UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------------------------------------------
FORM 10-Q
(mark one)
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarterly Period Ended September 27, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 1-11406
KADANT INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-1762325
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Acton Place, Suite 202
Acton, Massachusetts 01720
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (978) 776-2000
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 and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether or not the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 24, 2003
- ---------------------------- -------------------------------
Common Stock, $.01 par value 13,653,786
PART I - Financial Information
Item 1 - Financial Statements
- -----------------------------
KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)
Assets
September 27, December 28,
(In thousands) 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 65,687 $ 44,429
Accounts receivable, less allowances of $2,698 and $2,634 30,991 30,818
Unbilled contract costs and fees 3,836 6,002
Inventories (Note 5) 31,061 29,486
Deferred tax asset 7,046 6,668
Other current assets 2,442 2,974
-------- --------
141,063 120,377
-------- --------
Property, Plant, and Equipment, at Cost 74,008 70,220
Less: Accumulated depreciation and amortization 48,941 44,759
-------- --------
25,067 25,461
-------- --------
Other Assets 13,584 13,458
-------- --------
Goodwill 72,598 72,221
-------- --------
$252,312 $231,517
======== ========
<
2
>
KADANT INC.
Condensed Consolidated Balance Sheet (continued)
(Unaudited)
Liabilities and Shareholders' Investment
September 27, December 28,
(In thousands except share amounts) 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
Current Liabilities:
Current maturities of long-term notes payable $ 598 $ 585
Accounts payable 19,373 18,093
Accrued payroll and employee benefits 8,682 9,445
Accrued warranty costs 4,934 4,310
Accrued income taxes 4,673 1,404
Customer deposits 2,034 2,301
Other current liabilities 10,348 9,538
-------- --------
50,642 45,676
-------- --------
Deferred Income Taxes 1,007 940
-------- --------
Other Long-Term Liabilities 2,870 2,763
-------- --------
Long-Term Notes Payable - 580
-------- --------
Minority Interest 369 301
-------- --------
Shareholders' Investment (Note 7):
Preferred stock, $.01 par value, 5,000,000 shares authorized;
none issued - -
Common stock, $.01 par value, 150,000,000 shares authorized;
14,049,538 and 14,045,550 shares issued 140 140
Capital in excess of par value 95,746 98,567
Retained earnings 126,249 116,702
Treasury stock at cost, 395,752 and 495,265 shares (16,702) (20,901)
Deferred compensation (61) (27)
Accumulated other comprehensive items (Note 2) (7,948) (13,224)
-------- --------
197,424 181,257
-------- --------
$252,312 $231,517
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
3
>
KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
Three Months Ended
----------------------------------
September 27, September 28,
(In thousands except per share amounts) 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
Revenues $ 45,906 $ 50,084
-------- --------
Costs and Operating Expenses:
Cost of revenues 27,768 31,576
Selling, general, and administrative expenses 12,775 12,490
Research and development expenses 1,149 1,149
Restructuring and unusual items (Note 8) 157 101
-------- --------
41,849 45,316
-------- --------
Operating Income 4,057 4,768
Interest Income 243 676
Interest Expense (11) (1,084)
Other Income (Note 10) - 8
-------- --------
Income Before Provision for Income Taxes and Minority Interest 4,289 4,368
Provision for Income Taxes 1,630 1,660
Minority Interest (Income) Expense (4) 1
-------- --------
Net Income $ 2,663 $ 2,707
======== ========
Earnings per Share (Note 3):
Basic $ .20 $ .20
======== ========
Diluted $ .19 $ .20
======== ========
Weighted Average Shares (Note 3):
Basic 13,632 13,547
======== ========
Diluted 14,041 13,716
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
4
>
KADANT INC.
Condensed Consolidated Statement of Operations
(Unaudited)
Nine Months Ended
----------------------------------
September 27, September 28,
(In thousands except per share amounts) 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
Revenues $153,065 $139,802
-------- --------
Costs and Operating Expenses:
Cost of revenues 95,062 87,141
Selling, general, and administrative expenses 39,669 37,757
Research and development expenses 3,502 3,589
Restructuring and unusual items (Note 8) (23) 3,738
-------- --------
138,210 132,225
-------- --------
Operating Income 14,855 7,577
Interest Income 693 1,954
Interest Expense (39) (3,720)
Other Income (Note 10) - 469
-------- --------
Income Before Provision for Income Taxes, Minority Interest, and
Cumulative Effect of Change in Accounting Principle 15,509 6,280
Provision for Income Taxes 5,894 2,380
Minority Interest Expense 68 3
-------- --------
Income Before Cumulative Effect of Change in Accounting Principle 9,547 3,897
Cumulative Effect of Change in Accounting Principle (net of
income tax benefit of $12,420; Note 9) - (32,756)
-------- --------
Net Income (Loss) $ 9,547 $(28,859)
======== ========
Earnings per Share Before Cumulative Effect of Change in Accounting
Principle (Note 3):
Basic $ .70 $ .31
======== ========
Diluted $ .69 $ .30
======== ========
Earnings (Loss) per Share (Note 3):
Basic $ .70 $ (2.26)
======== ========
Diluted $ .69 $ (2.24)
======== ========
Weighted Average Shares (Note 3):
Basic 13,602 12,744
======== ========
Diluted 13,905 12,911
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
5
>
KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
Nine Months Ended
----------------------------------
September 27, September 28,
(In thousands) 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income (loss) $ 9,547 $(28,859)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Cumulative effect of change in accounting principle (Note 9) - 32,756
Noncash restructuring and unusual items - 2,441
Gain on sale of property (Note 8) (649) -
Depreciation and amortization 3,855 3,893
Provision for losses on accounts receivable 57 233
Minority interest expense 68 3
Other items 459 231
Changes in current accounts:
Accounts receivable 1,191 9,225
Unbilled contract costs and fees 2,460 (3,404)
Inventories (329) 5,352
Other current assets (301) (1,259)
Accounts payable 524 1,155
Other current liabilities 3,129 (4,593)
-------- --------
Net cash provided by operating activities 20,011 17,174
-------- --------
Investing Activities:
Purchases of property, plant, and equipment (2,570) (2,215)
Proceeds from sale of property, plant, and equipment (Note 8) 942 118
Acquisition of minority interest in subsidiary - (1,364)
Purchases of available-for-sale investments - (2,302)
Proceeds from repayments of note receivable - 200
Other, net (202) (296)
-------- --------
Net cash used in investing activities (1,830) (5,859)
-------- --------
Financing Activities:
Repurchases of Company subordinated convertible debentures - (31,369)
Net proceeds from issuance of Company common stock in public offering - 17,648
Net proceeds from issuance of Company and subsidiary common stock 1,165 472
Acquisition of subsidiary common stock - (1,461)
Repayments of long-term obligations (567) (537)
-------- --------
Net cash provided by (used in) financing activities 598 (15,247)
-------- --------
Exchange Rate Effect on Cash 2,479 2,866
-------- --------
Increase (Decrease) in Cash and Cash Equivalents 21,258 (1,066)
Cash and Cash Equivalents at Beginning of Period 44,429 102,807
-------- --------
Cash and Cash Equivalents at End of Period $ 65,687 $101,741
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
6
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. General
The interim condensed consolidated financial statements and related notes
presented have been prepared by Kadant Inc. (also referred to in this document
as "we," "us," "our," "Kadant," "the Company," or "the Registrant") without
audit and, in the opinion of management, reflect all adjustments of a normal
recurring nature necessary for a fair statement of the Company's financial
position at September 27, 2003, and its results of operations for the three- and
nine-month periods ended September 27, 2003, and September 28, 2002, and cash
flows for the nine-month periods ended September 27, 2003, and September 28,
2002. Interim results are not necessarily indicative of results for a full year.
Historical financial results have been restated to reflect the adoption
of the Financial Accounting Standards Board's (FASB's) Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets"
(Note 9), and SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections" (Note 10). The
condensed consolidated balance sheet presented as of December 28, 2002, has been
derived from the consolidated financial statements that have been audited by the
Company's independent auditors. The condensed consolidated financial statements
and related notes are presented as permitted by Form 10-Q and do not contain
certain information included in the annual financial statements and related
notes of the Company. The condensed consolidated financial statements and notes
included herein should be read in conjunction with the financial statements and
related notes included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 28, 2002, filed with the Securities and Exchange
Commission.
2. Comprehensive Income (Loss)
Comprehensive income (loss) combines net income (loss) and "other
comprehensive items," which represent certain amounts that are reported as
components of shareholders' investment in the accompanying balance sheet,
including foreign currency translation adjustments and deferred gains and losses
on foreign currency contracts. During the third quarters of 2003 and 2002, the
Company had a comprehensive loss of $793,000 and comprehensive income of
$4,023,000, respectively. During the first nine months of 2003 and 2002, the
Company had comprehensive income of $14,823,000 and a comprehensive loss of
$23,751,000, respectively.
<
7
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3. Earnings (Loss) per Share
Basic and diluted earnings (loss) per share were calculated as follows:
Three Months Ended Nine Months Ended
------------------------------ -------------------------------
September 27, September 28, September 27, September 28,
(In thousands except per share amounts) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
Basic
Income Before Cumulative Effect of Change in Accounting
Principle $ 2,663 $ 2,707 $ 9,547 $ 3,897
Cumulative Effect of Change in Accounting Principle (net
of income tax benefit of $12,420) - - - (32,756)
------- ------- ------- --------
Net Income (Loss) $ 2,663 $ 2,707 $ 9,547 $(28,859)
------- ------- ------- --------
Weighted Average Shares 13,632 13,547 13,602 12,744
------- ------- ------- --------
Basic Earnings (Loss) per Share:
Income Before Cumulative Effect of Change in Accounting
Principle $ .20 $ .20 $ .70 $ .31
Cumulative Effect of Change in Accounting Principle - - - (2.57)
------- ------- ------- --------
$ .20 $ .20 $ .70 $ (2.26)
======= ======= ======= ========
Diluted
Income Before Cumulative Effect of Change in Accounting
Principle $ 2,663 $ 2,707 $ 9,547 $ 3,897
Cumulative Effect of Change in Accounting Principle (net
of income tax benefit of $12,420) - - - (32,756)
------- ------- ------- --------
Net Income (Loss) $ 2,663 $ 2,707 $ 9,547 $(28,859)
------- ------- ------- --------
Weighted Average Shares 13,632 13,547 13,602 12,744
Effect of Stock Options 409 169 303 167
------- ------- ------- --------
Weighted Average Shares, as Adjusted 14,041 13,716 13,905 12,911
------- ------- ------- --------
Diluted Earnings (Loss) per Share:
Income Before Cumulative Effect of Change in Accounting
Principle $ .19 $ .20 $ .69 $ .30
Cumulative Effect of Change in Accounting Principle - - - (2.54)
------- ------- ------- ---------
$ .19 $ .20 $ .69 $ (2.24)
======= ======= ======= ========
Options to purchase approximately 304,200 and 400,700 shares of common stock for the third quarters of 2003 and 2002,
respectively, and 347,800 and 507,600 shares of common stock for the first nine months of 2003 and 2002,
<
8
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3. Earnings (Loss) per Share (continued)
respectively, were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average market price
for the common stock and their effect would have been antidilutive.
In addition, the computation of diluted earnings per share in 2002
excludes the effect of assuming the conversion of the Company's 4 1/2%
subordinated convertible debentures, convertible at $60.50 per share, because
the effect would have been antidilutive. The debentures were no longer
outstanding as of December 28, 2002.
4. Warranty Obligations
The Company provides for the estimated cost of product warranties,
primarily using historical information and estimated repair costs, at the time
product revenue is recognized. In the Pulp and Papermaking Equipment and Systems
segment (Papermaking Equipment segment), the Company typically negotiates the
terms regarding warranty coverage and length of warranty depending on the
products and applications. In the Composite and Fiber-based Products segment,
the Company offers a standard limited warranty on its composite building
products restricted to repair or replacement of the defective product or refund
of the original purchase price. Composite building products are new and the
Company has limited historical experience from which to estimate product
warranty costs. These products experienced a significant increase in warranty
claims in the second and third quarters of 2003 versus historical claim rates.
Accordingly, the Company has increased its estimated costs of product warranties
for this business and recorded related warranty expenses of $621,000 and
$1,098,000 in the three- and nine-month periods ended September 27, 2003,
respectively. While the Company engages in extensive product quality programs
and processes, the Company's warranty obligation is affected by product failure
rates, repair costs, service delivery costs incurred in correcting a product
failure, and supplier warranties on parts delivered to the Company. Should
actual product failure rates, repair costs, service delivery costs, or supplier
warranties on parts differ from the Company's estimates, revisions to the
estimated warranty liability would be required. The changes in the carrying
amount of product warranties for the three- and nine-month periods ended
September 27, 2003, are as follows:
Three Months Ended Nine Months Ended
(In thousands) September 27, 2003 September 27, 2003
- ----------------------------------------------------------------------------------------------------------------------------
Beginning Balance $ 4,917 $ 4,310
Provision charged to income 793 2,036
Usage (658) (1,582)
Other, net (a) (118) 170
------- -------
Ending Balance $ 4,934 $ 4,934
======= =======
(a) Primarily represents the effects of currency translation.
5. Inventories
The components of inventories are as follows:
(In thousands) September 27, 2003 December 28, 2002
- ----------------------------------------------------------------------------------------------------------------------------
Raw Materials and Supplies $12,646 $12,937
Work in Process 6,945 6,126
Finished Goods (includes $1,432 and $954 at customer locations) 11,470 10,423
------- -------
$31,061 $29,486
======= =======
<
9
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. Business Segment Information
Three Months Ended Nine Months Ended
------------------------------ ----------------------------
September 27, September 28, September 27, September 28,
(In thousands except per share amounts) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Equipment and Systems $42,023 $46,322 $138,254 $128,822
Composite and Fiber-based Products 3,883 3,762 14,811 10,980
------- ------- -------- --------
$45,906 $50,084 $153,065 $139,802
======= ======= ======== ========
Income Before Provision for Income Taxes, Minority Interest,
and Cumulative Effect of Change in Accounting Principle (a):
Pulp and Papermaking Equipment and Systems (b) $ 5,702 $ 5,839 $ 17,633 $ 12,746
Composite and Fiber-based Products (c) (d) (669) (272) 314 (2,647)
Corporate (e) (976) (799) (3,092) (2,522)
------- ------- -------- --------
Total Operating Income 4,057 4,768 14,855 7,577
Interest and Other Income (Expense), Net 232 (400) 654 (1,297)
------- ------- -------- --------
$ 4,289 $ 4,368 $ 15,509 $ 6,280
======= ======= ======== ========
Capital Expenditures:
Pulp and Papermaking Equipment and Systems $ 537 $ 266 $ 1,098 $ 897
Composite and Fiber-based Products 585 583 1,461 1,173
Corporate - 18 11 145
------- ------- -------- --------
$ 1,122 $ 867 $ 2,570 $ 2,215
======= ======= ======== ========
(a) Restated in the 2002 period to reflect the reclassification to "other income" of an extraordinary item in accordance
with the adoption of SFAS No. 145 resulting from repurchases of our subordinated convertible debentures (Note 10).
(b) Includes restructuring costs of $157 in the three-month period ended September 27, 2003 (Note 8), net restructuring
costs and unusual income of $23 in the nine-month period ended September 27, 2003 (Note 8), and restructuring and
unusual costs of $2,099 in the nine-month period ended September 28, 2002.
(c) Includes restructuring and unusual costs of $1,639 in the nine-month period ended September 28, 2002.
(d) Includes operating losses from the composite building products business of $771 and $661 in the three- and nine-month
periods ended September 27, 2003, respectively; $376 in the three-month period ended September 28, 2002; and $3,285,
including restructuring and unusual costs of $1,178, in the nine-month period ended September 28, 2002.
(e) Primarily general and administrative expenses.
7. Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-based Compensation - Transition and Disclosure," which provides
alternative methods of accounting for stock-based compensation and amends SFAS
No. 123, "Accounting for Stock-based Compensation," which provides a
fair-value-based method of recognizing stock-based compensation expense. As
permitted by SFAS No. 148 and SFAS No. 123, the Company has elected to
<
10
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
7. Stock-Based Compensation (continued)
continue to apply APB No. 25 to account for its stock-based compensation plans.
No stock-based employee compensation cost related to stock option awards is
reflected in net income, as all options granted under the plans had an exercise
price equal to the market value of the underlying common stock on the date of
grant. Had compensation cost for awards granted after 1994 under the Company's
stock-based compensation plans been determined based on the fair value at the
grant dates consistent with the method set forth under SFAS No. 123, the effect
on certain of the Company's financial results would have been as follows:
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
September 27, September 28, September 27, September 28,
(In thousands except per share amounts) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss):
As reported $ 2,663 $ 2,707 $ 9,547 $(28,859)
Deduct: Total stock-based employee
compensation expense determined
under the fair-value-based method
for all awards, net of tax (617) (692) (1,902) (1,839)
------- ------- ------- --------
Pro forma $ 2,046 $ 2,015 $ 7,645 $(30,698)
======= ======= ======= ========
Basic Earnings (Loss) per Share:
As reported $ .20 $ .20 $ .70 $ (2.26)
Pro forma .15 .15 .56 (2.41)
Diluted Earnings (Loss) Per Share:
As reported $ .19 $ .20 $ .69 $ (2.24)
Pro forma .15 .15 .55 (2.38)
8. Restructuring and Unusual Items
During the first nine months of 2003, the Company recorded net
restructuring and unusual income of $23,000, including $626,000 of restructuring
costs and $649,000 of unusual income as detailed below.
During the second quarter of 2003, the Company recorded restructuring
costs of $469,000, which were accounted for in accordance with SFAS No. 112,
related to severance costs for seven employees across all functions at the
Papermaking Equipment segment's Kadant Lamort subsidiary. During the third
quarter of 2003, the Company recorded an additional $157,000 of costs related to
this restructuring activity. These actions were taken in an effort to improve
profitability and were in response to a continued weak market environment and
reduced demand for the Company's products. During the second quarter of 2003,
unusual income resulted from a gain of $649,000 from the sale of property, for
approximately $921,000 in cash, at the same subsidiary.
<
11
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
8. Restructuring and Unusual Items (continued)
A summary of the changes in accrued restructuring costs, which are
included in other accrued expenses in the accompanying consolidated balance
sheet, follows:
(In thousands) Severance
- -----------------------------------------------------------------------------------------------
Balance at December 28, 2002 $ 28
Provision 626
Usage (21)
Currency translation (7)
------
Balance at September 27, 2003 $ 626
======
The specific restructuring measures and associated estimated costs are
based on the Company's best judgments under prevailing circumstances. The
Company believes that the restructuring reserve balance is adequate to carry out
the restructuring activities formally identified and committed to as of
September 27, 2003, and anticipates that all actions related to these
liabilities will be completed within a 12-month period from the date the
restructuring actions were taken.
9. Goodwill and Other Intangible Assets
The Company adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," effective December 30, 2001. SFAS No. 142 requires that amortization of
goodwill cease and that the Company evaluate the recoverability of goodwill and
other intangible assets annually, or more frequently if events or changes in
circumstances indicate that the carrying value of an asset might be impaired. As
a result of the adoption of the standard, the Company recorded an after-tax
goodwill impairment charge of $32,756,000 ($45,176,000 pre-tax), which was
recorded as a cumulative effect of change in accounting principle in its
restated results in the first quarter of 2002. This after-tax charge consists of
$29,869,000 at the Papermaking Equipment segment (specifically at the
stock-preparation reporting unit) and $2,887,000 at the Composite and
Fiber-based Products segment (specifically at the fiber-based granules reporting
unit). The impairment charge recorded in 2002 was primarily due to a change in
methodology from the undiscounted cash flow method used in 2001 under the
Company's previous accounting policy, to the discounted cash flow method used in
accordance with SFAS No. 142.
10. Recent Accounting Pronouncements
Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
- ----------------------------------------------------------------------------
No. 13, and Technical Corrections
- ---------------------------------
In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." Adoption of the standard generally is required in 2003. Under the
standard, transactions initially classified by the Company as extraordinary
items, such as gains and losses from the Company's early extinguishment of its
convertible debentures, will no longer be treated as such, but instead will be
reported as other nonoperating income or expense. The Company reclassified the
gain from repurchases of its debentures in the 2002 periods to "other income" in
the accompanying consolidated statements of income and operations to conform to
this standard.
Accounting for Revenue Arrangements with Multiple Deliverables
- --------------------------------------------------------------
In November 2002, the Emerging Issues Task Force (EITF) reached a final
consensus on EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." The provisions of EITF No. 00-21 are required
<
12
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Recent Accounting Pronouncements (continued)
to be adopted for revenue arrangements entered into by the Company in fiscal
periods beginning after June 15, 2003, although early adoption was permitted.
EITF No. 00-21 addresses arrangements with customers that have multiple
deliverables, such as equipment and installation, and provides guidance as to
when recognition of revenue for each deliverable is appropriate. Adoption of
this standard in the third quarter of 2003 did not have a material effect on the
Company's financial statements.
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
- ----------------------------------------------------------------------------
Indirect Guarantees of Indebtedness of Others
- ---------------------------------------------
In November 2002, the FASB issued FASB Interpretation (FIN) No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 clarifies that a
guarantor is required to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of FIN No. 45 are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. Adoption of this standard did not have an effect on the
Company's consolidated financial statements. See Note 4 for the Company's
related disclosure requirement under this standard.
Item 2 - Management's Discussion and Analysis of Financial Condition and
- ------------------------------------------------------------------------
Results of Operations
- ---------------------
Throughout this report on Form 10-Q, we make forward-looking statements,
which are statements concerning possible or assumed future results of
operations. When we use words such as "believes," "expects," "anticipates,"
"intends," "plans," "estimates," "should," "likely," "will," or similar
expressions, we are making forward-looking statements. Forward-looking
statements are not guarantees of performance. They involve risks, uncertainties,
and assumptions, and are based on the beliefs and assumptions of our management,
using information currently available to our management. Our future results of
operations may differ materially from those expressed in the forward-looking
statements. Many of the important factors that will determine these results and
values are beyond our ability to control or predict. You should not put undue
reliance on any forward-looking statements. For a discussion of important
factors that may cause our actual results to differ materially from those
suggested by the forward-looking statements, you should read carefully the
section captioned "Risk Factors" in this report on Form 10-Q. We assume no
obligation to update any such forward-looking statements.
Overview
Company Background
We operate in two segments: the Pulp and Papermaking Equipment and
Systems (Papermaking Equipment) segment and the Composite and Fiber-based
Products segment. Through our Papermaking Equipment segment, we develop,
manufacture, and market a range of equipment for the worldwide papermaking and
paper recycling industries. We have a large, stable customer base that includes
most of the world's major paper manufacturers and, as a result, we have one of
the largest installed bases of equipment in the pulp and paper industry. Our
installed base provides us with a spare parts and consumables business that
yields higher margins than our capital equipment business, and which we believe,
is less susceptible to the cyclical trends in the paper industry.
Through our Composite and Fiber-based Products segment, we develop,
manufacture, and market composite products made from recycled fiber and plastic,
primarily for the building industry, and manufacture and sell granules derived
from pulp fiber for use as carriers for agricultural; home lawn and garden; and
professional lawn, turf, and ornamental applications.
<
13
>
KADANT INC.
Overview (continued)
Prior to our incorporation, we operated as a division of Thermo Electron
Corporation. We were incorporated in Delaware in November 1991 as a wholly owned
subsidiary of Thermo Electron, and as the successor-in-interest to several of
its subsidiaries. In November 1992, we conducted an initial public offering of
our common stock and became a majority-owned public subsidiary of Thermo
Electron. On July 12, 2001, we changed our name to Kadant Inc. from Thermo
Fibertek Inc., and on August 8, 2001, we were spun off from Thermo Electron and
became a fully independent public company.
Pulp and Papermaking Equipment and Systems Segment
Our Papermaking Equipment segment consists of three primary product
lines: stock-preparation systems and equipment, papermaking machine accessories,
and water-management systems. Our principal products include:
- Stock-preparation systems and equipment: custom-engineered systems
and equipment for pulping, de-inking, screening, cleaning, and
refining waste fiber to prepare it for entry into the paper machine
during production of recycled paper;
- Papermaking machine accessory equipment: doctoring systems and
related consumables that clean papermaking rolls to keep paper
machines running efficiently, and profiling systems that control
moisture, web curl, and gloss during paper production; and
- Water-management systems: equipment that is essential for the
continuous cleaning of paper machine fabrics and the draining,
purifying, and recycling of process water during paper sheet
formation.
Composite and Fiber-Based Products Segment
Our Composite and Fiber-based Products segment consists of two product
lines: composite building products and fiber-based granular products. Our
principal products include:
- Composite building products: decking, railing systems, and roof tiles
that we develop and produce from a combination of recycled fiber,
plastic, and other materials, and market primarily to the building
industry; and
- Fiber-based granular products: biodegradable, absorbing granules that
we produce from papermaking byproducts for use as carriers for
agricultural; home lawn and garden; and professional lawn, turf, and
ornamental applications.
International Sales
During the first nine months of 2003, approximately 56% of our sales
were to customers outside the United States, principally in Europe and Asia. We
generally seek to charge our customers in the same currency in which our
operating costs are incurred. However, our financial performance and competitive
position can be affected by currency exchange rate fluctuations affecting the
relationship between the U.S. dollar and foreign currencies. We reduce our
exposure to currency fluctuations through the use of forward currency exchange
contracts. We may enter into forward contracts to hedge certain firm purchase
and sale commitments denominated in currencies other than our subsidiaries'
functional currencies. These contracts hedge transactions principally
denominated in U.S. dollars.
<
14
>
KADANT INC.
Overview (continued)
Application of Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of our
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Our actual results may differ from these estimates under
different assumptions or conditions.
Critical accounting policies are defined as those that reflect
significant judgments and uncertainties, and could potentially result in
materially different results under different assumptions and conditions. We
believe that our most critical accounting policies, upon which our financial
condition depends and which involve the most complex or subjective decisions or
assessments, are those described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" under the section captioned
"Application of Critical Accounting Policies and Estimates" in Exhibit 13 to our
Annual Report on Form 10-K for the fiscal year ended December 28, 2002, filed
with the Securities and Exchange Commission. There have been no material changes
since year-end 2002 that warrant further disclosure.
Industry and Business Outlook
Our products are primarily sold to the pulp and paper industry. The
paper industry has been in a prolonged downcycle, characterized by weak pulp and
paper prices, decreased capital spending, and consolidation of companies within
the industry. In response to weak market conditions, paper companies have
reduced capacity and postponed, or even canceled, capacity addition or expansion
projects. These trends, along with paper companies' actions to more quickly idle
their paper machines to adjust supply to demand, have adversely affected our
business. Over the long term, as the markets recover, we expect that
consolidation in the paper industry and improved capacity management will have a
positive effect on paper companies' financial performance and, in turn, will be
favorable to both paper companies and their suppliers, such as Kadant.
In addition, there has been a significant amount of downtime in North
America and Europe in the pulp and paper industry in the last few years. This,
coupled with weak economic conditions in the paper industry, has produced a
difficult market environment resulting in deferrals of capital projects by paper
companies and pricing pressure in some of our product lines. To mitigate the
effects of these difficult market conditions, we are concentrating our efforts
on several initiatives intended to improve our operating results, including
focusing on higher-margin parts and consumables businesses across all our
product lines, sourcing the manufacture of non-proprietary components from
third-party suppliers, shifting more production to our lower-cost manufacturing
facilities, and lowering our manufacturing overhead costs throughout the
business. In addition, we continue to focus our efforts on managing our
operating costs, capital expenditures, and working capital.
Despite the challenging industry environment, we are pursuing several
market opportunities. In the last several years, China has become a significant
market for our stock-preparation equipment. To capitalize on this growing
market, we are in the process of establishing an assembly facility in China for
this equipment and related aftermarket products, as well as for our accessories
and water-management products. During the first nine months of 2003, revenues
from China for stock-preparation equipment increased almost $12 million over the
comparable period last year. Revenues from China primarily arise from large
capital orders, the timing of which is often difficult to predict.
In the third quarter of 2003, our consolidated bookings increased by 15%
to $47.2 million (including a 5% increase from the favorable effect of currency
translation) versus the third quarter a year ago. The increase in bookings
largely resulted from a 14% increase in orders (including a 5% increase due to
the favorable effect of currency translation) at the Papermaking Equipment
segment, primarily in the stock-preparation equipment product line. Bookings in
this product line were led by stronger orders from China and Europe during the
quarter versus the same
<
15
>
KADANT INC.
Overview (continued)
period last year, but continue to be hampered by tight capital spending due to
sluggish industry conditions in North America.
We have also continued to invest in our composite building products
business, which, we believe, provides us with another internal growth
opportunity. We believe that the market for composite building products will
grow as consumer awareness of the advantages of these products increases their
acceptance as an alternative to traditional wood products. We continue to focus
on expanding our distribution network, with numerous distribution centers now
carrying our composite decking products throughout the U.S., and have recently
launched an incentive program to further expand our dealer base.
An unusually long winter, followed by a wet spring in much of the U.S. in
2003, delayed the start of the building season. This situation contributed to an
increase in inventory levels throughout the distribution chain, just as we
increased capacity and operating rates at our facility in Green Bay, Wisconsin.
Certain of our distributors chose to work down their inventory in the third
quarter of 2003, which had an adverse impact on sales. We believe that sales in
the fourth quarter of 2003 will be weak as distributors continue to work down
their inventory levels, and due to the seasonality of the business. We will
also curtail production at the Green Bay facility in the fourth quarter of 2003,
as we believe that we have sufficient inventory to meet current customer
demand. In addition, our composite building products business has recently
experienced a significant increase in warranty claims associated with our
decking products, which had an adverse impact on the profitability of this
business beginning in the second quarter of 2003. Accordingly, we have increased
our estimated costs of product warranties for this business and recorded related
warranty expenses of $0.6 million and $1.1 million in the three- and nine-month
periods ended September 27, 2003, respectively. The lower overhead absorption
due to the anticipated lower sales and production levels, reduced pricing due to
our winter-buy discount program, as well as the increase in warranty expense as
a percentage of revenues over last year, will have a significant impact on our
profitability in the composite building products business for the remainder of
2003. In addition, the price of plastic used in the production of our composite
building products dramatically increased in the first half of 2003, although it
has returned to more traditional levels. Higher-than-expected warranty claims
and/or an increase in the price of plastic would have an adverse impact on the
future profitability of this business. These factors considered, we expect our
composite building products business to report, on a GAAP (generally accepted
accounting principles) basis, an operating loss of $1.0 to $1.3 million, on
revenues of $1.8 to $2.3 million, in the fourth quarter of 2003, and an
operating loss of $1.7 to $2.0 million, on revenues of $12.1 to $12.6 million,
for the year.
Factoring in our higher booking levels at the Papermaking Equipment
segment and the anticipated operating loss at the composite building products
business, we expect to earn, on a consolidated GAAP basis, from $.15 to $.17 per
diluted share, on revenues of $45 to $47 million in the fourth quarter of 2003.
For the full year, we expect to earn $.84 to $.86 per diluted share (changed
from $.84 to $.92 per diluted share), on a GAAP basis, on revenues of $198 to
$200 million (changed from $195 to $200 million).
Results of Operations
Third Quarter 2003 Compared With Third Quarter 2002
- ---------------------------------------------------
Revenues
Revenues decreased to $45.9 million in the third quarter of 2003 from
$50.1 million in the third quarter of 2002, a decrease of $4.2 million, or 8%.
Revenues in 2003 include the favorable effect of currency translation of $2.2
million (or 5%) due to a weaker U.S. dollar relative to most of the functional
currencies in countries in which we operate.
Pulp and Papermaking Equipment and Systems Segment. Revenues at the
Papermaking Equipment segment decreased to $42.0 million in the third quarter of
2003 compared with $46.3 million in the third quarter of 2002, a
<
16
>
KADANT INC.
Third Quarter 2003 Compared With Third Quarter 2002 (continued)
- ---------------------------------------------------
decrease of $4.3 million, or 9%. The decline in 2003 includes a 14% decrease in
revenues primarily at our stock-preparation equipment product line, offset in
part by a 5% increase from the favorable effect of currency translation.
Revenues from the segment's stock-preparation equipment product line decreased
by $5.4 million, or 22%, in 2003 as a result of a 27% decrease in revenues from
Europe and China, primarily as a result of the timing of large orders, offset in
part by a 5% increase from the favorable effect of currency translation.
Revenues from the segment's water-management product line increased by $1.1
million, or 16%, in 2003 primarily due to increased sales in North America. The
segment's accessories product line revenues decreased $0.1 million in 2003 due
to a 6% decrease in demand in North America and Europe as a result of machine
shutdowns and mill closures caused by industry consolidation and capacity
rationalization, which was almost entirely offset by an increase from the
favorable effect of currency translation.
Composite and Fiber-Based Products Segment. Revenues at the Composite
and Fiber-based Products segment increased to $3.9 million in the third quarter
of 2003 from $3.8 million in 2002 as a result of an increase of $0.4 million in
revenues from our fiber-based granular products due to an increase in sales of
our granules for home lawn and garden use to a large customer. This increase was
almost entirely offset by a decrease in sales of our composite building products
due to weaker-than-expected demand during the third quarter of 2003 as a result
of the higher-than-expected inventory levels at the distributors primarily due
to the unusually long winter and wet spring in 2003.
Gross Profit Margin
Gross profit margin increased to 40% in the third quarter of 2003 from
37% in the third quarter of 2002. The gross profit margin at the Papermaking
Equipment segment increased to 42% in 2003 from 38% in the third quarter of 2002
primarily due to an increase in capital equipment gross profit margins and, to a
lesser extent, an overall change in product mix to a larger proportion of
higher-margin parts and consumables revenues compared to last year. The gross
profit margin at the Composite and Fiber-based Products segment decreased to 11%
in the third quarter of 2003 from 27% in the third quarter of 2002 primarily as
a result of higher-than-expected warranty costs of $0.6 million and lower sales
and production volumes. The composite building products business has experienced
a significant increase in warranty costs for our decking products in the second
and third quarters of 2003, which has adversely affected gross profit margins at
this segment. The anticipated lower sales and production volumes, reduced
pricing due to the winter-buy discount program, as well as the increase in
warranty expense as a percentage of revenues over last year, will continue to
adversely affect gross profit margins in the fourth quarter of 2003. Gross
profit margins from our fiber-based granular products decreased slightly as a
result of an increase in the cost of natural gas used in our production process
in 2003 compared with 2002.
Operating Expenses
Selling, general, and administrative expenses as a percentage of
revenues increased to 28% in the third quarter of 2003 compared with 25% in the
third quarter of 2002 primarily due to the decrease in revenues. Selling,
general, and administrative expenses increased to $12.8 million in 2003 from
$12.5 million in 2002 primarily due to an increase of $0.6 million from the
unfavorable effect of foreign currency translation at the Papermaking Equipment
segment, offset in part by a decrease in internal expenses resulting from our
ongoing efforts to reduce costs.
Research and development expenses as a percentage of revenues were 3% in
the third quarter of 2003 compared with 2% in the third quarter of 2002 due to
the decrease in revenues.
Restructuring and Unusual Items
During the third quarter of 2003, we recorded additional restructuring
costs of $0.2 million related to the restructuring actions taken during the
second quarter of 2003 (Note 8).
<
17
>
KADANT INC.
Third Quarter 2003 Compared With Third Quarter 2002 (continued)
- ---------------------------------------------------
During the third quarter of 2002, we recorded additional restructuring
costs of $0.1 million related to the restructuring actions taken in the first
quarter of 2002 as described in the results of operations for the first nine
months of 2003 compared with the first nine months of 2002.
Interest Income and Expense
Interest income decreased to $0.2 million in the third quarter of 2003
from $0.7 million in the third quarter of 2002 primarily due to lower average
invested balances. The decrease in average invested balances primarily relates
to the use of cash to repurchase and redeem our subordinated convertible
debentures in 2002, offset in part by cash generated from operating activities
in the third quarter of 2003.
Interest expense decreased to $11,000 in the third quarter of 2003 from
$1.1 million in the third quarter of 2002 as a result of the redemption and
repurchases of our subordinated convertible debentures in 2002. We expect
interest expense will be significantly lower for the remainder of 2003 compared
with 2002 due to the redemption of our debentures.
Income Taxes
Our effective tax rate was 38% in both the third quarter of 2003 and
2002. The effective tax rates exceeded the statutory federal income tax rate
primarily due to the impact of state income taxes and nondeductible expenses.
First Nine Months 2003 Compared With First Nine Months 2002
- ------------------------------------------------------------
Revenues
Revenues increased to $153.1 million in the first nine months of 2003
from $139.8 million in the first nine months of 2002, an increase of $13.3
million, or 9%. Revenues in 2003 include the favorable effect of currency
translation of $7.6 million (or 5%) due to a weaker U.S. dollar relative to most
of the functional currencies in countries in which we operate.
Pulp and Papermaking Equipment and Systems Segment. Revenues at the
Papermaking Equipment segment increased to $138.3 million in the first nine
months of 2003 compared with $128.8 million in the first nine months of 2002, an
increase of $9.5 million, or 7%. The increase in revenues in 2003 includes a 6%
increase from the favorable effect of currency translation and a 1% increase in
revenues primarily at the stock-preparation equipment product line. Revenues
from the segment's stock-preparation equipment product line increased by $8.6
million, or 14%, in 2003 as a result of an 8% increase from the favorable effect
of currency translation and a 6% increase primarily due to an increase in sales
from China, offset in part by lower sales from Europe and North America due to
continued market weakness. Revenues from the segment's water-management product
line increased $0.7 million, or 3%, in 2003 primarily due to a 2% increase from
the favorable effect of currency translation, as well as a 1% increase in sales
from North America. Revenues from the segment's accessories product line
increased by $0.1 million in 2003, due to a 6% increase from the favorable
effect of currency translation, which was almost entirely offset by decreases in
demand in North America and Europe as a result of machine shutdowns and mill
closures caused by industry consolidation and capacity rationalization.
Composite and Fiber-Based Products Segment. Revenues at the Composite
and Fiber-based Products segment increased to $14.8 million in the first nine
months of 2003 from $11.0 million in 2002 as a result of a $4.3 million increase
in sales of our composite building products in the first half of 2003 resulting
from our winter-buy discount program, increased marketing efforts, and expansion
of our distribution channels, offset in part by weaker-than-expected demand in
the third quarter of 2003 as a result of the higher-than-expected inventory
levels at the distributors primarily due to the unusually long winter and wet
spring in 2003. Revenues at our fiber-based granular products
<
18
>
KADANT INC.
First Nine Months 2003 Compared With First Nine Months 2002 (continued)
- -----------------------------------------------------------
business decreased $0.5 million in the first nine months of 2003 compared with
the first nine months of 2002 primarily due to a decrease in revenues from our
cat-box filler product.
Gross Profit Margin
Gross profit margin remained constant at 38% in the first nine months of
2003 and 2002. The gross profit margin at the Papermaking Equipment segment
remained constant at 39% in 2003 and 2002. The gross profit margin at the
Composite and Fiber-based Products segment increased to 28% in the first nine
months of 2003 from 26% in the first nine months of 2002. The higher gross
profit margin in 2003 was primarily due to an increase in revenues at the
composite building products business, offset in part by higher-than-expected
warranty costs of $1.1 million and, to a lesser extent, the higher costs of
plastic used in production. In addition, the increase in the gross profit margin
at this segment was offset by an increase in the cost of natural gas used in the
production of our fiber-based granules.
Operating Expenses
Selling, general, and administrative expenses as a percentage of
revenues were 26% in the first nine months of 2003 compared with 27% in the
first nine months of 2002 due to the increase in revenues in the 2003 period.
Selling, general, and administrative expenses increased to $39.7 million in 2003
from $37.8 million in 2002 primarily due to an increase of $2.0 million from the
unfavorable effects of foreign currency translation at the Papermaking Equipment
segment.
Research and development expenses as a percentage of revenues were 2% in
the first nine months of 2003 compared with 3% in the first nine months of 2002
primarily due to the increase in revenues in the 2003 period.
Restructuring and Unusual Items
During the first nine months of 2003, we recorded net restructuring
costs and unusual income of $23,000. Restructuring costs of $0.6 million, which
were accounted for in accordance with SFAS No. 112, related to severance costs
for seven employees across all functions at the Papermaking Equipment segment's
Kadant Lamort subsidiary. These actions were taken in an effort to improve
profitability and were in response to a continued weak market environment and
reduced demand for our products. We estimate annual savings from these actions
of approximately $0.4 million, primarily in cost of revenues, beginning in the
fourth quarter of 2003. Unusual income resulted from a gain of $0.6 million from
the sale of property, for approximately $0.9 million in cash, at the same
subsidiary (Note 8).
During the first nine months of 2002, we recorded restructuring and
unusual costs of $3.7 million. Restructuring costs of $1.1 million, which were
accounted for in accordance with Emerging Issues Task Force Pronouncement No.
94-3, related to severance costs for 68 employees across all functions primarily
at the Papermaking Equipment segment, all of whom were terminated as of
September 28, 2002. These actions were taken in an effort to improve
profitability and were in response to a continued weak market environment and
reduced demand for our products. Unusual costs of $2.6 million include noncash
charges of $2.4 million for asset writedowns, consisting of $1.4 million for the
writedown of fixed assets held for sale at the Composite and Fiber-based
Products segment and $1.0 million for the impairment of a laboratory in Ohio
held for sale at the Papermaking Equipment segment; and $0.2 million for related
disposal and facility-closure costs. We believe we achieved annual savings of
approximately $4.5 million ($1.7 million in cost of revenues; $2.3 million in
selling, general, and administrative expenses; and $0.5 million in research and
development expenses) from these actions beginning in the second quarter of
2002.
Interest Income and Expense
Interest income decreased to $0.7 million in the first nine months of
2003 from $2.0 million in the first nine months of 2002 primarily due to lower
average invested balances. The decrease in average invested balances resulted
<
19
>
KADANT INC.
First Nine Months 2003 Compared With First Nine Months 2002 (continued)
- -----------------------------------------------------------
primarily from the use of cash to repurchase and redeem our subordinated
convertible debentures in 2002, offset in part by proceeds received from our
June 2002 public stock offering and cash generated from operating activities in
the first nine months of 2003.
Interest expense decreased to $39,000 in the first nine months of 2003
from $3.7 million in the first nine months of 2002 as a result of the
repurchases and redemption of our subordinated convertible debentures in 2002.
Income Taxes
Our effective tax rate was 38% in both the first nine months of 2003 and
2002. The effective tax rates exceeded the statutory federal income tax rate
primarily due to the impact of state income taxes and nondeductible expenses.
Cumulative Effect of Change in Accounting Principle
In accordance with the requirements of SFAS No. 142, "Goodwill and Other
Intangible Assets," which we adopted as of December 30, 2001, we recorded a
transitional goodwill impairment charge in our restated results in the first
quarter of 2002, representing the cumulative effect of a change in accounting
principle of $32.8 million (consisting of $29.9 million at the Papermaking
Equipment segment and $2.9 million at the Composite and Fiber-based Products
segment), net of income tax benefit of $12.4 million. The impairment charge
recorded in 2002 was primarily due to a change in methodology from the
undiscounted cash flow method used in 2001 under our previous accounting policy,
to the discounted cash flow method used in accordance with SFAS No. 142 (Note
9).
Liquidity and Capital Resources
Consolidated working capital was $90.4 million at September 27, 2003,
compared with $74.7 million at December 28, 2002. Included in working capital
are cash and cash equivalents of $65.7 million at September 27, 2003, compared
with $44.4 million at December 28, 2002. Of the total cash and cash equivalents
at September 27, 2003, $7.7 million was held by a majority-owned subsidiary, and
the remainder was held by our wholly owned subsidiaries and us. At September 27,
2003, $35.9 million of cash and cash equivalents was held by our foreign
subsidiaries.
During the first nine months of 2003, cash of $20.0 million was provided
by operating activities, compared with $17.2 million in the first nine months of
2002. Cash of $2.5 million was provided by a decrease in unbilled contract costs
and fees due to the timing of progress billings on large contracts at the
Papermaking Equipment segment. Cash of $1.2 million was also provided by a
decrease in accounts receivable due to the timing of cash receipts at the
Papermaking Equipment segment. In addition, an increase in inventories used cash
of $0.3 million in 2003 as a result of an increase in finished goods inventory
at the Composite and Fiber-based Products segment, offset in part by a decrease
in inventory levels at the Papermaking Equipment segment. An increase in
accounts payable provided a source of cash of $0.5 million in 2003 primarily at
the Papermaking Equipment segment due to the timing of payments. In addition, an
increase of $3.1 million in cash resulted from an increase in other current
liabilities, primarily due to an increase in accrued income taxes, proceeds
received from the settlement of a forward foreign currency hedge contract and,
to a lesser extent, an increase in accrued warranty costs.
Our investing activities used $1.8 million of cash in the first nine
months of 2003, compared with $3.6 million in the first nine months of 2002
(excluding available-for-sale investment activity). During the first nine months
of 2003, we purchased property, plant, and equipment for $2.6 million, including
$1.3 million at our composite building products business, offset in part by
proceeds of $0.9 million received from the sale of property (Note 8).
Our financing activities provided cash of $0.6 million in the first nine
months of 2003, compared with a use of cash of $15.2 million in the first nine
months of 2002. During the first nine months of 2003, we received proceeds of
$1.2 million from the issuance of common stock in connection with our employee
stock option and stock purchase plans, which were offset in part by the
repayments of $0.6 million of long-term notes payable.
<
20
>
KADANT INC.
Liquidity and Capital Resources (continued)
In May 2003, our board of directors authorized the repurchase of up to
$25.0 million of our equity securities in the open market or in negotiated
transactions through May 15, 2004. As of November 6, 2003, no purchases had been
made under this authorization.
At September 27, 2003, we had $44.1 million of unremitted foreign
earnings that could be subject to tax if remitted to the U.S. Our practice is to
reinvest indefinitely the earnings of our international subsidiaries. We do not
expect that this will have a material adverse effect on our current liquidity.
Although we currently have no material commitments for capital
expenditures, we plan to make expenditures during the remainder of 2003 for
property, plant, and equipment of approximately $1.6 million, including $0.7
million at our composite building products business. We no longer expect to
expand our Green Bay, Wisconsin, composites facility in 2003. We have made
significant investments in production equipment and currently believe that we
have sufficient manufacturing capacity at that facility to meet demand in 2004.
We are establishing an assembly facility in China to support our
stock-preparation equipment business. We presently estimate that the China
facility will be operational in mid-2004 and that the costs to establish this
new facility, most of which we expect to incur in 2004, could range from $2.0 to
$3.0 million.
In the future, our liquidity position will be primarily affected by the
level of cash flows from operations and the amount of cash expended on capital
expenditures, or on acquisitions, if any. We believe that our existing
resources, together with the cash we expect to generate from operations, are
sufficient to meet the capital requirements of our current operations for the
foreseeable future.
Risk Factors
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, we wish to caution readers that the
following important factors, among others, in some cases have affected, and in
the future could affect, our actual results and could cause our actual results
in 2003 and beyond to differ materially from those expressed in any
forward-looking statements made by us, or on our behalf.
Our business is dependent on the condition of the pulp and paper industry, which
is currently in a downcycle.
We sell products primarily to the pulp and paper industry. Generally,
the financial condition of the global pulp and paper industry corresponds to the
condition of the general economy, as well as to a number of other factors,
including pulp and paper production capacity relative to demand. The global pulp
and paper industry has been in a prolonged downcycle, resulting in depressed
pulp and paper prices, decreased spending, mill closures, consolidations, and
bankruptcies, all of which have adversely affected our business. The pulp and
paper industry has also been affected by higher energy prices and slowing
economies in North America and Europe. In response to weak market conditions,
paper companies frequently reduce capacity and postpone, or even cancel,
capacity addition or expansion projects, increase papermaking machine downtime,
or close mills. The financial condition of the pulp and paper industry may not
improve in the near future, and the severity of the downturn could expand to our
Asian business.
Our business is subject to economic, currency, political, and other risks
associated with international sales and operations.
During the first nine months of 2003, approximately 56% of our sales were
to customers outside the United States, principally in Europe and Asia.
International revenues are subject to a number of risks, including the
following:
- agreements may be difficult to enforce and receivables difficult to
collect through a foreign country's legal system;
- foreign customers may have longer payment cycles;
- foreign countries may impose additional withholding taxes or
otherwise tax our foreign income, impose
<
21
>
KADANT INC.
Risk Factors (continued)
tariffs, or adopt other restrictions on foreign trade; and
- the protection of intellectual property in foreign countries may be
more difficult to enforce.
Although we seek to charge our customers in the same currency in which our
operating costs are incurred, fluctuations in currency exchange rates may
affect product demand and adversely affect the profitability in U.S. dollars of
products we provide in international markets where payment for our products and
services is made in their local currencies. Any of these factors could have a
material adverse impact on our business and results of operations.
An increasing portion of our international sales has and may in the
future come from China. We are in the process of establishing an assembly
facility in China for our stock-preparation equipment and related aftermarket
parts. An increase in revenues in China, as well as the operation of an assembly
facility there, will expose us to increased risk in the event of changes in the
policies of the Chinese government, political unrest, unstable economic
conditions, or other developments in China or in U.S.-China relations that are
adverse to trade, including enactment of protectionist legislation or trade
restrictions. Orders from customers in China, particularly for large systems
that have been tailored to a customer's specific requirements, involve increased
risk of cancellation prior to shipment due to payment terms that are applicable
to doing business in China. In addition, the timing of these orders is often
difficult to predict.
We are subject to intense competition in all our markets.
We believe that the principal competitive factors affecting the markets
for our products include quality, price, service, technical expertise, and
product innovation. Our competitors include a number of large multinational
corporations such as Voith Paper GmbH and Metso Corporation. Competition,
especially in China, is increasing as new companies enter the market and as
existing competitors expand their product lines and intensify efforts within
existing product lines. Competitors' technologies may prove to be superior to
ours. Many of these competitors may have substantially greater financial,
marketing, and other resources than we do. As a result, they may be able to
adapt more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the promotion and sale of their
services and products. Our current products, those under development, and our
ability to develop new technologies may not be sufficient to enable us to
compete effectively. In addition, our composite building products business is
subject to intense competition, particularly in the decking market, from
traditional wood products and other composite manufacturers, many of whom have
greater financial, technical, and marketing resources than we do. As a result,
we may be unable to compete successfully in this market.
Our composite building products business is a relatively new entrant into a new
market. Our success will depend on our ability to manufacture and commercialize
our composite building products.
In 2000, we began to develop, produce, market, and sell composite
products primarily for the building industry. Development, manufacturing, and
commercialization of our composite building products require significant
technical expertise and testing of their formulation and manufacturing
processes, and our efforts may not be successful. Further, growth of our
composite building products business requires ongoing market acceptance. We
expect to incur significant expenses to successfully market and distribute these
products. Our ability to market these products successfully depends on the
willingness of consumers to purchase fiber-based composite products as an
alternative to traditional building products. To penetrate the market and gain
market share, we need to educate consumers, including wood suppliers,
distributors, contractors, and homebuilders, regarding the benefits of our
fiber-based composite products over products made of wood, slate, and other
traditional materials. This strategy may not be successful. We have little
experience manufacturing these products at volume, cost, and quality levels
sufficient to satisfy expected demand, and we may encounter difficulties in
connection with any large-scale manufacturing or commercialization of these new
products. If we are successful, our capacity may not be sufficient to meet
demand without significant additional investment. In addition, the majority of
our production is largely dependent upon a single piece of equipment. If that
equipment were to fail for an extended period of time and spare parts or
replacement equipment were not readily obtainable, it would have a material
adverse effect on our revenues from this business in that period. If we were to
exit this business, we would incur significant losses.
<
22
>
KADANT INC.
Risk Factors (continued)
Our composite building products business may not be able to obtain effective
distribution of its products.
The composite building products business is subject to intense
competition, and we rely on distributors in the building products industry to
market, distribute, and sell our products. We may be unable to produce our
products in sufficient quantity to interest or retain these distributors or to
add new distributors. If we are unable to distribute our products effectively,
our revenues will decline and we will have to incur additional expenses to
market these products directly.
Higher interest rates could adversely affect demand for our composite building
products.
Demand for our composite building products is affected by several factors
beyond our control, including economic conditions. Recent demand for our
products has been driven, in part, by the availability of low-interest mortgage
and home equity loans. An increase in interest rates or tightened credit could
adversely affect demand for home remodeling projects, including demand for our
products.
Seasonality and weather conditions could adversely affect our business.
In general, the building products industry experiences seasonal
fluctuations in sales, particularly in the winter and early spring, when
holidays and adverse weather conditions in some regions usually reduce the level
of home improvement and new construction activity. In addition, our composite
building products are used or installed in outdoor construction applications,
and our sales volume, bookings, gross margins, and operating income can be
negatively affected by adverse weather. We expect our performance to reflect
these seasonal variations. Operating results will tend to be lower in quarters
with lower sales, which are not entirely offset by a corresponding reduction in
operating costs. In addition, we may also experience lower gross profit margins
in the fourth and first quarters due to seasonal incentive discounts offered to
our distributors. As a result of these factors, we believe sequential
period-to-period comparisons of our operating results are not reliable
indicators of future performance, and the operating results for any one
quarterly period may not be indicative of operating results to be expected for a
full year.
The failure of our composite building products to perform could result in
potential liabilities.
Our composite building products are new, have not been on the market for
long periods of time, and may be used in applications for which we may have
little knowledge or limited experience. Because we have limited historical
experience, we may be unable to predict the potential liabilities related to
product warranty or product liability issues. If our products fail to perform
over their warranty periods, we may not have the ability to protect ourselves
adequately against this potential liability, which could adversely affect our
operating results. We have recently experienced a significant increase in
warranty claims and warranty expense related to our composite decking products.
A continued increase in warranty claims or expenses and/or failure of our
products to perform or to be accepted in the marketplace will have an adverse
impact on the profitability of our business.
We are dependent on a single mill for the raw material used in our composite
building products and fiber-based granules, and we may not be able to obtain raw
material on commercially reasonable terms; and the manufacture of our
fiber-based granules is subject to commodity price risks.
We are dependent on a single paper mill for the fiber used in the
manufacture of our composite building products and fiber-based granules. This
mill has the exclusive right to supply the papermaking byproducts used in our
process to manufacture the granules. Although we believe our relationship with
the mill is good, the mill could decide to terminate its relationship with us,
and we would be forced to find an alternative supply for this raw material. We
<
23
>
KADANT INC.
Risk Factors (continued)
may be unable to find an alternative supply on commercially reasonable terms or
could incur excessive transportation costs if an alternative supplier were
found, which would increase our manufacturing costs and may prevent our products
from being competitive. Our composite building products also contain plastic,
which is subject to wide fluctuations in pricing, quality, and availability. Due
to higher energy costs, the price of plastic significantly increased in early
2003, although it has returned to more traditional levels. In the future, we may
be unable to obtain sufficient quantities at reasonable prices, which would
adversely affect our profitability and ability to produce a sufficient quantity
of our products or to produce our products at competitive prices.
In addition, we use natural gas in the production of our fiber-based
granular products. We manage our exposure to natural gas price fluctuations by
entering into forward contracts to purchase a portion of our natural gas
requirements from a supplier. There can be no assurance that we will be
effective in managing our exposure to natural gas price fluctuations.
Our inability to successfully identify and complete acquisitions or successfully
integrate any new or previous acquisitions could have a material adverse effect
on our business.
Our strategy includes the acquisition of technologies and businesses
that complement or augment our existing products and services. Promising
acquisitions are difficult to identify and complete for a number of reasons,
including competition among prospective buyers and the need for regulatory,
including antitrust, approvals. Any acquisition we may complete may be made at a
substantial premium over the fair value of the net assets of the acquired
company. We may not be able to complete future acquisitions, integrate any
acquired businesses successfully into our existing businesses, make such
businesses profitable, or realize anticipated cost savings or synergies, if any,
from these acquisitions.
In addition, we have previously acquired several companies and
businesses. As a result of these acquisitions, we have recorded significant
goodwill on our balance sheet, which amounted to approximately $72.6 million as
of September 27, 2003. In accordance with SFAS No. 142, we assess the carrying
value of the goodwill that we have recorded at least annually or whenever events
or changes in circumstances indicate that its current carrying value has
diminished. These events or circumstances generally would include operating
losses or a significant decline in earnings associated with the acquired
business or asset. In the first quarter of 2002, we recorded an after-tax
goodwill impairment charge upon the adoption of this standard of $32.8 million,
consisting of $29.9 million at the Papermaking Equipment segment and $2.9
million at the Composite and Fiber-based Products segment. In accordance with
SFAS No. 142, any future impairment losses identified after adoption will be
recorded as reductions to operating income, which could have a material adverse
effect on our results of operations. Our ability to realize the value of the
goodwill that we have recorded will depend on the future cash flows of these
businesses. These cash flows, in turn, depend partly on how well we have
integrated these businesses.
Our inability to protect our intellectual property could have a material adverse
effect on our business. In addition, third parties may claim that we infringe
their intellectual property, and we could suffer significant litigation or
licensing expense as a result.
We place considerable emphasis on obtaining patent and trade secret
protection for significant new technologies, products, and processes because of
the length of time and expense associated with bringing new products through the
development process and into the marketplace. Our success depends in part on our
ability to develop patentable products and obtain and enforce patent protection
for our products both in the United States and in other countries. We own
numerous U.S. and foreign patents, and we intend to file additional
applications, as appropriate, for patents covering our products. Patents may not
be issued for any pending or future patent applications owned by or licensed to
us, and the claims allowed under any issued patents may not be sufficiently
broad to protect our technology. Any issued patents owned by or licensed to us
may be challenged, invalidated, or circumvented, and the
<
24
>
KADANT INC.
Risk Factors (continued)
rights under these patents may not provide us with competitive advantages. A
patent relating to our fiber-based granular products expires in mid-2004. After
that date, we could be subject to additional competition in this market, which
could have an adverse effect on this business. In addition, competitors may
design around our technology or develop competing technologies. Intellectual
property rights may also be unavailable or limited in some foreign countries,
which could make it easier for competitors to capture increased market position.
We could incur substantial costs to defend ourselves in suits brought against us
or to proceed in suits in which we may assert our patent rights against others.
An unfavorable outcome of any such litigation could have a material adverse
effect on our business and results of operations. In addition, as our patents
expire, we rely on trade secrets and proprietary know-how to protect our
products. We cannot be sure the steps we have taken or will take in the future
will be adequate to deter misappropriation of our proprietary information and
intellectual property.
We seek to protect trade secrets and proprietary know-how, in part,
through confidentiality agreements with our collaborators, employees, and
consultants. These agreements may be breached, we may not have adequate remedies
for any breach, and our trade secrets may otherwise become known or be
independently developed by our competitors.
Third parties may assert claims against us to the effect that we are
infringing on their intellectual property rights. We could incur substantial
costs and diversion of management resources to defend these claims, which could
have a material adverse effect on our business, financial condition, and results
of operations. In addition, parties making these claims could secure a judgment
awarding substantial damages, as well as injunctive or other equitable relief,
which could effectively block our ability to make, use, sell, distribute, or
market our products and services in the United States or abroad. In the event
that a claim relating to intellectual property is asserted against us, or third
parties not affiliated with us hold pending or issued patents that relate to our
products or technology, we may seek licenses to such intellectual property or
challenge those patents. However, we may be unable to obtain these licenses on
commercially reasonable terms, if at all, and our challenge of the patents may
be unsuccessful. Our failure to obtain the necessary licenses or other rights
could prevent the sale, manufacture, or distribution of our products and,
therefore, could have a material adverse effect on our business, financial
condition, and results of operations.
Fluctuations in our quarterly operating results may cause our stock price to
decline.
Given the nature of the markets in which we participate and the effect of
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
(SAB No. 101), which became effective in January 2000, we cannot reliably
predict future revenues and profitability. Unexpected changes may cause us to
adjust our operations. A significant portion of our costs are fixed, due in part
to our significant selling, research and development, and manufacturing costs.
Thus, small declines in revenues could disproportionately affect our operating
results. Other factors that could affect our quarterly operating results
include:
- failure of our products to pass contractually agreed upon acceptance
tests, which would delay or prohibit recognition of revenues under
SAB No. 101;
- demand for and market acceptance of our products;
- competitive pressures resulting in lower sales prices of our
products;
- adverse changes in the pulp and paper industry;
- delays or problems in our introduction of new products;
- our competitors' announcements of new products, services, or
technological innovations;
- contractual liabilities incurred by us related to guarantees of our
product performance;
- increased costs of raw materials or supplies, including the cost of
energy; and
- changes in the timing of product orders.
- -
<
25
>
KADANT INC.
Risk Factors (continued)
Anti-takeover provisions in our charter documents and under Delaware law, our
shareholder rights plan, and the potential tax effects of our spinoff from
Thermo Electron could prevent or delay transactions that our shareholders may
favor.
Provisions of our charter and by-laws may discourage, delay, or prevent a
merger or acquisition that our shareholders may consider favorable, including
transactions in which shareholders might otherwise receive a premium for their
shares. For example, these provisions:
- authorize the issuance of "blank check" preferred stock without any
need for action by shareholders;
- provide for a classified board of directors with staggered three-year
terms;
- require supermajority shareholder voting to effect various amendments
to our charter and by-laws;
- eliminate the ability of our shareholders to call special meetings
of shareholders;
- prohibit shareholder action by written consent; and
- establish advance notice requirements for nominations for election to
our board of directors or for proposing matters that can be acted on
by shareholders at shareholder meetings.
In addition, our board of directors has adopted a shareholder rights
plan intended to protect shareholders in the event of an unfair or coercive
offer to acquire our company and to provide our board of directors with adequate
time to evaluate unsolicited offers. Preferred stock purchase rights have been
distributed to our common shareholders pursuant to the rights plan. This rights
plan may have anti-takeover effects. The rights plan will cause substantial
dilution to a person or group that attempts to acquire us on terms that our
board of directors does not believe are in our best interests and those of our
shareholders and may discourage, delay, or prevent a merger or acquisition that
shareholders may consider favorable, including transactions in which
shareholders might otherwise receive a premium for their shares.
The tax treatment of the distribution of our common stock by Thermo
Electron under the Internal Revenue Code and regulations promulgated thereunder
could also serve to discourage an acquisition of our company. An acquisition of
our Company could result in federal tax liability being imposed on Thermo
Electron and, in more limited circumstances, on shareholders of Thermo Electron
who received shares of our common stock in the distribution, if the acquisition
was determined to be pursuant to an overall plan that existed at the time of the
distribution (which took place in 2001). As part of the distribution, we have
agreed to indemnify Thermo Electron, but not the shareholders of Thermo
Electron, for any resulting tax liability if the tax liability is attributable
to certain acts by us, including an acquisition of our company. The prospect of
that tax liability and our indemnification obligation may have anti-takeover
effects.
A number of actions following our spinoff from Thermo Electron could cause the
distribution to be fully taxable to shareholders of Thermo Electron who received
shares of our common stock in the distribution and/or to Thermo Electron, and to
us.
The IRS has issued a ruling that no gain or loss will be recognized by
us, Thermo Electron, or its shareholders upon the distribution of our common
stock as of the date of the distribution, except with respect to cash received
in lieu of fractional shares of our common stock and distributions of our common
stock acquired by Thermo Electron within the past five years in taxable
transactions. However, the distribution could become fully taxable if we, Thermo
Electron, or the shareholders of Thermo Electron who received shares of our
common stock in the distribution, take any of a number of actions following the
distribution. We have entered into a tax matters agreement with Thermo Electron
that restricts our ability to engage in these types of actions. If any
conditions of the IRS ruling are not satisfied, the distribution could become
taxable to the shareholders of Thermo Electron who received shares of our common
stock in the distribution and/or Thermo Electron. As part of the distribution,
we have agreed to indemnify Thermo Electron, but not the shareholders of Thermo
Electron, for any resulting tax liability if the liability is attributable to
certain acts by us.
<
26
>
KADANT INC.
Risk Factors (continued)
Sales of substantial amounts of our common stock may occur from time to time,
which could cause our stock price to decline.
Our shares were distributed pro rata to the shareholders of Thermo
Electron, and from time to time, these shareholders have sold and may in the
future sell substantial amounts of our common stock in the public market if our
shares no longer meet their investment criteria or other objectives. Any sales
of substantial amounts of our common stock in the public market, or the
perception that such sales might occur, whether as a result of the distribution
or otherwise, could cause the market price of our common stock to decline.
We may have potential business conflicts of interest with Thermo Electron with
respect to our past and ongoing relationships that could harm our business
operations.
Conflicts of interest may arise between Thermo Electron and us in a
number of areas relating to our past and ongoing relationships, including:
labor, tax, employee benefit, indemnification, and other matters arising from
our separation from Thermo Electron. We may not be able to resolve any of these
potential conflicts.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------
Our exposure to market risk from changes in interest rates and foreign
currency exchange rates has not changed materially from our exposure at year-end
2002.
Item 4 - Controls and Procedures
- --------------------------------
(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer
(CEO) and chief financial officer (CFO), evaluated the effectiveness of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act) as of September 27, 2003. Based on this
evaluation, our CEO and CFO concluded that, as of September 27, 2003, our
disclosure controls and procedures were (1) designed to ensure that material
information relating to us, including our consolidated subsidiaries, is made
known to our CEO and CFO by others within those entities, particularly during
the period in which this report was being prepared, and (2) effective, in that
they provide reasonable assurance that information required to be disclosed by
us in the reports that we file or submit under the Securities Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms.
(b) Changes in Internal Controls Over Financial Reporting
During the period ended September 27, 2003, there were no changes in our
internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Securities Exchange Act) that materially affected, or were
reasonably likely to materially affect our internal control over financial
reporting.
<
27
>
KADANT INC.
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits
See Exhibit Index on the page immediately preceding exhibits.
(b) Reports on Form 8-K
On July 24, 2003, we furnished a Current Report on Form 8-K, dated July
23, 2003, under Item 9 - Regulation FD Disclosure (Information Furnished
Pursuant to Item 12 "Disclosure of Results of Operations and Financial
Condition"), containing a copy of a press release issued on July 23, 2003,
announcing our financial results for the fiscal quarter ended June 28, 2003.
<
28
>
KADANT INC.
SIGNATURE
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 as of the 6th day of November 2003.
KADANT INC.
/s/ Thomas M. O'Brien
----------------------------------------------------
Thomas M. O'Brien
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
<
29
>
KADANT INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- --------------------------------------------------------------------------------
31.1 Certification of the Principal Executive Officer of the
Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.
31.2 Certification of the Principal Financial Officer of the
Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.
32 Certification of the Chief Executive Officer and the Chief
Financial Officer of the Registrant Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
30