Milling & Baking News - June 8, 2004 - 18

F I N A N C I A L

R E S U L T S

Flavored glaze among steps seen
reigniting Krispy Kreme growth
WINSTON-SALEM, N.C. - The introduction of a chocolate-flavored glaze
and a range of other innovations aimed
at shoring up flagging off-premise donut
sales were detailed last week by Krispy
Kreme Doughnuts, Inc. executives. The
plans were spelled out in a May 25
conference call in connection with the
release of first-quarter financial results.
Krispy
Kreme
sustained a loss of
$24,438,000 in the first
quarter ended May 4,
compared with firstquarter net income of
$13,140,000, equal to
22c per share on the
common stock, in the
first quarter last year.
Total revenues were
$184,356,000, up 24%.
Results were consistent with the earnings
warning issued by the
company in a May 7
conference call (see
Milling & Baking News
of May 18, Page 12).
Charges from discontinued operations
in the first quarter
totaled $34,285,000. Income from continuing operations was $9,847,000, down
25% from $13,140,000.
The weaker operating results were
attributed in large measure to slumping
off-premise sales. In addition to repeating developing plans for a new sugarfree donut, John Tate, chief operating
officer, spoke extensively of innovations
the company believes will boost supermarket sales of its products. Included are
new products, new packaging designs
and new packaging configurations.
Mr. Tate began the discussion with a
review of innovations targeted to boost
on-premise sales. "We've been testing
flavored glazes for some time now,"
he said. "We will test our chocolate flavored glazed donut at retail beginning
in August. Our new family of miniature
donuts, currently mini-rings and donut
holes, should be ready to test in a retail
application midway through the third
quarter. We think these products play directly to consumer consumption trends
and should generate considerable consumer attention in the store. We will test
briefly and aggressively with a view to
getting the full benefit of these products
for the fourth quarter. Finally, as we said
before, we expect our sugar-free donuts
to be ready for introduction in the fourth
18 / Milling & Baking News, June 8, 2004

quarter in retail stores.
"On the wholesale new products front,
most of these same donut products provide the basis for a very exciting series of
new product launches. The chocolate flavored glaze, mini-rings, donut holes and
the sugar-free donut all provide a platform to introduce a continuous stream of
new products over the balance of the year

and exciting, eye-catching new packaging. This will be compounded by the
experimentation with a number of new
packs, including two-packs, four-packs
and assorted donut six-packs. Again, we
believe these packages provide newness,
eye appeal, and pricing opportunities.
They also add purchase combinations
which are not currently available to the
off-premise customer. We believe the
strategy of capturing share of customer
attention will lead to substantially increased sales per door."
The company also is taking several
steps, including a route restructuring,
to reduce the costs of its off-premise
business.
In addition to a basic review of the
company's results and company plans,
much of the conference call appeared
targeted toward questions that have
arisen following the May 7 earnings
warning. Since the warning, certain
securities analysts have expressed
skepticism over whether low-carbohydrate dieting was truly to blame for the
downturn in the company's business. In
addition, shareholders have filed a classaction lawsuit against the company's
top executive, alleging that the effects
of low-carbohydrate dieting were not
disclosed in timely enough fashion. The

Wall Street Journal published a lengthy
article, intimating questionable accounting practices by Krispy Kreme in connection with the purchase of franchise rights
for certain markets from franchisees.
Scott Livengood, Krispy's Kreme's
chairman, president and chief executive officer, devoted considerable time
to rebutting the Journal allegations,
characterizing the article as completely
inaccurate.
Seeking to deflect allegations that
either low-carbohydrate diets have
been hurting sales
for some time or that
other factors were
at work worsening
Krispy Kreme results,
Michael Phalen, chief
financial officer, said
that the company had
enjoyed solid growth
in off-premise sales
throughout
fiscal
2004. The positive
view of the donut
business was supported by Information Resources, Inc.
data showing broad
category growth. He
noted that the nonKrispy Kreme component of I.R.I. data
is used as a "control
group" against which to benchmark
Krispy Kreme performance. This nonKrispy Kreme segment accounts for 70%
of category sales.
"This control group experienced volume increases of approximately 8% in
Q1 (of fiscal 2004), 4.6% in Q2, 3.5% in
Q3 and 1% in Q4," Mr. Phalen said.
The deterioration in the most recent
quarter was breathtaking. For the 12
weeks ended April 18 (equating roughly
to the Krispy Kreme first quarter), this
same group experienced a 7.2% volume
decline. The pace of decline accelerated through the quarter, declining 2.7%,
6.2%, and 12.7% in the three four-week
periods within the quarter, Mr. Phalen
said.
The slump in off-premise sales resulted in a 260-basis point increase in
stale returns. "Not only did we sustain
declines in sales per door with no reductions in most of the cost elements of this
business, but we actually added costs as
route stops increased with the added
doors," Mr. Tate said.
Asked why drivers did not simply
cut back on the quantities delivered
to supermarkets, Mr. Phalen said such
cutbacks are not so simple and that the
effect has been particularly severe during off-peak periods for demand. "One
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Milling & Baking News - June 8, 2004

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