KADANT INC (KAI) FY 2024 MD&A

Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations should be read together with the consolidated 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.

A detailed discussion of the year-over-year results for 2023 compared with 2022 can be found in Part II, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 30, 2023, filed with the SEC.

Overview

Company Background

We are a global supplier of technologies and engineered systems that drive Sustainable Industrial Processing®. Our products and services play an integral role in enhancing efficiency, optimizing energy utilization, and maximizing productivity in process industries while helping our 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 our businesses.

Our financial results are reported in three reportable segments consisting of our Flow Control segment, Industrial Processing segment, and Material Handling segment. We have aggregated our operating segments into reportable segments where they contained similar products and economic characteristics, and shared similar types of customers, and production and distribution methods. Our Flow Control segment consists of our fluid-handling and doctoring, cleaning, & filtration operating segments and our Industrial Processing segment consists of our wood processing and fiber processing (formerly referred to as stock-preparation) operating segments. See Note 11, Business Segment and Geographical Information, in the accompanying consolidated financial statements for a description of and financial information on our reportable segments.

Industry and Business Overview

Bookings were a record $981.1 million in 2024, increasing 7% compared to 2023 due to strong contributions from our 2024 acquisitions. Organic bookings, which is defined as bookings excluding acquisitions and the effect of foreign currency translation, decreased 5% in 2024 compared to 2023 due to weaker demand for our capital equipment products driven by several factors, including economic uncertainties, macroeconomic conditions abroad, and the consolidation of some of our large customers.

While demand for our parts and consumables products remained strong in 2024, there was a lengthening in the timing for securing capital orders as customers became more cautious with some delaying large capital expenditures into 2025. From a geographic perspective, our operations in North America and Europe were also impacted by the consolidation of some large customers in the paper industry causing disruption and delays in their normal spending levels. In Europe, sluggish market conditions have been impacted by high interest rates and energy costs. Additionally, depressed conditions in China led to a tightening of available credit and more cautious capital spending.

We expect stronger capital bookings in 2025, especially in our Industrial Processing segment. However, the timing of securing capital orders can be uncertain and could shift by quarter and into 2026 due to macroeconomic uncertainty or other factors. We expect steady demand for our aftermarket products to continue in 2025.

We see long-term strength in our end markets as customers continue to rely on our products to help maximize productivity through more efficient production processes. In addition, we see growth opportunities from proposed and adopted legislation in the U.S. and abroad aimed at fueling investment.

An overview of our business by reportable segment is as follows:

•Flow Control – Our Flow Control segment bookings increased 1% in 2024 compared to 2023, including a 5% increase from acquisitions. Organic bookings decreased 3% in 2024 compared to 2023 primarily due to sluggish manufacturing activity, especially in Europe. Weaker demand for paper led to low mill operating rates and mill closures. In Europe, these challenges were further impacted by weak macroeconomic conditions and aggressive competition, which led to decreased demand for our capital equipment products. We expect steady demand in our Flow Control segment in 2025 and long-term strength in our end markets.

•Industrial Processing – Our Industrial Processing segment bookings increased 15% in 2024 compared to 2023, including an 18% increase from acquisitions. Organic bookings decreased 2% in 2024 compared to 2023 led by decreased demand for our capital equipment products at our wood processing business in North America. High mortgage rates and economic uncertainty led to a decline in new construction in the U.S., leading to reduced demand

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for OSB, lumber, and our products. Consequently, the number of dormant or idle lines in the North American lumber industry remained high as lumber producers waited for market conditions to improve. We anticipate that the significant pent up demand for housing, coupled with the continued focus on remodeling, will lead to increased demand for our wood processing products in 2025. Demand for our capital equipment and aftermarket parts products at our fiber processing businesses remained stable compared to 2023, except at our Chinese operations due to challenging market conditions. Overcapacity led to the closure of several smaller mills, while declining prices reduced profit margins at the remaining mills. These unfavorable conditions led to delays in capital project activity. In addition, the consolidation of some large customers in the paper industry disrupted and delayed their normal spending patterns, leading to decreased demand for our products in North America and Europe. In this environment, customers are increasingly focused on projects aimed at reducing input costs, which is expected to drive increased demand for our products in this segment.

•Material Handling – Our Material Handling segment bookings increased 5% in 2024 compared to 2023, including a 17% increase from acquisitions. Organic bookings decreased 13% led by a reduction in capital equipment bookings. At our conveying and vibratory business, a large $12 million capital order for a conveying line in 2023 resulted in comparatively weaker capital bookings in 2024. This impact was coupled with constrained capital spending by customers in the aggregates industry. However, the long-term outlook for the aggregates industry remains strong, particularly in North America, fueled by new infrastructure projects as a result of significant federal and state investment. At our baling businesses, organic bookings decreased both in North America and Europe, as customers were reluctant to commit to capital expenditures towards the end of the year. While quote activity was active, a drop in used paper prices, constrained market conditions in Europe, and uncertainty related to borrowing costs all contributed to customers’ hesitation. We expect customers will place these orders in 2025. For the overall Material Handling segment, planned infrastructure projects and asset modernization in the recycling and waste management sectors are expected to lead to increased demand in 2025.

Our global operations have been and continue to be impacted by complex market conditions fueled by inflationary pressures, geopolitical tensions, labor availability and uncertainty in the markets. While the U.S. economy has proven more resilient, growth in the European economy has slowed due to high interest rates, elevated inflation, and geopolitical tensions and China's manufacturing industry has contracted. We expect our operating environment to continue to be challenging, which creates continued uncertainty for 2025. However, we believe that the fundamentals of our business remain strong, particularly given our solid market position in key product lines, strong global operations teams, and long-term strength of our end markets.

International Sales

Approximately 50% 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 foreign currency 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.

Global Trade

The United States has imposed tariffs in the past and more recently proposed and implemented new tariffs on certain imports, which has and will continue to increase the cost of some of the parts and equipment we import. In addition, foreign countries may implement retaliatory tariffs in response to these actions by the United States, which may negatively impact our operations. Although we are working to mitigate the impact of tariffs through pricing and sourcing strategies, we cannot be sure these strategies will effectively mitigate the impact of these costs. For more information on risks associated with our global operations, including tariffs, please see Part I, Item 1A, "Risk Factors."

Acquisitions

We expect that a significant driver of our long-term growth will be through 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 have acquired several businesses in recent years and continue to pursue acquisition opportunities.

On January 1, 2024, we acquired Key Knife for $153.4 million, net of cash acquired and subject to a post-closing adjustment. Key Knife is a global supplier of engineered knife systems for custom chipping, planing, and flaking solutions for wood products industries, with revenue of approximately $65.0 million for the twelve months ended September 30, 2023, and is part of our Industrial Processing segment.

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On January 24, 2024, we acquired KWS for $79.4 million. KWS is a leading manufacturer of conveying equipment for the bulk material handling industry, with revenue of approximately $45.0 million for the twelve months ended September 30, 2023, and is part of our Material Handling segment.

On May 31, 2024, we acquired DSTI for $53.6 million, net of cash acquired. DSTI is a leading manufacturer of engineered fluid sealing and transfer solutions for rotating applications, with revenue of approximately $25.0 million for the twelve months ended March 31, 2024, and is part of our Flow Control segment.

We funded these acquisitions primarily through borrowings under our revolving credit facility. We expect several synergies in connection with the acquisitions, including expansion of product sales into new markets by leveraging our global sales network and relationships, broadening our product portfolio, and strengthening our position in the various markets we serve.

We also completed several smaller acquisitions in 2024. See Note 2, Acquisitions, in the accompanying consolidated financial statements for further details.

Results of Operations

2024 Compared to 2023

Revenue

The following table presents changes in revenue by segment between 2024 and 2023, and those changes excluding the effect of acquisitions and foreign currency translation, which we refer to as change in organic revenue. Organic revenue excludes the effect of acquisitions for the four quarterly reporting periods following the date of the acquisition. 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 measure.

Revenue by reportable segment in 2024 and 2023 is as follows:

Consolidated revenue increased 10% in 2024, including a 12% increase from acquisitions. Organic revenue decreased 2% primarily due to weak demand in our Material Handling segment, partially offset by stronger demand at our Industrial Processing segment, especially for our capital equipment products. From a geographic perspective, organic revenue was impacted by softening demand in Europe due to weak macroeconomic conditions.

Revenue at our Flow Control segment increased 2% while organic revenue decreased 1% in 2024 driven by lower demand for our capital equipment products in Europe reflecting challenging market conditions and a slowdown in manufacturing activity. This decrease was partially offset by higher demand for our capital equipment products in North America, especially our fluid handling products that help customers optimize energy utilization and maximize productivity.

Revenue at our Industrial Processing segment increased 22% in 2024, including a 17% increase from acquisitions. Organic revenue increased 6% in 2024 led by increased demand for our capital equipment products at our fiber processing business. Capital equipment revenue increased 28% at our fiber processing business due to higher completion rates on large projects recognized on an over time basis in China and increased replacement and refurbishment projects in North America. In addition, maintenance and production requirements at our customers in North America led to increased demand for our parts and consumables products at our wood processing business.

Revenue at our Material Handling segment increased 4% in 2024, including a 17% increase from acquisitions. Organic revenue decreased 13% led by weaker demand for our capital equipment products. At our conveying and vibratory business, a large expansion project for a conveying line in 2023 resulted in comparatively lower capital revenue in 2024. At our baling business in Europe, high interest rates and declines in waste paper prices led to decreased demand for our capital equipment products.

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Gross Profit Margin

Gross profit margin by reportable segment in 2024 and 2023 is as follows:

Consolidated gross profit margin increased to 44.3% in 2024 compared with 43.5% in 2023 due to a favorable increase in the proportion of parts and consumables revenue, which increased to 66% of total revenue compared to 62% in 2023. This increase was partially offset by the inclusion of $5.2 million of amortization expense related to acquired profit in inventory, which lowered consolidated gross profit margin in 2024 by 0.4 percentage points.

Within our reportable segments, gross profit margin:

•Increased to 52.5% at our Flow Control segment from 51.8% in 2023 primarily due to higher margins achieved on our capital equipment products. This increase was partially offset by the inclusion of $2.0 million of amortization expense related to acquired profit in inventory, which lowered gross profit margin in 2024 by 0.5 percentage points.

•Increased to 41.8% at our Industrial Processing segment from 40.2% in 2023 due to higher margins achieved on our capital equipment products and a higher proportion of parts and consumables revenue. These increases were partially offset by the inclusion of $2.2 million of amortization expense related to acquired profit in inventory, which lowered gross profit margin in 2024 by 0.5 percentage points.

•Increased to 36.3% at our Material Handling segment from 35.7% in 2023. The favorable increase in the proportion of parts and consumables revenue in 2024 was partially offset by the inclusion of $1.0 million of amortization expense related to acquired profit in inventory, which lowered gross profit margin in 2024 by 0.5 percentage points.

Selling, General, and Administrative Expenses

Selling, general, and administrative (SG&A) expenses by reportable segment and corporate in 2024 and 2023 are as follows:

Consolidated SG&A expenses as a percentage of revenue increased to 27% in 2024 compared to 25% in 2023 principally due to the impact of our acquisitions and acquisition-related costs. Consolidated SG&A expenses increased $43.7 million, or 18%, primarily due to the inclusion of $35.6 million of SG&A expenses from acquisitions, $4.7 million of incremental acquisition-related costs and annual wage increases. Acquisition-related costs included in SG&A consist of amortization expense associated with acquired backlog and acquisition costs.

Within our reportable segments and corporate, SG&A expenses:

•Increased $9.3 million at our Flow Control segment principally due to the inclusion of $5.2 million of SG&A expenses from acquisitions, $2.2 million of acquisition-related costs and increased compensation expense, partially offset by a decrease in commission expense.

•Increased $21.4 million at our Industrial Processing segment due to the inclusion of $19.5 million of SG&A expenses from acquisitions and increased compensation expense. These increases were partially offset by a $0.5 million favorable effect of foreign currency translation.

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•Increased $11.3 million at our Material Handling segment primarily due to the inclusion of $10.9 million of SG&A expenses from acquisitions and $2.4 million of incremental acquisition-related costs, partially offset by a decrease in expense related to external commissions and sales incentives.

•Increased $1.6 million at Corporate due to annual wage increases and consulting costs.

Other Costs, Net

The components of other costs, net in 2024 and 2023 are as follows:

Restructuring and Impairment Costs

•Restructuring and impairment costs of $0.4 million in 2023 within our Flow Control segment related to our restructuring plan to consolidate a small manufacturing operation into a larger facility in Germany. Restructuring and impairment costs related to this plan consisted of severance costs for the termination of 10 employees, facility and other closure costs, and asset-write downs.

•Restructuring costs of $0.4 million in 2023 within our Flow Control segment related to the termination of a contract at one of our operations in Germany.

Other Costs (Income)

•Loss of $0.7 million in 2024 related to the recognition of a cumulative translation adjustment associated with the liquidation of a small foreign subsidiary in the Flow Control segment.

•In 2022, we entered into several agreements with the local government in China to sell our then existing manufacturing building and land use rights of one of our subsidiaries in China (China Transaction). In connection with the China Transaction, we recognized other income of $0.8 million in 2023 related to the outsourcing of demolition and cleanup work of the then existing manufacturing building in China and sale of the remaining fixed assets. In addition, we incurred costs of $0.8 million in 2023 related to the relocation of machinery and equipment and administrative offices to the new manufacturing facility in China.

Interest Expense

Interest expense increased to $20.0 million in 2024 from $8.4 million in 2023 due to increased borrowings under our revolving credit facility, which were primarily used to fund our acquisitions and, to a lesser extent, a higher weighted average interest rate.

Provision for Income Taxes

Our provision for income taxes decreased to $40.5 million in 2024 from $42.2 million in 2023 primarily due to the decrease of $5.9 million in pre-tax income. The effective tax rate was 26.5% in both 2024 and 2023 and was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, state taxes, and nondeductible expenses.

Net Income

Net income decreased to $112.6 million in 2024 from $116.8 million in 2023 primarily due to a $11.6 million increase in interest expense, offset in part by a $5.5 million increase in operating income and a $1.7 million decrease in provision for income taxes (see discussions above for further details).

Non-GAAP Key Performance Indicators

In addition to the financial measures prepared in accordance with GAAP, we use certain non-GAAP financial measures, including organic revenue (defined as revenue excluding the effect of acquisitions and foreign currency translation), adjusted operating income, earnings before interest, taxes, depreciation, and amortization (EBITDA), adjusted EBITDA, adjusted EBITDA margin (defined as adjusted EBITDA divided by revenue), and free cash flow (defined as net cash provided by operating activities less capital expenditures).

We use organic revenue in order to understand our trends and to forecast and evaluate our financial performance and compare revenue to prior periods (see discussion in Revenue above). Adjusted operating income, adjusted EBITDA, and adjusted EBITDA margin exclude amortization expense related to acquired profit in inventory and backlog, acquisition costs,

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restructuring and impairment costs, relocation costs and other income and expense, as indicated. These items are excluded as they are not indicative of our core operating results and are not comparable to other periods, which have differing levels of incremental costs, expenditures or income, or none at all. Additionally, we use free cash flow in order to provide insight on our ability to generate cash for acquisitions and debt repayments, as well as for other investing and financing activities.

We believe these non-GAAP financial measures, when taken together with the corresponding GAAP financial measures, provide meaningful supplemental information regarding our performance by excluding certain items that may not be indicative of our core business, operating results, or future outlook. We believe that the inclusion of such measures helps investors gain an understanding of our underlying operating performance and future prospects, consistent with how management measures and forecasts our performance, especially when comparing such results to previous periods or forecasts and to the performance of our competitors. Such measures are also used by us in our financial and operating decision-making and for compensation purposes. We also believe this information is responsive to investors' requests and gives them additional measures of our performance.

Our non-GAAP financial measures are not meant to be considered superior to or a substitute for the results of operations or cash flows prepared in accordance with GAAP. In addition, our non-GAAP financial measures have limitations associated with their use as compared to the most directly comparable GAAP measures, in that they may be different from, and therefore not comparable to, similar measures used by other companies.

A reconciliation of adjusted operating income, adjusted EBITDA, and adjusted EBITDA margin from net income attributable to Kadant is as follows:

A reconciliation of free cash flow from net cash provided by operating activities is as follows:

(a)     Represents a gain on the China Transaction in our Industrial Processing segment.

(b)     Represents expense (income) within cost of revenue associated with amortization of acquired profit in inventory.

(c)     Represents intangible amortization expense associated with acquired backlog.

(d)     Represents the provision for or reversal of indemnification assets related to the establishment or release of tax reserves associated with uncertain tax positions.

(e)     Includes a loss of $0.7 million from the recognition of a cumulative translation adjustment associated with the liquidation of a small foreign subsidiary in our Flow Control segment in 2024.

(f)     Includes capital expenditures of $7.4 million in 2023 and $10.4 million in 2022 associated with the China Transaction.

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Liquidity and Capital Resources

Consolidated working capital was $250.8 million at December 28, 2024, compared with $225.8 million at December 30, 2023. Cash and cash equivalents were $94.7 million at December 28, 2024, compared with $103.8 million at December 30, 2023, which included cash and cash equivalents held by our foreign subsidiaries of $73.8 million at December 28, 2024 and $94.6 million at December 30, 2023.

Cash Flow

Cash flow information is as follows:

Operating Activities

Cash provided by operating activities decreased to $155.3 million in 2024 from $165.5 million in 2023 primarily due to an increase in cash used for working capital. Our operating cash flows are primarily generated 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.

During 2024, significant operating cash outflows were associated with accounts receivable, customer deposits and other liabilities. A decrease in customer deposits used cash of $29.8 million due to a reduction in capital equipment orders and an increase in accounts receivable and contract assets used cash of $9.8 million primarily due to our revenue growth. Other liabilities used cash of $21.2 million primarily due to cash outflows from incentive compensation and operating lease payments. These uses of cash were offset in part by cash provided from the shipment of inventory of $24.0 million and increases in accounts payable of $10.6 million related to inventory purchases and the timing of payments.

During 2023, significant operating cash inflows were associated with working capital related to inventory, other liabilities and unbilled revenue. Shipments of inventory provided cash of $14.1 million and increases in other liabilities provided cash of $9.2 million due to the timing of payments to subcontractors and outside vendors. In addition, a reduction in unbilled revenue provided cash of $6.5 million. These sources of cash were offset in part by $28.9 million of operating cash outflows associated with accounts payable and customer deposits primarily due to the timing of payments.

Investing Activities

Cash used in investing activities was $319.1 million in 2024 compared with $30.8 million in 2023. Consideration paid for acquisitions, net of cash acquired, was $300.3 million in 2024. Additionally, capital expenditures were $21.0 million in 2024 and $31.9 million in 2023, which included capital expenditures associated with the China Transaction of $7.4 million.

Financing Activities

Cash provided by financing activities was $159.9 million in 2024 compared with cash used of $111.1 million in 2023. Borrowings under our revolving credit facility were $305.2 million in 2024, which were primarily used to fund our 2024 acquisitions. Repayments of short- and long-term obligations were $124.5 million in 2024 compared to $94.0 million in 2023. Cash dividends paid to stockholders were $14.7 million in 2024 and $13.2 million in 2023. In addition, taxes paid related to the vesting of equity awards were $5.9 million in 2024 compared to $3.9 million in 2023.

Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash

The exchange rate effect on cash, cash equivalents, and restricted cash represents the impact of translation of cash balances at our foreign subsidiaries. The $6.5 million decrease in cash, cash equivalents, and restricted cash in 2024 related to exchange rates was primarily attributable to the strengthening of the U.S. dollar against the euro and the Canadian dollar and, to a lesser extent, the Brazilian real and Mexican peso. The $3.1 million increase in cash, cash equivalents and restricted cash in 2023 was primarily attributable to the weakening of the U.S. dollar against the euro, the Canadian dollar, and Mexican peso.

Borrowing Capacity and Debt Obligations

Our unsecured multi-currency revolving credit facility originally entered into on March 1, 2017 (as amended and restated to date, the Credit Agreement) matures on November 30, 2027 and has a total borrowing capacity of $400.0 million.

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In 2024, we borrowed $305.2 million under our revolving credit facility, which was primarily used to fund our acquisitions.

As of December 28, 2024, our outstanding balance under the Credit Agreement was $278.4 million, including $71.4 million of euro-denominated borrowings. We also had $121.8 million of available borrowing capacity, along with a $200.0 million uncommitted, unsecured incremental borrowing facility. Borrowings under our revolving credit facility bear variable rates of interest and adjust frequently based on prevailing market rates and the terms of our Credit Agreement. Under our debt agreements, our leverage ratio must be less than 3.75 or, if we elect, for the quarter during which a material acquisition occurs and for the three fiscal quarters thereafter, must be less than 4.25. As of December 28, 2024, our leverage ratio was 0.99 and we were in compliance with our debt covenants. See Note 6, Long-Term Obligations, in the accompanying consolidated financial statements for additional information regarding our debt obligations.

Additional Liquidity and Capital Resources

In addition to the obligations on our consolidated balance sheet at December 28, 2024, which include, but are not limited to, long-term obligations (Note 6), unrecognized tax benefits (Note 5), leases (Note 9), and contingent consideration associated with a 2024 acquisition (Note 2), we have outstanding letters of credit and bank guarantees of $13.9 million at December 28, 2024, primarily relating to performance obligations and customer deposit guarantees (Note 7).

On May 16, 2024, our board of directors approved the repurchase of up to $50.0 million of our equity securities during the period from May 16, 2024 to May 16, 2025. We have not repurchased any shares of our common stock under this authorization or under our previous $50.0 million authorization that expired on May 18, 2024.

We paid cash dividends of $14.7 million in 2024. On November 14, 2024, we declared a quarterly cash dividend of $0.32 per share totaling $3.8 million that was paid on February 6, 2025. 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 also subject to our compliance with the covenant in our Credit Agreement related to our consolidated leverage ratio.

We plan to make capital expenditures of approximately $24.0 to $26.0 million during 2025 for property, plant, and equipment.

As of December 28, 2024, we had approximately $296.1 million of total unremitted foreign earnings. It is our intent to indefinitely reinvest $255.3 million of these earnings to support the current and future capital needs of our foreign operations, including debt repayments, if any. In 2024, 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 $5.3 million.

We believe that our existing cash and cash equivalents, along with cash generated from operations and our existing borrowing capacity will be sufficient to meet the capital requirements of our operations for the next 12 months and the foreseeable future.

Application of Critical Accounting 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 and estimates 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 estimates and other accounting policies, see Note 1, Nature of Operations and Summary of Significant Accounting Policies, in the accompanying consolidated financial statements. We believe that our most critical accounting policies and estimates 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 tax 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

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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. 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 2024, we maintained a valuation allowance against a portion of our state operating loss carryforwards in the United States and a valuation allowance in certain foreign jurisdictions due to the uncertainty of future profitability in the state and those foreign jurisdictions. Our tax valuation allowance was $7.6 million at year-end 2024.

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 2024, our liability for these unrecognized tax benefits, including an accrual for the related interest and penalties, totaled $18.0 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 2024, we recorded $0.6 million of tax expense associated with these foreign earnings that we plan to repatriate in 2025. 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.

In December 2021, the OECD released the Pillar Two Rules. Since the release of the Pillar Two Rules, the OECD has issued four tranches of administrative guidance, as well as guidance on transitional safe harbor relief. Various countries, including the member states of the European Union, have adopted Pillar Two Rules into their domestic laws, with certain rules coming into effect for fiscal years beginning in 2024. While the Pillar Two Rules serve as a framework for implementing the minimum tax, countries may enact domestic laws that vary slightly from the Pillar Two Rules and may also adjust domestic tax incentives to align with the Pillar Two Rules on different timelines. We continue to assess the potential impact of the Pillar Two global minimum tax on our operations and effective tax rate. Certain jurisdictions in which we operate have enacted or proposed legislation to align with the OECD's Pillar Two Rules. For fiscal 2024, we qualify for the transitional safe harbor, which provides temporary relief from the application of the global minimum tax. As a result of meeting the transitional safe harbor criteria, we do not anticipate a material impact on our effective tax rate or incremental tax liabilities in the near term. We continue to evaluate our eligibility under the safe harbor provisions and monitor evolving regulatory guidance that may affect our long-term tax position.

Revenue Recognition

Approximately 90% 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.

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 using the multi-

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period excess earnings and relief-from-royalty valuation methods, which are based on projections of discounted cash flows or royalty payments avoided that we expect from the identifiable intangible assets of the acquired businesses. Our valuation models incorporate significant assumptions, including future revenue growth rates, customer attrition rates, gross and operating margins, discount rates and royalty rates. The determination of the allocation of the purchase price for 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 first day of our fourth quarter of each fiscal year, or more frequently if events or changes in circumstances indicate that the carrying value of an asset might be impaired. Potential impairment indicators include a significant decline in sales, earnings, or cash flows, material adverse changes in the business climate, and a significant decline in the market capitalization due to a sustained decrease in our stock price. We are permitted to first assess qualitative factors to determine whether the quantitative impairment test is necessary. If the qualitative impairment analysis (Step 0) results in a determination that the fair value of a reporting unit or an indefinite lived intangible asset is more likely than not less than its carrying amount, we perform a quantitative impairment analysis (Step 1). We may bypass the qualitative assessment and proceed directly to the quantitative assessment. 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 September 29, 2024 (the first day of the fourth quarter of 2024), we performed a qualitative impairment analysis on our goodwill and indefinite-lived intangible assets. Based on these analyses, we determined goodwill and indefinite-lived intangible assets were not impaired. Goodwill totaled $493.1 million and indefinite-lived intangible assets totaled $28.6 million at September 29, 2024. At year-end 2024, no factors were identified that would alter the conclusions of our September 29, 2024 analysis. Goodwill totaled $479.2 million and indefinite-lived intangible assets totaled $27.9 million at year-end 2024.

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 2024 and 2023. Definite-lived intangible assets were $251.6 million at year-end 2024.

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.

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 excessive 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 heading Recent Accounting Pronouncements, in the accompanying consolidated financial statements for further details.