CODI

Business Context and Reporting Period

Company: Compass Diversified Holdings (CODI)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2012
Business Overview: CODI is a Delaware statutory trust that acquires and manages a portfolio of small to middle-market businesses. As of June 30, 2012, the Company controlled eight operating segments: Advanced Circuits, American Furniture, Arnold Magnetics, CamelBak, ERGObaby, Fox Factory, Liberty Safe, and Tridien Medical. The Company operates under a management agreement with Compass Group Management LLC (CGM).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 53% year-over-year, driven primarily by the inclusion of Arnold Magnetics (acquired March 2012) and CamelBak (acquired August 2011), which contributed approximately $128.3 million and $84.5 million respectively in the first half of 2012.
• Operating Income: Operating income increased significantly to $29.1 million from $8.6 million in the prior year, aided by the new acquisitions and the absence of a $7.7 million impairment charge recorded at American Furniture in the prior year.
• Cash Flow Decline: Operating cash flow turned negative at $(5.0) million compared to $48.5 million in 2011. This decrease is attributed to the absence of Staffmark operating cash flow (sold in 2011), a $13.7 million payment of the supplemental put liability, and increased working capital investment in growing segments.
• Debt Structure: The Company exercised an option for a $30 million incremental term loan in April 2012, increasing total term loans to approximately $254 million. Interest expense rose to $13.7 million from $3.9 million due to higher debt levels and the inclusion of Arnold Magnetics.

Guidance, Outlook, and Risks

• Acquisition Activity: The Company acquired Arnold Magnetics for approximately $130.5 million and Universal Circuits for $2.8 million. It also sold its HALO subsidiary for approximately $66.4 million in net proceeds, which were used to repay debt.
• Outlook: Management notes that consumer spending is slowing and the U.S. housing market remains depressed, negatively impacting American Furniture. However, the tight credit environment is viewed as beneficial for the Company's acquisition model, as it does not rely on third-party transaction financing.
• Liquidity: The Company maintains a $290 million Revolving Credit Facility with approximately $269 million in borrowing base availability. Management believes current resources are sufficient to meet obligations and distributions for the next 12 months.
• Risks: Key risks include the ability to service indebtedness, the impact of the supplemental put obligation (estimated liability of $37.2 million), and the performance of portfolio companies in a slowing economic environment. The Company also faces risks related to the integration of Arnold Magnetics.

Investor Verification Checklist

• Supplemental Put Liability: Verify the fair value assumptions used to calculate the $37.2 million supplemental put obligation to the Manager, as this is a significant non-cash liability impacting net income.
• Working Capital Trends: Review the significant increase in accounts receivable and inventories, which contributed to the negative operating cash flow despite strong revenue growth.
• American Furniture Performance: Monitor the continued decline in sales and operating losses at American Furniture due to the depressed housing market and competitive pricing.
• Debt Covenants: Confirm continued compliance with the Fixed Charge Coverage Ratio (2.47:1) and Total Debt to EBITDA Ratio (2.01:1) covenants under the Credit Facility.
• Non-GAAP Reconciliations: Review the reconciliation of Net Income to Adjusted EBITDA and Cash Flow Available for Distribution (CAD) to understand the impact of non-cash charges and acquisition costs on reported earnings.