In last Monday's article on Krispy Kreme (NYSE:KKD), Seth Jayson warns us not to confuse the potential for a turnaround with McDonald's (NYSE:MCD) success in addressing its problems. McDonald's addressed its issues by slowing restaurant growth and focusing on food service and quality. Instead of being bigger, it wanted to be better.
Krispy Kreme should take note of this, but from last Monday's conference call and the post-call write-in question-and-answer session, that does not seem to be so. In fact, in my opinion, the company is simply too slow to react to changing market conditions and refuses to admit that it has a problem until it cannot hide said problem in its balance sheet anymore.
Much of the trouble the company faces right now has to do with its dealings with franchisees. This quarter's announcement to make investors' eyes glaze over -- besides missing analysts' estimates by $0.09 -- was an increase to doubtful accounts on the balance sheet by $2 million. In other words, some of its franchisees are unable to give the company their portion of the dough.
What management needs to figure out is how to recover from a 15.7% decline in revenue from KKM&D -- the business unit that produces doughnut mixes and manufactures doughnut-making equipment that all factory stores are required to purchase. The company blames the decrease on higher distribution costs and lower equipment sales. But if higher distribution costs were a significant problem, they would have had more of an impact as oil prices started to rise.
We saw a similar situation when management blamed poor first-quarter performance on low-carb diets. That was several quarters after the diet had severely hurt other distributors of high-carb foods such as Interstate Bakeries (OTC BB: IBCIQ). The decrease in equipment sales is most likely due to only four new franchise stores being opened last quarter after averaging 16 the past five quarters. However, examining comparable quarters reveals that the probable culprit is significant declines in the sales of its doughnut mixes and not distribution costs or equipment sales.
A decline in doughnut mixes would make sense considering the 16.7% decline in systemwide average sales per week from the prior year comparable period. So what is the company doing to help reverse the decline? It has just begun a qualitative research program to help it better understand several areas of its business. Most of the program deals with better understanding its customers and potential customers. This is good news since research has not been much of a theme in the annual and quarterly reports.
But this is something that all companies should be doing, anyway! The problem is the time it will take to implement solutions based on this research. For example, Krispy Kreme is currently in the process of building five stores to test its smaller stores concept. This is a move away from the current business model, which is based on building "factory" stores that can supply off-site sales for up to a 50-mile radius. The idea is to get the "hot doughnut experience" to more customers.
The impact of the off-site doughnuts on the Krispy Kreme brand name has been a topic of debate for a long time on the Krispy Kreme discussion board. But the stores are not up and running yet, and we will not get any idea of customer response from management until at least mid-2005. This is just another example of the company not responding to issues until they show up on the balance sheet, in my opinion.
Krispy Kreme, which remains a Motley Fool Stock Advisor recommendation, seems to have no problem reminding investors that its brand name is very strong. Maybe that is its pride since a recognizable brand name is an enviable quality for a company to have. But whether potential lies in a product, a company name, or a new technology, potential is not a guarantee of future value -- which in this case still looks like it may be zero.
Fool contributor John Bluis does not own shares in any of the companies mentioned.
