I'm shorting Krispy Kreme today

[DesertCat]

Ok, I've tried multiple ways to work out the model. I've reviewed the bankruptcy filing of "freedom rings", their PA franchisee (talk about ugly financials!), and looked through every SEC filing I could. The simplest way to approach the EBITDA is to look at their last 10Q (Q3, 2004). In it they broke down their segment profitability as follows

Company Stores $12.9M
Franchises $4.9M (royalties)
KKM&D $8.1M (Equipment/Supplies)
G&A -12.3M

It nets out to about $13.6M, or $54M in annual EBITDA. Since then however some things have changed. I'm convinced company stores cannot contribute any positive cash flow due to their declines. Franchisees are hurting as well, I'm convinced their contributions should be at least 20% less, but probably even less than that. KKM&D can no longer sell equipment which provided it's best margins, but I'm just ignoring that and applying their old margins to the new sales numbers.

I end up with the following (annualized)

Company Stores $0M
Franchises $16,093
KKM&D $30,274
Net EBITDA $46,366

So in this optimistic scenario, they can't even cover G&A anymore. If they can cut G&A in half, they'd have about $22M in EBITDA. Which is likely very close to their interest costs. No room for error here.

[DesertCat]

One last post. Reviewing the bankruptcy filings of Freedom Rings, their Philadelphia based regional franchisee, was pretty interesting. Specifically I read their operating report for December. Average sale per store was less than $30k per week. In total, their numbers were like this (for 5.5 stores),

Gross Sales $605k
Net Sales $400k (i.e. after ingredient cost)
Labor -166k (even running very few shifts)
Transport costs -$167k (drivers, gas, etc)
Back Office -$59k
Other Ops Costs -$72k
Royalties -$33k

Net cash flow -$91k

And this is without paying their rent or truck lease costs (since they were in bankruptcy)!

No surprise that all remaining Freedom Rings stores were shut down immedately after this reporting period. Running these numbers with estimates for truck lease costs, rent, and additioanl labor to handle more sales, gives me yet another estimate of franchise store break-even sales, about $55k per week.

Just a guess of course. But based on KKD's own filings, it's unlikely more than a tiny fraction of Krispy Kremes generate even that level of sales anymore.

[AvivaSimplex]

Interesting post. Running those numbers without changing the labor, transport, etc. costs, I get a break-even of $36k per week. Do you really think those changes, plus rent and truck lease costs, add up to $14k per week? [(55-36) * 2/3]

Also, keep in mind that since this was the franchise that went bankrupt, it likely had higher fixed costs than other franchises.

Lastly, KKD doesn't need its franchises to be profitable over the next 2 years or so. It just needs them not to go bankrupt, so they can keep buying ingredients and paying royalties. Without profitable franchises it certainly won't grow, but it also won't crater like you're hoping.

[gmandan]

I'm just curious, but how much of your portfolio does this bet represent? You mentioned earlier that you were planning on positioning no more than 5% of your total portfolio value but it sounds like you've added to that position.

[DesertCat]

[ QUOTE ]
Interesting post. Running those numbers without changing the labor, transport, etc. costs, I get a break-even of $36k per week. Do you really think those changes, plus rent and truck lease costs, add up to $14k per week? [(55-36) * 2/3]

Also, keep in mind that since this was the franchise that went bankrupt, it likely had higher fixed costs than other franchises.

Lastly, KKD doesn't need its franchises to be profitable over the next 2 years or so. It just needs them not to go bankrupt, so they can keep buying ingredients and paying royalties. Without profitable franchises it certainly won't grow, but it also won't crater like you're hoping.

[/ QUOTE ]

Transport costs, which is maintenance and gas, was $1k per week per store. My guess was that truck leases were 3x that, or $3k per store/week. I used $2 per SF per month for an average 4000 SF store, which works out to $2k per store/week. Lastly, I assumed store labor costs doubled when sales doubled.

I was probably way too aggressive on truck costs. I might be aggressive on how much the store labor costs increased to double sales, but note I didn't increase transporation labor and other costs at all to transport twice as much product, so that's probably a wash. Lowering truck lease to equal maintaince/gas charges lowers our break-even to around $50k per store/week. Note that the average KKD store is well below $50k per week now.

Freedom Rings went bankrupt, but so have many others already (Canada, Midwest, New England, and Houston gave up their franchises, they would rather run the stores under another brand name), and the remaining franchises aren't in much better shape. In the grand scheme, franchise revenues are declining rapidly. The franchise owners can't keep stores that are cash sinks open forever.

But since franchises were the smallest of their three legs of cash flow, you'd think they could survive less franchise revenues. But now they can't sell any more equipment (which had higher margins than ingredients), and total revenues are down 20%+, so KKM&D's (equipment and ingredients) cash flow contributions are declining rapidly as well.

What really matters is the company stores, they were the largest source of cash flow. But their sales are declining to the break-even levels as well, so they certainly can't contribute $80M a year in free cash flow anymore. My theory is they are now at break-even and contributing nothing. If it is, I don't believe franchises and KKM&D can generate enough cash flow to pay reasonable G&A + debt payments.

The final straw would be their lenders giving up. All of KKD's assets secured their last group of loans, and it was a syndicate. A couple more lenders pull out of the syndicate and KKD will be out of cash. Even now the lenders should have an itchy trigger finger to protect the remaining assets.

Specifically KKD is also guaranteed a good deal of franchise debt, that's why they were forced to take over the Freedom Rings franchises. So every franchise that folds potentially increases their cash burn as they are forced to settle guarantees. I'm betting more fold, KKD runs low on cash, their lenders refuse KKD more rope, forcing a Ch. 11 where the lenders take over the business.

[DesertCat]

[ QUOTE ]
I'm just curious, but how much of your portfolio does this bet represent? You mentioned earlier that you were planning on positioning no more than 5% of your total portfolio value but it sounds like you've added to that position.

[/ QUOTE ]

It's still less than 5%.

[Sniper]

Stock moving up after this filing

[DesertCat]

[ QUOTE ]
Stock moving up after this filing

[/ QUOTE ]

It's kindof interesting, since this news has been out a couple of weeks I'm not sure why it's moving the stock today (I'm down thousands! oh no! sell! sell! <sobs&gt.

But it's a good example of what could hurt my thesis. They are getting $10M in cash from selling these franchises, though they have to loan $3M of it back. The UK "rumour" is another example of them selling franchises to raise cash. If they raise enough cash this way, it would postpone the day of reckoning and I'll start having options expire as worthless.

I still think the market will be shocked by how bad their financials are once they release them this month (or if they miss the date), and that alone will give me a profit on my short dated options.

[mother_brain]

I missed it somewhere, what is the filing date? By the 14th?

[Mr. Now]

Mr. Now observes that the number of shares KDD shares short is such that very few shares are available for shorting, perhaps absolutely none.

Mr. Now also notices that KKD is exhibiting remarkable relative strength in the face of falling indexes today, 04/07/2006.

This leads Mr. Now to question the wisdom of attempting to benefit from what appear to be poor fundamentals.

With so many shorts involved in this instrument, Mr. Now wonders if there are actually any potential sellers remaining who really are ready, willing and able to actively sell this stock.

He also wonders what shorts will be forced to do, and to what extent they may do so collectively, as a crowd, if and when they reach their "collective uncle point".

Mr. Now wonders out loud, asking himself if a stock price of $9.90 or $10.05 might be just enough to send the shorts into absolute panic mode.

With so many shares short, just a few variables need to change to create conditions that are right for predictable crowd behavior to be made manifest in KKD.