Business Context and Reporting Period
Company: Compass Diversified Holdings (Compass Diversified Trust and Compass Group Diversified Holdings LLC)
Reporting Period: Fiscal year ended December 31, 2006
Structure: A Delaware statutory trust and LLC formed to acquire and manage small and middle-market businesses. The company completed its IPO on May 16, 2006, raising approximately $188.3 million in net proceeds. Operations for the initial businesses began on May 16, 2006, with the acquisition of Anodyne on August 1, 2006. Consequently, consolidated results reflect a partial year of operations.
Key Financial Metrics
| Metric | 2006 (in thousands) |
|---|---|
| Net Sales | $410,873 |
| Gross Profit | $99,232 |
| Operating Loss | $(7,257) |
| Net Loss | $(19,249) |
| Cash Provided by Operating Activities | $20,563 |
| Total Assets | $525,597 |
| Total Liabilities | $242,755 |
| Shareholders' Equity | $255,711 |
| Debt Outstanding (Revolving Credit Facility) | $85,000 (as of Dec 31, 2006) |
Note: The company reported a net loss primarily due to a $22.5 million non-cash expense related to the Supplemental Put Agreement and a $8.3 million loss on debt extinguishment. Income from discontinued operations (Crosman) was $8.4 million.
Material Changes and Segment Performance
As the company was formed in late 2005 and acquired its initial portfolio in May 2006, there are no meaningful year-over-year consolidated comparisons. However, segment performance for the period of ownership is as follows:
- CBS Personnel (Staffing): Generated $352.4 million in revenue (85.8% of total) and $17.1 million in operating income since acquisition.
- Advanced Circuits (PCBs): Generated $30.6 million in revenue and $7.5 million in operating income since acquisition.
- Silvue (Coatings): Generated $15.7 million in revenue and $4.7 million in operating income since acquisition.
- Anodyne (Medical Devices): Generated $12.2 million in revenue but reported an operating loss of $0.6 million since acquisition due to supply delays.
- Crosman (Discontinued): Sold on January 5, 2007, for approximately $143 million. The company expects to recognize a gain of $36–$37 million in Q1 2007.
Guidance, Outlook, and Risks
Recent Developments:
- Acquisitions: On February 28, 2007, the company acquired Aeroglide Corporation ($57 million) and Halo Branded Solutions ($61 million).
- Debt Repayment: Proceeds from the Crosman sale were used to repay $85 million of the Revolving Credit Facility.
- Distributions: The company paid quarterly distributions totaling $0.3952 per share in 2006 and intends to continue regular quarterly distributions.
Management Commentary: Management expects the new acquisitions (Aeroglide and Halo) to be accretive to cash flow available for distribution. The company relies on its Revolving Credit Facility ($250 million capacity) to fund future acquisitions and working capital.
Risks and Contingencies:
- Supplemental Put Agreement: A significant liability ($22.5 million accrued in 2006) exists where the Manager can force the company to purchase allocation interests based on the increase in fair value of businesses. This creates volatility in earnings.
- Related Party Transactions: The Manager (CGM) receives a management fee (0.5% quarterly of adjusted net assets) and profit allocations, which are paid prior to shareholder distributions.
- Tax Status: The IRS has issued a pronouncement suggesting the Trust may be treated as a partnership rather than a grantor trust, potentially changing tax reporting to Schedule K-1.
- Debt Covenants: The company must maintain specific financial ratios (e.g., Total Debt to EBITDA not to exceed 3:1). Breach could restrict distributions.
Investor Verification Checklist
- Supplemental Put Liability: Verify the fair value assumptions used to calculate the $22.5 million non-cash expense and the potential cash outflow upon termination of the management agreement.
- Cash Flow vs. Net Income: Confirm that operating cash flow ($20.6 million) is sufficient to cover the management fee, debt service, and shareholder distributions despite the reported net loss.
- Related Party Fees: Review the specific calculation of the management fee and profit allocation to understand the impact on distributable cash flow.
- Discontinued Operations: Confirm the final gain on the sale of Crosman and the timing of the $7.9 million profit allocation payment to the Manager.
- Tax Reporting: Monitor the company's decision regarding the IRS pronouncement on grantor trust vs. partnership status and its impact on shareholder tax filings.