Krispy Kreme: Reports Financial Results for Q3/2012

Winston-Salem / NC. (kkd) Krispy Kreme Doughnuts Inc., member of the South Korean Lotte Group, reported financial results for the third quarter of fiscal 2012, ended October 30, 2011. The Company also raised its outlook for fiscal 2012 and provided preliminary guidance for fiscal 2013. Q3/2012 highlights compared to the year-ago period:

• Revenues increased 9,4 percent to 98,7 million USD from 90,2 million USD
• Company same store sales rose 4,0 percent, the twelfth consecutive quarterly increase
• Operating income rose 36,2 percent to 5,6 million USD from 4,1 million USD
• Net income was 4,7 million USD (0,07 USD per share diluted) compared to 2,4 million USD (0,03 USD per share diluted) in the third quarter last year
• Cash provided by operating activities was 10,2 million USD compared to 7,4 million USD in the third quarter last year

The Company ended the third quarter of fiscal 2012 with a total of 678 Krispy Kreme stores systemwide, a net increase of nine shops during the quarter. As of October 30, 2011, there were 89 Company stores and 589 franchise locations.

Chief Executive Officer James H. Morgan: «Our third quarter performance reflects continued progress in strengthening our financial condition and realizing our vision for the Krispy Kreme brand. We generated a healthy increase in revenues, recorded our twelfth consecutive quarter of positive same store sales at Company stores, and delivered substantial improvements in both profitability and operating cash flow. Despite economic headwinds and input cost challenges, we now project fiscal 2012 consolidated operating income, exclusive of impairment charges and lease termination costs, of 24 to 26 million USD, which would represent at least 25 percent growth over fiscal 2011».

Morgan continued: «While we are encouraged by our near-term results, we also believe that maintaining a longer term perspective is critical to building shareholder value. We are therefore working on a number of initiatives to improve profitability in the Company Stores segment in the years ahead. In addition, within our franchise segments, we are expanding our international franchisee pipeline to expand our geographic reach and market penetration, developing plans to reintroduce domestic franchise marketing, and improving support to our existing franchisees throughout the world. In summary, fiscal 2012 is proving to be an exciting year at Krispy Kreme, both strategically and as a result of our financial performance, and we continue to position the Company to build shareholder value for the long term».

Consolidated Results

For the third quarter ended October 30, 2011, revenues increased 9,4 percent to 98,7 million USD from 90,2 million USD. Year-over-year revenue increases were generated in all four business segments.

Direct operating expenses increased to 85,9 million USD from 79,2 million USD in the same period last year, but as a percentage of total revenues, fell to 87,0 percent from 87,7 percent. General and administrative expenses increased to 4,9 million USD from 4,8 million USD in the year-ago period but, as a percentage of total revenues, decreased to 5,0 percent from 5,3 percent.

Operating income increased to 5,6 million USD from 4,1 million USD.

Interest expense decreased to 385’000 USD from 1,6 million USD, reflecting lower interest rates as a result of the January 2011 refinancing of the Company´s credit facilities, as well as the reduced level of indebtedness.

Net income was 4,7 million USD (0,07 USD per share diluted) compared to 2,4 million USD (0,03 USD per share diluted), in the third quarter last year.

Segment Results

Company Stores revenues increased 9,8 percent to 67,6 million USD from 61,6 million USD. Same store sales at Company stores rose 4,0 percent, the twelfth consecutive quarterly increase. Price increases instituted to help offset higher input costs drove the increase, but were partially offset by a decrease in customer traffic. The Company believes that expected cannibalization by new store openings in expansion markets adversely affected same store sales in the third quarter. The Company Stores segment posted an operating loss of 574’000 USD, compared to an operating loss of 1,4 million USD in the third quarter last year.

Domestic Franchise revenues increased 14,1 percent to 2,3 million USD from 2,0 million USD, reflecting an 11,7 percent rise in sales by domestic franchisees. Same store sales rose 7,9 percent at domestic franchise stores. Domestic Franchisee segment operating income improved to 1,1 million USD, compared to 499’000 USD in the third quarter last year.

International Franchise revenues increased 22,4 percent to 5,4 million USD from 4,4 million USD, driven by higher royalty revenues. Sales by international franchise stores rose 9,4 percent, and provisions for uncollectible royalties fell almost 700’000 USD from the third quarter last year. Adjusted to eliminate the effects of changes in foreign exchange rates, same store sales at international franchise stores fell 12,2 percent, reflecting, among other things, honeymoon effects from the over 300 stores opened internationally since the beginning of fiscal 2009, as well as cannibalization as markets develop. The International Franchise segment generated operating income of 3,3 million USD, up from 3,0 million USD in the third quarter last year.

KK Supply Chain revenues (including sales to Company stores) increased 11,7 percent to 50,3 million USD from 45,0 million USD in the same period last year, driven by selling price increases. External KK Supply Chain revenues rose 5,2 percent to 23,4 million USD from 22,2 million USD in the year-ago period. KK Supply Chain generated operating income of 7,0 million USD in the third quarter of fiscal 2012, down slightly from 7,3 million USD in the third quarter last year. KK Supply Chain has raised selling prices to recover rising input costs resulting from higher agricultural commodity prices, but generally has not marked up those higher costs; accordingly, KK Supply Chain´s operating margin declined in the third quarter of fiscal 2012 compared to the third quarter last year.

Outlook

Given our third quarter and fiscal year-to-date results, along with other current information, the Company is raising its fiscal 2012 outlook for consolidated operating income, exclusive of impairment charges and lease termination costs, to between 24 and 26 million USD from between 22 million USD and 24 million USD previously.

For fiscal 2013, the Company anticipates opening five to ten Company stores, between ten and 15 domestic franchise stores, and more than 60 international franchise stores. Although the Company looks for continued organic same store sales growth in its domestic stores, international franchise same store sales will likely continue to be pressured by the substantial growth in international markets in recent years. In addition, as prices of agricultural and other commodities are expected to remain volatile, the Company will continue working to reduce its consumption of certain key ingredients while taking other measures to combat the rise in input costs the Company has experienced over the past year.

Based on these factors, our preliminary guidance is for fiscal 2013 operating income in the range of 29 to 33 million USD, inclusive of estimated impairment and lease termination costs. In addition, we are also going to start expressing our guidance in terms of diluted earnings per share in order to conform to prevailing practice in the industry. Our preliminary estimate of diluted EPS for fiscal 2013 is in the range of 0,35 USD to 0,41 USD per share. The foregoing range assumes income tax expense for fiscal 2013 of approximately two million USD, which would give us an effective income tax rate of approximately seven percent. The estimated range does not give effect to the increase in the Company´s effective income tax rate for fiscal 2013 which would result from a conclusion that some or all of the Company´s deferred income tax assets are more likely than not to be realized.

As of the end of fiscal 2011, the Company had a valuation allowance of approximately 160 million USD, equal to the entire balance of its net deferred income tax assets. If, based on additional evidence, the Company concludes that some or all of such valuation allowance should be released to earnings in the fourth quarter, then the Company´s effective income tax rate for years after fiscal 2012 would rise substantially. Management currently estimates that its annual effective income tax rate subsequent to any reversal of the deferred income tax valuation allowance would be approximately 40 percent. Any reversal of the valuation allowance will have no effect on the Company´s actual income tax payments or other cash flows, notwithstanding the fact that the Company´s reported earnings would be reduced subsequent to any such reversal.