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 II , Item 1A , of this report and Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended January 1, 2022 (the Annual Report) and as may be further amended and/or restated in subsequent filings 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 operating segments. 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 vibratory, 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. Industry and Business Overview We had consolidated bookings of $265.9 million in the second quarter of 2022 down slightly from our record bookings of $266.1 million in the first quarter of 2022. Our consolidated bookings in the second quarter of 2022 included $25.9 million attributable to our acquisitions. See Acquisitions below for further details. We also had a higher unfavorable foreign currency translation impact compared to prior quarters due to the strengthening U.S. dollar resulting in a $9.9 million, or 4%, decrease in bookings compared to the second quarter of 2021. Following our record first quarter 2022 bookings, we continued 21 Table of Contents KADANT INC. to see strong demand for both parts and consumables and capital equipment products. We expect a lower level of bookings in the second half of the year compared to the record bookings in the first half of 2022 as end-market demand slows in response to actions taken by the central banks to control inflation. We ended the second quarter of 2022 with record consolidated backlog of $379.2 million. An overview of our business by segment is as follows: • Flow Control – Our Flow Control segment had its second highest bookings quarter, following our record bookings in the first quarter, increasing 36% compared to the second quarter of 2021. This increase included a 19% increase from our acquisition of The Clouth Group of Companies (Clouth) and a 5% decrease from the unfavorable effect of foreign currency translation. Orders for both parts and consumables products and capital equipment at our existing Flow Control businesses continue to be strong due to growth in the industries we serve. We expect bookings to moderate in the second half of 2022 compared with the record-setting booking performance achieved during the first half of the year. • Industrial Processing – Our Industrial Processing segment bookings increased 3% sequentially and 8% compared to the second quarter of 2021 resulting from strong demand for our capital equipment at our wood processing business due to the robust U.S. housing market and high demand for lumber, oriented strand board and plywood. Capital bookings at our stock-preparation business were lower in the second quarter of 2022 compared to the record bookings levels in the second and third quarters of 2021. While we continue to experience robust capital project activity, we expect a lower level of capital bookings in our Industrial Processing segment in the third quarter of 2022 compared to prior quarters as customers assess new capital expenditures, and as the pace of capacity expansion moderates and new equipment is brought online. Orders for parts and consumables products at our Industrial Processing segment increased over the second quarter of 2021 due to continued improvement in market conditions. • Material Handling – Our Material Handling segment bookings increased 49% compared to the second quarter of 2021, including a 30% increase from our acquisition of East Chicago Machine Tool Corporation (Balemaster) and a 19% increase in capital bookings at our conveying and vibratory business. We expect demand for baling products at our European operations to moderate in the second half of 2022. Many of our operations continue to be impacted by labor availability and supply chain constraints, the latter of which resulted in inflationary pressure on material costs, longer lead times, and increased freight costs. Our businesses are alleviating supply chain constraints through various measures, including advance purchases of raw materials to prevent potential manufacturing disruptions and mitigating increased material and freight costs through price adjustments, when possible. We believe that the fundamentals of our business will remain positive, particularly given our high backlog levels, continued strong bookings, and ongoing strength in the markets we serve. Despite this optimism, we expect our operating environment to continue to be challenging as a result of the factors impacting our business discussed above and the uncertainties and risks surrounding the COVID-19 pandemic, including China's zero-COVID policy. For more information related to these challenges, and other factors impacting our business, including recent geopolitical tensions, please see Risk Factors included in Part II, Item 1A , of this report, and Part 1, Item 1A, of our Annual Report and subsequent filings with the SEC. International Sales Slightly more than half of our sales are to customers outside the United States, mainly in Europe, Asia, and Canada. As a result, our financial performance can be materially affected by currency exchange rate fluctuations between the U.S. dollar and foreign currencies. In the first half of 2022, we experienced a significant unfavorable foreign currency translation effect on our results of operations compared to 2021 due to the strengthening of the U.S. dollar against foreign currencies in countries in which we operate, especially the euro. We expect this trend to continue throughout the remainder of the year. 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. To mitigate the impact of foreign currency transaction 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. 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 and subsequent filings with the SEC. 22 Table of Contents KADANT INC. Acquisitions We expect that a significant driver of our growth over the next several years will be the acquisition of businesses and technologies that complement or augment our existing products and services or may involve entry into a new process industry. We continue to pursue acquisition opportunities. In the third quarter of 2021, we acquired Clouth for $92.9 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 three manufacturing facilities in Germany and one in Poland. In the third quarter of 2021, we also acquired Balemaster for $53.5 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. Results of Operations Second Quarter 2022 Compared With Second Quarter 2021 Revenue The following table presents the change in revenue by segment between the second quarters of 2022 and 2021, 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 second quarters of 2022 and 2021 was as follows: (Non-GAAP) Three Months Ended Currency Translation Acquisitions Change in Organic Revenue (In thousands, except percentages) July 2, 2022 July 3, 2021 Total Increase % Change Increase % Change Flow Control $ 85,220 $ 70,762 $ 14,458 20 % $ (2,949) $ 11,949 $ 5,458 8 % Industrial Processing 84,402 82,681 1,721 2 % (3,683) 185 5,219 6 % Material Handling 52,027 42,368 9,659 23 % (2,431) 7,778 4,312 10 % Consolidated Revenue $ 221,649 $ 195,811 $ 25,838 13 % $ (9,063) $ 19,912 $ 14,989 8 % Consolidated revenue increased 13% in the second quarter of 2022, including a 10% increase from acquisitions and a 5% decrease from the negative effect of foreign currency translation. Organic revenue increased 8% due to higher demand for parts and consumables products, principally at our Flow Control segment and capital equipment at our Material Handling and Industrial Processing segments as described below. Revenue at our Flow Control segment increased 20% in the second quarter of 2022, while organic revenue increased 8%. Organic revenue increased due to higher demand for parts and consumables products in North America resulting from improved market conditions. Revenue at our Industrial Processing segment increased 2% in the second quarter of 2022, while organic revenue increased 6%. Organic revenue increased due to higher demand for parts and consumables products at our wood processing business due in part to maintenance spending by our customers. Also contributing to the organic revenue increase was an increase in demand for capital equipment at our European stock-preparation business due to several large projects. Revenue at our Material Handling segment increased 23% in the second quarter of 2022, while organic revenue increased 10% due to higher demand for capital equipment at our European baling operations due to improved business conditions. 23 Table of Contents KADANT INC. Gross Profit Margin Gross profit margin by segment in the second quarters of 2022 and 2021 was as follows: Three Months Ended Basis Point Change July 2, 2022 July 3, 2021 Flow Control 52.8% 52.8% 0 bps Industrial Processing 38.4% 40.1% (170) bps Material Handling 35.9% 34.9% 100 bps Consolidated Gross Profit Margin 43.3% 43.6% (30) bps Consolidated gross profit margin decreased to 43.3% in the second quarter of 2022 compared with 43.6% in the second quarter of 2021 due to the inclusion of $0.5 million of benefits received from government employee retention assistance programs, which increased gross profit margin in the 2021 period by 0.3 percentage points. Within our operating segments, gross profit margin: • Decreased to 38.4% from 40.1% at our Industrial Processing segment due to the impact of lower-margin capital equipment revenue at our Chinese stock-preparation business and the inclusion of $0.4 million for benefits received from government employee retention assistance programs, which increased gross profit margin in the 2021 period by 0.5 percentage points. • Increased to 35.9% from 34.9% at our Material Handling segment primarily due to a higher gross profit margin profile from our Balemaster business acquired in 2021. Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses by segment in the second quarters of 2022 and 2021 were as follows: Three Months Ended (In thousands, except percentages) July 2, 2022 % of Revenue July 3, 2021 % of Revenue Increase % Change Flow Control $ 20,969 25% $ 17,064 24% $ 3,905 23% Industrial Processing 15,614 18% 14,420 17% 1,194 8% Material Handling 9,498 18% 8,993 21% 505 6% Corporate 9,238 N/A 8,790 N/A 448 5% Consolidated SG&A Expenses $ 55,319 25% $ 49,267 25% $ 6,052 12% Consolidated SG&A expenses as a percentage of revenue remained flat at 25% in the second quarter of 2022 compared with the second quarter of 2021. Consolidated SG&A expenses increased $6.1 million du e to the inclusion of $5.0 million of SG&A expenses from acquisitions, increased selling-related costs associated with improved business conditions, and the inclusion of benefits received from government employee retention assistance programs of $1.0 million in the second quarter of 2021. These increases were offset by a $2.1 million favorable effect of foreign currency translation and a decrease of $0.6 million in acquisition costs. Within our operating segments, SG&A expenses: • Increased $3.9 million at our Flow Control segment principally due to the inclusion of $3.5 million of SG&A expenses from Clouth, increased selling-related costs, and $0.5 million of benefits received from government employee retention assistance programs which lowered SG&A in the 2021 period. These increases were partially offset by a $0.8 million favorable effect of foreign currency translation and a $0.2 million decrease in acquisition costs. • Increased $1.2 million at our Industrial Processing segment principally due to increased selling-related costs, partially offset by a $0.9 million favorable effect of foreign currency translation. • Increased $0.5 million at our Material Handling segment principally due to the inclusion of $1.4 million of SG&A expenses from Balemaster, partially offset by a $0.4 million favorable effect of foreign currency translation and a $0.3 million decrease in acquisition costs. 24 Table of Contents KADANT INC. Interest Expense Interest expense increased to $1.4 million in the second quarter of 2022 from $1.1 million in the second quarter of 2021 due to a higher weighted-average interest rate in the second quarter of 2022 as compared to the second quarter of 2021. Provision for Income Taxes Provision for income taxes increased to $10.0 million in the second quarter of 2022 from $8.9 million in the second quarter of 2021. The effective tax rate of 27% in the second quarter of 2022 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, state taxes, nondeductible expenses, and the cost of repatriating the earnings of certain foreign subsidiaries. The effective tax rate of 28% in the second quarter 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 Global Intangible Low-Taxed Income (GILTI) provisions. Net Income Net income increased to $26.4 million in the second quarter of 2022 from $23.0 million in the second quarter of 2021 primarily due to a $4.5 million increase in operating income, offset in part by a $1.0 million increase in provision for income taxes (see discussions above for further details). First Six Months 2022 Compared With First Six Months 2021 Revenue The following table presents changes in revenue by segment between the first six months of 2022 and 2021, 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 six months of 2022 and 2021 was as follows: (Non-GAAP) Six Months Ended Currency Translation Acquisitions Change in Organic Revenue (In thousands, except percentages) July 2, 2022 July 3, 2021 Total Increase % Change Increase % Change Flow Control $ 171,046 $ 134,516 $ 36,530 27 % $ (4,377) $ 24,222 $ 16,685 12 % Industrial Processing 177,487 151,835 25,652 17 % (5,072) 319 30,405 20 % Material Handling 99,596 81,923 17,673 22 % (3,494) 15,371 5,796 7 % Consolidated Revenue $ 448,129 $ 368,274 $ 79,855 22 % $ (12,943) $ 39,912 $ 52,886 14 % Consolidated revenue in the first six months of 2022 increased 22%, including an 11% increase from acquisitions and a 3% decrease from the negative effect of foreign currency translation. Organic revenue increased 14%, principally driven by higher demand for capital equipment at our Industrial Processing segment and, to a lesser extent, parts and consumables at our Flow Control and Industrial Processing segments, as described below. Revenue at our Flow Control segment increased 27% in the first six months of 2022, while organic revenue increased 12%. Organic revenue increased due to higher demand for our parts and consumables products in North America and capital equipment in Europe, resulting from improved market conditions. Revenue at our Industrial Processing segment increased 17% in the first six months of 2022, while organic revenue increased 20% due to higher demand for capital equipment, especially in Europe and, to a lesser extent, China and North America. 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 primarily occurred at our European and Chinese operations due to improved market conditions. Also contributing to the organic revenue increase was an increase in demand for parts and consumables products at our wood processing business due to maintenance spending by our customers. Revenue at our Material Handling segment increased 22% in the first six months of 2022, while organic revenue increased 7% due to higher demand for capital equipment at our European baling operations due to improved business 25 Table of Contents KADANT INC. conditions, and parts and consumables at our conveying business resulting from a strong demand in the aggregate and food and packaging industries. Gross Profit Margin Gross profit margin by segment in the first six months of 2022 and 2021 was as follows: Six Months Ended Basis Point Change July 2, 2022 July 3, 2021 Flow Control 52.6% 53.0% (40) bps Industrial Processing 38.5% 40.3% (180) bps Material Handling 36.1% 34.8% 130 bps Consolidated Gross Profit Margin 43.3% 43.7% (40) bps Consolidated gross profit margin decreased to 43.3% in the first six months of 2022 compared with 43.7% in the first six months of 2021 due to the inclusion of $0.9 million of benefits received from government employee retention assistance programs, which increased gross profit margin in the 2021 period by 0.2 percentage points, and the impact of lower margin capital equipment revenue. Within our operating segments, gross profit margin: • Decreased to 52.6% from 53.0% at our Flow Control segment due to a lower gross profit margin profile from our recently acquired Clouth business. • Decreased to 38.5% from 40.3% at our Industrial Processing segment due to the impact of lower-margin capital equipment revenue at our Chinese stock-preparation business and the inclusion of $0.7 million for benefits received from government employee retention assistance programs, which increased gross profit margin in the 2021 period by 0.4 percentage points. • Increased to 36.1% from 34.8% at our Material Handling segment primarily due to a higher gross profit margin profile from our Balemaster business acquired in 2021. Selling, General, and Administrative Expenses SG&A expenses by segment in the first six months of 2022 and 2021 were as follows: Six Months Ended (In thousands, except percentages) July 2, 2022 % of Revenue July 3, 2021 % of Revenue Increase % Change Flow Control $ 43,053 25 % $ 34,568 26 % $ 8,485 25% Industrial Processing 31,983 18 % 30,110 20 % 1,873 6% Material Handling 20,502 21 % 18,053 22 % 2,449 14% Corporate 18,949 N/A 15,967 N/A 2,982 19% Consolidated SG&A Expenses $ 114,487 26 % $ 98,698 27 % $ 15,789 16% Consolidated SG&A expenses as a percentage of revenue decreased to 26% in the first six months of 2022 compared with 27% in the first six months of 2021 principally due to higher revenue. Consolidated SG&A expenses increased $15.8 million due to the inclusion of $11.1 million of SG&A expenses from acquisitions, increased compensation expense associated with existing and new personnel, and increased selling-related costs associated with improved business conditions. These increases were offset in part by a $3.1 million favorable effect of foreign currency translation. Within our operating segments, SG&A expenses: • Increased $8.5 million at our Flow Control segment principally due to the inclusion of $7.8 million of SG&A expenses from Clouth and increased personnel and selling-related costs. These increases were partially offset by a $1.2 million favorable effect of foreign currency translation. • Increased $1.9 million at our Industrial Processing segment due to increased selling-related costs and a $0.6 million reversal of an indemnification asset related to the release of tax reserves. These increases were partially offset by a $1.2 million favorable effect of foreign currency translation. • Increased $2.4 million at our Material Handling segment principally due to the inclusion of $3.1 million of SG&A expenses from Balemaster, partially offset by a $0.7 million favorable effect of foreign currency translation. 26 Table of Contents KADANT INC. • Increased $3.0 million at Corporate primarily due to increased incentive compensation and travel expense due to improved business conditions. Gain on Sale and Other Expense, Net We entered into several agreements with the local government in China to sell the existing manufacturing building and land use rights at one of our subsidiaries in China for $25.2 million. The agreements became effective in the first quarter of 2022 after a 31% down payment was received, including 25% in 2021 and 6% in the first quarter of 2022, and a land use right in a new location was secured. As a result, we recognized a gain on the sale of these assets of $20.2 million, or $15.1 million, net of deferred taxes of $5.1 million, in the first quarter of 2022. A receivable of $16.1 million was recognized for the present value of the remaining amount of the sale proceeds, which is due the earlier of when the government sells the property or within two years from the effective date of the agreements. The amount of the receivable recorded at July 2, 2022 was $15.4 million. Our subsidiary, which is part of our Industrial Processing segment, will continue to occupy its current facility until construction of its new facility is complete. In the first quarter of 2022, we recognized an impairment charge of $0.2 million related to the write-down of certain fixed assets that will not be moved to the new facility. Interest Expense Interest expense increased to $2.6 million in the first six months of 2022 from $2.2 million in the first six months of 2021 due to a higher weighted-average interest rate for the first six months of 2022 compared to the first six months of 2021. Provision for Income Taxes Provision for income taxes increased to $23.3 million in the first six months of 2022 from $14.5 million in the first six months of 2021. The effective tax rate of 26% in the first six months of 2022 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, nondeductible expenses, 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. The effective tax rate of 27% in the first six 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. Net Income Net income increased to $67.9 million in the first six months of 2022 from $39.8 million in the first six months of 2021 primarily due to a $37.0 million increase in operating income, offset in part by a $8.8 million increase 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 foreign currency translation and acquisitions), 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 cash flow provided by operations 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 impairment costs, acquisition costs, amortization expense related to acquired profit in inventory and backlog, and certain gains or losses. 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 27 Table of Contents KADANT INC. and for compensation purposes. We also believe this information is responsive to investors' requests and gives them an additional measure 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 flow 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 is as follows: Three Months Ended Six Months Ended (In thousands, except percentages) July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 Net Income Attributable to Kadant $ 26,170 $ 22,864 $ 67,362 $ 39,425 Net Income Attributable to Noncontrolling Interest 239 163 488 398 Provision for Income Taxes 9,951 8,949 23,329 14,510 Interest Expense, Net 1,089 1,010 2,221 2,056 Other Expense, Net 19 24 41 48 Operating Income 37,468 33,010 93,441 56,437 Gain on Sale of Assets (a) — — (20,190) — Acquisition Costs — 603 76 1,901 Indemnification Asset Reversal (b) — — 575 — Impairment Costs — — 182 — Acquired Backlog Amortization (c) — 27 703 87 Acquired Profit in Inventory Amortization (d) — — (218) — Adjusted Operating Income (non-GAAP measure) 37,468 33,640 74,569 58,425 Depreciation and Amortization 8,486 7,689 17,228 15,315 Adjusted EBITDA (non-GAAP measure) $ 45,954 $ 41,329 $ 91,797 $ 73,740 Adjusted EBITDA Margin (non-GAAP measure) 20.7% 21.1% 20.5% 20.0% A reconciliation of free cash flow from cash flow provided by operating activities is as follows: Three Months Ended Six Months Ended (In thousands) July 2, 2022 July 3, 2021 July 2, 2022 July 3, 2021 Cash Provided by Operating Activities $ 18,797 $ 44,386 $ 42,565 $ 63,478 Less: Capital Expenditures (e) (6,947) (2,059) (9,815) (4,318) Free Cash Flow (non-GAAP measure) $ 11,850 $ 42,327 $ 32,750 $ 59,160 (a) Consists of a $20.2 million gain on the sale of a Chinese facility in our Industrial Processing segment pursuant to a relocation plan. (b) Represents an indemnification asset reversal related to the release of tax reserves associated with uncertain tax positions. (c) Represents intangible amortization expense associated with acquired backlog. (d) Represents income within the cost of revenue associated with amortization of acquired profit in inventory. (e) Includes capital expenditures of $3.1 million and $3.2 million in the three and six months ended July 2, 2022, respectively, associated with the construction of a new manufacturing facility in China (as discussed below). Liquidity and Capital Resources Consolidated working capital was $181.0 million at July 2, 2022, compared with $162.4 million at January 1, 2022. Cash and cash equivalents were $76.5 million at July 2, 2022, compared with $91.2 million at January 1, 2022, which included cash and cash equivalents held by our foreign subsidiaries of $70.1 million at July 2, 2022 and $83.8 million at January 1, 2022. 28 Table of Contents KADANT INC. Cash Flows Cash flow information in the first six months of 2022 and 2021 was as follows: Six Months Ended (In thousands) July 2, 2022 July 3, 2021 Net Cash Provided by Operating Activities $ 42,565 $ 63,478 Net Cash Used in Investing Activities (7,894) (3,869) Net Cash (Used in) Provided by Financing Activities (45,388) 32,698 Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash (5,418) (803) (Decrease) Increase in Cash, Cash Equivalents, and Restricted Cash $ (16,135) $ 91,504 Operating Activities Cash provided by operating activities decreased to $42.6 million in the first six months of 2022 from $63.5 million in the first six months of 2021. 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. Cash provided by income in the first six months of 2022 was offset in part by investments in working capital. Increases in inventory and accounts receivable used cash of $39.2 million, including $26.8 million from inventory primarily related to capital equipment orders that will ship in the latter half of fiscal 2022 and early fiscal 2023. These uses of cash were offset in part by an increase in cash provided of $9.3 million from customer deposits. Cash provided by income in the first six months of 2021 was offset in part by investments in working capital. Cash provided by working capital in 2021 included $12.9 million from accounts payable related to inventory purchases for increased order activity and $11.1 million in customer deposits for capital equipment orders. These sources of cash were offset in part by cash used of $22.6 million for accounts receivable and inventory as a result of revenue growth and to support increased demand. Investing Activities Cash used in investing activities was $7.9 million in the first six months of 2022, compared with $3.9 million in the first six months of 2021. Cash used in investing activities in the first six months of 2022 included capital expenditures of $9.8 million, which included $3.2 million for expenditures associated with the manufacturing facility and building relocation project in China. This use of cash was partially offset by proceeds received from the sale of assets of $1.9 million. Cash used in investing activities in the first six months of 2021 included capital expenditures of $4.3 million. Financing Activities Cash used in financing activities was $45.4 in the first six months of 2022, compared with cash provided by financing activities of $32.7 million in the first six months of 2021. Repayment of short- and long-term obligations was $51.4 million in the first six months of 2022, partially offset by borrowings under our revolving credit facility of $16.5 million compared to borrowings under our revolving credit facility of $88.9 million in the first six months of 2021, partially offset by repayment of short- and long-term obligations of $47.1 million. In addition, taxes paid related to the vesting of equity awards was $4.6 million in the first six months of 2022 compared to $3.4 million in the first six months of 2021. 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 $5.4 million reduction in cash, cash equivalents, and restricted cash in the first six months of 2022 was primarily attributable to the strengthening of the U.S. dollar against the euro and Chinese renminbi and, to a lesser extent, the British pound sterling. 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 July 2, 2022, the outstanding balance under the Credit Agreement was $210.5 million, which included $70.5 million of euro-denominated borrowings. As of July 2, 2022, we have a borrowing capacity available under the Credit Agreement of $189.0 million in addition to a $150.0 million uncommitted, unsecured incremental 29 Table of Contents KADANT INC. borrowing facility. 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 4.00. As of July 2, 2022, our leverage ratio was 1.05 and we were in compliance with our debt covenants. We expect to renew our Credit Agreement prior to its maturity date of December 14, 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 19, 2022, our board of directors approved the repurchase of up to $50 million of our equity securities during the period from May 19, 2022 to May 19, 2023. We have not repurchased any shares of our common stock under this authorization or under our previous $20 million authorization which expired on May 20, 2022. We paid cash dividends of $5.9 million in the first six months of 2022. On May 19, 2022, we declared a quarterly cash dividend of $0.26 per share totaling $3.0 million that will be paid on August 11, 2022. 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 $21 to $23 million during the remainder of 2022 for property, plant, and equipment, including $9 million for a new manufacturing facility. One of our Chinese subsidiaries is building a new manufacturing facility and relocating over the next two years. Capital expenditures for the new facility are estimated to be approximately $20 million, including $12 million in 2022. The cost of the new facility will be offset by the proceeds received from the sale of our existing facility. See Note 2 , Gain on Sale and Other Expense, Net, in the accompanying condensed consolidated financial statements for additional information regarding the relocation of our Chinese manufacturing facility. As of July 2, 2022, we had approximately $217.7 million of total unremitted foreign earnings. It is our intent to indefinitely reinvest $182.2 million of these earnings to support the current and future capital needs of our foreign operations, including debt repayments, if any. In the first six months of 2022, 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 $3.0 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 existing cash and cash equivalents, along with cash generated from operations, our existing borrowing capacity and continued access to debt markets, will be sufficient to meet the capital requirements of our operations for the next 12 months and 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 six months of 2022 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. 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 Estimates" in Part II, Item 7, of our Annual Report. There have been no material changes to these critical accounting policies since the end of fiscal 2021 that warrant disclosure. Recent Accounting Pronouncements See Note 1 , under the headings Recent Accounting Pronouncements Not Yet Adopted , in the accompanying condensed consolidated financial statements for details. 30 Table of Contents KADANT INC. 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.