Compass Diversified Holdings (CODI) Q3 2026 Earnings Call Transcript

Good afternoon, and welcome to the Compass Diversified Fiscal 2026 Third Quarter Conference Call. Today's call is being recorded. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. At this time, I would like to turn the call over to Ben Tapper, Vice President, Investor Relations. Ben, please go ahead.

Thank you, and welcome to Compass Diversified's third quarter 2026 conference call. Representing the company today are Elias Sabo, Chief Executive Officer, Zach Sautel, Chief Operating Officer, and Stephen Keller, Chief Financial Officer. Before we begin, I'd like to remind everyone that during the course of this call, Cody will make certain forward-looking statements, including discussions of forecasts and targets, future business and divestiture plans, future liquidity and leverage positions, Plans to return capital to shareholders, future performance of CODI and its obsidiaries, and other forward-looking statements regarding CODI and its financial results. Words such as believes, expects, anticipates, plans, projects, should, and future or similar expressions are intended to identify forward-looking statements. These forward-looking statements are subject to many risks and uncertainties in predicting future results and conditions. Certain factors could cause actual results to differ on a material basis from those projected in these forward-looking statements, and in some of these factors are enumerated in the risk factor discussion in the company's Form 10-K, as filed with the SEC on February 27, 2026, as well as in other SEC filings and press releases. Except as required by law, COTI undertakes no obligation to publicly update or revise any forward-looking statements, whether because of new information, future events, or otherwise. During today's call, we will refer to certain non-GAAP financial measures, definitions of these measures, reconciliations to the most directly comparable GAAP measures, and additional information regarding their use as included in today's earnings release, which is available in the Investor Relations section of the company's website at www.compassdiversified.com. Please note that references to EBITDA in our prepared remarks refer to adjusted EBITDA. Unless otherwise indicated, year-over-year comparisons of net sales and subsidiary adjusted EBITDA exclude Lugano from the prior year period and exclude the divested Sterno food service business from both the current and prior year periods. Our full-year 2026 outlook is presented on a different basis and includes the adjusted EBITDA generated by the Sterno food service business prior to its sale. CODI has not reconciled its full year 2026 subsidiary adjusted EBITDA outlook to the most directly comparable GAAP measure because management cannot predict with sufficient certainty all of the inputs necessary to provide such a reconciliation without unreasonable effort. These items could be material in our future results. Additional information regarding this limitation is included in today's earnings release. Throughout the call, we will refer to Compass Diversified as CODI or the company. At this time, I would like to turn the call over to Elias Sabo.

Elias? Thank you, Ben, and good afternoon, everyone. Our subsidiaries delivered another strong quarter despite continued macroeconomic uncertainty. That performance reinforces our confidence in the quality of our businesses and the strength of the CODI model. Based on our year-to-date results and current expectations for the remainder of the year, we are tightening our 2026 guidance range. As this is my final earnings call as CEO, I want to thank our team at Cody and across our subsidiaries. Cody has been the focus of my career, and I am proud of what we have built together. The past 18 months has been challenging, and I'm grateful to our stakeholders for their continued support. There is more work ahead, and I have complete confidence in Zach, Stephen, and the Cody team to build on our progress and deliver long-term value for our shareholders. I'll now turn the call over to Zach to discuss the quarter and our priorities going forward.

Thanks, Elias. I appreciate your confidence and look forward to building on our progress and delivering for our shareholders. Q3 was a strong quarter. Subsidiary adjusted EBITDA grew double digits, led by our consumer businesses, where adjusted EBITDA increased 28%. Cash generation supported further deleveraging, bringing our covenant leverage ratio down to approximately 4.5 times. Our management teams are executing well across many of our businesses. We are focused on ensuring that our performance translates into long-term shareholder value. Our priorities remain clear, drive profitable growth, generate cash flow for debt reduction, and pursue value-maximizing divestitures. In an increasingly uncertain M&A market, we remain committed to pursuing divestitures that drive long-term shareholder value. As we reduce leverage, we look to efficiently return capital to shareholders when appropriate. Our businesses continue to demonstrate their strength in an uncertain environment. The Honeypot, Boa, Primaloft, and Arnold delivered strong growth, reflecting their differentiated products and the execution of their management teams. Let me walk through the quarter, beginning with our consumer businesses. The Honeypot delivered another outstanding quarter with adjusted EBITDA more than doubling year-over-year, up 124% and continuing to gain traction in new categories while further expanding distribution. Well, the Honeypot benefited from tariff refunds in the quarter. Its results were driven primarily by strong underlying business performance. The Honeypot continues to be a leader in the attractive Better For You segment of feminine care. We believe demand for Better For You products creates a significant long-term growth opportunity, and the Honeypot is well positioned to lead that growth. Both BOA and Primaloft outperformed in Q3, delivering 22% and 28% adjusted EBITDA growth, respectively. BOA generated double-digit growth across all key segments, including workwear, alpine, outdoor, cycling, and helmets, driven by broader adoption and higher unit volumes. Primaloft performance reflects strong demand from leading global outdoor and lifestyle brands. Both businesses expanded margins through sales growth with improved operating efficiency. It is important to note that some of the quarter's strength reflected the timing of customers' orders, which we have considered in our expectations for the remainder of the year. At 5.11, our professional business provides a strong foundation, and we see a meaningful opportunity to broaden the brand's appeal to consumers. We are building on the quality and credibility 5.11 has earned with public safety and professional customers to reach people who value that same performance in their everyday lives. Third quarter adjusted EBITDA declined just under 2%, reflecting softness in the DTC channel, given its exposure to a more price-sensitive consumer. We're also reducing our reliance on discount-driven sales and emphasizing the reliable quality trust in the most demanding environments. We are starting to see progress. Full-price product sales increased approximately 10 percentage points compared with the prior year. At our new stores, 67% of sales came from customers new to 5.11, an encouraging early indication of the brand's ability to attract new buyers. Velocity delivered strong adjusted EBITDA growth, supported by improved margins and continued growth at King's apparel line. Industrial results were more mixed. Arnold more than doubled adjusted EBITDA, reflecting its specialized manufacturing expertise and growing demand for secure sources of rare earth magnets. Backlog is increasing, driven by strong demand and continued supply chain constraints that affect how quickly we can fulfill a growing volume of orders. Those same constraints reinforce the need for secure, reliable rare earth supply chains and support long-term demand for Arnold's capabilities. The team is making progress in expanding capacity and developing additional sources of raw materials. While directing available capacity toward opportunities that offer the greatest long-term value. That progress gives us confidence in Arnold's ability to translate strong demand into sustained growth. At Altor, we remain focused on improving execution and returning the business to growth. Weakness in life sciences and industrial, together with higher input costs, continue to weigh on results. Altor's commercial execution also needs to improve. The team has taken steps to fill key roles and streamline quoting and pricing processes, with a clear focus on competing more effectively and winning new business. Cold Chain remains an attractive long-term growth opportunity, and we are pushing new business and specialty pharmaceutical packaging. We are also winning new business across the appliance market, broadening our exposure in this segment. Pricing actions are beginning to recover higher costs. We're encouraged by these early steps, but performance remains below where it needs to be. The team is diligently working to translate this progress into better results, and that will take several quarters. Finally, RIMports, after adjusting for the sale of the Sterno food service business, delivered results in line with our expectations. Near-term expectations remain subdued as a large customer reduces its reliance on RIMports as its supplier. Collectively, our businesses delivered strong growth and cash generation this quarter. Our continued performance gives us confidence in our ability to deliver even as economic conditions remain uncertain. With that, I'll turn the call to Stephen to review our financial results, balance sheet, and outlook.

Thanks, Zach. Similar to last quarter, the year-over-year comparisons are complicated by the inclusion of Lugano in the prior year period and the sale of Sterno's food service business, which occurred earlier this year. I will begin with our reported gap results and then discuss our results on a more comparable basis. For the third quarter, gap net sales were $423 million compared with $473 million in the prior year period. Income from continuing operations was $23 million compared with a loss of $87 million last year. Basic earnings per share was $0.06, which includes an income tax benefit of $20.1 million related to the Lugano recovery. This compares with a per share loss of $1.21 in the prior year period. I will now turn to the operating results of our continuing subsidiaries, excluding Lugano, and the divested food service business. Net sales were up approximately 0.8% versus the prior year, with brand and consumer net sales increasing by 4% and industrial net sales declining 5%. On a comparable basis, subsidiary adjusted EBITDA was approximately $90 million, an increase of 12.9%, excluding both Lugano and the divested food service business from the prior year period. Adjusted EBITDA for our brand and consumer business increased 28%, while the adjusted EBITDA for industrial declined 19.6%. Similar to last quarter, these results benefited from our EPA tariff refunds received across several of our businesses during the quarter. Corporate expenses were approximately $22 million, resulting in total adjusted EBITDA of approximately $68 million. Corporate management fees, excluding fees paid by our subsidiaries, were $12.1 million. Actual corporate cash payments related third-quarter fees were $6.4 million, roughly half that amount. We continue to expect corporate cash management fees paid to the manager to be between $25 million and $30 million for the full year, reflecting the manager's repayment of the remaining management fees overpaid in connection with the Lugano restatement. Public company costs were approximately $10 million in the quarter, including $5.4 million of one-time costs stemming from Lugano and related matters. We have made meaningful progress in reducing these costs, with one-time expenses down more than 40% from the average quarter level in the first half. We are maintaining tight control over spending and looking to reduce these costs wherever possible. We are also actively pursuing additional D&O insurance recoveries, which we expect to offset a portion of the one-time costs. Ultimately, we are focused on spending less and recovering more. I will now walk through the cash flow statement of the balance sheet. Cash generation continues to improve substantially. We generated approximately $52 million of operating cash flow in the third quarter. Bringing year-to-date operating cash flow to more than $100 million, compared with an operating cash outflow of approximately $50 million through three-quarters of 2025. Capital expenditures were $6.6 million in the quarter and $18 million year-to-date, roughly half the prior year level. We ended the quarter with $127 million of cash and near full availability on a revolver. Total debt was approximately $1.57 billion. Our covenant leverage ratio was 4.5 times. Our senior secured net leverage was 0.5 times. Before turning to our outlook, I want to provide an update on Lugano. In September, the court approved Lugano's liquidation plan, and we received nearly $30 million in proceeds, which we applied to our term loan. Lugano is no longer a CODI subsidiary, and a liquidating trust is winding down its estate. Beyond receiving future recoveries from the trust, whose timing remains uncertain, our involvement in Lugano's bankruptcy is complete. We will continue to address Lugano-related litigation involving CODI. Turning to our Outlook. We are narrowing our 2026 subsidiary adjusted EBITDA guidance to between $330 million and $355 million. We now expect adjusted EBITDA of $250 million to $270 million for our brand and consumer businesses, and $80 million to $85 million for our industrial businesses. This reflects modestly higher expectations for brand and consumer, offset by lower expectations for industrial. Our updated guidance reflects strong year-to-date performance, tempered by a modest pull forward of demand in certain businesses, and in the increasing macroeconomic uncertainty. Finally, our outlook includes approximately $9 million of adjusted EBITDA generated by the external food service business before its sale, consistent with our full-year reporting. For modeling purposes, we assume capital expenditures of $30 million to $35 million for the full year. Our outlook does not assume any additional acquisitions or divestitures, nor does it assume a significant change in the current trade environment. With that, I'll turn the call back to Zach.

Thanks, Stephen. Our focus is on continuing to strengthen Cody's foundation while driving long-term value. We own high-quality businesses and are confident in our ability to build on their performance. That means sustaining strong subsidiary results and improving execution where needed. It also means further reducing leverage through organic cash flow generation and divestitures that create real shareholder value. As our balance sheet strengthens, we intend to pursue opportunities to return capital efficiently to shareholders when appropriate. Operational discipline and long-term value creation will guide every decision. I want to thank the CODI and subsidiary teams for their diligent work and our shareholders for their continued support. We will now take your questions. Operator, please open the line.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Our first question comes from the line of Chris Kennedy with William Blair. Your line is now open.

Good afternoon. Thanks for taking the question. Zach, I think you mentioned an uncertain M&A environment. Can you talk a little bit more about what you're seeing and the higher interest rates? Thanks for taking the question, guys.

Sure. Hey, Chris. So we've seen the market become increasingly uncertain. The M&A market become increasingly uncertain since the Q2 call. You know, 10-year Treasury rose to a 24-year high. I think it's up roughly 80 bps since the last call. Oil is hovering around $100 up roughly 20% since Q2. Inflation has ticked up, and we've seen market volatility increase, I think, largely in anticipation of midterm elections. So all of these factors, I think, are weighing on, in general, uncertainty in the market and has made some of the mid-market private equity firms have a bit more risk-off perspective. I would say despite an increasingly challenging M&A market, We are committed to pursuing a value-maximizing divestiture and exploring any and how options, everything certainly on the table. You know, we're seeing mid-market divestiture processes, of course, are time-consuming, always have been, but are becoming more so elongated in this uncertain environment. But, you know, we have high-quality businesses which remain attractive in any market. However, we're very focused on long-term value creation and will not sacrifice shareholder value for a short-term catalyst.

Understood. Thanks for that. And then just a quick follow-up on the free cash flow profile for this year. It's good to see the Logano intake. Can you reiterate what you're expecting? Thank you.

Yeah, so again, I think it's very consistent with what we've been saying. If you exclude the one-time cost and the one-time recoveries that are somewhat offsetting, we're still kind of thinking of like about $70 million of excess cash that we can then use to pay down debt. And that excess cash is, you know, after preferred payments, after interest. Payments, that's the same level that we've been talking about. So, again, we're on track, as we expected.

Great. Thank you. Appreciate it.

Thank you. Our next question comes from the line of Michael Legg with Lattenberg-Dalman. Your line is now open.

Thanks. Nice numbers, guys. Just a quick question on the tariff refund. How much was the tariff refund across the whole portfolio of the quarter?

It was a little around $7 million is what it was in the quarter. I think it's important to note, though, that we took the opportunity to use some of that $7 million to reinvest, or most of that $7 million to actually reinvest in the business. And so it wasn't like just a pure windfall. We did actually make some investments into the business to help drive long-term growth.

Okay, and then just another question. You mentioned a little bit of Facing stability, a less promotional environment in some of the branded business. Can you just talk a little bit about that? Hi, sure.

That's with respect to 5.11 specifically. Coming out of COVID, when many of the apparel retailers had excessive inventory, it was necessary to compete on price to some degree, and we have been very focused on reducing promotional pricing in our DTC channel in order to ensure that we're retaining the appropriate margins in the business. Okay, great. Thanks, guys.

Thank you. Our next question comes from the line of Larry Solo with CJS Securities. Your line is now open.

Great. Thanks. And first off, Elias, I wish you the best of luck. I've been on you for about 15 years, so you've done a great job, and I wish you all the best. Um, I guess just, uh, Zach, maybe, you know, it looks like, you know, you're, you're bigger businesses. Consumer-facing businesses actually held up pretty well in the quarter. I know obviously there's, you know, the clouds have only gotten thicker, although hopefully with the midterm elections behind us and perhaps the consumer outlook does improve a little bit. But I'm just curious, you know, what you're seeing particularly at your businesses, like things. You know, the environment's obviously not gotten better, but your results continue to do pretty well, even if you're a consumer-facing one. So just curious, you know, your customers specifically, you know, has your confidence changed at all, even through the year, never mind, just the last few months?

Hi, Larry. Thanks for the question. We still feel pretty good. We believe our consumer businesses continue to be well-positioned, and we're observing healthy growth, as you noted. The majority of our consumer products benefit from being highly differentiated, more performance-oriented, and are not easily substituted. And generally have exposure to a more affluent audience, which seems to be more insulated in this environment. Where we are seeing a little pressure is really in 5.11, and in particular in the DTC channel, where we do have exposure to some more price sensitive. Consumers, some of that softness is being driven, though, by reduction in promotional spend. But by and large, we still feel pretty confident about how our consumer businesses are positioned in this uncertain market.

Okay. And it sounds like on the acquisition front, excuse me, on the divestiture front, you're going to be patient and diligent. You're not going to. So for the sake of just, you know, doing a transaction, your back is not against the wall, but it does sound like you remain pretty confident you can get something done, you know, in the next few months. Is that a fair statement?

I wouldn't feel comfortable time-bounding our expectations on that. What I would say is that even in this uncertain market, we are very committed to exploring a value-maximizing divestiture, or I should say pursuing a value-maximizing divestiture, and remain committed as we have been consistently throughout the year. But I do want to reiterate that we have a great portfolio of high-quality businesses, and we won't sacrifice value for expediency. Yeah, great.

I appreciate that. Just lastly, Steve, if you can, just on the free cash flow, I know it's way too early to talk about 2027, but you're going to do close to a dollar this year, excluding some of the noise. You should have typically lower interest expense next year, right? Maybe some lower corporate, a little higher EBITDA, hopefully. You know, any reason why we, you know, it certainly should be higher, but I would think perhaps $1.52 in free cash for share is not. A crazy expectation. I know you're not going to guide to that today, but, you know, any color or thoughts on that would be great. Thanks.

Yeah, no, I think, again, we're still working through our plans for next year. I think you're correct to suggest that hopefully we'll have some lower interest costs next year. We'll also have some growth in the underlying performance, and hopefully some of these one-time costs will go away and we'll continue additional recoveries. So I think it will increase the magnitude. As you said, we're not going to sit here and give you a number yet, but we are committed to... You know, to growing and to getting – and to increasing our free cash flow. It's a key part of our deleveraging strategy, in addition to the inorganic piece that Zach is talking about.

Got it. Okay, great. Thanks again.

Thank you. As a reminder to ask a question at this time, please press star 11 on your touchstone telephone. Our next question comes from the line of Timothy D'Agostino with B-Riley Securities. Your line is now open.

Hi. Yes, thanks for riding the color on the free cash flow. I guess just looking at the balance sheet and, you know, cash and cash equivalents on hand, about $127 million. How should we think about, you know, that number and maybe what's available of cash on hand to pay down debt?

Yeah, so just a quirk of, like, when we got the recovery from Lugano, we got $30 million the day before the quarter ended, and we paid down the day, the 1st of October. So, you know, so we are, our senior secured is now, instead of 234, it's actually now, like, 204. Our cash went down because of that. So, that was just a timing issue of when the quarter ended. But again, we feel good about our cash generation throughout the year. And again, organically, we'll continue to drive down leverage. We've made good progress from Q1 to Q2, from Q2 to Q3, and we'll make further progress Q4 on an organic basis. And then on top of that, again, we will look to do an inorganic sale at some point, which will further do it.

Okay, I guess just thinking, you know, cash is probably sitting around $97 million, you know, post that pay down. I guess, could you just maybe provide color on how you think about, like, the minimum amount of cash you want to hold on hand? Just trying to get a better sense of, you know, what that number should look like and, you know, again, how much cash you actually want to have on hand.

Yes, again, that $127 million that we reported includes money at the, you know, at the subsidiaries and that they use, that's, you know, that is, that they need for day-to-day business. And so some of it, you know, depending on how some of it is in foreign jurisdictions, et cetera, it's not all necessarily easy to call upon right away. But again, we feel – we typically – I would say this was a little bit elevated of how much cash we would have at the end of a quarter. We – again, we had – we were lucky that we didn't have any – we were able to pay down all of our revolver, so that was also one of the reasons why we had more cash. But again, you will see us, you know, generate significant cash and use it to pay down – to pay down their senior debt. to further deliver it. That's the key focus. Okay. Thank you so much for the questions today.

Thank you. Our next question comes from Healy Sheth with Raymond James. Your line is now open.

Hi, thanks for the question. Just a quick one for me. So, following the results of the elections, any shift in expectations for the performance of any portfolio assets, either positively or negatively, or expectations for the M&A environment as it relates to any plans for divestiture?

No change in our expectations. It's really too early to tell how it's going to impact the economic environment, which the business operate in, or the M&A environment.

Got it.

Thank you. Thank you. And I'm currently showing no further questions at this time. I now like to hand the call back over to Zach Sautel for closing remarks.

All right. Well, thank you, everyone. We look forward to speaking to you in the new year.

This concludes today's conference. Thank you for your participation. You may now disconnect.