Pizza Pizza Royalty Corp

TSX:PZA

Earnings Call Transcript 2021-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Pizza Pizza Royalty Corp's Earning Call for the Third Quarter of 2021. [Operator Instructions] But after the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded on Wednesday, November 10, 2021.I will now turn the call over to Alexander Sewrattan, Director of Finance. Please go ahead, sir.

[Alexander Sewrattan]

Thank you. Good afternoon everyone, and welcome to Pizza Pizza Royalty Corp's earnings call for the third quarter ended September 30, 2021. Joining me on the call today are Pizza Pizza Limited's Chief Executive Officer, Paul Goddard; and Chief Financial Officer, Christine D'Sylva.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 the risk factors included in our annual Information Form. Please refer to our earnings press release and MD&A in the Investor Relations section of our website for a reconciliation and other disclosures related to our non-IFRS financial measures mentioned on this call. As a reminder, analysts are welcome to ask questions after the prepared remarks. Portfolio managers and media can contact us after the call.Before turning the call over to Paul for the business update, I wanted to spend a few moments reviewing the structure of the Corp for our new investors. Pizza Pizza Royalty Corp indirectly owns the Pizza Pizza and Pizza 73 brands and trademarks through its subsidiary, Pizza Pizza Royalty Limited Partnership. This partnership has two partners, Pizza Pizza Royalty Corp, the public company which owns 76.5%; and the other partner, Pizza Pizza Limited, the private operating company, which owns the remaining 23.5%. The Royalty Corp is a top line restaurant Royalty Corp that earns a monthly royalty through a lease agreement with Pizza Pizza Limited.In exchange for the use of the Pizza Pizza and Pizza 73 trademarks in its restaurant operations, Pizza Pizza pays the partnership a monthly royalty calculated as a percentage of Royalty Pool sales. Growth in the Corp is derived from increasing the same-store sales of the restaurants in the Royalty Pool and by adding new restaurants to the pool each year. The Royalty Pool is adjusted at the beginning of each year by adding new restaurants opened in the previous year, less any restaurants that have been permanently closed. For the fiscal year 2021, the Royalty Pool was adjusted on January 1, 2021, to include 622 Pizza Pizza restaurants and 103 Pizza 73 restaurants.With that review, I'll turn the call over to Paul Goddard to provide a business update.

[Paul Goddard, CEO, President & Director]

Thanks, Alex. Good afternoon everyone, and thanks for taking the time today to join our call. Today, we will highlight the results of our third quarter ended September 30, 2021. We are pleased with our positive same-store sales growth of 2.8% in the third quarter. Growth at the Pizza Pizza brand was supported by strong marketing campaigns, effective product innovation during the quarter, and by high vaccination rates and the lifting of COVID related restrictions, especially in Ontario.During the quarter, consumers became more comfortable with social interactions, which positively impacted our walk-in sales as well. Additionally, key non-traditional locations reopened, including universities, schools and large sporting and entertainment venues. While we continue to experience lingering effects of the pandemic in certain provinces, we remain optimistic that the fourth quarter, which has historically been our strongest, will continue this positive momentum.As mentioned, same-store sales growth on a combined basis increased 2.8% for the third quarter. Pizza Pizza restaurants, which account for 85% of our business, reported solid same-store sales growth of 5.7%, while Pizza 73 reported a same-store sales decrease of 11.4%, again, reflecting lingering pandemic effects. As everyone knows, hospitalizations were up and a lot of openings and closings, COVID related numbers as well.As mentioned on previous calls, our business is comprised of two revenue streams, our traditional restaurant network, which generates 90% of our Royalty Pool sales and our non-traditional and special event locations, which typically generate the remaining 10%. So since the pandemic began in March 2020, provinces across Canada have been in varying levels of operational restrictions, and those restrictions have changed the course as COVID-19 cases fluctuated.During the third quarter of 2021, the pandemic continued to impact all regions in which PPL operates. Provinces across Canada continue to face public health restrictions, including restrictions on dine-in desk counts, reduced operating hours and/or the temporary closures of stores. However, as the third quarter of 2021 progressed and vaccination rates increased, provinces across Canada began to lift these restrictions, including the return of in-person dining and easing up on the size of gatherings and the reopening of entertainment venues.As these restrictions lifted and customers emerge from stay-at-home orders, we began to see the return of our normally very robust walk in sales, especially with the warmer summer weather. We still, however, have out restaurants that continue to be impacted by the loss of walk-in sales, specifically those located in urban markets, where many of the walk-in sales are tied to corporate offices that have adopted work-from-home policies, whether temporary or longer-term remains to be seen.The second revenue stream, our non-traditional locations, which contribute 10% of our overall sales had, for the most part, remained closed since the onset of the pandemic due to the various government mandates, but we are happy to report that many of these sites have reopened as the provinces lifted COVID-19 restrictions. The reopening of our non-traditional location started off slowly as capacity restrictions were in place, but towards the end of the quarter, many were opened at full capacity.Our large non-traditional partnerships with entertainment venues and sports arenas are key sales channels, especially in the second half of the year. And that's, as many of you know, listening, hockey, basketball and other channels as well. And in the summer, is significant for us as well.While the lifting of restrictions have added win to our sales, and sales meaning sales and sales, we still face sales challenges as the delivery landscape continues to feel pressure via rising input costs and continued competition from third-party delivery services. To meet these challenges, we continue to focus on our core value offerings, new product innovations and our national expansion plan.Now I'd like to briefly touch on operations at PPL, the private operating company behind our underlying business. Pizza Pizza Limited's success stems from its long history of menu and technology innovation, along with convenient restaurant locations and high-quality menu offerings.Building on the success of our new gourmet thin pizzas from Q2, this quarter, we continue to expand our product offerings. Beyond our wide array of pizza offerings, we are well-known for our chicken selection. So the natural complement to that category was a fried chicken sandwich. This quarter, Pizza Pizza introduced three new fried chicken sandwiches. And we felt that the most exciting part of this sandwich launch was actually the introduction of our plant-based chicken sandwich.Plant-based consumers are growing a number and our chicken sandwich is the first in Canada's quick service restaurant sector. The reception of this product exceeded our expectations, attracted new customers and has highlighted the variety of plant-based products we offer. So we're very proud to be a first mover and a leading innovator in this space.The province of Alberta opened rapidly in early summer, packing restaurants and patios through the summer months. Despite concerning increases in COVID cases, the province did its best to stay the course. However, the province has struggled through recession in the oil sector, time and time again, and it's been doubly hit this time now dealing with the pandemic's effects.The vacancy rates in the urban centers of Calgary, which I think has over 30% vacancy and Edmonton are higher than those in Toronto and Montreal by a wide margin. Knowing the historical landscape and tough environment, we started and ended the quarter with a deep value proposition, our Plenty for $20 deal. We also introduced our One Topping pickup special to meet the demand for a single pizza offered at a lower price point.Additionally, we've have seen third-party delivery services continue to proliferate and, in fact, scale up in Alberta. So we have, for instance, layered on a Free Delivery message to drive customers to our own organic order channels. But to be candid, some of the things we tried haven't worked out well. Our summer innovations like Pretzel Crust and Mac & Cheese bites, although innovative did not resonate as we hoped to the volume levels that we hoped for, despite our strong brand and our reputation for innovation. So while we are not happy with our results in Alberta, we do know our food quality and our customer service and our execution of our partners out there is second to none.And as we wait for the oil and gas recovery to trickle down to other sectors of the broader Alberta economy, as well as to the everyday consumer, we are proactively amplifying and adapting our marketing messages and our marketing mix, better leverage all of our sales channels and increase our share of mouth in Alberta, especially working even harder to better drive our key volume movers.And other levers we can pull include a number of different things. I won't go into too much detail here, but obviously, we can spend more from our ad fund, new creative, product mix adjustments, more tech innovation, we're always doing, and that's always a key part of advantage for us. And this is an example. We haven't just released it yet, but in the near future on our app coming out shortly that we think will help drive repeat orders. So we're always innovating, and we're going to keep doing that.So like many companies across Canada, we continue to face inflationary headwinds as well, and we have to balance increasing retail prices to guard our restaurants' bottom line profits without impacting overall transactions. Over the last few months, we have been strategic in taking modest price increases across our menu. We'll continue to monitor the supply chain landscape and pass along the price increases where possible, but we will be very distant from doing so.Our diverse, high-quality menu, continually enhanced websites and apps, aggressive customer service stats, high-quality ratings, all of these things together, position the company very well to whether this pandemic and come out stronger. I think we've demonstrated our very, very robust resilience. We are confident that we'll be able to increasingly leverage our leading brands in new and existing markets and increase our restaurants' bottom line profits, along with our top line sales.We're encouraged by the overall latest GDP forecast for the country and most provinces. And there is a little relight there for Alberta. I think that was the most optimistic growth we're seeing coming out of some of the economists just last few days as well. So we are optimistic that things are getting closer to normal than they have been in quite some time, although we all know it's going to be somewhat different.So in closing, I just want to say how pleased I am with our momentum recently and acknowledge that this period has presented us with many challenges as well. But I think we've got used to adapting even faster than we have before and be even more agile. So we're pleased with our strong progress in resurgence at Pizza Pizza. And we know we have some work to do to get Pizza 73 re-surging similarly soon as well.So I want to personally thank our team of employees, partners and all of our operators for their outstanding work and tireless passion for our brands. We're excited about Q4 as well and our strong store growth, which has been a really good highlight this year as we work through our busiest quarter. And we're looking forward to an even better 2022.So thank you for listening, and I'll now ask Christine, our CFO, to provide a brief financial update.

[Christine D'Sylva, Chief Financial Officer]

Thanks, Paul. Today, I'd like to briefly cover the financial results for the quarter. Same-store sales growth, a key driver of yields for shareholders of the Company increased 2.8% for the quarter. Pizza Pizza restaurants had same-store sales of 5.7% for the quarter, while Pizza 73 restaurants decreased 11.4%. For the nine-month period, same-store sales decreased 3.4% with Pizza Pizza decreasing 1.8% and Pizza 73 decreasing 10.9%.Royalty Pool system sales for the quarter increased 3.5% to CAD129.7 million from CAD125.4 million for the same quarter last year. By brand, sales from the 620 Pizza Pizza restaurants in the Royalty Pool increased 6.4% to CAD111.3 million for the quarter compared to CAD104.7 million for the same quarter last year. Sales from the 103 Pizza 73 restaurants decreased 11.2% to CAD18.4 million for the quarter compared to CAD20.7 million last year.For the nine-month period, our sales decreased 2.7% to CAD355.9 million from CAD364.6 million in the prior year comparative period. The Partnership's Royalty income earned as a percentage of Royalty Pool sales increased 2.3% to CAD8.1 million for the quarter and decreased 3.1% to CAD23 million for the nine months. The change in the Royalty Pool sales and Royalty income reflects the same-store sales for the quarter end period.Additionally, while the number of stores in the Royalty Pool are 24 less from the comparative period, the financial effect for shareholders was mitigated by Pizza Pizza Limited continuing to pay royalties as part of the deficit by make-whole carryover amount. This make-whole payment will continue to be added to Royalty Pool sales until Pizza Pizza Limited has sufficient sales from its new store openings to offset sales loss when stores permanently close.So turning to partnership expenses. The administrative expenses, including Director, legal, auditor fees and listing costs were CAD119,000 for the quarter and CAD379,000 for the period. In addition to administrative expenses, the Partnership paid interest expense on its CAD47 million credit facility. Interest paid in the quarter was CAD350,000 and CAD1 million for the nine-month period. The Partnership is presently making interest-only payments on its non-revolving credit facility. The interest rate swap agreement fixed the facility's interest rate at the banker acceptance rate of 1.81% plus a credit spread.Our credit spread range is based on the level of debt-to-EBITDA. Due to the impact of COVID-19 on the Partnership over the trailing 12 months, we saw an increase in the credit spread on the facility by 25 basis points, giving us a combined rate of 2.935%. You can get a full breakdown of the credit spreads schedule in the company's MD&A. So after the Partnership has received Royalty income, paid administrative and interest expenses, the resulting net cash is available for distribution to its two partners.Turning to the shareholder dividend and working capital. The Company declared shareholder dividends of CAD4.3 million for the quarter or CAD0.175 per share compared to CAD3.7 million or CAD0.15 per share in the same quarter last year. Our resulting payout ratio was 90% this quarter. For the nine-month period, the Company declared dividends of CAD12.4 million or CAD0.505 per share compared to CAD12.7 million or CAD0.5139 per share in 2020. The payout ratio for the nine months is 97% compared to 92% in the prior year's comparative period.Since the Company was initially impacted by COVID-19 and reduced its monthly dividend from 2020, this dividend has since increased twice, with the most recent increase being a 9% increase effective August 2021. Our current monthly dividend is now CAD0.06 per share or CAD0.72 annualized. The Company's working capital reserve increased CAD500,000 during the nine month period and it ended the quarter at CAD5.8 million.We will continue to monitor the system sales and Royalty income and will consider further changes to the monthly dividend, taking into account the duration and impact of the pandemic on restaurant operations, and the timing and pace of the economic recoveries in the markets that Pizza Pizza and Pizza 73 are servicing. And we must note that it has been reassuring to see that with the easing of restrictions on restaurants and gathering, customer behavior is slowly returning to its pre-pandemic times.That concludes our financial overview. I'd like to turn the call over back to our operator to poll for questions.

[Operator]

Thank you. [Operator Instructions] And your first question will be from Derek Lessard at TD Securities.

[Derek J. Lessard, Research Analyst]

I guess my first question is, I was wondering if you could talk about the differences that you're seeing maybe in consumer behavior between, let's say, Ontario and Pizza 73 in Alberta. Both -- on both sides, restaurants appear to have been largely open for delivery and take out, just curious about the differences in consumers there?

[Paul Goddard, CEO, President & Director]

Yes. It's a good question. I mean we spend a lot of time looking at that. Obviously, Derek, relatively we are much happier with the Pizza Pizza performance. We've got the walk-in element there. The non-traditional is also a bigger chunk, right, of our overall sales here. We don't have as many non-traditional, for instance, out there and Pizza 73, just even customer behavioral side. So it is Alberta and fundamentally different in Ontario and well, I think yes and no. I think there's an economic backdrop in Alberta. Obviously, you're starting to see some encouraging signs there cautiously, about the economy and GDP forecast for next year are looking quite strong and things.But overall, I mean, they're both competitive markets. I mean, what we seem to glean from it, from some of the intel we get and see out there is that the third-party stuff, it's also a very competitive here, but we do see that a lot more restaurants seem to be available on those third-party platforms than previously were about a year or so ago. I think that growth onto those platforms is probably in the last year, have been more relative to the increase in the Ontario market on those platforms. Not to say they're not growing here as well, I think they are. But to me, that's a big part of it. So I think partly it's competitive dynamics versus necessarily a customer that doesn't like our food as much or does it like our pizza in general is a choice.We do know that our key movers continue to be very key for us. We've got a very broad array of selections, whether it's everyday deal or solo deal, other things. But we also think we need to tweak that. We're obviously not happy to get any competitive or negative results there. And so even though it's been a tough start out there and Alberta had to kind of retrench, I do think there's signs of optimism in the economy coming back. But we've seen this a little bit before, Derek, we go back so far with you. But I don't feel it we call back in I think 2015, when it was sort of the economy was very strong, prices were high before they dropped off. We actually stayed quite strong for a while. I don't know if it was six months or nine months even after things have collapsed for a lot of people and that obviously did hurt us.And I would say on the flip side, there seems to be a bit of a lag, too, right, in terms of things might be getting better, but it's not just like the oil and gas prices go high and instantly consumer confidence reverse back. So I think there is some reason to be optimistic there. But if you look at unemployment rate, it looks like it's kind of normalizing out there. So I guess back to behavior, I just think that means, hopefully, people will get more confident as we go through the coming months. And we cannot wait for that.Our view is that will be nice wind in our sales, but we're not going to wait for the economy to save us. We need to change things up because a lot of the things that we're typically used to doing and accentuating haven't been working as well out there, and you can see it in our results. So we need to really change it up. So we get that. And that could, like I say, come in the form of increased spend, new creatives, changing our marketing mix and focusing on which volume drivers we can really push on.We do think things like the chicken out there. We've also launched. We didn't launch it as quickly as we did hear. We staggered it consciously, but we're hoping that that will pan out quite well there. We also have plant-based chicken out there, too. Lots of folks that are big in the plant-based as well in Alberta, not just here. So I think there's a general sense of not as much confidence, higher unemployment out there. But at the end of the day, pizza consumers are pizza consumers. And I think if people feel that we have really great product, and we're top of mind, then we should be able to re-surge back, very similar to how we're doing here.So yes, we haven't figured it out as well as we need to, and that's clear for 73. But I do think we have some very good ideas and some really good plans of how we can do better than we have been. If that helps?

[Derek J. Lessard, Research Analyst]

Yes. Thanks for the color, Paul. And maybe just on the sandwiches for a second. You guys -- I remember you testing sandwiches in the market a number of years ago. So I guess I'm wondering what's different? What's different this time with the offering? I know there's plant-based, but just curious on the differences and why you think it will be more successful this time around?

[Paul Goddard, CEO, President & Director]

Yes, that's a really good question, Derek. And you have a very good memory. We definitely have plant-based sandwiches. We had a suite of Italian sandwiches a while ago. And I think we have very good training, very good product development, very good quality, but I just think we weren't really driving much volume in those sandwiches. And because we had so many that were different. I think we have a meatball sandwich. It was also very good. But with chicken sandwiches, it's a chicken sandwich and what we really changed with this one is, the chicken is the chicken, and there's the plant-based chicken option as well.But let's just talk about the real chicken, what we figured out as well, first of all, there's a very, very high demand in the general North American QSR market for chicken sandwiches, right? It has been sort of the case for now at least a couple of years, starting in the United States and then bridging into Canada. So if you look around, a lot of people have gotten into the chicken sandwich game, we do chicken really well. So I think that's different than last time. And we're focused on chicken, not three or four different sandwiches. So the thing is our operators, once they get really good at making sandwiches, as long as they're selling a fair amount of volume of those, retail units per week per store, that's significant.And so they get good at it, and then it's a virtuous cycle, right? So that's what's different. There's some good macro and micro demand for that chicken for a sandwiches that didn't used to be, fried-chicken sandwiches. So now stores are getting very used to that. They can see they're selling it, and so they want to do more of them. And the nuances of the product, having three different ones, is really more the add-ons, right, the sriracha sauce, the creamy garlic sauce or a vegan mayo, and that's about it, right? So -- and pickles and whatever. It's quite simple operationally.So they don't have meatballs that are sitting for hours, if no one buys one for a few hours, they're moving and there's core demand. And that is different than what we saw before. And we think in Alberta, there's really no reason why that shouldn't play out in a similar way, looking at the strength of some chicken players with chicken sandwiches in Alberta, too.

[Derek J. Lessard, Research Analyst]

Yes, that's helpful, Paul. And I guess maybe just harking back on to the efficiency of the restaurant or the store. Is there any -- I mean, obviously, to start-up, there will be some efficiency issues. But as they get used to it, is it a sandwich that could be done quickly? Or together quickly?

[Paul Goddard, CEO, President & Director]

It is, It is, it's quite simple. I think because we -- it's basically a chicken product fried and the plant-based, it's very, very minimally different to prepare separately, but the same idea, and it's quite simple. So you don't -- they don't have four or five sandwiches that are dramatically different from one another. And the difference is people are also buying them. So it's operationally easier so that stores are happy. The price point is good, and they're driving volume.And actually, we've been pretty happy with things like the sriracha, the hot sauce one and the plant-based volume. Hoping we can sustain that, but we've been pretty encouraged by the proportion of overall sandwiches. I don't want to disclose exactly what it is, but we've been pleasantly surprised by how many plant-based sandwiches have been for repeated weeks here, [ Pictet ], I'm talking about Pizza Pizza right now, because it's a very early launch for Pizza 73, but it's nice to see.Is it still a bit of a -- I want to try it, it's a fad. There's probably an element of that. But I do think there's a macro trend towards plant-based now that hopefully, this is the beginning of something that becomes more of a sustained demand for a new product, kind of like gluten-free, right. When we first introduced gluten-free crust, it kind of spiked and then it leveled off, but it never went away. It's still a small, but consistent chunk of our customers really like those alternative crusts, to be at Keto or gluten-free or cauliflower. And so even if the novelty wears off, these things tend to have a pretty a good sort of trailing consistent revenue. So we're hoping that the same will occur with the chicken.

[Derek J. Lessard, Research Analyst]

Okay. And so I see that the on-time delivery or free is making its come back. I'm just wondering, have you seen any incremental pickup in that? And maybe just give me an update on where you stand on your loyalty program.

[Paul Goddard, CEO, President & Director]

Okay. Yes, certainly, we have been trying to highlight in terms of the fact that we do deliver hot and fresh food very quickly. We've always had 40 minutes or free. There's only rare occasions where we will extend it on a Halloween Day, we have no guarantee because we don't have drivers to drive responsibly during those nights. But we've been really trying to accentuate that we know delivery better than other people. We have uniform drivers. It's -- we've got the tamper proof box. All these elements that kind of speak to the brand, speak to the customer. So we have been accentuating that in our marketing materials. You may even see a little more of that in some places.That attribute -- unless we don't have the guarantee, we never have had a time guarantee out there, but people do know that we performed very well, and we do get hot pizza people store steps within a reasonable time frame, and we do say satisfaction guaranteed. So I think that is a differentiator from not only other pizza competitors that don't offer any kind of time guarantee, but also with the third-party folks, and we've had some success with some prior marketing campaigns. It's frankly really challenging to third-party folks because they don't necessarily have that time guarantee or that expertise of a driver that is uniformed and has sort of a general kind of standard about them.So I think we have something that we continue to leverage to our advantage. And I think out West, we can -- despite not having a time guarantee, we think there's ways for us to, again, push organics, which is our own platforms and push digital and even drive our phone number because our phone numbers are out there, the 7373. So we think there's even some work we could do there to actually drive more through that channel as much as we're pushing for digital.So loyalty, there is still a lot of work. We've done a ton of background work on that. Our actual existing program is pretty decent. It's not that we're dissatisfied with it. We continue to get a lot of people signing up for it, and a lot of people do like having dollars that they can bank. We've had -- some people say, well, if I don't spend it soon enough, it does sort of taper off. But generally, people have been happy with it. So we do have plans to enhance that, and we're starting with Pizza Pizza; Pizza 73, we've got some ideas, but we haven't sort of formalized any plans there.If you recall, we did do air miles years ago, but we found that it just wasn't really good fit for us. It was too expensive basically. And given the size of our average check and our frequency of visit, it wasn't quite like coffee or large purchases at LCBO or the grocery stores. So we learned a lot from that experience. And we do have a huge amount of intel like we never have had before analytics wise with our business intelligence platform and some other tools, CRM tools and analytics that we brought on. So we do feel more capable than ever to figure out how many new organic customers we're getting, how many repeat customers, how much cannibalization. So we're more enabled than we have been. But I think some of the challenges with loyalty is just -- it takes a long time to actually develop and rollout a loyalty program and to do a Phase II program.We said, look, if we're going to do it, it has to be very feature-rich and offer a lot more than what we currently have. So we've spent a lot of time on it, but I can't give you a time line right now when a new version is coming out of that, it's kind of an iterative process, and it will still be some time, probably well into late next year, I would say, for Pizza Pizza and Pizza 73, probably beyond that. But we also realized we need to get more customer loyalty out there, as well as getting more organic customers. So we know that there's other ways we can do that, and we may end up doing a more formalized loyalty program there as well.

[Derek J. Lessard, Research Analyst]

Okay. And that's fair, Paul. Yes, that's it for me.

[Operator]

Thank you. At this time, I would like to turn the call back over to our speakers.

[Christine D'Sylva, Chief Financial Officer]

Thank you everyone for joining us this evening. If you do have any questions following the call, please contact us. Our information is on the earnings press release, and have a great evening.

[Operator]

Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.