UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~October~~April 1, ~~2016~~2017



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from ________ to _________

Commission file number 1-11406

KADANT INC.

(Exact name of registrant as specified in its charter)



Delaware		52-1762325
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

One Technology Park Drive
Westford, Massachusetts		01886
(Address of Principal Executive Offices)		(Zip Code)

Registrant's telephone number, including area code: (978) 776-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, ~~or a~~ smaller reporting company, or an emerging growth company. See definitions of "large accelerated filer," "accelerated ~~filer"~~filer," "smaller reporting company," and ~~"smaller reporting~~"emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer o		Accelerated filer x
Non-accelerated filer o		Smaller reporting company o
		Emerging growth company o

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.



Class		Outstanding at ~~October~~April 28, ~~2016~~2017
Common Stock, $.01 par value		~~10,914,753~~11,000,647

Table of Contents

Kadant Inc.

Quarterly Report on Form 10-Q

for the Period Ended ~~October~~April 1, ~~2016~~2017

Table of Contents



		Page
PART I: Financial Information

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheet as of ~~October~~April 1, ~~2016~~2017 and ~~January 2,~~December 31, 2016 (unaudited)	3

	Condensed Consolidated Statement of Income for the ~~three- and nine-month~~three-month periods ended ~~October~~April 1, ~~2016~~2017 and ~~October 3, 2015~~April 2, 2016 (unaudited)	5

	Condensed Consolidated Statement of Comprehensive Income for the ~~three- and nine-month~~three-month periods ended ~~October~~April 1, 2017 and April 2, 2016 (unaudited)	6

	Condensed Consolidated Statement of Cash Flows for the three-month periods ended April 1, 2017 and ~~October 3, 2015~~April 2, 2016 (unaudited)	7

	Condensed Consolidated Statement of ~~Cash Flows~~Stockholders' Equity for the ~~nine-month~~three-month periods ended ~~October~~April 1, ~~2016~~2017 and ~~October 3, 2015~~April 2, 2016 (unaudited)	8

	~~Condensed Consolidated Statement of Stockholders' Equity for the nine-month periods ended October 1, 2016 and October 3, 2015 (unaudited)~~	9

	Notes to Condensed Consolidated Financial Statements (unaudited)	109

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	2724

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	4134

Item 4.	Controls and Procedures	4135

PART II: Other Information

Item 1A.	Risk Factors	4235

Item 6.	Exhibits	4235

Table of Contents

PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.

Condensed Consolidated Balance Sheet

(Unaudited)

Assets


	October 1, 2016		January 2, 2016		April 1, 2017		December 31, 2016
(In thousands)

Current Assets:
Cash and cash equivalents	$	63,235	$	65,530	$	71,540	$	71,487
Restricted cash (Note 1)	2,240		1,406		1,543		2,082
Accounts receivable, less allowances of $2,492 and $2,163 (Note 1)	65,676		64,321
Accounts receivable, less allowances of $2,497 and $2,395 (Note 1)					71,926		65,963
Inventories (Note 1)	58,652		56,758		59,841		54,951
Unbilled contract costs and fees	4,903		6,580		4,262		3,068
Other current assets	11,161		10,525		13,037		9,799
Total Current Assets	205,867		205,120		222,149		207,350

Property, Plant, and Equipment, at Cost	126,813		118,014		127,631		124,424
Less: accumulated depreciation and amortization	77,512		75,721		79,001		76,720
	49,301		42,293		48,630		47,704

Other Assets	14,521		11,002		12,421		11,452

Intangible Assets, Net (Note 1)	56,710		38,032		51,816		52,730

Goodwill (Note 1)	157,719		119,051		153,811		151,455

Total Assets	$	484,118	$	415,498	$	488,827	$	470,691

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

Table of Contents

KADANT INC.

Condensed Consolidated Balance Sheet (continued)

(Unaudited)

Liabilities and Stockholders' Equity


	October 1, 2016			January 2, 2016			April 1, 2017			December 31, 2016
(In thousands, except share amounts)

Current Liabilities:
Short-term obligations (Note 6)	$	—		$	5,250
Current maturities of long-term obligations (Note 5)							$	655		$	643
Accounts payable	25,177			24,418			25,218			23,929
Customer deposits	22,062			20,123			25,337			21,168
Accrued payroll and employee benefits	19,627			19,583			17,231			20,508
Accrued income taxes	3,293			5,333
Other current liabilities	21,339			21,921			22,175			22,665
Total Current Liabilities	91,498			96,628			90,616			88,913

Long-Term Deferred Income Taxes	17,756			8,992			15,526			14,631

Other Long-Term Liabilities	22,114			15,933			17,500			17,100

Long-Term Obligations (Note 6)	63,517			26,000
Long-Term Obligations (Note 5)							69,895			65,768

Commitments and Contingencies (Note 13)	—			—
Commitments and Contingencies (Note 12)

Stockholders' Equity:
Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued	—			—			—			—
Common stock, $.01 par value, 150,000,000 shares authorized; 14,624,159 shares issued	146			146			146			146
Capital in excess of par value	100,193			100,536			98,974			101,405
Retained earnings	315,395			297,258			327,691			321,050
Treasury stock at cost, 3,709,406 and 3,850,779 shares	(90,895		)	(94,359		)
Accumulated other comprehensive items (Note 9)	(37,300		)	(36,972		)
Treasury stock at cost, 3,623,512 and 3,686,532 shares							(88,791		)	(90,335		)
Accumulated other comprehensive items (Note 8)							(44,542		)	(49,637		)
Total Kadant Stockholders' Equity	287,539			266,609			293,478			282,629
Noncontrolling interest	1,694			1,336			1,812			1,650
Total Stockholders' Equity	289,233			267,945			295,290			284,279

Total Liabilities and Stockholders' Equity	$	484,118		$	415,498		$	488,827		$	470,691

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

Table of Contents

KADANT INC.

Condensed Consolidated Statement of Income

(Unaudited)

Three Months Ended
October 1,
2016 October 3,
2015
(In thousands, except per share amounts)

Revenues (Note 12) $ 105,519
$ 91,929

Costs and Operating Expenses:

Cost of revenues 57,440
48,261
Selling, general, and administrative expenses 33,527
29,200
Research and development expenses 1,991
1,787
92,958
79,248

Operating Income 12,561
12,681

Interest Income 54
54
Interest Expense (305 ) (239 )

Income from Continuing Operations Before Provision for Income Taxes 12,310
12,496
Provision for Income Taxes 3,081
3,782

Income from Continuing Operations 9,229
8,714
Income (Loss) from Discontinued Operation (net of income tax provision (benefit) of $1 and $(2)) 3
(4 )

Net Income 9,232
8,710

Net Income Attributable to Noncontrolling Interest (75 ) (67 )

Net Income Attributable to Kadant $ 9,157
$ 8,643

Amounts Attributable to Kadant:

Income from Continuing Operations $ 9,154
$ 8,647
Income (Loss) from Discontinued Operation 3
(4 )
Net Income Attributable to Kadant $ 9,157
$ 8,643

Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):

Basic $ 0.84
$ 0.80
Diluted $ 0.82
$ 0.78

Earnings per Share Attributable to Kadant (Note 4):

Basic $ 0.84
$ 0.80
Diluted $ 0.82
$ 0.78

Weighted Average Shares (Note 4):

Basic 10,901
10,861
Diluted 11,189
11,096

Cash Dividend Declared per Common Share $ 0.19
$ 0.17

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

~~Table of Contents~~

~~KADANT INC.~~

~~Condensed Consolidated Statement of Income~~

~~(Unaudited)~~



	Nine Months Ended						Three Months Ended
	October 1, 2016			October 3, 2015			April 1, 2017			April 2, 2016
(In thousands, except per share amounts)

Revenues (Note 12)	$	313,885		$	282,507
Revenues (Note 11)							$	102,857		$	96,538

Costs and Operating Expenses:
Cost of revenues	171,569			148,775			53,865			52,562
Selling, general, and administrative expenses	102,095			92,490			34,799			32,496
Research and development expenses	5,640			5,247			2,147			1,704
Restructuring costs and other income (Note 3)	(317		)	300
Other income							—			(317		)
	278,987			246,812			90,811			86,445

Operating Income	34,898			35,695			12,046			10,093

Interest Income	175			150			104			55
Interest Expense	(914		)	(701		)	(348		)	(269		)

Income from Continuing Operations Before Provision for Income Taxes	34,159			35,144
Provision for Income Taxes (Note 5)	9,500			10,964

Income from Continuing Operations	24,659			24,180
Income from Discontinued Operation (net of income tax provision of $1 and $36)	3			56
Income Before Provision for Income Taxes							11,802			9,879
Provision for Income Taxes (Note 4)							2,735			2,888

Net Income	24,662			24,236			9,067			6,991

Net Income Attributable to Noncontrolling Interest	(318		)	(232		)	(116		)	(115		)

Net Income Attributable to Kadant	$	24,344		$	24,004		$	8,951		$	6,876

Amounts Attributable to Kadant:
Income from Continuing Operations	$	24,341		$	23,948
Income from Discontinued Operation	3			56
Net Income Attributable to Kadant	$	24,344		$	24,004

Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
Earnings per Share Attributable to Kadant (Note 3):
Basic	$	2.24		$	2.20		$	0.82		$	0.64
Diluted	$	2.19		$	2.15		$	0.80		$	0.62

Earnings per Share Attributable to Kadant (Note 4):
Weighted Average Shares (Note 3):
Basic	$	2.24		$	2.20		10,952			10,793
Diluted	$	2.19		$	2.16		11,205			11,018

Weighted Average Shares (Note 4):
Basic	10,854			10,900
Diluted	11,120			11,119

Cash Dividends Declared per Common Share	$	0.57		$	0.51
Cash Dividend Declared per Common Share							$	0.21		$	0.19

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

Table of Contents

KADANT INC.

Condensed Consolidated Statement of Comprehensive Income

(Unaudited)


	Three Months Ended						Nine Months Ended						Three Months Ended
	October 1, 2016			October 3, 2015			October 1, 2016			October 3, 2015			April 1, 2017			April 2, 2016
(In thousands)							October 1, 2016			October 3, 2015			April 1, 2017			April 2, 2016
	October 1, 2016
Net Income	$	9,232		October 3, 2015	$	8,710		$	24,662		$	24,236		$	9,067		$	6,991

Other Comprehensive Items:
Foreign currency translation adjustment	(979		)	(6,263		)	(243		)	(16,101		)	5,032			5,930
Pension and other post-retirement liability adjustments (net of tax provision (benefit) of $68 and $(91) in the three and nine months ended October 1, 2016, respectively, and $66 and $221 in the three and nine months ended October 3, 2015, respectively)	127			124			(144		)	412
Deferred gain on hedging instruments (net of tax provision (benefit) of $75 and $(148) in the three and nine months ended October 1, 2016, respectively, and ($43) and $35 in the three and nine months ended October 3, 2015, respectively)	139			97			99			17
Pension and other post-retirement liability adjustments (net of tax provision of $49 in 2017 and tax benefit of $236 in 2016)													82			(418		)
Deferred gain (loss) on hedging instruments (net of tax provision of $15 in 2017 and tax benefit of $72 in 2016)													27			(126		)
Other Comprehensive Items	(713		)	(6,042		)	(288		)	(15,672		)	5,141			5,386
Comprehensive Income	8,519			2,668			24,374			8,564			14,208			12,377
Comprehensive Income Attributable to Noncontrolling Interest	(92		)	(78		)	(358		)	(137		)	(162		)	(174		)
Comprehensive Income Attributable to Kadant	$	8,427		$	2,590		$	24,016		$	8,427		$	14,046		$	12,203

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

Table of Contents

KADANT INC.

Condensed Consolidated Statement of Cash Flows

(Unaudited)



	Three Months Ended
	April 1, 2017			April 2, 2016
(In thousands)	April 1, 2017			April 2, 2016

Operating Activities:
Net income attributable to Kadant	$	8,951		$	6,876
Net income attributable to noncontrolling interest	116			115
Net income	9,067			6,991
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	3,256			2,564
Stock-based compensation expense	1,295			1,323
Provision for losses on accounts receivable	129			76
Loss (gain) on the sale of property, plant, and equipment	41			(346		)
Other items, net	180			781
Contributions to U.S. pension plan	(90		)	(270		)
Changes in current assets and liabilities, net of effects of acquisition:
Accounts receivable	(5,043		)	3,259
Unbilled contract costs and fees	(1,134		)	4,313
Inventories	(3,964		)	(604		)
Other current assets	(1,886		)	(1,808		)
Accounts payable	805			(1,234		)
Other current liabilities	(973		)	(9,527		)
Net cash provided by operating activities	1,683			5,518

Investing Activities:
Purchases of property, plant, and equipment	(1,722		)	(524		)
Issuance of note receivable	—			(2,813		)
Proceeds from sale of property, plant, and equipment	—			385
Acquisition (Note 1)	(165		)	—
Other investing activities	(2		)	—
Net cash used in investing activities	(1,889		)	(2,952		)

Financing Activities:
Proceeds from issuance of debt	8,000			41,046
Repayment of debt	(4,610		)	(125		)
Tax withholding payments related to stock-based compensation	(2,182		)	(1,980		)
Dividends paid	(2,078		)	(1,831		)
Payment of debt issuance costs	(654		)	—
Payment of contingent consideration	—			(1,091		)
Change in restricted cash	590			(58		)
Other financing activities	(118		)	—
Net cash (used in) provided by financing activities	(1,052		)	35,961

Exchange Rate Effect on Cash and Cash Equivalents	1,311			460

Increase in Cash and Cash Equivalents	53			38,987
Cash and Cash Equivalents at Beginning of Period	71,487			65,530
Cash and Cash Equivalents at End of Period	$	71,540		$	104,517

See Note 1 for supplemental cash flow information.

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

Table of Contents

KADANT INC.

Condensed Consolidated Statement of ~~Cash Flows~~

~~(Unaudited)~~

Nine Months Ended
October 1,
2016 October 3,
2015
(In thousands)

Operating Activities:
Net income attributable to Kadant $ 24,344
$ 24,004
Net income attributable to noncontrolling interest 318
232
Income from discontinued operation (3 ) (56 )
Income from continuing operations 24,659
24,180
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:

Depreciation and amortization 10,934
8,247
Stock-based compensation expense 3,865
4,495
Tax benefits from stock-based compensation awards —
(875 )
Provision for losses on accounts receivable 420
205
(Gain) loss on the sale of property, plant, and equipment (384 ) 3
Other items, net 256
(91 )
Contributions to pension plan (810 ) (810 )
Changes in current assets and liabilities, net of effects of acquisition:

Accounts receivable 3,731
(2,052 )
Unbilled contract costs and fees 1,713
(2,601 )
Inventories 2,051
(16,045 )
Other current assets 620
(1,529 )
Accounts payable (5,599 ) 813
Other current liabilities (6,717 ) 14,140
Net cash provided by continuing operations 34,739
28,080
Net cash used in discontinued operation (2 ) (36 )
Net cash provided by operating activities 34,737
28,044

Investing Activities:

Acquisition, net of cash acquired (Note 2) (56,617 ) —
Purchases of property, plant, and equipment (3,579 ) (4,068 )
Proceeds from sale of property, plant, and equipment 409
33
Net cash used in investing activities (59,787 ) (4,035 )

Financing Activities:

Proceeds from issuance of long-term obligations 48,046
20,000
Repayments of short- and long-term obligations (15,429 ) (16,486 )
Purchases of Company common stock —
(8,920 )
Dividends paid (5,964 ) (5,346 )
Tax withholding payments related to stock-based compensation (2,572 ) (2,499 )
Payment of contingent consideration (1,091 ) —
Proceeds from issuance of Company common stock 1,780
285
Tax benefits from stock-based compensation awards —
875
Change in restricted cash (793 ) (368 )
Other items (27 ) —
Net cash provided by (used in) financing activities 23,950
(12,459 )

Exchange Rate Effect on Cash and Cash Equivalents (1,195 ) (786 )

(Decrease) Increase in Cash and Cash Equivalents (2,295 ) 10,764
Cash and Cash Equivalents at Beginning of Period 65,530
45,378
Cash and Cash Equivalents at End of Period $ 63,235
$ 56,142

~~See Note 1 for supplemental cash flow information.~~

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

~~Table of Contents~~

~~KADANT INC.~~

~~Condensed Consolidated Statement of~~ Stockholders' Equity

(Unaudited)


(In thousands, except share amounts)	Common Stock			Capital in Excess of Par Value				Retained Earnings			Treasury Stock						Accumulated Other Comprehensive Items				Noncontrolling Interest				Total Stockholders' Equity				Common Stock				Capital in Excess of Par Value			Retained Earnings				Treasury Stock					Accumulated Other Comprehensive Items			Noncontrolling Interest		Total Stockholders' Equity
	Shares	Amount					Shares				Amount									Shares								Amount				Shares							Amount

Balance at January 3, 2015	14,624,159	$	146	$	98,769				$	270,249		3,760,019		$	(87,727	)		$	(17,146	)			$	1,168			$	265,459

Net income	—	—		—				24,004			—		—				—				232				24,236

Dividends declared	—	—		—				(5,549		)	—		—				—				—				(5,549		)

Activity under stock plans	—	—		(373		)		—			(120,427	)	2,818				—				—				2,445

Tax benefits related to employees' and directors' stock plans	—	—		875				—			—		—				—				—				875

Purchases of Company common stock	—	—		—				—			204,760		(8,920		)		—				—				(8,920		)

Other comprehensive items	—	—		—				—			—		—				(15,577		)		(95		)		(15,672		)

Balance at October 3, 2015	14,624,159	$	146	$	99,271			$	288,704		3,844,352		$	(93,829	)		$	(32,723	)		$	1,305			$	262,874

Balance at January 2, 2016	14,624,159	$	146	$	100,536			$	297,258		3,850,779		$	(94,359	)		$	(36,972	)		$	1,336			$	267,945			14,624,159	$	146		$	100,536		$	297,258			3,850,779		$	(94,359	)	$	(36,972	)	$	1,336	$	267,945

Net income	—	—		—				24,344			—		—				—				318				24,662				—	—			—			6,876				—		—			—			115		6,991

Dividends declared	—	—		—				(6,207		)	—		—				—				—				(6,207		)
Dividend declared																													—	—			—			(2,063		)		—		—			—			—		(2,063		)

Activity under stock plans	—	—		(343		)		—			(141,373	)	3,464				—				—				3,121				—	—			(2,639		)	—				(80,942	)	1,983			—			—		(656		)

Other comprehensive items	—	—		—				—			—		—				(328		)		40				(288		)		—	—			—			—				—		—			5,327			59		5,386

Balance at October 1, 2016	14,624,159	$	146	$	100,193			$	315,395		3,709,406		$	(90,895	)		$	(37,300	)		$	1,694			$	289,233
Balance at April 2, 2016																													14,624,159	$	146		$	97,897		$	302,071			3,769,837		$	(92,376	)	$	(31,645	)	$	1,510	$	277,603

Balance at December 31, 2016																													14,624,159	$	146		$	101,405		$	321,050			3,686,532		$	(90,335	)	$	(49,637	)	$	1,650	$	284,279

Net income																													—	—			—			8,951				—		—			—			116		9,067

Dividend declared																													—	—			—			(2,310		)		—		—			—			—		(2,310		)

Activity under stock plans																													—	—			(2,431		)	—				(63,020	)	1,544			—			—		(887		)

Other comprehensive items																													—	—			—			—				—		—			5,095			46		5,141

Balance at April 1, 2017																													14,624,159	$	146		$	98,974		$	327,691			3,623,512		$	(88,791	)	$	(44,542	)	$	1,812	$	295,290

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

Table of Contents

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations

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

The Company and its subsidiaries' continuing operations include two reportable operating segments, Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products.

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

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

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

Interim Financial Statements

The interim condensed consolidated financial statements and related notes presented have been prepared by the Company, are unaudited, and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of the Company's financial position at ~~October~~April 1, ~~2016~~2017 and its results of operations, comprehensive income, cash flows, and stockholders' equity for the ~~three- and nine-month~~three-month periods ended ~~October~~April 1, ~~2016~~2017 and ~~October 3, 2015.~~April 2, 2016. Interim results are not necessarily indicative of results for a full year or for any other interim period.

The condensed consolidated balance sheet presented as of ~~January 2,~~December 31, 2016 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended ~~January 2,~~December 31, 2016. The condensed consolidated financial statements and related notes are presented as permitted by the Securities and Exchange Commission (SEC) rules and regulations for Form 10-Q and do not contain certain information included in the annual consolidated financial statements and related notes of the Company. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended ~~January 2,~~December 31, 2016, filed with the SEC.

~~Financial Statement Presentation~~

Certain reclassifications have been made to prior periods to conform with current reporting. As a result of the adoption of the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2016-09, "Improvements to Employee Share-Based Payment Arrangements," tax withholding payments made related to stock-based compensation awards have been reclassified from other current liabilities within operating activities and presented separately within financing activities in the condensed consolidated statement of cash flows for the 2015 period.

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~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

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

Critical Accounting Policies

Critical accounting policies are defined as those that entail significant judgments and estimates, and could potentially result in materially different results under different assumptions and conditions. The Company believes that the most critical accounting policies upon which its financial position depends, and which involve the most complex or subjective decisions or assessments, concern revenue recognition and accounts receivable, warranty obligations, income taxes, the valuation of goodwill and intangible assets, inventories and pension obligations. ~~Discussions~~A discussion of the application of these and other accounting policies ~~are~~is included in Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended ~~January 2,~~December 31, 2016.

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

Use of Estimates

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

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

Supplemental Cash Flow Information

The Company paid additional post-closing consideration of $165,000 in the first quarter of 2017 associated with the April 2016 acquisition of RT Holding GmbH, the parent corporation of a group of companies known as the PAALGROUP (PAAL).


	Nine Months Ended					Three Months Ended
(In thousands)	October 1, 2016			October 3, 2015		April 1, 2017		April 2, 2016
Non-Cash Investing Activities:
Fair value of assets of acquired business	$	87,060		$	—
Cash paid for acquired business	(58,894		)	—
Liabilities assumed of acquired business	$	28,166		$	—
Non-Cash Financing Activities:
Issuance of Company common stock	$	3,260		$	3,195	$	2,640	$	2,854
Dividends declared but unpaid	$	2,074		$	1,833	$	2,310	$	2,063

Restricted Cash

As of ~~October~~April 1, ~~2016~~2017 and ~~January 2,~~December 31, 2016, the Company had restricted cash of ~~$2,240,000~~$1,543,000 and ~~$1,406,000,~~$2,082,000, respectively. This cash serves as collateral for bank guarantees primarily associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into ~~during~~in the normal course of business. ~~All~~The majority of the bank guarantees will expire by the end of ~~2019.~~2018.

Banker's Acceptance Drafts

The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for ~~outstanding~~their trade accounts receivable. The banker's acceptance drafts are non-interest bearing obligations of the issuing bank and mature within six months of the origination date. The Company ~~has the ability to~~can sell the drafts at a discount to a third-party financial institution or transfer the drafts to vendors in settlement of current accounts payable prior to the scheduled maturity date. These drafts, which totaled ~~$6,181,000~~$9,229,000 and ~~$8,314,000~~$7,852,000 at ~~October~~April 1, ~~2016~~2017 and ~~January 2,~~December 31, 2016, respectively, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary sells orthe drafts to a bank and receives a discounted amount, transfers the banker's acceptance drafts in settlement of current accounts payable prior to maturity, or obtains cash payment on the scheduled maturity date.

Inventories

The components of inventories are as follows:



	April 1, 2017		December 31, 2016
(In thousands)	April 1, 2017		December 31, 2016
Raw Materials and Supplies	$	24,670	$	21,086
Work in Process	13,104		12,293
Finished Goods	22,067		21,572
Total Inventories	$	59,841	$	54,951

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

~~Inventories~~

~~The components of inventories are as follows:~~

October 1,
2016 January 2,
2016
(In thousands)
Raw Materials and Supplies $ 22,292
$ 22,324
Work in Process 14,467
13,819
Finished Goods 21,893
20,615
Total Inventories $ 58,652
$ 56,758

Intangible Assets, Net

~~Acquired intangible~~Intangible assets are as follows:


	October 1, 2016			January 2, 2016				April 1, 2017				December 31, 2016
(In thousands)								April 1, 2017				December 31, 2016
Indefinite-Lived	October 1, 2016	$	8,100	January 2, 2016		$	8,100			$	8,100			$	8,100

Definite-Lived, Gross	$	77,052		$	77,052			$	101,743			$	77,052
Acquisition (Note 2)	24,691			—
Acquisition								—				24,691
Accumulated amortization	(47,235		)	(40,908		)		(50,759		)		(49,040		)
Currency translation	(5,898		)	(6,212		)		(7,268		)		(8,073		)
Definite-Lived, Net	$	48,610		$	29,932			$	43,716			$	44,630

Total Intangible Assets, Net	$	56,710		$	38,032			$	51,816			$	52,730

Goodwill

The changes in the carrying amount of goodwill by segment are as follows:


(In thousands)	Papermaking Systems Segment			Wood Processing Systems Segment		Total			Papermaking Systems Segment			Wood Processing Systems Segment		Total
Balance at January 2, 2016
Balance at December 31, 2016
Gross balance	$	187,720		$	16,840	$	204,560		$	219,699		$	17,265	$	236,964
Accumulated impairment losses	(85,509		)	—		(85,509		)	(85,509		)	—		(85,509		)
Net balance	102,211			16,840		119,051			134,190			17,265		151,455
Acquisition (Note 2)	38,561			—		38,561
Currency Translation	(893		)	1,000		107			2,092			264		2,356
Total 2016 Adjustments	37,668			1,000		38,668
Balance at October 1, 2016
Total 2017 Adjustments									2,092			264		2,356
Balance at April 1, 2017
Gross balance	225,388			17,840		243,228			221,791			17,529		239,320
Accumulated impairment losses	(85,509		)	—		(85,509		)	(85,509		)	—		(85,509		)
Net balance	$	139,879		$	17,840	$	157,719		$	136,282		$	17,529	$	153,811

Warranty Obligations

The Company provides for the estimated cost of product warranties at the time of sale based on the actual historical occurrence rates and repair costs, as well as knowledge of any specific warranty problems that indicate that projected warranty costs may vary from historical patterns. The Company typically negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications. While the Company engages in extensive product quality programs and processes, the Company's warranty obligation is affected by product failure rates, repair costs, service delivery costs incurred in correcting a product failure, and supplier warranties on parts delivered to the Company. Should actual product failure rates,

~~Table of Contents~~

~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

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

repair costs, service delivery costs, or supplier warranties on parts differ from the Company's estimates, revisions to the estimated warranty liability would be required.

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

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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


	Nine Months Ended						Three Months Ended
(In thousands)	October 1, 2016			October 3, 2015			April 1, 2017			April 2, 2016
Balance at Beginning of Period	$	3,670		$	3,875
Balance at Beginning of Year							$	3,843		$	3,670
Provision charged to income	2,454			1,625			804			560
Usage	(2,574		)	(1,813		)	(570		)	(526		)
Acquisition	991			—
Currency translation	(19		)	(226		)	62			81
Balance at End of Period	$	4,522		$	3,461		$	4,139		$	3,785

Recent Accounting Pronouncements

Revenue from Contracts with Customers (Topic 606), Section A-Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40).In May 2014, the ~~FASB~~Financial Accounting Standards Board (FASB) issued ~~ASU~~Accounting Standards Update (ASU) No. 2014-09, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. In March 2016, the FASB issued ASU No. 2016-08, which further clarifies the guidance on the principal versus agent considerations within ASU No. 2014-09. In April 2016, the FASB issued ASU No. 2016-10 to expand the guidance on identifying performance obligations and licensing within ASU 2014-09. In May 2016, the FASB issued ASU No. 2016-11, which rescinds certain ~~previously issued~~previously-issued guidance, including, among other items, guidance relating to accounting for shipping and handling fees and freight services effective upon adoption of ASU No. 2014-09. Also in May 2016, the FASB issued ASU No. 2016-12, which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. In December 2016, the FASB issued ASU No. 2016-20, which clarifies narrow aspects of Topic 606 and corrects unintended application of the guidance. These new ASUs are effective for the Company beginning in fiscal 2018. Early adoption is permitted in fiscal 2017. The ~~guidance permits the use of either the retrospective or cumulative effect transition method. The~~ Company is ~~currently evaluating~~continuing to assess the ~~effect that~~potential effects of these ASUs ~~will have~~ on its condensed consolidated financial statements, business processes, systems and ~~related disclosures. The~~controls. While the assessment process is ongoing, the Company ~~has not yet selected a~~currently anticipates adopting these ASUs using the modified retrospective transition ~~method nor has it determined the effect of these standards on its ongoing financial reporting.~~

~~Compensation-Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.~~ ~~In June 2014, the FASB issued ASUNo. 2014-12, which clarifies the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period.~~approach. Under the new guidance, a performance target that affects vesting and could be achieved after completion of the service period should be treated as a performance condition under FASB Accounting Standards Codification (ASC) 718 and, as a result, should not be included in the estimation of the grant-date fair value of the award. An entity should recognize compensation cost for the award when it becomes probable that the performance target will be achieved. In the event an entity determines that it is probable that a performance target will be achieved before the end of the service period, the compensation cost of the award should be recognized prospectively over the remaining service period. The Company adoptedthis approach, this guidance atwould apply to all new contracts initiated in fiscal 2018. For existing contracts that have remaining obligations as of the beginning of fiscal ~~2016. The adoption of this ASU did not have an impact on~~2018, any difference between the recognition criteria in these ASUs and the Company’s ~~condensed consolidated financial statements.~~

~~Interest-Imputation~~current revenue recognition practices would be recognized using a cumulative effect adjustment to the opening balance of ~~Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.~~ ~~In April 2015, the FASB issued ASU No. 2015-03, which requires that debt issuance costs related to a recognized debt liability be presented~~retained earnings. The Company is also in the ~~balance sheet as a direct deduction from~~process of developing and implementing appropriate changes to its business processes, systems and controls to support the ~~carrying amount of that debt liability, consistent with debt discounts. In addition, in June 2015, the FASB issued ASU No. 2015-15, which allows an entity to defer the~~recognition criteria and disclosure requirements of ~~ASU No. 2015-03 on deferred issuance costs related to line-of-credit arrangements. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in~~ these ASUs. These new disclosure items are effective for the Company beginning in fiscal 2016. The Company adopted these ASUs at the beginning of fiscal 2016. Adoption of these ASUs did not have an impact on the Company’s condensed consolidated financial statements.

~~Table of Contents~~

~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

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

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

Inventory (Topic 330), Simplifying the Measurement of Inventory. In July 2015, the FASB issued ASU No. 2015-11, which requires that an entity measure inventory within the scope of this ASU at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Substantial and unusual losses that result from subsequent measurement of inventory should be disclosed in the financial statements. ~~This new guidance is effective for~~The Company adopted this ASU at the ~~Company~~ beginning inof fiscal 2017. ~~Early adoption is permitted. The Company is currently evaluating the effect that~~Adoption of this ASU ~~will~~did not have a material effect on ~~its~~the Company's condensed consolidated financial statements.

~~Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments~~. In September 2015, the FASB issued ASU No. 2015-16, which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer is required to record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In addition, an entity is required to present, separately on the face of the statement of income or through disclosure in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Company adopted this guidance at the beginning of fiscal 2016. Adoption of this ASU did not have an impact on the Company’s condensed consolidated financial statements.

Leases (Topic 842). . In February 2016, the FASB issued ASU No. 2016-02, which requires a lessee to recognize a right-of-use asset and a lease liability for operating leases, initially measured at the present value of the future lease payments, in its balance sheet. This ASU also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. This new guidance is effective for the Company in fiscal 2019. Early adoption is permitted. As part of the implementation of this new standard, the Company is in the process of reviewing current accounting policies and assessing the practical expedients allowed under this new guidance. The Company expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon adoption, which is required using the modified retrospective transition method. The Company is currently evaluating the other effects that the adoption of this ASU will have on its condensed consolidated financial statements.

~~Compensation -Stock Compensation (Topic 718):Improvements to Employee Share-Based Payment Accounting.~~ In March 2016, the FASB issued ASU No. 2016-09, which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the statement of cash flows. The Company early adopted this ASU at the beginning of fiscal 2016. This ASU requires that excess income tax benefits and tax deficiencies related to stock-based compensation arrangements be recognized as discrete items within the provision for income taxes instead of capital in excess of par value in the reporting period in which they occur. As a result of the adoption of this ASU, the Company recognized an income tax benefit of $106,000, or $0.01 per diluted share, and $502,000, or $0.05 per diluted share, in the Company’s condensed consolidated statement of income in the third quarter and first nine months of 2016, respectively. The Company prospectively adopted the requirement to classify the excess tax benefits from stock-compensation awards within operating activities in the condensed consolidated statement of cash flows in the first quarter of 2016. Prior period amounts were not restated. The Company also adopted the guidance in this ASU that requires that taxes paid related to the withholding of common stock upon the vesting of employee stock awards be presented separately within financing activities in the condensed consolidated statement of cash flows. The Company has retrospectively restated the 2015 period to reclassify the comparable amount, which was previously presented in other current liabilities within operating activities. There were no other material effects from adoption of this ASU on the Company’s condensed consolidated financial statements.

~~Table of Contents~~

~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

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

Table of Contents

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

guidance is effective for the Company in fiscal 2020. Early adoption is permitted beginning in fiscal 2019. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.

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

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

~~2. Acquisition~~

~~On April 4,~~Statement of Cash Flows (Topic 230), Restricted Cash. In November 2016, the ~~Company acquired all~~FASB issued ASU No. 2016-18, which requires inclusion of restricted cash and restricted cash equivalents within cash and cash equivalents when reconciling the ~~outstanding shares of RT Holding GmbH,~~beginning-of-period and end-of-period total amounts shown on the ~~parent corporation of a group of companies known as the PAALGROUP (PAAL) for approximately 49,713,000 euros, net~~statement of cash ~~acquired, or approximately $56,617,000. The~~flows. This new guidance is effective for the Company ~~entered into~~in fiscal 2018. Early adoption is permitted. As this ASU is presentation-related only, adoption of this ASU will not have a ~~$29,866,000 euro-denominated borrowing under its unsecured revolving credit facility in~~material impact on the ~~first quarter of 2016 to partially fund the acquisition. The remainder of the purchase price was funded from the~~ Company's internal overseas cash. The Company incurred acquisition transaction costs of approximately $1,832,000 in the first nine months of 2016, which were recorded in selling, general, and administrative expenses (SG&A) in the accompanying condensed consolidated statement of income.

PAAL, which is part of the Company's Papermaking Systems segment's Stock-Preparation product line, manufactures balers and related equipment used in the processing of recyclable and waste materials. This acquisition broadened the Company's product portfolio and extended its presence deeper into recycling and waste management. PAAL, headquartered in Germany, also has operations in the United Kingdom, France, and Spain. The Company anticipates several synergies in connection with this acquisition, including expanding sales of the products of the acquired business by leveraging Kadant's geographic presence to enter or further penetrate existing markets, as well as sourcing and manufacturing efficiencies.

~~This acquisition has been accounted for by using the purchase method of accounting and PAAL’s results have been included in the accompanying~~ condensed consolidated financial ~~statements from~~statements.

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

Intangibles - Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment.In January 2017, the FASB issued ASU No. 2017-04, which eliminates Step 2 in goodwill impairment testing, which requires that goodwill impairment losses be measured as the difference between the implied value of ~~acquisition. PAAL had revenue~~a reporting unit’s goodwill and its carrying amount. This ASU will reduce the cost and complexity of ~~$13,607,000 and earnings of $0.10 per diluted share, including acquisition costs of $0.01, in~~impairment testing by requiring goodwill impairment losses to be measured as the ~~third quarter of 2016.~~

For the first nine months of 2016, PAAL had revenue of $28,760,000 and a loss of $0.05 per diluted share, which included acquisition costs of $0.15 and one-time charges associated with acquired inventory and backlog of $0.12. The excess of the ~~purchase price~~reporting unit’s carrying amount, including goodwill and related goodwill tax effects, over its fair value. This new guidance is effective on a prospective basis for the ~~acquisition~~Company in fiscal 2020. Early adoption is permitted. The Company does not believe that adoption of PAAL over the tangible and identifiable intangible assets was recorded as goodwill and amounted to approximately $38,561,000, which is not deductible for tax purposes. The fair values are subject to adjustment upon finalization of the valuation, and therefore the current measurements of intangible assets, acquired goodwill, and assumed assets and liabilities are subject to change.this ASU will have a material effect on its condensed consolidated financial statements.

Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost. In March 2017, the FASB issued ASU No. 2017-07, which requires employers to include only the service cost component of net periodic pension cost and net periodic post-retirement benefit cost in operating expenses in the same income statement line item as the related employees' compensation costs. The other components of net benefit cost, including interest costs, amortization of prior service costs and settlement and curtailment effects, are to be included in non-operating expenses. The ASU also stipulates that only the service cost component of net benefit cost is eligible for capitalization. This new guidance is effective on a retrospective basis for the Company in fiscal 2018. Early adoption is permitted. The Company is currently evaluating the effects that adoption of this ASU will have on its condensed consolidated financial statements.

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

2. ~~Acquisition (continued)~~

~~The following table summarizes the purchase method of accounting for the acquisition of PAAL and the estimated fair values of assets acquired and liabilities assumed:~~

2016 Acquisition (In thousands) Total

Net Assets Acquired:
Cash and Cash Equivalents $ 2,277
Accounts Receivable 5,441
Inventories 3,947
Property, Plant, and Equipment 7,179
Other Assets 4,964
Intangible Assets 24,691
Goodwill 38,561
Total assets acquired 87,060

Accounts Payable 5,536
Customer Deposits 2,471
Capital Lease Obligations 4,360
Long-Term Deferred Tax Liability 8,485
Other Liabilities 7,314
Total liabilities assumed 28,166
Net assets acquired $ 58,894

Purchase Price:
Cash $ 29,028
Cash Paid to Seller Borrowed Under the Revolving Credit Facility 29,866
Total purchase price $ 58,894

Definite-lived intangible assets acquired related to the PAAL acquisition included $15,831,000 for customer relationships, $4,203,000 for product technology, $2,278,000 for tradenames, and $2,379,000 for other intangibles. The weighted-average amortization period for definite-lived intangible assets acquired is 12 years, which includes weighted-average amortization periods of 13 years for customer relationships, 9 years for product technology, and 14 years for tradenames.

~~3. Restructuring Costs and~~ Other Income

~~Other Income~~

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

~~Restructuring Costs~~

In the first nine months of 2015, the Company's Papermaking Systems segment recorded restructuring costs of $300,000 for severance costs associated with the reduction of nine employees in Canada and Sweden. These actions were taken to streamline the Company's operations in those locations.

~~Table of Contents~~

~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

4.3. Earnings per Share

Basic and diluted earnings per share (EPS) ~~were~~are calculated as follows:

Three Months Ended Nine Months Ended
October 1,
2016 October 3,
2015 October 1,
2016 October 3,
2015
(In thousands, except per share amounts)
Amounts Attributable to Kadant:
Income from Continuing Operations $ 9,154
$ 8,647
$ 24,341
$ 23,948
Income (Loss) from Discontinued Operation 3
(4 ) 3
56
Net Income $ 9,157
$ 8,643
$ 24,344
$ 24,004

Basic Weighted Average Shares 10,901
10,861
10,854
10,900
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan 288
235
266
219
Diluted Weighted Average Shares 11,189
11,096
11,120
11,119

Basic Earnings per Share:

Continuing operations $ 0.84
$ 0.80
$ 2.24
$ 2.20
Discontinued operation $ —
$ —
$ —
$ 0.01
Net income per basic share $ 0.84
$ 0.80
$ 2.24
$ 2.20

Diluted Earnings per Share:

Continuing operations $ 0.82
$ 0.78
$ 2.19
$ 2.15
Discontinued operation $ —
$ —
$ —
$ 0.01
Net income per diluted share $ 0.82
$ 0.78
$ 2.19
$ 2.16



	Three Months Ended
	April 1, 2017		April 2, 2016
(In thousands, except per share amounts)	April 1, 2017		April 2, 2016
Amounts Attributable to Kadant:
Net Income	$	8,951	$	6,876

Basic Weighted Average Shares	10,952		10,793
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan Shares	253		225
Diluted Weighted Average Shares	11,205		11,018

Basic Earnings per Share	$	0.82	$	0.64

Diluted Earnings per Share	$	0.80	$	0.62

~~Unvested restricted~~Restricted stock units (RSUs) ~~equivalent to approximately 5,000~~totaling 39,000 and 147,000 shares of common stock ~~for the third quarter of 2015, and approximately 49,000 and 31,000 shares of common stock for the first nine months of 2016 and 2015, respectively,~~ were not included in the computation of diluted EPS ~~because either~~in the ~~effect~~first quarters of ~~their inclusion~~2017 and 2016, respectively, as the effect would have been ~~anti-dilutive,~~antidilutive or, for unvested performance-based RSUs, the performance conditions had not been met as of the end of the reporting ~~period.~~periods.

5.4. Provision for Income Taxes

The provision for income taxes was ~~$9,500,000~~$2,735,000 and ~~$10,964,000~~$2,888,000 in the first ~~nine months~~quarters of ~~2016~~2017 and ~~2015,~~2016, respectively, and represented ~~28%~~23% and ~~31%~~29% of pre-tax income. The effective tax rate of ~~28%~~23% in the first ~~nine months~~quarter of 2017 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings and the net excess income tax benefits from stock-based compensation arrangements, offset in part by an increase in tax related to non-deductible expenses. The effective tax rate of 29% in the first quarter of 2016 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings ~~the adoption of ASU No. 2016-09 that resulted in a favorable adjustment for~~and the net excess income tax benefits from stock-based compensation ~~arrangements, a partial release of the U.S. valuation allowance related to state net operating losses, and a partial benefit of current-year state losses.~~arrangements. These items were offset in part by an increase in tax related to non-deductible ~~expenses. The effective tax rate of 31% in the first nine months of 2015 was lower than the Company's statutory tax rate primarily due to the distribution of the Company's worldwide earnings~~expenses and ~~an adjustment to increase deferred tax assets, which were offset in part by an increase in non-deductible expenses,~~ state ~~tax expense, and the U.S. tax cost of foreign operations.~~taxes.

5. Long-Term Obligations

Long-term obligations are as follows:



	April 1, 2017			December 31, 2016
(In thousands)	April 1, 2017			December 31, 2016
Revolving Credit Facility, due 2022	$	65,625		$	61,494
Obligations Under Capital Lease, due 2017 to 2022	4,359			4,309
Other Borrowings, due 2017 to 2023	566			608
Total	70,550			66,411
Less: Current Maturities of Long-Term Obligations	(655		)	(643		)
Long-Term Obligations	$	69,895		$	65,768

1714

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

5. Long-Term Obligations (continued)

~~6. Long-Term Obligations~~

~~Long-term obligations are as follows:~~

October 1,
2016 January 2,
2016
(In thousands)
Revolving Credit Facility, due 2018 $ 63,517
$ 26,000
Commercial Real Estate Loan, due 2016 —
5,250
Total Short- and Long-Term Obligations 63,517
31,250
Less: Short-Term Obligations —
(5,250 )
Long-Term Obligations $ 63,517
$ 26,000

~~The weighted average interest rate for the Company's long-term obligations was 1.43% as of October 1, 2016.~~

Revolving Credit Facility

~~The~~On March 1, 2017, the Company entered into an Amended and Restated Credit Agreement (2017 Credit Agreement) which became effective on March 2, 2017. The 2017 Credit Agreement is a five-year unsecured revolving credit facility ~~(2012 Credit Agreement)~~ in the aggregate principal amount of up to ~~$100,000,000 on August 3, 2012 and amended it on November 1, 2013 and March 29, 2016.~~$200,000,000. The ~~2012~~2017 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional ~~$50,000,000.~~$100,000,000. The principal on any borrowings made under the ~~2012~~2017 Credit Agreement is due on ~~November~~March 1, ~~2018.~~2022. Interest on any loans outstanding under the ~~2012~~2017 Credit Agreement accrues and generally is payable quarterly in arrears at one of the following rates selected by the Company: (i) the Base Rate, calculated as the highest of (a) the federal funds rate plus 0.50% ~~plus an applicable margin of 0% to 1%~~, (b) the prime rate as ~~defined, plus an applicable margin of 0% to 1%~~published by Citizens Bank, and (c) the ~~Eurocurrency~~thirty-day London Inter-Bank Offered Rate (LIBOR) rate, as defined, plus 0.50% ~~plus an applicable margin of 0% to 1%~~; or (ii) the ~~Eurocurrency~~LIBOR rate (with a zero percent floor), as defined, plus an applicable margin of 1% to 2%. The applicable margin is determined based upon the ratio of the Company's total debt, net of certain cash, as defined, to earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined in the ~~2012~~2017 Credit Agreement. For this purpose, total debt net of certain cash is defined as total debt less ~~up to $25,000,000~~the sum of (i) unrestricted U.S. cash, and (ii) 65% of unrestricted ~~U.S. cash.~~cash outside of the United States, but no more than an aggregate amount of $30,000,000. Contemporaneously with the execution of the 2017 Credit Agreement, we borrowed $42,000,000 and 26,300,000 euros under the 2017 Credit Agreement and applied the proceeds to pay off the previous credit facility.

The obligations of the Company under the ~~2012~~2017 Credit Agreement may be accelerated upon the occurrence of an event of default under the ~~2012~~2017 Credit Agreement, which includes customary events of default including, without limitation, payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy- and insolvency-related defaults, defaults relating to such matters as the Employment Retirement Income Security Act (ERISA), unsatisfied judgments, the failure to pay certain indebtedness, and a change of control default. In addition, the ~~2012~~2017 Credit Agreement contains negative covenants applicable to the Company and its subsidiaries, including financial covenants requiring the Company to comply with a maximum consolidated leverage ratio of 3.5 to 1, a minimum consolidated interest coverage ratio of 3 to 1, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing its fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to the discontinued operation. As of ~~October~~April 1, ~~2016,~~2017, the Company was in compliance with these covenants.

Loans under the ~~2012~~2017 Credit Agreement are guaranteed by certain domestic subsidiaries of the Company pursuant to an Amended and Restated Guarantee Agreement, dated as of March 1, 2017. In addition, one of the Company's foreign subsidiaries entered into a Guarantee Agreement ~~effective August 3, 2012.~~limited to certain obligations of two foreign subsidiary borrowers pursuant to a Guarantee Agreement dated as of March 1, 2017.

~~The Company borrowed $41,046,000~~As of April 1, 2017, the outstanding balance under the ~~2012~~2017 Credit Agreement ~~in the first quarter of 2016,~~was $65,625,000, of which ~~$29,866,000~~$26,625,000 was a euro-denominated borrowing used to fund the PAAL ~~acquisition, which occurred at the beginning of the second quarter of 2016.~~acquisition. As of ~~October~~April 1, ~~2016, the outstanding balance under the 2012 Credit Agreement was $63,517,000. As of October 1, 2016,~~2017, the Company had ~~$36,262,000~~$134,960,000 of borrowing capacity available under the committed portion of its 2012 Credit Agreement. The amount the Company is able to borrow under the 2012 Credit Agreement is the total borrowing capacity of $100,000,000 less any outstanding borrowings, letters of credit and multi-currency borrowings issued under the 20122017 Credit Agreement.

~~Commercial Real Estate Loan~~

The weighted average interest rate for the Revolving Credit Facility was 1.68% as of April 1, 2017.

Obligations Under Capital Lease

In connection with the ~~second quarter~~acquisition of ~~2016,~~PAAL, the Company ~~repaid~~assumed a sale-leaseback financing arrangement for PAAL's facility in Germany. Under this arrangement, the quarterly lease payment includes principal and interest based on an interest rate which is reset, from time to time, to prevailing short-term borrowing rates in Germany. The interest rate at April 1, 2017 was 1.70%. The quarterly lease payment also includes a payment toward a corresponding loan receivable from the landlord. The loan receivable, which is included in other assets in the accompanying condensed consolidated balance sheet, was $288,000 at April 1, 2017. The lease arrangement provides for a fixed price purchase option, net of the loan receivable, of $1,428,000 at the end of the lease term in 2022. If the Company does not exercise the purchase option for the facility, the Company will receive cash from the landlord to settle the loan receivable. As of April 1, 2017, $4,243,000 was outstanding ~~principal balance on~~under this capital lease obligation. The Company also assumed capital lease obligations for certain equipment as part of the ~~commercial real estate loan.~~PAAL acquisition. These capital lease obligations bear a weighted average interest rate of 3.44% and have an average remaining term of 2.9 years. As of April 1, 2017, $116,000 was outstanding under these capital lease obligations.

1815

Table of Contents

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

5. Long-Term Obligations (continued)

7.Other Borrowings

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

6. Stock-Based Compensation

The Company recognized stock-based compensation expense of ~~$1,269,000~~$1,295,000 and ~~$1,254,000 in the third quarters of 2016 and 2015, respectively, and $3,865,000 and $4,495,000~~$1,323,000 in the first ~~nine months~~quarters of ~~2016~~2017 and ~~2015,~~2016, respectively, within ~~SG&A~~selling, general, and administrative (SG&A) expenses in the accompanying condensed consolidated statement of income. The Company recognizes compensation ~~cost~~expense for all stock-based awards granted to employees and directors based on the grant date estimate of fair value for those awards. The fair value of RSUs is based on the grant date trading price of the Company's common stock, reduced by the present value of estimated dividends foregone during the requisite service period. For time-based RSUs, compensation expense is recognized ratably over the requisite service period for the entire award net of forfeitures. For performance-based RSUs, compensation expense is recognized ratably over the requisite service period for each separately-vesting portion of the award net of forfeitures and remeasured at each reporting period until the total number of RSUs to be issued is known. During the first quarter of 2016, the Company granted stock-based compensation to executive officers and employees consisting of 53,811 shares of performance-based RSUs and 58,438 shares of time-based RSUs and granted 20,000 shares of time-based RSUs to its non-employee directors. Unrecognized compensation expense related to stock-based compensation totaled approximately ~~$5,281,000~~$7,823,000 at ~~October~~April 1, ~~2016,~~2017, and will be recognized over a weighted average period of ~~1.7~~2.0 years.

~~8. Employee Benefit Plans~~On March 8, 2017, the Company granted to its executive officers performance-based RSUs, which represented, in aggregate, the right to receive 39,229 shares (the target RSU amount), subject to adjustment, with an aggregate grant date fair value of $2,234,000. The RSUs are subject to adjustment based on the achievement of the performance measure selected for the 2017 fiscal year, which is a specified target for adjusted EBITDA generated from continuing operations for the 2017 fiscal year. The RSUs are adjusted by comparing the actual adjusted EBITDA for the performance period to the target adjusted EBITDA. Actual adjusted EBITDA between 50% and 100% of the target adjusted EBITDA results in an adjustment of 50% to 100% of the RSU amount. Actual adjusted EBITDA between 100% and 115% of the target adjusted EBITDA results in an adjustment using a straight-line linear scale between 100% and 150% of the RSU amount. If actual adjusted EBITDA is below 50% of the target adjusted EBITDA for the 2017 fiscal year, these performance-based RSUs will be forfeited. In the first quarter of 2017, the Company recognized compensation expense based on the probable number of performance-based RSUs expected to vest, which was 100% of the target RSU amount. Following the adjustment, the performance-based RSUs will be subject to additional time-based vesting, and will vest in three equal annual installments on March 10 of 2018, 2019, and 2020, provided that the executive officer is employed by the Company on the applicable vesting dates. On March 8, 2017, the Company also granted time-based RSUs representing 38,331 shares to its executive officers and employees with an aggregate grant date fair value of $2,183,000. These time-based RSUs generally vest in three equal annual installments on March 10 of 2018, 2019, and 2020, provided the employee remains employed by the Company on the applicable vesting dates.

~~The~~On March 8, 2017, the Company ~~sponsors a noncontributory defined benefit retirement plan for the benefit of eligible employees at its Kadant Solutions division and its corporate office (included~~granted 12,000 RSUs in the ~~table below under "Pension Benefits").~~aggregate to its non-employee directors with a grant date fair value of $696,000. The ~~Company also sponsors a restoration plan for~~RSUs will vest ratably on the ~~benefit~~last day of ~~certain executive officers who also participate in the noncontributory defined benefit retirement plan (included in the table below under "Other Benefits"). In addition, employees at certain~~each fiscal quarter of ~~the Company's subsidiaries participate in defined benefit retirement and post-retirement welfare benefit plans (included in the table below under "Other Benefits").~~

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

Three Months Ended
October 1, 2016 Three Months Ended
October 3, 2015
(In thousands, except percentages)
Pension
Benefits

Other
Benefits

Pension
Benefits

Other
Benefits
Components of Net Periodic Benefit Cost:
Service cost $ 181
$ 58
$ 211
$ 55
Interest cost 318
64
307
62
Expected return on plan assets (322 ) (6 ) (356 ) (10 )
Recognized net actuarial loss 124
21
127
17
Amortization of prior service cost 14
24
15
22
Net Periodic Benefit Cost $ 315
$ 161
$ 304
$ 146

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

Discount Rate 4.22 % 4.09 % 3.87 % 3.72 %
Expected Long-Term Return on Plan Assets 5.00 % —
5.25 % —
Rate of Compensation Increase 3.00 % 3.01 % 3.00 % 2.98 %
2017.

1916

Table of Contents

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

~~8. Employee Benefit Plans (continued)~~

7. Employee Benefit Plans

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

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

The components of net periodic benefit cost for the Company's U.S. and non-U.S. pension plans and other post-retirement benefit plans are as follows:


		Nine Months Ended October 1, 2016						Nine Months Ended October 3, 2015							Three Months Ended April 1, 2017									Three Months Ended April 2, 2016
(In thousands, except percentages)		Pension Benefits			Other Benefits			Pension Benefits			Other Benefits				U.S. Pension Benefits			Non-U.S. Pension Benefits			Other Post-Retirement Benefits			U.S. Pension Benefits			Non-U.S. Pension Benefits			Other Post-Retirement Benefits
Components of Net Periodic Benefit Cost:
Service cost		$	543		$	176		$	633		$	167			$	196		32			$	35		$	181		25			$	33
Interest cost		954			192			921			190				314			24			39			318			26			38
Expected return on plan assets		(966		)	(20		)	(1,068		)	(31		)		(335		)	(8		)	—			(322		)	(7		)	—
Recognized net actuarial loss		372			65			381			52				113			9			13			124			10			12
Amortization of prior service cost		42			71			42			68				13			1			21			14			1			23
Settlement loss		—			114			—			—				—			—			—			—			—			114
Net Periodic Benefit Cost		$	945		$	598		$	909		$	446			$	301		$	58		$	108		$	315		$	55		$	220

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

Discount Rate		4.22		%	4.08		%	3.87		%	3.74		%		4.03		%	3.39		%	4.13		%	4.22		%	3.91		%	4.26		%
Expected Long-Term Return on Plan Assets		5.00		%	—			5.25		%	—				5.00		%	7.72		%	7.72		%	5.00		%	6.90		%	6.90		%
Rate of Compensation Increase		3.00		%	3.01		%	3.00		%	2.99		%		3.00		%	3.40		%	3.08		%	3.00		%	2.99		%	3.01		%

The Company made cash contributions of ~~$810,000~~$90,000 to its ~~Kadant Solutions division's~~U.S. noncontributory defined benefit ~~retirement~~pension plan in the first ~~nine months~~quarter of ~~2016~~2017 and expects to make cash contributions of ~~$270,000~~$990,000 over the remainder of ~~2016.~~2017. For the remaining pension and post-retirement ~~welfare benefits~~benefit plans, ~~the Company does not expect to make any~~no cash contributions other than to fund current benefit payments are expected in ~~2016.~~2017.

Table of Contents

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

8. Accumulated Other Comprehensive Items

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

Changes in each component of accumulated other comprehensive items (AOCI), net of tax, in the accompanying condensed consolidated balance sheet are as follows:

(In thousands)
Foreign
Currency
Translation
Adjustment

Unrecognized
Prior Service
Cost

Deferred Loss
on Pension and
Other Post-
Retirement
Plans

Deferred Loss
on Hedging
Instruments

Accumulated
Other
Comprehensive
Items
Balance at January 2, 2016 $ (27,932 ) $ (489 ) $ (8,322 ) $ (229 ) $ (36,972 )
Other Comprehensive Loss Before Reclassifications (283 ) (1 ) (575 ) (265 ) (1,124 )
Reclassifications from AOCI —
71
361
364
796
Net Current Period Other Comprehensive (Loss) Income (283 ) 70
(214 ) 99
(328 )
Balance at October 1, 2016 $ (28,215 ) $ (419 ) $ (8,536 ) $ (130 ) $ (37,300 )

Balance at January 3, 2015 $ (7,371 ) $ (589 ) $ (8,394 ) $ (792 ) $ (17,146 )
Other Comprehensive (Loss) Income Before Reclassifications (16,006 ) 3
57
1,325
(14,621 )
Reclassifications from AOCI —
70
282
(1,308 ) (956 )
Net Current Period Other Comprehensive (Loss) Income (16,006 ) 73
339
17
(15,577 )
Balance at October 3, 2015 $ (23,377 ) $ (516 ) $ (8,055 ) $ (775 ) $ (32,723 )

~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

~~9. Accumulated Other Comprehensive Items (continued)~~



(In thousands)	Foreign Currency Translation Adjustment			Unrecognized Prior Service Cost on Pension and Other Post- Retirement Benefit Plans			Deferred Loss on Pension and Other Post- Retirement Benefit Plans			Deferred Gain (Loss) on Hedging Instruments			Accumulated Other Comprehensive Items
Balance at December 31, 2016	$	(41,094	)	$	(397	)	$	(8,158	)	$	12		$	(49,637	)
Other comprehensive income (loss) before reclassifications	4,986			(1		)	(28		)	12			4,969
Reclassifications from AOCI	—			23			88			15			126
Net current period other comprehensive income	4,986			22			60			27			5,095
Balance at April 1, 2017	$	(36,108	)	$	(375	)	$	(8,098	)	$	39		$	(44,542	)

Balance at January 2, 2016	$	(27,932	)	$	(489	)	$	(8,322	)	$	(229	)	$	(36,972	)
Other comprehensive income (loss) before reclassifications	5,871			(2		)	(610		)	(239		)	5,020
Reclassifications from AOCI	—			24			170			113			307
Net current period other comprehensive income (loss)	5,871			22			(440		)	(126		)	5,327
Balance at April 2, 2016	$	(22,061	)	$	(467	)	$	(8,762	)	$	(355	)	$	(31,645	)

Amounts reclassified from AOCI are as follows:


		Three Months Ended						Nine Months Ended						Statement of Income		Three Months Ended
(In thousands)		October 1, 2016			October 3, 2015			October 1, 2016			October 3, 2015			Line Item		April 1, 2017			April 2, 2016			Statement of Income Line Item
Pension and Other Post-Retirement Plans: (a)	Pension and Other Post-Retirement Plans: (a)														Pension and Other Post-Retirement Plans: (a)
Amortization of prior service costs		$	(38	)	$	(37	)	$	(113	)	$	(110	)	SG&A expenses		$	(35	)	$	(38	)	SG&A expenses
Amortization of actuarial losses		(145		)	(144		)	(551		)	(433		)	SG&A expenses		(135		)	(260		)	SG&A expenses
Total expense before income taxes		(183		)	(181		)	(664		)	(543		)			(170		)	(298		)
Income tax benefit		64			64			232			191			Provision for income taxes		59			104			Provision for income taxes
		(119		)	(117		)	(432		)	(352		)			(111		)	(194		)
Cash Flow Hedges: (b)
Interest rate swap agreements		(21		)	(106		)	(157		)	(317		)	Interest expense		(12		)	(89		)	Interest expense
Forward currency-exchange contracts		—			—			(24		)	—			Revenues		—			(61		)	Revenues
Forward currency-exchange contracts		(113		)	—			(182		)	—			Cost of revenues		(11		)	(23		)	Cost of revenues
Forward currency-exchange contracts		—			237			—			1,743			SG&A expenses
Total (expense) income before income taxes		(134		)	131			(363		)	1,426
Income tax benefit (provision)		47			6			(1		)	(118		)	Provision for income taxes
Total expense before income taxes																(23		)	(173		)
Income tax benefit																8			60			Provision for income taxes
		(87		)	137			(364		)	1,308					(15		)	(113		)
Total Reclassifications		$	(206	)	$	20		$	(796	)	$	956				$	(126	)	$	(307	)


(a)	Included in the computation of net periodic benefit cost. See Note 87 for additional information.


(b)	See Note 109 for additional information.

~~10.~~

Table of Contents

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

9. Derivatives

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

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

~~Table of Contents~~

~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

~~10. Derivatives (continued)~~

Interest Rate Swap ~~Agreements~~Agreement

On January 16, 2015, the Company entered into a swap agreement (2015 Swap Agreement) to hedge its exposure to movements in the three-month ~~London Inter-Bank Offered Rate (LIBOR)~~LIBOR rate on future outstanding debt and has designated the 2015 Swap Agreement as a cash flow hedge. The 2015 Swap Agreement expires on March 27, 2020 and has a $10,000,000 notional value. Under the 2015 Swap Agreement, on a quarterly basis, the Company receives a three-month LIBOR rate and pays a fixed rate of interest of 1.50% plus an applicable margin. The fair value of the 2015 Swap Agreement ~~as of October 1, 2016~~ is included in other long-term ~~liabilities,~~assets, with an offset to AOCI, ~~(net~~net of ~~tax)~~tax, in the accompanying condensed consolidated balance sheet.

The Company has structured the 2015 Swap Agreement to be 100% effective and as a result there is no current impact to earnings resulting from hedge ineffectiveness. Management believes that any credit risk associated with the 2015 Swap Agreement is remote based on the Company's financial position and the creditworthiness of the financial institution ~~issuing~~that issued the 2015 Swap Agreement.

The counterparty to the 2015 Swap Agreement could demand an early termination of the 2015 Swap Agreement if the Company is in default under the ~~2012~~2017 Credit Agreement, or any agreement that amends or replaces the ~~2012~~2017 Credit Agreement in which the counterparty is a member, and the Company is unable to cure the default. An event of default under the ~~2012~~2017 Credit Agreement includes customary events of default and failure to comply with financial covenants, including a maximum consolidated leverage ratio of 3.5 to 1, ~~and~~ a minimum consolidated interest coverage ratio of 3 to 1.1, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing its fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to the discontinued operation. As of ~~October~~April 1, ~~2016,~~2017, the Company was in compliance with these covenants. The unrealized ~~loss~~gain associated with the 2015 Swap Agreement was ~~$147,000~~$82,000 as of ~~October~~April 1, ~~2016,~~2017, which represents the estimated amount that the Company would ~~pay to~~receive from the counterparty in the event of an early termination.

The Company entered into a swap agreement in 2006 (2006 Swap Agreement) to convert a portion of the Company's outstanding debt from a floating to a fixed rate of interest. The 2006 Swap Agreement expired in May 2016.

Forward Currency-Exchange Contracts

The Company uses forward currency-exchange contracts primarily to hedge exposures resulting from fluctuations in currency exchange rates. Such exposures result primarily from portions of the Company's operations and assets and liabilities that are denominated in currencies other than the functional currencies of the businesses conducting the operations or holding the assets and liabilities. The Company typically manages its level of exposure to the risk of currency-exchange fluctuations by hedging a portion of its currency exposures anticipated over the ensuing 12-month period, using forward currency-exchange contracts that have maturities of 12 months or less.

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

9. Derivatives (continued)

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

The Company recognized within SG&A expenses in the accompanying condensed consolidated statement of income a ~~loss of $120,000 and a~~ gain of ~~$46,000 in the third quarters of 2016 and 2015, respectively,~~$471,000 and a loss of ~~$556,000 and a gain of $53,000~~$211,000 in the first ~~nine months~~quarters of ~~2016~~2017 and ~~2015,~~2016, respectively, associated with forward currency-exchange contracts that were not designated as hedges. Management believes that any credit risk associated with forward currency-exchange contracts is remote based on the Company's financial position and the creditworthiness of the financial institutions issuing the contracts.

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~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

~~10. Derivatives (continued)~~

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


			October 1, 2016					January 2, 2016							April 1, 2017					December 31, 2016
		Balance Sheet Location	Asset (Liability) (a)			Notional Amount (b)		Asset (Liability) (a)			Notional Amount			Balance Sheet Location	Asset (Liability) (a)			Notional Amount (b)		Asset (Liability) (a)			Notional Amount
(In thousands)								Asset (Liability) (a)			Notional Amount			Balance Sheet Location	Asset (Liability) (a)			Notional Amount (b)		Asset (Liability) (a)			Notional Amount
Derivatives Designated as Hedging Instruments:	Derivatives Designated as Hedging Instruments:		Asset (Liability) (a)													Derivatives Designated as Hedging Instruments:
Derivatives in an Asset Position:		Balance Sheet Location				Notional Amount (b)
Forward currency-exchange contracts		Other Current Assets	$	10		$	950	$	—		$	—		Other Current Assets	$	3		$	950	$	—		$	—
Interest rate swap agreement		Other Assets	$	—		$	—	$	38		$	10,000		Other Long-Term Assets	$	82		$	10,000	$	62		$	10,000
Derivatives in a Liability Position:
Forward currency-exchange contracts		Other Current Liabilities	$	(65	)	$	1,683	$	(101	)	$	6,525		Other Current Liabilities	$	(21	)	$	946	$	(41	)	$	2,380
Interest rate swap agreement		Other Current Liabilities	$	—		$	—	$	(91	)	$	5,250
Interest rate swap agreement		Other Long-Term Liabilities	$	(147	)	$	10,000	$	—		$	—

Derivatives Not Designated as Hedging Instruments:	Derivatives Not Designated as Hedging Instruments:												Derivatives Not Designated as Hedging Instruments:
Derivatives in an Asset Position:
Forward currency-exchange contracts		Other Current Assets	$	7		$	384	$	2,536		$	15,612		Other Current Assets	$	—		$	—	$	2		$	227
Derivatives in a Liability Position:
Forward currency-exchange contracts		Other Current Liabilities	$	(134	)	$	17,611	$	—		$	—		Other Current Liabilities	$	(38	)	$	16,592	$	(237	)	$	17,185


(a)	See Note 1110 for the fair value measurements relating to these financial instruments.


(b)	The total notional amount is indicative of the level of the Company's derivative activity during the first ~~nine months~~quarter of ~~2016.~~2017.

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Notes to Condensed Consolidated Financial Statements

(Unaudited)

9. Derivatives (continued)

The following table summarizes the activity in AOCI associated with the Company's derivative instruments designated as cash flow hedges as of and for the ~~period~~three months ended ~~October~~April 1, ~~2016:~~2017:

(In thousands)
Interest Rate Swap
Agreements

Forward Currency-
Exchange
Contracts
Total
Unrealized loss, net of tax, at January 2, 2016 $ (162 ) $ (67 ) $ (229 )
Loss reclassified to earnings (a) 230
134
364
Loss recognized in AOCI (163 ) (102 ) (265 )
Unrealized loss, net of tax, at October 1, 2016 $ (95 ) $ (35 ) $ (130 )



(In thousands)	Interest Rate Swap Agreement		Forward Currency- Exchange Contracts			Total
Unrealized Gain (Loss), Net of Tax, at December 31, 2016	$	40	$	(28	)	$	12
Loss reclassified to earnings (a)	8		7			15
Gain recognized in AOCI	4		8			12
Unrealized Gain (Loss), Net of Tax, at April 1, 2017	$	52	$	(13	)	$	39

(a) See Note 98 for the income statement ~~of income~~ classification.

As of ~~October~~April 1, ~~2016,~~2017, the Company expects to reclassify ~~$73,000~~$21,000 of the net unrealized loss included in AOCI to earnings over the next twelve months.

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~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

~~11.~~10. Fair Value Measurements and Fair Value of Financial Instruments

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

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Inputs, other than quoted prices in active markets, that are observable either directly or indirectly.

Level 3—Unobservable inputs based on the Company's own assumptions.

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


	Fair Value as of October 1, 2016								Fair Value as of April 1, 2017
(In thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Money market funds and time deposits	$	7,464	$	—	$	—	$	7,464	$	10,418	$	—	$	—	$	10,418
Forward currency-exchange contracts	$	—	$	17	$	—	$	17	$	—	$	3	$	—	$	3
Interest rate swap agreement									$	—	$	82	$	—	$	82
Banker's acceptance drafts (a)	$	—	$	6,181	$	—	$	6,181	$	—	$	9,229	$	—	$	9,229

Liabilities:
Forward currency-exchange contracts	$	—	$	199	$	—	$	199	$	—	$	59	$	—	$	59
Interest rate swap agreement	$	—	$	147	$	—	$	147


	Fair Value as of January 2, 2016								Fair Value as of December 31, 2016
(In thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Money market funds and time deposits	$	9,767	$	—	$	—	$	9,767	$	10,855	$	—	$	—	$	10,855
Forward currency-exchange contracts	$	—	$	2,536	$	—	$	2,536	$	—	$	2	$	—	$	2
Interest rate swap agreement	$	—	$	38	$	—	$	38	$	—	$	62	$	—	$	62
Banker's acceptance drafts (a)	$	—	$	8,314	$	—	$	8,314	$	—	$	7,852	$	—	$	7,852

Liabilities:
Forward currency-exchange contracts	$	—	$	101	$	—	$	101	$	—	$	278	$	—	$	278
Interest rate swap agreement	$	—	$	91	$	—	$	91
Contingent consideration (b)	$	—	$	—	$	1,091	$	1,091


(a)	Included in accounts receivable in the accompanying condensed consolidated balance sheet.


~~(b)~~	~~Included in other current liabilities in the accompanying condensed consolidated balance sheet.~~

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

The Company uses the market approach technique to value its financial assets and liabilities, and there were no changes in valuation techniques during the first ~~nine months~~quarter of ~~2016.~~2017. The Company's financial assets and liabilities carried at fair value are comprised of cash equivalents, banker's acceptance drafts, and derivative instruments used to hedge the Company's foreign currency and interest rate risks. The Company's cash equivalents are comprised of money market funds and bank deposits which are highly liquid and readily tradable. These investments are valued using inputs observable in active markets for identical securities. The carrying value of banker's acceptance drafts approximates their fair value due to the short-term nature of the negotiable instrument. The fair ~~values~~value of the Company's interest rate swap ~~agreements are~~agreement is based on LIBOR yield curves at the reporting date. The fair values of the Company's forward currency-exchange contracts are based on quoted forward foreign exchange rates at the reporting date. The forward currency-exchange contracts and interest rate swap ~~agreements~~agreement are hedges of either recorded assets or liabilities or anticipated transactions. Changes in values of the underlying hedged assets and liabilities or anticipated transactions are not reflected in the table above. The Company recorded contingent consideration as part of its acquisition of a European manufacturer on December 30, 2013. The fair value of the contingent consideration was based on the present value of the estimated future cash flows. Changes to the fair value of contingent

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~~KADANT INC.~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

~~11. Fair Value Measurements (continued)~~

~~consideration were recorded in SG&A expenses in the accompanying condensed consolidated statement of income. This contingent consideration was paid during the first quarter of 2016.~~

~~The following table provides a rollforward of the fair value, as determined by Level 3 inputs, of the contingent consideration:~~

Nine Months Ended
October 1, 2016
(In thousands)
Balance at January 2, 2016 $ 1,091
Payment (1,091 )
Balance at October 1, 2016 $ —

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


	October 1, 2016					January 2, 2016						April 1, 2017				December 31, 2016
	Carrying Value		Fair Value			Carrying Value			Fair Value			Carrying Value		Fair Value		Carrying Value		Fair Value
(In thousands)						Carrying Value			Fair Value			Carrying Value		Fair Value		Carrying Value		Fair Value
Long-term Debt Obligations:
Revolving credit facility												$	65,625	$	65,625	$	61,494	$	61,494
Capital lease obligations												3,893		3,893		3,857		3,857
Other borrowings												377		377		417		417
	Carrying Value													$	69,895	$	69,895	$	65,768	$	65,768
Debt Obligations	$	63,517	Fair Value	$	63,517		$	31,250		$	31,250

The carrying ~~value~~values of the Company's ~~debt~~revolving credit facility and capital lease obligations ~~approximates~~approximate fair value as the obligations bear variable rates of interest, which adjust quarterly, based on prevailing market rates.

~~12.~~11. Business Segment Information

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


	Three Months Ended						Nine Months Ended						Three Months Ended
	October 1,			October 3,			October 1,			October 3,			April 1,		April 2,
(In thousands)	2016			2015			2016			2015			2017		2016
Revenues:
Papermaking Systems	$	96,078		$	80,789		$	280,436		$	248,069		$	88,550	$	84,027
Wood Processing Systems	7,962			9,119			25,437			25,910			9,943		8,707
Fiber-based Products	1,479			2,021			8,012			8,528			4,364		3,804
	$	105,519		$	91,929		$	313,885		$	282,507		$	102,857	$	96,538

Income from Continuing Operations Before Provision for Income Taxes:
Papermaking Systems	$	16,915		$	14,246		$	44,747		$	41,559
Wood Processing Systems	2,150			2,724			5,406			7,512
Corporate and Fiber-based Products (a)	(6,504		)	(4,289		)	(15,255		)	(13,376		)
Total operating income	12,561			12,681			34,898			35,695
Interest expense, net	(251		)	(185		)	(739		)	(551		)
	$	12,310		$	12,496		$	34,159		$	35,144

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KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

~~12.~~11. Business Segment Information (continued)


	Three Months Ended				Nine Months Ended				Three Months Ended
	October 1,		October 3,		October 1,		October 3,		April 1,			April 2,
(In thousands)	2016		2015		2016		2015		2017			2016
Income Before Provision for Income Taxes:
Papermaking Systems									$	14,258		$	13,497
Wood Processing Systems									2,504			806
Corporate and Fiber-based Products (a)									(4,716		)	(4,210		)
Total operating income									12,046			10,093
Interest expense, net									(244		)	(214		)
									$	11,802		$	9,879

Capital Expenditures:
Papermaking Systems	$	1,501	$	1,258	$	3,159	$	3,412	$	1,484		$	518
Other	342		159		420		656		238			6
	$	1,843	$	1,417	$	3,579	$	4,068	$	1,722		$	524

					October 1,		January 2,
(In thousands)					2016		2016
Total Assets:
Papermaking Systems					$	420,623	$	354,417
Wood Processing Systems					54,328		53,347
Corporate and Fiber-based Products (b)					9,147		7,719
Total assets from continuing operations					484,098		415,483
Total assets from discontinued operation					20		15
					$	484,118	$	415,498

(a) Corporate primarily includes general and administrative expenses.

~~(b) Primarily includes cash and cash equivalents and property, plant, and equipment.~~

~~13.~~12. Contingencies and Litigation

Right of Recourse

In the ordinary course of business, the Company's subsidiaries in China may receive banker's acceptance drafts from customers as payment for outstanding accounts receivable. These banker's acceptance drafts are non-interest bearing and mature within six months of the origination date. The Company's subsidiaries in China may use these banker's acceptance drafts prior to the scheduled maturity date to settle outstanding accounts payable with vendors. Banker's acceptance drafts transferred to vendors are subject to customary right of recourse provisions prior to their scheduled maturity dates. As of ~~October~~April 1, ~~2016~~2017 and ~~January 2,~~December 31, 2016, the Company had ~~$4,119,000~~$6,500,000 and ~~$6,897,000,~~$4,824,000, respectively, of banker's acceptance drafts subject to recourse, which were transferred to vendors and had not reached their scheduled maturity dates. Historically, the banker's acceptance drafts have settled upon maturity without any claim of recourse against the Company.

Litigation

From time to time, the Company is subject to various claims and legal proceedings covering a range of matters that arise in the ordinary course of business. Such litigation may include, but is not limited to, claims and counterclaims by and against the Company for breach of contract or warranty, canceled contracts, product liability, or bankruptcy-related claims. For legal proceedings in which a loss is probable and estimable, the Company accrues a loss based on the low end of the range of estimated loss when there is no better estimate within the range. If the Company were found to be liable for any of the claims or counterclaims against it, the Company would incur a charge against earnings for amounts in excess of legal accruals.

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Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q includes forward-looking statements that are not statements of historical fact, and may include statements regarding possible or assumed future results of operations. Forward-looking statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management, using information currently available to our management. When we use words such as "believes," "expects," "anticipates," "intends," "plans," "estimates," "seeks," "should," "likely," "will," "would," "may," "continue," "could," or similar expressions, we are making forward-looking statements.

Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions. Our future results of operations may differ materially from those expressed in the forward-looking statements. Many of the important factors that will determine these results and values are beyond our ability to control or predict. You should not put undue reliance on any forward-looking statements. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events, or otherwise. For a discussion of important factors that may cause our actual results to differ materially from those suggested by the forward-looking statements, you should read carefully the section captioned "Risk Factors" in Part I, Item 1A, of ~~the Company's~~our Annual Report on Form 10-K for the fiscal year ended ~~January 2,~~December 31, 2016 (fiscal ~~2015)~~2016), as filed with the Securities and Exchange Commission (SEC) and subsequent filings with the SEC.

Overview

Company Background

We are a leading global supplier of equipment and critical components used in process industries worldwide. In addition, we manufacture granules made from papermaking by-products. We have a diverse and large customer base, including most of the world's major paper and oriented strand board (OSB) manufacturers, and our products, technologies, and services play an integral role in enhancing process efficiency, optimizing energy utilization, and maximizing productivity in resource-intensive industries. We believe our large installed base provides us with a spare parts and consumables business that yields higher margins than our capital equipment business. In the first ~~nine~~three months of ~~2016,~~2017, approximately ~~62%~~68% of our revenue was from the sale of parts and consumables products.

On April 4, 2016, we acquired all the outstanding shares of RT Holding GmbH, the parent corporation of a group of companies known as the PAALGROUP (PAAL), for approximately 49.7 million euros, net of cash acquired, or approximately $56.6 million. We paid additional post-closing consideration of $0.2 million to the sellers in the first quarter of 2017. PAAL manufactures balers and related equipment used in the processing of recyclable and waste materials. This acquisition, which is included in our Papermaking Systems segment's Stock-Preparation product line, broadened our product portfolio and extended our presence deeper into recycling and waste management. PAAL, headquartered in Germany, also has operations in the United Kingdom, France and Spain.

Our continuing operations are comprised of two reportable operating segments: Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products. Through our Papermaking Systems segment, we develop, manufacture, and market a range of equipment and products for the global papermaking, paper recycling, recycling and waste management, and other process industries. Through our Wood Processing Systems segment, we ~~design,~~develop, manufacture, and market stranders and related equipment used in the production of OSB, and sell debarking and wood chipping equipment used in the forest products and the pulp and paper industries. Through this segment, we also provide refurbishment and repair of pulping equipment for the pulp and paper industry. Through our Fiber-based Products business, we manufacture and sell granules derived from pulp fiber for use as carriers for agricultural, home lawn and garden, and professional lawn, turf and ornamental applications, as well as for oil and grease absorption.

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Overview (continued)

Papermaking Systems Segment

Our Papermaking Systems segment consists of the following product lines:



	-	Stock-Preparation: custom-engineered systems and equipment, as well as standard individual components, for baling, pulping, de-inking, screening, cleaning, and refining primarily recyclable fibers; balers and related equipment used in the processing of recyclable and waste materials; and filtering, recausticizing, and evaporation equipment and systems used in the production of virgin pulp;
	-	Doctoring, Cleaning, & Filtration: doctoring systems and related consumables that continuously clean rolls to keep paper machines running efficiently; doctor blades made of a variety of materials to perform functions including cleaning, creping, web removal, flaking, and the application of coatings; profiling systems that control moisture, web curl, and gloss during paper converting; and systems and equipment used to continuously clean paper machine fabrics and rolls, drain water from pulp mixtures, form the sheet or web, and filter the process water for reuse. Doctoring and cleaning systems are also used in other industries, such as carbon fiber, textiles and food processing; and
	-	Fluid-Handling: rotary joints, precision unions, steam and condensate systems, components, and controls used primarily in the dryer section of the papermaking process and during the production of corrugated ~~boxboard,~~packaging, metals, plastics, rubber, textiles, chemicals, and food.

Wood Processing Systems Segment

Our principal wood-processing products and services include:



	-	Stranders: disc and ring stranders and related parts and consumables that cut ~~trees~~batch-fed logs into strands for OSB production;
	-	Rotary Debarkers: rotary debarkers and related parts and consumables that employ a combination of mechanical abrasion and log-to-log contact to efficiently remove bark from logs of all shapes and species;
	-	Chippers: disc, drum, and veneer chippers and related parts and consumables that are high quality, robust chipper systems for waste-wood and whole-log applications found in pulp woodrooms, chip plants, and sawmill and planer mill sites; and
	-	Repair: refurbishment and repair of pulping equipment used in the pulp and paper industry.

Fiber-based Products

We produce and sell biodegradable, absorbent granules derived from papermaking by-products for use primarily as carriers for agricultural, home lawn and garden, and professional lawn, turf and ornamental applications, as well as for oil and grease absorption.

International Sales

During the first ~~nine~~three months of 2017 and 2016, approximately 58% and ~~2015, approximately 59% and 48%~~53%, respectively, of our sales were to customers outside the United States, principally in Europe and Asia. The increase in the percentage of sales to customers outside the United States was primarily due to the acquisition of ~~PAAL, which is headquartered in Europe.~~PAAL. 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.

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~~KADANT INC.~~

~~Overview (continued)~~

Application of Critical Accounting Policies and Estimates

~~The~~Management's discussion and analysis of ~~our~~ financial condition and results of operations ~~are~~is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities

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KADANT INC.

Overview (continued)

at the date of our condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Our actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that entail significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies, upon which our financial position depends and which involve the most complex or subjective decisions or assessments, are those described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the section captioned "Application of Critical Accounting Policies and Estimates" in Part II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended ~~January 2,~~December 31, 2016, filed with the SEC. There have been no material changes to these critical accounting policies since fiscal year-end ~~2015~~2016 that warrant disclosure.

Industry and Business Outlook

Our products are primarily sold in global process industries and used to produce packaging, tissue, and ~~OSB, among other products, as well as for recycling and waste management.~~engineered wood. In the first ~~nine months~~quarter of ~~2016,~~2017, approximately ~~58%~~57% of our revenue was from the sale of products that support packaging, tissue, and ~~OSB production.~~other paper production, other than printing and writing and newsprint paper grades. Consumption of packaging, which is primarily comprised of ~~corrugated~~containerboard and boxboard, ~~and cartonboard,~~ is driven by many factors, including regional economic conditions, consumer spending on non-durable goods, demand for ~~processed foods~~food and ~~beverages,~~beverage packaging, and greater urbanization in developing regions. Consumption of tissue is fairly stable and in the developed world tends to grow with the population. For both tissue and packaging, growth rates in the developing world are expected to increase as per capita consumption of paper increases with rising standards of living. For balers and related equipment, demand is generally driven by rising standards of living and population growth, shortage and costs of landfilling, increasing recycling rates, and environmental regulation. In the first quarter of 2017, 14% of our revenue was related to products that support printing and writing paper grades as well as newsprint, which have been negatively affected by the development and increased use of digital media. While we expect the decline in the use of printing and writing and newsprint paper grades to continue due to the use of digital media, we expect global packaging and tissue production to be stable or to increase. In the first quarter of 2017, 10% of our revenue was from sales to OSB producers who manufacture engineered wood panels for the housing industry. The majority of OSB demand is in North America, as North American houses are more often constructed of wood compared to other parts of the world. Demand for OSB is tied to new home construction and home remodeling. The remainder of our revenue was from sales to other process industries, ~~that in general~~which tend to grow with the overall economy.

Our results of operations in the first ~~nine months~~quarter of ~~2016~~2017 were negatively affected by foreign currency translation compared to the first ~~nine months~~quarter of ~~2015.~~2016. When we translate the local currency results of our foreign subsidiaries into U.S. dollars during a period in which the U.S. dollar is strengthening, our financial results will reflect decreases due to foreign currency translation. The negative effect on our financial results will continue if the U.S. dollar continues to strengthen relative to the functional currencies of our foreign subsidiaries. Similarly, if the U.S. dollar weakens compared to the functional currencies of our foreign subsidiaries, our financial results will reflect increases due to foreign currency translation. Further, certain foreign subsidiaries may hold U.S. dollar assets or liabilities which, as the U.S. dollar strengthens versus the applicable functional currencies, will result in currency transaction gains on assets and losses on liabilities. We have presented the material effects of foreign currency translation on our financial results under Results of Operations below.

Our bookings ~~decreased 4%~~increased 23% to ~~$95~~$119 million in the ~~third~~first quarter of 2017 compared to the first quarter of 2016, ~~compared~~primarily due to ~~$99 million in~~ the ~~third quarter~~inclusion of ~~2015. Third quarter bookings in 2016 included~~ a $13 million, or 13%, increase in bookings from the PAAL acquisition ~~of PAAL~~ offset in part by a $1 million, or 1%, decrease from the unfavorable effects of foreign currency translation. Excluding the impacts of the acquisition and foreign currency translation, our bookings in the third quarter of 2016 decreased 16% compared to the third quarter of 2015. However, we are seeing increased project activity in certain regions such as China and Europe and expect a sequential increase in bookings for the fourth quarter of 2016. Our revenue, bookings, and income tend to be variable as demand for our capital equipment is dependent on regional economic conditions and the level of capital spending by our customers, among other factors. Demand for our parts and consumables products tends to be more predictable. Bookings for our parts and consumables products were ~~$64~~$75 million, or ~~67%~~63% of total bookings, in the ~~third~~first quarter of 2017, compared to $62 million, or 64%, in the first quarter of 2016.

The largest and most impactful regional market for our products in the first quarter of 2017 was North America, and we expect this will continue to be the case for the remainder of 2017. Our bookings in North America were $57 million in the first quarter of 2017, up 5% compared to the first quarter of 2016 and 16% sequentially. According to Resource Information Systems Inc. (RISI) reports, U.S. containerboard production was up 2.1% in the first quarter of 2017 compared to ~~$61 million, or 61% of total bookings,~~the same period in 2016. Likewise, RISI reported that U.S. containerboard mill operating rates in the ~~third~~first quarter of ~~2015.~~

2017 were up nearly 300 basis points to 96.8%, while total U.S. containerboard inventory was down 313 tons during the same period as a result of

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Overview (continued)

~~The largest and most impactful regional market for our products~~higher box shipments in the third quarter of 2016 continued to be North America. Our revenues and bookings in North America have declined in the last two quarters due to general economic uncertainty in the region which has led to more cautious spending by our customers, and has particularly impacted our parts and consumables business. Our bookings in North America were $47 million in the third quarter of 2016, down 14% compared to the third quarter of 2015. During the first ~~nine months of 2016,~~quarter. RISI reported that demand for printing and writing grades in North America declined 5.8% in the first quarter of 2017 compared to the same period in ~~2015,~~2016, while ~~containerboard production was essentially flat as total inventories~~newsprint demand in North America declined ~~more than 10% in September 2016 compared to the same period last year according to Resource Information Systems Inc. (RISI) reports.~~11.6%. U.S. housing starts in ~~September 2016 declined 9% to~~March 2017 were at a seasonally adjusted annual rate of ~~1.047~~1.215 million, ~~compared to August 2016, and are at their lowest level since March 2015~~up 9.2% year-over-year, according to the U.S. Census ~~Bureau and the U.S. Department of Housing and Urban Development.~~Bureau. Continued growth in housing starts is expected to have a positive impact on demand for structural wood panels, which includes OSB.

InWe saw steady business activity in Europe ~~demand for our products was slightly below second~~in the first quarter ~~2016 levels, although we~~of 2017 compared to the first quarter of 2016. We expect ~~a sequential increase in bookings~~the overall economy to remain stable in Europe for the ~~fourth quarter~~remainder of ~~2016.~~2017. Our bookings in Europe were ~~$31~~$32 million in the ~~third~~first quarter of 2017, up 66% compared to $19 million in the first quarter of 2016. This increase included $13 million in bookings from the PAAL acquisition. Excluding the acquisition and a negative foreign currency translation effect of $1 million, our bookings in Europe were up 6%. Bookings in Europe included $4 million of orders from customers in Russia, reflecting a $3 million increase compared to the first quarter of 2016, ~~up 34% compared~~due to ~~$23 million in the third quarter of 2015, including a $13 million increase from the acquisition of PAAL.~~increased demand for our products. Our bookings in Asia were ~~$11~~$21 million in the ~~third~~first quarter of 2017, up 19% compared to 2016, ~~down 31% from $15 million in the third quarter of 2015. This decrease includes~~and included a $1 million decrease from the negative effect of foreign currency translation. ~~Weak demand and~~We saw a ~~relatively soft domestic economy affected most paper grades~~continued strength in ~~China in 2015 and the first nine months of 2016, although we are seeing increased~~ project activity in containerboard grades during the first quarter of 2017, particularly in China, ~~and expect a sequential increase~~which followed strong bookings in ~~bookings for~~ the fourth quarter of 2016. The most recent RISI ~~forecasts of~~outlook for containerboard demand in China forecasts growth rates of ~~slightly less than 3%~~approximately 2.5% to 3.0% per year for the next few ~~years suggest new capital project activity may remain at reduced levels in China in the near term.~~years. Our bookings in the rest of the world increased 7%47% to $7$9 million in the ~~third~~first quarter of ~~2016~~2017 compared to the ~~third~~first quarter of ~~2015.~~2016; however, we expect that political uncertainty in Brazil will continue to have an adverse effect on our financial results in this region.

Based on our performance in the ~~third~~first quarter of 2017 and current visibility for the remainder of the year, we expect for the full year ~~2016~~2017 GAAP diluted earnings per share (EPS) of ~~$2.76~~$3.27 to ~~$2.82,~~$3.37, revised from our previous guidance of ~~$2.75~~$3.13 to $2.81. Our revised 2016 guidance includes $0.15 of acquisition costs, $0.12 of expense related to acquired inventory and backlog, a $0.02 benefit from a discrete tax item, and a $0.02 gain on the sale of assets.$3.23. For ~~2016,~~2017, we expect revenue of ~~$412~~$427 to ~~$416~~$437 million, revised from our previous guidance of ~~$415~~$423 to ~~$421~~$433 million. For the ~~fourth~~second quarter of ~~2016,~~2017, we expect to achieve GAAP diluted EPS of ~~$0.57~~$0.87 to ~~$0.63~~$0.91 on revenue of ~~$98~~$107 to ~~$102~~$110 million.

Results of Operations

~~Third~~First Quarter ~~2016~~2017 Compared With ~~Third~~First Quarter ~~2015~~2016

The following table sets forth our unaudited condensed consolidated statement of income expressed as a percentage of total revenues ~~from continuing operations~~ for the ~~third~~first fiscal quarters of ~~2016~~2017 and ~~2015.~~2016. The results of operations for the fiscal quarter ended ~~October~~April 1, ~~2016~~2017 are not necessarily indicative of the results to be expected for the full fiscal year.


	Three Months Ended				Three Months Ended
	October 1, 2016		October 3, 2015		April 1, 2017		April 2, 2016

Revenues	100	%	100	%	100	%	100	%

Costs and Operating Expenses:
Cost of revenues	54		53		52		54
Selling, general, and administrative expenses	32		32		34		34
Research and development expenses	2		2		2		2
Other income					—		—
	88		87		88		90
Operating Income	12		13		12		10
Interest Income (Expense), Net	—		—		—		—
Income from Continuing Operations Before Provision for Income Taxes	12		13
Income Before Provision for Income Taxes					12		10
Provision for Income Taxes	3		4		3		3
Income from Continuing Operations	9	%	9	%
Net Income					9	%	7	%

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Results of Operations (continued)

Revenues

Revenues for the ~~third~~first quarters of 2017 and 2016 ~~and 2015 were~~are as follows:


	Three Months Ended				Three Months Ended
	October 1, 2016		October 3, 2015		April 1, 2017		April 2, 2016
(In thousands)					April 1, 2017		April 2, 2016
Revenues:	October 1, 2016		October 3, 2015
Papermaking Systems	$	96,078	$	80,789	$	88,550	$	84,027
Wood Processing Systems	7,962		9,119		9,943		8,707
Fiber-based Products	1,479		2,021		4,364		3,804
	$	105,519	$	91,929	$	102,857	$	96,538

Papermaking Systems Segment. Revenues increased ~~$15.3~~$4.5 million, or ~~19%~~5%, to ~~$96.1~~$88.5 million in the ~~third~~first quarter of 2017 from $84.0 million in the first quarter of 2016, ~~from $80.8 million in~~due to the ~~third quarter~~inclusion of ~~2015, including $13.6~~$13.3 million in revenues from the acquisition of PAAL in April 2016, offset in part by a ~~$1.0~~$1.3 million decrease from the unfavorable effect of foreign currency translation. Excluding revenues from the acquisition and the unfavorable effect of foreign currency translation, revenues in our Papermaking Systems segment ~~increased $2.7~~decreased $7.5 million, or 3%9%, in the ~~third~~first quarter of 2017 compared to the first quarter of 2016 ~~compared to the third quarter of 2015~~ due to ~~increased demand for~~decreased bookings of our capital products ~~at our European and Chinese operations. These increases were offset~~ in ~~part by decreased~~mid-2016 resulting from reduced demand ~~for both our parts and consumables and capital products~~ at our North American ~~operations due to general economic uncertainty which has led to more cautious spending by our North American customers.~~and Chinese operations.

Wood Processing Systems Segment. Revenues ~~decreased $1.1~~increased $1.2 million, or ~~13%~~14%, to ~~$8.0~~$9.9 million in the ~~third~~first quarter of 2017 from $8.7 million in the first quarter of 2016, ~~from $9.1 million in the third quarter of 2015,~~ primarily due to ~~decreased~~continued growth in the housing industry resulting in increased demand for our ~~capital~~parts and consumables products.

Fiber-based Products. Revenues ~~decreased $0.5~~increased $0.6 million, or ~~27%~~15%, to ~~$1.5~~$4.4 million in the ~~third~~first quarter of 2017 from $3.8 million in the first quarter of 2016, ~~from $2.0 million in the third quarter of 2015,~~ primarily due to ~~decreased~~increased demand for our biodegradable granular products.

Papermaking Systems Segment by Product Line. The following table presents revenues for our Papermaking Systems segment by product line, the changes in revenues by product line between the ~~third~~first quarters of ~~2016~~2017 and ~~2015,~~2016, and the changes in revenues by product line between the ~~third~~first quarters of ~~2016~~2017 and ~~2015~~2016 excluding the effect of foreign currency translation. The increase in revenues excluding the effect of foreign currency translation represents the increase resulting from converting ~~third~~first quarter of ~~2016~~2017 revenues in local currency into U.S. dollars at ~~third~~first quarter of ~~2015~~2016 exchange rates, and then comparing this result to actual revenues in the ~~third~~first quarter of ~~2015.~~2016. The presentation of the changes in revenues by product line excluding the effect of foreign currency translation and an acquisition is a non-GAAP measure. We believe this non-GAAP measure helps investors gain an understanding of our underlying operations consistent with how management measures and forecasts our performance, especially when comparing such results to prior periods. This non-GAAP measure should not be considered superior to or a substitute for the corresponding GAAP measure.


	Three Months Ended						Increase Excluding Effect of Foreign Currency Translation		Three Months Ended						Increase Excluding Effect of Foreign Currency Translation
(In thousands)	October 1, 2016		October 3, 2015		Increase		Increase Excluding Effect of Foreign Currency Translation		April 1, 2017		April 2, 2016		Increase		Increase Excluding Effect of Foreign Currency Translation
Papermaking Systems Product Lines:
Stock-Preparation	$	44,099	$	35,708	$	8,391	$	8,713	$	41,153	$	38,418	$	2,735	$	3,261
Doctoring, Cleaning, & Filtration	28,955		23,058		5,897		6,494		25,350		23,839		1,511		2,113
Fluid-Handling	23,024		22,023		1,001		1,110		22,047		21,770		277		463
	$	96,078	$	80,789	$	15,289	$	16,317	$	88,550	$	84,027	$	4,523	$	5,837

Revenues from our Stock-Preparation product line in the ~~third~~first quarter of ~~2016~~2017 increased ~~$8.4~~$2.7 million, or ~~23%~~7%, compared to the ~~third~~first quarter of ~~2015, including $13.6~~2016, due to the inclusion of $13.3 million in revenues from the acquisition of PAAL, offset in part by a ~~$0.3~~$0.5 million decrease from the unfavorable effect of foreign currency translation. Excluding the acquisition and the unfavorable effect of foreign currency translation, revenues in our Stock-Preparation product line decreased ~~$4.9~~$10.1 million, or ~~14%~~26%, primarily due to lower bookings of our capital products in mid-2016 resulting from reduced demand at our North American and Chinese operations. Bookings of our Stock-Preparation capital products in China have increased in the fourth quarter of

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Results of Operations (continued)

~~due to lower demand for both our capital~~2016 and ~~parts and consumables products at our North American operations as a result~~the first quarter of general economic uncertainly which has led to more cautious spending by our North America customers. This decrease was offset in part by increased demand for our capital and, to a lesser extent, parts and consumables products at our Chinese operations.2017. Revenues from our Doctoring, Cleaning, & Filtration product line in the ~~third~~first quarter of ~~2016~~2017 increased ~~$5.9~~$1.5 million, or ~~26%~~6%, compared to the ~~third~~first quarter of ~~2015, including a $0.6 million decrease from the~~2016. Excluding an unfavorable effect of foreign currency ~~translation. Excluding the unfavorable effect~~translation of ~~foreign currency translation,~~$0.6 million, revenues from our Doctoring, Cleaning & Filtration product line increased ~~$6.5~~$2.1 million, or ~~28%~~9%, compared to the ~~third~~first quarter of ~~2015, primarily~~2016, due to increased demand for our ~~capital~~ products at our European ~~and North American operations and, to a lesser extent, our Chinese~~ operations. Revenues from our Fluid-Handling product line in the ~~third~~first quarter of ~~2016~~2017 increased ~~$1.0~~$0.3 million, or 5%1%, compared to the ~~third~~first quarter of ~~2015,~~2016, primarily due to increased demand for our ~~capital~~parts and consumables products, ~~at our Chinese and European operations,~~ offset in part by decreased demand for our capital products principally at our European and North American operations.

Gross Profit Margin

Gross margins for the ~~third~~first quarters of 2017 and 2016 ~~and 2015 were~~are as follows:


	Three Months Ended				Three Months Ended
	October 1, 2016		October 3, 2015		April 1, 2017		April 2, 2016
Gross Margin:
Gross Profit Margin:
Papermaking Systems	46.0	%	47.7	%	47.9	%	46.6	%
Wood Processing Systems	45.3		46.4		42.1		33.0
Fiber-based Products	15.0		44.1		55.0		51.6
	45.6	%	47.5	%	47.6	%	45.6	%

Papermaking Systems Segment. The gross profit margin in our Papermaking Systems segment ~~decreased~~increased to ~~46.0%~~47.9% in the ~~third~~first quarter of 2017 from 46.6% in the first quarter of 2016 ~~from 47.7% in the third quarter of 2015. This decrease was primarily~~ due to ~~the inclusion of lower~~higher gross profit margins ~~from the acquisition of PAAL~~on our parts and ~~a decrease~~consumables products and an increase in the proportion of higher-margin parts and consumables revenues. These increases were partially offset by the inclusion of lower gross profit margins at PAAL.

Wood Processing Systems Segment. The gross profit margin in our Wood Processing Systems segment ~~decreased~~increased to ~~45.3%~~42.1% in the ~~third~~first quarter of 2017 from 33.0% in the first quarter of 2016 ~~from 46.4% in the third quarter of 2015 primarily~~ due to ~~lower~~higher gross profit margins on our parts and consumables products ~~due~~and a change in product mix to ~~product mix~~an increased proportion of higher-margin parts and consumables revenues compared to the ~~third~~first quarter of ~~2015.~~2016.

Fiber-based Products. The gross profit margin in our Fiber-based Products business ~~decreased~~increased to ~~15.0%~~55.0% in the ~~third~~first quarter of 2017 from 51.6% in the first quarter of 2016 ~~from 44.1% in the third quarter of 2015 primarily~~ due to ~~decreased~~higher margins on our biodegradable granular products resulting from increased manufacturing efficiency related to ~~lower~~higher production ~~volumes.~~volume.

Operating Expenses

Selling, general, and administrative (SG&A) expenses as a percentage of revenues were ~~32%~~34% in both the ~~third~~first quarters of ~~2016~~2017 and ~~2015.~~2016. SG&A expenses increased ~~$4.3~~$2.3 million, or ~~15%~~7%, to ~~$33.5~~$34.8 million in the ~~third~~first quarter of 2017 from $32.5 million in the first quarter of 2016, ~~from $29.2 million in the third quarter of 2015,~~ primarily due to ~~an increase of $3.2 million from~~ the inclusion of $3.1 million of SG&A ~~and acquisition-related expenses~~expense from ~~the~~ PAAL, ~~acquisition. These increases were~~which was offset in part by ~~$0.3~~a decrease of $0.4 million from the favorable effect of foreign currency translation.

Total stock-based compensation expense was $1.3 million in both the ~~third~~first quarters of ~~2016~~2017 and ~~2015~~2016 and is included in SG&A expenses in the accompanying condensed consolidated statement of income.

Research and development (R&D) expenses were ~~$2.0~~$2.1 million and ~~$1.8~~$1.7 million in the ~~third~~first quarters of ~~2016~~2017 and ~~2015,~~2016, respectively, and represented 2% of revenues in both periods.

Other Income

Other income in the first quarter of 2016 represents a pre-tax gain of $0.3 million related to the sale of real estate in Sweden for cash proceeds of $0.4 million.

Interest Expense

Interest expense ~~increased to~~was $0.3 million in both the ~~third quarter~~first quarters of 2016 from $0.2 million in the third quarter of 2015 primarily due to higher average outstanding borrowings, offset in part by lower average interest rates in the third quarter of 2016 compared to the third quarter of 2015.2017 and 2016.

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KADANT INC.

Results of Operations (continued)

Provision for Income Taxes

Our provision for income taxes was ~~$3.1~~$2.7 million and ~~$3.8~~$2.9 million in the ~~third~~first quarters of ~~2016~~2017 and ~~2015,~~2016, respectively, and represented ~~25%~~23% and ~~30%~~29% of pre-tax income. The effective tax rate of ~~25%~~23% in the ~~third~~first quarter of 2017 was lower than our statutory tax rate primarily due to the distribution of our worldwide earnings and the net excess income tax benefits from stock-based compensation arrangements, offset in part by an increase in tax related to non-deductible expenses. The effective tax rate of 29% in the first quarter of 2016 was lower than our statutory tax rate primarily due to the distribution of our worldwide earnings ~~a partial release of the U.S. valuation allowance related to state net operating losses,~~ and a partial benefit of current-year state losses. These benefits were offset in part by an increase in tax related to non-deductible expenses. The effective tax rate of 30% in the third quarter of 2015 was lower than our statutory tax rate primarily due to the distribution of our worldwide earnings and an adjustment to increase deferred tax assets, which was offset in part by an increase in non-deductible expenses, state tax expense, and the U.S. tax cost of foreign operations.

~~Income from Continuing Operations~~

Income from continuing operations increased $0.5 million to $9.2 million in the third quarter of 2016 from $8.7 million in the third quarter of 2015, primarily due to a decrease in our provision for income taxes, offset in part by an increase in interest expense and a decrease in operating income (see ~~Revenues, Gross Margin, Operating Expenses, Interest Expense~~ ~~and~~ ~~Provision for Income Taxes~~ ~~discussed above).~~

~~First Nine Months 2016 Compared With First Nine Months 2015~~

The following table sets forth our unaudited condensed consolidated statement of income expressed as a percentage of total revenues from continuing operations for the first nine months of 2016 and 2015. The results of operations for the first nine months of 2016 are not necessarily indicative of the results to be expected for the full fiscal year.

Nine Months Ended
October 1,
2016 October 3,
2015

Revenues 100 % 100 %

Costs and Operating Expenses:
Cost of revenues 55
52
Selling, general, and administrative expenses 32
33
Research and development expenses 2
2
Restructuring costs and other income, net —
—
89
87
Operating Income 11
13
Interest Income (Expense), Net —
—
Income from Continuing Operations Before Provision for Income Taxes 11
13
Provision for Income Taxes 3
4
Income from Continuing Operations 8 % 9 %

~~Table of Contents~~

~~KADANT INC.~~

~~Results of Operations (continued)~~

~~Revenues~~

~~Revenues for the first nine months of 2016 and 2015 were as follows:~~

Nine Months Ended
October 1,
2016 October 3,
2015
(In thousands)
Revenues:
Papermaking Systems $ 280,436
$ 248,069
Wood Processing Systems 25,437
25,910
Fiber-based Products 8,012
8,528
$ 313,885
$ 282,507

~~Papermaking Systems Segment.~~ Revenues increased $32.4 million, or 13%, to $280.4 million in the first nine months of 2016 from $248.0 million in the first nine months of 2015, including $28.8 million in revenues from the acquisition of PAAL in April 2016, offset in part by a $5.4 million decrease from the unfavorable effect of foreign currency translation. Excluding the acquisition and foreign currency translation effect, revenues in our Papermaking Systems segment increased $9.0 million, or 4%, primarily due to increased demand for our capital products at our European and Chinese operations. These increases were offset in part by decreased demand for both our parts and consumables and capital products at our North American operations due to general economic uncertainty which has led to more cautious spending by our North American customers.

~~Wood Processing Systems Segment.~~ Revenues decreased $0.5 million, or 2%, to $25.4 million in the first nine months of 2016 from $25.9 million in the first nine months of 2015, including a decrease of $1.3 million from the unfavorable effect of foreign currency translation. Excluding the effect of foreign currency translation, revenues in our Wood Processing Systems segment increased $0.8 million, or 3%, due to increased demand for our capital products.

~~Fiber-based Products.~~ Revenues decreased $0.5 million, or 6%, to $8.0 million in the first nine months of 2016 from $8.5 million in the first nine months of 2015, primarily due to decreased demand for our biodegradable granular products.

~~Papermaking Systems Segment by Product Line.~~ The following table presents revenues for our Papermaking Systems segment by product line, the changes in revenues by product line between the first nine months of 2016 and 2015, and the changes in revenues by product line between the first nine months of 2016 and 2015 excluding the effect of foreign currency translation. The increase in revenues excluding the effect of foreign currency translation represents the increase resulting from converting the first nine months of 2016 revenues in local currency into U.S. dollars at the first nine months of 2015 exchange rates, and then comparing this result to actual revenues in the first nine months of 2015. The presentation of the changes in revenues by product line excluding the effect of foreign currency translation and an acquisition is a non-GAAP measure. We believe this non-GAAP measure helps investors gain an understanding of our underlying operations consistent with how management measures and forecasts our performance, especially when comparing such results to prior periods. This non-GAAP measure should not be considered superior to or a substitute for the corresponding GAAP measure.

Nine Months Ended Increase
Excluding
Effect of Foreign Currency
Translation

(In thousands) October 1,
2016 October 3,
2015 Increase (Decrease)
Papermaking Systems Product Lines:
Stock-Preparation $ 132,158
$ 101,625
$ 30,533
$ 31,651
Doctoring, Cleaning, & Filtration 80,374
77,144
3,230
6,013
Fluid-Handling 67,904
69,300
(1,396 ) 119
$ 280,436
$ 248,069
$ 32,367
$ 37,783

~~Table of Contents~~

~~KADANT INC.~~

~~Results of Operations (continued)~~

Revenues from our Stock-Preparation product line in the first nine months of 2016 increased $30.5 million, or 30%, compared to the first nine months of 2015, including $28.8 million in revenues from the acquisition of PAAL, offset in part by a $1.1 million decrease from the unfavorable effect of foreign currency translation. Excluding the acquisition and unfavorable effect of foreign currency translation, revenues from our Stock-Preparation product line increased $2.8 million, or 3%, compared to the first nine months of 2015, primarily due to increased demand for our capital products at our European operations and, to a lesser extent, our Chinese operations. These increases were offset in part by decreased demand for our capital products at our North American operations due to general economic uncertainty which has led to more cautious spending by our North American customers. Revenues from our Doctoring, Cleaning, & Filtration product line in the first nine months of 2016 increased $3.2 million, or 4%, including a $2.8 million decrease from the unfavorable effect of foreign currency translation. Excluding the effect of foreign currency translation, revenues from our Doctoring, Cleaning, & Filtration product line increased $6.0 million, or 8%, compared to the first nine months of 2015 due to increased demand for our capital products at our European and Chinese operations, offset in part by decreased demand for our products at our North American operations. Revenues from our Fluid-Handling product line in the first nine months of 2016 decreased $1.4 million, or 2%, compared to the first nine months of 2015, including a $1.5 million decrease from the unfavorable effect of foreign currency translation. Excluding the effect of foreign currency translation, revenues from our Fluid-Handling product line increased $0.1 million primarily due to an increase in demand for our capital products at our Chinese operations, as well as increased demand for our products at our European operations, which were largely offset by a decrease in demand for our parts and consumables products at our North American operations.

~~Gross Margin~~

~~Gross margins for the first nine months of 2016 and 2015 were as follows:~~

Nine Months Ended
October 1,
2016 October 3,
2015
Gross Margin:
Papermaking Systems 45.7 % 47.1 %
Wood Processing Systems 41.5
48.7
Fiber-based Products 45.7
50.1
45.3 % 47.3 %

~~Papermaking Systems Segment~~. The gross margin in our Papermaking Systems segment decreased to 45.7% in the first nine months of 2016 from 47.1% in the first nine months of 2015. This decrease was primarily due to the inclusion of lower gross margins from the acquisition of PAAL and a decrease in the proportion of higher-margin parts and consumables revenues.

~~Wood Processing Systems Segment.~~ The gross margin in our Wood Processing Systems segment decreased to 41.5% in the first nine months of 2015 from 48.7% in the first nine months of 2015 due to lower gross profit margins on our parts and consumables products due to product mix, and on our capital products due to targeted pricing. Also contributing to the lower gross profit margin in the first nine months of 2016 was a decrease in the proportion of higher-margin parts and consumables revenues compared to the first nine months of 2015.

~~Fiber-based Products.~~ The gross margin in our Fiber-based Products business decreased to 45.7% in the first nine months of 2016 from 50.1% in the first nine months of 2015, primarily due to decreased manufacturing efficiency related to lower production volumes.

~~Operating Expenses~~

SG&A expenses as a percentage of revenues was 32% and 33% in the first nine months of 2016 and 2015, respectively. SG&A expenses increased $9.6 million, or 10%, to $102.1 million in the first nine months of 2016 from $92.5 million in the first nine months of 2015, principally due to an increase of $7.9 million from the inclusion of SG&A expenses from the PAAL acquisition and $1.8 million of acquisition-related expenses. These increases were offset in part by a $1.8 million decrease from the favorable effect of foreign currency translation.

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~~Results of Operations (continued)~~

Total stock-based compensation expense was $3.9 million and $4.5 million in the first nine months of 2016 and 2015, respectively, and is included in SG&A expenses in the accompanying condensed consolidated statement of income.

~~Research and development expenses were $5.6 million and $5.2 million in the first nine months of 2016 and 2015, respectively, and represented 2% of revenues in both periods.~~

~~Restructuring Costs and Other Income~~

~~We recorded other income in the first nine months of 2016 from a pre-tax gain of $0.3 million related to the sale of real estate in Sweden for cash proceeds of $0.4 million.~~

Restructuring costs in the Papermaking Systems segment were $0.3 million in the first nine months of 2015, due to severance costs associated with the reduction of nine employees in Canada and Sweden. These actions were taken to further streamline our operations in those locations.

~~Interest Income~~

~~Interest income was $0.2 million in both the first nine months of 2016 and 2015.~~

~~Interest Expense~~

Interest expense increased to $0.9 million in the first nine months of 2016 from $0.7 million in the first nine months of 2015 primarily due to higher average outstanding borrowings, offset in part by lower average interest rates in the first nine months of 2016 compared to the first nine months of 2015.

~~Provision for Income Taxes~~

Our provision for income taxes was $9.5 million and $11.0 million in the first nine months of 2016 and 2015, respectively, and represented 28% and 31% of pre-tax income. The effective tax rate of 28% in the first nine months of 2016 was lower than our statutory tax rate primarily due to the distribution of our worldwide earnings, the adoption of Accounting Standards Update (ASU) No. 2016-09 that resulted in a favorable adjustment for the net excess income tax benefits from stock-based compensation ~~arrangements, a partial release of the U.S. valuation allowance related to state net operating losses, and a partial benefit of current-year state losses.~~arrangements. These items were offset in part by an increase in tax related to non-deductible ~~expenses. The effective tax rate of 31% in the first nine months of 2015 was lower than our statutory tax rate primarily due to the distribution of our worldwide earnings~~expenses and ~~an adjustment to increase deferred tax assets, which were offset in part by an increase in non-deductible expenses,~~ state ~~tax expense, and the U.S. tax cost of foreign operations.~~taxes.

Net Income ~~from Continuing Operations~~

~~Income from continuing operations~~Net income increased ~~$0.5~~$2.1 million to ~~$24.7~~$9.1 million in the first ~~nine months~~quarter of ~~2016 compared to $24.2~~2017 from $7.0 million in the first ~~nine months~~quarter of ~~2015,~~2016, primarily due to ~~a decrease in our provision for income taxes, offset in part by a decrease in our operating income and~~ an increase in ~~interest expense~~operating income (see Revenues, Gross Margin, andOperating Expenses, ~~Interest Expense~~ ~~and~~ ~~Provision for Income Taxes~~ discussed above).

Recent Accounting Pronouncements

Revenue from Contracts with Customers (Topic 606), Section A-Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40).In May 2014, the Financial Accounting Standards Board (FASB) issued ~~ASU~~Accounting Standards Update (ASU) No. 2014-09, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. In March 2016, the FASB issued ASU No. 2016-08, which further clarifies the guidance on the principal versus agent considerations within ASU No. 2014-09. In April 2016, the FASB issued ASU No. 2016-10 to expand the guidance on identifying performance obligations and licensing within ASU 2014-09. In May 2016, the FASB issued ASU No. 2016-11, which rescinds certain ~~previously issued~~previously-issued guidance, including, among other items, guidance relating to accounting for shipping and handling fees and freight services effective upon adoption of ASU No. 2014-09. Also in May 2016, the FASB issued ASU No. 2016-12, which narrowly amended the revenue recognition guidance regarding collectability, noncash consideration, presentation of sales tax and transition. In December 2016, the FASB issued ASU No. 2016-20, which clarifies narrow aspects of Topic 606 and corrects unintended application of the guidance. These new ASUs are effective

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~~Results of Operations (continued)~~

for us beginning in fiscal 2018. Early adoption is permitted in fiscal 2017. ~~The guidance permits the use of either the retrospective or cumulative effect transition method.~~ We are ~~currently evaluating~~continuing to assess the ~~effect that~~potential effects of these ASUs on our condensed consolidated financial statements, business processes, systems and controls. We are analyzing our current contracts and comparing our current accounting policies and practices pertaining to revenue recognition to those required under the new ASUs to identify potential differences. Based on procedures performed to date, we have identified certain contracts that would likely be impacted by applying the new revenue standard. These include contracts that are currently accounted for under the completed-contract method. Under the current guidance, we recognize revenue under the completed-contract method when the contract is substantially complete, the product is delivered and, if applicable, customer acceptance criteria is met. However, under the new guidance, revenue recognized related to such contracts will be accelerated if the “over time” criteria are met. We are still in the process of evaluating these contracts and other types of contracts and quantifying the expected impact that the standard will have on our ~~consolidated~~ financial statements and related disclosures. ~~We have not yet selected a~~While the assessment process is ongoing, we currently anticipate adopting these ASUs using the modified retrospective transition ~~method nor have we determined the effect of these standards on our ongoing financial reporting.~~

~~Compensation-Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.~~ In June 2014, the FASB issued ASU No. 2014-12, which clarifies the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period.approach. Under the new guidance, a performance target that affects vesting and could be achieved after completion of the service period should be treated as a performance condition under FASB Accounting Standards Codification (ASC) 718 and, as a result, should not be included in the estimation of the grant-date fair value of the award. An entity should recognize compensation cost for the award when it becomes probable that the performance target will be achieved. In the event an entity determines that it is probable that a performance target will be achieved before the end of the service period, the compensation cost of the award should be recognized prospectively over the remaining service period. We adoptedthis approach, this guidance atwould apply to all new contracts initiated in fiscal 2018. For existing contracts that have remaining obligations as of the beginning of fiscal ~~2016. The adoption of this ASU did not have an impact on our condensed consolidated financial statements.~~

~~Interest-Imputation of Interest (Subtopic 835-30): Simplifying~~2018, any difference between the ~~Presentation of Debt Issuance Costs.~~ In April 2015, the FASB issued ASU No. 2015-03, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In addition, in June 2015, the FASB issued ASU No. 2015-15, which allows an entity to defer the requirements of ASU No. 2015-03 on deferred issuance costs related to line-of-credit arrangements. The recognition ~~and measurement guidance for debt issuance costs are not affected by the amendments in these ASUs. These new disclosure items are effective for us beginning in fiscal 2016. We adopted the guidance~~criteria in these ASUs atand our current revenue recognition practices would be recognized using a cumulative effect adjustment to the ~~beginning~~opening balance of ~~fiscal 2016. Adoption~~retained earnings. We are also in the process of developing and implementing appropriate changes to our business processes, systems and controls to support the recognition criteria and disclosure requirements of these ~~ASUs did not have an impact on our condensed consolidated financial statements.~~

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

Inventory (Topic 330), Simplifying the Measurement of Inventory. In July 2015, the FASB issued ASU No. 2015-11, which requires that an entity measure inventory within the scope of this ASU at the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Substantial and unusual losses that result from subsequent measurement of inventory should be disclosed in the financial statements. ~~This new guidance is effective for us~~We adopted this ASU at the beginning inof fiscal 2017. ~~Early adoption is permitted. We are currently evaluating the effect that~~Adoption of this ASU ~~will~~did not have a material effect on our condensed consolidated financial statements.

~~Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments~~. In September 2015, the FASB issued ASU No. 2015-16, which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer is required to record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. In addition, an entity is required to present, separately on the face of the statement of income or through disclosure in the notes, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. We adopted this guidance at the beginning of fiscal 2016. Adoption of this ASU did not have an impact on our condensed consolidated financial statements.

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Results of Operations (continued)

in ~~its~~our balance sheet. This ASU also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. This new guidance is effective for us in fiscal 2019. Early adoption is permitted. As part of the implementation of this new standard, we are in the process of reviewing current accounting policies and assessing the practical expedients allowed under this new guidance. We expect that most of our operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon adoption, which is required using the modified retrospective transition method. We are currently evaluating the other effects that the adoption of this ASU will have on our condensed consolidated financial statements.

~~Compensation -Stock Compensation (Topic 718):Improvements to Employee Share-Based Payment Accounting.~~ In March 2016, the FASB issued ASU No. 2016-09, which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the statement of cash flows. We early adopted this ASU at the beginning of fiscal 2016. This ASU requires that excess income tax benefits and tax deficiencies related to stock-based compensation arrangements be recognized as discrete items within the provision for income taxes instead of capital in excess of par value in the reporting period in which they occur. As a result of the adoption of this ASU, we recognized an income tax benefit of $0.1 million, or $0.01 per diluted share, and $0.5 million, or $0.05 per diluted share, in our condensed consolidated statement of income in the third quarter and first nine months of 2016, respectively. We prospectively adopted the requirement to classify the excess tax benefits from stock-compensation awards within operating activities in the condensed consolidated statement of cash flows in the first quarter of 2016. Prior period amounts were not restated. We have also adopted the guidance in this ASU that requires that taxes paid related to the withholding of common stock upon the vesting of employee stock awards be presented separately within financing activities in the condensed consolidated statement of cash flows. We have retrospectively restated the 2015 period to reclassify the

comparable amount, which was previously presented in other current liabilities within operating activities. There were no other material effects from adoption of this ASU on our condensed consolidated financial statements.

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

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

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

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

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

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

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Results of Operations (continued)

Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost. In March 2017, the FASB issued ASU No. 2017-07, which requires employers to include only the service cost component of net periodic pension cost and net periodic post-retirement benefit cost in operating expenses in the same income statement line item as the related employees' compensation costs. The other components of net benefit cost, including interest costs, amortization of prior service costs and settlement and curtailment effects, are to be included in non-operating expenses. The ASU also stipulates that only the service cost component of net benefit cost is eligible for capitalization. This new guidance is effective on a retrospective basis for us in fiscal 2018. Early adoption is permitted. We are currently evaluating the effects that adoption of this ASU will have on our condensed consolidated financial statements.

Liquidity and Capital Resources

Consolidated working capital was $131.5 million at April 1, 2017, compared with $118.4 million at December 31, 2016. Included in working capital were cash and cash equivalents of $71.5 million at both April 1, 2017 and December 31, 2016. At April 1, 2017, $67.6 million of cash and cash equivalents was held by our foreign subsidiaries.

First Three Months of 2017

Our operating activities provided cash of $1.7 million in the first quarter of 2017. Working capital used cash of $12.2 million in the first quarter of 2017, including increases of $6.2 million in accounts receivable and unbilled costs and fees primarily in our Stock-Preparation product line and $4.0 million in inventory primarily from purchases related to the expected shipment of Stock-Preparation capital orders later in 2017. To a lesser extent, cash of $1.9 million was used to fund increases in other current assets largely related to prepayments for raw material and equipment and an increase in refundable income taxes. In addition, we used cash of $1.0 million for other current liabilities primarily related to the payment of incentive compensation in the first quarter of 2017.

Our investing activities used cash of $1.9 million in the first quarter of 2017, primarily related to $1.7 million of purchases of property, plant, and equipment.

Our financing activities used cash of $1.1 million in the first quarter of 2017. We received cash proceeds of $8.0 million from borrowings under our unsecured revolving credit facility (2017 Credit Agreement), which were more than offset by $4.6 million used for principal payments on our outstanding debt obligations, $2.2 million used for tax withholding payments related to stock-based compensation, and $2.1 million used for cash dividends paid to stockholders.

First Three Months of 2016

Our operating activities provided cash of $5.5 million in the first quarter of 2016. Working capital used cash of $5.6 million in the first quarter of 2016, including $9.5 million for other current liabilities primarily related to incentive compensation and income tax payments and $1.8 million for other current assets primarily related to an increase in refundable income taxes. These uses of cash were offset in part by $4.3 million of cash provided from a decrease in unbilled contract costs and fees related to shipments in the first quarter of 2016 and $3.3 million of cash provided by a decrease in accounts receivable.

Our investing activities used cash of $3.0 million in the first quarter of 2016 primarily related to the issuance of a note receivable from PAAL immediately prior to the acquisition used to collateralize bank guarantees.

Our financing activities provided cash of $36.0 million in the first quarter of 2016. We received $41.0 million in proceeds from borrowings under our previous unsecured revolving credit facility, of which $29.9 million was used to fund the PAAL acquisition, which occurred in April 2016. We used cash of $2.0 million for tax withholding payments related to the vesting of restricted stock awards and $1.8 million for cash dividends paid to stockholders. In addition, we paid $1.1 million of contingent consideration related to a prior period acquisition.

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KADANT INC.

Liquidity and Capital Resources

Consolidated working capital was $114.4 million at October 1, 2016, compared with $108.5 million at January 2, 2016. Included in working capital are cash and cash equivalents of $63.2 million and $65.5 million at October 1, 2016 and January 2, 2016, respectively. At October 1, 2016, $60.2 million of our cash and cash equivalents were held by our foreign subsidiaries.

~~First Nine Months of 2016~~

Our operating activities provided cash of $34.7 million in the first nine months of 2016. Working capital used cash of $4.2 million in the first nine months of 2016, including decreases of $5.6 million in accounts payable due to reduced project activity in our Stock-Preparation product line and $6.7 million in other current liabilities primarily related to income tax and incentive compensation payments and a decrease in billings in excess of costs and fees. These uses of cash were offset in part by $5.4 million of cash provided by decreases in accounts receivable and unbilled costs and fees primarily in our Stock-Preparation product line, and $2.1 million from a decrease in inventory primarily due to the shipment of Stock-Preparation orders in the third quarter of 2016.

Our investing activities used cash of $59.8 million in the first nine months of 2016 primarily related to the acquisition of PAAL for approximately $56.6 million in cash, net of cash acquired. In addition, we used $3.6 million for purchases of property, plant, and equipment in the first nine months of 2016.

Our financing activities provided cash of $24.0 million in the first nine months of 2016. We received cash proceeds of $48.0 million from borrowings under our unsecured revolving credit facility (2012 Credit Agreement), of which $29.9 million was used to fund the PAAL acquisition, and $1.8 million from the issuance of our common stock due to the exercise of employee stock options. These sources of cash were offset in part by $15.4 million used for principal payments on our outstanding debt obligations in the first nine months of 2016, of which $5.3 million was used to repay the remaining principal balance on our commercial real estate loan, $6.0 million used for cash dividends paid to stockholders, and $2.6 million used for tax withholding payments related to stock-based compensation. In addition, we paid $1.1 million of contingent consideration in the first nine months of 2016 related to a prior period acquisition.

~~First Nine Months of 2015~~

Our operating activities provided cash of $28.0 million in the first nine months of 2015. We used cash of $16.0 million for inventory and $4.7 million for accounts receivable and unbilled contract costs and fees. The cash used for inventory was primarily due to an increase in work in process at our Stock-Preparation product line in China related to projects that shipped later in 2015 and in 2016. The cash used for accounts receivable and unbilled contract costs and fees related to increased project activity, especially in our Stock-Preparation product line. These uses of cash were offset in part by $14.1 million of cash provided by other current liabilities primarily due to an increase in customer deposits related to capital equipment projects.

~~Our investing activities used cash of $4.0 million in the first nine months of 2015 primarily for purchases of property, plant, and equipment.~~

Our financing activities used cash of $12.5 million in the first nine months of 2015. We used cash of $16.5 million for principal payments on our outstanding debt obligations, $8.9 million for the repurchase of our common stock on the open market, $5.3 million for cash dividends paid to stockholders and $2.5 million for tax withholding payments related to stock-based compensation. These uses of cash were offset in part by cash proceeds of $20 million from borrowings under our 2012 Credit Agreement. (continued)

Additional Liquidity and Capital Resources

~~On May 20, 2015, our board of directors approved the repurchase by us of up to $20 million of our equity securities during the period from May 20, 2015 to May 20, 2016.~~ On May 18, 2016, our board of directors approved the repurchase by us of up to ~~an additional~~ $20 million of our equity securities during the period from May 18, 2016 to May 18, 2017. We did not purchase any shares of our common stock under ~~these authorizations~~this authorization in the first ~~nine months~~quarter of ~~2016.~~

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~~Liquidity and Capital Resources (continued)~~2017.

We paid ~~quarterly~~ cash dividends ~~totaling $6.0~~of $2.1 million and $1.8 million in the first ~~nine months~~quarters of ~~2016.~~2017 and 2016, respectively. On ~~September 14, 2016,~~March 8, 2017, we declared a quarterly cash dividend of ~~$0.19~~$0.21 per outstanding share of our common stock, which will be paid on ~~November 10, 2016 to shareholders of record on October 13, 2016.~~May 11, 2017. Future declarations of dividends are subject to our board of directors' approval and may be adjusted as business needs or market conditions change. The ~~payment~~declaration of cash dividends is subject to our compliance with the consolidated leverage ratio contained in our ~~2012~~2017 Credit Agreement.

It is our intent to reinvest indefinitely the earnings of our international subsidiaries in order to support the current and future capital needs of their operations. We do not anticipate the need to repatriate funds to the United States to satisfy domestic liquidity needs arising in the ordinary course of business. Through ~~October~~April 1, ~~2016,~~2017, we have not provided for U.S. income taxes on approximately ~~$185.7~~$193.1 million of unremitted foreign earnings. The U.S. tax cost has not been determined due to the fact that it is not practicable to estimate at this time. The related foreign tax withholding, which would be required if we were to remit the foreign earnings to the U.S., would be approximately ~~$4.0~~$4.1 million.

Although we currently have no material commitments for capital expenditures, we plan to make expenditures of approximately $3$17 to $4$18 million during the remainder of ~~2016~~2017 for property, plant, and ~~equipment.~~equipment, which includes approximately $12 million related to a facility project. We expect to incur an additional $4 million of capital expenditures for this facility project in 2018. We anticipate funding this project through borrowings available under our 2017 Credit Agreement.

In the future, our liquidity position will be primarily affected by the level of cash flows from operations, cash paid to satisfy debt repayments, capital projects, dividends, stock repurchases, or acquisitions. We believe that our existing resources, together with the cash available from our credit facilities 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.

Revolving Credit Facility

WeOn March 1, 2017, we entered into ~~our 2012~~the 2017 Credit Agreement, which became effective as of March 2, 2017. The 2017 Credit Agreement is a five-year unsecured revolving credit facility in the aggregate principal amount of up to ~~$100 million on August 3, 2012 and amended it on November 1, 2013 and March 29, 2016.~~$200 million. The ~~2012~~2017 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional ~~$50~~$100 million. The principal on any borrowings made under the ~~2012~~2017 Credit Agreement is due on ~~November~~March 1, ~~2018.~~2022. Interest on any loans outstanding under the ~~2012~~2017 Credit Agreement accrues and generally is payable quarterly in arrears at one of the following rates selected by us: (i) the Base Rate, calculated as the highest of (a) the federal funds rate plus 0.50% ~~plus an applicable margin of 0% to 1%~~, (b) the prime rate as ~~defined, plus an applicable margin of 0% to 1%,~~published by Citizens Bank, and (c) the ~~Eurocurrency~~thirty-day London Inter-Bank Offered Rate (LIBOR) rate, as defined, plus 0.50% ~~plus an applicable margin of 0% to 1%~~; or (ii) the ~~Eurocurrency~~LIBOR rate (with a zero percent floor), as defined, plus an applicable margin of 1% to 2%. The applicable margin is determined based upon the ratio of our total debt, net of certain cash, as defined, to earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined in the ~~2012~~2017 Credit Agreement. For this purpose, total debt net of certain cash is defined as total debt less ~~up to $25 million~~the sum of (i) unrestricted U.S. cash, and (ii) 65% of unrestricted ~~U.S. cash.~~cash outside of the United States, but no more than an aggregate amount of $30 million. Contemporaneously with the execution of the 2017 Credit Agreement, we borrowed $42.0 million and 26.3 million euros under the 2017 Credit Agreement and applied the proceeds to pay off the previous credit facility.

As of ~~October~~April 1, ~~2016,~~2017, the outstanding balance under the ~~2012~~2017 Credit Agreement was ~~$63.5~~$65.6 million, ~~an increase~~ of ~~$37.5~~which $26.6 million ~~from January 2, 2016. This increase includes~~was a ~~$29.9 million~~ euro-denominated borrowing used to fund the PAAL acquisition, ~~of PAAL~~which occurred in April 2016. ~~As of October 1, 2016, we~~We had ~~$36.3~~$135.0 million of borrowing capacity available under the committed portion of the ~~2012~~2017 Credit Agreement. ~~The amount we are able to borrow under the 2012 Credit Agreement is the total borrowing capacity~~

Table of ~~$100 million less any outstanding borrowings, letters of credit~~Contents

KADANT INC.

Liquidity and ~~multi-currency borrowings issued under the 2012 Credit Agreement.~~Capital Resources (continued)

Our obligations under the ~~2012~~2017 Credit Agreement may be accelerated upon the occurrence of an event of default under the ~~2012~~2017 Credit Agreement, which includes customary events of default including without limitation payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy- and insolvency-related defaults, defaults relating to such matters as the Employment Retirement Income Security Act (ERISA), unsatisfied judgments, the failure to pay certain indebtedness, and a change of control default. In addition, the ~~2012~~2017 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 3.5 to 1, ~~and~~ a minimum consolidated interest coverage ratio of 3 to 1, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing our fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to the discontinued operation. As of ~~October~~April 1, ~~2016,~~2017, we were in compliance with these covenants.

Loans under the ~~2012~~2017 Credit Agreement are guaranteed by certain of our domestic subsidiaries pursuant to an Amended and Restated Guarantee Agreement, dated as of March 1, 2017. In addition, one of our foreign subsidiaries entered into a Guarantee Agreement ~~effective August 3, 2012.~~limited to certain obligations of two foreign subsidiary borrowers pursuant to a Guarantee Agreement, dated as of March 1, 2017.

Obligations Under Capital Lease

~~Table~~In connection with the acquisition of ~~Contents~~

~~KADANT INC.~~

~~Liquidity~~PAAL, we assumed a sale-leaseback financing arrangement for PAAL's facility in Germany. Under this arrangement, the quarterly lease payment includes principal and ~~Capital Resources (continued)~~

~~Commercial Real Estate Loan~~

~~On May 4, 2006, we borrowed $10~~interest based on an interest rate which is reset, from time to time, to prevailing short-term borrowing rates in Germany. The interest rate at April 1, 2017 was 1.70%. The lease arrangement includes a net fixed price purchase option of $1.4 million at the end of the lease term in 2022. At April 1, 2017, $4.2 million was outstanding under ~~a promissory note. We repaid the outstanding balance on the loan of $5.1 million in the second quarter of 2016.~~this capital lease obligation.

Interest Rate Swap ~~Agreements~~Agreement

On January 16, 2015, we entered into a swap agreement (2015 Swap Agreement) to hedge our exposure to movements in the three-month LIBOR rate on future outstanding debt. The 2015 Swap Agreement expires on March 27, 2020, and has a $10 million notional value. Under the 2015 Swap Agreement, on a quarterly basis we receive a three-month LIBOR rate and pay a fixed rate of interest of 1.50% plus an applicable margin.

As of ~~October~~April 1, ~~2016,~~2017, the 2015 Swap Agreement had ~~a net~~an unrealized ~~loss~~gain of $0.1 million. We believe that any credit risk associated with the swap agreement is remote based on our financial position and the creditworthiness of the financial institution ~~issuing~~that issued the ~~swap agreement.~~2015 Swap Agreement.

The counterparty to the 2015 Swap Agreement could demand an early termination of the 2015 Swap Agreement if we are in default under the ~~2012~~2017 Credit Agreement, or any agreement that amends or replaces the ~~2012~~2017 Credit Agreement in which the counterparty is a member, and we are unable to cure the default. An event of default under the ~~2012~~2017 Credit Agreement includes customary events of default and failure to comply with financial covenants, including a maximum consolidated leverage ratio of 3.5 to 1 and a minimum consolidated interest coverage ratio of 3 to 1. The ~~net~~ unrealized ~~loss~~gain of $0.1 million associated with the 2015 Swap Agreement as of ~~October~~April 1, ~~2016~~2017 represents the estimated amount that we would ~~pay to~~receive from the counterparty in the event of an early termination.

~~We entered into a swap agreement in 2006 (2006 Swap Agreement) to convert the Commercial Real Estate Loan from a floating to a fixed rate of interest. The 2006 Swap Agreement expired in May 2016.~~

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk from changes in interest rates and foreign currency exchange rates has not changed materially from our exposure at fiscal year-end ~~2015~~2016 as disclosed in Item 7A of our Annual Report on Form 10-K for the fiscal year ended ~~January 2,~~December 31, 2016, filed with the SEC.

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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 ~~October~~April 1, ~~2016.~~2017. 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 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 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 ~~October~~April 1, ~~2016,~~2017, our Chief Executive Officer and Chief Financial Officer concluded that as of ~~October~~April 1, ~~2016,~~2017, our disclosure controls and procedures were effective at the reasonable assurance level.

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~~KADANT INC.~~

(b) Changes in Internal Control over Financial Reporting

There have not been any changes 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) during the fiscal quarter ended ~~October~~April 1, ~~2016~~2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1A – Risk Factors

~~Except for the risk factor shown below, there~~There have been no material changes from the risk factors disclosed in Part I, Item 1A of ~~the Company's~~our Annual Report on Form 10-K for the fiscal year ended ~~January 2,~~December 31, 2016, filed with the SEC.

~~Economic conditions and regulatory changes caused by the United Kingdom’s likely exit from the European Union could adversely affect our business.~~

The announcement in June 2016 that voters in the United Kingdom (U.K.) have approved an exit from the European Union (E.U.), referred to as Brexit, has resulted in volatility in the global stock market as well as currency exchange rate fluctuations. The announcement of Brexit and likely withdrawal of the U.K. from the E.U. may also create global economic uncertainty, which may cause our customers to closely monitor their costs and reduce their spending budgets. This could adversely affect our business, financial condition, operating results, and cash flows. Our revenues to customers in the U.K. represented 3% of total revenues in the first nine months of 2016.

Item 6 – Exhibits

See Exhibit Index on the page immediately preceding the exhibits.

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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 ~~9th~~10th day of ~~November, 2016.~~May, 2017.



	KADANT INC.

	/s/ Michael J. McKenney
	Michael J. McKenney
	Senior Vice President and Chief Financial Officer
	(Principal Financial Officer)

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EXHIBIT INDEX



Exhibit Number
Exhibit Number		Description of Exhibit

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.

101.INS		XBRL Instance Document.*

101.SCH		XBRL Taxonomy Extension Schema Document.*

101.CAL		XBRL Taxonomy Calculation Linkbase Document.*

101.LAB		XBRL Taxonomy Label Linkbase Document.*

101.PRE		XBRL Taxonomy Presentation Linkbase Document.*

101.DEF		XBRL Taxonomy Definition Linkbase Document.*

* Submitted electronically herewith.

Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Balance Sheet at ~~October~~April 1, ~~2016~~2017 and ~~January 2,~~December 31, 2016, (ii) Condensed Consolidated Statement of Income for the three ~~and nine~~ months ended ~~October~~April 1, ~~2016~~2017 and ~~October 3, 2015~~April 2, 2016, (iii) Condensed Consolidated Statement of Comprehensive Income for the three ~~and nine~~ months ended ~~October~~April 1, ~~2016~~2017 and ~~October 3, 2015,~~April 2, 2016, (iv) Condensed Consolidated Statement of Cash Flows for the ~~nine~~three months ended ~~October~~April 1, ~~2016~~2017 and ~~October 3, 2015,~~April 2, 2016, (v) Condensed Consolidated Statement of Stockholders' Equity for the ~~nine~~three months ended ~~October~~April 1, ~~2016~~2017 and ~~October 3, 2015,~~April 2, 2016, and (vi) Notes to Condensed Consolidated Financial Statements.

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2016 Acquisition (In thousands)	Total

Net Assets Acquired:
Cash and Cash Equivalents	$	2,277
Accounts Receivable	5,441
Inventories	3,947
Property, Plant, and Equipment	7,179
Other Assets	4,964
Intangible Assets	24,691
Goodwill	38,561
Total assets acquired	87,060

Accounts Payable	5,536
Customer Deposits	2,471
Capital Lease Obligations	4,360
Long-Term Deferred Tax Liability	8,485
Other Liabilities	7,314
Total liabilities assumed	28,166
Net assets acquired	$	58,894

Purchase Price:
Cash	$	29,028
Cash Paid to Seller Borrowed Under the Revolving Credit Facility	29,866
Total purchase price	$	58,894



	Three Months Ended October 1, 2016						Three Months Ended October 3, 2015
(In thousands, except percentages)	Pension Benefits			Other Benefits			Pension Benefits			Other Benefits
Components of Net Periodic Benefit Cost:
Service cost	$	181		$	58		$	211		$	55
Interest cost	318			64			307			62
Expected return on plan assets	(322		)	(6		)	(356		)	(10		)
Recognized net actuarial loss	124			21			127			17
Amortization of prior service cost	14			24			15			22
Net Periodic Benefit Cost	$	315		$	161		$	304		$	146

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

Discount Rate	4.22		%	4.09		%	3.87		%	3.72		%
Expected Long-Term Return on Plan Assets	5.00		%	—			5.25		%	—
Rate of Compensation Increase	3.00		%	3.01		%	3.00		%	2.98		%



(In thousands)	Foreign Currency Translation Adjustment			Unrecognized Prior Service Cost			Deferred Loss on Pension and Other Post- Retirement Plans			Deferred Loss on Hedging Instruments			Accumulated Other Comprehensive Items
Balance at January 2, 2016	$	(27,932	)	$	(489	)	$	(8,322	)	$	(229	)	$	(36,972	)
Other Comprehensive Loss Before Reclassifications	(283		)	(1		)	(575		)	(265		)	(1,124		)
Reclassifications from AOCI	—			71			361			364			796
Net Current Period Other Comprehensive (Loss) Income	(283		)	70			(214		)	99			(328		)
Balance at October 1, 2016	$	(28,215	)	$	(419	)	$	(8,536	)	$	(130	)	$	(37,300	)

Balance at January 3, 2015	$	(7,371	)	$	(589	)	$	(8,394	)	$	(792	)	$	(17,146	)
Other Comprehensive (Loss) Income Before Reclassifications	(16,006		)	3			57			1,325			(14,621		)
Reclassifications from AOCI	—			70			282			(1,308		)	(956		)
Net Current Period Other Comprehensive (Loss) Income	(16,006		)	73			339			17			(15,577		)
Balance at October 3, 2015	$	(23,377	)	$	(516	)	$	(8,055	)	$	(775	)	$	(32,723	)



(In thousands)	Interest Rate Swap Agreements			Forward Currency- Exchange Contracts			Total
Unrealized loss, net of tax, at January 2, 2016	$	(162	)	$	(67	)	$	(229	)
Loss reclassified to earnings (a)	230			134			364
Loss recognized in AOCI	(163		)	(102		)	(265		)
Unrealized loss, net of tax, at October 1, 2016	$	(95	)	$	(35	)	$	(130	)