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

Good morning, ladies and gentlemen. Welcome to the Diversified Royalty Corp. Investor Conference Call. [Operator Instructions] This call is being recorded on Wednesday, June 18, 2025. I would now like to turn the conference over to Sean Morrison, CEO; and Greg Gutmanis, CFO of Diversified Royalty Corp. Mr. Morrison, please go ahead.

Thanks for the intro. I would just like to first and start off by taking an opportunity to thank everybody for taking the time to join our announcement call. We are excited to host a call to announce Diversified Royalty Corp.'s second U.S. trademark and royalty transaction with Cheba Hut Toasted Subs. The Diversified team has been pursuing and working on this transaction since November 2025, and we've been hustling through the United States market for the last 5 to 6 years. So we're very excited about this opportunity. I would like to personally thank Greg Gutmanis, newly promoted to President of Diversified, who has led the Cheba Hut transaction; as well as Adrian Law and Ravish Sharma and all of our advisers. We prepared a presentation we'll take you through to describe the transaction and its impact on Diversified. Let's start. Okay. So just Cheba Hut, it was founded in 1998. It's currently a 77-location fast casual toasted sub sandwich franchise with about USD 174 million of run rate system sales. So it's a well-established business. It's an excellent royalty partner for Diversified. It's a proven business model. They're operating in 19 states. Strong historical growth. 11 newly opened or planned open location in 2025 and they have a very strong pipeline of new locations. Strong unit economics, so this is one of the key factors we look at with all our royalty partners. So the franchisees are making great profitability, strong history of same-store sales growth and very low store churn. And most exciting for us is it's our second U.S. royalty transaction, increases our exposure to DIV's unique franchise or royalty structure in the U.S. market, which we think is a huge opportunity for us moving forward.

So the transaction details here at the bottom of this slide, I'll go over them quickly. You can see the purchase price was USD 36 million. That was a 9x multiple based on the current first year $4 million royalty. The royalty grows contractually annually at a greater of 3.5% or U.S. CPI plus 1.5%. So there's some nice baked-in growth contractually into the annual royalty. Term debt, we put on USD 10 million of new non-amortizing term debt. Half of the topco, half in the subsidiary. The acquisition facility draw, we drew down USD 18 million on our acquisition facility. We've updated this and you'll see in later slides we've increased the size of the acquisition facility, but also for the first 12 months there is no contractual amortization. Despite that, we intend to voluntarily pay down this each and every month as we go forward and expect to pay it down over the next approximately 12 to 15 months. The balance of the purchase price, just over USD 8 million, was from cash on our balance sheet. So this transaction as a result of the above is quite accretive from a distributable cash per share increases just under 7%. So the store level economics, as Sean mentioned on the summary slide are very healthy. It's one of the key aspects that we look at in our underwriting and due diligence of these transactions. So the cost to build out a new Cheba Hut is approximately USD 150,000. The average location generates over $2.3 million, $2.4 million of system sales with a 10% to 12% store level EBITDA margin, which is about USD 275,000. So this is a 2 to 4-year -- call it, a 3-year payback, which is a great economics for the franchisee. There's also 3 multiunit franchisees operating 37 locations across 7 states in the U.S. We believe this is a testament to Cheba Hut's strong store-level economics. Existing franchisees are putting up their hands for incremental locations. They like the business model. So overall, Cheba Hut's store level economics are superior. Same-store sales growth, another key metric that we look at throughout the system. And particularly in recent periods of time where some chains have seen some headwinds from inflation and other factors, Cheba Hut has strong same-store sales growth over the historical period presented. The last 3 fiscal years, you can see, have ranged from 5% to 18.2%. The most recent quarter being Q1 of 2025 was positive 4.1% in same-store sales. This strength was a combination of both increased foot traffic and many price increases or average ticket. System sales growth, the chain has consistently grown over the historical period presented. We've grown from USD 65 million in 2021 to $149 million in 2024, representing a 32% CAGR. The new unit pipeline, so the chain continues to grow as it has in recent years and their forecast is quite robust. They are currently constructing 8 locations. They expect to open 11 in total in 2025, 16 to 18 new locations per year in both 2026 and 2027. You can see they've also signed up franchise agreements, which some of those previous numbers are included in, the 53 new franchise agreements have been signed. So there's a robust pipeline. It's a combination of new and existing franchisees and particularly the current year with the 11 locations planned, 8 of which are under construction today. On this Slide 9 in the slide deck, you can see a sample of their menu. Cheba Hut showcases over 30 signature sub sandwiches highlighting the harmony between great-tasting food, and well, a specific counterculture. So Cheba Hut's competitive advantage, as we mentioned, they had the strong unit economics and store level figures backstopped by some of the competitive advantages. Their overall business model focuses on quality and authenticity. They have a unique cannabis theme concept, which is unique into the sub sandwich space, a laid-back sandwich shop chain that is family-friendly, known for its niche and very tasty toasted subs plus snacks and desserts. And every location, they make it unique with local custom artwork that they have commissioned for each given location, reflecting the city's history and some local dynamics. Have the fun and relaxed atmosphere with a focus on authenticity. Unique sub flavors, proprietary homemade recipes, some high-quality ingredients. And most stores are located in suburban markets. The Cheba Hut management. So Scott Jennings is the founder of this, founded the concept in 1998 and is the entrepreneur behind the whole concept. He had enough foresight to bring on a strong management team, which we spent a lot of time over the last few months with and are excellent. So Marc Torres, the CEO, has been with the company since 2005, working his way up through the ranks, previously as Chief Operating Officer. Jimmy Wedding is a more recent addition to the team as the Chief Financial Officer and excellent individual and is very key in this transaction. Seth Larson, the Chief Relationship Officer has been with Cheba Hut also since 2005. All members listed above are also shareholders. So very motivated and very professional and solid management team. The royalty transaction listed on Slide 12. As I mentioned, DIV is purchasing a USD 4 million, which is approximately CAD 5.5 million royalty, from Cheba Hut at a 9x royalty acquisition multiple for an initial purchase price of USD 36 million. So just over CAD 50 million. The following table outlined on this Slide 12 is approximate sources and uses of funds. The acquisition facility, as I mentioned, is a USD 18 million draw, USD 10 million of term debt and the balance of just over USD 8 million was from cash on hand on our balance sheet. Impact to DIV from our adjusted revenue run rate going from $71.3 million to $76.9 million listed on the Slide 13. Normalized EBITDA going from $66.8 million to $72.4 million. Distributable cash listed there, and importantly, per share, going from $0.2714 per share to $0.2897, which I mentioned is approximately just under a 7% accretion run rate. Furthermore, going forward, we expect as the business continues and our portfolio has same-store sales growth this to continue with some improvement. Pro forma adjusted share contribution of our royalty portfolio. You can see here on Slide 14, on the bottom right, Cheba Hut is listed there as approximately 7% of our business going forward. I'll turn it back to Sean for a quick summary of the transaction.

So just to wrap things up, Cheba Hut has a history of success. It's got 77 locations and across 19 U.S. states. So proof of concept, blown well through that. It's a pure franchisor business. They got a couple of corporate stores, but the vast majority of their growth moving forward will be in the form of franchisees. As Greg and I have mentioned previously, their store level economics are a key item that we focus on, a great track record of same-store sales growth, strong store level economics for the franchisee. And we believe that, that makes the royalties that Cheba Hut receives as super high quality. So even though these aren't brands that Canadians know, the U.S. market is a very large market and we've done our homework to find other brands in the U.S. market that have great economics and are great partners for us. As we've stated, they have a really large pipeline. So they're kind of accelerating their growth prospects today and that's why we're such a good partner for them, opening up 16 to 18 new locations per year over the next couple of years and 11 this year. Very experienced management team. They've been with the business for most of them, over 20 years. They brought in some real recent talent in the CFO role. It's been very helpful in getting this transaction done. So it's just a really good team with a really bright future. The royalty structure, we were able to buy our -- this royalty stream for a 9x multiple. We've also got a kind of a hedge to inflation. We've got a floor of 3.5% royalty growth or U.S. CPI plus 150, the greater of. And diversification. Cheba Hut with locations across the states is expected to have no correlation with DIV's other royalty partners. So again, that's just part of the -- in our name, Diversified Royalty Corp. is a perfect fit. And the other aspect of that perfect fit is just being a U.S. deal. As I've mentioned previously, Greg and I have been down to the U.S. over the last 5, 6, 7 years, promoting this unique structure that's been proven in Canada over 20 years, but it's still a new concept in the U.S. market. Stratus was our first deal we got done a couple of years ago. This one is, we think, a really big opportunity for us to get out and let the U.S. market know that great businesses like Cheba Huts, the owners of these businesses have options. What we provide as an opportunity through our royalty structure is a much better economic outcome for the owners of these great franchisor businesses, and we look forward to promoting this throughout the U.S. franchise community. So just in summary, Cheba Hut is an excellent royalty partner for DIV. It's profitable, a well-run franchisor with a proven business model and attractive growth prospects. It's right down the plate. And just to add in terms of DIV's strong balance sheet enabled us to fully fund this transaction without the need to raise equity. So like Greg when he went through the sources and uses, we have a bunch of excess cash on hand. Our existing royalty partners were underlevered, and we had an undrawn acquisition facility. So raising the capital through those sources enabled us to raise -- or finance this transaction without having to raise any equity. We think this is a game changer for DIV as all prior trademark acquisitions have been funded concurrently or shortly thereafter with an equity raise. We expect to generate cash flow from our less than 100% payout ratio. The results of our dividend reinvestment plan and also refinancing out some of our underlevered royalty partners over the next 12 to 15 months will fully pay off the acquisition facility. The Board of Directors of DIV have approved a 10% increase in the annual dividend from $0.25 per share to $0.275 per share effective July. And furthermore, just giving us more dry powder, DIV's acquisition facility has been increased from $50 million to $70 million. So at closing, DIV has approximately CAD 45 million capacity on its acquisition facility which I think puts us in a great position to continue to drive this business forward with more acquisitions. So that wraps up our presentation. We're happy to take some questions from people on the call. Back to you, operator, to set up the question and answer, please.

[Operator Instructions] And with that, our first question comes from the line of Matthew Lee with Canaccord Genuity.

Nice locking acquisition here. First, are you concerned at all that the cannabis team aspects of the business are somewhat niche in nature? I mean, is there anything that prevents long-term expansion opportunities just given that there are still some geographies in the U.S. that maybe are against cannabis culture?

Yes. I mean we don't see that as a material factor. I mean, the U.S. market is 10x the size of Canada. They're existing -- already operating in 19 states. Just if they were matured in those states, it would be a massive business that would be bigger than most franchisors in Canada. So if there are a few states that don't progress to that direction, I don't think that's going to hold them back. The U.S. market is massive, and they are currently owning a 77-unit chain. I mean, some of the larger subway sandwich businesses are up to 3,000, 4,000 locations across the United States. And there's a few states that don't like the theme or the niche, I don't think that's going to slow them down or our partnership with them at all.

All right. Fair enough. And then in terms of using the Cheba acquisition to promote the DIV in the franchise community, just maybe talk a little bit more about why doing a deal like this helps elevate reputation and what that can maybe do for you in the future deals?

Just having entrepreneurs who've done a transaction like this resonates well with other founders. And so once we completed our first U.S. transaction, which was Stratus, we managed to get them onto panels at some franchise conferences and other entrepreneurs in the audience resonate towards why that individual did a transaction with us versus a private equity deal. The same concept applies here. This very professional and young management team, if we can have them assist us and work with us at some of these franchise conventions it will resonate a lot more authentically with potential entrepreneurs who might be considering a liquidity transaction.

Yes, that makes sense. And then maybe I missed this, but royalty coverage ratio, can you give us an idea of what level of coverage you have against that $4 million initial royalty?

Yes. We don't disclose the specific royalty coverages, but we bake those into our royalty roll-ins. This business is on a very sharp, steep trajectory. So run rate royalty coverage is solid. And every single month as they open new stores, it continues to add to that coverage. So it's a hard number to disclose. We don't do that with all our royalty partners, but let's just say this business is going to be dramatically more profitable in the next 12 months and earn way more than enough to pay our royalty and most likely qualify for incremental royalty roll-ins even as early as next year.

And your next question comes from the line of Gary Ho with Desjardins.

Just the first question just on the -- going back to the same-store sales growth slide. So very strong in '23, 18%-plus and then 5% in 2024 and 4% so far in Q1. Are you able to maybe give us a range, the split between foot traffic and maybe the price increase historically?

We haven't publicly disclosed that exact split. I can say that in each of those periods in that historical deck, both of those drivers were positive. So given the year, sometimes there's a little bit more foot traffic, sometimes a bit more on pricing or average ticket. But it was not one heavily offsetting a negative another, for example. It was both positive drivers.

Okay. And just curious on the structure of it. So was there an opportunity to kind of tie this to same-store sales growth as opposed to kind of being a fixed rate?

Yes. So it's not a fixed rate. It's a greater of 3.5% and a hedge to CPI. In the U.S. market, there are rules around how we can structure these royalty transactions and having a purely same-store sales growth metric doesn't work from a structuring perspective. So we've come up with both of our U.S. partners with either fixed, or in this case, a hedge to inflation with a floor which we love this approach, having a minimum of 3.5% growth. But with the upside of CPI, we think is a great metric and a way to structure these, especially in the U.S. market.

Okay. Got it. Okay. And then maybe just a quick question on the leverage. Can you share kind of where your pro forma leverage stands today? And where are you comfortable with? I think I heard a $45 million acquisition facility availability. So that would be kind of your dry powder for future acquisitions?

Correct. That's immediately as of today. Obviously, we intend to methodically pay down that acquisition facility. But as you can see from our most recent quarter, we had $172 million of senior debt, which is about 2.6 turns of leverage, adding the USD 28 million of debt drawn as disclosed in the slide deck, which is approximately CAD 38 million. That would be $210 million of senior debt, which is about 2.9. So call it 0.3 turns of incremental leverage on this transaction. In addition to that, we have $52.5 million of unsecured convertible debentures, which you're also aware of. So overall, our leverage pre and post went from sort of 3.3 and change to 3.6 and change, including those unsecured convertible.

And you're comfortable with these looking out, given that some of that acquisition line will kind of come back?

Absolutely. With that level of leverage, we're definitely quite comfortable with it. And the fact that, as you mentioned, there's $45 million undrawn at close and increasing capacity over time allows us to still have some flexibility there going forward and particularly over the next 12 to 15 months with -- as mentioned.

Okay. And if I can sneak one more in. The 10% divi increase. So that's higher than the 6.7% growth in distributable cash per share. Just wondering kind of the rationale behind that?

Yes, I think we had some dry powder in terms of our very low payout ratio and with the performance of our portfolio, especially Mr. Lube. Our payout ratio was kind of melting. So we like to trigger our dividend increases concurrent with new acquisitions. So we had a little bit of dry powder in there. So it was kind of a combination of the accretiveness of this transaction as well with just kind of closing the gap on a shrinking payout ratio.

[Operator Instructions] Your next question comes from the line of Michael Glen with Raymond James.

Maybe just to start, as you mentioned, the company was founded in 1998. Was there something recently that took place that sort of triggered a step change in the growth profile of the organization? I'm just trying to understand how -- it looks like there was a recent acceleration. Just trying to understand what was maybe underlying some of that?

Yes. I mean, as you can imagine, with all brands, they don't just start as a straight line growth from day 1. There's usually a germination period and these guys, basically partnering with some of their large franchisees, started to basically reach critical mass themselves. And the store level economics are so strong that they -- even the existing guys that are opening all these new stores have the financial capacity to basically accelerate their growth. So that was a huge factor. And then growth begets growth. When franchisees are making great money and they see their biggest franchisees adding store number 8, 9, 10, 11, new franchisees get excited about the opportunity to join the brand. And this is why these types of businesses are very attractive to all sorts of capital providers. And when we bumped into these guys at the Restaurant Finance & Development Conference, they were just blown away with how our model works, how it would and could work for them, especially at this inflection point in their growth prospects. And that's why we think there'll be huge brand ambassadors to Diversified because their case is going to be right down the middle of the plate for the types of deals and the types of businesses we want to partner with, with our unique structure.

And the pipeline, I think you gave us a number for the store pipeline, but did you provide a split as to what number of those stores are existing versus new franchisees?

No, we didn't provide a split, but it is a combination of both.

And so when you look at the -- when I think about the growth strategy, is this more looking for new entrants or single store owners? Or is it more like an area developer type strategy?

It's not really area developers. So even the franchisee groups who own multi-location, they don't have area development agreements. They buy incremental franchise locations as they grow. And for a new person, they can buy 1 or they call it a 3-pack where they would, say, have rights to open 3 locations for a brand-new franchisee, but it's a combination of both. So it's not relying on I'll sign an area developer for 20 states and 300 locations and over the next 10 years maybe you do it. That's not at all how these guys operate. It's very specifically working with the franchisees, identifying locations and having some credibility to it to not just have a whole bunch of numbers of theoretical locations. It's controlled methodical growth with qualified franchisees.

Okay. And just to go back to the dividend, how did you sort of balance the decision, your yield is already quite high, as I'm sure you're well aware of. So how did you balance the decision to raise by 10% versus keep the cash internally just to pay down debt so you can get yourself into the -- an even better acquisition position quicker?

Yes, that's a great question. And as you can imagine, as Greg mentioned previously, we think we'll have our acquisition facility fully paid off with permanent capital within the next 12 to 15 months. So with the extra addition from $50 million to $70 million on our acquisition facility with the -- our ability, we believe, to pay off our acquisition line in the next 12 months gives us tons of financial flexibility. So the high yield, I think, is a function of people wanting to understand if we're going to keep growing. And we think this is a huge opportunity for us to get our second U.S. deal, and I think that will accelerate our growth. And at the end of the day, we are a high dividend payer, and we think that the market will see our growth and give us a yield that's commensurate with the quality of the dividend we're paying combined with the growth prospects of the business. So at the end of the day, we've been a high dividend payer for 10 years, and we do have the financial capacity on our balance sheet to make the increase in dividend and pay our debt down at the same time. So I think that puts us in a pretty strong position.

And one more for me. So I think you highlight that all management was shareholders of the organization. Can you give some sense, I don't want to break it out explicitly, but like the portions owned, are they all roughly equal? Or was there one outsized sort of owner of the shareholding?

As you can imagine, most of these transactions, the founder owns control of the business and that's consistent in this case. Management's ownership is quite chunky. A lot larger than a lot of -- like it's not a token amount of equity for the rest of the team, it's a sizable chunk. And as part of this transaction, the founder sold some of his controlling interest to the 3 younger partners to increase their exposure. Very similar to what was happening in the Mr. Lube transaction, just a bigger -- even a bigger ownership position for the management team in this case. So the young management team that have 20 years of experience with the brand, they're jumping out of their boots because their ownership is increasing. This has been a nice first transaction, but they think they could grow this business dramatically, and that would increase our exposure to them and allow them to monetize even more growth. So we think this is going to be a very strong business over the next 10, 20 years with this management team owning a sizable chunk of the business.

And I'm showing no further questions at this time. I would like to turn it back to Mr. Morrison for closing remarks.

Again, just I appreciate everybody taking the time to hear what we're up to. Hopefully, they're as excited as we are about getting our second U.S. royalty transaction done, raising the dividend and getting on with growing this business and creating value for shareholders. So just thanks, everybody, for their time and support. And Greg and I are always available for questions from investors directly. We're happy to take a call from anybody to talk about our business. So feel free to reach out, and thank you very much.

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may now disconnect.