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

Thanks for joining us. We're here with Driven Brands. Today, we have with us Jonathan Fitzpatrick, President and Chief Executive Officer; Mike Diamond, Executive Vice President and Chief Financial Officer; and Daniel Rivera, Executive Vice President and Chief Operating Officer. Thanks for joining us today.

Most of our conversations over the last few days have been focused on the consumer. We started out talking about the consumer, and you're in a pretty defensive industry. So it's a little bit different, but we wondered if you could talk about what you're seeing with your consumer trends. Are you seeing any deferral at any of your businesses? And is there any business in particular that might be feeling a little bit more pressure than others?

Yes, sure. Yes. I mean I think in general, trends have been steady. We obviously won't talk in specifics on inter-quarter trends. We mentioned at the Q2 call, there was some friction we're seeing a little bit on the collision side, but that's driven as much by increasing inflation in the insurance rates. I think in general, the power of the Driven platform is its defensibility and the fact that customers need oil changes, they need to get their cars fixed. And Danny and team have done such a great job operating that we've really been able to keep the trains on the tracks and keep plugging along.

So maybe you could talk a little bit about your different businesses. It might take us a little while to get through them all. But with Take 5 -- and we'll start there, Take 5 has been a really strong performer, and it's set to be one of the company's main growth drivers going forward. Can you talk about what you're seeing for the growth potential there, both in the near term and the long term? And what the growth looks like in terms of company-operated and franchise stores?

Sure, want me to take that?

[indiscernible], yes.

Yes, yes, absolutely. So look, I'd start -- whenever we talk about Take 5, I think you got to start with the unit economics of the business, right? So this is a business that Jonathan has been doing this for 25 years. I've been doing this for close to 20 years. It is a phenomenal business, right? And we've been able to take a business that we bought back in 2016 with 40 units and replicate that now. We've got 1,000 units. We think we have a track record or a path to get to 2,000 units, and we've been able to scale that business and grow it very predictably. So I think for that business, it starts there. As far as the trajectory of the business, so I just mentioned, we see a path to 2,000 units, right? We've said pretty openly we're going to open about roughly 150 units a year. About 50 of those are going to be company-owned units, about 100 of those will be franchise units, just rough numbers, right? And if you tumble the math, you can kind of do the math on how many years it would take to get to 2,000 units. So nothing's changed as far as any of the -- our conviction with that business is still great. It continues to produce very predictable, great financial numbers. And if you look at the unit economics of the business in terms of opening new units and the ROI on that business, it's just phenomenal no matter how you look at it. So I think it's got a really healthy road ahead of it.

And how are you approaching the franchise partners? How many do you currently have, the average number of locations? Are they getting bigger over time?

Yes, it's a great question. So we have roughly about 60, let's call them, active franchise partners. So the franchising business -- so we have sitting here today visibility to about, call it, 1,000 locations, right? And when it comes to franchising. So if you think about the typical franchisee that we have, first off, they're amazing people or groups of people, generally speaking, they have experience in either other multiunit concepts, so it could be hotels, it could be QSR, et cetera, they typically have expertise with development, real estate construction. So they know this world, they know how to develop locations. When we bring on a franchisee, typically we're looking at a 10-unit deal. So we don't do onesie-twosie deals, and we also don't like the whole too big to fail kind of concept, right? So you're going to see we're very intentional with how we pick out franchisees, the size of the initial development agreement and then we scale that over time. So we have some franchisees that are on their second or third development agreement at this point because they've had so much success with the Take 5 business, and they love the model. And so that's been working us for us now since 2017 when we opened our first franchise location and see no reason why it would stop.

When we think about the industry, it's quite fragmented. And I think some would argue maybe a little saturated just because you have everyone from local mechanics to auto dealers offering to change your oil. So could you maybe talk about the opportunity that exists. We talked about the units that you expect to grow, but why you have license to grow? What's behind the expansion? And what makes the qualities behind Take 5 oil attractive or differentiated to customers versus everyone else?

Yes. It's amazing question. So I think when it comes to Take 5 oil change, it starts with we have a very specific and simple go-to-market proposition why consumers like this. We're fast, friendly and simple. Right -- it's as simple as that, right? So you can come to Take 5. You're going to get your oil change done in 10 minutes. You're going to stay in your car. It's all menu-based services. There's no heavy selling. So if you know, in the automotive industry, there's a bit of a trust factor that happens, right? You're talking about 50, 60 years of maybe folks selling more than they should and stuff like that. So our approach to that is it's a very simple business. It's almost like a QSR experience. You come in. There's a menu. These are the 5 services we sell, everything that we sell to show and tell. And we start every single transaction with a free bottle of water. So in a world where you have a consumer that is maybe expecting a certain type of experience when they come in before I've asked you for a $0.01, you have a free bottle of water, you're in and out in 10 minutes and you haven't been oversold anything, it makes a huge difference. And we see that difference not just in our NPS scores. So we enjoy kind of high 70% NPS scores, and we see it in our repeat rates. So it is a great proposition vis-a-vis the consumer. They reward us, the way that I said, through NPS scores and repeat rates. If we think about the competition, to your point, so there is a lot of mom-and-pops. So you can think of it maybe a couple of different slices, right? So you have your national competitors. Some of them are here today. I think quite highly of those folks. They do an amazing job. You've got some regional competitors that are starting to crop up a little bit that are trying to mimic some of the things that we've been successful with. They're trying, and that's okay. Competition is a healthy thing. I think we have a better mousetrap and we have better real estate than anybody out there and that pays dividends for us moving forward. And then you've got some scaled operators that are maybe more classic repair maintenance. Historically, those folks will get into the oil change business more as a means to do other work. So it's not so much that they're interested in doing an oil change for our customers, they're interested in, I'll call it, loss leaders, and maybe that's the wrong terminology, but they're interested in the loss leader to do your brakes, to do your tires, stuff like that. And we will win all day long vis-a-vis those competitors because at the end of the day, the consumer doesn't want to be on a dirty lobby for 2 hours talking about tires, right? They just want their oil change done in 10 minutes. So I think that's some of the reasons why consumers tend to -- we tend to enjoy very high repeat rates.

If we can maybe move on to car wash. The U.S. car wash business is undergoing a turnaround. I wondered if you could maybe talk us -- walk us all the way back to the acquisition and talk to us about what attracted you to the business in the first place, why this particular asset and just highlight some of the recent challenges that you're trying to work through.

Yes, I'll take that one, Kate. The -- we made the acquisition back in summer of 2020. And I think the car wash category in the United States has changed quite a bit over the last 4 years. I think we've seen significant competitive intensity. So we probably added in the express tunnel car wash category, approximately 3,000 new units over that time frame. So I think that's a big change from what we've seen. We've seen a massive infusion of institutional capital into the space. You now have probably 20 platforms with institutional capital behind it, all sort of buying for a lot of the same trade areas, a lot of the same real estate. I think that what has changed, obviously, over the last 12 to 18 months is a little bit of the macro pressure on the consumer. This was the first business that we've owned that was more discretionary than others. And I think we've seen that sort of flow through some of the underperformance in the business for us. I think Danny and the team have done a nice job stabilizing that business. We're focused on growing our membership count, our membership revenue. Ultimately, this business is still impacted by weather. I don't like being in the weather business, but that's the truth. So until we get that revenue subscription to a high enough amount to sort of offset the volatility of the weather, I think we're still going to have some lumpiness in the performance. So I think what we've said publicly, starting about a year ago is we won't be putting growth capital back into that asset class for Driven. We have -- when we think about our 3-year EBITDA growth targets, 2/3 of that growth was going to come from our oil change business. We still feel great about that. The other 1/3 was going to come from our glass and our procurement businesses. We feel great about that. We had not modeled any upside into the U.S. car wash business. I think what we are working through now, Mike and myself and the Board is, what is our long-term view on the U.S. car wash business within Driven Brands. And we're very optimistic that we can have a definitive decision on that before the end of the calendar year.

And would that include the international? Or is the international kind of a separate thought?

Yes. It's a separate business. We acquired both when we acquired the asset in 2020. The European business is a terrific business, run by one of our best executives, Tracy Gehlan, who lives in the U.K. It's an independently operated model. So it's sort of franchise-like. It's been very consistent, stable, predictable business, very high cash flow generative. So I think our focus is on the underperforming U.S. car wash business and what we do with that. And then once we get clarity on that, we'll sort of figure out what we want to do long term with the international business.

And I think you've gotten the question before that you have tried to rebrand the car wash business with the Take 5 brand. What is the status of the rebranding? And how does that impact any decision that you make with regards to the asset?

Yes. We are 95% finished with rebranding our U.S. car wash stores to Take 5 car wash. That made a lot of sense in terms of a lot of those stores are in the same trade areas and markets as our great Take 5 oil change business. That will not be a decision point in terms of whether we decide to stay in or outside of that asset class. So it was the right decision. I still think it was the right decision, but it won't be a determinant in what we do with the business on a go-forward basis.

Moving on to Auto Glass, which is a newer business for you. The integration of Auto Glass Now, the platform now seems to be behind us. How should we think about the potential for this platform to scale longer term? And what can we see over the next year?

Yes. Our underwriting thesis with our glass -- entrance into the glass business is very much intact. This is a really large category north of $5 billion. There's a magnificent leader in the space. Everyone knows the jingle. They've done a really magnificent job over the last 20 years. What we saw as the opportunity was there was a massive fragmentation below that one dominant player that probably has somewhere around 35% to 40% market share, highly concentrated in that insurance pay segment. We, in our collision business, do $2 billion worth of insurance collision work every year. So we have deep relationships with our insurance partners. There's a really big commercial opportunity. When I mean commercial, it's rental car fleet management companies, other large owners of fleets. Those are deep relationships that we have already. And then there's a retail component. So, we did 13 acquisitions to get scale. We did that about 18 months ago. We did have a more challenging integration period than we probably expected. That's behind us now. We're now excited about growing top line revenue in that business and sort of building out that platform and hitting our underwriting thesis and sort of pleased with the progress so far this year.

And for incremental growth for this business, would you consider M&A still? Or would you look more towards greenfields?

I think we were highly acquisitive with 13 acquisitions in about an 18-month period. I don't think there's a need to do incremental M&A because we've built a pretty scaled platform at this point. As we think about future unit growth, it will be a combination of de novo openings. And then the other thing that's very important in this category is mobile capabilities. So we can add capacity to our business without opening bricks-and-mortar stores, but by adding more mobile capabilities. So I think it will be more organic greenfield or mobile expansion versus future M&A in the space.

And then just to drill down a little bit on the actual business of Auto Glass. How does the average ticket and attachment rates work for the business? And how does it vary by customer type? And what are the KPIs required with regards to winning the insurance volumes?

Let me take that. Yes. So maybe the best way to start is to think about the types of customers that we have. So there's essentially 3 types of customers. So you have insurance business, you have commercial business and then you have retail business. And then within the insurance business, not to overcomplicate things, but there's 3 levels there as well. So you have natural insurance, regional insurance, and let's call it local insurance. The ARO, what we would call ARO, average repair order, the check profile of those businesses are all slightly different. So the easiest way to think about it is insurance business is the most profitable for us as the best margins. Next would come commercial, and then after that would come retail. So as far as -- that's loosely from a profile perspective how it looks. As far as building up the check, so basically, it starts with make model year of the car. You then source the glass. The glass is going to be specific to the make model that you're talking about. There's something in the industry called NAGS. Think of it as basically a book value of what a job should cost for certain make model year type of work. And then you price off of NAGS, so you can price at NAGS, you can discount off of NAGS, but it basically starts with what car are we talking about, which piece of glass are we talking about, what pricing structure do you want to have vis-à-vis NAGS. And then from there, really the next knock-on is going to be calibration. So for those of you that don't know, so I think it's 2018 if memory serves, from 2018 forward, every vehicle behind that front windshield has a camera, that camera handles the safety systems in the vehicle. So when you switch out the glass, you have to recalibrate that camera. So that's a natural kind of tailwind in the industry. And so that's the secondary piece to pricing out the job, so to speak.

If we could maybe move on to the legacy franchise businesses, Meineke, Maaco, CARSTAR, 1-800-Radiator, businesses that you've talked to that have steady performance and strong EBITDA margins, how do you view these brands in your overall portfolio? And how should we think about the businesses and their contribution to growth and profitability over the long term?

Mike's recently joined as our CFO and one of his first observations was we should be thinking about resegmenting how we report the business to the outside world. Clearly Take 5 oil change is a crown jewel within our portfolio and probably doesn't get the full spotlight that it deserves in our current reporting structure. So I think we will be most likely reporting Take 5 oil change as a stand-alone entity or stand-alone segment starting in 2025. I think that will allow people to really understand the power and the velocity of the earnings growth in that business. The question around the franchise businesses, Kate, is we have great businesses that you mentioned. They are very predictable, stable businesses, generally deliver a 2% to 4% same-store sales. There's nice moderate unit growth there. But really what they are is a collection of phenomenal cash flow businesses. So when you put all those together, you've got EBITDA margins in that segment, which would be north of 60%. That is the stable, predictable cash flow that we generate, which then we can reallocate into growth opportunities, whether that's Take 5 or other things. So, as part of this segmentation work that Mike is leading, it's highly likely next year that we will consolidate those franchise businesses into one segment where people can understand the stability, the predictability and the cash flow of those businesses as one segment. So great businesses. We love them. They're 100% franchised, obviously very asset light. I think they're probably a little bit misunderstood in terms of the cash flow generation that they provide to the Driven platform.

And just what about M&A overall, I mean would you be interested in looking towards other verticals within autos? And then again, for each of the segments, how do you think about M&A?

We've done a lot of M&A since I joined in 2012. So we've built a lot of these platforms with some level of M&A along the way. I think we've hit scale in almost all of the platforms that we operate in now. So we don't see M&A as a need to continue to grow those individual segments or platforms that we have. I think we'll always be opportunistic. If there's things that are interesting for us, we'll look at it. We generally get a look at all the assets that trade in this auto space. But we have the luxury today of having multiple growth levers in our business so we don't need to necessarily add more through M&A. We also think about if we were going to enter a new category, can that category provide the qualities that we look for? So can it be franchised? What does the margin look like? What is the labor profile of that business? What is the white space? So -- and can it be meaningful to Driven that's going to print north of $0.5 billion of EBITDA this year. So I think we're very comfortable with where we are. But I think over time, we'll continue to be opportunistic if things arise.

And with regards to leverage, it's been elevated, but you've stated that you've been comfortable at a certain level. Just how are you rethinking leverage? How has it trended in the last few quarters? And what is your targeted level?

Yes. I mean I think we've been pretty public that our goal is to get down to 4.5x net leverage by the end of this year and 3x by the end of 2026. And that's a priority for us. It's one of the things I'm focused on how we make sure that the cash we generate -- there's a couple of things. I think first and foremost, as Jonathan and Danny both mentioned, Take 5 really is a crown jewel. It has bone crushing unit economics. I bragged to my former friends at Yum!, you think Taco Bell has great economics. Just read the FDD of Take 5, like this thing is an investable proposition. And so, how can we find ways to continue in a disciplined manner to facilitate that growth. But the second big priority is figuring out how we continue to deleverage, right? We have strong cash flow. Jonathan mentioned that the franchise businesses, they continue to spin off a lot of cash. Right now, we're north of where we want to be. And so, we need to make sure we are disciplined and focused and get it back to a world in which we're all both internally and externally comfortable with what that number looks like. And at that point, we can then have the next level of conversation around what that means from a capital deployment perspective.

And Mike, I would ask, you talked a little bit about the segment reporting and your observation there, and we just talked about leverage, just as being new to the role, what have been maybe some of your other observations? Or what from your background or experience, I think if I remember correctly, there is some restaurant background in your experience, that you're bringing to Driven Brands?

Yes. I can -- well, I can probably use the rest of the 13 minutes for that, I've got so many thoughts. So, I think first of all, it's exciting and fun to be back in multi-location franchisee. And no disrespect to my friends still at Michaels, but there's just -- there's an urgency and a passion and a partnership that comes with the franchisee system that it's just -- it's -- it brings an intensity to it, but it's fun and exciting. There's just a lot going on that's really fun to tackle. I joined for a couple of reasons. I mean, I think one, like it is -- it is fun to be in my role where capital allocation is as focused on how you prioritize growth as it is how do you manage a shrinking pie. And I -- and so it's just -- it's -- I spent yesterday talking with our Head of Real Estate around the growth models and how we think about new unit locations, which is another passion of mine and making sure that we are, again, appropriately disciplined, making sure that I as the CFO don't choke off growth for what truly is a fantastic business model in our Take 5. We generate a lot of cash. We've got to figure out how we can continue to be efficient with that cash, support growth and delever. I mean, I think that to the other side, it's not really a negative because -- or [indiscernible] when I kind of came in knowing it's a complex business. We've got a lot going on. This is not Yum! where I'm from, where it was pretty Taco Bell, Pizza Hut, KFC, and while there's a lot [ that covers ] there, it's pretty easy. We've got a lot going on. And so, I think finding a way -- nothing will overcome performance. And so thankfully, we've got Danny and the team do a fantastic job continuing to execute on that. But how can we continue to find a way to shine a bright light on the Take 5 business, to effectively manage and nurture/just kind of have the franchisee business there that spits off cash and then incubate some of the other businesses, the glass business, the Driven advantage, which I think really just demonstrates the red thread we have across all of our various brands. How can we continue to bring that to this audience here and just demonstrate the various levers we have to continue to drive that profitable cash flow efficient growth.

I think, Kate, underpinning all of that, Mike also sees that the business is undervalued by at least 3x and you can make an enormous amount of money based on his stock that he got when he joined the company. So that's [indiscernible] basic hierarchy of needs, answer there as well.

Well, Mike, you didn't mention Driven Advantage. I do have that on my list of questions. I wondered if you could or whoever would like to maybe just explain what Driven Advantage is, how scaled -- how scaled you've been able to -- how big you've been able to scale it since its introduction? And when do you see the opportunity for a Driven Advantage?

Yes, want me to take that?

You take that first, yes.

So Driven Advantage, so maybe the starting point is, if you want to be a good franchisor, you want to introduce value to your franchisees. And one of the ways that a good franchisor will introduce value is by helping with savings, right? So, procurement being one of those things. So if you're going to buy widgets, whether it's pens or oil or four post lifts or anything else, you want to centralize that purchasing power, so you can get the benefits, number 1, to your corporate locations and then, number 2, pass those savings along to the franchisees. So Driven has been doing that for a long time. What Driven Advantage does is it brings us kind of into the 21st century, where you've got this Amazon-like experience, and I use that term very loosely, right? But it's a great experience. And if you're a franchisee or if you're one of our corporate locations and you want to buy anything to run your business, you can go into this Driven Advantage platform and you can buy it. And you can rest assured that, number one, the pricing you're going to get is way better than anything you could do yourself. And number 2, it's dead simple. I mean, it's search, create your list, buy and you're off to the races. And it gives us really [ unique ] power on the corporate side of things as well. So, for example, in our corporate businesses, if we talk about Take 5, you can actually go in there and create a curated list of what they're allowed to purchase, right? So, if you need a pen, you can buy this pen. You can't buy the $12 pen, right? You could buy the $0.40 pen because that's what you need to run an oil change. So, it gives us flexibility to run our corporate locations better, and it gives our franchisees the ability to very simply buy anything that they need to run their shops and do it at a cost-effective price. So that's all been done. What we're looking at now is this is -- this platform that we built and Jonathan had the vision for some years ago is interesting outside of the driven portfolio as well, right? So, we've got certain players that we don't have to -- I can't get into the specifics as to who right now, but people in the automotive industry that don't want to get into building out an SAP marketplace platform and everything else, but they want the benefits of scale. And they want the benefits of price that we get and they want simplicity. And so, we think that there could be a marketplace outside of Driven, and we're exploring those options now.

Okay. And then just in the last few minutes, I wanted to make sure it's an investor question that we get a fair amount, and I haven't heard you guys speak about it recently. So just curious about how you sound about this potential risk around EVs. And I know you have part of Auto Glass Now, I think, was a way to maybe diversify yourself a little bit from any kind of risk of EVs. But how are you thinking about it now that we've kind of come out of a really interesting period with low SAAR, maybe more hybrid than EV. How are you thinking about that as a risk?

I'll start. I think it's quite comical to look back over the last 4 or 5 years and look at the narrative on EV. 5 years ago, the entire world will go into EV in the next 3 to 5 years. I think what we've seen is the rich people who wanted to buy EVs for the most part, bought the EV. And now we've seen that stabilize and, quite frankly, moderate. I think it was forward this week announced they're pulling their big EV platform, and they're moving that to hybrid. So, I think the hype was way overdone 4 or 5 years ago, I think we're now seeing the reality that I think the car park will slowly evolve over time. I don't think anyone is quite sure if it will be EV or hybrid or something else. We have one business, I suppose, which is Take 5 oil change, which you could argue is directly exposed to an EV transition. If you take the most conservative approach and think that every new vehicle sold is going to be an electric vehicle. We're not seeing any impact to our business until the late 2030s. So, I think we're watching closely. We're not sort of buying into the hype. I think it will take time, but we don't see any risk to our business for the late 2030 based on the current trajectory of the industry.

And should the world go to more of a hybrid model where EV is de minimis, there's no exposure to Take 5 oil change, right? So, hybrids still need oil changes. So, you're back to kind of square one.

And if we're thinking about your consumer, I think, Jonathan, you had talked at a certain point within the last year that car prices being where they were, were just most of Middle America, I don't think was even in the -- could even afford it. How do you see, I guess, just that evolving over the next year? And what do you think it means for a more maintenance business like yours?

Yes. The average American household with $60,000 household income, it's pretty difficult to buy a new car these days. So, I think that is the price of new vehicles. So, I think we're seeing vehicles being driven that are older. I think we've now reached 12 years in the average life, higher mileage, older vehicles, more maintenance. So, I don't see that changing dramatically over the next couple of years. I think we've seen a little bit of noise with the total loss rates with used car come down. That's had a small impact on the collision business. But look, there's 280 million vehicles on the road in the United States today. The average age is 12 years. The mileage continues to grow. So, I think just on a macro basis, it feels really good to be in the automotive space for the next decade plus.

Okay. With that, we'll end our conversation. Thank you so much for joining us.