ITEM 1A. RISK FACTORS
Our business, operations and financial condition are subject to various risks and uncertainties. The following discussion of risk factors should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section and the consolidated financial statements and related notes. In addition to the factors affecting our specific operating segments identified in connection with the descriptions of these segments and the financial results of the operations of these operating segments elsewhere in this report, the most significant factors affecting our operations include the following:
Risks Related to Our Business and Structure
The global outbreak of the novel coronavirus, or COVID-19, caused severe disruptions in the U.S. and global economies, including supply chain disruptions, and has impacted, and may continue to adversely impact our performance and results of operations.
The COVID-19 pandemic has adversely impacted global commercial activity and contributed to significant volatility in the equity and debt markets. The COVID-19 pandemic and restrictive measures taken during the course of the pandemic to contain or mitigate its spread have caused, and are continuing to cause, business shutdowns, or the re-introduction of business shutdowns, cancellations of events and restrictions on travel, significant reductions in demand for certain goods and services, reductions in business activity and financial transactions, supply chain interruptions, labor shortages, increased inflationary pressure and overall economic and financial market instability both globally and in the United States. Many states, including those in which we operate, have issued orders requiring the closure of, or certain restrictions on the operation of certain businesses. Such actions and effects remain ongoing and the ultimate duration and severity of the COVID-19 pandemic, including COVID-19 variants, such as the recent Delta and Omicron variants, remain uncertain. Recurring COVID-19 outbreaks caused by different virus variants continue to lead to the re-introduction of certain restrictions in certain states in the United States and globally. Even after the COVID-19 pandemic subsides, the U.S. economy and most other major global economies may continue to experience a recession, and our business and operations, as well as the business and operations of our subsidiaries, could be materially adversely affected by a prolonged recession in the U.S. and other major markets.
The COVID-19 pandemic is having a particularly adverse impact on industries in which certain of our subsidiaries operate, including the foodservice and hospitality industries in which Sterno operates. As a result of the COVID-19 pandemic and other factors, supply chains worldwide have been, and continue to be, interrupted, slowed or rendered inoperable, which have also adversely impacted certain of our subsidiaries operating results.
Relatedly, costly litigation could increase in connection with merger and acquisition transactions, as parties to such transactions explore ways to avoid transactions by the assertion of claims of force majeure, material adverse change in the condition of target investments, and/or fraudulent misrepresentation. COVID-19 also continues to present a significant threat to our employees’ well-being and morale. Our key employees or executive officers may become sick or otherwise unable to perform their duties for an extended period of time and we may experience a potential loss of productivity, and extended period of remote working by our employees may increase operational risks, including technology availability and heightened cybersecurity risk.
These and other factors relating to or arising from the outbreak could have a material adverse effect on the Company’s business, results of operations, and cash flows. Even after COVID-19 has subsided, we may continue to experience materially adverse impacts to our business as a result of the virus's global economic impact and any economic impact that has occurred or may occur in the future.
The COVID-19 pandemic is continuing as of the filing date of this Annual Report on Form 10-K, and its extended duration may have further adverse impacts on our business. In addition to the foregoing, COVID-19 has exacerbated and may continue to exacerbate, many of the other risks described in this Annual Report on Form 10-K.
Our future success is dependent on the employees of our Manager and the management teams of our businesses, the loss of any of whom could materially adversely affect our financial condition, business and results of operations.
Our future success depends, to a significant extent, on the continued services of the employees of our Manager, most of whom have worked together for a number of years. Our Manager does not have an employment agreement
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with our Chief Executive Officer and, in any event, employment agreements may not prevent our Manager’s employees from leaving or from competing with us in the future.
The future success of our businesses also depends on their respective management teams because we operate our businesses on a stand-alone basis, primarily relying on existing management teams for management of their day-to-day operations. Consequently, their operational success, as well as the success of our internal growth strategy, will be dependent on the continued efforts of the management teams of the businesses. The loss of services of one or more members of our management team or the management team at one of our businesses could materially adversely affect our financial condition, business and results of operations.
We face risks with respect to the evaluation and management of future platform or add-on acquisitions.
A component of our strategy is to continue to acquire additional platform subsidiaries, as well as add-on businesses for our existing businesses. Generally, because such acquisition targets are held privately, we may experience difficulty in evaluating potential target businesses as the information concerning these businesses is not publicly available. In addition, we and our subsidiary companies may have difficulty effectively managing or integrating acquisitions. We may experience greater than expected costs or difficulties relating to such acquisition, in which case, we might not achieve the anticipated returns from any particular acquisition, which may have a material adverse effect on our financial condition, business and results of operations.
We may not be able to successfully fund future acquisitions of new businesses due to the lack of availability of debt or equity financing at the Company level on acceptable terms, which could impede the implementation of our acquisition strategy and materially adversely impact our financial condition, business and results of operations.
In order to make future acquisitions, we intend to raise capital primarily through debt financing at the Company level, additional equity offerings, the sale of stock or assets of our businesses, and by offering equity in the Trust or our businesses to the sellers of target businesses or by undertaking a combination of any of the above. Since the timing and size of acquisitions cannot be readily predicted, we may need to be able to obtain funding on short notice to benefit fully from attractive acquisition opportunities. Such funding may not be available on acceptable terms. In addition, the level of our indebtedness may impact our ability to borrow at the Company level. Another source of capital for us may be the sale of additional shares, subject to market conditions and investor demand for the shares at prices that we consider to be in the interests of our shareholders. These risks may materially adversely affect our ability to pursue our acquisition strategy successfully and materially adversely affect our financial condition, business and results of operations.
Under the Trust Agreement, the Company’s board of directors will have the power to cause the Trust to be converted to a corporation in the future at its sole discretion in ways with which you may disagree.
The Trust Agreement authorizes the Company, acting through the its board of directors and without further shareholder approval, to cause the Trust to be converted to a corporation (the “Conversion”). As a shareholder of the Trust, you may disagree with the terms of the Conversion that might be implemented by the Company’s board of directors in the future, and you may disagree with the board’s determination that the terms of the Conversion are not materially adverse to you as a shareholder or that they are in the best interests of the Trust and its shareholders. Your recourse, if you disagree, will be limited because our Trust Agreement gives broad authority and discretion to the Company’s board of directors to implement the Conversion as long as the board determines that it will be in the best interests of the Trust and its shareholders to do so.
The Company’s board of directors has full authority and discretion over the distributions of the Company, other than the profit allocation, and it may decide to reduce or eliminate distributions at any time, which may materially adversely affect the market price for our shares.
The Company’s board of directors has full authority and discretion to determine whether or not a distribution by the Company should be declared and paid to the Trust and in turn, subject to U.S. federal income taxes and applicable state and local taxes, to our shareholders, as well as the amount and timing of any distribution. In addition, the management fee and profit allocation will be payment obligations of the Company and, as a result, will be paid, along with other Company obligations, prior to the payment of distributions to our shareholders. The Company’s board of directors may, based on their review of our financial condition and results of operations and pending acquisitions or our tax structure, determine to reduce or eliminate distributions, which may have a material adverse effect on the market price of our shares.
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We rely entirely on receipts from our businesses to make distributions to our shareholders.
The Trust’s sole asset is its interest in the LLC, which holds controlling interests in our businesses. Therefore, we are dependent upon the ability of our businesses to generate earnings and cash flow and distribute them to us in the form of interest and principal payments on indebtedness and, from time to time, dividends on equity to enable us, first, to satisfy our financial and tax obligations and second to make distributions to our shareholders. This ability may be subject to limitations under laws of the jurisdictions in which they are incorporated or organized. If, as a consequence of these various restrictions, we are unable to generate sufficient receipts from our businesses, we may not be able to declare, or may have to delay or cancel payment of, distributions to our shareholders.
We do not own 100% of our businesses. While we receive cash payments from our businesses which are in the form of interest payments, debt repayment and dividends, if any dividends were to be paid by our businesses, they would be shared pro rata with the minority shareholders of our businesses and the amounts of dividends made to minority shareholders would not be available to us for any purpose, including Company debt service or distributions to our shareholders. Any proceeds from the sale of a business will be allocated among us and the non-controlling shareholders of the business that is sold.
The Company’s board of directors has the power to change the terms of our shares in its sole discretion in ways with which you may disagree.
As an owner of our shares, you may disagree with changes made to the terms of our shares, and you may disagree with the Company’s board of directors’ decision that the changes made to the terms of the shares are not materially adverse to you as a shareholder or that they do not alter the characterization of the Trust. Your recourse, if you disagree, will be limited because our Trust Agreement gives broad authority and discretion to our board of directors. In addition, we may change the nature of the shares to be issued to raise additional equity and remain a fixed-investment trust for tax purposes.
Certain provisions of the LLC Agreement of the Company and the Trust Agreement make it difficult for third parties to acquire control of the Trust and the LLC and could deprive you of the opportunity to obtain a takeover premium for your shares.
The LLC Agreement of the LLC and the Trust Agreement of the Trust contain a number of provisions that could make it more difficult for a third party to acquire, or may discourage a third party from acquiring, control of the Trust and the Company. These provisions include, among others:
•restrictions on the LLC’s ability to enter into certain transactions with our major shareholders, with the exception of our Manager, modeled on the limitation contained in Section 203 of the Delaware General Corporation Law, or DGCL;
•allowing only the LLC’s board of directors to fill newly created directorships, for those directors who are elected by our shareholders, and allowing only our Manager, as holder of a portion of the Allocation Interests, to fill vacancies with respect to the class of directors appointed by our Manager;
•requiring that directors elected by our shareholders be removed, with or without cause, only by a vote of 85% of our shareholders;
•requiring advance notice for nominations of candidates for election to the Company’s board of directors or for proposing matters that can be acted upon by our shareholders at a shareholders’ meeting;
•having a substantial number of additional authorized but unissued shares that may be issued without shareholder action;
•providing the Company’s board of directors with certain authority to amend the LLC Agreement and the Trust Agreement, subject to certain voting and consent rights of the holders of trust interests and Allocation Interests; and
•limitations regarding calling special meetings and written consents of our shareholders.
These provisions, as well as other provisions in the LLC Agreement and Trust Agreement may delay, defer or prevent a transaction or a change in control that might otherwise result in you obtaining a takeover premium for your shares.
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We may have conflicts of interest with the noncontrolling shareholders of our businesses.
The boards of directors of our respective businesses have fiduciary duties to all their shareholders, including the Company and noncontrolling shareholders. As a result, they may make decisions that are in the best interests of their shareholders generally, but which are not necessarily in the best interest of the Company or our shareholders. In dealings with the Company, the directors of our businesses may have conflicts of interest and decisions may have to be made without the participation of directors appointed by the Company, and such decisions may be different from those that we would make.
Our financing arrangements expose us to additional risks associated with leverage and inhibits our operating flexibility and reduces earnings and cash available for distributions to our shareholders.
At December 31, 2021, we had approximately $1,300 million of consolidated debt outstanding. This level of consolidated debt could have important consequences, such as (i) limiting our ability to obtain additional financing to fund our potential growth; (ii) increasing the cost of future borrowings; (iii) limiting our ability to use operating cash flow in our other areas of our business because of cash requirements to service our debt; and (iv) increasing our vulnerability to adverse economic conditions. Our financing arrangements subject the Company to certain customary affirmative and restrictive covenants. If we violate any of these covenants, our lender may accelerate the maturity of any debt outstanding under our 2021 Credit Facility. Our ability to meet our debt service obligations may be affected by events beyond our control and will depend primarily upon cash produced by our businesses. Any failure to comply with the terms of our indebtedness could materially adversely affect us.
Changes in interest rates could materially adversely affect us.
Our 2021 Credit Facility bears interest at floating rates which will generally change as interest rates change. We bear the risk that the rates we are charged by our lender will increase faster than the earnings and cash flow of our businesses, which could reduce profitability, adversely affect our ability to service our debt, cause us to breach covenants contained in our 2021 Revolving Credit Facility and reduce earnings and cash available for distribution, any of which could materially adversely affect us.
We may engage in a business transaction with one or more target businesses that have relationships with our officers, our directors, or our Manager, which may create potential conflicts of interest.
We may decide to acquire one or more businesses with which our officers, our directors, or our Manager have a relationship. Potential conflicts of interest may exist with respect to a particular acquisition, and, as a result, the terms of the acquisition of a target business may not be as advantageous to our shareholders as it would have been absent any conflicts of interest.
CGI Maygar Holdings LLC may exercise significant influence over the Company.
CGI Maygar Holdings LLC owns approximately 8.3 million or approximately 12.0% of our common shares and may have significant influence over the election of directors in the future.
If, in the future, we cease to control and operate our businesses, we may be deemed to be an investment company under the Investment Company Act of 1940, as amended.
Under the terms of the LLC Agreement, we have the latitude to make investments in businesses that we will not operate or control. If we make significant investments in businesses that we do not operate or control or cease to operate and control our businesses, we may be deemed to be an investment company under the Investment Company Act of 1940, as amended, or the Investment Company Act. If we were deemed to be an investment company, we would either have to register as an investment company under the Investment Company Act, obtain exemptive relief from the SEC or modify our investments or organizational structure or our contract rights to fall outside the definition of an investment company. Registering as an investment company could, among other things, materially adversely affect our financial condition, business and results of operations, materially limit our ability to borrow funds or engage in other transactions involving leverage and require us to add directors who are independent of us or our Manager and otherwise will subject us to additional regulation that will be costly and time-consuming.
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Certain of our businesses are dependent on a limited number of customers to derive a large portion of their revenue, and the loss of one of these customers may adversely affect the financial condition, business and results of operations of these businesses.
Our Marucci, Velocity, Altor and Sterno businesses derive a significant amount of revenue from a concentrated number of retailers, distributors or manufacturers.Any negative change involving these retailers, distributors or manufacturers, including industry consolidation, store closings, reduction in purchasing levels or bankruptcies, could negatively impact the sales of these businesses and may have a material adverse effect on the results of operations, financial condition and cash flows of these businesses.
Our businesses do not have and may not have long-term contracts with their customers and clients and the loss of customers and clients could materially adversely affect their financial condition, business and results of operations.
Our businesses are and may be, based primarily upon individual orders and sales with their customers and clients. Our businesses historically have not entered into long-term supply contracts with their customers and clients. As such, their customers and clients could cease using their services or buying their products from them at any time and for any reason. The fact that they do not enter into long-term contracts with their customers and clients means that they have no recourse in the event a customer or client no longer wants to use their services or purchase products from them. If a significant number of their customers or clients elect not to use their services or purchase their products, it could materially adversely affect their financial condition, business and results of operations.
Risks Related to Taxation
The Trust will be subject to U.S. corporate income taxes which reduces the earnings and cash available for distributions to holders of Trust common shares in respect of such investments and could adversely affect the value of Trust common shareholders’ investment.
Effective September 1, 2021, the Trust elected to be treated as a corporation for U.S. federal income tax purposes (the “Election”). The Trust will now incur entity level U.S. federal corporate income taxes and applicable state and local taxes that it would not otherwise incur if it were still treated as a partnership for U.S. tax purposes. In addition, before the tax reclassification, income from the Trust was passed through to holders of its preferred shares, which resulted in less income being passed through from the Trust to holders of its common shares and effectively reduced each common shareholder’s allocable share of the Trust’s income; however, after the tax reclassification, no income will pass through to any shareholders, but the Trust will not be able to claim a tax deduction for distributions in respect of the preferred shares. Therefore, the amount of cash available for distributions to holders of Trust common shares could be reduced and their investment could be adversely affected.
Following the tax reclassification, determinations, declarations, and payments of distributions to holders of Trust common shares will continue to be at the sole discretion of the Company’s board of directors. Historically, our distribution policy has been to make regular distributions on outstanding common shares, and we expect to continue this policy of regular distributions. However, because the Trust will incur entity level income taxes following the tax reclassification, we reduced our previous annual distribution from $1.44 per Trust common share per year to approximately $1.00 per common share per year. Our distribution policy may be changed at any time at the discretion of the Company’s board of directors.
Future changes to tax laws are uncertain and may result in the Trust paying corporate income tax at rates higher than expected or result in the Trust failing to realize the anticipated benefits of the Election.
Recent proposals for tax reform include proposals to raise corporate income tax rates and capital gains tax rates. Future changes to tax laws are uncertain, but any such changes could cause the Trust to fail to realize the anticipated benefits of the Election. If corporate income tax rates are raised, the anticipated advantages of being treated as a corporation for U.S. tax purposes would be diminished. In addition, any general changes to tax laws, such as changes to limitations on the deductibility of interest, could result in the Trust or its shareholders paying tax at rates higher than anticipated.
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We may fail to realize the anticipated benefits of the Election or those benefits may take longer to realize than expected or not offset the costs of the Election, which could have a material and adverse impact on the trading price of our securities.
We believe that the Election will, among other things, make it easier for both institutional and retail investors to own shares of the Trust, expand our investor base and drive greater value for all of our shareholders over time. The level of investor interest in the shares of the Trust, however, may not meet our expectations. The Election did not result in the Trust’s immediate inclusion in certain stock market indices, such as the Russell indices, and may not result in inclusion at all. Inclusion in such indices may not result in an increased demand for the Trust’s securities, we may not have greater access to capital and our profile with rating agencies may not improve. Consequently, we may fail to realize the anticipated benefits of the Election or those benefits may take longer to realize than we expect. In addition, there can be no assurance that the anticipated benefits of the Election will offset its costs, which could be greater than we expect, particularly if there is an increase in the U.S. federal corporate income tax rate. Our failure to achieve the anticipated benefits of the Election at all or in a timely manner, or a failure of any benefits realized to offset their costs, could have a material and adverse impact on the trading price of our securities.
Risks Related to the Preferred Shares
Distributions on the Series A Preferred Shares are discretionary and non-cumulative.
Distributions on the Series A Preferred Shares are discretionary and non-cumulative. Holders of the Series A Preferred Shares will only receive distributions of the Series A Preferred Shares when, as and if declared by the board of directors of the Company. Consequently, if the board of directors of the Company does not authorize and declare a distribution for a distribution period, holders of the Series A Preferred Shares would not be entitled to receive any distribution for such distribution period, and such unpaid distribution will not be payable in such distribution period or in later distribution periods. We will have no obligation to pay distributions for a distribution period if the board of directors of the Company does not declare such distribution before the scheduled record date for such period, whether or not distributions are declared or paid for any subsequent distribution period with respect to the Series A Preferred Shares, or any other preferred shares we may issue or our common shares. This may result in holders of the Series A Preferred Shares not receiving the full amount of distributions that they expect to receive, or any distributions, and may make it more difficult to resell Series A Preferred Shares or to do so at a price that the holder finds attractive.
The board of directors of the Company may, in its sole discretion, determine to suspend distributions on the Series A Preferred Shares, which may have a material adverse effect on the market price of the Series A Preferred Shares. There can be no assurances that our operations will generate sufficient cash flows to enable us to pay distributions on the Series A Preferred Shares. Our financial and operating performance is subject to prevailing economic and industry conditions and to financial, business and other factors, some of which are beyond our control.
The Series A, Series B and Series C Preferred Shares are equity securities and are subordinated to our existing and future indebtedness.
The Series A, Series B and Series C Preferred Shares are our equity interests and do not constitute indebtedness. This means that the Series A, Series B and Series C Preferred Shares rank junior to all of our indebtedness and to other non-equity claims on us and our assets available to satisfy claims on us, including claims in our liquidation. In addition, the rights allocated to the Company’s allocation interests may reduce the amount available for distribution by the Trust upon its liquidation, dissolution or winding up. Further, the Series A, Series B and Series C Preferred Shares place no restrictions on our business or operations or on our ability to incur indebtedness or engage in any transactions, subject only to the limited voting rights.
Risks Relating to Our Manager
Our Chief Executive Officer, directors, Manager and management team may allocate some of their time to other businesses, thereby causing conflicts of interest in their determination as to how much time to devote to our affairs, which may materially adversely affect our operations.
Only our Chief Financial Officer, Mr. Ryan Faulkingham, devotes substantially all of his time to our affairs. Our Chief Executive Officer, directors, Manager and members of our management team may engage in other business activities. This may result in a conflict of interest in allocating their time between our operations and our management and operations of other businesses. Conflicts of interest that arise over the allocation of time may not always be resolved in our favor and may materially adversely affect our operations. See Part III, Item 13. "Certain
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Relationships and Related Transactions, and Director Independence" for the potential conflicts of interest of which you should be aware.
Our Manager and its affiliates, including members of our management team, may engage in activities that compete with us or our businesses.
Neither our management team nor our Manager is expressly prohibited from investing in or managing other entities, including those that are in the same or similar line of business as our businesses. In this regard, the Management Services Agreement and the obligation to provide management services will not create a mutually exclusive relationship between our Manager and its affiliates, on the one hand, and the Company, on the other.
Our Manager need not present an acquisition or disposition opportunity to us if our Manager determines on its own that such acquisition or disposition opportunity does not meet the Company’s acquisition or disposition criteria.
Our Manager will review any acquisition or disposition opportunity presented to the Manager to determine if it satisfies the Company’s acquisition or disposition criteria, as established by the Company’s board of directors from time to time. If our Manager determines, in its sole discretion, that an opportunity fits our criteria, our Manager will refer the opportunity to the Company’s board of directors for its authorization and approval prior to the consummation thereof; opportunities that our Manager determines do not fit our criteria do not need to be presented to the Company’s board of directors for consideration. If such an opportunity is ultimately profitable, we will have not participated in such opportunity. Upon a determination by the Company’s board of directors not to promptly pursue an opportunity presented to it by our Manager in whole or in part, our Manager will be unrestricted in its ability to pursue such opportunity, or any part that we do not promptly pursue, on its own or refer such opportunity to other entities, including its affiliates.
We cannot remove our Manager solely for poor performance, which could limit our ability to improve our performance and could materially adversely affect the market price of our shares.
Under the terms of the Management Services Agreement, our Manager cannot be removed as a result of under-performance. Instead, the Company’s board of directors can only remove our Manager in certain limited circumstances or upon a vote by the majority of the Company’s board of directors and the majority of our shareholders to terminate the Management Services Agreement. This limitation could materially adversely affect the market price of our shares.
Our Manager can resign on 180 days’ notice and we may not be able to find a suitable replacement within that time, resulting in a disruption in our operations that could materially adversely affect our financial condition, business and results of operations as well as the market price of our shares.
Our Manager has the right, under the management services agreement, to resign at any time on 180 days’ written notice, whether we have found a replacement or not. If our Manager resigns, we may not be able to contract with a new manager or hire internal management with similar expertise and ability to provide the same or equivalent services on acceptable terms within 90 days, or at all, in which case our operations are likely to experience a disruption, our financial condition, business and results of operations as well as our ability to pay distributions are likely to be adversely affected and the market price of our shares may decline. In addition, the coordination of our internal management, acquisition activities and supervision of our businesses is likely to suffer if we are unable to identify and reach an agreement with a single institution or group of executives having the expertise possessed by our Manager and its affiliates. Even if we are able to retain comparable management, whether internal or external, the integration of such management and their lack of familiarity with our businesses may result in additional costs and time delays that could materially adversely affect our financial condition, business and results of operations.
We must pay our Manager the management fee regardless of our performance.
Our Manager is entitled to receive a management fee that is based on our adjusted consolidated net assets, as defined in the management services agreement, regardless of the performance of our businesses. The calculation of the management fee is unrelated to the Company’s net income. As a result, the management fee may incentivize our Manager to increase the amount of our assets. For example, the acquisition of additional assets or the incurrence of third party debt could be prioritized rather than increasing the performance of our businesses.
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We cannot determine the amount of the management fee that will be paid over time with any certainty.
The management fee paid to CGM for the year ended December 31, 2021 was $46.9 million. The management fee is calculated by reference to the Company’s adjusted net assets, which will be impacted by the acquisition or disposition of businesses, which can be significantly influenced by our Manager, as well as the performance of our businesses and other businesses we may acquire in the future. Changes in adjusted net assets and in the resulting management fee could be significant, resulting in a material adverse effect on the Company’s results of operations. In addition, if the performance of the Company declines, assuming adjusted net assets remains the same, management fees will increase as a percentage of the Company’s net income.
We cannot determine the amount of profit allocation that will be paid over time with any certainty.
We cannot determine the amount of profit allocation that will be paid over time with any certainty. Such determination would be dependent on the potential sale proceeds received for any of our businesses and the performance of the Company and its businesses over a multi-year period of time, among other factors that cannot be predicted with certainty at this time. Such factors may have a significant impact on the amount of any profit allocation to be paid. Likewise, such determination would be dependent on whether certain hurdles were surpassed giving rise to a payment of profit allocation. Any amounts paid in respect of the profit allocation are unrelated to the management fee earned for performance of services under the management services agreement.
The fees to be paid to our Manager pursuant to the Management Services Agreement, the offsetting Management Services Agreements and integration services agreements and the profit allocation to be paid to certain persons who are employees and partners of our Manager, as holders of the Allocation Interests, pursuant to the LLC Agreement may significantly reduce the amount of earnings and cash available for distribution to our shareholders.
Under the Management Services Agreement, the Company will be obligated to pay a management fee to and, subject to certain conditions, reimburse the costs and out-of-pocket expenses of our Manager incurred on behalf of the Company in connection with the provision of services to the Company. Similarly, our businesses will be obligated to pay fees to and reimburse the costs and expenses of our Manager pursuant to any offsetting Management Services Agreements entered into between our Manager and one of our businesses, or any integration services agreements to which such businesses are a party. In addition, Sostratus LLC, as holder of the Allocation Interests, will be entitled to receive profit allocations. While it is difficult to quantify with any certainty the actual amount of any such payments in the future, we do expect that such amounts could be substantial. See the section entitled Part 3, Item 13. “Certain Relationships and Related Transactions, and Director Independence” for more information about these payment obligations of the Company. The management fee and profit allocation will be payment obligations of the Company and, as a result, will be paid, along with other Company obligations, prior to the payment of distributions to shareholders. As a result, the payment of these amounts may significantly reduce the amount of earnings and cash available for distribution to our shareholders.
Our Manager’s influence on conducting our operations, including on our conducting of transactions, gives it the ability to increase its fees, which may reduce the amount of earnings and cash available for distribution to our shareholders.
Under the terms of the Management Services Agreement, our Manager is paid a management fee calculated as a percentage of the Company’s adjusted net assets for certain items and is unrelated to net income or any other performance base or measure. Our Manager controls and may advise us to consummate transactions, incur third party debt or conduct our operations in a manner that, in our Manager’s reasonable discretion, are necessary to the future growth of our businesses and are in the best interests of our shareholders. These transactions, however, may increase the amount of fees paid to our Manager. Our Manager’s ability to increase its fees, through the influence it has over our operations, may increase the compensation paid by our Manager. Our Manager’s ability to influence the management fee paid to it by us could reduce the amount of earnings and cash available for distribution to our shareholders.
Fees paid by the Company and our businesses pursuant to integration services agreements do not offset fees payable under the Management Services Agreement and will be in addition to the management fee payable by the Company under the Management Services Agreement.
The Management Services Agreement provides that our businesses may enter into integration services agreements with our Manager pursuant to which our businesses will pay fees to our Manager for services provided by our Manager relating to the integration of a business’s financial reporting, computer systems and decision making and
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management processes into our operations following an acquisition of such business. See Part III, Item 13. “Certain Relationships and Related Transactions, and Director Independence” for more information about these agreements. Unlike fees paid under the offsetting Management Services Agreements, fees that are paid pursuant to such integration services agreements will not reduce the management fee payable by the Company. Therefore, such fees will be in excess of the management fee payable by the Company.
The fees to be paid to our Manager pursuant to these integration service agreements will be paid prior to any principal, interest or dividend payments to be paid to the Company by our businesses, which will reduce the amount of earnings and cash available for distributions to shareholders.
Our profit allocation may induce our Manager to make suboptimal decisions regarding our operations.
Sostratus LLC, as holder of our Allocation Interests, will receive a profit allocation based on ongoing cash flows and capital gains in excess of a hurdle rate. Certain persons who are employees and partners of our Manager are owners of Sostratus LLC. In this respect, a calculation and payment of profit allocation may be triggered upon the sale of one of our businesses. As a result, our Manager may be incentivized to recommend the sale of one or more of our businesses to the Company’s board of directors at a time that may not be optimal for our shareholders.
The obligations to pay the management fee and profit allocation may cause the Company to liquidate assets or incur debt.
If we do not have sufficient liquid assets to pay the management fee and profit allocation when such payments are due, we may be required to liquidate assets or incur debt in order to make such payments. This circumstance could materially adversely affect our liquidity and ability to make distributions to our shareholders.
General Risk Factors
We could be negatively impacted by cybersecurity attacks.
We, and our businesses, use a variety of information technology systems in the ordinary course of business, which are potentially vulnerable to unauthorized access, computer viruses and cybersecurity attacks, including cybersecurity attacks to our information technology infrastructure and attempts by others to gain access to our proprietary or sensitive information, and ranging from individual attempts to advanced persistent threats. The risk of a security breach or disruption, particularly through cyber-attacks or cyber intrusions, including by computer hackers, nation-state affiliated actors, and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. The procedures and controls we use to monitor these threats and mitigate our exposure may not be sufficient to prevent cybersecurity incidents. The results of these incidents could include misstated financial data, theft of trade secrets or other intellectual property, liability for disclosure of confidential customer, supplier or employee information, increased costs arising from the implementation of additional security protective measures, litigation and reputational damage, which could materially adversely affect our financial condition, business and results of operations. Any remedial costs or other liabilities related to cybersecurity incidents may not be fully insured or indemnified by other means.
In addition, cybersecurity has become a top priority for global lawmakers and regulators, and some jurisdictions have proposed or enacted laws requiring companies to notify regulators and individuals of data security breaches involving certain types of personal data. If we fail to comply with the relevant and increasing complex laws and regulations, we could suffer financial losses, a disruption of our business, liability to investors, regulatory intervention or reputational damage.
Impairment of our goodwill, indefinite-lived intangible assets or other long-lived assets could result in significant charges that would adversely impact our future operating results.
A significant portion of our long-term assets are comprised of intangible assets, including goodwill and indefinite lived intangible assets recorded as a result of past acquisitions. We assess the potential impairment of goodwill and indefinite lived intangible assets on an annual basis, as well as whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If our analysis indicates that an individual asset’s carrying value exceeds its fair market value, we will record a loss equal to the excess of the individual asset’s carrying value over its fair value. The impairment testing steps require significant amounts of judgment and subjectivity.
Factors that could trigger impairment include the following:
•significant under performance relative to historical or projected future operating results;
•significant changes in the manner of or use of the acquired assets or the strategy for our overall business;
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•significant negative industry or economic trends;
•significant decline in our stock price for a sustained period;
•changes in our organization or management reporting structure could result in additional reporting units, which may require alternative methods of estimating fair values or greater desegregation or aggregation in our analysis by reporting unit; and
•a decline in our market capitalization below net book value.
As of December 31, 2021, we had identified indefinite lived intangible assets with a carrying value in our financial statements of $57.0 million, and goodwill of $815.4 million.
Our businesses are subject to unplanned business interruptions which may adversely affect our performance.
Operational interruptions and unplanned events at one or more of our production facilities, such as explosions, fires, inclement weather, natural disasters, accidents, transportation interruptions and supply could cause substantial losses in our production capacity. Furthermore, because customers may be dependent on planned deliveries from us, customers that have to reschedule their own operations due to our delivery delays may be able to pursue financial claims against us, and we may incur costs to correct such problems in addition to any liability resulting from such claims. Such interruptions may also harm our reputation among actual and potential customers, potentially resulting in a loss of business. To the extent these losses are not covered by insurance, our financial position, results of operations and cash flows may be adversely affected by such events.
Our businesses could experience fluctuations in the costs and availability of raw materials, components or whole goods which could result in significant disruptions to supply chains, production disruptions and increased costs for our businesses.
Our businesses require access to various raw materials, components and whole goods to manufacture and distribute products. Changes in the availability and price of raw materials, components and whole goods, which can fluctuate significantly as a result of economic volatility, regulatory instability or change in import tariffs or trade agreements, can significantly increase the costs of production and distribution, which could have a material negative effect on the profitability of the businesses.
We could be adversely affected if we experience shortages of components from our suppliers or if disruptions in the supply chain lead to parts shortages for our customers.
A portion of our annual cost of sales is driven by the purchase of goods. We select our suppliers based on total value (including price, delivery and quality), taking into consideration their production capacities and financial condition, and we expect that they will be able to support our needs. However, there is no assurance that adverse financial conditions, including bankruptcies of our suppliers, reduced levels of production, natural disasters, staffing shortages, supply chain issues or other problems experienced by our suppliers will not result in shortages or delays in their supply of components to us.For example, the COVID-19 pandemic has resulted in labor shortages and supply chain disruptions. Any significant production disruption could have a material impact on our operations, operating results and financial condition.If we were to experience a significant or prolonged shortage of critical components from our suppliers, we may be unable to meet our production schedules for some of our key products and to ship such products to our customers in a timely fashion, which would adversely affect our sales, profitability and customer relations.
Our businesses rely and may rely on their intellectual property and licenses to use others’ intellectual property, for competitive advantage. If our businesses are unable to protect their intellectual property, are unable to obtain or retain licenses to use other’s intellectual property, or if they infringe upon or are alleged to have infringed upon others’ intellectual property, it could have a material adverse effect on their financial condition, business and results of operations.
Each business's success depends in part on their, or licenses to use others’, brand names, proprietary technology and manufacturing techniques. These businesses rely on a combination of patents, trademarks, copyrights, trade secrets, confidentiality procedures and contractual provisions to protect their intellectual property rights. The steps they have taken to protect their intellectual property rights may not prevent third parties from using their intellectual property and other proprietary information without their authorization or independently developing intellectual property and other proprietary information that is similar. In addition, the laws of foreign countries may not protect our businesses’ intellectual property rights effectively or to the same extent as the laws of the United States.
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Stopping unauthorized use of their proprietary information and intellectual property, and defending claims that they have made unauthorized use of others’ proprietary information or intellectual property, may be difficult, time-consuming and costly. The use of their intellectual property and other proprietary information by others, and the use by others of their intellectual property and proprietary information, could reduce or eliminate any competitive advantage they have developed, cause them to lose sales or otherwise harm their business.
Our businesses may become involved in legal proceedings and claims in the future either to protect their intellectual property or to defend allegations that they have infringed upon others’ intellectual property rights. These claims and any resulting litigation could subject them to significant liability for damages and invalidate their property rights. In addition, these lawsuits, regardless of their merits, could be time consuming and expensive to resolve and could divert management’s time and attention. The costs associated with any of these actions could be substantial and could have a material adverse effect on their financial condition, business and results of operations.
Our businesses are and may be subject to federal, state and foreign environmental laws and regulations that expose them to potential financial liability. Complying with applicable environmental laws requires significant resources, and if our businesses fail to comply, they could be subject to substantial liability.
Some of the facilities and operations of our businesses are and may be subject to a variety of federal, state and foreign environmental laws and regulations including laws and regulations pertaining to the handling, storage and transportation of raw materials, products and wastes, which require and will continue to require significant expenditures to remain in compliance with such laws and regulations currently in place and in the future. Compliance with current and future environmental laws is a major consideration for our businesses as any material violations of these laws can lead to substantial liability, revocations of discharge permits, fines or penalties. Because some of our businesses use hazardous materials and generate hazardous wastes in their operations, they may be subject to potential financial liability for costs associated with the investigation and remediation of their own sites, or sites at which they have arranged for the disposal of hazardous wastes, if such sites become contaminated. Even if they fully comply with applicable environmental laws and are not directly at fault for the contamination, our businesses may still be liable. Our businesses may also be held liable for damages caused by environmental and other conditions that existed prior to our acquisition the assets, business or operations involved, whether or not such damages are subject to indemnification from a prior owner. Costs associated with these risks could have a material adverse effect on our financial condition, business and results of operations.
Defects in the products provided by our companies could result in financial or other damages to their customers, which could result in reduced demand for our companies’ products and/or liability claims against our companies.
As manufacturers and distributors of consumer products, certain of our companies are subject to various laws, rules and regulations, which may empower governmental agencies and authorities to exclude from the market products that are found to be unsafe or hazardous. Under certain circumstances, a governmental authority could require our companies to repurchase or recall one or more of their products. Additionally, laws regulating certain consumer products exist in some cities and states, as well as in other countries in which they sell their products, where more restrictive laws and regulations exist or may be adopted in the future. Any repurchase or recall of such products could be costly and could damage the reputation of our companies. If any of our companies were required to remove, or voluntarily remove, their products from the market, their reputation may be tarnished and they may have large quantities of finished products that they cannot sell. Additionally, our companies may be subject to regulatory actions that could harm their reputations, adversely impact the values of their brands and/or increase the cost of production.
Our companies also face exposure to product liability claims in the event that one of their products is alleged to have resulted in property damage, bodily injury or other adverse effects. Defects in products could result in customer dissatisfaction or a reduction in, or cancellation of, future purchases or liability claims against our companies. If these defects occur frequently, our reputation may be impaired permanently. Defects in products could also result in financial or other damages to customers, for which our companies may be asked or required to compensate their customers, in the form of substantial monetary judgments or otherwise. There can be no assurance that rapidly changing safety standards will not render unsaleable products that complied with previously-applicable safety standards. As a result, these types of claims could have a material adverse effect on our businesses, results of operations and financial condition.
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Our businesses are subject to certain risks associated with their foreign operations or business they conduct in foreign jurisdictions.
Some of our businesses have and may have operations or conduct business outside the United States. Certain risks are inherent in operating or conducting business in foreign jurisdictions, including exposure to local economic conditions; difficulties in enforcing agreements and collecting receivables through certain foreign legal systems; longer payment cycles for foreign customers; adverse currency exchange controls; exposure to risks associated with changes in foreign exchange rates; potential adverse changes in political environments; actual or threatened geopolitical conflict; withholding taxes and restrictions on the withdrawal of foreign investments and earnings; export and import restrictions; difficulties in enforcing intellectual property rights; and required compliance with a variety of foreign laws and regulations. These risks individually and collectively have the potential to negatively impact our financial condition, business and results of operations.
The success of our branded consumer businesses depends on our ability to maintain the value and reputation of the brand.
The name of our branded consumer businesses is integral to those businesses. Maintaining, promoting, and positioning our branded consumer businesses will depend, in part, on the success of marketing and merchandising efforts and the ability to provide a consistent, high quality products and services. Our branded consumer businesses rely on social media, as one of their marketing strategies, to have a positive impact on both brand value and reputation. The brand and reputation of our branded consumer businesses could be adversely affected if those subsidiaries fail to achieve their objectives, if their public image was to be tarnished by negative publicity, which could be amplified by social media, or if they fail to deliver innovative and high quality products. The reputation of our branded consumer businesses could also be impacted by adverse publicity, whether or not valid, regarding allegations that we or our subsidiaries, or persons associated with us or our subsidiaries or formerly associated with us or our subsidiaries, have violated applicable laws or regulations, including but not limited to those related to safety, employment, discrimination, harassment, whistle-blowing, privacy, corporate citizenship or improper business practices. Additionally, while our branded consumer businesses devote effort and resources to protecting their intellectual property, if these efforts are not successful the value of those brands may be harmed. Any harm to the brand or reputation of our subsidiaries could have a material adverse effect on our financial condition.
Risks Specific to Our Subsidiaries
Risks Related to Arnold
Arnold's operations and the prior operations of predecessor companies expose it to the risk of material environmental liabilities, which could have a negative effect on its financial condition or results of operations.
Arnold may be subject to potential liabilities related to the remediation of environmental hazards and to claims of personal injuries or property damages that may be caused by hazardous substance releases and exposures, mainly because of past operations and the operations of predecessor companies. Arnold continues to incur remedial response and voluntary clean-up costs for site contamination, for which we may not be fully indemnified, and are a party to lawsuits and claims associated with environmental and safety matters, including past production of products containing hazardous materials. Arnold also may become party to various legal proceedings relating to alleged impacts from pollutants released into the environment. Various federal, state, local and foreign governments regulate the discharge of materials into the environment and can impose substantial fines and criminal sanctions for violations. In addition, changes in laws, regulations and enforcement of policies, the discovery of previously unknown contamination or information related to individual sites, the establishment of stricter state or federal toxicity standards with respect to certain contaminants, or the imposition of new clean-up requirements or remedial techniques could require Arnold to incur additional costs in the future that would have a negative effect on its financial condition or results of operations.
Risks Related to Sterno
Sterno's products operate at high temperatures and use flammable fuels, each of which could subject our business to product liability claims.
Sterno products expose it to potential product liability claims typical of fuel based heating products. The fuels Sterno uses in its products are flammable and may be toxic if ingested. Although Sterno products have comprehensive labeling and it follows government and third party based standards and protocols, it cannot
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guarantee there will not be accidents due to misuse or otherwise. Accidents involving Sterno products may have an adverse effect on its reputation and reduce demand for its products. In addition, Sterno may be held responsible for damages beyond its insurance coverage and there can be no guarantee that it will be able to procure adequate insurance coverage in the future.
Risks Related to Velocity Outdoor
Velocity’s products are subject to product safety and liability lawsuits, which could materially adversely affect its financial condition, business and results of operations.
As a manufacturer of recreational airguns and archery products, Velocity is involved in various litigation matters that occur in the ordinary course of business. Although Velocity provides information regarding safety procedures and warnings with all of its product packaging, not all users of its products will observe all proper safety practices. Failure to observe proper safety practices may result in injuries that give rise to product liability and personal injury claims and lawsuits, as well as claims for breach of contract, loss of profits and consequential damages.
If any unresolved lawsuits or claims are determined adversely, they could have a material adverse effect on Velocity, its financial condition, business and results of operations. As more of Velocity’s products are sold to and used by its consumers, the likelihood of product liability claims being made against it increases. In addition, the running of statutes of limitations in the United States for personal injuries to minor children may be suspended during the child’s legal minority. Therefore, it is possible that accidents resulting in injuries to minors may not give rise to lawsuits until a number of years later.
There is a risk that Velocity's product liability insurance may not be sufficient to cover all liabilities incurred in connection with such claims and the financial consequences of these claims and lawsuits will have a material adverse effect on its business, financial condition, liquidity and results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
NONE
ITEM 2. PROPERTIES
The following is a summary as of December 31, 2021 of the physical properties owned or leased by our businesses that we consider materially important to those businesses.
5.11
5.11 is headquartered in Irvine, California and leases offices and warehouse space in locations worldwide. The summary below outlines 5.11's primary leased offices and warehouse space.
Location Square Feet Use
Bankstown, Australia 10,387 Office
Kowloon Bay, Hong Kong 17,759 Office
In addition, at December 31, 2021, 5.11 leased space for 87 retail stores, ranging in size from 3,250 square feet to 10,000 square feet.
BOA
BOA is headquartered in Denver, Colorado and leases offices and warehouse space in locations worldwide. The summary below outlines BOA's primary leased offices and warehouse space.
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Location Square Feet Use
Mondsee, Austria 15,714 Office
Hong Kong, China 20,000 Office/Warehouse
Ergobaby
Ergobaby is headquartered in Torrance, California and leases office and warehouse locations worldwide. The summary below outlines Ergobaby's primary leased office and warehouse space.
Location Square Feet Use
Torrance, CA 4,595 Corporate
Los Angeles, CA 16,378 Corporate
Carson, CA 5,000 Warehouse
Bialystok, Poland 9,688 Warehouse
Lugano
Lugano is headquartered in Newport Beach, California. The summary below outlines Lugano's primary leased office space and retail locations.
Location Square Feet Use
Newport Beach, CA 17,792 Corporate office and Retail salon
Palm Beach, FL 2,155 Retail salon
Aspen, CO 1,463 Retail salon
Lane Ocala, FL 2,014 Retail salon
Marucci Sports
Marucci is headquartered in Baton Rouge, Louisiana. The summary below outlines Marucci's primary leased office and manufacturing space.
Location Square Feet Use
Baton Rouge, LA 73,900 Office/Distribution Center
King of Prussia, PA 22,500 Manufacturing
Punxsutawney, PA 15,000 Manufacturing
Winnfield, PA 14,330 Manufacturing
Lafayette, LA 12,192 Retail Store
American Fort, UT 22,500 Distribution Center
Arnold
Arnold is headquartered in Rochester, New York and has eleven manufacturing facilities. Arnold owns the Ogallala, NE and the Greenville, OH locations. All other locations are leased. The summary below outlines Arnold's primary property locations.
Location Square Feet Use
Marengo, IL 94,220 Office/Warehouse
Marietta, OH 81,000 Office/Warehouse
Marengo, IL 55,200 Office/Warehouse
Norfolk, NE 109,000 Office/Warehouse
Rochester, NY 73,000 Office/Warehouse
Ogallala, NE 25,000 Office/Warehouse
Greenville, OH 70,908 Office/Warehouse
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Sheffield, England 25,000 Office/Warehouse
Lupfig, Switzerland 52,937 Office/Warehouse
Guangdong Province, China 113,302 Office/Warehouse
Altor Solutions
Altor is headquartered in Scottsdale, Arizona and operates 17 molding and fabricating facilities across North America. Altor owns the New Albany, IN, Bloomsburg, PA and El Dorado Springs, MO locations. All other locations are leased. The summary below outlines Altor's primary property locations.
Location Square Feet Use
Scottsdale, Arizona 7,000 Corporate
Anderson, South Carolina 133,250 Manufacturing/Warehouse
Compton, California 44,000 Manufacturing/Warehouse
Erie, Pennsylvania 35,772 Manufacturing/Warehouse
Fort Madison, Iowa 114,000 Manufacturing/Warehouse
Jackson, Tennessee 55,000 Manufacturing/Warehouse
Jefferson, Georgia 60,000 Manufacturing/Warehouse
Keller, Texas 131,073 Manufacturing/Warehouse
Modesto, California 79,000 Manufacturing/Warehouse
El Dorado Springs, Missouri 38,000 Manufacturing/Warehouse
New Albany, Indiana 65,000 Manufacturing/Warehouse
Bloomsburg, Pennsylvania 54,000 Manufacturing/Warehouse
Northbridge, MA 380,000 Manufacturing/Warehouse
Plymouth, WI 248,000 Manufacturing/Warehouse
Gnadenhutten, OH 98,200 Manufacturing/Warehouse
Tijuana, Mexico 60,000 Manufacturing/Warehouse
Queretaro, Mexico 100,000 Manufacturing/Warehouse
Sterno
Sterno is headquartered in Corona, California. Sterno owns manufacturing and production facilities in Memphis, Tennessee and Texarkana, Texas. All other properties are leased. The summary below outlines Sterno's primary property locations.
Location Square Feet Use
Corona, CA 12,330 Corporate Office
Memphis, TN 228,316 Manufacturing
Texarkana, TX 337,700 Manufacturing
Delta, Canada 45,000 Warehouse
La Porte, IN 20,000 Office
Toronto, Canada 13,867 Office
Vancouver, Canada 50,372 Office
Vancouver, Canada 33,711 Warehouse
Mississauga, Canada 100,000 Warehouse
Provo, UT 171,361 Office/Warehouse
Spanish Fork, UT 530,014 Warehouse
Calgary, Canada 28,748 Office/Warehouse
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Velocity Outdoor
Velocity Outdoor is headquartered in Bloomfield, New York. Velocity owns a 225,000 square foot manufacturing facility in Bloomfield, New York that also holds their corporate offices, and leases a 144,000 square foot finished goods warehouse in Farmington, New York. Velocity's Ravin subsidiary operates an 80,000 square foot manufacturing facility in Superior, Wisconsin.
Corporate
Our corporate offices are located in Westport, Connecticut and Costa Mesa, California, where we utilize space provided by our Manager.
We believe that our properties and the terms of their leases at each of our businesses are sufficient to meet our present needs and we do not anticipate any difficulty in securing additional space, as needed, on acceptable terms.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, we are involved in various claims and legal proceedings. While the ultimate resolution of these matters has yet to be determined, we do not believe that their outcome will have a material adverse effect on our financial position or results of operations.
Arnold
Our Arnold subsidiary was named as co-defendant, together with 300 West LLC (“300 West”), in a suit filed in the Twenty-Second Judicial Circuit, McHenry County, Illinois, Chancery Division (Case No. 13CH1046) in 2013 by the State of Illinois (the “Marengo Litigation”). Arnold leases a site in Marengo, McHenry County, Illinois (the “Site”) from 300 West. Since 2008, Arnold and 300 West have been a part of the Illinois Remediation Program with respect to the Site. In the Marengo Litigation, the State of Illinois claimed that 300 West and Arnold discharged Chlorinated VOCs into the groundwater on-Site, which has since migrated off-Site into private drinking wells. The State of Illinois sought injunctive relief and civil penalties. In June of 2016, the parties entered into a consent order (as amended and restated up and through the date hereof, the “Consent Order”). 300 West, at its expense, connected residents whose drinking water was impacted by the alleged release to the City of Marengo’s public water supply, as required by the Consent Order. The Consent Order also requires Arnold and 300 West to submit to the Illinois Environmental Protection Agency (IEPA) a comprehensive plan detailing steps to be taken by 300 West and Arnold to remediate on- and off-site soil and groundwater contamination. Remediation efforts are ongoing. The Consent Order also requires the ultimate settlement of any stipulated and civil penalties related to the Marengo Litigation. In May of 2021, the McHenry County State’s Attorney joined the Marengo Litigation as a plaintiff.
Certain damages incurred by Arnold in connection with the Marengo Litigation are subject to indemnification pursuant to the Stock Purchase Agreement, among SPS Technologies, LLC (“SPS”), SPS Technologies Limited (“SPS Ltd.”), Precision Castparts Corp. (collectively with SPS and SPS Ltd., the “SPS Entities”), Arnold and Audax Private Equity Fund, L.P., dated December 20, 2004, and prior consents to indemnification given by the SPS Entities. Arnold has cooperated with the governmental agencies in the Marengo Litigation investigations and proceedings, as well as the obligations agreed to pursuant to the Consent Order. CODI does not believe that the outcome of the Marengo Litigation will have a material adverse effect on its financial position or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common shares of Trust stock has traded on the New York Stock Exchange (the “NYSE”) under the symbol “CODI”.
Common Stock Holders
On December 31, 2021 there were 14 registered holders of our common stock. The number of registered holders includes banks and brokers who act as nominees, each of whom may represent more than one shareholder.
COMPARATIVE PERFORMANCE OF SHARES OF TRUST COMMON STOCK
The performance graph shown below compares the change in cumulative total shareholder return on common shares of Trust stock with the NYSE Composite Index and the NYSE Financial Sector Index for the previous five years, through the year ended December 31, 2021. The graph sets the beginning value of common shares of Trust stock and the indices at $100, and assumes that all quarterly dividends were reinvested at the time of payment. This graph does not forecast future performance of common shares of Trust stock.
Year ended December 31,
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Distributions
During the year ended December 31, 2021, we declared and paid cash distributions of $2.21 to holders of record of our common shares, including a special distribution to shareholders in August 2021. On August 3, 2021,in order to offset a portion of the tax liability to the shareholders as a result of the election to cause the Trust to be treated as a corporation for U.S. federal income tax purposes, the Company's board of directors declared a special cash distribution on the Trust’s common shares of $0.88 per common share. For the years 2020 and 2019, we declared and paid cash distributions of $1.44 per share to holders of record of our common shares. Following the tax reclassification, the Company’s board reduced our anticipated annual distribution from the current $1.44 per Trust common share per year to approximately $1.00 per common share per year. The Company’s board of directors has full authority and discretion to determine whether or not a distribution by the Company should be declared and paid to the Trust and in turn to our shareholders, as well as the amount and timing of any distribution. The Company’s board of directors may, based on their review of our financial condition and results of operations and any future changes to our tax structure, determine to modify future distributions.
Recent Sales of Unregistered Securities
On March 23, 2021, we consummated the issuance and sale of $1,000 million aggregate principal amount of our 5.250% 2029 Notes (the "2029 Notes") offered pursuant to a private offering to qualified institutional buyers in accordance with Rule 144A under the Securities Act, and to non-U.S. persons under Regulation S under the Securities Act. The Notes were issued pursuant to an indenture, dated as of March 23, 2021 (the “2029 Notes Indenture”), between the Company and U.S. Bank National Association, as trustee. The Notes bear interest at the rate of 5.250% per annum and will mature on April 15, 2029. Interest on the Notes is payable in cash on April 15th and October 15th of each year. The 2029 Notes are general unsecured obligations of the Company and are not guaranteed by our subsidiaries.
The proceeds from the sale of the 2029 Notes was used to repay debt outstanding under the 2018 Credit Facility in connection with entering into the 2021 Credit Facility and to redeem our 8.000% Senior Notes due 2026 (the “2026 Notes”).
On November 17, 2021, we consummated the issuance and sale of $300 million aggregate principal amount of our 5.000% 2032 Notes (the "2032 Notes") offered pursuant to a private offering to qualified institutional buyers in accordance with Rule 144A under the Securities Act, and to non-U.S. persons under Regulation S under the Securities Act. The Notes were issued pursuant to an indenture, dated as of November 17, 2021 (the “2032 Notes Indenture”), between the Company and U.S. Bank National Association, as trustee. The Notes bear interest at the rate of 5.000% per annum and will mature on January 15, 2032. Interest on the Notes is payable in cash on July 15th and January 15th of each year. The 2032 Notes are general unsecured obligations of the Company and are not guaranteed by our subsidiaries. The proceeds from the sale of the 2032 Notes was used to repay debt outstanding under the 2021 Credit Facility.
Purchases of Equity Securities by Issuer and Affiliated Purchasers
None.
ITEM 6. [Reserved]
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Item 7 contains forward-looking statements. Forward-looking statements in this Annual Report on Form 10-K are subject to a number of risks and uncertainties, some of which are beyond our control. Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by the forward-looking statements. Additional risks of which we are not currently aware or which we currently deem immaterial could also cause our actual results to differ, including those discussed in the sections entitled “Forward-Looking Statements” and “Risk Factors” included elsewhere in this Annual Report.
Overview
Compass Diversified Holdings, a Delaware statutory trust, was incorporated in Delaware on November 18, 2005. Compass Group Diversified Holdings LLC, a Delaware limited liability Company, was also formed on November 18, 2005. In accordance with the Third Amended and Restated Trust Agreement, dated as of August 3, 2021 (as amended and restated, the "Trust Agreement"), the Trust is sole owner of 100% of the Trust Interests (as defined in the Company's Sixth Amended and Restated Operating Agreement, dated as of August 3, 2021 (as amended and restated, the "LLC Agreement") of the Company and, pursuant to the LLC Agreement, the Company has outstanding the identical number of Trust Interests as the number of outstanding shares of the Trust. Sostratus LLC owns all of our Allocation Interests. The Company is the operating entity with a board of directors and other corporate governance responsibilities, similar to that of a Delaware corporation.
The Trust and the Company were formed to acquire and manage a group of small and middle-market businesses headquartered in North America. We characterize small and middle market businesses as those that generate annual cash flows of up to $75 million. We focus on companies of this size because we believe that these companies are more able to achieve growth rates above those of their relevant industries and are also frequently more amenable to efforts to improve earnings and cash flow.
In pursuing new acquisitions, we seek businesses with the following characteristics:
•North American base of operations;
•stable and growing earnings and cash flow;
•maintains a significant market share in defensible industry niche (i.e., has a “reason to exist”);
•solid and proven management team with meaningful incentives;
•low technological and/or product obsolescence risk; and
•a diversified customer and supplier base.
Our management team’s strategy for our subsidiaries involves:
◦utilizing structured incentive compensation programs tailored to each business in order to attract, recruit and retain talented managers to operate our businesses;
◦regularly monitoring financial and operational performance, instilling consistent financial discipline, and supporting management in the development and implementation of information systems to effectively achieve these goals;
◦assisting management in their analysis and pursuit of prudent organic cash flow growth strategies (both revenue and cost related);
◦identifying and working with management to execute attractive external growth and acquisition opportunities; and
◦forming strong subsidiary level boards of directors, including independent directors, to supplement management in their development and implementation of strategic goals and objectives.
Based on the experience of our management team and its ability to identify and negotiate acquisitions, we believe we are well positioned to acquire additional attractive businesses. Our management team has a large network of deal intermediaries to whom it actively markets and who we expect to expose us to potential acquisitions. Through this network, as well as our management team’s active proprietary transaction sourcing efforts, we typically have a substantial pipeline of potential acquisition targets. In consummating transactions, our management team has, in the past, been able to successfully navigate complex situations surrounding acquisitions, including corporate spin-
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offs, transitions of family-owned businesses, management buy-outs and reorganizations. We believe the flexibility, creativity, experience and expertise of our management team in structuring transactions provides us with a strategic advantage by allowing us to consider non-traditional and complex transactions tailored to fit a specific acquisition target.
In addition, because we intend to fund acquisitions through the utilization of our 2021 Revolving Credit Facility, we do not expect to be subject to delays in or conditions by closing acquisitions that would be typically associated with transaction specific financing, as is typically the case in such acquisitions. We believe this advantage is a powerful one and is highly unusual in the marketplace for acquisitions in which we operate.
Initial public offering and Company formation
On May 16, 2006, we completed our initial public offering of 13,500,000 shares of the Trust (the “IPO”). Subsequent to the IPO the Company’s board of directors engaged our Manager to externally manage the day-to-day operations and affairs of the Company, oversee the management and operations of the businesses and to perform those services customarily performed by executive officers of a public company.
From May 16, 2006 through December 31, 2021, we purchased twenty-two businesses (each of our businesses is treated as a separate operating segment) and disposed of eleven businesses. The tables below reflect summarized information relating to our acquisitions and dispositions from the date of our IPO through December 31, 2021 (in thousands):
Acquisitions
Ownership Interest - December 31, 2021
Business Acquisition Date CODI Purchase Price Primary Diluted
(1)The total purchase price for CBS Holdings includes the acquisition of Staffmark Investment LLC in January 2008 for a purchase price of $128.6 million. The Company renamed its CBS Personnel business Staffmark subsequent to the acquisition.
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(2) Velocity Outdoor (formerly "Crosman Corp.") was purchased by the Company in May 2006 and subsequently sold in January 2007. We reacquired Velocity Outdoor in June 2017.
(3)The total purchase price does not reflect add-on acquisitions made by our businesses subsequent to their purchase by CODI unless indicated.
(4) FOX completed an IPO of its common stock in August 2013 in which we sold a 22% interest in FOX, reducing our ownership interest to 53%.9. In July 2014, FOX completed a secondary offering in which we sold a 12% interest in FOX, reducing our ownership interest to 41% and resulting in the deconsolidation of FOX from our financial results. We subsequently sold our remaining shares of FOX and now hold no ownership interest in FOX. We recognized total net proceeds from the sale of our FOX shares of approximately $465.1 million.
(5) The total purchase price of Sterno includes the acquisition of Rimports in February 2018 for a purchase price of $154.4 million.
Dispositions
(1) CODI portion of the net proceeds from disposition includes debt and equity proceeds and reflects the accounting for the redemption of the sold business's minority shareholders and transaction expenses.
(2) Gain (loss) recognized on sale of our businesses is calculated by deducting our total invested capital from the net sale proceeds received.
(3) Sale price of Manitoba Harvest was C$370 million. Translation to USD is as of the date of sale.
* We made loans to and purchased a controlling interest in FOX on January 4, 2008, for approximately $80.4 million. In August 2013, FOX completed an initial public offering of its common stock. As a result of the initial public offering, our ownership interest in FOX was reduced to approximately 53.9%. No gain was reflected as a result of the sale of our FOX shares in the initial public offering because our majority classification of FOX did not change. FOX used a portion of their net proceeds received from the sale of their shares as well as proceeds from a new external FOX credit facility to repay $61.5 million in outstanding indebtedness to us under their existing credit facility with us. In July 2014, through a secondary offering, our ownership in FOX was lowered from approximately 54% to approximately 41%, and as a result we deconsolidated FOX as of July 10, 2014. In March and August 2016, through two more secondary offerings and a share repurchase by FOX, our ownership in the outstanding common stock of FOX was further lowered to approximately 23% as of September 30, 2016. In November 2016, through another secondary offering, our ownership in the outstanding common stock of FOX was further lowered to approximately 14%. On March 13, 2017, FOX closed on a secondary public offering of 5,108,718 shares of FOX common stock held by CODI, which represented CODI's remaining investment in FOX. We recognized total net proceeds from the sales of our FOX shares of approximately $465.1 million, plus proceeds from the repayment of the FOX credit facility of $61.5 million upon completion of their initial public offering, and a total gain of $428.7 million.
We are dependent on the earnings of, and cash receipts from, the businesses that we own in order to meet our corporate overhead and management fee expenses and to pay distributions. The earnings and distributions of our
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businesses are generally lowest in the first quarter, and strongest in the third and fourth quarter, of each fiscal year. These earnings and distributions, net of any non-controlling interest in these businesses, are available to:
•meet capital expenditure requirements, management fees and corporate overhead charges;
•fund distributions from the businesses to the Company; and
•be distributed by the Trust to shareholders.
2021 Highlights and Recent Events
Trust Tax Reclassification
On August 3, 2021, the shareholders of CODI approved amendments to the Second Amended and Restated Trust Agreement of the Trust and the Fifth Amended and Restated Operating Agreement of the Company to allow the Company’s Board of Directors (the “Board”) to cause the Trust to elect to be treated as a corporation for U.S. federal income tax purposes (the “tax reclassification”) and, at its discretion in the future, cause the Trust to be converted to a corporation. Following the shareholder vote, the Board resolved to cause the Trust to elect to be treated as a corporation for U.S. federal income tax purposes. Such election became effective September 1, 2021, prior to which the Trust had been taxed as a partnership for U.S. federal income tax purposes since January 1, 2007.
The tax reclassification resulted in a taxable gain to the Trust for U.S. federal income tax purposes of approximately $328 million, which gain was allocated and passed through to the Trust’s common shareholders of record as of the close of business on August 31, 2021. This taxable gain created current tax liability for those shareholders and will be reported on the Trust’s final 2021 Schedule K-1. Consequently, the Trust paid a special distribution of $0.88 cents per share on September 7, 2021 to Trust common shareholders of record as of the close of business on August 31, 2021 that was intended to partially cover the taxable income incurred by those shareholders.
Following the tax reclassification, determinations, declarations, and payments of distributions to holders of Trust common shares will continue to be at the sole discretion of the Board. Historically, our distribution policy has been to make regular distributions on outstanding common shares. Because the Trust will incur entity level income taxes following the tax reclassification, we reduced our anticipated annual distribution from the current $1.44 per Trust common share per year to $1.00 per Trust common share per year. Our distribution policy may be changed at any time at the discretion of the Board.
We will issue final Schedule K-1s with respect to our final taxable period as a partnership beginning January 1, 2021 and ending August 31, 2021, the last day on which the Trust was treated as a partnership for U.S. federal income tax purposes. Thereafter, items of income, gain loss, and deduction will not flow through to Trust shareholders and the Trust will no longer issue Schedule K-1s. Common shareholders will no longer be allocated taxable income as a result of their investment in the Trust and shareholders subject to rules regarding “unrelated business taxable income” (or “UBTI”) will no longer be allocated UBTI.
The Trust will be required to file Form 1120, U.S. Corporation Income Tax Return on an annual basis and for all taxable periods beginning on or after the tax reclassification. In addition, distribution with respect to Trust shares (including Trust preferred shares) will now be treated as corporate distributions and reported on Form 1099-DIV, instead of on Schedule K-1. Distributions from the Trust will be taxable as dividends to the extent the Trust has positive earnings and profits, as determined for U.S. federal income tax purposes. Dividends from the Trust with respect to Trust shares should be eligible for preferential tax treatment as “qualified dividends” to the extent the Trust shareholders receiving such dividends meet certain holding period requirements.
The foregoing description addresses only certain U.S. federal income tax consequences of the tax reclassification applicable to shareholders generally. We do not provide tax advice and nothing herein should be considered as such. Each shareholder should consult its tax advisor concerning the particular U.S. federal income, U.S. federal estate or gift, state, local, foreign and other tax consequences of the tax reclassification and holding Trust shares.
Acquisition of Lugano Diamonds
On September 3, 2021, the Company, through its newly formed acquisition subsidiaries, Lugano Holding, Inc., a Delaware corporation (“Lugano Holdings”), and Lugano Buyer, Inc., a Delaware corporation (“Lugano Buyer”) and a wholly-owned subsidiary of Lugano Holdings, acquired the issued and outstanding shares of stock of Lugano Diamonds and Jewelry Inc. ("Lugano") other than certain rollover shares described below (the “Lugano Transaction”). The Lugano Transaction was effectuated pursuant to a Stock Purchase Agreement (the “Lugano
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Purchase Agreement”), also dated September 3, 2021, by and among Lugano Buyer, the sellers named therein (“Lugano Sellers”) and Mordechai Haim Ferder in his individual capacity and as initial representative of the Sellers. Based in Newport Beach, California and founded in 2004, Lugano makes one-of-a-kind jewelry for some of the world’s most discerning clientele. In addition to its product offerings, Lugano frequently partners with local, influential organizations to host and sponsor more than 100 equestrian, social and charity events throughout the year.
The Company made loans to, and purchased a 60% equity interest in, Lugano. The purchase price, including proceeds from noncontrolling shareholders and net of transaction costs, was $263.3 million. The selling shareholders invested in the transaction along with the Company, representing 40% initial noncontrolling interest on both a primary and fully diluted basis. The fair value of the noncontrolling interest was determined based on the enterprise value of the acquired entity multiplied by the ratio of the number of shares acquired by the minority holders to total shares. The transaction was accounted for as a business combination. CGM acted as an advisor to the Company in the acquisition and will continue to provide integration services during the first year of the Company's ownership of Lugano. CGM will receive integration service fees of $2.3 million payable quarterly over a twelve month period as services are rendered which payments began in the quarter ended December 31, 2021. The Company incurred $1.8 million of transaction costs in conjunction with the Lugano acquisition, which was included in selling, general and administrative expense in the consolidated statements of operations during the third quarter of 2021. The Company funded the acquisition with cash on hand and a $120 million draw on its 2021 Revolving Credit Facility.
2021 Credit Facility
On March 23, 2021, we entered into a Second Amended and Restated Credit Agreement (the "2021 Credit Facility") to amend and restate the 2018 Credit Facility. The 2021 Credit Facility provides for revolving loans, swing line loans and letters of credit (the "2021 Revolving Credit Facility") up to a maximum aggregate amount of $600 million and also permits the Company, prior to the applicable maturity date, to increase the revolving loan commitment and/or obtain term loans in an aggregate amount of up to $250 million, subject to certain restrictions and conditions. All amounts outstanding under the 2021 Revolving Credit Facility will become due on March 23, 2026, which is the maturity date of loans advanced under the 2021 Revolving Credit Facility.
Senior Notes Issuance
On March 23, 2021, we consummated the issuance and sale of $1,000 million aggregate principal amount of our 5.250% Notes due 2029 (the "2029 Notes") offered pursuant to a private offering to qualified institutional buyers in accordance with Rule 144A under the Securities Act, and to non-U.S. persons under Regulation S under the Securities Act. The 2029 Notes were issued pursuant to an indenture, dated as of March 23, 2021 (the “2029 Notes Indenture”), between the Company and U.S. Bank National Association, as trustee. The 2029 Notes bear interest at the rate of 5.250% per annum and will mature on April 15, 2029. Interest on the 2029 Notes is payable in cash on April 15th and October 15th of each year. The 2029 Notes are general unsecured obligations of the Company and are not guaranteed by our subsidiaries.
The proceeds from the sale of the 2029 Notes was used to repay debt outstanding under the 2018 Credit Facility in connection with our entry into the 2021 Credit Facility and to redeem our 2026 Notes.
On November 17, 2021, we consummated the issuance and sale of $300 million aggregate principal amount of our 5.000% Notes due 2032 (the "2032 Notes") offered pursuant to a private offering to qualified institutional buyers in accordance with Rule 144A under the Securities Act, and to non-U.S. persons under Regulation S under the Securities Act. The 2032 Notes were issued pursuant to an indenture, dated as of November 17, 2021 (the “2032 Notes Indenture”), between the Company and U.S. Bank National Association, as trustee. The Notes bear interest at the rate of 5.000% per annum and will mature on January 15, 2032. Interest on the Notes is payable in cash on January 15th and July 15th of each year. The 2032 Notes are general unsecured obligations of the Company and are not guaranteed by our subsidiaries. The proceeds from the sale of the 2032 Notes was used to repay debt outstanding under the 2021 Revolving Credit Facility.
Common Share Offering
On September 7, 2021, we filed a prospectus supplement pursuant to which we may, but we have no obligation to, issue and sell up to $500 million shares of the common shares of the Trust in amounts and at times to be determined by us. Actual sales will depend on a variety of factors to be determined by us from time to time, including, market conditions, the trading price of Trust common shares and determinations by us regarding appropriate sources of funding. In connection with this offering, we entered into an At Market Issuance Sales
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Agreement with B. Riley Securities, Inc. (“B. Riley”) and Goldman Sachs & Co. LLC (“Goldman” and, together with B. Riley, the “Sales Agents”) pursuant to which we may sell common shares of the Trust having an aggregate offering price of up to $500 million, from time to time through B. Riley and Goldman, acting as sales agents and/or principals. We sold 3,387,385 Trust common shares during the year ended December 31, 2021 and received net proceeds of approximately $115.1 million. We incurred approximately $2.1 million in commissions payable to the Sales Agents during the year ended December 31, 2021.
Disposition of Liberty Safe
On July 16, 2021, the Company, as majority stockholder of Liberty Safe Holding Corporation (“Liberty”) and as Sellers Representative, entered into a definitive Stock Purchase Agreement (the “Liberty Purchase Agreement”) with Independence Buyer, Inc. (“Liberty Buyer”), Liberty and the other holders of stock and options of Liberty to sell to Liberty Buyer all of the issued and outstanding securities of Liberty, the parent company of the operating entity, Liberty Safe and Security Products, Inc. On August 3, 2021, Liberty Buyer completed the acquisition of Liberty pursuant to the Liberty Purchase Agreement, as amended. The sale price of Liberty was based on an aggregate total enterprise value of $147.5 million, and is subject to customary adjustments. After the allocation of the sale proceeds to Liberty's non-controlling shareholders, the repayment of intercompany loans to the Company (including accrued interest) of $26.5 million, and the payment of transaction expenses of approximately $4.5 million, the Company received approximately $128.0 million of total proceeds from the sale at closing. The Company recognized a gain on the sale of Liberty of $72.8 million during the year ended December 31, 2021.
Sale of Advanced Circuits
On October 13, 2021, the Company, as the representative (the “Sellers Representative”) of the holders (the “AC Sellers”) of stock and options of Compass AC Holdings, Inc. (“Advanced Circuits”), a majority owned subsidiary of the Company, entered into a definitive Agreement and Plan of Merger (the “AC Agreement”) with Tempo Automation, Inc. (“AC Buyer”), Aspen Acquisition Sub, Inc. (“AC Merger Sub”) and Advanced Circuits, pursuant to which AC Buyer will acquire all of the issued and outstanding securities of Advanced Circuits, the parent company of the operating entity, Advanced Circuits, Inc., through a merger of AC Merger Sub with and into Advanced Circuits, with Advanced Circuits surviving the merger and becoming a wholly owned subsidiary of AC Buyer (the “AC Merger”). Under the terms of the AC Agreement, the AC Sellers will receive consideration in the amount of $310 million, composed of $240 million in cash and $70 million in common stock of a publicly traded special purpose acquisition company (“SPAC”) selected by AC Buyer to acquire AC Buyer (the “SPAC Transaction”) upon the closing of the transaction, excluding certain working capital and other adjustments. In addition, the AC Sellers may receive 2.4 million additional shares of SPAC common stock within five years, subject to SPAC stock price performance. The Company owns approximately 67% of the outstanding stock of Advanced Circuits on a fully diluted basis and expects to receive approximately 77% of the gross consideration payable under the AC Agreement. This amount is in respect of the Company’s outstanding loans to Advanced Circuits and its equity interests in Advanced Circuits. The closing of the transaction is expected to occur in the second quarter of 2022, however, there can be no assurances that all of the conditions to closing, which include the closing of the SPAC transaction, will be satisfied.
Common shares - For the 2021 fiscal year we declared distributions to our common shareholders totaling $2.21 per share, inclusive of our special cash distribution of $0.88 per share in connection with our tax reclassification.
Preferred shares - For the 2021 fiscal year we declared distributions to our preferred shareholders totaling $1.8125 per share on our Series A Preferred Shares and $1.96875 on our Series B Preferred Shares and $1.96875 on our Series C Preferred Shares.
2021 Outlook and Significant Trends
COVID-19 Update
In March 2020, the World Health Organization categorized COVID-19 as a pandemic. The continued spread of COVID-19 and new variants of the virus around the world continue to present significant risks to our business. The economic and health conditions in the United States and across most of the globe have continued to change since the beginning of the pandemic and the ultimate impact of COVID-19 on our business is dependent on future developments, including the duration of the pandemic, the emergence of variants of the virus and the related length of its impact on the global economy, which are highly uncertain and difficult to accurately predict. The public health situation, global response measures and corresponding impacts on various markets remain fluid and uncertain. The health of our team and various stakeholders is our highest priority, and we have taken multiple steps to provide support and a safe work environment. The Company anticipates that COVID-19 will continue to impact the results of
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operations, including a potential decrease in gross margins, operating income and Adjusted EBITDA at certain of our businesses during 2022.
The following are two significant trends resulting from COVID-19 that we anticipate may negatively impact our operating performance in 2022:
Global Supply Chain
The disruption in the global supply chain due to transportation delays and U.S. port congestion are expected to continue in 2022 and continue to place constraints on several of our businesses. Surges in demand and shifts in shopping patterns related to COVID-19, as well as other factors, have continued to strain the global supply chain network, which has resulted in carrier-imposed capacity restrictions, carrier delays, and longer lead times. U.S. ports that have been unable to keep pace with unprecedented inbound container volume, which has led to shipping and unloading backlogs. The situation has been further exacerbated by COVID-19 protocols at many port locations. Due to the backlog at the ports and other supply chain disruptions, most of our businesses are experiencing shortages in materials and products, and significant increases in freight costs. Many of our companies are relying on expensive air freight to import goods to meet customer demand. We are also seeing the availability of raw materials, components and finished goods impacted by the supply chain challenges which has led to shortages of certain materials and led to pressure on revenue growth. In addition, the closure of certain Asian manufacturing facilities as a result of a lack of COVID-19 vaccines, local government quarantine efforts and electricity shortages have impacted our ability to import products timely. Further, in the U.S., the surge in demand along with COVID-19 related government stimulus and rising hourly labor wages, are creating labor shortages and higher labor costs. We expect these cost trends to continue in 2022.
Inflationary Cost Environment
During 2021, we experienced inflationary cost increases in our materials, labor and transportation costs. We expect that these inflationary cost increases will continue but will be partially mitigated by pricing actions implemented in 2021, as well as those that we plan to implement in 2022. In 2022, we expect changing market conditions and continued inflationary pressures to impact consumer spending. In December 2021, the Consumer Price Index increased approximately 7% year-over-year. and with price pressures unlikely to abate and expected changes in monetary policies, consumer spending may be negatively impacted in 2022.
Business Outlook
The Company anticipates that the areas of focus for 2022, which are generally applicable to each of our businesses, include:
•Achieving sales growth through a combination of new product development, increasing distribution, new customer acquisitions and international expansion;
•Raising prices on our goods due to rising input costs to preserve operating margins,
•Taking market share, where possible, in each of our niche market leading companies, generally at the expense of less well capitalized competitors;
•Striving for excellence in supply chain management, manufacturing and technological capabilities;
•Continuing to pursue expense reduction and cost savings in lower margin business lines or in response to lower production volume;
•Continuing to grow through disciplined, strategic acquisitions and rigorous integration processes; and
•Driving free cash flow through increased net income and effective working capital management, enabling continued investment in our businesses.
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Results of Operations
The following discussion reflects a comparison of the historical results of operations of our consolidated business for the years ended December 31, 2021, 2020 and 2019, and components of the results of operations as well as those components presented as a percent of net revenues, for each of our businesses on a stand-alone basis.
We acquired Lugano Diamonds in September 2021, BOA in October 2020 and Marucci Sports in April 2020. In the following results of operations, we provide (i) our actual Consolidated Results of Operations for the years ended December 31, 2021, 2020 and 2019, which includes the historical results of operations of each of our businesses (operating segments) from the date of acquisition in accordance with generally accepted accounting principles in the United States ("GAAP" or "US GAAP") and (ii) comparative historical components of the results of operations for each of our businesses on a stand-alone basis (“Results of Operations – Our Businesses”), for each of the years ended December 31, 2021, 2020 and 2019, where all years presented include relevant pro-forma adjustments for pre-acquisition periods and explanations where applicable. For the 2021 acquisition of Lugano Diamonds, the pro forma results of operations have been prepared as if we purchased this business on January 1, 2020. For the 2020 acquisitions of Marucci Sports and BOA, the pro forma results of operations have been prepared as if we purchased these businesses on January 1, 2019. We believe this presentation enhances the discussion and provides a more meaningful comparison of operating results. The following operating results of our businesses are not necessarily indicative of the results to be expected for a full year, going forward.
All dollar amounts in the financial tables are presented in thousands. References in the financial tables to percentage changes that are not meaningful are denoted by "NM."
Consolidated Results of Operations — Compass Diversified Holdings
Year Ended December 31,
Asset impairment expense — — 32,881
Year ended December 31, 2021 compared to the Year ended December 31, 2020
Net revenues
Net revenues for the year ended December 31, 2021 increased by approximately $482.1 million or 35.5% compared to the corresponding period in 2020. Our Marucci business, which we acquired in April 2020, contributed $74.7 million in incremental net revenue during the year ended December 31, 2021, and our BOA business, which we acquired in October 2020, contributed $139.9 million in incremental revenue in 2021. Our Lugano business, which we acquired in September 2021, had $54.4 million in revenue during the period of our ownership. During the year ended December 31, 2021 as compared to the year ended December 31, 2020, we saw notable sales increases at 5.11 ($43.9 million increase), and Velocity ($54.4 million increase) as a result of an increased consumer focus on
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outdoor related brands. Our Altor Solutions business also saw an increase in net revenues of $50.2 million, primarily as a result of add-on acquisitions that occurred in July 2020 and October 2020. We also saw notable increases in net revenue in 2021 as compared to 2020 at several of our other business which saw increased sales compared to the prior year, which was negatively impacted by the COVID-19 pandemic. These increases in net revenue occurred at Ergobaby ($18.9 million increase), Arnold ($41.0 million increase, which was partially attributable to an add-on acquisition in March 2021) and Sterno ($5.1 million increase). Refer to "Results of Operations - Our Businesses" for a more detailed analysis of net revenue by business segment.
We do not generate any revenues apart from those generated by the businesses we own. We may generate interest income on the investment of available funds, but expect such earnings to be minimal. Our investment in our businesses is typically in the form of loans from the Company to such businesses, as well as equity interests in those businesses. Cash flows coming to the Trust and the Company are the result of interest payments on those loans, amortization of those loans and, in some cases, dividends on our equity ownership. However, on a consolidated basis these items will be eliminated.
Cost of revenues
On a consolidated basis, cost of revenues increased approximately $251.1 million during the year ended December 31, 2021, compared to the corresponding period in 2020, primarily as a result of the increase in net revenues. Our Marucci and BOA businesses contributed $84.7 million of the increase, and our Lugano business had $30.2 million in cost of revenues in 2021. Gross profit as a percentage of net revenues was approximately 39.4% in year ended December 31, 2021 compared to 36.4% in 2020. We recognized $5.9 million in expense related to the amortization of the inventory step-up resulting from our purchase price allocation of Marucci Sports and BOA and Altor's acquisition of Polyfoam during the year ended December 31, 2020, and $2.8 million in expense related to the inventory step-up resulting from our purchase price allocation for Lugano during the year-ended December 31, 2021. Excluding the effect of the amortization of inventory step-up, gross profit as a percentage of net revenues was 39.7% and 36.8%, respectively, for 2021 and 2020. The increase in gross profit percentage in 2021 as compared to 2020 was primarily related to the increase in net revenue at our branded consumer businesses, which have higher gross margins than our niche industrial businesses. The gross margins at our niche industrial businesses have been impacted by global supply chain constraints and increased costs of materials and components. The impact from these factors has been mostly offset by gains in operating efficiencies and price increases to our customers. Refer to "Results of Operations - Our Businesses" for a more detailed analysis of gross profit by business segment.
Selling, general and administrative expense
Consolidated selling, general and administrative expense increased approximately $114.8 million during the year ended December 31, 2021, compared to the corresponding period in 2020. $20.2 million of the increase is attributable to our Marucci business, which was acquired in April 2020, and $38.9 million of the increase is attributable to BOA, which was acquired in October 2020. $12.0 million of the increase is attributable to Lugano, including $1.8 million in transaction costs related to the acquisition of Lugano in the current year. We also saw an increase in selling, general and administrative expense at several of our subsidiaries versus the prior year as spending on variable expenses was reduced in the prior year in response to the impact of the COVID-19 pandemic, with the current year spend reflecting more normal levels of selling, general and administrative spend. Refer to "Results of Operations - Our Businesses" for a more detailed analysis of selling, general and administrative expense by business segment. At the corporate level, general and administrative expense increased from $14.2 million in 2020 to $17.3 million in 2021. The increase in corporate general and administrative expense during 2021 is primarily due to increased professional fees associated with our election for the Trust to be treated as a corporation for U.S. federal income tax purposes, and an increase in variable spending that had been reduced in the prior year as a result of the COVID-19 pandemic.
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Fees to manager
Pursuant to the Management Services Agreement, we pay CGM a quarterly management fee equal to 0.5% (2.0% annually) of our consolidated adjusted net assets. We accrue for the management fee on a quarterly basis. For the year ended December 31, 2021, we incurred approximately $46.9 million in management fees as compared to $33.7 million in fees in the year ended December 31, 2020. The increase in management fees is primarily attributable to our acquisition of Marucci in April 2020, BOA in October 2020 and Lugano in September 2021, offset by our sale of Liberty in August 2021. CGM has entered into a waiver of the MSA for a period through December 31, 2021 to receive a 1% annual management fee related to BOA, rather than the 2% called for under the MSA, which resulted in a lower management fee paid during 2021 than would have normally been due. In the first quarter of 2021, the Company and CGM entered into a waiver agreement whereby CGM agreed to waive the portion of the management fee related to the amount of the cash proceeds deposited with the Trustee that was in excess of the amount payable related to the 2026 Notes at March 31, 2021. Additionally, CGM has entered into a waiver of the MSA at December 31, 2021 to exclude the cash balances held at the LLC from the calculation of the management fee. In the first quarter of 2020, as a proactive measure to provide the Company with additional liquidity in light of the onset of the COVID-19 pandemic, the Company drew $200 million down on the 2018 Revolving Credit Facility. The Company and CGM entered a waiver agreement whereby CGM agreed to waive the portion of the management fee attributable to cash balances at March 31, 2020 which reduced the amount of management fee that would have been paid in the first quarter of 2020. Additionally, as a result of an expected decline in earnings and cash flows in the second quarter of 2020 in light of the COVID-19 pandemic, CGM agreed to waive 50% of the management fee calculated at June 30, 2020.
Amortization expense
Amortization expense for the year ended December 31, 2021 increased $18.6 million to $80.3 million as compared to the prior year, primarily as a result of the acquisitions of Marucci in April 2020, BOA in October 2020 and Lugano in September 2021.
Interest Expense
We recorded interest expense totaling $58.8 million for the year ended December 31, 2021 compared to $45.8 million for the comparable period in 2020, an increase of $13.1 million. The increase in interest expense in the current year reflects the higher amount outstanding on our senior notes during the current year after we redeemed $600.0 million of our 8.000% 2026 Senior Notes and issued $1000.0 million of 5.250% 2029 Notes in March of 2021, and issued an additional $300.0 million of 5.000% Senior Notes due in 2032 in November 2021. We also had an increase in the average amount outstanding under our Revolving Credit Facility during 2021 compared to the prior year. The average amount outstanding on our Revolving Credit Facility in 2021 was approximately $125.2 million, while the average amount outstanding during 2020 was $101.4 million.
Income Taxes
We had income tax expense of $18.3 million with an effective income tax rate of 42.5% during the year ended December 31, 2021 compared to income tax expense of $10.2 million with an effective income tax rate of 229.5% during the same period in 2020. Our net income from continuing operations before income taxes for the year ended December 31, 2021 increased $38.8 million as compared to income from continuing operations before taxes for the year ended December 31, 2020 ($43.2 million in 2021 compared to $4.4 million in 2020). Our income tax provision increased by $8.2 million in 2021 as compared to 2020. The tax provision reflects the effect of state and local taxes, foreign taxes and the related allocation of income at our subsidiaries, in addition to the effect of the losses at our parent company. The effective tax rate for the years ended December 31, 2021 and 2020 includes a loss at our parent company, which was previously taxed as a partnership.
On September 1, 2021, the Trust elected to “check-the-box” to have the Trust treated as a corporation for U.S. federal income tax purposes. The Trust recorded a deferred tax benefit of $12.1 million at December 31, 2021 to reflect the effect of the classification of ACI as held-for-sale.
Year ended December 31, 2020 compared to the Year ended December 31, 2019
Net revenues
Net revenues for the year ended December 31, 2020 increased by approximately $96.3 million or 7.6% compared to the corresponding period in 2019. During the year ended December 31, 2020 as compared to the year ended
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December 31, 2019, we saw notable sales increases at 5.11 ($12.5 million increase) and Velocity ($68.2 million increase) as a result of an increased consumer focus on outdoor related brands. Our Altor business also saw an increase in net revenues of $8.6 million as a result of an add-on acquisition that occurred in July 2020. Our Marucci business, which we acquired in April 2020, had net sales of $43.4 million during our ownership period in 2020, and our BOA business, which we acquired in October 2020, had net sales of $25.3 million during our period of ownership. These increases in net revenue were partially offset by decreases in net revenue in 2020 as compared to 2019 at our other businesses, primarily as a result of the effects of the COVID-19 pandemic, notably Ergobaby ($15.3 million decrease), Arnold ($21.0 million decrease) and Sterno ($25.5 million decrease). Refer to "Results of Operations - Our Businesses" for a more detailed analysis of net revenue by business segment.
We do not generate any revenues apart from those generated by the businesses we own. We may generate interest income on the investment of available funds, but expect such earnings to be minimal. Our investment in our businesses is typically in the form of loans from the Company to such businesses, as well as equity interests in those businesses. Cash flows coming to the Trust and the Company are the result of interest payments on those loans, amortization of those loans and, in some cases, dividends on our equity ownership. However, on a consolidated basis these items will be eliminated.
Cost of revenues
On a consolidated basis, cost of revenues increased approximately $58.2 million during the year ended December 31, 2020, compared to the corresponding period in 2019, primarily as a result of the increase in net revenues. Gross profit as a percentage of net revenues was approximately 36.4% in year ended December 31, 2020 compared to 36.2% in 2019. We recognized $5.9 million in expense related to the amortization of the inventory step-up resulting from our purchase price allocation of Marucci Sports and BOA and Altor's acquisition of Polyfoam during the year ended December 31, 2020. Excluding the effect of the amortization of inventory step-up, gross profit as a percentage of net revenues was 36.8%. Refer to "Results of Operations - Our Businesses" for a more detailed analysis of gross profit by business segment.
Selling, general and administrative expense
Consolidated selling, general and administrative expense increased approximately $36.0 million during the year ended December 31, 2020, compared to the corresponding period in 2019. The increase in selling, general and administrative expense primarily relates to the acquisition of Marucci Sports in April 2020 and BOA in October 2020. In addition to the incremental selling, general and administrative expense incurred by these businesses subsequent to their acquisition, we incurred $4.8 million in acquisition costs and $2.1 million in integration related fees from these acquisitions in 2020. Refer to "Results of Operations - Our Businesses" for a more detailed analysis of selling, general and administrative expense by business segment. At the corporate level, general and administrative expense decreased from $14.9 million in 2019 to $14.2 million in 2020, primarily due to decreased travel costs, partially offset by costs associated with an unsuccessful acquisition.
Fees to manager
Pursuant to the Management Services Agreement, we pay CGM a quarterly management fee equal to 0.5% (2.0% annually) of our consolidated adjusted net assets. We accrue for the management fee on a quarterly basis. Concurrent with the September 2019 sale of Clean Earth, CGM agreed to waive the management fee on cash balances held at the Company, commencing with the quarter ended September 30, 2019 and continuing until the quarter during which the Company next borrowed under the 2018 Revolving Credit Facility. In March 2020, as a proactive measure to provide the Company with additional cash liquidity in light of the COVID-19 pandemic, the Company elected to draw down $200 million on our 2018 Revolving Credit Facility. The Company and CGM entered into a waiver agreement whereby CGM agreed to waive the portion of the management fee attributable to the cash balances held at the Company as of March 31, 2020. Additionally, as a result of an expected decline in earnings and cash flows in the second quarter of 2020, CGM agreed to waive 50% of the management fee calculated at June 30, 2020 that was paid in July 2020. Further, for the third quarter of 2020, the Company and CGM entered into a waiver agreement whereby CGM agreed to waive the portion of the management fee attributable to the cash balances held at the Company as of September 30, 2020. The result of these waivers was a decrease in the management fee during the year ended December 31, 2020 as compared to the prior year, despite the addition of the Marucci business in April 2020. CGM has also entered into a waiver of the MSA for a period through December 31, 2021 to receive a 1% annual management fee related to BOA, rather than the 2% called for under the MSA, which reduced the management fee paid for the fourth quarter of 2020.
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Amortization expense
Amortization expense for the year ended December 31, 2020 increased $8.1 million to $61.7 million as compared to the prior year, primarily as a result of the acquisitions of Marucci in April 2020 and BOA in October 2020.
Impairment expense
Velocity Outdoor performed an interim impairment test of their goodwill during the quarter ended September 30, 2019 as a result of operating results below forecasts in the current period as well as a re-forecast of the Velocity business in which planned earnings and revenue fell below the forecasts of prior periods. The impairment test resulted in Velocity Outdoor recording impairment expense of $32.9 million in the prior year ended December 31, 2019.
Interest Expense
We recorded interest expense totaling $45.8 million for the year ended December 31, 2020 compared to $58.2 million for the comparable period in 2019, a decrease of $12.4 million. The decrease in interest expense for the year ended December 31, 2020 reflects the repayment of our 2018 Term Loan during 2019 using a portion of the proceeds from the sale of Clean Earth and proceeds from the issuance of preferred shares, offset by an increase in interest expense related to our issuance of an additional $200 million of our 8.000% Senior Notes in May 2020.
Income Taxes
We had income tax expense of $10.2 million with an effective income tax rate of 229.5% during the year ended December 31, 2020 compared to income tax expense of $9.9 million with an effective income tax rate of 16.5% during the same period in 2019. The effective tax rate for the years ended December 31, 2020 and 2019 includes a loss at our parent company, which was previously taxed as a partnership. Although we had income from continuing operations before income taxes for the year ended December 31, 2020 as compared to a loss from continuing operations for the year ended December 31, 2019 ($4.4 million income in 2020 compared to a $60.1 million loss in 2019), our income tax provision increased by only $0.3 million in 2020 as compared to 2019. The tax provision reflects the effect of state and local taxes, foreign taxes and the related allocation of income at our subsidiaries, in addition to effect of the losses at our parent company. The effective income tax rate in the prior year also reflects the effect of the impairment expense recognized at Velocity and the utilization of tax credits.
Results of Operations — Our Businesses
We categorize the businesses we own into two separate groups of businesses (i) branded consumer businesses, and (ii) niche industrial businesses. Branded consumer businesses are characterized as those businesses that we believe capitalize on a valuable brand name in their respective market sector. We believe that our branded consumer businesses are leaders in their particular category. Niche industrial businesses are characterized as those businesses that focus on manufacturing and selling particular products or services within a specific market sector. We believe that our niche industrial businesses are leaders in their specific market sector.
Branded Consumer Businesses
5.11
Overview
5.11 is a leading provider of purpose-built technical apparel and gear for law enforcement, firefighters, EMS, and military special operations as well as outdoor and adventure enthusiasts. 5.11 is a brand known for innovation and authenticity and works directly with end users to create purpose-built apparel, footwear and gear designed to enhance the safety, accuracy, speed and performance of tactical professionals and enthusiasts worldwide. 5.11 operates sales offices and distribution centers globally, and 5.11 products are widely distributed in uniform stores, military exchanges, outdoor retail stores, its own retail stores and on 511tactical.com.
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Results of Operations
Year ended December 31,
Year ended December 31, 2021 compared to the Year ended December 31, 2020
Net sales
Net sales for the year ended December 31, 2021 were $445.0 million, an increase of $43.9 million, or 10.9%, compared to the same period in 2020. This increase is due primarily to direct-to-consumer growth of $35.0 million, up 22% from the prior year comparable period. Retail sales grew largely due to fifteen new retail store openings since December 2020 (bringing the total store count to eighty-seven as of December 31, 2021) as well as positive growth in same-store sales for the year ended December 31, 2021 as compared to the same period last year which was negatively impacted by the effects of the COVID-19 pandemic. Net sales were also positively impacted by wholesale sales growth of $18.6 million, up 8% from the prior year which was negatively impacted by the effects of the COVID-19 pandemic. The increase in sales from direct-to-consumer and wholesale was partially offset by a decrease of $8.4 million in sales in our direct to agency business (DTA) as we fulfilled a large contract in 2020 which did not repeat in 2021.
Gross profit
Gross profit as a percentage of net sales increased from 50.4% in the year ended December 31, 2020 to 52.9% in the year ended December 31, 2021. Growth in gross margin was driven by channel mix as direct-to-consumer sales, which realize a higher gross margin than wholesale sales, grew versus the prior period. The growth in gross profit percentage for the year ended December 31, 2021 as compared to the year ended December 31, 2020 was partially offset by increases in inbound ocean and air freight as logistic challenges caused by the COVID-19 pandemic increased supply chain costs.
Selling, general and administrative expense
Selling, general and administrative expenses for the year ended December 31, 2021 increased to $186.1 million or 41.8% of net sales compared to $162.4 million or 40.5% of net sales for the year ended December 31, 2020. The increase in selling, general and administrative expense for the year ended December 31, 2021 as compared to the prior year comparable period was driven by the costs associated with additional retail stores (eighty-seven open in 2021 versus seventy-three open in 2020 during the comparable period), as well as additional sales and marketing spend to drive digital sales. For the year ended December 31, 2020, management significantly reduced variable expenses, including payroll, bonus, travel and entertainment, and sales and marketing, as a response to decreased sales from the effects of the COVID-19 pandemic. While management continues to control and reduce variable expenses, payroll and bonus for fiscal 2021 increased in correlation with the increase in net sales.
Income from operations
Income from operations for the year ended December 31, 2021 was $39.4 million, an increase of $9.3 million when compared to the same period in 2020, based on the factors described above.
Year ended December 31, 2020 compared to the Year ended December 31, 2019
Net sales
Net sales for the year ended December 31, 2020 were $401.1 million, an increase of $12.5 million, or 3.2%, compared to the same period in 2019. This increase is due primarily to growth in e-commerce and retail sales growth of $30.2 million, or 31.2%, driven by growing demand in direct-to-consumer channels, specifically digital. Retail sales grew largely through twelve new retail store openings since December 2019 (bringing the total store count to seventy-three as of December 31, 2020) as well as the full-year impact of the sixteen stores opened in
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2019. The increase in net sales for the year ended December 31, 2020 were further increased by Direct-to-Agency (“DTA”) contracts fulfilled in 2020. The increase in net sales for the year ended December 31, 2020 as compared to the prior year was offset by the effects of the COVID-19 pandemic on store traffic in our wholesale channels and our own retail stores.
Gross Profit
Gross profit as a percentage of net sales increased from 49.3% in the year ended December 31, 2019 to 50.4% in the year ended December 31, 2020. Growth in gross margin was driven by channel mix as direct-to-consumer sales, which realize a higher gross margin than wholesale sales, grew versus the prior period. The growth in gross profit for the year ended December 31, 2020 as compared to the year ended December 31, 2019 was partially offset by additional inventory reserves and duty drawback accrual (increase in cost of goods sold) for audited duty drawback claims.
Selling, general and administrative expense
Selling, general and administrative expenses for the year ended December 31, 2020 increased to $162.4 million or 40.5% of net sales compared to $159.4 million or 41.0% of net sales for the year ended December 31, 2019. The decrease in selling, general and administrative expense as a percentage of net sales was driven by management’s decision to reduce variable expenses, including travel and entertainment, sales and marketing, and payroll as a response to decreased sales from the effects of the COVID-19 pandemic. The decrease was partially offset by an increase in marketing spend to drive demand in the growing direct to consumer channels and by the costs associated with additional retail stores (seventy-three open in 2020 versus sixty-one open in 2019 during the comparable period).
Income from operations
Income from operations for the year ended December 31, 2020 was $30.1 million, an increase of $7.7 million when compared to the same period in 2019, based on the factors described above.
BOA
Overview
BOA, creator of the revolutionary, award-winning, patented BOA Fit System, partners with market-leading brands to make the best gear even better. Delivering fit solutions purpose-built for performance, the BOA Fit System is featured in footwear across snow sports, cycling, hiking/trekking, golf, running, court sports, workwear as well as headwear and medical bracing. The system consists of three integral parts: a micro-adjustable dial, high-tensile lightweight laces, and low friction lace guides creating a superior alternative to laces, buckles, Velcro, and other traditional closure mechanisms. Each unique BOA configuration is engineered for fast, effortless, precision fit, and is backed by The BOA Lifetime Guarantee. BOA is headquartered in Denver, Colorado and has offices in Austria, Greater China, South Korea, and Japan.
Results of Operations
In the following results of operations, we provide comparative pro forma results of operations for BOA for the years ended December 31, 2020 and 2019 as if we had acquired the business on January 1, 2019. The results of operations that follow include relevant pro-forma adjustments for pre-acquisition periods and explanations where applicable. The operating results for BOA have been included in the consolidated results of operation from the date of acquisition, October 16, 2020.
Year ended December 31,
(in thousands) Pro forma Pro forma
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Pro forma financial information for BOA for the year ended December 31, 2020 and December 31, 2019 includes pre-acquisition results of operations for the period from January 1, 2020 through October 16, 2020, the acquisition date of BOA, and January 1, 2019 through December 31, 2019, for comparative purposes. The historical results of BOA have been adjusted to reflect the purchase accounting adjustments recorded in connection with the acquisition. Pro forma results of operations include the following pro forma adjustments as if we had acquired BOA January 1, 2019:
•Depreciation expense associated with the increase in depreciable lives of capital assets of $0.1 million for the year ended December 31, 2019.
•Amortization expense associated with the intangible assets recorded in connection with the purchase price allocation for BOA of $11.9 million for the year ended December 31, 2020, and $15.0 million for the year ended December 31, 2019.
•Management fees that would have been payable to the Manager during each period.
Year ended December 31, 2021 compared to the Pro forma Year ended December 31, 2020
Net sales
Net sales for the year ended December 31, 2021 were $165.2 million, an increase of $58.8 million or 55.3% when compared to net sales of $106.4 million for the year ended December 31, 2020. This increase is due to underlying category and BOA momentum within key markets including Snow Sports, Cycling, Athletic, Outdoor & Workwear. The three factors primarily impacting growth rates were market share gains in key categories, consumer participation increases as well as accelerated production ordering by BOA’s customers due to longer lead times resulting from overall global supply chain constraints.
Gross profit
Gross profit as a percentage of net sales was 61.1% for the year ended December 31, 2021 compared to 59.1% for the same period in 2020. The cost of sales for the year ended December 31, 2020 includes $1.5 million related to the amortization of inventory step-up resulting from the acquisition purchase price allocation. Excluding the effect of the inventory step-up, the gross profit as a percentage of net sales for the year ended December 31, 2020 was 60.5%. The increase in gross profit as a percentage of net sales during the current year is attributable primarily to product mix.
Selling, general and administrative expense
Selling, general and administrative expense for the year ended December 31, 2021 was $50.6 million, an increase of $9.7 million as compared to selling, general and administrative expense of $40.8 million for the year ended December 31, 2020. Selling general and administrative expense in the current year includes $3.3 million in integration services fees paid to CGM. The remainder of the increase in selling, general, and administrative expense is due to increased employee costs related to BOA's bonus plan, incremental headcount and marketing investments. Selling, general and administrative expense for the year ended December 31, 2020 included $2.5 million in transaction costs related to the acquisition of BOA, and $1.1 million in integration services fees paid to CGM.
Income from operations
Income from operations was $34.0 million for the year ended December 31, 2021 as compared to $5.8 million in income from operations in the year ended December 31, 2020, an increase of $28.2 million based on the factors noted above.
Pro forma Year ended December 31, 2020 compared to the Pro forma Year ended December 31, 2019
Net sales
Net sales for the year ended December 31, 2020 were $106.4 million, an increase of $0.1 million or 0.1% when compared to net sales of $106.3 million for the year ended December 31, 2019.
Gross profit
Gross profit as a percentage of net sales was 59.1% for the year ended December 31, 2020 compared to 58.0% for the same period in 2019. The cost of sales for the year ended December 31, 2020 includes $1.5 million related to the amortization of inventory step-up resulting from the acquisition purchase price allocation. Excluding the effect of the inventory step-up, the gross profit as a percentage of net sales for the year ended December 31, 2020 was 60.5%. The increase in gross profit as a percentage of net sales during the current year is attributable primarily to product mix.
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Selling, general and administrative expense
Selling, general and administrative expense for the year ended December 31, 2020 was $40.8 million, an increase of $1.7 million as compared to selling, general and administrative expense of $39.2 million for the year ended December 31, 2019. Selling, general and administrative expense for the year ended December 31, 2020 included $2.5 million in transaction costs related to the acquisition of BOA, and $1.1 million in integration services fees paid to CGM. Excluding these nonrecurring costs, selling, general and administrative expense for the year ended December 31, 2020 was approximately $37.2 million, a decrease of $2.0 million compared to the year ended December 31, 2019. This decrease was primarily attributable to a reduction in marketing activity and a reduced level of travel during 2020.
Income from operations
Income from operations was $5.8 million for the year ended December 31, 2020 as compared to $6.3 million in income from operations in the year ended December 31, 2019, a decrease of $0.5 million based on the factors noted above.
Ergobaby
Overview
Ergobaby, headquartered in Torrance, California, is a designer, marketer and distributor of wearable baby carriers and accessories, blankets and swaddlers, nursing pillows, strollers, and related products. Ergobaby primarily sells its Ergobaby and Baby Tula branded products through brick-and-mortar retailers, national chain stores, online retailers, its own websites and distributors and derives more than half of its sales from outside of the United States.
Results of Operations
Year ended December 31,
Year ended December 31, 2021 compared to the Year ended December 31, 2020
Net sales
Net sales for the year ended December 31, 2021 were $93.6 million, an increase of $18.9 million or 25.3% compared to the same period in 2020. During the year ended December 31, 2021, international sales were approximately $60.3 million, representing an increase of $12.2 million over the corresponding period in 2020 primarily as a result of increased sales to APAC and EMEA distributors as well as increased sales in EMEA direct territories through key accounts and e-commerce channels. Domestic sales were $33.3 million during the year ended December 31, 2021, reflecting an increase of $6.6 million compared to the corresponding period in 2020. The increase in domestic sales was primarily attributable to strong e-commerce sales across both the Ergo and Tula brands as well as increased key accounts sales.
Gross profit
Gross profit as a percentage of net sales was 65.3% for the year ended December 31, 2021 compared to 66.0% for the same period in 2020. The decrease in gross profit as a percentage of net sales was primarily due to increased inbound freight as a result of continued supply chain shortages. This more than offset favorable shifts in the mix of sales channels and mix of products sold during the year ended December 31, 2021.
Selling, general and administrative expense
Selling, general and administrative expense for the year ended December 31, 2021 increased to approximately $43.9 million or 46.9% of net sales compared to $36.3 million or 48.6% of net sales for the same period of 2020.
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The increase in selling, general and administrative expense for the year ended December 31, 2021 as compared to the year ended December 31, 2020 is a result of increases in variable expenses tied to sales (primarily outbound freight), marketing expenses related to multiple new product launches, as well as increased payroll expenses.
Income from operations
Income from operations for the year ended December 31, 2021 increased $3.9 million, to $9.1 million, compared to $5.2 million for the same period of 2020, primarily as a result of the factors described above.
Year ended December 31, 2020 compared to the Year ended December 31, 2019
Net sales
Net sales for the year ended December 31, 2020 were $74.7 million, a decrease of $15.3 million or 17.0% compared to the same period in 2019. During the year ended December 31, 2020, international sales were approximately $48.1 million, representing a decrease of $13.9 million over the corresponding period in 2019 primarily as a result of reduced sales volume at Ergobaby's Asia-Pacific and EMEA distributors as a result of the COVID-19 pandemic. Domestic sales were $26.7 million during the year ended December 31, 2020, reflecting a decrease of $1.4 million compared to the corresponding period in 2019. The decrease in domestic sales was driven by the Tula brand, primarily in the specialty account channel.
Gross Profit
Gross profit as a percentage of net sales was 66.0% for the year ended December 31, 2020 compared to 63.4% for the same period in 2019. The increase in gross profit as a percentage of net sales was due to the mix of sales channels, mix of products sold, as well as reduced freight costs and warranty expense during the year ended December 31, 2020.
Selling, general and administrative expense
Selling, general and administrative expense for the year ended December 31, 2020 decreased to approximately $36.3 million or 48.6% of net sales compared to $38.9 million or 43.2% of net sales for the same period of 2019. The decrease in selling, general and administrative expense for the year ended December 31, 2020 as compared to the year ended December 31, 2019 is a result of decreases in variable expenses in response to the COVID-19 pandemic and non-recurring expenses in the prior year.
Income from operations
Income from operations for the year ended December 31, 2020 decreased $5.2 million, to $5.2 million, compared to $10.4 million for the same period of 2019, primarily as a result of the factors described above.
Lugano
Overview
Lugano is a leading designer, manufacturer and marketer of high-end, one-of-a-kind jewelry sought after by some of the world’s most discerning clientele. Lugano conducts sales via its own retail salons as well as pop-up showrooms at Lugano-hosted or sponsored events in partnership with influential organizations in the equestrian, art and philanthropic community. Lugano is headquartered in Newport Beach, California.
Results of Operations
In the following results of operations, we provide comparative pro forma results of operations for Lugano for the years ended December 31, 2021 and 2020 as if we had acquired the business on January 1, 2020. The results of operations that follow include relevant pro-forma adjustments for pre-acquisition periods and explanations where applicable. The operating results for Lugano have been included in the consolidated results of operation from the date of acquisition, September 3, 2021.
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Year ended December 31,
Pro forma Pro forma
Pro forma financial information for Lugano for the year ended December 31, 2021 and December 31, 2020 includes pre-acquisition results of operations for the period from January 1, 2021 through September 3, 2021, the acquisition date of Lugano, and January 1, 2020 through December 31, 2020, for comparative purposes. The historical results of Lugano have been adjusted to reflect the purchase accounting adjustments recorded in connection with the acquisition. Pro forma results of operations include the following pro forma adjustments as if we had acquired Lugano January 1, 2020:
•Depreciation expense associated with the increase in depreciable lives of capital assets of $0.3 million and $0.6 million, for the years ended December 31, 2021 and 2020, respectively.
•Amortization expense associated with the intangible assets recorded in connection with the purchase price allocation for Lugano of $5.0 million for the years ended December 31, 2021 and 2020.
•Management fees that would have been payable to the Manager during each period.
Pro forma Year ended December 31, 2021 compared to the Pro forma Year ended December 31, 2020
Net sales
Net sales for the year ended December 31, 2021 increased approximately $57.9 million or 86.1%, to $125.1 million, compared to the corresponding year ended December 31, 2020. Lugano sells high-end jewelry primarily through retail salons in California, Florida and Colorado, and via pop-up showrooms at multiple equestrian, social and charitable functions each year. The effects of the COVID-19 pandemic in the prior year severely impacted both the operations of the retail salons and the number of events attended by Lugano which led to reduced net sales as compared to the current year.
Gross profit
Gross profit as a percentage of net sales totaled approximately 47.0% in the year ended December 31, 2021 compared to 49.4% in the year ended December 31, 2020. Lugano has an extensive network of suppliers through which they procure high quality diamonds and gemstones, which make up a significant percentage of the cost of sales. The uniqueness of the Lugano jewelry can lead to fluctuations in margins from period to period based on what designs are sold during the period. In the current period, Lugano recorded $2.8 million in amortization to cost of goods sold related to the amortization of inventory step-up resulting from the acquisition purchase price allocation. Excluding the effect of the inventory step-up, the gross profit as a percentage of net sales for the year ended December 31, 2021 was 53.0%.
Selling, general and administrative expense
Selling, general and administrative expense for the year ended December 31, 2021 increased to approximately $23.8 million or 19.1% of net sales compared to $12.6 million or 18.8% of net sales for the same period of 2020. The effects of the COVID-19 pandemic in the prior year led to a reduction in variable costs, particularly marketing spend, in the year ended December 31, 2021. The selling, general and administrative expense in the current year reflects a more normalized level of spending.
Income from operations
Income from operations increased $14.3 million during the year ended December 31, 2021 to $29.2 million compared to income from operations of $14.8 million during the same period in 2020, principally as a result of the increase in sales and gross profit in 2021, as described above.
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Marucci Sports
Overview
Founded in 2009 and headquartered in Baton Rouge, Louisiana, Marucci is a leading designer, manufacturer, and marketer of premium wood and metal baseball bats, fielding gloves, batting gloves, bags, grips, protective gear, sunglasses, on and off-field apparel, and other baseball and softball equipment used by professional and amateur athletes. Marucci also develops and licenses franchises for sports training facilities. Marucci products are available through owned websites, their team sales organization, Big Box Retailers, and third party e-commerce & resellers.
Results of Operations
In the following results of operations, we provide comparative pro forma results of operations for Marucci for the years ended December 31, 2020 and 2019 as if we had acquired the business on January 1, 2019. The results of operations that follows include relevant pro-forma adjustments for pre-acquisition periods and explanations where applicable. The operating results for Marucci have been included in the consolidated results of operation from the date of acquisition, April, 20, 2020.
Year ended December 31,
(in thousands) Pro forma Pro forma
Pro forma financial information for Marucci for the year ended December 31, 2020 and December 31, 2019 includes pre-acquisition results of operations for the period from January 1, 2020 through April 20, 2020, the acquisition date of Marucci, and January 1, 2019 through December 31, 2019, for comparative purposes. The historical results of Marucci have been adjusted to reflect the purchase accounting adjustments recorded in connection with the acquisition. Pro forma results of operations include the following pro forma adjustments as if we had acquired Marucci January 1, 2019:
•Depreciation expense associated with the increase in depreciable lives of capital assets of $0.2 million for the year ended December 31, 2020, and $0.8 million for the year ended December 31, 2019.
•Amortization expense associated with the intangible assets recorded in connection with the purchase price allocation for Marucci of $1.2 million for the year ended December 31, 2020, and $4.1 million for the year ended December 31, 2019.
•Management fees that would have been payable to the Manager during each period.
Year ended December 31, 2021 compared to the Pro forma Year ended December 31, 2020
Net sales
Net sales for the year ended December 31, 2021 were $118.2 million, an increase of $52.2 million as compared to net sales of $65.9 million for the year ended December 31, 2020. The increase in net sales was primarily due to increased customer demand and market share in many of Marucci's key product lines including aluminum and wood bats, batting gloves, and bags. The increased sales from these products occurred in both retail and direct channels. In the prior year, the shutdown of professional and youth baseball and softball in March as a response to the COVID-19 pandemic led to a significant drop off in demand for product through the first half of 2020, with demand beginning to pick up during the back half of 2020 after the resumption of professional and youth sports.
Gross profit
Gross profit for the year ended December 31, 2021 increased $30.6 million as compared to the year ended December 31, 2020. Gross profit as a percentage of sales was 54.5% for the year ended December 31, 2021 as compared to 51.2% for the year ended December 31, 2020. The cost of sales for the year ended December 31, 2020 includes $4.3 million related to the amortization of inventory step-up resulting from the acquisition purchase price allocation. Excluding the effect of the inventory step-up, the gross profit as a percentage of net sales for the year ended December 31, 2020 was 57.7%. During the current year, Marucci's facilities in Baton Rouge were damaged by floodwaters, which resulted in the write-off of $1.8 million in inventory, negatively impacting the gross profit in 2021 and resulting in a decrease versus adjusted gross profit percentage from 2020. Gross profit as a
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percentage of net sales during the year ended December 31, 2021 was also impacted by various factors including a shift of product mix in favor of higher margin products, mainly its aluminum bats, and channel mix, with increased sales through Marucci's higher margin direct-to-consumer and e-commerce channels, as well as increased freight costs.
Selling, general and administrative expense