Compass Diversified Holdings

Good afternoon and welcome to Compass Diversified's fourth quarter 2021 conference call. Today's call is being recorded. All lines have been placed on mute. If you'd like to ask a question at the end of the prepared remarks, please press 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 harbour statement. Please go ahead, sir.

Thank you, and welcome to Compass Diversified's fourth quarter 2021 conference call. Representing the company today are Elias Sabo, Cody's CEO, Ryan Fockingham, Cody's CFO, and Pat Mazzarello, COO of Compass Group Management. Before we begin, I'd like to point out that the Q4 2021 press release, including the financial tables and non-gap financial measure reconciliations, are available at the Investor Relations section on the company's website at www.compassdiversified.com. The company also filed its Form 10-K with the SEC today after the market closed, which includes reconciliations of non-GAAP financial measures discussed on this call, including adjusted EBITDA and cash available for distribution, and is also available at the Investor Relations section of the company's website. Please note that references to EBITDA in the following discussions refer to adjusted EBITDA as reconciled to net income or loss from continuing operations in the company's financial filings. The company does not provide a reconciliation of its full year expected 2022 adjusted earnings or adjusted EBITDA because certain significant reconciling information is not available without unreasonable effort. 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 regards to the future performance of COTI and its 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-K. as filed with the SEC for the quarter ended December 31, 2021, as well as in other SEC filings. In particular, the domestic and global economic environment as currently impacted by the COVID-19 pandemic and related supply chain and labor disruptions 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 Sabo.

Good afternoon. Thank you all for your time, and welcome to our fourth quarter earnings conference call. I want to start by recognizing that 2021 was an outstanding year for Cody. Our four consecutive quarters of record results have led to the best year in our history, and I couldn't be prouder. We continue to offer investors a unique opportunity to own a collection of diverse businesses across the consumer and industrial segments, and soon potentially health care. As we detailed at our investor day, we view healthcare as a natural next vertical to bring value to our shareholders. Ultimately, the quality, competitive position, and extraordinary management teams of our current subsidiaries demonstrate how our strategy to patiently deploy capital continues to define our success. In 2021, we continued our efforts with a number of significant transactions. At a platform level, we acquired Lugano Diamonds and Jewelry, which is a designer, manufacturer, and marketer of ultra-high-end, one-of-a-kind jewelry. Lugano has a disruptive business model that brings significant value to its customers, and we believe builds on our transformation to accelerate the collective growth potential of Cody. Throughout the year, we also built on our long track record of being business builders. Our permanent capital advantage allows us to invest in the future of our subsidiaries, and this year we consummated three add-on acquisitions, Ramco into Arnold Technologies, Lizard Skins into Marucci Sports, and Plymouth Foam into Altor Solutions. We have now completed 31 add-on transactions for our subsidiaries since our inception. All four of our acquisitions this year are meeting or exceeding our expectations and are on track to continue their growth trajectories. In 2021, we also sold LibertySafe and announced the divestiture of Advanced Circuits. At LibertySafe, we have made transformative investments during our 11 years of ownership that resulted in a solid gain for our shareholders. While the Advanced Circuits transaction has not closed, it is important to highlight how our unique permanent capital structure allowed us the time and flexibility to take a long-term approach to value creation, investing in operations and capabilities of the company over our more than 15-year ownership period. At the corporate level, we achieved the number of milestones that furthered our pursuit of a lower cost of capital. First and foremost, we converted from a pass-through entity to a C corporation for U.S. federal income tax purposes. This critical change will remove certain administrative requirements for shareholders and we believe this will help expand our current shareholder base and will improve the likelihood of our stock's inclusion within indices. In addition, it enabled us to implement an Atlas Market Stock Issuance Program, which is an important step to fund our business plan in a more efficient manner going forward. Beyond that, we also materially reduced our cost of capital by refinancing our 8% senior unsecured bonds with a $1 billion, 5.25% senior unsecured bond maturing in April, 2029. And in November, 2021, we achieved a further reduction in our capital costs with the placement of a $300 million, 5% senior unsecured bond maturing in January, 2032. Each of these initiatives provided transformative, tangible benefits in 2021, and ideally positioned us for further gains in 2022 and beyond as we patiently pursue value-additive transactions. Although this was a record year for Cody, it is important to recognize the ongoing challenges from inflation and supply chain disruptions. For the decade leading up to 2021, the global economy produced modest inflationary pressures, oftentimes underrunning central bank expectations. However, we are now grappling with inflationary pressures building at an unprecedented rate stemming from the effects of previously unseen levels of supply chain disruptions and an incredibly tight labor market with rapidly rising wages and very high levels of turnover. As 2021 progressed, these challenges became more acute, and we expect to continue to experience these headwinds at least through the first quarter of 2022. Despite these challenges, our subsidiary companies produced remarkable results. a testament to the strength of our management teams and the quality of the companies we own. We have conveyed repeatedly that we look to acquire market share leading businesses with defensible competitive barriers, factors that allow for margins to be protected in differing economic environments. I want to highlight that despite all the challenges from supply chain, labor availability, and rising inflation, for calendar year 2021, we produced, on a pro forma basis, almost 20% subsidiary adjusted EBITDA margins, up 155 basis points over prior year. In order to combat supply chain issues, we have chosen to significantly increase our inventory levels. However, a significant amount of our inventory at year end remained in transit and unavailable for delivery. We experienced a steady decline in warehouse deliveries throughout the fourth quarter with an offsetting increase in our in transit inventory. This past January marked a low for deliveries to our warehouses. While February has proven to be marginally better, product availability is still the largest challenge our subsidiaries face. We expect supply chain issues to linger throughout the first half of 2022 and cost pressures to continue to rise. Where appropriate, we expect our subsidiaries will continue to raise prices in order to combat rapidly rising costs and protect margins. Before turning to our financial results, I would like to discuss the initial public offering process for 5.11. As you are aware, in November of 2021, we announced the filing of a registration statement for the proposed public offering of 5.11's common stock. After being cleared by the Securities and Exchange Commission to proceed with the proposed offering, we monitored the markets carefully to find an opportune time to take the company public. The markets in the fourth quarter of 2021 and thus far in 2022 have been unsupported for new issuances. We have always viewed a public offering of 511 as a highly opportunistic event, and we do not feel compelled to complete a transaction while suboptimal market conditions persist. 511 has substantial runway to continue to grow at an accelerated rate as it builds out its domestic consumer business. 5.11's domestic consumer business represents just over 50% of total sales, and with expected growth rates in the consumer business far exceeding that in our professional division, we would expect the business mix to continue to shift towards consumer going forward. Given the continued market and economic uncertainty, we believe it is in the best interest of 5.11 and Cody shareholders to postpone the proposed initial public offering. 5.11 has an enthusiastic customer base and a strong position in the market, and we remain committed and excited for its continued growth in the meantime. We will continue to assess the capital markets, and when appropriate, we will consider leveraging the hard work already performed to position 511 to become a public company. Now, turning to our financial performance. I am pleased to report that our fourth quarter results were exceptional and once again exceeded our expectations. Throughout this presentation, when we discussed pro forma results, It will be as if we own Boa, Verrucci, and Lugano, and divested Liberty from January 1, 2020. On a pro forma basis, in the fourth quarter of 2021, consolidated revenue grew approximately 20%, and adjusted EBITDA grew approximately 17% over the prior year's quarter. For the full year, consolidated revenue grew by 24%, and adjusted EBITDA grew by 34%. And as a reminder, our subsidiary adjusted EBITDA grew by 1% in 2020 over 2019. In order to eliminate the base year effect in 2020, where results were distorted due to the pandemic, we would like to highlight that our compounded annual growth rate of subsidiary adjusted EBITDA from 2019, the year before the pandemic started, has been approximately 16%. We believe this is a more reflective measure of our growth given the dynamic environment and the execution of our acquisition strategy that has resulted in a much faster core growth rate over the past two years. Before I provide an update on our guidance, I want to reiterate that the macro environment remains uncertain. Many of the challenges we have dealt with throughout 2021 have continued into 2022. Demand continues to remain robust. However, the extensive supply-side challenges continue to increase. There are significant part shortages from our vendors, lack of available shipping capacity, issues with port congestion, and a lack of trucking capacity. While our companies and their management teams are taking all appropriate actions to mitigate the impact of these challenges, supply chain constraints continue to put pressure on revenue growth while materially raising product availability costs. Notwithstanding these unique challenges, we expect to produce for the full year of 2022 consolidated subsidiary adjusted EBITDA of between $400 million and $420 million. This represents pro forma adjusted EBITDA growth of approximately 1% to 6% from the prior year period. It is important to note that adjusted EBITDA includes advanced circuits, notwithstanding its held for sale classification. In addition, we expect full year 2022 adjusted earnings of between $110 million and $125 million. Our 2022 adjusted earnings range does not include advanced circuits due to its held for sale classification. We are guiding to a lower adjusted EBITDA growth rate than experienced over the past two years, principally due to two factors. First, We expect our Velocity outdoor business to revert to a more normalized level of demand. Velocity experienced a large spike in demand brought on by the pandemic and as a result was unable to fully satisfy customer demand in the back half of 2020. This resulted in Velocity fulfilling stocking orders in the first quarter of 2021 that will not repeat in 2022. Second, supply chain and inflation remain a concern. As a result, central banks around the world are becoming more restrictive in monetary policy, adding an element of risk to future demand. Consequently, we anticipate our adjusted EBITDA in the first quarter of 2022 to be flat to down a few percent as compared to the prior year. We expect our growth rate in 2022 to be temporarily depressed and below our long-term poor growth rate due to the factors highlighted. However, When we look at our growth over a three-year period from 2019 and including our guidance for 2022, our compounded annual rate of growth of pro forma consolidated subsidiary adjusted EBITDA would be approximately 11% to 13%. During 2021, we continued our efforts to refresh our board of directors. We were pleased to welcome Alex Bethall to our board on January 1 of this year. Alex brings a wealth of experience related to smaller, privately held companies, including consumer product companies, and his knowledge has already been quite valuable to our board. Our board is regularly reviewing its composition to ensure we have the right balance of skills and experience to oversee the Cody business. Accordingly, we will continue to refresh the board, ideally with diverse candidates as we round out our collective skill set and seek to enhance our board's effectiveness. In addition to the board refresh process that we have undertaken, the board recently approved an amendment to our organizational documents to declassify our board. This declassification will result in an annual election for all of our board members, starting with the May 2022 annual meeting. As a reminder, previously our board was staggered with each director serving three-year terms. Declassifying the board is an important governance enhancement for our shareholders and aligned with our philosophical view of accountability. Before I finish discussing our board, I want to take a moment to acknowledge the passing of Gene Ewing. Gene was an initial director of Compass when we became a public company in 2006. Over the years, Gene added immeasurable value to our board. Gene was a tremendous colleague and a personal friend for many years. We will sorely miss him. Lastly, before turning the call over to Pat to discuss our subsidiary results, We're excited to have Zoe Koskines join us as our new head of ESG. Zoe brings a wealth of experience to our ESG initiatives, and we will report on some of the work she will undertake in the coming year and beyond. With that, I will now turn the call over to Pal.