarter of the prior year. The Company experienced a temporary surge in orders and shipments in the second quarter of 2002 for this product line. We believe this was due to an effort by diesel truck manufacturers to sell as many diesel trucks as possible prior to October 31, 2002, when new, stricter federal environmental regulations became effective.

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For the six month period ended June 30, 2003, net sales for our Advanced Ceramic Operations were $32.2 million, an increase of $9.4 million, or 41.4%, from the $22.8 million in the first six months of 2002. These results were mainly due to a $9.7 million increase in shipments of armor products. Net sales for our orthodontic brackets product line were $4.2 million, an increase of $261,000, or 6.7%, from net sales of $3.9 million in the first six months of 2002. Net sales for our automotive/diesel component product line were $1.8 million, a decrease of $0.6 million, or 24.3%, from the $2.4 million in the corresponding period of the prior year.

Our Semicon Associates division had net sales for the three months ended June 30, 2003 of $1.9 million, an increase of $0.3 million, or 17.7%, from the $1.6 million in the corresponding quarter of the prior year. The increase in sales reflects higher shipments of microwave cathodes during the current quarter versus the same quarter last year. For the six month period ended June 30, 2003, net sales for the Semicon Associates division amounted to $3.6 million, an increase of $0.5 million, or 17.1%, from the $3.1 million in the first six months of 2002. Increases in sales of microwave cathodes accounted for this increase.

Our Thermo Materials division posted net sales for the three months ended June 30, 2003 of $2.4 million, an increase of $659,000, or 37.5%, from the $1.8 million in the corresponding quarter of the prior year. This improvement was mainly due to the completion of defense contracts, increase in shipments of defense products and growth in shipments of ceramic crucibles. For the six month period ended June 30, 2003, net sales for the Thermo Materials division amounted to $5.4 million, an increase of $2.0 million, or 59.1%, from the $3.4 million in the first six months of 2002. During the six months ended June 30, 2003, completion of defense contracts contributed $1.4 million to the increase of net sales over the corresponding prior six months ended June 30, 2002, while an increase in sales of rolls and crucibles added another $576,000 to the increase in net sales.

Gross Profit.    Our gross profit was $6.3 million for the three months ended June 30, 2003, an increase of $3.3 million, or 109.7%, from $3.0 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 28.5% for the three months ended June 30, 2003, compared to 20.5% for the corresponding prior year period.

For the six months ended June 30, 2003, our gross profit amounted to $11.2 million, an increase of $5.3 million, or 90.3%, from $5.9 million in the six months ended June 30, 2002. As a percentage of net sales, gross profit was 27.2% for the six months ended June 30, 2003, compared to 20.1% for the comparable prior year period.

Our Advanced Ceramic Operations division posted gross profits of $5.4 million for the three months ended June 30, 2003, an increase of $2.9 million, or 116.3%, from $2.5 million in the corresponding prior year quarter. As a percentage of net sales, gross profit was 30.4% for the three months ended June 30, 2003, compared to 22.2% for the corresponding prior year period.

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The three months ended June 30, 2003 benefited from a favorable comparison from the corresponding prior year period. During the three months ended June 30, 2002, the Advanced Ceramic Operations gross profits as a percentage of net sales were negatively impacted by a $650,000 warranty reserve for SAPI armor plates that was recorded in the second quarter of 2002. Gross profit margins were also negatively impacted by certain other manufacturing and production inefficiencies because of steep manufacturing learning curves to scale up to full production in the automotive/diesel line. Moreover, the Company experienced poor product yields and other manufacturing inefficiencies as production capacities were being increased to meet rising demand for personal armor and diesel engine components. To overcome these issues, the Company employed lean manufacturing techniques and invested in improving personnel training. Furthermore, in the three months ended June 30, 2003, gross profit margins of our Advanced Ceramic Operations were positively affected by a credit of $148,000 representing the unused balance of the warranty reserve established in the second quarter of 2002.

For the six months ended June 30, 2003, gross profit for the Advanced Ceramic Operations division amounted to $9.5 million, an increase of $4.6 million, or 92.6%, from $4.9 million for the corresponding prior year period. The improvement in gross profit was a result of increased armor sales, improved manufacturing efficiencies, better quality, and greater absorption of fixed manufacturing overhead costs when compared to the same period last year.

Other factors contributing to the rise in the gross profit as a percentage of net sales during the first six months of 2003 in our Advanced Ceramic Operations division included improved labor utilization, better training of personnel, increased workflow through the production facilities, changes in the design of products and an improved sales mix. We also continued to implement lean manufacturing techniques such as Demand Flow^® Technology in the production of diesel engine components, and we will continue to consider implementing this system, as well as other lean manufacturing techniques, into other product lines.

During the first six months of 2003, our Advanced Ceramic Operations division did not experience the same factors that negatively affected gross margins during the same period last year. Last year’s gross profit for the first six months was adversely impacted because we experienced a surge in armor and automotive/diesel orders with short delivery times which did not allow us enough time to prepare for the increased demands placed upon our personnel, facilities, and manufacturing techniques and capabilities. After installing new systems and adopting new manufacturing techniques in the second half of 2002, we were better prepared during the first six months of this year to benefit from higher production and shipment levels from an increasing backlog of orders. These changes led to greater operating leverage, production efficiencies and better absorption of manufacturing overhead costs that resulted in higher gross profits.

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Our Semicon Associates division had gross profit of $344,000 for the three months ended June 30, 2003, an increase of $77,000, or 28.8%, compared to $267,000 in the prior year quarter. As a percentage of net sales, gross profit was 18.3% for the three months ended June 30, 2003, compared to 16.7% for the corresponding prior year period. The increase is attributed to higher gross profits from microwave cathodes caused by increased levels of production and shipments and improved capacity utilization compared to the prior year period.

The Semicon Associates division had gross profit of $721,000 for the six months ended June 30, 2003, an increase of $209,000, or 40.8%, compared to $512,000 in the corresponding prior year period. As a percentage of net sales, gross profit was 19.9% for the six months ended June 30, 2003, compared to 16.6% for the corresponding prior year period.

Our Thermo Materials division had gross profit of $530,000 for the three months ended June 30, 2003, an increase of $302,000, or 132.5%, compared to $228,000 in the prior year quarter. As a percentage of net sales, gross profit was 21.9% for the three months ended June 30, 2003, compared to 13.0% for the corresponding prior year period. The increase in gross profit in the second quarter of 2003 was due to the completion of defense contracts and to more efficient manufacturing methods resulting in less scrap and rework. During the current quarter, completion of defense contracts and shipments of defense products added $235,000 to the increase in gross margins over the prior year quarter, while ceramic castables and rolls contributed another $166,000 increase to gross margins.

The Thermo Materials division had gross profit of $1.0 million for the six months ended June 30, 2003, an increase of $562,000, or 121.1%, compared to $464,000 in the corresponding prior year period. As a percentage of net sales, gross profit was 18.8% for the six months ended June 30, 2003, compared to 13.6% for the corresponding prior year period. Completion of defense contracts and shipments of defense products added $553,000 gross profit during the six months ended June 30, 2003, while the remaining product lines were relatively flat from the corresponding year ago period.

Selling Expenses.    Selling expenses were $574,000 for the three months ended June 30, 2003, an increase of $31,000, or 5.7%, from $543,000 in the corresponding prior year quarter. Selling expenses, as a percentage of net sales, decreased from 3.7% for the three months ended June 30, 2002 to 2.6% of net sales for the three months ended June 30, 2003, primarily due to the increase in net sales and better operating leverage.

For the six months ended June 30, 2003, selling expenses were $1.1 million, an increase of $90,000, or 9.1%, from $1.0 million in the corresponding prior year period. Selling expenses, as a percentage of net sales, decreased from 3.4% for the six months ended June 30, 2002 to 2.6% of net sales for the six months ended June 30, 2003, primarily due to the increase in net sales and better operating leverage.

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General and Administrative Expenses.    General and administrative expenses for the three months ended June 30, 2003 were $1.9 million, an increase of $727,000, or 63.6%, from $1.1 million in the corresponding prior year quarter. General and administrative expenses, as a percentage of net sales, increased from 7.8% for the three months ended June 30, 2002 to 8.5% of net sales for the three months ended June 30, 2003. For the three months ended June 30, 2003, increases in salary, bonus and personnel expenses primarily accounted for the rise in general and administrative expenses.

For the six months ended June 30, 2003, general and administrative expenses were $3.5 million, an increase of $1.2 million, or 53.7%, from $2.3 million in the six months ended June 30, 2002. General and administrative expenses, as a percentage of net sales, increased from 7.8% for the six months ended June 30, 2002 to 8.5% of net sales for the six months ended June 30, 2003. For the six month period ended June 30, 2003, increases in salary, bonus and personnel expenses primarily accounted for the rise in general and administrative expenses.

Research and Development.    Research and development expenses for the three months ended June 30, 2003 were $460,000, a decrease of $89,000, or 16.2%, from $549,000 in the corresponding prior year quarter. Research and development expenses, as a percentage of net sales, decreased from 3.8% for the three months ended June 30, 2002 to 2.1% of net sales for the three months ended June 30, 2003. The decrease as a percentage of sales was primarily due to the increase in net sales.

For the six months ended June 30, 2003, research and development expenses were $0.9 million, a decrease of $100,000, or 9.7%, from $1.0 million in the corresponding prior year period. Research and development expenses, as a percentage of net sales, decreased from 3.5% for the six months ended June 30, 2002 to 2.3% of net sales for the six months ended June 30, 2003. The decrease as a percentage of sales was primarily due to the increase in net sales.

Other Income.    Other income for the six months ended June 30, 2003 was $75,000, a decrease of $40,000, or 34.8%, from $115,000 in the corresponding prior year period. The major cause for the decrease was a $25,000 reduction in royalty income and a decrease in miscellaneous income of $13,000.

Interest Expense.    Interest expense for the six months ended June 30, 2003 was $28,000, a decrease of $4,000, or 12.5%, from $32,000 in the corresponding prior year period. Interest expense, as a percentage of net sales, was insignificant. The decrease was due to lower levels of borrowings and lower interest rates.

Income Taxes.    We used a combined federal and state tax rate of 35% for the six months ended June 30, 2003, resulting in a provision for taxes of $2.0 million, an increase of $1.4 million, or 343.6%, from $585,000 in the corresponding prior six month period. Our provision for income taxes for the three months ended June 30, 2003 was $1.2 million, an increase of $0.9 million, or 338.1%, from $273,000 in the corresponding prior year quarter. The effective income tax rate of 35% for the three months ended June 30, 2003 remained the same as in the corresponding prior year quarter.

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Liquidity and Capital Resources.    We generally meet our operating and capital requirements with cash flow from operating activities and borrowings under our bank line of credit. Our cash and cash equivalent totaled $644,000 at June 30, 2003, compared to $350,000 at December 31, 2002. We had working capital of $24.8 million at both June 30, 2003 and December 31, 2002.

Our net cash position increased by $294,000 during the sixth months ended June 30, 2003, compared to a decrease of $688,000 during the sixth months ended June 30, 2002. Cash flow provided by operating activities during the six months ended June 30, 2003 amounted to $5.7 million, which was offset by capital expenditures of $5.3 million, including $3.4 million used to purchase our Irvine, California facility, which we previously leased. We also reduced the balance due under our bank line of credit by $775,000. During the six months ended June 30, 2003, we also generated $753,000 from the issuance of common stock due to the exercise of stock options. During the six months ended June 30, 2002, we generated $1.5 million from operating activities and borrowed an additional $1.5 million under our bank line of credit. We also generated $284,000 from the issuance of common stock due to the exercise of stock options during the six months ended June 30, 2002. These amounts were offset by capital expenditures in the amount of $3.9 million.

In May 2002, we increased our revolving bank line of credit from $4.0 million to $7.5 million. The balance owed under this line of credit decreased from $2.4 million at December 31, 2002 to $1.6 million at June 30, 2003. In July 2003, we repaid the entire remaining balance due under this line of credit with a portion of the net proceeds from our recent public offering described below. The line of credit bears interest at one-half percentage point below the bank’s prime rate. The bank’s prime rate was 4.00% as of June 30, 2003.

We entered into a $500,000 capital equipment loan agreement during the third quarter of 1999. The term of this loan was 60 months, with a prepayment penalty, and bears interest at a fixed rate of 8.18%. The balance under this loan was $108,000 as of June 30, 2003. In July 2003, we repaid the entire balance due with a portion of the net proceeds from our recent public offering.

During July 2003, we completed a public offering of 1,725,000 newly issued shares of our common stock at a price to the public of $17.50 per share. We received net proceeds from this offering, after deducting underwriting discounts and offering expenses, of approximately $27.8 million. In the public offering, a selling stockholder also sold 345,000 shares of common stock. We did not receive any of the proceeds from this sale.

We used a portion of the net proceeds of the public offering to repay the outstanding balance under our bank line of credit, and used approximately $108,000 to repay the balance due under our equipment loan. During the next 12 months we also plan to use approximately $4.0 million of the net proceeds from the public offering to purchase and improve a manufacturing plant nearby our existing facility in Lexington, Kentucky. This new plant will increase our production capacity for ceramic components for heavy-duty diesel truck engines. We also plan to spend approximately $4.7 million to purchase machinery, equipment and furnaces, primarily for the new plant in Kentucky. We intend to use the balance of the net proceeds for working capital and other general corporate purposes.

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We believe that our current cash and cash equivalents on hand and cash we expect to generate from operations will be sufficient to finance our anticipated capital and operating requirements for at least the next 12 months.

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 June 30, 2003.

The Company utilized fixed rate 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.

As of June 30, 2003, the Company’s debt consisted of a $108,000 capital equipment loan at a fixed interest rate of 8.18% due July 28, 2004, and a bank line of credit of $1,615,000 for operating requirements. The bank line of credit interest rate is charged at one-half percentage point below the bank’s prime rate. The bank’s prime rate was 4.00% as of June 30, 2003. The carrying amount is a reasonable estimate of fair value as the rate of interest paid on the note and revolving credit facility approximates the current rate available for financing with similar terms and maturities.

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2003, pursuant to Rule 13a-15 under the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that those disclosure controls and procedures were adequate to ensure that information required to be disclosed in this report is recorded, processed, summarized and reported in a timely basis.

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PART II.    OTHER INFORMATION

From time to time, the Company is involved in legal proceedings incidental to its business. The Company believes that pending actions, individually and in the aggregate, will not have a material adverse effect on its financial condition, results of operations or cash flows, and that adequate provision has been made for the resolution of such actions and proceedings.

(a)    Exhibits:

(b)    Reports on Form 8-K:

On April 11, 2003, the Registrant filed a report on Form 8-K to furnish information pursuant to Item 12 relating to the Registrant’s preliminary results of operations for the three months ended March 31, 2003.

On April 30, 2003, the Registrant filed a report on Form 8-K to furnish information pursuant to Item 12 relating to the Registrant’s results of operations for the three months ended March 31, 2003.

On July 24, 2003, the Registrant filed a report on Form 8-K to furnish information pursuant to Item 12 relating to the Registrant’s results of operations for the second quarter and six months ended June 30, 2003.

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SIGNATURE

Pursuant to the requirements 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.

Dated:  August 8, 2003

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Index to Exhibits

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