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10-Q - KAI FORM 10-Q 2Q 2014 - KADANT INCkaiform10q2q2014.pdf
EX-10.1 - KAI FORM 10-Q 2Q 2014 EXHIBIT 10.1 - KADANT INCkaiform10q2q2014exhibit101.htm
EX-10.2 - KAI FORM 10-Q 2Q 2014 EXHIBIT 10.2 - KADANT INCkaiform10q2q2014exhibit102.htm
EX-31.1 - KAI FORM 10-Q 2Q 2014 EXHIBIT 31.1 - KADANT INCkaiform10q2q2014exhibit311.htm
EX-31.2 - KAI FORM 10-Q 2Q 2014 EXHIBIT 31.2 - KADANT INCkaiform10q2q2014exhibit312.htm
EX-32 - KAI FORM 10-Q 2Q 2014 EXHIBIT 32 - KADANT INCkaiform10q2q2014exhibit32.htm
EXCEL - IDEA: XBRL DOCUMENT - KADANT INCFinancial_Report.xls


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 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 June 28, 2014

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 Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
 
 
One Technology Park Drive
 
 
Westford, Massachusetts
 
01886
(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 the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
  Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨    No x

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 July 25, 2014
Common Stock, $.01 par value
 
10,928,698


PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)

Assets

 
 
June 28,
   
December 28,
 
(In thousands)
 
2014
   
2013
 
 
 
   
 
Current Assets:
 
   
 
Cash and cash equivalents
 
$
37,510
   
$
50,032
 
Restricted cash (Note 1)
   
167
     
168
 
Accounts receivable, less allowances of $2,486 and $2,689 (Note 1)
   
67,233
     
70,271
 
Inventories (Note 1)
   
60,087
     
62,805
 
Unbilled contract costs and fees
   
3,344
     
3,679
 
Other current assets
   
19,893
     
19,189
 
Assets of discontinued operation
   
130
     
144
 
Total Current Assets
   
188,364
     
206,288
 
 
               
Property, Plant, and Equipment, at Cost
   
119,035
     
117,997
 
Less: accumulated depreciation and amortization
   
75,156
     
73,112
 
 
   
43,879
     
44,885
 
 
               
Other Assets
   
10,894
     
11,230
 
 
               
Intangible Assets, Gross
   
79,691
     
78,223
 
  Less: accumulated amortization
   
33,386
     
30,373
 
 
   
46,305
     
47,850
 
 
               
Goodwill
   
134,098
     
131,915
 
 
               
Total Assets
 
$
423,540
   
$
442,168
 


The accompanying notes are an integral part of these condensed consolidated financial statements.
2


KADANT INC.
Condensed Consolidated Balance Sheet (continued)
(Unaudited)

Liabilities and Stockholders' Equity

 
 
June 28,
   
December 28,
 
(In thousands, except share amounts)
 
2014
   
2013
 
 
 
   
 
Current Liabilities:
 
   
 
Current maturities of long-term obligations (Note 6)
 
$
625
   
$
625
 
Accounts payable
   
29,254
     
28,388
 
Accrued payroll and employee benefits
   
16,385
     
19,116
 
Customer deposits
   
21,187
     
28,174
 
Other current liabilities
   
23,435
     
23,286
 
Liabilities of discontinued operation
   
213
     
213
 
Total Current Liabilities
   
91,099
     
99,802
 
 
               
Other Long-Term Liabilities
   
33,809
     
33,935
 
 
               
Long-Term Obligations (Note 6)
   
27,569
     
38,010
 
 
               
Commitments and Contingencies (Note 13)
   
     
 
 
               
Stockholders' Equity:
               
Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued
   
     
 
Common stock, $.01 par value, 150,000,000 shares authorized; 14,624,159 shares issued
   
146
     
146
 
Capital in excess of par value
   
95,998
     
96,809
 
Retained earnings
   
257,766
     
248,170
 
Treasury stock at cost, 3,695,461 and 3,524,742 shares
   
(84,665
)
   
(76,339
)
Accumulated other comprehensive items (Note 9)
   
642
     
710
 
Total Kadant Stockholders' Equity
   
269,887
     
269,496
 
Noncontrolling interest
   
1,176
     
925
 
Total Stockholders' Equity
   
271,063
     
270,421
 
 
               
Total Liabilities and Stockholders' Equity
 
$
423,540
   
$
442,168
 


The accompanying notes are an integral part of these condensed consolidated financial statements.
3


KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)

 
 
Three Months Ended
 
 
 
June 28,
   
June 29,
 
(In thousands, except per share amounts)
 
2014
   
2013
 
 
 
   
 
Revenues
 
$
104,835
   
$
82,165
 
 
               
Costs and Operating Expenses:
               
Cost of revenues
   
59,753
     
42,225
 
Selling, general, and administrative expenses
   
31,588
     
29,445
 
Research and development expenses
   
1,392
     
1,852
 
Restructuring costs and other income, net
   
66
     
218
 
 
   
92,799
     
73,740
 
 
               
Operating Income
   
12,036
     
8,425
 
 
               
Interest Income
   
82
     
142
 
Interest Expense
   
(250
)
   
(231
)
 
               
Income from Continuing Operations Before Provision for Income Taxes
   
11,868
     
8,336
 
Provision for Income Taxes
   
3,870
     
2,492
 
 
               
Income from Continuing Operations
   
7,998
     
5,844
 
Loss from Discontinued Operation (net of income tax benefit of $5 and $8)
   
(9
)
   
(12
)
 
               
Net Income
   
7,989
     
5,832
 
 
               
Net Income Attributable to Noncontrolling Interest
   
(131
)
   
(72
)
 
               
Net Income Attributable to Kadant
 
$
7,858
   
$
5,760
 
 
               
Amounts Attributable to Kadant:
               
Income from Continuing Operations
 
$
7,867
   
$
5,772
 
Loss from Discontinued Operation
   
(9
)
   
(12
)
Net Income Attributable to Kadant
 
$
7,858
   
$
5,760
 
 
               
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
               
Basic
 
$
0.71
   
$
0.52
 
Diluted
 
$
0.70
   
$
0.51
 
 
               
Earnings per Share Attributable to Kadant (Note 4):
               
Basic
 
$
0.71
   
$
0.52
 
Diluted
 
$
0.70
   
$
0.51
 
 
               
Weighted Average Shares (Note 4):
               
Basic
   
11,049
     
11,178
 
Diluted
   
11,246
     
11,331
 
 
               
Cash Dividends Declared per Common Share
 
$
0.15
   
$
0.125
 


The accompanying notes are an integral part of these condensed consolidated financial statements.
4

KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)

 
 
Six Months Ended
 
 
 
June 28,
   
June 29,
 
(In thousands, except per share amounts)
 
2014
   
2013
 
 
 
   
 
Revenues
 
$
198,202
   
$
158,369
 
 
               
Costs and Operating Expenses:
               
Cost of revenues
   
110,940
     
82,403
 
Selling, general, and administrative expenses
   
64,070
     
56,395
 
Research and development expenses
   
3,141
     
3,556
 
Restructuring costs and other income, net (Note 3)
   
394
     
218
 
 
   
178,545
     
142,572
 
 
               
Operating Income
   
19,657
     
15,797
 
 
               
Interest Income
   
304
     
251
 
Interest Expense
   
(556
)
   
(396
)
 
               
Income from Continuing Operations Before Provision for Income Taxes
   
19,405
     
15,652
 
Provision for Income Taxes (Note 5)
   
6,222
     
4,459
 
 
               
Income from Continuing Operations
   
13,183
     
11,193
 
Loss from Discontinued Operation (net of income tax benefit of $8 and $25)
   
(14
)
   
(41
)
 
               
Net Income
   
13,169
     
11,152
 
 
               
Net Income Attributable to Noncontrolling Interest
   
(258
)
   
(108
)
 
               
Net Income Attributable to Kadant
 
$
12,911
   
$
11,044
 
 
               
Amounts Attributable to Kadant:
               
Income from Continuing Operations
 
$
12,925
   
$
11,085
 
Loss from Discontinued Operation
   
(14
)
   
(41
)
Net Income Attributable to Kadant
 
$
12,911
   
$
11,044
 
 
               
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
               
Basic
 
$
1.17
   
$
0.99
 
Diluted
 
$
1.15
   
$
0.98
 
 
               
Earnings per Share Attributable to Kadant (Note 4):
               
Basic
 
$
1.16
   
$
0.99
 
Diluted
 
$
1.14
   
$
0.98
 
 
               
Weighted Average Shares (Note 4):
               
Basic
   
11,091
     
11,170
 
Diluted
   
11,280
     
11,299
 
 
               
Cash Dividends Declared per Common Share
 
$
0.30
   
$
0.25
 


The accompanying notes are an integral part of these condensed consolidated financial statements.
5


KADANT INC.
Condensed Consolidated Statement of Comprehensive Income
(Unaudited)


 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 28,
   
June 29,
   
June 28,
   
June 29,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
 
 
   
   
   
 
Net Income
 
$
7,989
   
$
5,832
   
$
13,169
   
$
11,152
 
 
                               
Other Comprehensive Items:
                               
Foreign Currency Translation Adjustment
   
579
     
(381
)
   
(178
)
   
(3,489
)
Pension and Other Post-Retirement Liability Adjustments (net of tax of $18 and $61 in the three and six months ended June 28, 2014, respectively, and $63 and $140 in the three and six months ended June 29, 2013, respectively)
   
33
     
120
     
110
     
257
 
Deferred (Loss) Gain on Hedging Instruments (net of tax of $3 and $52 in the three and six months ended June 28, 2014, respectively, and $51 and $80 in the three and six months ended June 29, 2013, respectively)
   
(99
)
   
94
     
(7
)
   
289
 
 
   
513
     
(167
)
   
(75
)
   
(2,943
)
Comprehensive Income
   
8,502
     
5,665
     
13,094
     
8,209
 
Comprehensive Income Attributable to Noncontrolling Interest
   
(118
)
   
(97
)
   
(251
)
   
(85
)
Comprehensive Income Attributable to Kadant
 
$
8,384
   
$
5,568
   
$
12,843
   
$
8,124
 


The accompanying notes are an integral part of these condensed consolidated financial statements.
6


KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)

 
 
Six Months Ended
 
 
 
June 28,
   
June 29,
 
(In thousands)
 
2014
   
2013
 
 
 
   
 
Operating Activities:
 
   
 
Net income attributable to Kadant
 
$
12,911
   
$
11,044
 
Net income attributable to noncontrolling interest
   
258
     
108
 
Loss from discontinued operation
   
14
     
41
 
Income from continuing operations
   
13,183
     
11,193
 
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
               
Depreciation and amortization
   
5,874
     
4,428
 
Stock-based compensation expense
   
2,811
     
2,558
 
Recovery of losses on accounts receivable
   
(29
)
   
(193
)
Gain on the sale of property, plant, and equipment
   
(122
)
   
(1,862
)
Other items, net
   
308
     
10
 
    Contributions to pension plan
   
(540
)
   
(540
)
Changes in current assets and liabilities, net of effects of acquisitions:
               
Accounts receivable
   
3,461
     
1,225
 
Unbilled contract costs and fees
   
299
     
1,781
 
Inventories
   
2,309
     
(6,852
)
Other current assets
   
(753
)
   
(451
)
Accounts payable
   
874
     
2,715
 
Other current liabilities
   
(12,480
)
   
4,059
 
Net cash provided by continuing operations
   
15,195
     
18,071
 
Net cash used in discontinued operation
   
(1
)
   
(173
)
Net cash provided by operating activities
   
15,194
     
17,898
 
 
               
Investing Activities:
               
Acquisitions, net of cash acquired
   
(2,770
)
   
(14,209
)
Purchases of property, plant, and equipment
   
(1,442
)
   
(2,572
)
Proceeds from sale of property, plant, and equipment
   
171
     
3,309
 
Other, net
   
-
     
849
 
Net cash used in continuing operations for investing activities
   
(4,041
)
   
(12,623
)
 
               
Financing Activities:
               
Proceeds from issuance of long-term obligations
   
11,401
     
18,900
 
Repayments of long-term obligations
   
(21,724
)
   
(9,750
)
Purchases of Company common stock
   
(11,250
)
   
(2,715
)
Dividends paid
   
(3,064
)
   
(1,401
)
Proceeds from issuance of Company common stock
   
557
     
337
 
Change in restricted cash
   
1
     
(165
)
Other, net
   
703
     
311
 
Net cash (used in) provided by continuing operations for financing activities
   
(23,376
)
   
5,517
 
 
               
Exchange Rate Effect on Cash and Cash Equivalents from Continuing Operations
   
(299
)
   
(1,023
)
 
               
(Decrease) Increase in Cash and Cash Equivalents from Continuing Operations
   
(12,522
)
   
9,769
 
Cash and Cash Equivalents at Beginning of Period
   
50,032
     
54,553
 
Cash and Cash Equivalents at End of Period
 
$
37,510
   
$
64,322
 
 
               

See Note 1 for supplemental cash flow information.
The accompanying notes are an integral part of these condensed consolidated financial statements.
7


KADANT INC.
Condensed Consolidated Statement of Stockholders' Equity
(Unaudited)


(In thousands, except share
 
Common
Stock
   
Capital in
Excess of Par
   
Retained
   
Treasury
Stock
   
Accumulated
Other
Comprehensive
   
Noncontrolling
   
Total
Stockholders'
 
    amounts)
 
Shares
   
Amount
   
Value
   
Earnings
   
Shares
   
Amount
   
Items
   
Interest
   
Equity
 
 
 
   
   
   
   
   
   
   
   
 
Balance at December 29, 2012
   
14,624,159
   
$
146
   
$
95,448
   
$
230,329
     
3,493,546
   
$
(74,025
)
 
$
(3,315
)
 
$
1,384
   
$
249,967
 
 
                                                                       
Net income
   
     
     
     
11,044
     
     
     
     
108
     
11,152
 
 
                                                                       
Dividends declared
   
     
     
     
(2,796
)
   
     
     
     
     
(2,796
)
 
                                                                       
Activity under stock plans
   
     
     
(1,379
)
   
     
(131,304
)
   
2,784
     
     
     
1,405
 
 
                                                                       
Tax benefits related to employees' and directors' stock plans
   
     
     
312
     
     
     
     
     
     
312
 
 
                                                                       
Purchases of Company common stock
   
     
     
     
     
100,000
     
(2,715
)
   
     
     
(2,715
)
 
                                                                       
Other comprehensive items
   
     
     
     
     
     
     
(2,920
)
   
(23
)
   
(2,943
)
 
                                                                       
Balance at June 29, 2013
   
14,624,159
   
$
146
   
$
94,381
   
$
238,577
     
3,462,242
   
$
(73,956
)
 
$
(6,235
)
 
$
1,469
   
$
254,382
 
 
                                                                       
Balance at December 28, 2013
   
14,624,159
   
$
146
   
$
96,809
   
$
248,170
     
3,524,742
   
$
(76,339
)
 
$
710
   
$
925
   
$
270,421
 
 
                                                                       
Net income
   
     
     
     
12,911
     
     
     
     
258
     
13,169
 
 
                                                                       
Dividends declared
   
     
     
     
(3,315
)
   
     
     
     
     
(3,315
)
 
                                                                       
Activity under stock plans
   
     
     
(1,514
)
   
     
(134,416
)
   
2,924
     
     
     
1,410
 
 
                                                                       
Tax benefits related to employees' and directors' stock plans
   
     
     
703
     
     
     
     
     
     
703
 
 
                                                                       
Purchases of Company common stock
   
     
     
     
     
305,135
     
(11,250
)
   
     
     
(11,250
)
 
                                                                       
Other comprehensive items
   
     
     
     
     
     
     
(68
)
   
(7
)
   
(75
)
 
                                                                       
Balance at June 28, 2014
   
14,624,159
   
$
146
   
$
95,998
   
$
257,766
     
3,695,461
   
$
(84,665
)
 
$
642
   
$
1,176
   
$
271,063
 


The accompanying notes are an integral part of these condensed consolidated financial statements.
8

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
1. Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations
Kadant Inc. and its subsidiaries' (collectively, "we," Kadant," "the Company," or "the Registrant") continuing operations include two reportable operating segments, Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products.

Through its Papermaking Systems segment, the Company develops, manufactures, and markets a range of equipment and products primarily for the global papermaking, paper recycling, and process industries. The Company's principal products in this segment include custom-engineered stock-preparation systems and equipment for the preparation of wastepaper for conversion into recycled paper; fluid-handling systems used primarily in the dryer section of the papermaking process and during the production of corrugated boxboard, metals, plastics, rubber, textiles, chemicals, and food; doctoring systems and equipment and related consumables important to the efficient operation of paper machines; and cleaning and filtration systems essential for draining, purifying, and recycling process water and cleaning paper machine fabrics and rolls.

Through its Wood Processing Systems segment, the Company designs and manufactures stranders and related equipment used in the production of oriented strand board (OSB), an engineered wood panel product used primarily in home construction. This segment also supplies debarking and wood chipping equipment used in the forest products and the pulp and paper industries.

Through its Fiber-based Products business, the Company manufactures and sells granules derived from papermaking byproducts primarily for use as agricultural carriers and for home lawn and garden applications, as well as for oil and grease absorption.

Interim Financial Statements
The interim condensed consolidated financial statements and related notes presented have been prepared by the Company, are unaudited, 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 June 28, 2014 and its results of operations and comprehensive income for the three and six month periods ended June 28, 2014 and June 29, 2013, and its cash flows and stockholders' equity for the six month periods ended June 28, 2014 and June 29, 2013. Interim results are not necessarily indicative of results for a full year or for any other interim period.

The condensed consolidated balance sheet presented as of December 28, 2013 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 2013. The condensed consolidated financial statements and related notes are presented as permitted by the Securities and Exchange Commission (SEC) rules and regulations for 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 December 28, 2013, filed with the SEC.

Fiscal Year
Typically, the Company's fiscal quarters and fiscal year consist of 13 and 52 weeks, respectively, ending on the Saturday closest to the end of the corresponding calendar quarter for the Company's fiscal quarters and on the Saturday closest to December 31 for the Company's fourth fiscal quarter and fiscal year. As a result, a 53rd week is added to the Company's fiscal year every five or six years.  In a 53-week fiscal year, the Company's fourth fiscal quarter contains 14 weeks. The Company's fiscal year ending January 3, 2015 (fiscal 2014) contains 53 weeks and the Company's fiscal year ending December 28, 2013 (fiscal 2013) contains 52 weeks. Each quarter of fiscal 2014 and 2013 contains 13 weeks, except the fourth quarter of 2014, which will contain 14 weeks.

Critical Accounting Policies
Critical accounting policies are defined as those that entail significant judgments and estimates, and could potentially result in materially different results under different assumptions and conditions. The Company believes that the most critical accounting policies upon which its financial position depends, and which involve the most complex or subjective decisions or assessments, concern revenue recognition and accounts receivable, warranty obligations, income taxes, the valuation of goodwill and intangible assets, inventories and pension obligations. A discussion of the application of these and other accounting policies is included in Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 2013.

Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.

9

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)

Supplemental Cash Flow Information

 
 
Six Months Ended
 
(In thousands)
 
June 28, 2014
   
June 29, 2013
 
 
 
   
 
Non-Cash Investing Activities:
 
   
 
Fair Value of Assets Acquired
 
$
5,602
   
$
22,812
 
Cash Paid for Acquired Businesses
   
(3,444
)
   
(15,332
)
Liabilities Assumed of Acquired Businesses
 
$
2,158
   
$
7,480
 
 
               
Non-Cash Financing Activities:
               
Issuance of Company Common Stock
 
$
2,718
   
$
2,353
 
Dividends Declared but Unpaid
 
$
1,640
   
$
1,395
 

Restricted Cash
As of June 28, 2014 and December 28, 2013, the Company had restricted cash of $167,000 and $168,000, respectively. This cash serves as collateral for bank guarantees primarily associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business. All the bank guarantees will expire by the end of 2014.

Banker's Acceptance Drafts
The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for their trade accounts receivable. The banker's acceptance drafts are non-interest bearing obligations of the issuing bank and mature within six months of the origination date. The Company has the ability to sell the drafts at a discount to a third-party financial institution or transfer the drafts to vendors in settlement of current accounts payable prior to the scheduled maturity date. These drafts, which totaled $9,267,000 and $10,765,000 at June 28, 2014 and December 28, 2013, respectively, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary obtains cash payment on the scheduled maturity date or upon the sale or transfer of the drafts prior to maturity.

Inventories
The components of inventories are as follows:

 
 
June 28,
   
December 28,
 
(In thousands)
 
2014
   
2013
 
 
 
   
 
Raw Materials and Supplies
 
$
22,368
   
$
20,836
 
Work in Process
   
16,587
     
21,051
 
Finished Goods
   
21,132
     
20,918
 
 
 
$
60,087
   
$
62,805
 

Warranty Obligations
The Company provides for the estimated cost of product warranties at the time of sale based on the actual historical occurrence rates and repair costs. The Company typically negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications. While the Company engages in extensive product quality programs and processes, the Company's warranty obligation is affected by product failure rates, repair costs, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to the Company. Should actual product failure rates, repair costs, service delivery costs, or supplier warranties on parts differ from the Company's estimates, revisions to the estimated warranty liability would be required.

The changes in the carrying amount of accrued warranty costs included in other current liabilities in the accompanying condensed consolidated balance sheet are as follows:

 
 
Six Months Ended
 
(In thousands)
 
June 28, 2014
   
June 29, 2013
 
 
 
   
 
Balance at beginning of period
 
$
4,571
   
$
4,462
 
Provision
   
1,284
     
505
 
Usage
   
(1,600
)
   
(996
)
Acquired
   
     
138
 
Currency translation
   
(6
)
   
(44
)
Balance at end of period
 
$
4,249
   
$
4,065
 

10

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1.            Nature of Operations and Summary of Significant Accounting Policies (continued)

Recent Accounting Pronouncements
Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-08, which provides new guidance on reporting discontinued operations and disclosures of disposals. Under the new guidance, only disposals representing a strategic shift in operations will be presented as discontinued operations. The new guidance also requires disclosure of the pre-tax income attributable to a disposal of a significant part of the company that does not qualify for discontinued operations reporting. This guidance is effective for the Company beginning in fiscal 2015. Adoption of this ASU is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows.
Revenue from Contracts with Customers (Topic 606) Section A—Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs—Contracts with Customers (Subtopic 340-40). In May 2014, the FASB issued ASU No. 2014-09, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new guidance is effective for the Company beginning in fiscal 2017. Early adoption is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect that ASU No. 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

Compensation—Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. In June 2014, the FASB issued ASU No. 2014-12, which clarifies the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. Under the new guidance, a performance target that affects vesting and could be achieved after completion of the service period should be treated as a performance condition under FASB Accounting Standards Codification (ASC) 718 and, as a result, should not be included in the estimation of the grant-date fair value of the award. An entity should recognize compensation cost for the award when it becomes probable that the performance target will be achieved. In the event that an entity determines that it is probable that a performance target will be achieved before the end of the service period, the compensation cost of the award should be recognized prospectively over the remaining service period. The new guidance is effective for the Company beginning in fiscal 2016. Early adoption is permitted. Adoption of this ASU is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows.

2. Acquisitions

On December 30, 2013, the Company acquired all the outstanding shares of a European producer of creping and coating blades for approximately $2,627,000 in cash, including $674,000 of cash acquired and $53,000 of debt assumed. An additional 1,000,000 euros, or approximately $1,362,000, of contingent consideration is due to the sellers within two years of the closing date if certain conditions are met, as defined in the purchase agreement.

This acquisition has been accounted for using the purchase method of accounting and its results have been included in the accompanying financial statements from the date of the acquisition. The Company has made a preliminary fair value assessment of the assets acquired and liabilities assumed, including identifiable intangible assets acquired of $1,800,000, which are being amortized using the straight-line method over 12 years. The excess of the acquisition purchase price over the tangible and identifiable intangible assets was recorded as goodwill and totaled $1,590,000, which is not deductible for tax purposes. The fair values are subject to adjustment upon finalization of the valuation, and therefore the current measurements of intangible assets, acquired goodwill, and assumed assets and liabilities are subject to change.

Pro forma disclosures of the results of operations are not required, as the acquisition is not considered a material business combination as outlined in FASB ASC 805, "Business Combinations."

During the first six months of 2014, the Company made post-closing adjustment payments of $817,000 related to acquisitions completed prior to 2014.

3.            Restructuring Costs and Other Income, Net

2013 Restructuring Plan
In 2013 and the first six months of 2014, the Company recorded restructuring costs totaling $2,237,000 related to its 2013 restructuring plan, including severance costs of $1,158,000 associated with the reduction of 22 employees in Brazil and severance costs of $497,000 associated with the reduction of 25 employees in Sweden. Also included in total restructuring costs were facility-related costs of $582,000. These actions were taken to streamline the Company's operations as a result of the acquisitions of Companhia Brasileira de Tecnologia Industrial (CBTI) and certain assets of the Noss Group in 2013. These restructuring charges all occurred in the Papermaking Systems segment.

Included in these restructuring costs were $394,000 of restructuring costs recorded in the first six months of 2014, including facility-related costs of $405,000, net of income from a reduction in severance and associated costs of $11,000 in Sweden.

Also included in these restructuring costs were $1,958,000 of restructuring costs recorded in the first six months of 2013, including $1,330,000 associated with severance and associated costs in Brazil and $628,000 related to severance and associated costs in Sweden.

11

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3.            Restructuring Costs and Other Income, Net (continued)

A summary of the changes in accrued restructuring costs included in other current liabilities in the accompanying condensed consolidated balance sheet is as follows:

(In thousands) 
 
Severance
Costs
   
Other
Costs
   
Total
Costs
 
Balance at December 28, 2013
 
$
467
   
$
   
$
467
 
Provision
   
(11
)
   
405
     
394
 
Usage
   
(370
)
   
(403
)
   
(773
)
Currency translation
   
(12
)
   
(2
)
   
(14
)
Balance at June 28, 2014
 
$
74
   
$
   
$
74
 

The Company expects to pay the remaining accrued restructuring costs by the end of 2014.

Other Income
The Company recorded other income of $1,740,000 in the second quarter of 2013 related to a pre-tax gain from the sale of real estate in China.

4. Earnings per Share

Basic and diluted earnings per share are calculated as follows:

 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 28,
   
June 29,
   
June 28,
   
June 29,
 
(In thousands, except per share amounts)
 
2014
   
2013
   
2014
   
2013
 
 
 
   
   
   
 
Amounts Attributable to Kadant:
 
   
   
   
 
Income from Continuing Operations
 
$
7,867
   
$
5,772
   
$
12,925
   
$
11,085
 
Income from Discontinued Operation
   
(9
)
   
(12
)
   
(14
)
   
(41
)
Net Income
 
$
7,858
   
$
5,760
   
$
12,911
   
$
11,044
 
 
                               
Basic Weighted Average Shares
   
11,049
     
11,178
     
11,091
     
11,170
 
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan
   
197
     
153
     
189
     
129
 
Diluted Weighted Average Shares
   
11,246
     
11,331
     
11,280
     
11,299
 
 
                               
Basic Earnings per Share:
                               
Continuing Operations
 
$
0.71
   
$
0.52
   
$
1.17
   
$
0.99
 
Discontinued Operation
 
$
   
$
   
$
   
$
 
Net Income per Basic Share
 
$
0.71
   
$
0.52
   
$
1.16
   
$
0.99
 
 
                               
Diluted Earnings per Share:
                               
Continuing Operations
 
$
0.70
   
$
0.51
   
$
1.15
   
$
0.98
 
Discontinued Operation
 
$
   
$
   
$
   
$
 
Net Income per Diluted Share
 
$
0.70
   
$
0.51
   
$
1.14
   
$
0.98
 

Options to purchase approximately 93,000 and 102,000 shares of the Company's common stock in the second quarter and first six months of 2013, respectively, were not included in the computation of diluted earnings per share as the effect of their inclusion would have been anti-dilutive. Unvested restricted stock units equivalent to approximately 69,000 shares of common stock for the second quarter of 2014 and approximately 63,000 and 41,000 shares of common stock for the first six months of 2014 and 2013, respectively, were not included in the computation of diluted earnings per share because either the effect of their inclusion would have been anti-dilutive, or for unvested performance-based restricted stock units, the performance conditions had not been met as of the end of the reporting period.

5. Provision for Income Taxes

The provision for income taxes was $6,222,000 and $4,459,000 in the first six months of 2014 and 2013, respectively, and represented 32% and 28% of pre-tax income. The effective tax rate of 32% in the first six months of 2014 was lower than the Company's statutory tax rate primarily due to the release of tax reserves that resulted from the expiration of tax statutes of limitations in jurisdictions outside the U.S., the release of state tax reserves in the U.S., and the distribution of the Company's worldwide earnings. These tax benefits were offset in part by tax expense associated with a reduction in deferred tax assets and an increase in nondeductible expenses. The effective tax rate of 28% in the first six months of 2013 was lower than the Company's statutory tax rate primarily due to the reduction of the 2012 U.S. tax cost of foreign earnings and a benefit from the 2012 U.S. research and development tax credit, both of which resulted from U.S. tax legislation enacted in January 2013. In addition, the Company's effective tax rate in the first six months of 2013 benefited from the release of a valuation allowance against deferred tax assets related to net operating loss carryforwards. The release of the valuation allowance was due to increased projected profitability associated with the CBTI acquisition. Also contributing to the lower effective tax rate in the first six months of 2013 were lower statutory tax rates in the Company's overseas operations and a more favorable distribution of the Company's worldwide earnings.

12

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

6. Long-Term Obligations

Long-term obligations are as follows:

 
 
June 28,
   
December 28,
 
(In thousands)
 
2014
   
2013
 
 
 
   
 
Revolving Credit Facility, due 2018
 
$
22,069
   
$
32,260
 
Variable Rate Term Loan, due from 2014 to 2016
   
6,125
     
6,375
 
Total Long-Term Obligations
   
28,194
     
38,635
 
Less: Current Maturities
   
(625
)
   
(625
)
Long-Term Obligations, less Current Maturities
 
$
27,569
   
$
38,010
 

The weighted average interest rate for the Company's long-term obligations was 2.56% as of June 28, 2014.

The Company entered into a five-year unsecured revolving credit facility (2012 Credit Agreement) in the aggregate principal amount of up to $100,000,000 on August 3, 2012 and amended it on November 1, 2013. The 2012 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional $50,000,000. The principal on any borrowings made under the 2012 Credit Agreement is due on November 1, 2018. Interest on any loans outstanding under the 2012 Credit Agreement accrues and is payable quarterly in arrears at one of the following rates selected by the Company: (i) the highest of (a) the federal funds rate plus 0.50% plus an applicable margin of 0% to 1%, (b) the prime rate, as defined, plus an applicable margin of 0% to 1% and (c) the Eurocurrency rate, as defined, plus 0.50% plus an applicable margin of 0% to 1% or (ii) the Eurocurrency rate, as defined, plus an applicable margin of 1% to 2%. The applicable margin is determined based upon the ratio of the Company's total debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined in the 2012 Credit Agreement. For this purpose, total debt is defined as total debt less up to $25,000,000 of unrestricted U.S. cash. There was $22,069,000 outstanding under the 2012 Credit Agreement at June 28, 2014.

The obligations of the Company under the 2012 Credit Agreement may be accelerated upon the occurrence of an event of default under the 2012 Credit Agreement, which includes customary events of default including without limitation payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy- and insolvency-related defaults, defaults relating to such matters as the Employment Retirement Income Security Act (ERISA), unsatisfied judgments, the failure to pay certain indebtedness, and a change of control default. In addition, the 2012 Credit Agreement contains negative covenants applicable to the Company and its subsidiaries including financial covenants requiring the Company to comply with a maximum consolidated leverage ratio of 3.5 to 1, a minimum consolidated interest coverage ratio of 3 to 1, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing its fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to the discontinued operation. As of June 28, 2014, the Company was in compliance with these covenants.

Loans under the 2012 Credit Agreement are guaranteed by certain domestic subsidiaries of the Company pursuant to a Guarantee Agreement, effective August 3, 2012.

As of June 28, 2014, the Company had $75,817,000 of borrowing capacity available under the committed portion of its 2012 Credit Agreement. The amount the Company is able to borrow under the 2012 Credit Agreement is the total borrowing capacity of $100,000,000 less any outstanding borrowings, letters of credit and multi-currency borrowings issued under the 2012 Credit Agreement.

7. Stock-Based Compensation

The Company recognized stock-based compensation expense of $1,416,000 and $1,289,000 in the second quarters of 2014 and 2013, respectively, and $2,811,000 and $2,558,000 in the first six months of 2014 and 2013, respectively, within selling, general, and administrative (SG&A) expenses in the accompanying condensed consolidated statement of income. Unrecognized compensation expense related to stock-based compensation totaled approximately $7,036,000 at June 28, 2014, and will be recognized over a weighted average period of 1.8 years.

13

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

8. Employee Benefit Plans

The Company sponsors a noncontributory defined benefit retirement plan for the benefit of eligible employees at its Kadant Solutions division and its corporate office (included in the table below in "Pension Benefits"). The Company also sponsors a restoration plan for the benefit of certain executive officers who also participate in the noncontributory defined benefit retirement plan (included in the table below in "Other Benefits"). In addition, employees at certain of the Company's subsidiaries participate in defined benefit retirement and post-retirement welfare benefit plans (included in the table below in "Other Benefits").

The components of the net periodic benefit cost for the pension benefits and other benefits plans are as follows:

 
 
Three Months Ended
   
Three Months Ended
 
 
 
June 28, 2014
   
June 29, 2013
 
(In thousands)
 
Pension
Benefits
   
Other
Benefits
   
Pension
Benefits
   
Other
Benefits
 
 
 
   
   
   
 
Components of Net Periodic Benefit Cost:
 
   
   
   
 
Service cost
 
$
213
   
$
81
   
$
236
   
$
53
 
Interest cost
   
321
     
74
     
283
     
69
 
Expected return on plan assets
   
(370
)
   
(12
)
   
(372
)
   
(13
)
Recognized net actuarial loss
   
79
     
9
     
115
     
22
 
Amortization of prior service cost
   
14
     
24
     
14
     
21
 
Net periodic benefit cost
 
$
257
   
$
176
   
$
276
   
$
152
 
 
                               
The weighted average assumptions used to determine net periodic benefit cost are as follows:
         
 
                               
Discount rate
   
4.79
%
   
4.30
%
   
3.89
%
   
4.00
%
Expected long-term return on plan assets
   
5.75
%
   
     
5.75
%
   
 
Rate of compensation increase
   
3.50
%
   
3.24
%
   
3.50
%
   
3.73
%

 
 
Six Months Ended
   
Six Months Ended
 
 
 
June 28, 2014
   
June 29, 2013
 
(In thousands)
 
Pension
Benefits
   
Other
Benefits
   
Pension
Benefits
   
Other
Benefits
 
 
 
   
   
   
 
Components of Net Periodic Benefit Cost:
 
   
   
   
 
Service cost
 
$
426
   
$
150
   
$
499
   
$
106
 
Interest cost
   
642
     
146
     
584
     
139
 
Expected return on plan assets
   
(740
)
   
(24
)
   
(753
)
   
(26
)
Recognized net actuarial loss
   
158
     
18
     
266
     
43
 
Amortization of prior service cost
   
28
     
45
     
28
     
42
 
Net periodic benefit cost
 
$
514
   
$
335
   
$
624
   
$
304
 
 
                               
The weighted average assumptions used to determine net periodic benefit cost are as follows:
         
 
                               
Discount rate
   
4.79
%
   
4.28
%
   
3.89
%
   
3.97
%
Expected long-term return on plan assets
   
5.75
%
   
     
5.75
%
   
 
Rate of compensation increase
   
3.50
%
   
3.23
%
   
3.50
%
   
3.71
%

The Company made cash contributions of $540,000 to its Kadant Solutions division's noncontributory defined benefit retirement plan in the first six months of 2014 and expects to make cash contributions of $540,000 over the remainder of 2014. For the remaining pension and post-retirement welfare benefits plans, the Company does not expect to make cash contributions other than to fund current benefit payments.

14

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

9. Accumulated Other Comprehensive Items

Comprehensive income combines net income and other comprehensive items, which represent certain amounts that are reported as components of stockholders' equity in the accompanying condensed consolidated balance sheet, including foreign currency translation adjustments, deferred losses and unrecognized prior service cost associated with pension and other post-retirement plans, and deferred losses on hedging instruments.

Changes in each component of accumulated other comprehensive items (AOCI), net of tax, in the accompanying condensed consolidated balance sheet are as follows:
(In thousands)
 
Foreign
Currency
Translation
Adjustment
   
Unrecognized
Prior Service
Cost
   
Deferred Loss
on Pension and
Other Post-
Retirement
Plans
   
Deferred Loss
on Hedging
Instruments
   
Accumulated
Other
Comprehensive
Items
 
Balance at December 28, 2013
 
$
8,919
   
$
(657
)
 
$
(6,919
)
 
$
(633
)
 
$
710
 
Other comprehensive loss before reclassifications
   
(171
)
   
(51
)
   
(1
)
   
(356
)
   
(579
)
Reclassifications from AOCI
   
     
47
     
115
     
349
     
511
 
Net current period other comprehensive  (loss) income
   
(171
)
   
(4
)
   
114
     
(7
)
   
(68
)
Balance at June 28, 2014
 
$
8,748
   
$
(661
)
 
$
(6,805
)
 
$
(640
)
 
$
642
 
 
                                       
Balance at December 29, 2012
 
$
8,124
   
$
(748
)
 
$
(9,645
)
 
$
(1,046
)
 
$
(3,315
)
Other comprehensive (loss) income before reclassifications
   
(3,466
)
   
     
9
     
(37
)
   
(3,494
)
Reclassifications from AOCI
   
     
46
     
202
     
326
     
574
 
Net current period other comprehensive  (loss) income
   
(3,466
)
   
46
     
211
     
289
     
(2,920
)
Balance at June 29, 2013
 
$
4,658
   
$
(702
)
 
$
(9,434
)
 
$
(757
)
 
$
(6,235
)

Amounts reclassified out of accumulated other comprehensive items are as follows:

 
 
Three Months Ended
   
Six Months Ended
 
Statement of Income
(In thousands)
 
June 28, 2014
   
June 29, 2013
   
June 28, 2014
   
June 29, 2013
 
Line Item
Pension and Other Post-retirement Plans: (1)
 
   
   
   
 
      
Amortization of prior service cost
 
$
(38
)
 
$
(35
)
 
$
(73
)
 
$
(70
)
SG&A expenses
Amortization of actuarial losses
   
(88
)
   
(137
)
   
(176
)
   
(309
)
SG&A expenses
Total expense before income taxes
   
(126
)
   
(172
)
   
(249
)
   
(379
)
 
Income tax benefit
   
44
     
59
     
87
     
131
 
Provision for income taxes
 
   
(82
)
   
(113
)
   
(162
)
   
(248
)
 
Cash Flow Hedges: (2)
                               
      
Interest rate swap agreements
   
(84
)
   
(90
)
   
(168
)
   
(196
)
Interest expense
Forward currency-exchange contracts
   
     
(40
)
   
     
(83
)
Revenues
Forward currency-exchange contract
   
(278
)
   
     
(278
)
   
 
SG&A expenses
Total expense before income taxes
   
(362
)
   
(130
)
   
(446
)
   
(279
)
 
Income tax benefit (expense)
   
67
     
46
     
97
     
(47
)
Provision for income taxes
 
   
(295
)
   
(84
)
   
(349
)
   
(326
)
 
Total reclassifications
 
$
(377
)
 
$
(197
)
 
$
(511
)
 
$
(574
)
 

(1) Included in the computation of net periodic benefit costs. See Note 8 for additional information.
(2) See Note 10 for additional information.

10. Derivatives

The Company uses derivative instruments primarily to reduce its exposure to changes in currency exchange rates and interest rates. When the Company enters into a derivative contract, the Company makes a determination as to whether the transaction is deemed to be a hedge for accounting purposes. For a contract deemed to be a hedge, the Company formally documents the relationship between the derivative instrument and the risk being hedged. In this documentation, the Company specifically identifies the asset, liability, forecasted transaction, cash flow, or net investment that has been designated as the hedged item, and evaluates whether the derivative instrument is expected to reduce the risks associated with the hedged item. To the extent these criteria are not met, the Company does not use hedge accounting for the derivative. The changes in the fair value of a derivative not deemed to be a hedge are recorded currently in earnings. The Company does not hold or engage in transactions involving derivative instruments for purposes other than risk management.

ASC 815, "Derivatives and Hedging," requires that all derivatives be recognized on the balance sheet at fair value. For derivatives designated as cash flow hedges, the related gains or losses on these contracts are deferred as a component of accumulated other comprehensive items. These deferred gains and losses are recognized in the period in which the underlying anticipated transaction occurs. For derivatives designated as fair value hedges, the unrealized gains and losses resulting from the impact of currency exchange rate movements are recognized in earnings in the period in which the exchange rates change and offset the currency gains and losses on the underlying exposures being hedged. The Company performs an evaluation of the effectiveness of the hedge both at inception and on an ongoing basis. The ineffective portion of a hedge, if any, and changes in the fair value of a derivative not deemed to be a hedge are recorded in the condensed consolidated statement of income.
15

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Derivatives (continued)

Interest Rate Swaps
The Company entered into a swap agreement in 2006 (the 2006 Swap Agreement) to convert a portion of the Company's outstanding variable rate term loan from a floating to a fixed rate of interest. The swap agreement matures in 2016, has the same terms and quarterly payment dates as the corresponding debt, and reduces proportionately in line with the amortization of the debt. Under the 2006 Swap Agreement, the Company receives a three-month LIBOR rate and pays a fixed rate of interest of 5.63% plus an applicable margin. The fair value for this instrument as of June 28, 2014, is included in other long-term liabilities, with an offset to accumulated other comprehensive items (net of tax) in the accompanying condensed consolidated balance sheet. The Company has structured the interest rate swap agreement to be 100% effective and as a result, there is no current impact to earnings resulting from hedge ineffectiveness. Management believes that any credit risk associated with the outstanding swap agreement is remote based on the Company's financial position and the creditworthiness of the financial institution issuing the swap agreement.

The counterparty to the swap agreement could demand an early termination of the swap agreement if the Company is in default under the 2012 Credit Agreement, or any agreement that amends or replaces the 2012 Credit Agreement in which the counterparty is a member, and the Company is unable to cure the default. An event of default under the 2012 Credit Agreement includes customary events of default and failure to comply with financial covenants, including a maximum consolidated leverage ratio of 3.5 to 1, and a minimum consolidated interest coverage ratio of 3 to 1. As of June 28, 2014, the Company was in compliance with these covenants. The unrealized loss of $619,000 as of June 28, 2014, represents the estimated amount that the Company would pay to the counterparty in the event of an early termination.
Forward Currency-Exchange Contracts
The Company uses forward currency-exchange contracts primarily to hedge exposures resulting from fluctuations in currency exchange rates. Such exposures result primarily from portions of the Company's operations and assets and liabilities that are denominated in currencies other than the functional currencies of the businesses conducting the operations or holding the assets and liabilities. The Company typically manages its level of exposure to the risk of currency-exchange fluctuations by hedging a portion of its currency exposures anticipated over the ensuing 24-month period, using forward currency-exchange contracts that have maturities of 24 months or less.

Forward currency-exchange contracts that hedge forecasted foreign currency exposures are designated as cash flow hedges. The fair values for these instruments are included in other current assets for unrecognized gains and in other current liabilities and other long-term liabilities for unrecognized losses, with an offset in accumulated other comprehensive items (net of tax). For forward currency-exchange contracts that are designated as fair value hedges, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item are recognized currently in earnings. The fair values of forward currency-exchange contracts that are not designated as hedges are recorded currently in earnings.

The Company recognized a gain of $15,000 in the second quarter of 2013, and a gain of $36,000 and $13,000 in the first six months of 2014 and 2013, respectively, included in selling, general, and administrative expenses, associated with forward currency-exchange contracts that were not designated as hedges. Management believes that any credit risk associated with forward currency-exchange contracts is remote based on the Company's financial position and the creditworthiness of the financial institutions issuing the contracts.

The following table summarizes the fair value of the Company's derivative instruments designated and not designated as hedging instruments, the notional values of the associated derivative contracts, and the location of these instruments in the condensed consolidated balance sheet:

 
 
 
June 28, 2014
   
December 28, 2013
 
Balance Sheet
 
Asset
   
Notional
   
Asset
   
Notional
 
(In thousands)
Location
 
(Liability) (a)
   
Amount (b)
   
(Liability) (a)
   
Amount
 
Derivatives Designated as Hedging Instruments:
 
 
   
   
   
 
Derivatives in a Liability Position:
 
 
   
   
   
 
Forward currency-exchange contracts
Other Current Liabilities
 
$
(31
)
 
$
1,340
   
$
(22
)
 
$
1,340
 
Forward currency-exchange contract
Other Long-Term Liabilities
 
$
(384
)
 
$
16,571
   
$
   
$
 
Interest rate swap agreement
Other Long-Term Liabilities
 
$
(619
)
 
$
6,125
   
$
(773
)
 
$
6,375
 
 
 
                               
Derivatives Not Designated as Hedging Instruments:
 
                               
Derivatives in an Asset Position:
 
                               
Forward currency-exchange contracts
Other Current Assets
 
$
   
$
   
$
97
   
$
1,419
 
Derivatives in a Liability Position:
 
                               
Forward currency-exchange contracts
Other Current Liabilities
 
$
   
$
   
$
(1
)
 
$
288
 

(a) See Note 11 for the fair value measurements related to these financial instruments.
(b) The total notional amount is indicative of the level of the Company's derivative activity during the first six months of 2014.

16

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Derivatives (continued)

The following table summarizes the activity in accumulated other comprehensive items (OCI) associated with the Company's derivative instruments designated as cash flow hedges as of and for the period ended June 28, 2014:

(In thousands)
 
Interest Rate Swap
Agreements
   
Forward Currency-
Exchange
Contracts
   
Total
 
Unrealized loss, net of tax, at December 28, 2013
 
$
(618
)
 
$
(15
)
 
$
(633
)
Loss reclassified to earnings
   
108
     
241
     
349
 
Loss recognized in OCI
   
(8
)
   
(348
)
   
(356
)
Unrealized loss, net of tax, at June 28, 2014
 
$
(518
)
 
$
(122
)
 
$
(640
)

As of June 28, 2014, $327,000 of the net unrealized loss included in OCI is expected to be reclassified to earnings over the next twelve months.

11. Fair Value Measurements

Fair value measurement is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy is established, which prioritizes the inputs used in measuring fair value into three broad levels as follows:

Level 1—Quoted prices in active markets for identical assets or liabilities.
Level 2—Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly.
Level 3—Unobservable inputs based on the Company's own assumptions.

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis:

 
 
Fair Value as of June 28, 2014
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
 
 
   
   
   
 
Assets:
 
   
   
   
 
Money market funds and time deposits
 
$
5,992
   
$
   
$
   
$
5,992
 
Banker's acceptance drafts (a)
 
$
   
$
9,267
   
$
   
$
9,267
 
 
                               
Liabilities:
                               
Forward currency-exchange contracts
 
$
   
$
415
   
$
   
$
415
 
Interest rate swap agreement
 
$
   
$
619
   
$
   
$
619
 
Contingent consideration (b)
 
$
   
$
   
$
1,362
   
$
1,362
 

 
 
Fair Value as of December 28, 2013
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
 
 
   
   
   
 
Assets:
 
   
   
   
 
Money market funds and time deposits
 
$
17,090
   
$
   
$
   
$
17,090
 
Banker's acceptance drafts (a)
 
$
   
$
10,765
   
$
   
$
10,765
 
Forward currency-exchange contracts
 
$
   
$
97
   
$
   
$
97
 
 
                               
Liabilities:
                               
Forward currency-exchange contracts
 
$
   
$
23
   
$
   
$
23
 
Interest rate swap agreement
 
$
   
$
773
   
$
   
$
773
 

(a) Included in accounts receivable in the accompanying condensed consolidated balance sheet.
(b) Included in other current liabilities in the accompanying condensed consolidated balance sheet.

The Company uses the market approach technique to value its financial assets and liabilities, and there were no changes in valuation techniques during the first six months of 2014. The Company's financial assets and liabilities carried at fair value include cash equivalents and derivative instruments used to hedge the Company's foreign currency and interest rate risks. The Company's cash equivalents are comprised of money market funds and bank deposits that are highly liquid and easily tradable. These investments are valued using inputs observable in active markets for identical securities. The carrying value of the banker's acceptance drafts approximates their fair value due to their short-term nature. The fair values of the Company's interest rate swap agreement are based on LIBOR yield curves at the reporting date. The fair values of the Company's forward currency-exchange contracts are based on quoted forward foreign exchange rates at the reporting date. The forward currency-exchange contracts and interest rate swap agreement are hedges of either recorded assets or liabilities or anticipated transactions. Changes in values of the underlying hedged assets and liabilities or anticipated transactions are not reflected in the table above. The Company recorded contingent consideration as part of its acquisition of a European manufacturer on December 30, 2013. The fair value of the contingent consideration is based on the present value of the estimated future cash flows.

17

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
11. Fair Value Measurements (continued)


The carrying value and fair value of the Company's long-term debt obligations are as follows:

 
 
June 28, 2014
   
December 28, 2013
 
 
 
Carrying
   
Fair
   
Carrying
   
Fair
 
(In thousands)
 
Value
   
Value
   
Value
   
Value
 
 
 
   
   
   
 
Long-term debt obligations
 
$
27,569
   
$
27,569
   
$
38,010
   
$
38,010
 

The carrying value of long-term debt obligations approximates fair value as the obligations bear variable rates of interest, which adjust quarterly based on prevailing market rates.

12. Business Segment Information

The Company has combined its operating entities into two reportable operating segments, Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products. In classifying operational entities into a particular segment, the Company aggregated businesses with similar economic characteristics, products and services, production processes, customers, and methods of distribution.

 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 28,
   
June 29,
   
June 28,
   
June 29,
 
(In thousands)
 
2014
   
2013
   
2014
   
2013
 
 
 
   
   
   
 
Revenues:
 
   
   
   
 
Papermaking Systems
 
$
91,975
   
$
79,253
   
$
170,159
   
$
151,650
 
Wood Processing Systems
   
9,837
     
     
21,110
     
 
Fiber-based Products
   
3,023
     
2,912
     
6,933
     
6,719
 
 
 
$
104,835
   
$
82,165
   
$
198,202
   
$
158,369
 
 
                               
Income from Continuing Operations Before Provision for Income Taxes:
                               
Papermaking Systems
 
$
13,803
   
$
11,821
   
$
23,213
   
$
21,765
 
Wood Processing Systems
   
1,495
     
     
2,849
     
 
Corporate and Fiber-based Products (a)
   
(3,262
)
   
(3,396
)
   
(6,405
)
   
(5,968
)
Total Operating Income
   
12,036
     
8,425
     
19,657
     
15,797
 
Interest Expense, Net
   
(168
)
   
(89
)
   
(252
)
   
(145
)
 
 
$
11,868
   
$
8,336
   
$
19,405
   
$
15,652
 
 
                               
Capital Expenditures:
                               
Papermaking Systems
 
$
772
   
$
1,226
   
$
1,289
   
$
2,398
 
Other
   
131
     
168
     
153
     
174
 
 
 
$
903
   
$
1,394
   
$
1,442
   
$
2,572
 

(a) Corporate primarily includes general and administrative expenses.

13. Contingencies and Litigation

Right of Recourse
 In the ordinary course of business, the Company's subsidiaries in China may receive banker's acceptance drafts from customers in payment of outstanding accounts receivable. These banker's acceptance drafts are non-interest bearing obligations of the issuing bank and mature within six months of the origination date. The Company's subsidiaries in China may use these banker's acceptance drafts prior to the scheduled maturity date to settle outstanding accounts payable with vendors. Banker's acceptance drafts transferred to vendors are subject to customary right of recourse provisions prior to their scheduled maturity date. As of June 28, 2014 and December 28, 2013, the Company had $4,865,000 and $5,688,000, respectively, of banker's acceptance drafts subject to customary right of recourse provisions, which were transferred to vendors and had not reached their scheduled maturity date. Historically, the banker's acceptance drafts have settled upon maturity without any claim of recourse against the Company.

General
From time to time, the Company is subject to various claims and legal proceedings covering a range of matters that arise in the ordinary course of business. Such litigation may include claims and counterclaims by and against the Company for breach of contract or warranty, canceled contracts, product liability, or bankruptcy-related claims. For legal proceedings in which a loss is probable and estimable, the Company accrues a loss based on the low end of the range of estimated loss when there is no better estimate within the range. If the Company were found to be liable for any of the claims or counterclaims against it, the Company would incur a charge against earnings for amounts in excess of legal accruals.

18

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," "seeks," "should," "likely," "will," "would," "may," "continue," "could," 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 Part II, Item 1A, of this Report.

Overview
Company Background
We are a leading global supplier of equipment used in process industries, including papermaking, paper recycling, and oriented strand board (OSB), an engineered wood panel product used primarily in home construction. In addition, we manufacture granules made from papermaking byproducts. We have a large customer base that includes most of the world's major paper and OSB manufacturers. We believe our large installed base provides us with a spare parts and consumables business that has lower volatility and yields higher margins than our capital equipment business.

Our continuing operations are comprised of two reportable operating segments: Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products. Through our Papermaking Systems segment, we develop, manufacture, and market a range of equipment and products for the global papermaking, paper recycling, and process industries. Through our Wood Processing Systems segment, we design, manufacture, and market stranders and related equipment used in the production of OSB, and sell debarking and wood chipping equipment used in the forest products and the pulp and paper industries. Through our Fiber-based Products business, we 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, as well as for oil and grease absorption.

Papermaking Systems Segment
Our Papermaking Systems segment consists of the following product lines: Stock-Preparation; Fluid-Handling; and Doctoring, Cleaning, & Filtration.
 
-
Stock-Preparation: custom-engineered systems and equipment, as well as standard individual components, for pulping, de-inking, screening, cleaning, and refining primarily recycled fiber for preparation for entry into the paper machine; recausticizing and evaporation equipment and systems used in the production of virgin pulp;
 
 
-
Fluid-Handling: rotary joints, precision unions, steam and condensate systems, components, and controls used primarily in the dryer section of the papermaking process and during the production of corrugated boxboard, metals, plastics, rubber, textiles, chemicals, and food; and
 
 
-
Doctoring, Cleaning, & Filtration: doctoring systems and related consumables that continuously clean rolls to keep paper machines running efficiently; doctor blades made of a variety of materials to perform functions including cleaning, creping, web removal, flaking, and the application of coatings; profiling systems that control moisture, web curl, and gloss during paper converting; and systems and equipment used to continuously clean paper machine fabrics and rolls, drain water from pulp mixtures, form the sheet or web, and filter the process water for reuse.

In the first quarter of 2014, our Papermaking Systems segment acquired all the outstanding shares of a European producer of creping and coating blades for approximately $2.6 million in cash, including $0.7 million of cash acquired. An additional 1 million euros, or approximately $1.4 million, of contingent consideration is due to the sellers within two years of the closing date if certain conditions are met, as defined in the purchase agreement.

Wood Processing Systems Segment
Our principal wood-processing products include:
 
-
Stranders: disc and ring stranders that cut trees into strands for OSB production;
 
 
-
Rotary Debarkers: rotary debarkers that employ a combination of mechanical abrasion and log-to-log contact to efficiently remove bark from logs of all shapes and species; and
 
 
-
Chippers: disc, drum, and veneer chippers that are high quality, robust chipper systems for waste-wood and whole-log applications found in pulp woodrooms, chip plants, sawmill, and planer mill sites.
Fiber-based Products
We produce biodegradable, absorbent granules from papermaking byproducts for use primarily as carriers for agricultural, home lawn and garden, and professional lawn, turf and ornamental applications, as well as for oil and grease absorption.
19

KADANT INC.
Overview (continued)
International Sales
During the first six months of 2014 and 2013, approximately 56% and 58%, respectively, of our sales were to customers outside the United States, principally in Europe and China. We generally seek to charge our customers in the same currency in which our operating costs are