Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

Or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

 

 

COMPASS DIVERSIFIED HOLDINGS

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   001-34927   57-6218917

(State or other jurisdiction of

incorporation or organization)

  (Commission file number)  

(I.R.S. employer

identification number)

 

 

COMPASS GROUP DIVERSIFIED HOLDINGS LLC

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   001-34926   20-3812051

(State or other jurisdiction of

incorporation or organization)

  (Commission file number)  

(I.R.S. employer

identification number)

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

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨      Smaller Reporting Company   ¨

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, 2012, there were 48,300,000 shares of Compass Diversified Holdings outstanding.

 

 

 


Table of Contents

COMPASS DIVERSIFIED HOLDINGS

QUARTERLY REPORT ON FORM 10-Q

For the period ended September 30, 2012

TABLE OF CONTENTS

 

     Page
Number
 
 

Forward-looking Statements

     4   

Part I

 

Financial Information

  

Item 1.

 

Financial Statements:

  
 

Condensed Consolidated Balance Sheets as of September 30, 2012 (unaudited) and December 31, 2011

     5   
 

Condensed Consolidated Statements of Operations for the three and nine months ended September  30, 2012 and 2011 (unaudited)

     6   
 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2012 and 2011 (unaudited)

     7   
 

Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September  30, 2012 (unaudited)

     8   
 

Condensed Consolidated Statements of Cash Flows for the nine months ended September  30, 2012 and 2011 (unaudited)

     9   
 

Notes to Condensed Consolidated Financial Statements (unaudited)

     10   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     28   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     58   

Item 4.

 

Controls and Procedures

     58   

Part II

 

Other Information

  

Item 1.

 

Legal Proceedings

     59   

Item 1A.

 

Risk Factors

     59   

Item 6.

 

Exhibits

     60   

Signatures

       61   

Exhibit Index

       63   

 

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Table of Contents

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. (“ACI” or “Advanced Circuits”) and Silvue Technologies Group, Inc.;

 

   

the “2011 acquisition” refer to the acquisition of CamelBak Products, LLC (“CamelBak”);

 

   

the “2012 acquisition” refer to the acquisition of Arnold Magnetic Technologies Holdings Corporation (“Arnold” or “Arnold Magnetics”);

 

   

the “Trust Agreement” refer to the amended and restated Trust Agreement of the Trust dated as of November 1, 2010;

 

   

the “Credit Facility” refer to a credit agreement (as amended) with a group of lenders led by Toronto Dominion (Texas) LLC, as agent, which provides for the Revolving Credit Facility and the Term Loan Facility;

 

   

the “Revolving Credit Facility” refer to the $290 million Revolving Credit Facility provided by the Credit Facility that matures in October 2016;

 

   

the “Term Loan Facility” refer to the $253.2 million Term Loan Facility, as of September 30, 2012, provided by the Credit Facility that matures in October 2017;

 

   

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


Table of Contents

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 on Form 10-Q. 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.

 

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PART I

FINANCIAL INFORMATION

ITEM 1. – FINANCIAL STATEMENTS

Compass Diversified Holdings

Condensed Consolidated Balance Sheets

 

(in thousands )    September 30,
2012
    December 31,
2011
 
     (unaudited)        

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 19,989      $ 131,973   

Accounts receivable, less allowances of $3,588 at September 30, 2012 and $2,420 at December 31, 2011

     119,532        69,114   

Inventories

     135,499        96,312   

Prepaid expenses and other current assets

     20,949        22,758   

Current assets of discontinued operations

     —          40,064   
  

 

 

   

 

 

 

Total current assets

     295,969        360,221   

Property, plant and equipment, net

     63,733        43,579   

Goodwill

     257,014        205,567   

Intangible assets, net

     348,218        328,070   

Deferred debt issuance costs, less accumulated amortization of $1,553 at September 30, 2012 and $227 at December 31, 2011

     8,748        6,942   

Other non-current assets

     16,129        13,889   

Non-current assets of discontinued operations

     —          71,638   
  

 

 

   

 

 

 

Total assets

   $ 989,811      $ 1,029,906   
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 64,028      $ 36,612   

Accrued expenses

     50,186        36,386   

Due to related party

     3,950        4,239   

Current portion of supplemental put obligation

     5,200        13,675   

Current portion, long-term debt

     2,550        2,250   

Other current liabilities

     1,955        1,694   

Current liabilities of discontinued operations

     —          23,306   
  

 

 

   

 

 

 

Total current liabilities

     127,869        118,162   

Supplemental put obligation

     37,005        35,814   

Deferred income taxes

     63,723        49,088   

Long-term debt, less original issue discount

     262,285        214,000   

Other non-current liabilities

     7,536        2,875   

Non-current liabilities of discontinued operations

     —          13,489   
  

 

 

   

 

 

 

Total liabilities

     498,418        433,428   

Stockholders’ equity

    

Trust shares, no par value, 500,000 authorized; 48,300 shares issued and outstanding at September 30, 2012 and December 31, 2011

     648,036        658,361   

Accumulated other comprehensive loss

     (363     —     

Accumulated deficit

     (211,177     (160,852
  

 

 

   

 

 

 

Total stockholders’ equity attributable to Holdings

     436,496        497,509   

Noncontrolling interest

     54,897        95,257   

Noncontrolling interest of discontinued operations

     —          3,712   
  

 

 

   

 

 

 

Total stockholders’ equity

     491,393        596,478   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 989,811      $ 1,029,906   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

Compass Diversified Holdings

Condensed Consolidated Statements of Operations

(unaudited)

 

     Three months ended September 30,     Nine months ended September 30,  
     2012     2011     2012     2011  
(in thousands, except per share data)                         

Net sales

   $ 241,228      $ 168,667      $ 666,571      $ 446,451   

Cost of sales

     164,281        117,837        455,036        311,168   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     76,947        50,830        211,535        135,283   

Operating expenses:

        

Selling, general and administrative expense

     39,422        30,395        119,756        77,347   

Supplemental put expense

     5,029        1,200        6,391        6,095   

Management fees

     4,429        4,792        13,294        11,707   

Amortization expense

     7,699        5,509        22,639        14,943   

Impairment expense

     —          —          —          7,700   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     20,368        8,934        49,455        17,491   

Other income (expense):

        

Interest income

     8        2        51        4   

Interest expense

     (5,924     (2,156     (19,660     (6,105

Amortization of debt issuance costs

     (485     (542     (1,326     (1,543

Other income (expense), net

     173        (78     (223     (78
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     14,140        6,160        28,297        9,769   

Provision for income taxes

     7,361        3,090        17,119        9,380   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     6,779        3,070        11,178        389   

Income (loss) from discontinued operations, net of income tax

     —          9,400        (1,168     13,780   

Loss on sale of discontinued operations, net of income tax

     (334     —          (464     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     6,445        12,470        9,546        14,169   

Less: Income from continuing operations attributable to noncontrolling interest

     2,959        2,587        6,996        4,643   

Less: Income (loss) from discontinued operations attributable to noncontrolling interest

     —          1,787        (226     2,026   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Holdings

   $ 3,486      $ 8,096      $ 2,776      $ 7,500   
  

 

 

   

 

 

   

 

 

   

 

 

 

Amounts attributable to Holdings:

        

Income (loss) from continuing operations

   $ 3,820      $ 483      $ 4,182      $ (4,254

Income (loss) from discontinued operations, net of income tax

     —          7,613        (942     11,754   

Loss on sale of discontinued operations, net of income tax

     (334     —          (464     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Holdings

   $ 3,486      $ 8,096      $ 2,776      $ 7,500   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and fully diluted income (loss) per share attributable to Holdings

        

Continuing operations

   $ 0.08      $ 0.01      $ 0.09      $ (0.09

Discontinued operations

     (0.01     0.16        (0.03     0.25   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 0.07      $ 0.17      $ 0.06      $ 0.16   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of shares of trust stock outstanding — basic and fully diluted

     48,300        47,376        48,300        46,944   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash distributions declared per share (refer to Note L)

   $ 0.36      $ 0.36      $ 1.08      $ 1.08   
  

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Table of Contents

Compass Diversified Holdings

Condensed Consolidated Statements of Comprehensive Income (Loss)

(unaudited)

 

     Three months ended September 30,      Nine months ended September 30,  
     2012      2011      2012     2011  
(in thousands)                           

Net income

   $ 6,445       $ 12,470       $ 9,546      $ 14,169   

Other comprehensive income (loss), net of tax

          

Foreign currency translation adjustment

     424         —           (363     —     
  

 

 

    

 

 

    

 

 

   

 

 

 

Total comprehensive income, net of tax

   $ 6,869       $ 12,470       $ 9,183      $ 14,169   
  

 

 

    

 

 

    

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Compass Diversified Holdings

Condensed Consolidated Statement of Stockholders’ Equity

(unaudited)

 

(in thousands)   Number of
Shares
    Amount     Accumulated
Deficit
    Accumulated
Other
Comprehensive
Loss
    Stockholders’
Equity
Attributable
to Holdings
    Non-
Controlling
Interest
    Non-
Controlling
Interest

of Disc.  Ops.
    Total
Stockholders’
Equity
 

Balance — January 1, 2012

    48,300      $ 658,361      $ (160,852   $ —        $ 497,509      $ 95,257      $ 3,712      $ 596,478   

Net income (loss)

    —          —          2,776        —          2,776        6,996        (226     9,546   

Other comprehensive loss — foreign currency translation

    —          —          —          (363     (363     —          —          (363

Proceeds received from Arnold noncontrolling shareholders

    —          —          —          —          —          1,713        —          1,713   

Proceeds received from noncontrolling shareholders

    —          —          —          —          —          2,916        —          2,916   

Distribution to noncontrolling shareholders related to the Fox recapitalization (refer to Note F)

    —          (8,544     —          —          (8,544     (6,555     —          (15,099

Accretion — CamelBak preferred stock

    —          —          (937     —          (937     937        —          —     

Redemption of noncontrolling interest holders

    —          (1,781     —          —          (1,781     (1,578     —          (3,359

Redemption of CamelBak preferred stock

    —          —          —          —          —          (48,022     —          (48,022

Option activity attributable to noncontrolling shareholders

    —          —          —          —          —          3,233        —          3,233   

HALO disposition

    —          —          —          —          —          —          (3,486     (3,486

Distributions paid

    —          —          (52,164     —          (52,164     —          —          (52,164
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance — September 30, 2012

    48,300      $ 648,036      $ (211,177   $ (363   $ 436,496      $ 54,897      $ —        $ 491,393   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Compass Diversified Holdings

Condensed Consolidated Statements of Cash Flows

(unaudited)

 

     Nine months ended September 30,  
(in thousands)    2012     2011  

Cash flows from operating activities:

    

Net income

   $ 9,546      $ 14,169   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation expense

     10,771        7,329   

Amortization expense

     27,102        26,024   

Impairment expense

     —          7,700   

Amortization of debt issuance costs and original issue discount

     3,277        1,543   

Supplemental put expense

     6,391        6,095   

Unrealized loss on interest rate swap

     2,108        —     

Noncontrolling stockholder charges and other

     3,250        2,210   

Deferred taxes

     (2,315     (5,687

Other

     1,399        1,036   

Changes in operating assets and liabilities, net of acquisition:

    

Increase in accounts receivable

     (22,898     (23,229

Increase in inventories

     (22,563     (146

Increase in prepaid expenses and other current assets

     (1,674     (806

Increase in accounts payable and accrued expenses

     20,661        28,451   

Payment of supplemental put liability

     (13,675     (6,892
  

 

 

   

 

 

 

Net cash provided by operating activities

     21,380        57,797   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Acquisitions, net of cash acquired

     (125,434     (258,559

Purchases of property and equipment

     (9,718     (15,099

Proceeds released from escrow related to Staffmark sale

     5,045        —     

Proceeds related to HALO sale

     66,473        —     

Purchase of noncontrolling interest

     (15,128     —     

Other investing activities

     974        140   
  

 

 

   

 

 

 

Net cash used in investing activities

     (77,788     (273,518
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from the issuance of Trust shares, net

     —          19,684   

Borrowings under Credit Facility

     169,500        270,000   

Repayments under Credit Facility

     (122,867     (73,500

Proceeds from issuance of CamelBak preferred stock

     —          45,000   

Redemption of CamelBak preferred stock

     (48,022     —     

Distributions paid

     (52,164     (49,529

Net proceeds provided by noncontrolling shareholders

     11,833        2,016   

Net proceeds paid to noncontrolling shareholders related to Fox

     (16,289     —     

Debt issuance costs

     (3,154     (593

Excess tax benefit on stock-based compensation

     5,755        —     

Other

     (366     (329
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (55,774     212,749   
  

 

 

   

 

 

 

Foreign currency impact on cash

     (199     —     

Net decrease in cash and cash equivalents

     (112,381     (2,972

Cash and cash equivalents — beginning of period

     132,370        13,536   
  

 

 

   

 

 

 

Cash and cash equivalents — end of period

   $ 19,989      $ 10,564   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

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Compass Diversified Holdings

Notes to Condensed Consolidated Financial Statements (unaudited)

September 30, 2012

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 eight businesses, or operating segments, at September 30, 2012. The operating segments are as follows: Compass AC Holdings, Inc. (“ACI” or “Advanced Circuits”), American Furniture Manufacturing, Inc. (“AFM” or “American Furniture”), Arnold Magnetic Technologies Holdings Corporation (“Arnold” or “Arnold Magnetics”) CamelBak Products, LLC (“CamelBak”), The ERGO Baby Carrier, Inc. (“ERGObaby”), Fox Factory, Inc. (“Fox”), Liberty Safe and Security Products, Inc. (“Liberty Safe” or “Liberty”), and Tridien Medical, Inc. (“Tridien”). Refer to Note F for further discussion of the operating segments.

Note B – Presentation and principles of consolidation

The condensed consolidated financial statements for the three and nine month periods ended September 30, 2012 and September 30, 2011, 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, 2011.

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. 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 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 amounts in the historical condensed consolidated financial statements have been reclassified to conform to the current period presentation. American Furniture implemented a revised standard costing system during 2011 which required American Furniture to reclassify certain costs between cost of sales and selling, general and administrative expenses. The change in format consists of reclassifying the trucking fleet expenses from selling, general and administrative expenses into cost of sales, as well as reclassifying certain manufacturing related expenses including rent, insurance, utilities and workers’ compensation from selling, general and administrative costs to cost of sales. Management believes that the format of reporting cost of sales going forward together with the revised standard costing system and the revaluation of standard costs will allow management to more timely react to changes in supply costs, product demand and overall price structure going forward which in turn should eliminate the accumulation of lower margin product and allow for more advantageous product procurement and the proper utilization of available assets. The reclassification from selling, general and administrative expense to cost of sales during the three and nine months ended September 30, 2011 was $1.5 million and $4.6 million, respectively. This reclassification lowered the historical gross profit recorded in these periods but had no net impact on operating income (loss) or net income (loss). In addition, this reclassification had no impact on the financial position or cash flows during these periods.

 

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Discontinued Operations

On May 1, 2012, the Company sold its majority owned subsidiary, HALO. As a result, the results of operations for the periods from January 1, 2012 through the date of sale and the three and nine months ended September 30, 2011, respectively, have been reclassified to exclude discontinued operations in accordance with accounting guidelines. In addition, HALO’s assets and liabilities have been reclassified as discontinued operations as of December 31, 2011. Refer to Note E for further discussion.

Note C – Recent accounting pronouncements

In July 2012, the Financial Accounting Standards Board (“FASB”) issued amended guidance for performing indefinite-lived intangible impairment tests, which will be effective for us January 1, 2013. It allows the Company to perform a qualitative assessment to determine whether further impairment testing of indefinite-lived intangible assets is necessary. The Company does not expect the adoption of the amended guidance will have a significant impact on the condensed consolidated financial statements.

In September 2011, the FASB issued amended guidance for performing goodwill impairment tests, which was effective for the Company beginning January 1, 2012. The guidance amended 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 adoption of the amended guidance did not have a significant impact on the condensed consolidated financial statements.

In June 2011, the FASB issued amended guidance for presenting comprehensive income, which was effective for the Company beginning January 1, 2012. The amended guidance eliminated the option to present other comprehensive income and its components in the statement of stockholders’ equity. The Company elected to present the items of net income and other comprehensive income in two separate, but consecutive statements. The adoption of the amended guidance did not 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 was 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 adoption of the amended guidance did not have a significant impact on the condensed consolidated financial statements.

Note D – Acquisition of business

Acquisition of Arnold Magnetics

On March 5, 2012, AMT Acquisition Corp. (“Arnold Acquisition”), a subsidiary of the Company, entered into a stock purchase agreement with Arnold Magnetic Technologies, LLC, and Arnold Magnetics pursuant to which Arnold Acquisition acquired all of the issued and outstanding equity of Arnold Magnetics.

Based in Rochester, NY with an operating history of more than 100 years, Arnold is a leading global manufacturer of engineered magnetic solutions for a wide range of specialty applications and end-markets, including energy, medical, aerospace and defense, consumer electronics, general industrial and automotive. From its nine manufacturing facilities located in the United States, the United Kingdom, Switzerland and China, Arnold produces high performance permanent magnets, flexible magnets and precision foil products that are mission critical in motors, generators, sensors and other systems and components. Based on its long-term relationships, Arnold has built a diverse and blue-chip customer base totaling more than 2,000 clients worldwide.

The Company made loans to and purchased a 96.6% controlling interest in Arnold on a primary and fully diluted basis. The purchase price, including proceeds from noncontrolling interests, was approximately $130.5 million (excluding acquisition-related costs). Acquisition related costs were approximately $4.8 million and were recorded to selling, general and administrative expense during the nine months ended September 30, 2012. The Company funded the acquisition through available cash on its balance sheet and a draw of $25 million on its Revolving Credit Facility. Arnold’s management and certain other investors invested in the transaction alongside the Company, collectively representing 3.4% initial noncontrolling interest on a primary and fully diluted basis. CGM acted as an advisor to the Company in the transaction and received fees and expense payments totaling approximately $1.2 million.

 

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The results of operations of Arnold have been included in the consolidated results of operations from the date of acquisition. Arnold’s results of operations are reported as a separate operating segment.

The table below includes the preliminary assets and liabilities assumed as of the acquisition date.

 

Arnold

(in thousands)

   Amounts
Recognized as
of Acquisition
Date
 

Assets:

  

Cash

   $ 6,965   

Accounts receivable, net (1)

     18,728   

Inventory (2)

     20,550   

Other current assets

     3,391   

Property, plant and equipment (3)

     20,805   

Intangible assets

     41,700   

Goodwill (4)

     51,441   

Other assets

     6,478   
  

 

 

 

Total assets

   $ 170,058   

Liabilities and noncontrolling interests:

  

Current liabilities

   $ 24,374   

Other liabilities

     98,417   

Noncontrolling interest (5)

     1,713   
  

 

 

 

Total liabilities and noncontrolling interest

   $ 124,504   

Net assets acquired

   $ 45,554   

Noncontrolling interest

     1,713   

Intercompany loans to businesses

     85,500   
  

 

 

 
   $ 132,767   
  

 

 

 

 

(1) Includes $19.1 million of gross contractual accounts receivable, of which $0.4 million was not expected to be collected. The fair value of accounts receivable approximated book value acquired.
(2) Includes $3.0 million of inventory fair value step up. This balance was fully amortized during the nine months ended September 30, 2012.
(3) Includes $13.8 million of property, plant and equipment fair value step up.
(4) Goodwill is not deductible for tax purposes.
(5) Fair value of noncontrolling interest approximates book value.

The intangible assets preliminarily recorded in connection with the Arnold Magnetics acquisition are as follows (in thousands):

 

Intangible assets

   Amount      Estimated
Useful Life

Customer relationships

   $ 22,770       15

Technology

     11,790       10

Technology

     1,260       7

Other

     90       less than one year

Trade name

     5,370       10

Trade name

     420       5
  

 

 

    
   $ 41,700      
  

 

 

    

Joint Venture

Arnold Magnetics is a 50% partner in a China rare earth mine-to-magnet joint venture. Arnold Magnetics accounts for its activity in the joint venture utilizing the equity method of accounting. Gains and losses from the joint venture are not material for the nine months ended September 30, 2012.

 

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Unaudited pro-forma information

The following unaudited pro-forma data for the nine months ended September 30, 2012 and 2011 gives effect to the acquisition of Arnold Magnetics, as described above, as if the acquisition had been completed as of January 1, 2011. 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.

 

     Nine months ended September 30,  
(in thousands)    2012      2011  

Net sales

   $ 689,820       $ 549,201   

Operating income

     50,869         23,172   

Net income

     9,923         15,250   

Net income attributable to Holdings

     3,153         8,581   

Basic and diluted net income attributable to Holdings

   $ 0.07       $ 0.18   

Other acquisition

On May 23, 2012, the Company’s subsidiary, Advanced Circuits, completed the acquisition of Universal Circuits, Inc. a manufacturer of printed circuit boards, for approximately $2.8 million. The manufacturing facility is located in Maple Grove, Minnesota. This acquisition expands ACI’s capabilities and provides immediate access to manufacturing capabilities of more advanced higher tech PCBs. The following is a preliminary summary of the assets and liabilities recorded in connection with this acquisition, pending finalization of the valuation efforts:

 

Assets:

  

Accounts receivable

   $ 2,304   

Inventory

     747   

Property, plant and equipment

     934   

Goodwill

     —     

Intangible asset, non-compete

     19   

Intangible asset, customer relationships

     393   
  

 

 

 

Total assets

   $ 4,397   

Liabilities:

  

Accounts payable and accrued expenses

   $ 2,282   

Note payable

     812   
  

 

 

 

Total liabilities

   $ 3,094   

Note E – Discontinued operations

On May 1, 2012, the Company sold its majority owned subsidiary HALO, to Candlelight Investment Holdings, Inc., for a total enterprise value of $76.5 million. The transaction is subject to customary escrow requirements and adjustment for certain changes in the working capital of HALO. The HALO purchase agreement contains customary representations, warranties, covenants and indemnification provisions.

At the closing, the Company received approximately $66.5 million in cash in respect of its debt and equity interests in HALO and for the payment of accrued interest and fees after payments to non-controlling shareholders and payment of all transaction expenses. The Company also subsequently received approximately $0.6 million of proceeds that were held in escrow. In addition, the Company expects to receive a tax refund of approximately $1.1 million resulting from the tax benefit of the transaction expenses incurred in connection with the transaction. The Company recognized a loss of $0.5 million for the nine months ended September 30, 2012 as a result of the sale of HALO. The net proceeds were used to repay outstanding debt under the Company’s Revolving Credit Facility.

 

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Summarized operating results for HALO for the three and nine months ended September 30, 2011, and January 1, 2012 through the date of disposition were as follows (in thousands):

 

     Three months
ended Sept. 30,
2011
     For the period
Jan. 1, 2012
through
disposition
    Nine months
ended Sept. 30,
2011
 

Net sales

   $ 43,651       $ 51,253      $ 115,633   
  

 

 

    

 

 

   

 

 

 

Operating income (loss)

     2,489         (2,141     4,919   

Income (loss) from continuing operations before income taxes

     2,488         (2,141     4,974   

Provision (benefit) for income taxes

     719         (973     969   
  

 

 

    

 

 

   

 

 

 

Income (loss) from discontinued operations (1)

   $ 1,769       $ (1,168   $ 4,005   
  

 

 

    

 

 

   

 

 

 

 

(1) 

The results for the periods from January 1, 2012 through disposition, the three months ended September 30, 2011, and the nine months ended September 30, 2011, exclude $0.7 million, $0.5 million and $1.6 million of intercompany interest expense, respectively.

Income from discontinued operations for the three and nine months ended September 30, 2011 on the condensed consolidated income statements also include $7.6 million and $9.8 million, respectively, of income from discontinued operations related to the Staffmark sale in October 2011.

The following table presents summary balance sheet information of HALO as of December 31, 2011 (in thousands):

 

     December 31,
2011
 

Assets:

  

Cash

   $ 397   

Accounts receivable, net

     30,275   

Inventories

     4,709   

Prepaid expenses and other current assets

     4,683   
  

 

 

 

Current assets of discontinued operations

   $ 40,064   
  

 

 

 

Property, plant and equipment, net

     1,656   

Goodwill

     39,773   

Intangible assets, net

     30,034   

Other non-current assets

     175   
  

 

 

 

Non-current assets of discontinued operations

   $ 71,638   
  

 

 

 

Liabilities:

  

Accounts payable

     14,014   

Accrued expenses and other current liabilities

     9,292   
  

 

 

 

Current liabilities of discontinued operations

   $ 23,306   
  

 

 

 

Deferred income taxes

     13,396   

Other non-current liabilities

     93   
  

 

 

 

Non-current liabilities of discontinued operations

   $ 13,489   
  

 

 

 
  
  

 

 

 

Noncontrolling interest of discontinued operations

   $ 3,712   
  

 

 

 

 

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Table of Contents

Note F – Operating segment data

At September 30, 2012, the Company had eight reportable operating segments. Each operating segment represents a platform 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 volume 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 most products 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.

 

   

Arnold Magnetics is a leading global manufacturer of engineered magnetic solutions for a wide range of specialty applications and end-markets, including energy, medical, aerospace and defense, consumer electronics, general industrial and automotive. Arnold Magnetics produces high performance permanent magnets, flexible magnets and precision foil products that are mission critical in motors, generators, sensors and other systems and components. Based on its long-term relationships, the company has built a diverse and blue-chip customer base totaling more than 2,000 clients worldwide. Arnold Magnetics is headquartered in Rochester, New York.

 

   

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, and a premium line of stroller travel systems. 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 Scotts Valley, California and its products are sold worldwide.

 

   

Liberty Safe is a designer, manufacturer and marketer of premium home and gun safes in North America. From it’s 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.

 

   

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 for each of the operating segments reconciled to amounts reflected in the consolidated financial statements. The operations of each of the operating segments are included in consolidated operating results as of their date of acquisition.

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 the Corporate and other line item. There were no significant inter-segment transactions.

 

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Table of Contents

A disaggregation of the Company’s consolidated revenue and other financial data for the three and nine months ended September 30, 2012 and 2011 is presented below (in thousan0ds):

 

Net sales of operating segments

   Three Months Ended September 30,      Nine Months Ended September 30,  
     2012      2011      2012      2011  

ACI

   $ 22,229       $ 19,592       $ 62,878       $ 59,905   

American Furniture

     20,728         23,695         72,359         83,112   

Arnold Magnetics

     31,951         —           75,787         —     

CamelBak

     36,672         16,059         121,140         16,059   

ERGObaby

     18,540         10,726         45,565         33,383   

Fox

     72,865         61,689         179,256         150,464   

Liberty

     23,385         21,786         67,000         60,611   

Tridien

     14,858         15,120         42,586         42,917   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     241,228         168,667         666,571         446,451   

Reconciliation of segment revenues to consolidated revenues:

           

Corporate and other

     —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total consolidated revenues

   $ 241,228       $ 168,667       $ 666,571       $ 446,451   
  

 

 

    

 

 

    

 

 

    

 

 

 

International Revenues

Revenues from geographic locations outside the United States were not material for any operating segment, except Fox, ERGObaby, CamelBak and Arnold, in each of the periods presented. Fox recorded net sales to locations outside the United States, principally Europe and Asia, of $50.2 million and $42.4 million for the three months ended September 30, 2012 and 2011, respectively, and $113.7 million and $100.7 million for the nine months ended September 30, 2012 and 2011, respectively. ERGObaby recorded net sales to locations outside the United States of $11.2 million and $6.4 million for the three months ended September 30, 2012 and 2011, respectively, and $26.7 million and $21.5 million for the nine months ended September 30, 2012 and 2011, respectively. CamelBak recorded net sales to locations outside the United States of $5.2 million and $20.4 million for the three and nine months ended September 30, 2012. CamelBak recorded net sales to locations outside the United States of $2.1 million for the three and nine months ended September 30, 2011. Arnold Magnetics recorded net sales to locations outside the United States of $13.9 million and $44.0 million for the three and nine months ended September 30, 2012. There were no significant inter-segment transactions.

 

Profit (loss) of operating segments (1)

   Three Months Ended September 30,     Nine Months Ended September 30,  
     2012     2011     2012     2011  

ACI

   $ 6,273      $ 6,609      $ 18,349      $ 20,496   

American Furniture (2)

     (581     (2,510     (1,032     (12,105

Arnold Magnetics (3)

     2,031        —          (1,795     —     

CamelBak

     5,085        (3,808     21,105        (3,808

ERGObaby

     4,240        2,547        7,905        7,132   

Fox

     10,991        10,017        22,137        19,643   

Liberty

     2,051        1,457        4,268        3,370   

Tridien

     1,130        1,669        3,054        4,011   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

     31,220        15,981        73,991        38,739   

Reconciliation of segment profit to consolidated income from continuing operations before income taxes:

        

Interest expense, net

     (5,916     (2,154     (19,609     (6,101

Other income (expense), net

     173        (78     (223     (78

Corporate and other (4)

     (11,337     (7,589     (25,862     (22,791
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consolidated income from continuing operations before income taxes

   $ 14,140      $ 6,160      $ 28,297      $ 9,769   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Segment profit (loss) represents operating income (loss).
(2) Includes $7.7 million of goodwill and intangible asset impairment charges during the nine months ended September 30, 2011.
(3) Includes acquisition-related costs in connection with the acquisition of Arnold expensed in accordance with acquisition accounting.
(4) Includes fair value adjustments related to the supplemental put liability.

 

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Table of Contents

 

Accounts receivable

   Accounts
Receivable
September 30, 2012
    Accounts
Receivable
December 31, 2011
 

ACI

   $ 6,960      $ 5,102   

American Furniture

     11,991        10,306   

Arnold Magnetics

     19,231        —     

CamelBak

     23,436        17,111   

ERGObaby

     6,722        2,867   

Fox

     33,791        18,635   

Liberty

     15,088        13,331   

Tridien

     5,901        4,182   
  

 

 

   

 

 

 

Total

     123,120        71,534   

Reconciliation of segment to consolidated totals:

    

Corporate and other

     —          —     
  

 

 

   

 

 

 

Total

     123,120        71,534   

Allowance for doubtful accounts

     (3,588     (2,420
  

 

 

   

 

 

 

Total consolidated net accounts receivable

   $ 119,532      $ 69,114   
  

 

 

   

 

 

 

 

     Goodwill
Sept. 30,
2012
     Goodwill
Dec. 31,
2011
     Identifiable
Assets
Sept. 30,
2012(1)
     Identifiable
Assets
Dec. 31,
2011(1)
 

Goodwill and identifiable assets of operating segments

           

ACI

   $ 57,615       $ 57,615       $ 24,621       $ 26,329   

American Furniture

     —           —           23,137         20,306   

Arnold Magnetics

     51,254         —           92,178         —     

CamelBak

     5,546         5,546         232,891         239,905   

ERGObaby

     41,664         41,471         70,753         74,457   

Fox

     31,372         31,372         93,571         80,392   

Liberty

     32,684         32,684         39,824         40,064   

Tridien

     19,555         19,555         18,592         19,139   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     239,690         188,243         595,567         500,592   

Reconciliation of segment to consolidated total:

           

Corporate and other identifiable assets (2)

     —           —           17,698         142,931   

Goodwill carried at Corporate level (3)

     17,324         17,324         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 257,014       $ 205,567       $ 613,265       $ 643,523   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Does not include accounts receivable balances per schedule above.
(2) Corporate assets were reduced during the nine months ended September 30, 2012 primarily as a result of cash at December 31, 2011 utilized to fund the acquisition of Arnold Magnetics.
(3) Represents goodwill resulting from purchase accounting adjustments not “pushed down” to the segments. This amount is allocated back to the respective segments for purposes of goodwill impairment testing.

Other segment information

Repurchase of CamelBak preferred stock

On March 6, 2012, CamelBak redeemed its 11% convertible preferred stock for $45.3 million plus accrued dividends of $2.7 million, from an affiliate of CGI Magyar Holdings, LLC ($47.7 million), the Company’s largest shareholder, and noncontrolling shareholders ($0.3 million). The Company funded the redemption with its cash through intercompany debt and an equity contribution from the Company of $19.2 million and $25.9 million, respectively. In addition, noncontrolling shareholders of CamelBak invested $2.9 million of equity in order for the Company and noncontrolling shareholders to maintain existing ownership percentages of CamelBak common stock of 89.9% and 10.1%, respectively.

Recapitalization of Fox

On June 18, 2012, the Company entered into an amendment (the “Amendment”) to the inter-company loan agreement with Fox (the “Loan Agreement”). The Loan Agreement was amended to (i) provide for term loan borrowings of $60 million and

 

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an increase to the revolving loan commitment of $2.0 million and to permit the proceeds thereof to fund cash distributions totaling $67.0 million by Fox to the Company and to its non-controlling shareholders, (ii) extend the maturity dates of the term loans under the Loan Agreement, and (iii) modify borrowing rates under the Loan Agreement. The Company’s share of the cash distribution was approximately $50.7 million with approximately $16.3 million being distributed to Fox’s non-controlling shareholders. All other material terms and conditions of the Loan Agreement were unchanged. The table below summarizes the stockholders’ equity impact as a result of the transaction.

 

Recapitalization proceeds to existing shareholders

   $ (13,252

Shares purchased from noncontrolling holders

     (10,969

Recapitalization proceeds to option holders

     (3,036

Shares purchased by noncontrolling holders

     7,204   

Tax benefit on options

     4,954   
  

 

 

 
   $ (15,099
  

 

 

 

Note G – Property, plant and equipment and inventory

Property, plant and equipment is comprised of the following at September 30, 2012 and December 31, 2011 (in thousands):

 

     September 30,
2012
    December 31,
2011
 

Machinery and equipment

   $ 75,936      $ 49,340   

Office furniture, computers and software

     6,121        4,030   

Leasehold improvements

     10,876        9,541   

Buildings and land

     405        —     
  

 

 

   

 

 

 
     93,338        62,911   

Less: accumulated depreciation

     (29,605     (19,332
  

 

 

   

 

 

 

Total

   $ 63,733      $ 43,579   
  

 

 

   

 

 

 

Depreciation expense was $3.9 million and $1.7 million for the three months ended September 30, 2012 and 2011, respectively, and $10.8 million and $4.8 million for the nine months ended September 30, 2012 and 2011, respectively.

Inventory is comprised of the following at September 30, 2012 and December 31, 2011 (in thousands):

 

     September 30,
2012
    December 31,
2011
 

Raw materials and supplies

   $ 88,181      $ 53,659   

Finished goods

     55,569        48,596   

Less: obsolescence reserve

     (8,251     (5,943
  

 

 

   

 

 

 

Total

   $ 135,499      $ 96,312   
  

 

 

   

 

 

 

Note H – 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 annually as of March 31 of each year, unless a triggering event occurs, by comparing the fair value of each reporting unit to its carrying value.

2012 Annual goodwill impairment testing

The Company is required to perform impairment reviews of goodwill balances at each of its reporting units at least annually and more frequently in certain circumstances. Each of the Company’s businesses represents a reporting unit, except at

 

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Arnold, which comprises three reporting units. Each of the reporting units is subject to impairment review at March 31, 2012, which represents the annual date for impairment testing, with the exception of American Furniture. The entire balance of American Furniture’s goodwill was impaired in 2011.

The FASB issued an Accounting Standards Update 2011-08 (“ASU”) in September 2011 that permits companies to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If a company concludes that it is more likely than not that the fair value of a reporting unit is not less than its carrying amount it is not required to perform the two-step impairment test for that reporting unit. This ASU was effective for fiscal years beginning after December 15, 2011. At March 31, 2012 the Company elected to use the qualitative assessment alternative to test goodwill for impairment for each of the reporting units that maintain a goodwill carrying value.

As prescribed by the ASU, factors to consider when making the qualitative assessment prior to performing Step 1 of the goodwill impairment test are as follows:

 

   

Macroeconomic conditions such as deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets;

 

   

Industry and market considerations such as deterioration in the environment in which an entity operates, an increased competitive environment, a decline (both absolute and relative to its peers) in market-dependent multiples or metrics, a change in the market for an entity’s products or services, or a regulatory or political development;

 

   

Cost factor, such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows;

 

   

Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual or planned revenue or earnings compared with actual and projected results of relevant prior periods;

 

   

Other relevant entity-specific events such as litigation, contemplation of bankruptcy, or changes in management, key personnel, strategy, or customers;

 

   

Events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing of all or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or a recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and

 

   

Sustained decrease (both absolute and relative to its peers) in share price, if applicable.

In addition to considering the above factors the Company performed the following procedures as of March 31, 2012 for each of the reporting units;

 

   

Compared and assessed Trailing Twelve month (“TTM”) net sales as of March 31, 2012 to TTM net sales as of March 31, 2011:

 

   

Compared and assessed TTM operating income as of March 31, 2012 to TTM operating income as of March 31, 2011;

 

   

Compared and assessed TTM Adjusted EBITDA as of March 31, 2012 to Adjusted EBITDA as of March 31, 2011;

 

   

Compared and assessed Adjusted EBITDA for the year-ended December 31, 2011 to budget;

 

   

Compared and assessed Adjusted EBITDA for the three-months ended March 31, 2012 to budget;

 

   

Compared the fair value of each of the reporting units to its carrying amount using the same metrics as those used in determining the value of the supplemental put as of March 31, 2012 and concluded that in each case the fair value of the reporting unit was in excess of its carrying amount; and

 

   

Performed market capitalization reconciliation for the Company and determined that the public market capitalization was significantly in excess of the fair value of the Company’s consolidated equity (as derived from the quarterly supplemental put analysis as of March 31, 2012).

Based on the qualitative assessment as outlined, the Company believes that it is more likely than not that the fair value of each of our reporting units is not less than its carrying amount at March 31, 2012.

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 three months ended March 31, 2011 which represented the remaining balance of goodwill on American Furniture’s balance sheet.

 

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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.

Other than the qualitative goodwill impairment review discussed above, 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, 2011, as filed with the Securities and Exchange Commission.

A reconciliation of the change in the carrying value of goodwill for the nine months ended September 30, 2012 and the year ended December 31, 2011, is as follows (in thousands):

 

     Nine months ended
September 30,
2012
    Year ended
December 31,
2011
 

Beginning balance:

    

Goodwill

   $ 247,002      $ 233,568   

Accumulated impairment losses

     (41,435     (35,535
  

 

 

   

 

 

 
     205,567        198,033   

Impairment losses

     —          (5,900

Acquisition of businesses (1)

     51,441        13,620   

Adjustment to purchase accounting

     6        (186
  

 

 

   

 

 

 

Total adjustments

     51,447        7,534   
  

 

 

   

 

 

 

Ending balance:

    

Goodwill

     298,449        247,002   

Accumulated impairment losses

     (41,435     (41,435
  

 

 

   

 

 

 
   $ 257,014      $ 205,567   
  

 

 

   

 

 

 

 

(1) 

Relates to the purchase of Arnold Magnetics in 2012 and CamelBak and Orbit Baby in 2011.

Other intangible assets

2012 Annual indefinite lived impairment testing

The Company completed its 2012 annual impairment testing on indefinite lived intangible assets as of March 31, 2012 and the results of the testing did not require impairment.

 

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Other intangible assets are comprised of the following at September 30, 2012 and December 31, 2011 (in thousands):

 

     September 30,
2012
    December 31,
2011
    Weighted
Average
Useful Lives

Customer relationships

   $ 191,878      $ 169,105      12

Technology and patents

     89,464        75,679      8

Trade names, subject to amortization

     7,595        1,305      10

Licensing and non-compete agreements

     7,736        7,417      4

Distributor relations and other

     606        516      5
  

 

 

   

 

 

   
     297,279        254,022     

Accumulated amortization customer relationships

     (44,215     (32,182  

Accumulated amortization technology and patents

     (31,063     (23,188  

Accumulated amortization trade names, subject to amortization

     (748     (143  

Accumulated amortization licensing and non-compete agreements

     (4,949     (2,917  

Accumulated amortization distributor relations and other

     (516     (452  
  

 

 

   

 

 

   

Total accumulated amortization

     (81,491     (58,882  

Trade names, not subject to amortization

     132,430        132,930     
  

 

 

   

 

 

   

Total intangibles, net

   $ 348,218      $ 328,070     
  

 

 

   

 

 

   

Amortization expense related to intangible assets was $7.7 million and $5.5 million for the three months ended September 30, 2012 and 2011, respectively, and $22.6 million and $14.9 million for the nine months ended September 30, 2012 and 2011, respectively. Estimated charges to amortization expense of intangible assets over the next five years, is as follows, (in thousands):

 

Oct 1, 2012 through Dec. 31, 2012

   $ 7,584   

2013

     29,002   

2014

     28,428   

2015

     24,881   

2016

     18,634   
  

 

 

 
   $ 108,529   
  

 

 

 

Note I – Debt

On October 27, 2011, the Company obtained a $515 million credit facility, with an optional $135 million increase, from a group of lenders led by Toronto Dominion (Texas) LLC. The Credit Facility provides for (i) a Revolving Credit Facility of $290 million due in October 2016, and (ii) a $225 million Term Loan Facility due in October 2017. The Term Loan Facility was issued at an original issuance discount of 96% and requires quarterly payments of approximately $0.56 million commencing March 31, 2012. The Credit Facility is secured by a first priority lien on all the assets of the Company, including, but not limited to, the capital stock of the businesses, loan receivables from the Company’s businesses, cash and other assets.

On April 2, 2012, the Company exercised its option for an incremental term loan in the amount of $30 million. The incremental term loan was issued at 99% of par value and increased the term loans outstanding under the Credit Facility from approximately $224.4 million to approximately $254.4 million. The quarterly amortization payments increased to approximately $0.64 million as a result of this incremental term loan. In addition, the Company amended its Credit Facility to reduce the margin on its LIBOR Loans from 6.00% to 5.00% and on its Base Rate Loans from 5.00% to 4.00% and reduce the LIBOR floor from 1.50% to 1.25%. All other terms of the Credit Facility remained unchanged. The Company paid an amendment fee in connection with this amendment of approximately $2.2 million, and incurred additional fees and expenses of approximately $0.6 million in the aggregate. Net proceeds from this incremental term loan were used to reduce the Revolving Credit Facility.

The Company had $19.0 million in outstanding borrowings under its Revolving Credit Facility at September 30, 2012. Borrowing base availability under our Revolving Credit Facility was approximately $269 million at September 30, 2012. Letters of credit outstanding at September 30, 2012 totaled approximately $1.7 million. At September 30, 2012, the Company was in compliance with all covenants.

 

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The following table provides the Company’s debt holdings at September 30, 2012 and December 31, 2011 (in thousands):

 

     September 30,
2012
    December 31,
2011
 

Revolving Credit Facility

   $ 19,000      $ —     

Term Loan Facility

     253,163        225,000   

Original issue discount

     (7,328     (8,750
  

 

 

   

 

 

 

Total debt

   $ 264,835      $ 216,250   
  

 

 

   

 

 

 

Less: Current portion, term loan facilities

     (2,550     (2,250
  

 

 

   

 

 

 

Long term debt

   $ 262,285      $ 214,000   
  

 

 

   

 

 

 

Note J – Derivative instruments and hedging activities

The Credit Facility requires the Company to hedge the interest on fifty percent of the outstanding debt under the Term Loan Facility. The Company purchased the following derivatives on October 31, 2011:

 

   

A two-year interest rate cap with a notional amount of $200 million effective December 31, 2011 through December 31, 2013. The agreement caps the three-month LIBOR rate at 2.5% in exchange for a fixed payment of $0.3 million. At September 30, 2012 this interest rate cap had a fair value of $0.001 million and is reflected in other current assets on the consolidated balance sheet. The difference between the fixed payment and its change in mark-to-market value is reflected as a component of interest expense; and

 

   

A three-year interest rate swap with a notional amount of $200 million effective December 31, 2013 through December 31, 2016. The agreement requires the Company to pay interest on the notional amount at the rate of 2.49% in exchange for the three-month LIBOR rate, with a floor of 1.5%. At September 30, 2012, this interest rate swap had a fair value loss of $3.9 million and is reflected in other non-current liabilities with its change in mark-to-market value reflected as a component of interest expense.

The Company did not elect hedge accounting for the above derivative transactions associated with the Credit Facility and as a result, periodic mark-to-market changes in fair value are reflected in the consolidated statement of operations.

Note K – Fair value measurement

The following table provides the assets and liabilities carried at fair value measured on a recurring basis at September 30, 2012 and December 31, 2011 (in thousands):

 

     Fair Value Measurements at September 30, 2012  
     Carrying
Value
     Level 1      Level 2      Level 3  

Assets:

           

Interest rate cap

   $ 1       $ —         $ 1       $ —     

Liabilities:

           

Supplemental put obligation

   $ 42,205       $ —         $ —         $ 42,205   

Call option of noncontrolling shareholder (1)

     25         —           —           25   

Put option of noncontrolling shareholders (2)

     50         —           —           50   

Interest rate swap

     3,930         —           3,930         —     

 

(1)

Represents a noncontrolling shareholder’s call option to purchase additional common stock in Tridien.

(2)

Represents put options issued to noncontrolling shareholders in connection with the Liberty acquisition.

 

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Table of Contents
     Fair Value Measurements at December 31, 2011  
     Carrying
Value
     Level 1      Level 2      Level 3  

Assets:

           

Interest rate cap

   $ 166       $ —         $ 166       $ —     

Liabilities:

           

Supplemental put obligation

   $ 49,489       $ —         $ —         $ 49,489   

Call option of noncontrolling shareholder

     25         —           —           25   

Put option of noncontrolling shareholders

     50         —           —           50   

Interest rate swap

     1,822         —           1,822         —     

A reconciliation of the change in the carrying value of our level 3 supplemental put liability from January 1, 2012 through September 30, 2012 and from January 1, 2011 through September 30, 2011 is as follows (in thousands):

 

     2012     2011  

Balance at January 1

   $ 49,489      $ 44,598   

Supplemental put expense (reversal)

     (1,540     3,228   

Payment of supplemental put liability

     (13,675     —     
  

 

 

   

 

 

 

Balance at March 31

   $ 34,274      $ 47,826   

Supplemental put expense

     2,902        1,667   
  

 

 

   

 

 

 

Balance at June 30

   $ 37,176      $ 49,493   

Payment of supplemental put liability

     —          (6,892

Supplemental put expense

     5,029        1,200   
  

 

 

   

 

 

 

Balance at September 30

   $ 42,205      $ 43,801   
  

 

 

   

 

 

 

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 Master 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 nine months ended September 30, 2012, was primarily related to a payment of approximately $13.7 million to CGM due to the profit allocation payment related to the sale of Staffmark offset by an increase in the estimated fair value of the Fox operating segment.

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 primary inputs associated with this valuation utilizing a Black-Scholes model are volatility of 30%, an estimated term of 5 years and a discount rate of 45%.

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. The primary inputs associated with this valuation utilizing a Black-Scholes model are volatility of 44%, an estimated term of 5 years and the underlying price equal to the exercise price at the time of issuance.

Interest rate cap – asset:

The Company’s derivative instrument at September 30, 2012 consisted of an over-the-counter (OTC) interest rate cap contract which is 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. As such, the Company categorized the cap as Level 2. Refer to Note J.

Interest rate swap – liability:

The Company’s derivative instrument at September 30, 2012 consisted of an over-the-counter (OTC) interest rate swap contract which is 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. As such, the Company categorized the swap as Level 2. Refer to Note J.

 

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Table of Contents

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 30, 2012, the Company paid a distribution of $0.36 per share to holders of record as of January 23, 2012. This distribution was declared on January 5, 2012.

 

   

On April 30, 2012, the Company paid a distribution of $0.36 per share to holders of record as of April 24, 2012. This distribution was declared on April 10, 2012.

 

   

On July 31, 2012, the Company paid a distribution of $0.36 per share to holders of record as of July 24, 2012. This distribution was declared on July 10, 2012.

 

   

On October 31, 2012, the Company paid a distribution of $0.36 per share to holders of record as of October 24, 2012. This distribution was declared on October 9, 2012.

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. A reconciliation of the change in the carrying value of the Company’s warranty liability for the nine months ended September 30, 2012 and the year ended December 31, 2011 is as follows (in thousands):

 

     Nine Months     Year Ended  
     Ended Sept. 30,     December 31,  
Warranty liability:    2012     2011  

Beginning balance

   $ 4,311      $ 3,237   

Accrual

     4,198        3,556   

Warranty payments

     (2,728     (2,769

Other

     —          287   
  

 

 

   

 

 

 

Ending balance

   $ 5,781      $ 4,311   
  

 

 

   

 

 

 

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, 2012 and December 31, 2011:

 

     % Ownership      % Ownership  
     September 30, 2012      December 31, 2011  
     Primary      Fully
Diluted
     Primary      Fully
Diluted
 

ACI

     69.6         69.4         69.6         69.4   

American Furniture

     99.9         99.9         99.9         99.9   

Arnold Magnetics

     96.7         87.6         n/a         n/a   

CamelBak

     89.9         76.7         89.9         76.7   

ERGObaby

     81.1         74.0         81.1         74.6   

FOX

     75.7         71.1         78.0         67.9   

Liberty

     96.2         87.6         96.2         87.6   

Tridien

     83.2         68.8         73.9         60.0   

 

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Table of Contents
     Noncontrolling Interest Balances  
     September 30,      December 31,  
(in thousands)    2012      2011  

ACI

   $ 7,355       $ 4,475   

American Furniture

     207         46   

Arnold Magnetics

     1,594         —     

CamelBak

     11,861         54,729   

ERGObaby

     10,881         10,233   

FOX

     11,996         13,661   

Liberty

     1,663         1,436   

Tridien

     9,240         10,577   

CGM

     100         100   
  

 

 

    

 

 

 
   $ 54,897       $ 95,257   
  

 

 

    

 

 

 

Recapitalization of Fox

As discussed in Note F, on June 18, 2012, the Company recapitalized its Fox subsidiary. As a result of this recapitalization, the Company’s ownership was 75.7% on a primary basis and 71.1% on a fully diluted basis as of September 30, 2012.

Tridien

On August 28, 2012, the Company purchased shares of stock of Anodyne from a group of Tridien’s noncontrolling shareholders for an aggregate purchase price of approximately $1.9 million. As a result of this transaction the Company’s ownership interest in Tridien increased to 83.2% on a primary basis and 68.8% on a fully diluted basis.

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 full year’s estimated 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, 2012 and 2011 are as follows:

 

     Three months ended September 30,     Nine months ended September 30,  
     2012     2011     2012     2011  

United States Federal Statutory Rate

     35.0     35.0     35.0     35.0

Foreign and State income taxes (net of Federal benefits)

     6.7        4.5        9.0        10.3   

Expenses of Compass Group Diversified Holdings, LLC representing a pass through to shareholders (1)

     15.6        18.0        16.2        39.3   

Impact of subsidiary employee stock options

     (1.0     1.7        (2.0     2.7   

Domestic production activities deduction

     (2.3     (6.2     (2.9     (11.8

Non-deductible acquisition costs

     (4.5     —          3.1        —     

Impairment expense

     —          —          —          21.1   

Non-recognition of NOL carryforwards at AFM

     4.0        —          3.5        —     

Other

     (1.4     (2.8     (1.4     (0.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Effective income tax rate

     52.1     50.2     60.5     96.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) The effective income tax rate for all periods includes a significant loss at the Company’s parent, which is taxed as a partnership.

 

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Table of Contents

Note P – Defined Benefit Plan

In connection with the acquisition of Arnold, the Company has a defined benefit plan covering substantially all of Arnold’s employees at its Lupfig, Switzerland location. The benefits are based on years of service and the employees’ highest average compensation during the specific period.

The following table sets forth the plan’s funded status and amounts recognized in the Company’s consolidated balance sheets at September 30, 2012.

 

     Date of acquisition
through
September 30, 2012
 

Change in benefit obligation:

  

Benefit obligation, acquisition date

   $ 15,662   

Service cost

     269   

Interest cost

     193   

Actuarial loss

     —     

Employee contributions and transfer

     232   

Benefits paid

     (156

Foreign currency translation

     (513

Retirees

     (1,117
  

 

 

 

Benefit obligation

     14,570   

Change in plan assets:

  

Fair value of assets, acquisition date

   $ 14,325   

Actual return on plan assets

     (41

Company contribution

     278   

Employee contributions and transfer

     232   

Benefits paid

     (156

Foreign currency translation

     (469

Retirees

     (1,117
  

 

 

 

Fair value of assets

     13,052   
  

 

 

 

Funded Status

   $ (1,518
  

 

 

 

The unfunded liability of $1.5 million is recognized in the consolidated balance sheet within other non-current liabilities at September 30, 2012. Net periodic benefit cost consists of the following at September 30, 2012:

 

     Date of acquisition
through
September 30, 2012
 

Service cost

   $ 269   

Interest cost

     193   

Expected return on plan assets

     (23
  

 

 

 

Net periodic benefit cost

   $ 439   
  

 

 

 

Assumptions used to determine the benefit obligations and components of the net periodic benefit cost at September 30, 2012:

 

     September 30, 2012  

Discount rate

     2.25

Expected return on plan assets

     2.50

Rate of compensation increase

     1.00

 

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Table of Contents

The Company considers the historical level of long-term returns and the current level of expected long-term returns for the plan assets, as well as the current and expected allocation of assets when developing its expected long-term rate of return on assets assumption. The assumptions used for the plan are based upon customary rates and practices for the location of the Company.

The Company, for the remainder of 2012, will be contributing per the terms of the agreement, and the expected contribution to the plan will be approximately $0.3 million.

The following presents the benefit payments which are expected to be paid for the plan:

 

Oct. 1, 2012 through Sept. 30, 2013

   $ 569   

Oct. 1, 2013 through Sept. 30, 2014

     1,015   

Oct. 1, 2014 through Sept. 30, 2015

     1,185   

Oct. 1, 2015 through Sept. 30, 2016

     596   

Oct. 1, 2016 through Sept. 30, 2017

     640   

Oct. 1, 2017 and thereafter

     4,731   

Asset management objectives include maintaining an adequate level of diversification to reduce interest rate and market risk and providing adequate liquidity to meet immediate and future benefit payment requirements.

The assets of the plan are reinsured in their entirety with Swiss Life Ltd. (“Swiss Life”) within the framework of the corresponding contracts with Swiss Life Collective BVG Foundation and Swiss Life Complementary Foundation. The assets are guaranteed by the insurance company and pooled with the assets of other participating employers. The breakdown of the allocation of assets in Swiss Life’s group life portfolio is as follows at the date of acquisition:

 

     Acquisition Date
Allocation
 

Certificates of deposit and cash and cash equivalents

     78

Fixed income bonds and securities

     7

Mutual funds

     1

Private equity and hedge funds

     1

Real estate

     11

Equity and other investments

     2
  

 

 

 
     100

The plan assets are pooled with assets of other participating employers and are not separable; therefore the fair values of the pension plan assets at September 30, 2012 were considered Level 3.

 

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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 and in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, as filed with the SEC on May 9, 2012.

Overview

Compass Diversified Holdings, a Delaware statutory trust, was formed 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

 

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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.

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 and is highly unusual in the marketplace for acquisitions in which we operate.

2012 Nine-months Highlights

Acquisition of Arnold Magnetics

On March 5, 2012, we purchased a 96.6% controlling interest (on a primary and fully diluted basis) in Arnold Magnetics, with headquarters in Rochester, NY. Arnold Magnetics has an operating history of more than 100 years and is a leading global manufacturer of engineered magnetic solutions for a wide range of specialty applications and end-markets, including energy, medical, aerospace and defense, consumer electronics, general industrial and automotive. From its nine manufacturing facilities located in the United States, the United Kingdom, Switzerland and China, Arnold produces high performance permanent magnets, flexible magnets and precision foil products that are mission critical in motors, generators, sensors and other systems and components. Based on its long-term relationships, Arnold Magnetics has built a diverse and blue-chip customer base totaling more than 2,000 clients worldwide.

The purchase price, including proceeds from non-controlling interests, was approximately $130.5 million (excluding acquisition-related costs) and was based on a total enterprise value of $124.2 million and included approximately $6.3 million in cash and working capital. Acquisition related costs were approximately $4.8 million. We funded the acquisition through available cash on hand and a draw of $25 million on our Revolving Credit Facility. Arnold’s management and certain other investors invested in the transaction alongside us, collectively representing approximately 3.4% in initial non-controlling interest on a primary and fully diluted basis. CGM acted as an advisor to the Company in the transaction and received fees and expense payments totaling approximately $1.2 million.

Preferred Stock Redemption

On March 6, 2012, we redeemed CamelBak’s 11% convertible preferred stock for $45.3 million plus accrued dividends of $2.7 million, from an affiliate of CGI Magyar Holdings LLC, CODI’s largest shareholder. The redemption was funded with available cash on hand.

Debt Re-pricing

On April 2, 2012, we exercised our option for an incremental term loan in the amount of $30 million. The incremental term loan was issued at 99% of par value and increased the term loans outstanding under the Credit Facility from approximately $224.4 million to approximately $254.4 million. In addition, in connection with the option we reduced the margin on Term Loan Facility LIBOR Loans from 6.00% to 5.00%, Base Rate Loans from 5.00% to 4.00% and reduced the LIBOR floor from 1.50% to 1.25%. We paid an amendment fee of approximately $2.2 million, and incurred additional fees and expenses of approximately $0.6 million. Net proceeds from this incremental term loan were used to reduce outstanding loans on the Revolving Credit Facility.

Sale of HALO

On May 1, 2012, we sold all of the issued and outstanding capital stock of HALO to Candlelight Investment Holdings, Inc. The total enterprise value received for HALO was $76.5 million.

At the closing, we received approximately $66.5 million in cash in respect of our debt and equity interests in HALO 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 outstanding debt under our Revolving Credit Facility. Our proceeds from the disposition approximate our carrying value of HALO. We recorded a loss on the sale of HALO of $0.5 million.

The transaction is subject to typical escrow requirements and adjustments for certain changes in the working capital of HALO. The HALO purchase agreement contains customary representations, warranties, covenants and indemnification provisions.

 

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Outlook

Net sales during the nine months ended September 30, 2012 increased at five of our eight businesses when compared to the same period of 2011. The preliminary estimate of U.S. gross domestic product (“GDP”), a measure of the total production of goods and services in the United States, increased during the third quarter of 2012 at the seasonally adjusted annualized rate of 2.0%, compared to 1.3% in the second quarter of 2012. The increased rate of growth is an indication that government and consumer spending is marginally increasing. Each of our businesses are impacted by the overall economic environment including both consumer spending and increasing commodity and fuel costs. Additionally, American Furniture Manufacturing Inc. (“AFM” or “American Furniture”) is also significantly affected by continued tight consumer credit markets and the depressed housing market which is evident in the decrease in quarter over quarter sales in the third quarter of 2012.

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.

Results of Operations

We were formed on November 18, 2005 and acquired our existing businesses (segments) as follows:

 

May 16, 2006

  

August 1, 2006

  

August 31, 2007

  

January 4, 2008

  

March 31, 2010

Advanced Circuits

   Tridien    American Furniture    Fox    Liberty Safe

 

September 16, 2010

  

August 24, 2011

  

March 5, 2012

ERGObaby

   CamelBak    Arnold Magnetics

In the following results of operations, we provide: (i) actual consolidated results of operations for the three and nine months ended September 30, 2012 and 2011, which includes the historical results of operations of our businesses (operating segments) from the date of acquisition and recasts prior period reporting for business sold during the periods presented (Staffmark and Halo) and: (ii) comparative results of operations for each of our businesses on a stand-alone basis for the three and nine-months ended September 30, 2012 and 2011 which include relevant pro-forma adjustments to historical results of operations and explanations, where appropriate, for the 2012 acquisition and 2011 acquisition.

Consolidated Results of Operations – Compass Diversified Holdings and Compass Group Diversified Holdings LLC

 

(in thousands)    Three months
ended
September 30,
2012
     Three months
ended
September 30,
2011
     Nine months
ended
September 30,
2012
     Nine months
ended
September 30,
2011
 

Net sales

   $ 241,228       $ 168,667       $ 666,571       $ 446,451   

Cost of sales

     164,281         117,837         455,036         311,168   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     76,947         50,830         211,535         135,283   

Staffing, selling, general and administrative expense

     39,422         30,395         119,756         77,347   

Fees to manager

     4,429         4,792         13,294         11,707   

Supplemental put expense

     5,029         1,200         6,391         6,095   

Amortization of intangibles

     7,699         5,509         22,639         14,943   

Impairment expense

     —           —           —           7,700   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) from operations

   $ 20,368       $ 8,934       $ 49,455       $ 17,491   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Net sales

On a consolidated basis, net sales increased $72.6 million and $220.1 million during the three and nine month periods ended September 30, 2012, respectively, compared to the same periods in 2011. These increases for both the three and nine month periods are due principally to increased revenues (and in the case of Arnold Magnetics and CamelBak, incremental revenues) at each of our operating segments with the exception of American Furniture and Tridien and for the quarter only, CamelBak. We realized revenues totaling approximately $68.6 million and $196.9 million in the three and nine months ended September 30, 2012 at Arnold Magnetics and CamelBak, which we acquired in March 2012 and August 2011, respectively. Refer to “Results of Operations – Our Businesses” for a more detailed analysis of net sales for each business segment.

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 businesses. 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.

Cost of sales

On a consolidated basis, cost of sales increased approximately $46.4 million and $143.9 million during the three and nine month periods ended September 30, 2012, respectively, compared to the same periods in 2011. These increases are due almost entirely to the corresponding increase in net sales. Gross profit as a percentage of net sales totaled approximately 31.9% and 30.1% of net sales for the three month periods ended September 30, 2012 and 2011, respectively. Gross profit as a percentage of net sales totaled approximately 31.7% and 30.3% of net sales for the nine month periods ended September 30, 2012 and 2011, respectively. The increase in gross profit percentage for both the three and nine months ended September 30, 2012 compared to the same periods in 2011 is principally attributable to the inclusion of CamelBak results of operations in both periods of 2012, compared to just thirty-six days in 2011. CamelBak’s profit margin during the nine months ended September 30, 2012 was approximately 46.0%. Refer to “Results of Operations – Our Businesses” for a more detailed analysis of cost of sales for each business segment.

Selling, general and administrative expense

On a consolidated basis, selling, general and administrative expense increased approximately $9.1 million and $42.4 million in the three and nine month periods ended September 30, 2012, respectively, compared to the same periods in 2011. The majority of 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 Arnold Magnetics and CamelBak during 2012. Refer to “Results of Operations – Our Businesses”, for a more detailed analysis of selling, general and administrative expense by segment.

Fees to manager

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, 2012 and 2011, we incurred approximately $4.4 million and $4.8 million, respectively, in expense for these fees. For the nine months ended September 30, 2012 and 2011 we incurred approximately $13.3 million and $11.7 million, respectively, in expense for these fees. The increase in management fees for the nine months ended September 30, 2012 compared to the same period in 2011 is due to management fees recast as a component of discontinued operations in the 2011 periods resulting from the sale of Staffmark and HALO. The remaining change is due to the increase in consolidated adjusted net assets as of September 30, 2012 in connection with the CamelBak acquisition in August 2011 and the Arnold Magnetics acquisition in March 2012, offset in part by the decrease in consolidated adjusted net assets in connection with the sales of Staffmark and HALO.

Supplemental put expense

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, 2012, we incurred approximately $5.0 million and $6.4 million, respectively, in expense compared to $1.2 million and $6.1 million for the corresponding periods in 2011. The change in supplemental put expense in all periods presented is attributable to the increase or decrease in the estimated fair value of our businesses during each of those periods.

 

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Impairment expense

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. As of September 30, 2012, the balance of goodwill carried at American Furniture is zero.

We completed our annual impairment analysis of goodwill as of March 31, 2012 and there was no indication of goodwill impairment at any of our reporting units.

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, 2012 and September 30, 2011, 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

Overview

Advanced Circuits is a provider of prototype, quick-turn and volume production printed circuit boards (“PCBs”) to customers throughout the United States. Collectively, prototype and quick-turn PCBs represent approximately 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 2011 and into the first and second quarter of 2012 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. On May 23, 2012 Advanced Circuits acquired the assets of Universal Circuits (“UCI”) for approximately $2.8 million. Universal Circuits supplies PCBs to major military, aerospace, and medical original equipment manufacturers and contract manufacturers. UCI’s Minnesota facility meets certain Department of Defense clearance requirements and is noted for custom and advanced technologies. Universal Circuits’ sales are primarily in the long-lead sector. For the three and nine-months ended September 30, 2012 the consolidated results of operations of Advanced Circuits includes net sales of Universal Circuits aggregating $3.5 million and $4.9 million, respectively, and gross profit of Universal Circuits aggregating $.08 million and $1.1 million, respectively. The following Results of Operations does not include any operating results from these two acquisitions prior to their respective date of acquisition.

 

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Results of Operations

The table below summarizes the income from operations data for Advanced Circuits for the three and nine month periods ended September 30, 2012 and September 30, 2011.

 

     Three months ended      Nine months ended  
(in thousands)    September 30,
2012
     September 30,
2011
     September 30,
2012
     September 30,
2011
 

Net sales

   $ 22,229       $ 19,592       $ 62,878       $ 59,905   

Cost of sales

     11,540         8,934         31,272         26,776   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     10,689         10,658         31,606         33,129   

Selling, general and administrative expense

     3,522         3,167         10,595         9,988   

Fees to manager

     125         125         375         375   

Amortization of intangibles

     769         757         2,287         2,270   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 6,273       $ 6,609       $ 18,349       $ 20,496   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 increased approximately $2.6 million or 13.5%, over the corresponding three month period ended September 30, 2011. The increase in net sales is the result of an increase in gross sales of prototype PCBs ($0.2 million), long-lead PCBs ($2.6 million) and assembly revenue ($0.4 million) during the three months ended September 30, 2012 compared to the same period of 2011, offset in part by a decrease in sales of quick-turn production PCBs ($0.2 million) and an increase in promotion and discount charges ($0.3 million). The increase in sales of long-lead PCBs is largely due to sales during the third quarter of 2012 attributable to Universal Circuits.

Sales from quick-turn and prototype PCBs represented approximately 56% of net sales during the three months ended September 30, 2012 compared to approximately 64% during 2011. The decrease in proportion of quick-turn and prototype PCB sales to total sales is a function of the addition of Universal Circuit’s 2012 long-lead sales.

Cost of sales

Cost of sales for the three months ended September 30, 2012 increased approximately $2.6 million from the comparable period in 2011 principally resulting from the increase in sales. Gross profit as a percentage of sales decreased during the three months ended September 30, 2012 (48.1% at September 30, 2012, compared to 54.4% at September 30, 2011). This decrease in margin is the result of: (i) the increase in promotional pricing, principally related to long-lead PCB sales during the three months ended September 30, 2012 and (ii) sales attributable to Universal Circuits, and a larger proportion of assembly sales during the three months ended September 30, 2012, each of which carry lower margins.

Selling, general and administrative expense

Selling, general and administrative expense increased approximately $0.4 million during the three months ended September 30, 2012 compared to the same period in 2011 due to acquisition related costs in connection with the acquisition of Universal Circuits totaling approximately $0.4 million.

Income from operations

Operating income for the three months ended September 30, 2012 was approximately $6.3 million compared to $6.6 million earned in the same period in 2011, a decrease of approximately $0.3 million, principally as a result of those factors described above.

Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 increased approximately $3.0 million or 5.0%, over the corresponding nine month period ended September 30, 2011. The increase in net sales is a result of an increase in gross sales of prototype and quick-turn production PCBs ($2.0 million), long-lead PCBs ($1.2 million) and assembly revenue ($1.9 million) during the nine months ended September 30, 2012 compared to the same period of 2011, offset in part by an increase in promotion and discount charges ($1.9 million). The increase in sales in the quick turn sector during 2012 compared to 2011 is due in part to quick-turn sales attributable to Universal Circuits. The increase in promotion and discount charges in 2012

 

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compared to the same period of 2011 are principally the result of discounting and price promotions incurred during 2012 in response to competitor’s pricing in the long-lead sector. The increase in sales of long-lead PCBs are largely due to sales during the second and third quarters of 2012 attributable to Universal Circuits.

Sales of quick-turn and prototype PCBs represented approximately 61.5% of net sales during the nine months ended September 30, 2012 compared to 63.2% in 2011.

Cost of sales

Cost of sales for the nine months ended September 30, 2012 increased approximately $4.5 million from the comparable period in 2011 due principally to the increase in sales. Gross profit as a percentage of sales decreased during the nine months ended September 30, 2012 (50.3% at September 30, 2012 compared to 55.3% at September 30, 2011). This decrease in margin is the result of: (i) the promotional pricing in long-lead PCB sales during the nine months ended September 30, 2012 noted above and (ii) sales attributable to Universal Circuits, and a larger proportion of assembly sales during the nine months ended September 30, 2012, each which carry lower margins

Selling, general and administrative expense

Selling, general and administrative expense increased approximately $0.6 million during the nine months ended September 30, 2012 compared to the same period in 2011 due principally to acquisition related costs in connection with the acquisition of Universal Circuits of approximately $0.4 million.

Income from operations

Operating income for the nine months ended September 30, 2012 was approximately $18.3 million compared to $20.5 million earned in the same period in 2011, a decrease of approximately $2.1 million, principally as a result of those factors described above.

American Furniture

Overview

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 most products in its line to its customers within 48 hours of receiving an order.

American Furniture implemented a revised standard costing system in the year 2011 which required American Furniture to reclassify certain costs between cost of sales and selling, general and administrative expenses. The change in format consisted of reclassifying the trucking fleet expenses from selling, general and administrative expenses into cost of sales as well as re-classifying certain manufacturing related expenses including rent, insurance, utilities and workers’ compensation from selling, general and administrative costs to cost of sales. Management believes that the format of reporting cost of sales going forward together with the revised standard costing system and the revaluation of standard costs will allow management to timely react to changes in supply costs, product demand and overall price structure which in turn should eliminate the accumulation of lower margin product, allow for more advantageous product procurement and allow for proper utilization of available assets. The reclassification from selling, general and administrative expense to cost of sales during the three and nine months ended September 30, 2011 was $1.5 million and $4.6 million, respectively.

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.

 

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Results of Operations

The table below summarizes the loss from operations data for American Furniture for the three and nine month periods ended September 30, 2012 and September 30, 2011.

 

     Three months ended     Nine months ended  
(in thousands)    September 30,
2012
    September 30,
2011
    September 30,
2012
    September 30,
2011
 

Net sales

   $ 20,728      $ 23,695      $ 72,359      $ 83,112   

Cost of sales

     19,534        23,463        67,548        78,210   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     1,194        232        4,811        4,902   

Selling, general and administrative expense

     1,762        2,196        5,804        7,545   

Fees to manager

     —          —          —          125   

Amortization of intangibles

     13        546        39        1,637   

Impairment expense

     —          —          —          7,700   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

   $ (581   $ (2,510   $ (1,032   $ (12,105
  

 

 

   

 

 

   

 

 

   

 

 

 

Three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 decreased approximately $3.0 million, or 12.5% over the corresponding three months ended September 30, 2011. During the three month period ending September 30, 2012, stationary product gross sales and motion product sales decreased approximately $3.1 million and $0.5 million, respectively, while recliner sales increased approximately $1.0 million. Sales of other products and a reduction in fuel surcharges were responsible for the remaining decrease in net sales during the three months ended September 30, 2012 compared to 2011. The decrease in gross sales in the stationary and motion product categories and other products is principally the result of a soft current retail environment and increased competition in pricing in our promotional furniture category during the three months ended September 30, 2012. The increase in recliner product sales is the result of supplying product to one of our largest customers for their recliner promotion event. We expect that sales for the remainder of the fiscal year will continue to be challenged by the current retail environment.

Cost of sales

Cost of sales decreased approximately $3.9 million in the three months ended September 30, 2012 compared to the same period of 2011 and is due primarily to the corresponding decrease in sales. Gross profit as a percentage of sales was 5.8% in the three months ended September 30, 2012 compared to 1.0% in the same period of 2011. The increase in gross profit as a percentage of sales of approximately 4.8% during the three months ended September 30, 2012 is principally attributable to a $1.2 million write off taken in 2011 to adjust overhead absorption in inventory resulting from adjustments to its standard costs in July 2011.

Selling, general and administrative expense

Selling, general and administrative expense for the three months ended September 30, 2012 decreased approximately $0.4 million compared to the same period of 2011. This decrease is primarily due to decreased costs of advertising and marketing ($0.2 million) and administrative salaries and benefits ($0.2 million) during the three months ended September 30, 2012 compared to the same period of 2011.

Loss from operations

Loss from operations totaled approximately $0.6 million for the three months ended September 30, 2012 compared to a loss from operations of approximately $2.5 million in the three months ended September 30, 2011, principally due to those factors described above.

 

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Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 decreased approximately $10.8 million, or 12.9%, over the corresponding nine months ended September 30, 2011. During the nine month period ending September 30, 2012, stationary product gross sales and motion product sales decreased approximately $10.0 million, and $1.2 million, respectively, while recliner sales increased approximately $1.1 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, 2012 compared to 2011. The decrease in gross sales in the stationary and motion product categories and other products is principally the result of a soft current retail environment and increased competition in pricing in our promotional furniture category during the nine months ended September 30, 2012 and to a lesser extent our inability to ship certain products during the first quarter 2012 due to a delay in receiving fabric kits that we outsourced to China. The increase in recliner product sales is the result of supplying product to one of our largest customers for their recliner promotion event. We expect that sales for the remainder of the fiscal year will continue to be challenged by the current retail environment.

Cost of sales

Cost of sales decreased approximately $10.7 million in the nine months ended September 30, 2012 compared to the same period of 2011 and is due primarily to the corresponding decrease in sales. Gross profit as a percentage of sales was 6.6% in the nine months ended September 30, 2012 compared to 5.9% in 2011. The increase in gross profit as a percentage of sales of approximately 0.7% during the nine months ended September 30, 2012 is principally attributable to a $1.2 million write off taken in 2011 to adjust overhead absorption in inventory resulting from adjustments to its standard costs in July 2011.

Selling, general and administrative expense

Selling, general and administrative expense for the nine months ended September 30, 2012, decreased approximately $1.7 million compared to the same period of 2011. This decrease is primarily due to decreased costs of advertising and marketing ($0.4 million) and administrative salaries and benefits ($1.1 million) during the nine months ended September 30, 2012 compared to the same period of 2011.

Impairment expense

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 eliminated the remaining balance of goodwill. The $1.8 million impairment charge to American Furniture’s trade name is in addition to $3.3 million in impairment charges to its trade name expensed in 2010. The impairment charges resulted from the annual analysis of goodwill and were necessary based on the deterioration of the promotional furniture market in 2011. There were no impairment charges for American Furniture during the comparable 2012 period and only $0.5 million in intangible assets are currently on its balance sheet.

Loss from operations

Loss from operations totaled approximately $1.0 million for the nine months ended September 30, 2012 compared to a loss from operations of approximately $12.1 million in the nine months ended September 30, 2011, principally due the factors described above, particularly the impairment charge in 2011.

Arnold Magnetics

Overview

Founded in 1895 and headquartered in Rochester, New York, Arnold Magnetics is a manufacturer of engineered, application specific permanent magnets. Arnold Magnetics products are used in applications such as general industrial, reprographic systems, aerospace and defense, advertising and promotional, consumer and appliance, energy, automotive and medical technology. Arnold Magnetics is the largest U.S. manufacturer of engineered magnets as well as only one of two domestic producers to design, engineer and manufacture rare earth magnetic solutions. Arnold operates a 70,000 sq. ft. manufacturing assembly and distribution facility in Rochester, New York with nine additional facilities worldwide, in countries including the United Kingdom, Switzerland and China. Arnold serves customers via three primary product sectors:

 

   

Permanent Magnet and Assemblies and Reprographics (“PMAG”) (approximately 70% of sales) – High performance magnets for precision motor/generator sensors as well as beam focusing applications and reprographic applications;

 

   

Flexmag (approximately 20% of net sales) – Flexible bonded magnets for advertising, consumer and industrial applications; and

 

   

Rolled Products (approximately 10% of net sales) – Ultra thin metal foil products utilizing magnetic and non- magnetic alloys.

 

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Arnold Magnetics is also a 50% partner in a China rare earth mine-to-magnet joint venture. Arnold Magnetics accounts for its activity in the joint venture utilizing the equity method of accounting. Gains and losses from the joint venture are not material during the three and nine months ended September 30, 2012.

On March 5, 2012, we made loans to and purchased a controlling interest in Arnold Magnetics for approximately $131 million, representing approximately 96.6% of the equity in Arnold Magnetics.

Pro-forma Results of Operations

 

     Three months ended      Nine months ended  
(in thousands)    September 30,
2012

(Pro-forma)
     September 30,
2011

(Pro-forma)
     September 30,
2012

(Pro-forma)
     September 30,
2011

(Pro-forma)
 

Net sales

   $ 31,951       $ 35,873       $ 99,036       $ 102,750   

Cost of sales (a)

     25,060         28,624         76,463         80,753   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     6,891         7,249         22,573         21,997   

Selling, general and administrative expense (b)

     3,740         3,925         12,070         11,869   

Fees to manager (c)

     125         125         375         375   

Amortization of intangibles (d)

     874         875         2,642         2,572   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 2,152       $ 2,324       $ 7,486       $ 7,182   
  

 

 

    

 

 

    

 

 

    

 

 

 

Pro-forma results of operations of Arnold Magnetics for the three and nine months ended September 30, 2012 and 2011 include the following pro-forma adjustments, applied to historical results as if we acquired Arnold Magnetics on January 1, 2011:

 

(a) Cost of sales for the nine months ended September 30, 2011 does not include $1.6 million of amortization expense associated with the inventory fair value step-up as a result of and derived from the purchase price allocation in connection with our purchase.
(b) Selling, general and administrative costs were reduced by approximately $0.1 million and $12.4 million in the three and nine-months ended September 30, 2012, respectively, representing adjustments for one-time transaction costs incurred as a result of our purchase.
(c) Represents management fees that would have been payable to the Manager in each period presented.
(d) Represents an increase in amortization of intangible assets totaling $0.7 million in the three month period ended September 30, 2011 and $0.6 million and $2.0 million in the nine months ended September 30, 2012 and 2011, respectively. These adjustments are the result of and were derived from the purchase price allocation in connection with our acquisition.

Pro forma three months ended September 30, 2012 compared to the pro forma three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 were approximately $32.0 million, a decrease of $3.9 million, or 10.9%, compared to the same period in 2011. The decrease in net sales is a result of decreased sales in the PMAG ($3.3 million), Flexmag ($0.1 million) and Rolled product ($0.5 million) sectors. PMAG sales represented approximately 72.7% of net sales for the three months ended September 30, 2012 compared to 74.1% for the same period in 2011. The decrease in sales is principally attributable to a decrease in reprographic application sales, a component of PMAG, during the three-months ended September 30, 2012 compared to the same period in 2011.

International sales were $13.9 million during the three months ended September 30, 2012 compared to $17.1 million during the same period in 2011, a decrease of $3.3 million or 19%.

Cost of sales

Cost of sales for the three months ended September 30, 2012 were approximately $25.1 million compared to approximately $28.6 million in the same period of 2011. The decrease of $3.6 million is due principally to the corresponding decrease in sales. Gross profit as a percentage of sales increased from 20.2% for the quarter ended September 30, 2011 to 21.6% in the quarter ended September 30, 2012. The increase is attributable to increased margins in the PMAG sector due to a more favorable customer/product sales mix, due in part to the decrease in reprographic application sales during the three months ended September 30, 2012 compared to the same period in 2011.

 

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Selling, general and administrative expense

Selling, general and administrative expense for the three months ended September 30, 2012 was approximately $3.7 million or 11.7% of net sales compared to $3.9 million or 10.9% of net sales during the same period in 2011.

Income from operations

Income from operations was approximately $2.2 million during the three months ended September 30, 2012 compared to $2.3 million in the three months ended September 30, 2011.

Pro forma nine months ended September 30, 2012 compared to the pro forma nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 were approximately $99.0 million, a decrease of $3.7 million, or 3.6%, compared to the same period in 2011. The decrease in net sales is a result of decreased sales in the PMAG product sector ($2.5 million) and decreases in sales in the Flexmag ($0.2 million) and Rolled Products ($1.0 million) sectors. PMAG sales represented approximately 73.0% of net sales for the nine months ended September 30, 2012 compared to 72.8% for the same period in 2011. The decrease in PMAG sales during the nine months ended September 30, 2012 compared to the same period in 2011 is principally attributable to lower reprographic application sales, a component of PMAG.

International sales were $44.0 million during the nine months ended September 30, 2012 compared to $47.0 million during the same period in 2011, a decrease of $3.0 million or 6%.

Cost of sales

Cost of sales for the nine months ended September 30, 2012 were approximately $76.5 million compared to approximately $80.8 million in the same period of 2011. The decrease of $4.3 million is due principally to the corresponding decrease in sales. Gross profit as a percentage of sales increased from 21.4% for the nine months ended September 30, 2011 to 22.8% in the nine months ended September 30, 2012. The increase is attributable to increased margins in the PMAG sector due to a more favorable customer/product sales mix, due in part to a decrease in reprographic application sales during the nine months ended September 30, 2012 compared to the same period in 2011, offset in part by a decrease in margins at its Rolled Product sector due to an unfavorable customer/product sales mix.

Selling, general and administrative expense

Selling, general and administrative expense for the nine months ended September 30, 2012 increased to approximately $12.1 million or 12.2% of net sales compared to $11.9 million or 11.6% of net sales for the same period in 2011. The $0.2 million increase in selling, general and administrative expenses incurred during the nine months ended September 30, 2012 compared to the same period in 2011 is attributable to initial increases in personnel costs and benefits and third party services to support growth initiatives.

Income from operations

Income from operations for the nine months ended September 30, 2012 was approximately $7.5 million, an increase of $0.3 million when compared to the same period in 2011, based on the factors described above.

CamelBak

Overview

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 systems (“Hydration Systems”), reusable water bottles (“Bottles”), specialty military gloves (“Gloves”) and performance accessories (“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 systems to the military, with a leading market share in post-issue hydration systems. 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.

 

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Results of Operations and 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, 2012 and September 30, 2011.

 

     Three months ended      Nine months ended  
(in thousands)    September 30,
2012
     September 30,
2011

(Pro-forma)
     September 30,
2012
     September 30,
2011

(Pro-forma)
 

Net sales

   $ 36,672       $ 38,319       $ 121,140       $ 114,695   

Cost of sales (a)

     20,050         22,771         65,400         68,025   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     16,622         15,548         55,740         46,670   

Selling, general and administrative expense (b)

     9,067         7,303         27,160         22,676   

Fees to manager (c)

     125         125         375         375   

Amortization of intangibles (d)

     2,345         2,180         7,100         6,936   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 5,085       $ 5,940       $ 21,105       $ 16,683   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Pro-forma results of operations of CamelBak for the three and nine month periods ended September 30, 2012 and 2011 include the following pro-forma adjustments, applied to historical results as if we acquired CamelBak on January 1, 2011:

 

(a) Cost of sales for the nine months ended September 30, 2011 does not include $6.0 million of amortization expense associated with the inventory fair value step-up as a result of and derived from the purchase price allocation in connection with our purchase.
(b) Selling, general and administrative costs were reduced by approximately $7.0 million in the three and nine-months ended September 30, 2011 representing an adjustment for one-time transaction costs incurred as a result of our purchase.
(c) Represents management fees that would have been payable to the Manager in each period presented.
(d) An increase in amortization of intangible assets totaling $1.8 million and $5.4 million, respectively, in the three and nine month periods ended September 30, 2012 and $1.3 million and $5.6 million, respectively in the three and nine months ended September 30, 2011. These adjustments are the result of and were derived from the purchase price allocation in connection with our acquisition.

Three months ended September 30, 2012 compared to the pro forma three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 were approximately $36.7 million, a decrease of $1.6 million, or 4.3%, compared to the same period in 2011. The decrease in gross sales is a result of decreased sales in Hydration Systems ($0.1 million), Accessories ($1.1 million) and Gloves ($3.9 million) offset in part by an increase in Bottle sales ($3.3 million). The decrease in Glove sales during the three months ended September 30, 2012 compared to the same period in 2011 is due to decreased demand from the U.S. military, resulting principally from a drawdown of U.S. combat troops during the period and the absence of sales from a direct contract with the U.S. Military that was not in effect in 2012. The increase in Bottle sales is principally due to the expansion of offerings in Bottles, such as the introduction of eddyTM and the continued expansion in its customer base, including new and existing customers.

Hydration Systems and Bottles represented approximately 86% of gross sales for the three months ended September 30, 2012 compared to 74% for the same period in 2011. This increase is due in large part to the significant decrease in Glove sales. Military sales represented approximately 38% of gross sales for the three months ended September 30, 2012 compared to 45% for the same period in 2011. International sales represented approximately 14% of gross sales for the three months ended September 30, 2012 compared to 16% for the same period in 2011.

Cost of sales

Cost of sales for the three months ended September 30, 2012 were approximately $20.1 million compared to approximately $22.8 million in the same period of 2011. The decrease of $2.7 million is due principally to the corresponding decrease in net sales and the significant decrease in Glove sales. Gross profit as a percentage of sales increased to 45.3% for the quarter ended September 30, 2012 compared to 40.6% in the quarter ended September 30, 2011. The increase is attributable to a favorable sales mix during the quarter ended September 30, 2012 compared to last year’s quarter, and the decrease in Glove sales as a percentage of total sales. Gloves carry a lower gross profit margin than CamelBak’s other product lines.

 

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Selling, general and administrative expense

Selling, general and administrative expense for the three months ended September 30, 2012 increased to approximately $9.1 million or 24.7% of net sales compared to $7.3 million or 19.1% of net sales for the same period of 2011. The $1.8 million increase in selling, general and administrative expense incurred during the three months ended September 30, 2012 compared to the same period in 2011 is attributable to: (i) increases in compensation expense ($0.8 million), (ii) increases in marketing costs ($0.4 million) and (iii) an increase in bad debt expense totaling $0.2 million, with the balance of the increase due principally to increased infrastructure costs and general overhead, which together with the increases noted above were necessary to support expansion in connection with growth initiatives.

Income from operations

Income from operations for the three months ended September 30, 2012 was $5.1 million, a decrease of $0.9 million when compared to the same period in 2011, principally based on the factors described above.

Nine months ended September 30, 2012 compared to the pro forma nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 were approximately $121.1 million, an increase of $6.4 million, or 5.6%, compared to the same period in 2011. The increase in gross sales is a result of increased sales in Hydration Systems ($10.1 million) and Bottles ($8.2 million) offset in part by a decrease in sales of Gloves ($9.2 million) and Accessories ($1.2 million). The increased Bottle and Hydration Systems sales during the nine months ended September 30, 2012 compared to the same period in 2011 is attributable to the continued success of “Antidote”, CamelBak’s new reservoir for the recreational Hydration Systems line, introduced in 2011, the expansion of offerings in Bottles, such as the introduction of eddyTM, and the continued expansion in its customer base, including new and existing customers, for all product lines. CamelBak began providing Hydration Systems as a subcontractor as part of the United States Marine Corps pack program beginning at the end of 2011, which contributed to the increase in Hydration Systems sales in the first nine months of 2012 compared to 2011. CamelBak anticipates fulfillment of this contract during the first quarter of 2013. The decrease in Glove sales during the nine months ended September 30, 2012 compared to the same period in 2011 is due to decreased demand from the U.S. military, resulting principally from a drawdown of U.S. combat troops during the period and the absence of sales from a direct contract with the U.S. Military that was not in effect in 2012.

Sales of Hydration Systems and Bottles represented approximately 85% of gross sales for the nine months ended September 30, 2012 compared to 74% for the same period in 2011. Military sales represented approximately 38% of gross sales for the nine months ended September 30, 2012 compared to 42% for the same period in 2011. International sales represented approximately 17% of gross sales for the nine months ended September 30, 2012 compared to 18% for the same period in 2011.

Cost of sales

Cost of sales for the nine months ended September 30, 2012 were approximately $65.4 million compared to approximately $68.0 million in the same period of 2011. The decrease of $2.6 million is due principally to the decrease in Glove sales. Gross profit as a percentage of sales increased to 46.0% for the nine months ended September 30, 2012 compared to 40.7% for the same period in 2011. The increase is attributable to a favorable sales mix during the nine months ended September 30, 2012 compared to last year, and the decrease in Glove sales as a percentage of total sales. Gloves carry a lower gross profit margin than CamelBak’s other product lines.

Selling, general and administrative expense

Selling, general and administrative expense for the nine months ended September 30, 2012 increased to approximately $27.2 million or 22.4% of net sales compared to $22.7 million or 19.8% of net sales for the same period of 2011. The $4.5 million increase in selling, general and administrative expense incurred during the nine months ended September 30, 2012 compared to the same period in 2011 is attributable to: (i) increases in sales commissions ($0.7 million), (ii) increases in marketing costs ($0.5 million), (iii) increases in rent and professional fees ($0.5 million) and (iv) increases in compensation expense ($2.1 million). The balance of the increase is due principally to increased infrastructure costs and general overhead, which together with the increases noted above were necessary to support expansion in connection with growth initiatives.

Income from operations

Income from operations for the nine months ended September 30, 2012 was approximately $21.1 million, an increase of $4.4 million when compared to the same period in 2011, based on the factors described above.

 

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ERGObaby

Overview

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 50 countries. ERGObaby’s product lines include baby carriers (organic and standard), accessories and Orbit Baby’s travel systems.

On September 16, 2010 we made loans to and purchased a controlling interest in ERGObaby for approximately $85.2 million, representing approximately 84% of the equity in ERGObaby. 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 November 18, 2011 ERGObaby acquired Orbit Baby. Orbit Baby produces and markets a premium line of stroller travel systems. Orbit Baby’s high-quality products include car seats, strollers and bassinets that are interchangeable using a patented hub ring. The results of operations for ERGObaby for the three and nine months ended September 30, 2011 do not include Orbit Baby operating results.

Results of Operations

The table below summarizes the income from operations for the three months and nine months ended September 30, 2012 and September 30, 2011.

 

     Three months ended      Nine months ended  
(in thousands)    September 30,
2012
     September 30,
2011
     September 30,
2012
     September 30,
2011
 
           

Net sales

   $ 18,540       $ 10,726       $ 45,565       $ 33,383   

Cost of sales (a)

     7,149         3,602         17,690         11,627   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     11,391         7,124         27,875         21,756   

Selling, general and administrative expense

     6,283         4,023         17,301         12,504   

Fees to manager

     125         125         375         375   

Amortization of intangibles

     743         429         2,294         1,287   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 4,240       $ 2,547       $ 7,905       $ 7,590   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 were $18.5 million, an increase of $7.8 million or 72.9% compared to the same period in 2011. Domestic sales were approximately $7.4 million in the three months ended September 30, 2012 compared to approximately $4.4 million in the same period for 2011. The increase is primarily attributable to Orbit Baby sales of $2.4 million in the 2012 period. International sales were approximately $11.2 million in the three months ended September 30, 2012 compared to $6.4 million in 2011, an increase of $4.8 million or 75%. Orbit Baby’s international sales were $1.4 million during the three months ended September 30, 2012. The remaining increase in international sales is due to an increase in sales in Asia and South America.

Excluding Orbit Baby sales of approximately $3.8 million in the three months ended September 30, 2012, baby carriers represented 89.4% of net sales in the quarter ended September 30, 2012 compared to 86.5% during the same period of 2011.

 

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Cost of sales

Cost of sales for the three months ended September 30, 2012 were approximately $7.1 million compared to $3.6 million in the same period of 2011. The increase of $3.5 million is due principally to the increase in sales in the same period. Gross profit as a percentage of sales decreased from 66.4% for the quarter ended September 30, 2011 to 61.4% for the quarter ended September 30, 2012. The 5.0% decrease is primarily attributable to lower margin Orbit Baby product sales in the September 30, 2012 period and a larger proportion of international baby carriers in the third quarter of 2012 compared to 2011. International baby carrier sales generate a lower gross profit margin than domestic baby carrier sales.

Selling, general and administrative expense

Selling, general and administrative expense for the three months ended September 30, 2012 increased to approximately $6.3 million and represented 33.9% of net sales compared to $4.0 million or 37.5% of net sales for the same period of 2011. The increase of $2.3 million is primarily attributable to the selling, general and administrative expenses of Orbit Baby ($1.6 million), offset in part by a decrease in professional fees in the third quarter of 2012 ($0.3 million), each as compared to the 2011 third quarter, and the impact of an earn-out provision that was reversed in the third quarter of 2011 ($1.0 million).

Amortization of intangibles

Amortization expense increased $0.3 million in the three months ended September 30, 2012 compared to the same period in 2011 as a result of amortizing those intangible assets acquired as part of the purchase of Orbit Baby.

Income from operations

Income from operations for the three months ended September 30, 2012 was $4.2 million compared to $2.5 million in the same period of 2011. The $1.7 million increase is due principally to those factors described above.

Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 were $45.6 million, an increase of $12.2 million or 36.5% compared to the same period in 2011. The increase is primarily attributable to Orbit Baby sales of $9.4 million during the nine months ended September 30, 2012 with the remaining 2012 increase attributable to baby carrier and accessory sales. Domestic sales were approximately $18.9 million in the nine months ended September 30, 2012 compared to approximately $11.9 million in the same period for 2011. The increase of $7.0 million or 58.7% is primarily attributable to Orbit Baby sales of $6.3 million in the 2012 period. International sales were approximately $26.7 million in the nine months ended September 30, 2012 compared to $21.5 million in 2011, an increase of $5.2 million or 24.2%. Orbit Baby’s international sales were $3.1 million in the nine months ended September 30, 2012.

Excluding Orbit Baby sales of $9.4 million, baby carriers represented 88.9% of sales in the nine months ended September 30, 2012 compared to 87.8 % during the same period of 2011.

Cost of sales

Cost of sales for the nine months ended September 30, 2012 were approximately $17.7 million compared to $11.6 million in the same period of 2011. The increase of $6.1 million is due principally to the increase in sales in the same period. Gross profit as a percentage of sales decreased from 65.2% for the nine months ended September 30, 2011 to 61.2% in 2012. The 4.0% decrease is primarily attributable to lower margin Orbit Baby product sales in the September 30, 2012 period and a larger proportion of international baby carriers during the nine months ended September 30, 2012 compared to the same period in 2011. International baby carrier sales generate a lower gross profit margin than domestic baby carrier sales.

Selling, general and administrative expense

Selling, general and administrative expense for the nine months ended September 30, 2012 increased to approximately $17.3 million or 38.0% of net sales compared to $12.5 million or 37.5% of net sales for the same period of 2011. The increase of $4.8 million is primarily attributable to the selling, general and administrative expenses of Orbit Baby ($4.1 million) and to a lesser extent the impact of an earn-out provision that was reversed in the third quarter of 2011 ($0.2 million) and an increase in marketing and personnel costs ($1.1 million) to support growth initiatives, offset in part by a decrease in bad debt expense ($0.4 million) at the baby carrier level during the nine-months ended September 30, 2012 compared to the same period in 2011.

 

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Amortization of intangibles

Amortization expense increased $1.0 million in the nine months ended September 30, 2012 compared to the same period in 2011 as a result of amortizing those intangible assets acquired as part of the purchase of Orbit Baby.

Income from operations

Income from operations for the nine months ended September 30, 2012 increased approximately $0.3 million to $7.9 million compared to the same period in 2011, due principally to those factors described above.

Fox Factory

Overview

Fox, headquartered in Scotts Valley, 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 manufacturers (“OEM”) on their high-performance models at the top of their product lines in the mountain bike and powered vehicle 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 160 OEM and 7,600 Aftermarket customers across its market segments. In each of the years 2011, 2010 and 2009, approximately 80%, 78% and 76% of net sales were to OEM customers. The remaining net sales were to Aftermarket customers.

Results of Operations

The table below summarizes the income from operations data for Fox Factory for the three and nine month periods ended September 30, 2012 and September 30, 2011.

 

     Three months ended      Nine months ended  
(in thousands)    September 30,
2012
     September 30,
2011
     September 30,
2012
     September 30,
2011
 

Net sales

   $ 72,865       $ 61,689       $ 179,256       $ 150,464   

Cost of sales

     52,746         42,816         129,593         105,787   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     20,119         18,873         49,663         44,677   

Selling, general and administrative expense

     7,662         7,427         23,177         20,746   

Fees to manager

     125         125         375         375   

Amortization of intangibles

     1,341         1,304         3,974         3,913   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 10,991       $ 10,017       $ 22,137       $ 19,643   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 increased approximately $11.2 million, or 18.1%, compared to the corresponding period in 2011. Sales growth was driven by sales to OEM which increased $9.6 million to $60.2 million during the three months ended September 30, 2012 compared to $50.6 million for the same period in 2011. The increase in net sales is largely driven by increased spec with our customers. The remaining increase in net sales totaling $1.6 million reflects increased sales to Aftermarket customers in the third fiscal quarter of 2012 compared to the same period in 2011.

 

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Cost of sales

Cost of sales for the three months ended September 30, 2012 increased approximately $9.9 million compared to the corresponding period in 2011. The increase in cost of sales is primarily due to increased net sales during the three months ended September 30, 2012 compared to the same period of 2011. Gross profit as a percentage of sales was approximately 27.6% for the three months ended September 30, 2012 compared to 30.6% for the same period in 2011. The 3.0% decrease in gross profit as a percentage of sales during 2012 is largely attributable to the increased overhead costs associated with consolidating our Watsonville operations, increased costs associated with expanding our Taiwanese operations and increased warranty costs and expedited freight costs incurred during the third quarter of 2012 compared to the same period of 2011.

Selling, general and administrative expense

Selling, general and administrative expense increased approximately $0.2 million during the three months ended September 30, 2012 compared to the same period in 2011. This increase is primarily the result of increases in employee related costs to support company growth during the three months ended September 30, 2012.

Income from operations

Income from operations for the three months ended September 30, 2012 increased approximately $1.0 million to $11.0 million compared to the corresponding period in 2011, based principally on the increase in net sales, offset in part by the increases in selling, general and administrative costs, all as described above.

Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 increased approximately $28.8 million, or 19.1%, compared to the corresponding period in 2011. Sales growth was driven by sales to OEM which increased $23.9 million to $143.5 million during the nine months ended September 30, 2012 compared to $119.6 million for the same period in 2011. The increase in net sales is largely driven by increased spec with our customers and to a lesser degree by increased demand for carryover product. The remaining increase in net sales totaling $4.9 million reflects increased sales to Aftermarket customers in the nine months ended September 30, 2012 compared to the same period in 2011.

Cost of sales

Cost of sales for the nine months ended September 30, 2012 increased approximately $23.8 million compared to the corresponding period in 2011. The increase in cost of sales is primarily due to increased net sales during 2012. Gross profit as a percentage of sales was approximately 27.7% for the nine months ended September 30, 2012 compared to 29.7% for the same period in 2011. The 2.0% decrease in gross profit as a percentage of sales during 2012 is largely attributable to the increased overhead costs associated with consolidating our Watsonville operations; increased costs associated with expanding our Taiwanese operations and increased expedited freight costs and warranty costs. WHY?

Selling, general and administrative expense

Selling, general and administrative expense increased approximately $2.4 million during the nine months ended September 30, 2012 compared to the same period in 2011. This increase is primarily the result of increases in employee costs necessary to support company growth during the nine months ended September 30, 2012 compared to the same period in 2011, and costs incurred in connection with a debt recapitalization ($0.8 million) which occurred during June 2012 (see – “Related Party Transactions and Certain Transactions Involving our Businesses”).

Income from operations

Income from operations for the nine months ended September 30, 2012 increased approximately $2.5 million to $22.1 million compared to the corresponding period in 2011, based principally on the increase in net sales, offset in part by the increases in selling, general and administrative costs, all as described above.

Liberty Safe

Overview

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

 

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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”) in addition to various sporting goods and home improvement retail outlets (“Non-Dealer” or “National account”). 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

The table below summarizes the results of operations for Liberty Safe for the three months ended September 30, 2012 and the three months ended September 30, 2011. It also summarizes the results of operations for the nine month period ended September 30, 2012 and the results of operations for the nine months ended September 30, 2011.

 

     Three months ended      Nine months ended  
(in thousands)    September 30,
2012
     September 30,
2011
     September 30,
2012
     September 30,
2011
 

Net sales

   $ 23,385       $ 21,786       $ 67,000       $ 60,611   

Cost of sales

     17,109         16,365         49,921         45,297   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     6,276         5,421         17,079         15,314   

Selling, general and administrative expense

     2,870         2,545         8,682         7,686   

Fees to manager

     125         125         375         375   

Amortization of intangibles

     1,230         1,294         3,754         3,883   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 2,051       $ 1,457       $ 4,268       $ 3,370   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 increased approximately $1.6 million, or 7.3%, over the corresponding three months ended September 30, 2011. Non-Dealer sales were approximately $12.6 million in the three months ended September 30, 2012 compared to $13.9 million in the same period in 2011 representing a decrease of $1.3 million or 9.4%. Dealer sales totaled approximately $10.8 million in the three months ended September 30, 2012 compared to $7.9 million in the same period in 2011 representing an increase of $2.9 million or 37.6%. The decrease in Non-Dealer sales in 2012 is due in large part to the absence of sales in the third quarter of 2012 in connection with a large National retail account’s holiday program which generated approximately $3.0 million in sales during the third quarter of 2011. The significant increase in net sales at the Dealer level is the result of strong demand for Liberty branded product. Management believes that the increased sales at the Dealer level continues to be bolstered by its national advertising campaign in conjunction with those accounts that maintain consistent Liberty Safe product advertising at the local level.

Cost of sales

Cost of sales for the three months ended September 30, 2012 increased approximately $0.7 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 26.8% and 24.9% of net sales for the three month periods ended September 30, 2012 and September 30, 2011, respectively. The increase in gross profit as a percentage of sales for the three months ended September 30, 2012 compared to 2011 is principally attributable to Dealer and Non-Dealer price increases enacted during the second and third quarter of 2012, and a favorable sales mix.

Selling, general and administrative expense

Selling, general and administrative expense for the three months ended September 30, 2012, increased approximately $0.3 million compared to the same period in 2011. This increase is largely the result of increased direct commission expense and co-op advertising costs, both related to growth initiatives and the increase in sales.

Income from operations

Income from operations was approximately $2.1 million for the three months ended September 30, 2012, representing an increase of $0.6 million compared to the same period in 2011. The improved operating results are principally due to the factors described above, particularly the increase in net sales.

 

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Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 increased approximately $6.4 million, or 10.5%, over the corresponding nine months ended September 30, 2011. Non-Dealer sales were approximately $38.3 million in the nine months ended September 30, 2012 compared to $37.0 million in the same period in 2011, representing an increase of $1.3 million or 3.5%. Dealer sales totaled approximately $28.7 million in the nine months ended September 30, 2012 compared to $23.6 million in the same period in 2011, representing an increase of $5.1 million or 21.6%. The increase in Non-Dealer sales in 2012 is due in large part to increased sales in the sporting goods channel. These increases were offset in part by the absence of sales in the third quarter of 2012, in connection with a large National retail account’s holiday program which generated approximately $3.0 million in sales during the third quarter of 2011. The increase in net sales at the Dealer level is the result of strong demand for Liberty branded product. Management believes that the increased sales at the Dealer level continue to be bolstered by its national advertising campaign in conjunction with those accounts that maintain consistent Liberty Safe product advertising at the local level.

Cost of sales

Cost of sales for the nine months ended September 30, 2012 increased approximately $4.6 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 25.5% and 25.3% of net sales for the nine month periods ended September 30, 2012 and September 30, 2011, respectively. The increase in gross profit as a percentage of sales for the nine months ended September 30, 2012 compared to 2011 is principally attributable to Dealer and Non-Dealer price increases enacted during the second and third quarter of 2012, and a favorable sales mix.

Selling, general and administrative expense

Selling, general and administrative expense for the nine months ended September 30, 2012, increased approximately $1.0 million compared to the same period in 2011. This increase is principally the result of increases in the following costs to support the significant increase in sales, particularly commission expense and co-op advertising ($0.3 million), and personnel costs ($0.3 million) all to support growth initiatives and the resultant increase in net sales.

Income from operations

Income from operations was approximately $4.3 million for the nine months ended September 30, 2012 representing an increase of $0.9 million compared to the same period in 2011, which reflected operating income of $3.4 million. The improved operating results are principally due to the factors described above, particularly the increase in net sales.

Tridien

Overview

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 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 most products are completed in-house (with a portion of our products manufactured in Taiwan) and are FDA compliant.

 

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Results of Operations

The table below summarizes the income from operations data for Tridien for the three and nine month periods ended September 30, 2012 and September 30, 2011.

 

     Three months ended      Nine months ended  
(in thousands)    September 30,
2012
     September 30,
2011
     September 30,
2012
     September 30,
2011
 

Net sales

   $ 14,858       $ 15,120       $ 42,586       $ 42,917   

Cost of sales

     11,092         11,064         31,793         31,429   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross profit

     3,766         4,056         10,793         11,488   

Selling, general and administrative expense

     2,222         1,969         6,497         6,225   

Fees to manager

     88         88         263         263   

Amortization of intangibles

     326         330         979         989   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 1,130       $ 1,669       $ 3,054       $ 4,011   
  

 

 

    

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Net sales

Net sales for the three months ended September 30, 2012 decreased approximately $0.3 million or 1.7% over the corresponding three months ended September 30, 2011. Net sales of non-powered support surfaces and patient positioning devices totaled $11.9 million in each of the three-month periods ended September 30, 2012 and 2011. Net sales of powered products totaled $2.9 million during the three months ended September 30, 2012 compared to $3.2 million in 2011, a decrease of $0.3 million or 7.1%, largely due to a periodic fleet upgrade from a large customer.

Cost of sales

Cost of sales were flat in the quarter ended September 30, 2012 compared to the same period in 2011, despite the decrease in sales. Gross profit as a percentage of sales was 25.3% in the three months ended September 30, 2012 compared to 26.8% in the corresponding period in 2011. The decrease in gross profit as a percentage of sales of 1.5% in the three months ended September 30, 2012 compared to the same period of 2011 is due to an unfavorable product sales mix.

Selling, general and administrative expense

Selling, general and administrative expense for the three months ended September 30, 2012 increased approximately $0.3 million compared to the same period of 2011. This increase is attributable to an increased spending on new product development.

Income from operations

Income from operations decreased approximately $0.5 million to $1.1 million for the three months ended September 30, 2012 compared to $1.6 million in the three months ended September 30, 2011 and is attributable to those factors described above. The Medical Device Tax, a 2.3% excise tax included as part of the Affordable Care act signed into law in 2010, will be levied on Tridien revenues beginning in 2013. If we are not able to pass these charges through to our customers it will have a negative impact on our results of operation in 2013.

Nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

Net sales

Net sales for the nine months ended September 30, 2012 decreased approximately $0.3 million or 1.0% compared to the corresponding nine months ended September 30, 2011. Net sales of non-powered support surfaces and patient positioning devices totaled $34.7 million in 2012 compared to $34.5 million during the same period in 2011, an increase of $0.3 million or 1.0%. Net sales of powered products totaled $7.8 million during the nine months ended September 30, 2012 compared to $8.5 million in 2011, a decrease of $0.6 million or 7.2%, largely due to a periodic fleet upgrade from a large customer.

Cost of sales

Cost of sales increased approximately $0.4 million in the nine months ended September 30, 2012 compared to the same period of 2011 primarily as a result of incremental costs incurred related to a new Midwest manufacturing facility. Gross

 

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profit as a percentage of sales was 25.3% in the nine months ended September 30, 2012 compared to 26.8% in the corresponding period in 2011. In addition to the costs associated with our new manufacturing and distribution facility, the decrease in gross profit as a percentage of sales in the nine months ended September 30, 2012 compared to the same period of 2011 is due to an unfavorable product sales mix.

Selling, general and administrative expense

Selling, general and administrative expense for the nine months ended September 30, 2012 increased 0.3 million compared to the same period in 2011. The increase is due to an increase in spending on new product development and spending on growth initiatives.

Income from operations

Income from operations decreased approximately $1.0 million to $3.1 million for the nine months ended September 30, 2012 compared to $4.0 million in the nine months ended September 30, 2011, due principally to those factors described above.

 

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Liquidity and Capital Resources

For the nine months ended September 30, 2012, on a consolidated basis, cash flows provided by operating activities totaled approximately $21.4 million, which represents a $36.4 million decrease in cash provided by operations compared to the nine months ended September 30, 2011. This decrease is the result of (i) capital investment associated with the build-up of inventories in 2012 ($22.4 million), (ii) the additional pay down of the supplemental put liability to our Manager in 2012 compared to 2011 ($6.8 million), and: (iii) the decrease in net income during the nine months ended September 30, 2012 compared to 2011 ($4.6 million).

For the nine months ended September 30, 2012, on a consolidated basis, cash flows used in investing activities totaled approximately $77.8 million, which reflects the acquisition of Arnold Magnetics ($124.1 million), further investment in existing portfolio companies ($16.3 million) and capital expenditures ($9.7 million) offset in part by proceeds from the sale of Halo ($66.5 million) and Staffmark ($5.0 million).

For the nine months ended September 30, 2012, on a consolidated basis, cash flows used in financing activities totaled approximately $55.8 million, principally reflecting distributions paid to shareholders of CODI during the year ($52.2 million) and non-controlling shareholders ($16.3 million), the cost of redemption of preferred stock and accumulated interest at Camelback ($48.0 million) offset in part by net borrowings on our Credit Facility ($46.6 million) and the sale of stock to non-controlling shareholders ($11.8 million).

At September 30, 2012, we had approximately $20.0 million of cash and cash equivalents on hand. The majority of our cash is invested in short-term money market 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, 2012, we had the following outstanding loans due from each of our businesses:

 

 

Advanced Circuits — $57.4 million;

 

 

American Furniture — $16.4 million;

 

 

Arnold Magnetics — $81.6 million;

 

 

CamelBak — $138.2 million;

 

 

ERGObaby — $55.6 million;

 

 

Fox — $73.5 million;

 

 

Liberty — $40.9 million; and

 

 

Tridien — $0 million.

Each loan to our businesses has a scheduled maturity date and each business is entitled to repay all or a portion of the principal amount of the outstanding loans, without penalty, prior to maturity. 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, 2012 is approximately $0.8 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 Facility; (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.

We recognized a non-cash charge to earnings of approximately $6.4 million during the nine months ended September 30, 2012 in order to reflect an increase in our estimated liability in connection with the Supplemental Put Agreement between us and CGM. A liability of approximately $42.2 million is reflected in our condensed consolidated balance sheet, which represents our estimated liability for this obligation at September 30, 2012. During the nine months ended September 30, 2012, we paid CGM $13.7 million in connection with the profit allocation earned on the sale of Staffmark.

 

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The current portion of the supplemental put liability of $5.2 million represents an accrual for the contribution-based profit allocation that will be paid to our Manager during the second quarter of 2013. This accrual primarily represents the contribution-based profit for the fifth anniversary date of Fox and reduces the overall supplemental put liability when paid.

The following table provides the contribution-based profit for each of the businesses we control at September 30, 2012 and the respective quarter end in which each five year anniversary occurs, reconciled to the total supplemental put liability:

 

(in thousands)    Contribution-based
profit allocation
accrual at September 30,
2012
    Quarter End of Fifth
Anniversary Date of
Acquisition

Advanced Circuits

   $ 2,246      June 30, 2016

American Furniture

     (13,791   September 30, 2017

Arnold Magnetics

     (1,097   March 31, 2017

CamelBak

     (744   September 30, 2016

ERGObaby

     539      September 30, 2015

FOX

     5,007      March 31, 2013

Liberty

     (13   March 31, 2015

Tridien

     (338   September 30, 2016
  

 

 

   

Total contribution-based profit portion

   $ (8,191  

Profit allocation due for HALO sale

     211     

Estimated gain on sale portion

     50,185     
  

 

 

   

Total supplemental put liability

   $ 42,205     
  

 

 

   

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, 2012 was paid on October 31, 2012 and was $17.4 million.

Our Credit Facility provides for the Revolving Credit Facility totaling $290 million which matures in October 2016 and a Term Loan Facility totaling approximately $253 million, which matures in October 2017.

On April 2, 2012, we exercised an option with our Lender to increase the Term Loan Facility by $30 million. In connection with the increase, we amended the pricing of the Term Loan Facility wherein borrowings under the facility now bear interest at LIBOR plus 5% with a floor of 1.25%. We incurred an amendment fee of approximately $2.2 million.

The Term Loan Facility requires quarterly payments of $0.6 million which commenced March 31, 2012, with a final payment of the outstanding principal balance due in October 2017.

At September 30, 2012, we had $19.0 million in outstanding borrowings under the Revolving Credit Facility.

We had approximately $269 million in borrowing base availability under this facility at September 30, 2012. Letters of credit totaling $1.7 million were outstanding at September 30, 2012. We currently have no exposure to failed financial institutions.

The following table reflects required and actual financial ratios as of September 30, 2012 included as part of the affirmative covenants in our Credit Facility:

 

Description of Required Covenant Ratio

  

Covenant Ratio Requirement

   Actual Ratio

Fixed Charge Coverage Ratio

  

greater than or equal to 1.5:1.0

   2.50:1.0

Total Debt to EBITDA Ratio

  

less than or equal to 3.5:1.0

   1.86:1.0

We intend to use the availability under our Credit Facility and cash on hand to pursue acquisitions of additional businesses to the extent permitted under our Credit Facility, to fund distributions and to provide for other working capital needs. We have considered the impact of recent market instability and credit availability in assessing the adequacy of our liquidity and capital resources.

 

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Interest Expense

We incurred interest expense totaling $19.7 million for the nine months ended September 30, 2012 compared to $6.1 million for the same period in 2011. The components of interest expense are as follows (in thousands):

 

     Nine months ended September 30,  
     2012     2011  

Interest on credit facilities

   $ 13,375      $ 3,847   

Unused fee on revolving credit facility

     1,984        2,041   

Amortization of original issue discount

     1,951        —     

Realized losses on interest rate hedges

     —          143   

Unrealized losses on interest rate derivatives

     2,108        —     

Amortization of interest rate cap

     165        —     

Letter of credit fees

     54        43   

Other

     23        31   
  

 

 

   

 

 

 

Interest expense

   $ 19,660      $ 6,105   
  

 

 

   

 

 

 

Average daily balance of debt outstanding

   $ 270,886      $ 128,170   
  

 

 

   

 

 

 

Effective interest rate

     9.7     6.4
  

 

 

   

 

 

 

Income Taxes

We incurred income tax expense of $17.1 million with an annual effective tax rate of 60.5% in the first nine months of 2012 compared to $9.4 million with an effective tax rate of 96.0% during the same period in 2011. A portion of the acquisition costs expensed in the nine months ended September 30, 2012 in connection with the Arnold and Universal Circuits acquisitions are not tax deductible and losses incurred at the Company, which is an LLC, are not tax deductible at the corporate level as those costs are passed through to the shareholders. For the first nine months of 2012, these two items accounted for 3.1% and 16.2%, respectively, of the increased effective tax rate compared to the Federal statutory rate at September 30, 2012. Goodwill impairment charges expensed in the nine months ended September 30, 2011 in connection with the American Furniture write-offs are not tax deductible and losses incurred at the Company, which is an LLC, are not tax deductible at the corporate level as those costs are passed through to the shareholders. For the first nine months of 2011, these two items accounted for 21.1% and 39.3%, respectively, of the increased effective tax rate compared to the Federal statutory rate at September 30, 2011. The components of income tax expense as a percentage of income from continuing operations before income taxes for the nine months ended September 30, 2012 and 2011 are as follows:

 

     Nine months ended September 30,  
     2012     2011  

United States Federal Statutory Rate

     35.0     35.0

Foreign and State income taxes (net of Federal benefits)

     9.0        10.3   

Expenses of Compass Group Diversified Holdings, LLC representing a pass through to shareholders (1)

     16.2        39.3   

Impact of subsidiary employee stock options

     (2.0     2.7   

Domestic production activities deduction

     (2.9     (11.8

Non-deductible acquisition costs

     3.1        —     

Impairment expense

     —          21.1   

Non-recognition of NOL carryforwards at AFM

     3.5        —     

Other

     (1.4     (0.6
  

 

 

   

 

 

 

Effective income tax rate

     60.5     96.0
  

 

 

   

 

 

 

 

(1) The effective income tax rate for all periods includes a significant loss at the company’s parent, which is taxed as a partnership.

 

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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 and Adjusted 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.

 

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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, 2012

 

    Consolidated     Corporate     Advanced
Circuits
    American
Furniture
    Arnold
Magnetics
    CamelBak     ERGObaby     Fox     Liberty     Tridien     Consolidated  

Income (loss) from continuing operations

  $ 11,178      $ (14,055   $ 9,410      $ (2,413   $ (4,605   $ 6,159      $ 1,668      $ 12,425      $ 477      $ 2,112      $ 11,178   

Adjusted for:

                     

Provision (benefit) for income taxes

    17,119        (65     4,869        —          (1,779     4,678        1,178        7,130        247        861        17,119   

Interest expense, net

    19,609        19,561        (1     6        (4     11        25        11        —          —          19,609   

Intercompany interest

    —          (29,289     3,778           1,219        4,389        9,932        4,765        1,815        3,336        55        —     

Depreciation and amortization

    38,108        (501     3,990        221        7,667        10,236        3,466        5,789        5,463        1,777        38,108