Edgar Filing: KADANT INC

kaiform10q2q2011.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 2, 2011

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

For the transition period from ________ to _________

Commission file number 1-11406

KADANT INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. 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

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 July 29, 2011
		Common Stock, $.01 par value			12,347,321

PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.

Condensed Consolidated Balance Sheet

(Unaudited)

Assets

	July 2,		January 1,
(In thousands)	2011		2011

Current Assets:
Cash and cash equivalents	$	43,912	$	61,805
Restricted cash (Note 2)		2,107		–
Accounts receivable, less allowances of $2,344 and $2,185		54,469		49,897
Inventories (Note 6)		60,950		41,628
Other current assets		14,350		9,876
Assets of discontinued operation		387		401
Total Current Assets		176,175		163,607

Property, Plant, and Equipment, at Cost		105,889		99,346
Less: accumulated depreciation and amortization		66,548		62,435
		39,341		36,911

Other Assets (including $66 of restricted cash at July 2, 2011; Note 2)		43,364		38,266

Goodwill		109,821		97,988

Total Assets	$	368,701	$	336,772

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 2,			January 1,
(In thousands, except share amounts)	2011			2011

Current Liabilities:
Short-term obligations and current maturities of long-term obligations	$	500		$	5,500
Accounts payable		27,008			23,756
Accrued payroll and employee benefits		13,931			15,739
Customer deposits		28,049			19,269
Other current liabilities		21,377			17,940
Liabilities of discontinued operation		2,397			2,397
Total Current Liabilities		93,262			84,601

Other Long-Term Liabilities		30,042			27,620

Long-Term Obligations (Note 8)		17,000			17,250

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		92,108			92,935
Retained earnings		178,226			165,131
Treasury stock at cost, 2,276,838 and 2,369,422 shares		(46,880	)		(48,786	)
Accumulated other comprehensive items (Note 4)		3,636			(3,586	)
Total Kadant Shareholders’ Investment		227,236			205,840
Noncontrolling interest		1,161			1,461
Total Shareholders’ Investment		228,397			207,301

Total Liabilities and Shareholders’ Investment	$	368,701		$	336,772

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

KADANT INC.

Condensed Consolidated Statement of Income

(Unaudited)

	Three Months Ended
	July 2,			July 3,
(In thousands, except per share amounts)	2011			2010

Revenues	$	82,457		$	69,136

Costs and Operating Expenses:
Cost of revenues		44,751			37,968
Selling, general, and administrative expenses		25,821			22,681
Research and development expenses		1,403			1,206
Restructuring costs and other income, net		–			(21	)
		71,975			61,834

Operating Income		10,482			7,302

Interest Income		122			32
Interest Expense		(299	)		(339	)

Income from Continuing Operations Before Provision for Income Taxes		10,305			6,995
Provision for Income Taxes		2,927			1,717

Income from Continuing Operations		7,378			5,278
Loss from Discontinued Operation (net of income tax benefit of $2 and $3)		(5	)		(5	)

Net Income		7,373			5,273

Net Income Attributable to Noncontrolling Interest		(69	)		(53	)

Net Income Attributable to Kadant	$	7,304		$	5,220

Amounts Attributable to Kadant:
Income from Continuing Operations	$	7,309		$	5,225
Loss from Discontinued Operation		(5	)		(5	)
Net Income Attributable to Kadant	$	7,304		$	5,220

Basic and Diluted Earnings per Share from Continuing Operations Attributable to Kadant (Note 5)	$	.59		$	.42

Basic and Diluted Earnings per Share Attributable to Kadant (Note 5)	$	.59		$	.42

Weighted Average Shares (Note 5):
Basic		12,321			12,426

Diluted		12,477			12,549

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

KADANT INC.

Condensed Consolidated Statement of Income

(Unaudited)

	Six Months Ended
	July 2,			July 3,
(In thousands, except per share amounts)	2011			2010

Revenues	$	154,137		$	130,257

Costs and Operating Expenses:
Cost of revenues		82,338			72,214
Selling, general, and administrative expenses		50,294			43,805
Research and development expenses		2,715			2,578
Restructuring costs and other income, net (Note 10)		–			(323	)
		135,347			118,274

Operating Income		18,790			11,983

Interest Income		221			70
Interest Expense		(556	)		(697	)

Income from Continuing Operations Before Provision for Income Taxes		18,455			11,356
Provision for Income Taxes (Note 7)		5,200			2,433

Income from Continuing Operations		13,255			8,923
Loss from Discontinued Operation (net of income tax benefit of $5 and $5)		(9	)		(9	)

Net Income		13,246			8,914

Net Income Attributable to Noncontrolling Interest		(151	)		(83	)

Net Income Attributable to Kadant	$	13,095		$	8,831

Amounts Attributable to Kadant:
Income from Continuing Operations	$	13,104		$	8,840
Loss from Discontinued Operation		(9	)		(9	)
Net Income Attributable to Kadant	$	13,095		$	8,831

Earnings per Share from Continuing Operations Attributable to Kadant (Note 5):
Basic	$	1.07		$	.71
Diluted	$	1.05		$	.71

Earnings per Share Attributable to Kadant (Note 5):
Basic	$	1.07		$	.71
Diluted	$	1.05		$	.71

Weighted Average Shares (Note 5):
Basic		12,294			12,418

Diluted		12,442			12,521

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 2,			July 3,
(In thousands)	2011			2010

Operating Activities:
Net income attributable to Kadant	$	13,095		$	8,831
Net income attributable to noncontrolling interest		151			83
Loss from discontinued operation		9			9
Income from continuing operations		13,255			8,923
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
Depreciation and amortization		3,847			3,355
Stock-based compensation expense		1,902			1,285
Provision for losses on accounts receivable		314			446
Gain on the sale of property, plant, and equipment		(18	)		(233	)
Other items, net		689			494
Changes in current assets and liabilities, net of effects of acquisitions:
Accounts receivable		(1,373	)		(5,118	)
Unbilled contract costs and fees		(1,609	)		(1,625	)
Inventories		(15,294	)		(4,797	)
Other current assets		(1,360	)		123
Accounts payable		1,494			5,667
Other current liabilities		5,809			1,638
Contributions to pension plan		(450	)		(1,750	)
Net cash provided by continuing operations		7,206			8,408
Net cash provided by discontinued operation		5			5
Net cash provided by operating activities		7,211			8,413

Investing Activities:
Acquisitions, net of cash acquired (Note 3)		(15,358	)		(2,592	)
Purchases of property, plant, and equipment		(3,964	)		(1,292	)
Dividend paid to minority shareholder		(579	)		–
Proceeds from sale of property, plant, and equipment		35			677
Other, net		58			–
Net cash used in continuing operations for investing activities		(19,808	)		(3,207	)

Financing Activities:
Repayments of short- and long-term obligations		(5,767	)		(250	)
Change in restricted cash (Note 2)		(2,173	)		–
Proceeds from issuance of Company common stock		149			–
Other, net		21			6
Net cash used in continuing operations for financing activities		(7,770	)		(244	)

Exchange Rate Effect on Cash and Cash Equivalents		2,474			(3,431	)

(Decrease) Increase in Cash and Cash Equivalents		(17,893	)		1,531
Cash and Cash Equivalents at Beginning of Period		61,805			45,675
Cash and Cash Equivalents at End of Period	$	43,912		$	47,206

Non-cash Investing Activities:
Fair value of assets acquired	$	21,844		$	–
Cash paid for acquired business		(15,849	)		–
Liabilities assumed of acquired business	$	5,995		$	–

Non-cash Financing Activities:
Issuance of Company common stock	$	1,855		$	369

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

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. General

The interim condensed consolidated financial statements and related notes presented have been prepared by Kadant Inc. (also referred to in this document as “we,” “Kadant,” “the Company,” or “the Registrant”), 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 2, 2011, and its results of operations for the three and six month periods ended July 2, 2011 and July 3, 2010, and cash flows for the six month periods ended July 2, 2011 and July 3, 2010. Interim results are not necessarily indicative of results for a full year.

The condensed consolidated balance sheet presented as of January 1, 2011, 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 1, 2011, filed with the Securities and Exchange Commission.

Certain prior-period amounts within operating activities in the statement of cash flows have been reclassified from other items, net, and are shown separately within operating activities to conform to the current period presentation.

2.	Restricted Cash

As of July 2, 2011, the Company had $2,173,000 of restricted cash, including $2,107,000 in current assets and $66,000 in other assets. This cash serves as collateral for bank guarantees primarily associated with providing assurance to customers in China that the Company will fulfill certain customer obligations entered into in the normal course of business. The restricted cash has been classified as either a current or long-term asset based on the length of time that the applicable bank guarantee will be outstanding. All of the bank guarantees will expire by September 30, 2012.

3.	Acquisitions

On May 27, 2011, the Company’s Kadant Johnson Europe B.V. subsidiary acquired all the stock of m-clean papertech holding AB (M-Clean), a European-based supplier of paper machine fabric and roll cleaning equipment. The aggregate purchase price for this acquisition was $15,849,000, which included $910,000 of cash acquired and $517,000 of debt assumed. The purchase price is subject to a post-closing adjustment.

The Company’s acquisitions have historically been made at prices above the fair value of the acquired assets, resulting in goodwill, due to expectations of synergies from combining the businesses. The Company anticipates several synergies in connection with this acquisition, including the use of the Company’s existing distribution channels to expand sales of the acquired business’ products.

The acquisition has been accounted for using the purchase method of accounting and the results of M-Clean have been included in the accompanying financial statements from the date of its acquisition. The Company recorded acquisition transaction costs of approximately $234,000 in the second quarter of 2011 in selling, general, and administrative expenses. Allocation of the purchase price for the acquisition was based on estimates of the fair value of the net assets acquired. The purchase price allocation includes identifiable intangible assets acquired of $6,633,000, which are being amortized using the straight-line method over a weighted-average period of 7 years. The excess of the acquisition purchase price over the tangible and identifiable intangible assets was recorded as goodwill and totaled $8,571,000, none of which is deductible for tax purposes. The allocation of the acquisition purchase price is subject to adjustment upon finalization of the valuations, and therefore the current measurements of inventory, intangible assets acquired, goodwill, assumed liabilities, and deferred income taxes are subject to change.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

3.	Acquisitions (continued)

Pro forma disclosures of the results of operations are not required, as the acquisition is not considered a material business combination as outlined in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805, “Business Combinations.”

In 2010, the Company’s Papermaking Systems segment completed acquisitions of a Canadian-based supplier of pressure screen baskets and a related dewatering equipment product line, as well as a European supplier of fluid-handling systems. The Company made additional purchase price payments totaling $419,000 in the first six months of 2011 related to these acquisitions.

4. Comprehensive Income (Loss)

Comprehensive income (loss) attributable to Kadant combines net income, other comprehensive items, and comprehensive (income) 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 cost 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 2,			July 3,			July 2,			July 3,
(In thousands)	2011			2010			2011			2010

Net Income	$	7,373		$	5,273		$	13,246		$	8,914

Other Comprehensive Items:
Foreign Currency Translation Adjustment		1,786			(5,813	)		7,936			(9,718	)
Pension and Other Post-Retirement Liability Adjustments, net (net of income tax of $47 and $91 in the three and six months ended July 2, 2011, respectively, and $66 and $108 in the three and six months ended July 3, 2010, respectively)		84			124			(793	)		204
Deferred Gain (Loss) on Hedging Instruments (net of income tax of $24 and $31 in the three and six months ended July 2, 2011, respectively, and $(24) and $(179) in the three and six months ended July 3, 2010, respectively)		1			(327	)		207			(668	)
		1,871			(6,016	)		7,350			(10,182	)
Comprehensive Income (Loss)		9,244			(743	)		20,596			(1,268	)
Comprehensive (Income) Loss Attributable to Noncontrolling Interest		(106	)		58			(279	)		106
Comprehensive Income (Loss) Attributable to Kadant	$	9,138		$	(685	)	$	20,317		$	(1,162	)

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

5. Earnings per Share

Basic and diluted earnings per share are calculated as follows:

	Three Months Ended						Six Months Ended
	July 2,			July 3,			July 2,			July 3,
(In thousands, except per share amounts)	2011			2010			2011			2010

Amounts Attributable to Kadant:
Income from Continuing Operations	$	7,309		$	5,225		$	13,104		$	8,840
Loss from Discontinued Operation		(5	)		(5	)		(9	)		(9	)
Net Income	$	7,304		$	5,220		$	13,095		$	8,831

Basic Weighted Average Shares		12,321			12,426			12,294			12,418
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan		156			123			148			103
Diluted Weighted Average Shares		12,477			12,549			12,442			12,521

Basic Earnings per Share:
Continuing Operations	$	.59		$	.42		$	1.07		$	.71
Discontinued Operation		–			–			–			–
Net Income	$	.59		$	.42		$	1.07		$	.71

Diluted Earnings per Share:
Continuing Operations	$	.59		$	.42		$	1.05		$	.71
Discontinued Operation		–			–			–			–
Net Income	$	.59		$	.42		$	1.05		$	.71

Options to purchase approximately 81,600 and 161,200 shares of common stock for the second quarters of 2011 and 2010, respectively, and 53,400 and 118,100 shares of the Company’s common stock for the first six months of 2011 and 2010, 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 during the period and the effect of their inclusion would have been anti-dilutive.

6. Inventories

The components of inventories are as follows:

	July 2,		January 1,
(In thousands)	2011		2011

Raw Materials and Supplies	$	25,507	$	16,718
Work in Process		17,375		8,584
Finished Goods		18,068		16,326
	$	60,950	$	41,628

7. Income Taxes

The provision for income taxes was $5,200,000 and $2,433,000 in the first six months of 2011 and 2010, respectively, and represented 28% and 21% of pre-tax income. The effective tax rate of 28% in the first six months of 2011 was lower than the Company’s statutory rate primarily due to the favorable geographic distribution of worldwide earnings and the expected utilization of foreign tax credits that were fully reserved in prior periods. The effective tax rate of 21% in the first six months of 2010 was lower than the Company’s statutory rate primarily due to the expected release of valuation allowances associated with the expected utilization in 2010 of various deferred tax assets that had been fully reserved for in prior periods and a favorable geographic distribution of earnings.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

7. Income Taxes (continued)

The Company has established valuation allowances related to certain domestic and foreign deferred tax assets and tax credits. The valuation allowance as of January 1, 2011 was $25,884,000, consisting of $11,375,000 in the U.S. and $14,509,000 in foreign jurisdictions. Compliance with ASC 740 requires the Company to periodically evaluate the necessity of establishing or adjusting a valuation allowance for deferred tax assets depending on whether it is more likely than not that a related tax benefit will be recognized in future periods. When assessing the need for a valuation allowance in a tax jurisdiction, the Company evaluates the weight of all available evidence to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. As part of this evaluation, the Company considers its cumulative three-year history of earnings before income taxes, taxable income in prior carryback years, future reversals of existing taxable temporary differences, prudent and feasible tax planning strategies, and expected future results of operations. As of July 2, 2011, the Company was in a three-year cumulative income position in the U.S.; however, due to the uncertainty of profitability in future periods, the Company has maintained its full valuation allowance in the U.S. Assuming, among other positive and negative factors, that the Company meets its estimates of 2011 forecasted earnings in the U.S., it may release a portion of its U.S. valuation allowance during 2011. The Company’s full valuation allowance in certain foreign jurisdictions was maintained as of July 2, 2011 as a result of the foreign subsidiaries being in a three-year cumulative loss position and the uncertainty of future profitability. Assuming, among other positive and negative factors, that certain of the Company’s foreign subsidiaries meet their estimates of 2011 forecasted earnings, these foreign jurisdictions would be in a three-year cumulative income position and a portion of the foreign valuation allowance may be released during 2011.

8. Long-Term Obligations

Long-term obligations are as follows:

	July 2,			January 1,
(In thousands)	2011			2011

Revolving Credit Facility	$	10,000		$	15,000
Variable Rate Term Loan, due from 2011 to 2016		7,500			7,750
Total Short- and Long-Term Obligations		17,500			22,750
Less: Short-Term Obligations and Current Maturities		(500	)		(5,500	)
Long-Term Obligations, less Current Maturities	$	17,000		$	17,250

The weighted average interest rate for the Company’s long-term obligations was 4.89% as of July 2, 2011.

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. The 2008 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional $75,000,000. The principal on any borrowings made under the 2008 Credit Agreement is due on February 13, 2013. As of July 2, 2011, the outstanding balance on the 2008 Credit Agreement was $10,000,000 and the Company had $64,033,000 of borrowing capacity available under the committed portion of the 2008 Credit Agreement. The amount the Company is able to borrow under the 2008 Credit Agreement is the total borrowing capacity less any outstanding borrowings, letters of credit and multi-currency borrowings issued under the 2008 Credit Agreement.

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 2, 2011, the remaining balance on the 2006 Commercial Real Estate Loan was $7,500,000. The 2006 Commercial Real Estate Loan is guaranteed and secured by real estate and related personal property of the Company and certain of its domestic subsidiaries, located in Theodore, Alabama; Auburn, Massachusetts; and Three Rivers, Michigan, pursuant to mortgage and security agreements dated May 4, 2006.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

9. Warranty Obligations

The Company provides for the estimated cost of product warranties at the time of sale based on the actual historical occurrence rates and repair costs. 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 accrued warranty costs included in other current liabilities in the accompanying condensed consolidated balance sheet are as follows:

	Six Months Ended
(In thousands)	July 2, 2011

Balance at January 1, 2011	$	3,778
Provision		1,110
Usage		(952	)
Acquired		86
Currency translation		213
Balance at July 2, 2011	$	4,235

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

10. Restructuring Costs and Other Income, Net

Restructuring costs and other income, net in the first six months of 2010 consisted of restructuring costs of $181,000 from adjustments related to prior period restructurings, a pre-tax gain of $285,000 from the sale of real estate in the U.S and a curtailment gain on a pension liability of $219,000 associated with the reduction of 25 full-time positions in France.

2008 Restructuring Plan

The Company recorded total restructuring costs of $4,515,000 in prior periods associated with its 2008 Restructuring Plan. These restructuring costs included facility-related costs of $385,000 and severance and associated costs of $4,130,000 related to the reduction of 329 employees in China, North America, Latin America, and Europe, all in its Papermaking Systems segment. The Company took these actions to adjust its cost structure and streamline its operations in response to the weak economic environment at the time.

A summary of the changes in accrued restructuring costs is as follows:

(In thousands)	Severance Costs

2008 Restructuring Plan
Balance at January 1, 2011	$	433
Payments		(45	)
Currency translation		8
Balance at July 2, 2011	$	396

The Company expects to pay the remaining accrued restructuring costs from 2011 to 2015.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

11. 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. 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 2,			July 3,			July 2,			July 3,
(In thousands)	2011			2010			2011			2010

Revenues:
Papermaking Systems	$	79,621		$	66,953		$	147,155		$	124,422
Fiber-based Products		2,836			2,183			6,982			5,835
	$	82,457		$	69,136		$	154,137		$	130,257

Income from Continuing Operations Before Provision for Income Taxes:
Papermaking Systems	$	13,073		$	10,895		$	23,770		$	17,199
Corporate and Fiber-based Products (a)		(2,591	)		(3,593	)		(4,980	)		(5,216	)
Total Operating Income		10,482			7,302			18,790			11,983
Interest Expense, Net		(177	)		(307	)		(335	)		(627	)
	$	10,305		$	6,995		$	18,455		$	11,356

Capital Expenditures:
Papermaking Systems	$	2,746		$	534		$	3,910		$	1,060
Corporate and Fiber-based Products		54			219			54			232
	$	2,800		$	753		$	3,964		$	1,292

(a) Corporate primarily includes general and administrative expenses.

12. Stock-Based Compensation

Stock Options

On March 9, 2011, the Company granted stock options to purchase 81,637 shares of the Company’s common stock to certain officers of the Company. The stock options will vest in three equal annual installments beginning on March 9, 2012, provided that the executive officer remains employed by the Company on the applicable vesting dates. In addition, in 2010, the Company granted stock options to purchase 140,000 shares of the Company’s common stock to certain officers of the Company. The Company is recognizing compensation expense associated with these stock options ratably over the vesting period based on the grant date fair value. Compensation expense of $173,000 and $86,000 associated with these stock options was recognized in the second quarters of 2011 and 2010, respectively, and $282,000 and $115,000 in the first six months of 2011 and 2010, respectively. Unrecognized compensation expense related to these stock options totaled approximately $1,515,000 at July 2, 2011, and will be recognized over a weighted average period of 2.3 years.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

12. Stock-Based Compensation (continued)

A summary of the Company’s stock option activity for the first six months of 2011 is as follows:

	Shares (In thousands)			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life

Options Outstanding at January 1, 2011		161		$	14.82
Granted		82		$	24.90
Exercised		(8	)	$	20.01
Options Outstanding at July 2, 2011		235		$	18.15	8.6 years

Non-Employee Director Restricted Stock Units

On March 10, 2011, the Company granted an aggregate of 25,000 restricted stock units (RSUs) to its non-employee directors with an aggregate fair value of $613,800, which will vest at a rate of 6,250 shares per quarter on the last day of each quarter in 2011, provided that the recipient is serving as a director on the applicable vesting date.

In the first quarter of 2011, the Company also granted to one of its non-employee directors 10,000 RSUs with the same terms and conditions as the 40,000 RSUs in aggregate granted to its other non-employee directors in prior periods. These RSUs will only vest and compensation expense related to these RSUs will only be recognized upon a change in control as defined in the Company’s 2006 equity incentive plan. The 50,000 RSUs will be forfeited if a change in control does not occur before the last day of the first quarter of 2015.

Performance-Based Restricted Stock Units

On March 9, 2011, the Company granted to certain officers of the Company performance-based RSUs, which represented, in aggregate, the right to receive 56,698 shares (the target RSU amount), subject to adjustment, with a grant date fair value of $24.90 per share. The RSUs are subject to adjustment based on the achievement of the performance measure selected for the 2011 fiscal year, which is the target adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined and adjusted in accordance with the RSU agreement, generated from continuing operations. The target RSU amount is adjusted by comparing the actual adjusted EBITDA for the performance period to the target adjusted EBITDA. Actual adjusted EBITDA between 50% and 115% of the target adjusted EBITDA results in an adjustment of 50% to 150% of the target RSU amount. If actual adjusted EBITDA is below 50% of the target adjusted EBITDA for the 2011 fiscal year, all RSUs will be forfeited. In the first six months of 2011, the Company recognized compensation expense based on the probable number of RSUs expected to vest, which was 150% of the target RSU amount. Following the determination of the number of RSUs earned based on the performance measure, the RSUs will be subject to additional time-based vesting, and will vest in three equal annual installments on March 10 of 2012, 2013, and 2014, provided that the officer is employed by the Company on the applicable vesting dates. The Company also granted performance-based RSUs to certain officers of the Company in prior periods.

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 each vesting tranche based on the grant date fair value. Compensation expense of $427,000 and $448,000 associated with performance-based RSUs was recognized in the second quarters of 2011 and 2010, respectively, and $694,000 and $624,000 in the first six months of 2011 and 2010, respectively. Unrecognized compensation expense related to the unvested performance-based RSUs totaled approximately $2,124,000 at July 2, 2011, and will be recognized over a weighted average period of 1.6 years.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

12. Stock-Based Compensation (continued)

Time-Based Restricted Stock Units

The Company granted 357 time-based RSUs on May 25, 2011 and 3,000 time-based RSUs on May 27, 2011 to certain employees of the Company with a grant date fair value of $26.98 and $29.34 per share, respectively. On March 9, 2011, the Company granted 60,988 time-based RSUs to certain employees of the Company with a grant date fair value of $24.90 per share. The RSUs generally vest in three equal installments on March 10 of 2012, 2013, and 2014. The Company also 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. The time-based RSU agreement provides 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. Compensation expense of $303,000 and $203,000 associated with these time-based RSUs was recognized in the second quarters of 2011 and 2010, respectively, and $550,000 and $347,000 in the first six months of 2011 and 2010, respectively. Unrecognized compensation expense related to the time-based RSUs totaled approximately $2,164,000 at July 2, 2011, and will be recognized over a weighted average period of 2.4 years.

A summary of the changes in the Company’s unvested RSUs for the first six months of 2011 is as follows:

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

Unvested RSUs at January 1, 2011		312		$	16.77
Granted (based on the target RSU amount)		156		$	24.87
Vested		(122	)	$	21.64
Forfeited		(9	)	$	8.81
Unvested RSUs at July 2, 2011		337		$	18.94

13. Employee Benefit Plans

The Company sponsors a noncontributory defined benefit retirement plan for the benefit of eligible employees at its Kadant Solutions division and the corporate office. 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. The Company also has a post-retirement welfare benefits plan for the benefit of eligible employees at its Kadant Solutions division (included in the table below in “Other Benefits”). No future retirees are eligible for this post-retirement welfare benefits plan, and the plans include limits on the employer’s contributions.

In March 2011, the Company approved a Restoration Plan (included in the table below in “Other Benefits”) for the benefit of certain executive officers who are also participants of the noncontributory defined benefit retirement plan. This plan provides a benefit equal to the benefits lost under the noncontributory defined benefit retirement plan as a consequence of applicable Internal Revenue Service limits on the levels of contributions and benefits.

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)

13. Employee Benefit Plans (continued)

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

	Three Months Ended						Three Months Ended
(In thousands)	July 2, 2011						July 3, 2010
	Pension Benefits			Other Benefits			Pension Benefits			Other Benefits

Components of Net Periodic Benefit Cost (Income):
Service cost	$	209		$	52		$	197		$	19
Interest cost		324			61			322			55
Expected return on plan assets		(359	)		–			(347	)		–
Recognized net actuarial loss		107			7			110			3
Amortization of prior service cost (income)		14			6			14			(15	)
Net periodic benefit cost		295			126			296			62
Curtailment gain		–			–			–			(219	)
Net periodic benefit cost (income)	$	295		$	126		$	296		$	(157	)

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

Discount rate		5.25	%		5.05	%		5.75	%		4.88	%
Expected long-term return on plan assets		6.25	%		–			7.00	%		–
Rate of compensation increase		4.00	%		3.22	%		4.00	%		2.00	%

	Six Months Ended						Six Months Ended
(In thousands)	July 2, 2011						July 3, 2010
	Pension Benefits			Other Benefits			Pension Benefits			Other Benefits

Components of Net Periodic Benefit Cost (Income):
Service cost	$	436		$	90		$	426		$	51
Interest cost		651			113			650			110
Expected return on plan assets		(712	)		–			(718	)		–
Recognized net actuarial loss		219			14			217			6
Amortization of prior service cost (income)		28			(1	)		28			(30	)
Net periodic benefit cost		622			216			603			137
Curtailment gain		–			–			–			(219	)
Net periodic benefit cost (income)	$	622		$	216		$	603		$	(82	)

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

Discount rate		5.25	%		5.02	%		5.75	%		5.09	%
Expected long-term return on plan assets		6.25	%		–			7.00	%		–
Rate of compensation increase		4.00	%		3.08	%		4.00	%		2.00	%

The Company recognized a curtailment gain of $219,000 in the three and six month periods ended July 3, 2010 associated with the reduction of 25 full-time positions in France.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

14. Derivatives

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

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

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 three-month LIBOR rate on future outstanding debt. The 2008 Swap Agreement has a five-year term and a $15,000,000 notional value, which decreased to $10,000,000 on December 31, 2010 and will decrease to $5,000,000 on December 30, 2011. Under the 2008 Swap Agreement, on a quarterly basis the Company receives a three-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 a floating to a fixed rate 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 receives a three-month LIBOR rate and pays a fixed rate of interest of 5.63%. The fair values for these instruments as of July 2, 2011 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 Company’s financial position and 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. As of July 2, 2011, the Company was in compliance with these covenants. The unrealized loss of $1,450,000 as of July 2, 2011 represents the estimated amount that the Company would 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 result primarily from portions of the Company’s operations and assets and liabilities that are denominated in currencies other than the functional currencies of the businesses conducting the operations or holding the assets and liabilities. The Company typically manages its level of exposure to the risk of currency-exchange fluctuations by hedging a portion of its currency exposures anticipated over the ensuing 12-month period, using forward currency-exchange contracts that have maturities of 12 months or less.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

14. 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 hedges are recorded currently in earnings. The Company recognized a gain of $84,000 and a loss of $21,000 in the second quarters of 2011 and 2010, respectively, and a gain of $81,000 and a loss of $30,000 in the first six months of 2011 and 2010, respectively, included in selling, general, and administrative expenses associated with forward currency-exchange contracts that were not designated as hedges. Management believes that any credit risk associated with forward currency-exchange contracts is remote based on the Company’s financial position and the creditworthiness of the financial institutions issuing the contracts.

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:

		July 2, 2011					January 1, 2011
	Balance Sheet	Asset			Notional		Asset			Notional
(In thousands)	Location	(Liability) (a)			Amount (b)		(Liability) (a)			Amount
Derivatives Designated as Hedging Instruments:
Derivatives in an Asset Position:
Forward currency-exchange contracts	Other Current Assets	$	186		$	6,589	$	131		$	1,794
Derivatives in a Liability Position:
Forward currency-exchange contracts	Other Current Liabilities	$	–		$	–	$	(59	)	$	1,056
Interest rate swap agreements	Other Long-Term Liabilities	$	(1,450	)	$	17,500	$	(1,595	)	$	17,750

Derivatives Not Designated as Hedging Instruments:
Derivatives in an Asset Position:
Forward currency-exchange contracts	Other Current Assets	$	6		$	520	$	–		$	–
Derivatives in a Liability Position:
Forward currency-exchange contracts	Other Current Liabilities	$	(4	)	$	520	$	(48	)	$	1,816

(a)	See Note 15 for the fair value measurements related to these financial instruments.

(b)	The total notional amount is indicative of the level of the Company’s derivative activity during the first six months of 2011.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

14. Derivatives (continued)

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 2, 2011:

(In thousands)	Interest Rate Swap Agreements			Forward Currency-Exchange Contracts			Total
Unrealized loss (gain), net of tax, at January 1, 2011	$	1,290		$	(50	)	$	1,240
(Loss) gain reclassified to earnings (a)		(281	)		30			(251	)
Loss (gain) recognized in OCI		136			(93	)		43
Unrealized loss (gain), net of tax, at July 2, 2011	$	1,145		$	(113	)	$	1,032

(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 income.

As of July 2, 2011, $481,000 of the net unrealized loss included in OCI is expected to be reclassified to earnings over the next twelve months.

15. Fair Value Measurements

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

•

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

•

Level 2—Inputs, other than 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:

	Fair Value as of July 2, 2011
(In thousands)	Level 1		Level 2		Level 3		Total

Assets:
Money market funds and time deposits	$	14,247	$	–	$	–	$	14,247
Forward currency-exchange contracts	$	–	$	192	$	–	$	192

Liabilities:
Forward currency-exchange contracts	$	–	$	4	$	–	$	4
Interest rate swap agreements	$	–	$	1,450	$	–	$	1,450

	Fair Value as of January 1, 2011
(In thousands)	Level 1		Level 2		Level 3		Total

Assets:
Money market funds and time deposits	$	28,156	$	–	$	–	$	28,156
Forward currency-exchange contracts	$	–	$	131	$	–	$	131

Liabilities:
Forward currency-exchange contracts	$	–	$	107	$	–	$	107
Interest rate swap agreements	$	–	$	1,595	$	–	$	1,595

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

15. Fair Value Measurements (continued)

The Company uses the market approach technique to value its financial assets and liabilities, and there were no changes in valuation techniques during the first six months of 2011. The Company’s financial assets and liabilities carried at fair value include cash equivalents and derivative instruments used to hedge the Company’s foreign currency and interest rate risks. The Company’s cash equivalents are comprised of money market funds and time deposits that are highly liquid and easily tradable. These investments are fair valued using inputs observable in active markets. 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 rates 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.

The carrying value and fair value of the Company’s debt obligations are as follows:

	July 2, 2011				January 1, 2011
	Carrying		Fair		Carrying		Fair
(In thousands)	Value		Value		Value		Value

Long-term debt obligations	$	17,000	$	17,000	$	17,250	$	17,250

The carrying value of long-term debt obligations approximates fair value as the obligations bear variable rates of interest, which adjust quarterly based on prevailing market rates.

16. Recent Accounting Pronouncements

Comprehensive Income. In June 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, the new rule will require an entity to present net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. This new guidance is effective for interim and annual periods beginning after December 15, 2011. The Company will adopt this new rule in fiscal 2012. While the adoption of this new guidance will change the presentation of comprehensive income, it will not have an impact on the Company’s results of operations or financial position.

Fair Value Measurements. In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (IFRSs). ASU No. 2011-04 establishes a number of new requirements for fair value measurements. These include: (1) a prohibition on grouping financial instruments for purposes of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; (2) an extension of the prohibition against the use of a blockage factor to all fair value measurements (that prohibition currently applies only to financial instruments with quoted prices in active markets); and (3) a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. In addition, for items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. This ASU is effective for interim and annual periods beginning after December 15, 2011. The Company will adopt this new rule in fiscal 2012. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

KADANT INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

17. Discontinued Operation

In 2005, the Company’s Kadant Composites LLC subsidiary (Composites LLC) sold substantially all of its assets to a third party. 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. As of July 2, 2011, 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 before the subsidiary ceased operations and judgments entered against it in litigation. 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.

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,” “seeks,” “should,” “likely,” “will,” “would,” “may,” “continue,” “could,” or similar expressions, we are making forward-looking statements.

Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions. Our future results of operations may differ materially from those expressed in the forward-looking statements. Many of the important factors that will determine these results and values are beyond our ability to control or predict. You should not put undue reliance on any forward-looking statements. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events, or otherwise. For a discussion of important factors that may cause our actual results to differ materially from those suggested by the forward-looking statements, you should read carefully the section captioned “Risk Factors” in Part 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 a manufacturer of granules made from papermaking byproducts. Our continuing operations are comprised of one reportable operating segment: Papermaking Systems, and a separate product line, Fiber-based Products. Through our Papermaking Systems segment, we develop, manufacture, and market a range of equipment and products for the global papermaking, paper recycling, and process 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.

On May 27, 2011, our Kadant Johnson Europe B.V. subsidiary acquired all the stock of m-clean papertech holding AB (M-Clean), a European-based supplier of paper machine fabric and roll cleaning equipment. The aggregate purchase price for this acquisition was $15.8 million, which included $0.9 million of cash acquired and $0.5 million of debt assumed, and is subject to a post-closing adjustment. We believe that the acquisition of this business will enhance our Papermaking Systems segment’s water management product offerings, strengthen our market position in Europe and China, and offer growth opportunities in North America.

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

Papermaking Systems Segment

Our Papermaking Systems segment consists of the following product lines: stock-preparation, fluid-handling, doctoring, and water-management.

Stock-preparation: 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;

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

Doctoring: doctoring systems and related consumables that continuously clean rolls to keep paper machines running efficiently; doctor blades made of a variety of materials to perform functions including cleaning, creping, web removal, flaking, and the application of coatings; and profiling systems that control moisture, web curl, and gloss during paper converting; and

-	Water-management: 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.

KADANT INC.

Overview (continued)

Fiber-based Products

We produce 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, our Kadant Composites LLC subsidiary (Composites LLC) sold substantially all of its assets to a third party. 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 related to 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. Composites LLC’s inability to pay or process warranty claims has exposed us to greater risks associated with litigation. For more information regarding litigation arising from these claims, see Part II, Item 1A, “Risk Factors.”

International Sales

During the first six months of 2011 and 2010, approximately 60% and 56%, respectively, of our sales were to customers outside the United States, principally in Europe and China. 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. Our actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that reflect significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that our most critical accounting policies, upon which our financial condition depends and which involve the most complex or subjective decisions or assessments, are those described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the section captioned “Application of Critical Accounting Policies and Estimates” in Part I, Item 7, of our Annual Report on Form 10-K for the fiscal year ended January 1, 2011, filed with the Securities and Exchange Commission (SEC). There have been no material changes to these critical accounting policies since fiscal year-end 2010 that warrant disclosure.

Industry and Business Outlook

Our products are primarily sold to the global pulp and paper industry. In North America, mill operating rates remained relatively high in the second quarter and inventories were generally low across most paper grades. Overall, we believe that higher mill operating rates lead to increased demand for our spare parts and consumables products. At the same time, however, many of the North American paper producers are facing increases in input costs, particularly fiber and energy. In many cases, we believe increased input costs will benefit our business since the return on investment of many of our products is based on increasing fiber yield and lowering energy costs. Our revenues in North America in the second quarter of 2011 were flat compared to last year’s second quarter and bookings were up 10% in the second quarter of 2011 compared to the prior year quarter. Although economic uncertainty is increasing in the U.S., there are a number of projects underway which, if they were finalized and booked as orders in the third quarter, would contribute to a strong booking performance in the third quarter of 2011. In Europe, after several periods of weak demand compared to other regions in which we operate, we experienced growth in both revenues and bookings. Revenues in Europe increased 24% in the second quarter of 2011 compared to the second quarter of 2010, while bookings increased 50%

KADANT INC.

Overview (continued)

compared to the same period. Export demand is a key driver for European mills that produce packaging grades, and a downturn in the global economy could have a negative effect on export demand, as could a strengthening of the euro. In China, our revenues increased significantly in the second quarter of 2011 primarily due to large stock-preparation capital orders booked late last year, which were shipped in the second quarter of 2011. Revenues in China increased 85% in the second quarter of 2011 compared to the prior year period. However, our bookings, which are more variable than revenues, decreased 16% in the second quarter of 2011 compared to the prior year period and decreased 26% from the first quarter of 2011. Bookings in China tend to be more variable compared to other regions in which we operate. Paper companies in China are scheduled to bring online significant capacity additions in the second half of 2011, which could lead to short-term overcapacity in some grades and potentially impact the timing of our orders from paper companies as the additional capacity is absorbed. However, we continue to have several active prospects, although not at the level of the first quarter of 2011 or the fourth quarter of 2010. We continue to increase our manufacturing capacity in China to meet the demand resulting from the strong bookings in the fourth quarter of 2010 and the first quarter of 2011. We are anticipating significant revenues from China in the second half of 2011, although the timing of this revenue is dependent on customer-requested delivery dates and the receipt of progress payments.

We continuously consider initiatives to improve our operating results and are currently concentrating our efforts on the following initiatives: focusing on higher-growth emerging markets, further penetrating existing markets where we see opportunity, growing our market share in low-share regions, increasing our parts and consumables sales, and leveraging our low-cost manufacturing operations in locations such as China and Mexico. We also continue to focus our efforts on managing our operating costs and working capital.

For the third quarter of 2011, we expect to report diluted earnings per share of $.40 to $.42 from continuing operations, on revenues of $80 to $82 million. We expect the fourth quarter to be our strongest quarter of the year for both revenues and earnings. We are maintaining our diluted earnings per share guidance for full year 2011 of $2.15 to $2.25 from continuing operations, on revenues of $325 to $335 million, revised from our previous guidance of $315 to $325 million.

Results of Operations

Second Quarter 2011 Compared With Second Quarter 2010

The following table sets forth our unaudited condensed consolidated statement of income expressed as a percentage of total revenues from continuing operations for the second fiscal quarters of 2011 and 2010. The results of operations for the fiscal quarter ended July 2, 2011 are not necessarily indicative of the results to be expected for the full fiscal year.

	Three Months Ended
	July 2,			July 3,
	2011			2010

Revenues		100	%		100	%

Costs and Operating Expenses:
Cost of revenues		54			55
Selling, general, and administrative expenses		31			32
Research and development expenses		2			2
Restructuring costs and other income, net		–			–
		87			89

Operating Income		13			11

Interest Income		–			–
Interest Expense		–			(1	)

Income from Continuing Operations Before Provision for Income Taxes		13			10
Provision for Income Taxes		4			2

Income from Continuing Operations		9	%		8	%

KADANT INC.

Results of Operations (continued)

Revenues

Revenues for the second quarters of 2011 and 2010 from our Papermaking Systems segment and Fiber-based Products business are as follows:

		Three Months Ended
		July 2,	July 3,
(In thousands)		2011	2010

Revenues:
Papermaking Systems	$	79,621	$ 66,953
Fiber-based Products		2,836	2,183
	$	82,457	$ 69,136

Papermaking Systems Segment. Revenues increased $12.7 million, or 19%, to $79.6 million in the second quarter of 2011 from $66.9 million in the second quarter of 2010, including a $4.6 million increase from the favorable effects of currency translation. Revenues in most of our product lines increased this quarter, including $7.3 million, or 29%, from stock-preparation and $4.4 million, or 22%, from fluid-handling. Revenues for our parts and consumables products in our Papermaking Systems segment increased $4.1 million, or 11%, as operating rates in the paper industry recovered to more traditional levels. Customers also increased their spending on our capital equipment products, resulting in increased capital revenues of $8.6 million, or 31%, in the second quarter of 2011 compared to the second quarter of 2010.

Fiber-based Products. Revenues increased $0.6 million, or 30%, to $2.8 million in the second quarter of 2011 from $2.2 million in the second quarter of 2010 primarily due to increased demand for our biodegradable granular products.

Papermaking Systems Segment by Product Line. The following table presents revenues for our Papermaking Systems segment by product line and the changes in revenues by product line between the second quarters of 2011 and 2010 including and excluding the effect of currency translation. The change in revenues excluding the effect of currency translation represents the change resulting from the conversion of current period revenues in local currency into U.S. dollars at the prior period exchange rates, and then comparing this result to the prior period revenues in U.S. dollars. The presentation of the changes in revenues by product line excluding the effect of currency translation is a non-GAAP (generally accepted accounting principles) measure. We believe this non-GAAP measure helps investors gain a better understanding of our underlying operations, consistent with how management measures and forecasts our performance, especially when comparing such results to prior periods. This non-GAAP measure should not be considered superior to or a substitute for the corresponding GAAP measure.

	Three Months Ended				Increase (Decrease) Excluding Effect of
(In millions)	July 2, 2011		July 3, 2010		Increase		Currency Translation

Papermaking Systems Product Lines:
Stock-Preparation	$	32.3	$	25.0	$	7.3	$	5.6
Fluid-Handling		24.5		20.1		4.4		2.6
Doctoring		13.7		12.7		1.0		0.3
Water-Management		8.5		8.5		–		(0.4	)
Other		0.6		0.6		–		–
	$	79.6	$	66.9	$	12.7	$	8.1

KADANT INC.

Results of Operations (continued)

Revenues in our stock-preparation product line in the second quarter of 2011 increased $5.6 million, or 23%, excluding a $1.7 million increase from the favorable effect of currency translation, compared to the second quarter of 2010, primarily due to higher demand for our capital products in China. In our fluid-handling product line, revenues in the second quarter of 2011 increased $2.6 million, or 13%, excluding a $1.8 million increase from the favorable effect of currency translation, compared to the prior year quarter primarily due to higher demand for our parts and consumables products in North America and, to a lesser extent, Europe. Revenues from our doctoring product line increased $0.3 million, or 2%, in the second quarter of 2011, excluding a $0.7 million increase from the favorable effect of currency translation, compared to the second quarter of 2010, primarily due to an increase in demand for our products in North America.

Revenues in the Papermaking Systems segment increased $12.7 million in the second quarter of 2011 compared to the second quarter of 2010, primarily driven by increases in China and Europe. In China, we saw a significant increase in revenues from large capital orders received in late 2010 and early 2011 as the paper industry adds capacity to meet demand from growth in the region as well as to compensate for government shutdowns of smaller inefficient mills. Our revenues in China increased $7.2 million, or 85%, in the second quarter of 2011 compared to the prior year quarter. In Europe, we believe our business benefited primarily from increased demand for our parts and consumables products, resulting in an increase in revenues of $4.9 million, or 24%, in this region in the second quarter of 2011 compared to the prior year quarter.

Gross Profit Margin

Gross profit margins for the second quarters of 2011 and 2010 are as follows:

	Three Months Ended
	July 2,	July 3,
	2011	2010

Gross Profit Margin:
Papermaking Systems	45.3%	44.9%
Fiber-based Products	56.6	50.8
	45 7%	45.1%

Papermaking Systems Segment. The gross profit margin in the Papermaking Systems segment increased to 45.3% in the second quarter of 2011 from 44.9% in the second quarter of 2010. This increase resulted from higher gross profit margins in all our product lines, except stock-preparation, primarily due to improved efficiencies at certain of our manufacturing facilities and to better pricing in certain of our markets, offset in part by an unfavorable change in product mix. We expect that the gross profit margins in this segment may decrease for the remainder of 2011 as revenues from lower-margin stock-preparation capital sales increase as a percentage of total sales compared to the second quarter of 2011.

Fiber-based Products. The gross profit margin in our Fiber-based Products business increased to 56.6% in the second quarter of 2011 from 50.8% in the second quarter of 2010 primarily due to manufacturing efficiencies from the increase in revenues and the lower cost of natural gas used in the production process. As is normally the case due to the seasonality of this business, we expect that the gross profit margins will be significantly lower in the second half of 2011.

Operating Expenses

Selling, general, and administrative expenses as a percentage of revenues were 31% and 32% in the second quarters of 2011 and 2010, respectively. Selling, general, and administrative expenses increased $3.1 million, or 14%, to $25.8 million in the second quarter of 2011 from $22.7 million in the second quarter of 2010, including a $1.3 million increase from the unfavorable effect of foreign currency translation. The increase in selling, general, and administrative expenses was largely due to a $1.9 million increase in selling expenses, much of which in turn was due to higher incentive, travel, and commission expenses resulting from higher revenues in the second quarter of 2011 compared to the prior year period.

Total stock-based compensation expense was $1.1 million and $0.8 million in the second quarters of 2011 and 2010, respectively, and is included in selling, general, and administrative expenses in the accompanying condensed consolidated statement of income. As of July 2, 2011, unrecognized compensation cost related to stock-based compensation was approximately $6.1 million, which will be recognized over a weighted average period of 2.0 years.

KADANT INC.

Results of Operations (continued)

Research and development expenses increased $0.2 million to $1.4 million in the second quarter of 2011 compared to $1.2 million in the second quarter of 2010 and represented 2% of revenues in both periods.

Restructuring Costs and Other Income, Net

There were no restructuring costs or other income in the second quarter of 2011. Restructuring costs and other income netted to $21 thousand of income in the second quarter of 2010, which included a curtailment gain on a pension liability of $0.2 million associated with the reduction of 25 full-time positions in France, largely offset by restructuring costs of $0.2 million associated with prior period restructurings.

Interest Expense

Interest expense was $0.3 million in both the second quarters of 2011 and 2010.

Provision for Income Taxes

Our provision for income taxes was $2.9 million and $1.7 million in the second quarters of 2011 and 2010, respectively, and represented 28% and 25%, respectively, of pre-tax income. The effective tax rate of 28% in the second quarter of 2011 was lower than our statutory rate primarily due to the favorable geographic distribution of worldwide earnings and the expected utilization of foreign tax credits that were fully reserved in prior periods. The effective tax rate of 25% in the second quarter of 2010 was lower than our statutory rate primarily due to the expected release of valuation allowances associated with the expected utilization in 2010 of various deferred tax assets that had been fully reserved for in prior periods and a favorable geographic distribution of earnings. We expect our effective tax rate to be approximately 28% in 2011 due to anticipated profitability in the U.S. and certain foreign tax jurisdictions. This does not include any assumptions related to the potential reversal of our tax valuation allowance.

We have established valuation allowances related to certain domestic and foreign deferred tax assets and tax credits. The valuation allowance as of January 1, 2011 was $25.9 million, consisting of $11.4 million in the U.S. and $14.5 million in foreign jurisdictions. Compliance with Accounting Standards Codification 740 requires us to periodically evaluate the necessity of establishing or adjusting a valuation allowance for deferred tax assets depending on whether it is more likely than not that a related tax benefit will be recognized in future periods. When assessing the need for a valuation allowance in a tax jurisdiction, we evaluate the weight of all available evidence to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. As part of this evaluation, we consider our cumulative three-year history of earnings before income taxes, taxable income in prior carryback years, future reversals of existing taxable temporary differences, prudent and feasible tax planning strategies, and expected future results of operations. As of July 2, 2011, we were in a three-year cumulative income position in the U.S.; however, due to the uncertainty of profitability in future periods, we have maintained our full valuation allowance in the U.S. Assuming, among other positive and negative factors, that we meet our estimates of 2011 forecasted earnings in the U.S., we may release a portion of our U.S. valuation allowance during 2011. Our full valuation allowance in certain foreign jurisdictions was maintained as of July 2, 2011 as a result of the foreign subsidiaries being in a three-year cumulative loss position and the uncertainty of future profitability. Assuming, among other positive and negative factors, that certain of our foreign subsidiaries meet their estimates of 2011 forecasted earnings, these foreign jurisdictions would be in a three-year cumulative income position and a portion of the foreign valuation allowance may be released during 2011.

Income from Continuing Operations

Income from continuing operations was $7.4 million in the second quarter of 2011 compared to $5.3 million in the second quarter of 2010. The increase in the 2011 period was primarily due to an increase in operating income of $3.2 million, offset in part by an increase in our effective tax rate (see Revenues, Gross Profit Margin, Operating Expenses, and Provision for Income Taxes discussed above).

Loss from Discontinued Operation

Loss from the discontinued operation was $5 thousand in both the second quarters of 2011 and 2010.

KADANT INC.

Results of Operations (continued)

Recent Accounting Pronouncements

Comprehensive Income. In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, the new rule will require an entity to present net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. This new guidance is effective for interim and annual periods beginning after December 15, 2011. We will adopt this new rule in fiscal 2012. While the adoption of this new guidance will change the presentation of comprehensive income, it will not have an impact on our results of operations or financial position.

Fair Value Measurements. In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (IFRSs). ASU No. 2011-04 establishes a number of new requirements for fair value measurements. These include: (1) a prohibition on grouping financial instruments for purposes of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; (2) an extension of the prohibition against the use of a blockage factor to all fair value measurements (that prohibition currently applies only to financial instruments with quoted prices in active markets); and (3) a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. In addition, for items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. This ASU is effective for interim and annual periods beginning after December 15, 2011. We will adopt this new rule in fiscal 2012. The adoption of this ASU is not expected to have a material impact on our consolidated financial statements.

KADANT INC.

Results of Operations (continued)

First Six Months 2011 Compared With First Six Months 2010

The following table sets forth our unaudited condensed consolidated statement of income expressed as a percentage of total revenues from continuing operations for the first six months of 2011 and 2010. The results of operations for the first six months of 2011 are not necessarily indicative of the results to be expected for the full fiscal year.

	Six Months Ended
	July 2,			July 3,
	2011			2010

Revenues		100	%		100	%

Costs and Operating Expenses:
Cost of revenues		53			55
Selling, general, and administrative expenses		33			34
Research and development expenses		2			2
Restructuring costs and other income, net		–			–
		88			91

Operating Income		12			9

Interest Income		–			–
Interest Expense		–			–

Income from Continuing Operations Before Provision for Income Taxes		12			9
Provision for Income Taxes		3			2

Income from Continuing Operations		9	%		7