Krispy Kreme Inc

NASDAQ:DNUT

Earnings Call Transcript 2021-Q2

[Operator]

Thank you for standing by and welcome to Krispy Kreme’s Second Quarter 2021 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions]

I would now like to hand the conference over to your host Senior Manager Communications, Cassie Williams.

[Cassie Williams, Senior Manager Communications]

Thank you, operator. Good morning and welcome to Krispy Kreme’s Q2, 2021 earnings call. Thank you for joining us today. 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, or future financial performance forward-looking statements involve inherent risks and uncertainties.

And we caution investors that a number of factors 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 registration statement on Form S-1. The company assumes no obligation to publicly update or revise any forward-looking statements accepted may be required by law. Additionally, today's call will include certain non-GAAP financial measures.

A reconciliation between GAAP and non-GAAP financial measures required by Regulation G can be found in the company's second quarter 2021 earnings press release, which will be furnished to the SEC on Form 8-K this evening and available at investors.krispykreme.com. For your convenience today's conference call is being webcast and recorded for replay via our Investor Relations’ website. Following prepared remark CEO, Mike Tattersfield, CFO and COO Josh Charlesworth, and Chief Accounting Officer, Joey Pruitt we'll take your question.

And now Mike will provide an update on Krispy Kreme’s business.

[Michael Tattersfield, CEO]

Welcome, everyone. And thank you for joining today's call.

We're excited to share our progress for the second quarter of 2021, which was the first in our return to the public market and one of the strongest quarters in our 84 year history. Q2 results demonstrate the effectiveness of our global transformation, and our continued progress towards becoming the most loved sweet treat brand in the world.

Our business is strong, healthy and expanding a direct result of the foundational work we've done to set our omni-channel strategy and deploy our hub and spoke model. We believe that our sustained growth in Q2 shows the resilience of our approach as well as the ability to adapt to evolving operating environments. Over our five-year transformation journey, Krispy Kreme has evolved into a truly global business with significant growth opportunities still to come.

We have made investments and now own and operate our businesses in the U.K. and Ireland, Australia and New Zealand, Mexico and the recently acquired business in Japan, with partners executing the omni-channel strategy in the remaining international markets. The success of Krispy Kreme brand and our omni-channel strategy around the world highlights the global opportunity ahead.

We're in early days of our international growth story, and we plan to both grow in our current geographic base and expand into new markets. Our focus on driving a high quality donut experience while growing our brand around innovation and celebratory occasion has taught us how to build a successful global business, enabling us to drive faster growth and stronger performance.

In addition to our global story, we see significant growth in the U.S. where we now control 48 of the 50 top markets and continue to build our omni-channel approach. This quarter that approach in all our core markets allow us to grow net revenue 43% to $349 million year-over-year, organic revenue grew positive 23% which represents one of the best quarters on record. We believe that organic growth is a fundamental indicator of the health of our business.

To put this in perspective, on a two-year stack basis, our organic revenues have grown 16% since 2019, demonstrating the strength of our performance compared to pre-COVID-19 results. Make no mistake this growth is due to the success of our omni-channel strategy and our increasing ability to reach customers wherever they are located. As we further implement our hub and spoke model, we see material gains and profitability.

Most notably, our adjusted EBITDA grew 78% in Q2, to $52.4 million, and our adjusted net income grew 254% to $20.5 million. Josh will help unpack these numbers in more detail as we explain what is driving our results at an operational segment level. It is important to note that this growth was ultimately driven by fundamental improvements in the business as we are now lapping the impact of COVID-19 in many of our key markets.

When we set out our transformation journey, we focused on three primary growth levers to drive our expansion. We believe together they drive sustainable value creation and set us on a path to becoming the most loved sweet treat brand in the world. These growth levers are first, increasing purchase frequency by giving consumers more reason to buy sweet treats through new platforms and channels.

Second, increasing availability by providing consumers with more convenient ways to buy a sweet treat and third, increasing profitability by implementing our hub and spoke business model that allows us to efficiently supply our expanding points of access with high quality sweet treats. I’ll explain those in a bit more detail. First, increasing purchase frequency. When a consumer chooses to indulge in a sweet treat, we want them to choose Krispy Kreme or insomnia cookies.

Building out our e-commerce capability is a primary mean for driving frequency and in the first half of the year 19% of our global retail sales were from e-commerce a proportion we expect to keep growing. The power of e-commerce is clear. In the full year 2020 82% of U.S. e-commerce delivery transactions were incremental to sales and e-commerce transaction values have increased as we expand our offerings into new areas like catering, gifting, and dark kitchen expansion.

We've also increased purchase frequency from product innovation by constantly evolving our core offering and regularly introducing new products. We provide customers with more reasons to choose Krispy Kreme more often. Our occasions based innovation, which focuses on holiday and major celebratory moment’s creates a steady drumbeat of reasons for consumers to purchase donuts in shareable formats of a dozen or more.

Our brand is powered by highly efficient marketing that keeps Krispy Kreme top of mind. By heavily leveraging social media, we can increase our cultural relevance and keep emotionally connected to consumers at lower cost. In addition to formal marketing activities, we also engage our passionate consumers through memorable, cultural and community shareable moments our acts of joy, which few love for our brand.

Year-to-date, we have generated more than 16.3 billion media impressions, largely driven by the success of our vaccine program, and innovative product rollouts. Our second driver, expanding availability is focused on building new ways for consumers to access our sweet treats. Notably, immediately after our Q2 close and for the first time ever 100% of our doughnuts served in the U.S. and Canada were delivered fresh no matter where they were purchased.

Creating more ways for consumers to engage with Krispy Kreme is fundamental to our growth story. Whether they access through our shops, e-commerce, our delivered fresh daily cabinets, or our branded sweet treat line. In the first half of 2021, we added 1,300 new global points of access. The majority in the form of new DFD doors as we complete the transformation of that business in the U.S. and Canada.

We remain committed to expanding consumer access to our sweet treats for consumers and we plan to add approximately 800 to 1,000 points of access per year globally, as we continue to execute our transformation. Further, since we launched our branded sweet treat line last year in 4,700 Walmart stores. We have expanded this consumer packaged goods offering to seven new U.S. retailers, including Albertsons, one of the largest grocery chains in America with multiple banners.

While early in this evolution, we believe the sweet treat line is scalable and will allow us to push toward wide distribution through grocery stores and convenience stores. Our third growth driver is increasing profitability. Over the past two years we have strategically acquired franchisees allowing us to take control of operations and drive efficiencies. As of the end of Q2, we control and operate 85% of the system in the U.S. and Canada and 73% globally.

To continue driving margins and profitability, we are expanding our hub and spoke manufacturing and distribution model, which enables us to efficiently execute our omni-channel strategy while increasing operating leverage and improving our bottom line. In deploying our hub and spoke model, we invest in a limited set of fresh donuts manufacturing hubs, primarily our Hot Light Theater Shops, and use those hubs to supply additional points of access.

Each new point of access within the hub and spoke network leverages an investment already made in a manufacturing hub, increasing efficiencies as new spokes are added. We believe that this model is vital to continue to profitability and margin growth and you can see this demonstrated clearly in the Q2 performance of our international segment where the hub and spoke model is more mature.

In the near term, we expect to further to point our hub and spoke model in the U.S. will incur some additional costs in the form of labor and training and route expansion costs which we view as investments and considerable growth to come. Finally, I must highlight that insomnia cookies was a key component of our outstanding Q2 growth, a proven winner and is clearly growing beyond its college campus origins.

The second quarter saw insomnia continue to deliver in digital innovation, new product development and operations excellence, including the opening of the 200th cookie shop in Westchester, Pennsylvania. Overall, our omni-channel strategy is working and our global expansion continues to capture more and more of our worldwide market opportunity. We are implementing our hub and spoke model globally and are seeing significant growth and increasing profitability as a result.

With that, I'll turn it over to Josh for a deeper dive in our performance and some operational developments in the second quarter.

[Josh Charlesworth, CFO and COO]

Thanks, Mike, and hello, everyone.

As Mike said, we are pleased to report an excellent Q2 with net revenue growth of 43%, organic revenue growth of 23% and adjusted EBITDA growth of 78%. Although our operations in several markets were impacted by COVID last year, our strong performance this quarter also reflects the underlying strength of our omni-channel business with revenue growth of 50% and adjusted EBITDA growth of 65% when compared to Q2, 2019.

The difference between the quarter’s 43% revenue growth and 23% organic sales growth is explained mostly by franchisee acquisitions made in the last 12 months. These include Japan, which we successfully integrated in December 2020, as well as franchisees in 12 U.S. cities, including San Francisco and Miami, which we acquired in Q1. We made no franchisee acquisitions in Q2.

All our business segments saw positive organic growth in the quarter with the International segment comprised of our fully-owned and operated businesses in the U.K. and Ireland, Australia, New Zealand and Mexico, leading the way with 126% growth. At the height of COVID restrictions last year, approximately 30% of our shops around the world closed however, demand for our sweet treats remain strong, and we were able to quickly reopen in the back half of 2021.

While lapping the effects of COVID explains much of the International segment’s Q2 growth. We are very pleased to see that these businesses where our signature hub and spoke operating model is most mature have come back stronger than ever. For example, the U.K. and Ireland market which makes the majority of its sales outside the brick and mortar donut shops delivered Q2 net revenue growth of 37% versus 2019.

Points of access to fresh doughnuts have increased by over 40% in the last 12 months in the U.K. and Ireland, driven mostly by additional delivered fresh daily doors at leading national supermarkets, Tesco Sainsbury's and ASDA. U.K. and Ireland spokes per hub are now 74 and sales per hub are $7.6 million explaining why the U.K. achieved EBITDA margin in excess of 30% in Q2.

The International segment helped drive overall consolidated adjusted EBITDA margin up 300 basis points versus last year to 14.7% year-to-date, higher than we expected at this point in the year. Looking to the consolidated P&L, product and distribution costs declined 380 basis points made mostly due to the International segment’s rebound. We're also lapping start-up expenses incurred in launching the U.S. branded sweet treats business last year.

We do see significant commodity cost pressure, particularly from edible oils. However in Q2, we continue to benefit from four contracts insulating us from this effect. Moving forward, we will use pricing to compensate for this headwind. Operating expenses rose 270 basis points, largely due to the acquisition and conversion of franchisees, which add their operating costs to our P&L.

Our existing control businesses saw some increased costs, with occupancy lease expenses rising on the exploration of temporary savings arrangements negotiated with landlords during the height of COVID. We also saw U.S. costs rise as we invest in deploying the hub and spoke system there. SG&A rose 50 basis points inflated by IPO-related expenses of $6.7 million. Excluding these we have seen 140 basis point reduction in SG&A reflecting the benefits of scale from our revenue growth.

On the bottom line, we saw a $15 million GAAP net loss driven by multiple one-time items, including interest related to our short-term dividend recap loan and related party interest. One-time income tax adjustments such as non-deductible public company executive compensation and the announced corporate tax rate increase in the U.K. Without these one-time items GAAP net income would be positive.

Adjusted net income, which also adds back stock-based comp, acquisition amortization and other non- recurring expenses was up to $20.5 million. Before reviewing the performance of our business segments individually, I wanted to update you on our consolidated net debt and leverage position as we've made a few significant cash and debt movements early in Q3. These include the proceeds from our IPO, and the repayment of a $500 million loan.

As of August 8, we have $118.7 million of cash and net debt of $646 million. Now with all IPO-related transactions complete, our total net leverage stands at 3.6 times using our Q2 trailing adjusted EBITDA, which is in line with our expectation going into the IPO process.

Turning to our results at the segment level in the U.S. and Canada, where our deployment of the hub and spoke model is ongoing, we delivered our eighth consecutive quarter of positive organic sales growth. Net revenue grew in line with expectations, rising 25% to $231 million from $184 million the previous year on a combination of franchisee acquisitions, and organic growth of 3.9%.

In turn driven by delivered fresh daily doughnuts sold in grocery and convenience stores, our new branded sweet treats line and insomnia cookies. Notably, the segment’s two-year organic growth stack is now 14.3% with sales proving resilient last year despite COVID. DFD doors now exceed 5,000 compared to just 2,000 in Q2, 2020. We've also seen average weekly sales per door increase more than 30% over this time, reflecting the success of our transition to only fresh donuts at a price consistent with menus at our donut shops.

Excluding the impact of exiting our legacy wholesale business, the U.S. and Canada segment would have recognized organic sales growth of nearly 19%. Highlighting the underlying performance of the business and bolstering our confidence in organic growth acceleration for the segment going forward. Looking to profitability, U.S. and Canada adjusted EBITDA grew to $28 million from $27.6 million the previous year, with DFD efficiencies, improving New York traffic and insomnia cookies all contributing to the bottom line.

U.S. and Canada EBITDA margin this quarter was 12.2% in line with the prior quarters 12.4%. This result reflects both efficiencies from implementing our hub and spoke model and the fact that we are still early in its deployment in the segment. We continue to invest in the new operating model. We hired more Krispy Kreme’s than ever before this past quarter as we integrated newly acquired shops, added hub and spoke routes and made the transition to DFD in major markets including Dallas, Houston and San Francisco.

A temporary increase in training costs and associated overtime plus increase wage inflation pressures are impacting short-term margin growth. However, we expect to mitigate these increases as well as commodity inflation with a price increase in September. We are aware that compared to Q2, 2020 EBITDA margin has declined from that quarter’s 15.0% that was the highest the company had seen in recent years. And is partly explained by a reduction in labor costs at the time, as sales shifted to pick up and drive through while our shop lobbies were closed in the face of COVID safety measures.

Turning to our CBG offering, our branded sweet treats line gained momentum in the quarter as we brought to market three new varieties, smallest bites, key lime crullers and chocolate crullers. The range is expanding. With our launch customer Walmart undertaking a shelf reset to give us more space, an Albertsons one of the largest grocery chains in the U.S. becoming our second largest customer.

Today, the line is already available at approximately 6,300 locations across the U.S. across 17 different retailers. To feed our branded sweet treats expansion, we undertook during Q2, an investment in three new production lines across our factory network, which will increase capacity by over 200%.

By leveraging existing infrastructure, we will require less than $2 million in capital investments to do so. We expect branded sweet treats to be profitable by the end of 2021. And overall in the U.S. and Canada we expect to see branded sweet treats, the New York market and the whole system at large to see margin improvements over time as we continue to deploy the hub and spoke model.

Moving to the International segment, we grew net revenue 159% to $89 million from $34 million the prior year, with organic revenue growth of 126% year-over-year, driven by increased foot traffic and in-shop dining following the lifting of COVID-19 restrictions. We grew international points of access by 600 versus the same quarter last year, helping the segment to 28% organic growth versus Q2, 2019 and demonstrating the strength of the omni-channel strategy.

In addition, e-commerce is now well established in the segment representing 15% of Q2 retail sales. Looking to profitability, International’s Q2 adjusted EBITDA grew to $24 million from $1.6 million driven by strong revenue growth and COVID recovery. Profitability continued to benefit from the robustness of our hub and spoke model, which is most mature in this segment.

Overall, International’s markets rebounded to match or exceed their performance prior to the pandemic. And we expect the segment to continue to contribute to strong EBITDA performance in the future.

Now turning to the Market Development segment, net revenue grew to $29 million from $26 million year-over-year with 17% organic growth driven by overseas franchise markets. Despite continued COVID-19 restrictions in certain segment markets, we continue to see growth with revenue exceeding pre-pandemic levels. Further, we saw the addition of 92 new points of access across the segment as well as strong e-commerce performance.

In our newly acquired Japan business, e-commerce and our recently launched DFD program continued to drive growth even despite government imposed state of emergency measures. Overall performance in the segment resulted in market development’s adjusted EBITDA growing to $10 million from $8 million representing 25% year-on-year growth.

Looking forward, we expect the segment to continue to deliver strong organic growth as we add more points of access in the world - across the world, including our upcoming new market entry in Egypt. As Mike explained, our hub and spoke operating model is key to the execution of our omni-channel strategy.

And as referred to earlier when discussing the U.K. and Ireland, we tracked three metrics to measure progress in the implementation of the hub and spoke model; points of access, spokes per hub and sales per hub with spokes. As of the end of Q2, we have 9,575 points of access and there's 70% gain over this time last year.

These points of access include 7,849 DFD doors, with 5,067 in the U.S. and Canada 2,264 in the international segment, and 518 in market development. This represents a global net increase of 1,261 doors from the end of 2020. Year-to-date, we have added 930 DFD doors in the U.S. with the largest gains in Dallas, Chicago and Houston. In brick and mortar we now have 1,726 Krispy Kreme and insomnia cookies, branded shops an increase of 39 since the beginning of the year.

We see significant whitespace opportunity to continue to grow our points of access, with the potential to have more than 2,900 points of access within the U.S. and Canada segment, and an additional 2,800 points of access in the International segment. 1,700 of these rest in the top U.S. markets, which are New York, Los Angeles, Chicago, Philadelphia, Dallas, San Francisco, Houston, Washington, DC, Atlanta and Boston. As we expand into these white spaces, we are aiming for an annual global development goal of 800 to 1,000 new points of access.

Looking to hubs as of Q2, we have 413 production facilities around the world, an increase of five since this quarter last year. Our strategy is to selectively add around 10 new production hubs per year. Much of our focus is on leveraging capacity at our existing hubs by adding new points of access. To that end, we have increased the number of hubs with spokes in the U.S. and Canada segment to 114 from 88 one year ago, mostly by converting legacy Hot Light Theater Shops.

With the additional points of access, we have increased average spokes per hub in the U.S. and Canada segment to 45 from 37 and in the International segment to 71 from 65 since the end of 2020. International’s higher average reflects the high proportion of off-premise DFD sales in that segment. International’s trailing 12 months sales per hub reached $8 million in Q2 up from $6.4 million in the full year 2020.

In the U.S. and Canada segment, average sales per hub reached $3.6 million, up from $3.5 million in the full year of 2020 and up from $3.2 million at the beginning of our transformation in 2019.

Turning to our expectations for the rest of the year and beyond based on the great progress through the first half of the year. We are confident in our ability to continue our momentum and deliver strong growth in 2021. Reflecting this, we are issuing full year 2021 guidance of net revenue of $1.34 billion to $1.38 billion or growth of 19.4% to 23%, organic revenue growth of 10% to 12%, adjusted EBITDA of $178 million to $185 million or growth of 22.4% to 27.2%, adjusted net income of $62 million to $68 million, or growth of 46.4% to 60.6%.

Q3, which is typically a seasonally softer quarter, is expected to see increased pressure from wage and commodities inflation, especially in the U.S. However, helped by our September price increase we remain confident in our ability to deliver on this full year guidance. Further looking beyond this year, we are also issuing a long-term outlook for organic revenue growth of 9% to 11%, adjusted EBITDA growth of 12% to 14% and adjusted net income growth of 18% to 22% per year.

Without the U.S. legacy wholesale business to wrap in 2022, the current momentum in our business means that we expect to exceed this long-term outlook next year. In addition, we expect total net leverage to be under three in the next 12 months. In accordance with our dividend policy, we expect to pay an initial cash dividend of $0.035 per share for the quarter ending October 3, 2021. Thereafter, we expect to maintain a stable quarterly dividend until we reach our long-term net leverage policy of two.

With this, I will now hand it over to Mike for some closing remarks.

[Michael Tattersfield, CEO]

Thank you very much everyone.

In summary, we're extremely confident about the long-term runway to grow Krispy Kreme on our journey to become the most loved sweet treat brand in the world. We're proud of the ongoing transformation in the U.S. and Canada as well as the outstanding performance in the international in the quarter. Most importantly, I want to thank our Krispy Kreme's around the world for their continued hard work and always showing up. We look forward to connecting with you all again soon.

With that, I'll hand it over to the operator as we would be pleased to answer any questions you may have. Thank you.

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of John Ivankoe of JPMorgan. Your question please.

[John Ivankoe, JPMorgan]

Hi, thank you very much. The question is on the U.S. margins, especially relative to international. One, I mean, I think, the U.S. margins were a little bit below our expectations than - certainly the question that we're going to ask is, when you think we could start to see margin growth again in the U.S.?

Do you have a specific date in mind? Could that come in the fourth quarter with additional menu pricing that you've discussed? And, secondly, as part of the IPO, closing the gap of margins between the U.S. and international would obviously be a huge opportunity on the income statement. What's in kind of your head around that thinking about the long-term? How close can those businesses get to? Do you have a number in mind? Do you have a timeframe in mind? Thank you.

[Michael Tattersfield, CEO]

Hi, John. Thanks for the questions. Yes, you're right. The first thing to highlight is that in the international businesses, where we have the material Hub and Spoke model, we do drive very high margins and in Q2 we saw even higher margins with the additional Points of Access that we're able to generate there during the COVID disruption. We're implementing the same model in the U.S. And now, we are indeed seeing the same benefits as particularly as we add Delivered Fresh Daily doughnuts, which are now across all our channels in the U.S. We're able to leverage the fixed costs back at the production hubs and drive up margins.

Now, what we're seeing right now is the change is accelerating. We're already at - the end of Q3 would already be the end - our year-end goal for DFD doors of 5,300. So in effect what we're seeing is the transition moving even faster in the U.S. And that means we've hired more Krispy Kreme's than ever before. We actually hired 1,700 people in quarter two alone. So with this level of change going - accelerating even the transition to Hub and Spoke, we've seen some additional implementation costs. You can imagine more training costs, more overtime as we fill the vacancies.

And hence why the margin, as you point out, a little bit lower in the U.S., but actually when you exclude the Branded Sweet Treat Line, which is a new business that we opened up last year, the entry into New York, which just happened last year, and of course we have reduced traffic still in the city there. And the most recent acquisitions are caught fresh donut business is doing already in the U.S. over 15% EBITDA margin. So we do have line of sight and indeed many ways greater confidence in our ability to drive EBITDA margin improvement towards those international levels.

Now in Q3, we are seeing commodity cost pressure coming through a little more on wheat, on edible oils, and sugar. The markets are all coming strong, hence our decision to take a price increase in September towards the end of the quarter though. So, you're right. Quarter four is when we will see in the U.S. the benefits of both that price increase and the efficiencies from the Hub and Spoke model, which, as I said, is going faster than even we expected.

You asked about long-term. We don't expect to close the gap all the way to those international margins. The international businesses were built effectively Greenfield with Hub and Spoke in mind whereas in the U.S. we have a legacy business that we're transitioning. There will be production hubs, Hot Light Theater Shops that we never add spokes to, so there is some inherent inefficiency there. We also, as I mentioned, are bringing on businesses like Branded Sweet Treats to become more profitable over time. So the transition will be a multi-year transition, but we will see 15% EBITDA margins in the U.S. in the years to come.

[Operator]

Thank you. Our next question comes from John Glass of Morgan Stanley. Your line is open.

[John Glass, Morgan Stanley]

Yes. Hi. This is Brian on for John. I guess just curious on the international side of the business. It seems like it was quite strong there. I am curious if there was kind of perhaps more pent-up demand than you expected the drove some of that. Perhaps in some of the individual countries, what's been stronger than your expectations and are there any still lagging? And I guess just also on opening new shops. Are there any kind of puts and takes there any of you think that are moving faster than expected? Or any that are still seeing some delays due to COVID?

[Josh Charlesworth, CFO and COO]

Yes, so, we'll take it on your two questions. So, our goal is going to be to open up between 10 and 15 new hubs in the global business, right, that includes the U.S. and international. And you're seeing that our focus on the international, we're going to opening up this week, we actually opened up in Egypt, right, which with a population of 100 million, in the City of Cairo 20 million.

So we can see opening up that hub there starts to really show how you're going to get the Hub and Spoke model working. That's one of the goals. In terms of international, even Josh alluded to it, right. There's - as businesses started to recover from COVID, they started to open up when you have the omni-channel approach, and the customer could use the business and where they wanted access the volume and the frequency of it as we also additionally opened up new points of access, you can see the improvements there both in our core, in the UK, New Zealand, Australia, Ireland and Mexico as well.

[Operator]

Thank you. Our next question comes from Sergio Matsumoto of Citi. Your line is open.

[Sergio Matsumoto, Citi]

Hi, good afternoon, and congratulations for your first quarter. My question is on the September price hike. If you could give us some color on how - what form this will take whether the rate will increase or there will be a changing - how that mix would be - would improve or maybe a more effective use of the promotions? Can you give us some color on that that would be great? Thanks.

[Michael Tattersfield, CEO]

Hi, Sergio. You bet. So, yes, we are always pursuing positive mix opportunities because we are continuously innovating with specialty doughnuts that we tend to price at premium price points. That is an ongoing part of our strategy. As a fresh donut provider, we're always in a position to do that. People get excited about the innovations we bring to the marketplace. More specifically, in September, what we're talking about is taking up menu prices for our core donut business, our core dozens business. It will vary across the country, depending on local market specifics.

We're very thoughtful and targeted as to what is the appropriate price point for different regions, different cities. That price increase is intended to cover the commodity inflation that I mentioned. Also we are seeing wage inflation typical that you're seeing across the industry, and actually in line with our expectations. The commodities are a little bit higher, and hence the need to lean in on pricing in September. But as a fresh only donut business to special occasion, infrequent purchase, we don't - we have a plenty of ability to bring that pricing. We know people love our dozen donuts. And so we have no concern about the ability for that to flow through to the bottom line.

[Josh Charlesworth, CFO and COO]

Yes, I mean, I will add one piece, which I think is important, which gives you the ability of how - why we think we have pricing power, right. Because as we started to discontinue the old wholesale program to the DFD program, we really introduced the exact same pricing structure that we actually have in our shops. And we saw our customers in those locations actually accept it, because it's a fresh product, right?

So as we continue to become a merchants and look at those different channels and how pricing can affect each unique channel and its own, right. And we see the opportunity there. It is a dozen business. So you have the ability that it still wants to be accessible. All right, so thinking even September was thoughtful about how we think about the business. We do believe we'll see that margin continue to flow through.

[Operator]

Thank you. Our next question comes from David Palmer of Evercore ISI. Your line is open.

[David Palmer, Evercore ISI]

Hi, maybe you can say this in millions in terms of EBITDA millions of how much higher your costs are now versus where they were back in June. I know for everybody they've gone up, but versus your own internal targets, how much have they adjusted, and what are the biggest buckets of that, and I have a quick follow up?

[Michael Tattersfield, CEO]

Hi, David. So I mean, the biggest bucket of increased costs on the P&L is of course in our operating expenses. It's driven by the biggest parts of our P&L, which are labor. As I mentioned, before, we're investing in labor, in line with the expansion of the system in the U.S. We're investing in labor with the investment over in the growth across the world. We have seen that increase in line with the market. The next biggest area of increase would definitely be on the product side. And we've seen that grow a bigger headwind than we expected. But that's as much as I can give.

[David Palmer, Evercore ISI]

Okay, and with regard to the U.S., there are some markets that are already if you add back the overhead would be at least high teens, if not 20s in terms of EBITDA margin. You've talked about the Southern California and Atlanta. When it comes to improving that U.S. margin from the 12% towards 15% plus, and maybe we can be greedy and think about getting up towards some of your better markets.

What is your path to getting there? Is it - I mean, clearly, the New York market can improve in profitability on a rebound, and perhaps rather quickly as that New York gets going again, but what is - you even talked about reinvesting behind the Hub and Spoke, so I want to be realistic about the past to improving this margin, and maybe you can walk us through how that will happen?

[Michael Tattersfield, CEO]

Sure. So I mean the first thing is golf targets. And you're right, we have aspirations for high margins. The reason I gave some specific details earlier on the UK is because even in the most mature Hub and Spoke cities there, we can continuously add more points of access and drive even more efficiency. So I mean the first thing to say is across the whole system, we are looking to leverage the omni-channel model to bring more efficiency. And when we talk a lot about Hubs where we have Spokes and adding DFD, leveraging the fixed cost there, we're definitely doing that.

But even in Hubs without Spokes with e-commerce now a permanent change a permanent addition to our channels, we're able to drive efficiency by having those transactions, which are highly incremental on top flow through at higher average transaction values to the bottom line. So it's a system wide effort.

Now, there is also a portfolio of cities, you're absolutely right, we have some cities, where the Hub and Spoke model is already a little more advanced, whether it be somewhere like Atlanta, which just reflects the history and the great heritage of the company, somewhere like Tampa, where we acquired the franchise, we went from being low single digit margins to low 20% margins in less than 18 months by improving operations, adding Spokes and of course, establishing a full omni-channel business in that area. And we'll be doing that across the system.

We made acquisitions at the end of last year, Dallas and Houston, which without Spokes, with some operating challenges have been lost making, New York we entered last year in the midst of a pandemic, we have a lot of confidence there, we're seeing the business strengthen, but it's still heavily diluted to the system as we wait for the full return of traffic and tourists. So it's a combination of efforts across the board. And in targeted cities where we can add particularly Delivered Fresh Daily doors.

That's why I talk a lot about the time we have right now with more DFD doors being added to the U.S. system than we even expected. And looking at that North Star somewhere like the UK where they're able whence they've got the critical mass and the maturity of the Hub and Spoke model to drive extraordinary EBITDA margins. It's very exciting for us to see that. But the implementation costs are real.

Yes, hiring people, adding drivers, adding route right now in this tight labor market means that we have to have people working overtime, it means that we're training more people than ever before. That's what we mean by those implementation costs. Because it's a big transformation and change. And we're not part of the implementation of that.

Once that settles, the new labor management systems demand planning systems that we've invested in, will really start to help us leverage the efficiency in each of those cities where we're adding these DFD doors. But right now, through the implementation, it's natural that we need to invest to make sure we're set up for long-term profitable growth.

[Operator]

Thank you. Our next question comes from Brian Mullen of Deutsche Bank. Your line is open.

[Brian Mullen, Deutsche Bank]

Hi, thank you. Just question on the DFD business in U.S. and Canada. There is now over 5000 DFD doors today, it's growing quickly. You know, at the same time, there is something like 150,000 grocery and convenience stores across the two countries. So a question is when we think about the ultimate long-term opportunity for DFD doors. What's the relevant number of vocations you actually think about internally or might actually consider for a cabinet one day, and I asked that understanding that not every single location is going to warrant one of your cabinets. So just any help on how you think about the long-term opportunity.

[Michael Tattersfield, CEO]

So you directed. This is Mike. Directed this is the U.S. and Canada, right. So with 300 current Theater shops today, you're still only going to have a certain amount of route that you have 5000, we think the opportunity in the U.S. is about another 2800 to 3000 a month doors, cabinets that are there in its potential, as you continue to open up the right Hub and Spoke, so that scarcity matters.

So when you're trying to do a model, and you're looking at 125,000 locations, we won't be in 125,000 locations. In fact, from an ACV perspective, even long-term, you can see a somewhere in the range of probably been between 5% and 10%, right. Scarcity is important to Krispy Kreme. It'll be following along the hubs that we continue to build, and do that exceptionally well. It's not every grocer, and even the groceries that we pick, it's not every one of their shops. So it's again that access because that's how you keep the brand special. That's how the merchandising and being a merchant really will work through.

[Operator]

Thank you. Our next question comes from Michael Rothstein of Goldman Sachs. Your line is open.

[Michael Rothstein, Goldman Sachs]

Hi, this is on Michael on for Jared Garber. Just want to touch really quickly on the 30% year-over-year AWS growth, a complete sales growth in the DFDs and that was really impressive, definitely far outpacing the organic revenue growth rates. But talk a little bit about what maybe drove that maybe are those kind of lower open rates, and then they ramp or are you guys making larger cabinets, DFD cabinets versus back then just trying to kind of figure out what was the key driver of that was? Thanks.

[Josh Charlesworth, CFO and COO]

Hi. Yes, thanks, Michael. So I think two main drivers are point to the first is we have as part of the transformation and learning from international being really focused on the high quality doors that might reference. Of course, they need to be local to the donut shop. So the doughnuts are fresh, but they also need to have the right level of traffic. And so we have been really thoughtful on those doors and have walked away from doors versus past years, where the volume and the traffic doesn't warrant, a fresh donut cabinet.

And the second one is the nature of the product, and the price point, we are now talking only what 100% fresh doughnuts, would you believe it, but a year ago 38% of our doughnuts in the U.S. were not fresh daily. Now it's 100%.

We now sell them always at the same price point as you would get in your local Krispy Kreme donut shop. So that comparison reflects a combination of better quality doors, there is less of them, and then we had in that old legacy wholesale business. But they're better doors that we will be more profitable then. And the first thing that drives up profitability is having the higher price point and that is driving the weekly sales up. And we're thrilled to see that across all our customers.

[Michael Tattersfield, CEO]

It's a one piece just augment on Mr. Josh out ability to be doing the thresh really matters for us as a system and that access point when we now start to have the DFD system and having the same doughnut or a doughnut maker doesn't even know where the doughnuts going. So that quality really matters. And you'll be able to get the right pricing structure, where customers will now say to Krispy Kreme, if I want a hot experience, I can go to a theater or not, I get it towards I want it.

[Operator]

Thank you. Our next question comes from Jon Tower of Wells Fargo. Your line is open.

[Jon Tower, Wells Fargo]

Great, thanks for taking the question. Just I'm curious to hear what you're seeing from a competitive response in the indulgent treat categories at the grocery channel or at sea stores. As you as you're rolling the DFD model out to more doors across especially the United States, are you seeing really any competitive response from those channels specifically?

[Michael Tattersfield, CEO]

So what's really specific were dozens business, right, so it's pretty unique. There's not a lot of direct competition that's doing a fresh dozens business across the U.S. in particular, as you call about. When we focus again, the brand tends to focus on occasions, and then make sure that the celebratory aspect of the brand is coming through. So from that aspect, we play in a different place of where the consumer is looking at it. So there is a space for the lower price point doughnut that a lot of the grocery stores do. There is actually two different sets of how the consumers making a decision.

[Operator]

Thank you. Our next question comes from Todd Brooks of C.L. King & Associates. Your line is open.

[Todd Brooks, C.L. King & Associates]

Hi, thanks for taking my question. If we could spend a minute on Branded Sweet Treats, and you talked about adding three new lines, capacity up dramatically. Doors up nicely this year. I think you said 6300 and getting to profitability by the end of 2021. I guess with that capacity that you're adding, how do you see that business growing as you get towards the out years of '22 and '23? And they said you added three new skews to the offering. But just if you kind of qualitatively walk us through what you think Branded Sweet Treats becomes for the business '22 and '23 and how the profit drag mitigates as the volumes rise? Thanks.

[Michael Tattersfield, CEO]

Appreciate the question, I'll start and then Josh will unpack a bit more. So if you think about the business, we just talked about the scarcity value of the fresh donut business. And that's really important for us as we build out the Hub and Spoke model. As we launched spring and Sweet Treat, we saw that as a different point that the customers looking for a different occasion.

And as we build that out, we started with Walmart, we are opening up to Albertsons and looking at other brands and their banners. We're going to be very disciplined about this, it really does matter how we build this business. And we see it as a really big potential because the occasion is different. It's not about the speed, it's we think about this brand, very much as we think about our hotline, experience, and how we're going to continue to build it.

And we will be able to match that potential, we think it's something that's pretty disruptive in the category, so that from at least a branding perspective, it competes against the occasion of a Krispy Kreme against itself, right. But it's a unique opportunity. On occasion use is different from how you see that coming through in margins and I’ll add Josh to.

[Josh Charlesworth, CFO and COO]

So I think Michael had a couple of data point. So the investment in these production lines is directly a result of conversations with customers, both our launch customer, Walmart, and other customers in other channels. And looking out over the next couple of years what we need to deliver on that and hence I referenced a capacity increase of about 200%. And that's in line with how we would expect to increase the business out to 2023, effectively up to about a threefold increase in the business, which is exciting, but would still give us probably only around about a 4% share of the enormous sweet snacks category. We do believe that with the strength of the Krispy Kreme brand that Mike talks about that there's room to grow faster than that.

And beyond that - but right now we're focused on the product selection that we have adding the new flavors as I mentioned earlier, and expanding only with the donut likes - like snacks. In terms of profitability, you're right, yes, it has - as we've been subscale and only just now started automating the process been actually a negative on our bottom line, and it will be dilutive.

We think next year still, but it quickly - because fundamentally, it is a premium priced proposition, be in line or even better in - over that timeframe from a margin point of view. So, we're excited to see the development of the business, our customer, Walmart, our new customers are also excited to bring it to the market. And so, we'll keep investing behind it appropriately.

[Operator]

Thank you. Our next question comes from Jaafar Mestari of BNP Paribas. Your line is open.

[Jaafar Mestari, BNP Paribas]

Hi, good afternoon. I just wanted to get an update on more medium-term inflation assumptions, if that's okay. I think at the time the idea you're saying you're budgeting for your wages to increase towards $15 minimum by 2025, if I'm correct, and you're also baking in 5% to 7% annual inflation on the commodity side. So what you're saying today, are those still reasonable with just a deeper start in for the 2021? Or are you now also budgeting for something a bit worse medium-terms? Is there any reason for that?

[Michael Tattersfield, CEO]

Hi, and thanks for staying with us today. So, yes, the assumptions you mentioned, which are the long-term assumptions are in line with our current expectations as well, the IPO not being that long ago. We already could see the IP - the wage pressure and to a certain extent the commodity pressure as well. I must admit the commodity pressure in the short-term has just been quite extraordinary.

And so in the very short-term, it's a little bit higher than we expected, but the long-term is in line with our expectations. And so all our plans and - with the focus on specialty dozens, making sure that we only ever have Delivered Fresh Daily doughnuts with their price point, the mass premium price point of Branded Sweet Treat and, of course, all our businesses across the world offering fresh dozen.

We know that we can cover those headwinds on cost, investing in our Krispy Kreme, making sure we always have the best quality ingredients, and indeed delivering on the bottom line because the - where we get the biggest benefit to that bottom line is the Hub and Spoke efficiencies coming through. So these are all things that we're aware of. We're used to dealing with hence why our immediate decision to go to the September price increase. And we remain confident in our expectations for 2021 and the long-term algorithm as well.

[Operator]

Thank you. That does conclude Q&A and today's conference call. Thank you for participating. You may now disconnect.