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Krispy Kreme: We're as Shocked as You Are

The company says the low-carb craze took it by surprise and is unprecedented.

Updated from 9:48 a.m. EDT

Krispy Kreme


brought its case for victimization to the investing public Tuesday, claiming an unprecedented onslaught of low-carbohydrate food caught it by surprise and pledging to counter the situation with smaller helpings.

The comments followed word of the company's first-ever quarterly loss earlier, a $24.4 million deficit that reflected the discontinuation of Krispy's Montana Mills division and writedowns to cover scheduled store closing.

Winston-Salem, N.C.-based Krispy Kreme, a doughnut maker that manages to report three different measures of per-share profitability, earned $9.8 million, or 16 cents a share, from continuing operations in the three months to May 2, compared with bottom-line earnings of $13.1 million, or 22 cents a share, last year. Excluding the store writedowns and discontinued operations, Krispy Kreme said first-quarter earnings rose 11.9% to $14.3 million, or 23 cents a share.

Total first-quarter revenue from company-owned, franchise and the firm's manufacturing and distribution segment rose 24% to $184.4 million, while revenue from franchise-only operations rose 40.2% to $7.1 million. Company-owned store sales rose 21.8% to $124.5 million. Same-store sales rose 4% systemwide and rose 5.2% at company-owned outlets.

Krispy Kreme saw its shares hammered on May 7 when it warned that growing consumer tastes for low-carb food would cut its per-share profit in the first quarter to the above-mentioned 23 cents a share. The stock fell from $31.80 to $22.51 that Friday and has continued to edge lower as investors

wondered if there wasn't more to the story than dietary trends. Shares closed Monday at $19.85 and were recently up 16 cents, or 0.8%, to $20.01 on the Instinet premarket session

"We don't have any definitive answer" as to why the low-carb trend is affecting sales now, rather than last year, the company said in a conference call.

Executives acknowledged they had "never, ever seen anything that has rivaled what has occurred in the last three to four months." It cited hundreds of newly introduced low-carb products in supermarkets and said publicity of the low-carb craze increased substantially in the last few months.

By contrast, the company said, low-fat diets of the early 1990s never had any measurable impact on its business

To a large extent, Krispy Kreme is a victim of its own success, having gone public at a split-adjusted $12 in April 2000 and steadily climbing to an all-time high of $49.74 on Aug. 19, 2003. The stock has spent its public life trading at a considerable valuation premium to the market and its peers, and currently fetches 20 times the current year's earnings estimate of $1.01 a share.

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Its recent fall is typical of a category of companies described in an April 22 column by Vitaliy Katsenelson on's

subscription sister site,

Street Insight

, as "religion stocks."

"These stocks are widely held. The common perception is that they are not risky," wrote Katsenelson. "The general public loves these companies, because people can relate to the companies' brands. A dying husband would tell his wife, 'Never sell (fill in the blank with the company name).'

"Whenever a problem surfaces at a 'religion stock,' it is brushed away with the comment that 'It's not like the company is going to go out of business.' True, a religion stock company is a solid leader in almost every market segment where it competes, and the company's products carry a strong brand name. However, one should always remember to distinguish between a good company and a good stock," Katsenelson wrote.

Krispy Kreme was sensitive to perceptions it was shifting the blame in its conference call.

"We don't mean to make excuses. It's not an excuse. It's what it is. What's important now is what are we going to do," the company said. It plans to have mini doughnuts and pastries made from doughnut holes in its retail stores midway through the third quarter. It will also venture into flavored glazes, and hopes to refine its ordering process.

Inventories in the quarter stood at $33.0 million at May 2, 2004, up from $28.6 million at Feb. 1, 2004.

Krispy Kreme earlier repeated a forecast for full-year 2005 earnings of $1.04 to $1.06 a share, an estimate analysts didn't buy when it was first issued May 7. The Thomson First Call consensus is for earnings of $1.01 a share. The company sees 2005 systemwide sales rising at a rate of 20% to 25%, with systemwide same-store sales rising in the low- to mid-single digits. In the second quarter, same-store sales are expected to come in at the low end of that guidance, the company said on the call.

"If the slope of the line continues to indicate decline, the forecast we're giving would not be applicable," the company said.

The company said it wouldn't let the quarter's results curb its plans for 100 new stores domestically and internationally by year end.

"We saw a real reversal in the first quarter from the trends we've enjoyed since we've been a public company," Krispy Kreme said. "We're assuming a continuation of current levels of consumption ... Store margins will bump along where they are until we get some traction from the new store and cost initiatives. In second half, as we get new products, if we can recover that 10% productivity per door, we'll releverage the business in a similar fashion."