##### 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 September 30, 2006
 Commission File No. 0-12640
 KAYDON CORPORATION
  Delaware
    
    13-3186040(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 Suite 300, 315 E. Eisenhower Parkway, Ann Arbor, Michigan
    
    48108(Address of principal executive offices)
    
    (Zip Code)
 (734) 747-7025
  þ o
  þ o o
  o þ




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##### 



Page No.Part I  Financial Information:Item 1. Financial StatementsConsolidated Condensed Balance Sheets  September 30, 2006 (Unaudited) and December 31, 2005
    
    1Consolidated Condensed Statements of Operations (Unaudited)- Quarter and First Three Quarters Ended September 30, 2006 and October 1, 2005
    
    2Consolidated Condensed Statements of Cash Flows (Unaudited)- First Three Quarters Ended September 30, 2006 and October 1, 2005
    
    3Notes to Consolidated Condensed Financial Statements (Unaudited)
    
    4-17Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    18-27Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    27Item 4. Controls and Procedures
    
    28Part II  Other Information:Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    29Item 6. Exhibits
    
    29Signatures
    
    30Statement Re: Computation of Ratio of Earnings to Fixed ChargesCertification Pursuant to Rule 13a-14(a)Certification Pursuant to 18 U.S.C. Section 1350




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ITEM 1. FINANCIAL STATEMENTS
KAYDON CORPORATION
 
 CONSOLIDATED CONDENSED BALANCE SHEETS
 September 30, 2006
    
    
    December 31, 2005(Unaudited)Assets:Cash and cash equivalents
    
    $
    349,525,000
    
    
    $
    320,804,000Accounts receivable, net
    
    
    58,806,000
    
    
    
    50,869,000Inventories, net
    
    
    55,310,000
    
    
    
    51,783,000Other current assets
    
    
    12,492,000
    
    
    
    14,671,000Total current assets
    
    
    476,133,000
    
    
    
    438,127,000Property, plant and equipment, net
    
    
    86,939,000
    
    
    
    79,603,000Goodwill, net
    
    
    118,608,000
    
    
    
    117,168,000Other intangible assets, net
    
    
    22,008,000
    
    
    
    24,288,000Other assets
    
    
    7,055,000
    
    
    
    11,401,000Total assets
    
    $
    710,743,000
    
    
    $
    670,587,000Liabilities and Shareholders Equity:Accounts payable
    
    $
    16,377,000
    
    
    $
    18,192,000Salaries and wages
    
    
    8,697,000
    
    
    
    8,963,000Taxes payable
    
    
    1,260,000
    
    
    
    4,507,000Interest payable
    
    
    2,867,000
    
    
    
    844,000Other accrued expenses
    
    
    13,372,000
    
    
    
    12,238,000Total current liabilities
    
    
    42,573,000
    
    
    
    44,744,000Long-term debt
    
    
    200,000,000
    
    
    
    200,000,000Long-term liabilities
    
    
    63,042,000
    
    
    
    66,167,000Total long-term liabilities
    
    
    263,042,000
    
    
    
    266,167,000Shareholders equity:Common stock
    
    
    3,693,000
    
    
    
    3,693,000Paid-in capital
    
    
    43,017,000
    
    
    
    47,702,000Retained earnings
    
    
    552,514,000
    
    
    
    510,818,000Less  treasury stock, at cost
    
    
    (188,676,000
    )
    
    
    (186,599,000
    )Less  restricted stock awards
    
    
    
    
    
    
    (7,584,000
    )Accumulated other comprehensive loss
    
    
    (5,420,000
    )
    
    
    (8,354,000
    )405,128,000
    
    
    
    359,676,000Total liabilities and shareholders equity
    
    $
    710,743,000
    
    
    $
    670,587,000
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KAYDON CORPORATION
 
 CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
 Quarter Ended
    
    
    First Three Quarters EndedSeptember 30,
    
    
    October 1,
    
    
    September 30,
    
    
    October 1,2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    $
    99,676,000
    
    
    $
    85,870,000
    
    
    $
    303,845,000
    
    
    $
    264,905,000Cost of sales
    
    
    58,795,000
    
    
    
    53,532,000
    
    
    
    177,824,000
    
    
    
    163,051,000Gross profit
    
    
    40,881,000
    
    
    
    32,338,000
    
    
    
    126,021,000
    
    
    
    101,854,000Selling, general and
administrative expenses
    
    
    16,011,000
    
    
    
    14,921,000
    
    
    
    51,356,000
    
    
    
    51,211,000Operating income
    
    
    24,870,000
    
    
    
    17,417,000
    
    
    
    74,665,000
    
    
    
    50,643,000Interest income
    
    
    4,363,000
    
    
    
    2,442,000
    
    
    
    11,686,000
    
    
    
    5,702,000Interest expense
    
    
    (2,390,000
    )
    
    
    (2,389,000
    )
    
    
    (7,189,000
    )
    
    
    (7,203,000
    )Income from continuing
operations before income taxes
    
    
    26,843,000
    
    
    
    17,470,000
    
    
    
    79,162,000
    
    
    
    49,142,000Provision for income taxes
    
    
    9,285,000
    
    
    
    5,825,000
    
    
    
    27,311,000
    
    
    
    17,020,000Income from continuing
operations
    
    
    17,558,000
    
    
    
    11,645,000
    
    
    
    51,851,000
    
    
    
    32,122,000Income from discontinued
operations before income taxes
(including in 2005 gain on
disposal of $41.0 million)
    
    
    
    
    
    
    41,206,000
    
    
    
    
    
    
    
    43,943,000Provision for income taxes
    
    
    
    
    
    
    15,667,000
    
    
    
    
    
    
    
    16,584,000Income from discontinued
operations
    
    
    
    
    
    
    25,539,000
    
    
    
    
    
    
    
    27,359,000Net income
    
    $
    17,558,000
    
    
    $
    37,184,000
    
    
    $
    51,851,000
    
    
    $
    59,481,000Weighted average common shares:Basic
    
    
    27,819,000
    
    
    
    27,763,000
    
    
    
    27,833,000
    
    
    
    27,809,000Diluted
    
    
    34,758,000
    
    
    
    34,663,000
    
    
    
    34,770,000
    
    
    
    34,726,000Earnings per share  continuing
operations:Basic
    
    $
    0.63
    
    
    $
    0.42
    
    
    $
    1.86
    
    
    $
    1.16Diluted
    
    $
    0.55
    
    
    $
    0.38
    
    
    $
    1.62
    
    
    $
    1.06Earnings per share  discontinued
operations:Basic
    
    
    
    
    
    $
    0.92
    
    
    
    
    
    
    $
    0.98Diluted
    
    
    
    
    
    $
    0.74
    
    
    
    
    
    
    $
    0.79Earnings per share:Basic
    
    $
    0.63
    
    
    $
    1.34
    
    
    $
    1.86
    
    
    $
    2.14Diluted
    
    $
    0.55
    
    
    $
    1.12
    
    
    $
    1.62
    
    
    $
    1.84Dividends declared per share
    
    $
    0.12
    
    
    $
    0.12
    
    
    $
    0.36
    
    
    $
    0.36
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KAYDON CORPORATION
 
 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
 First Three Quarters EndedSeptember 30, 2006
    
    
    October 1, 2005Cash flows from operating activities
    
    $
    55,351,000
    
    
    $
    31,120,000Cash flows from (used in) investing activities:Additions to property, plant and equipment, net
    
    
    (15,425,000
    )
    
    
    (6,843,000
    )Proceeds from sale of discontinued operations
    
    
    
    
    
    
    72,400,000Acquisition of business, net of cash acquired
    
    
    
    
    
    
    (42,668,000
    )Cash from (used in) investing activities
    
    
    (15,425,000
    )
    
    
    22,889,000Cash flows used in financing activities:Cash dividends paid
    
    
    (10,148,000
    )
    
    
    (10,149,000
    )Purchase of treasury stock
    
    
    (3,404,000
    )
    
    
    (6,102,000
    )Proceeds from exercise of stock options
    
    
    1,003,000
    
    
    
    1,000,000Excess tax benefits from stock-based compensation
    
    
    585,000
    
    
    
    Payments on debt
    
    
    (49,000
    )
    
    
    (46,000
    )Cash used in financing activities
    
    
    (12,013,000
    )
    
    
    (15,297,000
    )Effect of exchange rate changes on cash and
cash equivalents
    
    
    808,000
    
    
    
    544,000Discontinued Operations:Operating cash flows
    
    
    
    
    
    
    4,411,000Investing cash flows
    
    
    
    
    
    
    (274,000
    )Effect of exchange rate changes on cash and
cash equivalents
    
    
    
    
    
    
    (308,000
    )Net cash flows from discontinued operations
    
    
    
    
    
    
    3,829,000Net increase in cash and cash equivalents
    
    
    28,721,000
    
    
    
    43,085,000Cash and cash equivalents  Beginning of period
    
    
    320,804,000
    
    
    
    278,586,000Cash and cash equivalents  End of period
    
    $
    349,525,000
    
    
    $
    321,671,000Cash expended for income taxes
    
    $
    23,647,000
    
    
    $
    15,987,000Cash 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 consolidated 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 September 30, 2006, the Company
had $109.6 million invested in U.S. Government treasury bills, $106.3 million invested in
various money market and other short-term funds, $98.3 million invested in investment grade
prime commercial paper of several United States issuers, and $32.0 million invested in
time-deposits and other interest bearing accounts.
 (3)
    
    Inventories are summarized as follows:
 September 30, 2006
    
    
    December 31, 2005Raw Material
    
    $
    21,518,000
    
    
    $
    19,094,000Work in Process
    
    
    13,431,000
    
    
    
    12,593,000Finished Goods
    
    
    20,361,000
    
    
    
    20,096,000$
    55,310,000
    
    
    $
    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 $0.5 million and $(1.8) million, resulting in
comprehensive income of $18.1 million and $35.4 million for the quarters ended September 30,
2006 and October 1, 2005. On a first three quarters basis, other comprehensive income (loss),
net of tax, was approximately $2.9 million and $(5.2) million, resulting in comprehensive
income of $54.8 million and $54.3 million for the first three quarters ended September 30,
2006 and October 1, 2005.
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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 EndedSeptember 30, 2006
    
    
    October 1, 2005Numerators:Numerators for basic earnings per
share from continuing
operations, income from
continuing operations
    
    $
    17,558,000
    
    
    $
    11,645,000Interest and debt issuance costs
amortization related to Contingent
Convertible Notes, net of taxes
    
    
    1,521,000
    
    
    
    1,551,000Numerators for diluted earnings per
share from continuing
operations
    
    $
    19,079,000
    
    
    $
    13,196,000Denominators:Denominators for basic earnings
per share from continuing
operations, weighted average
common shares outstanding
    
    
    27,819,000
    
    
    
    27,763,000Potential dilutive shares resulting
from stock options, restricted
stock awards and phantom stock
units
    
    
    80,000
    
    
    
    41,000Dilutive shares resulting from
Contingent Convertible Notes
    
    
    6,859,000
    
    
    
    6,859,000Denominators for diluted
earnings per share from
continuing operations
    
    
    34,758,000
    
    
    
    34,663,000Earnings per share from continuing operations:Basic
    
    $
    0.63
    
    
    $
    0.42Diluted
    
    $
    0.55
    
    
    $
    0.38
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First Three Quarters EndedSeptember 30, 2006
    
    
    October 1, 2005Numerators:Numerators for basic earnings per
share from continuing
operations, income from
continuing operations
    
    $
    51,851,000
    
    
    $
    32,122,000Interest and debt issuance costs
amortization related to Contingent
Convertible Notes, net of taxes
    
    
    4,510,000
    
    
    
    4,565,000Numerators for diluted earnings per
share from continuing
operations
    
    $
    56,361,000
    
    
    $
    36,687,000Denominators:Denominators for basic earnings
per share from continuing
operations, weighted average
common shares outstanding
    
    
    27,833,000
    
    
    
    27,809,000Potential dilutive shares resulting
from stock options, restricted
stock awards and phantom stock
units
    
    
    78,000
    
    
    
    58,000Dilutive shares resulting from
Contingent Convertible Notes
    
    
    6,859,000
    
    
    
    6,859,000Denominators for diluted
earnings per share from
continuing operations
    
    
    34,770,000
    
    
    
    34,726,000Earnings per share from continuing operations:Basic
    
    $
    1.86
    
    
    $
    1.16Diluted
    
    $
    1.62
    
    
    $
    1.06
 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 fourth quarter of 2006, because during the third quarter ended September
30, 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 Three Quarters EndedSeptember 30, 2006
    
    
    October 1, 2005
    
    
    September 30, 2006
    
    
    October 1, 2005Net salesFriction and Motion Control ProductsExternal customers
    
    $
    57,456,000
    
    
    $
    48,284,000
    
    
    $
    175,133,000
    
    
    $
    143,641,000Intersegment  continuing operations
    
    
    83,000
    
    
    
    24,000
    
    
    
    146,000
    
    
    
    86,000Intersegment  discontinued operations
    
    
    
    
    
    
    4,000
    
    
    
    
    
    
    
    302,00057,539,000
    
    
    
    48,312,000
    
    
    
    175,279,000
    
    
    
    144,029,000Velocity Control ProductsExternal customers
    
    
    14,623,000
    
    
    
    13,655,000
    
    
    
    43,419,000
    
    
    
    42,827,000Intersegment  continuing operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,000
    )14,623,000
    
    
    
    13,655,000
    
    
    
    43,419,000
    
    
    
    42,826,000Sealing ProductsExternal customers
    
    
    10,339,000
    
    
    
    9,402,000
    
    
    
    31,982,000
    
    
    
    28,563,000Intersegment  continuing operations
    
    
    (30,000
    )
    
    
    (8,000
    )
    
    
    (71,000
    )
    
    
    (55,000
    )10,309,000
    
    
    
    9,394,000
    
    
    
    31,911,000
    
    
    
    28,508,000OtherExternal customers
    
    
    17,258,000
    
    
    
    14,525,000
    
    
    
    53,311,000
    
    
    
    49,572,000Intersegment  continuing operations
    
    
    (53,000
    )
    
    
    (16,000
    )
    
    
    (75,000
    )
    
    
    (30,000
    )17,205,000
    
    
    
    14,509,000
    
    
    
    53,236,000
    
    
    
    49,542,000Total consolidated net sales
    
    $
    99,676,000
    
    
    $
    85,870,000
    
    
    $
    303,845,000
    
    
    $
    264,905,000
 Quarter Ended
    
    
    First Three Quarters EndedSeptember 30, 2006
    
    
    October 1, 2005
    
    
    September 30, 2006
    
    
    October 1, 2005Operating incomeFriction and Motion Control Products
    
    $
    16,882,000
    
    
    $
    11,598,000
    
    
    $
    50,586,000
    
    
    $
    34,882,000Velocity Control Products
    
    
    3,477,000
    
    
    
    3,197,000
    
    
    
    10,460,000
    
    
    
    10,372,000Sealing Products
    
    
    1,653,000
    
    
    
    909,000
    
    
    
    4,388,000
    
    
    
    3,824,000Other
    
    
    799,000
    
    
    
    367,000
    
    
    
    4,257,000
    
    
    
    3,302,000Total segment operating income
    
    
    22,811,000
    
    
    
    16,071,000
    
    
    
    69,691,000
    
    
    
    52,380,000State income tax provision
included in segment operating
income
    
    
    745,000
    
    
    
    466,000
    
    
    
    2,256,000
    
    
    
    1,250,000Items not allocated to segment
operating income
    
    
    1,314,000
    
    
    
    880,000
    
    
    
    2,718,000
    
    
    
    (2,987,000
    )Interest expense
    
    
    (2,390,000
    )
    
    
    (2,389,000
    )
    
    
    (7,189,000
    )
    
    
    (7,203,000
    )Interest income
    
    
    4,363,000
    
    
    
    2,442,000
    
    
    
    11,686,000
    
    
    
    5,702,000Income from continuing operations
before income taxes
    
    $
    26,843,000
    
    
    $
    17,470,000
    
    
    $
    79,162,000
    
    
    $
    49,142,000
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##### Table of Contents



Quarter Ended
    
    
    First Three Quarters EndedSeptember 30, 2006
    
    
    October 1, 2005
    
    
    September 30, 2006
    
    
    October 1, 2005Depreciation and amortizationFriction and Motion Control Products
    
    $
    1,859,000
    
    
    $
    1,742,000
    
    
    $
    5,790,000
    
    
    $
    5,414,000Velocity Control Products
    
    
    453,000
    
    
    
    466,000
    
    
    
    1,363,000
    
    
    
    1,417,000Sealing Products
    
    
    235,000
    
    
    
    253,000
    
    
    
    791,000
    
    
    
    790,000Other
    
    
    924,000
    
    
    
    923,000
    
    
    
    2,778,000
    
    
    
    2,717,000Corporate
    
    
    746,000
    
    
    
    666,000
    
    
    
    2,319,000
    
    
    
    1,957,000Total consolidated depreciation and
amortization of continuing operations
    
    $
    4,217,000
    
    
    $
    4,050,000
    
    
    $
    13,041,000
    
    
    $
    12,295,000
 Quarter Ended
    
    
    First Three Quarters EndedSeptember 30, 2006
    
    
    October 1, 2005
    
    
    September 30, 2006
    
    
    October 1, 2005Additions to net property, plant and
equipmentFriction and Motion Control Products
    
    $
    6,607,000
    
    
    $
    797,000
    
    
    $
    12,278,000
    
    
    $
    3,544,000Velocity Control Products
    
    
    166,000
    
    
    
    137,000
    
    
    
    524,000
    
    
    
    700,000Sealing Products
    
    
    314,000
    
    
    
    433,000
    
    
    
    531,000
    
    
    
    545,000Other
    
    
    654,000
    
    
    
    551,000
    
    
    
    1,834,000
    
    
    
    1,552,000Corporate
    
    
    104,000
    
    
    
    (290,000
    )
    
    
    258,000
    
    
    
    502,000Total consolidated additions to net
property, plant and
equipment of
continuing operations
    
    $
    7,845,000
    
    
    $
    1,628,000
    
    
    $
    15,425,000
    
    
    $
    6,843,000
 September 30, 2006
    
    
    December 31, 2005Total assetsFriction and Motion Control Products
    
    $
    175,030,000
    
    
    $
    153,055,000Velocity Control Products
    
    
    85,929,000
    
    
    
    79,494,000Sealing Products
    
    
    20,941,000
    
    
    
    21,329,000Other
    
    
    94,011,000
    
    
    
    94,528,000Corporate
    
    
    334,832,000
    
    
    
    322,181,000Total consolidated assets
    
    $
    710,743,000
    
    
    $
    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 third 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 third 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 September 30, 2006 and
December 31, 2005 were $2.2 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 September 30, 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 September 30,
2006.
  September 30, 2006
    
    
    December 31, 20054% Contingent Convertible Senior
Subordinated Notes due 2023
    
    $
    200,000,000
    
    
    $
    200,000,000Other
    
    
    17,000
    
    
    
    66,000Total debt
    
    
    200,017,000
    
    
    
    200,066,000Less current maturities
    
    
    17,000
    
    
    
    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. As of September 30, 2006, an undiscounted accrual in the amount of
$1.1 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.During the third quarter of 2006, 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. Also during the third quarter of 2006, intangible assets
deemed to have indefinite useful lives were tested for impairment with no impairment loss
being realized.
  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
    
    
    $
    118,243,000Effect of foreign
currency exchange
rate changes
    
    
    365,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    365,000Balance as of
September 30, 2006
    
    $
    31,576,000
    
    
    $
    43,200,000
    
    
    $
    186,000
    
    
    $
    43,646,000
    
    
    $
    118,608,000
 11




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##### Table of Contents



September 30, 2006
    
    
    December 31, 2005Gross Carrying
    
    
    Accumulated
    
    
    Gross Carrying
    
    
    AccumulatedAmortized Intangible Assets
    
    Amount
    
    
    Amortization
    
    
    Amount
    
    
    AmortizationCustomer relationships and lists
    
    $
    18,694,000
    
    
    $
    6,687,000
    
    
    $
    18,694,000
    
    
    $
    4,940,000Patents and developed technology
    
    
    6,266,000
    
    
    
    1,430,000
    
    
    
    6,238,000
    
    
    
    920,000Distributor agreements
    
    
    374,000
    
    
    
    77,000
    
    
    
    374,000
    
    
    
    50,000Backlog
    
    
    
    
    
    
    
    
    
    
    351,000
    
    
    
    351,000Product names
    
    
    320,000
    
    
    
    56,000
    
    
    
    320,000
    
    
    
    32,000$
    25,654,000
    
    
    $
    8,250,000
    
    
    $
    25,977,000
    
    
    $
    6,293,000
  September 30, 2006
    
    
    December 31, 2005Carrying
    
    
    CarryingUnamortized Intangible Assets
    
    Amount
    
    
    AmountTrademarks
    
    $
    4,604,000
    
    
    $
    4,604,000
 Aggregate Intangible Assets Amortization ExpenseFor the first three quarters ended September 30, 2006
    
    $
    2,308,000For the first three quarters ended October 1, 2005
    
    $
    2,305,000Estimated 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 Three Quarters EndedSeptember 30, 2006
    
    October 1, 2005
    
    September 30, 2006
    
    October 1, 2005Pension BenefitsService cost
    
    $
    760,000
    
    
    $
    636,000
    
    
    $
    2,278,000
    
    
    $
    1,908,000Interest cost
    
    
    1,392,000
    
    
    
    1,270,000
    
    
    
    4,180,000
    
    
    
    3,810,000Expected return on plan assets
    
    
    (1,168,000
    )
    
    
    (1,083,000
    )
    
    
    (3,504,000
    )
    
    
    (3,249,000
    )Amortization of:Unrecognized net priorService cost
    
    
    50,000
    
    
    
    49,000
    
    
    
    150,000
    
    
    
    147,000Unrecognized net loss
    
    
    363,000
    
    
    
    220,000
    
    
    
    1,087,000
    
    
    
    660,000Total
    
    $
    1,397,000
    
    
    $
    1,092,000
    
    
    $
    4,191,000
    
    
    $
    3,276,000Quarter Ended

    
    First Three Quarters EndedSeptember 30, 2006

    
    October 1, 2005

    
    September 30, 2006

    
    October 1, 2005Postretirement BenefitsService cost
    
    $
    92,000
    
    
    $
    111,000
    
    
    $
    276,000
    
    
    $
    333,000Interest cost
    
    
    203,000
    
    
    
    221,000
    
    
    
    609,000
    
    
    
    663,000Amortization of:Unrecognized net priorService cost
    
    
    (443,000
    )
    
    
    (359,000
    )
    
    
    (1,327,000
    )
    
    
    (1,076,000
    )Unrecognized net gain
    
    
    (96,000
    )
    
    
    (176,000
    )
    
    
    (290,000
    )
    
    
    (528,000
    )Total
    
    $
    (244,000
    )
    
    $
    (203,000
    )
    
    $
    (732,000
    )
    
    $
    (608,000
    )
  (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 three quarters of 2006 is as follows:
 First Three Quarters EndedSeptember 30, 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 and September 30, 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 value of unrecognized compensation cost related to
unvested restricted stock awards aggregated $8.3 million at September 30, 2006, and is
expected to be amortized over a weighted-average period of 3.2 years. At December 31, 2005,
$7.6 million of unrecognized compensation cost was recorded as a deduction from
shareholders equity. This amount was reclassified to paid-in capital in accordance with
SFAS No. 123 (R). Amortization related to restricted stock awards equaled $0.8 million and
$2.4 million during the third quarter and first three quarters of 2006, and equaled $0.7
million and $2.0 million during the third quarter and first three quarters of 2005.
Restricted stock awards vest on January 5th of each year. The total grant-date
fair value of restricted stock that vested on January 5, 2006 was $2.6 million.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 $0.5 million during the third quarter and first three
quarters of 2006,
 14




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##### Table of Contents



and would have increased $0.5 million and $1.6 million during the third
quarter and first three quarters of 2005.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 three quarters of 2006 is as follows:
 First Three Quarters EndedSeptember 30, 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 and September 30, 2006
    
    
    75,250
    
    
    $
    28.35Exercisable at September 30, 2006
    
    
    22,250
    
    
    $
    24.83
 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 less than $0.1 million during the third
quarter, and equaled $0.2 million during the first three quarters of 2006. The total
intrinsic value of options exercised during the first three quarters of 2006 equaled $0.5
million.
 15




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##### Table of Contents



Options outstanding at September 30, 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
    
    
    8,950
    
    
    $
    21.10
    
    
    $
    22.60
    
    
    $
    22.39
    
    
    
    4.54Non-exercisable
    
    
    17,800
    
    
    $
    22.60
    
    
    $
    24.25
    
    
    $
    23.99
    
    
    
    4.4226,750
    
    
    $
    21.10
    
    
    $
    24.25
    
    
    $
    23.46
    
    
    
    4.46Over $25.00:Exercisable
    
    
    13,300
    
    
    $
    26.01
    
    
    $
    27.95
    
    
    $
    26.47
    
    
    
    6.28Non-exercisable
    
    
    35,200
    
    
    $
    26.01
    
    
    $
    41.59
    
    
    $
    32.78
    
    
    
    8.6148,500
    
    
    $
    26.01
    
    
    $
    41.59
    
    
    $
    31.05
    
    
    
    7.97Total options
    
    
    75,250
    
    
    $
    21.10
    
    
    $
    41.59
    
    
    $
    28.35
    
    
    
    6.72
 The aggregate intrinsic value of options outstanding as of September 30, 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 third quarter and first three quarters 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 (SFAS)
No. 144. These assets, reported as part of the Companys Other businesses for segment
reporting purposes, are immaterial at September 30, 2006. The Company expects to sell these
assets before December 31, 2006. During the third quarter of 2006, the Company classified
certain other land and building assets that are in the process of being sold as assets held
for sale as required under SFAS No. 144. These assets, reported as part of the Companys
Sealing Products segment, are immaterial at September 30, 2006. The Company expects to sell
these assets during 2007.(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



In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No.
158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans.
SFAS No. 158 requires an entity to recognize on the balance sheet an asset for a defined
benefit postretirement plans overfunded status or a liability for a plans underfunded
status effective for fiscal years ending after December 15, 2006. The offsetting debit or
credit will be made to the Accumulated Other Comprehensive Income/Loss component of
Shareholders Equity. In addition, entities are required to recognize subsequent changes
in the funded status of a defined benefit postretirement plan in comprehensive income in the
year in which the changes occur. SFAS No. 158 also will require entities to measure plan
assets and benefit obligations as of the date of the employers fiscal year-end, effective
for fiscal years ending after December 15, 2008. The Company has not completed its analysis
of the potential impact of SFAS No. 158 on its financial position, results of operations or
cash flows.
 17




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Overview
       18




---



##### Table of Contents



Results of Operations
 Third Quarter Results
       19




---



##### Table of Contents



20




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##### Table of Contents



First Three Quarters Results
     Liquidity and Capital Resources
  21




---



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Outlook
  Critical Accounting Policies and Estimates
  22




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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 
 23




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##### Table of Contents



Notes to Consolidated Financial Statements (Note 11)
 4% Contingent Convertible Senior Subordinated Notes-
  24




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##### Table of Contents



Notes to Consolidated Financial Statements (Note 2 and Note 4)
 Retirement Benefits 
   25




---



##### Table of Contents



Notes to Consolidated Financial Statements (Note 7)
 Income Taxes 
  26




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##### Table of Contents



Notes to Consolidated Financial Statements (Note 9)
 Forward-Looking Statements
   
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  27




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ITEM 4. CONTROLS AND PROCEDURES
  28




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PART II. OTHER INFORMATION
 
 ITEM 2.
    
    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 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 2006:
 Total Number ofTotal
    
    
    Average
    
    
    Shares
    
    
    Maximum NumberNumber
    
    
    Price
    
    
    Purchased as
    
    
    of Shares that MayOf Shares
    
    
    Paid
    
    
    Part of Publicly
    
    
    Yet be PurchasedPeriod
    
    Purchased
    
    
    Per Share
    
    
    Announced Plan
    
    
    Under the Plan (1)July 2 to July 29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,883,145July 30 to August 26
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,883,145August 27 to September 30
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,883,145Total
    
    
    
    
    
    
    
    
    
    
    
 
 (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
6. EXHIBITS
 Exhibit No.
    
    Description3
    
    Kaydon Corporation Bylaws, as amended through October 16, 2006
(previously filed as Exhibit 3.1 to the Companys Current Report on Form 8-K
filed October 17, 2006 and incorporated herein by reference)10
    
    Kaydon Corporation Supplemental Executive Retirement Plan, as
Amended and Restated (previously filed as Exhibit 10.1 to the Companys Current
Report on Form 8-K filed October 17, 2006 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
 29




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##### Table of Contents



KAYDON CORPORATIONNovember 7, 2006
    
    /s/ Brian P. Campbell

Brian P. CampbellChairman, President, Chief Executive
Officer and Chief Financial Officer
(Principal Executive Officer and
Principal Financial Officer)November 7, 2006
    
    /s/ Kenneth W. CrawfordKenneth W. CrawfordVice President and Corporate Controller

(Principal Accounting Officer)
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##### Table of Contents



Exhibit No.
    
    Description3
    
    Kaydon Corporation Bylaws, as amended through October 16, 2006 (previously filed as Exhibit
3.1 to the Companys Current Report on Form 8-K filed October 17, 2006 and incorporated herein
by reference)10
    
    Kaydon Corporation Supplemental Executive Retirement Plan, as Amended and Restated
(previously filed as Exhibit 10.1 to the Companys Current Report on Form 8-K filed October
17, 2006 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