• by Karlene Lukovitz  @KLmarketdaily, September 15, 2008

Krispy Kreme saw financial improvement in its fiscal '09 second quarter and first half, but it still has a long way to go to recover from its overexpansion and other troubles of recent years, say F&B/restaurant analysts.

The company reported a net loss of $1.9 million (-$0.03 per diluted share) for the second quarter, compared to a net loss of $27 million (-$0.42 per diluted share) in last fiscal Q2. For the first half, however, it showed $2.1 million in net income and positive $0.03 per diluted share, compared to a loss of $34.4 million (-$0.54 per diluted share) in last year's first half.

Total Q2 revenue declined 9.5% to $94.2 million. Company-owned store sales were down 13.5% to $65.1 million, including a drop of 10.5% for stand-alone KK stores and a drop of 15.7% for off-premises locations--meaning KK outlets within supermarkets, convenience stores and other retailers. KK supply-chain revenue declined 5.1% to $22.5 million. Franchise sales jumped 30%, but these represent a small portion of overall revenue: $6.6 million.

For the first half, total revenue declined 8% to $197.9 million, including an 11.9% drop for company store sales (down to $137.3 million) and a 4.4% decline in supply-chain revenue (down to $97 million). Franchise sales rose 30% in the six months, to $13.1 million.

The net improvement largely reflected lesser losses in this fiscal YTD from impairment charges (asset writeoffs) and lease termination costs from store shutdowns, which totaled $22.1 million in last year's second quarter alone. Systemwide, during Q2 the chain added 31 new stores (29 international and all franchises) and shut down seven (five U.S.). That brings total stores to 494. Most of these (80%) are franchises, and over half are now outside the U.S.

"We are not satisfied with our financial results for the second quarter," said Jim Morgan, chairman, president and CEO of KK, which was founded in 1937. Morgan noted that some of the Q2 shortfall was due to the economy's impact on sales and higher fuel and agricultural commodities prices. He added that KK's "near-term results may continue to be uneven" due to its vulnerability to such cost increases and financial troubles at some franchises that could reduce KK's royalties, but stressed that KK "must move forward on implementing our key strategic initiatives in order to achieve the positive long-term results we believe are possible."

These initiatives include:

• Building new, small retail concept shops in select markets to bring KK's signature doughnuts "closer to consumers" and establish the economics of a domestic hub-and-spoke model.

• Intense focus on shop-operation basics to improve the consumer experience and financial results.

• Developing, testing and deploying new menu offerings to give consumers more reasons to visit KK. One launch that KK considers to have particular promise is Kool Kreme, a proprietary soft-serve ice cream that will be accompanied by toppings bars (including fresh fruit toppings), which is now being tested in select markets.

• Improving business practices in the off-premises channel, "which has particular revenue and cost pressures."

• Building on international franchise development success, and enhancing franchisee operational support domestically and internationally.

• Providing increased supply-chain support around the world and improving franchisee service levels and economics.

"They're doing the right things by scaling the store concept down--their footprint has been too big to make the numbers work--and by reducing stores," says Bob Goldin, executive VP of Technomic, Inc., a research and consulting firm serving restaurants and food suppliers. "After being hot early in the decade, they expanded too aggressively and have too many locations, including those within other retailers. They were in some ways better off when people had to drive miles to find a KK store, because that gave them an aura of being special, which helped drive demand."

However, in Goldin's view, the prognosis is not good. "They have no momentum at all," he maintains. "Consumer consumption of high-fat baked goods is trending down, and Dunkin' Donuts has stolen their thunder. Among other things, KK, unlike Dunkin' Donuts, has not done a good job of capitalizing on specialty coffees, which are uptrending." (KK bakery goods have no trans-fat; however, half of the 200 calories in its original glazed doughnut are fat calories.)

"Although raw materials and fuel costs have stabilized in the last three months or so, they're still considerably higher than last year, and commercial bakeries as a whole are suffering," adds Christopher Shanahan, research analyst, chemicals, materials and food for market research company Frost & Sullivan.

"Krispy Kreme's popularity exploded around 2000, but the concept is no longer novel to consumers, and may prove to have been a fad," Shanahan says. "During the growth period, they relied too heavily on their brand equity, which now seems not to have been sufficiently supported by natural consumer demand."