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 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 December 30, 2023 (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 business. 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, energy, 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 process recycled paper and timber for 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 custom engineered knife systems. 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 Our consolidated bookings increased 17% to $251.7 million in the second quarter of 2024 compared to the second quarter of 2023, including a 13% increase from acquisitions and a 5% increase in organic bookings due to strong demand for our parts and consumables products across all segments. We expect overall demand for our products in the second half of 2024 to be similar to the first half of the year, despite persistent economic headwinds in certain regions. For 2024, we expect higher annual parts and consumables bookings driven by the high percentage of aftermarket business at our recent acquisitions. While demand for our parts and consumables products remains strong, we have seen a lengthening in the timing for securing capital 25 Table of Contents KADANT INC. orders as customers are being more cautious with some delaying large capital expenditures to later in the year or into early next year. This is due to several factors, including economic uncertainty surrounding actions by central banks, macroeconomic conditions abroad, and the consolidation of some of our large customers. Looking beyond 2024, we see long-term strength in our end markets as customers continue to turn to our products to help maximize productivity with 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, including those targeting environmental initiatives. An overview of our business by segment is as follows: • Flow Control – Our Flow Control segment bookings increased 7%, including 5% from organic bookings, compared to the second quarter of 2023 primarily resulting from increased demand in Europe for our parts and consumables products due to improvements in the paper market. Despite higher bookings in the quarter in Europe, there is continued uncertainty in the end markets we serve primarily due to geopolitical tensions and weak macroeconomic conditions. In North America, economic conditions and the consolidation of several of our large customers has created some uncertainty on the timing for securing capital orders. While we expect demand to follow its historical pattern and moderate slightly in the second half of 2024, the strength of our end markets and a record backlog at the end of the second quarter has placed the Flow Control segment in a solid position as we enter the second half of the year. • Industrial Processing – Our Industrial Processing segment bookings increased 22% compared to the second quarter of 2023, including 18% from acquisitions and 5% from organic bookings. Our parts and consumables bookings were a record in the second quarter, but we expect demand to moderate in the second half of the year, especially at our wood processing business with mill curtailments anticipated in response to low lumber prices. Demand for our capital equipment increased 37% sequentially and we expect comparatively higher capital bookings in the second half of the year compared to the first half of 2024. We expect steady demand in our Industrial Processing segment for the remainder of the year and higher annual bookings in 2024. • Material Handling – Our Material Handling segment bookings increased 28% compared to the second quarter of 2023, including 22% from acquisitions and 6% from organic bookings. The majority of our conveying and vibratory business is in North America where market conditions have caused customers to be more cautious with large capital expenditures. However, the long-term outlook for the aggregates industry remains strong fueled by new infrastructure projects as a result of significant federal and state investment. The largest concentration in our baling business is in Europe, where a growing need for efficient waste handling and packing solutions across various industries is increasing demand for our baling products. We expect steady demand in our Material Handling segment to continue for the remainder of 2024. 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 than predicted, growth in the European economy has slowed due to high interest rates and elevated inflation, and China's manufacturing activity has contracted. We expect our operating environment to continue to be challenging, which creates continued uncertainty for the remainder of 2024. However, we believe that the fundamentals of our business remain strong, particularly given our solid market position in key product lines, solid global operations teams, and long-term strength of our end markets. For more information related to these challenges, and other factors impacting our business, please see Risk Factors included in Part I, 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. 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. 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. 26 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 Risk Factors, included in Part I, Item 1A, of our Annual Report and subsequent filings with the SEC. 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. On January 1, 2024, we acquired Key Knife, Inc. and certain of its affiliates (collectively, Key Knife) for $153.4 million, net of cash acquired. 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. On January 24, 2024, we acquired KWS Manufacturing Company, Ltd. (KWS) for $81.2 million, subject to a post-closing adjustment. 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 Dynamic Sealing Technologies LLC and affiliates (collectively, DSTI) for $53.7 million, net of cash acquired and subject to a post-closing adjustment. 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. See Note 2 , Acquisitions, in the accompanying condensed consolidated financial statements for further details. Results of Operations Second Quarter 2024 Compared With Second Quarter 2023 Revenue The following table presents the change in revenue by segment between the second quarters of 2024 and 2023, and those changes excluding the effect of foreign currency translation and acquisitions 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 U.S. generally accepted accounting principles (GAAP) measure. Revenue by segment in the second quarters of 2024 and 2023 is as follows: Three Months Ended Increase (Decrease) Currency Translation Acquisitions (Non-GAAP) Change in Organic Revenue (In thousands, except percentages) June 29, 2024 July 1, 2023 % Change Increase (Decrease) % Change Flow Control $ 92,290 $ 95,729 $ (3,439) (4)% $ (762) $ 1,524 $ (4,201) (4)% Industrial Processing 114,753 89,967 24,786 28% (1,392) 14,771 11,407 13% Material Handling 67,722 59,357 8,365 14% (162) 11,087 (2,560) (4)% Consolidated $ 274,765 $ 245,053 $ 29,712 12% $ (2,316) $ 27,382 $ 4,646 2% Consolidated revenue increased 12% in the second quarter of 2024, while organic revenue increased 2%. The increase in organic revenue is largely due to increased demand for our capital equipment products at our Industrial Processing segment, 27 Table of Contents KADANT INC. partially offset by weaker demand for our Flow Control capital equipment products and Material Handling parts and consumables (aftermarket) products. From a geographic perspective, the majority of the organic revenue increase was driven by higher demand in North America where the U.S. economy and industrial demand continued to demonstrate resiliency against inflationary pressures, partially offset by softening demand in Europe due to weak macroeconomic conditions. Revenue at our Flow Control segment decreased 4% in the second quarter of 2024 primarily due to decreased demand for our capital equipment products in Europe as a result of challenging market conditions and a slowdown in manufacturing activity. Revenue at our Industrial Processing segment increased 28% in the second quarter of 2024, including a 16% increase from acquisitions. Organic revenue increased 13% in the second quarter of 2024 principally due to increased demand for our capital equipment products at both our wood processing and stock-preparation businesses. At our wood processing business, capital equipment revenue increased 86% in Europe due to the shipment of several large projects. At our stock-preparation business, the increased demand primarily related to replacement and refurbishment projects in North America and from mills in China seeking fiber processing solutions with reduced energy consumption. Revenue at our Material Handling segment increased 14% in the second quarter of 2024, while organic revenue decreased 4% primarily due to weaker demand for our parts and consumable products at our conveying and vibratory business as customers focused on capital investments. In addition, decreased demand for our capital equipment products at our baling business was due to constrained market conditions in Europe and the delay of several large projects to later in the year. Gross Profit Margin Gross profit margin by segment in the second quarters of 2024 and 2023 is as follows: Three Months Ended Basis Point Change June 29, 2024 July 1, 2023 Flow Control 53.0% 51.4% 160 bps Industrial Processing 41.3% 39.5% 180 bps Material Handling 37.8% 36.8% 100 bps Consolidated 44.4% 43.5% 90 bps Consolidated gross profit margin increased to 44.4% in the second quarter of 2024 compared with 43.5% in the second quarter of 2023 due to higher margins achieved on our capital equipment products across all our segments, especially at our Industrial Processing segment. Within our operating segments, gross profit margin: • Increased to 53.0% at our Flow Control segment from 51.4% in the 2023 period primarily due to higher margins achieved on our capital equipment products and, to a lesser extent, a higher proportion of parts and consumables revenue. These increases were partially offset by the inclusion of $0.2 million of amortization expense related to acquired profit in inventory, which lowered gross profit margin in 2024 by 0.3 percentage points. • Increased to 41.3% at our Industrial Processing segment from 39.5% in the 2023 period due to higher margins achieved on our capital equipment products. This was partially offset by lower margins achieved on our parts and consumables products and, to a lesser extent, the inclusion of $0.3 million of amortization expense related to acquired profit in inventory, which lowered gross profit margin in 2024 by 0.2 percentage points. • Increased to 37.8% at our Material Handling segment from 36.8% in the 2023 period primarily due to higher margins achieved on capital equipment revenue, partially offset by a lower proportion of parts and consumables revenue. 28 Table of Contents KADANT INC. Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses by segment in the second quarters of 2024 and 2023 are as follows: Three Months Ended (In thousands, except percentages) June 29, 2024 July 1, 2023 Increase % Change Flow Control $ 23,971 $ 22,200 $ 1,771 8% Industrial Processing 21,866 16,677 5,189 31% Material Handling 13,758 11,019 2,739 25% Corporate 10,409 10,094 315 3% Consolidated $ 70,004 $ 59,990 $ 10,014 17% Consolidated as a Percentage of Revenue 25% 24% Consolidated SG&A expenses as a percentage of revenue increased to 25% in 2024 from 24% in 20 23 due to the impact of our acquisitions and acquisition-related costs. Consolidated SG&A expenses increased $10.0 million, or 17%, primarily due to the inclusion of $8.2 million of SG&A expenses from acquisitions and an incremental $1.6 million of acquisition-related costs. Acquisition-related costs included in SG&A consist of amortization expense associated with acquired backlog and acquisition costs. Within our operating segments, SG&A expenses: • Increased $1.8 million at our Flow Control segment principally due to the inclusion of $0.6 million of SG&A expenses from an acquisition, $0.8 million of acquisition-related costs and increased compensation expense. • Increase d $5.2 million at our Industrial Processing segment due to the inclusion of $4.8 million of SG&A expenses from acquisitions and increased compensation expense associated with new and existing personnel. • Increased $2.7 million at our Material Handling segment principally due to the inclusion of $2.7 million of SG&A expenses from acquisitions and $0.7 million of acquisition-related costs, partially offset by a decrease of $0.3 million in external commissions. • Increased $0.3 million at Corporate due to increased compensation expense. Other Costs Other costs of $0.1 million were incurred in the second quarter of 2023 within our Industrial Processing segment related to the write-down of certain fixed assets that were not moved to a new manufacturing facility in China and facility moving costs. Interest Expense Interest expense increased to $5.2 million in the second quarter of 2024 from $2.2 million in the second quarter of 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 Provision for income taxes increased to $12.0 million in the second quarter of 2024 from $11.2 million in the second quarter of 2023. The effective tax rate of 28% in the second quarter of 2024 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. These items were offset in part by foreign tax credits. The effective tax rate of 27% in the second quarter of 2023 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, state taxes, nondeductible expenses, and tax expense associated with the Global Intangible Low-Taxed Income provisions. Net Income Net income increased to $31.6 million in the second quarter of 2024 from $29.9 million in the second quarter of 2023 primarily due to a $5.3 million increase in operating income, offset in part by a $3.0 million increase in interest expense and a $0.8 increase in provision for income taxes (see discussions above for further details). 29 Table of Contents KADANT INC. First Six Months 2024 Compared With First Six Months 2023 Revenue The following table presents changes in revenue and organic revenue by segment between the first six months of 2024 and 2023. Organic revenue is a non-GAAP measure as defined above in the results of operations for the second quarter of 2024 compared with the second quarter of 2023. Revenue by segment in the first six months of 2024 and 2023 is as follows: Six Months Ended Currency Translation Acquisitions (Non-GAAP) Change in Organic Revenue (In thousands, except percentages) June 29, 2024 July 1, 2023 Increase (Decrease) % Change Increase (Decrease) % Change Flow Control $ 178,972 $ 185,250 $ (6,278) (3)% $ (28) $ 1,524 $ (7,774) (4)% Industrial Processing 220,614 173,509 47,105 27% (1,499) 31,372 17,232 10% Material Handling 124,154 116,052 8,102 7% 39 18,849 (10,786) (9)% Consolidated $ 523,740 $ 474,811 $ 48,929 10% $ (1,488) $ 51,745 $ (1,328) —% Consolidated revenue in the first six months of 2024 increased 10%, while organic revenue remained flat. Stronger demand at our Industrial Processing segment, especially for our capital equipment products, was offset by weaker demand for our products at our other segments. From a geographic perspective, the majority of the change in organic revenue was driven by softening demand in Europe due to weak macroeconomic conditions, largely offset by strong industrial demand in North America. Revenue at our Flow Control segment decreased 3% in the first six months of 2024 due to decreased demand for our capital equipment products in Europe and China reflecting the challenging market conditions and slowdown in manufacturing activity. This decrease was partially offset by higher demand for our capital equipment products in North America driven by continued strength in the U.S. economy and underlying packaging industry. Revenue at our Industrial Processing segment increased 27% in the first six months of 2024, including an 18% increase from acquisitions. Organic revenue increased 10% in the first six months of 2024 primarily due to increased demand for our capital equipment products at both our wood processing and stock-preparation businesses. At our wood processing business, capital equipment revenue increased 20% due to higher demand for debarking products in Europe and the shipment of a large capital project for oriented strand board in North America. At our stock-preparation business, capital equipment revenue increased 25% 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. Revenue at our Material Handling segment increased 7% in the first six months of 2024 due to our acquisitions. Organic revenue decreased 9% driven by weaker demand for our products in North America and Europe. At our baling business in Europe, decreased demand for our capital equipment products was due to weaker market conditions, which have lengthened quote-to-order times and delayed several large projects to later in the year. At our conveying and vibratory business, several large parts orders associated with capital projects in the first half of 2023 resulted in comparatively lower organic parts and consumables revenue in the first half of 2024. Gross Profit Margin Gross profit margin by segment in the first six months of 2024 and 2023 is as follows: Six Months Ended Basis Point Change June 29, 2024 July 1, 2023 Flow Control 53.4% 52.3% 110 bps Industrial Processing 41.5% 40.0% 150 bps Material Handling 36.8% 36.4% 40 bps Consolidated 44.5% 43.9% 60 bps Consolidated gross profit margin increased to 44.5% in the first six months of 2024 compared with 43.9% in the first six months of 2023 due to higher margins achieved on our capital equipment products across all our segments, especially at our Industrial Processing segment. This increase was partially offset by the inclusion of $2.9 million of amortization expense related to acquired profit in inventory, which lowered consolidated gross profit margin in 2024 by 0.5 percentage points. 30 Table of Contents KADANT INC. Within our operating segments, gross profit margin: • Increased to 53.4% at our Flow Control segment from 52.3% in the 2023 period primarily due to higher margins achieved on our capital equipment products. • Increased to 41.5% at our Industrial Processing segment from 40.0% in the 2023 period due to higher margins achieved on our capital equipment products and, to a lesser extent, a higher proportion of parts and consumables revenue. These increases were partially offset by the inclusion of $1.6 million of amortization expense related to acquired profit in inventory, which lowered gross profit margin in 2024 by 0.7 percentage points. • Increased to 36.8% at our Material Handling segment from 36.4% in the 2023 period primarily due to higher margins achieved on our capital equipment products. This increase 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 0.8 percentage points. Selling, General, and Administrative Expenses SG&A expenses by segment in the first six months of 2024 and 2023 are as follows: Six Months Ended (In thousands, except percentages) June 29, 2024 July 1, 2023 Increase % Change Flow Control $ 47,395 $ 44,417 $ 2,978 7% Industrial Processing 44,384 32,975 11,409 35% Material Handling 27,798 21,738 6,060 28% Corporate 20,732 19,422 1,310 7% Consolidated $ 140,309 $ 118,552 $ 21,757 18% Consolidated as a Percentage of Revenue 27% 25% Consolidated SG&A expenses as a percentage of revenue increased to 27% in the first six months of 2024 compared with 25% in the first six months of 20 23 principally due to the impact of our acquisitions and acquisition-related costs. Consolidated SG&A expenses increased $21.8 million, or 18%, primarily due to the inclusion of $15.5 million of SG&A expenses from acquisitions, $3.6 million of acquisition-related costs and increased compensation expense associated with new and existing personnel. Within our operating segments, SG&A expenses: • Increased $3.0 million at our Flow Control segment principally due to the inclusion of $0.6 million of SG&A expenses from an acquisition, $0.8 million of acquisition-related costs and increased compensation expense. • Increased $11.4 million at our Industrial Processing segment due to the inclusion of $9.9 million of SG&A expenses from acquisitions and $0.7 million of acquisition-related costs. • Increased $6.1 million at our Material Handling segment primarily due to the inclusion of $4.9 million of SG&A expenses from acquisitions and $2.1 million of acquisition-related costs, partially offset by a decrease of $0.4 million in external commissions. • Increased $1.3 million at Corporate d ue to increased consulting costs and compensation expense. Other Costs Other costs of $0.1 million were incurred in the first six months of 2023 within our Industrial Processing segment related to the write-down of certain fixed assets that were not moved to a new manufacturing facility in China and facility moving costs. Interest Expense Interest expense increased to $9.9 million in the first six months of 2024 from $4.6 million in the first six months of 2023 due t o 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. 31 Table of Contents KADANT INC. Provision for Income Taxes Provision for income taxes decreased to $19.8 million in the first six months of 2024 from $20.9 million in the first six months of 2023. The effective tax rate of 26% in the six months of 2024 was higher than our statutory rate of 21% primarily due to the distribution of our worldwide earnings, nondeductible expenses, state taxes, and the cost of repatriating the earnings of certain foreign subsidiaries. These items were offset in part by foreign tax credits and net excess income tax benefits from stock-based compensation arrangements. The effective tax rate of 26% in the first six months of 2023 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 $56.6 million in the first six months of 2024 from $58.2 million in the first six months of 2023 primarily due to a $5.3 million increase in interest expense, offset in part by a $2.1 million increase in operating income and a $1.1 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 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 amortization expense related to acquired profit in inventory and backlog, acquisition costs, and other income or 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 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 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. 32 Table of Contents KADANT INC. 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) June 29, 2024 July 1, 2023 June 29, 2024 July 1, 2023 Net Income Attributable to Kadant $ 31,291 $ 29,734 $ 55,980 $ 57,809 Net Income Attributable to Noncontrolling Interests 283 212 579 396 Provision for Income Taxes 11,992 11,182 19,846 20,945 Interest Expense, Net 4,833 1,929 8,891 4,000 Other Expense, Net 2 21 32 42 Operating Income 48,401 43,078 85,328 83,192 Acquired Profit in Inventory Amortization (a) 529 — 2,860 — Acquired Backlog Amortization (b) 695 — 1,494 — Acquisition Costs 940 — 2,064 — Indemnification Asset (Provision) Reversal, Net (c) (66) 177 24 177 Other Costs — 74 — 74 Adjusted Operating Income (non-GAAP measure) 50,499 43,329 91,770 83,443 Depreciation and Amortization 11,296 8,237 22,236 16,683 Adjusted EBITDA (non-GAAP measure) $ 61,795 $ 51,566 $ 114,006 $ 100,126 Adjusted EBITDA Margin (non-GAAP measure) 22.5% 21.0% 21.8% 21.1% (a) Represents amortization expense within cost of revenue associated with acquired profit in inventory. (b) Represents intangible amortization expense associated with acquired backlog. (c) Represents the provision for or reversal of indemnification assets related to the release of tax reserves associated with uncertain tax positions. A reconciliation of free cash flow from cash flow provided by operating activities is as follows: Three Months Ended Six Months Ended (In thousands) June 29, 2024 July 1, 2023 June 29, 2024 July 1, 2023 Cash Provided by Operating Activities $ 28,066 $ 22,478 $ 50,897 $ 59,344 Capital Expenditures (4,974) (8,777) (11,245) (13,246) Free Cash Flow (non-GAAP measure) $ 23,092 $ 13,701 $ 39,652 $ 46,098 Liquidity and Capital Resources Consolidated working capital was $253.4 million at June 29, 2024, compared with $225.8 million at December 30, 2023. Cash and cash equivalents were $73.8 million at June 29, 2024, compared with $103.8 million at December 30, 2023, which included cash and cash equivalents held by our foreign subsidiaries o f $63.7 million at June 29, 2024 and $94.6 million at December 30, 2023. Cash Flows Cash flow information in the first six months of 2024 and 2023 is as follows: Six Months Ended (In thousands) June 29, 2024 July 1, 2023 Net Cash Provided by Operating Activities $ 50,897 $ 59,344 Net Cash Used in Investing Activities (301,518) (12,902) Net Cash Provided by (Used in) Financing Activities 222,837 (56,551) Exchange Rate Effect on Cash, Cash Equivalents, and Restricted Cash (3,491) 579 Decrease in Cash, Cash Equivalents, and Restricted Cash $ (31,275) $ (9,530) 33 Table of Contents KADANT INC. Operating Activities Cash provided by operating activities decreased to $50.9 million in the first six months of 2024 from $59.3 million in the first six months of 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. Significant cash outflows associated with working capital in the first six months of 2024 related to accounts receivable, customer deposits and other current liabilities. An increase in accounts receivable used cash of $7.3 million primarily due to our revenue growth, and a decrease in customer deposits used cash of $17.7 million due to a reduction in capital equipment orders. Other current liabilities used cash of $15.2 million primarily related to incentive compensation payments. These uses of cash were offset in part by cash provided by an increase in accounts payable of $14.0 million related to inventory purchases and the timing of payments. Significant cash outflows associated with working capital in the first six months of 2023 related to inventory, accounts payable and accounts receivable. Increases in inventory used cash of $10.8 million primarily related to capital equipment orders that shipped throughout 2023 and early 2024. Decreases in accounts payable used cash of $9.4 million primarily due to the timing of payments. In addition, an increase in accounts receivable used cash of $4.0 million mainly due to our revenue growth and the timing of shipments. Investing Activities Cash used in investing activities was $301.5 million in the first six months of 2024, compared with $12.9 million in the first six months of 2023. Consideration paid for acquisitions, net of cash acquired, was $291.6 million in the first six months of 2024. Additionally, cash used in investing activities included capital expenditures of $11.2 million in the first six months of 2024 and $13.2 million in the first six months of 2023. Financing Activities Cash provided by financing activities was $222.8 million in the first six months of 2024, compared with cash used in financing activities of $56.6 million in the first six months of 2023. Borrowings under our revolving credit facility were $295.2 million in 2024, including $291.2 million to fund our 2024 acquisitions. Repayments of short- and long-term obligations were $59.1 million in 2024 compared to $46.1 million in 2023. Cash dividends paid to stockholders were $7.2 million in 2024 and $6.4 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 $3.5 million decrease in cash, cash equivalents, and restricted cash in the first six months of 2024 related to exchange rates was primarily attributable to the strengthening of the U.S. dollar against the euro, and to a lesser extent, the Canadian dollar, the Chinese renminbi and Brazilian real. The $0.6 million increase in cash, cash equivalents, and restricted cash in the first six months of 2023 was primarily attributable to the weakening of the U.S. dollar against the euro, and to a lesser extent, the Mexican peso, and Brazilian real, partially offset by the strengthening of the U.S. dollar against the Chinese renminbi. 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. In the first six months of 2024, we borrowed $295.2 million under our revolving credit facility, which was primarily used to fund our acquisitions. As of June 29, 2024, our outstanding balance under the Credit Agreement was $333.3 million, which included $73.3 million of euro-denominated borrowings, and we had $66.9 million of available borrowing capacity, in addition to a $200.0 million uncommitted, unsecured incremental 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 4.25. As of June 29, 2024, our leverage ratio was 1.22 and we were in compliance with our debt covenants. See Note 6 , Long-Term Obligations, in the accompanying condensed consolidated financial statements for additional information regarding our debt obligations. 34 Table of Contents KADANT INC. Additional Liquidity and Capital Resources 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 our previous $50 million authorization that expired on May 18, 2024. We paid cash dividends of $7.2 million in the first six months of 2024. On May 16, 2024, we declared a quarterly cash dividend of $0.32 per share totaling $3.8 million that will be paid on August 8, 2024. 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 Credit Agreement related to our consolidated leverage ratio. We plan to make expenditures of approximately $18.0 to $20.0 million during the remainder of 2024 for property, plant, and equipment. As of June 29, 2024, we had approximately $273.6 million of total unremitted foreign earnings. It is our intent to indefinitely reinvest $221.1 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 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 $4.2 million. We believe that existing cash and cash equivalents, along with future 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 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 condensed 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 heading 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 2023 that warrant disclosure. Recent Accounting Pronouncements See Note 1 , under the heading 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.