Cadre Holdings, Inc.

Good afternoon and welcome to Cadre Holdings 3rd quarter 2024 conference call. Today's call is being recorded. All lines have been placed on mute. If you would like to ask a question at the end of the prepared remarks, please press the star key, then the number one on your touchtone phone. At this time, I would like to turn the conference over to Matt Berkowitz of the IGB group for introductions and the reading of the Safe Harbor Statement. Please go ahead, sir.

Thank you and welcome to today's conference call to discuss Cadre's 3rd quarter results. Before we begin, I would like to remind everyone that during today's call, we will be making several forward-looking statements and we make these statements under the Safe Harbor provisions of the Private Securities and Litigation Reform Act of 1995. These forward-looking statements reflect our best estimates and assumptions based on our understanding of information known to us today. These forward-looking statements are subject to the risks and uncertainties that face Cadre and the industries and markets in which we operate. More information on potential factors that could affect Cadre's financial results is included from time to time in Cadre's public reports, FODs, and the Securities and Exchange Commission. Please note that we have posted presentation materials on our website at -holdings.com, which supplement our comments this evening and include a reconciliation of certain non-GAP financial measures. I'd like to remind everyone that this call will be available for replay through November 20, 2024, starting at 8 p.m. Eastern time tonight. A webcast replay will also be available via the link provided in today's press release as well as on Cadre's website. At this time, I would like to turn the call over to Cadre's Chairman and CEO, Warren Kanders.

Good afternoon, and thank you for joining Cadre's earnings call to discuss our results for the third quarter of 2024. I am joined today by our President, Brad Williams, and Chief Financial Officer, Blaine Browers. During the quarter, we continue to see strong demand for Cadre's mission critical safety products across our law enforcement, first responder military, and nuclear markets. We've been pleased with the team's overall progress and execution, consistent with our stated strategic objectives. Implementation of the Cadre operating model is ongoing, and we remain excited about the potential to further optimize processes throughout the business, driving margin expansion and increased profitability as we continue to grow. While there was a short-term impact on our financial results this quarter as a result of the cybersecurity incidents, business macros are strong, and we continue to see attractive long-term growth opportunities supported by Cadre's and Trent's positions in the markets in which we operate, as well as favorable industry trends related to public safety. In the context of the U.S. election, I'd like to underscore the resilience and consistency of Cadre's business through cycles. Historically, our financial results have not been significantly affected by economic, political, geopolitical, and other cycles, and we expect this will continue to be the case. As you all know, our largest market segment is law enforcement, and over multiple decades, major domestic law enforcement budgets and police protection expenditures have grown, despite financial and industrial recessions and a political climate that has oscillated. In recent years, defund the police has become refund the police, and there is an expectation that regardless of which party is in office, there will be a commitment to public safety spending and ensuring those who protect and serve us are equipped with the safest and most reliable products. Looking ahead, complementing our core organic growth initiatives to capitalize on these headwinds, Cadre's M&A program is a key component to accelerate long-term growth. We continue to aggressively evaluate a robust pipeline of potential transactions and are tracking well to further grow our platform and enhance our market leadership through M&A. Cadre maintains an advantage in pursuing targets given the strength of our balance sheet and our ability to act quickly. Based on the opportunities we are seeing and the status of active discussions, we still believe we are well positioned to announce at least one transaction before the end of 2024 while maintaining patience and discipline. With that, thank you for being with us today, and I will turn the call over to Brad. Brad, over to you.

Thank you, Warren. On today's call, Blayne and I will provide a Q3 update and business overview, including recent trends and financial performance followed by a Q&A session. We'll begin on slide five. We made progress executing our strategic objectives during the third quarter and continued to see strong and recurring demand for our -in-class mission-critical safety equipment. Our teams remain committed to the principles of the Cadre operating model, which is driving improvement every day throughout the organization. From a broader demand and pricing growth perspective, Cadre continues to benefit from innovative product offering, premium brands, and leading positions across our law enforcement, first responder, military, and nuclear markets. Our mix in the third quarter was neutral. We maintained a strong orders backlog, which was $167 million as of September 30th. This represents a $21 million increase from Q2, excluding Alpha Safety and I-Corps. As Warren mentioned, our M&A funnel also remains strong. Blayne will outline our M&A priorities in greater detail, but the primary takeaway is that we continue to be excited about the opportunities we are actively evaluating. Based on our asset-like business model with minimal capex needs, Cadre's strong free cash flow generation continues to support our M&A objectives, while also enabling the company to prioritize the return of capital to shareholders. We've paid 12 consecutive quarterly dividends since going public and raised our dividend earlier this year to $0.35 per share on an annualized basis. Turning to slide six, I'll briefly highlight the long-term market tailwinds that investors familiar with Cadre know well. As public safety has increasingly become a nonpartisan issue, we see favorable macro trends fueling global demand for our mission-critical equipment. As Warren mentioned, Cadre's core law enforcement and military business has always been acyclical, delivering consistent and stable growth regardless of economic, political, and geopolitical conditions. A primary reason we were drawn to nuclear safety is the similar attributes it shares as a business area with very stable organic growth. Alpha Safety has a protected market position and highly visible revenue supported by long-term contracts and recurring purchase orders. As we take a step back and look at the nuclear safety sector as a whole, we like to think about long-term market tailwinds supporting growth in terms of three key nuclear missions. The first two are related to environmental safety, which is driven by DOE mission-critical and mandated cleanup efforts, and national security underpinned by expanding national defense programs. Third is nuclear energy, which we recognize is an area of growing interest as focus intensifies on how to increase the sustainability of energy supplies globally. We see future opportunities for our nuclear safety business in conjunction with the growth of the global small modular reactor pipeline. Once SMRs become operational, their requirements will resemble those of the current commercial nuclear reactor fleet, and there will be a number of opportunities for us to win new business. We expect to see demand for ventilation, shielding, and containment products, particularly during outing cycles, much like we do with existing reactors. Turning to slide seven, we outline the latest market trends impacting our business on a more current basis. Trends related to North American law enforcement, the geopolitical landscape, and new products have remained mostly unchanged in the last three months. Zooming in our consumer channel, which represents approximately 8% of Cadre sales after the acquisitions of IPOR and Alpha Safety, I'd like to highlight that we've continued to see solid demand despite broader market weakness. I'll now turn the call over to our CFO, Blaine Browers.

Thanks, Brad. I'll kick off my comments with a review of our M&A strategy. We continue to evaluate potential transactions consistent with our highly selected key criteria listed on slide eight. The pipeline is robust, and we see actionable opportunities to build out our nuclear platform, as well as to expand our suite of core safety products for law enforcement and military. Turning now to a summary of Cadre's financial performance, slides 10 and 11 detail our Q3 results. On slide 10, you'll see as discussed the effect of the cyber security incidents on our short-term financial performance. Our best estimate at this time is the cyber incidents created about five points of gross margin pressure in the quarter. In Q3, we've expensed $1.5 million related to inventory step-up amortization for the acquisitions of IPOR and Alpha Safety. In addition, intangibles amortization and cost of goods sold was $900,000 in Q3. Combined, this created 225 basis points of headwind compared to last year. Illustrated on slide 11 is net sales and adjusted EBITDA growth year over year, including our updated 2024 guidance, which I'll discuss in more detail in a moment. At its midpoint, this outlook implies full year revenue and adjusted EBITDA growth this year of over 17 and 21 percent, respectively. On slide 12, we present our capital structure as of September 30. Our net debt leverage of 1.3 times remains low, with ample dry powder available to continue to pursue acquisition opportunities. Before turning to our full year guidance on the next slide, I'd like to provide an update on the cyber security incident we reported last quarter. In response to the July incident, we immediately took steps to remediate the incident with the help of outside experts. During the process of reinstating the infected technology systems, we experienced the second cyber incident as we were transitioning to a steady state environment. Fortunate with the number of countermeasures already established, our internal and external cyber security teams were able to act quickly and minimize the disruption. To date, we have implemented many countermeasures to improve our infrastructure and will continue implementing additional countermeasures to protect our systems and data. Full year guidance in August was based on information we had available to us at the time as we worked diligently with cyber experts and internal teams to estimate how long it would take to resume normal operations. It's important to highlight that customer and supplier relationships remain strong. While these incidents have had an impact on our short-term financial performance, we continue to see favorable demand trends for cadre's -in-class mission critical safety equipment across our categories. To reiterate a point that Brad made, our teams have ramped up effectively and we've been pleased with their overall progress and execution, leveraging the cadre operating model to drive constant organizational improvement. With that being said, taking into account both cyber incidents, the company has modified its full year guidance for 2024, which is reflected on slide 13. Cadre now expects to generate net sales in the range of $560 to $570 million and adjusted EBITDA in the range of $101 to $107 million. We expect capital expenditures to be in the range of $6 to $8 million. I'll now turn it back to Brad for concluding comments.

Thank you, Blaine. In summary, we continue to execute in line with our strategic objectives and capitalize on the favorable market trends driving strong demand for cadre's -in-class mission critical safety equipment. Complementing our core organic growth initiatives, we are actively evaluating attractive M&A opportunities to add complementary businesses with strong margins, leading in defensible market positions and recurring revenue profiles. Supported by cadre's entrenched positions and favorable industry trends across our law enforcement, first responder, military and nuclear end markets, we are confident in cadre's forward outlook and excited to build on our track record of superior execution and further enhance our market leadership. With that, operator, please open up the lines for Q&A.

Thank you. If you have dialed in and would like to ask a question, please press star followed by number one on your telephone keypad to raise your hand and join the queue. To withdraw your question, press star one again. If you have dialed in and are listening via loudspeaker on your device, please pick up your handset and ensure that your phone is not on mute when asking your question. Our first question comes from the line of Jeff Sandsindran with B. Riley Securities. Please go ahead.

Hi, everyone. Just wanted to clarify a little bit on the cybersecurity. Regarding the revenue that did not occur in Q3, does that revenue shift into Q4, all of it in Q4? Also, was there any impact to future booking timing or order timing? Is it fair to say at this point that there is really no other impact to your business other than just the timing of shipping if you order?

Hi, Jeff. Thanks for the question. With the second incident, some of that revenue does get pushed into 2025, which is the reason the change in guidance. There is no other impact outside of the Q3 margins and then the point I just made on the revenue shifting out. At this point, it's contained inside Q3 and we're focused on executing to a large Q4 here. The teams are doing a great job of coming back up, ensuring supply chains were intact during the incidents, allowing us to not only build inventory during the incidents but be prepared for Q4s.

Okay, great. And then since you mentioned alpha safety and certainly an area that I think is top of mind for folks, can you just talk a little bit more about what you're seeing around alpha's M&A pipeline and maybe give us a sense, I guess, of how your broader pipeline stands at this moment where you might emphasize acquisitions and it sounds like there's no impact to that from the cyber incident. Is that correct?

That's correct. Hey, Jeff, it's Brad. I'll take that one. So I would say overall, the funnel for alpha safety is definitely solid, more than solid as we look at what's been going on the nuclear side of things. So companies in the funnel that we're looking for are everything from engineered type systems type companies that are in the funnel that would be solutions providers for large end customers, both in the US and also internationally. And then also very interested in the funnel with companies that are similar to alpha in manufacturing certain products for the nuclear industry where those products are repeated and supplied. So those are the two that we see the most opportunity in, not just in the US, but also internationally. If you remember, one of our strategies with alpha safety was to expand outside of the US geographically into Europe. And so we're also keen on acquisitions that fit into that.

OK, great. Thanks for taking my questions. I'll take the rest offline.

OK, thanks,

Jeff. Thanks, Jeff.

Our next question comes from the line of Lawrence Salo with CJS Securities. Please go ahead.

Great. Good evening, guys. I guess just not to be a dead horse with the security question, but just I guess, so it sounds like there was a second little breach, but you guys feel pretty confident that you now won't happen again. Was there any kind of, did you have to increase security or expenses anymore after the second breach? Is there any, going forward, any reoccurring expenses or anything related to this, or is it the minimum?

Hey, Larry. Appreciate the question. Coming out of the first incident, we had a number of countermeasures and additional security measures we put in place. Because of that, it minimized the impact of the second incident. So the teams did a great job of executing that first and then minimizing that second incident. So it was a much different scope and impact to the company. Coming out of that second incident, we absolutely had additional measures we put in place. And we've since engaged an additional group of outside experts to continue to put more countermeasures in place. So while we can't guarantee we can prevent any future events, I can assure you our environment is much more robust than it was going back to early July. But we're not done. We view this no different than any other part of the company when we think about continuous improvement and how do we get better. And we'll continue to apply resources, both time and money, to ensure we harden our environment. And this will be a longer-term project. There's a list of items that are short-term in nature and then a medium-term list and then there's a long-term list. And we'll continue to execute those. On a cost basis, there weren't significant or material costs incurred related to the second incident that we didn't talk about in earnings. So I wouldn't view this as materially changing our financial position because of these countermeasures. Certainly cost something, but it's not an amount that we would discuss externally.

All right. And I'm just curious, Blaine, you missed the sales number because I think you had died a little bit higher because of the second incident. But you actually, you were able to, you cut SG&A pretty significantly. I thought in the face of declining sales, I thought that SG&A would kind of stay up because it was just a temporary blip in the sales. So is that some of that just incentive comp or any color there?

Yeah, a good portion of that, Larry, was incentive comp. Obviously, on a year on your basis, when you look at the numbers, absolute, there's certainly some headwind there. And we evaluated the incentive comp structure and made appropriate adjustments based on the Q3 results.

Gotcha. Okay. And then just last question, just broad brush. It sounds like your end markets don't change rapidly anyhow, but it sounds like they're all doing consistent and steady and doing pretty well without, we can get into more detail offline, but there's no specific changes. It doesn't feel like the election or anything in the US is going to really change dramatically because of the results or anything like that. So anything we should be aware of just from a top level, high level on the map? No,

not at all, Larry. This is Brad. I mean, everything's in line macro-wise with what we've seen. As you know, that's why we love the business. Overall, just the durability of it. So whether it's elections or quote unquote defund the police or COVID or industrial recessions, financial recessions, you name it, we haven't seen any major changes like that. So nothing there to report. Gotcha. Great.

All right. Thank you very much.

Thank you, Larry.

Our next question comes from the line of Matt Coranda with Roth Capital. Please go ahead.

Hey, guys. Maybe trying to get at the cyber security question in a little bit of a different way. Is there any way to just characterize sort of sales by month in the quarter? Was it, I would assume it was down a bunch in July, just given production was constrained, then maybe recovered to positive in August, and then the September incident may have sent you back negative, but like any way to kind of just give us the shape of the quarter so we can understand sort of the impact of the two incidents and how they hit the quarter?

Yeah, it was, so July was the most severely impacted month in the quarter. In August, we started to ramp up and actually September was, you know, the strongest month in the quarter despite the second incident because the teams had built up quite a bit of production and inventory in the back half of August that got shipped prior to the second incident. The other good news, Matt, is the teams were able, the teams that were impacted by systems being down were still able to produce during the second incident. Some businesses on that 100% were 90%, other businesses maybe 60%, 70%. But they had the systems in place coming out of that first incident to immediately continue production, so it wasn't a case where there were significant outages like the first. Also call out, you can see it in the statement of cash flow in the balance sheet, but the teams did build inventory in September, which helps position us well for

Q4. Got it, okay. Then if we think about, I know there's noise from the cyber incident in the quarter, but any rough cut on the contribution that you got from ALFA and I-CORE within the third quarter?

I assume on a revenue

basis, I-CORE was pretty consistent with what we saw last quarter. Yeah, so again, they're a little over $20 million, fairly evenly spread through the year. Then ALFA tends to be a backend loaded business based on the timing of their projects. For them, they ramped up into Q3 from Q2 pretty significantly, called a 20%, 30% ramp sequentially. Again, completely unrelated to the incidents, neither of those businesses were impacted.

Yeah, okay, that's good to hear. Then just, I guess lastly on the guidance, I just want to get my head around, it's a pretty steep ramp in revenue, but also it would call for something in the low 20%, even on margin in the fourth quarter, which would be well ahead of any other quarter you guys have done. Maybe just speak to how we get the incrementals. Is it just a pure benefit of, hey, we just have a whole bunch of shipments that got delayed, pushed into the fourth quarter that we get without the associated SG&A costs? Maybe just give us a little bit of comfort around the ramp if we use the midpoint of the guide.

Yeah, so when we break it down a level lower, gross margins in Q4, we expect to be really similar to Q1 on a rate basis. We are going to incur incremental expenses around production in Q4 for overtime, et cetera. The EBITDA rate pickup in Q4, Matt, is really that leverage on the SG&A. We expect our SG&A to be really more in line with Q1 rather than what we saw in Q3. Obviously, it will be one of our bigger quarters from our revenue output. But like I said, the teams have the plans in place. We did build inventory in Q3, so we're bullish on Q4. Q4 will be a tough quarter and frankly a record quarter, but the teams have gone through the detailed plans and we're comfortable with our look for the year. Okay,

I appreciate it. I'll leave it there.

Our next question comes from the line of Sheila Coyoglu with Jeffreys. Please go ahead.

Hi. Good afternoon, guys. And maybe on that last line of questioning, no, I think it's just if you look at the Q4 implied run rate of 40% and then the margins as well, you're about 45% through the quarter. So, you know, is the quarter trending in line with that? How do we think about that exit rate and the cadence into 25% as well? So, I guess how, like what gives you confidence in that Q4 guidance despite what's happened?

So, you know, we are already into Q4. So, a couple of things, I guess, Sheila, and thanks for the question. You know, first the inventory position coming out, it looks like a very large revenue number, but some of that is, you know, is really inventory sitting and ready to go or relatively ready to go with the final steps to be made. You know, the second piece is, you know, we're looking at the schedules. You know, we're looking at incremental days, you know, OT. So, when we think about businesses that are on a four-day work week, you know, 410s, you know, they're looking at 510s and that incremental capacity. You also, you know, we've added days by, you know, postponing, you know, physical inventories to, again, you know, you get two or three days there. So, these are all small things, but when you start to add them up, you know, if you're running an additional day a week, you know, you're adding, you know, 25% capacity there. You add three days and a quarter, right, that gives you another 5% production capacity. You have inventory on the shelf. So, they do start to add up and, you know, we're, while it's a big number, we're comfortable with it and, you know, if we weren't, we wouldn't have put out the guidance, but, you know, certainly we'll require, you know, high level execution from the teams, but we're confident in the team's ability to execute.

Okay. And then maybe along the line of, like, the cadence for the 25 and maybe just bigger pictures stepping back, just given the complexity of the one-time items in the second half, how do we think about the underlying potential for the business in 2025 plus as the creative M&A continues to roll in and you keep pushing for that 50 basis points with the annual margin expansion. So, maybe if you could just talk about how we think about the underlying business or remove the one-time complexities for us.

Yeah, so I think, you know, the one-timers outside of the inventory step up, you know, we've talked about kind of this five-point margin pressure in Q3, which, you know, is approximately $5 million of pressure that should bounce back. You know, we think about next year, Sheila, we would say it's, you know, consistent with what we had seen historically, which is, you know, the market grows 3% for the, you know, military and law enforcement side, you know, expect more in that, you know, four to six range on the nuclear side. You know, the tough part now would be for us to think about, you know, quarterly timing. You know, it's pretty far out for us. We will, as we get into, you know, 2025, and now the guidance will provide a little more clarity on the timing and the pacing through the year. But nothing's really changed with our outlook. And in my mind, the one-timers are really just that $5 million of margin pressure in Q3, as well as the inventory step up.

Okay,

thank you so much. Appreciate it.

Thanks, Sheila.

Our next question comes from the Jordan Leonet with Bank of America. Please go ahead.

Hey, thank you guys for taking the question. For 4Q, could you give us a sense about what's driving the sales increase? Is it explosive ordinance devices? Is it commercial sales? What's the underlying growth by segment?

Yeah, it's, yeah, I'd say the two largest areas, if you're thinking sequentially, Jordan, is really armor and duty gear. I mean, they're, you know, two of the larger businesses definitely have some pent-up backlog coming out of Q3, as well as inventory. So those are the drivers. You know, the EOD business, the bombsuit side, you know, we expect it to be a big Q4 for us prior to the incident, so in the absence of those. So that's, you know, it'd still be a big quarter for them. And those are really the three bigger drivers for there. So EOD suits, as expected, you know, big Q4, and then armor and duty gear more driven by the incident pent-up backlog.

Got it. Thank you. Thank

you.

Our next question comes from the line of Mark Smith with Lake Street Capital Markets. Please go ahead.

Hi, guys. First off, just a kind of broad question on the nuclear business, just as we look at kind of new projects, startup of plants, you know, what kind of opportunities are you guys seeing and maybe run way for how long it takes, you know, to recognize and see benefit from some new startups?

Yeah. Hey, Mark, it's Brad. So from a new startup perspective, and maybe specifically where you're coming from is there's obviously a lot of information out there around small modular reactors, as we talked about in the remarks. The thing to keep in mind there is, you know, for us, our cycle currently, you know, with alpha safety would be once those type of plants are up and running, and they're starting to, you know, create waste in the reaction type process. So that's where our products, you know, tend to begin to kick in. So don't think of it as, you know, if a plant is being built, our products are involved in that beginning part of the process.

Okay. And then I just wanted to think also broadly here on kind of election results yesterday, last night, today, kind of exposure, any changes in long term outlook. I know Warren talked about kind of the consistency of the business, but maybe any reminders as you can give us on tariffs or any potential impact that you see from the results of the election?

Actually, you know, we don't see any changes, or we don't foresee any changes as we get forward, you know, in terms of from that perspective. I think there's been, you know, a lot of learnings, you know, wherever you sit, whether it's Republicans or Democrats in terms of law enforcement and, you know, the needs for, you know, continuing to invest in those areas. So, as you know, that's a big core part of the business that we have today. So we expect that it'll remain the same and remain strong. We don't expect, even though it's about 8% of the business on the consumer commercial side for us, we don't expect a, you know, large, extremely large uptick in demand and that side of things, you know, based on the transition from Democratic office to, you know, Republican side of things. So pretty much status quo, Mark, is where we're sitting, which is great. You know, innovation has been a key, as you know, as we've innovated a lot of products over the last couple of years and, you know, others continue to be in the pipeline. And, you know, for us, it's about sticking to our game and continuing to move forward with it. Supply chain wise, you know, keep in mind we don't have a supply chain that extends very, very lengthy, especially in the Asian countries, which is good for us. Most of the supply chain is regional and that gives us that ability to, you know, stay close to where we're at from a manufacturing standpoint and not be affected by, you know, some of the potential things that are being talked about.

Excellent. Thank you. You're

welcome. Thank you.

We have no further questions at this time. I will now turn the call back over to Brad Williams for any closing comments.

Thank you, Operator. I'd like to thank everyone again for joining us on today's call and for your continued interest in cadre. Thanks a lot.

This concludes today's conference call. Thank you and have a great day.