KADANT INC 10-K

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of our financial condition and results of operations should be read together with the financial statements and related notes set forth in Item 8 , "Financial Statements and Supplementary Data." The following discussion also contains forward-looking statements, including the outlook for our business, that involve a number of risks and uncertainties. See Part I , "Forward-Looking Statements," for a discussion of the forward-looking statements contained below and Part I, Item 1A , "Risk Factors," for a discussion of certain risks that could cause our actual results to differ materially from the results anticipated in such forward-looking statements. Overview Company Background We are a global supplier of high-value, critical components and engineered systems used in process industries worldwide. Our products, technologies, and services play an integral role in enhancing process efficiency, optimizing energy utilization, and maximizing productivity in resource-intensive industries. We previously reported our financial results by combining operating entities into three reportable operating segments: Papermaking Systems, Wood Processing Systems, and Material Handling Systems, and a separate product line, Fiber-based Products. During the first quarter of 2020, we changed our reportable operating segments to better align with our strategic initiatives to grow both organically and through acquisitions. See Note 12 , Business Segment and Geographical Information, in the accompanying consolidated financial statements for further details regarding our segments. Our financial results are reported in three new reportable operating segments: Flow Control, Industrial Processing, and Material Handling. The Flow Control segment consists of our fluid-handling and doctoring, cleaning, & filtration product lines; the Industrial Processing segment consists of our wood processing and stock-preparation product lines (excluding our baling products); and the Material Handling segment consists of our conveying and screening, baling, and fiber-based product lines. Financial information for 2019 and 2018 has been recast to conform to the new segment presentation. A description of each segment is as 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. Our 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. Our products include stock-preparation systems and recycling equipment, chemical pulping equipment, debarkers, stranders, chippers, and logging machinery. In addition, we provide 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. Our products include conveying and vibratory equipment and balers. In addition, we manufacture and sell biodegradable, absorbent granules used as carriers in agricultural applications and for oil and grease absorption. Industry and Business Overview and the Impact of COVID-19 The ongoing COVID-19 pandemic has resulted in significant worldwide economic disruption and adversely affected our bookings and results of operations for a substantial part of 2020, primarily due to delayed or reduced spending by our customers, as well as customer-requested delays on certain capital projects and service work. Consolidated bookings decreased $40 million, or 6%, to $648 million in 2020 compared with $688 million in 2019. Bookings decreased in all our segments in 2020 compared to 2019 as described below. • Flow Control – Bookings decreased $13 million, or 5%, in 2020 compared with 2019 due primarily to a decrease in capital equipment bookings at our North American and, to a lesser extent, Chinese businesses, largely driven by reduced or delayed spending levels related to the impact of COVID-19. In addition, demand for parts and consumables products decreased principally at our North American operations primarily due to COVID-19-related downtimes and shutdowns, as well as visitation restrictions at many customer facilities during 2020. • Industrial Processing – Bookings decreased $17 million, or 6%, in 2020 compared with 2019 primarily due to a 41% decrease in capital equipment bookings at our stock-preparation product line. Our stock-preparation business was impacted by customer-requested delays on large capital projects, reductions in capital equipment spending, and uncertainty in Asia surrounding our customers' response to China's recovered paper import restriction. Partially offsetting this decrease, was a 50% increase in capital equipment bookings at our wood processing business. This increase was fueled by a robust U.S. housing market and high demand for lumber, oriented strand board and plywood, 25 Table of Contents Kadant Inc. which increased mill run rates resulting in higher capital investment by our customers at our North American business, largely in the second half of 2020. Additionally, our European wood processing business experienced a similar impact for capital equipment due to increased mill run rates. On a sequential basis, the Industrial Processing segment's capital equipment bookings more than doubled in the fourth quarter of 2020, driven by an increase in stock-preparation equipment orders. While bookings for our parts and consumables products at our Industrial Processing segment decreased slightly in 2020 compared with 2019, we experienced a 32% sequential increase in bookings in the fourth quarter of 2020 resulting from increased mill run rates, which benefited our North American wood processing business, and the ongoing recovery from the significant downturn experienced earlier in the year due to the impact of COVID-19. • Material Handling – Bookings decreased $10 million, or 6%, in 2020 compared with 2019 led by a decline in demand for parts and consumables at our conveying and vibratory business due to reduced customer spending as a result of COVID-19 shutdowns and visitation restrictions. This decrease was partially offset by a slight increase in capital equipment bookings at our baler business, which was driven by strong demand in the fourth quarter of 2020. While our business continues to be impacted by COVID-19, we experienced a 37% sequential increase in consolidated bookings in the fourth quarter of 2020 compared with the third quarter of 2020, with increases in both capital equipment and parts and consumables products, largely driven by our Industrial Processing segment. Improved bookings across all our segments in the fourth quarter of 2020 resulted in backlog of $193.0 million at year-end 2020, a 13% increase from backlog at year-end 2019. In response to the ongoing COVID-19 pandemic, we continue to focus our efforts on: • protecting the health and safety of our employees through precautionary measures, including working remotely when employees are not required to be physically present, social distancing, wearing face coverings, adding safety and hygiene protocols within our facilities, restricting travel and other safeguards; • as a critical infrastructure company, serving the needs and expectations of our customers; • working closely with our supply chain to minimize potential disruptions; and • preserving our liquidity position. To mitigate the adverse effects of the COVID-19 pandemic on our business, we managed our discretionary spending in such areas as capital expenditures and travel-related costs, utilized government employee retention assistance programs, and executed restructuring actions to reduce payroll-related costs at certain of our operations. During 2020, we received benefits from government employee retention assistance programs of $6.1 million. We do not expect to receive significant benefits from these programs in 2021. Our discretionary spending levels in 2021 will be dependent on the extent and timing of the recovery from the pandemic. We generated $92.9 million in cash flows from operations during 2020. We believe that our existing cash balances, future cash generated from operations, and available borrowing capacity will be sufficient to satisfy our working capital needs, capital expenditures, dividends, debt repayments and other liquidity requirements associated with our existing operations. We do not have any mandatory principal payments on our long-term debt obligations until 2023. We continue to evaluate the impact of the COVID-19 pandemic on our business and will take actions that are in the best interests of our employees, customers, and stakeholders or as mandated by governmental authorities. While our global presence and the diversity of our products have provided some stability, there is continued uncertainty regarding the impact of the COVID-19 pandemic on our results of operations, financial condition and cash flows. This impact will depend upon factors outside our control, including the trajectory and duration of the pandemic, the development, availability, and distribution of effective vaccines and treatments, the implementation of public safety measures, and the timing of recovery in the markets in which we operate. Accordingly, we cannot predict the extent of the impact that the COVID-19 pandemic may have on our business in 2021. For more information on risks related to health epidemics to our business, including the COVID-19 pandemic, please see Part I, Item 1A , "Risk Factors." Global Trade In 2018, the United States began imposing tariffs on certain imports from China, which has and will continue to increase the cost of some of the equipment that we import. Although we are working to mitigate the impact of tariffs through pricing and sourcing strategies, we cannot be sure how our customers and competitors will react to certain actions we take. For more information on risks associated with our global operations, including tariffs, please see the risk factors included in Part I, Item 1A , "Risk Factors." 26 Table of Contents Kadant Inc. Acquisitions We expect that a significant driver of our growth over the next several years will be the acquisition of businesses and technologies that complement or augment our existing products and services or may involve entry into a new process industry. We continue to pursue acquisition opportunities. In June 2020, we made an acquisition in our Industrial Processing segment for approximately $6.9 million, net of cash acquired. In January 2019, we acquired SMH for $176.9 million, net of cash acquired. SMH, which is included in our Material Handling segment, is a leading provider of conveying and vibratory equipment and systems to various process industries, including mining, aggregates, food processing, packaging, and pulp and paper. See Note 2 , Acquisitions, in the accompanying consolidated financial statements for further details. International Sales Slightly more than half of our sales are to customers outside the United States, mainly in Europe, Asia, and Canada. As a result, our financial performance can be materially affected by currency exchange rate fluctuations between the U.S. dollar and foreign currencies. To mitigate the impact of currency rate fluctuations, we generally seek to charge our customers in the same currency in which our operating costs are incurred. Additionally, we may enter into forward currency exchange contracts to hedge certain firm purchase and sale commitments denominated in currencies other than our subsidiaries' functional currencies. We currently do not use derivative instruments to hedge our exposure to exchange rate fluctuations created by the translation into the U.S. dollar of our foreign subsidiaries' results that are in functional currencies other than the U.S. dollar. Results of Operations 2020 Compared to 2019 Revenue The following table presents changes in revenue by segment between 2020 and 2019, and those changes excluding the effect of foreign currency translation and an acquisition which we refer to as change in organic revenue. The presentation of the change in organic revenue is a non-GAAP measure. We believe this non-GAAP measure helps investors gain an understanding of our underlying operations consistent with how management measures and forecasts its performance, especially when comparing such results to prior periods. This non-GAAP measure should not be considered superior to or a substitute for the corresponding GAAP (generally accepted accounting principles in the United States) measure. Revenue by segment in 2020 and 2019 was as follows: (Non-GAAP) Change in Organic Revenue (In thousands, except percentages) January 2, 2021 December 28, 2019 Total Decrease % Change Currency Translation Acquisition Decrease % Change Flow Control $ 225,444 $ 250,339 $ (24,895) (10) % $ (2,822) $ — $ (22,073) (9) % Industrial Processing 261,577 301,948 (40,371) (13) % (326) 1,613 (41,658) (14) % Material Handling 148,007 152,357 (4,350) (3) % 917 — (5,267) (3) % Consolidated Revenue $ 635,028 $ 704,644 $ (69,616) (10) % $ (2,231) $ 1,613 $ (68,998) (10) % Consolidated revenue and organic revenue declined 10% due to lower capital equipment revenue at our Industrial Processing and Flow Control segments and lower parts and consumables revenue at all our segments as described below. Revenue at our Flow Control segment decreased 10% in 2020, while organic revenue declined 9%. Organic revenue was adversely impacted in 2020 by decreased demand for capital equipment principally at our North American operations due to reduced or delayed customer spending as a result of COVID-19 and due to relatively high demand in 2019. Organic revenue was also impacted by lower demand for parts and consumables products primarily at our North American operations due to COVID-19-related downtimes and shutdowns, as well as visitation restrictions at many customer facilities during 2020. Revenue from our Industrial Processing segment decreased 13% in 2020, while organic revenue declined 14%. Organic revenue at our stock-preparation business experienced decreased demand for capital equipment at our Chinese operations due to reduced or delayed customer spending as a result of COVID-19 and uncertainty in Asia surrounding the response to China's recovered paper import restrictions. Additionally, organic revenue from capital equipment at our European operations and parts and consumables at our North American operations decreased due to reduced customer spending as a result of COVID-19. Organic revenue at our North American wood processing business was negatively impacted by reduced demand for capital equipment due to changes in certain end markets and, to a lesser extent, reduced spending as a result of COVID-19, offset in part by increased demand for parts and consumables products. Despite an overall decline in organic revenue at our 27 Table of Contents Kadant Inc. North American wood processing operations, both parts and consumables products and capital equipment revenue strengthened in the second half of 2020, fueled by a robust U.S. housing market and high demand for lumber, OSB and plywood. Revenue and organic revenue at our Material Handling segment decreased 3% in 2020. Revenue at our conveying and vibratory equipment business declined due to a reduction in customer spending for parts and consumables products primarily as a result of shutdowns and visitation restrictions related to COVID-19. This decline was largely offset by increased capital equipment revenue at our conveying and vibratory equipment business primarily due to a large order received in late 2019, which is expected to be completed in early 2021. Revenue from capital equipment at our baler business declined due to a weak European economy during a substantial portion of 2020, compounded by the effect of COVID-19. Despite the overall decline in 2020, demand for our balers improved significantly in the latter half of the year. Gross Profit Margin Gross profit margin by segment in 2020 and 2019 was as follows: January 2, 2021 December 28, 2019 Flow Control 52.9 % 51.4 % Industrial Processing 41.3 % 38.3 % Material Handling 33.7 % 32.5 % Consolidated Gross Profit Margin 43.7 % 41.7 % Consolidated gross profit margin increased in 2020 due to a greater proportion of higher-margin parts and consumables revenue and benefits received in 2020 from government employee retention assistance programs of $3.7 million, which increased consolidated gross profit margin in 2020 by 0.6 percentage point. In addition, the amortization of acquired profit in inventory of $3.5 million related to the SMH acquisition lowered consolidated gross profit margin in 2019 by 0.5 percentage point. Gross profit margin at our Flow Control segment increased in 2020 due to a greater proportion of higher-margin parts and consumables revenue and improved margins on capital equipment revenue, as well as benefits received from government employee retention assistance programs. Gross profit margin at our Industrial Processing segment increased in 2020 primarily due to a greater proportion of higher-margin parts and consumables revenue at our wood processing business, as well as benefits received from government employee retention assistance programs of $2.9 million, which improved the gross profit margin by 1.1 percentage point. Gross profit margin at our Material Handling segment in 2019 was negatively affected by the amortization of acquired profit in inventory of $3.5 million, which lowered the gross profit margin in 2019 by 2.3 percentage points. The remaining 1.1 percentage point difference was primarily due to lower gross margins in 2020 on our capital equipment as a result of an unfavorable change in product mix. Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses in 2020 and 2019 were as follows: (In thousands, except percentages) January 2, 2021 % of Revenue December 28, 2019 % of Revenue Decrease % Change Flow Control $ 63,382 28 % $ 69,375 28 % $ (5,993) (9) % Industrial Processing 57,702 22 % 58,604 19 % (902) (2) % Material Handling 33,526 23 % 36,235 24 % (2,709) (7) % Corporate 27,295 N/A 28,311 N/A (1,016) (4) % Consolidated SG&A Expenses $ 181,905 29 % $ 192,525 27 % $ (10,620) (6) % Consolidated SG&A expenses as a percentage of revenue increased to 29% in 2020 compared with 27% in 2019 due to lower revenue in 2020. Consolidated SG&A expenses decreased $10.6 million in 2020 compared with 2019 due to reduced travel-related costs of $7.8 million, benefits received from government employee retention assistance programs of $2.2 million, and lower acquisition-related costs of $1.1 million. SG&A expenses as a percentage of revenue at our Flow Control segment was 28% in both 2020 and 2019. SG&A expenses decreased $6.0 million in 2020 compared with 2019 due to reduced travel-related costs of $2.8 million, and lower payroll-related costs as a result of restructuring actions taken in 2020 and benefits received from government employee retention assistance programs. SG&A expenses as a percentage of revenue at our Industrial Processing segment increased to 22% in 2020 compared with 19% in 2019 due to lower revenue in 2020. SG&A expenses decreased $0.9 million in 2020 compared with 2019 primarily 28 Table of Contents Kadant Inc. due to reduced travel-related costs of $2.8 million and benefits received from government employee retention assistance programs of $1.4 million. These decreases were partially offset by higher legal and other professional service fees and SG&A expenses from an acquired business of $1.2 million, including acquisition-related costs of $0.7 million in 2020. SG&A expenses as a percentage of revenue at our Material Handling segment decreased to 23% in 2020 compared with 24% in 2019. The 2020 period includes amortization of acquired backlog of $0.4 million, while the 2019 period includes amortization of acquired backlog of $1.3 million and other acquisition-related costs of $0.8 million associated with the acquisition of SMH. SG&A expenses at Corporate decreased $1.0 million in 2020 compared with 2019 primarily due to lower travel-related costs and professional service fees. Impairment and Restructuring Costs Impairment charges of $1.9 million in 2020 relate to actions taken associated with the timber-harvesting product line included in our Industrial Processing segment as a result of the continued decline in revenue and operating results for this business. Given this decline, we performed a quantitative analysis of the recoverability of the related intangible assets using the current projected cash flows for this product line. Based on this analysis, we determined that the fair values of the related intangible assets were less than their carrying values resulting in impairment charges in the fourth quarter of 2020. Restructuring costs were $1.1 million in 2020, which includes $0.6 million at our Flow Control segment, $0.3 million at our Industrial Processing segment, and $0.2 million at our Material Handling segment. These restructuring costs represent severance for 64 employees associated with a restructuring plan implemented in response to the slowdown in the global economy that was largely driven by the impact of COVID-19. We also reduced our workforce by 21 employees within our Industrial Processing segment with no associated severance costs. We expect annualized payroll-related savings as a result of these actions of approximately $4.6 million, including $2.7 million at our Flow Control segment, $1.5 million at our Industrial Processing segment, and $0.4 million at our Material Handling segment, which consist of approximately $2.1 million related to cost of sales and $2.5 million related to operating expenses. Impairment and restructuring costs of $2.5 million in 2019 represent actions taken relating to our timber-harvesting product line. See Impairment and Restructuring Costs in the Discussion of Operations for 2019 Compared to 2018 for a discussion of the impairment charges and restructuring costs recorded in 2019. See Note 1 , Nature of Operations and Summary of Significant Accounting Policies, under the heading Impairment of Long-Lived Assets , and Note 8 , Restructuring Costs, in the accompanying consolidated financial statements for further details relating to impairment charges and restructuring costs recorded in 2020 and 2019. Interest Expense Interest expense decreased $5.3 million to $7.4 million in 2020 due to a lower weighted average interest rate and lower outstanding debt. Other Expense, Net Other expense, net consists of expense related to the non-service component of our pensions and other post-retirement benefit plans. In 2019, other expense, net included a loss of $5.9 million for the settlement of a defined benefit retirement plan obligation at one of our U.S. divisions and our corporate office (Retirement Plan). See Note 3 , Employee Benefit Plans, under the heading Pension and Other Post-Retirement Benefits Plans in the accompanying consolidated financial statements for further details. Provision for Income Taxes Our provision for income taxes increased to $17.9 million in 2020 from $16.4 million in 2019. The effective tax rate of 24% in 2020 was higher than our statutory rate of 21% primarily due to nondeductible expenses, the distribution of our worldwide earnings, and state taxes. 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, the net reversal of tax reserves associated with uncertain tax positions, and a tax benefit for the partial release of a valuation allowance. The effective tax rate of 24% in 2019 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, nondeductible expenses, and tax expense associated with Global Intangible Low-Tax Income (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 and a net tax benefit associated with foreign exchange losses. 29 Table of Contents Kadant Inc. Net Income Net income increased $3.2 million to $55.7 million in 2020 primarily due a $6.2 million decrease in other expense, net and a $5.3 million decrease in interest expense, offset in part by a $6.7 million decrease in operating income and a $1.6 million increase in provision for income taxes (see discussions above for further details). 2019 Compared to 2018 Revenue The following table presents changes in revenue by segment between 2019 and 2018, and those changes excluding the effect of currency translation and an acquisition which we refer to as change in organic revenue. The presentation of the change in organic revenue is a non-GAAP measure. We believe this non-GAAP measure helps investors gain an understanding of our underlying operations consistent with how management measures and forecasts its performance, especially when comparing such results to prior periods. This non-GAAP measure should not be considered superior to or a substitute for the corresponding GAAP measures. (Non-GAAP) Change in Organic Revenue (In thousands, except percentages) December 28, 2019 December 29, 2018 Total Increase (Decrease) % Change Currency Translation Acquisition Increase (Decrease) % Change Flow Control $ 250,339 $ 247,966 $ 2,373 1 % $ (7,061) $ — $ 9,434 4 % Industrial Processing 301,948 314,229 (12,281) (4) % (8,622) — (3,659) (1) % Material Handling 152,357 71,591 80,766 113 % (2,924) 83,364 326 — % Consolidated Revenue $ 704,644 $ 633,786 $ 70,858 11 % $ (18,607) $ 83,364 $ 6,101 1 % Consolidated revenue in 2019 increased by 11%, largely due to an acquisition, offset in part by an unfavorable effect of currency translation. Organic revenue increased 1% primarily due to strong demand for our products at our Flow Control segment's North American operations. Revenue from our Flow Control segment increased 1% in 2019, while organic revenue increased 4%. Organic revenue increased due to unusually high demand in 2019 for our capital equipment and for parts and consumables products at our North American operations. Revenue from our Industrial Processing segment decreased 4% in 2019, while organic revenue declined 1%. Organic revenue at our stock-preparation business was negatively impacted by decreased demand for our capital equipment and, to a lesser extent, parts and consumables products at our Chinese operations due to uncertainty in Asia surrounding the response to China's recovered paper import restrictions. This decline was partially offset by increased demand for chemical pulping capital equipment at our North American operations and for stock preparation equipment and parts and consumables products at our European operations. Organic revenue at our North American wood processing business declined due to reduced demand for capital equipment, as many of our customers increased capacity and modernized facilities in 2018. In addition, a convergence of environmental conditions and related economic factors negatively affected our customers in the Pacific Northwest, and particularly impacted our timber-harvesting product line. This decline was offset in part by increased revenues from capital equipment orders at our European wood processing business. Revenue from our Material Handling segment increased 113% in 2019, while organic revenue was relatively unchanged. The 2019 period included revenue from our SMH acquisition. Gross Profit Margin Gross profit margins for 2019 and 2018 were as follows: December 28, 2019 December 29, 2018 Flow Control 51.4 % 50.8 % Industrial Processing 38.3 % 40.1 % Material Handling 32.5 % 36.8 % Consolidated Gross Profit Margin 41.7 % 43.9 % 30 Table of Contents Kadant Inc. Consolidated gross profit margin decreased in 2019 largely due to the lower gross margin profile of our SMH acquisition and $3.5 million of amortization of acquired profit in inventory that lowered our consolidated gross profit margin by 0.5 percentage point. Gross profit margin at our Flow Control segment increased in 2019 due to improved margins on parts and consumables revenue. Gross profit margin at our Industrial Processing segment decreased in 2019 primarily due to lower margins on capital equipment at our stock-preparation business. Gross profit margin at our Material Handling segment in 2019 was negatively impacted by the lower gross profit margin profile of our SMH acquisition, including the amortization of acquired profit in inventory of $3.5 million that lowered the gross profit margin in 2019 by 2.3 percentage points. Selling, General, and Administrative Expenses SG&A expenses for 2019 and 2018 were as follows: (In thousands) December 28, 2019 % of Revenue December 29, 2018 % of Revenue Increase (Decrease) % Change Flow Control $ 69,375 28 % $ 68,968 28 % $ 407 1 % Industrial Processing 58,604 19 % 62,420 20 % (3,816) (6) % Material Handling 36,235 24 % 16,495 23 % 19,740 120 % Corporate 28,311 N/A 29,531 N/A (1,220) (4) % Consolidated SG&A Expenses $ 192,525 27 % $ 177,414 28 % $ 15,111 9 % Consolidated SG&A expenses as a percentage of revenue decreased to 27% in 2019 compared with 28% in 2018 due to the lower SG&A as a percentage of revenue profile of our SMH acquisition. Excluding SG&A for SMH and the favorable effect of foreign currency translation of $4.7 million, consolidated SG&A expenses were essentially unchanged in 2019 compared with 2018. SG&A expenses as a percentage of revenue at our Flow Control segment was unchanged at 28% in 2019 and 2018. SG&A expenses increased in 2019 compared with 2018 primarily due to increased selling-related expense, offset in part by a favorable effect of foreign currency translation of $2.0 million. SG&A expenses as a percentage of revenue at our Industrial Processing segment decreased to 19% in 2019 compared with 20% in 2018 due to lower selling expenses. SG&A expenses decreased in 2019 compared with 2018 primarily due to a favorable effect of foreign currency translation of $2.0 million and decreased selling expense at our wood processing operations. SG&A expenses as a percentage of revenue at our Material Handling segment increased to 24% in 2019 compared with 23% in 2018. The increase in SG&A expenses of $19.7 million in 2019 was largely due to the SMH acquisition, including amortization of acquired backlog of $1.3 million and other acquisition-related costs of $0.8 million. SG&A expenses at Corporate decreased in 2019 compared with 2018 primarily due to $1.3 million of acquisition costs that were incurred in 2018 related to our SMH acquisition. Impairment and Restructuring Costs Impairment and restructuring costs of $2.5 million in 2019 relate to actions taken associated with the timber-harvesting product line included in our Industrial Processing segment. During 2019, revenue and operating results declined significantly for our timber-harvesting product line. Given this decline, we performed a quantitative analysis of the recoverability of the related intangible assets using the current projected cash flows for this product line. Based on this analysis, we determined that the fair values of certain of the related intangible assets were less than their carrying values and, as a result, recorded impairment charges totaling $2.3 million in the fourth quarter of 2019. These impairment charges consisted of $1.6 million for a definite-lived product technology and $0.7 million for an indefinite-lived tradename. We also incurred severance costs of $0.2 million for six employees in Canada associated with a restructuring plan for the timber-harvesting product line in 2019. Restructuring costs of $1.7 million in 2018 related to the integration of our Industrial Processing segment's U.S. and Swedish stock-preparation businesses into a newly constructed manufacturing facility in the United States to achieve economies of scale and greater efficiencies. The restructuring charges included $1.3 million for the relocation of machinery and equipment and administrative offices and $0.4 million primarily associated with employee retention costs and abandonment of excess facility and other closure costs. See Note 1 , Nature of Operations and Summary of Significant Accounting Policies, under the heading Impairment of Long-Lived Assets, and Note 8 , Restructuring Costs, in the accompanying consolidated financial statements for further details relating to impairment charges and restructuring costs recorded in 2019 and 2018. 31 Table of Contents Kadant Inc. Interest Expense Interest expense increased $5.7 million to $12.8 million in 2019 primarily due to interest expense on the additional borrowings related to our SMH acquisition. Other Expense, Net Other expense, net consists of expense related to the non-service component of our pensions and other post-retirement benefit plans. In 2019, other expense, net included a loss of $5.9 million for the settlement of a Retirement Plan obligation. In 2018, other expense, net included a curtailment loss of $1.4 million related to the freeze and termination of a Retirement Plan and a restoration plan for certain executive officers. See Note 3 , Employee Benefit Plans, under the heading Pension and Other Post-Retirement Benefits Plans , in the accompanying consolidated financial statements for further details. Provision for Income Taxes Our provision for income taxes was $16.4 million in 2019 and $18.5 million in 2018. The effective tax rate of 24% in 2019 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, nondeductible expenses, 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 and a net tax benefit associated with foreign exchange losses. The effective tax rate of 23% in 2018 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings and tax expense associated with GILTI. This incremental tax expense was offset in part by a decrease in tax related to the reversal of tax reserves associated with uncertain tax positions and the net excess income tax benefits from stock-based compensation arrangements. Net Income Net income decreased $8.5 million to $52.6 million in 2019 primarily due to a $5.7 million increase in interest expense, a $3.9 million increase in other expense, net, and a $0.8 million decrease in operating income, offset in part by a $2.1 million decrease in provision for income taxes (see discussions above for further details). Liquidity and Capital Resources Consolidated working capital was $155.1 million at January 2, 2021, compared with $151.4 million at December 28, 2019. Included in working capital were cash and cash equivalents of $65.7 million at January 2, 2021, compared with $66.8 million at December 28, 2019. Cash and cash equivalents held by our foreign subsidiaries was $63.6 million at January 2, 2021 compared with $58.9 million at December 28, 2019. Cash Flows 2020 and 2019 Cash flow information for 2020 and 2019 was as follows: (In thousands) January 2, 2021 December 28, 2019 Net Cash Provided by Operating Activities $ 92,884 $ 97,413 Net Cash Used in Investing Activities (14,545) (187,357) Net Cash (Used in) Provided by Financing Activities (84,556) 112,450 Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash 4,584 (350) (Decrease) Increase in Cash, Cash Equivalents, and Restricted Cash $ (1,633) $ 22,156 Operating Activities Cash provided by operating activities was $92.9 million in 2020 and $97.4 million in 2019. Our operating cash flows are primarily from cash received from customers, offset by cash payments for items such as inventory, employee compensation, operating leases, income taxes and interest payments on outstanding debt obligations. The change in cash provided by operating activities was primarily driven by cash earnings offset by changes in working capital. Cash used for working capital was $2.6 million in 2020 and cash provided by working capital was $2.0 million in 2019. Cash used for working capital in 2020 included cash used of $15.6 million for accounts payable primarily due to reduced spending levels in 2020 for capital equipment projects at a number of our subsidiaries, offset in part by cash provided of $13.2 million due to a reduction in unbilled revenue and accounts receivable primarily as a result of lower capital equipment revenue in 2020. Cash provided by working capital in 2019 included cash provided of $9.1 million from accounts receivable and unbilled revenue due to a number of capital equipment projects that were either in process or completed and shipped in the 32 Table of Contents Kadant Inc. second half of 2018, and $7.4 million from accounts payable. These increases in cash provided were offset in part by cash used of $5.6 million for other current assets primarily related to refundable income taxes. Investing Activities Cash used in investing activities was $14.5 million in 2020 and $187.4 million in 2019. Cash used for acquisitions was $7.1 million in 2020 and $177.8 million in 2019, including $176.9 million for the acquisition of SMH. Financing Activities Cash used in financing activities was $84.6 million in 2020 and cash provided by financing activities was $112.5 million in 2019. Repayment of short- and long-term obligations was $99.5 million in 2020 and $126.3 million in 2019. Repayment in 2020 included an $18.9 million prepayment of the outstanding principal balance on our commercial real estate loan (Real Estate Loan) using U.S. borrowings under our revolving credit facility. Repayment in 2019 included $71.1 million of cash repatriated from Europe that was used to repay U.S. borrowings under our revolving credit facility. Proceeds from issuance of long-term obligations were $26.0 million from U.S.-denominated borrowings under our revolving credit facility in 2020, including amounts used to prepay our Real Estate Loan. Proceeds from issuance of long-term obligations in 2019 were $247.2 million, including $179.3 million of U.S.-denominated borrowings for the acquisition of SMH and $56.1 million of euro-denominated borrowings to partially fund cash repatriated from Europe. Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash T he exchange rate effect on cash, cash equivalents, and restricted cash represents the impact of translation of cash balances at our foreign subsidiaries. The $4.6 million exchange rate effect on cash, cash equivalents, and restricted cash in 2020 primarily relates to the weakening of the U.S. dollar against the euro and Chinese renminbi. 2018 A detailed discussion of cash flows for 2018 can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended December 28, 2019, filed with the SEC. Debt Obligations We have borrowing capacity of over $400 million, of which $181.9 million was available to borrow as of January 2, 2021 under our Credit Agreement, along with an additional uncommitted, unsecured incremental borrowing facility of $150 million. In addition, under our uncommitted Multi-Currency Note Purchase and Private Shelf Agreement (Note Purchase Agreement), we may issue up to an additional $115 million of senior promissory notes. Under these agreements, our leverage ratio, as defined, must be less than 3.75. As of January 2, 2021, our consolidated leverage ratio was 1.61 and we were in compliance with our debt covenants. We do not have any mandatory principal payments on our long-term debt obligations until 2023. See Note 6 , Long-Term Obligations, in the accompanying consolidated financial statements for additional information regarding our debt obligations. Additional Liquidity and Capital Resources On May 13, 2020, our board of directors approved the repurchase of up to $20 million of our equity securities during the period from May 13, 2020 to May 13, 2021. We have not repurchased any shares of our common stock under this authorization or under the previous authorization, which expired on May 15, 2020. We paid cash dividends of $10.9 million in 2020. On February 4, 2021, we paid a quarterly cash dividend of $0.24 per share totaling $2.8 million. Future declarations of dividends are subject to our board of directors' approval and may be adjusted as business needs or market conditions change. The declaration of cash dividends is subject to our compliance with the covenant in our revolving credit facility related to our consolidated leverage ratio. We plan to make expenditures of approximately $14 to $15 million during 2021 for property, plant, and equipment. As of January 2, 2021, we had approximately $293.7 million of total unremitted foreign earnings. It is our intent to indefinitely reinvest $271.6 million of these earnings to support the current and future capital needs of our foreign operations, including debt repayments, if any. For 2020, we recorded withholding taxes on the earnings in certain foreign subsidiaries that we plan to repatriate in the foreseeable future. The foreign withholding taxes that would be required if we were to remit the indefinitely reinvested foreign earnings to the United States would be approximately $6.0 million. In the future, our liquidity position will be affected by the level of cash flows from operations, cash paid to service our debt obligations, acquisitions, capital projects, dividends, and stock repurchases. We believe that our existing resources, together with the borrowings available under our revolving credit facility and available through our Note Purchase Agreement, 33 Table of Contents Kadant Inc. and the cash we expect to generate from operations, will be sufficient to meet the capital requirements of our operations for the foreseeable future. Contractual Obligations and Other Commercial Commitments The following table summarizes our known contractual obligations and commercial commitments to make future payments or other consideration pursuant to certain contracts at year-end 2020, as well as an estimate of the timing in which these obligations are expected to be satisfied. Detailed information concerning these obligations and commitments can be found in Notes 3, 5, 6, 7, and 9 in the accompanying consolidated financial statements. Payments Due by Period or Expiration of Commitment (In millions) Less than 1 Year 1-3 Years 3-5 Years After 5 Years Total Contractual Obligations and Other Commitments: (a) Letters of credit and bank guarantees (b) $ 14.4 $ 4.2 $ — $ — $ 18.6 Retirement obligations on balance sheet 0.3 0.6 0.9 2.7 4.5 Long-term debt obligations — 219.6 3.4 5.0 228.0 Finance lease obligations 0.9 0.7 — — 1.6 Sales-leaseback financing arrangement (c) 0.5 1.7 — — 2.2 Operating lease obligations 4.4 6.3 4.4 11.5 26.6 Purchase obligations 0.5 1.3 — — 1.8 U.S. transition tax, net of available foreign tax credits — 0.8 1.9 — 2.7 Interest (d) 3.9 7.8 0.7 0.5 12.9 Total (e) $ 24.9 $ 243.0 $ 11.3 $ 19.7 $ 298.9 _________________________________ (a) We have purchase obligations related to the acquisition of raw material made in the ordinary course of business that may be terminated with minimal notice and are excluded from this table. (b) Principally relates to performance obligations and customer deposit guarantees required by certain of our sales contracts in which we provide these financial instruments to a customer as beneficiary, limited in amount to a negotiated percentage of the total contract value, in order to guarantee our warranty and performance obligations under the contract. These standby letters of credit and bank guarantees typically expire without being drawn by the beneficiary. (c) Excludes a liability of $1.6 million related to a net fixed price purchase option exercisable in 2022. (d) Assumes interest rates remain unchanged from rates at year-end 2020. (e) Excludes a liability for unrecognized tax benefits and an accrual for the related interest and penalties totaling $9.9 million. Due to the uncertain nature of these income tax matters, we are unable to make a reasonably reliable estimate as to if and when cash settlements with the appropriate taxing authorities will occur. Provisions in financial guarantees or commitments, debt or lease agreements, or other arrangements could trigger a requirement for an early payment, additional collateral support, amended terms, or acceleration of maturity. Off-Balance Sheet Arrangements We do not have special-purpose entities nor do we use off-balance-sheet financing arrangements, except for letters of credit and bank guarantees used in the ordinary course of business as disclosed in the table above. Application of Critical Accounting Policies and Estimates Management's discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. Our actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that entail significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions. For a discussion on the application of these and other accounting policies, see Note 1 , Nature of Operations and Summary of Significant Accounting Policies, in 34 Table of Contents Kadant Inc. the accompanying consolidated financial statements. We believe that our most critical accounting policies upon which our financial position depends, and which involve the most complex or subjective decisions or assessments, are those described below. Income Taxes We operate in numerous countries under many legal forms and, as a result, are subject to the jurisdiction of numerous domestic and non-U.S. tax authorities, as well as to tax agreements and treaties among these governments. Determination of taxable income in any jurisdiction requires the interpretation of the related tax laws and regulations and the use of estimates and assumptions regarding significant future events, such as the amount, timing and character of deductions, permissible revenue recognition methods under the tax law and the sources and character of income and available tax credits. Changes in tax laws, regulations, agreements and treaties, currency-exchange restrictions or our level of operations or profitability in each taxing jurisdiction could have an impact upon the amount of current and deferred tax balances and our results of operations. We compute our provision for income taxes using the asset and liability method, and we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and for tax loss or credit carryforwards. We measure deferred tax assets and liabilities using the currently enacted tax rates that are expected to apply to taxable income in the years in which we expect to realize those deferred tax assets and liabilities. We estimate the degree to which our deferred tax assets on deductible temporary differences and tax loss or credit carryforwards will result in an income tax benefit based on the expected profitability by tax jurisdiction, and we provide a valuation allowance for these deferred tax assets if it is more likely than not that they will not be realized in the future. If it were to become more likely than not that these deferred tax assets would be realized, we would reverse the related valuation allowance. Our tax valuation allowance was $9.6 million at year-end 2020. Should our actual future taxable income by tax jurisdiction vary from our estimates, additional valuation allowances or reversals thereof may be necessary. When assessing the need for a valuation allowance in a tax jurisdiction, we evaluate the weight of all available evidence to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. As part of this evaluation, we consider our cumulative three-year history of earnings before income taxes, taxable income in prior carryback years, future reversals of existing taxable temporary differences, prudent and feasible tax planning strategies, and expected future results of operations. At year-end 2020, we continued to maintain a valuation allowance in the United States against certain of our state operating loss carryforwards due to the uncertainty of future profitability in these state jurisdictions in the United States, and we maintained valuation allowances in certain foreign jurisdictions because of the uncertainty of future profitability. In the ordinary course of business there are inherent uncertainties and judgements required in quantifying our income tax positions. It is our policy to provide for uncertain tax positions and the related interest and penalties based upon our assessment of whether a tax benefit is more likely than not to be sustained upon examination by tax authorities. On a quarterly basis, we evaluate our uncertain tax positions against various factors, including changes in facts or circumstances, tax laws, or the status of audits by tax authorities. We believe that we have appropriately accounted for any liability for unrecognized tax benefits, and at year-end 2020, our liability for these unrecognized tax benefits, including an accrual for the related interest and penalties, totaled $9.9 million. To the extent we prevail in matters for which a liability for an unrecognized tax benefit is established or are required to pay amounts in excess of the liability, our effective tax rate in a given financial statement period may be affected. We intend to repatriate the distributable reserves of select foreign subsidiaries back to the United States and, during 2020, we recorded $0.7 million of net tax expense associated with these foreign earnings that we plan to repatriate in 2021. Except for these select foreign subsidiaries, we intend to reinvest indefinitely the earnings of our international subsidiaries in order to support the current and future capital needs of their operations, including the repayment of our foreign debt. Revenue Recognition Over 85% of our revenue is recognized at a point in time following the transfer of control of the goods or service to the customer, primarily relating to our products that require minimal customization for the customer. The remaining portion of our revenue is recognized on an over time basis using an input method that compares the costs incurred to date to the total expected costs required to satisfy the performance obligation. Most revenue recognized on an over time basis is for large capital products that are highly customized for the customer and, as a result, would include significant cost to rework in the event of cancellation. The over time basis of accounting requires significant judgment in determining applicable contract costs and the corresponding revenue to be recognized, which could be different if there were to be changes to the circumstances of the contract. When adjustments to revenue and costs are required, the adjustments are included in earnings in the period of the change. Judgment is also required for contracts involving variable consideration and multiple performance obligations. Our contracts covering the sale of our products include warranty provisions that provide assurance to our customers that the products will comply with agreed-upon specifications. We accrue warranty costs in the period in which the related revenue is 35 Table of Contents Kadant Inc. recognized based on historical occurrence rates and related repair costs, as well as specific warranty issues outside our typical experience. Should these factors differ from our estimates, revisions to the warranty liability would be required. Valuation of Goodwill and Intangible Assets We use assumptions and estimates in determining the fair value of assets acquired and liabilities assumed in a business combination, including the determination of the fair value of intangible assets acquired, which represents a significant portion of the purchase price in many of our acquisitions. We estimate the fair value of intangible assets primarily based on projections of discounted cash flows which we expect to arise from identifiable intangible assets of acquired businesses. The determination of the allocation of the purchase price to the fair value of intangible assets acquired requires significant judgment as does the determination as to whether such intangibles are amortizable or non-amortizable and, if amortizable, the amortization period of the intangible asset. We evaluate 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 the carrying value of an asset might be impaired. Estimates of discounted future cash flows arising from intangible assets acquired require assumptions related to revenue and operating income growth rates, discount rates, and other factors. Different assumptions from those made in our analysis could materially affect projected cash flows and our evaluation of goodwill and indefinite-lived intangible assets for impairment. At year-end 2020, we performed a qualitative impairment analysis (Step 0) for our reporting units, except our material handing reporting unit, and determined that the related goodwill and indefinite-lived intangible assets were not impaired. For our material handling reporting unit, we performed a quantitative impairment analysis (Step 1) and determined that the related goodwill's fair value exceeded its carrying value by 15% and was not impaired and the indefinite-lived intangible assets were not impaired. At year-end 2019, we performed a qualitative impairment analysis (Step 0) for all our reporting units and determined that the related goodwill and indefinite-lived intangible assets were not impaired, except for the impairment of the indefinite-lived tradename associated with our timber-harvesting product line which was $0.7 million. Goodwill totaled $351.8 million and indefinite-lived intangible assets totaled $24.4 million at January 2, 2021. Definite-lived intangible assets are evaluated for impairment if events or changes in circumstances indicate that the carrying value of an asset might be impaired, such as a significant reduction in cash flows associated with the assets. Actual cash flows arising from a particular intangible asset could vary from projected cash flows which could imply different carrying values from those established at the dates of acquisition and which could result in impairment of such asset. No indicators of impairment were identified in 2020 and 2019, except for the impairment of certain definite-lived intangible assets associated with the timber-harvesting product line within our Industrial Processing segment, which totaled $1.9 million in 2020 and $1.6 million in 2019. Definitive-lived assets were $136.5 million at January 2, 2021. A material adverse change in the business climate including a prolonged economic downturn and weakness in demand for our products could negatively affect the revenue and profitability assumptions used in our assessment of goodwill and intangible assets, which may result in impairment charges. Any future impairment charges could have a material adverse effect on our results of operations in the period in which an impairment is determined to exist. See Note 1 , Nature of Operations and Summary of Significant Accounting Policies, under the heading Impairment of Long-Lived Assets , in the accompanying consolidated financial statements for further details regarding impairment costs recorded in 2020 and 2019. Inventories We value our inventory at the lower of the actual cost (on a first-in, first-out; or weighted average basis) or net realizable value and include materials, labor, and manufacturing overhead. The valuation of inventory requires us to make judgments, based on currently available information, about the forecasted usage of and demand for each particular product or product line. Assumptions about future dispositions of inventory are inherently uncertain and, although we make every effort to ensure the accuracy of our forecasts of future product usage and demand, any changes in those assumptions may result in a write-down of inventory in the period in which inventory is deemed excess or obsolete, which could adversely affect our results of operations. Recent Accounting Pronouncements See Note 1 , Nature of Operations and Summary of Significant Accounting Policies, under the headings Recently Adopted Accounting Pronouncements and Recent Accounting Pronouncements Not Yet Adopted , in the accompanying consolidated financial statements for further details.