Compass Diversified Holdings (CODI) Q2 2024 Earnings Call Transcript

Good afternoon, and welcome to Compass Diversified Second Quarter 2024 Conference Call. Today's call is being recorded, and all lines are on mute. I would now like to hand over the conference to Cody Slach of Gateway Group for introductions and the safe harbor statement. Please proceed.

Thank you, and welcome to Compass Diversified second quarter 2024 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 2024 press release, including the financial tables and non-GAAP financial measure reconciliations for subsidiary adjusted EBITDA, adjusted earnings and pro-forma net sales are available at the Investor Relations section on the company's website at compassdiversified.com. The company also filed its Form 10-Q with the SEC today after the market closed, which includes reconciliations of certain non-GAAP financial measures discussed on this call and is also available at the Investor Relations section of the company's website. Please note that references to EBITDA in the following discussions refer to adjusted EBITDA as reconciled to net income or loss from continuing operations in the company's financial filings. The company does not provide a reconciliation of its full year expected 2024 adjusted earnings, adjusted EBITDA or subsidiary adjusted EBITDA because certain significant reconciling information is not available without unreasonable efforts. Throughout this call, we will refer to Compass Diversified as CODI or the company. Now allow me to read the following safe harbor statement. During this conference call, we may make certain forward-looking statements, including statements regarding expectations related to the future performance of CODI and its subsidiaries, the impact and expected timing of acquisitions and divestitures, and future operational plans such as ESG initiatives. Words such as believes, expects, anticipates, plans, projects, should, and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to 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-K as filed with the SEC for the year ended December 31, 2023, as well as in other SEC filings. In particular, the domestic and global economic environment, supply chain, labor disruptions, inflation, and changing interest rates all may have a significant impact on CODI and our subsidiary companies. Except as required by law, CODI undertakes no obligation to publicly update or revise any forward-looking statements, whether because of new information, future events, or otherwise. At this time, I would like to turn the call over to Elias Sabo.

Good afternoon, everyone, and thanks for joining us today. I am pleased to report yet another strong quarter of results, continuing to execute our strategy of owning a growing number of innovative, disruptive, and high-growth businesses meant we performed exceptionally well in the second quarter, even against the backdrop of a slowing economy. While the current business environment has had a negative impact on our industrial businesses, our branded consumer vertical performed extremely well this quarter, led by BOA, PrimaLoft, and Lugano. The strong performance of our consumer vertical more than offset any weakness we saw in our industrial businesses. As we predicted in Q1, inventory destocking headwinds subsided this past quarter. BOA had another great quarter and PrimaLoft returned to double-digit growth. We believe both businesses are positioned for a strong back half of the year. In addition, Lugano continued its trend of remarkable growth. Last quarter, we opened our first international salon in London. In just a few short months, like many of our Lugano salons, it has vastly exceeded our expectations. Combined, Lugano, BOA, and PrimaLoft represent approximately half of our EBITDA. With all three of these businesses performing well this past quarter and with them positioned so strongly for the rest of the year, we are feeling bullish about the second half of 2024 and beyond. As I mentioned earlier, despite our overall outperformance this quarter, a weakening global macroeconomy made for a challenging quarter for our industrial businesses. Our industrial vertical saw a decline in both revenues and adjusted EBITDA in Q2. We believe this somewhat muted performance will continue through the rest of the year. However, we remain confident in the overall positioning of this vertical, and we believe it is well positioned for a strong 2025. All-in-all, it was another great quarter for CODI, one that further demonstrated the power of our long-term strategy. By owning a group of non-correlated, high-growth innovative businesses, we not only smooth CODI's overall performance period to period, but in any given period, we are more likely to benefit from one or more of our businesses experiencing a true step change in growth. This is a story of diversified growth engines as evidenced this quarter when we grew by almost 20% year-over-year. Ryan will go into detail on our financial outlook shortly, but I'd like to briefly discuss our decision to leave our outlook unchanged. We still anticipate we will hit the high end of our consolidated guidance ranges. However, we are not raising our guidance range at this point out of an abundance of caution regarding the weakening economy and a concern for the short-term performance of our three industrial businesses. While overall we remain really positive about the rest of the year. As Ryan will detail shortly, within our overall outlook, we are shifting some of our adjusted EBITDA expectations from our industrial vertical to our consumer vertical. Even though our overall guidance is staying holistically the same, we believe this mix shift that favors our faster-growing, more protected, and highest value businesses creates an accelerated level of intrinsic value creation for our stakeholders now and positions us to drive significant growth into 2025 and beyond. With that, I will now turn the call over to Pat.

Thanks, Elias. As a reminder, throughout this presentation, when we discuss pro-forma results, it will be as if we owned the HoneyPot company as of January 1, 2023. I am pleased to report on another successful quarter. On a combined basis, pro-forma revenue and adjusted EBITDA grew by 6% and 18%, respectively. On a year-to-date basis, pro-forma revenue and adjusted EBITDA increased by 4.9% and 16.6%, respectively, versus year-to-date June 2023. Lugano continues to be the largest driver of growth we saw a broadening of strength with very good performance at both BOA and PrimaLoft this quarter. As Elias touched on, we believe all three of these businesses are well positioned for growth in the remainder of the year and beyond. Within our industrial segment, for the year-to-date period, revenues decreased by 6.7% and adjusted EBITDA decreased by 8% versus year-to-date June 2023. This decline was primarily driven by weak performance at Altor, which declined meaningfully in Q2. The decline was driven by a combination of reduced customer demand in some accounts and churn at a couple of our cold chain distribution partners. Though disappointing, the sales funnel at Altor remains robust and has almost tripled in size since this time last year. New contracts typically take some time to design and test, however, leading to a potentially muted second half of 2024. As a reminder, the company now has what we believe to be a world-class management team in place. And as a result, we are confident the company will rebound in 2025. Arnold continued to grow revenue in the quarter but once again experienced higher SG&A, as we began to modify our manufacturing footprint in an effort to improve efficiencies and grow technological capabilities. As part of this strategic relocation, we anticipate several million dollars in one-time expenses will be incurred over the next few quarters. In addition, we expect $10 million to $15 million in one-time capital expenditures as part of this project as we make our way through this transition. Sterno once again grew EBITDA modestly in the quarter as slightly softer sales in the company's food service division were more than offset by strong execution throughout the business. Turning to our consumer segment. For the year-to-date June 2024 period, pro-forma revenues increased by 10.9% and pro-forma adjusted EBITDA increased by almost 27% versus year-to-date June 2023. Lugano remained the strongest performer, both in the quarter and on a year-to-date basis. Our London salon significantly exceeded expectations during its first quarter of operation, and we continue to see strong performance in Aspen, Palm Beach, and Newport Beach. We're in the process of finalizing the location of our ninth salon and look forward to sharing its location with you likely on our next quarterly call. We expect Lugano's extraordinary growth to continue throughout the rest of this year and into 2025. I'm also very pleased to report on the acceleration of BOA in the quarter and PrimaLoft returned to growth in the period. For the second quarter, BOA grew revenue by 42.1% and adjusted EBITDA grew by almost 60% versus Q2 2023. The BOA brands saw growth in each of its industry verticals. Similarly, PrimaLoft grew revenue and EBITDA by 14.1% and 11.1%, respectively, as inventory headwinds in many of its apparel categories continue to abate as expected. We are encouraged by the performance of both PrimaLoft and BOA this quarter and by their prospects for the rest of the year. Turning to the HoneyPot company. Both for the quarter and for the year-to-date period, HoneyPot declined slightly in both revenue and EBITDA versus the same period in 2023. We purchased a company knowing that HoneyPot was losing a small number of non-core SKUs at one of its large national retailers. The short-term impact was slightly greater than our expectations. And as a result, HoneyPot's financial performance has been slightly below our expectations for the year-to-date period. The company continues to add new retail and online accounts, however, and we remain confident in the long-term mission-driven trajectory of the business. Lastly, the situation at 5.11 remains somewhat of a transition year for the business given the previously announced leadership changes, lingering inventory-related issues in DTC, and the challenging PFAS transition. As a result, financial performance was somewhat muted in both the quarter and year-to-date period. However, demand for the brand this year, particularly on the professional side, remains robust. While we see financial performance in the remainder of 2024 looking similar to performance in the year-ago period, we continue to expect strong growth in 2025 and beyond, following resolution of these exogenous issues facing the business. As a whole, we are very pleased with the first half and remain confident in our outlook for the full year. I will now turn the call over to Ryan for additional comments on our financial results.

Thank you, Pat. Moving to our consolidated financial results for the quarter ended June 30, 2024, I will 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, revenue for the quarter ended June 30, 2024, was $542.6 million, up 11% compared to $486.9 million for the prior year period. This increase was primarily a result of the acquisition of the HoneyPot company and strong growth at Lugano, BOA, and PrimaLoft, which was partially offset by lower revenue at Altor, 5.11, and at Velocity as a result of the sale of its Crosman division. Consolidated net loss for the second quarter of 2024 was $13.7 million compared to net income of $17.1 million in the prior year. The second quarter of 2024 included a loss on the sale of Crosman of $24.6 million as well as a $7.3 million tax expense recorded at Velocity related to a valuation allowance on its deferred tax assets. Adjusted EBITDA in the second quarter was $105.4 million, up 27% compared to $82.9 million in the prior year. The increase was due to the acquisition of the HoneyPot company and strong growth at Lugano, BOA, and PrimaLoft. Included in adjusted EBITDA in the second quarter of 2024 and 2023 were management fees and corporate costs of $21 million and $19.3 million, respectively. Adjusted earnings for the second quarter were above our expectations, coming in at $39.8 million. This was up significantly from $29.2 million in the prior year quarter due to strong performances at Lugano and BOA. Now moving to our 2024 guidance. As a result of our financial performance in the second quarter, our expectations for the remainder of 2024 and our current view of the economy, we are maintaining our 2024 outlook. Thus, our full year 2024 subsidiary adjusted EBITDA is consistent with what we provided on our last earnings call of between $480 million to $520 million. Given the outperformance of our branded consumer companies, we are increasing the subsidiary adjusted EBITDA range for our branded consumer vertical by $10 million to $365 million to $395 million. However, we are reducing the subsidiary adjusted EBITDA range for our industrial vertical also by $10 million to $115 million to $125 million. We expect full-year 2024 adjusted EBITDA to be between $390 million and $430 million, consistent with what we provided on our last earnings call. This range factors in an expected $86 million in corporate-level overhead and management fees in 2024. This compares to $341 million in adjusted EBITDA in 2023. Finally, we are maintaining our full-year 2024 adjusted earnings guidance range of between $148 million and $163 million, and we expect the remaining six months of adjusted earnings to be slightly more skewed toward the fourth quarter. Turning to our balance sheet. As of June 30, 2024, we had approximately $68.4 million in cash, approximately $544 million available on our revolver and our total leverage ratio was 3.2x. Our leverage ratio at the end of the quarter declined as anticipated as a result of our strong operating performance. Absent any significant acquisitions for the remainder of 2024, we expect our total leverage ratio to continue to decline. We have substantial liquidity. As previously communicated, we have the ability to upsize our revolver capacity by an additional $250 million. With our liquidity and capital, we stand ready and able to provide our subsidiaries with the financial support they need, invest in subsidiary growth opportunities, and act on compelling acquisition opportunities as they present themselves. Turning now to cash flow provided by operations. During the second quarter of 2024, we used $35 million of consolidated cash flow from operations. Lugano used $71 million in cash flow from operations to support its continued extraordinary growth. Outside of Lugano, the other nine subsidiaries combined produced $36 million in cash flow from operations in the second quarter allowing us to reduce our leverage as stated earlier. Finally, turning to capital expenditures. During the second quarter of 2024, we incurred $11.2 million of CapEx at our existing subsidiaries, compared to $13.7 million in the prior year period. The decrease was primarily a result of a decline in 5.11 store rollouts in 2024. For the full year of 2024, we anticipate total capital expenditures of between $55 million and $65 million. We continue to see strong returns on invested capital at several of our growth subsidiaries and believe they will have short payback periods. Capital expenditures for the remainder of 2024 will primarily be at Lugano for new retail salons and at Arnold as previously discussed by Pat. With that, I will now turn the call back over to Elias.

Thank you, Ryan. Before moving to the Q&A portion of the call, I'd like to briefly discuss both our ESG strategy and the current M&A market. As we have told you before, our business model is designed to foster the long-term development and growth of our subsidiaries. We are not constrained by short investment horizons, and our permanent capital base allows us to take a long-term view. This approach is vital because meaningful innovation and industry disruption both require time and they also require an exceptional talent pool. The future thinking for people and planet pillar of our ESG strategy prioritizes attracting the best people and focusing on their professional development and holistic well-being. Additionally, our commitment to diversity and inclusion enriches our teams with a variety of perspectives and experiences. We have integrated these principles into our business model so that we can attract and keep people who are not only really good at what they do, but who will also join us in taking bold steps, pushing boundaries, and creating lasting value for our stakeholders. Turning to the M&A market. While there has been an uptick in deals recently compared to what we've seen in years past, we have not returned to historic activity levels and recent deal quality hasn't met our standards. We remain steadfast in our efforts to identify, own, and actively manage innovative, high-growth companies. We also believe our competitive edge will shine in today's high-interest-rate landscape. When debt markets are weak for single asset buyouts, our permanent capital competitive advantage only grows. As Ryan mentioned, our strong liquidity position also enables us to act on acquisition opportunities and invest in our subsidiaries to build upon our track record of delivering growth into 2025 and beyond. With that, operator, please open the lines for Q&A.

Our first question today comes from Larry Solow of CJS Securities.

I guess two questions. One, operating, and one just on the M&A environment. Just it sounds like BOA had a really nice quarter, really good to see. Can you maybe give us a little more color on the strength? Is it just the subsiding of the inventory destocking? And is BOA the primary driver of the $10 million increase on the branded side?

I would say certainly one of them, Larry, this is Pat. It was really broad breadth, as I mentioned, across each of the BOA verticals. I would say the company is developing a great business in workwear, and it's becoming a more material part of their business, and that was certainly a driver of growth here as well, both domestically and internationally.

Yes. With respect to the $10 million driver of growth, Larry, I would say it is sort of a combination. PrimaLoft bounced back and exceeded our expectations, as did BOA. The numbers both put up were extraordinarily strong. And as you know, this has been one of the better-performing businesses that we've owned prior to the inventory destocking. So it's really good to see that behind them and get back on kind of a normal growth trajectory. And then, of course, Lugano continues just to grow at a remarkable level. So those three together, as I said, they roughly represent half of our EBITDA. Having them grow like they are right now enables us to up our expectations for the full year by $10 million on the consumer side.

And just on the HoneyPot, a little bit below expectation, as you called out. Some of the - it sounds like your thoughts on you were going to lose some of these SKUs. Is it also some traffic at these bigger box retail stores one in particular? And is that still the big box still the majority of your revenue?

Yes. A couple of the bigger box stores are close to half of our revenue or slightly more than that, probably a good chunk of our revenue. And I would say there are some well-publicized traffic reductions at least one of those that come into account.

Just last on the acquisition environment. Just curious, obviously, multiples haven't really come down. And I know in health care, in particular, I'm just curious your thoughts, no timetable, and I'm sure you've Kurt's a good man, so I'm sure you've repurposed him and doing a lot of good stuff behind the scenes there. But curious, are you expanding your horizons a little bit about health care? Again, any thoughts on potential investments in that vertical specifically.

Yes, in the M&A market, there's been an increase in deal volume. However, our focus is on companies that demonstrate strong innovation in their products and profitability, along with a capacity for ongoing innovation. This focus significantly narrows down our target opportunities. Unfortunately, we haven't seen many top-tier companies come to market yet, although there are signs of market recovery. In the health care sector, as well as in strong consumer and industrial businesses, we seek out businesses with A or A+ ratings, which tend to command premium multiples because they don't emerge in times of market compromise. When these businesses do come to the market, we expect to pay a premium. Currently, we are being a bit more flexible, considering slightly smaller deals than our usual historical sizes, possibly in the $15 million EBITDA range, which marks a slight shift towards a build strategy. Nonetheless, we are maintaining strict discipline regarding our investment criteria.

And the next question that we have is coming from Matt Koranda of ROTH Capital.

Maybe just sticking on the deal front for a second. I'm just curious, it sounds like a little bit of a tone shift from you guys in terms of just a little bit more awareness on a slowing or softening economy, especially on the industrial side of things. Does that change your posture toward our appetite for larger acquisitions going forward here? And maybe Elias, if you just unpack your commentary around deals not meeting your standards. It sounds like it may be more quality of deal flow, but maybe just curious if you could talk a little bit about pricing expectations and sort of if you could unpack that theme as well, that would be helpful.

Yes, I think the economy does seem to be weakening, and we've taken that into account when setting our expectations for the second half of the year. Despite having a strong quarter and feeling positive about the business, we opted not to raise our projections. This economic slowdown influences how we view potential acquisitions, as it suggests a possibility of reduced growth expectations or no growth at all. Such conditions affect our perspective on future earnings, which in turn influences our valuation considerations. As a result, this might limit our competitiveness, as we might hold a slightly more pessimistic view on the economic landscape currently. Regarding valuations, we anticipate paying higher multiples for our acquisitions. For instance, looking at companies like PrimaLoft and BOA, they have traded in the mid-double-digit range, around 15 times earnings. These are high-quality firms with robust economic moats, and we are particularly interested in businesses that demonstrate substantial innovation and have strong intellectual property or effective go-to-market strategies that are likely to endure. Additionally, we want to see these companies significantly outpace their respective industries in growth. These criteria are central to our strategy, and while capital costs have decreased, we have emphasized a focus on acquiring faster-growing and better-protected companies, which has gone hand in hand. Regardless of the timing—whether it was today, a year ago, or in stronger markets like 2021 or 2019—companies that meet these criteria tend to command strong multiples due to high demand for such assets. Historically, despite being our most expensive assets, these companies have also yielded the best returns on invested capital. This is our perspective on the current deal market, where activity has increased, but the quality of available options still remains a concern.

And then just curious, maybe on the balance sheet front, like if we're a little bit more reticent about the economy, why not focus on reducing that leverage? I know that you already are starting to do so. And you mentioned that without a deal, I guess, we just naturally sort of deleverage over the next couple of quarters. But maybe if you could talk about the trajectory there, where we might expect to end the year on that leverage if we didn't see a deal, and maybe would that be a priority of ours, like if we kind of see things softening a bit.

Yes, Matt, this is Ryan. Thanks for the question. You're right in that our leverage is continuing to come down, and you heard us on the past few calls talk about that post the HoneyPot transaction. We're seeing some continued really strong performance at our consumer subsidiaries which is growing the denominator there. So as we build our business, our leverage is coming down, coming down from a little above 3.8% down to about 3.7% this quarter. I'd expect kind of similar declines over the next two quarters as we not only grow the EBITDA line, but start to cash convert some of our other subsidiaries’ inventory and such. So still a focus of ours, I'd say it's more organic. I think what you also saw during the quarter is we raised a little bit of preferred. So I think that's been a good source of some equity capital for us to deleverage. But I do think we feel confident in our growth prospects for this year. Clearly, we're guiding to north of 12% growth in EBITDA year-over-year. So I think that all feels good. So I think we're in good shape on the balance sheet as I think about closing out the year.

And if I could just do one more on one of the fundamental businesses. So on Lugano, I wanted to hear if you guys had any sort of preliminary learnings you can share from the London salon opening. If you have quantifiable metrics, that's great, but just any learnings around that and how that sort of informs the additional expansion plans you may have for the rest of Europe. And also, I guess I noticed that the incrementals there just continue to be really strong, and it's kind of hard to model this thing, given you're punching above 40% in terms of incrementals. How sustainable is that? Sort of how should we think about modeling that going forward? I would assume you're probably going to try to tamp us down on that front, but it was impressive. So I just wanted to hear a little bit more on that.

Certainly. The company does an excellent job of establishing strong relationships in new markets before entering. They applied this strategy in London as well, where we initially worked with a smaller segment of European equestrian customers. This experience helped us understand the market better. Additionally, our business model, which focuses on building deep relationships and offering great value with exceptional products, has proven effective there too. We are learning that different purchasing behaviors from buyers can still align with our approach, which makes us optimistic about potential growth in other European locations. This reinforces our positive outlook on international and European expansion. Regarding growth, I can’t simplify your modeling too much, but I expect continued strong growth into 2024 and 2025. The extent of that growth will depend on how many salons we open and the ongoing development of our customer relationships.

Any rule of thumb around inventory investment translating to sort of sales? I know you guys have provided some metrics around that. Just curious if you have another crack at that one or if anything changed on that front.

Yes, Matt, it's basically remained similar to where it's been. I would say we do have some additional investment we're making upfront. As our growth rate is actually accelerating, which is really remarkable given how fast this business has been growing. But as it's accelerating, it actually requires a little bit more upfront capital, especially as we're expanding our footprint. And for example, going to London, now being international, it creates some challenges about moving inventory that kind of required a little bit more investment. So in general, I would say the numbers are sticking exactly where they have been historically. And as we look at the business, I mean, part of the question that passed that on your answer, Pat, for your question on modeling. I mean, the level of inventory investment also is a kind of component to modeling out how large and fast this business will grow. We've said this for three years, and I know it's hard for everybody. And for us too, to accept a little bit that as we put in more inventory, there is kind of demand within our network and as we're growing that network of buyers for there's additional demand that is there. And so we are creating more revenue opportunity with inventory investment. I think that continues and that has not slowed down. And so as we look into 2025, other than a desire to be a little bit more conservative and not get out over our skis, I would say there's nothing present right now that says this business should have a material change in kind of its performance and growth outlook. It's going to be the kind of same thing, getting the people onboarded, getting kind of the product and the inventory build. Those are sort of some of the constraints right now that we have to grow. It feels like demand still is solidly more within our network than what we're currently satisfying.

Our next question will be coming from the line of Derek Sommers of Jefferies.

A couple of quick questions on the subsidiaries. Just on HoneyPot and Lugano, could you remind us if there's any sort of seasonality we should be cognizant of in modeling those? And then additionally, any kind of commentary on the 5.11 business transition or transformation will be helpful as well.

Sorry, what was the second part?

5.11.

Seasonality at HoneyPot is diminishing. Q1 is usually a strong quarter for them, but there isn't much seasonality otherwise. For Lugano, Q4 and Q1 tend to perform better than Q2 and Q3, varying by year. Regarding the transition of 5.11, we are focusing on expanding our reach to attract more customers to this high-performing and trusted product. Understanding how to do this has been a significant part of our efforts over the past few months and will continue to be a priority. Additionally, inventory fluctuations related to COVID, whether buying too much or too little, are impacting our retail sales in DTC. Another challenge we are facing involves bringing in PFAS-free products across various SKUs, which is complex because different agencies, states, and consumer wholesale customers have various specifications. Some may prefer newer products, while others do not, forcing us to maintain double inventories on many items. While this presents operational challenges, we believe we are progressing faster than others in the industry, and it could become a tailwind for us once we navigate these issues by 2025, even though it's a headwind at present.

And then just on the interest rate cuts, it will flow through on your variable rate debt at the corporate level. But is there any kind of interest rate exposure we should be aware of at the subsidiary level?

No, Derek. All that subsidiary debt is owed to us. So there's no exogenous risk outstanding with respect to interest rate risk. Any cut would be a positive to the business.

Our next question will be coming from Robert Dodd of Raymond James.

I apologize for the background noise. It feels a bit repetitive to ask this question again, but regarding Lugano, a few quarters back, I inquired whether you believed it could reach one-third of total EBITDA this year, and you responded negatively. However, it is indeed a third this quarter. While this doesn't guarantee continued growth in that share, it raises the point about concentration being a substantial driver of your growth but also a significant consumer of cash. I believe there was a consumption of $71 million in operating cash flow during the first half. To support the accelerating growth, as you mentioned last quarter, could you provide an update on how you plan to continue maximizing the performance and returns at Lugano without letting it entirely dominate the financial needs?

Yes, Robert, we discussed this previously. It's a positive challenge since the return on invested capital is exceptionally high. From a capital allocation perspective, the demand for additional capital is tough to overlook because we can't redirect it elsewhere for better returns. This situation encourages us to keep funding this initiative, despite the risk you've mentioned regarding its increasing portfolio concentration. Like any rapidly growing business that requires capital, it's consuming a lot of resources during this period of significant growth. If its growth were to slow down to 20%, it would still generate strong cash flow. Even at 3% or 4% growth, it could produce substantial free cash flow. However, with growth rates of 40% to 50%, our capital needs are considerable. Strategically, we need to support this asset as long as it remains part of our portfolio, which is crucial for CODI's value creation and for maximizing Lugano's potential. Currently, there aren't alternatives to fund the capital that can effectively be utilized with these returns. Should the return on invested capital decline, everything would need to be reassessed. But as long as that remains stable, we'll continue to provide the necessary funding. Given its faster growth rate compared to the rest of our portfolio, its 33% concentration will likely increase if this trend continues, which we anticipate. Therefore, in the next few years, it will likely represent a larger share of CODI unless we find a creative solution.

It is really a higher problem. So they kind of tie that, I mean, you talked about the health care that you might be considering doing a more build strategy, are you making a smaller acquisition. Obviously, if you had done something larger on health care or hypothetically that one would actually reduce the Lugano concentration. So if you aim at something smaller in health care, when if you enter that, does that actually accelerate the need to find a solution? I mean, Lugano is not a problem, right, but to find some kind of creative way to manage the diversification in health care is going to hyper value to be a small add-on than might have been the case you thought a year then.

Sure. There is also the option for us to pursue acquisitions. You mentioned health care, but that's just one of the several sectors we invest in. We could consider another consumer business or an industrial tech company as well. Our teams are consistently seeking acquisition candidates. As we notice signs of potential opportunities, we anticipate chances to invest our capital. This approach would help diversify Lugano and reduce CODI's concentration. Balancing this with our leverage is essential, and access to capital markets is a crucial aspect. While we are exploring some smaller health care deals, we are also considering larger health care transactions. Although we may start with slightly smaller deals in that sector compared to industrial and consumer, we would gladly pursue a $500 million deal in health care just as we would in other sectors. If we initiate with a $200 million deal, we are open to that as well. My earlier point was that we aim to make acquisitions prudently without excessively leveraging our balance sheet, and we are carefully navigating that balance.

And our next question will be coming from Matthew P. Howlett of B. Riley.

Just to be clear, I think you said last call that you'd be comfortable taking leverage up half a turn to three quarters between temporarily. We still feel the same that if you found something you really wanted.

And I would say, Matt, given BOA and PrimaLoft and their return to growth, I mean these are just really outstanding businesses. We come up, I think all went through a traumatic period where inventory destocking was kind of a generational thing, nobody anticipated the events that COVID went unleash, including sometimes sell-in being half of what sell-through is and it really had to reset all of our expectations lower for a period of time. But these are great businesses that have good industries with growth, and they are taking share and they are really well protected. Even if the macro economy weakens a little bit here or there, those businesses can grow right on through it. They've proven the ability to do that in normal times where inventory changes aren't so wild. Looking at Lugano, which is, frankly, totally disconnected from the macro economy unless there's another great financial event that occurs. I mean, this is a company that deals with clientele that is very unique. It is a very disruptive business in a massive industry that they've got a tiny amount of share. So it's a really good formula to be able to grow outside of general macroeconomic conditions. As we said before, you look at those three businesses, and they are poised to grow not only now but in '25 and beyond. It's such a good stable base that you can get comfortable to then take on a little bit more balance sheet leverage and be comfortable with that. So maybe a long-winded answer of saying, yes, we remain confident for the right asset that we could take leverage up half to three-quarters of a term.

It's impressive that you have such strong consumer loyalty, which inspires a lot of confidence. They truly are a unique company. On that note, you mentioned new products at HoneyPot. Looking ahead to 2025, we discussed the potential for new technology at Velocity and new offerings at HoneyPot. Could you provide more details on what to expect and the potential impact for 2025? Additionally, is there anything notable in the other subsidiaries for 2025 that we should be aware of? As we consider 2025, are there any developments being rolled out in the subsidiaries that you would like to highlight?

Overall, all of our companies are working closely with our businesses, each having their own product roadmaps. For consumer businesses, these roadmaps are very detailed regarding new product introductions and execution plans for increasing profitability. We provide quarterly previews and discuss some business highlights. I can assure you that all of our consumer businesses are focused on rolling out innovative products. In our industrial sector, we are exploring ways to innovate further, improve efficiency, reduce costs, and offer better value to our customers while capturing some benefits for ourselves. We're also aiming to create environmentally friendly and distinctive solutions. It would be excessive to delve into specifics for all our companies, but I can share what drives our company's daily mission. Each day, we emphasize maintaining our innovation source and competitive edge against rivals. This focus permeates throughout the organization, beginning with me, extending through Pat, and reaching all our portfolio companies. Our innovation engine is more robust than ever, enabling us to meet, and potentially surpass, our core growth rates in the coming years, independent of the global economy. Despite managing a challenging quarter in one of our industrial businesses, we achieved nearly 20% growth, which is impressive. The strength of our businesses provides substantial optimism, along with visibility into 2025 and beyond, indicating our company is well-positioned for sustained growth rates over an extended timeframe.

It's a very strong statement, and I appreciate the confidence in the outlook. Regarding HoneyPot, it was growing at an impressive rate when you acquired it. While there was a minor setback, it was previously achieving around a 52% compound annual growth rate. Do you still believe it has the potential for long-term double-digit growth or mid double-digit growth?

Yes. I feel like it's a double-digit grower long-term. I think we'll get back on that trajectory. The brand is authentic, and they're really trying to destigmatize any issues around feminine care, and there is a real mission-driven aspect to them that we respect and we think the market and customers will reward.

And it's not unusual in the first integration period when we buy a company. There's a lot that these guys have to go through to become part of the CODI family. As we CODIYZE a company, as we say internally, the first part of that is there's a lot of reporting and other obligations that inevitably consume a lot of resources. We have to make some investments there. Before you start to get the benefit of some of the productivity that results from that, you're starting to have the resource drain and the costs that go in. It is not abnormal for us to have a period where growth is a little bit slower and then to see that start to accelerate, especially as we get more of an infrastructure build in a lot of the companies that we partner with for long-term growth. We'd expect by putting more investment in that their growth rates can pick up from where they were. Now HoneyPot was such a small company; its growth rate is the large numbers, or I guess the reverse here. So it was coming off such a small base. You're not going to get a 40%, 50% growth rate. But we're putting in a lot of infrastructure investment right now so that this company can be a double-digit grower consistently under our ownership. Given its innovative products, its current market share, and its brand perception from consumers, there is nothing that suggests that it can't kind of be a double-digit grower for an extended period of time.

There are no more questions. At this time, I would like to go ahead and turn the call back over to Mr. Elias. Please go ahead.

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 support.

This does conclude today's conference call for today. Thank you so much for joining. You may disconnect.