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Investigation Dunks Krispy Kreme

Jul 30, 2004 | USA Today

News that the Securities and Exchange Commission had launched an informal investigation into Krispy Kreme's (KKD) earnings left a bad taste in investors' mouths Thursday, driving the once highflying stock down almost $3 to $15.71, a low for the year. Last summer, the stock had hit $49.74.

Krispy Kreme said the investigation concerned the company's reacquisition of franchises and its warning in May that 2004 earnings would fall short of plans. The May announcement caused the company's stock to plummet from the $32 range to $20 and spawned several shareholder lawsuits.

At the time, Krispy Kreme CEO Scott Livengood blamed the popularity of low-carbohydrate diets for the company's reduced earnings expectations. But Wall Street analysts and investors were skeptical because the low-carb trend was strong last fall, but did not dent Krispy Kreme's earnings.

A few weeks after the May 7 profit warning, The Wall Street Journal reported that the company had used aggressive maneuvers to account for the repurchase of a struggling franchise chain in Michigan. According to the Journal, Krispy Kreme agreed to pay more for the buyback so that the franchisee could pay overdue interest on a company loan, a payment that immediately boosted earnings. The unusually high cost of the buyback, meanwhile, wound up on Krispy Kreme's balance sheet as an intangible asset that never affected the company's earnings. Krispy Kreme defended the action, saying auditor PricewaterhouseCoopers had approved it.

Analysts who follow the stock expressed concern over Krispy Kreme's business model, which seems to have faltered this year. After going public in 2000, the company took advantage of an almost cult-like appeal, rolling out franchise stores through the Southeast and other parts of the country.

Its growth strategy focused on building same-store sales while adding stores. The company owns 387 "factory stores" that sell doughnuts on site and ship them to supermarkets and other outlets. The strategy paid off initially, as the factory stores boosted their year-over-year sales numbers. But sales flattened in recent months as the novelty of Krispy Kreme has worn off in some markets.

Analyst John Ivankoe of J.P. Morgan Chase, who recommends that investors avoid the stock, says the company faces the possibility of an earnings restatement. In a report to clients Thursday, Ivankoe wrote that "the number of off-premise accounts should be reduced to improve overall profitability."

Skip Carpenter of Thomas Weisel Partners also believes retooling is needed: "As they built out the business, the euphoria of the brand has waned, and the product has become ubiquitous."

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