Pizza Pizza Royalty Corp.

Ladies and gentlemen, thank you for standing by and welcome to the Pizza Pizza Royalty Corps earnings call for the third quarter of 2023. During this presentation, all participants will be in listen-only mode. 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 Tuesday, November 7th of 2023. I will now turn the call over to Christine De Silva, CFO. Please go ahead.

Thank you. Good afternoon, everyone, and welcome to Pizza Pizza Royalty Corps' earnings call for the third quarter, ended September 30th, 2023. Joining me on the call today is Pizza Pizza Limited's Chief Executive Officer, Paul Goddard. Just a quick note, our discussion today will contain forward-looking statements that may involve risks relating to future events. Actual events may differ materially from the projections discussed today. All forward-looking statements should be considered in conjunction with the cautionary language in our earnings press release and the risk factors included in our annual information form. Please refer to our earnings press release and the MD&A in the investor relations section of our website for our reconciliation and other disclosures related to non-IFRS financial measures mentioned on this call. As a reminder, analysts are welcome to ask questions after the prepared remarks. Portfolio managers, media, and shareholders can contact us after the call. I would now like to turn the call over to Paul to provide a business update.

Thank you, Christine, and welcome, everyone, to Pizza Pizza's third quarter investor conference call. Today, I will discuss our third quarter results, and then Christine will summarize our key financial highlights before the Q&A at the end. We are very excited to announce our 10th consecutive quarter of positive sales with 7.0% same-store sales growth. During the quarter, the Pizza Pizza brand reported a 6.4% increase in same-store sales, and the Pizza 73 brand reported an 11.3% increase. Growth at both brands was driven by increases in both guest traffic and the average customer check. This consistency in performance has enabled our board to announce another increase to our monthly dividend, a 3.3% increase, resulting in an annualized rate of $0.93 a share. So getting into the details of the quarter, our positive momentum has continued in the third quarter and was driven by two key factors, growth in our walk-in and pick-up, are non-traditional sales and special events channels. And our marketing initiatives continue to show superb momentum. Our non-traditional sales typically account for 10% of total sales, and it has been really refreshing to see all of these special events and non-traditional locations welcome more hungry customers this year. We have many high-profile sponsorships and marketing activations through which we sell our delicious product. At our traditional locations, our customers continue to recognize our strong value proposition and convenience as well as our innovation and high quality menu offerings, all supported by our top of mind brand visibility and our ongoing restaurant network expansion. And as mentioned on our last call, our areas of focus for marketing continue to be building the brand, innovating our menu, and driving organic sales for our franchisees across Canada. And on the brand front, we continue to build on the successful Everyone Deserves Pizza campaign platform, identifying opportunities to advocate for our customers and bring pizza, and Pizza Pizza specifically, into fun and relevant social and cultural conversations. For example, this summer, unlike some companies who hopped on the popular shrinkflation bandwagon, in other words, shrinking the size or volume of their products but still selling it for the same price, Pizza Pizza announced its Growflation campaign to combat shrinkflation by giving out a medium pizza instead of a small pizza for the same small price. This campaign continues to highlight our promotional, and value offerings that speak to the pressures Canadians feel related to rising interest rates and price inflation. Food innovation also continues to be a key asset in driving brand visibility and incremental sales for us. In August, we were the first national QSR to introduce Strombolis to Canadians, essentially a rolled pizza dough filled with popular toppings, cheese, and sauce, as Stromboli is a great handheld snacking option and fills a gap in our pizza menu. The launch far exceeded our initial estimates, and this category has continued with solid performance since the initial marketing campaign. And good margin, by the way, for our operators on that product as well, so it's a real win-win. And meanwhile, at Pizza 73, we focused on food innovation there as well this quarter and shoring up opportunity day parts, specifically lunch and late night. Through new snackable menu items, such as our signature curly fries poutine, and a variety of new chicken fries, snack boxes, and a new under $10 menu, we have seen significant growth in both these day parts as well as our walk-in business. And the food innovation isn't just for our traditional restaurants. We continue to see the Pizza Pizza brand come alive in communities across Canada via our best-in-class sponsorship activities and special events programs. In addition to record sales of critical events like the C&E, and the Calgary Stampede. Just as an example, our team innovated our product offering at the CNA this year, at the exhibition, as we introduced deep-fried pizza. This innovation drove national media attention and helped nearly double our sales at the event versus previous years. So it really worked, and we got a lot of attention there and a lot of fun with that one, and it really translated into real results. So while brand-building campaigns and food innovations continue to find success driving visibility, relevance, and sales, We continue to invest in critical infrastructure to ensure we are successfully pushing orders through our websites, apps, and call center. In Q3, we introduced customer push notifications for Pizza 73 and a new in-app messaging platform for Pizza Pizza. And we invested incremental resources to further optimize and drive our online awareness and social media presence as well. So behind the scenes, there's a lot of IT investment, reinvestment, as I think long-time investors will know that we are very... focus on continuing those investments. And they really do, I think, put us in a position separate from most competitors in the space as a result. And finally, we expanded our virtual chicken-chicken restaurant concept to Pizza 73 this quarter. Previously, it was just at Pizza Pizza. And that is already contributing significantly to our third-party sales channel growth for that platform. So that's great to see. Turning to restaurant network growth, we continue to have a large pipeline of franchise leads that are eager to join the team. And we also have many of our current franchisees looking to further invest in their business and help drive our expansion too. We ended the third quarter with a total of 763 locations, of which 661 were Pizza Pizzas and 102 were Pizza 73. During the quarter, we opened seven traditional and six non-traditional Pizza Pizza restaurants. Meanwhile, four non-traditional Pizza Pizza restaurants were closed. And at the Pizza 73 brand, we opened one new traditional and one non-traditional restaurant. Our restaurant openings continue our national expansion plan as we open in British Columbia, Ontario, and Quebec. And COVID-related delays associated with construction, permits, and supply chain issues are slowly reducing and we'd say returning to normal overall. While we continue our expansion plans, we also continue with our renovation programs. Over 85% of our traditional Pizza Pizza stores now have our new look, and approximately 25% of the Pizza 73 traditional stores have been renovated this year. And those ones are actually very quick, given they have a smaller store footprint lobby area as well, so they're quicker and cheaper to do, so we expect to move a little faster even with those rentals, which is great. And our restaurants feature our hot and fresh new look and or a refresh on the interior and exterior, and significant upgrades continue to be made in regards to restaurant equipment, such as new and more efficient ovens, digital menu boards, and in-store technology. And beyond Canada, we continue working with our Mexican partners on the next set of restaurant openings. We are happy with the progress of the first three stores and what they're achieving down there and are excited about the long-term potential of this high-growth, high-pizza-consuming market. But we are going to be careful and purposeful in how and where we expand our new footprint there. And we do expect to see several more locations open there during 2024. As I close my comments, we are now in our busiest quarter and aren't going to stop pushing hard and leading with innovation, marketing initiatives, digital investments, and delivering high quality, great tasting food to our customers. And we look forward to closing off this year the way we started it, strong. And lastly, the key to our strong performance is our strong team. So I want to give a big thank you to all of our restaurant owner operators and our corporate team who are working hard together to continue building on our brand success by taking great care of our customers each and every day. Thank you for listening, and I'll now ask Christine to provide a brief financial update.

Thanks, Paul. Since Paul covered many of our initiatives, I'd like to briefly discuss how those promotions and activities drove our financial results this quarter. As mentioned, same-store sales, the key driver of yield growth for shareholders, increased 7% in the quarter. The combination of restaurants being added to the royalty pool and the same store sales resulted in an increase in royalty pool system sales and the corresponding increase in royalty income. Royalty pool system sales for the quarter increased 9% to $163.2 million from $149.7 million in the same quarter last year. By brand, sales from the 644 pizza pizza restaurants in the royalty pool increased 8.6% to $142 million for the quarter And sales from the 99 Pizza 73 restaurants increased 12.4% to $21.2 million for the quarter. The partnership's royalty income, earned as a percentage of system sales, increased 9.2% to $10.4 million for this quarter. The partnership also earned interest income on its cash and short-term investments. Turning to partnership expenses, administrative expenses for the quarter were $123,000 and include listing costs as well as director, legal, and auditor fees. In addition to admin expenses, the partnership pays interest expense on its $47 million credit facility. Interest paid in the quarter was $322,000. The partnership is currently making interest-only payments on the non-revolving facilities. The interest rate is lost through April 2025 using swap agreements that have fixed the interest at a banker's acceptance rate of 1.81% plus its credit spread for a combined interest rate of 2.685%. So after the partnership receives royalty and interest income and pays admin and interest expense, the resulting net cash is available for distribution to its two partners. Pizza Pizza Limited and the Pizza Pizza Royalty Corp, based on their ownership percentage. Pizza Pizza Royalty Corp shares 76.1% of the partnership distribution. It then pays taxes on its share of the partnership earnings, and any residual cash is available for dividends to the company shareholders. Turning to dividends and working capital, as Paul announced, today the Board of Directors increased the monthly dividend for the third time this year. The 3.3% increase brings the monthly dividend to 7.75 cents per share. And this dividend increase will begin with the November dividend, which is payable in December. The company declared shareholder dividends of 5.5 million in this past quarter, or 22.5 cents per share, compared to 5 million, or 20.25 cents per share, in 2022. The resulting payout ratio was 93% for the quarter. The company targets a payout ratio at or near 100% on an annualized basis. The company's working capital reserve increased $400,000 during the quarter and was $8 million as of September 30, 2023. With today's dividend increase, the company believes that there is sufficient cash flow to service the obligations as they fall due, and the company will continue to closely monitor sales, royalty income, and net income to determine when additional dividend adjustments may be warranted. That concludes our financial overview. I'd like to turn the call back to the operator to call for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please press star 1 on your touchtone phone. You'll hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order they are received. If you would like to withdraw from the question queue, please press star two. If you're using a speakerphone, please lift the handset before pressing any keys. One moment please for your first question. Your first question comes from Derek Lezard of TD Cohen. Your line is already open.

Hi, good afternoon. This is Cheryl sending for Derek. Thanks for taking our questions and congrats on another strong quarter.

Thanks, Cheryl.

So, obviously, another strong print on sensor sales growth. I'm wondering if you could help us break it down in terms of pricing and volume. And the number is particularly strong for a piece of 73. Could you highlight some of the drivers there?

Yeah, I can relate over to Chris for any more details. But I think, you know, it's helpfully both. I mean, I think what we really get more excited about is traffic growth, right? I mean, it's You know, there's obviously some price increases that we felt that we needed to pass along, but we're really excited about how we've been able to keep traffic growth, you know, coming. So I'd say that at Pizza 73, for instance, we had a lot of innovation there. I tried to touch on that in my formal remarks with these chicken snacker boxes, this curly fried poutine. We have gourmet fins out there, which was a real success out at Pizza Pizza. So we bridged that over as well. So there's actually a lot more available, and especially in the snack and day parts there, that represent great value out there. And so we think that's resonating. And we also think that, you know, the new website and app that we launched a while ago back there, they seem to get some pretty quick traction. It's just easier to use. People like ordering that way. And, you know, these new items that we've introduced are really, they obviously work very well for delivery, but for pickup or walk-in sales, they work really well. So I would say that's part of the background behind some of the success with 73 coming back so strong.

And in terms of traffic and ticket, a lot of the increase in our same-store sales, as Paul said, is really from traffic. We saw the return of our non-traditional business, a lot of people returning to special events. So that's one of our biggest drivers in terms of our same-store.

Okay, that's very helpful. And I guess with these numbers, are you seeing yourself taking market shares? And then on PISA 73, I think in Q2 last year, you mentioned that you were losing some shares back then in Alberta. Have you gained those shares back yet?

I think some of the latest data we've seen seems to indicate that we are. Yeah, are we gaining some share there? And so that's encouraging. I mean, I think overall we have some data saying that PISA as a category seems to be holding strong as well. which is good, some very modest growth, but we seem to be outpacing some others there, which is good, because I think for a while there, at least at 73, I think we were losing, and it does seem as though we are getting some of that back.

Okay, that's very helpful. And how has Sensor Sales Growth been trending so far in Q4?

Well, we haven't really, you know, we don't like to really comment on Q4. before we're ready to. But I'd just like to say, I think that overall, you know, we do feel really confident in our overall strategy at both brands. It seems to be really resonating. So, you know, we're always looking for ways to drive more traffic and more customer brand resonance. But I think overall, you know, we're pretty happy. I mean, days like Halloween, we'll be reporting on next quarter, things like that. But, you know, New Year's Eve will be coming up soon. The holidays is usually a strong time for us. And seasonally, this is, volume-wise is always a good quarter for us, but we're certainly aware of strong competition and a value-oriented customer, so we know that we have to be really careful to make sure we stay relevant. So, I mean, so far so good, but I just don't want to comment on Q4 specifically.

Okay. Thank you. That's helpful. And in terms of consumer behavior, obviously, macro backdrop is still a headwind overall. Any color on what you saw in the quarter in terms of consumer behavior, whether that's trade-down or order patterns, ticket, or anything like that?

I would say one thing that we did notice, and this hasn't been unique just to this past quarter, but I would say maybe this year roughly, is We do see strong growth in walk-in and pick-up. So in our parlance, we talk about walk-in as unpremeditated walk-in. You might be walking down a street in Queen Street in Toronto, for instance, or Montreal or wherever. You decide to get a slice and a drink or a salad, and that's walk-in. And pick-up is more premeditated, but you're still ordering from a different location and then picking it up. And so we notice that both those two channels are strong and continue to be growing faster than some of the other channels, and that's really true for both brands. So I think that is a reflection of you know, affordability, I guess, for some customers, getting tired of delivery. We certainly, you know, are big believers in delivery. We are very, very strong at that, obviously, for both brands. But we noticed that people really are looking for more walk-in and pick-up because they're saving that delivery fee. And so we're making sure that we have appropriate offerings for those channels for those customers.

Okay, that's helpful. And in terms of competition, are there any changes to the competitive behavior And how do you feel the promotional environment compared to maybe pre-pandemic level?

I would say competition-wise, I mean, everyone gets better at their game, I would say. I mean, we never underestimate our competitors. There's some really strong competitors out there. But I think, I guess the numbers speak for themselves. I think we've been very agile and we've been continually reinvesting in our menu, our technology, and our marketing approach. So I would say that, you know, if you look at the number of, marketing initiatives we have, I would say the content generation, especially on social platforms, digital content, use of influencers and other channels, I would say that's stronger for sure than pre-pandemic. And I think we've learned what works through a lot of experimentation and also just using data and seeing what resonates with people and what doesn't. And I think we are getting better at that and outpacing most of our competitors.

Additionally, to add on to what Paul was saying, you know, A lot of competitors may do discounting, whereas we're taking an approach of promoting the brand and creating a halo effect on our overall offering. We've had a lot of timely messages like our fixed rate campaign, especially in periods where customers are seeing a lot of inflation and a lot of headwinds. A lot of our campaigns may not necessarily price and discounting. It's more of an offering that resonates really strongly with our customers, and it's all levered up into our Everyone Deserves Pizza campaign. So there's a lot of brand work being done in competition, and we're just outpacing competition in terms of our positioning of our brand.

Okay, that's great to hear. And maybe just to follow up on that, you highlighted some of the digital or infrastructure investments in the quarter. Can you just provide some more color around that? And do you see that driving either increased traffic and or add-ons?

I think things like in-app messaging for sure do. I mean, it's actually not that easy within an app to actually create effective targeted push messages. And so that actually is something that, you know, both brands now we have that capability with our platforms that we've invested in. So we think that does result in more traffic. I mean, if you get a relevant contextual, contextually relevant message on your phone when you're commuting home, for instance, that there's something going on at a location nearby you, things like that. And score slice is another one with the in-venue message. ability to download and get people really using their phones more. I think that's just enhancing our websites and our apps. They're something we continue to do. We also put in the visual order tracking that we talked about, I think, last quarter that really, I mean, third-party platforms have that. But as far as I know, no other major pizza chain in Canada that I know of has that visual ability to track your order. So you're providing that more convenience to the customer on the web or on their app as well. And so you're creating more dialogue and more relationship with that customer. It makes them stickier. As well, I think things just to optimize our presence on Google and other platforms, social media-wise and search capabilities and things. I think, you know, I don't want to get too specific because I don't want to tell everyone and all our competitors our secrets, but we realize there's a huge advantage there if we can be a real leader and it seems as though those efforts and investments are starting to bear fruit.

Okay, that's awesome to hear. And I'm curious, how are commodity prices and labor costs trending? And given the costs that you're seeing, how do you feel about your pricing today?

I think generally, when we look at our procurement across, we've generally been able to keep a pretty decent line on costs. I mean, we have seen the massive levels of inflation that we did see a while ago that those seem to have abated generally. Things like construction costs for stores have been quite high. So we are trying to really push on our suppliers as much as possible, given our scale, whether it's beverage, boxes, other commodities. Cheese, we obviously can't control, but we try our best to manage that for our franchisees. So overall, I mean, we do see some issues, I suppose, but I think we've managed to keep our general food costs pretty consistent to help our franchisees' profitability. And that does mean passing on some price. We have done that, but the data suggests we've actually been increasing price generally a little less than the market baseline. In other words, less price increases than perhaps some others have put through. So I think that also helps our operators' margins.

Okay, that's helpful. Thank you. And in terms of new development, we've heard from some small format retail chains that there are delays in new store openings. as developers slow down their new development. I'm curious, is that something that you're also seeing? And do you still see the 3% restaurant network expansion rate for 2023? And how do you feel about your pipeline for 2024?

Yeah, that's a good point. I mean, I think that, you know, the financing for some of these people, like we see our pipeline as being very healthy, but certainly the cost of financing for new franchisees is higher. I mean, this cost of lending with a whether it's a first-tier lender or a second-tier lender, obviously those rates, I think, are a headwind more than it was a year ago. So I would anticipate actually probably a slight reduction, a 3%. It does seem a little optimistic to me. I don't know if Chris has any comment on that. But, I mean, we're still tracking quite well. But, I mean, it seems to me that, you know, you may see that slow a bit, even though we're very, you know, we're pushing hard very much so on the offense like we have been for some time. But I wouldn't be surprised if it actually does slow a little for sure, given that – that sort of tougher environment out there.

Okay, that's very helpful. And then maybe switching gears, so in terms of like the recent news about Ozempic, GLP-1 drugs, just curious what your thoughts are on the potential impact of that.

Yeah, I think there's a lot in the media about that certainly right now. I think it seems like everyone's taking Ozempic. I think, you know, look, we look at the overall pizza sector. It seems to be growing. We would, I think, say that, look, as much as we might sell fried food and things like that as well, and that's a very popular item, we feel there's such a range of items that are actually very healthy as well. And it's very, very feasible to have, you know, thin crust pizza, easy on the cheese, if you like, vegetable toppings, grilled chicken, etc. So there's so many, or salad, there's so many options. And even though, look, the bulk of our products are going to be, our sales are going to be chicken and pizza, but we feel there's an ability for, you know, people to really pivot within our menu and still get great value and very healthy items. And so I don't really see that. I mean, we've seen health trends in the past when Atkins was big as well and other trends, and we've been pretty consistent through that. I mean, so I feel we have something to offer people and we actually do feel that our health, you know, our pizza has every food group in it. And, you know, you don't have to get the extra large deep dish for one person if you don't want to, And so you can actually be very calorically smart and still have our healthy food. So it's obviously a big news item now with those ethics, but I don't necessarily see it as something that's going to materially impact us. We don't really see that.

Okay. Thanks for that. And then in terms of Mexico, now that you have your first three pizzerias, they're, I believe, offering for about a quarter now. Is there any update that you can share on the performance there? Any new learnings about the Mexican market?

It's still pretty early days there, but we've been really happy with the partner down there. I think we're getting really good recognition in Guadalajara for those restaurants that we have, and our partner's excited about building on it. We've got some unique menu items down there, some things that we... We have our standard menu here, a little smaller version, but there's some items that they have down there that we don't have here. like a garlic puffy bread and kind of a spicy pork type of pizza as well and some other things. So we like that they've catered to the local taste there, and it seems to be resonating. So it is early days, but we are pretty excited about next year as well and building on the initial success.

Okay, that's helpful. And maybe one last one from me. How are your franchisees faring given the current environment? I mean, the interest rates are still high, and then the macro... outlook is weakening. How do you feel about the health of your franchisees overall?

I think overall, I mean, Chris may have more to add, but I think we feel pretty good. I think that, you know, we're, we're really high touch with our franchisees. And so, you know, we usually hear if there's concerns or pockets of concern pretty quickly, and we really do everything we can to help them. And, you know, we've, I think had a really good track record, especially in the last few years was really trying to preserve their, their margin level and make sure that, you know, even with things like rents going up, minimum wage going up, we've really held the line on food costs. And we've actually, you know, had, you know, obviously smaller footprints as well as part of our strategy. So trying to keep leasing costs in order. So the things that we can control or influence a little bit, I think they appreciate our efforts to do that. And I think, you know, overall, I'd say, you know, some of the proof of that is our franchisees choice awards and things. I think we have a tight level and rapport with them, but yeah, certainly for some of them, their interest costs are higher than they used to be. And for a new franchisee getting a brand new loan, It's more expensive, so we want to make sure that it's the right partner, can they afford it, and things like that. But overall, I would say we've done pretty well, and there's going to be some stores across the entire system that maybe aren't doing that well right now, but it's a very small number, I would say. So generally, the health barometer is still quite strong for our franchisees, I would say.

Okay. That's super helpful. Thank you so much for taking our questions.

Thanks very much, Cheryl. Appreciate it.

Ladies and gentlemen, as a reminder, if you have a question, please press star 1. There are no further questions at this time. I would hand over the call to Christine De Silva. Please proceed.

Thank you, everyone, for joining us on the call today. If you have any questions following the call, please contact us. Our contact information is on our website and on the earnings release. Have a great evening.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation.