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Krispy Kreme Doughnuts
Re: Staying Cool About Krispy Kreme

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By zoningfool
January 5, 2005

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...while it's likely not advisable to sink new money in the stock (unless one is steeled for the risk inherent in such a move), it's not a good idea to sell when sentiment dips as low as it can get.

The problem is that while sentiment may be at an all-time low, the stock price may head even lower. I agree with the article that the latest news about the restatements is not unexpected. However, that is just one of the dominos likely to fall, each one of which will likely cause the price of the stock to fall. As much as we like to think it is the case that "the bad (or good) news is already priced in", it never seems to pan out that way. Bad news always seems to bring another hit to the stock price when it is announced. Maybe just wishful thinking on the part of some investors that it won't really happen and when it does, it takes the price down again.

As far as KKD, I would expect more delayed filings as the quarters pass, including a possible delay of the 10-K. Once the 10-K is delayed beyond the 15-day grace period, a delisting notice from the NYSE is a real possibility. The fortunate thing for longs is that Nasdaq begins the delisting process as soon as any required filing is delinquent--including the 10-Q's. As far as I could tell, the NYSE doesn't start the delisting process until the 10-K is delinquent. Perhaps KKD could file the annual report on time, but it has been my observation that a restatement process takes many months, especially when there is a concurrent SEC investigation. Keep in mind that, unlike the 10-Q's, the 10-K is audited. The auditors will not readily sign-off on it under the circumstances.

I would also expect changes in senior management. While this may be considered good news, there will still be a transition period to get through. I just don't know of any companies which undergo a change of the CEO/CFO under the circumstances of accounting irregularities along with delayed filings and an SEC investigation that have turned things around immediately. There seems to be a prolonged period of the new management focusing on non-operational issues (such as accounting reviews and SEC negotiations) before their attention is fully turned to normal business--in this case, selling donuts.

Another problem with KKD's current situation is that there may be an expansion of the periods needing to be reviewed, further complicating the situation and delaying filings of periodic reports. I hope not and have no evidence in particular that this will happen, but the potential exists whenever an accounting review is initiated.

The biggest problem I have with companies who announce restatements is that "all bets are off" for making investment decisions. By this I am referring to the inability of anyone attempting to do due diligence in determining such fundamentals as price/sales, price/earnings, operating margins, gross margins, net margins, EPS and the trends of these metrics. Right now, we as investors don't know what the top-line or bottom-line numbers are for the periods in question. So, how do we know what the aforementioned metrics are? How do we make comparisons to competitors or to prior quarters of KKD itself? This is the primary reason I avoid companies who are in the midst of restatements. I do not have a firm basis to make a rational decision. The published numbers, we are told by the company itself, cannot be relied upon.

Therefore, this is a high-risk investment at best. That risk-premium warrants a decline in price. Where the bottom is, is anyone's guess. But I am betting it hasn't been seen yet. That is why selling now--or at the first dead-cat bounce--may not be such a bad idea, IMHO.

zf


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