Krispy Kreme, Inc. (NASDAQ:DNUT) Q3 2023 Earnings Call Transcript

Krispy Kreme, Inc. (NASDAQ:DNUT) Q3 2023 Earnings Call Transcript November 9, 2023

Krispy Kreme, Inc. misses on earnings expectations. Reported EPS is $0.03 EPS, expectations were $0.06.

Operator: Thank you for standing by. My name is Dennis and I will be your conference operator today. At this time, I would like to welcome everyone to the Krispy Kreme Third Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Ms. Stephanie Daukus, Vice President of Investor Relations. Ms. Daukus, please go ahead.

Stephanie Daukus: Thank you. Good morning, everyone, and welcome to Krispy Kreme’s third quarter 2023 earnings call. Thank you for joining us today. Our earnings release and associated earnings presentation are available on our Investor Relations website at investors.krispykreme.com. Joining me on the call this morning are 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 would 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 and 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 than 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 for the year ended January 1, 2023, and in the other filings we make from time to time with the SEC. Forward-looking statements made today are only as of today. The company assumes no obligation to publicly 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. A reconciliation between non-GAAP financial measures and their closest comparable GAAP measures can be found in our third quarter 2023 earnings press release and Form 8-K filed today and is also available at investors.krispykreme.com.

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

Mike Tattersfield : Thank you, Stephanie. Good morning, and thank you, everyone, for joining us today. We had quite a bit of news this quarter at Krispy Kreme with our upcoming CEO succession and our exploration of strategic alternatives for Insomnia Cookies. To frame the call, I want to talk about our history. Afterwards, I’ll pass the mic to Josh to dive into our strategy and Jeremiah to cover our financial results and outlook for the remainder of the year. Krispy Kreme has been a loved sweet treat brand since Vernel Rudolph first started making donuts in 1937. Since joining the company in 2016, we’ve taken Krispy Kreme on a transformation to become focused as a donut company, always creating fricken also donuts. Vernon’s recipe and his hot-fresh donuts is how he built the brand.

We further developed the brand unlocking the power of a truly omni-channel brand. And importantly, we now deliver 100% of our donuts fresh daily, up from 50% since 2016. Also since 2016, we’ve nearly tripled the number of access points where consumers can buy fresh donuts daily and increase the geographies where we operate by roughly 50% as we are now in 37 countries. We learned that we need to be where consumers want us and develop our points of access beyond the fresh and theater shops to include delivery fresh daily to grocer, convenience, and we are now unlocking new channels, such as club and quick service restaurants. We have profitably reshaped our global ownership network via our hub-and-spoke model and also acquired Insomnia Cookies five years ago to help us strengthen our e-commerce and digital platform.

Digital orders now represent approximately 20% of consolidated retail sales. Finally, we have continuously invested in innovation and focus the brand on gifting, sharing and premiumization for our consumers worldwide. We know and believe there is nothing we can’t do with doughnuts. And as always, at the core of our company is our purpose to touch and enhance the lives through the joy there is Krispy Kreme, which guides our culture and sets our direction to becoming the most loved sweet treat brand in the world. As I reflect back, none of this would have been possible without our more than 23,000 global Krispy Kremers, our leaders and our culture to drive growth and results daily. This team has transformed our business from a legacy retail and wholesale operation to a fresh, nimble, unique omnichannel business that has more than proven itself.

I’m truly grateful and thankful to every Krispy Kremer. Turning to Insomnia Cookies. I mentioned our announcement to explore strategic alternatives for the company to enhance both brands’, growth trajectories and enable Krispy Kreme to focus on our core strategy of producing, selling and distributing fresh doughnuts daily. We thank Insomnia for their tremendous partnership in building upon our e-commerce and digital capabilities, all while we help grow the insomnia business here in the US to roughly 250 cookie bakeries, as well as we expand globally into the UK and Canada. Regarding the CEO transition, for some time now, I’ve been in conversations with the Board regarding my succession plan. Given the progress we’ve made on our strategy, the phenomenal team and culture we have in place, it was the right time to promote Josh as CEO effective January 1.

I am also excited to transition to a senior adviser role and Krispy Kreme ambassador, where I’ll support Josh and continue to spread the joy that is Krispy Kreme. Josh has played a critical role in Krispy Kreme’s growth for the last six years, has been a tremendous partner to me, and I love his passion for the brand and our Krispy Kremers. All of this gives me confidence in our future success. Josh, I couldn’t be happier to transition this role to you and look forward to watching more of your accomplishments as CEO. Now towards Q3. Our results this quarter demonstrate the continued strength of our team, our business model and the power of our brand. We delivered growth on both the top and bottom line, in line with our plans, while delivering adjusted EBITDA margin expansion through our hub-and-spoke model.

Our global expansion continued as we made our doughnuts available in two markets, Switzerland and Kazakhstan and Insomnia Cookies expanded internationally into Canada and the United Kingdom. With that said, I will now turn it over to Josh for a review of our strategy and to discuss the momentum we’ve seen so far in the fourth quarter. Josh, congratulations once again. Turn on that highlight amigo.

Josh Charlesworth: Thanks, Mike. It’s such a privilege and honor to be asked to lead this great team that you brought together to represent this incredible brand, which means so much to so many people and above all, to support all our Krispy Kremers around the world as we seek to firmly establish Krispy Kreme as the world’s most loved sweet treat. And on a more personal note, thank you, Mike, for the many years of support you’ve given me, including this period of CEO transition and I’m very pleased that you’ll be staying on as a member of the Krispy Kreme Board. I’m so excited for what is ahead of us at Krispy Kreme. Our strategy is clear, make our fresh donuts available in more places and keep reminding people of the joy that is Krispy Kreme, not just to eat, but to share and give to others.

We have made so much progress in leveraging the power of the Krispy Kreme brand under Mike’s leadership, now selling over 1.6 billion fresh donuts a year in over 13,000 points of access around the world. And yet, we have so much further to go. Our existing points of access represent less than 1% of the places a customer could in theory by Krispy Kreme donuts and our purchase frequency is less than three times a year despite the many occasions and celebrations where our consumers can and do enjoy our donuts. We’ve laid out a great strategy, and we will remain focused on maximizing our global growth opportunity, leveraging our profitable omni-channel fresh donut business. The key elements being; one, expand availability of fresh donuts through more points of access in both new countries and new sales channels, such as quick service restaurants; two, increased purchase frequency by continuing to strengthen our premium offerings for special occasions and improving e-commerce and loyalty programs; three, drive end-to-end productivity in our donut supply chain through operating excellence and automation; and four, improved capital efficiency by leveraging excess capacity in our fresh donut production hubs to supply more capital-light points of access.

And we are pleased with our progress so far. Our third quarter results were excellent with organic growth just under 10%, adjusted EBITDA margins up by 50 basis points and points of access increasing 14% to 13,394. The 522 points of access that we added in the quarter were across multiple markets, including 453 new deliver fresh daily merchandising displays or DFD doors, 59 fresh shops, and four hot light theaters. The new DFD doors include OXXO convenience stores in Mexico, Woolworths grocery stores in Australia, and Costco wholesale stores in the UK, Australia and Canada, reflecting the increasing diversity of our customer mix. This also demonstrates our ability to expand DFD across multiple channels in several markets around the world. The 186 DFD doors we added in the US, including two more new Kroger divisions with Dillons in Kansas and Pick ‘n Save in Wisconsin, and we also saw significant growth with Publix.

We now have just over 6,500 DFD doors in the US with average weekly sales up 12% year-over-year in the third quarter. We’re also confident that the quick service restaurant channel is an exciting DSD opportunity for Krispy Kreme, not just in the US but around the world. And we are making investments in the US that reflect our confidence in further scaling our delivery fresh daily network. While nothing has been finalized, we are excited about our continued partnership with McDonald’s, and we are in advanced discussions about expanding the relationship. Turning to the consumer. We saw even on our seasonally low summer months, strong engagement with the Krispy Kreme brand driven by premium price, specialty donuts and marketing activation. Our limited time donut collections generated billions of media impressions, significantly increased average transaction values and drove strong overall growth.

For example, our partnership with M&Ms in the summer, which included a one of a kind donut path with M&M’S Minis was a huge hit in 17 markets around the world. Our brand continues to grow and over-index with valuable younger consumers with 18 to 34 year olds, now representing 40% of our US consumer base up from 33% a year ago. This is a big contributor to the success of our Strawberry Glazed Doughnut partnership with Hailey Bieber, which sold out quickly every day we ran it in early September. These partnerships demonstrate our ability, to reach beyond seasonal occasions with creative and innovative marketing approaches especially with our more social media and digital savvy consumers. As we move into the peak holiday season, we have seen growth accelerate so far in the fourth quarter, thanks to a record overall performance in the buildup to Halloween especially in the US where we brought mystery and monsters to life, with a Scooby-Doo Dozen.

Looking ahead, we expect to maintain this momentum driven by more premium, specialty doughnut collections inspired by the holidays and pop culture. Selling the same fresh doughnuts both our beloved original glazed and our premium offerings that we make in our production hubs through more points of access, is at the heart of our unique hub-and-spoke operating model making Krispy Kreme more accessible and convenient to more consumers, and the hubs themselves more productive and profitable. This quarter, we increased the number of US hubs with spokes from 143 to 148 by adding delivery routes to existing locations. Our trailing 12 month sales per hub KPI, was up 9% year-over-year to $4.8 million helping drive US fresh margins up over 100 basis points compared to the same quarter, a year ago.

We are seeing continued success in replicating the hub-and-spoke model and leveraging growth and delivered fresh daily doors across several cities, notably Charlotte, Dallas, Denver, Houston and Miami which have had some of the largest increases in DFD doors this year. As evidenced by our third quarter results, our strategy continues to produce positive and tangible results and I’m excited for the future as we continue to pursue establishing Krispy Kreme as the world’s most loved sweet treat. I’ll turn the call over now to Jeremiah.

Jeremiah Ashukian: Thanks, Josh and good morning, everyone. The third quarter finished in line with our expectations as we delivered growth on both the top line, and adjusted EBITDA with improved performance throughout the business. We delivered our strongest third quarter adjusted EBITDA growth, since our return to the public markets. And if trends maintain, we continue to track toward the mid to high-end of our full year revenue and adjusted EBITDA guidance. Net revenue grew 7.9% to $407.4 million driven by successful execution of marketing activations, pricing actions and further expansion of our omnichannel approach globally and across all segments. Organic revenue grew 9.6% to $400.3 million. As a reminder, organic revenue excludes impacts of acquisitions, foreign currency and the branded sweet treats business.

Growth, pricing and the shift away from branded sweet treats resulted in product and distribution costs decreasing by 230 basis points year-over-year. GAAP net loss was $40.3 million in the quarter due to the forecasted effective tax rate and attributable noncash income tax expense. Importantly, we continue to expect an adjusted tax rate of between 24.5% and 26% for the full year 2023. Adjusted EBITDA grew 13.5% year-over-year to $43.7 million exceeding the revenue growth rate. In turn, adjusted EBITDA margins expanded across all reportable segments increasing 50 basis points year-over-year to 10.7%, demonstrating our ability to improve operating leverage through pricing and productivity initiatives. Diluted adjusted net income declined 3.6% year-over-year to $4.4 million.

Adjusted EPS remained flat compared to last year at $0.03 and despite net interest expense increasing 44% to $3.9 million. The increase was primarily driven by higher benchmark interest as well as reducing our reliance on vendor financing. Turning to the segment results. In the US segment, organic revenue grew 10.2% to $258.6 million, driven by effective premiumization opportunities and decreased discounting leading to an increased average transaction size. Adjusted EBITDA increased 8.8% year-over-year and margins expanded 30 basis points to 8.6%. Margin expansion was primarily driven by hub-and-spoke efficiencies and mitigating commodity inflation and labor pressures with the pricing taken from earlier in the year. We continue to be focused on waste mitigation in both materials and labor efficiency and we’re making improvements in both those areas.

We expect that these structural improvements should set up for persistent margin expansion moving forward, combined with benefits from our hub-and-spoke system maturing. And finally, Insomnia margins improved sequentially due to pricing actions taken in the quarter to address input costs. In the International segment, organic revenue increased 8.2% year-over-year driven by increased pricing and points of access growth. Notably, Mexico continues to grow double digits and accelerated both sequentially and year-over-year driven by strong e-commerce and hub-and-spoke expansion. Adjusted EBITDA increased 17.3%, expanding 30 basis points year-over-year and has returned to over 20%, primarily driven by declines in product and distribution costs as a percent of revenue due to effective pricing increases.

We saw strong operating leverage in the UK given actions taken to deploy cost control initiatives and introducing a nine-pack format in DFT. In the Market Development segment, Organic growth increased 9.1%, which was partially offset by the timing of equipment sales to franchisees. Notably, Canada grew more than 30% as points of access growth accelerated. Adjusted EBITDA increased $1.6 million or 13.3% with margin expansion of 220 basis points to 32.6% driven mainly by strong margin improvement in our company-owned Canadian and Japanese businesses from hub-and-spoke efficiencies combined with fewer lower margin equipment sales to franchisees. Moving to the balance sheet. We have a healthy balance sheet with ample liquidity and expect leverage to close the year below 4 times.

We are focused on the long-term health of the business and setting up our capital structure to support growth through a strong balance sheet. As we explore strategic alternatives for insomnia cookies, we expect to use any proceeds to fund our growth agenda and strengthen our financial positioning, which includes paying down debt and a continuation of a reduction in the usage of vendor financing. Over the longer term, we remain on track to be between 2 times and 2.5 times net leverage in 2026. Capital expenditures increased to 8.4% of revenues in the third quarter, driven by new store openings, and foreign exchange rates as we continue to invest behind our growth of our omni-channel strategy. Looking forward, and as Josh mentioned, the fourth quarter is seasonally our strongest and we’ve observed a strong October with low double-digit organic sales growth, proving that underlying demand remains robust.

Today, we are reaffirming our full year guidance ranges for revenue and adjusted EBITDA and continue to trend towards the mid to high end of the range. Additionally, I want to specifically call out the changes to interest expense and capital expenditure assumptions. We are updating our outlook for interest expense to between $47 million and $51 million due to the prevailing interest rate environment as well as our strategic reduction of vendor financing. In addition, we’re updating capital expenditures which we now expect to land between 7% and 8% of full year revenues, largely due to strategic investments and growth of our US delivered fresh daily network and foreign currency rates. In summary, we had a strong third quarter and are seeing momentum in the fourth quarter.

And we’re excited about the future growth opportunities in our business. With that, we will open up the call for questions. Operator?

See also 25 Best US Cities Where You Can Retire on $2,000 a Month and 15 Biggest Tea Producing Countries In The World.

Q&A Session

Operator: Your first question is from the line of John Ivankoe with JPMorgan. Please go ahead.

John Ivankoe: Hi, thank you. The question is on US margins. And I know in the past we’ve talked about DFD profitability really being looked at a market level. And I wonder if there’s any more intelligence or thinking around doing it at a root level or count level or even day of the week level. If there’s an opportunity for you to actually drive some margin maybe beyond what we saw in the third quarter out of that business in general? And secondly, I think there’s been some illusion that Krispy Kreme may use, potentially use third-party delivery into some DFD accounts as opposed to using your trucks and your drivers. And is that an initiative that is currently being tested or explored or something that we could talk about on this call? Thank you.

Mike Tattersfield: Yeah. Thanks, John. Appreciate the question around margins. I’ll open up and I’ll say we were pleased with kind of what we saw. This quarter with respect to US margins, we were up 30 basis points, obviously, in the US, but the US fresh business up over 100 basis points for the quarter. Really driven by some of that hub and spoke efficiency that you referenced, but also despite needing to absorb performance based accruals. So we still have bonuses this year that we expect to pay where we’re declining those bonuses or decreasing those accruals last year. With respect to your question around looking at the business differently, we’ll constantly kind of tinker with and explore, looking at different ways to investigate how to view the business. And maybe I’ll pass to Josh to kind of elaborate more.

Josh Charlesworth: Yeah. I think the primary focus that we look out for the health of the DFD business is the quality of the doors themselves. And then we make sure that the routes that we service them with are as efficient as possible. So the average sales per week of the door, which is over $600 a week, and again this quarter grew 12% after multiple quarters of strong growth demonstrates that we’re continuing to add productive doors and keep an eye on the existing base. Generally, it’s scale and density in a city that drives the profitability of the DFD routes. Routes that do 15 plus stops, get in, get out quickly, high quality doors, short driving times is the focus. In terms of between different customers and what have you, we do see C-store be a little higher margin than grocery, but that’s more reflecting the product portfolio.

There’s more loose donuts that we sell in the C-stores. And actually, in grocery stores at the moment, we have an initiative to add more cabinets that create greater display of those loose donuts. We’ve added over 120 this year. We see that as an opportunity to even improve the margin in the grocery stores. So we do a lot of analysis around it and that’s how we think about it. But the real quality of the doors and those routes is the primary thing across the different cities.

John Ivankoe: And in terms of perhaps considering a different route or style of distribution versus doing it in-house than potentially using the existing distribution capabilities of a third-party for example in various markets is that an opportunity?

Josh Charlesworth: It could be. The routes that we have today are all run by ourselves. As we’ve built out this model over the last couple of years, we’ve wanted to move quickly. We’ve wanted to protect quality. The most important thing is these doughnuts, which obviously fresh daily always displayed in the highest best way and then drive the profitability through the high-quality doors and the efficient routing. But that doesn’t say that looking forward third party couldn’t play a role, particularly as we look to scale DFD in the US. The quick service restaurant opportunity is clearly significant. And to scale at that magnitude we will need to be flexible in different models. But right now we’re focused on our in-house logistics model and making sure that those doughnuts are amazing, well served high service levels and the system remains strong throughout.

John Ivankoe: Sounds good.

Operator: Your next question is from the line of Sara Senatore with Bank of America. Please go ahead.

Sara Senatore: Great. Thank you. Hopefully, you can hear me. I have a question about the McDonald’s announcement. It’s twofold. One is, is that the CapEx increase? Is that the sort of reason for that? Or are there other initiatives that you’re also supporting? And maybe you could give a little color on that. And then with respect to McDonald’s, are there findings that you can share about things like pack size or loose doughnuts, what you know about the customers per your earlier comments about the relative profitability of different DFD doors. Just wondering if there’s anything – any insights that you can share from the early test. Thanks.

Jeremiah Ashukian: Yes. Thanks, Sara. Maybe I’ll address the CapEx question and I’ll flip it to Josh to address the McDonald’s question. Obviously, we continue to focus our spend on the highest returns. CapEx did tick up this quarter to about 8.4%, as we continue to invest behind growth and expansion of our US DFD network. But we also saw in our experience in the impact of foreign exchange rates on international investments in the quarter and obviously on a year-to-date basis which also contributed to some of the tick-up this quarter. Josh, do you want to cover the McDonald’s DFD?

Josh Charlesworth: Sure, thing Jeremiah. HI, Sarah. Yes, regarding McDonald’s itself nothing has been finalized but the opportunity to expand DFD through existing and new channels including QSR is clear. And we are discussing the potential for an expanded partnership with McDonald’s in the US. The learning has been very interesting through the pilot that we’ve done with them throughout the year in Kentucky and that is the nature of a lot of the discussions with McDonald’s right now, ongoing analysis and discussion with them, covering the operational execution, making sure the doughnuts are always arrive at the right time, right quality, understanding then indeed are the requirements that would be needed to scale beyond Kentucky and of course, commercial viability of the whole thing.

I mean our confidence in the US DFD opportunity including now QSR is what’s grown. It’s such that we’ve decided to thoughtfully start making additional investments. We’re just getting going, but those investments will be about — around manufacturing capacity to support scale growth because to your point around what have we learned from it what we’ve learned is that these QSR outlets behave in a very similar way from our point of view to a DFD door. We’re able to provide a fresh donut experience. The portfolio is relatively limited, but that doesn’t mean it couldn’t be added to over time. We’ve seen that both the loose donuts and the pre-packed donuts are well-received. And so from our point of view it’s behaving very well and substantiates the brand as we scale it.

And as I’ve mentioned before we don’t see sort of cannibalization of our base business in other DFD doors or indeed in our retail locations. And we’re excited for it. Our confidence has clearly grown enough to really start thinking about where we’d invest to support that kind of scale.

Sara Senatore: Thank you.

Operator: Your next question is from the line of Brian Mullan with Piper Sandler. Please go ahead.

Brian Mullan: Hey. Thank you. Just a question on Insomnia. I believe you’re expecting about $230 million of revenue from that business this year. How should we think about the store level margins associated with that revenue? And related to that maybe what’s a good way to think about the G&A and the D&A allocation we can try to come up with a good sense of adjusted EBITDA? If you’d be willing to share any color that would be great.

Jeremiah Ashukian: Yes, Brian, I can take that question. Look number one we’re super pleased with the business performance as it continues to grow and the profitability is improving sequentially. There also continues to be a lot of opportunities for growth expansion both in the US and internationally as we’re seeing great engagement early on in both Canada and the UK in the early stages. I don’t want to kind of speculate too much or at least kind of share too much just given the fact that we’re in a process right now and some of the other questions around financials and I’ll probably leave it at that.