Cheaper by the Dozen

Despite the recent announcement of aggressive cost-cutting moves, shares of the Winston-Salem, N.C., company tumbled another 18% this week, closing Friday at $6.16. The doughnut maker's stock hit an all-time low of $6.06 on Thursday, down 88% from its high of $49.37 set on Aug. 18, 2003. The stock action has been so negative, and the business fundamentals so discouraging, that some observers are starting to utter Krispy Kreme and the B-word in the same breath.

"It's definitely a short-seller's dream," says Bill Brandt, chief executive of Chicago-based Development Specialists, one of the nation's largest turnaround firms. "How long it lingers before it goes into bankruptcy is purely conjecture. But if I was [new CEO] Steve [Cooper], I would extend the opportunity as long as I can to build up enough cash to run this business successfully. Cash is king. He doesn't have much, and he needs to get some quickly."

On Tuesday, the 68-year-old company bit the bullet even harder by revealing plans to cut 25% of its corporate staff and get rid of the corporate airplane. The moves will generate $10.4 million in pretax savings. Krispy Kreme will take a cash charge of about $900,000 in its fiscal first quarter ending in April as a result. Even so, with a possible loan default looming, Krispy Kreme has warned that it needs to line up additional funds to cover its operations.

"I think bankruptcy is a real possibility at this point," says Morningstar restaurant analyst Carl Sibilski. "I would say individuals don't have any business being in this stock. It's too speculative. You could either make a lot or lose a lot of money. And the biggest risk is that no one knows what is going on inside that company." (Sibilski doesn't own shares of Krispy Kreme Doughnuts; Morningstar doesn't do investment banking.)

While Krispy Kreme has great brand recognition and a deliciously sweet product that consumers are willing to pay a premium for, the company has fallen victim to a growth strategy run amok and a heavy dose of accounting irregularities. Problems started in May, when the company lowered earnings guidance for the first time since going public in 2000. Krispy Kreme posted a loss for its fiscal third quarter ended Oct. 31. The wheels really came off weeks later when the company failed to file financial statements with the Securities and Exchange Commission on time.

By early January, Krispy Kreme declared it would have to restate results from some prior quarters because of accounting errors, potentially triggering the default of its main credit facility on Jan. 14. Soon after Chief Executive Scott Livengood stepped down, and the company hired turnaround company Kroll Zolfo Cooper. Kroll partner Steven Cooper, a restructuring expert, was named the new CEO. Cooper negotiated an extension on the $150 million bank credit facility until March 25.

"All this has created an impending cash crunch, in our view, and the company warned [Wednesday] that additional external financing would be needed by March 25 to fund operations and essential capital expenditures," wrote John Glass of CIBC World Markets in a Thursday note. "With way too many moving parts and now what appears to be a looming cash crunch, we advise equity investors to stay clear for the time being." (Glass doesn't own shares of Krispy Kreme Doughnuts; CIBC World Markets had a business relationship with the company.)

Not everyone is convinced that Krispy Kreme will succumb to Chapter 11, especially considering the strength of the brand.

"Bankruptcy is too hard to tell," says Dennis Milton, restaurant industry analyst with Standard & Poor's equity research. "My personal recommendation is if you have a position, hold it. There are heavy risks to the down side, but long-term there are potentially heavy rewards. But if you don't own it, I wouldn't get into it now with a possible delisting looming."

Krispy Kreme might turn into a good takeover target, adds Milton, for a company with deep pockets in search of a strong name with good expansion prospects abroad. On brand merits alone, Krispy Kreme seems to fit the bill. (Milton doesn't own shares of Krispy Kreme Doughnuts; Standard & Poor's may provide services to the company.)

"If I was handling the crisis management, I would say people still like fattening foods," says Peter Shankman, CEO of The Geek Factory, a public-relations firm in New York. "People still love the doughnuts and will continue to buy the stuff. If the company can get its house in order the brand will not go away. The blue-collar guy who buys it every morning doesn't care about Krispy Kreme's stock. He just wants to make sure he can still get his original glazed." (Shankman doesn't own shares of Krispy Kreme Doughnuts; The Geek Factory doesn't do investment banking.)

But Brandt, the turnaround specialist from Chicago, thinks the aura of Krispy Kreme's brand is overblown.

"It's a great brand, but not a brand that's outside of Jupiter in its market appeal," he says.

Rather, Brandt argues that Krispy Kreme's explosive growth was driven by its perception of being the hot new thing. But like many fads, once the novelty wore off the business came back to Earth. Now, he says, with the marketing buzz a distant memory Krispy Kreme will have to roll up its sleeves and compete head to head with other big brands like Dunkin' Donuts and Tim Hortons.

"This company wasn't so much into selling doughnuts as much as selling franchises," says Brandt. "And without the early buzz, the sales are not sustainable on a recurring basis." (Brandt doesn't own shares of Krispy Kreme Doughnuts; Development Specialists doesn't do investment banking.)

Krispy Kreme officials declined to comment for this story.

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"I've been asked about bottom-fishing a lot, and [the stock] keeps going down," says John Staszak, an analyst at New York independent research house Argus Research. "They've penetrated the domestic market as much as they can. I want to see a plan first. The near-term prospects aren't that good. They reached the point where they've done all they can do here. Maybe there's something to international growth, but I've had a Sell on them for a long time, since the beginning of the low-carb craze." (Staszak doesn't own shares of Krispy Kreme Doughnuts; Argus Research doesn't do investment banking.)