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EX-31.1 - KAI FORM 10-Q 1Q 2016 EXHIBIT 31.1 - KADANT INCkaiform10q1q2016exhibit311.htm
EX-2.1 - KAI FORM 10-Q 1Q 2016 EXHIBIT 2.1 - KADANT INCkaiform10q1q2016exhibit21.htm
EX-10.1 - KAI FORM 10-Q 1Q 2016 EXHIBIT 10.1 - KADANT INCkaiform10q1q2016exhibit101.htm
EX-31.2 - KAI FORM 10-Q 1Q 2016 EXHIBIT 31.2 - KADANT INCkaiform10q1q2016exhibit312.htm
EX-32 - KAI FORM 10-Q 1Q 2016 EXHIBIT 32 - KADANT INCkaiform10q1q2016exhibit32.htm


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 April 2, 2016


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 April 29, 2016
Common Stock, $.01 par value
 
10,854,322




PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)

Assets

 
 
April 2,
2016
 
January 2,
2016
(In thousands)
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
104,517

 
$
65,530

Restricted cash (Note 1)
 
1,522

 
1,406

Accounts receivable, less allowances of $2,262 and $2,163 (Note 1)
 
62,029

 
64,321

Inventories (Note 1)
 
58,681

 
56,758

Unbilled contract costs and fees
 
2,319

 
6,580

Other current assets
 
15,518

 
10,525

Total Current Assets
 
244,586

 
205,120

 
 
 
 
 
Property, Plant, and Equipment, at Cost
 
119,270

 
118,014

Less: accumulated depreciation and amortization
 
77,145

 
75,721

 
 
42,125

 
42,293

 
 
 
 
 
Other Assets
 
11,081

 
11,002

 
 
 
 
 
Intangible Assets, Net (Note 1)
 
38,147

 
38,032

 
 
 
 
 
Goodwill
 
121,681

 
119,051

 
 
 
 
 
Total Assets
 
$
457,620

 
$
415,498


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

 
 
April 2,
2016
 
January 2,
2016
(In thousands, except share amounts)
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
Short-term obligations (Note 5)
 
$
5,125

 
$
5,250

Accounts payable
 
23,796

 
24,418

Accrued payroll and employee benefits
 
14,492

 
19,583

Customer deposits
 
19,085

 
20,123

Accrued income taxes
 
2,091

 
5,333

Other current liabilities
 
19,590

 
21,921

Total Current Liabilities
 
84,179

 
96,628

 
 
 
 
 
Long-Term Deferred Income Taxes
 
11,680

 
8,992

 
 
 
 
 
Other Long-Term Liabilities
 
17,112

 
15,933

 
 
 
 
 
Long-Term Obligations (Note 5)
 
67,046

 
26,000

 
 
 
 
 
Commitments and Contingencies (Note 12)
 

 

 
 
 
 
 
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
 
97,897

 
100,536

Retained earnings
 
302,071

 
297,258

Treasury stock at cost, 3,769,837 and 3,850,779 shares
 
(92,376
)
 
(94,359
)
Accumulated other comprehensive items (Note 8)
 
(31,645
)
 
(36,972
)
Total Kadant Stockholders' Equity
 
276,093

 
266,609

Noncontrolling interest
 
1,510

 
1,336

Total Stockholders' Equity
 
277,603

 
267,945

 
 
 
 
 
Total Liabilities and Stockholders' Equity
 
$
457,620

 
$
415,498


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
 
 
April 2,
2016
 
April 4,
2015
(In thousands, except per share amounts)
 
 
 
 
 
 
 
Revenues
 
$
96,538

 
$
92,251

 
 
 
 
 
Costs and Operating Expenses:
 
 

 
 

Cost of revenues
 
52,562

 
47,914

Selling, general, and administrative expenses
 
32,496

 
32,222

Research and development expenses
 
1,704

 
1,660

Restructuring costs and other income (Note 2)
 
(317
)
 
84

 
 
86,445

 
81,880

 
 
 
 
 
Operating Income
 
10,093

 
10,371

 
 
 
 
 
Interest Income
 
55

 
53

Interest Expense
 
(269
)
 
(231
)
 
 
 
 
 
Income from Continuing Operations Before Provision for Income Taxes
 
9,879

 
10,193

Provision for Income Taxes (Note 4)
 
2,888

 
3,268

 
 
 
 
 
Income from Continuing Operations
 
6,991

 
6,925

Income from Discontinued Operation (net of income tax provision of $41)
 

 
65

 
 
 
 
 
Net Income
 
6,991

 
6,990

 
 
 
 
 
Net Income Attributable to Noncontrolling Interest
 
(115
)
 
(93
)
 
 
 
 
 
Net Income Attributable to Kadant
 
$
6,876

 
$
6,897

 
 
 
 
 
Amounts Attributable to Kadant:
 
 

 
 

Income from Continuing Operations
 
$
6,876

 
$
6,832

Income from Discontinued Operation
 

 
65

Net Income Attributable to Kadant
 
$
6,876

 
$
6,897

 
 
 
 
 
Earnings per Share from Continuing Operations Attributable to Kadant (Note 3):
 
 

 
 

Basic
 
$
0.64

 
$
0.63

Diluted
 
$
0.62

 
$
0.62

 
 
 
 
 
Earnings per Share Attributable to Kadant (Note 3):
 
 

 
 

Basic
 
$
0.64

 
$
0.63

Diluted
 
$
0.62

 
$
0.62

 
 
 
 
 
Weighted Average Shares (Note 3):
 
 

 
 

Basic
 
10,793

 
10,892

Diluted
 
11,018

 
11,086

 
 
 
 
 
Cash Dividends Declared per Common Share
 
$
0.19

 
$
0.17


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


 

4



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

 
 
Three Months Ended
 
 
 
April 2,
2016
 
April 4,
2015
 
(In thousands)
 
 
 
 
 
 
 
 
 
Net Income
 
$
6,991

 
$
6,990

 
 
 
 
 
 
 
Other Comprehensive Items:
 
 

 
 

 
Foreign currency translation adjustment
 
5,930

 
(12,102
)
 
Pension and other post-retirement liability adjustments (net of tax benefit of $236 in 2016 and tax provision of $92 in 2015)
 
(418
)
 
173

 
Deferred loss on hedging instruments (net of tax benefit of $72 in 2016 and tax provision of $17 in 2015)
 
(126
)
 
(508
)
 
Other Comprehensive Items
 
5,386

 
(12,437
)
 
Comprehensive Income (Loss)
 
12,377

 
(5,447
)
 
Comprehensive (Income) Loss Attributable to Noncontrolling Interest
 
(174
)
 
39

 
Comprehensive Income (Loss) Attributable to Kadant
 
$
12,203

 
$
(5,408
)
 

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

5



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

 
 
Three Months Ended
 
 
April 2,
2016
 
April 4,
2015
(In thousands)
 
 
 
 
 
 
 
Operating Activities:
 
 
 
 
Net income attributable to Kadant
 
$
6,876

 
$
6,897

Net income attributable to noncontrolling interest
 
115

 
93

Income from discontinued operation
 

 
(65
)
Income from continuing operations
 
6,991

 
6,925

Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
2,564

 
2,910

Stock-based compensation expense
 
1,323

 
1,588

Tax benefits from stock-based compensation awards
 

 
(687
)
Provision for losses on accounts receivable
 
76

 
185

Gain on the sale of property, plant, and equipment
 
(346
)
 

Other items, net
 
781

 
(836
)
Contributions to pension plan
 
(270
)
 
(270
)
Changes in current assets and liabilities:
 
 

 
 

Accounts receivable
 
3,259

 
(5,247
)
Unbilled contract costs and fees
 
4,313

 
1,817

Inventories
 
(604
)
 
(7,660
)
Other current assets
 
(1,808
)
 
(1,908
)
Accounts payable
 
(1,234
)
 
375

Other current liabilities
 
(9,527
)
 
589

Net cash provided by (used in) continuing operations
 
5,518

 
(2,219
)
Net cash used in discontinued operation
 

 
(41
)
Net cash provided by (used in) operating activities
 
5,518

 
(2,260
)
 
 
 
 
 
Investing Activities:
 
 

 
 

Issuance of note receivable
 
(2,813
)
 

Purchases of property, plant, and equipment
 
(524
)
 
(1,216
)
Proceeds from sale of property, plant, and equipment
 
385

 
5

Net cash used in continuing operations for investing activities
 
(2,952
)
 
(1,211
)
 
 
 
 
 
Financing Activities:
 
 

 
 

Proceeds from issuance of long-term obligations
 
41,046

 
10,000

Repayments of short-and long-term obligations
 
(125
)
 
(5,111
)
Tax withholding payments related to stock-based compensation
 
(1,980
)
 
(2,304
)
Dividends paid
 
(1,831
)
 
(1,630
)
Payment of contingent consideration
 
(1,091
)
 

Tax benefits from stock-based compensation awards
 

 
687

Proceeds from issuance of company common stock
 

 
148

Change in restricted cash
 
(58
)
 

Net cash provided by continuing operations for financing activities
 
35,961

 
1,790

 
 
 
 
 
Exchange Rate Effect on Cash and Cash Equivalents from Continuing Operations
 
460

 
(857
)
 
 
 
 
 
Increase (Decrease) in Cash and Cash Equivalents from Continuing Operations
 
38,987

 
(2,538
)
Cash and Cash Equivalents at Beginning of Period
 
65,530

 
45,378

Cash and Cash Equivalents at End of Period
 
$
104,517

 
$
42,840

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

6



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

(In thousands, except share amounts)
 
Common
Stock
 
Capital in
Excess of Par Value
 
Retained Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive Items
 
Noncontrolling Interest
 
Total
Stockholders' Equity
 
Shares
 
Amount
 
 
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 3, 2015
 
14,624,159

 
$
146

 
$
98,769

 
$
270,249

 
3,760,019

 
$
(87,727
)
 
$
(17,146
)
 
$
1,168

 
$
265,459

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
6,897

 

 

 

 
93

 
6,990

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dividends declared
 

 

 

 
(1,864
)
 

 

 

 

 
(1,864
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Activity under stock plans
 

 

 
(2,956
)
 

 
(102,346
)
 
2,388

 

 

 
(568
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Tax benefits related to employees' and directors' stock plans
 

 

 
687

 

 

 

 

 

 
687

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive items
 

 

 

 

 

 

 
(12,305
)
 
(132
)
 
(12,437
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 4, 2015
 
14,624,159

 
$
146

 
$
96,500

 
$
275,282

 
3,657,673

 
$
(85,339
)
 
$
(29,451
)
 
$
1,129

 
$
258,267

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 2, 2016
 
14,624,159

 
$
146

 
$
100,536

 
$
297,258

 
3,850,779

 
$
(94,359
)
 
$
(36,972
)
 
$
1,336

 
$
267,945

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 

 

 

 
6,876

 

 

 

 
115

 
6,991

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dividends declared
 

 

 

 
(2,063
)
 

 

 

 

 
(2,063
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Activity under stock plans
 

 

 
(2,639
)
 

 
(80,942
)
 
1,983

 

 

 
(656
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive items
 

 

 

 

 

 

 
5,327

 
59

 
5,386

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 2, 2016
 
14,624,159

 
$
146

 
$
97,897

 
$
302,071

 
3,769,837

 
$
(92,376
)
 
$
(31,645
)
 
$
1,510

 
$
277,603


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

7


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


1
1.    Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations
Kadant Inc. (collectively, "we," "Kadant," "the Company," or "the Registrant") was incorporated in Delaware in November 1991 and currently trades on the New York Stock Exchange under the ticker symbol "KAI."

The Company and its subsidiaries' 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 other 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 April 2, 2016 and its results of operations, comprehensive income (loss), cash flows, and stockholders' equity for the three-month periods ended April 2, 2016 and April 4, 2015. 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 January 2, 2016 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 2016. 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 January 2, 2016, filed with the SEC.

Financial Statement Presentation
Certain reclassifications have been made to prior periods to conform with current reporting. As a result of the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2016-09, tax withholding payments made related to stock-based compensation awards have been reclassified from other current liabilities within operating activities on the condensed consolidated statement of cash flows and presented separately within financing activities. In addition, on the condensed consolidated statement of cash flows, the tax benefits from stock-based compensation awards within operating activities for the three-month period ended April 4, 2015 have been reclassified from other items, net, and are now presented separately.

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

8


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

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)


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 January 2, 2016.

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.

Although the Company makes every effort to ensure the accuracy of the estimates and assumptions used in the preparation of its condensed consolidated financial statements or in the application of accounting policies, if business conditions were different, or if the Company were to use different estimates and assumptions, it is possible that materially different amounts could be reported in the Company's condensed consolidated financial statements.

Supplemental Cash Flow Information
 
 
Three Months Ended
(In thousands)
 
April 2,
2016
 
April 4,
2015
Non-Cash Financing Activities:
 
 

 
 

Issuance of Company Common Stock
 
$
2,854

 
$
2,633

Dividends Declared but Unpaid
 
$
2,063

 
$
1,864


Restricted Cash
As of April 2, 2016 and January 2, 2016, the Company had restricted cash of $1,522,000 and $1,406,000, 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 of the bank guarantees will expire by the end of 2017.

Banker's Acceptance Drafts
The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for outstanding 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 $7,853,000 and $8,314,000 at April 2, 2016 and January 2, 2016, respectively, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary sells the drafts to a bank and receives a discounted amount, transfers the banker's acceptance drafts in settlement of accounts payable prior to maturity, or obtains cash payment on the scheduled maturity date.

Inventories
The components of inventories are as follows:
 
 
April 2,
2016
 
January 2,
2016
(In thousands)
 
 
Raw Materials and Supplies
 
$
22,415

 
$
22,324

Work in Process
 
11,769

 
13,819

Finished Goods
 
24,497

 
20,615

 
 
$
58,681

 
$
56,758



9


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

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)


Intangible Assets, Net
Acquired intangible assets are as follows:
 
 
April 2,
2016
 
January 2,
2016
(In thousands)
 
 
Indefinite-Lived Intangible Asset
 
$
8,100

 
$
8,100

 
 
 
 
 
Definite-Lived Intangible Assets, Gross
 
$
77,052

 
$
77,052

Accumulated Amortization
 
(42,030
)
 
(40,908
)
Currency Translation
 
(4,975
)
 
(6,212
)
Definite-Lived Intangible Assets, Net
 
$
30,047

 
$
29,932

 
 
 
 
 
Total Intangible Assets, Net
 
$
38,147

 
$
38,032


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, as well as knowledge of any specific warranty problems that indicate that projected warranty costs may vary from historical patterns. 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:
 
 
Three Months Ended
(In thousands)
 
April 2,
2016
 
April 4,
2015
Balance at beginning of period
 
$
3,670

 
$
3,875

Provision charged to income
 
560

 
408

Usage
 
(526
)
 
(543
)
Currency translation
 
81

 
(192
)
Balance at end of period
 
$
3,785

 
$
3,548


Recent Accounting Pronouncements
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 GAAP when it becomes effective. In March 2016, the FASB issued ASU No. 2016-08, which further clarifies the guidance on the principal versus agent considerations within ASU No. 2014-09. In April 2016, the FASB issued ASU No. 2016-10 to expand the guidance on identifying performance obligations and licensing within ASU 2014-09. These new ASUs are effective for the Company beginning in fiscal 2018. Early adoption is permitted in fiscal 2017. The guidance permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect that these ASUs 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

10


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

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)


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 Company adopted this guidance at the beginning of fiscal 2016. The adoption of this ASU did not have an impact on the Company’s condensed consolidated financial statements.

Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. In April 2015, the FASB issued ASU No. 2015-03, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In addition, in June 2015, the FASB issued ASU No. 2015-15, which allows an entity to defer the requirements of ASU No. 2015-03 on deferred issuance costs related to line-of-credit arrangements. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in these ASUs. These new disclosure items are effective for the Company beginning in fiscal 2016. The Company adopted these ASUs at the beginning of fiscal 2016. Adoption of these ASUs did not have an impact on the Company’s condensed consolidated financial statements.

Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). In May 2015, the FASB issued ASU No. 2015-07, which removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. This ASU also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. The Company adopted the disclosure requirements in this guidance at the beginning of fiscal 2016. As this ASU is disclosure-related only, its adoption did not have an effect on the Company’s condensed consolidated financial statements.

Inventory (Topic 330), Simplifying the Measurement of Inventory. In July 2015, the FASB issued ASU No. 2015-11, which requires that an entity measure inventory within the scope of this ASU at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Substantial and unusual losses that result from subsequent measurement of inventory should be disclosed in the financial statements. This new guidance is effective for the Company beginning in fiscal 2017. Early adoption is permitted. The Company is currently evaluating the effect that this ASU will have on its condensed consolidated financial statements.

Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments. In September 2015, the FASB issued ASU No. 2015-16, which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer is required to record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In addition, an entity is required to present, separately on the face of the income statement or through disclosure in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Company adopted this guidance at the beginning of fiscal 2016. Adoption of this ASU did not have an impact on the Company’s condensed consolidated financial statements.
    
Leases (Topic 842). In February 2016, the FASB issued ASU No. 2016-02, which requires a lessee to recognize a right-of-use asset and a lease liability for operating leases, initially measured at the present value of the future lease payments, in its balance sheet. This ASU also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. This new guidance is effective for the Company in fiscal 2019. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.

11


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

1.    Nature of Operations and Summary of Significant Accounting Policies (continued)

    
Compensation -Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. In March 2016, the FASB issued ASU No. 2016-09, which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the statement of cash flows. The Company early adopted this ASU at the beginning of fiscal 2016. This ASU requires that excess income tax benefits and tax deficiencies related to stock-based compensation arrangements be recognized as discrete items within the provision for income taxes instead of additional paid in capital in the reporting period in which they occur. As a result of the adoption of this ASU, the Company recognized an income tax benefit of $205,000, or $0.02 per diluted share, in the Company’s condensed consolidated statement of income in the first quarter of 2016. The Company prospectively adopted the requirement to classify the excess tax benefits from stock-compensation awards within operating activities in the condensed consolidated statement of cash flows in the first quarter of 2016. Prior period amounts were not restated. The Company also adopted the guidance in this ASU that requires that taxes paid related to the withholding of common stock upon the vesting of employee stock awards be presented separately within financing activities in the condensed consolidated statement of cash flows. The Company has retrospectively restated the 2015 period to reclassify the comparative amount, which was previously presented in other current liabilities within operating activities. There were no other material effects from adoption of this ASU on the Company’s condensed consolidated financial statements.
 
2.    Restructuring Costs and Other Income

Other Income
In the first quarter of 2016, other income consisted of a pre-tax gain of $317,000 from the sale of real estate in Sweden for cash proceeds of $368,000.

Restructuring Costs
In the first quarter of 2015, the Company's Papermaking Systems segment recorded restructuring costs related to its 2015 restructuring plan of $84,000 for severance costs associated with the reduction of five employees in Canada and Sweden. These actions were taken to streamline the Company's operations in those locations.

3.    Earnings per Share

Basic and diluted earnings per share (EPS) were calculated as follows:
 
 
Three Months Ended
 
 
 
April 2,
2016
 
April 4,
2015
 
(In thousands, except per share amounts)
 
 
 
Amounts Attributable to Kadant:
 
 
 
 
 
Income from Continuing Operations
 
$
6,876

 
$
6,832

 
Income from Discontinued Operation
 

 
65

 
Net Income
 
$
6,876

 
$
6,897

 
 
 
 
 
 
 
Basic Weighted Average Shares
 
10,793

 
10,892

 
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan
 
225

 
194

 
Diluted Weighted Average Shares
 
11,018

 
11,086

 
 
 
 
 
 
 
Basic Earnings per Share:
 
 

 
 

 
Continuing Operations
 
$
0.64

 
$
0.63

 
Discontinued Operation
 
$

 
$
0.01

 
Net Income per Basic Share
 
$
0.64

 
$
0.63

 
 
 
 
 
 
 
Diluted Earnings per Share:
 
 

 
 

 
Continuing Operations
 
$
0.62

 
$
0.62

 
Discontinued Operation
 
$

 
$
0.01

 
Net Income per Diluted Share
 
$
0.62

 
$
0.62

 

12


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

3.    Earnings per Share (continued)



Unvested restricted stock units (RSUs) equivalent to approximately 147,000 and 46,000 shares of common stock for the first quarters of 2016 and 2015, respectively, were not included in the computation of diluted EPS because either the effect of their inclusion would have been anti-dilutive, or for unvested performance-based RSUs, the performance conditions had not been met as of the end of the reporting period.

4.    Provision for Income Taxes

The provision for income taxes was $2,888,000 and $3,268,000 in the first quarters of 2016 and 2015, respectively, and represented 29% and 32% of pre-tax income. The effective tax rate of 29% in the first quarter of 2016 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings and the adoption of ASU No. 2016-09 that resulted in a favorable adjustment for the net excess income tax benefits from stock-based compensation arrangements. These items were offset in part by an increase in tax related to non-deductible expenses and state taxes. The effective tax rate of 32% in the first quarter of 2015 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings, which was offset in part by an increase in state taxes, tax expense related to an increase in non-deductible expenses, and the U.S. tax cost of foreign operations.

5.    Short- and Long-Term Obligations

Short- and long-term obligations are as follows:
 
 
April 2,
2016
 
January 2,
2016
(In thousands)
 
 
Revolving Credit Facility, due 2018
 
$
67,046

 
$
26,000

Commercial Real Estate Loan, due 2016
 
5,125

 
5,250

Total Short- and Long-Term Obligations
 
72,171

 
31,250

Less: Short-Term Obligations
 
(5,125
)
 
(5,250
)
Long-Term Obligations
 
$
67,046

 
$
26,000


The weighted average interest rate for the Company's short-and long-term obligations was 1.72% as of April 2, 2016.

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 and March 29, 2016. 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.

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, 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,


13


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

5.    Short- and Long-Term Obligations (continued)


and certain actions related to the discontinued operation. As of April 2, 2016, 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.

The Company borrowed $41,046,000 under the 2012 Credit Agreement in the first quarter of 2016, of which $29,866,000 was a euro-denominated borrowing used to fund the acquisition of RT Holding GmbH, the parent corporation of a group of companies known as the PAALGROUP (PAAL), which occurred at the beginning of the second quarter of 2016. As of April 2, 2016, the outstanding balance under the 2012 Credit Agreement was $67,046,000. As of April 2, 2016, the Company had $32,151,000 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.

6.    Stock-Based Compensation

The Company recognized stock-based compensation expense of $1,323,000 and $1,588,000 in the first quarters of 2016 and 2015, respectively, within selling, general, and administrative (SG&A) expenses in the accompanying condensed consolidated statement of income. The Company recognizes compensation cost for all stock-based awards granted to employees and directors based on the grant date estimate of fair value for those awards. The fair value of RSUs is based on the grant date trading price of the Company's common stock, reduced by the present value of estimated dividends foregone during the requisite service period. For time-based RSUs, compensation expense is recognized ratably over the requisite service period for the entire award net of forfeitures. For performance-based RSUs, compensation expense is recognized ratably over the requisite service period for each separately-vesting portion of the award net of forfeitures and remeasured at each reporting period until the total number of RSUs to be issued is known. Unrecognized compensation expense related to stock-based compensation totaled approximately $7,830,000 at April 2, 2016, and will be recognized over a weighted average period of 2.0 years.

On March 8, 2016, the Company granted to its executive officers performance-based RSUs, which represented, in aggregate, the right to receive 53,811 shares (the target RSU amount), subject to adjustment, with an aggregate grant date fair value of $2,173,000. The RSUs are subject to adjustment based on the achievement of the performance measure selected for the 2016 fiscal year, which is a specified target for adjusted EBITDA generated from continuing operations for the 2016 fiscal year. The RSUs are adjusted by comparing the actual adjusted EBITDA for the performance period to the target adjusted EBITDA. Actual adjusted EBITDA between 50% and 100% of the target adjusted EBITDA results in an adjustment of 50% to 100% of the RSU amount. Actual adjusted EBITDA between 100% and 115% of the target adjusted EBITDA results in an adjustment using a straight-line linear scale between 100% and 150% of the RSU amount. If actual adjusted EBITDA is below 50% of the target adjusted EBITDA for the 2016 fiscal year, all performance-based RSUs will be forfeited. In the first quarter of 2016, the Company recognized compensation expense based on the probable number of performance-based RSUs expected to vest, which was 100% of the target RSU amount. Following the adjustment, the performance-based RSUs will be subject to additional time-based vesting, and will vest in three equal annual installments on March 10 of 2017, 2018, and 2019, provided that the executive officer is employed by the Company on the applicable vesting dates. On March 8, 2016, the Company also granted time-based RSUs representing 58,438 shares to its executive officers and employees with an aggregate grant date fair value of $2,359,000. These time-based RSUs generally vest in three equal annual installments on March 10 of 2017, 2018, and 2019, provided the employee remains employed by the Company on the applicable vesting dates.

On March 9, 2016, the Company granted 20,000 RSUs in the aggregate to its non-employee directors with a grant date fair value of $812,000. The RSUs will vest ratably on the last day of each fiscal quarter of 2016.


14


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


7.    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 under "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 under "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 under "Other Benefits").

The components of net periodic benefit cost for the pension benefits and other benefits plans are as follows:
 
 
Three Months Ended 
 April 2, 2016
 
Three Months Ended 
 April 4, 2015
(In thousands)
 
Pension
Benefits
 
Other
Benefits
 
Pension
Benefits
 
Other
Benefits
Components of Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
Service cost
 
$
181

 
$
58

 
$
211

 
$
57

Interest cost
 
318

 
64

 
307

 
65

Expected return on plan assets
 
(322
)
 
(7
)
 
(356
)
 
(11
)
Recognized net actuarial loss
 
124

 
22

 
127

 
17

Amortization of prior service cost
 
14

 
24

 
14

 
22

Settlement loss
 

 
114

 

 

Net periodic benefit cost
 
$
315

 
$
275

 
$
303

 
$
150

 
 
 
 
 
 
 
 
 
The weighted average assumptions used to determine net periodic benefit cost are as follows:
 
 

 
 
 
 
 
 
 
 
 
Discount rate
 
4.22
%
 
4.07
%
 
3.87
%
 
3.76
%
Expected long-term return on plan assets
 
5.00
%
 

 
5.25
%
 

Rate of compensation increase
 
3.00
%
 
3.01
%
 
3.00
%
 
2.99
%

The Company made cash contributions of $270,000 to its Kadant Solutions division's noncontributory defined benefit retirement plan in the first three months of 2016 and expects to make cash contributions of $810,000 over the remainder of 2016. For the remaining pension and post-retirement welfare benefits plans, no cash contributions other than to fund current benefit payments are expected in 2016.
 
8.    Accumulated Other Comprehensive Items

Comprehensive income (loss) 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.


15


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

8.    Accumulated Other Comprehensive Items (continued)



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 January 2, 2016
 
$
(27,932
)
 
$
(489
)
 
$
(8,322
)
 
$
(229
)
 
$
(36,972
)
Other comprehensive income (loss) before reclassifications
 
5,871

 
(2
)
 
(610
)
 
(239
)
 
5,020

Reclassifications from AOCI
 

 
24

 
170

 
113

 
307

Net current period other comprehensive  income (loss)
 
5,871

 
22

 
(440
)
 
(126
)
 
5,327

Balance at April 2, 2016
 
$
(22,061
)
 
$
(467
)
 
$
(8,762
)
 
$
(355
)
 
$
(31,645
)
 
 
 
 
 
 
 
 
 
 
 
Balance at January 3, 2015
 
$
(7,371
)
 
$
(589
)
 
$
(8,394
)
 
$
(792
)
 
$
(17,146
)
Other comprehensive (loss) income before reclassifications
 
(11,970
)
 
4

 
52

 
568

 
(11,346
)
Reclassifications from AOCI
 

 
23

 
94

 
(1,076
)
 
(959
)
Net current period other comprehensive (loss) income
 
(11,970
)
 
27

 
146

 
(508
)
 
(12,305
)
Balance at April 4, 2015
 
$
(19,341
)
 
$
(562
)
 
$
(8,248
)
 
$
(1,300
)
 
$
(29,451
)

Amounts reclassified out of AOCI are as follows:
 
 
Three Months Ended
 
Statement of Income
(In thousands)
 
April 2,
2016
 
April 4,
2015
 
Line Item
Pension and Other Post-Retirement Plans: (1)
 
 
 
      
Amortization of prior service costs
 
$
(38
)
 
$
(36
)
 
SG&A expenses
Amortization of actuarial losses
 
(260
)
 
(144
)
 
SG&A expenses
Total expense before income taxes
 
(298
)
 
(180
)
 
 
Income tax benefit
 
104

 
63

 
Provision for income taxes
 
 
(194
)
 
(117
)
 
 
Cash Flow Hedges: (2)
 
 

 
 

 
      
Interest rate swap agreements
 
(89
)
 
(104
)
 
Interest expense
Forward currency-exchange contracts
 
(61
)
 

 
Revenues
Forward currency-exchange contracts
 
(23
)
 

 
Cost of Revenues
Forward currency-exchange contracts
 

 
1,318

 
SG&A expenses
Total (expense) income before income taxes
 
(173
)
 
1,214

 
 
Income tax benefit (provision)
 
60

 
(138
)
 
Provision for income taxes
 
 
(113
)
 
1,076

 
 
Total Reclassifications
 
$
(307
)
 
$
959

 
 

(1)
Included in the computation of net periodic pension costs. See Note 7 for additional information.
(2)
See Note 9 for additional information.


16


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


9.    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.

Interest Rate Swaps
The Company entered into interest rate swap agreements in 2015 and 2006 and has designated these agreements as cash flow hedges. On January 16, 2015, the Company entered into a swap agreement (2015 Swap Agreement) to hedge its exposure to movements in the three-month London Inter-Bank Offered Rate (LIBOR) rate on future outstanding debt. The 2015 Swap Agreement expires on March 27, 2020 and has a $10,000,000 notional value. Under the 2015 Swap Agreement, on a quarterly basis, the Company receives a three-month LIBOR rate and pays a fixed rate of interest of 1.50% plus an applicable margin. The fair value of the 2015 Swap Agreement as of April 2, 2016 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 entered into a swap agreement in 2006 (the 2006 Swap Agreement) to convert a portion of the Company's outstanding debt from a floating to a fixed rate of interest. The swap agreement 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 of the 2006 Swap Agreement as of April 2, 2016 is included in other current liabilities, with an offset to accumulated other comprehensive items (net of tax) in the accompanying condensed consolidated balance sheet. The 2006 Swap Agreement expired in May 2016.

The Company has structured the interest rate swap agreements 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 swap agreements is remote based on the Company's financial position and the creditworthiness of the financial institution issuing the swap agreements.

The counterparty to the swap agreements could demand an early termination of the swap agreements 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 April 2, 2016, the Company was in compliance with these covenants. The unrealized loss associated with the swap agreements was $189,000 as of April 2, 2016, which represents the estimated amount that the Company would pay to the counterparty in the event of an early termination.


17


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

9.    Derivatives (continued)

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 12-month period, using forward currency-exchange contracts that have maturities of 12 months or less.

Forward currency-exchange contracts that hedge forecasted accounts receivable or accounts payable 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 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 loss of $211,000 in the first quarter of 2016 and a gain of $1,000 in the first quarter of 2015 included in SG&A 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:
 
 
 
 
April 2, 2016
 
January 2, 2016
 
 
Balance Sheet Location
 
Asset (Liability) (a)
 
Notional Amount (b)
 
Asset (Liability) (a)
 
Notional Amount
(In thousands)
 
 
 
 
 
Derivatives Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
Derivatives in an Asset Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Assets
 
$
69

 
$
1,829

 
$

 
$

Interest rate swap agreement
 
Other Long-Term Assets
 

 

 
38

 
10,000

Derivatives in a Liability Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Liabilities
 
$
(235
)
 
$
3,529

 
$
(101
)
 
$
6,525

Interest rate swap agreement
 
Other Current Liabilities
 
$
(25
)
 
$
5,125

 
$
(91
)
 
$
5,250

Interest rate swap agreement
 
Other Long-Term Liabilities
 
$
(164
)
 
$
10,000

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments:
 
 

 
 

 
 

 
 

Derivatives in an Asset Position:
 
 
 
 

 
 

 
 

 
 

Forward currency-exchange contracts
 
Other Current Assets
 
$
265

 
$
1,549

 
$
2,536

 
$
15,612

Derivatives in a Liability Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Liabilities
 
$
(172
)
 
$
16,009

 
$

 
$


(a)
See Note 10 for the fair value measurements relating to these financial instruments.
(b)
The total notional amount is indicative of the level of the Company's derivative activity during the first quarter of 2016.


18


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

9.    Derivatives (continued)


The following table summarizes the activity in AOCI associated with the Company's derivative instruments designated as cash flow hedges as of and for the period ended April 2, 2016:
(In thousands)
 
Interest Rate Swap
Agreements
 
Forward Currency-
Exchange
Contracts
 
Total
Unrealized loss, net of tax, at January 2, 2016
 
$
(162
)
 
$
(67
)
 
$
(229
)
Loss reclassified to earnings (a)
 
57

 
56

 
113

Loss recognized in AOCI
 
(144
)
 
(95
)
 
(239
)
Unrealized loss, net of tax, at April 2, 2016
 
$
(249
)
 
$
(106
)
 
$
(355
)

(a) See Note 8 for the income statement classification.

As of April 2, 2016, $272,000 of the net unrealized loss included in AOCI is expected to be reclassified to earnings over the next twelve months.

10.    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 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 April 2, 2016
(In thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Money market funds and time deposits
 
$
7,063

 
$

 
$

 
$
7,063

Forward currency-exchange contracts
 
$

 
$
334

 
$

 
$
334

Banker's acceptance drafts (a)
 
$

 
$
7,853

 
$

 
$
7,853

 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

Forward currency-exchange contracts
 
$

 
$
407

 
$

 
$
407

Interest rate swap agreements
 
$

 
$
189

 
$

 
$
189















19


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

10.    Fair Value Measurements (continued)


 
 
Fair Value as of January 2, 2016
(In thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Money market funds and time deposits
 
$
9,767

 
$

 
$

 
$
9,767

Forward currency-exchange contracts
 
$

 
$
2,536

 
$

 
$
2,536

Interest rate swap agreement
 
$

 
$
38

 
$

 
$
38

Banker's acceptance drafts (a)
 
$

 
$
8,314

 
$

 
$
8,314

 
 
 
 
 
 
 
 
 
Liabilities:
 
 

 
 

 
 

 
 

Forward currency-exchange contracts
 
$

 
$
101

 
$

 
$
101

Interest rate swap agreement
 
$

 
$
91

 
$

 
$
91

Contingent consideration (b)
 
$

 
$

 
$
1,091

 
$
1,091


(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 three months of 2016. The Company's financial assets and liabilities carried at fair value are comprised of cash equivalents, banker's acceptance drafts, 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 which are highly liquid and readily tradable. These investments are valued using inputs observable in active markets for identical securities. The carrying value of banker's acceptance drafts approximates their fair value due to the short-term nature of the negotiable instrument. The fair values of the Company's interest rate swap agreements 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 agreements 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 was based on the present value of the estimated future cash flows. Changes to the fair value of contingent consideration were recorded in SG&A expenses. This contingent consideration was paid during the first quarter of 2016.

The following table provides a rollforward of the fair value, as determined by Level 3 inputs, of the contingent consideration:
 
 
Three Months Ended 
 April 2, 2016
(In thousands)
 
Balance at beginning of period
 
$
1,091

Payment
 
(1,091
)
Balance at end of period
 
$


The carrying value and fair value of the Company's long-term debt obligations are as follows:
 
 
April 2, 2016
 
January 2, 2016
 
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
Long-term debt obligations
 
$
67,046

 
$
67,046

 
$
26,000

 
$
26,000


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.

20


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


11.    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 has aggregated businesses with similar economic characteristics, products and services, production processes, customers, and methods of distribution.
 
 
Three Months Ended
 
 
April 2,
 
April 4,
(In thousands)
 
2016
 
2015
Revenues:
 
 
 
 
Papermaking Systems
 
$
84,027

 
$
80,655

Wood Processing Systems
 
8,707

 
7,772

Fiber-based Products
 
3,804

 
3,824

 
 
$
96,538

 
$
92,251

 
 
 
 
 
Income from Continuing Operations Before Provision for Income Taxes:
 
 

 
 

Papermaking Systems
 
$
13,497

 
$
12,283

Wood Processing Systems
 
806

 
2,245

Corporate and Fiber-based Products (a)
 
(4,210
)
 
(4,157
)
Total operating income
 
10,093

 
10,371

Interest expense, net
 
(214
)
 
(178
)
 
 
$
9,879

 
$
10,193

 
 
 
 
 
Capital Expenditures:
 
 

 
 

Papermaking Systems
 
$
518

 
$
952

Other
 
6

 
264

 
 
$
524

 
$
1,216

 
 
 
 
 
 
 
April 2,
 
January 2,
(In thousands)
 
2016
 
2016
Total Assets:
 
 
 
 
Papermaking Systems
 
$
393,984

 
$
354,417

Wood Processing Systems
 
48,707

 
53,347

Corporate and Fiber-based Products (b)
 
14,914

 
7,719

Total Assets from Continuing Operations
 
457,605

 
415,483

Total Assets from Discontinued Operation
 
15

 
15

 
 
$
457,620

 
$
415,498


(a) Corporate primarily includes general and administrative expenses.
(b) Primarily includes cash and cash equivalents and property, plant, and equipment.

12.    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 as payment for outstanding accounts receivable. These banker's acceptance drafts are non-interest bearing 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 dates. As of April 2, 2016 and January 2, 2016, the Company had $4,656,000 and $6,897,000, respectively, of banker's acceptance drafts subject to recourse, which were transferred to vendors and had not reached their scheduled maturity dates. Historically, the banker's acceptance drafts have settled upon maturity without any claim of recourse against the Company.




21


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

12.    Contingencies and Litigation (continued)


Litigation
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.

13.    Subsequent Events

Acquisition
On April 4, 2016, the Company acquired all of the outstanding shares of RT Holding GmbH, the parent corporation of a group of companies known as the PAALGROUP (PAAL) for approximately 49,700,000 euros, net of cash acquired, or approximately $56,600,000. The Company entered into a $29,866,000 euro-denominated borrowing under its 2012 Credit Agreement in the first quarter of 2016 to fund the acquisition. PAAL manufactures channel balers and related equipment used in the processing of recyclable and waste materials. This acquisition broadens the Company's product portfolio and extends its presence deeper into recycling and waste management. PAAL, headquartered in Germany, has operations in Germany, the United Kingdom, France, and Spain. The purchase price allocation for the acquisition is not yet available.

Debt Repayment
In May 2016, the remaining principal balance of $5,125,000 on the commercial real estate loan was repaid and the 2006 Swap Agreement expired.

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 I, Item 1A, of the Company's Annual Report on Form 10-K for the fiscal year ended January 2, 2016 (fiscal 2015), as filed with the Securities and Exchange Commission (SEC).

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 yields higher margins than our capital equipment business. In the first three months of 2016, approximately 65% of our revenue was from the sale of parts and consumables products.



22


KADANT INC.



Overview (continued)

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 other 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; Doctoring, Cleaning, & Filtration; and Fluid-Handling.
 
-
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; and filtering, recausticizing, and evaporation equipment and systems used in the production of virgin pulp; 
 
-
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. Doctoring and cleaning systems are also used in other industries, such as carbon fiber, textiles and food processing.
 
-
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

Wood Processing Systems Segment
Our principal wood-processing products include:
 
-
Stranders: disc and ring stranders and related parts and consumables that cut trees into strands for OSB production; 
 
-
Rotary Debarkers: rotary debarkers and related parts and consumables 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 and related parts and consumables that are high quality, robust chipper systems for waste-wood and whole-log applications found in pulp woodrooms, chip plants, and 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.
Recent Acquisition
On April 4, 2016, we acquired all of the outstanding shares of RT Holding GmbH, the parent corporation of a group of companies known as the PAALGROUP (PAAL), for approximately 49.7 million euros, net of cash acquired, or approximately $56.6 million. PAAL manufactures channel balers and related equipment used in the processing of recyclable and waste materials. This acquisition broadens our product portfolio and extends our presence deeper into recycling and waste management. PAAL, headquartered in Germany, has operations in Germany, the United Kingdom, France, and Spain.


23


KADANT INC.



Overview (continued)
International Sales
During the first three months of 2016 and 2015, approximately 53% and 46%, respectively, 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.

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 (GAAP). The preparation of these condensed consolidated 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 condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Our actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that entail 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 position depends and which involve the most complex or subjective decisions or assessments, are those described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the section captioned "Application of Critical Accounting Policies and Estimates" in Part II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended January 2, 2016, filed with the SEC. There have been no material changes to these critical accounting policies since fiscal year-end 2015 that warrant disclosure.

Industry and Business Outlook
Our products are primarily sold in global process industries and used to produce packaging, tissue, and OSB, among numerous other products. In the first quarter of 2016, 63% of our revenue was from the sale of products that support packaging, tissue, and OSB production. Consumption of packaging, which is primarily comprised of corrugated boxboard and cartonboard, is driven by many factors, including regional economic conditions, consumer spending on non-durable goods, demand for processed foods and beverages, and greater urbanization in developing regions. Consumption of tissue is fairly stable, and in the developed world, tends to grow with the population. For both tissue and packaging, growth rates in the developing world are expected to increase as per capita consumption of paper increases with rising standards of living. The majority of OSB demand is in North America, as North American houses are more often constructed of wood compared to other parts of the world. Demand for OSB is tied to new home construction and remodeling. The remainder of our revenue was from sales to other process industries, which in general grow with the overall economy.

Our results of operations were negatively affected by foreign currency translation in the first quarter of 2016 compared to the first quarter of 2015. When we translate the local currency results of our foreign subsidiaries into U.S. dollars during a period in which the U.S. dollar is strengthening, our financial results will reflect decreases due to foreign currency translation. The negative effect on our financial results will continue if the U.S. dollar continues to strengthen relative to the functional currencies of our foreign subsidiaries. Similarly, if the U.S. dollar weakens compared to the functional currencies of our foreign subsidiaries, our financial results will reflect increases due to foreign currency translation. Further, certain foreign subsidiaries may hold U.S. dollar assets or liabilities which, as the U.S. dollar strengthens versus the applicable functional currencies, will result in currency transaction gains on assets and losses on liabilities. We have presented the material effects of foreign currency translation on our financial results under Results of Operations below.

Our bookings decreased 10% to $97 million in the first quarter of 2016 compared to $108 million in the first quarter of 2015. This decrease included a $4 million, or 3%, decrease from the unfavorable effects of foreign currency translation. Our revenue and income tends to be variable as demand for our capital equipment is dependent on regional economic conditions and the level of capital spending by our customers, among other factors. Demand for our parts and consumables products tends to be more predictable. Bookings for our parts and consumables products were $62 million, or 64% of total bookings, in the first quarter of 2016, compared to a record $68 million, or 63% of total bookings, in the first quarter of 2015.

24


KADANT INC.



Overview (continued)

The largest and most important regional market for our products in the first quarter of 2016 was North America, a trend we expect to continue into the remainder of 2016, although at lower revenue levels. Our bookings in North America were $54 million in the first quarter of 2016, down 5% compared to the first quarter of 2015. During the first quarter of 2016, demand for printing, writing, and newsprint grades all declined compared to the first quarter of 2015, while containerboard shipments saw a modest increase according to Resource Information Systems Inc. (RISI) reports. U.S. housing starts in March 2016 rose 14% compared to March 2015 and were at a seasonally adjusted annual rate of 1.089 million according to the U.S. Census Bureau and the Department of Housing and Urban Development. This growth is expected to have a positive impact on demand for U.S. lumber and structural wood panels, which includes OSB.

In Europe, we expect the overall economy to remain stable, yet somewhat constrained in 2016. Our bookings in Europe were $19 million in the first quarter of 2016, essentially flat compared to 2015, and included a negative currency translation effect of $1 million. Excluding the negative foreign currency translation effect, our bookings in Europe increased 3%. Our bookings in Europe will increase for the remainder of 2016 due to our recent acquisition of PAAL. Our bookings in Asia were $18 million in the first quarter of 2016, down 23% from $23 million in the first quarter of 2015. This decrease includes a $1 million decrease from the negative effects of foreign currency translation. Weak demand and a relatively soft domestic economy affected most paper grades in China in 2015, a trend we expect to continue in 2016. The most recent RISI forecasts of containerboard demand growth of approximately 3% per year for the next few years suggest new capital project activity may remain at reduced levels in China in 2016. Our bookings in the rest of the world decreased 31% to $6 million in the first quarter of 2016 compared to the first quarter of 2015 and were, and continue to be, negatively affected by the political uncertainty and recession in Brazil. This decrease includes a $1 million decrease from the negative effect of foreign currency translation.
    
The acquisition of PAAL will increase our 2016 revenue although the acquisition-related costs will have a negative effect on our GAAP diluted earnings per share (EPS). For 2016, we expect revenue of $412 to $422 million, revised from our previous guidance of $370 to $380 million. We expect to achieve GAAP diluted EPS for 2016 of $2.75 to $2.85, revised from our previous guidance of $2.80 to $2.90. Our revised 2016 guidance includes $0.14 of acquisition costs, $0.10 of expense related to acquired inventory and backlog and a $0.02 gain on the sale of assets. For the second quarter of 2016, we expect to achieve GAAP diluted EPS of $0.50 to $0.53 on revenue of $103 to $105 million. Our second quarter of 2016 GAAP diluted EPS includes $0.02 of acquisition costs and $0.10 of expense related to acquired inventory and backlog.

Results of Operations