If investors thought things could only get better for
Krispy Kreme Doughnuts
after its disastrous summer, Monday's third-quarter debacle proved them wrong.
Sales growth slowed, and the company posted a loss of 5 cents a share that disappointed Wall Street and drove the stock down $1.86, or 16.2%, to $9.64. Meanwhile, Krispy Kreme shelled out $3 million for legal bills in an ongoing investigation by the
Securities and Exchange Commission
into its accounting. That probe was elevated to a formal one in October.
After a 73% slide this year, Krispy Kreme shares recently started showing up in the portfolios of value investors whose risk-return calculus looks past the vagaries of a single quarter's or year's results. Still, even the vultures will have to swallow hard to digest the glaze on the company's earnings report Monday.
Among the more worrisome aspects of the release was Krispy Kreme's decision to raise its allowance for doubtful accounts from two of its franchisees during the quarter.
"That only happens when the franchisees are basically failing and can't pay their bills," said Donn Vickrey, a forensic accounting analyst with Camelback Research Alliance. "This comes on the heels of a quarter when they had to sell off some equipment to make ends meet. That was also a sale leaseback transaction. This is pretty troubling."
Any mention of Krispy Kreme's relationship with its franchisees raises red flags with investors, because transactions with these partnerships are apparently part of the SEC probe. According to reports this summer, investigators are looking into sale-leaseback deals with franchisees that allowed Krispy Kreme to book profits from the stores without amortizing the cost of purchasing them.
Also gumming up perceptions was a line in Monday's press release saying that Glazed Investments LLC, a franchisee in Colorado, Minnesota and Wisconsin, exercised a put option allowing it to sell an 11% interest in Krispy Kreme back to the company for $3.6 million. Glazed Investments was described in the release as a consolidated partnership, meaning its results go directly into the company's earnings statement.
"It seems strange that Krispy Kreme would agree to this deal that gave a put option to Glazed Investments, allowing the franchisee to sell their interest back to Krispy Kreme," Vickrey said. "Now,
Krispy Kreme takes a loss, and for some reason they went along with it."
Glazed Investments is run by Larry Jaro, a longtime franchiser who also ran AmeriKing, once Burger King's largest franchisee. Last December, as part of its liquidation under bankruptcy court supervision, AmeriKing sold 130 of its restaurants to a Miami private equity firm, Core Value Partners, for about $13.2 million. It fell into financial straits by expanding too rapidly and becoming overleveraged while the Burger King brand tanked.
It's impossible to know exactly what's going on in most of these transactions because the company refused to take questions on a conference call. But Krispy Kreme franchise deals have been raising questions with investors for a while.
For instance, last year it paid $67.5 million for franchise rights for Dallas and Shreveport, La. The seller, who some investors thought profited a bit too handsomely, was Jospeh McAleer Jr., a former Krispy Kreme chief executive, and Steven Smith, an emeritus director.
After the second quarter, shares of Krispy Kreme were hit extra hard after its auditors refused to sign off on the company's financials. This time around, the auditors won't review the financials for the second quarter or the third quarter until the ongoing investigations into accounting practices are completed.
The report showed Krispy-Kreme closed nine stores during the quarter, incurring a $5.5 million charge to the company.
"We believe there will be more store closures in the next two quarters," Glenn Guard, an analyst with Legg Mason, wrote in a research note out Friday.
In the three months ended Oct. 31, the company lost $3 million, or 5 cents a share, compared with earnings of $14.5 million, or 23 cents a share, last year. Backing out discontinued operations and other items, the company earned $2.4 million, or 4 cents a share. Analysts had been expecting earnings of 13 cents a share.
Overall revenue rose 1.4% from a year ago to $170.1 million, while company sales rose 9.6% to $121.2 million. The latter was boosted by the inclusion of revenue from a partnership in New England that was consolidated under the Fin-46 accounting standard.
Krispy Kreme said systemwide average sales per week fell 16.7% from a year ago to roughly $52,200 per store, while the same metric was down 19.9% to $58,400 at company stores. Same-store sales fell 6.4% from a year ago at systemwide stores and 6.2% at company stores.
The company also said its previous guidance for fourth-quarter sales is no longer valid and said it wasn't estimating profitability or revenue for next year.