Earnings Call Transcript - MCW Q2 2022

Operator, Operator

Good afternoon and welcome to Mister Car Wash’s Conference Call to discuss Financial Results for the Second Quarter of Fiscal 2022. Please note, this call is being recorded and a reproduction of this call in whole or in part is not permitted without written authorization from the company. I would now like to turn the conference over to Ms. Megan Everett, Senior Director of Communications. Please go ahead, ma’am.

Megan Everett, Senior Director of Communications

Thank you. Good afternoon everyone and thank you for joining us today for Mister Car Wash’s Q2 2022 earnings call. Speaking today are Chairperson and Chief Executive Officer, John Lai; and Chief Financial Officer, Jed Gold. After John and Jed have made their formal remarks, we will open the call to questions. Before we begin, I do need to remind everyone that comments made today may include forward-looking statements, which are subject to significant risks and uncertainties that could cause the company’s actual results to differ materially from management’s current expectations. These statements speak as of today and except as may be required by law. The company does not have any obligation to update or revise such statements as circumstances change. During this call today, management will also refer to certain non-GAAP financial measures. A reconciliation between the GAAP and non-GAAP financial measures can be found in the company’s earnings press release issued earlier today and posted to the Investor Relations section of Mister Car Wash’s website.

John Lai, CEO

Thanks, Megan and good afternoon everyone and welcome to our Q2 earnings call. Coming into the quarter, there were some concerns around inflation and whether or not people might start pulling back and getting into the car wash, particularly with gas prices soaring above $5 a gallon, and of course, the huge comp we were going up against. What we experienced was that demand remains solid. However, there was a little bit of softness on the retail side of our business, but that was offset by the strength of our Unlimited Wash Club program, which is 65% of our revenues. Our members remained loyal. Since our beginning over 25 years ago, we’ve been through various economic cycles, and what we’ve seen throughout is that in good times and tough times, the American consumer deeply values keeping their car clean. At $10 a wash or $20 for a club membership, it’s affordable, convenient, and brings people joy. We feel fortunate to be in a space that is so resilient. For Q2, I am happy to report that revenues increased by 14% to $225 million. Comparable store sales increased by 2.4%, and we opened 4 new Greenfield locations and acquired 6 new stores. We added 59,000 net new members to our Unlimited Wash Club program, and year-over-year, we’re up 20%. The real headline for UWC is that we didn’t see any impact to churn, which speaks to the loyalty we’ve engendered. However, on the retail side of our business, we did see some softness, which was in line with expectations. Like almost everyone right now, we’re experiencing some inflationary pressures in labor, chemistry, and utilities. I’ll let Jed go into more details on the cost side of the business. Big picture: with sales remaining relatively steady and with some cost pressure, we are experiencing some near-term headwinds to margins. Importantly, we are not slowing down on making long-term investments in people, programs, and stores because our focus has never been about maximizing margins in the near term. We are more interested in scaling our company with a long-term view given the incredible growth opportunity in front of us. Adjusted EBITDA came in at $74.5 million, just slightly below our internal expectations. Our five strategic focus initiatives are: number one, to expand our footprint; two, to build out our teams; three, to digitally innovate and enhance our member experience; four, to develop the next generation of wash products; and five, to make a sustainable impact in the communities we serve. A brief update on some of these initiatives: while we’ve been highly acquisitive, our business has shifted to become less of a consolidation play and more of an organic growth story. The 8 stores we've opened this year are off to a great start and our greenfield program has exceeded our expectations. We plan to add more than 20 stores in the back half of this year and we are even more excited about 2023. Currently, we have over 100 greenfield projects in our pipeline that we expect to open in the next few years. We think the addressable market is still underserved in many areas, and the opportunity to densify in each market we move into is huge. On the product and services side, we are planning to expand our service offerings in early 2023 with the goal of rolling out the biggest extra service offering in the history of our company. We pioneered HotShine almost two decades ago, and it completely changed the customer experience. With this new offering, we will continue our long history of innovation. Regarding retail pricing, we plan to leverage our pricing power by implementing modest retail price increases in Q3. I’d like to remind everyone that our pricing approach has been conservative. We believe it’s better to earn the right to a price increase by delivering exceptional value. On the sustainability front, we began piloting a water reduction and efficiency program in 15 stores in Salt Lake City in early 2021. We were able to reduce freshwater usage by 30% by reengineering parts of our wash process. We plan to leverage these results and expand the water reduction program into new regions. Lastly, I was in our Florida market recently, checking in on our teams. We’ve doubled our footprint in Florida in the last six months, and the teams are knee-deep in the post-acquisition integration process. Integration is not for the faint of heart and requires time, money, and a lot of effort. I was thrilled to see the progress the team has made, and I hope to answer questions during Q&A on how we’ve transformed the culture and lifted the lives of our new team members. Florida, like many parts of the country, is experiencing intense heat. Our general managers are focusing on safety and wellness, ensuring everyone is properly hydrated, handing out electrolyte packets, and giving necessary cooling breaks. We hope everyone appreciates how difficult it is to work in these conditions and the steps we are taking to ensure everyone's safety. Jed, I'm now going to turn it over to you.

Jed Gold, CFO

Thank you, John, and good afternoon everyone. We had a solid second quarter and overall, we are pleased with the results. I would refer you to our earnings release for a fuller review of our quarterly numbers. Rather than go through every line, I thought I would focus on a few highlights and trends to help you better understand the business and what has changed since our last earnings call. First, on the demand side, overall demand for our services remained relatively consistent throughout the second quarter. While we don’t talk about individual months, all three months comped positive, and June was our strongest comparable store sales month during the quarter. The UWC subscription side remained very steady. In line with expectations, we added 59,000 UWC members in the quarter and 185,000 in the first half of the year. As John indicated, we did not see a meaningful change in our churn rates, and we did not see club members trading down from the platinum package to the base package in the second quarter. Our retail business showed some moderation in volume trends in line with our expectations during the second quarter. Fluctuations in retail volumes are common based on external factors like weather, pricing, seasonality, and macro events. We also see an impact as retail customers transition to the UWC program. Our retail business was robust in the second quarter last year, benefitting from various factors, making for a difficult comparison this year. Early in the third quarter, we haven't seen substantial changes in our churn rate or the composition of our UWC subscription business, but we have observed continued deceleration in our retail volumes likely resulting from the broader macro environment. Given many macroeconomic outlooks suggesting continued degradation during the second half of 2022, we are taking a more cautious view on UWC membership growth, comparable store sales growth, and total revenue. On the expense side, we are seeing modest inflationary pressure across many areas, alongside growth and investments in public company costs, which are putting pressure on our margins. Adjusted cost of labor and chemicals increased by 127 basis points, other store operating expenses increased by 101 basis points, and G&A expenses increased by 172 basis points. Collectively, our expenses came in a bit higher than we expected in the second quarter, and we anticipate this trend continuing in the second half of the year. The biggest increases are due to growth initiatives as we bolster our internal capabilities and vertically integrate strategically. Current areas of focus include marketing, IT, digital, real estate, construction, and training. Given these trends and macro uncertainties, we think it prudent to be cautious in our outlook for the back half of the year. Our revised full year 2022 outlook calls for comparable store sales growth of 3% to 5%, net revenues of $860 million to $880 million, and adjusted EBITDA between $268 million and $278 million. A few additional points to note: First, with rising interest rates and the termination of our interest rate hedge in October, we estimate our interest expense to be around $42 million for the year. Combined with an increase in our projected weighted average shares outstanding to $329 million, we anticipate adjusted net income per diluted share of $0.36 to $0.39 for the year. Second, we completed a sale-leaseback on July 15, generating total proceeds of $55.2 million. This transaction means we will begin incurring additional rent expenses in Q3, coupled with further leasebacks anticipated later this year, which will increase our store operating expense line in the latter half of the year, as reflected in our outlook. Third, we have lowered our capital expenditure outlook for the year to between $235 million to $285 million from the previous outlook of $285 million to $315 million. This reduction results from project completion timing and favorable maintenance CapEx. Fourth, we remain comfortable with opening approximately 30 new locations this year, having more than 300 properties in various stages of development within our greenfield pipeline. While we don’t provide quarterly guidance, let me offer high-level comments to assist your modeling. We plan to open around 23 stores in the second half, primarily later in Q4. With any new greenfield store opening, we incur pre-opening costs and associated operating expenses, requiring a few months for the store to ramp up in volume and revenue. The late Q4 timing of new builds may temporarily pressure fourth-quarter margins with higher expenses and lower productivity rates. Additionally, consider the increments in rent from the sale leasebacks conducted in July and likely later this year. We believe fourth-quarter EBITDA margins could be a couple of points below Q3. Performance from our new greenfield locations has been very strong, and opening numerous stores late this year positions us well for next year as they ramp up and we better leverage this year's growth investments. In closing, I want to thank our hardworking team members who are executing the business every day and helping us fulfill our mission of becoming America’s premier car wash.

Operator, Operator

Thank you. And the first question will come from Randy Konik with Jefferies. Please go ahead.

Randy Konik, Analyst

Hey, guys. How are you? I guess, Jed, for you, any sort of added color on the retail side of the business on how severe the deceleration has been? Any volatility or specifics you are seeing related to certain markets or income levels that we can glean from the data? My second question would be regarding modest price increases — any color on how much you are considering? I just want to understand how that might offset some weakness in retail. Thanks, guys.

Jed Gold, CFO

Yes, Randy. As we discussed in Q1, we've seen a trend of continued moderation on the retail side. We have strong comparisons from last year, and our theory is that the macro environment is putting pressure on those retail volumes this quarter. It’s common to see short-term fluctuations based on weather, macro conditions, seasonality, price increases, or UWC conversions. It's tough to pinpoint how much is truly macro-driven, but it's likely a factor along with seasonality. A percentage of our retail customers are probably washing their vehicles less frequently. However, our UWC business is very resilient. We’ve not observed a material change in UWC churn or mix shift between base and platinum. Retail in Q2 was consistent with expectations, while further deterioration in retail volume has been noted. Our updated guidance reflects these trends. To address your second question: when looking at total sales, we’re seeing growth across all income demographics; no one demographic appears more affected than others. Even our most mature locations are still comping positively, indicating strong demand for car washes across the board.

John Lai, CEO

Yes, Jed, I want to add some context to Randy’s question. We have intentionally maintained a conservative pricing strategy. We are often the last to take price in the market, and we are comfortable with that. With our recent increase in retail prices, our pricing is now in line with the market median — roughly $10 for an express car wash, still very affordable for all motorists.

Jed Gold, CFO

To quantify, about 70% of our core stores will see a price change. The express price will increase by about $1, and the interior clean will go up by about $2. We are still competitive, often remaining below competitors. Historically, modest retail price increases cause some decline in retail volumes but are offset by a modest increase in UWC membership. Even amid the current macro environment, we anticipate this price increase will have a low single-digit impact on our comparable store sales.

Randy Konik, Analyst

Lastly, can you clarify how you are thinking about the factors that lead to changes in your guidance, particularly retail trends, expenses, and UWC penetration?

Jed Gold, CFO

The high end of the guidance reflects that, in July, our metrics aligned with Q2 but showed slight moderation from June. This insight has been factored into our outlook for a 5% growth expectation, taking into account potential further deterioration.

Operator, Operator

The next question will come from Simeon Gutman with Morgan Stanley. Please go ahead.

Simeon Gutman, Analyst

Hey everyone. Jed, a quick follow-up. Are you acknowledging a sequential deceleration in retail business or indicating it is similar to the first quarter?

Jed Gold, CFO

Yes, Simeon, we won't quantify specifics around retail volumes. However, the guidance indicates a slight deterioration from current levels, reflected in the high-end estimate for the year.

John Lai, CEO

This is a tough environment for businesses to gauge the trajectory of demand. We're facing high inflation, and while we show resilience, it’s hard to confirm the exact impact on demand.

Simeon Gutman, Analyst

John, can you elaborate on the new service you plan to introduce next year, especially in relation to pricing or membership?

John Lai, CEO

I intentionally kept details about our new offering confidential, but I can say it will be revolutionary. We aim to enhance our track record of introducing effective new services that deliver real value and make cars shine. More information will be available in our next call.

Simeon Gutman, Analyst

Great, thanks for the clarity. I look forward to hearing more.

Operator, Operator

Your next question will come from Simeon Siegel with BMO Capital Markets. Please go ahead.

Simeon Siegel, Analyst

Thank you. Good afternoon to everyone. I’d like to ask about retail. You’ve mentioned several macro factors; could you share insights on competition? Considering pricing and softness in retail, how do you plan to test and react to this.

John Lai, CEO

It's not about price for us; we focus inward on delivering value. Time and again, we’ve seen that as we adjust prices, volume remains stable. We prioritize quality and customer service over purely competing on price. Sure, we will explore price adjustments, but we do so cautiously.

Simeon Siegel, Analyst

Can you discuss your cash flow and debt coverage strategies? What levers do you have if necessary?

Jed Gold, CFO

We currently operate at about 3x leverage and are comfortable with our projected interest expenses. If necessary, we could pull back on capital expenditures and growth investments, but that seems unlikely right now. We used IPO proceeds to reduce debt, which strengthens our position.

Simeon Siegel, Analyst

Great, thank you. Best of luck for the rest of the year.

John Lai, CEO

Thanks, Simeon.

Operator, Operator

The next question will come from Michael Lasser with UBS. Please go ahead.

Michael Lasser, Analyst

Thank you for taking my question. A few months ago, you mentioned some retail business softness, and now it seems to have worsened. How long do you expect this trend to last? To what extent could it worsen due to price increases?

John Lai, CEO

I wish I had a crystal ball to provide a precise answer. However, we have noted gas prices rising significantly, but they have started to trend down week over week, which if it continues could positively impact car washes.

Michael Lasser, Analyst

You've seen significant variances in operating margins. What might risk your profitability going forward, considering rising interest and high leverage?

John Lai, CEO

I want to emphasize that margin expansion has never been our primary strategy. We are focused on long-term growth rather than short-term margins. Should conditions worsen, we can tighten up our operations, but we are committed to maintaining investments that will secure our long-term growth.

Jed Gold, CFO

To clarify, last year saw extraordinarily high margins due to rising sales; current adjustments reflect a move back towards averages balanced against ongoing growth and new builds.

Michael Lasser, Analyst

Understood. Thank you very much.

Operator, Operator

The next question will come from Elizabeth Suzuki with Bank of America. Please go ahead.

Elizabeth Suzuki, Analyst

Can you talk about cost savings you may have experienced from the water reduction pilot program, and whether this could be a source of margin improvement if expanded?

John Lai, CEO

The initiative isn't primarily economically driven; it's focused on environmental responsibility. While we've made strides in recycling and reducing freshwater usage, I hesitate to disclose specific savings until we gather more data.

Elizabeth Suzuki, Analyst

Regarding acquisition opportunities in Europe, what value do you present to potential targets and what stats indicate retention or EBITDA lift after a year or two post-acquisition?

John Lai, CEO

We’ve consistently improved acquired businesses, seeing EBITDA lifts of 30% to 40% in some cases by year three. Our people-centric approach makes us an acquirer of choice for those valuing their legacy, and we are disciplined in not overpaying just to expand our footprint.

Jed Gold, CFO

Focusing on greenfield expansions offers great potential as we form new locations. Currently, we have 100 projects in our pipeline, which is quite promising in a market where we have only captured about 20% share of our operating areas.

Operator, Operator

Your next question will come from Chris O’Cull with Stifel. Please go ahead.

Chris O’Cull, Analyst

Can you clarify a comment you made about comparable sales guidance? Are you factoring in a slight retail sales deceleration from July to achieve the high end?

Jed Gold, CFO

When considering uncertainties in the macro environment, we modeled a wider range of outcomes. Achieving 3% to 4% comp in the second half aligns us toward the 5% full-year goal.

Chris O’Cull, Analyst

What developments can you share regarding your mobile app improvements?

John Lai, CEO

The app will include features to enhance engagement with nearly 2 million members. Users will have functionalities like online registration, credit card updates, and the ability to switch programs, all aimed at improving member experience.

Ryan Sundby, Analyst

John, regarding integration, should we interpret your comments to imply that the adjustment period may be extended compared to prior acquisitions?

John Lai, CEO

Every acquisition is unique, and the timeline varies. We are focused on long-term gains, rather than short-term returns, ensuring that changes yield lasting benefits.

Ryan Sundby, Analyst

Does your guidance reflect any anticipation of increased churn or trade down?

Jed Gold, CFO

We anticipate no change in churn, reflecting ongoing stability. However, we have factored in uncertainties without expecting significant decline, based on previous pandemic experiences.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. John Lai for any closing remarks. Please go ahead.

John Lai, CEO

Thank you, operator. We feel fortunate to be in the resilient car wash space, one that brings joy to many motorists. We see the opportunity to continue scaling Mister Car Wash and are focused on building the company with enduring value. I want to thank everyone for joining today, and especially our hard-working team members who do an amazing job.

Operator, Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.