UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 28, 2020
OR
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________ to _________
Commission file number 001-11406
KADANT INC.
(Exact name of registrant as specified in its charter)
Delaware | 52-1762325 | ||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||
One Technology Park Drive
Westford, Massachusetts 01886
(Address of principal executive offices, including zip code)
(978) 776-2000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
Common Stock, $.01 par value | KAI | New York Stock Exchange | ||
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | Smaller reporting company | ☐ | |
Emerging growth company | ☐ | |||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of April 24, 2020, the registrant had 11,469,515 shares of common stock outstanding.
Kadant Inc.
Quarterly Report on Form 10-Q
for the Period Ended March 28, 2020
Table of Contents
Page | ||
PART I: Financial Information | ||
PART II: Other Information | ||
PART 1 – FINANCIAL INFORMATION
Item 1 – Financial Statements
KADANT INC.
Condensed Consolidated Balance Sheet
(Unaudited)
March 28, 2020 | December 28, 2019 | |||||||
(In thousands, except share and per share amounts) | ||||||||
Assets | ||||||||
Current Assets: | ||||||||
Cash and cash equivalents | $ | 60,012 | $ | 66,786 | ||||
Restricted cash | 2,063 | 1,487 | ||||||
Accounts receivable | 93,850 | 98,438 | ||||||
Less: allowance for credit losses | 2,712 | 2,698 | ||||||
Accounts receivable, net | 91,138 | 95,740 | ||||||
Inventories | 102,718 | 102,715 | ||||||
Unbilled revenue | 12,194 | 13,162 | ||||||
Other current assets | 19,556 | 17,686 | ||||||
Total Current Assets | 287,681 | 297,576 | ||||||
Property, Plant, and Equipment, at Cost | 179,639 | 181,341 | ||||||
Less: accumulated depreciation and amortization | 95,891 | 95,309 | ||||||
Property, Plant, and Equipment, at Cost, Net | 83,748 | 86,032 | ||||||
Other Assets | 39,932 | 45,851 | ||||||
Intangible Assets, Net (Note 1) | 166,690 | 173,896 | ||||||
Goodwill (Note 1) | 330,997 | 336,032 | ||||||
Total Assets | $ | 909,048 | $ | 939,387 | ||||
Liabilities and Stockholders' Equity | ||||||||
Current Liabilities: | ||||||||
Current maturities of long-term obligations (Note 4) | $ | 2,687 | $ | 2,851 | ||||
Accounts payable | 41,196 | 45,852 | ||||||
Accrued payroll and employee benefits | 22,036 | 31,968 | ||||||
Customer deposits | 25,588 | 24,012 | ||||||
Advanced billings | 8,335 | 11,280 | ||||||
Other current liabilities | 30,057 | 30,206 | ||||||
Total Current Liabilities | 129,899 | 146,169 | ||||||
Long-Term Obligations (Note 4) | 292,689 | 298,174 | ||||||
Other Long-Term Liabilities | 62,188 | 67,965 | ||||||
Commitments and Contingencies (Note 11) | ||||||||
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 | 105,457 | 106,698 | ||||||
Retained earnings | 445,027 | 435,249 | ||||||
Treasury stock at cost, 3,154,644 and 3,214,888 shares | (77,302 | ) | (78,778 | ) | ||||
Accumulated other comprehensive items (Note 7) | (50,554 | ) | (37,620 | ) | ||||
Total Kadant Stockholders' Equity | 422,774 | 425,695 | ||||||
Noncontrolling interest | 1,498 | 1,384 | ||||||
Total Stockholders' Equity | 424,272 | 427,079 | ||||||
Total Liabilities and Stockholders' Equity | $ | 909,048 | $ | 939,387 | ||||
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 | ||||||||
March 28, 2020 | March 30, 2019 | |||||||
(In thousands, except per share amounts) | ||||||||
Revenue (Notes 1 and 10) | $ | 159,127 | $ | 171,316 | ||||
Costs and Operating Expenses: | ||||||||
Cost of revenue | 90,804 | 100,801 | ||||||
Selling, general, and administrative expenses | 45,592 | 49,319 | ||||||
Research and development expenses | 3,076 | 2,621 | ||||||
139,472 | 152,741 | |||||||
Operating Income | 19,655 | 18,575 | ||||||
Interest Income | 51 | 56 | ||||||
Interest Expense | (2,459 | ) | (3,504 | ) | ||||
Other Expense, Net | (32 | ) | (99 | ) | ||||
Income Before Provision for Income Taxes | 17,215 | 15,028 | ||||||
Provision for Income Taxes (Note 3) | 4,559 | 3,963 | ||||||
Net Income | 12,656 | 11,065 | ||||||
Net Income Attributable to Noncontrolling Interest | (125 | ) | (165 | ) | ||||
Net Income Attributable to Kadant | $ | 12,531 | $ | 10,900 | ||||
Earnings per Share Attributable to Kadant (Note 2) | ||||||||
Basic | $ | 1.10 | $ | 0.98 | ||||
Diluted | $ | 1.09 | $ | 0.96 | ||||
Weighted Average Shares (Note 2) | ||||||||
Basic | 11,432 | 11,133 | ||||||
Diluted | 11,508 | 11,385 | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
KADANT INC.
Condensed Consolidated Statement of Comprehensive (Loss) Income
(Unaudited)
Three Months Ended | ||||||||
March 28, 2020 | March 30, 2019 | |||||||
(In thousands) | ||||||||
Net Income | $ | 12,656 | $ | 11,065 | ||||
Other Comprehensive Items: | ||||||||
Foreign currency translation adjustment | (12,574 | ) | (465 | ) | ||||
Pension and other post-retirement liability adjustments, net (net of tax of $20 and $8) | 50 | 21 | ||||||
Effect of other post-retirement plan settlement | (119 | ) | — | |||||
Deferred loss on cash flow hedges (net of tax of $119 and $104) | (302 | ) | (237 | ) | ||||
Total other comprehensive items | (12,945 | ) | (681 | ) | ||||
Comprehensive (Loss) Income | (289 | ) | 10,384 | |||||
Comprehensive Income Attributable to Noncontrolling Interest | (114 | ) | (132 | ) | ||||
Comprehensive (Loss) Income Attributable to Kadant | $ | (403 | ) | $ | 10,252 | |||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
KADANT INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
Three Months Ended | ||||||||
March 28, 2020 | March 30, 2019 | |||||||
(In thousands) | ||||||||
Operating Activities | ||||||||
Net income attributable to Kadant | $ | 12,531 | $ | 10,900 | ||||
Net income attributable to noncontrolling interest | 125 | 165 | ||||||
Net income | 12,656 | 11,065 | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 7,598 | 8,231 | ||||||
Stock-based compensation expense | 1,639 | 1,553 | ||||||
Provision for losses on accounts receivable | 103 | 64 | ||||||
Gain on sale of property, plant, and equipment | (10 | ) | (200 | ) | ||||
Other items, net | (877 | ) | 596 | |||||
Changes in current assets and liabilities, net of effects of acquisition: | ||||||||
Accounts receivable | 1,929 | (1,190 | ) | |||||
Unbilled revenue | 844 | (1,055 | ) | |||||
Inventories | (3,735 | ) | (3,263 | ) | ||||
Other current assets | (1,107 | ) | (189 | ) | ||||
Accounts payable | (3,440 | ) | 3,872 | |||||
Other current liabilities | (9,431 | ) | (9,608 | ) | ||||
Net cash provided by operating activities | 6,169 | 9,876 | ||||||
Investing Activities | ||||||||
Acquisition, net of cash acquired | — | (175,288 | ) | |||||
Purchases of property, plant, and equipment | (2,686 | ) | (2,168 | ) | ||||
Proceeds from sale of property, plant, and equipment | 14 | 293 | ||||||
Net cash used in investing activities | (2,672 | ) | (177,163 | ) | ||||
Financing Activities | ||||||||
Proceeds from issuance of long-term obligations | — | 189,000 | ||||||
Repayment of long-term obligations | (2,969 | ) | (6,404 | ) | ||||
Dividends paid | (2,628 | ) | (2,444 | ) | ||||
Tax withholding payments related to stock-based compensation | (2,318 | ) | (2,647 | ) | ||||
Proceeds from issuance of Company common stock | 913 | 723 | ||||||
Payment of debt issuance costs | — | (36 | ) | |||||
Net cash (used in) provided by financing activities | (7,002 | ) | 178,192 | |||||
Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash | (2,693 | ) | 153 | |||||
(Decrease) Increase in Cash, Cash Equivalents, and Restricted Cash | (6,198 | ) | 11,058 | |||||
Cash, Cash Equivalents, and Restricted Cash at Beginning of Period | 68,273 | 46,117 | ||||||
Cash, Cash Equivalents, and Restricted Cash at End of Period | $ | 62,075 | $ | 57,175 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
KADANT INC.
Condensed Consolidated Statement of Stockholders' Equity
(Unaudited)
Three Months Ended March 28, 2020 | ||||||||||||||||||||||||||||||||||
(In thousands, except share and per share amounts) | Common Stock | Capital in Excess of Par Value | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Items | Noncontrolling Interest | Total Stockholders' Equity | |||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||||
Balance at December 28, 2019 | 14,624,159 | $ | 146 | $ | 106,698 | $ | 435,249 | 3,214,888 | $ | (78,778 | ) | $ | (37,620 | ) | $ | 1,384 | $ | 427,079 | ||||||||||||||||
Net income | — | — | — | 12,531 | — | — | — | 125 | 12,656 | |||||||||||||||||||||||||
Dividend declared – Common Stock, $0.24 per share | — | — | — | (2,753 | ) | — | — | — | — | (2,753 | ) | |||||||||||||||||||||||
Activity under stock plans | — | — | (1,241 | ) | — | (60,244 | ) | 1,476 | — | — | 235 | |||||||||||||||||||||||
Other comprehensive items | — | — | — | — | — | — | (12,934 | ) | (11 | ) | (12,945 | ) | ||||||||||||||||||||||
Balance at March 28, 2020 | 14,624,159 | $ | 146 | $ | 105,457 | $ | 445,027 | 3,154,644 | $ | (77,302 | ) | $ | (50,554 | ) | $ | 1,498 | $ | 424,272 | ||||||||||||||||
Three Months Ended March 30, 2019 | ||||||||||||||||||||||||||||||||||
(In thousands, except share and per share amounts) | Common Stock | Capital in Excess of Par Value | Retained Earnings | Treasury Stock | Accumulated Other Comprehensive Items | Noncontrolling Interest | Total Stockholders' Equity | |||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||||
Balance at December 29, 2018 | 14,624,159 | $ | 146 | $ | 104,731 | $ | 393,578 | 3,514,163 | $ | (86,111 | ) | $ | (39,376 | ) | $ | 1,603 | $ | 374,571 | ||||||||||||||||
Net income | — | — | — | 10,900 | — | — | — | 165 | 11,065 | |||||||||||||||||||||||||
Adoption of ASU No. 2016-02, Leases | — | — | — | (17 | ) | — | — | — | — | (17 | ) | |||||||||||||||||||||||
Dividend declared – Common Stock, $0.23 per share | — | — | — | (2,570 | ) | — | — | — | — | (2,570 | ) | |||||||||||||||||||||||
Activity under stock plans | — | — | (1,951 | ) | — | (64,435 | ) | 1,579 | — | — | (372 | ) | ||||||||||||||||||||||
Other comprehensive items | — | — | — | — | — | — | (648 | ) | (33 | ) | (681 | ) | ||||||||||||||||||||||
Balance at March 30, 2019 | 14,624,159 | $ | 146 | $ | 102,780 | $ | 401,891 | 3,449,728 | $ | (84,532 | ) | $ | (40,024 | ) | $ | 1,735 | $ | 381,996 | ||||||||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
7
1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Kadant Inc. was incorporated in Delaware in November 1991 and trades on the New York Stock Exchange under the ticker symbol "KAI."
Kadant Inc. (together with its subsidiaries, the Company) is a global supplier of high-value, critical components and engineered systems used in process industries worldwide. Its products, technologies, and services play an integral role in enhancing process efficiency, optimizing energy utilization, and maximizing productivity in resource-intensive industries.
COVID-19
On March 11, 2020, the World Health Organization designated the novel coronavirus (COVID-19) a global pandemic. The future impact of the COVID-19 pandemic and any resulting economic impact of the pandemic are rapidly evolving and largely unknown. It is possible that the COVID-19 pandemic, the measures taken by the governments throughout the world, and the resulting economic impact may materially and adversely affect the Company’s results of operations, cash flows and financial position. The Company is closely monitoring the impact of COVID-19 on all aspects of its business.
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 March 28, 2020 and its results of operations, comprehensive (loss) income, cash flows, and stockholders' equity for the three-month periods ended March 28, 2020 and March 30, 2019. 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, 2019 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, 2019. The condensed consolidated financial statements and related notes are presented as permitted by the 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, 2019, filed with the SEC.
Financial Statement Presentation
In the first quarter of 2020, the Company realigned its business segments into three new reportable operating segments: Flow Control, Industrial Processing, and Material Handling. The Company previously reported its financial results by combining its operating entities into three reportable operating segments: Papermaking Systems, Wood Processing Systems, and Material Handling Systems, and a separate product line, Fiber-based Products. Financial information for 2019 has been recast to conform to the new segment presentation. See Note 10, Business Segment Information, for further detail regarding the Company's segments.
Use of Estimates and Critical Accounting Policies
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Although the Company makes every effort to ensure the accuracy of the estimates and assumptions used in the preparation of its condensed consolidated financial statements or in the application of accounting policies, if business conditions were different, or if the Company were to use different estimates and assumptions, it is possible that materially different amounts could be reported in the Company's condensed consolidated financial statements.
8
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
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, 2019 describe the significant accounting estimates and policies used in preparation of the consolidated financial statements. There have been no material changes in the Company’s significant accounting policies during the three months ended March 28, 2020, except that the Company no longer considers its policy with respect to accounting for pension benefits to be a critical accounting policy due to the settlement of its U.S. pension plan in December 2019.
Supplemental Cash Flow Information
Three Months Ended | ||||||||
(In thousands) | March 28, 2020 | March 30, 2019 | ||||||
Cash Paid for Interest | $ | 2,212 | $ | 2,782 | ||||
Cash Paid for Income Taxes, Net of Refunds | $ | 4,698 | $ | 4,679 | ||||
Non-Cash Investing Activities: | ||||||||
Post-closing acquisition adjustment | $ | — | $ | 1,567 | ||||
Liabilities assumed of acquired business | $ | — | $ | 29,664 | ||||
Non-cash additions to property, plant, and equipment | $ | 128 | $ | 193 | ||||
Non-Cash Financing Activities: | ||||||||
Issuance of Company common stock upon vesting of restricted stock units | $ | 3,670 | $ | 3,278 | ||||
Dividends declared but unpaid | $ | 2,753 | $ | 2,570 | ||||
Restricted Cash
The Company's restricted cash serves as collateral for banker's acceptance drafts issued in China and bank guarantees associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business. The majority of the bank guarantees will expire over the next twelve months.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company's condensed consolidated balance sheet that are shown in aggregate in the accompanying condensed consolidated statement of cash flows:
(In thousands) | March 28, 2020 | March 30, 2019 | December 28, 2019 | December 29, 2018 | ||||||||||||
Cash and cash equivalents | $ | 60,012 | $ | 56,478 | $ | 66,786 | $ | 45,830 | ||||||||
Restricted cash | 2,063 | 697 | 1,487 | 287 | ||||||||||||
Total Cash, Cash Equivalents, and Restricted Cash | $ | 62,075 | $ | 57,175 | $ | 68,273 | $ | 46,117 | ||||||||
Inventories
The components of inventories are as follows:
March 28, 2020 | December 28, 2019 | |||||||
(In thousands) | ||||||||
Raw Materials | $ | 49,617 | $ | 49,332 | ||||
Work in Process | 14,495 | 15,344 | ||||||
Finished Goods | 38,606 | 38,039 | ||||||
$ | 102,718 | $ | 102,715 | |||||
9
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Intangible Assets, Net
Acquired intangible assets by major asset class are as follows:
(In thousands) | Gross | Accumulated Amortization | Currency Translation | Net | ||||||||||||
March 28, 2020 | ||||||||||||||||
Definite-Lived | ||||||||||||||||
Customer relationships | $ | 171,583 | $ | (55,194 | ) | $ | (6,077 | ) | $ | 110,312 | ||||||
Product technology | 56,011 | (28,776 | ) | (2,096 | ) | 25,139 | ||||||||||
Tradenames | 6,527 | (2,551 | ) | (458 | ) | 3,518 | ||||||||||
Other | 17,964 | (13,416 | ) | (605 | ) | 3,943 | ||||||||||
252,085 | (99,937 | ) | (9,236 | ) | 142,912 | |||||||||||
Indefinite-Lived | ||||||||||||||||
Tradenames | 24,100 | — | (322 | ) | 23,778 | |||||||||||
Acquired Intangible Assets | $ | 276,185 | $ | (99,937 | ) | $ | (9,558 | ) | $ | 166,690 | ||||||
December 28, 2019 | ||||||||||||||||
Definite-Lived | ||||||||||||||||
Customer relationships | $ | 171,583 | $ | (51,798 | ) | $ | (4,141 | ) | $ | 115,644 | ||||||
Product technology | 56,011 | (27,819 | ) | (1,709 | ) | 26,483 | ||||||||||
Tradenames | 6,527 | (2,421 | ) | (427 | ) | 3,679 | ||||||||||
Other | 17,964 | (13,295 | ) | (593 | ) | 4,076 | ||||||||||
252,085 | (95,333 | ) | (6,870 | ) | 149,882 | |||||||||||
Indefinite-Lived | ||||||||||||||||
Tradenames | 24,100 | — | (86 | ) | 24,014 | |||||||||||
Acquired Intangible Assets | $ | 276,185 | $ | (95,333 | ) | $ | (6,956 | ) | $ | 173,896 | ||||||
Intangible assets are initially recorded at fair value at the date of acquisition. Subsequent impairment charges are reflected as a reduction in the gross balance, as applicable. Definite-lived intangible assets are stated net of accumulated amortization and currency translation in the accompanying condensed consolidated balance sheet. The Company amortizes definite-lived intangible assets over lives that have been determined based on the anticipated cash flow benefits of the intangible asset.
Goodwill
The changes in the carrying amount of goodwill by segment are as follows:
(In thousands) | Flow Control | Industrial Processing | Material Handling | Total | ||||||||||||
Balance at December 28, 2019 (a) | ||||||||||||||||
Gross balance | $ | 97,680 | $ | 207,536 | $ | 116,325 | $ | 421,541 | ||||||||
Accumulated impairment losses | — | (85,509 | ) | — | (85,509 | ) | ||||||||||
Net balance | 97,680 | 122,027 | 116,325 | 336,032 | ||||||||||||
2020 Adjustment | ||||||||||||||||
Currency translation | (1,552 | ) | (3,182 | ) | (301 | ) | (5,035 | ) | ||||||||
Total 2020 adjustment | (1,552 | ) | (3,182 | ) | (301 | ) | (5,035 | ) | ||||||||
Balance at March 28, 2020 | ||||||||||||||||
Gross balance | 96,128 | 204,354 | 116,024 | 416,506 | ||||||||||||
Accumulated impairment losses | — | (85,509 | ) | — | (85,509 | ) | ||||||||||
Net balance | $ | 96,128 | $ | 118,845 | $ | 116,024 | $ | 330,997 | ||||||||
(a) Goodwill balances as of December 28, 2019 have been recast to conform to the current period presentation. See Note 10, Business Segment Information, for further details regarding the Company's change in reportable operating segments.
10
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Impairment of Indefinite-Lived Assets
The Company evaluates the recoverability of goodwill and indefinite-lived intangible assets as of the end of each fiscal year or more frequently if events or changes in circumstances indicate that it is more likely than not that the carrying value of an asset might be impaired. Potential impairment indicators include a significant decline in sales, earnings, or cash flows, material adverse changes in the business climate, and a significant decline in the Company's market capitalization due to a sustained decrease in its stock price.
In March 2020, the Company experienced a significant decrease in market capitalization due to a decline in the Company’s stock price. During that time, the overall U.S. stock market also declined significantly amid market volatility driven by the uncertainty surrounding the outbreak of COVID-19. Based on these occurrences, the Company concluded that a triggering event had occurred related to the indefinite-lived assets within its material handling reporting unit. As a result, the Company prepared a quantitative impairment analysis (Step 1) for the material handling reporting unit, which indicated that its fair value exceeded its carrying value and the indefinite-lived assets were not impaired. The Company will continue to monitor for impairment indicators throughout 2020 and will conduct an interim period impairment analysis as required.
Warranty Obligations
The Company's contracts covering the sale of its products include warranty provisions that provide assurance to its customers that the products will comply with agreed-upon specifications during a defined period of time. The Company negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications.
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:
Three Months Ended | ||||||||
(In thousands) | March 28, 2020 | March 30, 2019 | ||||||
Balance at Beginning of Year | $ | 6,467 | $ | 5,726 | ||||
Provision charged to expense | 1,270 | 1,076 | ||||||
Usage | (1,365 | ) | (925 | ) | ||||
Acquisition | — | 295 | ||||||
Currency translation | (162 | ) | (3 | ) | ||||
Balance at End of Period | $ | 6,210 | $ | 6,169 | ||||
Revenue Recognition
The Company recognizes revenue under Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers. Most of the Company’s revenue is recognized at a point in time for each performance obligation under the contract when the customer obtains control of the goods or service. Most of the Company’s parts and consumables products and its capital products with minimal customization are accounted for at a point in time. The Company has made a policy election to not treat the obligation to ship as a separate performance obligation under the contract and, as a result, the associated shipping costs are reflected in cost of revenue when revenue is recognized.
The remaining portion of the Company’s revenue is recognized on an over time basis based on an input method that compares the costs incurred to date to the total expected costs required to satisfy the performance obligation. Contracts are accounted for on an over time basis when they include products which have no alternative use and an enforceable right to payment over time. Most of the contracts recognized on an over time basis are for large capital projects. These projects are highly customized for the customer and, as a result, would include a significant cost to rework in the event of cancellation.
11
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
The following table presents revenue by revenue recognition method:
Three Months Ended | ||||||||
March 28, | March 30, | |||||||
(In thousands) | 2020 | 2019 | ||||||
Point in Time | $ | 136,092 | $ | 148,276 | ||||
Over Time | 23,035 | 23,040 | ||||||
$ | 159,127 | $ | 171,316 | |||||
The transaction price includes estimated variable consideration where applicable. Such variable consideration relates to certain performance guarantees and rights to return the product. The Company estimates variable consideration as the most likely amount to which it expects to be entitled based on the terms of the contracts with customers and historical experience, where relevant. For contracts with multiple performance obligations, the transaction price is allocated to each performance obligation based on the relative stand-alone selling price.
The Company disaggregates its revenue from contracts with customers by reportable operating segment, product type and geography as this best depicts how its revenue is affected by economic factors.
The following table presents the disaggregation of revenue by product type and geography:
Three Months Ended | ||||||||
March 28, | March 30, | |||||||
(In thousands) | 2020 | 2019 | ||||||
Revenue by Product Type: | ||||||||
Parts and Consumables | $ | 105,098 | $ | 112,850 | ||||
Capital | 54,029 | 58,466 | ||||||
$ | 159,127 | $ | 171,316 | |||||
Revenue by Geography: | ||||||||
North America | $ | 93,823 | $ | 100,876 | ||||
Europe | 36,014 | 38,985 | ||||||
Asia | 15,908 | 17,078 | ||||||
Rest of World | 13,382 | 14,377 | ||||||
$ | 159,127 | $ | 171,316 | |||||
See Note 10, Business Segment Information, for information on the disaggregation of revenue by reportable operating segment.
The following table presents contract balances from contracts with customers:
March 28, 2020 | December 28, 2019 | |||||||
(In thousands) | ||||||||
Accounts Receivable | $ | 91,138 | $ | 95,740 | ||||
Contract Assets | $ | 12,194 | $ | 13,162 | ||||
Contract Liabilities | $ | 35,663 | $ | 37,216 | ||||
Contract assets represent unbilled revenue associated with revenue recognized on contracts accounted for on an over time basis, which will be billed in future periods based on the contract terms. Contract liabilities consist of customer deposits, advanced billings, and deferred revenue. Deferred revenue is included in other current liabilities in the accompanying condensed consolidated balance sheet. Contract liabilities will be recognized as revenue in future periods once the revenue recognition criteria are met. The majority of the contract liabilities relate to advance payments on contracts accounted for at a point in time. These advance payments will be recognized as revenue when the Company's performance obligations have been satisfied, which typically occurs when the product has shipped and control of the asset has transferred to the customer. The Company recognized revenue of $19,708,000 in the first three months of 2020 and $19,095,000 in the first three months of 2019 that was included in the contract liabilities balance at the beginning of 2020 and 2019. The majority of the Company's contracts for capital equipment have an original expected duration of one year or less. For contracts with an original expected duration of over one year, the aggregate amount of the transaction price allocated to the remaining partially unsatisfied
12
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
performance obligations as of March 28, 2020 was $13,194,000. The Company will recognize revenue for these performance obligations as they are satisfied, approximately 89% of which is expected to occur within the next twelve months.
Customers in China will often settle their accounts receivable with a banker's acceptance draft, in which case cash settlement will be delayed until the draft matures or is settled prior to maturity. For customers outside of China, final payment for the majority of the Company's products is received in the quarter following the product shipment. Certain of the Company's contracts include a longer period before final payment is due, which is typically within one year of final shipment or transfer of control to the customer.
The Company includes in revenue amounts invoiced for shipping and handling with the corresponding costs reflected in cost of revenue. Provisions for discounts, warranties, returns and other adjustments are provided for in the period in which the related sale was recorded. Sales taxes, value-added taxes, and certain excise taxes collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from revenue.
Accounts Receivable and Allowance for Credit Losses
The Company's accounts receivable arise from sales on credit to customers, are recorded at the invoiced amount, and do not bear interest. The Company establishes an allowance for credit losses to reduce accounts receivable to the net amount expected to be collected. The Company exercises judgment in determining its allowance for credit losses, which is based on its historical collection and write-off experience, adjusted for current macroeconomic trends and conditions, credit policies, specific customer collection issues, and accounts receivable aging categories. The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and each customer's current creditworthiness. The Company continuously monitors collections and payments from its customers. Account balances are charged off against the allowance when the Company believes it is probable the receivable will not be recovered. In some instances, the Company utilizes letters of credit to mitigate its credit exposure.
The changes in the allowance for credit losses are as follows:
Three Months Ended | ||||||||
(In thousands) | March 28, 2020 | March 30, 2019 | ||||||
Balance at Beginning of Period | $ | 2,698 | $ | 2,897 | ||||
Provision charged to expense | 103 | 64 | ||||||
Accounts written off | (26 | ) | (17 | ) | ||||
Currency translation | (63 | ) | 7 | |||||
Balance at End of Period | $ | 2,712 | $ | 2,951 | ||||
Banker's Acceptance Drafts included in Accounts Receivable
The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for their trade accounts receivable. The drafts are noninterest-bearing obligations of the issuing bank and mature within six months of the origination date. The Company's Chinese subsidiaries may sell the drafts at a discount to a third-party financial institution or transfer the drafts to vendors in settlement of current accounts payable prior to the scheduled maturity date. These drafts, which totaled $3,329,000 at March 28, 2020 and $5,230,000 at December 28, 2019, are included in accounts receivable in the accompanying condensed consolidated balance sheet until the subsidiary sells the drafts to a bank and receives a discounted amount, transfers the banker's acceptance drafts in settlement of current accounts payable prior to maturity, or obtains cash payment on the scheduled maturity date.
Recently Adopted Accounting Pronouncements
Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, which changes the way entities recognize impairment of financial assets measured at amortized costs, such as accounts receivable, by requiring immediate recognition of estimated credit losses expected to occur over their remaining lives. During 2018 and 2019, the FASB issued additional guidance and clarification. The Company adopted this ASU using a modified retrospective method at the beginning of fiscal 2020. The adoption of this ASU did not have a material impact on the Company’s condensed consolidated financial statements. See Accounts Receivable and Allowance for Credit Losses in this section for further information on the Company's allowance for credit losses.
13
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements Not Yet Adopted
Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting. In March 2020, the FASB issued ASU No. 2020-04, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by the discontinuation of reference rates, such as the London Interbank Offered Rate (LIBOR), if certain criteria are met. Generally, contract modifications related to reference rate reform may be considered an event that does not require remeasurement or reassessment of a previous accounting determination at the modification date. The guidance in this ASU is applicable to the Company's existing contracts and hedging relationships that reference LIBOR, and may be adopted by the Company prospectively beginning March 12, 2020 through December 31, 2022. The Company is currently evaluating the effects that the adoption of this ASU will have on its consolidated financial statements.
Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes. In December 2019, the FASB issued ASU No. 2019-12, which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and by clarifying and amending existing guidance, including the recognition of franchise tax, the treatment of a step up in the tax basis of goodwill, and the timing for recognition of enacted changes in tax laws or rates in the interim period annual effective tax rate computation. This new guidance is effective for the Company in fiscal 2021, with early adoption permitted. The Company is currently evaluating the effects that the adoption of this ASU will have on its consolidated financial statements.
2. Earnings per Share
Basic and diluted earnings per share (EPS) are calculated as follows:
Three Months Ended | ||||||||
March 28, 2020 | March 30, 2019 | |||||||
(In thousands, except per share amounts) | ||||||||
Net Income Attributable to Kadant | $ | 12,531 | $ | 10,900 | ||||
Basic Weighted Average Shares | 11,432 | 11,133 | ||||||
Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan Shares | 76 | 252 | ||||||
Diluted Weighted Average Shares | 11,508 | 11,385 | ||||||
Basic Earnings per Share | $ | 1.10 | $ | 0.98 | ||||
Diluted Earnings per Share | $ | 1.09 | $ | 0.96 | ||||
The effect of outstanding and unvested restricted stock units (RSUs) of the Company's common stock totaling 43,000 shares in the first three months of 2020 and 44,000 shares in the first three months of 2019 was not included in the computation of diluted EPS for the respective periods as the effect would have been antidilutive or, for unvested performance-based RSUs, the performance conditions had not been met as of the end of the reporting periods.
14
3. Provision for Income Taxes
The provision for income taxes was $4,559,000 in the first three months of 2020 and $3,963,000 in the first three months of 2019. The effective tax rate of 26% in the first three months of 2020 was higher than the Company's statutory rate of 21% primarily due to nondeductible expenses, state taxes, the distribution of the Company’s worldwide earnings, and tax expense associated with Global Intangible Low-Taxed Income (GILTI) provisions. This incremental tax expense was offset in part by the reversal of tax reserves associated with uncertain tax positions. The effective tax rate of 26% in the first three months of 2019 was higher than the Company's statutory tax rate of 21% primarily due to nondeductible expenses, the distribution of the Company’s worldwide earnings, state taxes, and tax expense associated with GILTI. This incremental tax expense was offset in part by a decrease in tax related to the net excess income tax benefits from stock-based compensation arrangements.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law and provides a substantial stimulus and assistance package intended to address the impact of the COVID-19 pandemic, including tax relief. The enactment of the CARES Act did not have a material impact on the Company’s provision for income taxes in the first three months of 2020. The Company continues to monitor any effects that may result from the new law.
4. Long-Term Obligations
Long-term obligations are as follows:
March 28, 2020 | December 28, 2019 | |||||||
(In thousands) | ||||||||
Revolving Credit Facility, due 2023 | $ | 260,485 | $ | 265,419 | ||||
Commercial Real Estate Loan, due 2020 to 2028 | 19,163 | 19,425 | ||||||
Senior Promissory Notes, due 2023 to 2028 | 10,000 | 10,000 | ||||||
Finance Leases, due 2020 to 2025 | 2,079 | 2,308 | ||||||
Other Borrowings, due 2020 to 2023 | 3,773 | 4,000 | ||||||
Unamortized Debt Issuance Costs | (124 | ) | (127 | ) | ||||
Total | 295,376 | 301,025 | ||||||
Less: Current Maturities of Long-Term Obligations | (2,687 | ) | (2,851 | ) | ||||
Long-Term Obligations | $ | 292,689 | $ | 298,174 | ||||
See Note 8, Derivatives, for the fair value information related to the Company's long-term obligations.
Revolving Credit Facility
In 2018, the Company entered into a second amendment (Second Amendment) to its existing amended and restated five-year, unsecured multi-currency revolving credit facility, dated as of March 1, 2017 (as amended, the Credit Agreement). Pursuant to the Second Amendment, the Company has a borrowing capacity of $400,000,000, with an uncommitted unsecured incremental borrowing facility of $150,000,000 under its Credit Agreement, with a maturity date of December 14, 2023. Interest on borrowings outstanding accrues and is payable in arrears calculated at one of the following rates selected by the Company: (i) the Base Rate, plus an applicable margin of 0% to 1.25%, or (ii) LIBOR (with a zero percent floor), as defined, plus an applicable margin of 1% to 2.25%. The Base Rate is calculated as the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate as published by Citizens Bank, N.A. (Citizens) and (c) thirty-day U.S. dollar LIBOR (USD LIBOR), as defined, plus 0.50%. The applicable margin is determined based upon the ratio of the Company's total debt, net of unrestricted cash up to $30,000,000 and certain debt obligations, to earnings before interest, taxes, depreciation, and amortization as defined in the Credit Agreement.
The obligations of the Company under the Credit Agreement may be accelerated upon the occurrence of an event of default, which includes customary events of default under such financing arrangements. In addition, the Credit Agreement contains negative covenants applicable to the Company and its subsidiaries, including financial covenants requiring the Company to maintain a maximum consolidated leverage ratio of 3.75 to 1.00, or for the quarter during which a material acquisition occurs and for the three fiscal quarters thereafter, 4.00 to 1.00, and limitations on making certain restricted payments (including dividends and stock repurchases).
Loans under the Credit Agreement are guaranteed by certain domestic subsidiaries of the Company. In addition, one of the Company’s foreign subsidiaries entered into a separate guarantee agreement limited to certain obligations of two foreign subsidiary borrowers.
15
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Long-Term Obligations (continued)
As of March 28, 2020, the outstanding balance under the Credit Agreement was $260,485,000, and included $59,713,000 of euro-denominated borrowings and $30,771,000 of Canadian dollar-denominated borrowings. As of March 28, 2020, the Company had $141,467,000 of borrowing capacity available under its Credit Agreement, which was calculated by translating its foreign-denominated borrowings using borrowing date foreign exchange rates.
See Note 8, Derivatives, under the heading Interest Rate Swap Agreements, for information relating to the swap agreements used to hedge the Company’s exposure to movements in the three-month USD LIBOR on its U.S. dollar-denominated debt borrowed under the Credit Agreement.
The weighted average interest rate for the outstanding balance under the Credit Agreement was 2.44% as of March 28, 2020.
Commercial Real Estate Loan
In 2018, the Company and certain domestic subsidiaries borrowed $21,000,000 under a ten-year promissory note (Real Estate Loan), which is repayable in quarterly principal installments of $262,500 with the remaining principal balance of $10,500,000 due July 6, 2028. Interest accrues and is payable quarterly in arrears at a fixed rate of 4.45% per annum. Any future voluntary prepayments are subject to a 2% prepayment fee if paid on or prior to July 6, 2020 and are subject to a 1% prepayment fee if paid in the twelve months following July 6, 2020. Thereafter, no prepayment fee will be applied to voluntary prepayment by the Company.
The Real Estate Loan is secured by real estate and related personal property of the Company and certain of its domestic subsidiaries, pursuant to mortgage and security agreements (Mortgage and Security Agreements). The obligations of the Company under the Real Estate Loan may be accelerated upon the occurrence of an event of default under the Real Estate Loan and the Mortgage and Security Agreements, which includes customary events of default for financings of this type. In addition, a default under the Credit Agreement or any successor credit facility would be an event of default under the Real Estate Loan. The effective interest rate for the Real Estate Loan, including amortization of debt issuance costs, was 4.60% as of March 28, 2020.
Senior Promissory Notes
In 2018, the Company entered into an uncommitted, unsecured Multi-Currency Note Purchase and Private Shelf Agreement (Note Purchase Agreement). Simultaneous with the execution of the Note Purchase Agreement, the Company issued senior promissory notes (Initial Notes) in an aggregate principal amount of $10,000,000, with a per annum interest rate of 4.90% payable semiannually, and a maturity date of December 14, 2028. The Company is required to prepay a portion of the principal of the Initial Notes beginning on December 14, 2023 and each year thereafter, and may optionally prepay the principal on the Initial Notes, together with any prepayment premium, at any time (in a minimum amount of $1,000,000, or the foreign currency equivalent thereof, if applicable) in accordance with the Note Purchase Agreement. The obligations of the Initial Notes may be accelerated upon an event of default as defined in the Note Purchase Agreement, which includes customary events of default under such financing arrangements.
In accordance with the Note Purchase Agreement, the Company may also issue additional senior promissory notes (together with the Initial Notes, the Senior Promissory Notes) up to an additional $115,000,000 until the earlier of December 14, 2021 or the thirtieth day after written notice to terminate the issuance and sale of additional notes pursuant to the Note Purchase Agreement. The Senior Promissory Notes are pari passu with the Company’s indebtedness under the Credit Agreement, and any other senior debt of the Company, subject to certain specified exceptions, and participate in a sharing agreement with respect to the obligations of the Company and its subsidiaries under the Credit Agreement. The Senior Promissory Notes are guaranteed by certain of the Company’s domestic subsidiaries.
Debt Compliance
As of March 28, 2020, the Company was in compliance with the covenants related to its debt obligations.
Finance Leases
The Company's finance leases primarily relate to contracts for its vehicles.
16
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
4. Long-Term Obligations (continued)
Other Borrowings
Other borrowings include a sale-leaseback financing arrangement for a manufacturing facility in Germany. Under this arrangement, the quarterly lease payment includes principal, interest, and a payment to the landlord toward a loan receivable. The interest rate on the outstanding obligation is 1.79%. The secured loan receivable, which is included in other assets in the accompanying condensed consolidated balance sheet, was $952,000 at March 28, 2020. The lease arrangement provides for a fixed price purchase option, net of the projected loan receivable, of $1,471,000 at the end of the lease term in 2022. If the Company does not exercise the purchase option for the facility, the Company will receive cash from the landlord to settle the loan receivable. As of March 28, 2020, $3,638,000 was outstanding under this obligation.
5. Stock-Based Compensation
The Company recognized stock-based compensation expense of $1,639,000 in the first three months of 2020 and $1,553,000 in the first three months of 2019 within selling, general, and administrative (SG&A) expenses in the accompanying condensed consolidated statement of income. The Company recognizes compensation expense for all stock-based awards granted to employees and directors based on the grant date estimate of fair value for those awards. The fair value of RSUs is based on the grant date price of the Company's common stock, reduced by the present value of estimated dividends foregone during the requisite service period. For time-based RSUs, compensation expense is recognized ratably over the requisite service period for the entire award based on the grant date fair value, and net of actual forfeitures recorded when they occur. For performance-based RSUs, compensation expense is recognized ratably over the requisite service period for each separately vesting portion of the award based on the grant date fair value, net of actual forfeitures recorded when they occur, and remeasured each reporting period until the total number of RSUs to be issued is known. Unrecognized compensation expense related to stock-based compensation totaled approximately $9,588,000 at March 28, 2020, and will be recognized over a weighted average period of 2.1 years.
Performance-based RSUs
On March 2, 2020, the Company granted to certain of its officers performance-based RSUs, which represented, in aggregate, the right to receive 35,808 shares (the target RSU amount), with an aggregate grant date fair value of $3,184,000. The RSUs are subject to adjustment based on the achievement of the performance measure selected for the 2020 fiscal year, which is a specified target for adjusted earnings before interest, taxes, depreciation, and amortization (adjusted EBITDA) generated from operations for the 2020 fiscal year. The RSUs are adjusted by comparing the actual adjusted EBITDA for the performance period to the target adjusted EBITDA. Actual adjusted EBITDA between 50% and 100% of the target adjusted EBITDA results in an adjustment of 50% to 100% of the RSU amount. Actual adjusted EBITDA between 100% and 115% of the target adjusted EBITDA results in an adjustment using a straight-line linear scale between 100% and 150% of the RSU amount. Actual adjusted EBITDA in excess of 115% results in an adjustment capped at 150% of the RSU amount. If actual adjusted EBITDA is below 50% of the target adjusted EBITDA for the 2020 fiscal year, these performance-based RSUs will be forfeited. The Company recognizes compensation expense based on the probable number of performance-based RSUs expected to vest. Following the adjustment, the performance-based RSUs will be subject to additional time-based vesting, and will vest in three equal annual installments on March 10 of 2021, 2022, and 2023, provided that the officer is employed by the Company on the applicable vesting dates.
Time-based RSUs
On March 2, 2020, the Company also granted time-based RSUs representing 33,600 shares to its officers and employees with an aggregate grant date fair value of $2,988,000. These time-based RSUs generally vest in three equal annual installments on March 10 of 2021, 2022, and 2023, provided that a recipient remains employed by the Company on the applicable vesting dates.
17
6. Retirement Benefit Plans
The Company includes the service cost component of net periodic benefit cost in operating income and all other components are included in other expense, net in the accompanying condensed consolidated statement of income.
In 2018, the Company's board of directors and its compensation committee approved amendments to freeze and terminate the Company's U.S. pension plan (Retirement Plan) and its restoration plan (Restoration Plan). In the fourth quarter of 2019, the Company settled its Retirement Plan obligation. In the first quarter of 2020, the Company settled its Restoration Plan obligation of $2,427,000 by paying a lump sum to its plan participants.
The components of net periodic benefit cost are as follows:
Three Months Ended March 28, 2020 | Three Months Ended March 30, 2019 | |||||||||||||||||||
(In thousands, except percentages) | Non-U.S. Pension | Other Post-Retirement | U.S. Pension | Non-U.S. Pension | Other Post-Retirement | |||||||||||||||
Service Cost | $ | 44 | $ | 2 | $ | — | $ | 43 | $ | 1 | ||||||||||
Interest Cost | 23 | 9 | 283 | 29 | 38 | |||||||||||||||
Expected Return on Plan Assets | (16 | ) | (1 | ) | (249 | ) | (17 | ) | (1 | ) | ||||||||||
Recognized Net Actuarial Loss | 11 | 4 | 8 | 5 | 3 | |||||||||||||||
Amortization of Prior Service Cost | 2 | — | — | — | — | |||||||||||||||
$ | 64 | $ | 14 | $ | 42 | $ | 60 | $ | 41 | |||||||||||
The weighted average assumptions used to determine net periodic benefit cost are as follows: | ||||||||||||||||||||
Discount Rate | 2.25 | % | 3.92 | % | 4.10 | % | 2.80 | % | 4.44 | % | ||||||||||
Expected Long-Term Return on Plan Assets | 7.21 | % | 7.21 | % | 4.10 | % | 9.22 | % | 9.22 | % | ||||||||||
Rate of Compensation Increase | 3.23 | % | 5.57 | % | — | % | 2.98 | % | 5.57 | % | ||||||||||
The Company does not plan to make any other material cash contributions to its other pension and post-retirement plans in 2020.
7. Accumulated Other Comprehensive Items
Comprehensive (loss) 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.
Changes in each component of accumulated other comprehensive items (AOCI), net of tax, are as follows:
(In thousands) | Foreign Currency Translation Adjustment | Pension and Other Post-Retirement Benefit Liability Adjustments | Deferred Loss on Cash Flow Hedges | Total | ||||||||||||
Balance at December 28, 2019 | $ | (36,145 | ) | $ | (831 | ) | $ | (644 | ) | $ | (37,620 | ) | ||||
Other comprehensive (loss) income before reclassifications | (12,563 | ) | 38 | (345 | ) | (12,870 | ) | |||||||||
Reclassifications from AOCI | — | (107 | ) | 43 | (64 | ) | ||||||||||
Net current period other comprehensive items | (12,563 | ) | (69 | ) | (302 | ) | (12,934 | ) | ||||||||
Balance at March 28, 2020 | $ | (48,708 | ) | $ | (900 | ) | $ | (946 | ) | $ | (50,554 | ) | ||||
18
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
7. Accumulated Other Comprehensive Items (continued)
Amounts reclassified from AOCI are as follows:
Three Months Ended | ||||||||||
(In thousands) | March 28, 2020 | March 30, 2019 | Statement of Income Line Item | |||||||
Retirement Benefit Plans (a) | ||||||||||
Recognized net actuarial loss | $ | (15 | ) | $ | (16 | ) | Other expense, net | |||
Amortization of prior service cost | (2 | ) | — | Other expense, net | ||||||
Total expense before income taxes | (17 | ) | (16 | ) | ||||||
Income tax benefit | 124 | 4 | Provision for income taxes | |||||||
107 | (12 | ) | ||||||||
Cash Flow Hedges (b) | ||||||||||
Interest rate swap agreements | (34 | ) | 20 | Interest expense | ||||||
Forward currency-exchange contracts | (23 | ) | — | Cost of revenue | ||||||
Total (expense) income before income taxes | (57 | ) | 20 | |||||||
Income tax benefit (provision) | 14 | (5 | ) | Provision for income taxes | ||||||
(43 | ) | 15 | ||||||||
Total Reclassifications | $ | 64 | $ | 3 | ||||||
(a) | Included in the computation of net periodic benefit cost. See Note 6, Retirement Benefit Plans, for additional information. |
(b) |
8. Derivatives
Interest Rate Swap Agreements
The Company has entered into interest rate swap agreements to hedge its exposure to movements in USD LIBOR on its U.S. dollar-denominated debt. In 2018, the Company entered into an interest rate swap agreement (2018 Swap Agreement) with Citizens which has a $15,000,000 notional value and expires on June 30, 2023. On a quarterly basis, the Company receives three-month USD LIBOR, which is subject to a zero percent floor, and pays a fixed rate of interest of 3.15% plus an applicable margin as defined in the Credit Agreement. In 2015, the Company entered into an interest rate swap agreement (2015 Swap Agreement) with Citizens which had a $10,000,000 notional value and expired on March 27, 2020. Under the 2015 Swap Agreement, the Company received three-month USD LIBOR and paid a fixed rate of interest of 1.5% plus an applicable margin as defined in the Credit Agreement.
The interest rate swap agreements have been designated as cash flow hedges and the Company structured its interest rate swap agreements to be 100% effective. Unrealized gains and losses related to the fair values of the swap agreements were recorded to AOCI, net of tax. In the event of early termination of the 2018 Swap Agreement, the Company will receive from or pay to the counterparty the fair value of the interest rate swap agreement, and the unrealized gain or loss outstanding will be recognized in earnings.
The counterparty to the 2018 Swap Agreement could demand an early termination of that agreement if the Company were to be in default under the Credit Agreement, or any agreement that amends or replaces the Credit Agreement in which the counterparty is a member, and if the Company were to be unable to cure the default (See Note 4, Long-Term Obligations).
Forward Currency-Exchange Contracts
The Company uses forward currency-exchange contracts that have maturities of twelve months or less to hedge exposures resulting from fluctuations in currency exchange rates. Such exposures result from assets and liabilities that are denominated in currencies other than the functional currencies.
Forward currency-exchange contracts that hedge forecasted accounts receivable or accounts payable are designated as cash flow hedges and unrecognized gains and losses are recorded to AOCI, net of tax. Deferred gains and losses are recognized in the statement of income in the period in which the underlying transaction occurs. The fair values of forward currency-
19
KADANT INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
8. Derivatives (continued)
exchange contracts that are designated as fair value hedges and forward currency-exchange contracts that are not designated as hedges are recognized currently in earnings.
The Company recognized within SG&A expenses in the accompanying condensed consolidated statement of income losses of $34,000 in the first three months of 2020 and losses of $37,000 in the first three months of 2019 associated with forward currency-exchange contracts that were not designated as hedges.
The following table summarizes the fair value of the Company's derivative instruments in the accompanying condensed consolidated balance sheet:
March 28, 2020 | December 28, 2019 | |||||||||||||||||
Balance Sheet Location | Asset (Liability) (a) | Notional Amount (b) | Asset (Liability) (a) | Notional Amount | ||||||||||||||
(In thousands) | ||||||||||||||||||
Derivatives Designated as Hedging Instruments: | ||||||||||||||||||
Derivatives in an Asset Position: | ||||||||||||||||||
Forward currency-exchange contract | Other Current Assets | $ | 72 | $ | 1,328 | $ | — | $ | — | |||||||||
2015 Swap Agreement | Other Current Assets | $ | — | $ | — | $ | 11 | $ | 10,000 | |||||||||
Derivatives in a Liability Position: | ||||||||||||||||||
Forward currency-exchange contracts | Other Current Liabilities | $ | (52 | ) | $ | 842 | $ | (75 | ) | $ | 4,825 | |||||||
2018 Swap Agreement | Other Long-Term Liabilities | $ | (1,275 | ) | $ | 15,000 | $ | (770 | ) | $ | 15,000 | |||||||
Derivatives Not Designated as Hedging Instruments: | ||||||||||||||||||
Derivatives in an Asset Position: | ||||||||||||||||||
Forward currency-exchange contracts | Other Current Assets | $ | — | $ | — | $ | 3 | $ | 387 | |||||||||
Derivatives in a Liability Position: | ||||||||||||||||||
Forward currency-exchange contracts | Other Current Liabilities | $ | (8 | ) | $ | 1,032 | $ | (43 | ) | $ | 2,545 | |||||||
(a) See Note 9, Fair Value Measurements and Fair Value of Financial Instruments, for the fair value measurements relating to these financial instruments.
(b) The total 2020 notional amounts are indicative of the level of the Company's recurring derivative activity.
The following table summarizes the activity in AOCI associated with the Company's derivative instruments designated as cash flow hedges as of and for the three months ended March 28, 2020:
(In thousands) | Interest Rate Swap Agreements | Forward Currency- Exchange Contracts | Total | |||||||||
Unrealized Loss, Net of Tax, at December 28, 2019 | $ | (589 | ) | $ | (55 | ) | $ | (644 | ) | |||
Loss reclassified to earnings (a) | 26 | 17 | 43 | |||||||||
(Loss) gain recognized in AOCI | (403 | ) | 58 | (345 | ) | |||||||
Unrealized (Loss) Gain, Net of Tax, at March 28, 2020 | $ | (966 | ) | $ | 20 | $ | (946 | ) | ||||
As of March 28, 2020, the Company expects to reclassify losses of $268,000 from AOCI to earnings over the next twelve months based on the estimated cash flows of the 2018 Swap Agreement and the maturity dates of the forward currency-exchange contracts.
20
9. Fair Value Measurements and Fair Value of Financial Instruments
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 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 March 28, 2020 | ||||||||||||||||
(In thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
Assets: | ||||||||||||||||
Money market funds and time deposits | $ | 6,689 | $ | — | $ | — | $ | 6,689 | ||||||||
Banker's acceptance drafts (a) | $ | — | $ | 3,329 | $ | — | $ | 3,329 | ||||||||
Forward currency-exchange contract | $ | — | $ | 72 | $ | — | $ | 72 | ||||||||
Liabilities: | ||||||||||||||||
2018 Swap Agreement | $ | — | $ | 1,275 | $ | — | $ | 1,275 | ||||||||
Forward currency-exchange contracts | $ | — | $ | 60 | $ | — | $ | 60 | ||||||||
Fair Value as of December 28, 2019 | ||||||||||||||||
(In thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
Assets: | ||||||||||||||||
Money market funds and time deposits | $ | 9,920 | $ | — | $ | — | $ | 9,920 | ||||||||
Banker's acceptance drafts (a) | $ | — | $ | 5,230 | $ | — | $ | 5,230 | ||||||||
2015 Swap Agreement | $ | — | $ | 11 | $ | — | $ | 11 | ||||||||
Forward currency-exchange contracts | $ | — | $ | 3 | $ | — | $ | 3 | ||||||||
Liabilities: | ||||||||||||||||
2018 Swap Agreement | $ | — | $ | 770 | $ | — | $ | 770 | ||||||||
Forward currency-exchange contracts | $ | — | $ | 118 | $ | — | ||||||||||