CODI

Business Context and Reporting Period

Company: Compass Diversified Holdings (Holdings) and Compass Group Diversified Holdings LLC (Company).
Filing Type: Form 10-Q (Quarterly Report).
Period Ended: March 31, 2011.
Business Overview: The Company is a holding company that acquires and manages a group of small and middle-market businesses headquartered in North America. As of March 31, 2011, it controlled eight operating segments: Advanced Circuits, American Furniture, ERGObaby, Fox Factory, HALO, Liberty Safe, Staffmark, and Tridien Medical.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 20.0% year-over-year, driven primarily by acquisitions made in 2010 (ERGObaby and Liberty Safe) and organic growth at Staffmark and Fox Factory.
• Profitability Improvement: Operating loss narrowed significantly from $15.2 million in Q1 2010 to $1.4 million in Q1 2011. This improvement was largely due to a decrease in the non-cash "Supplemental put expense" from $14.4 million to $3.2 million.
• Impairment Charges: The Company recorded a $7.7 million impairment charge in Q1 2011 related to the American Furniture segment ($5.9 million goodwill and $1.8 million trade name), compared to no impairment charges in Q1 2010.
• Cash Flow: Net cash provided by operating activities more than doubled to $39.8 million, primarily due to strong cash generation from Staffmark, Advanced Circuits, Fox, and Liberty Safe.
• Debt Reduction: Total debt decreased by $15.5 million as the Company repaid $15.0 million on its Revolving Credit Facility and $0.5 million on its Term Loan.

Guidance, Outlook, and Risks

• Outlook: Management expects sustained modest top-line growth for most businesses in fiscal 2011, with the exception of American Furniture and Tridien. American Furniture continues to face headwinds from the depressed housing market and tight credit conditions.
• Cost Pressures: Rising commodity costs (steel, cotton, fuel) pose a risk to gross profit margins. The Company plans to raise prices where possible to offset these increases.
• Acquisition Strategy: The Company believes the current credit environment benefits its acquisition model as it does not rely on third-party financing for closing deals.
• Staffmark IPO: Staffmark Holdings, Inc. filed a registration statement for an initial public offering (IPO) on April 12, 2011. The Company owns approximately 68.5% of Staffmark on a fully diluted basis.
• Key Risks:
  • Goodwill Impairment: HALO's fair value exceeded its carrying value by only 9.7%. A 1% increase in the discount rate could trigger an impairment charge.
  • Supplemental Put Obligation: A significant liability ($47.8 million) exists related to the Manager's right to force the Company to purchase their allocation interests. This liability fluctuates based on the fair value of the underlying businesses.
  • Seasonality: Several segments (HALO, Fox, Staffmark) are subject to significant seasonal fluctuations in revenue and earnings.

Investor Verification Checklist

• American Furniture Impairment: Verify the finalization of the goodwill and trade name impairment analysis, as the Q1 charge was based on preliminary results.
• HALO Valuation Sensitivity: Monitor HALO's performance closely, as its fair value is close to its carrying value, making it susceptible to future impairment charges.
• Staffmark IPO Status: Track the progress and pricing of the Staffmark IPO, which could impact the Company's liquidity and ownership structure.
• Supplemental Put Liability: Review future quarterly changes in the Supplemental Put liability, as increases in subsidiary valuations will result in non-cash charges to earnings.
• Margin Compression: Assess the Company's ability to pass on rising raw material and fuel costs to customers to maintain gross margins.