Krispy Kreme, Inc. (NASDAQ:DNUT) Q1 2023 Earnings Call Transcript May 11, 2023

Krispy Kreme, Inc. beats earnings expectations. Reported EPS is $0.09, expectations were $0.07.

Operator: Hello. My name is Jean-Louis. Welcome to the Krispy Kreme Q1 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the conference over to — pardon, Rob Ballew, Vice President of Investor Relations. Please go ahead.

Rob Ballew: Good morning, everyone, and welcome to Krispy Kreme’s first quarter 2023 earnings call. Thank you for joining us today. Our earnings release and accompanying earnings presentation deck are available on the Investor Relations portion of our website at investors.krispykreme.com. Joining me on the call this morning is Mike Tattersfield, President and Chief Executive Officer; Josh Charlesworth, Global President and Chief Operating Officer; and Jeremiah Ashukian, Chief Financial Officer. After prepared remarks, there will be a question-and-answer session. Before we begin, I’d like to remind you that this call contains forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities and Litigation Reform Act of 1995, including statements of expectations, future events, or future financial performance.

Forward-looking statements involve a number of inherent risks and uncertainties, and we caution investors that these risks could cause actual results to differ materially from those contained in any forward-looking statements. These factors and other risks and uncertainties are described in detail in the company’s Form 10-K filed with the SEC on March 02, 2023. Forward-looking statements made today speak only as of today. The company assumes no obligation to update or revise any forward-looking statements, except as may be required by law. Additionally, today’s call will include certain non-GAAP financial measures. Reconciliation between non-GAAP financial measures and their closest comparable GAAP measures can be found in the company’s first quarter earnings release this morning and is available at investors.krispykreme.com.

With that, I’ll now turn the call over to Mike.

Mike Tattersfield: Good morning, and thank you, everyone for joining us today. We are pleased to share our first quarter results, marking another period of accelerated organic growth, driven by our continued successful execution of our omni-channel strategy and a robust performance of our premium offerings for celebration, events and holidays. I want to start today’s call by thanking our Krispy Kremers, our team members for another strong quarter where we once achieved positive organic growth in every country we and our partners operate. Thank you. Without your efforts and dedication, this would not be possible. Since 1937, we’ve been serving our iconic Original Glazed Doughnut and it’s always been about sharing joyful moments.

As an affordable indulgent, we love that more than 80% of our doughnuts are brought to be shared with others. Nearly 40% of our customers buy our doughnuts who are partying or a special event in their life up from just 10% a few years ago. Our customers trust us to be part of their special moments. We don’t take that lightly. We are proud to carry on the best of what our founder Vernon Rudolph knew. Consumers love fresh doughnuts. We appreciate our history yet we know we are a doughnuts company that is constantly evolving, and the fresh is important as it is the important attribute our customers want in a sweet treat. We see this in the continued impressive growth of our delivered fresh daily or DFD business. Our ever-increasing confidence in our ability to continue to grow fresh points of access by 10% to 15% a year, allowed us to make the decision to exit our start-up CPG business branded Sweet Treats and focus our efforts in capital where our customers want us to bringing fresh and delicious Krispy Kreme donut to a convenient location.

Our omni-channel strategy where we provide convenient access to consumers through many channels is unique in the industry and is fueled by our passion for innovation and our understanding that access to our brand is our biggest opportunity. Through the efficiency of only 400 donut producing hubs worldwide, we know how to think differently and creatively, delivering fresh donuts when and where consumers want them. Thinking differently is meant that we not only think like an experiential donut company, but also donut logistics company, which makes our model very unique, that change in our model and culture enabled us to open and service more than 12,000 points of access daily with a long-term goal of at least 75,000 by growing global points of access by 10% to 15% per year.

While those points of access started at grocery and convenience stores, today, they include mass merchandisers, restaurants and drugstores. The uniqueness of our current model allows us to maximize an idea that was once only available at the 400 producing donut hub, taking it to every potential point of access in our system. Thinking like a donut logistics company with our DFD network truly unlock the power of our brand and reach. And thinking differently leads directly to the purpose of our company to touch and enhance the lives of others through the joy that is Krispy Kreme. We are committed to positively impacting the world by loving our people, our communities and our planet. In the first quarter, we donated much of our remaining branded sweet treat donut inventory to food banks across the US.

We also saw another strong quarter of community fundraising and local giving across the globe as we donated both to school children, supported the elderly and held more than 100 acts of joy worldwide. We worked hard to share joy in a way that really connected people to Krispy Kreme. Turning to our results. The first quarter marked a great start to the year for our brand with organic revenue growth accelerating to 14.4% as we had highly successful seasonal global campaigns including the critically important Valentine’s Day with great partnerships with Hershey’s, as well as a strong St. Patrick’s Day. This global campaign serves as the playbook moving forward for significant events and holidays as we’ll be able to leverage marketing costs, media coverage and brand partners across many or all of the country’s Krispy Kreme and our franchise partners operate, driving increased efficiencies on both the top and bottom line.

Also, strengthening our omni-channel capabilities in the first quarter was our e-commerce efforts. In the US, that included expanding availability of specialty donuts and more targeted marketing efforts. Additionally, Insomnia continues to benefit from the expanded radius of warm cookie delivery of up to 10 miles. These efforts led to a 23% increase in e-commerce revenue in the first quarter, compared to a year ago and led to a 220 point basis increase in sales mix of e-commerce to 19.6% of retail sales for the company during the quarter. This was our strongest quarter ever in e-commerce, both in revenue and percent of retail sales even when you compare that to the height of a pandemic, and we continue to see significant opportunity to grow in this channel.

We also continue to execute on our global expansion strategy, with a strong increase in points of access in our market development and International segment, which led to strong organic growth around the world, particularly in our equity-owned Japan and Canada markets and international franchise markets. Since the end of the quarter, a new franchise partner opened for the first time in Chile, which Chiles all one of the highest openings in the company’s history. We expect to open in 3 additional countries during the second quarter, including Switzerland, Costa Rica and Jamaica. We continue to be on track to open in up to seven new countries this year and expect to sign three to five new development agreements for additional countries to open in 2024, including further locations in Western Europe and South America.

Our pipeline of new hubs and fresh shops from our franchise partners is now well over 1,000 shops over the next five years, which will be used to further unlock additional points of access in those markets. We’ve seen that insomnia is really working across the entire country, the United States of America and recent new store openings are performing better than expected. To accelerate that growth, we are investing in capabilities and processes to rapidly expand the number of Insomnia store openings, both in 2023 and longer term and to launch internationally as they remain on track to open in the UK and Canada later this year. We expect to open nearly double the number of cookie shops this year compared to last year with further growth to come in 2024 and 2025.

As we look ahead, our focus remains relentless on driving the capital-light expansion of our omnichannel model. We continue to see momentum in our hub and spoke model, as well as existing DSD channels, and are now excited to grow our fresh business to new channels such as QSR, plug and drugstores. That’s why we have such confidence in our ability to grow to more than 75,000 bonds of access globally from 12,400 today. In addition to expanding DFP, we will also continue our work to align our specialty donuts across all channels and expand our e-commerce capabilities. Krispy Kreme has great momentum right now, and we remain confident and excited about the long-term 2026 expectations, we highlighted at our Investor Day last year, including growing revenue to $2.15 billion and adjusted EBITDA to $215 million.

My excitement about the growth of this incredible brand is stronger than ever. My belief is that brands with purpose and clear direction, while driving even challenging economic times. We’ve seen this in the resilience of the Krispy Kreme brand and culture. We have worked diligently over the past six years to transform our business model and operations to give more customers exactly what they want, where they want it and also fresh Krispy Kreme Doughnut. We have incredible momentum as we continue our journey to become the most loved sweet street brand in the world. With that, I hand the call over to Josh to give an update on the business and our PSC companies. Josh?

Josh Charlesworth: Thanks, Mike. In the last few months, we’ve made great progress around the world with the fresh daily Hub and Spoke operating model that we discussed back at our Investor Day last December. This is especially the case in the US, where strong growth across all our sales channels helped us to deliver 16% organic growth and EBITDA margins above 15% when excluding the now discontinued brand sweet treat line. The operating leverage of the model is particularly affected when we generate revenue off-premises by e-commerce or the local point of access, such as grocery stores, all from our existing fresh doughnut production hubs. In the US, upgrades to our web and app as well as continued expansion of our delivery zones, helped us to generate over 22% of retail sales via e-commerce in the first quarter.

And in Delivered Fresh Daily, we added over 350 doors, both to well-established customers like Walmart and Publix, but also with emerging newer customers like Target and Albertsons. We now have over 6,000 DFD doors across the US with average weekly sales up 35% from two years ago to nearly 650 doors. We’re also adding a larger DFD display cabinets, which add up to 70% of sales to a door. 63 of these premium cabinets went into grocery stores in the first quarter, including Kroger’s routes division and a tested target is more expected in the coming months. This off-premises sales growth is benefiting our 137 production hubs in several key US cities, including New York, Dallas, Houston, DC Metro and L.A., which all saw year-over-year margin growth in the first quarter.

Our previously announced U.S. shop network optimization program which focuses on poorer performing Hubs without Spokes, which do not benefit from the DFD expansion is also well underway. 29 shops have now already closed, all being converted into different shop formats and as a result, Hubs without Spokes have seen a 180 basis point margin improvement year-over-year. We expect another five to 10 more shops to go through this process through the end of 2023. We’re also making improvements to the doughnut shop experience itself, including the addition of new equipment in our drive-thrus, which represent around 60% of retail sales in the US. As well as the introduction of digital kiosks in our lobbies and select locations across the US. These kiosks have already proven popular with our customers, especially at the flagship shop in Times Square, New York.

The Fresh Day Hub-and-Spoke operating model is also showing early success in some newer international markets, including company-owned Canada and Japan, which both saw organic growth above 35% in the first quarter, as well as in international franchise markets, which grew even faster. In Japan, specifically, an acquisition we completed at the end of 2020, we have brought back the hotline experience to our doughnut shops, strengthened e-commerce and added over 160 DFD doors. This omnichannel-led growth is expected to deliver $60 million in revenue for Japan in 2023 at a more than 15% adjusted EBITDA margin. This compares to a loss at the time of the original acquisition. As Mike explained, our long-term global point-of-access goal of 75,000 includes the opportunity to take DFD to new partners in new sales channels.

We now have DFD listings in [indiscernible] through Walgreens in the US; in Club through Costco in the UK, Canada, and Australia; and in QSR to an expanded test of over 160 McDonald’s restaurants in Kentucky, which kicked off at the end of March. We are closely monitoring all of these new channels for quality, from a freshness, service, and of course, performance. Regarding McDonald’s, we are happy with our team’s ability to service these additional restaurant locations from three of our existing local production hubs, and we have not seen any adverse impact on existing sales at our doughnut shops or other DFD doors in Kentucky. I’ll now happily turn the call over to Jeremiah to give us more detail on our financials, including an update on our balance sheet, and our 2023 financial outlook.

Jeremiah Ashukian: Thanks, Josh, and good morning, everyone. We had a great first quarter. The fresh omnichannel model is working, and we are building confidence in our ability to drive both top and bottom line results. Sales per hub in the US increased 9% to $4.6 million, led by both strong points of access growth and record average weekly sales per DFD door. New door productivity is strong and e-commerce revenue saw its highest quarter ever even higher than the height of the pandemic. In addition to the benefits of the actions Josh outlined a few moments ago, we have also successfully taken pricing to offset significant inflation. Plus, we believe the exit of branded sweet treat will allow us to focus even more on our US fresh business.

Aside of the US, we’re seeing similarly strong performances in Japan, Canada and our international franchise segment and continue to make great progress on our global expansion plans. Turning to the financials. As Mike said, we saw strong growth across all our reporting segments in the first quarter with net revenue up 12.5% and year-over-year to $419 million. Organic revenue, which excludes the impact of acquisitions and changes in foreign currency, grew 14.4% and acceleration from last year, driven by pricing, our premium seasonal innovation, the growth of our delivered fresh daily donuts, including grocery and convenience stores and in e-commerce. We took further pricing in the first quarter in several key markets, including the US and the UK, bringing our effective global pricing to a low double-digit increase, and we continue to see lower levels of elasticity, thanks to the frequency of purchases strong specialty campaigns and the fact that it remains affordable indulgence for all income.

Adjusted EBITDA grew 12.3% in the first quarter to $55 million or an increase of 16% in constant currency once the $2 million impact of the stronger dollars considered. Pricing, Hub and Spoke efficiencies, the improvements in our US network and labor optimization offset elevated commodity and labor cost inflation. And a negative mix shift to maintain adjusted EBITDA margin levels at 13.1% in the first quarter compared to a year ago. GAAP net income of $1.6 million in the first quarter was negatively impacted by a $13.4 million largely non-cash expense related to the exit of branded sweet treat partially offset by a $9.7 million gain on the sale leaseback. Adjusted net income for the quarter increased 15.5% of $15.3 million and adjusted diluted EPS in the first quarter was $0.09, an increase of 13% or 25% in constant currency.

The US business segment’s total revenue increased 14% in the first quarter to $281 million, and organic revenue growth was also up 14% despite decreased revenue from branded sweet treat. Growth was driven by sales per hub increases to $4.6 million from $4.3 million a year ago and double-digit same-store sales growth by Insomnia Cookies. E-commerce and DFD revenue were strong in the first quarter, with record revenue for both channels in the US. Adjusted EPS EBITDA for the US segment in the first quarter increased 19% to $39 million, with margins increasing 60 basis points year-over-year to 13.7% and driven by strong performance in our US fresh donut business, we saw EBITDA margins expand 120 basis points. This reflects the successful pricing actions taken in the last nine months, the absorption benefits in our Hubs with Spokes from the growth in DFD off-premise sales and improved performance in Hubs without Spokes.

These factors more than offset double-digit ingredient cost inflation and elevated labor cost growth. International organic revenue growth was 7.3% and total revenues of $90.3 million while adjusted EBITDA for the quarter declined to $13.6 million. Organic growth was offset by continued softness in DSD in the UK as well as increased cost of goods sold in logistics cost in Australia and the UK. However, we are seeing continued strengthening in the retail environment in the UK, and we are making efforts to streamline costs, reduce waste, and we’ll continue to review pricing on a regular basis in all three markets. In the UK, we’re also working to expand visibility in the grocery channel, including secondary placement volume product, range pack sizes and grocery as well as looking at new partners and channels.

Market development, which is made up of our franchise businesses around the world and equity-owned Japanese and Canadian markets saw organic growth accelerates to 36%. Total revenue in the first quarter increased 27% to $47.3 million, even with a 9% impact from foreign exchange headwinds and franchise acquisitions. Market development and adjusted EBITDA increased 36% to $17 million despite a $1.3 million negative impact from foreign exchange headwinds. Adjusted EBITDA margins increased 250 basis points to 35.9% in the first quarter compared to the prior year and would have been higher if not for a mix shift due to the very strong organic revenue growth in equity on Japan and Canada. The growth in Japan led to adjusted EBITDA margins of over 20%, up nearly 800 basis points from a year ago.

During the first quarter, we completed a well oversubscribed refinancing of our Term Loan A and revolver facilities, extending our maturities at the same terms through March of 2020. Last quarter, I mentioned we would begin efforts to reduce our reliance on vendor financing programs to reduce what has become a more expensive financing vehicle and an increased impact to adjusted EBITDA as these costs do not hit net interest expense. We made progress on that reduction in the first quarter, reducing those levels by over $45 million. We expect this to be a long-term tailwind to our adjusted EBITDA and net income, and we remain on track to be between 2x and 2.5x net were in 2026. We are also reaffirming our 2023 guidance. This includes growth of 9% to 11% in organic revenue and 8% to 10% in net revenue, $205 million to $215 million in adjusted EBITDA and between $0.31 to $0.34 adjusted EPS.

We continue to expect capital expenditures of $105 million to $115 million or roughly 6.6% of revenue, including opening at least 30 to 40 new insomnia cookie shops and roughly 10 company built hubs in 2023. Our 2023 guidance continues to include modest headwinds from foreign exchange rates for the year, which is roughly negative 1% impact on revenue growth and approximately $3 million hit to adjusted EBITDA. While the impact for the full year is negative in the second half of 2023, we’ll start to see the benefits year-over-year from foreign exchange at current US dollar rate in the fourth quarter as the dollar peaked in early December 2022. Despite seeing roughly $25 million to $30 million in lower revenue from exiting brands we traced for the balance of the year, we remain confident in our guidance range for 2023 and are currently trending to be towards the middle or higher end of our revenue and adjusted EBITDA ranges.

We have good momentum in the business, and I continue to have a high degree of confidence that we can meet or even exceed our long-term outlook in 2026 that we provided at our Investor Day. Operator, we can open up the call to Q&A now, please.

Q&A Session

Operator: [Operator Instructions] We will now begin the question-and-answer session. [Operator Instructions] One moment for your first question. Your first question comes from the line of John Ivankoe of JPMorgan. Please go ahead.

A – Mike Tattersfield: Sure. Well, I mean, as I mentioned earlier, we’re really pleased from an operating point of view how it’s going. As I mentioned, getting those production hubs to double their production overnight, our Krispy Kreme has really sort of stepped up to the game. We’re only six weeks in, though, so it’s too early to sort of share too many specific results around it, very specifically about our experience with the McDonald’s restaurants. I mean we’re finding that the hours that we’re able to operate, often during operating hours, opening hours during the day, actually even complementary to what we do with, for example, our other grocery customers, which often need very early morning drops that the McDonald’s restaurants able to do at other times of the day.

So that’s working well. We’re doing it daily, as you say, and we’ve been very clear — and actually, McDonald’s been a fantastic partner so far in understanding this is a fresh daily proposition. That’s how we see our delivered fresh daily business and channel expanding, whether it’s in QSR or some of these other newer channels that I mentioned earlier. So I think that we certainly see it as a fresh daily business. That’s how we’ve built it, providing those amazing doughnuts to folks off-premise in all these more convenient locations because as you may have heard us say before, the number one reason why somebody might not buy a Krispy Kreme they didn’t come across it. It’s not convenient for them and an opportunity like this, obviously, makes it a lot more convenient for them when they see it,

A – Josh Charlesworth: I’ll only add one thing, John, keep in mind as well. It’s a different need states when you’re looking at the QSR, right? What are they using it for? What type of pack and all those things. So we will always do what we do in our routing system, right, deliver fresh daily. And then you adjust to what needs states McDonald’s or any other QSR would look at. This is what I need for my customer base.

Operator: Thank you. Your next question comes from the line of Bill Chappell with Truist Securities. Please go ahead.

A – Mike Tattersfield: Good morning.

A – Mike Tattersfield: So Bill, it’s Mike again. With the amount of growth that we have, not just in the US but in the international markets and even our market development, including Insomnia. But for Krispy Kreme in particular, the fresh business is just absolutely growing significantly and how to make sure that we can look at where we want to allocate resources, where do we want to allocate capital, how do we want to make sure that we can continue to improve the DFD experience logistic it was a pretty simple call for us in terms of this is where we should be. What we did learn again is that the brand amount does translate in that category. But at this point in time, we’re focusing our energy on fresh.

Operator: Thank you. Your next question comes from the line of Andrew Wolf of C.L. King. Please go ahead.

Operator: Thank you. [Operator Instructions] Your next question comes from the line of Sara Senatore of Bank of America. Please go ahead.

Operator: Thank you. Your next question comes from the line of Brian Harbour of Morgan Stanley. Please go ahead.

Operator: Thank you. Your next question comes from the line of David Palmer of Evercore. Please go ahead.

Operator: Thank you. Your next question comes from the line of Jon Tower of Citigroup. Please go ahead.

Operator: Thank you. There are no further questions at this time. I will turn the call over to Mike Tattersfield, President and Chief Executive Officer, for closing remarks. Please go ahead.

Mike Tattersfield: So appreciate everybody listening to our story this quarter and thank you for that. And I really appreciate all the Krispy Kreme’s around the world that make this happen every single day. Thank you. See you next quarter.

Operator: This concludes today’s conference call. You may now disconnect.