KADANT INC 10-Q

Item 2 – Management's Discussion and Analysis of Financial Condition and Results of Operations When we use the terms “we,” “us,” “our,” and the “Company,” we mean Kadant Inc., a Delaware corporation, and its consolidated subsidiaries, taken as a whole, unless the context otherwise indicates. This Quarterly Report on Form 10-Q and the documents we incorporate by reference in this report include forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act), and Section 27A of the Securities Act of 1933, as amended. These forward-looking statements are not statements of historical fact and may include statements regarding possible or assumed future results of operations. Forward-looking statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management, using information currently available to our management. When we use words such as "believes," "expects," "anticipates," "intends," "plans," "estimates," "seeks," "should," "likely," "will," "would," "may," "continue," "could," or similar expressions, we are making forward-looking statements. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions. Our future results of operations may differ materially from those expressed in the forward-looking statements. Many of the important factors that will determine these results and values are beyond our ability to control or predict. You should not put undue reliance on any forward-looking statements. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events, or otherwise. For a discussion of important factors that may cause our actual results to differ materially from those suggested by the forward-looking statements, you should read carefully Risk Factors included in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended January 2, 2021, as filed with the Securities and Exchange Commission (SEC) and as may be further amended and/or restated in subsequent filings with the SEC. 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. Our financial results are reported in three 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; and the Material Handling segment consists of our conveying and screening, baling, and fiber-based product lines. 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 primary products include rotary sealing devices, steam systems, expansion joints, doctor systems, roll and fabric cleaning devices, and filtration and fiber recovery systems. • Industrial Processing – Equipment, machinery, and technologies used to recycle paper and paperboard and process timber for use in the packaging, tissue, wood products, and alternative fuel industries, among others. Our primary 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 primary 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. 23 Table of Contents KADANT INC. Industry and Business Overview We had record consolidated bookings of $244.7 million in the third quarter of 2021, including bookings of $15.0 million attributable to our acquisitions. See Acquisitions below for further details. Our third quarter of 2021 bookings include record orders for capital equipment and continued strong demand for our parts and consumables products. This follows previous consolidated bookings records set in the prior three quarters as our businesses continue to rebound from the impact of the COVID-19 pandemic, which adversely affected our bookings and revenue for a substantial part of 2020. We ended the third quarter of 2021 with record consolidated backlog of $299.5 million. An overview of our business by segment is as follows: • Flow Control – During the third quarter of 2021, we acquired The Clouth Group of Companies (Clouth), which contributed $9.9 million of bookings for the quarter . Orders for both parts and consumables products and capital equipment at our existing Flow Control businesses continue to be strong, following record bookings during the first half of 2021 due to improved market conditions and pent-up demand from depressed levels encountered during most of 2020. • Industrial Processing – Our Industrial Processing segment had record bookings for capital equipment and continued strong demand for parts and consumables products during the third quarter of 2021. Orders for both capital equipment and parts and consumables products at our wood processing business were fueled by an ongoing robust U.S. housing market and high demand for lumber, oriented strand board and plywood, which continues to result in high parts consumption and drive new capital equipment investment by our customers. More recently, maintenance requirements at many of our wood processing customers have augmented demand for our parts products, which we expect to continue for the remainder of the year. Increased bookings at our stock-preparation business was led by orders for fiber processing systems at our North American and European businesses. This followed strong bookings for capital equipment at our Chinese operation in the prior quarter. Orders for parts and consumables products for our stock-preparation business moderated slightly following three quarters of strong bookings attributable to improved market conditions and pent-up demand. • Material Handling – Our Material Handling segment also had record bookings in the third quarter of 2021. In August 2021, we acquired East Chicago Machine Tool Corporation (Balemaster) and certain assets of affiliated companies, which contributed $5.1 million of orders for the period. Bookings for baling products at our European operations continue to be bolstered by improved business conditions, including the recovery of recycled commodity prices. Bookings at our conveying and screening business have begun to rebound from 2020 levels with ongoing improved demand for our parts and consumables products as a result of the relaxation of pandemic-related restrictions. While we have seen improved market conditions for our products and we expect our financial results for the remainder of 2021 to be strong, there is still some uncertainty regarding near-term economic growth due to ongoing risks surrounding the COVID-19 pandemic. Additionally, some of our operations have been and may continue to be impacted by supply chain constraints, resulting in inflationary pressure on material costs, longer lead times, and increased freight costs, as well as customer-requested delays in shipments. Also, in September 2021, China began limiting electricity usage within many of its provinces, requiring businesses in those regions to take downtime. We have been able to mitigate increased material costs through price adjustments on many of our products; however, we cannot be sure that we will be able to absorb future increases through price adjustments. While our businesses are working to alleviate supply chain constraints through various measures, we are unable to predict the impact of these constraints and the impact from China's energy use restrictions on the timing of revenue and operating costs on our business in the near future. For more information on risks related to health epidemics to our business, including COVID-19, and other factors impacting our business discussed above, please see Risk Factors included in Part II, Item 1A , of this report, and Part I, Item 1A, Risk Factors , included in our Annual Report on Form 10-K for the fiscal year ended January 2, 2021. International Sales 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 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. 24 Table of Contents KADANT INC. Global Trade The United States imposes 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 have worked 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, included in our Annual Report on Form 10-K for the fiscal year ended January 2, 2021. 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 the third quarter of 2021, we acquired Clouth for $93.1 million, net of cash acquired plus debt assumed. Clouth, which is included in our Flow Control segment, is a leading manufacturer of doctor blades and related equipment used in the production of paper, packaging, and tissue. We expect several synergies in connection with this acquisition, including deepening our presence in the growing ceramic blade market and expansion of product sales at our existing businesses by leveraging Clouth's complementary global geographic footprint. Clouth has two manufacturing facilities in Germany and one in Poland and generated revenue of approximately 40.5 million euros for the trailing twelve months ended June 30, 2021. In the third quarter of 2021, we also acquired Balemaster for $53.7 million, net of cash acquired. Balemaster, which is included in our Material Handling segment, is a leading U.S. manufacturer of horizontal balers and related equipment used primarily for recycling packaging waste at corrugated box plants and large retail and distribution centers. We expect several synergies in connection with this acquisition, including expanding our presence in the secondary material processing sector and creating new opportunities for leveraging our high-performance balers produced in Europe. Balemaster's revenue for the trailing twelve months ended June 30, 2021 was approximately $22.2 million. See Note 2 , Acquisitions, in the accompanying condensed consolidated financial statements for further details. In June 2020, we made an acquisition in our Industrial Processing segment for approximately $6.9 million, net of cash acquired. Results of Operations Third Quarter 2021 Compared With Third Quarter 2020 Revenue The following table presents the change in revenue by segment between the third quarters of 2021 and 2020, and those changes excluding the effect of foreign currency translation and acquisitions 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 U.S. generally accepted accounting principles (GAAP) measure. Revenue by segment in the third quarters of 2021 and 2020 was as follows: (Non-GAAP) Three Months Ended Currency Translation Acquisitions Change in Organic Revenue (In thousands, except percentages) October 2, 2021 September 26, 2020 Total Increase % Change Increase % Change Flow Control $ 76,253 $ 56,815 $ 19,438 34 % $ 1,332 $ 9,913 $ 8,193 14 % Industrial Processing 81,620 62,086 19,534 31 % 2,847 — 16,687 27 % Material Handling 41,916 35,709 6,207 17 % 419 2,845 2,943 8 % Consolidated Revenue $ 199,789 $ 154,610 $ 45,179 29 % $ 4,598 $ 12,758 $ 27,823 18 % Consolidated revenue in the third quarter of 2021 increased 29%, while consolidated organic revenue increased 18%, due to higher demand for parts and consumables products and capital equipment principally at our Industrial Processing and Flow Control segments as described below. 25 Table of Contents KADANT INC. Revenue at our Flow Control segment increased 34% in the third quarter of 2021, while organic revenue increased 14%. Organic revenue increased due to higher demand for parts and consumables products at substantially all locations resulting from improved market conditions and pent-up demand and due to increased capital equipment revenue at our North American business, which was attributable in part to customer reductions in spending and deferrals of equipment installations in the corresponding 2020 period. Revenue at our Industrial Processing segment increased 31% in the third quarter of 2021, while organic revenue increased 27% due to higher demand for both capital equipment and parts and consumables products at our wood processing and stock-preparation businesses. Demand for our wood processing business products was driven by high mill activity resulting in increased capital investment and higher parts consumption. Increased demand for capital equipment at our stock-preparation business was primarily attributable to capital orders at our Chinese business, offset in part by lower capital equipment revenue at our North American business due to the timing of orders. Organic revenue for parts and consumables products at our North American stock-preparation business also increased due to improved market conditions and pent-up demand coupled with a depressed 2020 period as a result of the COVID-19 pandemic. Revenue at our Material Handling segment increased 17% in the third quarter of 2021, while organic revenue increased 8%. Increased demand for products at our European baling operation due to improved business conditions in Europe, including the recovery of recycled commodity prices, was partially offset by lower capital equipment revenue at our conveying and screening business. Gross Profit Margin Gross profit margin by segment in the third quarters of 2021 and 2020 was as follows: Three Months Ended Basis Point Change October 2, 2021 September 26, 2020 Flow Control 49.7 % 52.9% (320) bps Industrial Processing 39.7 % 43.7% (400) bps Material Handling 31.9 % 31.1% 80 bps Consolidated Gross Profit Margin 41.9 % 44.2% (230) bps Consolidated gross profit margin declined to 41.9% in the third quarter of 2021 compared with 44.2% in the third quarter of 2020 due to the inclusion of $2.2 million of amortization of acquired profit in inventory, which lowered consolidated gross profit margin in the 2021 period by 1.1 percentage points, and the inclusion of $1.6 million for benefits received from government employee retention assistance programs, which increased consolidated gross profit margin in the 2020 period by 1.1 percentage points. Gross profit margin at our Flow Control segment decreased to 49.7% in the third quarter of 2021 compared with 52.9% in the third quarter of 2020 primarily due to the inclusion of $1.8 million of amortization of acquired profit in inventory for Clouth, which lowered gross profit margin in the 2021 period by 2.4 percentage points, and a lower gross profit margin profile for Clouth. Gross profit margin at our existing businesses increased principally due to higher margins on parts and consumables. Gross profit margin at our Industrial Processing segment decreased to 39.7% in the third quarter of 2021 compared with 43.7% in the third quarter of 2020 due to the inclusion of $1.4 million for benefits received from government employee retention assistance programs, which increased gross profit margin in the 2020 period by 2.3 percentage points, and the impact of lower-margin capital equipment revenue at our Chinese stock-preparation business. Gross profit margin at our Material Handling segment increased to 31.9% in the third quarter of 2021 compared with 31.1% in the third quarter of 2020 primarily due to a higher gross profit margin profile for Balemaster and an improved gross profit margin at our existing baler business resulting from a favorable product mix and higher revenue. These items were offset in part by $0.4 million of amortization of acquired profit in inventory for Balemaster, which lowered gross profit margin for this segment by 0.9 percentage points. 26 Table of Contents KADANT INC. Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses by segment in the third quarters of 2021 and 2020 were as follows: Three Months Ended (In thousands, except percentages) October 2, 2021 % of Revenue September 26, 2020 % of Revenue Increase % Change Flow Control $ 19,658 26 % $ 15,136 27 % $ 4,522 30% Industrial Processing 15,229 19 % 13,759 22 % 1,470 11% Material Handling 9,465 23 % 7,955 22 % 1,510 19% Corporate 7,964 N/A 7,003 N/A 961 14% Consolidated SG&A Expenses $ 52,316 26 % $ 43,853 28 % $ 8,463 19% Consolidated SG&A expenses as a percentage of revenue decreased to 26% in the third quarter of 2021 compared with 28% in the third quarter of 2020 primarily due to higher revenue. Consolidated SG&A expenses increased $8.5 million du e to the inclusion of $3.4 million of SG&A expenses from acquisitions, an incremental $0.9 million of acquisition-related costs, $0.9 million from the unfavorable effect of currency translation, and a $0.7 million decrease in benefits received from government employee retention assistance programs. The remaining $2.6 million is principally due to increased incentive compensation, travel-related costs, and professional services fees resulting from improved business conditions. SG&A expenses at our Flow Control segment increased $4.5 million principally due to the inclusion of $2.8 million of SG&A expenses from Clouth, $0.9 million of acquisition-related costs, and $0.4 million from the unfavorable effect of foreign currency translation. SG&A expenses at our Industrial Processing segment increased $1.5 million principally due to the inclusion of $0.7 million in the 2020 period for benefits received from government employee retention assistance programs, increased travel-related costs and professional service fees, and $0.5 million from the unfavorable effect of foreign currency translation. SG&A expenses at our Material Handling segment increased $1.5 million principally due to the inclusion of $0.6 million of SG&A expenses from Balemaster, increased travel-related costs and professional service fees, and $0.2 million of incremental acquisition-related costs. SG&A expenses at Corporate increased $1.0 million primarily due to additional incentive compensation as a result of our improved financial performance. Restructuring Costs Restructuring costs were $0.5 million in the third quarter of 2020, which represented severance costs of $0.3 million in our Flow Control segment and $0.2 million in our Industrial Processing segment. Interest Expense Interest expense decreased to $1.3 million in the third quarter of 2021 from $1.7 million in the third quarter of 2020 due to a lower weighted-average interest rate. Provision for Income Taxes Our provision for income taxes increased to $6.7 million in the third quarter of 2021 from $4.7 million in the third quarter of 2020. The effective tax rate of 25% in the third quarter of 2021 was higher than our statutory rate of 21% primarily due to nondeductible expenses, the distribution of our worldwide earnings, state taxes, and tax expense associated with Global Intangible Low-Taxed Income (GILTI) provisions. These increases in tax expense were offset in part by a decrease in tax related to the net excess income tax benefits from stock-based compensation arrangements. The effective tax rate of 24% in the third quarter of 2020 was higher than our statutory rate of 21% primarily due to nondeductible expenses and the distribution of our worldwide earnings. These increases in tax expense were offset in part by a tax benefit related to final GILTI regulations issued by the U.S. Treasury Department during the third quarter of 2020 on an election to provide a high-tax exception to the GILTI tax retroactive to 2018. Net Income Net income increased to $20.7 million in the third quarter of 2021 from $15.0 million in the third quarter of 2020 primarily due to a $7.4 million increase in operating income, offset in part by a $2.0 million increase in provision for income taxes (see discussions above for further details). 27 Table of Contents KADANT INC. First Nine Months 2021 Compared With First Nine Months 2020 Revenue The following table presents changes in revenue by segment between the first nine months of 2021 and 2020, and those changes excluding the effect of foreign currency translation and acquisitions 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 measure. Revenue by segment in the first nine months of 2021 and 2020 was as follows: (Non-GAAP) Nine Months Ended Currency Translation Acquisitions Change in Organic Revenue (In thousands, except percentages) October 2, 2021 September 26, 2020 Total Increase % Change Increase % Change Flow Control $ 210,769 $ 165,329 $ 45,440 27 % $ 6,749 $ 9,913 $ 28,778 17 % Industrial Processing 233,455 192,468 40,987 21 % 12,087 509 28,391 15 % Material Handling 123,839 108,800 15,039 14 % 3,348 2,845 8,846 8 % Consolidated Revenue $ 568,063 $ 466,597 $ 101,466 22 % $ 22,184 $ 13,267 $ 66,015 14 % Consolidated revenue in the first nine months of 2021 increased 22%, while consolidated organic revenue increased 14%, principally driven by higher demand for parts and consumables products and, to a lesser extent, capital equipment at our Flow Control and Industrial Processing segments as described below. Revenue at our Flow Control segment increased 27% in the first nine months of 2021, while organic revenue increased 17%. The increase in organic revenue resulted from higher demand for parts and consumables products and, to a lesser extent, capital equipment at substantially all locations. Increased demand for parts and consumables products was due in part to maintenance requirements at many of our customer locations and pent-up demand, while the 2020 period was depressed as a result of customer downtimes and shutdowns as well as visitation restrictions related to the COVID-19 pandemic. Increased demand for capital equipment was due to improved market conditions and pent-up demand w hile the corresponding 2020 period was adversely impacted by customer reductions in capital spending and deferrals of equipment installations as a result of the COVID-19 pandemic. Revenue at our Industrial Processing segment increased 21% in the first nine months of 2021, while organic revenue increased 15% due to higher demand for parts and consumables products at our wood processing and stock-preparation businesses and capital equipment at our wood processing business. Demand for parts and consumables products and, to a lesser extent, capital equipment at our wood processing business was driven by high mill activity resulting in higher parts consumption and increased capital investment. Demand for parts and consumables at our North American stock-preparation business increased due to improved market conditions and pent-up demand coupled with a depressed 2020 period as a result of the COVID-19 pandemic. Conversely, lower capital equipment revenue at our North American and European stock-preparation businesses due to the timing of orders and curtailed spending by our customers, which impacted revenue in the first half of 2021, was offset in part by revenue attributable to capital equipment orders at our Chinese business. Revenue at our Material Handling segment increased 14% in the first nine months of 2021, while organic revenue increased 8%. Increased demand for products at our European baling operation due to improved business conditions in Europe, including the recovery of recycled commodity prices, was partially offset by lower capital equipment revenue at our conveying and screening business. Gross Profit Margin Gross profit margin by segment in the first nine months of 2021 and 2020 was as follows: Nine Months Ended Basis Point Change October 2, 2021 September 26, 2020 Flow Control 51.8 % 53.1% (130) bps Industrial Processing 40.1 % 41.0% (90) bps Material Handling 33.8 % 33.5% 30 bps Consolidated Gross Profit Margin 43.1 % 43.5% (40) bps 28 Table of Contents KADANT INC. Consolidated gross profit margin declined slightly to 43.1% in the first nine months of 2021 compared with 43.5% in the first nine months of 2020. The 2021 period included $2.2 million of amortization of acquired profit in inventory, which lowered consolidated gross profit margin by 0.4 percentage points. We received benefits from government employee retention assistance programs of $0.9 million, or 0.2% of revenue, in the first nine months of 2021 compared with $2.9 million, or 0.6% of revenue, in the first nine months of 2020. Gross profit margin at our Flow Control segment decreased to 51.8% in the first nine months of 2021 compared with 53.1% in the first nine months of 2020 due to the inclusion of $1.8 million of amortization of acquired profit in inventory, which lowered the gross profit margin in the 2021 period by 0.9 percentage points and, to a lesser extent, a lower gross profit margin profile for Clouth. Gross profit margin at our Industrial Processing segment decreased to 40.1% in the first nine months of 2021 compared with 41.0% in the first nine months of 2020 due to lower benefits received from government retention assistance programs. We received benefits from government employee retention assistance programs of $0.7 million, or 0.3% of revenue, in the first nine months of 2021 compared with $2.4 million, or 1.2% of revenue, in the first nine months of 2020. Higher margins at our wood processing business primarily resulting from manufacturing efficiencies related to higher production volumes were offset by the impact of lower-margin capital equipment revenue at our Chinese stock-preparation business. Gross profit margin at our Material Handling segment increased slightly to 33.8% in the first nine months of 2021 compared with 33.5% in the first nine months of 2020. Selling, General, and Administrative Expenses SG&A expenses by segment in the first nine months of 2021 and 2020 were as follows: Nine Months Ended (In thousands, except percentages) October 2, 2021 % of Revenue September 26, 2020 % of Revenue Increase % Change Flow Control $ 54,226 26 % $ 46,876 28 % $ 7,350 16% Industrial Processing 45,339 19 % 42,499 22 % 2,840 7% Material Handling 27,518 22 % 24,730 23 % 2,788 11% Corporate 23,931 N/A 20,413 N/A 3,518 17% Consolidated SG&A Expenses $ 151,014 27 % $ 134,518 29 % $ 16,496 12% Consolidated SG&A expenses as a percentage of revenue decreased to 27% in the first nine months of 2021 compared with 29% in the first nine months of 2020 principally due to higher revenue. Consolidated SG&A expenses increased $16.5 million principally due to $5.2 million from the unfavorable effect of currency translation, the inclusion of $3.7 million of SG&A expenses from acquisitions, additional incentive compensation resulting from our improved financial performance, an incremental $2.5 million of acquisition-related costs, and increased professional service fees. SG&A expenses included benefits received from government employee retention assistance programs of $1.4 million in the first nine months of 2021 and $1.8 million in the first nine months of 2020. SG&A expenses at our Flow Control segment increased $7.4 million principally due to the inclusion of $2.8 million of SG&A expenses from Clouth, $2.1 million of acquisition-related costs, and $1.8 million from the unfavorable effect of foreign currency translation. SG&A expenses at our Industrial Processing segment increased $2.8 million principally due to $2.6 million from the unfavorable effect of foreign currency translation and a $0.7 million reduction in benefits received from government assistance programs. SG&A expenses at our Material Handling segment increased $2.8 million principally due to $0.8 million from the unfavorable effect of foreign currency translation, an incremental $0.8 million of acquisition-related costs, and the inclusion of $0.6 million of SG&A expenses from Balemaster. SG&A expenses at Corporate increased $3.5 million primarily due to additional incentive compensation as result of improved financial performance and, to a lesser extent, higher professional service fees. Restructuring Costs Restructuring costs were $0.9 million in the first nine months of 2020, which represented severance costs of $0.7 million in our Flow Control segment and $0.2 million in our Industrial Processing segment. 29 Table of Contents KADANT INC. Interest Expense Interest expense decreased to $3.5 million in the first nine months of 2021 from $6.1 million in the first nine months of 2020 due to a lower weighted-average interest rate and lower outstanding debt for the first nine months of 2021. Provision for Income Taxes Our provision for income taxes increased to $21.3 million in the first nine months of 2021 from $13.7 million in the first nine months of 2020 and represented 26% of pre-tax income in both periods. The effective tax rate in the first nine months of 2021 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, nondeductible expenses, state taxes, and tax expense associated with GILTI. These increases in tax expense were offset in part by a decrease in tax related to the net excess income tax benefits from stock-based compensation arrangements. The effective tax rate in the first nine months of 2020 was higher than our statutory rate of 21% primarily due to nondeductible expenses, the distribution of our worldwide earnings, and state taxes. These increases in tax expense were offset in part by a decrease in tax related to the net excess income tax benefits from stock-based compensation arrangements. Net Income Net income increased to $60.5 million in the first nine months of 2021 from $39.4 million in the first nine months of 2020 primarily due to a $26.1 million increase in operating income and a $2.6 million decrease in interest expense, offset in part by a $7.5 million increase in provision for income taxes (see discussions above for further details). Liquidity and Capital Resources Consolidated working capital was $177.4 million at October 2, 2021, compared with $155.1 million at January 2, 2021. Cash and cash equivalents were $82.6 million at October 2, 2021, compared with $65.7 million at January 2, 2021, which included cash and cash equivalents held by our foreign subsidiaries of $78.6 million at October 2, 2021 and $63.6 million at January 2, 2021. Cash Flows Cash flow information in the first nine months of 2021 and 2020 was as follows: Nine Months Ended (In thousands) October 2, 2021 September 26, 2020 Net Cash Provided by Operating Activities $ 101,410 $ 52,601 Net Cash Used in Investing Activities (148,587) (12,459) Net Cash Provided by (Used in) Financing Activities 66,714 (52,871) Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash (2,513) 660 Increase (Decrease) in Cash, Cash Equivalents, and Restricted Cash $ 17,024 $ (12,069) Operating Activities Cash provided by operating activities increased to $101.4 million in the first nine months of 2021 from $52.6 million in the first nine months of 2020. 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 increase in cash provided by operating activities in the 2021 period was principally driven by improvements in net income and working capital. Cash provided by working capital was $11.7 million in the first nine months of 2021. Cash provided by working capital in 2021 included $33.3 million from other current liabilities primarily due to an increase in customer deposits and advance billings related to capital equipment orders that will be fulfilled over the next year and $19.8 million from accounts payable attributable to increased inventory purchases. These sources of cash were offset in part by cash used of $22.3 million for accounts receivable mostly due to revenue growth and timing of shipments, $10.6 million for a buildup of inventories primarily for capital equipment orders and to mitigate potential supply chain issues, and $8.1 million for other current assets principally due to a prepayment for raw material at one of our Chinese businesses. Cash used for working capital was $15.4 million in the first nine months of 2020. Cash used for working capital in 2020 included $6.2 million for inventories primarily related to the buildup of inventory for capital equipment and spare parts 30 Table of Contents KADANT INC. that were shipped in late fiscal 2020 and early fiscal 2021 and $13.2 million from accounts payable primarily due to reduced spending levels in 2020. Investing Activities Cash used in investing activities was $148.6 million in the first nine months of 2021, compared with $12.5 million in the first nine months of 2020. Cash used in investing activities included consideration paid for acquisitions, net of cash acquired, of $141.5 million in the 2021 period and $7.1 million in the 2020 period. Financing Activities Cash provided by financing activities was $66.7 million in the first nine months of 2021, compared with cash used in financing activities of $52.9 million in the first nine months of 2020. Borrowings under our revolving credit facility were $151.9 million in the first nine months of 2021, including $140.3 million to fund acquisitions, and $26.0 million in the first nine months of 2020, including $18.9 million used to prepay the outstanding principal balance on our real estate loan. Repayment of long-term obligations was $72.7 million in the first nine months of 2021, and $69.0 million in the first nine months of 2020, including the $18.9 million prepayment of the real estate loan. 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 $2.5 million reduction in cash, cash equivalents, and restricted cash in the first nine months of 2021 was primarily attributable to the strengthening of the U.S. dollar against the euro. Borrowing Capacity and Debt Obligations We entered into an unsecured multi-currency revolving credit facility, dated as of March 1, 2017 (as amended and restated to date, the Credit Agreement). As of October 2, 2021, we have a borrowing capacity of $369.9 million, including $104.9 million available under the Credit Agreement, an additional $150 million in an uncommitted, unsecured incremental borrowing facility under the Credit Agreement, and $115 million of senior promissory notes available for issuance under our uncommitted Multi-Currency Note Purchase and Private Shelf Agreement (Note Purchase Agreement), which expires on December 14, 2021. Under these 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 4.00. As of October 2, 2021, our leverage ratio was 1.69 and we were in compliance with our debt covenants. Except for $5.6 million of short-term obligations and current maturities of long-term obligations, we do not have any material mandatory principal payments on our debt obligations until 2023. See Note 5 , Short- and Long-Term Obligations, in the accompanying condensed consolidated financial statements for additional information regarding our debt obligations. Additional Liquidity and Capital Resources On May 20, 2021, our board of directors approved the repurchase of up to $20 million of our equity securities during the period from May 20, 2021 to May 20, 2022. We have not repurchased any shares of our common stock under this authorization or our previous authorization, which expired on May 13, 2021. We paid cash dividends of $8.6 million in the first nine months of 2021. On September 9, 2021, we declared a quarterly cash dividend of $0.25 per share totaling $2.9 million that will be paid on November 11, 2021. 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 $5 to $7 million during the remainder of 2021 for property, plant, and equipment. As of October 2, 2021, we had approximately $230.6 million of total unremitted foreign earnings. It is our intent to indefinitely reinvest $212.5 million of these earnings to support the current and future capital needs of our foreign operations, including debt repayments, if any. In the first nine months of 2021, 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 $4.4 million. In the future, our liquidity position will be affected by 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 Credit Agreement and available through our Note Purchase Agreement, and the cash 31 Table of Contents KADANT INC. 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 There have been no material changes to our contractual obligations and other commercial commitments during the first nine months of 2021 compared with those disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations, set forth in Part II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended January 2, 2021, except for an increase of $81.0 million of short- and long-term obligations as of October 2, 2021 primarily related to our acquisitions. See Note 2 , Acquisitions, and Note 5 , Short- and Long-term Obligations, in the accompanying condensed consolidated financial statements. Application of Critical Accounting Policies and Estimates Management's discussion and analysis of financial condition and results of operations is based upon our condensed 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 liabilities, and the reported amounts of revenue and expenses during the reporting period. Our 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. Management evaluates its estimates on an ongoing basis based on historical experience, current economic and market conditions, and other assumptions management believes are reasonable. We believe that our most critical accounting policies which are significant to our consolidated financial statements, and which involve the most complex or subjective decisions or assessments, are those described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the section captioned "Application of Critical Accounting Policies and Estimates" in Part II, Item 7, of our Annual Report on Form 10-K for the fiscal year ended January 2, 2021. There have been no material changes to these critical accounting policies since the end of fiscal 2020 that warrant disclosure. Recent Accounting Pronouncements See Note 1 , under the headings Recently Adopted Accounting Pronouncements and Recent Accounting Pronouncements Not Yet Adopted , in the accompanying condensed consolidated financial statements for details. Item 3 – Quantitative and Qualitative Disclosures About Market Risk Our exposure to market risk from changes in interest rates and foreign currency exchange rates has not changed materially from our exposure as disclosed in Part II, Item 7A, of our Annual Report on Form 10-K for the fiscal year ended January 2, 2021.