Krispy Kreme's Bad Dough

It's official: The sugar high is over.

This morning, Motley Fool Stock Advisor pick Krispy Kreme Doughnuts (NYSE: KKD  ) announced that second-quarter 2005 net income dropped by 56% from last year despite higher sales. Investors fled the stock upon hearing the news, sending the shares lower by more than 11% as of this writing.

CEO Scott Livengood summed up the stickiness of the situation by admitting Krispy Kreme wasn't getting the job done on the fundamentals. I appreciate the hit-me-between-the-eyes honesty, but this may be the understatement of the year. Sales rose 11% from last year's second quarter, but operating costs rose 21% over the same period. Comparable store sales were up less than 1%. So what accounted for the revenue growth? Capital spending to open new stores. No wonder net income suffered.

Unfortunately, this isn't even the worst of the news. Krispy Kreme said it wouldn't provide earnings guidance for the third quarter and that it can no longer provide an accurate prediction for the full fiscal year. In other words: Remember when we said we'd earn between $1.04 and $1.06 per stub in May? Sorry, we were wrong. We can't tell you how long it will take to right the ship. And this after the Securities and Exchange Commission has decided to go out for a box of classic glazed.

Part of the problem, according to management, is the low-carb phenomenon. The company says its research shows that more than 1,000 low-carb products have been introduced during 2004, and -- get this -- media coverage of carb-conscious diets is apparently up more than 200% over last year. The alternatives, and the media blitz, may be forcing some of Krispy Kreme's normal constituency into the gym.

But is the ever-expanding appetite for all things low-carb really what's killing Krispy Kreme's business? Uh, no. The company continued to spend like a hyperactive teenager on a $10,000 shopping spree at Nordstrom (NYSE: JWN  ) even as it saw minimal new demand for its gooey products in existing stores. CEO Livengood says that's about to change and suggested this morning several ways in which the firm can improve, including being more efficient with deliveries, introducing a reloadable cash card apparently modeled after Starbucks' (Nasdaq: SBUX  ) version, and opening new, smaller-format stores that are less costly to operate.

You can call it irony, or maybe just desserts, but it turns out that Krispy Kreme is headed for a diet of its own. And that's probably a good thing. Investors are much more likely to appreciate a slimmer, sexier doughnut king.

For more jelly-filled Fool coverage:

  • Chief Operating Officer John Tate traded in sweet treats for stained tables at Restoration Hardware (Nasdaq: RSTO  ) .
  • Motley Fool co-founder David Gardner provides some perspective on Krispy Kreme's business.
  • The SEC has decided to go out for a box of doughnuts.
  • Fool Bill Mann says it's folly to blame low-carb diets for Krispy Kreme's problems.

With all its troubles, Krispy Kreme still can't knock David Gardner off his high horse. His picks are still walloping the market forMotley Fool Stock Advisorsubscribers. You can get in on the action by giving it a risk-free try for six months.

Fool contributor Tim Beyers loves a good jelly doughnut as much as the next guy, but he doesn't frequent Krispy Kreme. He doesn't own any of its stock either, nor any of the other companies mentioned. You can view Tim's Fool profile here.


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