SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

KAYDON CORPORATION

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

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

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

Common Stock Outstanding at August 6, 2004 – 28,210,280 shares, $.10 par value.

KAYDON CORPORATION FORM 10-Q

FOR THE QUARTER ENDED JULY 3, 2004

INDEX

ITEM 1. FINANCIAL STATEMENTS
KAYDON CORPORATION

See accompanying notes to consolidated condensed financial statements.

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KAYDON CORPORATION

See accompanying notes to consolidated condensed financial statements.

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KAYDON CORPORATION

See accompanying notes to consolidated condensed financial statements.

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KAYDON CORPORATION

(1)		The accompanying unaudited consolidated condensed financial statements of Kaydon Corporation and subsidiaries (“Kaydon” or the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included, and such adjustments are of a normal recurring nature. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.
(2)		Inventories are summarized as follows:

(3)

Comprehensive income reflects the change in equity of a business enterprise during a period from transactions and other events, and from circumstances involving nonowner sources. For the Company, comprehensive income consists primarily of net income, foreign currency translation adjustments and minimum pension liability adjustments. Other comprehensive income, net of tax, was approximately $0.2 million and $2.4 million, resulting in comprehensive income of $10.1 million and $10.7 million for the quarters ended July 3, 2004, and June 28, 2003. On a first half basis, other comprehensive income, net of tax, was approximately $0.8 million and $2.0 million, resulting in comprehensive income of $19.6 million and $17.4 million for the first halves ended July 3, 2004 and June 28, 2003.

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(4)

The following table reconciles the numerators and denominators used in the calculation of basic and diluted earnings per share for the periods presented.

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		Options to purchase 63,000 shares of common stock at prices ranging from $28.35 to $33.31 per share were outstanding during the second quarter of 2004, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during that period. Options to purchase 382,200 shares of common stock at prices ranging from $22.60 to $33.3125 per share were outstanding during the second quarter of 2003, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares during that period.
		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 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

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		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.
5)		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.” During the first three quarters of 2003 the Company aggregated its operating segments into three reportable segments referred to as Specialty Metal Formed Products, Ring, Seal and Filtration Products, and Other Metal Products. During the fourth quarter of 2003, the Company changed the aggregation of operating segments for purposes of reporting segment information. Prior year amounts have been reclassified to reflect the current year presentation.
		The Company has four reportable segments and other operating segments engaged in the manufacture and sale of the following:
		Friction and Motion Control Products – complex components used in specialized medical, aerospace, defense, security, electronic, material handling, construction and other industrial applications. Products include anti-friction bearings, split roller bearings, specialty balls and retaining devices.
		Velocity Control Products – complex components used in specialized robotics, material handling, machine tool, medical, amusement and other industrial applications. Products include industrial shock absorbers, safety shock absorbers, velocity controls, gas springs and rotary dampers.
		Sealing Products – complex and standard ring and seal products used in demanding industrial, aerospace and defense applications. Products include engine rings, sealing rings and shaft seals.
		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.

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

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(6) During May 2003, the Company completed the sale of $200.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”).

Interest expense on the Notes equaled $2.0 million for the second quarter of 2004. Note issuance costs of approximately $6.5 million are being amortized over a five-year period. Amortization of Note issuance costs during the second quarter of 2004 was $0.3 million. Amortization of Note issuance costs is recorded as a component of interest expense. Note issuance costs included in other assets in the Consolidated Condensed Balance Sheets as of July 3, 2004 and December 31, 2003 was $5.1 million and $5.7 million, respectively.

The Company’s 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 revolving credit facility will be based on the London Interbank Offered Rate. The revolving credit facility contains restrictive financial covenants on a consolidated basis including leverage and coverage ratios, utilizing measures of earnings and interest expense as defined in the revolving credit facility agreement. Under the leverage ratio restriction, the Company may not allow the ratio of total indebtedness, net of domestic cash in excess of $15.0 million, to adjusted earnings before interest expense, taxes, depreciation and amortization to exceed 3.0 to 1.0. Under the interest coverage ratio restriction, the Company may not allow the ratio of adjusted earnings before interest expense and taxes to interest expense to be less than 3.0 to 1.0. The Company is in compliance with all restrictive covenants contained in the revolving credit facility at July 3, 2004. After consideration of the facility’s covenants and $3.2 million of letters of credit issued under the facility, the Company has available credit under its revolving credit facility of $196.8 million at July 3, 2004.

The Company’s outstanding debt was as follows:

(7) As previously reported, the Company, along with certain other companies, was named as a defendant in a lawsuit filed in 1996 in the United States District Court for the Southern District of New York (the “Transactions Lawsuit”). Captioned Richard A. Lippe, et al. v. Bairnco Corporation, et al., the Transactions Lawsuit sought damages alleged by plaintiffs to be an amount of $700 million, plus interest and punitive damages against the defendants collectively. On March 14, 2003, the Court granted a motion for summary judgment, dismissing the case in its entirety against all defendants. On April 14, 2003, the plaintiffs filed a notice of appeal from the Court’s order granting summary judgment and dismissing the action. On April 9, 2004, the Court of Appeals issued its Summary Order affirming in all respects the earlier judgment of the District Court, which granted the motion for summary judgment, dismissing the case in its entirety against all

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defendants. On July 8, 2004 the lead attorney for the plaintiffs in the Transactions Lawsuit sent a written confirmation to the counsel of another defendant in the case stating that the plaintiffs would not file a cert petition, referring to a Petition for Certiorari in the United States Supreme Court. In effect, the Company believes that the attorney was confirming that the plaintiffs would take no further steps to appeal the decision by the Court of Appeals affirming the dismissal of the case against all defendants, including Kaydon. The time for filing such a Petition actually expires on August 16, 2004, however, given the written confirmation from plaintiffs’ counsel, it appears that the case has finally concluded. As a result, in the second quarter financial statements the Company reduced its previously recorded Transactions Lawsuit legal fee accrual by $1.7 million, leaving $0.2 million accrued at July 3, 2004, as the Company’s current and best estimate of its remaining costs to complete this litigation. This change in estimate increased second quarter net income by $1.1 million, or $0.04 per share on a diluted basis. Management has always believed that the plaintiff’s lawsuit was without merit.

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, 28th Judicial District. Armoloy of Connecticut, Inc. is no longer a party to the litigation. The Company’s insurance carrier has retained legal counsel to respond to the lawsuit. The Company believes that the alleged damages claimed in this lawsuit, and the associated legal costs, will be fully covered under the Company’s insurance policy. Further, the Company believes it has meritorious defenses to these claims including, but not limited to, the fact that the bearing utilized in the helicopter involved in the accident was inspected and approved prior to shipment by both U.S. government and Sikorsky Aircraft Corporation inspectors. Accordingly, an accrual is not recorded in the consolidated financial statements related to this legal action.

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 July 3, 2004, an undiscounted accrual in the amount of $3.2 million, representing the Company’s best estimate for ultimate resolution of these environmental matters, remains 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

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expected to be incurred in connection with claims, lawsuits and environmental matters are consistently accrued in the consolidated financial statements.

(8) During the second quarter of 2004, the Company determined that the fair value of one of the Company’s reporting units, as that term is defined by Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets,” had been reduced to an amount less than the reporting unit’s carrying amount. The reporting unit, one of the Company’s smallest, manufactures and markets specialty metal forming equipment for the commercial and residential air conditioning industries both in the United States and abroad. A change in competitive dynamics has resulted in a reduction of this reporting unit’s estimated future cash flows. The fair value of the reporting unit was estimated using the expected present value of its future cash flows. As calculated in accordance with SFAS No. 142, there is no implied fair value of the reporting unit’s goodwill. Therefore, during the second quarter, the Company incurred a $1.9 million pre-tax, non-cash goodwill impairment loss, which equaled $1.2 million after tax, or $0.04 per share on a diluted basis.

The changes in the carrying amount of goodwill for the first half ended July 3, 2004, are as follows:

Goodwill is stated net of accumulated amortization of $13.3 million at July 3, 2004 and December 31, 2003.

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     Other intangible assets are summarized as follows:

The intangible assets are being amortized on a straight-line basis over periods of 10 to 20 years.

     (9) The components of net periodic benefit costs are as follows:

Pension Benefits

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Postretirement Benefits

During the second quarter of 2004 the Financial Accounting Standards Board issued their Staff Position No. FAS 106-2 which provides guidance on the accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). As allowed under FAS 106-2, the Company has elected the prospective application method for recognizing the effects of the Act on its postretirement benefit plans. Under the prospective application method the Company’s postretirement benefit costs were not affected during the second quarter. Currently, the Company estimates that the effects of the Act will result in reducing net periodic postretirement benefit costs by $0.2 - $0.3 million in each of the third and fourth quarters of 2004.

(10) The Company accounts for stock-based compensation granted to employees and Directors using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25. The following table details the effect on net income and earnings per share had compensation cost for stock-based awards been recognized based on the fair value method prescribed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”:

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Kaydon Corporation and subsidiaries (“Kaydon” or 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 quarter to quarter. During the second quarter 2004, the Company was favorably impacted as the economy continued to rebound from the manufacturing slowdown of the last four years. The general economic rebound, both in the United States and in certain international markets, meant that during the quarter the Company experienced increased demand from various markets including specialty electronics, machinery, heavy equipment, industrial, and other key commercial markets. During the second quarter of 2004 the Company continued to experience a high level of incoming customer orders. Although second quarter orders did not equal the record level experienced in the first quarter of this year, which included a higher military and defense component, they were substantially higher than those received in last year’s comparable period. During 2004, the Company expects to continue to benefit from a general economic rebound in the manufacturing sector, continued strength in military and defense spending, as well as other factors including relatively low inflation and interest rates; however, because of the Company’s diverse product offerings, the specific impact these factors may have on the Company’s operating results is difficult to predict.

As a result of recent events, during the second quarter the Company reduced its previously recorded “Transactions Lawsuit” legal fee accrual by $1.7 million, pre-tax, in order to properly reflect its current and best estimate of the remaining costs to complete this litigation. Also during the second quarter, due to a change in the competitive dynamics affecting one of its reporting units, the Company incurred a $1.9 million pre-tax, non-cash goodwill impairment loss. The combination of these two transactions reduced the Company’s second quarter operating income by $0.2 million.

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 the second quarter 2004, the Company continued its investments in the Company-wide Six Sigma effort, lean manufacturing, and information system upgrades to strengthen the Company’s operational excellence.

Maintaining the Company’s strong balance sheet and financial flexibility remains a key strategy of the Company. In 2003, the Company issued $200.0 million of 4% Contingent Convertible Senior Subordinated Notes due 2023 (the “Notes”) and also negotiated a new $200.0 million revolving credit agreement. The Company’s current cash balances, $269.1 million at July 3, 2004, and the $200.0 million revolving credit

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facility provide 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 that follows should be read in conjunction with the unaudited Consolidated Condensed Financial Statements (and the Notes thereto), included elsewhere in this report, and the Company’s Annual Report for the year ended December 31, 2003, particularly “Item 7- Management’s Discussion and Analysis of Results of Operations and Financial Condition,” to assist in understanding the Company’s results of operations, its financial position, cash flows, capital structure and other relevant financial information.

Results of Operations

During the second quarter of 2004, the Company achieved sales of $84.4 million, as compared to $76.1 million in the second quarter of 2003, an increase of $8.2 million or 10.8 percent. The quarter was favorably impacted by increased demand across many of the Company’s product lines, including specialty bearings, split bearing products, specialty balls, linear deceleration products, filtration products, and metal alloys.

Specifically, Kaydon’s Friction and Motion Control Products reporting segment achieved sales of $42.7 million during the second quarter of 2004 as compared with $35.8 million during the second quarter of 2003, an increase of $6.8 million or 19.1 percent, as the Company experienced increased demand for custom-engineered bearings and split bearing products from various specialty electronics, machinery, heavy equipment, and industrial markets.

During the second quarter 2004, the Company’s Velocity Control Products reporting segment sales increased $1.7 million or 15.5 percent, to $12.5 million, when compared with second quarter 2003 sales of $10.8 million. Increased product demand from a variety of industrial markets, both in the United States and Europe contributed $1.2 million of the increase, while favorable foreign currency translation, primarily related to the continuing strength of the Euro, accounted for $0.5 million of the sales increase.

The Company’s Sealing Products reporting segment achieved sales of $9.7 million during the second quarter 2004, down $0.4 million or 3.8 percent from second quarter 2003 sales of $10.1 million, primarily as a result of decreased shipments to certain defense markets.

During the second quarter of 2004, sales of Kaydon’s Power and Data Transmission Products reporting segment decreased $1.0 million or 11.9 percent, to $7.6 million, when compared with second quarter 2003 sales of $8.6 million, primarily as a result of decreased demand from certain aerospace and defense markets.

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Sales of the Company’s remaining businesses equaled $12.0 million during the second quarter of 2004, an increase from the second quarter 2003 of $1.1 million or 10.3 percent. Increased demand for metal alloys utilized in the plumbing industry, along with material price increases that were passed along to customers, were partially offset by reduced demand for metal forming equipment.

Gross profit during the second quarter of 2004 of $32.8 million was 38.9 percent of sales, compared with $26.9 million or 35.4 percent of sales in the second quarter of 2003. Compared to the second quarter of 2003, the second quarter 2004 gross margin was positively impacted by increased sales volume, favorable product mix, and Six Sigma cost reduction initiatives.

Selling, general and administrative expenses during the second quarter of 2004 were $15.7 million, or 18.6 percent of sales, as compared to $13.8 million, or 18.2 percent of sales, during the second quarter of 2003.

Second quarter 2004 selling, general, and administrative expenses included two items, a $1.9 million goodwill impairment loss at one of the Company’s reporting units, and the reversal of $1.7 million of the previously recorded legal fee accrual related to the Transactions Lawsuit. During the second quarter, the Company determined that the fair value of one of the Company’s reporting units, as that term is defined by Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets,” had been reduced to an amount less than the reporting unit’s carrying amount. The reporting unit, one of the Company’s smallest, manufactures and markets specialty metal forming equipment for the commercial and residential air conditioning industries both in the United States and abroad. A change in competitive dynamics has resulted in a reduction of this reporting unit’s estimated future cash flows. The fair value of the reporting unit was estimated using the expected present value of its future cash flows. As calculated in accordance with SFAS No. 142, there is no implied fair value of the reporting unit’s goodwill. Therefore, during the second quarter, the Company incurred a $1.9 million pre-tax, non-cash goodwill impairment loss. On July 8, 2004 the lead attorney for the plaintiffs in the Transactions Lawsuit sent a written confirmation to the counsel of another defendant in the case stating that the plaintiffs would not file a cert petition, referring to a Petition for Certiorari in the United States Supreme Court. In effect, the Company believes that the attorney was confirming that the plaintiffs would take no further steps to appeal an earlier decision regarding the dismissal of the case against all defendants, including Kaydon. The time for filing such a Petition actually expires on August 16, 2004, however, given the written confirmation from plaintiffs’ counsel, it appears that the case has finally concluded. As a result, in the second quarter financial statements the Company reduced its previously recorded Transactions Lawsuit legal fee accrual by $1.7 million, leaving $0.2 million accrued at July 3, 2004, as the Company’s current and best estimate of its remaining costs to complete this litigation.

Also affecting second quarter selling, general, and administrative expenses were consulting charges, including those related to Sarbanes-Oxley compliance and Six Sigma project management, which increased approximately $0.3 million compared to last year’s second quarter. The differential in consulting charges will continue during the remainder of 2004, primarily as a result of completing our Sarbanes-Oxley Section

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404 implementation. In the future, absent Sarbanes-Oxley-related and other non-recurrent charges, the Company expects its selling, general, and administrative expenses to approximate 18 percent of sales.

The Company’s operating income was $17.1 million for the second quarter of 2004 compared to operating income of $13.1 million in the second quarter of 2003, an increase of $4.0 million or 30.8 percent.

Depreciation and amortization during the second quarter 2004 was $3.7 million, compared to $3.9 million during the second quarter of 2003.

On a reporting segment basis, operating income from the Friction and Motion Control Products reporting segment was $11.1 million during the second quarter of 2004 as compared to $7.0 million during the comparable period last year. Operating income was positively impacted by increased sales, as the profit metrics for this segment are very volume sensitive, and favorable product mix.

The Velocity Control Products reporting segment contributed $3.4 million to the Company’s operating income during the second quarter of 2004 as compared to $2.4 million during the comparable period last year. Increases in operating income were primarily due to increased product demand.

The Sealing Products reporting segment contributed $1.5 million to the Company’s operating income during the second quarter of 2004 as compared to $1.4 million during the comparable period last year. Operating income was positively impacted by improved operating efficiencies.

The Power and Data Transmission Products reporting segment reported an operating loss of ($0.1) million during the second quarter of 2004 as compared to operating income of $0.7 million during the comparable period last year. As previously disclosed, one business unit within this segment has been undergoing significant changes in its customers, and product offerings. Corrective actions continue to be implemented at this business focusing on increased efficiencies, overhead reductions, and a management reorganization.

Including the aforementioned $1.9 million goodwill impairment loss, the Company’s other businesses generated an operating loss of ($0.8) million during the second quarter of 2004 as compared to operating income $1.1 million during the comparable period last year.

Second quarter 2004’s results include a full quarter’s effect of the Company’s May 2003 issuance of the Notes. Last year’s second quarter included a little over one month’s worth of the effect, which accounts for the majority of the difference between interest expense and interest income on a comparable basis. Interest expense during the second quarter of 2004 was $2.4 million as compared to $0.9 million during the second quarter of 2003. Interest income during the second quarter of 2004 was $0.8 million as compared to $0.6 million during the second quarter of 2003.

The Company’s effective income tax rate in the second quarter of 2004 was 36 percent

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as compared to a 35 percent tax rate during the second quarter of 2003, primarily as a result of higher foreign taxes.

Second quarter 2004 net income and diluted earnings per share were $9.9 million and $0.36 based on 27.9 million common shares outstanding. Second quarter 2003 net income and diluted earnings per share were $8.3 million and $0.29 based on 28.9 million common shares outstanding.

Sales during the first half of 2004 were $167.7 million, an increase of 14.1 percent over last year’s first half sales of $147.0 million. As a result of the higher sales volume, gross profit for the first half of 2004 increased to $64.6 million or 38.5 percent of sales as compared to $50.9 million or 34.7 percent of sales during the first half of 2003. Operating income for the first half of 2004 was $32.7 million or 19.5 percent of sales. Operating income for the first half of 2003 was $23.8 million, or 16.2 percent of sales.

Net income for the first half of 2004 was $18.8 million or $0.68 per common share on a diluted basis. First half 2003 net income and diluted earnings per common share were $15.4 million and $0.52.

Liquidity and Capital Resources

At July 3, 2004, the Company’s current ratio was 9.3 to 1 and working capital totaled $337.0 million, including $269.1 million of cash and cash equivalents. At December 31, 2003, the current ratio was 8.5 to 1 and working capital totaled $317.9 million, including cash and cash equivalents of $255.8 million. Total debt outstanding at the end of the second quarter 2004, and at year-end 2003, was $200.1 million. Maintaining the Company’s strong balance sheet and financial flexibility remains a key strategy of the Company.

Cash flow from operations during the first half of 2004 was $25.7 million. As previously reported, first half 2004 cash flow from operations includes the receipt of a legal settlement in the amount of $2.5 million. Cash flow from operations during the first half of 2003 was $22.9 million. During the first half of 2004, the Company paid common stock dividends of $6.8 million, invested $5.1 million in net capital expenditures, and repurchased 28,700 shares of Company common stock for $0.8 million.

Management expects that the Company’s planned capital requirements, which consist of capital expenditures, dividend payments and its stock repurchase program, will be financed by operations and existing cash balances. In addition, the Company’s revolving credit facility provides additional financial strength to support the Company’s objectives including strategic acquisitions.

Outlook

Orders booked during the first half of 2004 equaled $178.4 million versus $153.1 million during the first half of 2003, resulting in a backlog of $107.6 million at July 3, 2004. The Company’s strong order intake during the first half is further evidence of positive momentum from the recovery in the manufacturing economy. Expected operating cash

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flows coupled with the Company’s current cash reserves and available credit under the Company’s $200.0 million revolving credit facility will provide substantial resources to fund the Company’s ongoing business development efforts which include internal and external growth initiatives as well as selected stock repurchases.

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 Notes to Consolidated Condensed Financial Statements (Note 7) in this quarterly report on Form 10-Q as well as Notes to Consolidated Financial Statements (Note 11) in the 2003 Annual Report on Form 10-K 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 discounted future cash flows including an estimate for terminal value. The Company utilizes a 10

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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, normally 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 discounted future 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 discounted future 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.

To better understand this accounting policy and its impact on the Company, readers should refer to Notes to Consolidated Condensed Financial Statements (Note 8) in this quarterly report on Form 10-Q as well as Notes to Consolidated Financial Statements (Note 12) in the 2003 Annual Report on Form 10-K 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 undiscounted future 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 undiscounted future 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 Condensed Financial Statements (Note 8) in this quarterly report on Form 10-Q as well as Notes to Consolidated Financial Statements (Note 1 and Note 12) in the 2003 Annual Report on Form 10-K for additional

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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.

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 Condensed Financial Statements (Note 9) in this quarterly report on Form 10-Q as well as Notes to Consolidated Financial Statements (Note 8) in the 2003 Annual Report on Form 10-K 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

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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) in the 2003 Annual Report on Form 10-K and other discussions in this quarterly report on Form 10-Q.

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 tax assets and liabilities are reviewed for recoverability by using estimates of future taxable income streams and the impact of tax planning strategies. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. Reserves are also estimated for ongoing audits regarding federal, state and international issues that are currently unresolved. Income tax is provided based upon an effective tax rate that is dependent upon tax regulations governing the regions in which the Company conducts business, geographic composition of worldwide earnings, the availability of tax credits and other factors.

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 the 2003 Annual Report on Form 10-K for additional information regarding income taxes.

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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 causing projected outcomes based on the assumptions to vary.

Forward-Looking Statements

This Form 10-Q 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,” “expects,” “anticipates,” “intends,” “will,” “may,” “potential” and other similar expressions, including statements regarding pending litigation, general economic conditions, competitive dynamics and the adequacy of capital resources. 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.

The Company’s customers’ economic cycles may affect Kaydon’s operating results.

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

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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.

Increased competition in the Company’s key markets could result in a reduction in Kaydon’s revenues and earnings and adversely affect the Company’s financial condition.

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.

Future acquisitions may require Kaydon to incur costs and liabilities, which may adversely affect the Company’s operating results.

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

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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.

Political, economic and regulatory conditions inherent in the international markets in which Kaydon participates could adversely affect the Company’s financial condition.

Typically, sales of the Company’s products from the Company’s foreign subsidiaries and from the Company’s domestic subsidiaries selling to foreign locations accounts for approximately 30 percent of net sales. These foreign sales could be adversely affected by changes in various foreign countries’ political and economic conditions, trade protection measures, differing intellectual property rights and changes in regulatory requirements that restrict the sales of the Company’s products or increase the Company’s costs.

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.

Kaydon’s manufactured critical performance products expose the Company to potential litigation-related costs, which may adversely affect the Company’s financial position and operating results.

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.

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In addition, litigation is time consuming and could divert management attention and resources away from the Company’s business.

The “Transactions Lawsuit” could materially adversely affect the Company if the trial court’s dismissal of the claims in such suit is reversed on appeal and if an adverse ruling is entered on appeal.

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. On March 24, 2004, oral arguments were heard by the Court of Appeals and on April 9, 2004 the Court of Appeals issued its Summary Order affirming in all respects the earlier judgment of the trial court which granted the motion for summary judgment, dismissing the case in its entirety against all defendants. On July 8, 2004 the lead attorney for the plaintiffs in the Transaction Lawsuit sent a written confirmation to the counsel of another defendant in the case stating that the plaintiffs would not file a cert petition, referring to a Petition for Certiorari in the United States Supreme Court. In effect, the Company believes that the attorney was confirming that the plaintiffs would take no further steps to appeal the decision by the Court of Appeals affirming the dismissal of the case against all defendants, including Kaydon. The time for filing such a Petition actually expires on August 16, 2004, so the plaintiffs still have the technical right to seek further review of the Court of Appeals’ decision. If an unfavorable outcome were to occur, the impact could be material to the Company.

ITEM 3. 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 9 basis point decrease in interest rates (10 percent of the Company’s weighted average investment interest rate for the second quarter of 2004) would have an immaterial impact on the Company’s pre-tax earnings. The Company conducts business in various foreign currencies, primarily in Europe, Canada, Mexico, and Japan. Therefore, changes in the value of currencies of these countries affect the Company’s financial position and cash flows when translated into U.S. dollars. The Company has mitigated and will continue to mitigate a portion of its currency exposure through operation of decentralized foreign operating companies in which many costs are local currency based. In addition, periodically the Company enters into derivative financial instruments in the form of forward foreign exchange contracts to reduce the

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effect of fluctuations in foreign exchange rates. A 10 percent change in the value of all foreign currencies would have an immaterial effect on the Company’s financial position and cash flows.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures provide reasonable assurance that the material information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. Except for the implementation of new enterprise resource planning (ERP) software at several locations, there have been no changes in the Company’s internal controls over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The aforementioned ERP software is not new to the Company, it was recently implemented at several locations as part of the Company’s ongoing program to update systems at all of its locations. The Company believes that the new ERP software will improve its internal control over financial reporting.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See the discussion in Notes to Consolidated Condensed Financial Statements (Note 7), which discussion is incorporated herein by reference.

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

(e)

The following table provides the information with respect to purchases made by the Company of shares of its common stock during each month in the second quarter of 2004:

(1)

On September 29, 1999, the Company’s Board of Directors authorized management to purchase up to 5,000,000 shares of its common stock in the open market.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

		The Company held its Annual Meeting of Shareholders on May 7, 2004, at which the shareholders voted on the election of Directors and ratification of the appointment of Ernst & Young LLP as the Company’s independent auditors for 2004. The results were as follows:
		Each of the nominees for Director was an incumbent and all nominees were elected. The following table sets forth the number of shares voted for and withheld with respect to each nominee.

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The stockholders approved the appointment of Ernst & Young LLP as the Company’s independent auditors for 2004 with the following vote: 25,969,816 votes for, 415,041 votes against, and 63,455 votes abstained.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a).   Exhibits

     (b). Reports on Form 8-K

		The Company filed a current report on Form 8-K on April 12, 2004, reporting under Items 5 and 7 the issuance of a press release reporting a favorable court ruling in Richard A. Lippe, et al. v. Bairnco Corporation, et. al.
		The Company filed a current report on Form 8-K on April 30, 2004, reporting under Items 7 and 12 the issuance of a press release disclosing material, non-public information regarding results of operations for the quarter ended April 3, 2004.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

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