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 October 2, 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 of (I.R.S. Employer
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 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 November 2, 2004
---------------------------- -------------------------------
Common Stock, $.01 par value 13,863,961
PART I - Financial Information
Item 1 - Financial Statements
KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)
Assets
October 2, January 3,
(In thousands) 2004 2004
- --------------------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 77,101 $ 74,451
Accounts receivable, less allowances of $1,753 and $1,680 34,593 32,507
Unbilled contract costs and fees 10,409 10,755
Inventories (Note 5) 30,436 33,203
Deferred tax asset 7,685 7,710
Other current assets 3,565 3,187
-------- --------
163,789 161,813
-------- --------
Property, Plant, and Equipment, at Cost 74,964 77,458
Less: Accumulated depreciation and amortization 51,752 51,631
-------- --------
23,212 25,827
-------- --------
Other Assets 10,656 10,537
-------- --------
Goodwill 73,571 73,536
-------- --------
$271,228 $271,713
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Condensed Consolidated Balance Sheet (continued)
(Unaudited)
Liabilities and Shareholders' Investment
October 2, January 3,
(In thousands, except share amounts) 2004 2004
- --------------------------------------------------------------------------------------------------------------------------------
Current Liabilities:
Current maturities of long-term obligations $ - $ 598
Accounts payable 23,877 23,896
Accrued payroll and employee benefits 10,273 11,356
Accrued warranty costs 8,256 4,530
Accrued income taxes 2,911 1,040
Customer deposits 2,017 2,406
Other current liabilities 7,668 10,983
-------- --------
55,002 54,809
-------- --------
Deferred Income Taxes 1,261 1,617
-------- --------
Other Long-Term Liabilities 3,090 3,178
-------- --------
Minority Interest - 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; 14,571,187
and 14,309,892 shares issued 146 143
Capital in excess of par value 98,178 94,454
Retained earnings 134,497 128,519
Treasury stock at cost, 707,226 and 208,226 shares (18,627) (8,788)
Deferred compensation (100) (31)
Accumulated other comprehensive loss (Note 2) (2,219) (2,539)
-------- --------
211,875 211,758
-------- --------
$271,228 $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 Operations
(Unaudited)
Three Months Ended
------------------------------
October 2, September 27,
(In thousands, except per share amounts) 2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 53,277 $ 45,906
-------- --------
Costs and Operating Expenses:
Cost of revenues 38,671 27,768
Selling, general, and administrative expenses 15,254 12,775
Research and development expenses 922 1,149
Gain on sale of subsidiary (149) -
Restructuring and unusual items (Note 6) - 157
-------- --------
54,698 41,849
-------- --------
Operating Income (Loss) (1,421) 4,057
Interest Income 356 243
Interest Expense (2) (11)
-------- --------
Income (Loss) Before Income Taxes and Minority Interest (1,067) 4,289
Provision (Benefit) for Income Taxes (568) 1,630
Minority Interest Income (6) (4)
-------- --------
Net Income (Loss) $ (493) $ 2,663
======== ========
Earnings (Loss) per Share (Note 3):
Basic $ (.04) $ .20
======== ========
Diluted $ (.04) $ .19
======== ========
Weighted Average Shares (Note 3):
Basic 13,977 13,632
======== ========
Diluted 13,977 14,041
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Statement of Operations
(Unaudited)
Nine Months Ended
-------------------------------
October 2, September 27,
(In thousands, except per share amounts) 2004 2003
- -------------------------------------------------------------------------------------------------------------------------------
Revenues $162,786 $153,065
-------- --------
Costs and Operating Expenses:
Cost of revenues 107,288 95,062
Selling, general, and administrative expenses 45,688 39,669
Research and development expenses 2,633 3,502
Gain on sale of subsidiary (149) -
Restructuring costs and unusual income (Note 6) - (23)
-------- --------
155,460 138,210
-------- --------
Operating Income 7,326 14,855
Interest Income 1,003 693
Interest Expense (14) (39)
-------- --------
Income Before Provision for Income Taxes and Minority Interest 8,315 15,509
Provision for Income Taxes 2,329 5,894
Minority Interest Expense 8 68
-------- --------
Net Income $ 5,978 $ 9,547
======== ========
Earnings per Share (Note 3):
Basic $ .42 $ .70
======== ========
Diluted $ .41 $ .69
======== ========
Weighted Average Shares (Note 3):
Basic 14,139 13,602
======== ========
Diluted 14,480 13,905
======== ========
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)
Nine Months Ended
-------------------------------
October 2, September 27,
(In thousands) 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 5,978 $ 9,547
Adjustments to reconcile net income to net cash provided by operating
activities:
Gain on sale of property (Note 6) (143) (649)
Gain on sale of subsidiary (149) -
Depreciation and amortization 3,613 3,855
Provision for losses on accounts receivable 330 57
Provision for warranty obligations 7,649 2,036
Minority interest expense 8 68
Other items (388) 459
Changes in current accounts, excluding the effects of disposition:
Accounts receivable (4,011) 1,191
Unbilled contract costs and fees 355 2,460
Inventories 2,793 (329)
Other current assets (309) (301)
Accounts payable (60) 524
Other current liabilities (6,401) 1,093
-------- --------
Net cash provided by operating activities 9,265 20,011
-------- --------
Investing Activities:
Sale of subsidiary, net of cash divested 126 -
Acquisition of minority interest in subsidiary (318) -
Purchases of property, plant, and equipment (1,621) (2,570)
Proceeds from sale of property, plant, and equipment 1,303 942
Other, net (223) (202)
-------- --------
Net cash used in investing activities (733) (1,830)
-------- --------
Financing Activities:
Purchases of Company common stock (10,261) -
Net proceeds from issuance of Company common stock 4,758 1,165
Repayments of long-term obligations (598) (567)
-------- --------
Net cash (used in) provided by financing activities (6,101) 598
-------- --------
Exchange Rate Effect on Cash 219 2,479
-------- --------
Increase in Cash and Cash Equivalents 2,650 21,258
Cash and Cash Equivalents at Beginning of Period 74,451 44,429
-------- --------
Cash and Cash Equivalents at End of Period $ 77,101 $ 65,687
======== ========
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," "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 October 2, 2004, its results of operations for the three- and
nine-month periods ended October 2, 2004, and September 27, 2003, and cash flows
for the nine-month periods ended October 2, 2004, and September 27, 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 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 January 3, 2004, 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 condensed
consolidated balance sheet, including foreign currency translation adjustments
and deferred gains and losses on foreign currency contracts.
The components of comprehensive income (loss) were as follows:
Three Months Ended Nine Months Ended
---------------------------- ----------------------------
October 2, September 27, October 2, September 27,
(In thousands) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ (493) $ 2,663 $ 5,978 $ 9,547
------- ------- ------- -------
Other Comprehensive Income (Loss)
Foreign Currency Translation Adjustments (721) (3,421) 366 5,445
Unrealized Loss on Foreign Currency Contracts (10) (35) (46) (169)
------ ------- ------- -------
(731) (3,456) 320 5,276
------ ------- ------- -------
Comprehensive Income (Loss) $(1,224) $ (793) $ 6,298 $14,823
======= ======= ======= =======
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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
---------------------------- ----------------------------
October 2, September 27, October 2, September 27,
(In thousands, except per share amounts) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Basic
Net Income (Loss) $ (493) $ 2,663 $ 5,978 $ 9,547
------ ------- ------- -------
Weighted Average Shares 13,977 13,632 14,139 13,602
------ ------- ------- -------
Basic Earnings (Loss) per Share $ (.04) $ .20 $ .42 $ .70
====== ======= ======= =======
Diluted
Net Income (Loss) $ (493) $ 2,663 $ 5,978 $ 9,547
------ ------- ------- -------
Weighted Average Shares 13,977 13,632 14,139 13,602
Effect of Stock Options - 409 341 303
------ ------- ------- -------
Weighted Average Shares, as Adjusted 13,977 14,041 14,480 13,905
------ ------- ------- -------
Diluted Earnings (Loss) per Share $ (.04) $ .19 $ .41 $ .69
====== ======= ======= =======
Due to the net loss in the third quarter of 2004, approximately 304,900 potential common shares were excluded from the
computation of diluted earnings per share as their inclusion would have had an anti-dilutive effect.
Options to purchase approximately 217,600 and 304,200 shares of common stock for the third quarters of 2004 and 2003,
respectively, and 229,000 and 347,800 shares of common stock for the first nine 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 anti-dilutive.
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.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Warranty Obligations (continued)
The composite building products business (the "composites business")
experienced a significant increase in warranty claims in the latter half of 2003
and the first nine months of 2004 versus historical claim rates associated with
excessive contraction of certain decking products. In addition, in the third
quarter of 2004, the Company increased its warranty reserve primarily as a
result of a significant number of claims associated with a new problem
concerning excessive oxidation that affects the integrity of the plastic used in
some of the Company's decking products. Included in this provision is the cost
of exchanging material held by our distributors with new material and our best
estimate of costs related to future potential valid claims arising from
installed product. Primarily as a result of this new problem, the Company
increased its estimated costs of product warranties for this business and
recorded related warranty expense of $4,576,000 and $5,906,000 in the three- and
nine-month periods ended October 2, 2004, respectively, versus $621,000 and
$1,098,000 in the three- and nine-month periods ended September 27, 2003,
respectively.
In total, the Company recorded consolidated warranty expense of
$4,946,000 and $7,649,000 in the three- and nine-month periods ended October 2,
2004, respectively, associated with all of its product lines. While the Company
engages in 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 the Company's consolidated product
warranties for the three- and nine-month periods ended October 2, 2004 and
September 27, 2003, are as follows:
Three Months Ended Nine Months Ended
---------------------------- ----------------------------
October 2, September 27, October 2, September 27,
(In thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Beginning Balance $ 4,931 $ 4,917 $ 4,530 $ 4,310
Provision charged to income 4,946 793 7,649 2,036
Usage (1,582) (658) (3,903) (1,582)
Other, net (a) (39) (118) (20) 170
-------- ------- ------- -------
Ending Balance $ 8,256 $ 4,934 $ 8,256 $ 4,934
======== ======= ======= =======
(a) Primarily represents the effects of currency translation.
5. Inventories
The components of inventories are as follows:
(In thousands) October 2, 2004 January 3, 2004
- ----------------------------------------------------------------------------------------------------------------------------
Raw Materials and Supplies $ 12,665 $ 13,049
Work in Process 7,955 7,806
Finished Goods (includes $376 and $860 at customer locations) 9,816 12,348
--------- --------
$ 30,436 $ 33,203
========= ========
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. Restructuring and Unusual Items
During the second quarter of 2003, the Company recorded restructuring
costs of $469,000, which were accounted for in accordance with Statement of
Financial Accounting Standards (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. During the third quarter of 2003,
the Company recorded an additional $157,000 of costs related to this
restructuring activity. 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.
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:
Accrued
(In thousands) Restructuring Costs
- -----------------------------------------------------------------------------------------------
Balance at January 3, 2004 $ 200
Usage (168)
Currency translation 1
-------
Balance at October 2, 2004 $ 33
=======
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 Nine Months Ended
---------------------------- ----------------------------
October 2, September 27, October 2, September 27,
(In thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Equipment and Systems $ 47,669 $ 42,023 $144,166 $138,254
Composite and Fiber-based Products 5,608 3,883 18,620 14,811
-------- -------- -------- --------
$ 53,277 $ 45,906 $162,786 $153,065
======== ======== ======== ========
Income (Loss) Before Income Taxes and Minority Interest:
Pulp and Papermaking Equipment and Systems (a) $ 5,595 $ 5,702 $ 18,090 $ 17,633
Composite and Fiber-based Products (b) (5,611) (669) (6,143) 314
Corporate (c) (1,405) (976) (4,621) (3,092)
-------- -------- -------- --------
Total Operating Income (Loss) (1,421) 4,057 7,326 14,855
Interest Income, Net 354 232 989 654
-------- -------- -------- --------
$ (1,067) $ 4,289 $ 8,315 $ 15,509
======== ======== ======== ========
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
7. Business Segment Information (continued)
Three Months Ended Nine Months Ended
---------------------------- ----------------------------
October 2, September 27, October 2, September 27,
(In thousands) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Capital Expenditures:
Pulp and Papermaking Equipment and Systems $ 291 $ 537 $ 1,126 $ 1,098
Composite and Fiber-based Products 179 585 479 1,461
Corporate 5 - 16 11
-------- -------- -------- --------
$ 475 $ 1,122 $ 1,621 $ 2,570
======== ======== ======== ========
(a) Includes a gain of $971 in the nine-month period ending October 2, 2004, which resulted from renegotiating a series of
agreements with one of the Company's licensees, a gain on sale of subsidiary of $149 in the three- and nine-month periods
ended October 2, 2004, restructuring costs of $157 in the three-month period ended September 27, 2003 and restructuring costs
and unusual income of $23 in the nine-month period ended September 27, 2003 (Note 6).
(b) Includes operating losses from the composite building products business of $5,689 and $6,991 in the three- and nine-month
periods ended October 2, 2004, respectively, and $771 and $661 in the three- and nine-month periods ended September 27, 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 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 Nine Months Ended
---------------------------- ----------------------------
October 2, September 27, October 2, September 27,
(In thousands, except per share amounts) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss):
As reported $ (493) $ 2,663 $ 5,978 $ 9,547
Deduct: Total stock-based employee compensation
expense determined under the fair-value-based method
for all awards, net of tax (557) (617) (1,686) (1,902)
------- ------- ------- -------
Pro forma $(1,050) $ 2,046 $ 4,292 $ 7,645
======= ======= ======= =======
Basic Earnings (Loss) per Share:
As reported $ (.04) $ .20 $ .42 $ .70
Pro forma $ (.08) $ .15 $ .30 $ .56
Diluted Earnings (Loss) Per Share:
As reported $ (.04) $ .19 $ .41 $ .69
Pro forma $ (.08) $ .15 $ .30 $ .55
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
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 tables below under the column entitled "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.
The following summarizes the components of the net periodic benefit cost
for the pension benefits and other benefit plans in the three- and nine-month
periods ended October 2, 2004 and September 27, 2003.
Three Months Ended Three Months Ended
(In thousands) October 2, 2004 September 27, 2003
- -------------------------------------------------------------------------------------------------------------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $ 160 $ - $ 156 $ -
Interest cost 242 13 257 19
Expected return on plan assets (343) - (317) -
Recognized net actuarial loss - 9 12 10
Amortization of prior service cost 12 (14) 11 (11)
------ ------ ----- ------
Net periodic benefit cost $ 71 $ 8 $ 119 $ 18
====== ====== ===== ======
Nine Months Ended Nine Months Ended
October 2, 2004 September 27, 2003
------------------------------------------------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $ 480 $ - $ 468 $ -
Interest cost 726 39 771 57
Expected return on plan assets (1,027) - (951) -
Recognized net actuarial loss - 27 36 30
Amortization of prior service cost 34 (44) 33 (33)
------ ------ ----- ------
Net periodic benefit cost $ 213 $ 22 $ 357 $ 54
====== ====== ===== ======
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.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Composites Business
Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," the impairment of tangible and intangible assets is assessed
when changes in circumstances indicate that their carrying values may not be
fully recoverable. To analyze recoverability, the Company projects undiscounted
net future cash flows over the remaining life of such assets. If these projected
cash flows are less than the carrying amount, an impairment loss would be
recognized, resulting in a write-down of the assets with a corresponding charge
to earnings. The impairment loss is measured based on the difference between the
carrying amount and fair value of the assets or asset group. The estimated fair
value of the Company's composites business under this accounting standard is
based on an estimated purchase price or, in the absence of a known purchase
price, an estimate of future cash flows associated with the asset group.
As outlined in Note 4 to the condensed consolidated financial statements,
the Company continued to experience problems in the composites business that
affected its profitability. In addition, the Company experienced a substantial
increase in warranty claims that affected its profitability in the three-month
period ending October 2, 2004. The claims were associated with a new problem
concerning excessive oxidation that affects the integrity of the plastic used in
some of its decking products. As a result of the increase in warranty claims and
in accordance with SFAS No. 144, the Company evaluated the long-lived assets of
its composites business for impairment. The Company performed an impairment
assessment of these long-lived assets as of October 2, 2004, based on the most
current information available regarding the estimated fair value of the
composites business and concluded that no impairment loss was required at that
time.
On October 27, 2004, the Company's board of directors approved a plan and
management committed to sell its composites business after making a
determination that the business no longer aligns with the Company's long-term
strategy. The Company intends to sell the composites business as a going concern
and is presently evaluating potential buyers for the composites business, as
well as the costs that may be incurred in selling the business. Under the plan
approved by the board of directors, the Company plans to sell the composites
business within the next year at a price that is reasonable compared to its
current fair value. As a result of the decision to sell the composites
business, the Company evaluated whether the composites business should be
classified as a discontinued operation under SFAS No. 144. The Company will be
presenting the composites business in its financial statements as a discontinued
operation starting in the fourth quarter of 2004, as all the criteria under SFAS
No. 144 have been met.
The composites business, which is included in the Composites and
Fiber-based Products segment, had total assets and liabilities of $11,301,000
and $6,881,000, respectively, as of October 2, 2004. Included in total assets as
of October 2, 2004, was $6,737,000 of property, plant, and equipment, net of
accumulated depreciation, and $95,000 of intangibles. Revenues and operating
loss for the nine-months ended October 2, 2004 were $13,751,000 and $6,991,000,
respectively. Going forward, the Company will continue to assess any potential
impairment loss or other costs associated with the sale of the business and
record a loss, if any, when required.
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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. On October 27, 2004, the
Company's board of directors approved a plan to sell its composite building
products business (the "composites business"), which is included in the
Composites and Fiber-based Products segment, after making a determination that
the business no longer aligns with the Company's long-term strategy. As a result
of the decision to sell the composites business, we will be presenting the
composites business in our financial statements as a discontinued operation for
accounting purposes beginning in the fourth quarter of 2004.
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 continues to trade
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.
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KADANT INC.
Overview (continued)
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;
- Papermaking 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 nine months of 2004, approximately 55% 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
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KADANT INC.
Overview (continued)
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.
Industry and Business Outlook
Our products are primarily sold to the pulp and paper industry. Although
the paper industry had been in a prolonged down cycle 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 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 control economic
growth, which 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 our recognizing revenue 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.
In the composites business, we experienced a substantial increase in
warranty claims that affected our profitability in the three-month period ending
October 2, 2004. The claims were associated with a new problem concerning
excessive oxidation that affects the integrity of the plastic used in some of
our decking products. As a result of the increased claims in the third quarter
of 2004 and our estimated future claims, we increased our warranty expense to
$4.6 million and $5.9 million in the three- and nine-month periods ended October
2, 2004, respectively, compared to $0.6 million and $1.1 million in the three-
and nine-month periods ended September 27, 2003, respectively. Included in the
increased warranty expense is the cost of exchanging material held by our
distributors with new material and our best estimate of costs related to future
potential valid claims arising from installed product. The composites business
had operating losses of $5.7 million and $7.0 million in the three- and
nine-month periods ended October 2, 2004, respectively, compared to operating
losses of $0.8 million and $0.7 million in the three- and nine-month periods
ended September 27, 2003, respectively.
On October 27, 2004, our board of directors approved a plan to sell our
composites business after making a determination that the business no longer
aligns with the Company's long-term strategy. We intend to sell the composites
business as a going concern and are presently evaluating potential buyers for
the composites business as well as the costs that may be incurred in selling the
business. As a result of the decision to sell the composites business, it will
be presented in our financial statements as a discontinued operation for
accounting purposes beginning in the fourth quarter of 2004.
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KADANT INC.
Overview (continued)
Going forward, our guidance will include only the results from our
continuing operations, which will exclude the discontinued operations for the
composites business. We expect to report, from continuing operations, for the
fourth quarter of 2004 on a GAAP basis, $0.06 to $0.08 per diluted share, on
revenues of $40 to $42 million. For the full year for continuing operations, we
expect to report, on a GAAP basis, $0.79 to $0.81 per diluted share on revenues
of $189 to $191 million.
Results of Operations
Third Quarter 2004 Compared With Third Quarter 2003
- ---------------------------------------------------
The following table sets forth our unaudited condensed consolidated
statement of operations expressed as a percentage of total revenues for the
third quarters of 2004 and 2003. The results of operations for the fiscal
quarter ended October 2, 2004 are not necessarily indicative of the results to
be expected for the full fiscal year.
Three Months Ended
-----------------------------
October 2, September 27,
2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
--- ---
Costs and Operating Expenses:
Cost of revenues 73 60
Selling, general, and administrative expenses 29 28
Research and development expenses 2 3
Gain on sale of subsidiary (1) -
--- ---
103 91
--- ---
Operating Income (Loss) (3) 9
Interest Income, net 1 -
--- ---
Income (Loss) Before Income Taxes and Minority Interest (2) 9
Provision (Benefit) for Income Taxes (1) 3
--- ---
Net Income (Loss) (1)% 6%
=== ===
Revenues
Revenues increased to $53.3 million in the third quarter of 2004 from
$45.9 million in the third quarter of 2003, an increase of $7.4 million, or 16%.
Revenues in 2004 include the favorable effect of currency translation of $1.3
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 third quarter of 2004 and 2003 were as follows:
Three Months Ended
-----------------------------
October 2, September 27,
(In thousands) 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Equipment and Systems $ 47,669 $ 42,023
Composite and Fiber-based Products 5,608 3,883
-------- --------
$ 53,277 $ 45,906
======== ========
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KADANT INC.
Third Quarter 2004 Compared With Third Quarter 2003 (continued)
- ---------------------------------------------------
Pulp and Papermaking Equipment and Systems Segment. Revenues at the
Papermaking Equipment segment increased to $47.7 million in the third quarter of
2004 compared with $42.0 million in the third quarter of 2003, an increase of
$5.7 million, or 13.6%, due primarily to an increase in revenues from our
stock-preparation equipment product line. The 2004 quarterly revenue increase
includes a $1.3 million, or 3%, favorable effect from foreign currency
translation. Revenues from the segment's stock-preparation equipment product
line increased $7.2 million, or 38%, in 2004 primarily as a result of a $4.0
million, or 58%, increase in revenues from North America due to several large
capital shipments and strong sales of spare parts and a $2.5 million, or 64%,
increase in revenues from China, primarily as a result of the timing of large
orders. Revenues from the segment's water-management product line decreased by
$1.9 million, or 24%, in 2004 primarily due to decreased sales of capital
equipment in North America. The segment's accessories product line revenues
increased $0.3 million, or 2%, in 2004 including a $0.7 million, or 5%, increase
from the favorable effect of currency translation.
Composite and Fiber-Based Products Segment. Revenues at the Composite
and Fiber-based Products segment increased $1.7 million, or 44%, to $5.6 million
in the third quarter of 2004 from $3.9 million in the third quarter of 2003 due
primarily to a 72% increase in sales of our composite building products
resulting from continued acceptance of composites as an alternative to wood in
the decking market and expansion of our distribution network.
Gross Profit Margin
Gross profit margin for the third quarters of 2004 and 2003 by segment was as follows:
Three Months Ended
----------------------------
October 2, September 27,
2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Equipment and Systems 39% 42%
Composite and Fiber-based Products (75%) 11%
--- --
27% 40%
Gross profit margin decreased to 27% in the third quarter of 2004 from
40% in the third quarter of 2003. The gross profit margin at the Papermaking
Equipment segment decreased to 39% in 2004 from 42% in 2003 primarily due to
lower profit margins from sales of capital equipment and, to a lesser extent,
an overall change in product mix to a larger proportion of revenues coming from
capital equipment sales compared to last year. The gross margin at the Composite
and Fiber-based Products segment was negative 75% in the third quarter of 2004
compared to a gross profit margin of 11% in the third quarter of 2003. The
negative gross margin in 2004 was primarily the result of warranty costs of $4.6
million and, to a lesser extent, higher production costs. The composite building
products business experienced a significant increase in warranty costs for our
decking products in the third quarter of 2004. The majority of this increase was
associated with a new problem concerning excessive oxidation that affects the
integrity of the plastic used in some of our decking products.
Operating Expenses
Selling, general, and administrative expenses as a percentage of revenues
increased to 29% in the third quarter of 2004 compared with 28% in the third
quarter of 2003. Selling, general, and administrative expenses increased $2.5
million, or 19%, to $15.3 million in the third quarter of 2004 from $12.8
million in the third quarter of 2003. This increase included a $1.5 million, or
28%, increase in general and administrative expenses and a $1.0 million, or 13%,
increase in selling expenses. The increase in general and administrative
expenses includes a $0.4 million increase in the costs associated with the
implementation of the internal control requirements of the Sarbanes-Oxley Act
and a $0.2 million increase from the unfavorable effect of foreign currency
translation at the Papermaking Equipment segment.
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KADANT INC.
Third Quarter 2004 Compared With Third Quarter 2003 (continued)
- ---------------------------------------------------
The increase in selling expenses includes $0.3 million in severance costs
associated with our European operations and a $0.2 million increase from the
unfavorable effect of foreign currency translation.
Research and development expenses decreased to $0.9 million, or 2% of
revenues, in the third quarter of 2004 compared with $1.1 million, or 3% of
revenues, in the third quarter of 2003.
Gain on Sale of Subsidiary
During the third quarter of 2004, we recognized a gain of $0.1 million
from the sale of a subsidiary in Latin America for $0.4 million.
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 6).
Interest Income and Expense
Interest income increased to $0.4 million in the third quarter of 2004
from $0.2 million in the third quarter of 2003 primarily due to higher average
invested balances.
Income Taxes
Our effective tax rate was 53% and 38% in the third quarters of 2004 and
2003, respectively. The effective tax rate for the third quarter of 2004 was a
53% income tax benefit, which was based on our 35% recurring effective tax rate
on pre-tax losses and a $0.2 million reduction in reserves for foreign tax
credits associated with the filing of the 2003 federal tax return. The 38%
effective tax rate in the third 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.
First Nine Months 2004 Compared With First Nine Months 2003
- -----------------------------------------------------------
The following table sets forth our unaudited condensed consolidated
statement of operations expressed as a percentage of total revenues for the
first nine months of 2004 and 2003. The results of operations for the first
nine months of 2004 are not necessarily indicative of the results to be expected
for the full fiscal year.
Nine Months Ended
------------------------------
October 2, September 27,
2004 2003
- --------------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
--- ---
Costs and Operating Expenses:
Cost of revenues 66 62
Selling, general, and administrative expenses 28 26
Research and development expenses 2 2
--- ---
96 90
--- ---
Operating Income 4 10
Interest Income, net 1 -
--- ---
Income Before Provision for Income Taxes and Minority Interest 5 10
Provision for Income Taxes 1 4
--- ----
Net Income 4% 6%
=== ===
Revenues
Revenues increased to $162.8 million in the first nine months of 2004
from $153.1 million in the first nine months of 2003, an increase of $9.7
million, or 6%. Revenues in 2004 include the favorable effect of currency
translation of $6.1 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 nine months of 2004 and 2003 were as follows:
Nine Months Ended
-----------------------------
October 2, September 27,
(In thousands) 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Equipment and Systems $144,166 $138,254
Composite and Fiber-based Products 18,620 14,811
-------- --------
$162,786 $153,065
======== ========
Pulp and Papermaking Equipment and Systems Segment. Revenues at the
Papermaking Equipment segment increased to $144.2 million in the first nine
months of 2004 compared with $138.3 million in the first nine months of 2003, an
increase of $5.9 million, or 4%. The increase in revenues in 2004 includes a
$6.1 million, or 4%, increase from the favorable effect of currency translation.
Revenues from the segment's stock-preparation equipment product line increased
$4.2 million, or 6%, in 2004. The revenue increase was the result of a $3.0
million, or 4%, increase from the favorable effect of currency translation, a
$1.7 million, or 8%, increase in sales from China and a $1.2 million increase in
sales from North America, offset in part by a $1.6 million decrease in sales
from Europe due to continued market weakness. Revenues from the segment's
water-management product line decreased $1.4 million, or 6%, in
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KADANT INC.
First Nine Months 2004 Compared With First Nine Months 2003 (continued)
- -----------------------------------------------------------
2004 primarily due to a $1.7 million, or 7%, decrease in sales from North
America, offset in part by a $0.5 million, or 2%, increase from the favorable
effect of currency translation. Revenues from the segment's accessories product
line increased by $3.0 million, or 7%, in 2004 due to a $2.6 million, or 6%,
increase from the favorable effect of currency translation and a $1.8 million
increase in sales from North America, which was largely offset by a $1.4 million
decrease in Europe due to lower demand.
Composite and Fiber-Based Products Segment. Revenues at the Composite
and Fiber-based Products segment increased $3.8 million, or 26%, to $18.6
million in the first nine months of 2004 from $14.8 million in the first nine
months of 2003 due primarily to a $3.5 million, or 34%, increase in sales of our
composite building products in the first nine months of 2004 resulting from
continued acceptance of composites as an alternative to wood in the decking
market and expansion of our distribution network.
Gross Profit Margin
Gross profit margin for the first nine months of 2004 and 2003 by segment was as follows:
Nine Months Ended
-----------------------------
October 2, September 27,
2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Equipment and Systems 39% 39%
Composite and Fiber-based Products (9%) 28%
--- ---
34% 38%
Gross profit margin decreased to 34% in the first nine months of 2004,
compared to 38% in the first nine months of 2003. The gross profit margin at the
Papermaking Equipment segment remained constant at 39% in 2004 and 2003. The
gross margin at the Composite and Fiber-based Products segment was negative 9%
in the first nine months of 2004 compared with gross profit margin of 28% in the
first nine months of 2003. The negative gross margin in 2004 was due primarily
to warranty costs in the composite building products business of $5.9 million
compared to $1.1 million in 2003 as discussed in the results of operations for
the third quarter of 2004.
Operating Expenses
Selling, general, and administrative expenses as a percentage of revenues
were 28% in the first nine months of 2004 compared with 26% in the first nine
months of 2003. Selling, general, and administrative expenses increased $6.0
million, or 15%, to $45.7 million in 2004 from $39.7 million in 2003. This
increase included a $3.0 million, or 13%, increase in selling expenses and a
$3.0 million, or 19%, increase in general and administrative expenses. The
increase in selling expenses includes a $1.1 million increase from the
unfavorable effect of foreign currency translation and a $0.3 million increase
in severance costs associated with our European operations. The increase in
general and administrative expenses includes a $0.7 million increase in the
costs associated with the implementation of the internal control requirements of
the Sarbanes-Oxley Act, a $0.5 million increase from the unfavorable effect of
foreign currency translation at the Papermaking Equipment segment and a $0.4
million increase in severance costs associated with our European operations. In
addition, general and administrative expenses included increased expenses of
$0.4 million associated with several projects underway to further streamline our
international organization, initial expenses of $0.2 million related to the
establishment of our wholly owned subsidiary in China and a $0.2 million
increase in audit-related fees. Also included in general and administrative
expenses, offsetting the expenses noted above, 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.
First Nine Months 2004 Compared With First Nine Months 2003 (continued)
- -----------------------------------------------------------
Research and development expenses as a percentage of revenues were 2% in
the first nine months of 2004 and 2003.
Gain on Sale of Subsidiary
During the first nine months of 2004, we recognized a gain of $0.1
million from the sale of a subsidiary in Latin America for $0.4 million.
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. 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 and Expense
Interest income increased to $1.0 million in the first nine months of
2004 from $0.7 million in the first nine months of 2003 primarily due to higher
average invested balances.
Income Taxes
Our effective tax rate was 28% and 38% in the first nine months of 2004
and 2003, respectively. The 28% effective tax rate in 2004 was lower than the
statutory federal income tax rate primarily due to a reduction of $0.4 million
in the first nine months of 2004 in tax reserves primarily associated with our
foreign operations, as the reserves were no longer required and a $0.2 million
reduction in reserves for foreign tax credits associated with the filing of the
2003 federal tax return. The 38% effective tax rate in the third quarter of 2003
exceeded the statutory federal income tax rate primarily due to the impact of
state income taxes and nondeductible expenses.
Recently, Congress passed new tax legislation, the American Jobs Creation
Act, for which the U.S. Treasury has not yet issued any regulations or guidance.
In addition, the accounting profession will be exposing for comment new
interpretations which may affect income tax accounting for calendar year
companies. It is too early to evaluate the impact of these pending changes.
Liquidity and Capital Resources
Consolidated working capital was $108.8 million at October 2, 2004,
compared with $107.0 million at January 3, 2004. Included in working capital are
cash and cash equivalents of $77.1 million at October 2, 2004, compared with
$74.5 million at January 3, 2004. At October 2, 2004, $45.9 million of cash and
cash equivalents was held by our foreign subsidiaries.
During the first nine months of 2004, cash of $9.3 million was provided
by operating activities, compared with $20.0 million in the first nine months of
2003. The cash provided by operating activities in 2004 was primarily the result
of $6.0 million of net income, a non-cash charge of $3.6 million for
depreciation and amortization expense and a $7.6 million provision for warranty
obligations. In addition, a decrease in other current liabilities used cash of
$6.4 million, an increase in accounts receivable used cash of $4.1 million and a
decrease in inventory provided a source of cash of $2.8 million in 2004.
Our investing activities used cash of $0.7 million in the first nine
months of 2004, compared with $1.8 million in the first nine months of 2003.
During the first nine months of 2004, we purchased property, plant, and
equipment for
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KADANT INC.
Liquidity and Capital Resources (continued)
$1.6 million and received proceeds of $1.3 million from the sale of property,
plant, and equipment.
Our financing activities used cash of $6.1 million in the first nine
months of 2004, compared with $0.6 million of cash provided in the first nine
months of 2003. During the first nine months of 2004, we purchased 509,000
shares of our common stock on the open market for $10.3 million (see Part II -
Item 2 for further discussion). In addition, we received proceeds of $4.8
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 nine months of 2004.
In May 2004, our board of directors authorized the repurchase of up to
$30.0 million of our equity securities in the open market or in negotiated
transactions through May 18, 2005. As of October 2, 2004, we had repurchased
460,400 shares under this authorization for $9.4 million. Under a previous
authorization, we repurchased an additional 48,600 shares for $0.9 million prior
to the third quarter of 2004.
At October 2, 2004, we had $55.4 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 2004 for
property, plant, and equipment of approximately $0.9 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 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 closure, 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.
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KADANT INC.
Risk Factors (continued)
Our business is subject to economic, currency, political, and other risks
associated with international sales and operations.
During the first nine months of 2004, approximately 55% 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.
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 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
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KADANT INC.
Risk Factors (continued)
acquisitions, we have 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.
We may not be successful in selling the composite building products business.
On October 27, 2004, our board of directors approved a plan to sell the
composite building products business. We cannot predict on what terms we may
sell the business or if we will be successful in selling this business at all.
Under applicable accounting rules, the results of the composite building
products business will be reported as a discontinued operation; however, we will
continue to report these results in our consolidated totals. For so long as we
continue to own the composite building products business, our consolidated
performance will continue to be subject to the risks and uncertainties related
to that business, which are identified in the following Risk Factors.
Our performance in the market for composite building products will depend on our
ability to manufacture and distribute our composite building products.
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. Growth of our composite building products business requires ongoing
market acceptance. We have limited experience manufacturing these products at
volume, cost, and quality levels sufficient to satisfy expected demand, and we
have in the past and continue to 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 dependant 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. In addition, the announcement of our
proposed sale of the composites business and warranty problems may impact our
relationship with our existing and proposed new distributors and may cause them
to reduce their purchases of our products. 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.
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 in 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 nine months of 2004,
we have experienced a significant increase in warranty claims and warranty
expense related to our composite decking products including, but not limited to,
excessive contraction of certain 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. In addition, we experienced a significant number of warranty claims and
associated warranty expense in the third quarter of 2004 associated with a new
problem concerning excessive oxidation that affects the integrity of the plastic
used in some of our decking products. Included in the increased warranty expense
is the cost of exchanging material held by our distributors with new material
that, we believe, is not susceptible to this oxidation issue and our best
estimate of
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KADANT INC.
Risk Factors (continued)
costs related to future potential valid claims arising from installed product.
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 and our
ability to sell the composites business on favorable terms.
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.
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.
In addition, we use natural gas in the production of our fiber-based
granular products. We may 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.
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KADANT INC.
Risk Factors (continued)
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.
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 (SAB) No. 104, "Revenue Recognition", 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;
- adverse changes in 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;
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KADANT INC.
Risk Factors (continued)
- 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.
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) as of October 2, 2004. Based on this
evaluation, our CEO and CFO concluded that, as of October 2, 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
During the period ended October 2, 2004, 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.
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PART II - OTHER INFORMATION
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
- --------------------------------------------------------------------
The following table provides information about purchases by us of our
common stock during the three months ended October 2, 2004:
Issuer Purchases of Equity Securities
-------------------------------------
Approximate
Dollar Value of
Total Number of Shares that May
Shares Purchased as Yet Be
Total Number of Average Price Paid Part of Publicly Purchased
Period Shares Purchased (1) per Share Announced Plans (2) Under the Plans
---------------- -------------------- ------------------ ------------------- ---------------
7/4/04 - 7/31/04 - - - $ 24,763,256
8/1/04 - 8/31/04 148,300 $19.41 148,300 $ 21,876,638
9/1/04 - 10/2/04 63,600 $19.23 63,600 $ 20,650,526
------- -------
Total: 211,900 $19.36 211,900
======= =======
(1) During the third quarter of 2004, we repurchased an aggregate of 211,900 shares of our common stock on the
open market pursuant to a repurchase program that we publicly announced on May 18, 2004.
(2) On May 18, 2004, our board of directors approved the repurchase by us of up to $30 million of our equity securities
through May 18, 2005. The repurchases may be made in the open market or in negotiated transactions, from time to
time, depending on market conditions. As of October 2, 2004, we had repurchased 460,400 shares of our common stock
for $9.4 million under this authorization and 48,600 shares of our common stock for $0.9 million under a previous
authorization, which expired on May 15, 2004.
Item 6 - Exhibits
- -----------------
See Exhibit Index on the page immediately preceding exhibits.
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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 12th day of November 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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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.
31