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 June 29, 2013

OR

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

Commission file number 1-11406

KADANT INC.
(Exact name of registrant as specified in its charter)

Delaware
 
52-1762325
(State or Other Jurisdiction 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 26, 2013
Common Stock, $.01 par value
 
11,161,917


PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)

Assets

 
 
June 29,
   
December 29,
 
(In thousands)
 
2013
   
2012
 
 
 
   
 
Current Assets:
 
   
 
Cash and cash equivalents
 
$
64,322
   
$
54,553
 
Restricted cash (Note 1)
   
165
     
-
 
Accounts receivable, less allowances of $2,204 and $2,306 (Note 1)
   
63,025
     
59,359
 
Inventories (Note 1)
   
54,052
     
42,077
 
Unbilled contract costs and fees
   
1,087
     
2,800
 
Other current assets
   
19,249
     
16,291
 
Assets of discontinued operation
   
500
     
513
 
Total Current Assets
   
202,400
     
175,593
 
 
               
Property, Plant, and Equipment, at Cost
   
111,326
     
109,046
 
Less: accumulated depreciation and amortization
   
69,850
     
69,878
 
 
   
41,476
     
39,168
 
 
               
Other Assets
   
36,637
     
36,240
 
 
               
Goodwill
   
108,381
     
107,947
 
 
               
Total Assets
 
$
388,894
   
$
358,948
 

























The accompanying notes are an integral part of these condensed consolidated financial statements.
2


KADANT INC.
Condensed Consolidated Balance Sheet (continued)
(Unaudited)

Liabilities and Stockholders' Equity

 
 
June 29,
   
December 29,
 
(In thousands, except share amounts)
 
2013
   
2012
 
 
 
   
 
Current Liabilities:
 
   
 
Short-term obligation and current maturities of long-term obligations (Note 6)
 
$
2,025
   
$
625
 
Accounts payable
   
26,050
     
23,124
 
Accrued payroll and employee benefits
   
14,336
     
16,358
 
Customer deposits
   
23,478
     
14,811
 
Accrued warranty costs (Note 1)
   
4,065
     
4,462
 
Deferred revenue
   
4,008
     
3,918
 
Other current liabilities
   
16,838
     
11,615
 
Liabilities of discontinued operation
   
234
     
379
 
Total Current Liabilities
   
91,034
     
75,292
 
 
               
Other Long-Term Liabilities
   
29,478
     
27,439
 
 
               
Long-Term Obligations (Note 6)
   
14,000
     
6,250
 
 
               
Commitments and Contingencies (Note 13)
   
     
 
 
               
Stockholders' Equity:
               
Preferred stock, $.01 par value, 5,000,000 shares authorized; none issued
   
     
 
Common stock, $.01 par value, 150,000,000 shares authorized; 14,624,159 shares issued
   
146
     
146
 
Capital in excess of par value
   
94,381
     
95,448
 
Retained earnings
   
238,577
     
230,329
 
Treasury stock at cost, 3,462,242 and 3,493,546 shares
   
(73,956
)
   
(74,025
)
Accumulated other comprehensive items (Note 9)
   
(6,235
)
   
(3,315
)
Total Kadant Stockholders' Equity
   
252,913
     
248,583
 
Noncontrolling interest
   
1,469
     
1,384
 
Total Stockholders' Equity
   
254,382
     
249,967
 
 
               
Total Liabilities and Stockholders' Equity
 
$
388,894
   
$
358,948
 

















The accompanying notes are an integral part of these condensed consolidated financial statements.
3


KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)

 
 
Three Months Ended     
 
 
 
June 29,
   
June 30,
 
(In thousands, except per share amounts)
 
2013
   
2012
 
 
 
   
 
Revenues
 
$
82,165
   
$
82,982
 
 
               
Costs and Operating Expenses:
               
Cost of revenues
   
42,225
     
46,684
 
Selling, general, and administrative expenses
   
29,445
     
25,490
 
Research and development expenses
   
1,852
     
1,393
 
Restructuring costs and other income, net
   
218
     
-
 
 
   
73,740
     
73,567
 
 
               
Operating Income
   
8,425
     
9,415
 
 
               
Interest Income
   
142
     
74
 
Interest Expense
   
(231
)
   
(196
)
 
               
Income from Continuing Operations Before Provision for Income Taxes
   
8,336
     
9,293
 
Provision for Income Taxes
   
2,492
     
2,705
 
 
               
Income from Continuing Operations
   
5,844
     
6,588
 
Loss from Discontinued Operation (net of income tax benefit of $8 and $4)
   
(12
)
   
(3
)
 
               
Net Income
   
5,832
     
6,585
 
 
               
Net Income Attributable to Noncontrolling Interest
   
(72
)
   
(42
)
 
               
Net Income Attributable to Kadant
 
$
5,760
   
$
6,543
 
 
               
Amounts Attributable to Kadant:
               
Income from Continuing Operations
 
$
5,772
   
$
6,546
 
Loss from Discontinued Operation
   
(12
)
   
(3
)
Net Income Attributable to Kadant
 
$
5,760
   
$
6,543
 
 
               
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
               
Basic
 
$
0.52
   
$
0.57
 
Diluted
 
$
0.51
   
$
0.56
 
 
               
Earnings per Share Attributable to Kadant (Note 4):
               
Basic
 
$
0.52
   
$
0.57
 
Diluted
 
$
0.51
   
$
0.56
 
 
               
Weighted Average Shares (Note 4):
               
Basic
   
11,178
     
11,575
 
Diluted
   
11,331
     
11,679
 
 
               
Cash Dividend Declared per Common Share
 
$
0.125
   
$
-
 



The accompanying notes are an integral part of these condensed consolidated financial statements.
4

KADANT INC.
Condensed Consolidated Statement of Income
(Unaudited)

 
 
Six Months Ended       
 
 
 
June 29,
   
June 30,
 
(In thousands, except per share amounts)
 
2013
   
2012
 
 
 
   
 
Revenues
 
$
158,369
   
$
167,095
 
 
               
Costs and Operating Expenses:
               
Cost of revenues
   
82,403
     
92,425
 
Selling, general, and administrative expenses
   
56,395
     
51,633
 
Research and development expenses
   
3,556
     
2,925
 
Restructuring costs and other (income) expense, net (Note 3)
   
218
     
307
 
 
   
142,572
     
147,290
 
 
               
Operating Income
   
15,797
     
19,805
 
 
               
Interest Income
   
251
     
168
 
Interest Expense
   
(396
)
   
(405
)
 
               
Income from Continuing Operations Before Provision for Income Taxes
   
15,652
     
19,568
 
Provision for Income Taxes (Note 5)
   
4,459
     
5,843
 
 
               
Income from Continuing Operations
   
11,193
     
13,725
 
Loss from Discontinued Operation (net of income tax benefit of $25 and $53)
   
(41
)
   
(64
)
 
               
Net Income
   
11,152
     
13,661
 
 
               
Net Income Attributable to Noncontrolling Interest
   
(108
)
   
(65
)
 
               
Net Income Attributable to Kadant
 
$
11,044
   
$
13,596
 
 
               
Amounts Attributable to Kadant:
               
Income from Continuing Operations
 
$
11,085
   
$
13,660
 
Loss from Discontinued Operation
   
(41
)
   
(64
)
Net Income Attributable to Kadant
 
$
11,044
   
$
13,596
 
 
               
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
               
Basic
 
$
0.99
   
$
1.18
 
Diluted
 
$
0.98
   
$
1.17
 
 
               
Earnings per Share Attributable to Kadant (Note 4):
               
Basic
 
$
0.99
   
$
1.17
 
Diluted
 
$
0.98
   
$
1.16
 
 
               
Weighted Average Shares (Note 4):
               
Basic
   
11,170
     
11,614
 
Diluted
   
11,299
     
11,704
 
 
               
Cash Dividends Declared per Common Share
 
$
0.25
   
$
-
 



The accompanying notes are an integral part of these condensed consolidated financial statements.
5


KADANT INC.
Condensed Consolidated Statement of Comprehensive Income
(Unaudited)


 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 29,
   
June 30,
   
June 29,
   
June 30,
 
(In thousands)
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Net Income
 
$
5,832
   
$
6,585
   
$
11,152
   
$
13,661
 
 
                               
Other Comprehensive Items:
                               
Foreign Currency Translation Adjustment
   
(381
)
   
(5,463
)
   
(3,489
)
   
(1,661
)
     Pension and Other Post-Retirement Liability Adjustments, net (net
        of tax provision of $63 and $140 in the three and six months
        ended June 29, 2013, respectively, and $70 and $138 in the
        three and six months ended June 30, 2012, respectively)
   
120
     
146
     
257
     
251
 
    Deferred Gain (Loss) on Hedging Instruments (net of tax provision
       of $51 and $80 in the three and six months ended June 29, 2013,
       respectively, and tax (benefit) provision of $(85) and $1 in the
       three and six months ended June 30, 2012, respectively)
   
94
     
(174
)
   
289
     
(10
)
 
   
(167
)
   
(5,491
)
   
(2,943
)
   
(1,420
)
Comprehensive Income
   
5,665
     
1,094
     
8,209
     
12,241
 
Comprehensive (Income) Loss Attributable to Noncontrolling Interest
   
(97
)
   
36
     
(85
)
   
(21
)
Comprehensive Income Attributable to Kadant
 
$
5,568
   
$
1,130
   
$
8,124
   
$
12,220
 
































The accompanying notes are an integral part of these condensed consolidated financial statements.
6


KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)

 
 
Six Months Ended
 
 
 
June 29,
   
June 30,
 
(In thousands)
 
2013
   
2012
 
 
 
   
 
Operating Activities:
 
   
 
Net income attributable to Kadant
 
$
11,044
   
$
13,596
 
Net income attributable to noncontrolling interest
   
108
     
65
 
Loss from discontinued operation
   
41
     
64
 
Income from continuing operations
   
11,193
     
13,725
 
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
               
Depreciation and amortization
   
4,428
     
4,272
 
Stock-based compensation expense
   
2,558
     
2,262
 
Benefit for recoveries on accounts receivable
   
(193
)
   
(225
)
Gain on the sale of property, plant, and equipment
   
(1,862
)
   
(106
)
Other items, net
   
10
     
779
 
Changes in current assets and liabilities, net of effects of acquisitions:
               
Accounts receivable
   
1,225
     
2,098
 
Unbilled contract costs and fees
   
1,781
     
(7,612
)
Inventories
   
(6,852
)
   
1,081
 
Other current assets
   
(451
)
   
461
 
Accounts payable
   
2,715
     
(2,600
)
Other current liabilities
   
4,059
     
(9,123
)
    Contributions to pension plan
   
(540
)
   
(480
)
Net cash provided by continuing operations
   
18,071
     
4,532
 
Net cash used in discontinued operation
   
(173
)
   
(835
)
Net cash provided by operating activities
   
17,898
     
3,697
 
 
               
Investing Activities:
               
Acquisitions, net of cash acquired
   
(14,209
)
   
(25
)
Proceeds from sale of property, plant, and equipment
   
3,309
     
262
 
Purchases of property, plant, and equipment
   
(2,572
)
   
(841
)
Other, net
   
849
     
-
 
Net cash used in continuing operations for investing activities
   
(12,623
)
   
(604
)
 
               
Financing Activities:
               
Proceeds from issuance of short- and long-term obligations
   
18,900
     
-
 
Repayments of long-term obligations
   
(9,750
)
   
(250
)
Purchases of Company common stock
   
(2,715
)
   
(8,377
)
Dividends paid
   
(1,401
)
   
-
 
Proceeds from issuance of Company common stock
   
337
     
138
 
Change in restricted cash
   
(165
)
   
632
 
Other, net
   
311
     
125
 
Net cash provided by (used in) continuing operations for financing activities
   
5,517
     
(7,732
)
 
               
Exchange Rate Effect on Cash and Cash Equivalents from Continuing Operations
   
(1,023
)
   
(280
)
 
               
Increase (Decrease) in Cash and Cash Equivalents from Continuing Operations
   
9,769
     
(4,919
)
Cash and Cash Equivalents at Beginning of Period
   
54,553
     
46,950
 
Cash and Cash Equivalents at End of Period
 
$
64,322
   
$
42,031
 
 
               
See Note 1 for supplemental cash flow information.
The accompanying notes are an integral part of these condensed consolidated financial statements.
7


KADANT INC.
Condensed Consolidated Statement of Stockholders' Equity
(Unaudited)


(In thousands, except share
 
Common
Stock
   
Capital in
Excess of Par
   
Retained
   
Treasury
Stock
   
Accumulated
Other
Comprehensive
   
Noncontrolling
   
Total
Stockholders'
 
amounts)
 
Shares
   
Amount
   
Value
   
Earnings
   
Shares
   
Amount
   
Items
   
Interest
   
Equity
 
 
 
   
   
   
   
   
   
   
   
 
Balance at December 31, 2011
   
14,624,159
   
$
146
   
$
93,701
   
$
198,706
     
2,983,717
   
$
(62,118
)
 
$
(7,955
)
 
$
1,150
   
$
223,630
 
 
                                                                       
Net income
   
     
     
     
13,596
     
     
     
     
65
     
13,661
 
 
                                                                       
Activity under stock plans
   
     
     
(602
)
   
     
(101,585
)
   
2,117
     
     
     
1,515
 
 
                                                                       
Tax benefits related to employees' and directors' stock plans
   
     
     
124
     
     
     
     
     
     
124
 
 
                                                                       
Purchases of Company common stock
   
     
     
     
     
382,754
     
(8,552
)
   
     
     
(8,552
)
 
                                                                       
Other comprehensive items
   
     
     
     
     
     
     
(1,376
)
   
(44
)
   
(1,420
)
 
                                                                       
Balance at June 30, 2012
   
14,624,159
   
$
146
   
$
93,223
   
$
212,302
     
3,264,886
   
$
(68,553
)
 
$
(9,331
)
 
$
1,171
   
$
228,958
 
 
                                                                       
Balance at December 29, 2012
   
14,624,159
   
$
146
   
$
95,448
   
$
230,329
     
3,493,546
   
$
(74,025
)
 
$
(3,315
)
 
$
1,384
   
$
249,967
 
 
                                                                       
Net income
   
     
     
     
11,044
     
     
     
     
108
     
11,152
 
 
                                                                       
Dividends declared
   
     
     
     
(2,796
)
   
     
     
     
     
(2,796
)
 
                                                                       
Activity under stock plans
   
     
     
(1,379
)
   
     
(131,304
)
   
2,784
     
     
     
1,405
 
 
                                                                       
Tax benefits related to employees' and directors' stock plans
   
     
     
312
     
     
     
     
     
     
312
 
 
                                                                       
Purchases of Company common stock
   
     
     
     
     
100,000
     
(2,715
)
   
     
     
(2,715
)
 
                                                                       
Other comprehensive items
   
     
     
     
     
     
     
(2,920
)
   
(23
)
   
(2,943
)
 
                                                                       
Balance at June 29, 2013
   
14,624,159
   
$
146
   
$
94,381
   
$
238,577
     
3,462,242
   
$
(73,956
)
 
$
(6,235
)
 
$
1,469
   
$
254,382
 


The accompanying notes are an integral part of these condensed consolidated financial statements.
8

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations

Kadant Inc. and its subsidiaries' (collectively, "we," Kadant," "the Company," or "the Registrant") continuing operations include one reportable operating segment, Papermaking Systems, and a separate product line, Fiber-based Products. Through its Papermaking Systems segment, the Company develops, manufactures, and markets a range of equipment and products primarily for the global papermaking and paper recycling and process industries. The Company's principal products in this segment include custom-engineered stock-preparation systems and equipment for the preparation of wastepaper for conversion into recycled paper; fluid-handling systems used primarily in the dryer section of the papermaking process and during the production of corrugated boxboard, metals, plastics, rubber, textiles, chemicals, and food; doctoring systems and equipment and related consumables important to the efficient operation of paper machines; and cleaning and filtration systems essential for draining, purifying, and recycling process water and cleaning paper machine fabrics and rolls. Through its Fiber-based Products business, the Company manufactures and sells granules derived from papermaking byproducts primarily for use as agricultural carriers and for home lawn and garden applications, as well as for oil and grease absorption.

Interim Financial Statements

The interim condensed consolidated financial statements and related notes presented have been prepared by the Company, are unaudited, and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of the Company's financial position at June 29, 2013, its results of operations and comprehensive income for the three and six month periods ended June 29, 2013 and June 30, 2012, and its cash flows and stockholders' equity for the six month periods ended June 29, 2013 and June 30, 2012. Interim results are not necessarily indicative of results for a full year or for any other interim period.

The condensed consolidated balance sheet presented as of December 29, 2012 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K. The condensed consolidated financial statements and related notes are presented as permitted by the Securities and Exchange Commission (SEC) rules and regulations for Form 10-Q and do not contain certain information included in the annual consolidated financial statements and related notes of the Company. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2012, filed with the SEC.

Critical Accounting Policies

Critical accounting policies are defined as those that entail significant judgments and estimates, and could potentially result in materially different results under different assumptions and conditions. The Company believes that the most critical accounting policies upon which its financial position depends, and which involve the most complex or subjective decisions or assessments, concern revenue recognition and accounts receivable, warranty obligations, income taxes, the valuation of goodwill and intangible assets, inventories, pension obligations, and derivatives. A discussion of the application of these and other accounting policies is included in Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2012.

Supplemental Cash Flow Information

 
 
Six Months Ended
 
(In thousands)
 
June 29, 2013
   
June 30, 2012
 
 
 
   
 
Non-Cash Investing Activities:
 
   
 
Fair Value of Assets Acquired
 
$
22,812
   
$
-
 
Cash Paid for Acquired Businesses
   
(15,332
)
   
-
 
Liabilities Assumed of Acquired Businesses
 
$
7,480
   
$
-
 
 
               
Non-Cash Financing Activities:
               
Issuance of Company Common Stock
 
$
2,353
   
$
1,829
 
Dividends Declared but Unpaid
 
$
1,395
   
$
-
 
9

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

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

Restricted Cash
    As of June 29, 2013, the Company had restricted cash of $165,000. 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. All the bank guarantees will expire by the end of 2013.

Banker's Acceptance Drafts
The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for their trade accounts receivable. The banker's acceptance drafts are non-interest bearing obligations of the issuing bank and mature within six months of the origination date. The Company has the ability to sell the drafts at a discount to a third-party financial institution or transfer the drafts to vendors in settlement of current accounts payable prior to the scheduled maturity date. These drafts, which totaled $8,197,000 and $9,794,000 at June 29, 2013 and December 29, 2012, respectively, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary obtains cash payment on the scheduled maturity date or upon the sale or transfer of the drafts prior to maturity.

Inventories

The components of inventories are as follows:

 
 
June 29,
   
December 29,
 
(In thousands)
 
2013
   
2012
 
 
 
   
 
Raw Materials and Supplies
 
$
20,245
   
$
19,561
 
Work in Process
   
17,658
     
8,371
 
Finished Goods
   
16,149
     
14,145
 
 
 
$
54,052
   
$
42,077
 

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 the accompanying condensed consolidated balance sheet are as follows:

 
 
Six Months Ended
 
(In thousands)
 
June 29, 2013
   
June 30, 2012
 
 
 
   
 
Balance at beginning of period
 
$
4,462
   
$
4,129
 
Provision
   
505
     
486
 
Usage
   
(996
)
   
(841
)
Acquired
   
138
     
-
 
Currency translation
   
(44
)
   
(41
)
Balance at end of period
 
$
4,065
   
$
3,733
 
10

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

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

Use of Estimates

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

Recent Accounting Pronouncements

Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-11. Currently, U.S. GAAP does not include explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU clarifies that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, although early adoption is permitted. This ASU will be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company has not yet adopted this ASU, but is currently evaluating the effect the adoption will have on its consolidated financial statements.

Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes. In February 2013, the FASB issued ASU No. 2013-10. This ASU permits the Fed Funds Effective Swap Rate (OIS) to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to UST and LIBOR. This ASU also removes the restriction on using different benchmark rates for similar hedges. Before this ASU, only Treasury obligations of the U.S. government (UST) and, for practical reasons, the London Interbank Offered Rate (LIBOR) swap rate, were considered benchmark interest rates. Including the Fed Funds Effective Swap Rate (OIS) as an acceptable U.S. benchmark interest rate in addition to UST and LIBOR will provide risk managers with a more comprehensive spectrum of interest rate resets to utilize as the designated benchmark interest rate risk component under the hedge accounting guidance. This ASU is effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. We will consider the guidance in this ASU for future transactions in which we elect to apply hedge accounting of the benchmark interest rate. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

Presentation of Financial Statements (Topic 205): Liquidation Basis of Accounting. In April 2013, the FASB issued ASU No. 2013-02. This ASU clarifies when an entity should apply the liquidation basis of accounting. In addition, the guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting. The ASU requires an organization to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent. The ASU requires financial statements prepared using the liquidation basis to present relevant information about a company's resources and obligations in liquidation, including: the organization's assets measured at the amount of the expected cash proceeds from liquidation, including any items it had not previously recognized under U.S. GAAP that it expects to either sell in liquidation or use in settling liabilities; the organization's liabilities as recognized and measured in accordance with existing guidance that applies to those liabilities; and accrual of the costs it expects to incur and the income it expects to earn during liquidation, including any anticipated disposal costs. This ASU is effective for reporting periods beginning after December 15, 2013, although early adoption is permitted. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.
11

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

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

 Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. In March 2013, the FASB issued ASU No. 2013-05. When a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity, the parent is required to apply the guidance in subtopic 830-30 to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. For an equity method investment that is a foreign entity, the partial sale guidance in Accounting Standards Codification section 830-30-40 still applies. As such, a pro rata portion of the cumulative translation adjustment should be released into net income upon a partial sale of such an equity method investment. However, this treatment does not apply to an equity method investment that is not a foreign entity. In those instances, the cumulative translation adjustment is released into net income only if the partial sale represents a complete or substantially complete liquidation of the foreign entity that contains the equity method investment. This ASU is effective prospectively for fiscal years and interim periods beginning after December 15, 2013. This ASU will be applied prospectively to derecognition events occurring after the effective date. Prior periods should not be adjusted. Early adoption is permitted. The Company has not yet adopted this ASU, but is currently evaluating the effect the adoption will have on its consolidated financial statements.

2. Acquisitions

On April 12, 2013, the Company's Papermaking Systems segment acquired all the outstanding stock of Companhia Brasileira de Tecnologia Industrial (CBTI) for approximately $8,140,000 in cash and $484,000 in assumed liabilities owed to Kadant. The purchase price included $1,123,000 of cash acquired. CBTI is a long-time licensee of the Company's doctoring, cleaning, and filtration, and stock preparation products and is also a supplier of industrial drying systems. This acquisition furthers the Company's strategy of expanding its presence in emerging markets. At the closing date, approximately $3,550,000 of the purchase price was deposited into an escrow fund to secure certain indemnification obligations of the sellers. Approximately $1,520,000 of the escrow fund will be released to the sellers on or about January 31, 2014, and the balance will be released on various dates over a five-year period ending on the fifth anniversary of the closing date, less the amount of any claims in each instance.
On May 3, 2013, the Company's Papermaking Systems segment acquired certain assets of the Noss Group (Noss), a Sweden-based developer and supplier of high-efficiency cleaners and approach flow systems, for approximately $6,708,000 paid at closing and subject to adjustment for redundancy and certain employee benefit payments. As part of the purchase agreement, the Company retained approximately $1,170,000 to fund certain anticipated redundancy and certain employee benefit payments in Sweden. Any payments made in excess of this estimate will be reimbursed by the sellers and amounts unpaid below this estimate will be due to the sellers. As of June 29, 2013, the Company has accrued $1,304,000 in estimated payments, including $615,000 in accrued restructuring costs and $689,000 in accrued employee benefits. This acquisition will expand the Company's product offerings in its Stock-Preparation product line, particularly for virgin pulp and approach flow applications. In addition, Noss has a large installed base and a high proportion of its revenues are parts and consumables products. At the closing date, approximately $1,970,000 of the purchase price was deposited into an escrow fund to secure certain indemnification obligations of the sellers. The escrow fund, less any claims made, will be released to the sellers in two installments on the first and second anniversaries of the closing date.

These acquisitions have been accounted for using the purchase method of accounting and the results of CBTI and Noss have been included in the accompanying financial statements from the date of the acquisitions. The Company recorded acquisition transaction costs of approximately $676,000 in the first six months of 2013 in selling, general, and administrative expenses. The Company has made preliminary fair value assessments of the assets acquired and liabilities assumed, including identifiable intangible assets acquired of $2,357,000, which are being amortized using the straight-line method over a weighted-average period of 7 years. The excess of the acquisition purchase prices over the tangible and identifiable intangible assets were recorded as goodwill and totaled $2,279,000, a portion of which will be deductible for tax purposes. The fair values are subject to adjustment upon finalization of the valuations, and therefore the current measurements of intangible assets, acquired goodwill, and assumed assets and liabilities are subject to change.

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 these acquisitions, including consolidating manufacturing facilities and the use of the Company's existing distribution channels to expand sales of the products of the acquired businesses.
12

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

2. Acquisitions (continued)

Pro forma disclosures of the results of operations are not required, as the acquisitions are not considered material business combinations as outlined in FASB ASC 805, "Business Combinations."

3.                Restructuring Costs and Other (Income) Expense, Net
The Company's restructuring costs and other (income) expense, net was $218,000 in the first six months of 2013, including $1,958,000 of restructuring costs and a $1,740,000 gain on the sale of assets, and $307,000 in the first six months of 2012.
Restructuring Costs
The Company recorded acquisition-related restructuring costs of $1,958,000 in the second quarter of 2013, including $1,330,000 associated with the reduction of 22 employees in Brazil and $628,000 associated with the reduction of 25 employees in Sweden. These actions were taken to streamline the Company's operations as a result of the recent acquisitions. All of these items occurred in the Papermaking Systems segment.

A summary of the changes in accrued restructuring costs included in other current liabilities in the accompanying condensed consolidated balance sheet is as follows:

(In thousands) 
 
Severance Costs
 
Provision
 
$
1,958
 
Currency translation
   
(92
)
Balance at June 29, 2013
 
$
1,866
 

Other (Income) Expense
Other income consisted of a pre-tax gain of $1,740,000 from the sale of real estate in China in the second quarter of 2013. Other expense consisted of accelerated depreciation of $307,000 in the first six months of 2012 associated with the disposal of equipment in China related to a facility consolidation.
13

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

4. Earnings per Share

Basic and diluted earnings per share are calculated as follows:

 
 
Three Months Ended
   
Six Months Ended
 
 
 
June 29,
   
June 30,
   
June 29,
   
June 30,
 
(In thousands, except per share amounts)
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Amounts Attributable to Kadant:
 
   
   
   
 
Income from Continuing Operations
 
$
5,772
   
$
6,546
   
$
11,085
   
$
13,660
 
Loss from Discontinued Operation
   
(12
)
   
(3
)
   
(41
)
   
(64
)
Net Income
 
$
5,760
   
$
6,543
   
$
11,044
   
$
13,596
 
 
                               
Basic Weighted Average Shares
   
11,178
     
11,575
     
11,170
     
11,614
 
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan
   
153
     
104
     
129
     
90
 
Diluted Weighted Average Shares
   
11,331
     
11,679
     
11,299
     
11,704
 
 
                               
Basic Earnings per Share:
                               
Continuing Operations
 
$
0.52
   
$
0.57
   
$
0.99
   
$
1.18
 
Discontinued Operation
 
$
   
$
   
$
   
$
(0.01
)
Net Income per Basic Share
 
$
0.52
   
$
0.57
   
$
0.99
   
$
1.17
 
 
                               
Diluted Earnings per Share:
                               
Continuing Operations
 
$
0.51
   
$
0.56
   
$
0.98
   
$
1.17
 
Discontinued Operation
 
$
   
$
   
$
   
$
(0.01
)
Net Income per Diluted Share
 
$
0.51
   
$
0.56
   
$
0.98
   
$
1.16
 

Options to purchase approximately 92,900 and 164,400 shares of the Company's common stock for the second quarters of 2013 and 2012, respectively, and 102,100 and 135,700 shares of the Company's common stock for the first six months of 2013 and 2012, respectively, were not included in the computation of diluted earnings per share as the effect of their inclusion would have been anti-dilutive. Unvested restricted stock units equivalent to approximately 2,000 shares of common stock for the second quarter of  2012, and 41,000 and 57,000 shares of common stock for the first six months of 2013 and 2012, respectively, were not included in the computation of diluted earnings per share because either the effect of their inclusion would have been anti-dilutive, or for unvested performance-based restricted stock units, the performance conditions had not been met as of the end of the reporting period.

5. Provision for Income Taxes

The provision for income taxes was $4,459,000 and $5,843,000 in the first six months of 2013 and 2012, respectively, and represented 28% and 30% of pre-tax income. The effective tax rate of 28% in the first six months of 2013 was lower than the Company's statutory tax rate primarily due to the reduction of the 2012 U.S. tax cost of foreign earnings and a benefit from the 2012 U.S. research and development tax credit, both of which resulted from U.S. tax legislation enacted in January 2013. In addition, the Company's effective tax rate in the first six months of 2013 benefited from the release of a valuation allowance against deferred tax assets related to net operating loss carryforwards. The release of the valuation allowance was due to increased projected profitability associated with the CBTI acquisition. Also contributing to the lower effective tax rate in the first six months of 2013 were lower statutory tax rates in the Company's overseas operations and a more favorable distribution of the Company's worldwide earnings. The effective tax rate of 30% in the first six months of 2012 was lower than the Company's statutory tax rate primarily due to the distribution of worldwide earnings and the expected utilization of foreign tax credits that were fully reserved in prior periods, the latter of which was due to an increase in estimated 2012 income in the U.S.
14

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

6. Short- and Long-Term Obligations

Short- and long-term obligations are as follows:

 
 
June 29,
   
December 29,
 
(In thousands)
 
2013
   
2012
 
 
 
   
 
Revolving Credit Facility, due 2017
 
$
8,000
   
$
-
 
Variable Rate Term Loan, due from 2013 to 2016
   
6,625
     
6,875
 
Short-term Obligation, due 2014
   
1,400
     
-
 
Total Short- and Long-Term Obligations
   
16,025
     
6,875
 
Less: Short-Term Obligation and Current Maturities
   
(2,025
)
   
(625
)
Long-Term Obligations, less Current Maturities
 
$
14,000
   
$
6,250
 

The weighted average interest rate for the Company's short- and long-term obligations was 4.42% as of June 29, 2013.

On August 3, 2012, the Company entered into a five-year unsecured revolving credit facility (2012 Credit Agreement) in the aggregate principal amount of up to $100,000,000. The 2012 Credit Agreement also includes an uncommitted unsecured incremental borrowing facility of up to an additional $50,000,000. The principal on any borrowings made under the 2012 Credit Agreement is due on August 3, 2017. Interest on any loans outstanding under the 2012 Credit Agreement accrues and is payable quarterly in arrears at one of the following rates selected by the Company: (i) the highest of (a) the federal funds rate plus 0.50% plus an applicable margin of 0% to 1%, (b) the prime rate, as defined, plus an applicable margin of 0% to 1% and (c) the Eurocurrency rate, as defined, plus 0.50% plus an applicable margin of 0% to 1% or (ii) the Eurocurrency rate, as defined, plus an applicable margin of 1% to 2%. The applicable margin is determined based upon the ratio of the Company's total debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined in the 2012 Credit Agreement. For this purpose, total debt is defined as total debt less up to $25,000,000 of unrestricted domestic cash. There was $8,000,000 outstanding under the 2012 Credit Agreement at June 29, 2013.

The obligations of the Company under the 2012 Credit Agreement may be accelerated upon the occurrence of an event of default under the 2012 Credit Agreement, which includes customary events of default including without limitation payment defaults, defaults in the performance of affirmative and negative covenants, the inaccuracy of representations or warranties, bankruptcy- and insolvency-related defaults, defaults relating to such matters as the Employment Retirement Income Security Act (ERISA), unsatisfied judgments, the failure to pay certain indebtedness, and a change of control default. In addition, the 2012 Credit Agreement contains negative covenants applicable to the Company and its subsidiaries including financial covenants requiring the Company to comply with a maximum consolidated leverage ratio of 3.5 to 1, maximum annual capital expenditures of $25,000,000, and a minimum consolidated interest coverage ratio of 3 to 1, and restrictions on liens, indebtedness, fundamental changes, dispositions of property, making certain restricted payments (including dividends and stock repurchases), investments, transactions with affiliates, sale and leaseback transactions, swap agreements, changing its fiscal year, arrangements affecting subsidiary distributions, entering into new lines of business, and certain actions related to the discontinued operation. As of June 29, 2013, the Company was in compliance with these covenants.

Loans under the 2012 Credit Agreement are guaranteed by certain domestic subsidiaries of the Company pursuant to a Guarantee Agreement, effective August 3, 2012.

As of June 29, 2013, the Company had $91,922,000 of borrowing capacity available under the committed portion of its 2012 Credit Agreement. The amount the Company is able to borrow under the 2012 Credit Agreement is the total borrowing capacity of $100,000,000 less any outstanding borrowings, letters of credit and multi-currency borrowings issued under the 2012 Credit Agreement.
Short-term Obligation

On April 11, 2013, one of the Company's subsidiaries in Brazil borrowed BRL 3,057,000, or approximately $1,400,000 at June 29, 2013, under a short-term note payable to partially fund the acquisition of CBTI. This borrowing was repaid in full on July 15, 2013.
15

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

7. Stock-Based Compensation

Stock-based compensation expense of $1,289,000 and $1,188,000 in the second quarters of 2013 and 2012, respectively, and $2,558,000 and $2,262,000 in the first six months of 2013 and 2012, respectively, was recognized within selling, general, and administrative expenses in the accompanying condensed consolidated statement of income. Unrecognized compensation expense related to stock-based compensation totaled approximately $6,566,000 at June 29, 2013, and will be recognized over a weighted average period of 1.8 years.

8. Employee Benefit Plans
 
The Company sponsors a noncontributory defined benefit retirement plan for the benefit of eligible employees at its Kadant Solutions division and its corporate office (included in the table below in "Pension Benefits"). The Company also sponsors a restoration plan for the benefit of certain executive officers who also participate in the noncontributory defined benefit retirement plan (included in the table below in "Other Benefits"). In addition, employees at certain of the Company's subsidiaries participate in defined benefit retirement and post-retirement welfare benefit plans (included in the table below in "Other Benefits").

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
 
 
 
June 29, 2013
   
June 30, 2012
 
(In thousands)
 
Pension
Benefits
   
Other
Benefits
   
Pension
Benefits
   
Other
Benefits
 
 
 
   
   
   
 
Components of Net Periodic Benefit Cost:
 
   
   
   
 
Service cost
 
$
236
   
$
53
   
$
243
   
$
34
 
Interest cost
   
283
     
69
     
331
     
57
 
Expected return on plan assets
   
(372
)
   
(13
)
   
(407
)
   
 
Recognized net actuarial loss
   
115
     
22
     
160
     
8
 
Amortization of prior service cost
   
14
     
21
     
14
     
6
 
Net periodic benefit cost
 
$
276
   
$
152
   
$
341
   
$
105
 
 
                               
The weighted average assumptions used to determine net periodic benefit cost are as follows:
         
 
                               
Discount rate
   
3.89
%
   
4.00
%
   
4.28
%
   
4.44
%
Expected long-term return on plan assets
   
5.75
%
   
-
     
6.25
%
   
-
 
Rate of compensation increase
   
3.50
%
   
3.73
%
   
4.00
%
   
3.44
%

 
 
Six Months Ended
   
Six Months Ended
 
 
 
June 29, 2013
   
June 30, 2012
 
(In thousands)
 
Pension
Benefits
   
Other
Benefits
   
Pension
Benefits
   
Other
Benefits
 
 
 
   
   
   
 
Components of Net Periodic Benefit Cost:
 
   
   
   
 
Service cost
 
$
499
   
$
106
   
$
505
   
$
73
 
Interest cost
   
584
     
139
     
651
     
115
 
Expected return on plan assets
   
(753
)
   
(26
)
   
(801
)
   
-
 
Recognized net actuarial loss
   
266
     
43
     
314
     
17
 
Amortization of prior service cost
   
28
     
42
     
28
     
11
 
Net periodic benefit cost
 
$
624
   
$
304
   
$
697
   
$
216
 
 
                               
The weighted average assumptions used to determine net periodic benefit cost are as follows:
         
 
                               
Discount rate
   
3.89
%
   
3.97
%
   
4.28
%
   
4.43
%
Expected long-term return on plan assets
   
5.75
%
   
-
     
6.25
%
   
-
 
Rate of compensation increase
   
3.50
%
   
3.71
%
   
4.00
%
   
3.46
%
16

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
8. Employee Benefit Plans (continued)
 
The Company made cash contributions of $540,000 to its Kadant Solutions division's noncontributory defined benefit retirement plan in the first six months of 2013 and expects to make cash contributions of $540,000 over the remainder of 2013. For the remaining pension and post-retirement welfare benefits plans, the Company does not expect to make cash contributions other than to fund current benefit payments.

9. Accumulated Other Comprehensive Items

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

The change in accumulated other comprehensive items (AOCI) by component, net of tax, in the accompanying condensed consolidated balance sheet is as follows:

(In thousands)
 
Foreign
Currency
Translation
Adjustment
   
Unrecognized
Prior Service
Cost
   
Deferred Loss
on Pension and
Other Post-
Retirement
Plans
   
Deferred Loss
on Hedging
Instruments
   
Accumulated
Other
Comprehensive
Items
 
Balance at December 29, 2012
 
$
8,124
   
$
(748
)
 
$
(9,645
)
 
$
(1,046
)
 
$
(3,315
)
Other comprehensive (loss) income before reclassifications
   
(3,466
)
   
     
9
     
(37
)
   
(3,494
)
Reclassifications from AOCI
   
     
46
     
202
     
326
     
574
 
Net current period other comprehensive (loss) income
   
(3,466
)
   
46
     
211
     
289
     
(2,920
)
Balance at June 29, 2013
 
$
4,658
   
$
(702
)
 
$
(9,434
)
 
$
(757
)
 
$
(6,235
)

Amounts reclassified out of accumulated other comprehensive items are as follows:

 
 
Three Months Ended
   
Six Months Ended
 
 
Income Statement
(In thousands)
 
June 29, 2013
   
June 29, 2013
 
Line Item
Pension and Other Post-retirement Plans: (1)
 
   
 
    
Amortization of prior service cost
 
$
(35
)
 
$
(70
)
Selling, general, and administrative expenses
Amortization of actuarial losses
   
(137
)
   
(309
)
Selling, general, and administrative expenses
Total expense before income taxes
   
(172
)
   
(379
)
 
Income tax benefit
   
59
     
131
 
Provision for income taxes
 
   
(113
)
   
(248
)
 
Cash Flow Hedges: (2)
               
    
Interest rate swap agreements
   
(90
)
   
(196
)
Interest expense
Forward currency-exchange contracts
   
(40
)
   
(83
)
Revenues
Total expense before income taxes
   
(130
)
   
(279
)
 
Income tax benefit (expense)
   
46
     
(47
)
Provision for income taxes
 
   
(84
)
   
(326
)
 
Total reclassifications
 
$
(197
)
 
$
(574
)
 

(1) Included in the computation of net periodic benefit costs. See Note 8 for additional information.
(2) See Note 10 for additional information.
17

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

10. 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 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 matures in 2016, 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% plus an applicable margin. The fair value for this instrument as of June 29, 2013 is included in other long-term liabilities, with an offset to accumulated other comprehensive items (net of tax) in the accompanying condensed consolidated balance sheet. The Company has structured the interest rate swap agreement to be 100% effective and as a result, there is no current impact to earnings resulting from hedge ineffectiveness. Management believes that any credit risk associated with the outstanding swap agreement is remote based on the Company's financial position and the creditworthiness of the financial institution issuing the swap agreement.

The counterparty to the swap agreement could demand an early termination of the swap agreement if the Company is in default under the 2012 Credit Agreement, or any agreement that amends or replaces the 2012 Credit Agreement in which the counterparty is a member, and the Company is unable to cure the default. An event of default under the 2012 Credit Agreement includes customary events of default and failure to comply with financial covenants, including a maximum consolidated leverage ratio of 3.5 to 1, maximum annual capital expenditures of $25,000,000, and a minimum consolidated interest coverage ratio of 3 to 1. As of June 29, 2013, the Company was in compliance with these covenants. The unrealized loss of $826,000 as of June 29, 2013, 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.

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.
18

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

10. Derivatives (continued)

The Company recognized a gain of $15,000 and a loss of $23,000 in the second quarters of 2013 and 2012, respectively, and a gain of $13,000 and a loss of $25,000 in the first six months of 2013 and 2012, 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:

 
 
 
June 29, 2013
   
December 29, 2012
 
                                           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
 
$
   
$
   
$
5
   
$
269
 
Derivatives in a Liability Position:
 
                               
Forward currency-exchange contracts
Other Current Liabilities
 
$
(160
)
 
$
2,629
   
$
(161
)
 
$
3,180
 
Interest rate swap agreement
Other Current Liabilities
 
$
   
$
   
$
(19
)
 
$
 
Interest rate swap agreement
Other Long-Term Liabilities
 
$
(826
)
 
$
6,625
   
$
(1,029
)
 
$
6,875
 
 
 
                               
Derivatives Not Designated as Hedging Instruments:
                               
Derivatives in an Asset Position:
 
                               
Forward currency-exchange contracts
Other Current Assets
 
$
15
   
$
962
   
$
24
   
$
1,013
 
Derivatives in a Liability Position:
 
                               
Forward currency-exchange contracts
Other Current Liabilities
 
$
   
$
   
$
(12
)
 
$
815
 

(a) See Note 11 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 2013.

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 June 29, 2013:

(In thousands)
 
Interest Rate Swap
Agreements
   
Forward Currency-
Exchange
Contracts
   
Total
 
Unrealized loss, net of tax, at December 29, 2012
 
$
(939
)
 
$
(107
)
 
$
(1,046
)
Loss reclassified to earnings (a)
   
271
     
55
     
326
 
Gain (Loss) recognized in OCI
   
17
     
(54
)
   
(37
)
Unrealized loss, net of tax, at June 29, 2013
 
$
(651
)
 
$
(106
)
 
$
(757
)
 
(a)     Included in interest expense and provision for income taxes for interest rate swap agreements and in revenues for forward currency-
exchange contracts in the accompanying condensed consolidated statement of income.

As of June 29, 2013, $408,000 of the net unrealized loss included in OCI is expected to be reclassified to earnings over the next twelve months.

19

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

11.            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 June 29, 2013
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
 
 
   
   
   
 
Assets:
 
   
   
   
 
Money market funds and time deposits
 
$
30,715
   
$
   
$
   
$
30,715
 
Banker's acceptance drafts (a)
 
$
   
$
8,197
   
$
   
$
8,197
 
Forward currency-exchange contracts
 
$
   
$
15
   
$
   
$
15
 
 
                               
Liabilities:
                               
Forward currency-exchange contracts
 
$
   
$
160
   
$
   
$
160
 
Interest rate swap agreement
 
$
   
$
826
   
$
   
$
826
 

 
 
Fair Value as of December 29, 2012
 
(In thousands)
 
Level 1
   
Level 2
   
Level 3
   
Total
 
 
 
   
   
   
 
Assets:
 
   
   
   
 
Money market funds and time deposits
 
$
19,768
   
$
   
$
   
$
19,768
 
Banker's acceptance drafts (a)
 
$
   
$
9,794
   
$
   
$
9,794
 
Forward currency-exchange contracts
 
$
   
$
29
   
$
   
$
29
 
 
                               
Liabilities:
                               
Forward currency-exchange contracts
 
$
   
$
173
   
$
   
$
173
 
Interest rate swap agreements
 
$
   
$
1,048
   
$
   
$
1,048
 

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

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 2013. 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 bank deposits that are highly liquid and easily tradable. These investments are valued using inputs observable in active markets for identical securities. The carrying value of the banker's acceptance drafts approximates their fair value due to their short-term nature. 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.
20

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

11. Fair Value Measurements (continued)

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

 
 
June 29, 2013
   
December 29, 2012
 
 
 
Carrying
   
Fair
   
Carrying
   
Fair
 
(In thousands)
 
Value
   
Value
   
Value
   
Value
 
 
 
   
   
   
 
Long-term debt obligations
 
$
14,000
   
$
14,000
   
$
6,250
   
$
6,250
 

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.

12. 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
 
 
 
June 29,
   
June 30,
   
June 29,
   
June 30,
 
(In thousands)
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Revenues:
 
   
   
   
 
Papermaking Systems
 
$
79,253
   
$
79,961
   
$
151,650
   
$
160,111
 
Fiber-based Products
   
2,912
     
3,021
     
6,719
     
6,984
 
 
 
$
82,165
   
$
82,982
   
$
158,369
   
$
167,095
 
 
                               
Income from Continuing Operations Before Provision for Income Taxes:
                               
Papermaking Systems
 
$
11,821
   
$
11,772
   
$
21,765
   
$
23,876
 
Corporate and Fiber-based Products (a)
   
(3,396
)
   
(2,357
)
   
(5,968
)
   
(4,071
)
Total Operating Income
   
8,425
     
9,415
     
15,797
     
19,805
 
Interest Expense, Net
   
(89
)
   
(122
)
   
(145
)
   
(237
)
 
 
$
8,336
   
$
9,293
   
$
15,652
   
$
19,568
 
 
                               
Capital Expenditures:
                               
Papermaking Systems
 
$
1,226
   
$
503
   
$
2,398
   
$
761
 
Corporate and Fiber-based Products
   
168
     
80
     
174
     
80
 
 
 
$
1,394
   
$
583
   
$
2,572
   
$
841
 
 
(a)   Corporate primarily includes general and administrative expenses.
21

KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
13. Contingencies and Litigation

Right of Recourse

 In the ordinary course of business, the Company's subsidiaries in China may receive banker's acceptance drafts from customers in payment of outstanding accounts receivable. These banker's acceptance drafts are non-interest bearing obligations of the issuing bank and mature within six months of the origination date. The Company's subsidiaries in China may use these banker's acceptance drafts prior to the scheduled maturity date to settle outstanding accounts payable with vendors. Banker's acceptance drafts transferred to vendors are subject to customary right of recourse provisions prior to their scheduled maturity date. As of June 29, 2013 and December 29, 2012, the Company had $3,474,000 and $4,170,000, respectively, of banker's acceptance drafts subject to customary right of recourse provisions, which were transferred to vendors and had not reached their scheduled maturity date. Historically, the banker's acceptance drafts have settled upon maturity without any claim of recourse against the Company.

Discontinued Operation

In 2005, the Company's Kadant Composites LLC subsidiary (Composites LLC) sold substantially all of its assets to a third party. Composites LLC ceased doing business in September 2007 after it had expended all of the cash proceeds from the sale to administer and pay warranty claims related to certain decking and roofing products. All activity related to this business is classified in the results of the discontinued operation in the accompanying condensed consolidated financial statements.

On October 24, 2011, the Company, Composites LLC, and other co-defendants entered into an agreement to settle a nationwide class action lawsuit related to allegedly defective composites decking building products manufactured by Composites LLC between April 2002 and October 2003, which was filed and approved in Connecticut state court. As of June 29, 2013, the Company has accrued $11,000 for the payment of remaining claims under the class action settlement and $223,000 in related costs.

General

From time to time, the Company is subject to various claims and legal proceedings covering a range of matters that arise in the ordinary course of business. Such litigation may include claims and counterclaims by and against the Company for breach of contract, canceled contracts, or alleged breaches of warranty and other contract commitments. For legal proceedings in which a loss is probable and estimable, the Company accrues a loss based on the low end of the range of estimated loss when there is no better estimate within the range. If the Company were found to be liable for any of the claims or counterclaims against it, the Company would incur a charge against earnings for amounts in excess of legal accruals.
22

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.

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; and Doctoring, Cleaning, & Filtration.

- Stock-Preparation: custom-engineered systems and equipment, as well as standard individual components, for pulping, de-inking, screening, cleaning, and refining primarily recycled fiber for preparation for entry into the paper machine; recausticizing and evaporation equipment and systems used in the production of virgin pulp;

- 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; and
  - Doctoring, Cleaning, & Filtration: doctoring systems and related consumables that continuously clean rolls to keep paper machines running efficiently; doctor blades made of a variety of materials to perform functions including cleaning, creping, web removal, flaking, and the application of coatings; profiling systems that control moisture, web curl, and gloss during paper converting; and systems and equipment used to continuously clean paper machine fabrics and rolls, drain water from pulp mixtures, form the sheet or web, and filter the process water for reuse.
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.
23

KADANT INC.
Overview (continued)
Recent Acquisitions
On April 12, 2013, we acquired all the outstanding stock of Companhia Brasileira de Tecnologia Industrial (CBTI) for approximately $8.1 million in cash and $0.5 million in assumed liabilities owed to us. CBTI is a long-time licensee of our doctoring, cleaning, and filtration products and stock-preparation products and is also a supplier of industrial drying systems. This acquisition furthers our strategy of expanding our presence in emerging markets.
On May 3, 2013, we acquired certain assets of the Noss Group (Noss), a Sweden-based developer and supplier of high-efficiency cleaners and approach flow systems, for approximately $6.7 million paid at closing and subject to adjustment for redundancy and certain employee benefit payments. As part of the purchase agreement, we retained approximately $1.2 million to fund anticipated redundancy and certain employee benefit payments in Sweden. This acquisition expands our product offerings in our Stock-Preparation product line, particularly for virgin pulp and approach flow applications. In addition, Noss has a large installed base and a high proportion of its revenues are parts and consumables products.

International Sales
During the first six months of 2013 and 2012, approximately 58% and 59%, 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.

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 II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended December 29, 2012, filed with the Securities and Exchange Commission (SEC). There have been no material changes to these critical accounting policies since fiscal year-end 2012 that warrant disclosure.

Industry and Business Outlook
Our products are primarily sold to the global pulp and paper industry. In North America, the paper industry has seen slow, but steady demand during the first half of 2013. While operating rates have remained strong for containerboard in the first half of 2013, printing and writing grades have continued to experience declines in demand. Our bookings in North America were $36 million in the second quarter of 2013, up 1% compared to the same period last year, but down 17% sequentially from the traditionally strong first quarter. In Europe, the market continues to be weak due to the general economic conditions and reduced demand for paper. Our bookings in Europe were $18 million in the second quarter of 2013, down 5% compared to the prior year and down 32% sequentially following a very strong first quarter that included two large stock preparation recycling system orders with a combined value of approximately $9 million. In China, overcapacity continues to be an issue due to new capacity that has recently come on the market combined with reduced growth in demand. Although the government recently announced an increase in the number of tons of capacity from older mills to be removed in 2013, new capacity coming online in 2013 from recycled containerboard machines is expected to add capacity thereby reducing the net effect of the capacity closure plans. Our bookings in China increased in the second quarter of 2013 to $15 million, up 54% compared to the second quarter of last year and 25% sequentially.
24

KADANT INC.
Overview (continued)

We expect to achieve GAAP (generally accepted accounting principles) diluted EPS from continuing operations of $0.47 to $0.49 in the third quarter of 2013 on revenues of $88 to $90 million. Our third quarter of 2013 guidance includes estimated restructuring costs of $0.01. For the full year, we expect revenues of $340 to $345 million, revised from our previous guidance of $336 to $343 million. We expect to achieve GAAP diluted EPS from continuing operations of $2.02 to $2.07, which includes a gain of $0.12 on the sale of assets and acquisition-related restructuring costs of $0.13. This compares to our previous GAAP diluted EPS guidance of $2.00 to $2.10, which included an estimated gain of $0.10 on the sale of assets. On an adjusted diluted EPS basis, excluding the restructuring costs and gain on sale, we are raising our guidance to $2.03 to $2.08 from our previous guidance of $1.90 to $2.00. Adjusted diluted EPS is a non-GAAP measure, which we believe helps investors to gain a more complete understanding of our underlying operations 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.

Results of Operations

Second Quarter 2013 Compared With Second Quarter 2012

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 2013 and 2012. The results of operations for the fiscal quarter ended June 29, 2013 are not necessarily indicative of the results to be expected for the full fiscal year.

 
 
Three Months Ended
 
 
 
June 29,
   
June 30,
 
 
 
2013
   
2012
 
 
 
   
 
Revenues
   
100
%
   
100
%
 
               
Costs and Operating Expenses:
               
    Cost of revenues
   
52
     
56
 
    Selling, general, and administrative expenses
   
36
     
31
 
    Research and development expenses
   
2
     
2
 
    Restructuring costs and other income, net
   
     
 
 
   
90
     
89
 
 
               
Operating Income
   
10
     
11
 
 
               
Interest Income
   
     
 
Interest Expense
   
     
 
 
               
Income from Continuing Operations Before Provision for Income Taxes
   
10
     
11
 
Provision for Income Taxes
   
3
     
3
 
 
               
Income from Continuing Operations
   
7
%
   
8
%
 
               
Revenues
Revenues for the second quarters of 2013 and 2012 from our Papermaking Systems segment and Fiber-based Products business are as follows:

 
 
Three Months Ended
 
 
 
June 29,
   
June 30,
 
(In thousands)
 
2013
   
2012
 
 
 
   
 
Revenues:
 
   
 
Papermaking Systems
 
$
79,253
   
$
79,961
 
Fiber-based Products
   
2,912
     
3,021
 
 
 
$
82,165
   
$
82,982
 
25

KADANT INC.
Results of Operations (continued)

Papermaking Systems Segment. Revenues decreased $0.7 million to $79.3 million in the second quarter of 2013 from $80.0 million in the second quarter of 2012 due to decreased demand for capital products at our North American and European operations offset in part by increases of $6.1 million from acquisitions and $0.6 million from the favorable effects of currency translation.
 
Fiber-based Products. Revenues decreased $0.1 million, or 4%, to $2.9 million in the second quarter of 2013 from $3.0 million in the second quarter of 2012 primarily due to decreased demand for our biodegradable granular products.
Papermaking Systems Segment by Product Line. The following table presents revenues for our Papermaking Systems segment by product line, the changes in revenues by product line between the second quarters of 2013 and 2012, and the changes in revenues by product line between the second quarters of 2013 and 2012 excluding the effect of currency translation. The decrease in revenues excluding the effect of currency translation represents the decrease resulting from the conversion of second quarter of 2013 revenues in local currency into U.S. dollars at the second quarter of 2012 exchange rates, and then comparing this result to the actual revenues in the second quarter of 2012. 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 more complete understanding of our underlying operations 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)
 
June 29,
2013
   
June 30,
2012
   
Increase (Decrease)
   
Currency
Translation
 
 
 
   
   
   
 
Papermaking Systems Product Lines:
 
   
   
   
 
Stock-Preparation
 
$
28.5
   
$
28.7
   
$
(0.2
)
 
$
(0.4
)
Doctoring, Cleaning, & Filtration (a)
   
27.7
     
27.6
     
0.1
     
(0.2
)
Fluid-Handling
   
23.1
     
23.7
     
(0.6
)
   
(0.7
)
 
 
$
79.3
   
$
80.0
   
$
(0.7
)
 
$
(1.3
)
(a)   Prior year amounts were formerly presented separately as Doctoring, Water-Management, and Other product lines and have been recast to conform to the current presentation.

Revenues in our Stock-Preparation product line in the second quarter of 2013 decreased $0.4 million, or 2%, excluding a $0.2 million favorable effect of currency translation, compared to the second quarter of 2012 due to decreased demand for our capital products at our North American and European operations, offset in part by an increase of $4.0 million from acquisitions. Revenues from our Doctoring, Cleaning, & Filtration product line in the second quarter of 2013 decreased $0.2 million, or 1%, excluding a $0.3 million favorable effect of currency translation, compared to the prior year period. An increase of $1.8 million from acquisitions in the second quarter of 2013 was offset by decreased demand for our capital products, especially at our European operations. In our Fluid-Handling product line, revenues in the second quarter of 2013 decreased $0.7 million, or 3%, excluding a $0.1 million favorable effect of currency translation, compared to the prior year period. Increases of $0.3 million from acquisitions and from demand for our capital products at our European and Chinese operations were offset by decreased demand for our products at our North American operations.
26

 
KADANT INC.
Results of Operations (continued)
 
Gross Profit Margin
        Gross profit margins for the second quarters of 2013 and 2012 are as follows:

 
 
Three Months Ended
 
 
 
June 29,
   
June 30,
 
 
 
2013
   
2012
 
 
 
   
 
Gross Profit Margin:
 
   
 
Papermaking Systems
   
48.7
%
   
43.4
%
Fiber-based Products
   
47.1
     
52.8
 
 
   
48.6
%
   
43.7
%

Papermaking Systems Segment. The gross profit margin in the Papermaking Systems segment increased to 48.7% in the second quarter of 2013 from 43.4% in the second quarter of 2012. Gross profit margins were higher in all of our product lines, especially our Stock-Preparation product line, compared to the second quarter of 2012. The increase in the gross profit margin in the Papermaking Systems segment resulted from higher gross profit margins for both capital and aftermarket products due to better pricing and, to a lesser extent, a higher proportion of parts and consumables products sold in the period.

Fiber-based Products. The gross profit margin in our Fiber-based Products business decreased to 47.1% in the second quarter of 2013 from 52.8% in the second quarter of 2012 as a result of decreased manufacturing efficiency due to lower production volumes.

Operating Expenses
Selling, general, and administrative expenses as a percentage of revenues were 36% and 31% in the second quarters of 2013 and 2012, respectively. Selling, general, and administrative expenses increased $3.9 million, or 16%, to $29.4 million in the second quarter of 2013 from $25.5 million in the second quarter of 2012 including increases of $2.9 million from acquisitions and $0.2 million from the unfavorable effect of currency translation.

Total stock-based compensation expense was $1.3 million and $1.2 million in the second quarters of 2013 and 2012, respectively, and is included in selling, general, and administrative expenses in the accompanying condensed consolidated statement of income.

Research and development expenses were $1.9 million and $1.4 million in the second quarters of 2013 and 2012, respectively, and represented 2% of revenues in both periods.

Restructuring Costs and Other Income, net
Restructuring costs and other income, net was $0.2 million in the second quarter of 2013, including $1.9 million of restructuring costs and a $1.7 million gain on the sale of assets. The restructuring costs of $1.9 million included $1.3 million associated with the reduction of 22 employees in Brazil and $0.6 million associated with the reduction of 25 employees in Sweden. We estimate annualized savings of $1.3 million in selling, general, and administrative expenses and $1.7 million in cost of revenues once these restructuring actions have been completed. These actions were taken to streamline our operations as a result of our recent acquisitions. All of these items occurred in the Papermaking Systems segment.

Interest Income
Interest income was $0.1 million in the second quarters of 2013 and 2012.

Interest Expense
Interest expense was $0.2 million in the second quarters of 2013 and 2012.
27

KADANT INC.
Results of Operations (continued)

Provision for Income Taxes
Our provision for income taxes was $2.5 million and $2.7 million in the second quarters of 2013 and 2012, respectively, and represented 30% and 29% of pre-tax income. The effective tax rate of 30% in the second quarter of 2013 was lower than our statutory tax rate primarily due to the release of a valuation allowance against deferred tax assets related to net operating loss carryforwards. The release of the valuation allowance was due to increased projected profitability associated with the CBTI acquisition. Also, the effective tax rate was lower due to a more favorable distribution of our worldwide earnings. The effective tax rate of 29% in the second quarter of 2012 was lower than our statutory tax rate primarily due to a more favorable distribution of our worldwide earnings and the expected utilization of foreign tax credits that were fully reserved in prior periods, due to an increase in estimated 2012 income in the U.S.

Income from Continuing Operations
Income from continuing operations decreased $0.8 million to $5.8 million in the second quarter of 2013 from $6.6 million in the second quarter of 2012. This decrease was primarily due to a decrease in operating income of $1.0 million offset in part by a $0.2 million decrease in our provision for income taxes (see Revenues, Gross Profit Margin, Operating Expenses, and Provision for Income Taxes discussed above).

Loss from Discontinued Operation
Loss from the discontinued operation was $12 thousand and $3 thousand in the second quarters of 2013 and 2012, respectively.

First Six Months 2013 Compared With First Six Months 2012

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 2013 and 2012. The results of operations for the first six months of 2013 are not necessarily indicative of the results to be expected for the full fiscal year.

 
 
Six Months Ended
 
 
 
June 29,
   
June 30,
 
 
 
2013
   
2012
 
 
 
   
 
Revenues
   
100
%
   
100
%
 
               
Costs and Operating Expenses: