Pizza Pizza Royalty Corp.

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. During the presentation, all participants will be in a listen-only mode, but after the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. As a reminder, this conference is being recorded on Wednesday, November 10th, 2021. I will now turn the call over to Alexander Suratin, Director of Finance. Please go ahead, sir.

Thank you. Good afternoon, everyone, and welcome to Pizza Pizza Royalty Corps' earnings call for the third quarter ended September 30th, 2021. Joining me on the call today are Pizza Pizza Limited's Chief Executive Officer, Paul Goddard, and Chief Financial Officer, Christine DaSilva. 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 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.

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 30th, 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-to-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 in Alberta 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, of 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 emerged 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 restaurants who 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. It remains to be seen. The second revenue stream, our non-traditional locations, which contribute 10% of our overall sales, have 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 province has lifted COVID-19 restrictions. The reopening of our non-traditional locations 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 if you're listening, hockey, basketball, and other channels as well. And in the summer, they're significant for us as well. While the lifting of restrictions has added wind to our 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 its 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 in number, and our chicken sandwich is the first in Canada's quick service restaurant sector. 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, 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 netted 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 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've tried haven't worked out well. Our summer innovations like pretzel crust and mac and cheese bites, although innovative, did not resonate as we'd hoped to the volume levels that we'd hoped for, despite our strong brand and our reputation for innovation. So while we're 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 to better advantage for us. And this is an example. We haven't just released it yet, but there's a new feature 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've been strategic in taking modest price increases across our menu. We'll continue to monitor the supply chain landscape and pass along price increases where possible, but we will be very persistent about doing so. Our diverse, high-quality menu, continually enhanced websites and apps, impressive customer service staffs, high-quality ratings, all these things together position the company very well to whether this pandemic can 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 their top-line sales. We're encouraged by the overall latest GDP forecast for the country and most provinces, and there is a little ray of light there for Alberta. I think that was the most optimistic growth we're seeing coming out of some of the economists just the 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 I acknowledge that this period has presented us with many challenges as well, but I think we've gotten used to adapting even faster than we have before, being even more agile. So we're pleased with our strong progress and resurgence at Pizza, and we know we have some work to do to get Pizza 73 resurging in a similar way 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 look 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.

Thanks, Paul. Today, I'd like to briefly cover the financial results for the quarter. Same-store sales growth, the key driver of yields for shareholders of the company, increased 2.8% for the quarter. 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 $129.7 million from $125.4 million for the same quarter last year. By brand sales from the 622 pizza pizza restaurants in the royalty pool increased 6.4% to 111.3 million for the quarter compared to 104.7 million for the same quarter last year. Sales from the 103 pizza 73 restaurants decreased 11.2% to 18.4 million for the quarter compared to 20.7 million last year. For the nine month period. Our sales decreased 2.7% to $355.9 million from $364.6 million in the prior year's comparative period. The partner's royalty income earned as a percentage of royalty pool sales increased 2.3% to $8.1 million for the quarter and decreased 3.1% to $23 million for the nine months. The change in the royalty pool sales and royalty income reflects the same store sales for the quarter and the period. Additionally, while the number of stores in the royalty pool are 24 less than the comparative period, the financial effect for shareholders was mitigated by Pizza Pizza Limited continuing to pay royalties as part of the deficit or 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 opening to offset sales lost when stores permanently close. So turning to partnership expenses, the administrative expenses, including director, legal, auditor fees, and listing costs, were $119,000 for the quarter and $379,000 for the period. In addition to administrative expenses, the partnership paid interest expense on its 47 million credit facilities, Interest paid in the quarter was $350,000 and $1 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's acceptance rate of 1.81% plus a credit spread. Our credit spread ranges 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 spread schedule in the company's MDNA. 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 dividends and working capital, The company declared shareholder dividends of 4.3 million for the quarter or 17.5 cents per share compared to 3.7 million or 15 cents 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 12.4 million or 50.5 cents per share compared to 12.7 million or 51.39 cents 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 in April 2020, the dividend has since increased twice, with the most recent increase being a 9% increase effective August 2021. Our current monthly dividend is now $0.06 per share, or $0.72 annualized. The company's working capital reserve increased $500,000 during the nine-month period and has ended the quarter at $5.8 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 recovery in the markets of Pizza Pizza and Pizza 73 services. And we must note that it has been reassuring to see that with the easing of restrictions on restaurants and gatherings, customer behavior is slowly returning to its pre-pandemic norms. That concludes our financial overview. I'd like to turn the call over back to our operator to call for questions.

Thank you. Ladies and gentlemen, as stated, if you would like to ask a question, please press star followed by one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request. And if you're using a speakerphone, please lift the handset before pressing any keys. And your first question will be from Derek Lessard at TD Securities. Please go ahead.

Good afternoon, everybody. Hope you're all well.

Hello.

Thanks, Derek. 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. You know, on both sides, restaurants appear to have been largely open for delivery and takeout. Just curious about the differences in consumers there.

Yeah, it's a good question. I mean, we spent a lot of time looking at that. Obviously, Derek is obviously much happier with the Pizza Pizza performance. You know, 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-traditionals, for instance, out there in Pizza 73, just even customer behavior aside. So, you know, is an Albertan fundamentally different than an Ontarian? Well, you know, I think yes and no. I think there's an economic backdrop there. In Alberta, obviously, you're starting to see some encouraging signs there, cautiously, about the economy and GDP forecast for next year looking quite strong and things. But, you know, 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 very competitive here. But we do see that, you know, 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 on those platforms has probably in the last year been more relative to the increase in the Ontario market on those platforms. Not to say they're not growing here as well, if they 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 doesn't like our pizza in general as 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 an everyday deal, a solo deal, other things. But we also think we need to tweak that. We're obviously not happy getting negative on negative results there. And so even though it's been a stop-start out there and Alberta had to kind of retrench, we do think there's signs of optimism in the economy coming back. But, you know, we've seen this a little bit before, Derek, you know, we'll go back so far with you, but I don't know if you'll recall 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 had collapsed for a lot of people. And that ultimately 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 roars 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 can't wait for that. Our view is that'll be nice, wind in our sails, 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 creative 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 here. 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. There's lots of folks that are big into 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 research that 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.

Yeah. Well, 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. I guess I'm wondering what's different this time. Is it the offering? I know there's plant-based, but just curious on the differences and why you think it'll be more successful this time around.

Yeah, that's a really good question, Derek, and you have a very good memory. We definitely have had some sandwiches. We had a suite of Italian sandwiches a while ago, and I think – You know, we had 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 had a meatball sandwich that was also very good. But, you know, 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. Let's just talk about, say, the real chicken. What we figured out is, 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. We're focusing 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 we're selling a fair amount of volume of those, or retail units per week per store, that's significant. And so they get good at it, and then it's a virtuous cycle, right? That's what's different. There's good macro and micro demand for that chicken fried sandwich that there didn't used to be, fried chicken sandwich. 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? 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 volume 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.

Yeah, 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'll be some efficiency issues, but as they get used to it, is it a sandwich that could be done quickly, put together quickly?

It is. It is. It's quite simple. I think because it's basically a chicken product, fried at the plant base, it's very, very minimally different to prepare separately, but it's the same idea, and it's quite simple. So 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 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. We're 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. I'm talking more Pizza Pizza right now. 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, be it keto or gluten-free or cauliflower. And so even if the novelty wears off, these things tend to have quite a good sort of trailing consistent revenue. So we're hoping that the same will occur with the chicken.

Okay. And so I see that the on-time delivery or free is making a comeback. I'm just wondering if Have you seen any incremental pickup from that? And maybe just give me an update on where you stand on your loyalty program.

Okay. Yeah, certainly we have been trying to highlight the fact that we do deliver hot and fresh food very quickly. We've always had 40 minutes for free. There's only rare occasions where we will extend it. On Halloween, we have no guarantee because we want 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. 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. At West, we don't have the guarantee. We never have had a time guarantee out there, but people do know that we perform very well and we do get hot pizza at people's doorsteps 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. We've had some success with some prior marketing campaigns. It's frankly really challenging the third-party folks because they don't necessarily have that time guarantee or that expertise of a driver that is uniform and has a general standard about them. So I think that's 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 organic, which is our own platforms, and push digital, and even drive our phone number, because our phone number is a huge asset 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 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 a 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 the LCBO or the grocery store. 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 rule out a loyalty program. And to do a phase two 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 timeline right now when, you know, a new version is coming out of that. It's kind of an iterative process and it will still be sometime, you know, probably well into, you know, late next year, I would say for Pizza Pizza and Pizza 73, probably beyond that. But we also realize 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 out there as well.

Okay, and that's fair, Paul. Yeah, that's it for me. Thanks for taking my questions. Okay, thanks very much, Derek.

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

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.

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.