Compass Diversified Earnings Call: Recovery Story Takes Shape

Compass Diversified ((CODI)) has held its Q3 earnings call. Read on for the main highlights of the call.

Compass Diversified Earnings Call Signals Cautious Recovery Amid Legacy Drag

The latest Compass Diversified (CODI) earnings call struck a cautiously constructive tone, blending clear signs of operational progress with the lingering weight of Lugano-related losses and elevated leverage. Management emphasized restored regulatory and credit compliance, improving subsidiary EBITDA, and strengthening brands in both consumer and industrial verticals. At the same time, they were candid about the significant hit from the Lugano bankruptcy, one-time investigation costs, high leverage around 5.3x, and near‑term pressure on liquidity and certain businesses like Arnold and 5.11. Overall, the narrative was one of a business stabilizing and rebuilding credibility, but still very much in recovery mode.

Regulatory and Credit Compliance Back on Track

CODI’s first priority in recent quarters—getting its house in order—has been met. The company is now current with its SEC filings for 2025 and back in compliance with its credit facility and bond indentures. This restores a more normal operating cadence, removes a critical overhang with lenders, and reopens access to its full revolving credit capacity. For investors, this is a key step in re-establishing financial discipline and transparency after the Lugano turmoil.

Top-Line Growth in the Third Quarter and Year to Date

Despite the noise from Lugano, CODI delivered modest but positive revenue growth. Third-quarter net sales were $472.6 million, up 3.5% year over year. Year-to-date consolidated net sales reached $1.4 billion, an 8.6% increase, or 6.1% when excluding Lugano. The growth shows that the underlying portfolio remains resilient and that the drag on reported results is more about legacy issues than current demand across the platform.

Subsidiary EBITDA Growth Ex-Lugano Shows Core Strength

Underlying profitability across CODI’s businesses improved, once Lugano is stripped out. Year-to-date subsidiary adjusted EBITDA excluding Lugano was $257 million, up 5.8% versus 2024. Key drivers were double-digit EBITDA growth at The Honey Pot and Sterno, coupled with incremental contribution from Altor’s acquisition of Lifoam. This improvement supports management’s message that the core portfolio is performing solidly even as the company works through past problems.

Consumer Brands: Honey Pot and BOA Lead the Charge

In the consumer vertical, sales grew 3.1% year to date, with standout performances from The Honey Pot and BOA. Honey Pot delivered strong double-digit EBITDA growth, successfully expanded into the menstrual category, gained shelf space, and improved inventory turns—outpacing internal expectations and reinforcing its brand momentum. BOA’s core business also grew double digits after the planned exit from a lower-value children’s business in China, underscoring CODI’s willingness to prune lower-return segments to strengthen overall profitability.

Industrial Vertical Powered by Altor and Sterno

The industrial vertical was the main growth engine, with sales up 10.5% year to date. Much of this was driven by Altor’s 2024 acquisition of Lifoam, which contributed meaningful revenue, while Sterno delivered double-digit EBITDA growth. Together, these businesses show how targeted M&A and operating improvements can drive scale and margin in CODI’s industrial portfolio, partially offsetting consumer and macro headwinds elsewhere.

Arnold: Short-Term Pain, Long-Term Strategic Positioning

Arnold remains a mixed story: a strategic asset with real long-term potential, but facing near-term financial pressure. As one of the few U.S. producers of samarium-cobalt magnets for aerospace and defense, Arnold sits at the center of a geopolitically important rare-earth supply chain. Management highlighted a growing backlog and structural demand for secure supply, but also flagged temporary disruption from rare-earth export restrictions out of China, which are expected to shave $6–$8 million off 2025 EBITDA before normalizing in 2026.

Liquidity Restored and Financing Flexibility Improved

The company has regained meaningful financial flexibility. CODI ended the quarter with $61.1 million in cash and had used less than $10 million on its revolver. A recent credit agreement amendment restored access to the full $100 million revolver and relaxed leverage covenants through 2027. While this flexibility is vital given elevated leverage and cash usage, management stressed that it does not intend to rely heavily on the revolver, instead targeting organic deleveraging and disciplined capital deployment.

Narrowed 2025 EBITDA Outlook Signals Growing Confidence

CODI tightened its 2025 subsidiary adjusted EBITDA guidance (excluding Lugano) to a range of $335 million to $355 million. With year-to-date subsidiary adjusted EBITDA ex-Lugano at $257 million and growing 5.8% year over year, this narrower range suggests greater confidence in the underlying performance of the portfolio. Management emphasized that this reflects solid execution at key brands and the benefits from earlier strategic moves such as the Lifoam acquisition.

Path to Stronger Free Cash Flow in 2026

On the cash-flow side, the company laid out a more constructive 2026 outlook. Management expects to generate $50 million to $100 million of free cash flow in 2026 after interest, preferred dividends, and capital expenditures. This improvement is expected to come from solid subsidiary EBITDA growth, normalized capital spending, and lower cash management fee outlays as previously overpaid fees are recouped. The goal is to direct this cash toward organic deleveraging, gradually bringing leverage down from today’s elevated levels.

Recovering Overpaid Management Fees to Ease Future Cash Burden

A notable piece of the clean-up story involves management fees tied to Lugano-influenced results. CODI and its Board are working to recover overpaid cash management fees, with full recoupment expected by the end of 2026. A fourth-quarter true-up is expected to create a one-time noncash P&L benefit and a current asset that will offset future management fees. Normalized (accounting) management fees are estimated around $55 million annually, and actual cash payments should be materially lower as recoupments are applied—helping liquidity and free cash flow over the next few years.

Lugano Bankruptcy Leaves Heavy Mark on Reported Earnings

The Lugano saga remains the biggest drag on CODI’s reported numbers. Lugano stayed in results through mid-November 2025 before entering Chapter 11, and year-to-date consolidated net loss was $215 million, including a $155 million loss tied directly to Lugano. Third-quarter GAAP net loss came in at $87.2 million, again heavily influenced by Lugano-related expenses. While these losses are backward-looking, they underscore the scale of the legacy issue CODI is still digesting.

Corporate and One-Time Costs Inflate Overhead

Public company and corporate management fees totaled $99.5 million year to date, with more than $37 million of that tied to one-time costs from the Lugano investigation and restatement. Excluding these unusual items, normalized fees are projected at roughly $55 million. The elevated corporate cost base has been a major headwind to profitability and cash flow in 2025, but management suggests the worst of the Lugano-related expenses are now behind the company.

High Leverage and Deleveraging Incentives Under Amended Covenants

Leverage remains one of the central concerns for investors. CODI expects its year-end leverage ratio, excluding deconsolidated Lugano, to be about 5.3x. Under the amended credit agreement, leverage covenants are relaxed through 2027, but the deal includes milestone fees if leverage does not fall below 4.5x by June 30, 2026. This structure provides breathing room but also creates a direct financial incentive—and potential cash cost—for the company to delever meaningfully over the next 18 months.

Cash Usage Highlights Near-Term Liquidity Sensitivity

Operationally, CODI is still consuming cash. Year-to-date cash used in operating activities was $54 million, and capital expenditures totaled $34 million. With cash and cash equivalents at $61.1 million at the end of the quarter, the company has a modest cushion, backed by its undrawn revolver. Still, these figures underscore that, in the near term, CODI must carefully manage working capital, spend, and investment decisions to avoid stretching its balance sheet further.

Tariffs, Inflation and Macro Headwinds Weigh on Consumer Brands

Beyond company-specific issues, the macro environment is also challenging. A fluid tariff landscape, inflation, and geopolitical uncertainty have slowed demand in parts of the consumer portfolio. 5.11, in particular, has been hit by tariff-driven cost pressures tied to production in Southeast Asia, which have moderated its growth despite otherwise solid brand positioning. Management acknowledged these headwinds as an ongoing risk factor for margins and volume.

Arnold’s Near-Term EBITDA Hit from Rare-Earth Constraints

The rare-earth market is having a noticeable near-term impact on Arnold. Export restrictions from China have disrupted supply, leading management to estimate a $6 million to $8 million EBITDA reduction in 2025. While CODI expects Arnold’s performance to normalize in 2026 as the company adapts to the new supply environment, this headwind is another factor limiting near-term earnings and slowing the pace of deleveraging.

Deleveraging Prioritized, but Asset Sales Will Be Disciplined

Reducing leverage is a clear strategic priority, and management openly discussed the potential use of asset sales or other transactions to accelerate balance sheet repair. However, they also stressed a disciplined approach: assets will only be sold at acceptable valuations, even if that means the process takes longer than investors might prefer. This stance may delay rapid deleveraging but is intended to protect long-term value rather than sacrifice it for short-term optics.

Insider Buying Paused by Technical Trading Restrictions

One notable investor signal is absent for now: insider buying. Management and the Board have not purchased shares recently, but this is due to closed trading windows tied to the timing of SEC filings and the annual audit process, not a lack of confidence. While this removes a near-term catalyst that typically reassures shareholders, the company suggested that such activity could resume once regulatory timing constraints are lifted.

Forward-Looking Guidance Signals Gradual Improvement and Deleveraging

Looking ahead, CODI’s guidance paints a picture of steady operational progress paired with disciplined balance sheet repair. For 2025, the company now expects subsidiary adjusted EBITDA (excluding Lugano) of $335–$355 million, building on 5.8% year-over-year growth already recorded year to date. Net sales are growing mid-single digits, with consumer and industrial verticals both positive and key brands like Honey Pot, Sterno, BOA, and Altor-Lifoam driving performance. Management anticipates normalized management fees of about $55 million next year, with actual cash payments lower thanks to fee recoupments. By 2026, CODI targets $50–$100 million of free cash flow after interest, preferred dividends, and CapEx, and “solid” subsidiary EBITDA growth, positioning the company to organically delever and work toward bringing leverage under critical covenant thresholds.

The earnings call framed Compass Diversified as a company in the middle of a multi-year repair and refocus. Core businesses are growing, industrial and consumer brands are showing healthy EBITDA expansion, and regulatory and credit issues have been stabilized. Yet heavy Lugano losses, elevated leverage, cash usage, and macro headwinds remain meaningful overhangs. For investors, the story is a balancing act: tangible operational progress and a clearer path to better free cash flow in 2026—set against near-term financial strain and execution risk as CODI seeks to delever without compromising long-term value.