##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
    FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT of 1934 For Quarter Ended October 2, 2004
    
    Commission File No. 0-12640
 KAYDON CORPORATION  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    13-3186040
(I.R.S. Employer Identification No.)
 Suite 300, 315 E. Eisenhower Parkway, Ann Arbor, Michigan
(Address of principal executive offices)
    
    48108
(Zip Code)
 Registrants telephone number, including area code: (734) 747-7025 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.
YES [X]  NO [  ] Common Stock Outstanding at November 5, 2004  28,202,081 shares, $.10 par
value.




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KAYDON CORPORATION FORM 10-Q FOR THE QUARTER ENDED OCTOBER 2, 2004 INDEX Page No.Part I  Financial Information:Item 1. Financial StatementsConsolidated Condensed Balance Sheets -
October 2, 2004 (Unaudited) and December 31, 2003
    
    
    1Consolidated Condensed Statements of Operations (Unaudited)-
Quarter and First Three Quarters Ended October 2, 2004
and September 27, 2003
    
    
    2Consolidated Condensed Statements of Cash Flows (Unaudited)-
First Three Quarters Ended October 2, 2004 and
September 27, 2003
    
    
    3Notes to Consolidated Condensed Financial Statements
    
    
    4 - 15Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    16-27Item 3. Quantitative and Qualitative Disclosures About
Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    29Part II  Other Information:Item 1. Legal Proceedings
    
    
    30Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    30Item 6. Exhibits
    
    
    31Signatures
    
    
    32Statement Re: Computation of Ratio of Earnings to Fixed ChargesCertification Pursuant to Rule 13a-14(a)Certification Pursuant to Section 906




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ITEM 1. FINANCIAL STATEMENTS
KAYDON CORPORATION 
 CONSOLIDATED CONDENSED BALANCE SHEETS
 October 2, 2004
    
    December 31, 2003(Unaudited)Assets:Cash and cash equivalents
    
    $
    269,348,000
    
    
    $
    255,756,000Accounts receivable, net
    
    
    49,270,000
    
    
    
    45,423,000Inventories, net
    
    
    52,655,000
    
    
    
    44,840,000Other current assets
    
    
    11,846,000
    
    
    
    14,231,000Total current assets
    
    
    383,119,000
    
    
    
    360,250,000Property, plant and equipment, net
    
    
    83,065,000
    
    
    
    84,707,000Goodwill, net
    
    
    111,721,000
    
    
    
    112,183,000Other intangible assets, net
    
    
    9,446,000
    
    
    
    8,903,000Other assets
    
    
    23,107,000
    
    
    
    24,331,000Total assets
    
    $
    610,458,000
    
    
    $
    590,374,000Liabilities and Shareholders Equity:Accounts payable
    
    $
    14,086,000
    
    
    $
    13,488,000Taxes payable
    
    
    8,012,000
    
    
    
    6,944,000Salaries and wages
    
    
    7,499,000
    
    
    
    6,544,000Accrued legal costs
    
    
    59,000
    
    
    
    2,387,000Interest payable
    
    
    2,844,000
    
    
    
    844,000Other accrued expenses
    
    
    13,525,000
    
    
    
    12,115,000Total current liabilities
    
    
    46,025,000
    
    
    
    42,322,000Long-term debt
    
    
    200,082,000
    
    
    
    200,128,000Long-term liabilities
    
    
    65,565,000
    
    
    
    67,405,000Total long-term liabilities
    
    
    265,647,000
    
    
    
    267,533,000Shareholders equity:Common stock
    
    
    3,693,000
    
    
    
    3,693,000Paid-in capital
    
    
    47,386,000
    
    
    
    46,948,000Retained earnings
    
    
    443,829,000
    
    
    
    425,645,000Less  treasury stock, at cost
    
    
    (184,478,000
    )
    
    
    (186,048,000
    )Less  restricted stock awards
    
    
    (7,757,000
    )
    
    
    (5,312,000
    )Accumulated other comprehensive loss
    
    
    (3,887,000
    )
    
    
    (4,407,000
    )298,786,000
    
    
    
    280,519,000Total liabilities and shareholders equity
    
    $
    610,458,000
    
    
    $
    590,374,000
 See accompanying notes to consolidated condensed financial statements. 1




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KAYDON CORPORATION 
 CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 Quarter Ended
    
    First Three Quarters EndedOctober 2, 2004
    
    Sept. 27, 2003
    
    October 2, 2004
    
    Sept. 27, 2003Net sales
    
    $
    83,337,000
    
    
    $
    67,995,000
    
    
    $
    251,046,000
    
    
    $
    214,953,000Cost of sales
    
    
    50,917,000
    
    
    
    43,441,000
    
    
    
    154,014,000
    
    
    
    139,459,000Gross profit
    
    
    32,420,000
    
    
    
    24,554,000
    
    
    
    97,032,000
    
    
    
    75,494,000Selling, general and
administrative expenses
    
    
    16,213,000
    
    
    
    11,721,000
    
    
    
    48,153,000
    
    
    
    38,853,000Operating income
    
    
    16,207,000
    
    
    
    12,833,000
    
    
    
    48,879,000
    
    
    
    36,641,000Interest income
    
    
    1,040,000
    
    
    
    648,000
    
    
    
    2,608,000
    
    
    
    1,763,000Interest expense
    
    
    (2,397,000
    )
    
    
    (2,477,000
    )
    
    
    (7,190,000
    )
    
    
    (3,693,000
    )Income before income taxes
    
    
    14,850,000
    
    
    
    11,004,000
    
    
    
    44,297,000
    
    
    
    34,711,000Provision for income taxes
    
    
    5,346,000
    
    
    
    3,852,000
    
    
    
    15,947,000
    
    
    
    12,149,000Net income
    
    $
    9,504,000
    
    
    $
    7,152,000
    
    
    $
    28,350,000
    
    
    $
    22,562,000Weighted average common shares:Basic
    
    
    27,862,000
    
    
    
    27,764,000
    
    
    
    27,881,000
    
    
    
    28,846,000Diluted
    
    
    27,920,000
    
    
    
    27,790,000
    
    
    
    27,934,000
    
    
    
    28,863,000Earnings per shareBasic
    
    $
    0.34
    
    
    $
    0.26
    
    
    $
    1.02
    
    
    $
    0.78Diluted
    
    $
    0.34
    
    
    $
    0.26
    
    
    $
    1.01
    
    
    $
    0.78Dividends per share
    
    $
    0.12
    
    
    $
    0.12
    
    
    $
    0.36
    
    
    $
    0.36
 See accompanying notes to consolidated condensed financial statements. 2




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KAYDON CORPORATION 
 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 First Three Quarters EndedOct. 2, 2004
    
    Sept. 27, 2003Cash flows from operating activities
    
    $
    36,751,000
    
    
    $
    42,517,000Cash flows used in investing activities:Capital expenditures, net
    
    
    (7,217,000
    )
    
    
    (7,206,000
    )Acquisition of business, net of cash acquired
    
    
    (3,964,000
    )
    
    
    Cash used in investing activities
    
    
    (11,181,000
    )
    
    
    (7,206,000
    )Cash flows from (used in) financing activities:Dividends paid
    
    
    (10,152,000
    )
    
    
    (10,648,000
    )Proceeds from issuance of common stock
    
    
    42,000
    
    
    
    5,104,000Purchase of treasury stock
    
    
    (1,818,000
    )
    
    
    (51,843,000
    )Proceeds from convertible notes
    
    
    
    
    
    
    200,000,000Convertible notes and credit facility issuance costs
    
    
    
    
    
    
    (7,194,000
    )Payments on long-term debt
    
    
    (75,000
    )
    
    
    (72,250,000
    )Cash from (used in) financing activities
    
    
    (12,003,000
    )
    
    
    63,169,000Effect of exchange rate changes on cash and
cash equivalents
    
    
    25,000
    
    
    
    (86,000
    )Net increase in cash and cash equivalents
    
    
    13,592,000
    
    
    
    98,394,000Cash and cash equivalents  Beginning of period
    
    
    255,756,000
    
    
    
    146,301,000Cash and cash equivalents  End of period
    
    $
    269,348,000
    
    
    $
    244,695,000Cash expended for income taxes
    
    $
    13,516,000
    
    
    $
    4,423,000Cash expended for interest
    
    $
    4,000,000
    
    
    $
    603,000
 See accompanying notes to consolidated condensed financial statements. 3




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KAYDON CORPORATION 
 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
  (1)
    
    The accompanying unaudited consolidated condensed financial statements of
Kaydon Corporation and subsidiaries (Kaydon or the Company) have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Rule 10-01 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 considered necessary for a fair presentation
have been included, and such adjustments are of a normal recurring nature.
The December 31, 2003 condensed balance sheet data was derived from
audited financial statements, but does not include all disclosures
required by generally accepted accounting principles. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Companys annual report on Form 10-K for the year
ended December 31, 2003.(2)
    
    Inventories are summarized as follows: October 2, 2004
    
    December 31, 2003Raw Material
    
    $
    18,560,000
    
    
    $
    16,500,000Work in Process
    
    
    17,376,000
    
    
    
    13,434,000Finished Goods
    
    
    16,719,000
    
    
    
    14,906,000$
    52,655,000
    
    
    $
    44,840,000
  (3)
    
    Comprehensive income reflects the change in equity of a business
enterprise during a period from transactions and other events, and from
circumstances involving nonowner sources. For the Company, comprehensive
income consists primarily of net income, foreign currency translation
adjustments and minimum pension liability adjustments. Other
comprehensive income (loss), net of tax, was approximately $(0.3) million
and $0.5 million, resulting in comprehensive income of $9.2 million and
$7.6 million for the quarters ended October 2, 2004, and September 27,
2003. Other comprehensive income, net of tax, was approximately $0.5
million and $2.5 million, resulting in comprehensive income of $28.9
million and $25.1 million for the first three quarters ended October 2,
2004 and September 27, 2003. 4




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(4)
    
    The following table reconciles the numerators and denominators used in
the calculation of basic and diluted earnings per share for the periods
presented. Quarter EndedOctober 2, 2004
    
    Sept. 27, 2003Numerators:Numerators for both basic and
diluted earnings per share,
net income
    
    $
    9,504,000
    
    
    $
    7,152,000Denominators:Denominators for basic earnings
per share, weighted average
common shares outstanding
    
    
    27,862,000
    
    
    
    27,764,000Potential dilutive shares resulting
from stock options, restricted
stock awards and phantom
stock units
    
    
    58,000
    
    
    
    26,000Denominators for diluted
earnings per share
    
    
    27,920,000
    
    
    
    27,790,000Earnings per share:Basic
    
    $
    0.34
    
    
    $
    0.26Diluted
    
    $
    0.34
    
    
    $
    0.26
 5




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First Three Quarters EndedOctober 2, 2004
    
    Sept. 27, 2003Numerators:Numerators for both basic and
diluted earnings per share,
net income
    
    $
    28,350,000
    
    
    $
    22,562,000Denominators:Denominator for basic earnings
per share, weighted average
common shares outstanding
    
    
    27,881,000
    
    
    
    28,846,000Potential dilutive shares resulting
from stock options, restricted
stock awards and phantom
stock units
    
    
    53,000
    
    
    
    17,000Denominator for diluted
earnings per share
    
    
    27,934,000
    
    
    
    28,863,000Earnings per share:Basic
    
    $
    1.02
    
    
    $
    0.78Diluted
    
    $
    1.01
    
    
    $
    0.78
 Options to purchase 113,000 shares of common stock at prices ranging from
$24.25 to $33.3125 per share were outstanding during the third quarter of
2003, but were not included in the computation of diluted earnings per
share because the options exercise price was greater than the average
market price of the common shares during that period. In May of 2003, the Company completed the sale of $200.0 million of 4%
Contingent Convertible Senior Subordinated Notes due 2023 (the Notes).
The Notes are convertible into a total of 6,858,710 shares of Company
common stock at a conversion price of $29.16 per share, provided certain
contingencies are met including that Company common stock has traded above
$34.99 for 20 out of 30 trading days for specified periods of time.
Currently, the above mentioned shares of the Companys common stock
underlying the Notes are not included in the Companys basic or diluted
earnings per share calculations, because these contingencies have not been
met. In October 2004, the Financial Accounting Standards Board ratified the
final consensus of the Emerging Issues Task Force (EITF) on EITF 04-8,
The Effects of Contingently Convertible Instruments on Diluted Earnings
per Share, which 6




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states that the impact of contingently convertible instruments that are
convertible into common stock upon the achievement of a specified market
price of the issuers shares, such as the Companys Notes, should be
included in diluted earnings per share computations regardless of whether
or not the market price trigger has been met. The provisions will be
effective for reporting periods ending after December 15, 2004. All prior
period earnings per share amounts presented will be restated to adjust net
income by adding back the after tax interest expense, including
amortization of issuance costs, attributable to the Notes and to increase
total shares outstanding by the number of shares that would be issuable
upon conversion. Assuming the Company does not eliminate the feature of
the Notes that allows conversion into common stock, the pro forma effects
of this new accounting pronouncement would have resulted in diluted
earnings per share of $0.32 for the third quarter of 2004, and $0.94 for
the first three quarters of 2004.5)
    
    The Company operates through operating segments for which separate
financial information is available, and for which operating results are
evaluated regularly by the Companys chief operating decision maker in
determining resource allocation and assessing performance. Certain of
the operating segments have similar economic characteristics, as well
as other common attributes, including nature of the products and
production processes, distribution patterns and classes of customers.
The Company aggregates these operating segments for reporting purposes.
Certain other operating segments do not exhibit the common attributes
mentioned above and, therefore, information about them is reported
separately. Still other operating segments do not meet the
quantitative thresholds for separate disclosure and their information
is combined and disclosed as Other. During the first three quarters
of 2003, the Company aggregated its operating segments into three
reportable segments referred to as Specialty Metal Formed Products,
Ring, Seal and Filtration Products, and Other Metal Products. During
the fourth quarter of 2003, the Company changed the aggregation of
operating segments for purposes of reporting segment information.
Prior year amounts have been reclassified to reflect the current year
presentation.The Company has four reportable segments and other operating segments
engaged in the manufacture and sale of the following:Friction and Motion Control Products complex components used in
specialized medical, aerospace, defense, security, electronic, material
handling, construction and other industrial applications. Products
include anti-friction bearings, split roller bearings, specialty balls
and retaining devices.Velocity Control Products complex components used in specialized
robotics, material handling, machine tool, medical, amusement and other
industrial applications. Products include industrial shock absorbers,
safety shock absorbers, velocity controls, gas springs and rotary
dampers.Sealing Products complex and standard ring and seal products used
in demanding industrial, aerospace and defense applications. Products
include 7




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engine rings, sealing rings and shaft seals.Power and Data Transmission Products-complex and standard
electrical and fiber optic products used in demanding industrial,
aerospace, defense, security, medical, electronic and marine equipment
applications. Products include slip-rings, slip-ring assemblies, video
and data multiplexers, fiber optic rotary joints and printed circuit
boards.Other-filter elements and filtration systems, metal alloys, machine
tool components, presses, dies and benders used in a variety of
industrial applications.The accounting policies of the operating segments are the same as those
of the Company. Segment performance is evaluated based on segment
operating income (which includes an estimated provision for state income
taxes) and segment assets.Items not allocated to segment operating income include certain
amortization and corporate administrative expenses, and other amounts.
Corporate assets consist of cash and cash equivalents, fixed assets and
certain prepaid expenses. The selling price for transfers between
operating segments and geographic areas is generally based on cost plus a
mark-up. 8




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Quarter Ended
    
    First Three Quarters EndedOct. 2, 2004
    
    Sept. 27, 2003
    
    Oct. 2, 2004
    
    Sept. 27, 2003Net salesFriction and Motion Control ProductsExternal customers
    
    $
    40,715,000
    
    
    $
    31,888,000
    
    
    $
    122,094,000
    
    
    $
    101,722,000Intersegment
    
    
    85,000
    
    
    
    116,000
    
    
    
    250,000
    
    
    
    288,00040,800,000
    
    
    
    32,004,000
    
    
    
    122,344,000
    
    
    
    102,010,000Velocity Control Products
    
    
    12,642,000
    
    
    
    10,536,000
    
    
    
    38,733,000
    
    
    
    32,081,000Sealing ProductsExternal customers
    
    
    8,767,000
    
    
    
    8,677,000
    
    
    
    28,098,000
    
    
    
    27,814,000Intersegment
    
    
    (20,000
    )
    
    
    
    
    
    
    (65,000
    )
    
    
    8,747,000
    
    
    
    8,677,000
    
    
    
    28,033,000
    
    
    
    27,814,000Power and Data Transmission ProductsExternal customers
    
    
    10,384,000
    
    
    
    8,323,000
    
    
    
    26,710,000
    
    
    
    24,858,000Intersegment
    
    
    (61,000
    )
    
    
    (116,000
    )
    
    
    (174,000
    )
    
    
    (288,000
    )10,323,000
    
    
    
    8,207,000
    
    
    
    26,536,000
    
    
    
    24,570,000OtherExternal customers
    
    
    10,829,000
    
    
    
    8,571,000
    
    
    
    35,411,000
    
    
    
    28,478,000Intersegment
    
    
    (4,000
    )
    
    
    
    
    
    
    (11,000
    )
    
    
    10,825,000
    
    
    
    8,571,000
    
    
    
    35,400,000
    
    
    
    28,478,000Total consolidated net sales
    
    $
    83,337,000
    
    
    $
    67,995,000
    
    
    $
    251,046,000
    
    
    $
    214,953,000
 Quarter Ended
    
    First Three Quarters EndedOct. 2, 2004
    
    Sept. 27, 2003
    
    Oct. 2, 2004
    
    Sept. 27, 2003Operating incomeFriction and Motion Control Products
    
    $
    10,152,000
    
    
    $
    7,592,000
    
    
    $
    30,232,000
    
    
    $
    20,321,000Velocity Control Products
    
    
    3,174,000
    
    
    
    2,167,000
    
    
    
    10,571,000
    
    
    
    6,549,000Sealing Products
    
    
    2,643,000
    
    
    
    1,094,000
    
    
    
    5,603,000
    
    
    
    3,252,000Power and Data Transmission Products
    
    
    1,281,000
    
    
    
    510,000
    
    
    
    812,000
    
    
    
    1,579,000Other
    
    
    247,000
    
    
    
    539,000
    
    
    
    1,030,000
    
    
    
    1,996,000Total segment operating income
    
    
    17,497,000
    
    
    
    11,902,000
    
    
    
    48,248,000
    
    
    
    33,697,000State income tax provision
included in segment operating
income
    
    
    289,000
    
    
    
    388,000
    
    
    
    842,000
    
    
    
    1,087,000Items not allocated to segment
operating income
    
    
    (1,579,000
    )
    
    
    543,000
    
    
    
    (211,000
    )
    
    
    1,857,000Interest expense
    
    
    (2,397,000
    )
    
    
    (2,477,000
    )
    
    
    (7,190,000
    )
    
    
    (3,693,000
    )Interest income
    
    
    1,040,000
    
    
    
    648,000
    
    
    
    2,608,000
    
    
    
    1,763,000Income before income taxes
    
    $
    14,850,000
    
    
    $
    11,004,000
    
    
    $
    44,297,000
    
    
    $
    34,711,000
 9




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Quarter Ended
    
    First Three Quarters EndedOct. 2, 2004
    
    Sept. 27, 2003
    
    Oct. 2, 2004
    
    Sept. 27, 2003Depreciation and amortizationFriction and Motion Control Products
    
    $
    1,666,000
    
    
    $
    1,621,000
    
    
    $
    5,427,000
    
    
    $
    5,529,000Velocity Control Products
    
    
    434,000
    
    
    
    402,000
    
    
    
    1,270,000
    
    
    
    1,209,000Sealing Products
    
    
    248,000
    
    
    
    243,000
    
    
    
    806,000
    
    
    
    835,000Power and Data Transmission Products
    
    
    327,000
    
    
    
    331,000
    
    
    
    1,136,000
    
    
    
    1,180,000Other
    
    
    265,000
    
    
    
    276,000
    
    
    
    819,000
    
    
    
    846,000Corporate
    
    
    646,000
    
    
    
    269,000
    
    
    
    1,476,000
    
    
    
    1,116,000Total consolidated depreciation and
amortization
    
    $
    3,586,000
    
    
    $
    3,142,000
    
    
    $
    10,934,000
    
    
    $
    10,715,000
 Quarter Ended
    
    First Three Quarters EndedOct. 2, 2004
    
    Sept. 27, 2003
    
    Oct. 2, 2004
    
    Sept. 27, 2003Additions to net property, plant and
equipmentFriction and Motion Control Products
    
    $
    1,493,000
    
    
    $
    1,151,000
    
    
    $
    5,228,000
    
    
    $
    4,997,000Velocity Control Products
    
    
    76,000
    
    
    
    104,000
    
    
    
    22,000
    
    
    
    247,000Sealing Products
    
    
    161,000
    
    
    
    34,000
    
    
    
    366,000
    
    
    
    391,000Power and Data Transmission Products
    
    
    248,000
    
    
    
    263,000
    
    
    
    587,000
    
    
    
    900,000Other
    
    
    189,000
    
    
    
    192,000
    
    
    
    792,000
    
    
    
    520,000Corporate
    
    
    (41,000
    )
    
    
    45,000
    
    
    
    222,000
    
    
    
    151,000Total consolidated additions to net
property, plant and equipment
    
    $
    2,126,000
    
    
    $
    1,789,000
    
    
    $
    7,217,000
    
    
    $
    7,206,000
 Oct. 2, 2004
    
    Dec. 31, 2003Total assetsFriction and Motion Control Products
    
    $
    153,508,000
    
    
    $
    146,183,000Velocity Control Products
    
    
    81,406,000
    
    
    
    71,268,000Sealing Products
    
    
    18,280,000
    
    
    
    17,094,000Power and Data Transmission Products
    
    
    41,127,000
    
    
    
    39,207,000Other
    
    
    46,075,000
    
    
    
    43,762,000Corporate
    
    
    270,062,000
    
    
    
    272,860,000Total consolidated assets
    
    $
    610,458,000
    
    
    $
    590,374,000
 10




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(6) During May 2003, the Company completed the sale of $200.0 million of 4%
Contingent Convertible Senior Subordinated Notes due 2023 (the Notes). Interest expense on the Notes equaled $2.0 million for the third quarter of
2004. Note issuance costs of approximately $6.5 million are being amortized
over a five-year period. Amortization of Note issuance costs during the third
quarter of 2004 was $0.3 million. Amortization of Note issuance costs is
recorded as a component of interest expense. Note issuance costs included in
other assets in the Consolidated Condensed Balance Sheets as of October 2, 2004
and December 31, 2003 was $4.8 million and $5.7 million, respectively. The Companys revolving credit facility, which is unsecured, provides for
borrowings and the issuance of letters of credit by the Company and its
subsidiaries in various currencies for general corporate purposes, including
acquisitions. Interest expense incurred on borrowings under the revolving
credit facility will be based on the London Interbank Offered Rate. The
revolving credit facility contains restrictive financial covenants on a
consolidated basis including leverage and coverage ratios, utilizing measures
of earnings and interest expense as defined in the revolving credit facility
agreement. Under the leverage ratio restriction, the Company may not allow the
ratio of total indebtedness, net of domestic cash in excess of $15.0 million,
to adjusted earnings before interest expense, taxes, depreciation and
amortization to exceed 3.0 to 1.0. Under the interest coverage ratio
restriction, the Company may not allow the ratio of adjusted earnings before
interest expense and taxes to interest expense to be less than 3.0 to 1.0. The
Company is in compliance with all restrictive covenants contained in the
revolving credit facility at October 2, 2004. After consideration of the
facilitys covenants and $3.2 million of letters of credit issued under the
facility, the Company has available credit under its revolving credit facility
of $196.8 million at October 2, 2004. The Companys outstanding debt was as follows: October 2, 2004
    
    December 31, 20034% Contingent Convertible Senior
Subordinated Notes due 2023
    
    $
    200,000,000
    
    
    $
    200,000,000Other
    
    
    143,000
    
    
    
    218,000Total debt
    
    
    200,143,000
    
    
    
    200,218,000Less current maturities
    
    
    61,000
    
    
    
    90,000Long-term debt
    
    $
    200,082,000
    
    
    $
    200,128,000
 (7) As previously reported, the Company, along with certain other companies,
was named as a defendant in a lawsuit filed in 1996 in the United States
District Court for the Southern District of New York (the Transactions
Lawsuit). In April 2004, the Court of Appeals issued its Summary Order
affirming in all respects an earlier judgment of the District Court, which
granted the motion for summary judgment, dismissing the case in its entirety
against all defendants. In July 2004, the lead attorney for the plaintiffs in
the Transactions Lawsuit sent a written confirmation to the counsel of another
defendant in the case stating that the plaintiffs would take no further steps
to appeal the decision by the Court of Appeals, even though they had until
August 16, 2004 to do so. As a result, in the second quarter financial
statements the Company reduced its previously 11




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##### Table of Contents



recorded Transactions Lawsuit legal fee accrual by $1.7 million. This change
in estimate increased second quarter net income by $1.1 million. As expected,
the August 16, 2004 deadline for the plaintiffs to take action to prolong the
case expired without any such action being taken. Therefore, the case has
concluded. As previously reported, in August 2000, an accident involving a MH53E
helicopter manufactured by Sikorsky Aircraft Corporation, resulted in four
deaths and two injuries during a military training mission. The Company
manufactures and sells swashplate bearings used on MH53E helicopters. In May
2002, the Company, along with Sikorsky Aircraft Corporation, The Armoloy
Corporation, Armoloy of Illinois, Inc., Armoloy of Connecticut, Inc. and
Investment Holdings, Inc., was named as a defendant in a lawsuit filed by the
relatives and the estates of the four deceased individuals, and by the two
injured individuals. The litigation currently is pending in the District Court
of Nueces County, Texas, 28th Judicial District. Armoloy of Connecticut, Inc.
is no longer a party to the litigation. The Companys insurance carrier has
retained legal counsel to respond to the lawsuit. The Company believes that
the alleged damages claimed in this lawsuit, and the associated legal costs,
will be fully covered under the Companys insurance policy. Further, the
Company believes it has meritorious defenses to these claims including, but not
limited to, the fact that the bearing utilized in the helicopter involved in
the accident was inspected and approved prior to shipment by both U.S.
government and Sikorsky Aircraft Corporation inspectors. Accordingly, an
accrual is not recorded in the consolidated financial statements related to
this legal action. The Company is involved in ongoing environmental remediation activities at
certain manufacturing sites as well as proceedings relating to the cleanup of
waste disposal sites that provide for the allocation of costs among potentially
responsible parties. One of the manufacturing sites undergoing environmental
remediation is a discontinued operation sold in December 2001, where the
Company retained the environmental liability. The Company is working with the
appropriate regulatory agencies to complete the necessary remediation or to
determine the extent of the Companys portion of the remediation necessary. As
of October 2, 2004, an undiscounted accrual in the amount of $3.1 million,
representing the Companys best estimate for ultimate resolution of these
environmental matters, remains in other long-term liabilities in the
consolidated financial statements. Various other claims, lawsuits and environmental matters arising in the normal
course of business are pending against the Company. The Companys estimated
legal costs expected to be incurred in connection with claims, lawsuits and
environmental matters are consistently accrued in the consolidated financial
statements. (8) During the third quarter of 2004, the Company acquired the net assets of
a privately-held manufacturer of linear deceleration products for $4.0 million,
of which $0.6 million was assigned to trademarks acquired, $0.6 million was
assigned to various other intangible assets acquired, and $1.1 million was
recognized as goodwill. The trademarks are not being amortized as they are
deemed to have indefinite useful lives. The other intangible assets are being
amortized over their respective useful lives ranging from less than one year
for backlog to 10 years for distributor agreements and customer relationships.
The goodwill is being reported as part of the Companys 12




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Velocity Control Products reporting segment and will not be amortized, but will
be subject to annual impairment testing. During the third quarter of 2004, the Company completed its annual goodwill
impairment test. Fair values of reporting units were estimated using the
expected present value of future cash flows. The fair value of all reporting
units exceeded their carrying value, which indicated no goodwill impairment. During the second quarter of 2004, the Company determined that the fair value
of one of the Companys reporting units, as that term is defined by Statement
of Financial Accounting Standards (SFAS) No. 142 Goodwill and Other
Intangible Assets, had been reduced to an amount less than the reporting
units carrying amount. The reporting unit, one of the Companys smallest,
manufactures and markets specialty metal forming equipment for the commercial
and residential air conditioning industries both in the United States and
abroad. A change in competitive dynamics has resulted in a reduction of this
reporting units estimated future cash flows. The fair value of the reporting
unit was estimated using the expected present value of its future cash flows.
As calculated in accordance with SFAS No. 142, there is no implied fair value
of the reporting units goodwill. Therefore, during the second quarter, the
Company incurred a $1.9 million pre-tax, non-cash goodwill impairment loss,
which equaled $1.2 million after tax. The changes in the carrying amount of goodwill for the first three quarters
ended October 2, 2004, are as follows: Friction and
    
    
    
    
    
    
    
    
    
    Power andMotion
    
    Velocity
    
    
    
    
    
    DataControl
    
    Control
    
    Sealing
    
    TransmissionProducts
    
    Products
    
    Products
    
    Products
    
    Other
    
    TotalBalance as of
December 31, 2003
    
    $
    30,697,000
    
    
    $
    41,817,000
    
    
    $
    186,000
    
    
    $
    16,094,000
    
    
    $
    23,389,000
    
    
    $
    112,183,000Effect of foreign
currency exchange
rate changes
    
    
    462,000
    
    
    
    
    
    
    
    
    
    
    
    (140,000
    )
    
    
    
    
    
    
    322,000Balance as of
April 3, 2004
    
    $
    31,159,000
    
    
    $
    41,817,000
    
    
    $
    186,000
    
    
    $
    15,954,000
    
    
    $
    23,389,000
    
    
    $
    112,505,000Effect of foreign
currency exchange
rate changes
    
    
    21,000
    
    
    
    
    
    
    
    
    
    
    
    (69,000
    )
    
    
    
    
    
    
    (48,000
    )Impairment loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,934,000
    )
    
    
    (1,934,000
    )Balance as of
July 3, 2004
    
    $
    31,180,000
    
    
    $
    41,817,000
    
    
    $
    186,000
    
    
    $
    15,885,000
    
    
    $
    21,455,000
    
    
    $
    110,523,000Effect of foreign
currency exchange
rate changes
    
    
    (356,000
    )
    
    
    
    
    
    
    
    
    
    
    429,000
    
    
    
    
    
    
    
    73,000Goodwill acquired
    
    
    
    
    
    
    1,125,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,125,000Balance as of
October 2, 2004
    
    $
    30,824,000
    
    
    $
    42,942,000
    
    
    $
    186,000
    
    
    $
    16,314,000
    
    
    $
    21,455,000
    
    
    $
    111,721,000
 Goodwill is stated net of accumulated amortization of $13.3 million at October
2, 2004 and December 31, 2003. 13




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##### Table of Contents



Other intangible assets are summarized as follows: October 2, 2004
    
    December 31, 2003Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmortized Intangible Assets
    
    Amount
    
    Amortization
    
    Amount
    
    AmortizationCustomer lists
    
    $
    7,740,000
    
    
    $
    2,773,000
    
    
    $
    7,740,000
    
    
    $
    2,193,000Patents
    
    
    1,233,000
    
    
    
    222,000
    
    
    
    1,124,000
    
    
    
    164,000Distributor agreements
    
    
    374,000
    
    
    
    3,000
    
    
    
    
    
    
    
    Customer relationships
    
    
    94,000
    
    
    
    1,000
    
    
    
    
    
    
    
    Backlog
    
    
    11,000
    
    
    
    11,000
    
    
    
    
    
    
    
    $
    9,452,000
    
    
    $
    3,010,000
    
    
    $
    8,864,000
    
    
    $
    2,357,000
 The intangible assets are being amortized on a straight-line basis over periods of 1 to 20 years. October 2, 2004
    
    December 31, 2003Carrying
    
    CarryingUnamortized Intangible Assets
    
    Amount
    
    AmountTrademarks
    
    $
    3,004,000
    
    
    $
    2,396,000
 Aggregate Intangible Assets Amortization ExpenseFor the first three quarters ended October 2, 2004
    
    $
    653,000For the first three quarters ended Sept. 27, 2003
    
    $
    630,000
 Estimated Intangible Assets Amortization ExpenseFor the year ending December 31, 2004
    
    $
    899,000For the year ending December 31, 2005
    
    $
    963,000For the year ending December 31, 2006
    
    $
    887,000For the year ending December 31, 2007
    
    $
    887,000For the year ending December 31, 2008
    
    $
    887,000
  (9)
    
    The components of net periodic benefit costs are as follows: Quarter Ended
    
    First Three Quarters EndedPension Benefits
    
    Oct. 2, 2004
    
    Sept. 27, 2003
    
    Oct. 2, 2004
    
    Sept. 27, 2003Service cost
    
    $
    590,000
    
    
    $
    601,000
    
    
    $
    1,768,000
    
    
    $
    1,772,000Interest cost
    
    
    1,244,000
    
    
    
    1,357,000
    
    
    
    3,731,000
    
    
    
    4,002,000Expected return on plan assets
    
    
    (951,000
    )
    
    
    (1,022,000
    )
    
    
    (2,854,000
    )
    
    
    (3,014,000
    )Amortization of:Unrecognized net transition
obligation
    
    
    
    
    
    
    6,000
    
    
    
    
    
    
    
    17,000Unrecognized net prior
service cost
    
    
    193,000
    
    
    
    290,000
    
    
    
    573,000
    
    
    
    856,000Unrecognized net loss
    
    
    273,000
    
    
    
    288,000
    
    
    
    821,000
    
    
    
    849,000Total
    
    $
    1,349,000
    
    
    $
    1,520,000
    
    
    $
    4.039.000
    
    
    $
    4,482,000
 14




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##### Table of Contents



Postretirement Benefits
    
    Quarter Ended
    
    First Three Quarters EndedOct. 2, 2004
    
    Sept. 27, 2003
    
    Oct. 2, 2004
    
    Sept. 27, 2003Service cost
    
    $
    145,000
    
    
    $
    203,000
    
    
    $
    522,000
    
    
    $
    608,000Interest cost
    
    
    294,000
    
    
    
    425,000
    
    
    
    1,036,000
    
    
    
    1,274,000Amortization of:Unrecognized net prior
service cost
    
    
    (281,000
    )
    
    
    (309,000
    )
    
    
    (823,000
    )
    
    
    (926,000
    )Unrecognized net gain
    
    
    (198,000
    )
    
    
    (85,000
    )
    
    
    (287,000
    )
    
    
    (255,000
    )Total
    
    $
    (40,000
    )
    
    $
    234,000
    
    
    $
    448,000
    
    
    $
    701,000
  During the second quarter of 2004, the Financial Accounting Standards Board
issued their Staff Position No. FAS 106-2 which provides guidance on the
accounting for the effects of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (the Act). As allowed under FAS 106-2, the Company
elected the prospective application method for recognizing the effects of the
Act on its postretirement benefit plans. Under the prospective application
method the Companys postretirement benefit costs were reduced by $0.3 million
during the third quarter of 2004. This Act also has the effect of reducing the
accumulated postretirement benefit obligation by $6.7 million.  The Company expects to contribute approximately
$5.6 million to its pension
plans in 2004.  (10)
    
    The Company accounts for stock-based compensation granted to employees
and Directors using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25. The following table details the effect on net
income and earnings per share had compensation cost for stock-based awards been
recognized based on the fair value method prescribed under Statement of
Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation: Quarter Ended
    
    First Three Quarters EndedOct. 2, 2004
    
    Sept. 27, 2003
    
    Oct. 2, 2004
    
    Sept. 27, 2003Reported net income
    
    $
    9,504,000
    
    
    $
    7,152,000
    
    
    $
    28,350,000
    
    
    $
    22,562,000Add: Total stock-based compensation
expense included in reported net
income, net of tax
    
    
    389,000
    
    
    
    210,000
    
    
    
    799,000
    
    
    
    630,000Deduct: Total stock-based
compensation expense
determined
under fair value method for all
awards, net of tax
    
    
    (420,000
    )
    
    
    (255,000
    )
    
    
    (892,000
    )
    
    
    (763,000
    )Pro-forma net income
    
    $
    9,473,000
    
    
    $
    7,107,000
    
    
    $
    28,257,000
    
    
    $
    22,429,000Earnings per share- Basic:As reported
    
    $
    0.34
    
    
    $
    0.26
    
    
    $
    1.02
    
    
    $
    0.78Pro-forma
    
    $
    0.34
    
    
    $
    0.26
    
    
    $
    1.01
    
    
    $
    0.78Earnings per share- Diluted:As reported
    
    $
    0.34
    
    
    $
    0.26
    
    
    $
    1.01
    
    
    $
    0.78Pro-forma
    
    $
    0.34
    
    
    $
    0.26
    
    
    $
    1.01
    
    
    $
    0.78
 15




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Kaydon Corporation and subsidiaries (Kaydon or the Company) provides an
array of proprietary, value added products to a diverse customer base covering
a broad spectrum of industries. This strategic diversification means that
demand for the Companys products depends, in part, upon a wide range of
general economic conditions, which affect the Companys markets in varying ways
from quarter to quarter. During the third quarter 2004, the Company was
favorably impacted as the economy continued to rebound from the manufacturing
slowdown of the last four years. The general economic rebound, both in the
United States and in certain international markets, meant that during the
quarter the Company experienced increased demand from various markets including
specialty electronics, machinery, heavy equipment, industrial, and other key
commercial markets. During the third quarter of 2004, the Company continued to
experience a high level of incoming customer orders, which were substantially
higher than those received in last years comparable period. During the
remainder of 2004, the Company expects to continue to benefit from a general
economic rebound in the manufacturing sector, continued strength in military
and defense spending, as well as other factors including relatively low
inflation and interest rates; however, because of the Companys diverse product
offerings, the specific impact these factors may have on the Companys
operating results is difficult to predict. During the third quarter of 2004 the Company incurred $1.0 million of costs
associated with Sarbanes-Oxley compliance and $0.8 million of due diligence
expenses related to acquisition initiatives. The Company expects to incur an
additional $1.0 million of Sarbanes-Oxley related expenses during the fourth
quarter of this year. The Company continues to focus on programs intended to reduce costs, improve
capacity utilization, increase efficiencies, and grow market share and cash
flow, thereby positioning the Company to capitalize on future opportunities in
targeted end-markets, especially during a period of sustained economic growth.
During the third quarter of 2004, the Company continued its investments in the
Company-wide Six Sigma effort, lean manufacturing, and information system
upgrades to strengthen the Companys operational excellence. Maintaining the Companys strong balance sheet and financial flexibility
remains a key strategy of the Company. In 2003, the Company issued $200.0
million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the
Notes) and also negotiated a new $200.0 million revolving credit agreement.
The Companys current cash balances, $269.3 million at October 2, 2004, and the
$200.0 million revolving credit facility provide financial strength to support
the Companys objectives, including strategic acquisitions. 16




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##### Table of Contents



In summary, the Companys future performance will be impacted by general
economic conditions, the length and breadth of a sustained industrial
manufacturing recovery, military and defense spending, the success of the
Companys cost reduction and capacity utilization efforts, as well as the
utilization of current liquidity levels in completing strategic acquisitions. The discussion that follows should be read in conjunction with the unaudited
Consolidated Condensed Financial Statements (and the Notes thereto), included
elsewhere in this report, and the Companys Annual Report for the year ended
December 31, 2003, particularly Item 7- Managements Discussion and Analysis
of Results of Operations and Financial Condition, to assist in understanding
the Companys results of operations, its financial position, cash flows,
capital structure and other relevant financial information. Results of Operations During the third quarter of 2004, the Company achieved sales of $83.3 million,
as compared to $68.0 million in the third quarter of 2003, an increase of $15.3
million or 22.6 percent. The quarter was favorably impacted by increased
demand across many of the Companys product lines, including specialty
bearings, split bearing products, linear deceleration products and slip-ring
products. Specifically, Kaydons Friction and Motion Control Products reporting segment
achieved sales of $40.8 million during the third quarter of 2004 as compared
with $32.0 million during the third quarter of 2003, an increase of $8.8
million or 27.5 percent, as the Company experienced increased demand for
custom-engineered bearings and split bearing products from various specialty
electronics, machinery, heavy equipment, and industrial markets. During the third quarter 2004, the Companys Velocity Control Products
reporting segment sales increased $2.1 million or 20.0 percent, to $12.6
million, when compared with third quarter 2003 sales of $10.5 million.
Increased product demand from a variety of industrial markets, both in the
United States and Europe contributed $1.5 million of the increase, while
favorable foreign currency translation, primarily related to the continuing
strength of the Euro, accounted for $0.6 million of the sales increase. The Companys Sealing Products reporting segment achieved sales of $8.7 million
which was relatively flat with the comparable period last year. During the third quarter of 2004, sales of Kaydons Power and Data Transmission
Products reporting segment increased $2.1 million or 25.8 percent, to $10.3
million, when compared with third quarter 2003 sales of $8.2 million, primarily
as a result of increased demand for specialty slip-ring products used in the
offshore oil and gas production markets and in certain security equipment
markets. Sales of the Companys remaining businesses equaled $10.8 million during the
third quarter of 2004, an increase from the third quarter 2003 of $2.3 million
or 26.3 percent. The increase was primarily the result of higher sales prices
on metal alloys caused by a pass through of higher raw material prices. 17




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##### Table of Contents



Gross profit during the third quarter of 2004 of $32.4 million was 38.9 percent
of sales, compared with $24.6 million or 36.1 percent of sales in the third
quarter of 2003. Compared to the third quarter of 2003, the third quarter 2004
gross margin was positively impacted by increased sales volume, favorable
product mix, inventory revaluations and Six Sigma cost reduction initiatives. Selling, general and administrative expenses during the third quarter of 2004
were $16.2 million, or 19.5 percent of sales, as compared to $11.7 million, or
17.2 percent of sales, during the third quarter of 2003. Third quarter 2004 selling, general, and administrative expenses, included $1.0
million of costs associated with Sarbanes-Oxley compliance and $0.8 million of
due diligence expenses related to acquisition initiatives. The Company expects
to incur an additional $1.0 million of Sarbanes-Oxley related expenses in the
fourth quarter of this year. In the future, absent Sarbanes-Oxley related and
other non-recurrent charges, the Company expects its selling, general, and
administrative expenses to approximate 18 percent of sales. The Companys operating income was $16.2 million for the third quarter of 2004
compared to operating income of $12.8 million in the third quarter of 2003, an
increase of $3.4 million or 26.3 percent. Depreciation and amortization during the third quarter 2004 was $3.6 million,
compared to $3.1 million during the third quarter of 2003. On a reporting segment basis, operating income from the Friction and Motion
Control Products reporting segment was $10.2 million during the third quarter
of 2004, as compared to $7.6 million during the comparable period last year.
Operating income was positively impacted by increased sales, as the profit
metrics for this segment are very volume sensitive, and favorable product mix. The Velocity Control Products reporting segment contributed $3.2 million to the
Companys operating income during the third quarter of 2004, as compared to
$2.2 million during the comparable period last year. Increases in operating
income were primarily due to increased product demand. The Sealing Products reporting segment contributed $2.6 million to the
Companys operating income during the third quarter of 2004, as compared to
$1.0 million during the comparable period last year. Operating income was
positively impacted by improved operating efficiencies, the revaluation of
inventory standards and certain reserve adjustments. The Power and Data Transmission Products reporting segment reported operating
income of $1.3 million during the third quarter of 2004, as compared to $0.5
million during the comparable period last year. 18




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##### Table of Contents



The Companys other businesses generated $0.2 million of operating income
during the third quarter of 2004 as compared to $0.5 million during the
comparable period last year. Interest expense during the third quarter of 2004 was $2.4 million as compared
to $2.5 million during the third quarter of 2003. As a result of higher
interest rates and higher cash balances, interest income during the third
quarter of 2004 was $1.0 million as compared to $0.6 million during the third
quarter of 2003. The Companys effective income tax rate in the third quarter of 2004 was 36
percent as compared to a 35 percent tax rate during the third quarter of 2003,
primarily as a result of higher foreign taxes. Third quarter 2004 net income and diluted earnings per share were $9.5 million
and $0.34 based on 27.9 million common shares outstanding. Third quarter 2003
net income and diluted earnings per share were $7.2 million and $0.26 based on
27.8 million common shares outstanding. Sales during the first three quarters of 2004 were $251.0 million, an increase
of 16.8 percent over last years first three quarters sales of $215.0 million.
As a result of the higher sales volume, gross profit for the first three
quarters of 2004 increased to $97.0 million or 38.7 percent of sales as
compared to $75.5 million or 35.1 percent of sales during the first three
quarters of 2003. Operating income for the first three quarters of 2004 was
$48.9 million or 19.5 percent of sales. Operating income for the first three
quarters of 2003 was $36.6 million, or 17.0 percent of sales. Net income for the first three quarters of 2004 was $28.4 million or $1.01 per
common share on a diluted basis. Net income and diluted earnings per common
share for the first three quarters of 2003 were $22.6 million and $0.78. Liquidity and Capital Resources At October 2, 2004, the Companys current ratio was 8.3 to 1 and working
capital totaled $337.1 million, including $269.3 million of cash and cash
equivalents. At December 31, 2003, the current ratio was 8.5 to 1 and working
capital totaled $317.9 million, including cash and cash equivalents of $255.8
million. Total debt outstanding at the end of the third quarter 2004, and at
year-end 2003, was $200.1 million. Maintaining the Companys strong balance
sheet and financial flexibility remains a key strategy of the Company. Cash flow from operations during the first three quarters of 2004 was $36.8
million. As previously reported, first three quarters 2004 cash flow from
operations includes the receipt of a legal settlement in the amount of $2.5
million. Cash flow from operations during the first three quarters of 2003 was
$42.5 million. During the first three quarters of 2004, the Company paid
common stock dividends of $10.2 million, invested $7.2 million in net capital
expenditures, invested $4.0 million in a product line acquisition, and
repurchased 65,600 shares of Company common stock for $1.8 million. 19




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Management expects that the Companys planned capital requirements, which
consist of capital expenditures, dividend payments and its stock repurchase
program, will be financed by operations and existing cash balances. In
addition, the Companys revolving credit facility provides additional financial
strength to support the Companys objectives including strategic acquisitions. Outlook Orders booked during the first three quarters of 2004 equaled $260.3 million
versus $221.4 million during the first three quarters of 2003, resulting in a
backlog of $106.1 million at October 2, 2004. The Companys strong order
intake during the first three quarters is further evidence of positive
momentum from the recovery in the manufacturing economy. Expected operating
cash flows coupled with the Companys current cash reserves and available
credit under the Companys $200.0 million revolving credit facility will
provide substantial resources to fund the Companys ongoing business
development efforts which include internal and external growth initiatives as
well as selected stock repurchases. Critical Accounting Policies and Estimates The Companys consolidated financial statements are prepared in conformity with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires the use of estimates, judgments, 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 and the reported amounts of revenues and expenses during the periods
presented. The Company continually evaluates the estimates, judgments, and assumptions
used to prepare the consolidated financial statements. In general, the
Companys estimates are based on historical experience, on information from
third party professionals and on various other judgments and assumptions that
are believed to be reasonable under the current facts and circumstances.
Actual results could differ from the current estimates made by the Company.
The Company has identified certain accounting policies and estimates, described
below that are the most critical to the portrayal of the Companys current
financial condition and results of operations Loss Contingencies and Legal Costs-The Company records loss contingencies as a
liability when it is probable that a liability has been incurred and the amount
of the loss is reasonably estimable. Estimated legal costs expected to be
incurred in connection with loss contingencies are accrued in the consolidated
financial statements. The Company believes the accounting estimates related to loss contingencies and
legal costs to be a critical accounting estimate as contingent liabilities are
often resolved over long time periods and estimation of probable losses and
costs to litigate requires forecasts that often depend on judgments from third
party experts and are based on potential actions by other third parties such as
plaintiffs, juries, and regulators.
To better understand this accounting policy and its historic impact on the
Company, readers should refer to Notes to Consolidated Condensed Financial
Statements (Note 20




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7) in this quarterly report on Form 10-Q as well as Notes to Consolidated
Financial Statements (Note 11) in the 2003 Annual Report on Form 10-K for
additional information regarding loss contingencies and legal costs. Impairment of Goodwill and Indefinite-Lived Intangible Assets-The Company
annually, or more frequently if events or changes in circumstances indicate a
need, tests the carrying amounts of goodwill and indefinite-lived intangible
assets for impairment. The Company identifies impairment of goodwill by comparing the fair value of
each of the Companys reporting units with the reporting units carrying
amount. The fair value of each of the Companys reporting units is derived
from an estimate of discounted future cash flows including an estimate for
terminal value. The Company utilizes a 10 percent discount rate, and a growth
assumption of 2 percent in perpetuity to calculate terminal value. Potential
goodwill impairment is identified if a reporting units carrying amount is more
than a reporting units fair value. If this occurs, normally a third-party
valuation specialist is utilized to assist the Company in determining the
implied fair value of the reporting units goodwill. The amount of any actual
impairment loss is calculated by comparing the implied fair value of the
reporting units goodwill with the carrying amount of the reporting units
goodwill. Trademarks are the Companys only indefinite-lived intangible assets. The
Company identifies impairment of these trademarks by comparing their fair value
to their carrying amounts. The fair value of the trademarks are calculated
based on estimates of discounted future cash flows including estimates for
terminal values related to the net amount of royalty expenses avoided due to
the existence of the trademarks. The Company believes the accounting estimates related to impairment of goodwill
and indefinite-lived intangible assets to be critical accounting estimates
because: the estimate of discounted future cash flows and terminal values,
while based on reasonable and supportable assumptions and projections, requires
the Companys subjective judgments; the time periods for estimating future cash
flows is often lengthy which increases the sensitivity to assumptions made;
projected outcomes based on the assumptions made can vary; and the calculation
of implied fair value is inherently subject to estimates. To better understand this accounting policy and its impact on the Company,
readers should refer to Notes to Consolidated Condensed Financial Statements
(Note 8) in this quarterly report on Form 10-Q as well as Notes to Consolidated
Financial Statements (Note 12) in the 2003 Annual Report on Form 10-K for
additional information regarding goodwill and intangible assets. Impairment of Long-Lived Assets-The Company continually evaluates whether
events and circumstances have occurred that indicate the remaining estimated
useful lives of long-lived assets including fixed assets and amortizable
intangible assets may warrant revision or that remaining balances may not be
recoverable. When factors indicate that such costs should be evaluated for
possible impairment, the Company uses an estimate of undiscounted future cash
flows over the remaining lives of the long-lived assets that are compared to
the carrying value of the asset to evaluate whether 21




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the asset costs are recoverable. The Company believes the accounting estimates related to long-lived asset
impairment to be a critical accounting estimate because: the estimate of
undiscounted future cash flows, while based on reasonable and supportable
assumptions and projections, requires the Companys subjective judgments; the
time periods for estimating future cash flows is often lengthy which increases
the sensitivity to assumptions made; and projected outcomes based on the
assumptions made can vary. To better understand this accounting policy and its impact on the Company,
readers should refer to Notes to Consolidated Condensed Financial Statements
(Note 8) in this quarterly report on Form 10-Q as well as Notes to Consolidated
Financial Statements (Note 1 and Note 12) in the 2003 Annual Report on Form
10-K for additional information regarding long-lived assets. Retirement Benefits-The Companys employee pension and postretirement benefit
costs and obligations recorded in the financial statements are dependent on the
Companys estimates provided to and used by the Companys actuaries in
calculating such amounts. The Company believes the accounting estimates related to retirement benefits to
be critical accounting estimates because of the wide range of assumptions used
in deriving yearly contribution and expense amounts as well as the amounts
recorded for retirement benefits in the Companys financial statements.
Significant assumptions include judgments regarding discount rates, health care
cost trend rates, inflation rates, salary growth rates, long-term return on
plan assets, retirement rates, mortality rates and other factors. The Company has developed estimates based on historical experience, on
information from third party professionals and on various other judgments and
assumptions that are believed to be reasonable under the current facts and
circumstances. Discount rate assumptions are based on investment yields
available on long-term bonds. Health care cost trend assumptions are developed
based on historical data, the near-term outlook, and on an assessment of likely
long-term trends. Inflation assumptions are based on an evaluation of external market indicators.
Salary growth assumptions reflect the Companys long-term experience, the
near-term outlook and assumed inflation. Long-term return on plan assets is
based on an evaluation of historical and expected returns of the individual
asset classes comprising the total plan assets. Retirement and mortality
rates are based primarily on actual plan experience and mortality tables. Actual results that differ from the Companys assumptions are accumulated and
amortized over future periods and, therefore, generally affect the Companys
recognized expense and recorded obligation in such future periods. While the
Company believes that the assumptions used are appropriate, significant
differences in actual experience or significant changes in assumptions would
affect the Companys pension and postretirement benefits costs and obligations. 22




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To better understand this accounting policy and its historic impact on the
Company, readers should refer to Notes to Consolidated Condensed Financial
Statements (Note 9) in this quarterly report on Form 10-Q as well as Notes to
Consolidated Financial Statements (Note 8) in the 2003 Annual Report on Form
10-K for additional information regarding costs, obligations, and assumptions
for employee pension and postretirement benefits. 4% Contingent Convertible Senior Subordinated Notes-In May of 2003, the
Company completed the sale of $200.0 million of 4% Contingent Convertible
Senior Subordinated Notes due 2023 (the Notes). The Notes are convertible
into a total of 6,858,710 shares of Company common stock at a conversion price
of $29.16 per share, provided certain contingencies are met including that
Kaydon common stock has traded above $34.99 for 20 out of 30 trading days for
specified periods of time. Currently, the above mentioned shares of the
Companys common stock underlying the Notes are not included in the Companys
basic or diluted earnings per share calculations, because these contingencies
have not been met. In October 2004, the Financial Accounting Standards Board ratified the final
consensus of the Emerging Issues Task Force (EITF) on EITF 04-8, The Effects
of Contingently Convertible Instruments on Diluted Earnings per Share, which
states that the impact of contingently convertible instruments that are
convertible into common stock upon the achievement of a specified market price
of the issuers shares, such as the Companys Notes, should be included in
diluted earnings per share computations regardless of whether or not the market
price trigger has been met. The provisions will be effective for reporting
periods ending after December 15, 2004. Assuming the Company does not
eliminate the feature of the Notes that allows conversion into common stock,
all prior period earnings per share amounts presented will be restated to
adjust net income by adding back the after tax interest expense, including
amortization of issuance costs, attributable to the Notes and to increase total
shares outstanding by the number of shares that would be issuable upon
conversion. In addition, the contingent interest feature of the Notes requires the Company
to deduct for tax purposes an amount of interest expense that is greater than
the stated coupon rate on the Notes. The deductibility for tax purposes of the
additional interest beyond the stated coupon rate may have to be recaptured, in
part or in whole, if the Notes are redeemed for cash instead of converted into
Company common stock. Should this happen, depending on other factors, tax
payments may increase. The Company believes that the current and potential future impact the Notes
have on the accounting for the Companys diluted earnings per share
calculations, and tax-related account balances as discussed above are critical
to the understanding of the Companys current financial condition and results
of operations. Application of EITF 04-8 may cause further dilution to the
Companys diluted earnings per share calculation, and redemption of the Notes
for cash may cause volatility in tax payments, cash flows and the liquidity of
the Company. To better understand the Notes and their impact on the Companys financial
reporting, readers should refer to Notes to Consolidated Financial Statements
(Note 2 and Note 23




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5) in the 2003 Annual Report on Form 10-K and other discussions in this
quarterly report on Form 10-Q. Income Taxes The Company records deferred tax assets and liabilities using
enacted tax rates for the effect of differences between the book and tax basis
of recorded assets and liabilities. These deferred tax assets and liabilities
are reviewed for recoverability by using estimates of future taxable income
streams and the impact of tax planning strategies. Deferred tax assets are
reduced by a valuation allowance if it is more likely than not that a portion
of the deferred tax asset will not be realized. Reserves are also estimated
for ongoing audits regarding federal, state and international issues that are
currently unresolved. Income tax is provided based upon an effective tax rate
that is dependent upon tax regulations governing the regions in which the
Company conducts business, geographic composition of worldwide earnings, the
availability of tax credits and other factors. The Company believes the accounting estimates related to income taxes to be a
critical accounting estimate because the range of assumptions used to determine
deferred tax assets and liabilities and to record current reserves and tax
rates, while based on reasonable and supportable information, may change from
year to year causing projected outcomes based on the assumptions to vary. To better understand this accounting policy and its impact on the Company,
readers should refer to Notes to Consolidated Financial Statements (Note 10) in
the 2003 Annual Report on Form 10-K for additional information regarding income
taxes. Inventories Inventories are stated at the lower of cost or market, with cost
determined on a first-in, first-out basis. The carrying value of inventory is
reduced for estimated obsolescence by the difference between its cost and the
estimated market value based upon assumptions regarding future demand. The
Company evaluates the inventory carrying value for potential excess and
obsolete inventory exposures by analyzing historical and anticipated demand.
In addition, inventories are evaluated for potential obsolescence due to the
effect of known or anticipated engineering change orders, new products, and
other factors. The Company believes the accounting estimates related to inventories to be a
critical accounting estimate because the range of assumptions used to determine
the valuation of inventories, while based on reasonable and supportable
information, may change causing projected outcomes based on the assumptions to
vary. Forward-Looking Statements This Form 10-Q contains forward-looking statements within the meaning of the
Securities Exchange Act of 1934 regarding the Companys plans, expectations,
estimates and beliefs. Forward-looking statements are typically identified by
words such as believes, expects, anticipates, intends, will, may,
potential and other similar expressions, including statements regarding
pending litigation, general economic conditions, competitive dynamics and the
adequacy of capital resources. These forward-looking statements may include,
among other things, projections of the Companys financial performance,
anticipated growth, characterization of and the Companys ability to control
contingent liabilities, and anticipated trends in the 24




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Companys businesses. These statements are only predictions, based on the
Companys current expectation about future events. Although the Company
believes the expectations reflected in the forward-looking statements are
reasonable, it cannot guarantee future results, performance or achievements or
that predictions or current expectations will be accurate. These
forward-looking statements involve risks and uncertainties, including those
specifically listed below, that could cause the Companys actual results,
performance or achievements to differ materially from those expressed or
implied by the forward-looking statements. In addition, the Company or persons acting on its behalf may from time to time
publish or communicate other items that could also be construed to be
forward-looking statements. Statements of this sort are or will be based on
the Companys estimates, assumptions, and projections and are subject to risks
and uncertainties, including those specifically listed below, that could cause
actual results to differ materially from those included in the forward-looking
statements. Kaydon does not undertake any responsibility to update its
forward-looking statements or risk factors to reflect future events or
circumstances. The following risk factors could affect the Companys operating
results. The Companys customers economic cycles may affect Kaydons operating results. Many of the Companys customers are in industries that are cyclical in nature
and sensitive to changes in general economic conditions and other factors,
including capital spending levels. Such industries include commercial and
military aerospace, semiconductor manufacturing, power generation, off-road and
heavy industrial equipment, and other capital equipment manufacturing. As a
result, the demand for the Companys products by these customers depends, in
part, upon general economic conditions. Historically, downward economic cycles
have reduced customer demand for the Companys products, thereby reducing sales
of the Companys products and resulting in reductions to the Companys revenues
and net earnings. Increased competition in the Companys key markets could result in a reduction
in Kaydons revenues and earnings and adversely affect the Companys financial
condition. The industries in which the Company operates are fragmented and the Company
faces competition from multiple companies across its diverse product lines.
Kaydon expects competitive pressures from new products and aggressive pricing
to increase, which may cause the Company to lose market share or compel the
Company to reduce prices to remain competitive, which could result in reduced
levels of revenues and earnings. The Companys competitors include U.S. and
non-U.S. companies, some of which benefit from lower labor costs and fewer
regulatory burdens. In addition, certain competitors, including Perkin Elmer,
Timken, SKF, and INA/FAG, are larger than Kaydon and may have access to greater
financial, technical, development, marketing, manufacturing, sales and
distribution services and other resources. Increased competition with these
companies or new entrants to the Companys key markets could prevent price
increases for the Companys products or could require price reductions for the
Companys products, which could adversely affect the Companys financial
condition, results of operations, growth or liquidity. 25




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Future acquisitions may require Kaydon to incur costs and liabilities, which
may adversely affect the Companys operating results. In addition to internal growth, Kaydons current strategy involves growth
through acquisitions of complementary businesses as well as acquisitions that
diversify the Companys product offerings. Like other companies with similar
growth strategies, Kaydon may be unable to continue to implement its growth
strategy, and this strategy may be ultimately unsuccessful. A portion of the
Companys expected future growth in revenues may result from acquisitions. The
Company frequently engages in evaluations of potential acquisitions and
negotiations for possible acquisitions, certain of which, if consummated, could
be significant to the Company. Although it is the Companys policy only to
acquire companies in transactions which are accretive to both earnings and cash
flow, any potential acquisitions may result in material transaction expenses,
increased interest and amortization expense, increased depreciation expense and
increased operating expense, any of which could have a material adverse effect
on the Companys operating results. Acquisitions may entail integration and
management of the new businesses to realize economies of scale and control
costs. In addition, acquisitions may involve other risks, including diversion
of management resources otherwise available for ongoing development of our
business and risks associated with entering new markets. The Company may not
be able to identify suitable acquisition candidates in the future, obtain
acceptable financing or consummate any future acquisitions. In addition, as a
result of the Companys acquisitions of other businesses, the Company may be
subject to the risk of unanticipated business uncertainties or legal
liabilities relating to those acquired businesses for which the sellers of the
acquired businesses may not indemnify the Company. Future acquisitions may
also result in potentially dilutive issuances of securities. Political, economic and regulatory conditions inherent in the international
markets in which Kaydon participates could adversely affect the Companys
financial condition. Typically, sales of the Companys products from the Companys foreign
subsidiaries and from the Companys domestic subsidiaries selling to foreign
locations accounts for approximately 30 percent of net sales. These foreign
sales could be adversely affected by changes in various foreign countries
political and economic conditions, trade protection measures, differing
intellectual property rights and changes in regulatory requirements that
restrict the sales of the Companys products or increase the Companys costs. The Company generates significant revenues outside the United States. Currency
fluctuations between the U.S. dollar and the currencies in which those
customers do business may have an impact on the demand for the Companys
products in foreign countries where the U.S. dollar has increased in value
compared to the local currency. The Company cannot predict the effects of
exchange rate fluctuations upon the Companys future operating results because
of the number of currencies involved, the variability of currency exposure and
the potential volatility of currency exchange rates. Relationships with customers and effective terms of sale frequently vary by
country, often with longer-term receivables than are typical in the United
States. 26




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Kaydons manufactured critical performance products expose the Company to
potential litigation-related costs, which may adversely affect the Companys
financial position and operating results. As a provider of critical performance products in a variety of industries
including aerospace, defense, construction, marine, medical, material handling,
machine tool positioning and other industrial applications, the Company faces a
risk of exposure to claims in the event that the failure, use or misuse of the
Companys products results, or is alleged to result, in bodily injury and/or
property damage. The Company, along with certain other companies, is named as
a defendant in a lawsuit arising from an August 2000 fatal accident involving a
MH53E helicopter manufactured by Sikorsky Aircraft Corporation. The Company
believes that the alleged damages claimed in this lawsuit, and the associated
legal costs, will be fully covered under the Companys insurance policy, but it
is possible that such costs will not be covered by insurance and, if so, the
Company will incur unknown additional direct costs. These claims have not been
finally resolved or settled. In the past, costs related to legal proceedings and settlements have had a
material effect on the Companys business, financial condition, results of
operations and liquidity. The Company cannot assure you that the ultimate cost
of current known or future unknown litigation and claims will not exceed
managements current expectations and it is possible that such costs could have
a material adverse effect on the Company. In addition, litigation is time
consuming and could divert management attention and resources away from the
Companys business. Failing to comply with the requirements of Section 404 of the Sarbanes-Oxley
Act of 2002 may adversely affect investor perceptions and the market value of
Company common stock. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, Kaydon Corporation
will be required to furnish a report of managements assessment of the
effectiveness of the Companys system of internal control over financial
reporting as part of Kaydons Annual Report on Form 10-K beginning with the
fiscal year ending December 31, 2004. The Companys independent auditors will
be required to furnish two reports, one on their assessment of the
effectiveness of the Companys system of internal control, and one on their
evaluation of managements assessment. In order to issue their report,
management must document both the design of the system of internal control, and
the testing processes that support their evaluation and conclusion. The Company
continues to spend an increased amount of management time and external resources to
comply with the requirements of Section 404. The process has required the
Company to hire additional personnel and outside consulting services. In
addition, the evaluation and attestation processes required by Section 404 are
new, therefore the Company may encounter problems or delays in completing the
review and evaluation, the implementation of improvements, and the receipt of a
positive attestation by its independent auditors. While the Company currently
believes that it has an adequate system of internal control over financial
reporting, in the event that the Companys management or its independent
auditors determine that the internal controls are not effective, as defined
under Section 404, investor perceptions of the Company may be
adversely affected. 27




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to certain market risks, which exist as part of its
ongoing business operations including interest rates and foreign currency
exchange rates. The exposure to market risk for changes in interest rates
relates primarily to investments in cash and cash equivalents. All highly
liquid investments, including highly liquid debt and investment instruments
purchased with an original maturity of three months or less, are considered
cash equivalents. The Company places its investments in cash equivalents with
high credit quality issuers and limits the amount of exposure to any one
issuer. A 15 basis point decrease in interest rates (10 percent of the
Companys weighted average investment interest rate for the third quarter of
2004) would have an immaterial impact on the Companys pre-tax earnings. The
Company conducts business in various foreign currencies, primarily in Europe,
Canada, Mexico, and Japan. Therefore, changes in the value of currencies of
these countries affect the Companys financial position and cash flows when
translated into U.S. dollars. The Company has mitigated and will continue to
mitigate a portion of its currency exposure through operation of decentralized
foreign operating companies in which many costs are local currency based. In
addition, periodically the Company enters into derivative financial instruments
in the form of forward foreign exchange contracts to reduce the effect of
fluctuations in foreign exchange rates. A 10 percent change in the value of
all foreign currencies would have an immaterial effect on the Companys
financial position and cash flows. 28




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ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Companys
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the Companys disclosure controls and procedures
pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon
that evaluation, the Companys Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls and procedures provide
reasonable assurance that the material information required to be disclosed by
the Company in the reports that it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Commissions rules and forms. Except for the
implementation of new enterprise resource planning (ERP) software at several
locations, there have been no changes in the Companys internal controls over
financial reporting that occurred during the most recent fiscal quarter that
have materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. The aforementioned ERP
software is not new to the Company, it was recently implemented at several
locations as part of the Companys ongoing program to update systems at all of
its locations. The Company believes that the new ERP software will improve its
internal control over financial reporting. 29




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PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS See the discussion in Notes to Consolidated Condensed Financial
Statements (Note 7), which discussion is incorporated herein by
reference. 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES (a) None (b) Not applicable (c) The following table provides the information with respect to
purchases made by the Company of shares of its common stock during
each month in the third quarter of 2004: Total Number ofTotal
    
    Average
    
    Shares Purchased
    
    Maximum Number ofNumber
    
    Price
    
    as
    
    Shares that MayOf Shares
    
    Paid
    
    Part of Publicly
    
    Yet be PurchasedPeriod
    
    Purchased
    
    Per Share
    
    Announced Plan
    
    Under the Plan (1)July 4 to July 31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,072,736August 1 to August 28
    
    
    36,900
    
    
    
    28.41
    
    
    
    36,900
    
    
    
    1,035,836August 29 to October 2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,035,836Total
    
    
    36,900
    
    
    
    28.41
    
    
    
    36,900
 (1) On September 29, 1999, the Companys Board of Directors authorized
management to purchase up to 5,000,000 shares of its common stock in the
open market. 30




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ITEM 6. EXHIBITS Exhibit No.
    
    Description10.1
    
    Kaydon Corporation Employee Stock Ownership and
Thrift Plan, as amended (previously filed as Exhibit 4.4 to
the Companys Form S-8 filed October 8, 2004 and incorporated
herein by reference)10.2
    
    Electro-Tec Corporation Employee Retirement
Benefit Plan, as amended (previously filed as Exhibit 4.5 to
the Companys Form S-8 filed October 8, 2004 and incorporated
herein by reference)12
    
    Statement Re: Computation of Ratio of Earnings to
Fixed Charges31
    
    Certification Pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 200232
    
    Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
 31




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##### Table of Contents



SIGNATURES 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. KAYDON CORPORATIONNovember 10, 2004
    /s/ Brian P. CampbellBrian P. CampbellChairman, President, Chief Executive
Officer and Chief Financial Officer November 10, 2004
    /s/ Kenneth W. CrawfordKenneth W. CrawfordVice President and Corporate Controller
(Principal Accounting Officer) 32




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EXHIBIT INDEX Exhibit No.
    
    Description10.1
    
    Kaydon Corporation Employee Stock Ownership and Thrift Plan, as amended
(previously filed as Exhibit 4.4 to the Companys Form S-8 filed October
8, 2004 and incorporated herein by reference)10.2
    
    Electro-Tec Corporation Employee Retirement Benefit Plan, as amended
(previously filed as Exhibit 4.5 to the Companys Form S-8 filed October
8, 2004 and incorporated herein by reference)12
    
    Statement Re: Computation of Ratio of Earnings to Fixed Charges31
    
    Certification Pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of
200232
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
 33