Good afternoon, and welcome to Compass Diversified's First Quarter 2023 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 introductions and the reading of the Safe Harbor statement. Please go ahead, sir.

Thank you, and welcome to Compass Diversified's first quarter 2023 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 would like to point out that the Q1 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 and 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 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 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-K, as filed with the SEC for the year ended December 31, 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 CODI and 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. We are pleased to report financial results that significantly exceeded our expectations. The strength and durability of our diversified group of subsidiaries was evidenced again in the first quarter, as we delivered growth in both, revenue and consolidated subsidiary adjusted EBITDA on a pro forma basis. This is an extraordinary accomplishment, amidst the backdrop of broad and unique macroeconomic challenges. And as a result, we are raising our full year outlook for both subsidiary adjusted EBITDA and adjusted earnings. I think the obvious question is, how are we able to achieve this. Well, it's no different than what we've said in the past, but perhaps this quarter it's more apparent. Our strategy of assembling a highly-diversified group of companies that reach a broad set of end markets, reach a wide set of consumer demographics and have a strong underlying core growth rate, drove the results we reported today. This is highly intentional and can be traced back to 2018, when we made a concerted strategic shift to transform our business towards higher-quality, higher-growth assets. I'd like to recognize our amazing group of companies and colleagues for allowing us to deliver these strong results today. But despite this, the headwinds we overcame in Q1 are still very much out there and cloud our near-term outlook. Similar to our remarks on our fourth quarter call, some of our branded consumer subsidiaries with exposure to wholesale continue to experience significant inventory destocking headwinds. As a reminder, in the first half of 2022, we benefited from extremely high demand from customers, who needed our product to help manage their own supply chain issues. With the pandemic winding down and some retailers reckoning with the fact that they over-ordered, it has created a whipsaw effect, until…

Thanks, Elias. Throughout this presentation when we discuss pro forma results, it will be as if we owned PrimaLoft, from January 1, 2022. On a combined basis revenue and EBITDA grew slightly and exceeded our expectations. As Elias discussed, the widely-reported supply chain disruptions in 2021 and 2022 created elevated inventory levels in multiple areas and in the quarter, led to order patterns that often differed materially from end customer demand. Despite this challenging backdrop, our management teams and employees continue to perform with agility and skill. Now, on to our subsidiary results. I'll begin with our niche industrial businesses. For the first quarter of 2023, revenues were approximately flat and adjusted EBITDA increased by 19% versus the first quarter of 2022. Each of our niche industrial businesses expanded margins in the quarter and in aggregate adjusted EBITDA margins expanded by over 250 basis points. In the first quarter, Arnold showed solid growth in revenue and EBITDA and bookings once again exceeded shipments. Margins expanded partially due to more positive sales mix, as the company continues to provide more technologically advanced solutions to their customers. Outdoor's revenue declined slightly in the quarter, as some of its more cyclical end markets faced headwinds. Adjusted EBITDA increased by almost 11% however, as raw material prices declined and management continued to work to gain efficiencies. As a reminder, Terry Moody, Outdoor's CEO, led a planned management transition a bit less than a year ago and we are very pleased by the early progress made by him and his team. At Sterno, demand for catering products continued to revert back to pre-pandemic levels, driving growth in the company's foodservice segment. Sterno's scented wax and oil business continued its solid performance as well and costs at the combined business were well managed in the quarter.…

Thank you, Pat. Moving to our consolidated financial results for the quarter ended March 31, 2023. I will 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. As a reminder, our sale of Advanced Circuits occurred in the first quarter of 2023 and therefore was reclassified to discontinued operations in our first quarter 10-Q. Now to our quarterly consolidated results. On a consolidated basis, revenue for the quarter ended March 31, 2023 was $542.2 million, up 6% compared to $510.5 million for the prior year period. This year-over-year increase primarily reflects our acquisition of PrimaLoft during the third quarter of 2022. Consolidated net income for the first quarter was $109.6 million compared to net income of $29.7 million in the prior year. The increase was primarily due to the $98 million gain on the sale of Advanced Circuits in the first quarter offset by an increase in interest expense as a result of financing the PrimaLoft acquisition and rising interest rates. Adjusted EBITDA in the first quarter was $91.9 million, up 11% compared to $83.2 million in the first quarter of last year. The increase was due to the benefit of the PrimaLoft acquisition. Adjusted earnings for the first quarter was above our expectations at $33.2 million, down from $36 million in the prior year quarter. The decline was primarily a result of higher interest expense. Now on to our financial outlook. As a result of the strong performance in the first quarter relative to our expectations, we are increasing our adjusted EBITDA and adjusted earnings estimates. For the full year 2023, we expect consolidated subsidiary adjusted EBITDA to range between $430 million and $460 million, an increase of $10…

Thank you, Ryan. I'd like to close by briefly providing an update on the M&A market and our strategic initiatives. In terms of M&A, not much has changed since we last spoke in March. Deal activity remained suppressed well below historic levels, and we continue to believe activity in the second half of 2023, will improve as economic headwinds moderate. On the ESG front, we continue to advance our key initiatives and execute our strategy. During the quarter, we had a variety of achievements throughout our organization that I would like to highlight. Reflective of CODI's commitment to creating a positive impact for people and planet, we are thrilled to be awarded the silver badge from Catalyst 2030, an organization that partners with corporations to achieve the 2030 sustainable development goals, outlined by the United Nations. We were awarded the silver badge, in recognition of our work with social enterprises and the way we've actively used our purchasing power, to partner with organizations with clearly defined social goals. Looking at our companies. Last month, BOA released their annual sustainability and social responsibility impact report, which outlines their future goals to significantly reduce their carbon footprint and create a more inclusive environment, with equitable opportunities. Arnold Magnetic Technologies announced its partnership with Cyclic Materials, a pioneer in developing more sustainable domestic supply chains for rare earth elements. Arnold and Cyclic will work together to develop a rare earth recycling program, creating an unprecedented circular supply chain for rare earth materials. I am proud of the progress CODI and our subsidiaries have made against our ESG framework, and we look forward to continuing on this path. In conclusion, we're proud of our first quarter results, which are a testament to the successful execution of our strategy. The fact, that we were able to generate organic growth in revenue and EBITDA, amongst such a challenging operating environment, speaks volumes to the quality of CODI's subsidiaries, the benefit of diversification amongst industries and the accelerated pace of our core growth rate. With that, operator, please open up the lines for Q&A.

[Operator Instructions] Your first question comes from the line of Larry Solow from CGS Securities. Please go ahead.

Thanks. Good evening or good afternoon, guys. I guess, just first I guess question on observation. So I feel like the year started off really strong, better than expected. Just trying to parse out the sort of the sequential -- a little bit of a drop mid-single digits, I guess millions or percentage. Is it some acceleration in inventory, I guess a combination of more inventory drawdowns or more than you originally expected or longer than you originally expected into Q2 and some sort of a little bit of end market slowdown? And on the end market slowdown are there particular businesses that are -- because it feels like most of the businesses the larger ones are still doing strong outside inventory drawdown. So I'm just trying to get a little bit more color on where you're seeing a little bit of some extra end market slowdown.

Yeah. Larry, it's Elias and thank you for the question. Q1 was a really good quarter for us. I think when we sat here couple of months ago when we talked about the first quarter on our fourth quarter earnings call, we had guided that we thought we might be down kind of high single digits to low double digits. And obviously, we performed significantly better than that really almost across the board. The business -- BOA obviously had as you see some of the weakness that we expected from kind of this inventory destocking, which is quite severe, and I would say that's continuing. But in general, our businesses performed really well. Coming into Q2, I think we're just taking a more conservative and cautious outlook yet again in our guidance. It's weighing on us what we're hearing in terms of the macro environment out there. We're starting to see some of the data really weakening. Jolt came out down a couple -- I think it's at two-year lows right now on kind of job openings. There's weakness in the regional banking sector. There's a bank down 40%-plus in the aftermarket right now and there's kind of just the continuing kind of rolling issues. So we want to be more cautious Larry. I would say, principally what you're hearing in terms of our outlook in Q2 is more us just being cautious and conservative. There is nothing that, I would say is kind of materially slower. There may be a little bit of slowdown for example within the 5.11 DTC business that we're seeing, but it's not so material that we would get really nervous right now. I would say, our industrial portfolio which was seeing incredible bookings growth kind of in the first quarter has now slowed to…

Yes, that's fair. I was going to ask you a question about Lugano, but maybe just on 5.11. So I know that obviously, the businesses did remarkably well last couple of years through COVID and then where a lot of other power businesses last few quarters have really struggled and they continued to grow. Maybe you could just give us -- you mentioned DTC which obviously has been the big growth driver. Is that still growing just a little bit slower? Maybe give us a little update there and just on new store opening plans for 5.11.

Yes. So, I'd say our DTC comps remain positive in Q1 of this year and that's sort of all the color we typically give on comps Larry. This is a Pat by the way.

Yes.

But I think that's a positive sign. A lot of the strength came from our professional business. Selling into law enforcement agencies was a very good business for the company in the first quarter. And again, unlike a lot of consumer brands out there right this diversified strategy really provides for consistency of earnings at 5.11 and that paid off. As it relates to the new store, we have, call it, between 10 and 20 new stores planned to be opened this year a little bit less than last year, but we are continuing to open them because the economics are just continue to be very compelling.

Got you. And if I could just slip one more just on Lugano. Just obviously the rapid growth there, I think you guys opened two new salons last year. Is the growth -- I feel like -- is the growth driven by the salon openings? There must be an optimal amount to you can't just open wherever. So I am just trying to rein in and get a little more color on growth trajectory, which has been amazing going forward. I feel like it will flow. But any thoughts on that?

Yes. The growth is partially driven by salon openings. It's also driven by increases in sort of average order size, which continues to increase materially, right? And so those -- and new customers and we're adding a lot of new customers. And not all of those come from salons. Some of them may come from our equestrian operations or they may come from other relationships and other events. So, I really can't -- it's not like 5.11 where you can point out our next stores times this equals that right? Like they -- it's a much more sort of complex picture there, so I can't give you a formula per se. But short answer is it's coming from everywhere.

Yes. No, that’s fair enough. Thanks Pat. Appreciate it.

Thank you, Larry.

Thank you. Your next question comes from the line of Cris Kennedy from William Blair. Please go ahead.

Yes. Good afternoon, and thanks for taking the question. Elias, given what you just talked about on the macro side, talk about your confidence in the visibility for the snapback in the second half for BOA and PrimaLoft.

Yes. Cris, thanks for the question, and good afternoon. I think you know the – I can't give you exact timing, right? And sort of Larry was kind of asking is it either deeper in terms of inventory kind of drawdown or is it going longer, a little bit of that is going to be hard for us to tell. I think one of the things that impacted both BOA and PrimaLoft was really this kind of zero COVID policy out of China, and I know we're beyond that now. But if you just think about how many of our brand partners get a material amount of their sales in the greater China market and having kind of a number of months, where Chinese consumers were on the sideline, it isn't just the product we sell to China-centric customers that then sell to the China market. It's brand partners globally that are sitting on significant inventory. Now with zero COVID being behind us, China reopening and consumption coming back I think that's going to clear inventory and clear the way for us to be able to snap back. I can't tell you whether it's Q3 Chris or it's Q4. I think we're getting through this inventory overhang kind of faster and on a very accelerated basis. But I feel confident in the snapback. I just don't know when the timing is going to be. And we won't – I won't give you specific numbers on how much. But I can tell you from our analysis we think there is a dramatically higher amount of sell-through than there is sell-in. And so at some point unless inventory goes to zero in the supply chain, which is obviously, not possible, at some point we have to start to match our sell-through. And…

No, I appreciate that. And then just a clarification on PrimaLoft not meeting your initial expectations is that primarily related to the inventory issue, or is there something more going on there? Thanks a lot, guys.

Yes. This is Pat. Their customer acquisitions have been at or above our expectations. Their, sort of, new technology rollouts has been at or above our expectations. It's just again the existing customers and existing SKUs the orders and the replan orders have been less than we expected due to what we perceive and what we're confident in our inventory issues in the supply chain.

Understood. Thank you.

Thank you. Your next question comes from Matt Koranda from Roth MKM. Please go ahead.

Hi, guys. It's Mike Zabran on for Matt. Just starting with Velocity. Both top-line growth and margins were under quite a bit of pressure in Q1 from the lower sell-in. But when are we expecting retailers to start stocking up for the summer quarters? What does that mean for overall seasonality throughout the year? In turn should we expect the typical 3Q seasonality in Velocity to be less aggressive this year given we're still seeing some caution from key retailers?

Yes there's a lot there. So let me unpack it a little. I'd say we think Q2 will be better than Q1 and Q3 will be better than Q2. So let me start with that sequentially, right? Within that we do believe we will see more sort of strength in the archery side than in the airgun side given those dynamics you talked about around hunting and gearing up for hunting if that makes sense. So Q1 was very weak. I would see Q1 as being a smaller percentage of the year than normal. Absent that we don't really have too much clarity.

Got it. That's helpful. Moving to working capital specifically on inventory. How are we thinking about inventory about how the inventory balance should move throughout the year given the different puts and takes from store and salon build-out to 5.11 as well as further the caution we're seeing from key retailers around restocking?

Yes. So I think what you guys saw is at least in the cash flow statement or use of inventory in the first quarter and that was at really two businesses. That was 5.11 and Lugano and both of that really was to support the growth we saw exiting 2022 but also the first quarter. So as we progress through the year both inventory and working capital, we expect to come down for a majority of the businesses, the exception being Lugano, right? If we continue to see this type of growth, we will continue to support that business with inventory. Outside of them though, we should see a significant cash conversion amongst the other nine subsidiaries as the year progresses.

Got it. That's helpful. Last one for me guys. Just on the healthcare front, maybe just an update on where we stand in building out a team there. Has the appetite for a potential acquisition within 2023 changed at all? And maybe just speak to the relative size of the pipeline and how we feel about current private market valuation specifically in healthcare?

Yeah. So really no major update from where we were in the last conference call. Team remains the same led by Curt Roth and then assisted by human capital that we have within the firm at various levels and that's how staffing will look until we start to get a couple -- a company or two acquired and then we'll start building up that vertical segment from a human capital standpoint. In terms of desire to do a deal, it's there. We want to be able to get some healthcare assets invested in and kind of in-house. Unfortunately Mike, the M&A markets remain really suppressed and it remains suppressed around all categories. Sellers continue to be very cautious. I don't think what's happening in the bank market helps. So when you see regional banks going out of business and their cost of capital investment-grade rated, capital going into junk territory right now that's not conducive to the M&A markets just broadly. So we continue to see that I think being a huge weight on all markets. Now all that being said, there are a couple of healthcare deals that have come through that have priced. I'd say broadly the pricing has been more elevated than one would anticipate given the massive run-up in capital costs over the course of the last year. And I would say pricing has really been more consistent with where pricing was in the free money economy of 2021 and prior to that than it should be in an economy that has a 5% federal funds rate right now and I think it's indicative of the fact that there's just a lot of capital out there that is sitting on the sideline. And when you think about the private markets where we are generally competing for…

Very detail and helpful. Thanks guys. That’s all for me guys.

Thank you.

Your next question comes from Kyle Joseph from Jefferies. Please go ahead.

Hey. Thanks, Elias and Ryan. Just kind of a follow-up there. Obviously, you were focused on healthcare there. But CODI at least in COVID has kind of had a history of zigging when others zag. And you guys did two acquisitions during the pandemic which have obviously been very fruitful, but it sounds like prices have been stubbornly high. But so just thinking about rate, leverage and market dislocation in terms of your capital allocation strategy is now the environment where it's kind of a layer-on acquisition environment? It doesn't sound like there's a lot of platform acquisitions out there given the M&A, but just kind of thinking about how you guys are thinking about capital allocation in this given all the dislocation in the market?

Yeah. So Kyle, I think one, you're right. We are looking more on add-on acquisitions and those generally tend to be much smaller. The competitiveness is typically a lot less and pricing comes in at much better price, at much better levels. And then obviously you have kind of either cost savings or revenue synergy opportunities that we look to extract. And kind of you can look at the most recent acquisition we made of Baum Bat into Marucci Sports. We think that's going to be a great opportunity to add that brand and a different technology and there's some real revenue synergies that exist. So we couldn't be more thrilled to acquire a company like that. But I would anticipate, we're going to see more bound-type kind of acquisitions not from just Marucci, but in terms of add-on acquisitions that have either good cost saving or synergy opportunities within our portfolio. I think you're also right that given the dearth of new platform opportunities that are out there trading, and when there is kind of one or two, they seem to fetch pricing that doesn't take into account the new elevated kind of borrowing cost that we have. I think, it's probably a bit more of a stretch to think that we'll do a platform, although sometimes these things can come up and we can find one. And we think there is great value and we can move really quickly. So I don't want to rule it out, but I would just say from a probability-weighted basis, it's a bit less likely that we're going to find that. So when you think about capital allocation, I would say number one priority within our firm is to fund the kind of high-return opportunities within our portfolio and Lugano clearly kind…

Got it. Very helpful. Thanks for answering my questions.

Thank you. Your next question comes from Sean-Paul Adams from Raymond James. Please go ahead.

Hi guys. It seems like you pretty much hit everything I had with BOA and PrimaLoft. Basically if I understand you guys correctly that you don't really know if this is going to continue past 2Q. So, adjusting run rate on that might be a little bit difficult. But as far as PrimaLoft goes have you guys seen any interest in any other regions?

Any other regions? Yes, I mean we sell globally, right? So, our brand partners manufacture through contract manufacturers in Asia and then they sell globally and you'll see the PrimaLoft brand on a lot of brand -- snow gear outerwear everywhere, right? So, I think when you say other regions, we do have some projects we're specifically working on in Europe now that could be accretive. But other than that I'm not sure. We sell globally. We ship primarily to -- or we have --- we work with our manufacturing partners in Asia who then sell to the partners of our end customers mostly in Asia and then those are shipped globally. Does that make sense?

Yes. Yes to clarify I meant that approximately 83% of the revenue was coming from Asia-Pacific, so -- which is of course, because of the textile industry. But I didn't know if you guys were getting any interest from sell directly to any--

We can't track exactly where it ends up. Does that make sense? So, that's where the buyers are contracted from the brands and there's kind of a pass-through there. So, that's -- actually you're right. That is where the revenue comes from, but that's not where the consumer buys the product if that makes sense.

Got you. Perfect. Thank you.

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

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 support.

This concludes Compass Diversified's conference call. Thank you all and have an excellent day.