Pizza Pizza Royalty Corp.

Thank you. Good morning everyone.

And welcome to Pizza Pizza Royalty Corp.' s Earnings Call for the fourth quarter and year ended December 31, 2018.

Joining me on the call today are Pizza Pizza Limited Chief Executive Officer, Paul Goddard and Chief Financial Officer, Curt Feltner. 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 Web site for reconciliation and other disclosures relating to non-IFRS measures mentioned on this call. As a reminder, analysts are welcome to ask questions after the prepared remarks.

Portfolio managers and media can contact us after the call. With that, I would like to turn the call over to Paul Goddard for business update.

Thanks Christine, and thanks everyone for accommodating the timing of our release this Friday afternoon. 2018 was a challenging year for Pizza Pizza in terms of same store sales growth.

In addition to the heightened competitive environment, we were comping against our promotional heavy 50th anniversary year of 2017. Consumers were offered exceptional value deals, especially in Q4, 2017 as Pizza Pizza celebrating our Made in Canada success story.

Despite the effect of lapping the 2017 anniversary year, we found that 2018 same store sales fell short of our expectations. Q4 same store sales decreased 2.1% and the full year decreased 1.6%.

As a market leader, we did not achieve our potential. Therefore, we have recently been taking and are continuing to take the necessary steps to improve our performance.

On our last conference call, I discussed the major shift in Pizza Pizza's marketing strategies, which began in mid-2018. The shift includes both long term strategic brand building, as well as short term sales growth activities.

What do we mean by branding building? While for us, it means refining and continually working to enhance consumers' brand perception and increasing our overall brand relevance which is for a successful path forward and maturing to historical positive same store sales growth levels.

We acknowledge brand building and elevating our brand relevances long term and an ongoing effort. However, we are committed to both brands improving the customer experience by providing the best food at the best value, while also keeping an eye on restaurant profitability.

Additionally, we have invested significant human resources to improve the foundations of our marketing efforts with data analytics to new digital marketing techniques through immediate buying and creative output. These were necessary moves to set ourselves up for best-in-class integrated marketing efforts and in turn best in class customer experience.

We are confident that both brands will deliver on our strategic initiatives, which I want to briefly highlight. First, specifically consumers are beginning to experience Pizza Pizza's more multifaceted and data-driven marketing approach to sales growth and brand imaging.

In addition to traditional advertising, print, radio, billboards and the like, consumers are beginning to routinely encounter our promotional campaigns much more through digital channels, such as social media and search. We will continue to invest more over time in the digital marketing channels to improve consumer targeting with enhanced efficiency and to increase order frequency, as well as new customer acquisition.

Second, consumers will also experience the re-launch of our Web site, targeted for the second half of 2019, followed by re-launch of our iPhone and Android ordering apps. This is one example of how we're aiming to provide extreme convenience to consumers, which I talked about on our last conference call.

Technology investments by Pizza Pizza limited continues to be one of our most critical strategic investments and one of our key differentiators. Third, in addition to technology, we continue to open and renovate and reimage our restaurants.

Pizza Pizza's new restaurant openings will continue our national expansion program across the Canada as we expect to add over 20 restaurants in 2019. As well our restaurant renovation program, which began early 2017, invites customers to experience a much more inviting and contemporary store ambience.

We launched for instance a relevant to the younger demographic in this quickly evolving competitive landscape. Currently, we now have over 100 of our traditional Pizza Pizza locations, or roughly 25% showcasing our new look.

So we are well on our way here. And again, this helps with our brand relevance and our service and experience excellence goals for our customers.

Fourth, consumers can also expect continued usage of attractive value offerings in this increasingly competitive environment. With our scale and market position, we are well-positioned to adjust our product mix in a nimble fashion to drive traffic as we ensure improved value for money for our customers.

Lastly fifth, consumers will also be provided menu innovation with the introduction of new pizzas similar to last year's cauliflower pizza launch. And new products will continue to enhance our brand perception and create market buzz.

We will also innovate on non pizza menu items to augment our core product mix. So in summary, effective execution of these various sales driving strategies is underway, and will be key to our future success.

Looking at Q4 sales in a bit more detail. At the time of our Q3 call last November, we were experiencing positive sales momentum.

However, the back half of the fourth quarter disappointed as our December holiday campaign, while our strongest to-date in terms of consumer engagement fell short of sales expectations. We learned from this and are finding these learning to the intention of ensuring future digital campaigns resonate more robustly in the marketplace.

Same-store sales growth, a key to shareholder yield growth is driven by the change in a customer checks and customer traffic both of which are affected by changes in pricing and sales mix. During the quarter and year, the average customer check increased, while the customer traffic count decreased.

So we continue to fine-tune our retail pricing, using our data analytics and business intelligence tools and an effort to boost traffic at both brands. At pizza pizza fourth quarter same store sales decreased 2.6% to have positive results of 0.3% at Pizza 73, operating largely in Alberta economy versus a three year negative trend.

So we are certainly encouraged by these results of course. With over 80% of sales coming from Pizza Pizza, royalty pool system sales decreased 1.5% in Q4 to $141.5 million from $142.7 million in Q4 of last year.

And for the year, royalty pool system sales decreased slightly by 0.9% to $546.3 million compared to $551.1 million in 2017. With regards to our dividend and our payout ratio, Pizza Pizza Royalty Corp's monthly dividend is supported by a healthy cash reserve, which is sitting at $4.2 million as of December 31st.

Sole purpose of this reserve is to support our dividend in the event of short to medium weakness in system sales, which we certainly have experienced recently. Touching on Pizza Pizza Limited's restaurant operations, the fourth quarter began with value delivery offerings, including the 1199 extra large pizza, the buy-one get-one for $5 special and we also reintroduced our popular large pizza walk-in special.

New innovative wing flavors, such as spicy gold and crispy were added at Pizza 73 to accompany our $0.50 wing deal at west, and marketing supported the offerings with print on-board and enhanced digital campaigns. The December marketing campaign featured our magical holiday special, quite a new and novel approach.

Creative TV and digital advertising built brand awareness through multiple social media channels. While enhancing our brand perception with novel and creative message, consumer traffic did fall short of expectations.

At the restaurant operations level in Q4, we've been focusing more than ever on our food quality and our [Technical Difficulty] restaurant assessment, and in the spirit of continuous improvement and service excellence. Touching on restaurant development during the quarter, PPL open four traditional Pizza Pizza restaurants, one in each of Québec, Prince Edward Island, British Columbia and Ontario.

Additionally, two non-traditional pizza locations were opened including one in Ontario's union station and one non-traditional pizza location was closed. PPL also opened one traditional pizza 72 restaurant in Alberta.

For the year then, PPL opened nine traditional and 11 non-traditional pizza restaurants. Traditional restaurant openings in 2018 continued PPL's national expansion plan of openings in Quebec, Ontario, Manitoba, first location at PEI, two locations in British Columbia, four traditional and two non-traditional pizza 72 restaurants were opened.

Additionally, PPL closed two traditional and 10 non-traditional locations during the year. For pizza73, one non-traditional location is closed during the year.

And as I mentioned earlier, we are targeting in addition of 20 new restaurants in 2019 addition. In addition to adding new restaurant and continuing our renovation program, Pizza Pizza is focused squarely on future growth and innovation.

And we continue to we reinvest heavily in our entire platform across Canada to ensure we are well-positioned to continue to lead the highly competitive QSR pizza market. Our roadmap both short and long-term will see our brand's reposition in the market by building increased brand relevance with consumer through quality messages, enhanced service, technologically and menu innovation and strategic execution at all levels of our business.

So we remain focused on further growing our top line sales, growing our network and improving on the guest experience. All of which we believe will drive value for all of our stakeholders for many years to come and market leader in QSR Pizza.

Thank you for joining our call. And I will now ask Curt Feltner, our CFO, to provide a quick financial update.

Thank you, Paul. Pizza Pizza is a top line restaurant royalty cost that earns monthly royalty through a lease arrangement with Pizza Pizza Limited for the use of the Pizza Pizza and Pizza 73 trademark in its restaurant operations.

The royalty is calculated as a percentage of royalty pool system sales reported by the restaurants that are in the royalty pool. Pizza Pizza Royalty Corp.

indirectly owns the brands and trademarks through its subsidiary Pizza Pizza Royalty Limited Partnership and the partnership has two partners, which is Pizza Pizza Royalty Corp. and Pizza Pizza Ltd, a private opco.

So with that background, let’s turn to the financial results. First, as Paul mentioned, same-store sales growth is the key driver of yield growth for shareholders and the same-store sales growth decreased 2.1% for the quarter compared to a decrease of 0.7% in the same quarter last year.

And for the full year, same-store sales decreased 1.6% compared to a decrease of 0.1% in 2017. By brand, same-store sales for the Pizza Pizza, operating largely in Eastern Canada decreased 2.6% for the quarter, while same-store sales at Pizza 73 operating largely in Alberta, increased 0.3% for the quarter.

For the three months ended December 31, 2018, sales from the 758 restaurants in the Royalty pool decreased 1.5% to $141.5 million from $143.7 million in the prior year quarter comparable quarter when there were 751 restaurants in the royalty pool. For the year, royalty pool system sales decreased 0.9% to $546.3 million from $551.1 million in 2017.

So, now turning to the statement of operations. The following partnership transactions are consolidated in to Pizza Pizza Royalty Corp.'

s financial statement. So through the lease arrangement with Pizza Pizza Limited.

The partnership receives royalty income calculated as a percentage of top-line system sales. Royalty income earned by the partnership decreased by 1.1% to $9.2 million for the quarter and decreased of 0.6% plus $35.4 million for the year.

As a reminder, 6% royalty is earned on royalty pool system sales from 652 Pizza Pizza restaurants and the 9% royalties earned on the sales from 106 Pizza 73 restaurants. Using this royalty income, the partnership paid administrative expenses and interest expense before making monthly partnership distribution.

Administrative expenses for the quarter were $164,000, that's down from $189,000 in Q4, 2017. And for the year, admin expenses decreased to $562,000 from $645,000 in 2017.

Admin expenses are incurred at the partnership level and consistent director fees, audit, legal and public reporting fee, as well as D&O insurance. In addition to admin expenses, the partnership paid interest expense on its $47 million credit facility.

Interest expense for the year was $1.3 million, and was relatively unchanged from 2017. The interest rate was 2.75% for both year and this rate is hedged through April 2020, which is the credit facility's maturity date.

So one note on interest. Interest expense reported in the statement of earnings defers from interest actually paid due to hedge accounting.

And so we've included full interest expense reconciliation in the company's MD&A for your reference. After the partnership receives royalty income pays admin and interest expense, the resulting net cash is available for distribution to its partners based upon their ownership percentage.

So effective January 21, 2018, after new restaurants were added to the royalty pool, Pizza Pizza Royalty Corp. own 77.7% of the partnership compared to the prior year of 2017 when the Royalty Corp owned 78.9%.

Pizza Pizza Limited owns the remaining 22.3% in 2018. Current income tax for the quarter for the Royalty Corp.

was $1.5 million and was $5.7 million for 2018. These are both consistent with prior year comparative periods.

The company's operating earnings for the quarter were $9 million and were $34.9 million for 2018, and leads were also consistent with prior year comparative periods. Now regarding our earnings per share fully diluted basic earnings per share decreased 2.3% to $0.217 per share for the quarter, and decreased 2.1% to $0.849 per share for the year.

EPS decreased as compared to 2017 due largely to a decrease in royalty income, and also an increase in Pizza Pizza Limited's equivalent shares as of January 1, 2018 adjustment date. As compared to basic EPS, the company considered adjusted EPS to be a more meaningful indicator of the company's operating performance, and its ability to pay the monthly dividend.

Therefore, the company also reports fully diluted adjusted EPS. Adjusted EPS for the quarter decreased 2.6% to $0.227 when compared to the same period in 2017, and decreased 1.9% to $0.877 per year.

The adjusted EPS calculation is based on earnings adjusted for deferred taxes and actual interest paid. And you can refer to our your company's MD&A for a full reconciliation of our adjusted earnings as well.

So turning to dividends and working capital. The company declared shareholder dividends of $0.2139 per share for the quarter, which was unchanged from the quarter in 2017.

The payout ratio for the Pizza Pizza Royalty Corp. is 99% for the quarter, and was 95% in the same quarter in 2017.

For 2018, the full year the company declared dividends of $0.8556 per share, which was unchanged from 2017. Payout ratio was 1.04 for the year and 1.01 in 2017.

Company's working capital reserves [Technical Difficulty] dividends in the event that short to medium-term variability in system sales and that’s variability in the company's royalty income. And as a reminder, the company does not have capital expenditure requirements or employees.

So the working capital reserve for the year decreased 838,000 and the decrease in the reserve is attributable to reported negative same-store sales, as well as a 2017 true-up payment to Pizza Pizza limited of 111,000 made as part of the January 1st adjustment in the first quarter of 2018. With this reserve in place, the company will continue to target an annual payout ratio at or near 100% on an annualized basis.

So that concludes the financial overview. I'll now turn the call back to our operator for analyst questions.

Just a quick question maybe on what happened at closer to the end of Q4 in terms of -- I think, Paul, you said the magical holiday promotion. What is it exactly?

And you said that you learned from some of the not necessarily mistakes is probably the wrong word. But what is it that you learnt with this promotion?

We actually did a very similar promotion out west as well as Pizza 73, but involved in a survey, a novel new approach, very digitally focused campaign, bundling essentially pizza with some seasonal T-shirts that were quite playful targeted at teen level market essentially and the millennials as well. But it came with a different approach with accretive folks.

And it certainly got a lot of engagement in terms of the -- we measure the digital impressions that we get created when we do something like this and actually the very high. But our conversion rate wasn’t what we were expecting.

And although it did register I have to say better -- Pizza 73 is a slightly different offer because obviously it’s different brand and come up with a different pizza offering. But it was you just maybe looking at it forensically a little too different perhaps, even though we did get I think some buzz on social media and things like that.

It was a new approach. My sense is maybe we just changed quite a bit too much, and it was a little unusual I guess something we might have thought that was an unusual or different approach than we've taken in the past.

So I think we learnt from that a little bit in terms of how we put our digital together, what types of campaigns, what flavor we have.

The drop in traffic at Pizza Pizza, it didn’t accelerate in Q4 versus the previous three quarters?

We don't really track it. But the notice was different just was in December.

We don’t track and report, is what I meant really. But we were, as Paul has mentioned earlier, we did see some good momentum in the first two thirds of the quarter, the back is where we had the fall off.

And we felt like maybe some of the more traditional avenues of advertising that we employed in the past, meaning fliers, bill boards those things that maybe, the learnings that we had from our digital campaign that was a great campaign all in all, but maybe we look to in the future having more of a mixture of traditional and digital.

It doesn’t seem like it's an ideal environment for the third party delivery guys right now to be thriving. And do you have any sense if that competitive intensity is picking up amongst the delivery like the third-party channel, delivery channel?

And whether or not they're doing it at a loss just to increase subscribers or members, or what have you?

I think it’s a good observation, they are committed. It seems to be extremely aggressive out there, competition amongst these third-party providers.

It is difficult to get a lot of data, because not a lot of them are public. Obviously, that might change with folks like Uber.

But you do get some restaurant industry data and things like that say overall that third-party segment for QSR has grown, it's growing but I don't think they are making a lot of money. They are clearly advertising heavily some more than others and they are trying to build share as they're trying to build volume.

And I think the economics are challenged on one level value driven market, but they are clearly are those people that, those customers out there they really do want convenience as well. And they see those services very valuable.

So certainly don’t feel that they are going away and we need to certainly adapt them and learn how to work well in this market despite them being. But I think they are certainly aggressively trying to outdo each other.

And maybe just going back to my previous question on some of the limitations of the marketing in Q4. Has that changed your view on how you're approaching digital marketing going forward as you roll out the new initiatives.

I think the key point I guess we’re trying to say is that we're really learning as we go here, and we’re really underpinning our decisions with a lot more data and research in our own walls, using our own data, customer data and also third-party. So, I think were certainly not going to be dissuaded from pivoting to digital where we just think we need to hone our efforts there, and make sure that our creative is also very effective.

So essentially those are your creative elements of what you’re bundling together, what you're actually offering out there. And then there's your media mix, your different channels, whether it's traditional like Curt said, or digital.

And so we certainly still believe that there is tremendous opportunity to get a better return on advertising spend in many ways through digital means. And to in many ways, we think we've just scratched the surface there and don’t want to be dissuaded too soon by one particular campaign since it maybe didn’t hit a home run, because we saw some positive elements within that campaign and learned a lot, it's more the combination of what is creative and then also what is the media mix.

And I think, depending where we are as well in the market, certain demographics, certain city, certain parts of Canada, might warrants certainly slightly different approach or emphasis as well. So, I think we’re trying to be intelligent about how we do it.

But I don't think we dramatically pull out a digital or anything like that, it’s still very much hold the course and just make sure we get more effective balance campaigns.

Now, in terms of the competitive intensity. Who is pushing hard?

Is it just the other pizza players? Is it across the board for the QSR segment?

Or is it a tight consumer? Where do you think the big pressure on or the big driver value is coming from?

I do think its multiple factors in our view. You’re right.

You’re getting a very value conscious customer in many ways. We see trends towards pick up for instance in our own business with people that really -- value add to customers that want pick up and spare themselves the delivery charge.

But rather counter intuitively in some ways, you do keep third-party delivery overall growing as a percentage of total QSR business in Canada. So I think there's multiple things going on there.

I do think there is, just in general, no doubt that the fact that we’re not just competing with other pizza QSR players anymore. We’re competing with every QSR in effect FSR to some degree, which is a whole new disruptive landscape.

And I think we and all other pizza players are adapting to that, and so are QSR players. And our sense is that all QSR players out there are really pushing harder than ever for that incremental sale, it's extremely competitive.

There is more restaurants than ever out there, more choice for customers out there. And that’s to make sure you stand apart from those folks, you have to do something different.

You have to provide great service, great quality, great convenience and something that really is a cohesive offering to people.

One of your bigger U.S. competitors have some pretty good same store sales comps recently, and they obviously separated out by market.

But is there any sense whether or not they are getting more aggressive in Canada?

I think overall in terms of value message, yes. I think that that is something that you see.

And at least we're trying to make sure that we find that right balance between check and traffic. But obviously, tilting towards transaction volume and getting that traffic.

We certainly do see certain price points in the market that others are really anchoring around and we're conscious of those. And I guess we're trying to make sure that our value-oriented customer base, both customers that are really focused that way, we have something that speaks to that.

And maybe just one final one for me, so on Pizza 73, first positive comp in a while, congratulations there. I was just wondering if you can maybe talk about some of the drivers that are behind that improvement overtime?

I think traditionally, because we have also -- we've been certainly changing up our media mix out there too and doing more digital. So, it's interesting to see perhaps for different reasons some of the differences.

But it does seem like we've got some traction there in Q4. We had a $0.50 wing deal and we've launched three new wing flavors that seem to have resonated, as well as some other tried and true deals that we get a lot of mix through.

So I think it's that also just I think good execution in operations as well. And I think that’s not to be forgotten at all.

This is just making sure that our stores are making pizzas properly and at service times, and our metrics are met and our own customer rating systems have us rated highly. So, I think that that's part of the success out there.

Just to add to what Paul has seen for Pizza 73. Specifically, in Q4, we had more of a value branded promotional campaign there as well.

So if we look at year-over-year pricing, it fits nicely as far as the competitive landscape, what our real true value was there. And I think the customers responded well to that in addition to the overall campaign.

Maybe I should know this. But do you guys have ever run across campaigns between Pizza 73 and Pizza Pizza?

Just wondering if there is any learnings that you've learned from out west that could be applied here?

The brands are different but we certainly have in the past have had some similarity or with similar promotions, leveraging if it's a new creative offering or you have some good and free we introduced for instance a while ago at both brands. It's usually done it little differently.

But certainly you're trying to learn what works at one and that might work well at the other if it's a targeted at the same folks. So I think we're certainly looking at things like that right now, saying as Curt mentioned, value in key ROE speaking enough and loudly enough on the value front to our core Pizza Pizza customer for instance.

Thank you. And thank you everyone for joining us on the call this afternoon.

If you have any questions after this call, please contact us. Our information is on the earnings release.

Have a great weekend.