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EX-32 - KAI FORM 10-Q 1Q 2018 EXHIBIT 32 - KADANT INCkaiform10q1q2018exhibit32.htm
EX-31.2 - KAI FORM 10-Q 1Q 2018 EXHIBIT 31.2 - KADANT INCkaiform10q1q2018exhibit312.htm
EX-31.1 - KAI FORM 10-Q 1Q 2018 EXHIBIT 31.1 - KADANT INCkaiform10q1q2018exhibit311.htm
EX-10.4 - KAI FORM 10-Q 1Q 2018 EXHIBIT 10.4 - KADANT INCkaiform10q1q208exhibit104.htm
EX-10.3 - KAI FORM 10-Q 1Q 2018 EXHIBIT 10.3 - KADANT INCkaiform10q1q2018exhibit103.htm
EX-10.2 - KAI FORM 10-Q 1Q 2018 EXHIBIT 10.2 - KADANT INCkaiform0q1q2018exhibit102.htm
EX-10.1 - KAI FORM 10-Q 1Q 2018 EXHIBIT 10.1 - KADANT INCkaiform10q1q2018exhibit101.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 March 31, 2018
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 001-11406

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, a smaller reporting company, or an emerging growth company. See the 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 x
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)
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 April 27, 2018
Common Stock, $.01 par value
 
11,090,209



Kadant Inc.
Quarterly Report on Form 10-Q
for the Period Ended March 31, 2018
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)
 
 
March 31,
2018
 
December 30,
2017
(In thousands, except share and per share amounts)
 
 
Assets
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
72,210

 
$
75,425

Restricted cash (Note 1)
 
1,532

 
1,421

Accounts receivable, less allowances of $3,216 and $2,879 (Note 1)
 
91,529

 
89,624

Inventories (Note 1)
 
95,840

 
84,933

Unbilled revenue
 
2,375

 
2,374

Other current assets
 
14,429

 
12,246

Total Current Assets
 
277,915

 
266,023

 
 
 
 
 
Property, Plant, and Equipment, at Cost
 
169,523

 
165,231

Less: accumulated depreciation and amortization
 
88,851

 
85,508

Property, Plant, and Equipment, at Cost, Net
 
80,672

 
79,723

 
 
 
 
 
Other Assets
 
14,541

 
14,311

Intangible Assets, Net (Note 1)
 
129,635

 
133,036

Goodwill (Note 1)
 
269,514

 
268,001

Total Assets
 
$
772,277

 
$
761,094

 
 
 
 
 
Liabilities and Stockholders' Equity
 
 
 
 
Current Liabilities:
 
 
 
 
Current maturities of long-term obligations (Note 5)
 
$
710

 
$
696

Accounts payable
 
37,026

 
35,461

Customer deposits
 
40,034

 
30,103

Accrued payroll and employee benefits
 
23,400

 
29,616

Advanced billings
 
5,745

 
7,316

Other current liabilities
 
25,274

 
29,038

Total Current Liabilities
 
132,189

 
132,230

 
 
 
 
 
Long-Term Obligations (Note 5)
 
240,226

 
241,384

Long-Term Deferred Income Taxes
 
29,125

 
29,085

Other Long-Term Liabilities
 
25,510

 
25,891

 
 
 
 
 
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
 
99,828

 
103,221

Retained earnings
 
351,355

 
342,893

Treasury stock at cost, 3,533,950 and 3,613,838 shares
 
(86,596
)
 
(88,554
)
Accumulated other comprehensive items (Note 8)
 
(21,212
)
 
(26,715
)
Total Kadant Stockholders' Equity
 
343,521

 
330,991

Noncontrolling interest
 
1,706

 
1,513

Total Stockholders' Equity
 
345,227

 
332,504

Total Liabilities and Stockholders' Equity
 
$
772,277

 
$
761,094


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
 
 
March 31,
2018
 
April 1,
2017
(In thousands, except per share amounts)
 
 
 
 
 
 
 
Revenues (Note 11)
 
$
149,193

 
$
102,857

 
 
 
 
 
Costs and Operating Expenses:
 
 

 
 

Cost of revenues
 
83,114

 
53,840

Selling, general, and administrative expenses
 
45,776

 
34,620

Research and development expenses
 
2,869

 
2,147

Restructuring costs (Note 2)
 
770

 

 
 
132,529

 
90,607

 
 
 
 
 
Operating Income
 
16,664

 
12,250

 
 
 
 
 
Interest Income
 
183

 
104

Interest Expense
 
(1,732
)
 
(348
)
Other Expense, Net (Note 7)
 
(246
)
 
(204
)
 
 
 
 
 
Income Before Provision for Income Taxes
 
14,869

 
11,802

Provision for Income Taxes (Note 4)
 
3,861

 
2,735

 
 
 
 
 
Net Income
 
11,008

 
9,067

 
 
 
 
 
Net Income Attributable to Noncontrolling Interest
 
(150
)
 
(116
)
 
 
 
 
 
Net Income Attributable to Kadant
 
$
10,858

 
$
8,951

 
 
 
 
 
Earnings per Share Attributable to Kadant (Note 3):
 
 

 
 

Basic
 
$
0.98

 
$
0.82

Diluted
 
$
0.96

 
$
0.80

 
 
 
 
 
Weighted Average Shares (Note 3):
 
 

 
 

Basic
 
11,042

 
10,952

Diluted
 
11,342

 
11,205

 
 
 
 
 
Cash Dividend Declared per Common Share
 
$
0.22

 
$
0.21


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
 
 
March 31,
2018
 
April 1,
2017
(In thousands)
 
 
 
 
 
 
 
Net Income
 
$
11,008

 
$
9,067

 
 
 
 
 
Other Comprehensive Items:
 
 

 
 

Foreign currency translation adjustment
 
5,336

 
5,032

Pension and other post-retirement liability adjustments, net (net of tax provision of $34 and $49)
 
117

 
82

Deferred gain on cash flow hedges (net of tax provision of $8 and $15)
 
93

 
27

Other Comprehensive Items
 
5,546

 
5,141

Comprehensive Income
 
16,554

 
14,208

Comprehensive Income Attributable to Noncontrolling Interest
 
(193
)
 
(162
)
Comprehensive Income Attributable to Kadant
 
$
16,361

 
$
14,046


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
 
 
March 31,
2018
 
April 1,
2017
(In thousands)
 
 
 
 
 
 
 
Operating Activities
 
 
 
 
Net income attributable to Kadant
 
$
10,858

 
$
8,951

Net income attributable to noncontrolling interest
 
150

 
116

Net income
 
11,008

 
9,067

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

 
 

Depreciation and amortization
 
6,099

 
3,256

Stock-based compensation expense
 
1,464

 
1,295

Provision for losses on accounts receivable
 
316

 
129

Loss on the sale of property, plant, and equipment
 
24

 
41

Other items, net
 
(386
)
 
180

Contributions to U.S. pension plan
 

 
(90
)
Changes in current assets and liabilities, net of effects of acquisitions:
 
 

 
 

Accounts receivable
 
(799
)
 
(5,043
)
Unbilled revenue
 
2,064

 
(1,134
)
Inventories
 
(9,674
)
 
(3,964
)
Other current assets
 
(435
)
 
(1,886
)
Accounts payable
 
3,854

 
805

Other current liabilities
 
(6,319
)
 
(973
)
Net cash provided by operating activities
 
7,216

 
1,683

 
 
 
 
 
Investing Activities
 
 

 
 

Purchases of property, plant, and equipment
 
(5,151
)
 
(1,722
)
Acquisition
 

 
(165
)
Proceeds from sale of property, plant, and equipment
 
28

 

Other investing activities
 

 
(2
)
Net cash used in investing activities
 
(5,123
)
 
(1,889
)
 
 
 
 
 
Financing Activities
 
 

 
 

Repayment of debt
 
(13,382
)
 
(4,610
)
Proceeds from issuance of debt
 
12,000

 
8,000

Tax withholding payments related to stock-based compensation
 
(3,641
)
 
(2,182
)
Dividends paid
 
(2,316
)
 
(2,078
)
Proceeds from issuance of Company common stock
 
742

 

Payment of debt issuance costs
 

 
(654
)
Other financing activities
 
(111
)
 
(118
)
Net cash used in financing activities
 
(6,708
)
 
(1,642
)
 
 
 
 
 
Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash
 
1,511

 
1,362

 
 
 
 
 
Decrease in Cash, Cash Equivalents, and Restricted Cash
 
(3,104
)
 
(486
)
Cash, Cash Equivalents, and Restricted Cash at Beginning of Period
 
76,846

 
73,569

Cash, Cash Equivalents, and Restricted Cash at End of Period
 
$
73,742

 
$
73,083


See Note 1 – Supplemental Cash Flow Information and Recently Adopted Accounting Pronouncements, Statement of Cash Flows (Topic 230), Restricted Cash for further details.

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 December 31, 2016
 
14,624,159

 
$
146

 
$
101,405

 
$
321,050

 
3,686,532

 
$
(90,335
)
 
$
(49,637
)
 
$
1,650

 
$
284,279

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Net income
 

 

 

 
8,951

 

 

 

 
116

 
9,067

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Dividend declared
 

 

 

 
(2,310
)
 

 

 

 

 
(2,310
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Activity under stock plans
 

 

 
(2,431
)
 

 
(63,020
)
 
1,544

 

 

 
(887
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Other comprehensive items
 

 

 

 

 

 

 
5,095

 
46

 
5,141

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at April 1, 2017
 
14,624,159

 
$
146

 
$
98,974

 
$
327,691

 
3,623,512

 
$
(88,791
)
 
$
(44,542
)
 
$
1,812

 
$
295,290

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 30, 2017
 
14,624,159

 
$
146

 
$
103,221

 
$
342,893

 
3,613,838

 
$
(88,554
)
 
$
(26,715
)
 
$
1,513

 
$
332,504

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Net income
 

 

 

 
10,858

 

 

 

 
150

 
11,008

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adoption of ASU No. 2014-09 (Note 1)
 

 

 

 
119

 

 

 

 

 
119

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adoption of ASU No. 2016-16 (Note 1)
 

 

 

 
(75
)
 

 

 

 

 
(75
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Dividend declared
 

 

 

 
(2,440
)
 

 

 

 

 
(2,440
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Activity under stock plans
 

 

 
(3,393
)
 

 
(79,888
)
 
1,958

 

 

 
(1,435
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Other comprehensive items
 

 

 

 

 

 

 
5,503

 
43

 
5,546

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at March 31, 2018
 
14,624,159

 
$
146

 
$
99,828

 
$
351,355

 
3,533,950

 
$
(86,596
)
 
$
(21,212
)
 
$
1,706

 
$
345,227


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. was incorporated in Delaware in November 1991 and currently trades on the New York Stock Exchange under the ticker symbol "KAI."
    
Kadant Inc. and its subsidiaries' (collectively, the Company) 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 for the global papermaking, paper recycling, recycling and waste management, and other process industries. The Company's principal products 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 and equipment used in industrial piping systems to compensate for movement and to efficiently transfer fluid, power, and data; doctoring systems and equipment and related consumables important to the efficient operation of paper machines and other industrial processes; and filtration and cleaning systems essential for draining, purifying, and recycling process water and cleaning fabrics, belts, and rolls in various process industries.

Through its Wood Processing Systems segment, the Company develops, manufactures, and markets stranders, debarkers, chippers, and logging machinery used in the harvesting and production of lumber and oriented strand board. 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 biodegradable, absorbent granules derived from papermaking by-products 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.

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 March 31, 2018 and its results of operations and comprehensive income for the three-month periods ended March 31, 2018 and April 1, 2017, and its cash flows and stockholders' equity for the three-month periods ended March 31, 2018 and April 1, 2017. 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 30, 2017 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 30, 2017. 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 30, 2017, 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 the Financial Accounting Standards Board's (FASB) Accounting Standards Update (ASU) No. 2017-07, Compensation - Retirement Benefits (Topic 715), Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost, certain components of net benefit cost have been reclassified from operating income to non-operating expenses and included in other expense, net in the condensed consolidated statement of income in the 2017 period. In addition, as a result of the adoption of the FASB's ASU No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash, the change in restricted cash has been reclassified from financing activities and exchange rate effect on cash and included in cash, cash equivalents, and restricted cash in the condensed consolidated statement of cash flows in the 2017 period.
    
    

8

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

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

Effective at the beginning of fiscal 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (Topic 606), using a modified retrospective method. See Recently Adopted Accounting Pronouncements in this footnote for further discussion. Results for fiscal 2018 are presented under Topic 606, while prior period amounts are not adjusted and are reported under the Company's prior method of reporting revenue recognition in accordance with Revenue Recognition (Topic 605) (Topic 605). The impact on any financial statement line item created by applying Topic 606 versus Topic 605 to the Company's results for the first quarter of 2018 is not material.

Use of Estimates and Critical Accounting Policies
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.

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, 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 30, 2017, and in Revenue Recognition and Recently Adopted Accounting Pronouncements, Revenue from Contracts with Customers (Topic 606), in this footnote.

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)
 
March 31,
2018
 
April 1,
2017
Cash Paid for Interest
 
$
2,459

 
$
388

Cash Paid for Income Taxes, Net of Refunds
 
$
8,455

 
$
3,774

 
 
 
 
 
Non-Cash Investing Activities:
 
 

 
 

Estimated post-closing adjustment (a)
 
$
400

 
$

 
 
 
 
 
Non-cash additions to property, plant and equipment
 
$
1,816

 
$
125

 
 
 
 
 
Non-Cash Financing Activities:
 
 

 
 

Issuance of Company common stock upon vesting of restricted stock units
 
$
2,755

 
$
2,640

Dividends declared but unpaid
 
$
2,440

 
$
2,310


(a) Represents an estimated post-closing purchase price adjustment related to the 2017 acquisition of certain assets of Unaflex, LLC, which is expected to be settled in 2018.


9

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

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

Restricted Cash
The Company's restricted 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.

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company's condensed consolidated balance sheet that are shown in aggregate in the accompanying condensed consolidated statement of cash flows:
(In thousands)
 
March 31,
2018
 
April 1,
2017
 
December 30,
2017
 
December 31,
2016
Cash and cash equivalents
 
$
72,210

 
$
71,540

 
$
75,425

 
$
71,487

Restricted cash
 
1,532

 
1,543

 
1,421

 
2,082

Total Cash, Cash Equivalents, and Restricted Cash
 
$
73,742

 
$
73,083

 
$
76,846

 
$
73,569


Banker's Acceptance Drafts included in Accounts Receivable
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 noninterest bearing obligations of the issuing bank and mature within six months of the origination date. The Company's subsidiaries may 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 $12,021,000 at March 31, 2018 and $15,960,000 at December 30, 2017, 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:
 
 
March 31,
2018
 
December 30,
2017
(In thousands)
 
 
Raw Materials and Supplies
 
$
42,582

 
$
38,952

Work in Process
 
22,395

 
18,203

Finished Goods
 
30,863

 
27,778

 
 
$
95,840

 
$
84,933



10

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 by major asset class are as follows:
(In thousands)
 
Gross
 
Currency
Translation
 
Accumulated
Amortization
 
Net
March 31, 2018
 
 
 
 
 
 
 
 
Definite-Lived
 
 
 
 
 
 
 
 
Customer relationships
 
$
113,283

 
$
(419
)
 
$
(31,196
)
 
$
81,668

Product technology
 
46,501

 
(584
)
 
(20,797
)
 
25,120

Tradenames
 
5,227

 
(218
)
 
(1,628
)
 
3,381

Other
 
13,744

 
(28
)
 
(11,178
)
 
2,538

 
 
178,755

 
(1,249
)
 
(64,799
)
 
112,707

Indefinite-Lived
 
 
 
 
 
 
 
 
Tradenames
 
16,600

 
328

 

 
16,928

Acquired Intangible Assets
 
$
195,355

 
$
(921
)
 
$
(64,799
)
 
$
129,635

 
 
 
 
 
 
 
 
 
December 30, 2017
 
 

 
 

 
 

 
 

Definite-Lived
 
 
 
 
 
 
 
 
Customer relationships
 
$
113,301

 
$
(621
)
 
$
(28,789
)
 
$
83,891

Product technology
 
46,501

 
(737
)
 
(19,841
)
 
25,923

Tradenames
 
5,227

 
(262
)
 
(1,504
)
 
3,461

Other
 
13,754

 
(35
)
 
(10,863
)
 
2,856

 
 
178,783

 
(1,655
)
 
(60,997
)
 
116,131

Indefinite-Lived
 
 
 
 
 
 
 
 
Tradenames
 
16,600

 
305

 

 
16,905

Acquired Intangible Assets
 
$
195,383

 
$
(1,350
)
 
$
(60,997
)
 
$
133,036

    
Intangible assets are initially recorded at fair value at the date of acquisition and are stated net of accumulated amortization and currency translation in the accompanying condensed consolidated balance sheet. The Company amortizes definite-lived intangible assets over lives that have been determined based on the anticipated cash flow benefits of the intangible asset.

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 30, 2017
 
 
 
 
 
 
Gross balance
 
$
247,014

 
$
106,496

 
$
353,510

Accumulated impairment losses
 
(85,509
)
 

 
(85,509
)
Net balance
 
161,505

 
106,496

 
268,001

2018 Adjustments
 
 
 
 
 
 
   Acquisitions (a)
 
(309
)
 
(75
)
 
(384
)
   Currency translation
 
2,131

 
(234
)
 
1,897

   Total 2018 adjustments
 
1,822

 
(309
)
 
1,513

Balance at March 31, 2018
 
 

 
 

 
 

Gross balance
 
248,836

 
106,187

 
355,023

Accumulated impairment losses
 
(85,509
)
 

 
(85,509
)
Net balance
 
$
163,327

 
$
106,187

 
$
269,514



11

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

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

(a) Relates to adjustments to the purchase price allocation, principally for inventory, for acquisitions completed in 2017. The purchase price allocation for the Company's 2017 acquisitions will be finalized by the second quarter of 2018 and any resulting adjustments are not expected to be material.

Warranty Obligations
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)
 
March 31,
2018
 
April 1,
2017
Balance at December 30, 2017
 
$
5,498

 
$
3,843

Provision charged to expense
 
715

 
804

Usage
 
(364
)
 
(570
)
Currency translation
 
61

 
62

Balance at March 31, 2018
 
$
5,910

 
$
4,139


Revenue Recognition

Effective at the beginning of fiscal 2018, the Company adopted Topic 606, using a modified retrospective method. See Recently Adopted Accounting Pronouncements in this footnote for further discussion. Results for fiscal 2018 are presented under Topic 606, while prior period amounts are not adjusted and are reported in accordance with Topic 605. The impact on any financial statement line item created by applying Topic 606 versus Topic 605 to the Company's results for the first quarter of 2018 is not material.

Approximately 95% of the Company’s revenue in the first quarter of 2018 was recognized at a point in time for each performance obligation under the contract when the customer obtains control of the goods or service. The majority of the Company’s parts and consumables products and capital products with minimal customization are accounted for at a point in time. The Company has made a policy election to not treat the obligation to ship as a separate performance obligation under the contract and, as a result, the associated shipping costs are accrued when revenue is recognized.

The remaining 5% of the Company’s revenue in the first quarter of 2018 was recognized on an over time basis based on an input method that compares the costs incurred to date to the total expected costs required to satisfy the performance obligation. Contracts are accounted for on an over time basis when they include products which have no alternative use and an enforceable right to payment over time. The majority of the contracts recognized on an over time basis are for large capital projects within the Company's Stock-Preparation product line and, to a lesser extent, its Fluid-Handling and Doctoring, Cleaning, and Filtration product lines. These projects are highly customized for the customer and as a result would include a significant cost to rework in the event of cancellation.

The Company's contracts covering the sale of its products include warranty provisions that provide assurance to its customers that the products will comply with agreed-upon specifications. The Company negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications.


12

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

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

The Company disaggregates its revenue from contracts with customers by product line, product type, and geography as this best depicts how its revenue is affected by economic factors as shown below:
 
 
Three Months Ended
 
 
March 31,
 
April 1,
(In thousands)
 
2018
 
2017
Revenues by Product Line:
 
 
 
 
Papermaking Systems:
 
 
 
 
Stock-Preparation
 
$
45,483

 
$
41,153

Doctoring, Cleaning, & Filtration
 
27,222

 
25,350

Fluid-Handling
 
32,886

 
22,047

Papermaking Systems
 
$
105,591

 
$
88,550

Wood Processing Systems
 
39,141

 
9,943

Fiber-based Products
 
4,461

 
4,364

 
 
$
149,193

 
$
102,857

Revenue by Product Type:
 
 

 
 

Parts and Consumables
 
$
95,985

 
$
70,444

Capital
 
53,208

 
32,413

 
 
$
149,193

 
$
102,857

Revenue by Geography:
 
 

 
 

North America
 
$
77,616

 
$
50,166

Europe
 
41,493

 
32,751

Asia
 
20,148

 
11,898

Rest of World
 
9,936

 
8,042

 
 
$
149,193

 
$
102,857


The following table presents revenue by revenue recognition method:
 
 
Three Months Ended
 
 
March 31,
(In thousands)
 
2018
Timing of Revenue Recognition:
 
 

Point in Time
 
$
142,005

Over Time
 
7,188

 
 
$
149,193



13

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

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

The following tables present the balances from contracts with customers and the significant changes in contract asset and contract liabilities:
 
 
March 31,
2018
 
December 30,
2017
(In thousands)
 
 
Balances from Contracts with Customers:
 
 
 
 
Accounts receivable, net
 
$
91,529

 
$
89,624

Contract assets
 
2,375

 
2,374

Contract liabilities
 
(47,759
)
 
(38,702
)
 
 
Contract Assets
 
Contract Liabilities
(In thousands)
 
 
Balance at December 30, 2017
 
$
2,374

 
$
(38,702
)
Impact from the adoption of Topic 606
 
2,021

 
(3,932
)
Reclassification to accounts receivable, net
 
(3,476
)
 

Contract assets recognized
 
1,403

 

Revenue recognized
 

 
27,325

Cash received and not recognized as revenue
 

 
(31,503
)
Currency translation
 
53

 
(947
)
Balance at March 31, 2018
 
$
2,375

 
$
(47,759
)

Contract assets relate to unbilled revenue associated with revenue recognized on contracts accounted for on an over time basis. Unbilled amounts will be billed in future periods based on the contract terms. Contract liabilities consist of customer deposits, advanced billings and deferred revenue included in other current liabilities in the accompanying condensed consolidated balance sheet. Contract liabilities will be recognized as revenue in future periods once the revenue recognition criteria are met. The majority of the contract liabilities relate to advanced payments on contracts accounted for at a point in time. These advance payments will be recognized as revenue when the Company's performance obligations have been satisfied, which typically occurs when the product has been delivered and control of the asset has transferred to the customer.

Customers in China will often settle their accounts receivable with a banker's acceptance draft, in which case cash settlement will be delayed until the banker's acceptance draft matures or is settled prior to maturity. For customers outside of China, final payment for the majority of the Company's products is received in the quarter following the product shipment. Certain of the Company's contracts include a longer period before final payment is due, which is typically within one year of final shipment or transfer of control to the customer.
    
Recently Adopted 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 Company adopted this ASU using the modified retrospective transition approach effective at the beginning of fiscal 2018. The guidance applies 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 this ASU and the Company's previous revenue recognition practices under Topic 605 was recognized using a cumulative-effect adjustment that increased retained earnings by $119,000. The increase in retained earnings primarily related to contracts, which meet the over time criteria under the new revenue standard and, as a result, the portion of the contract completed as of the beginning of fiscal 2018 was recognized immediately in retained earnings. Partially offsetting this increase was a reduction of retained earnings associated with certain contracts which were previously accounted for under the percentage-of-completion method of accounting, but do not meet the requirements for over time recognition under Topic 606. Amounts previously recognized in fiscal 2017 based on the percentage-of-completion method of accounting were deferred at the beginning of fiscal 2018 and will be recognized along with the remaining revenue and costs in fiscal 2018 when control of the asset has been transferred to the customer.


14

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

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

The Company has implemented certain modifications to its existing internal controls to support the recognition criteria and disclosure requirement of this ASU. See Revenue Recognition in this footnote for further disclosures required by this ASU.

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. The Company adopted this ASU at the beginning of fiscal 2018 with no impact on the Company's condensed consolidated statement of cash flows.
 
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. The Company adopted this ASU at the beginning of fiscal 2018 on a modified retrospective basis, which resulted in an immaterial adjustment to retained earnings. The impact of the adoption of this standard to future periods will be dependent on future asset transfers, which generally occur in connection with acquisitions and other business structuring activities.

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. The Company adopted this ASU at the beginning of fiscal 2018. Prior period amounts related to the Company's cash flows from financing activities, exchange rate effect on cash, and cash, cash equivalents, and restricted cash were restated as required by this ASU, which did not have a material effect on the Company's statement of cash flows. See Restricted Cash in this footnote for further disclosures required by this ASU.

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 Company adopted this ASU on a prospective basis at the beginning of fiscal 2018. The adoption of this ASU will impact how the Company assesses acquisitions and disposals of businesses in the future.

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 costs and operating expenses in the same income statement line item as the related employees' compensation costs. The other components of net benefit cost are to be included in non-operating expenses. The Company adopted this ASU at the beginning of fiscal 2018 and prior period amounts were reclassified with no impact on the Company’s condensed consolidated net income. As a result of the adoption, the Company reclassified $204,000 from operating income to other expense, net in the accompanying condensed consolidated statement of income for the three months ended April 1, 2017.

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. The Company adopted this ASU on a prospective basis at the beginning of fiscal 2018. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial statements.
    
Income Taxes (Topic 740), Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. In March 2018, the FASB issued ASU No. 2018-05, an amendment to the December 2017 SEC Staff Accounting Bulletin No. 118 (SAB 118), which allowed SEC registrants to record provisional amounts in earnings due to the complexities involved in accounting for the December 22, 2017 enactment of the Tax Cuts and Jobs Act of 2017. While the Company’s accounting for certain tax effects is incomplete, it has determined reasonable estimates for those effects and has recorded provisional amounts in the condensed consolidated financial statements as of March 31, 2018 and December 30, 2017.

Recent Accounting Pronouncements Not Yet Adopted
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,

15

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

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

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 using the modified retrospective transition method and early adoption is permitted. The Company is assessing the practical expedients allowed under this new guidance as well as reviewing the impact on its systems, processes and controls to account for its leases. The Company has not completed its evaluation but believes this standard will have a significant impact on its balance sheet but is not expected to have a material impact on the Company’s results of operations or cash flows. As of the end of fiscal 2017, the Company had approximately $8.1 million of future lease payments due after fiscal 2018. The actual impact of this new standard will depend on the total amount of the Company’s lease commitments as of the adoption date.

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 with early adoption 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.

Derivatives and Hedging (Topic 815), Targeted Improvements in Accounting for Hedging Activity. In August 2017, the FASB issued ASU No. 2017-12, which provides improvements to current hedge accounting to better portray the economic results of an entity’s risk management activities and to simplify the application of current hedge accounting guidance. This new guidance is effective on a prospective basis for the Company in fiscal 2019. 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.
    
Income Statement - Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. In February 2018, the FASB issued ASU No. 2018-02, which allows a reclassification from accumulated other comprehensive items (AOCI) to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017. The reclassification is elective and would allow the income tax effects on items that were originally recorded in AOCI be reclassified from AOCI to retained earnings. This ASU is effective for the Company in fiscal year 2019 and interim periods therein and should be applied either at the beginning of the period of adoption or retrospectively to each period in which the income tax effects of the Tax Cuts and Jobs Act of 2017 are recognized. 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.

2.    Restructuring Costs

In 2017, the Company constructed a 160,000 square foot manufacturing facility in the United States that will integrate its U.S. and Swedish Papermaking stock-preparation product lines into a single manufacturing facility to achieve economies of scale and greater efficiencies. As a result of the consolidation and integration of these facilities, the Company developed a restructuring plan totaling approximately $1,900,000, primarily related to costs for the relocation of machinery and equipment and administrative offices, severance, and abandonment of leased facilities in the Papermaking Systems segment. As a result of this plan, the Company recorded restructuring charges of $203,000 in 2017 associated with severance costs for the reduction of four employees in the United States and six employees in Sweden. In the first three months of 2018, the Company recorded additional restructuring costs of $770,000 related to this plan, including $563,000 for the relocation of machinery and equipment and administrative offices, and $210,000 associated with employee retention costs and abandonment of excess facility and other closure costs. The Company expects to record additional restructuring charges of approximately $900,000, including $750,000 for the relocation of machinery and equipment and $150,000 of other costs, in 2018 when certain specified criteria are met.
    

    

16

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

2.    Restructuring Costs (continued)


A summary of the changes in accrued restructuring costs included in other accrued expenses in the accompanying condensed consolidated balance sheet are as follows:
(In thousands) 
 
Severance
 
Relocation
 
Other (a)
 
Total
Balance at December 30, 2017
 
$
203

 
$

 
$

 
$
203

Provision (reversal)
 
(3
)
 
563

 
210

 
770

Usage
 

 
(358
)
 
(120
)
 
(478
)
Currency translation
 
(1
)
 

 

 
(1
)
Balance at March 31, 2018
 
$
199

 
$
205

 
$
90

 
$
494


(a) Includes employee retention costs that are accrued ratably over the period through which employees must work to qualify for a payment and facility closure and clean-up costs associated with the U.S. stock-preparation operations.

The Company expects to complete this restructuring plan and pay all accrued restructuring costs in 2018.

3.    Earnings per Share

Basic and diluted earnings per share (EPS) are calculated as follows:
 
 
Three Months Ended
 
 
March 31,
2018
 
April 1,
2017
(In thousands, except per share amounts)
 
 
Amounts Attributable to Kadant:
 
 
 
 
Net Income
 
$
10,858

 
$
8,951

 
 
 
 
 
Basic Weighted Average Shares
 
11,042

 
10,952

Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan Shares
 
300

 
253

Diluted Weighted Average Shares
 
11,342

 
11,205

 
 
 
 
 
Basic Earnings per Share
 
$
0.98

 
$
0.82

 
 
 
 
 
Diluted Earnings per Share
 
$
0.96

 
$
0.80


Restricted stock units (RSUs) totaling 30,000 shares in the first three months of 2018 and 39,000 shares in the first three months of 2017 of common stock 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 Tax Cuts and Jobs Act of 2017 (2017 Tax Act) was signed into law on December 22, 2017 and its provisions are generally effective for tax years beginning January 1, 2018. The most significant impacts of the 2017 Tax Act to the Company include a decrease in the federal corporate income tax rate from 35% to 21% and a one-time mandatory transition tax on deemed repatriation of previously tax-deferred and unremitted foreign earnings. On December 22, 2017, the SEC staff issued SAB 118 to provide guidance on accounting for the 2017 Tax Act’s impact. In accordance with SAB 118, the Company recognized the provisional tax impacts related to the re-measurement of its deferred income tax assets and liabilities and the one-time mandatory transition tax on deemed repatriation of unremitted foreign earnings in the three months ended December 30, 2017. In the first quarter of 2018, the Company recorded an additional provisional net income tax expense of $787,000, including the impact of state taxes, for the one-time mandatory transition tax, primarily due to a 2018 tax law change associated with the 2017 Tax Act that impacted the provisional amount initially recorded.

Additional work is still necessary to finalize the provisional tax impacts of the 2017 Tax Act, including the completion of a more detailed analysis of the Company’s historical foreign earnings and the understanding and application of anticipated additional regulatory guidance regarding the provisions of the 2017 Tax Act that may be issued by the Internal Revenue Service

17

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

4.    Provision for Income Taxes (continued)


and state and local jurisdictions. Any subsequent adjustment to the provisional amounts will be recorded to current tax expense in the quarter of 2018 in which the analysis is complete.

The provision for income taxes was $3,861,000 in the first three months of 2018 and $2,735,000 in the first three months of 2017. The effective tax rate of 26% in the first three months of 2018 was higher than the Company's 2018 statutory tax rate of 21% primarily due to a true-up to the federal provisional net income tax expense initially recorded in 2017 for the 2017 Tax Act, the U.S. tax cost of foreign operations, including the global intangible low-taxed income provisions of the 2017 Tax Act, and the distribution of the Company's worldwide earnings. This incremental tax expense was offset in part by a decrease in tax related to the net excess income tax benefits from stock-based compensation arrangements, the release of tax reserves, and a favorable impact to state taxes primarily related to the true-up to the provisional net income tax expense initially recorded in 2017 for the 2017 Tax Act. The effective tax rate of 23% in the first three months of 2017 was lower than the Company's 2017 statutory tax rate of 35% 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.

5.    Long-Term Obligations

Long-term obligations are as follows:
 
 
March 31,
2018
 
December 30,
2017
(In thousands)
 
 
Revolving Credit Facility, due 2022
 
$
235,851

 
$
237,011

Obligations Under Capital Lease, due 2018 to 2022
 
4,689

 
4,633

Other Borrowings, due 2018 to 2023
 
396

 
436

Total
 
240,936

 
242,080

Less: Current Maturities of Long-Term Obligations
 
(710
)
 
(696
)
Long-Term Obligations
 
$
240,226

 
$
241,384

See Note 10 for the fair value information related to the Company's long-term obligations.
Revolving Credit Facility
In 2017, the Company entered into an Amended and Restated Credit Agreement, as amended (the 2017 Credit Agreement), which is a five-year unsecured multi-currency revolving credit facility in the aggregate principal amount of up to $300,000,000. The 2017 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional $100,000,000. The principal on any borrowings 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 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.
        
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

18

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

5.    Long-Term Obligations (continued)


new lines of business, and certain actions related to a discontinued operation. As of March 31, 2018, 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. In addition, one of the Company's foreign subsidiaries entered into a guarantee agreement limited to certain obligations of two foreign subsidiary borrowers.

As of March 31, 2018, the outstanding balance under the 2017 Credit Agreement was $235,851,000, including $56,796,000 of Canadian dollar-denominated borrowings and $50,055,000 of euro-denominated borrowings. As of March 31, 2018, the Company had $63,737,000 of borrowing capacity available under its 2017 Credit Agreement, which was calculated by translating its foreign-denominated borrowings using borrowing date foreign exchange rates.
    
The weighted average interest rate for the revolving credit facility was 2.86% as of March 31, 2018.

Obligations Under Capital Lease
The Company's obligations under capital leases include a sale-leaseback financing arrangement for a manufacturing facility in Germany. Under this arrangement, the quarterly lease payment includes principal, interest, and a payment to the landlord toward a loan receivable. The interest rate on the outstanding obligation is 1.79%. The loan receivable, which is included in other assets in the accompanying condensed consolidated balance sheet, was $458,000 at March 31, 2018. The lease arrangement provides for a fixed price purchase option, net of the projected loan receivable, of $1,639,000 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 March 31, 2018, $4,596,000 was outstanding under this capital lease obligation and $93,000 was outstanding under other capital lease obligations.

6.    Stock-Based Compensation

The Company recognized stock-based compensation expense of $1,464,000 in the first three months of 2018 and $1,295,000 in the first three months of 2017 within selling, general, and administrative 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 based on the grant date fair value, and net of actual forfeitures recorded when they occur. For performance-based RSUs, compensation expense is recognized ratably over the requisite service period for each separately-vesting portion of the award based on the grant date fair value, net of actual forfeitures recorded when they occur and remeasured each reporting period until the total number of RSUs to be issued is known. Unrecognized compensation expense related to stock-based compensation totaled approximately $8,987,000 at March 31, 2018, and will be recognized over a weighted average period of 2.0 years.

On March 7, 2018, the Company granted to certain of its officers performance-based RSUs, which represented, in aggregate, the right to receive 28,637 shares (the target RSU amount), subject to adjustment, with an aggregate grant date fair value of $2,794,000. The RSUs are subject to adjustment based on the achievement of the performance measure selected for the 2018 fiscal year, which is a specified target for adjusted EBITDA generated from operations for the 2018 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. Actual adjusted EBITDA in excess of 115% results in an adjustment capped at 150% of the RSU amount. If actual adjusted EBITDA is below 50% of the target adjusted EBITDA for the 2018 fiscal year, these performance-based RSUs will be forfeited. In the first three months of 2018, 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 2019, 2020, and 2021, provided that the officer is employed by the Company on the applicable vesting dates. On March 7, 2018, the Company also granted time-based RSUs representing 28,086 shares to its officers and employees with an aggregate grant date fair value of $2,741,000. These time-

19

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

6.    Stock-Based Compensation (continued)


based RSUs generally vest in three equal annual installments on March 10 of 2019, 2020, and 2021, provided the employee remains employed by the Company on the applicable vesting dates.
    
7.    Retirement Benefit Plans

Effective at the beginning of fiscal 2018, the Company retrospectively adopted ASU No. 2017-07. See Recently Adopted Accounting Pronouncements in Note 1 for further discussion. As a result, only the service cost component of net periodic benefit cost is included in operating income. All other components are included in other expense, net in the accompanying condensed consolidated statement of income. The components of net periodic benefit cost are as follows:
 
 
Three Months Ended 
 March 31, 2018
 
Three Months Ended 
 April 1, 2017
(In thousands, except percentages)
 
U.S. Pension
 
Non-U.S. Pension
 
Other Post-Retirement
 
U.S. Pension
 
Non-U.S. Pension
 
Other Post-Retirement
Service Cost
 
$
175

 
$
36

 
$
53

 
$
196

 
$
32

 
$
35

Interest Cost
 
298

 
30

 
43

 
314

 
24

 
39

Expected Return on Plan Assets
 
(322
)
 
(11
)
 
(1
)
 
(335
)
 
(8
)
 

Recognized Net Actuarial Loss
 
135

 
16

 
34

 
113

 
9

 
13

Amortization of Prior Service Cost
 

 
2

 
22

 
13

 
1

 
21

 
 
$
286

 
$
73

 
$
151

 
$
301

 
$
58

 
$
108

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

 
 
 
 
 
 
 
 
 
 
 
 
 
Discount Rate
 
3.51
%
 
3.80
%
 
3.65
%
 
4.03
%
 
3.39
%
 
4.13
%
Expected Long-Term Return on Plan Assets
 
4.50
%
 
7.43
%
 
7.43
%
 
5.00
%
 
7.72
%
 
7.72
%
Rate of Compensation Increase
 
3.00
%
 
3.69
%
 
3.07
%
 
3.00
%
 
3.40
%
 
3.08
%
 
The Company does not plan to make any material cash contributions to its pension and post-retirement benefit plans other than to fund current benefit payments in 2018.

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.

Changes in each component of AOCI, net of tax, are as follows:
(In thousands)
 
Foreign
Currency
Translation
Adjustment
 
Unrecognized
Prior Service
Cost on Pension and
Other Post-
Retirement Benefit Plans
 
Net Actuarial Loss
on Pension and
Other Post-
Retirement Benefit Plans
 
Deferred Gain
on Cash Flow Hedges
 
Total
Balance at December 30, 2017
 
$
(17,501
)
 
$
(319
)
 
$
(8,974
)
 
$
79

 
$
(26,715
)
Other comprehensive income (loss) before reclassifications
 
5,293

 
(1
)
 
(39
)
 
89

 
5,342

Reclassifications from AOCI
 

 
18

 
139

 
4

 
161

Net current period other comprehensive income
 
5,293

 
17

 
100

 
93

 
5,503

Balance at March 31, 2018
 
$
(12,208
)
 
$
(302
)
 
$
(8,874
)
 
$
172

 
$
(21,212
)
 
 
 
 
 
 
 
 
 
 
 

20

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
 
(In thousands)
 
March 31,
2018
 
April 1,
2017
Statement of Income
Line Item
Pension and Other Post-Retirement Plans: (a)
 
 
      
Amortization of actuarial loss
 
$
(185
)
 
$
(135
)
Other expense, net
Amortization of prior service cost
 
(24
)
 
(35
)
Other expense, net
Total expense before income taxes
 
(209
)
 
(170
)
 
Income tax benefit
 
52

 
59

Provision for income taxes
 
 
(157
)
 
(111
)
 
Cash Flow Hedges: (b)
 
 

 
 

      
Interest rate swap agreement
 
(5
)
 
(12
)
Interest expense
Forward currency-exchange contracts
 

 
(11
)
Cost of revenues
Total expense before income taxes
 
(5
)
 
(23
)
 
Income tax benefit
 
1

 
8

Provision for income taxes
 
 
(4
)
 
(15
)
 
Total Reclassifications
 
$
(161
)
 
$
(126
)
 

(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 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 AOCI. These deferred gains and losses are recognized in the 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.

Interest Rate Swap Agreement
In January 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.


21

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

9.    Derivatives (continued)

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 were to be 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 if the Company were to be 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 March 31, 2018, the Company was in compliance with these covenants. The unrealized gain associated with the 2015 Swap Agreement was $204,000 as of March 31, 2018, 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 twelve 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. The Company recognized within SG&A expenses in the accompanying condensed consolidated statement of income gains of $13,000 in the first three months of 2018 and $471,000 in the first three months of 2017 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.

22

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 in the accompanying condensed consolidated balance sheet:
 
 
 
 
March 31, 2018
 
December 30, 2017
 
 
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:
 
 
 
 
 
 
 
 
 
 
Interest rate swap agreement
 
Other Long-Term Assets
 
$
204

 
$
10,000

 
$
126

 
$
10,000

 
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contract
 
Other Current Assets
 
$
24

 
$
1,002

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
Derivatives Not Designated as Hedging Instruments:
 
 

 
 

 
 

 
 

Derivatives in an Asset Position:
 
 
 
 

 
 

 
 

 
 

Forward currency-exchange contracts
 
Other Current Assets
 
$

 
$

 
$
17

 
$
1,244

Derivatives in a Liability Position:
 
 
 
 
 
 
 
 
 
 
Forward currency-exchange contracts
 
Other Current Liabilities
 
$
(1
)
 
$
2,366

 
$
(16
)
 
$
2,049


(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 three months of 2018.

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 three months ended March 31, 2018:
(In thousands)
 
Interest Rate Swap
Agreement
 
Forward Currency-
Exchange
Contract
 
Total
Unrealized Gain, Net of Tax, at December 30, 2017
 
$
79

 
$

 
$
79

Loss reclassified to earnings (a)
 
4

 

 
4

Gain recognized in AOCI
 
71

 
18

 
89

Unrealized Gain, Net of Tax, at March 31, 2018
 
$
154

 
$
18

 
$
172

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

As of March 31, 2018, the Company expects to reclassify $85,000 of the net unrealized gain included in AOCI to earnings over the next twelve months as a result of forward contract maturities and the interest rate swap's estimated cash flows.

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.


23

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

10.    Fair Value Measurements and Fair Value of Financial Instruments (continued)


The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis:
(In thousands)
 
Level 1
 
Level 2
 
Level 3