Compass Diversified (NYSE:CODI) Q4 2023 Earnings Call Transcript
Compass Diversified (NYSE:CODI) Q4 2023 Earnings Call Transcript February 28, 2024
Compass Diversified isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon. And welcome to Compass Diversified’s Fourth Quarter and Full Year 2023 Conference Call. Today’s call is being recorded. All lines have been placed in 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.
Cody Slach: Thank you. And welcome to Compass Diversified’s fourth quarter and full year 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’d like to point out that the Q4 2023 press release, including the financial tables and non-GAAP financial measure reconciliations for subsidiary adjusted EBITDA, 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-K 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 2024 adjusted earnings, adjusted EBITDA, or subsidiary 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 expectations related to the future performance of CODI and its subsidiaries, the impact and expected timing of acquisitions and divestitures, and future operational plans, such as ESG initiatives.
Words such as believes, expects, anticipates, plans, projects, should 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 risks factor discussion in the Form 10-K as filed with the SEC for the year ended December 31, 2023, 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 because of new information, future events or otherwise. At this time, I would like to turn the call over to Elias Sabo.
Elias Sabo: Good afternoon, everyone, and thanks for joining us today. I am pleased to report a strong fourth quarter, capping off another exceptional year for CODI. Our results continue to demonstrate that owning premium businesses with defensible competitive moats can drive financial outperformance, even during periods of economic uncertainty. These results are highly intentional. In 2018, we embarked on a strategy to own and manage high-growth, innovative and disruptive businesses. This transformation is driving a significant tailwind for our business, as evidenced by our fourth quarter. Despite experiencing unique challenges in our business, 2023 marked our fifth straight year of subsidiary adjusted EBITDA growth. Our branded consumer businesses produced essentially flat pro forma subsidiary adjusted EBITDA results compared to prior year.
On the other hand, our industrial businesses produced 18% annual growth in subsidiary adjusted EBITDA. Our diversification yet again led to a reduction of financial volatility, which we believe will be further reduced as we add more subsidiaries and enter into the healthcare vertical. In our branded consumer vertical, inventory destocking issues masked the underlying strength of most of the brands we own throughout 2023. Lugano once again delivered remarkable growth, producing 53% annual revenue growth and 65% adjusted EBITDA growth. As we have mentioned, Lugano has created a very innovative and disruptive business model within the high jewelry industry. We continue to fund capital investment to expand the company’s footprint and inventory position, realizing exceptionally strong returns on invested capital that is fueling the company’s rapid growth.
In the fourth quarter, our branded consumer businesses experienced strong subsidiary adjusted EBITDA growth of 26% over prior year. As inventory destocking headwinds started to subside. You will remember the year -- the prior year’s fourth quarter started a major inventory destocking trend that lasted throughout 2023. We believe channel inventory will continue to right-side and turn into a tailwind in 2024, which we expect will enable a much higher level of growth for many of our consumer businesses, making up for the growth we didn’t experience in 2023. Our industrial businesses generated double-digit subsidiary EBIT -- subsidiary adjusted EBITDA growth in the fourth quarter and full year. The easing of inflationary pressures boosted margins and resulted in adjusted EBITDA growth above long-term trends.
We expect this tailwind to normalize as we progress through 2024 and for our industrial vertical to revert back towards trend growth. We remain optimistic about our industrial vertical in 2024 since backlogs remain at very healthy levels. Now, I’d like to return to our competitive positioning. The strategy we outlined last month’s Investor Day detailed our focus on buying and managing more innovative and disruptive businesses. We unveiled this strategy with our management change in 2018. Since then, we have been opportunistically divesting our subsidiaries that grew alongside their industry and focused our efforts towards acquiring more innovative and disruptive businesses with fundamentally faster growth rates. We’ve seen the efforts of this transition really begin to manifest in the numbers as evidenced by our results in the fourth quarter and full year.
This important shift has boosted the power of our growth engine to produce a more consistent, faster level of growth. So, when one or two of our subsidiaries aren’t growing near trend, for example, what we experienced in 2023 with both Boa and PrimaLoft, we have other subsidiaries growing at or above trend, like Lugano and our industrial vertical did in 2023. This diversification in growth drivers not only reduces financial volatility, but it also increases the likelihood of us achieving our core growth rate on an annual basis. As we outlined at our Investor Day, another way in which we create value for our shareholders is through opportunistic M&A transactions. Although the M&A markets were weak for most of 2023, we were able to consummate the divestiture of Marucci Sports, realizing a significant gain for our shareholders.
In early 2024, we acquired the HoneyPot Company, an innovative, disruptive company in the feminine hygiene space. We believe opportunistic M&A transactions, like Marucci and HoneyPot, create value for our shareholders, accelerate our core growth rate and minimize the likelihood of long-term growth decay on a consolidated basis. Before passing the call over to Pat, I’d like to discuss two topics. First, a few macro trends we’re seeing, and second, address the shift to the way we guide our business, which we believe will simplify how you think about evaluating CODI. First, a few thoughts on how macroeconomic conditions are affecting our business. Including the HoneyPot Company, approximately 70% of our consolidated subsidiary adjusted EBITDA is generated by our branded consumer vertical.
So far in 2024, the U.S. consumer is looking healthy, notwithstanding tighter monetary conditions that have existed over the past two years. Unemployment continues to be at historically low levels, wages continue to grow above trend and the easing of inflationary pressures is causing real wages to grow again after declining for much of the past two years. Access savings continue to exist from pandemic-led government transfer payments, albeit at lower levels as savings buffered high inflation rates over the past couple of years. Taken together, we believe this bodes well for our branded consumer business in 2024. Regarding our industrial vertical, which represented approximately 30% of consolidated subsidiary adjusted EBITDA in 2023, global growth is expected to remain positive but at subdued levels due to the negative impact of tight monetary conditions and global tensions.
We believe our industrial subsidiaries are positioned to continue to take market share through innovation, as evidenced by Altor Solutions being first to market with a biodegradable solution, and Arnold Technologies leading the market in advanced materials used to generate green energy. We believe our industrial businesses will continue to perform well again in 2024 as a stable macro-economy and company-led innovation is expected to lead to another year of growth. Thus far in 2024, our results have exceeded our expectations. While we are reiterating our outlook we provided just a few weeks ago at our Investor Day, we are certainly optimistic about 2024 and believe upside exists based on the trends we are currently experiencing. Speaking of our outlook, we are adjusting how we communicate our guidance to help simplify the analysis of our business.
Today we currently own 10 subsidiary businesses across the consumer and industrial verticals, and at some point, we expect to enter the healthcare market. We expect to own and manage 15 companies one day, and perhaps, more than that in the future. To help quantify this scale more simply, we will provide subsidiary adjusted EBITDA guidance ranges on a branded consumer and industrial level. Despite this change, as part of our governance protocols, we remain focused on transparency and we will continue to disclose the same level of detail as we have done previously. We are shifting the narrative as we believe it will be easier for you to follow CODI, as we continue to expand the number of subsidiaries we own. With that, I will now turn the call over to Pat.
Pat Maciariello: Thanks, Elias. As a reminder, throughout this presentation when we discuss pro forma results, it will be as if we owned PrimaLoft as of January 1, 2022. In addition, we have not included the HoneyPot in our 2023 results as it was acquired after year end. I am pleased to report on a very successful year for CODI in 2023, one in which we exited the year far stronger than we entered thanks to the quality and positioning of our businesses. On a consolidated basis for the year, revenue was approximately flat and pro forma subsidiary grew by 4.4%. As Elias mentioned, in the fourth quarter, on a consolidated basis, we saw a material acceleration as many of the headwinds facing our businesses over the last year began to abate.
As a result, in the fourth quarter, revenue and subsidiary adjusted EBITDA growth exceeded our expectations, growing by 7% and 27.4% respectively. Both our industrial and branded consumer verticals had strong quarters, growing subsidiary adjusted EBITDA by 30.2% and 26.3% respectively. For the full year within our industrial vertical, revenues decreased by 5.1% and subsidiary adjusted EBITDA increased by 18.3% for 2022. In this quarter, we saw broad earning strength in our industrial businesses as positive revenue mix to higher margin products combined with lower input and shipping costs. In many cases, we passed on the benefits from lower cost to our customers, leading to the slight revenue decline. However, our industrial management teams continue to operate efficiently and drive solid margin growth.
For the year, both Arnold and Altor grew adjusted EBITDA by over 20% and Sterno by over 11%. A continued return to travel and more pre-pandemic activities continues to have a positive impact on several areas of our industrial business, and we believe this trend will be ongoing. In addition, specifically at Arnold, we want to once again point out the investments in research and development made over the last several years. As a result of Arnold’s technology center, the team continues to add new product -- projects and though not a significant driver of growth in 2023, the company is growing rapidly in new industries, including medical devices. Turning to our consumer vertical, for 2023, revenues increased by 2.7% and pro forma subsidiary adjusted EBITDA was approximately flat first 2022.
Growth accelerated in the back half of the year, however, and for the fourth quarter, revenue and subsidiary adjusted EBITDA grew by 13.4% and 26.3%, respectively, for Q4 2022. As Elias mentioned, we believe this quarter represents a transitional period where, though inventory-related distortions in the supply chain have not fully dissiplate -- dissipated, the headwind they have had on our consumer revenues has weakened significantly. Specifically, to give color on two of our businesses furthest up the supply chain, though challenges at PrimaLoft remain, they appear to be abating somewhat and we are seeing improvements. Brand partners are delaying the timing of their orders often to the latest possible moment, but many indicate solid order expectations on a full year basis.
Conversely, forward technologies return to growth and adjusted EBITDA in the quarter and we are further encouraged by double-digit growth in bookings thus far in 2024. Lugano once again led our growth for the quarter and for the year, as both revenue and adjusted EBITDA grew by 53% and close to 65%, respectively. We grew revenue in every salon in 2023 and saw a meaningful increase in average transaction value. In addition, in the fourth quarter, we benefited from the relocation and expansion of our flagship Palm Beach salon. We are excited about the opening of our London salon in the second quarter of this year and continue to evaluate additional markets. As a whole, we are very pleased with the performance of our subsidiary businesses in 2023 and particularly in the fourth quarter.
We are confident in the positioning of our businesses and the outlook for 2024. I will now turn the call over to Ryan for additional comments on our financial results.
Ryan Faulkingham: Thank you, Pat. Moving to our consolidated financial results for the quarter ended December 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-K that was filed with the SEC earlier today. As a reminder, our sale of Marucci occurred in the fourth quarter of 2023 and its results have been reclassified to discontinued operations for all periods. On a consolidated basis, revenue for the quarter ended December 31, 2023, was $567 million, up 7%, compared to $529.7 million for the prior year period. This increase was primarily a result of strong growth of Lugano and 5.11, partially offset by lower revenue at Sterno, Altor and Velocity.
Consolidated net income for the fourth quarter was $139.4 million, compared to a net loss of $11.8 million in the prior year. The fourth quarter net income was primarily due to the gain on the sale of Marucci, partially offset by impairment expense recorded at PrimaLoft. Adjusted EBITDA in the fourth quarter was $94.8 million, up 35%, compared to $70 million in the prior year. The increase was due to strong growth of Lugano and 5.11, as well as an expansion in EBITDA margin at our industrial businesses. Included in adjusted EBITDA in the fourth quarters of 2023 and 2022 were management fees and corporate costs of $20.9 million and $20.8 million, respectively. Adjusted earnings for the fourth quarter were significantly above our expectations, coming in at $38.1 million.
This was up significantly from $16.3 million in the prior year quarter and up 29% sequentially. Adjusted earnings was above our expectations due to strong performances at Lugano and 5.11 and by our industrial businesses. In addition, our adjusted earnings was positively impacted throughout 2023 by much lower taxes than we anticipated at our subsidiaries, primarily Velocity and PrimaLoft, where we had weaker performance and related income tax benefits. We believe that for modeling purposes, the tax provision at our subsidiaries on a consolidated basis will approximate 10% of subsidiary adjusted EBITDA. However, in 2023, our tax provision was only 7% of subsidiary adjusted EBITDA. Now on to our financial outlook. At our Investor Day in January, we mentioned that we would be enhancing our guidance to the street to reduce confusion.
Providing guidance on our adjusted earnings and subsidiary adjusted EBITDA will continue and remain the same. However, we are adding a third guidance metric called adjusted EBITDA. This differs from subsidiary adjusted EBITDA in that we deduct corporate level expenses and corporate level management fees. One additional note, we will refer to subsidiary adjusted EBITDA on a pro forma basis upon acquisitions, but we will not provide adjusted EBITDA nor adjusted earnings on a pro forma basis. We are also enhancing guidance by providing subsidiary adjusted EBITDA separately for our consumer and industrial verticals as Elias previously mentioned. So now, moving to our 2024 guidance. As a reminder, we acquired the HoneyPot Company on February 1st of this year.
We expect full year 2024 subsidiary adjusted EBITDA consistent with the range we provided at our Investor Day of between $480 million and $520 million. The midpoint of this range, $500 million, implies an 11% growth rate over 2023. This is pro forma for the acquisition of the HoneyPot. The subsidiary adjusted EBITDA range for our industrial businesses will be between $125 million and $135 million. The subsidiary adjusted EBITDA range for our branded consumer businesses will be between $355 million and $385 million. Moving to our new adjusted EBITDA guidance, we expect full year 2024 adjusted EBITDA to be between $390 million and $430 million. This range factors in an expected $86 million in corporate level overhead and management fees in 2024.
This compares to $341 million in adjusted EBITDA in 2023. Now on to adjusted earnings. We expect full year 2024 adjusted earnings to be between $145 million and $160 million. At the midpoint of this range, and assuming the same share count as at December 31, 2023, of 75.3 million shares, we expect to earn $2.03 in adjusted earnings per common share. Given the discontinued operations in 2023, it’s challenging to compare 2024 adjusted earnings to 2023 adjusted earnings. However, as I mentioned earlier, last year’s adjusted earnings benefited by approximately $13 million from lower taxes at our subsidiaries than we had anticipated. Turning to our balance sheet, as of December 31, 2023, we had approximately $450.5 million in cash, approximately $598 million available on a revolver and our leverage was 3.11 times.
During the fourth quarter, we sold Marucci, providing approximately $480 million in cash at closing. We also sold 3.5 million common trust shares in a private placement, yielding approximately $74 million in cash proceeds. Subsequent to the end of the fourth quarter, we acquired the HoneyPot Company for an enterprise value of $380 million. We used cash on our balance sheet to fund our $343 million investment, with the remainder of the purchase price provided by minority shareholders. After closing the HoneyPot acquisition, our total leverage increased to approximately 3.7 times. As a reminder, the first and second quarter are traditionally our lower cash flow quarters. In addition, we pre-funded Lugano with significant inventory early in the first quarter of 2024 in preparation for the London salon opening, which is planned in the second quarter, and thus, we anticipate our leverage will increase during the first quarter and second quarter, then decline sequentially in the third quarter and fourth quarter as a result of strong growth we expect in our subsidiaries adjusted EBITDA.
We have substantial liquidity, and as previously communicated, we have the ability to upsize our revolver capacity by an additional $250 million. With our liquidity and capital, we stand ready and able to provide our subsidiaries with the financial support they need, invest in subsidiary growth opportunities and act on compelling acquisition opportunities as they present themselves. Turning now to cash flow provided by operations, during the third -- fourth quarter of 2023, we received $21.1 million of cash flow from operations, primarily due to strong operating performance. This is up $10 million from the prior year’s comparable period. During the fourth quarter, we used $24.4 million in working capital, a decrease from use of $27.7 million in the prior year.
For the full year 2023 period, cash flow provided by operations increased $106 million as compared to the prior year. During 2023, Lugano invested $157 million in inventory to fund its growth. This inventory investment has generated an exceptional return on invested capital and enabled the strong growth Lugano has experienced. Outside of Lugano, our remaining subsidiaries monetized significant working capital during 2023. And finally, turning to capital expenditures, during the fourth quarter of 2023, we incurred $17.2 million of capital expenditures at our existing subsidiaries, compared to $23.7 million in the prior year period. The decrease was primarily a result of the timing of retail buildouts at Lugano to support their continued growth.
For the full year of 2024, we anticipate total CapEx of between $50 million and $60 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 2024 will primarily be at Lugano for new retail salons. With that, I’ll now turn the call back over to Elias.
Elias Sabo: Thank you, Ryan. I would like to close by briefly providing an update on the M&A market and our strategic initiatives. In the fourth quarter, we not only saw an increase in deal activity, but also in the quality of businesses coming to market. Our competitors continue to struggle with leveraged buyout financing as a function of the current environment, specifically in consumer. We are seeing our cost of capital advantage significantly expand in this environment, which leads us to believe that now is a great time for us to be an acquirer. Our acquisition of the HoneyPot Company in February is a perfect example. Our competitors in the consumer market pulled back dramatically, just as their financing partners have, which is how we were able to get this deal done.
For an on-trend company in the personal health and well-being space, we were able to transact at a multiple that was lower than the historic average. Today’s market reminds us of the financing market of 2020, when large uncertainties driven by COVID kept competition sidelined, yet our permanent capital structure allowed us to buy quality assets like Marucci and Boa. Today, we have a level of optimism that we haven’t had in years. We’re able to consummate M&A at more attractive valuations with better shareholder return prospects than in past years. On the ESG front, our focus continues to not only be about compliance, but ESG is integral to our mission, reflecting our commitment to transparency and responsible business practices. This focus is essential for our continued success and the creation of long-term value for our investors and stakeholders.
We will release our first sustainability report in Q2, which we expect to include details of greenhouse gas emissions, human capital initiatives and governance practices. Additionally, we will continue to seek partnerships and acquisitions that align with our sustainability values, ensuring that our growth is both responsible and aligned with our long-term vision. Our most recent acquisition of the HoneyPot exemplifies the type of company that aligns with CODI’s strategic vision and objectives. To conclude, we continue to make great strides improving upon the quality of our subsidiaries as a whole. In addition, we remain steadfast in our efforts to identify and acquire similar disruptive businesses to further build upon our track record of delivering growth for our shareholders.
I’d like to thank the entire CODI team for their tireless efforts in transitioning this business into a different and stronger company than we were six years ago. With that, Operator, please open the lines for Q&A.
Operator: Thank you. [Operator Instructions] Your first question comes from Larry Solow of CJS Securities. Your line is already open.
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