Compass Diversified Holdings

Good afternoon and welcome to Compass Diversified Second Quarter 2022 Conference Call. Today's call is being recorded. All lines are being 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 instructions and the reading of the Safe Harbor Statement. Please go ahead, sir.

Thank you and welcome to Compass Diversified second quarter 2022 conference call. Representing the company today are Elias Szabo, Cody's CEO, Ryan Falkingham, Cody's CFO, and Pat Massarello, COO of Compass Group Management. Before we begin, I'd like to point out that the Q2 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 10-Q with the SEC today after the market closed, which includes reconciliations of non-GAAP financial measures discussed on this call, including adjusted EBITDA and adjusted earnings, 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 four-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 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 June 30, 2022, 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 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'd like to turn the call over to Elias Szabo.

Good afternoon, everyone, and thanks for joining us today on our second quarter 2022 conference call. I am pleased to report that we continued our strong momentum in the second quarter of the year as we recorded our sixth consecutive record quarter and our sixth straight quarter of double-digit increases in pro forma consolidated subsidiary-adjusted EBITDA, once again enabling us to raise our 2022 outlook. We're extremely pleased with these results, particularly given the macroeconomic headwinds that all companies are facing today. We again need to acknowledge the skill and agility of our management teams and employees. Each day it seems they wake up to face a new issue stemming from inflation or a new supply chain disruption, and each day they put forth extraordinary effort and adjust. In our last several earnings calls, We discussed our strong execution against the tough macro environment and this quarter was certainly no different. Though inflation may be just starting to crest and there has been some improvement in certain pain points of the supply chain, we remain guarded as inflation will likely remain at elevated levels for some time and slight improvements in the supply chain could reverse quickly. During the quarter, we again delivered double-digit sales growth in both our branded consumer and niche industrial businesses. Our growth this quarter was led by BOA Technologies and Lugano Diamonds, which each had excellent quarters. BOA produced record quarterly revenues and over $24 million of EBITDA, nearly reaching its record Q1 figure. We mentioned last quarter that one component of BOA's growth could be due to the elongation of the supply chain, and that some demand could be the result of pull forward from future quarters. Though this dynamic did not impact the company's stellar performance in the second quarter, we do believe that BOA's growth rates will slow somewhat in the second half of the year from these torrid levels. It's our expectation, however, that the company will continue to show growth due to its exceptional technology, low penetration in existing markets, and planned expansion into new markets. We believe Lugano continues to offer its customers a better value proposition than other ultra-high-end jewelers. In addition, the company has benefited from geographic expansion and Cody's continued inventory investments following our acquisition late last year. Due to these investments and the hard work of the Lugano team, EBITDA has grown by over 60% in the year-to-date period. Overall, we once again did an extraordinary job of growing while preserving margins. In fact, in the second quarter, our consolidated pro forma adjusted EBITDA margins actually expanded slightly versus the second quarter of 2021. Though we anticipate continued economic headwinds could impact our margins going forward, we believe our subsidiary's strong competitive position and exceptional management will continue to allow us to outperform our competitors in this challenging environment. Before I turn the call over to Pat, I want to address the closing of our Primaloft acquisition and the refinancing of our $1 billion bank facility, both of which occurred subsequent to Q2. We are excited about what Primaloft adds to the Cody family of companies. We believe the company possesses significant intellectual property, strong growth prospects, and a world-class management team. Mike Beaucheneau- equally as important, though, their commitment to sustainability and their position as an enabler of growth of sustainable apparel. Mike Beaucheneau- is very much aligned with cody's commitment to responsible growth and a good example of how we want to operate our business. Mike Beaucheneau- As part of this transaction compass group management will waive approximately $5 million of management fees in the first year of ownership. Separately, our refinancing, which we completed simultaneously with the Primaloft transaction, both expanded Cody's capital base and increased our financial flexibility. This enabled a further reduction in our blended cost of capital, which we believe is a key to creating long-term shareholder value. With that, I will now turn the call over to Pat.

Thanks, Elias. On a combined basis, Revenue and pro forma subsidiary adjusted EBITDA in both our branded consumer and niche industrial businesses grew meaningfully and continued to exceed our expectations. For the quarter, as Elias mentioned, EBITDA growth exceeded revenue growth as we were able to increase margins slightly. Our businesses continue to perform admirably throughout this unprecedented period. However, several of our companies who sell to retailers focused on mass channels did face pressure as consumers in that segment continue to be impacted most acutely by inflation. Nevertheless, our management teams continue to execute for their customers and employees, and we're able to drive considerable growth as a whole in this difficult environment. Now, on to our subsidiary results. I'll begin with our niche industrial business. For the year-to-date period, revenues increased by 16.8%, and adjusted EBITDA increased by 16.4% versus the year-to-date period of 2021. Arnold and Altor once again posted meaningful revenue and adjusted EBITDA growth, driven by solid execution and stronger than expected demand. Arnold continues to benefit from investments made over the last several years in technology and infrastructure. Though the company will be comping against a very large defense-related order in the back half of this year, we are continuing to see strengthened bookings and believe the company will have solid performance in the remainder of the year. Altor had solid growth. partially driven by its acquisition of Plymouth Foam in the fourth quarter of 2021. Though margins continue to be pressured by higher raw material costs at Altora, our expectations are that these margin levels should improve in the back half of the year. Turning to our consumer businesses. For the year-to-date period, revenues increased by 13% and pro forma adjusted EBITDA increased by 11.8% as compared to the same period in 2021. Demand for BOA's performance fit systems continued to exceed our expectations. The company's revenue increased by over 44% in the year-to-date period, and it delivered just under $50 million of adjusted EBITDA in the first half of the year. As Elias mentioned, we believe BOA's growth will moderate in the back half of the year from these elevated levels, though we anticipate continued growth. Lugano grew pro forma adjusted EBITDA by over 60% in the year-to-date period. We continue to see a strong correlation between inventory purchases and revenue, and we'll continue to support Lugano, and we look forward to the anticipated opening of two new salons this year in Houston and Newport Beach. As mentioned last quarter, Marucci did not have a significant product launch in the second quarter of 2022 like it did in the corresponding quarter of 2021. As such, it experienced an expected decline in EBITDA. In Q3 of this year, however, Marucci is launching the highly anticipated CatX line of bats. Though it's early, the company is seeing significant demand from both customers and its retail partners, and we're excited about the launch and the product. Touching briefly on 5.11's performance to date, for the year-to-date period, revenues increased by 6.7%, and adjusted EBITDA was approximately flat versus the same period in 2021. We feel that this is strong performance in the face of supply chain challenges, and very difficult retail and wholesale environments. We believe the company's diverse channel mix, as well as its strong brand, loyal consumer base, and experienced management team is allowing it to continue to outperform its competitors. Turning to velocity. As mentioned in our prior earnings call, Q2 represented a very difficult comparable period for the company as retailers continued to replenish inventory levels in Q2 of 2021. We have seen just the opposite so far in 2022, as inventory levels in the mass channel are being reduced materially, sometimes regardless of product performance. Though we are confident in the team in place and the strategic steps they are taking to ensure future success, we anticipate the back half of the year will be somewhat challenging. As a whole, we are very pleased with the performance of our businesses in the second quarter. We are optimistic about the remainder of the year. However, we remain very aware of the potential macroeconomic headwinds and will adjust as needed. 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 on advanced circuits as well as our adjusted EBITDA calculation. First, ACI. As you are aware, we announced the termination of the ACI sale last week. As a result, we expect to reclassify ACI from held for sale to continuing operations in our third quarter reporting. In addition, since its operating results will be reclassified to continuing operations, COTI will get the benefit of ACI's earnings contribution to our non-GAAP adjusted earnings metric from January 1st, 2022. Therefore, our guidance, which I will discuss later in my remarks, has been updated to reflect ACI's full year of adjusted earnings contribution. Now onto the adjusted EBITDA calculation. Effective this quarter, we are no longer adding back management fees to our adjusted EBITDA calculation. The impact of this change is a reduction in consolidated adjusted EBITDA by $14.9 million in the current quarter, which were the total management fees expensed in the quarter. Of this $14.9 million, $1.5 million was incurred by our subsidiaries. Please note that this amount excludes ACI as it was in discontinued operations at June 30th. As you'll hear in our consolidated subsidiary adjusted EBITDA guidance shortly, we have updated it to reflect this calculation change. In addition, our current year reporting periods and prior year reporting periods have been adjusted to reflect that management fees are no longer added back to adjusted EBITDA. And for clarification, this calculation change has no impact on our adjusted earnings calculation since all management fees are deducted. Moving to our consolidated financial results for the quarter ended June 30th, 2022, I'll limit my comments largely to the overall results for Cody since the individual subsidiary results are detailed in our form 10Q that was filed with the SEC earlier today. On a consolidated basis, Q2 revenue was up 19% to $515.6 million compared to $431.5 million in the prior year period. This increase primarily reflects the company's acquisition of Lugano in September 2021, as well as the strong double-digit growth from Boa Marucci, Arnold Magnetics, and Altor Solutions. Consolidated net income for the quarter was $31 million, a significant increase compared to an $11.3 million loss in the prior year-ago quarter. As a reminder, Q2 last year included a $33.3 million loss on debt extinguishment in connection with the redemption in April 2021 of our 8% senior notes due 2026. As introduced earlier this year, we believe adjusted earnings, a non-GAAP financial metric, will allow investors to assess our operating performance in a more meaningful and transparent way. Adjusted earnings for the quarter was $39.3 million, up $11.4 million, or 41% from the year-ago quarter. Our adjusted earnings generated during the quarter were above our expectations for the reasons previously highlighted by Elias and Pat. Turning to our balance sheet, as of June 30, 2022, we had approximately $102.7 million in cash, zero drawn down on our revolver, and our leverage was just below three times. Of note, the manager once again waived fees on cash balances held at Cody as of June 30. Subsequent to the quarter, we purchased Primaloft. For a $530 million enterprise value, we funded our portion of the purchase price of approximately $495 million with the proceeds from a new $400 million term loan A and a draw on our revolver. At the same time, we amended our senior secured credit facility to provide additional flexibility and extend the maturity of our revolver to coincide with maturity of this new term loan A, which is July 2027. Pro forma for this transaction, our leverage would be approximately four times, and our liquidity would be over $500 million. As you can see, 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 second quarter of 2022, we used $1.8 million of cash flow from operations. Our cash earnings during the quarter were able to fund our working capital needs, which were primarily directed towards our strategic inventory investment at Lugano. Inventory levels at all our companies are a significant focus of our management teams in this difficult economic environment, and we are monitoring levels to ensure we meet consumer demand without a negative financial impact. And finally, turning to capital expenditures, during the second quarter, we incurred $14 million of CapEx on our existing businesses compared to $8.8 million in the prior year period. The increase was primarily a result of the continued retail store expansion at our 511 subsidiary. For the full year of 2022, we anticipate total CapEx spend of between $55 million and $65 million. We have incurred $24.4 million year-to-date, and the spend we expect in the second half of the year will be primarily at Lugano for its expanded headquarters and new retail salons, and at 511 as we continue to increase its retail store count from its current 94 stores. Now, on to our adjusted EBITDA and adjusted earnings guidance. Despite our excellent performance in the second quarter, we remain in uncertain times driven by market volatility, the two quarters of GDP contraction that was recently reported, inflationary pressures impacting consumer behavior, and labor market shortages, amongst others. However, as a result of our company's strong performance in the second quarter that exceeded our expectations and our current view of the economy, we are once again raising our 2022 full-year consolidated subsidiary adjusted EBITDA outlook. Now, there are a number of factors impacting this revised guidance, so I'd like to clearly discuss each. As you are aware, Our previous guidance range of 2022 full year consolidated subsidiary adjusted EBITDA was $410 million to $430 million. We are now including Primaloft into our guidance range by adding $30 million of adjusted EBITDA at the bottom end of the range and $35 million at the top end of the range. This would move our guidance range to $440 million to $465 million. As I mentioned earlier, we are no longer adding back management fees in the calculation of adjusted EBITDA, and therefore, our consolidated subsidiary adjusted EBITDA range would come down by roughly 8 million at the top and bottom ends of the range. This would move our guidance range down to 432 million to 457 million. Finally, because of our strong Q2 performance, we are increasing this revised range to between $445 million to $470 million. At the midpoint, this is a $13 million raise due to strong Q2 performance and implies 10% year-over-year growth. Next, I'd like to discuss adjusted earnings. As I mentioned earlier, because of the ACI sale termination, we are adding their full year 2022 results into our revised adjusted earnings guidance. In addition, we are raising our adjusted earnings guidance range because of our strong Q2 performance. Offsetting these increases is a slight reduction in our adjusted earnings guidance range for the acquisition of Primaloft as it generates its strongest earnings in Q1 and Q2 given seasonality of ordering for the outerwear industry. As a result of these items, our revised full-year adjusted earnings guidance range will move from our previous range of $120 million to $135 million upwards to $130 million to $145 million. The midpoint of our adjusted earnings range implies a 7% increase from prior year. With that, I will now turn the call back over to Elias.

Thank you, Ryan. I would like to close by briefly providing an update on the M&A market and on our ESG-related activities in the quarter. M&A activity remains somewhat below historic levels, though it has picked up slightly in the second quarter. Potential sellers remain somewhat hesitant to begin processes given the economic headwinds and the macro backdrop. We anticipate activity continuing to increase modestly in the back half of the year if these headwinds start to moderate. On the ESG front, we have had a productive quarter developing and implementing our mission, vision and values in an effort to strengthen our corporate governing purpose. It is our goal to continue to build and strengthen our culture of trust, transparency and accountability necessary to deliver long-term results. Our MVV process has enabled the creation of a clear pathway for the growth of our ESG framework, which has been strategically developed to deliver an environmental and social focus areas underpinned by good governance. We expect to have the COMPASS ESG framework formally approved by the COTI Board of Directors in the next quarterly board meeting, and it will be publicly shared upon board approval. In addition, we are developing a set of core metrics and minimum standards to be tracked by each COTI company to enable consistent subsidiary measuring and reporting to enable us to develop accurate metrics for continual improvement. Our longer term goal is to be able to integrate impact reporting into our public disclosures. Lastly, we are continuing to develop policies and programs that create an inclusive and healthy working environment that inspires people to do their best. Our focus towards diversity of people and thought has introduced new perspectives, skills, and approaches to problem solving that enhances our strategic and operating capabilities. We believe that this focus is an indicator of a commitment to building a high-performing, purpose-driven workforce and inclusive culture. In this last quarter, 50% of our new hires at Compass Group Management have come from diverse backgrounds, and we recently added one new female board member, as we're pleased to announce the appointment of Terri Schaffer to our board of directors on July 2nd. In conclusion, it was a great quarter for Cody. Relative to our expectations, our performance was once again outstanding. As gross domestic product shrank for the second consecutive quarter, we once again grew revenue and adjusted EBITDA by double digits. Our management teams and employees continue to put forth incredible effort, and I'd like to give thanks and recognition to all of them. With that, operator, please open up the lines for Q&A.

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. Your first question comes from Chris Kennedy, William Blair. Please go ahead.

Good afternoon, and thank you for taking the question. Elias, you guys have been acquiring faster growing businesses over the last couple of years. Can you just talk about the long-term growth profile of Compass today versus maybe two or three years ago?

Sure, Chris, and good afternoon to you, and thank you for the question. You know, we have, if you look back over the last few years, and if I go back to pre the pandemic in 2019, if you remember, we sold a couple of businesses which were one of which was relatively slower growing and cleaner, very good business, but kind of grew at GDP. And then in 2021, we sold another business, Liberty Safe, which was also a relatively slow growth business. And so through the sale of those businesses and then the acquisition of BOA, Marucci, Lugano, and now Primaloft, What we've seen is the portfolio composition has changed really dramatic with respect to our core growth rate. And, you know, I would say before we used to talk in the context of we are a, you know, slightly stronger than GDP growth company. Now we believe we're, you know, kind of a high single digit, you know, type growth company, you know, potentially a low double digit growth company at the adjusted EBITDA line. And that's a subsidiary adjusted EBITDA company. you know, pre-deduction of management fees. You know, just to be clear here, Chris, you know, and as we've defined new adjusted earning metrics, you know, we do get quite a bit of leverage on growth. Our management fees, as you know, principally don't grow unless we do acquisitions. So if we think adjusted EBITDA at the subsidiary level is growing kind of high single digits, there's a leveraging up of kind of the corporate EBITDA, which deducts management fees because that expense stays flat. And then as you further know, we locked in all of our debt prior to the increase in debt rates that happened at the beginning of this year. And $1.3 billion of our debt in the bond market is locked in at 5% and 5.25% respectively. And now we have just a small amount For Primaloft, we have a $400 million term loan that's floating rate, but the spreads are relatively low on that. And so if you think about just the amount of fixed expenses that we come underneath, including interest and management fees, we think that high single-digit growth rate of subsidiary-adjusted EBITDA should leverage into strong growth rates and adjusted earnings. just based on how the math works. But I think largely one of the things that we're demonstrating right now and may have been not as apparent to the market is that the core growth rate of this company has absolutely accelerated as we've engineered this portfolio transition by buying faster growth businesses and shedding some of our slower growth businesses.

Great explanation. And then just one last one on the the health of your consumer. I know Cody generally has higher end consumers, but just there's a lot of uncertainty out there. But just talk about the health of your consumer and your ability to pass through inflationary pressures on your consumer. Thanks a lot.

Sure. So, you know, I would say just and I'll give kind of an overall macro view of what we're seeing. And frankly, you know, our guidance is very much tempered based on some of the headlines and this change in Fed posture. We really haven't seen in a very long time a Federal Reserve that has been as aggressive as it is and is projecting to be kind of further aggressive going forward. And so the overall uncertainty, Chris, just that exists in the marketplace right now has caused us to really temper expectations. Now, all that being said, we generally see demand as staying strong. I would have said a quarter ago, we see demand really more at a torrid level. And so I think it's kind of downshifted a little bit. But part of what we think is happening is there's a more normalization of inventories throughout the supply chain right now. So some of the initial orders that are coming in can be reflective of that. And so as we've all heard, companies You know, have really expanded their inventory positions, you know, and there was an elongation of the supply chain. I would say broadly, we're now seeing companies start to shrink their inventory position. And it really doesn't matter whether you're at the low end, the middle end, or the high end of the marketplace. We're just seeing that broadly. And that's starting to bring down slightly what the new order flow coming in. So we do think there will be some inventory adjustment that generally weighs a little bit on what our revenue growth looks like and otherwise would be without that normalization. Now, on the other side, I will say we're also starting to see some moderation in inflation and some of the other issues that our companies are dealing with. Supply chains are starting to loosen a little bit. We're seeing flow of goods get better. We're seeing employee availability in certain job classifications and in certain regions get much better. And I think those are all going to precede either a topping of inflation and even a kind of lowering of inflation later in the year. So although we're seeing demand start to moderate slightly, we're also seeing kind of the impact on our cost of goods start to moderate as well. And with our customers, we've been able to push through and continue to push through price increases that will protect margins. And as you saw in the second quarter, we were actually able to expand margins year over year due to what we view as very good inelasticity of demand for the products that we generally sell. Now, when you think about kind of the portfolio, we skew towards the middle and higher end buyer in our portfolio. And if you just had to take a real kind of guesstimate here, I would say less than 10% of our adjusted earnings is driven by mass channel distribution that we have. And that's obviously, in today's environment, very good for us because we are seeing the mass channel, unlike the rest of the business, have end market demand that is really declining rapidly. I think that customer in particular is getting hit hardest from food and energy inflation. And therefore, discretionary items aren't being purchased as much. So if you think about our guidance, it really includes that component of our portfolio weakening quite significantly. But outside of that, we see end demand staying pretty strong. And our greatest evidence of end demand really comes from two companies, Lugano, which continues to put up record quarters And continues even into, you know, kind of the beginning of the third quarter to have extraordinary growth that we're experiencing. And 5-11 through the direct-to-consumer channel, and we're seeing incredible growth, you know, strong growth there, too. So I would say, you know, it doesn't feel like end market demand, end consumer demand for us. is weakening at all. There could be some inventory adjustments that cause growth rates to decline somewhat, but we feel generally pretty good, but are cautious given just the general macro economic environment that we're operating in today.

Great. Thanks for taking the questions. Thank you, Chris.

Thank you. The next question comes from Larry Solo of CJS Securities. Please go ahead.

Great. Good afternoon, guys. Just a couple of follow-ups to that, on the price increases, which I know a lot of your businesses certainly have pricing power as leaders. Have you found it increasingly more difficult to continue to raise prices? Have you seen some pushback from customers or some elasticity as you continue to raise price? I'm just trying to get a feel for that. And have you also, are there other workarounds, you know, have you been able to maybe increase suppliers in some instances? Or I know you've been building inventory outside of Lugano, but in other places where you normally don't hold as much inventory. So just trying to get some idea on some of the workarounds.

Hey, Larry, this is Pat. I would say holistically what we're trying to do is provide value to our customers. And so, you know, product A may be, you know, product line A, you may be able to raise prices a little bit more than product line B, right? We had sort of the, what I'll call the hatchet, you know, raise, and now further raises are more scalpel, you know, as you will, kind of looking at what products are really sort of underpriced relative to the value that they convey to the customers, right? We have a diverse group of suppliers, you know, at each business, that we're constantly, you know, looking for the best prices on. And then, you know, as Elias mentioned, we are seeing, you know, certain sort of COGS-related items moderate a little. Freight costs are down. That was a big driver. I mean, they're still, you know, significantly up from, you know, year-ago levels. But freight costs are down. Gas energy is down. So we're seeing some of that, which is also, you know, just starting to maybe – I think that's why Elias used the term cresting. We're just kind of starting to see that cresting. So that's sort of where we are now in kind of a state of play. Does that make sense?

Yeah, absolutely. Just specifically on Lugano, do they sort of benefit or maybe not really get impacted? Inflationary environments on diamonds, and I would also think the audience that these are being sold to, this type of environment, obviously the performance doesn't seem to be impacting them, but I know it also seems like the more you invest in working capital,

complete the more you can earn so just trying to you know me that's not quite true but um you know so does the inflationary environment actually hurt Lugano or maybe actually benefit some I think if the benefit in so couple things first is diamond prices go up it's good to have a lot of diamonds um right so right so so that's number one second I would say you know it's probably I mean I know all of us as we see inflation you know we look to hard assets as stores of value right and their pieces are beautiful, they're pieces of art, but there's also sort of a very large, you know, hard asset sort of component of it. So in that way, I do believe, you know, there's strong demand, and we've seen it from competitors, kind of strong demand for all sorts of, not all, but for many sort of ultra high-end retailers, right? So it's kind of ultra high-end jewelers. So it's kind of both pieces, if that makes sense, right? We don't mind it. And I just add that, you know, because of Mudano's business model that we've talked about, we think we're providing again, more value, um, you know, to our customers than any of the, um, you know, than any of our competitors because of some of the ways that that team there has been able to disintermediate, um, and purchase.

Okay. No, fair enough. I just, just left on five 11. Um, yeah, I think you guys mentioned, you know, revenue is up close to 7% year to date and, um, EBITDA sort of flat, um, Just more supply chain issues. Were those supply chain issues more front-end loaded? Meaning I thought a lot of that was in the beginning of the year, and hopefully some of that is waning for 511. And then on the other side of it, on the revenue side, I think you mentioned the direct-to-consumer side is still doing really well. How about the professional side? I would feel like more dollars are going into that these days than maybe a couple of years ago. Maybe that's just perception, but any thoughts on that?

So we are seeing the, and I think, you know, we had stronger performance in Q2 than in Q1 at 5.11, right? And I think we touched on last time that in March we really saw kind of the really critical, like not getting any inventory in issues sort of abate, right? But there's still a lot of acute issues. I mean, you heard about the trucker strike in the L.A. and the Bay Area ports, right? Well, that cost us some revenue as we weren't able to get products shipped in, if that makes sense. Um, and then on professional side, you know, our professional business is very strong and we're seeing strong professional demand. Um, and I think some of these sort of pullback that we witnessed, uh, you know, post pandemic in sort of people's appetite, uh, to support local and international, um, um, um, professional, um, markets has, has, um, mitigated and they've realized that they need to, you know, that they need to catch up. And so we're seeing really good, um, professional demand. Where we're seeing some weakness is in wholesale, which is a smaller component of our business. But if you remember, 511 does have some wholesale business, nonprofessional consumer wholesale business, which is facing the same sort of inventory. That's the same mass retailer. Yep, yep, yep. Yeah, that's what you hear about it. Right. And so there is some of that. And I'd say, you know, e-com and DTC continues to be strong. I would say ECOM is moderating a little bit from Yerba levels, but I'd say it's still strong in putting up respectable numbers.

Great. Awesome, Mike. Great. I appreciate all that call. Thanks, Pat.

Thank you. The next question comes from Matt Caranda of Roth Capital. Please go ahead.

Hey, guys. It's Mike Xavier, and I'm for Matt. Just in terms of 511, could you just comment on your comfortability with the current store count in relation to your initial rollout expectations? And then from there, has the ability to get inventory improved at all since last quarter, or are we still experiencing some headwinds on that front?

So I think we have 94 stores now. We will be opening a number of stores in the back half I think if we said we were going to do 25 this year, I think we'll do 20 to 25, one to two a month. I think the back half is more loaded than the front half. So I would be looking forward in the next several months to the press release of our 100th store. And again, those stores are continuing to perform well. What we've seen, we have seen improvements in the receipts of inventory. But again, if you say it took... you know, two months to get from factory to 511 before, we still are budgeting in sort of three or longer, right? It's just that that elongation has happened and our inventory has expanded sort of because of that, right? But yet that elongation has stayed constant or maybe improved slowly a day or two here or there, if that makes sense. We have not yet started to sort of reduce those levels and you know pull back you know on on our order time and being able to order kind of closer to when we need it if that makes sense to shrink the inventory we're not yet in that phase of the recovery but we are able to manage our inventory better because that the kind of the elongation has stopped getting longer that makes sense right yeah absolutely that's helpful thank you um and

For Marucci, could you just comment on the demand environment and help us understand what's really dragging our margins here?

Yeah, I mean, a couple things. First, Marucci, like everybody else, and we touched on it, had some air shipments, and those air freight, as you know, put in inventory and averaged out over time. We've seen that improve. We expect margins to improve significantly in Q3. And I would also say You know, we feel demand is good. Pre-orders were good, and we feel demand is good for this sort of next line of bats and accessories and gloves. You know, we're making inroads, and we think those inroads will continue in Q3. Really, we were comping against a smaller launch last year. I believe it was the Cat 9 pastime that we didn't kind of replicate this year before the Cat X. So I'd expect a much better Q3 than Q2 at Marucci. Thank you.

Right. Okay. Got it. And last one for me. In terms of the M&A environment, maybe just speak to how comfortable we are pursuing any additional tuck-in opportunities in the near term and maybe just comment on private market multiples and how they've changed quarter to date.

Yeah. So, you know, as Ryan mentioned in his section, pro forma for the Primaloft acquisition, we're right around four times leverage right now. It's well within sort of what is tolerable. And given kind of the growth of the portfolio, which I talked about earlier, and the increased core growth rate, the free cash flow that we generate pre-making investments, whether in growth capex or working capital, we're just in a very different position that allows us to have leverage that is above our target leverage. But to be clear, we're above our target leverage. As we've said out there, our target leverage is kind of three to three and a half times, and we sit a half a turn above the high end of our target. So our goal is to reduce our leverage back to within our target leverage. We feel that's a responsible amount of risk for us to have in our balance sheet for our shareholders. And it gives us the flexibility to run our business well Now, I think there's a few ways to get there. Clearly, the ATM that you guys are all aware that we have in place allows us to get equity capital into deleverage. But on top of that, just growth in the portfolio increases the denominator, and that's deleveraging in and of itself, and free cash flow will as well. So we think that those three components, growth, cash flow from operations, and ATM, are will get us back within sort of our leverage window in a relatively short period of time. And that's why we're comfortable at where we are right now. Now, that being said, I think for small tuck-ins, we're still open for business. And generally, those are at better purchase price multiples. There are synergies that you can achieve, and they're generally smaller. So it's not going to push the needle on leverage all that much. In terms of new platform acquisitions, we would need to bring in a substantial amount of equity capital in order to deleverage, in order to pursue that. And that's just not something that we see a need for right now. Now, clearly, we think the deleveraging that will happen given the ATM and the growth and the cash flow from operations, that's going to help put us in position to be able to look at platforms here in the near term. But I would say right now for tuck-in acquisitions, we're more open for business. We're a little bit more hesitant to add significant amounts of leverage on our balance sheet given where we are relative to target. In terms of your question on multiples, I would say it really is a bifurcated market. And that's typically what you see in times like this. What we're seeing right now are the A quality businesses. And I'll point to Primaloft as being You know, the best business that we have seen, you know, come out here in 2022, at a minimum 22, maybe even longer. But for a great business like that, there's lots of buyers who line up and there's lots of capital that's available. And even though debt costs have increased, buyers are still willing to step up and pay large multiples for companies of best quality. When you get into the lower quality companies, we're just seeing those companies not transact. And so there's still expectations from sellers that the lower quality companies are going to transact at levels where they would have a year or maybe pre-pandemic. And that's just not the case. And buyers generally aren't either willing or they get through diligence and they find reasons to you know, kind of walk away. So I think it's a, you know, very interesting market right now where you have, you know, either very high prices that are being paid for a quality businesses and then really not much that's happening outside of that. My sense is as markets open up again, we'll probably see multiples contract somewhat on some of the lower quality businesses as there seems to have been a general repricing that's occurred in the, at least in the public markets and in the debt markets for sure. So I think that will factor into the private markets. But I wouldn't expect for the, you know, high-quality A-type businesses to see any material reduction in the valuation that's out there.

Very clear. Thanks, guys. That's all for me. Thank you.

Thank you. Once again, ladies and gentlemen, if you do have a question, please press star 1 at this time.

The next question comes from Barry Hames of Sage. Please go ahead.

Thanks so much. Great quarter once again. I have two questions. One, the financial markets have only recently gotten a little better, but I'm just wondering, is there a set of circumstances where you would go back to the notion of a 511 IPO? And second question, I wonder if you could give us a little bit of an update on the healthcare initiative you guys have talked about. Have you built up the team? Are you starting to look at acquisitions yet? So just would love an update there. Thanks so much.

Sure, Barry. Thank you for the question. So first with regards to 5.11, what we have said on numerous occasions and will continue to say, 5.11 is a great business. And this is one of the A plus companies that we have in our portfolio. We're fortunate now to have a number of kind of A type businesses, 5.11 being kind of the one that we've had longest. We are happy holding 5.11 as long as necessary because it is gonna provide great growth tailwinds for our shareholders and tremendous shareholder value creation, whether it's owned 100% or whatever, we have some minority interest there, or whether we have a component of that that is publicly floated. Now that being said, this company has done a lot in order to make itself a publicly viable company. From the creation of an extraordinary management team with great systems that they have in place And the underlying elements, whether it's working on ESG, whether it's working in a SOX compliant environment, the company has the systems and the talent to be able to be a public company. And it has the growth opportunity that public investors want. So it naturally should be a public company. We do not view ourselves as needing to force it out into the public markets before they're accommodative. And so as markets become more constructive, as we see the consumer businesses, which still are trading relatively poorly, especially if you look at a lot of the consumer IPOs that occurred late in 21, mid and late 21s, They have performed incredibly poorly. That's just creating a really kind of negative backdrop still for consumer companies to go public. And I would say a company of this ilk, we don't feel a need to try to get it out there unless the markets are going to be very accommodative and reward our shareholders with the type of multiple that this company deserves. And so are we always evaluating whether this company is ready to go back and and become a public company? Absolutely. Do we think right now conditions, even though they've moderately ticked up financial conditions in the last month or two, do we think now is the time? Not yet. But as you know, financial markets can change rapidly. The tone of financial markets can change. You know, if we see a headline inflation start to really come down and the Federal Reserve change its policy stance, and that creates the next, you then 511 will be ready and at that point we'll make a decision because we do view this eventually as becoming a public company. And so, I'm sorry, your second question that you had asked?

Healthcare.

Oh, on the healthcare initiative. Yeah, we continue to advance along on healthcare. It's an important initiative. I would say there's, you know, some candidates that we are in talks with, as you know, You know, this is predicated on getting a leader who will be in and can direct that effort for us. And we're feeling more confident by year end that we'll have some positive news to announce there.

Great. Thanks so much.

Thank you. The next question comes from Matthew Howlett of B. Riley. Please go ahead.

Oh, hey, guys. Thanks for taking my question. Sorry, hopping on a little late. Did you note any FX items on the earnings or the guidance here? Do you say FX? No, no FX, Matt. Okay, nothing with the strong dollar is not going to have any impact. I mean, there's nothing to note there with the dollar strength at all.

You don't adjust that out. You're not adjusting that out. No, we don't adjust that out. There's some impact. It's pretty modest across the group of companies. So it's technically factored in as part of our guidance is the way to think about it.

Gotcha. Okay, gotcha. Good. Okay, good. Second question, on Sterno, did It was a nice pickup there. Was it, you know, I know you had some on the two divisions. Was it just that the heating lamp, you know, with the sort of return to, you know, conference schedule, or was it the other division with the candlewood stuff? Was there any sort of, any reason for the pickup there?

I would say the strength in Q2 was definitely driven by the, you know, by the, by the Sterno side of the business, the core Sterno, kind of the, you know, the party and the getting outdoors and the buffet sets as, you know, I think people are making up for, you know, weddings that didn't happen over the last couple of years and parties that didn't happen over the last couple of years.

Okay. Yeah, exactly. That's why any update on, you know, sort of the other side of the business and that there was some, you know, with Walmart, some of the inventory issues, anything there?

I mean, I would say, you know, not performing as strong right now at this moment as the other side of the business. you know, performing fine, taking all necessary, you know, actions. And it kind of goes into some of the things we said before about kind of the more cost-conscious consumer, you know, being pinched a little bit by inflation.

Gotcha. Okay. And then real quickly on Lugano, I mean, you said two more salons. I mean, any sense of how we think about modeling sales with these additional salons coming on?

Let us think through that. I don't think we have a good answer for that right now. I mean, and the short answer is, you know, the salons vary, right? Salons can vary materially in the sales level they have. So I think we're hesitant to put out sort of salon-level guidance.

Gotcha. Okay. Well, certainly, you know, they certainly have a great big following. So it would be really interesting to, you know, could obviously – you know, have a really meaningful impact that these are, these are successful. So we'll look for that. And then just remind us again, the Marucci introduced the new bats. Interesting. How often do they introduce a new bat like that? You can just go over. So is it once a year or once every two years?

Yeah. So the big launches like the cat X cat nine, you know, the big sort of Marucci level launches tend to be once every two years, I would say there are sort of, you know, incremental launches or slightly smaller launches that we have in between. So, Victis, our sister company, launched a Knox, I think it was last year? Last year. Last year we came out in the summer with the Cat9 Pastime, which was a different design sort of version of it. And then there's also right now markets that are launching. We've launched a whole glove line, right? But it's the big bat launches. We've launched softball lines with the Echo. But it's the big sort of Marucci bat launches that, provide the lumpiness. And for those, it's usually every two years.

Okay, gotcha.

Okay, so this is going to be a third quarter event, right? Yeah, we have a launch in the third quarter. It's going well. We should have a good quarter. Great.

Wonderful. Great job. I really appreciate it.

Thank you, Matt.

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

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 CODI. Thank you for your continued support.

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