Driven Brands Holdings Inc. (NASDAQ:DRVN) Q3 2023 Earnings Call Transcript

Driven Brands Holdings Inc. (NASDAQ:DRVN) Q3 2023 Earnings Call Transcript November 1, 2023

Driven Brands Holdings Inc. beats earnings expectations. Reported EPS is $0.2, expectations were $0.19.

Operator: Good morning. My name is Lara, and I will be your conference operator today. At this time, I would like to welcome everyone to the Driven Brands Q3 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Joel Arnao, SVP of Finance. Joel, you may begin your conference.

Joel Arnao: Good morning, and welcome to Driven Brands third quarter 2023 earnings conference call. The earnings release and the leverage ratio reconciliation are available for download on our website at investors.drivenbrands.com. On the call today with me are Jonathan Fitzpatrick, President and Chief Executive Officer; Danny Rivera, Executive Vice President and Chief Operating Officer, and Gary Ferrera, Executive Vice President and Chief Financial Officer. In a moment, Jonathan, Danny and Gary will walk you through our financial and operating performance for the quarter. Before we begin our remarks, I’d like to remind you that management will refer to certain non-GAAP financial measures. You can find these reconciliations to the most directly comparable GAAP financial measures on the company’s Investor Relations website and in its filings with the Securities and Exchange Commission.

During the course of this call, we may also make forward-looking statements in regards to our current plans, beliefs and expectations. These statements are not guarantees for future performance and are subject to a number of risks and uncertainties and other factors that can cause actual results and events to differ materially from the results and events contemplated by these forward-looking statements. Please see our earnings release and our filings with the Securities and Exchange Commission for more information. Today’s prepared remarks will be followed by a question-and-answer session. We ask you to limit yourself to one question and one follow-up. Now, I’ll turn it over to my partner, Jonathan

Jonathan Fitzpatrick: Thanks, Joel and we appreciate everyone for joining us to discuss Driven Brands’ third quarter 2023 financial results. Now, as always, I want to acknowledge the hard work and strong execution by our more than 11,000 Driven Brands team members and our amazing franchisees, for how they continue to navigate an extremely dynamic macroeconomic environment. I’m sure that many of you had a chance to attend our Investor Day in September. I hope the insights we shared were valuable to you and that you left the event with a better understanding of the power of the Driven platform and our commitment to unlocking the true value of our business. Now, our platform creates many benefits, such as enhancing our competitive advantages, diversification and generating robust cash flow.

We are making progress on the actions we have taken to improve Driven’s performance and continue to act with urgency to accelerate the pace of improvement in our Car Wash and US Glass businesses. We outlined a multiyear strategy, created a Chief Operating Officer position, made leadership changes within US Glass and US Car Wash and shared our strategic plan to maximize the return on our investments through disciplined capital deployment and portfolio management. We have a platform that generates high steady-state returns, with a long runway for reinvestment at exceptional returns and we’re incredibly motivated to see our valuation mirror our results over time. Now let me review some of our third quarter highlights, before turning it over to Danny, who will discuss Take 5 Oil Change, Car Wash and Glass.

Next Gary will detail our third quarter results and full year 2023 outlook. For the quarter, we delivered 12% revenue growth versus prior year, supported by 6.4% same-store sales growth and 6% net store growth, achieving adjusted diluted EPS of $0.20 per share. We continued to be pleased by the performance of our Quick Lube and our franchise businesses across all metrics. All being key contributors to this quarter’s growth. Now let me give you an update on our US Carwash business. Danny, Gary and I have spent a lot of time reviewing all aspects of the US Car Wash business over the last 90 days. Danny is laser-focused on operational opportunities and he will discuss those in more detail shortly. Now after our detailed review in Q3, we decided to close 29 US Car Wash locations, which began in Q4.

Generally, these locations were on average more than 13 years old, had suboptimal real estate and had significant competitive intrusion. On an LTM basis, these locations had negative same-store sales and traffic and negative EBITDA contribution. Consequently, we will see some small benefit in Q4 for closing these 29 loss-making locations. Additionally, we are actively reviewing our pipeline for new Car Wash locations. Now this is in line with our commitment to stop all capital and not to open new stores until we determine the base business is performing. We expect that over the next two to three quarters, we will likely see a return of capital from selling these pipeline sites. We are making steady progress on the US Car Wash business and getting the US Glass integration behind us.

And as I have said previously, this will likely take several quarters. Gary will provide an update on the impact to fiscal 2023 store openings shortly. Now as a reminder, our short-term focus is to deliver our guidance for 2023 and set the company up for a strong 2024. This means improving the US Car Wash business, getting the US Glass integration challenges behind us, a very disciplined strategy for deploying capital, which will primarily be used to open Take 5 Oil Change company stores, a focus on free cash flow generation and generally using excess free cash flow to pay down debt. Now I want to reiterate, that we have taken several steps to improve Driven’s performance. Gary and I are responsible for strategy and capital allocation. The creation of the Chief Operating Officer role is an important one, as Danny is responsible for all the operating segments.

Simply put, he owns the P&L. Danny is responsible for the day-to-day decision-making, finding and executing on growth opportunities and ultimately delivering segment-level revenue and profits. Danny has been my partner for 10 years at Driven. And most recently he served as President of our Maintenance segment. So with that let me hand it over to Danny, our Chief Operating Officer to discuss our key business segments.

Danny Rivera: Thanks Jonathan. Before I begin, let me introduce myself. I met many of you at our Investor Day. But for those of you I have not met, I’ve been a part of the Driven leadership team for over a decade. Throughout that period, I’ve been President of Meineke, President of Take 5 Oil Change and Group President of our Maintenance segment. While Jonathan and Gary focused on strategy and capital allocation, it’s my job to ensure that the capital they have allocated realizes the returns we underwrote. I am focused on executing our operating playbook, which enables Driven, over time, to take acquired businesses and turn them into high-growth engines that deliver predictable and scalable results. Driven’s operating playbook has been developed over the past 10 years.

We’ve implemented it across all of our businesses, both company and franchise. The playbook has several chapters, all of which are important and build upon one another. Those chapters include culture, people, brand positioning, process and continual improvement. We are repeating the very same playbook that has been successful at our most mature growth business Take 5 Oil Change with both our Take 5 Car Wash and Auto Glass Now. With that background, let me discuss Driven’s three primary growth levers: Take 5 Oil Change, Take 5 Car Wash and Auto Glass Now. This quarter Take 5 Oil Change, both company and franchise locations, continued to drive customer acquisition and delivered strong same-store sales of 14%. We continue to outpace the competition as our differentiated 10-minute stainer car old change model builds brand recognition with top quartile NPS scores and increasing repeat rates.

Further, we grew our footprint over 23% year-over-year and our franchise pipeline remains robust at more than 750 units. We expect asset-light franchise store growth to drive our footprint growth moving forward. Our franchisees remain excited about the performance of their stores and of course, the returns they’re generating. I’m also excited that in Q4 we will be celebrating our 1,000 store openings and we just recently opened our 300th franchise locations. Let’s now switch over to our Car Wash business. We are experiencing softer retail volumes in the US Car Wash segment, driven by a challenging macro environment for our most discretionary business and continued competitive intrusion. However, our International Car Wash business continues to perform well despite challenging conditions in Europe.

As Jonathan mentioned, I have been leaning into operational opportunities in the US Car Wash business. The following are some of the actions that we have taken. First, I’ve made a series of leadership changes, including changes in marketing, operations and a change in President. I have also made changes to how our teams are structured, their priorities and our management processes against those priorities. Our immediate priorities are two-folds: to be the best at the basics and to improve margins. Regarding being the best of the basics, we’re focused on a handful of operational KPIs and processes that ensure we’re open and operating, we’re reducing downtime due to equipment failure, we’re winning on must-win days and we’re delivering our fast friendly and convenient promise in order to delight our customers.

Regarding improving margins, we have implemented a data-driven approach to identify opportunities for better operational and financial performance. For example we are taking a more disciplined approach to our promotional strategy to ensure we are reducing discounting, while focusing our marketing efforts on attracting long-term customers. We are also implementing an improved pricing strategy that we will begin rolling out in Q4, enabling us to better capture the value that are different levels of offer. Finally, from an operational perspective, we are taking a close look at costs particularly variable costs and identifying outliers and implementing operational guardrails to help obtain proper variable margins. These actions along with the closing of 29 unprofitable locations gives me confidence that we can improve the business over the next several quarters.

As I mentioned at the Investor Day, we are also excited to roll out Take 5 Rewards our new loyalty program that will initially focus on Take 5 Oil Change and Car Wash. We will be testing this new program in Q4 of this year. Our new platform will offer a Take 5 Oil Change subscription and a combo subscription across both Take 5 Oil Change and Car Wash. Our subscriptions will also be coupled with a loyalty program designed to drive frequency across both businesses. Lastly, let’s cover our US Glass business an important component of our longer-term growth. As Jonathan mentioned on the last earnings call and at our Investor Day, we have encountered a series of challenges integrating the 12 businesses we acquired that ultimately make up the Glass business.

These integration challenges have resulted in underperformance of our US Glass business in 2023. We also said that it will take several quarters to get through these challenges. We are continuing to make progress and our goal is to exit Q1 of 2024 with these integration challenges largely in the rearview mirror. Some of the progress we’ve made with the integration include; we completed the rollout of our new point-of-sale system; we completed the rollout of our new centralized call center; we are in the process of centralizing all product purchasing and plan on being fully rolled out by Q1 of 2024; more than 95% of our locations have calibration capabilities; and all employees are now on one payroll and benefits platform. We have also made the decision to slow down new unit growth in Q4 and in 2024 to make sure that the base business is performing at the levels we expect.

We remain extremely bullish on our US Glass business and look forward to a strong 2024 as we put up mountains of integration work behind us. As I mentioned at Investor Day, Car Wash and Glass have many similarities to our Take 5 Oil Change business, and as such, should be performing similarly. I am confident in the driven playbook as we have successfully proven it with our Take 5 Oil Change business. It will not happen overnight but the vision is clear, our priorities have been cemented, and we have the team in place to execute. In my newly created role as COO, I look forward to taking the success of our Take 5 Oil Change business and methodically spreading those best practices and those results throughout Driven. And with that, I will now turn it over to my partner Gary.

Gary Ferrera: Thanks Danny and welcome everyone. Today I will share with you our third quarter financial performance and outlook for the remainder of the year, as well as how our focus on cash flow, disciplined growth, and strategic capital allocation is shaping our future. On a consolidated basis, we had another strong quarter of topline growth versus Q3 2022. Our system-wide sales reached $1.6 billion representing a 10% increase from the prior year period. This growth was driven by a 6% increase in same-store sales and a 6% net store growth. This translated into reported revenue for the quarter of $581 million, an increase of over 12%. This growth was primarily led by our Maintenance segment, followed by our Paint, Collision and Glass segment.

Adjusted EBITDA was $127 million or 22% of revenue versus $129 million or 25% of revenue in the same quarter last year. This margin decline and the resulting slight decline in adjusted EBITDA is directly attributable to the Car Wash and TC&G segment with approximately $7 million of the impact on Car Wash being driven by increased rent expense from sale leasebacks. Both the Maintenance and Platform Services segment experienced significant growth in adjusted EBITDA as well as margin expansion in the quarter versus the prior year. I’ll now focus on our performance by segment. We are pleased with the positive same-store sales growth of 90% in Maintenance, our largest segment. Revenue from this segment grew an impressive 22% over the prior year period.

This was primarily driven by our Take 5 Oil Change business, which continues to perform strongly across both our franchise and company-owned locations. As we’ve mentioned before, industry tailwinds including an aging car park and increased vehicle complexity drive average tech and a flight to trusted brands. Take 5 Oil Change continues to benefit from these trends as we saw another quarter of positive car count trends. Maintenance segment adjusted EBITDA margin increased by over 110 basis points versus Q3 2022, due to flow-through from strong top line performance as well as a continued focus on operational efficiency. This drove an increase in segment adjusted EBITDA of over 25% for almost $18 million versus Q3 2022. In our Car Wash segment, we experienced a same-store sales decline of 4% versus the prior year period.

This decline was entirely driven by our US Car Wash operation. Total segment revenue including the international business increased 2%. The Car Wash segment adjusted EBITDA margin decreased to 17% in the quarter versus 28% in Q3 2022 resulting in a decline in adjusted EBITDA of approximately $15 million. The US portion of the business experienced higher costs, primarily due to the fixed costs associated with ramping locations, including the 57 new stores opened during the last 12 months, while experiencing soft retail demand and increased competition. As I mentioned earlier, approximately $7 million of these fixed costs can be attributed to increased rent expense from sale-leaseback activity versus Q3 2022. We are making significant operational improvements and closing underperforming stores to improve the financial performance of our US Car Wash business.

In our Paint, Collision & Glass segment we achieved positive same-store sales growth of 9% and segment revenue growth of 14%. However, segment adjusted EBITDA margin decreased to 25% from 34% in Q3 2022, resulting in a $6 million decline in adjusted EBITDA. The US Glass business drove this decrease as Paint and Collision delivered increases over the prior year quarter. As Danny mentioned previously, he and his team are working through the integration issues related to the 12 US Glass acquisition. In our Platform Services segment, revenue increased 8% over the prior year period. 1-800-Radiator saw sequential improvement from negative 11% in Q2 to down less than 5% in Q3. As a reminder, 1-800-Radiator comprises only about 25% of the revenue for the segment.

Platform Services adjusted EBITDA margin increased to 40% from 38% in the prior year period, resulting in segment adjusted EBITDA of $22 million. Now I will focus on some key components below adjusted EBITDA. Depreciation and amortization expense totaled $46 million in the quarter, reflecting a $9 million increase from the prior year, mainly due to an increase in company-operated store count. Additionally, interest expense reached $41 million, a $14 million increase from Q3 2022, primarily due to an increase in total debt levels driven by our securitization issuance in Q4 2022, as well as by higher interest on our term loan and revolver, which are our only outstanding debt tranches with variable rates. Net loss for the third quarter was $799 million versus net income of $38 million in Q3 2022 due to the non-cash goodwill and asset impairments in our US Car Wash business of approximately $960 million.

During the quarter ended September 30, 2023, we conducted an in-depth review of our US Car Wash operations. This review focused on assessing underperforming stores in their local competitive environment, understanding new store growth patterns and identifying opportunities for potential revenue and expense optimization. As a result of this analysis, we decided to close 29 stores. These closures began in Q4. We’ve also put a pause on opening new stores and have initiated the process of selling assets we won’t be utilizing. Due to these actions and in the course of our review of our results during the quarter, we decided to recognize non-cash impairment charges totaling $111 million associated with property, equipment and right-of-use assets.

In light of these factors and using current higher interest rates in our discounted cash flow analysis, we determined that the carrying value of our US Car Wash reporting unit within the Car Wash segment surpassed its current market value. Consequently, we registered a non-cash goodwill impairment charge of $851 million. Adjusted net income was $34 million for the quarter resulting in adjusted diluted EPS for the quarter of $0.20 versus $0.32 in the prior year period. Cash flow from operating activities for the nine months was $212 million, an increase of 26% from $168 million from the prior year period. At the end of the third quarter, we had $387 million in liquidity comprising $211 million in cash and cash equivalents along with $176 million of undrawn capacity on our variable funding securitization senior notes and our revolving credit facility.

Our liquidity does not account for the additional $135 million of variable funding notes, which could be utilized at the company’s discretion if specific conditions continue to be met. This liquidity along with our ability to continuously generate strong cash flows from operations provides us flexibility in executing our long-term growth plan. As you may recall in August, we announced a $50 million share repurchase authorization recognizing the opportunity to purchase shares at what we view as an advantageous level. We completed the repurchases and retired 3.6 million shares during the quarter. This impacted our net leverage ratio for the quarter by just under 0.1 times and it is now 4.8 times for the quarter versus 4.7 times in Q3 2022. As we stated in our recent Investor Day, we are extremely focused on generating excess cash flow and deleveraging in 2024.

As a reminder, our debt structure is over 75% fixed with that portion of the debt at an interest rate of approximately 4.3%. The remainder is made up of term loan and revolving credit facility with a total blended interest rate of approximately 5.2%. I will now turn to our fiscal 2023 full year financial outlook. We are reaffirming the outlook that we provided on our second quarter earnings call of revenue of approximately $2.3 billion, adjusted EBITDA of approximately $535 million and adjusted EPS of approximately $0.92. We also continue to expect same-store sales growth of 5% to 7%. This guidance reflects continued strength in our Maintenance, Paint and Collision businesses partially offset by weakness in our US Car Wash and US Glass businesses.

As we discussed during our Investor Day, we are very focused on disciplined growth and driving cash flow. Therefore, we made the decision to slow new unit growth from what was provided earlier in the year. We are now expecting 2023 new unit growth to approximate 250 units versus our original outlook of 365 units primarily driven by fewer new units in our US Car Wash and US Glass businesses. I wanted to wrap-up with a couple of accounting-related matters. First in Q4, we converted certain pre-IPO equity the time-based vesting from vesting that was based on the achievement of certain sponsor returns after the sponsor owned less than 50% of our outstanding stock. This conversion results in a non-cash stock compensation expense charge of approximately $43 million, which we will recognize ratably over the 18th month vesting period including approximately $5 million in Q4 2023.

Second, related to our review of the US Car Wash business we transferred assets on our balance sheet amounting to $271 million from property and equipment to assets earmarked for sale. In closing, I just wanted to take a moment to thank all the teams across the organization for being laser-focused on driving operational efficiencies during the quarter so that we can deliver on our commitments for the remainder of the year and set ourselves up for a strong 2024. Thank you all for your time this morning. That concludes our prepared remarks. I will now turn it back over to the operator for Q&A.

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Peter Benedict from Baird. Please go ahead.

See also 15 Best ARK Stocks To Buy Now and 16 Billionaires Who Live Like Regular People.

Q&A Session

Peter Benedict: Hey, guys. Good morning. Thanks for taking the question. First one just around the Car Wash business you talked about a new pricing structure Dan I think you mentioned that. Can you maybe expand on that maybe a number of number of tiers you’re thinking about? Any clarity there? And related to that, the new leadership in US Car Wash is that internally sourced folks? Anybody from the outside? Just curious kind of your views on how it’s different to operating waste an oil change business. That’s my first question.

Danny Rivera: Hey, Peter thank you for the question. Appreciate that. So yes related to the first question around pricing look, ultimately the team, and I are super focused on operations and improving margins. Part of both of those is a focus on pricing. And our changes we think will lead to improve margins as we capture kind of more value from across all of our packages and our wash packages vis-à-vis our consumers. As far as leadership changes – operationally, our leadership changes we did bring it over an individual from our Quick Lube business who is a seller operator for us there and brought them over to our carwash business. Ultimately, the two businesses are different but ultimately they’re also retail businesses. And when it comes to people and leadership and operations there’s certainly a lot of — we believe there’s a lot of similarities and we think that that individual is going to be very helpful to us in our Car Wash business.

Peter Benedict: Okay. Thank you. And then maybe Gary just on the Car Wash and PC&G segment margins, obviously down a lot in 3Q. How should we think about in the fourth quarter? I mean, is 3Q the bottom in terms of those segment margins should you get some improvement at least sequentially there? And then just on the car wash openings for next year, I mean, I think you were saying maybe 20 — is that now zero just so we level set for next year on the new car wash units. Thank you.

Gary Ferrera: Yeah. Let me answer the first part of the question is I’ve already forgotten because I’m over 60, but the margins when you go into the next quarter obviously never say bottom right because it inks with us. But the plan is as you can see from the numbers, we’ve put out if we hit our guidance means you’d have a slight margin improvement in Q4. And so how that’s going to mix between the segments, obviously, we don’t guide to that. But Danny is doing a lot of work with his team to try to get margins short up there. So I think, it will more translate into where we come out on the top line. Jonathan?

Jonathan Fitzpatrick: Yeah, Pete, Jonathan here on the openings. Yeah, we’re sort of actively working through what locations in our pipeline we can exit or sell I think the 20% number that we gave at the Investor Day will likely be lower sort of a work in progress here, but we’ll update throughout the year, but definitely lower than the 20% we gave.

Peter Benedict: Understood. Thanks, guys. Good luck.

Jonathan Fitzpatrick: Thank you.

Operator: Your next question comes from the line of Seth Sigman from Barclays. Please go ahead.

Seth Sigman: Great. Good morning, everyone. I wanted to focus on the maintenance business. I think you gave us the quick loop the 14% comp is very strong. What’s happening in the rest of the maintenance business? I know, there have been some mixed messages out there across the industry. But it does seem like you’re outperforming pretty nicely here. So, just any more perspective on the rest of maintenance, and what you’re seeing from a consumer perspective? And then I have one follow-up. Thank you.

Jonathan Fitzpatrick: Hey, Seth, it’s Jonathan. Yeah, look Take 5 Oil Change represents over 90% of our maintenance segment. The balance is our Minonk business which is a pure franchise business and continues to perform very steady and we’re not seeing any sort of major trend changes in that mining key business. But again Take 5 Oil Change is more than 90% of that segment. So that’s the key driver in it.

Seth Sigman: Perfect. And then just from a margin perspective, both quarter-over-quarter and year-over-year nice improvement here. And in fact the last couple of quarters, you’ve seen a big step-up in the profitability of the maintenance segment. Can you just talk about the drivers there and maybe some perspective on whether that’s starting to reach a ceiling? Or do you feel like there’s still more room to go? Thanks..

Jonathan Fitzpatrick: Yes, Seth look like we talked about at the Investor Day, this Take 5 Oil Change business is one of the greatest multiunit businesses that I’ve ever been involved with. We’ve got significant same-store sales growth, positive traffic. We’ve also got natural ARO or check growth in that business. The team has executed phenomenally well, with our attachment rate of our big four items. Our NPS scores are still in the high 70s which is top two and likelihood to refer. And then obviously, we’ve got a significant amount of new stores that are ramping, contributing to same-store sales growth obviously when they hit sort of month 13. So, we’re incredibly proud of the team that Mo and the team and all the efforts that are doing there. So, we expect to see continued growth in that maintenance segment specifically with Take 5 Oil Change.

Seth Sigman: Thanks for that. And congrats on the progress.

Jonathan Fitzpatrick: Thanks, Seth.

Operator: Your next question comes from the line of Simeon Gutman from Morgan Stanley. Please go ahead.

Simeon Gutman: Hey, good morning, everyone. I wanted to focus on Car Wash for a minute. So margins are a bit lower where we are today obviously, versus prior. Can you talk about your confidence in the time frame in which margins stabilize. And it feels like, it’s a little bit beyond even sales deleverage. I think we have 10 to 15 points of lower margins. So, how do you separate that out between weaker sales, higher rent or other miscellaneous things and within the margin.

Jonathan Fitzpatrick: Good morning, Simeon. Look, I think nothing has dramatically changed from what we talked about at Investor Day. We do have headwinds in the US Car Wash business, in terms of macro consumer demand along with the competitive intrusion that we’ve spoken about before. We’ve also seen incremental margin pressure from the approximately $7-plus million of sale and leaseback expense that’s on the business this year. We’ve also got 57 stores that are less than one year old, which are ramping and therefore, they tend to be sort of margin dilutive as they get to their ramp cycle. Danny has been really focused on sort of that middle part of the P&L to make sure that we’re managing margins, on a go-forward basis. So, I think we are really working hard on the things that we can control and we’re optimistic that we’ll see margin improvement, over the next several quarters in that car wash business again, on the things that we can control.