By Eric Smith
Compass Diversified Holdings CEO Elias Sabo called tactical gear brand 5.11 a “significant driver” for CODI in the third quarter as 10.1 percent revenue growth surpassed the parent company’s expectations, but he also warned that heavy investments will take a toll on the subsidiary’s earnings in the short term.
5.11’s EBITDA decreased 16.1 percent compared to the same period in 2017, but Sabo countered that number by highlighting the investments in new systems and infrastructure, as well as changes in executive management—Francisco Morales was named CEO and Matt Hyde was named executive chairman during the quarter—as critical movs for future growth.
“We believe these investments will position the company for long-term growth,” Sabo said on Wednesday afternoon’s third-quarter earnings conference call with analysts. “Yet these investments have created significant operational strain starting in late 2017 and continuing throughout 2018.
“Given the significant one-time costs associated with moving into the new warehouse, the significant one-time costs associated with changes in executive management, we now expect 5.11 to produce lower earnings in 2018 than in 2017. As a reminder, we do not add back one-time cost to our earnings like the costs incurred at 5.11 this year. And as a result, we expect the elimination of these one-time costs as well as continued revenue growth to provide a significant tailwind to earnings growth in 2019.”
SGB interviewed 5.11’s new CEO last month for a Q&A, 5.11 CEO Francisco Morales Talks Retail Expansion, Tactical Sector Growth, in which he spoke of the brand’s recent growth and its rampant retail expansion of 50 branded stores by the end of 2018.
“5.11 is poised to take advantage of favorable market conditions, and our retail expansion provides a direct line to our customer base,” Morales told SGB. “We see brick-and-mortar as an opportunity to communicate directly with our customers and build a community around the 5.11 Always Be Ready mindset.”
At the same time, Morales, who cofounded the brand and came back to 5.11 when CODI bought it in 2016, discussed the significant investment the parent company is making to ensure long-term growth.
“We are making big investments in infrastructure—this began last fall with our brand new 400,000-plus-square-foot distribution center in Manteca, CA, in addition to a new ERP implementation,” he said. “The plan is that all of these systems work together and operate at the highest levels of efficiency. We are making significant investments in technology and people to grow the business to ultimately support an omnichannel experience in our retail stores.”
Sabo echoed that sentiment on Wednesday’s call, adding that CODI expects the benefits of those investments—which totaled $4.7 million in the quarter—not to begin showing up in earnings reports until next year.
“In addition, we are in the process of optimizing inventory across channels, which may or may not result in a non-cash charge in the fourth quarter,” Sabo said. “To the extent we have a non-cash charge for this inventory we will not include this charge in our EBITDA or cash flow in the fourth quarter. Although 2018 has been a challenging year for 5.11 from an operational standpoint, we are optimistic that 2019 will produce significant growth in revenues and earnings.”
Sabo and his team spent much of the call discussing 5.11, but looking at the overall CODI picture for Q3, the company reported revenue for the third quarter ended September 30 of $448.7 million, up 38.5 percent from $324 million a year ago and beating Wall Street estimates by $39.2 million.
The company’s net income was $5.8 million as compared to net income of $8.4 million for the quarter ended September 30, 2017. Earnings of (7) cents per share was well short of Wall Street’s target of 17 cents per share.
Cash flow for the third quarter of 2018 reflects year-over-year earnings increases at 5.11, as well as Advanced Circuits, Arnold Magnetics, Clean Earth and Sterno Products businesses, offset by declines at the Company’s Liberty, ErgoBaby and Manitoba Harvest businesses.
Another one of CODI’s companies, Velocity Outdoor, also got some coverage on the call. The subsidiary was rebranded during the quarter from its old name, Crosman Corp., and SGB spoke to its CEO about the rebrand and other happenings at the company in September for SGB Executive Q&A: Velocity Outdoor CEO Bob Beckwith.
Velocity is the holding company of such well-known sportsman’s brands as Crosman, Benjamin, CenterPoint Archery, CenterPoint Optics, LaserMax and Game Face Airsoft. And in the third quarter Velocity acquired Superior, WI-based Ravin Crossbows, LLC for $94 million.
Like 5.11, the company stood out for CODI in Q3 but pressures will mount in the coming year. Velocity Outdoor’s year-to-date revenue increased 24.6 percent while EBITDA increased 55.3 percent compared to the same period in 2017, due primarily to the addition of Ravin.
“For much of 2017 and early 2019, Ravin products were in allocation to its customers and Ravin customers were stocking inventory,” CODI partner Pat Maciariello said on the call. “Thus we do not believe this level of revenue growth is sustainable. Importantly, we acquired – when we acquired Ravin, we assumed a normalized level of revenues and EBITDA in valuing the company. For the balance of the year and heading into 2019, we expect Velocity to face a challenging outdoor retail market similar to Liberty. However, for 2019, we expect to offset some of these challenges through product innovation for both Ravin’s and Velocity’s historic product line.”
Photo courtesy 5.11