Pizza Pizza Royalty Corp

TSX:PZA

Earnings Call Transcript 2024-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Pizza Pizza Royalty Corp.'s Earnings Call for the Second Quarter of 2024. [Operator Instructions] As a reminder, this conference is being recorded on August 7, 2024. I would now like to turn the call over to Christine D'Sylva, CFO.

[Christine D'Sylva, executive]

Thank you. Good afternoon, everyone, and welcome to Pizza Pizza Royalty Corp.'s earnings call for the second quarter ended June 30, 2024. 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 a 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 Goddard to provide a business update.

[Paul Goddard, executive]

Thanks, Christine, and good afternoon, everyone. Thank you for joining Pizza Pizza Royalty Corp.'s Second Quarter Investor Conference Call. Today, I will discuss our second quarter results and will share a brief outlook for what's ahead in the second half of 2024. Christine will then summarize our key financial highlights before the Q&A at the end. Following 12 consecutive quarters of robust positive same-store sales growth, we experienced headwinds as consumers faced challenges with higher interest rates trickling through the economy, which has impacted household purchasing power. In the second quarter of 2024, our brands reported a combined 3.9% same-store sales decline as Pizza Pizza restaurants reported a 5.1% decline after 2 years -- 2 very strong years of double-digit and near double-digit growth, while Pizza 73 restaurants reported a positive 3.7% growth. And both brands saw an increase in the average customer check offset by a decline in traffic. As we have discussed on past calls, our sales are driven by key areas of our strategy, including our well-positioned and diverse value offerings throughout our menu, our convenience and presence where customers can experience and interact with our brands through a variety of platforms and the strength and resiliency of our brands, supported by effective marketing initiatives. So as consumer discretionary spending has decreased in the last few months, the competition in the QSR industry has increased. And while many brands speak to customers about price, we are focused on speaking to value. Throughout our entire menu and our multiple ordering channels, we promote and highlight products and specials at all price points to attract every customer. We know our customers are looking for value as well as quality, especially in a challenged economic landscape. So we have to find the right balance of perceived value for money. At the Pizza 73 brand, we successfully launched an XXL pizza Extra Large and a $19.99 price point speaking directly to the value customers are looking for and a creative new offering has been well received by customers. This is a very large 18-inch pizza. And as we move into the second half of 2024, we will continue to focus on and promote value to our customers as we look to gain traffic and share of consumer QSR spend. We are fortunate to have an expansive restaurant and digital footprint nationally from coast to coast across Canada to ensure that we are able to reach customers in all metropolitan areas across Canada and rural areas as well. As noted on previous calls, we have seen a shift in customer behavior with customers moving increasingly to pick up orders. And with well over 750 locations across Canada, we are ideally positioned to capture all audiences, especially those looking to save on delivery, tip and surcharges that many companies charge. Our in-store pickup channel has grown steadily over the 3 -- last 3-plus years and continues to look strong. And also, we know convenience is key for our busy customers and our industry-leading omnichannel approach lets people get their favorite hot and fresh pizza and wings in the most convenient, fast and easy way possible. In addition to our in-store orders, we have the best-in-class technology for customers to order on, whether it's through their smartphone app, iPad app, Apple Watch app or by ordering through our websites, and we continue to invest in critical technology infrastructure to ensure we are successfully receiving even more orders through our websites apps and also via our customer contact center. As mentioned in the past, over 60% of our orders are being placed on our digital platforms and Pizza Pizza customers order on the offer web can also visually track their orders on a map as it is delivered to them. Ensuring we are accessible to all potential customers has been a key priority of our business and has proven to be a key differentiator for us.

In terms of the strength of the brands, we're something we're very proud of, Pizza Pizza's marketing activities have been recognized as industry best-in-class winning numerous industry awards for our brand work and everyone deserves pizza platform.

We've talked about owning key days, and this quarter was no different. We had a viral launch of our 420 promotional pre-rolls and Hot Boxes to a specific customer demographic. This promotion was hugely successful turning us a massive $2 million sales day, and the pre-roll promotion allowed us to highlight a new product at a great price point and margin for our stores. And our flavor of that was really quite a cheeky specific campaign really targeted, and it really was validating to us to see how well that could work with that particular demographic. And this is a really fruitful brand-building initiative, and it's an example of how we continually succeed in keeping our brands top of mind with customers, which is always so critical, of course, in our highly competitive QSR market. We also highlight our brands through our best-in-class sponsorship programs. You can see our brands at fields and arenas across the country from Little League games all the way to the National Hockey League and the NBA. These sponsorship programs have been key to driving brand recognition, especially as we expand to new markets. In this quarter, we are happy to announce we are partnered with BC Place home to the BC Lions and Vancouver Whitecaps. We look forward to introducing sports enthusiasts and concert goers to our delicious food as we continue to ramp up our already strong presence in British Columbia.

And I would be remiss if I didn't mention the additional benefit of our sponsorships that comes when your favorite team makes to playoffs to the in-stadium concessions. This quarter, our nontraditional sales were bolstered by the incredible playoff run by the Edmonton Oilers where our Pizza 73 brand is a key sponsor. So as we look at the overall strength of our foundation, we've got brand strength, resident marketing messages, a continually enhanced menu, innovations in technology, reliable, consistency and quality and convenience for our customers. And this will continue to be growth -- key to our growth as we go forward. Turning to restaurant network growth. After a bit slower start to the year, we ramped up our store openings with 6 new traditional and 8 nontraditional Pizza Pizza locations opening in the second quarter, while we closed one traditional and 8 nontraditional locations. So for the 6 months, we have opened 26 locations, 8 traditional and 18 nontraditional locations while we have closed 3 traditional and 13 nontraditional locations. While we continue to focus on openings across Canada, we are pleased to say that half of our traditional store openings have been in our biggest and longest standing market, province of Ontario. Meanwhile, our successful expansions to the major markets of B.C. and Quebec continues. And beyond Canada, we continue working with our Mexican partners on the next set of restaurant openings and are happy to report that 2 locations opened in the second quarter, bringing our current total to 4 locations. So we continue to see good momentum there in Mexico, and we expect several more restaurant openings there this year.

Now on to our outlook and some closing remarks. As we look forward to the remainder of 2024, we are well positioned to continue driving our business executing on our plans of innovation, marketing initiatives, digital investments and providing high quality, great value and delicious hot and fresh food to our customers, however and wherever they want us. We know the economic landscape is challenged, but we will ensure that our customers continue to see us offering the best food at best price. And remember, our vision is always the best food, especially for you. Lastly, thank you to our team members and restaurant owner operators for your relentless commitment and dedication to our customers and our brands and for being such passionate team members in our success. Thank you for listening today, and I'll now ask Christine, our CFO, to provide a brief financial update.

[Christine D'Sylva, executive]

Thanks, Paul. Before going into the results for the quarter, I wanted to remind everyone of our structure. Pizza Pizza 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. On January 1, 2024, the Royalty Pool increased by 31 restaurants as a result of adding 45 new restaurants, less 14 which were permanently closed in 2023. So for 2024, there will be 774 restaurants in the royalty pool compared to 2023 when there were 743. So now let's briefly cover some financial highlights. As Paul mentioned, same-store sales, a key driver of yield growth for shareholders, decreased 3.9% for the quarter. Pizza Pizza restaurants reported same-store sales declines of 5.1%, while Pizza 73 restaurants were 3.7% positive. Both brands saw an increase in the average ticket, offset by a decline in traffic. The combination of new restaurants added to the Royalty Pool on January 1 and the same-store sales decline resulted in a decrease in Royalty Pool System Sales and the corresponding royalty income for the quarter. Royalty Pool systems sales for the quarter decreased 2% to $155.4 million from $158.5 million in the same quarter last year. By brand, sales from the 672 Pizza Pizza restaurants in the Royalty Pool decreased 2.8%, to $133.8 million for the quarter and sales from the 102 Pizza 73 restaurants increased 3.3% to $21.5 million for the quarter. The partnership's royalty income earned as a percentage of Royalty Pool sales decreased 1.6% to $10 million this quarter. The partnership also earns interest income on its cash and short-term investments. For the quarter, the partnership earned $103,000 of interest income. Turning to partnership expenses. Administrative expenses for the quarter were $194,000, and these included listing and shareholder meeting costs as well as director, legal and auditor fees. In addition to administrative expenses, the partnership is making interest-only payments on its $47 million credit facility. Interest paid in the quarter was $319,000. To note, during the quarter, in response to the cessation of the SEDAR benchmark interest rate, the credit facility was amended. The amendment transitioned the $47 million term loan from bankers' acceptances to core loans. The remaining terms and conditions are consistent with those of the previous facility. The fixed interest rate on the swaps remained unchanged with this amendment and the company will continue to pay 1.81% plus the credit spread through April 2025. The company's normal practice is to renegotiate the terms of its credit facility approximately 1 year in advance of its maturity. As such, it intends to renegotiate the facility that matures in April 2025, later this year. The company expects a new facility will be similar in size, however, at a higher interest rate as compared to the existing facility. So now -- after the partnership has received its royalty and interest income and pays administrative and interest expense, the resulting net cash is available for distribution to its 2 partners based on their ownership percentage. Effective January 1, 2024, after new restaurants were added to the Royalty Pool, and the 2023 vending was trued up, Pizza Pizza Limited's ownership increased to 25.2%. Pizza Pizza Royalty Corp. shares in the remaining 74.8% of the partnership distributions. 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 and working capital. The company declared shareholder dividends of $5.7 million for the current quarter or $0.2325 per share, compared to $5.4 million or $0.22 per share in 2023. The payout ratio of 109% resulted in the company's working capital reserve decreasing by $400,000 this quarter. The company ended the quarter with a healthy reserve of $6.8 million, excluding the reclassification of the credit facility. The reserve is available to stabilize dividends and to fund other expenditures in the event of short- to medium-term variability in system sales and in turn royalty income. The company has historically targeted a payout ratio at or near 100% on an annualized basis and will continue to do so. That concludes our financial overview. I'd like to turn the call back to the operator to poll for questions.

[Operator]

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

[Derek Lessard, analyst]

I guess I just wanted to drill down in terms of the sort of that consumer weakness that you're seeing. Are you able to maybe add some color there to what you're seeing in terms of the habits if consumers are trading down, buying less? I know you Paul, you mentioned less delivery versus walk-in, so just maybe some color there would be helpful.

[Paul Goddard, executive]

Right. No, I understand, Derek, it's a very good question. And we are basically, I mean I know you see that as a macro situation backdrop right now, I think you just with macro indicators and other QSRs reporting other retailers reporting, but we are seeing that. I mean people are definitely being more deliberate and a little more discerning in their overall spend. Our core [indiscernible] products continue to grow, our mix, I would say, stayed pretty strong. But in terms of how they obtain the orders, that seems to have changed. Pickup has been growing for us steadily that continues. And we do see delivery as a channel being challenged, and that's something that we've actually put a lot of effort and we continue to put a lot of effort into regaining, especially organic delivery. And we've done a lot to do that, but it's definitely difficult. And I think people are getting a little fatigued and especially with third-party aggregators as well. You can see that some of those folks, some are doing strong, but some are seeing a little bit of plateauing, if you like, there, just given the level of check size, especially on those platforms where you're often paying a higher price and you have a platform fee or something. So it's not only the merchant being charged, but the end customer as well. But even for us with a much more efficient cost-effective delivery, some people are saying what I'm going to preorder, I'd like to convenience to that, but I'm going to pick it up. I'm going to save on that charge. So we are seeing that. And I think -- I guess we just continue to notice things like average check very obviously by channel and by brand. So our walk-in business is still strong. I would say not as strong relatively in terms of growth, that was sort of fairly flat or some other areas. That means what in our parlance would be unpremeditated walk-in orders where you're just come and get a slice or 2 and a drink or something and a salad. That's obviously lower check, but that's been fairly stable. But late night has also been a little lower average ticket we've noticed sort of lunch late night dayparts and lower average ticket than our delivery orders as well. So when people stop doing delivery or stop deliveries much, we do feel that quite readily.

[Derek Lessard, analyst]

And do you think -- I guess, do you have a feeling of whether it's trending worse? Or is it stabilizing? Like how do you feel about the trends so far?

[Paul Goddard, executive]

I think it's a little early to tell. I mean, I think just generally, there's a -- people just seem to be in a market really emphasizing value you see it everywhere. And I think customers seem to be responding to that pretty well. I think just generally people -- although inflation has come off a little bit, obviously, and interest rates seem to be poised to go down a little more. I still think there's a bit of a lag there. My view would be in just looking at some research that people still feel economically squeezed, many, many people in our core market. So I think, if anything, I would say, it's probably stabilizing. Maybe there's a little bit more deterioration potential, I suppose, but I don't think it's sort of a massive decline, but it's just sort of subtle. But I think, fortunately, for us, I mean, I think we were able to adjust different levers a little bit to emphasize, say, things like walk in a little more or pick up a little more.

Delivery is hard to move the needle on. We've had a hard time doing delivery. But I think we've got some good plans, I think, for the remainder of the year that hopefully with some product innovation and some really compelling not only price points, but I think just the innovation of the products and the flavor profile of some things coming up that will help. But I mean the overall backdrop is challenging right now. I think people are feeling the squeeze and they're still feeling almost a hangover effect even if interest rates are coming down and inflation isn't as bad. And I think that's kind of clear across the market, not just for us.

[Derek Lessard, analyst]

So you did try to pick some price, it looks like. I guess the average check was up so how do you balance that out with sort of the backdrop that we're talking about here?

[Paul Goddard, executive]

Yes, it's a very good point. And that's sort of the art of it, right? What we really want is primarily revenue growth through traffic growth, right? We want more orders really at the end of the day. We don't really want to be relying on price increases. That's for sure, especially in this environment. But I think we've been pretty nimble in adjusting. So couple examples would be even a Pizza 73, as I mentioned in my prepared comments, with the XXL in 1999. That immediately got a response that sort of sub $20 price point for a really large 18-inch pizza, it's the biggest one in the market around pizza, people really like that. They also like our 4 small pizza deal in 1999 out there. They have a snack box out of it there as well that's really snack size. It's resonated well. And at Pizza Pizza, the fixed rate pizza, we've done very well. We actually increased the price this year for 2024, but it was fixed price last year and it's fixed price fall this year, but we took an extra dollar there at $17.99. And yes, that is still mixed very, very well. It's in sort of our top 3 or 4 mixing specials, and that's been very powerful. And so I think that's done well. And I think some of our creative occasion making efforts, if you like to call it that, like the 420 promotion, even though it's a limited audience, really got media attention. And I think it actually still some thunder even that week that it was released from some other large QSRs doing big launches that week. And it's not that we didn't expect that quite that much. It was really exciting. And then on Valentine's Day is another one where we had a third wheel deal were celebrating a couple with a third wheel and that third person gets an extra pizza sort of thing or a free pizza. So we've kind of created some new occasions. There's a little bit novel and just get some media attention and some focus. And people might not necessarily buy that special that we're offering, but really get our name out there and it gets into their mind and they basically still want to transact, maybe even they're still their favorite pepperoni pizza that end up buying. So I think some of those occasion making aspects have really helped. And we've also had some success with third-party with ghost kitchens with Chicken Chicken on third-party apps where we really haven't had to invest really much at all, and yet we have a solid offering on those programs, those channels when people are looking for chicken pizza, they find Chicken Chicken. And we're pretty clear that it's us behind the scenes, but we can deliver to that channel, so it becomes a new revenue stream. So there's sort of -- I would say it's a combination of offerings and yes, some -- a little more value-conscious price points and in some cases, are lower than what we've had for a little while.

[Derek Lessard, analyst]

Okay. That's helpful, Paul. And I guess, I don't mean to beat a dead horse, but the -- obviously, with these challenges comes an increasingly competitive environment. We're seeing whatever maybe like $5 menu deals. So I was curious on, one, is the competitive environment? Has it -- yes, it's definitely increased, but has it become irrational? And two, are you seeing maybe any customers shop the grocery channel more often, I don't know, like frozen pizza or stuff like that.

[Paul Goddard, executive]

Yes. In terms of substitutes and things, I mean, there is just increasingly more and more competition, I would say, across the board. It is hard to sit as attribute where are we losing? We look like our market share data shows that we're pretty stable. I know last year, we seem to take quite a bit of share from people. It does look like we may have lost a tiny bit of market share relative to last year. But we had big gains last year at the expense of many of our competitors we felt. And it seems like we may have given a little bit of that back. And so I think there is a bit of that, and we know -- I think we know which levers we need to pull to try and pivot even more to value to drive traffic. But you got some very good competitors out there, and they're pretty nimble as well. But I think -- like to think that we're more nimble and with our omnichannel approach, I mean, essentially, it just counting up with the Pizza Pizza. I think it's something like 10 or 11 channels, essentially, we have if you include our third-party channels and digital channels, call center walk-in, special events, nontraditional, et cetera, et cetera. We just -- we're so available, right, and we're so convenient. But we have to have a compelling offering. And grocery is another competitor. I mean, I think depending on what piece of the grocery market, some people get very, very -- value-conscious people can get a very, very good deal on frozen pizzas at the low end of the market. But the quality, I would say, is not comparable, but there probably are some customers that do drop off and say, you know what I'm okay with 2 pizzas for $5.99 or something like that, if it's a really low-end pizza, but those gourmet pizzas that you also see shrink-wrap for more upscale grocery stores.

I've got sort of mixed data on that one, nothing really robust. But I mean it seems like that's also an area where people are realizing, those are very expensive, even though the quality is actually a little bit better than some other grocery items -- frozen grocery items, but the price point is pretty high versus getting a fresh pizza delivered or for pickup. So I think generally, I would say I'm probably a little more worried about more -- the best of the best competitors or other substitutes for pizza itself in QSR and the third-party channels just because there's so much choice on those, more so than losses, I think, to the grocery channel would be my sense overall.

[Derek Lessard, analyst]

All right. That's fair. And I guess maybe, Paul, just talk on I think you did highlight some of the innovation in your last comments, but you did launch, I guess, the Hawaiian Stromboli in Q2. Just curious about any -- like how well -- one, how that's -- how demand has been trending for that? And any kind of new and exciting innovations in the pipeline.

[Paul Goddard, executive]

Yes, we do have some coming up. I think we always do. I don't want to look at Canada of the bag too much, but there are some coming very soon literally in the next few weeks, even there's some exciting one and then beyond. The Strombolis have done well, we did promote the Hawaiian one is sort of the attention grabbing one of the window clings and digital channels and things. But we actually have several different Strombolis and I would say they've all done well. They're really easy to make operationally. The margin for operators, quite frankly, is excellent and they're super tasty, you kind of you can eat with one hand, it's snack size and people have really, really, I think, been excited about it. It's a really -- it's not -- it's like we invented Strombolis but a lot of competitors in our space, larger chains don't tend to do it because I think they consider it operationally complex. And we've, I think, found a successful way to have a great tasting product at a good price point, good margin for franchisees. So it's done well and so have other things like Poutine and other sites that we've had Jalapeño Poppers and some of the ones we've introduced a long time ago. We still see really good take up on those sides. And I think sometimes it's really just showing people that were novel and creative and we have something for them. and they might or may not try it, but that might actually win their visit to our store, for instance. And they may try it, they may not or they might only try it once, but they -- we tend to keep in their minds, and they keep thinking about Pizza Pizza and Pizza 73.

[Derek Lessard, analyst]

Awesome. And maybe one final one for me. Again, in the context of this higher interest rate environment, I was curious on sort of your ability to attract quality franchisees given -- I guess, given the higher interest rates and what it would cost to own a franchise?

[Paul Goddard, executive]

So you're saying the delay -- I just didn't quite get at the beginning of your question there.

[Derek Lessard, analyst]

No, I think the increase in the higher interest rate environment.

[Paul Goddard, executive]

Yes. I mean, right, we're still seeing a very strong pipeline of franchisees. I would say we don't always get the franchisees where we want them, but I think we've had a really good success overall matching up where we need real estate, where we need franchisees or want franchisees. I mean I know in Quebec, I think we've got a couple of sites that are ready and we are waiting for those franchisee deals to get finalized. So there's sometimes a timing issue. But I think generally, we're quite good at franchising them up. And I do think so far, despite higher loan costs for those folks. I mean, I think generally, it's been pretty attractive. I think people see us as a very attractive business to own and be an entrepreneur. And so what we've tried to do, we can't obviously control interest rates. But I think what we've really tried to do is keep the cost of the stores down. And in some cases, we've either given franchise fee breaks or discounts or ways to sort of help their cash flow in that first beginning period for the first 6 months or a year to make it a little more economically attractive and soften the blow of those higher interest rates for the loan that they're taking. So I think it's sort of a combination of that, but we've been pretty successful at slowly, but carefully decreasing the cost of our store construction because we did see inflation there, and we really tried to sort of take some decisive action to do that, which makes it obviously, more affordable, so we don't have as much of their asset leverage for the franchisee.

[Operator]

[Operator Instructions] There are no further questions at this time. I would now like to turn the conference back over to Christine for any closing remarks.

[Christine D'Sylva, executive]

Thank you, everyone, for joining our call today. If you have any further questions after the call, please feel free to contact us. Our information is on the press release and on our website. Have a great evening.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.