##### 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 July 1, 2006
    
    Commission File No. 0-12640
 KAYDON CORPORATION
  Delaware
    
    13-3186040(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 Suite 300, 315 E. Eisenhower Parkway, Ann Arbor, Michigan
    
    48108(Address of principal executive offices)
    
    (Zip Code)
 (734) 747-7025
  þ o
  þ o þ
  o þ




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##### 



Page No.Part I  Financial Information:Item 1. Financial StatementsConsolidated Condensed Balance Sheets -
July 1, 2006 (Unaudited) and December 31, 2005
    
    
    1Consolidated Condensed Statements of Operations (Unaudited) -
Quarter and First Half Ended July 1, 2006 and July 2, 2005
    
    
    2Consolidated Condensed Statements of Cash Flows (Unaudited) -
First Half Ended July 1, 2006 and July 2, 2005
    
    
    3Notes to Consolidated Condensed Financial Statements (Unaudited)
    
    
    4 - 16Item 2. Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    17 - 26Item 3. Quantitative and Qualitative Disclosures About
Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27Part II  Other Information:Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    28Item 4. Submission of Matters to a Vote of Security Holders
    
    
    28Item 6. Exhibits
    
    
    29Signatures
    
    
    30Statement Re: Computation of Ratio of Earnings to Fixed ChargesSection 302 Certification of Chief Executive Officer & Chief Financial OfficerSection 906 Certification of Chief Executive Officer & Chief Financial Officer




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##### Table of Contents



ITEM 1. FINANCIAL STATEMENTS
 KAYDON CORPORATION
 
 CONSOLIDATED CONDENSED BALANCE SHEETS
 July 1, 2006
    
    
    December 31, 2005(Unaudited)Assets:Cash and cash equivalents
    
    $
    343,338,000
    
    
    $
    320,804,000Accounts receivable, net
    
    
    57,919,000
    
    
    
    50,869,000Inventories, net
    
    
    54,115,000
    
    
    
    51,783,000Other current assets
    
    
    12,186,000
    
    
    
    14,671,000Total current assets
    
    
    467,558,000
    
    
    
    438,127,000Property, plant and equipment, net
    
    
    81,899,000
    
    
    
    79,603,000Goodwill, net
    
    
    118,243,000
    
    
    
    117,168,000Other intangible assets, net
    
    
    22,777,000
    
    
    
    24,288,000Other assets
    
    
    8,803,000
    
    
    
    11,401,000Total assets
    
    $
    699,280,000
    
    
    $
    670,587,000Liabilities and Shareholders Equity:Accounts payable
    
    $
    17,166,000
    
    
    $
    18,192,000Salaries and wages
    
    
    8,662,000
    
    
    
    8,963,000Taxes payable
    
    
    4,116,000
    
    
    
    4,507,000Interest payable
    
    
    867,000
    
    
    
    844,000Other accrued expenses
    
    
    12,922,000
    
    
    
    12,238,000Total current liabilities
    
    
    43,733,000
    
    
    
    44,744,000Long-term debt
    
    
    200,000,000
    
    
    
    200,000,000Long-term liabilities
    
    
    65,938,000
    
    
    
    66,167,000Total long-term liabilities
    
    
    265,938,000
    
    
    
    266,167,000Shareholders equity:Common stock
    
    
    3,693,000
    
    
    
    3,693,000Paid-in capital
    
    
    48,458,000
    
    
    
    47,702,000Retained earnings
    
    
    538,339,000
    
    
    
    510,818,000Less  treasury stock, at cost
    
    
    (185,928,000
    )
    
    
    (186,599,000
    )Less  restricted stock awards
    
    
    (9,034,000
    )
    
    
    (7,584,000
    )Accumulated other comprehensive loss
    
    
    (5,919,000
    )
    
    
    (8,354,000
    )389,609,000
    
    
    
    359,676,000Total liabilities and shareholders equity
    
    $
    699,280,000
    
    
    $
    670,587,000
  1




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KAYDON CORPORATION
 
 CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
 (UNAUDITED)
 Quarter Ended
    
    
    First Half EndedJuly 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Net sales
    
    $
    102,664,000
    
    
    $
    94,473,000
    
    
    $
    204,169,000
    
    
    $
    179,035,000Cost of sales
    
    
    59,067,000
    
    
    
    58,352,000
    
    
    
    119,029,000
    
    
    
    109,519,000Gross profit
    
    
    43,597,000
    
    
    
    36,121,000
    
    
    
    85,140,000
    
    
    
    69,516,000Selling, general and
administrative expenses
    
    
    17,430,000
    
    
    
    18,017,000
    
    
    
    35,345,000
    
    
    
    36,290,000Operating income
    
    
    26,167,000
    
    
    
    18,104,000
    
    
    
    49,795,000
    
    
    
    33,226,000Interest income
    
    
    3,927,000
    
    
    
    1,733,000
    
    
    
    7,323,000
    
    
    
    3,260,000Interest expense
    
    
    (2,388,000
    )
    
    
    (2,396,000
    )
    
    
    (4,799,000
    )
    
    
    (4,814,000
    )Income from continuing
operations before income taxes
    
    
    27,706,000
    
    
    
    17,441,000
    
    
    
    52,319,000
    
    
    
    31,672,000Provision for income taxes
    
    
    10,002,000
    
    
    
    6,168,000
    
    
    
    18,026,000
    
    
    
    11,195,000Income from continuing operations
    
    
    17,704,000
    
    
    
    11,273,000
    
    
    
    34,293,000
    
    
    
    20,477,000Income from discontinued
operations before income taxes
    
    
    
    
    
    
    1,722,000
    
    
    
    
    
    
    
    2,737,000Provision for income taxes
    
    
    
    
    
    
    577,000
    
    
    
    
    
    
    
    917,000Income from discontinued
operations
    
    
    
    
    
    
    1,145,000
    
    
    
    
    
    
    
    1,820,000Net income
    
    $
    17,704,000
    
    
    $
    12,418,000
    
    
    $
    34,293,000
    
    
    $
    22,297,000Weighted average common shares:Basic
    
    
    27,836,000
    
    
    
    27,778,000
    
    
    
    27,840,000
    
    
    
    27,832,000Diluted
    
    
    34,773,000
    
    
    
    34,696,000
    
    
    
    34,779,000
    
    
    
    34,757,000Earnings per share  continuing
operations:Basic
    
    $
    0.64
    
    
    $
    0.41
    
    
    $
    1.23
    
    
    $
    0.74Diluted
    
    $
    0.55
    
    
    $
    0.37
    
    
    $
    1.07
    
    
    $
    0.68Earnings per share 
discontinued operations:Basic
    
    
    
    
    
    $
    0.04
    
    
    
    
    
    
    $
    0.06Diluted
    
    
    
    
    
    $
    0.03
    
    
    
    
    
    
    $
    0.05Earnings per share:Basic
    
    $
    0.64
    
    
    $
    0.45
    
    
    $
    1.23
    
    
    $
    0.80Diluted
    
    $
    0.55
    
    
    $
    0.40
    
    
    $
    1.07
    
    
    $
    0.73Dividends declared per share
    
    $
    0.12
    
    
    $
    0.12
    
    
    $
    0.24
    
    
    $
    0.24
  2




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KAYDON CORPORATION
 
 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 First Half EndedJuly 1, 2006
    
    
    July 2, 2005Cash flows from operating activities
    
    $
    37,898,000
    
    
    $
    18,150,000Cash flows used in investing activities:Additions to property, plant and equipment, net
    
    
    (7,580,000
    )
    
    
    (5,215,000
    )Acquisition of business, net of cash acquired
    
    
    
    
    
    
    (42,668,000
    )Cash used in investing activities
    
    
    (7,580,000
    )
    
    
    (47,883,000
    )Cash flows used in financing activities:Cash dividends paid
    
    
    (6,762,000
    )
    
    
    (6,770,000
    )Purchase of treasury stock
    
    
    (3,404,000
    )
    
    
    (6,102,000
    )Proceeds from exercise of stock options
    
    
    1,003,000
    
    
    
    494,000Excess tax benefits from stock-based compensation
    
    
    547,000
    
    
    
    Payments on debt
    
    
    (32,000
    )
    
    
    (30,000
    )Cash used in financing activities
    
    
    (8,648,000
    )
    
    
    (12,408,000
    )Effect of exchange rate changes on cash and cash
equivalents
    
    
    864,000
    
    
    
    560,000Discontinued Operations:Operating cash flows
    
    
    
    
    
    
    3,620,000Investing cash flows
    
    
    
    
    
    
    (163,000
    )Effect of exchange rate changes on cash and cash
equivalents
    
    
    
    
    
    
    (267,000
    )Net cash flows from discontinued operations
    
    
    
    
    
    
    3,190,000Net increase (decrease) in cash and cash equivalents
    
    
    22,534,000
    
    
    
    (38,391,000
    )Cash and cash equivalents  Beginning of period
    
    
    320,804,000
    
    
    
    278,586,000Cash and cash equivalents  End of period
    
    $
    343,338,000
    
    
    $
    240,195,000Cash expended for income taxes
    
    $
    13,344,000
    
    
    $
    9,155,000Cash expended for interest
    
    $
    4,000,000
    
    
    $
    4,000,000
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KAYDON CORPORATION
 
 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
 (UNAUDITED)
 (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, 2005 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, 2005.(2)
    
    The Company considers all highly liquid debt and investment instruments purchased with a
maturity of three months or less to be cash equivalents. At July 1, 2006, the Company had
$109.5 million invested in U.S. Government treasury bills, $103.1 million invested in various
money market and other short-term funds, $94.8 million invested in investment grade prime
commercial paper of several United States issuers, and $32.5 million invested in time-deposits
and other interest bearing accounts.(3)
    
    Inventories are summarized as follows:
 July 1, 2006
    
    
    December 31, 2005Raw Material
    
    $
    20,993,000
    
    
    $
    19,094,000Work in Process
    
    
    11,439,000
    
    
    
    12,593,000Finished Goods
    
    
    21,683,000
    
    
    
    20,096,000$
    54,115,000
    
    
    $
    51,783,000
 (4)
    
    Comprehensive income reflects the change in equity of a business enterprise during a period
from transactions and other events, and from circumstances involving non-owner 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 $2.0 million and $(2.6) million, resulting in
comprehensive income of $19.7 million and $9.8 million for the quarters ended July 1, 2006 and
July 2, 2005. On a first half basis, other comprehensive income (loss), net of tax, was
approximately $2.4 million and $(3.4) million, resulting in comprehensive income of $36.7
million and $18.9 million for the first halves ended July 1, 2006 and July 2, 2005.
 4




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(5)
    
    The following table reconciles the numerators and denominators used in the calculations of
basic and diluted earnings per share from continuing operations for the periods presented.
 Quarter EndedJuly 1, 2006
    
    
    July 2, 2005Numerators:Numerators for basic earnings per
share from continuing
operations, income from
continuing operations
    
    $
    17,704,000
    
    
    $
    11,273,000Interest and debt issuance costs
amortization related to Contingent
Convertible Notes, net of taxes
    
    
    1,486,000
    
    
    
    1,507,000Numerators for diluted earnings per
share from continuing
operations
    
    $
    19,190,000
    
    
    $
    12,780,000Denominators:Denominators for basic earnings
per share from continuing
operations, weighted average
common shares outstanding
    
    
    27,836,000
    
    
    
    27,778,000Potential dilutive shares resulting
from stock options, restricted
stock awards and phantom stock
units
    
    
    78,000
    
    
    
    59,000Dilutive shares resulting from
Contingent Convertible Notes
    
    
    6,859,000
    
    
    
    6,859,000Denominators for diluted
earnings per share from
continuing operations
    
    
    34,773,000
    
    
    
    34,696,000Earnings per share from continuing
operations:Basic
    
    $
    0.64
    
    
    $
    0.41Diluted
    
    $
    0.55
    
    
    $
    0.37
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First Half EndedJuly 1, 2006
    
    
    July 2, 2005Numerators:Numerators for basic earnings per
share from continuing
operations, income from
continuing operations
    
    $
    34,293,000
    
    
    $
    20,477,000Interest and debt issuance costs
amortization related to Contingent
Convertible Notes, net of taxes
    
    
    2,989,000
    
    
    
    3,014,000Numerators for diluted earnings per
share from continuing
operations
    
    $
    37,282,000
    
    
    $
    23,491,000Denominators:Denominators for basic earnings
per share from continuing
operations, weighted average
common shares outstanding
    
    
    27,840,000
    
    
    
    27,832,000Potential dilutive shares resulting
from stock options, restricted
stock awards and phantom stock
units
    
    
    80,000
    
    
    
    66,000Dilutive shares resulting from
Contingent Convertible Notes
    
    
    6,859,000
    
    
    
    6,859,000Denominators for diluted
earnings per share from
continuing operations
    
    
    34,779,000
    
    
    
    34,757,000Earnings per share from continuing
operations:Basic
    
    $
    1.23
    
    
    $
    0.74Diluted
    
    $
    1.07
    
    
    $
    0.68
 The Company has outstanding $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. The Notes become convertible during any calendar quarter if
the closing sale price of Company common stock is more than $34.99 for at least 20 trading
days in a period of 30 consecutive trading days ending on the last trading day of the
preceding calendar quarter. Based on this formula, holders will be able to convert their
Notes during the third quarter of 2006, because during the second quarter ended July 1, 2006
the closing sale price of Company common stock was more than $34.99 for at least 20 trading
days in the period of 30 consecutive trading days ended on the last trading day of the
quarter. The Notes are discussed further in Note 7.
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(6)
    
    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.Following the sale of its Power and Data Transmission Products segment in July 2005, the
Company has three 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 engine rings, sealing
rings and shaft seals.Other-filter elements and liquid and gas-phase air 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, exchange gains and losses applicable to non-functional currency
assets and liabilities, 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.
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Quarter Ended
    
    
    First Half EndedJuly 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Net salesFriction and Motion Control ProductsExternal customers
    
    $
    60,615,000
    
    
    $
    50,687,000
    
    
    $
    117,677,000
    
    
    $
    95,357,000Intersegment  continuing operations
    
    
    32,000
    
    
    
    36,000
    
    
    
    63,000
    
    
    
    62,000Intersegment  discontinued operations
    
    
    
    
    
    
    194,000
    
    
    
    
    
    
    
    298,00060,647,000
    
    
    
    50,917,000
    
    
    
    117,740,000
    
    
    
    95,717,000Velocity Control ProductsExternal customers
    
    
    14,278,000
    
    
    
    14,434,000
    
    
    
    28,796,000
    
    
    
    29,172,000Intersegment  continuing operations
    
    
    
    
    
    
    (1,000
    )
    
    
    
    
    
    
    (1,000
    )14,278,000
    
    
    
    14,433,000
    
    
    
    28,796,000
    
    
    
    29,171,000Sealing ProductsExternal customers
    
    
    10,808,000
    
    
    
    10,471,000
    
    
    
    21,643,000
    
    
    
    19,161,000Intersegment  continuing operations
    
    
    (18,000
    )
    
    
    (28,000
    )
    
    
    (41,000
    )
    
    
    (47,000
    )10,790,000
    
    
    
    10,443,000
    
    
    
    21,602,000
    
    
    
    19,114,000OtherExternal customers
    
    
    16,963,000
    
    
    
    18,687,000
    
    
    
    36,053,000
    
    
    
    35,047,000Intersegment  continuing operations
    
    
    (14,000
    )
    
    
    (7,000
    )
    
    
    (22,000
    )
    
    
    (14,000
    )16,949,000
    
    
    
    18,680,000
    
    
    
    36,031,000
    
    
    
    35,033,000Total consolidated net sales
    
    $
    102,664,000
    
    
    $
    94,473,000
    
    
    $
    204,169,000
    
    
    $
    179,035,000
 Quarter Ended
    
    
    First Half EndedJuly 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Operating incomeFriction and Motion Control Products
    
    $
    17,785,000
    
    
    $
    12,675,000
    
    
    $
    33,704,000
    
    
    $
    23,284,000Velocity Control Products
    
    
    3,291,000
    
    
    
    3,734,000
    
    
    
    6,983,000
    
    
    
    7,175,000Sealing Products
    
    
    1,735,000
    
    
    
    1,724,000
    
    
    
    2,735,000
    
    
    
    2,915,000Other
    
    
    1,539,000
    
    
    
    1,897,000
    
    
    
    3,458,000
    
    
    
    2,935,000Total segment operating income
    
    
    24,350,000
    
    
    
    20,030,000
    
    
    
    46,880,000
    
    
    
    36,309,000State income tax provision
included in segment operating
income
    
    
    800,000
    
    
    
    289,000
    
    
    
    1,511,000
    
    
    
    784,000Items not allocated to segment
operating income
    
    
    1,017,000
    
    
    
    (2,215,000
    )
    
    
    1,404,000
    
    
    
    (3,867,000
    )Interest expense
    
    
    (2,388,000
    )
    
    
    (2,396,000
    )
    
    
    (4,799,000
    )
    
    
    (4,814,000
    )Interest income
    
    
    3,927,000
    
    
    
    1,733,000
    
    
    
    7,323,000
    
    
    
    3,260,000Income from continuing operations
before income taxes
    
    $
    27,706,000
    
    
    $
    17,441,000
    
    
    $
    52,319,000
    
    
    $
    31,672,000
 8




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##### Table of Contents



Quarter Ended
    
    
    First Half EndedJuly 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Depreciation and amortizationFriction and Motion Control Products
    
    $
    1,955,000
    
    
    $
    1,880,000
    
    
    $
    3,931,000
    
    
    $
    3,672,000Velocity Control Products
    
    
    449,000
    
    
    
    472,000
    
    
    
    910,000
    
    
    
    951,000Sealing Products
    
    
    276,000
    
    
    
    269,000
    
    
    
    556,000
    
    
    
    537,000Other
    
    
    926,000
    
    
    
    1,043,000
    
    
    
    1,854,000
    
    
    
    1,794,000Corporate
    
    
    796,000
    
    
    
    630,000
    
    
    
    1,573,000
    
    
    
    1,291,000Total consolidated depreciation and
amortization of continuing operations
    
    $
    4,402,000
    
    
    $
    4,294,000
    
    
    $
    8,824,000
    
    
    $
    8,245,000
 Quarter Ended
    
    
    First Half EndedJuly 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Additions to net property, plant
and equipmentFriction and Motion Control Products
    
    $
    2,588,000
    
    
    $
    1,367,000
    
    
    $
    5,671,000
    
    
    $
    2,747,000Velocity Control Products
    
    
    130,000
    
    
    
    360,000
    
    
    
    358,000
    
    
    
    563,000Sealing Products
    
    
    64,000
    
    
    
    56,000
    
    
    
    217,000
    
    
    
    112,000Other
    
    
    673,000
    
    
    
    722,000
    
    
    
    1,180,000
    
    
    
    1,001,000Corporate
    
    
    19,000
    
    
    
    367,000
    
    
    
    154,000
    
    
    
    792,000Total consolidated additions to net
property, plant and
equipment of
continuing operations
    
    $
    3,474,000
    
    
    $
    2,872,000
    
    
    $
    7,580,000
    
    
    $
    5,215,000
 July 1, 2006
    
    
    December 31, 2005Total assetsFriction and Motion Control Products
    
    $
    166,076,000
    
    
    $
    153,055,000Velocity Control Products
    
    
    85,087,000
    
    
    
    79,494,000Sealing Products
    
    
    20,626,000
    
    
    
    21,329,000Other
    
    
    93,447,000
    
    
    
    94,528,000Corporate
    
    
    334,044,000
    
    
    
    322,181,000Total consolidated assets
    
    $
    699,280,000
    
    
    $
    670,587,000
 9




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##### Table of Contents



(7)
    
    Interest expense on the Companys 4% Contingent Convertible Senior Subordinated Notes due
2023 (the Notes) equaled $2.0 million for the second quarter of 2006. Note issuance costs
of approximately $6.5 million are being amortized over a five-year period. Amortization of
Note issuance costs during the second quarter of 2006 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 July 1, 2006 and December
31, 2005 were $2.5 million and $3.1 million, respectively.The Companys $300.0 million senior unsecured revolving credit facility provides for
borrowings and issuance of letters of credit by the Company and its subsidiaries in various
currencies for general corporate purposes, including acquisitions. The credit facility
matures on July 12, 2010 and is guaranteed by the Company and certain of the Companys
domestic subsidiaries. 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
3.5 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 July 1, 2006. After consideration of the facilitys
covenants and $4.5 million of letters of credit issued under the facility, the Company has
available credit under its revolving credit facility of $295.5 million at July 1, 2006.
  July 1, 2006
    
    
    December 31, 20054% Contingent Convertible
Senior Subordinated Notes due
2023
    
    $
    200,000,000
    
    
    $
    200,000,000Other
    
    
    34,000
    
    
    
    66,000Total debt
    
    
    200,034,000
    
    
    
    200,066,000Less current maturities
    
    
    34,000
    
    
    
    66,000Long-term debt
    
    $
    200,000,000
    
    
    $
    200,000,000
 10




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##### Table of Contents



(8)
    
    The Company is involved in ongoing environmental remediation activities at
certain manufacturing sites. One of the manufacturing sites undergoing environmental
remediation is a discontinued operation sold in 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 July 1, 2006, an undiscounted accrual in the amount of
$1.4 million, representing the Companys best estimate for ultimate resolution of these
environmental matters, is recorded in other long-term liabilities in the Consolidated Condensed
Balance Sheet.Various other claims 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 accrued in the Consolidated Condensed Balance
Sheet.(9)
    
    Annually during the third quarter, or between annual tests if certain circumstances exist,
the Company tests the carrying amounts of goodwill and certain intangible assets, deemed to
have indefinite useful lives, for impairment.
  Friction andMotion
    
    
    VelocityControl
    
    
    Control
    
    
    SealingProducts
    
    
    Products
    
    
    Products
    
    
    Other
    
    
    TotalBalance as of
January 1, 2006
    
    $
    30,136,000
    
    
    $
    43,200,000
    
    
    $
    186,000
    
    
    $
    43,646,000
    
    
    $
    117,168,000Effect of foreign
currency exchange
rate changes
    
    
    114,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    114,000Balance as of
April 1, 2006
    
    $
    30,250,000
    
    
    $
    43,200,000
    
    
    $
    186,000
    
    
    $
    43,646,000
    
    
    $
    117,282,000Effect of foreign
currency exchange
rate changes
    
    
    961,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    961,000Balance as of
July 1, 2006
    
    $
    31,211,000
    
    
    $
    43,200,000
    
    
    $
    186,000
    
    
    $
    43,646,000
    
    
    $
    118,243,000
 11




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##### Table of Contents



July 1, 2006
    
    
    December 31, 2005Gross Carrying
    
    
    Accumulated
    
    
    Gross Carrying
    
    
    AccumulatedAmortized Intangible Assets
    
    Amount
    
    
    Amortization
    
    
    Amount
    
    
    AmortizationCustomer relationships and lists
    
    $
    18,694,000
    
    
    $
    6,105,000
    
    
    $
    18,694,000
    
    
    $
    4,940,000Patents and developed technology
    
    
    6,266,000
    
    
    
    1,260,000
    
    
    
    6,238,000
    
    
    
    920,000Distributor agreements
    
    
    374,000
    
    
    
    68,000
    
    
    
    374,000
    
    
    
    50,000Backlog
    
    
    
    
    
    
    
    
    
    
    351,000
    
    
    
    351,000Product names
    
    
    320,000
    
    
    
    48,000
    
    
    
    320,000
    
    
    
    32,000$
    25,654,000
    
    
    $
    7,481,000
    
    
    $
    25,977,000
    
    
    $
    6,293,000
  July 1, 2006
    
    
    December 31, 2005Carrying
    
    
    CarryingUnamortized Intangible Assets
    
    Amount
    
    
    AmountTrademarks
    
    $
    4,604,000
    
    
    $
    4,604,000
 Aggregate
Intangible Assets Amortization ExpenseFor the first half ended July 1, 2006
    
    $
    1,539,000For the first half ended July 2, 2005
    
    $
    1,527,000
 Estimated
Intangible Assets Amortization ExpenseFor the year ending December 31, 2006
    
    $
    3,076,000For the year ending December 31, 2007
    
    $
    3,022,000For the year ending December 31, 2008
    
    $
    2,951,000For the year ending December 31, 2009
    
    $
    2,628,000For the year ending December 31, 2010
    
    $
    2,267,000
 12




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##### Table of Contents



(10)
    
    The components of net periodic benefit cost (income) are as follows:
 Quarter Ended
    
    
    First Half EndedPension Benefits
    
    July 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Service cost
    
    $
    759,000
    
    
    $
    636,000
    
    
    $
    1,518,000
    
    
    $
    1,272,000Interest cost
    
    
    1,394,000
    
    
    
    1,270,000
    
    
    
    2,788,000
    
    
    
    2,540,000Expected return on plan assets
    
    
    (1,168,000
    )
    
    
    (1,083,000
    )
    
    
    (2,336,000
    )
    
    
    (2,166,000
    )Amortization of:Unrecognized net priorService cost
    
    
    50,000
    
    
    
    49,000
    
    
    
    100,000
    
    
    
    98,000Unrecognized net loss
    
    
    362,000
    
    
    
    220,000
    
    
    
    724,000
    
    
    
    440,000Total
    
    $
    1,397,000
    
    
    $
    1,092,000
    
    
    $
    2,794,000
    
    
    $
    2,184,000
 Quarter Ended
    
    
    First Half EndedPostretirement Benefits
    
    July 1, 2006
    
    
    July 2, 2005
    
    
    July 1, 2006
    
    
    July 2, 2005Service cost
    
    $
    92,000
    
    
    $
    111,000
    
    
    $
    184,000
    
    
    $
    222,000Interest cost
    
    
    203,000
    
    
    
    221,000
    
    
    
    406,000
    
    
    
    442,000Amortization of:Unrecognized net priorService cost
    
    
    (442,000
    )
    
    
    (359,000
    )
    
    
    (884,000
    )
    
    
    (717,000
    )Unrecognized net gain
    
    
    (97,000
    )
    
    
    (176,000
    )
    
    
    (194,000
    )
    
    
    (352,000
    )Total
    
    $
    (244,000
    )
    
    $
    (203,000
    )
    
    $
    (488,000
    )
    
    $
    (405,000
    )
  (11)
    
    As of January 1, 2006, the Company adopted the revision to Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-Based Compensation. This revision, SFAS No.
123 (R), requires Kaydon to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award. The cost is
recognized over the period during which an employee is required to provide service in exchange
for the award. SFAS No. 123 (R) applies to all awards granted after January 1, 2006 and to
awards modified, repurchased or canceled after that date. The impact of the adoption was not
significant.The Companys 1999 Long Term Stock Incentive Plan provides for the issuance of 2,000,000
shares of Company common stock, plus an additional 2,000,000 shares resulting from certain
re-acquisitions of shares by the Company, for stock-based incentives in various forms. The
Companys 2003 Non-Employee Directors Equity Plan provides for the issuance of 300,000
shares of Company common stock in various forms to non-employee members of the Companys
Board of Directors. The Company has granted both restricted stock awards and fixed stock
options pursuant to its equity incentive plans.
 13




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##### Table of Contents



A summary of restricted stock information pursuant to the Companys equity incentive plans
for the first half of 2006 is as follows:
 First Half EndedJuly 1, 2006Wtd. Avg.Restricted
    
    
    Grant DateStock
    
    
    Fair ValueOutstanding at January 1, 2006
    
    
    381,427
    
    
    $
    26.73Granted
    
    
    87,020
    
    
    $
    34.18Vested
    
    
    (102,131
    )
    
    $
    25.58Canceled
    
    
    (2,400
    )
    
    $
    31.12Outstanding at April 1, 2006
    
    
    363,916
    
    
    $
    28.81Granted
    
    
    4,500
    
    
    $
    41.59Canceled
    
    
    (1,632
    )
    
    $
    26.45Outstanding at July 1, 2006
    
    
    366,784
    
    
    $
    28.98
 Grant-date fair value of restricted stock awards equals the closing market price of Company
common stock on the date of grant. The unamortized value of unvested restricted stock
awards, aggregating $9.0 million at July 1, 2006, is recorded in the Consolidated Condensed
Balance Sheet as a deduction from shareholders equity, and is expected to be amortized over
a weighted-average period of 3.9 years. Amortization related to restricted stock awards
equaled $0.8 million and $1.6 million during the second quarter and first half of 2006, and
equaled $0.7 million and $1.3 million during the second quarter and first half of 2005.
Restricted stock awards vest on January 5th of each year.Restricted stock awards granted pursuant to the Companys equity incentive plans allow for
continued annual vesting if a grantee retires at or after the age of 65, even though the
grantee is no longer providing services to the Company. For awards made prior to January 1,
2006, compensation cost associated with these restricted stock awards is being amortized
ratably over the awards normal five- to ten-year vesting periods, or up to the date of
actual retirement of the grantee, when applicable. Concurrent with the adoption of SFAS No.
123 (R), the Company changed this approach for new awards granted after January 1, 2006, so
that compensation cost related to grantees who become retirement eligible during the normal
vesting period is amortized ratably over the period from the grant date to the date
retirement eligibility is achieved. Compensation expense is recognized immediately for
awards granted to retirement eligible employees. Had the Company recognized compensation
cost under this new approach for all outstanding restricted stock awards, the expense would
have decreased $0.2 million and $0.3 million during the second quarter and first half of
2006, and would have increased $0.5 million and $1.0 million during the second quarter and
first half of 2005.
 14




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##### Table of Contents



The Company is applying the provisions of SFAS No. 123 (R) to its outstanding stock options
using a modified version of prospective application. Under this
transition method, compensation expense is recognized on or after January 1, 2006 for the
portion of outstanding stock options for which the requisite service has not yet been
rendered, based on the grant-date fair value of those stock options previously calculated
under SFAS No. 123 for the purpose of making pro-forma disclosures. For periods before
January 1, 2006, Kaydon will not restate the financial statements to reflect compensation
expense previously reported in the pro-forma footnote disclosures under the provisions of
SFAS No. 123.A summary of fixed stock option information pursuant to the Companys equity incentive plans
for the first half of 2006 is as follows:
 First Half EndedJuly 1, 2006Option
    
    
    Wtd. Avg.Shares
    
    
    Ex. PriceOutstanding at January 1, 2006
    
    
    102,000
    
    
    $
    25.04Exercised
    
    
    (32,000
    )
    
    $
    25.06Outstanding at April 1, 2006
    
    
    70,000
    
    
    $
    25.03Granted
    
    
    14,000
    
    
    $
    41.59Exercised
    
    
    (8,750
    )
    
    $
    22.99Outstanding at July 1, 2006
    
    
    75,250
    
    
    $
    28.35Exercisable at July 1, 2006
    
    
    20,000
    
    
    $
    24.91
 The exercise price of each fixed option equals the market price of Company common stock on
the date of grant. Options granted become exercisable at the rate of 10.0 percent, 20.0
percent or 25.0 percent per year, commencing one year after the date of grant, and options
expire five or ten years after the date of grant. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model. Compensation
expense related to fixed stock options equaled $0.1 million and $0.2 million during the
second quarter and first half of 2006, and equaled $0.0 million during both the second
quarter and first half of 2005. The total intrinsic value of options exercised equaled $0.1
million and $0.5 million during the second quarter and first half of 2006.
 15




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##### Table of Contents



Options outstanding at July 1, 2006, are as follows:
 Wtd.Wtd.
    
    
    Avg.Avg.
    
    
    RemainingOption
    
    
    Lowest
    
    
    Highest
    
    
    Exercise
    
    
    ContractualShares
    
    
    Price
    
    
    Price
    
    
    Price
    
    
    Life (years)Exercise price per
share:Under $25.00:Exercisable
    
    
    7,700
    
    
    $
    22.60
    
    
    $
    22.60
    
    
    $
    22.60
    
    
    
    5.14Non-exercisable
    
    
    19,050
    
    
    $
    21.10
    
    
    $
    24.25
    
    
    $
    23.80
    
    
    
    4.4426,750
    
    
    $
    21.10
    
    
    $
    24.25
    
    
    $
    23.46
    
    
    
    4.64Over $25.00:Exercisable
    
    
    12,300
    
    
    $
    26.01
    
    
    $
    27.35
    
    
    $
    26.35
    
    
    
    6.22Non-exercisable
    
    
    36,200
    
    
    $
    26.01
    
    
    $
    41.59
    
    
    $
    32.65
    
    
    
    8.8748,500
    
    
    $
    26.01
    
    
    $
    41.59
    
    
    $
    31.05
    
    
    
    8.19Total options
    
    
    75,250
    
    
    $
    21.10
    
    
    $
    41.59
    
    
    $
    28.35
    
    
    
    6.93
 The aggregate intrinsic value of options outstanding as of July 1, 2006 is $0.7 million.Prior to January 1, 2006, the Company accounted for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25. Had
compensation cost for stock-based awards been recognized based on the fair value method
prescribed under SFAS No. 123 (R), the effect on net income and earnings per share from
continuing operations during the second quarter and first half of 2005 would not have been
significant.(12)
    
    During 2005, the Company classified certain land and building assets that are in the process
of being sold, due to the consolidation of the Companys liquid filtration products business,
as assets held for sale as required under Statement of Financial Accounting Standards No. 144.
These assets, reported as part of the Companys Other businesses for segment reporting
purposes, are immaterial at July 1, 2006. The Company expects to sell these assets before
December 31, 2006.(13)
    
    In July 2006, the Financial Accounting Standards Board (the FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48
prescribes a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken in a tax return, and provides guidance
regarding subsequent de-recognition of a tax position, classification, interest and penalties,
accounting in interim periods, and disclosure. FIN 48 is effective for fiscal years beginning
after December 15, 2006. The Company has not completed its analysis of the potential impact of
FIN 48 on its financial position, results of operations or cash flows.
 16




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Overview
        17




---



##### Table of Contents



Results of Operations
 Second Quarter Results
       18




---



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19




---



##### Table of Contents



First Half Results
     Liquidity and Capital Resources
   20




---



##### Table of Contents



Outlook
  Critical Accounting Policies and Estimates
   21




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##### Table of Contents



Inventories 
  Impairment of Long-Lived Assets 
  Notes to Consolidated Financial Statements (Note 1 and Note 11)
 Impairment of Goodwill and Indefinite-Lived Intangible Assets 
  22




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##### Table of Contents



Notes to Consolidated Financial Statements (Note 11)
 4%
Contingent Convertible Senior Subordinated Notes
   23




---



##### Table of Contents



Notes to Consolidated Financial Statements (Note 2 and Note 4)
 Retirement Benefits 
   24




---



##### Table of Contents



Notes to Consolidated Financial Statements (Note 7)
 Income Taxes 
  Notes to Consolidated Financial Statements (Note 9)
 25




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##### Table of Contents



Forward-Looking Statements
   
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  26




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##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES
 27
    Table of Contents   
 PART II. OTHER INFORMATION
 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  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)April 2 to April 29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,913,145April 30 to May 27
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,913,145May 28 to July 1
    
    
    30,000
    
    
    $
    35.90
    
    
    
    30,000
    
    
    
    4,883,145Total
    
    
    30,000
    
    
    $
    35.90
    
    
    
    30,000
 
 (1)
    
    On May 6, 2005, the Companys Board of Directors authorized management to purchase up to
5,000,000 shares of its common stock in the open market. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
   Nominee
    
    Votes For
    
    Votes WithheldDavid A. Brandon
    
    
    25,370,371
    
    
    
    390,642Brian P. Campbell
    
    
    25,022,521
    
    
    
    738,492James OLeary
    
    
    25,477,909
    
    
    
    283,104Thomas C. Sullivan
    
    
    25,459,200
    
    
    
    301,813Timothy J. ODonovan
    
    
    25,456,820
    
    
    
    304,193
  28




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ITEM 6.EXHIBITS
 Exhibit No.
    
    
    
    Description12
    
    
    
    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
 29




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##### Table of Contents



KAYDON CORPORATIONAugust 7, 2006
    
    /s/ Brian P. CampbellBrian P. CampbellChairman, President, Chief ExecutiveOfficer and Chief Financial Officer
(Principal Executive Officer and 
Principal Financial Officer)August 7, 2006
    
    /s/ Kenneth W. CrawfordKenneth W. CrawfordVice President and Corporate Controller(Principal Accounting Officer)
 30




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##### Table of Contents



Exhibit No.
    
    
    
    Description12
    
    
    
    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