Compass Diversified (CODI) Q1 2017 Earnings Report, Transcript and Summary

Good morning and welcome to Compass Diversified Holdings 2017 first 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 first quarter 2017 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 first quarter 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-Q with the SEC last night which includes reconciliations of non-GAAP financial measures discussed on this call. Please note that references to EBITDA in the following discussions refer to adjusted EBITDA as reconciled in the company's financial filings. 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 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 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 first quarter 2017 earnings conference call. During the first quarter, our leading middle market businesses generated stable operating results that were consistent with our expectations. We continue to reinvest in our current subsidiaries during the quarter as well as strengthened our balance sheet by monetizing our remaining investment in FOX. Before discussing our first quarter financial results, I will highlight some of our achievements. During the quarter, our Clean Earth subsidiary completed the add-on acquisition of AERC Recycling Solutions, a universal waste and electronic waste recycling company serving 2,500 commercial and industrial customers nationwide. The addition of AERC has expanded Clean Earth service offering, enhanced its Eastern United States presence and provide a close-to-close coverage with its California facilities. Further, this acquisition has opened up new cross-selling opportunities for Clean Earth with existing customers and for adding new regional and national customers. We look forward to working with Clean Earth as it expands into these new areas. Along with this acquisition, during the quarter, we also strengthened CODI's liquidity position by monetizing our remaining interest in FOX for total net proceeds of over $136 million. With this divestiture, we have generated approximately $525 million in proceeds from selling our FOX subsidiary over the past 3.5 years. In addition, we have increased total gains realized for shareholders to over $770 million since our May 2006 IPO. Turning to our operating results. During the first quarter, our middle market, niche industrial and branded consumer businesses generated stable levels of earnings that were consistent with our expectations. This includes strong performance at our Clean Earth, Sterno Products, ERGObaby and 5.11 subsidiaries with each reporting year-over-year double-digit revenue increases. Our niche industrial businesses reported solid performance for the first quarter with a combined year-over-year revenue increase of 12.7% and EBITDA growth of 4.5%. This included a 24% revenue and 21% EBITDA year-over-year increase from Clean Earth, which has benefited from the accretive add-on acquisitions the company has completed over the last 12 months. Also during the quarter, our Sterno Products subsidiary produced a 20% revenue and 9% EBITDA year-over-year increase as it continues to benefit from the acquisition of Northern International completed in January of 2016. In our branded consumer businesses, we reported combined revenue growth of 9.3% for the first quarter of 2017 and EBITDA growth of 5.7% compared with the prior year. During the quarter, a large national outdoor retailer filed for bankruptcy protection and as a result, our Liberty and 5.11 businesses required accounts receivable reserves of $1.4 million and $1.3 million, respectively. Even with the negative impact this had on these subsidiaries, our branded consumer businesses were able to produce growth in revenue and earnings, which we are very pleased with. We have solid performance from ERGObaby, which increased revenue 16.5% and EBITDA 9.4% year-over-year. We also have strong revenue and EBITDA growth at our 5.11 subsidiary. For the first quarter of 2017, 5.11 reported year-over-year double-digit revenue and EBITDA growth of 15.5% and 57.5%, respectively. For the three months ended March 31, 2017, CODI generated cash flow available for distribution and reinvestment, which we refer to as cash flow or CAD of $14.9 million, which was in line with our expectations. For the first quarter, we paid a cash distribution of $0.36 per share, representing a current yield of approximately 8.7%. Since going public in May of 2006, CODI has paid cumulative distributions of approximately $15 per share. To summarize, our first quarter performance demonstrated steady cash flow from our existing subsidiaries. In addition to our financial performance, we capitalized on an opportunity to strengthen our Clean Earth business with an accretive strategic add-on acquisition of AERC. We also bolstered our balance sheet by divesting our remaining investment in FOX. Using those proceeds, we repaid the outstanding balance of our revolving credit facility. Our balance sheet is strong and we have ample liquidity, more than $500 million to continue pursuing compelling add-on and platform acquisitions. 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. For the first quarter, our niche industrial businesses reported a combined revenue increase of 12.7% as compared to the year earlier period, while EBITDA rose 4.5% during the same time frame. The combined EBITDA margin declined to 14.6% for the quarter ended March 31, 2017 from 15.7% in the prior year quarter. Advanced Circuits results for the first quarter were consistent with the prior year and management's expectations. Revenue was flat on a year-over-year basis, while EBITDA decreased 3.3%, primarily due to lower sales in quick-turn, small-run PCBs and assembly, slightly offset by growth in quick-turn production and long lead time PCBs. First quarter EBITDA margins for this subsidiary were lower at 30.8%, compared to 31.8% in the year ago period, reflecting the current sales mix. For the first quarter, Arnold Magnetics results were in line with our expectations. Revenues were down 3.2% year-over-year, reflecting lower domestic sales in PMAG, slightly offset by higher international sales. EBITDA declined by 11.5% during the quarter as compared to last year. We continue to make improvements in operations and productivity and are very pleased with the progress the Arnold management team have made these past few months. We continue to believe in Arnold's strong competitive advantage and ability to reach our long-term expectations. Clean Earth produced strong first quarter results on a year-over-year basis meeting our expectations. Revenue rose 23.5% during the quarter compared to the prior year, attributable to increases in contaminated soil volumes and contributions from the add-on acquisitions of Phoenix Soil and EWS Alabama. Clean Earth's first quarter EBITDA increased by 21.3%, while EBITDA margins were essentially flat compared with the prior year. We continue to be very pleased with Clean Earth's performance. Sterno Products produced solid first quarter results consistent with our expectations. During the quarter, revenue increased by 19.5% year-over-year and EBITDA increased by 9.1%, reflecting the continuing benefit from the add-on acquisition of Northern International, which was completed in January 2016. Sterno continues to invest in productivity enhancements to increase manufacturing efficiencies. However in 2017, Sterno's primary chemical raw material has increased in price and we anticipate this increased pricing to remain in place over the balance of the year presenting some margin headwinds. Next, I will turn to our branded consumer businesses, which include Liberty Safe, ERGObaby, Manitoba Harvest and 5.11 Tactical. Please note that the revenue and EBITDA numbers I will provide for 5.11 will be on a pro forma basis as if this business was acquired on January 1, 2016. Our branded consumer businesses generated solid results for the first quarter of 2017 that were consistent with our expectations. Combined revenue increased 9.3% compared to the year earlier period and EBITDA increased 5.7% compared to the first quarter of last year. As mentioned by Alan, a large outdoor retailer filed for bankruptcy and as a result, Liberty Safe and 5.11 Tactical took a combined accounts receivable reserve of approximately $2.7 million. Absent this extraordinary charge, EBITDA would have increased by approximately 20% year-over-year, exceeding our expectations. During the first quarter, Liberty Safe's revenue and EBITDA declined 3.5% and 46%, respectively, compared to the year earlier period. As I mentioned, Liberty's results were significantly impacted by the bankruptcy of a large outdoor retailer. Excluding the accounts receivable reserve associated with the bankruptcy, Liberty's EBITDA would have been down approximately 22% year-over-year, meeting our expectations. Based on Liberty's results to-date, current market conditions and the impact of the bankruptcy, we expect 2017 revenue and EBITDA to be softer than communicated on our previous call. We are still in the process of analyzing this impact and hope to have more color for our next quarterly earnings call. Our ERGObaby subsidiary generated solid results during the first quarter of 2017 as it continued to benefit from the 2016 add-on acquisition of Baby Tula. For the first quarter, revenue increased 16.5% year-over-year, reflecting solid international carrier sales and strong contributions from Baby Tula, offset slightly by a decline in domestic retail sales of an infant travel systems and accessories. As a remainder, in 2016, we decided to wind down the Orbit Baby business and as a result, the loss of those revenues will distort revenue comparisons throughout 2017. EBITDA increased 9.4% from the prior year due to improved margins based on channel mix, offset by investments made ahead of 2017 product launches scheduled for the middle of the year. We expect to see the benefits of these new products in the back half of 2017. First quarter results for Manitoba Harvest were slightly below our expectations. Revenues declined by 4.3% for the first quarter of 2017 compared with the prior year period, while EBITDA declined by 10.5%. As we anticipated, Manitoba's first quarter results were impacted by excess inventory levels at our customers within our fastest growing market outside of North America compared to the prior year. This was offset partially by higher club store demand. We expect the oversupply situation will be resolved through the course of 2017 and remain optimistic about Manitoba's long term prospects. Lastly, during the first quarter, our 5.11 subsidiary's performance met our expectations. On a pro forma basis, revenue increased by 15.5% for the first quarter compared with the prior year period, while EBITDA for 5.11 increased by 57.5%, as compared to the previous year. As I mentioned earlier, 5.11 was also impacted by the bankruptcy of a large national outdoor retailer. Excluding the accounts receivable reserve taken with respect to the bankruptcy, 5.11's EBITDA would have increased by approximately 78% year-over-year, exceeding our expectations. The first quarter's performance benefited from the timing of a direct-to-agency order and further growth in high margin distribution channels, including retail and e-commerce, as 5.11 continues to penetrate the consumer market. I would like to remind everyone that the timing of direct-to-agency orders is difficult to predict and they can have a strong quarter-to-quarter impact on 5.11's financial results. As discussed on our March conference call, we continue to invest growth capital in this business to facilitate its long-term growth. 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 March 31, 2017. 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 March 31, 2017, was $290 million, up over 50% compared to $193.3 million for the prior year period. This year-over-year increase reflects notable revenue growth in our Clean Earth, ERGObaby and Sterno subsidiaries, due primarily to contributions from our add-on acquisitions as well as the revenue contribution from 5.11. Net loss for the quarter ended March 31, 2017, was $21.1 million as compared to a net loss of $15 million for the quarter ended March 31, 2016. During the first quarter of 2017, we finalized the goodwill impairment testing at our Arnold subsidiary that had been recorded on a preliminary basis last quarter and recorded an additional $8.9 million of goodwill impairment expense. Cash flow available for distribution or reinvestment, which we refer to as CAD, for the quarter ended March 31, 2017, was $14.9 million compared to $13.6 million in the prior year period. First quarter CAD was in line with our expectations. Given the seasonality of certain of our businesses, the first quarter typically has lower EBITDA than other quarters. This quarter's CAD was negatively impacted by the bankruptcy of a large outdoor retail customer previously mentioned. This was offset by lower-than-anticipated CapEx spend. As a result of our 2017 earnings expectations for each of our subsidiaries and the accretive acquisitions we completed in 2016 and year-to-date and taking into account our revised expectations for Liberty, we still anticipate CAD will exceed our distribution for the full year 2017. Turning now to the balance sheet. We had approximately $115.3 million in cash and cash equivalents and net working capital of $347.9 million as of March 31, 2017. We had $564.2 million outstanding on our term debt facility and no borrowings under our revolving credit facility as of March 31, 2017. During the quarter, we successfully repriced our term loan B and lowered the spread by 50 basis points. We have no significant debt maturities until 2019. In addition, we had net borrowing availability of $546.1 million under our revolving credit facility at quarter's end. During the first quarter, CODI sold its remaining shares in its former subsidiary FOX in a secondary public offering for total net proceeds of approximately $136.1 million. Including this divestiture, CODI has realized approximately $525 million in proceeds from its investment in FOX. Utilizing the proceeds from our final FOX sale, we paid down the balance of our revolving credit facility, further enhancing our liquidity position to pursue attractive acquisition opportunities. Turning now to capital expenditures. During the first quarter of 2017, we incurred $4.7 million of maintenance CapEx compared to $3.7 million in the prior year. The increase was primarily due to additional CapEx spend at 5.11 to support their long-term growth objectives. First quarter maintenance CapEx was lower than we had anticipated. We expect to realize this spend throughout the balance of the year as we continue to invest in the long term health of our subsidiaries. For the full year 2017, we continue to estimate incurring maintenance CapEx of between $20 million and $25 million and growth CapEx in the range of $15 million to $20 million. As mentioned previously, our 2017 growth CapEx spend will be primarily for 5.11 Tactical. This includes 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 anticipate further growth capital spend at our Manitoba Harvest subsidiary in order to increase our access to organic chem supply and continue enhancing operational efficiency. With that, I will now turn the call back over to Alan

Thanks Ryan. Our first quarter performance reflects stable cash flow generation from our family of niche leading businesses that was consistent with our expectations. Additionally, we continue to reinvest in the growth of our subsidiaries with the accretive add-on acquisition of AERC for Clean Earth. Also, we continue to strengthen our balance sheet by monetizing our interest in FOX, realizing approximately $136.1 million in net proceeds. Including our FOX sale as well as past opportunistic sales of subsidiaries, since going public CODI has realized over $770 million of gain for our shareholders. I will close by commenting briefly on M&A activity. Middle market deal flow during the quarter was flat to slightly down compared to the prior year, while competition remains steady. 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. As we continue forward in 2017, we remain committed in pursuing both attractive platform and add-on acquisitions, while maintaining our disciplined approach to deploying capital. With over $500 million in available capital, we are well positioned to continue executing on this investment strategy, which should drive cash flow growth and support our ability to provide cash distributions to our shareholders. Before I open up the lines for Q&A, I would like to announce that we will be hosting our 2017 Analyst and Investor Luncheon at the St. Regis Hotel on Thursday, June 15. In addition to presentations from members of CODI senior management team, Tom Davin, the CEO of 5.11 Tactical, will be presenting as well. We hope to see many of you in attendance at this event. This concludes our opening remarks and we will be happy to take any questions you may have. Operator, please open the phone lines.

[Operator Instructions]. And your first question comes from the line of Larry Solow with CJS Securities. Your line is open.

Great. Thanks. Good morning guys.

Good morning.

In the aforementioned bankruptcy of a large outdoor retailer, I think it begins with a G, on the Liberty outlook for Liberty Safe, is it surely impacted by that? Or are there other things going on? And my second question, I guess is a part of that is, so it sounds like maybe this bankruptcy will linger in terms of the impact even though I think these guys were now pulled out by someone else. So if you could discuss that, I guess, how it reflects Liberty and seems like more of impact to Liberty going forward and on 5.11 as well?

Sure. With respect to Liberty, I think as indicated on our last conference call, we did not expect their performance to be as robust this calendar year as it was last calendar year. And that was largely due to anticipated margin headwinds associated with steel price increases as well as just some overall market softness that they expected. Not real, not in a weak sense, but just not as robust. But we still thought that they were on track to have a year that would be slightly down from prior year. The impact of the bankruptcy is certainly not immaterial for Liberty and the future for the relationship and opportunity to generate revenues and cash flow from the retailer that has gone through the bankruptcy remains a bit uncertain at this time other than some pretty limited publicly available information, which is why we made this specific reference that we would hopefully be able to provide more color on the next quarterly call. So will it linger? Larry, I just don't know. I imagine it will, to a certain extent. But for how long and to what level of impact? We just don't know at this point. I think that based on early scenarios, I certainly have confidence that Liberty's EBITDA is on track to be, call it, still a double digit numbers. But I just don't know. So it's not as though the company is going to go to zero cash flow. I think we will still have a really nice year of cash flow generation and I think they are taking all the steps you would expect for I am looking at their operating cost to working hard on attracting additional new, large customers. So I think you are doing all the right things and I think that the outlook for the company is good. But this bankruptcy is a little bit fluid right now as a situation. So it's little hard for us to completely wrap our arms around it. But we will, obviously, provide more detail going forward. And then just to put the market comments in context, I think with reference to the double digit EBITDA number, I think hopefully that reinforces the fact that while we probably anticipate a softer year this year, absent the bankruptcy, it wasn't in the context of the market falling off a cliff. This wasn't what we experienced a couple of years ago where we had a year of robust demand and then a year where it's going to be really problematic. So nothing like that. I would say just the normal ebbs and flows and I think an obvious follow-up question would be, if the change in administration had an impact on this? Hard to say, but I think it probably has, but very difficult to quantify. With respect to 5.11, I will make an opening remark and Elias may want to elaborate on that. But I think that the impact of 5.11, although, meaningful to us this quarter, I think, 5.11 has many very positive things occurring at the company that will more than offset the bump for them. So you are accurate. This is a bigger deal for Liberty than it is for 5.11. And we do not alter our year long expectations for 5.11 at all relative to what we communicated last quarter. Elias, is there anything you would like to add to that?

Yes. Nothing further.

Okay. And I assume Liberty is inevitably, the demand would be the demand regardless of what retail channel it is going through. It may just be an interruption obviously.

We certainly hope that's the case, Larry. Although and this is not a comment specific to Liberty, it's just a comment that really relates to how we are looking at things across any one in that sells through bricks and mortar retail. There is clearly a lot going on there. And it's very difficult to predict how it will all shake out. I hope that you are right. I think there have been other industries that have seen some consolidation and there's questions as to where that demand went because it didn't seem to filter through other retailers. So I don't throw this out there in the context of us speaking that that will happen to Liberty. But I will tell you from a strategic standpoint, it is something that we are paying a lot of attention to and doing all that we can to make sure that Liberty is well positioned, even not only within its traditional networks, but that it continues to explore other distribution channels for their products.

Right. And so to stick with that topic and switching to ERGObaby and you sort of mentioned the bricks and mortar and sort of the e-commerce seems to be accelerating and taking a little bit of share away from the bricks-and-mortar companies. I know a couple of years ago at the ERGObaby presentation at the Analyst Day, you guys spoke about a huge online effort they have. Has that helped them at all? And really sticking with that, I noticed that the revenue number was up nicely, but EBITDA was up somewhat less and I guess that sort of investing in these new products is coming out in the back half of the year?

Yes, Larry. So as you recall from that presentation, online is a big part of the ERGObaby strategy. I would say that was reinforced even more so with the acquisition of Baby Tula, which has a much larger percentage of its sales which go through the online channel. And that channel continues to grow nicely. ERGObaby continues to invest in its website, mobile optimization, all the things that you would need to be investing in the ever changing online world as well as working with important online channel partners. And we do continue to see growth there. Clearly, it is impacting bricks and mortar retail, but I think ERGObaby in particular and with the Baby Tula brand, it is positioned really well in order to make that transition. These products also because they are soft goods and they are relatively easy to ship. You can view them online. They are products that do lend themselves to easy online distribution, maybe a little unlike some other things that may be harder to deliver. So ERGO continues to make progress there, I would say, in just keeping context that ERGO is a global business and we still generate a large chunk of our revenues internationally. So the international market is also starting to adopt online retail, but much slower than the U.S. and I would say that a lot of the channels that we are still going through and the distribution partners that we are using there aren't experiencing the same level of disruption that we are seeing here in the U.S. So I think we are doing really well and continuing to advance in the online business at ERGO. And with the respect to EBITDA deleveraging that you referenced, that is solely for some new products that we are launching. We have two major product launches that are coming up for ERGObaby that will be happening in the middle to later part of this year. As you know, the cost you incur before the product launch, but you don't start booking any other revenues. So there is some deleveraging of EBITDA that happens prior to that. I would also say in the first quarter, Baby Tula had a major product launch that came out late in the quarter, really didn't recognize much revenue, but it was kind of be impacting in April and going forward with the revenue line and those expenses for the prelaunch were fully borne in Q1. So we did have kind of a lot of spending for product that will be coming in and we are really excited about not only the Baby Tula product, which came out, which is called the Free to Grow, which has got great reviews and is doing very well in the marketplace, but also the ERGObaby products that we will be launching later in the year.

Got it. Great. If I just may just squeeze 1 more and just on the Clean Earth, a flat year last year and I think a lot of it, you guy have actually done very well with the bolt-on acquisition including this latest one, AERC. I know that the industry is sort of with the company itself sort of been held back a little bit as maybe a third or a quarter, I don't know exactly how much dredging it makes up or made up at its max or its peak. So obviously, dredging has been down last couple of years. Any updated thoughts, it seems like dredging activity seems to be picking up and how that might help Clean Earth in 2017 going forward?

Sure. I think that we are more optimistic about the dredging market this year than we have been probably since we have acquired the company. And again, it's very difficult to predict just because of the entities that you are conducting business with. It could be a bit bureaucratic and take a long time to get some of these projects started, which I think we talked about in the past. But the activity, its level does seem to be picking up and obviously to the extent that Clean Earth can have a good year in dredging, it would be great for their results and their margins from a mix standpoint. So we are optimistic. I am not sure that we are prepared to quantify it for you, but we certainly expect the dredge business to be better in 2017 than it was in 2016.

Great. That's encouraging. Okay. Great. Thanks a lot guys. I appreciate it.

Thanks.

Thank you Larry.

And your next question comes from the line of Doug Mewhirter with SunTrust.

This is actually Matya, on for Doug.

Hi Matya.

Hi Matya.

So has the recent customer bankruptcy and also just the general retail environment changed how you are thinking about your existing 5.11 stores and any new store openings this year?

Elias will take that.

Yes. So I would say clearly, we have heightened awareness on retail and bricks and mortar in general. And if you look at the 5.11 kind of physical footprint today, it's really so immature. It hasn't affected what our current growth plans are in that business line. Today with 5.11 and really just to kind of set the stage, the 5.11 consumer brand really is a relatively new effort on the business. It had been predominately serving the professional market and law enforcement and related areas and built a really solid business over a number of years and then kind of five, six years ago started expanding through consumer wholesale into the consumer market. There is, we believe, a lot of pent-up demand for this product, but the access to the product through distribution is still relatively limited in terms of the number of doors where you can get it. And so what we found is that as we have gone into markets and opened bricks and mortar stores and created availability of product, these stores are opening up and are opening up profitably immediately and have kind of strong growth tailwinds behind them. And so it's really bucking the trend of what we are seeing in retail. Now part of that I think is, we have an under-penetrated market and there's not a lot of access to distribution. And so for the foreseeable future, we think continuing to open retail stores to create additional distribution point is the right strategy. I think as the market gets more saturated partly through us opening stores and hopefully partly through getting more consumer wholesale and obviously we have, what I will call, an omnichannel effort that's going on because we do have a big online presence that's growing as well, through all of those different sources of distribution, we will see long term how this plays out. But in the near term, we still have only a limited store base. I think as of the end of the quarter we exited with 12 stores. So with the store base that's that limited, we still have a lot of runway left in front of us and we are bucking the retail trend. I will also say that there are certain things that we can do as a retailer and omnichannel retailer that may be more unique and we can create different experiential opportunities to bring people into the store. And we view that as a great opportunity as the face of retail changes for this company to continue to explore. So I would say, right now full steam ahead and notwithstanding all the disruption that's happening in bricks and- mortar, what we are experiencing is considerably different in a positive way to the overall bricks and mortar retail space.

Got it. That makes sense. And then sticking with 5.11, can you give us an update or early takeaways from your operational improvement projects? And is there any other projects that you are considering at this time?

Yes. So what we are doing for when you say operational improvements kind of there's two main areas that we are working on right now. We are in process of installing a new ERP system and that is in process. As I think everybody is aware, these things always are harder to install. They are more costly to install. But once they are in, there is great benefits that we think that can be realized through kind of visibility throughout the entire organization. The system that we are installing will really help with a lot of our direct-to-consumer efforts. It will enable a lot of the benefits that can be realized for an omnichannel retailer. And so we are very excited about what we believe will be operational benefits, both in revenue enhancements and in terms of margin improvement once the ERP is fully implemented. But that's kind of in-process right now and we would expect by the end of the year for that to be implemented, up and running and then to start to realize some of the benefits in 2018 and beyond from that system integration. The other area that we are moving on is, we are doing a facility consolidation in the Northern California market and that remains on plan. It really is giving access to a much larger distribution facility to support the growth in the business. And so it will create some additional efficiency. But I would say, that project is as much about creating opportunity for growth and the distribution capabilities that we will need based on what our anticipation of growth in this business will look like, more so than just purely on the efficiency.

Got it. Thank you. That's all I for now.

And your next question comes from the line of Leslie Vandegrift with Raymond James. Your line is open.

Good morning.

Good morning Leslie.

Thank you. So first of all on the AERC add-on to Clean Earth, do you just kind of have an estimate of what you are looking for that to add on to the business on annual basis? Obviously, the first year there's a ramp up that kind of, what it brings to Clean Earth?

Yes. So not something we typically quantify, Leslie. But I can tell you, early on, there is generally a good amount of work that has to be done as part of integrating the business, setting strategy, optimizing management teams, et cetera. So that will be in process most of the year. So I think from a 2017 standpoint, there won't be much of an impact. I think, if any it will be in 2018 and we are hopeful for that given early indications.

Okay. And then you talked about the market activity in the call and the higher valuations you had seen, which just kind of slowed middle market deal flow. Does that mean that you are not seeing as many opportunities to look at add-ons and acquisitions right now?

Leslie, I think we are seeing very comparable levels to what we have seen historically. I think there are some regional disparities between level of deal flow that are just again not attributable to anything in particular. And really the bucket hasn't changed. With these comments that we make in prepared remarks, it's interesting, it gets very difficult to say the same thing in a different way. But I feel a bit like a broken record with respect to market conditions. Really if you look back over the last couple of years, I wouldn't say that valuations are higher this quarter than they were last quarter or a quarter before. I would just more so suggest that they remain high. So the market has been the same. So we haven't seen a real decreased level of transaction flow. We also benchmark our deal flow and what we look at utilizing a third-party resource to make sure that we have a good record of seeing what we should see. And those statistics remain strong. So I think that we are really active in where we should be and we are seeing what we should see. But like it has been for quite some time, sometimes on paper, a perfect A-plus company is trading at a valuation level that we just simply are not comfortable with. And that being said, we are still very committed to going after opportunities where we have strong conviction even if that means paying a full and fair price, but paying out lighter valuations has never been our strategy and I don't believe we intend to change that strategy. So we will be selectively aggressive as we always have. We see opportunities that we get excited about. We routinely yet outbid at times over the years and I am sure that will continue as well. But we have also been very fortunate over the years to find great opportunities that we believe provide appropriate risk adjusted returns for our shareholders. And so that's what we will continue to pursue as we always have. We are just as excited about new subsidiary companies as we are about adding on to our existing group of companies, which we think is the best composition of subsidiaries that we have ever had and so deploying capital behind those outstanding management teams remains a real priority and something that's of interest to us. So we will really just keep doing what we are doing in the market. It really is what it's been for really the last couple of years. And so we are hopeful that we will be able to achieve some deployment of capital in 2017 as we move forward. But at the same time, as you know, we are not going to deploy it for the sake of deploying it. We are going to deploy it into opportunities that we have conviction on and that we think makes sense to drive value for our shareholders.

Okay. All right. Thank you. And then on 5.11, the tax effect, we talked about that before. Can you just kind of talk about the impact of that for the quarter?

So the tax asset continues to be a benefit for us on federal taxes in the U.S. They still aren't international business. So they are subject to some foreign taxes as well as local state taxes. But the asset continued to assist in our cash flow for the quarter. We don't typically provide the exact amount, but it was absolutely meaningful for the quarter.

Okay. All right, understandable. And then just last quick question, I know you discussed Manitoba a bit earlier, but just on the inventory issues, kind of the way out there that you are focusing on working with the foreign supplier?

Yes. So as we had mentioned on our last conference call, one of our foreign markets, which is our fastest growing foreign market outside of North America had gotten into an inventory position that was oversupplied and we anticipate that there would be softness here. I wish we had more clarity to say here as an exact date in which we will be able to resume normal sales into that market. I think, as you know, it doesn't really go like that. The market kind of has to clear through some of that product and as it does, then I think, kind of the up and normal pattern will start to resume. I would say, as of right now, we still have limited visibility with respect to whether or not that market will start to contribute here in the near term. We do think longer term this problem will resolve. And it's unlikely, the fact that there was inventory problem that built up, by definition, means that there was probably too much product that was sold in 2016 and so you had kind of an over build at that point and now it's working its way through and so has kind of that whipsaw effect between 2016 and 2017. So I would say, we expect the market to normalize likely later in 2017, but not to resume to levels of 2016 for that particular market. But obviously, it will be far better than what we are anticipating, which was virtually zero in Q1 and probably likely a similar amount in Q2. And so we think the problem will resume and it will get to something that's more normalized, albeit less than what 2016 levels are. That being said, I would say there is a lot of progress that was made in Manitoba that was really masked by the fact that we had this issue of oversupply in that market, principally the additional organic supply which has allowed us to get into some new U.S. channels, the club channel in particular, that has really fostered some pretty good growth. And so we are really excited about some of the progress that was made notwithstanding this. And I think that's why in the prepared comments we said from a long term, outlook for Manitoba continues to remain bright.

Okay. Perfect. Thank you for taking my questions this morning.

Thank you.

Thank you.

[Operator Instructions]. Your next question comes from the line of Kyle Joseph with Jefferies. Your line is open.

Hi. Good morning guys and thanks for taking my questions.

Good morning Kyle.

Good morning.

Just wanted to get an update on your macro outlook. We had a little uninspiring GDP in the first quarter. The new administration has talked about healthcare, taxes and infrastructure a little bit. But just sort of potential benefit headwinds as a result of what's occurred over the last, I don't know since we last spoke, I guess, you could say?

Sure. And I imagine that a couple of us may take a shot at answering this question. But from my perspective, as we look across our group of companies, there has been a lot of talk as you said about a lot of different initiatives from the new administration and nothing to-date has really, in my opinion, given us any reason to alter our outlook for 2017. To the extent, there is meaningful tax reform that is very pro-business that could lead, I hope, to some growth in our economy that hopefully would also benefit our specific subsidiaries. But it all remains largely still speculation. And so until we really know what these policies are going to look like, then it's very hard to move forward. I think one of the things that we are pleased that there doesn't seem to be much talk about border adjustment tax any longer, which we highlighted as a potential risk for several of our companies, when we spoke last quarter. So again, nothing is final. But to the extent that doesn't come back into play that's certainly something that we would view as a positive for our group of subsidiaries. But what we are hopeful, Kyle, that we will see some more growth going forward, but until there is really a tangible change in policy, it's very difficult to do anything other than speculate. Elias, Ryan, any comments beyond that?

Kyle, I would only mention that as you started with the economy was sort of lackluster in Q1. I would say, we felt that it was lackluster as well as we were going through the quarter. But it really is sort of consistent with what the last couple of years has been. And I know there is a lot of, as Alan has mentioned, there is anticipation of a lot of change, whether it's tax or healthcare or potential border adjustment and tariffs and other things. There's a lot of talk about this but really hasn't, kind of, nothing has pushed its way through, in our opinion, in the economy and it kind of feels like where we were if we talked a year ago in terms of the macroeconomic outlook for our company. So I would say, as to Alan's point, it kind of feels steady with where it's been over the last couple of years, which I don't think is great and the economy is not expanding a robust level. It's just kind of continuing to limp along here and we kind of for our businesses, you are in a fist fight everyday with your competitors to maintain share and take share and try to grow the business. But I would say that's kind of the general overall feel we had kind of year-to-date.

Got it. And then, not to beat a dead horse on retail trends, but is there anyway you can all give us some. full disclosure on this, I am not retail guy at all so I don't really understand the business, but is there anyway to mitigate risk to specific retailers to avoid taking a reserve on receivables? And how do you guys think about that?

Well, the primary way. Well there are several ways you can do that. One is you can insure an accounts receivable, a balance. Unfortunately, when you typically want to get that insurance, it's probably too late and then it becomes cost prohibitive. So you really have to have a really good forward-looking assessment that is really your own individually, because if everyone else is taking it because of all the factors that lead to that conclusion, then the insurance becomes really expensive. So that's one way and it's something that we always consider in all of our companies as well as us here at corporate do investigate and stay current on as a risk management tool. The other things you can do obviously is when you start to see or have concerns about a receivable and doing business with that customer, you can certainly work on the terms that you agreed to ship your goods to with those consumers and that can take a whole lot of different forms. You can either from the, on one end of the world you can say, look, we are not shipping you anything unless you pay upfront. On the other end, it is either you have got to clean up some longer past due receivables before we will ship you more and really anything in between. And I think that all of our companies, they do a really good job in that context and are very focused on their own working capital management. And I think that in this case, I think all things considered, I think Liberty and 5.11 both did good jobs as the tea leaves started to become readable for them as it relates to the receivable balances. So I think that those are the types of things we typically will do. And again, I think that the accounting groups and finance groups and leadership at all of our subsidiaries are very focused on this and always have been. I mean long before there was this, call it, a current disruption in retail that's becoming more prominent, it's something that they do day-in and day-out. And I am sure they will continue to do that.

Great. Thanks very much for answering my questions.

Sure. My pleasure.

And your next question comes from the line of Brian Hogan with William Blair. Your line is open.

Good morning.

Good morning.

Good morning.

First question is on ERGO and just digging into Baby Tula. The trends have been sequentially down for the past couple of quarters. I know probably seasonally, first quarter is maybe a little softer. May be that explains d a little bit of it. But can you elaborate on the trends that you are seeing in the Baby Tula?

Yes. Brian, so the observation is correct. I would say, a lot of the business is the excitement for the business out of the consumers is based on new products and product launches. And I think a lot of the timing of product launches is going to effect kind of how some of these trends look. And so back into 2016, we were comping against a very, very successful, some very successful product launches that had occurred through 2015 that we knew were going to be difficult comparisons and we kind of forecasted that into our analysis when we acquired the company and for the price that we paid for the business. And we really knew that coming into 2017, the business would be, in a lot of cases, gearing up for a major new product launch. And as I had mentioned, we had this carrier that's out there called Free to Grow that launched right at the end of Q2 or Q1. Very little revenue contribution in Q1. But I would say, this industry is characterized by product refreshes and new products coming out that really drive a lot of growth. And so the revenue and financial performance sequentially has been slightly down as we were gearing up for that. And we feel pretty good about that product and further product launches or refreshes that we have coming along for the year now.

Should we expect like product refreshes and launches like on a yearly basis then? Is that fair?

Well, Tula is a little bit different in that we have kind of the, what I will say is a everyday seller, but it's all very limited run and Tula is not a mass market distributor like ERGObaby is. And so the model is a little bit different. This was a major refresh of a product line that the carrier design changed. And then I would say Tula in the business, when I talk about refreshes, it's really about kind of limited number of prints that are coming out and the refreshes that happen throughout the year. I would say, what we launched at the end of Q1 in the Free to Grow was kind of a new design of a carrier that no longer needed an insert. It's kind of a very popular kind of carrier now. And it was something that gearing up for that was a big event for Tula. So now will there be kind of product roadmap and do we have that and are we working on installing that in the same way that we did with ERGO? Yes. And will there likely be kind of products that are not only in 2017 but 2018 and 2019 that are thoughtfully laid out in terms of the cadence for either kind of evolutionary or new prints and just refreshes versus kind of major revolutionary product? Yes, that's some of the things that we work on and we have done that at ERGO very successfully and that's part of the process of integrating Tula into the ERGO brand but still maintaining the core DNA of Tula.

Sure. And then further in the ERGO. If you back out the Baby Tula and you back out the Orbit Baby impact, sales were down 1% and obviously you are talking about a refresh that's maybe been pushed out to later this year. Does all that explains it? Or is there more softness?

Yes. I would say, there is some cross currents right now at ERGO. The largest of which is, we are gearing up for a major product launch that's coming in the third quarter here. And the normal trends that we have experienced and this is from history that retailers in order to create additional space, floor space for that, start to work down some of their inventory, retailers are making their own estimates as to what they believe that product will do and they are trying to balance what their inventory needs will look like in advance of that product launch. And so that's been a very traditional kind of in advance of a product launch. We see a little bit of softness in advance of that. And I think ERGO is experiencing that right now. Now that being said and as noted on this call today, there is a lot of disruption in bricks and mortar retail and we are facing, we are finding that to be the case with ERGO. We do have a robust online channel that allows us to navigate it better. Internationally, we feel very good about where the business is and growth internationally. But the U.S. market is probably a little bit softer, not even withstanding the impact of bringing out a new product, just in general for consumer the U.S. market in Q1 felt a little softer than it had before. But I would say, this is a portfolio that is very well balanced. On the ERGO side, we derive a majority of our revenues outside of the United States. Those markets continue to perform very well and we feel that as this new product launches it will push us back to growth rates that we find that are more consistent with the long term growth rate for ERGO.

Sure. Thanks for that. You touched on this earlier, but on 5.11, the timing of the stores and how many stores do you expect to add in 2017, the cadence of that? I mean the same-store sales trends are very impressive at 15% and big margins are attractive. So it's like, why not build faster, I guess? I know it's very far out but?

Yes. So we haven't given out the actual number of stores that we are looking to open. I would tell you that if you went back to 2016 at the end of Q1, we had four stores and at the end of Q1 2017, we had 12. Now we would hope to be able to add faster than that as this has become an effort for us going forward. But as you know, as you are building this out, it's really a lot of things that go into it. It's kind of the people first and foremost and the processes for doing this, you are talking about negotiating on a number of different leases and doing the buildout and all of that requires a lot of resources. The capital resources is probably the easiest to provide, because we have access to a very strong balance sheet today. And so capital is not the issue. But it really is, the gating item is kind of on the people and the human resources that you need to build this out. And we are going to try to, I would say, step on the gas to kind of accelerate the development, because all the things that you just mentioned are the same things that we are seeing, which we are very encouraged about in this line of business. But at the same point, not stepping on the gas so hard to the point that it could cause the performance to deteriorate, because we are going into potentially suboptimal locations or we are not finding the right people to do this. So we are trying to accelerate our growth in this area. And I think we will be able to give updates quarterly on how that growth is going. We would expect the growth to accelerate from what we had over the last years, which was kind of net eight stores if you went from the Q1 2016 to 2017. We would expect acceleration of that growth. But there's limitations on how fast you can grow and still do in a good and responsible manner.

Okay. Sure. And then, I guess, briefly on the Arnold and impairment charge, what exactly led to that charge? And you mentioned business trends are kind of reversing or starting improving here lately, but just can you elaborate on that, please.

Sure, Brian. So if you recall in our disclosure last quarter, the fourth quarter, we booked the impairment on a preliminary basis. So we did the analysis as of 12/31/16. We were preliminary, in that the process was going to take a couple of months to get the analysis squared away and this Q1 recognition was finalizing that original analysis. So the total impairment was a little over $24 million.

All right. I appreciate that. And then the Clean Earth, the contract that started in January for dredge, at least that's what it sounded like. Is that right?

No. Brian, just to jump in there. There is no specific contract in dredge that started in January, at least that I intended to refer to. So I apologize if I misled.

Okay. And maybe there was contract that started in January of something, I guess, maybe whatever it was. But I guess, what I am trying to get to, should we expect the same seasonal bounce in the second quarter? And given that the warmer weather we had in the first quarter just here, because we are off of a higher first quarter than I anticipated, so that's just kind of.

Yes. No, that's right. And we also had some snow in certain parts of the country, even in the first quarter that were a little bit challenging. But I wouldn't say to you that the second and third quarters just because these projects can be lumpy. So I don't want to guide you or anyone towards a bump-in over the other quarter, but I would say over these next six months, that is clearly the seasonal time where dredge is most active. And then when you get to the fourth quarter, it really will depend on projects and weather and things of that nature. So I think you are right to focus on the second and third quarters as being the primary season for the dredge business. But it gets very difficult not just in dredge, but in a lot of cleaners business segments that really pinpoint a quarter-to-quarter performance just based on the nature of the projects that they work on.

All right. And then last one from me, the rationale behind the sales of the Fox Factory, you have a $115 million of cash on the balance sheet now and nothing on your revolver. Can you pay down more debt or the term debt at all? Or what's the rationale and thought process of the cash on the balance sheet?

Well, look, I think first and foremost, we are not in the business of owning minority stakes in publicly traded companies. And so from day one, after the FOX IPO, I believe that we made it pretty clear to the market that we were very interested in owning this. We thought and continue to believe that it's a great investment, but that investment would always be looked at in the context of future liquidity for our business. And so we certainly don't hope to have a lot of cash on our balance sheet for an extended period of time. But I think that for CODI and for FOX, finalizing our exit, I think, was good for both companies and really allows us to focus on deploying capital and growing our base business as opposed to having this retained minority ownership in FOX, which in some ways nothing intricate with respect to our financial statements, but in many ways it wasn't something that we ever really felt we got recognition or reward for and didn't really impact our CAD. And I think it was hard for people who were following the CODI story to necessarily absorb what that investment meant to us in the context of our valuation. And so we think it was consistent with our strategy. We certainly don't expect to have a cash balance that is meaningful over the long term. As I mentioned, we are certainly hopeful about our ability to deploy capital over the balance of this year. And while we certainly could pay down a more of the term debt, I don't know, that is not our strategy at the moment, because we view that as a much more of a permanent piece of our capital structure. Our leverage is low. As you know it's below 2.5 times as we speak. And so we think that we have alternate uses of capital that are better for long term value creation than to paying off what we consider to be permanent part of our capital structure.

All right. I appreciate the thoughts. Thank you.

Thank you.

Thank you Brian.

And there are no further questions at this time. I will turn the call back over to management.

Well, thanks, everyone again for joining us on today's call and for your continued interest in CODI. We look forward to sharing our progress with you in the future. Thank you.

And ladies and gentlemen, this concludes today's conference call. You may now disconnect.