Pizza Pizza Royalty Corp

TSX:PZA

Earnings Call Transcript 2024-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Pizza Pizza Royalty Corporation's Earnings Call for the first quarter of 2024.

[Operator Instructions]

As a reminder, this conference is being recorded on May 10, 2024. I will now turn the call over to Christine D'Sylva, CFO. Please go ahead.

[Christine D'Sylva, executive]

Thank you. Good morning, everyone, and welcome to the Pizza Pizza Royalty Corp's earnings call for the first quarter of 2024. Joining me on the call today is Pizza Pizza Limited's Chief Executive Officer, Paul Goddard. Just a quick note, our discussion today will contain forward-looking statements that may involve risks relating to future events. Actual events may differ materially from the projections discussed today.

All forward-looking statements should be considered in conjunction with the cautionary language in our earnings press release and with the risk factors included in our annual information form. Please refer to our earnings press release and the MD&A in the Investor Relations section of our website for a reconciliation and other disclosures relating to non-IFRS financials mentioned on the call.

As a reminder, analysts are welcome to ask questions after the prepared remarks. Portfolio managers, media and shareholders can contact us after the call. I'll now turn the call over to Paul Goddard to provide a business update.

[Paul Goddard, executive]

Thanks, Christine, and good morning, everyone. Thanks for joining our first quarter investor conference call. Today, I will discuss our first quarter results and will share a brief outlook for what's ahead in 2024. Christine will then summarize our key financial highlights before the Q&A at the end. Following over 2 years of continuous strong same-store sales growth, we are pleased to report our 12th consecutive quarter of positive same-store sales growth, which now makes it 3 years of continuous positive same-store sales growth. We're very proud of that. In the first quarter of 2024, we reported a combined 1.7% same-store sales growth as Pizza Pizza restaurants reported 0.6% growth and Pizza 73 restaurants reported 8.5% growth and growth at both brands was driven by increases in both guest traffic and the average customer check.

The first quarter is typically our [ slowest ] quarter in sales. And while our sales growth was softer than previous quarters, we continue to report positive sales in a challenging economic environment. And also, I would comment that our result last year, obviously, for this quarter were very strong as well, tougher to lap those, obviously, but we managed to do that. So that's great. And moreover, in terms of this year, the unseasonably warm weather -- or winter in Canada, did adversely affect sales. And in case you didn't know, snow days are great sales days for pizza.

As we have discussed on past calls, our sales are driven by key areas of our strategy, including our well positioned in diverse value offerings throughout our menu, our convenience and presence where customers can experience and interact with our brands through a variety of platforms and the strength and resiliency of our brands, supported by effective marketing initiatives. And to give a bit more color on the importance of value, the QSR industry is naturally competitive, not just within the pizza category, but with all other QSR players, at home meal delivery companies and third-party food delivery platforms, of course.

So we know our customers are looking for value as well as quality, especially in a challenged economic landscape. So we have to find the right balance of perceived value for money. In achieving this, we promote key specials and introducing new products at price points that attracts customers. Many of our marketing messages are centered around our always on value offerings that resonate with consumers including our fixed-rate pizza, our snack boxes and our walk-in and pickup specials. And in addition to value, I'd also like to talk a little bit about presence and convenience.

Having the ability to interact with our customers through our expansive restaurant footprint across Canada, whether it's through our wide delivery network or in-store, ensures that we are able to reach customers in all metropolitan areas across Canada. In fact, our restaurant locations are within a 10-minute drive of 60% of Canadian households.

Over the last 3 years, we have seen a shift in consumer behavior with customers moving increasingly to pick up orders. And with over 750 locations across Canada, we are ideally positioned to capture all audiences, especially those looking to save on delivery, tips and surcharges that many companies charge. Our in-store pickup channel has grown steadily over the last 3 years, and it is the highest sales level it has ever been. Beyond our physical locations, we continue to invest in critical technology infrastructure to ensure we are successfully receiving even more orders through our websites, apps and call center.

Over 60% of our orders are being placed on our digital platforms, that's online via web and apps and over the phone. Even though we have the best-in-class technology for customers to order on, we also utilize third-party food delivery platforms to reach customers who choose to use those providers.

While these channels are not as financially attractive for our stores or for us, relative to our own organic channels, we know that there is a subset of customers that only use these platforms to at least prefer them to order their food and we need to have a presence there. Ensuring we are accessible to all potential consumers has always been a key priority of our business and has proven to be a key differentiator for us as well with this omnichannel approach.

In terms of strength of our brands, Pizza Pizza's innovative marketing activities and partnerships continue to be recognized as industry best-in-class and are well received by Canadians. Leveraging our popular Everyone Deserves Pizza campaign and theme, we continue to focus on inclusivity and bringing people together to enjoy our products. When we look at days and occasions that bring people together, we look to see where there is already demand and we use that demand to create opportunity. So building on the success of our 2023 Valentine's Day promotion slices for singles, we decided to celebrate the Third Wheels in our lives this year.

The Third Wheel pizza promotion was as successful as the previous year, in fact even more, with over 9 million impressions and higher sales on Valentine's Day than the prior year which was also a very successful day for us. So we really are -- have really developed a lot of experience in terms of building occasions and sales around particular events. So this was an example of a very fruitful brand-building initiative, and it's just one example of how we continually succeed in keeping our brands top of mind with customers, which is key in our competitive QSR landscape.

Another way to keep our brands top of mind is through our many high-profile sponsorships and marketing activations. This year, we were one of the first sponsors of the inaugural season of the professional women's hockey team, the PWHL. We're very proud to be a sponsor of this league and support all athletes because like we said, Everyone Deserves Pizza. The overall strength of our foundation, brand strength, marketing messages, enhanced menu, innovations in technology and continuous presence for our customers will continue to be key to our growth as we go forward.

Turning now to restaurant growth, network growth. We had a slower start to the year in the development pipeline with our traditional network, but continue to expand our nontraditional network rapidly across the country in Q1. And I do want to mention that we still do feel confident about meeting our delivery targets for 2024 for both traditional and nontraditional restaurants as well in that range of 3% to 4% or so. During the quarter, we opened 2 traditional and 9 nontraditional Pizza Pizza locations and closed 2 traditional and 5 nontraditional locations.

Meanwhile, we opened 1 nontraditional Pizza 72 restaurant during the quarter as well. So over the year, we will accelerate our restaurant openings across Canada as part of our national expansion as we have plans to open more in Quebec, Ontario, British Columbia and in Atlantic Canada. Construction times, permitting and supply chains seem to be now working at more of a normal pace as well, which is excellent to see. And beyond Canada, we continue working with our Mexican partners on the next set of restaurant openings, which is very exciting.

We are happy with the progress the first stores are achieving and are excited about the long-term potential of this high-growth, high pizza consuming market, but we are going to be focused and judicious as to how we further expand our footprint in Mexico to make sure it makes sense, but we're very happy with our partner and our progress so far there.

Now on to outlook and closing remarks. As we look further into 2024, we are well positioned to continue driving our business, executing on our plans of innovation, marketing initiatives, digital investments and delivering high quality, great value and delicious hot and fresh food to our customers. We know the economic landscape is challenged, and we will ensure that our customers continue to see us offering the best food as a value offering.

Lastly, thank you to our team members and restaurant owner operators for your commitment and dedication to our customers and our brands and for being such key members in our success. Thank you for listening, and I'll now ask Christine to provide a brief financial update.

[Christine D'Sylva, executive]

Thanks, Paul. Before going into the results for the quarter, I just want to spend a few moments reviewing the structure for any new investors. Pizza Pizza Royalty Corp. is a top line restaurant Royalty Corp that earns a monthly royalty through a lease agreement with Pizza Pizza Limited, the private operating company. In exchange for the use of the Pizza Pizza and Pizza 73 trademarks in the restaurant operations, Pizza Pizza Limited pays in partnership a monthly royalty calculated as a percentage of Royalty Pool sales. Growth in the Corp is derived from increasing same-store sales of the restaurants in the Royalty Pool and by adding new restaurants to the pool each year. On January 1 of each year, the Royalty Pool is adjusted by adding new restaurants opened in the previous year less any restaurants that have been permanently closed.

In exchange for adding these restaurants, Pizza Pizza Limited ownership of the partnership increases. So on January 1, 2024, the Royalty Pool increased by 31 restaurants as a result of adding 45 restaurants less 14 that closed in 2023. For the fiscal year of 2024, there will be 774 restaurants in the Royalty Pool made up of 672 Pizza Pizza locations and 102 Pizza 73 locations. This is compared to 2023 when there were 743. So briefly covering the financial results for the quarter, as Paul mentioned, same-store sales growth, the key driver of yield for shareholders increased 1.7% for the quarter, where Pizza Pizza restaurants reported 0.6% and Pizza 73 restaurants reported 8.5%, and both brands saw an increase in customer transactions and average ticket.

The combination of restaurants being added to the Royalty Pool, the same-store sales growth and the extra day in February of 2024 for the leap year resulted in an increase in Royalty Pool system sales and the corresponding royalty income.

Royalty Pool system sales for the quarter increased 4.3% to $148.9 million from $142.7 million in the same quarter last year. By brand, sales from the 672 Pizza Pizza restaurants increased 3.7% to $128.3 million, and sales from the 102 Pizza 73 restaurants increased 8.2% to $20.6 million. The partnership's royalty income earned as a percentage of Royalty Pool sales increased 4.6% to $9.6 million for the quarter. The partnership also earned interest income on its cash and short-term investments. For the quarter, the partnership earned $120,000.

Turning to partnership expenses. Administrative expenses for the quarter were $126,000, and these included listing costs as well as director and legal and auditor fees. In addition to admin expenses, the partnership pays interest on its $47 million credit facility. Interest paid in the quarter was $319,000. The partnership is making interest-only payments on the non-revolving facility.

The interest rate is locked through April 2025 using swap agreements that have fixed the rate at 1.81% plus a credit spread for a combined rate of 2.685%. So after the partnership has received royalty income and interest income and has paid administrative and interest expense, the resulting net cash is available for distribution to its 2 partners: Pizza Pizza Limited and Pizza Pizza Royalty Corp. Effective January 1, 2024, after adding the restaurants to the Royalty Pool, and truing up the 2023 vending, Pizza Pizza Limited's ownership increased 1.3% to 25.2%. Pizza Pizza Royalty Corp. shares in the remaining 74.8% of the partnership earnings and distribution. So the Royalty Corp. received a distribution, pays its tax on the share of the partnership earnings and any residual cash is available for distribution and dividends to the shareholders.

Speaking to shareholder dividends. The company declared shareholder dividends of $5.7 million for the quarter or $0.2325 per share. This is compared to $5.2 million or $0.2125 per share in 2023. The resulting payout ratio was 122% for the quarter, and this includes the distribution paid to Pizza Pizza for the Class B shares relating to the true-up of the 2023 vend-in.

Additionally to note, system sales for the quarter ended March 31 have generally been the softest and historically this quarter results in a payout ratio of greater than 100. However, the company targets the payout ratio at or near 100% on an annualized basis. The payout ratio resulted in the company using working capital to the tune of approximately $1 million, but has ended the year with a healthy $7.2 million working capital reserve. That concludes the financial overview. I'd like to turn the call back to the operator to poll for questions.

[Operator]

[Operator Instructions]

Your question is from Derek Lessard from TD Cowen.

[Derek Lessard, analyst]

Happy to talk to you, and congrats on your 3-year positive trend. I just wanted to maybe touch on the Pizza Pizza brand itself and sort of the smaller increase in same-store sales there, Paul. Just curious if it's more a function of like you were lapping that a really tough comp and 15% growth last year in weather. Was there anything else in there in terms of increased competitive activity or anything like that?

[Paul Goddard, executive]

Yes, that's a good point, Derek. And like you and I both mentioned, yes, we were lapping that strong number, 15.5% for last year for Pizza Pizza in Q1, but that's our job to lap that as best we can and we managed to, so I think first of all, I'd say that. But yes, I would say that we have seen more aggressive competitive behavior relative to some other ones, it's always intense, but we have seen an even higher level of, I would call it, extreme discounting, almost irrational discounting from some players in the market and the frequency of that and the magnitude of that seems a little more intense, and it does depend on what part of Canada and which competitors, but we have noticed that. We've also noticed third-party channels getting even more competitive as well. So yes, it is more intensive, and we do think -- the third factor, I guess, the third comment would be that just the overall macro environment does seem challenging, as I tried to allude to in my comments in terms of consumer discretionary, the attitude of people and need to be very careful with spending.

So I think all of those aspects do represent some challenges for us incrementally. And I just think that the good news is we've been able to successfully manage in that environment and I guess, with our various channels and our ability to really even accentuate value more, we still feel quite confident that we know how to attract customers and get traffic volume growth. But it is more challenging, I would say than say, this time last year to the background environment.

[Derek Lessard, analyst]

Okay. That's helpful. And I guess I picked up on your comments, on your prepared remarks with, I guess, a shift in consumer behavior and sort of, I guess, going more towards that in-store pickups. Is that part of the -- I guess, is that part of the sort of the macro backdrop? Or I guess it's cheaper to not pay the added delivery?

[Paul Goddard, executive]

Yes. Exactly. And I don't think we're unique in that regard. I think if you look at just across not only Canada and other QSR and in the U.S. as well. I mean, you see that theme coming through with a lot of different players. I think the good news is -- for us is we have, for many years, been very strong and capable in that pickup sector especially whether it's digital or just arbitrary walk-in, non-premeditated walk-in. We're sort of distinguishing our terminology internally with pick up being a premeditated order usually digital when you're going to pick up and you order your pizza on your app or what have you, and it's ready for you perfectly when you get there or just you walk in and you grab a slice randomly. But we have been very effective at that, and we do see that.

But it's, I think, pretty clear and you would notice that our delivery check is higher, particularly than our pickup check. So that -- as much as we get great volume, it's a great trend in pickup. We also do like to get organic delivery ideally and our average check is higher. So that is sort of a good news, bad news situation. We're very capable of driving that pickup at both brands, and we've seen that and we compete very well there. But we also want to keep driving that delivery -- organic delivery. So it is on balance, it's a change -- it is a changing behavior. People are scared for these big checks -- these big check sizes, especially with third-party platforms. And so we still have that affordability option. I think that's nice whether it's through [ the ] pickup, but pickup is the most affordable.

[Derek Lessard, analyst]

Yes. But I guess it's good to have those options during more challenging times.

[Paul Goddard, executive]

Yes.

[Derek Lessard, analyst]

But on the other hand, pretty strong -- or very strong actually in Alberta. Could you maybe talk about some of the drivers and maybe differences in the backdrop there?

[Paul Goddard, executive]

Yes. I think we've been taking a fresh look at our whole marketing approach there. We recently had some success with sort of a very, kind of, innovative menu offerings, including sort of spicy Indian food offerings, curly fries. We've also been successful in creating more of a snack day part, sort of a curly fries snack box out there. So that's kind of resonated nicely as well and so we're pretty pleased there.

And I think we're going to keep putting more effort and trying to also supplant what we see at Pizza Pizza with the success we've had, some of those similar analogous themes over to Pizza 73. And we've been doing that a little while now, and so that's encouraging. And we've also optimized third party there. We do use those platforms as kind of an additional growth channel. And that was -- we did as a success, especially this last quarter in sort of driving that more and optimizing that. Although just like at Pizza Pizza, we prefer our main organic channels, obviously.

[Derek Lessard, analyst]

Okay. Curious on product innovation or your product, I guess, your innovation pipeline. Maybe just talk about -- you talked about the curly fries, Paul, but anything else that coming down on the pipe that you guys are excited about that could jump -- I guess, push sales up?

[Paul Goddard, executive]

Well, we're always doing new things. I mean I think Christine probably has more than I do with [indiscernible] figures. But I think 1 example, and this is just starting in the market now is things like our strong boilies at Pizza Pizza have been very successful. That's kind of a small kind of roll-up pizza that's very sort of snack size, very quick, and we're promoting heavily right now, Hawaiian strong boilie, which seems to be getting great traction, and we're advertising that through digital and non-digital channels. So that's one example. We've been very successful with poutine, lots of different poutine recipes, not just basic poutine but curly fries poutine, poutine with chicken, et cetera, popcorn chicken and other things. And so some of those have really resonated nicely. And I think the snack day part, I think we're starting to really get some traction as well with both brands.

So we'll keep innovating. I don't want to give away all of our product pipeline. But we're always going to be looking to innovate on toppings, crust, core pizza offerings, core chicken offerings and even other categories like desserts, cookies and things like that. So I think we've been pretty successful at trying to find the balance there and make sure that it also makes sense for us in terms of the operating company profitability and franchisee profitability as well.

[Derek Lessard, analyst]

Sorry, go ahead, Christine.

[Christine D'Sylva, executive]

Derek, to add on to what Paul was saying, for 4/20, we did even a mini version of the strong boilies. They were called pre-rolls. They were at a price point sub-$5, but it hit that snack day part. So what we're trying to do is trying to find things that we already have in our system that are working well, augment them and hit them at a price point where it's really affordable and craveable for our customers. So that was 4/20, and that really went over well in the market, and we saw a nice pickup there as well.

[Derek Lessard, analyst]

Awesome. And in terms of the franchisees being on board with sort of these, I guess, additional snacking options. How are they in terms of profitability, number one. And number two, is there any extra work for them? Or how does that work out?

[Paul Goddard, executive]

Yes, that's a good question. I mean you know the business well, right? I mean we have to make sure that, number one, it's something customers want and we think its novel or tasty and the value is there. Number one, do they like it? And then does it work operationally for our franchisees. It just can't be too funky, too operationally complex. And so the good news is something like these pre-rolls or strong boilies is, they're still working with the same things, right? It's basically like almost like a smaller pizza, right? They're dealing with the dough, the sauce, the same ingredients.

We're not trying to make them -- make extremely complex different products they've never seen before, which I think some other QSR players are maybe getting a little into the others lanes. And I think we're still sticking to our core. So franchisees do like it. And frankly, they see better margins on some of these items that are smaller, similar with our Gourmet Thin pizzas.

It's actually less product, it's thinner, it's Gourmet. They have the capability to make them, it's just a less amount of product basically in fact, faster to make. So in some ways, it's operationally better and they can make better margins on those items. So we've been quite careful to sort of make sure that we're cognizant of our operators on what they need to be successful. So they've been generally very, very receptive to this and the general types of innovation that we bring forward.

[Derek Lessard, analyst]

Awesome. And you also alluded to getting back to some strong, I guess, network expansion last quarter in a large pipeline of franchisees. Is that still the case? And I guess there's no changes to your expectations, as you alluded to on network expansion in 2024.

[Paul Goddard, executive]

Yes, we're very encouraged by the franchisee pipeline. And definitely, our big areas of focus and growth are still B.C., probably #1 and Quebec. We still think there's a lot of white space there to keep growing. And then even in the core markets, Alberta, Ontario, there's still opportunities, the Prairies, Atlantic, even though we don't have such a population base, obviously, we've been really successful there, very happy with the sales levels. So yes, we were slowing on the traditional side. And if you look at Q1 in isolation, we definitely -- we know we're behind in terms of traditional targets, but we've got a lot lined up for Q2, Q3, Q4. So we do feel confident that we are on track.

And then on traditional side, I would mention we've accelerated that as well. I mean those are easier to put in. They're hostage market, hospitals, universities, colleges, et cetera, institutions. And they can also get closed quickly sometimes if our partner -- food service partner decides to not have us there. But generally, I would say our net location growth and our reputation has been very strong there. So even though it's not as sort of material for us, at the operating company level, it still makes sense. It spreads the brand. It gives us great exposure and traction. So we'll continue doing that at both brands and both traditional and we know traditional is the biggest part.

[Derek Lessard, analyst]

Awesome. And I think this one is a little bit more granular, my last question. And it's -- last quarter, you had launched the A-level operation initiative, and I think that was focused on the overall customer experience and sort of the in-store restaurant operations. Could you maybe just elaborate on some of the initiatives under that and maybe some of the progress you've made so far?

[Paul Goddard, executive]

Yes, that's a good point. And that is a really powerful initiative. And it's a great way for us to just be even more frequent and just really essentially constantly in touch with our operators. And so we've got a number of KPIs that they need to really get to and not only just get you to achieve that A level sort of certification but to maintain it or they lose it. So it's not just like you can reach that target on customer service ratings, et cetera, cleanliness, freshness, sales, performance, et cetera.

It's a multifaceted dashboard basically. And we say you've got it and we make -- we certainly make sure there's a lot of recognition for those operators, and they set the example and raise the bar for others, but they can't just take it for granted once they reach that level, they have to sustain it or they lose that status. So it's become a way to just really extenuate the importance of the guest experience and also tied together with their financial, which you're talking to operators, you've got to speak your language, which is not only customer satisfaction, but how are you making more money by doing this. And so I think it spreads together those 2 aspects, financial performance and customer satisfaction, very nicely in terms of just saying, every restaurant system should be A level.

We're always striving for that. But it's an extremely -- just to give you a sense, it's a very high, high standard above even our already high standards. So it's not easy to achieve. And there's still -- I would say it's still early days in terms of the number of people that we have recognized and certified at that level at both brands, but we're very happy with the growth and the people that are starting to achieve that, if that makes sense.

[Derek Lessard, analyst]

Yes, that does absolutely. Could you give us a sense of how many operators are sort of a percentage in the network that have achieved that standard?

[Paul Goddard, executive]

Christine might know better than me. I know it's still a low number overall in proportion of the entire network that are [indiscernible] just recognizing, it's only been so long. But if you look across our entire network, I would say it's probably still less than 10%, but we're happy with that trajectory. I mean I think it would be -- we've had a comfort with the pace and it does seem to gather more momentum as more people get into it, I would anticipate an acceleration of that so that hopefully, a very significant portion of our stores reach that standard and aspire to reach that standard. There's a nice envy factor, it creates where you get an operator says, "Can I come and visit your store because you're only 5 kilometers away from mine and why are you doing so much better?" And often, it comes down to their quality service, cleanness, guest experience and just professionalism of the store, how strong is their team and all those aspects, right?

There's a people aspect and a sort of technical aspect of just competence and capability. And so we want our operators to celebrate that and actually become coaches themselves so that we're not the only coaches. And that's a mentality where it becomes a sort of a very good or contagious effect across the network.

[Operator]

There are no further questions at this time. I will now hand the call back to Christine D'Sylva for the closing remarks.

[Christine D'Sylva, executive]

Thank you, everyone, for joining our call today. If you have any questions after this call, please feel free to contact us. Our information is available on our website and on our press release. Have a great rest of the day.

[Operator]

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect.