Pizza Pizza Royalty Corp. (PZRIF) CEO Paul Goddard on Q1 2019 Results - Earnings Call Transcript

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About: Pizza Pizza Royalty Corp. (PZRIF)
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Earning Call Audio

Pizza Pizza Royalty Corp. (OTC:PZRIF) Q1 2019 Results Earnings Conference Call May 9, 2019 5:00 PM ET

Company Participants

Christine D'Sylva - IR

Curtis Feltner - CFO

Paul Goddard - CEO

Conference Call Participants

Derek Lessard - TD Securities

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Pizza Pizza Royalty Corp. First Quarter Results Conference Call. During the presentation, all participants will be on a listen-only mode. After the speakers' remarks, there will, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded on Thursday, May 9, 2019.

I will now turn the call over to Christine D'Sylva, Vice President of Finance and Investor Relations. Please go ahead.

Christine D'Sylva

Thank you. Good afternoon everyone and welcome to Pizza Pizza Royalty Corp.'s earnings call for the first quarter ended March 31, 2019. Joining me on the call today are Pizza Pizza Limited's 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 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 measures mentioned on this call. As a reminder, analysts are welcome to ask questions after the prepared remarks. Portfolio managers, investors and media can contact us after the call.

With that, I would like to turn the call over to Paul Goddard for our business update.

Paul Goddard

Thanks, Christine and thanks everyone, for joining our call today. The first quarter System Sales generated by the 772 restaurants in the Royalty Pool decreased 1.1% to $133.9 million from $135.3 million in the prior year quarter. Same-store sales growth, the key driver of yield growth for shareholders of the company decreased by 1.5% for the quarter compared to Q1 of last year. Royalty Pool System Sales for the quarter decreased as a result from the decrease in same-store sales growth offset by the sales from additional restaurants added to the Royalty Pool on January 1, 2019.

Although our first quarter sales results were below our expectations, we are seeing positive traffic movement at both brands as customers have begun responding positively to our refreshed marketing approach allowing with more effective value-oriented campaigns. And as discussed in our Q4 call, Pizza Pizza is undergoing a major shifts in marketing strategy. The shift include both long-term strategic brand building as well as short and long-term sales growth tactics. Our marketing campaigns continue to enhance our brands' consumer consumption and increase our overall brand relevance, which is essential to our successful path forward and returning to historical sales growth levels.

Looking at Q1 sales by brand, same-store sales growth, the key to shareholder yield growth, is driven by the change in the customer check and customer traffic, both of which are affected by changes in pricing and sales mix. Last year, the average customer check increased significantly, which contributed to greater-than-anticipated softness in customer orders. The soft traffic count resulted in negative 2.4% same-store sales at Pizza Pizza in Q1. However, at Pizza 73 operating largely in Alberta, we were very encouraged to report 2.9% positive same-store sales growth continuing that positive trend started in Q4 of last year.

Pizza Pizza's marketing campaigns have recently featured attractive value offerings in its increasingly competitive environment, especially with the entry of third-party delivery services and with [indiscernible] as well as we continue with traffic-driving tactics while enhancing our brand image. Marketing supported the offerings with print, billboard, radio and enhanced digital campaigns. And we are continuing to build on iterate of various digital marketing channels to generate sales.

Touching on Pizza Pizza's Limited Q1 restaurant operations, the first quarter began by focusing on delivery offerings including our $11.99 extra-large Pizza deal and our buy one, get one for $5 deal. January is normally a challenging month for retail, and this January was especially so as consumers were clearly very deal-focused. In February, we launched our annual Cineplex dinner and movie promo, which resonated well, but over all drove less traffic than in previous years. And in March, we continued the Cineplex promo. But additionally, Pizza Pizza's launched its new Tex-Mex Pizza and accompanying avocado fries demonstrating our ongoing commitment to menu innovation in line with evolving consumer taste profiles.

On the back end of Q1 2019, we did find traffic counts were moving in the right direction, closer to more expected levels, which is encouraging, especially at Pizza 73 as I said. Technology investment by Pizza Pizza Limited continues to be one of our key strategic focuses. In terms of digital orders, our total delivery and pick-up orders over 50% were placed using one of our digital channels. And this percentage continues to increase at both brands, which is great to see. Consumers will see a relaunch of our website targeted for the second half of 2019 followed by a relaunch of our iPhone, Android ordering apps.

We expect to drive further conversion of digital ordering with the enhanced website and apps. And the strategic IT investments will continue to drive our brand relevance and perception as well, keeping us ahead of the competition and top of mind as we drive convenience and royalty through our popular and easy-to-use digital ordering platforms. Touching on restaurant development, during the quarter, PPL opened 2 traditional Pizza Pizza restaurants, 1 in Québec, 1 in British Columbia and 3 traditional Pizza Pizza restaurants were closed.

Additionally, 4 nontraditional Pizza Pizza locations were opened and 4 nontraditional locations were closed. At the Pizza 73 brand, PPL closed 1 traditional and 1 nontraditional restaurant in Alberta. As well we continue to make good progress on our restaurant innovation program with 25% of our traditional Pizza Pizza locations now showcasing our new look. So that's well over 100 locations to date, including new and renovated stores. The refreshed updated image in these restaurants provide a much more modern, relevant and welcoming ambience, one that enriches the overall guest experience and demonstrates our commitment to continuously improving the dining experience.

As we grow our national network of restaurants, we continue to roll out our reimaged look of Pizza Pizza, we remain laser-focused on our future growth and innovation. We're working hard to drive incremental traffic and in turn overall results for all of our stakeholders. These efforts are underpinned by our strategic data-driven marketing approach, our key investments, modern reimaged restaurants, food quality, value focused and innovation at all times, at all levels. We will continue to ensure that we remain customer-centric to ensure we relentlessly evolve, improve and build on brand relevance and maintain our position as the market leaders in the Canadian QSR pizza space.

Thank you for joining the call. I'll now have Curtis Feltner, our CFO, to provide a quick financial update.

Curtis Feltner

Thank you, Paul. Pizza Pizza is a top line restaurant royalty corp. that earns a monthly royalty through a lease agreement with Pizza Pizza Limited, which uses the Pizza Pizza and Pizza 73 trademarks in its restaurant operations. The royalty is calculated as a percentage of Royalty Pool System Sales reported by the restaurant 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. So this partnership has 2 partners, Pizza Pizza Royalty Corp. and Pizza Pizza Limited, which is a private operating company.

So with that background, let's turn to Q1 financial results.

First, as Paul mentioned, same-store sales growth, which is the key driver of yield growth for shareholders decreased 1.5% for the quarter compared to a decrease of 0.2% in the same quarter last year. And same-store sales for Pizza Pizza, which operates largely in Eastern Canada, otherwise they're across Canada now, but largely in the Eastern Canada, same-store sales decreased 2.4% for the quarter while same-store sales growth for Pizza 73, operating largely in Alberta, increased 2.9% in the quarter.

Royalty Pool System Sales for the quarter decreased 1.1% to $133.9 million from $135.3 million in the same quarter last year. By brand sales from the 660 Pizza Pizza restaurants and the Royalty Pool decreased 1.9% to $111 million for the quarter compared to $113.2 million in the same quarter last year. Sales from the 112 Pizza 73 restaurants increased 3.4% to $22.9 million compared to $22.1 million in the same quarter last year.

The number of restaurants in the company's Royalty Pool increased by 14 locations to 772 restaurants on the January 1, 2019, adjustment date. The number of restaurants in the Royalty Pool will remain unchanged through December 31, 2019.

Now turning to the statements of earnings, the following partnership transactions are consolidated into Pizza Pizza Royalty Corp.'s financial statement. Through the lease agreement, Pizza Pizza Royalty Limited Partnership received royalty income from Pizza Pizza, calculated as a percentage of top line sales, royalty income earned by the partnership decreased slightly by 0.7% to $8.7 million for the quarter.

By brand, a 6% royalty was earned on $111 million in System Sales from that Pizza Pizza restaurants for the quarter and a 9% royalty was earned from the Pizza 73 restaurants, which recorded $22.9 million in System Sales for the quarter. So the partnership uses its royalty income, first, to pay administrative expenses and then interest expense before making monthly distributions to its partner.

Administrative expenses for the quarter decreased to $104,000 compared to $145,000 for the 2018 comparable quarter. Administrative expenses consist the directors' fees, audit, legal and public recording fee as well as directors' and officers' insurance, and a decrease in administrative expenses for the quarter is largely due to 1 less director compared to this time last year.

In addition to admin expenses, the partnership pays interest expense on its $47 million credit facility.

Interest expense for the quarter was $311,000 and was will relatively unchanged from same quarter in 2018. The interest rate was 2.75% for both this year and last year and it's hedged through April of 2020, which is the credit facility maturity date.

So one note of interest, the interest expense on the statements of earnings differs from interest actually paid through the hedged accounting. So a full interest expense reconciliation can be found in our MD&A, that's filed on SEDAR and on our website. So after the partnership received its royalty income, paid admin and interest expense, the resulting net cash is available for distribution to its 2 partners based on their ownership percentage. So effective would be, adjustment date is January 1, 2019, after new restaurants were added for the Royalty Pool, the Pizza Pizza Royalty Corp. owns 77% of the partnership, which is a decrease from 77.7% in 2018.

So Pizza Pizza Limited ownership actually increased by 0.7% to 23%, and the increase is a result of adding additional royalty from the 14 net restaurants that we added to the Royalty Pool. So the company's operating earnings before income taxes for the quarter is consistent with the prior year comparative period at $8.3 million. Current income tax for the quarter was also the same as Q1 2018 at $1.4 million. Now regarding our earnings per share, our fully diluted basic earnings per share decreased 2.8% to $0.211 per share for the quarter from $0.217 in Q1 last year.

However, as compared to basic EPS, the company considers adjusted earnings per share to be a more meaningful indicator of the company's operating performance and its ability to pay amount of dividend. So the adjusted EPS for the quarter decreased 1% to $0.216 from $0.218 in Q1 last year. And the adjusted EPS calculation is based on earnings adjusted for deferred taxes and for actual interest paid, and again, you can refer to our MD&A for a full reconciliation of adjusted earnings.

Now just turning briefly to our dividends and working capital. In the quarter, the company declared shareholder dividends of $5.3 million, which is $0.2139 per share, which is unchanged from prior year. Payout ratio was 107% for the quarter and was the same last year for Q1. And just a reminder, for Q1, Pizza Pizza and Pizza 73 restaurants are subject to seasonal variations in their business. System Sales for the quarter ended March 31, have generally been exhausted of the 4 quarters and System Sales for our fourth quarter December 31 have generally been our strongest sales quarter.

Now the company's working capital reserve is now $3.9 million at March 31, 2019. The reserve is available to stabilize the dividends in the event of short- to medium-term variability in System Sales and also the end, of course, into our variability in our company's royalty income. So the company, as a reminder, does not have capital expenditure requirements nor do we have employees. And its $3.9 million reserve decreased to 3.9 -- by $345,000 since the beginning of the year. The decrease in the reserve is directly attributable to the reported negative same-store sales growth as well as a 2018 true-up payment to Pizza Pizza Limited of $31,000 made in relation to the January 1, 2019 adjustment date.

So with the $3.9 million reserve in place, the company will target an annual payout ratio at/or near 100% on an annualized basis for 2019.

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

Question-and-Answer Session

Operator

[Operator Instructions]. And your first question comes from the line of Derek Lessard with TD Securities.

Derek Lessard

I just want to maybe Paul, in your prepared remarks, you noted that the customers have beguan to respond positively to your fresh -- your refreshed marketing approach. I guess, if I remember last quarter, I mean it was a tough quarter in terms of the marketing or marketing penetration. I'm just wondering if you could maybe talk a little bit about that reaction in terms of traffic, and why you think it's resonating?

Paul Goddard

Well, yes. It's good question, Derek. I think really we just starting notice throughout the quarter that obviously, we got work to do here to drive traffic further, but we did see it coming back moving in the right direction as we progress through. January started quite weak for us. We had our Cineplex as I mentioned in February. Introduced the new Tex-Mex Pizza in March, along with some other promotions and the -- and the Pizza 73 stores just starting to resonate better, it just seem like we're getting a little more traction there on the traffic overall with really various efforts I guess, I could say. So it does give me some confidence that things are starting to resonate better. Its only 1 quarter, but we have said on previous calls taken I guess -- bold moves to take in different direction in marketing and that is presenting us in a new way and it's a little different from our previous approaches. It does take time to take effect, but I do like the general direction.

Derek Lessard

Okay. And would you say -- and I guess, maybe 2 follow-ups on that. You just said bold moves, can you maybe just highlight a few of them?

Paul Goddard

I think it's just generally our combination of promotional approaches, the menu innovation side, the medium mix. I don't want to get into specific details for competitive reasons, but I would just say that these are flavors, the contents, the creative aspects I guess, and how we appear, how we sound, how we look, how we come across is one element that we change to a lot of fun and also on the medium mix. So we're doing that, but we're also trying to make sure we don't mess with things that we know works well. Some of our proven value offerings, which we think we can actually amplify those to drive traffic. So we're keeping the things that works [in latitude], but we're also willing to innovate and take some risk and experiment with some new approaches that we think we need to do for the medium and longer term.

Derek Lessard

Okay. And as it's traffic, would you say that as -- you said it's going the right direction, is it positive?

Paul Goddard

Well, I think we still have work to do, but we are seeing that -- variability, but we're seeing a general trend that way at Pizza Pizza. We still have to really dig out of these lower volume levels, but we see it's going on the right direction. At Pizza 73, we are seeing positive traffic period after period. And so were also trying to learn from our experience out there as well. Bringing all over Pizza Pizza site where applicable.

Derek Lessard

And I guess, to follow up on that, I mean it's been great job on driving the same-store sales in Alberta. I think it's the, well, they were 2.9% this quarter and modestly positive in Q4. Just maybe if you can talk about what's been the driver behind that? You did, you just mentioned bringing some of the learnings over, so what's been successful for you there?

Paul Goddard

I think just overall, I think we've struck a better balance overall in terms of value offerings recognizing that's a big part of our traffic driver. And I think just the price points that we set in various promotions as well as the various products. We've got the solo Pizzas out there that work well. We got $20 for $20 that worked well, we've got a triple threat deal with a price at $34.99 level. So we just, we feel that our price points are actually at the right level there, and we can be resonating a little better with the market.

And we'll well-aware here, which the fact that different price points work well too although, I think we've taken a little more of a creative approach I guess, not everything we have done has worked, we know that. But we are also trying to learn from things that didn't work and push the things that did work a little better. So things like our $30.99 deal, looks very, very well. Our extra large $11.99 worked well and we do look at it by channel as well and I think we're learning as we go. But I think we're getting better at it. But at the end of the day, hopefully, more, better traffic as we progressed through the year.

Derek Lessard

I know it's still early in B.C., wondering if you maybe you could just talk about the opportunity there, like how's it going out west and any plans to accelerate the growth of the restaurant pace there?

Paul Goddard

I think our pace there were, I think being quite careful to just make sure that we cite the right location as well. So I think location, we're certainly keen to build more out there as lead times on, from design and permitting right through to construction is a bit more of the boring process out there. It's taking longer than would like for permitting in particular, but we think our pace is about right there. We don't want to get too ahead of ourselves. We want to make sure we like the locations and we have the franchisees ready to go. So it's important that it is in new market, has a lot of long-term potential. But we think presence in Quebec, there will be more growth probably in short-term, but I think B.C. will start to accelerate more over time. But we're trying to take this through a measured approach.

Derek Lessard

Okay. I mean, it's a bit of, do you think there's any impact now that I guess, there's no NHL or Canadian NHL teams in the playoffs, do you think that's an impact in Q2 for you guys? Have you seen any signs of that?

Paul Goddard

I don't think it should be too much because as of this last year. I think a similar but obviously, it was really ashamed to see the Flames, Maple Leaf and the Jets, all out. And now really we just, now the Raptors left and hopefully, they keep going. So that I think could be a net positive. But overall, it's pretty much lost last year in terms of hockey. Yes, we were certainly hoping for more, but we can't draw them out for our business, it would've been nice but any playoff run even with the Raptors should help.

Derek Lessard

Okay. In a similar vein, the weather help, does that help you? If it's inclement weather it's still been pretty cold in Eastern Canada. Any thoughts there?

Paul Goddard

Honestly, it's been a mix. We do overlay weather. As we look at the same day last year as we go and it's been a mixed bag. I mean I know in April, we had last year I think a massive Ice Storm. I think it was around mid-April that we didn't have this year. So things like that actually make it harder for us to comp against when you get worse weather this year than last year obviously, that is awful. That's something we can't control. And also our Q1 did have Easter and that was that’s negative.

Derek Lessard

Okay maybe just one final one from me. In terms of a competitive environment, I'm wondering your thoughts on like if it's -- like whos driving that competitive intensity? Is it -- are they all stemming from the third-party delivery guys? Or is there some other big pizza player that's stepping up? Just wondering if there's anything specific that's really driving the intensity there?

Paul Goddard

I guess I've said on the prior call that I still feel the same way, that it's a combination of factors. i don't know if I can pick any particular one. I think the third-party side, you can see that those folks are aggressively marketing. So that is definitely a factor and also, I think a lot of the large Pizza competitors are resorting to deep discounting more frequently, so I think that's an indication of the fact that the market doesn't appear they're really be growing and people are really trying to grab share. And so I would say those are the 2 biggest factors, third-party delivery and large competitors keep discounting.

Derek Lessard

Okay. And in terms of your share, are you maintaining -- are you holding your weight essentially against them? Or have you been taking share from the smaller guys from the independents in mom-and-pops?

Paul Goddard

Generally speaking, I mean, I don't actually have any recent up-to-date data on the overall market share from our last call. I would say that generally, there is a sense that we are gaining share from some of the smaller independents that don't have such indicative [ph] multi-channel offerings, convenience and scale like we do. So my sense is perhaps, it's more valid between the bigger players and the third-party delivery.

Operator

And there are no further questions at this time. I turn the call back over to the presenters.

Christine D'Sylva

Thank you very much, and thank you, everyone, for being on our call today. If you have any questions after this call, please contact us. Our information is on the earnings release. Thanks and have a great evening.

Operator

This concludes today's conference call. You may now disconnect.