Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations

Kadant Inc. was incorporated in Delaware in November 1991 and currently trades on the New York Stock Exchange under the ticker symbol "KAI." Kadant Inc. (together with its subsidiaries, the Company) is a global supplier of high-value, critical components and engineered systems used in process industries worldwide. The Company has a diverse and large customer base, including most of the world's major paper, lumber and oriented strand board (OSB) manufacturers, and various mining companies across multiple industries. Its products, technologies, and services play an integral role in enhancing process efficiency, optimizing energy utilization, and maximizing productivity in resource-intensive industries.

The Company's operations include three reportable operating segments, Papermaking Systems, Wood Processing Systems, and Material Handling Systems, and a separate product line, Fiber-based Products. See Note 2 for information regarding the Company's most recent acquisition, which comprises its new Material Handling Systems segment.

Interim Financial Statements

The interim condensed consolidated financial statements and related notes presented have been prepared by the Company, are unaudited, and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of the Company's financial position at March 30, 2019, its results of operations, comprehensive income, cash flows, and stockholders' equity for the three-month periods ended March 30, 2019 and March 31, 2018. Interim results are not necessarily indicative of results for a full year or for any other interim period.

The condensed consolidated balance sheet presented as of December 29, 2018 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 29, 2018. The condensed consolidated financial statements and related notes are presented as permitted by the Securities and Exchange Commission (SEC) rules and regulations for Form 10-Q and do not contain certain information included in the annual consolidated financial statements and related notes of the Company. The condensed consolidated financial statements and notes included herein should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2018, filed with the SEC.

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 revenues 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.

Notes 1 and 3 to the consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 2018 describe the significant accounting estimates and policies used in preparation of the consolidated financial statements. There have been no material changes in the Company’s significant accounting policies during the three months ended March 30, 2019, except for the adoption of Accounting Standards Codification (ASC), Leases (Topic 842) (ASC 842). See Recently Adopted Accounting Pronouncements within this note and Note 8 for further details.

Supplemental Cash Flow Information

See Note 8 for supplemental cash flow information related to the Company's lease obligations.



	Three Months Ended
(In thousands)	March 30, 2019		March 31, 2018
Cash Paid for Interest	$	2,782	$	2,459
Cash Paid for Income Taxes, Net of Refunds	$	4,679	$	8,455

Non-Cash Investing Activities:
Post-closing adjustments	$	1,567	$	397

Liabilities assumed of acquired business	$	29,664	$	—

Non-cash additions to property, plant, and equipment	$	193	$	1,816

Non-Cash Financing Activities:
Issuance of Company common stock upon vesting of restricted stock units	$	3,278	$	2,755
Dividends declared but unpaid	$	2,570	$	2,440

Restricted Cash

The Company's restricted cash serves as collateral for bank guarantees primarily associated with providing assurance to customers that the Company will fulfill certain customer obligations entered into in the normal course of business. The majority of the bank guarantees will expire over the next twelve months.

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company's condensed consolidated balance sheet that are shown in aggregate in the accompanying condensed consolidated statement of cash flows:



(In thousands)	March 30, 2019		March 31, 2018		December 29, 2018		December 30, 2017
Cash and cash equivalents	$	56,478	$	72,210	$	45,830	$	75,425
Restricted cash	697		1,532		287		1,421
Total Cash, Cash Equivalents, and Restricted Cash	$	57,175	$	73,742	$	46,117	$	76,846

Banker's Acceptance Drafts included in Accounts Receivable

The Company's Chinese subsidiaries may receive banker's acceptance drafts from customers as payment for their trade accounts receivable. The drafts are noninterest-bearing obligations of the issuing bank and mature within six months of the origination date. The Company's 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 $7,772,000 at March 30, 2019 and $7,976,000 at December 29, 2018, 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.

Inventories

The components of inventories are as follows:



	March 30, 2019		December 29, 2018
(In thousands)	March 30, 2019		December 29, 2018
Raw Materials	$	46,684	$	44,522
Work in Process	20,239		15,876
Finished Goods	36,106		25,975
	$	103,029	$	86,373

Intangible Assets, Net

Acquired intangible assets by major asset class are as follows:



(In thousands)	Gross		Accumulated Amortization			Currency Translation			Net
March 30, 2019
Definite-Lived
Customer relationships	$	166,183	$	(41,222	)	$	(4,498	)	$	120,463
Product technology	57,001		(24,619		)	(1,761		)	30,621
Tradenames	5,227		(2,090		)	(419		)	2,718
Other	17,784		(12,581		)	(576		)	4,627
	246,195		(80,512		)	(7,254		)	158,429
Indefinite-Lived
Tradenames	26,300		—			(133		)	26,167
Acquired Intangible Assets	$	272,495	$	(80,512	)	$	(7,387	)	$	184,596

December 29, 2018
Definite-Lived
Customer relationships	$	113,283	$	(38,160	)	$	(4,520	)	$	70,603
Product technology	46,501		(23,563		)	(1,677		)	21,261
Tradenames	5,227		(1,980		)	(390		)	2,857
Other	13,744		(11,476		)	(127		)	2,141
	178,755		(75,179		)	(6,714		)	96,862
Indefinite-Lived
Tradenames	16,600		—			(115		)	16,485
Acquired Intangible Assets	$	195,355	$	(75,179	)	$	(6,829	)	$	113,347

Intangible assets are initially recorded at fair value at the date of acquisition. Definite-lived intangible assets are stated net of accumulated amortization and currency translation in the accompanying condensed consolidated balance sheet. The Company amortizes definite-lived intangible assets over lives that have been determined based on the anticipated cash flow benefits of the intangible asset.

Goodwill

The changes in the carrying amount of goodwill by segment are as follows:



(In thousands)	Papermaking Systems			Wood Processing Systems		Material Handling Systems		Total
Balance at December 29, 2018
Gross balance	$	241,912		$	101,771	$	—	$	343,683
Accumulated impairment losses	(85,509		)	—		—		(85,509		)
Net balance	156,403			101,771		—		258,174
2019 Adjustments
Acquisition (Note 2)	—			—		86,502		86,502
Currency translation	(1,031		)	123		—		(908		)
Total 2019 adjustments	(1,031		)	123		86,502		85,594
Balance at March 30, 2019
Gross balance	240,881			101,894		86,502		429,277
Accumulated impairment losses	(85,509		)	—		—		(85,509		)
Net balance	$	155,372		$	101,894	$	86,502	$	343,768

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. The Company negotiates the terms regarding warranty coverage and length of warranty depending on the products and applications.

The changes in the carrying amount of accrued warranty costs included in other current liabilities in the accompanying condensed consolidated balance sheet are as follows:



	Three Months Ended
(In thousands)	March 30, 2019			March 31, 2018
Balance at Beginning of Year	$	5,726		$	5,498
Provision charged to expense	1,076			715
Usage	(925		)	(364		)
Acquisition	295			—
Currency translation	(3		)	61
Balance at End of Period	$	6,169		$	5,910

Revenue Recognition

The Company recognizes revenue under ASC 606, Revenue from Contracts with Customers. Most of the Company’s revenue is recognized at a point in time for each performance obligation under the contract when the customer obtains control of the goods or service. The majority of the Company’s parts and consumables products and capital products with minimal customization are accounted for at a point in time. The Company has made a policy election not to treat the obligation to ship as a separate performance obligation under the contract and, as a result, the associated shipping costs are accrued when revenue is recognized.

The remaining portion of the Company’s revenue is recognized on an over time basis based on an input method that compares the costs incurred to date to the total expected costs required to satisfy the performance obligation. Contracts are accounted for on an over time basis when they include products which have no alternative use and an enforceable right to payment over time. Contracts recognized on an over time basis are typically for large capital projects which are highly customized for the customer and, as a result, would include a significant cost to rework in the event of cancellation.

The following table presents revenue by revenue recognition method:



	Three Months Ended
	March 30,		March 31,
(In thousands)	2019		2018
Point in time	$	148,276	$	142,005
Over time	23,040		7,188
	$	171,316	$	149,193

The transaction price is typically based on the amount billed to the customer and includes estimated variable consideration where applicable. Such variable consideration relates to certain performance guarantees and rights to return the product. The Company estimates variable consideration as the most likely amount to which it expects to be entitled based on the terms of the contracts with customers and historical experience, where relevant. For contracts with multiple performance obligations, the transaction price is allocated to each performance obligation based on the relative stand-alone selling price.

The following table presents the disaggregation of revenues by product type and geography:



	Three Months Ended
	March 30,		March 31,
(In thousands)	2019		2018
Revenues by Product Type:
Parts and Consumables	$	112,850	$	95,985
Capital	58,466		53,208
	$	171,316	$	149,193
Revenues by Geography:
North America	$	100,876	$	77,616
Europe	38,985		41,493
Asia	17,078		20,148
Rest of World	14,377		9,936
	$	171,316	$	149,193

See Note 12, Business Segment Information, for further details on the disaggregation of revenues by segment and product line.

The following table presents balances from contracts with customers:



	March 30, 2019		December 29, 2018
(In thousands)	March 30, 2019		December 29, 2018
Accounts receivable	$	104,120	$	92,624
Contract assets	$	16,996	$	15,741
Contract liabilities	$	38,950	$	34,774

Contract assets represent unbilled revenues associated with revenue recognized on contracts accounted for on an over time basis, which will be billed in future periods based on the contract terms. Contract liabilities consist of customer deposits, advanced billings, and deferred revenue. Deferred revenue is included in other current liabilities in the accompanying condensed consolidated balance sheet. Contract liabilities will be recognized as revenue in future periods once the revenue recognition criteria are met. The majority of the contract liabilities relate to advanced payments on contracts accounted for at a point in time. These advance payments will be recognized as revenue when the Company's performance obligations have been satisfied, which typically occurs when the product has shipped and control of the asset has transferred to the customer. The Company recognized revenue of $19,095,000 in the first three months of 2019 and $27,325,000 in the first three months of 2018 that was included in the contract liabilities balance at the beginning of 2019 and 2018, respectively.

Customers in China will often settle their accounts receivable with a banker's acceptance draft, in which case cash settlement will be delayed until the banker's acceptance draft matures or is settled prior to maturity. For customers outside of China, final payment for the majority of the Company's products is received in the quarter following the product shipment. Certain of the Company's contracts include a longer period before final payment is due, which is typically within one year of final shipment or transfer of control to the customer.

Recently Adopted Accounting Pronouncements

Leases (Topic 842). In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, which requires a lessee to recognize a right-of-use (ROU) asset and a corresponding lease liability for operating leases, initially measured at the present value of the future lease payments, on its balance sheet. This ASU also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, generally on a straight-line basis. The Company adopted this ASU as of the beginning of fiscal 2019 using the cumulative-effect adjustment method. As a result, prior period amounts were not restated and continue to be under Topic 840, Leases, which did not require the recognition of operating leases on the balance sheet and is not comparative. As permitted under ASC 842, the Company elected the package of practical expedients for expired or existing contracts, which does not require the reassessment of prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected practical expedients relating to its ongoing accounting, including a short-term lease recognition exemption allowing lessees not to recognize ROU assets and liabilities with a term of 12 months or less and an election not to separate lease and non-lease components for all leases except vehicle leases.

The adoption of this standard as of the beginning of fiscal 2019 resulted in increases of 2.3% to total assets and 4.8% to total liabilities and an immaterial decrease to retained earnings. In addition, the adoption of this ASU did not have a material impact on the Company’s condensed consolidated statements of income or cash flows. See Note 8, Leases, for required lease accounting disclosures.

Derivatives and Hedging (Topic 815), Targeted Improvements in Accounting for Hedging Activity. In August 2017, the FASB issued ASU No. 2017-12, which revises hedge accounting to better portray the economic results of an entity’s risk management activities, simplifies hedge accounting guidance, and improves disclosures of hedge accounting arrangements. The Company adopted this ASU on a prospective basis at the beginning of fiscal 2019. The adoption of this ASU did not have a material effect on the Company's condensed consolidated financial statements.

Recent Accounting Pronouncements Not Yet Adopted

Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU No. 2016-13, which significantly changes the way entities recognize impairment of many financial assets by requiring immediate recognition of estimated credit losses expected to occur over their remaining lives. This new guidance is effective for the Company in fiscal 2020 with early adoption permitted beginning in fiscal 2019. The Company is currently evaluating the effects that the adoption of this ASU will have on its condensed consolidated financial statements.

Compensation-Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20), Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. In August 2018, the FASB issued ASU 2018-14, which removes, adds and clarifies several disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. This new guidance is effective on a retrospective basis for the Company in fiscal 2021. Early adoption is permitted. The Company does not believe that the adoption of this ASU will have a material effect on its condensed consolidated financial statements.