Compass Diversified's Q3 2025 Call: Contradictions on Lugano's Performance and Margins, Divestiture Strategy, Leverage, and Management Fees

Date of Call: Jan 14, 2026

Financials Results

• Revenue: $1.4B year-to-date, an increase of 8.6% over the prior year, or 6.1% excluding the impact of Lugano.

Guidance:

• Tightening expected subsidiary-adjusted EBITDA range for 2025, excluding Lugano, to between $335M and $355M.
• Expect to organically delever in 2026 through solid growth in subsidiary-adjusted EBITDA. Outlook for 2026 will be provided on the Q4 call.
• Free cash flow expected to be strong in 2026, with $50M-$100M generated after interest, preferred dividends, and CapEx.

Business Commentary:

Compliance and Reporting:

• Compass Diversified completed its SEC filings for 2025 and is now back in compliance with the reporting requirements under its credit facility and bond indentures.
• The company expressed gratitude for the patience and support of its stakeholders throughout the process of getting back on track.

Organizational Changes:

• Pat Maciariello retired after 20 years with CGM, and Zach Sawtelle stepped into the role of COO for CGM.
• The leadership transition is seen as a natural progression with Sawtelle's extensive experience and involvement in successful acquisitions.

Financial Performance and Challenges:

• For the third quarter, net sales were $472.6 million, up 3.5% year-over-year. Year-to-date, consolidated net sales were $1.4 billion, an increase of 8.6% over the prior year.
• The financial results were impacted by expenses related to the Lugano investigation and the ongoing operations of Lugano, which was included in the consolidated results.

Consumer and Industrial Vertical Performance:

• The consumer vertical saw sales up 3.1%, driven by strong growth at The Honeypot, while BOA declined slightly due to a strategic exit in China.
• The industrial vertical delivered mid-single-digit sales growth, primarily driven by Altor’s acquisition of Lifoam, despite short-term challenges at Arnold due to rare earth supply chain disruptions.

Future Outlook and Strategic Focus:

• The company aims to continue deleveraging, invest for growth, and return capital to shareholders when appropriate.
• Compass Diversified is focused on delivering consistent long-term shareholder value and is looking to execute strategic transactions, including potential business sales.

Sentiment Analysis:

Overall Tone: Positive

• "We’re also back in compliance with the reporting requirements...and we’re returning to a more normal operating cadence." "Despite that volatility, our subsidiaries...delivered mid-single-digit growth in subsidiary-adjusted EBITDA." "I think 2026 is shaping up to be a great year." "We have very strong expectations that we will have a growth year next year and that our free cash flow is going to be very strong."

Q&A:

• Question from Lance Vitanza (TD Cowen): Could you comment on how the Honeypot's performance has been shaping up relative to your internal expectations and the drivers of any outperformance?
  Response: The Honeypot is significantly outperforming expectations due to successful expansion into the larger menstrual category, gaining shelf space and achieving fast inventory turns, supported by strong brand marketing.

• Question from Lance Vitanza (TD Cowen): Are there any assets off the table for sale?
  Response: All businesses remain available for sale, but the company will be disciplined on valuation and not take a discount on premium assets.

• Question from Larry Solow (CJS Securities): How do you see the economy today versus the start of the year?
  Response: Growth moderated after Q1 due to tariff-related demand pull-forward and consumer reticence to accept inflation, impacting apparel producers like 5.11. The industrial vertical faced unique headwinds from rare earth export restrictions.

• Question from Larry Solow (CJS Securities): What is the normalized management fee for 2026?
  Response: The non-cash management fee cost is expected to be around $55M for 2026, with cash payments substantially lower due to recoupment of overpaid fees.

• Question from Timothy DeAgostino (B. Riley Securities): What are the different avenues for selling an asset?
  Response: Avenues include IPOs (like Fox Factory or previously withdrawn 5.11 filing) for long-term value unlocking, or faster liquidity via investment banks engaging strategic or private equity buyers.

• Question from Timothy DeAgostino (B. Riley Securities): Has oversight of portfolio companies changed going forward?
  Response: Primary change is outsourcing the internal audit function for scalability and expertise. Some criteria for founder/CEO ownership may be adjusted, but overall the model has worked well for 20 years.

• Question from Matt Koranda (Roth Capital): Can you attain the 4.5x leverage covenant organically this year?
  Response: The company aims to reach below 4.5x leverage organically, but will also consider asset sales to accelerate deleveraging without destroying shareholder value.

• Question from Matt Koranda (Roth Capital): What is the update on Arnold and the supply chain disruption?
  Response: Export restrictions caused a $6-$8M EBITDA disruption in 2025, but China has loosened controls and normalization is occurring. The backlog provides a tailwind for 2026, and long-term growth is expected to be above trend due to customer shift towards secure sourcing.

• Question from Chris Kennedy (William Blair): Any updated thoughts on long-term organic revenue growth targets for subsidiaries?
  Response: Arnold's growth is expected to be materially higher in the short term (3-5 years) due to supply chain disruptions. Other subsidiaries like Honeypot are performing slightly better and 5.11 slightly worse than prior targets due to tariffs.

• Question from Chris Kennedy (William Blair): What is the expected free cash flow conversion for the business?
  Response: Strong free cash flow of $50M-$100M is expected in 2026, a marked change from historical patterns, due to Lugano's removal and the elimination of the common dividend.

Contradiction Point 1

Assessment of Lugano's Performance and Margin Outlook

Contradiction on whether strong margins were unusual or sustainable.

How has oversight of portfolio companies evolved or will it evolve by 2026? - Timothy DeAgostino (B. Riley Securities)

2025Q3: Lugano's investment is viewed as an unprecedented, unique event. - [Stephen Keller](CFO)

What contributed to Lugano's Q4 EBITDA margin improvement, where are the three new salons located, and is there any regional variation in the high-end consumer's health? - Randolph Binner (B. Riley Securities)

2024Q4: The strong Q4 margin was due to operating leverage... There is nothing unusual; however, opening three new salons in 2025 will cause some near-term margin dilution... - [Elias Sabo](CEO), [Patrick Maciariello](COO)

Contradiction Point 2

Strategic Approach to Asset Divestitures

Contradiction on the flexibility and conditions for selling assets.

Are there any assets that are off-limits for sale under any circumstances, or are all subsidiaries potential sale candidates? - Lance Vitanza (TD Cowen)

2025Q3: The company's model has always been that all assets are for sale at all times, provided the valuation is attractive... The company will be disciplined and not take a discount on premium assets. - [Elias Sabo](CEO)

What progress has been made on tariffs and what remains ongoing? How does your portfolio's exposure compare to competitors? What is the outlook for M&A activity in 2025, and will you be more active? - Lance Vitanza (TD Cowen)

2024Q4: The M&A market is recovering... The intention is to deploy capital more actively. - [Elias Sabo](CEO)

Contradiction Point 3

Strategy and Stance on Leverage and M&A

The company's willingness to take on leverage for M&A appears inconsistent.

Can you achieve the 4.5x leverage covenant milestone by mid-2026 organically through potential working capital cash flows? - Matt Koranda (Roth Capital)

2025Q3: The company is focused on organically delivering below 4.5x leverage to avoid the fee and accelerate deleveraging. - [Stephen Keller](CFO)

What is your leverage appetite at current levels, and could divestitures allow for more aggressive M&A? - Lawrence Solow (CJS Securities)

2024Q1: Comfortable increasing leverage temporarily to fund acquisitions due to strong growth profile and cash flow generation. - [Elias Sabo](CEO)

Contradiction Point 4

Leverage Target & Management Fee Outlook

Guidance regarding the leverage covenant fee and its organic achievability has shifted.

Can you achieve the 4.5x leverage covenant milestone by mid-2026 organically through cash from working capital? - Matt Koranda (Roth Capital)

2025Q3: The company is focused on organically delivering below 4.5x leverage to avoid the fee and accelerate deleveraging. - [Stephen Keller](CFO)

With leverage expected to reach 4x in H1 2024, can the company acquire larger assets and consider selling smaller subsidiaries? - Lawrence Solow (CJS Securities)

2023Q4: Leverage is currently at 3.7x and may temporarily increase into the 4x range due to inventory funding for Lugano, but is expected to decline back to around 3.5x as growth offsets debt. - [Elias Sabo](CEO)