3
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 July 3, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission file number 1-11406
KADANT INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-1762325
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
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 (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 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 August 3, 2004
---------------------------- -----------------------------
Common Stock, $.01 par value 14,054,128
PART I - Financial Information
Item 1 - Financial Statements
- -----------------------------
KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)
Assets
July 3, January 3,
(In thousands) 2004 2004
- --------------------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 81,588 $ 74,451
Accounts receivable, less allowances of $1,767 and $1,680 32,096 32,507
Unbilled contract costs and fees 11,704 10,755
Inventories (Note 5) 32,445 33,203
Deferred tax asset 7,714 7,710
Other current assets 3,365 3,187
-------- --------
168,912 161,813
-------- --------
Property, Plant, and Equipment, at Cost 74,987 77,458
Less: Accumulated depreciation and amortization 51,150 51,631
-------- --------
23,837 25,827
-------- --------
Other Assets 9,969 10,537
-------- --------
Goodwill 73,815 73,536
-------- --------
$276,533 $271,713
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
KADANT INC.
Condensed Consolidated Balance Sheet (continued)
(Unaudited)
Liabilities and Shareholders' Investment
July 3, January 3,
(In thousands, except share amounts) 2004 2004
- --------------------------------------------------------------------------------------------------------------------------------
Current Liabilities:
Current maturities of long-term obligations $ - $ 598
Accounts payable 25,336 23,896
Accrued payroll and employee benefits 9,332 11,356
Accrued warranty costs 4,931 4,530
Customer deposits 3,780 2,406
Accrued income taxes 3,014 1,040
Other current liabilities 8,615 10,983
-------- --------
55,008 54,809
-------- --------
Deferred Income Taxes 1,271 1,617
-------- --------
Other Long-Term Liabilities 3,180 3,178
-------- --------
Minority Interest 58 351
-------- --------
Shareholders' Investment:
Preferred stock, $.01 par value, 5,000,000 shares authorized;
none issued - -
Common stock, $.01 par value, 150,000,000 shares authorized; 14,562,854
and 14,309,892 shares issued 146 143
Capital in excess of par value 98,044 94,454
Retained earnings 134,990 128,519
Treasury stock at cost, 495,326 and 208,226 shares (14,525) (8,788)
Deferred compensation (151) (31)
Accumulated other comprehensive loss (Note 2) (1,488) (2,539)
-------- --------
217,016 211,758
-------- --------
$276,533 $271,713
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
Three Months Ended
----------------------------
July 3, June 28,
(In thousands, except per share amounts) 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Revenues $57,782 $55,784
------- -------
Costs and Operating Expenses:
Cost of revenues 36,652 35,086
Selling, general, and administrative expenses 15,566 13,382
Research and development expenses 693 1,310
Restructuring and unusual items (Note 6) - (180)
------- -------
52,911 49,598
------- -------
Operating Income 4,871 6,186
Interest Income 318 214
Interest Expense (4) (11)
------- -------
Income Before Provision for Income Taxes and Minority Interest 5,185 6,389
Provision for Income Taxes 1,428 2,428
Minority Interest Expense 14 72
------- -------
Net Income $ 3,743 $ 3,889
======= =======
Earnings per Share (Note 3):
Basic $ .26 $ .29
======= =======
Diluted $ .26 $ .28
======= =======
Weighted Average Shares (Note 3):
Basic 14,218 13,601
======= =======
Diluted 14,555 13,908
======= =======
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
Six Months Ended
-----------------------------
July 3, June 28,
(In thousands, except per share amounts) 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Revenues $109,509 $107,159
-------- --------
Costs and Operating Expenses:
Cost of revenues 68,617 67,294
Selling, general, and administrative expenses 30,434 26,894
Research and development expenses 1,711 2,353
Restructuring and unusual items (Note 6) - (180)
-------- --------
100,762 96,361
-------- --------
Operating Income 8,747 10,798
Interest Income 647 450
Interest Expense (12) (28)
-------- --------
Income Before Provision for Income Taxes and Minority Interest 9,382 11,220
Provision for Income Taxes 2,897 4,264
Minority Interest Expense 14 72
-------- --------
Net Income $ 6,471 $ 6,884
======== ========
Earnings per Share (Note 3):
Basic $ .46 $ .51
======== ========
Diluted $ .44 $ .50
======== ========
Weighted Average Shares (Note 3):
Basic 14,220 13,588
======== ========
Diluted 14,579 13,837
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
Six Months Ended
----------------------------
July 3, June 28,
(In thousands) 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 6,471 $ 6,884
Adjustments to reconcile net income to net cash provided by operating
activities:
Gain on sale of property (Note 6) (140) (649)
Depreciation and amortization 2,419 2,607
Provision for losses on accounts receivable 218 77
Minority interest expense 14 72
Other non-cash items 312 172
Changes in current accounts:
Accounts receivable (993) (4,259)
Unbilled contract costs and fees (878) (7,725)
Inventories 911 (1,440)
Other current assets (117) (208)
Accounts payable 1,261 4,809
Other current liabilities (601) 2,718
------- -------
Net cash provided by operating activities 8,877 3,058
------- -------
Investing Activities:
Purchases of property, plant, and equipment (1,146) (1,448)
Proceeds from sale of property, plant, and equipment 1,279 940
Acquisition of minority interest in subsidiary (318) -
Other, net (94) (125)
------- -------
Net cash used in investing activities (279) (633)
------- -------
Financing Activities:
Net proceeds from issuance of Company common stock 4,598 791
Purchases of Company common stock (6,159) -
Repayments of long-term obligations (598) (567)
------- -------
Net cash (used in) provided by financing activities (2,159) 224
------- -------
Exchange Rate Effect on Cash 698 5,404
------- -------
Increase in Cash and Cash Equivalents 7,137 8,053
Cash and Cash Equivalents at Beginning of Period 74,451 44,429
------- -------
Cash and Cash Equivalents at End of Period $81,588 $52,482
======= =======
The accompanying notes are an integral part of these condensed consolidated financial statements.
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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," "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 July 3,
2004, its results of operations for the three- and six-month periods ended July
3, 2004, and June 28, 2003, and cash flows for the six-month periods ended July
3, 2004, and June 28, 2003. Interim results are not necessarily indicative of
results for a full year.
The condensed consolidated balance sheet presented as of January 3, 2004,
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 consolidated
financial statements and related notes of the Company. The condensed
consolidated financial statements and notes included herein should be read in
conjunction with the consolidated financial statements and related notes
included in the Company's Annual Report on Form 10-K for the fiscal year ended
January 3, 2004, filed with the Securities and Exchange Commission.
2. Comprehensive Income
Comprehensive income combines net income and "other comprehensive items,"
which represents certain amounts that are reported as components of
shareholders' investment in the accompanying condensed consolidated balance
sheet, including foreign currency translation adjustments and deferred gains and
losses on foreign currency contracts. During the second quarters of 2004 and
2003, the Company had comprehensive income of $2,780,000 and $8,870,000,
respectively. During the first six months of 2004 and 2003, the Company had
comprehensive income of $7,522,000 and $15,616,000, respectively.
The components of comprehensive income were as follows:
Three Months Ended Six Months Ended
------------------------ ------------------------
July 3, June 28, July 3, June 28,
(In thousands) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------------
Net Income $3,743 $3,889 $6,471 $ 6,884
------ ------ ------ -------
Other Comprehensive (Loss) Income
Foreign Currency Translation Adjustments (949) 5,119 1,087 8,866
Deferred Loss on Foreign Currency Contracts (14) (138) (36) (134)
------ ------ ------
(963) 4,981 1,051 8,732
------ ------ ------
Comprehensive Income $2,780 $8,870 $7,522 $15,616
====== ====== ====== =======
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3. Earnings per Share
Basic and diluted earnings per share were calculated as follows:
Three Months Ended Six Months Ended
------------------------- -------------------------
July 3, June 28, July 3, June 28,
(In thousands, except per share amounts) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Basic
Net Income $ 3,743 $ 3,889 $ 6,471 $ 6,884
------- ------- ------- -------
Weighted Average Shares 14,218 13,601 14,220 13,588
------- ------- ------- -------
Basic Earnings per Share $ 0.26 $ 0.29 $ 0.46 $ 0.51
======= ======= ======= =======
Diluted
Net Income $ 3,743 $ 3,889 $ 6,471 $ 6,884
------- ------- ------- -------
Weighted Average Shares 14,218 13,601 14,220 13,588
Effect of Stock Options 337 307 359 249
------- ------- ------- -------
Weighted Average Shares, as Adjusted 14,555 13,908 14,579 13,837
------- ------- ------- -------
Diluted Earnings per Share $ 0.26 $ 0.28 $ 0.44 $ 0.50
======= ======= ======= =======
Options to purchase approximately 222,400 and 345,700 shares of common
stock for the second quarters of 2004 and 2003, respectively, and 234,700 and
369,500 shares of common stock for the first six months of 2004 and 2003,
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 the effect of their inclusion would have been
antidilutive.
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
(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. The composite building products business experienced an increase
in warranty claims versus historical claim rates in the latter half of 2003 and
the first six months of 2004. The Company increased its estimated costs for
product warranties for this business and recorded related warranty expenses of
$1,330,000 in the first six months of 2004 versus $477,000 in the first six
months of 2003. While the Company engages in extensive product quality programs
and processes, its warranty obligation is affected by product failure rates,
repair costs, service delivery costs incurred in correcting product failures,
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.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Warranty Obligations (continued)
The changes in the carrying amount of the Company's consolidated product
warranties for the three- and six- month periods ended July 3, 2004 and June 28,
2003, are as follows:
Three Months Ended
---------------------------------------
(In thousands) July 3, 2004 June 28, 2003
- ------------------------------------------------------------------------------------------------------------------------------
Balance at Beginning of Period $4,922 $4,564
Provision charged to income 1,408 640
Usage (1,375) (454)
Other, net (a) (24) 167
------ ------
Balance at End of Period $4,931 $4,917
====== ======
Six Months Ended
---------------------------------------
(In thousands) July 3, 2004 June 28, 2003
- ------------------------------------------------------------------------------------------------------------------------------
Balance at Beginning of Period $4,530 $4,310
Provision charged to income 2,703 1,243
Usage (2,321) (924)
Other, net (a) 19 288
------ ------
Balance at End of Period $4,931 $4,917
====== ======
(a) Represents the effects of currency translation.
5. Inventories
The components of inventories are as follows:
(In thousands) July 3, 2004 January 3, 2004
- ------------------------------------------------------------------------------------------------------------------------------
Raw Materials and Supplies $13,341 $13,049
Work in Process 7,391 7,806
Finished Goods (includes $725 and $860 at customer locations) 11,713 12.348
------- -------
$32,445 $33,203
======= =======
6. Restructuring and Unusual Items
During the second quarter of 2003, the Company recorded net restructuring
costs and unusual income of $180,000, including $469,000 of restructuring costs
and $649,000 of unusual income as detailed hereafter. The restructuring costs of
$469,000, which were accounted for in accordance with Statement of Financial
Accounting Standards No. 112 (SFAS No. 112), "Employers' Accounting for
Postemployment Benefits - an amendment of SFAS No. 5 and 43", 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 the Company's products. The unusual income
resulted from a gain of $649,000 from the sale of property, for approximately
$921,000 in cash, at the same subsidiary.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. Restructuring and Unusual Items (continued)
A summary of the changes in accrued restructuring costs, which are
included in other current liabilities in the accompanying condensed consolidated
balance sheet, are as follows:
(In thousands) Severance
- -----------------------------------------------------------------------------------------------
Balance at January 3, 2004 $200
Usage (46)
Currency translation 5
----
Balance at July 3, 2004 $159
====
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
its restructuring activities and anticipates that all actions related to these
liabilities will be completed by the end of 2004.
7. Business Segment Information
Three Months Ended Six Months Ended
------------------------- --------------------------
July 3, June 28, July 3, June 28,
(In thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Equipment and Systems $50,933 $50,674 $ 96,497 $ 96,231
Composite and Fiber-based Products 6,849 5,110 13,012 10,928
------- ------- -------- --------
$57,782 $55,784 $109,509 $107,159
======= ======= ======== ========
Income Before Provision for Income Taxes and
Minority Interest:
Pulp and Papermaking Equipment and Systems (a) $ 6,152 $ 6,691 $ 12,495 $ 11,931
Composite and Fiber-based Products (b) 104 571 (532) 983
Corporate (c) (1,385) (1,076) (3,216) (2,116)
------- ------- -------- --------
Total Operating Income 4,871 6,186 8,747 10,798
Interest Income, Net 314 203 635 422
------- ------- -------- --------
$ 5,185 $ 6,389 $ 9,382 $ 11,220
======= ======= ======== ========
Capital Expenditures:
Pulp and Papermaking Equipment and Systems $ 505 $ 359 $ 835 $ 561
Composite and Fiber-based Products 190 228 300 876
Corporate 8 8 11 11
------- ------- -------- --------
$ 703 $ 595 $ 1,146 $ 1,448
======= ======= ======== ========
(a) Includes a gain of $971 in the six-month period ending July 3, 2004, which resulted from renegotiating a series of agreements
with one of the Company's licensees, and net restructuring costs and unusual income of $180 in the three- and six-month periods
ended June 28, 2003 (Note 6).
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
7. Business Segment Information (continued)
(b) Includes operating losses from the composite building products business of
$370 and $1,302 in the three- and six-month periods ended July 3, 2004,
respectively, and operating income of $26 and $110 in the three- and
six-month periods ended June 28, 2003, respectively.
(c) Primarily general and administrative expenses.
8. Stock-Based Compensation
As permitted by SFAS No. 148, "Accounting for Stock-based Compensation -
Transition and Disclosure," and SFAS No. 123, "Accounting for Stock-based
Compensation," the Company has elected to continue to apply Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations 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 Six Months Ended
------------------------- -------------------------
July 3, June 28, July 3, June 28,
(In thousands, except per share amounts) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Net Income:
As reported $3,743 $3,889 $6,471 $6,884
Deduct: Total stock-based employee
compensation expense determined
under the fair-value-based method
for all awards, net of tax (623) (616) (1,129) (1,285)
------ ------ ------- ------
Pro forma $3,120 $3,273 $5,342 $5,599
====== ====== ====== ======
Basic Earnings per Share:
As reported $ .26 $ .29 $ .46 $ .51
Pro forma $ .22 $ .24 $ .38 $ .41
Diluted Earnings Per Share:
As reported $ .26 $ .28 $ .44 $ .50
Pro forma $ .21 $ .24 $ .37 $ .40
9. Employee Benefit Plans
One of the Company's U.S. subsidiaries has a noncontributory defined
benefit retirement plan. Benefits under the plan are based on years of service
and employee compensation. Funds are contributed to a trustee as necessary to
provide for current service and for any unfunded projected benefit obligation
over a reasonable period. The same subsidiary has a post-retirement welfare
benefits plan (reflected in the table below in "Other Benefits"). No future
retirees are eligible for the post-retirement welfare benefits plan, and the
plan includes a limit on the subsidiary's contributions.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
9. Employee Benefit Plans (continued)
The following summarizes the components of the net periodic benefit cost
for the pension benefits and other benefits plans in the three- and six-month
periods ended July 3, 2004 and June 28, 2003.
Three Months Ended Three Months Ended
(In thousands) July 3, 2004 June 28, 2003
- --------------------------------------------------------------------------------------------------------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $158 $ - $156 $ -
Interest cost 227 13 257 19
Expected return on plan assets (342) - (317) -
Recognized net actuarial loss - 9 12 10
Amortization of prior service cost 11 (15) 11 (11)
---- ---- ---- ----
Net periodic benefit cost $ 54 $ 7 $119 $ 18
==== ==== ==== ====
Six Months Ended Six Months Ended
July 3, 2004 June 28, 2003
--------------------------------------------------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $320 $ - $312 $ -
Interest cost 484 26 514 38
Expected return on plan assets (684) - (634) -
Recognized net actuarial loss - 18 24 20
Amortization of prior service cost 22 (30) 22 (22)
---- ---- ---- ----
Net periodic benefit cost $142 $ 14 $238 $ 36
==== ==== ==== ====
The weighted-average assumptions used to determine net periodic benefit cost were as follows:
Discount rate 6.25% 6.25% 6.75% 6.75%
Expected long-term return on plan assets 8.50% - 8.75% -
Rate of compensation increase 4.00% - 5.00% -
No cash contributions are expected for the pension and post-retirement welfare benefits plans in 2004.
10. Recent Accounting Pronouncement
Consolidation of Variable Interest Entities
In January 2003, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest
Entities - An Interpretation of Accounting Research Bulletin (ARB) No. 51",
which addresses consolidation by business enterprises of variable interest
entities (VIEs). In December 2003, the FASB completed deliberations of proposed
modifications to FIN 46 (Revised Interpretations) resulting in multiple
effective dates based on the nature as well as the creation date of the VIE. The
Company does not have interests in special purpose entities and the adoption of
the provisions of FIN 46 and the Revised Interpretations in the first quarter of
2004 did not have an effect on its condensed consolidated financial statements.
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KADANT INC.
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
- -------------
This Quarterly Report on Form 10-Q includes forward-looking statements
that are not statements of historical fact, and may include statements regarding
possible or assumed future results of operations. Forward-looking statements are
subject to risks and uncertainties and are based on the beliefs and assumptions
of our management, using information currently available to our management. When
we use words such as "believes," "expects," "anticipates," "intends," "plans,"
"estimates," "should," "likely," "will," "would," or similar expressions, we are
making forward-looking statements.
Forward-looking statements are not guarantees of performance. They
involve risks, uncertainties, and assumptions. 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. We undertake no obligation to publicly update
any forward-looking statement, whether as a result of new information, future
events, or otherwise. 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.
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 and products for the domestic and
international papermaking and paper recycling industries. We have a large,
stable customer base that includes most of the world's major paper
manufacturers. 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.
We were incorporated in Delaware in November 1991 to be the
successor-in-interest to several papermaking equipment businesses of Thermo
Electron Corporation (Thermo Electron). In November 1992, we completed an
initial public offering of a portion of our outstanding common stock. On July
12, 2001, we changed our name to Kadant Inc. from Thermo Fibertek Inc. In August
2001, Thermo Electron disposed of its remaining equity interest in Kadant by
means of a stock dividend to its shareholders. In May 2003, we moved the listing
of our common stock to the New York Stock Exchange, where it trades under the
symbol "KAI".
Pulp and Papermaking Equipment and Systems Segment
Our Papermaking Equipment segment designs and manufactures
stock-preparation systems and equipment, paper machine accessory equipment, and
water-management systems for the paper and paper recycling industries. Principal
products include:
- Stock-preparation systems and equipment: custom-engineered systems
and equipment, as well as standard individual components, for
pulping, de-inking, screening, cleaning, and refining recycled and
virgin fibers in preparation for entry into the paper machine during
the production of recycled paper;
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KADANT INC.
Overview (continued)
- Paper machine accessory equipment: doctoring systems and related
consumables that continuously clean papermaking rolls to keep paper
machines running efficiently; doctor blades made of a variety of
materials to perform functions including cleaning, creping, web
removal, and application of coatings; and profiling systems that
control moisture, web curl, and gloss during paper production; and
- Water-management systems: systems and equipment used to continuously
clean paper machine fabrics and to drain, purify, and recycle 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 and railing systems and roof
tiles produced from recycled fiber, plastic, and other materials, and
marketed through distributors primarily to the building industry; and
- Fiber-based granular products: biodegradable, absorbant granules made
from papermaking byproducts for use primarily as carriers in
agricultural, home lawn and garden, and professional lawn, turf and
ornamental applications.
International Sales
During the first six months of 2004, 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 seek to 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.
Application of Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based upon our condensed 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. 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 Item 7 of our
Annual Report on Form 10-K for the fiscal year ended January 3, 2004, filed with
the Securities and Exchange Commission. There have been no material changes to
these critical accounting policies and estimates since year-end 2003 that
warrant further disclosure.
14
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KADANT INC.
Overview (continued)
Industry and Business Outlook
Our products are primarily sold to the pulp and paper industry. Although
the paper industry had been in a prolonged downcycle for the past several years,
the performance of paper producers, especially in North America, has been
gradually improving over the past few quarters. Increased operating rates and
improved pricing has helped to increase the profitability of paper producers
during this period. Nevertheless, paper companies are still cautious about
increasing their capital and operating spending in the current market
environment. We expect, however, that as the market recovers, paper companies
will increase their capital and operating spending, which will have a positive
effect on paper company suppliers, such as Kadant, although the timing of such
effect is difficult to predict. We continue to concentrate our efforts on
several initiatives intended to improve our operating results, including: (i)
expanding our business in China, (ii) increasing our higher-margin parts and
consumables businesses across all our product lines, (iii) sourcing the
manufacture of non-proprietary components from third-party suppliers, (iv)
shifting more production to our lower-cost manufacturing facilities, and (v)
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.
We continue to pursue market opportunities outside of North America. In
the last several years, China has become a significant market for our
stock-preparation equipment. To capitalize on this growing market, we have
established a wholly owned subsidiary that will operate a manufacturing and
assembly facility in China for this equipment and related aftermarket products,
as well as for our accessories and water-management products in the future.
Revenues from China are primarily derived from large capital orders, the timing
of which is often difficult to predict. Recently, our customers in China have
experienced delays in obtaining financing for their capital addition and
expansion projects due to efforts by the Chinese government to better control
economic growth. These efforts are reflected in a slowdown in financing
approvals in China's banking system. This has caused delays in receiving orders
and, as a result, will delay revenue recognition on these projects to periods
later than originally expected. We plan to use our new facility in China as a
base for increasing our aftermarket business, which we believe will be more
predictable.
We have also continued to invest in our composite building products
business which, we believe, provides us with an internal growth opportunity. The
market for composite building products has grown 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 wholesale distribution centers and retail lumber yards
throughout the U.S. now carrying our composite decking products.
We did, however, experience some problems in the composite building
products business that affected our profitability in the first six months of
2004 and will continue to hamper profitability in the second half of 2004.
Beginning in mid-2003 and continuing into the first six months of 2004, we
experienced an increase in warranty claims over the first six months of 2003,
which had an adverse impact on profitability. The majority of these claims were
associated with excessive contraction of certain decking products. Although we
believe the production problems were corrected in 2003, we are still
experiencing a significant level of claims associated with decking products
produced and installed before the corrective actions were implemented. In
addition, the cost of plastic used in our composite building products has
significantly increased recently. The combination of higher warranty expense and
plastic costs over last year will continue to have a significant adverse impact
on our profitability in the composite building products business for the
remainder of 2004. These factors considered, for the third quarter of 2004 we
expect our composite building products business to report, on a generally
accepted accounting principles (GAAP) basis, in the range of an operating loss
of $0.2 million to operating income of $0.1 million, on revenues of $4 to $4.5
million. For the full year, we expect this business to report an operating loss
of $1.3 to $1.9 million, compared to our previously announced guidance of an
operating loss of $0.8 to $1.2 million, on revenues of $16 to $17 million.
15
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KADANT INC.
Overview (continued)
For the total company, for the third quarter of 2004, we expect to earn,
on a consolidated GAAP basis, $0.17 to $0.20 per diluted share, on revenues of
$46 to $48 million. For the full year, we expect to earn, on a consolidated GAAP
basis, $0.85 to $0.90 per diluted share on revenues of $205 to $210 million,
down from our previously announced guidance of $0.90 to $1.00 per diluted share,
on revenues of $205 to $215 million.
Results of Operations
Second Quarter 2004 Compared With Second Quarter 2003
- -----------------------------------------------------
The following table sets forth our unaudited condensed consolidated
statement of income expressed as a percentage of total revenues for the second
fiscal quarters of 2004 and 2003. The results of operations for the fiscal
quarter ended July 3, 2004, are not necessarily indicative of the results to be
expected for the full fiscal year.
Three Months Ended
---------------------------
July 3, June 28,
2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
---- ----
Costs and Operating Expenses:
Cost of revenues 64 63
Selling, general, and administrative expenses 27 24
Research and development expenses 1 2
---- ----
92 89
---- ----
Operating Income 8 11
Interest Income, net 1 -
---- ----
Income Before Provision for Income Taxes and Minority Interest 9 11
Provision for Income Taxes 2 4
---- ----
Net Income 7% 7%
==== ====
Revenues
Revenues increased to $57.8 million in the second quarter of 2004 from
$55.8 million in the second quarter of 2003, an increase of $2.0 million, or 4%.
Revenues in 2004 included the favorable effect of currency translation of $1.7
million due to a weaker U.S. dollar relative to most of the functional
currencies in countries in which we operate.
Revenues by segment for the second quarter of 2004 and 2003 were as
follows:
Three Months Ended
--------------------------
July 3, June 28,
(In thousands) 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Equipment and Systems $50,933 $50,674
Composite and Fiber-based Products 6,849 5,110
------- -------
$57,782 $55,784
======= =======
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KADANT INC.
Results of Operations (continued)
Second Quarter 2004 Compared With Second Quarter 2003 (continued)
- -----------------------------------------------------
Pulp and Papermaking Equipment and Systems Segment. Revenues at the
Papermaking Equipment segment increased to $50.9 million in the second quarter
of 2004 compared with $50.7 million in the second quarter of 2003, an increase
of $0.2 million, or 1%. Revenues in the 2004 period included a $1.7 million, or
3%, increase from the favorable effect of currency translation. Revenues from
the Papermaking Equipment segment's stock-preparation equipment product line
decreased by $0.5 million, or 2%, in the second quarter of 2004 compared to the
second quarter of 2003 as a result of a decrease in sales in North America,
which was partially offset by the favorable effect of foreign currency
translation from sales in Europe and an increase in sales in China. Sales in
North America decreased $1.8 million, or 22%, in the 2004 quarter compared to
the 2003 quarter due to the timing of several large orders that shipped in the
second quarter of 2003. Sales in Europe increased $0.4 million, or 4%, in the
second quarter of 2004 compared to 2003, which included a $1.0 million, or 10%,
favorable effect of currency translation. Revenues in the stock-preparation
equipment product line from China increased $0.8 million, or 9%, to $10.4
million in the second quarter of 2004 compared to $9.6 million in the second
quarter of 2003 due to the timing of several large orders. Revenues from the
segment's paper machine accessories product line increased $1.1 million, or 7%,
in the second quarter of 2004 compared to 2003 due primarily to a $0.7 million
favorable effect of currency translation. Revenues from the segment's
water-management product line decreased $0.3 million, or 3%, in 2004, including
a $0.1 million favorable effect of currency translation.
Composite and Fiber-Based Products Segment. Revenues at the Composite
and Fiber-based Products segment increased to $6.8 million in the second quarter
of 2004 from $5.1 million in 2003 as a result of an increase of $1.7 million, or
52%, in sales of our composite building products due to higher demand resulting
from continued acceptance of composites as an alternative to wood in the decking
market, our increased marketing efforts and expansion of our distribution
channels.
Gross Profit Margin
Gross profit margin was 37% in the second quarters of 2004 and 2003.
Gross profit margin for the second quarters of 2004 and 2003 by segment
was as follows:
Three Months Ended
--------------------------
July 3, June 28,
2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Equipment and Systems 38% 37%
Composite and Fiber-based Products 22% 37%
--- ---
37% 37%
--- ---
The gross profit margin at the Papermaking Equipment segment increased to
38% in the second quarter of 2004 from 37% in the second quarter of 2003. The
gross profit margin at the Composite and Fiber-based Products segment decreased
to 22% in the second quarter of 2004 from 37% in the second quarter of 2003 due
primarily to higher warranty costs associated with composite building products.
The warranty provision increased to $0.8 million in the second quarter of 2004
compared to $0.3 million in the second quarter of 2003 as the result of an
increase in claims associated with excessive contraction of certain decking
products. Although we believe the production problems were corrected in 2003, we
are still experiencing claims associated with product produced and installed
before the corrective actions were implemented. We expect that our gross profit
margins in the third quarter of 2004 will continue to be adversely affected by
the higher warranty costs. The price of plastic used to produce our composite
products has recently increased and we expect this will also adversely affect
gross profit margins in the third quarter of 2004.
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KADANT INC.
Results of Operations (continued)
Second Quarter 2004 Compared With Second Quarter 2003 (continued)
- -----------------------------------------------------
Operating Expenses
Selling, general, and administrative expenses as a percentage of
revenues increased to 27% in the second quarter of 2004 compared with 24% in the
second quarter of 2003. Selling, general, and administrative expenses increased
$2.2 million, or 16%, to $15.6 million in the second quarter of 2004 from $13.4
million in 2003. This increase included a $0.7 million, or 8%, increase in
selling expenses, a $0.5 million increase from the unfavorable effect of foreign
currency translation at the Papermaking Equipment segment, a $0.4 million
increase related to severance costs associated with one of our European
operations and a $0.2 million increase in costs associated with the
implementation of the internal control requirements of the Sarbanes-Oxley Act.
Research and development expenses decreased $0.6 million to $0.7 million,
or 1% of revenues, in the second quarter of 2004 compared with $1.3 million, or
2% of revenues, in the second quarter of 2003 due, in part, to the timing of
material purchases for research and development projects.
Restructuring and Unusual Items
During the second quarter of 2003, we recorded net restructuring costs
and unusual income of $0.2 million. Restructuring costs of $0.5 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. 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 6).
Interest Income
Interest income increased to $0.3 million in the second quarter of 2004
from $0.2 million in the second quarter of 2003 primarily due to higher average
invested balances.
Income Taxes
Our effective tax rate was 28% and 38% in the second quarters of 2004
and 2003, respectively. The 28% effective tax rate in the second quarter of 2004
was lower than the statutory federal income tax rate due mainly to a reduction
of $0.4 million in the second quarter of 2004 in tax reserves primarily
associated with our foreign operations, as the reserves were no longer required.
The 38% effective tax rate in the second quarter of 2003 exceeded the statutory
federal income tax rate primarily due to the impact of state income taxes and
nondeductible expenses.
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KADANT INC.
Results of Operations (continued)
First Six Months 2004 Compared With First Six Months 2003
- ---------------------------------------------------------
The following table sets forth our unaudited condensed consolidated
statement of income expressed as a percentage of total revenues for the first
six months of 2004 and 2003. The results of operations for the first six months
of 2004 are not necessarily indicative of the results to be expected for the
full fiscal year.
Six Months Ended
-------------------------
July 3, June 28,
2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
---- ----
Costs and Operating Expenses:
Cost of revenues 63 63
Selling, general, and administrative expenses 28 25
Research and development expenses 1 2
---- ----
92 90
---- ----
Operating Income 8 10
Interest Income, net 1 -
---- ----
Income Before Provision for Income Taxes and Minority Interest 9 10
Provision for Income Taxes 3 4
---- ----
Net Income 6% 6%
==== ====
Revenues
Revenues increased to $109.5 million in the first six months of 2004 from
$107.2 million in the first six months of 2003, an increase of $2.3 million, or
2%. Revenues in the 2004 period included the favorable effect of currency
translation of $4.7 million due to a weaker U.S. dollar relative to most of the
functional currencies in countries in which we operate.
Revenues by segment for the first six months of 2004 and 2003 were as follows:
Six Months Ended
--------------------------
July 3, June 28,
(In thousands) 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Equipment and Systems $ 96,497 $ 96,231
Composite and Fiber-based Products 13,012 10,928
--------- ---------
$ 109,509 $ 107,159
========= =========
Pulp and Papermaking Equipment and Systems Segment. Revenues at the
Papermaking Equipment segment increased to $96.5 million in the first six months
of 2004 compared with $96.2 million in the first six months of 2003, an increase
of $0.3 million. Revenues in the 2004 period included a $4.7 million, or 5%,
increase from the favorable effect of currency translation. Revenues from the
Papermaking Equipment segment's stock-preparation equipment product line
decreased by $3.0 million, or 6%, in the first six months of 2004 compared to
the first six months of 2003 due primarily to a decrease in sales in North
America and China. Sales in North America decreased $2.8 million, or 18%, in the
first six months of 2004 compared to 2003 due to the timing of several large
orders that shipped in 2003. Revenues in the stock-preparation equipment product
line from China decreased $0.8 million, or 4%, to $17.1 million in the first six
months of 2004 from $17.9 million in the first six months of 2003. Sales in
Europe increased $0.7
<
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KADANT INC.
Results of Operations (continued)
First Six Months 2004 Compared With First Six Months 2003 (continued)
- ---------------------------------------------------------
million, or 4%, in the first six months of 2004 compared to 2003, which included
a $2.4 million, or 13%, favorable effect of currency translation. Revenues from
the segment's paper machine accessories product line increased $2.7 million, or
9%, including a $1.9 million favorable effect of currency translation, in the
first six months of 2004 compared to the first six months of 2003. Revenues from
the segment's water-management product line increased $0.5 million, or 4%, in
the first six months of 2004, due primarily to a $0.5 million favorable effect
of currency translation.
Composite and Fiber-Based Products Segment. Revenues at the Composite
and Fiber-based Products segment increased $2.1 million, or 19%, to $13.0
million in the first six months of 2004 from $10.9 million in 2003 primarily as
a result of a $1.6 million, or 21%, increase in sales of our composite building
products due to higher demand resulting from continued acceptance of composites
as an alternative to wood in the decking market, as well as, our increased
marketing efforts and expansion of our distribution channels. Revenues from our
fiber-based granular products increased $0.5 million, or 14%, in the first six
months of 2004 compared with the first six months of 2003.
Gross Profit Margin
Gross profit margin was 37% in the first six months of 2004 and 2003.
Gross profit margin for the first six months of 2004 and 2003 by segment
was as follows:
Six Months Ended
---------------------------
July 3, June 28,
2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Equipment and Systems 39% 38%
Composite and Fiber-based Products 19% 35%
--- ---
37% 37%
--- ---
The gross profit margin at the Papermaking Equipment segment increased to
39% in the first six months of 2004 from 38% in 2003. The gross profit margin at
the Composite and Fiber-based Products segment decreased to 19% in the first six
months of 2004 from 35% in the first six months of 2003 due primarily to higher
warranty costs associated with composite building products. The warranty
provision increased to $1.3 million in the first six months of 2004 compared to
$0.5 million in the first six months of 2003 as the result of an increase in
claims associated with excessive contraction of certain decking products.
Although we believe the production problems were corrected in 2003, we are still
experiencing claims associated with product produced and installed before the
corrective actions were implemented. We expect that our gross profit margins in
the third quarter of 2004 will continue to be adversely affected by higher
warranty costs. The price of plastic used to produce our composite products has
recently increased and we expect this will also adversely affect gross profit
margins in the third quarter of 2004.
Operating Expenses
Selling, general, and administrative expenses as a percentage of
revenues were 28% in the first six months of 2004 compared with 25% in the first
six months of 2003. Selling, general, and administrative expenses increased $3.5
million, or 13%, to $30.4 million in the first six months of 2004 from $26.9
million in the first six months of 2003 primarily due to a $1.2 million, or 11%,
increase in general and administrative expenses, an increase of $1.2 million
from the unfavorable effects of foreign currency translation at the Papermaking
Equipment segment and a $1.1 million, or 7%, increase in selling expenses. Also
included in selling, general and administrative expenses was a gain of
approximately $1.0 million in the first quarter of 2004, which resulted from
renegotiating a series of agreements with one of our licensees.
<
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KADANT INC.
Results of Operations (continued)
First Six Months 2004 Compared With First Six Months 2003 (continued)
- ---------------------------------------------------------
Operating Expenses (continued)
Research and development expenses as a percentage of revenues were 1% and
2% in the first six months of 2004 and 2003, respectively.
Restructuring and Unusual Items
During the first six months of 2003, we recorded net restructuring costs
and unusual income of $0.2 million due to the reasons discussed in the results
of operations for the second quarter of 2004.
Interest Income
Interest income increased to $0.6 million in the first six months of
2004 from $0.5 million in the first six months of 2003 primarily due to higher
average invested balances.
Income Taxes
Our effective tax rate was 31% and 38% in the first six months of 2004
and 2003, respectively. The 31% effective tax rate in the first six months of
2004 was lower than the statutory federal income tax rate due mainly to a
reduction of $0.4 million in the second quarter of 2004 in tax reserves
primarily associated with our foreign operations, as the reserves were no longer
required. The 38% effective tax rate in the first six months of 2003 exceeded
the statutory federal income tax rate primarily due to the impact of state
income taxes and nondeductible expenses.
Liquidity and Capital Resources
Consolidated working capital was $113.9 million at July 3, 2004, compared
with $107.0 million at January 3, 2004. Included in working capital are cash and
cash equivalents of $81.6 million at July 3, 2004, compared with $74.5 million
at January 3, 2004. At July 3, 2004, $45.7 million of cash and cash equivalents
was held by our foreign subsidiaries.
During the first six months of 2004, cash of $8.9 million was provided
by operating activities, compared with $3.1 million in the first six months of
2003. The cash provided by operating activities in 2004 was primarily the result
of net income and non-cash charges for depreciation and amortization expense. In
addition, an increase in accounts payable provided a source of cash of $1.3
million in 2004 primarily at the Papermaking Equipment segment due to the timing
of payments.
Our investing activities used $0.3 million of cash in the first six
months of 2004, compared with $0.6 million in the first six months of 2003.
During the first six months of 2004, we purchased property, plant, and equipment
for $1.1 million and received proceeds of $1.3 million from the sale of
property, plant, and equipment.
Our financing activities used cash of $2.2 million in the first six
months of 2004, compared with $0.2 million of cash provided in the first six
months of 2003. During the first six months of 2004, we purchased 297,100 shares
of our common stock on the open market for $6.2 million. (See Part II - Item 2
for further discussion.) In addition, we received proceeds of $4.6 million from
the issuance of our common stock in connection with our employee stock option
and stock purchase plans and used cash to repay $0.6 million of long-term notes
payable in the first six months of 2004.
< 21
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KADANT INC.
Liquidity and Capital Resources (continued)
At July 3, 2004, we had $53.8 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 certain of our international subsidiaries. We do
not expect that this will have a material adverse effect on our current
liquidity.
In May 2004, our board of directors authorized the repurchase of up to
$30 million of our equity securities in the open market or in negotiated
transactions through May 18, 2005. As of July 3, 2004, we purchased 248,500
shares of our common stock on the open market for $5.2 million under this
authorization. In addition, during the second quarter of 2004, we purchased
48,600 shares of our common stock on the open market for $1.0 million under a
previous authorization to purchase up to $25 million of our common stock, which
expired on May 15, 2004.
Although we currently have no material commitments for capital
expenditures, we plan to make expenditures during the remainder of 2004 for
property, plant, and equipment of approximately $2.9 million, including $1.0
million for our manufacturing and assembly facility in China.
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 and stock repurchases, or 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 2004 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.
We sell products primarily to the pulp and paper industry, which is a
cyclical 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. In recent years, the industry in certain geographic regions,
notably North America, 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. As paper
companies consolidate in response to market weakness, they frequently reduce
capacity and postpone or even cancel capacity addition or expansion projects.
These cyclical downturns can cause our sales to decline and adversely affect our
profitability.
Our business is subject to economic, currency, political, and other risks
associated with international sales and operations.
During the first six months of 2004, 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 tariffs, or adopt other
restrictions on foreign trade; and
- the protection of intellectual property in foreign countries may be
more difficult to enforce.
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KADANT INC.
Risk Factors (continued)
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. An increase in revenues, as well as our planned
operation of a manufacturing and assembly facility in China, 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 credit risk 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 that 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.
Competitors' technologies may prove to be superior to ours. Our current
products, those under development, and our ability to develop new technologies
may not be sufficient to enable us to compete effectively. Competition,
especially in China, could increase if new companies enter the market or if
existing competitors expand their product lines or intensify efforts within
existing product lines. In addition, our composite building products business is
subject to intense competition, particularly in the decking market, from
traditional wood products and other composite lumber 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 success in the market for composite building products will depend on our
ability to manufacture and distribute 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 testing
and technical expertise in the formulation and manufacture of the products, and
our efforts may not be successful. Further, growth of our composite building
products business requires ongoing market acceptance. We expect to incur
significant branding and distribution expenses to successfully market and
distribute these products and our strategy may not be successful. We have
limited 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. Our capacity may not be sufficient to meet demand without
significant additional investment. In addition, the majority of our production
is dependent upon a single piece of equipment. If that equipment were to fail
for an extended period of time, it would have a material adverse effect on our
revenues from this business in that period. 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.
<
23
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KADANT INC.
Risk Factors (continued)
Economic conditions 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 fourth and first quarters, 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. 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 over long periods of
time 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 for applications about 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. In the second half of 2003 and the first six months of 2004,
we experienced a significant increase in warranty claims and warranty expense
related to our composite decking products including, but not limited to,
excessive contraction of our deck boards. Although we believe we corrected these
problems in 2003, claims relating to these production problems continue for
boards produced prior to implementation of the corrective manufacturing changes.
Although we increased the warranty provisions accordingly, we cannot guarantee
that the reserves established will be sufficient if we incur warranty claims
higher than anticipated. In addition, there can be no assurance that other
problems will not develop. A continued high level of warranty claims or expenses
and/or failure of our products to perform or to be accepted in the marketplace
would have an adverse impact on the profitability of our business.
We are dependent on a single mill for the raw material used in our fiber-based
granules, and we may not be able to obtain raw material on commercially
reasonable terms; in addition, the manufacture of our composite building
products and 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 fiber-based granules and composite building products. 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 not to renew its contract with us at the
end of 2005, or may not agree to renew on commercially reasonable terms. If this
were to occur, we would be forced to find an alternative supply for this raw
material. We 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 might
prevent prices for our products from being competitive.
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KADANT INC.
Risk Factors (continued)
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 short-term forward contracts to purchase specified quantities of
natural gas from a supplier. We may not be able to effectively manage our
exposure to natural gas price fluctuations.
Our composite building products also contain plastics, which are subject
to wide fluctuations in pricing and availability. Higher energy costs can
increase the price of plastic significantly and rapidly. 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.
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 previously acquired several companies
and businesses. As a result of these acquisitions, we recorded significant
goodwill on our balance sheet, and in conjunction with the adoption of SFAS No.
142, "Goodwill and Other Intangible Assets", in 2002, we recorded a transitional
impairment charge upon the adoption of this standard. Any future impairment
losses identified 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 depend, in part, 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 rights under these
patents may not provide us with competitive advantages. A patent relating to our
fiber-based granular products expired in the second quarter of 2004. As a
result, we could be subject to increased 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 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.
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KADANT INC.
Risk Factors (continued)
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 in defending 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 prohibit 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. 104, "Revenue Recognition" (SAB No. 104) we may
not be able to reliably predict future revenues and profitability, and
unexpected changes may cause us to adjust our operations. A large proportion 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. 104;
- 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.
Anti-takeover provisions in our charter documents, under Delaware law, and in
our shareholder rights plan 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.
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KADANT INC.
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
2003.
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 of 1934, as amended) as of July 3, 2004. Based
on this evaluation, our CEO and CFO concluded that, as of July 3, 2004, 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
No change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended) occurred during the fiscal quarter ended July 3, 2004 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 2 - Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
- ------------------------------------------------------------------------------
Securities
- ----------
The following table provides information about purchases by us of our
common stock during the three months ended July 3, 2004:
Total Number of Shares Remaining Funds
Purchased as Part of Available to
Total Number of Shares Average Price Paid Publicly Announced Plans Repurchase Shares
Period Purchased (1) per Share (2) Under the Plans
------------------------ ---------------------- ------------------ ------------------------ -----------------
4/4/04 - 4/30/04 - - - $ 25,000,000
5/1/04 - 5/31/04 154,800 $20.09 154,800 $ 27,819,338
6/1/04 - 7/3/04 142,300 $21.43 142,300 $ 24,763,256
------- -------
Total: 297,100 $20.73 297,100
======= =======
(1) We repurchased an aggregate of 48,600 and 248,500 shares of our
common stock pursuant to the repurchase programs that we publicly
announced on May 16, 2003 ("2003 Repurchase Program") and May 18, 2004
("2004 Repurchase Program"), respectively. Of the 297,100 shares
repurchased, all shares were purchased on the open market.
(2) Our board of directors approved the repurchase by us of up to $25
million of our common stock pursuant to the 2003 Repurchase Program and
up to $30 million of our common stock pursuant to the 2004 Repurchase
Program. The repurchases may be made in the open market or in negotiated
transactions, from time to time, depending on market conditions. The
expiration date of the 2003 Repurchase Program was May 15, 2004. On May
18, 2004, our board of directors authorized the 2004 Repurchase Program,
which provides for the repurchase of up to $30 million of our equity
securities in the open market or in negotiated transactions through May
18, 2005. As of July 3, 2004, 248,500 shares of our common stock had been
repurchased for $5.2 million under the 2004 Repurchase Program.
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KADANT INC.
Item 4 - Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
On May 18, 2004, at the annual meeting of shareholders, the shareholders
elected one incumbent director, Mr. William A. Rainville, to the class of
directors whose three-year term expires at Kadant's annual meeting of
shareholders in 2007. Mr. Rainville received 13,060,781 shares voted in favor of
his election and 438,910 shares voted against.
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 April 29, 2004, we furnished a Current Report on Form 8-K furnishing
(pursuant to Item 12) the text of our press release dated April 28, 2004,
announcing our first quarter 2004 financial results.
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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 10th day of August, 2004.
KADANT INC.
/s/ Thomas M. O'Brien
----------------------------------------------------
Thomas M. O'Brien
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
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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