Pizza Pizza Royalty Corp.

Thank you. Good afternoon, everyone, and welcome to Pizza Pizza Royalty Corp's earnings call for the second quarter ended June 30, 2019.

Joining me on the call today are Pizza Pizza Limited's Chief Executive Officer, Paul Goddard; and Chief Financial Officer, Curtis 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 website for a reconciliation and other disclosures related to our non-IFRS measures mentioned on this call. As a reminder, analysts are welcome to ask questions after the prepared remarks.

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

Thanks Christine, and thanks, everyone, for joining our call today. We are pleased to report positive growth for the second quarter, especially with the improvement in traffic counts as customers responded positively to our new product offerings and value-oriented promotional campaigns at both brands.

Second quarter System Sales from the 772 restaurants in the Royalty Pool increased 2.4% to $134.3 million from $131.1 million in the prior year quarter. Pizza 73 continued its positive sales momentum in the underperforming western economies, further outpacing competitors, while Pizza Pizza made good progress in the east.

Same-store sales growth, the key driver of yield growth for shareholders of the company increased 1.6% for the quarter compared to Q2 of last year. As I mentioned, we attribute this quarter's positive momentum primarily to our continued focus on new product introductions and value.

So we have also put an even greater emphasis than ever on superior execution at our restaurants. Our marketing campaigns continue to enhance our brands, consumer perception and increase our overall brand relevance, which is central to our successful path forward and we're trending to historical sales growth levels.

On prior calls, we've mentioned that Pizza Pizza has been undergoing a transformation of sorts with a distinct shift in our overall marketing strategy. The shift is ongoing and includes both long-term strategic brand building initiatives as well as short and long-term sales growth strategies in practice.

Over the past year and particularly recently, we've continued to steadily build up our in-house data analytics capabilities, along with external market research to continuously improve our decision making, demographic targeting and conversion rates to bolster our sales performance. We feel these efforts are starting to pay off, despite in an ever more competitive market environment.

Touching on our Q2 sales results and sales building strategies. First, the improved traffic growth and the increase in the average customer check resulted in 0.8% positive same-store sales of Pizza Pizza, and a strong 5.8% same-store sales growth at Pizza 73 in Q2.

This improvement in customer traffic counts reversed a year-long trend of traffic loss at Pizza Pizza, while Pizza 73 continued its traffic growth, which began late last year. It is always challenging in our industry to simultaneously grow traffic and pickup.

So we are certainly pleased to see it happen in Q2. Pizza Pizza's marketing campaign focused on driving baseline price points like our $11.99 extra-large 2 topping deal and our lead deal featuring a large 3 topping pizza with 3 drinks at $13.99.

Attractive value offerings, certainly resonate with consumers in this increasingly competitive environment. However, our recent major marketing campaigns such as boards featuring Cauliflower Crust Pizzas and plant-based protein toppings at premium price points have been supportive in increasing the average customer check.

Additionally, we have recently taken selective price increases where we felt it would not adversely impact traffic and these limited price increases further contributed to our positive same-store sales growth. And during Q2, Pizza Pizza also launched our delivery done better marketing campaign, designed to shine up ride it right on our many delivery advantages over competitors.

As part of delivery done better, in the second quarter Pizza Pizza floated 50% off at regular menu pricing. This 50% off promo brought focus to our convenience and into the [Indiscernible] including our less delivery time guarantee.

The pizza industry in general, of course, is responding to third party delivery aggregators. During Q2, we continued to see a significant amount of pressure applied by the aggregators through a substantial amount of discounting and heavy advertising in the marketplace.

Our delivery done better message will continue targeting industry competitors as well as third party aggregators. Value-driven campaigns and new product introductions are bringing back traffic, while also growing the average customer check.

In [Indiscernible] our marketing dollars were spent on traditional media, such as prints, billboard, radio, etcetera, but also on enhanced digital campaigns where we continue to reach new customers. And we'll continue to build on and iterate on our usage of various digital marketing channels to generate sales, while varying accumulating our marketing mix appropriately to seek various customer segments and behaviors.

Balancing our media message in traditional and digital marketing is both an art and a science. But in general, we are increasingly striking this balance more effectively, at least.

Meanwhile, technology investment by Pizza Pizza Limited continues to be one of our top strategic investments. In terms of digital orders, of total delivery and pickup orders over 50%, in fact, closer to 55% now, are placed using one of our digital channels, and this percentage continues to increase at both brands.

We will continue to accelerate the conversion of digital, given our significant digital advantage with these customers and wide array of ordering options and platforms, thereby allowing us to be the most convenient choice for our customers and in doing so, outpacing our competitors, pardon me. Consumers will see a relaunch of our website, targeted for rollout prior to year-end 2019, followed by a relaunch of our iPhone, iPad and Android ordering apps.

And as I mentioned, we expect to drive further conversion to digital ordering with enhancements in apps as well as with our ongoing loyalty efforts. And it is always our intention to drive our average check on digital channels higher than our traditional phone channel check wherever possible, which in turn should help us drive overall system sales and same-store sales sales growth over time.

Also, as some of you may have read in the media recently, our customer contact centers are beginning to employ artificial intelligence to speed the ordering process and reduce ordering costs -- operating costs, I should say, and errors. We believe we are a first mover in Canada in QSR with this initiative.

And although we are currently still in early development mode, we are excited at the prospect of allowing customers to speak to a pleasantly human sounding AI robot to order by phone should he choose to do so. So we see the potential for our AI voice solution to further speed up the ordering process, reduce costs, make it more convenient for them to order from Pizza Pizza, for those who wish to call in versus click to order.

And now I'm turning to restaurant development. During the quarter, Pizza Pizza Limited opened 2 nontraditional Pizza Pizza restaurants, while 3 traditional and 4 nontraditional Pizza Pizza were closed.

At the Pizza 73 brand, 4 nontraditional restaurants were closed. For the first 6 months, Pizza Pizza Limited has opened 2 traditional Pizza Pizza restaurants, one in Québec and one in B.C.

6 traditional Pizza Pizza restaurants were closed, principally in our more mature Ontario market. Additionally, 6 nontraditional Pizza Pizza locations were opened and 8 in nontraditional locations were closed.

At the Pizza 73 brand, 1 traditional and 5 non-traditional restaurants were closed. Pizza Pizza has historically had a low restaurant closure rate, especially for our traditional restaurants.

Though, we are increasingly taking a hard look at underperforming locations and being disciplined about closing a few more here and there as we prioritize restaurant profitability. And at the same time, and as we've often said on these calls, the nontraditional restaurants are more volatile in nature due to shorter contractual arrangements with licensees and often grow or shrink more in spurts.

In terms of overall restaurant network growth, we do expect the majority of our restaurant openings to come in the back half of the year and get us closer to our net openings target of somewhere near or closer to 1% for the year. In addition to new restaurants, our restaurant reimaging program continues to progress well.

We started rolling out the new design back in early 2017, and we now have over 25% of our traditional Pizza Pizza locations showcasing our new renovated look. Customers enjoying our more contemporary store ambiance, which is more inviting and comfortable with cloud-based music, communal tables, charging stations for mobile devices, modern butcher block tables, modern chairs, etcetera.

Our new look helps us stay relevant with the younger demographic, along with other key demographics, such as families, too, in this quickly evolving competitive landscape. So as I said, with approximately 118, I believe it is, new and renovated locations, we are well on our way with over 25% of our traditional Pizza Pizza restaurants now reimaged.

And as well I should say, our non-traditional locations are also continuously adopting the new look, evolving to the new image as we build all new non-trad locations for the new design. So as we grow our national network of restaurants and continue to roll out our reimage look, at Pizza Pizza we remain laser focused on our future growth and innovation as always.

And we're working hard to further drive internal traffic and, in turn, overall results for all of our stakeholders. And these efforts are underpinned by our strategic data driven marketing approach, our IT investments, our modern, reimaged restaurants, our food quality and value focus and innovation at all levels.

So overall, we will continue to ensure that we remain customer driven in all we do. We will continuously evolve, improve and build on our brand relevance and maintain our position as the market leaders in Canadian QSR pizza.

I just want to close by thanking our entire team as well as employees, partners and franchisees for helping us turn positive this quarter and capitalizing on a positive momentum at both brands. Thank you again for joining the call this afternoon.

I'll now ask Curtis Feltner, our CFO, to provide a brief financial update.

Thank you, Paul. Pizza Pizza is a top line restaurant royalty, corporate earns a monthly royalty through a 99-year lease agreement with Pizza Pizza Limited, which uses the Pizza Pizza and Pizza 73 trademarks in its restaurant operations.

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

indirectly owns the Pizza Pizza and Pizza 73 brands and trademarks through its subsidiary, Pizza Pizza Royalty Limited partnership. This partnership has 2 partners, Pizza Pizza Royalty Corp., which currently owns 77% of the partnership and the second partner, Pizza Pizza Limited, a private operating company, owns the remaining 23%.

So with that background, let's turn to the Q2 financial results. As Paul mentioned, our same-store sales growth increased 1.6% for the quarter.

Year-to-date same-store sales growth is reported flat when compared to the same period in 2018. By brand, same-store sales increased 0.8% for Pizza Pizza, operating largely in Eastern Canada.

And for Pizza 73, same-store sales increased 5.8%, and that brand operates largely in Alberta. Royalty Pool System Sales for the quarter increased 2.4% to $134.3 million over the same quarter last year.

By brand sales from the 660 Pizza Pizza restaurants in the Royalty Pool increased 1.7% to $112.2 million for the quarter. Sales from the 112 Pizza 73 restaurants increased 6.2% to $22.1 million.

The increase in royalty from sales is driven by the reported same-store sales growth and the addition of new restaurants to the Royalty Pool on January 1, 2019. Now turning to the company's statements of earnings, the following partnership transactions are consolidated into Pizza Royalty Corp's financial statement.

Through a lease agreement that I mentioned earlier, Pizza Pizza Royalty Limited partnership receives royalty income from Pizza Pizza Limited calculated as a percentage of top line restaurant sales, but royalty income earned by the partnership increased 2.7% to $8.7 million for the quarter and increased 1% to $17.4 million for the 6-month period. Using this royalty income, the partnership pays administrative expenses and interest expense before making partnership distributions.

One important note on our credit facility was during the quarter, which was on June 28, 2019, the partnership amended and extended its $47 million credit facility with a syndicate of chartered banks, the partnership's current interest rate, which began in 2015 and is projected to remain unchanged through April 2020 is 2.75%. So subsequent to the quarter end, the partnership entered into a 5-year forward-swap arrangement, which will begin April 2020 and will have a new effective interest rate of 2.685%, comprised of a fixed rate of 1.81% plus the credit spread currently at 0.875%.

So management and the Board felt it prudent to lock in rates now in order to provide shareholders' comfort over future interest payments. After the partnership receives royalty income and pays admin and interest expense, the resulting net cash is available for distribution to its 2 partners based upon their ownership percentage.

Effective January 1, 2019, after new restaurants, restaurants were added to the Royalty Pool, Pizza Pizza Limited's ownership increased by 0.7% to 23%. So the increase is a result of adding the additional royalties from the 14 net restaurants added to the Royalty Pool on January 1.

And as I mentioned earlier, Pizza Pizza Royalty Corp. owns 77% of the partnership, which is a slight decrease from the 77.7% in 2018.

The Company's operating earnings before income taxes for the quarter was $8.3 million compared to $8.1 million in Q2 last year. Current income tax for the quarter was $1.4 million and is unchanged from the same quarter last year.

Turning to dividends and working capital. In the quarter, the company declared shareholder dividends of $21.39 per share, which is unchanged from the prior year comparable quarter.

The payout ratio was 107% for the quarter and it's 107% year-to-date. On a trailing four-quarter basis, the payout ratio is 104%.

The quarterly payout ratio historically increases in the first half of the year due to seasonality of sales at the restaurants. The Company's working capital reserve is $3.5 million at June 30, 2019, and this is a decrease of $732,000 since the beginning of the year.

The decrease in the reserve is largely attributable to the 107% payout ratio for the first six months of the year when System Sales are historically weaker than the second half of the year due to the seasonality that I mentioned. So 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 our financial overview. I'll now turn the call back to our operator, Chris, for questions.

Chris?

Yes. Good afternoon everybody.

I guess, you answered a lot of them in your prepared comments, especially on the sales, but Paul, best comp sales numbers that you guys have had in seven quarters. Maybe if you could just talk about some of the bigger new products that you think drove that?

And maybe give me an indication of how you feel about the momentum you've generated?

Right. Yes, I think, as I mentioned, I think some of the new introductions have really been exciting.

The cauliflower, which actually is a reintroduction, but the market can have a different way. And then the plant-based topping that's been, I think, very successful.

And so far, I think we really got a lot of the media attention because we were perceived as a first mover really, in Canada, in a particular store [ph]. So they've got from the premium side, it's also good, obviously, for restaurant profitability with the more premium pricing.

But I also think a lot of our tried and true value offerings have worked very well as well. We've been around a little bit with how we advertise, with more on the digital side and accentuating different aspects.

So I would say, mixing up that recipe of our proven value offerings has also been a big part of us. We keep close attention to where -- which of these offers are really driving volume, and we've been able to capitalize on that quite nicely.

And then just -- maybe just a follow-up on the cauliflower, I remember there being some supply issues, have those been fixed?

We're comfortable that we have a strategy in place to prevent those from recurring.

Okay.

Yes, but we, certainly, we want to make sure that we have a much higher degree of confidence going in and doing a relaunch there. And actually, just yesterday, in fact, Q3 for Pizza 73 is public now.

We just announced the Pizza 73. We replenish protein toppings and the cauliflower crust as well.

So we've not done that before at west [ph]. So we're going to be hopefully now we'll do well, we'll see for Q3, but that was just announced yesterday.

So there's upside. And then also at restaurant [ph] and Everyday Deal, we had a lot for little offer that that's been very well out there, 2 mediums, 2 drinks, with the special for $22.

That seems t be resonated quite nicely as well in that market, I think with the price mix versus competition. It's overall, I think we've sort of found the balance with the offerings a little better than we have in prior quarters.

And I think the marketing techniques that we're using have helped. And I think just the super emphasis on quality execution of sorts.

I mean we're just -- we're cautiously attracting -- traffic keep building in our stores and just making sure that we're upping the customer view and perception of how we're actually executing day-to-day with our food. So sort of the marketing and the operations, I would say, are on a -- offers that resonate nicely.

Okay. That's just some great color.

It is -- and then you did mention again, too, in some of your prepared remarks that your pizza competitors and even some QSRs have been having a tough go as third-party providers flex their muscle. So your numbers do stick out.

Just wondering what you think has made you, at least in this quarter, more successful than the rest?

Well, I mean, I think -- I'd like to think we're sort of much of data-driven, first of all, I think that was a big shift that we started over a year ago with our marketing. And so I think we're just more informed.

Not everything we try works, of course, but I think just generally, we're hitting it more often than not. And that feels good.

I think versus competitors, I can't really speak to what they're doing, but obviously, we're keeping a close eye on them and on the third-party aggregators. It seems like that the delivery done better campaign was really trying to play up our advantages versus someone else, someone in the branded uniform coming at your doorstep with an insulated delivery bag, if there's a customer issue, we'll look after it, where the time is to be guaranteed, you can order from us in countless ways basically.

So we're trying to really highlight that and also take more of healthier premium deal as well where we can with some of the new on-trend offerings. But we're not only paying the value card.

Okay. And I guess my question on that delivery done better, I was wondering what it entailed.

And I guess, you just described it as better service as -- maybe you can explain it again?

Now, that's what we tried to do. We really try to highlight our guarantee on the fact that we've done it on our flyers, our billboards and you've seen we were taking a little bit of cheeky approach to challenge the third parties a little bit, not saying that we don't -- or I'd like to call, we carry it into those delivery bag.

We don't have surge pricing. So in other words, we're also giving the affordability of our delivery service versus third-party people.

Okay.

So, we're really just trying to highlight that the trusted nature of our brand. We're going to have a lot time.

We've got a lot of expertise here through different means. But a lot of that was visual on billboards, I would say, and printed material, as well as targeted display, social and search digital ads, that had different messages, but along those lines that we've had a number of different [Indiscernible].

All right. And you talked about the -- your in-house analytics.

I was just wondering -- and how much data do you think that you can get from it. And maybe if I -- maybe said another way, like how much potential do you think you have left?

Like are you in the early innings of this? Is there a lot more that you can squeeze from this new data analytics that you have?

I think so. I still think we are in early stages.

And I think it's -- we do use a lot third-party research as well. We certainly don't every answers in-house, but what we do have is this massive wealth of data and ability now to tap into it like never before.

So I do think that because we now have the architecture in that place, and our entire ERP system with all of our account data and distribution data as well, we just have a more informed view than we ever have. And so I think it is sort of sequential process.

I do think that as we build up our loyalty program, which is also on the slate, that will take some time, I mean, and it's probably more in 2020, but we are, right now, thinking of that. And we imagine the loyalty side as well.

With the new website coming out, we'll tend to make it a lot easier to create a profile, make royalty even more appealing, more simple to use. I think we were successful with it already.

But I think -- we think there's a lot more capability there. So it's really trying to -- and we convert more to digital and get more signups, more loyalties people signed up, then you can really leverage your data, and we're going to just have so much more measurability there, along with increased digital advertising efforts.

So it's just -- you're just -- you're collecting more and more data and that's more and more relevant over time. So since we now have the infrastructure in place, we should be able to leverage that better in future.

Okay. Maybe just on the competition front, is -- are any of your bigger, let's call them, pizza competitors, are they still aggressively building out in the bigger space?

I would say that we do -- pardon me, we do see certain competitors in certain geographies more than others. So we're cognizant of that.

I think it's not getting easier for anybody [Indiscernible]. Yes, pardon me, Derek.

We do see more competitors in certain places. Okay.

Pardon, my throat.

Yes. No problem.

Take another sip. If you want, I can ask Curt a question.

Yes. Go and ask.

Give me a minute.

Yes. Curt, just maybe on the extension of the credit facilities, when does it -- when did you extend it to?

Yes. So the current rate that we have is equivalent to 2.75%.

So we -- instead of blending, we continue that rate through April 2020. And then at that point, then the new rate that comes into effect for five years after April 2020 is 2.685%.

So it goes down from 2.75% to 2.68%, but that begins second quarter of 2020.

Okay. Does the -- does that spread change or that's locked in?

Because you said -- 1 plus a credit spread.

Yes. Same credit spread.

We felt like, and our bankers did too, that we sort of squeezed into a sweet spot in the rates. So yes, and we're seeing some movement in -- dollar movement in rates in the U.S., but Canada doesn't seem that way.

So we jumped in, and we were pleased with the outcome.

Okay. So the -- and so it's five years, so April 2025, I guess, is the -- would be the term?

Yes.

Okay. All right.

Coming back to -- now to Derek, I apologize. I'm still breathing, Derek.

Yes. Maybe just one last one for me.

And I don't know if I got the right message, but in the MD&A, are you talking about a slowdown in restaurant openings? Or was that 1%, always sort of guidance?

I think we've said historically 2%, we did turn that back a little to 1%. We know they were light on the first half of the year here.

So we've got lots to do for Q3 and Q4. But we do anticipate that as a pretty significant ramping back up.

But that said, look, in my comments I also said that we are making some closures there, where we think it makes sense to as well. We've been -- I would say, a bit hesitant in the past with the -- with other chains of our size, to quote, but we also want to make sure that we're -- we've got long-term profitable locations.

So, yes, we want to grow faster on that basis. But we also think it's important to do some clean up.

And on the non-traditionals, we have seen a little more closure here recently than we're used to as well. And that's just -- like I said, those had always been a little more volatile.

We have some new ones coming out with Wal-Mart expansion on the hub side, but we have some of those that are midway that are typically smaller volume anyways. We still don't want to lose them really, but on a material basis, those are typically smaller volume locations than the traditional store, right?

Okay. All right.

Actually, I do have one last one, and it's on the plant-based offerings. And it's in this tied to the supply chain, just wondering, like there's a few QSRs obviously in Canada that are offering a plant-based options.

Just wondering how you guys think about your supply and your ability to make sure that, that supply continues?

Yes. It's a really good point, Derek, obviously, there's obviously this huge demand and everyone seems to be rushing in the industry.

I think on the cauliflower, I mean, we've actually got multiple suppliers there, so that's one way that we've handled that and also inventorying more product, leverage frozen product when we get it. So that's wee bit risk there more easily, natural lasted a little bit there, too.

On the plant-based toppings, those are from two different suppliers. If not, there was big one, U.S.

one that are lot of people were using, that's a very decent supplier, but we're actually not using that company. So I guess, we're just tried to do our due diligence on the suppliers and one of them is owned by a major Canadian entity as well.

So we're pretty consistent with them that we have their liability [ph] supply. That's always, but I think that in the sausage crumble area, for instance, we haven't seen too many people doing that one.

And on the [Indiscernible] which has been around for a long time, which does know what it’s doing. So hopefully, we have some good steady supply there.

Sorry, the company is called ease [ph]?

EAS [ph]

Okay.

That's the company -- the other company as they -- a company owned by a major Canadian firm.

Okay. That's from me.

Everybody thanks for taking my questions.

Okay. Thanks very much, Derek.

Yes. Thanks Derek.

Thank you, Chris, and thank you, everyone, for being on the call with us this evening. If you have any questions after this call, please contact us, our information is on the earnings release.

Thank you, and have a good evening.