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KKD released disappointing 1QF15 results after the close yesterday, hitting bottom line estimates but missing top line estimates by 335 bps.  The company also lowered its full-year adjusted EPS outlook from $0.73-0.79 per share to $0.69-0.74 per share due to unfavorable weather and higher than expected costs associated with ERP implementation and management succession.  “Severe winter weather” negatively impacted on-premises and wholesale sales throughout the company-owned unit base in the Southeast.

Despite the disappointing headlines, KKD continues to look quite healthy under the hood.  The stock’s reaction to the headline is far from surprising.  The stock trades at a premium valuation and continues to have its fair share of doubters, but we believe concerns are overdone.  The truth is, not much has changed to deter us from our bullish thesis.  KKD is still one of the best growth stories in the restaurant space and will continue to leverage its operating model by investing for the future and building out smaller, higher returning stores.  The company plans to grow units by +10% this year and, even with the guide down, adjusted EPS in the +13-21% range.  When the dust settles, we believe people will be willing to pay for this, even if the double-digit comp story has passed.  KKD still has a strong financial profile with compelling unit economics, strong FCF generation and impressive returns on incremental invested capital.

To touch a bit upon executive management succession, we have faith that incoming CEO Tony Thompson will build upon Morgan’s success.  Thompson was a well-respected executive at Papa John’s International, where he served as President and COO and played an instrumental role in the company’s technological innovation and success.  Former CEO James Morgan is transitioning to Executive Chairman and will remain very much involved with the company.

What we liked:

  • Tony Thompson’s first official day on the job as the new CEO and James Morgan’s first day as Executive Chairman.
  • System domestic same-store sales growth of +2.3%.
  • Franchise domestic same-store sales growth of +4.5%, versus expectations of +4.2%, despite a near +12% comp last year.
  • With the new guidance, KKD is still projected to grow adjusted EPS by13-21% in FY15.
  • Plan to grow system-wide store count +10% this year.
  • Continue to focus domestic growth on small factory shops.
  • Expect additional franchisee development announcements over the next several quarters.
  • Repurchased just over $25 million of stock during the quarter and remain committed to returning cash to shareholders through share buybacks.
  • Focused on driving top of mind awareness with the introduction of its ready-to-drink bottled coffee, bagged coffee and K-Cups.

What we didn’t like:

  • Total revenues missed street estimates by over $4 million or 3.35%.
  • Company owned domestic same-store sales decreased -1.5% versus expectations of +1.1%.
  • International franchise same-store sales decreased -2.2%.
  • Guiding down full year adjusted EPS by $0.04-0.05 due to disappointing 1Q performance, higher than anticipated ERP investment and higher than anticipated costs for executive management succession.
  • Wholesale channel revenues, exclusive of the effects of refranchising, decreased -1.6%.
  • Company owned operating income of $4.4 million, down from $5.3 million a year ago.

Howard Penney

Managing Director

Fred Masotta