Driven Brands Holdings Inc. Q1 FY2021 Earnings Call

Good morning, and welcome to the Driven Brands First Quarter 2021 Earnings Conference Call. My name is Tamia, and I will be your operator today. As a reminder, this call is being recorded. Joining the call this morning are Jonathan Fitzpatrick, President and Chief Executive Officer; Tiffany Mason, Executive Vice President and Chief Financial Officer; and Rachel Webb, Vice President of Investor Relations. During today's call, management will refer to certain non-GAAP financial measures. You can find the reconciliation to the most directly comparable GAAP financial measures on the company's Investor Relations website in its filings with the Securities and Exchange Commission.

Thank you, Tamia, and good morning, everyone. We had a great quarter across the board and are excited to share the results. Before we jump in, let me explain the power of Driven Brands. Driven Brands is the largest automotive services company in North America. Our four operating segments provide diversification to our business model, diversity across our brands, geographies, and needs-based service categories. We have scale in an industry where scale matters. And we combine this scale with sophistication, which allows us to leverage our massively growing data capabilities to drive more cars to our shops through more effective marketing, to identify the best possible real estate, and to drive cost efficiencies through purchasing. That creates profitable growth for us and our franchisees, generating better returns than most independents could achieve on their own. Our industry is massive and extremely fragmented. It's roughly $300 billion and growing. And we're the biggest in our space today despite having less than 5% market share. Now we have consistently taken share in this industry for the past decade, and we will continue to do this for the next decade. We have many levers to grow organically. And because of our asset-light business model, we generate a significant amount of cash flow. Put all this together, we grow same-store sales and units and we generate substantial cash. Over the long term, Driven will consistently deliver double-digit revenue growth and double-digit adjusted EBITDA growth. And this is before we layer on acquisitions, which we see as incremental upside to our model. This is the power of Driven Brands.

Thanks, Jonathan, and good morning, everyone. We delivered strong first quarter results, thanks to the hard work of the entire Driven Brands team. Their efforts allowed us to capitalize on some important industry tailwinds. Our consumers have more money in their pockets. Vaccine distribution is accelerating. Consumer sentiment is picking up, and vehicle miles traveled are beginning to increase. And that is all good news for Driven. We took important steps in 2020 to position ourselves to capture market share in 2021, and we are off to a great start. System-wide sales were a record $1 billion in the first quarter, from which we generated revenue of $329 million, an increase of 83% versus the prior year. Adjusted EBITDA was $78 million, more than double that of the prior year. And as a percentage of revenue, the adjusted EBITDA margin was nearly 24%. And finally, adjusted EPS was $0.19 for the first quarter, exceeding our expectations, as a result of strong sales volumes, which allowed us to leverage our expense base, driving significant flow-through. This is the power of the Driven Brands platform: a scaled, growing, highly franchised business with a diverse need-based service offering that delivers very attractive margins. Now let me break things down a bit more. System-wide sales growth in the quarter was primarily driven by the addition of new stores from acquisitions as well as new franchise and company-operated stores. We have tremendous white space to continue growing our store count in this roughly $300 billion highly fragmented industry. Our franchise, company greenfield, and M&A pipelines are all robust, and we are aggressively growing our footprint. Since Q1 last year, we've added 1,157 net new stores. In the first quarter of this year alone, we added 22. Same-store sales were positive 0.5% for the quarter despite the fact that vehicle miles traveled were still down roughly 10%. Our Q1 same-store sales improved 390 basis points sequentially from Q4 and on a 2-year stacked basis were nearly 3%, trending back toward our historical average.

Your first question comes from the line of Simeon Gutman with Morgan Stanley.

This is Michael Kessler standing in for Simeon. First, I wanted to ask about the trends throughout Q1. There was clearly an increase when you look at sales per store, comparable sales, and same-store sales. Could you discuss how that developed throughout Q1 and break down the factors you mentioned, such as stimulus, the reopening, recovery in miles driven, consumer confidence, and your own market share gains? It would be helpful to understand how these aspects interacted and how you observed them throughout the quarter.

Michael, thanks for the question. It's Tiffany. So I'll give you a qualitative overview. We're not going to provide monthly comps here, but we'd be happy to talk about it qualitatively. January was solid. We had strong growth in Maintenance and in Platform Services. Those comps were positive, certainly supported by stimulus and pent-up demand from Q4. Obviously, in Q4, we were dealing with the second wave of COVID. We saw some folks sit on the sidelines as it related to deferred maintenance on their vehicles. These folks returned with some extra money in their pockets in Q1. And so those categories or segments of our business certainly benefited. February was the low point. And then in March, we had double-digit positive same-store sales overall as vaccine distribution picked up, as consumer sentiment was improving, and vehicle miles traveled was increasing. If you were to normalize our monthly comps on a 2-year basis, it looks just like you'd expect. January is positive. February is just slightly negative, and March is positive and certainly the strongest month of the quarter. And that follows pretty well with VMT when you compare VMT month-by-month in 2021 versus 2020. And so I think those are really good signs. And certainly, that momentum that we saw in March, as Jonathan said in his prepared remarks, continued into April.

That's very helpful. I have a quick follow-up regarding your expectations for the remainder of the year. Have you incorporated the improving trends into the raised guidance? Is there a change in your expectations for the rest of the year? Are we just building on the Q1 performance compared to your prior expectations? Also, should we take it to mean that since April has been strong, there has been further acceleration compared to March, or is it more consistent now with the reopening?

Yes. Michael, thanks for the question. So I want to be really clear here. We have rolled the beat from Q1 into our guidance, and we have held our expectations for the balance of the year. I think it's really important early in this reopening to not get ahead of ourselves. What I would say is one quarter doesn't make a trend. I think there's a lot of volatility potential in Q2. As you know, Q2 is the low point or the peak of the pandemic a year ago. We have strong momentum in April, but I think we need to see Q2 play out before we feel good about giving you a new full-year outlook for 2021. So we've rolled in the beat. We're bullish on 2021 overall. We think things are trending in the right direction. And we want to stay focused, deliberate, and resolute as we finish out the second quarter.

Your next question comes from the line of Liz Suzuki with Bank of America.

Just can you provide any details on regional differences in segment performance? So in areas that opened up earlier, are segments that are more sensitive to miles driven seeing a greater recovery?

Liz, it's Jonathan. I'll take that, and Tiffany can obviously come in if she wants to. Look, it's pretty obvious, right? I mean places in the South, Texas, Florida, the Carolinas, people were driving more than places in the Northeast, right, and the West, to some extent. So we're definitely seeing a correlation in terms of those markets doing better than some of the northern markets, I would say. And I would include Canada in the northern markets. But we think that, obviously, as things are starting to open up now, and the CDC just released some positive guidelines yesterday, I think we'll see more and more driving throughout all of our geographies. But definitely, we saw some increased movement in our broadly southern markets.

Great. And just a follow-up on that. Please continue.

Sorry, Liz. I didn't jump in there fast enough. I think the only thing I was going to add is, just keep in mind, our services are essential, right? So in most cases, anytime you see a shutdown or a temporary restriction of some sort, it’s going to cause a delay on occasion, but it's not going to be a lost occasion. So that’s the only thing I'd add to the commentary there.

I'm curious if interest from franchisees aligns with those regional trends. In areas that have reopened quickly, are you noticing increased interest from potential franchisees looking to start new businesses?

Interest is pretty widespread, Liz. I mean you see the pipeline numbers that I talk about. It's the biggest it's ever been in the 9 years that I've been at Driven Brands. So we're seeing interest from far and wide because I think people understand the resiliency of our business models, that we perform well in all cycles. There's money to be made and massive fragmentation in the industry. So we're not seeing a correlation to franchise interest in only those states that are opening up but in all places.

Your next question comes from the line of Chris Horvers with JPMorgan.

So you talked about a number of positive factors, but you also had a couple of headwinds during the quarter in terms of the weather in Texas, in that region, in February. And then you talked about Canada. Is there a way to sort of diagnose how much of a headwind that might be in terms of like, I don't know, regional sort of store exposure or percentage of sales? And then did you talk about the overall 2-year comp trend in March in terms of how that was relative to the overall quarter?

Go ahead, Tiffany.

I apologize, Jonathan. I was going to mention that we indeed experienced quite severe weather in Texas and the Gulf Coast states during mid to late February, which is evident in our monthly comparisons. This is part of why I noted that February's performance was the weakest of the three months. Texas makes up about 14% of our operational area, and for context, Canada represents about 20% for our PC&G segment. The lockdowns in Canada are definitely impacting us as well. However, the strength of the Driven Brands platform lies in its diversification. We operate in Canada, serve almost every region in the U.S., and with our Car Wash business, we now have an international presence. This diversification is beneficial in various aspects, both geographically and operationally.

And then in terms of the 2-year trend in March relative to the overall quarter?

So the 2-year performance was the strongest on both a 1-year and a 2-year basis.

Got it. The other question is more specific about modeling. Can you clarify the Corporate/Other line? Your revenues and compensation exceeded expectations. This line item was also higher from a dollar perspective, but the overall flow-through was impressive. What factors drive that line item? Was there any incentive compensation accrual that contributed to it, or is it related to the variable costs compared to revenues?

Yes. Chris, the only thing that's in Corporate/Other would be shared services, so corporate office expenses. And then advertising flows through that line as well. So we can follow up in calls this afternoon and kind of work through the details there, but there's nothing out of the ordinary.

Your next question comes from the line of Peter Benedict with Baird.

First question, we noticed the 62 PC&G stores that were reclassified over to Maintenance in the quarter. Can you just give us a sense for what was behind that adjustment?

Sure. Peter, yes, I'd be happy to. So those 62 stores are for a brand called Drive N Style. That is a brand that's actually managed by Daniel Rivera, who runs our Maintenance segment. And so we reclassified those stores to align with all of the other brands that he manages in the Maintenance portfolio. Drive N Style, in terms of financial results, is pretty insignificant. So it really doesn't move the needle in terms of financial performance. Put it at 62 stores in terms of unit count that moves from PC&G to Maintenance as of the 1st of the year, immaterial to the segment as a whole. Yes, of course.

I understand. I have another question. Considering the various factors at play, will EBITDA in the second quarter be larger than in the first quarter? Is there any seasonal influence to consider? I'm curious about your thoughts on stimulus as well. While I realize you aren't providing specific guidance, it seems likely that the growth trend will continue. I just want to ensure we're not overlooking anything, such as factors in Canada or other considerations for the second quarter.

Yes. Peter, I think you're thinking about it the right way. This business is roughly 60% fixed, 40% variable. So the beauty of this business is as we get the flywheel working, right, so as you get the volume running through the top line, we get phenomenal fixed cost leverage, and therefore, flow-through in the business. So again, we've rolled in the beat from Q1 into the outlook or into the guidance for the full year, and we've held Q2 through Q4 steady. To the extent we see continued improvement in consumer sentiment from vaccines and which causes vehicle miles traveled to continue to improve and the business outperforms our current expectation, then I would agree you'll start to see just even better flow-through on the business.

Your next question comes from the line of Sharon Zackfia with William Blair.

I have a question on the Maintenance segment, where the margins have been kind of in that 30% range for most of the last year. And I think during due diligence, we talked about ongoing margins in the mid-20% range. Has something changed there? I mean is the business just more profitable at this point? And should we be thinking about kind of 30% as the new normal?

So Sharon, the Maintenance segment consists of two key brands. One is Take 5, which operates in the Quick Lube sector, and the other is Meineke, a fully franchised total car care brand that has been in existence since the mid-'70s. Take 5 is newer and serves as a significant growth opportunity for us, featuring a combination of company-owned and franchised locations. Both brands are experiencing strong growth, and in fact, we expect the franchised units to surpass the growth of company-owned units this year. This segment boasts impressive margins, around the mid-30% range. As this business continues to thrive and expand its store count, it positively influences the overall margin profile of the Maintenance segment. So, that's the key takeaway to consider about this segment.

Yes, I would add that Daniel Rivera and the team did an excellent job in 2020 by reevaluating the operational efficiency of the Take 5 business. This business is extremely labor-efficient, and we have enhanced that efficiency further, especially in response to the decreased demand in March 2020, by aligning our labor accordingly. We've maintained that labor consistency while increasing the number of cars processed. The business operates on a highly efficient labor model, and I believe this, coupled with the growth in the franchise, is driving the noticeable shift in the margin profile of that segment.

Your next question comes from the line of Kate McShane with Goldman Sachs.

This is somewhat open-ended question. But do miles driven have to be positive for the collision business to comp positively? Or can you get to a spot where miles driven still down from the year before, but with the combination of market share gains, we could still see a positive comp?

You nailed it, Kate. Miles driven are still somewhat depressed, especially in Canada compared to the U.S., but they are recovering well in Canada. Our strategy over the next five years is that, regardless of what happens with miles driven, we will continue to capture market share in this industry. In 2020, we experienced a significant turning point where insurance carriers and our partners recognized the advantages of working with fewer, larger providers after we managed hundreds of millions of dollars in car repairs for them. Therefore, as we look ahead over the next five years, our focus is not primarily on miles driven, but on increasing our market share. While we certainly hope for a recovery in miles driven and anticipate that it will happen, our main emphasis remains on growing our share in the industry. We feel very optimistic about that.

Okay. My second question is about the platform. In your prepared comments, you mentioned that you have inventory available compared to some of your competitors. How do you anticipate this will evolve for the rest of 2021? Will this continue to be a disadvantage for you relative to your competitors?

Yes, a significant portion of our Platform Services business consists of our 1-800 business, which operates as a unique franchise distribution model focusing on select product lines. The team at 1-800, led by Kyle Marshall, has done an outstanding job managing our supply chain and maintaining in-stock inventory levels, ensuring our franchisees have the necessary products to sell. We are confident about the future of that segment due to our established capabilities in supply chain and inventory management. Additionally, we believe we possess strengths in this area that many of our competitors lack.

Your next question comes from the line of Karen Short with Barclays.

Just a couple of questions. I wanted to just clarify with respect to the comp in terms of April. You're talking about the comp in April being in line with March, correct, not in line with the quarter?

I don't think we actually gave, Karen, specific guidance for April comp. I think what we said is that we're very pleased with how April is performing so far.

Okay. And then I was wondering if you could maybe give a little bit more color on the repeat rates that you talked about with respect to the retail and commercial customers. You talked about how that had been improving. I just was wondering if you could give a little bit more directional color on that, where it is today versus where it's been in the past.

Sure. I'll use Take 5 as an example. We have focused on increasing awareness and encouraging trial in our business. When customers visit our stores, they experience an impressive 10-minute stay-in-your-car oil change. We achieve very high Net Promoter Scores, which means when customers visit us for the first time, they are likely to return. As we promote trial and awareness in 2020, these customers come back since they need two or more oil changes each year. This is how we enhance our repeat rates through effective marketing and excellent operational execution. Regarding our commercial customers, we have a dedicated team that aims to provide outstanding service to our insurance partners. When the insurance partners recognize the capabilities of our franchisees, they provide us with more business. This merit-based system helps us gain market share and improve repeat rates with both commercial and retail customers.

Right. But any way to just give some progress in terms of what repeat rates may be today versus where they've been in the past?

I think they're accelerating, I think, within the Take 5 business. And we typically don't want to give business-level metrics, Karen. But I will tell you that within the Take 5 business, we've seen sort of 500 basis points of improvement in repeat rates. And we've seen, obviously, when you look at our Paint, Collision & Glass business, when we look at our same-store sales performance versus the industry metrics, you can see that we're sort of 500 basis points better than the industry. So there would be some data points that I'd point you to.

Our last question comes from the line of Peter Keith with Piper Sandler.

I wanted to ask you, Jonathan, about your advertising spend. So it's clear there seems to be some sequential improvement happening in the business. Can you now, I guess, press the gas pedal on your advertising spend? Do you have cash that you feel like you can allocate to that? And secondly, just now that you've integrated Car Wash, has there been some type of unlock in terms of the cross-marketing opportunities across the different segments?

Yes. Great questions, Peter. The answer on advertising spend is, thankfully, we're not like Henry Ford, who used to say, "50% of my marketing works, I just don't know which 50%." So we have a data-driven marketing team, and we're able to very quickly test and learn and quantify which programs work and which promotions work. So as we find things that work, we lean into those more heavily. And when we think about advertising investment, we think of it like any other investment at Driven Brands: we look at return on investment. So if there's an opportunity to lean in more heavily to an investment because we know it works, we will do so and have been doing so. So that's sort of question number one. Question number two, in terms of the Car Wash unlock. Look, it's a phenomenal business. We bought a really terrific business in August. We integrated it very quickly, specifically on the U.S. business. Gabe Mendoza and the team there are just doing wonderful things in terms of focusing on the key levers of that business. So the key levers are: how do we further improve Wash Club membership rates, and Tiffany has talked about the benefit of recurring revenue streams; how do we maximize revenue per wash, and we're doing that through great merchandising and great selling techniques. So we've owned this business for 7 months, and I will tell you that I couldn't be more pleased with the team and the progress that we've made over the first 7 months. And I think there's just tremendous opportunity for us as we look ahead.

Okay. That's great. Maybe a quick follow-up on Car Wash then, and maybe it's a bit nitpicky. But you showed last quarter really strong improvement in the subscriber base as a percent of revenue from 41% to 45%. Now it sounds like Q1, you're still trending at 45%. I was wondering if you can comment on that. Maybe it's just a function of nonsubscription revenue has really bounced back strongly. But any color there would be appreciated.

Yes. It's kind of a champagne problem, Peter, in that we have continued to add incremental Wash Club subscriptions, but we've increased revenue per wash for non-Wash Club subscriptions at a faster rate. So we're growing both. And we don't back off from our long-term view around sort of 60% Wash Club subscriptions over time. But we're just growing Wash Club and non-Wash Club revenue per wash at a faster rate in this quarter.

So we did add 50,000 Wash Club members, Peter, in the quarter, which is still phenomenal. Yes, agree.

Thanks, Tamia. And I think that wraps up our earnings call for Q1. We look forward to talking to many of you over the next coming days and when we announce Q2 earnings. Thank you, all.

Thank you. This concludes today's conference call. You may now disconnect.