Compass Diversified Holdings

Good afternoon, and welcome to Compass Diversify's third quarter 2021 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 prepared remarks, please press the star key and the number one on your touchtone phone. At this time, I would like to turn the conference over to Matt Berkowitz of the IGV group for introductions and the reading of the Safe Harbor Statement. Please go ahead, sir.

Thank you, and welcome to Compass Diversified's third quarter 2021 conference call. Representing the company today are Elias Sabo, Cody's CEO, Ryan Falkingham, Cody's CFO, and Pat Mazzarello, COO of Compass Group Management. Before we begin, I'd like to point out that the Q3 2021 press release, including the financial tables and non-GAAP financial measure reconciliations, are available at the investor relations section on the company's website at www.compassdiversify.com. The company also filed its Form 10-Q with the SEC today after the market closed, which includes reconciliations of non-GAAP financial measures to discuss on this call, including adjusted EBITDA and cash available for distribution, and is also available at the investor relations section of our website. Please note that references to EBITDA in the following discussions refer to adjusted EBITDA as reconciled net income and the company's financial filings. The company does not provide a reconciliation of its full year expected 2021 adjusted EBITDA or 2021 payout ratio because certain significant reconciling information is not available without unreasonable efforts. Throughout this call, we will refer to Compass Diversified as COTI or the company. Now allow me to read the following Safe Harbor statement. During this conference call, we may make certain forward-looking statements, including statements with regard to the future performance of COTI and subsidiaries and statements related to the impact of COTI's updated tax structure and the impact and expected timing of acquisitions and dispositions. Words such as believes, expects, plans, projects, and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements, And some of these factors are enumerated in the risk factor discussion in the Form 10-Q as filed with the SEC for the quarter ended September 30, 2021, as well as in other SEC filings. In particular, the domestic and global economic environment is currently impacted by the COVID-19 pandemic and related supply chain disruption has a significant impact on our subsidiary companies. Except as required by law, Cody undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. At this time, I would like to turn the call over to Elias Szabo.

Good afternoon. Thank you all for your time, and welcome to our third quarter earnings conference call. I want to start by pointing out the momentous milestone that Cody achieved during the quarter. After over a year of analysis, preparation, documentation, and communication that culminated with a shareholder vote, we elected to be treated as a C corporation for U.S. federal income tax purposes. I want to thank our entire team for their tireless effort to get this election completed. We are confident the benefits of this election will be profound and long-lasting, and we are already encouraged by the initial reaction in the markets. We believe this change in tax structure will allow a wider audience of investors to access our company, provide a lower cost of capital, and give us more depth in our capital access. With the lowest cost of capital among our peers, we believe we have built a competitive advantage in the marketplace that will be a key differentiator as we continue to seek opportunistic acquisition and build leading businesses. In September, we filed a prospective supplement with the SEC to enable share issuance under an at-the-market common share program. We believe this program offers an efficient and cost-effective way for us to raise common equity capital to fuel our growth and build towards our goal of $1 billion in EBITDA. In pursuit of that objective, we have reconstituted our portfolio over the past three years to increase the company's core growth rate and provide a tailwind to meet our growth objectives. That said, we are aware we need more than core growth alone. The second part of our business model and critical to us achieving our growth objective is by having a low-cost, efficient way to access equity capital. To demonstrate this point, I would like to take a moment to review our capital allocation and capital raising decisions over the past few years. In 2019, when asset prices favored divestment, we sold Clean Earth and Manitoba Harvest at record prices without deploying any capital. Late in 2019, we raised $115 million of equity capital through the issuance of Series C preferred stock. By the end of the year, our balance sheet was strong and we were ready to pounce on opportunities. With the strongest balance sheet in our company's history and record capital availability, we were then able to close on Marucci Sports and BOA Technologies in 2020, despite the far-reaching implications of the COVID-19 pandemic. To further strengthen our balance sheet during 2020, we also raised an additional $88 million of equity capital and $200 million of unsecured bonds. These capital allocation and capital raising decisions, although creating modest equity dilution, have allowed our growth rates and earnings power to materially accelerate. This is evidenced by the first nine months of this year, during which we have produced $135 million of cash available to distribute and reinvest or CAD. This is the highest amount of CAD ever produced in our company's history by a significant margin. In 2021, we have continued to be active with capital raising and capital allocation decisions. Thus far, we have refinanced our unsecured debt to lower the interest rate by 2.75 percentage points, or 34% from the original issuance rate, while at the same time upsizing the offering by an additional $400 million to $1 billion. This series of decisions have put us in position to have the lowest cost of capital in our company's history, and we are set to continue leveraging our permanent capital structure to drive long-term shareholder value. During the third quarter and subsequently, we announced a few key transactions. We closed on the divestiture of LibertySafe, invested in Altor Solutions by adding on Plymouth Foam to strengthen Altor's status as an industry leader. Acquired Lugano Diamonds and Jewelry, a new subsidiary that designs, manufactures, and markets high-end, one-of-a-kind jewelry. Announced the execution of a definitive agreement to divest advanced circuits. Our longest holding, which we expect to be closed in 2022, subject to satisfaction of closing conditions. And just recently, we made an acquisition to add lizard skins to Marucci, which will strengthen Marucci's leading position in diamond sports and offer an opportunity for expansion into new markets. Taken together, this collection of transactions over approximately one quarter represents our approach to sustainably investing with our permanent capital model. One, we strategically acquire businesses poised for growth. Two, manage and build businesses with our resources and expertise. And three, divest opportunistically when it makes sense for all constituents. The divestiture of Liberty Safe and the anticipated divestiture of Advanced Circuits in particular highlight an important advantage to our permanent capital business model. Both businesses were held for more than a decade, something nearly unheard of in the traditional private equity model. Over our ownership, we invested significant growth capital in both businesses. This is a core component of our sustainable investing model that is enabled by our permanent capital approach. At Advanced Circuits, we completed a number of add-on acquisitions and growth capital expenditures, the most recent of which upgraded its Arizona plant to become a world-class manufacturing facility. At Liberty, while we only completed one add-on acquisition, we more importantly invested a significant amount of growth capital that enabled the company to dramatically expand its manufacturing capabilities and capture the revenue growth available to it as demand increased in 2020 and into 2021. Importantly, the ability to divest these businesses on our preferred timeline and not required based on fund life has enabled us to achieve a return on invested capital for Liberty that significantly exceeded our underwriting expectations, and we expect a similar result for Advanced Circuit. The platform acquisition of Lugano Diamonds & Jewelry is an exciting opportunity to bring a growing luxury goods brand to the Cody portfolio. We are pleased to partner with Modi and Idit Furter as we seek to build Lugano into a global iconic jewelry brand. When you look at this company closely, we believe it is clear that the Lugano model is disruptive to the jewelry industry. Lugano acquires loose stones and then designs unique, one-of-a-kind pieces. However, these aren't just sold in stores. Lugano creates a bespoke selling experience in their retail salons, providing value to the customer with a streamlined, simple, and curated selling experience. We believe the addition of Lugano will be accretive to our growth profile over time. Lugano will require a significant investment in inventory and growth capital expenditures as we build unique salons in strategic markets around the country and internationally. Now turning to our financial performance. I am pleased to report that our third quarter results were exceptional and once again exceeded our expectations. Throughout this presentation, when we discuss pro forma results, it will be as if we owned BOA, Marucci, and Lugano, and divested Liberty from January 1st, 2020. On a pro forma basis, consolidated revenue grew approximately 18% and adjusted EBITDA grew approximately 19% over the prior year's quarter. I would like to highlight that our consolidated adjusted EBITDA margin remained approximately flat at 19.5% year over year. This is an incredible accomplishment and reflects the dedication of each of our subsidiary company management teams. Our subsidiary teams have encountered numerous challenges unique to their businesses in the ongoing pandemic recovery. In particular, supply chain disruptions, lack of labor availability, and rapidly increasing inflation have created challenges never experienced before. For our companies to deliver nearly 20% top-line growth with static year-over-year margins is a testament to the exceptional talent we possess at our subsidiary level. Before I provide an update on our guidance, I want to reiterate that the macro environment remains uncertain, and many of the challenges we have dealt with throughout the year are increasing with each passing quarter. Demand continues to remain robust throughout our portfolio. However, supply-side challenges are extensive and increasing. There are significant park shortages from our vendors, lack of available shipping capacity, issues with port congestion, and finally, a lack of trucking capacity. Our companies are performing admirably in dealing with these challenges. However, the current state of the supply chain is putting pressure on revenue growth and materially raising costs to create product availability. Second, labor availability is scarce. Elevated open positions are suppressing revenue growth and labor costs are rising rapidly as a result. These factors, along with a significant increase in commodity costs, are causing our cost structure to increase rapidly. As a result, we have been forced to raise prices in order to protect margins. Thus far, we have found demand to be inelastic during these times, as the veracity of demand has allowed us to raise prices without diminishing sales. Notwithstanding these unique challenges, And in light of our extraordinary year-to-date results and our expectations for the balance of the year, we now expect to produce pro forma consolidated subsidiary adjusted EBITDA of between $380 million and $390 million. This represents pro forma growth of approximately 30% to 33% from the prior year and an improved payout ratio of less than 55%. based on our historic distribution rate of $0.36 per share each quarter. To aid in our comparisons, given the number of transactions that occurred in the quarter, I would like to walk through our guidance as compared to the prior quarter. Last quarter, we guided to adjusted EBITDA between $350 million and $370 million. LibertySafe was expected to produce approximately $25 million in adjusted EBITDA and included in our updated guidance is an expectation for Lugano to produce $35 million in adjusted EBITDA. Thus, the net effect of the M&A transactions we completed were to increase our guidance by $10 million on a pro forma basis. This would have made last quarter's guidance range increase to $360 million to $380 million on a pro forma basis to include the acquisitions and divestitures. As you will see from this analysis, we are raising our guidance by $20 million on the bottom of the range and $10 million on the top of the range. I would also like to take a minute to discuss our ongoing ESG efforts. We are pleased to announce that we have hired a new head of ESG who will be starting with us on December 1st. We believe this will allow us to accelerate our ESG initiatives at the Cody level, while at the same time leading the acceleration of initiatives across all portfolio companies. I also wanted to highlight recent ESG success stories at two of our subsidiaries. First, at our Altor Solutions subsidiary, we experienced an increase in customer wins at our rational packaging minority investments. We are proud to highlight that our investment in Rational Packaging in September 2020 was crucial to commercializing their products, which are manufactured using recycled and environmentally friendly inputs and are 100% post-consumer recyclable. In addition, at Altar, we continue to make progress towards the development of a fully curbside recyclable custom packaging product offering that we expect to have commercialized by 2022. We believe this initiative, along with rational packaging, will allow us to offer a robust suite of environmentally friendly products to our customers by mid-next year. We are incredibly proud of the Altor management team in working towards reducing our environmental impact. Second, at Ergobaby, we expanded our EverLove program to Europe, which provides consumers with previously loved carriers. Ergobaby also published internally its first-ever annual impact report, which will serve as a baseline across five important categories for the company to measure annually. Sustainability. diversity, equity, and inclusion, education and science, giving back, and people and policy. We are proud of Betty Rader and the entire Ergo Baby team for taking leadership in this important area. We continue to see compelling ESG opportunities across our subsidiaries that we believe will drive growth and increase profitability over time. And we look forward to having our new head of ESG lead these efforts. Before turning the call over to Pat, I want to say that I am also proud to announce that over the past 90 days, including post Q3, we have invested approximately $110 million in growth capital at our subsidiaries through add-on acquisitions and growth capital expenditures. These investments are a continuation of the sustainable investing we are afforded under our permanent capital model, and we believe these investments provide tangible benefit to our constituents. Our employees benefit from enhanced opportunities. Our communities benefit from increased employment. And our shareholders benefit from the synergy and return on invested capital we expect to achieve. With that, I will now turn the call over to Pat.