Papa John's International (PZZA)

TOP CONTRIBUTORS

Vincent McPhillip

Papa John's International is the world's third largest pizza delivery company after Domino's and Pizza Hutt. Known for its high-quality pizza and use of fresh ingredients, Papa John's has 3,208 locations in 50 states and 28 countries.^[1]. In FY 2007, the company generated $1B in revenue and $52M in operating income^[2]. Today, Papa John's is navigating a difficult operating environment. Rising food and energy prices^[3], the housing slump^[4] and a weakening job market^[5] are taking a toll on restaurant spending ^[6] in its core domestic market. At the same time, rising prices for key inputs like wheat and cheese as well as oil and fuel are putting negative pressure on the company's margins. So far, Papa John's has successfully dealt with these challenges with a continued focus on international growth, marketing and product innovation. Papa John's was the only national pizza company to report positive domestic comparable sales in 2007 with a .4% increase^[7].

Business Overview

Papa John's was founded in 1984 when "Papa" John Schnatter knocked out a broom closet in the back of his father's tavern and sold his car to begin selling pizzas to the tavern's customers. From its humble beginnings in Jeffersonville, Indiana, Papa John's has expanded to over 3,000 worldwide locations but maintains its commitment to superior-quality pizza and timely delivery to your doorstep. Papa John's has five reportable segments including domestic restaurants, domestic franchising, domestic commissaries (Quality Control Centers), international operations and variable interest entities.

Domestic Restaurants

Papa John's 648 domestic company-owned stores produced approximately 47% of the company's revenue in fiscal 2007^[8]. In its company-owned stores, Papa John's generates revenue from the retail sales of pizza and other food and beverage products. Company-owned stores averaged $836,000 in annual sales in 2007^[9]. In order to increase average annual sales, Papa John's clusters its restaurants in targeted markets in order to take advantage of operational, distribution and advertising efficiencies.

Domestic Franchise

In addition to 648 company-owned stores, there are 2,112 franchised restaurants in the U.S^[10]. Under the franchise system, a franchisee, usually a local entrepreneur, requests permission from the company in order to open a Papa John's location. The company's franchising agreement requires the franchisee to provide the initial capital for equipment, signs, seating and decorations. Meanwhile, the company owns or obtains long-term leases for the building of the restaurant and the land. These franchises generate revenue for the company through payment of rent, royalties based on sales, and initial fees. Of the total 2,760 domestic locations, 23.5% were company-owned. Through a combination of net openings more heavily weighted toward franchise units and selective refranchising, Papa John's hopes to decrease its percentage of company-owned stores to below 20% over the next few years^[11].

Commissary Sales

Papa John's also maintains large "Quality Control Centers" that sell food and supplies to company-owned and franchised stores. These QC Centers take advantage of volume purchasing of food and supplies and provides consistency and efficiencies of scale in fresh dough production. Through the vertical integration of its food supply chain Papa John's can leverage the vast purchasing power of company-owned and franchised stores to lower costs.

International Operations

With the exception of eight company-owned Chinese stores and six company-owned U.K. locations, Papa John's franchises all of its international locations which totaled 434 restaurants in 2007. Papa John's top international locations are the U.K. (88), China (69) and Korea (64).

Trends & Forces

Rising Food and Energy Costs Shrink Margins

• Rising Food Costs: Papa John's margins are dependent on food prices. In particular, the company is dependent on the price wheat (used to make dough) and cheese, two key ingredients of any pizza. Over the past few quarters the prices of these key inputs have risen significantly; in February 2008 a bushel of wheat cost $11.21 compared to $4.35 a year earlier^[12]. The company is also impacted by the price of corn, beef, poultry, other important ingredients for much of its menu.

• Rising Energy Costs: Papa John's is also affected by the price of oil which has risen four-fold since 2001 with the price of gas rising more than two-thirds since last year alone.^[13] Oil is used to produce food, as well as to transport it all over the world. More importantly, the company consumes large quantities of gas delivering its pizzas to the homes of its customers. Furthermore, Papa John's relies on diesel to fuel the delivery fleet of its domestic supply chain. Intense competition in the pizza delivery category limits the company's ability to pass rising food and energy costs onto customers; because of this, increased costs shrink margins and hurt profitability.

U.S. Consumer Slowdown Hampering Performance

References

1. ↑ Papa John's 2007 10-K Item 1. Business General
2. ↑ WSJ.com Papa John's Annual Income Statement
3. ↑ The Boston Globe- Surging costs of groceries hit home
4. ↑ Bloomberg Case-Shiller Index Falls
5. ↑ NYTimes Unemployment Rising
6. ↑ Bitter taste: Food costs, less consumer spending hurting restaurants
7. ↑ Papa John's 2007 10-K Letter to Shareholders
8. ↑ Papa John's 2007 10-K Item 7. Management's Discussion
9. ↑ Papa John's 2007 10-K Item 7. Management's Discussion
10. ↑ Papa John's 2007 10-K Item 2. Properties
11. ↑ Papa John's 2007 10-K Item 1. Business- General
12. ↑ The Boston Globe- Surging costs of groceries hit home
13. ↑ 'Most Worrisome Consumer Trends' http://www.bloggingstocks.com/2007/11/30/best-and-worst-of-2007-most-worrisome-consumer-trends/
14. ↑ Papa John's- Investor Relations, Comparable Sales
15. ↑ Papa John's- Investor Relations, Comparable Sales
16. ↑ Papa John's- Investor Relations, Comparable Sales
17. ↑ Papa John's- Investor Relations, Comparable Sales
18. ↑ Papa John's- Investor Relations, Comparable Sales
19. ↑ Papa John's- Investor Relations, Comparable Sales