Updated from 11:21 a.m. EDT

Krispy Kreme's

(KKD)

transformation from growth stock to deep-value play made giant steps Thursday, although it is probably still too early for all but the strongest-stomached investors to take a flier on the pastry purveyor.

The Winston-Salem, N.C., doughnut-shop chain gapped down for the third time in four months after reporting a 55% decline in second-quarter earnings and previewing a major second-half sales disappointment. The company, which refused to provide earnings guidance for its current third quarter, tried and failed to soothe investors with a new focus on long-term growth.

Krispy Kreme, a company that cooks and sells doughnuts and still manages to report at minimum three different measures of quarterly profitability, earned $5.76 million, or 9 cents a share, on the latest quarter's bottom line, down from $13.0 million, or 21 cents a share, last year. Total revenue rose 11.5% to $177.5 million on a 0.1% rise in systemwide same-store sales.

Excluding a store-closing charge and discontinued operations, the company earned 12 cents a share in the most recent quarter. Excluding just the discontinued operations, the company earned 10 cents a share.

Analysts surveyed by Thomson First Call had been forecasting earnings of 22 cents a share on revenue of $188.5 million in the 2004 period. The stock, which nearly touched $40 on March 5, was recently fetching $13.67, down $1.69, or 11%, from Wednesday's close. That's about 14 times the current Thomson First Call consensus earnings estimate of 97 cents for the current fiscal year, a forecast that will come down after Thursday's news.

Krispy Kreme blamed the low-carbohydrate diet craze when it issued its first-ever profit warning on May 7, an announcement that dropped its shares from $31.80 to $22.51 on that day. Wall Street has

been skeptical of the explanation and turned paranoid earlier this month when the company's

chief operating officer bailed. Word of a

Securities and Exchange Commission

probe of the company's franchise-repurchase accounting

lopped another 15% off the stock on July 29.

Carl Sibilski, a stock analyst with Morningstar, said diet trends probably do affect Krispy-Kreme's business, given that other bakeries and grocery stores are experiencing the same difficulties. But Sibilski thinks the low-carb craze is exacerbating a more fundamental problem in the company's operations that stem from its hyper-growth strategy that was adopted after its 2000 IPO.

"When you're doing something well, you tend to keep doing it when it's working, and for them, for the longest time, it just worked to keep adding more stores," Sibilski said.

The strategy was not without its triumphs, leaving Krispy Kreme the No. 1 provider of doughnuts in grocery stores. But now that the party is over, the hangover has begun.

"They have to stop, take a couple of deep breaths, and make sure they can get their operations up to a successful level of efficiency before they can start growing again," he said.

Joe Bonner, a retail analyst at Argus Research, said Krispy-Kreme is facing other, structural problems.

"The real issue is that they're not getting enough productivity from their off-premises sales -- the doughnut packages that they sell in supermarkets," Bonner said. "That's where you really see a lot of erosion in operating profit, and I think that's the big problem that they need to solve."

Bonner thinks that after the series of bad news, the stock is getting cheap, but he wouldn't touch it until the company's brush-up with the SEC is resolved.

"This investigation takes value right out of the stock," he said. "In the post-Enron, post-WorldCom world, I just don't think anybody can go near it until that gets resolved. Assuming it does get resolved, I'd say the stock is pretty cheap, even if they're not growing at 20% of 25% -- maybe they're growing at 10% or 15%."

He thinks the stock could go up into the $20 to $30 range if governance issues were put to rest.

Sibilski doubts there's more downside in the shares.

"In my opinion, the chances of overpaying for this stock right now, given all the recent events and current news, is basically nil," Sibilski added. "It's very hard to find anyone optimistic on the stock, and if they're out there, they're being very quiet."

Robert Miceli, an earnings quality analyst with Camelback Research Alliance, said the SEC investigation into the company's franchise accounting could have legs. While the SEC won't elaborate on the probe, Miceli believes it probably relates to Krispy-Kreme's habit of not writing down the value of franchise rights it repurchases from franchisees.

"It's hard to tell if this is an outright violation of GAAP," Miceli said. "But we have stated that it is a violation of industry practices based on our own investigation of industry peers."

In Thursday's release, Krispy Kreme said systemwide sales for all of fiscal 2005 will rise 15% from the previous year, not the 20% to 25% it previously forecast. Top-line growth will be 10% in the year's second half. The company also cut the number of stores it plans to open this year.

"Although we are disappointed with the second-quarter financial results, we are optimistic about the long-term growth potential of the business," Krispy Kreme said in a statement. "We are focusing our efforts and resources on initiatives that improve long-term business prospects. We have core strategies with supporting initiatives, a leading consumer brand and great people to address the current challenges."

In a conference call Thursday morning, Scott Livengood, the company's chairman and chief executive, played up a new strategy in improving efficiencies that is aimed at starting a smaller store formula.