UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------------------------------------------
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 1, 2006
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 (I.R.S. Employer
of Incorporation or Organization) Identification No.)
One Acton Place, Suite 202
Acton, Massachusetts 01720
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (978) 776-2000
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (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 is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
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 August 3, 2006
---------------------------- -----------------------------
Common Stock, $.01 par value 13,903,581
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
-----------------------------
KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)
Assets
July 1, December 31,
(In thousands) 2006 2005
----------------------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 43,444 $ 40,822
Accounts receivable, less allowances of $2,273 and $2,221 49,031 41,822
Unbilled contract costs and fees 27,628 11,603
Inventories (Note 5) 40,187 35,115
Other current assets 14,226 11,969
Assets of discontinued operation (Note 12) 9,064 14,030
-------- --------
Total Current Assets 183,580 155,361
-------- --------
Property, Plant, and Equipment, at Cost 90,785 85,668
Less: Accumulated depreciation and amortization 55,941 52,761
-------- --------
34,844 32,907
-------- --------
Other Assets 7,150 6,856
-------- --------
Intangible Assets 35,136 36,262
-------- --------
Goodwill 128,923 124,425
-------- --------
Total Assets $389,633 $355,811
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Balance Sheet (continued)
(Unaudited)
Liabilities and Shareholders' Investment
July 1, December 31,
(In thousands, except share amounts) 2006 2005
----------------------------------------------------------------------------------------------------------------------------------
Current Liabilities:
Current maturities of long-term obligations (Note 6) $ 9,500 $ 9,000
Accounts payable 38,336 20,229
Accrued payroll and employee benefits 14,491 14,002
Customer deposits 5,496 3,636
Billings in excess of contract costs and fees 3,694 8,032
Accrued restructuring costs (Note 8) 855 4,781
Other current liabilities 18,979 13,636
Liabilities of discontinued operation (Note 12) 3,737 6,599
-------- --------
Total Current Liabilities 95,088 79,915
-------- --------
Long-Term Obligations (Note 6) 48,758 46,500
-------- --------
Other Long-Term Liabilities 19,740 20,726
-------- --------
Minority Interest 1,218 1,045
-------- --------
Shareholders' Investment:
Preferred stock, $.01 par value, 5,000,000 shares authorized;
none issued - -
Common stock, $.01 par value, 150,000,000 shares authorized; 14,604,520
shares issued 146 146
Capital in excess of par value 95,178 97,297
Retained earnings 143,671 136,050
Treasury stock at cost, 701,339 and 1,055,756 shares (16,112) (24,254)
Deferred compensation - (124)
Accumulated other comprehensive items (Note 2) 1,946 (1,490)
-------- --------
224,829 207,625
-------- --------
Total Liabilities and Shareholders' Investment $389,633 $355,811
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
Three Months Ended
-----------------------------
July 1, July 2,
(In thousands, except per share amounts) 2006 2005
----------------------------------------------------------------------------------------------------------------------------------
Revenues $ 89,567 $ 65,086
-------- ----------
Costs and Operating Expenses:
Cost of revenues 56,847 40,385
Selling, general, and administrative expenses 22,498 18,497
Research and development expenses 1,496 1,247
-------- --------
80,841 60,129
-------- --------
Operating Income 8,726 4,957
Interest Income 251 379
Interest Expense (804) (473)
-------- --------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 8,173 4,863
Provision for Income Taxes 2,529 1,654
Minority Interest Expense 47 62
-------- --------
Income from Continuing Operations 5,597 3,147
(Loss) Income from Discontinued Operation (net of income tax benefit of
$417 in 2006 and income tax expense of $111 in 2005) (Note 12) (627) 207
-------- --------
Net Income $ 4,970 $ 3,354
======== ========
Basic Earnings per Share (Note 3):
Continuing Operations $ .41 $ .23
Discontinued Operation (.05) .01
-------- --------
Net Income $ .36 $ .24
======== ========
Diluted Earnings per Share (Note 3):
Continuing Operations $ .40 $ .22
Discontinued Operation (.05) .02
-------- --------
Net Income $ .35 $ .24
======== ========
Weighted Average Shares (Note 3):
Basic 13,702 13,891
======== ========
Diluted 14,056 14,181
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
Six Months Ended
-----------------------------
July 1, July 2,
(In thousands, except per share amounts) 2006 2005
----------------------------------------------------------------------------------------------------------------------------------
Revenues $165,158 $115,830
-------- --------
Costs and Operating Expenses:
Cost of revenues 103,821 72,367
Selling, general, and administrative expenses 44,619 33,391
Research and development expenses 3,041 2,295
Restructuring costs 138 -
-------- --------
151,619 108,053
-------- --------
Operating Income 13,539 7,777
Interest Income 510 851
Interest Expense (1,598) (475)
-------- --------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 12,451 8,153
Provision for Income Taxes 3,984 1,857
Minority Interest Expense 105 62
-------- --------
Income from Continuing Operations 8,362 6,234
Loss from Discontinued Operation (net of income tax benefit
of $494 and $84) (Note 12) (741) (156)
-------- --------
Net Income $ 7,621 $ 6,078
======== ========
Basic Earnings per Share (Note 3):
Continuing Operations $ .61 $ .45
Discontinued Operation (.05) (.01)
-------- ---------
Net Income $ .56 $ .44
======== ========
Diluted Earnings per Share (Note 3):
Continuing Operations $ .60 $ .44
Discontinued Operation (.05) (.01)
-------- --------
Net Income $ .55 $ .43
======== ========
Weighted Average Shares (Note 3):
Basic 13,641 13,909
======== ========
Diluted 13,948 14,196
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
Six Months Ended
-----------------------------
(Revised -
See Note 1)
July 1, July 2,
(In thousands) 2006 2005
----------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 7,621 $ 6,078
Loss from discontinued operation (Note 12) 741 156
-------- --------
Income from continuing operations 8,362 6,234
Adjustments to reconcile income from continuing operations to net cash (used
in) provided by operating activities:
Depreciation and amortization 3,755 2,719
Stock-based compensation expense 203 -
Provision for losses on accounts receivable 187 44
Minority interest expense 105 62
Other, net 321 64
Changes in current accounts, net of effects of acquisitions:
Accounts receivable (6,211) 2,402
Unbilled contract costs and fees (15,729) (6,125)
Inventories (2,266) 3,066
Other current assets (1,255) 902
Accounts payable 17,198 (1,619)
Other current liabilities (5,026) (2,866)
-------- --------
Net cash (used in) provided by continuing operations (356) 4,883
Net cash used in discontinued operation (3,461) (428)
-------- --------
Net cash (used in) provided by operating activities (3,817) 4,455
-------- --------
Investing Activities:
Acquisitions, net of cash acquired (Note 4) (5,574) (101,365)
Capitalized acquisition costs (Note 4) - 1,916
Purchases of property, plant, and equipment (1,106) (875)
Proceeds from sale of property, plant, and equipment 110 9
Other, net (5) 116
-------- --------
Net cash used in continuing operations (6,575) (100,199)
Net cash provided by (used in) discontinued operation 4,195 (42)
-------- --------
Net cash used in investing activities (2,380) (100,241)
-------- --------
Financing Activities:
Proceeds from issuance of short- and long-term obligations (Note 6) 15,008 60,000
Increase in short- and long-term obligations - 4,000
Repayments of short- and long-term obligations (12,850) -
Net proceeds from issuance of Company common stock 4,265 639
Purchases of Company common stock - (2,085)
Excess tax benefits from stock option exercises 965 -
Payment of debt issuance costs (186) -
-------- --------
Net cash provided by continuing operations 7,202 62,554
Net cash provided by discontinued operation - -
-------- --------
Net cash provided by financing activities 7,202 62,554
-------- --------
Exchange Rate Effect on Cash 987 (2,675)
-------- --------
Change in Cash from Discontinued Operation 630 39
-------- --------
Increase (Decrease) in Cash and Cash Equivalents 2,622 (35,868)
Cash and Cash Equivalents at Beginning of Period 40,822 82,089
-------- --------
Cash and Cash Equivalents at End of Period $ 43,444 $ 46,221
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. General
The interim condensed consolidated financial statements and related notes
presented have been prepared by Kadant Inc. (also referred to in this document
as "we," "Kadant," "the Company," or "the Registrant") without audit and, in the
opinion of management, reflect all adjustments of a normal recurring nature
necessary for a fair statement of the Company's financial position at July 1,
2006, its results of operations for the three- and six-month periods ended July
1, 2006, and July 2, 2005, and cash flows for the six-month periods ended July
1, 2006, and July 2, 2005. Interim results are not necessarily indicative of
results for a full year.
The condensed consolidated balance sheet presented as of December 31,
2005, has been derived from the consolidated financial statements that have been
audited by the Company's independent registered public accounting firm. The
condensed consolidated financial statements and related notes are presented as
permitted by Form 10-Q and do not contain certain information included in the
annual 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, 2005, filed with the Securities and Exchange Commission.
Certain prior-period amounts have been reclassified to conform to the
2006 presentation.
Supplemental Cash Flow Information
Six Months Ended
-----------------------------
July 1, July 2,
(In thousands) 2006 2005
----------------------------------------------------------------------------------------------------------------------------------
Non-cash Investing Activities:
Fair value of assets acquired $ 6,716 $156,667
Cash paid for acquired business (5,574) (104,531)
-------- --------
Liabilities assumed of acquired business $ 1,142 $ 52,136
======== ========
Non-cash Financing Activities:
Increase in short- and long-term obligations $ 3,779 $ -
======== ========
The increase in short- and long-term obligations of $3,779,000 in the
first six months of 2006 relates to additional consideration to be paid for
Kadant Johnson consisting of $1,941,000 of additional consideration to be paid
over four years for certain tax assets of Kadant Johnson, the value of which
the Company expects to realize, $1,670,000 which the Company expects to pay in
the third quarter of 2006 in settlement of post-closing adjustments, and
$168,000 of acquisition-related costs the Company expects to pay in 2006.
In the first six months of 2005, the Company separately disclosed the
operating, investing, and financing portions of the cash flows attributable to
its discontinued operation, which in prior periods were reported on a combined
basis as a single amount.
2. Comprehensive Income
Comprehensive income combines net income and "other comprehensive items,"
which represents certain amounts that are reported as components of
shareholders' investment in the accompanying condensed consolidated balance
sheet, including foreign currency translation adjustments and deferred gains and
losses on hedging
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
2. Comprehensive Income (continued)
instruments. The components of comprehensive income are as follows:
Three Months Ended Six Months Ended
------------------------ ------------------------
July 1, July 2, July 1, July 2,
(In thousands) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Net Income $ 4,970 $ 3,354 $ 7,621 $ 6,078
------- ------- ------- -------
Other Comprehensive Items:
Foreign Currency Translation Adjustments 2,788 (2,997) 3,216 (3,663)
Deferred Gain (Loss) on Hedging Instruments 66 (266) 220 (366)
------- ------- ------- -------
2,854 (3,263) 3,436 (4,029)
------- ------- ------- -------
Comprehensive Income $ 7,824 $ 91 $11,057 $ 2,049
======= ======= ======= =======
3. Earnings per Share
Basic and diluted earnings per share are calculated as follows:
Three Months Ended Six Months Ended
------------------------ -----------------------
July 1, July 2, July 1, July 2,
(In thousands, except per share amounts) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations $ 5,597 $ 3,147 $ 8,362 $ 6,234
(Loss) Income from Discontinued Operation (627) 207 (741) (156)
------- ------- ------- -------
Net Income $ 4,970 $ 3,354 $ 7,621 $ 6,078
======= ======= ======= =======
Basic Weighted Average Shares 13,702 13,891 13,641 13,909
Effect of Stock Options 354 290 307 287
------- ------- ------- -------
Diluted Weighted Average Shares 14,056 14,181 13,948 14,196
======= ======= ======= =======
Basic Earnings per Share:
Continuing Operations $ .41 $ .23 $ .61 $ .45
Discontinued Operation (.05) .01 (.05) (.01)
------- ------- ------- -------
Net Income $ .36 $ .24 $ .56 $ .44
======= ======= ======= =======
Diluted Earnings per Share:
Continuing Operations $ .40 $ .22 $ .60 $ .44
Discontinued Operation (.05) .02 (.05) (.01)
------- ------- ------- -------
Net Income $ .35 $ .24 $ .55 $ .43
======= ======= ======= =======
Options to purchase approximately 74,000 and 218,000 shares of common
stock for the second quarters of 2006 and 2005, respectively, and 157,800 and
222,700 shares of common stock for the first six months of 2006 and 2005,
respectively, were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average market price
for the common stock and the effect of their inclusion would have been
anti-dilutive.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Acquisitions
On January 21, 2006, the Company, on behalf of its subsidiary Kadant
Light Machinery (Jining) Co., Ltd. (Kadant Jining), entered into an asset
purchase agreement with Jining Huayi Light Industry Machinery Co., Ltd. (Huayi)
to acquire substantially all the assets of Huayi, excluding accounts receivable
and certain liabilities associated with the business, for approximately
$20,000,000, subject to adjustment (Huayi Acquisition). Huayi is a supplier of
stock-preparation equipment in China, with unaudited revenues of approximately
$15,000,000 in 2005. Pursuant to the asset purchase agreement, 20% of the
purchase price, or approximately $4,000,000, will be issued in the form of
bank payment guarantees upon completion of the purchase obligations outlined
below to secure certain post-closing and indemnification obligations of the
sellers. The bank payment guarantees may be drawn upon by the sellers over 19
months from the date of issuance as certain obligations are satisfied.
On June 2, 2006, Kadant Jining assumed responsibility for the operation
of the acquired business and completed the acquisition of fixed assets
consisting of machinery, equipment, and inventory, for approximately $6,716,000,
of which $5,574,000 was paid in cash and $1,142,000 will be paid over the next
19 months as certain obligations are satisfied. The acquisition of the Huayi
business will allow the Company to deliver its stock-preparation systems and
aftermarket products to customers in China more efficiently, supply parts and
components to North America and Europe, and extend our customer base to
include more small-to-midsize mills. This acquisition was accounted for under
the purchase method of accounting and the operating results for Kadant Jining
have been included in the accompanying condensed consolidated financial
statements from the acquisition date of June 2, 2006. The allocation of the
purchase price was based on estimates of the fair value of the assets acquired
and is subject to adjustment upon finalization of the purchase price
allocation. The acquisition of the buildings and land-use rights, and payment
of the remaining purchase price for the business, are expected to be completed
in the third quarter of 2006 upon the issuance of required governmental
certificates. The remaining purchase obligation is approximately $13,225,000,
which includes $1,875,000 of cash to be acquired. The Company plans to finance
the remaining purchase obligation, of which $10,593,000 will be paid in the
third quarter of 2006 and the remaining $2,632,000 will be paid over the next
19 months as certain obligations are satisfied, through a combination of cash
and borrowings in China.
On May 11, 2005, the Company acquired all the outstanding stock of The
Johnson Corporation (Kadant Johnson), a privately held supplier of fluid-
handling systems and equipment based in Three Rivers, Michigan. The purchase
price for the acquisition was $113,925,000, of which $101,458,000 was paid in
cash at closing, $1,670,000, which the Company expects to pay in the third
quarter of 2006 in settlement of post-closing adjustments, $4,856,000 for
acquisition-related costs the majority of which have been paid, and $5,941,000
of additional cash consideration the Company expects to pay over four years.
The additional consideration of $5,941,000 relates to certain tax assets of
Kadant Johnson, the value of which the Company expects to realize. In the
second quarter of 2006, the Company paid $600,000 of this additional
consideration. The remaining balance, of which $1,774,000 is included in other
current liabilities and $3,567,000 is included in other long-term liabilities
in the accompanying condensed consolidated balance sheet, is due over the next
four years as follows: 33% in May of 2007, 15% in both May 2008 and 2009, and
37% in May 2010.
The parties also agreed in the purchase agreement to an earn-out
provision, based on the achievement of certain revenue targets between the
closing date of May 11, 2005 and July 1, 2006, which could have increased the
purchase price by up to $8,000,000. This earn-out provision was not met as the
revenue targets were not achieved by Kadant Johnson.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Acquisitions (continued)
The acquisition was accounted for under the purchase method of
accounting. The total consideration through July 1, 2006, for Kadant Johnson was
$113,925,000 for acquired assets of $160,112,000, including goodwill of
$54,336,000 and intangible assets of $34,480,000, and assumed liabilities of
$46,187,000. Included in intangible assets is $8,100,000 associated with the
acquisition of the Johnson tradename, which has an indefinite life and is not
being amortized. The remaining intangible assets are being amortized using the
straight-line method over periods ranging from 3 to 20 years with a
weighted-average amortization period of 15 years.
The following condensed consolidated statement of operations is presented
as if the acquisition of Kadant Johnson had been made at the beginning of the
period presented. This information is not necessarily indicative of what the
actual condensed combined statement of income of Kadant and Kadant Johnson would
have been for the period presented, nor does it purport to represent the future
combined results of operations of Kadant and Kadant Johnson.
Six Months Ended
(In thousands) July 2, 2005
---------------------------------------------------------------------------------------
Revenues $145,031
--------
Operating Loss* (2,553)
--------
Loss from Continuing Operations (2,676)
Loss from Discontinued Operation (156)
--------
Net Loss $ (2,832)
========
Basic Loss per Share:
Loss from Continuing Operations $ (.19)
Net Loss $ (.20)
Diluted Loss per Share:
Loss from Continuing Operations $ (.19)
Net Loss $ (.20)
* Included in operating loss was $11.0 million in one-time bonuses and
$3.1 million in acquisition-related costs that Kadant Johnson incurred prior to
the acquisition.
5. Inventories
The components of inventories are as follows:
July 1, December 31,
(In thousands) 2006 2005
-----------------------------------------------------------------------------------------------------------
Raw Materials and Supplies $22,383 $19,971
Work in Process 10,520 5,605
Finished Goods (includes $569 and $328 at customer locations) 7,284 9,539
------- --------
$40,187 $35,115
======= =======
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. Long-Term Obligations and Other Financial Instruments
Long-term Obligations
Long-term obligations are as follows:
July 1, December 31,
(In thousands) 2006 2005
-----------------------------------------------------------------------------------------------------------
Variable Rate Term Loan, due from 2006 to 2009 $43,250 $55,500
Variable Rate Term Loan, due from 2006 to 2016 10,000 -
Variable Rate Term Loan, due 2010 5,008 -
------- -------
Total Long-Term Obligations 58,258 55,500
Less: Current Maturities (9,500) (9,000)
------- ------
Long-Term Obligations, less Current Maturities $48,758 $46,500
======= =======
To fund a portion of the purchase price for the acquisition of Kadant
Johnson, the Company entered into a term loan and revolving credit facility
(Credit Agreement) effective May 9, 2005 and as subsequently amended in the
aggregate principal amount of up to $95,000,000, including a $35,000,000
revolver. On May 11, 2005, the Company borrowed $60,000,000 under the Credit
Agreement, which is repayable in quarterly installments over a five-year
period.
On May 4, 2006, the Company borrowed $10,000,000 under a promissory
note (Loan) from Citizens Bank of Massachusetts (Lender). The Loan is
repayable in quarterly installments of $125,000 over a ten-year period with
the remaining principal balance of $5,000,000 due upon maturity. Interest on
the Loan accrues and is payable quarterly in arrears at one of the following
rates selected by the Company (a) the prime rate or (b) the three-month London
Inter-Bank Offered Rate (LIBOR) plus a 1% margin. The Loan is guaranteed and
secured by real estate and related personal property of the Company and
certain of its domestic subsidiaries located in Theodore, Alabama; Auburn,
Massachusetts; Three Rivers, Michigan; and Queensbury, New York, pursuant to
mortgage and security agreements dated May 4, 2006 (Mortgage and Security
Agreements).
The obligations of the Company under the Loan may be accelerated upon the
occurrence of an event of default under the Loan and the Mortgage and Security
Agreements, which includes customary events of default including without
limitation payment defaults, defaults in the performance of covenants and
obligations, the inaccuracy of representations or warranties, bankruptcy and
insolvency related defaults, liens on the properties or collateral, and
uninsured judgments. In addition, the occurrence of an event of default under
the Credit Agreement or any successor credit facility would be an event of
default under the Loan.
On May 5, 2006, the Company used $7,750,000 of the proceeds from the Loan
to prepay a portion of its existing variable-rate term loan under the Credit
Agreement.
On June 6, 2006, Kadant Jining borrowed 40 million Chinese Renminbi, or
$5,008,000, under a 47 month interest-only loan with Bank of China Limited.
Interest on this loan accrues and is payable quarterly in arrears based on the
interest rate published by Bank of China Limited for a loan of the same term
less 10%.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. Long-Term Obligations and Other Financial Instruments (continued)
Financial Instruments
The Company entered into a swap agreement, which was effective May 17,
2005, to convert $36,000,000 of the principal balance of the $60,000,000 term
loan under the Credit Agreement from a floating rate to a fixed rate of
interest. This swap agreement has a five-year term with the same quarterly
payment dates as the hedged portion of the term loan and reduces proportionately
in line with the amortization of the term loan. Under this swap agreement, the
Company will receive a three-month LIBOR rate and pay a fixed rate of interest
of 4.125%. The net effect on interest expense for the hedged portion of the term
loan ($36,000,000) is that the Company will pay a fixed interest rate of up to
5.375% (the sum of the 4.125% fixed rate under this swap agreement and the
applicable margin of up to 1.25% on the term loan). The guarantee provisions and
the default and financial covenants, as well as certain restrictions on the
payment of dividends included in the Credit Agreement also apply to this swap
agreement.
This swap agreement has been designated as a cash flow hedge and is
carried at fair value with unrealized gains or losses reflected within other
comprehensive items. As of July 1, 2006, the unrealized gain associated with
this swap agreement was $918,000, which is included in other assets and within
accumulated other comprehensive items on a net of tax basis in the accompanying
condensed consolidated balance sheet. Management believes that any credit risk
associated with this swap is remote based on the creditworthiness of the
financial institution issuing it.
To hedge the exposure to movements in the variable interest rate on the
$10,000,000 Loan, on May 3, 2006, the Company entered into a swap agreement with
the Lender effective May 5, 2006, which converts the Loan from a floating rate
to a fixed rate of interest. This swap agreement has a ten-year term, the same
quarterly payment dates as the Loan, and reduces in line with the amortization
of the Loan. This swap agreement automatically terminates in the event there are
no outstanding borrowings under the Credit Agreement (or successor credit
facility), the Loan, or any other borrowing in which Citizens Bank of
Massachusetts is a lender. Under this swap agreement, the Company will
receive a three-month LIBOR rate and pay a fixed rate of interest of 5.63%. The
net effect on interest expense for the $10,000,000 Loan is that the Company will
pay a fixed interest rate of 6.63% (the sum of the 5.63% fixed rate under this
swap agreement and the applicable margin of 1% on the loan). The guarantee and
default provisions of the Credit Agreement (and any successor Credit Facility)
and the Loan, including those contained in the Mortgage and Security Agreement,
also apply to this swap agreement.
This swap agreement has been designated as a cash flow hedge and is
carried at fair value with unrealized gains or losses reflected within other
comprehensive items. As of July 1, 2006, the unrealized loss associated with
this swap agreement was $25,000, which is included in other liabilities and
within accumulated other comprehensive items on a net of tax basis in the
accompanying condensed consolidated balance sheet. Management believes that any
credit risk associated with this swap is remote based on the creditworthiness of
the financial institution issuing it.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
7. Warranty Obligations
The Company provides for the estimated cost of product warranties at the
time of sale based on its actual historical return rates and repair costs. In
the Pulp and Papermaking Systems (Papermaking Systems) segment, 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 product failures, and supplier warranties on parts
delivered to the Company. Should actual product failure rates, repair costs,
service delivery costs, or supplier warranties on parts differ from the
Company's estimates, revisions to the estimated warranty liability would be
required.
The changes in the carrying amount of the Company's product warranties
included in other current liabilities in the accompanying condensed consolidated
balance sheet are as follows:
Three Months Ended Six Months Ended
--------------------------- --------------------------
July 1, July 2, July 1, July 2,
(In thousands) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Balance at Beginning of Period $ 2,787 $ 3,755 $ 2,836 $ 3,582
Provision charged to income 800 117 1,033 970
Usage (369) (238) (659) (912)
Acquired warranty obligation - 232 - 232
Other, net (a) 80 (100) 88 (106)
------- ------- -------- -------
Balance at End of Period $ 3,298 $ 3,766 3,298 $ 3,766
======== ======= ======= =======
(a) Represents the effects of currency translation.
See Note 12 for warranty information related to the discontinued operation.
8. Restructuring Costs
2004 Restructuring Plan
In an effort to improve operating performance at the Papermaking Systems
segment's Kadant Lamort subsidiary in France, the Company approved a
restructuring of that subsidiary on November 18, 2004. This restructuring was
initiated to strengthen Kadant Lamort's competitive position in the European
paper industry. The restructuring primarily included the reduction of 97 full-
time positions across all functions in France and was implemented in 2005.
The Company accrued a restructuring charge, in accordance with Statement of
Financial Accounting Standards (SFAS) No. 112, "Employers' Accounting for
Postemployment Benefits - An Amendment of Financial Accounting Standards Board
(FASB) Statements No. 5 and 43," for severance and other termination costs in
connection with the workforce reduction of $9,235,000 in the fourth quarter of
2004 and reduced the estimate by $71,000 in 2005.
2005 Restructuring Plan
The Company recorded restructuring costs of $317,000 during 2005
associated with its 2005 Restructuring Plan. These restructuring costs included
$221,000 for severance and associated costs related to the reduction of 14
full-time positions in the U.S. and $96,000 for equipment relocation costs,
both in our Papermaking Systems segment. The restructuring costs of $138,000
in the first quarter of 2006 relate to additional equipment relocation costs
associated with the 2005 Restructuring Plan.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
8. Restructuring Costs (continued)
A summary of the changes in accrued restructuring costs are as follows:
Severance
(In thousands) & Other
-------------------------------------------------------------------------------------------------------
2004 Restructuring Plan
Balance at December 31, 2005 $ 4,658
Usage (4,235)
Currency translation 432
--------
Balance at July 1, 2006 $ 855
========
2005 Restructuring Plan
Balance at December 31, 2005 $ 123
Provision 138
Usage (261)
--------
Balance at July 1, 2006 $ -
========
The estimated restructuring costs are based on the Company's best
judgments under prevailing circumstances. The Company believes that the
restructuring reserve balance is adequate to carry out the restructuring
activities formally identified and committed to as of July 1, 2006. Due to the
lengthy restructuring process in France and the long notification periods, the
related cash payments associated with the Kadant Lamort restructuring, which
was initiated at the end of 2004, will extend into the second half of 2006.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
9. Business Segment Information
The Company has combined its operating entities into one operating
segment, Papermaking Systems, and two separate product lines, Fiber-based
Products and Casting Products, which are reported in Other. In classifying
operational entities into a particular segment, the Company aggregated
businesses with similar economic characteristics, products and services,
production processes, customers, and methods of distribution. Kadant Jining,
acquired in June 2006, is presented in the Papermaking Systems segment within
the stock-preparation systems and equipment product line.
Three Months Ended Six Months Ended
--------------------------- --------------------------
July 1, July 2, July 1, July 2,
(In thousands) 2006 2005 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Systems $85,427 $ 62,528 $156,500 $110,099
Other (a) (c) 4,140 2,558 8,658 5,731
------- -------- -------- --------
$89,567 $ 65,086 $ 165,158 $115,830
======= ======== ======== ========
Income from Continuing Operations Before Provision
for Income Taxes and Minority Interest Expense:
Pulp and Papermaking Systems (b) $11,016 $ 6,149 $ 17,767 $ 9,770
Corporate and Other (a) (2,290) (1,192) (4,228) (1,993)
------- -------- -------- --------
Total Operating Income 8,726 4,957 13,539 7,777
Interest (Expense) Income, Net (553) (94) (1,088) 376
------- -------- -------- --------
$ 8,173 $ 4,863 $ 12,451 $ 8,153
======= ======== ======== ========
Capital Expenditures:
Pulp and Papermaking Systems $ 638 $ 612 $ 975 $ 752
Corporate and Other (a) (c) 85 97 131 123
------- -------- --------- --------
$ 723 $ 709 $ 1,106 $ 875
======= ======== ======== ========
(a) "Other" includes the results from the Company's Fiber-based Products business and Kadant Johnson's Casting Products business.
(b) In the first quarter of 2006, the Company changed its reporting of certain royalty income and associated expenses from
Corporate to the Pulp and Papermaking Systems segment. Information in the 2005 periods have been reclassified to conform
to this presentation.
(c) Corporate primarily includes general and administrative expenses.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Stock-Based Compensation Plans
The Company maintains stock-based compensation plans primarily for its
key employees and directors, although the plans permit awards to others expected
to make significant contributions to the future of the Company. The plans
authorize the compensation committee of the Company's board of directors (the
board committee) to award a variety of stock and stock-based incentives, such as
restricted stock, nonqualified and incentive stock options, stock bonus shares,
or performance-based shares. The award recipients and the terms of awards,
including price, granted under these plans are determined by the board
committee. Outstanding options granted under these plans prior to 2001 are
nonqualified options that are exercisable immediately, but are subject to
provisions similar to vesting that restrict transfer and afford the Company the
right to repurchase the shares at the exercise price upon certain events. The
restrictions and repurchase rights for these options generally lapse over five
to ten years and the terms of the options may range from five to twelve years.
Options granted under these plans in 2001 and after are nonqualified options
that vest over three years and are not exercisable until vested. To date, all
options have been granted at an exercise price equal to the fair market value of
the Company's common stock on the date of grant. Upon a change-of-control, as
defined in the plans, all options or other awards become fully vested and all
restrictions lapse. The Company generally issues shares of its common stock held
in treasury to satisfy option exercises.
On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment" (SFAS 123R). SFAS 123R replaces SFAS No. 123, "Accounting
for Stock-Based Compensation" (SFAS 123), supersedes Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25),
and amends SFAS No. 95 "Statement of Cash Flows." SFAS 123R requires all
share-based payments to employees that are ultimately expected to vest and do
actually vest, including grants of employee stock options, to be recognized in
the financial statements based on their fair values. The pro forma disclosures
previously permitted under SFAS 123 are no longer an alternative to recognition
of compensation expense in the income statement under SFAS 123R. Effective
January 1, 2006, the Company adopted SFAS 123R, using the modified prospective
method. Under this method, beginning on January 1, 2006, the Company recognized
compensation cost for all share-based payments to employees based on the grant
date estimate of fair value for those awards. The Company has used the Black-
Scholes option-pricing model to determine fair value for all share-based
payments. Compensation expense is recognized over the vesting period of the
award. Prior-period financial information has not been restated for the
adoption of SFAS 123R.
As of July 1, 2006, the Company had several share-based compensation
plans that are described below. As a result of the adoption of SFAS 123R on
January 1, 2006, the Company's results of operations for the three and
six-months ended July 1, 2006 included incremental share-based compensation
pre-tax expense of $79,000 and $203,000, respectively, related to stock options.
The total stock-based compensation cost, including compensation expense
associated with restricted stock, for the three and six-months ended July 1,
2006 of $592,000 and $804,000, respectively, is included in selling, general,
and administrative expenses in the accompanying condensed consolidated statement
of income. The total income tax benefit recognized in the income statement for
share-based compensation agreements for the three and six-months ended July 1,
2006 was $237,000 and $322,000, respectively. The adoption of SFAS 123R also
resulted in the inclusion in cash flows from financing activities of $965,000 of
total tax benefits realized from stock options exercised during the first six
months of 2006 that would have been reflected in cash flows from operating
activities prior to the adoption of SFAS 123R.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Stock-Based Compensation (continued)
Stock Options - There were no stock options granted in the first six
months of 2006. For the first six months of 2005, the fair value of each option
grant was estimated on the grant date using the Black-Scholes option-pricing
model, assuming no expected dividends, with the following assumptions:
Six Months Ended
July 2, 2005
-----------------------------------------------------------------------------------------------------------
Options Granted 115,000
Weighted-average Exercise Price $ 19.28
Weighted-average Grant Date Fair Value $ 8.10
Expected Life (in years) 5
Volatility 42%
Risk-Free Interest Rate 3.89%
The Black-Scholes option-pricing model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option-pricing models require the input
of highly subjective assumptions, including expected stock price volatility.
Expected stock price volatility was calculated based on a review of the
Company's actual historic stock prices commensurate with the expected life of
the award. The expected option life was derived based on a review of the
Company's historic option holding periods, including a consideration of the
holding period inherent in currently vested but unexercised options. The
risk-free interest rate is based on the yield on zero-coupon U.S. Treasury
securities for a period that is commensurate with the expected term of the
option. The compensation expense recognized for all equity-based awards is net
of estimated forfeitures. Forfeitures are estimated based on an analysis of
actual option forfeitures.
A summary of the Company's stock option activity for the six months ended
July 1, 2006 is as follows:
Weighted
Average
Weighted Remaining
Average Contractual Aggregate
Shares Exercise Term Intrinsic Value
(In thousands) Price (In years) (In thousands)
-------------------------------------------------------------------------------------------------------------------------------
Options Outstanding at December 31, 2005 1,699 $15.82
Granted - -
Exercised (334) $13.09
Forfeited / Expired (8) $37.70
-----
Options Outstanding at July 1, 2006 1,357 $16.36 2.9 $10,911
=====
Options Exercisable at July 1, 2006 1,243 $15.88 2.6 $10,503
=====
The total intrinsic value of options exercised (i.e., the difference
between the market price at exercise and the price paid by the employee to
exercise the options) during the six month periods ended July 1, 2006 and July
2, 2005, was $3,051,000 and $580,000, respectively. The aggregate intrinsic
value of options outstanding and options exercisable as of July 1, 2006 is based
on the difference between the closing price of the Company's common stock on
July 1, 2006, which was $23, and the exercise price of the applicable option. In
calculating the aggregate intrinsic value, the Company excluded those options
with an exercise price greater than the closing price per share of the Company's
common stock as of July 1, 2006.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Stock-Based Compensation (continued)
The Company received $4,265,000 from stock option exercises during the
six month period ended July 1, 2006. As of July 1, 2006, the Company had
approximately $178,000 of unrecognized compensation cost related to stock option
awards that it expects to recognize as expense over a weighted average period of
1.4 years.
Restricted Stock - The Company grants shares to outside directors, which
vest immediately, but are restricted from resale for three years from the date
of award. In the first six months of 2006 and 2005, the Company awarded 20,000
shares and 17,500 shares, respectively, of its restricted common stock with an
aggregate value of $478,000 and $352,000, respectively, to its outside
directors.
For periods prior to the adoption of SFAS 123R, the Company elected to
follow the accounting under APB Opinion No. 25 and related interpretations to
account for its stock-based compensation plans. For these prior periods, no
stock-based employee compensation cost related to stock option awards is
reflected in net income, as all options granted under the plans had an exercise
price equal to the market price of the underlying common stock on the date of
grant.
The following table illustrates the impact on net income and earnings per
share as if the Company had applied the fair value recognition provisions of
SFAS 123 to the Company's stock-based employee compensation for the three- and
six-month periods ended July 2, 2005.
Three Months Ended Six Months Ended
(In thousands, except per share amounts) July 2, 2005 July 2, 2005
---------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations $ 3,147 $ 6,234
Income (Loss) from Discontinued Operation 207 (156)
------- -------
Net Income As Reported 3,354 6,078
Deduct: Total stock-based employee compensation expense determined
under the fair-value-based method for all awards, net of tax (147) (349)
------- -------
Pro forma net income $ 3,207 $ 5,729
======= =======
Basic Earnings per Share:
As reported:
Income from continuing operations $ .23 $ .45
Net income $ .24 $ .44
Pro forma:
Income from continuing operations $ .22 $ .42
Net income $ .23 $ .41
Diluted Earnings per Share:
As reported:
Income from continuing operations $ .22 $ .44
Net income $ .24 $ .43
Pro forma:
Income from continuing operations $ .21 $ .41
Net income $ .23 $ .40
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
11. Employee Benefit Plans
Defined Benefit Pension Plans and Post-Retirement Welfare Benefit Plans
The Company's Kadant Web Systems subsidiary has a noncontributory
defined benefit retirement plan. Benefits under the plan are based on years of
service and employee compensation. Funds are contributed to a trustee as
necessary to provide for current service and for any unfunded projected benefit
obligation over a reasonable period. Effective December 31, 2005, this plan was
closed to new participants. This same subsidiary has a post-retirement welfare
benefit plan (included in the table below in "Other Benefits"). No future
retirees are eligible for this post-retirement welfare benefit plan and the plan
includes limits on the subsidiary's contributions.
The Company's Kadant Lamort subsidiary sponsors a defined benefit pension
plan, which is included in the table below in "Other Benefits." Benefits under
this plan are based on years of service and projected employee compensation.
The Company's Kadant Johnson subsidiary also offers a post-retirement
welfare benefit plan (included in the table below in "Other Benefits") to its
U.S. employees upon attainment of eligible retirement age.
The components of the net periodic benefit cost for the pension benefits
and other benefits plans in the three- and six-month periods ended July 1, 2006
and July 2, 2005 are as follows:
Three Months Ended Three Months Ended
(In thousands) July 1, 2006 July 2, 2005
----------------------------------------------------------------------------------------------------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $ 181 $ 59 $ 182 $ 84
Interest cost 260 91 250 79
Expected return on plan assets (354) - (351) -
Recognized net actuarial loss (gain) 13 8 (1) 9
Amortization of prior service cost (income) 12 (14) 12 (12)
----- ----- ----- ----
Net periodic benefit cost $ 112 $ 144 $ 92 $ 160
===== ===== ===== =====
The weighted-average assumptions used to determine net periodic benefit cost are as follows:
Discount rate 5.75% 5.30% 6.00% 5.00%
Expected long-term return on plan assets 8.50% - 8.50% -
Rate of compensation increase 4.00% 2.00% 4.00% 2.50%
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
11. Employee Benefit Plans (continued)
Six Months Ended Six Months Ended
(In thousands) July 1, 2006 July 2, 2005
------------------------------------------------------------------------------------------------------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $ 376 $ 118 $ 357 $ 118
Interest cost 524 182 503 119
Expected return on plan assets (707) - (702) -
Recognized net actuarial loss 30 16 - 17
Amortization of prior service cost (income) 24 (28) 24 (24)
----- ----- ----- ------
Net periodic benefit cost $ 247 $ 288 $ 182 $ 230
===== ===== ===== ======
The weighted-average assumptions used to determine net periodic benefit cost are as follows:
Discount rate 5.75% 5.30% 6.00% 5.10%
Expected long-term return on plan assets 8.50% - 8.50% -
Rate of compensation increase 4.00% 2.00% 4.00% 2.50%
No cash contributions are expected in 2006 for the Kadant Web Systems'
noncontributory defined benefit retirement plan. For the remaining pension and
post-retirement welfare benefit plans, no cash contributions, other than funding
current benefit payments, are expected in 2006.
12. Discontinued Operation
On October 21, 2005, our Kadant Composites LLC subsidiary (Kadant
Composites LLC) sold substantially all of its assets to LDI Composites Co.
(the Buyer). As part of the sale transaction, Kadant Composites LLC retained
the warranty obligations associated with products manufactured prior to the
sale date. Kadant Composites LLC deposited $3,500,000 of the sale proceeds into
a special escrow fund administered by the Buyer to satisfy these warranty
claims. During the second quarter of 2006, this special escrow fund was fully
utilized and Kadant Composites LLC assumed responsibility for claims payment
and processing.
Operating results for the composites business are as follows:
Three Months Ended Six Months Ended
--------------------- ---------------------
July 1, July 2, July 1, July 2,
(In thousands) 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------
Revenues $ - $ 5,548 $ - $10,784
------- ------- ------- -------
Operating (Loss) Income (1,140) 318 (1,432) (240)
Interest Income 96 - 197 -
------- ------- ------- -------
(Loss) Income Before Income Tax Benefit (Provision) (including
$130 loss on disposal in the first six months of 2006) (1,044) 318 (1,235) (240)
Income Tax Benefit (Provision) 417 (111) 494 84
------- -------- ------- -------
(Loss) Income From Discontinued Operation $ (627) $ 207 $ (741) $ (156)
======= ======= ======= =======
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Notes to Condensed Consolidated Financial Statements
(Unaudited)
12. Discontinued Operation (continued)
The major classes of assets and liabilities of the discontinued operation
included in the accompanying condensed consolidated balance sheet are as
follows:
July 1, December 31,
(In thousands) 2006 2005
-----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents $ 5,113 $ 5,743
Restricted cash 736 4,145
Other accounts receivable 629 1,545
Current deferred tax asset 2,110 2,110
Other assets 476 487
------- -------
Total Assets 9,064 14,030
------- -------
Accrued warranty costs 3,563 5,276
Other current liabilities 174 1,323
------- -------
Total Liabilities 3,737 6,599
------- -------
Net Assets $ 5,327 $ 7,431
======= =======
The restricted cash of $736,000 as of July 1, 2006 represents the portion
of the sale proceeds placed in escrow to satisfy certain indemnification
obligations and associated interest. Other accounts receivable of $629,000
represents the portion of the sales price held by the Buyer for one year to
satisfy certain indemnification obligations.
All future activity associated with the warranty reserve will continue to
be classified in the results of the discontinued operation in the Company's
consolidated financial statements. As part of the sale transaction, Kadant
Composites LLC retained the warranty obligations associated with products
manufactured prior to the sale date. Through the sale date of October 21, 2005,
Kadant Composites LLC offered a standard limited warranty to the original owner
of its decking and roofing products, limited to repair or replacement of the
defective product or a refund of the original purchase price.
Prior to the sale of the composites business, Kadant Composites LLC
recorded an estimate for warranty-related costs at the time of sale based on its
actual historical return rates and repair costs, as well as other analytical
tools for estimating future warranty claims. These estimates are revised for
variances between actual and expected claims rates. Kadant Composites LLC's
analysis of expected warranty claims rates includes detailed assumptions
associated with potential product returns, including the type of product sold,
temperatures at the location of installation, density of boards, and other
factors. Certain assumptions, such as the effect of weather conditions and high
temperatures on the product installed, include inherent uncertainties that are
subject to fluctuation, which could impact Kadant Composites LLC's future
warranty provisions. Due to the highly subjective nature of these assumptions,
Kadant Composites LLC has recorded its best estimate of the cost of expected
warranty claims. It is reasonably possible that the ultimate settlement of such
claims may exceed the amount recorded.
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KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
12. Discontinued Operation (continued)
A summary of the changes in accrued warranty costs in the first six
months of 2006 and 2005 is as follows:
Six Months Ended
-----------------------
July 1, July 2,
(In thousands) 2006 2005
----------------------------------------------------------------------------------------------------------------------------
Balance at Beginning of Period $ 5,276 $ 4,327
Provision 969 633
Usage (2,682) (1,474)
------- -------
Balance at End of Period $ 3,563 $ 3,486
======= ========
13. Subsequent Event
Recent Accounting Pronouncement
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109"
(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statements in accordance with SFAS No.
109. FIN 48 prescribes a recognition and measurement method of a tax position
taken or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosures and transitions. FIN 48 will become effective in the first
quarter of 2007. The Company is currently analyzing the effect that FIN 48 will
have on its financial statements.
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KADANT INC.
Item 2 - Management's Discussion and Analysis of Financial Condition and
------------------------------------------------------------------------
Results of Operations
---------------------
This Quarterly Report on Form 10-Q includes forward-looking statements
that are not statements of historical fact, and may include statements regarding
possible or assumed future results of operations. Forward-looking statements are
subject to risks and uncertainties and are based on the beliefs and assumptions
of our management, using information currently available to our management. When
we use words such as "believes," "expects," "anticipates," "intends," "plans,"
"estimates," "should," "likely," "will," "would," or similar expressions, we are
making forward-looking statements.
Forward-looking statements are not guarantees of performance. They
involve risks, uncertainties, and assumptions. Our future results of operations
may differ materially from those expressed in the forward-looking statements.
Many of the important factors that will determine these results and values are
beyond our ability to control or predict. You should not put undue reliance on
any forward-looking statements. We undertake no obligation to publicly update
any forward-looking statement, whether as a result of new information, future
events, or otherwise. For a discussion of important factors that may cause our
actual results to differ materially from those suggested by the forward-looking
statements, you should read carefully the section captioned "Risk Factors" in
Part II, Item 1A of this Report.
Overview
Company Background
We are a leading supplier of equipment used in the global papermaking and
paper recycling industry and are also a manufacturer of granules made from
papermaking byproducts. Our continuing operations consist of one operating
segment, Pulp and Papermaking Systems (Papermaking Systems), and two separate
product lines, Fiber-based Products and Casting Products. We aggregate into the
Papermaking Systems segment our businesses with similar economic
characteristics, products and services, production processes, customers, and
methods of distribution.
We were incorporated in Delaware in November 1991. On July 12, 2001, we
changed our name to Kadant Inc. from Thermo Fibertek Inc. Our common stock is
listed on the New York Stock Exchange, where it trades under the symbol "KAI".
Pulp and Papermaking Systems Segment
Our Papermaking Systems segment designs and manufactures
stock-preparation systems and equipment, paper machine accessory equipment,
water-management systems, and fluid-handling systems and equipment primarily for
the paper and paper recycling industries. Our principal products include:
- Stock-preparation systems and equipment: custom-engineered systems and
equipment, as well as standard individual components, for pulping,
de-inking, screening, cleaning, and refining recycled and virgin
fibers for preparation for entry into the paper machine during the
production of recycled paper;
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KADANT INC.
Overview (continued)
- Paper machine accessory equipment: doctoring systems and related
consumables that continuously clean papermaking rolls to keep paper
machines running efficiently; doctor blades made of a variety of
materials to perform functions including cleaning, creping, web
removal, and application of coatings; and profiling systems that
control moisture, web curl, and gloss during paper production;
- Water-management systems: systems and equipment used to continuously
clean paper machine fabrics and to drain, purify, and recycle process
water during paper sheet formation; and
- Fluid handling systems and equipment: rotary joints, precision unions,
steam and condensate systems, components, and controls used primarily
in the dryer section of the papermaking process and during the
production of corrugated boxboard, metals, plastics, rubber, and
textiles.
Other
Our other business lines include our Fiber-based Products business and
our Casting Products business.
Our Fiber-based Products business produces biodegradable, absorbent
granules from papermaking byproducts for use primarily as carriers for
agricultural, home lawn and garden, and professional lawn, turf and ornamental
applications, as well as for oil and grease absorption.
Our Casting Products business manufactures grey and ductile iron
castings.
Discontinued Operation
On October 21, 2005, our Kadant Composites LLC subsidiary (Kadant
Composites LLC) sold substantially all the assets comprising its composites
business to LDI Composites Co. (the Buyer). As part of the sale transaction,
Kadant Composites LLC retained the warranty obligations associated with products
manufactured prior to the sale date. Kadant Composites LLC deposited $3.5
million of the sale proceeds into a special escrow fund administered by the
Buyer to satisfy these warranty claims. During the second quarter of 2006, this
special escrow fund was fully utilized and Kadant Composites LLC assumed
responsibility for claims payment and processing. As of July 1, 2006, the
accrued warranty reserve associated with the composites business was $3.6
million. All future activity associated with this warranty reserve will
continue to be classified in the results of the discontinued operation in
our consolidated financial statements.
International Sales
During the first six months of 2006 and 2005, approximately 59% and 62%,
respectively, of our sales were to customers outside the United States,
principally in Europe and Asia. We generally seek to charge our customers in
the same currency in which our operating costs are incurred. However, our
financial performance and competitive position can be affected by currency
exchange rate fluctuations affecting the relationship between the U.S. dollar
and foreign currencies. We seek to reduce our exposure to currency
fluctuations through the use of forward currency exchange contracts. We may
enter into forward contracts to hedge certain firm purchase and sale commitments
denominated in currencies other than our subsidiaries' functional currencies.
These contracts hedge transactions principally denominated in U.S. dollars.
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KADANT INC.
Overview (continued)
Application of Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these condensed consolidated
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of our condensed consolidated financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Our actual results may differ from these estimates under
different assumptions or conditions.
Critical accounting policies are defined as those that reflect
significant judgments and uncertainties, and could potentially result in
materially different results under different assumptions and conditions. We
believe that our most critical accounting policies, upon which our financial
condition depends and which involve the most complex or subjective decisions or
assessments, are those described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" under the section captioned
"Application of Critical Accounting Policies and Estimates" in Item 7 of our
Annual Report on Form 10-K for the fiscal year ended December 31, 2005, filed
with the Securities and Exchange Commission. There have been no material changes
to these critical accounting policies since fiscal year-end 2005 that warrant
further disclosure, except for the adoption of SFAS 123R as noted below.
Our adoption of Statement of Financial Accounting Standards No. 123
(revised 2004), "Share Based Payment" (SFAS 123R), in the first quarter of 2006
requires that we recognize stock-based compensation expense associated with
stock options in the statement of income, rather than disclose it in a pro forma
footnote to our consolidated financial statements. Determining the amount of
stock-based compensation to be recorded requires us to develop estimates to be
used in calculating the grant-date fair value of stock options. We did not grant
any stock options in the first six months of 2006. For options granted prior to
January 1, 2006, we calculated the grant-date fair values using the
Black-Scholes valuation model. The use of valuation models requires us to make
estimates of the following assumptions:
Expected volatility - We derived the estimated stock price volatility
based on a review of our actual historic stock prices commensurate with
the expected life of the award.
Expected option life - Our estimate of an expected option life was
derived based on a review of our historic option holding periods,
including a consideration of the holding period inherent in currently
vested but unexercised options. We believe that this historical data is
currently the best estimate of the expected term of a new option.
Risk-free interest rate - We used the yield on zero-coupon U.S.
Treasury securities for a period that is commensurate with the expected
term assumption as the risk-free interest rate.
The amount of stock-based compensation recognized during a period is
based on the value of the portion of the awards that are ultimately expected to
vest. SFAS 123R requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. The term "forfeitures" is distinct from "cancellations" or
"expirations" and represents only the unvested portion of the surrendered
option. Similar to the analysis for the expected option life, we reviewed
historical forfeiture data and have applied an annual forfeiture rate of 2.5% to
all unvested options as of December 31, 2005. We will reevaluate this analysis
quarterly and adjust the forfeiture rate as necessary. Ultimately, we will
recognize the actual expense over the vesting period only for the shares that
vest.
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KADANT INC.
Overview (continued)
Industry and Business Outlook
Our products are primarily sold to the pulp and paper industry. The paper
industry had been in a prolonged downcycle for the past several years. The
performance of paper producers, especially in North America, has been
generally improving over the past year. However, paper producers are still being
negatively affected by higher operating costs, especially higher energy and
chemical costs. We believe paper companies are still cautious about increasing
their capital and operating spending in the current market environment. We
expect, however, if the financial performance of paper companies continues to
improve, they will increase their capital and operating spending, which would
have a positive effect on paper company suppliers, such as Kadant. We continue
to concentrate our efforts on several initiatives intended to improve our
operating results, including: (i) increasing aftermarket sales in China, (ii)
increasing sales of paper machine accessories and water management products in
China, (iii) increasing our use of low-cost manufacturing bases in China and
Mexico, and (iv) penetrating new markets outside the paper industry. In
addition, we continue to focus our efforts on managing our operating costs,
capital expenditures, and working capital.
On May 11, 2005, we acquired all the outstanding stock of The Johnson
Corporation (Kadant Johnson), a leading supplier of fluid-handling systems and
equipment, including steam and condensate systems, components, and controls.
These products are used primarily in the dryer section of the papermaking
process and during the production of corrugated boxboards, metals, plastics,
rubber, textiles, and food. Kadant Johnson was a privately held company based in
Three Rivers, Michigan, with approximately 575 employees. The
purchase price for the acquisition was approximately $113.9 million, including
$101.5 million paid in cash at closing, $1.7 million, which we expect to pay in
the third quarter of 2006 in settlement of post-closing adjustments, $4.8
million for acquisition-related costs the majority of which have been paid,
and $5.9 million of additional cash consideration we expect to pay over four
years. The additional consideration of $5.9 million relates to certain tax
assets of Kadant Johnson, the value of which we expect to realize. We paid
$0.6 million of this additional consideration in the second quarter of 2006,
and the remaining amount is due over the next four years as follows: 33% in
2007, 15% in both 2008 and 2009, and 37% in 2010.
On January 21, 2006, on behalf of our subsidiary Kadant Light Machinery
(Jining) Co., Ltd. (Kadant Jining), we entered into an asset purchase agreement
with Jining Huayi Light Industry Machinery Co., Ltd. (Huayi) to acquire
substantially all the assets of Huayi, excluding accounts receivable and certain
liabilities of the business, for approximately $20 million, subject to
adjustment (Huayi Acquisition). Huayi is a supplier of stock-preparation
equipment in China with unaudited revenues of approximately $15 million in 2005.
On June 2, 2006 Kadant Jining assumed responsibility for the operation of the
acquired business and purchased fixed assets consisting of machinery, equipment,
and inventory, for approximately $6.7 million, of which $5.6 million was paid
in cash and $1.1 million will be paid over the next 19 months as certain
obligations are satisfied. We expect that the acquisition of Huayi's buildings
and land-use rights and payment of the remaining purchase price for the business
will be completed in the third quarter of 2006. We plan to finance the remaining
purchase obligation totaling approximately $13.2 million, of which $10.6 million
will be paid in the third quarter of 2006 and the remaining $2.6 million will be
paid over the next 19 months as certain obligations are satisfied, through a
combination of cash and borrowings in China.
We continue to pursue market opportunities outside placeNorth America. In
the last several years, China has become a significant market for our stock-
preparation equipment. To capitalize on this growing market, we have acquired
a manufacturing and assembly business in China through our Huayi Acquisition
for this equipment and related products, as well as for certain of our
accessories and water-management products in the future. Revenues from China
are primarily derived from large capital orders, the timing of which is often
difficult to predict. At times our customers in China have experienced delays
in obtaining financing for their capital addition and expansion projects due
to efforts by the Chinese government to control economic growth, which are
reflected in a slowdown in financing approvals in China's banking system.
These delays can cause delays in receiving orders and, as a result, could delay
our recognizing revenue on these projects to periods later than originally
anticipated. We plan to use our new facility in China as a base for increasing
our aftermarket business, which we believe will be more predictable.
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KADANT INC.
Overview (continued)
Our 2006 guidance reflects expected revenues and earnings per share from
continuing operations, which excludes the results from our discontinued
operation. For the third quarter of 2006, we expect to earn between $.35 and
$.37 per diluted share, on revenues of $88 to $90 million. The guidance
reflects a projected tax rate of 32 percent for the second half of 2006 and
some dilution related to the Huayi Acquisition. For the full year, we expect
to earn between $1.20 and $1.28 per diluted share, an increase from our
earlier estimate of between $1.18 and $1.25, on revenues of $320 to $330
million, revised from our previous estimate of $300 to $310 million. A
portion of the revenue increase is related to the Huayi Acquisition.
Results of Operations
Second Quarter 2006 Compared With Second Quarter 2005
The following table sets forth our unaudited condensed consolidated
statement of income expressed as a percentage of total revenues for the second
fiscal quarters of 2006 and 2005. The results of operations for the fiscal
quarter ended July 1, 2006 are not necessarily indicative of the results to be
expected for the full fiscal year.
Three Months Ended
------------------------
July 1, July 2,
2006 2005
----------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
------- -------
Costs and Operating Expenses:
Cost of revenues 63 62
Selling, general, and administrative expenses 25 28
Research and development expenses 2 2
------- -------
90 92
------- -------
Operating Income 10 8
Interest Income - 1
Interest Expense (1) (1)
------- -------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 9 8
Provision for Income Taxes 3 3
Minority Interest Expense - -
------- -------
Income from Continuing Operations 6 5
(Loss) Income from Discontinued Operation - -
------ -------
Net Income 6% 5%
======= =======
Revenues
Revenues increased $24.5 million, or 38%, to $89.6 million in the second
quarter of 2006 from $65.1 million in the second quarter of 2005. Revenues in
the second quarter of 2006 included a $14.7 million, or 224%, increase from
stock-preparation equipment sales in China, which included $0.7 million from
Kadant Jining acquired in June 2006. Revenues in the second quarter of 2006
also included a $10.0 million, or 90%, increase from Kadant Johnson, which was
acquired in May 2005, and a $0.1 million unfavorable effect of currency
translation due to a stronger U.S. dollar relative to some of the functional
currencies in countries in which we operate.
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KADANT INC.
Results of Operations (continued)
Revenues for the second quarters of 2006 and 2005 from our Papermaking
Systems segment and other businesses are as follows:
Three Months Ended
--------------------------
July 1, July 2,
(In thousands) 2006 2005
----------------------------------------------------- ------------------ ------------------- ------------------ ------------------
Revenues:
Pulp and Papermaking Systems $ 85,427 $ 62,528
Other 4,140 2,558
---------- ----------
$ 89,567 $ 65,086
========== ==========
Pulp and Papermaking Systems Segment. Revenues at the Papermaking
Systems segment increased to $85.4 million in the second quarter of 2006 from
$62.5 million in the second quarter of 2005, an increase of $22.9 million, or
37%. The increase in revenues in 2006 was due primarily to a $14.7 million, or
224%, increase from stock-preparation equipment sales in China, which included
$0.7 million from Kadant Jining acquired in June 2006 and a $9.4 million, or
89%, increase from Kadant Johnson primarily due to their inclusion for the full
2006 quarter. These increases were offset in part by a $2.2 million, or 16%,
decrease in sales of stock preparation equipment in our North America-based
business.
The following table presents revenues at the Papermaking Systems segment
by product line, the changes in revenues by product line between the second
quarter of 2006 and 2005, and the changes in revenues by product line between
the second quarter of 2006 and 2005 excluding the effect of currency
translation. The presentation of the changes in revenues by product line,
excluding the effect of currency translation is a non-GAAP (generally accepted
accounting principles) measure. We believe this non-GAAP measure helps investors
gain a better understanding of our underlying operations, consistent with how
management measures and forecasts our performance, especially when comparing
such results to prior periods.
Increase
(Decrease)
Three Months Ended Excluding
---------------------- Effect of
July 1, July 2, Increase Currency
(In millions) 2006 2005 (Decrease) Translation
--------------------------------------------------------------------------------------------------------------------------------
Product Line:
Stock-Preparation Equipment $ 40.9 $ 29.2 $ 11.7 $ 12.1
Fluid Handling 20.0 10.6 9.4 9.0
Accessories 14.4 15.3 (0.9) (0.9)
Water-Management 9.5 7.0 2.5 2.6
Other 0.6 0.4 0.2 0.2
------- ------- ------- -------
$ 85.4 $ 62.5 $ 22.9 $ 23.0
======= ======= ======= =======
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KADANT INC.
Results of Operations (continued)
Revenues from the segment's stock-preparation equipment product line
increased $11.7 million, or 40%, in the second quarter of 2006 compared to the
second quarter of 2005, including a $0.4 million decrease from the unfavorable
effect of currency translation. Excluding the effect of currency translation,
revenues from the stock-preparation equipment product line increased $12.1
million, or 42%, due to a $14.7 million, or 224%, increase in sales in China due
to several large systems orders received in the first six months of 2006, offset
in part by a $2.2 million, or 16%, decrease in sales in our North American-based
business. The decrease in sales in our North American-based business was
primarily due to strong sales of our Chemi-Washer(TM) products in the second
quarter of 2005.
Revenues from the fluid-handling product line increased $9.4 million, or
89%, in the second quarter of 2006, including a $0.4 million increase from the
favorable effect of currency translation. This increase was primarily due to the
inclusion of Kadant Johnson for a full quarter in 2006 compared to their
inclusion from May 11, 2005 in the prior year period.
Revenues from the segment's accessories product line decreased $0.9
million, or 6%, in the second quarter of 2006 compared to the second quarter of
2005 due primarily to a decrease in sales in Europe attributed in part to mill
consolidations and machine shutdowns.
Revenues from the segment's water-management product line increased $2.5
million, or 37%, in the second quarter of 2006 compared to the second quarter of
2005 due primarily to an increase in capital sales in North America and
Europe.
Other. Revenues from the Fiber-based Products business increased $1.0
million, or 49%, to $3.1 million in the second quarter of 2006 from $2.1 million
in the second quarter of 2005 due to higher pricing and increased sales of
Biodac(TM), our product family of biodegradable granules that we produce from
papermaking byproducts. Revenues from our Casting Products business increased
$0.6 million in the second quarter of 2006 compared to the second quarter of
2005 due to the inclusion of Kadant Johnson for a full quarter in 2006 compared
to their inclusion from May 11, 2005 in the prior year period.
Gross Profit Margin
Gross profit margin was 37% in the second quarter of 2006 compared to 38%
in the second quarter of 2005.
Gross profit margins for the second quarters of 2006 and 2005 for our
Papermaking Systems segment and our other businesses were as follows:
Three Months Ended
--------------------
July 1, July 2,
2006 2005
-----------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Systems 37% 38%
Other 31 37
-- ---
37% 38%
The gross profit margin at the Papermaking Systems segment was 37% and
38% in the second quarter of 2006 and 2005, respectively. The fluid handling
product line contributed a 3% increase in gross profit margins in the second
quarter of 2006, which was more than offset by lower margins in our
stock-preparation product line as the revenue from this product line in the
quarter was primarily derived from large capital orders that contained lower
than normal margins. The gross profit margin at our other businesses decreased
to 31% in the second quarter of 2006 from 37% in the second quarter of 2005 due
to the inclusion of lower margins at the Casting Products business for the full
2006 period compared to their inclusion from May 11, 2005 in the prior year
period.
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KADANT INC.
Results of Operations (continued)
Operating Expenses
Selling, general, and administrative expenses as a percentage of revenues
decreased to 25% in the second quarter of 2006 from 28% in the second quarter of
2005 primarly due to the increase in revenues. Selling, general, and
administrative expenses increased to $22.5 million in the second quarter of 2006
from $18.5 million in the second quarter of 2005, an increase of $4.0 million,
or 22%. This increase was primarily due to a $3.4 million increase associated
with the inclusion of Kadant Johnson for a full quarter in 2006 compared to
their inclusion from May 11, 2005 in the prior year period.
Research and development expenses were $1.5 million and $1.2 million in
the second quarters of 2006 and 2005, respectively, and represented 2% of
revenues in both periods.
Interest Income
Interest income decreased to $0.3 million in the second quarter of 2006
from $0.4 million in the second quarter of 2005 primarily due to lower average
cash balances resulting from the May 2005 acquisition of Kadant Johnson.
Interest Expense
Interest expense increased to $0.8 million in the second quarter of 2006
from $0.5 million in the second quarter of 2005 due primarily to interest
expense associated with the $60.0 million in borrowings entered into in May
2005 to fund the Kadant Johnson acquisition.
Provision for Income Taxes
Our effective tax rate was 31% and 34% in the second quarters of 2006 and
2005, respectively. In the second quarter of 2006, we lowered our annual
effective tax rate from 34% to 32% as a result of improved tax efficiencies in
our foreign operations. This resulted in a $0.2 million, or $.02 per diluted
share, benefit in the second quarter of 2006.
Income from Continuing Operations
Income from continuing operations increased to $5.6 million in the second
quarter of 2006 from $3.1 million in the second quarter of 2005, an increase of
$2.5 million, or 78%, due to the reasons outlined above.
(Loss) Income from Discontinued Operation
The discontinued operation had a net loss of $0.6 million in the second
quarter of 2006 compared to net income of $0.2 million in the second quarter of
2005. Subsequent to the sale of Kadant Composites LLC in October 2005, the most
significant component of the operating costs in the discontinued operation is
any change associated with the warranty obligation. The net loss in the second
quarter of 2006 was primarily due to $1.0 million in pre-tax warranty expense.
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KADANT INC.
Results of Operations (continued)
First Six Months 2006 Compared With First Six Months 2005
The following table sets forth our unaudited condensed consolidated
statement of income expressed as a percentage of total revenues for the first
six months of 2006 and 2005. The results of operations for the first six months
of 2006 are not necessarily indicative of the results to be expected for the
full fiscal year.
Six Months Ended
-----------------------
July 1, July 2,
2006 2005
-------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
------- -------
Costs and Operating Expenses:
Cost of revenues 63 62
Selling, general, and administrative expenses 27 29
Research and development expenses 2 2
------- -------
92 93
------- -------
Operating Income 8 7
Interest Income 1 1
Interest Expense (1) (1)
------- -------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 8 7
Provision for Income Taxes 3 2
Minority Interest Expense - -
------- -------
Income from Continuing Operations 5 5
Loss from Discontinued Operation - -
------- -------
Net Income 5% 5%
======= =======
Revenues
Revenues increased $49.3 million, or 43%, to $165.2 million in the first
six months of 2006 from $115.8 million in the first six months of 2005. Revenues
in the 2006 period included a $28.4 million increase from Kadant Johnson,
acquired in May 2005, and an $18.1 million, or 148%, increase in
stock-preparation sales in China, which included $0.7 million from Kadant Jining
acquired in June 2006. Revenues in the 2006 period also included a $1.5 million
unfavorable effect of currency translation due to a stronger U.S. dollar
relative to some of the functional currencies in countries in which we operate.
Revenues by segment for the first six months of 2006 and 2005 were as
follows:
Six Months Ended
-----------------------
July 1, July 2,
(In thousands) 2006 2005
---------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Systems $156,500 $110,099
Other 8,658 5,731
-------- -------
$165,158 $115,830
======== =======
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KADANT INC.
Results of Operations (continued)
Pulp and Papermaking Systems Segment. Revenues at the Papermaking Systems
segment increased $46.4 million, or 42%, to $156.5 million in the first six
months of 2006 from $110.1 million in the first six months of 2005. The increase
in revenues in 2006 was due primarily to a $28.4 million increase from Kadant
Johnson primarily due to their inclusion for the full six months of 2006, and an
$18.1 million increase in revenues from stock-preparation equipment in China,
including a $0.7 million increase from Kadant Jining acquired in June 2006.
Revenues in the first six months of 2006 include the unfavorable effect of
currency translation described above, all of which related to this segment.
Revenues at the Papermaking Systems segment by product line were as
follows:
Increase
(Decrease)
Six Months Ended Excluding
---------------------- Effect of
July 1, July 2, Increase Currency
(In millions) 2006 2005 (Decrease) Translation
---------------------------------------------------------------------------------------------------------------------------------
Product Line:
Stock-Preparation Equipment $ 71.8 $ 53.8 $ 18.0 $ 19.4
Fluid Handling 39.0 10.6 28.4 28.0
Accessories 28.5 30.6 (2.1) (1.6)
Water-Management 16.0 14.3 1.7 1.7
Other 1.2 0.8 0.4 0.4
------- ------- -------- ------
$ 156.5 $ 110.1 $ 46.4 $ 47.9
======= ======= ======== =======
Revenues from the segment's stock-preparation equipment product line
increased $18.0 million, or 33%, in the first six months of 2006 compared to the
first six months of 2005, including a $1.4 million decrease from the unfavorable
effect of currency translation. Excluding the effect of currency translation,
revenues from the stock-preparation equipment product line increased $19.4
million, or 36%, due to an $18.1 million, or 148%, increase in sales in China
and a $1.6 million, or 7%, increase in sales in our North American business.
Revenues from the fluid handling product line increased $28.4 million in
the first six months of 2006, including a $0.4 million increase from the
favorable effect of currency translation. This increase was primarily due to the
inclusion of Kadant Johnson for the full 2006 period compared to their inclusion
from May 11, 2005 in the prior year period.
Revenues from the segment's accessories product line decreased $2.1
million, or 7%, in the first six months of 2006 compared to the first six months
of 2005, including a $0.5 million decrease from the unfavorable effect of
currency translation. Excluding the effect of currency translation, revenues
from the segment's accessories product line decreased $1.6 million, or 5%, due
to a decrease in sales in North America and Europe.
Revenues from the segment's water-management product line increased $1.7
million, or 12%, in the first six months of 2006 compared to the first six
months of 2005, due primarily to an increase in capital sales in North America.
Other. Revenues from the Fiber-based Products business increased $1.4
million, or 27%, to $6.6 million in the first six months of 2006 from $5.2
million in the first six months of 2005 due to increased sales of our Biodac(TM)
products. Revenues from our Casting Products business increased $1.5 million in
the first six months of 2006 due to the inclusion of Kadant Johnson for the
entire 2006 period compared to their inclusion from May 11, 2005 in the prior
year period.
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KADANT INC.
Results of Operations (continued)
Gross Profit Margin
Gross profit margin was 37% in the first six months of 2006 compared to
38% in the first six months of 2005.
Gross profit margins for the first six months of 2006 and 2005 for our
Papermaking Systems segment and our other businesses were as follows:
Six Months Ended
-------------------------
July 1, July 2,
2006 2005
-----------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Systems 38% 37%
Other 30 40
-- --
37% 38%
The gross profit margin at the Papermaking Systems segment increased to
38% in the first six months of 2006 from 37% in the first six months of 2005.
The fluid handling product line contributed a 5% increase in gross profit
margins in the first six months of 2006, which was largely offset by lower
margins in our stock-preparation product line as the revenue from this product
line was primarily derived from large capital orders that contained lower than
normal margins. The gross profit margin at our other businesses decreased to 30%
in the first six months of 2006 from 40% in the first six months of 2005 due to
the inclusion of lower margins at the Casting Products business for the full
2006 period compared to their inclusion from May 11, 2005 in the prior year
period.
Operating Expenses
Selling, general, and administrative expenses as a percentage of revenues
decreased to 27% in the first six months of 2006 from 29% in the first six
months of 2005 primarily due to the increase in revenues. Selling, general, and
administrative expenses increased to $44.6 million in the first six months of
2006 from $33.4 million in the first six months of 2005, an increase of $11.2
million, or 34%. This increase was primarily due to a $10.7 million increase
associated with the inclusion of Kadant Johnson for the full 2006 period
compared to their inclusion from May 11, 2005 in the prior year period.
Research and development expenses were $3.0 million and $2.3 million in
the first six months of 2006 and 2005, respectively, and represented 2% of
revenues in both periods. The $1.3 million increase in research and development
expenses was primarily the result of the inclusion of Kadant Johnson for the
full 2006 period compared to their inclusion from May 11, 2005 in the prior year
period.
On January 1, 2006, we adopted SFAS 123R using the modified prospective
method. We calculate compensation cost on the date of grant using the fair value
of the options as determined by the Black-Scholes valuation model. In the first
six months of 2006, we recognized $0.2 million, or $.01 per diluted share,
associated with stock-based compensation expense as a result of the adoption of
SFAS 123R. Prior to the adoption of SFAS 123R, we accounted for share-based
payments to employees using Accounting Principles Board Opinion No. 25's (APB
25), "Accounting for Stock Issued to Employees," intrinsic value method and, as
such, generally recognized no compensation cost for employee stock options. The
adoption of SFAS 123R under the modified prospective method allowed us to
recognize compensation cost beginning with the effective date (a) based on the
requirement of SFAS 123R for all share-based payments granted after the
effective date and (b) based on the requirements of SFAS 123 for all awards
granted to employees prior to the effective date of SFAS 123R that remain
unvested on the effective date. Under the modified prospective method, prior
periods are not restated for the effect of SFAS 123R.
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KADANT INC.
Results of Operations (continued)
As of July 1, 2006, the total compensation cost related to unvested
stock option awards not yet recognized in the condensed consolidated statement
of income was approximately $0.2 million, which will be recognized over a
weighted average period of 1.4 years.
Interest Income
Interest income decreased to $0.5 million in the first six months of 2006
from $0.9 million in the first six months of 2005 primarily due to lower average
cash balances resulting from the May 2005 acquisition of Kadant Johnson.
Interest Expense
Interest expense increased to $1.6 million in the first six months of
2006 from $0.5 million in the first six months of 2005 due primarily to interest
expense associated with the $60.0 million in borrowings entered into in May 2005
to fund the Kadant Johnson acquisition.
Provision for Income Taxes
Our effective tax rate was 32% and 23% in the first six months of 2006
and 2005, respectively. In the second quarter of 2006, we lowered our annual
effective tax rate from 34% to 32% as a result of improved tax efficiencies in
our foreign operations, which resulted in a $0.2 million, or $.02 per diluted
share, benefit in the first six months of 2006. The 23% effective tax rate in
the first six months of 2005 consisted of our 34% recurring tax rate, offset by
an 11% non-recurring tax benefit associated with a reimbursement of $0.9 million
received from our former parent company, Thermo Electron Corporation (Thermo
Electron), pursuant to our tax matters agreement for tax years in which we were
included in Thermo Electron's consolidated tax return.
Income from Continuing Operations
Income from continuing operations increased to $8.4 million in the first
six months of 2006 from $6.2 million in the first six months of 2005, an
increase of $2.1 million, or 34%, due to the reasons outlined above.
Loss from Discontinued Operation
The loss from our discontinued operation increased to $0.7 million in
the first six months of 2006 from $0.2 million in the first six months of 2005.
Subsequent to the sale of Kadant Composites LLC in October 2005, the most
significant component of the operating costs in the discontinued operation is
any change associated with the warranty obligation. The net loss in the first
six months of 2006 was primarily due to $1.0 million in pre-tax warranty
expense.
Liquidity and Capital Resources
Consolidated working capital, including the discontinued operation, was
$88.5 million at July 1, 2006, compared with $75.4 million at December 31, 2005.
Included in working capital are cash and cash equivalents of $43.4 million at
July 1, 2006, compared with $40.8 million at December 31, 2005. At July 1,
2006, $33.7 million of cash and cash equivalents were held by our foreign
subsidiaries.
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KADANT INC.
Liquidity and Capital Resources (continued)
First Six Months of 2006
Our operating activities used cash of $3.8 million in the first six
months of 2006, including $0.3 million used by continuing operations and $3.5
million used by the discontinued operation. The cash used by operating
activities in the first six months of 2006 was primarily due to an increase in
unbilled contract costs and fees of $15.7 million, an increase in accounts
receivable of $6.2 million, and an increase in inventories of $2.3 million.
These increases were primarily associated with an increase in contracts in our
stock preparation product line recognized under the percentage-of-completion
method. An additional $5.0 million of cash was used in the first six months of
2006 due to a reduction of other current liabilities. The reduction of other
current liabilities was due primarily to a decrease of $4.4 million in
billings in excess of contract costs and fees due to the timing of contracts
recognized under the percentage-of-completion method and a decrease of $4.1
million in accrued restructuring costs due to payments made in the first six
months of 2006, offset by an increase in other current liabilities of $3.5
million. Offsetting these uses of cash in the first six months of 2006 was a
$17.2 million source of cash associated with an increase in accounts payable.
In addition, cash was provided in the first six months of 2006 from $8.4
million of income from continuing operations, and a non-cash charge of $3.8
million for depreciation and amortization expense. The $3.5 million of cash
used by the discontinued operation was primarily related to the payment of
$2.7 million for warranty claims and the payment of $1.2 million in accrued
expenses to reimburse the Buyer for claims paid on our behalf.
Our investing activities used cash of $2.4 million in the first six
months of 2006, including $6.6 million used by continuing operations and $4.2
million provided by the discontinued operation. We used cash of $5.6 million
in our continuing operations to complete the purchase of certain fixed assets
of Huayi. We also used $1.1 million in our continuing operations to purchase
property, plant, and equipment. The cash provided by the discontinued
operation of $4.2 million relates to the reduction of restricted cash of $3.4
million held in escrow to satisfy warranty claims and the cash proceeds of
$0.8 million received in the first quarter of 2006 from the Buyer of the
assets of Kadant Composites LLC for post-closing adjustments.
Our financing activities provided cash of $7.2 million in the first six
months of 2006 related entirely to our continuing operations. We received $10.0
million in proceeds from a commercial real estate loan entered into in May 2006
and $5.0 million in loan proceeds in June 2006 associated with the Huayi
Acquisition. In addition, we received $4.3 million of proceeds from the issuance
of common stock in connection with the exercise of employee stock options. We
used cash of $12.3 million in the first six months of 2006 for principal
payments on our term loan. We also paid $0.6 million to the sellers of Kadant
Johnson associated with the first installment due for additional consideration
related to anticipated tax benefits.
First Six Months of 2005
Our operating activities provided cash of $4.5 million during the first
six months of 2005, including $4.9 million provided by our continuing operations
and $0.4 million used by the discontinued operation. The cash provided by our
continuing operations was primarily due to income from continuing operations of
$6.2 million, a decrease in inventories of $3.1 million, and a non-cash charge
for depreciation and amortization expense of $2.7 million. In addition, a
decrease in accounts receivable in the first six months of 2005 provided an
increase in cash of $2.4 million primarily at the Papermaking Systems segment,
due to the timing of payments. Offsetting these sources of cash was an increase
in unbilled contract costs and fees which used cash of $6.1 million in the first
six months of 2005 and a decrease in other current liabilities which used cash
of $2.9 million. The cash used in the discontinued operation related primarily
to a decrease in other current liabilities of $0.8 million due primarily to a
decrease in accrued warranty associated with $1.5 million of warranty claims
paid in the first six months of 2005 offset by a warranty provision of $0.6
million. Offsetting this use of cash was a decrease in accounts receivable which
provided cash of $0.5 million.
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KADANT INC.
Liquidity and Capital Resources (continued)
Our investing activities used cash of $100.2 million during the first six
months of 2005 primarily associated with our continuing operations. During the
first six months of 2005, we used cash of $101.4 million to acquire the stock of
The Johnson Corporation.
Our financing activities provided cash of $62.6 million in the first six
months of 2005, related entirely to our continuing operations. During the first
six months of 2005, we received proceeds of $60 million from a term loan we
entered into to fund a portion of the purchase price for Kadant Johnson. We also
increased our short- and long-term obligations by $4 million, which represents
additional consideration for Kadant Johnson to be paid over five years. In
addition, we used cash of $2.1 million to purchase our common stock on the open
market.
Additional Liquidity and Capital Resources
We completed our acquisition of Kadant Johnson on May 11, 2005 for
approximately $113.9 million, of which $101.5 million was paid in cash at
closing, $1.7 million, which we expect to pay in the third quarter of 2006 in
settlement of post-closing adjustments, $4.8 million for acquisition-related
costs the majority have been paid, and $5.9 million we expect to pay in
annual installments through 2010 related to certain tax assets acquired from
Kadant Johnson, the value of which we expect to realize. In the second quarter
of 2006, we paid $0.6 million of this additional consideration. The remaining
balance, of which $1.8 million is included in other current liabilities and
$3.5 million is included in other long-term liabilities in the accompanying
condensed consolidated balance sheet, is due over the next four years as
follows: 33% in May of 2007, 15% in both May 2008 and 2009, and 37% in May
2010. To fund $60 million of the purchase price, we entered into a term loan
and revolving credit facility (Credit Agreement) effective as of May 9, 2005,
and as subsequently amended, in the aggregate principal amount of up to $95
million, including a $35 million revolver. The Credit Agreement includes a
$60 million term loan, which is repayable in quarterly installments over a
five-year period. The current remaining aggregate principal amount to be
repaid each year is as follows: $4.5 million, $10.5 million, $13.5 million,
and $14.8 million in 2006, 2007, 2008, and 2009, respectively.
The amount we are able to borrow under the revolving line of credit is
the total borrowing capacity less any outstanding letters of credit and
multi-currency borrowings issued under the Credit Agreement. As of July 1,
2006, we had $14.4 million of borrowing capacity under the revolving line of
credit.
Our obligations under the Credit Agreement may be accelerated upon the
occurrence of an event of default under the Credit Agreement, which include
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 ERISA, uninsured judgments and
the failure to pay certain indebtedness, and a change-of-control default.
In addition, the Credit Agreement contains negative covenants applicable
to us and our subsidiaries, including financial covenants requiring us to comply
with a maximum consolidated leverage ratio of 3.0, which is lowered to 2.5 in
certain circumstances including when we make a material acquisition, and a
minimum consolidated fixed charge coverage ratio of 1.5. Pursuant to an
amendment to the Credit Agreement effective December 28, 2005, this maximum
consolidated leverage ratio is increased from 2.5 to 2.75 in the second and
third quarter of 2006 due to the Huayi Acquisition. In addition to the
financial covenants, we are also required to comply with covenants related to
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 our fiscal year, negative pledges,
arrangements affecting subsidiary distributions, and entering into new lines
of business. As of July 1, 2006, we were in compliance with these covenants.
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KADANT INC.
Liquidity and Capital Resources (continued)
The loans under the Credit Agreement are guaranteed by certain of our
domestic subsidiaries and secured by a pledge of 65% of the stock of our
first-tier foreign subsidiaries and our subsidiary guarantors pursuant to a
guarantee and pledge agreement effective May 9, 2005 in favor of JPMorgan Chase
Bank, N.A., as agent on behalf of the lenders.
On May 4, 2006, we borrowed $10 million under a promissory note (Loan)
from Citizens Bank of Massachusetts (Lender). The Loan is repayable in
quarterly installments of $125 thousand over a ten-year period with the
remaining principal balance of $5 million due upon maturity. Interest on the
Loan accrues and is payable quarterly in arrears at one of the following rates
selected by us (a) the prime rate or (b) the three-month London Inter-Bank
Offered Rate (LIBOR) plus a 1% margin. The Loan is guaranteed and secured by
real estate and related personal property of Kadant and certain of its
domestic subsidiaries, located in Theodore, Alabama; Auburn, Massachusetts;
Three Rivers, Michigan; and Queensbury, New York, pursuant to mortgage and
security agreements dated May 4, 2006 (Mortgage and Security Agreements).
Our obligations under the Loan may be accelerated upon the occurrence of
an event of default under the Loan and the Mortgage and Security Agreements,
which includes customary events of default including without limitation payment
defaults, defaults in the performance of covenants and obligations, the
inaccuracy of representations or warranties, bankruptcy and insolvency related
defaults, liens on the properties or collateral and uninsured judgments. In
addition, the occurrence of an event of default under the Credit Agreement or
any successor credit facility would be an event of default under the Loan.
On May 5, 2006, we used $7.8 million of the proceeds from the Loan to
prepay a portion of our existing variable-rate term loan under the Credit
Agreement.
To hedge the exposure to movements in the variable interest rate on the
Loan, on May 3, 2006, we entered into a swap agreement with Citizens Bank of
Massachusetts effective May 5, 2006, which converts the Loan from a floating
rate to a fixed rate of interest. The swap agreement has a ten-year term, the
same quarterly payment dates as the Loan, and reduces in line with the
amortization of the Loan. The swap agreement automatically terminates in the
event there are no outstanding borrowings under the Credit Agreement (or
successor credit facility), the Loan, or any other borrowing under which
Citizens Bank of Massachusetts is a lender. Under the swap agreement,
we will receive a three-month LIBOR rate and pay a fixed rate of interest of
5.63%. The net effect on interest expense for the Loan is that we will pay a
fixed interest rate of 6.63% (the sum of the 5.63% fixed rate under the swap
agreement and the applicable margin of 1% on the loan). The guarantee and
default provisions of the Credit Agreement (and any successor credit facility)
and the Loan, including those contained in the Mortgage and Security Agreement,
also apply to the swap agreement.
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KADANT INC.
Liquidity and Capital Resources (continued)
On January 21, 2006, on behalf of our subsidiary Kadant Jining, we
entered into an asset purchase agreement with Huayi to acquire substantially all
of the assets of Huayi, excluding accounts receivable and certain liabilities of
the business, for approximately $20 million, subject to adjustment. Huayi is a
supplier of stock-preparation equipment in China with unaudited revenues of
approximately $15 million in 2005. On June 2, 2006, Kadant Jining assumed
responsibility for the operation of the acquired business and completed the
acquisition of fixed assets consisting of machinery, equipment, and inventory,
for approximately $6.7 million, of which $5.6 million was paid in cash and
$1.1 million will be paid over the next 19 months as certain obligations are
satisfied. On June 6, 2006, Kadant Jining borrowed 40 million Chinese
Renminbi, or $5.0 million, under a 47 month interest-only loan with Bank of
China Limited. Interest on this loan accrues and is payable quarterly in
arrears based on the interest rate published by Bank of China Limited for a
loan of the same term less 10%. The acquisition of Huayi's buildings and
land-use rights, and payment of the remaining purchase price for the business
are expected to be completed in the third quarter of 2006 upon the issuance of
required governmental certificates. The remaining purchase obligation is
approximately $13.2 million, which includes $1.9 million of cash to be
acquired. We plan to finance the remaining purchase obligation, of which $10.6
million will be paid in the third quarter of 2006 and $2.6 million will be
paid over the next 19 months as certain obligations are satisfied, through a
combination of cash and borrowings in China.
On May 6, 2005, our board of directors authorized the repurchase of up
to $15.0 million of our equity securities in the open market or in negotiated
transactions for the period from May 18, 2005 through May 18, 2006. As of July
1, 2006, we had repurchased 376,700 shares of our common stock for $7.1
million under this authorization. On May 3, 2006, our board of directors
authorized the repurchase of up to $15.0 million of our equity securities in
the open market or in negotiated transactions for the period from May 18, 2006
through May 18, 2007. As of July 1, 2006, no purchases had been made under
this new authorization. From July 2, 2006 through August 9, 2006, we purchased
49,500 shares for $1.1 million under this new authorization.
It is our practice to reinvest indefinitely the earnings of our
international subsidiaries, except in instances in which we can remit such
earnings without a significant associated tax cost. Through July 1, 2006, we
have not provided for U.S. income taxes on approximately $57.7 million of
unremitted foreign earnings. We believe that any U.S. tax liability due upon
remittance of such earnings would be immaterial due to the availability of
U.S. foreign tax credits generated from such remittance. The related foreign
tax withholding, which would be required if we remitted the foreign earnings
to the U.S., would be approximately $2.4 million.
On October 21, 2005, Kadant Composites LLC sold its composites
business, presented as a discontinued operation in the accompanying condensed
consolidated financial statements. As part of the transaction, Kadant
Composites LLC retained the warranty obligation associated with products
manufactured prior to the sale date. At July 1, 2006, the warranty reserve for
the composites business was $3.6 million. Our liquidity and consolidated
results will continue to be impacted by future cash payments for warranty
claims and any adjustments to this warranty obligation. Adjustments to our
results for these items will continue to be classified within the results for
the discontinued operation in our consolidated financial statements.
Excluding the completion of the Huayi Acquisition, we currently have no
material commitments for capital expenditures. We plan to make expenditures of
approximately $3.0 million during the remainder of 2006 for property, plant, and
equipment.
In the future, our liquidity position will be primarily affected by the
level of cash flows from operations and the amount of cash expended on the Huayi
Acquisition, debt repayments, capital projects, stock repurchases, or additional
acquisitions, if any. We believe that our existing resources, together with the
cash available from our Credit Agreement, cash proceeds from additional
borrowings we anticipate entering into in China to complete the Huayi
Acquisition, and the cash we expect to generate from continuing operations, will
be sufficient to meet the capital requirements of our current operations for the
foreseeable future.
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KADANT INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------
Our exposure to market risk from interest rates and foreign currency
exchange rates has not changed materially from our exposure at year-end 2005.
Item 4 - Controls and Procedures
--------------------------------
(a) Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and with the participation of our
Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness
of our disclosure controls and procedures as of July 1, 2006. The term
"disclosure controls and procedures," as defined in Securities Exchange Act
Rules 13a-15(e) and 15d-15(e), means controls and other procedures of a
company that are designed to ensure that information required to be disclosed
by the company in the reports that it files or submits under the Securities
Exchange Act is recorded, processed, summarized, and reported, within the
time periods specified in the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by a company in the reports
that it files or submits under the Securities Exchange Act is accumulated and
communicated to the company's management, including its principal executive and
principal financial officers, as appropriate to allow timely decisions regarding
required disclosure. Management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of
achieving their objectives, and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based upon the evaluation of our disclosure controls and procedures as of
July 1, 2006, our Chief Executive Officer and Chief Financial Officer
concluded that as of July 1, 2006, our disclosure controls and procedures were
effective at the reasonable assurance level.
(b) Changes in Internal Control Over Financial Reporting
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended) occurred during the fiscal quarter ended July 1, 2006 that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
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KADANT INC.
PART II - OTHER INFORMATION
Item 1A - Risk Factors
----------------------
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, we wish to caution readers that the following
important factors, among others, in some cases have affected, and in the future
could affect, our actual results and could cause our actual results in 2006 and
beyond to differ materially from those expressed in any forward-looking
statements made by us, or on our behalf.
Our business is dependent on the condition of the pulp and paper industry.
We sell products primarily to the pulp and paper industry, which is a
cyclical industry. Generally, the financial condition of the global pulp and
paper industry corresponds to the condition of the general economy, as well as
to a number of other factors, including pulp and paper production capacity
relative to demand. In recent years, the industry in certain geographic
regions, notably North America, has been in a prolonged downcycle, resulting
in decreased spending, mill closures, consolidations, and bankruptcies, all of
which have adversely affected our business. As paper companies consolidate in
response to market weakness, they frequently reduce capacity and postpone or
even cancel capacity addition or expansion projects. These cyclical downturns
can cause our sales to decline and adversely affect our profitability.
A significant portion of our international sales has, and may in the future,
come from China.
During the first six months of 2006 approximately $33.2 million, or 20%,
of our revenues were to customers in China. Our operation of manufacturing
facilities in China, as well as an increase in revenues there, will expose us
to increased risk in the event of changes in the policies of the Chinese
government, political unrest, unstable economic conditions, or other
developments in China or in U.S.-China relations that are adverse to trade,
including enactment of protectionist legislation or trade restrictions. Orders
from customers in China, particularly for large systems that have been
tailored to a customer's specific requirements, involve increased credit risk
due to payment terms that are applicable to doing business in China. In
addition, the timing of these orders is often difficult to predict.
Our business is subject to economic, currency, political, and other risks
associated with international sales and operations.
During the first six months of 2006 approximately 59% of our sales were
to customers outside the United States, principally in Europe and Asia.
International revenues are subject to a number of risks, including the
following:
- agreements may be difficult to enforce and receivables difficult to
collect through a foreign country's legal system;
- foreign customers may have longer payment cycles;
- foreign countries may impose additional withholding taxes or
otherwise tax our foreign income, impose tariffs, or adopt other
restrictions on foreign trade; and
- the protection of intellectual property in foreign countries may be
more difficult to enforce.
Although we seek to charge our customers in the same currency in which
our operating costs are incurred, fluctuations in currency exchange rates may
affect product demand and adversely affect the profitability in U.S. dollars of
products we provide in international markets where payment for our products and
services is made in their local currencies. Any of these factors could have a
material adverse impact on our business and results of operations.
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KADANT INC.
Risk Factors (continued)
We are subject to intense competition in all our markets.
We believe that the principal competitive factors affecting the markets
for our products include quality, price, service, technical expertise, and
product innovation. Our competitors include a number of large multinational
corporations that may have substantially greater financial, marketing, and other
resources than we do. As a result, they may be able to adapt more quickly to new
or emerging technologies and changes in customer requirements, or to devote
greater resources to the promotion and sale of their services and products.
Competitors' technologies may prove to be superior to ours. Our current
products, those under development, and our ability to develop new technologies
may not be sufficient to enable us to compete effectively. Competition,
especially in China, could increase if new companies enter the market or if
existing competitors expand their product lines or intensify efforts within
existing product lines.
Our debt may adversely affect our cash flow and may restrict our investment
opportunities.
On May 9, 2005, we entered into a Credit Agreement, as subsequently
amended, consisting of a $60 million five-year term loan and a $35 million
revolver. On May 11, 2005, we borrowed $60 million to fund the acquisition of
Kadant Johnson under the term loan. On May 4, 2006, we borrowed $10 million
under a ten-year variable-rate note and on June 6, 2006, we borrowed $5
million under a 47 month variable-rate note. We may also obtain additional
long-term debt and working capital lines of credit to meet future financing
needs, which would have the effect of increasing our total leverage.
Our leverage could have negative consequences, including:
- increasing our vulnerability to adverse economic and industry
conditions,
- limiting our ability to obtain additional financing,
- limiting our ability to pay dividends on or repurchase our capital
stock,
- limiting our ability to acquire new products and technologies
through acquisitions or licensing, and
- limiting our flexibility in planning for, or reacting to, changes
in our business and the industries in which we compete.
Our indebtedness bears interest at floating rates and as a result, our
interest payment obligations on this indebtedness will increase if interest
rates increase. To reduce the exposure to floating rates, we have converted 60%
of the original term loan and the entire $10 million note to fixed rates of
interest through interest rate swap agreements.
Our ability to satisfy our obligations and to reduce our total debt
depends on our future operating performance and on economic, financial,
competitive, and other factors beyond our control. Our business may not generate
sufficient cash flows to meet these obligations or to successfully execute our
business strategy. If we are unable to service our debt and fund our business,
we may be forced to reduce or delay capital expenditures or research and
development expenditures, seek additional financing or equity capital,
restructure or refinance our debt, or sell assets. We may not be able to obtain
additional financing or refinance existing debt or sell assets on terms
acceptable to us or at all.
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KADANT INC.
Risk Factors (continued)
Restrictions in our Credit Agreement may limit our activities.
Our Credit Agreement contains, and future debt instruments to which we
may become subject may contain, restrictive covenants that limit our ability
to engage in activities that could otherwise benefit us, including
restrictions on our ability and the ability of our subsidiaries to:
- incur additional indebtedness,
- pay dividends on, redeem, or repurchase our capital stock,
- make investments,
- create liens,
- sell assets,
- enter into transactions with affiliates, and
- consolidate, merge, or transfer all or substantially all of our
assets and the assets of our subsidiaries.
We are also required to meet specified financial ratios under the terms of
our Credit Agreement. Our ability to comply with these financial restrictions
and covenants is dependent on our future performance, which is subject to
prevailing economic conditions and other factors, including factors that are
beyond our control such as foreign exchange rates, interest rates, changes in
technology, and changes in the level of competition.
Our failure to comply with any of these restrictions or covenants may
result in an event of default under our Credit Agreement and the Loan, which
could permit acceleration of the debt under those instruments and require us to
repay the debt before its scheduled due date.
If an event of default occurs, we may not have sufficient funds available
to make the required payments under our indebtedness. If we are unable to repay
amounts owed under our debt agreements, those lenders may be entitled to
foreclose on and sell the collateral that secures our borrowings under the
agreements.
Our Kadant Composites LLC subsidiary is responsible for certain continued
warranty obligations associated with its former composites business, even though
it has disposed of this business.
On October 21, 2005, Kadant Composites LLC sold its composites business.
As part of the transaction, Kadant Composites LLC retained the warranty
obligation associated with products manufactured prior to the sale date. Our
consolidated results will continue to be impacted by these warranty obligations
and we may be unable to accurately predict the potential liabilities related to
these product warranties. In 2003 and 2004, Kadant Composites LLC experienced a
significant increase in warranty claims and warranty expense related to its
composite decking products including, but not limited to, contraction of
certain deck boards and excessive oxidation that affects the integrity of the
plastic used in some of its decking products. Included in the increased
warranty expense was the cost of exchanging material held by its distributors
with new material that, we believe, is not susceptible to this oxidation issue,
and our best estimate of future potential costs related to valid claims arising
from installed products. In 2005, Kadant Composites LLC experienced a higher-
than-expected level of warranty claims associated with previously identified
product issues. Kadant Composites LLC assesses the adequacy of the warranty
reserve each quarter and increases the warranty provision as needed; however,
the reserve established may not be sufficient if Kadant Composites LLC incurs
warranty claims higher than anticipated. It is reasonably possible that the
ultimate settlement of such warranty claims may exceed the amount of the
warranty reserve. In addition, there can be no assurance that other problems
will not develop. A continued high level of warranty claims or expenses would
have an adverse impact on the warranty reserve and would adversely affect our
consolidated results.
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KADANT INC.
Risk Factors (continued)
Our inability to successfully integrate Kadant Johnson into our business could
have a material adverse effect on our business.
On May 11, 2005, we acquired Kadant Johnson. The integration of Kadant
Johnson into our business involves the merger of employees, products, and
services over multiple U.S. and international locations. We
may not be successful in integrating this business into our current structure,
or in obtaining the anticipated cost savings or synergies from the acquisition.
To meet our quarterly certification requirements and in anticipation of
incorporating Kadant Johnson into our 2006 Sarbanes-Oxley compliance process,
we will also be performing a detailed review of Kadant Johnson's internal
control structure to ensure that its controls over financial reporting are
consistent with our policies and procedures. Given the multi-location
structure of the Kadant Johnson business, this review will take significant
time and effort, similar to our Sarbanes-Oxley compliance efforts in 2004, and
will involve significant cost. During this process, we may identify control
deficiencies. Our ability to realize the value of the goodwill and other
intangibles recorded for this acquisition will depend on the future cash flows
of the Kadant Johnson business. If these future cash flows are below what we
anticipated, we may incur future impairment losses associated with goodwill and
intangibles, which could have a material adverse effect on our results of
operations.
Our inability to successfully integrate Kadant Jining or to complete the
acquisition of the remaining assets could adversely affect our business.
Our strategy includes the ability to manufacture components and equipment
in low-cost regions such as China. We recently entered into
an asset purchase agreement to acquire a Chinese supplier of stock-preparation
equipment. On June 2, 2006, our subsidiary, Kadant Light Machinery (Jining) Co.,
Ltd. (Kadant Jining) assumed responsibility for the operation of the acquired
business and completed the acquisition of fixed assets consisting of machinery,
equipment and inventory. In the third quarter of 2006, we expect to complete the
remaining portion of the acquisition which includes acquiring the land use
rights and buildings. The completion of this acquisition is subject to the
satisfaction of closing conditions, including obtaining required governmental
certificates, and we may not be able to complete this acquisition on favorable
terms or on a timely basis. Our inability to successfully acquire title to all
of the assets would delay the implementation of our strategy to manufacture
parts and components for stock-preparation equipment in a low-cost region, and
could adversely affect our ability to compete cost-effectively in Asia and
other markets.
We will be working on integrating Kadant Jining into our business, and in
anticipation of incorporating them into our 2007 Sarbanes-Oxley compliance
process, we will be reviewing their internal control structure to ensure that
their controls over financial reporting are consistent with our policies and
procedures. We may identify control deficiencies during this process and we may
not be successful in integrating Kadant Jining into our business or obtaining
the anticipated cost savings or synergies from the acquisition.
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KADANT INC.
Risk Factors (continued)
Our inability to successfully identify and complete acquisitions or successfully
integrate any new or previous acquisitions could have a material adverse effect
on our business.
Our strategy includes the acquisition of technologies and businesses that
complement or augment our existing products and services. Promising acquisitions
are difficult to identify and complete for a number of reasons, including
competition among prospective buyers and the need for regulatory, including
antitrust, approvals. We do incur costs from time to time associated with
potential acquisitions, which are deferred during the due diligence phase.
Future operating results could be negatively impacted in any quarter in which we
determine that a potential acquisition will not close and such associated costs
are expensed. Any acquisition we may complete may be made at a substantial
premium over the fair value of the net assets of the acquired company. We may
not be able to complete future acquisitions, integrate any acquired businesses
successfully into our existing businesses, make such businesses profitable, or
realize anticipated cost savings or synergies, if any, from these acquisitions.
In addition, we have previously acquired several companies and businesses and,
as a result, we have recorded significant goodwill and intangible assets on our
balance sheet. Any future impairment losses identified will be recorded as
reductions to operating income, which could have a material adverse effect on
our results of operations. Our ability to realize the value of the goodwill and
intangibles that we have recorded will depend on the future performance and cash
flows of these businesses, which will depend, in part, on how well we have
integrated these businesses.
Our inability to obtain the anticipated benefits from the restructuring of our
Kadant Lamort subsidiary would have a negative effect on our future operating
results.
In an effort to improve operating performance at our Kadant Lamort
subsidiary in France, we approved a restructuring of that subsidiary on
November 18, 2004. This restructuring was intended to strengthen Kadant
Lamort's competitive position in the European paper industry. We accrued a
restructuring charge of $9.2 million in the fourth quarter of 2004 for
severance and other termination costs in connection with the workforce
reduction. If we are unable to obtain the anticipated benefits from
this restructuring, our future operating results will be negatively impacted.
Natural gas is a significant cost in the manufacture of our fiber-based granular
products, and our results from operations will be adversely affected by
continued high natural gas costs.
We use natural gas in the production of our fiber-based granular
products, the price of which is subject to fluctuation. We seek to
manage our exposure to natural gas price fluctuations by entering into
short-term forward contracts to purchase specified quantities of natural
gas from a supplier. We may not be able to effectively manage our exposure
to natural gas price fluctuations. Continued high costs of natural gas
will adversely affect our consolidated results if we are unable to
effectively manage our exposure or pass these costs on to customers in the
form of surcharges.
We are dependent on two mills for the raw material used in our fiber-based
granules, and we may not be able to obtain raw material on commercially
reasonable terms.
We are dependent on two paper mills for the fiber used in the manufacture
of our fiber-based granular products. These mills have the exclusive right to
supply the papermaking byproducts used in the manufacturing process. Due to
manufacturing changes at the mills, we recently had some difficulty obtaining
sufficient raw material to operate at optimal production levels. We are working
with the mills to ensure a stable supply of raw material. To date, we have been
able to meet all of our customer delivery requirements, but there can be no
assurance that we will be able to meet future delivery requirements. Although we
believe our relationship with the mills is good, the mills could decide not to
renew the contract when it expires at the end of 2007, or may not agree to renew
on commercially reasonable terms. If the mills were unable or unwilling to
supply us sufficient fiber, we would be forced to find an alternative supply for
this raw material. We may be unable to find an alternative supply on
commercially reasonable terms or could incur excessive transportation costs if
an alternative supplier were found, which would increase our manufacturing costs
and might prevent prices for our products from being competitive.
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Risk Factors (continued)
Our inability to protect our intellectual property could have a material adverse
effect on our business. In addition, third parties may claim that we infringe
their intellectual property, and we could suffer significant litigation or
licensing expense as a result.
We place considerable emphasis on obtaining patent and trade secret
protection for significant new technologies, products, and processes because of
the length of time and expense associated with bringing new products through the
development process and into the marketplace. Our success depends in part on our
ability to develop patentable products and obtain and enforce patent protection
for our products both in the United States and in other countries. We own
numerous U.S. and foreign patents, and we intend to file additional
applications, as appropriate, for patents covering our products. Patents may
not be issued for any pending or future patent applications owned by or
licensed to us, and the claims allowed under any issued patents may not be
sufficiently broad to protect our technology. Any issued patents owned by or
licensed to us may be challenged, invalidated, or circumvented, and the rights
under these patents may not provide us with competitive advantages. A patent
relating to our fiber-based granular products expired in the second quarter of
2004. As a result, we could be subject to increased competition in this
market, which could have an adverse effect on this business. In addition,
competitors may design around our technology or develop competing
technologies. Intellectual property rights may also be unavailable or limited
in some foreign countries, which could make it easier for competitors to
capture increased market share. We could incur substantial costs to defend
ourselves in suits brought against us or in suits in which we may assert our
patent rights against others. An unfavorable outcome of any such litigation
could have a material adverse effect on our business and results of operations.
In addition, as our patents expire, we rely on trade secrets and proprietary
know-how to protect our products. We cannot be sure the steps we have taken or
will take in the future will be adequate to deter misappropriation of our
proprietary information and intellectual property.
We seek to protect trade secrets and proprietary know-how, in part,
through confidentiality agreements with our collaborators, employees, and
consultants. These agreements may be breached, we may not have adequate remedies
for any breach, and our trade secrets may otherwise become known or be
independently developed by our competitors.
Third parties may assert claims against us to the effect that we are
infringing on their intellectual property rights. We could incur substantial
costs and diversion of management resources in defending these claims, which
could have a material adverse effect on our business, financial condition, and
results of operations. In addition, parties making these claims could secure a
judgment awarding substantial damages, as well as injunctive or other equitable
relief, which could effectively block our ability to make, use, sell,
distribute, or market our products and services in the United
States or abroad. In the event that a claim relating to intellectual property is
asserted against us, or third parties not affiliated with us hold pending or
issued patents that relate to our products or technology, we may seek licenses
to such intellectual property or challenge those patents. However, we may be
unable to obtain these licenses on commercially reasonable terms, if at all, and
our challenge of the patents may be unsuccessful. Our failure to obtain the
necessary licenses or other rights could prohibit the sale, manufacture, or
distribution of our products and, therefore, could have a material adverse
effect on our business, financial condition, and results of operations.
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KADANT INC.
Risk Factors (continued)
Fluctuations in our quarterly operating results may cause our stock price to
decline.
Given the nature of the markets in which we participate and the
effect of Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," we
may not be able to reliably predict future revenues and profitability, and
unexpected changes may cause us to adjust our operations. A large proportion
of our costs are fixed, due in part to our significant selling, research and
development, and manufacturing costs. Thus, small declines in revenues could
disproportionately affect our operating results. Other factors that could
affect our quarterly operating results include:
- failure of our products to pass contractually agreed upon
acceptance tests, which would delay or prohibit recognition of
revenues under SAB No. 104;
- failure of a customer, particularly in China,
to comply with an order's
contractual obligations;
- adverse changes in demand for and market acceptance of our products;
- competitive pressures resulting in lower sales prices of our
products;
- adverse changes in the pulp and paper industry;
- delays or problems in our introduction of new products;
- delays or problems in the manufacture of our products;
- our competitors' announcements of new products, services, or
technological innovations;
- contractual liabilities incurred by us
related to guarantees of our product performance;
- increased costs of raw materials or supplies, including the cost of
energy;
- changes in the timing of product orders; and
- fluctuations in our effective tax rate.
Anti-takeover provisions in our charter documents, under Delaware law, and in
our shareholder rights plan could prevent or delay transactions that our
shareholders may favor.
Provisions of our charter and bylaws may discourage, delay, or prevent a
merger or acquisition that our shareholders may consider favorable, including
transactions in which shareholders might otherwise receive a premium for their
shares. For example, these provisions:
- authorize the issuance of "blank check" preferred stock without any
need for action by shareholders;
- provide for a classified board of directors with staggered three-
year terms;
- require supermajority shareholder voting to effect various
amendments to our charter and bylaws;
- eliminate the ability of our shareholders to call special meetings
of shareholders;
- prohibit shareholder action by written consent; and
- establish advance notice requirements for nominations for election
to our board of directors or for proposing matters that can be acted
on by shareholders at shareholder meetings.
In addition, our board of directors has adopted a shareholder rights plan
intended to protect shareholders in the event of an unfair or coercive offer to
acquire our company and to provide our board of directors with adequate time to
evaluate unsolicited offers. Preferred stock purchase rights have been
distributed to our common shareholders pursuant to the rights plan. This rights
plan may have anti-takeover effects. The rights plan will cause substantial
dilution to a person or group that attempts to acquire us on terms that our
board of directors does not believe are in our best interests and those of our
shareholders and may discourage, delay, or prevent a merger or acquisition that
shareholders may consider favorable, including transactions in which
shareholders might otherwise receive a premium for their shares.
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KADANT INC.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about purchases by us of our
common stock during the three months ended July 1, 2006:
Issuer Purchases of Equity Securities
-------------------------------------
Approximate Dollar Value
Total Number of Shares of Shares that
Purchased as Part of May Yet Be
Total Number of Shares Average Price Paid Publicly Announced Purchased
Period Purchased (1) per Share Plans (2) Under the Plans
---------------------------------------------------------------------------------------------- --------------------------------
4/2/06 - 4/30/06 - - - $ 7,944,105
5/1/06 - 5/31/06 - - - $ 15,000,000
6/1/06 - 7/1/06 - - - $ 15,000,000
Total: - - -
(1) During the second quarter of 2006, we did not repurchase any of our common stock.
(2) On May 3, 2006, our board of directors authorized the repurchase of up to $15 million of our equity securities in
the open market or in negotiated transactions for the period from May 18, 2006 through May 18, 2007
Item 4 - Submission of Matters to a Vote of Security Holders
On May 25, 2006, at the annual meeting of shareholders, the
shareholders re-elected two incumbent directors and approved our 2006 equity
incentive plan. Dr. John K. Allen and Mr. Francis L. McKone were elected to
the class of directors whose three-year term expires at Kadant's annual
meeting of shareholders in 2009. Dr. Allen received 12,408,200 shares voted
in favor of his election and 636,811 shares voted against. Mr. McKone received
11,046,203 shares voted in favor of his election and 1,998,808 shares voted
against.
At the annual meeting, stockholders also approved a proposal to adopt
our 2006 equity incentive plan and reserve 900,000 shares of our common stock
for distribution under the plan. The plan received 8,346,743 shares voted in
favor of adoption, 3,148,307 shares voted against, 25,286 shares abstained,
and 1,524,675 shares of broker non-votes.
Item 6 - Exhibits
See Exhibit Index on the page immediately preceding exhibits.
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KADANT INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized as of the 10th day of August, 2006.
KADANT INC.
/s/ Thomas M. O'Brien
----------------------------------
Thomas M. O'Brien
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
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KADANT INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
--------------------------------------------------------------------------------
2.1 Business Transfer Agreement dated as of May 31, 2006 between
Kadant Light Machinery (Jining) Co., Ltd. and Jining Huayi Light
Industry Machinery Company. (1).
10.1 (Middle/Long-Term) RMB Loan Agreement dated as of June 6, 2006
between Kadant Light Machinery (Jining) Co., Ltd. and Bank of
China Limited, Jining Branch.
10.2 Supplementary Agreement to (Middle/Long-Term) RMB Loan Agreement
dated as of June 6, 2006 between Kadant Light Machinery (Jining)
Co., Ltd. and Bank of China Limited, Jining Branch.
10.3 Payment Guarantee Agreement dated as of June 6, 2006 between
Kadant Light Machinery (Jining) Co., Ltd. and Bank of China
Limited, Jining Branch.
31.1 Certification of the Principal Executive Officer of the
Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.
31.2 Certification of the Principal Financial Officer of the
Registrant Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended.
32 Certification of the Chief Executive Officer and the Chief
Financial Officer of the Registrant Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(1) The schedules and annexes to the agreement have been omitted
from this filing pursuant to Item 601(b)(2) of Regulation S-K.
The Company will furnish copies of any of the schedules to the
U.S. Securities and Exchange Commission upon request.
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