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SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)

KAYDON CORPORATION

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

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

          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       o No

          Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

          Indicate by check mark whether the Registrant is an accelerated filer.     Yes x       o No

          The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant on June 29, 2002 (based on the June 28, 2002 closing sales price of $23.61 of the Registrant’s Common Stock, as reported on the New York Stock Exchange Composite Tape on such date) was approximately $468,315,000.

          Number of shares outstanding of the Registrant’s Common Stock at March 11, 2003:

30,187,767 shares of Common Stock, par value $0.10 per share.

          Portions of the Registrant’s definitive Proxy Statement to be filed for its 2003 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report.

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10-K Report

      This Form 10-K and all other Company filings with the Securities and Exchange Commission are also accessible at no charge on the Company’s website at www.kaydon.com as soon as reasonably practicable after filing with the Commission.

Forward-Looking Statements

      This Form 10-K contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 regarding the Company’s plans, expectations, estimates and beliefs. Forward-looking statements are typically identified by words such as “believes,” “anticipates,” “estimates,” “expects,” “intends,” “will,” “may” and other similar expressions. These forward-looking statements may include, among other things, projections of the Company’s financial performance, anticipated growth, characterization of and the Company’s ability to control contingent liabilities, and anticipated trends in the Company’s businesses. These statements are only predictions, based on the Company’s current expectation about future events. Although the Company believes the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, performance or achievements or that predictions or current expectations will be accurate. These forward-looking statements involve risks and uncertainties that could cause the Company’s actual results, performance or achievements to differ materially from those expressed or implied by the forward-looking statements.

      In addition, the Company or persons acting on its behalf may from time to time publish or communicate other items that could also be construed to be forward-looking statements. Statements of this sort are or will be based on the Company’s estimates, assumptions, and projections and are subject to risks and uncertainties that could cause actual results to differ materially from those included in the forward-looking statements. Kaydon does not undertake any responsibility to update its forward-looking statements or risk factors to reflect future events or circumstances. For a specific discussion of the risks and uncertainties that could affect the Company’s operating results, please refer to the Forward-Looking Statements section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 herein.

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Item 1.     BUSINESS

General Development of Business

      Kaydon Corporation (the “Company” or “Kaydon”) is a leading designer and manufacturer of custom-engineered, critical performance products for a broad customer base. Kaydon was incorporated under the laws of Delaware in 1983 as a wholly owned subsidiary of Bairnco Corporation, its former parent company. The Company became a separate public company in 1984 when it was spun-out of Bairnco Corporation as a dividend to Bairnco’s shareholders. At the time of its incorporation, Kaydon was principally involved in the design and manufacture of bearing systems and components as well as filters and filter housings. Since 1984, the Company has pursued a diversified growth strategy in the manufacturing sector. The Company’s principal products now include the previously mentioned bearing systems and components and filters and filter housings, and also custom rings, shaft seals, linear deceleration products, slip-rings, video and data multiplexers, fiber optic rotary joints, printed circuit boards, specialty retaining rings, specialty balls, fuel cleansing systems, industrial presses and metal alloy products. These products are used by customers in a wide variety of medical, instrumentation, material handling, machine tool positioning, aerospace, defense, security, construction, electronic, marine and other industrial applications. The Company performs as an extension of its customers’ engineering and manufacturing functions, with a commitment to identify and provide engineered solutions to design problems through technical innovation, cost-effective manufacturing and outstanding value-added service.

Recent Developments

      On May 17, 2002, the Company purchased substantially all of the assets of Printed Circuit Solutions Manufacturing, Inc. (“PCSM”), a designer of printed circuit boards and flexible printed tapes, for $4.4 million. The results of PCSM are reported in the Ring, Seal and Filtration Products reporting segment.

      On December 31, 2001, the Company sold the net assets of its Fluid Power Products reporting segment, a manufacturer of hydraulic fluid power products. The reporting segment was acquired via acquisitions of five companies during the 1995 to 1997 timeframe. The sale was necessary as a result of recent operating losses, an outlook for prolonged weakness in the demand for hydraulic fluid power products which would have led to continuing losses, excess industry capacity, structural changes in competitive dynamics, adverse customer trends, and a competitive disadvantage in the absence of an integrated hydraulic systems capability. The Fluid Power Products reporting segment was sold to a private ownership group that already participated in the hydraulic fluid power products market.

      On March 1, 2001, the Company purchased, for $70.6 million, all of the outstanding stock of ACE Controls, Inc., and an affiliated company (“ACE”), a privately held leading manufacturer of linear deceleration products serving various industrial markets. ACE has locations in Michigan, Germany, the United Kingdom and Japan. The results of ACE are reported in the Specialty Metal Formed Products reporting segment.

      On August 28, 2000, the Company acquired three businesses known as the “Tridan Group” of companies. The acquisition included the purchase of substantially all of the assets of Tridan International, Inc., a manufacturer of specialty production equipment for the commercial and residential air conditioning industry, and the purchase of substantially all of the assets of Canfield Technologies, Inc., and affiliates, a manufacturer of metal alloy and engineered materials sold into the electronics, construction and specialty manufacturing industries. In addition, the acquisition included the purchase of all of the outstanding stock and certain real estate formerly leased by Indiana Precision, Inc., a manufacturer of specialty tooling for the plastic packaging industry. The purchase price for the Tridan Group of companies was $46.6 million. The Tridan Group of companies compose the Other Metal Products reporting segment.

Industry Segments

      The Company operates through individual operating units which manufacture complex and standard metal products that are sold primarily to equipment manufacturers and other assemblers, integrators and distributors, and for which separate financial information is available (“operating segments”). Certain of the operating segments have similar long-term average gross margins and all of them exhibit other common

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      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 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.

      Fluid Power Products— standard and custom-made hydraulic cylinders used in heavy industrial equipment applications. The Fluid Power Products business was sold on December 31, 2001.

      Net sales related to the Company’s three continuing reportable segments and one discontinued segment during 2002, 2001 and 2000 are set forth in the following table:

Net Sales by Reportable Segment

      See Notes to Consolidated Financial Statements (Note 14) contained in Item 8. Financial Statements and Supplementary Data for additional information on the Company’s reportable segments.

      Sophisticated technology plays a significant role in all of Kaydon’s reportable segments in the design, engineering and manufacturing of its products. Due to the custom-engineered, proprietary nature of the Company’s products, substantially all of the manufacturing is done in-house and subcontractors are utilized for occasional specialized services. Products are manufactured utilizing a variety of metalworking and other process technologies after working closely with customers to engineer the required solution to their design challenges.

      Kaydon sells its products in each reportable segment through a sales organization consisting of salespersons and representatives located throughout North America, Europe and Asia. Salespersons are trained to provide technical assistance to customers, as well as to serve as a liaison between the factory engineering staffs of Kaydon and its customers. Also, a global network of specialized distributors and agents provides local availability of Kaydon products to serve the requirements of customers. During 2002, 2001 and 2000, sales to no single customer exceeded 10 percent of Kaydon net sales. However, during 2002, sales to one

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      The Company does not consider its business in any reportable segment to be seasonal in nature or to have special working capital requirements. Compliance with federal, state and local regulations relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not expected to result in material capital expenditures by the Company or to have a material adverse effect on the Company’s earnings or competitive position. In general, raw materials required by the Company are attainable from various sources and in the quantities desired. Various provisions of federal law and regulations require, under certain circumstances, the renegotiations of military procurement contracts or the refund of profits determined to be excessive. The Company, based on experience, believes that no material renegotiations or refunds will be required. The Company has not made any public announcement of, or otherwise made public information about, a new product or a new industry segment which would require the investment of a material amount of the Company’s assets or which would otherwise result in a material cost.

Backlog

      The Company sells certain products on a build-to-order basis that requires substantial order lead-time. This results in a backlog of unshipped, scheduled orders. Other products are manufactured on the basis of sales projections or annual blanket purchase orders. Backlog in the Specialty Metal Formed Products reporting segment was $50.5 million at December 31, 2002 and $49.0 million at December 31, 2001. Backlog in the Ring, Seal and Filtration Products reporting segment was $36.1 million at December 31, 2002 and $38.4 million at December 31, 2001. Backlog in the Other Metal Products reporting segment was $1.7 million at December 31, 2002 and $4.2 million at December 31, 2001. The Company expects to ship 90 percent of the year-end backlog over the following twelve months. Backlog has become less indicative of future results as the Company has made efforts to shorten manufacturing lead times, creating a faster response to customer orders.

Patents and Trademarks

      The Company holds various patents, patent applications, licenses, trademarks and trade names. The Company considers its patents, patent applications, licenses, trademarks and trade names to be valuable, but does not believe that there is any reasonable likelihood of a loss of such rights which would have a material adverse effect on the Company’s present business as a whole.

Competition

      The major domestic and foreign markets for the Company’s products in all reporting segments are highly competitive. Competition is based primarily on price, product engineering and performance, technology, quality and overall customer service, with the relative importance of such factors varying by degree among products. The Company’s competitors include a large number of other well-established diversified manufacturers as well as other smaller companies. Although a number of companies of varying size compete with the Company, no single competitor is in substantial competition with the Company with respect to more than a few of its product lines and services.

Employees

      The Company employs approximately 1,850 people. Satisfactory relationships have generally prevailed between the Company and its employees.

International Operations

      Within the Specialty Metal Formed Products reporting segment, the Company manufactures various bearing products in Mexico and England, and has a linear deceleration products assembly and distribution facility in Germany. Slip-ring products, part of the Ring, Seal and Filtration Products reporting segment, are manufactured in Canada and England. In addition, within all reporting segments, the Company distributes a wide array of products throughout North America, Europe and Asia. The Company’s foreign operations are subject to political, monetary, economic and other risks attendant generally to international businesses. These risks generally vary from country to country.

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      See Notes to Consolidated Financial Statements (Note 14) contained in Item 8. Financial Statements and Supplementary Data for additional information on the Company’s operations by geographic area.

Item 2.     PROPERTIES

      The following list sets forth the location of the Company’s principal manufacturing facilities for each reportable segment:

      The Company considers that its properties are generally in good condition, are well maintained, and are generally suitable and adequate to carry on the Company’s business. Substantially all of the properties are owned by the Company and are not subject to significant encumbrances. The Company’s manufacturing facilities have sufficient capacity to meet increased customer demand. The Company’s leased executive offices are located in Ann Arbor, Michigan.

Item 3.     LEGAL PROCEEDINGS

      As previously reported, the Company, along with certain other companies, was named as a defendant in a lawsuit filed in 1995 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. In July 2002, the Company filed two motions. The first was a motion to exclude the testimony of three of plaintiffs’ proposed expert witnesses, including both of plaintiffs’ proposed valuation witnesses. The second motion, filed along with similar motions from the other defendants in the case, was for summary judgment dismissing all claims against the Company and the other defendants. On January 28, 2003, the Court granted the motion to exclude the testimony of three of plaintiffs’ proposed experts.

      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 the 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. Although the plaintiffs have the right to appeal the Court’s order in this case, and the Company may incur additional costs, the Company believes the Court’s decision will withstand any possible appeal. Management has always believed that the Company had meritorious defenses to the claims pending against it in this litigation. Accordingly, no provision had been reflected in the consolidated financial statements for any alleged damages. Expenditures to litigate this matter equaled $6.6 million in 2002, $3.9 million in 2001, and $2.8 million in 2000. During the second quarter of 2002, a $7.5 million provision was recorded in order to support the Company’s most current and best estimate of the cost to continue to litigate the Transactions Lawsuit. As of December 31, 2002, a $5.3 million

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      As previously reported, the Company was involved in a U.S. government grand jury investigation and a private lawsuit related to a May 1996 accident involving a Sikorsky Aircraft Corporation CH-53E helicopter (collectively, the “Sikorsky Matter”).

      During the second quarter of 2000, a $12.6 million provision was recorded in order to support the Company’s best estimates to litigate the Transactions Lawsuit and the Sikorsky Matter discussed above.

      Regarding the Sikorsky Matter, during the third quarter of 2000, Kaydon reached a settlement with Sikorsky Aircraft Corporation and recorded an additional $9.1 million provision to reflect both the amount of the settlement with Sikorsky and the estimated amount of a potential settlement with the U.S. government, less amounts the Company had previously reserved to litigate these matters. In April 2001, the Company reached a settlement with the U.S. government regarding their investigation of inspection and product certification procedures at the Company’s Muskegon, Michigan facility. The settlement included the payment of $7.5 million to the U.S. government, including a $1.0 million fine. The payment to the U.S. government was completed during April 2001 and was offset by the previously recorded provisions without any impact on year 2001 earnings. In addition to the U.S. government settlement, Kaydon entered into a three-year agreement with the U.S. Department of Navy, on behalf of the U.S. Department of Defense, which confirms that Kaydon is presently eligible to contract with the U.S. government, ensures that Kaydon has, and will continue to have, a program of acceptable contracting policies and procedures, and establishes and implements a program of compliance reviews, audits and reports.

      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. Kaydon’s portion of the settlement payment was offset by amounts previously recorded to litigate this legal matter. 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 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, in the United States District Court for the Southern District of Texas. Currently, the Company’s insurance provider is in the process of responding to the claim. 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 inspectors and Sikorsky Aircraft Corporation. 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. An accrual is recorded in the consolidated financial statements equal to the Company’s most current and best estimates to litigate these legal actions.

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      No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2002.

      Executive officers, who are elected by the Board of Directors, serve for a term of one year.

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Market Information and Dividends

      The New York Stock Exchange is the principal market on which the Company’s Common Stock is traded under the symbol KDN. The following table sets forth high and low sales prices of the Company’s Common Stock as reported on the New York Stock Exchange Composite Tape and the cash dividends declared per share for the periods indicated.

      The Company expects that its practice of paying quarterly dividends on its Common Stock will continue, although future dividends will continue to depend upon the Company’s earnings, capital requirements, financial condition and other factors.

      As of December 31, 2002, there were 1,028 holders of record of the Company’s Common Stock.

Equity Compensation Plan Information

      The following table gives information about the Company’s common stock that may be issued upon the exercise of options, warrants and rights under all of its existing equity compensation plans as of December 31, 2002, including Kaydon’s 1993 Stock Option Plan, 1999 Long-Term Stock Incentive Plan, 1993 Non-Employee Directors Stock Option Plan and the Director Deferred Compensation Plan:

(1)	Includes only options outstanding under Kaydon’s 1993 Stock Option Plan, 1999 Long-Term Stock Incentive Plan and 1993 Non-Employee Directors Stock Option Plan, as no warrants or rights were outstanding as of December 31, 2002.
(2)	Includes shares of Kaydon common stock issuable pursuant to phantom stock units outstanding under Kaydon’s Director Deferred Compensation Plan. This Plan is the only equity plan that has not been approved by shareholders and provides a vehicle for a director to defer compensation and acquire Kaydon common stock (see below— Director Deferred Compensation Plan).
(3)	Includes shares available for issuance under Kaydon’s 1999 Long-Term Stock Incentive Plan, which allows for the granting of stock options, stock appreciation rights and for awards of restricted stock, restricted stock units and stock-based performance awards to employees of and consultants to the Company.

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Director Deferred Compensation Plan

      In December 2000, the Board of Directors approved, effective January 1, 2001, a Director Deferred Compensation Plan for non-employee Directors. Under this plan, non-employee Directors may elect to defer payment of all or a part of their compensation, that would have otherwise been received in cash, to a Kaydon Corporation common stock “phantom” stock account. A “phantom” stock account is a notional number of Kaydon shares (whole and fractional) equal to the dollar amount of the Director’s deferred fees plus all dividends payable during each quarter based upon the number of notional shares credited to the Director’s account at the beginning of the quarter divided by the market value of Kaydon common stock on the last business day of a quarter. The election to defer receipt of compensation by a non-employee Director is made annually and any non-employee Director can terminate this deferral at the end of any calendar year that he or she designates. When a non-employee Director elects to terminate his or her deferral of compensation, an election is permitted to receive the compensation either in cash or in shares of Kaydon common stock. The amount shown in column (A) above assumes these Directors elect to receive their deferred compensation in shares of Kaydon common stock. The number of shares reserved for issuance under this plan is not limited in amount, other than by the dollar value of the non-employee Directors’ annual compensation.

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Item 6.     SELECTED FINANCIAL DATA

	(1)	Prior to 2002, the Company amortized goodwill and indefinite-lived intangible assets. See Notes to Consolidated Financial Statements (Note 12) contained in Item 8. Financial Statements and Supplementary Data for further discussion.
	(2)	Includes an unusual litigation-related charge of $7.5 million.
	(3)	Includes the after tax effect, $4.8 million or $0.16 per share, of the unusual litigation-related charge.
	(4)	Represents a $16.8 million pre-tax ($13.2 million or $0.44 per share after tax) loss on the cumulative effect of accounting change relating to goodwill impairment.
	(5)	Includes the after tax effect, $4.8 million or $0.16 per share, of the unusual litigation-related charge and the after tax effect, $13.2 million or $0.44 per share, of the cumulative effect of accounting change.
	(6)	Includes a special charge, to write-down the value of assets of the Fluid Power Products Group, of $38.1 million pre-tax and a net gain on the sale of the assets of the Fluid Power Products Group of $0.2 million pre-tax.
	(7)	Includes the after tax effect, $26.3 million or $0.88 per share, of the net special charge, $37.9 million, to write-down the value and to sell the assets of the Fluid Power Products Group.
	(8)	Includes unusual litigation-related charges of $21.7 million.
	(9)	Includes the after tax effect, $13.7 million or $0.46 per share, of the unusual litigation-related charges.

(10)	EBITDA is defined as Operating Income From Continuing Operations plus Depreciation and Amortization.

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      The Company’s 2002 operating results reflect a challenging economic environment as its customer base in many key markets exhibited cautious capital spending patterns throughout the year. Specifically, Kaydon continued to experience the effect of soft demand from many of its key markets including construction equipment, off-highway equipment, and other heavy equipment markets. In addition, the Company experienced weak demand from its distribution networks as inventory reductions in the manufacturing sector continued. These declines were partially offset by gains in security, military and certain industrial markets.

      The Company continues its focus on operating and financial strategies to improve operating performance and shareholder returns. These strategies include internal and external programs to strengthen the Company’s competitive positions in key markets, including increased levels of manufacturing efficiency and customer service, new product development and market share initiatives, cost reduction initiatives, cash flow management and the acquisition of selected companies, which can enhance future growth and profitability.

      The discussion which follows should be reviewed in conjunction with the financial statements and related footnotes to assist in understanding the Company’s results of operations, its financial position, cash flows, capital structure and other relevant financial information.

Analysis of 2002 Operations Compared to 2001 Operations

      Net sales from continuing operations of $279.4 million in 2002 decreased $6.2 million or 2.2 percent compared to 2001’s sales of $285.6 million. Specifically, the Specialty Metal Formed Products reporting segment achieved sales of $167.0 million during 2002 compared to 2001 sales of $168.1 million. Increased sales of custom-engineered bearings to the security market of $2.6 million, and $4.8 million of incremental sales due to the full year impact from the ACE Controls acquisition completed on March 1, 2001 were more than offset by reduced demand for specialty bearings in the industrial and heavy equipment markets and for specialty ball products. The Company’s Ring, Seal and Filtration Products reporting segment achieved sales of $91.0 million during 2002, up $1.7 million from 2001 sales of $89.3 million. Increased sales of certain slip-ring products in the security, military and industrial markets were partially offset by reduced demand for various filtration systems and ring products as compared to 2001. The Company’s Other Metal Products reporting segment achieved sales of $21.3 million during 2002, down $6.8 million from 2001 sales of $28.2 million. Reduced demand for metal forming equipment and metal alloy products contributed to the decline in sales.

Selected Data For The Year 2002 Compared With The Year 2001

      The Company’s gross margin percentage from continuing operations equaled 34.1 percent in 2002, as compared to 35.0 percent achieved in 2001. The decrease in gross margin percentage was primarily due to reduced volume and unfavorable sales mix within the Specialty Metal Formed Products and Ring, Seal and Filtration Products reporting segments. Many of Kaydon’s products are high value-added and have strong contribution margins, which causes the Company’s profit performance to be sensitive to sales volume and mix. In addition, the Company increased its inventory reserves related to slow moving items by approximately $1.0 million more during 2002 as compared to 2001.

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      Selling, general and administrative expenses from continuing operations totaled $49.5 million or 17.7 percent of sales in 2002, compared to $54.3 million or 19.0 percent of sales for 2001. In 2001, excluding goodwill and indefinite-lived intangible asset amortization, selling, general and administrative expenses from continuing operations totaled $50.7 million or 17.7 percent of sales. Increased employee benefit costs, including insurance and pension costs of approximately $0.7 million were offset by reduced bad debt expenses of approximately $1.0 million during 2002. The Company is taking the appropriate actions to manage its business and reduce its cost structure consistent with the trend in current economic conditions, and this is being done in a prudent and rational manner. Attention is focused on prudent investments in advanced manufacturing techniques, human capital, and system upgrades. These programs are intended to grow market share, to position the Company to further capitalize on its targeted end-markets and to increase its operating leverage ratio when a more favorable economic environment is restored. However, due to current conditions in the insurance industry, and the recent lower returns on pension plan assets and lower interest rates, the Company expects to see additional increases in 2003 for insurance and pension costs. Pension costs are expected to increase by $2.5 million to $3.0 million in 2003 as compared to 2002.

      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. This restructuring plan resulted in a $0.5 million charge in the fourth quarter of 2002, and a related $0.5 million liability in the Company’s December 31, 2002 balance sheet. In addition to the costs recorded in the fourth quarter of 2002, the Company expects to incur in 2003 approximately $1.8 million of additional costs related to headcount reductions, equipment relocation and other restructuring expenses. This restructuring plan is expected to provide annualized cost savings to the Company of approximately $2.0 million per year beginning in 2004.

      During the second quarter of 2002, a $7.5 million provision was recorded in order to support the Company’s most current and best estimate of the cost to continue to litigate the Transactions Lawsuit. The change in the estimate during the second quarter resulted from recent spending levels and new information provided by the Company’s outside attorneys regarding forecasted spending levels to complete the trial phase. This legal action is further discussed in the Notes to Consolidated Financial Statements (Note 11) and other discussions throughout this Annual Report.

      Operating income from continuing operations equaled $38.4 million during 2002, compared to $45.5 million in 2001, with operating margins of 13.7 percent and 15.9 percent in 2002 and 2001, respectively. Operating income from continuing operations, excluding the $7.5 million of unusual litigation expenses, equaled $45.9 million during 2002, or an operating margin of 16.4 percent. Operating income from continuing operations, excluding goodwill and indefinite-lived intangible asset amortization equaled $49.2 million during 2001, or an operating margin of 17.2 percent.

      On a reporting segment basis, operating income from the Specialty Metal Formed Products reporting segment was $30.1 million during 2002 as compared to $34.6 million during 2001. Excluding goodwill and indefinite-lived intangible asset amortization, 2001 operating income from the Specialty Metal Formed Products reporting segment would have been $35.6 million. The decrease in operating income is primarily due to reduced volume and unfavorable sales mix specific to certain custom-engineered bearings and specialty ball products. In addition, the reporting segment’s operating income was negatively impacted by additional inventory reserves related to slow moving items, employee benefit, and other intangible asset amortization costs during 2002 as compared to 2001.

      The Ring, Seal, and Filtration Products reporting segment contributed $10.3 million to the Company’s operating income during 2002 as compared to $14.3 million during 2001. Excluding goodwill and indefinite-lived intangible asset amortization, 2001 operating income from the Ring, Seal, and Filtration Products reporting segment would have been $15.1 million. The decrease in operating income is primarily due to reduced volume and unfavorable sales mix specific to certain filtration system products and custom ring products. In addition, the reporting segment’s operating income was negatively impacted by additional inventory reserves related to slow moving items, and employee benefit costs during 2002 as compared to 2001.

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      The Other Metal Products reporting segment contributed $2.6 million of operating income during 2002 as compared to $2.2 million during 2001. Excluding goodwill and indefinite-lived intangible asset amortization, 2001 operating income from the Other Metal Products reporting segment would have been $3.3 million. The decrease in operating income is primarily due to reduced volume of certain metal forming products, sold to the Far East markets, and various metal alloy products. Partially offsetting these declines, the reporting segment’s operating income was favorably impacted by reduced bad debt expenses during 2002 as compared to 2001.

      Net interest income in 2002 was $0.8 million, while net interest expense in 2001 was $0.3 million. The increased net interest income was primarily due to lower debt levels during 2002. In February 2002, the Company reduced its outstanding bank revolving credit facility debt by $40.0 million.

      Income from continuing operations equaled $25.4 million during 2002, compared to $28.5 million in 2001, with return on sales of 9.1 percent and 10.0 percent in 2002 and 2001, respectively. Income from continuing operations, excluding the $4.8 million after tax impact of unusual litigation expenses, equaled $30.2 million during 2002, or a return on sales of 10.8 percent. Income from continuing operations, excluding goodwill and indefinite-lived intangible asset amortization equaled $30.8 million during 2001, or a return on sales of 10.8 percent.

      Diluted earnings per common share from continuing operations decreased to $0.85 in 2002 compared to $0.95 in 2001, both years based on 30.0 million weighted average common shares outstanding. Diluted earnings per common share from continuing operations, excluding the $4.8 million after tax impact of unusual litigation expenses, equaled $1.01 in 2002. Diluted earnings per common share from continuing operations, excluding goodwill and indefinite-lived intangible asset amortization, equaled $1.03 in 2001.

      The effective income tax rate on continuing operations was 35.1 percent in 2002 as compared to a 37 percent tax rate during 2001. This reduction is primarily due to the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets,” as the Company is no longer amortizing goodwill, and due to an increase in U.S. foreign income tax credits related to the 2001 acquisition of ACE Controls. The Company expects the effective tax rate for the 2003 year to be approximately 35 percent.

      As required, on January 1, 2002, the Company adopted SFAS No. 142. As a result, Kaydon is no longer amortizing goodwill and indefinite-lived intangible assets beginning in 2002, but is required to subject these assets to an annual impairment analysis. During the second quarter of 2002, the Company completed the first step of the two-step goodwill impairment test required by SFAS No. 142. Step one is designed to identify potential impairment by comparing the fair value of the Company’s reporting units, as that term is defined by SFAS No. 142, with the reporting unit’s carrying amount. As required by SFAS No. 142, the comparison was done as of January 1, 2002. Fair values of the reporting units were estimated using the expected present value of future cash flows. As a result of completing step one, the Company identified two reporting units whose carrying amount exceeded their fair value, which indicates potential goodwill impairment. Both reporting units are part of the Company’s Other Metal Products reporting segment. The aggregate total carrying amount of goodwill at these two reporting units was $19.3 million as of January 1, 2002. During the third quarter of 2002, the Company engaged a valuation specialist to assist it in completing step two of the goodwill impairment test, which measures the amount of any impairment loss by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. As a result of completing step two of the goodwill impairment test, the Company determined that the implied fair value of the goodwill of the two aforementioned reporting units equaled $2.5 million. Therefore, under SFAS No. 142, the Company incurred a pre-tax, non-cash goodwill impairment loss of $16.8 million as of January 1, 2002. The two reporting units are expected to generate positive future cash flows, but under the provisions of SFAS No. 142 the present values of those cash flows (reporting unit fair value) resulted in the implied fair value of goodwill being significantly less than the carrying amount. Under previous guidance, specifically Accounting Principles Board Opinion No. 17, goodwill was tested for impairment using an undiscounted cash flow (recoverability) approach. In accordance with SFAS No. 142, the $16.8 million goodwill impairment loss ($13.2 million or $0.44 per share on an after tax, diluted basis) was recognized as the cumulative effect of a change in accounting principle as of January 1, 2002. Therefore, previously reported first quarter and cumulative year-to-date results for 2002 have been restated to reflect the goodwill impairment loss.

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      During the third quarter of 2001, the Company recorded a special non-cash charge of $38.1 million pre-tax to write-down the value of the assets of its Fluid Power Products reporting segment. The majority of the special charge, $34.6 million, resulted from the write-down of certain non-current intangible and fixed assets to estimated fair value in accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The remaining $3.5 million comprised reductions in the carrying amount of certain current assets including inventory in the amount of $2.0 million and accounts receivable in the amount of $1.5 million.

      On December 31, 2001, the Company sold the net assets of the Fluid Power Products reporting segment for approximately $16 million cash. Final costs to sell and final adjustments related to the sale resulted in a net gain on the sale of $0.2 million pre-tax, which was recorded in the fourth quarter of 2001.

      Also, in the fourth quarter of 2001, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which replaces SFAS No. 121, as it relates to the impairment or disposal of long-lived assets. Upon adoption of the new pronouncement, which does not include goodwill in the scope of its requirements, the Company retroactively applied this pronouncement as of January 1, 2001. Because goodwill is not covered by SFAS No. 144, the Company retroactively applied the provisions of Accounting Principles Board Opinion No. 17, “Intangible Assets” to goodwill, and recorded the previously written-down goodwill in accordance with that pronouncement during 2001. Upon meeting the criteria for applying held for sale accounting under SFAS No. 144 during early December 2001, the Company held for sale the net assets of the Fluid Power Products reporting segment, as a discontinued operation. The adoption of SFAS No. 144 did not affect the amounts and timing of the previously recorded asset write-downs and eventual sale of the Fluid Power Products reporting segment in the fourth quarter of 2001.

      The total (loss) in 2001 from the discontinued Fluid Power Products reporting segment, including write-down of assets and gain on disposal discussed above, which is presented separately from continuing operations in the consolidated financial statements, was $(47.7) million. (Loss), after tax credits, from discontinued operations in 2001 of $(32.5) million resulted in diluted (loss) per common share from discontinued operations of $(1.08).

      The Company’s net income for 2002, including the cumulative effect of an accounting change was $12.2 million or $0.41 per common share on a diluted basis. The Company’s total net (loss) for 2001, including results of discontinued operations, was $(4.0) million or $(0.13) per common share on a diluted basis.

Analysis of 2001 Operations Compared to 2000 Operations

      Net sales from continuing operations of $285.6 million in 2001 increased $6.8 million or 2.5 percent compared to 2000’s sales of $278.8 million. Strategic acquisitions completed in August 2000 and March 2001, which both expanded existing product lines and added new product offerings, accounted for an increase of $49.1 million in year over year sales. Excluding the impact of these acquisitions, sales of the remaining Kaydon operations decreased $42.3 million or 15.7 percent, reflecting the continued broad-based slowdown in economic activity throughout the global manufacturing sector. Specifically, the Company experienced an extended downturn for various products sold by its Specialty Metal Formed Products reporting segment. This segment achieved sales of $168.1 million during 2001 compared to 2000 sales of $182.1 million. Excluding the impact of acquisitions, sales of this reporting segment decreased $44.1 million or 24.2 percent as a result of reduced demand for custom-engineered bearings and specialty ball products from the specialty electronic manufacturing equipment market, heavy equipment markets, and the specialty ball markets. Partially offsetting this decline, the Company’s Ring, Seal and Filtration Products reporting segment achieved sales of $89.3 million during 2001, up a modest $1.8 million from 2000 sales achieved of $87.5 million. Stronger demand for certain ring products from aerospace and marine markets accounted for the increase. The Company’s Other Metal Products reporting segment achieved sales of $28.2 million during 2001 as compared with $9.2 million in 2000. The companies in this reporting segment were purchased in August 2000.

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Selected Data For The Year 2001 Compared With The Year 2000

      The Company’s gross margin percentage from continuing operations equaled 35.0 percent in 2001, as compared to 42.7 percent achieved in 2000. The decrease in gross margin percentage was due to reduced sales levels excluding acquisitions, primarily to the reduced sales achieved by the Company’s Specialty Metal Formed Products reporting segment. Kaydon’s high value-added products and resultant strong contribution margins make the Company’s profit performance very volume sensitive. Absent the effect of recent acquisitions, a gross margin decline of approximately $26.1 million can be directly attributed to the aforementioned $42.3 million decrease in sales volume compared to 2000.

      Selling, general and administrative expenses from continuing operations totaled $54.3 million or 19.0 percent of sales in 2001, compared to $38.7 million or 13.9 percent of sales for 2000, with $12.8 million of the increase in selling, general and administrative expenses relating to recent acquisitions. These acquisitions have higher selling, general and administrative expense cost structures than many of the other Kaydon operations, including increases for goodwill amortization. Selling, general, and administrative expenses as a percentage of sales for these recent acquisitions range from approximately 19 to 28 percent.

      Operating income from continuing operations equaled $45.5 million during 2001, compared to $58.4 million in 2000, with operating margins of 15.9 percent and 21.0 percent in 2001 and 2000, respectively. Operating income from continuing operations, excluding the $21.7 million of unusual litigation expenses, equaled $80.2 million during 2000, or an operating margin of 28.8 percent.

      On a reporting segment basis, operating income from the Specialty Metal Formed Products reporting segment was $34.6 million during 2001 as compared to $62.5 million during 2000. The decrease in operating income is primarily due to decreased volume and unfavorable sales mix specific to certain custom bearing and specialty ball products. In addition, recent acquisitions have higher selling, general and administrative expense cost structures than the other operations within the segment, including increases for goodwill amortization.

      The Ring, Seal, and Filtration Products reporting segment contributed $14.3 million to the Company’s operating income during 2001 as compared to $13.9 million during 2000. The increase in operating income is primarily due to volume increases related to certain ring products from aerospace and marine markets.

      The Other Metal Products reporting segment contributed $2.2 million of operating income during 2001 as compared to $0.7 million during 2000. The companies in this reporting segment were purchased in August 2000.

      Net interest expense from continuing operations in 2001 was $0.3 million, while net interest income from continuing operations in 2000 was $5.1 million. The increased interest expense was due to higher average bank borrowings during 2001 related to recent acquisitions.

      Net income from continuing operations in 2001 was $28.5 million, down 29.2 percent from the prior year, with return on sales of 10.0 percent. Net income from continuing operations in 2000, excluding the after tax effect, $13.7 million, of the unusual litigation expenses, was $54.0 million, with return on sales of 19.4 percent.

      Diluted earnings per common share from continuing operations decreased to $0.95 in 2001 based on 30.0 million weighted average common shares outstanding, compared to $1.33 in 2000 based on 30.2 million weighted average common shares outstanding. Diluted earnings per common share from continuing operations in 2000, excluding the after tax effect, $0.46 per common share, of the unusual litigation expenses, was $1.79.

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      The effective tax rate on continuing operations was 37.0 percent in 2001 and 36.7 percent in 2000.

      During the third quarter of 2001, the Company recorded a special non-cash charge of $38.1 million pre-tax to write-down the value of the assets of its Fluid Power Products reporting segment. The write-down was necessary as a result of recent operating losses, an outlook for prolonged weakness in the demand for hydraulic fluid power products which likely would have led to continuing losses, structural changes in competitive dynamics, and adverse customer trends. The majority of the special charge, $34.6 million, resulted from the write-down of certain non-current intangible and fixed assets to estimated fair value in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The estimated fair value of intangible and fixed assets was determined by the Company’s management based on current and projected operating performance, tangible asset values and other relevant factors. The remaining $3.5 million comprised reductions in the carrying amount of certain current assets including inventory in the amount of $2.0 million and accounts receivable in the amount of $1.5 million. These charges to current assets reflected recent adverse credit trends of certain customers, changes in product manufacturing and customer service strategies, product pricing challenges caused by new competitive pressures, and other factors.

      During the latter part of November 2001, the Company received an unsolicited offer from a private ownership group to purchase the Fluid Power Products reporting segment. Negotiations with the private ownership group continued during December, until the sale of the reporting segment closed on December 31, 2001. The Company sold the net assets of the Fluid Power Products reporting segment for approximately $16 million cash. Final costs to sell and final adjustments related to the sale resulted in a net gain on the sale of $0.2 million pre-tax, which was recorded in the fourth quarter.

      Also, in the fourth quarter of 2001, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which replaces SFAS No. 121, as it relates to the impairment or disposal of long-lived assets. Upon adoption of the new pronouncement, which does not include goodwill in the scope of its requirements, the Company retroactively applied this pronouncement as of January 1, 2001. Because goodwill is not covered by SFAS No. 144, the Company retroactively applied the provisions of Accounting Principles Board Opinion No. 17, “Intangible Assets” to goodwill, and recorded the previously written-down goodwill in accordance with that pronouncement. Upon meeting the criteria for applying held for sale accounting under SFAS No. 144 during early December 2001, the Company held for sale the net assets of the Fluid Power Products reporting segment, as a discontinued operation. The adoption of SFAS No. 144 did not affect the amounts and timing of the previously recorded asset write-downs and eventual sale of the Fluid Power Products reporting segment in the fourth quarter.

      Net sales for the Fluid Power Products reporting segment totaled $49.4 million and $60.5 million in 2001 and 2000. Operating loss for the Fluid Power Products reporting segment totaled $(9.8) million and $(1.4) million in 2001 and 2000. As a result of the adoption of SFAS No. 144, the operating results of the Fluid Power Products reporting segment are presented separately from continuing operations in the consolidated financial statements.

      The total (loss) in 2001 from the discontinued Fluid Power Products reporting segment, including write-down of assets and gain on disposal discussed above, which is presented separately from continuing operations in the consolidated financial statements, was $(47.7) million. Net (loss), after tax credits, from discontinued operations in 2001 of $(32.5) million resulted in diluted (loss) per common share from discontinued operations of $(1.08). Total operating (loss) in 2000 from the discontinued Fluid Power Products operating segment, was $(1.4) million. Net (loss), after tax credits, from discontinued operations in 2000 of $(0.9) million resulted in diluted (loss) per common share from discontinued operations of $(0.03).

      The Company’s total net (loss) for the year, including results of discontinued operations, was $(4.0) million or $(0.13) per common share on a diluted basis, based on 30.0 million weighted average common shares outstanding. Diluted earnings per common share in 2000, on the Company’s total net income of $39.3 million, including discontinued operations, was $1.30 based on 30.2 million weighted average common shares outstanding.

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Liquidity, Working Capital, and Cash Flows

      One of the Company’s financial strategies is to maintain a high level of liquidity and cash flow, which continued in 2002. Historically, Kaydon Corporation has generated significant cash flows from operating activities to fund capital expenditures, dividends and other operating requirements. Cash flow generation has been enhanced by the Company’s continuing efforts to improve operating efficiencies, cost reductions and the management of working capital requirements. One of the Company’s strengths is its ability to generate cash from operations in excess of requirements for capital investments and dividends.

      Free cash flow is cash from operations remaining after the Company has satisfied its capital investment initiatives to enhance manufacturing efficiencies, expand productive capacity and avail itself of other competitive opportunities. As one of its financial strategies, the Company focuses on maximizing free cash flow to achieve management’s primary objective—maximizing long-term shareholder value. The consolidated statements of cash flows are summarized as follows:

      In 2002 the Company again experienced strong operating cash flows as operating activities provided $62.2 million, including a tax refund received in the first quarter of 2002 of $10.1 million related to the sale of the Fluid Power Products reporting segment completed on December 31, 2001.

      Net capital expenditures to reduce costs, improve quality and expand productive capacity equaled $8.8 million in 2002, $9.6 million in 2001 and $8.8 million in 2000. Common stock dividends paid in 2002, 2001 and 2000 equaled $14.6 million, $14.6 million and $13.5 million. During 2003 the Company expects to invest approximately $12.0 million in net capital expenditures, including approximately $2.9 million in capital related to the restructuring plan initiated in the fourth quarter of 2002. The restructuring plan is further discussed in the Notes to Consolidated Financial Statements (Note 15). Cash paid to litigate the Transactions Lawsuit equaled $6.6 million, $3.9 million, and $2.8 million in 2002, 2001 and 2000. The Transactions Lawsuit is further discussed in the Notes to Consolidated Financial Statements (Note 11) and other discussions throughout this Annual Report. Because of positive returns earned in prior years on the Company’s pension plan investments, required annual contributions to the Company’s pension plans have been negligible. However, recent plan asset performance, and the current under funded status of the Company’s pension plans, will cause these minimum contributions to increase. The Company’s contribution for the 2002 pension plan year will be approximately $0.7 million. The Company estimates that its contribution for the 2003 pension plan year will be approximately $4.7 million.

      The Company repurchased 690 shares of its common stock in 2002 for less than $0.1 million compared to 67,940 shares for $1.7 million in 2001 and 883,957 shares for $20.2 million in 2000. Of the 5,000,000 shares currently authorized by the Board of Directors for repurchase, 1,469,132 shares have been repurchased as of December 31, 2002. The Company expects to be more active in share repurchases in 2003 as compared to 2002.

      The Company continues its active corporate development efforts to complement internal growth through the acquisition of additional companies to meet Kaydon’s well-disciplined criteria. On May 17, 2002 the Company used a portion of its cash resources to purchase substantially all of the assets of Printed Circuit Solutions Manufacturing, Inc., a designer of printed circuit boards and flexible printed tapes, for $4.4 million. On March 1, 2001, the Company purchased for $70.6 million, all of the outstanding stock of ACE Controls,

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      The Company believes its current cash balances and future cash flows from operations, along with its borrowing capacity and access to financial markets are adequate to fund its strategies for future growth, including working capital, expenditures for manufacturing expansion and efficiencies, selected stock repurchases, market share initiatives and corporate development activities.

      At December 31, 2002 the Company’s current ratio was 6.0 to 1 and working capital totaled $203.6 million, including $146.3 million of cash and cash equivalents. At December 31, 2001, the current ratio was 6.9 to 1 and working capital totaled $230.3 million, including cash and cash equivalents of $152.6 million.

      The Company’s working capital turnover was 1.4 times in 2002, compared to 1.2 times in 2001. Excluding cash, the working capital turnover was 4.9 times in 2002 compared to 3.7 times in 2001. The Company’s inventory turnover ratio was 3.6 times in 2002 compared to 3.5 times in 2001, while the days-sales year end balance equaled 49 days in 2002 compared to 53 days in 2001.

      During 1999, the Company entered into a $300.0 million domestic revolving credit facility, which terminates in June 2004. The facility permits the Company to borrow under several different interest rate options based on the London Interbank Offered Rate (LIBOR). The Company utilized the facility during 2001 and 2000 to finance the acquisition of ACE and the Tridan Group of companies. In 2002, the Company reduced by $40.0 million the amount outstanding on the credit facility. After consideration of the facility’s covenants, the Company had available credit under the revolving credit facility of $111.6 million at December 31, 2002. Absent a potential acquisition or significant erosion of the spread between the interest rate paid on debt and the interest rate earned on invested cash and cash equivalents, the Company expects current outstanding debt levels on this facility of $72.2 million to be maintained during 2003. Because the credit facility terminates in June 2004, all amounts outstanding thereunder will be reclassified as short-term debt in the Company’s consolidated financial statements beginning in June 2003.

Corporate Development

      The Company maintains an active acquisition program, which has made important contributions to the Company’s growth. As discussed earlier in the Liquidity, Working Capital and Cash Flows section, on May 17, 2002, the Company used a portion of its cash resources to purchase substantially all of the assets of Printed Circuit Solutions Manufacturing, Inc., a designer of printed circuit boards and flexible printed tapes, for $4.4 million. During the last five years, excluding operations classified as discontinued, the Company acquired seven businesses for $136.6 million.

      The Company utilizes well-disciplined criteria in selecting acquisitions, including the long-term enhancement of its financial strength and shareholder value.

      The initial earnings benefit of acquisitions to the Company is less than the corresponding increase in sales since earnings are reduced by acquisition related costs such as interest and added depreciation. Generally, the anticipated earnings improvement for the Company comes from subsequent growth of acquired companies, since future incremental sales are not burdened with these fixed acquisition costs. Future earnings are also anticipated to benefit from improved operating efficiencies and cost containment programs.

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Litigation

      As previously reported, the Company, along with certain other companies, was named as a defendant in a lawsuit filed in 1995 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. In July 2002, the Company filed two motions. The first was a motion to exclude the testimony of three of plaintiffs’ proposed expert witnesses, including both of plaintiffs’ proposed valuation witnesses. The second motion, filed along with similar motions from the other defendants in the case, was for summary judgment dismissing all claims against the Company and the other defendants. On January 28, 2003, the Court granted the motion to exclude the testimony of three of plaintiffs’ proposed experts.

      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 the 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. Although the plaintiffs have the right to appeal the Court’s order in this case, and the Company may incur additional costs, the Company believes the Court’s decision will withstand any possible appeal. Management has always believed that the Company had meritorious defenses to the claims pending against it in this litigation. Accordingly, no provision had been reflected in the consolidated financial statements for any alleged damages. Expenditures to litigate this matter equaled $6.6 million in 2002, $3.9 million in 2001, and $2.8 million in 2000. During the second quarter of 2002, a $7.5 million provision was recorded in order to support the Company’s most current and best estimate of the cost to continue to litigate the Transactions Lawsuit. As of December 31, 2002, a $5.3 million accrual was recorded as a current liability in the consolidated financial statements, reflecting the estimated remaining costs to litigate this matter, including consideration of the aforementioned events of March 14, 2003.

      The Company is a party to various other lawsuits and matters arising in the normal course of business that are pending. Refer to the Notes to Consolidated Financial Statements (Note 11) for further information.

Forward-Looking Statements

      This Form 10-K contains forward-looking statements within the meaning of the Securities Exchange Act of 1934 regarding the Company’s plans, expectations, estimates and beliefs. Forward-looking statements are typically identified by words such as “believes,” “anticipates,” “estimates,” “expects,” “intends,” “will,” “may” and other similar expressions. These forward-looking statements may include, among other things, projections of the Company’s financial performance, anticipated growth, characterization of and the Company’s ability to control contingent liabilities, and anticipated trends in the Company’s businesses. These statements are only predictions, based on the Company’s current expectation about future events. Although the Company believes the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, performance or achievements or that predictions or current expectations will be accurate. These forward-looking statements involve risks and uncertainties, including those specifically listed below, that could cause the Company’s actual results, performance or achievements to differ materially from those expressed or implied by the forward-looking statements.

      In addition, the Company or persons acting on its behalf may from time to time publish or communicate other items that could also be construed to be forward-looking statements. Statements of this sort are or will be based on the Company’s estimates, assumptions, and projections and are subject to risks and uncertainties, including those specifically listed below, that could cause actual results to differ materially from those included in the forward-looking statements. Kaydon does not undertake any responsibility to update its forward-looking statements or risk factors to reflect future events or circumstances. The following risk factors could affect the Company’s operating results.

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      Many of the Company’s customers are in industries that are cyclical in nature and sensitive to changes in general U.S. and worldwide economic conditions and other factors, including capital spending levels. As a result, the demand for the Company’s products by these customers depends, in part, upon general economic conditions and business confidence levels. Downward economic cycles have affected the Company’s customers and reduced sales of the Company’s products resulting in reductions to the Company’s revenues and net earnings. The Company expects a general economic recovery in industrial manufacturing and upward economic cycle to result in increased revenues and operating results. However, the Company provides no assurances that any such recovery, upward cycle or increased sales and operating results will occur. If such recovery does not occur, Kaydon’s revenues may remain stable or decline and the Company may incur lower levels of profitability.

      The industries in which the Company operates are fragmented and it faces competition from multiple companies across all of the Company’s diverse product lines. Kaydon expects competitive pressures from new products and aggressive pricing to increase, which may cause the Company to lose market share or compel the Company to reduce prices to remain competitive, and which could result in reduced levels of revenues and earnings. Kaydon’s competitors include U.S. and non-U.S. companies, some of whom benefit from lower labor costs and regulatory burdens. In addition, certain competitors are larger than Kaydon and may have greater resources. Increased competition with these companies or new entrants to the Company’s key markets could prevent price increases for the Company’s products or could require price reductions, which could adversely affect the Company’s financial condition, results of operations, growth or liquidity and could affect the Company’s operating performance.

      As part of the Company’s growth strategy, Kaydon has pursued, and intends to continue pursuing, acquisitions of complementary businesses as well as acquisitions that diversify the Company’s product offerings. The Company’s ability to grow through acquisitions depends upon the ability to identify, negotiate and complete suitable acquisitions. If the Company is not able to successfully manage future acquisitions, the Company may incur losses. Acquisitions and integration of those acquisitions into Kaydon’s existing structure involve a number of risks, including:

	—	difficulties in integrating acquisitions into the Company’s operations;
	—	delays in realizing the intended efficiencies, cost savings and revenue synergies;
	—	unanticipated problems or liabilities; and
	—	diversion of Company management’s time and attention.

      Sales of the Company’s products from the Company’s foreign subsidiaries and from domestic subsidiaries selling to foreign locations accounted for approximately 29.9 percent of the Company’s net sales for the fiscal year ended December 31, 2002. These foreign sales could be adversely affected by changes in various foreign countries’ political and economic conditions, trade protection measures, restrictions on repatriation of earnings, differing intellectual property rights and changes in regulatory requirements that restrict the sales of the Company’s products or increase costs. Also, changes in exchange rates between the U.S. dollar and other currencies could potentially result in increases or decreases in the Company’s costs and earnings and may adversely affect the value of the Company’s assets outside the United States.

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      As a provider of critical performance products in a variety of industries including aerospace, defense, construction, marine, medical, material handling, machine tool positioning and other industrial applications, the Company faces a risk of exposure to claims in the event that the failure, use or misuse of the Company’s products results, or is alleged to result, in bodily injury and/or property damage.

      The Company, along with certain other companies, is named as a defendant in a lawsuit arising from an August 2000 fatal accident involving a MH53E helicopter manufactured by Sikorsky Aircraft Corporation. The Company believes that the alleged damages claimed in this lawsuit, and the associated legal costs, will be fully covered under the Company’s insurance policy, but it is possible that such costs will not be covered by insurance and, if so, the Company will incur unknown additional direct costs. Further, the Company believes that there are 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 inspectors and Sikorsky Aircraft Corporation. These claims have not been finally resolved.

      In the past, costs related to legal proceedings and settlements have had an effect on the Company’s business, financial condition, results of operations and liquidity. The Company makes no assurances that the ultimate cost of current known or future unknown litigation and claims will not exceed the Company’s current expectations and it is possible that such costs could have a material adverse effect on the Company.

      The Company, along with certain other companies, was named as a defendant in a lawsuit filed in 1995 in the United States District Court for the Southern District of New York (the “Transactions Lawsuit”). The Transactions Lawsuit sought damages alleged by plaintiffs to be an amount of $700 million, plus interest and punitive damages against the defendants collectively. In July 2002, the Company filed a motion, along with similar motions from the other defendants in the case, for summary judgment dismissing all claims against the Company and the other defendants. 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. Although the plaintiffs have the right to appeal the Court’s order in this case, and the Company may incur additional costs, the Company believes the Court’s decision will withstand any possible appeal. Management has always believed that the Company had meritorious defenses to the claims pending against it in this litigation. Accordingly, no provision had been reflected in the consolidated financial statements for any alleged damages. As of December 31, 2002, a $5.3 million accrual was recorded as a current liability in the consolidated financial statements, reflecting the estimated remaining costs to litigate this matter, including consideration of the aforementioned events of March 14, 2003. While the Company currently believes the amount of the ultimate liability, if any, with respect to this action will not materially affect the financial condition, results of operations, or liquidity of the Company, the Company realizes that the ultimate outcome of this litigation is uncertain. Were an unfavorable outcome to occur, the impact could be material to the Company.

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Item 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

      The Company is exposed to certain market risks which exist as part of its ongoing business operations including interest rates and foreign currency exchange rates. The exposure to market risk for changes in interest rates relates primarily to the Company’s long-term debt borrowings under the revolving credit facility and investments in cash and cash equivalents. The interest rate on the long-term debt borrowings under the credit facility is variable and is based on the London Interbank Offered Rate (LIBOR). A 23 basis point increase in interest rates (10 percent of the Company’s weighted average long-term debt interest rate for the 2002 year) would have an immaterial effect on the Company’s pre-tax earnings. All highly liquid investments, including highly liquid debt and investment instruments purchased with an original maturity of three months or less, are considered cash equivalents. The Company places its investments in cash equivalents with high credit quality issuers and limits the amount of exposure to any one issuer. A 17 basis point decrease in interest rates (10 percent of the Company’s weighted average investment interest rate for the 2002 year) would have an immaterial impact on the Company’s pre-tax earnings. The Company conducts business in various foreign currencies, primarily in Europe, Canada, and Japan. Therefore, changes in the value of currencies of these countries affect the Company’s financial position and cash flows when translated into U.S. dollars. The Company has mitigated and will continue to mitigate a portion of its currency exposure through operation of decentralized foreign operating companies in which all costs are local currency based. In addition, periodically, the Company enters into derivative financial instruments in the form of foreign exchange contracts to reduce the effect of fluctuations in foreign exchange rates. A 10 percent change in the value of all foreign currencies would have an immaterial effect on the Company’s financial position and cash flows.

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Item 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT AUDITORS

To the Shareholders and Board of Directors of Kaydon Corporation:

      We have audited the accompanying consolidated balance sheet of Kaydon Corporation (“the Company”) as of December 31, 2002, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended. Our audit also included the financial statement schedule for the year ended December 31, 2002 listed at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. The financial statements of Kaydon Corporation as of December 31, 2001, and for each of the years in the two-year period ended December 31, 2001, were audited by other auditors who have ceased operations and whose report dated February 1, 2002, expressed an unqualified opinion on those statements before the revisions and restatement adjustments described below and in Notes 1 and 12.

      We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

      In our opinion, the 2002 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kaydon Corporation at December 31, 2002, and the consolidated results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule for the year ended December 31, 2002, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

      As discussed in Note 12, effective January 1, 2002 the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”).

      As discussed above, the consolidated financial statements of the Company as of December 31, 2001, and for each of the years in the two-year period ended December 31, 2001, were audited by other auditors who have ceased operations. However, the Company made certain revisions and adjustments to prior years’ financial statements to comply with adoption requirements of the new accounting pronouncement or to conform with the current year’s presentation, as follows:

	(i) As described in Note 12, the 2001 and 2000 consolidated financial statements have been revised to include the transitional and other disclosures required by SFAS 142, which the Company adopted as of January 1, 2002. Our audit procedures with respect to the disclosures in Note 12 regarding 2001 and 2000 included (a) agreeing the previously reported income from continuing operations and net income (loss) (in total and the related earnings-per-share amounts) to the previously issued consolidated financial statements and the adjustments to amounts representing amortization expense (including any related tax effects) recognized in those periods related to goodwill as a result of initially applying SFAS 142 to the Company’s underlying records obtained from management, (b) testing the mathematical accuracy of the reconciliation of adjusted income from continuing operations and net income (loss) to previously reported income from continuing operations and net income (loss) and the related earnings-per-share amounts. Additionally, our procedures with respect to the disclosures in Note 12 regarding 2001 included (a) agreeing the cost basis and accumulated amortization of customer lists, patents, trademarks and other to the Company’s underlying records obtained from management, (b) agreeing 2001 amortization expense for other intangible assets to the Company’s underlying records obtained from management, and (c) agreeing the changes in the carrying amount of goodwill to the Company’s underlying records obtained from management.
	(ii) As described in Note 1, the Company reclassified $10,101,000 of refundable income taxes from other accrued expenses to taxes recoverable in the 2001 consolidated balance sheet. We audited the adjustment that was applied to reclassify taxes recoverable in the 2001 consolidated balance sheet. Our procedures included

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	(a) agreeing the amount of taxes recoverable to the Company’s underlying records obtained from management, and (b) testing the mathematical accuracy of the restatement of taxes recoverable.

      In our opinion, the revisions and adjustments described in (i) and (ii) above are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 consolidated financial statements of the Company other than with respect to such revisions and adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 consolidated financial statements taken as a whole.

Ernst & Young LLP

Detroit, Michigan

      This audit report of Arthur Andersen LLP, the Company’s former independent public accountants, is a copy of the original report dated February 1, 2002 rendered by Arthur Andersen LLP on the Company’s consolidated financial statements included in the Company’s Form 10-K filed on March 15, 2002, and has not been reissued by Arthur Andersen LLP since that date. The Company is including this copy of the Arthur Andersen LLP audit report pursuant to Rule 2-02(e) of Regulation S-X under the Securities Act of 1933.

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Shareholders and Board of Directors of Kaydon Corporation:

      We have audited the accompanying consolidated balance sheets of Kaydon Corporation (a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kaydon Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States.

      Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule of valuation and qualifying accounts is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.

Arthur Andersen LLP

Detroit, Michigan

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KAYDON CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these statements.

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KAYDON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME