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Diversified Royalty Corp
Symbol DIV
Shares Issued 120,825,785
Close 2020-08-07 C$ 1.93
Recent Sedar Documents

Diversified earns $2.9-million in Q2

2020-08-08 02:00 ET - News Release

Mr. Sean Morrison reports

DIVERSIFIED ROYALTY CORP. ANNOUNCES SECOND QUARTER RESULTS

Diversified Royalty Corp. has released its financial results for the three months ended June 30, 2020, and the six months ended June 30, 2020.

Highlights:

  • Revenue of $6.3-million and adjusted revenue of $7.5-million for second quarter 2020;
  • Completed closing of $9-million senior credit facility on April 27, 2020, which was used to partially refinance the acquisition of the trademarks and certain other intellectual property rights utilized by Oxford Learning Centres Inc. in its franchised supplemental education service business.

Second quarter results

In Q2 2020, Diversified generated $6.3-million of revenue compared with $7.5-million in the three months ended June 30, 2019. After taking into account the Diversified royalty entitlement related to Diversified's royalty arrangements with Nurse Next Door Homecare Professional Services Inc., Diversified's adjusted revenue was $7.5-million in Q2 2020 compared with $7.5-million in Q2 2019. Adjusted revenue for Q2 2020 was flat compared with Q2 2019 due to a number of factors, including: the impact of the COVID-19 pandemic, which included negative same-store-sales growth (SSSG) at Mr. Lube Canada Limited Partnership and lower royalty income from the Air Miles licences, as well as royalty and management fee waivers for Mr. Mikes Restaurants Corp. and Sutton Group Realty Services Ltd., offset by incremental revenues related to the Nurse Next Door royalty transaction in November, 2019, and the acquisition of the Oxford rights in February, 2020.

For the six months ended June 30, 2020, Diversified generated $13.6-million of revenue compared with $14.0-million for the six months ended June 30, 2019. After taking into account the Diversified royalty entitlement related to Diversified's royalty arrangements with Nurse Next Door, Diversified's adjusted revenue was $16.0-million for the six months ended June 30, 2020, and $14.0-million for the six months ended June 30, 2019. The increase in adjusted revenue was due to the incremental revenues related to the Nurse Next Door royalty transaction in November, 2019, the acquisition of the Oxford rights in February, 2020, and the acquisition of the MRM rights in May, 2019. The increase was partially offset by the impact of the COVID-19 pandemic, as noted herein.

Royalty partner business updates

Mr. Lube: SSSG for the Mr. Lube stores in the royalty pool was minus 12.5 per cent in Q2 2020 and minus 10.0 per cent for the six months ended June 30, 2019. Mr. Lube's SSSG was negatively impacted by the COVID-19 pandemic, which resulted in a slowdown in consumer activity across the country and recommendations from all levels of government for people to work from home and self-isolate. As certain provinces started easing the restrictions put in place to fight the COVID-19 pandemic and Canadians started driving more, Mr. Lube's business has stabilized with June, 2020, SSSG for the Mr. Lube stores in the royalty pool up 0.4 per cent (compared with SSSG of minus 27 per cent in April, 2020, and minus 11 per cent in May, 2020). In July, 2020, SSSG for the 135 Mr. Lube flagship locations (122 of which are in the Mr. Lube royalty pool) was approximately 1.6 per cent year over year.

Air Miles: According to Alliance Data Systems Inc.'s news release dated July 23, 2020, the number of Air Miles reward miles issued decreased by 26 per cent in Q2 2020 and 12 per cent for the six months ended June 30, 2020, reflecting a decline in discretionary spending, including credit card spend and delays in promotions by sponsors. In addition, ADS announced that Air Miles reward miles redeemed decreased by 42 per cent in Q2 2020 and 25 per cent for the six months ended June 30, 2020, reflecting the impact of the COVID-19 pandemic on travel-related categories, partially offset by strength from merchandise redemptions. According to ADS, LoyaltyOne is supporting collectors and sponsors by pivoting the reward portfolio to reflect more non-travel options. ADS also noted that the Air Miles business continues to renew with sponsors, including a multiyear national renewal with Shell Canada Products, as LoyaltyOne focuses on driving collector engagement in key categories, such as gasoline, grocery and liquor, which are deemed essential services. Royalty income from the Air Miles licences were down 22.4 per cent in the three months and 8.4 per cent in the six months ended June 30, 2020, compared with the same prior periods.

Nurse Next Door: Nurse Next Door's home health care services were considered an essential service across all its markets where such determinations were made by government authorities, and all of Nurse Next Door's franchisees were open for business. Nurse Next Door management has noted that system sales in North America were relatively flat for the three months and six months ended June 30, 2020, compared with prior year.

As previously disclosed, on Feb. 14, 2020, St. Joseph Health Personal Care Services LLC delivered notice of termination to Nurse Next Door, with the intent of terminating its master licence agreement, which covers 42 Nurse Next Door franchise locations in California, effective Aug. 14, 2020. Nurse Next Door has advised Diversified that this termination will occur on Aug. 14, 2020, as originally contemplated, and will result in the payment of a termination fee of approximately $1.1-million (U.S.) by St. Joseph to Nurse Next Door, which is expected to be paid in September. Nurse Next Door has advised Diversified that Nurse Next Door expects to have other opportunities to grow in California as a result of this termination through to the sale of new franchises in the territories currently covered by the master licence agreement, following a 12-month restricted period posttermination. These new franchises, once sold, are expected to be subject to Nurse Next Door's standard franchise fees and other charges, which are higher than the discounted rates paid by St. Joseph under the master licence agreement, and are expected by Nurse Next Door to achieve higher sales volumes than the St. Joseph's franchises.

In Q2 2020, Nurse Next Door did not add any new franchisees to its network, and received notices from three franchisees of their purported termination of their respective franchise agreements. In third quarter to date, Nurse Next Door entered into agreements with four new franchisees (two of which are operational) with at least eight in the pipeline, and received notices from 15 franchisees of their purported termination of their respective franchise agreements. These 18 franchisees seeking termination have ceased paying franchise fees and have, in some cases, started competing businesses. Diversified understands that Nurse Next Door has not accepted the purported terminations and is still determining its next steps.

These 18 franchisees represented approximately 28 per cent of Nurse Next Door's 2019 recurring franchise revenues (being Nurse Next Door's revenues excluding initial franchise fees and corporate store revenue). After adjusting for St. Joseph's lost revenue, these 18 franchisees represented approximately 31 per cent of 2019 residual recurring franchise revenues. As a result, Diversified expects that the termination of the St. Joseph's contract and the purported terminations by the 18 franchisees noted herein may cause Nurse Next Door to temporarily generate less than full royalty coverage in the short term. However, as at June 30, 2020, Nurse Next Door had $9.6-million of cash on its balance sheet, $8.6-million of positive working capital and no debt. In addition, Nurse Next Door will receive the termination payment of approximately $1.1-million (U.S.) from St. Joseph in September, 2020. According to Nurse Next Door, its plan is to corporately run three of these franchises immediately, which is expected by Nurse Next Door to generate significantly higher net margins to Nurse Next Door. Nurse Next Door has advised Diversified that Nurse Next Door intends to resell the franchises of the other 15 franchisees to new or existing franchisees, generating incremental initial franchise fees in addition to replacing the lost recurring franchise revenues. The largest of these franchises (based on recurring franchise revenues) being resold is in premium markets that Nurse Next Door is confident will be operational before year-end. Furthermore, Nurse Next Door expects that the incremental revenues from the four new franchises and at least eight in the pipeline will further enhance Nurse Next Door's profitability, once operational. Accordingly, Diversified currently expects Nurse Next Door to continue to make its royalty payments.

Sutton: As disclosed in Diversified's news release dated March 31, 2020, with the dramatic slowdown of residential real estate activity due to the COVID-19 pandemic, Diversified waived 75 per cent of Sutton's April and May royalty and management fee obligations (that were payable in May and June, 2020, respectively). The June, 2020, royalty payment and management fees were not subject to a waiver and were received in full. According to the Real Estate Board of Greater Vancouver's news release dated July 3, 2020, homebuyers and sellers have gradually become more active in each month of the COVID-19 pandemic, and home sales and listing activity in metro Vancouver returned to more historically typical levels with June sales volumes up 18 per cent (compared with minus 39 per cent in April and minus 44 per cent in May). According to the Toronto Regional Real Estate Board, sales volumes were only down 1 per cent in June (compared with minus 67 per cent in April and minus 54 per cent in May). Vancouver and Toronto comprise two of Sutton's primary markets. Diversified will continue to assess the impact of COVID-19 on Sutton's business and liquidity to determine if any further royalty relief is necessary.

Oxford: SSSG for Oxford locations in the royalty pool on a constant currency basis was minus 41 per cent in Q2 2020 and minus 30 per cent for the period from Feb. 20, 2020, to June 30, 2020. SSSG was negatively impacted by the COVID-19 pandemic, which resulted in the temporary suspension of in-person tutoring services for all its locations. In mid-March, Oxford management pivoted its business to provide on-line tutoring with over 95 per cent of its locations able to provide this service. Oxford sales are improving with June, 2020, SSSG on a constant currency basis of minus 33 per cent for the Oxford locations in the royalty pool (compared with SSSG of minus 47 per cent in April, 2020, and minus 44 per cent in May, 2020). In early July, in accordance with regional guidelines, certain Oxford locations have started transitioning back to in-centre services at a reduced capacity. Oxford is in the process of making the necessary changes in its locations to ensure that every parent, student and staff member will have the safest possible experience at is locations. Currently, approximately 50 per cent of Oxford's 154 locations are open for in-centre services at a reduced capacity.

Mr. Mikes: Currently, 43 of 45 Mr. Mikes restaurants have reopened for in-restaurant or patio dining. Overall SSSG for Mr. Mikes restaurants in the royalty pool, including stores that were temporarily closed due to the COVID-19 pandemic, was minus 28 per cent in June. SSSG for Mr. Mikes restaurants in the Mr. Mikes royalty pool that have reopened for in-restaurant and patio dining was minus 19 per cent in June, 2020. Notwithstanding the partial reopening of such Mr. Mikes restaurants, Diversified continues to expect that Mr. Mikes will experience a slow recovery and constrained cash flows. Accordingly, Diversified has waived Mr. Mikes's fixed royalty and management fee payment for the period from Feb. 24, 2020, to July 12, 2020. Diversified anticipates that Mr. Mikes may require royalty relief for an extended period of time and is in discussions with its lenders and Mr. Mikes in this regard.

Second quarter commentary

Sean Morrison, president and chief executive officer of Diversified, stated: "The COVID-19 pandemic had a significant impact on the operations of our royalty partners. However, as certain provinces have started easing restrictions put in place to fight the COVID-19 pandemic, we are starting to see encouraging trends in the performance of our royalty partners. The management teams of our royalty partners continue to pro-actively support their franchisees by means of negotiating rent deferrals and concessions, arranging for improved payment terms with suppliers, or promoting government-sponsored initiatives."

Mr. Morrison continued: "DIV will be working closely with Nurse Next Door management to deal with the recent franchisee departures. With its strong balance sheet, Nurse Next Door has financial flexibility to continue paying its royalty while working through this challenging time. We continue to be in regular discussions with our royalty partners and, in consultation with the board, monitor developments with a focus on the long-term success of DIV and its royalty partners."

Distributable cash and dividends declared

In Q2 2020, distributable cash was $4.9-million (4.05 cents per share), a decrease of $600,000 (decrease of 1.0 cent per share) compared with Q2 2019. The decrease was primarily due to lower adjusted revenue on account of the reasons discussed herein, higher interest expense and lower interest income.

For the six months ended June 30, 2020, distributable cash was $10.4-million (8.89 cents per share), an increase of $100,000 (decrease of 0.63 cent per share) compared with the six months ended June 30, 2019. The increase in distributable cash was due to higher adjusted revenue, largely offset by higher interest expense, lower interest income and higher current tax expense. The decrease in distributable cash per share was primarily due to a higher weighted-average number of common shares outstanding for the six months ended June 30, 2020.

In Q2 2020, dividends declared exceeded distributable cash by $1.1-million, and the corporation's payout ratio was 123.4 per cent. The shortfall in distributable cash was financed by a $3.8-million GST refund related to the acquisition of the Nurse Next Door trademarks.

For the six months ended June 30, 2020, dividends declared exceeded distributable cash by $2.2-million, and the corporation's payout ratio was 121.5 per cent. However, the company's dividend reinvestment plan (DRIP) was open for participation during the three months ended March 31, 2020. As a portion of the dividends declared during the first quarter of 2020 were settled through a reinvestment in the company's shares for participants in the DRIP, the payout ratio on a cash basis was 111.4 per cent. The shortfall in distributable cash was financed by a $3.8-million GST refund related to the acquisition of the Nurse Next Door trademarks.

As announced on March 31, 2020, given the economic uncertainty facing Diversified and its royalty partners as a result of the COVID-19 pandemic, the board of directors of the corporation approved changing the monthly dividend from 1.958 cents per share per month (23.50 cents per share on an annualized basis) to 1.667 cents per share per month (20 cents per share on an annualized basis), effective with the dividend declared in the month of April, 2020. The board of directors believes the reduction of the monthly dividend is a prudent measure to preserve capital and maintain liquidity in the current market environment. In addition, starting with the April, 2020, monthly dividend, the board approved the temporary suspension of the DRIP until further notice as the board does not believe it is in the best interests of the company or its shareholders to issue shares at current prices.

Net income (loss)

Net income for Q2 2020 was $2.9-million, compared with net income of $3.4-million in Q2 2019. Net income decreased due to lower income from operations and higher interest expense and finance costs, partially offset by the fair value adjustment on financial instruments.

Net loss for the six months ended June 30, 2020, was $8.9-million, compared with net income of $5.9-million for the prior period. The net loss for the six months ended June 30, 2020, was primarily due to a non-cash impairment related to the MRM rights. In connection with the COVID-19 pandemic, Mr. Mikes is experiencing constrained cash flows and has advised Diversified that it will likely be unable to pay its fixed royalty payments to Diversified. In light of these developments, the corporation recorded a non-cash impairment of $19.8-million ($14.5-million net of tax) related to the Mr. Mikes trademarks, which is discussed in more detail in the notes to the corporation's consolidated financial statements for Q2 2020. The net loss for the six months ended June 30, 2020, was also due to lower revenues and higher interest expense, which were slightly offset by an increase in other finance income and a tax recovery.

About Diversified Royalty Corp.

Diversified is a multiroyalty corporation, engaged in the business of acquiring top-line royalties from well-managed multilocation businesses and franchisors in North America. Diversified's objective is to acquire predictable, growing royalty streams from a diverse group of multilocation businesses and franchisors.

Diversified currently owns the Mr. Lube, Air Miles, Sutton, Mr. Mikes, Nurse Next Door and Oxford Learning Centres trademarks. Mr. Lube is the leading quick-lube service business in Canada, with locations across Canada. Air Miles is Canada's largest coalition loyalty program with approximately two-thirds of Canadian households actively participating in the Air Miles program. Sutton is among the leading residential real estate brokerage franchisor businesses in Canada. Mr. Mikes currently operates casual steak house restaurants primarily in Western Canadian communities. Nurse Next Door is one of North America's fastest-growing home care providers with locations across Canada and the United States, as well as in Australia. Oxford Learning Centres is one of Canada's leading franchised supplemental education services in Canada and the United States.

Diversified expects to increase cash flow per share by making accretive royalty purchases and through the growth of purchased royalties. Diversified expects to pay a predictable and stable dividend to shareholders and increase the dividend as cash flow per share increases allow.

We seek Safe Harbor.

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