Columbus Mckinnon Corp Q3 FY2022 Earnings Call

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. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Deborah Pawlowski. Over to you, Deborah.

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 Rustowicz, 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 2 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 the 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 3, 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 $0.60, 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% of our revenue in the third quarter and 33% 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 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, 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 4. 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 5. 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, 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 months 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 2023. I'll now turn the call over to Greg, and he will cover the details of the quarter.

Thank you, David. Good morning, everyone. On slide 6, net sales in the second quarter were $216.1 million, representing a 29.7% increase compared to the same period last year, and slightly exceeding the guidance provided last quarter. Our guidance accounted for an estimated sales impact from supply chain challenges that we, along with other industrial companies, are addressing. As David mentioned earlier, we expect the revenue impact to be about $20 million in the third quarter. Sequentially, sales decreased by 3.4%. However, as we discussed previously, our fiscal third quarter typically represents our seasonal low point due to having three fewer shipping days in the US and even fewer days in Europe because of the holiday calendar. The third quarter benefited from one month of revenue contribution from our recent acquisition, Garvey Corporation. Together, Dorner and Garvey generated over $36 million in revenue for the quarter. Analyzing our sales performance, sales volume was a significant contributor to growth, increasing by $9 million or 5.4%. We also saw positive pricing, with a year-over-year improvement of 3.4%. Our pricing actions resulted in $5.6 million in year-over-year price increase, up from the $4 million reported last quarter. Foreign currency fluctuations negatively impacted sales by $1.5 million, accounting for 0.9% of sales. In terms of sales by region in the third quarter, we experienced continued strength in the US, with sales volume increasing by 7.5% and pricing improving by 3.6%, up 120 basis points from the second quarter. Outside of the US, sales volume rose about 3%, with a 10% increase in Latin America, 5% in Europe, and 2% in Canada. Conversely, volume fell 7% in APAC from a relatively small base. Internationally, pricing improved by 3.1%, an increase of 40 basis points from the second quarter. We anticipate that the strength of our value proposition will allow us to continue mitigating inflationary pressures through pricing. Given the recent increases in raw material costs globally, we plan to implement further pricing actions in the fiscal fourth quarter, coinciding with our annual price increases, to keep pace with material cost inflation. On slide seven, gross margin was recorded at 34.7%, which included a $1 million negative impact from the recent Garvey acquisition related to backlog amortization and inventory step-up expenses, reflecting one month of amortization. The fourth quarter will see an additional negative impact of $2.9 million from these items as they reach full amortization. Additionally, we settled a $2.9 million product liability legal claim during the quarter for a product sold over 48 years ago by a predecessor company acquired by Columbus McKinnon in 1995. Adjusting for these factors and some realignment costs, we matched a record adjusted gross margin of 36.7% from the previous quarter, representing a 320 basis point increase from last year. This achievement is significant considering the typical seasonal decline of around 100 to 120 basis points we usually observe in gross margins during the third quarter, in addition to the notable supply chain constraints faced. Overall, our precision conveyance acquisitions added 120 to 180 basis points to our adjusted gross margin this quarter, alongside improved year-over-year productivity in our factories. Looking at our gross profit bridge for the quarter, third-quarter gross profit saw an increase of $19.8 million from the prior year, driven by several factors. Our acquisitions contributed $16.7 million to gross profit. Productivity gains added $3.6 million, sales volume and product mix contributed $3.2 million, and pricing, net of material inflation, provided an additional $1.4 million. These gains were partially offset by higher product liability costs, totaling $3 million, which included the $2.9 million legal settlement mentioned earlier. As shown on slide eight, RSG&A costs were $53.5 million for the quarter, accounting for 24.8% of sales. Acquisitions increased RSG&A costs by $6.7 million compared to the prior year, while there was also a $1.7 million rise in incentive and stock-based compensation compared to last year. We incurred $400,000 in acquisition-related costs, which we've 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 expenses to remain consistent with fiscal Q3, factoring in a full quarter's impact from the Garvey acquisition and additional investments aimed at strategic growth initiatives. Turning to slide nine, adjusted operating income was $20.5 million, resulting in an adjusted operating margin of 9.5% of sales, up 280 basis points year-over-year. This margin expansion was primarily driven by our accretive acquisitions this fiscal year, contributing 180 basis points, along with operating leverage from improved volume and strategic pricing. As highlighted on slide 10, GAAP earnings per diluted share for the quarter were $0.34, while adjusted earnings per diluted share rose significantly to $0.60 from $0.36 in the prior year period. It’s important to note that we are adding back amortization expense on a tax-affected basis to the adjusted earnings per diluted share calculations, which we believe better reflects the company’s cash generation capabilities. In Q3, this adjustment added $0.17 to adjusted earnings per diluted share. All periods shown on this chart have been restated to incorporate this change. Following the acquisition financing completed last May and more recently in December, interest expense is currently around $4.9 million per quarter. We anticipate weighted average diluted shares outstanding to be approximately $29 million in the fourth quarter. Our GAAP tax rate is expected to range from 15% to 17% for the full year, while we will continue to use a 22% rate for our pro forma non-GAAP tax calculations when determining non-GAAP adjusted earnings per share. On slide 11, our adjusted EBITDA margin continues to grow, reaching 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 contributed 300 basis points to the adjusted EBITDA margin this quarter. Our return on invested capital also shows improvement at 7.7% on a trailing 12-month basis. We are targeting a 19% EBITDA margin and expect our ROIC to reach double digits in fiscal 2023, excluding the effects of future acquisitions. Moving to slide 12, we generated $3 million in cash during the third quarter and have accrued $14.2 million year-to-date. To date, we have incurred $14 million in cash outflows related to acquisition deal costs, and we have added around $42 million in inventory to meet rising demand and mitigate supply chain impacts. Our working capital as a percentage of sales was 15.2%, in line with our expectations. Capital expenditures totaled $2.8 million for the quarter, with an anticipated full-year expenditure of $12 million to $16 million. Turning to slide 13, we refined our capital structure after acquiring Dorner, which included an equity offering and a new term loan B. Our low-cost, flexible capital structure consists of a $450 million term loan B, with an interest rate of LIBOR plus 2.75% and a 50 basis point LIBOR floor. To finance the Garvey acquisition, we took advantage of the accordion feature of our term loan B, borrowing an additional $75 million. As of December 31st, our pro forma net leverage ratio, which includes both Dorner's and Garvey's December LTM adjusted EBITDA but does not account for anticipated cost synergies, stood at 2.9 times. We aim to achieve our target leverage ratio of two times by fiscal 2023, assuming no additional acquisitions occur. Lastly, our liquidity, combining cash on hand and availability from our revolver, was robust at approximately $190 million at the end of December. Please move to slide 14, and I will hand it back 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, defining 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 months 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 play in 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. 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?

Can you hear me now?

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 pull forward into the trailing 12 numbers, if you feel comfortable to grow past those given the strength in food and beverage?

Yeah. We do provide support to the 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 did support that initial build, but we believe that there is growing demand for vaccines and other related pharmaceutical requirements that position us well for growth as we head into this coming fiscal year.

Right. 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 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. Regarding the plan to reduce leverage to 2x, could you outline what the appropriate annual targets are and how the pipeline appears at this moment? Are there similar targets to Dorner Garvey available, or are they generally smaller in scale? Any guidance on this would be appreciated.

Yes. 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 in 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, 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, 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 of 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. Yes. 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 Howe with Greg Palm from Craig-Hallum Capital Group. Please go ahead.

Yes. Thanks. Good morning, everyone. I guess just starting off on the supply chain impact related commentary. How does that $20 million of unshipped orders compared to maybe your initial expectations? And did I hear it right where you're expecting sort of a similar level of impacts here in the current quarter?

Yes. Hi, 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 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 has the cadence of that usually play out?

Yes. 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 advance through the third quarter. And then sequentially we're thinking 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.

Yes, it's Greg. I would say it's kind of hard to compare because a year ago we were significantly ramping up from the low points of the pandemic. We definitely have that data, and I’m sure we discussed it on the call last year, and it was likely higher than 7%. However, I believe it's largely due to the significant decline that most companies experienced when the pandemic started in 2020.

Okay. Good. All right. I'll hop back in the queue. Thanks.

Okay. Thanks Greg.

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

Thank you. I've encountered that variation in many other instances of my last name, which I won't elaborate on during this call.

Hey, Chris, good morning.

Good morning. Yes, 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 does an inorganic opportunity need to come to fruition to get to 50% or higher of the mix?

Yes. 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 think 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 transformed 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 Solutions space.

Yes. So, Chris, 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 in the attractive segments that we're talking about here. But just de facto the precision conveyance is typically an 8% kind of growth business. We've been outgrowing that at Dorner at double digits. And we would expect with revenue synergies we can move Garvey into that sort of growth trajectory. So that business continues to grow. And then clearly linear motion and automation are the other two key components that are today growing.

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

Thank you. To follow up on the earlier question about mergers and acquisitions, we are entering a rising interest rate environment. Depending on what Jerome Powell communicates, we will see how things develop. How do you view this situation in relation to your current net leverage, which is nearing two times? How does this environment relate to your balance sheet, and what are your thoughts on the implications for pricing potential opportunities in the market? Do you believe that multiples will decrease as companies pursue these opportunities, or what are your 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 with 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.

Yes. To add on, from a net leverage perspective, we were at 2.9 times excluding cost synergies. On a financial covenant basis, we will report being below 2.8 times for the quarter. This aligns with our target when we acquired Garvey, aiming for 2.8 on a pro forma basis. We are comfortable going up to 3.5 times. However, in the case of Dorner, leverage was initially higher. We have been transparent about our plans to raise equity to help finance the acquisition. Equity will always be a consideration in the equation. There are many factors that must align for an acquisition to be completed, requiring both strategic and cost considerations. This unpredictability makes it clear that nothing is finalized until the deal is concluded.

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 and the overall strategy we have for the business.

Thank you.

Thank you. The next question is from Jon Tanwanteng with CJS Securities. Please go ahead.

Hi, 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 contributed within your fiscal Q4 guidance?

Sure. I'll begin and then Greg can elaborate. In examining the synergistic value of the acquisition, we see significant potential from combining Dorner's advanced conveyor technology with Garvey's top-tier accumulation technology. Both companies have strong, patented products and solid brand recognition in their respective markets. We believe there's substantial synergy to be achieved in terms of sales and growth. For instance, we recently secured a $700,000 order in December and have additional orders in the pipeline. There's considerable potential to expand Garvey's business beyond its traditional focus on the food, beverage, and pharmaceutical sectors, where it currently derives about 80% of its revenue, into more industrial technology and automation areas. Similarly, Garvey can help us introduce more Dorner products into the pharmaceutical, life sciences, and food and beverage sectors. This creates a promising opportunity to synergize the two businesses effectively. We also have significant global prospects to expand both businesses internationally by leveraging the wider Columbus McKinnon footprint. The driving motivation behind the acquisition is primarily focused on growth synergies rather than cost synergies, although we do have cost synergy opportunities that we've already started to realize. Now, I'll turn it over to Greg to discuss that further.

On the cost synergy front, what we aimed for when we presented the acquisition was about $600,000 in cost synergies for the next fiscal year, which is roughly 2% of sales. The reason this figure might seem small compared to expectations with Dorner is that, as a small family-run company, we need to make certain investments to elevate the company to public standards. However, on a positive note, one synergy we have already achieved is incorporating Garvey into the Columbus McKinnon insurance program, which resulted in a $200,000 reduction in our overall insurance costs. This means I have already accomplished one-third of the $600,000 in synergies. We anticipate additional savings in administrative and sourcing areas as our sourcing teams get involved. We believe reaching the $600,000 target will not be overly challenging, but there will be some necessary investments in the business that may offset the overall expected cost synergies, bringing the net figure back to around 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 in 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?

In a typical year, excluding the COVID years, we would anticipate at least a 100 basis point improvement, maybe even more. This expectation is based on the seasonal decline we typically see in the third quarter, followed by stronger margins in the fourth quarter due to more shipping days, higher fixed cost absorption, and the implementation of our annual price increases. Generally, we would expect to see a substantial increase in gross margins sequentially. However, the ongoing impact of Omicron, which we've been managing since around November, is affecting our staffing both in our facilities and with our suppliers. This results in challenges in obtaining the necessary components to ship products, leading to inefficiencies. For example, if a motor is delayed, production is halted while we shift focus to another product. Our operations team is doing an excellent job navigating this complexity. While we have increased inventory, the absence of just one component can halt product shipments, which is true for both legacy Columbus McKinnon and Dorner and Garvey. From a margin perspective, we expect it to be similar to this quarter, likely with a positive bias. We're making progress in adding more staff at our facilities, which is crucial. Our supply chain team is also actively seeking alternative suppliers, with some members currently in Eastern Europe exploring options for certain components. It's undoubtedly challenging, but we've shown our ability to manage these difficulties over the past year.

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

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

You bet.

Thank you. The next question is from Steve Ferazani with Sidoti & Company. Please go ahead.

Good morning, everyone. Thanks for all the information this morning. I do want to ask a couple of questions about Garvey. 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 of backlog, it would be 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 there are material swings. And so, 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 performed well for us in the fourth quarter or the third quarter I should say. And as we advance into the fourth quarter, 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 Dorner 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.

Right. That's helpful. And then on – in terms of Garvey being a 100% North America, how early on are you thinking about international opportunities to Garvey and how much will can Dorner 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 pulled 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 US. 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 the time.

Thank you, Steve.

Thank you. The next question is from Matt Summerville with D.A. Davidson. Please go ahead.

Good morning. This is Will Jellison on for Matt Summerville today.

Hi, 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 push-out 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 one of – I'd have to see our sequential P&L but clearly 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 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, why you thought it was the right time for that business to transition its ownership moving forward? And of those Garvey executives staying on board, if they are going to be owners of Columbus stock moving forward.

Right. Yeah, great question. And we're thrilled with the acquisition and the addition of the management team from Garvey to 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 multiple, and it's 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 Liptak with Seaport Research. Please go ahead.

Hey. Good morning, guys and thanks for the nice quarter.

Good morning, Walt.

I wanted to ask about gross margin. It's positive to see where it is and the conversion that's taking place. Can you provide a bit more detail about the pricing and the supply chain, and explain why we're not experiencing more challenges on the gross margin line?

Yes. 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. We're 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.

Yes. Additionally, we observed significant productivity in our plants despite facing supply chain challenges, and our factories are operating at full capacity. We have a record backlog, and we're focused on meeting customer needs and demands. The high level of activity this quarter contributed to the $3.6 million in productivity we achieved. Another factor is that Garvey and Dorner have stronger gross margins compared to legacy Columbus McKinnon, typically around 40% or more. This provided a positive impact on 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.

Yes, we are in a very dynamic environment. Assuming all things remain equal, we would expect to see volume benefits as we move through this quarter. If we account for all the potential challenges with our planned offsetting actions, we tend to be around or slightly better than where we ended up in the third quarter. We are making an effort to exceed that, but we remain cautious about unknown factors. So far, we have been navigating these challenges successfully, but there are still uncertainties we face.

And maybe just the cautionary part of all this is really the raw material inflation. So 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 the inflation has definitely accelerated steel prices we've talked about in the past. We haven't locked in for the most part through 12/31. We've renegotiated those contracts and we will see higher steel costs going forward.

Energy prices.

And we have the opportunity to raise price and respond, but at the same time

Okay. Got it. And then kind of along those lines the inventory stepped up quarter-over-quarter. Was that just again in front of it, or is it do you only buy inventory to meet the existing order book?

Yes. 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 $700,000. Was that a pull through from Dorner to Garvey or Garvey to Dorner? So was it basically, was it pharma or industrial?

Yes. 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 JPMorgan. Steve, go ahead.

Hey guys, good morning.

Hi, good morning, Steve.

When considering the medium-term outlook for warehouse activity, which remains quite strong today, how do you view the potential for growth in either the calendar year or the fiscal year 2022? Can we expect solid growth in that business during this period, given our current position? I don't see it as a cyclical issue; rather, it's a growth market with some fluctuations. Could you provide a more detailed perspective on what you anticipate for calendar year 2022 or the next fiscal year?

Yes. 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. How do you see free cash flow and working capital in relation to sales, as it has been historically? What are your thoughts on the appropriate free cash conversion?

Sure. I'll mention that our working capital as a percentage of sales is in the mid-teens, around 15%, which aligns with our expectations for this point in our business cycle. We finished last year at 9%, which was unusually low and not a sustainable level for the growth we aim to achieve. I believe we're in a good position and will strive to maintain that level of working capital. Now, I'll turn it over to Greg to discuss the free cash flow cycle.

Yes. So Steve, regarding our free cash flow conversion, we typically have over 100% free cash flow conversion. We are not a capital expenditure-intensive company. Last year, our free cash flow conversion was 29%, as we reduced inventory due to the pandemic. This year, on a trailing 12-month basis, it's 48%. Together, these figures will average about 100% or a little over. So that's the way to think about it moving forward. It's about 100%.

We tend to be better now.

Got it. And just one more question regarding the supply chain's effect on revenues. It seems the impact in the third quarter was somewhat worse compared to the second quarter. You mentioned previously that you expected a similar effect. Was it indeed larger than anticipated? Also, what gives you confidence that this situation won't worsen in the near future?

Yes. 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, 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 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 just being mindful that 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. 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 is 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.