Quarterly Letter — Q3 2021

Dear Friends —

I love fishing.

Any fishing: conventional, fly, jigging, ripping, dead sticking, wacky rigging, split shotting, trolling, you name it, I am there – farm ponds, lakes, rivers, oceans, anywhere - and excited to catch all types of fish. There is something special about fishing. Thanks to my dad, I found the powerful joy of fishing at a very young age and never stopped.

The late great philosopher Henry David Thoreau said, “Many men go fishing all of their lives without knowing that it is not fish they are after.” People often think they are going fishing, but they seek something else like the primal thrill of the hunt, the beautiful bond with nature, the simplicity of the adventure, and the profound value of friendship that fishing with great people brings.

On that last point, my brother (see pic above!) has been my life-long fishing partner, and when I recently had the honor to be his best man in his wedding and arrange his bachelor party in August, of course, part of the festivities had to include fishing. He lives in New York, NY, so I arranged a late-night “drunken” fishing charter in Sheepshead Bay for a fantastic group of ten of his closest friends, some of whom never fished before. We had a blast on the Marilyn Jean IV fishing boat with Captain Tony and his crew, who put us on fish all night long. We caught over a hundred porgies, blackfish, seabass, cod, fluke, striped bass, and bluefish. It was an incredible experience.

That trip reminded me of Charlie Munger’s quote (h/t Jake Taylor on the Value After Hours S03/E35 podcast) about fishing and investing (Munger is Warren Buffett’s right-hand man and Vice-Chairman of Berkshire Hathaway and someone we have quoted frequently in these missives):

“There’s a rule of fishing that’s a very good rule. The first rule of fishing is “fish where the fish are,” and the second rule of fishing is “don’t forget rule number one.” And in investing it’s the same thing. Some places have lots of fish, and you don’t have to be that good a fisherman to do pretty well. Other places are so heavily fished that no matter how good a fisherman you are, you aren’t going to do very well. And in the world we’re living in now, an awful lot of places are in the second category.”

At North Beach, Dillon, Spencer, and I take Charlie’s advice to heart by attempting to fish where the fish are, AND the other fishermen are not. Whether private or public companies, we go where we can find great value AND limited competition. We see both in very small companies. We continue to find great value in private companies valued at less than $5 million and public companies less than $1 billion. We have the flexibility to go wherever we want to make money for our owner-partners. Most professional investors are fishing for much bigger companies for a variety of non-investment reasons. 

We go fishing for great undervalued service companies that can deliver free cash flow growth for a long, long time. For us, this is what we do all day, every day. There is no fundamental difference between catching an exceptional private operating company and catching the common stock of an exceptional public company. We keep it reel(!) by protecting, enhancing, and deploying our hard-earned and sacred permanent capital in a durable, concentrated, and differentiated collection of superior companies run by able and honorable entrepreneurs that possess important and unique long-term competitive advantages so that free cash flow earnings are very likely to be materially higher many years from now.

Fish on!

PRIVATE COMPANY INVESTMENT UPDATE

Once again, our overall private company results were lackluster in what matters: achieving free cash flow potential. However, we made good progress during the quarter solving the issues that were impeding our progress. As a result, at each operating company, we have a definitive plan to get traction in the form of free cash flow growth no matter what the terrain.

Aggregate profitability was underwhelming again due to employee overtime wages and the increased use of subcontractors to service our customers at the required level of service excellence. Nevertheless, the company Presidents did an admirable job managing through their respective issues, while maintaining high levels of customer satisfaction, adhering to growth budgets the best they could, and keeping employees safe and engaged.

As discussed in our previous two letters, the problem of finding qualified employees to hire seems to be diminishing (finally). The external hiring environment - which we cannot control - has improved a bit. More willing candidates are genuinely interested in pursuing a career with one of our operating companies than earlier this year. We also made improvements internally and learned on the go, resulting in a much improved hiring process. One major decision was to centralize the necessary hiring support and administration at the holding company level. The great Nikki Salas is now leading this effort, splitting time between our operating company Brahler’s Cleaning & Restoration and leading this human resources initiative for us. As hiring improves, our operating companies can tap into meaningful growth initiatives as they build up the underlying employee base to support the additional work.

ACN Solutions

Like a well-tuned machine, Spencer Wirick, ACN’s President (and our Director of Public Investments), executed another solid quarter of revenue growth, EDGAR filings, and, most importantly, free cash flow sent up to our holding company. Spencer continued to keep controllable expenses in line with his budget and launched the overhaul of our improved website. The new look and the behind-the-scenes magic should better capture new EDGAR filing business through enhanced search engine optimization. In addition, the migration of clients to our online subscription platform continued at a good pace during the quarter. The goal, of course, is for more revenue growth with a decline in cost per filing, yielding more free cash flow.

Brahler’s Cleaning & Restoration

Joy Plumley, Brahler’s President, continues to be a force to be reckoned with. In a quarter fraught with personnel challenges (i.e., not enough employees), revenue, gross margin, and net income improved quarter over quarter. Behind the scenes, she is working on three important initiatives. First, she continues to focus on getting the right employees in the right seats on the bus. As an example, she hired a new, very experienced Director of Operations in Dave Alexander and a new dynamo business development associate. Second, she is reestablishing and revising internal operational systems for success. Third, increasing our real estate footprint utilization by moving the Reconstruction division to our Lincoln Way building.

Finally, a word about Joy’s character: frequently during the quarter, she could be found on a job site very much after-hours working side-by-side with our hard-working crew members covered head-to-toe in mud and other nasty stuff. While not an optimal long-term use of her time, she continually demonstrates the ownership mindset that we love and will make Brahler’s more successful in the future.

Hart’s Ambulette

Kristy Summers, Hart’s President, grew revenue and trip count during the quarter despite another surge in the COVID pandemic headwind that resulted in temporary nursing home closures and medical appointment cancellations. Expenses were primarily high by design due to the costs associated with her preventative vehicle maintenance program, which is now complete. Behind the scenes, Kristy successfully worked on two key initiatives during the quarter: improving our facility marketing program and reducing accounts receivable.

We remain frustrated regarding our ability to purchase new wheelchair vans. We have accessible growth opportunities to support at least two additional vans for our fleet but were only able to source one van during the quarter at a price that will ensure a very compelling return on our invested capital. The van order is placed; however, we do not have a delivery date due to the popular excuse these days of “supply chain issues!”

S&S Filter

S&S’s President, Dan DeBellis, is a big fan of Ryan Holiday’s excellent book The Obstacle is the Way: The Timeless Art of Turning Trials into Triumph. That title summarizes S&S’s third quarter well.   

There are several highlights: new business wins at existing customer locations, pricing increases with significant clients (in one case 40%), and positive hiring metrics (up three employees compared to the start of the quarter, including hiring our first employee outside of the Youngstown area. However, we still need more employees to offset overtime and subcontractor costs that continue to kill profitability.

In addition to the personnel challenges, supply chain issues have also been a major barrier to growth this quarter. For example, our most critical filter media for water plants has seen a 90% slowdown in freight availability this year. However, we have avoided cost overruns in our waste-water plant projects by planning for this and communicating with our customers.

Finally, we have not been successful in improving our working capital problems. We are doubling down on our effort once again with sound solutions designed and currently implemented. We are poised to see significant gains in the fourth quarter.

New Company Pipeline

When Dillon Thompson, our Director of Private Investments, is not working expertly to improve our operating companies’ operational profitability, he is working hard to find new enduringly profitable service companies for us to acquire. His pipeline is always teeming with interesting opportunities - today is no different. It is focused on the managed information technology service space and a few add-on opportunities for our existing operating companies. While still too early to get more specific here, we remain excited to meet and learn from these incredibly talented entrepreneurs. They built unique businesses and are now looking for the proper transition plans and homes for their companies. We hope to help them.   

PUBLIC COMPANY INVESTMENT UPDATE

We remain focused on building a collection of publicly-held essential service companies with (1) broad insider ownership where management teams are aligned with investors on a long-term basis; (2) impeccable balance sheets for maximum financial flexibility; (3) high and stable returns on invested capital; (4) long-term revenue growth runways; and (5) most importantly, the trade-off between durable competitive advantages and the price paid for our shares skewed materially in our favor.

Since our initial allocation of public company capital at the end of Q3 2020, our return on capital deployed is 81% compared to the S&P 500 Index’s return of 31% through the end of September. In addition, year-to-date and Q3 2021 returns were 43% and 0%, respectively, compared to 16% and 1% for the S&P 500 Index.

Despite this exceptional one-year period of outperformance, we, frankly, do not expect it to continue to such a degree. But, again, we can’t say this enough - we remain relatively unexcited with our aggregate public company investment opportunity set because market valuations are too high.

That said, we don’t have to buy the whole market (i.e., index investing) and are not forced to put capital to work at any time. There is no master strategic plan nor a need to proceed in some ordained or conventional fashion. By remaining flexible and keeping our investment options open, we decide what makes long-term investment sense given a practical and tight circle of competence.  As Warren Buffett is fond of saying, “there are no called strikes in investing.” We have the luxury and patience to only invest when presented with a “fat pitch.”

One of the fat pitches that Spencer found during Q3 is a very well-run travel and entertainment service microcap company with very high insider ownership, an impeccable balance sheet, and an excellent free cash flow yield. The company had been on our radar in 2020 as a perfect post-COVID lockdown/“reopening” investment, but we passed on it at the time due to better opportunities. After selling our full position in Support.com (see Spencer’s insightful blog post about our exit entitled “Selling When Things are Divorced from Reality”), we started building a small position in this company when the COVID “delta” variant was rearing its ugly head.  

Other than our positions in AmerisourceBergen Corp, Berkshire Hathaway Inc., Criteo S.A., and Graham Holdings Company, we will continue to refrain from publicly identifying the eleven other companies in our collection as we are still building our positions. In most cases, these are illiquid, “trade-by-appointment” situations in very small public companies. 

 …

There were two important non-operational achievements during the quarter. First, our inaugural North Beach Advisory Board quarterly meeting was held in August. We welcomed, learned from, and were challenged by our three incredible Board members; we look forward to reporting to them again early next month. Second, we added one outside owner partner in the third quarter and are looking forward to adding two more this quarter - we are honored and humbled by their consideration of a long-term investment in North Beach.

…

 Thoreau again: “Everyone should believe in something. I believe I’ll go fishing.” Good thing there is no losing in fishing. Either you catch something or learn about the water you are fishing in (either way, it’s better than work!). The core focus of creating a best-in-class investment holding company is the ultimate trophy Dillon, Spencer, and I are fishing for every day, all day. Doing so will push hard on our investment strategy’s self-sustaining flywheel, which is simply owning enduringly profitable companies that generate free cash flow that we will use to own more and more enduringly profitable companies that generate more and more free cash flow.

As always, thank you for your continued interest in North Beach Holdings.

Best regards,

Russell P. Moenich

President/Chief Investment Officer