Columbus McKinnon Corporation

Greetings and welcome to Columbus McKinnon Corporation Third Quarter Fiscal Year 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Debra Polosky. Over to you, Debra.

Thank you, Peter, and good morning, everyone. We certainly appreciate your time today and your interest in Columbus McKinnon. Joining me are David Wilson, our President and CEO, and Greg Rustowitz, our Chief Financial Officer. We released our third quarter fiscal 2022 financial results this morning before the market opened. You can access that release as well as the slides that will accompany our conversation today at our website, www.columbusmckinnon.com. After David and Greg's formal discussion this morning, we will open the line for Q&A. We kindly ask that you ask one question with a follow-up question and then get back in queue to allow for continuous flow and adequate time. If you'll turn to slide two in the deck, I will first review the Safe Harbor Statement. As you know, we may make some forward-looking statements during the formal discussions as well as during the Q&A session. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated here today. These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed with Securities and Exchange Commission. These documents can be found at our website or at sec.gov. During today's call, we will also discuss some non-GAAP financial measures, which we believe are useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We've provided the reconciliation of non-GAAP measures with comparable GAAP measures in the tables in today's release and the slides for your information. So with that, if you will turn to slide three, I will turn it over to David to begin. David?

Thank you, Deb, and good morning, everyone. Our team is executing well in a challenging environment, and once again, we delivered a very strong quarter. Sales were up 30% despite leaving approximately 20 million of planned shipments unshipped in the quarter due to pandemic-related supply chain constraints. This reflects strong contributions from our conveyor solutions acquisitions, solid organic growth, and the impact of our pricing power. We achieved adjusted gross margin of 36.7%, which tied the previous record set just last quarter. This is especially noteworthy as it demonstrates the effectiveness of our strategy to drive stronger margin performance through operational improvements and acquisitions. Additionally, it is set against the backdrop of our seasonally weakest quarter. We are continuing to make good progress on driving margin expansion, and in the last two quarters have delivered the highest adjusted gross margins in Columbus McKinnon's history. Strong margins, cost discipline, and two great acquisitions drove our bottom line growth. Adjusted EPS was 60 cents, a 67% increase over the prior year period. 80-20 continues to provide benefits, and year-to-date has contributed $2.6 million to operating income. Adjusted EBITDA margin has expanded to 15.4% year-to-date, even as sales for our organic businesses remain below pre-COVID volumes by approximately 11%. Our new precision conveyance platform is advancing Columbus McKinnon's Intelligent Motion Solutions transformation. The Garvey acquisition, which we completed in December, is an excellent example of the potential we have to continue to build out this platform where we are providing unique, high-value solutions to markets with strong secular growth drivers. Acquisitions provided 17 percent of our revenue in the third quarter and 33 percent of our adjusted operating income. We continue to be encouraged with the strength of demand across our targeted markets, but remain impacted by persistent global capacity and supply chain challenges. Our conveying solutions platform is expanding our presence in life sciences, e-commerce, and the food and beverage markets. We are also active in many areas where the pandemic is driving increased demand, whether it's the production and distribution of vaccines or rapid COVID tests, or just the increased use of online ordering that is driving e-commerce and parcel distribution systems. We ended the quarter with a record backlog of 295 million, of which approximately 178 million is shippable in the fourth quarter. Please turn to slide four. We've been very pleased with the addition of Garvey, the acquisition we just completed in December. It's an excellent enhancement to our precision conveyance solutions offering. With the acquisition of Dorner last April, and now with the addition of Garvey, Our higher growth, higher margin businesses are becoming more relevant within our portfolio mix. Combined with our linear motion and automation solutions, over 40% of our business now has a stronger growth profile and higher earnings potential. Let me review the Garvey acquisition in a little more detail on slide five. Garvey was already on Dorner's target list when we acquired them. They bring a market-leading position for accumulation solutions in food and beverage and life sciences. Briefly, accumulation is the buffering science in a conveying system. It balances volume between processes that operate at different speeds. For example, in a pharmaceutical production process, you can imagine there would be vial unloading, filling, labeling, sealing, and packaging processes. Not all of the machines in this process operate at the same rate. Garvey's patented and advanced accumulation solutions are enhancements to continuous flow production lines such as this and increase efficiency and productivity by balancing the flow between machines. Their solutions store and reintroduce product as needed to transform batch production from one machine into single piece flow for the next machine in a production process. Founded in 1926 and highly regarded for its engineering expertise to design systems that can handle a large variety of product shapes and sizes, Garvey's solutions convey, accumulate, and combine and align products rapidly. They offer a broad product offering across both modular standard and highly engineered accumulation solutions. In fact, they are a leader in bottling operations that range from small vaccine vials to reverse tapered wine bottles and more. With approximately $30 million in annual revenue when we acquired them, their gross margin was approximately 40% and EBITDA margin was 30%. We are truly excited about the combination of this business with Dorner in our precision conveyance platform. In just our first month together, we were successful in creating sales synergies, winning a $700,000 combined solutions project for a ready-to-eat packaged food products company. Our combined solution manages the product throughout the process from assembly to packaging through metal detection and bulk packaging. We expect $0.05 in EPS accretion from the acquisition in fiscal 23. I'll now turn the call over to Greg, and he will cover the details of the quarter. Greg?

Thank you, David. Good morning, everyone. On slide six, net sales in the second quarter, $216.1 million, up 29.7% from the prior year period, and slightly ahead of the guidance we provided last quarter. Our guidance included an estimated impact to sales for supply chain challenges we and every other industrial company are addressing. As David mentioned earlier, we estimate that the impact of revenue was approximately $20 million in the third quarter. Sequentially, sales were down 3.4%, but as we discussed last quarter, our fiscal third quarter is our seasonal low point due to three less shipping days in the U.S. and even less shipping days in Europe due to the holiday schedule. The third quarter had the benefit of one month of our most recent acquisition, Garvey Corporation, in our results. Overall, Dorner and Garvey together delivered over $36 million of revenue in the quarter. Looking at our sales bridge, Sales volume was a major driver of growth, with volume up $9 million or 5.4%. We also realized positive pricing as we saw year-over-year pricing improve by 3.4%. Our pricing actions resulted in $5.6 million of year-over-year price, up from the $4 million of year-over-year price we reported last quarter. Foreign currency was a headwind, and reduced sales by $1.5 million or 0.9% of sales. Let me provide a little color on sales by region. For the third quarter, we saw continued strength in the U.S. with sales volume up 7.5%. We also improved pricing 3.6% up 120 basis points from second quarter levels. Outside of the U.S., sales volume was up approximately 3% as volume increased 10% in Latin America 5% in Europe and 2% in Canada. Volume declined 7% in APAC off of a relatively small base. We also improved pricing internationally by 3.1%. This was up over second quarter levels by 40 basis points. We expect that with the pricing power inherent in our value proposition, we will continue to see our pricing actions mitigate inflationary pressures. With raw material inflation accelerating globally, We are taking more pricing actions in the fiscal fourth quarter, which is also our timeframe for implementing annual price increases. With these actions, we expect to stay out in front of material cost inflationary pressures. On slide seven, gross margin was 34.7%, which included a million dollar negative impact from the recent Garvey acquisition for amortization of backlog acquired and inventory step-up expense. This represents one month's amortization. The fourth quarter will include an additional $2.9 million negative impact from both of these items as the balances are fully amortized. We also settled a $2.9 million product liability legal claim in the quarter. This claim was for a product that was sold over 48 years ago by a predecessor company that Columbus McKinnon acquired in 1995. Normalizing for these items as well as some business realignment costs, we matched the record adjusted gross margin of 36.7 reported last quarter. This was up 320 basis points from the prior year. This was a meaningful accomplishment given the normal seasonal decline of about 100 to 120 basis points we typically experience in gross margins in the fiscal third quarter, as well as the significant supply chain constraints we experienced. Overall, Our precision conveyance acquisitions were 180 basis points accretive to our adjusted gross margin this quarter. In addition to the impact of our acquisitions, adjusted gross margins reflected improved year-over-year productivity in our factories. Let me point out a few highlights in our gross profit bridge for the quarter. Third quarter gross profit increased $19.8 million compared with the prior year and was driven by several factors. Our acquisitions provided $16.7 million of gross profit. As just discussed, productivity added $3.6 million. Sales volume and mix added $3.2 million, and pricing net of material inflation added $1.4 million. Offsetting these items were higher product liability costs of $3 million, which included the $2.9 million legal settlement I just discussed. As shown on slide 8, our SG&A costs were $53.5 million in the quarter, or 24.8% of sales. The acquisitions added $6.7 million to RSG&A costs compared with the prior year. We also recorded $1.7 million in higher incentive and stock-based compensation compared with the prior year period. In addition, we incurred $400,000 in acquisition deal costs, which we have included as a pro forma item in our adjusted operating income, adjusted EBITDA, and adjusted EPS calculations. For the fiscal fourth quarter, we expect RSG&A expense to be similar to fiscal Q3. This includes a full quarter impact from the Garvey acquisition, as well as additional investments in strategic growth initiatives. Turning to slide nine, adjusted operating income was $20.5 million. Adjusted operating margin was 9.5% of sales, up 280 basis points from the prior year. This margin expansion was largely driven by the accretive acquisitions completed this fiscal year, which contributed 180 basis points. We also benefited from operating leverage on improved volume and strategic pricing. As you can see on slide 10, we recorded GAAP earnings per diluted share for the quarter of 34 cents. Adjusted earnings per diluted share of 60 cents was up substantially from 36 cents in the prior year period. As a reminder, we are adding back amortization expense on a tax-affected basis to our adjusted earnings per diluted share calculation. We feel that this is a better indicator of the true cash generation capabilities of the company. In Q3, this added 17 cents to adjusted earnings per diluted share. All periods on this chart have been restated for this change. With the acquisition financings that we completed last May and more recently this past December, Interest expense is running at approximately $4.9 million per quarter. Weighted average diluted shares outstanding are anticipated to be about $29 million in the fourth quarter. Our tax rate on a GAAP basis is expected to be in a range of 15% to 17% for the full year, and we continue to use 22% for our pro forma non-GAAP tax rate when calculating non-GAAP adjusted earnings per share. On slide 11, our adjusted EBITDA margin continues to expand and was 15.4% on a year-to-date basis. For the quarter, adjusted EBITDA margin improved to 14.2% up 330 basis points. Our recent acquisitions were accretive to our adjusted EBITDA margin by 300 basis points in the quarter. Our return on invested capital also continues to improve and was 7.7% on a trailing 12-month basis. We continue to target a 19% EBITDA margin and expect our ROIC to be double digits in fiscal 23, excluding the impact of future acquisitions. Moving to slide 12, we generated 3 million of cash in the third quarter. Year-to-date, we have generated 14.2 million. On a year-to-date basis, we incurred $14 million of cash outflows related to acquisition deal costs. We also have added approximately 42 million of inventory to meet rising demand and lessen supply chain impacts. Our working capital as a percent of sales was 15.2%, which was in line with what we were expecting. Capital expenditures were 2.8 million in the quarter. We expect capital expenditures of 12 to 16 million for the full year. Turning to slide 13, we refinanced the capital structure post Dorner acquisition which included an equity offering and a new term loan B. Our low-cost, flexible capital structure is comprised of a $450 million term loan B, which carries an interest rate of LIBOR plus 2.75%, with a 50 basis point LIBOR floor. To finance the Garvey acquisition, we utilized the accordion feature of our term loan B and borrowed an additional $75 million. As of December 31st, on a pro forma basis, which includes both Dorner's and Garvey's, December LTM adjusted EBITDA, but excludes expected cost synergies, our net leverage ratio was 2.9 times. We expect to achieve our targeted leverage ratio of two times within fiscal 23, barring any additional acquisitions. Finally, our liquidity, which includes our cash on hand and revolver availability, remained strong and was approximately $190 million at the end of December. Please advance to slide 14, and I will turn it back over to David.

Thanks, Greg. As I'd mentioned earlier, demand has been increasing across all markets with strong tailwinds from life sciences, food and beverage, e-commerce, warehousing, and parcel management. Total orders were up 37% year-over-year in the quarter. Organic orders increased a very solid 14% year-over-year. It's worth noting that sequentially, the average daily order rate remained essentially unchanged from the second quarter, defying our typical seasonality for the third quarter. Average daily orders in January through last Friday were up 7% when compared with the third quarter. Our record backlog includes 24 million of Garvey orders, which are expected to ship over the next 12 months. Garvey's lead times are typically four to six months with projects that can run up to a year. In total, our conveying solutions backlog is developing quite nicely. Please advance to slide 15, where I will review our expectations for the fourth quarter. As we advance into the last quarter of our fiscal year, we are expecting net sales to be approximately $235 million. This reflects the assumption that supply chain challenges and labor shortages will continue at current levels. We expect order rates to remain robust as our pipeline of opportunities is in excellent shape. In particular, the food and beverage, e-commerce, and life sciences markets are very promising. We're also seeing an uptick in aerospace as the industry gears up for its recovery. Automotive, while hampered by chip shortages, continues to add production lines for electronic vehicles. The metals industry is making significant investments in expansion and upgrades. The paper and package board industry is also investing in capacity increases and productivity improvements driven by the growth in e-commerce. These investments are supporting all of those boxes that are showing up on our doorsteps. Both industries are expanding within their available footprints and building out new capacity. Regarding the supply chain, Electrical components, castings, and motors remain difficult to source predictably. As you would imagine, we're working very closely with our existing suppliers and are proactively assessing and developing relevant alternatives to add new sources of supply where appropriate. We're also remaining agile and flexible within our operations to advance projects and expedite deliveries despite these difficulties. The highly contagious and rapidly spreading COVID Omicron variant has, as you might imagine, increased near-term staffing challenges as well. Nonetheless, we remain very encouraged by market developments and the transformation we are driving through the implementation of our Blueprint for Growth 2.0 strategy. We believe Columbus McKinnon is uniquely matched to this moment in the global economy. The solutions we bring to market are addressing some of the most pressing issues the world is facing as the pandemic enters its third year. We provide productivity and automation solutions that solve issues related to an unprecedented shortage of workers while also making workplaces safer. We plan infrastructure investments and assist the world's manufacturers as they reshore and rebalance their global production capacity. Our solutions also support the explosive growth in e-commerce, the energy transition and resulting shift to electric vehicles, as well as the pharmaceutical and food and beverage industries move to a more direct to consumer model. Through these unprecedented times, we are successfully transforming Columbus McKinnon into a higher growth, higher margin enterprise. And we're truly excited about what the future holds. With that, Peter, we can open up the line for questions.

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before placing the star keys. As a reminder, we ask that you limit to one question and one follow-up. One moment please while we poll for questions. The first question is from the line of Michael McGinn with Wells Fargo. Please go ahead.

Hey, good morning, everybody. Good morning, Mike. Mike? Mike, we can't hear you. Peter? Hear me now?

Hear me now? Oh, yes. Yeah, Mike, we can hear you now. Go ahead. Okay. Sorry about that. So you mentioned, Garvey, that COVID was a potential tailwind in the pharma business. Are you able to frame if there was any revenue or margin pulled forward into the trillion 12 numbers and if you feel comfortable to grow past those given the strength in food and beverage?

Yeah, we do provide support to the, you know, COVID environment and provide vaccine-related accumulation technology, not only for the accumulation through the production process, but also for the drying process as you take those products out of cold storage. And so, we, you know, did support that initial build, but we believe that there's growing demand for vaccines and other related pharmaceutical requirements that, you know, position us well for growth as we head into this coming fiscal year.

Great. And can you?

Yeah, sorry. Just to add some color. So, Garvey is headquartered in New Jersey, which, as you know, is kind of a, you know, headquarters for a lot of the pharma companies. And they've got really strong relationships with people like Pfizer, Merck. Abbott Labs, J&J.

Yeah, their customer list is a virtual who's who of pharmaceuticals and food and beverage companies.

Got it. And then regarding the deleveraging down to 2X, can you frame for us what the right number of targets per year, how the pipeline kind of looks as it stands today? Are there similar type of Dorner, Garvey targets out there or something more smaller in size? How do you? Any help there would be great.

Yeah, sure, Mike. As we've discussed, we intend to be programmatic in our approach to developing the company and executing on our strategy through M&A, and we have an active and developing pipeline of opportunities and very attractive spaces. And our initial moves into conveying solutions, precision and specialty conveying solutions, have provided us with great access into that fragmented landscape there that in addition to our efforts to continue to develop the company in the linear motion and automation areas. And so we've got a nice pipeline of opportunities and we're in active discussions, but those discussions and resulting possibilities develop at their own paces. And I would say that we have opportunities that range in size from Garvey-like opportunities you know, up to opportunities that could be even larger than Dorner-sized opportunities.

And I think, Mike, one of the really impressive results in December was the fact that together with Dorner, Garvey and Dorner won a very significant sized order that David talked about on the call, over $700,000, and that's just in the first month. And that truly is a revenue synergy that would not have occurred Without Garvey.

Right. Yeah, and there are others that are right behind that in terms of areas where they have the leading accumulation technology and we have leading conveying technology. And independently, we may not have been successful in either case in the past, but combined, we're a much more attractive opportunity for customers in multiple attractive end markets.

Great. Appreciate the time. Thank you. Thanks, Mike.

Thank you. The next question is from Chris Harvey. Sorry, it's with Greg Palm with Greg Holland Capital Group. Please go ahead.

Yeah, thanks. Morning, everyone. I guess just starting off on the supply chain impact-related commentary, how does that $20 million impact of unshipped orders compared to maybe your initial expectations? Did I hear it right? Were you expecting sort of a similar level of impacts here in the current quarter?

Yeah. Hey, Greg. Good morning. Yes, this is David. I would say that it's a little bit worse than we anticipated coming into the quarter. We had kind of pegged a $15 million number in our models and had a bigger impact in the period than we than we expected. And that said, there's a lot of bright spots and continued challenges as it relates to the supply chain. And as I mentioned in my prepared remarks earlier, the Omicron variant's impact with rising infection rates had an impact on our near-term labor supply. But the overall impact of $20 million was a little bit higher than we'd anticipated coming into the quarter.

Okay, fair enough. And the demand commentary for January, I think you said that daily orders up 7% in January, or at least to date. What is that normally during this time? And maybe just remind us in terms of the March quarter, how is the cadence of that usually play out?

Yeah, I would say seasonally, our lowest quarter is our third quarter. And that's why it was noteworthy that our order rates remained essentially unchanged. through the third quarter, so that was a very positive development as we advanced through the third quarter. And then sequentially, we're thinking, you know, this is a nice run-up in the early days of January, up 7%. And that 7% is split about 5% on the short cycle side and about 10% on the projects side.

Yeah, Greg, it's Greg. I would say it's kind of hard to compare in that a year ago, we were in a significant ramp up from the low points of the pandemic. And so we certainly have that data. I'm sure we talked about it on the call a year ago, and it was probably higher than 7%. But I would say it's largely because we had such a significant decline as most companies did with the pandemic starting in 2020.

Okay, good. All right. I'll hop back in the queue. Thanks. Great. Thanks, Greg.

Thank you. The next question is from Chris Harvey with Barrington Research. Please go ahead.

Thank you. I've heard that variation and many others of my last name, which I won't get into. Hey, Chris.

Good morning.

Good morning. Yeah, just as I think about conveying solutions, you mentioned the backlog remains robust here. The combination of conveying automation and linear is now 41%. Can you talk more about this slide? How do you see the evolution of this 41%, perhaps getting closer to that 50-50 split with your legacy lifting solutions business over time? Can you achieve that with the existing set of businesses in play or not? Does an inorganic opportunity need to come to fruition to get to 50% or higher of the mix?

Yeah, I would say that we would be planning to move in that direction through the growth that would be both organic and through acquisition and believe that the 50% is achievable and even more over time. And that is not to say that the lifting solutions portion of the business doesn't grow at a very attractive rate compared to historical levels because we've got a lot of very interesting organic developments in play there that we're pretty excited about and we think will allow for some nice growth. So over the course of our strategic planning horizon, which is a five-year period, we believe that we strategically transform the business to a business that has a higher mix of high growth, high margin, secularly oriented product offerings that are very attractive in the intelligent motion solution space.

So, Greg, it's really just a matter of time. It can get there. It's a question of how quickly and clearly with the right sorts of inorganic acquisitions, we can accelerate that transition and move the mix beyond that as we get bigger and bigger. you know, the attractive segments that we're talking about here. But just, you know, de facto, the precision conveyance is typically an 8%, you know, kind of growth business. We've been outgrowing that, outpacing that at Dorner at double digits. And we would expect with revenue synergies, we can move Garvey into that sort of a growth trajectory. So, you know, that business continues to grow. And then clearly, you know, linear motion and automation are the other two key components that are, you know, today growing.

Yeah, so those growing in the mid-single digits and outpacing the organic growth of the legacy lifting portion.

Okay. Okay.

And then following up on the previous question surrounding M&A, you know, we're entering this rising rate environment and depending on what Powell wants to say we'll see what happens but how would you place this in the context with where your net leverage is today it's going to be closer to two times here yeah how do we place this environment into context with your balance sheet and what's your opinion on how this all shakes out as in regard to pricing some of these opportunities in the market Do you think multiples come down as companies with leverage exit these potential opportunities? Or do you have any thoughts on that?

Sure. I think we're in a good position. We've got a healthy balance sheet and a strong cash generation through really all business cycles within our portfolio. And what we've added to it complements that same performance. And we're trending in the right direction, everything remaining on track. The businesses we've acquired are performing well, and the opportunity landscape is attractive. And so we're going to be disciplined and thoughtful, but we have the ability through both leverage and equity to advance with opportunities in this market. And I would anticipate that it's logical what you said, that as rates go up and highly leveraged companies are maybe taking themselves out of the mix, that potentially pricing would come down a little bit.

Yeah, so Greg, just to add on. So from a net leverage perspective, we were at 2.9 times. And that's not including cost synergies. On a financial covenant basis, we're below 2.8 times in the quarter is what we'll report. So in line with what we talked about when we bought Garvey, where I think we targeted, we said we would be at 2.8 on a pro forma basis. We're comfortable at up to three and a half times. And clearly in the case of Dorner, leverage out of the gates was higher than that. But we also had plans and were very transparent that we're going to be raising equity to help finance So equity is always a part of the equation that will be looked at. And, you know, there's a lot that has to happen for an acquisition to get consummated. It's got to make sense, both strategically as well as from a cost perspective. And that's why it's just such an unpredictable part that you just don't know. You know, it's not over until it's over with the deal.

Right. That makes sense. Okay. If I kind of summarize that, it seems like the opportunities are still there. Columbus McKinnon remains in good position, but at the same time, you're going to remain prudent and disciplined as the timing of such deals may be unpredictable. But where you are on the finish line for these deals doesn't necessarily change.

That's right. That's right, Chris. And we're really excited about the M&A strategy, the overall strategy we have for the business.

Thank you.

Thank you. The next question is from John Tanventing with CJS Securities. Please go ahead.

Hey, guys. Good morning. Congrats on a nice quarter and thanks for taking my questions. Also, congrats on getting Garvey at a nice price, especially compared to Arrowhead and other things that might be going on in the market right now. My first question is, could you talk a little bit more about the Garvey synergies, maybe broken down between what you identified as cost synergies and perhaps the broader revenue potential, whether it's from insourcing or cross-selling, first of all? And then second, I guess, how much do you think Garvey contributes within your fiscal Q4 guidance?

Yeah, sure. Let me start, John, and then ask Greg to add on. As we look at the synergistic value of the acquisition, as I mentioned in my earlier comments, bringing Dorner's leading conveyor technology together with Garvey's leading accumulation technology, and they're both robust patented differentiated offerings, and leading brand recognition around their spaces, we think there's a lot of synergy that we can garner on the selling side, on the growth side. And so, as I mentioned, we secured a $700,000 order in the December month, and we've got more that are following. We have opportunities to really develop the Garvey business outside of its historical position in food and beverage and pharmaceuticals, where about 80% of their business is today, into more industrial technology. and other automation spaces. And likewise, they have an opportunity to help us pull more of the Dorner product into their pharmaceutical and life science and food and beverage application spaces. And so we've got this really nice complement and a great opportunity to leverage the two businesses together. We also have a great opportunity globally to take both businesses further abroad, leveraging the broader Columbus McKinnon footprint, and so the whole premise behind the deal was really geared towards growth synergy versus cost synergy, although we do have cost synergy opportunities, and we've realized some of those already, and I'll let Greg talk a little bit more about that.

So on the cost synergy side, John, what we targeted when we put out the deck on the acquisition was about $600,000 of cost synergies next year, in the next fiscal year, and that's really approximately 2% of sales. And the reason why it's such a maybe small number compared to what we expected with Dorner is because as a small family-run company, there are certain investments we need to make to bring the company up to public company standards. But on the positive side, one synergy that we've already realized is by pulling Garvey into the Columbus McKinnon Insurance Program. we saved $200,000 on our overall insurance costs. So in essence, I've got a third of the $600,000 of synergies already accomplished. And there's going to be other, you know, administrative savings. There's going to be some sourcing savings as, you know, we get our sourcing teams involved. But, you know, we think that, you know, achieving the $600,000 won't be that difficult, but there are going to be investments made into the business that will kind of offset the overall cost synergies that we expect to that net number of 2%.

Okay, great. Thanks for that color. Greg, I just wanted to dive deeper a little bit into the margin headwind you guys might be seeing due to Omicron and the supply chain. Could you maybe talk about how much uplift you'd normally see on a sequential basis going to a seasonally strong quarter and how much headwind is there against that? And maybe secondly, do you think that environment gets worse or before it gets better at this point?

Yeah. So in a normal year, you know, let's put the COVID years out of the picture. We would expect probably at least 100 basis point uplift, maybe even more, because, you know, with the seasonal decline we see in the third quarter, we usually, you know, would have strong, we definitely would have stronger margins in Q4 because there's more shipping days, there's more fixed cost absorption, there's price increases that are are historically implemented in the quarter annual price increases. So we would normally expect to see a nice jump sequentially in gross margins. Impact of Omicron, we've been dealing with this now probably since sometime in November in one form or fashion, and it has an impact on staffing, not only in our own facility, but also in our suppliers. And so it's a constant challenge to get all of the components necessary to ship a product in. And so that is certainly having an impact. It becomes a somewhat inefficient process. As you start producing something, you're expecting, say, a motor to come in. The motor's delayed. And so you've got to stop, put that aside, just start working on another product. So our operations team is doing a fantastic job managing all this complexity that's coming. And as I talked about, we've added a lot of inventory to the system, but all it takes is one component not being there, and that prevents a product from being shipped. And that rings true for both Legacy Columbus McKinnon as well as Dorner and Garvey. We would expect, though, that from a margin perspective, that it would be comparable to this quarter with probably a positive bias. You know, we're making headway on adding more staff to our facility, our plants, which is important. You know, we continue to work hard with the supply chain, looking for alternative suppliers. I know a number of our sourcing team are in Eastern Europe as we speak, looking at alternative sources and certain components. So it's a challenge, but I think we've demonstrated that we have been able to manage this challenge over really the last year.

Yeah, so I would just add that, you know, given all the puts and takes, we have a number of dynamic actions and circumstances that are evolving in the quarter, but overall would be in line to positively biased with how we finish the third quarter.

Got it. Thanks, Dave and Greg. Appreciate it. You bet.

Thank you. The next question is from Steve Farzani with Sidoti and Company. Please go ahead.

Morning, everyone. Thanks for all the information this morning. I do want to ask a couple of questions about Garvey. The first one is just you noted the longer lead times, and I'm trying to think about how you price those projects to reduce risks. Clearly, if we went back a year and you were sitting on a year backlog, it would be a a challenging point given the higher costs. We wouldn't expect that 12-month period to exist again necessarily, but how do you avoid those issues when you're pricing 12 months ahead and if that becomes a larger portion of your revenue?

Right. Yeah, with our long-term contracts, what we try to do, Steve, is we try to make sure that we have a tie to relevant indices or metrics that allow for adjustment to the extent their material swings. And so You know, that is something that we consider as it relates to longer-term large projects. Garvey has done a nice job of preserving and expanding margins. They certainly perform well for us in the fourth quarter, or in our third quarter, I should say, and as we advance into the fourth quarter, you know, we're confident about what we've got in the forecast. And it's a really... attractive area that we're participating in and where their differentiated offerings allow us to have a level of price influence in the environment. That coupled with the partnership with Dorner and the ability for Dorner to provide a more attractive offering from a conveyor solutions perspective where Garvey had historically produced some of those systems in their own factories, there's a margin opportunity as you think about the scale and benefit of substituting donor offerings for those legacy Garvey conveyor offerings. And so not only would that result in a better solution for the customer, but a more attractive position for our company. And so we take all of that into consideration and feel like we're in a good spot.

That's helpful. And then in terms of Garvey being 100% North America, how early on are you thinking about international opportunities to Garvey, and how much will Condorner help that?

Yeah, sure. What I would say is that while they are very highly biased towards North America, and I think it's fair to think of them as 100% thereabouts North America, they do sell to large global companies that specify their product and then pull them into other geographies. And so we'd sell to an American entity and then it might move to another location to help their consistency of application and production around the world. But Dorner certainly can help them. And with their reach, they would help to take that offering beyond where they are today in the U.S. And certainly with the Columbus McKinnon reach, where we're partnering with Dorner and engaging more globally to support their development, the collective Columbus McKinnon entity can really help to drive that support for global expansion.

Great. Thanks for your time. Thank you, Steve.

Thank you. The next question is from Matt Somerville with DA Davidson. Please go ahead.

Good morning. This is Will Jellison on for Matt Somerville today. Hey, Will. Good morning. I wanted to start with a question on adjusted operating income. If you look at the sequential move from fiscal second quarter to fiscal third quarter, the decremental margin on the lower revenue came in relatively high. And I was just wondering if you could provide more color on that, if it was driven entirely by the $20 million pushout and the supply chain challenges, or if there are other things to consider there.

Let me think about that for a second, Will. I think, you know, one of, I'd have to see our sequential P&L, but clearly, you know, gross margins were comparable on an adjusted basis, so sequentially they were the same. So I think you saw more amortization expense with Garvey. That isn't an adjusted item, so I'm not talking about the backlog amortization and the inventory step-up. And then I would say it's got to be RSG&A costs. You know, higher stock comp and incentive accruals would be the bigger drivers there.

Got it. Okay, thank you. And then as a follow-up, I'm curious about Garvey having been a family-owned and operating business for 90-plus years prior to your acquisition. I was just wondering, you know, why, why you thought the, it was the right time for that business to transition its ownership moving forward. And of those Garvey executives staying on board, um, if they are going to be owners of Columbus stock moving forward.

Right. Yeah. Great question. And we're, we're thrilled with the acquisition and the addition of the management team from Garvey to our, our organization. They've been having a big impact already. We've got them engaged in the company, and they are engaged through incentive programs that link them to the performance of Columbus McKinnon, both in stock and incentives. And I think right now is a great time to bring the companies together, as I said, because we've got a terrific offering with Dorner, and the combination along with Garvey really brings the benefit of their accumulation technologies that are leading with our conveying solutions that are leading, and packs a powerful punch as it relates to serving not only the legacy food and beverage and pharmaceutical customers that Garvey's been serving, but also our ability to bridge them into other really important areas where they can have an impact. So I think it's a terrific transaction. It was a great opportunity. multiple, and it is going to create a lot of synergistic value for us, and the team that joined us is really a terrific team.

Understood. Thank you for taking my questions. Thanks.

Thank you. The next question is from Walter Liptick with Seaport Research. Please go ahead.

Hey, good morning, guys, and thanks for the nice quarter. Good morning, Walt. I wanted to ask one about gross margin. And, you know, it's nice to see the, you know, the gross margin, where it is, and the, you know, the conversion that's happening there. Can you walk us through a little bit about just a little bit more detail about the pricing and the supply chain and why we're not seeing more headwinds on the gross margin line?

Yeah, so while we've had a pretty quick response to the inflationary pressures we saw coming in Q1 through Q2 and in Q3, and as Greg has communicated throughout with our bridges as well as in his comments through these calls, He's highlighted that we've outpaced the inflationary pressure with the price increases that we've put in place. And in this past quarter, we had $5.6 million of price, which was an increase sequentially over what we had in Q2, and that more than offset the inflationary pressure. So we've been successful in moving in that direction, speaking to the pricing power that we have within the organization. And as we head into Q4, we're very mindful of where we are. paying close attention to continued movement in the supply base and with the impact that might have. And we're preparing to implement additional changes to make sure that we're in line with where we think we should be from a pricing standpoint. But that's how I would comment, and I'd ask Greg to answer that.

Yeah, and in addition to that, we also saw some really good productivity in our plans despite the supply chain challenges. And our factories are busy. We have record backlog. We're trying to meet customer needs and demands. And so there was a high level of activity in the quarter, which helped generate the $3.6 million of productivity that we saw in the quarter. And then probably the other factor, Walt, is that Garvey, as well as Dorner, are stronger gross margin businesses. than legacy Columbus McKinnon and typically in the 40% plus range. And so that was a little bit of a tailwind to our gross margins in the third quarter.

Okay, great. And so with the comments you made on the fourth quarter, David, should we expect about the same gross margin level? It sounds like you're still a little bit cautious.

Yeah, I mean, we're obviously in a very dynamic environment. And all things being equal, we would certainly assume to get volume benefits as we head into this quarter and through this quarter. And so, you know, if we neutralize all the potential headwinds with offsetting actions we would be taking, you know, we're biased to be, you know, kind of at or slightly positive to where we were in Q3 in this quarter. And, you know, we're working hard to try to see if we can do better than that, but we're also cautious about things we don't know. You know, then we've been kind of navigating those challenges successfully to date, but we're, you know, we don't know what we don't know.

And maybe, you know, just the cautionary part of all this is really the raw material inflation. So, you know, in the fiscal second quarter, the net inflation was about a $12 million annualized rate. And in this quarter, it's a $16 million annualized rate. So, you know, inflation has definitely accelerated. Steel prices, we've talked about in the past. We had them locked in for the most part through 1231. We've renegotiated those contracts. And, you know, we will see higher steel costs going forward.

Energy prices of energy prices. And we have the opportunity to raise price and respond. But at the same time, there's a lag and the backlog isn't always there.

Okay, got it. Along those lines, the inventory stepped up quarter over quarter. Was that just to get in front of it, or do you only buy inventory to meet the existing order book?

Yeah, it was deliberate. We worked hard to make sure we had inventory. to support the growing demand, and obviously we're trying to be mindful of trying to take advantage of opportunities to buy inventory where we can get it at a discount as well. So a couple of good reasons to be increasing inventory with a near $300 million backlog and a great demand profile.

And also buying in advance of vendor price increases.

Okay, got it. And then just switching gears with that synergistic Garvey-Dorner order of 700K, was that a pull-through from Dorner to Garvey or Garvey to Dorner? So it was basically, was it pharma or was it industrial?

It was Garvey to Dorner, and it was in the food and beverage space.

Okay, got it. All right, thanks, guys. Thanks, Walt.

Thank you. The next question is from Steve Tusa with JP Morgan. Please go ahead.

Hey, guys. Good morning. Hi, Steve. Good morning, Steve. When you look at kind of the, I'll call it, you know, medium-term outlook for some of the, you know, warehouse activity that you're seeing out there, understanding that it's still pretty strong today, I mean, how do you think about that on kind of the next either calendar or, you know, Can that business grow pretty solidly over that time period, given kind of where we are in that? I don't think it's really a cycle. I mean, it's more of a growth market, but there sometimes are ebbs and flows. So, you know, just some commentary, a little more solid commentary on what you would expect calendar 22 or fiscal, you know, next fiscal year.

Yeah. Thanks, Steve. We're encouraged by what we're seeing there. We've seen demand increase throughout this fiscal year. and really positively biased towards what's possible there as we head out into the next fiscal year. So we do see that growing solidly as we advance through fiscal 23 or calendar 22.

Okay, great. And then how do you kind of see free cash flow now? you know, working capital kind of in line with sales, you know, where it's been historically. How do you guys think about kind of the proper free cash conversion?

Sure. So, I'll just comment that on a working capital as a percent of sales basis, we're at the mid-teens. We're right around 15%, and that's kind of where we expected to be as a business at this point in our cycle. We ended last year at 9%, which was abnormally low and, you know, not really a sustainable level in the growth we're trying to achieve. And so, I feel like we're in a good spot and we're going to try to continue to navigate with the business performing at that level of working capital. And I'll ask Greg to talk about the free cash flow cycle.

Yeah, so Steve, when you look at our free cash flow conversion, I think that was the other part of your question, we're typically over 100% free cash flow conversion. We're not a CapEx intensive company at all. And if you look last year, our free cash flow conversion was 229%, which reflects, you know, as we reduced inventory in light of the pandemic this year, it's, you know, year-to-date on a training 12-month basis, year-to-date it's 48%. It's going to, you know, both of those together are going to average about, you know, 100% or a little over. So on an ongoing basis, that's the way to think about it. It's about, you know, 100%. We tend to be better, yeah. Yeah.

Got it. And then just one more just on the supply chain impact on revenues. I think it was a little bit worse in 3Q versus 2Q. You kind of said it, I think, back then, that you would have expected a similar impact. Was it a bit bigger than expected? And then what gives you the confidence that it's not going to get worse here in the near term?

Yeah, it was slightly larger than we expected, but really in the same zip code, more or less. And then as we look at the balance of this quarter – You know, we've had another quarter under our belt. We're working very closely with our vendors, moving to find alternative sources, as Greg indicated earlier, and, you know, working to position ourselves to have a level of success. So we've learned things as we advance through the past three quarters, and we feel like we're applying those well as we head through this quarter. And what you're hearing from us a little bit is maybe the cautionary sense of, you know, just being mindful that, you know, there are things that haven't happened yet that we'll have to see how they unfold. But I feel like we're pretty well positioned to execute on the quarter we have in front of us, and we've got a great backlog to do it from. And we're working to do everything within our power to position ourselves to be in control of what those outcomes are.

Great. Thanks a lot.

Thanks, Steve.

Thank you. Again, if you have a question, please press star 1 on your telephone keypad. Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. I would like to turn the call back to Mr. David Wilson for closing remarks.

Great. Thank you, Peter. We're executing on our strategy and building out the Columbus McKinnon Business System, or CMBS as we call it, to drive excellence and scalability in our core competencies. As a result, we're creating a higher growth, higher margin, more valuable Columbus McKinnon business. In closing, I want to emphasize how resilient and agile our team has been over the last two years while navigating what has been a very dynamic landscape. It's hard to believe that we're still in the midst of a global pandemic, but we are. And I'm proud to say that Columbus McKinnon has not only persevered, but is emerging as a stronger and a better company. We appreciate your time today and your interest in Columbus McKinnon. Thank you and make it a great day.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.