Compass Diversified Holdings (CODI) 2011 Q3 法說會逐字稿

Good day, everyone. Welcome to the Compass Diversified Holdings 2011 third-quarter earnings conference. Today's conference is being recorded. All lines have been placed on mute. (Operator Instructions). At this time, I would like to turn the conference over to David Burke with the IGB Group for opening introductions and the reading of the Safe Harbor statement. Please go ahead, sir.

Thank you and welcome to Compass Diversified Holdings' third-quarter 2011 conference call. Representing the Company today are Alan Offenberg, CEO and Jim Bottiglieri, CFO.

Before we begin, I would like to point out that the Q3 press release, including the financial tables, is available on the Company's website at www.CompassDiversifiedHoldings.com. The Company also filed its Form 10-Q with the SEC yesterday.

Please note that throughout this call, we will refer to Compass Diversified Holdings as CODI or the Company.

Now allow me to read the following Safe Harbor statement. During this conference call, we may make certain forward-looking statements, including statements with regard to future performance of CODI. 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 inherent uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements and some of these factors are enumerated in the risk factor discussion in the Form 10-K as filed with the Securities and Exchange Commission for the year ended December 31, 2010, as well as in other SEC filings.

In particular, domestic and global economic environment has a significant impact on our subsidiary companies. CODI undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. At this time, I would like to turn the call over to Alan Offenberg.

Good morning. Thank you all for your time and welcome to our third-quarter 2011 earnings conference call. We are pleased to report strong third-quarter results that were consistent with our expectations. For the three months ended September 30, 2011, CODI generated cash flow of $25.5 million, an increase of over 7% from the year-earlier period.

Our notable performance is attributable to the leadership position and comparative financial strength of our niche businesses during a challenging economic environment. As we continue to prudently manage our subsidiaries while taking advantage of opportunities to increase their relative marketshare, our results for the quarter were also positively impacted by our newest platform company, CamelBak, which we acquired in August 2011.

Before I turn the call over to Jim to give more specifics on our financials, I would like to make some general comments on each of our subsidiaries and other recent developments. Advanced Circuits met our expectations in the third quarter as demand for our core quick-turn and prototype production services remain strong.

In addition, we continue to maintain healthy margins in this business by utilizing our operating capacity more effectively following the addition of ACI-Tempe in March of 2010. Going forward, we will seek opportunities to further consolidate the industry and strengthen our number one market position in the quick-turn manufacturing niche.

American Furniture performed in line with our expectations during the seasonally slow third quarter. Excluding the impact of a one-time accounting adjustment related to the implementation of the new inventory costing system, AFM reported nearly breakeven cash flow for the quarter. While this business continues to be adversely affected by the soft retail environment in the furniture industry, we remain focused on reducing AFM's overall cost structure and working capital requirements.

ERGObaby exceeded our expectations in the third quarter. We continue to extend the Company's productline and expand distribution channels, which led to a 35% increase in revenue on a pro forma basis. Since acquiring this business in September 2010, we have made significant investments that have enhanced ERGObaby's infrastructure. We expect to see these enhancements to support the continued growth in this business as we maintain our focus on leveraging ERGObaby's leading brand for child mobility and transport products and expanding customer penetration levels in the US and internationally.

Turning to Fox Racing Shox, we posted another strong quarter in terms of both revenue and profitability that met our expectations. We continue to benefit from our strong marketshare in our core mountain bike business, as well as increased penetration levels in new verticals, including military, powered sports and off-road vehicles. We remain well-positioned to drive future performance in this business as we continue to leverage Fox's leading reputation for high-performance suspension products and meet the strong demand among market enthusiasts.

HALO exceeded our expectations in Q3 by reporting for the seventh consecutive quarter period-over-period revenue growth. HALO's leading position in the promotional products industry has enabled the Company to capitalize on the increase in overall spending on marketing-related products. We remain focused on pursuing additional add-on acquisitions in order to take advantage of our scalable infrastructure and expand our industry leadership.

Pursuant to this strategy, HALO acquired Logos Your Way on October 3, 2011 for an approximate $2 million purchase price. At Liberty Safe, revenue increased approximately 18% in Q3, exceeding our expectations. We continue to experience strong demand for our premium home and gun safes as we optimize the Company's marketing initiatives and continue to build the Liberty brand.

We also improved profitability for the fourth consecutive quarter, which reflects increased operating leverage and our ongoing efforts to increase operating efficiencies. Bookings for the remainder of 2011 and into 2012 remain strong.

Moving to Tridien Medical, we reported Q3 results consistent with our expectations. While demand for the Company's core products remain relatively stable, we continue to invest in R&D in an effort to bring new innovative products to market by the end of 2012 and further our position as the number one provider of leading medical support services.

As I mentioned earlier, we realized positive contributions in the quarter from our newest platform company. On August 24, we acquired CamelBak Products, the global leader in personal hydration gear and pioneer of the hands-free hydration category. Based in Petaluma, California, CamelBak offers a complete line of hands-free hydration packs, reusable BPA-free water bottles and performance accessories for outdoor recreation and military use.

CamelBak's strong brand recognition as the premier innovator of personal hydration products has enabled the Company to establish preferred partnerships with top national retailers, sporting goods stores, independent and chain specialty retailers, as well as the US military.

CamelBak is an ideal addition to our family of businesses due to its market leadership, history of stable cash flows, proven management led by CEO, Sally McCoy and exciting growth potential. CamelBak's advanced hydration solutions offers superior performance, as well as important health and environmental benefits.

We plan to capitalize on the Company's number one market position, as well as favorable macro trends, including the growing demand for improved everyday hydration to accelerate future growth. By expanding CamelBak's leading product platform and strengthening its global distribution network, we intend to increase consumer penetration levels both in the US and abroad.

And finally, at Staffmark, revenue in the third quarter increased on a sequential basis following a temporary disruption in the US automotive supply chain that resulted from the Japanese earthquake earlier this year.

As we announced last month, we sold Staffmark to a strategic buyer for a total enterprise value of $295 million. CODI received approximately $220 million of total proceeds from the sale with respect to its debt and equity interest in Staffmark, as well as the payment of accrued interest and fees.

This transaction represented a very profitable opportunity for us to monetize our entry in one of our initial subsidiaries at the time of our IPO in May of 2006. We expect to report a gain from this sale ranging between $75 million to $90 million in the fourth quarter of 2011.

The sale of Staffmark is consistent with our investment philosophy aimed at maximizing value for our shareholders and significantly expands our capacity to take advantage of both organic and acquisition-related growth opportunities going forward. By utilizing the proceeds to further strengthen our balance sheet, we have ensured our position as an all-cash buyer of new platform and add-on businesses providing a key competitive advantage in light of the challenging market conditions.

Including Staffmark, CODI has realized more than $185 million in gains since going public. Importantly, our enhanced liquidity positions, combined with our current family of niche market leaders, which includes the addition of three new platform companies over the past year and a half, bodes well for CODI to continue to provide shareholders with attractive distributions.

For the third quarter, we paid a cash distribution of $0.36 per share, representing a coverage ratio of cash flow to distributions paid of $1.47 for the quarter. Since going public, CODI has paid cumulative distributions of approximately $7.08 per share.

With those introductory comments complete, I would like to turn the call over to Jim Bottiglieri to add his comments on our financial results.

Thanks, Alan. Today, I will discuss our financial results for the quarter and nine months ended September 30, 2011, including a review of the operating results of each of our subsidiaries.

On a consolidated basis, revenue for the quarter ended September 30, 2011 increased to $490 million as compared to $460.8 million for the prior-year period. Net income for the quarter was $12.5 million as compared to a net loss of $29.4 million for the quarter ended September 30, 2010. During the third quarter of 2010, CODI recorded a $42.4 million non-cash impairment charge for the Company's American Furniture Manufacturing subsidiary.

Now turning to our subsidiary results beginning with Advanced Circuits. For the quarter ended September 30, 2011, Advanced Circuits' revenue was $19.6 million compared to $20.2 million in the prior-year period, mainly due to lower long lead sales, partially offset by higher quick-turn and assembly sales.

During the third quarter of 2011, sales attributable to Circuit Express, which we refer to as ACI-Tempe, were approximately $4.4 million as compared to $5.2 million in the year-earlier period due to softer economic conditions, particularly for military applications. Despite the lower revenues, income from operations for the quarter increased slightly to $6.6 million as compared to $6.5 million for the same period in 2010.

For the nine-month period ended September 30, 2011, Advanced Circuits revenue increased approximately 10.9% to $59.9 million compared to $54 million for the prior period of 2010, which was primarily due to strong demand for our overall product offerings.

During the period, sales attributable to ACI-Tempe were $14.4 million as compared to $15.6 million in the prior-year period of 2010. Income from operations was $20.5 million compared to $13.7 million for the prior period in 2010. This increase was primarily due to the operating profit generated from the increased sales volume, as well as for the 2010 recording of $3.8 million in non-cash stock compensation expense.

Now I would like to turn to American Furniture Manufacturing, or AFM. For the quarter ended September 30, 2011, AFM's revenues decreased to $23.7 million as compared to $32.1 million of revenue in the prior-year quarter as this business continues to be adversely affected by the soft retail environment and the overall furniture industry.

AFM reported a loss from operations of $2.5 million as compared to an operating loss of $42.7 million in the third quarter of 2010, which reflected the aforementioned non-cash impairment charge of $42.4 million. The current quarter results include an approximate $1.4 million one-time inventory adjustment made to write off excess overhead absorption resulting from AFM revising its standard costs during the quarter in connection with the implementation of a new inventory costing system.

For the nine-month period ended September 30, 2011, revenue was $83.1 million compared to $109.4 million in the year-earlier period. Loss from operations was $12.1 million versus an operating loss of $38.8 million for the prior-year period. The loss from operations for the nine months ended September 30, 2011 includes a non-cash impairment expense of $7.7 million recorded in the first quarter.

Turning now to our newest company, CamelBak, which we acquired on August 24, 2011. For the quarter ended September 30, 2011, revenue increased approximately 37% to $38.3 million compared to $27.9 million in the prior-year period, which were both prepared on a pro forma basis as if we acquired CamelBak on January 1, 2010. This increase is attributable to higher sales across its leading product platform. The Company had pro forma income from operations of $5.9 million for the third quarter of 2011 as compared to $3.6 million in the same period last year.

For the nine months ended September 30, 2011, CamelBak reported revenue of $114.7 million on a pro forma basis compared to $90.8 million in the prior-year period. Pro forma income from operations for the nine months ended September 30, 2011 was $16.7 million compared to $12.6 million for the prior-year period.

Moving on to ERGObaby, which we acquired on September 16, 2010. For the quarter ended September 30, 2011, revenue climbed approximately 35.4% to $10.7 million compared to $7.9 million in the prior-year period, which was prepared on a pro forma basis as if we had acquired ERGObaby on January 1, 2010. This increase reflects strong product sales in US and international markets, as well as the addition of new distributors.

The Company reported income from operations of $2.5 million in the third quarter of 2011 as compared to pro forma income from operations of $1.8 million in the same period last year. SG&A expenses for the third quarter of 2011 include approximately $1.9 million in costs related to the Company's expansion initiatives, as well as approximately $1 million of a reversal of a previously recorded liability associated with an earnout provision with ERGObaby's former owner.

For the nine-month period ended September 30, 2011, revenue increased approximately 41% to $33.4 million compared to $23.7 million in the prior year, which was prepared on a pro forma basis. Income from operations for the nine months ended September 30, 2011 was $7.6 million as compared to pro forma income from operations of $6.5 million in the year-earlier period.

Turning to Fox Racing Shox, revenue of $61.7 million for the quarter ended September 30, 2011 was essentially flat compared to $61.4 million in the prior-year period. During the third quarter of 2011, we recorded higher sales in power vehicles offset by a more normalized seasonal sales pattern in our core mountain bike sector during the quarter.

Income from operations was $10 million for the quarter ended September 30, 2011 compared to income of $10.4 million in the year-earlier period, primarily as a result of higher SG&A expenses to support the Company's year-to-date sales growth. For the nine months ended September 30, 2011, revenue climbed approximately 16.9% to $150.5 million compared to $128.7 million in the prior-year period due to increased sales in our mountain biking sector, as well as in the powered vehicle sector. Income from operations for the first nine months of 2011 increased to $19.6 million compared to $16.3 million for the prior-year period, mainly due to a strong increase in net sales.

Moving on to HALO Branded Solutions. For the quarter ended September 30, 2011, the Company's revenue rose approximately 6.1% to $43.7 million compared to $41.1 million for the same period last year. The increase was due to higher sales from existing customers, as well as from the recruitment of new account representatives.

Income from operations for the three-month period ended September 30, 2011 was $2.5 million compared to income from operations of $1.3 million for the third quarter of 2010. For the nine months ended September 30, 2011, HALO's revenues was $115.6 million compared to $106.1 million for the same period last year, an increase of approximately 9%. Income from operations was $4.9 million versus income of $0.8 million for the prior-year period. During the nine months ended September 30, 2011, SG&A expenses were reduced by approximately $1.8 million due to proceeds from the legal settlement.

Turning to Liberty Safe, which we acquired on March 31, 2010. For the quarter ended September 30, 2011, revenue increased approximately 17.9% to $21.8 million compared to $18.5 million in the prior-year period. The increase was primarily due to higher sales across all distribution channels. The Company reported operating income of $1.5 million for the third quarter of 2011 as compared to income of $0.4 million in the same period last year, which reflects the higher level of sales achieved in 2011.

For the nine-month period ended September 30, 2011, Liberty increased revenues by approximately 26.3% to $60.6 million compared to $48.0 million in the prior-year period, which was prepared on a pro forma basis as if we acquired Liberty Safe on January 1, 2010. The increase was due to higher sales across all distribution channels. Income from operations for the nine months ended September 30, 2011 was $3.4 million compared to a pro forma operating income of $1.9 million for the prior-year period.

Staffmark. For the quarter ended September 30, 2011, revenue was $277.6 million as compared to $271.3 million for the same period last year. The Company's income from operations was $9.8 million for the third quarter of 2011 as compared to $10.6 million for the previous-year period. For the nine months ended September 30, 2011, revenue was $780.1 million compared to $740.1 million. Income from operations was $14.5 million as compared to income from operations of $16 million in the year-earlier period. As mentioned earlier, we sold Staffmark on October 17, 2011 to a subsidiary of Japanese-based Recruit Co., Ltd.

Now on to Tridien Medical. For the quarter ended September 30, 2011, revenue increased to $15.1 million as compared to $14.7 million for the same period last year. Income from operations for the third quarter was $1.7 million compared to $2.2 million in the same period of 2010 as we continued to experience pricing pressure from customers and to invest in new product developments. For the nine-month period ended September 30, 2011, revenue was $42.9 million compared to $46.8 million for the same period last year. Income from operations was $4.0 million compared to $7.8 million for the same period in 2010.

Turning now to the balance sheet, we had $10.6 million in cash and cash equivalents as of September 30, 2011. As previously announced, on October 27, we signed a credit agreement for a revolving credit facility totaling $290 million and a term loan facility in the amount of $225 million. The two facilities, led by TD Securities, BMO Capital Markets and SunTrust Robinson Humphrey, combined for $515 million in new debt financing and replaced our previous revolving credit facility and term loan facility.

With this agreement, we have refinanced our existing debt and improved our mix of debt to equity within our capital structure. We appreciate the ongoing support of our banking group, which underscores our future prospects. Upon closing, we had borrowing availability of approximately $287.1 million under our new revolving credit facility and have no significant debt maturities until October of 2016.

During the third quarter of 2011, we incurred approximately $2.3 million of maintenance capital expenditures. As indicated on our prior calls, we anticipate incurring maintenance capital expenditures of between $10 million to $12 million for the full year of 2011 as we remain committed to investing in the future performance of our subsidiaries. This estimate includes a level of expenditures that would have otherwise been incurred in 2012 to take advantage of the 100% bonus depreciation incentives available in 2011.

We also incurred approximately $1.4 million in growth capital expenditures during the third quarter that were largely spent on Liberty Safe to increase production capabilities. For the nine months ended September 30, 2011, we incurred approximately $7.6 million of growth capital expenditures. I will now turn the call back over to Alan.

Thanks, Jim. The strong performance of our diverse family of niche-leading businesses combined with our balance sheet strength positions CODI well for the future. With significant access to capital, we plan to continue to invest in high return organic growth initiatives and pursue accretive acquisitions of companies with a real reason to exist under favorable valuations and terms.

We also remain committed to providing our owners with attractive distributions as we have consistently done throughout our history as a public company. I would like to thank everyone again for joining us on today's call. We will be happy to take any questions you may have. Operator, please open the phone lines.

(Operator Instructions). Larry Solow, CJS Securities.

Hi, good morning, guys. Considering this is your first I guess public call since the CamelBak acquisition, I was wondering if you could maybe discuss a little bit more of sort of your initiatives over there? They have had some pretty decent growth recently and you said you are going to focus on more penetration in the consumer area. I don't know if you could just sort of elaborate on that and on your outlook for CamelBak.

I think like many companies that operate in consumer products or in (inaudible) consumer products in particular, CamelBak will always be focused on new product introduction, as well as evolution of their product. So I think that is an initiative that is not just current, but one that I expect you would hear us talk about throughout our partnership with CamelBak.

More specifically, they are, as we mentioned, the leader in hands-free hydration, as well as BPA-free bottles and I think that one of the things that they have currently is they have done a good job of introducing filtration technology to their bottles. And I think that one of the areas that I think CamelBak will continue to pursue aggressively is continued focus on filtration technology, water purification opportunities to further penetrate that area. And we believe that that is an area where consumers have great interest and an area where we think not only that CamelBak existing technology, but some of the new technologies that they are developing would result in some very attractive new product introductions for the Company.

I think in addition to that, an initiative that we are very focused on is developing a more cohesive plan for international growth and expansion. And I would say that our evaluation of that initiative is in its earlier stages, but one that has, I would say, top priority of both us and the management team. And we intend to work on that over the coming months and into the new year. And I think it is very important for us to analyze this appropriately and move as quickly as we can yet to do so in a way that is well thought out. So that is I think developing over the longer-term a more cohesive and focused strategy for international expansion is at the top of the list for initiatives for CamelBak, as well as new product introductions.

Okay. And then you gave us a little bit of an outlook for the remainder of 2011 and I realize looking out to '12, there is obviously multiple variables on what can happen. But perhaps you could just discuss sort of where you stand today your view on some of the -- I guess the two larger other companies, Advanced Circuits and Fox, which is -- Advanced Circuits has been solid and Fox has had incredible growth. Do you see these -- how do you see trends in those two businesses as you look out into '12?

I think that broadly, and I would ask Jim or Elias to elaborate in greater detail if they would like to. I think that we have seen solid performance through the third quarter and I think that we would expect that solid performance to continue through the balance of the year.

As Jim mentioned in his remarks, Advanced Circuits did see their long run production business slow, which is I think indicative of some economic softening, which is well discussed throughout the business community. So I won't elaborate on that. But I think as we -- so as we look ahead to 2012, I think that we internally have a tone that is cautious. I wouldn't say it is one of concern in the context of a real falloff for these businesses, but it is not a tone where I would tell you or anyone else that we expect to grow materially in 2012.

When you talk about these three largest businesses, I think that we would probably guide you more towards a steady-state environment relative to 2011 as opposed to a solid growth year in 2012. Jim or Elias, would you add to that? No further comments on that.

Okay. Just lastly, your decision to raise debt a significant amount, increase your term loan, is that based on your optimism on acquisitions or is it more just to capitalize on rates you get today?

Well, I think there's a couple of things. I think that -- number one -- in no particular order, number one, we did have maturities at the end of next year and the year after. So I think that just addressing our long-term liquidity was important for us.

I think with respect to the amounts of the debt, the amount of debt that we raised, I think our business model is such that we will go through periods where we have meaningful liquidity as we do today and other periods where our liquidity is tighter just based on our normal business activities of acquiring new subsidiary companies and making investments in those companies and making acquisitions to those companies to the extent that that is appropriate.

So I think that we wanted to both extend our maturities, but also position ourselves to have sufficient liquidity to continue to build our business, which we are focused on doing as mentioned in the comments. Jim, I don't know if you want to comment on the rates.

I will just add one other thing to that too. We heard from shareholders about the dilution from equity offerings. So we didn't want to change our mix of debt with equity. The way I look at it is that -- I mean if our typical deal size is about $100 million, we clearly have the capital to do three acquisitions. So I think that we set ourselves up and then it is just a matter of time when the acquisitions get done.

Right. And I imagine you never time anything, but let's say at least hopeful for an acquisition in the next 6 to 12 months because obviously in the near term, you are diluting your capital there.

I think that is the standard statement. We are always hopeful. There is obviously no guarantee that we will be able to --.

Right. But I would imagine you wouldn't want to dilute your [CAD] per share -- obviously you could have waited or I guess --.

Oh no, we did have the -- as Alan mentioned, we did have the maturity coming up in the second half of the year and we did have conversations with the rating agencies that expected us to refinance at about this time. So I am not sure waiting was really that much of an option.

Got you. Okay, great. Thanks a lot.

Vernon Plack, BB&T Capital Markets

Yes, thanks. And Alan, I wanted to hear a little more. We have talked about some of the larger companies, but ERGObaby is off to a great start and you had tremendous growth there and from a growth outlook for ERGObaby, just like some additional color, as well as where -- you talked about the growth, but really interested -- and you talked about marketing and penetration, but really just wanted to get some more color on ERGObaby if we could, please.

Sure, Vernon. I am actually going to ask Elias to address this question for you.

Thank you.

Hey, Vernon, good to talk to you this morning. On ERGObaby, growth has really been driven by a lot of international increased penetration. We have talked about on prior calls one of our primary objectives was to get broader distribution internationally. We have had reasonably good success doing that. We also have been able to penetrate some larger mass retailers here in the United States that continue to add to the distribution capabilities.

And so that business, because it is earlier in its marketshare development stage, we think has a lot of continuing upside. And one of the things that you will see, and that we have continued to suggest to everybody, is that ERGObaby, we expect strong revenue growth continuing to go forward, but we are also spending into that as we continue to raise brand awareness. We are continuing to increase our marketing and advertising and we are getting some pretty positive results in terms of how that is being viewed by the market.

So at this point, we continue to invest heavily in the business and we continue to broaden out our distribution and we think that, as a result of that, this will continue to grow revenues at a pretty accelerated pace. I would also tell you that just the category itself being kind of a juvenile products category we think is generally a little bit more recession-resilient than some other categories. And so we have a large international distribution already. I know there is a lot of concern just with what is happening in Europe and around the globe, but we think that this is a little bit more insulated just by the very nature of the product category.

Okay, great. Thanks, Elias. And a follow-up for you, Jim. Just so that I am clear on the amount of capital that you have at your disposal today in terms of the revolver, it is roughly probably not changed too much, $287 million from what you stated earlier.

The full revolver, which was $290 million, we do have some small letters of credits outstanding against that bringing it down to roughly to $287 million, but we also have cash on our balance sheet and as we speak today, it is about $125 million.

You said $125 million?

$125 million, yes.

Okay, now from -- you took down a term loan of $225 million and I think you put $75 million of that to work, which would leave you with $150 million, correct? I am trying to understand the difference between those --.

We also had fees associated with the issuance of the debt. We had the original issue discount plus just bank fees and that type stuff, which were about $15 million. So it was only $210 million net and then we had -- we took the -- we closed on the 27th and we had the distribution on the 31st, but we basically had to fund the distribution right away.

Okay. So you --.

And I just gave you a round number. It might be a little bit higher.

Right. So today, you have roughly over $400 million, $415 million in available capital?

That is about right, yes.

Okay, thank you very much.

(Operator Instructions). Troy Ward, Stifel Nicolaus.

Great, thank you and good morning. Just a follow-up question on the debt. Alan, you talked about kind of the process a little bit. Was it also -- did the market dictate a little bit the size of the amount of debt you had to take (multiple speakers)?

That is a very good point, Troy. We were told that basically in order to get the deal done, the lenders needed basically a deal size of $200 million plus just to create the liquidity in the market. So we were -- basically about $200 million was the starting point.

On the term loan.

On the term loan, yes.

Right, okay. And then a little bit more color on Advanced Circuits, specifically on ACI-Tempe. It seems like the revenue from that unit has been slipping and I think it is mentioned in the Q the last couple of quarters about the military. Can you give us a little more color around what is going on with that and if you expect to see any stability there?

Yes, so Elias is going to answer that question.

Yes, so Troy, ACI-Tempe is our higher technology facility and typically a lot of the higher tech stuff relates to defense work. I think as we all have heard, there has been a real slowdown in defense-related spending right now. What we are hearing, and we work with most of the bigger defense contractors that are creating new platforms for the Department of Defense, because of this general uncertainty that is in Washington right now, and with the Super Committee if they don't come up with an agreement, I think a lot of it falls to defense in terms of spending contraction. There is just a general hesitancy for the major contractors right now to be doing some of the research and development that they typically would be doing.

So as a result of that slowdown, we are seeing our Tempe business fall off a little bit. Now that has moderated and in the third quarter, kind of what we experienced out there is kind of consistent for what we are seeing so far in the fourth quarter. The rest of the business, as Alan had mentioned, is holding up reasonably well. Our long lead business has, in our Aurora facility, slowed down a little bit. That is the very low-margin part of the business. So that is a little bit less influential on our cash flow. But regarding Tempe, I would say there is not further deterioration from Q3, but we have yet to see that business pick up. And I think until we see a little more clarity out of what is happening in Washington with respect to future defense projects, I would set expectations that you shouldn't expect a material increase in that business segment until there is more clarity.

And could you just remind me what percentage of the overall business is the Tempe business?

Yes, so the Tempe business is kind of roughly was 25% -- it was roughly 25% of the business. It is falling off, as we have indicated, a little bit faster. So that is probably going to be down a few percentage points, but call it 20 -- probably 22%, 23% at this point.

And I think you said the long lead stuff is the lower margin. Where does Tempe margins rate compared to the quick-turn?

The Tempe margins are slightly lower than what we see out of the quick-turn business and so if you were segmenting the margin profile of the business, the prototyping quick-turn business is the highest margin business. The next would be the stuff that we process out of Tempe and then clearly the lowest margin is the long lead.

Right, okay, great. And then quickly on AFM, would it be fair to say that the business would have been flattish were it not for the inventory adjustment this quarter?

That is exactly right.

Okay. And then now that -- as we are looking at Q4, obviously, we're well into Q4 here today, can you describe what you are seeing and then also is there seasonality as it relates to Q2, Q3 or Q4? Is there any inventory buildup that is potentially helping the numbers or going to help the numbers in the near term?

Let me address -- I think there are two parts of the question. The first is heading into the quarter, what are we seeing? And I would say to that that we really don't see any material change at the macro level as it relates to American Furniture and the promotional products -- sorry -- promotional furniture industry.

Seasonality, in the normal course, the Company's biggest quarter would be the first quarter, which is -- we may have referred to it in the past as the Company's tax season where sales have historically been driven higher in that quarter as people have received early refund checks and have used that refund to go ahead and acquire new furniture.

I think that we have seen -- in this more challenging economy, we have not really seen those patterns as vividly as we have in prior years. So with that first-quarter business historically, we would expect to see a buildup in inventory in the fourth quarter to support those first-quarter sales.

I think that it is fair to expect that we would anticipate the first quarter continuing to be -- again, in the context of a weakened macroenvironment -- a stronger quarter for American Furniture that will require some investment in inventory in the fourth quarter. However, I would say that the macroenvironment hasn't changed. So in the context of prior years where I would express real optimism for performance out of the business in the first quarter consistent with historical patterns, I am a bit more tempered in my expectations given the current macroeconomic environment.

From what you feel now about the business, do you think it can be a cash flow-positive business, EBITDA-positive business in 2012?

That is my hope and I am working very hard along with the management team to make that my expectation. As I sit here today, I would say that we would like to see the Company be a breakeven to cash flow-positive business in 2012. I think that and I assure you that we are doing everything we can to make that happen.

And I know they had some headcount reductions earlier this year. Have we seen the full impact of that yet or is there still some benefit to be seen?

I would say that, while it may not be fully reflected due to ongoing changes at the Company, I wouldn't guide you towards expecting a meaningful change in the Company's financial reporting attributable to further headcount reduction.

Okay. And then one last one, just more macro picture from the acquisition standpoint, where do you believe the market is today? And I assume it has been a bit volatile over the last two or three months with regard to available pricing on new acquisitions. So where do you see kind of the market today with the potential for new acquisitions for the platform?

I think that what we have seen and you hit the keyword right is volatility. I think that we have seen -- we still continue to see what I would consider high-quality opportunities, but the volume of those opportunities I think is lower than it has been as compared to recent quarters and I think the velocity at which those opportunities are presenting themselves to us has slowed.

I have read a lot recently in the trades that it appears as though -- due to the volatility that you allude to sellers of businesses have in fact decided to perhaps put the brakes on the process of selling companies. I think the volatility also extends to the debt markets where financing, although that doesn't impact us directly, I do think it impacts the market broadly, that the impact on the financing markets has slowed activity a little bit as well.

And so we are optimistic relative to the opportunities that we are seeing. However, I don't believe that it has been as rapid of a market as it was earlier in the year. And it is hard to say when that is going to change. Again, Elias mentioned earlier as it related to Advanced Circuits just the need to find some clarity in this market and the need to see some stability before things can sort themselves out. And I think that might extend to the broad M&A market as well.

Again, that is all against the backdrop of there being a lot of capital to deploy from both strategic and financial acquirers. And so I know that the capital is on the sidelines, but the opportunities are there, but again, perhaps at this stage right now, not as many as we would like to see.

All right. Thanks, guys.

JT Rogers, Janney Montgomery Scott.

Good morning, everyone. Just a follow-up on that talk of capital on the sidelines. Are you still seeing private equity sponsors being aggressive on the multiple front? And then also I guess in terms of the volatility hurting debt financing, is that helping you all given your certainty of close?

I think that the private equity sponsors, by everything we have seen, continue to be aggressive. I think that there does not appear to be I would say any noteworthy multiple compression in the context of the price that needs to be paid for an attractive subsidiary company despite the fact that they may be getting a turn or a turn and a half less of -- sorry -- a half a turn or a turn less of debt in support of those acquisitions.

Sorry, JT, your second -- the second part of your question?

The second part of the question was volatility is impacting the availability of debt financing. Does that help you all with certainty -- with you coming with certainty of close?

I think the certainty to close helps us in any market. And I think that what we learned back in the -- when the economy was even more volatile than it is today is I think that while we would have hoped being one of the few buyers out there that could execute transactions, I think we had hoped that it would have set us up to be more acquisitive during that period of time.

I think it is a differentiator. In virtually every acquisition of a subsidiary that we do, our certainty to close is cited to us during and after the fact as a major differentiator and a reason why, among a variety of reasons, people like to work with us. I think though I don't know that it advantages us in the context of seeing opportunities that aren't otherwise there. And by that I mean if the market is slowing down and people have decided that they don't want to sell their businesses or corporations have decided to hold off on selling a subsidiary, I don't know, while it happens occasionally and it is something that we are proud of, it is not as though we have a flood of opportunities that are only coming our way because we have the certainty to close.

I don't want to overstate it. I don't think the debt markets are closed in support of new buyout transactions. It is rather I think that the leverage attainable in support of those transactions is just a bit more conservative.

Okay, great. Thanks. That is really helpful. In terms of the broader macro economic outlook, just looking at Staffmark, I think we were talking about there being the potential for a bounceback in the third quarter due to restocking after the supply chain disruptions in the second quarter. Did you all see that bounceback occur and if that did occur, what does that imply about sort of the base level of activity? I mean we saw low single digit growth in Staffmark, really not a huge pickup from the second quarter.

I will let Elias elaborate on that since he has focused on that for the last 12 years.

Yes, JT, and obviously that's, as Alan said, a business that we divested in mid-October. So our data only goes through there. What we did see is, as the quarter materialized, a progressing of strength in the business and actually you saw the blended overall year-over-year growth rate in the third quarter. What you didn't see was that July was actually, from a temp revenue standpoint, down slightly year-over-year, but by September, it was up very strongly and then even into the beginning of October, we were year-over-year comping kind of at high single digit, low double digit over the prior year.

So there was a material pickup. We do attribute a lot of that to the restocking in the auto market. As you know, there was significant disruption from the tsunami and these plants actually came on a little bit later and as they started coming on, they first were using their full time and then as the quarter materialized, we saw their temp usage really start to pick up.

So that did, in fact, occur and the business was performing extremely well late into the third quarter, early into the fourth quarter as we owned that business during that period. There are a lot of things you probably can read into that. Obviously it is the shortest cycle business that we had in our portfolio at the time and those accelerating trends I think probably boded well just in general. Although I think there was probably a propensity to use a little bit more temp labor given kind of the uncertainty that most of us feel in the markets today.

Okay, great. Thanks a lot. And obviously, it is not going to affect you all going forward, but it seems like that's going to be a good gauge on broader macro activity. Just one last question on ERGObaby. Saw some margin compression there from higher cotton prices. It seems like cotton prices have moderated somewhat. I was just wondering if you could expect some recovery of that margin.

And then just the $1.9 million that you all referenced increase in expenses due to expansion, is that a one-time event? Does that reverse itself in future quarters or is that ongoing?

So a couple of things. On the margin change, I would say there are two things that are really driving the margin change. Number one is there is a big move from the traditional productline to our organic productline and our organic carriers are a higher price point, but they are a lower gross margin percentage. The combination of those two things create a higher gross profit dollar per unit. So as we mix shift over to more organic product sales, and there has been a strong, strong move towards organic, it is much better in terms of absolute dollars that are being delivered, but you will see a little bit of dilution in the gross margin. We think that is a fine trend given that we think GP dollar per unit is probably a more -- having a higher number is better obviously.

The second thing that is occurring is our international distribution carries a lower margin than our domestic business. And in the domestic business, we have independent sales reps we have to pay commission, we also have to do a lot more sales and marketing activities here. In our international markets, the lower gross margin that we yield with a lower price point is respective of the fact that they actually have to invest in all of that sales and marketing infrastructure in their home markets.

So clearly as the business shifts to both organic and a higher international component, we would expect to see margin degradation. Now what we were able to do and cotton prices did rise pretty dramatically in the beginning part of the year and then cotton prices have since fallen. I think we got all the way up to over $2 and now we are down probably to $0.95 or so on the spot market. What we were able to do is we did pass through, like most of the soft good companies, branded soft good companies that are out there, pass through pricing increases midyear and those have held and so we have been able to recover that.

There is some price pressure, cost pressure in terms of wage rates, especially in China that is mitigating some of those cotton price declines. But on balance, we have been able to maintain our margins outside of the mix shift.

Now with respect to the costs that you said and the G&A investment, there were some one-time costs in the third quarter. Those costs related to a big marketing and advertising push that we are getting ready to launch. We've really wanted to aggressively get a better understanding of the consumer and their thoughts and what will resonate as we launch into this. And so as you conduct those studies, especially on a company of this size, it can have an outsized impact on what your SG&A spend is in any one quarter.

That being said, I do want to caution you that our outlook for 2012 and beyond is to materially ramp up our spending. And so notwithstanding that we had some one-time costs in the third quarter, we have a commitment to really increase our spend here. We are increasing it at the point of attack with much more advertising and marketing to be done both domestically and globally and we believe that, as we really elevate the brand awareness here, that it will have a very high return on investment. And that as a result of that, we will be able to accelerate our marketshare gains and more than offset any of the increased spend with revenue growth.

So I know it was a little bit of a mixed answer in that there were some one-time costs, but I want you guys to understand that we do have an ongoing commitment to kind of continuing to invest in this business.

Okay, thanks a lot. That is a lot of help.

At this time, I will turn things back over to Mr. Alan Offenberg for closing remarks.

I would like to thank all of you for your participation on today's call. We appreciate the support and we look forward to speaking with you next quarter. Thanks.

That concludes today's conference. Thank you for joining us.