Diversified Royalty Corp. (DIV) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Thank you for standing by. This is the conference operator. Welcome to the Diversified Royalty Corp. Special Announcement Conference Call regarding the company's agreement to acquire U.S.-based Stratus Building Solutions Trademarks announced earlier today. The presentation slides for this call can be found on the corporate website, www.diversifiedroyaltycorp.com. [Operator Instructions] Please keep in mind that certain information discussed on this call may be forward-looking in nature and constitute forward-looking information or financial outlook within the meaning of applicable securities laws. Such information involves but is not limited to comments with respect to the proposed transaction with Stratus and the expected implications thereof to the company. Any such information is based on management's expectations and assumptions, all of which management considered reasonable at the time they were prepared. Such information also involves known and unknown risks, uncertainties and other factors outside management's control that could cause actual results to differ materially from those expressed on this call. Participants on this call should not place undue reliance on such information, which is provided as of the date of this call. The company does not undertake any obligation to publicly update such information to reflect subsequent events or circumstances, except as required by law. All forward-looking information and financial outlook referred to on this call is expressly qualified in its entirety by this cautionary statement and the more detailed statements in the company's investor presentation dated today's date. I would now like to turn the conference over to Mr. Sean Morrison, President and CEO of the company; and Mr. Greg Gutmanis, CFO and VP of Acquisitions of the company. Please go ahead, Mr. Morrison.

Thank you for that intro. I'd just like to thank everybody for taking the time to listen to our investor presentation regarding Stratus Building Solutions. I'll be taking you guys through the presentation. We'll start on Page 5. And as we are live with an offering, we will not be able to answer any questions. So if you go to Page 5 of the presentation, DIV has been building a diversified portfolio of royalties from high-quality multi-location and franchisor businesses in Canada. Our objective has included bringing our unique loyalty model to the U.S. market. In this regard, DIV has been promoting the royalty model at various International Franchise Association events in the U.S., reaching out to various franchise professionals and franchisor business owners directly. DIV's business development efforts have paid off with Stratus, our first U.S. royalty transaction. I'd like to walk you through this. In terms of the transaction overview on Slide 6. We've entered into an agreement with SBS Franchising, LLC, called Stratus thereafter, to acquire the trademarks and certain other intellectual property used by Stratus in its business, thereby adding a 7th royalty stream and our first U.S. royalty stream to DIV's portfolio for a purchase price of approximately $80.3 million. Stratus was founded in 2006. It is an industry-leading franchisor in the commercial cleaning and building maintenance offering both master franchises and turnkey janitorial unit franchises across North America. There are 58 master franchises located in the United States, 10 located in Canada, and of those, 13 are corporate-owned and 55 are franchised. In terms of positive industry trends, the global commercial cleaning industry is large and grew at a CAGR of 5.8% from 2015 through 2022, and the importance of the office cleaning has been greatly enhanced due to COVID-19. The annual royalty will be USD 6 million, which is approximately CAD 8 million, representing 14% of DIV's pro forma adjusted revenues. The sources of capital, we will use $20.1 million of term debt in a special entity that used to acquire the trademarks for Stratus. We will borrow an incremental $15 million in limited partnership with respect to Mr. Lube, which is an underlevered asset at the moment, and we'll draw down approximately $47 million on our acquisition facility. We intend to use the net proceeds from the bought deal offering of common shares to partially repay the amount drawn on the acquisition facility. It's an accretive transaction, and there's built-in royalty growth. So we're buying the trademarks and IP for 9.9x the royalty, and the Stratus royalty will grow at 5% per year for 4 years and 4% per year thereafter. On Slide 7, we believe this is a transformative transaction and believe Stratus is an excellent royalty acquisition for the following reasons: The industry, commercial cleaning and janitorial solutions is a stable industry with room for sophisticated operators such as Stratus to accumulate market share. The importance of office cleaning has been greatly enhanced due to COVID as well. The business model, Stratus has been in business for 16-year operating history, strong store-level economics, and they are attracting talented master franchisees with very low turnover. The experienced ownership and management team, one of the owners has successfully owned and operated several franchisors. The other 2 owners were previously Stratus master franchisees with strong IT skills. They brought those skills to bear and have created an IT/CRM systems that are now a competitive strength. In terms of growth, Stratus has achieved scale and its system sales have grown steadily at double digit rates for over the past 5 years. And Stratus is ranked in 2020 as the #10 fastest-growing franchisor in Entrepreneur Magazine's Franchise 500 rankings. Diversification, no correlation with DIV's other royalty partners. The size is, like I said previously, it's a CAD 8 million annual royalty, which represents about 14% of DIV's pro forma adjusted revenues. Transformative, we think the transaction is transformative. Stratus represents DIV's first U.S. royalty transaction. The U.S. franchise market is significantly larger than Canada's, proving the royalty model with a U.S. company is anticipated to be transformative for DIV and is expected to greatly expand the number of potential royalty partners available to DIV going forward. An overview of Stratus is found on Slide 8. It was founded in 2006, has a head office in North Hollywood, California. It's an industry-leading franchisor in commercial cleaning and building maintenance with master franchisees operating across North America. Stratus' 68 master franchisees are operating in 60 major cities across North America. 58 of those are in the United States, 10 of them in Canada supporting 25 -- approximately 2,500 unit franchisees. 13 of the master franchisees are corporately owned and 55 are franchised. Stratus believes it has an opportunity to grow from 68 master franchises up to 150 across the United States and Canada over the next 5 to 10 years. So pretty good growth opportunities here for the business. Stratus generated annual sales -- system sales of USD 147 million for the trailing 12 months ended August 31, 2022. Stratus together with its affiliates, SBS Services Group LLC and Stratus Building Solutions Canada, Inc. generated combined revenue of approximately $15 million for the year ended December 31, 2021. Financial performance is laid out on Slide 9. Stratus generated trailing 12-month system sales of USD 147 million, approximately CAD 197 million, to the end of August 2022 and is growing system sales from USD 56.4 million to approximately CAD 75 million in 2017, representing a CAGR of over 21%. You can see the chart there. Stratus' same-store sales growth from '17 to '21 has averaged over 16% per annum. Stratus has added 32 master franchisees over the past 5 years and is forecasting 85-plus over the next 5 to 10. During COVID-19 status experienced some positive onetime disinfecting cleaning revenue, partially offset by interrupted recurring monthly cleaning as some customers temporarily closed their premises. This has largely normalized. The cleaning market on Slide 10. The global cleaning services market is very large, approximately USD 151 billion and is forecasted to grow at 6.85% CAGR over the next -- from 2021 to 2026. The commercial cleaning and janitorial solutions industry is highly fragmented. The industry remains mostly comprised of small, local and regional players. The big 3 in the U.S. franchise commercial cleaning industry are Jan-Pro, Jani-King and Coverall. Stratus is among the top 10 commercial cleaning franchisors in the United States. The business model, as outlined on Page 11. Stratus operates a 3-tier franchise model, the franchisors, SBS franchising LLC. Master franchises, 68 locations, 13 are corporate owned. The vast majority of new markets are expected to be franchised going forward. Unit franchisees approximately 2,500 typically individuals manning 2- to 4-person teams that clean 3 to 4 commercial buildings. Only 15% of the 68 master franchises are in mature markets, 35% are in developing markets and about 50% in early-stage markets. The developing and early-stage markets are forecasted by Stratus to be capable of generating double-digit same-store sales growth for many years. Management, the top 3, CEO, CTO and COO, were all co-owners of the business equally. They all bring a different skill set to the table. Afshin spent 7 years at DreamWorks, followed by another 7 years as President of Instructional Systems Design, a software developer for the health care industry, before becoming a Stratus master franchisee with Foad for the LA territory in 2008. Foad is the CTO, worked for 10 years with Afshin and develop OPUS IT platform, the technology backbone of Stratus. And Stuart Erskine, COO, owner of various franchise businesses, including Magnetsigns and EmbroidMe, joined Stratus as an equal partner in 2016 and brings a strong franchisor background and is focused on running the Canadian operations. They brought in a couple of presidents to help them solidify and build up the business for its future growth. Doug Flaig, President of the franchisor business, has over 20 years, overseeing hundreds of Dunkin' Donuts, Burger King, 7-Eleven and Wetzel's Pretzels stores, formerly CEO of Safe Facilities Services, a janitorial services provider. Joe is the Divisional President of the corporate, and he has 12 years of experience as a Stratus master franchisee. And David Earl, is the CFO and is responsible for finance and financial reporting for the past 3 years and before that was Vice President, Global Controller for PSI Services LLC. In terms of fit on Slide 13, diversification and Industry, the acquisition of Stratus represents DIV's 7th royalty stream and first U.S. royalty stream with investments in Mr. Lube, Air Miles, Sutton Realty, Mr. Mikes, Nurse Next Door and Oxford Learning. DIV currently has no exposure to the industrial cleaning and building maintenance market. The industrial cleaning market represents a significant market with a very large growth opportunity. Stratus' royalty represents currently 14% of DIV's pro forma adjusted revenue. In terms of diversification, this slide on Page 14 gives you a sense of the portfolio today, pro forma for the Stratus acquisition, and you can see that Stratus represents about 14% of pro forma revenues and will actually be our second largest royalty partner moving forward. In terms of being accretive on Slide 15, kind of the numbers, the current run rate adjusted revenue will grow from $49.2 million to $57.2 million of adjusted revenue. Normalized EBITDA will go from $45.9 million to $53.9 million. Distributable cash flow increased from $30.4 million to $34.4 million. The dividend per share is being increased from $0.235 to $0.24 concurrent with, I think, starting January 1. And the payout ratio decreases slightly from 96.2% to 94.4%. The dividend, the Board of Directors has approved a 2.1% increase in the dividend from $0.235 to $0.24 commencing January 1, 2023. And like mentioned previously, the payout ratio drops to approximately 94%. The summary Stratus is a perfect fit for DIV's royalty model, a proven franchisor business with historically steady, predictable cash flows, strong master franchisee and unit franchisee economics and an opportunity to grow its master franchise business count from 68 up to 150 over the next 5 to 10 years. DIV's unique royalty model on Stratus to retain 100% equity ownership, monetize a significant portion of their current cash flows and the benefit -- and benefit from the future growth and profitability from continued strong same-store sales growth and from opening new master franchises. We strongly believe that Stratus royalty transaction will be transformative for DIV, will be a catalyst to open up the very large U.S. franchisor market to DIV's unique royalty model. In summary, the industry commercial cleaning and janitorial solutions is a stable industry with room for sophisticated operators, such as Stratus, to accumulate market share, and COVID-19 has enhanced these services. The business model is proven. It's been in operations for over 16 years, strong store-level economics, and they're attracting talented master franchisees with very low turnover in that part of the business. The management team is experienced, and the growth for the businesses has achieved scale and system sales have grown steadily over the past 5 years. Diversification, no correlation with DIV's other royalty partners. The size is USD 6 million and CAD 8 million, representing 14%. And as I mentioned previously, it will be slightly -- just slightly the second largest royalty partner for Diversified. And lastly, we think it's transformative -- represents our first royalty transaction. The U.S. market is significantly larger than Canada's and proving the royalty model with the U.S. company will be transformative and expected to greatly expand the number of potential royalty partners for Diversified. All sorts of detail in Appendix A, B and C. And I just want to thank everybody for their support of Diversified and for taking the time to listen to this presentation, and we're excited to come to market with it. So again, just appreciate everybody's time, and thank you very much.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Goodbye.