Driven Brands Holdings Inc. (DRVN) Earnings Call Transcript & Summary

I'm with William Blair & Company. We're going to do this in a fireside chat form. So first, I want to thank Jonathan and Tiffany for joining us today. And for those of you who don't know Driven, fairly new public company, but very interesting [indiscernible] the diversification of the end markets. There are a lot of interesting [indiscernible] ideas, I think, out there that also has a really healthy growth aspect to it. So hopefully, we can go to that. But I do need to tell you talk about anything that I completely [indiscernible].

So first, Jonathan, could you start by describing the origins of Driven? I know a lot of people in this room are familiar, but we do have as a multi-sector conference, so people may not be as well versed as others. And tell us again, why you think it's interesting to serve these different end markets in the ways that you do across the Driven portfolio?

Sure. Thanks, Sharon. Good morning, everyone. So Driven Brands focuses on the automotive aftermarket. We've got 4 segments or business segments within our company. We have a Quick Lube segment, which is a [indiscernible] company-owned Quick Lube segment, an amazing business that generates about mid-30, high-30% 4-wall EBITDA margins. We've got a Car Wash segment, which is defined of domestic U.S. and international for the world's biggest car wash company, we've got over 1,000 locations. Stores in the U.S. are company-owned stores and then our stores internationally are what we call franchise or independent operator, which is kind of like a franchise model. We've got a Glass and Collision segment, where we've just entered into the glass space about 4, 5 months ago, and that's focused on auto replacement, auto repair. And then we've got a pretty big collision business. We do about $2 billion of collision repair primarily for our insurance partners on an annual basis. And then our last segment is what we call Platform Services, which is really sort of a franchise distribution part of our business. So today, Driven -- 4,000-plus locations primarily in North America, about 80% franchised versus company, primary growth levers today are our Glass business, our Quick Lube and our Car Wash.

Yes. I think it's also helpful to talk about why you think these are attractive end markets? And I think we get asked a lot about EVs, particularly as it relates to Quick Lube. So maybe if you could touch on that, that would be helpful.

Let's talk about our -- why we're attractive right now. So we've got -- our core customer is a $60,000 household income. We very much focus on cars that are 4-plus years of age. Average age of the vehicle today is over 12 years of age on the U.S. roads. We are very much focused in what we call needs-based services. So when you think about how this business performs and sort of more challenging times. We do really, really well. If you look at the most recent sort of challenging times, look back at the COVID time and during March of 2020, like everyone, we took a pretty big hit. But by June, we were back to 0 comps because people still use their cars every day to sort of carry on their lives. Look back at 2007, 2008, we had less than 6 months where we like just under 1% negative sales. We bounce back very quickly. Ultimately, this is a needs-based service category, and again, focusing on the customers with the household income of about $60,000. In terms of EV, I mean, there's a lot of noise around EV. I think you'll have to sort of peel back the numbers a little bit to really understand what's happening with EV adoption. It's kind of simple math when you look at it. If you look at the 285 million vehicles on the road in the United States today, less than 2% of them are electric vehicles. We believe that the EV change is going to happen relatively slowly. If you look at a 20-year average of about 16 million, 17 million new cars a year that are sold, even if we started selling all new vehicles as electric, is not happening anytime soon. It will take 15 years plus to sort of change out the fleet from sort of the internal combustion [ they ] have today. So specifically with EV, our Quick Lube business, obviously, electric vehicles, not hybrid vehicles, but electric vehicles don't require all changes. But as we look at our Quick Lube business, we believe that's going to continue to grow through -- past 2035. So that's kind of how we think about it.

And how -- given that Take 5, which is one of the quick lube concepts, is franchise as well? How are the franchisees viewing the attractiveness of the business given EV adoption over time?

Yes. So we started this Quick Lube business in 2016. We had 0 stores in 2016. We bought an initial platform of about 35 stores and then grew that company-wise. We now have 750 locations. We're now opening more franchise locations annually than company stores. Sitting here today, we've got a pipeline of about 750 franchise units, which will open over the next sort of 3 to 4 years. Franchisees are coming from existing multiunit categories like hotels or fast food or restaurant businesses because the unit level economics and the returns are so good. So cost about [ $750,000 ] Quick Lube ex real estate. You're getting to maturity at about $1.1 billion in less than 36 months, and you're generating 35% plus 4-wall EBITDA margins. So think about the return profile on that pretty exceptional across any sort of multiunit category. So our franchise growth has accelerated over the past 2 years [indiscernible] our power of the return profile. The Quick Lube business is pretty interesting in that it's a stay in your car, 10-minute drive-through model. So that's what we really like. We focus on either service and fast friendly service. So we offer a very limited menu, very limited set of incremental products outside of the old change, which really goes back to making sure we get customers in and out in less than 10 minutes. So it's highly differentiated, and I think our franchisees are seeing pretty phenomenal returns both in terms of speed to cash flow breakeven.

Really helpful. I think one of the other questions we get asked a lot is what is the advantage of having Car Wash with Maintenance, with Paint, Collision & Glass. Why does that all belong under one corporate umbrella? And what are the synergies from a consumer-facing perspective or a customer acquisition perspective as well as from a cost perspective?

Yes. So we operate a pretty classic sort of shared service layer at the Driven Brands level. So all the core corporate functions like Tiffany runs finance and a bunch of other things, but finance, IT, legal, accounting, HR, all sits at a shared service layer and then that supports the 4 operating segments. So that's sort of classic efficiencies from a shared service perspective. So we get to leverage as we grow new units. . The second thing that we get is the scale advantages that we have now. So we are the largest player in automotive aftermarket, but yet we've still got less than 5% share. So whether it's -- you think about oil, we buy 10 million gallons of oil a year, buy oil as competitively or more competitively than anyone else in the industry. Think about our paint, our glass, our car wash chemicals. So we get the scale benefit by across our businesses. I think something that we're working on and have been doing for the last couple of years is collect a lot of rich data from our customers. So if you think about customers that come into automotive aftermarket, unlike a lot of other retailers, our customers willingly give us their personal information. So our customers typically give us their name, their address, their e-mail address, their contact information. So sitting here today, we've got about 23 million unique customers in our central data lake, and that sort of 23 million, which is growing at about 900,000 per quarter really then sort of feeds a lot of our activities, let's say, from a marketing and CRM perspective. So one of the things we're working on is really sort of harnessing the power of that customer data to make sure that we're leveraging our CRM. So put most simply, Sharon, if you think about we've got a market where we've got Quick Lubes and we've got Car Washes, our other businesses, we can take customers that have come in from our Quick Lube or our Car Wash and invite them to the other brands, right? So that's really sort of power of data that of managing total wallet share of customers and making sure that we get those customers to spend their aftermarket dollars in one of our -- that's one. I don't know, Tiffany, if you wanted to?

No, that's great. I think that's the overall [indiscernible] strategy, right, to leverage power of having all [indiscernible] getting consumer [indiscernible]. Can you talk from a segment perspective, organically? How you expect the rate of growth to be amongst the segments? And maybe clarify any material differences in the margin structure in the different segments, because obviously, a rate of growth relative to margin would impact corporate.

I'll start, Jonathan. So Jonathan laid out nicely to start of his comments. I think, first and foremost, 2 really important things to remember. First of all, Maintenance segment and the Car Wash segment take up 70% of our EBITDA. So sometimes I think investors have attended sort of wrapped around the [indiscernible] keeping track of 4 different segments, lots of different [indiscernible] don't need to -- so think about the fact that 70% of our EBITDA margin [indiscernible] in Car Wash, those are the 2 things we watch. That's obviously where we're putting a lot of our capital out. So we're leaning quickly Car Wash business. And now we've got a new growth vehicles. So if someone listen to our presentations or our one-on-one today, we're going to continue [indiscernible] respectively. So those are the 2 takeaways, 2 key takeaways. As you think about the rate of growth, so if I just work across the 4 segments. In the Maintenance segment, really in the Car Wash segment, too. Those are high-growth segments. That's where we're investing a lot of capital. Those segments ought to do outsized growth relative [indiscernible]. The aftermarket itself historically has grown around 4% on -- so we should grow at least 4% and about the way that we're segments and the fact that we have unique go-to-market strategies segments which profiles in each of the segments on Car Wash was doing 35% plus 4-wall EBITDA margin. So at that growth segment. In the PC&G segment, that's Paint, Collision & Glass is the largest system like but the smallest contributor percentage. The highly franchise business, small royalty rate, it's less than [indiscernible] at margin that was very healthy, [indiscernible]. So it's a great cash [indiscernible] and then in the Platform Services business, again, highly franchised, great royalty rate that [indiscernible] all that mix is out to 5% corporate margin. And the beauty of this model is the better the top line velocity rate the flow-through. This is a 60-40 [indiscernible] market. So while we've got always opportunities to drive costs out of the [indiscernible] velocity can get to the top line in these high-frequency services.

I think something I'd be remiss not to ask is there are a lot of conflicting data points on the health of the consumer. And so I know, Jonathan, you mentioned you're more defensive. But what are the key leading indicators that you look at for your business? And then separately, given that we are in a rising rate environment, does that in any way jeopardize the closure rates on the franchise pipeline?

Let's start with the consumer. It's sort of the hot topic in every meeting that Tiffany and I go to. So we have KPIs that we look at across every one of our businesses to understand -- is there any early warning signs around the health of the [ consumer ]? Put simply, we look at 2 things at the top of that list, we look at traffic, what's happening with consumer traffic and then we look at [indiscernible] mix. So is there a trade down within our business. And happy to say that we're not seeing any degradation on either traffic demand or already trade down within our segments. I think it goes back to the needs-based basis of this business. So we're not seeing any degradation in traffic. We're not seeing any trade down. Clearly, there's a lot of talk about where the consumer is at the end of this year if we continue to see inflationary pressures, people say that the consumer still has sort of 6, 9 months left of a cushion coming out of the pandemic. We're not seeing any degradation today. In terms of rising interest rate environment and what that does, doesn't do anything for Tiffany and I -- Tiffany will talk about our capital structure. We've essentially got a sub-4% fixed rate environment for sort of a 7-year tenure. We use a whole business securitization financing structure. So it doesn't impact us. In terms of our franchisees, our franchisee pipeline, probably 45% of our franchisees own their underlying real estate. So they've got sort of cushion there when it comes to sort of P&L protection. If we look at COVID as an example, the year of 2020 really is sort of the depth of the COVID. We didn't lose one franchisee during that period. So our franchisees are actually making more money than they've ever made right now. And a lot of them have come out and performed very well over the last 2 years. So we're not seeing any negative impact in terms [indiscernible].

One other question that comes up quite a bit is how dependent are you on M&A to grow? So I think it'd be helpful to go through the organic growth algorithm. And then from an M&A perspective, maybe talk about kind of what the key characteristics are that you look for? What the ROI profile is? And also, are there other segments you'd be interested in adding?

Yes. So we've been public about 18 months now, and Tiffany sort of talked about our organic growth, [ Algo ], low double-digit revenue growth sort of flat to consistent margins and then sort of low double-digit EBITDA growth. That's our organic model. We don't supplement that with the M&A that we've done. So we are very proficient in M&A. We've done over 80 transactions over the last 7, 8 years. We've built out a team that's very good at M&A. So it's not something that's episodic for us. We've got people, process and systems around how to be effective from an M&A perspective. I'll give you an example, we got into the Car Wash business, U.S. coming up on 2 years ago, now Tiffany, August of 2020. In the first year of owning that business, we acquired over 100 Car Wash units domestically. We were able to turn that sort of that funnel and execution plan on because we've got a team in place that have done this for many, many years. In terms of -- let's talk about value and multiples. It varies by industry segment. The Car Wash segment is a hot segment right now. You've got a lot of institutional capital flowing into Car Wash. You're seeing sort of multiple appreciation of the 100-plus units we did last year. Our blended multiple was single digit to high single digit. Our average deal size was 2.3 stores. And what you're seeing in the industry is though people paying what we call for platform acquisitions, so platform acquisitions being 10, 15, 20-plus stores, you're seeing some really lofty valuations out there. And I'll give you an example. There's an asset right now that's in the marketplace that is about 17 stores, it's actual EBITDA -- EBITDA on an LTM basis is about $22 million, $23 million. It's essentially got embedded about $100 million of real estate value. They're selling off a 2-year pro forma adjusted EBITDA of about $44 million. So I've been doing M&A for 20 years. It's one thing to see 1-year adjusted, but 2-year adjusted is kind of crazy. And that will trade for 18x to 19x that forward 2-year multiple. So forward 2-year EBITDA. So just letting you know that within the Car Wash space, there's some crazy valuations being paid because we have scale already, we've got 350 units. We can be very stealth and deliberate about buying the small stores at much more accretive prices. So highly sort of deliberate in terms of the multiples we're willing to pay. In other categories, we got into the Glass business. We closed our first transaction there, December 26, 2021. And we're pretty active in terms of turning on the M&A machine that we've done before. I think we'll be able to acquire businesses there in the mid- to high single-digit multiples and that's be synergies. So pretty happy with that. In all 80 transactions that we've done, that's from small stores to large acquisitions. We've never had an acquisition that we don't create incremental value on in all cases. When we think about looking at an asset before we purchase it, we ask ourselves, first of all, 2 questions. Can we make the asset better if it's part of Driven Brands and can that asset make Driven Brands better? So that's the first 2 questions. And then we go through the standard sort of financial diligence, purchasing synergy diligence, what the data benefits are, the customer benefits. So we've got a very robust, I'll call it, underwriting process for any transactions that we do. Typically, when you think about value creation, if we pay, let's say, 8x for a business, we'd be looking for 2 turns of multiple appreciation within the first year of ownership. That's a minimum of what we're looking for. And then obviously, that improves over time. So that's how we think about sort of multiples and value creation. [indiscernible].

And maybe a question on the balance sheet then, given that M&A is inherently opportunistic. I mean how do you view your cash because you're a strong free cash flow generator, maintaining that fire power for M&A versus paying down the debt? I understand the debt is a low rate. But there are questions on what kind of leverage ratio you might be comfortable with? And if that's changed at all in the past 6 months?

So as Jonathan [indiscernible] 5 quarters, 6 now. So obviously, private equity [indiscernible] prior, we were comfortable [indiscernible] operating [indiscernible] prior to the IPO. I spent a lot of time with our banking partners, talking about [indiscernible] institutional [indiscernible] we had great conversations. The reality is our guardrail, I used guardrail [indiscernible] guardrail right now is 5x levered. We did a lot of benchmarking at guardrail vitality, and we're confident that 5 times [indiscernible] it affords us the flexibility to continue to grow aggressively. We got a tremendous -- fantastic white space to grow. It's a $300 billion industry. And we're consolidating in. We are the largest scale play. We are leaning into Quick Lube, Car Wash and Glass, as you [indiscernible] and we're going after it as quickly as we can. So 5x leverage allows us to operate in that growing industry to grow at the pace that we feel is appropriate to generate the returns to all of you. And it gives us the flexibility. Because we have the whole business securitization structure, which Driven started in 2015 [indiscernible] towards us really low-cost access to the debt capital markets. Jonathan mentioned the structure in place. Our -- that portfolio today is about 3.7% fixed rate. That's about 8% of [indiscernible] so we've set it up quite nicely. We generate a significant amount of cash. Our highly franchised brands that are highly cash generative, some of those brands that are older in the portfolio, provide that cash flow that allow us to invest in over and above anything -- the cash generation of those businesses that cash conversion is 95% plus. So we've got multiple means, whether it's cash generation, operating [indiscernible], access to that capital revolving credit facility. We actually a sale leaseback strategy with Car Wash, where we [indiscernible] all the capital that we put into and get it back out to -- So we just have multiple means at which we grow at this pace. So we're sitting in a nice place. We actually came into 2022 with our war chest loaded because we [indiscernible].

I know you mentioned Car Wash and the multiples there. In the other segments, are the multiples coming down at all? Or are they still kind of similar to where you saw them?

Yes, they never got as frothy as Car Wash. So I think the other -- like I mentioned Glass, mid- to high single digits or mid. Quick Lube, we've sort of acquired everything we wanted to acquire. So that was probably done at a blended 5x. There are the 2 places where [indiscernible].

And then another question is obviously from an inflation standpoint, at the unit level, where are you seeing or are you seeing commodity or labor pressure? And how is customer receptance trend, any price you've had to take?

Yes, the other elephant in the room for everyone, right? Let's talk about commodities, first of all. So 82% of our stores, 83% are franchised or essentially edged from a franchise commodity perspective. Our franchisees are pretty adept at raising price to sort of protect their margins as they raise price, we get paid off the top line revenue, their top line revenue that's sort of a natural tailwind as they take price, we get paid more royalty. In terms of the company stores, it's Quick Lube and Car Wash. So in Car Wash, we're the largest player in the world. We've got phenomenal contracts in place with our suppliers. So we've got that caps, collars and all sorts of rebate structure in there. So we're not seeing any real pressure at the car wash business. On the quick lube business, we buy 10 million gallons of oil a year. I think we're #2 or #3 users of oil. We've got a phenomenal contract in place. I think we are seeing some pricing pressure there, but we've taken price 3 times in the last 12 months in our Quick Lube business. Our average check in that business is now north of $80. It was about $70, 2 years ago. That's coming from 2 things. It's both price and then sort of premium mix trade-up, so people are buying more what we call premium oils. So we actually think we've got incremental elasticity to take more price if we wanted to, but we've been super thoughtful in terms of how much price to take and when to take it. I think you can fall into a trap of taking price now and then sort of losing your customers over time. But we're absolutely playing the long ball in terms of making sure that we don't our customers short term to protect margins. So we've got the lifetime value of those customers. So I'd say, overall, from a commodity perspective, we're in pretty good shape. We've definitely seen some cost pressures. But I would say if you look at our margins, we have done a really good job of protecting them. In terms of labor, Again, our franchisees do an amazing job of hiring their folks. They give out a lot of equity in their business. Franchisees are owner-operators have been dealing with franchisees for 25 years. They're amazing individuals. They're all in, right? They are the ultimate owners of their businesses. So they know they have got to do whatever it takes to be successful. And our franchisees do a phenomenal job in terms of labor. Across our businesses, both company and franchise, variable compensation is a core component of this industry. So almost every employee, even if they're paid a competitive base rate, if you like, everyone has a chance to make variable compensation on top of that. So we were well above sort of the $15 an hour sort of minimum wage years ago because we pay variable compensate. In terms of our company stores, I'll talk about sort of the challenges with labor. We're not immune to it, but I think we're sort of better positioned than some other folks. One is folks still a large contingent of people in the United States that want to work around cars, in cars, around cars, underneath cars. We've got people that have a little bit of a passion to work in our place, maybe more of a passion than working in a warehouse doing a graveyard shift packing boxes or whatever. We talked about advancements. So our Quick Lube stores and Car Wash. Right now, in our Quick Lube stores, we've got about 600 company stores. 70% of those store managers were promoted from within, right? So this is an opportunity of advancement. We're a growing company. We spend a lot of time on culture with our team. So we do big events. We do a lot of recognition, a lot of rewards for our employees to make sure that they know that we're not just a job that we are a career. And I would say that hours of operation are a good thing, right? Our stores are typically open 8 to 6, Monday through Saturday, so employees have sort of regular hours of operation. They typically get Sundays off. They get evenings off. So put all that in the blender, I'd say we're not immune to labor challenges going pretty well.

How about supply chain? So that's also another topic that's kind of inescapable. Can you talk about how you navigated particularly the last year? And if you have any mismatch between -- you keep hearing about mismatches, mismatch between your availability versus what you need?

No, for the most part, not. I mean we've taken share in every category because we've got a dedicated procurement supply chain team that make sure that we're leveraging our balance sheet if we need to, or ordering in advance, we're leveraging our scale with our vendor supplier partners. So we have done an amazing job. Tiffany, especially has done an amazing job of making sure that we've got the product or the parts in our stores when others don't. And that's enabled us to take share against all categories -- all businesses. People may not know this, but 80% of our competition in the automotive aftermarket space is small chains and independents, right? So our ability to get product at the right price at the right time into our stores, both company and franchise, when 80% of the competition are struggling with it has really been a tailwind in terms of the ability to take share over the last...

Perfect. Well, I think we have 35 seconds, Tiffany.

Yes, maybe just a function of the -- 35 seconds to go. I think what I was just going to say is I think what Jonathan is describing is the benefits of scale in a fragmented [indiscernible] just to further punctuate the point on margin. We expanded corporate EBITDA margins by [indiscernible]. In our guidance that we issued in February of this year [indiscernible] to held EBITDA margins flat. While flat margins may not seem all that exciting in an environment where we're lapping high inflation from last year, continued inflation is actually [indiscernible]. So we're pretty proud of what the team has accomplished, whether it's challenging inflationary environment, supply chain environment, et cetera, I think we're proving the [indiscernible] of scale and sufficiency.

Great. Thank you.

Thanks, Sharon.

Thanks, Sharon.