Pizza Pizza Royalty Corp. (PZA) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Pizza Pizza Royalty Corp.'s earnings call for the second quarter of 2023. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Alexander Sewrattan, Director of Finance. Please go ahead.

Thank you. Good afternoon, everyone, and welcome to the Pizza Pizza Royalty Corp.'s earnings call for the second quarter ended June 30, 2023. Joining me on the call today are Pizza Pizza Limited's Chief Executive Officer, Paul Goddard; and Chief Financial Officer, Christine D'Sylva. Our discussion today will contain forward-looking statements that may involve risks relating to future events. Actual events may differ materially from the projections discussed today. All forward-looking statements should be considered in conjunction with the cautionary language in our earnings press release and the risk factors included in our annual information form. Please refer to our earnings press release and MD&A in the Investor Relations section of our website for a reconciliation and other disclosures related to our non-IFRS financial measures mentioned on this call. As a reminder, analysts are welcome to ask questions after the prepared remarks 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. 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 2023, the Royalty Pool was adjusted on January 1, 2023, to include 644 Pizza Pizza restaurants and 99 Pizza 73 restaurants. So with that review, I'll turn the call over to Paul Goddard to provide a business update.

Thanks, Alex. Good afternoon, everyone. Thank you for joining us today on our call to discuss our Q2 2023 results. We are delighted to report continued strong results as we reported another positive quarter, with same-store sales growth of 9.4%. We are extremely proud that both brands reported positive sales this quarter, and this is actually the first quarter in which we had no impact from the pandemic when compared to the prior year. This strong same-store sales growth translated into a 10.9% increase in royalty income and drove our second dividend increase this year back in June 2023 and yielded an adjusted EPS growth of 11.8%. During the quarter, the Pizza Pizza brand reported a 9.8% in same-store sales and the Pizza 73 brand reported a 7% increase. Growth at both brands was driven by increases in both guest traffic and average check. Now let's get into more detail on our performance for the quarter. 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. This quarter, we continued our focus on building brand engagement through innovative promotions and products, delivering great value and celebrating key moments. When we launched our poutine offerings at Pizza Pizza in 2022, we experienced a nice lift in our appetizer and sides category. And when we launched our buffalo chicken sandwiches in 2021, it was also well received. So we decided to combine them. And this quarter, we added a new offering at Pizza Pizza, the Buffalo Chicken Poutine. This new item has highlighted the poutine category and provides customers with a compelling value offering at less than $10. Additionally, with the success of poutine at Pizza Pizza, we took our learnings and ported them over to Pizza 73, but this time with a twist. The well-known and well-loved curly fries at Pizza 73 were essentially reintroduced as poutine. This new item has gone extremely well and has become an important part of that brand's lunch offering. So we're extremely happy with how this product is doing and look at this as a great example of how cross-pollination of innovation can drive incremental new sales growth. Our pipeline for product development is strong, and we look forward to introducing more items to our customers as we progress through the year and beyond. And as discussed on our last call, Pizza Pizza has always celebrated special occasions, and this quarter was no different. We ran our annual 4/20 promotion and created a new Buzz Off Pizza to keep mosquitoes away for the [indiscernible] weekend and Canada Day. Additionally, our teams rallied the community during the Pride events across Canada. And for every special moment, we are there celebrating with our customers and their communities. We are focused on building our brand engagement and our promotions. For the first 6 months, have proven successful as we experienced a continued increase in traffic. Like all businesses, our stores are faced with continued inflationary cost increases across the supply chain and some tight labor markets. Our goal is to take modest selective price increases across our menu when needed to help with input cost increases while not adversely impacting customer traffic. We know customers are looking for value, so we have to find the right balance of perceived value for money. It is a fine balance but one that we have been able to achieve. As we move into the second half of the year, we will continue to leverage our brand assets with innovative marketing campaigns focused on driving traffic to our restaurants while also increasing brand awareness. Additionally, we will continue to support enhancements of our digital capabilities to stay focused on our core competitive advantages of convenience, innovation, high-quality menu offerings and network expansion. And turning to the restaurant network expansion. We ended the second quarter with a total of 752 locations, of which 652 were Pizza Pizzas and 100 were Pizza 73s. We opened 5 traditional and 2 nontraditional Pizza Pizzas and closed 3 traditional locations and 1 nontraditional location. Additionally, during the quarter, the company opened 1 nontraditional Pizza 73 and closed 1 traditional Pizza 73. Our Pizza Pizza restaurant openings this quarter were across many provinces, including British Columbia, Ontario, Quebec and Manitoba. So while we continue our expansion plans, we have not taken our sights off our renovation programs. Over 85% of our traditional Pizza Pizza stores have our new look, and 25% of the Pizza 73 traditional stores have also been renovated this year. And those renovations, by the way, are a little quicker and easier, just given the smaller footprint of Pizza 73 and our reception area there, a little quicker. And our new refreshed look overall creates a warm, modern and inviting space for our customers to come pick up or sit and enjoy our Hot & Fresh offerings. And we remain focused on growing our business right across Canada. We are well known as Canada's very own homegrown leading national pizza brand, something we are very proud of. One exciting piece to note during the quarter, our Mexican partners opened the first 3 PZA Pizzerias. The PZA Pizzeria brand has been well received in Mexico, and while it is not material at this early stage, we are excited by our early success there and for the potential it provides for us to further scale our business down there in Mexico with 3x the population of Canada and a fast-growing pizza-loving market. And of course, we also see potential for other international markets as well. Looking ahead, in 2023, you will see us continue pushing [ hard ] in menu innovation, marketing initiatives, restaurant growth, technology and other digital-first investments. And we will work closely with our owner-operators to ensure they are delivering excellent and consistent products and service in a clean, safe and attractive restaurant ambiance. I'd like to close by congratulating our entire team, our operators and our employees. We're all one team. We've worked all very hard together to create a very innovative, ambitious and collaborative culture right across the country and now internationally at both brands. So with that, I'd like to turn the call over to Christine for a brief financial update.

Thanks, Paul. Since Paul covered many of the drivers for this quarter, I'd like to briefly discuss how those promotions and activities drove our financial results. As mentioned earlier, same-store sales growth, the key driver of yield for shareholders, increased 9.4% for the quarter. Pizza Pizza restaurants reported 9.8% same-store sales growth, and Pizza 73 restaurants reported 7% for the quarter. Both brands saw an increase in customer traffic as well as the average [ check ]. The combination of 16 net new restaurants being added to the Royalty Pool and the same-store sales growth resulted in an increase in Royalty Pool system sales and the corresponding increase in royalty income. Royalty Pool system sales for the quarter increased 11.2% to $158.5 million from $142.5 million in the same quarter last year. By brand, sales in the 644 Pizza Pizza restaurants in the Royalty Pool increased 12% to $137.7 million for the quarter, and sales from the 99 Pizza 73 restaurants increased 6.4% to $20.8 million for the quarter. The partnership's royalty income earned as a percentage of Royalty Pool sales increased 10.9% to $10.1 million for the quarter. The partnership also earned interest income on its cash and short-term investments. Now turning to partnership expenses. Administrative expenses for the quarter were $148,000 and include listing costs as well as director, legal and auditor fees. In addition to administrative expenses, the partnership paid interest expense on its $47 million credit facility. Interest paid in the quarter was $320,000. The partnership is currently making interest-only payments on the nonrevolving facility. The interest rate is locked through April 2025 using swap premiums at a fixed interest rate at a bank acceptance rate of 1.81% plus the credit spread. The credit spread changes based on the level of debt to EBITDA, and the all-in rate is currently at 2.685%. So after the partnership receives royalty and interest income and pays administrative and interest expenses, the resulting net cash is available for distribution to its 2 partners: Pizza Pizza Limited, the private operating company, and Pizza Pizza Royalty Corp. based on their ownership percentage. Pizza Pizza Royalty Corp's share is 76.1% of the partnership distribution. It pays taxes on its share of the partnership earnings, and the residual cash is available for dividends to the company's shareholders. Turning to shareholder dividends. During the quarter, the company increased its monthly dividend for the second time this year. With the most recent 3.5% increase, the current monthly dividend exceeds the pre-COVID rate and stood at $0.075 per share per month. The company declared shareholder dividends of $5.4 million in the current quarter or $0.22 per share compared to $4.9 million or $0.1975 per share in 2022. The resulting payout ratio was 95% for the quarter, and the company targets a payout ratio at or near 100% on an annualized basis. The company's working capital reserve increased $300,000 during the quarter and was $7.6 million at June 30, 2023. With the most recent dividend increase, the company believes there is sufficient cash flow to service obligations as they fall due. And we will continue to monitor sales closely and royalty income to determine when additional dividend increases may be warranted. That concludes our financial overview. I'd like to turn the call back to the operator to poll for questions.

[Operator Instructions] Your first question comes from Derek Lessard from TD Cowen.

I wanted to hit on the same-store sales strength. I mean that 2-year stack is really impressive, and congratulations on that. So maybe just talk about what you're seeing in terms of the consumer. It doesn't seem like there's been any deceleration in spend here in the face of, I guess, mortgage payments that may have doubled for some. So any color on the consumer would be helpful, whether it's trade-down, maybe dynamics, ordering preferences, et cetera.

Yes. I think -- thanks, by the way. We appreciate the compliment. I think we are pretty proud of what we've done here and it's nice to get past the last year, the pandemic and have a quarter [ breaching ] pre-pandemic and see the strength continue. So we do see the strength continuing. I mean I think we, certainly with a lot of other people, share some concerns about the economy. I mean there's lots of different viewpoints out there, consumer confidence, and we've got [ those ] rates. I mean, hopefully, inflation has peaked, I guess. I mean, you saw the Central Bank increase its rate by [ a quarter point ], et cetera, recently. But there's certainly some concerns and some potential headwinds there. So we're being really careful to make sure we provide that value, I would say, number one. And yes, we have -- we're pretty judicious about price increases here and there because our input costs, they went up massively. And they -- I would say that escalation has been tempered so we've seen some relief there. But there's still certainly some inflation and input costs with store construction, for instance, as well, not just food input costs that are definitely -- not necessarily going fully our way. And so we think consumer confidence is -- it seems to be holding up, but I don't take it for granted. And so we think we're going to stay focused on value. But we are also really pushing ahead on the restaurant expansion and innovation, like we feel like things like the Buffalo Chicken Poutine, Create Your Own Pizza, Pizza 73, the Gourmet Thins out there, I mean, we really feel we need to innovate and keep doing it. And we think consumer confidence will hang in there, at least enough for us also we provide up value, and people see the quality that we provide in the convenience, I guess, above all.

Additionally, we think, Derek, we have multiple channels for our customers to get our pizza. So where a customer may have chosen delivery in the past, we're at every corner. So they can walk to the store if they can't afford the delivery fee and pick up their orders. So that ability to pivot within our own system for customers has really helped us ensure that we don't lose customers should they face headwinds in the economy.

Okay, makes sense. I guess also, might we see Pizza 73 joining in on the fun and anything? I know you pointed out, Paul, to the poutine there and the curly fries. But anything specific that you can point out that's driving that nice 7% jump?

Yes. I think it's a combination of factors, but I think we talked to you on our last call about our new website and app there. That really, I think, it's just it's so much easier to use. It's faster, quicker, much more pleasant experience. We would not -- we didn't have the create your own pizza capability, and a lot of people don't, by the way. And so it's just very easy. So I think just the easy convenience is just so much more pleasant experience there. And then I think we have been successful with poutine, has been very successful out there. People like those curly fries, but they also like the poutine twist on that. And the Gourmet Thins that we had, it's a great success out here and still do have success. That seems to have done pretty well as well out there. So some menu innovation, some technology stuff. And also, I would highlight our local marketing team there that works very closely with our team here. But we've got some very senior people. They've invested in more people that are very capable and they're Alberta-based. And we think that's really given a new kind of renewed vigor, I guess, and some different approaches. We're not just taking what Pizza Pizza does and sticking a blue color on the logo there. It's a different market, different behavior, different demographics. And so we're trying to really do a lot more sort of localized stuff. But then we also are cross-pollinating when it makes sense. If it works here, certain things do port really nicely over there. So I think it's sort of a combination of all those things. And I think the brand is sort of -- and the renovations that we're underway with as well, people do start to see us, just we're continuing to reinvest in the brand just like we did here. And so I think it's -- I don't think consumers there necessarily are massively better. I don't think the market is tremendously healthier than it was last quarter, let's say, out there. But I just think generally, we've kind of been picking up our game there overall.

Okay. And I think you mentioned 25% of the restaurants have been renovated? Is the plan to roll it out to, I guess, the remaining 75%?

Yes, pretty much. And we do have some new stores as well as we're building. We haven't had as much pace with the growth there as we have with the rest of the country at Pizza Pizza. But we still do have some growth there. And those renovations are smaller by nature. It's a smaller footprint restaurant. The customer area is smaller. It's just a slightly different approach where people are more trained to come in to pick up, and they might sit at some high counter kind of barstool type arrangement. But it's very small compared to a typical Pizza Pizza. And so the costs associated with renovating that what we call the sort of the lobby or customer area is much smaller for the operator. And it's very quick and easy relative to the Pizza Pizza one, which is actually pretty substantial for our operators at the time to take that.

Right, okay. And so it seems, for here anyway, it seems like the summer rain here in Montreal and otherwise forest fires, and that got me thinking about, I guess the first thing is like how have your outdoor venues been doing? And second, do you guys benefit from inclement summer weather?

Yes, it's a good question. I think we have, for instance, had some big success. I mean the weather does play a big role. I mean, often, when it's raining, generally speaking, we do get kind of a boost in deliveries. So it might be walk-in, overall, but when weather -- when it's raining or in the summer, people do delivery a little more. And we do see still pickup overall growing very rapidly like faster than delivery growth. But we have had some success. I know it's more getting into post quarter, but we do annually do quite a big exercise in Montreal at -- Moving Day and Canada Day there. And this year, we did a huge amount of extra marketing, promoting our -- how we are very active in Montreal. And we do things like Boots and Hearts and Calgary Stampede, obviously, and that's sort of, again, this next quarter. But we have done very well in these other venues in places like Canada's Wonderland. I mean we've been very successful there for many years, and they've been a great partner, and we've actually just been increasing our presence in a number of our units on site there at very key locations for them, in their most popular rides and things. So we -- I would say it's a real specialty we have that -- really, I can't think of anyone else that really has that specialty where our outdoor events, our special events teams, they're kind of a mobile army. They know how to set up equipment and tents and trailers and deploy student resources, mostly train them up fast. And we can be really nimble, really increasingly nationally, still primarily Ontario and Alberta, but we also think there's potential to do even more in Quebec, even more in British Columbia, places like The Maritimes. So I think that is a really unique skill set we have in our team. But weather, overall, sometimes it does hurt walk-in business, if was not so good, but we did get the delivery boost, let's say, overall.

Okay. And I know it's always tough out there, but I was -- has there been any changes to the competitive intensity? Or has sort of that inflationary backdrop kicked everyone sort of so to speak?

I haven't really noticed overall. I mean we certainly have some very serious competitors that we monitor very closely. And I think we have -- really have our ear to the ground there. But we're trying to be driven by our own demographics, our own analysis, our own data and customer behavior. But it doesn't line up. I think that there's some strong competitors out there as well, and they're creative as well. But we think that relative to the peer group, especially in pizza, we've been outpacing pretty much everyone we can think of. And we don't get to talk to you about it because we know that things can change pretty quickly. So our view is let's keep innovating, let's keep being the leader and let's not let anyone [indiscernible] progress. But it's a strong field out there. I mean there's some really smart companies out there. We're not the only one, but we think that we've got the best track record recently and we hope to keep it that way.

Okay. That's it for me, everyone.

Okay. Thanks very much, Derek. Appreciate it.

There are no further questions at this time. You may proceed.

Thank you all for your time today. If you have any other questions, you can contact myself or Christine D'Sylva, and our contact information can be found on our earnings press release. Thank you, again.

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