Good afternoon, and welcome to Compass Diversified Third Quarter 2022 Conference Call. Today’s call is being recorded. All lines have been placed on mute. [Operator Instructions] At this time, I would like to turn the conference over to Cody Slach of Gateway Group for instructions and the reading of the Safe Harbor statement. Please go ahead, sir.

Thank you, and welcome to Compass Diversified’s third quarter 2022 conference call. Representing the company today are Elias Sabo, CODI’s CEO; Ryan Faulkingham, CODI’s CFO; and Pat Maciariello, COO of Compass Group Management. Before we begin, I’d like to point out that the Q3 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 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 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 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 future performance of CODI and its subsidiaries, the impact and expected timing of acquisitions and dispositions and future operational plans such as ESG initiatives. Words such as believes, expects, anticipates, plans, projects and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements, and some of these factors are enumerated in the risk factor discussion in the Form 10-Q as filed with the SEC for the quarter ended September 30, 2022, as well as in other SEC filings. In particular, the domestic and global economic environment, supply chain, labor disruptions and inflations all may have a significant impact on our subsidiary companies. Except as required by law, CODI undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. At this time, I would like to turn the call over to Elias Sabo.

Good afternoon, everyone, and thanks for joining us today on our third quarter 2022 conference call. I am pleased to report that we delivered another exceptional quarter with third quarter revenue and pro forma combined subsidiary EBITDA increasing by 15% and 16% respectively over prior year. Q3 marked our seventh consecutive quarter of double-digit consolidated pro forma subsidiary EBITDA growth. Notwithstanding the difficult macro climate, the strength of our year-to-date operating results is enabling us to raise our 2022 outlook once again. The macro environment has created significant challenges and distortions over the past few years. The effects of the pandemic on the global economy were profound and we continued to wrestle with headwinds stemming from the pandemic. Throughout much of 2022, we dealt with erratic supply chains, labor shortages, and inflation running at 40-year highs. Despite these challenges, we generated record year-to-date operating results, which is a testament to the competitive positioning and management strength at our subsidiary companies. As we finish 2022 and enter 2023, we face new macro led challenges. Supply chains are starting to normalize, but labor markets remain unbalanced and inflation continues particularly in wages. Global demand has eased with Europe showing significant weakness and Asia’s growth becoming more erratic due to China’s zero COVID policy. Domestic spending has remained strong amongst the more affluent consumer, but we have seen a large decline in discretionary purchases for price sensitive shoppers. Together, these macro issues pose a difficult challenge as we finish 2022 and enter 2023. Despite these challenges, we believe CODI is positioned to outperform in both good times and bad times. We own a collection of subsidiaries with diverse end markets, business cycles, investment cycles, and inventory cycles amongst others. This diversification proved to be essential during the pandemic where we produce growth in…

Thanks, Elias. Throughout this presentation, when we discuss pro forma results, it will be as if we owned PrimaLoft and Lugano from January 1, 2021. On a combined basis, revenue and pro forma adjusted EBITDA and both our branded consumer and our niche industrial business grew and continued to exceed our expectations. Once again, third quarter EBITDA growth exceeded revenue growth as our higher margin businesses outpaced the group as a whole. Before I get to our subsidiary results, I wanted to provide a high level view of the quarter’s results. As Elias alluded to, several of our companies who sell to retailers focused on mass channels continue to face pressures as their consumers remain impacted by inflation, and retailers continue to focus on reducing inventories. These headwinds were most acutely felt at Sterno, Velocity and ERGO Baby. In addition, currency headwinds increased in the third quarter and impacted several of our subsidiaries. Despite these challenges on a consolidated basis, we were able to achieve meaningful growth in the quarter. Once again, our management teams executed well for their customers and employees and we are proud to be their partners. Now onto our subsidiary results, I’ll begin with our niche industrial businesses. For the first nine months of 2022, revenues increased by 13.2% and adjusted EBITDA increased by 10.8% versus the year-to-date period of 2021. Arnold and Altor posted meaningful revenue and adjusted EBITDA growth. Arnold continues to show improving margins driven by technology investments made over the last several years. Additionally, the company continues to have meaningfully positive book-to-bill ratios as demand for its technology. With enable efficiency gains in numerous industries and applications continue to increase. As we mentioned last quarter, the company is competing against a very large defense related order in the back half of last…

Thank you, Pat. On to our consolidated financial results for the quarter ended September 30, 2022. I’ll limit my comments largely to the overall results for CODI since the individual subsidiary results are detailed in our form 10-Q that was filed with the SEC earlier today. On a consolidated basis, third quarter revenue was up 22% to $597.6 million compared to $488.2 million in the prior year period. This increase reflects the company’s acquisition of PrimaLoft in July 2022, as well as the strong double-digit revenue growth from BOA, Lugano, Marucci, 5.11 and Altor. On a pro forma basis assuming we had acquired Lugano and PrimaLoft on January 1, 2021, net sales were up 15% compared to the prior year period. Consolidated net income for the quarter was $2.6 million, down from $90.1 million in the comparable year ago quarter. As a reminder, Q3 last year included a $72.7 million gain on the sale of Liberty Safe. 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 $46 million, up $10.1 million or 28% 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. In addition, our adjusted earnings were positively impacted by a $3.5 million income tax benefit at PrimaLoft, primarily due to the acquisition costs expense during the quarter. I’ll provide an update on our adjusted earnings guidance shortly. Before I get to our balance sheet metrics, in this rising interest rate environment, I want to highlight how fortunate we are to have placed $1.3 billion of bonds on our balance sheet in 2021 at a blended fixed rate…

Thank you, Ryan. I would like to close by briefly providing an update on the M&A market and our strategic initiatives. M&A activity remains significantly below historic levels. Potential sellers remain hesitant to begin processes given the economic headwinds and the macro backdrop. We anticipate the remainder of this year to be extremely slow with a gradual increase occurring in 2023 if economic headwinds start to moderate. Strategically, we continue to focus our internal efforts on the development and implementation of our ESG strategy. During the third quarter, we spent a significant amount of time working with our subsidiaries to understand how our overarching ESG framework will be implemented into our companies. We believe that the environmental, social and governance standards that we use to build our framework will allow us over time to deploy capital in a different way than many in the marketplace in a way that we think reflects risk more appropriately. We believe implementation of our ESG framework requires board involvement and oversight. In the last quarter, our board has undergone training regarding proposed climate disclosure, reporting regulations and we continue to build out and enhance the learning process so that our board understands the risks and opportunities. In our most recent board meeting, we presented our ESG framework and we received buy-in from our directors as we proceed to implementation. Finally, we believe health and wellbeing should be a priority for all. In line with the World Health Organization objective to raise awareness of mental health, we have adopted a health and wellbeing month during the month of November, which will become an annual event. This campaigns aligns with one of our key ESG imperatives of future proofing for our people and planet, specifically, our focus on health and wellbeing and attracting and retaining the best talent. In conclusion, it was another great quarter for CODI. Relative to our expectations, our performance was once again outstanding. Our management teams and employees continue to put forth incredible effort and I’d like to give thanks and recognition to all of them. Before turning over to Q&A, I’d like to briefly mention that we will be hosting our Investor and Analyst Day in New York City on January 19, 2023. We will be highlighting each of our consumer companies with a more detailed showcase of PrimaLoft’s products, including a presentation from Mike Joyce, PrimaLoft, CEO. More details to follow in the coming weeks, but we hope to see you all there. With that, operator, please open up the lines for Q&A.

[Operator Instructions] Your first question comes from the line of Larry Solow with CJS Securities. Larry Solow, your line is now open.

Great. Thank you very much. Good evening – good afternoon or good evening guys. Elias, you mentioned supply chain issues starting to improve a little bit, but there’s still obviously a lot of some disjointed stuff and sounds like labor market still very difficult. How about for you guys specifically? Are there any companies that are disproportionately any use subsidiaries still feeling the supply chain impact or challenges more so than the average. And have you been able to obviously labor costs are higher, but have you guys been able for the most part, been able to hire, [indiscernible] amount of people or do you have a lot of shortages across managing your companies?

Yes, I’ll let Pat talk about supply chain by company. I would say, in terms of labor markets, Larry, they continue to remain out of balance. I think it’s one of the bigger issues clearly on the macro – at the macro level. Wage inflation is running extremely high. I think we all saw the JOLTS data the other day and ADP with almost 8% wage inflation year-on-year. It’s quite troubling I would say, when we see this kind of imbalance. There’s been some additional hiring that we’ve been able to, I would say, it’s company by company experience. It’s not broadly and universal, there’s still a lot of openings. There’s still a lot of overtime that is being asked, which is really inefficient from both a cost and productivity standpoint. So I would say, it’s not only wage inflation that is problematic here, but the fact that there’s just not enough labor for the available spots continues to be an issue. I think there’s been some marginal improvement on labor availability, but it’s not material. In terms of supply chain path, what are you – what are we seeing in terms of company by companies that are struggling still more so than the average.

Yes. I mean, it’s – everybody’s still struggling and it is getting better. It’s definitely getting better, everywhere at each of our 11 businesses, though, there’s challenges at each of the 11. Couple I would point to that may have had higher revenues if not for the supply chain issues though would be velocity where we manufacture a lot of sporting goods equipment. Oftentimes, you have 99% of the product done, but you’re waiting on one piece and that cost us some revenue this quarter as we just didn’t have that one final piece to assemble it. I would also say at Advanced Circuits, we have a large assembly business, where we assemble componentry for our clients and again, you have hundreds of pieces on a product and you have 99% of those in, but you don’t have the hundredth. And so you can’t ship the product. So those are two things that stand out as where we probably missed out on a little bit of revenue this quarter, if that’s helpful, Larry.

In general, Larry, supply chains are easing and shipping costs have come back to pre-pandemic levels, port congestion has really been reduced and we’re getting a good flow coming out of the ports and getting into our warehouses, so are there a couple of continuing minor issues that are experienced in the third quarter? Yes. Could there even be a little bit of problems existing in the fourth probably, but even less so. I think the point to take is that supply chains are clearly normalizing and I think now on the other side, it’s probably allowing companies to deaccumulate inventory a little bit, because supply chains are normalizing. So I think those two things go hand in hand and that’s likely going to put system-wide, some pressure down on order demand, as companies are able to work down some of that inventory and manage more just in time based on a more efficient supply chain again.

Got it. Great. And just one more, just quick follow-up on – just on a consumer question, just on BOA, obviously really impressive growth this year. I think it’s close to $70 million year-to-date EBITDA. Seems like your visibility is pretty strong, multi-year strong visibility. I mean, I guess, growth may slow next year. I don’t expect as a double again, but it sounds like you guys feel like maybe this was an outsized year, but it doesn’t feel like we’re going to contract or anything next year, right? Maybe just growth may slow a little bit. Is that sort of fair?

Yes. Larry, I think when you think about BOA, and we really wanted to highlight for everyone, not only BOA but PrimaLoft, 5.11 and Lugano. We put all three of those into companies that have relatively low market share in the respective industries, but also are really fast market share takers. So take BOA as an example. BOA’S market share is under 5% today, but it’s got disruptive technology, when people experience using the product in a category, if you’re a golfer and you use a BOA product and then you go do a Peloton ride, you’re probably likely to want the product for a Peloton as well. And so as we get into more of these categories, there’s a huge TAM that’s out there. The product is, as I said, a really exceptional and people love it and it’s very disruptive to the 100-year old kind of non-innovative lace industry. And so it may be an easy target that we’re going after. But when you have those kind of dynamics of a disruptive product with low market share and your gains in market share are allowing you to have accelerated revenue gain at the company well in excess of what the industry is, right? I mean, the industry isn’t growing 20%, 30% like BOA is. All of that growth is being enabled by market share. It’s hard when you look and say, well, with sub-5% should growth start to really wane, we just are still so kind of under penetrated relative to our potential. We think there’s really good legs for long-term accelerated growth in this business. Now, if I want to take a much more narrow view at Q4 or the first half of 2023 or even all of 2023, look, it’s hard to tell what our partners…

Excellent. I appreciate all that color, Elias. Thanks.

Thank you, Larry.

Your next question comes from the line of Cris Kennedy with William Blair. Cris Kennedy, your line is now open.

Yes. Good afternoon and thanks for taking the question. Can you talk a little bit about the healthcare strategy, kind of what areas is Kurt going to be focused on and kind of the timing of his onboarding and when we might see something within that area?

Sure. Thank you, Cris. And Kurt is here with us today. He joined on November 1, two days ago. As I mentioned in the prepared remarks, we’ve worked with Kurt for a number of years, so we know him and I think it’s really great when you can work with someone who fits culturally in with what you are doing. When we think about the healthcare kind of vertical and industry one we talk about actionable opportunities. I think in 2021, there was north of – yes, there was 1,700, I don’t know if that’s exact, but let’s say north of 1,500 kind of controlled transactions that occurred, which is really an incredible number. So we think at the top of the funnel, there’s the ability to have a lot more opportunities to be seen. And as you know, we have a pretty tight lens in terms of – and filter in terms of what can make it down through to an opportunity that we want to ultimately close on. But this industry I think serves up enough opportunities for us to be able to meet our criteria and still be quite active. In terms of what we’re looking for, I can tell you pretty definitively what we don’t want to do, and that is – we don’t want to take binary risk in anything. So we’re not going to go into biopharmaceutical development or medical device where you either hit it and it’s a home run or it’s a zero. That’s not what we’re set up and established to do. That’s much more venture capital than us. So when you take out all of sort of that drug development, medical development, kind of area that obviously is going to narrow down kind of the view that we look at, it really leave sort of a broad area of services that we would like to be focused on. And I would say, within the service space, it’s a huge area. There are a lot of essential services that are done on behalf of, whether it be hospitals, outpatient centers, pharmaceutical companies, medical device companies. There are essential services that exist out there that are continuing to grow and are not subject broadly to government reimbursement. We think those are the type of companies that really lend themselves well for kind of an LV – the control transaction and investment like we would typically consider.

I appreciate that.

In terms of your question on when we can expect to put capital to work and have something, I mean, Kurt just joined two days ago, so I think it’s a little premature to be thinking about that. Obviously, we have a team here, he’ll be drawing from a lot of the resources that we have. We have a business development team that will be making a lot of contacts and has been already working in the healthcare area to let the bankers and the other deal intermediaries know that we’re going to be active here. But I would say, in terms of a deal, it’s going to take a little bit of time in order for us to get fully up to speed and running. I would hope that happens in 2023, but as we said earlier, the M&A market is frozen shop right now, and we are seeing virtually nothing come through from the sell side. And so we can’t create something out of nothing clearly. And the longer we stay in an M&A freeze, the longer delayed we will be before we’re able to kind of put money to work in the healthcare vertical. And that’s a little bit outside of our control. I think we need to probably see the federal reserve pause or at least become less aggressive in monetary policy. We need to see, how that’s going to impact the economy. And then I think deals will start to open up and come to market and we’ll be in position when that happens. But I think everybody should know, the near-term outlook for M&A, whether it’s in healthcare, consumer or industrial, it’s quite limited right now.

Understood. And then just a quick follow-up, in terms of strategic add-ons, is that still frozen as well or there’s still opportunities happening? And thanks for taking the questions.

I mean, we’re always looking for add-ons, but unfortunately the same dynamics that are affecting the platform market, is affecting the add-on market. I think the add-on market, because it’s smaller and it’s so entrepreneurial typically can be a little different than the platform market. And so there is some marginally better activity levels there. But even sellers and the add-on – potential add-ons, they understand that the stock market’s down 20% year-to-date bond market is an accommodated financing and granted, they might not be big enough to achieve bond financing, but I think you can see the headlines, you can see the macro and just broadly sellers are hesitant to come and initiate a process right now, even an add-on process.

Very clear. Thank you.

Thank you.

[Operator Instructions] Your next question comes from Matt Koranda with ROTH Capital. Matt Koranda, your line is now open.

Hey guys, good afternoon. Just wanted to follow-up on some of the comments that Elias made earlier. I guess, what I was curious about what the inventory destocking that you mentioned is just how are you preparing your subsidiaries for sort of inventory destocking at their customers. Who’s most prepared at the moment in the subsidiary landscape and then who may need a little bit of work on that front? And then I had a follow-up as well.

Sure. I’ll let Pat handle that.

Yes. I mean, we’ve broadly looked at the length of the supply chain for each subsidiary, again, by subsidiary, right? And figured out sort of what that meant and if it’s a business that’s characterized by a lot of overseas and there was a lot on the overseas, just think about what that would be as far as a headwind. And I think I’m going to touch on, we think we’re – each of our subsidiaries is better prepared than their competitors in this space. And we focus hard on it and we have focused hard on it, and we’ll continue to focus on it as we go into budgeting season. But I’m not going to come in sort of on the specifics.

And I think just overall, Matt, what we’re seeing is, and as we’ve talked to our subsidiary companies, we just have to be prepared for whatever comes in the back half of 2022 here and into 2023. And it’s quite uncertain. We think inventory destocking is happening now, we know in some of our companies where we get point of sale versus what ours are, and we see a divergence of those. So we already know in some businesses that we’re seeing a certain amount of destocking happening in Q3 and Q4 and that could bleed into early 2023. I would say, end demand continues to remain relatively strong. Now there are pockets of weakness. Europe is weak, Asia is relatively weak, the more price sensitive shopper is weak. But where the vast majority of our products go, which are domestic consumption by a more affluent customer, that end demand has stayed really strong and probably will continue to stay strong. If you think the – that consumer also has a job, jobs are really plentiful, wages are going up a lot, their wage growth is higher than the inflation that they are experiencing. So there’s no need to reduce discretionary spending. So that’s sort of where we stand today. But as we look into early 2023, none of us know any better than you guys on the call, what this experiment of the government printing trillions of dollars, pumping it into the economy, creating massive inflation, and then having to reverse course what that’s going to bring. And so we have to be really cautious and we have to be ready to move quickly. I would say, the bigger picture and when you say how are your companies dealing with this inventory de-accumulation, it really is a question of…

Makes a lot of sense. Thanks for all the detail, Elias. And then just was curious about your willingness or posture toward doing any opportunistic divestitures to sort of delever the balance sheet in the near-term or set yourself up for some of the incremental acquisitions that may come from the medical side. And then any update to your leverage targets just given the higher rate environment and the incremental loan on revolver is going to be a little bit more expensive on a go forward basis. So any updates to sort of how we should be thinking about leverage and willingness to go higher on – lower on leverage in a higher rate environment?

Yes. So first in terms of opportunistic divestitures, I – we – this about us, everything’s for sale at the right price. And so if we can find the right opportunity and the right buyer that finds value that we think is accretive for our shareholders, we are always open to that. But it clearly has to be in any company that we would consider a divestiture, something that is value accretive to our shareholders over holding that business and that’s a pretty high bar. And so it feels like a stretch for us to be able to achieve that in an environment that is this negative and where multiples have contracted so hard. I mean we can look at a lot of public companies and heck, you’re seeing multiples contract 30%, 40%, 50%, 60% in a lot of businesses. I think it would be difficult to achieve sort of evaluations that we would expect for our businesses in today’s environment. Not to say that that’s not possible, I just would think that it’s difficult to anticipate that. And so we’re always open. I would say when markets come back, there’ll be some companies that strategically we think make more sense than others. And so we’ll always consider that, but it doesn’t seem to be a likely target right now. In terms of our leverage, and I can let Ryan speak to this as well. Our target remains 3.5, understand we have over 70% of our total obligations fixed right now, which in hindsight now looks like a very good kind of move we made last year. So we don’t overly expose to higher borrowing costs. Yes, we have a little bit of higher borrowing costs of course, because on the 30% that’s not fixed. Those rates are going up. It was anticipated most of that debt was placed for the PrimaLoft acquisition. And so we feel very comfortable that PrimaLoft earnings and earnings growth will be able to cover any additional costs that we have on that floating rate debt. But we are not changing our leverage policy. We do remain a little bit above what our target leverage is, but given growth in the portfolio and given our cash flow that we produce now from operations, we feel comfortable with where we are. Ryan, any additional thoughts on the balance sheet?

Yes, just the only other thing I’d add too is just simply we’ve been investing pretty heavily into the growth of the subsidiaries and that’s certainly added working capital into the balance sheet. And that we are at a high point right now seasonally, so we’ve got cash conversion that should occur over the next couple quarters and at the same time investing in businesses that continue to growth should that make sense. But we’ll have some I think tailwind to leverage with that conversion.

Okay. Excellent, guys. I’ll jump back in queue. Thank you.

Thank you, Matt.

Your next question comes from the line of Matthew Howlett with B. Riley. Matthew Howlett, your line is open.

Thanks for taking my questions. Sorry, jumping on late. I heard the comments on Marucci, but that was really the outperformer. I’m least relative to my numbers, I know there’s some seasonality with the first half of the year. You mentioned what some success, some growth and some other product categories. What can you tell us what’s going on there? I mean, it looks like a you have $230 million into the company, its generating $120-plus million of EBITDA that looks like terrific. Just curious on what’s going on there.

Yes. So this is Pat. As I mentioned, and I think I mentioned it in Q2. Q2 was a little bit light because we didn’t have a product launch and In Q3, we had what is kind of the big every other year launch at the Marucci brand which is the CAT X. And so that was that, that produced a very strong Q3 I wouldn’t take kind of Q3 numbers and multiply by four and say that’s what the company’s doing now. We will have a good solid to good Q4. And there’s – and then beyond that, there’s sort of momentum in sort of the other brand adjacencies that I mentioned. So in fast pitch softball and fielding gloves, which is a large market and we’re beginning to get some traction in. So beyond that, there will be sort of incremental growth. I would say this business is characterized on the Marucci side by which is most of the business by a big launch every two years, which will drive sort of again Q3 and Q4, and then we’ll have other smaller launches on the Victus side on and with other products.

Earlier you mentioned some supply chain issues were getting the products to shelter and that that’s cleared up in terms of with the reach and launch…

Yes, yes, I mean you’ll see that the margin growth or the sort of EBITDA growth did not keep up with the revenue growth and a lot of that was driven by this was one of the companies that was most sort of heavily impacted by having to air ship a lot of products. And that is starting to clear up as Elias mentioned more broadly, but specifically to Marucci that is starting to clear up. And we’re starting to see margins return to sort of a more normal level. Now, there’s some margin mix right as we sell Lizard Skins back ribs, and as we sell gloves, these may not have the exact same margins as aluminum bats or wood bats, but there will be mixed, but the sort of the big supply chain costs are knock on wood getting behind us.

Great. And then maybe you can help me understand this a little bit more. I mean one of the benefits of CODI’s structure like the inter-company debt that you eliminate, but it’s just since you own the companies, you have the debt against them, just go a little bit over them, that’s floating rate debt. I mean, is it – do I think of it right where you’re going to be able to take cash more cash out of the companies? I know it’s for tax purposes, but do I – my thinking about that, the right way where you could maybe fund more working capital, but not obviously doing anything to jeopardize the companies or pressure the companies from a debt service coverage ratio. Just walk me through that interplay with intercompany debt, the cash flows that come from the companies, clearly they’re better to be inside CODI than they are using third-party leverage loans. Just go over that rising rates on the intercompany debt part.

Sure. So Matt – you want to do that last? Okay, I’ll take the last. So I would start off by saying Matt high level that in the end, whatever subsidiary earns in free cash flow, it will send to CODI and I will do that because all of the management teams, right, are equity owners of each individual, each company’s individual stock, and they want to pay their debt back off as quickly as possible. So they’re going to pay interest back in principle and do so as much as possible. Now in the case of rising rates, you’re correct in that there will be more interest expense paid, but what that probably means is they’ll just pay a little less principle back because the interest expense is a little higher, right? But in the end, that subsidiary will send whatever cash flow it can to CODI. I think this – the little benefit that we do get though is with some rising interest expense at the subsidiary level, which as you said is intercompany and gets eliminated. They’re all C corps and they in theory will have less pre-tax income and paid some less taxes there. Absolutely. So in theory, a little less cash goes out of the system because of that and yet stays within CODI. So it is really tax strategy at the subsidiary level. You’re correct, it all floats. It all does eliminate, but I think the key message here is in the end, every subsidiary will send as much cash as they can through whether interest expense or [indiscernible] interest or principal payments.

So if I hear you correctly, you’re indifferent from the CODI perspective from shareholders of CODI, what shareholders are indifferent to how you get that cash. I mean, all in all, obviously it’s nice to limit pay less than taxes, but in reality is you don’t, I mean, you’re not trying to take more money out of the companies by raising interest – higher interest expense internally.

No, that, that, that’s correct. I mean there is an income stream to CODI, which is now reclassified as a C corp. So in theory, we have higher interest income coming up to CODI, but our expenses that CODI more than offset that interest income. We actually operate in an – on an annual basis in an – in a well position, assuming we don’t sell. So there’s really not a whole heck of a lot of tax impact at CODI for this, certainly our interest expense is rising, so that does add interest expense at – up at CODI. So there’s – those are really the dynamics affecting us here with rising rates. Is that…

And Matt just, it’s interesting and counterintuitive, higher interest rates because we’ve locked in our debt on 70%, whatever, 72% of it or something is locked in because of that higher interest rates likely are earnings accretive to CODI. And I know that’s a kind of strange concept to think about, but we only have 28% of our debt that actually has a higher interest expense out the door, but our companies have a 100% of their debt owed to us with higher interest expense, which gives them a greater tax shield and therefore has lower cash taxes. So if you think about the two net items to CODI, the one is, well, the companies are going to have less cash taxes that are going out the door. On the other side, CODI’s got a little more interest expense because the debt that we locked in at CODI, the amount of interest expense going out the door is less than the amount of tax savings that we end up achieving by having our companies pay us higher interest rates. And again, I know that’s counterintuitive, but our cash flow actually improves marginally and a rising interest rate, our cash earnings improve marginally because of that, which is I know a little bit counterintuitive, but it also has to do with us having most of our debt fixed and our companies having their debt be variable.

Sort of an embedded inflation edge yet that that I didn’t really see at first and now I see it. And of course, since you own the companies, I mean there’s no in terms of debt service coverage is never, they’re not obviously worried about anything you see in the broader leverage loan mark in terms of interest coverage and things like that, it’s not an issue with your company. So that’s an interesting dynamic. And I guess with that, I mean, was there any update to the network? Do you know the working capital, the capital expenditures in Lugano and at 511, I know you’d laid out some guidance, it was around $70 million last quarter. Just curious an update there, but Lugano looks like the more money you give it, the more money it makes. I mean, any update there?

No, I mean, it will be – you’ve seen us as the company continues to grow, we’ll continue to fund inventory and we monitor it. Obviously very closely as it’s a large investment, but the companies proven it to be good stewards and a lot of the sort of ratios that we look for around inventory are improving or not – at least not getting worse. So they’re solid and stable. And as it relates to 511, I think we’re about to open our 107th store. The store is proved to be a great driver of growth and profit and we believe we’ll continue to do that next year.

Great, guys. Congratulations.

Thank you.

Thank you, Matt.

There are no further questions at this time. I would now like to turn the conference back over to Mr. Sabo.

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. That concludes the call operator.

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