UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------------------------------------------
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 2005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission file number 1-11406
KADANT INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 52-1762325
(State or Other Jurisdiction (I.R.S. Employer Identification No.)
of Incorporation or Organization)
One Acton Place, Suite 202
Acton, Massachusetts 01720
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (978) 776-2000
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether or not the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 4, 2005
---------------------------- -----------------------------
Common Stock, $.01 par value 13,894,703
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
- -----------------------------
KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)
Assets
July 2, January 1,
(In thousands) 2005 2005
- --------------------------------------------------------------------------------------------------------------------------------
Current Assets:
Cash and cash equivalents $ 46,221 $ 82,089
Accounts receivable, less allowances of $2,479 and $1,678 41,879 30,022
Unbilled contract costs and fees 18,111 10,258
Inventories (Note 5) 38,295 27,316
Deferred tax asset 9,013 6,691
Other current assets 7,639 6,703
Assets of discontinued operation (Note 14) 14,919 15,650
-------- --------
Total Current Assets 176,077 178,729
-------- --------
Property, Plant, and Equipment, at Cost 85,239 68,224
Less: Accumulated depreciation and amortization 51,402 51,160
-------- --------
33,837 17,064
-------- --------
Other Assets 19,447 11,342
-------- --------
Intangible Assets 37,574 3,694
-------- --------
Goodwill 121,732 74,408
-------- --------
Total Assets $388,667 $285,237
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
2
>
KADANT INC.
Condensed Consolidated Balance Sheet (continued)
(Unaudited)
Liabilities and Shareholders' Investment
July 2, January 1,
(In thousands, except share amounts) 2005 2005
- --------------------------------------------------------------------------------------------------------------------------------
Current Liabilities:
Current maturities of long-term obligations (Note 6) $ 9,037 $ -
Accounts payable 24,724 21,327
Accrued payroll and employee benefits 13,478 11,261
Accrued warranty costs (Note 8) 3,766 3,582
Accrued restructuring costs (Note 9) 9,289 10,026
Accrued income taxes 5,345 886
Other current liabilities 17,036 10,419
Liabilities of discontinued operation (Note 14) 6,572 7,578
-------- --------
Total Current Liabilities 89,247 65,079
-------- --------
Deferred Income Taxes 21,295 4,370
-------- --------
Long-Term Obligations (Note 6) 51,980 -
-------- --------
Other Long-Term Liabilities 11,407 3,327
-------- --------
Minority Interest 1,174 -
-------- --------
Shareholders' Investment:
Preferred stock, $.01 par value, 5,000,000 shares authorized;
none issued - -
Common stock, $.01 par value, 150,000,000 shares authorized;
14,604,520 shares issued 146 146
Capital in excess of par value 97,525 98,450
Retained earnings 135,251 129,173
Treasury stock at cost, 709,817 and 689,407 shares (17,930) (18,158)
Deferred compensation (299) (50)
Accumulated other comprehensive items (Note 2) (1,129) 2,900
-------- --------
213,564 212,461
-------- --------
Total Liabilities and Shareholders' Investment $388,667 $285,237
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
3
>
KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
Three Months Ended
---------------------------
July 2, July 3,
(In thousands, except per share amounts) 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 65,086 $ 52,652
-------- --------
Costs and Operating Expenses:
Cost of revenues 40,385 32,255
Selling, general, and administrative expenses 18,497 14,575
Research and development expenses 1,247 581
-------- --------
60,129 47,411
-------- --------
Operating Income 4,957 5,241
Interest Income 379 318
Interest Expense (473) (4)
-------- --------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 4,863 5,555
Provision for Income Taxes 1,654 1,558
Minority Interest Expense 62 14
-------- --------
Income from Continuing Operations 3,147 3,983
Income (Loss) from Discontinued Operation (net of income tax expense
of $111 in 2005 and income tax benefit of $130 in 2004) (Note 14) 207 (240)
-------- --------
Net Income $ 3,354 $ 3,743
======== ========
Basic Earnings per Share (Note 3):
Continuing Operations $ .23 $ .28
Discontinued Operation .01 (.02)
-------- --------
Net Income $ .24 $ .26
======== ========
Diluted Earnings per Share (Note 3):
Continuing Operations $ .22 $ .27
Discontinued Operation .02 (.01)
-------- --------
Net Income $ .24 $ .26
======== ========
Weighted Average Shares (Note 3):
Basic 13,891 14,218
======== ========
Diluted 14,181 14,555
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
4
>
KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)
Six Months Ended
---------------------------
July 2, July 3,
(In thousands, except per share amounts) 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $115,830 $100,152
-------- --------
Costs and Operating Expenses:
Cost of revenues 72,367 60,288
Selling, general, and administrative expenses 33,391 28,346
Research and development expenses 2,295 1,469
-------- --------
108,053 90,103
-------- --------
Operating Income 7,777 10,049
Interest Income 851 647
Interest Expense (475) (12)
-------- --------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 8,153 10,684
Provision for Income Taxes 1,857 3,353
Minority Interest Expense 62 14
-------- --------
Income from Continuing Operations 6,234 7,317
Loss from Discontinued Operation (net of income tax benefit
of $84 and $456) (Note 14) (156) (846)
-------- --------
Net Income $ 6,078 $ 6,471
======== ========
Basic Earnings per Share (Note 3):
Continuing Operations $ .45 $ .51
Discontinued Operation (.01) (.05)
-------- --------
Net Income $ .44 $ .46
======== ========
Diluted Earnings per Share (Note 3):
Continuing Operations $ .44 $ .50
Discontinued Operation (.01) (.06)
-------- --------
Net Income $ .43 $ .44
======== ========
Weighted Average Shares (Note 3):
Basic 13,909 14,220
======== ========
Diluted 14,196 14,579
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
5
>
KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
Six Months Ended
---------------------------
July 2, July 3,
(In thousands) 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income $ 6,078 $ 6,471
Loss from discontinued operation (Note 14) 156 846
-------- --------
Income from continuing operations 6,234 7,317
Adjustments to reconcile income from continuing operations to
net cash provided by operating activities:
Depreciation and amortization 2,719 1,833
Provision for losses on accounts receivable 44 218
Loss (gain) on sale of property, plant, and equipment 30 (140)
Minority interest expense 62 14
Other non-cash items 34 312
Changes in current accounts, net of effects of acquisition:
Accounts receivable 2,402 (232)
Unbilled contract costs and fees (6,125) (878)
Inventories 3,066 (416)
Other current assets 902 (83)
Accounts payable (1,619) 1,297
Other current liabilities (2,866) (980)
-------- --------
Net cash provided by operating activities 4,883 8,262
-------- --------
Investing Activities:
Acquisition, net of cash acquired (Note 4) (101,365) -
Capitalized acquisition costs (Note 4) 3,073 -
Acquisition of minority interest in subsidiary - (318)
Purchases of property, plant, and equipment (875) (919)
Proceeds from sale of property, plant, and equipment 9 1,279
Other, net (1,041) (93)
-------- --------
Net cash used in investing activities (100,199) (51)
-------- --------
Financing Activities:
Proceeds from issuance of short- and long-term obligations (Note 6) 60,000 -
Increase in short- and long-term obligations (Note 4) 4,000 -
Net proceeds from issuance of Company common stock 639 4,598
Purchases of Company common stock (2,085) (6,159)
Repayments of long-term obligations - (598)
-------- --------
Net cash provided by (used in) financing activities 62,554 (2,159)
-------- --------
Exchange Rate Effect on Cash (2,675) 698
-------- --------
Net Cash (Used in) Provided by Discontinued Operation (431) 240
-------- --------
(Decrease) Increase in Cash and Cash Equivalents (35,868) 6,990
Cash and Cash Equivalents at Beginning of Period 82,089 74,412
-------- --------
Cash and Cash Equivalents at End of Period $ 46,221 $ 81,402
======== ========
Non-cash Investing Activities:
Fair value of assets acquired $156,667 $ -
Cash paid for acquired business (104,531) -
Obligation to be paid for acquired business (4,000) -
-------- --------
Liabilities assumed of acquired business $ 48,136 $ -
======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements.
<
6
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. General
The interim condensed consolidated financial statements and related notes
presented have been prepared by Kadant Inc. (also referred to in this document
as "we," "Kadant," "the Company," or "the Registrant") without audit and, in the
opinion of management, reflect all adjustments of a normal recurring nature
necessary for a fair statement of the Company's financial position at July 2,
2005, its results of operations for the three- and six-month periods ended July
2, 2005, and July 3, 2004, and cash flows for the six-month periods ended July
2, 2005, and July 3, 2004. Interim results are not necessarily indicative of
results for a full year.
The condensed consolidated balance sheet presented as of January 1, 2005,
has been derived from the consolidated financial statements that have been
audited by the Company's independent auditors. The condensed consolidated
financial statements and related notes are presented as permitted by Form 10-Q
and do not contain certain information included in the annual consolidated
financial statements and related notes of the Company. The condensed
consolidated financial statements and notes included herein should be read in
conjunction with the consolidated financial statements and related notes
included in the Company's Annual Report on Form 10-K for the fiscal year ended
January 1, 2005, filed with the Securities and Exchange Commission.
Results for the six-month period ended July 3, 2004 have been
reclassified to reflect the Company's composite building products business as a
discontinued operation (Note 14).
2. Comprehensive Income
Comprehensive income combines net income and "other comprehensive items,"
which represents certain amounts that are reported as components of
shareholders' investment in the accompanying condensed consolidated balance
sheet, including foreign currency translation adjustments and deferred gains and
losses on foreign currency contracts. The components of comprehensive income are
as follows:
Three Months Ended Six Months Ended
------------------------ ----------------------
July 2, July 3, July 2, July 3,
(In thousands) 2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Net Income $ 3,354 $ 3,743 $ 6,078 $ 6,471
------- ------- ------- -------
Other Comprehensive Items:
Foreign Currency Translation Adjustments (2,997) (949) (3,663) 1,087
Deferred Loss on Foreign Currency Contracts (266) (14) (366) (36)
------- ------- ------- -------
(3,263) (963) (4,029) 1,051
------- ------- ------- -------
Comprehensive Income $ 91 $ 2,780 $ 2,049 $ 7,522
======= ======= ======= =======
<
7
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3. Earnings per Share
Basic and diluted earnings per share are calculated as follows:
Three Months Ended Six Months Ended
------------------------ ----------------------
July 2, July 3, July 2, July 3,
(In thousands, except per share amounts) 2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations $ 3,147 $ 3,983 $ 6,234 $ 7,317
Income (Loss) from Discontinued Operation 207 (240) (156) (846)
------- ------- ------- -------
Net Income $ 3,354 $ 3,743 $ 6,078 $ 6,471
======= ======= ======= =======
Basic Weighted Average Shares 13,891 14,218 13,909 14,220
Effect of Stock Options 290 337 287 359
------- ------- ------- -------
Diluted Weighted Average Shares 14,181 14,555 14,196 14,579
======= ======= ======= =======
Basic Earnings per Share:
Continuing Operations $ .23 $ .28 $ .45 $ .51
Discontinued Operation .01 (.02) (.01) (.05)
------- ------- ------- -------
Net Income $ .24 $ .26 $ .44 $ .46
======= ======= ======= ========
Diluted Earnings per Share:
Continuing Operations $ .22 $ .27 $ .44 $ .50
Discontinued Operation .02 (.01) (.01) (.06)
------- ------- ------- -------
Net Income $ .24 $ .26 $ .43 $ .44
======= ======= ======= =======
Options to purchase approximately 218,000 and 222,400 shares of common
stock for the second quarters of 2005 and 2004, respectively, and 222,700 and
234,700 shares of common stock for the first six months of 2005 and 2004,
respectively, were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average market price
for the common stock and the effect of their inclusion would have been
anti-dilutive.
4. Acquisition
On May 11, 2005, the Company acquired all the outstanding stock of The
Johnson Corporation (Kadant Johnson), a leading supplier of steam and condensate
systems, components, and controls used primarily in the dryer section of the
papermaking process and during the production of corrugated boards, metals,
plastics, rubber, and textiles. Kadant Johnson was a privately held company
based in Three Rivers, Michigan with approximately 575 employees and 2004 annual
revenues of $76,092,000. The purchase price for the acquisition was $101,458,000
in cash, subject to a further post-closing adjustment, and $3,073,000 of
acquisition-related costs. In addition to the consideration paid at closing, the
Company issued a letter of credit to the sellers for $4,000,000 related to
certain tax assets of Kadant Johnson, the value of which the Company expects to
realize. This amount is subject to adjustment based on The Johnson Corporation's
final tax returns for 2004 and 2005. This additional consideration, of which
$600,000 is included in other current liabilities and $3,400,000 is included
other long-term liabilities in the accompanying condensed consolidated balance
sheet, is due over the next five years as follows: 15% in May of 2006, 2007,
2008 and 2009, and 40% in May 2010.
<
8
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Acquisition (continued)
The parties also agreed in the purchase agreement to an earn-out
provision, based on the achievement of certain revenue targets between the
closing date (May 11, 2005) and July 1, 2006, which could increase the purchase
price by up to $8,000,000. This contingent consideration will be accounted for
as an increase in goodwill, if and when the revenue targets are achieved.
To fund a portion of the purchase price, the Company entered into a term
loan and revolving credit facility (see Note 6 for further discussion).
Pursuant to the purchase agreement, at the closing of the acquisition
$12,750,000 of the purchase price was deposited into an escrow fund, primarily
to secure certain indemnification obligations of the sellers. On the 18th-month
anniversary of the closing, the balance of the escrow fund in excess of
$2,000,000 and amounts held for unresolved claims will be distributed to the
sellers. The remainder of the escrow fund will be held until the fifth
anniversary of the closing to satisfy certain tax, environmental, and other
indemnity claims.
The following table summarizes the purchase method of accounting for the
acquisition and the estimated fair values of the assets acquired and the
liabilities assumed (in thousands):
Allocation of Purchase Price
Cash and Cash Equivalents $ 4,071
Accounts Receivable, net 17,733
Notes Receivable 5,577
Inventory 13,280
Other Current Assets 5,258
Property, Plant, and Equipment 18,551
Long-Term Deferred Tax Assets 8,689
Other Assets 657
Intangible Assets 34,480
Goodwill 48,371
--------
Total Assets Acquired $156,667
--------
Accounts Payable $ 6,578
Other Current Liabilities 15,242
Short- and Long-Term Debt 3,286
Long-Term Deferred Tax Liabilities 17,148
Other Liabilities 4,727
Minority Interest 1,155
--------
Total Liabilities Assumed 48,136
--------
Net Assets Acquired $108,531
========
Consideration Paid:
Cash $ 41,458
Debt 60,000
Short- and Long-Term Obligations 4,000
Acquisition Costs 3,073
--------
Total Consideration Paid $108,531
========
<
9
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Acquisition (continued)
The estimated values of current assets, excluding inventory, and current
liabilities were based upon their historical costs in the hands of the seller on
the date of acquisition due to their short-term nature. Inventory and property,
plant, and equipment were recorded at estimated fair value based primarily on
cost and market approaches.
The following are the identifiable intangible assets acquired and the
respective periods over which the assets will be amortized on a straight-line
basis:
(In thousands) Amount Life
- -------------------------------------------------------------------------------------------------------------------
Existing technology $ 7,840 11 years *
Customer relationships 15,700 17 years *
Distribution network 2,400 17 years
Trade name 8,100 Indefinite
Licensing agreement 400 20 years
Non-compete agreements 40 3 years
--------
$ 34,480
========
* approximate weighted-average lives
The amount assigned to identifiable intangible assets acquired was based
on their respective fair values determined as of the acquisition date by an
outside valuation consultant, using income and cost approaches. The excess of
the purchase price over the tangible and identifiable intangible assets was
recorded as goodwill and amounted to approximately $48,371,000. In accordance
with current accounting standards, the goodwill will not be amortized and will
be tested for impairment annually in the fourth quarter of the Company's fiscal
year, as required by Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets."
The amortization expense associated with these acquired intangibles was
$268,000 in the second quarter of 2005. The estimated future amortization
expense associated with these acquired intangible assets is $983,000 in the
second half of 2005; $1,967,000 in 2006; $1,967,000 in 2007; $1,952,000 in 2008;
$1,943,000 in 2009; $1,943,000 in 2010; and the remaining $15,357,000
thereafter.
The acquisition was recorded under the purchase method of accounting as
of May 11, 2005 and the operating results of Kadant Johnson were included in
Kadant's condensed consolidated statement of income from the acquisition date of
May 11, 2005 to July 2, 2005.
<
10
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Acquisition (continued)
The following condensed consolidated statement of income is presented as
if the acquisition of Kadant Johnson had been made at the beginning of the
periods presented. This information is not necessarily indicative of what the
actual condensed combined statement of income of Kadant and Johnson would have
been for the periods presented, nor does it purport to represent the future
combined results of operations of Kadant and Johnson.
Six Months Ended
-------------------------------------
(In thousands) July 2, 2005 July 3, 2004
- -----------------------------------------------------------------------------------------------------------------------------
Revenues $ 145,031 $ 138,142
--------- ---------
Operating (Loss) Income * (2,553) 13,824
--------- ---------
(Loss) Income from Continuing Operations (2,676) 7,843
Loss from Discontinued Operation (156) (846)
--------- ---------
Net (Loss) Income $ (2,832) $ 6,997
========= =========
Basic (Loss) Earnings per Share:
(Loss) Income from Continuing Operations $ (.19) $ .55
Net (Loss) Income $ (.20) $ .49
Diluted (Loss) Earnings per Share:
(Loss) Income from Continuing Operations $ (.19) $ .54
Net (Loss) Income $ (.20) $ .48
* Included in operating loss for the first six months of 2005 was $11.0 million in one-time bonuses and $3.1 million
in acquisition-related costs incurred by The Johnson Corporation prior to the acquisition.
5. Inventories
The components of inventories are as follows:
(In thousands) July 2, 2005 January 1, 2005
- -----------------------------------------------------------------------------------------------------------------------------
Raw Materials and Supplies $ 18,060 $ 12,849
Work in Process 7,538 6,047
Finished Goods (includes $635 and $611 at customer locations) 12,697 8,420
--------- ---------
$ 38,295 $ 27,316
========= =========
6. Short- and Long-Term Obligations
The components of short- and long-term obligations are as follows:
(In thousands) July 2, 2005 January 1, 2005
- -----------------------------------------------------------------------------------------------------------------------------
Current Portion of Term Loan $ 9,000 $ -
Other Short-Term Obligations 37 -
--------- ---------
Current Maturities of Long-Term Obligations $ 9,037 $ -
========= =========
Long-Term Portion of Term Loan $ 51,000 $ -
Other Long-Term Obligations 980 -
--------- ---------
Long-Term Obligations $ 51,980 $ -
========= =========
<
11
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. Short- and Long-Term Obligations (continued)
To fund a portion of the purchase price for the acquisition of Kadant
Johnson, the Company entered into a term loan and revolving credit facility (the
"Credit Agreement") effective May 9, 2005 in the aggregate principal amount of
up to $85,000,000, including a $25,000,000 revolver. The Credit Agreement is
among Kadant, as Borrower, the Foreign Subsidiary Borrowers from time to time
parties thereto, the several banks and other financial institutions or entities
from time to time parties thereto, and JPMorgan Chase Bank, N.A., as
Administrative Agent. On May 11, 2005, the Company borrowed $60,000,000 under
the term loan facility, which is repayable in equal quarterly installments over
a five-year period. The aggregate principal to be repaid each year is as
follows: $4,500,000, $9,000,000, $10,500,000, $13,500,000, $15,000,000, and
$7,500,000 in 2005, 2006, 2007, 2008, 2009, and 2010, respectively. Interest on
the revolving loan and the term loan accrues and is payable quarterly in arrears
at one of the following rates selected by Kadant: (a) the prime rate plus an
applicable margin initially set at 0% for 2005, and up to 0.25% thereafter or,
(b) a Eurocurrency rate plus an applicable margin initially set at 1% for 2005,
and between 0.625% and 1.25% thereafter. The applicable margin is determined
based upon Kadant's total debt to earnings before interest, taxes, depreciation
and amortization (EBITDA) ratio.
In connection with the Credit Agreement, Kadant agreed to pay a
commitment fee, payable quarterly, at an initial rate of 0.25% per annum of the
unused amount of revolving credit commitments, subject to adjustment based upon
Kadant's total debt to EBITDA ratio (resulting in a per annum rate of between
0.175% and 0.275%).
Debt issuance costs were approximately $646,000 and are included in other
assets in the accompanying condensed consolidated balance sheet. These costs are
being amortized to interest expense over five years based on the
effective-interest method. As of July 2, 2005, the unamortized debt issuance
costs were approximately $616,000.
The obligations of Kadant under the Credit Agreement may be accelerated
upon the occurrence of an event of default under the Credit Agreement, which
include customary events of default including, without limitation, payment
defaults, defaults in the performance of affirmative and negative covenants, the
inaccuracy of representations or warranties, bankruptcy- and insolvency-related
defaults, defaults relating to such matters as ERISA, uninsured judgments and
the failure to pay certain indebtedness, and a change of control default.
In addition, the Credit Agreement contains negative covenants applicable
to Kadant and its subsidiaries, including financial covenants requiring Kadant
to comply with a maximum consolidated leverage ratio of either 2.5 or 3.0 and a
minimum consolidated fixed charge coverage ratio of 1.5, 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 Kadant's fiscal year, negative pledges, arrangements
affecting subsidiary distributions, and entering into new lines of business. As
of July 2, 2005, Kadant was in compliance with these covenants.
The loans under the Credit Agreement are guaranteed by certain domestic
subsidiaries of Kadant and secured by a pledge of 65% of the stock of the
Company's first-tier foreign subsidiaries and the Company's subsidiary
guarantors pursuant to a guarantee and pledge agreement effective May 9, 2005 in
favor of JPMorgan Chase Bank, N.A., as agent on behalf of the lenders.
<
12
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
7. Swap Agreement
Kadant entered into a swap agreement (the "Swap Agreement"), which was
effective May 17, 2005, to convert $36,000,000 of the principal balance of the
$60,000,000 term loan from a floating rate to a fixed rate of interest. The Swap
Agreement has a five-year term, the same quarterly payment dates as the hedged
portion of the term loan and reduces proportionately in line with the
amortization of the term loan. Under the Swap Agreement, Kadant will receive a
3-month LIBOR rate and pay a fixed rate of interest of 4.125%. The net effect on
interest expense for the hedged portion of the term loan ($36,000,000) is that
Kadant will pay a fixed interest rate of up to 5.375% (the sum of the 4.125%
fixed rate under the Swap Agreement and the applicable margin of up to 1.25% on
the term loan). The guarantee provisions and the default and financial
covenants, as well as certain restrictions on the payment of dividends, included
in the Credit Agreement, which are outlined in Note 6, also apply to the Swap
Agreement.
The Swap Agreement has been designated as a cash flow hedge and is
carried at fair value. As of July 2, 2005, the unrealized loss associated with
the Swap Agreement was $127,000, which is included in other long-term
liabilities in the accompanying condensed consolidated balance sheet. Management
believes that any credit risk associated with the swap is remote based on the
creditworthiness of the financial institution issuing the Swap Agreement.
8. Warranty Obligations
The Company provides for the estimated cost of product warranties at the
time of sale based on our actual historical return rates and repair costs. In
the Pulp and Papermaking Systems (Papermaking Systems) segment, the Company
typically negotiates the terms regarding warranty coverage and length of
warranty depending on the products and applications. While the Company engages
in extensive product quality programs and processes, the Company's warranty
obligation is affected by product failure rates, repair costs, service delivery
costs incurred in correcting a product failure, and supplier warranties on parts
delivered to the Company. Should actual product failure rates, repair costs,
service delivery costs, or supplier warranties on parts differ from the
Company's estimates, revisions to the estimated warranty liability would be
required.
The changes in the carrying amount of the Company's product warranties
for the three- and six-month periods ended July 2, 2005 and July 3, 2004 are as
follows:
Three Months Ended Six Months Ended
--------------------------- --------------------------
July 2, July 3, July 2, July 3,
(In thousands) 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at Beginning of Period $ 3,755 $ 3,921 $ 3,582 $ 3,661
Provision charged to income 117 574 970 1,373
Usage (238) (1,011) (912) (1,593)
Acquired warranty obligation 232 - 232 -
Other, net (a) (100) (24) (106) 19
------- ------- ------- -------
Balance at End of Period $ 3,766 $ 3,460 $ 3,766 $ 3,460
======= ======= ======= =======
(a) Represents the effects of currency translation.
See Note 14 for warranty information related to the discontinued operation.
<
13
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
9. Restructuring Costs
In an effort to improve operating performance at the Papermaking Systems
segment's Kadant Lamort subsidiary in France, the Company approved a proposed
restructuring of that subsidiary on November 18, 2004. This restructuring was
initiated to strengthen Kadant Lamort's competitive position in the European
paper industry. Under French law, the proposed restructuring required
consultation with Kadant Lamort's workers' council, which consists of elected
employees supported by trade union representatives, before implementation. The
restructuring originally proposed the reduction of up to 136 full-time positions
across all functions in France, and is expected to be implemented in 2005. The
Company accrued a restructuring charge of $9,235,000 in the fourth quarter of
2004, in accordance with Statement of Financial Accounting Standards (SFAS) No.
112, "Employers' Accounting for Postemployment Benefits - An Amendment of
Financial Accounting Standards Board (FASB) Statements No. 5 and 43," for
severance and other termination costs in connection with the workforce
reduction. As a result of the restructuring, the Company expects to realize a
curtailment resulting in a reduction in the accrued liability associated with
Kadant Lamort's pension plan of approximately $800,000, which will be recognized
in 2005 when the restructuring plan has been implemented. In addition, during
the fourth quarter of 2004, the Company recorded restructuring costs of
$280,000, which were accounted for in accordance with SFAS No. 112, related to
severance costs of 11 employees at one of the Papermaking Systems segment's U.S.
subsidiaries.
A summary of the changes in accrued restructuring costs is as follows:
(In thousands) Severance
- ----------------------------------------------------------------------------------------------
Balance at January 1, 2005 $10,026
Usage (150)
Currency translation (587)
-------
Balance at July 2, 2005 $ 9,289
=======
The specific restructuring measures and associated estimated costs are
based on the Company's best judgments under prevailing circumstances. The
Company believes that the restructuring reserve balance is adequate to carry out
the restructuring activities formally identified and committed to during the
fourth quarter of 2004, and anticipates that all actions related to these
liabilities will be completed in 2005.
<
14
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Business Segment Information
The Company has combined its operating entities into one reportable
operating segment, Papermaking Systems. In addition, the Company has two
separate product lines; Fiber-based Products and Casting Products, which are
included in the "Other" category below. In classifying operational entities into
a particular segment, the Company considered how management assesses performance
and makes operating decisions and aggregated businesses with similar economic
characteristics, products and services, production processes, customers, and
methods of distribution.
Three Months Ended Six Months Ended
---------------------------- ---------------------------
July 2, July 3, July 2, July 3,
(In thousands) 2005 2004 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues (a):
Pulp and Papermaking Systems $ 62,528 $ 50,933 $110,099 $ 96,497
Other (c) 2,558 1,719 5,731 3,655
-------- -------- -------- --------
$ 65,086 $ 52,652 $115,830 $100,152
======== ======== ======== ========
Income from Continuing Operations Before Provision
for Income Taxes and Minority Interest Expense (a):
Pulp and Papermaking Systems (b) $ 5,934 $ 6,152 $ 9,310 $ 12,495
Corporate and Other (c,d) (977) (911) (1,533) (2,446)
-------- -------- -------- --------
Total Operating Income 4,957 5,241 7,777 10,049
Interest (Expense) Income, Net (94) 314 376 635
-------- -------- -------- --------
$ 4,863 $ 5,555 $ 8,153 $ 10,684
======== ======== ======== ========
Capital Expenditures (a):
Pulp and Papermaking Systems $ 612 $ 505 $ 752 $ 835
Corporate and Other (c,d) 97 50 123 84
-------- -------- -------- --------
$ 709 $ 555 $ 875 $ 919
======== ======== ======== ========
July 2, 2005 January 1, 2005
- ---------------------------------------------------------------------------------------------------------------------------------
Total Assets:
Pulp and Papermaking Systems $341,147 $196,248
Corporate and Other (c,d) 32,601 73,339
-------- --------
Total Assets from Continuing Operations 373,748 269,587
Total Assets from Discontinued Operations 14,919 15,650
-------- --------
$388,667 $285,237
======== ========
(a) The results for Kadant Johnson are included from the acquisition date of May 11, 2005 to July 2, 2005.
(b) Includes a pre-tax gain of $970 in the six-month period ending July 3, 2004, which resulted from
renegotiating a series of agreements with one of the Company's licensees.
(c) Other includes the results from the Fiber-based Products business and Casting Products business.
(d) Corporate primarily includes general and administrative expenses.
<
15
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
11. Stock-Based Compensation Plans and Pro Forma Stock-Based Compensation
Expense
As permitted by SFAS No. 148, "Accounting for Stock-based Compensation -
Transition and Disclosure," and SFAS No. 123, "Accounting for Stock-based
Compensation" (SFAS No. 123), the Company has elected to continue to apply
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB Opinion No. 25), and related interpretations to account for its
stock-based compensation plans. No stock-based employee compensation cost
related to stock option awards is reflected in net income, as all options
granted under the plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. Had compensation cost for awards
granted after 1994 under the Company's stock-based compensation plans been
determined based on the fair values at the grant dates consistent with the
method set forth under SFAS No. 123, the effect on certain of the Company's
financial results would have been as follows:
Three Months Ended Six Months Ended
----------------------- -------------------------
July 2, July 3, July 2, July 3,
(In thousands, except per share amounts) 2005 2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations $ 3,147 $ 3,983 $ 6,234 $ 7,317
Income (Loss) from Discontinued Operation 207 (240) (156) (846)
------- ------- ------- -------
Net Income As Reported 3,354 3,743 6,078 6,471
Deduct: Total stock-based employee compensation expense
determined under the fair-value-based method for all
awards, net of tax (147) (623) (349) (1,129)
------- ------- ------- -------
Pro forma net income $ 3,207 $ 3,120 $ 5,729 $ 5,342
======= ======= ======= =======
Basic Earnings per Share:
As reported:
Income from continuing operations $ 0.23 $ 0.28 $ 0.45 $ 0.51
Net income $ 0.24 $ 0.26 $ 0.44 $ 0.46
Pro forma:
Income from continuing operations $ 0.22 $ 0.24 $ 0.42 $ 0.44
Net income $ 0.23 $ 0.22 $ 0.41 $ 0.38
Diluted Earnings per Share:
As reported:
Income from continuing operations $ 0.22 $ 0.27 $ 0.44 $ 0.50
Net income $ 0.24 $ 0.26 $ 0.43 $ 0.44
Pro forma:
Income from continuing operations $ 0.21 $ 0.23 $ 0.41 $ 0.42
Net income $ 0.23 $ 0.21 $ 0.40 $ 0.37
12. Employee Benefit Plans
One of the Company's U.S. subsidiaries has a noncontributory defined
benefit retirement plan. Benefits under the plan are based on years of service
and employee compensation. Funds are contributed to a trustee as necessary to
provide for actuarially determined costs, generally equal to the minimum amounts
required by the Employee Retirement Income Security Act (ERISA). The same
subsidiary has a post-retirement welfare benefits plan (reflected in the table
below in "Other Benefits"). No future retirees are eligible for the
post-retirement welfare benefits plan, and the plan includes a limit on the
subsidiary's contributions.
<
16
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
12. Employee Benefit Plans (continued)
The Company's Kadant Lamort subsidiary sponsors a defined benefit pension
plan, which is included in the table below in "Other Benefits." Benefits under
this plan are based on years of service and projected employee compensation.
Kadant Johnson also offers a post-retirement welfare benefit plan
(reflected in the table below in "Other Benefits") to its U.S. employees upon
attainment of eligible retirement age. Kadant Johnson pays 75% of all plan costs
for retirees with a retirement date prior to January 1, 2005, and 50% of all
plan costs for retirees with a retirement date after January 1, 2005, with no
limits on its contributions. The accrued post-retirement benefit cost associated
with this plan was $4,753,000 at July 2, 2005, and is included in other
long-term liabilities in the accompanying condensed consolidated balance sheet.
The components of the net periodic benefit cost for the pension benefits
and other benefits plans in the three- and six-month periods ended July 2, 2005
and July 3, 2004 are as follows:
Three Months Ended Three Months Ended
(In thousands) July 2, 2005 July 3, 2004
- -------------------------------------------------------------------------------------------------------------------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $ 182 $ 84 $ 158 $ 34
Interest cost 250 79 227 42
Expected return on plan assets (351) - (342) -
Recognized net actuarial (gain) loss (1) 9 - 9
Amortization of prior service cost 12 (12) 11 (15)
-------- ------- ------- --------
Net periodic benefit cost $ 92 $ 160 $ 54 $ 70
======== ======== ======== ========
Six Months Ended Six Months Ended
July 2,2005 July 3, 2004
-------------------------------------- -------------------
Pension Other Pension Other
Benefits Benefits Benefits Benefits
-------- -------- -------- --------
Components of Net Periodic Benefit Cost:
Service cost $ 357 $ 118 $ 320 $ 38
Interest cost 503 119 484 59
Expected return on plan assets (702) - (684) -
Recognized net actuarial loss - 17 - 18
Amortization of prior service cost 24 (24) 22 (30)
-------- -------- -------- --------
Net periodic benefit cost $ 182 $ 230 $ 142 $ 85
======== ======== ======== ========
The weighted-average assumptions used to determine net periodic benefit cost are as follows:
Discount rate 6.00% 5.10% 6.25% 4.80%
Expected long-term return on plan assets 8.50% - 8.50% -
Rate of compensation increase 4.00% 2.50% 4.00% 2.50%
<
17
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
12. Employee Benefit Plans (continued)
No cash contributions are expected for the U.S. subsidiary's
noncontributory defined benefit retirement plan and no cash contributions, other
than funding current benefit payments, are expected for the other pension and
post-retirement welfare benefits plans in 2005.
On December 8, 2003, the Medicare Prescription Drug Improvement and
Modernization Act of 2003 (the Act) was enacted that provides for a Medicare
prescription drug benefit beginning in 2006 and federal subsidies to employers
who provide drug coverage to retirees. The Company's accumulated postretirement
benefit obligation or net periodic postretirement benefit cost do not reflect
any amount associated with the subsidy as the Company has not yet determined
whether the benefits provided by the plan are actuarially equivalent to or
better than Medicare Part D under the Act.
13. Recent Accounting Pronouncements
Share-Based Payment
On December 16, 2004, the FASB issued SFAS No. 123 (revised 2004) "Share-
Based Payment" (SFAS No. 123R). SFAS No. 123R replaces SFAS No. 123, supersedes
APB Opinion No. 25, and amends SFAS No. 95 "Statement of Cash Flows." SFAS No.
123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial statements based on
their fair values. SFAS No. 123R is effective for the Company on January 1,
2006. The pro forma disclosures previously permitted under SFAS No. 123 will no
longer be an alternative to financial statement recognition. As permitted by
SFAS No. 123, the Company currently accounts for share-based payments to
employees using APB Opinion No. 25's intrinsic value method and, as such,
generally recognizes no compensation cost for employee stock options. Under SFAS
123R, companies must determine the appropriate fair value model to be used at
the date of adoption. The transition methods include prospective and
retrospective adoption options. Management is evaluating the requirements of
SFAS No. 123R. The impact of the adoption of SFAS No. 123R cannot be predicted
at this time because it will vary based on the levels of share-based payments
granted in the future and the options then outstanding.
Inventory Costs
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," which requires that abnormal amounts of
idle facility expense, freight, handling costs and wasted material be recognized
as current-period charges. This Statement also introduces the concept of "normal
capacity" and requires the allocation of fixed production overheads to inventory
based on the normal capacity of the production facilities. Unallocated overheads
must be recognized as an expense in the period in which they are incurred. SFAS
No. 151 will be effective for the Company on January 1, 2006. Management is
currently evaluating the requirements of SFAS No. 151 and the impact this
standard will have on its financial statements.
14. Discontinued Operation
On October 27, 2004, the Company's board of directors approved a plan and
management committed to sell the Company's composite building products business
(composites business) after making a determination that the business no longer
aligned with the Company's long-term strategy. The Company intends to sell the
composites business as a going concern and has engaged an investment banking
firm for that purpose. The Company plans to sell this business in 2005 at a
price that is reasonable compared to its carrying value. As a result of this
decision, the Company evaluated whether the composites business should be
classified as a discontinued operation under SFAS No. 144. The Company has
presented the composites business in the accompanying condensed consolidated
financial statements as a discontinued operation, as all the criteria under SFAS
No. 144 have been met. All prior periods have been restated to reflect the
composites business as a discontinued operation.
<
18
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
14. Discontinued Operation (continued)
Operating results for the composites business are as follows:
Three Months Ended Six Months Ended
------------------------ ------------------------
July 2, July 3, July 2, July 3,
(In thousands) 2005 2004 2005 2004
- -----------------------------------------------------------------------------------------------------------------------------
Revenues $ 5,548 $ 5,130 $ 10,784 $ 9,357
------- -------- -------- --------
Income (Loss) Before Provision for Income Taxes 318 (370) (240) (1,302)
Income Tax (Provision) Benefit (111) 130 84 456
------- -------- -------- --------
Income (Loss) From Discontinued Operation $ 207 $ (240) $ (156) $ (846)
======= ======== ======== ========
The major classes of assets and liabilities of the discontinued operation included in the accompanying condensed
consolidated balance sheet are as follows:
July 2, January 1,
(In thousands) 2005 2005
- -----------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents $ - $ 39
Accounts receivable, less allowances 1,705 2,252
Inventories 3,861 4,035
Other current assets 1,966 1,981
Property, plant, and equipment, at cost, net 6,803 6,760
Other assets 584 583
-------- --------
Total Assets 14,919 15,650
-------- --------
Accounts payable 1,262 1,446
Accrued warranty costs 3,486 4,327
Other current liabilities 924 905
Other liabilities 900 900
-------- --------
Total Liabilities 6,572 7,578
-------- --------
Net Assets $ 8,347 $ 8,072
======== ========
The composites business offers a standard limited warranty to the
original owner of its decking and roofing products, limited to repair or
replacement of the defective product or a refund of the original purchase price.
The composites business records an estimate for warranty-related costs at the
time of sale based on actual historical return rates and repair costs, as well
as other analytical tools for estimating future warranty claims. These estimates
are revised for variances between actual and expected claims rates. The analysis
of expected warranty claims rates includes detailed assumptions associated with
potential product returns, including the type of product sold, temperatures at
the location of installation, density of boards, and other factors. Certain
assumptions, such as the effect of weather conditions and high temperatures on
the product installed, include inherent uncertainties that are subject to
fluctuation, which could impact future warranty provisions. Due to the highly
subjective nature of these assumptions, the Company has recorded its best
estimate of the cost of expected warranty claims. It is reasonably possible that
the ultimate settlement of such claims may exceed the amount recorded.
<
19
>
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
14. Discontinued Operation (continued)
The composites business experienced warranty issues that affected its
profitability in 2003 and 2004. There was a substantial increase in warranty
claims in 2004, with the most significant increase occurring in the three-month
period ended October 2, 2004. During the first six months of 2004, the majority
of the claims were associated with contraction of certain decking products. In
the three-month period ended October 2, 2004, the increased claims were
associated with a new issue concerning excessive oxidation that affected the
integrity of the plastic used in some of the decking products manufactured prior
to October 2003. As a result of the increase in claims received and the estimate
for future potential claims, the Company increased its warranty expense in 2004
compared to prior periods. Included in this increased warranty expense was the
cost of exchanging material held by the composites business' distributors with
new material and its best estimate of costs related to future potential valid
claims arising from installed products.
A summary of the changes in accrued warranty costs in the six-month
periods ended July 2, 2005 and July 3, 2004 is as follows:
Six Months Ended
------------------------
July 2, July 3,
(In thousands) 2005 2004
- -----------------------------------------------------------------------------------------------------------------------------
Balance at Beginning of Period $ 4,327 $ 869
Provision 633 1,330
Usage (1,474) (728)
-------- --------
Balance at End of Period $ 3,486 $ 1,471
======== ========
The Company likely will not be able to transfer all the liabilities of
the composites business in a sale. Any changes associated with the carrying
value of liabilities that are not assumed by a buyer would continue to impact
the Company's consolidated results after the sale is completed.
<
20
>
KADANT INC.
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
- -------------
This Quarterly Report on Form 10-Q includes forward-looking statements
that are not statements of historical fact, and may include statements regarding
possible or assumed future results of operations. Forward-looking statements are
subject to risks and uncertainties and are based on the beliefs and assumptions
of our management, using information currently available to our management. When
we use words such as "believes," "expects," "anticipates," "intends," "plans,"
"estimates," "should," "likely," "will," "would," or similar expressions, we are
making forward-looking statements.
Forward-looking statements are not guarantees of performance. They
involve risks, uncertainties, and assumptions. Our future results of operations
may differ materially from those expressed in the forward-looking statements.
Many of the important factors that will determine these results and values are
beyond our ability to control or predict. You should not put undue reliance on
any forward-looking statements. We undertake no obligation to publicly update
any forward-looking statement, whether as a result of new information, future
events, or otherwise. For a discussion of important factors that may cause our
actual results to differ materially from those suggested by the forward-looking
statements, you should read carefully the section captioned "Risk Factors" in
this Report.
Overview
Company Background
We are a leading supplier of equipment used in the global papermaking and
paper recycling industry and are also a manufacturer of granules made from
papermaking byproducts. Our continuing operations consist of one reportable
operating segment, Pulp and Papermaking Systems (Papermaking Systems), and two
separate product lines; Fiber-based Products and Casting Products. In
classifying operational entities into a particular segment, we considered how
our management assesses performance and makes operating decisions, and
aggregated businesses with similar economic characteristics, products and
services, production processes, customers, and methods of distribution. We also
manage a composite building products business (composites business), which is
presented as a discontinued operation in the accompanying condensed consolidated
financial statements as a result of our decision to sell that business.
We were incorporated in Delaware in November 1991 to be the successor-
in-interest to several papermaking equipment businesses of Thermo Electron
Corporation (Thermo Electron). In November 1992, we completed an initial public
offering of a portion of our outstanding common stock. On July 12, 2001, we
changed our name to Kadant Inc. from Thermo Fibertek Inc. In August 2001, Thermo
Electron disposed of its remaining equity interest in us by means of a stock
dividend to its shareholders. In May 2003, we moved the listing of our common
stock to the New York Stock Exchange, where it continues to trade under the
symbol "KAI."
Pulp and Papermaking Systems Segment
Our Papermaking Systems segment designs and manufactures stock-
preparation systems and equipment, paper machine accessory equipment, and
water-management systems for the paper and paper recycling industries. With the
acquisition of The Johnson Corporation (Kadant Johnson) in May 2005, we added
fluid handling systems, which improve dryer performance during the papermaking
process. Our principal products include:
- Stock-preparation systems and equipment: custom-engineered systems and
equipment, as well as standard individual components, for pulping,
de-inking, screening, cleaning, and refining recycled and virgin
fibers for preparation for entry into the paper machine during the
production of recycled paper;
<
21
>
KADANT INC.
Overview (continued)
- Paper machine accessory equipment: doctoring systems and related
consumables that continuously clean papermaking rolls to keep paper
machines running efficiently; doctor blades made of a variety of
materials to perform functions including cleaning, creping, web
removal, and application of coatings; and profiling systems that
control moisture, web curl, and gloss during paper production;
- Water-management systems: systems and equipment used to continuously
clean paper machine fabrics and to drain, purify, and recycle process
water during paper sheet formation; and
- Fluid handling: rotary joints, precision unions, steam and condensate
systems, components, and controls used primarily in the dryer section
of the papermaking process and during the production of corrugated
boxboard, metals, plastics, rubber, and textiles.
Other
Our other business lines include the Fiber-based Products business and
Casting Products business.
Our Fiber-based Products business produces biodegradable, absorbent
granules from papermaking byproducts for use primarily as carriers for
agricultural, home lawn and garden, and professional lawn, turf and ornamental
applications, as well as for oil and grease absorption.
Our Casting Products business manufactures grey and ductile iron
castings.
Discontinued Operation
We produce composite building products, including decking and railing
systems and roof tiles, made from recycled fiber, plastic, and other material,
which are marketed through distributors primarily to the building industry.
On October 27, 2004, our board of directors approved a plan and
management committed to sell our composites business after making a
determination that the business no longer aligned with our long-term strategy.
We intend to sell the composites business as a going concern and are working
with an investment banking firm for that purpose. We plan to sell the composites
business by the end of 2005 at a price that is reasonable compared to its
carrying value. The composites business had total assets and liabilities of
$14.9 million and $6.6 million, respectively, as of July 2, 2005, including
accrued warranty costs of $3.5 million, which we may retain in the sale of the
business. In addition, revenues and net income for the second quarter of 2005
were $5.5 million and $0.2 million, respectively, and the revenues and net loss
for the first six months of 2005 were $10.8 million and $0.2 million,
respectively. The composites business has been presented as a discontinued
operation in the accompanying condensed consolidated financial statements for
all periods presented.
International Sales
During the first six months of 2005 and 2004, approximately 62% and 61%,
respectively, of our sales were to customers outside the United States,
principally in Europe and Asia. We generally seek to charge our customers in the
same currency in which our operating costs are incurred. However, our financial
performance and competitive position can be affected by currency exchange rate
fluctuations affecting the relationship between the U.S. dollar and foreign
currencies. We seek to reduce our exposure to currency fluctuations through the
use of forward currency exchange contracts. We may enter into forward contracts
to hedge certain firm purchase and sale commitments denominated in currencies
other than our subsidiaries' functional currencies. These contracts hedge
transactions principally denominated in U.S. dollars.
<
22
>
KADANT INC.
Overview (continued)
Application of Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The preparation of these condensed consolidated financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of our condensed consolidated financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results may differ from these estimates under different assumptions or
conditions.
Critical accounting policies are defined as those that reflect
significant judgments and uncertainties, and could potentially result in
materially different results under different assumptions and conditions. We
believe that our most critical accounting policies, upon which our financial
condition depends and which involve the most complex or subjective decisions or
assessments, are those described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" under the section captioned
"Application of Critical Accounting Policies and Estimates" in Item 7 of our
Annual Report on Form 10-K for the fiscal year ended January 1, 2005, filed with
the Securities and Exchange Commission. There have been no material changes to
these critical accounting policies since fiscal year-end 2004 that warrant
further disclosure.
Industry and Business Outlook
Our products are primarily sold to the pulp and paper industry. The paper
industry had been in a prolonged downcycle for the past several years. While the
performance of paper producers, especially in North America, has been gradually
improving over the past year, the industry is continuing to experience sluggish
demand. The profitability of paper producers is still being negatively affected
by higher operating costs, especially higher energy and chemical costs. We
believe paper companies are still cautious about increasing their capital and
operating spending in the current market environment. We expect, however, if the
market recovers, paper companies will increase their capital and operating
spending, which would have a positive effect on paper company suppliers, such as
Kadant, although the timing of such effect is difficult to predict. We continue
to concentrate our efforts on several initiatives intended to improve our
operating results, including: (i) integrating the Kadant Johnson acquisition,
(ii) penetrating new markets outside the paper industry, (iii) opening a
stock-preparation production plant in China, (iv) increasing aftermarket sales,
(v) completing the Kadant Lamort restructuring, and (vi) selling the composites
business. In addition, we continue to focus our efforts on managing our
operating costs, capital expenditures, and working capital.
In an effort to improve operating performance at our Kadant Lamort
subsidiary in France, we approved a proposed restructuring of that subsidiary on
November 18, 2004. This restructuring is intended to strengthen Kadant Lamort's
competitive position in the European paper industry. Under French law, the
proposed restructuring required consultation with Kadant Lamort's workers'
council, which represents the employees, before implementation. The
restructuring originally proposed the reduction of up to 136 full-time positions
in France. We accrued a restructuring charge of $9.2 million in the fourth
quarter of 2004 for severance and other termination costs in connection with the
workforce reduction. Kadant Lamort experienced intermittent work stoppages by
employees protesting the proposed restructuring while the consultations with
the workers' council were in process. We recently completed the necessary
consultations with the workers' council and expect the restructuring to be fully
implemented by the fourth quarter of 2005. We expect that Kadant Lamort will
continue to experience significant operating losses until these restructuring
actions are completed.
We continue to pursue market opportunities outside North America. In the
last several years, China has become a significant market for our
stock-preparation equipment. To capitalize on this growing market, we plan to
build a manufacturing and assembly facility in China for our stock-preparation
equipment and related aftermarket products.
<
23
>
KADANT INC.
Overview (continued)
Revenues from China are primarily derived from large capital orders, the timing
of which is often difficult to predict. For the past several quarters, our
customers in China have experienced delays in obtaining financing for their
capital addition and expansion projects, which we believe is due to efforts by
the Chinese government to control economic growth, which are reflected in a
slowdown in financing approvals in China's banking system. This has caused
delays in receiving orders and, as a result, will delay our recognizing revenue
on these projects to periods later than originally expected. We plan to use our
new facility in China as a base for increasing our aftermarket business, which
we believe will be more predictable.
On May 11, 2005, we acquired all the outstanding stock of Kadant Johnson,
a leading supplier of steam and condensate systems, components, and controls
used primarily in the dryer section of the papermaking process and during the
production of steel, plastics, rubber, and textiles. Kadant Johnson was a
privately held company based in Michigan with approximately 575 employees at
operations in North and South America, Europe and Asia. Kadant Johnson's primary
products include rotary joints, syphons, and related steam and condensate
systems. The purchase price was $101.5 million in cash, subject to a further
post-closing adjustment as outlined in the purchase agreement for Kadant
Johnson, and $3.1 million in acquisition related costs. In addition to the cash
consideration, we issued a letter of credit to the sellers for $4 million,
subject to adjustment, related to certain tax assets of Kadant Johnson, the
value of which we expect to realize. The parties also agreed in the purchase
agreement to an earn-out provision, based on the achievement of certain revenue
targets between the closing date and July 1, 2006, which could increase the
purchase price by up to $8 million. The majority of the results for Kadant
Johnson will be reported in the Pulp and Papermaking Systems segment within the
fluid handling product line. Results associated with the Casting Products
business will be reported in "Other."
Our 2005 guidance reflects expected revenues and earnings per share from
continuing operations, which excludes the results from our composite building
products business (accounted for as a discontinued operation). For the third
quarter of 2005, we expect to earn between $.19 to $.21 per diluted share, on
revenues of $65 to $67 million. For the full year, we expect to earn between
$.92 to $1.00 per diluted share, on revenues of $250 to $260 million.
<
24
>
KADANT INC.
Results of Operations
Second Quarter 2005 Compared With Second Quarter 2004
- -----------------------------------------------------
The following table sets forth our unaudited condensed consolidated
statement of income expressed as a percentage of total revenues for the second
fiscal quarters of 2005 and 2004. The results of operations for the fiscal
quarter ended July 2, 2005 are not necessarily indicative of the results to be
expected for the full fiscal year.
Three Months Ended
-------------------------------
July 2, July 3,
2005 2004
- -----------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
------- -------
Costs and Operating Expenses:
Cost of revenues 62 61
Selling, general, and administrative expenses 28 28
Research and development expenses 2 1
------- -------
92 90
------- -------
Operating Income 8 10
Interest Income (Expense), net - 1
------- -------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 8 11
Provision for Income Taxes 3 3
Minority Interest Expense - -
------- -------
Income from Continuing Operations 5 8
Income (Loss) from Discontinued Operation - (1)
------- -------
Net Income 5% 7%
======= =======
Revenues
Revenues increased $12.4 million, or 24%, to $65.1 million in the second
quarter of 2005 from $52.7 million in the second quarter of 2004. Revenues in
the second quarter of 2005 include an $11.1 million, or 21%, increase from
recently acquired Kadant Johnson, and the favorable effect of currency
translation of $1.2 million, or 2%, due to a weaker U.S. dollar relative to most
of the functional currencies in countries in which we operate.
Revenues for the second quarters of 2005 and 2004 from our Papermaking
Systems segment and other businesses are as follows:
Three Months Ended
----------------------------
July 2, July 3,
(In thousands) 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Systems $ 62,528 $ 50,933
Other 2,558 1,719
-------- --------
$ 65,086 $ 52,652
======== ========
<
25
>
KADANT INC.
Results of Operations (continued)
Pulp and Papermaking Systems Segment. Revenues at the Papermaking Systems
segment increased $11.6 million, or 23%, to $62.5 million in the second quarter
of 2005 from $50.9 million in the second quarter of 2004. Revenues in the second
quarter of 2005 include a $10.6 million, or 21%, increase from recently acquired
Kadant Johnson, and the favorable effect of currency translation described
above, all of which related to this segment.
Revenues at the Papermaking Systems segment by product line are as
follows:
Increase
(Decrease)
Three Months Ended Excluding
------------------------- Effect of
July 2, July 3, Increase Currency
(In millions) 2005 2004 (Decrease) Translation
- ----------------------------------------------------------------------------------------------------------------------------------
Product Line:
Stock-Preparation Equipment $ 29.2 $ 26.9 $ 2.3 $ 1.7
Accessories 15.3 15.9 (0.6) (1.1)
Water-Management 7.0 7.8 (0.8) (0.9)
Fluid Handling 10.6 - 10.6 10.6
Other 0.4 0.3 0.1 0.1
------- ------- -------- --------
$ 62.5 $ 50.9 $ 11.6 $ 10.4
======= ======= ======== ========
Revenues from the segment's stock-preparation equipment product line
increased $2.3 million, or 9%, in the second quarter of 2005 compared to the
second quarter of 2004, including a $0.6 million increase from the favorable
effect of currency translation. Excluding the effect of currency translation,
revenues from the stock-preparation equipment product line increased $1.7
million, or 6%, due to a $7.7 million increase in sales in our North
American-based business due to strong sales in our Chemi-Washer(TM) product
line. This increase was offset in part by a $3.9 million, or 37%, decrease in
sales in China in the second quarter of 2005 related to the timing of several
large orders and to continued delays by customers in securing their financing
approvals from the Chinese government. In addition, sales in Europe decreased
$2.1 million, or 20%, in the second quarter of 2005 due to continuing weakness
in the European market for stock-preparation capital equipment.
Revenues from the segment's accessories product line decreased $0.6
million, or 4%, in the second quarter of 2005 compared to the second quarter of
2004, including a $0.5 million increase from the favorable effect of currency
translation. Excluding the effect of currency translation, revenues from the
segment's accessories product line decreased $1.1 million, or 7%, due to a
decrease in sales in North America and Europe due to weaker demand for our
capital equipment.
Revenues from the segment's water-management product line decreased $0.8
million, or 10%, in the second quarter of 2005 compared to the second quarter of
2004, including a $0.1 million increase from the favorable effect of currency
translation. Excluding the effect of currency translation, revenues from the
segment's water-management product line decreased $0.9 million, or 12%, due
primarily to weak demand for our capital equipment in North America.
Revenues from the fluid handling product line were $10.6 million in the
second quarter of 2005, which reflects the results for Kadant Johnson from the
acquisition date of May 11, 2005 to July 2, 2005.
<
26
>
KADANT INC.
Results of Operations (continued)
Other. Revenues from the Fiber-based Products business increased $0.4
million, or 19%, to $2.1 million in the second quarter of 2005 from $1.7 million
in the second quarter of 2004, primarily as a result of an increase in sales to
an existing customer of Biodac(TM), our product family of biodegradable granules
that we produce from papermaking byproducts. Revenues from the Casting Products
business were $0.5 million in the second quarter of 2005.
Gross Profit Margin
Gross profit margin was 38% in the second quarter of 2005 compared to 39%
in the second quarter of 2004.
Gross profit margins for the second quarters of 2005 and 2004 for our
Papermaking Systems segment and our other businesses are as follows:
Three Months Ended
----------------------------
July 2, July 3,
2005 2004
- ----------------------------------------------------------------------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Systems 38% 38%
Other 37 45
------ ------
38% 39%
The gross profit margin at the Papermaking Systems segment was 38% in the
second quarter of 2005 and 2004. The fluid handling product line contributed a
3% increase in gross profit margins in the second quarter of 2005, which was
offset by lower margins in our stock-preparation product line. The gross profit
margin at our other businesses decreased to 37% in the second quarter of 2005
from 45% in the second quarter of 2004 due to the inclusion of lower margins at
the Casting Products business.
Operating Expenses
Selling, general, and administrative expenses as a percentage of revenues
remained constant at 28% in the second quarters of 2005 and 2004. Selling,
general, and administrative expenses increased to $18.5 million in the second
quarter of 2005 from $14.6 million in the second quarter of 2004, an increase of
$3.9 million, or 27%, due primarily to the inclusion of $4.1 million in selling,
general, and administrative expenses from Kadant Johnson. In addition, an
increase of $0.4 million in the second quarter of 2005 was due to the
unfavorable impact of foreign currency translation in the Papermaking Systems
segment compared to the second quarter of 2004.
Research and development expenses were $1.2 million and $0.6 million in
the second quarters of 2005 and 2004, respectively, and represented 2% and 1% of
revenues in the 2005 and 2004 periods, respectively.
Interest Income
Interest income increased to $0.4 million in the second quarter of 2005
from $0.3 million in the second quarter of 2004 primarily due to higher
prevailing interest rates, offset in part by a decrease in the average cash
balances resulting from the May 2005 acquisition of Kadant Johnson.
Interest Expense
Interest expense increased to $0.5 million in the second quarter of 2005
from $4 thousand in the second quarter of 2004 due to interest expense
associated with the $60.0 million in borrowings entered into in May 2005 to fund
the Kadant Johnson acquisition.
<
27
>
KADANT INC.
Results of Operations (continued)
Income Taxes
Our effective tax rate was 34% and 28% in the second quarters of 2005 and
2004, respectively. The 28% effective tax rate in the second quarter of 2004
consisted of our 35% recurring tax rate offset by a 7% non-recurring tax benefit
resulting from a reduction of $0.4 million in tax reserves primarily associated
with our foreign operations, as the reserves were no longer required.
Income from Continuing Operations
Income from continuing operations decreased to $3.1 million in the second
quarter of 2005 from $4.0 million in the second quarter of 2004, a decrease of
$0.9 million, or 21%. The largest components of this decrease can be attributed
to a decrease in gross profit margins and an increase in interest expense
(see Gross Profit Margin and Interest Expense above for further discussion).
Income (Loss) from Discontinued Operation
The discontinued operation had net income of $0.2 million in the second
quarter of 2005 compared to a net loss of $0.2 million in the second quarter of
2004, due primarily to a $0.4 million increase in revenues, and a $0.3 million
decrease in operating expenses, which was offset by a $0.2 million increase in
income taxes.
First Six Months 2005 Compared With First Six Months 2004
- ---------------------------------------------------------
The following table sets forth our unaudited condensed consolidated
statement of income expressed as a percentage of total revenues for the first
six months of 2005 and 2004. The results of operations for the first six months
of 2005 are not necessarily indicative of the results to be expected for the
full fiscal year.
Six Months Ended
---------------------------
July 2, July 3,
2005 2004
- ---------------------------------------------------------------------------------------------------------------------------
Revenues 100% 100%
------- -------
Costs and Operating Expenses:
Cost of revenues 62 60
Selling, general, and administrative expenses 29 28
Research and development expenses 2 2
------- -------
93 90
------- -------
Operating Income 7 10
Interest Income, net - 1
------- -------
Income from Continuing Operations Before Provision for
Income Taxes and Minority Interest Expense 7 11
Provision for Income Taxes 2 4
Minority Interest Expense - -
------- -------
Income from Continuing Operations 5 7
Loss from Discontinued Operation - (1)
------- -------
Net Income 5% 6%
======= =======
<
28
>
KADANT INC.
Results of Operations (continued)
Revenues
Revenues increased $15.6 million, or 16%, to $115.8 million in the first
six months of 2005 from $100.2 million in the first six months of 2004. Revenues
in the 2005 period include a $10.6 million, or 11%, increase from recently
acquired Kadant Johnson, and the favorable effect of currency translation of
$2.3 million due to a weaker U.S. dollar relative to most of the functional
currencies in countries in which we operate.
Revenues by segment for the first six months of 2005 and 2004 were as
follows:
Six Months Ended
----------------------------
July 2, July 3,
(In thousands) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Pulp and Papermaking Systems $ 110,099 $ 96,497
Other 5,731 3,655
--------- ---------
$ 115,830 $ 100,152
========= =========
Pulp and Papermaking Systems Segment. Revenues at the Papermaking Systems
segment increased $13.6 million, or 14%, to $110.1 million in the first six
months of 2005 from $96.5 million in the first six months of 2004. Revenues in
the first six months of 2005 include the favorable effect of currency
translation described above, all of which related to this segment.
Revenues at the Papermaking Systems segment by product line are as
follows:
Increase
(Decrease)
Three Months Ended Excluding
------------------------- Effect of
July 2, July 3, Increase Currency
(In millions) 2005 2004 (Decrease) Translation
- ----------------------------------------------------------------------------------------------------------------------------------
Product Line:
Stock-Preparation Equipment $ 53.8 $ 48.6 $ 5.2 $ 4.0
Accessories 30.6 31.9 (1.3) (2.2)
Water-Management 14.3 15.3 (1.0) (1.2)
Fluid Handling 10.6 - 10.6 10.6
Other 0.8 0.7 0.1 0.1
------- ------- -------- ---------
$ 110.1 $ 96.5 $ 13.6 $ 11.3
======= ======= ========= =========
Revenues from the segment's stock-preparation equipment product line
increased $5.2 million, or 11%, in the first six months of 2005 compared to the
first six months of 2004, including a $1.2 million increase from the favorable
effect of currency translation. Excluding the effect of currency translation,
revenues from the stock-preparation equipment product line increased $4.0
million, or 8%, due to a $9.9 million, or 76%, increase in sales in our North
American-based business. These increases were offset in part by a $4.9 million,
or 28%, decrease in sales in China in the first six months of 2005 due to
continued delays by customers in securing their financing approvals from the
Chinese government. In addition, sales in Europe decreased $1.0 million, or 5%,
in the first six months of 2005 due to continued weakness in the European market
for stock-preparation capital equipment.
<
29
>
KADANT INC.
Results of Operations (continued)
Revenues from the segment's accessories product line decreased $1.3
million, or 4%, in the first six months of 2005 compared to the first six months
of 2004, including a $0.9 million increase from the favorable effect of currency
translation. Excluding the effect of currency translation, revenues from the
segment's accessories product line decreased $2.2 million, or 7%, due to a
decrease in sales in North America and Europe.
Revenues from the segment's water-management product line decreased $1.0
million, or 6%, in the first six months of 2005 compared to the first six months
of 2004, including a $0.2 million increase from the favorable effect of currency
translation. Excluding the effect of currency translation, revenues from the
segment's water-management product line decreased $1.2 million, or 8%, due
primarily to a decrease in capital sales in North America.
Revenues from the fluid handling product line were $10.6 million in the
first six months of 2005, which reflects the results for Kadant Johnson from the
acquisition date of May 11, 2005 to July 2, 2005.
Other. Revenues from the Fiber-based Products business increased $1.5
million, or 43%, to $5.2 million in the first six months of 2005 from $3.7
million in the first six months of 2004, primarily as a result of an increase in
sales to an existing customer of Biodac(TM), our product family of biodegradable
granules that we produce from papermaking byproducts. Revenues from the Casting
Products business were $0.5 million in the first six months of 2005.
Gross Profit Margin
Gross profit margin was 38% in the first six months of 2005 compared to
40% in the first six months of 2004.
Gross profit margins for the first six months of 2005 and 2004 for our
Papermaking Systems segment and our other businesses are as follows:
Six Months Ended
--------------------------
July 2, July 3,
2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Gross Profit Margin:
Pulp and Papermaking Systems 37% 40%
Other 40 39
------ ------
38% 40%
The gross profit margin at the Papermaking Systems segment decreased to
37% in the first six months of 2005 from 40% in the first six months of 2004.
The fluid handling product line contributed a 1% increase in gross profit
margins in the first six months of 2005, which was offset by lower margins in
our stock-preparation product line. The gross profit margin at our other
businesses was 40% and 39% in the first six months of 2005 and 2004,
respectively.
Operating Expenses
Selling, general, and administrative expenses as a percentage of revenues
were 29% and 28% in the first six months of 2005 and 2004, respectively.
Selling, general, and administrative expenses increased to $33.4 million in the
first six months of 2005 from $28.3 million in the first six months of 2004, an
increase of $5.1 million, or 18%. The $5.1 million increase was primarily due to
$4.1 million of selling, general, and administrative expenses in the 2005 period
associated with Kadant Johnson and a gain of approximately $1.0 million in the
first quarter of 2004. The gain in the first quarter of 2004 resulted from the
renegotiation of a series of agreements with one of our licensees, which lowered
selling, general, and administrative expenses in that period.
<
30
>
KADANT INC.
Results of Operations (continued)
Research and development expenses were $2.3 million and $1.5 million and
represented 2% of revenues in the first six months of 2005 and 2004. Included in
the $0.8 million increase in research and development expenses were $0.2 million
of research and development expenses associated with Kadant Johnson.
Interest Income
Interest income increased to $0.9 million in the first six months of 2005
from $0.6 million in the first six months of 2004 primarily due to higher
prevailing interest rates.
Interest Expense
Interest expense increased to $0.5 million in the first six months of
2005 from $12 thousand in the first six months of 2004 due to interest expense
associated with the $60.0 million in borrowings entered into in May 2005 to fund
the Kadant Johnson acquisition.
Income Taxes
Our effective tax rate was 23% and 31% in the first six months of 2005
and 2004, respectively. The 23% effective tax rate in the first six months of
2005 consisted of our 34% recurring tax rate, offset by an 11% non-recurring tax
benefit associated with a reimbursement of $0.9 million received from our former
parent company, Thermo Electron, pursuant to our tax matters agreement for tax
years in which we were included in Thermo Electron's consolidated tax return.
The 31% effective tax rate in the first six months of 2004 consisted of a 35%
recurring tax rate, offset by a 4% non-recurring tax benefit resulting from a
reduction of $0.4 million in tax reserves primarily associated with our foreign
operations, as the reserves were no longer required.
Income from Continuing Operations
Income from continuing operations decreased to $6.2 million in the first
six months of 2005 from $7.3 million in the first six months of 2004, a decrease
of $1.1 million, or 15%. The largest component of this decrease can be
attributed to a decrease in gross profit margins (see Gross Profit Margin
above for further discussion).
Loss from Discontinued Operation
The loss from our discontinued operation decreased to $0.2 million in the
first six months of 2005 from $0.8 million in the first six months of 2004, due
primarily to a $1.4 million increase in revenues.
Liquidity and Capital Resources
Consolidated working capital, including the discontinued operation, was
$86.8 million at July 2, 2005, compared with $113.7 million at January 1, 2005.
Included in working capital are cash and cash equivalents of $46.2 million at
July 2, 2005, compared with $82.1 million at January 1, 2005. At July 2, 2005,
$23.9 million of cash and cash equivalents were held by our foreign
subsidiaries.
Our operating activities provided $4.9 million and $8.3 million of cash
during the first six months of 2005 and 2004, respectively. The most significant
components of the cash provided in the first six months of 2005 were the cash
provided by income from continuing operations of $6.2 million and a non-cash
charge for depreciation and amortization expense of $2.7 million. The remaining
portion of the cash provided in the first six months of 2005 is comprised of the
following offsetting components. An increase in unbilled contract costs and fees
used cash of $6.1
<
31
>
KADANT INC.
Liquidity and Capital Resources (continued)
million in the first six months of 2005. A decrease in inventories in the first
six months of 2005 provided cash of $3.1 million. A decrease in other current
liabilities used cash of $2.9 million in the first six months of 2005. A
decrease in accounts receivable in the first six months of 2005 provided an
increase in cash of $2.4 million primarily at the Papermaking Systems segment,
due to the timing of payments.
Our investing activities used cash of $100.2 million and $51 thousand in
the first six months of 2005 and 2004, respectively. During the first six months
of 2005, we used cash of $101.4 million to acquire the stock of The Johnson
Corporation. In addition, during the first six months of 2005, $3.1 million of
deferred acquisition costs associated with the Kadant Johnson acquisition were
capitalized to goodwill.
Our financing activities provided cash of $62.6 million in the first six
months of 2005 and used cash of $2.2 million in the first six months of 2004.
During the first six months of 2005, we received proceeds of $60 million from a
term loan we entered into to fund a portion of the purchase price for Kadant
Johnson. We also increased our short- and long-term obligations by $4 million,
which represents additional consideration for Kadant Johnson to be paid over the
next five years. In addition, we used cash of $2.1 million to purchase our
common stock on the open market. In the first six months of 2004, we used cash
of $6.2 million to purchase our common stock on the open market and received
$4.6 million from the issuance of common stock in connection with the exercise
of employee stock options.
Our discontinued operation used cash of $0.4 million in the first six
months of 2005 and provided cash of $0.2 million in the first six months of
2004. The use of cash of $0.4 million in the first six months of 2005 was
primarily due to a decrease in accrued warranty costs of $0.8 million, and the
loss from discontinued operation of $0.2 million, offset by a decrease in
accounts receivable of $0.5 million.
On October 22, 2004, the American Jobs Creation Act of 2004 (the Act) was
signed into law. The Act creates a temporary incentive for U.S. multinationals
to repatriate accumulated income earned outside the U.S. at an effective tax
rate of 5.25%. On December 21, 2004, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position, "Accounting and Disclosure Guidance for the
Foreign Earnings Repatriation Provision within the American Jobs Creation Act of
2004" (FAS No. 109-2). FAS No. 109-2 allows companies additional time to
evaluate the effect of the law on unrepatriated foreign earnings, and whether
they continue to qualify for the exception in SFAS No. 109, "Accounting for
Income Taxes," to recognizing deferred tax liabilities, and would require
explanatory disclosures from those who need the additional time. Through July 2,
2005, we have not provided U.S. income taxes on approximately $52.3 million of
unremitted foreign earnings because such earnings were intended to be
indefinitely reinvested outside the U.S. Whether we will ultimately utilize and
benefit from the provisions of the Act depends on a number of factors, including
the results of reviewing future Congressional guidance before a decision can be
made. Until that time, we will make no change in our current intention to
indefinitely reinvest accumulated earnings of our foreign subsidiaries, except
in instances in which we can remit such earnings without a significant
associated tax cost. We do not expect that this will have a material adverse
effect on our current liquidity. Absent the repatriation incentive of the Act,
we believe that any U.S. tax liability due upon remittance of such earnings
would be immaterial due to the availability of U.S. foreign tax credits
generated from such remittance. The related foreign tax withholding, which would
be required if we remitted the foreign earnings to the U.S., would be
approximately $1.9 million.
In May 2004, our board of directors authorized the repurchase of up to
$30 million of our equity securities in the open market or in negotiated
transactions through May 18, 2005. Prior to January 1, 2005, we had repurchased
460,400 shares of our common stock under this authorization for $9.3 million.
For the period from January 2, 2005 through May 18, 2005, we repurchased an
additional 109,700 shares of our common stock under this authorization for $2.1
million. On May 6, 2005, our board of directors authorized the repurchase of up
to $15 million of our equity securities in the open market or in negotiated
transactions for the period from May 18, 2005 through May 18, 2006. As of July
2, 2005, we had repurchased 1,200 shares of our common stock under this new
authorization for $25 thousand.
<
32
>
KADANT INC.
Liquidity and Capital Resources (continued)
We completed our acquisition of Kadant Johnson on May 11, 2005 for $101.5
million in cash, subject to a further post-closing adjustment as outlined in the
purchase agreement for Kadant Johnson, and $3.1 million in acquisition related
costs. In addition to the cash consideration, we issued a letter of credit to
the sellers for $4 million, subject to adjustment, related to certain tax assets
of Kadant Johnson, the value of which we expect to realize. We also agreed in
the purchase agreement to an earn-out provision, based on the achievement of
certain revenue targets between the closing date and July 1, 2006, which could
increase the purchase price by up to $8 million. To fund $60 million of the
purchase price, we entered into a term loan and revolving credit facility (the
Credit Agreement) effective as of May 9, 2005 in the aggregate principal amount
of up to $85 million, including a $25 million revolver. The Credit Agreement
includes a $60 million five-year term loan, which is repayable in equal
quarterly installments over a five-year period. The aggregate principal to be
repaid each year is as follows: $4.5 million, $9 million, $10.5 million, $13.5
million, $15 million, and $7.5 million in 2005, 2006, 2007, 2008, 2009, and
2010, respectively. Interest on the revolving loan and the term loan accrues and
is payable quarterly in arrears at one of the following rates selected by us:
(a) the prime rate plus an applicable margin initially set at 0% for 2005, and
up to 0.25% thereafter or, (b) a eurocurrency rate plus an applicable margin
initially set at 1% for 2005, and between 0.625% and 1.25% thereafter. The
applicable margin is determined based upon our total debt to earnings before
interest, taxes, depreciation and amortization (EBITDA) ratio.
The obligations for us under the Credit Agreement may be accelerated upon
the occurrence of an event of default under the Credit Agreement, which include
customary events of default including, without limitation, payment defaults,
defaults in the performance of affirmative and negative covenants, the
inaccuracy of representations or warranties, bankruptcy- and insolvency-related
defaults, defaults relating to such matters as ERISA, uninsured judgments and
the failure to pay certain indebtedness, and a change of control default.
In addition, the Credit Agreement contains negative covenants applicable
to us and our subsidiaries, including financial covenants requiring us to comply
with a maximum consolidated leverage ratio of either 2.5 or 3.0 and a minimum
consolidated fixed charge coverage ratio of 1.5, 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, negative pledges, arrangements affecting subsidiary
distributions, and entering into new lines of business. As of July 2, 2005, we
are in compliance with all the covenants in the Credit Agreement.
The loans under the Credit Agreement are guaranteed by certain of our
domestic subsidiaries and secured by a pledge of 65% of the stock of our
first-tier foreign subsidiaries and our subsidiary guarantors pursuant to a
guarantee and pledge agreement effective as of May 9, 2005 in favor of JPMorgan
Chase Bank, N.A., as agent on behalf of the lenders.
Although we currently have no material commitments for capital
expenditures, we plan to make expenditures during the remainder of 2005 for
property, plant, and equipment of approximately $3.9 million, including $1.2
million for our manufacturing and assembly facility in China to support our
stock-preparation equipment business. This estimate excludes the capital
expenditure requirement for Kadant Johnson, which will not have a significant
effect on our liquidity in the second half of 2005.
Our future liquidity position will be primarily affected by the level of
cash flows from operations and the amount of cash expended on debt repayments,
capital projects, stock repurchases, or additional acquisitions, if any. We
believe that our existing resources, together with the cash available from our
credit facility and the cash we expect to generate from continuing operations,
will be sufficient to meet the capital requirements of our operations for the
foreseeable future.
<
33
>
KADANT INC.
Risk Factors
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, we wish to caution readers that the following
important factors, among others, in some cases have affected, and in the future
could affect, our actual results and could cause our actual results in 2005 and
beyond to differ materially from those expressed in any forward-looking
statements made by us, or on our behalf.
Our business is dependent on the condition of the pulp and paper industry.
We sell products primarily to the pulp and paper industry, which is a
cyclical industry. Generally, the financial condition of the global pulp and
paper industry corresponds to the condition of the general economy, as well as
to a number of other factors, including pulp and paper production capacity
relative to demand. In recent years, the industry in certain geographic regions,
notably North America, has been in a prolonged downcycle, resulting in depressed
pulp and paper prices, decreased spending, mill closures, consolidations, and
bankruptcies, all of which have adversely affected our business. As paper
companies consolidate in response to market weakness, they frequently reduce
capacity and postpone or even cancel capacity addition or expansion projects.
These cyclical downturns can cause our sales to decline and adversely affect our
profitability.
Our business is subject to economic, currency, political, and other risks
associated with international sales and operations.
During the first six months of 2005 and 2004, approximately 62% and 61%,
respectively, of our sales were to customers outside the United States,
principally in Europe and Asia. International revenues are subject to a number
of risks, including the following:
- agreements may be difficult to enforce and receivables difficult to
collect through a foreign country's legal system;
- foreign customers may have longer payment cycles;
- foreign countries may impose additional withholding taxes or
otherwise tax our foreign income, impose tariffs, or adopt other
restrictions on foreign trade; and
- the protection of intellectual property in foreign countries may be
more difficult to enforce.
Although we seek to charge our customers in the same currency in which
our operating costs are incurred, fluctuations in currency exchange rates may
affect product demand and adversely affect the profitability in U.S. dollars of
products we provide in international markets where payment for our products and
services is made in their local currencies. Any of these factors could have a
material adverse impact on our business and results of operations.
A significant portion of our international sales has, and may in the
future, come from China. An increase in revenues, as well as our planned
operation of a manufacturing and assembly facility in China, will expose us to
increased risk in the event of changes in the policies of the Chinese
government, political unrest, unstable economic conditions, or other
developments in China or in U.S.-China relations that are adverse to trade,
including enactment of protectionist legislation or trade restrictions. Orders
from customers in China, particularly for large systems that have been tailored
to a customer's specific requirements, involve increased credit risk due to
payment terms that are applicable to doing business in China. In addition, the
timing of these orders is often difficult to predict.
<
34
>
KADANT INC.
Risk Factors (continued)
We are subject to intense competition in all our markets.
We believe that the principal competitive factors affecting the markets
for our products include quality, price, service, technical expertise, and
product innovation. Our competitors include a number of large multinational
corporations that may have substantially greater financial, marketing, and other
resources than we do. As a result, they may be able to adapt more quickly to new
or emerging technologies and changes in customer requirements, or to devote
greater resources to the promotion and sale of their services and products.
Competitors' technologies may prove to be superior to ours. Our current
products, those under development, and our ability to develop new technologies
may not be sufficient to enable us to compete effectively. Competition,
especially in China, could increase if new companies enter the market or if
existing competitors expand their product lines or intensify efforts within
existing product lines.
Our debt may adversely affect our cash flow and may restrict our investment
opportunities.
On May 9, 2005, we entered into a Credit Agreement, consisting of a $60
million five-year term loan and a $25 million revolver. On May 11, 2005, we
borrowed $60 million to fund the acquisition of Kadant Johnson under the term
loan. We may also obtain additional long-term debt and working capital lines of
credit to meet future financing needs, which would have the effect of increasing
our total leverage.
Our leverage could have negative consequences, including:
- increasing our vulnerability to adverse economic and industry
conditions,
- limiting our ability to obtain additional financing,
- limiting our ability to pay dividends on or repurchase our capital
stock,
- limiting our ability to acquire new products and technologies through
acquisitions or licensing, and
- limiting our flexibility in planning for, or reacting to, changes in
our business and the industries in which we compete.
Our indebtedness bears interest at floating rates pursuant to the terms
of the Credit Agreement. As a result, our interest payment obligations on this
indebtedness will increase if interest rates increase. To reduce the exposure to
floating rates, we have converted $36 million, or 60%, of our indebtedness to a
fixed rate of interest through an interest rate swap.
Our ability to satisfy our obligations and to reduce our total debt
depends on our future operating performance and on economic, financial,
competitive, and other factors beyond our control. Our business may not generate
sufficient cash flows to meet these obligations or to successfully execute our
business strategy. If we are unable to service our debt and fund our business,
we may be forced to reduce or delay capital expenditures or research and
development expenditures, seek additional financing or equity capital,
restructure or refinance our debt or sell assets. We may not be able to obtain
additional financing or refinance existing debt or sell assets on terms
acceptable to us or at all.
<
35
>
KADANT INC.
Risk Factors (continued)
Restrictions in our Credit Agreement may limit our activities.
Our Credit Agreement contains, and future debt instruments to which we
may become subject may contain, restrictive covenants that limit our ability to
engage in activities that could otherwise benefit us, including restrictions on
our ability and the ability of our subsidiaries to:
- incur additional indebtedness,
- pay dividends on, redeem or repurchase our capital stock,
- make investments,
- create liens,
- sell assets,
- enter into transactions with affiliates, and
- consolidate, merge or transfer all or substantially all of our assets
and the assets of our subsidiaries.
We are also required to meet specified financial ratios under the terms
of our Credit Agreement. Our ability to comply with these financial restrictions
and covenants is dependent on our future performance, which is subject to
prevailing economic conditions and other factors, including factors that are
beyond our control such as foreign exchange rates, interest rates, changes in
technology, and changes in the level of competition.
Our failure to comply with any of these restrictions or covenants may
result in an event of default under our Credit Agreement, which could permit
acceleration of the debt under that instrument and require us to repay that debt
before its scheduled due date.
If an event of default occurs, we may not have sufficient funds available
to make the required payments under our indebtedness. If we are unable to repay
amounts owed under our Credit Agreement, those lenders may be entitled to
foreclose on and sell the collateral that secures our borrowings under that
agreement.
Our inability to successfully integrate Kadant Johnson into our business could
have a material adverse effect on our business.
On May 11, 2005, we acquired Kadant Johnson. Over the coming months, we
will be working to integrate Kadant Johnson into our business. This integration
will involve the merger of employees, products and services over multiple U.S.
and international locations. We may not be successful in integrating this
business into our current structure, or in obtaining the anticipated cost
savings or synergies from the acquisition. To meet our quarterly certification
requirements and in anticipation of incorporating Kadant Johnson into our 2006
Sarbanes-Oxley compliance process, we will also be performing a detailed review
of Kadant Johnson's internal control structure to ensure that its controls over
financial reporting are consistent with our policies and procedures. Given the
multi-location structure of the Kadant Johnson business, this review will take
significant time and effort, similar to our Sarbanes-Oxley compliance efforts in
2004, and will involve significant cost. We may identify control deficiencies
during this process. Our ability to realize the value of the goodwill and other
intangibles recorded for this acquisition will depend on the future cash flows
of the Kadant Johnson business. If these future cash flows are below what we
anticipated, we may incur future impairment losses associated with goodwill and
intangibles, which could have a material adverse effect on our results of
operations.
<
36
>
KADANT INC.
Risk Factors (continued)
Our inability to successfully identify and complete acquisitions or successfully
integrate any new or previous acquisitions could have a material adverse effect
on our business.
Our strategy includes the acquisition of technologies and businesses that
complement or augment our existing products and services. Promising acquisitions
are difficult to identify and complete for a number of reasons, including
competition among prospective buyers and the need for regulatory, including
antitrust, approvals. We do incur costs from time to time associated with
potential acquisitions, which are deferred during the due diligence phase.
Future operating results could be negatively impacted in any quarter in which we
determine that a potential acquisition will not close and these associated costs
are expensed. Any acquisition we may complete may be made at a substantial
premium over the fair value of the net assets of the acquired company. We may
not be able to complete future acquisitions, integrate any acquired businesses
successfully into our existing businesses, make such businesses profitable, or
realize anticipated cost savings or synergies, if any, from these acquisitions.
In addition, we have previously acquired several companies and businesses. As a
result of these acquisitions, we have recorded significant goodwill on our
condensed consolidated balance sheet, and in conjunction with the adoption of
SFAS No. 142, "Goodwill and Other Intangible Assets," in 2002, we recorded a
transitional impairment charge upon the adoption of this standard. Any future
impairment losses identified will be recorded as reductions to operating income,
which could have a material adverse effect on our results of operations. Our
ability to realize the value of the goodwill that we have recorded will depend
on the future cash flows of these businesses. These cash flows depend, in part,
on how well we have integrated these businesses.
Our inability to successfully complete the proposed restructuring of our Kadant
Lamort subsidiary would have a negative effect on our future operating results.
In an effort to improve operating performance at our Kadant Lamort
subsidiary in France, we approved a proposed restructuring of that subsidiary on
November 18, 2004. This restructuring is intended to strengthen Kadant Lamort's
competitive position in the European paper industry. Under French law, the
proposed restructuring required consultation with Kadant Lamort's workers'
council, which represents the employees, before implementation. The
restructuring originally proposed the reduction of up to 136 full-time positions
in France. Kadant Lamort experienced intermittent work stoppages by employees
protesting the proposed restructuring while the consultations with the workers'
council were in process. We recently completed the necessary consultations with
the workers' council and expect the restructuring to be fully implemented by the
fourth quarter of 2005. We expect that this subsidiary will continue to
experience operating losses until these restructuring actions are completed. If
we were unable to complete this restructuring, our future operating results
would be negatively impacted.
We may not be successful in selling our composite building products business.
On October 27, 2004, our board of directors approved a plan to sell our
composite building products business (the "composites business"). We cannot
predict on what terms we may sell the business or if we will be successful in
selling this business at all. There are certain liabilities associated with our
composites business, such as warranty obligations, which we will likely not be
able to transfer to a future buyer. If we are not able to transfer these
liabilities with the sale, it could have a material adverse effect on our future
results of operations. Under applicable accounting rules, the results of the
composites business will be reported as a discontinued operation; however, we
will continue to report these results in our consolidated financial statements.
For as long as we continue to own the composite building products business, our
consolidated performance will continue to be subject to the risks and
uncertainties related to that business, including the risks identified in the
following Risk Factors.
<
37
>
KADANT INC.
Risk Factors (continued)
Our performance in the market for composite building products will depend on our
ability to manufacture and distribute our composite building products.
Development, formulation, manufacturing, and commercialization of our
composite building products require significant testing and technical expertise
and our efforts may not be successful. Growth of our composites business
requires ongoing market acceptance. Our composites business is subject to
intense competition, particularly in the decking market, from traditional wood
products and other composite lumber manufacturers, many of whom have greater
financial, technical, and marketing resources than we do. As a result, we may be
unable to compete successfully in this market. We have limited experience
manufacturing these products at volume, cost, and quality levels sufficient to
satisfy expected demand, and we have in the past and may continue to encounter
difficulties in connection with any large-scale manufacturing or
commercialization of these products. Our capacity may not be sufficient to meet
demand without significant additional investment. In addition, the majority of
our production is dependent upon a single piece of equipment. If that equipment
were to fail for an extended period of time, it would have a material adverse
effect on our revenues from this business in that period. We rely on
distributors in the building products industry to market, distribute, and sell
our products. We may be unable to produce our products in sufficient quantity to
interest or retain these distributors or to add new distributors. In addition,
the announcement of our proposed sale of the composites business and warranty
issues may impact our relationships with our existing and proposed new
distributors and may cause them to reduce or curtail their purchases of our
products. If we are unable to distribute our products effectively, our revenues
will decline and we will have to incur additional expenses to market these
products directly.
The failure of our composite building products to perform over long periods of
time could result in potential liabilities.
Our composite building products are relatively new, have not been on the
market for long periods of time, and may be used in applications about which we
may have little knowledge or limited experience. Because we have limited
historical experience, we may be unable to predict the potential liabilities
related to product warranty or product liability issues. If our products fail to
perform over their warranty periods, we may not have the ability to protect
ourselves adequately against this potential liability, which could adversely
affect our operating results. In 2003 and 2004, we experienced a significant
increase in warranty claims and warranty expense related to our composite
decking products including, but not limited to, contraction of certain deck
boards and excessive oxidation that affects the integrity of the plastic used in
some of our decking products. Included in the increased warranty expense was the
cost of exchanging material held by our distributors with new material that, we
believe, is not susceptible to this oxidation issue, and our best estimate of
costs related to future potential valid claims arising from installed product.
Although we increased the warranty provisions accordingly, we cannot guarantee
that the reserves established will be sufficient if we incur warranty claims
higher than anticipated. In addition, there can be no assurance that other
problems will not develop. A continued high level of warranty claims or expenses
and/or failure of our products to perform or to be accepted in the marketplace
would have an adverse impact on the profitability of our business and our
ability to sell the composites business on favorable terms.
<
38
>
KADANT INC.
Risk Factors (continued)
Economic conditions could adversely affect demand for our composite building
products.
Demand for our composite building products is affected by several factors
beyond our control, including economic conditions. Recent demand for our
products has been driven, in part, by the availability of low-interest mortgage
and home equity loans. A further increase in interest rates or tightened credit
could adversely affect demand for home remodeling projects, including demand for
our products.
Seasonality and weather conditions could adversely affect our business.
In general, the building products industry experiences seasonal
fluctuations in sales, particularly in the fourth and first quarters, when
holidays and adverse weather conditions in some regions usually reduce the level
of home improvement and new construction activity. In addition, our composite
building products are used or installed in outdoor construction applications,
and our sales volume, bookings, gross margins, and operating income can be
negatively affected by adverse weather. Operating results will tend to be lower
in quarters with lower sales, which are not entirely offset by a corresponding
reduction in operating costs. In addition, we may also experience lower gross
profit margins in the fourth and first quarters due to seasonal incentive
discounts offered to our distributors. As a result of these factors, we believe
sequential period-to-period comparisons of our operating results are not
reliable indicators of future performance, and the operating results for any one
quarterly period may not be indicative of operating results to be expected for a
full year.
We are dependent on a single mill for the raw material used in our fiber-based
granules, and we may not be able to obtain raw material on commercially
reasonable terms. In addition, the manufacture of our composite building
products and fiber-based granules is subject to commodity price risks.
We are dependent on a single paper mill for the fiber used in the
manufacture of our fiber-based granules and composite building products. This
mill has the exclusive right to supply the papermaking byproducts used in the
manufacturing process. Although we believe our relationship with the mill is
good, the mill could decide not to renew its contract with us at the end of
2005, or may not agree to renew on commercially reasonable terms. If this were
to occur, we would be forced to find an alternative supply for this raw
material. We may be unable to find an alternative supply on commercially
reasonable terms or could incur excessive transportation costs if an alternative
supplier were found, which would increase our manufacturing costs and might
prevent prices for our products from being competitive.
In addition, we use natural gas in the production of our fiber-based
granular products. We seek to manage our exposure to natural gas price
fluctuations by entering into short-term forward contracts to purchase specified
quantities of natural gas from a supplier. We may not be able to effectively
manage our exposure to natural gas price fluctuations.
Our composite building products also contain plastics, which are subject
to wide fluctuations in pricing and availability. Higher energy costs can
increase the price of plastic significantly and rapidly. We may be unable to
obtain sufficient quantities at reasonable prices, which would adversely affect
our profitability and ability to produce a sufficient quantity of our products
or to produce our products at competitive prices.
Our inability to protect our intellectual property could have a material adverse
effect on our business. In addition, third parties may claim that we infringe
their intellectual property, and we could suffer significant litigation or
licensing expense as a result.
We place considerable emphasis on obtaining patent and trade secret
protection for significant new technologies, products, and processes because of
the length of time and expense associated with bringing new products through the
development process and into the marketplace. Our success depends in part on our
ability to develop patentable products and obtain and enforce patent protection
for our products both in the United States and in other countries. We
<
39
>
KADANT INC.
Risk Factors (continued)
own numerous U.S. and foreign patents, and we intend to file additional
applications, as appropriate, for patents covering our products. Patents may not
be issued for any pending or future patent applications owned by or licensed to
us, and the claims allowed under any issued patents may not be sufficiently
broad to protect our technology. Any issued patents owned by or licensed to us
may be challenged, invalidated, or circumvented, and the rights under these
patents may not provide us with competitive advantages. A patent relating to our
fiber-based granular products expired in the second quarter of 2004. As a
result, we could be subject to increased competition in this market, which could
have an adverse effect on this business. In addition, competitors may design
around our technology or develop competing technologies. Intellectual property
rights may also be unavailable or limited in some foreign countries, which could
make it easier for competitors to capture increased market position. We could
incur substantial costs to defend ourselves in suits brought against us or in
suits in which we may assert our patent rights against others. An unfavorable
outcome of any such litigation could have a material adverse effect on our
business and results of operations. In addition, as our patents expire, we rely
on trade secrets and proprietary know-how to protect our products. We cannot be
sure the steps we have taken or will take in the future will be adequate to
deter misappropriation of our proprietary information and intellectual property.
We seek to protect trade secrets and proprietary know-how, in part,
through confidentiality agreements with our collaborators, employees, and
consultants. These agreements may be breached, we may not have adequate remedies
for any breach, and our trade secrets may otherwise become known or be
independently developed by our competitors.
Third parties may assert claims against us to the effect that we are
infringing on their intellectual property rights. We could incur substantial
costs and diversion of management resources in defending these claims, which
could have a material adverse effect on our business, financial condition, and
results of operations. In addition, parties making these claims could secure a
judgment awarding substantial damages, as well as injunctive or other equitable
relief, which could effectively block our ability to make, use, sell,
distribute, or market our products and services in the United States or abroad.
In the event that a claim relating to intellectual property is asserted against
us, or third parties not affiliated with us hold pending or issued patents that
relate to our products or technology, we may seek licenses to such intellectual
property or challenge those patents. However, we may be unable to obtain these
licenses on commercially reasonable terms, if at all, and our challenge of the
patents may be unsuccessful. Our failure to obtain the necessary licenses or
other rights could prohibit the sale, manufacture, or distribution of our
products and, therefore, could have a material adverse effect on our business,
financial condition, and results of operations.
Fluctuations in our quarterly operating results may cause our stock price to
decline.
Given the nature of the markets in which we participate and the effect of
Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition," we may not be
able to reliably predict future revenues and profitability, and unexpected
changes may cause us to adjust our operations. A large proportion of our costs
are fixed, due in part to our significant selling, research and development, and
manufacturing costs. Thus, small declines in revenues could disproportionately
affect our operating results. Other factors that could affect our quarterly
operating results include:
- failure of our products to pass contractually agreed upon acceptance
tests, which would delay or prohibit recognition of revenues under
SAB No. 104;
- adverse changes in demand for and market acceptance of our products;
- competitive pressures resulting in lower sales prices of our products;
- adverse changes in the pulp and paper industry;
- delays or problems in our introduction of new products;
- our competitors' announcements of new products, services, or
technological innovations;
- contractual liabilities incurred by us related to guarantees of our
product performance;
- increased costs of raw materials or supplies, including the cost of
energy; and
- changes in the timing of product orders.
<
40
>
KADANT INC.
Risk Factors (continued)
Anti-takeover provisions in our charter documents, under Delaware law, and in
our shareholder rights plan could prevent or delay transactions that our
shareholders may favor.
Provisions of our charter and bylaws may discourage, delay, or prevent a
merger or acquisition that our shareholders may consider favorable, including
transactions in which shareholders might otherwise receive a premium for their
shares. For example, these provisions:
- authorize the issuance of "blank check" preferred stock without any
need for action by shareholders;
- provide for a classified board of directors with staggered three-year
terms;
- require supermajority shareholder voting to effect various amendments
to our charter and bylaws;
- eliminate the ability of our shareholders to call special meetings of
shareholders;
- prohibit shareholder action by written consent; and
- establish advance notice requirements for nominations for election to
our board of directors or for proposing matters that can be acted on
by shareholders at shareholder meetings.
In addition, our board of directors has adopted a shareholder rights plan
intended to protect shareholders in the event of an unfair or coercive offer to
acquire our company and to provide our board of directors with adequate time to
evaluate unsolicited offers. Preferred stock purchase rights have been
distributed to our common shareholders pursuant to the rights plan. This rights
plan may have anti-takeover effects. The rights plan will cause substantial
dilution to a person or group that attempts to acquire us on terms that our
board of directors does not believe are in our best interests and those of our
shareholders and may discourage, delay, or prevent a merger or acquisition that
shareholders may consider favorable, including transactions in which
shareholders might otherwise receive a premium for their shares.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
- -------------------------------------------------------------------
We are exposed to market risk from changes in interest rates and foreign
currency exchange rates, which could affect our results of operations and
financial condition.
We borrowed $60 million in May 2005 to fund a portion of the Kadant
Johnson acquisition. Through an interest rate swap $36 million, or 60%, of the
borrowing has been converted to a fixed rate of interest. The remaining portion
of the borrowing bears a variable rate of interest based on LIBOR. A
100-basis-point increase in LIBOR rates at July 2, 2005, would increase our
annual pre-tax interest expense by $0.2 million.
Except as described above, our exposure to market risk from interest
rates and foreign currency exchange rates has not changed materially from our
exposure at year-end 2004.
<
41
>
KADANT INC.
Item 4 - Controls and Procedures
- --------------------------------
(a) Evaluation of Disclosure Controls and Procedures
In May 2005 we acquired Kadant Johnson, a private company with internal
control procedures that had not been designed for public company reporting.
Prior to our acquisition, Kadant Johnson's independent certified public
accountants identified material weaknesses in Kadant Johnson's controls over the
inventory reserve calculation and financial close procedures. Kadant Johnson
adjusted their inventory obsolescence reserve before the acquisition date by
restating prior periods to increase their reserve in compliance with our policy
and generally accepted accounting principles. In addition, we added internal
control procedures to ensure that Kadant Johnson's disclosure controls, as they
relate to Kadant's consolidated financial reporting, were adequate and in
compliance with our policies and procedures. As a result, we made a number of
changes to internal controls over financial reporting (as such term is defined
in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended) during the second quarter of 2005 including:
- reviewing and strengthening Kadant Johnson's tax accounting process,
- reviewing and strengthening Kadant Johnson's intercompany
reconciliation process,
- enhancing the documentation relating to Kadant Johnson's reserve
calculations for accounts receivable and warranty to comply with its
policies, and
- accelerating and improving Kadant Johnson's financial close
procedures.
We are continuing the process of evaluating Kadant Johnson's internal
controls and, as of the date of this quarterly report, have not yet completed
our evaluation. We do not anticipate that our evaluation of the internal
controls of Kadant Johnson will be complete by December 31, 2005 and, as
permitted, we will be excluding this acquisition from our reporting under
Section 404 of the Sarbanes-Oxley Act of 2002 at December 31, 2005.
Our management, under the supervision and with the participation of our
Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness
of our disclosure controls and procedures as of July 2, 2005. The term
"disclosure controls and procedures," as defined in Securities Exchange Act
Rules 13a-15(e) and 15d-15(e), means controls and other procedures of a company
that are designed to ensure that information required to be disclosed by the
company in the reports that it files or submits under the Securities Exchange
Act is recorded, processed, summarized, and reported, within the time periods
specified in the SEC's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by a company in the reports that it files
or submits under the Securities Exchange Act is accumulated and communicated to
the company's management, including its principal executive and principal
financial officers, as appropriate to allow timely decisions regarding required
disclosure. Management recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving their objectives, and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based upon the evaluation of our disclosure controls and procedures as of July
2, 2005, our Chief Executive Officer and Chief Financial Officer concluded that
as of July 2, 2005, our disclosure controls and procedures were effective at the
reasonable assurance level.
(b) Changes in Internal Control Over Financial Reporting
Other than the changes resulting from our acquisition of Kadant Johnson
outlined above, 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
July 2, 2005 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
<
42
>
KADANT INC.
PART II - OTHER INFORMATION
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
- --------------------------------------------------------------------
The following table provides information about purchases by us of our
common stock during the three months ended July 2, 2005:
Issuer Purchases of Equity Securities
-------------------------------------
Approximate Dollar
Total Number of Value of Shares that
Shares Purchased as May Yet Be
Total Number of Average Price Paid Part of Publicly Purchased
Period Shares Purchased (1) per Share Announced Plans Under the Plans
- --------------------------------------------------------------------------------------------------------------------------
4/3/05 - 4/30/05 - - - $ 20,650,526
5/1/05 - 5/31/05 110,900 $18.80 110,900 $ 14,975,285
6/1/05 - 7/2/05 - - - $ 14,975,285
Total: - - -
(1) On May 6, 2005, our board of directors authorized the repurchase of up to
$15 million of our equity securities in the open market or in negotiated
transactions for the period from May 18, 2005 through May 18, 2006. As of
July 2, 2005, we had repurchased 1,200 shares of our common stock for $25
thousand under this authorization. In addition, in May 2005 we repurchased
109,700 shares of common stock for $2.1 million under a previous
authorization, which expired on May 18, 2005.
Item 4 - Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
On June 7, 2005, at the annual meeting of shareholders, the shareholders
elected two directors, John M. Albertine and Thomas C. Leonard, to the class of
directors whose three-year term expires at Kadant's annual meeting of
shareholders in 2008. Mr. Albertine received 11,193,179 shares voted in favor
of his election and 211,878 shares voted against. Mr. Leonard received
11,299,774 shares voted in favor of his election and 105,283 shares voted
against.
Item 6 - Exhibits
- -----------------
See Exhibit Index on the page immediately preceding exhibits.
<
43
>
KADANT INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized as of the 11th day of August, 2005.
KADANT INC.
/s/ Thomas M. O'Brien
----------------------------------------------------
Thomas M. O'Brien
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
<
44
>
KADANT INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- --------------------------------------------------------------------------------
10.1 International Swap Dealers Association, Inc. Master Agreement dated
May 25, 2005 between Kadant Inc. and Citizens Bank of Massachusetts
and Swap Confirmation dated May 18, 2005.
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.
45