Compass Diversified (CODI) Earnings Call Transcript

Good afternoon, and welcome to Compass Diversified's Fiscal 2026 Second Quarter Conference Call. Today's call is being recorded. [Operator Instructions] 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 Sawtelle, 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, CODI 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 in some of these -- 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's Foodservice 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's Foodservice 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 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 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. 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, 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 Sterno'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 considers 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 2 additional awards, each equal to 12.5 basis points of average adjusted net assets. One is designed to increase the manager's ownership of CODI 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's 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. CODI 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 CODI 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 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 Honey Pot 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 up 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. Within 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's 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-related 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 Sterno's 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 of our continuing subsidiaries, which exclude Lugano and divested foodservice business, net sales were approximately $411 million, roughly flat with the prior year. Branded 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% Branded Consumer adjusted EBITDA increased 24.2%, while the adjusted EBITDA for Industrial declined 12.8%. It's 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 Sterno's Food Service business, which generated approximately $2 million in adjusted EBITDA through the May 1 sale date, subsidiary adjusted EBITDA was approximately $94 million. Corporate expenses were approximately $29 million, resulting in total adjusted EBITDA of approximately $66 million. Corporate management fees, excluding fees paid by our subsidiaries, were $12.3 million for the quarter as reflected in our income statement. Actual cash payments related to second quarter fees were $6.2 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 $16 million in the quarter. This includes more than $12 million of Lugano related and other onetime costs. We do not add these costs back in calculating 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-to-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'm accountable for both and I'm 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 our revolver. Total debt was approximately $1.6 billion, down nearly $300 million from year-end, primarily reflecting the application of the Sterno's sale proceeds to our term loan. Our covenant leverage ratio was 4.8x, down from 5.3x at the end of the first quarter. Our senior secured net leverage was 0.66x. 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 rightsized 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 exclude it. We now expect Branded 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 2 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. Operator, please open the line.

[Operator Instructions] And our first question comes from the line of Chris Kennedy with William Blair.

Zach, you've had a large role at Compass over the years. Can you just provide some perspective as to what you think the consumer and the industrial subsidiaries can grow over the long term?

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.

Got it. And then any update on free cash flow guidance for this year? Clearly, it's improving. Just are we at a sustainable level going forward?

I'm going to let Stephen answer that question.

Yes. 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.

And our next question comes from the line of Lance Vitanza with TD Cowen.

A couple, if I can. The first is on the corporate cost structure. I think that's an area that appears increasingly important to the equity story. And as investors look toward 2027, should we be thinking about total corporate expense, including management fees and public company costs as being closer to $50 million than the levels we've seen historically? And are there additional opportunities over the longer term beyond the MSA amendment that might further reduce corporate overhead over time?

Yes. I think, the way to think about it, I think a little bit higher than $50 million is probably the right way. There is a -- on the base fees next year, there is a -- from the management fee, there is a $30 million cap. We're targeting this year to have about -- excluding the onetime 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, think in that $30 million to $35 million is probably the right way to think about it.

Okay. That's helpful. And then on Altor, you mentioned in the prepared remarks that the work to improve performance remains fairly comprehensive, and it sounds like it's going to take several quarters to execute. EBITDA down obviously quite a bit in the second quarter. As we think about the next few quarters, what milestones can we be watching for to gauge whether the turnaround is progressing as expected? And how should we think about the cadence of improvement from here, both towards stabilizing results and then ultimately returning the platform to growth. Is it going to be sort of like the proverbial straight line towards flat and then growth? Or do we have a few more really tough quarters to come and then a big hockey stick up higher in 2 or 3 quarters' time? How would you sort of describe that?

Lance, this is Zach. Thank you for the question. Our assumption is a gradual improvement over the next 4 to 5 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 several quarters. So I would anticipate the recovery to stretch modestly over a handful of future quarters.

So if I could just get one -- if I could just get one more in before I jump back in the queue. You've talked a lot, including today about the substantial discount to intrinsic value, we agree. And you've made progress over the past year with the Sterno's transaction, balance sheet is in much better shape, et cetera. As you think about closing the discount from here, do you believe additional asset sales remain the primary catalyst? Or can continued operating performance and deleveraging begin to narrow the gap even absent another transaction?

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 and 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.

And our next question comes from the line of Larry Solow with CJS Securities.

Zach, just want to welcome you. I know you've been with the company for a while, but welcome to your new role or your pending new role -- well, I guess, COO is a new role, you're welcome. I guess just a follow-up on that question. I think we all agree probably the fastest way to close that gap in underlying value and value we see in the market today is through an asset sale. Just your thoughts, kind of big picture, thinking outside the box, any other levers the size of an asset sale at a good price, which I think is an obvious way to hopefully improve the value there. But just any other thoughts? Clearly, you're going to run by this -- the playbook is probably going to be run pretty much the same. I don't expect you to come in there and upend everything. But just any thoughts on how -- other ways to sort of narrow that gap over time?

Certainly. There are alternative methods, but I do believe that the most prudent way, given where we're -- 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 our shareholders.