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StockTalk
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TMF Interview With Papa John's International President Blaine Hurst and CFO Dru Milby
December 10, 1998
With Brian Graney (TMF Panic)
Based in Louisville, Kentucky, Papa John's International <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PZZA)") else Response.Write("(Nasdaq: PZZA)") end if %> is the fourth-largest pizza delivery company in the country. The firm owns and operates 470 restaurants, with franchisees operating another 1,352. Earlier this week, we talked with Papa John's President Blaine Hurst and CFO Dru Milby about the pizza business and the company's strategy for the future.
TMF: In the pizza business, is taste the most important factor from the customer's viewpoint, or are there other important considerations, too?
Hurst: We got to talking with the folks from Gallup and were trying to define how to measure brand. And one thing they said that was particularly enlightening is that brand equity can be best managed by customer loyalty. In other words, if the customer is coming back to you and buying from you a second, third, fourth time, particularly in our category, then that's really brand equity. If you just generate trial [purchases] from television commercials but they don't buy from you a second time, you really haven't created any brand equity.
And we asked, "What drives customer loyalty?" Their research said 80 percent of customer loyalty comes from that customer experience, that perfect pizza experience. [For instance], did we answer the phone promptly, did we get your order accurately, were we friendly on the phone, were our drivers friendly when they delivered the pizza, was the pizza an 8, 9 or 10 on a scale of 10, how did the product taste? All of those factors dramatically influence that customer experience, which drives customer loyalty, which drives brand equity.
TMF: How do you attract new customers to the business? What promotions work the best?
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"So, really if you're measuring the number of stores and looking at the stores we're opening and how well those stores are doing with respect to sales growth, those clearly are the key drivers of our overall growth story."
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Hurst: There really are two principal ways that we get new customers. One way is what you would expect -- with television advertising and other forms of advertising. In most of the markets that we are currently in, our brand awareness is still relatively low, in the 30, 40, 50 percent range. In our mature markets like Louisville, our brand awareness is in the 90 percent range. So, in many markets, simply being on television or promoting it through advertising generates trial.
And it's not [one] particular offer. Some offers do a little better than others, and some commercials do a little bit better than others. But, more than anything, just for people to hear our name, that's the most important thing. That's why some of the stuff that Pizza Hut is doing [in the courts] has actually been helpful to us.
The other thing that we have to focus on is referrals by satisfied, by excited, by wowed customers. Back in August when I was in San Diego, which is a relatively new market for us, I was in the San Diego Zoo wearing my logo shirt, which I pretty much wear everywhere I go. And I was stopped by no less than 12 people saying, "We hear you're the new pizza shop in town, we hear you got the best pizza, when are you going to open one close to me?" That's how you drive trials -- by extraordinary execution.
TMF: One way that I found out about the company was through advertising -- coupons and direct mailing circulars. Tell us about that aspect of the business. How does that work and does that hurt the operating profits of each individual franchisee, or is it more distributed throughout the whole company?
Hurst: No. As a matter of fact, franchisees contribute 1 percent of sales to a national marketing fund. They contribute on average about 2 percent to a local cooperative of stores within a common direct marketing area. That's because if one of our stores can't afford television ads and we're not advertising sufficiently on national TV, the direct marketing component of the business -- the flyers that you get in the mail, the free-standing inserts that you get in your newspaper, the coupons, if you will -- are a key component of how we've actually grown the brand. In fact, in our newer markets, about the only way we have to market directly to the consumer is through the direct mail and free-standing inserts of a newspaper or something like that.
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"I think Papa John's has already had a significant impact on the quality of product that our competitors are providing. That's why we don't sit still."
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We're also trying to work with schools. We give away a lot of pizza. We take pizzas to the park on Saturday when the parents and kids are out there for soccer games and give away free pizza. The cost of a good piece of pizza is probably 17 cents for one topping, maybe 20 cents. That's cheaper than a mailer, and my return rate on a slice that I give away is about 30 percent. I don't get anywhere close to that on direct mail. So, we're giving away our product. Because once people taste our product, [we've found] 30 to 35 percent of them would come back and buy the product. So, we try a lot of different marketing.
TMF: You were talking a little bit about costs. Could you go on a little bit more and compare the operating cost per square foot for a typical Papa John outlet with the operating cost for a typical fast food restaurant?
Milby: When we look at operating costs, square footage is typically not a major factor because we don't dine-in. So, that's really not something that we publish or, quite frankly, that we even track. We tend to look for places that are leased -- most are leased spaces, some are owned -- typically in the 1,200- to 1,400-square foot range. There's some on the higher end of that, even -- in the 1,500- and 1,600 square feet for the larger restaurants. So, that's really not a major factor for us, but certainly space cost for us is a factor that is variable with sales. Normally, it would run about 26.5% to 27% [of revenues] on the high side -- it's been a little higher than that this quarter because of cheese prices. But then other operating costs will run in the neighborhood of 50% or 52%. That's usually where we run.
TMF: What are the main moving parts, then, that shareholders should really keep their eyes on to see how the company's doing compared to its competitors?
Milby: There's a couple of areas. On our monthly shareholder calls, certainly same-store sales or comp sales is always a question. And that obviously is something that they can look at relative to other like businesses or restaurants in general. And it is also typically the indicator of the overall health of the business as well as growth opportunities. So, that certainly is one key factor for us. I think the other thing right now would be our development, or store openings.
TMF: Is that going to be the main driver of revenues and earnings growth in the next 10 years, the expansion plans? Or is there some other way of driving the business besides expansion?
Hurst: It's principally through the restaurant expansion plan and then acquisitions of franchise restaurants by company restaurants. In addition, next year about $400 million of our revenues [will come from] commissary equipment. We supply through the commissary system all of the Papa John's restaurants in the United States. So, part of the revenue growth that you will see actually comes through our commissary system. So, really if you're measuring the number of stores and looking at the stores we're opening and how well those stores are doing with respect to sales growth, those clearly are the key drivers of our overall growth story.
TMF: And on the individual unit basis, is there a way to drive sales? I don't know how many times you can change pizza. I guess you can use more toppings or something else. But what will really drive your sales locally?
Hurst: It's been kind of interesting. Most of the other chains out there -- and certainly most of the fast feeders in the market -- attempt to drive sales through product news or product introductions. We've all seen that. At Papa John's, our belief is that by staying focused -- we have a very focused menu, we don't plan to deviate from that -- we can continue to drive sales because we continue to draw performance in terms of customer experience. It allows us to keep everything simpler. I'll be in a restaurant on a Friday night and you know, some of our busier restaurants on a Friday night will make 200 to 220 pizzas an hour. And if you're doing six different crusts, guess what? You cannot do that effectively and do a quality job. So, it's very interesting.
Our oldest markets -- Louisville and Lexington, Kentucky -- continue [to perform]. We've had 14 years of positive comp sales in Louisville. In Lexington, [we've had] 13 years of positive comp sales. Lexington will average more than $1 million a store this year. Louisville will be darn close to that $1 million a store level. And we just haven't seen the top of this thing yet. I'm sure at some point there will be a top, but we haven't introduced new products -- other than our thin crust product -- since we started in Louisville 14 years ago.
We believe that we operate our restaurants at about 75 percent of where they should be. In other words, 75 percent of the experiences that the customer gets is the perfect pizza experience. We don't believe that our competitors do that good a job. That's why our sales per unit are so much better than theirs. But we believe there's a lot of market opportunity in just taking that 75 to 85 or 90 percent. That's where I think we're going to see the growth -- just getting better at what we do.
TMF: You touched just a little bit on the legal dispute with Pizza Hut. I guess what interests us the most, from the shareholders' point of view, is how this all came about. And how important is this issue for prospective shareholders?
Hurst: Our belief is the Pizza Hut lawsuit is really more of a public relations stunt. I don't know about you, but I haven't participated in a lot of lawsuits. But if I were filing a lawsuit, I'm not sure that I'd send a copy of the suit, a press release, and a video news release to every media outlet unless there was some PR perceived value in that
How it came about, Pizza Hut challenged us earlier this year, twice before the National Advertising Division of the Better Business Bureau. The NAD is kind of the highest arbitrator of truth in advertising and the advertising industry. And the NAD in both cases found that Papa John's advertising was truthful. As a matter of fact, in one case they said it's truthful and accurate for Papa John's to advertise that consumers significantly prefer Papa John's traditional thin crust pizzas over Pizza Hut products. Basically, they said we had better pizza. They also said that the comparison of Papa John's freshly prepared pizza sauce to Pizza Hut sauce re-manufactured from paste is both meaningful and relevant to the consumer. In other words, we have better ingredients. So, they upheld our right to continue to say "Better Ingredients, Better Pizza."
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"I believe that all told we will still see two or three strong pizza companies out there. This isn't about eliminating our competition. It's about winning our fair share of the market."
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Then they have an appeals process, if you will. Pizza Hut decided that they weren't going to get anywhere with the NAD, basically, and went to federal court to file the lawsuit. So, that's kind of how we got here. We honestly feel pretty positive about the suit right now. If this ends up before a jury and doesn't get thrown out of court, there's always some risk. But all in all we feel very comfortable with our position defending this lawsuit and don't anticipate any material problems that would impact the shareholders. The legal fees that we're incurring for this we've been incurring all along. So, from an earnings perspective, we're fine with it. Again, there is a little risk and I don't want to deny that -- I don't want to deny that with anybody -- but we feel about as confident as we can feel in a situation like this.
TMF: Finally, how do you personally see the industry evolving in the next 10 years and what's Papa John's place in the industry going to be 10 years from now?
Hurst: I think the consumer will have better pizza than they have today. I think Papa John's has already had a significant impact on the quality of product that our competitors are providing. That's why we don't sit still. We're constantly improving our products, constantly looking for better ingredients -- scouring the globe, literally, for better ingredients. So, I think that the consumer will win in this because the consumer will get better pizza. And I think we're raising the bar on the whole industry.
I would hope that in 10 years -- actually, next year on a month-to-month kind of sales basis -- we will surpass Little Caesar's as the third largest pizza company in America, in terms of total sales. And so, I think we will continue to progress. In 10 years, we should be number one. Pizza Hut's got 12,300 units right now, so that's a long stretch. I think we will continue to aggressively pursue that number one position.
I believe that all told we will still see two or three strong pizza companies out there. This isn't about eliminating our competition. It's about winning our fair share of the market. Today it's about a $25 billion market. We'll be real happy with about 25 percent share of that market.
TMF: Thank you to both of you for talking with us today. You've been very gracious with your time.
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