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The Honolulu Advertiser
Posted on: Sunday, January 23, 2005

Krispy Kreme finds holes in profits

By Allen G. Breed
Associated Press

WINSTON-SALEM, N.C. — Roy Blount Jr. knew something was wrong at his beloved Krispy Kreme — long before the stock price began to plummet and the scent of corporate scandal filled the air.

Sue Kain, left, Harold Gregory and Bill Arnold, right, chat at the Krispy Kreme store in Winston-Salem, N.C., where Krispy Kreme was born. Gregory and Arnold drive 15 miles almost every day to meet at Krispy Kreme. Sales-wise, Krispy Kreme's dunkers have turned into sinkers.

Kim Walker • Associated Press

When the North Carolina company opened its first doughnut shop in New York City, the Georgia-born humorist rushed right down to see how his favorite boyhood treat fared in that Northern clime. Bathed in the red-neon glow of the familiar "Hot Doughnuts Now" sign, he ate five of the signature glazed ones in one sitting and couldn't wait to tell his fellow Gothamites of their good fortune.

"When Krispy Kremes are hot," he wrote in the Sept. 8, 1996, edition of the New York Times Magazine, "they are to other doughnuts what angels are to people."

To investors and analysts, Krispy Kreme's financial woes are a black spot on the portfolio. A federal securities probe, allegations of padded sales figures and last week's ouster of CEO Scott Livengood have tainted what had been a sweet American success story.

But to Southerners for whom a hot Krispy Kreme is part of a fond childhood memory of visits to Grandma and church get-togethers, the pain runs much deeper.

"It's the classic story of the country girl that comes to the city," Blount said. "You think anything that sweet couldn't get in trouble.

According to company legend, Vernon Carver Rudolph was looking for a place to open his own doughnut shop in the summer of 1937 when he landed in Peoria, Ill., with $25, a Pontiac loaded with frying and rolling equipment, and a secret potato flour-and-yeast-based recipe. He was standing on a street corner when he pulled a pack of Camel cigarettes out of his pocket and noticed where they were manufactured.

"Why not Winston-Salem?" the Paducah, Ky., native thought. "A town with a company producing a nationally advertised product has to be a good bet."

Rudolph used the last of his money to rent a tiny brick storefront across the street from Salem Academy and College. He had to borrow the money for his first batches of flour, eggs, potatoes and yeast.

By November, Rudolph was selling 1,000 dozen doughnuts a week at 25 cents a dozen. Things were going so well that he'd already obtained business licenses to sell in Charlotte, and had designs on Raleigh and Durham.

By the 1960s, the company had developed an assembly-line system that automated the making of doughnuts in every store, a process so mesmerizing it was eventually put on display for customers.

Rudolph's brother, Lewis, tried to convince him that Krispy Kreme should devote itself to the wholesale mix business and let franchisees take the financial risk of opening new stores. But Vernon Rudolph didn't want to give up that much control.

Krispy Kreme developed an assembly-line system that automated the making of doughnuts in every store, a process so mesmerizing that it was eventually put on display for customers.

Kim Walker • Associated Press

"We're going to be the biggest doughnut company in the world," his son, Vernon C. Rudolph Jr. recalls his father saying. "We're going to be the leader."

But Vernon Rudolph died in 1973 at age 58. Three years later, Krispy Kreme became a wholly owned subsidiary of Chicago-based conglomerate Beatrice Foods.

In 2000, the company went public at $21 a share. Investors weary from the dot-com bust seemed to embrace this tangible, flour-and-sugar product like financial comfort food.

Soon, Rosie O'Donnell was serenading the treats on her talk show, and Krispy Kreme won key product placements on "Sex and the City" and NBC's "Friends."

The glazed rings suddenly had become chic. Lines at grand openings were two, three hours long.

Stock prices soared to near $50 by the summer of 2003. Nearly 400 Krispy Kreme stores as far away as South Korea were producing nearly 3 billion doughnuts a year.

Then, like a doughnut left too long under a bright lamp, things started to deflate.

Last May, Krispy Kreme issued its first profits warning. Blaming the low-carbohydrate craze (each original glazed packs 200 calories, 12 grams of fat and 22 grams of carbs), the company slashed its 2005 earnings forecast by 10 percent.

By fall, the Securities and Exchange Commission announced it was looking into some dubious accounting practices at Krispy Kreme.

Last month, amid allegations in a stockholder lawsuit of padded sales figures, the company restated its 2004 earnings and warned investors that it was in danger of defaulting on a $150 million credit line. On Jan. 14, the stock hit an all-time low close of $8.72.

Critics say Krispy Kreme grew too big, too fast, that it had gone against the strength of its hot doughnut sales and saturated its markets with cold grocery- and convenience-store pastries.

"They grew faster than they were being efficient," said Carl Sibilski, who follows the company for Morningstar in Chicago. But Sibiliski is confident the company can get beyond that.

"From the brand perspective, I think it's still rising in popularity," he said. "Now, from a financial standpoint, the company needs to regain confidence among investors."