Compass Diversified (CODI) Earnings Call Transcript & Summary

Good morning, and welcome to Compass Diversified's call to discuss its acquisition of BOA Technology. [Operator Instructions] As a reminder, this conference call is being recorded, and the press release and slide presentation regarding today's announcement are available on the Investor Relations section of the company's website. The archived replay can be accessed on the CODI website following the call. I would now like to turn the conference over to your host, Matt Berkowitz of the IGB Group. Matt, you may now begin.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. On the call with me today are Elias Sabo, CEO of CODI; Ryan Faulkingham, CFO of CODI; and Pat Maciariello, COO of Compass Group Management. During this conference call, we may make certain forward-looking statements, including statements about the expected closing of the transaction with BOA Technology Inc., expected accretion and financial impact of the transaction, anticipated future performance of both BOA and CODI and statements with respect to BOA's ESG efforts. Words such as believes, expects, projects, estimates 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 discussions in our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K as well as in other SEC filings. 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. This presentation includes an estimate of accretion to 2021 cash flow available for distribution and reinvestment, which the company refers to as CAD, which is a non-GAAP financial measure. In reliance on the unreasonable efforts exception provided under Regulation G, we have not reconciled 2021 CAD accretion to comparable GAAP measures because we do not provide guidance on the applicable reconciling items as a result of the uncertainty regarding and the potential variability of these items. For the same reasons, we are unable to address the probable significance of the unavailable information, which could be material to future results. With that said, I will now turn the call over to CODI's CEO, Elias Sabo.

Good afternoon, everyone. We are excited to announce that CODI has entered into a definitive agreement to acquire BOA Technology Inc., creators of the award-winning BOA Fit System featured in performance footwear, action sports, outdoor and medical products worldwide. This transaction represents our second platform acquisition in 2020 and our 21st platform acquisition since coming public in 2006. As a reminder, we remained patient and disciplined in 2018 and 2019, consummating only one platform acquisition in early 2018 and refraining from completing another platform acquisition for over 2 years. During this time, we took advantage of market conditions and sold 2 of our businesses, using the proceeds to strengthen our balance sheet. Further, as you may know, during the second quarter, we strategically accessed the capital markets and raised approximately $290 million of additional capital. Our balance sheet was already strong, and this capital raise provided CODI meaningful financial flexibility to execute on growth opportunities. Our capital allocation strategy, conservative balance sheet management and permanent capital model put us in position to capitalize on the current market dislocation at a time when our peers struggle to secure the debt financing necessary to close transactions of this ilk with the certainty that sellers are seeking in this uncertain market. We believe this transaction is compelling on a number of levels for CODI. But before we dive into the specifics, we would like to show you just a little bit about what makes BOA such an incredible company. Please refer to Slide 3 for a short video about BOA. [Presentation]

I'll now turn it over to Pat to go through some additional details about BOA.

So at CODI, we are focused on partnering with niche market-leading brands, and BOA is exactly that. BOA was founded in 2001 with a revolutionary performance fit system that transcend how snowboarders dialed in and offered a superior alternative designed to address the deficiencies found in traditional closures. The company's rotational dial-based system has eliminated the need for laces, buckles or straps and provides a simple, better solution. With just one hand, users can get unmatched precision and micro-adjustability, offering a fast, effortless precision fit that improves performance for elite athletes and enthusiasts alike. Over the past nearly 2 decades, the BOA Fit System has become the leading performance fit solution integrated into market-leading, well-known premium brand partner products. Though the company got its start with a focus on transforming snowboarding products, the team has successfully established industry-changing solutions across an array of segments, including mountain, athletic and professional, bringing better performance to countless products for the benefit of the consumers. While BOA is headquartered in Denver, along with its new state-of-the-art Performance Fit Lab, it is truly a global organization with operations in Austria, China, Japan and South Korea. We estimate that approximately 75% of its products are used in end markets outside of North America. Importantly, BOA has established itself as a strategic and trusted partner to many leading brands around the world. As of today, more than 400 highly collaborative global brand partners have integrated BOA Fit Systems into their performance footwear, headwear and medical bracing products. BOA's edge in the market and commitment to innovation has only sharpened as the company has grown, which is evidenced by its diverse intellectual property portfolio that consists of nearly 160 global patents with 85 more currently pending under review. This is a clear competitive advantage, creating a significant barrier to entry and helping to protect its best-in-class product innovation. Today, the company is uniquely positioned to expand its category leadership and grow its share of a large addressable market, which brings us to the strategic rationale behind the transaction. As we've said before, we continue to see a real opportunity to strategically enhance our portfolio with rapidly growing companies in the branded consumer space. Today's announcement as well as our recent acquisition of Marucci, another well-known, respected and aspirational brand, reflects our commitment to the investment criteria we have long prioritized. Highly defensible market positions, favorable long-term macroeconomic trends in the market in which the company operates, strong margins and minimal CapEx requirements and low technological or product obsolescence risk. We believe BOA is an ideal addition to our diverse holdings and will benefit from our significant experience helping companies in the outdoor and athletic industries grow across channels and execute their strategic priorities, similar to 5.11, Velocity Outdoor, Liberty Safe and, previously, CamelBak and Fox Factory. At the end of the day, there are 3 reasons we are excited about BOA. First, the ability to increasingly capture share within a large addressable market. Today, the segments and price lanes in which BOA operates see an estimated 700 million pairs of footwear sold globally each year. However, current sales of systems represent under 3% of that market or 16 million to 17 million pairs annually. This leaves a tremendous amount of white space for BOA to capitalize on. Second, the opportunity to continue to drive innovation and expand the barriers to entry mentioned earlier. BOA's proprietary technology and the company's new state-of-the-art Performance Fit Lab in Denver are clear differentiators in the marketplace. Protected by nearly 160 patents, the team is pioneering new ways to advance human performance through independent scientific studies, hands-on research and biomechanical testing to quantitatively define and measure the impact of the BOA Fit System on athletic performance. With a focus on agility and speed, power and precision and overall endurance and health, BOA is continually pushing the limit of what is possible for the benefit of casual, serious and professional athletes alike. As you can see on the slide, initial testing has shown statistically significant performance improvements, and the company is continuing to pursue peer-reviewed white papers that further underscore and validate those results. And third, BOA has an incredibly talented and growth-oriented management team. We have spent significant time over the past few months getting to know BOA's CEO, Shawn Neville, and his team around the world, and we could not be more impressed by their leadership or clear vision for the future of BOA. We look forward to this partnership and the opportunities ahead to build on the company's momentum. With its revolutionary products, broad and diverse portfolio of intellectual property, large and growing addressable consumer market and proven management team, we see significant upside in the BOA business. And we think our operational expertise and resources will prove invaluable as we work to grow and build sustainable, long-term success at BOA. Now I'd like to turn it over to Ryan to give a brief overview of the details and financials of the company and transaction, which you can see here on Slide 6.

Thanks, Elias. BOA has an exceptional financial profile and has experienced rapid growth over the past several years. As Elias discussed, we see a clear opportunity to build on this momentum and expect to deliver continued profitable growth. Over the past year, revenues have exceeded $100 million with approximately $300 million of adjusted EBITDA. BOA's EBITDA margins are around 30%. It benefits from low capital expenditures, about 4% of sales, and the company has negative working capital. From 2017 to 2019, the company's revenue CAGR, or compounded annual growth rate, was around 18%, reflecting consistent strong growth. Like many consumer-focused companies, BOA's 2020 financial performance has been negatively impacted by COVID-19. With that said, 2020 financial metrics are currently tracking to be roughly flat against 2019 numbers as the company has expertly navigated the initial impact and continues to be well positioned. We believe that products with a BOA system have performed better than the overall end markets they sell into. Turning to the transaction itself on Slide 7. CODI has agreed to purchase BOA for a total of $454 million. This excludes working capital and certain other adjustments upon closing, and we expect to close the transaction on or before October 31. As part of the transaction, the BOA management team as well as BOA's former 2 larger shareholders will roll over approximately $62 million and will become approximately 18% equity owners in the BOA business. Additionally, CGM, our manager, will reduce its management fee on BOA assets by 50% through the end of 2021, equivalent to approximately $5.7 million in savings to CODI. We estimate the transaction to be approximately $10 million accretive to CAD for the full year 2021. Now I'd like to provide a quick overview of the structure of the financing for the transaction on Slide 8. CODI will finance the transaction with a mix of available cash on hand, approximately $100 million, and by drawing around $300 million from our revolver. That will leave us with approximately $300 million in availability on our revolver moving forward. In addition, we have the option to upsize our revolver availability by $250 million. Further, we have no debt maturities until 2023. Adjusted EBITDA for the trailing 12 months ended June 30, 2020, if we include BOA's and Marucci's results prior to our ownership is approximately $276 million. Total outstanding indebtedness after we close on BOA will be approximately $900 million, bringing total leverage to approximately 3.3x. Now as we move on to Slide 9, just a few notable points on how the transaction came together over the past few months. Prior to the onset of COVID-19, we met with Shawn and the BOA team in advance of the launch of a formal process. Our team stayed in contact with the company's advisers, and after the economy began to reopen in parts of the U.S., we pursued a negotiated transaction in earnest. Throughout the process, our permanent capital model has proven to be a distinct competitive advantage. By funding deals off our balance sheet rather than relying on third-party capital, we have certainty of financing and increased visibility to closure at a time when other industry players have struggled with debt financing due to market uncertainty. Earlier this month, we were awarded exclusivity to pursue the acquisition. And despite the challenges presented by the pandemic, we were able to complete the due diligence process across the full business and its functions, including accounting, legal and other key operational divisions, both in person and virtually. I'll now turn it back over to Elias to discuss how we transformed CODI's portfolio in recent years.

Thanks, Pat. Now taking a step back to the CODI level for a minute, I want to reflect on the composition of our portfolio, which has changed dramatically in just the last 2 years. In 2019, we capitalized on favorable market conditions to opportunistically divest our holdings in Clean Earth and Manitoba Harvest at attractive valuations and use the proceeds to repay debt and strengthen our balance sheet. As the COVID-19 pandemic spread across the U.S. and the world, it created a market dislocation that presented us with attractive opportunities to leverage our permanent capital base. As we conveyed earlier this year and earlier in the presentation, we have since pivoted to a more aggressive acquisition strategy, intending to use our strong balance sheet position to acquire and partner with best-in-class companies. As a result of these strategic moves, CODI now added 2 highly aspirational and rapidly growing consumer businesses to our portfolio this year, Marucci and BOA, and in turn, achieving a faster core growth rate and a multiple arbitrage, netting roughly $100 million in added capital while retaining essentially the same cash flow to holdings. Further, with these acquisitions, we have increased our branded consumer EBITDA concentration to over half the portfolio. And despite the negative impact of COVID, on a pro forma basis as if we owned Marucci and BOA since January 1, 2019, we estimate our branded consumer EBITDA would have increased by approximately 7% on a year-over-year basis in the first half of 2020. Now flipping to Page 11. Here, you can see the capital allocation breakdown, which shows the recent changes in our portfolio. As you can see, we sold Clean Earth and Manitoba Harvest for net proceeds of $711 million. We are acquiring BOA and Marucci together for $590 million and expect that they will contribute similar levels of cash flow to CODI as the recent divested businesses did on a comparable basis with significant upside and growth opportunities as described today. Before we turn it over for questions, I just want to reiterate: we could not be more excited about the compelling strategic and financial benefits of this transaction and our team's unwavering commitment to executing on our acquisition strategy amid heightened uncertainty. Not only does BOA meet our strict investment criteria, but consistent with our commitment to ESG and conducting our business in a socially responsible and ethical manner, BOA has placed a strong focus on being a good corporate citizen and doing good for its communities and the environment. As just one example, so far in 2020, BOA has implemented packaging redesign and material changes to reduce overall virgin plastic usage and is on track to cut virgin plastic use by 50% as a percent of total volume and utilize recycled materials at 100% of its packaging by 2026. CODI's differentiated model has proven resilient, and looking ahead, we remain focused on protecting our employees across our subsidiaries and the communities in which we operate while partnering with subsidiary management teams to navigate the ongoing impacts of the pandemic and position our companies for long-term success. We very much look forward to welcoming the BOA team to the CODI family, and I am confident that, together, we will capitalize on the many opportunities that will benefit BOA stakeholders and CODI shareholders alike. With that, I would like to open the line for questions. Operator?

[Operator Instructions] Your first question comes from Larry Solow with CJS Securities.

Just a couple of quickies just on -- from a high level. So certainly, you guys are very experienced with brand names and leaders. This one's a little different in that you don't really have, I guess, a consumer-facing brand. It's more selling to the OEM, right? So with suspension for FOX, I came in looking for a bike with FOX. Do I come in looking for a shoe with BOA? Or does it just happen -- so happen that a good shoe has BOA on it? So is that a little bit of a different marketing strategy, I guess? And how do you sort of look at that?

Yes. Larry, it's Elias. I would say we look at BOA very similar to Fox Factory in that these are component products that are sold to OE partners similar to the way that FOX was. And very similar with FOX, people would come in and look for FOX to be specked on their bake, and they would ask for that. I would say probably not quite as much of the time does BOA get requested specifically, "I want the BOA system," but it happens a lot. And I would say this is earlier kind of in its evolution than FOX was when we acquired the company. And if you look at a category, for example, and I would say take snowboard where within the price lanes and in that specific category, we have very strong market share, kind of north of 50% of the addressable market because the product originated there. In that category, when we did our diligence checks, what we heard is people will specifically come in and say, "I only want to look at boots that have the BOA system on them." So I think as the categories mature and people get more familiarity with the simplicity of the closure system, the performance benefits that they receive from the closure system, they then go in and they ask for it. And so again, really strong parallel to FOX. I would say where the parallel isn't so strong and what makes BOA such an exciting opportunity is the TAM is just so dramatically larger here. We think we're really early in terms of this product getting into the marketplace. We talked about being kind of 3% or less of the addressable market right now. We think there's huge runway. So a lot of similarities to FOX, but I think probably a much stronger and larger TAM to address.

And just a follow-up to that is -- so obviously, these guys have been around for, I think, about almost 20 years. And you mentioned growth close to 20% the last 3 years, so probably an acceleration in the last few years. What's sort of driven that acceleration? And you mentioned most of the majority of sales are outside the U.S., although it looks like a lot of the brands themselves are global. So what is -- is there any reason why there's been much greater sales ex U.S. than U.S.?

Yes, I mean, a couple of things. I think there's a -- in certain categories, there's a premium nature that the price points go higher sort of in Asia and other categories. Golf is one example I'd point to. And that has driven -- the company has a lot of market share in the area in Asia as far as what's driven growth. It's been across the board. I'd say cycling has been strong and has been a strong growth driver over the last 4 or 5 years, and the company has some great partners in the cycling sector that has helped drive growth. But broadly, it's been across the board.

Your next question comes from Kyle Joseph with Jefferies.

Congrats on an exciting acquisition, and I appreciate all the color you've given us in the slide. It's very helpful. Looking at Slide 11, I think you guys do a good job detailing how you essentially really replaced the economics of the 2019 sales with the 2 acquisitions there. But -- so stepping back on the heels of 2 acquisitions so far in 2020 and where the balance sheet is, can you give us a sense for your appetite for further acquisitions or sales?

Yes. I think, Kyle, we're -- first, thank you for the kind words to start, and good afternoon as well. I think we're looking to be more of a net investor, and we've been saying that all year. I'll just step back, and one of the things we want to highlight in addition to changing the composition of the portfolio, I think we were very fortunate on our timing in that we sold at kind of the end of the last up cycle. And now that earnings are compressed across most companies due to a pandemic, we think now is a great time to be putting money to work. And we don't know how long that window is going to stay open and available to us. But typically, when our peers are struggling to get financing, especially in the debt capital markets, those proved to be really good times for us to be able a deployer of capital. So we are open for business. We are aggressive obviously for the right assets when we see really high-quality, great growth, very defensible businesses like Marucci and BOA, and we'll continue to look for those. Now we're always balancing kind of what our balance sheet, where we're at, where our leverage is. We're at 3.3x pro forma for the -- we have been higher in our history. And we think we're kind of near the bottom of the cycle, not near the top. So it does give you a little bit more confidence. And directionally, that earnings should be growing and naturally deleveraging, right? And so we think we still have balance sheet capacity. I would say there is -- depending on how the markets over the next 12 to 24 months, how they change, I would say there is appetite for some of the portfolio probably to continue to rotate. We've said we are looking to kind of change to slightly larger businesses within the portfolio. That strategic decision -- or strategic kind of rationale continues to be out there. So I would say that we continue to look to be active here, but we would be likely -- I think of it as are we net acquirers, net divesters or sort of net neutral? I would say where we are in the cycle today, we still look at being net investors as being the best way to enhance and create value for our shareholders. And we think given the cycle kind of being near the bottom, maybe at the bottom and starting to turn up, now is a great time to be doing that, and we'll get natural deleveraging with kind of earnings growth. And with a faster core growth rate in the portfolio, one of the things we really wanted to emphasize is that what we divested versus what we brought in, we fully expect that these companies we've acquired are dramatic -- pretty significantly faster growth businesses than what we sold. And so as a result of that, we think we have just better core growth prospects, and that adds to our confidence of natural deleveraging of the balance sheet and the ability to kind of use our balance sheet a tad more aggressively than maybe we have in the past.

Got it. That's really helpful. And then one more for me, kind of a 2-part question, but you guys talked about how the business has struggled a bit in COVID, and that's not terribly surprising. But just flipping through the deck, there's a lot of pictures of socially distant activity, whether it's golf, hiking, biking and whatnot. And so can you walk us through the impact of COVID? And have you seen -- actually seen some tailwinds in certain merchandise categories? And then second to that is, do you have any sense for how much e-commerce represents in terms of their sales?

Yes. So first, clearly, there are segments that you're seeing an uptick in if you think about our sales -- I mean if you think about the outdoor sort of activity. If you think about our sales though, there's a long lead time, right? And so we'll ship them. So it's not the direct bike store selling out. We would have made that product 6 months ago, right? And so we haven't -- that's not necessarily in these numbers as much. There's a little bit of it but not as much. A lot of it has to do with sort of, in Q2, everything just sort of stopped. And in Q2, when we were all on lockdown here nationwide, everything just sort of stopped, and honestly, orders for the company did, too. And so that was a big driver of kind of the flatness from last year to this year despite our belief -- our strong belief that this is a growth company and will continue to grow as it has done historically. With regards to sort of the e-comm piece, that's all based on our partners by industry. And the largest, footwear, everybody will -- the snowboard e-comm will differ from the athletic wear e-comm, which will differ from the golf e-comm. So we don't have that data, and we don't track that data.

[Operator Instructions] And your next question comes from Robert Dodd with Raymond James.

Congrats on a very interesting acquisition. If I can ask a question about kind of synergies, and not that that's something you typically focus on with your portfolio companies, but when we look at it, Marucci Sports obviously doesn't make shoes right now, but I can't find a baseball cleat on the market that has a BOA system. And if there's performance enhancements, that would obviously make sense. If we look at 5.11, they do make shoes. None of them involve the BOA system today. There are obviously other things like helmet retention systems for law enforcement, et cetera, et cetera, et cetera, that 5.11 could be involved in. So is it -- was any of this -- or what -- first, what should be expectations of the potential synergies between the different businesses within CODI given that there does seem to be some fairly compelling overlap between what various components of your businesses can do in relation to BOA?

Yes, Robert, it's a great question. Let me first say this company and its prospects stand on its own merits. And if we had no synergy potential at all, we would say this is one the most exciting acquisitions that we've seen. Collectively, when I talk to our team here, we all said this is one of the most exciting opportunities that we've seen. The fact that's it's creating true differentiation to the end products that it goes on and it's really early in a massive addressable market, I mean these kind of opportunities -- now obviously, we got to execute against that. But these kind of opportunities don't come around all that often, which is why the enthusiasm is so high. So I just want to clear that even without any type of synergies within our portfolio, this acquisition is, in our mind, an A+ opportunity that we were able to sign up. In terms of how we look at it integrating into our portfolio, what you mentioned is 100% correct. I mean 5.11 has a lot of different footwear in their line. Tactical is an area that BOA already has some product in. And so whether it be in helmets or whether it be in footwear that we already have, that is a natural to be able to incorporate that. Now there is a certain level of R&D that has to take place. These systems, what we -- I hope what comes across is that this is not just about convenience. It's not just not having to tie your shoe. You have something convenient to be able to dial it. This imparts actual performance improvements. And as a result of that, we actually have to do quite a bit of design and testing with our OE partners. So what we plan on doing is bringing together companies that would have opportunities to incorporate the BOA system either into existing products that they have, like 5.11 or potential new products that they could go into. But then from there, I would just say the time line to be able to get a product that's going to impart the type of the performance improvements that BOA drives in each of its products, that's going to take a little bit of time. That could be a kind of a year time line. And so we'll be working on that. But I do believe there are some really great opportunities where BOA can gain additional sales funnel opportunities, right, within our portfolio. But then our companies in the portfolio can see significant benefits. And I will tell you, when BOA goes on a product, that product typically moves up significantly in terms of its market share because as people get exposed to it -- like if you are in Asia right now and in Japan, the vast majority of people who are golfing wear products with the BOA system. So when it started, it didn't have that much. We went on with one of our OE partners. That OE partner took tremendous amounts of share. So those opportunities exist in the portfolio, too. It's with every -- with all of our OE partners, but we think there's great synergies amongst our companies as well.