🔴Krispy Kreme $DNUT Q2 2022 Earnings Call🔴

Good day and thank you for standing by. Welcome to the Krispy Kreme 2nd quarter 2022 earnings call. At this time all participants are on a listen-only mode. After the speaker's presentation there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker today, Rob Baloo, Vice President Investor Relations. Please go ahead, sir.

Thank you. Good morning everyone and welcome to Krispy Kreme's second quarter 2022 earnings call. Thank you for joining us today. Our second quarter earnings release, company and 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, Chief Operating and Financial Officer; and Joey Pruitt, Chief Accounting Officer. After prepared remarks by Mike and Josh, 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 provision 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 these forward-looking statements. These factors and other risks and uncertainties are described in detail in the company's 10-K. Forward-looking statements made today speak 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 contain certain non-GAAP financial measures. Reconciliation between non-GAAP financial measures and their closest GAAP measures can be found on the company's second quarter 2022 earnings release and our Form 10-Q, which will be furnished to the SEC and available at investors.krispykreme.com. With that, I'll turn the call over to Mike.

Good morning and thank you everyone for joining us today. We are pleased to share our second quarter 2022 results as we continue to put up strong organic growth due to the strength of our omni-channel strategy. I want to start today's call by thanking our amazing group of Krispy Kremers, our team members, for their continued hard work to create moments of joy for our customers, especially while navigating significant uncertainty across the world. Our people continue to be at the forefront of delivering on our mission of becoming the world's most loved sweet treat brand. The purpose of our company is to touch and enhance the lives of others through the joy that is Krispy Kreme. The power of our brand allows us to do that in a special way. The second quarter included Mother's Day campaigns around the globe, Platinum Jubilee celebrations in the UK, and the Beat the Pump gas promotion of a dozen donuts for the price of a gallon of gas in the US. These campaigns perfectly highlight our key brand values of joy, generosity, and connection with consumers, which we know drives strong brand love, especially in periods of weaker consumer sentiment. We are proud to be a global company in more than 30 countries, and campaigns like these highlight the good we can do and how we really drive genuine consumer connections with our brand in an impactful way. Turning to our performance, the continued progress of our long-term strategy to drive our omni-channel model was well apparent in the second quarter with an additional 382 fresh points of access during the quarter. The overwhelming majority of those were low capital delivered fresh daily or DFD doors. This included strong points of access growth in Australia, South Africa, Japan, and Latin America, as well as new customers like HEB in Mexico. This led to global organic revenue growth of roughly 9% despite a challenging consumer environment. The increase in fresh points of access led to sales per hub growth of more than 20% in both the US and our international markets. This highlights how we can leverage the economies of scale of our 413 production hubs to deliver fresh donuts every day. In fact, total donuts sold during the quarter was up 7% globally from a year ago. We saw strong performance in the US and our hubs with spokes and Insomnia Cookies, as well as in Mexico, Australia, and New Zealand, and market development including a robust performance in equity-owned Japan. Additionally, Branded Sweet Treats achieved break-even adjusted EBITDA in the second quarter for the first time as we continue to improve and refine. On the other hand, the UK has seen a challenged consumer environment in recent months from soaring energy costs and other inflation, which led to a significant decline in general retail and supermarket traffic in the UK. Additionally, hubs without spokes underperformed in the US, growing 5% slower than our hubs with spokes, which highlights the importance of continuing the transformation of the US to hub and spoke. Despite robust organic revenue growth, adjusted EBITDA in the quarter declined modestly to $47.4 million due to significant foreign exchange headwinds of $2.7 million, cycling a very tough margin comp in the UK as they were re-emerging from COVID in the second quarter of 2021, and in the US from our vaccine promotion and investments in the consumer through brand building promotions. It's worth pointing out, however, that this level of EBITDA is still nearly 50% up compared to pre-pandemic and 60% up from 2020. Pricing actions offset most of our inflation in the quarter, and we continue to look at pricing and promotional activity strategically. We took pricing actions early in the third quarter in the US and UK and will continue to review pricing. Additionally, we expect lower promotional activity after August. In the US and Canada segment, our performance was driven by the strength of our hubs and spokes, highlighted by the 22% increase in sales per hub and Insomnia Cookies. Organic revenue grew 6% in the second quarter while total revenue grew 8.5%. Our DFD business continued to gain momentum as we added over 100 points of access during the quarter, bringing us to more than 6,000 locations in the US and Canada, well on our way to more than 10,000 points of access. We also saw our most successful ever National Donut Day in early June. Adjusted EBITDA in the second quarter declined modestly in the US and Canada due to weaker performance in our hubs without spokes, cycling a banner quarter from our vaccine promotion a year ago, and modestly higher promotional activity to help consumers with acts of joy and delayed price increase to the beginning of the third quarter. However, we see a very bright pathway forward through innovation, continued DFD expansion, and already beginning to see inflation moderating significantly looking ahead into 2023. Insomnia Cookies had another strong quarter, growing double-digit organic revenue and adjusted EBITDA. This was driven by same-store sales growth and 22 new cookie shops in the last 12 months. Insomnia has a strong pipeline that we believe will deliver unit growth in the mid-teens percentage each year moving forward. In June, we expanded our delivery zone and are now working with third parties to expand the reach for Insomnia Cookies by up to an additional eight miles. Both of these will drive increased e-commerce sales which have a higher ATV. We see tremendous long-term potential for Insomnia as it increases its own global TAM that continues to grow with recent success beyond college campuses and urban markets and upcoming entry into select suburban locations with continued product innovation. Our startup Branded Sweet Treats business, quality packaged shelf-stable doughnut bites and mini-cruellers, broke even on adjusted EBITDA for the first time. We continue to see great opportunity for Branded Sweet Treats in the coming years. Our international segment had another quarter of strong organic revenue of 13%, led by 28% organic growth in Mexico. We added more than 200 points of access in the quarter to bring us to more than 3,400, bringing our year-to-date total to more than 500 additional points of access. This led to sales per hub growth of 23% compared to a year ago on a trailing 12-month basis. While US dollar strength and inflation are headwinds in the short term internationally, we remain extremely optimistic about our ability to grow revenue and margin through our omni-channel strategy, increase our fresh points of access in a capital-efficient manner, and continue to innovate and take pricing when appropriate. Indeed, international, including countries in market development, showed outstanding organic growth across the board. Even the UK had positive organic growth cycling a tremendous quarter a year ago and with the worst consumer sentiment there in decades. In fact, our market development segment performance accelerated in Q2 with organic growth of 90% and adjusted EBITDA growing 6.5% despite significant FX headwinds and franchise. This was led by a robust performance in both our franchise business as well as our equity-owned Japan market where we are implementing our omni-channel model with the expansion of e-commerce and the launch of DFD. Krispy Kreme is truly a loved global brand. Roughly half of our system-wide sales and adjusted EBITDA are outside the US. As you know, our goal is to open up at least three new countries per year going forward. Earlier this year we announced signed agreements in Switzerland, Jordan, Costa Rica, and Chile. Today I'm pleased to announce the signing of a new strong partner in Turkey with a great new agreement to bring the hub and spoke model to Turkey from a proven restaurant operator, one of our largest development deals ever. International interest from our high-quality partners remains very high. With a proven model, we are building a very strong pipeline for new market entries with both existing and new franchise partners, as well as looking at equity stakes in strategic markets. We expect to be able to announce further market entries later this year as we continue our journey to become the most loved sweet treat brand in the world. Turning to a few other drivers of our growth, e-commerce remains a pillar of our omni-channel strategy. In the second quarter, 17.5% of our retail sales came from our e-commerce, up from less than 10% pre-pandemic and 17.2% for the full year 2021, with a goal to achieve e-commerce penetration of over 25% globally long-term. We continue to strengthen our capabilities with our mobile app in order to improve the user experience and enhance our customer targeting to more than 13 million loyalty members, a 22% increase from a year ago, and continue to expand accessibility with additional third-party partners. Innovation remains a significant driver of frequency as we create and introduce premium fresh and buzzworthy offerings to customers across our points of access. We had successful seasonal activations across the globe during the quarter, including Mother's Day and National Donut Day, as well as patriotic July 4th donuts that had a successful DFD campaign for the first time in the US. We're also launching a fantastic new fritter that will be available only on Fridays this year, and are even testing ice cream and shakes as we think about unique ways to drive additional frequency. Additionally, we expect to launch a fourth price tier later this year for our most premium donuts, like the hand-cut cinnamon rolls and these new fritters, that will command a higher price. We also invested in our consumers in the second quarter with strong promotions and connections in a time of need. Our customers expect this from our brand, and it can truly drive strong brand love. We always believe in a balanced approach to pricing and promotions. While the cost of pricing changes may not match up every quarter, we continue to see significant room to improve margin to 15% and beyond in the coming years. While short-term macro challenges remain, as we look ahead we see a strong path for success over the coming years, including a robust pipeline of low-capital points of access, new cookie shops, a significant number of new market entries, and we will continue to bring consumers along while managing margin. Additionally, in the second quarter we began the steps for the next evolution of the hub-and-spoke model in the US, including our hubs without spokes, reviewing our overall G&A structure and how we can better leverage our scale with the acquired domestic and international franchisees, as well as other considerations. It's no secret that some of our legacy hubs without spokes in the US are underperforming both on the top and bottom line. We knew this when we acquired the system over the last few years in order to control the brand and begin implementing our hub and spoke model, that not every shop would remain as it was then. In particular, hubs without spokes today. Some of this optimization may include converting shop types and exiting underperformers that are not set up well to support DFD. Earlier this morning we announced that we will be hosting Investor Day on December 15th here at our headquarters in Charlotte, North Carolina, which will also be webcast, where we will lay out our strategic vision and financial model through 2025. We will have a number of exciting updates to share with you, including the work I just referenced, automation efforts in 2023 and beyond, how we see a path forward for Insomnia Cookies and Branded Sweet Treats, as well as a number of other strategies underway that give us a very high degree of confidence that we will deliver our long-term growth algorithm with a very high return on our investment. We are very excited about our path in the coming years and are looking forward to sharing that full compelling vision with investors in just a few short months. I'll now turn it over to Josh to walk you through the Q2 financials and our 2022 outlook. Josh.

Thank you. As a reminder, to ask a question you will need to press star one one on your telephone. Please stand by. Our first question comes from Brian with Morgan Stanley. Your line is now open.

Hi, good morning guys. It's Brian for John. Maybe just the first question about the US hubs without spokes. What kind of defines the ones that you'll be closing? Is there a location issue, or what would you observe about those locations as they've kind of evolved out of COVID over the last year and a half?

Good morning. This is Mike. You know, we've talked about the transformation in the US, which we really started to close in on last year. We just even finalized a lot with the Midwest acquisition. When we acquired it, it was to get control of the system and including the largest markets, so we knew even then that some of the hubs were underperforming. And the whole plan was how do we evolve the system much more to this omni-channel model and the hub and spoke. So that's always the lens that's there. So the shops that aren't there are the shops that can't convert, they can't change over and do that. And that's really, you know, the inflationary time sometimes will actually highlight the gap that exists because you can see even across the world the hub and spoke model really allows us to drive our revenue per hub, which you can start to see happen.

Okay, great. Thank you. And then just on the improvement in organic growth as you went into July, was that primarily due to pricing? Maybe if you could comment on some of the underlying trends in the on-premise business, maybe in the delivery channel as well. What are the other drivers besides the pricing impact?

So you've got again promotional activity or merchandising mix that works. Points of access continue to grow, as is pricing. We look at pricing in a very different way. You can either be reactive or proactive. We're in this business for the long term, so we really look at pricing strategically. We didn't take price in the US or even the UK in the first half of the year. So we then really started to learn what's the merchandising mix, even as consumers are challenged, because we serve a broad spectrum of consumers. So finding that mix right and tweaking not just the promotional mix, but we actually were able to open up a new tier, which we do our customized handmade donuts, which are more expensive, a premium price, and you can see the customers are gravitating to it. They're always going to look at pricing, and we're very strategic about it, and our customers always tell us is it worth it. And we can see even as we brought fresh donuts to the DFD channel, when they can get access to that even across the brand, they want the fresh Krispy Kreme experience. So clearly we haven't seen the impact from pricing that we take.

Thank you.

Thanks Brian.

Thank you. Our next question comes from John Ivanko with JP Morgan. Your line is now open.

Hi, thank you. I wanted to talk about DFD in the US. If you can make some comments around DFD sales per door, profit per door, how the system is evolving from a profitability perspective, and if you have some opportunities, the more experience you have, the more data you have, maybe to do some portfolio management on the DFD side as you really kind of sharpen the pencil in terms of looking at profitability per account, especially as it's even more important now given your margins and profits, just making sure that you're doing business in all the right profitable places.

John, this is Mike again. I'll give you at least the strategic part, which we really learned from our international businesses, which is really how do you drive this omni-channel approach to the DFD and actually have the same donut mix that you have in the shop translate over to the DFD doors so that the Krispy Kreme experience is absolutely the same. And the points of access can be a real big driver of margin and opportunity. That's really started last year when we had the DFD start, and then you can see now we even tried it for the first time in the US market where we were able to activate on a promotion such as a July 4th activity and push that into the DFD door, so you can see the tape there and really raise sales. I'll pass it on to Josh, he'll get into a little bit more of the margin.

Have you gone through the exercise of making sure every DFD door is profitable each of the seven days a week, or even each route is profitable seven days a week? It would seem to me through my observations in South Florida, for example, in some cases the donuts are sold out at the end of the day, in other cases there's quite a lot at the end of the day. People don't necessarily eat the same number of donuts on Monday morning as they might Saturday or Sunday morning, for example. Does it make sense to apply a more granular type of approach to managing those accounts, or is it your belief that it's important to have availability so consumers know that it's there and the good days will more than offset some of the slower ones?

Yeah, one area I would add on is the ability when you start thinking about points of access and how you're talking to our customer base. Before, they were only getting access to Krispy Kreme in the 300 shops. You're now able to talk to them when you get the omni-channel approach and get the right donut mix into the 6,000 doors in the United States, with the potential to get beyond 11,000. You can see then the brand will also start to resonate and the frequency starts to become much clearer, and you can communicate about the product and it's accessible there. So that's not just the journey Josh described about how to get to the route profitability and door and sizing, but how do you make sure the consumer then has access to it and can get to those access points.

Okay, thank you.

Thank you. Our next question comes from the line of Carl with HSBC. Your line is now open.

Yes, good morning everyone. What is the biggest point of resistance that you face for getting pricing in the US to keep revenue pace with or ahead of inflation for real organic growth? And maybe related to that, can you comment on brand power? Do you have the brand power in new markets where you're expanding into to get the pricing that you need despite inflation? And what's your pricing experience in established markets versus new markets?

So again, we always look at our brand and the opportunity of how we can price strategically across everything we do. It's really about always finding the price where customers think it's worth it. How do you continue to innovate the points of access, which gives you more access and frequency? We can't take price. We took price in DFD last year, we continue to take price, but we're very strategic about how we do it. And you have to think about even the innovation that we start to launch in tiering and pricing, so that's a huge opportunity where you have value and tiering across your customers. There is no barrier today to what you can price right away. We actually just try to really manage that continuously across all of our customer base. And all of our customer base are always looking for value, they will also look for premium innovation and gifting. The thing that's pretty interesting is we're a low-frequency item, right? So you got to make sure when people want gifting in those aspects, that's when they engage with our brand. You brought up other countries and said the awareness of Krispy Kreme is worldwide. There's not a lot of opportunities where you go in where you open up the Krispy Kreme that they're not aware. Recent openings, for example, that we have in Cairo, they're still at, I can't even manage the capacity that comes out of the shops. Our partner there is really looking then figuring out how to get the hub and spoke system. So the uniqueness of the model is how do you drive the business from a traditional donut shop, which is what it was in the past, to a hub and spoke system. And when we do that well and get the access points, we can really drive the business.

Thank you.

Thank you. Our next question comes from the line of Bill Chapel with [firm]. Your line is now open.

Good morning.

Hi Bill, can you hear me?

Yeah, we can. I guess two questions. One, I'm just trying to understand maybe the change in tone or change in strategy. I mean, three, six months ago it seemed like the model was in place and things were moving pretty well, being implemented well, and you felt very good about even maybe some upside to the numbers. And then we've had what seems to be weather and economic slowdown, and maybe the model's been stress-tested, and you seem to be talking more about strategic tweaks to the model and changes. So I can't understand if this is something that was always in the works and you're just explaining it a little bit more, or if you felt like you had to take a little more corrective action after the model has been stress-tested a little bit.

So nothing has fundamentally changed from the model. The strategic model, building an omni-channel business with a hub and spoke, is exactly what we've been doing in the US. When we're still going through the transformation phase, as we just talked about in front, which is how do you get to the majority of your business being hub and spoke from a system that didn't have that before. And all you're seeing is just the US moving a bit faster now on the few hubs that actually don't fit into the system. There was a plan always with them to actually move on some of those hubs, and I'm just talking about in the US. From the UK model, you know that UK business is a fantastic business because I think you are alluding to that business as well. Even under duress, which the UK is experiencing as a consumer base today, we still get 20% margins. The reason we can do large 20% margins is because we have a great hub and spoke, very efficient model. They'll continue to tweak it. The macro environment is challenging customers everywhere in the world. It just shows you the resilience of our brand. It's actually growing in every single one of our countries where we operate today, in regions. And so when you get the benefit of the hub and spoke, you get to have more access in a very capital-efficient way. We're very bullish on exactly what we're doing.

Okay, well, and just to follow up on that, I guess was it not considered on the long-term algorithm? I mean, I understand this is an unusual year, but it's also unusual in terms of price increases which are driving some of the sales, and there will be other years with macroeconomic changes and heat waves and other things. Does 10% to 12% long-term top-line make sense, or you really haven't seen any change to that outlook?

Okay, I'll leave it there. Thanks.

Thank you. As a reminder, at this time please press star one one. Our next question comes from the line of Jared Garber with Goldman Sachs. Your line is now open.

Good morning, thank you for the question. I just wanted to dig into the US organic growth number. Certainly decelerated a bit, no matter what stack you look at. And I just wanted to get an understanding. So 6%, I think you told us last quarter you were running about 10% price in the US, correct me if I'm wrong there, but I think that's what I picked up last quarter. Plus you've got high single digits points of access growth, which if I'm not mistaken also kind of feeds into that organic growth number. So just want to understand the driver of the deceleration in the US organic growth number and if you're seeing any pushback or softness or weakening in consumer demand trends as the consumer continues to be pressured by the broader macro.

You asked, Jared, just one question about the consumer. And I think one of the big learnings we had was that we can even go to a higher tier of pricing. So what we did is that we really learned how to grab our cinnamon roll product in the US particularly, using that just on one day part, which is on Sunday, and really getting to what we call our fourth tier of pricing. And it actually unlocks a lot of big opportunities that, you know, eventually even one day might scale even into the full omni-channel model. There's no resistance that we've seen from customers. We still try to be very affordable on this, but there's clearly an opportunity to continue to put premium into our brand while we still try to maintain that kind of base price per dozen and try to drive that across the world.

Okay, great. Thanks for that clarity.

Thanks, John.

Thank you. Our next question comes from Jafar Masari with BNP Paribas. Your line is now open.

Hi, good morning. I just had a couple of short questions. Just going back on some of the details of the update in your guidance. So if I take the midpoint of EBITDA and revenue, it looks like your updated guidance is something like 100 basis points below what it was before. And obviously international can have higher margins. So are you able to assess how much of the change in margins is purely translation from higher margin international profits and how much would you say is other fundamental changes, including inflation? And then a similar question on the $10 to $12 million impact that you're singling out. If I understand correctly, it is the impact of FX translation and FX impact on costs. I just wanted to clarify if that's the case or whether it's FX translation and total cost increases regardless of whether they're currency related. So if I take $10 to $12 and adjust for that, am I adjusting for FX in a clean way?

Sure, sure. Thanks, Jafar. Yeah, if you think about the $10 to $12 million of FX impacts, certainly there are a few different factors there. We know that the dollar has been strong. The primary impacts for us are in the UK, in Australia, and in Japan, as well as in our international franchise business. And that $10 million or so assumes that the current rates that are out there will continue, and it does include both some translation, primarily translation, but then some transactional impacts as well.

Thank you, that's very clear. So it sounds like it's all FX related, and the only cost impact that's in the $10 to $12 is your operations purchasing elsewhere. And then when you talk about the spokes...

Yeah, some of our commodities are obviously impacted by the strength of the dollar, they're globally traded, and so there is a transactional element to it, but the majority is the translation. And about half of it is the pound, so we'll have to watch how that plays out.

Great. And then just to close on that, and I'll be done after that. The no change to the organic growth guidance range, is it because effectively we may have ended up at the top end and actually it may end up being that the low end now, or is it as you just suggested that organic growth remains very similar, the difference is what sort of promotion you need to deliver to get there and how fast you can get some of those costs covered?

All right, thank you very much.

Thank you. And I'm currently showing no further questions at this time. I'd like to turn the call back over to Mike Tattersfield for closing remarks.

So thank you everybody for spending a little time and learning about our business. I'm always appreciative to all the Krispy Kremers. I actually visited them in the shop today and I just said hello. I really look forward to continuing our journey of building the most loved sweet treat brand in the world and deliver upon that every day. So thank you for your participation.

Hold on, deliver with prominence every day. Thank you all for joining. You may now disconnect.