Compass Diversified Holdings (CODI) Q2 2026 earnings call transcript

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 second 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 subsidiaries, 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 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, CODI 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 are 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 of 2026 subsidiary adjusted EBITDA outlook to the most directly comparable gap measure because CODI does not provide guidance for income or loss from continuing operations, and management cannot predict with sufficient certainty all of the inputs necessary to provide such a reconciliation without unreasonable effort.

Additional information regarding this limitation is included in today's earnings release. Throughout this call, we will refer to Compass Diversified as Cody 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. In the second quarter, our subsidiaries delivered double-digit adjusted EBITDA growth and strong cash flow. Based on our first-half performance and current expectations for the remainder of the year, However, we are maintaining our fiscal 2026 total subsidiary-adjusted EBITDA outlook. Zach and Stephen will provide detail on our operating performance and outlook shortly. Beyond subsidiary performance, we took concrete actions to strengthen our balance sheet and improve alignment with shareholders. In May, we completed the previously announced sale of Cerno's food service business at an attractive valuation, applying more than $280 million of the proceeds to debt reduction.

We also amended our management services agreement. The amendment followed a board-led review that considered investor perspectives and market practices. It lowers fees and ties more of the manager's compensation to shareholder returns and operating performance. Let me provide some additional details. Effective January 1, 2027, the amended agreement reduces the base management fee from 2% to 1.25% of average adjusted net assets on the first $3 billion in assets and caps the 2027 base fee at $30 million. It also establishes two additional awards, each equal to 12.5 basis points of average adjusted net assets. One is designed to increase the manager's ownership of Cody shares, and the other is tied directly to shareholder returns and operating performance. Even assuming full payout of both awards, we expect the amended agreement to reduce 2027 fees by approximately $20 million compared with the prior management fee formula.

While the Sterno sale and MSA changes are important milestones, our work is not done. Our shares continue to trade at what we believe is a meaningful discount to intrinsic value, and we remain focused on closing that gap.

Before I hand the call over to Zach, I want to briefly address the leadership transition we announced in June. I will retire as Chief Executive Officer at the end of this year, and Zach will succeed me. Cody has been the focus of my career, and I am proud of what we have accomplished. The challenges following Lugano made the past year one of the most difficult periods in our history. I wanted to remain in place through the most acute phase of that work and help put Cody in a position to move forward. With the progress we have made and Zach ready to lead, I believe this is the right time for the transition. I have worked with Zach for 17 years.

He understands our businesses, our people, and our model, and I have complete confidence in him. Over the remainder of the year, Zach and I will continue working closely to ensure a smooth transition.

With that, I'll turn the call over to Zach.

Thanks, Elias. I appreciate your confidence, and I look forward to working closely with you through the transition. Our near-term priorities are straightforward, drive profitable growth across our subsidiaries, pursue divestitures where we can realize attractive value, further reduce debt, and as our balance sheet strengthens, efficiently return capital to the shareholders to close the valuation gap in our current share price. We are moving with urgency and discipline to realize value for our shareholders.

Turning to the quarter, our strong operating performance was broad-based. Every one of our branded consumer businesses grew adjusted EBITDA. BOA grew adjusted EBITDA 27% on growth across all primary segments with expanding gross margins. The Honeypot grew adjusted EBITDA 32% on expanded period care distribution across grocery, drug, and mass, where it is significantly outpacing the broader category. Primaloft returned to growth with adjusted EBITDA of 28%, supported by strong demand from our Asian brand partners. 5.11 grew adjusted EBITDA by 14% on expanded margins of more than 200 basis points through more disciplined promotional activity and tariff refunds. We estimate that some of the second quarter strength at BOA and Primaloft reflected the timing of customer orders. We have considered that timing in our expectations for the remainder of the year.

With an industrial, Arnold delivered a standout performance with adjusted EBITDA up nearly 50%. Backlog remains strong, supported by demand for rare earth magnets sourced outside China and continued progress at our Thailand facility. Rimports, our home fragrance business, benefited from tariff refunds while absorbing separation costs related to the Sterno Food Services divestiture. As discussed last quarter, lower expected volume from a large customer will weigh on results in the second half. Altor is where we have work to do. Adjusted EBITDA declined roughly 50 in the quarter Tariff disruption weighed on white goods while softer vaccine demand affected the cold chain business Higher input costs and competition added further pressure Those are real market factors but they are not the only issue Our commercial execution has not been good enough and we are urgently working to correct this issue The team is focusing its commercial efforts on the end markets where Altor is strongest and taking costs out to match current demand This will take several quarters Taken together, the quarter reinforced our confidence in our businesses and the teams running them.

With that, I'll turn the call over to Stephen to review our financial results, balance sheet, and outlook.

Thanks, Zach. As Ben noted in the introduction, the year-over-year comparisons are complicated by the inclusion of Lugano in the prior year period and the sale of Sternos food service business during the quarter. I will begin with our reported GAAP results and then discuss our results on a more comparable basis. For the second quarter, GAAP net sales were $424 million compared with $479 million in the prior year period.

Income from continuing operations was $82 million compared with a loss of $81 million last year. Basic earnings per share were $0.86 compared with a loss of $0.88 in the prior year period. The current quarter results included a $182 million gain on the sale of Sternos food service business and a $58 million reduction in the fair value of our receivable from Lugano.

Turning to the operating results on our continuing subsidiaries, which exclude Lugano and the vested food service business, net sales were approximately $411 million, roughly flat with the prior year. Brand and consumer net sales increased 7.2%, while industrial net sales declined 11.5%. On the same basis, subsidiary adjusted EBITDA was approximately $92 million, an increase of 12.6%. Brand and consumer adjusted EBITDA increased 24.2%, while the adjusted EBITDA for industrial declined 12.8%. It is important to note that these results benefited from IEPA tariff refunds received across several of our businesses during the quarter.

As Zach described in detail, strong performance across our branded consumer businesses and at Arnold more than offset the challenges at Altor. On a reported basis, including Sturno's food service business, which generated approximately $2 million in adjusted EBITDA through the MAF 1 sale date, The Compass Diversified Holdings earnings conference call. We continue to expect corporate cash management fees paid to the manager to be between $25 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 $16 million in the quarter. This includes more than $12 million of Lugano-related and other one-time costs. We do not add these costs back in calculated and adjusted EBITDA. They are included in corporate expenses and reduced total adjusted EBITDA. These costs remain elevated due primarily to ongoing professional fees associated with Lugano and the related litigation, investigation, and bankruptcy proceedings. To date, D&O insurance recoveries have offset only a small portion of the related cash outlays. Year and date, we have received around $2 million of D&O insurance reimbursements. We have submitted additional claims and expect significant further recoveries, though the timing and amount are not fully within our control. I am accountable for both and am focused on recovering more and spending less.

Cash generation improved substantially. We generated approximately $30 million of operating cash in the second quarter, bringing year-to-date operating cash flow to more than $50 million, compared with an operating cash outflow of approximately $65 million in the first half of 2025.

Capital expenditures were $6 million in the quarter and $11 million year-to-date, roughly half the prior year level. We ended the quarter with $87 million of cash and near full availability on a revolver. Total debt was approximately $1.6 billion, down nearly $300 million from year end, primarily reflecting the application of external sale proceeds to our term loan. Our covenant leverage ratio was 4.8 times, down from 5.3 times at the end of the first quarter. Our senior secured net leverage was 0.66 times. Subsequent to the quarter end, we amended our senior credit facility to extend all of our term loan and $54 million of our revolving commitments to January 12, 2028. We have right-sized the revolver to reflect our expected liquidity needs, strong cash generation, and continued focus on reducing debt.

We believe the amended facility provides the financial flexibility we need. Reducing leverage remains a top financial priority. We made real progress during the first half, but there is more work to do. Before turning to our outlook, I want to provide a brief update on Lugano. During the quarter, we announced a settlement with the Unsecured Creditors Committee intended to facilitate the orderly liquidation of Lugano's assets, preserve value in the state, and accelerate a portion of our recovery. Under the settlement, we currently expect to receive nearly $20 million in recovery by early fall, which we intend to apply to debt reduction. We expect additional recoveries over time, although the timing and amount remains uncertain. We will continue to update investors as appropriate.

Turning to our outlook, we are maintaining our fiscal 2026 total subsidiary adjusted EBITDA outlook of $320 million to $365 million. One note on the outlook, it includes the roughly $9 million of adjusted EBITDA generated by the food service business before the sale, because that is how we report the full year. The quarterly year-over-year comparisons I gave you a moment ago excluded. We now expect brand and consumer adjusted EBITDA of $235 million to $270 million. For industrial, we expect $85 million to $95 million. This reflects a stronger outlook for our branded consumer business and a softer outlook for industrial. For modeling purposes, we continue to assume capital expenditures of $30 million to $40 million for the full year.

Our outlook incorporates the order timing at BOA and Primaloft that Zach discussed, as well as the current operating environment at Altor. It does not assume any additional acquisitions or divestitures or significant changes in the current trade environment.

With that, I'll turn the call back to Zach.

Thanks, Stephen. I want to close by emphasizing two things. First, we have great businesses led by strong management teams. We will continue to support our teams with the resources and flexibility they need to perform. We are focused on ensuring that our businesses deliver long-term shareholder value.

Second, our priorities are unchanged, drive profitable growth across our subsidiaries, pursue divestitures where we can realize attractive value, and reduce debt. As our balance sheet strengthens, we intend to efficiently return capital to shareholders. We believe that our continued execution against these priorities will narrow the gap between our share price and the underlying value of our business. Thank you for your time. Elias, Stephen, and I will now take your questions.

Sure, absolutely. Thank you for the question. I think we have a carefully curated portfolio of very high quality consumer and industrial businesses that are well positioned in their respective markets. And as we've outlined in prior earnings calls, I think across the spectrum, the consumer businesses vary from high single digit to double digit profitability growth opportunities. And I think on the industrial side of the business, the opportunity remains in the mid single digit to high single digit growth opportunities in the future.

I'm going to let Stephen answer that question.

Sorry. Yeah, no, I think no significant changes here. I mean, again, obviously, short of any divestiture that we may do during the second half of the year, which would substantially change it, but I think we're still on track for the way that we have described it, still kind of in that $50 million range, given where we're at, and that's after all payments.

Yeah, I think, that's the way I think about it. I think a little bit higher than $50 million is probably the right way. You know, there is a, you know, on the base fees next year, there is a, up on the management fee, there is a $30 million cap. We're targeting this year to have about, excluding the one-time fees on public company costs, we're talking about $25 million this year, but I would expect those to come down next year as we kind of deal with some of the, as we deal with some of the auditor changes, et cetera. So I think somewhere for corporate costs, somewhere around $20 million is probably the right number to think about it.

And then for management fees, thinking that $30 to $35 million is probably the right way to think about it.

Hi, Lance. This is Zach. Thank you for the question. Our assumption is gradual improvement over the next four to five quarters. Q2 was a very challenging quarter. Some external factors, some internal factors of note with high oil prices, our primary raw material has inflated, and that is squeezing margins, and we do not anticipate that to abate for some of the time. So I would anticipate the recovery to stretch modestly over a handful of future quarters.

Great question. We are still highly committed to an additional divestiture in order to accelerate the deleveraging process, and that hasn't changed. And we are continuing to evaluate multiple opportunities to pursue what would be an attractive divestiture in realization for our shareholders. We still think that is an important part of the next steps in order to close that gap between our intrinsic value and where the share price is currently trading.

Certainly. There are alternative methods, but I do believe that the most prudent way, given where our share price is currently trading, would be to monetize an asset, whether that is a full monetization or a partial monetization. And we're evaluating everything across the spectrum, with the North Star being what is the best way to create value in the share price for a shareholder.

Have you seen any change since the beginning of the year or today across your brand of businesses? Generally speaking, we are seeing a strong consumer through our businesses in the data that we see. And I would generally characterize Q2 performance in the consumer side of our subsidiaries at or slightly above expectations. So we are not seeing weakness in the consumer and probably performing, again, modestly better than expectations set in January of this year.

Can you kind of give us a thought on what it was in the quarter And I assume there a number you have kind of baked into guidance or is that just for what it was in the quarter Yeah that correct I would characterize IEPA tariff rebates in Q2 as relatively modest mid millions and I would characterize expected tariff refunds for the business modestly more than that in the back half of the year Okay.

That's correct. It is included in the guidance.

Look, again, our number one, we've always said that we would like to be operating around three or three and a half times. We think that's the right level. And so to get there, we clearly need to do a divestiture, which is what Zach's been talking about as one of the key focus areas. Outside of that, the things that we're doing is, one, driving the businesses forward and also trying to maximize our recoveries from Lugano and some other areas. We think, excluding a divestiture, which is lumpy and happens when it happens, we think we can get down to close to around four and a half times by the end of the year on an organic basis.

And then we would, like I said, we would like to add additional inorganic, whether it's asset sales, business sales, et cetera. And so that is those getting that leverage down is a key focus and driving cash flow. So ultimately, given our businesses, though, we do have really strong free cash flow generating businesses, and that's going to be a key point for organically leveraging this year and into next year.

I think you'd see us under four times. I think you would see us start thinking through how to return capital efficiently to shareholders. Obviously, we'd have to work with the board to do that. But I think under four, we would see ourselves in a position to probably return capital. And again, with a focus on closing the gap to intrinsic value.

It's a similar amount of money from tax. That $20 million that we're talking about would primarily come from the Gordon Brothers guarantee that was admitted to the inventory. The additional recoveries that we have line of sight to would be tax refunds. Those are just hard to predict when. It's not entirely clear. It's hard to predict when the IRS will refund the money, but you would expect another $20 million or so coming in for that over the next couple of years or so. And then there are other things. There are lots of other recoveries that we would expect the liquidating trust of the final estate to go after. They're very hard to predict, and they have both the amount and the timing.

And so I think we would expect some additional recovery. It's just hard to quantify, and so we wouldn't want to – we're operating as if those would be zero, and then if there are more, we'll be – to your point, we'll use that to pay down debt immediately or return capital shareholder.

So I would not characterize it as normal seasonality per se. As we noted in the prepared remarks, we do think that the Iran conflict did cause some B2B partners likely to modestly accelerate some orders into Q2. However, I do want to emphasize we believe that to be modest, and that is reflected in our projections for the back half of the year, and we remain confident in the business's performance for the back half of the year. So we think that they did perform modestly above expectations as a result of some pull forward, but despite that tailwind, the businesses are really well positioned for a strong back half of the year.

Sure. We think moderating the promotional activity is the right decision to create long-term value in the business to ensure that we're getting the right customer that's paying full price for a great quality product. And so it is striking the right balance of ensuring that we are not disappointing our customer in a tough market environment, but also ensuring that we're realizing the appropriate value for the great products that 5.11 is delivering. I would also call out that the professional business, which is the heritage of the business, the DDB portion of the business, is performing incredibly strong and is seeing a robust demand both in North America and across Europe, in particular somewhat driven by the increase in conflicts both in Europe and the Middle East.

Great. Well, thank you everyone for your time, and we look forward to discussing Q3 with you in the future. Take care.