Ladies and gentlemen, thank you for standing by. Welcome to Q3 2021 Kadant Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]. I would now like to turn the conference over to your host, Mr. Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

Thank you, Grace. Good morning everyone and welcome to Kadant's Third Quarter Earnings Call. With me on the call today is Jeff Powell, our President and Chief Executive Officer. Before we begin, let me read our Safe Harbor statement. Various remarks that we may make today about Kadant's future plans and expectations, financial and operating results and prospects are forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks and uncertainties that may cause our actual results to differ materially from these forward-looking statements as a result of various important factors, including those outlined at the beginning of our slide presentation and those discussed under the heading Risk Factors in our annual report on Form 10-K for the fiscal year ended January 2, 2021, and subsequent filings with the Securities and Exchange Commission. In addition, any forward-looking statements we make during this webcast represent our views and estimates only as of today. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our views or estimates change. During this webcast, we will refer to some non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures is contained in our third quarter earnings press release and the slides presented on the webcast and discussed in the conference call, which are available in the Investors section of our Website at www.kadant.com. Finally, I wanted to note that when we refer to GAAP earnings per share or EPS and adjusted EPS on this call, we are referring to each of these measures as calculated on a diluted basis. With that, I'll turn the call over to Jeff Powell, who will give you an update on Kadant's business and future prospects. Following Jeff's remarks, I'll give an overview of our financial results for the quarter. And we will then have a Q&A session. Jeff?

Thanks, Mike. Hello, everyone. Thank you for joining us this morning to review our third quarter results and discuss our outlook for the remainder of the year. We had another quarter of record revenue and bookings, along with strong EBITDA margin performance and free cash flow, positioning us well for a strong finish to the year. I'd like to begin by reviewing our operational highlights for the third quarter. The robust demand for aftermarket parts and a high level of capital project activity in the third quarter led to an all-time high for revenue and bookings. Our aftermarket parts and consumable business was exceptionally strong in most regions of the world, and new order activity was driven by solid demand across all of our operating segments. In the third quarter, we announced the closing of two acquisitions, one in our Flow Control segment and another in our Material Handling segment. The integration of these businesses is going well and their financial results contributed to our third quarter performance. Just after the third quarter closed, we completed an acquisition of a small manufacturing business in India. It is a well-established manufacturer of engineered stock preparation and equipment used to process recycle and virgin fiber for paper packaging and tissue production. Our acquisition of this business will create a new manufacturing base for us in India, where we have leading market position and have been active for more than 20 years. It also provides a strategic platform to accelerate new business opportunities in the fast-growing Indian packaging and tissue markets. Before moving on to our Q3 financial performance, I want to comment on the global supply chain and how we are managing in this complex environment. The headwinds found within the global supply chain continued to be a challenge, pushing out expected…

Thank you, Jeff. I'll start with some key financial metrics from our third quarter. Consolidated gross margins were 41.9% in the third quarter of 2021 compared to 44.2% in the third quarter of 2020. Our consolidated gross margins in the third quarter of 2021 were negatively affected by the amortization of acquired profit and inventory related to the Clouth and Balemaster acquisitions, which lowered consolidated gross margins by 110 basis points. In the third quarter of 2020, government assistance benefits increased consolidated gross margins by 110 basis points. Excluding the impact from both of these, consolidated gross margins were approximately 43% in both periods. Our parts and consumable revenue represented 66% of revenue in both periods. SG&A expenses were 52.3 million in the third quarter of 2021, an increase of 8.5 million compared to 43.9 million in the third quarter 2020. Third quarter of 2021 SG&A includes 3.4 million in SG&A from our acquisitions. There was an unfavorable foreign currency translation effect of 0.9 million in the quarter and a reduction in government assistance benefits of 0.7 million. We also incurred acquisition-related costs of 1.3 million in the third quarter of 2021 compared to 0.4 million in the third quarter of 2020. The remaining increase in SG&A expenses is primarily associated with increased incentive compensation and travel-related costs due to improved business conditions. As a percentage of revenue, SG&A expenses decreased to 26.2% in the third quarter of 2021 compared to 28.4% in the prior year period. Our effective tax rate was 24.6% in the third quarter of 2021, lower than we anticipated, primarily due to tax benefits from acquisition-related expenses, employee equity awards and the reversal of tax reserves associated with uncertain tax positions. Our GAAP diluted EPS was $1.75 in the third quarter, up 37% compared to $1.28…

Thank you. [Operator Instructions]. Your first question comes from the line of Kurt Yinger from D.A. Davidson. Your line is open.

Great. Thanks and good morning, Jeff and Mike.

Good morning, Kurt.

Just wanted to start off on the supply chain. With orders being pushed out, do you expect that's really a Q4 type phenomenon as you get into next year? Can you kind of get back on track and continue to grow sequentially, or do you expect that's going to remain a challenge in terms of delivering the plan and the backlog?

So as Mike mentioned, we had quite a bit of revenue that shifted from Q4 into next year. Right now, our thinking is that the first couple of quarters of next year, we're still going to see some shipping challenges. And a lot of it has to do with logistics and shipping is probably one of the biggest challenges we have. But kind of what we're hearing and what you read is that they think by summertime, they should have this kind of sorted out. And so we think it's -- right now, our expectation is it's going to be a first half of the year type phenomenon. And we're hoping that the back half of the year, things will be back to something a little more normal. We've never dealt with this before. So nobody knows for sure, but our sense is that things will start to sort themselves out the first quarter or two of next year.

Got it. And when you think about just the capacity of your system and the flexibility that you might have, is the supply chain a limiting factor to kind of revenue growth from here or is it more just based on more of a headwind in terms of delivering to kind of scheduled out timelines?

Yes. I think it's more of a delivery problem. It's not -- I don't think it's going to be a revenue issue. It's not going to curtail revenue, or I don't expect us to lose much in the way of revenue because of it. It's taking a little longer to deliver than we might otherwise.

Okay, that's helpful. All right. And then just on the margin front, can you just talk directionally about how you're thinking about the potential kind of impact as capital presumably increases as a proportion of revenue in 2022. Is that something with overall volume levels being higher, do you think you can kind of hold in that 42 to 43 gross margin range you've kind of achieved here in the second half, or could that drag be a real needle mover?

I don't know if it will be a real needle mover, Kurt, but there's no question that that mix of capital and parts and consumables plays a part in the gross margin performance. So I always say when we're heavier capital that will create some pressure on gross margins. But the good news side of that is we get operating leverage on it. So our operating margins will be better.

Got it. Okay. All right. That's helpful. And then just last one for me. As you look across your segments, your different customer sets and geographies, it seems like over the last quarter or two here, things have been universally strong. But I guess as you look ahead to Q4, any notable pockets of acceleration or deceleration or any trends you're kind of thinking about heading into 2022 that are different from what you've seen over the last couple of months?

I would say no, not right now. I think our customers continue to operate at a fairly high operating rate, as you know. Two-thirds of our business recently has been parts and consumables, and they tend to go as the operating rates go. And so most of our customers around the globe are operating at very high rates. Demand is pretty high still. And so right now, we've had kind of broad growth across all three of our segments, and we don't see any significant variation from one segment to the other. I think everybody seems to be operating at a pretty high rate right now. Demand is pretty high.

Got it. Okay. That’s good to hear. Well, I appreciate all the color and good luck here in Q4.

Thanks.

Thank you. Next, we have Walt Liptak from Seaport Research. Your line is open.

Hi. Good morning, guys.

Hi, Walt.

Hi, Walt.

Hi. I wanted to ask, just to go back to that last question about the shipping and if you could just go into a little bit more detail. We've all heard about what's going on, on the West Coast ports. Is it that you're having trouble getting component parts in through the ports or is there something else going on with shipping about getting products out from your factory someplace else?

Yes. It's a little bit of everything, but I would tell you that the bigger issue for us is getting containers and ships out of China, frankly. That's a big part of it. As you know, a large percentage of our business in China is sold and stays in China, but they still do manufacture components for some of their sister divisions around the globe. And right now, shipping is just very tough. The costs have gone up substantially. We've been able to manage that side of it, but the timing -- the schedules are somewhat out of our control. So that's what we're dealing with or struggling with. As I said earlier -- Kurt asked the question, I think most of the experts think that it will start to resolve itself here over the next several months in the spring time and early summer. That certainly is our hope and expectation. But that's really what it is. It's getting our equipment kind of shift to customers.

Okay. I wonder if you can give us some more detail about the types of products, which segment some of the delayed shipments are in?

Yes. I would say, Walt, it's heavily -- probably, frankly, to no surprise, it's heavily weighted in Industrial Processing. So of that $13 million revenue shift number that I gave, 80% of that is in Industrial Processing. And again, sticking with the 13 million when you kind of split that amongst the product offerings in Industrial Processing, half of that is in the stock product line and then 30% is in the wood product line. So it's very heavily weighted in Industrial Processing.

Okay, got it. Okay, great. And maybe to segue into another question is in Industrial Process, great orders there. It's been really strong tied to the residential builds. How is the funnel looking for projects? Do you get visibility on some of those projects? Do you think the order activity will continue into 2022?

I think demand continues to be fairly strong. After the quarter closed, we booked an order on the wood processing side for -- what was it, Mike?

8 million --

$8 million order we booked in the last week for some new stranders in the OSB market, which is a very -- one of the biggest orders. I think it is actually the biggest order in the company's history. So right now, demand continues to be very strong. Lumber prices are off of their high. They're down in the $575 range, still well above the historical average of about $375. So they've dropped quite a bit. But they're still -- companies are still very profitable, demand is very high and they're reinvesting back in their businesses to meet that demand.

Okay. All right. Great. Thank you for that. And maybe just the last one for me is -- I wonder if you could just help us go through the M&A that you completed and just talk about which segments those are in, and a little bit about the fit with Kadant?

Sure. So Clouth, which was based out of Germany, is in the Flow Control Group and they were -- as you know, Walt, one of our oldest businesses, one of the original business with Kadant was the doctoring blade [ph] business, and Clouth was a major competitor. So we were kind of number one and number two in the world in that particular market. And so they joined the Kadant family. And so we combined two of the -- the two strongest blade suppliers in the world together. So there's tremendous -- as you might imagine, tremendous opportunities there for product development, for market penetration, for sharing best practices. They had very, very sophisticated manufacturing operations in Europe that we can leverage. So it's just -- I think I mentioned when we made the acquisition, it was our number one acquisition target for 30 years. And so you couldn't ask for anything much better than that. Balemaster, which was in our Material Handling segment, again, I think I mentioned we've been talking to them for about five years. They're a premier baler supplier in the U.S. Record demand, as I mentioned, a very strong business serving the -- principally, the containerboard markets. What they're primarily going after is OCC and pre-consumer cardboard from box plants and board mills and things. So again, a great fit for us. As you know, we’re the largest supplier of balers in the world through our European operation combined with this. And they're seeing -- for several quarters now, they've seen near record demand. So just a great fit for us in a market that's doing very well. As the global economy shifts more and more to these renewable materials and principally fiber cellulose fiber, demand for recycling that continues to go up. So it's…

Okay, great. Thank you very much. Congratulations on those deals and I appreciate you running through them for us.

Sure. Thanks, Walt.

Thank you. [Operator Instructions]. Your next question comes from the line of Bobby Eubank from Chevy Chase Trust. Your line is open.

Hi, guys. Congrats on those acquisitions and the strong bookings. I wish you the best with dealing with these logistical issues that you and many other companies are dealing with. On inflation and some of the challenges of managing costs, I know it's a little bit early but any kind of early reads on 2022 kind of OpEx increases from an organic basis? Thank you.

Thanks for the question, Bobby. Well, of course, in our next call, when we wrap up the year, we'll give a lot of color on 2022. So I don't want to front-run that. But I would say it's -- we won't be surprised if the inflationary pressures continue into 2022. But I think our folks are very in tune with their input costs, and they're making adjustments accordingly.

Great. That's the kind of color I was looking for. And I appreciate that. I'm glad that you're aware of it and watching and monitoring it. And just kind of what are you seeing in the day-to-day challenges right now in terms of operating costs?

Well, certainly, prices have -- there's two things that are happening. Of course, costs are going up and delivery times are lengthening. One of the -- we've talked about this before, one of the many pluses of our highly decentralized structure is that our local operations teams on the ground can make decisions pretty quickly based on what they're seeing. So for instance, we might see delivery issues in Europe, but we might see cost issues in North America, or we might see something in China. But our local teams there obviously work it every day. And so they're able to respond pretty quickly to try to manage those cost increases and those logistic challenges. And when necessary, they also can respond quickly to raise prices to pass along those increased costs. We always work hard not to do that, because we pride ourselves in being able to continually improve the value that we deliver to our customers. But there are times when your input costs go up to an extent that you can't offset those through productivity or other issues, in which case then you have to pass them on. And so we -- when required to do that, we do that. And like I said, it's done at the local level based on the conditions that our operating teams are seeing there. So we feel good that we're able to stay in front of these issues. You'll see our margin -- Mike mentioned our gross margins were the same this quarter as they were a year ago. And even though we've seen these inflationary challenges, and that's because our guys manage it locally in real time. So that's always served us well.

Thank you very much and best wishes.

Thank you, Bobby.

Thank you. [Operator Instructions]. Presenters, I'm showing no further question at this time. I would now like to turn the conference back to Mr. Jeff Powell, President and Chief Executive Officer, for any closing remarks. Sir?

Thanks, Grace. Before wrapping up the call today, I just want to leave you with a few takeaways. 2021 is shaping up to be the best year in our history across a wide range of metrics. We made solid progress this year on our efforts to accelerate revenue growth and the acquisitions we completed in the second half of the year will further contribute to this growth and our long-term sustainability. Our year-to-date free cash flow is at a record level and our ability to generate free cash flow remains a cornerstone of our business model. We look forward to a strong finish in 2021. With that, we want to thank you for joining us today, and please stay safe.

Thank you, presenters. Ladies and gentlemen, this concludes today’s conference call. Thank you all for joining. You may now disconnect.