QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 29, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
Commission file number 001-11406
KADANT INC.
(Exact name of registrant as specified in its charter)
Delaware
52-1762325
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
One Technology Park Drive
Westford, Massachusetts
01886
(Address of principal executive offices)
(Zip Code)
Registrant's telephone number, including area code: (978) 776-2000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Net income attributable to noncontrolling interest
487
343
Net income
42,478
30,675
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
17,739
13,056
Stock-based compensation expense
5,346
4,283
Provision for losses on accounts receivable
344
238
Loss on the sale of property, plant, and equipment
79
37
Other items, net
(3,543
)
(738
)
Contributions to U.S. pension plan
—
(810
)
Changes in current assets and liabilities, net of effects of acquisitions:
Accounts receivable
(9,598
)
(16,225
)
Unbilled revenues
(3,947
)
(2,582
)
Inventories
(10,155
)
(3,504
)
Other current assets
241
(2,517
)
Accounts payable
4,182
2,049
Other current liabilities
9,384
8,366
Net cash provided by operating activities
52,550
32,328
Investing Activities
Purchases of property, plant, and equipment
(12,817
)
(8,718
)
Proceeds from sale of property, plant, and equipment
173
111
Acquisitions, net of cash acquired
—
(204,228
)
Net cash used in investing activities
(12,644
)
(212,835
)
Financing Activities
Repayment of debt
(81,540
)
(20,272
)
Proceeds from issuance of debt
37,000
222,019
Dividends paid
(7,200
)
(6,699
)
Tax withholding payments related to stock-based compensation
(3,886
)
(2,206
)
Proceeds from issuance of Company common stock
813
—
Dividend paid to noncontrolling interest
(465
)
(882
)
Payment of debt issuance costs
(158
)
(1,257
)
Other financing activities
(351
)
(288
)
Net cash (used in) provided by financing activities
(55,787
)
190,415
Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash
(2,906
)
7,911
(Decrease) Increase in Cash, Cash Equivalents, and Restricted Cash
(18,787
)
17,819
Cash, Cash Equivalents, and Restricted Cash at Beginning of Period
76,846
73,569
Cash, Cash Equivalents, and Restricted Cash at End of Period
$
58,059
$
91,388
See Note 1 – Supplemental Cash Flow Information and Recently Adopted Accounting Pronouncements, Statement of Cash Flows (Topic 230), Restricted Cash for further details.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Kadant Inc. was incorporated in Delaware in November 1991 and currently trades on the New York Stock Exchange under the ticker symbol "KAI."
Kadant Inc. and its subsidiaries' (collectively, the Company) operations include two reportable operating segments, Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products.
Through its Papermaking Systems segment, the Company develops, manufactures, and markets a range of equipment and products for the global papermaking, paper recycling, recycling and waste management, and other process industries. The Company's principal products include custom-engineered stock-preparation systems and equipment for the preparation of wastepaper for conversion into recycled paper and balers and related equipment used in the processing of recyclable and waste materials; fluid-handling systems and equipment used in industrial piping systems to compensate for movement and to efficiently transfer fluid, power, and data; doctoring systems and equipment and related consumables important to the efficient operation of paper machines and other industrial processes; and filtration and cleaning systems essential for draining, purifying, and recycling process water and cleaning fabrics, belts, and rolls in various process industries.
Through its Wood Processing Systems segment, the Company develops, manufactures, and markets stranders, debarkers, chippers, and logging machinery used in the harvesting and production of lumber and oriented strand board. Through this segment, the Company also provides refurbishment and repair of pulping equipment for the pulp and paper industry.
Through its Fiber-based Products business, the Company manufactures and sells biodegradable, absorbent granules derived from papermaking by-products for use primarily as carriers for agricultural, home lawn and garden, and professional lawn, turf and ornamental applications, as well as for oil and grease absorption.
Interim Financial Statements
The interim condensed consolidated financial statements and related notes presented have been prepared by the Company, are unaudited, and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of the Company's financial position at September 29, 2018, its results of operations and comprehensive income for the three- and nine-month periods ended September 29, 2018 and September 30, 2017, and its cash flows and stockholders' equity for the nine-month periods ended September 29, 2018 and September 30, 2017. Interim results are not necessarily indicative of results for a full year or for any other interim period.
The condensed consolidated balance sheet presented as of December 30, 2017 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 30, 2017. The condensed consolidated financial statements and related notes are presented as permitted by the Securities and Exchange Commission (SEC) rules and regulations for Form 10-Q and do not contain certain information included in the annual consolidated financial statements and related notes of the Company. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended December 30, 2017, filed with the SEC.
Financial Statement Presentation
Certain reclassifications have been made to prior periods to conform with current reporting. As a result of the adoption of the Financial Accounting Standards Board's (FASB) Accounting Standards Update (ASU) No. 2017-07, Compensation - Retirement Benefits (Topic 715), Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost, certain components of net benefit cost have been reclassified from operating income to non-operating expenses and included in other expense, net in the condensed consolidated statement of income in the 2017 period. In addition, as a result of the adoption of the FASB's ASU No. 2016-18, Statement of Cash Flows (Topic 230), Restricted Cash, the change in restricted cash has been reclassified from financing activities and exchange rate effect on cash and included in cash, cash equivalents, and restricted cash in the condensed consolidated statement of cash flows in the 2017 period.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Effective at the beginning of fiscal 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (Topic 606), using a modified retrospective method. See Recently Adopted Accounting Pronouncements in this note for further discussion. Results for fiscal 2018 are presented under Topic 606, while prior period amounts are not adjusted and are reported under the Company's prior method of reporting revenue recognition in accordance with Accounting Standards Codification (ASC), Revenue Recognition (Topic 605) (Topic 605). The impact on any financial statement line item arising from the application of Topic 606 versus Topic 605 on the Company's results for the third quarter and first nine months of 2018 is not material.
Use of Estimates and Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.
Critical accounting policies are defined as those that entail significant judgments and estimates, and could potentially result in materially different results under different assumptions and conditions. The Company believes that the most critical accounting policies upon which its financial position depends, and which involve the most complex or subjective decisions or assessments, concern revenue recognition, income taxes, the valuation of goodwill and intangible assets, inventories, and pension obligations. A discussion of the application of these and other accounting policies is included in Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 30, 2017, and in Revenue Recognition and Recently Adopted Accounting Pronouncements, Revenue from Contracts with Customers (Topic 606), in this note.
Although the Company makes every effort to ensure the accuracy of the estimates and assumptions used in the preparation of its condensed consolidated financial statements or in the application of accounting policies, if business conditions were different, or if the Company were to use different estimates and assumptions, it is possible that materially different amounts could be reported in the Company's condensed consolidated financial statements.
Supplemental Cash Flow Information
Nine Months Ended
(In thousands)
September 29, 2018
September 30, 2017
Cash Paid for Interest
$
5,914
$
1,421
Cash Paid for Income Taxes, Net of Refunds
$
20,823
$
12,479
Non-Cash Investing Activities:
Estimated post-closing adjustment (a)
$
397
$
—
Fair value of assets acquired
$
—
$
241,141
Cash paid for acquired businesses
—
(206,447
)
Liabilities assumed of acquired businesses
$
—
$
34,694
Non-cash additions to property, plant and equipment
$
783
$
1,938
Non-Cash Financing Activities:
Issuance of Company common stock upon vesting of restricted stock units
$
3,976
$
3,018
Dividends declared but unpaid
$
2,444
$
2,312
(a) Represents an estimated post-closing purchase price adjustment related to the 2017 acquisition of certain assets of Unaflex, LLC, which is expected to be settled in 2018.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Restricted Cash
The Company's restricted cash serves as collateral for bank guarantees primarily associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business. The majority of the bank guarantees will expire over the next twelve months.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company's condensed consolidated balance sheet that are shown in aggregate in the accompanying condensed consolidated statement of cash flows:
(In thousands)
September 29, 2018
September 30, 2017
December 30, 2017
December 31, 2016
Cash and cash equivalents
$
57,384
$
90,622
$
75,425
$
71,487
Restricted cash
675
766
1,421
2,082
Total Cash, Cash Equivalents, and Restricted Cash
$
58,059
$
91,388
$
76,846
$
73,569
Banker's Acceptance Drafts included in Accounts Receivable
The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for their trade accounts receivable. The banker's acceptance drafts are noninterest-bearing obligations of the issuing bank and mature within six months of the origination date. The Company's subsidiaries may sell the drafts at a discount to a third-party financial institution or transfer the drafts to vendors in settlement of current accounts payable prior to the scheduled maturity date. These drafts, which totaled $14,193,000 at September 29, 2018 and $15,960,000 at December 30, 2017, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary sells the drafts to a bank and receives a discounted amount, transfers the banker's acceptance drafts in settlement of current accounts payable prior to maturity, or obtains cash payment on the scheduled maturity date.
Inventories
The components of inventories are as follows:
September 29, 2018
December 30, 2017
(In thousands)
Raw Materials and Supplies
$
43,739
$
38,952
Work in Process
23,895
18,203
Finished Goods
24,102
27,778
$
91,736
$
84,933
Intangible Assets, Net
Acquired intangible assets by major asset class are as follows:
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
(In thousands)
Gross
Currency Translation
Accumulated Amortization
Net
December 30, 2017
Definite-Lived
Customer relationships
$
113,301
$
(621
)
$
(28,789
)
$
83,891
Product technology
46,501
(737
)
(19,841
)
25,923
Tradenames
5,227
(262
)
(1,504
)
3,461
Other
13,754
(35
)
(10,863
)
2,856
178,783
(1,655
)
(60,997
)
116,131
Indefinite-Lived
Tradenames
16,600
305
—
16,905
Acquired Intangible Assets
$
195,383
$
(1,350
)
$
(60,997
)
$
133,036
Intangible assets are initially recorded at fair value at the date of acquisition and are stated net of accumulated amortization and currency translation in the accompanying condensed consolidated balance sheet. The Company amortizes definite-lived intangible assets over lives that have been determined based on the anticipated cash flow benefits of the intangible asset.
Goodwill
The changes in the carrying amount of goodwill by segment are as follows:
(In thousands)
Papermaking Systems Segment
Wood Processing Systems Segment
Total
Balance at December 30, 2017
Gross balance
$
247,014
$
106,496
$
353,510
Accumulated impairment losses
(85,509
)
—
(85,509
)
Net balance
161,505
106,496
268,001
2018 Adjustments
Acquisitions (a)
(17
)
(75
)
(92
)
Currency translation
(3,552
)
(2,276
)
(5,828
)
Total 2018 adjustments
(3,569
)
(2,351
)
(5,920
)
Balance at September 29, 2018
Gross balance
243,445
104,145
347,590
Accumulated impairment losses
(85,509
)
—
(85,509
)
Net balance
$
157,936
$
104,145
$
262,081
(a) Relates to a purchase price allocation adjustment primarily for inventory and a purchase price adjustment for acquisitions completed in 2017. The purchase price allocations for the Company's 2017 acquisitions were finalized in the second and third quarters of 2018.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Warranty Obligations
The changes in the carrying amount of accrued warranty costs included in other current liabilities in the accompanying condensed consolidated balance sheet are as follows:
Nine Months Ended
(In thousands)
September 29, 2018
September 30, 2017
Balance at Beginning of Year
$
5,498
$
3,843
Provision charged to expense
2,584
1,931
Usage
(1,828
)
(1,506
)
Acquisitions
—
790
Currency translation
(215
)
382
Balance at End of Period
$
6,039
$
5,440
Revenue Recognition
Effective at the beginning of fiscal 2018, the Company adopted Topic 606, using a modified retrospective method. See Recently Adopted Accounting Pronouncements in this note for further discussion. Results for fiscal 2018 are presented under Topic 606, while prior period amounts are not adjusted and are reported in accordance with Topic 605. The impact on any financial statement line item arising from the application of Topic 606 versus Topic 605 on the Company's results for the third quarter and first nine months of 2018 is not material.
Approximately 90% in the third quarter of 2018 and 93% in the first nine months of 2018 of the Company’s revenue was recognized at a point in time for each performance obligation under the contract when the customer obtains control of the goods or service. The majority of the Company’s parts and consumables products and capital products with minimal customization are accounted for at a point in time. The Company has made a policy election to not treat the obligation to ship as a separate performance obligation under the contract and, as a result, the associated shipping costs are accrued when revenue is recognized.
The remaining 10% in the third quarter of 2018 and 7% in the first nine months of 2018 of the Company’s revenue was recognized on an over time basis based on an input method that compares the costs incurred to date to the total expected costs required to satisfy the performance obligation. Contracts are accounted for on an over time basis when they include products which have no alternative use and an enforceable right to payment over time. The majority of the contracts recognized on an over time basis are for large capital projects within the Company's Stock-Preparation product line and, to a lesser extent, its Fluid-Handling and Doctoring, Cleaning, & Filtration product lines. These projects are highly customized for the customer and, as a result, would include a significant cost to rework in the event of cancellation.
The Company's contracts covering the sale of its products include warranty provisions that provide assurance to its customers that the products will comply with agreed-upon specifications. The Company negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
The Company disaggregates its revenue from contracts with customers by product line, product type, and geography as this best depicts how its revenue is affected by economic factors as shown below:
Three Months Ended
Nine Months Ended
September 29,
September 30,
September 29,
September 30,
(In thousands)
2018
2017
2018
2017
Revenues by Product Line:
Papermaking Systems:
Stock-Preparation
$
62,983
$
52,065
$
164,842
$
139,396
Fluid-Handling
33,083
28,532
98,500
73,099
Doctoring, Cleaning, & Filtration
30,704
30,538
87,469
82,921
Papermaking Systems
$
126,770
$
111,135
$
350,811
$
295,416
Wood Processing Systems
37,042
39,714
109,335
61,050
Fiber-based Products
1,933
1,945
9,705
9,427
$
165,745
$
152,794
$
469,851
$
365,893
Revenues by Product Type:
Parts and Consumables
$
92,749
$
83,755
$
283,591
$
224,239
Capital
72,996
69,039
186,260
141,654
$
165,745
$
152,794
$
469,851
$
365,893
Revenues by Geography:
North America
$
74,089
$
68,369
$
227,080
$
170,092
Europe
44,912
46,475
131,437
113,178
Asia
32,887
25,215
78,537
53,658
Rest of World
13,857
12,735
32,797
28,965
$
165,745
$
152,794
$
469,851
$
365,893
The following table presents revenue by revenue recognition method:
Three Months Ended
Nine Months Ended
September 29,
September 29,
(In thousands)
2018
2018
Timing of Revenue Recognition:
Point in Time
$
148,524
$
436,527
Over Time
17,221
33,324
$
165,745
$
469,851
The following tables present the balances from contracts with customers:
September 29, 2018
December 30, 2017
(In thousands)
Balances from Contracts with Customers:
Accounts receivable
$
96,326
$
89,624
Contract assets
$
8,315
$
2,374
Contract liabilities
$
48,959
$
38,702
Contract assets represent unbilled revenue associated with revenue recognized on contracts accounted for on an over time basis. Unbilled amounts will be billed in future periods based on the contract terms. Contract liabilities consist of customer deposits and advanced billings, and deferred revenue which is included in other current liabilities in the accompanying condensed consolidated balance sheet. Contract liabilities will be recognized as revenue in future periods once the revenue recognition criteria are met. The majority of the contract liabilities relate to advanced payments on contracts accounted for at a point in time. These advance payments will be recognized as revenue when the Company's performance obligations have been satisfied, which typically occurs when the product has been delivered and control of the asset has transferred to the customer.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
The Company recognized revenue of $5,787,000 in the third quarter of 2018 and $35,900,000 in the first nine months of 2018 that was included in the contract liabilities balance at the beginning of fiscal 2018.
Customers in China will often settle their accounts receivable with a banker's acceptance draft, in which case cash settlement will be delayed until the banker's acceptance draft matures or is settled prior to maturity. For customers outside of China, final payment for the majority of the Company's products is received in the quarter following the product shipment. Certain of the Company's contracts include a longer period before final payment is due, which is typically within one year of final shipment or transfer of control to the customer.
Recently Adopted Accounting Pronouncements
Revenue from Contracts with Customers (Topic 606), Section A-Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs-Contracts with Customers (Subtopic 340-40). In May 2014, the FASB issued ASU No. 2014-09, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The Company adopted this ASU using the modified retrospective transition approach effective at the beginning of fiscal 2018. The guidance applies to all new contracts initiated in fiscal 2018. For existing contracts that have remaining obligations as of the beginning of fiscal 2018, any difference between the recognition criteria in this ASU and the Company's previous revenue recognition practices under Topic 605 was recognized using a cumulative-effect adjustment that increased retained earnings by $119,000. The increase in retained earnings primarily related to contracts, which meet the over time criteria under the new revenue standard and, as a result, the portion of the contract completed as of the beginning of fiscal 2018 was recognized immediately in retained earnings. Partially offsetting this increase was a reduction of retained earnings associated with certain contracts which were previously accounted for under the percentage-of-completion method of accounting, but do not meet the requirements for over time recognition under Topic 606. Amounts previously recognized in fiscal 2017 based on the percentage-of-completion method of accounting were deferred at the beginning of fiscal 2018 and will be recognized along with the remaining revenue and costs in fiscal 2018 when control of the asset has been transferred to the customer.
The Company has implemented certain modifications to its existing internal controls to support the recognition criteria and disclosure requirements of this ASU. See Revenue Recognition in this note for further disclosures required by this ASU.
Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. In August 2016, the FASB issued ASU No. 2016-15, which simplifies the diversity in practice related to the presentation and classification of certain cash receipts and cash payments in the statement of cash flows under Topic 230. The Company adopted this ASU at the beginning of fiscal 2018 with no impact on the Company's condensed consolidated statement of cash flows.
Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory. In October 2016, the FASB issued ASU No. 2016-16, which requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs and eliminates the exception for an intra-entity transfer of an asset other than inventory. The Company adopted this ASU at the beginning of fiscal 2018 on a modified retrospective basis, which resulted in an immaterial adjustment to retained earnings. The impact of the adoption of this standard on future periods will be dependent on future asset transfers, which generally occur in connection with acquisitions and other business structuring activities.
Statement of Cash Flows (Topic 230), Restricted Cash. In November 2016, the FASB issued ASU No. 2016-18, which requires inclusion of restricted cash and restricted cash equivalents within cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company adopted this ASU at the beginning of fiscal 2018. Prior period amounts related to the Company's "cash flows from financing activities," "exchange rate effect on cash," and "cash, cash equivalents, and restricted cash" were restated as required by this ASU, which did not have a material effect on the Company's statement of cash flows. See Restricted Cash in this note for further disclosures required by this ASU.
Business Combinations (Topic 805), Clarifying the Definition of a Business. In January 2017, the FASB issued ASU No. 2017-01, which clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The Company adopted this ASU on a prospective basis at the beginning of fiscal 2018. The adoption of this ASU will impact how the Company assesses acquisitions and disposals of businesses in the future.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Compensation - Retirement Benefits (Topic 715), Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post-retirement Benefit Cost. In March 2017, the FASB issued ASU No. 2017-07, which requires employers to include only the service cost component of net periodic pension cost and net periodic post-retirement benefit cost within costs and operating expenses in the same income statement line item as the related employees' compensation costs. The other components of net benefit cost are required to be included within non-operating expenses. The Company adopted this ASU at the beginning of fiscal 2018 and prior period amounts were reclassified with no impact on the Company’s condensed consolidated net income. As a result of the adoption, the Company reclassified $216,000 in the third quarter of 2017 and $637,000 in the first nine months of 2017 from operating income to other expense, net in the accompanying condensed consolidated statement of income.
Compensation - Stock Compensation (Topic 718), Scope of Modification Accounting. In May 2017, the FASB issued ASU No. 2017-09, which provides clarity on which changes to the terms or conditions of share-based payment awards require entities to apply the modification accounting provisions required in Topic 718. The Company adopted this ASU on a prospective basis at the beginning of fiscal 2018. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial statements.
Income Taxes (Topic 740), Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. In March 2018, the FASB issued ASU No. 2018-05, an amendment to the December 2017 SEC Staff Accounting Bulletin No. 118 (SAB 118), which allowed SEC registrants to record provisional amounts in earnings due to the complexities involved in accounting for the December 22, 2017 enactment of The Tax Cuts and Jobs Act of 2017 (2017 Tax Act). While the Company’s accounting for certain tax effects is incomplete, it has determined reasonable estimates for those effects and has recorded provisional amounts in the condensed consolidated financial statements as of September 29, 2018 and December 30, 2017.
Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40), Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. In August 2018, the FASB issued ASU No. 2018-15, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The Company elected to early adopt this ASU on a prospective basis in the third quarter of 2018. The adoption of this ASU did not have a material impact on the Company's condensed consolidated financial statements.
Recent Accounting Pronouncements Not Yet Adopted
Leases (Topic 842). In February 2016, the FASB issued ASU No. 2016-02, which requires a lessee to recognize a right-of-use asset and a lease liability for operating leases, initially measured at the present value of the future lease payments, in its balance sheet. This ASU also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. This new guidance is effective for the Company in fiscal 2019 and early adoption is permitted. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842), Targeted Improvements which provides an additional transition method that allows entities to recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. The Company has elected to adopt this new transition method when it adopts ASU 2016-02 at the beginning of fiscal 2019.
The Company is completing the assessment of the practical expedients allowed under this new guidance and finalizing its elections and the impact on its systems, processes and controls to account for its leases. The Company has substantially completed the evaluation of its lease population and is implementing a third-party software solution to assist with the accounting under the new standard. The implementation of this new standard will have a significant impact on the Company's disclosures and balance sheet as it expects that assets and liabilities will increase upon adoption for right-of-use assets and lease liabilities, but is not expected to have a material impact on its results of operations or cash flows. The Company’s operating leases are summarized in Note 7 to the consolidated financial statements for 2017 included in the Company's Annual Report on Form 10-K, filed with the SEC. The actual impact of this new standard will depend on the total amount of the Company’s lease commitments as of the adoption date.
Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU No. 2016-13, which significantly changes the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining lives. This new
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
guidance is effective for the Company in fiscal 2020 with early adoption permitted beginning in fiscal 2019. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.
Derivatives and Hedging (Topic 815), Targeted Improvements in Accounting for Hedging Activity. In August 2017, the FASB issued ASU No. 2017-12, which provides improvements to current hedge accounting to better portray the economic results of an entity’s risk management activities and to simplify the application of current hedge accounting guidance. This new guidance is effective on a prospective basis for the Company in fiscal 2019. Early adoption is permitted. The Company does not believe that adoption of this ASU will have a material effect on its condensed consolidated financial statements.
Income Statement - Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. In February 2018, the FASB issued ASU No. 2018-02, which allows a reclassification from accumulated other comprehensive items (AOCI) to retained earnings for stranded tax effects resulting from the 2017 Tax Act. The reclassification is elective and would allow the income tax effects on items that were originally recorded in AOCI to be reclassified from AOCI to retained earnings. This ASU is effective for the Company in fiscal year 2019 and interim periods therein and should be applied either at the beginning of the period of adoption or retrospectively to each period in which the income tax effects of the 2017 Tax Act are recognized. Early adoption is permitted. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.
Compensation-Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20), Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. In August 2018, the FASB issued ASU 2018-14, which removes, adds and clarifies several disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. This new guidance is effective on a retrospective basis for the Company in fiscal 2021. Early adoption is permitted. The Company does not believe that the adoption of this ASU will have a material effect on its condensed consolidated financial statements.
2. Restructuring Costs
In 2017, the Company constructed a 160,000 square foot manufacturing facility in the United States that integrated its U.S. and Swedish papermaking stock-preparation product lines into a single manufacturing facility to achieve economies of scale and greater efficiencies. As a result of the consolidation and integration of these facilities, the Company developed a restructuring plan totaling approximately $1,920,000, primarily related to costs for the relocation of machinery and equipment and administrative offices, severance, and abandonment of leased facilities in the Papermaking Systems segment. As a result of this plan, the Company recorded restructuring charges of $203,000 in 2017 associated with severance costs for the reduction of four employees in the United States and six employees in Sweden. In the first nine months of 2018, the Company recorded additional restructuring costs of $1,717,000 related to this plan, including $1,318,000 primarily for the relocation of machinery and equipment and administrative offices, $454,000 associated with employee retention costs and abandonment of excess facility and other closure costs, and a reversal of $55,000 of severance costs no longer required. The Company does not expect to incur additional charges related to this restructuring plan.
A summary of the changes in accrued restructuring costs included in other accrued expenses in the accompanying condensed consolidated balance sheet are as follows:
(In thousands)
Severance
Relocation
Other (a)
Total
Balance at December 30, 2017
$
203
$
—
$
—
$
203
(Reversal) provision
(55
)
1,318
454
1,717
Usage
(77
)
(1,315
)
(439
)
(1,831
)
Currency translation
(8
)
(3
)
—
(11
)
Balance at September 29, 2018
$
63
$
—
$
15
$
78
(a) Includes employee retention costs that are accrued ratably over the period through which employees must work to qualify for a payment and facility closure and clean-up costs.
The Company expects to pay the remaining accrued restructuring costs in 2018.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3. Earnings per Share
Basic and diluted earnings per share (EPS) are calculated as follows:
Three Months Ended
Nine Months Ended
September 29, 2018
September 30, 2017
September 29, 2018
September 30, 2017
(In thousands, except per share amounts)
Amounts Attributable to Kadant:
Net Income
$
18,784
$
13,285
$
41,991
$
30,332
Basic Weighted Average Shares
11,101
11,004
11,078
10,986
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan Shares
320
340
310
296
Diluted Weighted Average Shares
11,421
11,344
11,388
11,282
Basic Earnings per Share
$
1.69
$
1.21
$
3.79
$
2.76
Diluted Earnings per Share
$
1.64
$
1.17
$
3.69
$
2.69
Restricted stock units (RSUs) totaling 11,000 shares of common stock in the third quarter of 2018, 4,000 in the third quarter of 2017, 25,000 in the first nine months of 2018 and 21,000 in the first nine months of 2017 were not included in the computation of diluted EPS, as the effect would have been antidilutive or, for unvested performance-based RSUs, the performance conditions had not been met as of the end of the reporting periods.
4. Provision for Income Taxes
The 2017 Tax Act was signed into law on December 22, 2017 and its provisions are generally effective for tax years beginning January 1, 2018. The most significant impacts of the 2017 Tax Act to the Company include a decrease in the federal corporate income tax rate from 35% to 21% and a one-time mandatory transition tax on deemed repatriation of previously tax-deferred and unremitted foreign earnings. On December 22, 2017, the SEC staff issued SAB 118 to provide guidance on accounting for the 2017 Tax Act’s impact. In accordance with SAB 118, the Company recognized the provisional tax impacts related to the remeasurement of its deferred income tax assets and liabilities and the one-time mandatory transition tax on deemed repatriation of unremitted foreign earnings in the three months ended December 30, 2017. In the first nine months of 2018, the Company recorded an additional provisional net income tax expense of $792,000, which included the impact of state taxes for the one-time mandatory transition tax, primarily due to a 2018 tax law change associated with the 2017 Tax Act that impacted the provisional amount initially recorded.
Additional work is still necessary to finalize the provisional tax impacts of the 2017 Tax Act, including the completion of a more detailed analysis of the Company’s historical foreign earnings and the understanding and application of anticipated additional regulatory guidance regarding the provisions of the 2017 Tax Act that may be issued by the Internal Revenue Service and state and local jurisdictions. Any subsequent adjustment to the provisional amounts will be recorded to current tax expense in the fourth quarter of 2018 when the analysis will be complete.
The provision for income taxes was $15,575,000 in the first nine months of 2018 and $10,550,000 in the first nine months of 2017. The effective tax rate of 27% in the first nine months of 2018 was higher than the Company's 2018 statutory tax rate of 21% primarily due to the global intangible low-taxed income (GILTI) provisions of the 2017 Tax Act, the distribution of the Company's worldwide earnings, the cost of repatriating the earnings of certain foreign subsidiaries, and a change in estimate to the federal and state provisional net income tax expense initially recorded in 2017 for the 2017 Tax Act. This incremental tax expense was offset in part by a decrease in tax related to the reversal of tax reserves associated with uncertain tax positions and the net excess income tax benefits from stock-based compensation arrangements. The effective tax rate of 26% in the first nine months of 2017 was lower than the Company's 2017 statutory tax rate of 35% primarily due to the distribution of the Company's worldwide earnings and the net excess income tax benefits from stock-based compensation arrangements, offset in part by an increase in tax related to non-deductible expenses and unrecognized tax benefits.
The Company has elected to account for GILTI as a current period expense when incurred (the period cost method). Because of the complexity of the GILTI tax rules and the lack of legislative guidance, the Company continues to evaluate the
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Provision for Income Taxes (continued)
provisions of the 2017 Tax Act and the application of ASC 740, Income Taxes. The final impact on the Company from the 2017 Tax Act’s GILTI tax legislation may differ from the estimate calculated by the Company. Such differences could be material, due to, among other things, changes in interpretations of the 2017 Tax Act, future legislative action to address questions that arise because of the 2017 Tax Act, changes in accounting standards for income taxes or related interpretations in response to the 2017 Tax Act, or any updates or changes to estimates the Company has utilized to calculate the GILTI inclusion.
5. Long-Term Obligations
Long-term obligations are as follows:
September 29, 2018
December 30, 2017
(In thousands)
Revolving Credit Facility, due 2022
$
168,468
$
237,011
Commercial Real Estate Loan, due 2028
20,738
—
Obligations Under Capital Lease, due 2018 to 2022
4,277
4,633
Other Borrowings, due 2018 to 2023
286
436
Unamortized Debt Issuance Costs
(154
)
—
Total
193,615
242,080
Less: Current Maturities of Long-Term Obligations
(1,686
)
(696
)
Long-Term Obligations
$
191,929
$
241,384
See Note 10 for the fair value information related to the Company's long-term obligations.
Revolving Credit Facility
In 2017, the Company entered into an Amended and Restated Credit Agreement, as amended (the 2017 Credit Agreement), which is a five-year unsecured multi-currency revolving credit facility in the aggregate principal amount of up to $300,000,000. The 2017 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional $100,000,000. The principal on any borrowings is due on March 1, 2022. Borrowing may be denominated in U.S. dollars or certain foreign currencies as defined in the 2017 Credit Agreement. Interest on any loans outstanding accrues and generally is payable quarterly in arrears at one of the following rates selected by the Company: (i) the Base Rate, calculated as the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate as published by Citizens Bank, and (c) the thirty-day London Inter-Bank Offered Rate (LIBOR) rate, as defined, plus 0.50%; or (ii) the LIBOR rate (with a zero percent floor), as defined, plus an applicable margin of 1% to 2%. The applicable margin is determined based upon the ratio of the Company's total debt, net of certain cash and debt, as defined, to earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined in the 2017 Credit Agreement. For this purpose, total debt net of certain cash and debt is defined as total debt less the sum of (i) unrestricted U.S. cash, and (ii) 65% of unrestricted cash outside of the United States, but no more than an aggregate amount of $30,000,000.
The obligations of the Company under the 2017 Credit Agreement may be accelerated upon the occurrence of an event of default under the 2017 Credit Agreement, which includes customary events of default including, without limitation, payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy- and insolvency-related defaults, defaults relating to such matters as the Employment Retirement Income Security Act (ERISA), unsatisfied judgments, the failure to pay certain indebtedness, and a change of control default. In addition, the 2017 Credit Agreement contains negative covenants applicable to the Company and its subsidiaries, including financial covenants requiring the Company to comply with a maximum consolidated leverage ratio of 3.5 to 1, a minimum consolidated interest coverage ratio of 3 to 1, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing its fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to a discontinued operation. As of September 29, 2018, the Company was in compliance with these covenants.
Loans under the 2017 Credit Agreement are guaranteed by certain domestic subsidiaries of the Company pursuant to an Amended and Restated Guarantee Agreement. In addition, one of the Company's foreign subsidiaries entered into a guarantee agreement limited to certain obligations of two foreign subsidiary borrowers.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
5. Long-Term Obligations (continued)
As of September 29, 2018, the outstanding balance under the 2017 Credit Agreement was $168,468,000, including $43,687,000 of Canadian dollar-denominated borrowings and $33,781,000 of euro-denominated borrowings. As of September 29, 2018, the Company had $131,156,000 of borrowing capacity available under its 2017 Credit Agreement, which was calculated by translating its foreign-denominated borrowings using borrowing date foreign exchange rates.
The weighted average interest rate for the revolving credit facility was 3.07% as of September 29, 2018.
Commercial Real Estate Loan
In July 2018, the Company and certain domestic subsidiaries borrowed $21,000,000 under a promissory note (Real Estate Loan) which is repayable in quarterly principal installments of $262,500 over a ten-year period with the remaining principal balance of $10,500,000 due upon maturity. Interest accrues and is payable quarterly in arrears at a fixed rate of 4.45% per annum. The Company is not permitted to prepay any amount in the first twelve months of the term of the Real Estate Loan. Any voluntary prepayments are subject to a 2% prepayment fee if paid in the second twelve months of the term of the Real Estate Loan, and are subject to a 1% prepayment fee if paid in the third twelve months of the term of the Real Estate Loan. Thereafter, no prepayment fee will be applied to voluntary prepayment by the Company.
The Real Estate Loan is secured by real estate and related personal property of the Company and certain of its domestic subsidiaries, pursuant to mortgage and security agreements dated July 6, 2018 (Mortgage and Security Agreements). The obligations of the Company under the Real Estate Loan may be accelerated upon the occurrence of an event of default under the Real Estate Loan and the Mortgage and Security Agreements, which includes customary events of default including, without limitation, payment defaults, defaults in the performance of covenants and obligations, the inaccuracy of representations or warranties, bankruptcy- and insolvency-related defaults, liens on the properties or collateral and uninsured judgments. In addition, the occurrence of an event of default under the 2017 Credit Agreement or any successor credit facility would be an event of default under the Real Estate Loan. The Company used the proceeds from the Real Estate Loan to repay a portion of its U.S. dollar-denominated debt under the 2017 Credit Agreement.
During the third quarter of 2018, the Company incurred $158,000 of debt issuance costs related to the Real Estate Loan. The effective interest rate for the Real Estate Loan, including amortization of debt issuance costs, was 4.55% as of September 29, 2018.
Obligations Under Capital Lease
The Company's obligations under capital leases include a sale-leaseback financing arrangement for a manufacturing facility in Germany. Under this arrangement, the quarterly lease payment includes principal, interest, and a payment to the landlord toward a loan receivable. The interest rate on the outstanding obligation is 1.79%. The secured loan receivable, which is included in other assets in the accompanying condensed consolidated balance sheet, was $645,000 at September 29, 2018. The lease arrangement provides for a fixed price purchase option, net of the projected loan receivable, of $1,545,000 at the end of the lease term in 2022. If the Company does not exercise the purchase option for the facility, the Company will receive cash from the landlord to settle the loan receivable. As of September 29, 2018, $4,205,000 was outstanding under this capital lease obligation and $72,000 was outstanding under other capital lease obligations.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
6. Stock-Based Compensation
The Company recognizes compensation expense for all stock-based awards granted to employees and directors based on the grant date estimate of fair value for those awards. The fair value of RSUs is based on the grant date price of the Company's common stock, reduced by the present value of estimated dividends foregone during the requisite service period. For time-based RSUs, compensation expense is recognized ratably over the requisite service period for the entire award based on the grant date fair value, and net of actual forfeitures recorded when they occur. For performance-based RSUs, compensation expense is recognized ratably over the requisite service period for each separately-vesting portion of the award based on the grant date fair value, net of actual forfeitures recorded when they occur and remeasured each reporting period until the total number of RSUs to be issued is known. The Company recognized stock-based compensation expense of $1,736,000 in the third quarter of 2018, $1,547,000 in the third quarter of 2017, $5,346,000 in the first nine months of 2018 and $4,283,000 in the first nine months of 2017 within selling, general, and administrative (SG&A) expenses in the accompanying condensed consolidated statement of income. Unrecognized compensation expense related to stock-based compensation totaled approximately $6,698,000 at September 29, 2018, and will be recognized over a weighted average period of 1.7 years.
7. Retirement Benefit Plans
Effective at the beginning of fiscal 2018, the Company retrospectively adopted ASU No. 2017-07. See Recently Adopted Accounting Pronouncements in Note 1 for further discussion. As a result, only the service cost component of net periodic benefit cost is included in operating income. All other components are included in other expense, net in the accompanying condensed consolidated statement of income. The components of net periodic benefit cost are as follows:
Three Months Ended September 29, 2018
Three Months Ended September 30, 2017
(In thousands, except percentages)
U.S. Pension
Non-U.S. Pension
Other Post-Retirement
U.S. Pension
Non-U.S. Pension
Other Post-Retirement
Service Cost
$
175
$
35
$
53
$
171
$
35
$
43
Interest Cost
298
30
43
307
28
43
Expected Return on Plan Assets
(322
)
(11
)
(1
)
(331
)
(10
)
(1
)
Recognized Net Actuarial Loss
135
15
34
110
10
22
Amortization of Prior Service Cost
—
2
22
14
2
22
$
286
$
71
$
151
$
271
$
65
$
129
The weighted average assumptions used to determine net periodic benefit cost are as follows: