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Edited Transcript of CODI earnings conference call or presentation 2-Mar-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Compass Diversified Holdings Earnings Call

Westport Mar 2, 2017 (Thomson StreetEvents) -- Edited Transcript of Compass Diversified Holdings earnings conference call or presentation Thursday, March 2, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Scott Eckstein

IGB Group - IR

* Alan Offenberg

Compass Diversified Holdings - CEO

* Elias Sabo

Compass Group Management - Founding Partner

* Ryan Faulkingham

Compass Diversified Holdings - CFO

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Conference Call Participants

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* Larry Solow

CJS Securities - Analyst

* Kyle Joseph

Jefferies LLC - Analyst

* Leslie Vandegrift

Raymond James & Associates, Inc. - Analyst

* Doug Mewhirter

SunTrust Robinson Humphrey - Analyst

* Brian Hogan

William Blair & Company - Analyst

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Presentation

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Operator [1]

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Good morning and welcome to Compass Diversified Holdings 2016 fourth quarter and full year conference call. Today's call is being recorded.

(Operator instructions)

At this time, I would like to turn the conference over to Scott Eckstein of the IGB Group for introductions and the reading of the Safe Harbor statement. Please go ahead, sir.

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Scott Eckstein, IGB Group - IR [2]

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Thank you and welcome to Compass Diversified Holdings fourth quarter and full year 2016 conference call. Representing the Company today are Alan Offenberg, Chief Executive Officer, Ryan Faulkingham, Chief Financial Officer, and Elias Sabo a Founding Partner of Compass Group Management.

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 this morning, which includes reconciliations of non-GAAP financial measures discussed on this call. Please note that 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 may 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 that 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 Securities and Exchange Commission for the year ended December 31, 2016 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 statement whether as a result of new information, future events or otherwise. At this time, I would like to turn the call over to Alan Offenberg.

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Alan Offenberg, Compass Diversified Holdings - CEO [3]

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Good morning. Thank you all for your time, and welcome to our fourth quarter and full year 2016 earnings conference call. In the fourth quarter and full year 2016, our leading middle market businesses continued to generate solid levels of cash flow.

During this time, we also capitalized on market opportunities to complete platform and add-on acquisitions. Additionally, we strengthened our balance sheet by partially monetizing our interest in FOX and completing a public offering that raised additional proceeds.

Before talking about our subsidiary's performance in 2016, I'll review our acquisition highlights and success in using our financial strength to create even greater value for our shareholders. A major achievement in 2016 was the platform acquisition of 5.11 Tactical, a leading designer and marketer of purpose built tactical apparel and gear serving a wide range of global customers. Including law enforcement, military special operations and firefighters, as well as outdoor enthusiasts.

5.11 was a very attractive transaction for CODI, considering the company's recognized industry leadership, broad customer base and extensive product line. In addition, this acquisition was accretive to our shareholders. CODI acquired a substantial tax asset as part of our this transaction which will have a positive effect on CODI's annual cash flow.

Since acquiring 5.11, the company's performance has met our initial expectations. We are very excited about 5.11's growth prospects, as it continues to serve tactical professionals, and expand its consumer penetration worldwide.

During this period, we also reinvested in our current subsidiaries by completing four accretive add-on acquisitions. In January 2016, our subsidiary, Sterno Products, acquired Northern International, an industry leader in flameless candles and outdoor lighting products for a retail segment. The addition of Northern International has expanded Sterno's product offering into complementary categories and channels serving Sterno's primary markets, while continuing to build on the strength of the iconic Sterno brand.

Also in 2016, our subsidiary ERGObaby completed the completed add-on acquisition of Baby Tula. This transaction has strengthened ERGObaby's already attractive industry position through product extension, with Tula's premium baby carriers, toddler carriers, slings, blankets and wraps. The products are already sold to retailers and consumers in more than 70 countries worldwide from Tula's strong direct channel presence and growing international distribution relationships. We expect the addition of this high-quality brand will continue to support ERGObaby's growth.

In the same timeframe, our subsidiary, Clean Earth, completed two add-on acquisitions. This began with Phoenix Soil, a provider of environmental services for non-hazardous contaminated materials. Shortly afterwards, the Company acquired EWS Alabama, which provides hazardous and non-hazardous waste management services to 250 customers in 11 states across the country.

With these highly complementary acquisitions, Clean Earth has enhanced its already impressive growth potential, broadened its geographic reach and expanded is capabilities. These improved service offerings have everything created significant new cross-selling opportunities with both existing as well as potential new, regional and national customers.

In addition to our success on the acquisition front, in 2016, CODI also took steps to improve its financial liquidity. Our former subsidiary, FOX, completed three secondary offerings in which CODI participated. Through these offerings, CODI realized $182.5 million in proceeds while retaining approximately 14% ownership of FOX.

Supplementing this activity, we also consummated the sale of our majority owned subsidiary, Tridien Medical to Hill-Rom, receiving approximately $22.7 million in net proceeds. Through these transactions as well as other FOX secondary sales and past opportunistic sales of subsidiaries, we have increased the gains we have achieved for CODI shareholders to approximately $650 million since our May 2006 IPO.

By doing so, we also strengthened our financial and liquidity position, allowing us to continue to pursue compelling add-on and platform acquisitions. Additionally, in December, we completed a 5.6 million share public offering that raised approximately $99.7 million of net proceeds, which were used to repay a portion of the outstanding balance of our revolving credit facility.

Turning to our full-year 2016 results. Our niche industrial and branded consumer businesses generated solid levels of cash flow. In particular, our Sterno Products, ERGObaby, Manitoba Harvest and 5.11 subsidiaries each showed double-digit EBITDA growth for the full year.

Our niche industrial businesses produced solid results for the full year 2016, with a combined year-over-year revenue increase of 15.1% and EBITDA growth of 2.5%. This included a 56% revenue and 34% EBITDA year-over-year increase from Sterno Products, which continued to benefit from the addition of Northern International.

In our branded consumer businesses, we reported combined revenue growth of 9.6% for the full year 2016 and EBITDA growth of 15.4% compared with the prior year. These results reflect strong growth from our ERGObaby, Manitoba Harvest and 5.11 subsidiaries, which each reported year-over-year double-digit EBITDA growth. Our ERGObaby and Manitoba Harvest subsidiaries continued to benefit from the add-on acquisitions of Baby Tula and Hemp Oil Canada respectively.

Additionally, since assuming ownership of 5.11, this business continued to produce results in line with our expectations. For the three months and full year ended December 31, 2016, CODI generated cash flow available for distribution and reinvestment, which we refer to as cash flow or CAD, of $24.6 million and $76.4 million respectively. Fourth quarter CAD, which increased year over year and exceeded our distribution for the quarter, was impacted by higher CapEx spend during the fourth quarter. Ryan will provide further details in his comments.

For the fourth quarter, we paid a cash distribution of $0.36 per share, representing a current yield of 8.6%. This brings cumulative distributions paid since CODI's 2006 IPO to $14.64 per share.

To summarize, 2016 was a very exciting period for CODI. Based on the cash flow generation provided by our current subsidiaries, including the acquisitions we completed in 2016, we expect that our CAD will exceed our distribution for 2017.

Before turning the call over to Elias, I want to welcome Sally McCoy to CODI's Board of Directors. Sally was the CEO of our former subsidiary CamelBak while it was under our ownership. During her tenure, Sally's 30 plus years of specialty outdoor an active lifestyle industry experience made her an extremely valuable business partner.

We are very excited to welcome Sally back to the CODI family. I'm confident her broad branded consumer products and mergers and acquisition expertise will make her a strong addition to our Board, and we look forward to our contributions as a Director. I will now turn the call over to Elias to review the quarterly performance of our current group of subsidiaries.

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Elias Sabo, Compass Group Management - Founding Partner [4]

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Thank you, Alan. I will begin by reviewing our niche industrial businesses, which include advanced circuits, Arnold Magnetics, Clean Earth, and Sterno products.

Our niche industrial businesses continued to generate stable free cash flow in the fourth quarter. We reported a combined revenue increase of 15.7% during the fourth quarter of 2016 as compared to the year-earlier period, while EBITDA declined by 4.1% compared to the prior year.

The combined EBITDA margin declined 16.8% for the quarter ended December 31, 2016 from 20.3% in the prior-year quarter. Primarily due to investments made in our Arnold subsidiary, which temporarily depressed EBITDA margins, and Sterno's acquisition of NII, which has historically carried lower EBITDA margins.

Advanced Circuits reported fourth-quarter 2016 revenue that was consistent with the fourth quarter of 2015, while EBITDA increased 3.4% year over year. Reflecting growth in assembly and subcontract sales, which was partially offset by lower sales and long lead time PCBs and quick turn PCBs mainly due to the macro economic environment. Fourth-quarter EBITDA margins were higher by 60 basis points compared to the year-ago period. Based on ACI's 2016, results we believe 2017 revenue and earnings will be consistent with 2016.

Arnold Magnetics' fourth-quarter 2016 results were down from the fourth quarter of 2015. Revenue decreased 5.5% year over year, primarily due to lower sales in PMAG, precision thin metals and flex MAG. EBITDA decreased by 52% year over year.

As we mentioned on our previous call, we have hired an entirely new senior management team under the leadership of Dan Miller. Dan is making the necessary investments in lean manufacturing and engineering and sales talent which were the contributing factor to the lower results during the quarter as compared to the prior year.

Arnold continues to maintain a competitive advantage in the marketplace, and we believe the heightened focus on operational excellence and strategic execution it can reach our long-term expectations. Looking ahead, we expect 2017 results for Arnold will be comparable with 2016.

Clean Earth's fourth-quarter revenue rose 5% compared to the prior year. Primarily due to increases in contaminated soil volumes and the benefits of recent add-on acquisitions, including Phoenix soil and EWS Alabama.

Clean earth's fourth-quarter EBITDA declined by 3.1%, and EBITDA margins decreased to 20.1% compared to 21.7% last year. Mainly due to higher back-end costs at some of our soil facilities and acquisition-related costs. Clean Earth's performance continued to meet our expectations, and we expect them to achieve solid earnings growth in 2017 relative to 2016.

Sterno closed out the year with strong top-line growth in the fourth quarter, reflecting the add-on acquisition of Northern International. Revenue increased by 50%, and EBITDA increased approximately 10% compared to the year-ago period. In addition to the revenue and EBITDA contribution from NII, Sterno continues to show improved operational leverage due to manufacturing efficiencies. We expect Sterno will achieve modest earnings growth in 2017.

Next, let's turn to our branded consumer businesses which include Liberty Safe, ERGObaby, Manitoba Harvest and 5.11 Tactical. Please note the revenue and EBITDA numbers I provide for Manitoba Harvest and 5.11 will be on a pro forma basis as if these businesses were acquired on January 1, 2015.

Our branded consumer businesses achieved results for the fourth quarter of 2016, consistent with our expectations. Combined revenue increased by 21.7% on a year-over-year basis, while EBITDA on a combined basis rose by 41% compared with the prior year. EBITDA margin rose to 18.5% for the quarter ended December 31, 2016, compared to 16% in the prior-year quarter.

Liberty Safe reported solid results for the fourth quarter, in line with our expectations. Liberty's fourth-quarter revenue rose 7% compared to the fourth quarter of 2015, reflecting continued strong overall consumer demand, specifically in the dealer channel.

Fourth-quarter EBITDA margins with approximately 15%, compared with 18.4% in the year-ago period. This decrease in fourth-quarter EBITDA margins reflects higher steel prices as compared to prior year.

Given continued demand for Liberty's products, we expect Liberty will achieve modest revenue growth in 2017. With steel prices returning to more normalized levels, we expect 2017 earnings will be down slightly compared with 2016.

During the fourth quarter, ERGObaby continued to benefit from the add-on acquisition Baby Tula completed in 2016. Revenues increased by 26%, and EBITDA increased nearly 31% year over year. Reflecting solid international carrier sales, strong contributions from Baby Tula and improved margins based on channel mix.

The ERGObaby and Baby Tula brands have exciting new product launches scheduled for 2017. As these product launches are scheduled to occur during the middle of the year, we expect ERGObaby's results to be more back-end loaded than in prior years. For the full year 2017, we expect ERGObaby to achieve revenue and earnings growth as demand levels for their products remain strong.

Our Manitoba Harvest subsidiary experienced another quarter of strong top-line growth, as it continues to benefit from its 2016 acquisition of Hemp Oil Canada. Revenue grew by 75% for the fourth quarter of 2016 compared with the prior year. EBITDA increased substantially during the fourth quarter of 2016, while EBITDA margins grew to approximately 18% compared with 1.6% in the year-ago period.

These improvements reflect our success in obtaining organic hemp seed supply, and continued progress in building the company's infrastructure to support its continued growth. We remain excited about Manitoba Harvest's long-term prospects, however, we expect near-term results to be negatively impacted by excess inventory levels in our fastest growing market outside of North America. Due to the negative effects from this oversupply in that geography, we expect Manitoba Harvest to achieve only modest growth in 2017 and for growth to be weighted towards the latter half of 2017.

We continue to invest in strengthening the infrastructure of Manitoba Harvest, in we are pleased to announce that Bill Chiasson has accepted the role of CEO. Bill brings a wealth of experience to Manitoba Harvest, including prior roles as CFO of Levi Strauss, Senior Vice President of Finance of Kraft Foods and CEO and Chairman of LeapFrog Industries. Bill has a deep working relationship with CODI, and recently served as Interim CEO of ERGObaby and continues to serve as ERGObaby's Chairman of the Board.

Lastly, 5.11's performance during the fourth quarter was in line with our expectations. On a pro forma basis, revenue increased by 19% for the fourth quarter compared with the prior-year period, and EBITDA increased by over 51% as compared to the prior year. This increase in EBITDA was primarily due to the timing of a direct agency order, and growth in the higher margin retail and eCommerce distribution channels during the fourth quarter of 2016 compared with the prior-year period.

I would like to point out that 5.11 experiences seasonality in both its domestic professional and consumer channels, and as a result the first quarter tends to be the company's lowest quarter. Further, the timing of direct agency orders is hard to predict and can distort financial results on a quarter-to-quarter basis.

We expect 5.11 to produce both revenue and earnings growth in 2017, and we are investing a significant amount of growth capital to support its long-term growth initiative as Ryan will discuss in his section. I would now like to turn the call over to Ryan to add his comments on our financial results.

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Ryan Faulkingham, Compass Diversified Holdings - CFO [5]

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Thank you, Elias. Today I will discuss our consolidated financial results for the quarter and year ended December 31, 2016. I will limit my comments largely to the overall results for our Company, since the individual subsidiary results are detailed on our Form 10-K that was filed with the SEC this morning. At the end of my remarks, I will comment on CAD for 2017.

On a consolidated basis, revenue for the quarter ended December 31, 2016 was $318.6 million, up approximately 60% as compared to $199.5 million for the prior-year period. This year-over-year increase reflects notable revenue growth in our ERGObaby, Manitoba Harvest and Sterno subsidiaries due primarily to contributions from our add-on acquisitions as well as the revenue contribution from 5.11.

Revenue for the year ended December 31, 2016 increased to $978.3 million, an increase of $250.3 million or 34.4% compared to approximately $728 million for the prior year. The increase in revenue year over year is primarily the result of the contributions from our add-on acquisitions and 5.11. Net income for the fourth quarter was $2 million, compared to a net loss of $1.5 million in the year-earlier period.

During the fourth quarter, as a result of lower operating results at Arnold, we recorded $16 million impairment of goodwill. This impairment expense is preliminary and will be finalized in the first quarter of 2017.

For the year ended December 31, 2016, net income was $56.5 million, primarily as a result of a $74.5 million gain on CODI's investment in FOX. Net income for the year ended December 31, 2015 was $165.8 million, primarily due to the gain on the sale of CamelBak completed in 2015.

Cash flow available for distribution or reinvestment, which we refer to as CAD, for the quarter ended December 31, 2016 was $24.6 million compared to $16.1 million in the prior-year period. CAD for the quarter was slightly below our expectations, primarily due to lower operating results at Arnold as a result of our investment in operations and engineering and sales talent as well as increased CapEx spend at Arnold to strengthen its infrastructure.

For the year ended December 31, 2016, cash flow was $76.4 million as compared to $82.4 million for the prior year. Taking into consideration the cash flow accretive platform and add-on acquisitions we completed in 2016, we anticipate our CAD will exceed our distribution for the full year 2017.

Turning now to the balance sheet. We had $39.8 million in cash and cash equivalents, and networking capital of $250.3 million as of December 31, 2016. We had $565.7 million outstanding on our term debt facility, and $4.4 million in borrowings under our revolving credit facility as of December 31, 2016. We have no significant debt maturities until 2019.

In addition, we had net borrowing availability of $541.2 million under our revolving credit facility at quarter's end. Additionally, our 5.1 million shares of FOX had a value of $141.8 million at December 31, 2016.

Turning now to capital expenditures. During the fourth quarter of 2016, we incurred $6.6 million of maintenance capital expenditures compared to $4.5 million in the prior-year period. The increase was primarily due to Arnold, as I previously mentioned, and the addition of 5.11.

For the full year 2016, we incurred maintenance CapEx of $20.4 million as compared to maintenance CapEx of $18.2 million for the year ended December 31, 2015. The increase was primarily attributable to increased maintenance CapEx spend at Advanced Circuits and Arnold as compared to the prior-year period, as well as additional CapEx spend for 5.11.

For the full year 2017, we expect to incur maintenance CapEx of between $20 million and $25 million, and anticipate growth CapEx spend of between $15 million and $20 million as we continue to invest in the long-term health of our subsidiaries. As Elias mentioned earlier, the majority of our growth CapEx spend will be to support 5.11's long-term growth objectives. Including installation of a new ERP system, moving into a larger, more efficient warehouse and continued growth in our direct to consumer channel. In addition we expect to spend growth capital at our Manitoba Harvest subsidiary in order to increase our access to organic hemp supply and to enhance operational efficiency.

I'd like to now make a few comments on 2017 CAD. We mentioned previously in our remarks that we anticipate covering our distribution during 2017. In addition, Elias highlighted our overall expectations for earnings at each of our subsidiaries in 2017.

I'd like to remind investors of the seasonal nature of certain of our businesses, and as a result we generate our lowest EBITDA during the first quarter. Further, we anticipate our maintenance CapEx spend will be front-end loaded in 2017.

Our seasonally lower EBITDA coupled with this early 2017 CapEx spend will negatively impact our CAD generation in the first quarter. However, we look at the benefit of comparatively higher EBITDA and lower CapEx spend as the year progresses. I will now turn the call over to Alan.

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Alan Offenberg, Compass Diversified Holdings - CEO [6]

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Thanks, Ryan. In closing, 2016 was an exciting year for CODI, as we continued to take advantage of market opportunities by completing both platform and add-on acquisitions that were accretive to CAD. Additionally, we continued to strengthen our balance sheet by partially monetizing our interest in FOX accessing the capital markets.

I'll close by commenting briefly on M&A activity. Middle-market deal flow was steady and competitive in 2016. This was due to high valuation levels driven by the availability of debt capital with favorable terms, and financial and strategic buyers seeking to deploy available equity capital.

Our team remains focused on marketing CODI's beneficial ownership and management aspects to pursue attractive platform acquisitions, while maintaining our disciplined approach to deploying capital. In addition, we will continue to reinvest in our current subsidiaries through complementary add-on acquisitions. Looking ahead, CODI is in an excellent position to keep executing on this strategy, which should support our ability to drive cash distributions too and create long-term value for our shareholders.

This concludes our opening remarks, and we'll be happy to take any questions you may have. Operator, please open the phone lines.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Larry Solow, CJS Securities.

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Larry Solow, CJS Securities - Analyst [2]

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Hello, good morning. Thank you. Good morning, guys.

I was wondering if you could just maybe give us, my usual question, since you guys are in multiple industries out there, your view from the retail perspective, maybe the industrial perspective you get a little bit. What you're seeing in trends, and obviously who knows what's going to happen on the new presidential regime, what's going to happen there? But what's the tone you're seeing, any change in ones or would be great.

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Alan Offenberg, Compass Diversified Holdings - CEO [3]

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Sure, and, Larry, I'll ask Elias and Ryan to comment but I'll give it a try to start. I think that if we're looking simply through the lens of our Companies, the economy feels very similar to what it's felt like for the last few years. Meaning kind of slow and steady, a modest growth type economy. So I haven't seen any real dramatic shifts there I think that, as you alluded to, with respect to the new administration.

But broadly defined, I'd say it feels as though there's positive thought around changes, particularly with respect to corporate tax rates which could be interesting. However offset somewhat by concerns about potential border adjustment taxes and how that might impact certain companies. So I don't really have the clarity on that, nor do I think anyone else does yet at this point, but these are certainly things we're talking about at a subsidiary level all the way up through the CODI Board level.

With respect to the individual segments, on the industrial side, I don't know any particular changes or tones as it relates to the comments I just made on the macro side. And on the consumer side, I'd say that our Companies, again, are not seeing anything dramatically different. But I think some long-term trends, just based on what we've seen in the news in the last year, is that bricks-and-mortar retail is becoming challenging.

You're seeing some very prominent retailers that I've been around forever closing stores, some of them closing their entire group of bricks-and-mortar stores. So that long-term trend, we're not sure how it will shake our.

But one thing for sure is that online retailing is becoming obviously a big issue, and for some of our Companies that participate in that segment, making sure that they develop a comprehensive omni-channel strategy to distribute their products is definitely a very important strategic consideration that they're all working on actively and have been for some time. But just to give you some broad perspectives, I think I'll take a breath right there and ask Elias or Ryan if there's anything they'd like to add to that.

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Elias Sabo, Compass Group Management - Founding Partner [4]

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No, Alan, I think you covered it well.

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Alan Offenberg, Compass Diversified Holdings - CEO [5]

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Great.

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Larry Solow, CJS Securities - Analyst [6]

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Excellent. Just a couple of company specific, holding specific questions on some of your more recent acquisitions. On Sterno, I assume the pretty rapid growth obviously on the top line was helped by the acquisition, not so much on the bottom line. Is that mostly I guess because of their raw materials costs that have come back up?

And then just on Sterno, also in terms of you discussed the 5.11 Tactical, the initiative, the direct to consumer. How but at sterno? I though with that being such a well-recognized brand over so many years that the efforts of the direct to consumer might be something you would explore more? Thanks.

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Elias Sabo, Compass Group Management - Founding Partner [7]

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Sure, Larry, it's Elias. No, I would say that Sterno, we look over the course of the year rather than quarter to quarter things can shift around a little bit. Clearly, revenue was benefited by the acquisition of Northern International.

As we commented, Northern International has significantly lower margins than Sterno so it did have an affect to distort revenue growth a little higher and EBITDA growth not as high. And it may have looked like there was less bottom-line leverage than there actually was. We think Sterno is performing still really well, and we believe that 2016 was really a great year. It exceeded our expectations, both on the core Sterno brand and in terms of performance on top and bottom line.

And we're really excited about the NII acquisition and some of the things that we're doing. We've integrated that business now fully. We've put in some new management at the top, new general management, and we're adding some processes that I think are starting to bear some initial fruit. So we still feel pretty positive about that business, and think over the course of the year and including the fourth quarter that either met or exceeded our expectations across the board.

In terms of direct to consumer, I would say we really look at Sterno more as the based in the broad part of the business does go, especially on the Sterno side, Northern International deal a little bit different. But that Sterno side goes to food service and is more through that channel,

But what we are trying to expand on the Sterno brand, and we are trying to bring out products that will be placed at traditional retail and maybe used in camping and other products that are needed for heating food or liquids or the like. While your portable and you need mobility. So it is something were trying to capitalize on.

I would say as the Sterno talks about, we have a lot of products that out there that we think are achieving singles and doubles. I don't know that we have many home run products that have come out, but we do have a focus on broadening out the consumer side of Sterno's business. And it's something that has been growing as a percentage over the last few years, albeit from a relatively low base.

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Larry Solow, CJS Securities - Analyst [8]

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Got it. Okay, great. I appreciate it. Thanks.

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Operator [9]

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Kyle Joseph, Jefferies.

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Kyle Joseph, Jefferies LLC - Analyst [10]

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Hey, morning, guys. Thanks for taking my questions.

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Alan Offenberg, Compass Diversified Holdings - CEO [11]

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Morning, Kyle.

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Kyle Joseph, Jefferies LLC - Analyst [12]

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I appreciate the color you gave on the companies and their outlook pre and post election. I'm wondering are there any companies that are potentially impacted by the politics of the election? I guess I'm thinking specifically about Liberty Safes in general, and if there's been any change in the demand for their products?

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Alan Offenberg, Compass Diversified Holdings - CEO [13]

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The demand for Liberty's products has remained fairly consistent and strong. So from the finish of the year and based on what we've seen this year and we've given you the statement that we believe their revenues will be up slightly this year, based on what we know today. And so it does remain to be seen.

We just -- it's been a long time, obviously, since there's been a pro-firearms administration and so we'll have to see how the year shakes out. But based on what we see right now, demand levels remain steady and we're certainly hopeful of that to continue throughout the rest of the year.

I'd say with respect to some of the other companies, we certainly have heard very recently about potential meaningful increases in defense spending, which has an opportunity to provide some additional business to advanced circuits and Arnold. So that, again, very difficult to quantify, but again at the most macro level could be positive for those two companies.

And I think that the border adjustment tax that we hear a lot about, it certainly puts some challenges on some of our companies. I would say, 5.11 could have to navigate that a little bit, perhaps ERGObaby to a degree as well, and that's really -- I'll stop there. And again open it to my team for additional clarification or commentary should they have any.

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Ryan Faulkingham, Compass Diversified Holdings - CFO [14]

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Nope, that's good. Good, Al.

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Kyle Joseph, Jefferies LLC - Analyst [15]

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Yes, that works for me, thank you for that. You talked about middle market deal flow in general for 2016. Given what public market valuations did in late 2016 early 2017, have you seen a similar rally in terms of middle market company valuations and has that changed your thoughts on the buying versus selling in any way?

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Alan Offenberg, Compass Diversified Holdings - CEO [16]

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Valuations in middle market private M&A have really just been pretty robust for quite some time for the reasons expressed in the prepared remarks. And I would say that we have not seen over the years as much of a correlation as one would expect between public company valuations and private M&A valuations. And so I don't believe that we have any reason based on what we've seen to really have a change of view or strategy with respect to our own acquisition or opportunistic divestiture decision making.

And we have seen -- one thing I should have mentioned in the prepared remarks but didn't. At the very beginning of the year with respect to deal flow, it didn't seem like there was much change. I would say more recently here in the last few weeks, so I certainly don't want to call it a trend, but there certainly seems to be a modest pickup in activity with high-quality opportunities.

So that's a good thing. But no, we haven't really seen any changes to the middle market M&A valuations landscape, and as I said, it remains robust and has been robust for quite some time.

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Kyle Joseph, Jefferies LLC - Analyst [17]

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Got it. That's great color, thanks. And I just wanted again to the industrial or performance versus consumer. Consumer has seen good revenue growth, and then EBITDA growth outpacing that revenue growth.

Industrial, revenue growth has remained pretty strong but while EBITDA growth has trailed that. Is that just really Company specific developments made Arnold specifically, or are you seeing any competitive changes in either of those, call it, sectors?

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Alan Offenberg, Compass Diversified Holdings - CEO [18]

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Yes, on the industrial side and on the consumer side I think it's all company specific. I guess broadly characterizing the segments. The consumer side will typically be a higher growth group of companies versus the industrial companies, but it does get on a specific company-by-company level.

On the industrial margins, clearly we're as a group impacted by Arnold and some of the things that we've talked about there. Although we're really excited about what we're doing with the business now and where we think it can go. This past year certainly was a transition year in many respects, and we had to make some pretty meaningful investments into the Company which certainly put pressure on margins in the short term but we firmly believe it's the right long-term strategy.

As referenced earlier, on some of our consumer businesses, the acquisition of NII, which Elias mentioned. Great acquisition, we're super excited about it, and its integration is going really well. But as a business segment, it's a lower margin business than the core Sterno business.

But I would say the acquisition of NII makes Sterno a better company, regardless of the fact that there is some mix issue associated with the product margins in each segment of that business. And so beyond that, I don't really have any other specific comments that are obvious to me. But happy to elaborate if there's any area you want to poke into a little bit more.

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Kyle Joseph, Jefferies LLC - Analyst [19]

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No, that's great color and thanks very much for answering my questions.

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Alan Offenberg, Compass Diversified Holdings - CEO [20]

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Any time.

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Ryan Faulkingham, Compass Diversified Holdings - CFO [21]

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Thanks, Kyle.

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Operator [22]

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Leslie Vandegrift, Raymond James.

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Leslie Vandegrift, Raymond James & Associates, Inc. - Analyst [23]

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Hello, good morning. Just a quick follow up on, you were just talking about Arnold and the capital expenditures you had for the year trying to get that up to the I guess the new green technology efforts you've been talking about in the past. I was curious, it was $2.2 million of CapEx for the quarter, so about a third of it.

What exactly does that focus in, and then how much of that is done? So our we going to see that heightened level in 2017, or at least the beginning of it?

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Ryan Faulkingham, Compass Diversified Holdings - CFO [24]

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Yes, Leslie, I'll handle that. There was significant maintenance CapEx spend at Arnold in Q4 to the tune of about $2.2 million. Alan mentioned specifically that we're making some strong investments into machinery that really frankly needs to have, it in order to position the business to where not only it needs to be but where it can go.

We do anticipate that to continue in 2017. So Arnold will have increased maintenance CapEx year over year, so that trend will continue in 2017.

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Leslie Vandegrift, Raymond James & Associates, Inc. - Analyst [25]

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Okay. And then on 5.11, I know you discussed the direct agency orders and looking at -- seeing those new commerce channels, et cetera, direct to consumer, et cetera. But what is the CapEx you're looking at early in the year, because you discussed that would be a large portion of it as well?

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Ryan Faulkingham, Compass Diversified Holdings - CFO [26]

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Yes, so in terms of 5.11's CapEx, a large majority of it will be growth CapEx. They'll still have maintenance CapEx. But we highlighted the three main projects, one being an ERP system, another being significant investment in a new warehouse which will provide capacity and streamline operations, and also investing in the direct to consumer efforts as well.

So that will be a significant amount of the growth CapEx spend that I had indicated. The range we provided in our comments was $15 million to $20 million, again, a large majority that will be 5.11.

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Leslie Vandegrift, Raymond James & Associates, Inc. - Analyst [27]

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Okay. And then lastly, you talked about the ERGObaby products expected midyear. How much of an impact on the waiting do you think that will be for them?

You said, so front-end loaded a bit of the expenses there. Is that going to be a -- one new products, is this a whole line they're coming out with? I know you can't tell me a lot exactly, but the revenue expectation you see for them.

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Ryan Faulkingham, Compass Diversified Holdings - CFO [28]

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Yes, and, Leslie, we're not going to specifically talk about the products. But I would say Baby Tula has a product that is launching here, as does ERGObaby has a couple of products. And it will be staged second and third quarters as those launches happen, and so it will have an affect.

As you know, with consumer products when you are launching a new product, there's typically some costs that are born in anticipation of new product launches. There's a little bit of clearing of some inventory that happens to make room for some new product on the retail floor. So this is the normal part of business, especially for a company like ERGO that's constantly launching new products.

But we did want to identify that the calendar has shifted a little bit later in the year this year for product launches than what its been in prior years. And as a result of that, we would think the revenue and earnings of the business will be lower in the beginning part of the year than ti will be in the latter part of the year.

We're not going to give actual possession, but I would just say if you think about ERGO's first half as being lower than what would we expect in the second half. And really as these new products launch, getting the benefit of both that revenue growth but also in the first half absorbing a little bit more cost associated with that. And that combination, you can model out how that will affect the company.

But I also want to mention, we still feel positive about ERGObaby for the year. It's just the how the year will develop, maybe a little bit more back-end loaded terms of financial performance than the beginning part of the year.

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Leslie Vandegrift, Raymond James & Associates, Inc. - Analyst [29]

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Okay, thank you. I appreciate it.

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Alan Offenberg, Compass Diversified Holdings - CEO [30]

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Thanks.

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Operator [31]

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Doug Mewhirter, SunTrust.

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Doug Mewhirter, SunTrust Robinson Humphrey - Analyst [32]

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Hello, good morning. Most of my questions have been answered. First a very minor numbers question.

It looked like there was a reverse impairment or a write up on ERGObaby. I just wondered if you could give me a little more details on that or if I interpreted that correctly?

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Alan Offenberg, Compass Diversified Holdings - CEO [33]

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Yes, sure. In Q4, ERGObaby benefited from the ability to sell some of the Orbit Baby assets, and therefore took about -- received about $1 million in cash. And that would be the reversal in Q4.

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Doug Mewhirter, SunTrust Robinson Humphrey - Analyst [34]

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Okay, that makes sense. Second, you talked about be margin squeeze on Liberty Safe because of steel costs which makes sense. I would assume that you are reluctant to pass on those costs that the competitive environment is such that you could not raise prices unilaterally without a significant loss of volume?

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Alan Offenberg, Compass Diversified Holdings - CEO [35]

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I think historically, with respect to Liberty and its steel prices, they are typically able to pass along some of that. But in terms of a full recouping of a fluctuation in steel price, that's usually not been the way it's gone. And because of their relationships with their customers, because that can work two ways.

So I think you want to be mindful of not only your own business, but making sure you're a good partner to your customers. And so they've tried to walk that line pretty delicately over the years, and I think they've done so successfully. So we would expect them to be able to recoup some of it, but certainly not all of it.

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Doug Mewhirter, SunTrust Robinson Humphrey - Analyst [36]

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Okay, thanks for that. My last question is a more regulatory question. I saw the headlines where I think they officially classified the hemp plant as some sort of -- they upgraded the controlled substance in the United States and I know it's legal in Canada, which is why you have Manitoba.

Do you see any risk of the -- there'll be tighter regulations on the I guess the so-called manufactured hemp products that are now legal to sell in the US, which I'm sure you sell a lot of in the US? Do see any risk there from a regulatory perspective?

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Elias Sabo, Compass Group Management - Founding Partner [37]

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So we don't see any risk in terms of the ability to sell product in the United States. And I think there's clear case law that has already gone up to the circuit court level. This is from over a decade ago that established that hemp foods should not fall under the Controlled Substance Act in terms of being able to sell it.

It's rapidly growing in terms of distribution and it's becoming more mainstream. Some of the larger grocery chains and some of the larger big-box retailers are starting to pick this product up. So I think that further just solidifies the position that this is a food product, and is not subject to regulatory risk. And so we feel very good about that.

On the other side, I would say there has been some movement since our acquisition of Manitoba Harvest in terms of the cultivation of hemp in the United States, and that really was part of a farm bill that was introduced under the prior administration. As part of that, it was really for only research purposes. So today, the cultivation of hemp continues to remain within more of the university and research setting, and it hasn't moved farther along towards full legalization for commercial growing of hemp in the United States.

So I would say that we're still a ways off from that. I think the other component of that is not only do you need to grow it, but you need the infrastructure and assets to be able to process it. And is a, it's not just something that just immediately comes up. I think there's a few things.

One, crops need to generally become productive, which takes some time getting the infrastructure invested in, it takes a little bit of time. So if legislation was to pass that allowed for the cultivation of hemp in the United States, which it has yet to do, I think there's still a couple of year lag before you could see any real commercial volumes come on. So based on where we're at, we don't really see those being a US crop and a US competitive crop, at least for the next few years.

Now look, laws can change and the regulations can change with respect to that. But right now, we think we have a reasonably strong runway and we continue to build our brand.

Last thing I would note is, although we currently get our supply from Canada, if US was to change regulations obviously we would look at that as a market as well. But in terms of distribution in the US, we feel there is -- I don't want to say no risk because that's hard to say anything, but there is virtually little risk on any changes to being able to distribute in the US.

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Doug Mewhirter, SunTrust Robinson Humphrey - Analyst [38]

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Okay. Thanks for that. That's all my questions.

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Alan Offenberg, Compass Diversified Holdings - CEO [39]

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Thank you.

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Operator [40]

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(Operator instructions)

Brian Hogan, William Blair.

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Brian Hogan, William Blair & Company - Analyst [41]

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Good morning. A follow up to the Manitoba Harvest there. Can you elaborate on the elevated inventory and then on the impacts?

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Elias Sabo, Compass Group Management - Founding Partner [42]

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Sure. So we were, throughout 2016, we had a market in Asia that was growing very, very rapidly for us, and the distributors there ended up, and as you know, you generally go through distributors. Especially a lot of our companies do when we access international markets.

Our distributors were very, very strong. I think it really helped boost the last half of 2016. Unfortunately, the inventory levels that they've reported back to us are higher and the shelf lives of these products are pretty long.

So we're at a period where we have a glut of supply in that one particular market that needs to work through. And I think that definitely will have a negative impact on the business, especially in the first half as we're going to be comping from selling product into that market last year. We sold for the full year into that market, and in the first half of this year we see virtually no sales to that market as inventory levels rebalance.

Now we do think that notwithstanding the really material decline that we'll experience out of that market that we are having growth in other parts of our business, both in North America and elsewhere that will help to make up for it. But when you have your fastest growing and largest non-North American market go from being a large purchaser to really purchasing nothing for at least the immediate future here in the first half of the year, that's going to have a impact on financial results. That's why we wanted to point that out and let everyone know that although we still think that Manitoba Harvest will experience some growth this year, it will be negatively impacted and the first half will see the majority of that negative impact.

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Brian Hogan, William Blair & Company - Analyst [43]

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How much of your sales are to the Asian market?

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Elias Sabo, Compass Group Management - Founding Partner [44]

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We don't typically disclose that, but I would say it is a double-digit level of sales, a double-digit percentage.

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Brian Hogan, William Blair & Company - Analyst [45]

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Low double-digits or it's not a third, is it?

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Elias Sabo, Compass Group Management - Founding Partner [46]

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Yes, low double digits.

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Brian Hogan, William Blair & Company - Analyst [47]

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All right. And then can you comment on the leadership change there at Manitoba Harvest? Why the change, or is the founder still there?

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Elias Sabo, Compass Group Management - Founding Partner [48]

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Yes, so the founder is still there. When we acquired the business, we had always anticipated building out and strengthening the management team. The founder is really great, he actually presented at our investor conference last year.

And for all those who attended, I think you see his enthusiasm and excitement about the product and the opportunities and the benefits of hemp just as a superfood. But we were always anticipating upgrading and augmenting the management team, and being able to really push on a much more aggressive basis.

I think we've said all along we've viewed this much more like ERGObaby in terms of when we acquired that business, and the founder was still going to stay active with the business. But yet we wanted to build and augment a team around her in the ERGObaby case.

Well the same is true here with Manitoba Harvest. We've got a very strong founder, and for all intents and purpose has invented the industry, he's the grandfather of hemp. But we wanted to augment around him and his understanding of the product and enthusiasm for the product with the management. And we said that we're really looking to build out the infrastructure.

The first step of that is brining on a CEO who not only has worked with us so we know him and we feel that his style meshes really well and we know what his capabilities are. But also has relevant experience and is a senior position with Kraft Foods understands this industry really well.

So we feel really good about bringing Bill on as CEO. We're continuing to look to build out more of the senior management team, and we think that as we put these senior management assets in place it really sets the Company up well for long-term growth.

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Brian Hogan, William Blair & Company - Analyst [49]

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All right. And then collectively, I believe 5.11 and Liberty Safe have some exposure to Gander Mountain which I believe has or will be filing bankruptcy I guess. Can you quantify the exposure there?

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Ryan Faulkingham, Compass Diversified Holdings - CFO [50]

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We're not going to quantify the exposure on a company-by-company basis, but I think it's fair to say that in the context of our consolidated financial performance as a company that you wouldn't consider it material. And that each company is doing all of the things that you would expect them to do in the context of their relationship with Gander given the news of the last several weeks.

And we're very comfortable with how each of those companies are managing through that situation. And while it's not at all something that we're excited about, I think it's something that both companies are prepared for regardless of what the outcome is at Gander Mountain.

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Brian Hogan, William Blair & Company - Analyst [51]

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Sure. And then you took an impairment in Clean Earth as well, and since the Arnold is not nearly the same size -- .

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Ryan Faulkingham, Compass Diversified Holdings - CFO [52]

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No, that was not an impairment, Brian, that was a write down of assets. We got out of the facility in Williamsport, Pennsylvania that had been focused on the fracking industry. Obviously that industry has a dried up over the past years. But I think importantly to note is that we retained those permits, and should it come back we'd be in a position to capitalize and get into that again.

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Brian Hogan, William Blair & Company - Analyst [53]

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All right, thanks for the clarification. And then lastly, FOX factory, you obviously still own 14% of it and it's performed really well and had another strong quarter recently. I guess what are your plans for your holdings of FOX factory given your debt load and leverage and whatnot?

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Ryan Faulkingham, Compass Diversified Holdings - CFO [54]

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Yes, I think our strategy with respect to our FOX holdings remains consistent as it's been since we've taken the company public, which is to say that we are not in the business of owning minority stakes in companies. We've been pleased to own these FOX shares because we still have high regard for the company and its management team and its opportunities.

But we view that obviously as an investment while we own it, but view it as a source of liquidity to fund the growth of our business going forward. And as we have over the last several years, opportunistically monetized some of the positions. We would expect to continue to do that opportunistically going forward.

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Brian Hogan, William Blair & Company - Analyst [55]

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Okay. And then I guess just one final one. I think, Ryan, some of your comments about the first quarter being the seasonally weakest than some of the other by company, CapEx plans and whatnot. Were you suggesting that the first quarter CAD will be below the dividend, but the full year still be comfortably about that? Is that what you are suggesting?

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Ryan Faulkingham, Compass Diversified Holdings - CFO [56]

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Yes. The comments are that, yes, Q1 will be weaker relative to the other quarters. I think it is safe to say if you consider consensus as well as share offering in Q4, you'll see that. And that is right that as the year progresses, I would expect that we would exceed it and therefore exceed it on a full-year basis.

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Brian Hogan, William Blair & Company - Analyst [57]

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Okay, thanks for your time.

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Ryan Faulkingham, Compass Diversified Holdings - CFO [58]

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Thank you.

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Operator [59]

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I'm showing no further questions. I would now like to turn the call back to management for any further remarks.

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Alan Offenberg, Compass Diversified Holdings - CEO [60]

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Thanks, everyone, for joining us on today's call and following the CODI story. We look forward to sharing our progress with you in the future.

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Operator [61]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Everyone have a great day.