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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:

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

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

      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 þ          No o

        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.     þ

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

       The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant on June 28, 2003 (based on the June 27, 2003 closing sales price of $20.83 of the Registrant’s Common Stock, as reported on the New York Stock Exchange Composite Tape on such date) was approximately $421,500,000.

     Number of shares outstanding of the Registrant’s Common Stock at March 3, 2004:

     28,217,768 shares of Common Stock, par value $0.10 per share.

     Portions of the Registrant’s definitive Proxy Statement to be filed for its 2004 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report.

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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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PART I

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 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 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 Velocity Control Products reporting segment.

Industry Segments

      The Company operates through operating segments for which separate financial information is available, and for which operating results are evaluated regularly by the Company’s chief operating decision maker in determining resource allocation and assessing performance. Certain of the operating segments have similar economic characteristics, as well as other common attributes, including nature of the products and production processes, distribution patterns and classes of customers. The Company aggregates these operating segments for reporting purposes. Certain other operating segments do not exhibit the common attributes mentioned above and, therefore, information about them is reported separately. Still other operating segments do not meet the quantitative thresholds for separate disclosure and their information is combined and disclosed as “Other.” Prior to the fourth quarter of 2003 the Company aggregated its operating segments into three continuing and one discontinued reportable segments referred to as Specialty Metal Formed Products, Ring, Seal and Filtration Products, Other Metal Products and Fluid Power Products. During the fourth quarter of 2003, the Company changed the

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      The Company has four continuing reportable segments, one discontinued reportable segment, and other operating segments engaged in the manufacture and sale of the following:

      Friction and Motion Control Products — complex components used in specialized medical, aerospace, defense, security, electronic, material handling, construction and other industrial applications. Products include anti-friction bearings, split roller bearings, specialty balls and retaining devices.

      Velocity Control Products — complex components used in specialized robotics, material handling, machine tool, medical, amusement and other industrial applications. Products include industrial shock absorbers, safety shock absorbers, velocity controls, gas springs and rotary dampers.

      Sealing Products — complex and standard ring and seal products used in demanding industrial, aerospace and defense applications. Products include engine rings, sealing rings and shaft seals.

      Power and Data Transmission Products — complex and standard electrical and fiber optic products used in demanding industrial, aerospace, defense, security, medical, electronic and marine equipment applications. Products include slip-rings, slip-ring assemblies, video and data multiplexers, fiber optic rotary joints and printed circuit boards.

      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.

      Other — filter elements and filtration systems, metal alloys, machine tool components, presses, dies and benders used in a variety of industrial applications.

      Net sales related to the Company’s four continuing reportable segments, one discontinued reportable segment, and other operating segments during 2003, 2002 and 2001 are set forth in the following table:

      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

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      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 2003, 2002 and 2001, sales to no single customer exceeded 10 percent of Kaydon net sales. However, during 2003, sales to three customers exceeded 10 percent (19.8 percent, 17.3 percent, and 10.3 percent) of net sales in the Sealing Products reporting segment, and two customers exceeded 10 percent (11.7 percent and 11.4 percent) of net sales in the Power and Data Transmission Products reporting segment.

      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. In addition, certain products are manufactured on the basis of sales projections or annual blanket purchase orders. Backlog in the Friction and Motion Control Products reporting segment was $55.2 million at December 31, 2003 and $46.3 million at December 31, 2002. Backlog in the Velocity Control Products reporting segment was $5.5 million at December 31, 2003 and $4.2 million at December 31, 2002. Backlog in the Sealing Products reporting segment was $13.6 million at December 31, 2003 and $16.3 million at December 31, 2002. Backlog in the Power and Data Transmission Products reporting segment was $15.9 million at December 31, 2003 and $15.2 million at December 31, 2002. Backlog in other businesses was $6.7 million at December 31, 2003 and $6.3 million at December 31, 2002. The Company expects to ship approximately 75 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

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Employees

      The Company employs approximately 1,860 people. Satisfactory relationships have generally prevailed between the Company and its employees.

International Operations

      Certain friction and motion control products are manufactured in Mexico and the United Kingdom, certain velocity control products are assembled and distributed through a facility in Germany, and certain power and data transmission products are manufactured in Canada, the United Kingdom and Mexico. 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.

      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.

Available Information

      The Company’s internet address is www.kaydon.com. The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to all such reports and statements are accessible at no charge on the Company’s website as soon as reasonably practicable after filing with the Securities and Exchange Commission.

Item 2.     Properties

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

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      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 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 a motion 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. 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 is complete, and the appeal is expected to be heard by the Court of Appeals during the first 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 $2.9 million in 2003, $6.6 million in 2002 and $3.9 million in 2001. 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, 2003, a $2.4 million accrual remains as a current liability in the consolidated financial statements, reflecting the estimated remaining costs to litigate this matter.

      As previously reported, in July 2001, the Company, the Company’s insurance provider and the plaintiff agreed to a settlement of a product liability lawsuit, with the settlement payment to the plaintiff being shared between the Company and the Company’s insurance provider. The Company believed that the majority of its portion of the settlement payment, which equaled $2.8 million, was covered under the Company’s commercial general liability policy, and, therefore, filed a legal claim in August 2001 in an attempt to recover $2.6 million from the Company’s insurance provider. Subsequently, the Company’s insurance provider filed a counterclaim in an attempt to recover its portion of the settlement payment, $2.6 million, from the Company. Because of the uncertainties involved, and based on a demand from the Company’s insurance provider to settle this case out of court, the Company recorded a $1.3 million charge to cost of sales and a corresponding credit to other accrued expenses during December 2001. Throughout 2002 and most of 2003 there was very little activity in this case.

      On December 1, 2003, the court granted the Company’s motion for summary judgment, and after the Company’s insurance provider filed a notice of appeal from the court’s decision, the Company and the Company’s insurance provider agreed to settle the case for $2.5 million, which the Company’s insurance provider paid to the Company in January 2004. The Company has recorded the $2.5 million settlement amount, as well as the reversal of the $1.3 million accrual recorded in 2001, a total of $3.8 million, as a credit to cost of sales in the Consolidated Income Statement for the year ended December 31, 2003.

      As previously reported, in August 2000, an accident involving a MH53E helicopter manufactured by Sikorsky Aircraft Corporation, resulted in four deaths and two injuries during a military training mission. The Company manufactures and sells swashplate bearings used on MH53E helicopters. In May 2002, the Company, along with Sikorsky Aircraft Corporation, The Armoloy Corporation, Armoloy of Illinois, Inc., Armoloy of Connecticut, Inc. and Investment Holdings, Inc., was named as a defendant in a lawsuit filed by the relatives and the estates of the four deceased individuals, and by the two injured individuals. The litigation currently is pending in the District Court of Nueces County, Texas, 28^th Judicial District. Armoloy of Connecticut, Inc. is no longer a party to the litigation. The Company’s insurance provider has

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      The Company is involved in ongoing environmental remediation activities at certain manufacturing sites as well as proceedings relating to the cleanup of waste disposal sites that provide for the allocation of costs among potentially responsible parties. One of the manufacturing sites undergoing environmental remediation is a discontinued operation sold in December 2001, where the Company retained the environmental liability. The Company is working with the appropriate regulatory agencies to complete the necessary remediation or to determine the extent of the Company’s portion of the remediation necessary. As of December 31, 2003, an undiscounted accrual in the amount of $3.3 million representing the Company’s best estimate for ultimate resolution of these environmental matters is included in other long-term liabilities in the consolidated financial statements.

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

Item 4.     Submission of Matters to a Vote of Security Holders

      No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2003.

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

PART II

Item 5.     Market for the Registrant’s Common Equity and Related Stockholder Matters

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 closing sales prices of the

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      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, 2003, there were 995 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, 2003, including Kaydon’s 1999 Long-Term Stock Incentive Plan, 1993 Non-Employee Directors Stock Option Plan, the 2003 Non-Employee Directors Equity Plan and the Director Deferred Compensation Plan.

(1)	Includes only options outstanding under Kaydon’s 1999 Long-Term Stock Incentive Plan, the 1993 Non-Employee Directors Stock Option Plan and the 2003 Non-Employee Directors Equity Plan, as no warrants or rights were outstanding as of December 31, 2003.
(2)	Includes shares of Kaydon common stock 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. 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.
(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 and shares available for issuance under the 2003 Non-Employee Directors Equity Plan which allows for the granting of stock options and for awards of restricted stock.

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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 a $3.8 million favorable impact related to a legal settlement.
(3)	Includes the after tax effect, $3.1 million or $0.11 per share, of the pre-tax $3.8 million favorable legal settlement and a pre-tax $0.9 million gain on sale of assets.
(4)	Includes the after tax effect, $4.8 million or $0.16 per share, of a pre-tax $7.5 million litigation-related charge.
(5)	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.
(6)	Includes the after tax effect, $4.8 million or $0.16 per share, of the litigation-related charge and the after tax effect, $13.2 million or $0.44 per share, of the cumulative effect of accounting change.
(7)	Includes a 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.
(8)	Includes the after tax effect, $26.3 million or $0.88 per share, of the net charge, $37.9 million, to write-down the value and to sell the assets of the Fluid Power Products Group.
(9)	Includes the after tax effect, $13.7 million or $0.46 per share, of the pre-tax $21.7 million litigation-related charges.

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Overview

      The Company provides an array of proprietary, value added products to a diverse customer base covering a broad spectrum of industries. This strategic diversification means that demand for the Company’s products depends, in part, upon a wide range of general economic conditions, which affect the Company’s markets in varying ways from year to year. During 2003, the Company was favorably impacted as the economy emerged from the manufacturing slowdown of the last four years. The general economic rebound and increased military and defense spending meant that during the year the Company experienced increased demand from various markets including military and defense, industrial, marine equipment, and other key commercial markets. In addition, during 2003, the Company experienced increased demand from its distributors who had reduced inventories during the manufacturing slowdown. As a result of these positive factors, the Company achieved increases in customer order levels in each quarter during 2003 compared to 2002. Partially offsetting these gains, the Company was negatively impacted during 2003 by reduced capital spending levels in the power generation equipment, construction equipment, other heavy equipment, and specialty ball markets. In addition, the Company was impacted by lower sales of security scanning equipment due to the completion in early 2003 of sales related to homeland security programs. In 2004, the Company would expect to continue to benefit from a general economic rebound in the manufacturing sector, continued increases in military and defense spending, as well as other factors including low inflation and interest rates, although because of the Company’s diverse product offerings, it is difficult to predict the specific impact these factors may have on the Company’s operating results.

      The Company continues to focus on programs intended to reduce costs, improve capacity utilization, increase efficiencies, and grow market share and cash flow, thereby positioning the Company to capitalize on future opportunities in targeted end-markets, especially during a period of sustained economic growth. During 2003, the Company launched a Company-wide Six Sigma effort and continued its investments in lean manufacturing and information systems to strengthen the Company’s operational excellence. In addition, during 2003, the Company substantially completed its restructuring plan to enhance operating performance and balance manufacturing utilization in the Specialty Bearings Group, part of the Company’s Friction and Motion Control Products reporting segment.

      Maintaining the Company’s strong balance sheet and financial flexibility remains a key strategy of the Company. During May 2003, the Company issued $200.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”). Net proceeds received from the Notes were $194.0 million. The Company used $72.2 million of the net proceeds to repay the full amount outstanding on the Company’s $300.0 million revolving credit facility, which was then cancelled. Net proceeds were also used to repurchase 2.0 million shares of Company common stock for $43.5 million, concurrent with the offering of the Notes. The remaining proceeds of $78.3 million will be utilized for general corporate purposes. Also, in July 2003, the Company negotiated a new $200.0 million revolving credit agreement. The Company’s current cash balances and the $200.0 million revolving credit facility enhance liquidity and provide additional financial strength to support the Company’s objectives including strategic acquisitions.

      In summary, the Company’s future performance will be impacted by general economic conditions, the length and breadth of a sustained industrial manufacturing recovery, military and defense spending, the success of the Company’s cost reduction and capacity utilization efforts, as well as the utilization of current liquidity levels in completing strategic acquisitions.

      The discussion which follows should be reviewed in conjunction with the Consolidated Financial Statements and the related Notes to Consolidated Financial Statements contained in this Annual Report to assist in understanding the Company’s results of operations, its financial position, cash flows, capital structure and other relevant financial information.

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Analysis of 2003 Operations Compared to 2002 Operations

      Net sales of $294.1 million in 2003 increased $14.7 million or 5.3 percent compared to 2002’s net sales of $279.4 million. Specifically, the Friction and Motion Control Products reporting segment achieved sales of $138.6 million during 2003, up $6.5 million or 4.9 percent compared to 2002 sales of $132.1 million. Increased sales of custom-engineered bearings to defense and military markets of $8.2 million were partially offset by reduced sales to specialty ball markets of $2.0 million. The Company’s Velocity Control Products reporting segment achieved sales of $43.1 million during 2003, up $8.2 million, or 23.5 percent from 2002 sales of $34.9 million. Increased product demand from a variety of industrial markets and a 5 percent price increase implemented in April 2003 contributed to $4.1 million of the increase, while favorable foreign currency translation, primarily related to the strengthening of the Euro, accounted for another $4.1 million of the increase. The Company’s Sealing Products reporting segment achieved sales of $37.5 million during 2003, up $3.8 million, or 11.3 percent from 2002 sales of $33.7 million, primarily as a result of increased demand from defense markets. The Company’s Power and Data Transmission Products reporting segment achieved sales of $35.6 million during 2003, down $1.5 million, or 4.1 percent from 2002 sales of $37.1 million. Lower sales to manufacturers of security scanning equipment of $5.1 million, was partially offset by increased sales to military, defense, and certain marine markets. The Company’s other businesses achieved sales of $39.2 million during 2003, down $2.3 million, or 5.6 percent from 2002 sales of $41.6 million, due primarily to lower shipments of presses and dies to China as a result of reduced business activity and marketing efforts caused by the SARS outbreak. See Notes to Consolidated Financial Statements (Note 14) for a discussion of the Company’s change in segment reporting made in 2003, for which the previously reported segment information in 2002 and 2001 has been adjusted.

      The Company’s gross margin percentage equaled 35.9 percent in 2003, as compared to 34.1 percent achieved in 2002. The 2003 gross profit includes a $3.8 million favorable impact related to the settlement of a legal matter. As previously reported, in July 2001, the Company, the Company’s insurance provider and the plaintiff agreed to a settlement of a product liability lawsuit, with the settlement payment to the plaintiff being shared between the Company and the Company’s insurance provider. The Company believed that the majority of its portion of the settlement payment, which equaled $2.8 million, was covered under the Company’s commercial general liability policy, and, therefore, filed a legal claim in August 2001 in an attempt to recover $2.6 million from the Company’s insurance provider. Subsequently, the Company’s insurance provider filed a counterclaim in an attempt to recover its portion of the settlement payment, $2.6 million, from the Company. Because of the uncertainties involved, and based on

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      Selling, general and administrative expenses totaled $49.9 million or 17.0 percent of sales in 2003, compared to $49.5 million or 17.7 percent of sales for 2002. During the third quarter of 2003, the Company classified certain land and building assets that were in the process of being sold as assets held for sale as required under Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” These assets, a warehousing facility in the Company’s Friction and Motion Control Products reporting segment, were valued at their carrying amount of $0.8 million. The opportunity to sell these assets arose due to the facility transferring its inventory to third party warehousing locations in various geographic areas to provide better logistical support to customers. During the fourth quarter of 2003, the Company sold the assets held for sale for approximately $1.7 million, net of closing costs, and recorded a gain on sale of $0.9 million reported as a component of selling, general and administrative expenses in the Consolidated Statements of Income. In addition, during 2003 and January of 2004 the Company settled certain product liability claims for approximately $0.6 million, which was less than what had been estimated at the end of 2002. As a result, during the fourth quarter of 2003 the Company reduced its product liability accrual by $1.5 million favorably impacting 2003 selling, general and administrative expenses. Also, during 2003, the Company substantially completed its restructuring plan that began in late 2002 to enhance operating performance and balance manufacturing utilization in the Specialty Bearings Group, part of the Friction and Motion Control Products reporting segment. This restructuring plan resulted in charges, included in selling, general and administrative expenses, of $0.8 million in 2003 and $0.5 million in 2002. This restructuring plan is expected to provide annualized cost savings to the Company of approximately $2.0 million per year by the end of 2004, primarily from reduced labor costs as a result of both the relocation of manufacturing to lower cost locales, and lower headcount.

      Both gross profit margin and selling, general, and administrative expenses were equally affected during the year by increased insurance and employment-related costs, Sarbanes-Oxley compliance, and the Company-wide Six Sigma implementation. These costs negatively impacted 2003 by approximately $3.9 million compared to 2002. The Six-Sigma program, initiated in April 2003, has identified potential annualized savings of approximately $2.0 million.

      During the second quarter of 2002, a $7.5 million provision was recorded in order to support the Company’s then 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 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 $55.7 million during 2003, compared to $38.4 million in 2002, with operating margins of 18.9 percent and 13.7 percent in 2003 and 2002, respectively.

      On a reporting segment basis, operating income from the Friction and Motion Control Products reporting segment was $30.8 million during 2003 as compared to $25.7 million during 2002. Operating income in 2003 includes $1.4 million of the aforementioned favorable adjustments related to the

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      The Velocity Control Products reporting segment contributed $8.2 million to the Company’s consolidated operating income during 2003 as compared to $4.4 million during 2002. Increases in operating income were primarily due to increased product demand, a 5 percent price increase implemented in April 2003, and favorable foreign currency translation, primarily related to the strengthening of the Euro, which accounted for $1.0 million of the increase.

      The Sealing Products reporting segment contributed $4.6 million to the Company’s consolidated operating income during 2003 as compared to $3.9 million during 2002. Increases in operating income were primarily due to increased sales volumes and reduced inventory reserve expenses related to slow moving and obsolete items, partially offset by increased insurance and employment-related costs.

      The Power and Data Transmission Products reporting segment contributed $1.1 million to the Company’s consolidated operating income during 2003 as compared to $4.8 million during 2002. One business unit within this segment underwent significant changes in its customers and product offerings during 2003, resulting in reduced operating income of $3.3 million as compared to 2002. Sales by this business unit to manufacturers of security scanning equipment decreased by $5.1 million in 2003 compared to 2002 as a result of the completion in early 2003 of sales related to homeland security programs, which was only partially offset during the year by increased demand from military and defense markets. Corrective actions implemented at this business unit, as it adapted to lower 2003 volume levels, and a changing mix of commercial and defense products, include headcount reductions of approximately 15 percent, focus on increased efficiencies and overhead reductions, and the planned launch of a new enterprise resource planning system.

      The Company’s other businesses contributed $3.3 million to the Company’s consolidated operating income during 2003 as compared to $4.2 million during 2002. Reductions in operating income are primarily due to lower sales volumes and higher raw material costs for metal alloys.

      Changes in exchange rates applicable to non-functional currency assets and liabilities resulted in exchange gains of $1.5 million during 2003 and $0.9 million in 2002.

      During May 2003, the Company issued $200.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”). Net proceeds received from the Notes were $194.0 million. The Company used $72.2 million of the net proceeds to repay the full amount outstanding on the Company’s $300.0 million revolving credit facility, which was then cancelled. Net proceeds were also used to repurchase 2.0 million shares of Company common stock for $43.5 million, concurrent with the offering of the Notes. The remaining proceeds of $78.3 million will be utilized for general corporate purposes.

      Net interest expense during 2003 was $3.8 million as compared to net interest income reported during 2002 of $0.8 million. When comparing 2003 with 2002, interest expense on the Notes of $4.8 million and amortization of Note issuance costs of $0.8 million was partially offset by $1.0 million of reduced interest expense on the Company’s outstanding bank debt that was retired in connection with the issuance of the Notes, and by $0.4 million of interest income on the additional cash balances which resulted from the issuance of the Notes. Amortization of Note issuance costs is recorded as a component of net interest expense. The Company would expect approximately $9.3 million of interest and amortization of Note issuance costs to be charged to interest expense related to the Notes during 2004.

      The effective income tax rate was 35.0 percent in 2003 and 35.1 percent in 2002. The Company expects the effective tax rate for 2004 to be approximately 36 percent.

      Income before cumulative effect of accounting change equaled $33.8 million during 2003, compared to $25.4 million in 2002, with return on sales of 11.5 percent and 9.1 percent in 2003 and 2002, respectively.

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      On January 1, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets.” As a result, as of January 1, 2002, the Company is no longer amortizing goodwill and indefinite-lived intangible assets, but performs an annual impairment analysis.

      During the second quarter of 2002, the Company compared the fair value of the Company’s reporting units, 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, the Company identified two reporting units whose carrying amount exceeded their fair value, which indicated potential goodwill impairment. For purposes of reporting segment information, both reporting units are included in “Other.” 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 who assisted it in determining 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. 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.

      The Company’s net income for 2003 was $33.8 million or $1.18 per common share on a diluted basis, compared with net income for 2002 of $12.2 million or $0.41.

Analysis of 2002 Operations Compared to 2001 Operations

      Net sales of $279.4 million in 2002 decreased $6.2 million or 2.2 percent compared to 2001’s net sales of $285.6 million. Specifically, the Friction and Motion Control Products reporting segment achieved sales of $132.1 million during 2002, down $5.9 million or 4.2 percent compared to 2001 sales of $138.0 million. Decreased sales of specialty bearings, to the industrial and heavy equipment markets, and of specialty ball products were partially offset by increased sales of custom-engineered bearings to the security scanning equipment market. The Company’s Velocity Control Products reporting segment

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      The Company’s gross margin percentage 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 Friction and Motion Control Products and Sealing 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 and obsolete items by approximately $1.0 million more during 2002 as compared to 2001.

      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. Goodwill and indefinite-lived intangible asset amortization included in selling, general and administrative expenses during 2001, but not during 2002 due to an accounting change, was $3.6 million. 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. In addition, during the fourth quarter of 2002, the Company initiated a restructuring plan to enhance operating performance and balance manufacturing utilization in the Specialty Bearings Group, part of the Friction and Motion Control 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 Consolidated Balance Sheet.

      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 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.

      On a reporting segment basis, operating income from the Friction and Motion Control Products reporting segment was $25.7 million during 2002 as compared to $29.9 million during 2001. Operating income was negatively impacted during 2002 due to reduced volume and unfavorable sales mix specific to certain custom-engineered bearings and specialty ball products, increased inventory reserves related to slow moving and obsolete items, and employee benefit and other intangible asset amortization costs as compared to 2001.

      The Velocity Control Products reporting segment contributed $4.4 million to the Company’s consolidated operating income during 2002 as compared to $4.7 million during 2001. Reductions in operating income due to unfavorable sales mix and the first full year of acquisition related costs of ACE Controls, purchased March 1, 2001, more than offset favorable increases in operating income due to increased sales volumes and reduced goodwill amortization expense included in 2001 results, but not in 2002, due to an accounting change.

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      The Sealing Products reporting segment contributed $3.9 million to the Company’s consolidated operating income during 2002 as compared to $7.5 million during 2001. Reductions in operating income were primarily due to reduced sales volumes, unfavorable sales mix, increased inventory reserve expenses related to slow moving and obsolete items, and higher employee benefit costs during 2002 as compared to 2001.

      The Power and Data Transmission Products reporting segment contributed $4.8 million to the Company’s consolidated operating income during 2002 as compared to $4.2 million during 2001. Increases in operating income were primarily due to increased sales volumes and reduced goodwill amortization expense included in 2001 results, but not in 2002 due to an accounting change, partially offset by higher employee benefit costs during 2002 as compared to 2001.

      The Company’s other businesses contributed $4.2 million to the Company’s consolidated operating income during 2002 as compared to $4.8 million during 2001. Reductions in operating income were primarily due to lower sales volumes, partially offset by reduced goodwill amortization expense included in 2001 results, but not in 2002 due to an accounting change.

      Changes in exchange rates applicable to non-functional currency assets and liabilities resulted in exchange gains of $0.9 million during 2002 and exchange losses of $0.2 million in 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.

      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 was primarily due to the adoption of SFAS No. 142 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.

      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.

      On January 1, 2002, the Company adopted SFAS No. 142. As a result, as of January 1, 2002, the Company is no longer amortizing goodwill and indefinite-lived intangible assets, but performs an annual impairment analysis. Goodwill amortization expense from continuing operations equaled $3.6 million in 2001.

      During the second quarter of 2002, the Company compared the fair value of the Company’s reporting units, 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, the Company identified two reporting units whose carrying amount exceeded their fair value, which indicated potential goodwill impairment. For purposes of reporting segment information, both reporting units are included in “Other.” 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 who assisted it in determining 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. 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.

      During the third quarter of 2001, the Company recorded a 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 charge, $34.6 million, resulted from the write-down of certain non-current intangible and fixed assets to

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      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.

      In 2001, net sales for the Fluid Power Products reporting segment totaled $49.4 million and operating loss totaled $(9.8) million. 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, 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).

      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.

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 2003. 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. Net cash from operating activities equaled $60.6 million in 2003, $62.2 million in 2002, and $51.2 million in 2001. Included in 2002 net cash from operating activities is the receipt of a $10.1 million tax refund 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 $11.9 million in 2003, including $2.6 million related to the aforementioned restructuring plan, $8.8 million in 2002 and $9.6 million in 2001. During 2004 the Company expects to invest approximately $13.5 million in net capital expenditures. Common stock dividends paid in 2003, 2002 and 2001 equaled $14.0 million, $14.6 million and $14.6 million.

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      Cash paid to litigate the Transactions Lawsuit equaled $2.9 million, $6.6 million, and $3.9 million in 2003, 2002 and 2001. 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 returns and declining interest rates have caused these minimum contributions to increase. The Company contributed $1.2 million during 2003 to its pensions plans, and estimates that payments during 2004 will be approximately $6.4 million. The Company’s payments to various taxing authorities were $4.0 million during 2003, after a $5.6 million overpayment from 2002 that was credited to 2003 estimated tax payments. Tax payments are estimated to be approximately $10.0 million during 2004.

      During May 2003, the Company completed the sale of $200.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”) pursuant to Rule 144A under the Securities Act of 1933, as amended. The Notes bear interest at 4.0 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 Company 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 Company 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. The conversion price represents a 34.0 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 the Company 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.

      In addition, the contingent interest feature of the Notes requires the Company to deduct for tax purposes an amount of interest expense that is greater than the stated coupon rate on the Notes. The deductibility for tax purposes of the additional interest beyond the stated coupon rate may have to be recaptured, in part or in whole, if the Notes are redeemed for cash instead of converted into Company common stock. Redemption of the Notes for cash may cause volatility in tax payments, cash flows and the liquidity of the Company.

      Net proceeds received from the Notes in May 2003 were $194.0 million. The Company used $72.2 million of the net proceeds to repay the full amount outstanding on the Company’s $300.0 million revolving credit facility. The revolving credit facility was then cancelled. Net proceeds were also used to repurchase 2.0 million shares of Company common stock for $43.5 million, concurrent with the offering of the Notes. The remaining proceeds of $78.3 million will be utilized for general corporate purposes.

      Note issuance costs of approximately $6.5 million are being amortized as a component of net interest expense over a five-year period. Note issuance costs included in other assets in the Consolidated Balance Sheet as of December 31, 2003 equaled $5.7 million.

      In connection with the May issuance of the Notes, the Company received ratings during the third quarter of 2003 from both Standard and Poor’s and Moody’s. Standard and Poor’s assigned an issuer rating of BB+, and rated the Company’s Notes BB-. Moody’s assigned an issuer rating of Ba2, and rated the Company’s Notes Ba3.

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      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. The revolving credit facility contains restrictive financial covenants on a consolidated basis including leverage and interest coverage ratios, utilizing measures of earnings and interest expense as defined in the revolving credit facility agreement. Under the leverage ratio restriction, the Company may not allow the ratio of total indebtedness, net of domestic cash in excess of $15.0 million, to 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 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 December 31, 2003. After consideration of the facility’s covenants and $2.5 million of letters of credit issued under the facility, the Company has available credit under its revolving credit facility of $197.5 million at December 31, 2003.

      Fees paid in connection with the revolving credit facility of approximately $0.8 million are being amortized as a component of net interest expense over a three-year period. Revolving credit facility fees included in other assets in the Consolidated Balance Sheet as of December 31, 2003, equaled $0.7 million.

      The Company repurchased 2,429,432 shares of its common stock in 2003 for $52.2 million (including 2.0 million shares concurrent with the offering of the Notes) compared to 690 shares for less than $0.1 million in 2002 and 67,940 shares for $1.7 million in 2001. Of the 5,000,000 shares currently authorized by the Board of Directors for repurchase, 3,898,564 shares have been repurchased as of December 31, 2003. The Company will continue to make selective stock repurchases during 2004, the amount of which will depend on the market for the Company’s common stock and the Company’s financial position and liquidity.

      The Company’s corporate development efforts are aimed to complement internal growth through the acquisition of additional companies consistent with Kaydon’s well-disciplined criteria. On March 1, 2001, the Company purchased for $70.6 million, all of the outstanding stock of ACE Controls, Inc. and its affiliated company ACE Controls International, Inc. (collectively known as “ACE”) headquartered in Farmington Hills, Michigan, with additional facilities in Germany, the United Kingdom and Japan. ACE manufactures a wide range of linear deceleration products serving various industrial markets. The Company utilized its revolving credit facility to finance the acquisition. 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, 2003, the Company’s current ratio was 8.5 to 1 and working capital totaled $317.9 million, including $255.8 million of cash and cash equivalents. At December 31, 2002, the current ratio was 6.0 to 1 and working capital totaled $203.6 million, including cash and cash equivalents of $146.3 million.

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      The Company’s significant contractual obligations as of December 31, 2003 are set forth below.

See Notes to Consolidated Financial Statements (Note 5) for additional information on the Company’s 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”). Interest payments on the Notes are expected to be $8.0 million per year. The Company expects to contribute approximately $6.4 million to its pension plans and $0.8 million to its postretirement benefit plans in 2004.

Corporate Development

      The Company maintains an active acquisition program, which has made important contributions to the Company’s growth. 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.

Litigation

      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 a motion 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. 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 is complete, and the appeal is expected to be heard by the Court of Appeals during the first 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 $2.9 million in 2003, $6.6 million in 2002 and $3.9 million in 2001. 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, 2003, a $2.4 million accrual remains as a current liability in the consolidated financial statements, reflecting the estimated remaining costs to litigate this matter.

      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.

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Critical Accounting Policies and Estimates

      The Company’s consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States. The preparation of these financial statements requires the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.

      The Company continually evaluates the estimates, judgments, and assumptions used to prepare the consolidated financial statements. In general, the Company’s estimates are based on historical experience, on information from third party professionals and on various other judgments and assumptions that are believed to be reasonable under the current facts and circumstances. Actual results could differ from the current estimates made by the Company. The Company has identified certain accounting policies and estimates, described below, that are the most critical to the portrayal of the Company’s current financial condition and results of operations.

      Loss Contingencies and Legal Costs — The Company records loss contingencies as a liability when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Estimated legal costs expected to be incurred in connection with loss contingencies are accrued in the consolidated financial statements.

      The Company believes the accounting estimates related to loss contingencies and legal costs to be a critical accounting estimate as contingent liabilities are often resolved over long time periods and estimation of probable losses and costs to litigate requires forecasts that often depend on judgments from third party experts and are based on potential actions by other third parties such as plaintiffs, juries, and regulators.

      To better understand this accounting policy and its historic impact on the Company, readers should refer to the Notes to Consolidated Financial Statements (Note 11) in this Annual Report for additional information regarding loss contingencies and legal costs.

      Impairment of Goodwill and Indefinite-Lived Intangible Assets — The Company annually, or more frequently if events or changes in circumstances indicate a need, tests the carrying amounts of goodwill and indefinite-lived intangible assets for impairment.

      The Company identifies impairment of goodwill by comparing the fair value of each of the Company’s reporting units with the reporting unit’s carrying amount. The fair value of each of the Company’s reporting units is derived from an estimate of future discounted cash flows including an estimate for terminal value. The Company utilizes a 10 percent discount rate, and a growth assumption of 2 percent in perpetuity to calculate terminal value. Potential goodwill impairment is identified if a reporting unit’s carrying amount is more than a reporting unit’s fair value. If this occurs, a third-party valuation specialist is utilized to assist the Company in determining the implied fair value of the reporting unit’s goodwill. The amount of any actual impairment loss is calculated by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill.

      A trademark is the Company’s only indefinite-lived intangible asset. The Company identifies impairment of this trademark by comparing its fair value to its carrying amount. The fair value of the trademark is calculated based on an estimate of future discounted cash flows including an estimate for terminal value related to the net amount of royalty expense avoided due to the existence of the trademark.

      The Company believes the accounting estimates related to impairment of goodwill and indefinite-lived intangible assets to be critical accounting estimates because: the estimate of future discounted cash flows and terminal values, while based on reasonable and supportable assumptions and projections, requires the Company’s subjective judgments; the time periods for estimating future cash flows is often lengthy which increases the sensitivity to assumptions made; projected outcomes based on the assumptions made can vary; and the calculation of implied fair value is inherently subject to estimates.

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      To better understand this accounting policy and its impact on the Company, readers should refer to Notes to Consolidated Financial Statements (Note 12) in this Annual Report for additional information regarding goodwill and intangible assets.

      Impairment of Long-Lived Assets — The Company continually evaluates whether events and circumstances have occurred that indicate the remaining estimated useful lives of long-lived assets including fixed assets and amortizable intangible assets may warrant revision or that remaining balances may not be recoverable. When factors indicate that such costs should be evaluated for possible impairment, the Company uses an estimate of future undiscounted cash flows over the remaining lives of the long-lived assets that are compared to the carrying value of the asset to evaluate whether the asset costs are recoverable.

      The Company believes the accounting estimates related to long-lived asset impairment to be a critical accounting estimate because: the estimate of future undiscounted cash flows, while based on reasonable and supportable assumptions and projections, requires the Company’s subjective judgments; the time periods for estimating future cash flows is often lengthy which increases the sensitivity to assumptions made; and projected outcomes based on the assumptions made can vary.

      To better understand this accounting policy and its impact on the Company, readers should refer to Notes to Consolidated Financial Statements (Note 1 and Note 12) in this Annual Report for additional information regarding long-lived assets.

      Retirement Benefits — The Company’s employee pension and postretirement benefit costs and obligations recorded in the financial statements are dependent on the Company’s estimates provided to and used by the Company’s actuaries in calculating such amounts.

      The Company believes the accounting estimates related to retirement benefits to be critical accounting estimates because of the wide range of assumptions used in deriving yearly contribution and expense amounts as well as the amounts recorded for retirement benefits in the Company’s financial statements. Significant assumptions include judgments regarding discount rates, health care cost trend rates, inflation rates, salary growth rates, long-term return on plan assets, retirement rates, mortality rates and other factors.

      The Company has developed estimates based on historical experience, on information from third party professionals and on various other judgments and assumptions that are believed to be reasonable under the current facts and circumstances. Discount rate assumptions are based on investment yields available on long-term bonds. Health care cost trend assumptions are developed based on historical data, the near-term outlook, and on an assessment of likely long-term trends.

      Inflation assumptions are based on an evaluation of external market indicators. Salary growth assumptions reflect the Company’s long-term experience, the near-term outlook and assumed inflation. Long-term return on plan assets is based on an evaluation of historical and expected returns of the individual asset classes comprising the total plan assets. Retirement and mortality rates are based primarily on actual plan experience and mortality tables.

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      The following table summarizes certain of the Company’s assumptions:

      Actual results that differ from the Company’s assumptions are accumulated and amortized over future periods and, therefore, generally affect the Company’s recognized expense and recorded obligation in such future periods. While the Company believes that the assumptions used are appropriate, significant differences in actual experience or significant changes in assumptions would affect the Company’s pension and postretirement benefits costs and obligations.

      To better understand this accounting policy and its historic impact on the Company, readers should refer to Notes to Consolidated Financial Statements (Note 8) in this Annual Report for additional information regarding costs, obligations, and assumptions for employee pension and postretirement benefits.

      4% Contingent Convertible Senior Subordinated Notes — In May of 2003, the Company completed the sale of $200.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”). The Notes are convertible into a total of 6,858,710 shares of Company common stock at a conversion price of $29.16 per share, provided certain contingencies are met including that Kaydon common stock has traded above $34.99 for 20 out of 30 trading days for specified periods of time. 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.

      In addition, the contingent interest feature of the Notes requires the Company to deduct for tax purposes an amount of interest expense that is greater than the stated coupon rate on the Notes. The deductibility for tax purposes of the additional interest beyond the stated coupon rate may have to be recaptured, in part or in whole, if the Notes are redeemed for cash instead of converted into Company common stock. Should this happen, depending on other factors, tax payments may increase.

      The Company believes that the current and potential future impact the Notes have on the accounting for the Company’s diluted earnings per share calculations, and tax-related account balances as discussed above are critical to the understanding of the Company’s current financial condition and results of operations. Volatility in the Company’s stock price could cause the underlying shares to be included in the diluted earnings per share calculation in one quarter, and not in a subsequent quarter. Redemption of the Notes for cash may cause volatility in tax payments, cash flows and the liquidity of the Company.

      To better understand the Notes and their impact on the Company’s financial reporting, readers should refer to Notes to Consolidated Financial Statements (Note 2 and Note 5) and other discussions in this Annual Report.

      Income Taxes — The Company records deferred tax assets and liabilities using enacted tax rates for the effect of differences between the book and tax basis of recorded assets and liabilities. These deferred

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      The Company believes the accounting estimates related to income taxes to be a critical accounting estimate because the range of assumptions used to determine deferred tax assets and liabilities and to record current reserves and tax rates, while based on reasonable and supportable information, may change from year to year causing projected outcomes based on the assumptions to vary.

      To better understand this accounting policy and its impact on the Company, readers should refer to Notes to Consolidated Financial Statements (Note 10) in this Annual Report for additional information regarding income taxes.

      Inventories – Inventories are stated at the lower of cost or market, with cost determined on a first-in, first-out basis. The carrying value of inventory is reduced for estimated obsolescence by the difference between its cost and the estimated market value based upon assumptions regarding future demand. The Company evaluates the inventory carrying value for potential excess and obsolete inventory exposures by analyzing historical and anticipated demand. In addition, inventories are evaluated for potential obsolescence due to the effect of known or anticipated engineering change orders, new products, and other factors.

      The Company believes the accounting estimates related to inventories to be a critical accounting estimate because the range of assumptions used to determine the valuation of inventories, while based on reasonable and supportable information, may change from year to year causing projected outcomes based on the assumptions to vary.

Forward-Looking Statements

      This Annual Report 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,” “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 economic conditions and other factors, including capital spending levels. Such industries include commercial and military aerospace, semiconductor manufacturing, power generation, off-road and heavy industrial equipment, and other capital equipment manufacturing. As a result, the demand for the Company’s products by these customers depends, in part, upon general economic conditions. Historically, downward economic cycles have reduced customer demand for the Company’s products, thereby reducing sales of the Company’s products and resulting in reductions to the Company’s revenues and net earnings.

      The industries in which the Company operates are fragmented and the Company faces competition from multiple companies across its diverse product lines. Kaydon expects competitive pressures from new products and aggressive pricing to increase, which may cause the Company to lose market share or compel the Company to reduce prices to remain competitive, which could result in reduced levels of revenues and earnings. The Company’s competitors include U.S. and non-U.S. companies, some of which benefit from lower labor costs and fewer regulatory burdens. In addition, certain competitors, including Perkin Elmer, Timken, SKF, and INA/FAG, are larger than Kaydon and may have access to greater financial, technical, development, marketing, manufacturing, sales and distribution services and other resources. Increased competition with these companies or new entrants to the Company’s key markets could prevent price increases for the Company’s products or could require price reductions for the Company’s products, which could adversely affect the Company’s financial condition, results of operations, growth or liquidity.

      In addition to internal growth, Kaydon’s current strategy involves growth through acquisitions of complementary businesses as well as acquisitions that diversify the Company’s product offerings. Like other companies with similar growth strategies, Kaydon may be unable to continue to implement its growth strategy, and this strategy may be ultimately unsuccessful. A portion of the Company’s expected future growth in revenues may result from acquisitions. The Company frequently engages in evaluations of potential acquisitions and negotiations for possible acquisitions, certain of which, if consummated, could be significant to the Company. Although it is the Company’s policy only to acquire companies in transactions which are accretive to both earnings and cash flow, any potential acquisitions may result in material transaction expenses, increased interest and amortization expense, increased depreciation expense and increased operating expense, any of which could have a material adverse effect on the Company’s operating results. Acquisitions may entail integration and management of the new businesses to realize economies of scale and control costs. In addition, acquisitions may involve other risks, including diversion of management resources otherwise available for ongoing development of our business and risks associated with entering new markets. The Company may not be able to identify suitable acquisition candidates in the future, obtain acceptable financing or consummate any future acquisitions. In addition, as a result of the Company’s acquisitions of other businesses, the Company may be subject to the risk of unanticipated business uncertainties or legal liabilities relating to those acquired businesses for which the sellers of the acquired businesses may not indemnify the Company. Future acquisitions may also result in potentially dilutive issuances of securities.

      Sales of the Company’s products from the Company’s foreign subsidiaries and from the Company’s domestic subsidiaries selling to foreign locations accounted for approximately 32.8 percent of net sales for the fiscal year ended December 31, 2003. These foreign sales could be adversely affected by changes in

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      The Company generates significant revenues outside the United States. Currency fluctuations between the U.S. dollar and the currencies in which those customers do business may have an impact on the demand for the Company’s products in foreign countries where the U.S. dollar has increased in value compared to the local currency. The Company cannot predict the effects of exchange rate fluctuations upon the Company’s future operating results because of the number of currencies involved, the variability of currency exposure and the potential volatility of currency exchange rates.

      Relationships with customers and effective terms of sale frequently vary by country, often with longer-term receivables than are typical in the United States.

      As a provider of critical performance products in a variety of industries including aerospace, defense, construction, marine, medical, material handling, machine tool positioning and other industrial applications, the Company faces a risk of exposure to claims in the event that the failure, use or misuse of the Company’s products results, or is alleged to result, in bodily injury and/or property damage. The Company, along with certain other companies, is named as a defendant in a lawsuit arising from an August 2000 fatal accident involving a MH53E helicopter manufactured by Sikorsky Aircraft Corporation. The Company believes that the alleged damages claimed in this lawsuit, and the associated legal costs, will be fully covered under the Company’s insurance policy, but it is possible that such costs will not be covered by insurance and, if so, the Company will incur unknown additional direct costs. These claims have not been finally resolved or settled.

      In the past, costs related to legal proceedings and settlements have had a material effect on the Company’s business, financial condition, results of operations and liquidity. The Company cannot assure you that the ultimate cost of current known or future unknown litigation and claims will not exceed management’s current expectations and it is possible that such costs could have a material adverse effect on the Company. In addition, litigation is time consuming and could divert management attention and resources away from the Company’s business.

      The Company, along with certain other companies, was a defendant in a lawsuit filed in 1996 asserting claims for fraudulent conveyance and successor liability relating to the Company’s acquisition of certain assets in 1983 and the Company’s 1984 spin-off from Bairnco Corporation (the “Transactions Lawsuit”). The plaintiffs in the Transactions Lawsuit alleged and sought damages of $700 million, plus interest and punitive damages against the defendants collectively. As previously disclosed, the plaintiff’s claims were dismissed with prejudice by the trial court on March 14, 2003. On April 14, 2003, the plaintiffs filed a notice of appeal. Briefing on the appeal is complete, and the appeal is expected to be heard by the Court of Appeals during the first quarter of 2004. If an unfavorable outcome were to occur, the impact could be material to the Company.

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 investments in cash and cash equivalents. All highly liquid investments, including highly liquid debt and investment instruments purchased with an original maturity of three months or less, are considered cash equivalents. The Company places its investments in cash equivalents with high credit quality issuers and limits the amount of exposure to any one issuer. A 10.0

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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 sheets of Kaydon Corporation (“the Company”) as of December 31, 2003 and 2002, and the related consolidated statements of income, shareholders’ equity, and cash flows for the years then ended. Our audit also included the financial statement schedule for the years ended December 31, 2003 and 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 audits. The consolidated statements of income, shareholders’ equity and cash flows of Kaydon Corporation for the year 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 12 and 14.

      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 2003 and 2002 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kaydon Corporation at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule for the years ended December 31, 2003 and 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 above, the financial statements and schedule for the year ended December 31, 2001, were audited by other auditors who have ceased operations. As described in Note 12, the Company adopted Financial Accounting Standards No. 142 Goodwill and Other Intangible Assets as of January 1, 2002 and, accordingly, the 2001 consolidated financial statements have been revised to include the transitional disclosures required by that Statement. Our audit procedures with respect to the disclosures in Note 12 with respect to 2001 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 reported net income (loss) representing amortization expense (including related tax effects), recognized in that period 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.

      As described in Note 14, the Company changed the composition of its reportable segments in 2003, and the amounts in the 2001 financial statements relating to reportable segments have been restated to conform to the 2003 composition of reportable segments. We audited the adjustments that were applied to restate the disclosures for reportable segments reflected in the 2001 financial statements. Our procedures

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      In our opinion, the disclosures for 2001 in Note 12 are appropriate and the adjustments for 2001 in Note 14 are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2001 consolidated financial statements of the Company other than with respect to such disclosures and adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2001 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

The accompanying notes are an integral part of these statements.

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KAYDON CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME