Business Context and Reporting Period
Company: Compass Diversified Trust (the "Trust") and Compass Group Diversified Holdings LLC (the "Company").
Reporting Period: Quarterly period ended September 30, 2006.
Structure: The Trust is a Delaware statutory trust formed to acquire and manage a group of small and middle-market businesses. The Company is the operating entity. As of November 1, 2006, there were 20,450,000 shares of Trust stock outstanding.
Key Events: The Company completed its Initial Public Offering (IPO) on May 16, 2006, raising approximately $269.9 million in net proceeds. Concurrently, it acquired controlling interests in four "initial businesses" (CBS Personnel, Crosman, Advanced Circuits, and Silvue). On July 31, 2006, the Company acquired a controlling interest in Anodyne Medical Device, Inc.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 |
|---|---|---|
| Net Sales | $183.8 million | $278.5 million |
| Gross Profit | $45.0 million (24.5% margin) | $68.8 million (24.7% margin) |
| Operating Income | $2.8 million | $7.9 million |
| Net Loss | $(3.9) million | $(1.8) million |
| Loss Per Share (Basic & Diluted) | $(0.19) | $(0.18) |
| Cash and Cash Equivalents | $13.0 million | $13.0 million (Ending Balance) |
| Net Cash Provided by Operating Activities | N/A | $10.3 million |
| Total Debt Outstanding | $69.5 million | $69.5 million |
Note: The Net Loss is significantly impacted by a non-cash "Supplemental Put Expense" of $8.0 million recognized in the quarter.
Material Changes and Segment Performance
Due to the May 16, 2006 IPO and acquisitions, consolidated results for the three and nine months ended September 30, 2006, are not comparable to prior periods. However, historical stand-alone data for the acquired businesses shows the following trends compared to the prior year:
- CBS Personnel: Revenues decreased slightly in the quarter but increased for the nine-month period. Operating income increased due to reduced bad debt expense and restructuring costs.
- Crosman: Significant growth in both revenue and operating income, driven by increased sales of "soft air" products and air rifles, alongside improved gross margins.
- Advanced Circuits: Revenue increased, but operating income decreased slightly due to non-cash loan forgiveness charges and increased amortization expenses.
- Silvue: Revenue and operating income increased, aided by the inclusion of Nippon ARC for a full nine-month period.
- Anodyne: Included in consolidated results only from August 1, 2006 (acquisition date).
Guidance, Outlook, Risks, and Unusual Items
Unusual Items
- Supplemental Put Expense: The Company recognized an $8.0 million non-cash expense related to a Supplemental Put Agreement with its Manager (CGM). This liability represents the estimated increase in the fair value of the Company's businesses over its basis, which CGM could claim if the Management Services Agreement were terminated.
- Acquisition Costs: Significant investing cash outflows ($345.8 million) were driven by the acquisition of initial businesses and Anodyne.
Liquidity and Capital Resources
The Company maintains a $225 million secured credit facility (Financing Agreement) maturing in May 2011. As of September 30, 2006, $69.5 million was outstanding ($50 million term loan, $10 million delayed draw term loan, and $9.5 million revolving credit). The Company believes it has sufficient liquidity to meet obligations and anticipated distributions for the next twelve months.
Risks and Contingencies
- Dividend Policy: Distributions to shareholders are dependent on the cash flow of the underlying businesses. Management fees and the potential Supplemental Put obligation must be paid prior to shareholder distributions.
- Debt Covenants: The Financing Agreement requires maintaining a minimum cash flow and a debt-to-cash flow ratio of 3:1. The Company was in compliance as of September 30, 2006.
- Taxation: Shareholders may be subject to taxes on taxable income that exceeds cash distributions received.
Investor Verification Checklist
- Supplemental Put Liability: Verify the valuation methodology used to calculate the $8.0 million non-cash expense and the potential future cash impact if the agreement is triggered.
- Debt Covenants: Monitor the Company's ability to maintain the required debt-to-cash flow ratio (3:1) and minimum cash flow levels under the Financing Agreement.
- Segment Integration: Assess the post-acquisition performance of the initial businesses and Anodyne to ensure projected synergies and cash flows are being realized.
- Dividend Coverage: Review the "Cash Flow Available for Distribution" (CAD) metric to confirm that operating cash flows are sufficient to cover the declared quarterly distributions ($0.2625 per share for Q3 2006).
- Related Party Transactions: Review the Management Services Agreement and the Supplemental Put Agreement to understand the priority of payments to the Manager versus shareholders.