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Edited Transcript of CODI earnings conference call or presentation 28-Feb-19 2:00pm GMT

Q4 2018 Compass Diversified Holdings Earnings Call

Westport Apr 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Compass Diversified Holdings earnings conference call or presentation Thursday, February 28, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David P. Swanson

Compass Diversified Holdings LLC - Partner & Manager, East Coast Office of The Compass Group

* Elias Joseph Sabo

Compass Diversified Holdings LLC - Partner, CEO & Director

* Patrick A. Maciariello

Compass Diversified Holdings LLC - Partner & COO, CODI

* Ryan J. Faulkingham

Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer

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Conference Call Participants

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* Brian Dean Hogan

William Blair & Company L.L.C., Research Division - Associate

* Lawrence Scott Solow

CJS Securities, Inc. - MD

* Leslie Shea Vandegrift

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Leon Berman

The IGB Group, Inc. - President

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Presentation

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Operator [1]

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Good morning, and welcome to Compass Diversified Holdings Fourth Quarter and Full Year 2018 Conference Call. Today's call is being recorded. (Operator Instructions)

At this time, I would like to turn the conference over to Leon Berman of The IGB Group for introductions and the reading of the safe harbor statement. Please go ahead, sir.

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Leon Berman, The IGB Group, Inc. - President [2]

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Thank you, and welcome to Compass Diversified Holdings' Fourth Quarter and Full Year 2018 Conference Call. Representing the company today are Elias Sabo, CODI's CEO and Founding Partner of Compass Group Management; and Ryan Faulkingham, CFO. Also joining us today are Dave Swanson and Pat Maciariello, partners of Compass Group Management, who will review our subsidiaries' performance.

Before we begin, I would like to point out that the Q4 press release, including the financial tables and non-GAAP financial measure reconciliations, are available on the company's website at www.compassdiversifiedholdings.com. The company also filed its Form 10-K with the SEC last night, which includes reconciliations of non-GAAP financial measures discussed on this call. Please note that references to EBITDA in the following discussions refer to adjusted EBITDA as reconciled to net income in the company's financial filings. The company does not provide a reconciliation of the ratio of its estimated cash flow available for distribution and reinvestment to its distribution. This is because certain significant information is not available without unreasonable efforts, including, but not limited to, our company's future earnings, current taxes, capital expenditures and the distribution to be paid as approved quarterly by our Board of Directors. Throughout this call, we will refer to Compass Diversified Holdings as CODI or the company.

Now allow me to read the following safe harbor statement. During this conference call, we will make certain forward-looking statements, including statements with regard to the future performance of CODI. Words such as believes, expects, 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 Factors discussion in the Form 10-K as filed with the Securities and Exchange Commission for the year ended December 31, 2018, as well as in other SEC filings. In particular, the domestic and global economic environment 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.

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [3]

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Good morning. Thank you all for your time, and welcome to our fourth quarter earnings conference call.

I will begin by recapping our 2018 successes and challenges. 2018 was one of our busiest years ever. In February, we consummated the platform acquisition of Foam Fabricators. Foam Fabricators is performing in line with our expectations and is cash flow accretive. Also in February, we consummated the add-on acquisition of Rimports into the Sterno Group. Rimports is performing ahead of our expectations and is highly cash flow accretive. Throughout the year, we consummated 3 accretive add-on acquisitions for Clean Earth, which are performing in line with our expectations.

In September, we consummated the add-on acquisition of Ravin into Velocity Outdoor. Ravin performed below our expectations for our period of ownership in 2018. However, Ravin brings significant intellectual property and is highly strategic to Velocity. We are pleased with the Ravin acquisition and expect it to be cash flow accretive in 2019.

Also in 2018, we strengthened our balance sheet with the issuance of $100 million of perpetual preferred stock and the refinancing of our debt. The refinancing of our debt was a significant milestone for us, as we were able to issue an unsecured bond for the first time in our history. We also lengthened our debt maturities to 2023, 2025 and 2026, respectively. Not only did the refinancing enable us to lower our balance sheet risk, but we were able to lower our weighted average cost of capital, which we believe will provide significant benefits to our shareholders for years to come. We are pleased with our balance sheet flexibility; however, the refinancing did increase our blended interest rate and our total interest cost, providing a headwind to cash flow in 2018.

Now turning to our financial performance, throughout the presentation when we refer to pro forma adjusted results, revenue and EBITDA for Velocity, including Ravin, Foam Fabricators and Rimports will be as if these businesses were acquired on January 1, 2017.

During the fourth quarter, revenue increased by 1% and EBITDA declined by 12% on a pro forma basis from the fourth quarter of 2017. Our industrial businesses continued to perform above expectations, with revenue and EBITDA growth of 3.5% and 5.3%, respectively. Dave will provide further details in his section.

Our consumer businesses, however, performed below our expectations in the fourth quarter and throughout 2018. Fourth quarter revenue and EBITDA decreased by 2.3% and 34.5%, respectively. Pat will provide further details in his section.

During the fourth quarter, we experienced unusually large amounts of onetime expenses. Included in these numbers are approximately $4.5 million of onetime charges.

Over the course of 2018, we made significant investments in our 2 fastest-growing subsidiaries, which possess the potential to generate significant shareholder value. We invested heavily in the management, sales and marketing functions at Manitoba Harvest, causing a 14% decline in EBITDA year-over-year but accelerating revenue growth to 21% as a result. We also invested heavily in our 5.11 subsidiary, completing an ERP implementation, moving into our new distribution center and adding several new executive management personnel. These investments came at a heavy cost to EBITDA and given 5.11's negligible cash taxes, these costs weighed heavily on our 2018 cash flow.

Although our financial performance in 2018 was below our expectations, we are confident that we increased shareholder value as a result of our actions. Last week, we announced a definitive agreement to sell Manitoba Harvest to Tilray in a transaction that values Manitoba Harvest at up to CAD 419 million. This sale will generate a return on our invested capital that will far exceed our return threshold. We believe the strategic investments we made in Manitoba Harvest which caused margins to decline under our ownership were a catalyst that enabled this transaction to occur.

In the same regard, we believe the decisions we executed at 5.11, although painful and a drag on our 2018 financial performance, will serve to dramatically increase shareholder value in the future. As Pat will highlight, we anticipate strong revenue and earnings growth at 5.11 in 2019.

For the 3 months ended December 31, 2018, CODI generated cash flow available for distribution and reinvestment, which we refer to as cash flow, or CAD, of $22.9 million, representing a decline of approximately 10% over the prior year. For the year-to-date period, our cash flow grew approximately 2%. Our cash flow growth in 2018 was below expectations. However, we are pleased to have grown cash flow given the significant investments we made in 5.11 and Manitoba Harvest, mentioned previously. For 2019, we expect slightly above-trend subsidiary consolidated EBITDA growth and, as a result, expect a CAD payout ratio of 75% to 95%. Ryan will provide further details in his comments.

For the fourth quarter, we've made a cash distribution of $0.36 per common share, representing a current yield of 9%. This brings cumulative distributions paid since CODI's 2006 IPO to $17.52 per share. We are pleased to have produced cash flow that exceeded our fourth quarter and our full year 2017 distributions.

We also paid cash distributions on January 30 of approximately $0.45 per share on our 7.25% Series A preferred shares and approximately $0.49 per share on our 7.875% Series B preferred shares. Both distributions cover the period from and including October 30, 2018, up to, but excluding, January 30, 2019.

I will now turn the call to Dave to review our niche industrial subsidiaries' 2018 full year performance.

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David P. Swanson, Compass Diversified Holdings LLC - Partner & Manager, East Coast Office of The Compass Group [4]

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Thanks, Elias. On a pro forma adjusted basis 2018 revenues for our niche industrial businesses increased by 10.6%, while EBITDA increased by 9.4% compared to 2017.

Starting with Advanced Circuits, 2018 revenue increased by 5.4% and EBITDA increased 10% compared to the prior year, exceeding our expectations. We expect Advanced Circuits' 2019 financial performance to be roughly flat with 2018.

Arnold Magnetics' 2018 revenue increased 11.6% and EBITDA increased 35.8% from 2017, exceeding our expectations. We continued to experience increased demand across our aerospace and defense end markets, as well as benefit from operational improvements. We expect Arnold to achieve solid growth in 2019.

Clean Earth's 2018 revenue increased 26.4% and EBITDA increased 17% from 2017, meeting our expectations. Clean Earth continued to experience solid organic growth across its contaminated materials and hazardous waste service lines and benefited from recent add-on acquisitions. We anticipate solid growth in 2019 and we continue to seek add-on opportunities.

The Sterno Group's 2018 revenue increased 5.9% and EBITDA increased 4.5% from 2017, meeting our expectations. Sterno's 2018 margins were impacted by integration costs associated with the Rimports acquisition and increased chemical input costs. We expect Sterno to achieve solid growth in 2019.

Lastly, Foam Fabricators' 2018 revenue increased 1.6% and EBITDA increased 1.4% compared to the prior year, meeting our expectations. We expect Foam Fabricators' 2019 financial results to be roughly flat as compared to 2018.

I will now turn over the call to Pat to review our branded consumer subsidiaries 2018 performance.

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Patrick A. Maciariello, Compass Diversified Holdings LLC - Partner & COO, CODI [5]

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Thanks, Dave. On a pro forma adjusted basis, 2018 revenues for our branded consumer businesses increased 6.1%, while EBITDA decreased 14.8% compared to 2017.

Beginning with Liberty Safe, 2018 revenue decreased 10.1% and EBITDA decreased 31.3% from 2017, performing below our expectations. Liberty Safe experienced both a challenging outdoor sporting goods market and rising input costs due to steel tariffs. We expect Liberty's financial performance to stabilize in 2019 and be in line with 2018 results.

ErgoBaby's 2018 revenues decreased 12% and EBITDA decreased 36% from 2017, below our expectations. As we have discussed on prior calls, we believe the headwinds faced in 2018 were transitory and we expect a recovery in performance in 2019. We anticipate modest growth in revenue and earnings in 2019.

Velocity Outdoor's 2018 revenue increased 10.3%, while EBITDA increased 21.9% from 2017, due primarily to the addition of Ravin. As a reminder, for much of 2017 and early 2018 Ravin's products were on allocation to its customers and Ravin's customers were stocking inventory. Importantly, when we acquired Ravin, we assumed a normalized level of revenues and EBITDA when valuing the company. For 2019, we expect Velocity's financial performance to decline from 2018, in part due to tough comparisons for Ravin and in part due to continuing challenges in the outdoor sporting goods market.

Turning now to 5.11. 5.11's 2018 revenue increased 12.2%, exceeding our expectations, while EBITDA decreased 16.2% compared to 2017. As discussed on previous earnings calls, 5.11's margins were negatively impacted by the installation of a new ERP system, the transition to a new distribution warehouse and the recruitment of a number of executive management team members. With these activities largely behind us, we expect 5.11 to produce a strong rebound in margins in 2019, as well as continued solid revenue growth.

Lastly, on the Manitoba Harvest sale process, the process is moving along smoothly and we are hopeful the transaction closes in the next few weeks.

With that, I will now turn the call over to Ryan to add his comments on our financial results.

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [6]

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Thank you, Pat. Today, I will discuss our consolidated financial results for the quarter and year ended December 31, 2018. I will limit my comments largely to the overall results for our company since the individual subsidiary results are detailed in our Form 10-K that was filed with the SEC yesterday. At the end of my remarks, I will comment on CAD for 2019.

On a consolidated basis revenue for the quarter ended December 31, 2018, was $452.5 million, up 29.9%, compared to $348.4 million for the prior year period. This year-over-year increase reflects notable revenue growth at our Clean Earth subsidiary, which benefited from the 3 add-on acquisitions in 2018; increased revenue contributions from 5.11 Tactical as well as contributions from our acquisitions of Foam Fabricators and Rimports in early 2018 and Ravin in the third quarter.

Revenue for the year ended December 31, 2018, increased to $1.7 billion, an increase of $421.9 million, or 33.2%, compared to $1.3 billion for the prior year. The increase in revenue year-over-year is primarily the result of notable sales increases at Clean Earth, 5.11, Manitoba Harvest, Arnold and our legacy Sterno business, and also reflects our acquisition of Foam Fabricators and the add-on acquisitions of Rimports and Ravin.

Net loss for the quarter ended December 31, 2018, was $6.5 million as compared to net income of $49.1 million for the quarter ended December 31, 2017. During the fourth quarter of 2017, CODI recorded an income tax benefit of $38.7 million, primarily related to the enactment of the Tax Cuts and Jobs Act in December 2017, which lowered the U.S. federal corporate income tax rate from 35% to 21%.

For the year ended December 31, 2018, net loss was $1.8 million. Net income for the year ended December 31, 2017, was $33.6 million, primarily due to the previously mentioned income tax benefit.

Cash flow available for distribution or reinvestment, which we refer to as CAD, for the quarter ended December 31, 2018, was $22.9 million compared to $25.6 million in the prior year period. During the fourth quarter, our cash flow results were primarily impacted by lower earnings in our branded consumer businesses and higher interest costs than in the prior year. For the year ended December 31, 2018, cash flow was $93.7 million as compared to $92.2 million in the prior year.

Moving to our balance sheet, we had approximately $53.3 million in cash and cash equivalents and net working capital of $429.1 million as of December 31, 2018. We also had $496 million outstanding on our term loan facility, $400 million in senior notes and $228 million in outstanding borrowings under our revolving credit facility. We have no significant debt maturities until 2023 and had net borrowing availability of approximately $372 million under our revolving credit facility at the end of the year.

At December 31, 2018, our leverage ratio was approximately 3.9x. As a result of the expected sale of Manitoba Harvest, and assuming we receive the net proceeds we anticipate at close and 6 months thereafter, we estimate our pro forma leverage ratio will be approximately 3.3x. In addition, we will have pro forma revolver availability of greater than $550 million, providing us great flexibility in managing our business.

Turning now to capital expenditures, during the fourth quarter of 2018, we incurred $5.4 million of maintenance capital expenditures compared to $6.9 million in the prior year period. For the full year 2018, we incurred maintenance CapEx of $27.2 million, as compared to maintenance CapEx of $20.3 million for the year ended December 31, 2017. The increase in maintenance CapEx was primarily related to the acquisitions completed during 2018. During the fourth quarter, we continued to invest growth capital, spending $3.1 million, primarily at a 5.11 subsidiary.

For the full year 2019, we expect to incur maintenance CapEx of between $27 million and $32 million and anticipate growth CapEx spend of between $18 million and $23 million, as we continue to invest in the long-term growth of our subsidiaries. The larger share of our growth CapEx spend will be to support 5.11's long-term growth objectives.

I'd like to now make a few comments on our expectations for 2019, as well as explain how we will provide guidance to our investors going forward. As most of you know, the quarterly cadence of certain aspects of our CAD calculation are very difficult to predict, for example, capital expenditures and current tax expense, or cash taxes.

The recognition of capital expenditures in our financial statements is driven by a point in time at which an asset is placed into service, which may at times slip into subsequent quarters, reducing our ability to predict quarterly CapEx. Our subsidiary executive teams are limited to a budgeted capital expenditure spend in any given year; thus, on an annual basis, we can estimate it reasonably well.

The recognition of cash taxes, calculated under income tax accounting rules, are estimated by applying an annual expected tax rate to quarterly results. Certain of our companies begin the year in a taxable loss position, then move into an income position, which causes significant swings in quarterly cash taxes, diminishing our ability to predict our quarterly cash taxes. However, on an annual basis, we estimate cash taxes reasonably well.

Therefore, going forward we will provide our investors with an estimate of what our expected ratio will be of our annual common distribution to our annual CAD or our payout ratio. If there is a change in our annual payout ratio guidance, we will update our investors via our commentary in future quarterly earnings calls. As mentioned in Elias's comments, we anticipate our distribution payout ratio for the full year of 2019 will be between 75% and 95%, assuming the same level of distributions in 2019 as in 2018. Finally, I'd like to remind investors of the seasonal nature of certain of our businesses and, as a result, we typically generate our lowest quarterly EBITDA during the first quarter.

With that, I will now turn the call back over to Elias.

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [7]

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Thank you, Ryan. As we reflect on 2018, we generated year-over-year revenue growth and increased cash flows as we continued to provide shareholders stable and sizeable distributions. Our team continued to draw upon our strong balance sheet to capitalize on accretive market opportunities, and we are pleased to have completed a total of 6 accretive acquisitions during 2018, including 5 add-on acquisitions and 1 platform. As we look towards 2019, we are well positioned to have solid growth in consolidated revenues and earnings. We expect a stronger balance sheet position as a result of our expected sale of Manitoba Harvest and we anticipate generating our highest level of CAD since going public almost 13 years ago.

I would like to close by briefly discussing M&A activity and our forward growth strategy. Middle market M&A activity remains at historically high levels. Debt capital remains robust, with favorable terms and strategic and private equity acquirers continue to seek opportunities to deploy available capital. As a result, valuation multiples remain robust.

Our acquisition efforts will continue to focus on accretive add-on opportunities and selective platform opportunities where we can acquire niche market leaders at valuations where we can expect to exceed our weighted average cost of capital. Further, we will continue to consider opportunistic divestures in this robust market, in line with our strategy of creating long-term shareholder value. Going forward, we will maintain an intense focus on executing our proven and disciplined acquisition strategy, opportunistically divesting when appropriate, distributing sizeable distributions and creating long-term shareholder value.

With that, operator, please open up the lines for questions and answers.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Larry Solow from CJS Securities.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [2]

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Just a couple on the guidance outlook, Elias. It seems like a pretty wide range at 150 to 190. Is it just variability at some of your larger holdings that's driving that, or anything in particular?

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [3]

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I think it's just still early in the year, Larry, and so we'd like a little wider range. Obviously -- and there's a lot of factors that can affect it. I think Ryan did a really good job of highlighting some of the things are a little more unpredictable. In some cases, we increase our CapEx if we think there is good opportunities to pursue -- in some cases, maintenance CapEx as well. That can have a negative effect on CAD. As you know, our cash flow is actually defined as our CapEx, not our depreciation. And so that can affect it. And it could be for a good reason. We're investing in the business because we may think there's good opportunities to pursue. So we just felt it was prudent at this point in the year to have a wider range. I think as we go through the year our goal would be to narrow that as we get more kind of clarity on how the year is developing. And clearly, the economic backdrop is going to play a reasonably large role in what we're able to produce. We're assuming sort of consensus GDP growth out there. But if that is higher or lower, clearly that could make us move around within the range.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [4]

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Fair enough. So it sounds like you're assuming a similar sort of economic backdrop that we're in now. Obviously, that could go one way or the other, but . . .

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [5]

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Yes, probably a little bit slower economic growth in 2019 than what we experienced in '18. That's what we've factored in. But I think consensus is 2% to 2.5%. That's sort of what we're factoring in with our guidance.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [6]

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And did you incorporate, or maybe not, just on the sale of Manitoba? I think that would actually be accretive to CAD if you -- is that included in that number or not?

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [7]

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So as of right now, Manitoba Harvest is included in the number as if we continued to own it. We'll update guidance after the sale, likely on our first quarter. That being said, given the timing of payments I think as we communicated in our release, we're getting a portion of our proceeds upon the close. We're also getting a portion of the proceeds 6 months later. So as a result of that, it doesn't have as much of a positive CAD impact given the staging of those payments. I would say the other expectation we have is Manitoba Harvest is expected to be more -- seasonally they're expected to be weakest in the first quarter, the period that we're still owning them. And so as a result of that, both of those sort of distort what the kind of CAD impact will be upon divestiture. So that's something that we'll update after the closing.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [8]

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Okay. Fair enough. And then obviously Manitoba, that announced sale sounds opportunistic. Just in general, the environment out there, anything could happen for you guys. But obviously, you mentioned you have a good amount of liquidity now. And you've continued to do tuck-in acquisitions, which seem easier at least for you guys strategically in an elevated price environment. Pricing -- but have prices and quality of stuff that you've been seeing in terms of stuff on the market changed at all the last couple quarters?

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [9]

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No, not really. I think there was a modest probably dip in what you had in December, early January, probably as much to do with credit markets which started to get really tight. The term loan market in particular really sold off, as did the bond market. So that drives a lot of M&A activity and valuation multiples. But appreciate that was only over about a 4-week period. And so it was so temporary that it didn't derail or cause multiples to decline. I think there is more talk now about where we are in the cycle. You start to hear that a little bit more. So that can overall have an impact on kind of activity. But as of yet, Larry, we're still seeing activity at historically high levels, I would say, or at least pricing at historically high levels. So we continue to be really patient. This is what I think where our capital structure and the permanent capital that we have really stands out. Our strategy is we're always open for business for a new platform acquisition, but we're also going to be very disciplined on pricing. And in today's market that makes it more unlikely to actually find an asset that kind of meets our pricing and return thresholds. But that being said, as you've identified, we feel really good about our strategy to continue to do tuck-in acquisitions at much more favorable prices. Generally can also have some ability to create savings and even higher levels of accretion. And then we remained positioned with a strong balance sheet. But we still would consider opportunistic divestitures, given where we are.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [10]

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Great. And then just a couple questions. You guys did a good job of giving us the outlook for each holding. But just on Sterno, seasonally I know the core Sterno was strongest in Q4. And I don't know, I would think their Rimports section would be pretty strong in Q4. So just curious why sequentially it was sort of flat Q3 to Q4 on the EBITDA basis. Anything there that's noteworthy?

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Patrick A. Maciariello, Compass Diversified Holdings LLC - Partner & COO, CODI [11]

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The only thing I would just be a slight shifting in sort of the type of holiday promotions at a couple of our customers, one in particular, where kind of a bigger focus on Q3 than last year and a slightly lesser focus on Q4 than last year. Nothing really in total though out of the ordinary.

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Lawrence Scott Solow, CJS Securities, Inc. - MD [12]

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Okay. And then just lastly, maybe for David, just on Advanced Circuits, I know it's not quite one of your bigger holdings these days, but still more than a rounding error. Had a very good quarter and a good year in '18. Might we get a little more growth in '19 than sort of the flat expectation you mentioned?

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Patrick A. Maciariello, Compass Diversified Holdings LLC - Partner & COO, CODI [13]

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This is Pat. So I'd say it did -- the company's doing -- it had a good quarter. The company's doing a good job of attracting defense customers, which hasn't historically been sort of their core customer base. We're optimistic that what you said is a possibility, but nothing we'd commit to right now.

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [14]

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Yes. I would say, Larry, we still look at the backdrop of the industry that we are participating in, which is not really a robust industry, in circuit boards. I mean, this company is an awesome company to produce free cash flow. I think as you look at it, it has very little CapEx, doesn't pay a lot of taxes. The working capital is negligible. So from a just producing free cash flow, it is a great company. It is also very predictable and doesn't have a lot of kind of variability, either quarter-to-quarter or year-to-year. I would say kind of the other side of that is it's not a great growth business because it doesn't fit in a great growth industry. And so although 2018 was very positive and we're really pleased with Advanced Circuits, I think coming off that strong of a year it's probably reasonable to expect kind of this year to moderate.

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Operator [15]

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Your next question comes from the line of Leslie Vandegrift from Raymond James.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [16]

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Just a quick follow-up on Clean Earth. You mentioned the impact of acquisitions last year. But at the end of the year, it underperformed at least our estimates. Was there any impact from the government shutdown? Did they have contracts with them that had issues?

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David P. Swanson, Compass Diversified Holdings LLC - Partner & Manager, East Coast Office of The Compass Group [17]

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No, no noticeable impact from the government shutdown, nothing specific. I think there was a little bit of wet weather, particularly in the Northeast in the fourth quarter, which creates some timing for certain work. But no impact that we noticed from the government shutdown.

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [18]

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And I would just add, Leslie, that Clean Earth is a business, as we all know, that can have some lumpiness in its quarter-to-quarter cadence. We don't really look at quarter-to-quarter with that business. We look much more on an annual basis. From an annual basis, 2018 was a really good year. Not only were the tuck-ins very accretive, but the organic growth in both lines of business that constitute 90-plus-percent of our EBITDA, contaminated materials and hazardous, both of those grew above what kind of the long-term normalized growth rate is. As you know, projects year to year can go -- one might be in the third quarter this year, in the second quarter the year before. So that can distort quarterly comparisons. But I would say with Clean Earth, because of that we really need to look on an annual basis. And we're extremely pleased with the performance. It was one of their -- it was a really good year of performance for Clean Earth and we expect 2019 to carry on with that.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [19]

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Okay. And then, on that note, you mentioned the possibility of some near-term acquisitions again for Cleaner. Now what's the overall appetite there just over the next 12, 18 months?

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David P. Swanson, Compass Diversified Holdings LLC - Partner & Manager, East Coast Office of The Compass Group [20]

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Yes, we think this is a core competency of this company and this management team. Their track record with the add-ons has been really strong, both in terms of growing revenue and improving efficiencies. And it's a very fragmented market, so we think there's a lot of opportunity to continue what Clean Earth has been doing. And the track record would suggest very accretive add-on acquisitions. And we're seeing a lot of opportunities to continue that, I'd say particularly on the hazardous side of the business.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [21]

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Okay. And then on the sale of Manitoba, part of the deal obviously is the receiving of some stock from Tilray. And was curious. You guys held the Fox Factory shares for quite a while and made a large gain on those when you sold them. What's the plan for the Tilray stock? Kind of same idea, hold for a longer period? Or is that more of a short-term plan, given your (inaudible) today.

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [22]

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Yes. I would say just broadly, in general, our business is not to hold publicly traded companies because, as you know, we are -- predominantly we look to generate income on our assets and holding publicly traded stock is a non-income-producing balance sheet asset. So that would just be sort of our broad statement. We don't give timing expectations with respect to divestitures of any assets, including publicly traded companies that we have on our balance sheet. That being said, I would say as we looked at this transaction and Manitoba Harvest is -- kind of was our fastest-growing business from a revenue standpoint and was really positioned incredibly well. And I think as some of the legislation is changing and we're finding what kind of what we term internally this hemp curiosity that was starting to take place, we had real positive views as to this company and its opportunity. And the company has announced recently that it's entering into the CBD market in states where it's legal to distribute, which is another huge positive. So all that being said, I would just say, Leslie, we are very positive about the company. And when we divested it, it was at a price that we thought was great for our shareholders. But equally important is we thought the buyer here was just the ideal partner for this company and that together they would be able to do more than what we would have been able to do with this company on our own. So we have a very favorable outlook, kind of the entire space, on the buyer and on Manitoba. And so we feel good about the shares that we're taking, which is why we took a relatively healthy slug as part of the consideration here. But we're not going to give kind of any public announcement yet as to what our intentions on timing are with those shares.

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Leslie Shea Vandegrift, Raymond James & Associates, Inc., Research Division - Senior Research Associate [23]

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Okay. And my last question just kind of hits 5.11 and ErgoBaby directly. You've had a lot of expansion, certainly on the 5.11 side, with the retail store space. And obviously, brick and mortar, as everybody knows, has had its trouble overall. What's the reasoning or I guess the valuation there on expanding retail stores versus putting that CapEx into marketing and online sales, given the overall market for brick and mortar?

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Patrick A. Maciariello, Compass Diversified Holdings LLC - Partner & COO, CODI [24]

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Yes. I don't think it's an either/or and I think that to some extent your retail stores help drive online as well, so, first of all, I'd say. Within those the ROI we're able to kind of see as we model these out and as they come to fruition, these stores significantly surpasses our threshold. And we also think it's great for consumer awareness. We try to place these stores in areas that there's a lot of people driving buy seeing our signs, lot of curiosity. And we think so far it's doing great things for the brand, and at the same time having a really positive financial impact.

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [25]

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Yes, Leslie. I think the other thing just to keep in mind here is that the channel that 5.11 goes through, which is sort of the outdoor/sporting goods channel, is one that has seen dramatic consolidation. We see the negative effects of that on Velocity Outdoor and Liberty's results kind of over the last couple of years. But there's just a limited number of distribution points that exist out there. And because this is an apparel product and it is more from a gender base, it's more of a male product than female, overwhelmingly more male, we think it's important to have physical points of distribution where people can go in that are being exposed to the brand and get the feel, how it fits. There's just some important aspect as we are bringing in new customers. So we feel that it's really important because there's not as well-established of a distribution network to go through more a traditional consumer wholesale approach that we have some of our own. Now I will also say that our approach is more of an omnichannel approach, so we do have online consumer wholesale, traditional brick-and-mortar consumer wholesale, and then both our own brick and mortar and online and they all work together. What we're able to do in our own stores is really merchandise the entire line and we're able to create experiences that are different than what some of our consumer wholesale partners that are likely going to go deeper on a fewer SKUs and have kind of other brands so they can't create the experience that we are able to around our brand. So we think that these all work synergistically. There's other businesses that have done this extremely well. And we're really excited about it. We brought in a new executive chairperson in Matt Hyde earlier this year and he is helping to really drive the strategy on our direct-to-consumer. And we couldn't be more excited about what we're seeing out of that business and think that can be a great growth engine here for the next few years.

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Operator [26]

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Your next question comes from the line of Brian Hogan from William Blair.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [27]

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Can you answer a quick question on your leverage? You said you're targeting -- well, pro forma it's 3.3 for the Manitoba Harvest, assuming you get all the proceeds. What level are you targeting? Is that what level you're looking for? Is it more like 3? I know you can go up to 3.5 on a normal course and with expansion up to 4.25 with acquisitions. But just what are you comfortable with?

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [28]

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Yes. So Brian, those covenant metrics are actually from our old credit agreement. So one of the things that Elias mentioned in his comments was this refinance we did provided really good flexibility to us as we manage our business because the covenant metrics that we live in today are 3.5 on our senior, so senior being our revolver under Term Loan B, and 5x total. So we're comfortably, even at 12/31, at a little over 3.9x leveraged, we're still comfortably within our covenant. So this brings us down into more comfortable zone. So we don't typically talk about a target. I think what we think about in balance sheet risk is maintaining availability on our revolver, which we have. That gives us the flexibility we need to manage our business. So I think 3.3 is a nice place to be. I think we always seek, though, to have a good balance sheet and a strong balance sheet. So if that were to go down even further, that's good news. But I think where we sit today pro forma for Manitoba Harvest is a real good position to be.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [29]

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All right. And then, on Sterno, I'm just kind of backing into what the organic growth rate was for the business in the quarter. I didn't see the contribution from Rimports in the 10-K for the year, so I was just kind of wondering if you would provide that.

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Patrick A. Maciariello, Compass Diversified Holdings LLC - Partner & COO, CODI [30]

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Brian, we've not…

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [31]

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Yes. So the Rimports full year number is in the MD&A. So you'll be able to back into. . .

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [32]

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(inaudible)

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [33]

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It's in our section in the consolidated section of the MD&A.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [34]

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Okay, consolidated section. All right.

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [35]

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It's in there. Sorry if you've got to dig for it, but it's there.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [36]

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Okay, I missed that part in the consolidated. I just didn't see it in the Sterno section. And then likewise is that the same thing for Velocity? Can you see the Ravin contribution?

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [37]

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Yes, Ravin -- no, Ravin's not there. It's not there. But if you look up the information on the website, inside of that Excel file you'll be able to -- I think you'll get some helpful data there, which is on our website.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [38]

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All right. And then, can you comment on 5.11's growth expansion plans? Is it still more adding more stores? What is the -- or is that kind of you were adding a lot of stores and have you backed off of that a little bit and basically getting down to what are same-store sales? I know it's on a small base and I get that. And it's hard to read. Established stores are growing. But how has that view changed?

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [39]

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So Brian, the stores are doing exceptionally well. But it's off of a small base. And so I would caution everybody that when we look at same-store sales, and one of the reasons that we don't give out same-store sales data right now is because you look at a kind of a little over 40 stores and it's just too small to make sense, especially given that a lot of these stores are relatively new. And as you know, there's a ramp-up period that is going to make your percent of same-store sales look stronger based on that. So we look at by whole by cohort going back 4 years, 3 years. And our same-store sales comps are meeting or exceeding what our expectations are by cohort. But again, as you get back a few years it might be on 3 stores, so it doesn't really give you a lot of great data. We believe that these stores are absolutely a critical part of our strategy going forward as we evolve this brand from what was traditionally just a professional brand to what will be -- is now more of a consumer lifestyle brand. And so we are fully committed to continuing to invest in our retail store development, with the proviso that the numbers continue to look attractive to support that. And right now that remains the case. So that is our sort of de facto position going forward. I would say because of everything that we did over the course of 2018, and we had a really busy year, we may have a few less store openings in 2019 than we had in 2018. And much of that is we had a lot of new executive management personnel who also believes fully in this kind of strategy and what we're building out. But as they're getting integrated in and as we're really defining and honing in, one of the good things is when you get to 40, 50 stores you can really start to mine through the data, figure out what is working really well, figure out what's not working so well. And you can adjust your strategy so that your probability of success on your next store opening is higher. So we're in the process right now of doing that. That probably will make our store opening count in '19 be temporarily lower than what it otherwise would. But we think this is really a -- not only is this financially accretive in terms of high return on invested capital, kind of has a very quick payback, but it's also really strategic because it continues to drive the business more towards a consumer lifestyle brand. So for those reasons we are remaining committed and will so as long as the store performance remains strong as it is.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [40]

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Sure. And then the ERP system, is that headwinds completely behind you at this point, do you think? And with that also I would say is the bankruptcies in the industry, if you will, distributors headwinds, are they behind you as well, in your opinion?

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Patrick A. Maciariello, Compass Diversified Holdings LLC - Partner & COO, CODI [41]

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Brian, this is Pat. On the ERP, there's little issues always here or there as you move through. But in the U.S., which is most of our distribution, we strongly believe the largest issues are behind us. There will be some implementation in Europe, but that's -- we have some learnings that we've taken from the U.S. We believe that will go much smoother. So that's number one. Your second question I believe was on bankruptcies in the industry. We look at this every day. I'd say I don't see another Gander out there right now and we're optimistic that that won't happen this year. And so that's all I'd say. We've looked over the landscape and we're comfortable now that there's nothing like a Gander on the horizon.

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [42]

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Yes. And Brian, 2018 -- the end of '17 and '18 were very disruptive because we had these ERP and warehouse transitions both going and they went at the same time. We also had a bunch of executive management personnel changes that occurred. So when you have all of that, that's a lot for the company to go through. Frankly, I think the financial performance of the business and the margins that the company generated despite those activities was strong. And now I know that it wasn't strong relative to history or what we all expect, but considering those factors I think it was really good. As we said in our commentary, we believe the vast majority of that is behind us. Will we have a little bit of tweaking here or there on the ERP to get out more efficiency? Yes. But the disruption part of this is behind us. And so we believe that, other than maybe talking about a comp to a prior year, we believe we won't be talking about the ERP as an issue in '19 and beyond.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [43]

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Sure. And then switching over to ErgoBaby, excluding [Baby 2], it looked like the Ergo sales legacy, if you will, were down 30% year-over-year. Is that still impacted by the Babies "R" Us bankruptcy? Or what's -- and obviously Amazon as well [impacting]. But what's driving that?

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [44]

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I don't think those numbers are exactly accurate. Ryan, is there -- we'll get you the exact numbers after. But I would say the -- and I think some of the toy companies, other companies with exposure to Babies "R" Us have said the same thing. The business that was lost at Toys "R" Us and Babies "R" Us hasn't sort of bounced back into other places in the market as quickly as we would have hoped. I think we're on solid footing now as we enter into 2019, but that was a big part of the driver in Q4 2018.

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Ryan J. Faulkingham, Compass Diversified Holdings LLC - Executive VP, CFO & Co-Compliance Officer [45]

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Yes. And Brian, just to give you overall, so ErgoBaby's consolidated revenues dropped 12% year-over-year, of which ErgoBaby performed better than the Baby Tula brand. And so by definition of that statement, ErgoBaby was less than the 12% for the year. And that was with some pretty significant inventory changes in our global distribution system that served as a massive headwind. So we think the Ergo, sort of the core legacy Ergo brand which constitutes most of the revenue in the business, is sort of a mid-single-digit down year-over-year. But considering some of the headwinds that it faced which we think are more transitory, we think that it's poised for 2019 to be stronger.

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Brian Dean Hogan, William Blair & Company L.L.C., Research Division - Associate [46]

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Sure. And then one last one. And I guess what business or businesses -- I'm not asking you to pick a favorite child -- are you most excited about now from a growth opportunity and market potential?

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [47]

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Yes. So I think when you look at our portfolio of subsidiaries we have some really great businesses that produce stable and predictable cash flow. I think of a company like a Sterno or an Advanced Circuits. I mean, these are really just great free cash flow providers. And that's consistent with what our business model is. We provide very sizeable distributions to our shareholders. We need to focus on generating really strong free cash flow as a result. But sometimes that comes at the expense of having rapidly growing businesses. I would say if you looked at how we kind of construct the portfolio, we had always thought of really kind of the 2 primary businesses that were going to generate organic growth were 5.11 and Manitoba, that have -- when I say generate, really strong organic growth. And then we look at our other 8 companies and we say, okay, those are going to generate really good solid free cash flow. And the way that we're going to be able to help lever that up is through some tuck-in acquisitions. So there are 2 companies that I would say have pretty favorable outlooks right now that can drive kind of accelerated free cash flow -- or accelerated shareholder value growth. First and foremost is 5.11. It's the company that has the biggest market potential and the one that has a very large potential multiple on exit, given its shift to consumer lifestyle. And so that's a business that we continue to believe internally can be transformational to the entire company. I would say the second company which has just done such a phenomenal job and continues to do a great job is Clean Earth because it's able to continue to consolidate amongst what are a lot of 1- and maybe 2-plant operated small mom-and-pops that are out there. These are bought at really attractive valuations. And that company, that management team, is so skilled at integrating these that in many cases we're finding these are low single-digit multiples post synergies that we're able to bring them in. That is massively value accretive. So I would say those 2 companies, in particular, now that Manitoba is being sold, have really large potential. But 5.11 in terms of if you think about transformational potential, i.e., what we had with a Fox years ago, I would say the one company that potentially if we execute well can get there would be a 5.11.

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Operator [48]

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I am showing no further questions at this time. I would now like to turn the conference back to Mr. Elias Sabo.

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Elias Joseph Sabo, Compass Diversified Holdings LLC - Partner, CEO & Director [49]

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I'd like to thank everyone again for joining us on today's call and for your continued in CODI. We look forward to sharing our progress with you in the future. Thank you, and have a nice day.

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Operator [50]

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This concludes Compass Diversified Holdings conference call. Thank you and have a great day.