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 28, 2014

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 25, 2014
Common Stock, $.01 par value
 
10,928,698

PART 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements

KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)

Assets

 
  
June 28,
    
December 28,
  
(In thousands)
  
2014
    
2013
  
 
  
   
 
Current Assets:
  
   
 
Cash and cash equivalents
  
$
37,510
    
$
50,032
  
Restricted cash (Note 1)
    
167
      
168
  
Accounts receivable, less allowances of $2,486 and $2,689 (Note 1)
    
67,233
      
70,271
  
Inventories (Note 1)
    
60,087
      
62,805
  
Unbilled contract costs and fees
    
3,344
      
3,679
  
Other current assets
    
19,893
      
19,189
  
Assets of discontinued operation
    
130
      
144
  
Total Current Assets
    
188,364
      
206,288
  
 
                
Property, Plant, and Equipment, at Cost
    
119,035
      
117,997
  
Less: accumulated depreciation and amortization
    
75,156
      
73,112
  
 
    
43,879
      
44,885
  
 
                
Other Assets
    
10,894
      
11,230
  
 
                
Intangible Assets, Gross
    
79,691
      
78,223
  
  Less: accumulated amortization
    
33,386
      
30,373
  
 
    
46,305
      
47,850
  
 
                
Goodwill
    
134,098
      
131,915
  
 
                
Total Assets
  
$
423,540
    
$
442,168
  


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 28,
    
December 28,
  
(In thousands, except share amounts)
  
2014
    
2013
  
 
  
   
 
Current Liabilities:
  
   
 
Current maturities of long-term obligations (Note 6)
  
$
625
    
$
625
  
Accounts payable
    
29,254
      
28,388
  
Accrued payroll and employee benefits
    
16,385
      
19,116
  
Customer deposits
    
21,187
      
28,174
  
Other current liabilities
    
23,435
      
23,286
  
Liabilities of discontinued operation
    
213
      
213
  
Total Current Liabilities
    
91,099
      
99,802
  
 
                
Other Long-Term Liabilities
    
33,809
      
33,935
  
 
                
Long-Term Obligations (Note 6)
    
27,569
      
38,010
  
 
                
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
    
95,998
      
96,809
  
Retained earnings
    
257,766
      
248,170
  
Treasury stock at cost, 3,695,461 and 3,524,742 shares
    
(84,665
)
    
(76,339
)
Accumulated other comprehensive items (Note 9)
    
642
      
710
  
Total Kadant Stockholders' Equity
    
269,887
      
269,496
  
Noncontrolling interest
    
1,176
      
925
  
Total Stockholders' Equity
    
271,063
      
270,421
  
 
                
Total Liabilities and Stockholders' Equity
  
$
423,540
    
$
442,168
  


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 28,
    
June 29,
  
(In thousands, except per share amounts)
  
2014
    
2013
  
 
  
   
 
Revenues
  
$
104,835
    
$
82,165
  
 
                
Costs and Operating Expenses:
                
Cost of revenues
    
59,753
      
42,225
  
Selling, general, and administrative expenses
    
31,588
      
29,445
  
Research and development expenses
    
1,392
      
1,852
  
Restructuring costs and other income, net
    
66
      
218
  
 
    
92,799
      
73,740
  
 
                
Operating Income
    
12,036
      
8,425
  
 
                
Interest Income
    
82
      
142
  
Interest Expense
    
(250
)
    
(231
)
 
                
Income from Continuing Operations Before Provision for Income Taxes
    
11,868
      
8,336
  
Provision for Income Taxes
    
3,870
      
2,492
  
 
                
Income from Continuing Operations
    
7,998
      
5,844
  
Loss from Discontinued Operation (net of income tax benefit of $5 and $8)
    
(9
)
    
(12
)
 
                
Net Income
    
7,989
      
5,832
  
 
                
Net Income Attributable to Noncontrolling Interest
    
(131
)
    
(72
)
 
                
Net Income Attributable to Kadant
  
$
7,858
    
$
5,760
  
 
                
Amounts Attributable to Kadant:
                
Income from Continuing Operations
  
$
7,867
    
$
5,772
  
Loss from Discontinued Operation
    
(9
)
    
(12
)
Net Income Attributable to Kadant
  
$
7,858
    
$
5,760
  
 
                
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
                
Basic
  
$
0.71
    
$
0.52
  
Diluted
  
$
0.70
    
$
0.51
  
 
                
Earnings per Share Attributable to Kadant (Note 4):
                
Basic
  
$
0.71
    
$
0.52
  
Diluted
  
$
0.70
    
$
0.51
  
 
                
Weighted Average Shares (Note 4):
                
Basic
    
11,049
      
11,178
  
Diluted
    
11,246
      
11,331
  
 
                
Cash Dividends Declared per Common Share
  
$
0.15
    
$
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 28,
    
June 29,
  
(In thousands, except per share amounts)
  
2014
    
2013
  
 
  
   
 
Revenues
  
$
198,202
    
$
158,369
  
 
                
Costs and Operating Expenses:
                
Cost of revenues
    
110,940
      
82,403
  
Selling, general, and administrative expenses
    
64,070
      
56,395
  
Research and development expenses
    
3,141
      
3,556
  
Restructuring costs and other income, net (Note 3)
    
394
      
218
  
 
    
178,545
      
142,572
  
 
                
Operating Income
    
19,657
      
15,797
  
 
                
Interest Income
    
304
      
251
  
Interest Expense
    
(556
)
    
(396
)
 
                
Income from Continuing Operations Before Provision for Income Taxes
    
19,405
      
15,652
  
Provision for Income Taxes (Note 5)
    
6,222
      
4,459
  
 
                
Income from Continuing Operations
    
13,183
      
11,193
  
Loss from Discontinued Operation (net of income tax benefit of $8 and $25)
    
(14
)
    
(41
)
 
                
Net Income
    
13,169
      
11,152
  
 
                
Net Income Attributable to Noncontrolling Interest
    
(258
)
    
(108
)
 
                
Net Income Attributable to Kadant
  
$
12,911
    
$
11,044
  
 
                
Amounts Attributable to Kadant:
                
Income from Continuing Operations
  
$
12,925
    
$
11,085
  
Loss from Discontinued Operation
    
(14
)
    
(41
)
Net Income Attributable to Kadant
  
$
12,911
    
$
11,044
  
 
                
Earnings per Share from Continuing Operations Attributable to Kadant (Note 4):
                
Basic
  
$
1.17
    
$
0.99
  
Diluted
  
$
1.15
    
$
0.98
  
 
                
Earnings per Share Attributable to Kadant (Note 4):
                
Basic
  
$
1.16
    
$
0.99
  
Diluted
  
$
1.14
    
$
0.98
  
 
                
Weighted Average Shares (Note 4):
                
Basic
    
11,091
      
11,170
  
Diluted
    
11,280
      
11,299
  
 
                
Cash Dividends Declared per Common Share
  
$
0.30
    
$
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 28,
    
June 29,
    
June 28,
    
June 29,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
 
  
   
   
   
 
Net Income
  
$
7,989
    
$
5,832
    
$
13,169
    
$
11,152
  
 
                                
Other Comprehensive Items:
                                
Foreign Currency Translation Adjustment
    
579
      
(381
)
    
(178
)
    
(3,489
)
Pension and Other Post-Retirement Liability Adjustments (net of tax of $18 and $61 in the three and six months ended June 28, 2014, respectively, and $63 and $140 in the three and six months ended June 29, 2013, respectively)
    
33
      
120
      
110
      
257
  
Deferred (Loss) Gain on Hedging Instruments (net of tax of $3 and $52 in the three and six months ended June 28, 2014, respectively, and $51 and $80 in the three and six months ended June 29, 2013, respectively)
    
(99
)
    
94
      
(7
)
    
289
  
 
    
513
      
(167
)
    
(75
)
    
(2,943
)
Comprehensive Income
    
8,502
      
5,665
      
13,094
      
8,209
  
Comprehensive Income Attributable to Noncontrolling Interest
    
(118
)
    
(97
)
    
(251
)
    
(85
)
Comprehensive Income Attributable to Kadant
  
$
8,384
    
$
5,568
    
$
12,843
    
$
8,124
  


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 28,
    
June 29,
  
(In thousands)
  
2014
    
2013
  
 
  
   
 
Operating Activities:
  
   
 
Net income attributable to Kadant
  
$
12,911
    
$
11,044
  
Net income attributable to noncontrolling interest
    
258
      
108
  
Loss from discontinued operation
    
14
      
41
  
Income from continuing operations
    
13,183
      
11,193
  
Adjustments to reconcile income from continuing operations to net cash provided by operating activities:
                
Depreciation and amortization
    
5,874
      
4,428
  
Stock-based compensation expense
    
2,811
      
2,558
  
Recovery of losses on accounts receivable
    
(29
)
    
(193
)
Gain on the sale of property, plant, and equipment
    
(122
)
    
(1,862
)
Other items, net
    
308
      
10
  
    Contributions to pension plan
    
(540
)
    
(540
)
Changes in current assets and liabilities, net of effects of acquisitions:
                
Accounts receivable
    
3,461
      
1,225
  
Unbilled contract costs and fees
    
299
      
1,781
  
Inventories
    
2,309
      
(6,852
)
Other current assets
    
(753
)
    
(451
)
Accounts payable
    
874
      
2,715
  
Other current liabilities
    
(12,480
)
    
4,059
  
Net cash provided by continuing operations
    
15,195
      
18,071
  
Net cash used in discontinued operation
    
(1
)
    
(173
)
Net cash provided by operating activities
    
15,194
      
17,898
  
 
                
Investing Activities:
                
Acquisitions, net of cash acquired
    
(2,770
)
    
(14,209
)
Purchases of property, plant, and equipment
    
(1,442
)
    
(2,572
)
Proceeds from sale of property, plant, and equipment
    
171
      
3,309
  
Other, net
    
-
      
849
  
Net cash used in continuing operations for investing activities
    
(4,041
)
    
(12,623
)
 
                
Financing Activities:
                
Proceeds from issuance of long-term obligations
    
11,401
      
18,900
  
Repayments of long-term obligations
    
(21,724
)
    
(9,750
)
Purchases of Company common stock
    
(11,250
)
    
(2,715
)
Dividends paid
    
(3,064
)
    
(1,401
)
Proceeds from issuance of Company common stock
    
557
      
337
  
Change in restricted cash
    
1
      
(165
)
Other, net
    
703
      
311
  
Net cash (used in) provided by continuing operations for financing activities
    
(23,376
)
    
5,517
  
 
                
Exchange Rate Effect on Cash and Cash Equivalents from Continuing Operations
    
(299
)
    
(1,023
)
 
                
(Decrease) Increase in Cash and Cash Equivalents from Continuing Operations
    
(12,522
)
    
9,769
  
Cash and Cash Equivalents at Beginning of Period
    
50,032
      
54,553
  
Cash and Cash Equivalents at End of Period
  
$
37,510
    
$
64,322
  
 
                

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 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
  
 
                                                                        
Balance at December 28, 2013
    
14,624,159
    
$
146
    
$
96,809
    
$
248,170
      
3,524,742
    
$
(76,339
)
  
$
710
    
$
925
    
$
270,421
  
 
                                                                        
Net income
    
–
      
–
      
–
      
12,911
      
–
      
–
      
–
      
258
      
13,169
  
 
                                                                        
Dividends declared
    
–
      
–
      
–
      
(3,315
)
    
–
      
–
      
–
      
–
      
(3,315
)
 
                                                                        
Activity under stock plans
    
–
      
–
      
(1,514
)
    
–
      
(134,416
)
    
2,924
      
–
      
–
      
1,410
  
 
                                                                        
Tax benefits related to employees' and directors' stock plans
    
–
      
–
      
703
      
–
      
–
      
–
      
–
      
–
      
703
  
 
                                                                        
Purchases of Company common stock
    
–
      
–
      
–
      
–
      
305,135
      
(11,250
)
    
–
      
–
      
(11,250
)
 
                                                                        
Other comprehensive items
    
–
      
–
      
–
      
–
      
–
      
–
      
(68
)
    
(7
)
    
(75
)
 
                                                                        
Balance at June 28, 2014
    
14,624,159
    
$
146
    
$
95,998
    
$
257,766
      
3,695,461
    
$
(84,665
)
  
$
642
    
$
1,176
    
$
271,063
  


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 two reportable operating segments, Papermaking Systems and Wood Processing Systems, and a separate product line, Fiber-based Products.

Through its Papermaking Systems segment, the Company develops, manufactures, and markets a range of equipment and products primarily for the global papermaking, 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 Wood Processing Systems segment, the Company designs and manufactures stranders and related equipment used in the production of oriented strand board (OSB), an engineered wood panel product used primarily in home construction. This segment also supplies debarking and wood chipping equipment used in the forest products and the pulp and paper industries.

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 28, 2014 and its results of operations and comprehensive income for the three and six month periods ended June 28, 2014 and June 29, 2013, and its cash flows and stockholders' equity for the six month periods ended June 28, 2014 and June 29, 2013. 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 28, 2013 has been derived from the consolidated financial statements contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 2013. 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 28, 2013, filed with the SEC.

Fiscal Year
Typically, the Company's fiscal quarters and fiscal year consist of 13 and 52 weeks, respectively, ending on the Saturday closest to the end of the corresponding calendar quarter for the Company's fiscal quarters and on the Saturday closest to December 31 for the Company's fourth fiscal quarter and fiscal year. As a result, a 53rd week is added to the Company's fiscal year every five or six years.  In a 53-week fiscal year, the Company's fourth fiscal quarter contains 14 weeks. The Company's fiscal year ending January 3, 2015 (fiscal 2014) contains 53 weeks and the Company's fiscal year ending December 28, 2013 (fiscal 2013) contains 52 weeks. Each quarter of fiscal 2014 and 2013 contains 13 weeks, except the fourth quarter of 2014, which will contain 14 weeks.

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 and pension obligations. A discussion of the application of these and other accounting policies is included in Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 2013.

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.

9
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)

Supplemental Cash Flow Information

 
  
Six Months Ended
  
(In thousands)
  
June 28, 2014
    
June 29, 2013
  
 
  
   
 
Non-Cash Investing Activities:
  
   
 
Fair Value of Assets Acquired
  
$
5,602
    
$
22,812
  
Cash Paid for Acquired Businesses
    
(3,444
)
    
(15,332
)
Liabilities Assumed of Acquired Businesses
  
$
2,158
    
$
7,480
  
 
                
Non-Cash Financing Activities:
                
Issuance of Company Common Stock
  
$
2,718
    
$
2,353
  
Dividends Declared but Unpaid
  
$
1,640
    
$
1,395
  

Restricted Cash
As of June 28, 2014 and December 28, 2013, the Company had restricted cash of $167,000 and $168,000, respectively. This cash serves as collateral for bank guarantees primarily associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business. All the bank guarantees will expire by the end of 2014.

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 $9,267,000 and $10,765,000 at June 28, 2014 and December 28, 2013, 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 28,
    
December 28,
  
(In thousands)
  
2014
    
2013
  
 
  
   
 
Raw Materials and Supplies
  
$
22,368
    
$
20,836
  
Work in Process
    
16,587
      
21,051
  
Finished Goods
    
21,132
      
20,918
  
 
  
$
60,087
    
$
62,805
  

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)
  
June 28, 2014
    
June 29, 2013
  
 
  
   
 
Balance at beginning of period
  
$
4,571
    
$
4,462
  
Provision
    
1,284
      
505
  
Usage
    
(1,600
)
    
(996
)
Acquired
    
–
      
138
  
Currency translation
    
(6
)
    
(44
)
Balance at end of period
  
$
4,249
    
$
4,065
  

10
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1.            Nature of Operations and Summary of Significant Accounting Policies (continued)

Recent Accounting Pronouncements
Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360) Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-08, which provides new guidance on reporting discontinued operations and disclosures of disposals. Under the new guidance, only disposals representing a strategic shift in operations will be presented as discontinued operations. The new guidance also requires disclosure of the pre-tax income attributable to a disposal of a significant part of the company that does not qualify for discontinued operations reporting. This guidance is effective for the Company beginning in fiscal 2015. Adoption of this ASU is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows.
Revenue from Contracts with Customers (Topic 606) Section A—Summary and Amendments That Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs—Contracts with Customers (Subtopic 340-40). In May 2014, the FASB issued ASU No. 2014-09, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new guidance is effective for the Company beginning in fiscal 2017. Early adoption is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect that ASU No. 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting.

Compensation—Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. In June 2014, the FASB issued ASU No. 2014-12, which clarifies the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. Under the new guidance, a performance target that affects vesting and could be achieved after completion of the service period should be treated as a performance condition under FASB Accounting Standards Codification (ASC) 718 and, as a result, should not be included in the estimation of the grant-date fair value of the award. An entity should recognize compensation cost for the award when it becomes probable that the performance target will be achieved. In the event that an entity determines that it is probable that a performance target will be achieved before the end of the service period, the compensation cost of the award should be recognized prospectively over the remaining service period. The new guidance is effective for the Company beginning in fiscal 2016. Early adoption is permitted. Adoption of this ASU is not expected to have a material impact on the Company's consolidated financial position, results of operations or cash flows.

2. Acquisitions

On December 30, 2013, the Company acquired all the outstanding shares of a European producer of creping and coating blades for approximately $2,627,000 in cash, including $674,000 of cash acquired and $53,000 of debt assumed. An additional 1,000,000 euros, or approximately $1,362,000, of contingent consideration is due to the sellers within two years of the closing date if certain conditions are met, as defined in the purchase agreement.

This acquisition has been accounted for using the purchase method of accounting and its results have been included in the accompanying financial statements from the date of the acquisition. The Company has made a preliminary fair value assessment of the assets acquired and liabilities assumed, including identifiable intangible assets acquired of $1,800,000, which are being amortized using the straight-line method over 12 years. The excess of the acquisition purchase price over the tangible and identifiable intangible assets was recorded as goodwill and totaled $1,590,000, which is not deductible for tax purposes. The fair values are subject to adjustment upon finalization of the valuation, and therefore the current measurements of intangible assets, acquired goodwill, and assumed assets and liabilities are subject to change.

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

During the first six months of 2014, the Company made post-closing adjustment payments of $817,000 related to acquisitions completed prior to 2014.

3.            Restructuring Costs and Other Income, Net

2013 Restructuring Plan
In 2013 and the first six months of 2014, the Company recorded restructuring costs totaling $2,237,000 related to its 2013 restructuring plan, including severance costs of $1,158,000 associated with the reduction of 22 employees in Brazil and severance costs of $497,000 associated with the reduction of 25 employees in Sweden. Also included in total restructuring costs were facility-related costs of $582,000. These actions were taken to streamline the Company's operations as a result of the acquisitions of Companhia Brasileira de Tecnologia Industrial (CBTI) and certain assets of the Noss Group in 2013. These restructuring charges all occurred in the Papermaking Systems segment.

Included in these restructuring costs were $394,000 of restructuring costs recorded in the first six months of 2014, including facility-related costs of $405,000, net of income from a reduction in severance and associated costs of $11,000 in Sweden.

Also included in these restructuring costs were $1,958,000 of restructuring costs recorded in the first six months of 2013, including $1,330,000 associated with severance and associated costs in Brazil and $628,000 related to severance and associated costs in Sweden.

11
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
3.            Restructuring Costs and Other Income, Net (continued)

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
    
Other
Costs
   
Total
Costs
  
Balance at December 28, 2013
  
$
467
    
$
–
    
$
467
  
Provision
    
(11
)
    
405
      
394
  
Usage
    
(370
)
    
(403
)
    
(773
)
Currency translation
    
(12
)
    
(2
)
    
(14
)
Balance at June 28, 2014
  
$
74
    
$
–
    
$
74
  

The Company expects to pay the remaining accrued restructuring costs by the end of 2014.

Other Income
The Company recorded other income of $1,740,000 in the second quarter of 2013 related to a pre-tax gain from the sale of real estate in China.

4. Earnings per Share

Basic and diluted earnings per share are calculated as follows:

 
  
Three Months Ended
    
Six Months Ended
  
 
  
June 28,
    
June 29,
    
June 28,
    
June 29,
  
(In thousands, except per share amounts)
  
2014
    
2013
    
2014
    
2013
  
 
  
   
   
   
 
Amounts Attributable to Kadant:
  
   
   
   
 
Income from Continuing Operations
  
$
7,867
    
$
5,772
    
$
12,925
    
$
11,085
  
Income from Discontinued Operation
    
(9
)
    
(12
)
    
(14
)
    
(41
)
Net Income
  
$
7,858
    
$
5,760
    
$
12,911
    
$
11,044
  
 
                                
Basic Weighted Average Shares
    
11,049
      
11,178
      
11,091
      
11,170
  
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan
    
197
      
153
      
189
      
129
  
Diluted Weighted Average Shares
    
11,246
      
11,331
      
11,280
      
11,299
  
 
                                
Basic Earnings per Share:
                                
Continuing Operations
  
$
0.71
    
$
0.52
    
$
1.17
    
$
0.99
  
Discontinued Operation
  
$
–
    
$
–
    
$
–
    
$
–
  
Net Income per Basic Share
  
$
0.71
    
$
0.52
    
$
1.16
    
$
0.99
  
 
                                
Diluted Earnings per Share:
                                
Continuing Operations
  
$
0.70
    
$
0.51
    
$
1.15
    
$
0.98
  
Discontinued Operation
  
$
–
    
$
–
    
$
–
    
$
–
  
Net Income per Diluted Share
  
$
0.70
    
$
0.51
    
$
1.14
    
$
0.98
  

Options to purchase approximately 93,000 and 102,000 shares of the Company's common stock in the second quarter and first six months of 2013, 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 69,000 shares of common stock for the second quarter of 2014 and approximately 63,000 and 41,000 shares of common stock for the first six months of 2014 and 2013, 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 $6,222,000 and $4,459,000 in the first six months of 2014 and 2013, respectively, and represented 32% and 28% of pre-tax income. The effective tax rate of 32% in the first six months of 2014 was lower than the Company's statutory tax rate primarily due to the release of tax reserves that resulted from the expiration of tax statutes of limitations in jurisdictions outside the U.S., the release of state tax reserves in the U.S., and the distribution of the Company's worldwide earnings. These tax benefits were offset in part by tax expense associated with a reduction in deferred tax assets and an increase in nondeductible expenses. 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.

12
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

6. Long-Term Obligations

Long-term obligations are as follows:

 
  
June 28,
    
December 28,
  
(In thousands)
  
2014
    
2013
  
 
  
   
 
Revolving Credit Facility, due 2018
  
$
22,069
    
$
32,260
  
Variable Rate Term Loan, due from 2014 to 2016
    
6,125
      
6,375
  
Total Long-Term Obligations
    
28,194
      
38,635
  
Less: Current Maturities
    
(625
)
    
(625
)
Long-Term Obligations, less Current Maturities
  
$
27,569
    
$
38,010
  

The weighted average interest rate for the Company's long-term obligations was 2.56% as of June 28, 2014.

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 on August 3, 2012 and amended it on November 1, 2013. 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 November 1, 2018. 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 U.S. cash. There was $22,069,000 outstanding under the 2012 Credit Agreement at June 28, 2014.

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, 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 28, 2014, 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 28, 2014, the Company had $75,817,000 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.

7. Stock-Based Compensation

The Company recognized stock-based compensation expense of $1,416,000 and $1,289,000 in the second quarters of 2014 and 2013, respectively, and $2,811,000 and $2,558,000 in the first six months of 2014 and 2013, respectively, within selling, general, and administrative (SG&A) expenses in the accompanying condensed consolidated statement of income. Unrecognized compensation expense related to stock-based compensation totaled approximately $7,036,000 at June 28, 2014, and will be recognized over a weighted average period of 1.8 years.

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

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 28, 2014
    
June 29, 2013
  
(In thousands)
  
Pension
Benefits
    
Other
Benefits
    
Pension
Benefits
    
Other
Benefits
  
 
  
   
   
   
 
Components of Net Periodic Benefit Cost:
  
   
   
   
 
Service cost
  
$
213
    
$
81
    
$
236
    
$
53
  
Interest cost
    
321
      
74
      
283
      
69
  
Expected return on plan assets
    
(370
)
    
(12
)
    
(372
)
    
(13
)
Recognized net actuarial loss
    
79
      
9
      
115
      
22
  
Amortization of prior service cost
    
14
      
24
      
14
      
21
  
Net periodic benefit cost
  
$
257
    
$
176
    
$
276
    
$
152
  
 
                                
The weighted average assumptions used to determine net periodic benefit cost are as follows:
          
 
                                
Discount rate
    
4.79
%
    
4.30
%
    
3.89
%
    
4.00
%
Expected long-term return on plan assets
    
5.75
%
    
–
      
5.75
%
    
–
  
Rate of compensation increase
    
3.50
%
    
3.24
%
    
3.50
%
    
3.73
%

 
  
Six Months Ended
    
Six Months Ended
  
 
  
June 28, 2014
    
June 29, 2013
  
(In thousands)
  
Pension
Benefits
    
Other
Benefits
    
Pension
Benefits
    
Other
Benefits
  
 
  
   
   
   
 
Components of Net Periodic Benefit Cost:
  
   
   
   
 
Service cost
  
$
426
    
$
150
    
$
499
    
$
106
  
Interest cost
    
642
      
146
      
584
      
139
  
Expected return on plan assets
    
(740
)
    
(24
)
    
(753
)
    
(26
)
Recognized net actuarial loss
    
158
      
18
      
266
      
43
  
Amortization of prior service cost
    
28
      
45
      
28
      
42
  
Net periodic benefit cost
  
$
514
    
$
335
    
$
624
    
$
304
  
 
                                
The weighted average assumptions used to determine net periodic benefit cost are as follows:
          
 
                                
Discount rate
    
4.79
%
    
4.28
%
    
3.89
%
    
3.97
%
Expected long-term return on plan assets
    
5.75
%
    
–
      
5.75
%
    
–
  
Rate of compensation increase
    
3.50
%
    
3.23
%
    
3.50
%
    
3.71
%

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 2014 and expects to make cash contributions of $540,000 over the remainder of 2014. 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.

14
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

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.

Changes in each component of accumulated other comprehensive items (AOCI), net of tax, in the accompanying condensed consolidated balance sheet are 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 28, 2013
  
$
8,919
    
$
(657
)
  
$
(6,919
)
  
$
(633
)
  
$
710
  
Other comprehensive loss before reclassifications
    
(171
)
    
(51
)
    
(1
)
    
(356
)
    
(579
)
Reclassifications from AOCI
    
–
      
47
      
115
      
349
      
511
  
Net current period other comprehensive  (loss) income
    
(171
)
    
(4
)
    
114
      
(7
)
    
(68
)
Balance at June 28, 2014
  
$
8,748
    
$
(661
)
  
$
(6,805
)
  
$
(640
)
  
$
642
  
 
                                        
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
  
Statement of Income
(In thousands)
  
June 28, 2014
    
June 29, 2013
    
June 28, 2014
    
June 29, 2013
  
Line Item
Pension and Other Post-retirement Plans: (1)
  
   
   
   
 
      
Amortization of prior service cost
  
$
(38
)
  
$
(35
)
  
$
(73
)
  
$
(70
)
SG&A expenses
Amortization of actuarial losses
    
(88
)
    
(137
)
    
(176
)
    
(309
)
SG&A expenses
Total expense before income taxes
    
(126
)
    
(172
)
    
(249
)
    
(379
)
 
Income tax benefit
    
44
      
59
      
87
      
131
  
Provision for income taxes
 
    
(82
)
    
(113
)
    
(162
)
    
(248
)
 
Cash Flow Hedges: (2)
                                
      
Interest rate swap agreements
    
(84
)
    
(90
)
    
(168
)
    
(196
)
Interest expense
Forward currency-exchange contracts
    
–
      
(40
)
    
–
      
(83
)
Revenues
Forward currency-exchange contract
    
(278
)
    
–
      
(278
)
    
–
  
SG&A expenses
Total expense before income taxes
    
(362
)
    
(130
)
    
(446
)
    
(279
)
 
Income tax benefit (expense)
    
67
      
46
      
97
      
(47
)
Provision for income taxes
 
    
(295
)
    
(84
)
    
(349
)
    
(326
)
 
Total reclassifications
  
$
(377
)
  
$
(197
)
  
$
(511
)
  
$
(574
)
 

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

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.
15
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. Derivatives (continued)

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 variable rate term loan 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 28, 2014, 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, and a minimum consolidated interest coverage ratio of 3 to 1. As of June 28, 2014, the Company was in compliance with these covenants. The unrealized loss of $619,000 as of June 28, 2014, 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 24-month period, using forward currency-exchange contracts that have maturities of 24 months or less.

Forward currency-exchange contracts that hedge forecasted foreign currency exposures 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 and other long-term 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 $15,000 in the second quarter of 2013, and a gain of $36,000 and $13,000 in the first six months of 2014 and 2013, 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 28, 2014
    
December 28, 2013
  
Balance Sheet
  
Asset
    
Notional
    
Asset
    
Notional
  
(In thousands)
Location
  
(Liability) (a)
    
Amount (b)
    
(Liability) (a)
    
Amount
  
Derivatives Designated as Hedging Instruments:
 
  
   
   
   
 
Derivatives in a Liability Position:
 
  
   
   
   
 
Forward currency-exchange contracts
Other Current Liabilities
  
$
(31
)
  
$
1,340
    
$
(22
)
  
$
1,340
  
Forward currency-exchange contract
Other Long-Term Liabilities
  
$
(384
)
  
$
16,571
    
$
–
    
$
–
  
Interest rate swap agreement
Other Long-Term Liabilities
  
$
(619
)
  
$
6,125
    
$
(773
)
  
$
6,375
  
 
 
                                
Derivatives Not Designated as Hedging Instruments:
 
                                
Derivatives in an Asset Position:
 
                                
Forward currency-exchange contracts
Other Current Assets
  
$
–
    
$
–
    
$
97
    
$
1,419
  
Derivatives in a Liability Position:
 
                                
Forward currency-exchange contracts
Other Current Liabilities
  
$
–
    
$
–
    
$
(1
)
  
$
288
  

(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 2014.

16
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
10. 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 June 28, 2014:

(In thousands)
  
Interest Rate Swap
Agreements
    
Forward Currency-
Exchange
Contracts
    
Total
  
Unrealized loss, net of tax, at December 28, 2013
  
$
(618
)
  
$
(15
)
  
$
(633
)
Loss reclassified to earnings
    
108
      
241
      
349
  
Loss recognized in OCI
    
(8
)
    
(348
)
    
(356
)
Unrealized loss, net of tax, at June 28, 2014
  
$
(518
)
  
$
(122
)
  
$
(640
)

As of June 28, 2014, $327,000 of the net unrealized loss included in OCI is expected to be reclassified to earnings over the next twelve months.

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 28, 2014
  
(In thousands)
  
Level 1
    
Level 2
    
Level 3
    
Total
  
 
  
   
   
   
 
Assets:
  
   
   
   
 
Money market funds and time deposits
  
$
5,992
    
$
–
    
$
–
    
$
5,992
  
Banker's acceptance drafts (a)
  
$
–
    
$
9,267
    
$
–
    
$
9,267
  
 
                                
Liabilities:
                                
Forward currency-exchange contracts
  
$
–
    
$
415
    
$
–
    
$
415
  
Interest rate swap agreement
  
$
–
    
$
619
    
$
–
    
$
619
  
Contingent consideration (b)
  
$
–
    
$
–
    
$
1,362
    
$
1,362
  

 
  
Fair Value as of December 28, 2013
  
(In thousands)
  
Level 1
    
Level 2
    
Level 3
    
Total
  
 
  
   
   
   
 
Assets:
  
   
   
   
 
Money market funds and time deposits
  
$
17,090
    
$
–
    
$
–
    
$
17,090
  
Banker's acceptance drafts (a)
  
$
–
    
$
10,765
    
$
–
    
$
10,765
  
Forward currency-exchange contracts
  
$
–
    
$
97
    
$
–
    
$
97
  
 
                                
Liabilities:
                                
Forward currency-exchange contracts
  
$
–
    
$
23
    
$
–
    
$
23
  
Interest rate swap agreement
  
$
–
    
$
773
    
$
–
    
$
773
  

(a) Included in accounts receivable in the accompanying condensed consolidated balance sheet.
(b) Included in other current liabilities 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 2014. 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 agreement 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 agreement 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 Company recorded contingent consideration as part of its acquisition of a European manufacturer on December 30, 2013. The fair value of the contingent consideration is based on the present value of the estimated future cash flows.

17
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 28, 2014
    
December 28, 2013
  
 
  
Carrying
    
Fair
    
Carrying
    
Fair
  
(In thousands)
  
Value
    
Value
    
Value
    
Value
  
 
  
   
   
   
 
Long-term debt obligations
  
$
27,569
    
$
27,569
    
$
38,010
    
$
38,010
  

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 two reportable operating segments, Papermaking Systems and Wood Processing 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 28,
    
June 29,
    
June 28,
    
June 29,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
 
  
   
   
   
 
Revenues:
  
   
   
   
 
Papermaking Systems
  
$
91,975
    
$
79,253
    
$
170,159
    
$
151,650
  
Wood Processing Systems
    
9,837
      
–
      
21,110
      
–
  
Fiber-based Products
    
3,023
      
2,912
      
6,933
      
6,719
  
 
  
$
104,835
    
$
82,165
    
$
198,202
    
$
158,369
  
 
                                
Income from Continuing Operations Before Provision for Income Taxes:
                                
Papermaking Systems
  
$
13,803
    
$
11,821
    
$
23,213
    
$
21,765
  
Wood Processing Systems
    
1,495
      
–
      
2,849
      
–
  
Corporate and Fiber-based Products (a)
    
(3,262
)
    
(3,396
)
    
(6,405
)
    
(5,968
)
Total Operating Income
    
12,036
      
8,425
      
19,657
      
15,797
  
Interest Expense, Net
    
(168
)
    
(89
)
    
(252
)
    
(145
)
 
  
$
11,868
    
$
8,336
    
$
19,405
    
$
15,652
  
 
                                
Capital Expenditures:
                                
Papermaking Systems
  
$
772
    
$
1,226
    
$
1,289
    
$
2,398
  
Other
    
131
      
168
      
153
      
174
  
 
  
$
903
    
$
1,394
    
$
1,442
    
$
2,572
  

(a) Corporate primarily includes general and administrative expenses.

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 28, 2014 and December 28, 2013, the Company had $4,865,000 and $5,688,000, 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.

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 or warranty, canceled contracts, product liability, or bankruptcy-related claims. 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.

18
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 global supplier of equipment used in process industries, including papermaking, paper recycling, and oriented strand board (OSB), an engineered wood panel product used primarily in home construction. In addition, we manufacture granules made from papermaking byproducts. We have a large customer base that includes most of the world's major paper and OSB manufacturers. We believe our large installed base provides us with a spare parts and consumables business that has lower volatility and yields higher margins than our capital equipment business.

Our continuing operations are comprised of two reportable operating segments: Papermaking Systems and Wood Processing 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. Through our Wood Processing Systems segment, we design, manufacture, and market stranders and related equipment used in the production of OSB, and sell debarking and wood chipping equipment used in the forest products and the pulp and paper industries. 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.

In the first quarter of 2014, our Papermaking Systems segment acquired all the outstanding shares of a European producer of creping and coating blades for approximately $2.6 million in cash, including $0.7 million of cash acquired. An additional 1 million euros, or approximately $1.4 million, of contingent consideration is due to the sellers within two years of the closing date if certain conditions are met, as defined in the purchase agreement.

Wood Processing Systems Segment
Our principal wood-processing products include:
 
-
Stranders: disc and ring stranders that cut trees into strands for OSB production;
 
 
-
Rotary Debarkers: rotary debarkers that employ a combination of mechanical abrasion and log-to-log contact to efficiently remove bark from logs of all shapes and species; and
 
 
-
Chippers: disc, drum, and veneer chippers that are high quality, robust chipper systems for waste-wood and whole-log applications found in pulp woodrooms, chip plants, sawmill, and planer mill sites.
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.
19
KADANT INC.
Overview (continued)
International Sales
During the first six months of 2014 and 2013, approximately 56% and 58%, 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 entail significant judgments and estimates, 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 position 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 28, 2013, filed with the Securities and Exchange Commission (SEC). There have been no material changes to these critical accounting policies since fiscal year-end 2013 that warrant disclosure.

Industry and Business Outlook
Our products are primarily sold in global process industries, including papermaking, paper recycling, and OSB. Our bookings increased to $115 million in the second quarter of 2014, including $14 million from acquisitions, compared to $87 million in the second quarter of 2013. The paper industry in North America has remained relatively stable in the second quarter of 2014 with containerboard mills continuing to run at high operating rates. For the first half of 2014, containerboard mill operating rates were 96% while printing, writing and newsprint grades continued to experience declining performance year-over-year. Our bookings in North America increased 43% to $52 million in the second quarter of 2014, including $8 million from acquisitions, compared to the second quarter of 2013. Sequentially, bookings in North America were down 26% due to the inclusion of a large stock-preparation system order for $11 million in the first quarter of 2014. The European market is showing signs of improvement compared to prior quarters, although the outlook is tempered by geo-political uncertainty in the Ukraine and expanding economic sanctions against Russia. Our bookings in Europe increased 18% to $22 million in the second quarter of 2014 compared to the second quarter of 2013, but were down 12% sequentially. In China, investments in new capacity and efficiency upgrades in the paper industry appear to be on a better trajectory with industrial production reported to be up 9% in the first six months of 2014 compared to the corresponding prior year period. Our bookings in China increased 96% to $29 million in the second quarter of 2014 compared to the second quarter of 2013, primarily due to the inclusion of several large orders for stock-preparation systems with a combined value of $15 million. In addition, our Wood Processing Systems segment booked two orders in China for OSB strander systems totaling $4 million. Our bookings in China can be quite variable and we anticipate a sequential decline in China bookings compared to the strong bookings in the second quarter of 2014. In South America, the weakness in the overall economy, particularly in Brazil, has tempered economic activity. That said, demand for containerboard and tissue in Brazil is expected to grow over the next five years. Our bookings in South America decreased to $5 million in the second quarter of 2014 compared to $11 million in the second quarter of 2013. Sequentially, our bookings in South America were down 15%.

We had record bookings in the first and second quarters of 2014 and overall market conditions remain healthy. However, it is not unusual for customers with larger capital projects, particularly in China, to delay shipment for any number of reasons, and we saw several of these being deferred from the third to the fourth quarter of 2014 and also into early 2015. As a result of the change in the timing of these large capital projects, we are lowering our full year 2014 guidance. We expect revenues of $400 to $410 million in 2014, lowered from our previous guidance of $410 to $420 million. We expect to achieve GAAP (generally accepted accounting principles) diluted earnings per share (EPS) from continuing operations of $2.50 to $2.60 in 2014, lowered from our previous guidance of $2.60 to $2.70. The 2014 guidance includes $0.17 of expense associated with the amortization of acquired profit in inventory and backlog and $0.03 of restructuring costs. We expect to achieve GAAP diluted EPS from continuing operations of $0.52 to $0.54 in the third quarter of 2014, on revenues of $94 to $96 million.

20
KADANT INC.
Results of Operations

Second Quarter 2014 Compared With Second Quarter 2013

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 2014 and 2013. The results of operations for the fiscal quarter ended June 28, 2014 are not necessarily indicative of the results to be expected for the full fiscal year.

 
  
Three Months Ended
  
 
  
June 28,
    
June 29,
  
 
  
2014
    
2013
  
 
  
   
 
Revenues
    
100
%
    
100
%
 
                
Costs and Operating Expenses:
                
Cost of revenues
    
57
      
52
  
Selling, general, and administrative expenses
    
30
      
36
  
Research and development expenses
    
1
      
2
  
Restructuring costs and other income, net
    
–
      
–
  
 
    
88
      
90
  
Operating Income
    
12
      
10
  
Interest Income
    
–
      
–
  
Interest Expense
    
–
      
–
  
Income from Continuing Operations Before Provision for Income Taxes
    
12
      
10
  
Provision for Income Taxes
    
4
      
3
  
Income from Continuing Operations
    
8
%
    
7
%

Revenues
Revenues for the second quarters of 2014 and 2013 are as follows:

 
  
Three Months Ended
  
 
  
June 28,
    
June 29,
  
(In thousands)
  
2014
    
2013