Papa John's Turns to Shaq, Investments to Right Ship

When Starboard Value LP made a $200 million investment in Papa John’s this past March, the company—known for its 2014 shareholder coup and turnaround of Darden Restaurants—disclosed an option to add another $50 million by month’s end. Starboard, whose CEO Jeff Smith chairs Papa John's board, exercised that right, the pizza chain said during its Tuesday afternoon first-quarter review. Papa John's has no shortage of brand-market and balance sheet initiatives that could use capital support.

The company swung a Q1 net loss of $3.8 million, or 12 cents per share, down from net income of $17.4 million, or 52 cents per share, in the year-ago period.

Papa John's said it took a hit of 12 cents per share on two separate efforts to recover from last year’s customer sentiment slide, which kicked into gear following reports founder and then-chairman John Schnatter used a racial slur in a conference call.

It said North America franchise royalty fees decreased $7.3 million year-over-year as the company provided $4.9 million in short-term royalty reductions to operators. That relief resulted in a 12-cent loss per share.

Papa John's also forked up $5.1 million on legal and advisory fees, some of which went to fight Schnatter’s lawsuits as well as the strategic review process that ended with Starboard’s deal. This resulted in another 12-cent per share hit.

Additionally, 5,336-unit (3,336 North America) Papa John’s said it absorbed a 19-cent per share decrease from a one-time adjustment of $5.9 million related to options to buy company stock for Starboard and franchisees. Excluding these charges, Papa John’s earnings per share of 31 cents beat Wall Street’s call of 24 cents per share.

Papa John’s also saw sequential improvement in its North America same-store sales. The company’s Q1 decrease of 6.9 percent was its third consecutive period of improvement. However, it still paints a negative 12.2 percent two-year stack.

Q1 2019: –6.9 percent
Q4 2018: –8.1 percent
Q3 2018: –9.8 percent
Q2 2018: –6.1 percent
Q1 2018: –5.3 percent

It does, though, reflect an improvement in February and March compared to January, when comp sales plummeted 10.5 percent due to ticket pressure from ineffective promotions and the initial impact of the conversion to Papa John’s new loyalty program. And despite sales pressure, restaurant-level margins have held up, increasing 60 basis points due to lower food costs of 130 basis points and favorability on insurance costs.

The company posted revenues of $398.41 million, surpassing the Zacks Consensus Estimate by 6.46 percent. This compares to year-ago revenues of $427.37 million.

Overall, Ritchie spun a positive narrative during Tuesday’s conference call, pointing to several changes he believes will get Papa John’s back into positive territory—a standing the company enjoyed for 14 straight years before the downturn.

It will take patience, he added. The moves are meant to be a sustainable solution. They’re not aimed at providing short-term lift. Ritchie estimated it could take 12–18 months to emerge, and the company is not quite a year removed from “our second big event that has caused some significant decline,” he said, referring to the Schnatter call. The first is likely a nod to the NFL comments made by Schnatter the previous November.

In response, Papa John’s expects improved results to show in the second half of the year, with North America comps dropping 1–5 percent for the year.

Some further resolution to the Schnatter dilemma could be coming, however. The parties agreed in March to a separation plan where Schnatter would leave the company’s board in exchange for having a say in his replacement. Discussions on that latter note have been held but no decision made. It also resolved two legal disputes.

Now, an SEC filing Monday revealed Schnatter is thinking about selling all or part of his 31 percent stake in the pizza chain. His term as director expired last week and he did not seek reelection. Papa John’s also terminated Schnatter’s contractual rights as its founder under the founder’s agreement. In turn, he no longer has a formal role within Papa John’s.

The filing said Schnatter solicited financial advisers’ help to explore selling his stake.

Papa John's

Shaq will provide a marketing boost for Papa John's.

The impact of Shaq

Papa John’s announcement that NBA Hall of Famer and TV analyst Shaquille O’Neal joined the company’s board was met with high marks throughout the organization, Ritchie said. In addition to investing in nine Atlanta locations, O’Neal is also stepping in as ambassador for Papa John’s as part of a marketing agreement—a jolt of PR energy it surely needs.

Ritchie said the announcement “was very exciting for the brand internally.”

“But I think, from a consumer standpoint, we saw a direct correlation to sentiment, [we saw] improvement directly after that announcement,” he said.

Already, O’Neal has offered input and advice on marketing, store design, operations, and consumer-facing initiatives. This past Friday, he was at Morehouse College in Atlanta helping Papa John’s connect with an HBC audience.

“Very broad in his reach and very tactical in his efforts,” Ritchie said, “and spends a lot of time in engagement and those things as we build up to the opportunities as it relates to the advertising.”

He added the South Atlanta investment would drive outside interest to garner addition franchisees into the system. O’Neal currently owns a Krispy Kreme in Atlanta and previously had 27 Five Guys Burgers and Fries franchises. Additionally, O’Neal founded and runs Big Chicken, a fast casual in Las Vegas, as well as Shaquille’s, a fine-dine restaurant in Los Angeles.

Ritchie said the O’Neal deal was “unanimously supported” by the National Marketing Fund board that’s made up of Papa John’s franchise partners and corporate employees.

“That was nice to get that support,” Ritchie said. “At the same time, we know until we can get sales back to positive—this is a company that experienced 14 consecutive years flat to positive sales growth—so we’re not accustomed to sales declines when the brand is as strong as Papa John’s.”

Another marketing change Ritchie hopes will reroute the chain’s positioning is the March hiring of former Subway SVP of marketing for North America, Karlin Linhardt. He also worked at McDonald’s from 1995–2005 and spent a decade with Anheuser-Busch.

The role was vacant since May 2018. Brandon Rhoten, who left for Potbelly, resigned about a year after joining the company. The former VP of advertising, media, and digital/social at Wendy’s International exited the position May 25.

“As we added a strong CMO to the team, last quarter, we also made tangible progress improving key elements of the customer value proposition,” Ritchie said.

"Regarding menu strategy, we expect Papa John’s to eventually launch a mix and match platform including Two Medium, One-Topping Pizzas for $6 each. We are hopeful that this platform can reignite traffic but remain concerned about the immediate check and margin investment required to drive sustainable transaction gains." — BTIG analyst Peter Saleh

More on that value note …

Papa John’s unveiled last quarter what it called the most extensive product launch, as far as number of pizzas, in company history. It introduced six new specialty options. Beyond the product innovation, however, it provided a premium and value construct the brand didn’t have before.

The $12 promotional price point was joined by a menu simplification process that cut lower-performing pizzas across the system. It was also balanced with a $6 medium, one-topping price point that provided an entry point for new customers, Ritchie said.

COO Mike Nettles said, with value-seeking customers, it served as a customer acquisition tool: $6 to bring them in, $12 to trade them up. The pricing structure helped check pressures and provided a value offering the company was comfortable with from a margins standpoint.

Also, it allowed Papa John’s to learn where new innovations fit. Items like sandwiches and some other recent tests, for examplee. “We are using that data to really inform our product innovation,” he said.

“I will go also one step further,” Nettles added. “We found out with a lot of the value proposition items that even though they may have been out there as a customer acquisition tool, with the right marketing and the right digital targeting of that marketing, there are great [opportunities] for up-sells.”

Papa John’s made heavy investments in 2018 in customer understanding, market segmentation, customer needs assessment, and customer journey mapping. It’s looking deeper at daypart opportunities from early dinner to afternoon snack lunch and even late night, Nettles said. “And one of the things that we’ve learned is that those value propositions do tend to run different behaviors based up a customer’s need state,” he said.

The pricing and product tests have unfurled in local markets. Ritchie said they’re resonating and working with Papa John’s unit-level economics. But the company wants to make sure they’re scalable and sustainable before spreading systemwide.

“The reason why we have not launched nationally yet is we're trying to measure the level of incrementality for things to be sustainable on the menu to drive overall healthy traffic and profitability growth,” he said of the sandwiches in particular.

BTIG analyst Peter Saleh weighed in on the menu changes in a Wednesday note.

“Regarding menu strategy, we expect Papa John’s to eventually launch a mix and match platform including Two Medium, One-Topping Pizzas for $6 each. We are hopeful that this platform can reignite traffic but remain concerned about the immediate check and margin investment required to drive sustainable transaction gains,” he wrote.

Papa John's

Papa John's has found sucess with a $12 and $6 pricing structure.

Loyalty for long-term gain

Papa Rewards, which relaunched in Q4 of last year, is an important lever to drive this renewed value proposition. Ritchie said the platform enables more personalized experiences and helps with targeted promotions, instead of the broad LTO launches of old. In the past, Papa John’s didn’t provide the point of access customers needed, Ritchie said.

Papa Rewards drives satisfaction without sacrificing perceive value or brand differentiation, he added, which can happen with blanket promotions.

Out the gate, the transition did cause some softness in ticket due to richer customer offerings, new program trials, and consumers cashing out legacy rewards. Papa John’s used a free cheesecake deal to garner addition members. That along with a two medium pizza for $6 deal provided some outsized pressure. It’s why Papa John’s comps stabilized somewhat with a more normalized check in February and March.

Papa John’s introduced a major mapping upgrade last year as well for its ordering tracking platform. There is now tech available in “several hundred corporate and franchise restaurants” that enables guests to visually follow the delivery on a map for the first time.

The platform offers detailed metrics and enhanced insights regarding the delivery driver’s time and motion for Papa John’s learnings as well.