It won't file results on time, and frustrated franchisees fear the doughnut maker may give up making the glazed treats on-site
Will the dark clouds hanging over Krispy Kreme Doughnuts ever lift? The Winston-Salem (N.C.)-based doughnut chain disclosed on Sept. 12 that it won't be able to file its second-quarter results on time, the latest in a long series of setbacks as it tries to recover from plunging sales and an accounting scandal.
The company, which is under Securities and Exchange Commission investigation for accounting irregularities, said it can't report results for the quarter ended July 30 because of "material weaknesses" in its bookkeeping. Krispy Kreme (KKD) said that when it finally does report, it expects that revenues for the quarter will have fallen to $110 million, down sharply from the $140 million booked in the same quarter of 2005, when the chain operated 370 factory stores, or 75 more than today.
Surprisingly, Krispy Kreme's stock didn't tumble on the latest news. Shares of the former Wall Street darling dipped just 4 cents on Sept. 12, closing at $8.05. Some investors were heartened by the company's disclosure that average weekly sales rose 8% in company-owned stores and 5% systemwide— a sign that management may have at least stanched the bleeding after closing dozens of underperforming stores over the past year.
AN "UNDERVALUED GEM."
"Average weekly sales have stabilized over the past two quarters. They may have finally hit bottom and be coming back up again," said one analyst, who asked not to be identified given that Krispy Kreme hasn't filed timely financials in more than a year. Krispy Kreme first announced an SEC investigation into its accounting in October, 2004; in January, 2005, the company announced that it was restating previous financial results.
Indeed, many investors remain bullish that despite the spate of bad news, Krispy Kreme remains an undervalued gem. George Schultze, president of Purchase (N.Y.)-based Schultze Asset Management, which holds roughly 5.6% of Krispy Kreme's shares, contends that the company is grossly undervalued when compared to such chains as Panera Bread (PNRA), Tim Horton's (THI), and Starbucks (SBUX).
Schultze believes that even with its many store closings, Krispy Kreme will still report more than $500 million in revenues during its current fiscal year, which ends next February. Schultze notes that this is roughly in line with the company's current market capitalization of $495 million; by contrast, those other restaurant chains are trading at well more than three times their revenues. "It's a business that's temporarily distressed, but they're not going into bankruptcy," says Schultze. "And when the clouds blow away, it might be an attractive buyout candidate."
Still, Krispy Kreme has a long way to go before it becomes a growth company again. There has been little progress made under new Chief Executive Officer Daryl Brewster, who joined the company last March— perhaps because so much effort has gone into cleaning up the books and resolving the SEC probe (see BusinessWeek.com, 03/08/06, "New CEO's Hole Story," ").
"The turnaround hasn't begun," says Richard Reinis, a Los Angeles franchisee who operates 18 stores. "Given the pace things are going, there are many franchisees who are frustrated." (Krispy Kreme declined to make Brewster or other executives available for an interview.)
Because of Brewster's connections in the grocery business—he previously served as president of the $6 billion snack and cereal division of Kraft Foods—some franchisees expect him to push sales in that channel, particularly of new products with a longer shelf life (see BusinessWeek.com, 03/07/08, "Can Krispy Kreme Rise Again?"). They also expect Brewster to expand Krispy Kreme's offerings beyond doughnuts, perhaps adding bagels and muffins in the morning, beefing up the chain's uninspired coffee choices, and incorporating a lunch menu, as Dunkin' Donuts does.
And they anticipate that instead of producing doughnuts fresh at each store—an expensive proposition that put a number of franchisees under—Krispy Kreme will move to the same kind of "hub and spoke" system employed by Dunkin' Donuts, where goods are made in a central commissary and then shipped each morning to nearby stores. If Krispy Kreme goes that route, it will cut costs but run the risk of alienating customers who have long associated Krispy Kreme with its hot-out-of-the-fryer, locally made, glazed doughnuts.
In Chicago, one franchisee has begun broadening the menu on his own. And in Los Angeles, Reinis has partnered with The Coffee Bean & Tea Leaf, a popular California coffee company, in hopes of driving more traffic to his stores throughout the day. But still, some franchisees say they need headquarters to spend more on marketing to help drive traffic back to their stores.
"Dunkin' Donuts has become a marketing genius. They are omnipresent in every marketing channel known to man," says one franchisee. "But Krispy Kreme has zero marketing. They have to have a marketing department, marketing budget, and message."
But for Brewster, job one is bringing Krispy Kreme's books up to date. Doing so is critical to restoring investor confidence in the stock. And this will allow the company to begin signing up new franchisees again, which it is prohibited by law from doing so long as it's behind in its financial filings. So while Krispy Kreme may yet rise again, it still has a lot of work left to do.