Compass Diversified Holdings

Good afternoon and welcome to Compass Diversified Third Quarter 2023 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 star, then the number one on your touchstone phone. At this time, I would like to turn the conference over to Cody Sla 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 third quarter 2023 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 would like to point out that the Q3 2023 press release, including the financial tables and non-GAAP financial measure reconciliations for adjusted EBITDA adjusted earnings, and pro forma net sales 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 certain non-GAAP financial measures discussed on this call and is also available at the investor relations section of the company's website. Please note that references to EBITDA in the following discussions refer to adjusted EBITDA as reconciled to net income or loss from continuing operations in the company's financial filings. The company does not provide a reconciliation of its full year expected 2023 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 CODI 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 expectations related to the sale of Marucci and the future performance of CODI and its subsidiaries, the impact and expected timing of acquisitions and divestitures, including the divestiture of Marucci and future operational plans such as ESG initiatives. Words such as believes, expects, anticipates, plans, projects, should, and future or similar expressions are intended for forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements, and some of these factors are enumerated in the risk factor discussion in the Form 10-K as filed with the SEC for the year ended December 31st, 2022, as well as in other SEC filings. In particular, the domestic and global economic environment, supply chain, labor disruptions, inflation, and rising interest rates all may have a significant impact on COTI and our subsidiary companies. Except as required by law, Cody undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. At this time, I would like to turn the call over to Elias Sabo.

Good afternoon, everyone, and thanks for joining us today. Before I discuss our third quarter results, I would like to cover the press release we issued this afternoon announcing the agreement to divest Marucci Sports to Fox Factory Holding Company at an enterprise value of $572 million. Cody expects to realize a pre-tax gain on the sale of between $225 million to $245 million, and we expect the net proceeds will be used to pay down outstanding debt and for general corporate purposes. We are extremely proud of the growth Marucci has experienced under our ownership, and we feel fortunate to have been able to partner with their outstanding team. We acquired the business in April 2020 based on our confidence in both Marucci's brand and management. Keep in mind, this was at a time when few transactions were being completed due to the pandemic, but our flexible capital structure and our commitment to seizing strong opportunities even in times of economic uncertainty, allowed us to execute at a time when others weren't. Since then, the Marucci team has acted decisively, strengthening their brand and growing their core business. They have gained share in new markets like fielding gloves and softball. We have also expanded the Marucci product portfolio by acquiring Lizard Skins and Bound Bath. We are honored to have partnered in this success. Thank you to Kurt and the entire Marucci team for their contributions over the last several years. We wish them nothing but continued success. Now on to our third quarter. We are pleased to report remarkably strong third quarter results, which once again exceeded our expectations and have us raising our full year outlook. Our consistently strong results reflect not only the diversification of our subsidiaries, but our ability to find excellent businesses that produce category-leading growth. To underscore this point, since 2019, we have grown consolidated subsidiary adjusted EBITDA for four straight years, despite volatile economic cycles and a once-in-a-generation pandemic. I am pleased to tell you, given our increased subsidiary adjusted EBITDA guidance that Ryan will highlight shortly, we fully expect 2023 to be a fifth straight year of growth. During the third quarter, pro forma consolidated revenue declined by 1%, while pro forma adjusted EBITDA grew 11%. EBITDA margins expanded by approximately 250 basis points to a record 21.9% in the quarter. The decline in revenue was due to our industrial businesses. While they benefited from lower commodity input costs, driving the 19% EBITDA growth, we passed some of those lower input costs on to our customers and experienced a mixed shift to higher margin categories, resulting in an 8% decline in revenues. When you look at year-to-date EBITDA performance, our industrial businesses have performed exceptionally well, posting 14% growth. We expect this segment to produce strong growth in the fourth quarter and into 2024. Our branded consumer businesses exceeded our expectations by growing in the third quarter. Pro forma revenues increased by 2% and EBITDA increased by almost 9%. This represents the first quarter of positive EBITDA growth this year. As we have stated many times before, inventory-related destocking headwinds have significantly lowered our consumer growth rate in 2023. Even though these headwinds still existed in the third quarter, we were able to produce solid growth. While we expect inventory destocking to continue in the fourth quarter, comparisons to prior year are expected to ease, and we expect growth rates will further accelerate. Given the broader difficult macroeconomic backdrop, We are certainly pleased with our subsidiary's resilience and performance to date, and we remain confident in an even stronger 2024. With that, I will now turn the call over to Pat.

Thanks, Elias. Throughout this presentation, when we discuss pro forma results, it will be as if we owned Primaloft from January 1st, 2022. As Elias mentioned, performance in Q3 materially exceeded our expectations. and we experienced significant growth in both our consumer and niche industrial segments. Lugano continued to perform extremely well, driven by new salon openings, a strong management team, and a disruptive business model. Last quarter, we mentioned that we faced headwinds in several segments due to correcting inventory levels in the supply chain. These headwinds have eased in certain areas but remain in others. Specifically, in Q3, though financial performance was muted at FOA, bookings turned positive. Primaloft, on the other hand, continue to seek to reduce demand as apparel makers remain cautious about consumer demand in 2024. Though a significant headwind to Cody's performance in 2023, we continue to expect these businesses to become a tailwind as the rate of inventory to stocking continues to decrease. Though it may not happen at the same time for Primaloft and BOA due to different industry dynamics, we are confident it will happen for both. Now, on to our subsidiary results. I'll begin with our niche industrial businesses. For the year-to-date period ending September 2023, revenues declined by 5.7%. However, adjusted EBITDA increased by 14.5% versus the same period last year. For the third quarter, adjusted EBITDA increased by 19%. On a combined basis, our industrial businesses expanded margins in the quarter significantly. and consolidated adjusted EBITDA margins grew by over 400 basis points versus the prior year's quarter. Though adjusted EBITDA declined slightly for Arnold in the third quarter, for the year-to-date period, the company continued to show solid growth in revenue in adjusted EBITDA as they gained traction securing new projects across markets. Demand levels in the aerospace and defense markets remain elevated, driven by the commercial aerospace sector. And for the year-to-date period, the company's book-to-bill ratio remains above 1. Altor continued to show profit growth in the quarter as adjusted EBITDA increased by almost 21% in the year-to-date September period. Though revenue continues to be pressured as lower margin, more cyclical end markets face headwinds, and the company passed on contractual raw material savings, the efficiency gains made by the management team at Altor significantly more than offset these revenue headwinds. At Sterno, revenue declined by approximately 8% in the year-to-date September period compared to a year ago, again driven by lumpiness in the company's scented wax business. Despite this decline, the company continued to operate efficiently and benefit from reduced input and shipping costs, leading to growth in EBITDA of over 40% in the quarter and 12.5% on a year-to-date basis. Turning to our consumer businesses. For the year-to-date September 2023 period, revenues increased marginally and adjusted EBITDA declined by 2.2% as compared to the prior year. As a group, These businesses showed significant improvement in the third quarter, however, as revenue and adjusted EBITDA increased by 2.1% and 8.6%, respectively, versus Q3 22. We are hopeful that Q3 represented a turning point for BOA. While the company continued to show a climb in adjusted EBITDA through the year-to-date period, bookings were positive in Q3 versus prior year, and our belief is that the worst of the inventory destocking headwinds are behind us for this business. As we approach ski season, the buzz surrounding the launch of Alpine Boots incorporating our technology continues to gain momentum, and we anticipate a strong launch. Lugano's growth accelerated further in the third quarter, and for the year-to-date period, revenues in adjusted EBITDA grew by 48% and over 56%, respectively, compared to prior year. The company benefited from a solid increase in average transaction size in the quarter and saw strong growth in many of its salons, including Washington, D.C., and its new Greenwich, Connecticut salon. Progress continues to be made on our second flagship salon in Palm Beach, and we anticipated opening in the fourth quarter. Similarly, construction of the company's London salon is scheduled to begin prior to year end, and we anticipate opening in the first half of 2024. The management team at Lugano continues to execute at an incredibly high level, and we look forward to 2024. Marucci once again had an exceptional quarter, and for the year-to-date period, revenue and adjusted EBITDA grew by over 17% and over 50%, respectively, compared to the year-ago period. Primaloft continued to show modest declines in both revenue and adjusted EBITDA in the September year-to-date period as compared to the prior year. As we enter booking season for fall winter of 2024, brands remain cautious. Though the company is adding new programs and customers, and we have experienced very little customer attrition, we anticipate a muted Q4, but remain optimistic about the company's prospects in 2024 and beyond. Under Cody ownership, Primaloft remains well positioned, and we believe it will prosper following industry-wide inventory destocking trends in the apparel business. 511 had another solid third quarter, and for the year to date September 2023 period, revenue and adjusted EBITDA grew by 10% and 8.6% respectively. Though the company is not immune to the headwinds facing consumers today, 511 once again benefited from its diverse channel mix as its professional sales increased both domestically and internationally during the quarter. We continue to see this momentum in the fourth quarter. Velocity continued to struggle in the third quarter, though performance didn't improve significantly on a sequential basis. We continue to focus both on cost controls and demand stimulation and believe performance will improve in 2024. Before turning the call over to Ryan, I wanted to discuss a regulatory change coming in the near future impacting our business. As has been broadly covered, California and several other states have enacted laws banning the sale and distribution of textiles containing PFAS chemicals effective January 1st, 2025. These chemicals are used broadly to impart water resistance and oil repellency and prevent staining. Amongst our subsidiaries, this regulatory change will have the most impact on 511. However, they have been proactive in sourcing non-PFAS versions of impacted products and will be transitioning in 2024. As a whole, we are pleased with our performance in the third quarter as it came in significantly above our expectations. While inevitably there will always be challenges in a broad group of diversified businesses, the quarter's performance once again demonstrated the strength of our model, and we look forward to growth in the fourth quarter and in 2024. I will now turn the call over to Ryan for his comments on our consolidated financial results.

Thank you, Pat. Moving to our consolidated financial results for the quarter ended September 30th, 2023, I will 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 September 30th, 2023 with $569.6 million down 1% compared to $575.8 million for the prior year period. This slight year-over-year decrease primarily reflects declines at Velocity and at BOA as a result of inventory destocking headwinds partially offset by strong revenue growth at Lugano and Marucci. Consolidated net loss for the third quarter was $3.8 million compared to net income of $2.6 million in the prior year. The decrease was primarily due to impairment expense recorded at Velocity Outdoor of $32.6 million, partially offset by strong consolidated gross margin performance. Adjusted EBITDA in the third quarter was $103.9 million, up 13% compared to $91.9 million in the third quarter of 22. The increase was due to an expansion in EBITDA margin at a consolidated level, as our industrial companies expanded margins significantly, as Pat highlighted earlier. EBITDA margin expansion at our consumer businesses were primarily due to Lugano and Marucci. Adjusted earnings for the third quarter was significantly above our expectations at $41 million. This was down from $41.6 million in the prior year quarter, primarily due to increased interest expense, but up sequentially by over 15%. adjusted earnings were above our expectations also due to the strong performance at Lugano and Marucci. Now onto our financial outlook. We are pleased to announce that we are raising our full year adjusted EBITDA and adjusted earnings guidance as a result of the strong performance in the third quarter. We are continuing to include Marucci in our guidance ranges as we are not certain the timing of the close of that sale process. For the full year 2023, we now expect consolidated subsidiary adjusted EBITDA to range between $450 million and $465 million, an increase of $12.5 million at the midpoint. This implies 4% growth over the prior full-year adjusted EBITDA pro forma for the acquisition of Primaloft and implies our fourth quarter 2023 consolidated subsidiary adjusted EBITDA will be up over 10% from the prior year comparable period. For the full year 2023, we expect adjusted earnings to range between $130 million and $140 million, an increase of over $13 million at the midpoint. Turning to our balance sheet, as of September 30, 2023, we had approximately $64.7 million in cash, approximately $486 million available on a revolver, and our leverage was 4.03 times. Our leverage decreased sequentially, and we expect it to decline in the fourth quarter. We have substantial liquidity and as previously communicated, we have the ability to upsize our revolver capacity by an additional 250Million upon the close of the Marucci sale process, which we expect in the 4th quarter. We anticipate using the proceeds to pay down existing debt. And for general corporate purposes with our liquidity and capital, we stand ready and able to provide our subsidiaries with a financial support. They need invest in subsidiary growth opportunities. and act on compelling acquisition opportunities as they present themselves. Turning now to cash flow provided by operations. During the third quarter of 2023, we received $19.7 million of cash flow from operations, primarily a result of strong operating performance. This is up $24.3 million from the prior year's comparable period. During the third quarter, we used $48.7 million in working capital. a substantial decrease from 62.8 million in the prior year when we needed to support many of our businesses' inventory levels as a result of supply chain disruptions. For the year-to-date period, cash flow provided by operations has increased almost 100 million as compared to the prior year. Year-to-date Lugano has consumed 139 million in working capital to fund its inventory growth, which has generated exceptional return on invested capital and enabled the strong year-to-date growth rate we have experienced. We expect to continue to monetize working capital across the business in Q4, with the exception of Lugano, as we continue to fund its growth objectives. And finally, turning to capital expenditures, during the third quarter of 2023, we incurred $12.1 million of capital expenditures at our existing subsidiaries, compared to $15 million in the prior year period. The decrease was primarily a result of the timing of retail build-outs at Lugano and 511 to support their continued growth. For the full year of 2023, we anticipate total capital expenditures of between $60 million and $70 million. We continue to see strong returns on invested capital at several of our growth subsidiaries and believe they will have short payback periods. Capital expenditures in the fourth quarter will primarily be at Lugano for new retail salons. 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 our strategic initiatives. In terms of M&A, we have seen some green shoots emerge with a few higher quality deals being reviewed. But overall, markets are weak. Of course, the current economic backdrop suppresses M&A activity with rising borrowing costs and treasury yields hitting 20-year highs. The lack of visibility continues, and as we remain on the sidelines, we continue to strengthen our pipeline of targets for each of our verticals, including healthcare, and fully expect to capitalize once the broader market headwinds ease. In the realm of ESG, our steadfast objective has always been to create tangible, social, and environmental benefits that resonate with our core values while delivering robust financial returns for our stakeholders. Transparency and accountability have remained the cornerstones of our business ethos, driving us to invest in people, refine processes, and explore growth avenues that pave the way for transformative, long-term changes within our companies. Throughout 2023, we have developed a systemic approach to ESG initiatives. We focused on climate action with a number of new programs aimed at waste reduction and emissions, both scopes one and two, We have made progress on social responsibility with diverse new hires, new programs designed to improve the well-being of our employees, and by strengthening partnerships with community organizations. We've recently developed our human rights and labor policy, and through sound corporate governance, we continue to uphold the highest standards of ethics, transparency, and accountability in order to safeguard our shareholders' interests. We are also collaborating with each of our subsidiaries so that they too can create their own ESG strategies that align with our vision. I extend my gratitude to our dedicated employees, shareholders, and all stakeholders who have partnered with us in our journey towards positive change and sustainable value creation. Moving forward, Compass remains committed to driving positive change and leading the industry to become the model of choice through our unwavering commitment to ESG principles. We will continue to innovate, collaborate, and set an example for others, ensuring our business practices not only meet the demands of the present, but also enhance the future. In conclusion, we're proud of our third quarter results. They continue to highlight the benefits of our strategy. Owning a diversified group of strong, disruptive, and industry-leading businesses is how we were able to produce the robust, double-digit adjusted EBITDA growth we saw this quarter. As we continue to work through this period of uncertainty, we are entering the end of the year from a position of strength. The strategic decision to divest Marucci will allow us to deleverage our balance sheet, and provide ourselves with strong liquidity to act when we feel is appropriate. I'd like to extend my thanks to the entire Cody family for their strong execution during the quarter amidst the persistent, challenging environment. Before turning over to Q&A, I'd like to mention that we will be hosting our Investor and Analyst Day in Newport Beach, California on January 17th, 2023. We will be showcasing our Lugano Diamond subsidiary with presentations from Lugano and Cody Management, and we will hold the event at their newest membership club, Preve. Expect more details in the coming weeks, but we hope to see you all there. With that, operator, please open the lines for Q&A.

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one in your telephone keypad. Your first question comes from the line of Larry Solo from CJS Securities. Your line is now open.

Great. Good afternoon, guys, and congrats on the announced sale. It looks like 11 and a half times trailing EBITDA. My memory shows, of course, that's about what you have paid for it. Of course, you've grown the business quite some since, so. I guess the first question relates to that is, in terms of reducing the debt, are there any restrictions, or you'll be able to reduce sort of the, I guess, the variable piece first, right? Yeah, Larry, this is Ryan.

Yeah, so, sorry. Yeah, there's no inability of us. We could pay our revolver back and our term loan aid. Both are prepayable.

Got it. Okay, great. And then, just switching gears. Elias, you gave us a good kind of state of the union on the M&A environment. How about just in terms of it obviously feels like, you know, the consumer has certainly gotten a little bit better through the year and certainly or not as worse as we thought it was going to be in the beginning of the year. And it looks like finally inventory stocking might be starting to wane. But just kind of what's your assessment where you stand today from where we were in the beginning of the year in terms of your, you know, your average consumer, I know you had kind of gotten a little bit more optimistic that a lot of your businesses, your consumers weren't being impacted by this, you know, the slowdown in the economy, but any kind of update on that, those thoughts would be great.

Sure, Larry. You know, I would say if you went back to a year from today or at the beginning of the year, you know, we are much more constructive and positive really across the board. Obviously our industrial businesses have had a great year. A lot of that, and I know there's some revenue headwind, but a big chunk of that is due to the declines in commodity costs and us sharing those with our customers. So I think you need to look through that because unit growth is still present and the companies are performing exceptionally well. On a kind of earnings generation standpoint, we would expect that to continue the big change from a year ago. And from the beginning of the year is how we look at, you know, kind of our consumer businesses. And so, you know, when you think about end consumer demand. It's held up better than I think anybody has anticipated over the course of the year. That's not just for us. That's just consumption broadly. And, you know, we see strong wage growth that's still out there and employment growth. And I think that's a great underpinning. Clearly, it's, you know, kind of counterbalancing some of the increased, you know, kind of interest costs and monetary headwinds that we're all suffering from. But the consumer has broadly held up, you know, for us. the big issue because a lot of our earnings are generated at the wholesale level where we're selling into, you know, a retailer or even farther down in the case of a Primaloft or a BOA. You know, we've the whole year been sounding the alarm bells that this inventory destocking is a headwind that frankly, a year and a half ago, we didn't anticipate. I don't think anybody really did. And again, it's sort of a generational type of thing. I mean, this is all the result of distortion that came out of the pandemic supply chain issues requiring us to over order, you know, kind of across the board and then dealing with all that excess inventory. So, you know, we were very cautious that that was going to create, you know, a depression to, or depress our earnings on our consumer side. And it, in fact, it, you know, where we stand today, isn't to say that those headwinds are gone completely, but the comparisons have become so easy. Now, as we come into the fourth quarter, we feel it's very easy to lap those with companies like BOA, Primaloft, you know, Velocity, 511, everybody who's through the, you know, consumer wholesale market. And as we come into 2024, you know, eventually sell-through will match sell-in. And when that happens, we expect a real strong snapback in, you know, kind of earnings from BOA, Primaloft, you know, all the companies that have that wholesale exposure or even farther down. I will say for now, we're seeing some sequential improvement in terms of order patterns out of those companies. But it isn't back to where it was a year and a half ago. But if comparisons have become so easy, they're no longer headwinds. So we are very bullish. We feel Q4 and what we've seen so far in October lead us to believe we're going to have another great quarter. And as we come into 24, you know, we're preparing for what we think is going to be, you know, a really strong year.

Awesome. And you get a lot of detail. Lugano, obviously, really, really not going to cover up the whole, just on BOA, which obviously, you know, one of your larger consumer brands and probably been taking the grunt, you know, big impact from the destocking. Can you just speak to some of the sort of, you know, the operating trends outside of that destocking? I know you had, I think, in the beginning of the year, kind of projected or called out that you thought SKUs would be up, you know, over 10% by this fall compared to last fall. And For what it's worth, I have seen a lot more BOA and REI circulars and whatnot, so it does seem to be at least anecdotally getting more into the U.S., but just any color on trends that we might not actually be seeing in the recorded numbers would be great.

Thanks. Sure. This is Pat Larry. How are you? I would just say, you know, we touched on it that the headwinds and bookings are starting to not be as much headwinds anymore. And I touched on that specifically. We are continuing to grow SKUs. And, you know, at every quarterly board meeting, I see solid growth in our SKUs. I don't have the exact numbers in front of me, but it's in that same realm. And as you look out to 25, you know, kind of project beyond 24 projected SKUs are growing. are strong too. We mentioned Alpine. It's getting a really strong start. If you go in the, you know, any of the skeets, ski outfitters and ski stores, I think they'll tell you the same thing. It's taking a significant chunk of demand there. And then there's other pockets. I mean, we have some strong momentum in some of our Asian businesses, you know, and you've probably seen the Under Armour Slip Speed, which is being pushed very well and is a really amazing shoe. I'm wearing them right now. So, you know, there's a lot of other pockets of sort of success and growth there.

Great. Thanks, Bob. I appreciate it. Thanks for the call, guys.

Your next question comes from the line of Matt Caranda from Roth Capital. Your line is now open.

Matt, I think you're on mute.

Yeah, your next question comes from Robert Dodd from Raymond James.

Hi, guys. Congrats on the quarter. On the leverage, I mean, to your point, you're at 403 here. After the Marucci sale, whatever exactly that is, you're likely to drop at least down to the bottom end of your target range of three times, I think, maybe even slightly below that. Does that increase the likelihood of expanding more vigorously into that the healthcare vertical in 2024, given you will have quite a lot of available capital at that stage by the standards of where you normally make large acquisitions, if that makes sense.

Robert, this is Elias, and thank you for the question. The answer is yes, if I want to be very succinct. You know, clearly we were being cautious as our leverage, you know, had been outside of the stated leverage range that we wanted to be in. And, you know, it just so happened to be at a time when M&A activity is at, you know, basically 20-year lows. So it wasn't that hard to be patient and disciplined during this time. having capital available right now, and as you mentioned, being, you know, now well within our leverage targets, it is a really good opportunistic spot for us. And, you know, generally in conditions where it's murkiest, you know, the outlook and, you know, kind of you can't turn on CNBC or Bloomberg or any of the other financial outlets without hearing you know, kind of what is going to be the economic outcome from all of this monetary tightening and, you know, how our consumer is going to hold up. And, you know, you can name the whole myriad of, you know, kind of issues and problems that everybody is looking at right now and how that's going to impact, you know, kind of the economy. And generally, that causes, you know, buyers to really tense up. We've found historically when we can be active in markets because we have permanent capital, our capital is committed from our banks, as you know, and we have a lot of flexibility. We found that these are the most ideal times to be an aggressive acquirer. And so, you know, it really works out quite well that we're opening up all this balance sheet capacity at a time when economic, you know, kind of murkiness is probably reaching its peak. And generally that creates really good opportunities to the extent we could deploy and acquire a health care company or two. That would be outstanding and, you know, Rob, who runs our group is sitting next to me right now on this call and, you know, he's pursuing a number of different opportunities that are out there. We have a very robust pipeline, but it takes two to tango as, you know, and we need the kind of sellers to be out there. But we have. you know, a list of companies that we're following that we think would be great targets within that space. And to the extent they come to market, which we're hearing, you know, is going to happen in 24. I think we would love to be able now to more aggressively move into healthcare and start to get the benefits of a broader diversification strategy that we outlined to you guys a year and a half ago when we initiated this vertical.

Got it. I appreciate that. Yeah, and to your point, the timing of the acquisition of Malucci kind of is to exactly that point as well. On Logano, it's been very successful. On the working capital question, the ROI has been very strong on the working capital investments as well. But is there a point at which the amount of working capital you've got allocated to Logano and just the relative concentration there begins to be a concern and is there a point at which you have to look at alternative, the only financial use business is off your own balance sheet, but is there a point at which that doesn't become ideal given how much working capital that business can consume and utilize?

Yeah, I mean, Robert, I think that's a great question and one that we think about all the time. It's not a 24 or 25 issue as we look out, but if this company continues with growth rates, which frankly are just torrid at this point, look, it could get to the point where its sheer size starts to, you know, kind of exceed what our diversification sort of efforts would look like. You know, if the company is going to continue at these growth rates, clearly we would be all ecstatic if it can continue at these growth rates. And given the return on invested capital we're enjoying, we would love to fund that. But your point is very well taken. And what we don't want to do is essentially be a proxy for any one company. And so, to the extent that its growth was starting to overwhelm us, that potential opportunity to kind of seek alternative financing and outside financing while still being part of the Cody portfolio clearly exists for us. I think in the near term, and I'm going to say in the near term over the next couple of years, You know, even on some of the more bullish assumptions that we could make, we don't believe that we would, you know, kind of reach that point. But, you know, to the extent it was starting to get there, we would have and do have available to us, you know, kind of outside, you know, off of our balance sheet. financing opportunities that we could pursue. But I do want to point that's a couple of years away. And that's if the company was continuing to grow at this level, you know, which is a really high bar that you would, you know, we would be asking.

Yeah, yeah, yeah. Understood. Thank you for that. Last one, if I can. With the California, with the PFAS fabrics, have you done any So testing with customers. Do customers notice any performance difference on the alternative fabrics versus the old ones? And frankly, if they do, do they care? Or do you think it's just not going to be an issue? Because anybody else selling legitimately into California is going to face the same issues.

Hey, Robert and Pat, let me say it this way. We believe there's a case that certain customers will still want PFAS products, right? And so that creates demand, but also complexity. You know, it's a good product. There's also a lot of uncertainty in the enforcement of this regulation. The enforcement agency, I don't believe, has been named yet. So there's uncertainty out there as to what's going to happen on 1-1-25. So I can't answer it broadly other than to say, you know, it's seven states, so by definition, 43 other states, at least for now, will still allow PFAS. And I would assume some customers, either on the consumer or law enforcement side in those states and internationally, would want PFAS product.

Got it. Thank you.

Thank you.

Your next question comes from the line of Matt Caranda from Roth Capital. Your line is now open.

Hey, guys. It's Mike Zabrin on for Matt. Can you hear me all right?

Absolutely.

Okay, great. Maybe just on the Marucci sale, can you just help us better understand what net proceeds from the transaction after taxes, after fees, and after the CGM incentive payment will look like and what will this do to pro forma net leverage?

Yeah, sure. This is this is Ryan. So I think the best way to think about it is, you know, 572Million of gross proceeds and then, you know, you could take the diluted ownership percentage and the minority shareholders would share in that. So, post minority shareholders, it's about 500Million. from there we would have and these numbers still would still need to be calculated we would have our allocation interest payment as well as tax payment given our reclassification to a c corp and that nets all down again those numbers aren't finalized but around 400 million of net proceeds which we could use to pay off our debt that helpful absolutely thanks for that ron And I think you might have heard earlier about leverage levels will be within our financial policy of three to three and a half times.

Got it. That's helpful. Thank you, Ryan. Moving to 511, maybe just speak to the progress and status of the retail build-out strategy. I know we're still spending CapEx there. And then Where do we stand cleaning up the inventory? It's been a drag on margins in prior quarters. And lastly, just any callouts on the mix or purchasing behavior of prosumers versus everyday consumers?

Yeah, sure. Let's see, on retail, I'd say we're, given the current retail environment, we're slowing our store rollout, and we're going to come up with a plan, a more limited plan for 2024. I would say, though, that our e-comm continues to be a growth, continues to grow. And so, you know, that's not to say, you know, and retail continues to grow. So it's not to say that DTC is not going to be a driver of growth. It just may be a little bit less investment in 2024, and you'll see that in our CapEx numbers holistically when we provide those for 2024. You know, on inventory, we think we're managing it well. You know, I've learned long ago never to say never as far as, you know, inventory goes and if you need to take further actions. you know, but we believe we're managing it well. I would, you know, in a lot of cases we can sell slow moving inventory through our DTC channel, which obviously has higher margins, obviously maximizes the chance that you don't have to take any markdown. So never say never. And you know, there's a lot of stuff out like PFAS that we just talked about, but we're going to, we're going to try hard to manage inventory appropriately. And then the last question is on the prosumer, Anecdotally, I have heard of the conflict in the Middle East driving pockets of orders here or orders there. I haven't broken that out and I haven't seen that broken out in the professional business specifically. But I would say our professional business has been a driver of growth, was a driver of growth in Q3, and we believe will continue to be a driver of growth in Q4. speaks to our diversified model and the strength of that within 5.11 specifically.

Got it. That makes a lot of sense. Last one for me. I guess just preliminarily, how are we thinking about top-line growth in 2024? Maybe just speak to which brands might be leading the way and why, and then which brands, like a couple group of brands could be potentially more constrained based on Uh, today's environment.

Yeah, so, Mike, you know, we don't give sort of top line growth targets. We typically give even dot growth. And as, you know, you know, with ten, I guess now going down to nine subsidiaries. you know, that can vary and margins are a lot different. And so, you know, we focus a little bit less on top line and we've always focused on, you know, kind of EBITDA and adjusted earnings as the right metrics. You know, as I said earlier, you know, and to start the call, holistically, we feel that Q3 was a turning point for us and that there's accelerating results in Q4 and 2024 you know, should be a really good year for us. And I would say if you think about what we've said historically, you know, our core growth, we expect to be high single digit, you know, possibly low double digit. We're going to be, you know, call it half of that this year. You know, is it possible next year we have enough growth to make up for, you know, kind of coming in underneath it so that over the two-year period together, we get back to our core growth. It's absolutely possible. Now, I'm going to ask everyone not to take that as a, you know, kind of early guidance, but I'm saying that is a possibility given what we're seeing right now and trending. If you want to get a little bit more granular, I would say, you know, we look at ours and our industrial vertical, which has had a phenomenal year in 2023 is likely slowing the pace of growth. In twenty four, but still having good growth as that's not a double digit growth kind of vertical. We've never thought of it as that. So I think that probably reverts back to something that is more normalized, which is kind of a mid single digits growth. And then within the consumer business, I think as you look across it, you know, clearly we have big expectations for Lugano. We expect to continue to have large funding needs that will go into that. One of the things with Lugano is it's not an up leveraging. When we fund additional working capital, the way that translates into EBITDA growth doesn't add leverage. It's not a huge deleverager. but it isn't an up-leverager as well. And so Lugano, we, you know, continue to remain with very high expectations. I think you're going to see BOA come back with, you know, some pretty good growth probably as the year develops and inventories, you know, start to sell in, starts to match, sell through. My sense is you're going to see that accelerating pretty strong, but we have pretty good expectations on that. And I think, you know, in general, we would see our consumer businesses, you know, getting back holistically to be, you know, kind of that double-digit type growth business that it's been historically and that we would expect going forward, which, you know, drives sort of the consolidated growth rate in that high single-digit, low double-digit range. So, you know, it's a little early for us to give too much more granularity than that, but I would say, you know, You know, it feels like there's some tailwinds coming in terms of are there any problem areas that we look at coming into 2024? You know, the answer is no. Right now, you know, we suffered through a really difficult year with consumer wholesale. And that negatively impacted 511. It negatively impacted Ergobaby. it negatively impacted at a big time level, Velocity, Primaloft, and BOA. And so, you know, we look at that and say, if that huge negative is starting to subside, it is eventually going to actually turn into a positive. I think that really bodes well for our business. And that's, you know, kind of a idiosyncratic microeconomic issue that's benefiting us. I don't really know the macro and how 24 is going to shape up. It could be a soft landing. It could be a shallow recession, could be continued growth. I think none of us really know that's creating the murkiness. But regardless of that, I think the micro, you know, kind of economic outlook that each of our companies are suffering from or benefiting from going forward, you know, give us great optimism that there really aren't right now anticipated problem areas coming in the portfolio in 2024. Very helpful.

So that's all from me, guys. Thank you.

Thank you. Thank you.

Your next question comes from the line of Chris Kennedy from William Blair. Your line is now open.

Good afternoon. Thanks for taking the question. Can you talk about the wide range of guidance for the fourth quarter? What brings you to the upper end of the range and what brings you to the lower end, some of the puts and takes?

Yeah, sure. Chris, I'll take that in a lie so you can add some color. Certainly we've highlighted as part of our script the expectations for adjusted EBITDA. We think it'll be midpoint of that guidance implies greater than 10% growth. So that's obviously very positive. We feel certainly good about that. Adjusted earnings can be interesting as you get into the fourth quarter, specifically around taxes, which is probably a broken record. on behalf of Compass, but taxes can be challenging for, you know, 10 different subsidiaries having different, you know, tax situations that can impact fourth quarter specifically. So, you know, just maintaining a little bit of conservatism there. If you run those numbers, you know, that midpoint of adjusted earnings implies, you know, some growth over last year, but not as much as adjusted EBITDA. And we certainly could get there if taxes turn out to be, you know, less than we anticipated.

Yeah, Chris, just follow up to say, you know, kind of the range that we give obviously, you know, we're one third of the quarter through right now and we have decent visibility on where revenues came out in October. I think I also mentioned earlier in the call based on what we saw in October. it would lead us to be more bullish, not more pessimistic, and probably lead us to be more at the high end of the range, not the low end, because it was a very positive October that we saw sort of across the board. But that being said, as you know, there's two very important months, and as holiday season approaches, you know, it becomes really meaningful. The number one determinant that can swing our earnings within that range is, you know, frankly how Lugano does. And we know it's a large, you know, kind of business within our portfolio. It is also one that doesn't have a backlog and, you know, it's benefited by being the end distributor of the product throughout the year and not having inventory destocking headwinds. But it also has the shortest visibility because every day we wake up and we look at what the sales were from the day before to figure out how the company is doing. And so, you know, it gives the level of uncertainty, obviously, because we don't have that backlog. Outside of that, I think, you know, most of our other businesses either work on backlogs, you know, and of some varying length that give us a little bit more confidence. But I think within that range, the high end of the range or exceeding the high end will be predicated on performance at Lugano. And, you know, what we've seen over the last over the really the course of this year, but even over the last month in October and before that. you know, frankly gives us a lot of confidence that they're gonna perform like they have been throughout the year. And so we feel really good about the guidance range and, you know, hopefully being able to do what we've done all year, which is, you know, give a guidance range and then come in and, you know, be able to exceed it and, you know, kind of raise guidance, although since it's the fourth quarter, the last part of that isn't applicable. But, you know, I think we want to provide something that we feel very certain about and then hopefully be able to over-deliver on expectations.

Yeah, thank you for that. Very helpful. And then just a follow-up on PrimaLoft, I think you talked about softer demand there. Can you just talk, give us a reminder on kind of the visibility of that business and when we should start to see bookings improve or whatnot.

Yeah, so we're starting to book now for fall, winter of 2024 for the most part. um and so that's where you know i was saying that a lot of the brands are cautious if you read i won't name the names but if you read some of the big brands um you know discussions they're cautious about what the first half of 2024 is going to look like that obviously you know flows through to um to how they uh to how they work um right and so we're Our hope is that what we're going to do is see later orders and kind of see that order book build later over time, but we're just not there yet in the fall-winter 24 booking cycle. Got it. Thanks for taking the questions.

Thank you, Cruz.

As a reminder, if you have a question, please press star 1 on your telephone keypad. Your next question comes from the line of Barry Hames from Sage Asset Management. Their line is now open.

Thanks so much. Congrats on the quarter. I had two questions. One is, getting back to the inventory destock, primarily in consumer, if next year you got to a point where sell-in and sell-through matched, what sort of range of incremental revenues would you get next year? Or said another way, You know, how much were revenues hurt this year by the fact that, you know, sell-in was less than sell-through? And then my second question is on Lugano, you know, realizing that each location is a little different, could you give us just sort of a rough range to stand up a new location, you know, between CapEx and working capital? You know, what kind of range per location we're talking about? Thank you.

Sure. And thank you for the question. So in terms of, you know, kind of inventory destocking, it's impossible to tell because we don't get from our consumers, from our customers, exactly what their sell-through is and what their sell-in is. I can tell you anecdotally for Primaloft, for example, you know, one of their customers we talked to, as Pat said, we don't name names of customers, but we talked to our person who's handling the general management of that product. And they said, yeah, we expect to be up double digits with it. And we talked to the purchasing department and they said, yeah, your sales are going to be down 20% your orders. So, you know, that would kind of correlate to call it a 30%. you know, plus or minus inventory contraction that is, or, you know, kind of net cost of inventory contraction to our revenues this year. You know, I think broadly, I would say between 20 and 40% seems about right. I gave you one other anecdotal piece of evidence, one of our own companies, which is farther up the supply chain. You know, we asked our CEO, What are our purchase orders right now relative to what they would normally be to the factory? And believe it or not, they're down about 50%. And so, you know, I think it's going to vary by company and, you know, to further the point of how long do you think until we're reverting back to normal orders to our factory? And, you know, the response was we'll probably be back to normal by mid next year. So that means orders will start getting to those factories 90 to 120 days in advance. So, you know, in this particular company, you know, we're probably looking at year end when we start to open up orders to a more normalized basis. So I think it's impossible to tell. I would be absolutely stunned if the impact was less than 20%. And I can tell you, you know, not more than 50, but I think 20 to maybe 30% is probably if you ask for a gut, you know, kind of instinct and a swag feels like the right number in terms of Lugano.

You know, I'll let Pat answer that. I mean, there's a broad range based on the store. It can be from, you know, $4 to $10 million or plus of CapEx based on the store. And then, you know, inventory is at least the high end of that. It is kind of what we stock it with and probably a little more.

So I think if you're modeling it, I would say, you know, $15 to $20 million of total investment that goes into the business between CapEx and inventory is And then, you know, we stand these things up and, you know, look, we expect to get very high returns on invested capital, 30, 40%, you know, types of return on that.

Great. Thank you so much. Appreciate it.

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 support.

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