UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the quarterly period ended September 30, 2011
Or
For the transition period from to
COMPASS DIVERSIFIED HOLDINGS
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(Commission
file number)
(I.R.S. employer
identification number)
COMPASS GROUP DIVERSIFIED HOLDINGS LLC
Sixty One Wilton Road
Second Floor
Westport, CT 06880
(203) 221-1703
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company’ in Rule 12b-2 of the Exchange Act
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of November 1, 2011, there were 48,300,000 shares of Compass Diversified Holdings outstanding.
QUARTERLY REPORT ON FORM 10-Q
For the period ended September 30, 2011
TABLE OF CONTENTS
Forward-looking Statements
Part I
Financial Information
Item 1.
Financial Statements:
Condensed Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 (unaudited)
Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2011 (unaudited)
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
Part II
Other Information
Legal Proceedings
Item 1A.
Risk Factors
Item 6.
Exhibits
Signatures
Exhibit Index
2
NOTE TO READER
In reading this Quarterly Report on Form 10-Q, references to:
the “Trust” and “Holdings” refer to Compass Diversified Holdings;
“businesses”, “operating segments”, “subsidiaries” and “reporting units” refer to, collectively, the businesses controlled by the Company;
the “Company” refer to Compass Group Diversified Holdings LLC;
the “Manager” refer to Compass Group Management LLC (“CGM”);
the “initial businesses” refer to, collectively, Staffmark Holdings, Inc. (“Staffmark”), Crosman Acquisition Corporation, Compass AC Holdings, Inc. and Silvue Technologies Group, Inc.;
the “2010 acquisitions” refer to, collectively, the acquisitions of Liberty Safe and Security Products, LLC and ERGObaby Carrier, Inc.;
the “Trust Agreement” refer to the amended and restated Trust Agreement of the Trust dated as of November 1, 2010;
the “Credit Agreement” refer to the Credit Agreement with a group of lenders led by Madison Capital, LLC which provides for a Revolving Credit Facility and a Term Loan Facility;
the “Revolving Credit Facility” refer to the $340 million Revolving Credit Facility provided by the Credit Agreement that matures in December 2012;
the “Term Loan Facility” refer to the $72.5 million Term Loan Facility, as of September 30, 2011, provided by the Credit Agreement that matures in December 2013;
the “LLC Agreement” refer to the third amended and restated operating agreement of the Company dated as of November 1, 2010; and
“we”, “us” and “our” refer to the Trust, the Company and the businesses together.
3
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, contains both historical and forward-looking statements. We may, in some cases, use words such as “project,” “predict,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,” “could,” “potentially,” or “may,” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q are subject to a number of risks and uncertainties, some of which are beyond our control, including, among other things:
our ability to successfully operate our businesses on a combined basis, and to effectively integrate and improve future acquisitions;
our ability to remove CGM and CGM’s right to resign;
our organizational structure, which may limit our ability to meet our dividend and distribution policy;
our ability to service and comply with the terms of our indebtedness;
our cash flow available for distribution and reinvestment and our ability to make distributions in the future to our shareholders;
our ability to pay the management fee, profit allocation when due and supplemental put price if and when due;
our ability to make and finance future acquisitions;
our ability to implement our acquisition and management strategies;
the regulatory environment in which our businesses operate;
trends in the industries in which our businesses operate;
changes in general economic or business conditions or economic or demographic trends in the United States and other countries in which we have a presence, including changes in interest rates and inflation;
environmental risks affecting the business or operations of our businesses;
our and CGM’s ability to retain or replace qualified employees of our businesses and CGM;
costs and effects of legal and administrative proceedings, settlements, investigations and claims; and
extraordinary or force majeure events affecting the business or operations of our businesses.
Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by the forward-looking statements. Additional risks of which we are not currently aware or which we currently deem immaterial could also cause our actual results to differ.
In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements. The forward-looking events discussed in this Quarterly Report on Form 10-Q may not occur. These forward-looking statements are made as of the date of this Quarterly Report. We undertake no obligation to publicly update or revise any forward-looking statements to reflect subsequent events or circumstances, whether as a result of new information, future events or otherwise, except as required by law.
4
PART I
FINANCIAL INFORMATION
ITEM 1. - FINANCIAL STATEMENTS
Compass Diversified Holdings
Condensed Consolidated Balance Sheets
Assets
Current assets:
Cash and cash equivalents
Accounts receivable, less allowances of $4,893 at September 30, 2011 and $5,481 at December 31, 2010
Inventories
Prepaid expenses and other current assets
Total current assets
Property, plant and equipment, net
Goodwill
Intangible assets, net
Deferred debt issuance costs, less accumulated amortization of $8,425 at September 30, 2011 and $6,882 at December 31, 2010
Other non-current assets
Total assets
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable
Accrued expenses
Due to related party
Current portion, long-term debt
Current portion of workers’ compensation liability
Other current liabilities
Total current liabilities
Supplemental put obligation
Deferred income taxes
Long-term debt
Workers’ compensation liability
Other non-current liabilities
Total liabilities
Stockholders’ equity
Trust shares, no par value, 500,000 authorized; 48,300 shares issued and outstanding at September 30, 2011 and 46,725 shares issued and outstanding at December 31, 2010
Accumulated other comprehensive loss
Accumulated deficit
Total stockholders’ equity attributable to Holdings
Noncontrolling interest
Total stockholders’ equity
Total liabilities and stockholders’ equity
See notes to condensed consolidated financial statements.
5
Condensed Consolidated Statements of Operations
(unaudited)
Net sales
Service revenues
Total revenues
Cost of sales
Cost of services
Gross profit
Operating expenses:
Staffing expense
Selling, general and administrative expense
Supplemental put expense
Management fees
Amortization expense
Impairment expense
Operating income (loss)
Other income (expense):
Interest income
Interest expense
Amortization of debt issuance costs
Other income, net
Income (loss) be fore income taxes
Provision for income taxes
Net income (loss)
Net income attributable to noncontrolling interest
Net income (loss) attributable to Holdings
Basic and fully diluted income (loss) per share attributable to Holdings
Weighted average number of shares of trust stock outstanding – basic and fully diluted
Cash distributions declared per share (refer to Note L)
6
Condensed Consolidated Statement of Stockholders’ Equity
Balance — January 1, 2011
Net income
Other comprehensive income – cash flow hedge gain
Comprehensive income
Issuance of Trust shares for CamelBak acquisition (see Note D)
Offering costs from the issuance of Trust shares in 2010
Issuance of stock by CamelBak noncontrolling shareholders
Issuance of preferred stock to CamelBak noncontrolling shareholders
Beneficial conversion feature - CamelBak preferred stock
Accretion - CamelBak preferred stock
Option activity attributable to noncontrolling interest holders
Distributions paid
Balance — September 30 , 2011
7
Condensed Consolidated Statements of Cash Flows
Cash flows from operating activities:
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation expense
Noncontrolling stockholder charges and other
Deferred taxes
Other
Changes in operating assets and liabilities, net of acquisition:
Increase in accounts receivable
Increase in inventories
Increase in prepaid expenses and other current assets
Increase in accounts payable and accrued expenses
Payment of supplemental put liability
Net cash provided by operating activities
Cash flows from investing activities:
Acquisitions, net of cash acquired
Purchases of property and equipment
Other investing activities
Net cash used in investing activities
Cash flows from financing activities:
Proceeds from the issuance of Trust shares, net
Borrowings under Credit Agreement
Repayments under Credit Agreement
Proceeds from issuance of CamelBak preferred stock
Net proceeds provided by noncontrolling interest
Debt issuance costs
Net cash provided by financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents — beginning of period
Cash and cash equivalents — end of period
8
September 30, 2011
Note A — Organization and business operations
Compass Diversified Holdings, a Delaware statutory trust (“Holdings”), was organized in Delaware on November 18, 2005. Compass Group Diversified Holdings, LLC, a Delaware limited liability company (the “Company”), was also formed on November 18, 2005. Compass Group Management LLC, a Delaware limited liability company (“CGM” or the “Manager”), was the sole owner of 100% of the Interests of the Company as defined in the Company’s operating agreement, dated as of November 18, 2005, which were subsequently reclassified as the “Allocation Interests” pursuant to the Company’s amended and restated operating agreement, dated as of April 25, 2006 (as amended and restated, the “LLC Agreement”).
The Company is a controlling owner of nine businesses, or operating segments, at September 30, 2011. The operating segments are as follows: Compass AC Holdings, Inc. (“ACI” or “Advanced Circuits”), AFM Holdings Corporation (“AFM” or “American Furniture”), CamelBak Products, LLC (“CamelBak”), The ERGO Baby Carrier, Inc. (“ERGObaby”), Fox Factory, Inc. (“Fox”), HALO Lee Wayne LLC (“HALO”), Liberty Safe and Security Products, LLC (“Liberty Safe” or “Liberty”), Staffmark Holdings, Inc. (“Staffmark”), and Tridien Medical (“Tridien”). Refer to Note E for further discussion of the operating segments.
Note B — Presentation and principles of consolidation
The condensed consolidated financial statements for the three month and nine month periods ended September 30, 2011 and September 30, 2010, are unaudited, and in the opinion of management, contain all adjustments necessary for a fair presentation of the condensed consolidated financial statements. Such adjustments consist solely of normal recurring items. Interim results are not necessarily indicative of results for a full year or any subsequent interim period. The condensed consolidated financial statements and notes are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and presented as permitted by Form 10-Q and do not contain certain information included in the annual consolidated financial statements and accompanying notes of the Company. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
Seasonality
Earnings of certain of the Company’s operating segments are seasonal in nature. Earnings from AFM are typically highest in the months of January through April of each year, coinciding with homeowners’ tax refunds. Earnings from Staffmark are typically lower in the first quarter of each year than in other quarters due to reduced seasonal demand for temporary staffing services and to lower gross margins during that period associated with the front-end loading of certain payroll taxes associated with payroll paid to its employees. Earnings from HALO are typically highest in the months of September through December of each year primarily as the result of calendar sales and holiday promotions. HALO generates approximately two-thirds of its operating income in the months of September through December. Revenue and earnings from Fox are typically highest in the third quarter, coinciding with the delivery of product for the new bike year. Earnings from Liberty are typically lowest in the second quarter due to lower demand for safes at the onset of summer. Earnings from CamelBak are typically higher in the spring and summer months than other months as this corresponds with warmer weather in the Northern Hemisphere and an increase in hydration related activities.
Consolidation
The condensed consolidated financial statements include the accounts of Holdings and all majority owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Reclassifications
Certain prior period amounts have been reclassified to conform to current year presentation.
9
Note C — Recent accounting pronouncements
In September 2011, the Financial Accounting Standards Board (“FASB”) issued amended guidance for performing goodwill impairment tests, which is effective for the Company beginning January 1, 2012. The guidance amends the two-step goodwill impairment test by permitting an entity to first assess qualitative factors in determining whether the fair value of a reporting unit is less than its carrying amount. The Company does not expect the adoption of the amended guidance to have a significant impact on the condensed consolidated financial statements.
In June 2011, the FASB issued amended guidance for presenting comprehensive income, which will be effective for the Company beginning January 1, 2012. The amended guidance eliminates the option to present other comprehensive income and its components in the statement of stockholders’ equity. The Company may elect to present the items of net income and other comprehensive income in a single continuous statement of comprehensive income or in two separate, but consecutive, statements. Under either method the statement would need to be presented with equal prominence as the other primary financial statements. The Company does not expect the adoption of the amended guidance to have a significant impact on the condensed consolidated financial statements.
In May 2011, the FASB issued amended guidance for measuring fair value and required disclosure information about such measures, which will be effective for the Company beginning January 1, 2012, and applied prospectively. The amended guidance requires an entity to disclose all transfers between Level 1 and Level 2 of the fair value hierarchy as well as provide quantitative and qualitative disclosures related to Level 3 fair value measurements. Additionally, the amended guidance requires an entity to disclose the fair value hierarchy level which was used to determine the fair value of financial instruments that are not measured at fair value, but for which fair value information must be disclosed. The Company does not expect the adoption of the amended guidance to have a significant impact on the condensed consolidated financial statements.
In January 2010, the FASB issued amended guidance to enhance disclosure requirements related to fair value measurements. The amended guidance for Level 1 and Level 2 fair value measurements was effective for the Company January 1, 2010. The amended guidance for Level 3 fair value measurements was effective for the Company January 1, 2011. The guidance requires disclosures of amounts and reasons for transfers in and out of Level 1 and Level 2 recurring fair value measurements as well as additional information related to activities in the reconciliation of Level 3 fair value measurements. The guidance expanded the disclosures related to the level of disaggregation of assets and liabilities and information about inputs and valuation techniques. The adoption of this amended guidance did not have a significant impact on the condensed consolidated financial statements.
In December 2010, the FASB issued amended guidance for performing goodwill impairment tests, which was effective for the Company January 1, 2011. The amended guidance requires reporting units with zero or negative carrying amounts to be assessed to determine if it is more likely than not that goodwill impairment exists. As part of this assessment, entities should consider all qualitative factors that could impact the carrying value. The adoption of this amended guidance did not have a significant impact on the condensed consolidated financial statements.
Note D — Acquisition of business
Acquisition of CamelBak Products, LLC
On August 24, 2011, CamelBak Acquisition Corp. (“CamelBak Acquisition”), a subsidiary of the Company, entered into a stock purchase agreement with CamelBak Products LLC (“CamelBak”), and certain management stockholders pursuant to which CamelBak Acquisition acquired all of the membership interests of CamelBak.
Based in Petaluma, California and founded in 1989, CamelBak invented the hands-free hydration category and is the global leader in personal hydration gear. The company offers a complete line of technical hydration packs, reusable BPA-free water bottles, performance hydration accessories, specialized military gloves and performance accessories for outdoor, recreation and military use. CamelBak’s reputation as an innovator of best-in-class personal hydration products has enabled the company to establish partnerships with leading national retailers, sporting goods stores, independent and chain specialty retailers and the U.S. military. Through its global distribution network, CamelBak products are available in more than 50 countries worldwide.
The Company made loans to and purchased a 90% controlling interest in CamelBak. The purchase price, including proceeds from noncontrolling interest, was approximately $258.6 million (excluding acquisition-related costs). The Company funded its portion of the acquisition through drawings on its Revolving Credit Facility, as well as through funds provided by a private placement of 1,575,000 of its common shares at the closing price of $12.50 per share on August 23, 2011, to CGI Magyar Holdings LLC (“CMH”), its largest shareholder. In addition, an affiliate of CMH purchased $45.0 million of 11% convertible preferred stock in CamelBak Acquisition Corp and CamelBak’s management and certain other investors invested in the transaction alongside the Company collectively representing an approximately 10% initial noncontrolling interest on a primary and fully diluted basis. Acquisition-related costs were approximately $4.4 million and were recorded in selling, general and administrative expense on the Company’s condensed consolidated statement of operations. CGM acted as an advisor to the Company in the transaction and received fees and expense payments totaling approximately $2.4 million.
10
The results of operations of CamelBak have been included in the consolidated results of operations since the date of acquisition. CamelBak’s results of operations are reported as a separate operating segment. The table below includes the provisional recording of assets and liabilities assumed as of the acquisition date. The amounts recorded for inventory, property, plant and equipment, intangible assets and goodwill are preliminary pending finalization of valuation efforts.
CamelBak
Assets:
Cash
Accounts receivable, net (1)
Inventory (2)
Other current assets
Property, plant and equipment (3)
Intangible assets
Goodwill (4)
Other assets
Liabilities and noncontrolling interests:
Current liabilities
Other liabilities
Total liabilities and noncontrolling interest
Costs of net assets acquired
Intercompany loans to businesses
The intangible assets preliminarily recorded in connection with the CamelBak acquisition are as follows (in thousands):
Customer relationships
Technology
Patents
Non-compete agreement
Trade name
Unaudited pro forma information
The following unaudited pro forma data for the nine months ended September 30, 2011 and 2010 gives effect to the acquisition of CamelBak, as described above, as if the acquisition had been completed as of January 1, 2010. The pro forma data gives effect to historical operating results with adjustments to interest expense, amortization and depreciation expense, management fees and related tax effects. The information is provided for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred if the transaction had been consummated on the date indicated, nor is it necessarily indicative of future operating results of the consolidated companies, and should not be construed as representing results for any future period.
11
Note E — Operating segment data
At September 30, 2011, the Company had nine reportable operating segments. Each operating segment represents an acquisition. The Company’s operating segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. A description of each of the reportable segments and the types of products and services from which each segment derives its revenues is as follows:
Advanced Circuits, an electronic components manufacturing company, is a provider of prototype, quick-turn and production rigid printed circuit boards. ACI manufactures and delivers custom printed circuit boards to customers mainly in North America. ACI is headquartered in Aurora, Colorado.
American Furniture is a leading domestic manufacturer of upholstered furniture for the promotional segment of the marketplace. AFM offers a broad product line of stationary and motion furniture, including sofas, loveseats, sectionals, recliners and complementary products, sold primarily at retail price points ranging between $199 and $1,399. AFM is a low-cost manufacturer and is able to ship any product in its line within 48 hours of receiving an order. AFM is headquartered in Ecru, Mississippi and its products are sold in the United States.
CamelBak is a designer and manufacturer of personal hydration products for outdoor, recreation and military use. CamelBak offers a complete line of technical hydration packs, reusable BPA-free water bottles, performance hydration accessories, specialized military gloves and performance accessories. Through its global distribution network, CamelBak products are available in more than 50 countries worldwide. CamelBak is headquartered in Petaluma, California.
ERGObaby is a premier designer, marketer and distributor of babywearing products and accessories. ERGObaby’s reputation for product innovation, reliability and safety has led to numerous awards and accolades from consumer surveys and publications. ERGObaby offers a broad range of wearable baby carriers and related products that are sold through more than 900 retailers and web shops in the United States and internationally. ERGObaby is headquartered in Los Angeles, California.
Fox is a designer, manufacturer and marketer of high end suspension products for mountain bikes, all-terrain vehicles, snowmobiles and other off-road vehicles. Fox acts as both a tier one supplier to leading action sport original equipment manufacturers and provides after-market products to retailers and distributors. Fox is headquartered in Watsonville, California and its products are sold worldwide.
HALO serves as a one-stop shop for approximately 40,000 customers providing design, sourcing, and management and fulfillment services across all categories of its customer promotional product needs. HALO has established itself as a leader in the promotional products and marketing industry through its focus on service through its approximately 900 account executives. HALO is headquartered in Sterling, Illinois.
Liberty Safe is a designer, manufacturer and marketer of premium home and gun safes in North America. From its over 200,000 square foot manufacturing facility, Liberty produces a wide range of home and gun safe models in a broad assortment of sizes, features and styles. Liberty is headquartered in Payson, Utah.
Staffmark, a national provider of contingent workforce solutions that serves the temporary staffing needs of employers throughout the United States, provides a full spectrum of light industrial and clerical staffing solutions. Staffmark is headquartered in Cincinnati, Ohio.
12
Tridien is a leading designer and manufacturer of powered and non-powered medical therapeutic support surfaces and patient positioning devices serving the acute care, long-term care and home health care markets. Tridien is headquartered in Coral Springs, Florida and its products are sold primarily in North America.
The tabular information that follows shows data of each of the operating segments reconciled to amounts reflected in the condensed consolidated financial statements. The operations of each of the operating segments are included in consolidated operating results as of their date of acquisition. Revenues from geographic locations outside the United States were not material for any operating segment, except Fox, ERGObaby and CamelBak, in each of the periods presented below. Fox recorded net sales to locations outside the United States, principally Europe and Asia, of $42.4 million for both the three months ended September 30, 2011 and 2010, and $100.7 million and $84.8 million for the nine months ended September 30, 2011 and 2010, respectively. Of the Asian sales, sales to Taiwan totaled $17.2 million and $18.5 million for the three months ended September 30, 2011 and 2010, respectively, and $40.8 million and $38.1 million for the nine months ended September 30, 2011 and 2010, respectively. ERGObaby recorded net sales to locations outside the United States of $6.4 million for the three months ended September 30, 2011 and $21.5 million for the nine months ended September 30, 2011. CamelBak recorded net sales to locations outside the United States of $2.1 million for the three months and nine months ended September 30, 2011. There were no significant inter-segment transactions.
Segment profit is determined based on internal performance measures used by the Chief Executive Officer to assess the performance of each business. Segment profit excludes certain charges from the acquisitions of the Company’s initial businesses not pushed down to the segments which are reflected in Corporate and other. A disaggregation of the Company’s consolidated revenue and other financial data for the three and nine months ended September 30, 2011 and 2010 is presented below (in thousands):
Net sales of operating segments
ACI
American Furniture
ERGObaby
Fox
HALO
Liberty
Staffmark (4)
Tridien
Total
Reconciliation of segment revenues to consolidated revenues:
Corporate and other
Total consolidated revenues
13
American Furniture (2)
CamelBak (5)
Reconciliation of segment profit to consolidated income (loss) before income taxes:
Interest expense, net
Corporate and other (3)
Total consolidated income (loss) before income taxes
Accounts receivable
Staffmark
Reconciliation of segment to consolidated totals:
Allowance for doubtful accounts
Total consolidated net accounts receivable
14
Goodwill and identifiable assets of operating segments
American Furniture (3)
Reconciliation of segment to consolidated total:
Corporate and other identifiable assets
Goodwill carried at Corporate level (2)
Other segment information
In connection with the acquisition of ERGObaby in September 2010, the Company recorded contingent consideration of $0.2 million during 2010, its then fair value. The contingent consideration relates to the $2.0 million additional cash payment the sellers would be entitled to in the event ERGObaby’s net sales, as determined on a consolidated basis in accordance with U.S. GAAP, for the fiscal year ending December 31, 2011 are equal to or greater than a contractually agreed upon fixed amount. If the sellers do not reach this sales goal for the fiscal year ended December 31, 2011, the sellers would not be entitled to any payment. During the three and six months ended June 30, 2011, the Company recorded an increase in the fair value of the contingent consideration of $0.4 million and $0.9 million, respectively, associated with the increased probability of obtaining the contractually agreed upon sales goal for 2011. However, during the third quarter of 2011 it became apparent that ERGObaby will more than likely not reach its sales goal for the full year and it therefore reversed the entire $1.0 million previously accrued. This reversal of expense was recorded to selling, general and administrative expense on the condensed consolidated statement of operations. Refer to Note I for valuation techniques applied to the contingent consideration liability.
15
Note F — Property, plant and equipment and inventory
Property, plant and equipment is comprised of the following at September 30, 2011 and December 31, 2010 (in thousands):
Machinery and equipment
Office furniture, computers and software
Leasehold improvements
Less: accumulated depreciation
Depreciation expense was $2.5 million and $7.3 million for the three and nine months ended September 30, 2011, respectively, and $2.2 million and $6.3 million for the three and nine months ended September 30, 2010, respectively.
Inventory is comprised of the following at September 30, 2011 and December 31, 2010 (in thousands):
Raw materials and supplies
Finished goods
Less: obsolescence reserve
Note G — Goodwill and other intangible assets
Goodwill represents the difference between purchase cost and the fair value of net assets acquired in business acquisitions. Indefinite lived intangible assets, representing trademarks and trade names, are not amortized until their useful life is determined to no longer be indefinite. Goodwill and indefinite lived intangible assets are tested for impairment at least annually as of March 31, unless a triggering event occurs, by comparing the fair value of each reporting unit to its carrying value.
2011 Annual goodwill impairment testing
The Company conducted its annual goodwill impairment testing as of March 31, 2011. At each of the reporting units tested, the units’ fair value exceeded carrying value with the exception of American Furniture. The carrying amount of American Furniture exceeded its fair value due to the significant decrease in revenue and operating profit at American Furniture resulting from the negative impact on the promotional furniture market due to the significant decline in the U.S. housing market, high unemployment rates and aggressive pricing employed by its competitors. As a result of the carrying amount of goodwill exceeding its fair value, the Company recorded a $5.9 million impairment charge during the nine months ended September 30, 2011 which represented the remaining balance of goodwill on American Furniture’s balance sheet. The Company previously recorded a goodwill impairment charge totaling $35.5 million at American Furniture in the third quarter of 2010.
The carrying amount of American Furniture exceeded its fair value at March 31, 2011 by a significant amount due primarily to the significant decrease in revenue and operating profit together with management’s revised outlook on near term operating results. Further, the results of this analysis indicated that the carrying value of American Furniture’s trade name exceeded its fair value by approximately $1.8 million. The fair value of the American Furniture trade name was determined by applying the relief from royalty technique to forecasted revenues at the American Furniture reporting unit.
16
Of the remaining seven reporting units as of March 31, 2011, the fair value of one of the reporting units was not substantially in excess of its carrying value. Information from step-one of the impairment test for this reporting unit is as follows:
Reporting Unit
A one percent increase in the discount rate, from 13% to 14%, would have impacted the fair value of HALO by approximately $5.0 million and would have required the Company to perform a step-two analysis that may have resulted in an impairment charge for HALO as of March 31, 2011. Factors that could potentially trigger a subsequent interim impairment review in the future and possible impairment loss at the HALO reporting unit include significant underperformance relative to future operating results or significant negative industry or economic trends.
The estimates employed and judgment used in determining critical accounting estimates have not changed significantly from those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC.
2010 Annual goodwill impairment testing
The Company completed its 2010 annual goodwill impairment testing as of March 31, 2010. For each reporting unit, the analysis indicated that the fair value of the reporting unit exceeded its carrying value and as a result the carrying value of goodwill was not impaired as of the March 31, 2010 testing.
A reconciliation of the change in the carrying value of goodwill for the nine months ended September 30, 2011 and the year ended December 31, 2010, is as follows (in thousands):
Beginning balance:
Accumulated impairment losses
Impairment losses
Acquisition of businesses (1)
Adjustment to purchase accounting
Total adjustments
Ending balance:
Relates to the purchase of CamelBak in 2011 and ERGObaby, Liberty Safe, Circuit Express and Relay Gear in 2010.
17
Other intangible assets
Other intangible assets are comprised of the following at September 30, 2011 and December 31, 2010 (in thousands):
Technology and patents
Trade names, subject to amortization
Licensing and non-compete agreements
Distributor relations and other
Accumulated amortization customer relationships
Accumulated amortization technology and patents
Accumulated amortization trade names, subject to amortization
Accumulated amortization licensing and non-compete agreements
Accumulated amortization distributor relations and other
Total accumulated amortization
Trade names, not subject to amortization
Total intangibles, net
Amortization expense related to intangible assets was $8.5 million and $23.9 million for the three and nine months ended September 30, 2011, respectively, and $7.5 million and $21.1 million for the three and nine months ended September 30, 2010, respectively.
Note H — Debt
The Credit Agreement at September 30, 2011 provides for a Revolving Credit Facility totaling $340 million, subject to borrowing base restrictions, which matures in December 2012, and a Term Loan Facility with a balance of $72.5 million at September 30, 2011, which matures in December 2013. The Term Loan Facility requires quarterly payments of $0.5 million with a final payment of the outstanding principal balance due on December 7, 2013.
The Company had $220.0 million in outstanding borrowings under its Revolving Credit Facility at September 30, 2011. Letters of credit outstanding at September 30, 2011 totaled approximately $70.2 million. The portion of these letters of credit outstanding that were removed during October 2011 as a result of the sale of Staffmark was $67.3 million. At September 30, 2011, the Company was in compliance with all covenants. Refer to Note P for details on the Company’s sale of its Staffmark operating segment and the new debt financing arrangement.
The following table provides the Company’s debt holdings at September 30, 2011 and December 31, 2010 (in thousands):
Revolving credit facility
Term loan facility
Total debt
Less: Current portion, term loan facility
Less: Current portion, revolving credit facility
Long term debt
18
Note I — Fair value measurement
The following table provides the assets and liabilities carried at fair value measured on a recurring basis at September 30, 2011 and December 31, 2010 (in thousands):
Liabilities:
Call option of noncontrolling shareholder (1)
Put option of noncontrolling shareholders (2)
Contingent consideration related to ERGObaby (3)
Represents a noncontrolling shareholder’s call option to purchase additional common stock in Tridien.
Represents put options issued to noncontrolling shareholders in connection with the Liberty acquisition.
Represents contingent consideration liability related to the acquisition of ERGObaby in September 2010.
Derivative liability – interest rate swap
Call option of noncontrolling shareholder
Put option of noncontrolling shareholders
Contingent consideration related to ERGObaby acquisition
A reconciliation of the change in the carrying value of our level 3 supplemental put liability from January 1, 2011 through September 30, 2011 and from January 1, 2010 through September 30, 2010 is as follows (in thousands):
Balance at January 1
Balance at March 31
Balance at June 30
Balance at Sep 30
A reconciliation of the change in the carrying value of our level 3 call option of a noncontrolling shareholder from January 1, 2011 through September 30, 2011 is as follows (in thousands):
Fair value adjustment to Call option
Balance at September 30
19
A reconciliation of the change in the carrying value of our level 3 contingent consideration liability at ERGObaby from January 1, 2011 through September 30, 2011 is as follows (in thousands):
Fair value adjustment to contingent consideration liability
Valuation Techniques
Supplemental put:
The Company and CGM entered into a Supplemental Put Agreement in 2006, which requires the Company to acquire the Allocation Interests owned by CGM upon termination of the Management Services Agreement. Essentially, the put right granted to CGM requires the Company to acquire CGM’s Allocation Interests in the Company at a price based on 20% of the company’s profits upon clearance of a 7% annualized hurdle rate. Each fiscal quarter the Company estimates the fair value of this potential liability associated with the Supplemental Put Agreement. Any change in the potential liability is accrued currently as a non-cash adjustment to earnings. The change in the supplemental put liability during the three and nine months ended September 30, 2011, was primarily related to increases in the estimated values of the Advanced Circuits and Fox operating segments, offset by a payment of approximately $6.9 million to CGM due to the election to receive the positive contribution-based profit allocation payment for the Advanced Circuits business following the fifth anniversary of the date upon which the Company acquired Advanced Circuits.
Options of noncontrolling shareholders:
The call option of the noncontrolling shareholder was determined based on inputs that were not readily available in public markets or able to be derived from information available in publicly quoted markets. As such, the Company categorized the call option of the noncontrolling shareholder as Level 3.
The put options of noncontrolling shareholders were determined based on inputs that were not readily available in public markets or able to be derived from information available in publicly quoted markets. As such, the Company categorized the put options of the noncontrolling shareholders as Level 3.
Contingent consideration:
The fair value of this contingent consideration liability for ERGObaby was valued assuming a percentage probability of achieving the agreed upon sales goal, discounted to present value utilizing a discounted cash flow model. The probability percentage at September 30, 2011 was 0%.
Interest rate swap:
The Company’s derivative instrument consisted of an over-the-counter (OTC) interest rate swap contract which was not traded on a public exchange. The fair value of the Company’s interest rate swap contract was determined based on inputs that were readily available in public markets or could be derived from information available in publicly quoted markets. The swap expired in January 2011. See Note J.
The following table provides the assets and liabilities carried at fair value measured on a non-recurring basis as of September 30, 2011 (in thousands):
Goodwill (1)
Trade name (2)
Represents the fair value of goodwill at the AFM business segment subsequent to the goodwill impairment charge recognized during the first quarter of 2011. See Note G for further discussion regarding impairment and valuation techniques applied.
Represents the fair value of AFM’s trade name at the AFM business segment subsequent to the impairment charge recognized during the first quarter of 2011.
20
Note J — Derivative instruments and hedging activities
On January 22, 2008, the Company entered into a three-year interest rate swap (“Swap”) agreement with a bank, fixing the rate of its Term Loan Facility borrowings at 7.35%. The Company’s objective for entering into the Swap was to manage the interest rate exposure on a portion of its Term Loan Facility by fixing its interest rate at 7.35% and avoiding the potential variability of interest rate fluctuations. The Swap was designated as a cash flow hedge and expired in January 2011.
Note K — Comprehensive income (loss)
The following table sets forth the computation of comprehensive income (loss) for the three and nine months ended September 30, 2011 and 2010 (in thousands):
Other comprehensive income:
Unrealized gain on cash flow hedge
Total other comprehensive income
Total comprehensive income (loss)
Note L — Stockholder’s equity
The Trust is authorized to issue 500,000,000 Trust shares and the Company is authorized to issue a corresponding number of LLC interests. The Company will at all times have the identical number of LLC interests outstanding as Trust shares. Each Trust share represents an undivided beneficial interest in the Trust, and each Trust share is entitled to one vote per share on any matter with respect to which members of the Company are entitled to vote.
Distributions:
On January 28, 2011, the Company paid a distribution of $0.34 per share to holders of record as of January 21, 2011. This distribution was declared on January 5, 2011.
On April 12, 2011, the Company paid a distribution of $0.36 per share to holders of record as of March 29, 2011. This distribution was declared on March 10, 2011.
On July 28, 2011, the Company paid a distribution of $0.36 per share to holders of record as of July 21, 2011. This distribution was declared on July 6, 2011.
On October 31, 2011, the Company paid a distribution of $0.36 per share to holders of record as of October 25, 2011. This distribution was declared on October 10, 2011.
In connection with the acquisition of CamelBak, and discussed in Note D, the Company issued 1,575,000 of its common shares in a private placement at the closing price of $12.50 per share on August 23, 2011, to CHM, its largest shareholder. The weighted average number of Trust shares outstanding during the three and nine months ended September 30, 2011 was computed based upon these additional shares considered outstanding from August 24, 2011 through September 30, 2011.
Note M — Warranties
The Company’s CamelBak, ERGObaby, Fox, Liberty and Tridien operating segments estimate their exposure to warranty claims based on both current and historical product sales data and warranty costs incurred. The Company assesses the adequacy of its recorded warranty liability quarterly and adjusts the amount as necessary.
21
A reconciliation of the change in the carrying value of the Company’s warranty liability for the nine months ended September 30, 2011 and the year ended December 31, 2010 is as follows (in thousands):
Beginning balance
Accrual
Warranty payments
Other (1)
Ending balance
Represents warranty liabilities acquired in 2011 related to CamelBak and in 2010 related to Liberty Safe and ERGObaby.
Note N — Noncontrolling interest
Noncontrolling interest represents the portion of the Company’s majority-owned subsidiary’s net income (loss) and equity that is owned by noncontrolling shareholders.
The following tables reflect the Company’s ownership percentage of its majority owned operating segments and related noncontrolling interest balances as of September 30, 2011 and December 31, 2010:
FOX
CGM
22
Note O — Income taxes
Each fiscal quarter the Company estimates its annual effective tax rate and applies that rate to its interim pre-tax earnings. In this regard, the Company reflects the tax impact of certain unusual or infrequently occurring items and the effects of changes in tax laws or rates in the interim period in which they occur.
The computation of the annual estimated effective tax rate in each interim period requires certain estimates and significant judgment, including the projected operating income for the year, projections of the proportion of income earned and taxed in other jurisdictions, permanent and temporary differences and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, as additional information is obtained or as the tax environment changes.
The reconciliation between the Federal Statutory Rate and the effective income tax rate for the three and nine months ended September 30, 2011 and 2010 are as follows:
United States Federal Statutory Rate
Foreign and State income taxes (net of Federal benefits)
Expenses of Compass Group Diversified Holdings, LLC representing a pass through to shareholders (1)
Credit utilization
Quarterly effective tax rate adjustment
Effective income tax rate
Note P — Subsequent Event
Staffmark sale
On October 17, 2011, the Company sold its majority owned subsidiary, Staffmark, for a total enterprise value of $295 million. The Company’s share of the net proceeds, at closing, after accounting for the redemption of Staffmark’s noncontrolling holders and the payment of transaction expenses totaled $220 million. In addition, an escrow tax refund of $5 million is expected to be received by Staffmark for payment of transaction expenses that will be distributed to the Company’s and Staffmark’s noncontrolling holders. CGM’s profit allocation is expected to range from approximately $11 million to $15 million and is anticipated to be paid in the first quarter of 2012. The transaction also increases availability under the Company’s Revolving Credit Facility by approximately $67 million, as letters of credit guaranteeing payments for Staffmark’s workers compensation liability are no longer required to be provided by the Company. The sale of Staffmark did not meet the criteria for the assets of Staffmark to be classified as held for sale at September 30, 2011. The Company anticipates recording a gain on the sale of Staffmark ranging between $75 million and $90 million for the quarter ended December 31, 2011.
The transaction is subject to typical escrow requirements and adjustments for certain changes in the working capital of Staffmark. The Stock Purchase Agreement contains customary representations, warranties, covenants and indemnification provisions.
In connection with this sale, the Company removed its registration statement on Form S-1 previously filed on April 12, 2011 with the Securities and Exchange Commission for a proposed initial public offering of Staffmark’s common stock. The previously capitalized initial public offering costs incurred of $1.9 million will be expensed during the fourth quarter of 2011.
Debt refinancing
On October 27, 2011, the Company obtained a $515 million credit facility, with an optional $135 million increase, from a group of lenders (the “New Credit Facility”). The New Credit Facility provides for (i) a revolving line of credit of $290 million (the “New Revolving Credit Facility”), and (ii) a $225 million term loan (the “New Term Loan Facility”). The New Term Loan Facility was issued at an original issuance discount of 96%.
23
New Revolving Credit Facility
The New Revolving Credit Facility will become due in October 2016. The New Credit Facility permits the Company to increase the New Revolving Credit Facility commitment and/or obtain additional term loans in an aggregate amount of up to $135 million. Advances under the New Revolving Credit Facility can be either base rate loans or LIBOR loans. Base rate revolving loans bear interest at a fluctuating rate per annum equal to the greatest of (i) the prime rate of interest, (ii) the sum of the Federal Funds Rate plus 0.5% for the relevant period and (iii) the sum of the applicable LIBOR rate plus 1.00%, plus a margin ranging from 2.00% to 3.00% based upon the ratio of total debt to adjusted consolidated earnings before interest expense, tax expense, and depreciation and amortization expenses for such period (the “Total Debt to EBITDA Ratio”). LIBOR loans bear interest at a fluctuating rate per annum equal to the British Bankers Association LIBOR Rate (“LIBOR”), for the relevant period plus a margin ranging from 3.00% to 4.00% based on the Total Debt to EBITDA Ratio.
New Term Loan Facility
The New Term Loan Facility requires quarterly payments of approximately $0.56 million commencing March 31, 2012 with a final payment of all remaining principal and interest due in October 2017. The New Term Loan Facility bears interest at a combination of a variable LIBOR rate for the relevant period plus 6.00% for the portion of the New Term Loan Facility comprised of LIBOR loans and a fluctuating rate per annum equal to the greatest of (i) the prime rate of interest, (ii) the sum of the Federal Funds Rate plus 0.5% for the relevant period, (iii) the sum of the applicable LIBOR rate plus 1.00% and (iv) 2.50%, plus 5.00% for the portion of the New Term Loan Facility comprised of base rate loans. The LIBOR rate for term loans is subject to a minimum rate of 1.5%.
Use of Proceeds
The proceeds of the New Term Loan Facility and advances under the New Revolving Credit Facility were, and will be used, as applicable, (i) to refinance existing indebtedness of the Company, (ii) to pay fees and expenses, (iii) to fund acquisitions of additional businesses, (iv) to fund permitted distributions, (v) to fund loans by the Company to its subsidiaries and (vi) for other general corporate purposes of the Company.
The Company will pay (i) commitment fees equal to 1% per annum of the unused portion of the New Revolving Credit Facility, (ii) quarterly letter of credit fees, (iii) letter of credit fronting fees of up to 0.25% per annum and (iv) administrative and agency fees. In addition, the Company paid approximately $6.6 million for administrative and closing fees. Opening availability was approximately $287.1 million.
24
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This item 2 contains forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q are subject to a number of risks and uncertainties, some of which are beyond our control. Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by the forward-looking statements. Additional risks of which we are not currently aware or which we currently deem immaterial could also cause our actual results to differ, including those discussed in the sections entitled “Forward-Looking Statements” and “Risk Factors” included elsewhere in this Quarterly Report as well as those risk factors discussed in the section entitled “Risk Factors” in our Annual Report on Form 10-K.
Overview
Compass Diversified Holdings, a Delaware statutory trust, was incorporated in Delaware on November 18, 2005. Compass Group Diversified Holdings, LLC, a Delaware limited liability company, was also formed on November 18, 2005. In accordance with the Trust Agreement, the Trust is sole owner of 100% of the Trust Interests (as defined in the LLC Agreement) of the Company and, pursuant to the LLC Agreement, the Company has outstanding, the identical number of Trust Interests as the number of outstanding shares of the Trust. The Manager is the sole owner of the Allocation Interests of the Company. The Company is the operating entity with a board of directors and other corporate governance responsibilities, similar to that of a Delaware corporation.
The Trust and the Company were formed to acquire and manage a group of small and middle-market businesses headquartered in North America. We characterize small to middle market businesses as those that generate annual cash flows of up to $60 million. We focus on companies of this size because of our belief that these companies are often more able to achieve growth rates above those of their relevant industries and are also frequently more susceptible to efforts to improve earnings and cash flow.
In pursuing new acquisitions, we seek businesses with the following characteristics:
North American base of operations;
stable and growing earnings and cash flow;
significant market share in defensible industry niche (i.e., has a “reason to exist”);
solid and proven management team with meaningful incentives;
low technological and/or product obsolescence risk; and
a diversified customer and supplier base.
Our management team’s strategy for our subsidiaries involves:
utilizing structured incentive compensation programs tailored to each business to attract, recruit and retain talented managers to operate our businesses;
regularly monitoring financial and operational performance, instilling consistent financial discipline and supporting management in the development and implementation of information systems to effectively achieve these goals;
assisting management in their analysis and pursuit of prudent organic cash flow growth strategies (both revenue and cost related);
identifying and working with management to execute attractive external growth and acquisition opportunities; and
forming strong subsidiary level boards of directors to supplement management in their development and implementation of strategic goals and objectives.
Based on the experience of our management team and its ability to identify and negotiate acquisitions, we believe we are positioned to acquire additional attractive businesses. Our management team has a large network of approximately 2,000 deal intermediaries to whom it actively markets and whom we expect to expose us to potential acquisitions. Through this network, as well as our management team’s active proprietary transaction sourcing efforts, we typically have a substantial pipeline of potential acquisition targets. In consummating transactions, our management team has, in the past, been able to successfully navigate complex situations surrounding acquisitions, including corporate spin-offs, transitions of family-owned businesses, management buy-outs and reorganizations. We believe the flexibility, creativity, experience and expertise of our management team in structuring transactions provides us with a strategic advantage by allowing us to consider non-traditional and complex transactions tailored to fit a specific acquisition target.
25
In addition, because we intend to fund acquisitions through the utilization of our Revolving Credit Facility, we do not expect to be subject to delays in or conditions by closing acquisitions that would be typically associated with transaction specific financing, as is typically the case in such acquisitions. We believe this advantage is a powerful one, especially in the current tight credit environment, and is highly unusual in the marketplace for acquisitions in which we operate.
2011 Highlights
Acquisition of CamelBak
On August 24, 2011, we purchased a controlling interest in CamelBak Products, LLC (“CamelBak”). Based in Petaluma, California and founded in 1989, CamelBak invented the hands-free hydration category and is the global leader in personal hydration gear. CamelBak offers a complete line of technical hydration packs, reusable BPA-free water bottles, performance hydration accessories and specialized military gloves and performance accessories for outdoor, recreation and military use. CamelBak’s premier brand as an innovator of best-in-class personal hydration products has enabled it to establish preferred partnerships with leading national retailers, sporting goods stores, independent and chain specialty retailers and the U.S. military. Through its global distribution network, CamelBak products are available in more than 50 countries worldwide. We made loans to and purchased an 89.9% interest in CamelBak. The purchase price, including proceeds from noncontrolling interests was approximately $258.6 million (excluding acquisition-related costs).
We funded the cash consideration and acquisition-related costs through drawings under our Revolving Credit Facility, funds provided by the sale of 1,575,000 shares of CODI common stock to CGI Magyar Holdings, LLC (“CGI Magyar”), our largest shareholder, and the sale to an affiliate of CGI Magyar, 652 shares of the CamelBak Acquisition Corp.’s Series A 11% convertible preferred stock (redeemable at our option) for an aggregate consideration of $45 million. In addition, CamelBak’s management and certain other investors invested in the transaction alongside us, collectively representing an approximate 2.1% minority interest.
Our Manager acted as an advisor in the transaction for which it received fees and expense payments totaling $2.4 million.
As mentioned above, on August 23, 2011, in connection with the acquisition of CamelBak, we completed the sale of 1,575,000 shares of common stock of CODI to CGI Magyar, for consideration per share equal to the market value thereof on August 23, 2011, for $12.50 per share, or an aggregate sale price of $19.7 million. The sale to CGI Magyar was made pursuant to an exemption from registration under Section 4(2) of the Securities Act of 1933. The proceeds were used to fund the CamelBak acquisition.
Sale of Staffmark
On October 17, 2011, we entered into a Stock Purchase Agreement and sold all of the issued and outstanding capital stock of Staffmark to Recruit Co., LTD. and RGF Staffing USA, Inc. The total enterprise value received for Staffmark was $295 million.
At the closing we received approximately $220 million in cash in respect of our debt and equity interests in Staffmark and for the payment of accrued interest and fees after payments to non-controlling shareholders and payment of all transaction expenses. The net proceeds were used to repay substantially all of the outstanding debt under our Revolving Credit Facility.
In addition, Staffmark is expected to receive a tax refund of approximately $5 million from the recording of transaction expenses incurred in connection with the transaction, which refund, according to the terms of the Stock Purchase Agreement, will be distributed upon receipt to the Company and each other shareholder of Staffmark who sold shares of Staffmark. The profit allocation due to our Manager for this sale is estimated to range from $11 million to $15 million and is expected to be paid in the first quarter of 2012, and which amount has been previously expensed and reflected in our supplemental put accrual. We anticipate that we will recognize a gain of between $75 million and $90 million for the fiscal quarter ending December 31, 2011 as a result of the sale of Staffmark.
26
New Credit Facility
On October 27, 2011, we obtained a $515 million credit facility, with an optional $135 million increase, from a group of lenders. This credit facility replaced our existing Credit Agreement. The Credit Facility provides for (i) a revolving line of credit (the “New Revolving Credit Facility”) of $290 million, and (ii) a $225 million term loan (the “New Term Loan Facility” and together with the New Revolving Credit Facility, the “New Credit Facility”). The term loans were issued at an original issuance discount of 96%. The New Term Loan Facility requires quarterly payments of approximately $0.56 million commencing March 31, 2012 with a final payment of all remaining principal and interest due in October 2017. All amounts outstanding under the New Revolving Credit Facility will become due in October 2016. The New Credit Facility also permits the Company to increase the revolving loan commitment and/or obtain additional term loans in an aggregate amount of up to $135 million, subject to certain restrictions, lender approval and market demand. The proceeds of the New Term Loan Facility and advances under the New Revolving Credit Facility were, or will be, as applicable, used (i) to refinance certain existing indebtedness of the Company pursuant to its prior Credit Agreement, originally dated as of November 21, 2006, as amended, (ii) to pay fees and expenses arising in connection with the Credit Facility, (iii) to fund acquisitions of additional businesses, (iv) to fund permitted distributions, (v) to fund loans to our subsidiaries and (vi) for other general corporate purposes.
Increase in quarterly distributions
On March 29, 2011 and July 6, 2011 and October 10, 2011 we declared quarterly distributions of $0.36 per share which represented an increase of $0.02 per share over each distribution made in the corresponding quarters of 2010.
Outlook
Sales and operating income during the nine months ended September 30, 2011 increased on a consolidated basis compared to the same period of 2010. The estimate of gross domestic product (“GDP”), a measure of the total production of goods and services, increased during the first, second and third quarter of 2011 at the seasonally adjusted annualized rate of 0.4%, 1.3% and 2.5%, respectively, compared to 3.1% for the fourth quarter of 2010. The increasing rate of growth to date in 2011 indicates that consumer spending is increasing even though it is still below consumer spending in the fourth quarter of 2010. Each of our businesses is impacted by the overall economic environment including changes in consumer spending and increasing commodity and fuel costs. Additionally, American Furniture is significantly affected by continued tight consumer credit markets and the depressed housing market which is evident in the significant decrease in sales and operating profit to date in fiscal 2011.
However, we continue to believe that we will experience sustained flat to modest top-line growth in each of our businesses, with the exception of American Furniture and Tridien, through the remainder of fiscal 2011, although we cannot accurately predict the impact that rising commodity costs, such as steel, cotton and fuel may have on our gross profit margins if we are not able to successfully raise prices to offset the potential price increases. In addition, the recent Federal debt crisis and the impact that it may have on mitigating domestic economic growth for the remainder of fiscal 2011 may result in limiting the top-line revenue growth at our portfolio companies.
We also believe that the current credit environment may continue to benefit our acquisition model as we do not rely on separate third-party financing as a component to closing.
We are dependent on the earnings of, and cash receipts from, the businesses that we own to meet our corporate overhead and management fee expenses and to pay distributions. These earnings and distributions, net of any minority interests in these businesses, will be available:
First, to meet capital expenditure requirements, management fees and corporate overhead expenses;
Second, to fund distributions from the businesses to the Company; and
Third, to be distributed by the Trust to shareholders.
27
Results of Operations
We were formed on November 18, 2005 and acquired our existing businesses (segments) as of September 30, 2011 as follows:
As noted above, we acquired our businesses on various dates through August 24, 2011. As a result, we cannot provide what we believe is a meaningful comparison of our historical consolidated results of operations for the entire three and nine month periods ended September 30, 2011 compared to the same periods in 2010. In the following results of operations, we provide: (i) our consolidated historical results of operations for the three and nine months ended September 30, 2011 and 2010, which includes the results of operations of our businesses (segments) from the date of acquisition; and (ii) comparative results of operations for each of our businesses, on a stand-alone basis, for each of the three and nine month periods ended September 30, 2011 and 2010, which include pro forma results of operations for platform businesses acquired subsequent to January 1, 2010 including pro-forma operating data and adjustments applied to historical results of operations for periods prior to our acquisition of the business in order to provide meaningful comparative data.
Consolidated Results of Operations – Compass Diversified Holdings and Compass Group Diversified Holdings LLC
Staffing, selling, general and administrative expense
Fees to manager
Amortization of intangibles
Income (loss) from operations
On a consolidated basis, net sales increased $29.2 million and $123.5 million during the three and nine month periods ended September 30, 2011, respectively, compared to the same periods in 2010. These increases for both the three and nine month periods are due principally to increased revenues at each of our operating segments with the exception of American Furniture and Tridien. Advanced Circuits experienced slightly lower sales in the third quarter of 2011 compared to 2010. In addition, we realized revenues totaling approximately $10.7 million and $33.4 million in the three and nine months ended September 30, 2011 at ERGObaby, which we acquired in September 2010, and $16.1 million in revenues at CamelBak in the three and nine months ended September 30, 2011. Staffmark sales increased approximately $40.0 million in the nine months ended September 30, 2011 as compared to the same period in 2010. Refer to Results of Operations – Our Businesses for a more detailed analysis of net sales for each business segment.
28
We do not generate any revenues apart from those generated by the businesses we own. We may generate interest income on the investment of available funds, but expect such earnings to be minimal. Our investment in our businesses is typically in the form of loans from the Company to such businesses, as well as equity interests in those companies. Cash flows coming to the Trust and the Company are the result of interest payments on those loans, amortization of those loans and, in some cases, dividends on our equity ownership. However, on a consolidated basis these items will be eliminated.
On a consolidated basis, cost of sales increased approximately $17.5 million and $84.7 million during the three and nine month periods ended September 30, 2011, respectively, compared to the same periods in 2010. These increases are due almost entirely to the corresponding increase in net sales. Gross profit as a percentage of net sales totaled approximately 22.7% and 21.6% of net sales for the three month periods ended September 30, 2011 and 2010, respectively. Gross profit as a percentage of net sales totaled approximately 22.0% of net sales for the nine month period ended September 30, 2011 compared to 21.0% during the same period in 2010. The increase in gross profit percentage for both the three and nine months ended September 30, 2011 compared to the same periods in 2010 is principally attributable to the inclusion of ERGObaby results for the full three and nine-month periods ended September 30, 2011. ERGObaby’s profit margin during the three and nine months ended September 30, 2011 was approximately 66% and 65%, respectively. Refer to Results of Operations - Our Businesses for a more detailed analysis of cost of sales for each business segment.
On a consolidated basis, staffing, selling, general and administrative expense increased approximately $11.1 million and $21.2 million in the three and nine month periods ended September 30, 2011, respectively, compared to the same periods in 2010. These increases are due principally to increases in costs directly tied to sales, such as commissions and direct customer support services, and selling, general and administrative costs at ErgoBaby, Liberty and CamelBak during the first nine months of 2011. Refer to Results of Operations – Our Businesses for a more detailed analysis of staffing, selling, general and administrative expense by segment. At the corporate level, selling, general and administrative expense decreased approximately $2.7 million in the nine month period ended September 30, 2011 and no change in the three month period, compared to the same periods in 2010. This decrease is due to a decrease in non-cash charges related to a call option granted by the Company in 2008 to the former CEO of Tridien totaling $3.6 million in the nine month period ended September 30, 2011 compared to the same period in 2010. Ignoring the change in the fair value of the call option in 2011, selling, general and administrative costs increased approximately $0.9 million in the nine months ended September 30, 2011 compared to 2010. This increase is principally due to increases in professional fees ($0.7 million) and salaries and wages ($0.2 million) in the first nine months of 2011.
Pursuant to the Management Services Agreement, we pay CGM a quarterly management fee equal to 0.5% (2.0% annually) of our consolidated adjusted net assets. We accrue for the management fee on a quarterly basis. For the three months ended September 30, 2011 and 2010, we incurred approximately $5.3 million and $4.0 million, respectively, in expense for these fees. For the nine months ended September 30, 2011 and 2010, we incurred approximately $13.0 million and $11.4 million, respectively, in expense for these fees. The increase in management fees for the three and nine months ended September 30, 2011 is due principally to the increase in consolidated adjusted net assets as of September 30, 2011 in connection with the CamelBak acquisition in August 2011 and the inclusion of ERGObaby for the full first nine months of 2011.
Concurrent with the IPO, we entered into a Supplemental Put Agreement with our Manager pursuant to which our Manager has the right to cause us to purchase the Allocation Interests then owned by it upon termination of the Management Services Agreement. We accrue for the supplemental put expense on a quarterly basis. For the three and nine months ended September 30, 2011, we incurred approximately $1.2 million and $6.1 million, respectively, in expense compared to $1.6 million and $18.6 million in expense for the corresponding periods in 2010. The change in supplemental put expense in all periods presented is attributable to the increase in the fair value of certain of our businesses during each of those periods.
Amortization of intangibles expense increased approximately $1.0 million and $2.8 million in the three and nine months ended September 30, 2011, respectively, as compared to the corresponding 2010 periods. The increases were due to increased amortization of intangible assets in connection with the acquisitions of ERGObaby and CamelBak.
We incurred an impairment charge in the first quarter of 2011 totaling $7.7 million, which is reflected in the operating results for the nine months ended September 30, 2011, at our American Furniture business segment based on our annual goodwill impairment analysis. The portion of the impairment charge that was attributable to impaired goodwill at American Furniture was $5.9 million. The remaining $1.8 million charge reflected a write down of the unamortized balance of American Furniture’s intangible asset, its trade name. The write downs were necessary based on the further deterioration of the promotional furniture market.
29
Results of Operations — Our Businesses
The following discussion reflects a comparison of the historical, and where appropriate, pro-forma results of operations for each of our businesses for the three and nine month periods ending September 30, 2011 and September 30, 2010, which we believe is the most meaningful comparison in explaining the comparative financial performance of each of our businesses. The following results of operations are not necessarily indicative of the results to be expected for the full year going forward.
Advanced Circuits
Advanced Circuits is a provider of prototype, quick-turn and volume production PCBs to customers throughout the United States. Collectively, prototype and quick-turn PCBs represent over 60% of Advanced Circuits’ gross revenues. Prototype and quick-turn PCBs typically command higher margins than volume production PCBs given that customers require high levels of responsiveness, technical support and timely delivery of prototype and quick-turn PCBs and are willing to pay a premium for them. Advanced Circuits is able to meet its customers’ demands by manufacturing custom PCBs in as little as 24 hours, while maintaining over 98.0% error-free production rates and real-time customer service and product tracking 24 hours per day.
While global demand for PCBs has remained strong in recent years, industry wide domestic production has declined over 50% since 2000. In contrast, Advanced Circuits’ revenues increased steadily through 2008 (2009 saw a slight reduction) and increased again in 2010 and into the first and second quarter of 2011 as its customers’ prototype and quick-turn PCB requirements, such as small quantity orders and rapid turnaround, are less able to be met by low cost volume manufacturers in Asia and elsewhere. Advanced Circuits’ management anticipates that demand for its prototype and quick-turn printed circuit boards will remain strong and anticipates that demand will be impacted less by current economic conditions than by its longer lead time production business, which is driven more by consumer purchasing patterns and capital investments by businesses.
We purchased a controlling interest in Advanced Circuits on May 16, 2006.
On March 11, 2010, Advanced Circuits acquired Circuit Express based in Tempe, Arizona for approximately $16.1 million. Circuit Express focuses on quick-turn manufacturing of prototype and low-volume quantities of rigid PCBs primarily for aerospace and defense related customers. In the following discussion of results of operations, we may refer to Circuit Express as ACI-Tempe.
The table below summarizes the income from operations data for Advanced Circuits for the three and nine month periods ended September 30, 2011 and September 30, 2010.
Income from operations
30
Three months ended September 30, 2011 compared to the three months ended September 30, 2010.
Net sales for the three months ended September 30, 2011 decreased approximately $0.6 million, or 2.9%, compared to the corresponding three month period ended September 30, 2010. The decrease in net sales is principally the result of decreased sales of long-lead time PCBs ($0.9 million) and prototype PCB’s ($0.2 million) during the three-months ended September 30, 2011 compared to the same period in 2010. This decrease was offset in part by increases during the current quarter in quick turn PCB sales ($0.4 million) and assembly revenue ($0.2 million). Sales from quick-turn and prototype PCBs represented approximately 63.8% of gross sales during the three-months ended September 30, 2011 compared to 61.5% during the same period in 2010. The decrease in revenues of long-lead production PCB’s is due to softer retail economic conditions in 2011 compared to 2010. Net sales attributable to ACI-Tempe were approximately $4.4 million in the quarter ended September 30, 2011 compared to $5.2 million during the same period in 2010. The decrease in revenues for the ACI-Tempe operations is also due to softer economic conditions, particularly military applications.
Cost of sales for the three months ended September 30, 2011 decreased approximately $0.3 million compared to the comparable period in 2010. This decrease is principally due to the corresponding decrease in net sales. Gross profit as a percentage of sales increased marginally during the three months ended September 30, 2011 (54.4% at September 30, 2011 as compared to 54.3% at September 30, 2010) largely as a result of effective cost containment measures instituted at our ACI-Tempe branch.
Selling, general and administrative expense was approximately $3.2 million during the three-months ended September 30, 2011 compared to $3.6 million in the same period in 2010. The decrease of $0.4 million in the 2011 third quarter is due to the elimination of some duplication of processes between the ACI-Tempe and Aurora locations.
Operating income for the three months ended September 30, 2011 was approximately $6.6 million, compared to $6.5 million earned in the same period in 2010, an increase of approximately $0.1 million, principally as a result of those factors described above.
Nine months ended September 30, 2011 compared to the nine months ended September 30, 2010.
Net sales for the nine months ended September 30, 2011 increased approximately $5.9 million, or 10.9%, over the corresponding nine month period ended September 30, 2010. The increase in net sales is a result of increased gross sales in long-lead time PCBs ($0.6 million), quick-turn production and prototype PCBs ($3.9 million) and assembly revenue ($1.3 million). Sales from quick-turn and prototype PCBs represented approximately 63.2% of gross sales in 2011 compared to 62.7% in 2010. The increased sales in quick turn and prototype PCB’s is due to more robust economic conditions in 2011, particularly the first six months. Net sales attributable to ACI-Tempe were approximately $14.4 million in the nine months ended September 30, 2011 compared to $15.6 million in the same period in 2010. The decrease in revenues for the ACI-Tempe operations is due to softer economic conditions, particularly military applications.
Cost of sales for the nine months ended September 30, 2011 increased approximately $2.5 million from the comparable period in 2010. This increase is principally due to the corresponding increase in sales. Gross profit as a percentage of sales increased marginally during the nine months ended September 30, 2011 (55.3% at September 30, 2011 as compared to 55.1% at September 30, 2010) due to effective cost containment measures instituted at our ACI-Tempe branch.
Selling, general and administrative expense decreased approximately $3.6 million during the nine months ended September 30, 2011 compared to the same period in 2010 due principally to non-cash stock compensation issued to management in January 2010 totaling approximately $3.8 million, and $0.3 million in direct acquisition costs incurred in acquiring ACI-Tempe in the nine months ended September 30, 2010. Ignoring these one-time 2010 charges, selling, general and administrative expense increased approximately $0.5 million during the nine months ended September 30, 2011 compared to the same period in 2010. Advertising and marketing costs increased $0.2 million, costs associated with exploring new business acquisitions increased $0.2 million and employee benefits increased $0.1 million in the nine months ended September 30, 2011 compared to the same period in 2010.
31
Operating income for the nine months ended September 30, 2011 was approximately $20.5 million, an increase of approximately $6.8 million compared to $13.7 million earned in the same period in 2010, principally as a result of those factors described above.
Founded in 1998 and headquartered in Ecru, Mississippi, American Furniture is a leading U.S. manufacturer of upholstered furniture, focused exclusively on the promotional segment of the furniture industry. American Furniture offers a broad product line of stationary and motion furniture, including sofas, loveseats, sectionals, recliners and complementary products, sold primarily at retail price points ranging between $199 and $1,399. American Furniture is a low-cost manufacturer and is able to ship any product in its line to over 800 customers within 48 hours of receiving an order.
American Furniture’s products are adapted from established designs in the following categories: (i) motion and recliner; (ii) stationary; (iii) occasional chair, and; (iv) accent tables and rugs. American Furniture’s products are manufactured from common components and offer proven select fabric options, providing manufacturing efficiency and resulting in limited design risk or inventory obsolescence.
The table below summarizes the loss from operations data for American Furniture for the three and nine month periods ended September 30, 2011 and September 30, 2010.
Loss from operations
Net sales for the three months ended September 30, 2011 decreased approximately $8.4 million, or 26.2%, over the corresponding three months ended September 30, 2010. Stationary product net sales decreased approximately $6.3 million, motion product sales decreased approximately $2.3 million and recliner product sales increased approximately $0.2 million. The decrease in net sales in the stationary and motion product categories is the result of an extremely soft current retail environment and increased competition in pricing in the promotional furniture category during the third quarter of 2011. Sales to AFM’s two largest customers decreased approximately $5.8 million in the third quarter of 2011 compared to 2010. We expect net sales to be flat or lower during the fourth quarter of 2011.
32
Cost of sales decreased approximately $5.7 million in the three months ended September 30, 2011 compared to the same period of 2010 and is due to the corresponding decrease in sales and a one-time adjustment made to write-off excess overhead absorption of $1.4 million resulting from AFM revising its standard costs on July 31, 2011. Gross profit as a percentage of sales was 7.4% in the three months ended September 30, 2011 compared to 13.9% in the same period of 2010. The write-off is responsible for 5.5% of the decrease in gross profit as a percentage of sales. The remaining decrease in gross profit as a percentage of sales of approximately 1.1% during the three months ended September 30, 2011 is principally attributable to reduced selling prices that have been necessary based on aggressive competitor pricing.
Selling, general and administrative expense for the three months ended September 30, 2011, decreased approximately $0.3 million compared to the same period of 2010. This decrease is primarily due to decreased costs of insurance, bad debt expense and sales commissions. AFM initiated cost cutting measures during the first half of fiscal 2011 such as reducing headcount and consolidating warehouse facilities which have begun to reflect savings.
We incurred an impairment charge at American Furniture in the third quarter of 2010 totaling $42.4 million. We conducted an interim test for impairment at American Furniture at that time which was triggered based on results of operations that had deteriorated significantly during the second and third quarter of 2010. The portion of the impairment charge that was attributable to impaired goodwill at American Furniture was $41.4 million. The remaining $1.0 million reflected a write off of the unamortized American Furniture trade name. There were no impairment charges for American Furniture during the comparable 2011 period.
Loss from operations totaled approximately $2.5 million for the three months ended September 30, 2011 compared to a loss from operations of approximately $42.7 million in the three months ended September 30, 2010, principally due to those factors described above, particularly the impairment charge that was recorded in the 2010 period.
Net sales for the nine months ended September 30, 2011 decreased approximately $26.3 million, or 24.0%, when compared to the corresponding nine months ended September 30, 2010. Stationary product net sales decreased approximately $17.4 million, recliner product sales decreased approximately $7.2 million, and motion product sales decreased approximately $0.9 million. Sales of other products and a reduction in fuel surcharges were responsible for the remaining decrease in net sales during the nine months ended September 30, 2011 compared to 2010. The decrease in net sales in all categories is the result of an extremely soft current retail environment and increased competition in pricing in our promotional furniture category during the year. Sales to AFM’s largest customer decreased $17.1 million in the nine months ended September 30, 2011 compared to 2010.
Cost of sales decreased approximately $16.9 million in the nine months ended September 30, 2011 compared to the same period of 2010 and is due primarily to the corresponding decrease in sales and a one-time adjustment made to write-off excess overhead absorption resulting from AFM revising its standard costs on July 31, 2011. Gross profit as a percentage of sales was 11.5% in the nine months ended September 30, 2011 compared to 17.3% in the same period of 2010. The write-off is responsible for 1.5% of the decrease in gross profit as a percentage of sales. The remaining decrease in gross profit as a percentage of sales of approximately 4.3% during the nine months ended September 30, 2011 is principally attributable to reduced selling prices that have been necessary based on aggressive competitor pricing.
Selling, general and administrative expense for the nine months ended September 30, 2011, decreased approximately $1.1 million compared to the same period of 2010. This decrease is primarily due to decreased costs of insurance ($0.5 million), and bad debt expense ($0.6 million). AFM initiated cost cutting measures during the period such as reducing headcount and consolidating warehouse facilities which have begun to reflect savings. We expect to realize additional savings during the fourth fiscal quarter of 2011 as a result of these measures.
American Furniture incurred an impairment charge to its goodwill ($5.9 million) and unamortized trade name ($1.8 million), aggregating $7.7 million during the nine months ended September 30, 2011. This impairment charge eliminates the remaining balance of goodwill. The $1.8 million impairment charge to American Furniture’s trade name in addition to $3.3 million in impairment charges to its trade name written off in 2010. The remaining intangible asset balance attributable to AFM’s trade name, after the latest impairment charge, is $1.2 million. We incurred an impairment charge at American Furniture in the third quarter of 2010 totaling $42.4 million resulting from an interim test for impairment which was triggered based on results of operations which had deteriorated significantly during the second and third quarter of 2010.
33
Loss from operations totaled approximately $12.1 million for the nine months ended September 30, 2011 compared to a loss from operations of approximately $38.8 million in the nine months ended September 30, 2010, principally due the impairment charges and other factors described above.
CamelBak, headquartered in Petaluma, California, is a premier designer and manufacturer of personal hydration products for outdoor, recreation and military applications. CamelBak offers a broad range of recreational and military personal hydration packs, reusable water bottles, specialty military gloves and performance accessories.
As the leading supplier of hydration products to specialty outdoor, cycling and military retailers, CamelBak maintains the leading market share position in recreational markets for hands-free hydration packs and the leading market share position for reusable water bottles in specialty channels. CamelBak is also the dominant supplier of hydration packs to the military, with a leading market share in post-issue hydration packs. Over its more than 20-year history, CamelBak has developed a reputation as the preferred supplier for the hydration needs of the most demanding athletes and soldiers. Across its markets, CamelBak is respected for its innovation, leadership and authenticity.
On August 24, 2011, we made loans to and purchased a controlling interest in CamelBak for approximately $258.6 million, representing 90% of the equity in CamelBak.
Pro forma Results of Operations
The table below summarizes the pro-forma income from operations data for CamelBak for the three and nine month periods ended September 30, 2011 and September 30, 2010.
Cost of sales (a)
Selling, general and administrative expense (b)
Fees to manager (c)
Amortization of intangibles (d)
Pro-forma results of operations of CamelBak for the three and nine month periods ended September 30, 2011 and 2010 include the following pro-forma adjustments, applied to historical results as if we acquired CamelBak on January 1, 2010:
34
Pro forma three months ended September 30, 2011 compared to the pro forma three months ended September 30, 2010.
Net sales for the three months ended September 30, 2011 were approximately $38.3 million, an increase of $10.4 million, or 37.2%, compared to the same period in 2010. The increase in net sales is a result of increased sales in hydration packs ($4.0 million), bottles ($4.0 million), gloves ($1.0 million) and accessories ($1.4 million). The increased sales during the three months ended September 30, 2011 compared to the same period in 2010 is attributable to the continued success of “Antidote”, CamelBak’s new reservoir included in its 2011 recreational hydration pack line, the expansion of offerings in bottles and the continued expansion in its customer base, including new and existing customers, for all product lines. Sales of hydration packs and bottles represented approximately 73% of gross sales for the three months ended September 30, 2011 compared to 71% for the same period in 2010. Military sales represented approximately 40% of gross sales for the three months ended September 30, 2011 compared to 44% for the same period in 2010.
Cost of sales for the three months ended September 30, 2011 were approximately $22.8 million compared to approximately $15.4 million in the same period of 2010. The increase of $7.4 million is due principally to the corresponding increase in sales. Gross profit as a percentage of sales decreased from 44.8% for the quarter ended September 30, 2010 to 40.6% in the quarter ended September 30, 2011. The decrease is attributable to: (i) increases in duty charges in 2011 as a result of a one-time benefit, due to a customs ruling on CamelBak’s behalf, received in the three months ended September 30, 2010; and (ii) price increases from suppliers in the third quarter of 2011 for raw materials, particularly resins and fabric, which were not reflected in customer pricing.
Selling, general and administrative expense for the three months ended September 30, 2011 increased to approximately $7.3 million or 19.1% of net sales compared to $6.4 million or 23.0% of net sales for the same period of 2010. The $0.9 million increase in selling, general and administrative expenses incurred during the three months ended September 30, 2011 compared to the same period in 2010 is attributable to; (i) gains from foreign currency derivatives included in the three months ended September 30, 2010 balance ($0.2 million); (ii) increases in advertising and marketing costs ($0.1 million); and (iii) increased research and development costs ($0.1 million), with the balance of the increase due to increased infrastructure costs such as personnel costs and benefits, and general overhead necessary to support expansion initiatives in connection with current and anticipated increased sales volume.
Income from operations for the three months ended September 30, 2011 was approximately $5.9 million, an increase of $2.3 million when compared to the same period in 2010, based on the factors described above.
Pro forma nine months ended September 30, 2011 compared to the pro forma nine months ended September 30, 2010.
Net sales for the nine months ended September 30, 2011 were approximately $114.7 million, an increase of $23.9 million, or 26.3%, compared to the same period in 2010. The increase in net sales during 2011 is the result of increased sales (on a gross basis) in hydration packs ($12.3 million), bottles ($11.5 million), and accessories ($2.4 million). These increased sales were offset in part by a decrease in glove sales aggregating $2.5 million during the nine months ended September 30, 2011 compared to the same period in 2010. The increased sales of hydration packs, bottles and accessories is attributable to the successful launch of CamelBak’s new reservoir “Antidote” in 2011 (CamelBak’s new reservoir included in its 2011 recreational hydration pack line), the expansion of offerings in bottles and the continued expansion in its customer base, including new and existing customers. The decrease in glove sales during the current year-to-date period is attributable to less direct contract sales to the US military resulting, in part, from a drawdown of US combat troops overseas. Sales of hydration packs and bottles represented approximately 74% of gross sales for the nine months ended September 30, 2011 compared to approximately 67% for the same period in 2010. Military sales represented approximately 39% of gross sales for the nine months ended September 30, 2011 compared to 42% for the same period in 2010.
35
Cost of sales for the nine months ended September 30, 2011 were approximately $68.0 million compared to approximately $51.4 million in the same period of 2010. The increase of $16.7 million is due principally to the corresponding increase in sales. Gross profit as a percentage of sales decreased from 43.4% for the year-to-date period ended September 30, 2010 to 40.7% for the same period ended September 30, 2011. The decrease is attributable to: (i) increases in duty charges in 2011 as a result of a one-time benefit, due to a customs ruling on CamelBak’s behalf received in 2010; (ii) price increases from suppliers in the first nine months of 2011 for raw materials, particularly resins and fabric, not reflected in customer pricing, and (iii) expedited freight costs due to a supplier capacity constraint in the first nine months of 2011 not reflected in customer pricing. CamelBak management has taken steps to rectify these capacity constraint issues, which should significantly mitigate these charges in the future.
Selling, general and administrative expense for the nine months ended September 30, 2011 increased to approximately $22.7 million or 19.8% of net sales compared to $19.3 million or 21.3% of net sales for the same period of 2010. The $3.3 million increase in selling, general and administrative expenses incurred during the nine months ended September 30, 2011, compared to the same period in 2010 is attributable to: (i) increases in advertising and marketing costs ($1.3 million); (ii) increased research and development costs ($0.4 million), and (iii) bad debt expense (0.4 million), with the balance of the increase due to increased infrastructure costs such as personnel costs and benefits, and general overhead necessary to support expansion initiatives in connection with current and anticipated increased sales volume.
Income from operations for the nine months ended September 30, 2011 increased approximately $4.1 million to $16.7 million compared to the same period in 2010, which reflected income from operations totaling $12.6 million, based principally on the factors described above.
ERGObaby, with headquarters in Los Angeles, California, is a premier designer, marketer and distributor of baby wearing products and accessories. ERGObaby offers a broad range of wearable baby carriers and related products that are sold through more than 900 retailers and web shops in the United States and internationally in approximately 20 countries. ERGObaby has two main product lines: baby carriers (organic and standard) and accessories.
ERGObaby’s reputation for product innovation, reliability and safety has led to numerous awards and accolades from consumer surveys and publications, including Parenting Magazine, Pregnancy Magazine and Wired Magazine.
On September 16, 2010, we made loans to and purchased a controlling interest in ERGObaby for approximately $85.2 million, representing 84% of the equity in ERGObaby.
36
The table below summarizes the income from operations for the three months ended September 30, 2011 and the pro-forma income from operations data for ERGObaby for the nine month period ended September 30, 2011 and the three and nine month periods ended September 30, 2010.
Pro-forma results of operations of ERGObaby for the nine month periods ended September 30, 2011 and 2010 and the three months ended September 30, 2010 include the following pro-forma adjustments, applied to historical results as if we acquired ERGObaby on January 1, 2010:
Three months ended September 30, 2011 compared to the pro forma three months ended September 30, 2010.
Net sales for the three months ended September 30, 2011 were approximately $10.7 million, an increase of $2.8 million, or 35.4%, compared to the same period in 2010. Domestic sales were approximately $4.3 million in the three months ended September 30, 2011 compared to approximately $3.6 million in the same period in 2010, as the number of domestic retail outlets ERGObaby’s products sold to increased from 850 as of September 30, 2010 to 997 as of September 30, 2011. Domestic sales increased approximately 21% during the three month period ended September 30, 2011 compared to the same period in 2010 principally as the result of new distribution channels and increased average sales per store. International sales were approximately $6.4 million in the three months ended September 30, 2011 compared to $4.3 million in the same period of 2010, an increase of $2.1 million or 47.3%. This significant increase is primarily attributable to continued increases in sales to distributors in Asia, principally Japan, and South Korea, and the addition of new distributors during 2011 in Europe and Southeast Asia. Baby carriers represented 86.5% of sales for the three months ended September 30, 2011 compared to 87.6% for the same period in 2010. The remaining net sales in each of the three month periods ended September 30, 2011 and 2010 reflect accessory sales.
Cost of sales for the three months ended September 30, 2011 were approximately $3.6 million compared to approximately $2.3 million in the same period of 2010. The increase of $1.3 million is due principally to the corresponding increase in sales. Gross profit as a percentage of sales decreased from 70.9% for the quarter ended September 30, 2010 to 66.4% in the most recent quarter ended September 30, 2011. The decrease is attributable to: (i) a greater percentage of organic baby carriers (which are standard baby carriers made with organic cotton) that generate a 7% to 10% lower gross profit margin than standard carriers and accounted for 47% of total baby carrier sales in the third quarter of 2011 compared to 42% in the same period of 2010; (ii) a greater percentage of net sales were international sales in the third quarter of 2011 compared to 2010, which carry a lower price point and, as a result, generate lower gross profit margins (on average, international sales have a gross profit margin of approximately 59% compared to 72% for domestic sales); and (iii) price increases in raw materials, particularly cotton.
37
Selling, general and administrative expense for the three months ended September 30, 2011 increased to approximately $4.0 million or 37.5% of net sales compared to $3.3 million or 41.8% of net sales for the same period of 2010. During the three months ended September 30, 2011. ERGObaby reversed a previously recorded liability ($1.0 million) related to the former owner’s earn-out provision. The earn-out provision provides for a payment to ERGObaby’s former owner of $2.0 million if net sales meet or exceed an agreed upon hurdle rate in calendar year 2011. We currently believe that the hurdle amount will not be met. Ignoring the reversal of the previously recorded liability affecting the earn-out provision, selling, general and administrative expenses increased by $1.7 million in the three months ended September 30, 2011 compared to the same period in 2010. The increase in expenses during the three months ended September 30, 2011 compared to the same period in 2010 is due principally to increases in marketing costs ($0.7 million), personnel costs, as a result of increased headcount ($0.9 million), and professional fees ($0.3 million). These increased expenses all related to expansion initiatives and general overhead in order to support the current and anticipated increased sales volume. These increases in expenses were offset in part by a decrease in bad debt expense of $0.2 million.
Income from operations for the three months ended September 30, 2011 increased $0.8 million to $2.5 million compared to $1.8 million earned during 2010 based principally on the factors described above.
Net sales for the nine months ended September 30, 2011 were $33.4 million, an increase of $9.7 million or 40.8% compared to the same period in 2010. Domestic sales were approximately $11.9 million in the nine months ended September 30, 2011 compared to approximately $11.3 million in the same period for 2010. The number of domestic retail outlets ERGObaby’s products were sold to increased from 850, as of September 30, 2010, to 997, as of September 30, 2011. This favorable increase in the number of retail outlets selling our product was offset in part by a decrease in shipments to several large domestic consolidators during the third quarter of 2011. Excluding the impact of sales to consolidators in each of the periods, domestic sales increased approximately 13% during the nine month period ended September 30, 2011 compared to the same period in 2010 due to new distribution channels and an increase in same store sales. International sales were approximately $21.5 million in the nine months ended September 30, 2011 compared to $12.4 million in 2010, an increase of $9.1 million or 73.3%. This significant increase is primarily attributable to continued increases in sales to distributors in Japan and South Korea due to share gains and new store distribution, and the addition of new distributors during 2011 in Europe and Southeast Asia. Baby carriers represented 87.8% of sales for the nine months ended September 30, 2011 compared to 87.2% for the same period in 2010. The remaining net sales in each of the nine month periods ended September 30, 2011 and 2010 reflect accessory sales.
Cost of sales for the nine months ended September 30, 2011 were approximately $11.6 million compared to $7.0 million in the same period of 2010. The increase of $4.6 million is due principally to the increase in sales. Gross profit as a percentage of sales decreased from 70.4% for the nine months ended September 30, 2010 to 65.2% in the same period of 2011. The decrease is attributable to: (i) a greater percentage of organic baby carriers (which are standard baby carriers made with organic cotton) that generate a 7% to 10% lower gross profit margin than standard carriers and accounted for 44% of baby carrier sales in the first nine months of 2011 compared to 37% in the same period of 2010); (ii) a greater percentage of net sales were international sales in the first nine months of 2011 compared to 2010, which carry a lower price point and, as a result, generate lower gross profit margins (on average, international sales have a gross profit margin of 59% compared to approximately 72% for domestic sales); and (iii) price increases in raw materials, particularly cotton, and a weaker U.S. dollar.
Selling, general and administrative expense for the nine months ended September 30, 2011 increased to approximately $12.5 million or 37.5% of net sales compared to $8.5 million or 35.9% of net sales for the same period of 2010. During the nine months ended September 30, 2011 ERGObaby reversed a previously recorded liability ($0.2 million) related to the former owner’s earn-out provision. The earn-out provision provides for a payment to ERGObaby’s former owner of $2.0 million if net sales meet or exceed an agreed upon hurdle rate in calendar year 2011. As of September 30, 2011, we estimate that the hurdle amount will not be met. Ignoring the reversal of the previously recorded liability affecting the earn-out provision, selling, general and administrative expenses increased by $4.2 million in the nine months ended September 30, 2011 compared to the same period in 2010. The increase in expenses during the nine months ended September 30, 2011 compared to the same period in 2010 is due principally to increases in marketing costs ($1.3 million), personnel costs, as a result of increased headcount ($1.9 million), and professional fees ($0.9 million). These increased expenses all related to expansion initiatives and general overhead in order to support the current and anticipated increased sales volume.
38
Income from operations for the nine months ended September 30, 2011 increased approximately $1.1 million to $7.6 million compared to the same period in 2010 in which ERGObaby earned approximately $6.5 million, based principally on the factors described above.
Fox Factory
Fox, headquartered in Watsonville, California, is a branded action sports company that designs, manufactures and markets high-performance suspension products for mountain bikes and power sports, which include: snowmobiles, motorcycles, all-terrain vehicles, ATVs, and other off-road vehicles.
Fox’s products are recognized by manufacturers and consumers as being among the most technically advanced suspension products currently available in the marketplace. Fox’s technical success is demonstrated by its dominance of award winning performances by professional athletes across its suspension products. As a result, Fox’s suspension components are incorporated by original equipment manufacturer (“OEM”) customers on their high-performance models at the top of their product lines in the mountain bike and power sports sector. OEMs capitalize on the strength of Fox’s brand to maintain and expand their own sales and margins. In the Aftermarket segment, customers seeking higher performance select Fox’s suspension components to enhance their existing equipment.
Fox sells to more than 200 OEM and 7,600 Aftermarket customers across its market segments. In each of the years 2010, 2009 and 2008, approximately 78%, 76% and 76% of net sales were to OEM customers. The remaining net sales were to Aftermarket customers.
The table below summarizes the income from operations data for Fox Factory for the three and nine month periods ended September 30, 2011 and September 30, 2010.
39
Net sales for the three months ended September 30, 2011 increased approximately $0.3 million compared to the corresponding period in 2010. OEM sales increased $1.0 million to $50.6 million during the three months ended September 30, 2011 compared to $49.6 million for the same period in 2010. The increase in OEM sales is attributable to increases in sales in the powered vehicles sector totaling $4.0 million representing a 40.6% increase from the comparable prior year period, offset in part by a $3.0 million decrease in OEM sales in the mountain biking sector. The increase in OEM sales in the powered vehicles sector during the three months ended September 30, 2011 is the result of an increase in sales of suspension components to the ATV and off-road markets. The decrease in OEM sales to the mountain biking sector during the three months ended September 30, 2011 is due to a more normalized seasonal sales pattern experienced during the current quarter. OEM mountain biking sales were higher than normal in the third fiscal quarter of 2010 due to a delay in the buying pattern of the OEM’s that pushed some second quarter 2010 sales into the third fiscal quarter. A greater proportion of these sales were reflected in the first half of 2011. Aftermarket sales decreased approximately $0.6 million to $11.1 million during the three months ended September 30, 2011 compared to $11.7 million in the same period in 2010. This decrease is attributable to decreases in Aftermarket net sales in the powered vehicles sector resulting from a decrease in military sales.
International OEM and Aftermarket sales totaled approximately $42.4 million during the three months ended September 30, 2011 and 2010.
Cost of sales for the three months ended September 30, 2011 decreased approximately $0.5 million, compared to the corresponding period in 2010. Gross profit as a percentage of sales was approximately 30.6% for the three months ended September 30, 2011 compared to 29.4% for the same period in 2010. The 1.2% increase in gross profit as a percentage of sales during 2011 is attributable to reductions in freight costs and a favorable customer/product mix during the most recent quarter.
Selling, general and administrative expense increased approximately $1.2 million during the three months ended September 30, 2011 compared to the same period in 2010. This increase is the result of increases in (i) sales and marketing costs ($0.1 million), (ii) engineering costs ($0.6 million), and (iii) other administrative costs, largely personnel related, ($0.5 million) during the three months ended September 30, 2011, compared to 2010, principally to support the significant increase in year-to-date sales.
Income from operations for the three months ended September 30, 2011 decreased approximately $0.4 million to $10.0 million compared to the corresponding period in 2010, based principally on the factors described above.
Net sales for the nine months ended September 30, 2011 increased approximately $21.7 million, or 16.9%, compared to the corresponding period in 2010. OEM sales increased $17.6 million to $119.6 million during the nine months ended September 30, 2011 compared to $102.0 million for the same period in 2010. The increase in OEM net sales is attributable to increases in sales in the mountain biking sector totaling $5.6 million and increases in sales in the powered vehicles sector totaling approximately $12.0 million, representing a 60.6% increase from the comparable prior year period. The increase in OEM sales in the mountain biking sector during the nine months ended September 30, 2011 is due to strong sales of the new model year product and inventory replenishment at OEM’s during the first two quarters of 2011 that did not occur during 2010. The significant increase in OEM sales to the powered vehicle sector during the nine months ended September 30, 2011 is the result of an increase in sales of suspension components to the ATV and off-road markets. Aftermarket sales increased approximately $4.1 million to $30.8 million during the nine months ended September 30, 2011 compared to $26.7 million in the same period in 2010. This increase is attributable to increases in Aftermarket net sales in the powered vehicles sector totaling approximately $2.3 million and the mountain biking sector totaling approximately $1.7 million.
International OEM and Aftermarket sales totaled $100.7 million during the nine months ended September 30, 2011 compared to $84.8 million during the same period in 2010, an increase of $15.9 million or 18.8%.
40
Cost of sales for the nine months ended September 30, 2011 increased approximately $14.5 million, or 15.8%, compared to the corresponding period in 2010. The increase in cost of sales is attributable to the increase in net sales for the same period. Gross profit as a percentage of sales was approximately 29.7% for the nine months ended September 30, 2011 compared to 29.1% for the same period in 2010. The 0.6% increase in gross profit as a percentage of sales during the first three quarters of 2011 is attributable to efficiencies achieved in connection with the increased production volume. This was offset in part by an unfavorable product and customer mix compared to 2010, increased raw material commodity costs and unfavorable foreign exchange rates.
Selling, general and administrative expense increased approximately $3.9 million during the nine months ended September 30, 2011 compared to the same period in 2010. This increase is the result of increases in: (i) sales and marketing costs ($0.6 million); (ii) engineering costs ($1.4 million), and (iii) other administrative costs, largely personnel related, ($1.9 million) during the nine months ended September 30, 2011, compared to 2010, principally to support the significant increase in sales.
Income from operations for the nine months ended September 30, 2011 increased approximately $3.3 million to $19.6 million compared to the corresponding period in 2010, based principally on the significant increase in net sales, offset in part by the increases in selling, general and administrative costs, all as described above.
HALO, headquartered in Sterling, IL, is an independent provider of customized drop-ship promotional products in the U.S. Through an extensive group of dedicated sales professionals, HALO serves as a one-stop shop for over 40,000 customers throughout the U.S. HALO is involved in the design, sourcing, management and fulfillment of promotional products across several product categories, including apparel, calendars, writing instruments, drink ware and office accessories. HALO’s sales professionals work with customers and vendors to develop the most effective means of communicating a logo or marketing message to a target audience. Approximately 90% of products sold are drop shipped, resulting in minimal inventory risk. HALO has established itself as a leader in the promotional products and marketing industry through its focus on service through its over 900 account executives.
HALO acquired the promotional products distributor Relay Gear in February 2010. In October 2011, HALO acquired the promotional products operations of Logos Your Way, Inc.
Distribution of promotional products is seasonal. Management estimates that HALO expects to realize approximately 45% of its sales and 70% of its operating income in the months of September through December, due principally to calendar sales and corporate holiday promotions.
The table below summarizes the income from operations data for HALO for the three and nine month periods ended September 30, 2011 and September 30, 2010:
41
Net sales for the three months ended September 30, 2011 increased approximately $2.5 million, or 6.1%, compared to the same period in 2010. The increase in net sales in the three months ended September 30, 2011 compared to the same period in 2010, is primarily attributable to increased sales to existing customers as a result of improving macro-economic conditions and, to a lesser extent, the development of several new significant customers and the replacement of account executives with new account executives that, on average, generated larger sales.
Cost of sales for the three months ended September 30, 2011 increased approximately $1.2 million compared to the same period in 2010. The increase in cost of sales is primarily attributable to the corresponding increase in net sales for the same period. Gross profit as a percentage of net sales totaled approximately 39.2% and 38.3% of net sales for the three month periods ended September 30, 2011 and 2010, respectively. The increase in gross profit percentage of 0.9% for the three months ended September 30, 2011 compared to the same period in 2010 is principally attributable to improved product sourcing and procurement efficiencies realized during the current quarter.
Selling, general and administrative expense for the three months ended September 30, 2011 increased approximately $0.2 million compared to the same period in 2010. Direct commission expenses increased by approximately $0.4 million as a result of increased sales in the three months ended September 30, 2011 offset in part by a decrease in medical insurance costs totaling $0.3 million. Selling, general and administrative costs represented 31.8% of net sales for the three months ended September 30, 2011, compared to 33.3% in the same period in 2010.
Income from operations was approximately $2.5 million for the three months ended September 30, 2011 representing an increase of $1.2 million compared to the same period in 2010. The improved operating results are principally due to the increase in net sales and gross profit margins, offset in part by higher direct commission expense and other factors as described above.
Net sales for the nine months ended September 30, 2011 increased approximately $9.5 million, or 9.0%, compared to the same period in 2010. Sales increases attributable to accounts acquired as part of the Relay Gear acquisition in February 2010 accounted for approximately $0.5 million of the increase in net sales in the nine months ended September 30, 2011 compared to the same period in 2010. The remaining increase in net sales in the nine months ended September 30, 2011 compared to the same period in 2010 is primarily attributable to increased sales to existing customers as a result of improving macro-economic conditions and, to a lesser extent, the development of several new significant customers and the replacement of account executives with new account executives that, on average, generated larger sales.
Cost of sales for the nine months ended September 30, 2011 increased approximately $5.2 million compared to the same period in 2010. The increase in cost of sales is primarily attributable to the corresponding increase in net sales for the same period. Gross profit as a percentage of net sales totaled approximately 39.3% and 38.8% of net sales for the nine month periods ended September 30, 2011 and 2010, respectively. The increase in gross profit percentage for the three months ended September 30, 2011 compared to the same period in 2010 is attributable to improved product sourcing and procurement efficiencies realized during 2011.
Selling, general and administrative expenses for the nine months ended September 30, 2011 were approximately $38.4 million an increase of $0.2 million compared to the same period in 2010. Approximately $1.8 million of litigation settlement proceeds are reflected as a reduction to selling, general and administrative costs in the nine months ended September 30, 2011. Excluding the impact of the settlement proceeds, selling, general and administrative expenses increased approximately $2.0 million in the nine months ended September 30, 2011 compared to the same period in 2010. Direct commission expenses increased by approximately $1.6 million as a result of increased sales in 2011, together with an increase of $0.4 million in salaries and wages. Excluding the impact of the settlement proceeds, selling general and administrative costs represented 34.7% of net sales for the three months ended September 30, 2011 compared to 36.0% in the same period in 2010.
42
Income from operations was approximately $4.9 million for the nine months ended September 30, 2011, representing an increase of $4.1 million compared to the same period in 2010, which reflected operating income of $0.8 million. The improved operating results are principally due to the increase in net sales and settlement proceeds, offset in part by direct commission expense and other factors as described above.
Liberty Safe
Based in Payson, Utah and founded in 1988, Liberty Safe is the premier designer, manufacturer and marketer of home and gun safes in North America. From its over 200,000 square foot manufacturing facility, Liberty Safe produces a wide range of home and gun safe models in a broad assortment of sizes, features and styles ranging from an entry level product to good, better and best products. Products are marketed under the Liberty brand, as well as a portfolio of licensed and private label brands, including Remington, Cabela’s and John Deere. Liberty Safe’s products are the market share leader and are sold through an independent dealer network (“Dealer sales”) in addition to various sporting goods and home improvement retail outlets (“Non-Dealer Sales”). Liberty has the largest independent dealer network in the industry.
Historically, approximately 60% of Liberty Safe’s net sales are Non-Dealer sales and 40% are Dealer sales.
On March 31, 2010 we made loans to and purchased a controlling interest in Liberty Safe for approximately $70.2 million, representing 96.2% of the equity in Liberty Safe.
Results of Operations and Pro-forma Results of Operations
The table below summarizes the results of operations for Liberty Safe for the three months ended September 30, 2011 and the three months ended September 30, 2010. It also summarizes the results of operations for the nine month period ended September 30, 2011 and the pro-forma results of operations for the nine months ended September 30, 2010.
Selling, general and administrative expense (a)
Amortization of intangibles (b)
Pro-forma results of operations of Liberty Safe for the nine months ended September 30, 2010 include the following pro-forma adjustments applied to historical results as if we acquired Liberty Safe on January 1, 2010.
Net sales for the three months ended September 30, 2011 increased approximately $3.3 million, or 17.9%, over the corresponding three months ended September 30, 2010. Non-Dealer sales were approximately $13.9 million in the three months ended September 30, 2011 compared to $12.8 million in the same period in 2010 representing an increase of $1.1 million or 8.6%. Dealer sales totaled approximately $7.9 million in the three months ended September 30, 2011 compared to $5.7 million in the same period in 2010 representing an increase of $2.2 million or 38.6%. The increase in Non-Dealer sales in 2011 is due to strong results in the sporting goods channel ($1.6 million) and the farm and fleet channel ($0.9 million) offset in part by the loss of a club account to an import product line ($0.5 million) and a decline in the home improvement channel ($0.9 million). The sporting goods channel increase is the result of Liberty Safe being the sole supplier to two major accounts that offered robust sales promotions in the third quarter of 2011 resulting in higher retail sales. The farm and fleet channel increase is attributable to (i) fulfilling a significant number of backorders that existed at the end of the first and second quarter and (ii) increased sell through at retail driven by a robust co-op advertising campaign. The increase in Dealer sales in 2011 is the result of strong retail demand. Management believes that these increased Dealer sales levels are the result, in large part, to incremental sales generated by its national advertising campaign in conjunction with those accounts that maintain consistent Liberty Safe product advertising at the local level.
43
Cost of sales for the three months ended September 30, 2011 increased approximately $1.9 million. The increase in cost of sales is primarily attributable to the increase in net sales for the same period. Gross profit as a percentage of net sales totaled approximately 24.9% and 21.9% of net sales for the three month periods ended September 30, 2011 and September 30, 2010, respectively. The increase in gross profit as a percentage of sales for the three months ended September 30, 2011 compared to 2010 is attributable to a price increase that took effect on June 1, 2011 and a favorable product mix with certain customers. This was offset in part by higher freight costs.
Selling, general and administrative expense for the three months ended September 30, 2011, increased approximately $0.3 million compared to the same period in 2010. This increase is largely the result of increased direct commission expense and co-op advertising, both related to the significant increase in sales.
Income from operations was approximately $1.5 million for the three months ended September 30, 2011, representing an increase of $1.1 million compared to the same period in 2010, which reflected operating income of $0.4 million. The improved operating results are principally due to the factors described above, particularly the increase in net sales.
Nine months ended September 30, 2011 compared to the pro-forma nine months ended September 30, 2010.
Net sales for the nine months ended September 30, 2011 increased approximately $12.6 million, or 26.3%, over the corresponding nine months ended September 30, 2010. Non-Dealer sales were approximately $36.9 million in the nine months ended September 30, 2011 compared to $29.5 million in the same period in 2010, representing an increase of $7.4 million or 25.1%. Dealer sales totaled approximately $23.7 million in the nine months ended September 30, 2011 compared to $18.5 million in the same period in 2010, representing an increase of $5.2 million or 28.1%. The significant increase in Non-Dealer sales in 2011 is the result of increased sales in the sporting goods channel ($7.3 million) and the farm and fleet channel ($3.3 million), offset in part by the loss of a club account to an import product line ($1.9 million) and a decline in the home improvement channel ($1.3 million). The sporting goods channel increase results from Liberty Safe being the sole supplier to two major accounts that offered robust sales promotions in the first three quarters of 2011 resulting in higher retail sales. The farm and fleet channel increase is attributable to (i) fulfilling a significant number of backorders that existed at the end of the first and second quarter and (ii) increased sell through at retail driven by a robust co-op advertising campaign. The increase in Dealer sales is due, in large part, to incremental retail sales generated by Liberty’s national advertising campaign in conjunction with those accounts that maintain consistent Liberty Safe product advertising at the local level.
Cost of sales for the nine months ended September 30, 2011 increased approximately $9.6 million. The increase in cost of sales is primarily attributable to the increase in net sales for the same period. Gross profit as a percentage of net sales totaled approximately 25.3% and 25.5% of net sales for the nine month periods ended September 30, 2011 and September 30, 2010, respectively. The decrease in gross profit as a percentage of sales of 0.2% for the nine months ended September 30, 2011 compared to 2010 is primarily attributable to higher transportation costs (1.3%), offset in part by an increase in sales prices. A price increase went into effect June 1, 2011 to offset higher transportation costs and potentially higher commodity costs, and as a result we currently expect that Liberty Safe’s margins will increase slightly through the remainder of 2011.
Selling, general and administrative expense for the nine months ended September 30, 2011, increased approximately $1.6 million compared to the same period in 2010. This increase is principally the result of increases in the following costs to support the significant increase in sales: (i) commission expense ($0.4 million), (ii) co-op advertising ($0.3 million) and the ongoing national ad campaign being conducted by Liberty Safe ($0.3 million) (iii) costs associated with increased headcount ($0.3 million) to support the increase in net sales and (iv) other miscellaneous cost increases ($0.3 million).
44
Income from operations was approximately $3.4 million for the nine months ended September 30, 2011, representing an increase of $1.5 million compared to the same period in 2010, which reflected operating income of $1.9 million. The improved operating results are principally due to the factors described above, particularly the increase in net sales.
Staffmark, a national provider of contingent workforce solutions that serves the temporary staffing needs of employers throughout the United States, provides a full spectrum of light industrial and clerical staffing solutions. Staffmark has a client base of approximately 6,000 and currently places over 41,000 temporary employees weekly in a broad range of industries.
Staffmark is focused on establishing and maintaining a leading position within the markets in which it operates. It seeks to achieve this by winning its clients’ business one location at a time and leveraging that success into a broader relationship where it services multiple client locations. As Staffmark’s client relationships develop, it enhances its position within markets by: (i) hiring additional sales and operations staff; (ii) opening branch and on-site locations; and (iii) making strategic acquisitions. This strategy enables Staffmark to gain operating leverage in its markets, raise the awareness of its brand and realize efficiencies of scale.
A closely monitored statistic within the temporary staffing industry is the temporary penetration rate, which measures the percentage of the total United States workforce that is temporary versus full-time based on data from the United States Bureau of Labor Statistics. The temporary penetration rate in September 2011 was 1.74%, up slightly from 1.69% in December 2010 and 1.70% reported at the end of the second quarter of 2011.
On October 17, 2011, we sold Staffmark to a subsidiary of Japan-based Recruit Co. Ltd for an enterprise value of $295 million. After costs, fees and non-controlling interests we received approximately $220 million at closing and expect to record a gain on the sale of Staffmark in the fourth quarter of 2011 ranging between $75 million and $90 million.
The table below summarizes the income from operations data for Staffmark for the three and nine month periods ended September 30, 2011 and 2010.
Three months ended September 30, 2011 compared to the three months ended September 30, 2010
Revenues for the three months ended September 30, 2011 increased $6.3 million, or 2.3%, over the corresponding three months ended September 30, 2010. This small increase in revenues reflects flattening demand for temporary staffing services (primarily light industrial and clerical), resulting in part from reduced demand related to the earthquake and tsunami in Japan, which has disrupted the supply chain with companies located in the United States. The impact was felt particularly with reduced temporary staffing services provided to Staffmark’s auto-related customers that supply parts to Japanese automakers. Temporary staffing services increased approximately $6.3 million and were solely responsible for the quarter over quarter revenue increase in spite of the reduction in temporary staffing services resulting from the aforementioned supply chain interruption. Management believes that the supply chain disruption which began in the second quarter of 2011 negatively impacted top line revenues, primarily in light industrial temporary staffing services. We began to see a recovery in these industries toward the end of the third fiscal quarter.
45
Direct cost of service revenues for the three months ended September 30, 2011 increased approximately $5.9 million compared to the same period a year ago. This increase is principally the direct result of the increase in service revenues. Gross profit as a percentage of revenue was approximately 15.0% and 15.2% of revenues for the three-month periods ended September 30, 2011 and 2010, respectively. The majority of the decrease in the gross profit margin of approximately 20 basis points is the result of higher state unemployment tax rates in 2011 resulting from further increases in funding required for various states’ depleted unemployment reserves.
Staffing, selling, general and administrative expense for the three months ended September 30, 2011, increased approximately $1.1 million compared to the same period a year ago. The increased costs incurred during the three months ended September 30, 2011 compared to the same period of 2010 are primarily attributable to increases in overhead costs, particularly in staffing expense, necessary to service the increase in revenues and overall operations and to a lesser extent, increases in costs associated with the on-going PeopleSoft conversion and integration. Staffing, selling, general and administrative expense as a percentage of revenues was 11.0% during the three months ended September 30, 2011 compared to 10.8% during the same period in 2010.
Fees to manager for the three months ended September 30, 2011, increased approximately $0.3 million versus the same period a year ago. In fiscal 2010, the Management Services Agreement was amended for a one-time reduction in the fee to 25% of the total annual fee. This amendment expired December 31, 2010.
Income from operations decreased approximately $0.9 million for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 based on the factors described above.
Revenues for the nine months ended September 30, 2011 increased $40.0 million, or 5.4%, over the corresponding nine months ended September 30, 2010. This increase in revenues primarily reflects increased demand for temporary staffing services during the first quarter of 2011 coupled with the flattening of service revenues in the second quarter of 2011 due in part to the supply chain interruption experienced at auto related customers (see the three month service revenue comparison above). Temporary staffing service revenue increases in light industrial and managed services are principally responsible for the increase. Temporary staffing service revenue increased approximately $39.1 million, leasing revenue increased $0.5 million and direct hire revenue increased approximately $0.3 million in the nine months ended September 30, 2011 compared to the same period last year. Management believes that the supply chain disruption in the second quarter of 2011 negatively impacted top line revenues, primarily in light industrial temporary staffing services, and we began to see a recovery in these industries toward the end of the third fiscal quarter of 2011.
Direct cost of service revenues for the nine months ended September 30, 2011 increased approximately $36.7 million compared to the same period a year ago. This increase is principally the direct result of the increase in service revenues. Gross profit as a percentage of service revenue was approximately 14.1% and 14.4% of revenues for the nine month periods ended September 30, 2011 and 2010, respectively. The majority of the decrease in the gross profit margin of approximately 30 basis points is the result of higher state unemployment tax rates in 2011 resulting from further increases in funding required for various states’ depleted unemployment reserves, offset in part by the increased gross profit provided by the increase in direct hire revenues.
Staffing, selling, general and administrative expense for the nine months ended September 30, 2011 increased approximately $4.6 million compared to the same period a year ago. The increased costs incurred during the nine months ended September 30, 2011 compared to the same period of 2010 are primarily attributable to increases in: (i) overhead costs ($4.0 million), primarily in staffing expense, necessary to service the increase in revenues and overall operations; (ii) a non-recurring, non-cash compensation charge related to a one-time cost for accelerating vesting rights in stock options ($0.6 million), and (iii) costs associated with the on-going PeopleSoft conversion ($0.5 million). These increases were offset in part by a reduction in bad debt expense ($1.0 million) incurred during the nine months ended September 30, 2011 compared to the same period of 2010. Staffing, selling, general and administrative expense as a percentage of revenues was approximately 11.7% during both the nine months ended September 30, 2011 and 2010.
46
Fees to manager for the nine months ended September 30, 2011, increased approximately $0.7 million versus the same period a year ago. In fiscal 2010, the Management Services Agreement was amended for a one-time reduction in the fee to 25% of the total annual fee. This amendment expired December 31, 2010.
Income from operations decreased approximately $1.6 million for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 based principally on the factors described above.
Tridien Medical, headquartered in Coral Springs, Florida, is a leading designer and manufacturer of powered and non-powered medical therapeutic support services and patient positioning devices serving the acute care, long-term care and home health care markets. Tridien is one of the nation’s leading designers and manufacturers of specialty therapeutic support surfaces with manufacturing operations in multiple locations to better serve a national customer base.
Tridien, together with its subsidiary companies, provides customers the opportunity to source leading surface technologies from the designer and manufacturer.
Tridien develops products both independently and in partnership with large distribution intermediaries. Medical distribution companies then sell or rent the therapeutic support surfaces, sometimes in conjunction with bed frames and accessories to one of three end markets: (i) acute care, (ii) long term care and (iii) home health care. The level of sophistication largely varies for each product, as some patients require simple foam mattress beds (“non-powered” support surfaces) while others may require electronically controlled, low air loss, lateral rotation, pulmonary therapy or alternating pressure surfaces (“powered” support surfaces). The design, engineering and manufacturing of all products are completed in-house (with the exception of PrimaTech products, which are manufactured in Taiwan) and are FDA compliant.
The table below summarizes the income from operations data for Tridien for the three and nine month periods ended September 30, 2011 and September 30, 2010.
47
Net sales for the three months ended September 30, 2011 increased approximately $0.4 million, or 2.7% compared to the corresponding three months ended September 30, 2010. Net sales of non-powered support surfaces and patient positioning devices totaled $11.9 million in the three months ended September 30, 2011 compared to $11.6 million during the same period in 2010, an increase of $0.3 million or 3.2%. Net sales of powered products totaled $3.2 million during the three months ended September 30, 2011 compared to $3.1 million in the same period of 2010, an increase of $0.1 million, or 0.6%. Sales of non-powered support surfaces were greater in the third quarter of 2011 compared to the same period in 2010 due to timing of dormitory sales. The slight increase in powered sales during the third quarter of 2011 compared to 2010 is due to the launch of the new ST products.
Cost of sales increased approximately $0.9 million in the three months ended September 30, 2011 compared to the same period of 2010. Gross profit as a percentage of sales was 26.8% in the three months ended September 30, 2011 compared to 30.8% in the corresponding period in 2010. The decrease in gross profit as a percentage of sales of 4.0% in 2011 is principally due to selling price concessions made to customers in 2011 in exchange for long term purchase commitments (3.0%), increases in foam costs (0.4%), one time start-up costs associated with opening a new production facility (0.2%) and an unfavorable product mix.
Selling, general and administrative expense for the three months ended September 30, 2011 increased marginally compared to the same period of 2010. This increase is principally the result of increased spending on infrastructure, marketing and sales support in an effort to spur positive growth activity in both powered and non-powered product revenue. Selling, general and administrative expense as a percentage of net sales was approximately 13.0% for both the three months ended September 30, 2011 and 2010.
Income from operations decreased approximately $0.5 million to $1.7 million for the nine months ended September 30, 2011 compared to $2.2 million in the nine months ended September 30, 2010, due principally to those factors described above.
Net sales for the nine months ended September 30, 2011 decreased approximately $3.9 million or 8.3% compared to the corresponding nine months ended September 30, 2010. Net sales of non-powered support surfaces and patient positioning devices totaled $34.5 million in 2011 compared to $35.8 million during the same period in 2010, a decrease of $1.3 million or 3.7%. Net sales of powered products totaled $8.5 million during the nine months ended September 30, 2011 compared to $10.4 million in the same period of 2010, a decrease of $1.9 million or 18.7%. Sales of non-powered support surfaces were lower for the nine months ended September 30, 2011 compared to the same period in 2010 as the result of higher than normal sales in 2010 as a result of sales to one customer who was replacing product manufactured by another company with a product manufactured by Tridien, combined with price concessions granted to certain customers in 2011 compared to 2010 in exchange for long term purchase commitments. The significant decrease in powered product sales, totaling $2.0 million, during the nine months ended September 30, 2011 compared to the same period of 2010 is the result of the loss of a large customer during the period combined with the timing of capital purchases of powered products by our remaining large customers.
Cost of sales decreased approximately $0.6 million in the nine months ended September 30, 2011 compared to the same period of 2010 primarily as a result of the decrease in sales. Gross profit as a percentage of sales was 26.8% in the nine months ended September 30, 2011 compared to 31.5% in the corresponding period in 2010. The decrease in gross profit as a percentage of sales of 4.7% in 2011 is principally due to increases in foam costs (0.4%), the major component in non-powered products, selling price concessions made to customers in 2011 in exchange for long term purchase commitments (3.1%), one time start-up costs associated with opening a new production facility (0.5%), the negative impact in labor and overhead absorption rates resulting from a decrease in production volume (0.3%) and an unfavorable product mix.
Selling, general and administrative expense for the nine months ended September 30, 2011 increased approximately $0.7 million compared to the same period of 2010. This increase is principally the result of increased spending on infrastructure, marketing and sales support in an effort to spur positive growth activity in both powered and non-powered product revenue.
48
Income from operations decreased approximately $3.8 million to $4.0 million for the nine months ended September 30, 2011 compared to $7.8 million in the nine months ended September 30, 2010, due principally to those factors described above.
Liquidity and Capital Resources
For the nine months ended September 30, 2011, on a consolidated basis, cash flows provided by operating activities totaled approximately $57.8 million, which represents a $29.0 million increase in cash provided by operations compared to the nine months ended September 30, 2010. This increase is the result of operating cash generated at our business segments, specifically, Staffmark ($21.9 million), Advanced Circuits, ($15.2 million), Fox ($6.5 million) and Liberty ($6.9 million). In each case, with the exception of Liberty, the majority of the operating cash was used to pay down their intercompany loans. Liberty used the cash generated by operations to fund the expansion of its production lines.
Cash flows used in investing activities totaled approximately $273.5 million for the nine months ended September 30, 2011, which reflects the cash expenditure associated with acquiring CamelBak of $258.6 million, maintenance capital expenditures of approximately $7.5 million and growth capital expenditures totaling $7.5 million, which includes approximately $6.6 million in costs associated with Liberty’s new production line. The growth capital expenditures were primarily incurred at Liberty Safe and Fox.
Cash flows provided by financing activities totaled approximately $212.7 million for the nine months ended September 30, 2011, principally reflecting net borrowings under our Revolving Credit Facility and Term Loan Facility totaling $196.5 million, proceeds from common stock sales of $19.7 million and the sale of preferred stock at CamelBak totaling $45.0 million, all in connection with the acquisition of CamelBak, offset by distributions paid to shareholders during the year totaling approximately $49.5 million. The sale of our common stock was to CGI Magyar, our largest shareholder and the sale of CamelBak preferred stock was to an affiliate of CGI Magyar.
At September 30, 2011, we had approximately $10.6 million of cash and cash equivalents on hand. The majority of our cash is invested in short-term money market accounts or resides in interest free checking accounts, and is maintained in accordance with the Company’s investment policy, which identifies allowable investments and specifies credit quality standards.
As of September 30, 2011, we had the following outstanding loans due from each of our businesses:
Advanced Circuits — $70.8 million;
American Furniture — $20.1 million;
CamelBak — $140.0 million;
ErgoBaby — $44.1 million;
Fox — $28.1 million;
HALO — $45.2 million;
Liberty — $40.5 million;
Staffmark — $55.3 million; and
Tridien — $3.2 million.
Each loan has a scheduled maturity and each business is entitled to repay all or a portion of the principal amount of the outstanding loans, without penalty, prior to maturity. As of September 30, 2011, American Furniture was not in compliance with its Maintenance Fixed Charge Coverage Ratio requirement included in the amended credit agreement with us dated December 31, 2010. We are required to fund, in the form of an additional equity investment, any shortfall in the difference between Adjusted EBITDA and Fixed Charges as defined in American Furniture’s credit agreement with us. Per the maintenance agreement, the shortfall that we are required to fund, AFM is in turn required to pay down on its term debt with us. The amount of the shortfall at September 30, 2011 is approximately $0.7 million.
Our primary source of cash is from the receipt of interest and principal on the outstanding loans to our businesses. Accordingly, we are dependent upon the earnings of and cash flow from these businesses, which are available for (i) operating expenses; (ii) payment of principal and interest under our Credit Agreement; (iii) payments to CGM due pursuant to the Management Services Agreement, the LLC Agreement, and the Supplemental Put Agreement; (iv) cash distributions to our shareholders; and (v) investments in future acquisitions. Payments made under (iii) above are required to be paid before distributions to shareholders and may be significant and exceed the funds held by us, which may require us to dispose of assets or incur debt to fund such expenditures.
49
We incurred non-cash charges to earnings of approximately $6.1 million during the nine months ended September 30, 2011 in order to recognize an increase in our estimated liability in connection with the Supplemental Put Agreement between us and CGM. A non-current liability of approximately $43.8 million is reflected in our condensed consolidated balance sheet, which represents our estimated liability for this obligation at September 30, 2011.
The following table provides the contribution-based profit for each of the businesses we control at September 30, 2011 and the respective quarter end in which each five year anniversary occurs, reconciled to the total supplemental put liability:
Advanced Circuits(1)
Total contribution-based profit portion
Estimated gain on sale portion
Total supplemental put liability
We believe that we currently have sufficient liquidity and resources to meet our existing obligations, including quarterly distributions to our shareholders, as approved by our board of directors, over the next twelve months. The quarterly distribution for the three months ended September 30, 2011 was paid on October 31, 2011 and was $17.4 million. We have considered the impact of recent market instability and credit availability in assessing the adequacy of our liquidity and capital resources.
On October 17, 2011 we sold our majority interest in Staffmark for a total enterprise value of $295 million. At the closing, we received approximately $220 million in cash in respect of our debt and equity interests in Staffmark and for the payment of accrued interest and fees after payments to non-controlling shareholders and payment of all transaction expenses. The net proceeds were used to repay substantially all of the outstanding debt under our Revolving Credit Facility. In addition, Staffmark is expected to receive a tax refund of approximately $5 million from the recording of transaction expenses incurred in connection with the transaction, which refund, according to the terms of the Stock Purchase Agreement, will be distributed upon receipt to the Company and each other shareholder of Staffmark who sold shares of Staffmark. The profit allocation due to the Company’s Manager for this sale is estimated to range from $11 million to $15 million, which is expected to be paid in the first quarter of 2012 and which amount has been previously expensed and reflected in our supplemental put accrual. We anticipate that we will recognize a gain of between $75 million and $90 million for the fiscal quarter ending December 31, 2011 as a result of the sale of Staffmark.
On October 27, 2011, we entered into a new $515 million credit facility, with an optional $135 million increase, from a group of lenders that replaced our existing Credit Agreement. The Credit Facility provides for (i) a revolving line of credit of $290 million, and (ii) a $225 million term loan. The term loans were issued at an original issuance discount of 96%. The New Term Loan Facility requires quarterly payments of approximately $0.56 million commencing March 31, 2012 with a final payment of all remaining principal and interest due in October 2017. All amounts outstanding under the New Revolving Credit Facility will become due in October 2016. The New Credit Facility also permits us to increase the Revolving Loan Commitment and/or obtain additional term loans in an aggregate amount of up to $135 million, subject to certain restrictions, lender approval and market demand. The proceeds of the New Term Loan Facility and advances under the New Revolving Credit Facility were, or will be, as applicable, used (i) to refinance certain existing indebtedness of the Company pursuant to its prior Credit Agreement, originally dated as of November 21, 2006, as amended, (ii) to pay fees and expenses arising in connection with the New Credit Facility, (iii) to fund acquisitions of additional businesses, (iv) to fund permitted distributions, (v) to fund loans to our subsidiaries and (vi) for other general corporate purposes.
50
Advances under the New Revolving Line of Credit can be either base rate loans or LIBOR loans. Base rate revolving loans bear interest at a fluctuating rate per annum equal to the greatest of (i) the prime rate of interest quoted by the Agent, (ii) the sum of the Federal Funds Rate plus 0.5% for the relevant period and (iii) the sum of the applicable LIBOR rate plus 1.00%, plus a margin ranging from 2.00% to 3.00% based upon the ratio of total debt to adjusted consolidated earnings before interest expense, tax expense, and depreciation and amortization expenses for such period LIBOR loans bear interest at a fluctuating rate per annum equal to the LIBOR Rate for the relevant period plus a margin ranging from 3.00% to 4.00% based on the Total Debt to EBITDA Ratio. Base rate borrowings under the prior Revolving Credit Facility were at margins ranging from 1.5% to 2.5% and LIBOR borrowings under the prior Revolving Credit Facility were at margins ranging from 2.5% to 3.5%.
The New Term Loan Facility bears interest at a combination of a variable LIBOR rate for the relevant period plus 6.00% for the portion of the term loan comprised of LIBOR loans and a fluctuating rate per annum equal to the greatest of (i) the prime rate of interest quoted by the Agent, (ii) the sum of the Federal Funds Rate plus 0.5% for the relevant period, (iii) the sum of the applicable LIBOR rate plus 1.00% and (iv) 2.50%, plus 5.00% for the portion of the term loan comprised of base rate loans. The LIBOR rate for term loans is subject to a minimum rate of 1.5%. The prior Term Loan Facility bore interest at base rate plus 3% and LIBOR plus 4%.
We are required to pay (i) commitment fees equal to 1% per annum of the unused portion of the Revolving Loan Commitment, (ii) quarterly letter of credit fees equal to the Applicable LIBOR Margin for loans under the New Revolving Line of Credit multiplied by the sum of the maximum aggregate amount available for drawing under a letter of credit plus the aggregate amount of all unreimbursed payments and disbursements under such letter of credit, (iii) letter of credit fronting fees of up to 0.25% per annum and (iv) administrative and agency fees. Upon execution of the New Credit Facility, we paid approximately $6.6 million to the Agent and Lenders for administrative and closing fees.
The New Credit Facility provides for a sub-facility under the New Revolving Line of Credit pursuant to which letters of credit may be issued in an aggregate amount not to exceed $100 million outstanding at any time. At no time may the (i) aggregate principal amount of all amounts outstanding under the Revolving Line of Credit, plus (ii) the aggregate amount of all outstanding letters of credit, exceed the Revolving Loan Commitment. At September 30, 2011 we had $70.2 million in outstanding letters of credit and as of October 17, 2011 (after the Staffmark sale) we had $2.9 million in outstanding letters of credit.
51
Reconciliation of Non-GAAP Financial Measures
From time to time we may publicly disclose certain “non-GAAP” financial measures in the course of our investor presentations, earnings releases, earnings conference calls or other venues. A non-GAAP financial measure is a numerical measure of historical or future performance, financial position or cash flow that excludes amounts, or is subject to adjustments that effectively exclude amounts, included in the most directly comparable measure calculated and presented in accordance with GAAP in our financial statements, and vice versa for measures that include amounts, or are subject to adjustments that effectively include amounts, that are excluded from the most directly comparable measure as calculated and presented. GAAP refers to generally accepted accounting principles in the United States.
Non-GAAP financial measures are provided as additional information to investors in order to provide them with an alternative method for assessing our financial condition and operating results. These measures are not meant to be a substitute for GAAP, and may be different from or otherwise inconsistent with non-GAAP financial measures used by other companies.
The tables below reconcile the most directly comparable GAAP financial measures to EBITDA, Adjusted EBITDA and Cash Flow Available for Distribution and Reinvestment (“CAD”).
Reconciliation of Net income (loss) to EBITDA and Adjusted EBITDA
EBITDA – Earnings before Interest, Income Taxes, Depreciation and Amortization (“EBITDA”) is calculated as net income (loss) before interest expense, income tax expense (benefit), depreciation expense and amortization expense. Amortization expenses consist of amortization of intangibles and debt charges, including debt issuance costs, discounts, etc.
Adjusted EBITDA – Is calculated utilizing the same calculation as described above in arriving at EBITDA further adjusted by: (i) non-controlling stockholder compensation, which generally consists of non-cash stock option expense; (ii) successful acquisition costs, which consist of transaction costs (legal, accounting, due diligences, etc.) incurred in connection with the successful acquisition of a business expensed during the period in compliance with ASC 805;(iii) increases or decreases in supplemental put charges, which reflect the estimated potential liability due to our manager that requires us to acquire their Allocation Interests in the Company at a price based on a percentage of the fair value in our businesses over their original basis plus a hurdle rate. Essentially, when the fair value of our businesses increases we will incur additional supplemental put charges and vice versa when the fair value of our businesses decreases; (iv) management fees, which reflect fees due quarterly to our manager in connection with our Management Services Agreement (“MSA”); (v) impairment charges, which reflect write downs to goodwill or other intangible assets and (vi) gains or losses recorded in connection with the sale of fixed assets.
We believe that EBITDA andAdjusted EBITDA provide useful information to investors and reflect important financial measures as they exclude the effects of items which reflect the impact of long-term investment decisions, rather than the performance of near term operations. When compared to net income (loss) these financial measures are limited in that they do not reflect the periodic costs of certain capital assets used in generating revenues of our businesses or the non-cash charges associated with impairments. This presentation also allows investors to view the performance of our businesses in a manner similar to the methods used by us and the management of our businesses provides additional insight into our operating results and provides a measure for evaluating targeted businesses for acquisition.
We believe these measurements are also useful in measuring our ability to service debt and other payment obligations. EBITDA and Adjusted EBITDA are not meant to be a substitute for GAAP, and may be different from or otherwise inconsistent with non-GAAP financial measures used by other companies.
52
The following table reconciles EBITDA and Adjusted EBITDA to net income (loss), which we consider to be the most comparable GAAP financial measure (in thousands):
Adjusted EBITDA
Nine-months ended September 30, 2011
Adjusted for:
Provision (benefit) for income taxes
Intercompany interest
Depreciation and amortization
EBITDA
(Gain) loss on sale of fixed assets
Non-controlling stockholder compensation
Acquisition charges
Impairment charges
Decrease in earnout probability
Supplemental put
Nine-months ended September 30, 2010
Acquisition expenses
Increase in earnout probability
53
The table below details cash receipts and payments that are not reflected on our income statement in order to provide an additional measure of management’s estimate of CAD. CAD is a non-GAAP measure that we believe provides additional information to evaluate our ability to make anticipated quarterly distributions. It is not necessarily comparable with similar measures provided by other entities. We believe that CAD, together with future distributions and cash available from our businesses (net of reserves) will be sufficient to meet our anticipated distributions over the next twelve months. The table below reconciles CAD to net income and to cash flow provided by operating activities, which we consider to be the most directly comparable financial measure calculated and presented in accordance with GAAP.
Adjustment to reconcile net income (loss) to cash provided by operating activities:
Noncontrolling interests and noncontrolling stockholders charges
Changes in operating assets and liabilities
Plus:
Unused fee on revolving credit facility (1)
Successful acquisition expense (2)
Less:
Maintenance capital expenditures: (3)
Compass Group Diversified Holdings LLC
ERGO baby
Halo
Estimated cash flow available for distribution and reinvestment
Distribution paid in March 2011 and April 2010
Distribution paid in July 2011/2010
Distribution paid in October 2011/2010
Cash flows of certain of our businesses are seasonal in nature. Cash flows from American Furniture are typically highest in the months of January through April coinciding with income tax refunds. Cash flows from Staffmark are typically lower in the first quarter of each year than in other quarters due to: (i) reduced seasonal demand for temporary staffing services and (ii) lower gross margins earned during that period due to the front-end loading of certain payroll taxes and other costs associated with payroll paid to our employees. Cash flows from HALO are typically highest in the months of September through December of each year primarily as the result of calendar sales and holiday promotions. HALO generates approximately two-thirds of its operating income in the months of September through December. Revenue and earnings from Fox are typically highest in the third quarter, coinciding with the delivery of product for the new bike year. Earnings from Liberty are typically lowest in the second quarter due to lower demand for safes at the onset of summer. Earnings from CamelBak are typically higher in the spring and summer months than other months as this corresponds with warmer weather in the northern hemisphere and an increase in hydration related activities.
54
Contractual Obligations and Off-Balance Sheet Arrangements
We have no special purpose entities or off-balance sheet arrangements, other than operating leases entered into in the ordinary course of business.
Long-term contractual obligations, except for our long-term debt obligations, are generally not recognized in our consolidated balance sheet. Non-cancelable purchase obligations are obligations we incur during the normal course of business, based on projected needs.
The table below summarizes the payment schedule of our contractual obligations at September 30, 2011:
Long-term debt obligations (a)
Capital lease obligations
Operating lease obligations (b)
Purchase obligations (c)
Supplemental put obligation (d)
The table does not include the long-term portion of the actuarially developed reserve for workers compensation, included as a component of long-term liabilities, which does not provide for annual estimated payments beyond one year.
Critical Accounting Estimates
The preparation of our financial statements in conformity with GAAP requires management to adopt accounting policies and make estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates under different assumptions and judgments and uncertainties, and potentially could result in materially different results under different conditions. These critical accounting estimates are reviewed periodically by our independent auditors and the audit committee of our board of directors.
We conducted our annual goodwill impairment testing as of March 31, 2011. At each of our reporting units tested, the units’ fair value exceeded carrying value with the exception of American Furniture. The carrying amount of American Furniture exceeded its fair value due to the significant decrease in revenue and operating profit at American Furniture resulting from the negative impact on the promotional furniture market due to the significant decline in the U.S. housing market, high unemployment rates and aggressive pricing employed by our competitors. As a result of the carrying amount of goodwill exceeding its fair value, we recorded a $5.9 million impairment charge as of March 31, 2011 which represented the remaining balance of goodwill on American Furniture’s balance sheet. We recorded a goodwill impairment charge totaling $35.5 million in the third quarter of 2010.
55
Of the remaining seven reporting units as of March 31, 2011 the fair value of one of the reporting units was not substantially in excess of its carrying value. Information from step-one of the impairment test for this reporting unit is as follows:
A one percent increase in the discount rate, from 13% to 14%, would have impacted the fair value of HALO by approximately $5.0 million and would have required us to perform a step-two analysis that may have resulted in an impairment charge for HALO as of March 31, 2011. Factors that could potentially trigger a subsequent interim impairment review in the future and possible impairment loss at our HALO reporting unit include significant underperformance relative to future operating results or significant negative industry or economic trends.
Other than described above, the estimates employed and judgment used in determining critical accounting estimates have not changed significantly from those disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K, for the year ended December 31, 2010, as filed with the SEC.
Recent Accounting Pronouncements
Refer to footnote C to our condensed consolidated financial statements.
56
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The quantitative and qualitative disclosures about market risk required by this item have not changed materially from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010 as filed with the SEC on March 10, 2011. For a discussion of our exposure to market risk, refer to Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk,” contained in our Annual Report on Form 10-K for the year ended December 31, 2010.
ITEM 4. - CONTROLS AND PROCEDURES
As required by Exchange Act Rule 13a-15(b), Holding’s Regular Trustees and the Company’s management, including the Chief Executive Officer and Chief Financial Officer of the Company, conducted an evaluation of the effectiveness of Holdings’ and the Company’s disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), as of September 30, 2011. Based on that evaluation, the Regular Trustees of Holdings’ and the Chief Executive Officer and Chief Financial Officer of the Company concluded that Holdings’ and the Company’s disclosure controls and procedures were effective as of September 30, 2011.
In the third quarter of 2011, the Company acquired CamelBak (see Note D- Acquisition of Business to our Condensed Consolidated Financial Statements), which represented 21.8% of our total assets as of September 30, 2011. The Company is in the process of fully integrating CamelBak into its internal controls over financial reporting and, in reliance on interpretive guidance issued by the SEC staff, disclosure of changes in internal control over financial reporting related to CamelBak has been excluded. Other than as described above, in connection with the evaluation required by Exchange Act Rule 13a-15(d), Holding’s Regular Trustees and the Company’s management, including the Chief Executive Officer and Chief Financial Officer of the Company, concluded that no changes in Holdings’ or the Company’s internal control over financial reporting occurred during the third quarter of 2011 that have materially affected, or are reasonably likely to materially affect, Holdings’ and the Company’s internal control over financial reporting.
57
PART II
OTHER INFORMATION
Legal proceedings associated with the Company’s and Holdings’ business together with legal proceedings for the businesses have not changed materially from those disclosed in Part I, Item 3 of our 2010 Annual Report on Form 10-K as filed with the SEC on March 10, 2011.
Risk factors and uncertainties associated with the Company’s and Holdings’ business have not changed materially from those disclosed in Part I, Item 1A of our 2010 Annual Report on Form 10-K as filed with the SEC on March 10, 2011.
58
ExhibitNumber
Description
59
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ James J. Bottiglieri
Date: November 8, 2011
60
Chief Financial Officer
(Principal Financial and Accounting Officer)
61
EXHIBIT INDEX
62