Papa John's Enters Damage-Control Mode

Papa John’s CEO Steve Ritchie said Tuesday the company is “working to demonstrate that our future will not be defined by the words and actions of one person.”

The pizza chain sure has its work cut out. Papa John’s string of bad sales remained sour in the second quarter, and that time period didn't even include the July 11 controversy surrounding exiled founder John Schnatter. In the period that ended July 1, Papa John’s North America same-store sales dropped 6.1 percent. Yet as troublesome as that stretch was, it’s about to get worse—and has already. The company’s comps in the region decreased about 10.5 percent from July 2 to July 29. Papa John’s also ballooned its outlook for the fiscal year from negative 3 percent to negative 7–10 percent.

This is a precipitous drop for a company that enjoyed a solid run of momentum in fiscal 2016 after a 2015 where “the vast majority of our franchisees” posted record sales and profitability, Ritchie said.

Here’s how the arrow has turned in regards to North America comps:

Q2 2016: 4.8 percent
Q3 2016: 5.5 percent
Q4 2016: 3.8 percent
Q1 2017: 2 percent
Q2 2017: 1.4 percent
Q3 2017: 1 percent
Q4 2017: -3.9 percent
Q1 2018: -5.3 percent
Q2 2018: -6.1 percent

There are a lot of trends driving this chart, but Ritchie sees a direct and resounding correlation with the public-relations earthquake triggered by Schnatter last November.

“On the marketing front, the research and analysis we conducted after the NFL comments by our founder in November of 2017 have made it clear that we needed to move away from a founder-centric marketing plan. Obviously, the recent events have further evidenced that we need to move on,” Ritchie said during an August 7 conference call. Doing so comes with a direct cost, too. Removing Schnatter from promotional materials, as well as a third-party audit into the brand's culture, is going to cost Papa John's between $30–$50 million, the company estimated.

During a third-quarter earnings review on November 1, Schnatter said: “The NFL has hurt us. And more importantly, by not resolving the current debacle to the player and owners' satisfaction, NFL leadership has hurt Papa John's shareholders.” The incident dropped Papa John’s stock 11 percent at the time, and Ritchie said the consumer sentiment turned dramatically.

“So if you go back to the third quarter of 2017, we were 1.1 percent positive, and directly after the earnings call, we saw a very sharp decline. The quarter ended up negative 3.9 percent, but the comp trends have basically been between negative 5 and negative 6 percent since that event, and the comments from our founder,” he said.

Before Schnatter’s headline-busting decision to step down as chairman on July 11, which came in the wake of a report he used a racial slur during a May conference call between executives and the company’s then-marketing agency Laundry Service, Ritchie said comps declined 6.1 percent to start Q3. Once the news hit, he said, the company saw "another precipitous drop of roughly 4 percent" due to the "very inexcusable and irresponsible comments from Mr. Schnatter."

Schnatter goes on the offensive

The numbers appear to back what Ritchie is saying. However, there’s one person who doesn’t quite agree: Schnatter.

The company’s founder, who still owns close to 30 percent of its shares, released a scathing statement following Tuesday’s weak sales report, writing he is “seriously concerned about the company’s declining sales, financial performance and, most importantly, the direction the company headed under the stewardship of Steve Ritchie and the current board of directors.”

“Today’s results highlight the further deterioration of Papa John’s financial performance under the tenure of Steve Ritchie, since he assumed CEO responsibilities in mid-2016,” Schnatter added. “Instead of addressing the real and fundamental issues confronting the company since that time period, and taking actions to turn sales around, the company is trying to deflect attention from the source of the problem—management’s ongoing failures with regard to financial performance—and blame me for its problems.”

In Schnatter’s view, Papa John’s performance was declining “long prior” to his NFL comments. He added that his comments during the Laundry Service incident “were seriously misrepresented.”

"I am not going away and will continue to fight to do what’s best for the company and its employees, franchisees, shareholders, and customers.” — John Schnatter, Papa John's founder.

According to reports, Schnatter “used the N-word” when asked how he would distance himself from racist groups online. Schnatter allegedly responded: “Colonel Sanders called blacks [racial slur],” and then complained about Sanders not facing the same kind of public outcry. He admitted the comments, but said he wasn’t racist, and “would never use that word, and Papa John’s doesn’t use that word.” Schnatter also expressed regret about resigning as chairman. The company has tried to remove itself from its founder by removing him from marketing, even changing imagery, and also evicting Schnatter from its company headquarters in Louisville, Kentucky. Schnatter has no plans to disappear, though.

“I built this company from the ground up and am still its largest shareholder. Results under my leadership demonstrate that I know what works and what doesn’t work for this company,” he said in the statement. “Indeed, history shows that the company performs better with me involved, and it declines when I step away. I have little doubt that the company’s financial performance will continue to deteriorate under the current CEO and board of directors. I am not going away and will continue to fight to do what’s best for the company and its employees, franchisees, shareholders, and customers.”

What the future holds

What does Papa John’s do now? There’s just no other way to position it—2018 is going to be a challenging one for the 5,247-unit chain.

This includes “a number of store closures in the U.S.,” CFO Joe Smith, who came on board in April, said in the call. Papa John’s isn’t sure how many restaurants it will shutter this year, but said it is doing everything it can to mitigate the closures and is forecasting more than 350 global openings for the year, mostly in international markets. Ritchie added that Papa John’s sees the setback as a temporary issue, “and then we can really start to move the brand forward back in 2019 and beyond.”

Papa John’s is targeting the fourth quarter to aggressively roll out a new advertising and marketing campaign. It tapped Hollywood powerhouse Endeavor Global Marketing as its new ad agency and promoted Victoria Russell to a newly created role of Chief of Diversity and Inclusion. Papa John’s also hired Nimbus in June as its first multicultural agency.

“Our work to drive new branding and marketing campaigns that differentiate Papa John's and refocus us on our value proposition is more important now than ever as we try to reestablish trust with our customers. Moving forward, these efforts will take into account what consumers, in particular millennials and Gen Z consumers expect from a business, including their expectations that companies have an active role in making the world a better place,” Ritchie said.

As Ritchie mentioned, Papa John’s is taking this opportunity to shine a new light on value.

“We know the importance value plays as part of our calendar and menu strategy. During the second quarter we offered a $12.99 bundle. While this had potential, it was clear that promotions alone are not going to reinvigorate trust in our brand given the broader sentiment issues,” he said.

“That being said, accessible value does have an important role to play,” Ritchie added. “And as we implement our brand relaunch, you should also expect to see value offerings. Knowing value can come through choice, variety, bundles, limited time offers and other options, we are focusing our efforts on building an arsenal of well tested proven products and offers that we believe will gain broad support from our franchisees.

Papa John’s said it recently completed a pricing study that evaluated each restaurant in its U.S. system to help with appropriate pricing by market.

Additionally, the chain is making progress on the tech front. It launched an API (application program interface) that allows it to leverage a new preferred national partnership with DoorDash and voice ordering by Amazon Alexa.

Ritchie said the deal would help Papa John’s deliver in some outlying rural areas and suburban developments outside its delivery zones. “More than 1,000 restaurants in hundreds of cities across the United States will soon be able to expand their delivery areas utilizing DoorDash technology to serve communities that would have otherwise been excluded,” he said.

Franchisee focus

Ritchie said Papa John’s is doing all it can to ease the burden for operators during this downswing. It employed third-party efficiency experts to review the potential for improvements within its restaurants. The experts are also conducting time and motion studies to “directly supplement the work we are doing within our restaurant design of the future.”

Ritchie said he’s traveled the country talking with franchisees and seeking input from operators. He said some aid could come in short-term royalty reductions, reimbursement for certain costs related to individual restaurant’s décor, and other assistance.

“Our franchisees live in the same communities in which they operate and the Papa John's leadership team is committed to supporting them and to helping them rebuild trust in our brand in their communities,” Ritchie said.

“We're very confident that this is a new day for the Papa John's brand,” he added later in the call. “And frankly, an opportunity as we work through these sentiment challenges to leapfrog within the category and frankly the industry to do something that is uniquely different than anything we've ever done before.”