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Good morning, ladies and gentlemen, and welcome to the Recipe Unlimited Corp. Second Quarter 2022 Financial Results Conference Call. [Operator Instructions]. This call is being recorded on Wednesday, August 3, 2022. I will now like to turn the conference over to Frank Hennessey.
Thank you, Serjio. Good morning, everyone. Joining me on today's conference call is Ken Grondin, our Chief Financial Officer, and we are once again presenting via webcast.
Second quarter saw a very strong return of guests to our dining rooms. Total system sales for the quarter was $873.1 million, up 55% versus last year. Sales level was greater than Q2, 2019, which included Milestones. Demand has continued to remain strong through the summer, even in a high inflationary environment. Same Restaurant Sales was up 61% versus last year, and more impressively was up 4% versus Q2 F'19. Franchise margin rate held steady at 4.7% for the third consecutive quarter, and our corporate margin rate was strong at 9.5%. Further, this quarter saw minimal subsidies, which makes the corporate rate even more impressive. Dining rooms reopened. We saw the impressive return of the cake, increased sales by $117 million or 198% versus last year. Core restaurant brands reported strong sales growth versus the previous year, including our limited service brands, led by New York Fries with 130% sales increase, as customers once again returned to malls. Retail sales also grew in the quarter, up 9.8% versus last year. Margins in the retail sector were disappointing, but we have now reached agreement with most grocers on necessary price increases due to inflationary pressures, and we expect to return to historic margin rates by the end of the fiscal year. Adjusted EBITDA for the quarter was up 25% versus last year at $37.9 million, with only $300,000 worth of subsidies in Q2 versus $26.7 million in Q2 F'21. Net income before adjustments to the change in fair value and income taxes, was up 34% for the quarter, and up 97% on a year-to-date basis. We're especially proud of our operating teams who have met this surge of demand, while navigating a challenging food cost and labor shortage environment. We have balanced our menu pricing to ensure that we maintain and enhance our valued leadership position. While some of our sales [ lift ] has come from increased prices, much more has been due to higher check averages, due in part to more bundles being offered in purchase versus past discounting tactics. We believe our pricing and costing strategy, including temporary reduction in rebate rates to cover some commodity price surges, have enabled our franchise partners to better manage this inflationary food and labor market. However, in this environment, we feel it's appropriate to stay adaptable to the changing circumstances. In recent weeks, we have seen a leveling off of certain commodity prices, gasoline being one. But still, prices are extreme highs, and supply chains still have a long way to go to fully recover. For the balance of the year, we expect commodity prices to remain in the low double-digit range, and not returning to low single-digit until the second half of '23. In the past several years, Recipe has made significant investments in obtaining data and insights. One of these data points is our social media scraper that measures and pulls in every day, all social media commentary on any of our restaurants. We also get real-time feedback from our payment devices which guests use to rate our restaurants when paying their bills. We receive hundreds of social media comments every day, and since we began this system, we have received over 750,000 written reviews from Canadians. Having this direct feedback from our customers is crucially important in the environment that we are all living in. By studying keywords used in these commentaries, we are able to determine guests' sentiment. We are very pleased by the positive feedback guests are giving us about their experiences, and most importantly, about the positive value for the experience, their readiness since the reopening of restaurants. But we know that opinions can change quickly, so we'll be ever vigilant to ensure we're always listening to the feedback from our guests, and acting and adapting as appropriate. I'll now turn it over to Ken to give us a deeper review of our financial results.
Thank you, Frank, and good morning, everyone. For the first part of the financial review, I will focus on Recipe's Q2 2022 consolidated results, and I will finish with a summary of our segmented business performance as reported last night and posted on SEDAR. My comments will focus on the variance between Q2 this year versus Q2 last year, 2021. Total gross revenue for the second quarter of 2022 was $336.6 million compared to $207.6 million in the second quarter of 2021, an increase of 62%. The increase in gross revenue was primarily driven by higher corporate restaurant sales due to fewer dining room restrictions, and higher franchise revenues from both increased system sales and improved realized royalty rates, due to a stronger franchise portfolio compared to 2019 and less royalty assistance programs. System sales were impacted by minimal dining room restrictions during Q2 this year, while the same quarter last year, 96.5% of operating weeks were impacted. Adjusted EBITDA was $37.9 million for the quarter compared to $30.4 million in Q2 2021. The increase was driven by increased corporate and franchise contribution from higher system sales, partially offset by lower government subsidies and an increase in food and restaurant labor costs. Note that government subsidies in Q2 were only $300,000 compared to $26.7 million in Q2 2021. For Q2 2022, the company generated net earnings of $16.6 million or diluted EPS of $0.28 compared to net earnings of $19.4 million or diluted EPS of $0.33 in 2021. The decrease in net earnings and EPS was primarily due to the increase in deferred taxes and the reduction in fair value of the Keg partnership in [ KRI ] units, partially offset by an increase in operating income and the gain on the divestiture of the Prime Pubs brand. Turning to segmented results for the quarter. Total sales from corporate restaurants increased from $92.8 million in the second quarter of 2021 to $186.6 million in 2022. The sales increase from 2021 was largely driven by fewer dining room restrictions and higher average spending by our dine-in customers. Total adjusted EBITDA from corporate restaurants was $17.8 million in the second quarter of 2022 compared to $2.8 million in 2021. Adjusted EBITDA as a percentage of corporate system sales was 9.5% in Q2 2022 compared to only 3.2% in 2021. The $15 million increase in the quarter was driven by higher corporate restaurant sales and the benefit of closing or selling underperforming restaurants, partially offset by a corresponding increase in the cost of sales and a decrease in government subsidies. Total system sales from franchise restaurants increased from $381.7 million in Q2 2021 to $584.8 million in 2022. The increase from 2021 was driven by fewer dining room restrictions compared to 2021 and a return of guests to our dining rooms. Total adjusted EBITDA from franchise restaurants increased from $17.3 million in Q2 2021 to $27.4 million in 2022. The increase in adjusted EBITDA from Q2 2021, reflects the increase in system sales and higher net royalty rates. The increase in the franchise adjusted EBITDA rate as a percentage of franchise system sales from 4.5% in 2021 to 4.7% in 2022, reflects a stronger franchise portfolio and less royalty assistance programs. Turning to the retail and catering segment. Retail sales reported within the retail and catering segment, relate to the manufacture and distribution of fresh frozen and non-perishable branded and private label food products. Catering sales relate to food and beverage sales from Recipe's catering divisions, operating under the Pickle Barrel and Marigolds and Onions banners. Sales from the retail and catering division in Q2 were $101.7 million compared to $87.3 million in 2021, representing an increase of $14.4 million or 16.5%, primarily due to Recipe's catering of the RBC Canadian Open in June 2022, and increased sales to retail grocery customers. Adjusted EBITDA from the retail and catering division in Q2 was $4.3 million compared to $6.4 million in 2021. The decrease in contribution was attributed to significantly higher retail food input costs, without sufficient grocery price increases, partially offset by the catering contribution from the RBC Canadian Open event. The company continues to execute its growth strategy in the Retail segment, which includes growing its market share in a number of retail categories. During 2021 and 2022, the company continued to experience sales growth in its retail segment, and has gained over 50% market share in a number of categories. Particularly the popularity of the fresh -- frozen and fresh ribs category, has experienced higher-than-anticipated growth. The ribs category traditionally has higher gross margins than other grocery categories, and rib margins have continued to be challenged in 2022 due to higher protein input costs. Price negotiations with our grocery partners have been ongoing, and each price adjustment requires a few months to be completed. Price adjustments were beginning to be deployed through the end of the first quarter of 2022. However, food input costs have continued to rise throughout the second, and now the third quarter, which depresses margins, and will require further price negotiations with grocery partners. Management anticipates that it will take until later in 2022 for grocer price negotiations to be completed, to reasonably recover gross margins on sales to grocers. Turning to the central operations segment. Central operations segment consists – sales -- consist of sales generated by Recipe's off-premise call center business, representing fees generated from delivery, call ahead, web and mobile-based meal orders. Central operations segment adjusted EBITDA consists of franchise fees, property and equipment, rent and vendor volume rebates, reduced by central overhead costs, and royalties paid to the Keg Royalty Income Fund. Adjusted EBITDA from the central segment before net royalty expense, was a loss of $7.9 million in the quarter compared to a positive EBITDA of $4.5 million in 2021.
The decrease is due to lower call center fees being charged on mobile and web orders, increased marketing costs at the Keg including some one-time expenses, higher administrative labor costs driven by hiring that was deferred during the pandemic, additional central costs from the Burger's Priest and Fresh acquisitions, the impact of government subsidies received in the prior year periods, and lower vendor purchase allowances due to closed restaurants, the sale of Milestones, and some strategic food cost inflation assistance provided to franchisees, as Frank discussed. During the 26 weeks ended June 26th, 2022, management successfully opened 8 new restaurants and exited 17 locations, with 1 net new restaurant opening in the second quarter. In addition, 29 locations were sold as part of the Pubs divestiture in the second quarter. The company ended the quarter with 1,223 restaurants. Recipe's restaurant closures were part of our pre-COVID long-term strategic plan where management identified locations that no longer fit the long-term plan of the company, and/or restaurants that were underperforming. For corporate restaurant locations that no longer fit the long-term strategic plan of the company, management is taking steps to exit these sites.
For franchise locations that are underperforming, the company will work with franchisees to help them achieve sustainable success, which may include the company providing financial support in the form of royalty or other financial assistance. It should be noted that the majority of the strategic and planned restaurant closures that were identified in 2019, were completed in 2020 and 2021. There will be future restaurant closures, but most will correspond with replacement locations in the same markets. Our portfolio plan for 2022 is to finish the year with net new unit growth for the full year, with most new units coming in the third and fourth quarters, subject to successfully meeting construction and training schedules around the busy holiday period. Turning to total net debt. The company's net debt at the end of Q2 was $338.8 million, a decrease of $35.5 million from Q1 2022, and our available liquidity was $521.1 million. The decrease in net debt was due to debt repayments of $20 million, and $15 million in cash generated during the quarter. This concludes the financial commentary of the call. I'll now turn the discussion back to Frank.
Thank you, Ken. In the quarter, we sold the Pub business as part of our portfolio realignment. Our focus going forward is to support our brands that continue to be relevant to guests, and to overall have a portfolio of brands that have the ability to generate Same Restaurant Sales growth, free cash flow and new unit growth. We also want to continue to invest in asset-light businesses. Today, Recipe is 83% franchise. We look to increase that percentage as we seek new acquisition opportunities. Our debt leverage is at 2.3x, which demonstrates, we are in a very strong position to take advantage of opportunities that fit our criteria. Finally, I want to revisit my comments from the last quarter on the subject of dividends. As I stated last quarter, it is a strong desire of the company to resume the payment of dividends as soon as possible. To be clear, the strength of our business and our balance sheet would support an immediate reintroduction of the dividend. However, in Q1, the company received COVID-related government subsidies as a result of dining room closures and other government-mandated operating restrictions. The current legislation is unclear with respect to how prior subsidies in the tax year will be treated, in the event the company reintroduces a dividend in this fiscal year. More specifically, it is possible that the company will be required to repay the subsidies received in Q1 in the event that we pay a dividend at any time during 2022. We intend to provide specific guidance as to the timing of our reinstatement of dividends upon our Q3 release. And with that, I'll turn it back to Sergio to answer some questions.
[Operator Instructions] Your first question comes from George Doumet from Scotiabank.
Congrats on the strong restaurant economics and the recovery rates. I just want to talk a little bit about the central segment. The results there were below expectations. I think you gave some color. I think, Frank, you spoke to vendor volume rebates levels being lower due to higher [ labor ] costs. Can you maybe give us a little flavor there, like the sense of magnitude? And that's the first part of the question. Second part, maybe for Ken. Should we expect that contribution -- I think it was -- in the first half of the year was minus $22 million of EBITDA. Should we expect a similar level of contribution from central in the second half of the year?
I'll try to tackle the first part of that question. Yes. I think -- listen, through the first half of this year, but particularly in the second quarter, just like the entire world saw, there was some real rapid increases coming from basically a lot of commodity-based products. We certainly have had supply chain disruptions and interruptions due to just pure COVID things, but a lot of the real spikes were commodity related. Some of that was just crop issues, and then the war also driving some of those prices up. So, we've had to make some very conscious choices about the pace by which menu pricing can be implemented to our guests, and to avoid kind of a lot of price shocks, and to be more measured in our response. So, we have kind of stair-step pricing as we've approached some of the brands.
And in some cases, we've -- we're especially in places where we think these are more commodity based, and so it will be temporary. We have taken some of our rates down to try to mitigate some of the short-term -- until we can get our full pricing into the system. But twofold. one, we think once the pricing is in, we feel pretty good about where we're at right now on menu pricing in our brands. We expect that rate to recover as commodity prices decrease again. So yes, we think it's temporary. But yes, there was also some other aspects going on in that line, with the sale of Milestones. But overall, we expect that rate to come back to historic levels. I'll let Ken talk about this.
Yes. So George, your question on expectations for the second half, and -- as you know, we don't give guidance, but I will comment that there are some structural changes within the central segment that will have us having a kind of some different cost structure flowing through central. As we said, we will have some more permanent changes to our royalty rebate structure because of closing restaurants and selling brands like Milestones. And there are some additional costs in central that did not resemble pre-COVID because of the acquired brands, and just other aspects of our cost structure that we, over time, expect to be made up in our other 3 segments: corporate franchise, and the retail and catering segment. So I wouldn't -- we do not expect the net loss in central to be as high as the first half, but it will continue to be a -- it [ won't ] be a positive number for the rest of 2022.
And, maybe or Frank. A lot of your peers have called out some issues securing availability. So it's not just pricing, but availability for key food supplies. Can you maybe characterize how the situation looks like for Recipe?
Yes. I think just because of our size and our relationships, we tend to try to make sure we're always first in line. It doesn't mean we haven't had disruptions in it. There's been -- in some cases, some plans have gone on strike, and so that just interrupts your supply. But it seems to be -- the situation seems to be improving and stabilizing. I think what you have going on, George, is that, in many food manufacturing facilities, they've also faced lot of the staffing issues of everyone else. And so, you've seen production fall off in some cases. And that was going on a lot in the early part of Q2. But again, we're starting to see some stabilization there. So, we're getting the specs that we need, and we just need some of these commodity prices to start declining a little bit. That's going to take some time.
Okay. Just one -- last one, if I may, on capital allocation. Maybe more of a technical question. But is it possible that we can see buyback activity happen sooner than, I guess, the reinstatement of the dividend? Or I guess, are they kind of in the same bucket?
Yes. They're in the same bucket. The buyback would be -- yes, same unclear rules as it applies to dividends, leasing this fiscal year.
George, if we were to do a buyback for a normal course issuer bid, the treatment of that buyback is recognized like a dividend for the purposes of the subsidy [ callback ] rules. So, the same reason we can't pay a dividend through the rest of 2022. We can't exercise any buybacks either.
Your next question comes from John Zamparo from CIBC.
I wanted to ask about transaction count and how that compares to Q2 '19. Obviously, you referenced Sam Restaurant Sales are nicely above, and that's encouraging to see. But I'm curious how transaction count is fair? Are there any significant divergences by restaurant concept?
Yes. It's obviously something we look at very, very closely. And I think the good news is that we're not seeing anything material happen there. And I think that's part and parcel of the fact that all -- we're not alone in just taking pricing. It's going up in all restaurants, but it's also going up in grocery. So, it does depend on the sector. We do have some brands that are having maybe more of a decline of guest counts, but we have other brands that are -- their guest counts are above '19 level. So, it really is a bit of a mix. But again, we've been -- so far, we've been very happy with the elasticity impact that is -- it's not nearly as what we thought it may have been. So, we feel good about it, but again, as I said in my prepared comments, we need to continue to watch that, and watch guest sentiment, and really make sure that we are providing and continue to provide good value, but do that in a way by not discounting our business. And I think the teams have done a really great job of that.
On franchisee profitability, I wonder what you can say about how your franchisees are faring versus historical levels, either on dollars or margins? And ultimately, what I'm wondering is, is this an environment where you feel confident in getting to your target openings of [ 40 ] for this year?
Yes. We're still pushing hard on that. I mean it's -- there's -- I think we're kind of heavy into the last quarter on those openings, which ideally don't want to be, but there's some contract staff and trying to get contractors and things like that, where that's playing out. So yes, I think, again, depending on the banner, the franchisees are in a little bit different place. I think we're trying to preserve margin dollars, but the rate may not be where it was. And again, some brands have done extremely well. I'd say our limited service brands are continuing to do very, very well, and profitability is very healthy there.
But yes, I think the biggest thing, if you ask the franchisees what their kind of #1 concern is, it's staffing levels and making sure that they're continuing to get staff. We feel like on the food inflation side with the pricing that we've taken there, we've got to that. We feel comfortable about where we're at. But a lot of our efforts centrally here are around, and designed to help the franchisees on the staffing levels, national hiring days, et cetera, utilizing the foreign worker program. Yes, that's kind of their big concern at this moment.
Okay. On food costs, you've mentioned in the past that because of your buying power, it's meant that you have the ability to defer some food cost increases. I just want to better understand that. Is that still the case? And if so, I mean, should we interpret that as you might see a disproportionate increase in your food costs versus what commodity markets are showing in Q3 or Q4? Or would your food costs react quickly to some of the reductions we've seen in commodity prices?
Yes. There's a lot there without getting into entire dissertation. I mean some of our brands at -- Swiss Chalet, St-Hubert for example, that are primarily chicken -- I mean, chicken is very much regulated in this country, and it's really completely tied to corn pricing. That tends to lag whatever is going on in the markets by 6 to 8 weeks. So that's probably the one which would respond probably the quickest to a change in pricing, in markets. And I would say that we've been mindful, been watching other large -- larger, in some cases, U.S. public companies and full service space, and their forecast on pricing, and I would [ adhere ] on inflation. And I would say that ours is relatively consistent with what they're reporting. So -- and on our size and our buying ability, we think that is significantly better than what smaller business and smaller chains, and certainly what independents are feeling. I think they're feeling the full front of food inflation.
Just one -- last one, and a follow-up on George's question about the net central figure. I think this is where a lot of us have challenges in forecasting because there's a few inputs here. If we look back to Q2 2019, it was I think minus $4 million, it's now minus $20 million before the net Keg royalty. I just want to get a sense of versus '19 what the split is on higher corporate SG&A versus that change in vendor rebates. I know you're not going to guide to what vendor rebates are going to be, or the change in vendor rebates are going to be back half of the year, but can you give some commentary on how much of that delta versus '19 is the change in rebates?
I would say the change in rebates is about 1/3 of that change.
Your next question comes from Peter Sklar from BMO.
Frank, sorry, I'm back on the central segment. So right at the beginning of the Q&A call, when you got that first question on the central segment, you entered into a discussion on how commodity prices have increased and how you've been measured in terms of menu board price increases. I didn't understand what that had to do with the cost structure or the expenses you're taking in the -- or the net expense in the central segment?
Yes. Let me clarify, Peter. So basically, what I was saying is that, as these price increases come through to us, where we feel we have no option, because it's primarily commodity base. In some cases, we've absorbed some of the shock of that, and to provide time for our restaurants to adjust menu pricing. We just -- we have full service restaurants out there, we just don't -- can't just change menu pricing overnight. So, they'll allow that time to happen, to get the pricing increases pass through. But also, we're watching how much pricing we're actually putting through that's based solely on commodity increase. And the reason for that is that, if we feel something is transitionary versus structural, then we want to make sure that we're not putting permanent menu price increases through that's going to hurt the long-term value to guests, and hurt long-term sales potential in some of these brands. So that's why I'm saying it's temporary and it tends to relate to commodity-based products.
When you say you're absorbing some of the shock, like is this -- you're absorbing like for your corporate restaurants or your franchisees or both?
No. It's in our rates of -- that are in central and our rebate rates.
Peter, it's to all restaurants, corporate and franchise, and is absorbed by us taking less rebate in some of those commodity items.
Sorry, I don't follow you. So you're taking less vendor rebates, and so that benefit is passed through to your corporate and franchise restaurants? Is that what you're saying?
The cost impact that goes through is lessened to the restaurants.
Okay. And then, Ken, just again on the Central segment, you talked about there's certain structural changes in expenses, and that are like -- it seems like it's a permanent change. So like, what changes have happened? Is this allocation between your divisions in central? Or is this new costs have kind of entered into the realm?
Peter, we've talked about some of this before. First off, our call center fees are less. We've made a policy decision to change the rates we're charging on mobile and web orders. So, as you see, those fees are what happened, what they were in prior quarters. The rates are about half on similar volumes of orders. So that's structural. We have some structural change because of rebates that are -- we're no longer collecting on restaurants we -- sales from restaurants we've closed or sales from brands we've sold, like Milestones and other pubs.
Those are structural. We do have some -- we've taken on some central costs from brands we've acquired, where we expect those costs will be offset by corporate and franchise contributions from those brands, and in particular, Burgers' Priest and Fresh are the ones that are most recent. We've got some other, call it -- as you said, transitional costs related to hiring and overheads and travel entertainment, and being out in the market more with our marketing costs that are catching up compared to 2020 and 2021. So again, it's -- we're still not a -- we don't have a normal quarter yet, Peter. So, it's sort of mapping all of the transition versus the structural changes. But suffice to say that we want -- central segment will continue to be a negative contributor for the next couple of quarters.
Okay. And then lastly, Frank, like, if you look at the performance of your corporate restaurants and your franchise restaurants, you're almost back to pre-COVID levels in terms of revenues and EBITDA performance. So, I'm just wondering can you comment -- I'd be curious to hear about your sense of the consumer. On the one hand, the consumer is really being squeezed, as you know, by high food and fuel prices. So the consumer has less discretionary wallet. But on the other hand, like there's a lot of pent-up demand and the society is coming out of COVID. Everybody really wants to get back to restaurants. So, it kind of seems that there's 2 forces at play here. And I'm just wondering if you could talk a little bit about that and what's your feeling about the consumer as you see them in your restaurants?
Well, I think to the point about the consumers getting squeezed, so we watch all of that, and that's why we're being very, very careful about how we're pricing. And again, to the point that our franchisees' profitability, and that's why we look at that franchise royalty rate, and we're very, very happy where that's placed. So, we are mindful of all the other pressures that are going on with the consumer. That being said, you're correct. I mean, our revenue is -- we're running -- from a sales point of view, we're running above '19 levels with one less significantly larger brand not in our portfolio. We have not -- we have said this in my prepared statement that we have continued to see strong demand as we progress through the summer.
So we have not really seen a falling off of demand. So we opened basically -- our restrictions came off beginning of February, and I know people have talked about, yes, there's a surge, people pent-up, and certainly, we believe that to be true, but it seems to be sustained. And we'd like to think, although we do not have good data for this, we'd like to think we're picking up share because people still feel that there's value in the experience in coming to our restaurants, but we don't have good data on that yet. But so far, we're very pleased with how sales performance has continued to progress through the summer.
And what about the -- you didn't mention that -- as I recall, you have a relatively large mix of [ patio ] restaurants. Do you think that's having an impact because people feel safer still being on patio versus indoor, and that kind of the society coming out of COVID is coinciding with summer weather?
Yes. I mean -- listen, I think where we have restaurants that are -- that have patios and we've invested in those patios and made them be more special. I think that's just table stakes as you go forward in this industry. But again, go back to New York Fries and the huge increase in sales there, and that's in the mall environment. So, I'm not sure -- I couldn't put a number out here of what percentage of people are still COVID cautious out there, but we're seeing very full dining rooms in patio. So yes, we can't put our finger on there's -- it's just because of patios, because for our overall business. That's still roughly a smaller percentage of our business than our -- in seating, dining, in our full-service location.
[Operator Instructions] Mr. Hennessey, there are no further questions at this time. Please proceed.
Okay. Thank you, everyone. We hope you enjoy the rest of the summer, and we look forward to updating you on our Q3 results in November. Thank you, everyone.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.