Compass Diversified Holdings (CODI) 2016 Q3 法說會逐字稿

Good morning, and welcome to Compass Diversified Holdings' 2016 third-quarter conference call. Today's call is being recorded. All lines have been placed on mute. (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.

Thank you, and welcome to Compass Diversified Holdings' third-quarter 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'd like to point out that the third-quarter press release, including the financial tables and non-GAAP financial measure reconciliations, and of the Company's form 10-Q, which includes reconciliations of non-GAAP financial measures discussed on this call, are available on the Company's website at www.compassdiversifiedholdings.com. 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 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, 2015, 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 would like to turn the call over to Alan Offenberg.

Good morning. Thank you all for your time and welcome to our third-quarter 2016 earnings conference call. In the third quarter, we continued to generate stable free cash flow across both our niche industrial and our branded consumer businesses. We also took advantage of market opportunities by consummating and accretive platform acquisition, while also continuing to realize gains for our shareholders.

Before discussing our subsidiaries' third-quarter performance, I would like to talk more about our recent acquisition and our success in monetizing our interest in Fox Factory Holding Corp., or Fox. During the quarter, we utilized our strong balance sheet to continue growing our family of leading middle-market businesses by completing a platform acquisition of 5.11 Tactical, a leading provider of tactical apparel and gear that serves a wide range of global customers, including law enforcement, military, special operations and firefighters, as well as outdoor enthusiasts.

5.11 represented a very attractive transaction for us because it already possessed many of the qualities we look for in our Companies -- a commanding leadership position, a broad customer base, as well as an expensive product line. Equally important, their management team is quite seasoned with a proven track record of success. 5.11 also has compelling opportunities for further growth as we expect the company to expand its consumer penetration globally.

In addition to adding a company that we believe has many of the qualities we consider essential for success, the acquisition of 5.11 was also accretive to our shareholders. As part of this transaction, CODI acquired a substantial tax asset, the positive effect of which will be meaningful for CODI's annual cash flow.

Overall, we expect this transaction to provide $0.30 to $0.35 per share of cash flow accretion to CODI on an annualized basis. We are very excited about this addition to the CODI family, and have already started working with CEO, Tom Davin and his team to continue serving tactical professionals, while working to grow 5.11's presence in the expanding tactical consumer market.

During the quarter, we also generated $63 million in proceeds from our partial divestiture in Fox. We remain a substantial shareholder in Fox and continue to be excited about the Company's growth potential. Also, during the quarter, we consummated the sale of our majority-owned subsidiary Tridien Medical to Hill-Rom. We have enjoyed our time working with Tridien's management team, and appreciate their many accomplishments during our ownership, and wish them and the company continued success in the future.

By completing these transactions, we have further bolstered our financial liquidity for capitalizing on strategic add-on and platform acquisition opportunities while increasing the total gains realized from investment in our subsidiaries. Including these latest transactions, as well as Fox secondary sales and past opportunistic sales with subsidiaries, we have now realized over $625 million in gains for our shareholders since going public just over 10 years ago.

Now let's turn to our year-to-date results. During the first nine months of the year, our middle-market niche industrial and branded consumer businesses continued to generate consistent free cash flow. In particular, our ERGObaby, Liberty Safe and Sterno product subsidiaries each showed double-digit EBITDA growth for the first nine months of 2016 compared with prior-year.

Our niche industrial businesses produced solid results during the nine months ended September 30, with a combined revenue increase of 14.9% and EBITDA growth of 3.5% compared with the first nine months of 2015. This included a 59% revenue and 46% EBITDA year-over-year increase from our Sterno products subsidiary. Sterno continues to benefit from the add-on acquisition of Northern International completed earlier this year.

In our branded consumer businesses, we reported combined revenue growth of 5.5% for the first nine months of 2016 and EBITDA performance that was in line with prior-year. This included solid results from our ERGObaby subsidiary, which reported 17% growth in both revenue and EBITDA for the nine months ended September 30, 2016 compared with the prior-year period. ERGObaby continues to benefit from the integration of the Baby Tula business, whose contributions have met our expectations and have supported ERGObaby's continued growth.

Our Manitoba Harvest subsidiary continue to seek considerable benefits from its 2015 acquisition of Hemp Oil Canada, achieving a 38% increase in revenue on a year-over-year basis for the first nine months of 2016. We are pleased with the progress Manitoba has achieved this year and believe this business is well-positioned for additional growth in 2017.

For the three months ended September 30, 2016, CODI generated cash flow available for distribution and reinvestment, which we refer to as cash flow or CAD of $22.6 million, which exceeded our distribution for the quarter. For the third quarter, we paid a cash distribution of $0.36 per share, representing a current yield of approximately 7.8%. This brings cumulative distributions paid to $14.28 per share since CODI went public in May of 2006.

As a result of the cash flow accretive add-on acquisitions for Sterno, Clean Earth, and ERGObaby completed earlier this year, and the platform acquisition of 5.11 Tactical in the third quarter, we anticipate that our CAD will approximate our distribution for the full-year of 2016. Longer-term, we continue to expect that on a full-year basis, the cash flow generation provided by our current group of subsidiaries, including the add-on acquisitions mentioned earlier as well as the addition of 5.11 Tactical, will provide us with cash flow generation that meaningfully exceeds our distribution.

In conclusion, the first nine months of 2016 have been a period of sustained progress for CODI. Our current businesses as a whole continue to generate stable operating results that were consistent with our expectations.

We also expanded our family of leading middle-market businesses and strengthened our cash flow with the accretive platform acquisition of 5.11 Tactical and the add-on acquisitions that we completed earlier this year. These acquisitions, coupled with our partial divestiture in Fox, plus the sale of Tridien Medical, have further strengthened our financial position and enhanced our ability to continue providing cash distributions to our shareholders.

I will now turn the call over to Elias to review the quarterly performance of our current group of subsidiaries.

Thank you, Alan. I will begin by reviewing our niche industrial businesses which include Advanced Circuits, Arnold Magnetics, Clean Earth, and Sterno products. As Alan highlighted in his remarks, our Tridien Medical business was sold to Hill-Rom during the third quarter. The discussion of results to follow excludes Tridien.

Our niche industrial businesses continued to generate stable free cash flow. We reported a combined revenue increase of 19% during the third quarter of 2016 as compared to the year-earlier period. EBITDA on a combined basis was consistent with the third quarter of 2015. The combined EBITDA margin declined to 18.2% for the quarter ended September 30, 2016 from 22.2% in the prior-year quarter.

Advanced Circuits reported softer results in the third quarter. Revenue decreased 2.5% and EBITDA decreased 4.9% year-over-year, reflecting lower sales and long lead-time PCBs, and quick-turn PCBs, mainly due to the overall economic slowdown, partially offset by growth in assembly and subcontract sales.

Third-quarter EBITDA margins were lower by 80 basis points compared to the year-ago period. Based on ACI's results to date, we believe full-year 2016 earnings will be slightly below 2015 full-year earnings.

Arnold Magnetics' third-quarter 2016 results were down from the third quarter of 2015. Revenue decreased 17% year-over-year, primarily due to higher PMAG sales in the prior year, resulting from a one-time sale in September of 2015. EBITDA decreased by 38% year-over-year, reflecting the PMAG sales impact in the third quarter of 2015, as well as executive transition-related costs that we incurred during the third quarter of 2016 as a result of executive management changes.

Given the third quarter's results, we now expect that Arnold for the full-year 2016 will experience a modest EBITDA decline from the prior year. Clean Earth's third quarter revenue was up by 17%, primarily due to increases in contaminated soil, hazardous waste, and dredge material volumes. Clean Earth's third-quarter EBITDA declined by 8.7% and EBITDA margins decreased to 19.4% compared to 24.9% last year, mainly due to higher backend costs at some of our soil facilities. The performance of recent add-on acquisitions, including Phoenix Soil and EWS Alabama, continue to meet our expectations, and Clean Earth remains on track for a solid year in 2016.

Sterno continued to perform well in the third quarter. Revenue increased by over 75% and EBITDA increased 47% compared to the year-ago period, reflecting the addition of Northern International. In addition to the contribution to EBITDA from NII, Sterno continues to improve operational leverage with further manufacturing efficiencies and has benefited from lower raw material prices.

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 third quarter of 2016 consistent with our expectations. Combined revenue increased by 2% on a year-over-year basis, while EBITDA declined by 10% compared with the prior year. Liberty Safe reported solid results for the third quarter, in line with our expectations. Liberty's third-quarter revenue was slightly above 2015 levels, reflecting continuing strong overall consumer demand, particularly in the dealer channel.

Third-quarter EBITDA margin (technical difficulty) compared with 18.6% in the year-ago period. This decrease in third-quarter EBITDA margins primarily reflects lower manufacturing overhead absorption as compared to last year, due to our planned inventory build in the third quarter of last year. Given the strong demand for Liberty's products, we remain confident in its prospects for the remainder of the year.

ERGObaby had another solid quarter as it continued to benefit from the add-on acquisition of Baby Tula completed earlier this year. Revenues increased by 35% and EBITDA increased by 38% year-over-year, primarily due to Baby Tula's results. EBITDA also increased, due to improved margins based on channel mix.

Our Manitoba Harvest subsidiary experienced strong topline growth both on a sequential and a year-over-year basis. Revenue grew by 70% for the third quarter of 2016 compared with the prior year, while EBITDA increased by 27%, as the Company continued to benefit from its Hemp Oil Canada acquisition completed last December. Importantly, we are very pleased with our efforts obtaining organic seed supply and continuing to make progress towards building the Company's infrastructure to support its future growth. We believe this business is well-positioned to achieve further organic growth in 2017.

Lastly, 5.11's performance under our ownership during the month of September met our expectations. For the third quarter, on a pro forma basis, revenue was down 13% for the quarter compared with the prior-year period, and EBITDA decreased by $4.9 million for the third quarter of 2016 as compared to the prior year.

Both of these declines were primarily as a result of a large Direct To Agency, or DTA, international sales order that occurred during the third quarter of 2015. The DTA business can include large orders and their timing could have a meaningful impact on year-over-year results, positive or negative. Offsetting the DTA decline was meaningful growth in the higher-margin retail and eCommerce distribution channels during the third quarter of 2016. This business continues to perform well, and we are quite enthusiastic about its growth potential, particularly as 5.11 gained increased momentum in the tactical consumer market.

I would now like to turn the call over to Ryan to add his comments on our financial results.

Thank you, Elias. Today I will discuss our consolidated financial results for the quarter ended September 30, 2016. I will limit my comments largely to the overall results for our Company, since the individual subsidiary results are detailed in our Form 10-Q that was filed with the SEC yesterday.

On a consolidated basis, revenue for the quarter ended September 30, 2016 was $252.3 million, an increase of $67.4 million as compared to $184.8 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.

Net income for the third quarter was $50.2 million compared to $166 million in the year-earlier period. The year-over-year decline was primarily due to the $164 million gain on the sale of CamelBak that CODI recorded during the third quarter of 2015.

Cash flow available for distribution or reinvestment, which we refer to as CAD, for the quarter ended September 30, 2016 was $22.6 million for the third quarter of 2016 compared to $23.8 million in the prior-year period. As we mentioned on our last conference call, as a result of the recent cash flow accretive add-on acquisitions for Sterno, Clean Earth, and ERGObaby, and taking into consideration the expected accretion from our platform acquisition of 5.11, we anticipate our CAD will approximate our distribution for the full-year 2016.

Turning now to the balance sheet, we had $26.4 million in cash and cash equivalents, and net working capital of $289 million as of September 30, 2016. We had approximately $567.1 million outstanding on our term debt facility and $167 million in borrowings under our revolving credit facility as of September 30, 2016.

The increase in outstanding debt from the prior quarter is a result of our acquisition of 5.11 Tactical completed in the third quarter. Specifically, we upsized our term loan by $250 million and borrowed $150 million on our revolver, at the same time expanding our revolver capacity from $400 million to $550 million.

We have no significant debt maturities until 2019. In addition, we had net borrowing availability of approximately $378 million under our revolving credit facility at quarter's-end. Additionally, our 8.6 million shares of Fox, which are recorded as an equity method investment on our balance sheet, had a value of $198 million at September 30, 2016.

Turning now to capital expenditures, during the third quarter of 2016, we incurred $4.1 million of maintenance CapEx compared to $5.5 million in the prior-year period. The decrease is primarily attributable to reduced maintenance CapEx spend at Liberty, Arnold, and Clean Earth as compared to the prior-year period.

For the fourth quarter of 2016, we expect to incur maintenance CapEx of between $5 million and $6.5 million. We anticipate growth CapEx spend for the remainder of 2016 to be between $1 million and $2 million, as we continue to invest in the long-term health of our subsidiaries.

I will now turn the call back over to Alan.

Thanks, Ryan. Overall, in the third quarter, we continued to generate consistent free cash flows across our niche industrial and branded consumer businesses. Complementing this performance, we capitalized on favorable market opportunities to complete the accretive platform acquisition of 5.11 Tactical. Also during the third quarter, we consummated the sale of Tridien Medical and realized $53 million in proceeds from partially monetizing our interest in Fox, increasing the gains we have realized for shareholders to over $625 million.

I'll conclude my remarks by briefly commenting on M&A activity. We continue to see lower middle market deal flow in the third quarter of 2016 as compared to the prior year. Trends contributing to high valuation levels have persisted, including the availability of debt capital with accretive -- with attractive terms, and financial and strategic buyers seeking to deploy available equity capital.

Consistent with our strategy, moving ahead, we will continue to explore attractive opportunities for platform acquisitions, seeking leading middle-market companies with a strong reason to exist that meet our specific criteria. In conjunction with this, we will also continue to reinvest in the growth of our current subsidiaries, including strategic add-on acquisitions that can drive further cash flow growth.

Given our strong balance sheet and substantial liquidity position, we remain in an excellent position to keep executing on our strategy, which should continue to create long-term shareholder value and support our ability to provide stable cash distributions.

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

(Operator Instructions) Kyle Joseph, Jefferies.

Thanks for taking my questions. I just had a few company-specific ones. So, for 5.11, I know we have kind of some limited data. I was just hoping to get a little more color on that. Could you describe -- is there any -- I know you mentioned the business is a little bit lumpy. Is there any big seasonality in that business that you can give us some color on?

Yes. So, Kyle, there's a little bit of seasonality. Fourth quarter is typically the strongest quarter predominantly due to two factors. One, a lot of the law enforcement (technical difficulty) agencies have budgets that they typically either use or lose, and so they will traditionally spend a little higher in the fourth quarter in order to use up the remaining budget dollars. That's on the professional segment of the business.

And then in the consumer segment of the business, clearly there is a tendency towards the holiday season to drive higher sales. And we would expect as we move further into that, as a percentage of overall sales as our consumer grows, we would expect that to carry even greater seasonality.

On the flip side, Q1 is typically our lowest seasonal period. And then Q2 and Q3 is usually kind of a -- pretty average for us.

Great. And then can you give us some color on whether it's revenue or EBITDA for that business? Or I mean, I guess what you can do is give us what the Q3 growth rate would have been ex- the big sale in 2015?

I'm sorry, Kyle, can you repeat -- I just want to make sure we understood that.

Yes -- no, I'm just trying to get a sense for the growth of the Company. I know in this past quarter, revs and EBITDA were down. It sounded like that was primarily because of a very difficult comp and strong sales in the third quarter of 2015. So I'm wondering if you can give us a growth rate ex-ing out that large sale, if that's possible?

Yes. So the growth would be (multiple speakers) -- yes, hold on one second. We're getting that data for you, Kyle.

Okay.

And in the meantime, Kyle, I would also point you to the 8-K/A that we filed last night with 5.11's financials pro forma with ours two nights ago -- sorry. And you can see six months June, over prior-year six months June, and you can get some growth rates there, that that's going to be something that you can use for data.

That's helpful, yes, I'll follow-up on that. (multiple speakers) I'm sorry.

Kyle, in the third quarter, business was, outside of the large DTA contract, roughly flat revenue and EBITDA. What we look at is year-to-date, because you can get some orders that will flow from one quarter to the other, and that would be up mid-single digits. So, year-to-date, excluding DTA, kind of consistent with our expectations for this business, kind of mid to high-single digits revenue growth.

Thanks. That's very helpful. And then, Ryan, just for you, you did a good job talking about the pro forma capitalization and your new debt. Can you give us a sense of -- and I can go back to the queue and whatnot, but in terms of your cost of funds, any changes there or just a bigger debt balance?

Yes -- no, just a bigger debt balance. I mean obviously our term debt has a little higher rate than our revolver, so blended, it's probably a little higher. But no changes to rates or terms.

Okay. And then one last one for me. In terms of ERGObaby, apologies if I missed this in your commentary, Elias, but it looked like the gross margin was down a little bit sequentially and year-over-year. Did you guys -- can you give us an explanation, is there anything related to the Tula acquisition there? Or was there something one-time?

Yes. So, on a sequential basis, there is a little bit of mix shift that can happen. I think that can be -- end up being a little bit based on kind of contributions from our different product lines, whether it's ERGO or Baby Tula. You know, some of the channels, Baby Tula especially, which goes much more Direct To Consumer and much less through international distribution, will carry some higher margins.

So depending on the different growth rates and kind of the mix, margins can change sequentially. In terms of year-over-year, most of the change in kind of any noise remaining in the numbers continues to be due to Orbit. I think as you know from our last call, we made a decision to wind down the Orbit business. And part of the wind-down of that business is giving kind of credits and trying to just liquidate through the inventory and get through that process. Outside of Orbit, this business, we look at is kind of stable to up in terms of margin year-over-year.

Great. Thanks for all the color there. Congratulations on a good quarter. It looks like all your hard work over the past few years is really paying off. Thanks, guys.

Thank you, Kyle.

Larry Solow, CJS Securities.

Wondering just if you can just give us just like -- to me I thought the obviously year-to-date things are fine, but it looks like, at least based on some of my expectations, some of your industrial businesses -- there are some specific regions that sort of each holding, but it looks like in general, a little softness on the industrial side.

Is that fair to say that that's sort of a common theme you guys are seeing? Because I know a lot of our industrial companies are seeing that. Any thoughts on that would be great.

Yes. Larry, I think that it is company-specific as we talk about some of the industrials. If you'd like to go through them, we can do that. So for the quarter -- look, the quarter was okay for some of the industrial businesses. Year-to-date performance is pretty strong, which I think is an important metric.

And it's not as though we'd seen anything in the third quarter that leads us to conclude that the group is positioned for a rocky road. But we did specifically call out Arnold because we are now letting you and everyone else know that we expect them to have a modest decline year-over-year. We are early in the year. We didn't necessarily -- we did not expect that.

So I think that Arnold specifically is experiencing some softness. Clean Earth I would say is -- year-to-date results are more reflective of how we view that company for the year. As you know and we've discussed in the past, it can be a little bit lumpy. But I think with Clean Earth, that's what we get -- although the dredge business is soft at Clean Earth. And that's oftentimes not a segment of their business where they have really any control in terms of driving the starting of projects and the bidding associated with projects.

So, it's both lumpy and not something that they can necessarily drive on their own. So again, another reference to a company-specific point. But excluding dredge, we are very pleased with the Company's performance year-to-date and certainly expect it to finish the year up versus prior year.

And so I share your caution with respect to industrials. As we've talked about really all year, and I don't think this has changed -- through the lens of the companies we own, we don't see anything more than a flat to modest growth economy. And so we are really very happy with the way our Companies perform -- are performing in that context, but time will tell.

Okay. And I know Arnold, I know that the management change is a couple of months old, but I'm not sure if you ever actually publicly sort of commented on that sort of what you can say and what sort of the outlook is going forward.

Sure.

I know Arnold has probably been -- it's one of your modest sized holdings, but I would say it's probably been one of the few that have not probably lived quite up to expectations.

Yes, that's a very fair characterization, Larry. Arnold has certainly not performed during our ownership up to the level that we would have expected. And we've talked about many of the reasons for that over the years.

And I think that we are in a good position now to really take a look and ask ourselves, do we still believe in this investment thesis? Do we think there is long-term upside for the Company? Can we create value here? And it goes without saying the good news is, even in all this context, the Company continues to generate meaningful positive free cash flow and contribute to our CAD.

But we've announced publicly that the former CEO Tim Wilson has retired. He's been replaced by Dan Miller, who is the current CEO of the business. And so that's something we are very pleased and grateful for all of Tim's contributions to the Company. But we are equally as excited about what Dan brings to the Company -- operational expertise, we believe is second to none; surrounding himself with some great existing talent at the Company but also augmented the team.

I'd prefer not to comment really below that level as that would be very atypical for us to do at any of our subsidiaries, but Dan has made some changes and brought in some people as well that we think can really help position Arnold to execute on the plan that we really envisioned from day one. And the team there has done a great job. We've talked in the past about all of the segments that they are in.

The great news is that the diversification of their business has allowed us to maintain that cash flow that I referenced earlier. However, we've not been able to see each segment of -- sorry, each division of their business perform strongly at the same time. So it seems as though once a couple of them click, one experiences some softness.

But we are, as I said, really confident going forward that Dan and his team will be able to realize on Arnold's potential. But understand, every time there is a change like this, and you've got a global operation like Arnold with multiple industries, it's simple to describe, but running a global business is always complex and execution is critical. And so I don't want to -- while I have the enthusiasm I referenced, I don't want to imply to you or anyone that Dan can press the easy button, and we are just right back where we want to be.

This will take a little bit of time. You've already heard our thoughts on the balance of this year. And I think that, as you would expect, the team, along with us, are taking a very strategic and thoughtful approach to what we need to do to position the Company for long-term success.

And we'll talk about next year probably at our next quarterly call, but my expectation is that Arnold will perform as we described earlier on the call -- slightly down versus the prior year. And it's not as though we're going to -- it's unlikely that we forecast a dramatic upturn for next year. I think we really charge Dan and the team with doing all the things required to position and create long-term value as opposed to just taking short-term measures that don't result in any long-term benefit.

And I'm clear -- I realize that the macro on the drudging part of the business has just been against you guys for a while, and hopefully inevitably that will change. But just the mention of the higher backend costs at the soil facilities, is that something that is just a temporary issue or --?

Yes, look, it's certainly something that they are working to try to mitigate, but for right now, I cannot classify it as temporary. But it's fair to say that management is certainly not pleased to see its backend costs increase, and are working diligently to try to create alternatives that can bring that cost back down to a level that is much more pleasing to them and to us.

Okay. Just a housekeeping question. Just on 5.11 Tactical, it was obviously you got a month of [ops] in the quarter, but I believe you end up -- your management fee ends up going up for the full quarter. So essentially was that probably a little bit dilutive on a CAD basis for the quarter, just because of the --?

That's right, Larry. That's right. Because we have only one month of earnings.

Got it, great. Appreciate it guys, thanks a lot.

Thanks, Larry.

Leslie Vandegrift, Raymond James.

Quick question. Just a follow-up on some of the 5.11. You talked about the 30% to 35% -- or $0.30 to $0.35 of expected CAD contribution there annually going forward. So, with the DTA that you talked about benefiting from, from that acquisition, about what portion of that is because of that and not US sales? Expectations, obviously.

So the -- I think you are asking what part of -- how much of the business is the DTA business and how much does that drive the results? I would say on an annual basis, the DTA piece of it is less than 10%. And, in terms of driving the amount of cash flow for CODI, it will have some impact, but it's more about the lumpiness quarter to quarter. And I would say it's less about -- we think that that business line is closer to a low than it is to a high in terms of what its annual contribution should be.

So we think there is upside to this as we go forward. But in terms of -- I think what we are trying to just forecast for the market is that this can be very lumpy. And from a quarter to quarter basis, we can look like we are up significantly, or we can look like it's down significantly. And I would suggest that we all look at this kind of on a year-to-date basis.

But it is less than 10% of the business. And because the consumer side of the business is growing as rapidly as it is, we would expect over time for just the differential in growth rates to cause that component of the business to become even a smaller contributor.

Okay. All right. And then on that with the consumer side growing, you talked about global penetration in your opening remarks on that. Do you have a specific target for the next country or continent, I guess, you could do more than one at once?

So, on the consumer side, it's predominantly a domestic business. And when we talk about growing consumer penetration, it's really right now, I would say focus two-fold. The primary focus is getting more points of distribution. And we are doing that through developing our own retail stores, which is a big part of our growth plans, as well as continuing to open up and merchandise new wholesale accounts.

And so, as we get more points of distribution, that obviously will carry a lot of growth, we expect, with that. In addition, and as we've done with all of our consumer businesses -- and I think as you have been aware -- a big emphasis is on raising the awareness levels, creating stronger marketing programs, reinvesting back into marketing. And so I would say that's kind of the second pillar here in growing the consumer business.

But just to reemphasize, this is a predominantly domestic consumer business. The international component of the business is more on the professional side.

Okay. And then so -- but on that side, if you're looking more for the international on the professional side then, is there a target there, specific -- I don't know, government in another country or I know you've said police and military. Is there somewhere right now that you're looking?

So, internationally, I would say there is a lot of targets. I mean we have a very large sales funnel for different governmental agencies internationally that we are working with, whether that be in the Middle East, in Latin America -- I mean that's a focus area for us. And we're obviously trying to grow the -- each of the different areas of the business. It can be a little bit lumpier when some of the international governments buy, as we mentioned.

But we have a really good robust sales pipeline. I think now it's about converting that sales pipeline into contracts that we can execute against. Clearly, a headwind that we face right now is the strengthening dollar that, over the last year, as we know, has strengthened against all currencies, and specifically, some of the Latin American currencies, even more so.

So that does provide somewhat of a headwind. And we are not able to forecast where the dollar goes, but I would say a strengthening dollar will be a headwind to being able to kind of execute against some of the international growth. But Leslie, it's -- we are looking for a wide range of governments that we are going after in terms of broadening out this business and getting more penetration globally. So it's not one specific -- it's a pretty good sales funnel we have right now.

Okay, perfect. And actually on that last little point there on the -- with the strengthening dollar, I saw on Manitoba, it was a slight [Forex] loss, not a large one. But I didn't -- because of the movement against the Canadian dollar as well. But what is -- do you hedge against that? How big of an impact do you see that going forward even if we are just stable right here? Instead of frankly even bouncing around a bit.

Yes. So, we do not hedge the dollar loonie, and the reason for that is the largest -- we have a relatively large business in the United States where we are selling supply to US-based customers, and we have costs in the US. So clearly, that doesn't need to be hedged maybe just from the production side.

Ultimately, from the supply side, ultimately, when we look at the impact on the earnings of the Company, given US distribution, given the costs that we have in both Canada and the US, we didn't think there was a materially -- material enough benefit from putting a hedge in place to offset some of the volatility of kind of the hedge and hedge accounting.

And so it will move around a little bit, but we think what could happen is, it could clearly distort the revenue picture if the US dollar strengthened, but at the same time, it may depress what the costs are of the product that we are receiving out of Canada. And it may depress some of the costs that we are paying for individual rent, all of the things that are domiciled in Canada and paid for in loonies.

So when we look at it, yes, it could have -- it could slow down some of the revenue growth, but it may add to margins, and net-net on an operating cash flow basis, it doesn't have a material impact. So, as a result of that, we've chosen not to hedge the loonie.

Okay, all right, perfect. Thank you. And just the last little comment on the Manitoba, you are talking about US sales, I will say even down here in a small market in Memphis, I recently noticed a couple of their hemp food products show up. So I guess it is working. So good job and congratulations on the quarter, guys.

Hopefully you're a customer. (laughter)

I was just going to say, Leslie, on behalf of the Company, I hope you did more than notice it.

Yes, I did, actually. I'm allergic to fish, so the Omega 3's in that stuff is fantastic for me. Thanks, guys. (laughter)

Excellent. Thank you, Leslie.

Thanks, guys.

Doug Mewhirter, SunTrust.

I had a question about your sales growth and trying to, I guess, figure out what the overall maybe organic sales growth was year-over-year this quarter and year-to-date? Because I know you had some bolt-on acquisitions and some lumpiness. Any kind of estimate in sort of round numbers what that might have been for the 3Q 2016?

Doug, I'll jump in on behalf of Ryan in the group. But that's just not a number that we have readily available. I'd prefer that we not guess at it. But I can also tell you that we'd be pleased to try to calculate that at least in a -- while it may not be as precise as we'd like, I'm just not sure maybe it can be precise. But if it can't be, at least we could get close, I would think. But that's just -- Ryan, feel free to elaborate.

That's fair, Alan. I think that's fair. But I think the best way to think about it, Doug, these, just to go through company by company and talk about what we think to be long-term growth rates for each business, which I think we've done a number of times -- but in terms of I think the challenge really is the addition of some of our add-on businesses, which, while we recognize we don't pro forma those, we do platforms, given their somewhat smaller nature to the add-ons.

And we do a lot of them. We've done five of them. So to pro forma all those would be a little cumbersome in terms of reporting. So we recognize it's difficult to get to, but I would say that it's part of our next earnings call, Q4 will provide some guidance to what we expect for 2017 on a full-year basis, both revenue and EBITDA. So that should help.

Thanks for that. I appreciate the challenge of getting the information. Moving to a more political side, in case you haven't noticed, there is an election coming up and two of your big subsidiaries are, I would say, have a lot of political influence, Liberty and 5.11 now.

I know Liberty got a bit whipsawed in the last time there was sort of a run on the bank in this regard, and I don't know if they -- if either of those two subsidiaries have contingency plans or they are trying -- if they have taken measures to avoid disruption from either a spike or a sudden drop in sales. Because I know they like to have a steady production that kind of keeps and helps them on the margin side.

Yes, interestingly, we have noticed there is an election upcoming. And with respect to the Liberty Safe, they really made operational changes since their last, what I'll just call cycle, where the inventory at retail really got bloated. And although safes were selling at retail, there was just too much inventory in the channel, and Liberty basically spent a whole -- plus they had high levels of their own inventory where they spent a lot of the year not producing, which meaningfully hurt their margins and free cash flow, as you would expect.

But what they've done since -- and at that time, they were also importing a large number of states which had long lead-time. And once you make that commitment to order them, even if you start to see the pace of sales slowing down, you can't really unwind those orders. So what Liberty has done since then -- and they've done a nice job in our opinion and continue to refine it -- but they have moved as we referenced earlier, or even in the past year or so, to a more level loading of their inventory build to try to, as you referenced, maintain a more stable level, yet also have a level of inventory of core products that allows them to satisfy a potential surge in demand.

But not so much that they have excess inventory. And they are, I think -- and they have meaningfully reduced their imported program, and they've got great new equipment in their factory that allows them to ramp up demand to the extent they need to. So I think Liberty is, relative to the last cycle, has both changed their practices as well as having lived through it recently.

Because they are just much more cognizant of seeing the signs and knowing how to deal with them, and it's very important here also that to have their retail partners. They also don't want to be in the same situation that they were in, in the last cycle. So I think Liberty is very well-positioned for whatever the future holds in that election year or in a year where there's just some other factor that may drive surge in demand.

So with respect to 5.11, I'll ask Elias to share his thoughts on that.

Yes. So we don't actually think there will be much impact on 5.11 here. It's a business that I think you are well aware from how we've communicated about the Company, the market that we supply are mostly related to law enforcement both on the federal and at the local levels. And so, I don't think there will be a meaningful impact one way or another based on the election results, in terms of the programs that we are doing with kind of the -- those agencies.

Last question maybe on the financial side or the balance sheet side, you leveraged up to buy 5.11 and it should be a good use of the capital, so -- which is fine. And I know that you did that secondary or you participated in the secondary offering with Fox Factory, which will help you get some funds to maybe deleverage.

Is there some sort of target or range which you are shooting for as you move into next year? And has -- does the leverage affect your willingness to make acquisitions, maybe the size of the acquisition or the nature of the acquisition?

So, Doug, I think we -- as you saw in the filed Q last night where our leverage as of September 30 is [3.7] and you mentioned our -- one of our primary drivers to be able to de-lever would be Fox shares amongst other opportunities, but with respect to where we are positioned, we do in the short-term want to de-lever.

I think if you look back at our history, we are generally comfortable in the sort of 2 to 3 times with respect to leverage. However, even at 3.7, we remain able to acquire businesses both add-on as well as platforms. Can we buy a 5.11 size business today? No. But could we buy a $100 million or $200 million platform? Yes.

So we are still in business. We are still looking. There's still a lot of great opportunities. And as you know in the past too, one of the best ways or a great way for us to deploy capital is through add-ons, given their accretive nature. So, well-positioned today but it's due, as you mentioned, expect to deliver in the short-term to provide us more capital to grow.

And here is the yen and the yang relationship that exists between Elias and me versus Ryan. While we'll never take for granted the support of the debt and equity capital markets, I would go so far as to say that while Ryan is factually correct, that maybe today we do not have the liquidity to acquire a 5.11 size transaction at this moment. I can also tell you that we definitively are looking for opportunities just like that in addition to the size that Ryan referenced, we believe that if we are able to find opportunities as of the quality of a 5.11 for example, and are able to bring additional cash to our -- to CODI, that we would hope and it would be consistent with history that we would be able to find support to enable us to consummate and acquisition of that size.

So, it's been kind of -- the way we've lived since being a public company, if you go back and look at our history, it's particularly with respect to our leverage levels, it's never just purely consistent. It's either kind of getting to a level like it is now where we are a little uncomfortable and absolutely want to bring it down or after typically after a opportunistic divestiture, we can find ourselves virtually deleveraged with the exception of what we would consider to be part of our permanent capital structure.

So, we continue to live that way. We've grown accustomed to it. It doesn't mean we don't have periods of higher leverage than we prefer to live with, but we've also had periods of lower leverage. And so I would say we are very much operating business as usual with a desire to, in a very disciplined way, continue to deploy capital if appropriate. And if not, we'll keep fighting until we find the right opportunities.

Okay, thanks. That's all my questions.

Brian Hogan, William Blair.

The inventory level on the balance sheet, particularly the finished goods inventory was up big and I think the footnote set a step up due to the 5.11. I guess can you give -- is that the run rate going forward roughly that level? That seems like an awfully high inventory level to be continuing for that level of business but can you just explain inventory there?

You are exactly right. The reason for the significant increase is 5.11 and above and beyond the normalized 511 inventory, is that step-up which is in finished goods. It was a little over around $40 million roughly, so it -- and that will amortize pretty quickly through cost of sales, and so you'll see that come down over time here.

How short is that? Is it like three months? Is it like six months? What kind of time?

It's nine months. Their inventory turns are a little bit longer, and I think it's also the reason why their inventory balance for that business was a little bit higher than you'd expect, given the nature of their business and their product offerings. They need to maintain sizes and colors across a pretty broad spectrum to provide for both the professional and consumer end-users.

And look, the long-term nature of the returns really is actually also a good thing because their products aren't really fashion-related. They don't go out of style. They continue to be desired, so there's really -- from our perspective, much lower inventory risk even though the balance is what it is.

Elias, do you have any other comments to add there?

I would just say, Ryan, that it's -- this will be a heavier working capital business than some of our other companies. And part of the nature is you just need to be in stock for satisfying the end customer and there is a variety of sizes. So the inventory turns will be lower in this business than they've been in some of the other businesses that we've owned.

And it's just something that we will need to understand and kind of will be something we do address in terms of managing going forward. As Ryan said, it is relatively low obsolescence risk here. So we feel good in terms of the financial impact from carrying a larger balance sheet. But nonetheless, this Company will, by the nature of the industry that it serves and the structure of the industry, carry a larger amount of inventory with lower turns than what we are used to out of some of our other companies.

Sure. Just you know there could be some more inefficiency there. Staying with 5.11, the store openings -- we kind of briefly talked about the growth there of the retail channel. And you had eight retail stores. I mean do you plan to double that? I mean how fast do you plan to actually to grow that business? Because I mean I did see in the 10-Q that base revenues were down 4% but offset by the retail eCommerce channel. So --?

Yes, so we don't give specific targets in terms of the amount of new store openings that we'll have, but suffice it to say that this is a -- with only eight stores incredibly underpenetrated. And we think there is a lot of runway in order to grow the number of stores that we have, which really benefits us because it does allow us to display the full range of product that we have.

And as you know with a lot of wholesale customers, it's a much more limited amount that you get in terms to displace, so we think this is good. Allows us to open of our distribution points which today, remain very much undersaturated. And so it is a key pillar of what our growth is and not to get too specific targets, I would say there should be a good expectation that we will grow these businesses as a very high return on investment.

The payback is really short with these retail openings and as the comp store sales are growing very nicely right now. So there's a lot of tailwinds with that side of the business. And as long as those tailwinds are continuing, it's an area that we think is prudent to deploy capital into.

Now in addition to that, and I think what you'll hear a lot of companies talk about, is having a strong omnichannel strategy. Our eCommerce business is growing very rapidly and we think that that is part of just the brand becoming more well-known and being elevated, and is a critical pillar as well to the growth of the consumer business.

And lastly, wholesale remains also a meaningful component. So, we are focused on kind of the all three channels of consumer growth. But right now, the retail is massively underpenetrated and we think there's lots and lots of runway here for us to grow that side.

All right. And then do you have an appropriate expense base there? Do you need to add more infrastructure there? I mean outside of building out stores, but is it fully staffed? Fully ramped?

Yes, so I would say we have -- as you indicated, our SG&A will by definition grows as we -- with every new box that we open, although this is also kind of really high margin because we are capturing the retail spread as well. So, it more than offsets any of the SG&A build. So in terms of -- I think what you're asking, do we have in the infrastructure at a corporate level to be able to handle the rollout, I would say we are mostly built out.

Although depending on the speed at which we roll out retail, may dictate that we need some additional overhead to support it. But today we do have a pretty good group with infrastructure in systems that is in place and would be capable of handling additional leverage. But again you always will need to add to that if you are really accelerating in terms of rollout.

Sure. Shifting over to the Advanced Circuits, obviously some softness across the sales and then demand. We kind of take a step back and your strategy, you are mostly United States and you have some foreign competition that's very stiff. Do you have the right strategy there in place? Do you need to be -- have some international manufacturing? What's your thoughts there?

Yes, so just to step back and maybe as we said when we think about strategy for Advanced Circuits, the business really kind of is in two primary areas. One is it is a quick turn provider of circuit boards, mostly supporting research and development needs and then kind of pre-production needs. That is the largest part of the business.

And I would say that is really a relatively insulated part of the business from overseas competition due to the fact that if you need a circuit board for a prototype or a preproduction run, you need it. You are less price-sensitive and you really don't want those products being held up in customs from foreign suppliers.

And by and large, the foreign suppliers are meant to and equipped to run massive volumes of kind of a longer lead programs, not really doing as much of the quick turn stuff. So that is one side of the business and the largest side.

The other side of the business focuses on defense, and defense business needs to stay in the United States as a result of the ITAR requirements. And you know secrecy around a lot of our defense programs. So we intentionally have looked for businesses when we are either doing acquisitions or as we've positioned this Company that really met the criteria of its quick turn. And it's going to be more insulated or it's going to be defense-related and it's going to stay here.

As we all know, when sequestration went into effect, it pushed down a lot of the defense work and that's had a real dampening effect on Advanced Circuits revenue opportunity. And so it's made the business a kind of stable to slightly down business here over the last few years. At some point, we will bottom out on defense level.

And we feel that the Company will be positioned well, and is positioned well, in order to experience revenue growth again as kind of defense bottoms out and starts to pick up a little bit. In terms of is the strategy right and do we need international manufacturing assets or partnerships, what I would tell you is we already have international partnerships.

So when a customer migrates from being in preproduction to production, if they need help getting to a lower cost base for high-volume runs, we have the ability to do it. The problem with that business quite frankly is it's really low margin. And we'll do it as an add-on service for our customers, but it's never been something that's been a primary driver of where we want to go with the business, because we think it changes the margin profile really negative.

And we think that wouldn't be value additive to our shareholders. And I think if you just look at the competition. And as they are -- the publicly traded competitors, you'll see margin profiles that are significantly lower than what we are able to achieve in this business. And so, we understand the fact that the business has been a hand of flattish to down a little bit business, and that makes you question whether the strategy is kind of the right strategy.

While all that being said, you know we do think that eventually defense will come back. And there is a market for this business that is domestic entities higher-margin, higher-value stuff that we like, and think the strategy is right now best for our shareholders and value creation.

Thanks for that long explanation. It's really helpful. On Manitoba Harvest, how was the crop basically like and the supply being able to meet demand?

Sure. So we have to separate into two. One, the organic and nonorganic. In terms of nonorganic, we have overly sufficient -- it's a well-supplied market. So on the nonorganic side, there is no issues. In terms of the organic, the initial because we're now just starting to get the crop in, and we're just starting to get seed, and we are doing all the things that we have to do, like microbe testing and all of the food safety that goes on.

Initial thoughts are, it looks good and it looks like the crop is going to be significantly larger than what it was last year. A lot of that is due to the work that we've been doing with farmers in order to either convert over to organic crop or to develop new organic crop. So we've been working very hard on that.

But a lot of it will depend on, as more and more of the organic feed is coming in, it has to pass some very high testing that we do in terms of food safety. But initial kind of expectations are it looks pretty good, and we feel as that's going to be a good tailwind coming into this year.

Sure, thanks. And then one last one, and it's kind of a housekeeping -- going through the 10-Q and subsequent events, there is $7 million profit allocation. Does that show up on the income statement in the 4Q or where does that show up?

No, Brian. That is considered a distribution. So that was declared by the Audit Committee last week and will get paid out in November. And that does not go through the income statement. You'd see that on the cash flow statement and through equity again in Q4.

Thank you.

Bernie Picchi, Palisade Capital Management.

Congratulations on all the interest you've had here in the call, but I can't believe that there was -- there were no questions particularly regarding the capital structure on this proxy that you sent out regarding the trust preferred. Could you talk about that, provide a little bit more color behind it, and how that fits into your scheme vis-a-vis the capital structure? And also your desire to keep your leverage at a certain level?

Bernie, I'll take a first crack at this, and then perhaps Ryan and Elias may add onto that. And obviously we are in an area here where what I can say is a little bit challenged just because it's a public filings, and all of the things that go along with that. But I would say first conceptually, from the beginning, one of the things we've always been interested in was trying to identify a -- an appropriate piece of capital that could slot between our common stock and our current debt facilities.

And so, we've looked for that for quite a while, and think there may be some opportunities for us to further explore that. I think that we are -- we've also told the public for many, many years that in order to ultimately achieve our growth plans, we will undoubtedly have, at some point in the future, a need to issue common equity as well as likely expand our existing credit facilities. So I mean holistically, we've always been looking to evolve our capital structure over time to support the growth of our business, but to also deliver as low a cost of capital as we can.

And so, that's really what our intentions are. And we continue to explore all that and hope that over time, we will be able to de-lever as we discussed. Ryan touched on the levers that we can pull to do that, so I won't repeat what he said already. But hopefully, that gives you the context of the filing that you referenced. And if not, happy to elaborate, if possible, as to maybe a more specific inquiry.

Alan, I realize that you are constrained and there are things you can't really talk about because it is a filing -- as you said, public filing, but are you close to the limit of your borrowing capacity -- under your leverage capacity, I should say -- under your bank covenants? And is this a device that would shift more of the capital structure from debt to equity? Something that you need to do in order to give you some more breathing room vis-a-vis the banks?

I'll touch on that, Bernie. We do have over $370 million available under our revolver, but we are constrained from a leverage standpoint. As you are aware, we have the ability to enter an acquisition. And acquisitions-like period, which we are in now, which allows us to go to [4.35]. So we do have still a lot of room with respect to leverage, but you are exactly right.

This is longer-term if this presents itself. And this is a good opportunity for us, it is a way that we think we can shift to the equity side some of our capital and thereby, of course, reducing leverage. I'd also say interestingly too there are some interesting preferred products out there that may, in fact, improve our equity cost of capital when you think about it broadly. So it's really an interesting opportunity for us to do exactly what you said.

Okay, well, thanks. And thanks for the full answers to so many of the questions, and congratulations on the interest that your Company has engendered. It's great.

Thank you, Bernie. We appreciate your questions, and I know we look forward to seeing you very soon here. So thanks for being on the call today.

I'm showing no further questions at this time. I would now like to turn the conference back to management for closing remarks.

I'd like to thank everyone again for joining us on today's call and following our story. We look forward to sharing our progress with you in the future. Thanks.