Attached files

file filename
EX-32 - KAI FORM 10-Q 2Q 2017 EXHIBIT 32 - KADANT INCkaiform10q2q2017exhibit32.htm
EX-31.2 - KAI FORM 10-Q 2Q 2017 EXHIBIT 31.2 - KADANT INCkaiform10q2q2017exhibit312.htm
EX-31.1 - KAI FORM 10-Q 2Q 2017 EXHIBIT 31.1 - KADANT INCkaiform10q2q2017exhibit311.htm
EX-10.3 - KAI FORM 10-Q 2Q 2017 EXHIBIT 10.3 - KADANT INCkaiform10q2q2017exhibit103.htm
EX-10.2 - KAI FORM 10-Q 2Q 2017 EXHIBIT 10.2 - KADANT INCkaiform10q2q2017exhibit102.htm
EX-10.1 - KAI FORM 10-Q 2Q 2017 EXHIBIT 10.1 - KADANT INCkaiform10q2q2017exhibit101.htm
EX-2.1 - KAI FORM 10-Q 2Q 2017 EXHIBIT 2.1 - KADANT INCkaiform10q2q2017exhibit21.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 July 1, 2017
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, smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer x
Non-accelerated filer o
 
Smaller reporting company o
 
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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 28, 2017
Common Stock, $.01 par value
 
11,004,321



Kadant Inc.
Quarterly Report on Form 10-Q
for the Period Ended July 1, 2017
Table of Contents

 
 
Page
PART I: Financial Information
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II: Other Information
 
 
 
 
 
 



PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)
 
 
July 1,
2017
 
December 31,
2016
(In thousands, except share amounts)
 
 
Assets
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
85,840

 
$
71,487

Restricted cash (Note 1)
 
2,141

 
2,082

Accounts receivable, less allowances of $2,490 and $2,395 (Note 1)
 
68,994

 
65,963

Inventories (Note 1)
 
63,390

 
54,951

Unbilled contract costs and fees
 
6,421

 
3,068

Other current assets
 
14,377

 
9,799

Total Current Assets
 
241,163

 
207,350

 
 
 
 
 
Property, Plant, and Equipment, at Cost
 
130,518

 
124,424

Less: accumulated depreciation and amortization
 
80,535

 
76,720

 
 
49,983

 
47,704

 
 
 
 
 
Other Assets
 
13,182

 
11,452

Intangible Assets, Net (Note 1)
 
51,659

 
52,730

Goodwill (Note 1)
 
158,827

 
151,455

Total Assets
 
$
514,814

 
$
470,691

 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
Current Liabilities:
 
 
 
 
Current maturities of long-term obligations (Note 5)
 
$
696

 
$
643

Accounts payable
 
28,875

 
23,929

Customer deposits
 
29,073

 
21,168

Accrued payroll and employee benefits
 
19,010

 
20,508

Other current liabilities
 
27,703

 
22,665

Total Current Liabilities
 
105,357

 
88,913

 
 
 
 
 
Long-Term Deferred Income Taxes
 
15,011

 
14,631

Other Long-Term Liabilities
 
18,038

 
17,100

Long-Term Obligations (Note 5)
 
65,071

 
65,768

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
 
100,301

 
101,405

Retained earnings
 
333,476

 
321,050

Treasury stock at cost, 3,619,838 and 3,686,532 shares
 
(88,701
)
 
(90,335
)
Accumulated other comprehensive items (Note 8)
 
(35,916
)
 
(49,637
)
Total Kadant Stockholders' Equity
 
309,306

 
282,629

Noncontrolling interest
 
2,031

 
1,650

Total Stockholders' Equity
 
311,337

 
284,279

Total Liabilities and Stockholders' Equity
 
$
514,814

 
$
470,691


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
 
Six Months Ended
 
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
(In thousands, except per share amounts)
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues (Note 11)
 
$
110,242

 
$
111,828

 
$
213,099

 
$
208,366

 
 
 
 
 
 
 
 
 
Costs and Operating Expenses:
 
 

 
 

 
 
 
 
Cost of revenues
 
57,418

 
61,567

 
111,283

 
114,129

Selling, general, and administrative expenses
 
39,159

 
36,072

 
73,958

 
68,568

Research and development expenses
 
2,222

 
1,945

 
4,369

 
3,649

Other income
 

 

 

 
(317
)
 
 
98,799

 
99,584

 
189,610

 
186,029

 
 
 
 
 
 
 
 
 
Operating Income
 
11,443

 
12,244

 
23,489

 
22,337

 
 
 
 
 
 
 
 
 
Interest Income
 
102

 
66

 
206

 
121

Interest Expense
 
(392
)
 
(340
)
 
(740
)
 
(609
)
 
 
 
 
 
 
 
 
 
Income Before Provision for Income Taxes
 
11,153

 
11,970

 
22,955

 
21,849

Provision for Income Taxes (Note 4)
 
2,955

 
3,531

 
5,690

 
6,419

 
 
 
 
 
 
 
 
 
Net Income
 
8,198

 
8,439

 
17,265

 
15,430

 
 
 
 
 
 
 
 
 
Net Income Attributable to Noncontrolling Interest
 
(102
)
 
(128
)
 
(218
)
 
(243
)
 
 
 
 
 
 
 
 
 
Net Income Attributable to Kadant
 
$
8,096

 
$
8,311

 
$
17,047

 
$
15,187

 
 
 
 
 
 
 
 
 
Earnings per Share Attributable to Kadant (Note 3):
 
 

 
 

 
 
 
 
Basic
 
$
0.74

 
$
0.76

 
$
1.55

 
$
1.40

Diluted
 
$
0.72

 
$
0.75

 
$
1.52

 
$
1.37

 
 
 
 
 
 
 
 
 
Weighted Average Shares (Note 3):
 
 

 
 

 
 
 
 
Basic
 
11,001

 
10,870

 
10,976

 
10,831

Diluted
 
11,296

 
11,152

 
11,250

 
11,085

 
 
 
 
 
 
 
 
 
Cash Dividends Declared per Common Share
 
$
0.21

 
$
0.19

 
$
0.42

 
$
0.38


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






4


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

 
 
Three Months Ended
 
Six Months Ended
 
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Income
 
$
8,198

 
$
8,439

 
$
17,265

 
$
15,430

 
 
 
 
 
 
 
 
 
Other Comprehensive Items:
 
 

 
 

 
 

 
 

Foreign currency translation adjustment
 
8,655

 
(5,194
)
 
13,687

 
736

Pension and other post-retirement liability adjustments (net of tax provision (benefit) of $11 and $60 in the three and six months ended July 1, 2017, respectively, and $77 and $(159) in the three and six months ended July 2, 2016, respectively)
 
81

 
147

 
163

 
(271
)
Deferred gain (loss) on hedging instruments (net of tax provision (benefit) of $1 and $16 in the three and six months ended July 1, 2017, respectively, and $(151) and $(223) in the three and six months ended July 2, 2016, respectively)
 
7

 
86

 
34

 
(40
)
Other Comprehensive Items
 
8,743

 
(4,961
)
 
13,884

 
425

Comprehensive Income
 
16,941

 
3,478

 
31,149

 
15,855

Comprehensive Income Attributable to Noncontrolling Interest
 
(219
)
 
(92
)
 
(381
)
 
(266
)
Comprehensive Income Attributable to Kadant
 
$
16,722

 
$
3,386

 
$
30,768

 
$
15,589


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

5


KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
 
 
Six Months Ended
 
 
July 1,
2017
 
July 2,
2016
(In thousands)
 
 
 
 
 
 
 
Operating Activities:
 
 
 
 
Net income attributable to Kadant
 
$
17,047

 
$
15,187

Net income attributable to noncontrolling interest
 
218

 
243

Net income
 
17,265

 
15,430

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
6,531

 
7,477

Stock-based compensation expense
 
2,736

 
2,596

Provision for losses on accounts receivable
 
84

 
320

Loss (gain) on the sale of property, plant, and equipment
 
30

 
(350
)
Other items, net
 
2,161

 
289

Contributions to U.S. pension plan
 
(540
)
 
(540
)
Changes in current assets and liabilities, net of effects of acquisition:
 
 

 
 

Accounts receivable
 
(476
)
 
3,699

Unbilled contract costs and fees
 
(2,968
)
 
818

Inventories
 
(6,147
)
 
(2,498
)
Other current assets
 
(2,652
)
 
459

Accounts payable
 
3,363

 
172

Other current liabilities
 
5,989

 
(8,663
)
Net cash provided by operating activities
 
25,376

 
19,209

 
 
 
 
 
Investing Activities:
 
 

 
 

Acquisition (Note 1)
 
(165
)
 
(56,617
)
Purchases of property, plant, and equipment
 
(3,435
)
 
(1,736
)
Proceeds from sale of property, plant, and equipment
 
50

 
399

Net cash used in investing activities
 
(3,550
)
 
(57,954
)
 
 
 
 
 
Financing Activities:
 
 

 
 

Proceeds from issuance of debt
 
8,000

 
46,046

Repayment of debt
 
(11,235
)
 
(12,250
)
Dividends paid
 
(4,388
)
 
(3,894
)
Tax withholding payments related to stock-based compensation
 
(2,206
)
 
(2,435
)
Payment of debt issuance costs (Note 5)
 
(1,147
)
 

Payment of contingent consideration
 

 
(1,091
)
Proceeds from issuance of Company common stock
 

 
1,374

Change in restricted cash
 
93

 
724

Other financing activities
 
(215
)
 

Net cash (used in) provided by financing activities
 
(11,098
)
 
28,474

 
 
 
 
 
Exchange Rate Effect on Cash and Cash Equivalents
 
3,625

 
(1,048
)
 
 
 
 
 
Increase (Decrease) in Cash and Cash Equivalents
 
14,353

 
(11,319
)
Cash and Cash Equivalents at Beginning of Period
 
71,487

 
65,530

Cash and Cash Equivalents at End of Period
 
$
85,840

 
$
54,211


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 2, 2016
 
14,624,159

 
$
146

 
$
100,536

 
$
297,258

 
3,850,779

 
$
(94,359
)
 
$
(36,972
)
 
$
1,336

 
$
267,945

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Net income
 

 

 

 
15,187

 

 

 

 
243

 
15,430

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Dividends declared
 

 

 

 
(4,133
)
 

 

 

 

 
(4,133
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Activity under stock plans
 

 

 
(1,491
)
 

 
(123,872
)
 
3,035

 

 

 
1,544

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Other comprehensive items
 

 

 

 

 

 

 
402

 
23

 
425

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at July 2, 2016
 
14,624,159

 
$
146

 
$
99,045

 
$
308,312

 
3,726,907

 
$
(91,324
)
 
$
(36,570
)
 
$
1,602

 
$
281,211

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
14,624,159

 
$
146

 
$
101,405

 
$
321,050

 
3,686,532

 
$
(90,335
)
 
$
(49,637
)
 
$
1,650

 
$
284,279

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Net income
 

 

 

 
17,047

 

 

 

 
218

 
17,265

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Dividends declared
 

 

 

 
(4,621
)
 

 

 

 

 
(4,621
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Activity under stock plans
 

 

 
(1,104
)
 

 
(66,694
)
 
1,634

 

 

 
530

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Other comprehensive items
 

 

 

 

 

 

 
13,721

 
163

 
13,884

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at July 1, 2017
 
14,624,159

 
$
146

 
$
100,301

 
$
333,476

 
3,619,838

 
$
(88,701
)
 
$
(35,916
)
 
$
2,031

 
$
311,337


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, "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' 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, recycling and waste management, 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 and balers and related equipment used in the processing of recyclable and waste materials; 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 develops, manufactures, and markets 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 sells debarking and wood chipping equipment used in the forest products and the pulp and paper industries. Through this segment, the Company also provides refurbishment and repair of pulping equipment for the pulp and paper industry.

Through its Fiber-based Products business, the Company manufactures and sells granules derived from papermaking by-products 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 July 1, 2017 and its results of operations and comprehensive income for the three- and six-month periods ended July 1, 2017 and July 2, 2016, and its cash flows and stockholders' equity for the six-month periods ended July 1, 2017 and July 2, 2016. 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 31, 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 December 31, 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 December 31, 2016, filed with the SEC.

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 31, 2016.


8

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

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

Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (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
The Company paid additional post-closing consideration of $165,000 in the first quarter of 2017 associated with the April 2016 acquisition of RT Holding GmbH, the parent corporation of a group of companies known as the PAALGROUP (PAAL).
 
 
Six Months Ended
(In thousands)
 
July 1,
2017
 
July 2,
2016
Non-Cash Investing Activities:
 
 

 
 

Fair value of assets acquired
 
$

 
$
86,555

Cash paid for acquired business
 

 
(58,894
)
Liabilities assumed of acquired business
 
$

 
$
27,661

Non-Cash Financing Activities:
 
 

 
 

Issuance of Company common stock
 
$
2,814

 
$
3,057

Dividends declared but unpaid
 
$
2,311

 
$
2,070


Restricted Cash
As of July 1, 2017 and December 31, 2016, the Company had restricted cash of $2,141,000 and $2,082,000, 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. The majority of the bank guarantees will expire by the end of 2018.

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 can 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 $10,181,000 and $7,852,000 at July 1, 2017 and December 31, 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 current accounts payable prior to maturity, or obtains cash payment on the scheduled maturity date.

Inventories
The components of inventories are as follows:
 
 
July 1,
2017
 
December 31,
2016
(In thousands)
 
 
Raw Materials and Supplies
 
$
27,555

 
$
21,086

Work in Process
 
14,418

 
12,293

Finished Goods
 
21,417

 
21,572

Total Inventories
 
$
63,390

 
$
54,951


9

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

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

Intangible Assets, Net
Intangible assets are as follows:
 
 
July 1,
2017
 
December 31,
2016
(In thousands)
 
 
Indefinite-Lived
 
$
8,100

 
$
8,100

 
 
 
 
 
Definite-Lived, Gross
 
$
101,743

 
$
77,052

Acquisition
 

 
24,691

Accumulated amortization
 
(52,494
)
 
(49,040
)
Currency translation
 
(5,690
)
 
(8,073
)
Definite-Lived, Net
 
$
43,559

 
$
44,630

 
 
 
 
 
Total Intangible Assets, Net
 
$
51,659

 
$
52,730


Goodwill
The changes in the carrying amount of goodwill by segment are as follows:
(In thousands)
 
Papermaking Systems Segment
 
Wood Processing Systems Segment
 
Total
Balance at December 31, 2016
 
 
 
 
 
 
Gross balance
 
$
219,699

 
$
17,265

 
$
236,964

Accumulated impairment losses
 
(85,509
)
 

 
(85,509
)
Net balance
 
134,190

 
17,265

 
151,455

Currency Translation
 
6,704

 
668

 
7,372

Total 2017 Adjustments
 
6,704

 
668

 
7,372

Balance at July 1, 2017
 
 

 
 

 
 

Gross balance
 
226,403

 
17,933

 
244,336

Accumulated impairment losses
 
(85,509
)
 

 
(85,509
)
Net balance
 
$
140,894

 
$
17,933

 
$
158,827


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.


10

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

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

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)
 
July 1,
2017
 
July 2,
2016
Balance at Beginning of Year
 
$
3,843

 
$
3,670

Provision charged to income
 
1,209

 
1,524

Usage
 
(1,056
)
 
(1,623
)
Acquisition
 

 
991

Currency translation
 
224

 
(20
)
Balance at End of Period
 
$
4,220

 
$
4,542


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 Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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. In May 2016, the FASB issued ASU No. 2016-11, which rescinds certain previously-issued guidance, including, among other items, guidance relating to accounting for shipping and handling fees and freight services effective upon adoption of ASU No. 2014-09. Also in May 2016, the FASB issued ASU No. 2016-12, which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. In December 2016, the FASB issued ASU No. 2016-20, which clarifies narrow aspects of Topic 606 and corrects unintended application of the guidance. These new ASUs are effective for the Company beginning in fiscal 2018. Early adoption is permitted in fiscal 2017. The Company is continuing to assess the potential effects of these ASUs on its condensed consolidated financial statements, business processes, systems and controls. While the assessment process is ongoing, the Company currently anticipates adopting these ASUs using the modified retrospective transition approach. Under this approach, this guidance would apply to all new contracts initiated in fiscal 2018. For existing contracts that have remaining obligations as of the beginning of fiscal 2018, any difference between the recognition criteria in these ASUs and the Company’s current revenue recognition practices would be recognized using a cumulative effect adjustment to the opening balance of retained earnings. The Company is also in the process of developing and implementing appropriate changes to its business processes, systems and controls to support the recognition criteria and disclosure requirements of these ASUs.

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. The Company adopted this ASU at the beginning of fiscal 2017. Adoption of this ASU did not have a material effect 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. As part of the implementation of this new standard, the Company is in the process of reviewing current accounting policies and assessing the practical expedients allowed under this new guidance. The Company expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon adoption, which is required using the modified retrospective transition method. The Company is currently evaluating the other 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)

Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU No. 2016-13, which significantly changes the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining lives. This new guidance is effective for the Company in fiscal 2020. Early adoption is permitted beginning in fiscal 2019. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.

Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. In August 2016, the FASB issued ASU No. 2016-15, which simplifies the diversity in practice related to the presentation and classification of certain cash receipts and cash payments in the statement of cash flows under Topic 230. This ASU addresses the following eight specific cash flow issues: debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance; distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This new guidance is effective for the Company in fiscal 2018. Early adoption is permitted. The Company does not believe that adoption of this ASU will have a material impact on its condensed consolidated financial statements.

Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory. In October 2016, the FASB issued ASU No. 2016-16, which requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs and eliminates the exception for an intra-entity transfer of an asset other than inventory. This new guidance is effective for the Company in fiscal 2018 with adoption required on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Early adoption is permitted. The Company is currently evaluating the effect that the adoption of this ASU will have on its condensed consolidated financial statements.

Statement of Cash Flows (Topic 230), Restricted Cash. In November 2016, the FASB issued ASU No. 2016-18, which requires inclusion of restricted cash and restricted cash equivalents within cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This new guidance is effective for the Company in fiscal 2018. Early adoption is permitted. As this ASU is presentation-related only, adoption of this ASU will not have a material impact on the Company's condensed consolidated financial statements.

Business Combinations (Topic 805), Clarifying the Definition of a Business. In January 2017, the FASB issued ASU No. 2017-01, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The revised definition of a business under this ASU will reduce the number of transactions that are accounted for as business combinations. This new guidance is effective on a prospective basis for the Company in fiscal 2018. Early adoption is allowed for certain transactions. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.

Intangibles - Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment. In January 2017, the FASB issued ASU No. 2017-04, which eliminates Step 2 in goodwill impairment testing, which requires that goodwill impairment losses be measured as the difference between the implied value of a reporting unit’s goodwill and its carrying amount. This ASU will reduce the cost and complexity of impairment testing by requiring goodwill impairment losses to be measured as the excess of the reporting unit’s carrying amount, including goodwill and related goodwill tax effects, over its fair value. This new guidance is effective on a prospective basis for the Company in fiscal 2020. Early adoption is permitted. The Company does not believe that adoption of this ASU will have a material effect on its condensed consolidated financial statements.

 Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost. In March 2017, the FASB issued ASU No. 2017-07, which requires employers to include only the service cost component of net periodic pension cost and net periodic post-retirement benefit cost in operating expenses in the same income statement line item as the related employees' compensation costs. The other components of net benefit cost, including interest costs, amortization of prior service costs and settlement and curtailment effects, are to be included in non-operating expenses. The ASU also stipulates that only the service cost component of net benefit cost is eligible for

12

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

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

capitalization. This new guidance is effective on a retrospective basis for the Company in fiscal 2018. Early adoption is permitted. The Company is currently evaluating the effects that adoption of this ASU will have on its condensed consolidated financial statements.

Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. In May 2017, the FASB issued ASU No. 2017-09, which provides clarity on which changes to the terms or conditions of share-based payment awards require entities to apply the modification accounting provisions required in Topic 718. This new guidance is effective on a prospective basis for the Company in fiscal 2018. Early adoption is permitted. The Company does not believe that adoption of this ASU will have a material effect on its condensed consolidated financial statements.

2.    Other Income

In the first six months 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.

3.    Earnings per Share

Basic and diluted earnings per share (EPS) are calculated as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
(In thousands, except per share amounts)
 
 
 
 
Amounts Attributable to Kadant:
 
 
 
 
 
 
 
 
Net Income
 
$
8,096

 
$
8,311

 
$
17,047

 
$
15,187

 
 
 
 
 
 
 
 
 
Basic Weighted Average Shares
 
11,001

 
10,870

 
10,976

 
10,831

Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan Shares
 
295

 
282

 
274

 
254

Diluted Weighted Average Shares
 
11,296

 
11,152

 
11,250

 
11,085

 
 
 
 
 
 
 
 
 
Basic Earnings per Share
 
$
0.74

 
$
0.76

 
$
1.55

 
$
1.40

 
 
 
 
 
 
 
 
 
Diluted Earnings per Share
 
$
0.72

 
$
0.75

 
$
1.52

 
$
1.37


Unvested restricted stock units (RSUs) equivalent to approximately 19,000 and 26,000 shares of common stock in the second quarters of 2017 and 2016, respectively, and 29,000 and 87,000 shares of common stock in the first six months of 2017 and 2016, respectively, were not included in the computation of diluted EPS as the effect would have been antidilutive or, for unvested performance-based RSUs, the performance conditions had not been met as of the end of the reporting periods.

4.    Provision for Income Taxes

The provision for income taxes was $5,690,000 and $6,419,000 in the first six months of 2017 and 2016, respectively, and represented 25% and 29% of pre-tax income. The effective tax rate of 25% in the first six months of 2017 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings and the net excess income tax benefits from stock-based compensation arrangements, offset in part by an increase in tax related to non-deductible expenses and unrecognized tax benefits. The effective tax rate of 29% in the first six months of 2016 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings and 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.


13

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




5.    Long-Term Obligations

Long-term obligations are as follows:
 
 
July 1,
2017
 
December 31,
2016
(In thousands)
 
 
Revolving Credit Facility, due 2022
 
$
60,673

 
$
61,494

Obligations Under Capital Lease, due 2017 to 2022
 
4,557

 
4,309

Other Borrowings, due 2017 to 2023
 
537

 
608

Total
 
65,767

 
66,411

Less: Current Maturities of Long-Term Obligations
 
(696
)
 
(643
)
Long-Term Obligations
 
$
65,071

 
$
65,768

Revolving Credit Facility
On March 1, 2017, the Company entered into an Amended and Restated Credit Agreement (2017 Credit Agreement) which became effective on March 2, 2017. The 2017 Credit Agreement is a five-year unsecured multi-currency revolving credit facility in the aggregate principal amount of up to $200,000,000. On May 24, 2017, the Company entered into a first amendment and limited consent (First Amendment) which increased the revolving loan commitment to $300,000,000. The 2017 Credit Agreement also included an uncommitted unsecured incremental borrowing facility of up to an additional $100,000,000. The principal on any borrowings made under the 2017 Credit Agreement is due on March 1, 2022. Borrowing may be denominated in U.S. dollars or certain foreign currencies, as defined in the 2017 Credit Agreement. Interest on any loans outstanding under the 2017 Credit Agreement accrues and generally is payable quarterly in arrears at one of the following rates selected by the Company: (i) the Base Rate, calculated as the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate as published by Citizens Bank, and (c) the thirty-day London Inter-Bank Offered Rate (LIBOR) rate, as defined, plus 0.50%; or (ii) the LIBOR rate (with a zero percent floor), 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, net of certain cash, as defined, to earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined in the 2017 Credit Agreement. For this purpose, total debt net of certain cash is defined as total debt less the sum of (i) unrestricted U.S. cash, and (ii) 65% of unrestricted cash outside of the United States, but no more than an aggregate amount of $30,000,000. Contemporaneously with the execution of the 2017 Credit Agreement, the Company borrowed $42,000,000 and 26,300,000 euros under the 2017 Credit Agreement and applied the proceeds to pay off the previous credit facility.
    
The obligations of the Company under the 2017 Credit Agreement may be accelerated upon the occurrence of an event of default under the 2017 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 2017 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 a discontinued operation. As of July 1, 2017, the Company was in compliance with these covenants.
    
Loans under the 2017 Credit Agreement are guaranteed by certain domestic subsidiaries of the Company pursuant to an Amended and Restated Guarantee Agreement, dated as of March 1, 2017. In addition, one of the Company's foreign subsidiaries entered into a Guarantee Agreement limited to certain obligations of two foreign subsidiary borrowers pursuant to a Guarantee Agreement dated as of March 1, 2017.

As of July 1, 2017, the outstanding balance under the 2017 Credit Agreement was $60,673,000, of which $25,673,000 was euro-denominated. As of July 1, 2017, the Company had $239,841,000 of borrowing capacity available under its 2017 Credit Agreement, which is calculated by translating its foreign-denominated borrowings using transaction date foreign exchange rates.

14

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

5.    Long-Term Obligations (continued)


The weighted average interest rate for the borrowings under the 2017 Credit Agreement was 1.78% as of July 1, 2017.
    
Subsequent to the end of the quarter, the Company borrowed an aggregate $170,018,000 under the 2017 Credit Agreement, of which $62,690,000 was Canadian dollar-denominated and $61,769,000 was euro-denominated, which was used to fund the acquisition of the forest products business of NII FPG Company (NII). See Note 13, Subsequent Event, for further details. Under the First Amendment, the lenders agreed to certain limited funding conditions under the 2017 Credit Agreement in connection with the closing of the acquisition.

Debt Issuance Costs
During the first six months of 2017, the Company incurred an additional $1,147,000 of debt issuance costs related to the 2017 Credit Agreement and First Amendment. Unamortized debt issuance costs were $1,325,000 as of July 1, 2017, which are included in other assets in the accompanying condensed consolidated balance sheet and are being amortized to interest expense based on the straight-line method.

Obligations Under Capital Lease
In connection with the acquisition of PAAL, the Company assumed a sale-leaseback financing arrangement for PAAL's facility in Germany. Under this arrangement, the quarterly lease payment includes principal and interest based on an interest rate which is reset, from time to time, to prevailing short-term borrowing rates in Germany. The interest rate at July 1, 2017 was 1.70%. The quarterly lease payment also includes a payment toward a corresponding loan receivable from the landlord. The loan receivable, which is included in other assets in the accompanying condensed consolidated balance sheet, was $357,000 at July 1, 2017. The lease arrangement provides for a fixed price purchase option, net of the loan receivable, of $1,518,000 at the end of the lease term in 2022. If the Company does not exercise the purchase option for the facility, the Company will receive cash from the landlord to settle the loan receivable. As of July 1, 2017, $4,444,000 was outstanding under this capital lease obligation. The Company also assumed capital lease obligations for certain equipment as part of the PAAL acquisition. These capital lease obligations bear a weighted average interest rate of 3.43% and have an average remaining term of 2.7 years. As of July 1, 2017, $113,000 was outstanding under these capital lease obligations.

Other Borrowings
The Company's PAAL subsidiary sells certain equipment to an intermediary who leases the equipment to a third party. The revenue from the equipment sale is deferred due to risk of default and repurchase obligation provisions. Revenue is recognized and borrowings reduced over the corresponding lease term with the remaining residual value of the equipment recognized when the default provisions lapse.

6.    Stock-Based Compensation

The Company recognized stock-based compensation expense of $1,441,000 and $1,273,000 in the second quarters of 2017 and 2016, respectively, and $2,736,000 and $2,596,000 in the first six months of 2017 and 2016, respectively, within selling, general, and administrative (SG&A) expenses in the accompanying condensed consolidated statement of income. The Company recognizes compensation expense 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. During the first quarter of 2017, the Company granted stock-based compensation to executive officers and employees consisting of 39,229 shares of performance-based RSUs and 38,331 shares of time-based RSUs and granted 12,000 shares of time-based RSUs to its non-employee directors. Unrecognized compensation expense related to stock-based compensation totaled approximately $6,515,000 at July 1, 2017, and will be recognized over a weighted average period of 1.8 years.
    

15

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




7.    Employee Benefit Plans

The Company sponsors a noncontributory defined benefit pension plan for eligible employees at one of its U.S. divisions and its corporate office. Three of the Company’s non-U.S. subsidiaries also sponsor defined benefit pension plans covering certain employees at those subsidiaries. Funds for the U.S. pension plan and one of the non-U.S. pension plans are contributed to a trustee as necessary to provide for current service and for any unfunded projected benefit obligation over a reasonable period. The remaining two non-U.S. pension plans are unfunded as permitted under their plans and applicable laws. Benefits under the Company’s pension plans are based on years of service and employee compensation.

The Company also provides other post-retirement benefits under two plans in the United States and at one of its non-U.S. subsidiaries. In addition, the Company provides a restoration plan for certain executive officers which fully supplements benefits lost under the noncontributory defined benefit retirement plan as a consequence of applicable Internal Revenue Service limits and restores benefits for the limitation of years of service under the retirement plan.

The components of net periodic benefit cost for the Company's U.S. and non-U.S. pension plans and other post-retirement benefit plans are as follows:
 
 
Three Months Ended 
 July 1, 2017
 
Three Months Ended 
 July 2, 2016
(In thousands, except percentages)
 
U.S. Pension
Benefits
 
Non-U.S. Pension
Benefits
 
Other Post-Retirement
Benefits
 
U.S. Pension
Benefits
 
Non-U.S. Pension
Benefits
 
Other Post-Retirement
Benefits
Components of Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
 
$
147

 
33

 
$
53

 
$
181

 
27

 
$
33

Interest cost
 
302

 
26

 
45

 
318

 
26

 
38

Expected return on plan assets
 
(328
)
 
(9
)
 

 
(322
)
 
(7
)
 

Recognized net actuarial loss
 
108

 
9

 
27

 
124

 
10

 
12

Amortization of prior service cost
 
13

 
1

 
23

 
14

 
1

 
22

Net Periodic Benefit Cost
 
$
242

 
$
60

 
$
148

 
$
315

 
$
57

 
$
105

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

 
 
 
 
 
 
 
 
 
 
 
 
 
Discount Rate
 
4.03
%
 
3.47
%
 
4.11
%
 
4.22
%
 
3.88
%
 
4.30
%
Expected Long-Term Return on Plan Assets
 
5.00
%
 
7.72
%
 
7.72
%
 
5.00
%
 
6.90
%
 
6.90
%
Rate of Compensation Increase
 
3.00
%
 
3.44
%
 
3.06
%
 
3.00
%
 
2.98
%
 
3.03
%

16

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

7.    Employee Benefit Plans (continued)


 
 
Six Months Ended 
 July 1, 2017
 
Six Months Ended 
 July 2, 2016
(In thousands, except percentages)
 
U.S. Pension
Benefits
 
Non-U.S. Pension
Benefits
 
Other Post-Retirement
Benefits
 
U.S. Pension
Benefits
 
Non-U.S. Pension
Benefits
 
Other Post-Retirement
Benefits
Components of Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
 
$
343

 
$
65

 
$
88

 
$
362

 
$
52

 
$
66

Interest cost
 
616

 
50

 
84

 
636

 
52

 
76

Expected return on plan assets
 
(663
)
 
(17
)
 

 
(644
)
 
(14
)
 

Recognized net actuarial loss
 
221

 
18

 
40

 
248

 
20

 
24

Amortization of prior service cost
 
26

 
2

 
44

 
28

 
2

 
45

Settlement loss
 

 

 

 

 

 
114

Net Periodic Benefit Cost
 
$
543

 
$
118

 
$
256

 
$
630

 
$
112

 
$
325

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

 
 
 
 
 
 
 
 
 
 
 
 
 
Discount Rate
 
4.03
%
 
3.43
%
 
4.12
%
 
4.22
%
 
3.89
%
 
4.27
%
Expected Long-Term Return on Plan Assets
 
5.00
%
 
7.72
%
 
7.72
%
 
5.00
%
 
6.90
%
 
6.90
%
Rate of Compensation Increase
 
3.00
%
 
3.42
%
 
3.07
%
 
3.00
%
 
2.99
%
 
3.02
%
    
The Company made cash contributions of $540,000 to its U.S. noncontributory defined benefit pension plan in the first six months of 2017 and expects to make cash contributions of $540,000 over the remainder of 2017. For the remaining pension and post-retirement benefit plans, no cash contributions other than to fund current benefit payments are expected in 2017.

8.    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, unrecognized prior service cost and deferred losses associated with pension and other post-retirement benefit plans, and deferred gains (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 on Pension and Other Post-
Retirement Benefit Plans
 
Deferred Loss
on Pension and
Other Post-
Retirement Benefit Plans
 
Deferred Gain (Loss)
on Hedging
Instruments
 
Accumulated
Other
Comprehensive
Items
Balance at December 31, 2016
 
$
(41,094
)
 
$
(397
)
 
$
(8,158
)
 
$
12

 
$
(49,637
)
Other comprehensive income (loss) before reclassifications
 
13,524

 
(3
)
 
(62
)
 
16

 
13,475

Reclassifications from AOCI
 

 
47

 
181

 
18

 
246

Net current period other comprehensive income
 
13,524

 
44

 
119

 
34

 
13,721

Balance at July 1, 2017
 
$
(27,570
)
 
$
(353
)
 
$
(8,039
)
 
$
46

 
$
(35,916
)
 
 
 
 
 
 
 
 
 
 
 
Balance at January 2, 2016
 
$
(27,932
)
 
$
(489
)
 
$
(8,322
)
 
$
(229
)
 
$
(36,972
)
Other comprehensive income (loss) before reclassifications
 
713

 
(1
)
 
(583
)
 
(317
)
 
(188
)
Reclassifications from AOCI
 

 
48

 
265

 
277

 
590

Net current period other comprehensive income (loss)
 
713

 
47

 
(318
)
 
(40
)
 
402

Balance at July 2, 2016
 
$
(27,219
)
 
$
(442
)
 
$
(8,640
)
 
$
(269
)
 
$
(36,570
)

17


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

8.    Accumulated Other Comprehensive Items (continued)


Amounts reclassified from AOCI are as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
(In thousands)
 
July 1,
2017
 
July 2,
2016
 
July 1,
2017
 
July 2,
2016
 
Statement of Income
Line Item
Pension and Other Post-Retirement Plans: (a)
 
 
 
 
 
 
 
      
Amortization of actuarial losses
 
$
(144
)
 
$
(146
)
 
$
(279
)
 
$
(406
)
 
SG&A expenses
Amortization of prior service costs
 
(37
)
 
(36
)
 
(72
)
 
(74
)
 
SG&A expenses
Total expense before income taxes
 
(181
)
 
(182
)
 
(351
)
 
(480
)
 
 
Income tax benefit
 
64

 
63

 
123

 
167

 
Provision for income taxes
 
 
(117
)
 
(119
)
 
(228
)
 
(313
)
 
 
Cash Flow Hedges: (b)
 
 

 
 

 
 

 
 

 
      
Interest rate swap agreements
 
(6
)
 
(47
)
 
(18
)
 
(136
)
 
Interest expense
Forward currency-exchange contracts
 

 
37

 

 
(24
)
 
Revenues
Forward currency-exchange contracts
 

 
(46
)
 
(11
)
 
(69
)
 
Cost of revenues
Total expense before income taxes
 
(6
)
 
(56
)
 
(29
)
 
(229
)
 
 
Income tax benefit (provision)
 
3

 
(108
)
 
11

 
(48
)
 
Provision for income taxes
 
 
(3
)
 
(164
)
 
(18
)
 
(277
)
 
 
Total Reclassifications
 
$
(120
)
 
$
(283
)
 
$
(246
)
 
$
(590
)
 
 

(a)
Included in the computation of net periodic benefit cost. See Note 7 for additional information.
(b)
See Note 9 for additional information.

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.

Accounting Standards Codification (ASC) 815, Derivatives and Hedging, requires that all derivatives be recognized in the accompanying condensed consolidated 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 AOCI. These deferred gains and losses are recognized in the accompanying condensed consolidated statement of income 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 accompanying condensed consolidated statement of income.


18

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

9.    Derivatives (continued)

Interest Rate Swap Agreement
On January 16, 2015, the Company entered into a swap agreement (2015 Swap Agreement) to hedge its exposure to movements in the three-month LIBOR rate on future outstanding debt and has designated the 2015 Swap Agreement as a cash flow hedge. 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 is included in other assets, with an offset to AOCI, net of tax, in the accompanying condensed consolidated balance sheet.

The Company has structured the 2015 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 2015 Swap Agreement is remote based on the Company's financial position and the creditworthiness of the financial institution that issued the 2015 Swap Agreement.

The counterparty to the 2015 Swap Agreement could demand an early termination of the 2015 Swap Agreement if the Company is in default under the 2017 Credit Agreement, or any agreement that amends or replaces the 2017 Credit Agreement in which the counterparty is a member, and the Company is unable to cure the default. An event of default under the 2017 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, 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 a discontinued operation. As of July 1, 2017, the Company was in compliance with these covenants. The unrealized gain associated with the 2015 Swap Agreement was $48,000 as of July 1, 2017, which represents the estimated amount that the Company would receive from 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 anticipated currency exposures 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 value for these instruments is included in other current assets for unrecognized gains and in other current liabilities for unrecognized losses, with an offset in AOCI, 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 value of forward currency-exchange contracts that are not designated as hedges is recorded currently in earnings with gains reported in other current assets and losses reported in other current liabilities.

In the second quarter of 2017, the Company entered into forward currency-exchange contracts associated with the anticipated consideration to be paid for the acquisition of NII (see Note 13, Subsequent Event, for further details) and recognized a loss of $1,754,000 associated with these transactions. The Company recognized within SG&A expenses in the accompanying condensed consolidated statement of income losses of $1,846,000 and $225,000 in the second quarters of 2017 and 2016, respectively, and losses of $1,493,000 and $436,000 in the first six months of 2017 and 2016, respectively, associated with its forward currency-exchange contracts that were not designated as hedges, including the contracts related to the NII acquisition. 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.

19

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

9.    Derivatives (continued)

The following table summarizes the fair value of the Company's derivative instruments designated and not designated as hedging instruments, the notional value of the associated derivative contracts, and the location of these instruments in the accompanying condensed consolidated balance sheet:
 
 
 
 
July 1, 2017
 
December 31, 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
 
$
58

 
$
950

 
$

 
$

Interest rate swap agreement
 
Other Long-Term Assets
 
$
48

 
$
10,000

 
$
62

 
$
10,000

Derivatives in a Liability Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Liabilities
 
$
(37
)
 
$
863

 
$
(41
)
 
$
2,380

 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments:
 
 

 
 

 
 

 
 

Derivatives in an Asset Position:
 
 
 
 

 
 

 
 

 
 

Forward currency-exchange contracts
 
Other Current Assets
 
$
9

 
$
386

 
$
2

 
$
227

Derivatives in a Liability Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Liabilities
 
$
(2,005
)
 
$
141,396

 
$
(237
)
 
$
17,185


(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 six months of 2017, except for $124,459,000 for the one-time purchase of forward currency-exchange contracts entered into in anticipation of consideration to be paid for the acquisition of NII. These contracts are included in derivatives not designated as hedging instruments in a liability position in the table above.

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 six months ended July 1, 2017:
(In thousands)
 
Interest Rate Swap
Agreement
 
Forward Currency-
Exchange
Contracts
 
Total
Unrealized Gain (Loss), Net of Tax, at December 31, 2016
 
$
40

 
$
(28
)
 
$
12

Loss reclassified to earnings (a)
 
11

 
7

 
18

(Loss) Gain recognized in AOCI
 
(21
)
 
37

 
16

Unrealized Gain, Net of Tax, at July 1, 2017
 
$
30

 
$
16

 
$
46

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

As of July 1, 2017, the Company expects to reclassify $11,000 of the net unrealized gains included in AOCI to earnings over the next twelve months.


20

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




10.    Fair Value Measurements and Fair Value of Financial Instruments

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 July 1, 2017
(In thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets: