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Compass Diversified Holdings, Incorporated (NYSE:CODI)

Q4 2007 Earnings Call

March 12, 2008 9:00 am ET

Executives

Joseph Massoud – Chief Executive Officer & Director

James J. Bottiglieri – Chief Financial Officer & Director

Elias

Alan

Analysts

Larry Solow – CJS Securities

Vernon C. Plack, CFA – BB&T Capital Markets

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Jeff Smith – Eagle Investment Management

Jim [Coran] – New Salem Investment Management

Operator

Good morning and welcome to the Compass Diversified Holdings 2007 fourth quarter and year end conference call. Today’s call is being recorded. At this time all lines have been placed on mute. (Operator Instructions) At this time I’d like to turn the call over to [Nick Rust] for introductions and the reading of the Safe Harbor Statement. Please go ahead sir.

Nick

Welcome to Compass Diversified Holdings 2007 fourth quarter and year end conference call. Representing the company today are Joe Massoud, CEO and Jim Bottiglieri, CFO. I would first like to point out that the Q4 press release including the financial tables is available at www.CompassDiversifiedHoldings.com. In addition, management expects to file Form 10K for the year ended 7/31/2007 with the SEC by the end of the week. Please note that this presentation we will refer to Compass Diversified Holdings as CODI for the company.

Before I turn the call over to Joe for his opening remarks, allow me to read the following Safe Harbor Statement. During this conference call we will make statements that contain certain forward-looking statements including statements with regards to the future performance of the company and each of its businesses. Words such as believes, expects, projects and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ materially from those projected in these forward-looking statements. Some of these factors are enumerated in the risk factors discussion in the Form 10K to be filed by the company with the Securities & Exchange Commission for the year ended December 31, 2007 and other filings with the Securities & Exchange Commission. The company undertakes no obligation to publically update or revise these forward-looking statements whether as a result of new information, future events or otherwise.

At this time I would now like to turn the call over to Joe Massoud for his opening remarks.

Joseph Massoud

Good morning everyone and welcome to today’s earnings conference call. During this call we’d like to accomplish a few things. In addition to discussing our operating results for the quarter and the year, we’ll also review our recent acquisition activity. Before that however, given the current volatility in the public markets we’d like to use this opportunity to distribute broadly some very important facts so let’s us make the following points very clear regarding Compass Diversified Holdings or CODI. Number one, as you will here in more detail CODI’s cash available for distributions increased significantly from 2006 to 2007. On a per share basis fourth quarter to fourth quarter that increase was 17% from $0.48 to $0.56. Unlike most participants in the broadly defined financial industry, and unlike many private equity firms that have received much coverage in the press, we had an excellent fourth quarter and an excellent 2007. Number two, in 2007 and since inception we’ve had a distribution coverage in excess of 1.3 times. This provides us with three things: a) the ability to reinvest in our business without raising outside capital; b) significant defensive and downside protection to that distribution if necessary; and c) additional room for growth of the distribution subject to the board’s decision on that matter. We expect to continue to have significant coverage over our distribution in 2008 notwithstanding the state of the economy. Number three, since our May, 2006 IPO we have increased our distribution level by 24%. As has always been and continues to be the stated intention of our board to provide regularly increasing distributions to our shareholders over time.

Number four, we currently have no liquidity concerns whatsoever. In fact, at a current leverage of less than two times debt to EBIDTA we are substantially underleveraged. Number five, as a result we continue to have significant availability to make accretive acquisitions or add on platform acquisitions with our existing committed debt facility. Number six, we believe the current environment is extraordinarily fertile for those few acquirers, including us, who currently have the ability to finance acquisitions without outside financing. Our acquisition of Fox Factory and Staffmark in January were the direct results of our structural capabilities. Furthermore, our experience in the last recession in 2000 to 2002 was that this environment was extremely fertile for us from both an operating point of view as our company picked up market share and customers from weaker or more leveraged competitors and also from a new acquisition perspective as we became one of the few sources of available capital in the market. We are beginning to see this current environment unfold similarly.

The current state of the market also appears to have led some investors to attempt to group companies and their respective prospects. In our case I think this might be a mistake. In particular, I’ve seen our stock trade generally with the yield base specialty finance company or asset managers despite the fact that our company is simply a group of eight easy to understand manufacturing distribution and services businesses each serving a particular niche in which it is leader. For example, we are not a business development company. This means we are not broadly exposed to credits across a number of companies for which we have varying degrees of knowledge. To reiterate, we control eight niche leading healthy businesses and are excited about the prospects of each and every one of them. As a result, we control our own destiny. We are not owners of some tranche of security which is behind another lender or dependant on the efforts of a private equity firm to do the right thing. We in the subsidiary management teams are in the driver’s seat.

Furthermore, we have not been distributing 90 to 150% of our annual cash flow in the past as I have seen rumored that some of the yield based specialty finance companies have done. We have maintained a substantial coverage of our distribution providing significantly more scrutiny to our security to our distribution rate as well s potential for growth. We expect to continue to have a significant cushion in 2008 despite the current economy. Importantly, our financial statements are tremendously transparent. As investors you know how each of these businesses is doing and can track their individual progress as well as our overall results. There’s no guess work as to how much cash flow we are actually earning. We deliver the cash available for distribution calculation in our financial statements and provide a company-by-company analysis.

As noted earlier we are not overleveraged. Much of the recent press highlights private equity firms that have gotten in trouble acquiring similar businesses to those we own. These transactions are substantially more leveraged and therefore more at risk to changes in the economy. Furthermore, we are proud of our average acquisition multiple which we believe has been materially lower than those of comparable companies sold to private equity firms over time. This is largely due to our business model which allows us the luxury of patience both on the acquisition and ultimate exit side. We are also not regulatoraily constrained and our ability to raise capital and to reiterate we have current capacity to consummate additional accretive acquisitions.

Another distinction is that unlike business development companies or even the private equity asset managers that trade publically, our ability to generate cash flow and growth is not dependent on transactions. We expect our cash flow to grow organically and we do not have assets that are naturally shrinking like loans that amortize, pre-pay or cease to perform or funds that we manage with finite lives. At the end of the call we’ll be happy to elaborate further on any of these differences if you would like.

Turning to an overview of our specific performance, I’m very pleased to report strong performance in each of our current portfolio diverse businesses. As evidence of this performance and the growth our company, as I said before, our count in the fourth quarter was $0.56 per share as compared to $0.48. As a result of our [CAD] growth, the board of directors increased our quarterly cash distribution to shareholders in the third quarter 2007 to $0.325 per share which was an 8% increase over the rate for the second quarter and a 24% increase over the original rate. The board will continue to evaluate the distribution on a quarterly basis with the intent of increasing the distribution over the long term as we grow our current businesses and make accretive acquisitions.

Our performance in 2007 was built upon the favorable results of our portfolio businesses as well as the strength of our acquisition activities. Each of our businesses performed in line with our expectation and met not only with their financial goals for the year but also critical strategic objectives. On the acquisition front we completed three new acquisitions each of which were accretive to our shareholders: Halo Branded Solutions, Aeroglide Corporation and American Furniture Manufacturing. Each of these companies brings to CODI a strong operating platform and highly competent management team. In addition, the ability to complete these acquisitions in a very difficult credit environment validated the strength of our permanent capital platform. Since the beginning of the year we’ve completed two significant transactions.

On January 4th we acquired our eight subsidiary business in Fox Factory, Inc. a leading designer, manufacturer and marketer of high end suspension products for mountain bikes, all terrain vehicles, snowmobiles and other off road vehicles. The Fox acquisition is performing extremely well for us and is expected to show revenue and cash flow growth in 2008 and will be accretive to us in 2008 and well beyond. In addition to its current strong performance the further opportunity to build the Fox management and CODI shareholders is present on both the revenue and profit margin side of the business. We are excited about the platform and we believe that the current environment was an important facilitator to our ability to be the successful acquirer in this case at the valuation at which we were able to acquire it.

On January 23rd, CODI capitalized CBS Personnel with the acquisition of Staffmark Investment, LLC. We believe the addition of Staffmark will enhance CBS Personnel market, geographic and product diversity as well as increase its density and ability to serve customers in many of its key markets. The company now has over 400 branches in 35 states. Integration plans have been developed and the integration is well under way. Our team at CBS is taking a best of breed approach optimizing the senior and mid level management teams that both entities brought to the table. There will be a limited number of branch closings and in those cases only where there is significant geographic overlap. As a result of this approach we did not expect to suffer significant customer losses from the merger and are pleased to report that this goal is well in hand. In addition, we are confident in our internal projections for corporate costs synergies as well as the ability to optimize product offerings across our combined customer base.

In terms of the effect of the economy on the combined CFD Staffmark business I have a couple comments. First, there’s no doubt that the current softness is affecting the industry as a whole as well as our company specifically. Please keep in mind that we as a CODI management team and CBS management team have been together since 1999 and managed successfully through the 2000 to 2002 downturn which was a deep one in the staffing industry. We are aware of the impact of the economy and believe that the timing and structure of our acquisition are ideal given the nature of cycles in this industry. As a result of management’s efforts and dense geographic model, CBS outperformed its public industry peers in managing its revenues during that period of downturn. More recently CBS has again outperformed its public industry peers in terms of both revenue growth and operating margins in 2007 and we are optimistic that this will continue over the course of 2008. In addition, bearing in mind where we stood in the economic cycle this transaction was structured extremely defensively in that it involved only approximately $80 million of cash adding $18 million of 2007 EBITDA prior to any cost synergies. In addition, we acquired substantial tax assets which shield virtually all of that cash flow from taxes so the transaction is materially accretive to cash and available for distribution even in a down economy. In the short run we expect the combined entity to be better for CODI’s cash flow generation capabilities than CBS would have been alone particularly given the impact of the economy. We also expect in this downturn to repeat our strategy of the last downturn rapidly adding customers in our core markets as our density allows us to continue to serve those customers even as other competitors close branches and exit those markets. Beyond the current cycle we firming believe in the long run a company of this size in this industry should be very interesting for our shareholders to own at our embedded valuation.

With those introductory comments complete I’d like to turn the call over to Jim Bottiglieri to discuss our fourth quarter and yearend financial results.

James J. Bottiglieri

Today I will review our financial results for the quarter and year ended December 31, 2007 including a review of the operating results of each of our subsidiary companies. On a consolidated basis revenue for the quarter and year ended December 31, 2007 were $208.1 million and $917.9 million respectively. Net loss for the quarter was $3.4 million or approximately $0.11 per share. The net loss was primarily due to the recording of a $10 million minority interest expense associated with the $47 million ACI refinancing done in October, 2007. For the year ended December 31, 2007 net income was $40.4 million or $1.46 per share. Net income for 2007 includes a $36 million gain recorded from the sale of Crossman Acquisition Corporation on January 5, 2007.

Turning now to results of our individual businesses. Advanced Circuits – For the quarter ended December 31, 2007 Advanced Circuits revenue increased to $13.2 million compared to $11.6 million for the quarter ended December 31, 2006 largely due to increased sales from prototype and quick term production. Income from operations for the fourth quarter were $3.7 million compared to $1.8 million for the same period in 2006. The increase in operating income was largely due to the operating profit resulting from the increase in sales and from lower non-cash charges associated with ACI loan forgiveness program of approximately $1.4 million. For the full year ended December 31, 2007 Advanced Circuits revenue increased to $52.3 million compared to $48.1 million in 2006 due largely to increased sales from prototype and quick term production. Income from operations in 2007 increased to $17.1 million compared to $12.6 million for 2006. This increase was principally due to the operating profit generated by higher sales in 2007 and from lower selling and general administrative expenses mainly due to lower non-cash charges of approximately $3.5 million in fiscal 2007 associated with ACI’s loan forgiveness program.

Aeroglide – for the quarter ended December 31, 2007 Areoglide’s revenues increased to $18.6 million compared to $14.3 million for the same period last year principally due to increased machinery sales. Income from operations for the quarter ended December 31, 2007 was $2.4 million compared to income from operations of $2.3 million for the same period in 2006. The increase is attributable to the operating profit generated from the higher sales and was partially offset by the increased amortization expense of $.5 million due to the amortization of intangibles recognized in connection with our purchase of Aeroglide in February, 2007. In 2007 revenue increased to $64 million compared $48.1 million for 2006 due predominately increased machinery sales. Income from operations for fiscal 2007 was $3.7 million compared to $6.1 million in 2006. This decrease was due to a $4 million increase in amortization expense due to the amortization of intangibles recognized in connection with our purchase of Aeroglide which more than offset the operating income resulting from the increased sales level. Aeroglide continues to maintain [inaudible] level of new machinery backlog.

American Furniture Manufacturing – for the quarter ended December 31, 2007 revenues decreased to $35.5 million compared to $40.6 million the prior year quarter. Operating income was $2.1 million compared to $2.4 million for the fourth quarter of 2006. This decrease was due to lower sales partially offset by higher gross profit margins due to raw material costs savings and improved labor efficiencies. For the year, revenues in fiscal 2007 were $156.6 million compared to $165.4 million for the comparable prior year period primarily due to the soft retail climate in the furniture industry. Operating income was $10.9 million compared to $9.9 million in the comparable period in 2006. This increase in operating income was due to higher gross profit margins of 22.9% in fiscal 2007 versus 21.1% in fiscal 2006 resulting from the factors previously numerated. Lower amortization expense of $400,000 also contributed to the increase in operating income. In terms of an update on AFM operations in Mississippi, as reported last month American Furniture Manufacturing sustained a fire at its main production facility on the evening of February 12th. In the four weeks since the fire the team at American Furniture has worked tirelessly to restore production capacity and vigorously responded to this challenge. In short order production has been started at temporary facilities on restoring manufacturing capabilities to greater than 80% of pre-fire levels. Since the fire we have carefully reviewed the situation and believe that this event will not materially impact American Furniture’s ability to produce cash flow in the medium to long term. In fact, we are encouraged by the positive response we have received from American Furniture’s customers continued to be enthusiastic about the future of this business.

Anodyne Medical Device – for the quarter ended December 31, 2007 Anodyne’s revenues increased to $14.7 million compared to $8.1 million for the same period last year largely due to sales from new product roll outs and from the inclusion of sales from Primatech which was acquired subsequent to last year’s quarter. Income from operations increased to $1.1 million compared to $.6 million for the same period in 2006. The increase in operating income is largely due to the increased sales. For the full year 2007 revenue increased to $44.2 million compared to $23.4 million on 2006 due to sales from new product roll outs as well as the inclusion of a full year sales of Anatomic which was acquired in October, 2006 and a partial year sales from Primatech acquired in fiscal 2007. The sales increase was also due to fiscal 2006 consisting of only 10.5 months as Anodyne began operations on February 15, 2006. Income from operations increased to $2.9 million compared to $.3 million for the prior year. This increase in operating income is due to the increase in sales partially offset by higher amortization expense of approximately $.6 million.

CBS Personnel – for the quarter ended December 31, 2007 CBS Personnel reported revenue of $148.2 million compared to $144.5 million for the same period last year principally due to the inclusion of sales from the acquisition of SCS which was acquired in November, 2006. Excluding SCS revenue declined quarter-over-quarter by approximately $3 million due principally to weaker economic conditions. We believe this decrease is less than the decrease reported by most of the companies publically traded peers and further believe this is evidence of CBS getting market share in the markets in which it operates and is a further affirmation of CBS dense operating model. Income from operations decreased from $9.4 million for the fourth quarter of fiscal 2006 to $7.8 million for the fourth quarter of fiscal 2007. The positive impact on operating income resulted from the increased sales was more than offset by lower gross profit margins resulting from the higher mix of lower margin light industrial accounts resulting both from the SCS acquisition which primarily provides light industrial staffing and from incremental growth in this sector. For the full year 2007 CBS Personnel increased revenues to $569.9 million compared to $551.1 million due to the same factors that affect the results for the quarter. Income from operations decreased to $22.5 million in fiscal 2007 compared to $23.2 million in 2006. Operating income decreased largely due to the impact of the declining gross profit margins to 18.5% in fiscal 2007 versus 19% in fiscal 2006 for the reasons explained above. The decrease in profit margin had a larger impact than the increase in sales.

Halo Branded Solutions – for the quarter ended December 31, 2007 Halo’s revenues increased to $51.9 million compared to $39.8 million for the same period last year principally due to acquisitions made since September, 2006 and from increased sales to existing customers. Income from operations was approximately $5 million compared to approximately $3.1 million for the same period in 2006. The increase in income is largely attributable to increased sales partially offset by $.6 million of amortization expense associated with the amortization of intangibles established in connection with our purchase of Halo in February, 2007. For the full year 2007 Halo’s revenues increased $144.3 million compared to $115.6 million for 2006. Income from operations increased to $6.6 million compared to approximately $6.1 million in fiscal 2006. The increase in revenues is attributable to the full year impact of acquisitions consummated during 2006 and from Halo’s 2007 acquisition. In combination these acquisitions contributed $22.3 million of the increase in sales. The increase in operating income was a result of the increase in sales being partially offset by $1.8 million of increased amortization expense.

Silvue Technologies Group – for the quarter ended December 31, 2007 excluding the sales and operating income from Silvue’s Henderson Nevada application facility that was shutdown in 2006 revenue increased $6.1 million from $5.6 million in fiscal 2006. Income from operations was approximately $2.1 million in the fourth quarter of fiscal 2007 compared to $1.9 million for the same period in 2006. For the year ended December 31, 2007 Silvue’s revenues increased to $22.5 million compared to $21.3 million in 2006. The 2006 revenue numbers exclude $2.8 million of revenues from the Henderson facility. Income from operations was approximately $6.5 million compared to $5.9 million in 2006 again, excluding the operating profits from the shutdown facility in 2006.

For the quarter and year ended December 31, 2007 CODI reported cash flow available for distribution of $17.7 million and $46.3 million respectively. For the period from its initial public offering on May 16, 2006 through December 31, 2007 CODI reported cash flow available for distribution of $70 million and a coverage ratio of approximately 1.4 times on all distributions paid through January 30, 2008. Turning to the balance sheet we had $19.4 million in cash and cash equivalents which was subsequently used to partially fund the purchases of Fox and Staffmark. We also had net working capital of $192.6 million as of December 31, 2007. Subject to borrowing based restrictions at December 31, 2007 CODI had $325 million in revolving loans available to be used to fund acquisition and working capital requirements.

I will now turn the call back over to Joe.

Joseph Massoud

Looking forward to 2008 we see an economic environment that is uncertain and we’re planning accordingly. Notwithstanding this factor and even with the impact of the economy on certain of our businesses which are cyclical in nature we are confident in the ability of each of our businesses to perform within their niche market and believe that overall 2008 will be a strong year for CODI in terms of cash flow generation. The model was created to capitalize on the strength of the overall mix of businesses then we believe it is playing itself out. We are also confident that our financing model and the current credit environment will allow us to consummate exciting and accretive acquisitions such as Fox Racing Shocks and Staffmark both of which were acquired earlier this year.

Regarding our stock price, we are needless to say disappointed. While not knowing exactly why our stock has moved in the direction it has it does seem that we have been lumped in to some extent inappropriately with the financial sector broadly. Substantial material differences were noted at the beginning of the call. As an attempt to further educate the market however, we are attempting to reignite our investor relations efforts. I have been and will continue to speak to as many investors as possible as well as present at various conferences and talk to as many research analysts as possible. We believe that 2006 and 2007 have been excellent years from the operating and cash flow point of view for CODI and that we’ve rewarding our shareholders well through our substantial increases in distributions. We are also confident and excited about 2008 and beyond however, we understand that part of having this reflected itself in our stock price is communication to a wider audience.

Before opening up the call to questions, let me once again reiterate that our model to grow cash flow per share consists of two fundamental strategies: working with our management teams to grow our existing businesses and identifying attractive and accretive acquisition opportunities. We believe that the future is bright for CODI on both fronts and we’re confident in our ability to execute against our strategy of consistently increasing our cash flow per share and our distribution to shareholders. Thank you for your time and we’ll be happy to take any questions you may have. Operator please open the phone line for questions.

Question-and-Answer Session

Operator

The question and answer session will be conducted electronically. (Operator Instructions) We’ll take our first question from Larry Solow with CJS Securities.

Larry Solow – CJS Securities

Could you just elaborate a little more, there’s been some concern over your distribution coverage and I know you don’t like to give specific guidance but could you like say do you have like some kind of worse case downside baked into your assumptions and what that would do to your coverage ratios in 2008?

Joseph Massoud

One, you’re right we don’t give guidance and two, there is a variety when you say worse case there are so many cases. I can tell you that as we torture our numbers on a company-by-company basis there is no case in which we don’t have healthy positive coverage of our distribution. My sense is that our best case is that the coverage is going to look like what its looked like in the past depending on what our board decides to do with the distribution in terms of potentially increasing it as some point during the year. But, from a worse case point of view, sort of really taking a gloomy view of the economy, at this current time we still see pretty healthy and positive coverage of the distribution. Jim, is there anything you’d add to that?

James J. Bottiglieri

No. I think under all scenarios that we ran we at least covered the distribution completely.

Joseph Massoud

I mean we ran – now I’m talking and I’m hesitant because I think we’ve tended to be in our past both as Compass Diversified Holdings and prior among the more conservative and bearish groups that I know. I have a nick name internally as being a perm-a-bear because we always look at our companies and say, “What if this happens? And, what if that happens? And, what if it goes bad like this? And, what if it goes bad like that?” Notwithstanding all those scenarios we still have positive coverage. I think more realistically given what we’re seeing in the environment I think our coverage will continue to be as healthy as it has been in the past.

Larry Solow – CJS Securities

Then, just to elaborate there’s been some probably increased concerns, just you most recent purchases are probably into more cyclical companies and obviously you see the economy, you know what’s going on, can you just discuss kind of your strategy.

Joseph Massoud

I don’t know if I would disagree with the premise. The two most recent purchases have been Fox and Staffmark and I think in one case its actually spot on and the other case it’s not. I’ll deal with the one that’s not. In terms of Fox Factory what we’re seeing is significant growth in the business. I understand it’s a consumer disposable but given the company’s sort of global reach and its penetration into new markets and its increasing placement with its customers we don’t expect this company to suffer cyclically and haven’t been seeing it suffer cyclically. So, I disagree with that notation on Fox. On Staffmark, clearly staffing is a cyclical industry. I think the good news is if you look at the data as we track it if some of the major public comps last year were down 4 to 8%, I think our same store Jim just mentioned were down 2% it reflects the model of the business, it also reflects the strength of our management team which we think and have had comments from outside analyst who know the industry, we think it’s literally the best management team we’ve met in the industry bar none did a great job from 2000 to 2002, outperformed over a 12 quarter period the public comps in every single quarter. So, while it’s cyclical we think our management team is the right team to manage through the cycle.

Then if you at the transaction structure the transaction structure very specifically was made, the sellers of that business had a long term view on the growth potential and the opportunity associated with these two companies powerfully being together and were interested in owning equity of the combined business. We were also interested in having them take back equity because from an accretion point of view we were very concerned about putting cash out the door with its related costs in an environment in which earnings could go down. So I will again point to the fact that this is a business that had 2007 $18 million earnings of EBTIDA, you know the industry Larry is a virtually non cap ex industry, there’s almost no tax paid at that level of cash flow because of the cash assets that we also required. So, you’re talking about buying a business effectively buying its cash flow for four times which gives you a lot of cushion to accretion. If the business had stayed flat this company would be monstrously accretive and even if it declined in the kind of 10 to 15 or even 20% range from a cash flow point of view it’s still materially accretive. So, no doubt the company itself is cyclical but there’s also no doubt from anyone who cares to look at the transaction that it was structured in a way that virtually guarantees it will be accretive regardless of the economy and given the tremendous revenue and costs synergies available from a combination if you look out a couple years the combination of this business is going to be a very exciting one we think for CODI shareholders.

Again, premise I would half disagree with because I don’t think it applies to both acquisitions. But, even in the case that it does apply its more than just saying, “Hey you bought a staffing company we’re going into a recession, why did you do that?” You have to think about how we structured it and you have to think about our history. We have already doubled the size of CBS once by doing the virtual identical thing coming out of the last downturn. So, this is a model that we’re pretty familiar with and to be blunt we’re pretty confident about.

Larry Solow – CJS Securities

Lastly just on the American Furniture [inaudible].

Joseph Massoud

So AFM was in August, interestingly the problem in AFM is I would have loved to have gotten on the calls over the next couple of quarters and said, “See, we told you it wasn’t going to be all that cyclical.” Unfortunately I think right now we’ll just have to look at revenues because I think from an EBITDA point of view it is undoubtedly going to be somewhat lower this year because we missed several weeks of production and because we were a little inefficient and we’ll hopefully recoup that all in business interruption insurance but it will be hard to get a pure comp. American Furniture Manufacturing again, I would tell you to look at a couple of things, to not say, “Hey this is furniture.” But to say what segment of the market does this serve and in the promotional segment it’s a market actually that has grown. I think it’s probably one of the only furniture companies that we’ve seen that’s had double digit growth in each of the last five years. It’s a segment that’s not currently under attack by Asian competitors. In fact, in the promotional segment virtually all product is US assembled and US manufactured because the cost to assemble and delivery and sell the product is less than the cost to just ship from Asia. I mean you’re talking about the extreme low end of the pricing of the furniture market. Then, you’re talking about a business that’s extraordinarily efficient and then you wrap that up in a bow and you realize we paid on a tax effective basis under five time cash flow. There was plenty of cushion in there. If the economy had an impact on the company we didn’t conceive of a situation in which our multiple still would have been in excess of say 6.5 or 7 times cash flow.

In all these cyclical businesses part of acquiring these businesses is to think about what you’re paying in terms of mid cycle earnings and there are times when you buy companies whose earnings may go down in a cycle and again, I think that constitutes a minority of our companies but, some of these companies exist and if you pay the right multiple those are frequently the best transactions out there. Again, it’s the reason why we don’t distribute 99% of our cash flow or 100% of our cash flow because I think we are aware of these industries and understand how they work and have built sufficient cushion. This is a long subject to discussion at each of our board member meetings, how do we think the prospects of the company could vary to the upside and downside and what does it mean for our distribution policy. Our decision to increase distributions are not made lightly and these factors are certainly discussed. Sorry for the long winded answer, did I cover what you were asking out there Larry?

Larry Solow – CJS Securities

Yes you did.

Operator

We’ll take your next question from Vernon Plack with BB&T Capital Market.

Vernon C. Plack, CFA – BB&T Capital Markets

Jim, on the call several weeks ago we talked about Fox a little bit and you gave a revenue number I think for 07 around $105 million. There was no real discussion regarding operating income or EBITDA, any other guidance that you can provide for us there in terms of what we could expect out of FOX?

James J. Bottiglieri

We did give the multiple that we bought the business at.

Vernon C. Plack, CFA – BB&T Capital Markets

You did do that, yes.

James J. Bottiglieri

We do think that the business is going to be growing so that most of what we paid will be lower than what we’re projecting next year’s EBITDA. But, I think you can use that multiple as a guidance.

Vernon C. Plack, CFA – BB&T Capital Markets

Okay. Joe, I know last year in May you gave a [CAD] per share estimate of $1.62 to $1.82, that was in May. I know you haven’t given a [CAD] estimate this year but can we expect this year’s number to be higher or lower based on what you’re seeing in this type of economy?

Joseph Massoud

I think it’s too early, when you say based upon what you’re seeing, I think that’s a tricky question and some of it has to do with acquisitions we’ve done and different things. Our hope and we have no reason to dispel the hope currently is that it will be a higher number than last year but I have no – again, we are trying very hard as I’m sure every public company does, we’re trying very hard to be straight forward and accurately convey information to all our shareholders simultaneously that’s kind of appropriate so that they can think about the investment decision. I don’t exactly know whether the length of this downturn is two quarters or four quarters and whether it’s going to have kind of a labor tail? I mean, there’s a lot of theories out there so our hope, which currently we have no reason to dispel is that [CAD] per share would be higher in 08 than in 07. But talk about a forward-looking statement that has a lot of factors around it, that might be the kind of all forward-looking statements.

Vernon C. Plack, CFA – BB&T Capital Markets

Jim, you mentioned – did I hear you correctly, essentially you have is it roughly $325 million in untapped?

James J. Bottiglieri

That is as of December 31st.

Operator

We’ll take our next question from Henry Coffey with Ferris, Baker Watts.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

A couple of questions, I sort of her the tail end of Vernon’s question, how much sort of debt and acquisition capacity do you have right now? And, can you sort of break it down for me?

James J. Bottiglieri

Let’s start with the debt that’s outstanding right now. We’ve got $155 million under our term loan facility outstanding and we’ve got $50 million under our revolver outstanding. That’s as we speak right now.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Right. That’s of December or as of right now?

James J. Bottiglieri

That’s as of right now.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Okay.

James J. Bottiglieri

So basically that will leave us $275 million of availability under the revolver.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

$275 of additional availability?

James J. Bottiglieri

Additional availability, right.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

And the revolver is for $325, right?

James J. Bottiglieri

That’s correct.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

And what is the current borrowing cost on both of these facilities?

James J. Bottiglieri

We swapped out the term debt and that’s roughly at 7.25 fixed now due to the swap.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

And is that plus fees and costs?

James J. Bottiglieri

Well, we had some debt issuance cost being amortized.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Right. So, what would be the all in costs on that facility now?

James J. Bottiglieri

That’s probably at –

Joseph Massoud

The cash has already been spent. I’m not sure I understand the question Henry. I mean incrementally?

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

I’m just trying to model, the all in costs in the quarter.

Joseph Massoud

I understand what you’re saying.

James J. Bottiglieri

It’s basically $5 million being amortized over six years so that’s a little less than $1 million a year.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Then the cost on the revolver is?

James J. Bottiglieri

2.5 over LIBOR right now.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

And you can borrow incrementally against that at that rate?

James J. Bottiglieri

That’s correct.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Then you talked a little bit about AFM and the staffing business but before we get into those two there’s some component of cyclicality to your other businesses. Obviously, not as much as with those two, what is your outlook for your other businesses? Maybe make that an open ended question and you can give us whatever you want.

Joseph Massoud

Again, you can take this with whatever caveat that you’ve got. Part of the issue is we don’t really know how the year is going to turn. So, Advanced Circuits is a business that has historically moved with the R&D cycle more than towards the economic cycle and what do I mean by that? For example, in the last recession you saw that they didn’t move together because of times when electronics purchasing was down or medical device purchasing was down the companies that were the OEMs were increasing their R&D to try to basically get customers whether individual or corporate to spend out of their Malays. So, I’m cautious that remember Advanced Circuits, for those of you on the call that know the company, don’t look like kind of your average circuit board company which is why it produces like 35 to 40% EBITDA margins. It’s a quick turn prototype specialist, largest in the country in that space, its grown rapidly. We currently are not seeing a slowdown for demand in its product. This is not a back fund business, it might be the opposite of a backlog business, people want their product in two or three days. So, I have no idea what it’s going to do later in the year but we have no reason to believe – our managers talk to customers, tries to get projections to give you a sense of what we grew our capacity last year and are thinking already about capacity issues over the next 12 to 18 months. So, this business currently is not seeing anything in the way of a slowdown. Jim or Elias or Alan, you guys are all on the call I know, interrupt me if you want to add more color.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Putting that second line on Joe, what does that do for margins? I know there’s a real economies of scale benefit that goes with the business?

Joseph Massoud

I wouldn’t the margin – there’s a lot of things that go into margin including some increase of some of the materials and things, I’m not sure we think a lot is going to change in margins in one direction or another. Elias, do you have any further comment to that?

Elias

No, I think that’s correct.

Joseph Massoud

You’re right that there are economies of scale in the business, there’s also other factors going on that this may to some extent offset. Aeroglide, a different business, I mean it’s a backlog business, it’s got a six to nine month backlog typically. Our backlog looks fine right now, I cannot tell you that six months from now the six to nine month backlog is going to be as strong as it is now. I just don’t know. We again, talk to our customers and this is an instance where they have a lot of international customers, it’s a global business, a lot of business is in Asia and Europe. Food companies I think is the largest segment of the customers and at this point backlog is our best way to feel the pulse of the individual and in this case it’s a very healthy individual as measured by backlog which is really the best I can do to tell you. We feel good about this, we talk to our customers, we are, in this case, expanding our sales efforts particularly in Asia, those are beginning to yield fruit. There’s no reason why this company shouldn’t be growing this year but in terms of speaking specifically about what I can tell you which is the current backlog, it’s healthy and strong and is as healthy as we’ve seen it. Alan, anything else to add there?

Alan

No Joe.

Joseph Massoud

Our goal for AFM this year and I can tell you right now we’re delivering product on a daily basis that’s not quite the level as pre-fire. I think we’ve talked to you guys about our manufacturing capability versus pre-fire. We’re hoping to get that up to 100% here in the reasonably short term with the bringing online of one additional facility. But, I don’t actually – we feel very confident that the insurance is going to cover all of the issues associated with loss inventory and with rebuilding the building. We believe we’re going to get some business interruption insurance. If you were to say to me, “Look instead of making X of EBITDA, this year as a result of the fire, the loss weeks, the resulting inefficiency of operating out of multiple facilities instead of one until you get that facility rebuilt in the fall that you made Y.” I know the theory behind it is, I know our insurance consultants tell us that X minus Y aught be the business interruption insurance and that we ought to collect that, so I’m hopeful that the cash generation of AFM this year is actually on par with as if we didn’t have the fire. I unfortunately, wouldn’t be too shocked if there was a couple of million dollar short fall in that or something because again I’m cynical about most things.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Particularly insurance I hope.

Joseph Massoud

Anodyne not a cyclical business historically at all. These are specialty medical mattress largely, we sell other support services but largely mattresses. The business has grown, you saw the fourth quarter results, it’s by far our best quarter and that’s because we have increased product placement with some critical customers, those are going to continue. This business is going to grow this year I think. Again, barring something that is totally unexpected, this business is going to perform pretty well notwithstanding the economy because it’s a) in that niche and b) it’s a product that the market desperately needs that it doesn’t have.

CBS, we’ve talked about. Halo, I you know I think what happen with Halo was it was our first year with the company last year and our management said to us, “It’s a strong year. Here’s what it’s going to look like.” The fourth quarter is where all the EBITDA is generated and I’ve maintained that one of the beauties of our model Henry is that we can own businesses for longer than – forever theoretically. Once you know a business you know it and you have some level of comfort and ability to work with it so you shouldn’t be in a structure where you kind of then have to sell a business. So Halo last year was our first full year and I will tell you that we were interested anxious to see how the fourth quarter came out and it hit on all cylinders exactly what we projected and maybe even a little better. This year, going into the first quarter you start building backlog again and the backlog looks fine. There’s a couple of dynamics here: number one, is the type of products we supply had actually tended to be less cyclical than other segments of kind of the marketing budgets for corporations. Number two, is we are a rapid [inaudible] of sales reps and we’re a grower and a consolidator in the industry. So, there is an offsetting effect, I think this year is going to be fine for this company. It’s going to be flat or better. Some of that is going to be that even if there is sort of same customer decline, we’ve added a lot of new people and we continue to consolidate the business and those are going to help us. We’re also working on a couple of really interesting add on acquisitions here over the course of the year that we hope we can get that are going to be brought in at extraordinarily attractive multiple. I think we’ve talked in the past about this company’s ability to buy at three to four times cash flow at the end of the day once you consolidate some of the back office. So, we think that opportunity is going to exist this year. We think this is going to be a good year for Halo.

Then Silvue has not really historically been a cyclical business. I mean it serves the ophthalmic market. It’s got so much international exposure right now that a big driver of the growth train is non-US. The ultimate product growth whether it’s in the metals area or electronics area we think it’s going to be very strong this year and should offset any kind of decline. So, we look for that business actually to grow over the course of the year. Again, lots of factors impact these and these are all as I said, caveat to all the forward-looking comments.

But, it really is a matter of CBS having the most and CBS represents maybe 30% of our cash flow or something, I’d have to look at the numbers. It’s an important element but the other sides of the business we are more insulated and we have good feelings about them and a number of them have whether its new products or new end markets, have some very strong trends that will assist them even if there is some cyclical softness.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

So on FOX our traders what to know if there’s going to be a product dividend?

Joseph Massoud

I doubt their bikes are that good.

Henry Coffey, CFA – Ferris, Baker Watts Incorporated

Yes they are. We have the National Masters Champion here.

Operator

(Operator Instructions) We’ll go next to Jeff Smith with Eagle Investment Management.

Jeff Smith – Eagle Investment Management

Just one follow up question on CBS Personnel, could you tell us what the EBITDA margin was during the last recession? How bad did it get?

Joseph Massoud

That’s a good one. EBITDA margin last recession, a very different business because it was a much smaller scale so you would kind of expect the EBITDA margin to be smaller but I’m trying to think. For our company –

James J. Bottiglieri

Yeah Joe the margin came down to in the low 3% range.

Joseph Massoud

I was just going to say 3 to 4% but again, understand the nature of the fixed cost in this business is pretty dramatic so we wouldn’t that to occur again in this downturn necessarily. But, to answer your question that’s what happen last time.

Jeff Smith – Eagle Investment Management

What would you expect it to go to I guess if we do go into another recession?

Joseph Massoud

I think we’re kind of maybe in a recession already so let’s just say however you define it where we are incremental numbers make a big difference so when I tell you closer to 4 than 3 you might say that’s not much of a difference. But, if you’re trying to play it out and you say it’s in the low 3s that’s probably close enough for whatever they say.

Elias

How would you comment on that? I would say that this year, this recession we think will be a lot different than the last one in that there wasn’t gross margin expansion like there was in the late 90s and 2000 and the primary driver of EBITDA margin decrease last time was gross margin contraction. This business is highly variable, if you just look at the SG&A cost about 70 to 75% of our SG&A is variable costs and depending on the depth of revenue changes if you’re very gloomy and you believe there’s a lot of revenue change I think there’s a lot of SG&A that can be taken out and margins can be relatively well preserved. So, we think our operating model being as dense as it is gives us the ability to ratchet down our SG&A load proportional to revenue declines and we think that margins because they didn’t expand during this last up cycle don’t have a lot, on the gross margin side, we don’t think that there’s a lot of downside to be had. So further to Joe’s point we would think that we should be able to preserve our EBITDA margin which is in the low 4% today. We think that we should be able to preserve those margins coming into a recession if we’re not in one already and if it contracts we think it would only be slight contraction.

Operator

We’ll take our next question from Jim [Coran] with New Salem Investment Management.

Jim [Coran] – New Salem Investment Management

I wonder if you could comment on the effect of this sort of title wave of specs is having on your efforts in the acquisition front?

Joseph Massoud

A couple of thoughts and one is there great buyers when you’re selling a business. There’s never been a more rational buyer in the history of buyers than in a spec I think. From determining how many middle market companies there are to acquire I can’t think of [inaudible] I actually can’t think of one single instant, literally one in the last decade we’ve been doing this where a primarily competitor for a transaction was a spec. Elias, Alan can you guys think of one?

Elias

I can’t Joe.

Alan

Neither can I.

Joseph Massoud

I mean so the primary reason is a couple fold. Number one, half the companies we’ve acquired either in Compass Diversified Holdings or before have not been in auction process, they’ve been transactions that we’ve gone out an found and networked to. So, typically specs aren’t able to do that. Then, in the other half where we’ve been acquirers we’ve typically tried to make a trade off of not being at the highest value but being able to guaranty some sort of certainty of close because we can bring our financing. The specs in theory have the money but of course are subject to vote so they are a very uncertain financer. The reason you go with a spec as a seller is because you want a high value and you’re willing to live with the uncertainty that either they’ll raise the side-by-side debt they need or they’ll get through the vote but the valuation is so high that you’re willing to kind of overlook it. That’s almost the opposite business model proposition that we offer. Actually, the specs have had no effect on us. In addition, if you look at the specs, a lot of them are larger. The transactions we’re looking at are $80 to $200 million acquisitions at the extreme high end, more like $80 to $150 or $170 and a lot of the specs right now that are being raised are targeted at the higher end than that. So, it hasn’t really affected us on the buy side. I’ve certainly said we haven’t sold a business to a spec ever either although we have talked to them because they can be reasonably high value participants.

Operator

It appears we have no further questions at this time. I’d like to turn the call back over to our speakers for any additional or closing remarks.

Joseph Massoud

Thank you all for your time. It’s an interesting market out there and I know one where you’re trying to understand the fundamentals of businesses and think about how the operations look. We’d encourage you to dig in on Compass Diversified Holdings. We think the more you learn the better a story it is. We’re available if people have follow up questions to the extent that these are questions we can answer. We’ll continue to be as disclosive as we have been in the past. We appreciate your time and we look forward to talking to you again next quarter.

Operator

Once again that does conclude today’s call. We do appreciate your participation. You may disconnect at this time.

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Source: Compass Diversified Holdings, Inc. Q4 2007 Earnings Call Transcript
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