Has Krispy Kreme turned the corner?

Has Krispy Kreme turned the corner?
Tags: Coffee/Bakery/Donut, Financing and capital improvements, Food & Beverage, Franchising & Growth, Legal Issues, Operations Management
May 4, 2009 - Christa Hoyland

When Dan Brinton left Krispy Kreme in 2006, he was unhappy with the chain's inflexible structure. He had been a franchise operator in the Houston area for eight years but ended up one of several litigants who filed suit against the company, with his settled in mediation. He also gave testimony in the U.S. Securities and Exchange Commission's investigation into the company's accounting practices.

But plenty more was wrong with the chain then.

The company struggled with having grown too quickly and with too much debt in the 1990s. Losses continued to mount. The tactics of its executives were suspect, and the CEO desk had a new face behind it every few years. Analysts called for a corporation and menu overhaul.

Brinton returned to a different corporate culture last May when he became a franchise partner and area developer in Arizona. He now has confidence in the brand and its new leadership.

"I've seen the good, the bad and the ugly," Brinton said. "I would not have come back to this brand to fail."

One significant difference Brinton experienced is the company's openness to his idea of a neighborhood store model, which former Krispy Kreme executives had rejected. The neighborhood — or hub and spoke — model relies on a centralized factory store to provide cooked donuts three to four times daily rather than having them made on site like the traditional model. Additionally, the footprint is about half the size at an average of 1,500 square feet location, and the stores are strategically located near neighborhoods, hence the name.

Almost a year later, his stores are doing well and he is preparing to open a sixth next week.

"The return on investment is very good from an operating perspective," Brinton said. "The ease of operations are actually easier than we thought. From a customer perspective, it's pretty seamless."

More options

The neighborhood store is now one of three restaurant models available to operators, including the small retail shop, touted as one of the company's strategic initiatives. The stores are significantly smaller than traditional stores and range in size from 900 to 2,500 square feet, enabling them to fit into more locations, including end caps with a drive-thru.

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The retail shops allow operators to choose among various models: Prepare all donuts on site, rely on a nearby factory store to provide partially prepared product to be finished with hot glaze at the retail shop, or have fresh product delivered several times daily from a nearby factory shop.

Larger retail shops also can offer Krispy Kreme's full line of specialty beverages, including coffees and espresso drinks.

The idea behind the stores is to provide customers with more convenient locations, which company research has shown consumers want from the brand, said Krispy Kreme spokesman Brian Little. The store's smaller footprint also fits analysts' call for a less expensive operating option to the factory store.

"The economics of our small retail shops are attractive because they are less expensive to open, run and staff," Little said. "Also, when locations are supplied by a large Krispy Kreme factory store, it improves the utilization of the factory store and significantly enhances the return on those stores as well."

Positive steps

In recent months, Krispy Kreme has shown it may be righting itself. In March, the SEC investigation was settled and only former executives fined. Last month, the company reported its first operating profit in four years. Although Krispy Kreme still posted a net loss of $303,000 for the quarter, it was a significant improvement over the $67 million loss in the prior year. And same-store sales were finally up, if just a 0.9 percent increase.

Krispy Kreme chairman, president and CEO Jim Morgan said in the latest quarterly financial release that the company is "seeing early signs of progress" toward achieving its strategic goals, including implementing new food and labor cost-management tools and training to improve shop operations — another improvement that analysts have called for.

Mark Krieger, food equity analyst, agrees that the company has made some progress but says it still falls short in some areas.

"Obviously, Wall Street is ecstatic about KKD's turnaround efforts as evidenced by its stock, which has more than quadrupled in the past six weeks," he said in an e-mail.

Krieger said the two main drivers of that success are the company's debt restructuring and its successful international franchise expansion.

The small retail concept shop is another positive step, he said, because it "offers the best of both worlds. The customer gets fresh baked donuts while KKD does so at a lower cost."

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Krieger, however, said that even though the company cut its long-term debt by 8 percent in the last year, it has far to go in trimming costs. For instance, Krispy Kreme's selling, general and administrative cost category as a percent of sales increased 40 basis points from 6.2 percent to 6.6 percent.

"This is unacceptable and something management needs to put as a high priority to reduce," he said.

Brand loyalty unchanged

For Brinton, Krispy Kreme's saving grace lies in consumers' continued love of the product despite the company's legal and financial troubles.

"From a real world perspective, nothing has really tainted the brand, if we can just get out of our own way sometimes," he said. "The customer focus is what's so important and that's what Krispy Kreme's strategic plan is saying. We're going to be more customer focused and do what our customers are asking us to do and have been asking for 70 years – be more convenient."

Brinton also said he thinks Krispy Kreme is doing the right thing by focusing on developing profitable store platforms before moving into new menu lines, such as the sandwiches that analysts have suggested.

"Krispy Kreme is back and being more flexible and, I think, going about it in a very prudent and smart way," he said. "I think they've turned the corner."