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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT of 1934

KAYDON CORPORATION

Registrant’s telephone number, including area code: (734) 747-7025

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X]  NO [   ]

     Indicate by check mark whether the registrant is an accelerated filer. YES [X]  NO [   ]

     Common Stock Outstanding at October 31, 2003 – 28,162,627 shares, $.10 par value.

KAYDON CORPORATION FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 27, 2003

INDEX

ITEM 1. FINANCIAL STATEMENTS
KAYDON CORPORATION
CONSOLIDATED CONDENSED BALANCE SHEETS

See accompanying notes to consolidated condensed financial statements.

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KAYDON CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)

See accompanying notes to consolidated condensed financial statements.

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KAYDON CORPORATION
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See accompanying notes to consolidated condensed financial statements.

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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 year-end 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, 2002.
(2)		Inventories are summarized as follows:

(3)

Comprehensive income reflects the change in equity of a business enterprise during a period from transactions and other events, and from circumstances involving nonowner sources. For the Company, comprehensive income consists primarily of net income, foreign currency translation adjustments and minimum pension liability adjustments. Other comprehensive income (loss), net of tax, was approximately $0.5 million and $(0.4) million, resulting in comprehensive income of $7.6 million and $ 7.9 million for the quarters ended September 27, 2003, and September 28, 2002. For the first three quarters, other comprehensive income, net of tax, was approximately $2.5 million and $2.0 million, resulting in comprehensive income of $25.1 million and $5.5 million for the first three quarters ended September 27, 2003 and September 28, 2002.

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(4)

The following table reconciles the numerators and denominators used in the calculation of basic and diluted earnings per share from operations before cumulative effect of accounting change for the periods presented.

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Options to purchase 113,000 shares of common stock at prices ranging from $24.25 to $33.3125 per share were outstanding during the third quarter of 2003, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during that period. Options to purchase 439,300 shares of common stock at prices ranging from $24.25 to $33.3125 per share were outstanding during the third quarter of 2002, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during that period.

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		In May of 2003, the Company completed the sale of $200.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”). The Notes are convertible into a total of 6,858,710 shares of Company common stock at a conversion price of $29.16 per share, provided certain contingencies are met including that Kaydon common stock has traded above $34.99 for 20 out of 30 trading days for specified periods of time. Unless and until this contingency or other conversion contingencies are met, the above mentioned shares of the Company’s common stock underlying the Notes will not be included in the Company’s basic or diluted earnings per share calculations. Should this contingency be met, diluted earnings per share would, depending on the relationship between the interest on the Notes and the earnings per share of Kaydon common stock, be expected to decrease as a result of the inclusion of the underlying shares in the diluted earnings per share calculation. Volatility in the Company’s stock price could cause this condition to be met in one quarter and not in a subsequent quarter, increasing the volatility of diluted earnings per share. For more information on the Notes, readers should refer to Notes to Consolidated Financial Statements (Note 6), and Management’s Discussion and Analysis of Financial Condition and Results of Operations in this quarterly report on Form 10-Q.
(5)		The Company operates through individual operating units 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 (“operating segments”). The Company’s operating segments manufacture complex and standard metal products that are sold primarily to equipment manufacturers and other assemblers or integrators and distributors. Certain of the operating segments have similar long-term average gross margins and all of them exhibit other common attributes, including the nature of the products and production processes, distribution patterns and classes of customers. As a result, based upon current and expected future long-term financial performance, the Company aggregates its operating segments into three reportable segments engaged in the manufacture and sale of the following:
		Specialty Metal Formed Products – complex metal products 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, linear deceleration products and metal retaining devices.
		Ring, Seal and Filtration Products – complex and standard ring, seal and filtration products used in demanding industrial, aerospace, defense, security, medical, electronic and marine equipment applications. Products include engine rings, sealing rings, shaft seals, slip-rings, slip-ring assemblies, video

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		and data multiplexers, fiber optic rotary joints, printed circuit boards, filter elements and filtration systems.
		Other Metal Products- metal alloys, machine tool components, presses, dies and benders used in a variety of industrial applications.
		The accounting policies of the operating segments are the same as those of the Company. Segment performance is evaluated based on segment operating income (which includes an estimated provision for state income taxes) and segment assets.
		Items not allocated to segment operating income include certain amortization and corporate administrative expenses, and other amounts. Corporate assets consist of cash and cash equivalents, fixed assets and certain prepaid expenses. The selling price for transfers between operating segments and geographic areas is generally based on cost plus a mark-up.

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(6)  On May 23, 2003, the Company completed the sale of $170.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”) in a private placement to a group of qualified institutional investors pursuant to Rule 144A under the Securities Act of 1933, as amended. On May 30, 2003, the Company completed the sale of an additional $30.0 million of Notes. The Notes bear interest at 4 percent per year, payable semi-annually, and under certain circumstances beginning in 2008, may bear additional contingent interest of 0.50 percent per year. The Notes are convertible into a total of 6,858,710 shares of the Company’s common stock at a conversion price of $29.16 per share, provided certain contingencies are met including that Kaydon common stock has traded above $34.99 for 20 out of 30 trading days for specified periods of time. The conversion price represents a 34 percent premium based on the closing price of $21.76 per share for the common stock on May 19, 2003. The Notes may not be redeemed by the Company for five years, but are redeemable at any time thereafter at par, plus accrued and unpaid interest. Holders of the Notes will have the option to require Kaydon to purchase their Notes at par for one day each at the end of 5, 10, and 15 years after issuance. In addition, the holders have the right to require redemption of the Notes before the specified maturity dates in the event of a change of control of the Company, as identified in the Notes Indenture.

Interest expense on the Notes equaled $2.0 million for the third quarter of 2003. Note issuance costs of approximately $6.4 million are being amortized over a five-year period. Amortization of Note issuance costs during the third quarter of 2003 was $0.3 million. Amortization of Note issuance costs is recorded as a component of net interest expense. $6.0 million of these costs are included in other assets in the Consolidated Condensed Balance Sheet as of September 27, 2003.

A portion of the net proceeds from the Notes was utilized to repay the outstanding balance on the Company’s $300.0 million revolving credit facility, which was then cancelled. On July 28, 2003, the Company entered into a new three-year $200.0 million unsecured revolving credit facility with seven banks. The new 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. Interest expense incurred on borrowings under the new revolving credit facility will be based on the London Interbank Offered Rate (LIBOR). The revolving credit facility contains restrictive financial covenants on a consolidated basis including a leverage ratio and an interest coverage ratio. 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 3.00 to 1.00. 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 3.00 to 1.00. The Company is in compliance with all restrictive covenants contained in the revolving credit facility at September 27, 2003. After consideration of the facility’s covenants and $2.6 million of letters of credit issued under the facility, the Company has available credit under its revolving credit facility

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of $197.4 million at September 27, 2003.

The Company’s outstanding debt as of September 27, 2003, and December 31, 2002, was as follows:

(7)  As previously reported, the Company, along with certain other companies, was named as a defendant in a lawsuit filed in 1996 in the United States District Court for the Southern District of New York (the “Transactions Lawsuit”). Captioned Richard A. Lippe, et al. v. Bairnco Corporation, et al., the Transactions Lawsuit sought damages alleged by plaintiffs to be an amount of $700 million, plus interest and punitive damages against the defendants collectively.

On March 14, 2003, the Court granted the motion of Kaydon and the other defendants for summary judgment, dismissing the case in its entirety against all defendants. In its ruling, the Court held, among other things, that plaintiffs had failed to support their fraudulent conveyance claims against the Company with any concrete evidence, so that no reasonable jury could find against the Company.

On April 14, 2003, the plaintiffs filed a notice of appeal from the Court’s order granting summary judgment and dismissing the action. Briefing on the appeal currently is underway, and the appeal is expected to be heard by the Court of Appeals during the first or second quarter of 2004. Management has always believed that the Company had meritorious defenses to the claims pending against it in this litigation and believes the Court’s dismissal of the action will be upheld on appeal. Accordingly, no provision has been reflected in the consolidated financial statements for any alleged damages. Expenditures to litigate this matter equaled $2.6 million in the first three quarters of 2003, $6.6 million in 2002, $3.9 million in 2001, and $2.8 million in 2000. As of September 27, 2003, a $2.7 million accrual is included as a current liability in the consolidated financial statements, reflecting the estimated remaining costs to litigate this matter.

As previously reported, in July 2001, Kaydon, Kaydon’s insurance provider and the plaintiff agreed to a settlement of a lawsuit which involved one of Kaydon’s subsidiaries as the defendant, with the settlement payment to the plaintiff being shared between Kaydon and Kaydon’s insurance provider. The Company believes that the loss sustained in the settlement of the lawsuit is covered under Kaydon’s commercial general liability policy, and that the ultimate resolution of the current litigation related to this matter between Kaydon and Kaydon’s insurance provider will not have a material effect on the Company’s consolidated financial

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statements.

In August 2000, an accident involving a MH53E helicopter manufactured by Sikorsky Aircraft Corporation, resulted in four deaths and two injuries during a military training mission. The Company manufactures and sells swashplate bearings used on MH53E helicopters. In May 2002, the Company, along with Sikorsky Aircraft Corporation, The Armoloy Corporation, Armoloy of Illinois, Inc., Armoloy of Connecticut, Inc. and Investment Holdings, Inc., was named as a defendant in a lawsuit filed by the relatives and the estates of the four deceased individuals, and by the two injured individuals. The litigation currently is pending in the District Court of Nueces County, Texas, 28^th Judicial District. Armoloy of Connecticut, Inc. is no longer a party to the litigation. The Company’s insurance provider has retained legal counsel to respond to the lawsuit. The Company believes that the alleged damages claimed in this lawsuit, and the associated legal costs, will be fully covered under the Company’s insurance policy. Further, the Company believes it has meritorious defenses to these claims including, but not limited to, the fact that the bearing utilized in the helicopter involved in the accident was inspected and approved prior to shipment by both U.S. government and Sikorsky Aircraft Corporation inspectors. Accordingly, an accrual is not recorded in the consolidated financial statements related to this legal action.

Various other claims, lawsuits and environmental matters arising in the normal course of business are pending against the Company. The Company’s estimated legal costs expected to be incurred in connection with claims, lawsuits and environmental matters are consistently accrued in the consolidated financial statements.

(8)  The changes in the carrying amount of goodwill for the first three quarters ended September 27, 2003, are as follows:

During the first quarter of 2003, the Company completed the annual goodwill impairment test for certain of the Company’s reporting units. Fair values of the reporting units tested were carried forward from detailed calculations completed during the first quarter of 2002, as allowed by Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets.” The fair value of all reporting units tested exceeded their carrying value, which indicated no goodwill impairment.

During the third quarter of 2003, the Company completed the annual goodwill impairment test for the Company’s remaining reporting units. Fair values of the reporting units were estimated using the expected present value of future cash flows. The fair value of all reporting units tested exceeded their carrying value, which indicated no goodwill impairment.

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     Other intangible assets are summarized as follows:

During the third quarter of 2003 certain fully-amortized intangible assets were removed from the Company’s financial statements. The remaining intangible assets are being amortized on a straight-line basis over periods of 10 to 20 years.

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(9)  During the fourth quarter of 2002, the Company initiated a restructuring plan to enhance operating performance and balance the manufacturing capacity among three plants in the Specialty Metal Formed Products reporting segment. The restructuring plan reserve equaled $0.5 million at December 31, 2002. During the first quarter of 2003, the Company increased the reserve by $0.4 million related to employee termination and severance costs for 57 hourly and 11 salaried employees. Activity related to this restructuring plan reserve for the first three quarters of 2003 is as follows: