Q3 2022 Compass Diversified Holdings Earnings Call
With Radick supply chain labor shortages and inflation running at 40 year highs despite.
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 finished 2022 and enter 2023, we face new macro led challenges supply chains are starting to normalize but labor markets remained unbalanced and inflation continues particularly in wages.
Global demand has eased with Europe , showing significant weakness in Asia as 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 the difficult challenges, we finished 2022 and enter 2023.
Despite these challenges we believe Cody is positioned to outperform in both good times and bad times, we own our 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 produced growth in 2020 against a very difficult macro backdrop.
As you are aware our strategic initiative of ours has been to launch a healthcare vertical.
This afternoon, we announced that effective November one Curt Roth has joined our team with responsibility over our healthcare initiative.
Kurt brings a wealth of healthcare investing and transaction experience, having previously worked closely with the compass team. During his tenure at Robert W. Baird most.
Most recently he spent the last seven years as head of corporate development and strategy was so Terra health, a leading global provider of mission critical end to end sterilization solutions lab testing and advisory services for the healthcare industry.
During his tenure so terra consistently grew revenue and expanded profitability, while developing a successful track record of identifying completing and integrating strategic acquisitions. We are delighted to have her join our team not only does he possess the skills to build our health care vertical but more importantly.
He aligns with our culture and values.
Healthcare is an important initiative that will allow us to see a significant increase in actionable opportunities.
Health care industry is large and growing rapidly and we believe the cyclical nature of the industry will add to the diversification of our subsidiaries and further decrease our financial volatility.
As we've also stated on prior calls the subsidiary company transformation over the past few years has created a much faster core growth rate I would like to highlight that four of our subsidiaries Boardwalk Prime aloft 511 in Lugano are all rapid market share taking businesses with low <unk>.
Penetration in industries with positive long term macro trends.
These four businesses represent over 50% of our consolidated subsidiary EBITDA and we believe their ability to continue to take share at a rapid pace will both soften any reduction in demand while accelerating the growth rate in stronger times.
Before I turn the call over to Pat I wanted to discuss the recent shifts in the capital markets and the implications as we head into 2023.
As we're all aware the federal reserve, who is aggressively tightened monetary policy and an effort toward off high inflation.
This is in part caused a major correction in the stock and bond markets with the bond market, indicating the likelihood of a recession in 2023.
Broadly we have seen a reduction in new orders across our subsidiary companies, However, and market demand for the majority of our goods remained strong we believe a period of inventory de accumulation is taking place first as supply chains are normalizing and companies are moving back to <unk>.
Just in time inventory and second as fears of an economic slowdown are causing companies to plan inventory more carefully.
Taking these factors into consideration we are planning for a more challenging demand demand environment in 2023, with easing supply and inflationary pressures notwithstanding a weaker demand outlook. We are confident in our company's competitive positioning and market share growth and believe we are poised to outperform our pea.
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 prime aloft and Lugano from January one 2021.
On a combined basis revenue and pro forma adjusted EBITDA in 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 scenario results I wanted to provide a high level view of the quarters results and the alliance alluded to.
Several of our companies who sell the retailers focused on mass channels continued to face pressures as their consumers remain impacted by inflation and retailers continue to focus on reducing inventories. These headwinds were most acutely felt that 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 team executed well for their customers and employees and we are proud to be their partners.
Now onto our subsidiary results ill.
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 outdoor posted meaningful revenue and adjusted EBITDA growth Arnold continues to show improving margins driven by technology investments made over the last several years. Additionally.
Additionally, the company continues to have meaningfully positive book to bill ratios as demand for its technology.
Enabling efficiency gains in numerous industries and applications continued to increase.
As we mentioned last quarter. The company is comping against a very large defense related order in the back half of last year, which should have solid performance in the fourth quarter.
Outdoor once again had solid growth, partially driven by its acquisition of <unk> foam in the fourth quarter of 2021.
So margins remain pressured by higher raw material prices at outdoor gross margins ticked up sequentially and we expect them to continue to improve in Q4.
The Sterno group faced some challenges in the third quarter, though the foodservice portion of the business continues to return to normalcy post pandemic and we expect a strong fourth quarter in that segment. The company is seeing pressure and sales of its value driven line of Senate waxes. These pressures are a result of both inflation impacting end users.
And retailers focusing on driving down inventory levels as discussed earlier, we expect these pressures to continue in the near term.
Turning to our consumer businesses for the year to date period revenues increased by 16, 5% and pro forma adjusted EBITDA increased by 18% as compared to the same period in 2021.
<unk> had another very strong quarter of performance and for the year to date period revenues increased by 38, 5% and EBITDA by close to 50% from the same period last year and.
In the fourth quarter, we expect <unk> to be approximately flat to last year as the company comps against the very strong Q4 'twenty one.
We want to recognize that the full year of 2022 has been an exceptional year of growth in our second full year of partnering with a company.
We remain enthusiastic about both expansion into adjacent categories and believe the company will continue to gain market penetration in the years ahead.
Louganos growth accelerated in the third quarter and the company has now grown both revenue and pro forma adjusted EBITDA for the year to date period by close to 70%.
We benefited in the quarter from both the opening of our new Houston Salon and from an increase in average transaction size.
Lugano Lugano was starting the fourth quarter, well and we plan on opening our new flagship Newport Salon before year end to continue and to continue expanding geographically in 2023.
We believe that Lugano possesses a disruptive business model and we will continue to support the company with investments in inventory people and new salons.
<unk> also had an exceptional quarter as the launch of the highly anticipated Cat X line of bats was above expectation.
For the year to date September period, <unk> revenue and EBITDA grew by 41, 9% and 13, 2% respectively.
Margins improved in the quarter as the supply chain related issues, we experienced in the first half of the year began to somewhat dissipate.
Marucci is also having early success entering several new markets, including fueling gloves and fast pitch softball, and we are confident these adjacent categories will be drivers of further growth.
Turning now to our most recent acquisition Prime aloft.
For the year to date period pro forma revenue and EBITDA.
Increased by 25, 8% and 33% respectively.
For the third quarter on a pro forma basis revenue and EBITDA were approximately flat with 2021 levels.
Due to the seasonal nature of prime loss outerwear, driven business. The second half of the year typically accounts for less than a third of full year EBITDA.
Booking in quoting trends are solid heading into 2023, and we remain pleased with the prime aloft acquisition and optimistic that they will continue to take market share.
Touching briefly on 511, we are proud of the company's performance in a difficult environment for apparel businesses for the year to date period revenue and EBITDA grew by nine 2% and three 4% respectfully respectively. Despite the headwinds and the industry's 511 continues to grow in the third quarter and its direct to consumer.
Comps remained meaningfully positive.
We continue to be excited by the brand's potential and believe the business remains well positioned for continued growth.
As a whole we were very pleased with the performance of our businesses in the third quarter as Elias mentioned, we believe there will be continued economic headwinds in the fourth quarter, but on a consolidated basis <unk> is well positioned to weather. These storms and have solid performance I will now turn the call over to Ryan for additional comments on our financial results.
Thank you Pat.
Onto our consolidated financial results for the quarter ended September 32022.
I will limit my comments largely to the overall results for Coty 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 Prime aloft in July 2022, as well as the strong double digit revenue growth from Boa Lugano, Marucci 511 and <unk>.
On a pro forma basis, assuming we had acquired Lugano and prime aloft on January one 2000, 2021, net sales were up 15% compared to the prior year period.
Consolidated net income for the quarter was $2 6 million down from $91 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 as introduced earlier this year, we believe adjusted earnings are non-GAAP financial metrics will allow investors to assess our operating performance and 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 and.
In addition, our adjusted earnings were positively impacted by a $3 $5 million income tax benefit at Prime aloft, 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 and 2021 at a blended fixed rate of five 2% representing.
Representing 70% of our total outstanding debt and with maturities of 2029 and beyond.
Now to the balance sheet.
As a result of the continued retail store expansion at our legato and 511 subsidiaries.
For the full year of 2022, we anticipate total capex investments of between $50 million and $60 million to.
The capital expenditure spend in the fourth quarter will be primarily for Lugano, New expanded headquarters in Newport Beach and.
In addition, we will continue to support five eleven's retail store expansion from its current 107 stores.
Now onto our adjusted EBITDA and adjusted earnings guidance.
Despite our excellent performance in the third quarter, we remain in uncertain times, driven by market volatility inflationary pressures impacting consumer behavior and labor shortages amongst others.
As a result of our company's strong performance in the third quarter that exceeded our expectations and our current view of the economy. We are once again, raising our 2022 full year consolidated subsidiary adjusted EBITDA outlook.
Our previous range was 445 million to $470 million, our revised range is $460 million to $407 million.
At the midpoint this implies year over year growth in subsidiary adjusted EBITDA from 2021 on a pro forma basis to include Prime a lot of 12%.
Next I'd like to discuss adjusted earnings.
As Pat mentioned earlier prime off generates its strongest earnings in Q1, and Q2, given seasonality of ordering for the outerwear industry.
Further because of a significant income tax benefit at prime of life that I mentioned earlier, coupled with strong performance across our subsidiaries. Our Q3 adjusted earnings were significantly above expectations.
As a result of these items our revised full year adjusted earnings guidance range will move from our previous range of 100 $130 million to $145 million upwards to $145 million to $155 million the.
The midpoint of our adjusted earnings range implies a 10% increase from the prior year.
We anticipate our fourth quarter adjusted earnings will be down from prior year, primarily as a result of final off seasonality as well as higher interest costs from funding the <unk> acquisition and increasing rates on our term loan and revolver credit facilities.
With that I'll 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.
M&A activity remains significantly below historic levels.
Potential sellers remain hesitant to begin processes, given the economic headwinds in 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.
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.
And our most recent board meeting we presented our ESG framework and we've received by <unk> 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 our health and wellbeing months during the month of November which will become an annual event. This.
This campaigns aligns with one of our key ESG imperative 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 Coty 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 things in recognition to all of them before.
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 private loss product, including a presentation from Mike Joyce Prime aloft 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.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad. Your first question comes from the line of Larry Solow with C. J F Securities Larry.
<unk> Your line is now open.
Great. Thank you. Thank you very much good evening, good afternoon or evening.
You mentioned the supply chain.
Issues started to improve a little bit, but there's still obviously a lot of some disjointed stuff in.
It sounds like labor market is still very difficult.
How about you guys specifically are there any companies that are disproportionately into your subsidiary is still feeling the.
Yes, the supply chain impact.
Our 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.
SaaS has a lot of people are.
A lot of shortages across any of your company.
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.
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 has 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 Theres still a lot of openings. There is still a lot of overtime.
Being asked which is really inefficient from both a cost and productivity standpoint, So I would say.
It is not only wage inflation that is problematic here, but the fact that there's just not enough labor for the available spot continues to be an issue.
I think theres been some marginal improvement on labor availability.
But it's not material in terms of supply chain path.
What are we seeing in terms of company by companies that are struggling still more so than the average.
Everybody is still struggling and it is getting better.
Definitely getting better everywhere at each of our 11 businesses. So theres challenges that 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.
Lot of sporting goods equipment oftentimes you have 99% of the of the product done, but youre 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'd 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 and we don't have the 100 and so you can't ship the product. So those are two.
Things that stand out as where we'd probably.
Missed out on a little bit of revenue.
This quarter Thats helpful, Larry and general layering and 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 yes are there a couple of <unk>.
<unk> 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 accumulate inventory a little bit because supply chains are normalizing. So I think those two things go hand in hand, and thats likely going to put systemwide.
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 then just one more just quick follow up on just auto subsidiary question was just on ball, obviously really impressive growth this year I think.
That's a 70 million year to date EBITDA.
It seems like your visibility.
Strong multiyear strong visibility I mean, I guess the growth may slow next year, I don't expect that to double again, but.
It sounds like.
You guys feel like.
Maybe just without pause year, but it doesn't feel like we're going to contract drilling for next year right.
The 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 below but prime along 511 in Lugano, we put all three of those into companies that have relatively low market share in their respective industries, but also are really fast market share takers.
So take bold.
As an example, both market share is under 5% today, but its got disruptive technology.
When people experience using the product in a category if youre a golfer and you use the product and then you go do a peloton ride youll, probably likely to want the product for a peloton as well and so as we get into more of these categories.
There is 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 laser industry.
So maybe 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.
Sure.
It's hard when you look and say well with sub 5% should growth start to really wean. We just are still so underpenetrated relative to our potential we think there's really good legs for long term accelerated growth in this business now if I wanted to take a much more.
More narrow view at Q4 or the first half of Q.
2023, or even all of 2023 look it's hard to tell what our partners are going to do it's hard for us to know how much inventory they brought in and what they need to work down through the supply chain. So clearly inventory.
Accumulation can negatively in the short term impact the strength of growth, but I would say there is no view that boa.
Or any of those four businesses that we mentioned which represent over half of our EBITDA. There is no view that these companies are taking market share and going to continue to take market share at a rapid pace and we may have a year or a period of time or six months whatever it may be where there is some factor.
Or is that hold that growth back somewhat but the intermediate to long term growth trends.
For both <unk> and the other three remain absolutely intact and there is nothing that makes us less excited about that company as we stand today or the other three or any of our companies to be honest with you, but there is nothing that makes us less excited about boa.
Right now than where we were three months ago, a year ago or upon the acquisition I mean, this is a great company and we believe it has accelerated.
<unk> revenue and EBITDA growth potential for years to come.
Excellent because you saw that color life. Thanks. Thank.
Thank you Larry.
Your next question comes from the line, Chris 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 as Kirk can be focused on and kind of the timing of his onboarding and when we might see something within that area.
Sure. Thank you Chris.
Curt is here with US today, he joined on November one two days ago.
As I mentioned in the prepared remarks, we've worked with for a number of years, So we know them and they get it.
Really great. When you can work with someone who fits culturally and with what you were doing when we think about the healthcare kind of vertical and industry. When we talk about actionable opportunities I think in 2021, there was <unk>.
North of yes, there were <unk> hundred I don't know.
That's exactly let's say north of 500 kind of control transactions that occurred.
Which is really an incredible number so we think at the top of the funnel. There is 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.
Anything so we're not going to go into biopharmaceutical development or medical device.
Are you either hit it and its a homerun 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 leads.
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.
<unk> 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 L. B.
Control transaction and investment like we would.
Typically consider.
I appreciate in terms of your question on when we can expect to put capital to work and have something I mean, Curt 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 we will be making a lot of contacts and has been already.
<unk> in the healthcare area.
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 its 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.
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 and monetary policy, we need to see how thats 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 health care consumer or industrial.
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 are there 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 in the add on potential add ons.
Understand that the stock markets down 20% year to date the bond market is an accommodated financing and granted they may 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 comment initiate a process right now.
Even in add on process.
Very clear thank you.
Thank you.
Ladies and gentlemen, as a reminder, should you have a question. Please press <unk>.
Star followed by the number one.
Our next question comes from Matt.
Koranda with Roth capital, Matthew Matt Matt Koranda. Your line is now open.
Okay.
Hey, guys good afternoon.
Just wanted to follow up on some of the comments made.
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, whose most prepared at the moment and 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 broadly looked at the length of the supply chain.
For each subsidiary again by subsidiary right and figure it out sort of what that meant.
If it's a.
Our business is characterized by a lot of overseas and there was a lot on the overseas just think about what that would be as far as the headwind and I think I'm going to touch on we think each of our subsidiaries is better prepared than their competitors in the 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 Mt. What we're seeing is and as we've talked to our subsidiary company. We just have to be prepared for whatever comes in the back half of 'twenty, two here and into 'twenty three.
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.
And that we're seeing a.
Certain amount of Destocking happening in Q3, and Q4 and that could bleed into early 2023, I would say and demand continues to remain relatively strong now there are pockets of weakness Europe as weak Asia relatively weak the more price sensitive shopper is weak, but where the vast majority.
40 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 and if you think.
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 is 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 into the economy, creating massive inflation and then having to reverse course, what thats 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 is inventory accumulation. It really is a question of however, our our companies preparing for a potential reduction in demand.
That could result, either from inventory destocking or a hard landing driven by the policies of the federal reserve.
And as we did in 2020 and as we did in the prior recessions and.
On the financial crisis in 2009.
We moved quickly and tried to be proactive with our companies to say look we need to be we need to pull back quickly on spending if we see that our demand isn't materializing and so there are certain things that are companies like to do for more intermediate and long term those are the things that start to get pulled back.
To the extent you have demand weakening so I would say right now and market demand for our products I want to get this across again.
At the.
At the expense of maybe being redundant and market demand for the majority of our products is really good.
But we're being cautious and we're not saying to our company.
Our management teams now is the time you need to start pulling back, but you need to be watching everything really closely and we need to be prepared to pull back and manage costs more tightly if demand starts to slow down.
The markets are suggesting even though we're not seeing it the markets are suggesting that and I would just say.
As the management team at our subsidiary management teams are all committed to being an very vigilant and on high alert right now to see which direction. The economy is going to go based on macro policies that are being implemented principally by the federal reserve.
It makes a lot of sense. Thanks for all the detail.
And then just was curious about your willingness.
Our posture towards doing any opportunistic divestitures to sort of de lever the balance sheet in the near term are 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.
The incremental load on revolvers can 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 or lower on leverage.
At a higher rate environment.
Yes, so first in terms of <unk>.
<unk> divestitures.
We know this about us everything's for sale at the right price.
So if we can find.
The right opportunity and the right buyer that find 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 or something that is value accretive to our shareholders over holding that business and that's a pretty high bar.
So it feels like a stretch.
For us to be able to achieve that in an environment that is negative and where multiples have contracted so hard I mean, we can look at a lot of public companies and heck youre seeing multiples contract $30 $40 $50, 60% and 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.
Some companies that strategically, we think make more sense than others and so we will always consider that but it doesn't seem to be a likely target right now in terms of our leverage and I can let Brian speak to this as well our target remains three and a half.
Understand we have over 70% of our total obligations fixed right now, which in hindsight now looks like a very good move we made last year. So we don't overly exposed to higher borrowing costs. Yes, we will we have a little bit of higher borrowing costs of course, because on the 30% that's not fixed those rates are going.
It was.
Dissipated most of that debt was placed for the prime aloft acquisition and so we feel very comfortable.
Prime of loss earnings and earnings growth will be able to cover any additional cost 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.
It's just simply we have been investing.
Pretty heavily into the growth of the <unk>.
The city areas and Thats, 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 of quarters and at the same time investing in businesses that continue to growth should that make sense, but we will have some I think tailwind to leverage with that conversion.
Okay excellent so 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.
Your line is open.
Thanks for taking my question sorry for jumping on late I heard the comments on <unk>, but that was really the outperformance lift relative to my numbers.
There's some seasonality with the first half of the year you mentioned with some success.
So growth in some other product categories.
What can you tell us tell us whats going on there, but yet it looks like.
$230 million into the company generating 120, plus of EBITDA 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 <unk> brand, which is the capex and so that was.
<unk> 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 in there and then beyond that there is sort of momentum in sort of the other brand adjacencies that I mentioned, so and fast pitch softball, and field and gloves, which is.
A large market and we're beginning to get some traction and so beyond that there will be sort of incremental growth I would say.
This business is characterized on the <unk> side by most of the business by a big launch every two years.
Which will drive sort of again Q3, and Q4 and then we will have other smaller launches.
And Victor side on.
And with other products.
Earlier this year, you mentioned some supply chain issues of getting the products to shelf that's cleared up.
In terms of.
With the recently.
Youll see that.
Youll see that the margin growth.
Are these sort of EBITDA growth did not keep up with revenue growth and a lot of that was driven by.
This was one of those companies that was most 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 maruti that is starting to clear up and we're starting to see margins return to sort of a more normal level now there is some margin mix right as we sell.
Lizard skins back ribs, and and as we sell gloves. This may not have the exact same margins as aluminum bats, or wood mats, but there'll be mix, 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 coatings to structure.
The intercompany debt to eliminate but its just since you own. The companies you have the debt again, just go a little bit over them that's floating rate debt.
Is it do I think of it right, where you are going to be able to take cash more cash out of the companies I know, it's for tax purposes, but might thinking about that the right way, where you could maybe fund more working capital, but not do anything to jeopardize the companys or pressure that competition, but debt service coverage ratio just walk me through that interplay within there.
The debt the cash flows that come from the company is clearly there.
Better to the insight Tony then they are using third party leveraged loans, just just go over that rising rates.
Somebody that part.
Sure So Matt.
Under that Alaska.
Okay I'll take the last.
So I would start off by saying that high level.
In the end whatever subsidiary.
Earns in free cash flow it will send the Cody.
And we'll do that because all of the management teams our.
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.
Correct and that there will be more interest expense paid but that probably means that they'll just pay a little less principal back because the interest expenses, a little higher rates, but in the end that subsidiary will send whatever cash flow. It can to Coty I think they're a little benefit that we do get those with <unk>.
Some rising interest expense at the subsidiary level, which as you said as intercompany and gets eliminated Theyre All C Corp, and they in theory will have less pretax income and pay some less taxes there.
So in theory, a little less cash goes out of the system because of that and yet stage within coty. So.
It is really tax strategy at the subsidiary level Youre correct. It all floats.
It does eliminate but I think the key message here is in the end every subsidiary Wilson as much cash as they can for whether interest expense or amortization of interest or principal payments.
So if I hear you correctly, you are different from Dakota perspective from shareholders of Coty.
Shareholders are indifferent to how you get that cash.
All in all obviously nice eliminate pay less in taxes, but in reality as you don't.
And I'm trying to take more money out of the company by raising seeing higher interest expenses internally.
No. That's correct I mean, there is an income stream to Coty, which is now reclassified as a C corp. So in theory, we have higher interest income coming up to Coty.
Our expenses that coding more than offset that interest income.
We operate in an on an annual basis in an NOL position, assuming we don't sell so theres really not a whole heck of a lot of.
Tax impact at Cody for this.
Certainly our interest expenses rising so that does that interest expense.
At.
Cody.
So those.
Those are really the dynamics affecting us here with rising rates.
Yes.
And Matt just.
Interesting.
And counter intuitive higher interest rates, because we've locked in our debt 70, whatever 72% of it or something is locked in because of that higher interest rates likely are earnings accretive to Cody and I know thats 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 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 Coty. The one is while the companies are going to have less cash taxes that are going out the door.
On the other side <unk> got a little more interest expense.
Because the debt that we locked in at Cody the amount of interest expense going out the door is less than the amount of tax savings that we ended up achieving by having our companies pay off higher interest rates and again, I know thats counterintuitive, but our cash flow actually improves margins.
<unk> in a rising interest rate our cash earnings improved 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.
Yes, it's sort of an embedded inflation I would say that yet.
That I didn't really see it first analysis see it and of course since you own the companies, but there is no in terms of debt service coverages Denver.
Obviously worried about anything you see in the broader leveraged loan market in terms of interest coverage on an issue with your company. So that's an interesting dynamic and I guess with that I mean was there any update to the net working capital capital expenditures and Lugano.
511, I know you had laid out some guidance was around 70 million last quarter, just curious an update there, but it looks like the more money you give it to more money. It makes in any any update there.
No I mean, it will be <unk>.
<unk> seen that.
As the company continues to grow we will continue to fund inventory and we monitor it.
Obviously very closely as its a large investments but the companies.
<unk> proven to be good stewards and a lot of the <unk>.
Sort of ratios that we look forward around inventory are improving or at least not getting.
So there are solid and stable and as it relates to 511 I think we are about to open a 107 store the stores proved to be a great driver of growth and profit.
We believe we will continue to do that next year.
Great guys congratulations.
Thank you Matt.
There are no further questions at this time I would now like to turn the conference back over to Mr. Sable.
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 continued support.
That concludes the call operator.
This concludes compass diversified conference call. Thank you and have a great day.