Compass Diversified - Q2 2022
August 3, 2022
Transcript
Operator (participant)
Good afternoon, and welcome to Compass Diversified's second quarter 2022 conference call. Today's call is being recorded. All lines have been placed on mute. If you would like to ask a question at the end of the prepared remarks, please press the star key, then the number one on your touch-tone phone. At this time, I would like to turn the conference over to Cody Slach of Gateway Group for instructions and the reading of the safe harbor statement. Please go ahead, Sir.
Cody Slach (Senior Managing Director and Director of Investor Relations)
Thank you, and welcome to Compass Diversified's second-quarter 2022 conference call. Representing the company today are Elias Sabo, CODI's CEO, Ryan Faulkingham, CODI's CFO, and Pat Maciariello, COO of Compass Group Management. Before we begin, I'd like to point out that the Q2 2022 press release, including the financial tables and non-GAAP financial measure reconciliations, are available at the investor relations section on the company's website at compassdiversified.com. The company also filed its Form 10-Q with the SEC today after the market closed, which includes reconciliations of non-GAAP financial measures discussed on this call, including adjusted EBITDA and adjusted earnings, and is also available at the investor relations section of the company's website. Please note that references to EBITDA in the following discussions refer to adjusted EBITDA as reconciled to net income or loss from continuing operations in the company's financial filings.
The company does not provide a reconciliation of its full-year expected 2022 Adjusted earnings or Adjusted EBITDA because certain significant reconciling information is not available without unreasonable efforts. Throughout this call, we will refer to Compass Diversified as CODI or the company. Now allow me to read the following safe harbor statement. During this call, we may make certain forward-looking statements, including statements with regard to the future performance of CODI and its subsidiaries and statements related to the impact of CODI's updated tax structure and the impact and expected timing of acquisitions and dispositions. Words such as believes, expects, plans, projects, and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions.
Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements, and some of these factors are enumerated in the risk factor discussion in the Form 10-Q, as filed with the SEC for the quarter ended June 30th, 2022, as well as in other SEC filings. In particular, the domestic and global economic environment is currently impacted by the COVID-19 pandemic and related supply chain and labor disruptions, has a significant impact on our subsidiary companies. Except as required by law, CODI undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. At this time, I'd like to turn the call over to Elias Sabo.
Elias Sabo (CEO)
Good afternoon, everyone, and thanks for joining us today on our second quarter 2022 conference call. I am pleased to report that we continued our strong momentum in the second quarter of the year as we recorded our sixth consecutive record quarter and our sixth straight quarter of double-digit increases in pro forma consolidated subsidiary Adjusted EBITDA, once again enabling us to raise our 2022 outlook. We're extremely pleased with these results, particularly given the macroeconomic headwinds that all companies are facing today. We again need to acknowledge the skill and agility of our management teams and employees. Each day it seems they wake up to face a new issue stemming from inflation or a new supply chain disruption, and each day they put forth extraordinary effort and adjust.
In our last several earnings calls, we discussed our strong execution against a tough macro environment, and this quarter was certainly no different. Though inflation may be just starting to crest and there has been some improvement in certain pain points of the supply chain, we remain guarded, as inflation will likely remain at elevated levels for some time, and slight improvements in the supply chain could reverse quickly. During the quarter, we again delivered double-digit sales growth in both our branded consumer and niche industrial businesses. Our growth this quarter was led by BOA Technology and Lugano Diamonds, which each had excellent quarters. BOA produced record quarterly revenues and over $24 million of EBITDA, nearly reaching its record Q1 figure.
We mentioned last quarter that one component of BOA's growth could be due to the elongation of the supply chain and that some demand could be the result of pull forward from future quarters. Though this dynamic did not impact the company's stellar performance in the second quarter, we do believe that BOA's growth rates will slow somewhat in the second half of the year from these torrid levels. It's our expectation, however, that the company will continue to show growth due to its exceptional technology, low penetration in existing markets, and planned expansion into new markets. We believe Lugano continues to offer its customers a better value proposition than other ultra-high-end jewelers.
In addition, the company has benefited from geographic expansion and CODI's continued inventory investments following our acquisition late last year. Due to these investments and the hard work of the Lugano team, EBITDA has grown by over 60% in the year-to-date period. Overall, we once again did an extraordinary job of growing while preserving margins. In fact, in the second quarter, our consolidated pro forma adjusted EBITDA margin actually expanded slightly versus the second quarter of 2021. Though we anticipate continued economic headwinds could impact our margins going forward, we believe our subsidiary's strong competitive position and exceptional management will continue to allow us to outperform our competitors in this challenging environment. Before I turn the call over to Pat, I want to address the closing of our PrimaLoft acquisition and the refinancing of our $1 billion bank facility, both of which occurred subsequent to Q2.
We are excited about what PrimaLoft adds to the CODI family of companies. We believe the company possesses significant intellectual property, strong growth prospects, and a world-class management team. Equally as important, though, their commitment to sustainability and their position as an enabler of growth of sustainable apparel is very much aligned with CODI's commitment to responsible growth and a good example of how we wanna operate our business. As part of this transaction, Compass Group Management will waive approximately $5 million of management fees in the first year of ownership. Separately, our refinancing, which we completed simultaneously with the PrimaLoft transaction, both expanded CODI's capital base and increased our financial flexibility. This enabled a further reduction in our blended cost of capital, which we believe is a key to creating long-term shareholder value. With that, I will now turn the call over to Pat.
Pat Maciariello (COO)
Thanks, Elias. On a combined basis, revenue and pro forma subsidiary Adjusted EBITDA in both our branded consumer and niche industrial businesses grew meaningfully and continued to exceed our expectations. For the quarter, as Elias mentioned, EBITDA growth exceeded revenue growth as we were able to increase margins slightly. Our businesses continued to perform admirably throughout this unprecedented period. However, several of our companies who sell to retailers focused on mass channels did face pressure as consumers in that segment continued to be impacted most acutely by inflation. Nevertheless, our management teams continued to execute for their customers and employees and were able to drive considerable growth as a whole in this difficult environment. Now, on to our subsidiary results. I'll begin with our niche industrial business.
For the year-to-date period, revenues increased by 16.8%, and adjusted EBITDA increased by 16.4% versus the year-to-date period of 2021. Arnold and Altor once again posted meaningful revenue and adjusted EBITDA growth, driven by solid execution and stronger than expected demand. Arnold continues to benefit from investments made over the last several years in technology and infrastructure. Though the company will be comping against a very large defense-related order in the back half of this year, we are continuing to see strength in bookings and believe the company will have solid performance in the remainder of the year. Altor had solid growth, partially driven by its acquisition of Plymouth Foam in the fourth quarter of 2021.
Though margins continue to be pressured by higher raw material costs at Altor, our expectations are that these margin levels should improve in the back half of the year. Turning to our consumer businesses. For the year-to-date period, revenues increased by 13% and pro forma adjusted EBITDA increased by 11.8% as compared to the same period in 2021. Demand for BOA's performance fit systems continued to exceed our expectations. The company's revenue increased by over 44% in the year-to-date period and it delivered just under $50 million of adjusted EBITDA in the first half of the year. As Elias mentioned, we believe BOA's growth will moderate in the back half of the year from these elevated levels, though we anticipate continued growth. Lugano grew pro forma adjusted EBITDA by over 60% in the year-to-date period.
We continue to see a strong correlation between inventory purchases and revenue, and we'll continue to support Lugano, and we look forward to the anticipated opening of two new salons this year in Houston and Newport Beach. As mentioned last quarter, Marucci did not have a significant product launch in the second quarter of 2022 like it did in the corresponding quarter of 2021. As such, it experienced an expected decline in EBITDA. In Q3 of this year, however, Marucci is launching the highly anticipated CATX line of bats. Though it's early, the company is seeing significant demand from both customers and its retail partners, and we're excited about the launch and the product. Touching briefly on 5.11's performance to date. For the year-to-date period, revenues increased by 6.7%, and adjusted EBITDA was approximately flat versus the same period in 2021.
We feel that this is strong performance in the face of supply chain challenges and very difficult retail and wholesale environments. We believe the company's diverse channel mix as well as its strong brand, loyal consumer base, and experienced management team is allowing it to continue to outperform its competitors. Turning to Velocity. As mentioned in our prior earnings call, Q2 represented a very difficult comparable period for the company as retailers continued to replenish inventory levels in Q2 of 2021. We have seen just the opposite so far in 2022 as inventory levels in the mass channel are being reduced materially, sometimes regardless of product performance.
Though we are confident in the team in place and the strategic steps they are taking to ensure future success, we anticipate the back half of the year will be somewhat challenging. As a whole, we are very pleased with the performance of our businesses in the second quarter. We are optimistic about the remainder of the year. However, we remain very aware of the potential macroeconomic headwinds and will adjust as needed. I will now turn the call over to Ryan for his comments on our financial results.
Ryan Faulkingham (CFO)
Thank you, Pat. Before I get into our financial performance, I wanted to make a few comments on Advanced Circuits as well as our Adjusted EBITDA calculation. First, ACI. As you are aware, we announced the termination of the ACI sale last week. As a result, we expect to reclassify ACI from held for sale to continuing operations in our third quarter reporting. In addition, since its operating results will be reclassified to continuing operations, Cody will get the benefit of ACI's earnings contribution to our non-GAAP adjusted earnings metric from January 1, 2022. Therefore, our guidance, which I will discuss later in my remarks, has been updated to reflect ACI's full year of adjusted earnings contribution. Now on to the Adjusted EBITDA calculation. Effective this quarter, we are no longer adding back management fees to our Adjusted EBITDA calculation.
The impact of this change is a reduction in consolidated Adjusted EBITDA by $14.9 million in the current quarter, which were the total management fees expensed in the quarter. Of this $14.9 million, $1.5 million was incurred by our subsidiaries. Please note that this amount excludes ACI as it was in discontinued operations at June thirtieth. As you'll hear in our consolidated subsidiary Adjusted EBITDA guidance shortly, we have updated it to reflect this calculation change. In addition, our current year reporting periods and prior year reporting periods have been adjusted to reflect that management fees are no longer added back to Adjusted EBITDA. For clarification, this calculation change has no impact on our Adjusted earnings calculation since all management fees are deducted.
Moving to our consolidated financial results for the quarter ended June 30, 2022, I'll limit my comments largely to the overall results for CODI, since the individual subsidiary results are detailed in our Form 10-Q that was filed with the SEC earlier today. On a consolidated basis, Q2 revenue was up 19% to $515.6 million, compared to $431.5 million in the prior-year period. This increase primarily reflects the company's acquisition of Lugano in September 2021, as well as the strong double-digit growth from BOA, Marucci, Arnold Magnetics, and Altor Solutions. Consolidated net income for the quarter was $31 million, a significant increase compared to an $11.3 million loss in the prior-year quarter.
As a reminder, Q2 last year included a $33.3 million loss on debt extinguishment in connection with the redemption in April 2021 of our 8% senior notes due 2026. As introduced earlier this year, we believe adjusted earnings, a non-GAAP financial measure, metric, will allow investors to assess our operating performance in a more meaningful and transparent way. Adjusted earnings for the quarter was $39.3 million, up $11.4 million, or 41% 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. Turning to our balance sheet. As of June 30, 2022, we had approximately $102.7 million in cash, 0 drawn down on our revolver, and our leverage was just below 3x.
Of note, the manager once again waived fees on cash balances held at CODI as of June 30. Subsequent to the quarter, we purchased PrimaLoft for a $530 million enterprise value. We funded our portion of the purchase price of approximately $495 million with the proceeds from a new $400 million Term Loan A and a draw on our revolver. At the same time, we amended our senior secured credit facility to provide additional flexibility and extend the maturity of a revolver to coincide with maturity of this new Term Loan A, which is July 2027. Pro forma for this transaction, our leverage would be approximately 4x and our liquidity would be over $500 million.
As you can see, we have substantial liquidity, and as previously communicated, we have the ability to upsize our revolver capacity by an additional $250 million. With this liquidity and capital, we continue to be well-positioned 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. During the second quarter of 2022, we used $1.8 million of cash flow from operations. Our cash earnings during the quarter were able to fund our working capital needs, which were primarily directed towards our strategic inventory investment at Lugano. Inventory levels at all our companies are a significant focus of our management teams in this difficult economic environment, and we are monitoring levels to ensure we meet consumer demand without a negative financial impact.
Finally, turning to capital expenditures. During the second quarter, we incurred $14 million of CapEx on our existing businesses compared to $8.8 million in the prior year period. The increase was primarily a result of the continued retail store expansion at our 5.11 subsidiary. For the full year of 2022, we anticipate total CapEx spend of between $55 million and $65 million. We have incurred $24.4 million year to date, and the spend we expect in the second half of the year will be primarily at Lugano for its expanded headquarters and new retail salons and at 5.11 as we continue to increase its retail store count from its current 94 stores. Now on to our Adjusted EBITDA and adjusted earnings guidance.
Despite our excellent performance in the second quarter, we remain in uncertain times driven by market volatility, the two quarters of GDP contraction that was recently reported, inflationary pressures impacting consumer behavior and labor market shortages, amongst others. However, as a result of our company's strong performance in the second 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. Now there are a number of factors impacting this revised guidance, so I'd like to clearly discuss each. As you are aware, our previous guidance range of 2022 full-year consolidated subsidiary Adjusted EBITDA was $410 million-$430 million.
We are now including PrimaLoft into our guidance range by adding $30 million of adjusted EBITDA at the bottom end of the range and $35 million at the top end of the range. This would move our guidance range to $440 million-$465 million. As I mentioned earlier, we are no longer adding back management fees in the calculation of adjusted EBITDA, and therefore, our consolidated subsidiary adjusted EBITDA range would come down by roughly $8 million at the top and bottom ends of the range. This would move our guidance range down to $432 million-$457 million. Finally, because of our strong Q2 performance, we are increasing this revised range to between $445 million-$470 million.
At the midpoint, this is a $13 million raise due to strong Q2 performance and implies 10% year-over-year growth. Next, I'd like to discuss adjusted earnings. As I mentioned earlier, because of the ACI sale termination, we are adding their full year 2022 results into our revised adjusted earnings guidance. In addition, we are raising our adjusted earnings guidance range because of our strong Q2 performance. Offsetting these increases is a slight reduction in our adjusted earnings guidance range for the acquisition of PrimaLoft as it generates its strongest earnings in Q1 and Q2, given seasonality of ordering for the outerwear industry. As a result of these items, our revised full-year adjusted earnings guidance range will move from our previous range of $120 million-$135 million, upwards to $130 million-$145 million.The midpoint of our adjusted earnings range implies a 7% increase from prior year. With that, I will now turn the call back over to Elias.
Elias Sabo (CEO)
Thank you, Ryan. I would like to close by briefly providing an update on the M&A market and on our ESG related activities in the quarter. M&A activity remains somewhat below historic levels, though it has picked up slightly in the second quarter. Potential sellers remain somewhat hesitant to begin processes given the economic headwinds and the macro backdrop. We anticipate activity continuing to increase modestly in the back half of the year if these headwinds start to moderate. On the ESG front, we have had a productive quarter developing and implementing our mission, vision, and values in an effort to strengthen our corporate governing purpose. It is our goal to continue to build and strengthen our culture of trust, transparency, and accountability necessary to deliver long-term results.
Our MVV process has enabled the creation of a clear pathway for the growth of our ESG framework, which has been strategically developed to deliver in environmental and social focus areas underpinned by good governance. We expect to have the Compass ESG framework formally approved by the CODI board of directors in the next quarterly board meeting, and it will be publicly shared upon board approval. In addition, we are developing a set of core metrics and minimum standards to be tracked by each CODI company to enable consistent subsidiary measuring and reporting to enable us to develop accurate metrics for continual improvement. Our longer-term goal is to be able to integrate impact reporting into our public disclosures. Lastly, we are continuing to develop policies and programs that create an inclusive and healthy working environment that inspires people to do their best.
Our focus towards diversity of people and thought has introduced new perspectives, skills, and approaches to problem-solving that enhances our strategic and operating capabilities. We believe that this focus is an indicator of a commitment to building a high-performing, purpose-driven workforce and inclusive culture. In this last quarter, 50% of our new hires at Compass Group Management have come from diverse backgrounds, and we recently added one new female board member, as we're pleased to announce the appointment of Teri Shaffer to our board of directors on July second. In conclusion, it was a great quarter for CODI. Relative to our expectations, our performance was once again outstanding.
As gross domestic product shrank for the second consecutive quarter, we once again grew revenue and Adjusted EBITDA by double digits. Our management teams and employees continue to put forth incredible effort, and I'd like to give thanks and recognition to all of them. With that, operator, please open up the lines for Q&A.
Operator (participant)
Thank you. 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 Cris Kennedy, William Blair. Please go ahead.
Cris Kennedy (Research Analyst)
Yeah, good afternoon, and thank you for taking the question. Elias, you guys have been acquiring faster-growing businesses over the last couple of years. Can you just talk about the long-term growth profile of Compass today versus maybe two or three years ago?
Elias Sabo (CEO)
Sure, Cris, good afternoon to you, and thank you for the question. You know, we have—if you look back over the last few years, and if I go back to pre the pandemic in 2019, if you remember, we sold a couple of businesses, one of which was, you know, relatively slower-growing and cleaner. Very good business, but, you know, kinda grew at GDP. Then in 2021, we sold another business, Liberty Safe, which was, you know, also a relatively slow growth business. Through the sale of those businesses and then the acquisition of BOA, Marucci, Lugano, and now PrimaLoft, you know, what we've seen is the portfolio composition has changed really dramatic with respect to our core growth rate.
You know, I would say before, we used to talk in the context of we are a, you know, slightly stronger than GDP growth company. Now we believe we're, you know, kind of a high single digit, you know, type growth company, you know, potentially a low double-digit growth company at the adjusted EBITDA line. That's a subsidiary adjusted EBITDA, you know, pre the deduction of management fees. You know, just to be clear here, Cris, you know, as we've defined new adjusted earnings metrics, you know, we do get quite a bit of leverage on growth. Our management fees, as you know, principally don't grow unless we do acquisitions.
If we think Adjusted EBITDA at the subsidiary level is growing kinda high single digits%, there's a leveraging up of, you know, kind of the corporate EBITDA, which deducts management fees because that expense stays flat. As you further know, we locked in all of our debt prior to the increase in debt rates that happened, you know, at the beginning of this year. $1.3 billion of our debt in the bond market is locked in at 5% and 5.25%, respectively. Now we have just, you know, a small amount for PrimaLoft. We have, you know, $400 million term loan that's floating rate, but the spreads are relatively low on that.
If you think about just the amount of fixed expenses that we come underneath, including interest and management fees, you know, we think that high single-digit growth rate of subsidiary Adjusted EBITDA should leverage into strong, you know, kinda growth rates and adjusted earnings, you know, just based on how the math works. But, you know, I think largely one of the things that we're demonstrating right now and may have been, you know, not as apparent to the market, is that the core growth rate of this company has absolutely accelerated as we've engineered this portfolio transition by buying faster growth businesses and shedding some of our slower growth businesses.
Cris Kennedy (Research Analyst)
Yeah, great explanation. Then just one last one on the health of your consumer. I know Cody generally has higher end consumers, but just there's a lot of uncertainty out there. Just talk about the health of your consumer and your ability to pass through inflationary pressures on your consumer. Thanks a lot.
Elias Sabo (CEO)
Sure. You know, I would say I'll give kind of a overall macro view of what we're seeing. Frankly, you know, our guidance is very much tempered based on some of the headlines and this change in Fed posture. We really haven't seen in a very long time a Federal Reserve that has been as aggressive as it is and is projecting to be, you know, kinda further aggressive going forward. The overall uncertainty, Cris, just that exists in the marketplace right now has caused us to really temper expectations. Now all that being said, we generally see demand as staying strong. I would have said a quarter ago we see demand really more at a torrid level, and so I think it's, you know, kind of downshifted a little bit.
Part of what we think is happening is there's more normalization of inventories throughout the supply chain right now. Some of the initial orders that are coming in can be reflective of that. As we've all heard, you know, customers or companies, you know, have really expanded their inventory positions, you know, and there was an elongation of the supply chain. I would say broadly, we're now seeing companies start to shrink their inventory position, and it really doesn't matter whether you're at the low end, the middle end, or the high end of the marketplace. We're just seeing that broadly, and that's starting to bring down slightly what the new order flow coming in.
We do think there will be some inventory adjustment that generally weighs a little bit on what our revenue growth looks like and otherwise would be without that normalization. Now, on the other side, I will say we're also starting to see some moderation in inflation in some of the you know, other issues that our companies are dealing with, supply chains are starting to loosen a little bit. We're seeing flow of goods get better. We're seeing employee availability in certain job classifications and in certain regions get much better. I think those are all going to proceed either a topping of inflation and even a you know, kind of lowering of inflation later in the year.
Although we're seeing demand start to moderate slightly, we're also seeing, you know, kind of the impact on our cost of goods start to moderate as well. With our customers, we've been able to push through and continue to push through price increases that will protect margins. As you saw in the second quarter, we were actually able to expand margins year-over-year due to the what we view as, you know, very good inelasticity of demand for the products that we generally sell. Now, when you think about kind of the portfolio, we skew towards the middle and higher end buyer in our portfolio.
You know, if you just had to take a real kind of guesstimate here, you know, I would say less than 10% of our Adjusted earnings is driven by mass channel distribution that we have. That's obviously, in today's environment, you know, very good for us because we are seeing the mass channel, unlike the rest of the business, have end market demand that is really declining rapidly. I think that customer in particular is getting hit hardest from food and energy inflation, and therefore discretionary items aren't being purchased as much. If you think about our guidance, it really includes, you know, that component of our portfolio weakening quite, you know, significantly. Outside of that, you know, we see end demand staying pretty strong.
You know, our greatest evidence of end demand really comes from two companies, Lugano, which continues to put up record quarters, and continues even into, you know, kind of the beginning of the third quarter to have extraordinary growth that we're experiencing. 5.11 through the direct-to-consumer channel, and we're seeing incredible growth, you know, strong growth there too. I would say, you know, it doesn't feel like end market demand, end consumer demand for us is weakening at all. There could be some inventory adjustments that cause growth rates to decline somewhat. We feel, you know, generally pretty good, but are cautious given just the general macroeconomic environment that we're operating in today.
Cris Kennedy (Research Analyst)
Great. Thanks for taking the questions.
Elias Sabo (CEO)
Thank you, Cris.
Operator (participant)
Thank you. The next question comes from Larry Solow of CJS Securities. Please go ahead.
Larry Solow (Managing Director and Equity Analyst)
Great. Good afternoon, guys. Just a couple follow-ups to that, Elias. On the price increases, which I know a lot of your businesses certainly have pricing power as leaders. Have you found it increasingly more difficult to continue to raise prices? Or have you seen some pushback from customers or some elasticity as you continue to raise price? I'm just trying to get a feel for that. Have you also—Are there other workarounds? You know, have you been able to maybe increase suppliers in some instances? Or I know you've been building inventory outside of Lugano, but in other places where you normally don't hold as much inventory. So just trying to get some idea on some of the workarounds.
Pat Maciariello (COO)
Hey, Larry, this is Pat. I would say holistically what we're trying to do is provide value to our customers. You know, product A may be, you know, product line A, you may be able to raise prices a little bit more than product line B, right? We had sort of the, what I'll call the hatchet, you know, raise, and now further raises are more scalpel, you know, as you will, kind of looking at what products are really sort of underpriced relative to the value that they convey to the customers, right? We have a diverse group of suppliers, you know, at each business that we're constantly you know looking for the best prices on.
You know, as Elias mentioned, we are seeing, you know, certain sort of, COGS-related items moderate a little. Freight costs are down. That was a big driver. I mean, they're still, you know, significantly up from, you know, year ago levels, but freight costs are down. Gas energy is down. We're seeing some of that, which is also, you know, just starting to maybe—I think that's why Elias said that, used the term cresting. We're just kind of starting to see that cresting. That's sort of where we are now in kind of a state of play. Does that make sense?
Larry Solow (Managing Director and Equity Analyst)
Yeah, no, absolutely. Just specifically on Lugano, do they sort of benefit, you know, or maybe not really get impacted, you know, inflationary environments on diamonds? I would also think the people that, you know, the audience that you know, that these are being sold to, you know, does this type of environment, obviously, the performance there doesn't seem to be impacting them, but I know it also seems like the more you invest in working capital, it's almost like the more you can earn. Just trying to, you know, maybe that's not quite true, but, you know, so does the inflationary environment actually hurt Lugano or maybe it actually benefits them?
Pat Maciariello (COO)
I think it benefits. A couple things. First, as diamond prices go up, it's good to have a lot of diamonds. Right?
Larry Solow (Managing Director and Equity Analyst)
Right. Right.
Pat Maciariello (COO)
So, that's number one. Second, I would say, you know, it's probably. I mean, I know all of us as we see inflation, you know, we look to hard assets as stores of value, right? And their pieces are beautiful. They're pieces of art. But there's also sort of a very large, you know, hard asset sort of component of it. In that way, I do believe, you know, there's strong demand, and we've seen it from competitors, kind of strong demand for, not all, but for many sort of ultrahigh-end retail of those, right?
It's kinda Ultra high-end jewelers. It's kind of both pieces, if that makes sense, right? We don't mind it. I'd just add that, you know, because of Lugano's business model that we've talked about, we think we're providing, again, more value, you know, to our customers than any of the, you know, than any of our competitors because of some of the ways that that team there has been able to disintermediate, and purchase.
Larry Solow (Managing Director and Equity Analyst)
Okay. No, fair enough. Just lastly on 5.11, I think you guys mentioned, you know, revenue is up close to 7% year to date and, EBITDA is sort of flat. Just more supply chain issues. Were those supply chain issues more front-end loaded? Meaning I thought that was a lot of that in the beginning of the year, and hopefully some of that is waning for 5.11. Then on the other side of it, on the revenue side, I think you mentioned the direct-to-consumer side is still, you know, doing really well. How about the professional side? I would feel like that's, you know, it feels like more dollars are going into that these days and maybe a couple years ago, but, maybe that's just perception.
Pat Maciariello (COO)
Yeah.
Larry Solow (Managing Director and Equity Analyst)
You know, any thoughts on that?
Pat Maciariello (COO)
We are seeing. I think, you know, we had stronger performance in Q2 than in Q1 at 5.11, right? I think we touched on last time that in March, we really saw kind of the really critical, like not getting any inventory in, issues sort of abate, right? There's still a lot of acute issues. I mean, you heard about the trucker strike in the L.A. and the Bay Area ports, right?
Larry Solow (Managing Director and Equity Analyst)
Right.
Pat Maciariello (COO)
Well, that cost us some revenue as we weren't able to get products shipped in.
Larry Solow (Managing Director and Equity Analyst)
Uh-huh.
Pat Maciariello (COO)
If that makes sense.
Larry Solow (Managing Director and Equity Analyst)
Mm-hmm.
Pat Maciariello (COO)
On professional side, you know, our professional business is very strong, and we're seeing strong professional demand. I think some of the sort of pullback that we witnessed, you know, post-pandemic in sort of people's appetite to support local and international professional markets has mitigated, and they've realized that they need to catch up.
Larry Solow (Managing Director and Equity Analyst)
Right.
Pat Maciariello (COO)
We're seeing really good professional demand. Where we're seeing some weakness, is in wholesale, which is a smaller component of our business. If you remember, 5.11 does have some wholesale business, non-professional consumer wholesale business.
Larry Solow (Managing Director and Equity Analyst)
Right.
Pat Maciariello (COO)
You know, which is facing the same sort of inventory.
Larry Solow (Managing Director and Equity Analyst)
That's the same as retailer. Yep. Yep. Yep.
Pat Maciariello (COO)
Yeah, that's what you hear about it. Right. There is some of that. I'd say.
Larry Solow (Managing Director and Equity Analyst)
Got it.
Pat Maciariello (COO)
You know, e-com and DTC continues to be strong. I would say e-com is moderating a little bit from year-over-year levels, but you know, I'd say it's still strong and putting up respectable numbers.
Larry Solow (Managing Director and Equity Analyst)
Great. Awesome. Mike, great. I appreciate all the color. Thanks, Pat.
Operator (participant)
Thank you. The next question comes from Matt Koranda of ROTH Capital. Please go ahead.
Mike Zabran (Research Associate)
Hey, guys. It's Mike Zabran on for Matt. Just in terms of 5.11, could you just comment on your comfortability with your store, the current store count in relation to your initial rollout expectations? Then from there, has the ability to get inventory improved at all since last quarter, or are we still experiencing some headwinds on that front?
Pat Maciariello (COO)
I think we have 94 stores now. We will be opening a number of stores in the back half. I think if we said we were gonna do 25 this year, I think we'll do 20-25, one to two a month. I think what the back half is more loaded than the front half. You know, look, I would be looking forward in the next several months to the, you know, the press release of our 100th store. Again, those stores are continuing to perform well. We've seen improvements in the receipts of inventory. But again, if you say it took, you know, two months to get from factory to 5.11 before, it's still. We still are budgeting in sort of three or longer, right?
It's just that elongation has happened, and our inventory has expanded, sort of because of that, right? Yet that elongation has stayed constant or maybe improved slightly a day or two here or there, if that makes sense. We have not yet started to sort of reduce those levels and, you know, pull back, you know, on our order time and being able to order kind of closer to when we need it, if that makes sense, to shrink the inventory. We're not yet in that phase of the recovery, but we are able to manage our inventory better because that the elongation has stopped getting longer if that makes sense.
Mike Zabran (Research Associate)
Right. Yeah, absolutely. That's helpful. Thank you. For Marucci, could you just comment on the demand environment and help us understand what's really dragging on margins here?
Pat Maciariello (COO)
Yeah. I mean, a couple things. First, Marucci, like everybody else, and we touched on it, had some air shipments, and those air freight, as you know, get put in inventory and average out over time. We've seen that improve. We expect margins to improve significantly in Q3. I would also say, you know, we feel demand is good. Pre-orders were good, and we feel demand is good for this sort of next line of bats and accessories and gloves. You know, we're making inroads, and we think those inroads will continue in Q3. Really, we are comping against a smaller launch last year. I believe it was the CAT9 Pastime that we didn't kind of replicate this year above the CAT, before the CATX.I'd expect a much better Q3 than Q2 at Marucci.
Mike Zabran (Research Associate)
Right. Okay. Got it. Last one from me. In terms of the M&A environment, maybe just speak to how comfortable we are pursuing any additional tuck-in opportunities in the near term. Maybe just comment on private market multiples and how they've changed quarter to date.
Elias Sabo (CEO)
Yeah. You know, as Ryan mentioned in his section, pro forma for the PrimaLoft acquisition, we're right around four times leverage right now. It's well within sort of what is tolerable, and given kind of the growth of the portfolio, which I talked about earlier, and the increased core growth rate, the free cash flow that we generate, pre-making investments, whether in growth CapEx or working capital, you know, we're just in a very different position that allows us to have leverage that is above our target leverage. To be clear, we're above our target leverage. As we've set out there, our target leverage is, you know, kind of 3x-3.5x, and we sit a half a turn above the high end of our target. Our goal is to reduce our leverage back to within our target leverage.
We feel that's, you know, a responsible amount of risk for us to have in our balance sheet for our shareholders, and it gives us the flexibility to run our business well. Now, I think there's a few ways to get there. You know, clearly, the ATM that you guys are all aware that we have in place allows us to get equity capital in to deleverage. But on top of that, just growth in the portfolio increases the denominator, and that's deleveraging in and of itself, and free cash flow will as well. So we think that those, you know, three components, growth, cash flow from operations, and ATM will get us back within sort of our leverage window in a relatively short period of time, and that's why we're comfortable at where we are right now.
Now, that being said, I think for small tuck-ins, we're still open for business. Generally, those are you know, at better purchase price multiples. There's synergies that you can achieve, and they're generally smaller, so it's not gonna push the needle on leverage all that much. In terms of new platform acquisitions, we would need to bring in, you know, a substantial amount of equity capital in order to deleverage, in order to pursue that, and that's just not something that, you know, we see a need for right now. Now, clearly, we think the deleveraging that will happen given the, you know, the ATM and the growth and the cash flow from operations, that's gonna help put us in position to be able to look at, you know, platforms here in the near term.
I would say right now, for tuck-in acquisitions, we're, you know, more open for business. We're a little bit more hesitant to add significant amounts of leverage on our balance sheet given where we are relative to target. In terms of your question on multiples, I would say, it really is a bifurcated market, and that's typically what you see in times like this. What we're seeing right now are the A quality businesses, and I'll point to PrimaLoft as being, you know, the best business that we have seen, you know, come out here in 2022, at a minimum 2022, maybe even longer. For a great business like that, there's lots of buyers who line up, and there's lots of capital that's available.
Even though debt costs have increased, buyers are still willing to step up and pay large multiples for companies of best quality. When you get into the lower quality companies, we're just seeing those companies not transact. There's still expectations for from sellers that the lower quality companies are gonna transact at levels where they would have a year or, you know, maybe pre-pandemic, and that's just not the case. Buyers generally, you know, aren't either willing or they get through diligence, and they find reasons to, you know, kind of walk away. I think it's a, you know, very interesting market right now where you have either very high prices that are being paid for A quality businesses and then really not much that's happening outside of that.
My sense is, as markets open up again, we'll probably see multiples contract somewhat on some of the lower quality businesses, as there seems to have been a general repricing that's occurred at least in the public markets and in the debt markets for sure. I think that will factor into the private markets, but I wouldn't expect for the, you know, high-quality A-type businesses to see any material reduction in the valuation that's out there.
Mike Zabran (Research Associate)
Very clear. Thanks, guys. That's all for me.
Elias Sabo (CEO)
Thank you.
Operator (participant)
Thank you. Once again, ladies and gentlemen, if you do have a question, please press star one at this time. The next question comes from Barry Haimes of Sage. Please go ahead.
Barry Haimes (Managing Partner)
Thanks so much. Great quarter, once again. I had two questions. One, the financial markets have only recently gotten a little better, but I'm just wondering, is there a set of circumstances where you would go back to the notion of a 5.11 IPO? Second question, I wonder if you'd give us a little bit of an update on the healthcare initiative you guys have talked about. You know, have you built out the team? Are you starting to look at acquisitions yet? Just would love an update there. Thanks so much.
Elias Sabo (CEO)
Sure, Barry. Thank you for the question. First, with regards to 5.11, you know, what we have said on numerous occasions and will continue to say, 5.11 is a great business. This is one of the A-plus companies that, you know, we have in our portfolio. We're fortunate now to have a number of, you know, kinda A-type businesses, 5.11 being, you know, kinda the one that we've had longest. We are happy holding 5.11 as long as necessary because it is gonna provide great growth tailwinds for our shareholders and tremendous shareholder value creation, whether it's owned 100% or, you know, whatever, we have some minority interest there, or whether we have a, you know, component of that that is publicly floated. Now that being said, this company has done a lot in order to make itself a publicly viable company.
From the creation of an extraordinary management team with great systems that they have in place and the underlying elements, whether it's working on ESG, whether it's working in a SOX-compliant environment, the company has the systems and the talent to be able to be a public company, and it has the growth opportunity that public investors want. It naturally should be a public company. We do not view ourselves as needing to force it out into the public markets before they're accommodative. As markets become more constructive, as we see the consumer businesses which still are trading, you know, relatively poorly, especially if you look at a lot of the consumer IPOs that occurred late in 2021, mid and late 2021, they have performed incredibly poorly.
That's just creating a really, you know, kind of negative backdrop still for consumer companies to go public. I would say a company of this ilk, we don't feel a need to try to get it out there unless the markets are gonna be very accommodative and reward our shareholders with the type of multiple that this company deserves. Are we always evaluating whether this company is ready to go back and become a public company? Absolutely. Do we think right now conditions, even though they've moderately ticked up financial conditions in the last month or two, do we think now is the time? Not yet. As you know, financial markets can change rapidly. The tone of financial markets can change.
You know, if we see headline inflation start to really come down and the Federal Reserve change its policy stance, and that creates the next, you know, kind of bull run in the market, then 5.11 will be ready, and at that point, we'll make a decision because we do view this eventually as becoming a public company. I'm sorry, your second question that you had asked?
Barry Haimes (Managing Partner)
Healthcare.
Elias Sabo (CEO)
Oh, on the healthcare initiative. Yeah, we continue to advance along on healthcare. It's an important initiative. I would say there's you know some candidates that we are in talks with. As you know, this is predicated on getting a leader who will be in and can direct that effort for us. We're feeling more confident by year-end that we'll have some positive news to announce there.
Barry Haimes (Managing Partner)
Great. Thanks so much.
Operator (participant)
Thank you. The next question comes from Matthew Howlett of B. Riley. Please go ahead.
Matthew Howlett (Managing Director and Senior Analyst)
Oh, hey, guys. Thanks for taking my question. Sorry, hopping on a little late. Did you note any FX items on the earnings or the guidance here?
Pat Maciariello (COO)
Did you say FX? No, no FX, Matt.
Matthew Howlett (Managing Director and Senior Analyst)
Okay, nothing with the strong dollar is not gonna have any impact or, I mean, there's nothing to note there with the dollar strength at all?
Pat Maciariello (COO)
Yeah. You don't adjust that out. You're not adjusting that out. No, we don't adjust that out. There's some impact. It's pretty modest across the group of companies. It's technically factored in as part of our guidance, as a way to think about it.
Matthew Howlett (Managing Director and Senior Analyst)
Gotcha. Okay. Gotcha. Good. Okay, good. Second question, on Sterno, there's a nice pickup there. Was it. You know, I know you had some on the two divisions. Was it just that the heating lamp, you know, with the sort of return to, you know, conference schedule, or was it the other division with the candle with stuff? Was there any sort of reason for the pickup there?
Pat Maciariello (COO)
I would say the strength in Q2 was definitely driven by the Sterno side of the business, the core Sterno kind of the party and the getting outdoors and the buffet sets, as you know, I think people are making up for, you know, weddings that didn't happen over the last couple of years and parties that didn't happen over the last couple of years.
Matthew Howlett (Managing Director and Senior Analyst)
Okay. Yeah, exactly. That's why. Any update on, you know, sort of the other side of the business? I know there was some, you know, with Walmart, some of the inventory issues. Anything there?
Pat Maciariello (COO)
I mean, I would say, you know, not performing as strong right now at this moment as the other side of the business, you know, performing fine, taking all necessary, you know, actions. It kinda goes into some of the things we said before about kind of the more cost-conscious consumer, you know, being pinched a little bit by inflation.
Matthew Howlett (Managing Director and Senior Analyst)
Gotcha. Okay. Real quickly on Lugano. I mean, you said two more salons. I mean, any sense of how we think about modeling sales with these additional salons coming on?
Pat Maciariello (COO)
Let us think through that. I don't think we have a good answer for that right now. I mean, and the short answer is, you know, the salons vary, right? Salons can vary materially in the sales level they have. I think we're hesitant to put out sort of salon level guidance.
Matthew Howlett (Managing Director and Senior Analyst)
Gotcha. Okay. Well, it certainly, you know, they certainly have a great big following, so it'd be really interesting to, you know, could obviously, you know, have a really meaningful impact if these are successful. So we'll look for that. Just remind us again, the Marucci the new bats interesting. How often do they introduce a new bat like that? You could just go over sort of, is it once a year or is it once every two years?
Pat Maciariello (COO)
Yeah. The big launches like the CATX, CAT9, you know, the big sort of Marucci level launches tend to be once every two years. I would say there are sort of, you know, incremental launches or slightly smaller launches that we have in between. Victus, our sister company, launched the NOX, I think it was last year. Last year, we came out in the summer with the CAT9 Pastime, which was a different design sort of version of it, you know. There are also markets that are launching right now. We launched the glove, a whole glove line, right. But it's the big bat launches that, you know, we've launched softball lines with the Echo, but it's the big sort of Marucci bat launches that provide the lumpiness. For those, it's usually every two years.
Matthew Howlett (Managing Director and Senior Analyst)
Okay. Gotcha. This is gonna be a third-quarter event, right?
Pat Maciariello (COO)
Yeah. We have a launch in the third quarter. It's going well. We should have a good quarter.
Matthew Howlett (Managing Director and Senior Analyst)
Great. Wonderful. Great. Great job. I really appreciate it.
Pat Maciariello (COO)
Thank you, Matt.
Operator (participant)
Thank you. There are no further questions at this time. I would now like to turn the conference back to Mr. Sabo.
Elias Sabo (CEO)
Thank you, operator. As always, I'd like to thank everyone again for joining us on today's call and for your continued interest in CODI. Thank you for your continued support.
Operator (participant)
This concludes Compass Diversified's conference call. Thank you and have a great day.