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Compass Diversified Holdings (NYSE:CODI)

June 12, 2013 12:15 pm ET

Executives

Michael Cimini - Managing Director and Investor Relations Practice Leader

Alan B. Offenberg - Chief Executive Officer of Compass Group Diversified Holdings LLC and Director of Compass Group Diversified Holdings LLC

Elias J. Sabo - Partner

James J. Bottiglieri - Chief Financial Officer of Compass Group Diversified Holdings LLC, Principal Accounting Officer of Compass Group Diversified Holdings LLC and Director of Compass Group Diversified Holdings LLC

Sally McCoy - Chief Executive Officer

Patrick A. Maciariello - Principal of Compass Group Management Llc

David P. Swanson - Partner

Analysts

Lawrence Solow - CJS Securities, Inc.

Michael Cimini

Good afternoon, and welcome to the Compass Diversified Holdings Analyst Investor Luncheon. My name is Mike Cimini of the IGB Group. As a reminder, this event will be webcast, so if you have a question during Q&A, please wait for a microphone to be handed to you. There will be 2 Q&A sessions. The first, with Sally McCoy, Chief Executive Officer of CamelBak, which is one of CODI's subsidiary businesses. And the other, for CODI, will be held at the conclusion of the event.

And with that, I would like to introduce Alan Offenberg, Chief Executive Officer of Compass Diversified Holdings. Alan?

Alan B. Offenberg

Thank you, Michael. Everybody hear me okay? Good. Well, thank you all for being here today. We really appreciate your attendance and look forward to walk you through our presentation. But before I do that, just like to introduce some folks that are here with me up on the stage here. First, to my left is Elias Sabo. He is a founding member of Compass Group Management; then Jim Bottiglieri, our Chief Financial Officer; Pat Maciariello, a partner with Compass Group Management; and Dave Swanson, also a partner with Compass Group Management. And as Michael made reference to in his introduction, we're also joined today by Sally McCoy, the Chief Executive Officer of CamelBak. She'll be making a more in-depth presentation on CamelBak today as compared to our other subsidiary companies, and I have no doubt that Sally's presentation will be the highlight of the day today. And hopefully, you're all enjoying your CamelBak bottles that were left for you. I think that I'd personally like to thank Sally for inventing the product, but I'm hoping you'll thank us because we actually paid for those. So hopefully, you'll put them to good use, I have no doubt, particularly if the weather stays like it is right now.

So with that, I'll move into the presentation starting on Page 3. And I know many of you here are familiar with our story, but just to give you our overview, we acquire, own and manage a group of niche middle-market leading businesses. And presently, we have 8 subsidiary companies. Four of our subsidiaries are in our branded products businesses. These are high cash flowing, rapidly growing businesses, currently representing approximately 2/3 of our consolidated EBITDA. And our other 4 companies are in our niche industrial segments, again, high free cash flow-generating companies, stable, predictable cash flow businesses, and they currently represent about 1/3 of our consolidated EBITDA.

We had a great 2012, which we're very proud of. As you can see on the slide, our revenues and cash flow available for distribution and reinvestment were up 45.8% and 12.6%, respectively. And you were -- as you know from our first quarter call as well, we're off to a great start this year, and so we're very excited about the current position of our subsidiaries and their positions with respect to future continued success.

We've been operating in the middle market for our entire careers. We have 27 professionals dedicated to our efforts, and it's not a style that's new to us, investing in middle-market, niche-leading businesses. It's what we've done. It's what we've always done, and it's what we'll continue to do. Of some further evidence of our success has been the realized gains. We've sold 5 companies since being public, generating almost $200 million in gains.

Moving on to the next slide. You see our performance relative -- since being public relative to the major indices. And again, we're very proud of this chart. As you can see, we have outperformed the indices on a pretty material basis and something, again, that we're really proud of. We think it's driven, obviously, by the strength of our underlying subsidiaries and our ability to grow our business. And we provide consistent distributions to our shareholders along the way, currently paying $0.36 a quarter, roughly 8.5% yield. We've cumulatively distributed $9.24 since being public in May of 2006, and we've never reduced our distribution, and we've earned our distribution since being a public company.

Another thing we think is a real differentiator as it relates to our company is our transparency, which we believe is unprecedented. We provide you with segment reporting on all 8 of our subsidiaries, which really allows our investors to look at the companies individually to value them and to draw your own conclusions as opposed to relying on a third-party calculation done by someone else. We give you all the information you need to value our subsidiaries.

And moving on to the next slide. As it relates to our growth strategy, it's really multiple pronged, and I think -- and it's not a one size fits all. We certainly pursue organic growth at all of our subsidiary companies. We reinvest in all of our businesses. Some companies will also seek to make add-on acquisitions to those platform companies. Some companies, that's not as natural a fit. So I think we've demonstrated our ability to be successful pursuing all types of those strategies and being flexible and working with our subsidiary company management teams to affect what's going to be the most successful strategies for them to pursue long term. The worst thing we can do is try to force a strategy onto a company that doesn't make sense. And I think that's again been one of our key differentiators in how we're able to work with our companies and build them. In addition to growing CODI, obviously, platform acquisitions as new subsidiary companies is a key driver to that as well. And I think many of you are familiar with the comments I'm about to make, but I think it's important that I make them again. I think when we look at our business, first and foremost, we evaluate ourselves on how do the businesses we own perform, how do they do in a given year and really, secondarily, on how many platform acquisitions did we make in any one year. We're a very disciplined group when it comes to making new subsidiary company acquisitions. We've been disciplined historically. We're committed to maintain that discipline going forward. When you combine that with different market conditions, there are periods of time where we find ourselves more active on the new subsidiary acquisition side. Other times, not for lack of effort but where we're just less active in terms of getting those acquisitions consummated. But I think we will pursue all of the initiatives I described to further CODI's growth, and again, we're very pleased with how we're positioned right now.

I'm going to turn the presentation now to Elias who's going to walk you through the next few slides.

Elias J. Sabo

Thank you, Alan. As Alan mentioned, we group our businesses into primary groupings, one being branded products, the other being niche industrial. Our branded products businesses consist of 4 companies: Fox Racing Shox, CamelBak, who you'll hear from Sally later about, Liberty Safe and ERGObaby. And these companies, as a common theme, have a high passion from their consumer base, a very loyal consumer, elasticity of their brands that allow for new product introductions, allow for great defensible market positions and allow for market share to be taken. The evidence of that is in the performance, both from 2011 to '12. You see that we had a strong double-digit top line growth among this group of businesses, as well as greater than 20% EBITDA growth, some margin expansion. We are committed to investing in our high-growth businesses, and we've done that consistently. And you see the payoff is starting to occur on an even, more rapid basis. In 2013, we grew top line of these 4 subsidiaries in the first quarter, 19% consolidated. And bottom line, actually, had an expansion of over 30% with a 230-basis-point increase in our EBITDA margin.

Flipping to our niche industrial businesses. These businesses are made up of Advanced Circuits, Tridien, Arnold Magnetic and American Furniture. The dispersion of cash flow from these businesses is really tilted towards 2 of the businesses, which represent about 90% of free cash flow, and that's Arnold Magnetic and Advanced Circuits. These businesses have very strong defensible positions in their marketplaces. Each of the marketplaces have long-term growth opportunities and strong fundamental outlook. What I would say is, in the last 1.5 years, as a consolidated group, we've seen the industrial side of the business be much more stable. It hasn't grown as much as the branded side of the business. In the first quarter, we're roughly flat year-over-year in revenue. Our margins did come down very moderately by about 100 basis points, and it had a small amount of EBITDA erosion. But we do see this as a very stable business. It's a very high free cash flow business, generally these businesses are characterized by low CapEx, relatively low working capital and high free cash flow.

Flipping to the next slide. The way that we create value, and Alan alluded to this, is really in 3 steps, the first 2 steps being the most important. First and foremost is the acquisition of good companies. We are extremely disciplined, and that comes in 2 forms. First and foremost is finding great businesses with great reasons to exist that demonstrate all of the characteristics that we're looking for, whether it be in terms of strong, elastic brands, some unique business situation where there's a competitive differentiator that allows our companies to take market share.

Second is being able to acquire these business at reasonable valuation. And beyond that, once the companies are acquired, it's all about managing these businesses. There is no, as Alan alluded to, one size fits all. Each of the companies have their own unique opportunities for growth. We help to develop strategies with these companies, and then we stay very close with our management teams on execution of those strategies. And they can take multiple different manners in which they can grow. In some cases, there's augmenting management teams. In other cases, there's doing acquisitions of complementary product lines or other adjacencies. And the proof of that has been in the ability for these companies to grow above what their market growth rates have been.

And then the last stage of our value-creation model is, on an opportunistic basis, being able to divest of these companies. An important aspect of our business model is we do not have timelines under which we're looking to either mobilize money and make investments or divest of these companies. It truly is opportunistic, and it gives us a huge advantage in the marketplace. To date, we sold 5 companies, generated about $200 million of gains. That's about $4 per share of value that we've created. Importantly, in every business that we sold, we've been able to achieve a gain over what the purchase price was.

Flipping to the next slide to talk a little bit about the current environment. The CODI business model is one that is very well received in this environment. First and foremost, due to the financing structure that we have, we are able to consummate acquisitions of new platform companies off of our balance sheet. We have about $290 million of liquidity from our revolver that allows us to do that. And that really is important to both the seller and an intermediary because it gives a much higher confidence level in being able to close. We can close transactions more discretely, and we can close acquisitions on a much more -- much quicker timeline.

In addition, as we -- as I've mentioned, there is no investment pace that is dictated to us, and it lets us be much more flexible in terms of acquisitions that we're looking at, in terms of divestitures as well. And beyond that, we're able to invest much more into our businesses in order to facilitate future growth.

On Page 10, we'll go back to a slide that Alan had on in his summary, and this is the overperformance that we've had versus the indices. I would point your attention to how we've done compared to the S&P 500, just probably the broadest index that we comp to. And we've had about a 600-basis-point per annum premium that we've earned for our shareholders.

And with that, I will turn it over to Jim.

Alan B. Offenberg

I'm sorry, how much is the overperformance?

Elias J. Sabo

Significant.

James J. Bottiglieri

Okay. Before I turn the presentation over to Sally, I just wanted to take us through CODI's debt position, as well as liquidity. As Elias mentioned, the gains that we realized on the sales have largely been used to repay debt. So with that, based off our March 31 numbers, our consolidated debt to EBITDA was less than 2x, often fairly [ph] underdeleveraged. Just describing our facilities, we've got 2 facilities. We've got a term debt facility that's a little over $280 million term debt. That's LIBOR plus 400 basis points, and we've got a $290 million revolver. That's, at the midpoint, is LIBOR plus 2.5. Right now we've got about $275 million availability under that revolving credit facility.

Turning to the next slide is the balance sheet. Again, you could see under the long-term debt section, that's basically that at March 31, that's largely the term debt. We did incur some revolver borrowings after the quarter end. Our working capital was just the working capital needed to run our businesses, and it typically runs at this type of level.

Turning to the next slide. This is based off our December 31 year end. It is a pro forma schedule in that it adds on Arnold as if we owned Arnold as of the 1st of the year and removed HALO that was sold in May of 2012. So with that, you can see roughly a little shy of $160 million of subsidiary EBITDA at that point in time to the full year, made up by the components as you see the -- on the chart. Obviously, you're looking at the 2 biggest companies being Fox and CamelBak. This was, at that point in time, was about 25% of our EBITDA.

With that, I think that's a great introduction, so let's turn it over to Sally.

Sally McCoy

Hello, everybody. How was lunch? That's the important part. I'm here today to speak about CamelBak and not give you any forward-looking information. That's my assignment. So with that, thank you for your questions now. I'll take them at the end.

So our story begins with every -- like every great story does, with a tube sock in West Texas. We were founded in 1989 by an EMT who was going to ride the "Hotter'N Hell 100" on his bike and put an IV bag in a tube sock and put it on his jersey. And hence, the great idea was born. That almost didn't make it out of West Texas. That was one of the first products. And, you can tell it was in the late '80s and a Texas interpretation of that. But since that time, the company was maniacally devoted to what we called hands-free rehydration. The military went on to call it hydration on the move. But it first began in mountain bike, with the growth of mountain bike, they really adopted it because if you're a mountain biker, you know that you get thirsty, and you don't want to take your hands off the handlebar.

The next market, interestingly, really was military. And that was a cultural change in the military because you know what, as a sergeant said, "If the canteen was good enough for me, it's good enough for you." But the younger guys coming in especially, said, "Well, look, I can defend myself, and I can stay hydrated." So CamelBak made its inevitable progress into the military, and they, to this day, are some of our strongest supporters. And it also, of course, went into outdoor because whatever you're doing, it's easier to stay hydrated if you have it right there and right available.

So from that time, in the last, really, 6 or 7 years, we have grown the vision of the company to be bigger. Hydration is bigger. Water is bigger. Water is going to be something we hear about, certainly, the rest of our lives. You hear about peak water. You're going to hear about water rights but also your personal hydration level. So we've expanded into purification, into filtration and into the bottle you have today, which if the study of Pepperdine's right and I believe it is, you'll drink 24% more water if you use this versus a single-use disposable water bottle, a narrow head or something like that. So all you have to do is bite and sip in case you're wondering how you use that. Bite that so...

What's our mission? It's the same as it was back in West Texas. It is like to continuously reinvent and forever change the way people hydrate and perform. It's a broad mission, but it's also quite specific. We have the opportunity to be the dominant hydration company. And that can mean a lot of things. It hits a lot of people in a lot of different markets. I think it will be the same 100 years from now because that is really the focus of the brand. And we know and you can Google it now, hydration makes you think better, makes you perform better and also makes you look younger in case you wanted to know, so important in some of our markets.

Our vision, we use kind of Jim Collins' concept on the vision, which was more like a big, hairy, audacious goal. We would like to replace bottled water as the most common way to hydrate. And I would give Compass thanks for making sure there's no bottled water in the room. New York is one of our markets, the financial people especially where we need to get this through. But truly, it's a $10 billion market. It's a market that many people, if you ask 30 years ago, nobody would have thought we would have paid for bottled water. And so I think, 30 years from now, people will wonder that we ever did again, and we have the opportunity to give people reasons not to.

So how do we actually do this? What makes CamelBak, CamelBak? When I first came in as CEO 6.5 years ago, the -- we have a ton of different meetings. We have our own facility down in Mexico where we make all of our reservoirs. We have a distribution center. We have people work in the Philippines, some in Europe, and we have a lot in our headquarters in Petaluma, which is 45 minutes north of San Francisco. We all got together, had a lot of talk and meetings, and then we honed our values down to 4. And anybody can say, oh, we're obsessively innovative. They actually can't. At CamelBak, we are committed to new products that fulfill our mission and vision, and we have consistently brought out new products every season. And our cycle begins again in July and August. We take on challenges -- and we failed sometimes. We failed before we ever get to market to solve problems in unusual ways. And they're common problems on how to drink more, how to stay better hydrated. Our other one is we give a blank. You fill it in with whatever word you choose, and it means that we are absolutely dedicated at what we do, how we do it, its impact on people and the environment.

Rest stops are overrated. We certainly strive to be first, but we definitely want to be the best. And we choose to not coast [ph]. We can't coast [ph] in the business world today.

Some people inspire us. Passionate people do make better products, and we are constantly inspired by our customers. From the operator who was on the team that took down Osama bin Laden who uses CamelBak as he described in the 60 minutes. You can YouTube it if you want, to the yoga instructor who drinks more water from our bottle. We are -- we go after our core markets, and we approach them in a language that they're used to. But the stories that we get back, the stories that we get back from hospital rooms where somebody puts their CamelBak on their hospital bed, and that's how they stayed hydrated. They inspire us, and they inspire us to do a better job. And that is the 4 core values and what everybody follows at CamelBak or they don't stay at the company very long. But we don't have turnover problem at all so...

And how do we back that with the customer? If we build it, we back it. We have a Got Your Bak guarantee. And what people want right now are brands that they can trust, people that they can trust. In the age of Instagram and Twitter and Pinterest, you have to be on it all the time, and we try to make it simple by making it -- we guarantee our work.

So what does all this culture and what do all this mission and vision add up to? I think it adds up to strong financial performance. And I warned you, we only have 2 number slides here, so don't get too excited about that. We are absolutely committed to taking it from hands rehydration all the way through hydration and innovating in a broad base of customers that are both in niche sports, as well as continuing to pursue the sustainability movement that will eliminate bottled water.

How do we do it? We do it with a team that's -- as all of us have been here, I joined about 6.5 years ago and added Jason and Nick shortly after that and Chris Strain about 3 years ago. But other than that, the team has been together a long time. We work as a team. We have expertise in many fields because we go after core customers in different fields, we have -- Nick, who is this Vietnam veteran, 20-year Marine. He was also an acquisition officer. We have Layne, who is a junior cyclist. I spent some time climbing in the Himalayas. So we have people that are core in our markets, as well as good in business. And we need that because when we speak to mountain bikers, we want to speak, obviously, to somebody who's in the sport. We participate in the industry that's mountain biking. We participate in sports. We've gone after running in the last year. We have some new running products in market this year, right now. And those sports, of course, millennials. I know at least one person in the audience who was at the Governors Ball over this weekend. But if you don't know, it's a music festival. And you could have gotten a cool bottle like this or 2 others if you were there, as well as free filtered water provided by CamelBak.

We go to Austin City Limits, Lollapalooza, The Hangout Festival, Wanderlust. We go to some of these places, and we do provide clean filtered water. We also sell some packs and some bottles, but we do it because we want to stay connected. We are connected with the millennials through both the military and through a lot of the events and marketing that we do. We have about half of -- 500,000 followers between our military and recreational sites on Facebook.

And of course, our -- what we call our government military and industrial consumers. This is a real photo of an astronaut. That blue thing is our bite valve. Every other year, without fail, and NASA buys about 250 of them. They use them in space and in training. And of course, special operations, we're close to some of the wild-land fire people, and we work with every branch in the Armed Forces.

But we also are looking at the larger trend of water health sustainability, and we look at this because when people drink bottled water, this is one of the key to our innovations really. We look -- when you poll them and you ask them why they do it, it -- the answers you get are taste, temperature, convenience and safety. And the top 2 are actually convenience and taste. So if you say those are the reasons people are doing it, then you can begin to understand we get up in the morning, thinking, "What's going to help somebody change their habits?" Because that's really what it's about. We want you to change your habit. We want to make it so convenient. We want to make it so satisfying. And temperature correlates to taste, and there's lots of opportunities in those 4 areas. And I can't tell you more yet.

Bottled water, I think a lot of people don't realize is it's applicable both in the civilian world and the military world. The last statistic that I heard was every 29 trips in Afghanistan of a free supply truck for water, a soldier contractor is killed. And what are they doing with those bottles of water? They put it in their CamelBak. So there's certainly an opportunity in the military world, as obviously one in the civilian world.

All right. So what does all this add up to? Hopefully, you've heard that we have a company really unified and passionate around innovation in your health, your performance and in sustainability of our own products and of global issues. What's it made revenue? I think you can see that it's paid off in both revenue and EBITDA growth. The -- as Brad Johnson, who was a former CFO at REI used to say, there's no mission without margin. And I would add, there's no margin without a mission. So I think we are aligned in a great opportunity. It's a broad market, and you're beginning to see that paid out.

You're also beginning to see a shift, as we grow the markets more to direct business. And of course, certainly, the U.S. government and actually, most governments have -- are trying to control military spending, and we will remain dedicated. There are lots of companies that will drop out of the military business, go out of business, et cetera. CamelBak won't. CamelBak will stand behind the war fighter and the challenges that they face as they become more expeditionary forces for sadly future conflicts. But we also are very, very committed, both internationally -- we focused a lot on our international growth now and domestically on what we call the recreation market.

In our packs, specifically, which really is a way to organize yourself, handle your gear. We have added multiple categories. Like I said, running is new in the marketplace this year. Paddle, I don't know how many of you do stand up paddle, but it's growing in many places. And while we never expected to be a huge market, CamelBak is wherever there are cynics typical to hydrate situations. You'll also find CamelBak there because that means that whether you come into the brand from the military or from stand up Paddle or from you bought a bottle from us from Target, we like it, and we find it exciting. We're an interesting company of a bunch of hard-core people who find it really fun to reach out and sell average Americans who don't have 2-bracket [ph] lives.

With our bottle product, we do have specialty kids products. We do have everyday bottles, which is what characterize the Compass bottle. We have insulated bottles. We have bottles that will keep ice cold for 3 days if you wanted. And we have -- we work with Team Garmin, one of the pro teams, and they use our bottles for the Tour de France next month. We also are -- those of you that are cyclists, who -- I think, as a percentage, financial people are largely the biggest group of road cyclists that we see. But on your $10,000 bike, we have the perfect bottle. It won't spill, it will keep your water cold, and it will look as good as your bike. So check it out if you don't have one.

Recently, we've added Groove, which was basically when you go to another city, not New York because I know you guys like your tap water here, but if you go to another city with a beach and the water doesn't quite taste right, it's a great application of Groove. I know a lot of people who use it everyday, that, that bottle has a filter in it, plant-based filter, that filters the water as you drink. And so it takes taste and odor out of the water as you drink it.

And then All Clear is a product that you see right there. It's also a great travel product. Those of you that are going anywhere abroad, in 60 seconds, you can take clear water and with a UV light, make it microbiologically safe. It's an amazing product.

So when we take these products, we are expanding products, we are expanding categories and we're expanding markets. We're working more and more. People have different concepts of water in different places, but everybody needs it. Some people like it hot. Some people like it cold. Some people like it -- well, the French like it in bottles. We haven't mastered everything there, but we still do a fair amount of business in our -- even in France.

So these are some of our distributors worldwide. We also have international military distributors in NATO countries where we will do products for them. And we work with them. We have good relationships with what we would call premium retails. We want to be found. You can't obsolete bottled water in a single channel. So we want to be everywhere that you expect a premium product to be. We want to be represented well. And as you know, that always takes a lot of partnership and working room in the retail space and online and everywhere else. And we're a very actively managing that, and of course, a couple of those are New York shops for your benefit.

Here, our headquarters. Like I said, we're 45 minutes north of San Francisco, right at the base of the wine country. In case you're planning to visit, you might want to include a weekend. We did build out the facility, it looks out into the wetlands beyond, but we built in that with a LEED certification, and we would look forward to a visit. I can't promise you'll be able to do that just after a visit, but that's what it looks like where we live.

So I'll take questions now. Yes, sir?

Question-and-Answer Session

Unknown Attendee

So roughly how far with the water sheds [ph] and then also who are your competitors and which are the ones you worry about the most?

Sally McCoy

Well, we're in multiple markets. So I don't generally like to talk about -- I mean, outdoor hydration packs have a different market than bike hydration packs. It has different markets in reservoirs and bottles. I'm not trying to be evasive, so -- I mean, some of the competitors we look at -- we still have vast majority of market share in both bike and outdoor packs. North Face I think has tried multiple times against us. Osprey is somebody that I respect as a pack maker. It's different in Europe. Europe tends to have their own favorite pack brand by country, and sometimes they'll sell hydration separately. So if you go down to the actual hydration reservoir which, keep in mind, we're the only ones who have our own factory and make. We -- in the military space, there's a company called SOURCE that we compete against. In the consumer part, there's Platypus, which is owned by Cascade Designs, and a small company called Hydropack. But we own the vast majority of that part of the business.

Unknown Analyst

[indiscernible]

Sally McCoy

I think in the -- I think we are gaining. We brought out the new Antidote into the new reservoir, and that bumped up our market share. So I think in both the bike and outdoor, we have gained market share over the last little bit. But it's not huge because that part of the market isn't growing as fast as the others. In bottles, we have competitors from no-name bottled water to Nalgene, Sigg, though they've kind of faded from the U.S. market, a brand called Contigo is trying to come in, Thermos. So we're definitely gaining share there.

Unknown Analyst

What percentage of your revenue comes from U.S. government agencies? And how do you see that for the next 3 [ph] years?

Sally McCoy

As you saw up there, our military -- can I [indiscernible]? All right. So most of our military -- the military business you saw projected on the screen is divided into about half agency and about half retail.

Unknown Analyst

[indiscernible]

Sally McCoy

Well...

Alan B. Offenberg

Yes, it's hard for Sally to answer that. Let me say the following things that we've said publicly. With respect to the military business, which, again, is mostly sold on the military retailer PXs as opposed to via government contracts, I think it's fair to say that with troop deployment reducing, that, that certainly represents some headwinds going forward with respect to some of those sales. And the contract base business is really a little bit lumpy. Sally, would you agree with that?

Sally McCoy

Yes.

Alan B. Offenberg

It's lumpy based on the needs of the various branches of the Armed Forces, so it's tough to predict. But I will say that troop deployment certainly is meaningful relative to our military business, and we would expect there to be some headwinds associated with the reduction in troop deployment over time.

Sally McCoy

There's 2 index in that. One is uptempo, meaning how quickly they deploy, and the other is where we're deployed. We do -- I was asked earlier. We do sell NATO-like governments as well.

Unknown Analyst

You showed your distributors, you showed your products, some of your products. What do you think the primary driver for growth is going to be going forward based on what you know right now? Is it going to be a broader distribution, new products? Just what drives growth for CamelBak?

Sally McCoy

We -- my expectation is we will -- new products will drive a tremendous amount of growth. There will be some new domestic distribution, and we align some of these products and product categories, and there will be definitely international growth. So those are the big 3 for us.

Unknown Analyst

With your goal of coming out with new products every season, what percentage of your revenues are spent on R&D? And is there a pathway in the future that you may be able to get more efficient in that? Or are you happy with where you currently are?

Sally McCoy

Well, we always try to get better. And as a percentage -- I know the actual number, but I'm not positive what's the exact percentage in my head. But between R&D and product management, it's probably close to 2 -- 2%. And the good news is that when we were -- we focus on that first, and we spend it in accordance with our good ideas. All Clear took us 3 years to get out and get right. That was our first electronic product. So we are focused on global supply chain, and we're focused on bringing innovation out quicker. And I think that you'll see that, but I think there are products that we make that -- when you deal with water, you want to make sure that it actually performs correctly. So I don't think doubling is the answer, but I think you'll see that we have a focus on making our products aesthetic, making our products perform and new definitions in new areas that we think we can take the brand to.

Unknown Analyst

Have you looked at buying any competitors? And would Nalgene be a potential one, as you know how large they are?

Sally McCoy

We certainly have a management team and owners that are supportive of and experienced in acquisitions. I can't comment on Nalgene. They are part of Thermo Fisher. We look consistently as part of our growth strategy. We have, in the past, bought 2 different military and consolidated them into the -- consolidated 1 in and sold 1 separately. So we're an experienced team at doing that, and we definitely would look at opportunistic acquisitions at the right value.

Unknown Analyst

Do you have much of a direct business via the web? And is that an opportunity for you, especially if you're selling to soldiers on bases, to sell them directly as opposed to through distribution?

Sally McCoy

Well, it is. We just started with the web fourth quarter of last year, and we didn't put up our full line until, I believe, February of this year. So we are now selling direct. We do allow our key retail partners to sell us direct as well. And the -- we still see most of the soldiers and war fighters buying through either army -- base army supply stores and PXs -- exchanges, as they call them.

Unknown Analyst

Have you focused at all on third world water purification?

Sally McCoy

We have done some research in that area, we have. That's all I can say.

Unknown Analyst

What year did you become part of Compass? And what's been the difference in terms of being owned by Compass as opposed to -- I don't know what the history was, who you were owned by before and why they had sold to Compass.

Sally McCoy

Let me give you a little bit of the history so you'll understand. We've basically been with Compass since August of 2011. And we were previously owned by Irving Place Capital, who was -- Bear Stearns Merchant Banking prior to that. And I stepped in off the board at McKinsey. My background is I was with North Face in the '80s and did a turnaround, interior design. And then, I was an investment banker for a little while in the outdoor space and came in, candidly, at CamelBak because they had bought, essentially, a military company that had a tremendous upside -- and started off consumer, went military, and I think it's an incredible brand with a lot of opportunity. So I think Compass is a great fit because the situation was we rebuilt the culture, we rebuilt the company, we grew the business. And I think Compass make it stick good, but I think they selected us because they believe that we fill their investment thesis. We're -- we dominate a niche, but we believe that niche is huge. We believe there's a huge potential in it and getting the -- and we're driving towards that. So it is the difference between a company that was going through over-leveraged turnaround to -- and they were supportive, believe me, during that time. I'm not saying anything negative about IPC. And I think Compass is, "full force and let's go ahead." So it's been a -- and as you -- when you have a private equity sale, many people leave. Nobody left, and we continue to recruit top-notch people.

Unknown Analyst

Could you describe the margins between the government business and the retail business? And then secondarily, do you have -- are there patents associated with the bottle, the new products?

Sally McCoy

Sorry, you're not getting the margins but...

Unknown Analyst

Could you -- is one higher than the other?

Sally McCoy

Yes and no.

Unknown Analyst

All right. I'll ask the guy from the NSA. Are there patents associated with the different products?

Sally McCoy

Yes. We have a pretty -- we certainly patent anything that's meaningful and we vigorously defend it. As you know, getting patents has been slower and whatnot. But we have a whole portfolio of patents. We have layered patents. We're, in development, bringing out new patents, and I expect them to issue. So we have brought protection in many of our designs. Some things, you can't. But we have first-to-market usually on those so...

Unknown Analyst

In the purification and filtration area, how technologically sophisticated is that? And could you give us some idea as to, first, its relevant size? And secondly, do you view this as an area of new growth potential?

Sally McCoy

What was last sentence, I'm sorry?

Unknown Analyst

Do you view this as an area of new growth potential for the company?

Sally McCoy

Yes, I do, one among many. It is -- the UV system that we have has only been out a year now, so it's new. And people need -- people are beginning to find it out. We're seeing velocity of sales picking up. I think we have a lot of R&D, some on -- some specific to the military and others in that area. We don't -- we see it becoming a big opportunity. There's disaster preparedness. The humanitarian market has its own dynamics. I don't see that in as a close-in opportunity for us. But we work on some of the microbiological. It's a very complicated issue, and we work on simple solutions. So I like the category.

Unknown Analyst

What type of -- relative size in the company?

Sally McCoy

Right now, it's small. It's just -- we have 1 product out a year. It's small. But it's about where we thought it would be.

Alan B. Offenberg

So perhaps, we could have 1 last question for Sally, and then we'll be here after the formal part of the presentation so you all can certainly follow up with her individually. But I think for timing purposes, we probably have time for one more.

Unknown Analyst

What are the 2 or 3 things that you think could happen that would accelerate your growth, money, people, whatever? And on the other side, what 2 or 3 things might happen that would slow up your growth, economically speaking or whatever?

Sally McCoy

I think the accelerants are the speed of the social movement towards a disposable-free life, that rate of change, rapid growth in the categories that are a broader reach. And so I think that social movement is huge. I also think, obviously, we're going to have new products, and I think speed of acceptance there and -- are the things that are most important. I think we are well -- we have definitely assembled a group that I think is capable of providing the products, the market and the velocity to get that growth. I think on the risk side, obviously, there's an enormous amount of macroeconomic risk out there, regional risks. Obviously, there's sequestration there. Those things will all be headwinds for us in those businesses, frankly. Thank you.

Alan B. Offenberg

Thanks so much, Sally. Appreciate that. I think now we're going to turn it over to Pat, who is going to walk you through our other branded companies.

Patrick A. Maciariello

Thanks, Alan. I'll walk you through our branded consumer companies briefly and then Dave will walk you through our niche industrial businesses. Starting with Fox Racing Shox. Fox is a company we bought in January of 2008, and Fox provides suspension in a number of categories.

Our largest category is currently mountain bikes, where we believe we are the leader market share-wise in suspension for bikes that cost sort of $2,000 and up, so kind of premium mountain bikes. So these are not mountain bikes that are sold in Wal-Mart or in Dick's Sporting but these are bikes that are sold in specialty bike retailers, and they're for people who want to go downhill fast. We have several other off-road categories that we participate in as well. We participate in Side by Side, which is a growing market. And then, we have a very good market position in Side by Side. We're also in other off-road, Jimmy Jib off-road racing-type applications, Baja 1000-type applications, lifted track-type applications, as well as select military applications.

Really, what we've done here and what we've been working on over the last couple of years with the management team is transitioning a lot of our bike manufacturing to Taiwan, and that's for a couple of reasons. It's for cost reasons, but it's also for to be close to a lot of the bike OEM manufacturers. A lot of our OEM customers have their bikes manufactured by manufacturing contractors in Taiwan, and there's kind of a bike hub in premium mountain bikes there. And so this will enable us to reduce inventory as well. So we're excited about that, and we're working hard on that. You can see some of the growth there. It's been a good run to date, and we're confident of that.

Moving on here to ERGObaby. ERGObaby is the, we believe, the premier designer of baby carriers. We offer organic baby carriers. We offer multiple designs. It's really a product that we believe mothers and fathers alike are passionate about. ERGObaby is a market share leader in a lot of geographies that it's in. It's a global business. We do a lot of business in Asia, a lot of business in Europe, and it's a market share leader in many of the geographies it's in.

You see here, this was an interesting -- from a Compass perspective and a value-added perspective and you see kind of the spectrum of companies that we purchased. When we purchased this company a couple of years ago, the company was really working with a small management team in a small headquarters in Maui, Hawaii. And we built up a management team, we built up an employee base in Los Angeles. And we've also worked to sort of add additional products. We have a couple of cool new products coming out this year. We have some great new carriers coming out this year.

We've also acquired a company called Orbit Baby, which we fits -- which we feel fits right in. It's a fast-growing stroller and stroller system, car seat-type business that we feel fits right in with the sort of premium brand. This, again, kind of fits in with Compass' investment philosophy, I think, for a couple reasons. First, it is a very large market share player in a small market. But also, it's a brand that people are passionate about. And we're very passionate about it as well.

Next is Liberty Safe. Liberty Safe is the premier manufacturer of gun safes in the U.S., and Liberty Safe is one of them. There are a couple real branded manufacturers of gun safes in the U.S. We sell to -- through retailers such as Cabela's and Gander Mountain. We also sell through a large dealer network. And it's really the market share leader. We feel like we're on -- whatever side of the gun debate you're on, we feel like we're on the right one because we keep it safe.

And so what we've done here and how we work with management here is in a couple of ways. First, we have -- we really work -- the management came to us with a large investment to move part of their safe line from Asia to here, to move their small safe line here. And they had worked with private equity firms in the past that, quite frankly, were not as excited about it as we were because maybe it would be a 4-year payback as opposed to a 2- to 3-year payback. We were excited about that though. Given our hold period, that's the type of investment we want to make. And the ability to make those types of investments, I think, really excite the management team. It is something that the management team likes. So we made that investment, about a $10 million capital expenditure investment. We now have a small safe line here. It couldn't happen at a better time with what's going on in the market. And as you can see their financials, the company has grown quite rapidly.

The second thing we did here as far as really focusing in on spending, at the point of attack, we started a marketing campaign. The company had traditionally lived right by just a stellar brand reputation. And word of mouth as it happened is much sort of been proactive in marketing, and we really encourage the team there to be proactive and have had great results.

Dave, I'll hand it over to you.

David P. Swanson

Thanks, Pat. So I'm Dave Swanson, and I'm going to walk through the 4 companies that are in our niche industrial segment. As Alan mentioned, collectively, they represent about 1/3 of our consolidated EBITDA, the largest of which is Advanced Circuits. Advanced Circuits is a printed circuit board manufacturer focused primarily on quick-turn and prototype segments. They're able to ship product to customers in as little as 24 hours from receiving an order. They also provide printed circuit board assembly services to their customers, and this has been a very fast-growing segment for the company over the last couple of years, approximately $30 million of EBITDA.

In terms of some of ACI's strengths, very low customer concentration, large customers less than 2% of sales. They are the largest quick-turn manufacturer in the U.S., the market share leader. On average, over 300 unique orders per day. Unique orders per day is a key driver of efficiency in this industry. Higher volume of orders result in less setup time and less labor cost. So ACI benefits from some very nice economies of scale, which are really reflective in its margin levels, kind of 35% to 40% EBITDA margins, which are very spectacular in this industry, higher than other companies that we're aware of anyway. We have done several add-on acquisitions in the last couple of years that have been successfully integrated, and we think that's one of many growth opportunities for Advanced Circuits in the future.

Arnold Magnetic Technologies. That's our most recent acquisition, completed a little over a year ago. They are a manufacturer of permanent magnets and magnetic assemblies. They serve a very diverse set of end markets, which include aerospace and defense, oil and gas exploration, automotive and general industrial. Very much a global presence and a global footprint with manufacturing facilities in the U.S., Europe and Asia. EBITDA of about $17 million. Arnold is also market share leader, and we believe that they are a technology leader in the industry.

A very highly technical sales process where Arnold engineers work with customer engineers at kind of the early stages of design and spec process at the beginning of programs. Arnold is also an expert in rare earth magnets, and rare earth magnets have some very exciting applications in some high-growth markets. We think Arnold will benefit from some good macro trends. One is a trend toward electrification in a lot of its end markets, including automotive. Customers need their products to run kind of smaller, hotter, faster, which plays very well with Arnold's capabilities.

The third company is Tridien Medical Device. Tridien is a manufacturer of medical therapeutic support services. Their products would include powered and non-powered mattresses, as well as patient positioning devices. They serve acute care, long-term care and home health care markets. Their products are primarily used for prevention and treatment of pressure wounds or pressure ulcers in patients that are immobile or have limited mobility. EBITDA of approximately $6 million.

Again, we think some a very nice macro trends in this industry, increasing obesity, aging of the population. Importantly, an increasing focus by hospitals and long-term care facilities, as well as Medicare and insurance companies, on preventing pressure wounds. It's a lot less expensive to prevent a pressure ulcer than it is to treat it after it happens. So Tridien is very focused on innovation and product development. We've made some pretty significant investments over the last year or so in some R&D initiatives and believe that Tridien has a good pipeline of product to allow it to benefit from the good macro trends in the industry.

Last but not least, American Furniture Manufacturing is a manufacturer of upholstered furniture, focused exclusively on the promotional segment, which is a low price point segment. They manufacture sofas, loveseats, recliners. Frequently, AFM designs its product to be kind of a low-cost version of popular high-end styles, has very lean and low-cost manufacturing in northeast Mississippi. One of the things we like about this industry, it is insulated from imported products. Upholstered furniture is very expensive to ship, given how bulky it is, in particular. But the promotional price point, those costs are high on a relative basis. Also, promotional price point customers require pretty short lead times, which is very hard to serve from Asia.

So the furniture industry has been very difficult over the last several years. I think AFM has done a great job of cutting costs in order to be a survivor in this industry. We did add a new CEO in the fourth quarter of last year to replace a retiring CEO. The new CEO was formerly president of a La-Z-Boy subsidiary, and we're very excited to have him on board. Also added a new head of sales in the fourth quarter of last year. So we think AFM is very well positioned relative to its competitors to benefit as the industry rebounds historically in a way the industry has had some correlation to the general health of the housing market. To the extent that the housing market continues to improve, we think that will benefit AFM.

So with that, I think I'll turn it back to Alan for some closing remarks, and then questions.

Alan B. Offenberg

Great. Thanks, Dave. That's perfect. So before I get to my brief closing remarks, first, I'd really just like to extend another thanks to Sally McCoy for what was, in my mind anyway, a tremendous presentation. Sally, your passion, your talent and your leadership just continue to impress me every day. And we tell our investors what great subsidiary company management teams we have on a regular basis, and I don't think there's a finer example than you. So thank you, Sally, much appreciate it.

We own -- we acquire, own and manage a diverse set of subsidiaries, all of which are operating in industries with favorable macroeconomic outlooks, and each of these companies, in our opinion, have a real reason to exist. And we will continue to execute on that strategy of acquiring those companies and managing the ones we have that we've articulated to you today. In my opinion, our group of branded consumer companies and niche industrial businesses have never been stronger. I think we're really poised for continued growth, and we will, along the way, stay committed to doing the best we can on behalf of our shareholders, as well as always providing you with the transparency and liquidity and the ability to access us with any questions that you have. We're grateful for your support. We thank you all for being here today, and we'd be happy to take any questions that you have.

Unknown Analyst

A few questions about the financing of new acquisitions in the balance sheet. You guys said less than 2x leverage right now. Are you -- at the time of acquisition, are you -- are your leverage levels comparable to your traditional kind of middle-market private equity players out there? And then, do have ever raise equity at the CODI level to finance acquisitions?

Alan B. Offenberg

Yes, so when we acquire a company, we'll utilize our revolving credit facility to write the check to purchase that company. We'll then fund into that acquired entity in the form of both debt and equity. So that's all intercompany debt. So you won't see the individual subsidiary company levels of intercompany debt in our filings because it consolidates out. However, we will -- at the subsidiary level, we are capped by our own credit agreement to not have intercompany debt at that subsidiary level beyond 5x. And I would say, historically, we've been closer to 4, 4.5x at the subsidiary company level. And that debt is designed and intended in every way, shape or form to look like what a third-party debt provider would have in terms of pricing, covenants, et cetera. So I think that -- and that would obviously, to the extent we borrow it on our revolver, it would take our corporate level borrowings higher, but we're also acquiring EBITDA at the same time as that acquisition. So I would say that 2 to 2.5x leverage is probably where we'd find ourselves. Jim, I don't think we are permitted to go beyond 3. Is that right? 3.25. So with respect to raising equity to support acquisitions, we have raised equity in the past. It's been more in the context of an extension of what you're describing. And by that, I mean we utilize our revolving credit facility to make an acquisition and that -- not in -- we haven't raised equity at the same time, but if you -- post that acquisition, we have raised equity to utilize that capital to delever our revolver and effectively reload our dry powder to go out and make subsequent acquisitions.

Unknown Analyst

When it comes to the upholstery's market position, did you press the line and use those proceeds to buy these additional companies? Or typically, are you involved with traditional private equity auction process? Is that where you typically find your...

Alan B. Offenberg

Yes, we certainly participate in the auction market and work with all of the various intermediaries that would bring those transactions to market. We also try our best to generate our own direct level of deal flow. Candidly, I think that given the size and types of the companies that we're acquiring, if you want to make a sweet spot like a $20 million to $25 million EBITDA company with the target characteristics we look for, it's very hard to find those opportunities that aren't at least competitive in the context of a process that's "kept honest" by bringing at least a couple of parties to the table. Don't get me wrong, we strive for proprietary deal flow and work at that every day. But I do think it's a term that is overused by many in the industry and exaggerated. And so where we find ourselves successful in the broader auction, typically in the context of a process where the opportunity, for some reason, takes it slightly out of the bull's eye and puts it a little bit to the side for a reason that might be macro, might be specific to the company. But where it takes a little bit more effort, either to slog through some of the details and get comfortable. I think those situations are ones that we excel at and truly differentiate ourselves at. I think that also over the course of the years, we've done, I think, a great job with the intermediary community as being a credible acquirer of businesses, delivering on what we propose and not a group that is one to play games. And because of that reason, there's been a bit of a trend in the marketplace, with some of the auction properties to not go as broadly, to go to a smaller group of potential buyers. And I think that we're increasingly finding ourselves on those shortlists, which is a great situation because, look, it doesn't eliminate the competitive process, but it significantly reduces it to a group of credible buyers. And I think our ability to execute on those transactions has been good for us. So yes, we see those broadly marketed transactions, and we do our best to see transactions that are certainly less competitive, as well.

I'm going to let the person with the microphone dictate who goes next.

Unknown Analyst

Could you comment on what are the 2 or 3 metrics that you really run the company by? Is it earnings, cash flow, whatever?

Alan B. Offenberg

I would say cash flow is certainly our primary metric. We certainly also look at how our return on our securities have been. So as we highlighted there, we obviously measure the stock price and our total return relative to the various indices. But on a day-to-day basis, I would say the cash flow of our existing subsidiaries, individually and collectively, is the metric that we focus on, more so because sometimes, as much as I would like to be able to control what the stock market does, I found that, that effort is sometimes one that is not necessarily rewarded. So on a day-to-day basis -- and all of our companies have different operating metrics as well, but cash flow is a great barometer for how they're executing [indiscernible] on their plans.

Unknown Attendee

[indiscernible]

Alan B. Offenberg

Again, in terms of day-to-day measurement, we would certainly be focused on the cash flow number. [indiscernible] a more macro level, but we certainly do look at per share data as well. But on a day-to-day basis, I think just the operating metric of the individual company on a consolidated basis is what's driving us, because I think that to the extent we grow that as we intend to, clearly that will result in better per share numbers as well.

Unknown Attendee

Can you talk about what you're seeing on the M&A side? It's been slow, first half; kind of what do you think of the back half?

Alan B. Offenberg

Yes, as we mentioned on our most recent call, it's been a slow first half. It was a slow back half of last year as well, particularly in the fourth quarter, to the extent you weren't working on a tax-driven, year-end transaction. We express cautious optimism about an uptick in activity, based largely on what others in the community had been talking about, as well as we had started to see some opportunities that were more appealing to us. And I think that continues, so I think the modest uptick is generally something that we're seeing right now. And it feels -- it's good. It's a good development. The flipside is you're comparing it against the period where I guess activity was fine, but quality opportunities were lacking. So I feel -- and Elias, feel free to elaborate, I feel more excited about the prospect for a busier second half today than I even did 6 weeks ago, or whenever we last spoke to the public based on the quality of the opportunities we're seeing, along with just an uptick in general in the velocity, the amount of transaction that we're seeing. So it's an environment that's certainly competitive, but it's -- I was talking to an investor the other day, and he didn't go back to 2009, when the world was falling apart, and that was a competitive market, just with different dynamics. So the market is always competitive. But I would say though that the availability of both debt and equity capital is -- it makes it a competitive market, and will tend to probably drive prices to what I'll just call fair levels. It's going to be hard to get a true feel in a market like this when there is a lot of capital looking at that similar opportunities. But I am optimistic that, that level of activity will continue to improve. And even if it doesn't improve beyond what it is right now today, it's better than it was a little 3 months ago, undoubtedly.

Unknown Attendee

Historically, how much of the investment capital has been returned, or has been invested in platform companies which you already own and buying bolt-ons, relatives and new platforms, and do you see that mix changing going forward at all?

Alan B. Offenberg

I just want to make sure I understand the question. How much have we invested in platforms versus add-ons? I would say the vast majority has been spent on platform acquisitions. Our add-on acquisitions in our group of subsidiaries now tended to be smaller add-on acquisition, as opposed to companies of equal size. And I would expect that it's a hard thing to predict --

James J. Bottiglieri

Other than staff market.

Alan B. Offenberg

Other than staff market, that's right. Thank you, Jim, I was thinking about our group of existing subsidiaries. I think that it's somewhat opportunistic, I think, to the extent a company has the opportunity to make a transformational add-on acquisition. We're certainly open to that and I wouldn't say that we have a preference to do that versus another platform acquisition. To date, though, in a group of existing subsidiaries, this smaller add-on acquisition that we've been able to just absorb and bring into our system and have it be accretive early on has been a good model for the companies in making those acquisitions.

Unknown Attendee

So in terms of where incremental EBITDA comes through with the deployed into acquisition, is it more synergies from acquisitions that you make? Or is it more normalization of turn-arounds, or is it justifying growth businesses and the growth of those businesses themselves drive the EBITDA?

Alan B. Offenberg

For existing -- for newly acquired -- Yes, look, I think the growth is driven by executing on strategies with management. I think that, again, we do look for companies that have shown a good history of cash flow and growth. And I hope that when we acquire companies, we can work to optimize them and have growth rates that are beyond industry levels. So I do think that the company's national growth profile is certainly a part of it. But as Elias mentioned in his earlier comments, we've been successful in working with companies to have them outperform what would be standard growth. I think that synergies is not something that I really would like to bank on. I think that when you acquire a company, we certainly look to optimize it in almost every case, we've been able to make operating improvements. But I think that we always need to be careful about building in too much optimism with respect to synergies because that can be an exercise of getting too comfortable with your own modeling as opposed to realizing what the execution risk is associated with achieving those. So we tend to be conservative as we look at synergies yet at the same time, look to optimize our operations once we acquire them and work with them and management. So it's a combination of both, but I think it's really looking to -- and with respect to platform, sorry add-on acquisitions being a driver of growth for those businesses, again, company by company specific. Some companies are absolutely are natural acquires, and will look to build some of their growth that way, whereas others I think are much more suited to an organic growth strategy, which is, again, also a strategy we're very happy to support.

Unknown Attendee

Would you talk about your interest in services business? Obviously, Staffmark service business is less competitive market, more difficult market, it's got a harder market to monetize the assets in? It's got more opportunity for add-on, and so I see pluses and minuses?

Alan B. Offenberg

Yes, we did very well on the Staffmark investment, which we're very proud of. I think that service -- services businesses have some unique challenges that make them difficult. And I'd say that if we could find a best-of-breed service company that with, again a real reason to exist, that's a tough hurdle often times for them to pass. That is evidenced by outsized margins because many of these services businesses are very low level of cash flow margins. I wouldn't say we would be opposed to it, but I would say that the segments that Elias walked you through being our enthusiast-branded businesses and our niche industrial businesses, are more exciting to us at a macro level than a services businesses. But a specific services business could be interesting to us if we found the right opportunity.

Lawrence Solow - CJS Securities, Inc.

You guys did a good job investing or taking out cost either to improve initiative [ph], are there still -- I realize there are a couple of ongoing things, and looking forward with your existing legacy businesses, is there still more significant opportunities?

Alan B. Offenberg

I would say that if you had our panel of CEOs from our subsidiary businesses, they would always tell you there's more. And I think it's what they work on every day. I don't think they're ever satisfied with the margin of their businesses and they look to improve it. So, Larry, it's hard for me to -- I don't know if I want to use the word significant, but I would say that there are always -- I would say every one of our subsidiary companies would tell you that there are further operating efficiencies that -- opportunities to improve operating efficiencies and improve margins that exist in the subsidiaries and they will work on that every day and work to achieve it.

Lawrence Solow - CJS Securities, Inc.

Second part. How much -- and I realize this is probably something like a moving target, but how much time do you guys spend with the existing businesses versus looking at prospective acquisition kind of --

Alan B. Offenberg

A lot. We would -- I would say at least 50-50 and probably even more. I think that working with our existing subsidiary -- at first, and it's not just -- I don't want to suggest it's one or the other, we are always doing both of those activities every day. But in terms of the -- you maybe look back on it on an allocated basis, I would say some years, it's 50%, 60%, maybe even close to 70% with the existing. Other year, it may be less. But I think one of the reasons that we've been able to have the success we've had with our subsidiary companies is the amount of time we dedicate senior-level attention to work with all of them. I mean, again, when you see someone and get to meet someone like Sally today, what you realize is it reinforces that we're not the day-to-day operators of these companies because we have that talent there. But in terms of working with them, analyzing them, asking questions, trying to help evaluate future opportunities, that's something we dedicate a lot of time to. And even as we think about growing our business, we really don't want to stray from that model. And if anything, if you were to look at entities that you may want to consider comparable to us, I think what you might find is that you've got the senior-level professionals, perhaps being primary relationships with 6, 7, even 8 companies. I don't see that ever happening for us. I think that having senior-level investment professionals that have relationships with 3 or 4 companies is probably as thin as we would want to get.

Unknown Attendee

I have 3 quick questions. First one is, what is the share of maintenance CapEx? That always going to be like 6%, 7% of EBITDA for new companies? Second question is about, what percentage of distributable cash flows you're distributing in dividends? And the third one is, since you're lending to your own companies, have you ever taught about your business structure?

Alan B. Offenberg

So the percentage of maintenance CapEx relative for new companies, it's I think if you were to look at the companies we have now, it's probably indicative of the general level of maintenance CapEx but it's hard to predict. Is not as though we have a target rather I would say when it comes to valuing companies, we are focused on free cash flow, which certainly incorporates capital expenditures. And the EBITDA is a nice convention, obviously, to talk about, but CapEx is real cash flow for a company. So I don't -- I just want to make sure I'm answering your question, I don't -- we don't have a specific target. I think the level of maintenance CapEx you see across our group of subsidiaries is a good representation of about what future maintenance CapEx for new companies would be?

James J. Bottiglieri

Historical to that [indiscernible]

Alan B. Offenberg

Yes, thank you, Jim. The second question about the percentage of cash flow available for distribution and reinvestment that we paid in distribution, historically that's been about 70%.

James J. Bottiglieri

It includes the gains on sales on top of our cash flow generation, it has been historically up 30% of our cash flow is distributed.

Alan B. Offenberg

Right. And the last question, about the BDC structure. We -- it's not something that we would look to migrate towards. I think that our business model is different than a BDC that we are only lending to companies that we own and have control, investments in. So being a lender is just on a standalone basis, to a company that we didn't own, is not part of our business model. Furthermore, our structure allows us a greater level of flexibility with respect to our distribution as compared to a BDC that has statutory requirements and dictates the amount of capital that they need to provide any distribution. And I think for us, what that is really allowed us to do over the years is a lot of the BDCs had trouble back when the market was tough for their businesses back in 2009, for example, and had a hard time being able to sustain their level of distribution because they have to distribute out so much, whereas we've been able to -- well, not earn our distribution every quarter of every year, by virtue of how our distributions, coupled with our gains had worked, we've been able to, for lack of a better term, have some set aside for a tough time to provide us a buffer, such that we never had to reduce our distribution and we've always been able to sustain it, and from inception to the present have earned it. So I think that flexibility, candidly, I think it's better for our shareholders and better for the stability of our stock price.

I don't know if you need a microphone from that level, but maybe for those being recorded.

Unknown Attendee

So one question, I mean, the one that sticks out is American Furniture. I guess you guys paid like almost $100 million for it. It doesn't seem like it's worth a fraction of that, it's losing a lot of money.

Alan B. Offenberg

I wish I could disagree with you.

Unknown Attendee

Yes, so, what's the plan there? I mean not to -- things happen, but it's a tough business.

Alan B. Offenberg

Yes.

Unknown Attendee

So the management is great, but what's going on there?

Alan B. Offenberg

Yes. So we've obviously lived through a tough time with American Furniture. We bought it at a peak, both in its performance as well as probably the peak of the overall economy back at the time. And we've had really challenging times since then. I think the way we've thought about American and continue to think about it, well, first, the first decision we had to make was with the company's underperforming, how do we feel about our initial investment thesis, how do we feel about our ability to help the company get to a point where it can be self-sustaining. And I think what we first found was that the investment thesis, although I would say, we overestimated the company's reason to exist, elements of the investment thesis still hold true. And I think the company remains resistant to Asian imports because of the price point that they serve, so it's hard to -- whereas other furniture companies have been decimated by either cheaper import products, it's hard to ship bulky upholstered furniture and land it here in the United States at a price that is as good as what American can deliver to its customers. The other thing that is, is American's customer base. So if you take companies like Bob's or Big Lots or Value City, these are customers that can demand 5,000 pieces of furniture in 4 weeks' time. And only a domestic producer can really satisfy that need because it's just again it's hard to get things on both than have them built and have them shipped here and distributed in some of the time constraints that are put out there by the promotionally priced furniture retailer. So I think that the company has a position in its market that is valuable and one that should see better days. However, so once you check that boxes then, okay, well, the company wasn't making money, it was losing money and had some real challenges and so, can you fix that? Can you get the company to the point where it's self-sustaining? And I would say, that was a question that we spent a lot of time trying to figure out and really suggested to ourselves that if we couldn't, if the company -- it's always easier to exaggerate for effect, that the company was going to lose $10 million a year, indefinitely, until such time that there was an economic rebound. But that's not something we would have thought was a good idea for us to continue to hold and wait for. Fortunately, the company has been able to make some pretty dramatic changes in both its management, it's cost structure, it's new profile, it's customer relationships, to the point where the company is on track to be cash flow breakeven for this year, if not even better. Jim, I don't know if you're going to be upset with me for saying that. But that's slightly better. That's fine. And so, I think because we're able to achieve that and are on track for that, we then have to think about, okay, now where do we stand? And we believe that provided that American Furniture can be self-sustaining, that there is opportunity for the company to see meaningfully better financial performance down the line with housing rebounds, with an economic rebound. I certainly am in no position to tell you when I think that will be. However, if the company can be self-sustaining until that time, we think right now is basically it represents an option on an economic recovery, and it's a situation that isn't demanding and extraordinary or an outsized amount of our management team's dedication and time. And it's not preventing us at all from pursuing our growth initiatives, and if it was -- because that's another thing you have to consider, if it's taking time away from things you would otherwise be doing to build value, is that the right thing to do for your shareholders? And if it's not interfering in that way, it's currently self-sustaining, we believe in elements of its business model and we think it can perform well in an economic recovery, our position right now is that it's something we should hold onto and...

James J. Bottiglieri

Right now, I just wanted to add that we fully incurred their business, so basically, it's all stuck on the [indiscernible]

Unknown Attendee

It's working capital

James J. Bottiglieri

As Alan mentioned in his [indiscernible]

Unknown Attendee

[indiscernible] option on the economy.

Alan B. Offenberg

Right. But if the company's performance deteriorates, in a meaningful way, we might be faced with difficult decisions, but I don't foresee that any time in the near term and I'm more optimistic about American Furniture's opportunity to improve today than I've been in quite a while.

Unknown Attendee

Can I ask some more follow-up questions? Unrelated. The second one was, you sold a bunch of businesses. And so I was wondering, like, when you decide like, "Oh, I'm going to sell a business." I assume that you think that, well, you got the gain and then you'll have to redeploy that capital into something better. But just to understand the thought process and also as an investor, should I give you credit for making distributions from gain? Are they things that I can say, these are going to be sustainable? Or should I not?

Alan B. Offenberg

You want to take over for a little while? I've been -- they've heard enough of me.

Unknown Executive

So on the first question regarding sales of businesses, it's a little bit more complex than that, I mean, in some instances, the company's been approached by strategic buyers and I think it's a proverbial offer you can't refuse. In many cases, it is in combination with management, identifying when is the right point for the company to seek different ownership or that ownership may be able to expand it it's earnings because their synergies or other opportunities that we aren't able to take advantage of in our current structure. And so we don't have poor sale signs on our businesses, but generally, opportunistically, there are times when these companies are approached or when the markets are just so strong that it does make sense for us to divest and then look for assets that fits the profile and the growth opportunity that we think we can have a meaningful impact on. In terms of your second question regarding the distribution and where the distribution is funded, as Jim said, if you include both the free cash flow and you include the gains spend roughly 70%. Although we do strive to have our free cash flow cover all of the distribution, and I think in most of the years absent 2009, where we made a decision, strategically, to maintain the dividend, when most yield-oriented vehicles were cutting their dividend, we did have our dividend and see our distribution -- excuse me, exceed what our free cash flow level was. But beyond that, and last year, we covered our distribution, we expect to be able to do that with the growth profile of these businesses to produce enough cash flow, both to invest back in the businesses and cover the distribution on a free cash flow. So in our -- in a way that we manage the businesses is that we need to rely on asset sales in order to fund the distribution.

Unknown Attendee

And last question is, I'm just trying to understand how to place you guys. As far as I know, you're not the BDC, you're not Berkshire Hathaway, which doesn't have distribution insurances. And just help me understand how I should contextualize. Is this like buying a publicly traded private equity fund and being an LP? Is that what this is like, except you make distributions made known or how should I understand this?

Alan B. Offenberg

That's a question we spend a lot of time actually meeting with investors in trying to tell our story. I would say that it is not too unfair to characterize as you did as a publicly traded private equity firm, but I'd make a few key notable exceptions, in addition to the one you made, which is, yes, we make distributions. Number two, we provide a level of transparency that you're never going to see from a private equity firm. Number three is, in fact, unlike a private equity firm, when you've made commitments to your fund, which could be tied up for 10 years if they changed your style along the way, you're still stuck there. Or you could try to sell it as a secondary market, but that's not particularly liquid. Whereas if you don't like what we're doing, you can sell your shares in us and move on. But I'd say the most important differentiator is that, again, we sell businesses opportunistically from time to time. But we buy -- every subsidiary, we buy, we buy towards with a view towards owning it forever. And invest in those businesses and look to build them, as if we're going to own them forever. And there may be some that we do own forever, depending on how things go. So I think that -- and Elias made a critical point earlier, when you think about us compared to a private equity firm, our permanent capital public structure eliminates the pressure that a private equity firm can have on the front end of their fund, which is to deploy capital before their investment period is over. And then on the back end, which is to harvest their capital because they have to go get it, then go raise another fund. We don't experience any of that. So we are basically a publicly traded partnership. But you have I think a much better position as a shareholder of CODI than you do as a limited partner in a private equity fund.

Would you -- Elias will elaborate on...

Elias J. Sabo

Yes, and I mean to Alan's point, the one piece of elaboration, is the way the time line in the permanent capital, unlike a traditional private equity fund, allows us, and Pat alluded to it, to make investments in the business not just to -- we hear from management a lot when we meet with them. We don't want to be out in the private equity treadmill anymore. 2 years in, lean out the SG&A of the company and then put us up for sale, because we have to go with that business, and now we have a leaned out cost structure, probably didn't invest a lot in capital expenditures and we have to go with the other businesses and now represents the new owner that we have all of these growth opportunities. It's a very difficult thing for management and I think it's one of the things that private equity has historically done to gain a lot of returns. Where we are truly different is we view ourselves more as a strategic acquirer of these businesses in a long-term investor. We think a much longer purview in terms of return on invested capital and making the right investments in these businesses and, by and large, if we are divesting a business, this is a healthy company that has adequate investment, has good revenue growth, far better than what the market has been growing at, so that we're taking share and they're set up for that. And that's why we've been able to achieve what I'll call our strategic multiples on sales of our businesses because of that. It's a real large differentiator from what I would consider the traditional private equity model. So although some of the characteristics of how we operate may have private equity comparisons in them, I would say the way that we execute the business model is much more of an invest and grow, like a traditional strategic public company acquirer would.

Unknown Attendee

I have 2 questions. First, how do you incentivize the managers of your subsidiaries?

Alan B. Offenberg

Our management teams that our subsidiaries all have both salary and bonus plans as well as equity ownership of their individual unique subsidiary. So typically in the form of both common stock as they invested cash in at the time of our acquisition of the company, as well as an option plan that will put in place with the management team. So there is again, salary, annual bonuses typically tied to performance relative to that year's budget, and equity upside in the form of both common stock as well as options in their subsidiary.

Unknown Attendee

An unrelated question, is there considerable tax shelter in the distribution? How was that created?

Alan B. Offenberg

Jim?

James J. Bottiglieri

Sure. So as we mentioned, we are the [indiscernible] businesses, so the way income falls up to us -- first comes up to us as interest income on the company debt as well as taxes, ordinary income. At Compass, the rest of the cash flow comes up to the business as a repayment of a principal debt, so it takes a combination of how order cash flow comes up either as interest income or debt on any given year without a sale of the business. It typically runs about 50% return of capital and 50% taxes and ordinary income.

Alan B. Offenberg

The microphone is on its way.

Unknown Attendee

Could you talk about a bit about the pipeline for acquiring new companies this year? Would expect to acquire a new one before the end of the year? And then on the other side of that, could you talk about a bit about what you're looking in raising additional funds? And then would expect these to be dilutive or [indiscernible]?

Alan B. Offenberg

Sure. Some of your questions are going to be hard for me to answer directly. So I appreciate what you're trying to determine, but some of them are going to be tough to answer directly. If you'd like, I think that we would, based on the level of activity that I chatted about earlier, which is improved slightly, we certainly would like to acquire another company this year-end and hope to be able to do that. But it's really impossible for me to tell you without any question that, that will happen. But we think that we are in a good position to hopefully execute on that to the extent all of the other dynamics associated with making that acquisition or acquisitions, plural depending, or how they all play out. So just like any other year, we like to acquire a new subsidiary company each year. We hope to be able to do it this year, but it's really just tough for us to be able to guarantee that. In terms of raising new capital, that's really going to be dictated by our growth and to the extent we need supplemental capital to support our growth, whether or not our existing liquidity supports it. So again, a very difficult thing to let you know when or how or what form. I am comfortable letting you know that we feel very confident in our ability to raise -- increase our existing debt facilities if need be to raise public debt and to raise equity based on our performance and based on the current status of the capital markets. So I think all forms of capital raising are available to us to the extent we need it, but it again will be driven by our existing liquidity, coupled with whatever capital we may need to the extent it's inadequate -- our current level is inadequate to support our growth.

Unknown Attendee

[indiscernible]

Alan B. Offenberg

Yes, well, I think all of the equity -- every time we raise equity it's by definition will be dilutive to the existing equity owners. And so --

James J. Bottiglieri

When combined with an acquisition, these acquisitions are accretive, take into consideration the equity.

Alan B. Offenberg

That's right.

James J. Bottiglieri

If you just look at the equity line itself, they're obviously dilutive.

Unknown Attendee

Alan, earlier you mentioned an option on economic recovery. Just based on what you're seeing through the eyes of your subsidiaries, what's your take on the state and direction of the current economy?

Alan B. Offenberg

Yes, it feels solid. I would say concern remains. As Sally mentioned, that the macroeconomic things that are -- be it social unrest in certain countries, be it just concern about monetary policy, we have a whole lot of things at a real macro level that I think bring concerns to each of our subsidiaries for different reasons. Yet as evidenced by our first quarter reported results, performances of our businesses are solid, so -- and we expect them to be solid as a group for the year. But it's not a period of exuberance or one where people are comfortable, even in the face perhaps of solid performance, to say we're going to knock it out of the park this year. I think there is still that overriding concern that there could be pressure, but not a real allocation of why specifically they feel that way. And I don't think that so -- unfortunately, it's hard to speak beyond, again, our group of subsidiary and what they've done in the first quarter, which was great. But I think that there's -- So I think it will be a solid year and the economy feels solid, but not always completely surefooted, if that makes any sense. You're our resident economist, Elias. Would you like to have a crack at that?

Elias J. Sabo

I would concur.

Alan B. Offenberg

Okay.

Well, it appears as though there are no further questions. So thank you, all, again for being here. We really appreciate your attendance and your support and feel free to be in touch with us if we can ever be helpful to you as you evaluate CODI. Thanks.

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Source: Compass Diversified Holdings - Shareholder/Analyst Call
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