Edgar Filing: KADANT INC

kaiform10q2q2009.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________________________________________________

FORM 10-Q

(Mark One)

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

For the quarterly period ended July 4, 2009

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

For the transition period from ________ to _________

Commission file number 1-11406

KADANT INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

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

Large accelerated filer o	Accelerated Filer x
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company o

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

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


		Class			Outstanding at August 5, 2009
		Common Stock, $.01 par value			12,269,997

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.

Condensed Consolidated Balance Sheet

(Unaudited)

Assets

	July 4,		January 3,
(In thousands)	2009		2009

Current Assets:
Cash and cash equivalents	$	27,066	$	40,139
Accounts receivable, less allowances of $2,481 and $2,985		35,557		54,517
Inventories (Note 4)		42,066		55,762
Unbilled contract costs and fees		10,909		9,631
Other current assets		8,981		16,434
Assets of discontinued operation		510		524
Total Current Assets		125,089		177,007

Property, Plant, and Equipment, at Cost		103,458		103,225
Less: accumulated depreciation and amortization		61,963		61,587
		41,495		41,638

Other Assets		43,470		43,242

Goodwill		96,749		95,030

Total Assets	$	306,803	$	356,917

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

KADANT INC.

Condensed Consolidated Balance Sheet (continued)

(Unaudited)

Liabilities and Shareholders’ Investment

	July 4,			January 3,
(In thousands, except share amounts)	2009			2009

Current Liabilities:
Short-term obligations and current maturities of long-term obligations (Note 6)	$	4,018		$	3,289
Accounts payable		14,543			24,212
Accrued payroll and employee benefits		9,637			14,475
Customer deposits		7,492			11,747
Other current liabilities		23,096			22,840
Liabilities of discontinued operation		2,427			2,427
Total Current Liabilities		61,213			78,990

Other Long-Term Liabilities		27,619			31,412

Long-Term Obligations (Note 6)		25,346			52,122

Shareholders’ Investment:
Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued		–			–
Common stock, $.01 par value, 150,000,000 shares authorized; 14,624,159 shares issued		146			146
Capital in excess of par value		93,969			92,916
Retained earnings		148,464			152,548
Treasury stock at cost, 2,354,162 and 2,074,362 shares		(49,388	)		(46,707	)
Accumulated other comprehensive items (Note 2)		(2,113	)		(6,188	)
Total Kadant Shareholders’ Investment		191,078			192,715
Noncontrolling interest		1,547			1,678
Total Shareholders’ Investment		192,625			194,393

Total Liabilities and Shareholders’ Investment	$	306,803		$	356,917

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

KADANT INC.

Condensed Consolidated Statement of Operations

(Unaudited)

	Three Months Ended
	July 4,			June 28,
(In thousands, except per share amounts)	2009			2008

Revenues	$	50,132		$	92,406

Costs and Operating Expenses:
Cost of revenues		29,348			53,843
Selling, general, and administrative expenses		19,248			26,924
Research and development expenses		1,722			1,497
Restructuring costs		1,013			–
		51,331			82,264

Operating (Loss) Income		(1,199	)		10,142

Interest Income		92			511
Interest Expense		(507	)		(640	)

(Loss) Income from Continuing Operations Before Income Tax (Benefit) Provision		(1,614	)		10,013
Income Tax (Benefit) Provision		(398	)		2,977

(Loss) Income from Continuing Operations		(1,216	)		7,036
Loss from Discontinued Operation (net of income tax benefit of $2 and $2)		(5	)		(5	)

Net (Loss) Income		(1,221	)		7,031

Net Loss (Income) Attributable to Noncontrolling Interest		28			(143	)

Net (Loss) Income Attributable to Kadant	$	(1,193	)	$	6,888

Amounts Attributable to Kadant:
(Loss) Income from Continuing Operations	$	(1,188	)	$	6,893
Loss from Discontinued Operation		(5	)		(5	)
Net (Loss) Income Attributable to Kadant	$	(1,193	)	$	6,888

(Loss) Earnings per Share from Continuing Operations Attributable to Kadant (Note 3):
Basic	$	(.10	)	$	.50
Diluted	$	(.10	)	$	.50

(Loss) Earnings per Share Attributable to Kadant (Note 3):
Basic	$	(.10	)	$	.50
Diluted	$	(.10	)	$	.50

Weighted Average Shares (Note 3):
Basic		12,265			13,703

Diluted		12,265			13,822

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

KADANT INC.

Condensed Consolidated Statement of Operations

(Unaudited)

	Six Months Ended
	July 4,			June 28,
(In thousands, except per share amounts)	2009			2008

Revenues	$	115,089		$	178,270

Costs and Operating Expenses:
Cost of revenues		69,665			105,647
Selling, general, and administrative expenses		41,453			52,293
Research and development expenses		3,192			3,105
Restructuring costs and other income, net		1,770			(473	)
		116,080			160,572

Operating (Loss) Income		(991	)		17,698

Interest Income		299			1,052
Interest Expense		(1,320	)		(1,235	)

(Loss) Income from Continuing Operations Before Provision for Income Taxes		(2,012	)		17,515
Provision for Income Taxes		2,066			5,265

(Loss) Income from Continuing Operations		(4,078	)		12,250
Loss from Discontinued Operation (net of income tax benefit of $5 and $5)		(9	)		(9	)

Net (Loss) Income		(4,087	)		12,241

Net Loss (Income) Attributable to Noncontrolling Interest		3			(240	)

Net (Loss) Income Attributable to Kadant	$	(4,084	)	$	12,001

Amounts Attributable to Kadant:
(Loss) Income from Continuing Operations	$	(4,075	)	$	12,010
Loss from Discontinued Operation		(9	)		(9	)
Net (Loss) Income Attributable to Kadant	$	(4,084	)	$	12,001

(Loss) Earnings per Share from Continuing Operations Attributable to Kadant (Note 3):
Basic	$	(.33	)	$	.86
Diluted	$	(.33	)	$	.85

(Loss) Earnings per Share Attributable to Kadant (Note 3):
Basic	$	(.33	)	$	.86
Diluted	$	(.33	)	$	.85

Weighted Average Shares (Note 3):
Basic		12,386			13,935

Diluted		12,386			14,048

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

KADANT INC.

Condensed Consolidated Statement of Cash Flows

(Unaudited)

	Six Months Ended
	July 4,			June 28,
(In thousands)	2009			2008

Operating Activities:
Net (loss) income attributable to Kadant	$	(4,084	)	$	12,001
Net (loss) income attributable to noncontrolling interest		(3	)		240
Loss from discontinued operation		9			9
(Loss) income from continuing operations		(4,078	)		12,250
Adjustments to reconcile (loss) income from continuing operations to net cash provided by operating activities:
Depreciation and amortization		3,719			3,776
Stock-based compensation expense		1,308			1,576
Provision for losses on accounts receivable		499			382
Gain on the sale of property, plant, and equipment		(6	)		(652	)
Other, net		(2,595	)		(268	)
Changes in current accounts, net of effects of acquisition:
Accounts receivable		18,750			(3,653	)
Unbilled contract costs and fees		(1,080	)		8,314
Inventories		13,769			(8,704	)
Other current assets		7,176			(224	)
Accounts payable		(9,593	)		2,270
Other current liabilities		(9,282	)		(4,124	)
Net cash provided by continuing operations		18,587			10,943
Net cash provided by (used in) discontinued operation		5			(25	)
Net cash provided by operating activities		18,592			10,918

Investing Activities:
Purchases of property, plant, and equipment		(2,040	)		(3,149	)
Acquisition consideration		(1,135	)		(2,119	)
Proceeds from sale of property, plant, and equipment		37			923
Other, net		–			6
Net cash used in continuing operations for investing activities		(3,138	)		(4,339	)

Financing Activities:
Proceeds from issuance of long-term obligations		19,000			37,000
Repayments of long-term obligations		(45,035	)		(35,099	)
Purchases of Company common stock		(3,722	)		(18,855	)
Proceeds from issuances of Company common stock		–			1,237
Other, net		5			(609	)
Net cash used in continuing operations for financing activities		(29,752	)		(16,326	)

Exchange Rate Effect on Cash and Cash Equivalents		1,225			2,081

Change in Cash from Discontinued Operation		–			1

Decrease in Cash and Cash Equivalents		(13,073	)		(7,665	)
Cash and Cash Equivalents at Beginning of Period		40,139			61,553
Cash and Cash Equivalents at End of Period	$	27,066		$	53,888

Non-cash Financing Activities:
Issuance of Company common stock	$	78		$	244

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

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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”), 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 July 4, 2009, and its results of operations for the three- and six-month periods ended July 4, 2009 and June 28, 2008 and cash flows for the six-month periods ended July 4, 2009 and June 28, 2008. Interim results are not necessarily indicative of results for a full year.

The condensed consolidated balance sheet presented as of January 3, 2009, has been derived from the consolidated financial statements that have been audited by the Company’s independent registered public accounting firm. The condensed consolidated financial statements and related notes are presented as permitted by Form 10-Q and do not contain certain information included in the annual consolidated financial statements and related notes of the Company. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2009, filed with the Securities and Exchange Commission on March 10, 2009.

Certain prior-period amounts have been reclassified to conform to the 2009 presentation, including the adoption of a new accounting standard. See Note 16 for further information.

The Company has evaluated all subsequent events through August 12, 2009, the date these financial statements were issued.

2.	Comprehensive Income (Loss)

Comprehensive income (loss) attributable to Kadant combines net (loss) income, other comprehensive items, and comprehensive loss attributable to noncontrolling interest. Other comprehensive items represent certain amounts that are reported as components of shareholders’ investment in the accompanying condensed consolidated balance sheet, including foreign currency translation adjustments, deferred gains and losses and unrecognized prior service loss associated with pension and other post-retirement plans, and deferred gains and losses on hedging instruments. The components of comprehensive income (loss) attributable to Kadant are as follows:

	Three Months Ended						Six Months Ended
	July 4,			June 28,			July 4,			June 28,
(In thousands)	2009			2008			2009			2008

Net (Loss) Income	$	(1,221	)	$	7,031		$	(4,087	)	$	12,241

Other Comprehensive Items:
Foreign Currency Translation Adjustment		8,308			21			4,051			7,895
Pension and Other Post-Retirement Liability Adjustments, net (net of income tax of $97 and $118 in the three and six months ended July 4, 2009, respectively, and $62 and $116 in the three and six months ended June 28, 2008, respectively)		(174	)		(118	)		(215	)		(213	)
Deferred Gain on Hedging Instruments (net of income tax of $49 and ($49) in both the three and six months ended July 4, 2009, respectively, and $297 and $358 in the three and six months ended June 28, 2008, respectively)		316			415			251			653
		8,450			318			4,087			8,335
Comprehensive Income		7,229			7,349			–			20,576
Comprehensive Loss Attributable to Noncontrolling Interest		(54	)		(140	)		(9	)		(366	)
Comprehensive Income (Loss) Attributable to Kadant	$	7,175		$	7,209		$	(9	)	$	20,210

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

3.	(Loss) Earnings per Share

Basic and diluted (loss) earnings per share are calculated as follows:

	Three Months Ended						Six Months Ended
	July 4,			June 28,			July 4,			June 28,
(In thousands, except per share amounts)	2009			2008			2009			2008

Amounts Attributable to Kadant:
(Loss) Income from Continuing Operations	$	(1,188	)	$	6,893		$	(4,075	)	$	12,010
Loss from Discontinued Operation		(5	)		(5	)		(9	)		(9	)
Net (Loss) Income	$	(1,193	)	$	6,888		$	(4,084	)	$	12,001

Basic Weighted Average Shares		12,265			13,703			12,386			13,935
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan		–			119			–			113
Diluted Weighted Average Shares		12,265			13,822			12,386			14,048

Basic (Loss) Earnings per Share:
Continuing Operations	$	(.10	)	$	.50		$	(.33	)	$	.86
Discontinued Operation		–			–			–			–
Net (Loss) Income	$	(.10	)	$	.50		$	(.33	)	$	.86

Diluted (Loss) Earnings per Share:
Continuing Operations	$	(.10	)	$	.50		$	(.33	)	$	.85
Discontinued Operation		–			–			–			–
Net (Loss) Income	$	(.10	)	$	.50		$	(.33	)	$	.85

Options to purchase approximately 41,200 and 54,800 shares of our common stock for the second quarters of 2009 and 2008, respectively, and 58,500 and 55,100 shares of our common stock for the first six months of 2009 and 2008, 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. In addition, the dilutive effect of restricted stock units totaling 63,400 and 38,300 shares of common stock was not included in the computation of diluted (loss) earnings per share in the three- and six-month periods ended July 4, 2009, respectively, as the effect would have been anti-dilutive.

4.	Inventories

The components of inventories are as follows:

	July 4,		January 3,
(In thousands)	2009		2009
Raw Materials and Supplies	$	18,859	$	21,687
Work in Process		6,877		16,230
Finished Goods		16,330		17,845
	$	42,066	$	55,762

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

5.	Income Taxes

The provision for income taxes was $2,066,000 and $5,265,000 in the first six months of 2009 and 2008, respectively. The provision for income taxes in the first six months of 2009 included income tax expense of $1,216,000 associated primarily with earnings from the Company’s foreign operations and income tax expense of $850,000 associated with applying a valuation allowance to certain foreign deferred tax assets. The effective tax rate of (103)% in the first six months of 2009 is primarily due to the valuation allowance we established in the first six months of 2009 for certain foreign deferred tax assets; and the tax impact of the full valuation allowance we established for certain U.S. deferred tax assets as a result of our accumulated loss position in the U.S. and the uncertainty of profitability in future periods. Our effective tax rate in future periods will be impacted by the geographic distribution of earnings.

6.	Short- and Long-Term Obligations

Short- and Long-term Obligations

Short- and Long-term obligations are as follows:

	July 4,			January 3,
(In thousands)	2009			2009

Revolving Credit Facility	$	15,000		$	38,000
Variable Rate Term Loan, due from 2009 to 2016		8,500			8,750
Variable Rate Term Loan, due from 2010 to 2011		5,864			5,872
Short-Term Obligation under Kadant Jining Credit Facilities		–			2,789
Total Short- and Long-Term Obligations		29,364			55,411
Less: Short-Term Obligations and Current Maturities		(4,018	)		(3,289	)
Long-Term Obligations, less Current Maturities	$	25,346		$	52,122

The weighted average interest rate for long-term obligations was 4.95% as of July 4, 2009.

Revolving Credit Facility

On February 13, 2008, the Company entered into a five-year unsecured revolving credit facility (2008 Credit Agreement) in the aggregate principal amount of up to $75,000,000, which includes an uncommitted unsecured incremental borrowing facility of up to an additional $75,000,000. The Company can borrow up to $75,000,000 under the 2008 Credit Agreement with a sublimit of $60,000,000 within the 2008 Credit Agreement available for the issuances of letters of credit and bank guarantees. The principal on any borrowings made under the 2008 Credit Agreement is due on February 13, 2013. As of July 4, 2009, the outstanding balance on the 2008 Credit Agreement was $15,000,000 and the Company had $53,205,000 of borrowing capacity available under the committed portion of the 2008 Credit Agreement.

The obligations of the Company under the 2008 Credit Agreement may be accelerated upon the occurrence of an event of default under the 2008 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), uninsured judgments and the failure to pay certain indebtedness, and a change of control default.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

6.	Short- and Long-Term Obligations (continued)

The 2008 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 and a minimum consolidated fixed charge coverage ratio of 1.2, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing its fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to the discontinued operation. As of July 4, 2009, the Company was in compliance with these covenants. Our earnings before interest, taxes, depreciation and amortization (EBITDA), as defined in the 2008 Credit Agreement, is a factor used in the consolidated leverage and fixed charge ratios. The Company expects to stay in compliance with these financial covenants during the remainder of 2009; however, this is largely dependent on its ability to meet its EBITDA targets and take other potential actions, such as repaying a portion of its debt obligations, as needed to stay in compliance with the covenants. In addition, the Company may seek to renegotiate certain terms of its 2008 Credit Agreement or seek waivers from compliance with these financial covenants, both of which could result in increased borrowing costs and fees.

Commercial Real Estate Loan

On May 4, 2006, the Company borrowed $10,000,000 under a promissory note (2006 Commercial Real Estate Loan), which is repayable in quarterly installments of $125,000 over a ten-year period with the remaining principal balance of $5,000,000 due upon maturity. As of July 4, 2009, the remaining balance on the 2006 Commercial Real Estate Loan was $8,500,000.

The Company’s obligations under the 2006 Commercial Real Estate Loan may be accelerated upon the occurrence of an event of default under the 2006 Commercial Real Estate Loan and the related Mortgage and Security Agreements, which include 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 2008 Credit Agreement or any successor credit facility would be an event of default under the 2006 Commercial Real Estate Loan.

Kadant Jining Loan and Credit Facilities

On January 28, 2008, the Company’s Kadant Jining subsidiary (Kadant Jining) borrowed 40 million Chinese renminbi, or approximately $5,864,000 at the July 4, 2009 exchange rate (2008 Kadant Jining Loan). Principal on the 2008 Kadant Jining Loan is due as follows: 24 million Chinese renminbi, or approximately $3,518,000, on January 28, 2010 and 16 million Chinese renminbi, or approximately $2,346,000, on January 28, 2011.

On July 30, 2008, Kadant Jining and the Company’s Kadant Yanzhou subsidiary (Kadant Yanzhou) each entered into a short-term credit line facility agreement (2008 Facilities) that would allow Kadant Jining to borrow up to an aggregate principal amount of 45 million Chinese renminbi, or approximately $6,597,000 at the July 4, 2009 exchange rate, and Kadant Yanzhou to borrow up to an aggregate principal amount of 15 million Chinese renminbi, or approximately $2,199,000 Facilities at the July 4, 2009 exchange rate. The 2008 Facilities have a term of 364 days and are renewable annually on or before July 30 at the discretion of the lender. As of July 4, 2009, there were no borrowings outstanding under the 2008 Facilities.

KADANT

Notes to Condensed Consolidated Financial Statements

(Unaudited)

7.	Warranty Obligations

The Company provides for the estimated cost of product warranties at the time of sale based on the 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 included in other current liabilities in the accompanying condensed consolidated balance sheet are as follows:

	Six Months Ended
(In thousands)	July 4, 2009

Balance at Beginning of Period	$	3,671
Provision (income) charged to expense		(303	)
Usage		(1,015	)
Currency translation		22
Balance at End of Period	$	2,375

See Note 17 for warranty information related to the discontinued operation.

8.	Restructuring Costs and Other Income, Net

2008 Restructuring Plan

In 2008, the Company initiated a 2008 Restructuring Plan that consisted of severance and associated costs related to the reduction of 329 full-time positions in China, North America, Latin America, and Europe, all at its Papermaking Systems segment. These actions were taken to adjust the Company’s cost structure and streamline its operations in response to the weak economic environment, which accelerated in the fourth quarter of 2008, and its negative impact on current and projected order volumes, especially in its stock-preparation equipment product line. The Company recorded additional restructuring costs, which consisted of severance and associated costs of $157,000, in the first six months of 2009 associated with its 2008 Restructuring Plan.

2009 Restructuring Plan

The Company recorded restructuring costs of $1,613,000 in the first six months of 2009 associated with its 2009 Restructuring Plan, which consisted of severance and associated costs related to the reduction of 78 full-time positions in China, the U.S., and Europe, all at its Papermaking Systems segment. These actions were taken to adjust the Company’s cost structure and streamline its operations in response to the continued weak economic environment.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

8.	Restructuring Costs and Other Income, Net (continued)

A summary of the changes in accrued restructuring costs, of which $1,809,000 is included in other current liabilities and $551,000 is included in other long-term liabilities as of July 4, 2009 in the accompanying condensed consolidated balance sheet, is as follows:

(In thousands)	Severance Costs

2008 Restructuring Plan
Balance at January 3, 2009	$	2,872
Provision		34
Payments		(544	)
Currency translation		(3	)
Balance at April 4, 2009		2,359
Provision		123
Payments		(539	)
Currency translation		5
Balance at July 4, 2009	$	1,948

2009 Restructuring Plan
Balance at January 3, 2009	$	–
Provision		723
Payments		(380	)
Currency translation		4
Balance at April 4, 2009		347
Provision		890
Payments		(842	)
Currency translation		17
Balance at July 4, 2009	$	412

The Company expects to pay the remaining accrued restructuring costs as follows: $1,809,000 in 2009 and $551,000 from 2010 to 2015.

Other Income

In the first quarter of 2008, the Company sold real estate in France for $746,000, resulting in a pre-tax gain of $594,000 on the sale.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

9.	Business Segment Information

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

	Three Months Ended						Six Months Ended
	July 4,			June 28,			July 4,			June 28,
(In thousands)	2009			2008			2009			2008

Revenues:
Papermaking Systems	$	47,995		$	90,453		$	109,982		$	173,711
Other		2,137			1,953			5,107			4,559
	$	50,132		$	92,406		$	115,089		$	178,270

(Loss) Income from Continuing Operations Before Income Tax (Benefit) Provision:
Papermaking Systems	$	700		$	14,740		$	3,582		$	25,618
Corporate and Other (a)		(1,899	)		(4,598	)		(4,573	)		(7,920	)
Total Operating (Loss) Income		(1,199	)		10,142			(991	)		17,698
Interest Expense, Net		(415	)		(129	)		(1,021	)		(183	)
	$	(1,614	)	$	10,013		$	(2,012	)	$	17,515

Capital Expenditures:
Papermaking Systems	$	743		$	1,282		$	1,855		$	2,707
Corporate and Other		140			257			185			442
	$	883		$	1,539		$	2,040		$	3,149

(a)	Corporate primarily includes general and administrative expenses.

10.	Stock-Based Compensation

Restricted Stock Units

On March 4, 2009, the Company granted an aggregate of 20,000 restricted stock units (RSUs) to its outside directors with an aggregate fair value of $157,000, which will vest at a rate of 5,000 shares per quarter on the last day of each quarter in 2009. On March 4, 2009, the Company also granted to its outside directors an aggregate of 40,000 RSUs with an aggregate fair value of $314,000, which will only vest and compensation expense will only be recognized upon a change in control as defined in the Company’s 2006 equity incentive plan. The 40,000 RSUs will be forfeited if a change in control does not occur prior to the end of the first quarter of 2010.

Performance-Based Restricted Stock Units

On March 3, 2009, the Company granted to certain officers of the Company performance-based RSUs, which represent, in aggregate, the right to receive 92,500 shares (the target RSU amount), subject to adjustment, with a grant date fair value of $8.47 per share. The RSUs will cliff vest in their entirety on the last day of the Company’s 2011 fiscal year, provided that certain performance criteria are met and the officer remains employed by the Company through the vesting date. The target RSU amount is subject to adjustment based on the achievement of a specified EBITDA target generated from continuing operations for the 2009 fiscal year and is forfeited is actual EBITDA is below 50% of the target EBITDA for the 2009 fiscal year. As of July 4, 2009, no compensation expense had been recognized related to these RSUs as the Company does not anticipate that the performance criteria will be met.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

10.	Stock-Based Compensation (continued)

The performance-based RSU agreements provide for forfeiture in certain events, such as voluntary or involuntary termination of employment, and for acceleration of vesting in certain events, such as death, disability or a change in control of the Company. If the officer dies or is disabled prior to the vesting date, then a ratable portion of the RSUs will vest. If a change in control occurs prior to the end of the performance period, the officer will receive the target RSU amount; otherwise, the officer will receive the number of deliverable RSUs based on the achievement of the performance goal, as stated in the RSU agreements.

Each performance-based RSU represents the right to receive one share of the Company’s common stock upon vesting. The Company recognizes compensation expense associated with performance-based RSUs ratably over the vesting period based on the grant date fair value. Compensation expense of $441,000 and $566,000 was recognized in the second quarters of 2009 and 2008, respectively, and $931,000 and $986,000 was recognized in the first six months of 2009 and 2008, respectively, associated with performance-based RSUs granted prior to 2009. Unrecognized compensation expense related to the unvested performance-based RSUs totaled approximately $1,350,000 at July 4, 2009, and will be recognized over a weighted average period of 1.0 years.

Time-Based Restricted Stock Units

The Company granted time-based RSUs in prior periods to certain employees of the Company. Each time-based RSU represents the right to receive one share of the Company’s common stock upon vesting. The Company is recognizing compensation expense associated with these time-based RSUs ratably over the vesting period based on the grant date fair value. Compensation expense of $124,000 and $127,000 was recognized in the second quarters of 2009 and 2008, respectively, and $230,000 and $240,000 was recognized in the first six months of 2009 and 2008, respectively, associated with time-based RSUs. Unrecognized compensation expense related to the time-based RSUs totaled approximately $982,000 as of July 4, 2009, and will be recognized over a weighted average period of 2.2 years.

A summary of the changes in the Company’s unvested RSUs for the six months ended July 4, 2009 is as follows:

	Units (In thousands)			Weighted Average Grant-Date Fair Value

Unvested RSUs at January 3, 2009		294		$	27.05
Granted		153		$	8.23
Vested		(10	)	$	7.85
Forfeited / Expired		(42	)	$	24.53
Unvested RSUs at July 4, 2009		395		$	20.53

11.	Employee Benefit Plans

Defined Benefit Pension Plans and Post-Retirement Welfare Benefits Plans

The Company’s Kadant Web Systems subsidiary has a noncontributory defined benefit retirement plan. Benefits under the plan are based on years of service and employee compensation. Funds are contributed to a trustee as necessary to provide for current service and for any unfunded projected benefit obligation over a reasonable period. Effective December 31, 2005, this plan was closed to new participants. This same subsidiary also has a post-retirement welfare benefits plan (included in the table below in “Other Benefits”). No future retirees are eligible for this post-retirement welfare benefits plan.

The Company’s Kadant Lamort subsidiary sponsors a defined benefit pension plan (included in the table below in “Other Benefits”). Benefits under this plan are based on years of service and projected employee compensation.

The Company’s Kadant Johnson subsidiary also offers a post-retirement welfare benefits plan (included in the table below in “Other Benefits”) to its U.S. employees upon attainment of eligible retirement age. This plan will be closed to employees who will not meet its retirement eligibility requirements on January 1, 2012.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

11.	Employee Benefit Plans (continued)

The components of the net periodic benefit cost (income) for the pension benefits and other benefits plans in the three-and six-month periods ended July 4, 2009 and June 28, 2008 are as follows:

	Three Months Ended						Three Months Ended
(In thousands)	July 4, 2009						June 28, 2008
	Pension Benefits			Other Benefits			Pension Benefits			Other Benefits

Components of Net Periodic Benefit Cost (Income):
Service cost	$	205		$	35		$	187		$	22
Interest cost		330			64			301			64
Expected return on plan assets		(324	)		–			(364	)		–
Recognized net actuarial loss		124			2			18			–
Amortization of prior service cost (income)		14			(90	)		14			(199	)
Net periodic benefit cost (income)	$	349		$	11		$	156		$	(113	)

The weighted-average assumptions used to determine net periodic benefit cost (income) are as follows:

Discount rate		6.25	%		6.20	%		6.00	%		5.90	%
Expected long-term return on plan assets		8.50	%		–			8.50	%		–
Rate of compensation increase		4.00	%		2.00	%		4.00	%		2.00	%

	Six Months Ended						Six Months Ended
(In thousands)	July 4, 2009						June 28, 2008
	Pension Benefits			Other Benefits			Pension Benefits			Other Benefits

Components of Net Periodic Benefit Cost (Income):
Service cost	$	410		$	70		$	403		$	43
Interest cost		660			124			598			127
Expected return on plan assets		(648	)		–			(732	)		–
Recognized net actuarial loss		248			2			29			–
Amortization of prior service cost (income)		28			(273	)		28			(397	)
Net periodic benefit cost (income)	$	698		$	(77	)	$	326		$	(227	)

The weighted-average assumptions used to determine net periodic benefit cost (income) are as follows:

Discount rate		6.25	%		6.15	%		6.00	%		5.90	%
Expected long-term return on plan assets		8.50	%		–			8.50	%		–
Rate of compensation increase		4.00	%		2.00	%		4.00	%		2.00	%

The Company recognized a curtailment gain of $278,000 in the three-month period ending July 4, 2009 associated with the reduction of 11 full-time positions in the U.S.

The Company made cash contributions of $2,400,000 to the Kadant Web Systems noncontributory defined benefit retirement plan in the first six months of 2009 and expects to make cash contributions of $1,200,000 per quarter over the remainder of 2009. For the remaining pension and post-retirement welfare benefits plans, no cash contributions other than the funding of current benefit payments are expected in 2009.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

12.	Derivatives

The Company uses derivative instruments primarily to reduce its exposure to currency exchange and interest rate risk. The Company accounts for such instruments in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), as amended. When the Company enters into a derivative contract, it makes a determination as to whether the transaction is deemed to be a hedge for accounting purposes. For a contract deemed to be a hedge, the Company formally documents the relationship between the derivative instrument and the risk being hedged. In this documentation, the Company specifically identifies the asset, liability, forecasted transaction, cash flow, or net investment that has been designated as the hedged item, and evaluates whether the derivative instrument is expected to reduce the risks associated with the hedged item. To the extent these criteria are not met, the Company does not use hedge accounting for the derivative instrument. The changes in the fair value of a derivative not deemed to be a hedge are recorded currently in earnings. The Company does not hold or engage in transactions involving derivative instruments for purposes other than risk management.

Interest Rate Swaps

The Company entered into interest rate swap agreements in 2008 and 2006 to hedge its exposure to variable-rate debt and has designated these agreements as cash flow hedges. On February 13, 2008, the Company entered into a swap agreement (2008 Swap Agreement) to hedge the exposure to movements in the 3-month LIBOR rate on future outstanding debt. The 2008 Swap Agreement has a five-year term and a $15,000,000 notional value, which decreases to $10,000,000 on December 31, 2010, and $5,000,000 on December 30, 2011. Under the 2008 Swap Agreement, on a quarterly basis the Company receives a 3-month LIBOR rate and pays a fixed rate of interest of 3.265% plus the applicable margin. The Company entered into a swap agreement in 2006 (the 2006 Swap Agreement) to convert a portion of the Company’s outstanding debt from floating to fixed rates of interest. The swap agreement has the same terms and quarterly payment dates as the corresponding debt, and reduces proportionately in line with the amortization of the debt. Under the 2006 Swap Agreement, the Company will receive a three-month LIBOR rate and pay a fixed rate of interest of 5.63%. The fair values for these instruments as of July 4, 2009 are included in other liabilities, with an offset to accumulated other comprehensive items (net of tax) in the accompanying condensed consolidated balance sheet. The Company has structured these interest rate swap agreements to be 100% effective and as a result, there is no current impact to earnings resulting from hedge ineffectiveness. Management believes that any credit risk associated with the swap agreements is remote based on the creditworthiness of the financial institution issuing the swap agreements.

The counterparty to the swap agreement could demand an early termination of the swap agreement if the Company is in default under the 2008 Credit Agreement, or any agreement that amends or replaces the 2008 Credit Agreement in which the counterparty is a member, and the Company is unable to cure the default. An event of default under the 2008 Credit Agreement includes customary events of default and failure to comply with financial covenants, including a maximum consolidated leverage ratio of 3.5 and a minimum consolidated fixed charge coverage ratio of 1.2. The unrealized gain (loss) represents the estimated amount that the Company would receive (pay) to the counterparty in the event of an early termination.

Forward Currency-Exchange Contracts

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

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

12. Derivatives (continued)

Forward currency-exchange contracts that hedge forecasted accounts receivable or accounts payable are designated as cash flow hedges. The fair values for these instruments are included in other current assets for unrecognized gains and in other current liabilities for unrecognized losses, with an offset in accumulated other comprehensive items (net of tax). For forward currency-exchange contracts that are designated as fair value hedges, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item are recognized currently in earnings. The fair values of forward currency-exchange contracts that are not designated as a hedge are recorded currently in earnings. The Company recognized a gain of $57,000 and a loss of $550,000 in the three- and six-month periods ending July 4, 2009, respectively, included in selling, general, and administrative expenses associated with forward currency-exchange contracts that were not designated as a hedge.

The following table summarizes the fair value of the Company’s derivative instruments designated and not designated as hedging instruments, the notional values of the associated derivative contracts, and the location of these instruments in the condensed consolidated balance sheet as of July 4, 2009:

(In thousands)	Balance Sheet Location	Asset (Liability)			Notional Amount (a)

Derivatives Designated as Hedging Instruments:
Derivatives in an Asset Position:
Forward currency-exchange contracts	Other Current Assets	$	80		$	3,695
Derivatives in a Liability Position:
Interest rate swap agreements	Other Long-Term Liabilities	$	(1,756	)	$	23,500

Derivatives Not Designated as Hedging Instruments:
Derivatives in a Liability Position:
Forward currency-exchange contracts	Other Current Liabilities	$	(16	)	$	872

(a) The total notional amount is indicative of the level of the Company’s derivative activity during the second quarter of 2009.

The following table summarizes the activity in accumulated other comprehensive items (OCI) associated with the Company’s derivative instruments designated as cash flow hedges as of and for the period ended July 4, 2009:

(In thousands)	Interest Rate Swap Agreements			Forward Currency-Exchange Contracts			Total
Unrealized loss (gain), net of tax, at January 3, 2009	$	1,800		$	(151	)	$	1,649
(Loss) Gain Reclassified to Earnings (a)		(279	)		109			(170	)
Gain Recognized in OCI		(70	)		(11	)		(81	)
Unrealized loss (gain), net of tax, at July 4, 2009	$	1,451		$	(53	)	$	1,398

(a) Included in interest expense for interest rate swap agreements and in revenues for forward currency-exchange contracts in the accompanying condensed consolidated statement of operations.

As of July 4, 2009, $538,000 of the net unrealized loss included in OCI is expected to be reclassified to earnings over the next twelve months .

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

13.	Fair Value Measurements

SFAS No. 157, “Fair Value Measurements” (SFAS 157) defines fair value as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. SFAS 157 establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:

•

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

•

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

•

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

The following table presents the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of July 4, 2009:

	Fair Value
(In thousands)	Level 1		Level 2		Level 3		Total
Assets:
Forward currency-exchange contracts	$	–	$	80	$	–	$	80
Liabilities:
Forward currency-exchange contracts	$	–	$	16	$	–	$	16
Interest rate swap agreements	$	–	$	1,756	$	–	$	1,756

The Company uses the market approach technique to value its financial assets and liabilities, and there were no changes in valuation techniques during the first six months of 2009. The Company’s financial assets and liabilities carried at fair value comprise derivative instruments used to hedge the Company’s foreign currency and interest rate risks. The fair values of the Company’s interest rate swap agreements are based on LIBOR yield curves at the reporting date. The fair values of the Company’s forward currency-exchange contracts are based on quoted forward foreign exchange prices at the reporting date. The forward currency-exchange contracts and interest rate swap agreements are hedges of either recorded assets or liabilities or anticipated transactions. Changes in values of the underlying hedged assets and liabilities or anticipated transactions are not reflected in the table above.

14.	Letters of Credit

Certain of the Company’s contracts, particularly for stock-preparation and systems orders, require the Company to provide a standby letter of credit to a customer as beneficiary, limited in amount to a negotiated percentage of the total contract value, in order to guarantee warranty and performance obligations of the Company under the contract. Typically, these standby letters of credit expire without being drawn by the beneficiary. One of the Company’s customers indicated its intention to draw upon all outstanding standby letters of credit issued to the customer as beneficiary to secure warranty and performance obligations under multiple contracts. The Company believes the attempted draws by the customer in the first six months of 2009 are for reasons unrelated to the Company’s warranty and performance obligations and the Company has opposed and intends to continue to vigorously oppose such actions. As of July 4, 2009, the customer had submitted draws against standby letters of credit totaling $2,270,000 and the Company has obtained preliminary injunctions against payment to the customer. The outstanding standby letters of credit to this customer, including those that the Company has obtained preliminary injunctions against payment, total $5,845,000.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

15.	Pending Litigation

The Company has been named as a co-defendant, together with the Company’s Kadant Composites LLC subsidiary (Composites LLC) and another defendant, in a consumer class action lawsuit filed in the United States District Court for the District of Massachusetts (the District Court) on December 27, 2007 on behalf of a putative class of individuals who own GeoDeck™ decking or railing products manufactured by Composites LLC between April 2002 and October 2003. The complaint in this matter purports to assert, among other things, causes of action for unfair and deceptive trade practices, fraud, negligence, breach of warranty and unjust enrichment, and it seeks compensatory damages and punitive damages under various state consumer protection statutes. The District Court dismissed the complaint against all defendants in its entirety on November 19, 2008. The plaintiffs have appealed the District Court’s dismissal to the U.S. First Circuit Court of Appeals (Court of Appeals). The Court of Appeals has yet to schedule a hearing on the plaintiffs’ appeal. The Company intends to defend against this action vigorously, but there is no assurance the Company will prevail in such defense or that additional lawsuits asserting similar claims will not be filed against the Company. The Company could incur significant costs to defend this lawsuit or similar lawsuits and a judgment or a settlement of such claims could have a material adverse impact on the Company’s condensed consolidated financial results. The Company has not made an accrual related to this litigation as it believes that an adverse outcome is not probable and estimable at this time.

16.	Recent Accounting Pronouncements

In December 2008, the FASB issued FSP No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (FSP 132(R)-1). FSP 132(R)-1 requires additional disclosures about an employer’s plan assets of defined benefit pension or other postretirement plans. This rule expands current disclosures of defined benefit pension and postretirement plan assets to include information regarding the fair value measurements of plan assets similar to the Company’s current SFAS 157 disclosures. FSP 132(R)-1 is effective for fiscal years ending after December 15, 2009. The Company is currently evaluating the potential impact of the adoption of FSP 132(R)-1 on its financial statement disclosures.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (FSP 115-2 and 124-2). This FSP amends the other-than-temporary impairment guidance for certain debt securities and will require the investor to assess the likelihood of selling the debt security prior to recovery of its cost basis. If an investor is able to meet the criteria to assert that it does not intend to sell the debt security and more likely than not will not be required to sell the debt security before its anticipated recovery, impairment charges related to credit losses would be recognized in earnings whereas impairment charges related to non-credit losses would be reflected in other comprehensive income. FSP 115-2 and 124-2 is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted FSP 115-2 and 124-2 on July 4, 2009, which had no effect on its condensed consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (FSP FAS 107-1 and APB 28-1). This FSP requires the fair value disclosures required by SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” regarding the fair value of financial instruments to be included in interim financial statements. FSP FAS 107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009 and requires additional disclosure from that previously required. The Company adopted FSP FAS 107-1 and APB 28-1 in the second quarter of 2009, which had no effect on its condensed consolidated financial statements.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

16.	Recent Accounting Pronouncements (continued)

In April 2009, the FASB issued FSP No. 157- 4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly" (FSP 157- 4). FSP 157- 4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP 157- 4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP 157- 4 is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted FSP 157- 4 in the second quarter of 2009, which had no effect on its condensed consolidated financial statements.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (SFAS 165). SFAS 165 identifies the following: the period after the balance sheet date during which management shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; the circumstances under which an entity shall recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity shall make about events or transactions that occurred after the balance sheet date. The Company adopted SFAS 165 in the second quarter of 2009, which had no effect on its condensed consolidated financial statements.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” (SFAS 168). Upon its effective date, the “FASB Accounting Standards Codification,” or the Codification, will become the single source of authoritative nongovernmental generally accepted accounting principles in the U.S. (GAAP). The Codification is effective for interim and annual periods ending after September 15, 2009. The adoption of the Codification will have no impact on the Company’s financial position or results of operations.

17.	Discontinued Operation

In 2005, Composites LLC sold substantially all of its assets to LDI Composites Co. (Buyer). Under the terms of the asset purchase agreement, Composites LLC retained certain liabilities associated with the operation of the business prior to the sale, including the warranty obligations associated with products manufactured prior to the sale date. Composites LLC retained all of the cash proceeds received from the asset sale and continued to administer and pay warranty claims from the sale proceeds into the third quarter of 2007. On September 30, 2007, Composites LLC announced that it no longer had sufficient funds to honor warranty claims, was unable to pay or process warranty claims, and ceased doing business. All activity related to this business is classified in the results of the discontinued operation in the accompanying condensed consolidated financial statements.

Through the sale date of October 21, 2005, Composites LLC offered a standard limited warranty to the owner of its decking and roofing products, limited to repair or replacement of the defective product or a refund of the original purchase price. Composites LLC records the minimum amount of the potential range of loss for products under warranty in accordance with SFAS No. 5, “Accounting for Contingencies” (SFAS 5). As of July 4, 2009, the accrued warranty costs associated with the composites business were $2,142,000, which represents the low end of the estimated range of warranty reserve required based on the level of claims received. Composites LLC has calculated that the total potential warranty cost ranges from $2,142,000 to approximately $13,100,000. The high end of the range represents the estimated maximum level of warranty claims remaining based on the total sales of the products under warranty. Composites LLC will continue to record adjustments to the accrued warranty costs to reflect the minimum amount of the potential range of loss for products under warranty based on judgments entered against it in litigation, if any.

See Note 15 for information related to pending litigation associated with the composites business.

KADANT INC.

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

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

Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions. Our future results of operations may differ materially from those expressed in the forward-looking statements. Many of the important factors that will determine these results and values are beyond our ability to control or predict. You should not put undue reliance on any forward-looking statements. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events, or otherwise. For a discussion of important factors that may cause our actual results to differ materially from those suggested by the forward-looking statements, you should read carefully the section captioned “Risk Factors” in Part II, Item 1A, of this Report.

Overview

Company Background

We are a leading supplier of equipment used in the global papermaking and paper recycling industries and are also a manufacturer of granules made from papermaking byproducts. Our continuing operations are comprised of one reportable operating segment: Pulp and Papermaking Systems (Papermaking Systems), and a separate product line, Fiber-based Products, reported in Other Business. Through our Papermaking Systems segment, we develop, manufacture, and market a range of equipment and products for the global papermaking and paper recycling industries. We have a large customer base that includes most of the world’s major paper manufacturers. We believe our large installed base provides us with a spare parts and consumables business that yields higher margins than our capital equipment business, and which have traditionally been less susceptible to the cyclical trends in the paper industry.

Through our Fiber-based Products line, we manufacture and sell granules derived from pulp fiber for use as carriers for agricultural, home lawn and garden, and professional lawn, turf and ornamental applications, as well as for oil and grease absorption.

In addition, prior to its sale in 2005, our Kadant Composites LLC subsidiary (Composites LLC) operated a composite building products business, which is presented as a discontinued operation in the accompanying condensed consolidated financial statements.

We were incorporated in Delaware in November 1991. On July 12, 2001, we changed our name to Kadant Inc. from Thermo Fibertek Inc. Our common stock is listed on the New York Stock Exchange, where it trades under the symbol “KAI.”

Papermaking Systems Segment

Our Papermaking Systems segment designs and manufactures stock-preparation systems and equipment, fluid-handling systems and equipment, paper machine accessory equipment, and water-management systems primarily for the paper and paper recycling industries. Our principal products include:

Stock-preparation systems and equipment: custom-engineered systems and equipment, as well as standard individual components, for pulping, de-inking, screening, cleaning, and refining recycled and virgin fibers for preparation for entry into the paper machine during the production of recycled paper;

Fluid handling systems and equipment: rotary joints, precision unions, steam and condensate systems, components, and controls used primarily in the dryer section of the papermaking process and during the production of corrugated boxboard, metals, plastics, rubber, textiles and food;

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

KADANT INC.

Overview (continued)

including cleaning, creping, web removal, and application of coatings; and profiling systems that control moisture, web curl, and gloss during paper production; and

Water-management systems: systems and equipment used to continuously clean paper machine fabrics, drain water from pulp mixtures, form the sheet or web, and filter the process water for reuse.

Other Business

Our other business consists of our Fiber-based Products business that 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.

Discontinued Operation

In 2005, Composites LLC sold substantially all of its assets to LDI Composites Co. Under the terms of the asset purchase agreement, Composites LLC retained certain liabilities associated with the operation of the business prior to the sale, including the warranty obligations associated with products manufactured prior to the sale date. Composites LLC retained all of the cash proceeds received from the asset sale and continued to administer and pay warranty claims from the sale proceeds into the third quarter of 2007. On September 30, 2007, Composites LLC announced that it no longer had sufficient funds to honor warranty claims, was unable to pay or process warranty claims, and ceased doing business.

Through the sale date of October 21, 2005, Composites LLC offered a standard limited warranty to the owners of its decking and roofing products, limited to repair or replacement of the defective product or a refund of the original purchase price. As of July 4, 2009, the accrued warranty costs associated with the composites business were $2.1 million, which represents the low end of the estimated range of warranty reserve required based on the level of claims received. Composites LLC has calculated that the total potential warranty cost ranges from $2.1 million to approximately $13.1 million. The high end of the range represents the estimated maximum level of warranty claims remaining based on the total sales of the products under warranty. Composites LLC will continue to record adjustments to accrued warranty costs to reflect the minimum amount of the potential range of loss for products under warranty based on judgments known to be entered against it in litigation, if any.

All activity related to this business is classified in the results of the discontinued operation in the accompanying condensed consolidated financial statements.

Composites LLC’s inability to pay or process warranty claims has exposed us to greater risks associated with litigation. For more information regarding our current litigation arising from these claims, see Part II, Item 1, “Legal Proceedings,” and Part II, Item 1A, “Risk Factors”.

International Sales

During the first six months of both 2009 and 2008, approximately 60% of our sales were to customers outside the United States, principally in Asia and Europe. 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.

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.

KADANT INC.

Overview (continued)

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 Part I, Item 7, of our Annual Report on Form 10-K for the fiscal year ended January 3, 2009, filed with the Securities and Exchange Commission (SEC). There have been no material changes to these critical accounting policies since fiscal year-end 2008 that warrant disclosure.

Industry and Business Outlook

Our products are primarily sold to the global pulp and paper industry. The worldwide economic downturn continues to negatively impact paper producers. In response to the economic slowdown, paper producers have taken numerous steps to control operating costs including closing factories, increasing downtime at paper mills, deferring maintenance and upgrades, and delaying or canceling projects. Revenues in all of our product lines within our papermaking systems segment in the first six months of 2009 were negatively impacted, which resulted in a $63.7 million, or 37%, decrease in revenues in this segment in the first six months of 2009 compared to the first six months of 2008. A significant factor contributing to this decrease was the slowdown in China, where there is more linerboard capacity than needed to meet demand. There were also significant declines in North America, where paper companies have curtailed production, closed mills and shut down paper machines. In addition, fluid-handling revenues declined significantly, partly due to lower energy costs.

In response to this difficult environment, we have taken a number of steps to optimize our business structure and maximize internal efficiencies, which include integrating multiple operations in a region, merging our sales teams in certain markets, and reducing the number of employees in certain locations. In addition, we continue to concentrate our efforts on several initiatives intended to improve our operating results, including: increasing aftermarket sales, delivering products and technical solutions that provide our customers with a good return on their investments through energy-savings and fiber-yield improvements, penetrating existing markets where we see opportunity, and increasing our use of low-cost manufacturing bases. We also continue to focus our efforts on managing our operating costs, capital expenditures, and working capital.

For 2009, we expect GAAP (generally accepted accounting principles) revenues and earnings per share from continuing operations, which exclude the results from our discontinued operation, as follows: For the third quarter of 2009, we expect to report a diluted loss per share of $.28 to $.30 from continuing operations, on revenues of $46 to $48 million. This includes $.14 of incremental tax provision and $.04 of estimated restructuring costs. For 2009, we expect to report a diluted loss per share of $.60 to $.65 from continuing operations, on revenues of $210 to $220 million, revised from our previous guidance of diluted loss per share of $.55 to $.65, on revenues of $220 to $230 million. The full year guidance includes $.37 of incremental tax provision and $.15 of estimated restructuring costs. The incremental tax provision is associated with the valuation allowance established for certain U.S. and foreign deferred tax assets as a result of our cumulative loss position in the U.S. and certain foreign tax jurisdictions.

KADANT INC.

Results of Operations

Second Quarter 2009 Compared With Second Quarter 2008

The following table sets forth our unaudited condensed consolidated statement of operations expressed as a percentage of total revenues from continuing operations for the second fiscal quarters of 2009 and 2008. The results of operations for the fiscal quarter ended July 4, 2009 are not necessarily indicative of the results to be expected for the full fiscal year.

	Three Months Ended
	July 4,			June 28,
	2009			2008

Revenues		100	%		100	%

Costs and Operating Expenses:
Cost of revenues		59			58
Selling, general, and administrative expenses		38			29
Research and development expenses		3			2
Restructuring costs		2			–
		102			89

Operating (Loss) Income		(2	)		11

Interest Income		–			1
Interest Expense		(1	)		(1	)

(Loss) Income from Continuing Operations Before Income Tax (Benefit) Provision		(3	)		11
Income Tax (Benefit) Provision		(1	)		4

(Loss) Income from Continuing Operations		(2	)		7
Loss from Discontinued Operation		–			–

Net (Loss) Income		(2	)%		7	%

Revenues

Revenues decreased to $50.1 million in the second quarter of 2009 from $92.4 million in the second quarter of 2008, a decrease of $42.3 million, or 46%. Revenues in the second quarter of 2009 include a $4.2 million, or 5%, decrease from the unfavorable effects of currency translation. Excluding the effects of currency translation, revenues decreased $38.1 million, or 41%, in the second quarter of 2009 due to a decrease in revenues in all of our major product lines as our customers continued to take steps to control operating costs including increasing downtime at paper mills and delaying or canceling projects. Excluding the effects of currency translation, the largest revenue declines in the second quarter of 2009 were in our stock-preparation equipment product line, which decreased $20.0 million, or 54%, and our fluid-handling product line, which decreased $11.5 million, or 41%.

KADANT INC.

Results of Operations (continued)

Revenues for the second quarters of 2009 and 2008 from our Papermaking Systems segment and our other businesses are as follows:

	Three Months Ended
	July 4,		June 28,
(In thousands)	2009		2008

Revenues:
Papermaking Systems	$	47,995	$	90,453
Other Business		2,137		1,953
	$	50,132	$	92,406

Papermaking Systems Segment. Revenues at the Papermaking Systems segment decreased to $48.0 million in the second quarter of 2009 from $90.4 million in the second quarter of 2008, a decrease of $42.4 million, or 47%. Revenues in the 2009 period include a $4.2 million, or 5%, decrease from the unfavorable effects of currency translation.

Other Business. Revenues from the Fiber-based Products business increased $0.1 million, or 9%, to $2.1 million in the second quarter of 2009 from $2.0 million in the second quarter of 2008 primarily due to stronger sales of Biodac™, our line of biodegradable granular products.

The following table presents revenues at the Papermaking Systems segment by product line, the changes in revenues by product line between the second quarters of 2009 and 2008, and the changes in revenues by product line between the second quarters of 2009 and 2008 excluding the effect of currency translation. The presentation of the changes in revenues by product line excluding the effect of currency translation is a non-GAAP measure. We believe this non-GAAP measure helps investors gain a better understanding of our underlying operations, consistent with how our management measures and forecasts our performance, especially when comparing such results to prior periods. This non-GAAP measure should not be considered superior to or a substitute for the corresponding GAAP measure.

	Three Months Ended				Decrease Excluding Effect of
(In millions)	July 4, 2009		June 28, 2008		Decrease			Currency Translation

Product Line:
Stock-Preparation Equipment	$	16.4	$	37.3	$	(20.9	)	$	(20.0	)
Fluid-Handling		15.1		28.0		(12.9	)		(11.5	)
Accessories		10.9		16.8		(5.9	)		(4.6	)
Water-Management		5.2		7.7		(2.5	)		(2.0	)
Other		0.4		0.6		(0.2	)		(0.1	)
	$	48.0	$	90.4	$	(42.4	)	$	(38.2	)

Revenues from the segment’s stock-preparation equipment product line decreased $20.9 million, or 56%, in the second quarter of 2009 compared to the second quarter of 2008, including a $0.9 million, or 2%, decrease from the unfavorable effect of currency translation. Excluding the effect of currency translation, revenues from the segment’s stock preparation equipment product line decreased $20.0 million, or 54%, primarily due to an $8.1 million, or 56%, decrease in stock-preparation equipment sales in North America, a $7.1 million, or 65%, decrease in stock-preparation equipment sales in China, and a $4.8 million, or 41%, decrease in stock-preparation equipment sales in Europe. These significant decreases were due to a reduction in orders as major manufacturers cancelled or postponed projects due to the current economic environment. We expect to continue to see declines in stock-preparation equipment sales in the third quarter of 2009.

KADANT INC.

Results of Operations (continued)

Revenues from the segment’s fluid-handling product line decreased $12.9 million, or 46%, in the second quarter of 2009 compared to the second quarter of 2008, including a $1.4 million, or 5%, decrease from the unfavorable effect of currency translation. Excluding the effect of currency translation, revenues from the segment’s fluid-handling product line decreased $11.5 million, or 41%, primarily due to a decrease in revenues in Europe, and to a lesser extent, North America and China, as customers curtailed production and reduced their order volumes.

Revenues from the segment’s accessories product line decreased $5.9 million, or 35%, in the second quarter of 2009 compared to the second quarter of 2008, including a $1.3 million, or 7%, decrease from the unfavorable effect of currency translation. Excluding the effect of currency translation, revenues from the segment’s accessories product line decreased $4.6 million, or 28%, primarily due to decreased demand in North America and Europe due to significantly lower demand in the current economic environment.

Revenues from the segment’s water-management product line decreased $2.5 million, or 33%, in the second quarter of 2009 compared to the second quarter of 2008, including a $0.5 million, or 7%, decrease from the unfavorable effect of currency translation. Excluding the effect of currency translation, revenues from the segment’s water management product line decreased $2.0 million, or 26%, primarily due to a decrease in capital sales in North America.

Gross Profit Margin

Gross profit margins for the second quarters of 2009 and 2008 are as follows:

	Three Months Ended
	July 4,			June 28,
	2009			2008

Gross Profit Margin:
Papermaking Systems		41	%		42	%
Other Business		45			29
		41	%		42	%

Gross profit margin decreased to 41% in the second quarter of 2009 from 42% in the second quarter of 2008.

Papermaking Systems Segment. The gross profit margin in the Papermaking Systems segment decreased to 41% in the second quarter of 2009 from 42% in the second quarter of 2008. This decrease was primarily due to lower margins in our water-management product line due to the underabsorption of overhead costs given reduced order volumes. We are in the process of consolidating our water-management manufacturing facility into our facilities in Massachusetts and Mexico and we expect to continue to see reduced margins in this product line until this consolidation is completed in the fourth quarter of 2009. In addition, an increase in the gross profit margin in our stock preparation equipment product line due to a more favorable product mix and cost reductions was offset by decreases in the gross profit margins in our fluid handling and accessories product lines.

Other Business. The gross profit margin in our Fiber-based Products business increased to 45% in the second quarter of 2009 from 29% in the second quarter of 2008 primarily due to the lower cost of natural gas.

Operating Expenses

Selling, general, and administrative expenses as a percentage of revenues increased to 38% in the second quarter of 2009 from 29% in the second quarter of 2008. Selling, general, and administrative expenses decreased $7.7 million, or 29%, to $19.2 million in the second quarter of 2009 from $26.9 million in the second quarter of 2008. This decrease includes a $1.5 million decrease from the favorable effect of foreign currency translation and a $6.2 million net decrease primarily due to expense reductions throughout the Company, including our recent restructuring efforts that reduced the number of employees and merged our sales forces in certain markets.

KADANT INC.

Results of Operations (continued)

Total stock-based compensation expense was $0.6 million and $0.8 million in the second quarters of 2009 and 2008, respectively, and is included in selling, general, and administrative expenses in the accompanying condensed consolidated statement of operations. As of July 4, 2009, unrecognized compensation cost related to restricted stock units was approximately $2.4 million, which will be recognized over a weighted average period of 1.4 years.

Research and development expenses increased $0.2 million to $1.7 million in the second quarter of 2009 compared to $1.5 million in the second quarter of 2008 and represented 3% and 2% of revenues in the second quarter of 2009 and 2008, respectively.

Restructuring Costs

We recorded restructuring costs of $1.0 million in the second quarter of 2009, consisting of severance and associated charges primarily related to the reduction of 35 full-time positions in the U.S., Europe, and China in the Papermaking Systems segment. We estimate annualized savings of $1.4 million in cost of revenues and $1.0 million in selling, general, and administrative expenses from the 2009 restructuring actions. We expect to incur an additional $1.0 million in restructuring costs during the remainder of 2009.

Interest Income

Interest income decreased $0.4 million, or 82%, to $0.1 million in the second quarter of 2009 from $0.5 million in the second quarter of 2008 due to lower average interest rates and, to a lesser extent, lower average invested balances in the 2009 period.

Interest Expense

Interest expense decreased $0.1 million, or 21%, to $0.5 million in the second quarter of 2009 from $0.6 million in the second quarter of 2008 primarily due to lower average borrowing rates and to a lesser extent, lower average outstanding borrowings during the second quarter of 2009 compared to the second quarter of 2008.

Income Tax (Benefit) Provision

Our income tax benefit of $0.4 million in the second quarter of 2009 was primarily due to tax benefits associated with our foreign operations.

(Loss) Income from Continuing Operations

Loss from continuing operations was $1.2 million in the second quarter of 2009 compared to income from continuing operations of $7.0 million in the second quarter of 2008. The decrease in the 2009 period was primarily due to a decrease in operating income of $11.3 million (see Revenues, Gross Profit Margin, and Operating Expenses discussed above).

Loss from Discontinued Operation

Loss from the discontinued operation was $5 thousand in both the second quarters of 2009 and 2008.

As of July 4, 2009, the accrued warranty costs associated with the composites business were $2.1 million, which represents the low end of the estimated range of warranty reserve required based on the level of claims received. Composites LLC has calculated that the total potential warranty cost ranges from $2.1 million to approximately $13.1 million. The high end of the range represents the estimated maximum level of warranty claims remaining based on the total sales of the products under warranty.

KADANT INC.

Results of Operations (continued)

Composites LLC retained all of the cash proceeds received from the asset sale in October 2005 and continued to administer and pay warranty claims from the sale proceeds into the third quarter of 2007. On September 30, 2007, Composites LLC announced that it no longer had sufficient funds to honor warranty claims, was unable to pay or process warranty claims, and ceased doing business. Composites LLC will continue to record adjustments to accrued warranty costs to reflect the minimum amount of the potential range of loss for products under warranty based on judgments entered against it in litigation. Our consolidated results in future reporting periods will be negatively impacted if the future level of warranty claims exceeds the warranty reserve.

Recent Accounting Pronouncements

In December 2008, the FASB issued FSP No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (FSP 132(R)-1). FSP 132(R)-1 requires additional disclosures about an employer’s plan assets of defined benefit pension or other postretirement plans. This rule expands current disclosures of defined benefit pension and postretirement plan assets to include information regarding the fair value measurements of plan assets similar to our current SFAS No. 157, “Fair Value Measurements,” disclosures. FSP 132(R)-1 is effective for fiscal years ending after December 15, 2009. We are currently evaluating the potential impact of the adoption of FSP 132(R)-1 on our financial statement disclosures.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (FSP 115-2 and 124-2). This FSP amends the other-than-temporary impairment guidance for certain debt securities and will require the investor to assess the likelihood of selling the debt security prior to recovery of its cost basis. If an investor is able to meet the criteria to assert that it does not intend to sell the debt security and more likely than not will not be required to sell the debt security before its anticipated recovery, impairment charges related to credit losses would be recognized in earnings whereas impairment charges related to non-credit losses would be reflected in other comprehensive income. FSP 115-2 and 124-2 is effective for interim and annual reporting periods ending after June 15, 2009. We adopted FSP 115-2 and 124-2 on July 4, 2009, which had no effect on our condensed consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (FSP FAS 107-1 and APB 28-1). This FSP requires the fair value disclosures required by SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” regarding the fair value of financial instruments to be included in interim financial statements. FSP FAS 107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009 and requires additional disclosure from that previously required. We adopted FSP FAS 107-1 and APB 28-1 in the second quarter of 2009, which had no effect on our condensed consolidated financial statements.

In April 2009, the FASB issued FSP No. 157- 4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly" (FSP 157- 4). FSP 157- 4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP 157- 4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP 157- 4 is effective for interim and annual reporting periods ending after June 15, 2009. We adopted FSP 157- 4 in the second quarter of 2009, which had no effect on our condensed consolidated financial statements.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (SFAS 165). SFAS 165 identifies the following: the period after the balance sheet date during which management shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; the circumstances under which an entity shall recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity shall make about events or transactions that occurred after the balance sheet date. We adopted SFAS 165 in the second quarter of 2009, which had no effect on our condensed consolidated financial statements.

KADANT INC.

Results of Operations (continued)

First Six Months 2009 Compared With First Six Months 2008

The following table sets forth our unaudited condensed consolidated statement of operations expressed as a percentage of total revenues from continuing operations for the first six months of 2009 and 2008. The results of operations for the first six months of 2009 are not necessarily indicative of the results to be expected for the full fiscal year.

	Six Months Ended
	July 4,			June 28,
	2009			2008

Revenues		100	%		100	%

Costs and Operating Expenses:
Cost of revenues		60			59
Selling, general, and administrative expenses		36			29
Research and development expenses		3			2
Restructuring costs and other income, net		2			–
		101			90

Operating (Loss) Income		(1	)		10

Interest Income		–			1
Interest Expense		(1	)		(1	)

(Loss) Income from Continuing Operations Before Provision for Income Taxes		(2	)		10
Provision for Income Taxes		2			3

(Loss) Income from Continuing Operations		(4	)		7
Loss from Discontinued Operation		–