Compass Diversified Holdings

Good afternoon, and welcome to Compass Diversified's first quarter 2022 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 Cody Slough of Gateway Group for introductions and the reading of the safe harbor statement. Please go ahead, sir.

Thank you, and welcome to Compass Diversified's first quarter 2022 conference call. Representing the companies today are Elias Sabo, Cody's CEO, Ryan Falkingham, Cody's CFO, and Pat Maciarello, COO of Compass Group Management. Before we begin, I would like to point out that the Q1 2022 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 compassdiversified.com. The company also filed its form 10Q 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 know 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 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 Cody and its subsidiaries, and statements related to the impact of Cody'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 March 31, 2022, 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, COTI 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, everyone, and thanks for joining us today on our first quarter 2022 conference call. I'm pleased to report that we carried last year's momentum into the first quarter of the year, where we recorded our fifth consecutive quarter of record results that is enabling us to raise our 2022 outlook. We're extremely pleased with these results, and I want to acknowledge and thank our management teams and employees. They continue to put forth an extraordinary effort that we believe will generate sustainable long-term value for our shareholders. In our last earnings call, we discussed our strong execution against a tough macro environment, and this quarter was certainly no different. Supply chain constraints, inflationary pressures, and the lack of labor were all rising headwinds our companies had to navigate in the quarter. Our ability to execute on our strategy despite these constraints is a testament to the strength of our management teams and the quality of the companies we own. During the quarter, we delivered double-digit sales growth in both our branded consumer and niche industrial businesses. Importantly, our fastest growing business, Boa Technologies, continued to perform above expectations as revenue and adjusted EBITDA growth continued to accelerate. In fact, Boa's $25 million of adjusted EBITDA in the first quarter represents the highest EBITDA-producing quarter a Cody business has ever reported. As we have said on prior calls, Boa's unique combination of disruptive technology, strong intellectual property, relatively low penetration in a very large addressable market, when combined with an extraordinary management team, has led to performance that is significantly stronger than expected when we acquired the business a year and a half ago. One component of the growth story to keep in mind for the first quarter, however, is the elongation of the supply chain. So it's conceivable some of this quarter's demand reflects pull forward from future quarters, but with only 5% penetration in the addressable market, we remain quite optimistic that BOA's long-term growth story remains intact. Lugano continues to perform significantly ahead of our expectations. And as mentioned on our Q4 call, we have seen a historical relationship between inventory investment and highly profitable revenue growth pay dividends. We were excited our investment translated into almost 50% pro forma adjusted EBITDA growth, and we will plan on putting more capital in this business as this correlation is expected to continue. Overall, we did an extraordinary job posting year-over-year growth while preserving margins. In the first quarter, we had only 100 basis points of margin degradation, despite unprecedented supply chain and inflationary conditions. Though we anticipate the economic headwinds that impacted our margins could persist in the short term, we believe that the quality of all our subsidiaries' competitive positioning allows us, in a more stable inflationary environment, to be able to fully recruit all of that margin.

With that, I will now turn the call over to Pat. Thanks, Elias. On a combined basis, revenue and EBITDA in both our branded consumer and our niche industrial businesses grew meaningfully and exceeded our expectations. As Elias mentioned, our businesses performed admirably throughout the continued supply chain and inflation headwinds, though these headwinds led margins and EBITDA performance to lag revenue growth slightly. While we are working through appropriate cost and pricing actions at each business to address the modest margin compression, these actions often take time to implement and may not be reflected in our financial performance in the short term. Our management team partners at each of our businesses continue to execute for their customers and employees, and I remain very proud to work with each of them. Now, to our subsidiary results. I'll begin with our niche industrial businesses. For the first quarter of 2022, revenues increased by 19.5% and adjusted EBITDA by 9.4% versus the first quarter of 2021. Arnold and Altor both posted meaningful revenue and adjusted EBITDA growth in the quarter, driven by solid execution and stronger than expected demand. Altor's margins declined somewhat due to higher raw material costs, but we expect that most of these costs will be passed through contractually later this year. At Sterno, demand for our catering products grew significantly throughout the quarter, and into Q2, as leisure travel and conventions continued to return domestically. Sterno's scented wax products, however, saw a reduction in demand from an abnormally strong first quarter in 2021, which was likely partially driven by federal stimulus payments in that period. Turning to our consumer businesses, for the first quarter of 2022, revenues increased by 14% and adjusted EBITDA increased by 13% compared to Q1 2021. Demand for BOA's performance fit system continued to exceed our expectations. The company's revenue increased by over 55% in the quarter, and it delivered a Cody record $25 million of quarterly EBITDA. Similarly, Lugano grew pro forma adjusted EBITDA by over 46%. As stated, we are seeing a direct correlation at Lugano between inventory purchases and revenue. We believe the team at Lugano has created a better business model to serve the needs of their clients. We will continue to support Lugano as they grow and open new salons in the back half of the year, which will continue to require intelligent investments and relatively liquid inventory. Also in the quarter, Marucci made a series of strategic decisions to air freight and significant product to retail partners to gain shelf space in both new and existing product categories. This led to strong revenue growth, though impacted margins in Q1. We believe this decision will have significant long-term benefits for the company. Marucci will have a tough comparison in the second quarter as the company had several product launches in Q221. We are excited and optimistic, however, about the much-anticipated launch of the CatX in the third quarter and believe it should lead to favorable comparisons in that period. Turning to velocity, as anticipated, we experienced a return to pre-pandemic demand levels in the company's airgun business in Q1. We believe we will have another difficult comparison in the second quarter of this year as the company continued to replenish retail inventory levels in Q2 of 2021, but will be comparing to post-pandemic demand patterns in the back half of 2022. As a whole, we are pleased with the performance of our businesses in the first quarter and remain optimistic about the remainder of the year. I will now turn the call over to Ryan for his comments on our financial results.

Thank you, Pat. Before I get into our financial performance, I wanted to make a few comments regarding advanced circuits. Last quarter, we indicated that the closing of the ACI sale remained on track and was expected to occur early in the second quarter. Per the terms of the merger agreement, the merger of ACI and Tempo is subject to and conditioned upon a concurrent business combination between Tempo and ACE Convergence Acquisition Corp., which is a SPAC. Earlier this week, ACE announced that the previously scheduled shareholder meeting to approve the Tempo ACE business combination has been postponed to allow ACE additional time to revise and finalize its financing arrangements. As a result of the announcement, we will not be taking any further questions related to the ACI transaction. Moving to our consolidated financial results for the quarter ended March 31st, 2022, I'll limit my comments largely to the overall results for Cody, since the individual subsidiary results are detailed in our Form 10-Q that was filed with the SEC earlier today. On a consolidated basis, revenue for the quarter ended March 31, 2022 was $510.5 million, up 25% compared to $408.6 million for the prior year period. This year-over-year increase primarily reflects the company's acquisition of Lugano in September of 2021, as well as a strong double-digit growth from BOA, Naruchi Sports, and Outdoor Solutions. Consolidated net income for the quarter ended March 31, 2022, was $29.7 million, a 35% increase compared to $22 million in the prior year-ago quarter. As introduced last quarter, adjusted earnings, a non-gap financial metric, will allow investors to assess our operating performance in a more meaningful and transparent way. Adjusted earnings for the quarter ended March 31st, 2022 was 36 million, up 9.9 million or 38% from the year ago quarter. Our adjusted earnings generated during the quarter were above our expectations, primarily due to the strong performance across our consumer and industrial businesses on a combined basis. Turning to our balance sheet, as of March 31st, 2022, we had approximately $97.3 million in cash, zero drawn down on our revolver, and our leverage was approximately three times. We have substantial liquidity, and as previously communicated, we have the ability to upsize our revolver capacity by an additional $250 million. With this liquidity and capital, we continue to be well-positioned to provide our subsidiaries with the financial support they need, invest in subsidiary growth opportunities, and act on compelling acquisition opportunities as they present themselves. Turning now to cash flow. During the first quarter of 2022, we used $33.5 million of cash flow from operations, primarily a result of our strategic investment in inventory at Lugano. In addition, certain of our subsidiaries saw an increase in inventory in transit as a result of the port and trucking delays. As we've mentioned before, we believe a significant strategic advantage of our business model is that with our strong balance sheet and access to capital, we can sustainably invest in our subsidiaries for the long term. And in today's challenging supply chain environment, ensuring our subsidiaries have adequate inventory to meet their demand levels is crucial in accelerating their competitive advantages by solidifying strong customer relationships. It's important to note that when the supply chain challenges abate, the strategic investments we've made in inventory will convert to cash. And finally, turning to capital expenditures, during the first quarter of 2022, We spent $10.4 million of capital expenditures for our existing businesses, compared to $7.3 million in the prior year period. The increase was primarily a result of the continued retail store expansion at our 511 subsidiary. Despite our excellent performance in the first quarter, we remain in uncertain times, driven by market and interest rate volatility, the unexpected GDP contraction that was recently reported, inflationary pressures causing commodity prices to rise, and labor market shortages. However, as a result of our company's strong performance in the first quarter that exceeded our expectations, we are raising our 2022 full year consolidated subsidiary adjusted EBITDA outlook to between $410 million and $430 million, a $10 million increase in the bottom and the top end of the range. Further, we are raising our 2022 full year adjusted earnings outlook to between 120 million and 135 million. Moving to CapEx, for the full year of 2022, we continue to anticipate total capital expenditure spend of between 70 million and 80 million. While this is a large increase from 2021, we believe these investments will have short payback periods and provide strong returns on invested capital. The 2022 capital expenditure spend will primarily be at Lugano for new retail salons and at 511 as we continue to increase its retail store count from its current 88 stores. We believe our companies are positioned extremely well, even better than before, and have the utmost confidence in our management teams to continue to drive strong results that ultimately create long-term, sustainable value for our shareholders. With that, I will now turn the call back over to Ryan.

Thank you, Ryan. I would like to close by briefly providing an update on the M&A market Cody's corporate initiatives, and discussing our go-forward growth strategy. Beginning with the overall M&A market, activity remains depressed as potential sellers are choosing to delay processes given the economic headwinds and the macro backdrop. We anticipate activity to remain depressed in the second quarter as these headwinds persist, followed by a gradual uptick in activity in the back half of the year if these headwinds start to moderate. As a brief update on one of our primary corporate initiatives, we are aggressively enhancing and institutionalizing our ESG practices. As we have stated in the past, we believe sound and well-implemented ESG practices not only can be beneficial to society and our environment, but also contribute to the management of risk and enhance long-term returns. In this regard, I am excited to share our progress today. By way of background, our ESG strategies will focus on initiatives such as diversity, equity and inclusion of people and thought, health and well-being of our customers and employees, attracting and retaining the best talent, environmental considerations, transparency and continuing to be a trusted partner with investors, businesses and communities. Fundamentally, Cody's ESG strategy is a primary business decision that will be anchored throughout the corporate ethos in order to directly enhance Cody's purpose of building sound and sustainable businesses, culminating in strong shareholder returns. Along these lines, we have begun to directly link and implement our ESG practices into our portfolio companies, vertically integrating and aligning these strategies throughout the organization. These ESG parameters will become an important factor in managing risk, reducing the cost of capital, and expanding multiples at all of our companies. Additionally, diversity continues to stay front of mind during our hiring process, and we have recently added three talented diverse hires to our team. We believe diversity of people and thought introduces new perspectives, skills, and approaches to problem solving that enhances the company's strategic and operating capabilities. We are pleased with our progress to date and feel confident that we can continue to expand on these efforts. In conclusion, it was a great quarter for Cody. Relative to our expectations, our performance was outstanding. In this backdrop, the fact that Gross Domestic Product contracted 1.4% and we grew revenue and adjusted EBITDA by double digits is an incredible effort, and I'd like to give thanks and recognition to all of our management teams and employees. With that, operator, please open up the lines for Q&A.

Certainly. As a reminder, to ask a question, you will need to press star 1 on your telephone keypad. And to withdraw your question, press the pound key. Again, that will be star 1 on your telephone keypad to ask a question. We have the first question comes from the line of Matt Caranda of Ross Capital. Your line is now open. You may ask your question.

Hey, guys. Good afternoon. Nice job on the quarter. So just maybe starting out with one thematic and then I'll follow up with maybe one or two on the segments. But just in terms of the consumer businesses, you guys have a lot of diversity in your consumer segment, if you will. So any takeaways that you guys have on consumer behavior sort of through the arc of the first quarter and maybe through the last month here, just any changes that you've noticed in terms of behavior on the higher, the low end? as consumers respond to the inflationary environment, the public market volatility, or the Ukraine-Russia conflict?

Yeah, Matt. We obviously are monitoring trends throughout our entire portfolio and even in our industrial business where some of the end products may make its way into the consumer markets. I would say in general, we were surprised by the strength of consumer spending. you know, pretty much across the board in the first quarter. Really, with the exception, as Pat mentioned, of Sterno, where our scented wax products, you know, benefited greatly from some of the pandemic conditions, people staying at home, and, you know, I think that drove a significant increase in demand for that product, and that saw some weakness. Now, I would also say one conclusion, you know, we could draw is is that also goes through the mass channel principally. And I think if you thought about, you know, kind of consumer stratification, it feels that the, you know, kind of more affluent customer right now is continuing to spend, you know, if I was venturing a guest, you know, wage gains are offsetting for that consumer, you know, their basket of goods and how they measure inflation. And yet on the lower end of the spectrum with, you know, sort of the more mass products and lower price points, you know, my sense is inflation is eating away at purchasing power. And if somebody is making a decision to buy eggs or milk, you know, or buy, you know, kind of a consumer discretionary product, you know, clearly staples become the thing that they purchase. So I think we are starting to see initial signs of erosion for, you know, sort of more of the mass consumer. and the lower price point items as inflation is, you know, quite problematic and eroding purchasing power there. But, you know, as you know, most of our consumer businesses, you know, are more enthusiast, you know, type brands and they, you know, tend to skew towards the higher end consumer, the more affluent consumer. And we just have not seen a real weakening of demand there. And in fact, as we run forward through April, I would say we continue to see really good, strong demand across most of the consumer portfolio. So we have not seen weakening yet. I think some of the market volatility that we're starting to see right now could eventually play into that. But it has not manifested yet into any of the real-time data that we're seeing.

Okay. Super thorough and helpful, Elias. Thank you. Maybe just on a segment one, I mean, BOA putting up pretty stunning growth and margins to boot. Just was curious if you guys might be able to, I mean, you can't really quantify pull forward there, but I'm wondering how much is your sense that that has pulled forward some revenue from like the footwear OEMs that may be a little bit nervous about supply chains? disruption versus sort of just core growth and share take for that business?

Matt, this is Patton. Thanks. It's a good question and one we spend a lot of time thinking. I can tell you demand is broad at BOA. It's in many channels and we think it's strong and we can see into the second quarter and we think it's sustainable. I can tell you There might be some, you know, pull forward if you think about the, what is there on the ocean? Another month, another 45 days, right? That there wasn't sort of, you know, a year and a half ago. If you think of that as sort of a small headwind, but we think we're going to perform very well, you know, despite that. And we think much of the demand, most of the demand is real.

Excellent. Maybe I'll just sneak one in on Marucci as well. I was just curious about In that segment, where do you think you're taking the most share? You mentioned kind of using Air Freight strategically to kind of fill customers and then win shelf space. So just curious, like, in which categories maybe that you think you're winning the most share there? And then do the costs essentially go away in the near term, or are we going to kind of continue to use that as a tool to continue to take share?

So answering your second question first, we'll selectively use it as a tool, but they should mitigate. And as we look ahead, a lot more of kind of what we have planned in Q3, Q4 sales, you know, is not using expedited freight. Going back to your first question, we're, you know, we're trying to grow in a lot of categories. And some of that air freight that we spent helped us do that this quarter. Be that, you know, gloves, be that bags, be that fast pitch softball. You know, we think that Marucci is a disruptive brand that really has the potential to expand into, additional adjacencies within baseball, within softball, and maybe beyond. And so that's the opportunity we took in Q1. Okay, excellent.

I'll leave it there, guys. Thank you. Thank you, Matt.

Thank you. We have the next question. It comes from the line of Chris Kennedy of William Blair. Your line is now open. You may ask your question.

Thank you, and good afternoon, and thanks for taking the question. Can you give a little bit more details on Lugano just because we don't have the history with the business? Are we kind of at a normalized run rate or how should we think about that going forward?

So, I mean, I think Q2 or Q1, excuse me, is seasonally a bit high. You know, we have a location in Aspen that is a, you know, a heavy Q1 location. All that being said, the business has seen a noticeable uptick in sort of run rate. And so I would say, you know, can you say you can multiply Q4? No. Or excuse me, Q1 by four to get to our current run rate? No. But the business has seen significant, significant growth in underlying demand. And, you know, we see that continuing.

Okay, great. And then Elias, I appreciate your comments on potential acquisitions in the space. I assume you were mostly referring to platform deals, but can you talk about add-on opportunities? Yeah, sure, Chris.

I mean, platforms certainly have been slow in the beginning of the year, given all the headwinds. And I think a couple of things are clearly occurring there. Um, you've got earnings degradation from, for the vast majority of companies. I mean, you know, we were able to buck this trend, but for most companies dealing with supply chain in the inflationary environment, you know, it's causing their earnings to, um, you know, take a hit and, you know, generally sellers don't want to be in the market in those conditions. And then if you couple that with the multiple compression and just the risk off sentiment that you're seeing in the public markets. That clearly factors its way through to private markets. And, you know, for kind of the deals that we're looking at that also are, you know, competitors would be tapping into the bond market in order to provide financing. You know, I think we all know the bond market is really struggling right now and generally not open for business. So, you know, as a result, I think, you know, investment bankers are telling their clients and sellers are seeing that now is not an opportune time. Now, we do think the first half of the year, Q2 looks like it's going to be equally as weak. Hopefully, it starts to ease as the year goes on, but that's going to be predicated on market conditions. In terms of add-ons, we're working a number of add-ons. These are a little bit different in that these are generally direct negotiated transactions where we're coming up with a list of potential companies that would benefit our subsidiaries. And we continue to work through that. I would tell you that sellers of those businesses are not immune to the same factors that are happening broadly in the marketplace and what's happening in the platform side. And I think unless we're willing to give credit for some of the pro forma kind of adjustments that sellers would be looking for, around normalizing earnings when the supply chain starts to normalize itself, it makes doing transactions more difficult today. It doesn't mean that there's not a robust pipeline and that we're not pursuing them. I think it just means that it's a little bit more difficult to transact in this market. So I would say our views and our expectations are muted right now in terms of M&A, and I would you know, suggest that, you know, kind of we think this is going to be probably a tough year. But that doesn't mean that we're not out pounding the, you know, the pavement and working extraordinarily hard to generate M&A opportunities. And, you know, if you went back and you thought in 2020, you know, we probably could have sang the same tune on our Q1 earnings call when we were dealing with a pandemic. And why would companies want to come to market in these times? And yet we acquired two businesses that were extraordinary. So I don't want to paint a dire picture that it isn't going to be possible. The truth is when we're in these times in our business model with committed financing and permanent capital, this is really where we shine. When our peers are not able to gain access to the financing that they need to transact, this is generally where we're able to come in and acquire businesses you know, businesses that we think are top quality businesses and typically not in as competitive as an environment. So, you know, we're out there working really hard and trying to find new opportunities. And I think if we can find some, we'll be in a really advantaged position relative to our competitors. But the overall M&A environment remains muted both for platforms and add-ons. Great.

Appreciate the color. Thanks, guys.

Thank you. The next question comes from the line of Robert Dodd of Raymond James. Your line is now open. You may ask your question.

Hi, guys, and congratulations on the quarter and the margin performance. Kind of following on, actually, to that question, I mean, tough environment, multiples are down, et cetera, et cetera. How long do you think the environment needs to remain volatile, disrupted, etc. before sellers potentially become motivated? I may be willing to accept a little bit of a lower multiple when you know, maybe they have capital needs, you have capital, etc. I mean, how long would it need to go on before that would really shift in your your favor?

Yeah, Robert, that's a tough question to answer. I mean, I think if we look back at history, there is some amount of time where a seller needs to readjust expectations, and it's difficult. I always say asset prices are sticky on the downside, right? And so when you have an expectation that the private market is delivering multiples of whatever X, and now it's 80% of X or 70% of X, mentally getting comfortable with that is difficult. And I think it ultimately becomes really a case-by-case decision. There are some companies that have to transact. Think of the competitors that we're typically dealing with in traditional private equity. A lot of them have fund life. So if you're at the end of a fund life, you're going to have to sell your business regardless, right? And there's generational changes of assets where you have maybe a founder that wants to kind of get all of their ducks in a row as they're starting to do some estate planning. So there can be specific things that generate deal flow. As you know, though, that generally just means that you're sort of looking amongst a smaller funnel. because it's just not as wide open as it's historically been. My sense is it's going to take the better part. If markets stay volatile like this, if multiples in the public markets continue to contract as they have, it's probably going to take the better part of this year for price expectations to readjust. And then I think there is a point where you just have to, you know, kind of give in and say, this is the new environment that we're working in. And here is the value that, you know, we should expect to receive and we would be happy transacting at. But I can tell you, it's not three months and it's, you know, likely not six months. There needs to be a, you know, kind of setting in process that happens. Now, we do remain, you know, kind of hopeful that the back half of the year gets a little better and that 23 is meaningfully better, but some of that is going to be predicated on market conditions starting to ease a bit.

Very helpful. Thanks a lot on that one. You said it's broad-based strength. Are there any, when it's broad-based, is it broad-based across all product types? Obviously, there's different levels of penetration, so Yeah, snowboarding boots might not be growing as fast. But in geography, I mean, any areas that are doing exceptionally well?

It's across geographies. Maybe in this quarter there was a little bit of strength in Asia. But that is the thing, right? BOA is a company whose revenue really sort of comes close to, as far as the breakout matching GDP of the globe. And so it's a much more international business than certain of our other businesses. And so we have seen strong demand internationally. We've seen strong demand in Europe. We've seen strong demand in Asia. You know, it comes down to the fact, I think, that the sort of performance fit wrap and boas technology just has a small penetration in overall footwear, right? And I personally believe it's a lot better product than shoelaces, particularly for performance applications. And we have a lot of data that backs that up. So there's market share to be gained. in a lot of segments, and that's what you're seeing, and we believe that's what you're going to continue to see.

I appreciate that, and if I can, one more, if I can, on Logano, obviously also doing very well. I presume it is the inventory investment, is that correlated with the number of salons and growth, etc., but is it investing in the same level of inventory per salon or are you growing inventory per salon as well?

It's both. It's both. And it's, you know, we're making opportunistic purchases that we can then convey value on to our end consumer that we have strong relationships with throughout the country. And so it's both of those. There's a certain level of inventory you need. when you build a new salon, but we also see that the more inventory we have, the more choices we have for our consumers, the greater amount of activity we're able to see.

Robert, I would just say when we acquired Lugano and we talked to you guys about this originally, You know, we said this is a highly disruptive business model, and they approach the industry, you know, in a fundamentally different way that disintermediates a lot of steps, you know, in the process. And they deliver a phenomenal value to their end customer as a result. And, you know, the demand in that business is really constrained by the amount of investment that we can make in it. And, you know, we had said, look, there's a real strong correlation between investing in inventory and having more product availability and revenue, profitable revenue growth in that business. And, you know, I think we obviously monitor this on a real time basis and very closely. But what we've seen is that correlation continues to exist as we put more investment in the business. And when you run the return on invested capital of putting this in, it is so high that our goal is to continue to pump capital in until that correlation would break down. The fact that it's not breaking down just means there's significant excess demand that is sitting there and it will be driven, greater revenue and profitable revenue growth can be driven by further investment. know what we've experienced so far has been you know exceptional growth the correlation if anything has actually gotten stronger under our ownership not weaker and as a result of that you know we plan on continuing to put significantly you know greater amounts of capital into um you know our inventory here because we think demand is significantly greater than what we're currently satisfying And we think this is going to be not only a big year in 22, but we think we're setting this company up for multiple years of accelerated growth.

I appreciate that, Howard. Thank you.

Thank you. Again, if anyone would like to ask a question, you will need to press star 1 on your telephone keypad. Again, that will be star 1 on your telephone keypad to ask a question. Our next question comes from the line of Matthew Howard of B. Riley. Your line is now open. You may ask your question.

Oh, hey, guys. Thanks for taking my questions. Congrats. First off, what's the update on the health care vertical? I know you're in the market for the team. I just want to get the update there.

Yeah, Matthew, and thanks for the question. As we've said, we continue to look for the leader. We've got a couple of candidates in mind. We're not ready to make an announcement yet, but that does progress. And we think when we get the right leader, That will be something that we are able to launch. We remain confident that we will launch this effort sometime in 2022. But we continue to progress along that, you know, finding that right leader. And, you know, I would tell you for us, you know, we continue to believe having someone with that domain expertise who can come in and be able to guide that effort is, you know, incredibly important. you know, for us as we go forward and making sure that, you know, we're identifying the right assets that, you know, kind of fit within our model. And so, you know, we are progressing forward with that. And, you know, I'm confident that in 22, we'll be able to, you know, fully launch that effort.

Great. Okay. Look forward to that. An update on just on interest rates. Cody, you did just a tremendous job refinancing the balance sheet fixed rates. My question's around, if the Fed does go to 300 basis for short-term, is there any, at the portfolio company level, is there any impact that you could see? I know you structure things differently with your intercompany loans than the traditional LBO market, but just go over it. Anything, if rates do, short-term rates go up significantly, what impact would be? Is that to your advantage? Just maybe walk me through that.

Yeah, so... you know as you identified we hit the market and probably timed it pretty well with um you know the bonds that we you know issued last year um and you know kind of in hindsight we were glad to get that duration into our balance sheet really at you know pretty much optimal timing so um you know we view that as a great asset that we have on our balance sheet if you remember You know, those are eight and ten year bonds respectively. So we've got, you know, long duration in our balance sheet. And I would point out that we have no short term debt. And so interest rate volatility today has zero impact on us. Now, if we were to borrow into our revolver, that is a LIBOR based or whatever LIBOR, I guess, is phased out. But it's a, you know, kind of an index plus the margin. And so as the index goes up, of course, that would be variable rate debt. But we have nothing drawn there. So our interest rate exposure at the parent is zero. Now, we use mostly floating rate debt as we lend to our subsidiaries in our structure. And so what would happen theoretically, and I think it's probably more than theoretical in practice, is as the interest expense rises, due to the fact that there is kind of a higher base rate that's being charged, the index has gone up, that would have the net effect of lowering taxable income at the subsidiary level, and as a result, lowering the amount of tax burden that our companies have. Now, offsetting that is that interest expense from the sub comes up to be interest income at the parent, But because the parent absent a sale generates a net loss in a normal year, we think that the effect of rising interest rates will actually, in this case, because we were fortunate to lock in with long duration our interest rates last year at the parent, the effect of rising interest rates actually lower the tax expense holistically for the company and and raise the amount of free cash flow production that we would be able to generate.

And that's important given your new structure, I mean, with your new conversion to Secorp. And I got to assume that from a sort of strategic standpoint, when you bid on these portfolio companies, certainly your structures has to be advantageous versus what's traditionally available in the leveraged loan market day as rates rise.

Yeah, I think, well, I mean, as I commented earlier, The types of companies that we're typically going after, you know, and especially the larger businesses, if they're, you know, kind of $500 million type businesses, plus or minus, you know, those are companies that largely would be trying to tap into the bond market, maybe the smaller end of the bond market. That market has completely been eviscerated. As you know, the leveraged loan market is, you know, pretty much on pause right now as well. And so our structure, we always say that our business shines in times like this. The higher the volatility, the more advantaged we are as a buyer. We bring certainty to a process. We have committed financing. So if you're selling a business today and you have to go out and rely on financing, the reality is there's a bigger level of risk in that financing being able to come through today than there was a year ago. and so what is the value of the certainty we bring it's greater today than it was a year ago i know that putting a you know numerical number on that is always hard to do and it's in the eyes of the seller how much risk they're willing to take but our structure is absolutely advantaged from a financing standpoint in times of increased volatility and market uncertainty now i could also say we just have an advantage structure in many other respects as well, even when market volatility isn't high, our permanent capital and our mentality of being long-term business builders is something that transcends through all types of market conditions. And it's a massive advantage to us, whether we sit in today's market or we sit in a market that was relatively robust from a financing standpoint a year ago, you know, it's why we think permanent capital is, you know, really sort of what a lot of people would like to emulate that are competing for these types of assets, because it is so advantageous in terms of not only being able to win companies, but being able to build businesses, but your point of having an exaggerated advantage in these times of, you know, market volatility is spot on.

Great. Thanks for that. And just, Just for one further point on that revolver, clearly you got that at your hip pocket, the accordion feature, well over a billion. I think you laid out the M&A environment pretty clearly to us, but is there a scenario where you could utilize that this year and go into it if there was just a tremendous opportunity? What should we expect on that revolver being drawn down this year, if at all?

Well, I think it's going to be predicated on whether or not we can transact against a meaningful size platform acquisition as to whether we would borrow on that. In terms of cash flow, you heard Pat and Ryan in our scripted comments already talk about the fact that we've made a significant investment in inventory in order to ease supply chain. And frankly, this is something that with the strength of our balance sheet is a huge advantage for us. And you see it in the results we were able to post in Q1, which were extraordinary in this backdrop. But that is somewhat predicated on the fact that, you know, we did do a billion three of financing at roughly 5% last year and, you know, long duration financing. And we're able to use, you know, I think the number is over the last six months, about $150 million to invest in inventory to take market share. And that's not only going to pay dividends in Q1, as you saw, and over the balance of 2022. But those share gains are going to be here long after supply chains normalize. And when supply chains normalize, as Ryan said, we expect to monetize a big part of that, you know, kind of inventory investment that we've made to get through these times. So if I look at our business today and I say, on the one hand, we have inventory investment that we made a huge investment in over the course of the last six months. likely we have enough inventory. And I'm going to exclude Lugano from that because I just went through the correlation of how Lugano's inventory investment drives really high return on invested capital growth in that business. So let's separate that for a second. The remainder of the business, frankly, has adequate inventory and, if anything, is likely to be monetizing over the balance of the year and into 2023. So that's a cash flow positive. You also have our business which we had said, you know, with the change in the corporate structure, is now a meaningful free cash flow pre-working capital provider. And so we've got high free cash flow production that we're creating. You've got working capital that should be a cash producer, not a cash user. Now, against that, we have some elevated capex for 511 in Lugano, which we think is very high return capex. And we have investment and further inventory growth at Lugano, which is extremely high return on invested capital. But the net of that should be positive free cash flow going forward. So the use of the Revolver really is a function of how much we can deploy into either add-ons or new platform acquisitions.

Yeah, it looks like a very return on invested capital. I really appreciate it, Les. Thank you. Thank you.

Thank you. Next question comes from the lineup team along of Adirondack. Your line is now open. You may ask your question.

Thank you. I'm going to try BOA again. Hopefully you can help me out. How much of the growth was, I guess let's call it seasonal, the obvious seasonal drivers, and then second derivative, how much of the growth was call it existing product platforms, verticals, however you want to describe it, and product extensions with existing customers and then maybe how much was brand new customers, I guess. I don't know if you can kind of parse it a little bit better.

Yeah, Tim, it's Elias. And I guess a long time I haven't seen you. Hopefully we'll reconnect at a conference here one of these days.

When I find management that executes, I get out of the way.

Good. So maybe I don't want to see you then at a future conference. But, you know, to your question, I would say, you know, we look at it a little bit differently. And, you know, when we acquired BOA, we had said, what are the things we really like about it? It's a disruptive technology that is, you know, for the most part, upending an industry that hadn't had innovation that came in in 100 years. It is a performance enhancement. So it's not just a convenience product. And that really is, you know, kind of very important here. And we now have a lot of documentation around it. And we work with a broad range of partners. And within that, it's a global business, you know, where I think the U.S. is probably the smallest market and end market that we actually deliver product to. And then we couple that with one of the best, if not the best management team that I've ever worked with. And I think that creates really explosive underlying organic opportunities. So it's hard to parse out with all the different things that you said. But what I would say is the market share of this business is around 5% of its addressable market. And it's got incredible IP, over 160 patents that we have globally issued, It has really the elements that you would look for for being able to drive sustainable long-term growth. I would say that every year, we work with our brand partners to extend our technology on additional platforms that they have. That is an ongoing thing that we do year in and year out. In addition to that, Our management team has done an exceptional job of being able to get into new industry verticals, and each one of those are at different levels of their maturation. So if you took Snowboard, where the company started, we have a very high level of market penetration, and by definition, that means the opportunities and the growth rate in that business are going to be less. But we have seeded markets, and if you call them verticals or whatever you want to call them, You know, we've really had the management had the foresight to seed a lot of different verticals and they are at different stages of their maturation process. So what we see with this company is that, you know, it's sort of a little bit of everything that you said, except we're really not bringing a lot of new brand partners into the fold. We have so many outstanding opportunities with our brand partners to be able to expand on new platforms that they have. And then, of course, when we get on those new platforms, the ultimate thing that drives this business, and it's like in any consumer product, if we partner on a new platform, how is that product going to do to the end consumer? And what we find is that product does really well and takes market share in its own little area when we're on there. It's a little bit of everything that you said, probably not as much in terms of getting new brand partners because we have the brand partners that we want to work with. Of course, there's probably some here or there that we add into the fold, but mostly it's we're taking market share from a relatively small point right now with a disruptive technology and outstanding management team and great IP position. We think those continue to be all the elements for making a company that has long-term sustainable growth opportunities.

Translation, it's very early innings and the runway is really long. You don't need to start dissecting this that closely because there's just a lot on the plate, a lot of opportunity. Keep up the good work.

Thanks. Yeah, Tim, you just said what it took me five minutes to say in 10 seconds. Maybe I'll turn the call over to you for some of that next time.

Yeah, that is 100% correct. Super, thanks.

Thank you. There are no further questions at this time. I would now like to turn the conference back over to Mr. Elias, sir.

Thank you, operator. As always, I'd like to thank everyone again for joining us on today's call. and for your continued interest in coding. Thank you for your continued support.

Ladies and gentlemen, that concludes today's conference call. Thank you all for participating. You may now disconnect.