Thank you for standing by, and welcome to the Fourth Quarter 2021 Kadant Inc. Earnings Conference Call. [Operator Instructions] As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Michael McKenney, Executive Vice President and Chief Financial Officer. Please go ahead.

Thank you, Jonathan. Good morning, everyone, and welcome to Kadant's Fourth Quarter and Full Year 2021 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 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 the non-GAAP financial measures to the most directly comparable GAAP measures is contained in our fourth quarter earnings press release and slides presented on the webcast and discussed in the conference call, which are available 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 to 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 fourth quarter and full year results and discuss our business outlook for 2022. The fourth quarter was a solid finish to an exceptional year. Despite the uncertainties brought about by the pandemic, supply chain constraints and macroeconomic headwinds, we had another well-executed quarter and generated record cash flow among several other financial records. Good capital project activity across all our operating segments and robust aftermarket demand led to strong bookings and record backlog. I'll provide more details about this activity when I discuss the results of our operating segments. Our balance sheet remains healthy, and we finished the year well positioned to capitalize on new opportunities as they develop. As many of you know, our technologies play a pivotal role in helping our customers advance their sustainability initiatives with product innovations that reduce waste or generate more yield with fewer inputs, particularly fiber, energy and water. This is what we refer to as sustainable industrial processing, producing more while consuming less. And it is a major element of our strategic focus and value proposition. At the end of 2021, we were honored to be named by Newsweek magazine as one of America's most responsible companies for a second consecutive year. We were also selected as a winner of the 2021 SEAL Business Sustainability Award in the environmental initiatives category. It's rewarding to be recognized for our sustainability efforts and our work towards driving sustainable industrial processing. Turning now to Slide 6 and our Q4 financial performance. You can see we had significant increases across all our key financial metrics and achieved new records in essentially every metric shown in the slide. Q4 revenue was up 30% compared to the fourth quarter of 2020 to a record…

Thank you, Jeff. I'll start with some key financial metrics from our fourth quarter, which included some notable records. Consolidated gross margins were 42.4% in the fourth quarter of 2021 compared to 44.1% in the fourth quarter of 2020, down 170 basis points. Our consolidated gross margins in the fourth 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 90 basis points. In the fourth quarter of 2020, government assistance benefits increased consolidated gross margins by 50 basis points. Excluding the impact from both these items, consolidated gross margins were down 30 basis points due to a higher mix of capital revenue. Our overall percentage of parts and consumables revenue decreased to 63% of total revenue in the fourth quarter 2021 compared to 67% in the fourth quarter of 2020 due to a significantly higher capital revenue at our Industrial Processing segment. SG&A expenses were $57.8 million in the fourth quarter of 2021 and increased -- an increase of $10.4 million compared to $47.4 million in the fourth quarter of 2020. Fourth quarter of 2021, SG&A includes $6.4 million in SG&A from our acquisitions and an increase of $1.5 million in acquisition-related costs, which totaled $1.7 million in the fourth quarter 2021 compared to $0.2 million in the prior year. The remaining increase in SG&A expense is primarily associated with increased incentive compensation due to improved business conditions. As a percentage of revenue, SG&A expenses decreased to 26.4% in the fourth quarter of 2021 compared to 28.1% in the prior year period. For the first time in our history, our quarterly GAAP diluted EPS exceeded $2, reaching $2.07 in the fourth quarter 2021 compared to $1.40 in the fourth quarter of 2020.…

Our first question comes from the line of John Franzreb from Sidoti.

Congratulations on a great quarter. Actually, this kind of dovetails into what you're just talking about. A common theme emerging this reporting season is higher capital spending on projects that has either been deferred by labor or equipment availability. I'm curious if you think that you're benefiting from this trend? And if so, by about how much?

Well, I think certainly, there was a slowdown in capital project activity in the prior year when pandemic really was raging through the globe. And so some of that has started to back up again. So I think there certainly has -- we are benefiting from that. But I would also say, in our particular markets that there have been shifts associated with the pandemic that are driving demand, that are likely to remain as the pandemic eases. In particular, the at-home deliveries which require a lot more packaging. And the housing boom associated with people working from home, needing different housing arrangements, which has driven our -- a lot of our wood processing businesses. So I think probably it's a combination of both of those, a social shift that's taken place in the way we live and work. and the way we consume goods, along with some activity on the capital project side. But I think it's -- we're in the early stages, I would say, of executing these capital projects that have come in. And so there's still a fair amount of runway, I think, left on catching up.

Got it. And Jeff, you mentioned in your prepared remarks that you've achieved the 20% EBITDA target this year you said often support in your 2019 Investor Day. I'm curious, did you expect to achieve it this early? Or has something happened that kind of outperformed our original expectations?

Well, this was our third kind of 5-year plan that we've put out in '19. And I think the first one we achieved some metrics in 3 years and the second one, we did it in 4 years. So it's not unusual for us to hit some of the targets or many of the targets before the end of the 5 years. I will point out that we haven't met them all yet. We're -- we met the EBITDA margin goal. We've -- we're approaching the earnings per share goal, but our revenue is still -- we still have some further work to do there. And so we try to set ambitious goals, but also goals that we believe that our people can drive towards achieving. And we're quite pleased with this. The 80/20 initiative, which we implemented, started implementing years ago has really delivered some solid results for us and the divisions that have been in that program for a while, and that's certainly helping us. Some of the acquisitions we've made have been very extremely profitable acquisitions. They've been accretive to that. So it's really been a combination, I think, of increased operating leverage, internal cost initiatives through 80/20 and just some accretive acquisitions. And so we're pleased with it. And once we've achieved most of the metrics, and we think it's appropriate to issue a new 5-year plan, of course, we'll -- our EBITDA margin goal will go up. We'll set a plan to decrease that even further through the next plan.

Got it. Got it. And I guess one last question, I'll get back in the queue. Just about with higher commodity costs and other input costs affecting companies across the board. I just wonder if you could kind of review how you manage higher input costs and pricing across your 3 business segments?

Yes. Well, one of the great things about our decentralized structure, and we believe there are many is that our teams out there are very focused on the local conditions on the ground and they're structured to respond very quickly to changes take place. So there's no corporate, if you will, procurement manager or sourcing manager that's trying to manage things globally. We have 20 major operating units around the world that are basically making changes in real time as they see the conditions on the ground changing. So that's allowed us to move quickly on the sourcing side, cost control side and were required on the pricing side. But -- so they've done a very good job of staying ahead of the issues. And that's obviously shown by the fact that our actual kind of on a same-store sale gross margin actually was up 20 basis points for the year, so we able to actually prove it a little bit. And that's just through the hard work of our people making, like I said, real-time decisions really based on the conditions locally. And that's -- through this pandemic, that decentralized structure really served us well. And we believe there's great positive benefits from it, generally speaking, during times of crisis, that's where 20 really strong management teams making local decisions in real time really benefits us. And this is just one example of it.

So are you at price cost equilibrium right now? Or is there still a lag going on? And if so, how long?

Well, it kind of depends on the commodity. There are some commodities that are starting to moderate a little bit, but there are others that are still there. I would say, generally speaking, the supply chain constraints are still there and -- what -- in the areas where we've had to put some new pricing in that's working through the system. Some of that takes longer than others because you might have existing projects that you signed before the inflation took over, took off. And also, we have some supply agreements that kind of set prices for a year or more. So I would say there's still some pricing to work through the system. But the more important thing for us is we're really focused on our costs, trying to keep our costs down as low as possible so that we can minimize the price increases to our customers.

Our next question comes from the line of Chris Howe from Barrington Research.

Well, as it relates to the outlook, you talked about the many puts and takes that may influence that outlook. As we take that and put it into context versus this past year, there's certainly continuing uncertainty regarding the timing of capital shipments. Can you talk about the puts and takes with gross margin and also leverage on the operating line? How you see perhaps the first half in the second half playing out versus last year, perhaps a reversal? Or is it too early to tell based on the timing of orders?

Well, Chris, I have a view as it stands today. And of course, that may change. But I'd say just looking at the big picture, looking at our guidance, if I kind of lay that out over the year, interestingly enough, to me, it looks like the first quarter and our last quarter, the fourth quarter, will be relatively -- there's equilibrium between those 2, which would lead you to believe that the middle of the year is where we'll have our highest revenue numbers in the second and third quarter. If I do it -- if I split that first half, second half, the revenue is about the same. But to your point on different pressure points, I would say the -- I expect in the latter half of the year, our margins will be better. Our operating performance will be better than in the first half. And that's primarily driven by I'm looking at capital shipments in the second quarter that will put some pressure on our margin performance. And that will start to abate as we go into the latter half of the year. So revenue -- on the top line revenue, relatively even split first half, second half, but operating metrics and performance will perform, I believe, better in the second half of the year compared to the first half.

Okay. Perfect. And just throw a question here for Jeff. You mentioned the potential for improvement initiatives as we consider the integration of Clouth and their margin in the context of the business. Can you place kind of this opportunity into further detail? I think on the last call, you had mentioned just opportunities across the business for product development and sharing of best practices. What type of synergistic opportunity, whether that's leverage or growth you see for the combination?

Yes. There's actually several levers out there that are available for pooling. The -- one of them that we're doing right now is we -- as you know, we had a ceramics play business that we're investing in pretty heavily and starting to take some market share, but it's always -- that's kind of a pioneering work, so it's always challenging. And these guys are very strong in that area. So one of the first things we did is we're -- we moved our ceramics business over to them. We're in the process of doing that and shutting down our facilities, Mike mentioned some of the impairment charges that we were taking associated with doing that. So that's something that we're doing we did almost immediately, which we'll benefit from. And then the guys are going to get together. We have our global kind of strategy meeting coming up here in a few weeks. And so all the team members, the senior management will be getting together here in a few weeks for a week to start to really work through the details of the synergies that exist and what we're going to tackle first. And I would tell you that between kind of consolidating the ceramics business, rationalizing the product development and then importantly, the 80/20 initiatives, which had a big impact on our Doctoring, Cleaning and Filtration business, and we expect we'll have similar benefits to them. This will -- these will take a couple of years, 2 or 3 years before you'll see the full benefits of those -- so there's a fair amount of work to do, but we think it is very achievable, very doable. And we expect we'll see progress throughout this year and the next year too.

Our next question comes from the line of Kurt Yinger from D.A. Davidson.

Just 2 quick ones for me. I mean, I just wanted to start off on project time lines. I mean, given what's going on in the supply chain, are customers coming back to you at all and kind of pushing orders out to later dates? Or do you expect that could be an issue at some stage this year?

Well, there's -- clearly, there's challenges everywhere. And so that's always a possibility. I would tell you the project I mentioned that was put on hold really was not a supply chain issue. There's other considerations, I think that the customer is looking at that impacted their decision to put this thing on hold right now while they do some work. So we're seeing that, and it could affect timing a little bit on projects. It really, I think, would depend on which part of the world, we have things shipping in any given quarter. Obviously, stuff that's produced and sold in their current market is in a little better shape than something that's got to be put on a ship and shipped halfway around the world. So timing -- I'll be honest with you, timing on capital shipments is always a challenge in our business. If something ships on a Friday, it's in the quarter. If it slips to a Monday at the end of the quarter, then it's into the next one. So that's something that we manage and watch closely. So it's possible. We've not had anything other than that one project I mentioned that has been delayed. But is it possible to say, hey, I want you to ship that 3 weeks from now or 4 weeks from now and do it today because of this or that, that's a possibility. We have that under good times, and it certainly can be accentuated during these times. It's our it's our hope and our belief that some of these logistics, in particular, the transportation side will start to improve a little bit as the year progresses that some of these backlogs will start to work itself out. It won't be as much of an issue in the latter half of the year as it is at the beginning of the year.

Got it. Okay. That's helpful. And then -- sorry, it seems like operating rates are still very healthy. Market environment seems very solid. But do you foresee any challenges lapping some of these parts and consumables comps, just given how strong 2021 was and it's not necessarily as lumpy as the capital side, but -- sometimes that can be a challenge as well, I presume?

Yes. It's a funny thing. Our capital, of course, really, as we install new capital equipment, it starts to throw off consumables and parts. And so while there might have been some, I would say, pent-up demand that we experienced last year as people restocked their shelves. We're putting an awful lot of capital equipment out and capital equipment over time, consumes parts. So there could be a little bit of, I would say, moderation that may take place. But as long as the operating rates stay high because our cap -- over the long run, our capital equipment, as I said, drives our consumables. As operating rates stay high, our parts consumables kind of are a function of that. As we're putting a lot of capital out right now, we would expect to see the benefits of that over the next few years as they consume parts. So we've leased a joke that if we could sell parts without selling capital, it would be an easier business, but it's really the capital that drives the parts.

Right, right. Okay. That's a helpful reminder. And then just lastly, in terms of geographies. I mean the North American market is very strong. But even looking at Europe and Asia revenue this year grew very nicely rebounding off of 2020. As you look into 2022, any kind of directional commentary in terms of markets you think will be strongest or areas that you think might see momentum start to slow a bit?

I'd say, Kurt, we did -- it was -- 2021 was a very good year across all the geographies. And we're really anticipating that we'll see that again in 2022.

Our next question comes from the line of Walter Liptak from Seaport.

I wonder -- first maybe ask a follow-on. When you were talking about the seasonality for 2022 and more capital shipments in the second quarter. I wonder if you could just help us understand your backlog and how far out does your visibility go right now? Is it that in the second half, you just don't have the bookings yet, those will still come in? And just maybe talk a little bit more about what I'm hearing on the mix as it might be more capital projects this year as opposed to parts orders.

Yes. Well, I'd say, Walt, that our backlog right now is at $310 million. There is a small piece of that, that's actually going into 2023. So it's spread throughout the year. I won't say evenly, it's -- but it is spread throughout the year. I think our visibility tends to be pretty good 2 quarters out. So the second half of the year is a little bit more of a challenge to predict what's going to happen on the capital front. But in the -- we have good visibility on the first half. And I would say, to your question, on the margin front, what -- I guided to 43 to 43.5. And I'm looking at the -- what we have for capital shipments in the first half of the year. And I think if I look at that margin range, we'll probably see margins in the first half of the year towards the low end of that range towards $43 million. And then in the second half, that average out towards the higher end of the range.

Okay. Great. Yes, that helps. And in thinking about the gross margin that you guys just reported, understanding that Clouth and Balemaster hit -- it sounds like there was some amortization expense flowing through. I wonder, is that ongoing expense, typically, those are below the gross margin line? It sounds like you guys are putting it through cost of goods sold. Is that going to be an ongoing headwind to the gross margin?

No. The -- what you want to look at for that, Walt, and you'll see the pretax number in our EBITDA table is the line called acquired profit and inventory. That's what's going through cost of goods sold and in the margins. And that, we basically finished that. So that's -- when you acquire a business, you have to do a fair value everything, including the inventory and then that gets amortized as the inventory turns. So that is now behind us. We do have --

Okay. I understand, those were purchase accounting costs.

And the other amortization, that actually goes through SG&A, not through cost of goods sold.

Okay. Got it. Okay. That makes more sense. Okay. And just on the -- sticking with this gross margin, and I appreciate the guidance for 2022. How does the bookings that you've got right now, can you adjust those if prices keep going up? Or how are you dealing with the inflation or some of those orders that have been booked, have you been able to cover the inflation that's already happened?

Yes. Well, of course, we've been talking about this essentially throughout 2021. It's much easier for us on the parts and consumables front. That -- those orders have very quick cycle times. So we're able to react to input cost changes very, very currently. The area where you'd have more risk is on capital that may be in the backlog for an extended period of time. On some larger projects, we have surcharge arrangements so we can make adjustments. But I would say the majority they're priced currently. And what we've tried to do is reduce the window that the quotation is good for. So to limit the exposure, the customer has to place the order, say, within a month or the quote expires. But nonetheless, it's -- we'll -- we can get capital goods that will be in backlog and material or input costs can increase, and we'll be -- we'll have to face into that.

Okay. All right. Sounds good. And then maybe just the last one. Last quarter, you guys talked a little bit about China logistics. And this call, we haven't heard too much about that. I wonder if you could just give us an update on what's happening there? Is it just a continuation of their COVID policies that have things shut down or how are things going?

Yes. China is still maintaining this zero-COVID policy. They're the only country really in the world that's doing that. And they've actually managed their pandemic infection rate pretty well, but it does introduce some real challenges to getting things out of there. Now they haven't shut imports down recently from an outbreak or things like that. But it's still a challenge. The containers, they're still hard to get, ports are still congested. I mean it's an ongoing challenge. Again, I mentioned earlier, we're hoping that we're going to see a little bit of relief as the year progresses on that. But I think everybody has kind of adjusted -- we've adjusted our delivery schedules and we're managing the best we can. The risk, of course, is the unknown that you get a major outbreak at a port city or something, they would shut things down for a month. That's the risk. But as of right now, I would say that we're -- that we're managing reasonably well, and we're hoping that things will continue to improve as the year progresses.

All right. Great. And maybe just one final -- final one for me. Just a follow-up. You were talking a little bit about sort of the funnel for capital projects that you're seeing. And it sounds like they were still strong across the board. I wonder if you could talk a little bit just about the wood products and wood processing CapEx projects? And if we see this rising interest rate environment, do those projects keep on going forward? Or how are you thinking of the risk of potential slowdown from higher rates?

Well, it's interesting. Housing starts were 1.7 and 1.7 in November and December, January, they're at 1.6, so still very high levels. Wood pricing, of course, the composite index is back up again, quite high, not quite to the record that it was still quite high. So the -- our customers are still -- there's still good demand. and they're making very good price on it. So you need to keep in mind that in the '08, '09 crash, there was some capacity that was taken offline. And so demand has come back to that level and in some cases, even stronger demand than back then, it was a little less capacity. And so it doesn't take much to see prices go up. There's a fair amount of new capacity coming online. And so interesting to see what that does to pricing. But the other thing to keep in mind is as part of this climate initiative globally, there's more and more construction migrating to use of wood. I mean if you think of houses that are built out of wood frame, tick frame, it's really a primer in North America. The rest of the world, the tradition has not done that. Well, Masonry has one of the highest greenhouse gas footprint or highest carbon footprints, any of the industrials out there. And so there's the beginning of a migration away and I believe we believe there will be a continual migration away from brick and concrete and Masonry construction to wood-based just because they won't be able to meet the climate initiatives without it. And we've seen estimates that could really drive demand for wood products over the next many years. So it's going quite interesting to see what happens around the world as people respond to these greenhouse gas targets they have. And they are just trying going to be able to do it by continuing to build houses on of high carbon footprint Masonry products.

Our next question comes from the line of Bobby Eubank from Chevy Chase Trust.

Two questions for you. One, Mike, are you able to split out the difference between volume and price in the 18% organic revenue for the quarter?

No, Bobby. That -- as Jeff -- you heard Jeff say, we have 20 operating units and the price increases have been quite varied by the units. So I couldn't say that I could honestly give you a good split on that.

Okay. But it's fair to say that price is a meaningful contributor you think to organic revenue?

Fair to say that price is a contributor. I mean, margins are kind of the same. So it obviously -- it hasn't gone down, but hasn't gone up.

Right. Yes. And then the book-to-bill step down even pulling out the $10 million from that one project. As we look through the rest of 2022 and your discussions with customers across those 20 business units, what's the kind of tone from them look like? Are we -- if you look at the market, there's a lot of expectations that we're hitting kind of a peak in the cycle, and it feels a little early? But how do your customers feel and order outlook for the second half of the year, if you can kind of just tease it out from customers?

I think, as Mike mentioned, I think when you were talking prior questions, visibility is always tough for us, particularly on capital projects for the back half of the year. We have decent visibility in the front half. The back half, it's a little harder. And because we're so geographically diverse, it really varies quite a bit. I would tell you that if we look, for instance, in Asia, that our project activity level, I would say, is quite strong right now, and it wouldn't surprise us to see that continue through the year and some solid bookings in Asia for this year. I would say North America, bookings were quite strong in last year. And so as a possible they might moderate some. It's very possible. And then Europe, I would say it's kind of in the middle. They improved last year, but they're having good activity now. So it really -- I think if I had to guess, I would say Asia is strong, Europe kind of steady. And the question is in North America, can we keep it going there? And it's very difficult, I think, to forecast the back half of the year. All I can tell you is that our customers are making good money, prices are up. If you look at the prices of lumber, as I mentioned itself. If you look at the prices of boxes, they put several price increases in there. So I think the customers are doing well. And normally, when our customers do well, they invest in their businesses over time, and that benefits us.

Makes a lot of sense. If I can do a follow-up, what does the acquisition pipeline look like? Not a focus on this call, but congratulations on a strong free cash flow, clearly have capacity to do so.

Yes. I mean, as I think we mentioned on the last couple of calls, the activity level as far as deal flow is quite strong. So our corporate development group is quite busy with that. The issue with us, we always point out that we try to maintain our discipline. And so finding something that's a good strategic fit for us and at a price that we think we can create some value with is always really the challenge. We've passed on some things that weren't a good strategic fit. We've also passed on some things that we think valuation-wise just didn't make sense. It's always a challenge. There's a lot of money out there right now. We say money is kind of free and unlimited and availability. It's out there chasing deals. And so they price things quite high in some cases. We typically buy privately owned companies, and we often buy companies that we've known for a long time and had relationships or even negotiations with for many years. If you look at most of our acquisitions that they follow in that -- under that strategy. And so at any given time, we're talking to 100 or 200 companies. We're following a couple of hundred. And if we can find something that meets our criteria, as you pointed out, we've got the balance sheet to do it. So we're not constrained in any way from a financing or capital standpoint. Our challenge is finding things that are a good strategic fit and a good value. And our people are working hard at it, but it's always hard to predict when they'll come.

[Operator Instructions] And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Jeffrey Powell, President, Chief Executive Officer and Director.

Thank you, Jonathan. So before wrapping up the call today, I just want to leave you with a couple of takeaways. 2021 was a record-setting year for Kadant, and our employees deserve a lot of credit for achieving these results. And I really want to thank all of our employees around the world for tireless effort to meet our customers' needs. In 2022, we will continue to focus on meeting our customers' needs with innovative technologies and solutions that really drive sustainable industrial processing. Our financial health is excellent, and our ability to generate strong free cash flow remains the cornerstone of Kadant’s business model. And we look forward to delivering exceptional value for our stakeholders in 2022. With that, I want to thank you for joining us today, and please take care and stay safe.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect, good day.