KADANT INC 10-Q

Item 1 – Financial Statements KADANT INC. Condensed Consolidated Balance Sheet (Unaudited) April 1, 2023 December 31, 2022 (In thousands, except share and per share amounts) Assets Current Assets: Cash and cash equivalents $ 81,183 $ 76,371 Restricted cash 4,324 3,354 Accounts receivable, net of allowances of $ 3,587 and $ 3,595 131,268 130,297 Inventories 179,199 163,672 Contract assets 12,389 14,898 Other current assets 41,743 26,818 Total Current Assets 450,106 415,410 Property, Plant, and Equipment, net of accumulated depreciation of $ 125,754 and $ 121,442 120,274 118,855 Other Assets 39,478 54,516 Intangible Assets, Net 171,396 175,645 Goodwill 387,890 385,455 Total Assets $ 1,169,144 $ 1,149,881 Liabilities and Stockholders' Equity Current Liabilities: Short-term obligations and current maturities of long-term obligations (Note 5) $ 3,352 $ 3,821 Accounts payable 57,939 58,060 Accrued payroll and employee benefits 30,336 35,672 Customer deposits 80,190 64,361 Advanced billings 10,219 7,966 Other current liabilities 43,811 43,581 Total Current Liabilities 225,847 213,461 Long-Term Obligations (Note 5) 178,555 197,340 Long-Term Deferred Income Taxes 39,672 38,745 Other Long-Term Liabilities 40,765 44,764 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 117,547 119,924 Retained earnings 685,325 660,644 Treasury stock at cost, 2,920,678 and 2,949,997 shares ( 71,569 ) ( 72,287 ) Accumulated other comprehensive items (Note 7) ( 49,085 ) ( 54,578 ) Total Kadant Stockholders' Equity 682,364 653,849 Noncontrolling interest 1,941 1,722 Total Stockholders' Equity 684,305 655,571 Total Liabilities and Stockholders' Equity $ 1,169,144 $ 1,149,881 The accompanying notes are an integral part of these condensed consolidated financial statements. 3 Table of Contents KADANT INC. Condensed Consolidated Statement of Income (Unaudited) Three Months Ended April 1, 2023 April 2, 2022 (In thousands, except per share amounts) Revenue (Notes 1 and 10) $ 229,758 $ 226,480 Costs and Operating Expenses: Cost of revenue 127,712 128,269 Selling, general, and administrative expenses 58,562 59,168 Research and development expenses 3,370 3,078 Gain on sale and other costs, net (Note 2) — ( 20,008 ) 189,644 170,507 Operating Income 40,114 55,973 Interest Income 299 102 Interest Expense ( 2,370 ) ( 1,234 ) Other Expense, Net ( 21 ) ( 22 ) Income Before Provision for Income Taxes 38,022 54,819 Provision for Income Taxes (Note 4) 9,763 13,378 Net Income 28,259 41,441 Net Income Attributable to Noncontrolling Interest ( 184 ) ( 249 ) Net Income Attributable to Kadant $ 28,075 $ 41,192 Earnings per Share Attributable to Kadant (Note 3) Basic $ 2.40 $ 3.54 Diluted $ 2.40 $ 3.53 Weighted Average Shares (Note 3) Basic 11,681 11,630 Diluted 11,694 11,655 The accompanying notes are an integral part of these condensed consolidated financial statements. 4 Table of Contents KADANT INC. Condensed Consolidated Statement of Comprehensive Income (Unaudited) Three Months Ended April 1, 2023 April 2, 2022 (In thousands) Net Income $ 28,259 $ 41,441 Other Comprehensive Items: Foreign currency translation adjustment 5,573 ( 2,284 ) Post-retirement liability adjustments, net (net of tax of $( 2 ) and $ 2 ) ( 6 ) 9 Deferred (loss) gain on cash flow hedges (net of tax of $( 14 ) and $ 68 ) ( 39 ) 277 Other comprehensive items 5,528 ( 1,998 ) Comprehensive Income 33,787 39,443 Comprehensive Income Attributable to Noncontrolling Interest ( 219 ) ( 203 ) Comprehensive Income Attributable to Kadant $ 33,568 $ 39,240 The accompanying notes are an integral part of these condensed consolidated financial statements. 5 Table of Contents KADANT INC. Condensed Consolidated Statement of Cash Flows (Unaudited) Three Months Ended April 1, 2023 April 2, 2022 (In thousands) Operating Activities Net income attributable to Kadant $ 28,075 $ 41,192 Net income attributable to noncontrolling interest 184 249 Net income 28,259 41,441 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 8,446 9,445 Stock-based compensation expense 2,238 2,260 Gain on the sale of assets (Note 2) — ( 20,190 ) Non-cash impairment costs (Note 2) — 182 Other items, net 842 6,325 Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable 517 ( 9,127 ) Contract assets 2,637 ( 409 ) Inventories ( 13,997 ) ( 9,359 ) Other assets 1,293 1,113 Accounts payable 77 8,864 Customer deposits 11,114 3,329 Other liabilities ( 4,560 ) ( 10,106 ) Net cash provided by operating activities 36,866 23,768 Investing Activities Acquisition, net of cash acquired — ( 62 ) Purchases of property, plant, and equipment ( 4,469 ) ( 2,868 ) Proceeds from sale of property, plant, and equipment 32 1,595 Other investing activities ( 30 ) 44 Net cash used in investing activities ( 4,467 ) ( 1,291 ) Financing Activities Proceeds from issuance of short- and long-term obligations — 15,516 Repayment of short- and long-term obligations ( 20,761 ) ( 35,064 ) Tax withholding payments related to stock-based compensation ( 3,897 ) ( 4,550 ) Dividends paid ( 3,036 ) ( 2,905 ) Other financing activities ( 63 ) — Net cash used in financing activities ( 27,757 ) ( 27,003 ) Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash 1,140 ( 664 ) Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash 5,782 ( 5,190 ) Cash, Cash Equivalents, and Restricted Cash at Beginning of Period 79,725 94,161 Cash, Cash Equivalents, and Restricted Cash at End of Period $ 85,507 $ 88,971 See Note 1 , Nature of Operations and Summary of Significant Accounting Policies, under the heading Supplemental Cash Flow Information for further details. The accompanying notes are an integral part of these condensed consolidated financial statements. 6 Table of Contents KADANT INC. Condensed Consolidated Statement of Stockholders' Equity (Unaudited) Three Months Ended April 1, 2023 (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 31, 2022 14,624,159 $ 146 $ 119,924 $ 660,644 2,949,997 $ ( 72,287 ) $ ( 54,578 ) $ 1,722 $ 655,571 Net income — — — 28,075 — — — 184 28,259 Dividends declared – Common Stock, $ 0.29 per share — — — ( 3,394 ) — — — — ( 3,394 ) Activity under stock plans — — ( 2,377 ) — ( 29,319 ) 718 — — ( 1,659 ) Other comprehensive items — — — — — — 5,493 35 5,528 Balance at April 1, 2023 14,624,159 $ 146 $ 117,547 $ 685,325 2,920,678 $ ( 71,569 ) $ ( 49,085 ) $ 1,941 $ 684,305 Three Months Ended April 2, 2022 (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 January 1, 2022 14,624,159 $ 146 $ 115,888 $ 551,848 3,003,419 $ ( 73,596 ) $ ( 30,350 ) $ 1,680 $ 565,616 Net income — — — 41,192 — — — 249 41,441 Dividends declared – Common Stock, $ 0.26 per share — — — ( 3,031 ) — — — — ( 3,031 ) Activity under stock plans — — ( 3,237 ) — ( 38,633 ) 947 — — ( 2,290 ) Other comprehensive items — — — — — — ( 1,952 ) ( 46 ) ( 1,998 ) Balance at April 2, 2022 14,624,159 $ 146 $ 112,651 $ 590,009 2,964,786 $ ( 72,649 ) $ ( 32,302 ) $ 1,883 $ 599,738 The accompanying notes are an integral part of these condensed consolidated financial statements. 7 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 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 technologies and engineered systems that drive Sustainable Industrial Processing. Its products and services play an integral role in enhancing efficiency, optimizing energy utilization, and maximizing productivity in process industries while helping customers advance their sustainability initiatives with products that reduce waste or generate more yield with fewer inputs, particularly fiber, energy, and water. Producing more while consuming less is a core aspect of Sustainable Industrial Processing and a major element of the strategic focus of the Company's three reportable operating segments: Flow Control, Industrial Processing, and Material Handling. 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 April 1, 2023, its results of operations, comprehensive income, cash flows and stockholders' equity for the three-month periods ended April 1, 2023 and April 2, 2022. 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 31, 2022 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 31, 2022 (the Annual Report). The condensed consolidated financial statements and related notes are presented as permitted by the rules and regulations of the Securities and Exchange Commission (SEC) 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 Annual Report. 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. Note 1 to the consolidated financial statements in the Annual Report describes 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 April 1, 2023. Supplemental Cash Flow Information Three Months Ended (In thousands) April 1, 2023 April 2, 2022 Cash Paid for Interest $ 2,161 $ 1,017 Cash Paid for Income Taxes, Net of Refunds $ 9,558 $ 8,013 Non-Cash Investing Activities: Reduction in fair value of assets acquired $ — $ ( 983 ) Cash paid for acquired businesses — ( 62 ) Reduction in liabilities assumed $ — $ ( 1,045 ) Purchases of property, plant, and equipment in accounts payable $ 299 $ 264 8 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) Three Months Ended (In thousands) April 1, 2023 April 2, 2022 Non-Cash Financing Activities: Issuance of Company common stock upon vesting of restricted stock units $ 4,246 $ 4,578 Dividends declared but unpaid $ 3,394 $ 3,031 Restricted Cash The Company's restricted cash generally serves as collateral for bank guarantees associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business and for certain banker's acceptance drafts issued to vendors. 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) April 1, 2023 April 2, 2022 December 31, 2022 January 1, 2022 Cash and cash equivalents $ 81,183 $ 86,192 $ 76,371 $ 91,186 Restricted cash 4,324 2,779 3,354 2,975 Total Cash, Cash Equivalents, and Restricted Cash $ 85,507 $ 88,971 $ 79,725 $ 94,161 Inventories The components of inventories are as follows: April 1, 2023 December 31, 2022 (In thousands) Raw Materials $ 74,726 $ 71,040 Work in Process 49,868 38,612 Finished Goods 54,605 54,020 $ 179,199 $ 163,672 Intangible Assets, Net Gross intangible assets were $ 342,732,000 at April 1, 2023 and $ 343,130,000 at December 31, 2022. Intangible assets are 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. Accumulated amortization was $ 160,694,000 at April 1, 2023 and $ 155,834,000 at December 31, 2022. 9 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 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 31, 2022 Gross balance $ 118,309 $ 209,919 $ 142,765 $ 470,993 Accumulated impairment losses — ( 85,538 ) — ( 85,538 ) Net balance 118,309 124,381 142,765 385,455 2023 Activity Acquisition adjustments — — ( 13 ) ( 13 ) Currency translation 1,181 581 686 2,448 Total 2023 activity 1,181 581 673 2,435 Balance at April 1, 2023 Gross balance 119,490 210,500 143,438 473,428 Accumulated impairment losses — ( 85,538 ) — ( 85,538 ) Net balance $ 119,490 $ 124,962 $ 143,438 $ 387,890 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 provides for the estimated cost of product warranties at the time of sale based on historical occurrence rates and repair costs, as well as knowledge of any specific warranty problems that indicate projected warranty costs may vary from historical patterns. The Company negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications. The Company's liability for warranties is included in other current liabilities in the accompanying condensed consolidated balance sheet. The changes in the carrying amount of product warranty obligations are as follows: Three Months Ended (In thousands) April 1, 2023 April 2, 2022 Balance at Beginning of Year $ 7,283 $ 7,298 Provision charged to expense 1,425 1,462 Usage ( 1,068 ) ( 1,538 ) Currency translation 87 ( 74 ) Balance at End of Period $ 7,727 $ 7,148 Revenue Recognition Most of the Company’s revenue relates to products and services that require minimal customization and is recognized at a point in time for each performance obligation under the contract when the customer obtains control of the goods or service. The remaining portion of the Company’s revenue is recognized over time 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. 10 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) The following table presents revenue by revenue recognition method: Three Months Ended April 1, April 2, (In thousands) 2023 2022 Point in Time $ 204,239 $ 203,311 Over Time 25,519 23,169 $ 229,758 $ 226,480 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 April 1, April 2, (In thousands) 2023 2022 Revenue by Product Type: Parts and consumables $ 151,563 $ 146,244 Capital 78,195 80,236 $ 229,758 $ 226,480 Revenue by Geography (based on customer location): North America 132,453 124,336 Europe 54,157 58,366 Asia 27,770 31,987 Rest of world 15,378 11,791 $ 229,758 $ 226,480 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: April 1, 2023 December 31, 2022 (In thousands) Contract Assets $ 12,389 $ 14,898 Contract Liabilities $ 96,348 $ 82,413 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 short- and long-term customer deposits, advanced billings, and deferred revenue. Deferred revenue is included in other current liabilities and long-term customer deposits are included in other long-term 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 $ 27,016,000 in the first quarter of 2023 and $ 34,477,000 in the first quarter of 2022 that was included in the contract liabilities balance at the beginning of 2023 and 2022, respectively. The majority of the Company's contracts for capital equipment have an original expected duration of one year or less. Certain capital contracts require long lead times and could take up to 24 months to complete. For contracts with an original expected duration of over one year, the aggregate amount of the transaction price allocated to the remaining unsatisfied or partially unsatisfied performance obligations as of April 1, 2023 was $ 51,838,000 . The Company will recognize revenue for these performance obligations as they are satisfied, approximately 74 % of which is expected to occur within the next twelve months and the remaining 26 % after the first quarter of 2024. 11 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 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 non-interest bearing obligations of the issuing bank and generally 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 $ 5,325,000 at April 1, 2023 and $ 5,729,000 at December 31, 2022, 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. 2. Gain on Sale and Other Costs, Net Gain on sale and other costs, net recognized during the first quarter of 2022 was $ 20,008,000 , and was comprised of a gain on the sale of a building of $ 20,190,000 , net of an impairment charge of $ 182,000 . Gain on Sale of Assets The Company entered into several agreements with the local government in China to sell the existing manufacturing building and land use rights of one of its subsidiaries in China for $ 25,159,000 and relocate to a new facility (China Transaction). The agreements became effective in the first quarter of 2022 after a 31 % down payment was received, including 25 % in 2021 and 6 % in the first quarter of 2022, and a land use right in a new location was secured. As a result, the Company recognized a gain on the China Transaction of $ 20,190,000 , or $ 15,143,000 , net of deferred taxes of $ 5,047,000 , in the first quarter of 2022. A receivable of $ 16,082,000 was recognized for the present value of the remaining amount of the sale proceeds, which is due the earlier of when the government sells the property or within two years from the effective date of the agreements. The subsidiary, which is part of the Industrial Processing segment, will continue to occupy its current facility until construction of its new facility is complete, which is expected during the second half of 2023. A summary of the change in the outstanding receivable on the China Transaction is as follows: (In thousands) April 1, 2023 Balance at Inception $ 17,294 Present value discount ( 1,212 ) Receivable recorded, net 16,082 Accretion of interest income 422 Currency translation ( 1,323 ) Balance at December 31, 2022 (included in other assets) 15,181 Accretion of interest income 141 Currency translation 125 Balance at April 1, 2023 (included in other current assets) $ 15,447 Impairment Costs During the first quarter of 2022, the Company recognized an impairment charge of $ 182,000 within its Industrial Processing segment associated with the write-down of certain fixed assets that will not be moved to the new manufacturing facility in China in connection with the China Transaction. 12 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 3. Earnings per Share Basic and diluted earnings per share (EPS) were calculated as follows: Three Months Ended April 1, 2023 April 2, 2022 (In thousands, except per share amounts) Net Income Attributable to Kadant $ 28,075 $ 41,192 Basic Weighted Average Shares 11,681 11,630 Effect of Stock Options, Restricted Stock Units and Employee Stock Purchase Plan Shares 13 25 Diluted Weighted Average Shares 11,694 11,655 Basic Earnings per Share $ 2.40 $ 3.54 Diluted Earnings per Share $ 2.40 $ 3.53 The effect of outstanding and unvested restricted stock units (RSUs) of the Company's common stock totaling 38,000 shares in the first quarter of 2023 and 17,000 shares in the first quarter of 2022 were 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. 4. Provision for Income Taxes The provision for income taxes was $ 9,763,000 in the first quarter of 2023 and $ 13,378,000 in the first quarter of 2022. The effective tax rate of 26 % in the first quarter of 2023 was higher than the Company's statutory rate of 21% primarily due to the distribution of the Company's worldwide earnings, nondeductible expenses, and state taxes. These increases in tax expense in the first quarter of 2023 were offset in part by a decrease in tax expense related to the net excess income tax benefits from stock-based compensation arrangements. The effective tax rate of 24 % in the first quarter of 2022 was higher than the Company's statutory rate of 21% primarily due to the distribution of the Company's worldwide earnings, nondeductible expenses, state taxes, and tax expense associated with the Global Intangible Low-Taxed Income provisions. These increases in tax expense in the first quarter of 2022 were offset in part by a decrease in tax expense related to the net excess income tax benefits from stock-based compensation arrangements and the reversal of tax reserves associated with uncertain tax positions. 5. Short- and Long-Term Obligations Short- and long-term obligations are as follows: April 1, 2023 December 31, 2022 (In thousands) Revolving Credit Facility, due 2027 $ 167,514 $ 186,131 Senior Promissory Notes, due 2023 to 2028 10,000 10,000 Finance Leases, due 2023 to 2026 1,759 1,940 Other Borrowings, due 2023 to 2028 2,634 3,090 Total 181,907 201,161 Less: Short-term Obligations and Current Maturities of Long-Term Obligations ( 3,352 ) ( 3,821 ) Long-Term Obligations $ 178,555 $ 197,340 See Note 9 , Fair Value Measurements and Fair Value of Financial Instruments, for the fair value information related to the Company's long-term obligations. Revolving Credit Facility On November 30, 2022, the Company entered into a sixth amendment to its unsecured multi-currency revolving credit facility, originally entered into on March 1, 2017 (as amended and restated to date, the Credit Agreement). Among other things, this amendment extended the maturity date to November 30, 2027, and increased the uncommitted, unsecured incremental 13 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) borrowing facility from $ 150,000,000 to $ 200,000,000 . Pursuant to the Credit Agreement, the Company has a borrowing capacity of $ 400,000,000 and 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, as defined, plus an applicable margin of 0 % to 1.25 %, or (ii) Eurocurrency Rate, Term SOFR (plus a 10 basis point credit spread adjustment), CDOR Rate, and RFR, as applicable and defined, plus an applicable margin of 1.0 % to 2.25 %. The margin is determined based upon the ratio of the Company's total debt, net of unrestricted cash up to $ 50,000,000 , to earnings before interest, taxes, depreciation, and amortization as defined in the Credit Agreement. Additionally, the Credit Agreement requires the payment of a commitment fee payable in arrears on the available borrowing capacity under the Credit Agreement, which ranges from 0.125 % to 0.350 %. Obligations 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, if the Company elects, for the quarter during which a material acquisition occurs and for the three fiscal quarters thereafter, 4.25 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. As of April 1, 2023, the outstanding balance under the Credit Agreement was $ 167,514,000 , which included $ 74,514,000 of euro-denominated borrowings. The Company had $ 232,760,000 of borrowing capacity available as of April 1, 2023, which was calculated by translating its foreign-denominated borrowings using the administrative agent's borrowing date foreign exchange rates, in addition to the $ 200,000,000 uncommitted, unsecured incremental borrowing facility. The weighted average interest rate for the outstanding balance under the Credit Agreement was 4.81 % as of April 1, 2023 and 4.33 % as of year-end 2022. See Note 8 , Derivatives, under the heading Interest Rate Swap Agreement, for information relating to the swap agreement. 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 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. The Initial 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 April 1, 2023, the Company was in compliance with the covenants related to its debt obligations. 6. Stock-Based Compensation The Company recognized stock-based compensation expense of $ 2,238,000 in the first quarter of 2023 and $ 2,260,000 in the first quarter of 2022 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 12,796,000 at April 1, 2023, which will be recognized over a weighted average period of 2.0 years. 14 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) Performance-based RSUs On March 7, 2023, the Company granted performance-based RSUs to certain of its officers, which represented, in aggregate, the right to receive 21,009 shares (target RSU amount), with an aggregate grant date fair value of $ 4,528,000 . The RSUs are subject to adjustment based on the achievement of the performance measure selected for the fiscal year, which is a specified target for adjusted earnings before interest, taxes, depreciation, and amortization (target adjusted EBITDA) generated from operations for the 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 target 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 target RSU amount. Actual adjusted EBITDA in excess of 115 % results in an adjustment capped at 150 % of the target RSU amount. If actual adjusted EBITDA is below 50 % of the target adjusted EBITDA for the 2023 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 2024, 2025, and 2026, provided that the officer is employed by the Company on the applicable vesting dates. Time-based RSUs On March 7, 2023, the Company granted time-based RSUs representing 16,528 shares to certain of its officers and employees with an aggregate grant date fair value of $ 3,562,000 . These time-based RSUs vest in three equal annual installments on March 10 of 2024, 2025, and 2026, provided that a recipient is employed by the Company on the applicable vesting dates. 7. 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. 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 Gain on Cash Flow Hedges Total Balance at December 31, 2022 $ ( 54,488 ) $ ( 148 ) $ 58 $ ( 54,578 ) Other comprehensive items before reclassifications 5,538 ( 8 ) 7 5,537 Reclassifications from AOCI — 2 ( 46 ) ( 44 ) Net current period other comprehensive items 5,538 ( 6 ) ( 39 ) 5,493 Balance at April 1, 2023 $ ( 48,950 ) $ ( 154 ) $ 19 $ ( 49,085 ) 15 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) Amounts reclassified from AOCI are as follows: Three Months Ended (In thousands) April 1, 2023 April 2, 2022 Statement of Income Line Item Retirement Benefit Plans Recognized net actuarial loss $ ( 1 ) $ ( 7 ) Other expense, net Amortization of prior service cost ( 2 ) ( 3 ) Other expense, net Total expense before income taxes ( 3 ) ( 10 ) Income tax benefit 1 3 Provision for income taxes ( 2 ) ( 7 ) Cash Flow Hedges (a) Interest rate swap agreements 60 ( 111 ) Interest expense Income tax (provision) benefit ( 14 ) 27 Provision for income taxes 46 ( 84 ) Total Reclassifications $ 44 $ ( 91 ) (a) See Note 8 , Derivatives, for additional information. 8. Derivatives Interest Rate Swap Agreement In 2018, the Company entered into an interest rate swap agreement (2018 Swap Agreement) with Citizens Bank to hedge its exposure to movements in USD LIBOR on its U.S. dollar-denominated debt. The 2018 Swap Agreement 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. The Company designated its 2018 Swap Agreement as a cash flow hedge and structured it to be 100 % effective. Unrealized gains and losses related to the fair value of the 2018 Swap Agreement are recorded to AOCI, net of tax. In the event of early termination, the Company will receive from or pay to the counterparty the fair value of the 2018 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 it were to be unable to cure the default. See Note 5 , Short- and Long-Term Obligations, for further details. Forward Currency-Exchange Contracts The Company uses forward currency-exchange contracts that generally 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 of the Company's subsidiaries. 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-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. Gains and losses reported within SG&A expenses in the accompanying condensed consolidated statement of income associated with the Company's forward currency-exchange contracts that were not designated as hedges were not material for the three-month periods ended April 1, 2023 and April 2, 2022. 16 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) The following table summarizes the fair value of derivative instruments in the accompanying condensed consolidated balance sheet: April 1, 2023 December 31, 2022 Balance Sheet Location Asset (Liability) (a) Notional Amount (b) Asset (Liability) (a) Notional Amount (In thousands) Derivatives Designated as Hedging Instruments: Derivative in an Asset Position: 2018 Swap Agreement Other Current Assets $ 75 $ 15,000 $ 131 $ 15,000 Derivatives in a Liability Position: Forward currency-exchange contracts Other Current Liabilities $ ( 51 ) $ 430 $ ( 54 ) $ 430 Derivatives Not Designated as Hedging Instruments: Derivatives in an Asset Position: Forward currency-exchange contracts Other Current Assets $ 2 $ 189 $ 15 $ 647 (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 2023 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 April 1, 2023: (In thousands) Interest Rate Swap Agreement Forward Currency- Exchange Contract Total Unrealized Gain (Loss), Net of Tax, at December 31, 2022 $ 99 $ ( 41 ) $ 58 Gain reclassified to earnings (a) ( 46 ) — ( 46 ) Gain recognized in AOCI 4 3 7 Unrealized Gain (Loss), Net of Tax, at April 1, 2023 $ 57 $ ( 38 ) $ 19 (a) See Note 7 , Accumulated Other Comprehensive Items, for the income statement classification. As of April 1, 2023, the Company expects to reclassify gains of $ 19,000 from AOCI to earnings over the next twelve months based on the estimated cash flows of the 2018 Swap Agreement and the maturity date of the forward currency-exchange contract. 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. 17 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 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 April 1, 2023 (In thousands) Level 1 Level 2 Level 3 Total Assets: Money market funds and time deposits $ 5,162 $ — $ — $ 5,162 Banker's acceptance drafts (a) $ — $ 5,325 $ — $ 5,325 2018 Swap Agreement $ — $ 75 $ — $ 75 Forward currency-exchange contracts $ — $ 2 $ — $ 2 Liabilities: Forward currency-exchange contracts $ — $ 51 $ — $ 51 Fair Value as of December 31, 2022 (In thousands) Level 1 Level 2 Level 3 Total Assets: Money market funds and time deposits $ 8,351 $ — $ — $ 8,351 Banker's acceptance drafts (a) $ — $ 5,729 $ — $ 5,729 2018 Swap Agreement $ — $ 131 $ — $ 131 Forward currency-exchange contracts $ — $ 15 $ — $ 15 Liabilities: Forward currency-exchange contract $ — $ 54 $ — $ 54 (a) Included in accounts receivable in the accompanying condensed consolidated balance sheet. The Company uses the market approach technique to value its financial assets and liabilities, and there were no changes in valuation techniques during the first three months of 2023. Banker's acceptance drafts are carried at face value, which approximates their fair value due to the short-term nature of the negotiable instrument. The fair values of the forward currency-exchange contracts are based on quoted forward foreign exchange rates at the reporting date. The fair value of the 2018 Swap Agreement is based on USD LIBOR yield curves at the reporting date. The forward currency-exchange contracts and the 2018 Swap Agreement are hedges of either recorded assets or liabilities or anticipated transactions and represent the estimated amount the Company would receive or pay upon liquidation of the contracts. Changes in values of the underlying hedged assets and liabilities or anticipated transactions are not reflected in the table above. The carrying value and fair value of debt obligations, excluding lease obligations, are as follows: April 1, 2023 December 31, 2022 Carrying Value Fair Value Carrying Value Fair Value (In thousands) Debt Obligations: Revolving credit facility $ 167,514 $ 167,514 $ 186,131 $ 186,131 Senior promissory notes 10,000 10,019 10,000 9,773 Other 2,634 2,634 3,090 3,090 $ 180,148 $ 180,167 $ 199,221 $ 198,994 The carrying value of the Company's revolving credit facility approximates the fair value as the obligation bears variable rates of interest, which adjust frequently, based on prevailing market rates. The fair value of the senior promissory notes is primarily calculated based on quoted market rates plus an applicable margin available to the Company at the respective period end, which represent Level 2 measurements. 10. Business Segment Information The Company has three reportable operating segments: Flow Control, Industrial Processing, and Material Handling. The Flow Control segment consists of the fluid-handling and doctoring, cleaning, & filtration product lines; the Industrial Processing segment consists of the wood processing and stock-preparation product lines; and the Material Handling segment consists of the conveying and vibratory, baling, and fiber-based product lines. 18 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) A description of each segment follows: • Flow Control – Custom-engineered products, systems, and technologies that control the flow of fluids used in industrial and commercial applications to keep critical processes running efficiently in the packaging, tissue, food, metals, and other industrial sectors. The Company's primary products include rotary sealing devices, steam systems, expansion joints, doctor systems, roll and fabric cleaning devices, and filtration and fiber recovery systems. • Industrial Processing – Equipment, machinery, and technologies used to recycle paper and paperboard and process timber for use in the packaging, tissue, wood products and alternative fuel industries, among others. The Company's primary products include stock-preparation systems and recycling equipment, chemical pulping equipment, debarkers, stranders, chippers, and logging machinery. In addition, the Company provides industrial automation and digitization solutions to process industries. • Material Handling – Products and engineered systems used to handle bulk and discrete materials for secondary processing or transport in the aggregates, mining, food, and waste management industries, among others. The Company's primary products include conveying and vibratory equipment and balers. In addition, the Company manufactures and sells biodegradable, absorbent granules used as carriers in agricultural applications and for oil and grease absorption. The following table presents financial information for the Company's reportable operating segments: Three Months Ended April 1, April 2, (In thousands) 2023 2022 Revenue Flow Control $ 89,521 $ 85,826 Industrial Processing 83,542 93,085 Material Handling 56,695 47,569 $ 229,758 $ 226,480 Income Before Provision for Income Taxes Flow Control $ 24,189 $ 21,725 Industrial Processing (a) 15,967 38,159 Material Handling (b) 9,287 5,844 Corporate (c) ( 9,329 ) ( 9,755 ) Total operating income 40,114 55,973 Interest expense, net (d) ( 2,071 ) ( 1,132 ) Other expense, net (d) ( 21 ) ( 22 ) $ 38,022 $ 54,819 Capital Expenditures Flow Control $ 1,404 $ 525 Industrial Processing 2,579 1,952 Material Handling 462 384 Corporate 24 7 $ 4,469 $ 2,868 (a) Includes a gain on the sale of a facility of $ 20,190,000 (see Note 2 , Gain on Sale and Other Costs, Net) and non-cash charges for the write-off of an indemnification asset of $ 575,000 and the write-down of machinery and equipment of $ 182,000 in the three months ended April 2, 2022. (b) Includes acquisition-related expenses of $ 717,000 in the three months ended April 2, 2022. (c) Represents general and administrative expenses. (d) The Company does not allocate interest and other expense, net to its segments. 19 Table of Contents KADANT INC. Notes to Condensed Consolidated Financial Statements (Unaudited) 11. Commitments and Contingencies Right of Recourse In the ordinary course of business, the Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for their trade accounts receivable. The drafts are non-interest bearing obligations of the issuing bank and generally mature within six months of the origination date. The Company's Chinese subsidiaries 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 dates. The Company had $ 5,981,000 at April 1, 2023 and $ 11,238,000 at December 31, 2022 of banker's acceptance drafts subject to recourse, which were transferred to vendors and had not reached their scheduled maturity dates. Historically, the banker's acceptance drafts have settled upon maturity without any claim of recourse against the Company. Litigation 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, but is not limited to, 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. 20 Table of Contents KADANT INC.