Pizza Pizza Royalty Corp.

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Pizza Pizza Royalty Corps earnings call for the first quarter of 2022. During the presentation, all participants are in a listen-only mode. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star then the number one on your telephone keypad. As a reminder, this conference call is being recorded on Wednesday, May 11, 2022. I would now like to turn the conference call over to Mr. Alexander Swatton, Director of Finance, please go ahead.

Thank you. Good afternoon, everyone, and welcome to Pizza Pizza Royalty Corps' earnings call for the first quarter ended March 31, 2022. 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 MV&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, and 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's 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 at the restaurant 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 open in the previous year, less any restaurants that have been permanently closed. For the fiscal year 2022, The royalty pool was adjusted on January 1, 2022, to include 624 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, and welcome everyone to Pizza Pizza's first quarter investor conference call. Today, I will discuss our first quarter results, and then Christine, our CFO, will summarize our key financial highlights before the Q&A at the end. Today we are pleased to present the financial results of the Realty Corp for the first quarter which ended March 31st, 2022. Results for the first quarter were driven by strong same-store sales. Pizza Pizza reported same-store sales growth of 16.0% and Pizza 73 reported 2.1% growth for a combined 13.6% same-store sales growth. The positive results for the quarter were due to the increase in guest traffic from the easing of government restrictions and an increase in the average check. As a result, our board was pleased to announce an 8.3% increase in the shareholder dividend effective February 2022. Turning to our quarterly results, we didn't expect that after nearly two years since the start of the pandemic, we would once again see government restrictions return in January and February due to the Omicron surge, of course, but that's exactly what happened, as you know. However, the good news was that as those restrictions lifted, we experienced an increase in sales from walk-in traffic and saw the reopening of key non-traditional stores, especially sports venues. And in addition to increased sales to our already strong pickup and delivery business, growth across all channels was well supported by menu innovation, strong promotional campaigns, and operational excellence. Now, with almost all restrictions removed and the return of warmer weather as we enter the second quarter, we are optimistic that this momentum will continue as almost all government restrictions have been removed and customers are feeling more comfortable visiting our restaurants. You're still waiting for some non-traditional locations to reopen, such as some university and college locations that are waiting until September, and for a more robust return to office in our urban markets. But at the same time, we know that the pandemic has affected consumer behavior and the importance of digital sales channels, including delivery, has grown. So we will continue to support ongoing enhancements to our digital assets and to our digital marketing capabilities, and we'll continue to focus on our core competitive advantages of convenience, innovation, high-quality menu offerings, and restaurant network expansion. Speaking to our operations during the first quarter, the first quarter is always an exciting one for us in spite of the government restrictions we saw this year, as I said, in Jan and Feb. It's always the beginning of a new year with new food innovation, new marketing campaigns, and a lot of excitement at our key non-traditional locations where the NHL and NBA teams make their playoff runs. Pizza Pizza and Pizza 73 are the official pizza sponsors for almost all the Canadian NHL teams and for Canada's only NBA team. While fans enjoy watching their teams, especially when they make it into the playoffs, they can also enjoy a hot and fresh slice from our many concession locations in the arenas or can order our game day specials to enjoy while watching from the comfort of their own homes. Additionally, as I mentioned on our last call, we reintroduced our score slice promotion and during Raptors games and new in 2021 Maple Leafs games as well, fans were directed to a massive QR code. Some of you may have seen it if you've been to some of the games in Toronto. shown on the Central Arena scoreboard, which loaded a free slice coupon into their digital wallet to use with their Pizza Pizza app. In addition to being a fun digital giveaway for existing customers, this was also a phenomenal program to drive app downloads for fans that didn't already have our app and introduce them to our array of fast, convenient, organic ordering platforms. Seeing the success of this activation, we've also now rolled it out for the Toronto Football Club, TFC, home games at BMO Field in Toronto, and are excited to see how fans is similarly engaged with the activation this season. Turning to our marketing and food innovations, pizza and wings have gone hand-in-hand at Pizza Pizza for decades, and we've established a lead position on our quality wings, which are raised without antibiotics and fried to crispy perfection. So, early in the quarter, we built on the success of our chicken sandwich launch and our overall chicken category with the introduction of three new wing sauces, Hot Honey, National Hot, and Mango Inferno. These new sauces capitalized on the hot wings trend we were seeing, and were launched in time for all of those Super Bowl orders. A Dave and Wing sales are at their very highest. And just in time for New Year's resolutions at Pizza 73, we started the year off with a New Year New Crust campaign, where we introduced customers to our Keto Crust pizzas that were well-received at Pizza Pizza back in 2021. Pizza Pizza has always been at the forefront of alternative crusts, and we took the opportunity to expand that category at the Pizza 73 brand as well. We're excited to be able to provide an offering that is relevant to consumers at that unique time of year as well, where Google search trends show a spike in interest in keto diets, not surprisingly. Continuously refreshing the pizza category with new crusts, recipes, and toppings brings new life to our pizza menu. Early in 2022, we introduced two new gourmet pizzas, the Chicken Shawarma and Halifax-style Doner Pizzas. Both of these pizza flavor profiles are emerging trends, and the Doner Pizza has been on the menu in Halifax for several years and is very popular with customers. So constant innovation and focus on our core helps us stay top of mind and the first choice for pizza eaters. Sharing key moments with customers from Valentine's Day to Friday night game nights at home all translate into winning moments for us. In the latter part of the quarter, we once again partnered with the number one card game in the world, Uno by Mattel, to offer our customers the ultimate pizza and game night experience, another opportunity to share moments with our customers. At both Pizza Pizza and Pizza 73, our marketing strategies are structured to support restaurant profitability while also increasing customer orders and order frequency. Whether you prefer to phone 967-1111, tap your Pizza Pizza app, or simply walk into your local neighborhood Pizza Pizza. And all our campaigns are supported by our in-house marketing team to be designed and creative and deploy it on an array of assets from radio, flyer, billboards, and on our multiple social media digital channels. So, on the sales side, we are very pleased with our momentum. On the more sobering side of things, though, and consistent with our comments on the last earnings call, we do continue to face significant inflationary cost increases across our supply chain and in labor markets. Our goal is to take modest selective price increases across our menu to offset often double-digit input cost increases we've seen, but do it in a balanced approach, a balanced way, so as not to adversely impact overall customer traffic. We know our customers are looking for value as well as quality, so we ought to find that proper balance of perceived value for money. And it's a fine line to walk. It's certainly an art. And we need to keep those customers happy and revisiting and continuing to see the value and the quality that we always promise. But we've also got a simple chance to do that while we drive profitability and sales growth for our unit operators, our own operators, and our private operating company, Pizza Pizza Limited, as well. So I just want everyone to be aware of that. But I do want to emphasize, though, that the realty corp investors are, of course, insulated from that operational risk since our key drivers are for the realty core investors are really the top line revenues and in turn the same store sales growth and that restaurant network growth. So turning to network growth, during the quarter PPL opened two traditional and five non-traditional pizza restaurants and four traditional pizza restaurants were closed. The new restaurants were opened outside of our core markets as we continue to expand our footprint across Canada. This quarter we opened in Portage La Prairie, Manitoba and Moncton, New Brunswick. Our non-traditional location development plan continues to be well executed with three of the five openings in high volume service stations where we offer delivery as well. Pizza Pizza Limited Management expects to accelerate its restaurant network expansion to 5% traditional restaurant growth and continue its renovation program throughout 2022 and beyond. To date, we are proud to say that 80% of our restaurants feature our hot and fresh new look. As the warmer weather returns and walk-in sales increase, customers will experience the new look and style at Pizza Pizza locations across the country. We remain focused on growing our business across Canada, and it's safe to say we are known and respected as a major homegrown national brand and the leading pizza chain in the country. The past two years have taught us a lot about ourselves, our business, and our customers, and we couldn't have emerged through the worst of this pandemic without the tireless dedication and resilience of our restaurant owner-operators and our passionate employees as well. So a quick shout-out and big thank you to all of them, and of course to all of our loyal customers of both brands as well. We know trends continuously change, but our diverse high-quality menu network penetration, digital assets, and strong customer service reputation have all helped us stay strong during these uncertain times and have been a real constant. Our restaurant network growth continues to be strong, and as we continue to scale effectively, we've only become stronger. So we look forward to the rest of the year, the return to full operations, and the sales that will come with it. Thanks for listening, and I'll now hand it over to Christine, our CFO, for a brief financial update.

Thanks, Paul. Before I go into the financial results for the quarter, I'd briefly like to discuss the January 1st royalty pool adjustments. As Alex mentioned, on January 1st of each year, the royalty pool was adjusted by adding new restaurants opened in the past year, less any restaurants that have permanently closed. On January 1st, 2020, the royalty pool increased by two net restaurants as a result of opening 37 new locations while closing 35 restaurants permanently in 2021. In exchange for adding new restaurants to the royalty pool, Pizza Pizza Limited is compensated in equivalent company shares using an agreed-upon formula, which is designed to be accretive to the current shareholder. Generally, when additional restaurants are added to the pool, the forecasted increase in system sales, and in turn the company's royalty income, would result in an increase in Pizza Pizza's interest in the company. In the case where the system sales of the closed restaurants exceed those of the new restaurants, As we saw in 2020 and 2021, a deficit or make-hold carryover amount will be created, and royalties on this deficit will be paid by Pizza Pizza Limited to the partnership in that year. The make-hold carryover amount will be carried forward, and royalties will continue to be paid for subsequent years until, on an adjustment date, system sales of new restaurants are sufficient to offset the system sales of the deficit. On January 1, 2022, the net sales from the vendants partially offset the make-hold carryover from 2020 and 2021. The remaining make-hold carryover amount will continue to be paid, and a royalty will happen every year until, on an adjustment date, the vended and sales exceed the deficit. As noted earlier, for 2022, there will be 727 restaurants in the royalty pool, comprised of 624 pizza-to-pizza locations, and 103 pieces, 73 locations. Now turning to the results of the quarter. Same store sales, the key drive reveals growth for shareholders of the company increased 13.6% for the quarter. Growth sales reported by the restaurants in the royalty pool for the quarter were 122.9 million, a 13.6% increase as compared to 108.2 million in the first quarter of 2021. By brand, sales from the 624 Pizza Pizza restaurants increased 13.2% to 104.8 million. And sales from the 103 Pizza 73 restaurants increased 0.7% to 18.1 million for the quarter. Royalty income for the quarter was 7.9 million compared to 7 million in 2021. As Paul mentioned earlier, the increase in royalty pool sales and royalty income for the quarter is largely due to the reopening of the economy and many of our non-traditional locations. Turning to the partnership expenses, administrative expenses, which include director, legal, and auditor fees, as well as public company listing costs, were $112,000 per quarter. In addition to the administrative expenses, the partnership paid interest expense on its $47 million credit facility. Interest paid in the first quarter was $356,000. The partnership is making interest-only payments on the non-revolving credit facility. The interest rate swap agreement fixed the interest rate at a bank of acceptance rate of 1.81 plus the credit spread. The swap is locked in and matures in April of 2025. The credit spread ranges based on the level of debt to EBITDA. Due to the impact of COVID-19 on the partnership, the credit spread did increase by 25 basis points in April of 2021. for a combined rate of 2.935. The debt to EBITDA ratio for the last four quarters is 1.46. And therefore, the credit spread has decreased to the lowest tier effective April of 2022. Please reference the company's MD&A for the full credit spread schedule. And after paying partnership expenses and administrative expenses, the resulting net cash is available for distribution to its two partners based on their percentage ownership. For shareholder dividends, the company declared shareholder dividends of $0.19 per share, or $4.7 million for the quarter, compared to $4.1 million, or $0.16.5 per share, for the prior year's comparable quarter. The resulting payout ratio for the quarter was 108% and was 106% in the prior year's quarter. The company initially reduced the monthly dividend in April 2020. and had subsequent increases in November of 2020, August of 2021, and most recently, February 2022. Any further changes will be implemented with a view to maintain the continuity and consistency of monthly distribution. The company's working capital decreased $350,000 in the quarter to $6.2 million as of March 31st. Distance sales for the first quarter have generally been the softest, resulting in the utilization of some working capital during this period. However, with government mandate restrictions predominantly lifted, the company will continue to closely monitor sales and royalty income to determine when additional dividend adjustments may be warranted. With that financial overview, I would like to turn the call back to our operator to ask a question.

And if you would like to advise if there are any questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by one on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order they are received. Should you wish to decline from the pulling process, please press star followed by two. And if you're using a speakerphone, please lift your handset before pressing any keys. Your first question comes from Derek Lazard with TD Securities. Please go ahead.

Yeah, thanks, and good afternoon, everybody. Hope you're all well.

Hi, Derek. Hey, Derek.

Thanks. I just wanted to maybe the first point is to maybe touch a little bit on inflation and pricing. I'm just curious on how much more that you think you might need to do, and secondly, I was just wondering how the consumer reception has been.

Yeah, Chris, you might have a little more to add to that, but I think, you know, generally we're just – Obviously, keeping a very close eye on our input costs. I mean, we have seen increases, you know, across the board for all food and non-food items that you can really think of, consistent with what you're just seeing in the overall economy. So we're definitely not immune to that. And I think we've just been staying really close to it and trying to strike that balance. So, you know, we have seen traffic and check up. So we think we're finding the balance quite well. We know consumers are definitely value conscious, especially our core demographic. But we also feel that we do need to and can get away with some price increases if we do pass on. So we're trying to be quite systematic about that and sort of orchestrate when throughout the year both brands is the best time to do that. Do we see an end to that? I don't think anyone can say that right now. We're just sort of putting some increases through recently and we'll see how it goes, I guess. Certainly it would be nice to see some relief, but I don't think we're anticipating any in the short term. I don't know if Christine has anything to add to that.

No, I think that covers it. I think customers' reception of it, given the fact that traffic is up and tickets are both positive, moving in the right direction, I think we've got a good balance of communicating the changes as well as doing it modestly and slowly over periods of time.

Okay, and I guess you touched on sort of my follow-up to that in terms of the mechanism. So has it been price increases sort of across the board? Are you doing it through bundling? Maybe some color on sort of the mechanisms.

Yeah, I think it's been a combination of things. I don't want to go too much into detail just for proprietary reasons, but to give some transparency, I mean, definitely some key specials You can see they're pretty key price points for us. We've also taken a close look at competition and what people are doing. And we definitely try to be judicious about it, but we look at the mix of our different specials and create your own side items, things like that, and just look for certain opportunities there as well. And also on the fuel side, we're conscious of drivers also having that additional pressure they face economically with vastly increased fuel costs, just as another example. So we're trying to sort of take all that into account with our pricing, our delivery, et cetera, and our overall supply chain.

Okay, I appreciate the color and also the sensitivity around it. I guess another question I do have is where are you guys in terms of the recovery for walk-ins? And I know you alluded to it a little bit in your prepared remarks, Paul, But how many non-traditionals are still closed in the network?

Yeah, it's about 20%, 20-25%, I would say. About a quarter are still not. So mainly the college university side, I think, is the piece that a lot of those institutions just said, look, we're just going to wait until the next school year in September rather than, you know, with all the, you know, different restrictions in different provinces. So that's a pretty big number for us. We're very strong in that market, so about a quarter. But obviously, some of those are a bit lumpy, like the sports venues and things that we have turned back on. As soon as those were not restricted and were open, we really sprung back. So things like walk-in just overall has actually been trending really nicely for us. And also pickup is also very, very strong for us, which we really like. In fact, we think we can capitalize on pickup growth further at both brands as well.

And you're not fully recovered on the walk-in side just yet?

No, we're not yet. I would say when we look back at 2018, 2019, but we certainly like the trend line. And so it does seem that as these restrictions have lifted, we still have a little way to go, but it's definitely been showing some good trend there. So that, you know, with a bit of, you know, good execution, that should continue.

Okay. I guess another hot topic has been labor availability. I guess How have you guys and your franchisees in particular been managing through that? And I'm just wondering, has it impacted your pool of qualified potential franchisees?

I guess I'll just answer the latter point first. On the pool of franchisees, we continue to see a really strong pipeline there, which I think is really encouraging. We're pretty excited about that, especially as we've really now become so known in places like Quebec and D.C., And so we really do have that national profile now, and we're getting, you know, franchisee applications from all over the place too, those new regions and, of course, our popular core regions of Ontario and Alberta and things like that. So really good on the pipeline. I think people are seeing us as a very, you know, solid business with a great reputation and good track record and good investment return for people. In terms of labour, it is tough. I mean, we are definitely having to manage things, be very creative. There's definitely a tightness of labour for drivers, no question about it. We're competing with... you know, others, other pizza delivery companies. We're competing with third-party companies that are also, of course, large employers of drivers, and it's very difficult. So I think we certainly have to be creative, I guess. We've managed it, I think, quite well, but it has been a burden. I mean, there's cases where we have owner-operators going out and delivering their own food during peak times. If they have to get in their car and do it, they're happy to do it, and they're very dedicated to do that, but it's not ideal. And I think we do have a little bit of stickiness, I would say, in a good way with a lot of our family operated businesses that perhaps some that are maybe, you know, all our drivers are independent contractors. But some of them, I think they like the environment and they have stayed with us for a long time as much as we also have, you know, a churn rate as well of some drivers. I think generally we have a lot of long-time drivers too that tend to stick around where they may not if they're working for another company. So it is tough is the bottom line, especially with wage increases and things all the time. availability and wages is definitely a pressure on us.

Okay. And maybe along the same lines, you know, maybe just remind me of your, the outlook for the, for your restaurant growth this year. And you know, it has any, have you experienced any things like construction delays and, and permit delays and what have you because of, because of the labor issue?

We haven't had issues, actually, surprisingly in a way, with construction labor as much. That side's actually been pretty good. We've been really happy with our own team, which we've grown. We're very solid, and our contractors and their quality of build and things like that. I would say with some aspects, yes, it's more of the inflationary aspects of things. I'll just give an example. Something like steel for our cabinets and our back-of-house operations. I mean, just the cost of those items has gone up. So we're worried about that. We have actually tried to preempt some of those problems, supply chain issues we saw coming by it. ramping up on inventory a little more than we otherwise would. Just so we do tie up a bit of capital on the private company side to do that for, you know, be it ovens or construction materials, et cetera. So I think we've sort of managed to have a bit of a shock absorber in there rather than have, you know, massive delays that way. And we realize we're a little bit late this quarter for sure, but we're, you know, we're pretty on target for Q2, Q3, especially. So that's our plan is, you know, round about 5% again. We're really trying to say we should be able to grow, you know, three dozen ish locations a year and so that's our ambition and with non-traditional we're hoping to have circa 20 and there would be some closures in there as well with normal cleaning and just optimizing some of the laggards so we would expect some closures but we want to show more net growth and I think we've really got a team that can execute on that although yes there are some supply chain things that keep coming up and it's definitely in some parts can get slowed down with waiting for certain items but it's the inflationary part that probably worries us more than anything

Yeah. Okay. And, um, maybe just one last one for me. I know, uh, in the MDNA, um, no, no stores have been open just yet in Mexico, which is just curious again about sort of, you know, the timeframe, the timeframe there, and maybe just remind us about the, uh, the opportunities that you see in those markets and maybe others.

Yeah, we'll definitely give more detail, Derek, because I'm glad you mentioned that. Mexico, we're excited about it. We've been working with these folks for now well over two and a half years, I guess, and they've been up here, we've been down there, and we're certainly kicking into a higher gear. But it'll still be, in our estimation, probably very late this year, I think, before we'd see any locations light up there. It would be starting in the Guadalajara region. with our partner base there, and then scaling up over time. But we've been doing a lot of work behind the scenes on, as you can imagine, supply chain, construction, planning, real estate, siting locations, procurement, branding, marketing strategies, all that stuff. There's a lot of ongoing work behind the scenes there. It's just right now we don't have much to say on it, but I'm excited in future quarters to start talking more about that.

Okay, fair enough. That's it for me. Thanks for taking my question, everyone.

Okay, Derek, thanks very much. Appreciate it, Diane.

This concludes the question session for today. Please proceed with closing remarks.

Thank you, everyone, for joining our call this afternoon. If you have any questions following the call, please feel free to contact us. Our information is on the earnings release. Have a good evening.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.