Business Context and Reporting Period
Company: Compass Diversified Holdings (a Delaware statutory trust) and Compass Group Diversified Holdings LLC.
Reporting Period: Quarterly period ended September 30, 2010 (Form 10-Q).
Business Model: The Company acquires and manages a group of small and middle-market businesses headquartered in North America. As of September 30, 2010, the Company operated eight reportable segments: Advanced Circuits, American Furniture, ERGObaby, Fox Factory, HALO, Liberty Safe, Staffmark, and Tridien Medical.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sept 30, 2010 | Nine Months Ended Sept 30, 2010 | Nine Months Ended Sept 30, 2009 |
|---|---|---|---|
| Total Revenues | $460,767 | $1,218,708 | $886,681 |
| Gross Profit | $99,531 | $256,249 | $192,839 |
| Operating Income (Loss) | $(21,212) | $(27,301) | $(51,119) |
| Net Income (Loss) Attributable to Holdings | $(30,059) | $(47,488) | $(24,590) |
| Net Cash Provided by Operating Activities | N/A | $28,827 | $21,434 |
| Cash and Cash Equivalents (End of Period) | $24,468 | $24,468 | $46,997 |
| Total Debt (Revolving + Term) | $175,800 | $175,800 | $76,500 |
| Supplemental Put Obligation | $30,712 | $30,712 | $12,082 |
Note: Operating loss for the nine months ended Sept 30, 2010, includes a significant non-cash impairment charge of $42.4 million.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 42% year-over-year for the three months ended September 30, 2010, and 37.5% for the nine-month period. Growth was driven by acquisitions (ERGObaby, Liberty Safe, Circuit Express) and organic growth in Staffmark, Fox Factory, and Advanced Circuits.
- Impairment Charges: The Company recorded a $42.4 million impairment charge in the third quarter of 2010 related to the American Furniture segment. This consisted of $41.4 million in goodwill impairment and $1.0 million in trade name write-off due to deteriorated operating results and a revised outlook for the furniture industry.
- Supplemental Put Expense: The Company incurred $18.6 million in supplemental put expense for the nine months ended September 30, 2010, compared to a reversal of $8.5 million in the prior year. This increase reflects the rising fair value of the Company's businesses, offset partially by the decline in American Furniture's value.
- Acquisitions: Significant capital was deployed for acquisitions totaling approximately $173.7 million in the first nine months of 2010, including ERGObaby ($85.2 million), Liberty Safe ($70.2 million), and Circuit Express ($16.1 million).
- Debt Levels: Total debt increased from $76.5 million at December 31, 2009, to $175.8 million at September 30, 2010, primarily due to borrowings under the Revolving Credit Facility to fund acquisitions.
Guidance, Outlook, and Risks
- Outlook: Management remains optimistic about continued growth in sales and operating income for the remainder of 2010, despite the underperformance of Liberty Safe and American Furniture. Liberty Safe's results are being compared to abnormally high 2009 sales driven by anticipation of stricter gun laws.
- Capital Resources: The Company has a $340 million Revolving Credit Facility (with ~$172.7 million availability) and a $74.5 million Term Loan. Management believes liquidity is sufficient to meet obligations and fund distributions for the next 12 months.
- Key Risks:
- Goodwill Impairment: The $42.4 million charge for American Furniture is preliminary and subject to finalization in Q4 2010.
- Supplemental Put Liability: The Company has a contractual obligation to purchase the Manager's allocation interests upon termination of the Management Services Agreement. The liability is estimated at $30.7 million and fluctuates with the fair value of the businesses.
- Economic Conditions: The retail furniture market remains severely impacted by economic uncertainty and the housing market. Staffmark margins are pressured by higher unemployment taxes.
- Unusual Items: The financial results are significantly impacted by the non-cash impairment charge and the supplemental put expense, which do not reflect cash outflows in the current period.
Investor Verification Checklist
- Finalize Impairment Analysis: Verify the finalization of the American Furniture goodwill impairment analysis expected in Q4 2010 to confirm if the $42.4 million charge will be adjusted.
- Supplemental Put Liability: Monitor the fair value of the Company's portfolio businesses, as fluctuations directly impact the Supplemental Put obligation and reported earnings.
- Debt Covenants: Confirm continued compliance with credit agreement covenants (Fixed Charge Coverage, Interest Coverage, Leverage Ratio), which were met as of September 30, 2010.
- Seasonality: Assess the impact of seasonality on HALO (strong Q4) and American Furniture (strong Q1) when projecting full-year results.
- Acquisition Integration: Evaluate the performance of recent acquisitions (ERGObaby, Liberty Safe) as they are integrated into the consolidated results.