Krispy Kreme

Krispy Kreme Doughnuts, Inc. FIN Professor XXX XXXX Month xx, xxxx History Krispy Kreme was founded by Vernon Rudolph after he purchased the famous secret recipe of yeast-raised doughnuts in 1937 from a French chef in New Orleans. Rudolph began to sell these doughnuts wholesale to supermarkets. The demand for his doughnuts grew quickly, and by cutting a hole in the wall of the factory to sell directly to customers the concept of Krispy Kreme retail stores was born. The retail concept for Krispy Kreme doughnuts allowed Rudolph to grow his factory stores to 29 shops in 12 states by the late 1950’s.When Rudolph died in 973 Beatrice Foods bought his company and expanded it to more than 100 locations and expanded the menu to include soups and sandwiches. Beatrice tried to reduce costs by changing the appearance of the stores and using cheaper ingredients. This negatively affected the company and Beatrice sold the company to a group of franchise owners. This group of owners was led by Joseph McAleer, who was the first Krispy Kreme franchisee. The leveraged buyout was completed for $24 million in 1982. The new group brought back the original recipe and logo.By 1989 the group was almost debt free and they were beginning to expand. The company CEO, Scott Livengood, took the company public in April of 2000. The share price after the first day was $40. 63. Holes in Doughnut Accounting Practices In May of 2004 Krispy Kreme announced to its investors that they should expect earnings to be 10% lower than predicted. It was at this time that the low-carb diet had taken the U. S by storm, and Krispy Kreme blamed this low-carb diet for their low wholesale and retail sales.They also announced the sales of a the Montana Mills bakery chain of 28 bakery cafe’s that had been acquired in January of 2003 for $40 million in stock. Krispy Kreme also announced that the Hot Doughnut and Coffee Shops were falling short of expectations and three of them were closing at a cost o f $7 to $8 million. Krispy Kreme (KKD) stock price closed down 30% that day. Shortly after on May 25th, 2004 when the Wall Street Journal published a story about how Krispy Kreme handled is accounting for franchise acquisitions.According to the article Krispy Kreme recorded the interest paid by the franchisee as interest income for immediate profit, except that Krispy Kreme booked the purchase cost of the franchise as an intangible asset and did not amortize it. In the repurchase agreement of the 7 stores in Michigan, they allowed one of the franchises top executives to stay on with the company after the repurchase. This executive left the company shortly after closing the deal, and had to pay him $5 million in severance which Krispy Kreme also rolled into the unamortized-asset category. Krispy Kreme claimed it followed GAAP standards and had done nothing wrong.The final shoe to drop as on July 29th, 2004 when Krispy Kreme announced that the Securities and Exchange Commission (SEC) had launched an informal investigation related to â€Å"franchise reacquisitions and the company’s previously announced reduction in earning guidance†. Krispy Kreme (KK) shares fell another 15%. The revelations about the companies accounting practices and showing interest as immediate income and not amortizing the repurchased franchises but rather showing them as intangible assets alone could justify the devaluation of their stock price by approx. 45%.Couple their earnings decline and the announcement of store closings and it easily can be justified. Couple that with the fear of the unknown. If Krispy Kreme was treating their interest and reacquired franchises as they were which seems to be blatantly wrong, what else might the SEC find during their investigation? This fear would certainly drive investors away and their share price down. The facts along with its ratings being dropped by 50% of analysts to â€Å"Hold† from â€Å"buy† a few months earlier. K rispy Kreme Deep Fried and Possible Deeper Issues Krispy Kreme grew incredibly quickly in the years leading up to the nvestigation (as shown in the chart below) and then may have tried to meet Wall Street expectations through some questionable practices such as shipping more product or pulling ahead product orders, then allowing the orders to be returned shortly after for credit. â€Å"Testimony by a former sales manager at a Krispy Kreme outlet in Ohio, said a regional manager ordered that retail store customers be sent double orders on the last Friday and Saturday of the 2004 fiscal year, explaining â€Å"that Krispy Kreme wanted to boost the sales for the fiscal year in order to meet Wall Street projections. The witness said the manager explained that the doughnuts would be returned for credit the following week – once fiscal 2005 was under way† (Chin, 2005). It seems pretty clear that Krispy Kreme was using questionable methods to inflate profits. Investors also l ater found out that Scott Livengood (CEO), the former COO John W. Tate, and the former CFO Randy Casstevens, â€Å"unloaded more than 475,000 shares of Krispy Kreme stock for proceeds of $19. 8 Million†, (Chin, 2005) while they were fully aware sales were declining since January of 2003.During this investigation, Scott Livengood, Krispy Kreme’s CEO announced his retirement. It would seem to me that there may be some deeper issues with Krispy Kreme and if I were a shareholder I would want out, or to be certain that Krispy Kreme’s accounting mess was cleaned up. The chart below shows Krispy Kreme’s performance during the years leading up to the investigation. Krispy Kreme Re-made Fresh Today Krispy Kreme’s stock has not fully recovered, (see chart below), but as of the end of 2012 Krispy Kreme seems to have made a comeback. â€Å"Krispy Kreme Doughnuts, Inc. Krispy Kreme) is a retailer and wholesaler of doughnuts complementary beverages and treats a nd packaged sweets. The Company’s principal business is owning and franchising Krispy Kreme stores, at which a variety of doughnuts, including the Company’s Original Glazed doughnut, are sold and distributed together with complementary products, and where a broad array of coffees and other beverages are offered. As of January 29, 2012, there were 234 Krispy Kreme stores operated domestically in 38 states and in the District of Columbia, and there were 460 shops in 20 other countries around the world.Of the 694 total stores, 292 were factory stores and 402 were satellites. The Company operates in four segments: Company Stores, domestic franchise stores, international franchise stores, and the KK Supply Chain† (â€Å"Krispy Kreme Doughnuts†). As of close of business on Friday last week KKD traded at $14. 80, way below its heyday when the stock traded in the $40’s but it is double its all-time low. Krispy Kreme doughnuts (KKD as of March 22, 2013 When compared to its competitors Krispy Kreme’s P/E is 49. 33. This is much higher than the others but its P/S is in the middle.Krispy Kreme’s competitors are listed as Dunkin’ Brands Group, Einstein Noah restaurant Group, and Starbuck Corporation. Below is the direct competitor comparison. Direct Competitor Comparison| | | KKD| DNKN| BAGL| SBUX| Industry| Market Cap:| 989. 57M| 3. 94B| 253. 09M| 42. 99B| 384. 28M| Employees:| N/A| 1,104| 6,912| 160,000| 10. 87K| Qtrly Rev Growth (yoy):| 0. 16| -0. 04| -0. 04| 0. 11| 0. 30| Revenue (ttm): | 435. 84M| 658. 18M| 427. 01M| 13. 66B| 453. 84M| Gross Margin (ttm):| 0. 17| 0. 79| 0. 21| 0. 57| 0. 31| EBITDA (ttm):| 47. 93M| 304. 86M| 48. 46M| 2. 46B| 47. 5M| Operating Margin (ttm): | 0. 09| 0. 38| 0. 07| 0. 14| 0. 07| Net Income (ttm):| 20. 78M| 108. 18M| 12. 74M| 1. 43B| N/A| EPS (ttm):| 0. 30| 0. 93| 0. 74| 1. 86| 0. 78| P/E (ttm):| 49. 33| 39. 95| 20. 01| 30. 87| 29. 99| PEG (5 yr expected):| 1. 02| 1. 58| 0. 98| 1. 43| 1. 50| P/S (ttm):| 2. 24| 5. 96| 0. 59| 3. 13| 1. 04| | | | | Suggestions for a Krisp/Klean Future Making Doughnuts I three things I might suggest if I were the CFO for Krispy Kreme doughnuts would be to insure open communication with investors and insure them that internal auditing systems are in place.I’m sure that investors lost all trust in the previous management because of the questionable practices that were followed. Krispy Kreme needs to rebuild that trust by having open lines of communication with its investors. I would take a serious look at closing unprofitable stores, and research other markets to open more stores. Some areas may still be underperforming while others are booming. Concentrate on the areas that show better potential and take advantage of that market while it is supporting growth. Because their competitors seem to offer expanded menus I would concentrate on healthy choices for the lunchtime crowd.Everyone is aware of Krispy Kreme’s doughnuts, but I’m not so sure their other menu items are well known as an option for lunch/brunch. Other than the morning rush for doughnuts, they could make their stores more profitable with being the †go toâ€Å" spot for lunch also. References Chin, N. (2005). Krispy Kreme Dougnuts: Empty calories or empty profits? Retrieved from http://www. corporateconflicts. com/index-sb-cases-kk. html Krispy kreme doughnuts. (n. d. ). Retrieved from http://www. google. com/finance? client=ob&q=NYSE:KKD Krispy Kreme Krispy Kreme Doughnuts, Inc. FIN Professor XXX XXXX Month xx, xxxx History Krispy Kreme was founded by Vernon Rudolph after he purchased the famous secret recipe of yeast-raised doughnuts in 1937 from a French chef in New Orleans. Rudolph began to sell these doughnuts wholesale to supermarkets. The demand for his doughnuts grew quickly, and by cutting a hole in the wall of the factory to sell directly to customers the concept of Krispy Kreme retail stores was born. The retail concept for Krispy Kreme doughnuts allowed Rudolph to grow his factory stores to 29 shops in 12 states by the late 1950’s.When Rudolph died in 973 Beatrice Foods bought his company and expanded it to more than 100 locations and expanded the menu to include soups and sandwiches. Beatrice tried to reduce costs by changing the appearance of the stores and using cheaper ingredients. This negatively affected the company and Beatrice sold the company to a group of franchise owners. This group of owners was led by Joseph McAleer, who was the first Krispy Kreme franchisee. The leveraged buyout was completed for $24 million in 1982. The new group brought back the original recipe and logo.By 1989 the group was almost debt free and they were beginning to expand. The company CEO, Scott Livengood, took the company public in April of 2000. The share price after the first day was $40. 63. Holes in Doughnut Accounting Practices In May of 2004 Krispy Kreme announced to its investors that they should expect earnings to be 10% lower than predicted. It was at this time that the low-carb diet had taken the U. S by storm, and Krispy Kreme blamed this low-carb diet for their low wholesale and retail sales.They also announced the sales of a the Montana Mills bakery chain of 28 bakery cafe’s that had been acquired in January of 2003 for $40 million in stock. Krispy Kreme also announced that the Hot Doughnut and Coffee Shops were falling short of expectations and three of them were closing at a cost o f $7 to $8 million. Krispy Kreme (KKD) stock price closed down 30% that day. Shortly after on May 25th, 2004 when the Wall Street Journal published a story about how Krispy Kreme handled is accounting for franchise acquisitions.According to the article Krispy Kreme recorded the interest paid by the franchisee as interest income for immediate profit, except that Krispy Kreme booked the purchase cost of the franchise as an intangible asset and did not amortize it. In the repurchase agreement of the 7 stores in Michigan, they allowed one of the franchises top executives to stay on with the company after the repurchase. This executive left the company shortly after closing the deal, and had to pay him $5 million in severance which Krispy Kreme also rolled into the unamortized-asset category. Krispy Kreme claimed it followed GAAP standards and had done nothing wrong.The final shoe to drop as on July 29th, 2004 when Krispy Kreme announced that the Securities and Exchange Commission (SEC) had launched an informal investigation related to â€Å"franchise reacquisitions and the company’s previously announced reduction in earning guidance†. Krispy Kreme (KK) shares fell another 15%. The revelations about the companies accounting practices and showing interest as immediate income and not amortizing the repurchased franchises but rather showing them as intangible assets alone could justify the devaluation of their stock price by approx. 45%.Couple their earnings decline and the announcement of store closings and it easily can be justified. Couple that with the fear of the unknown. If Krispy Kreme was treating their interest and reacquired franchises as they were which seems to be blatantly wrong, what else might the SEC find during their investigation? This fear would certainly drive investors away and their share price down. The facts along with its ratings being dropped by 50% of analysts to â€Å"Hold† from â€Å"buy† a few months earlier. K rispy Kreme Deep Fried and Possible Deeper Issues Krispy Kreme grew incredibly quickly in the years leading up to the nvestigation (as shown in the chart below) and then may have tried to meet Wall Street expectations through some questionable practices such as shipping more product or pulling ahead product orders, then allowing the orders to be returned shortly after for credit. â€Å"Testimony by a former sales manager at a Krispy Kreme outlet in Ohio, said a regional manager ordered that retail store customers be sent double orders on the last Friday and Saturday of the 2004 fiscal year, explaining â€Å"that Krispy Kreme wanted to boost the sales for the fiscal year in order to meet Wall Street projections. The witness said the manager explained that the doughnuts would be returned for credit the following week – once fiscal 2005 was under way† (Chin, 2005). It seems pretty clear that Krispy Kreme was using questionable methods to inflate profits. Investors also l ater found out that Scott Livengood (CEO), the former COO John W. Tate, and the former CFO Randy Casstevens, â€Å"unloaded more than 475,000 shares of Krispy Kreme stock for proceeds of $19. 8 Million†, (Chin, 2005) while they were fully aware sales were declining since January of 2003.During this investigation, Scott Livengood, Krispy Kreme’s CEO announced his retirement. It would seem to me that there may be some deeper issues with Krispy Kreme and if I were a shareholder I would want out, or to be certain that Krispy Kreme’s accounting mess was cleaned up. The chart below shows Krispy Kreme’s performance during the years leading up to the investigation. Krispy Kreme Re-made Fresh Today Krispy Kreme’s stock has not fully recovered, (see chart below), but as of the end of 2012 Krispy Kreme seems to have made a comeback. â€Å"Krispy Kreme Doughnuts, Inc. Krispy Kreme) is a retailer and wholesaler of doughnuts complementary beverages and treats a nd packaged sweets. The Company’s principal business is owning and franchising Krispy Kreme stores, at which a variety of doughnuts, including the Company’s Original Glazed doughnut, are sold and distributed together with complementary products, and where a broad array of coffees and other beverages are offered. As of January 29, 2012, there were 234 Krispy Kreme stores operated domestically in 38 states and in the District of Columbia, and there were 460 shops in 20 other countries around the world.Of the 694 total stores, 292 were factory stores and 402 were satellites. The Company operates in four segments: Company Stores, domestic franchise stores, international franchise stores, and the KK Supply Chain† (â€Å"Krispy Kreme Doughnuts†). As of close of business on Friday last week KKD traded at $14. 80, way below its heyday when the stock traded in the $40’s but it is double its all-time low. Krispy Kreme doughnuts (KKD as of March 22, 2013 When compared to its competitors Krispy Kreme’s P/E is 49. 33. This is much higher than the others but its P/S is in the middle.Krispy Kreme’s competitors are listed as Dunkin’ Brands Group, Einstein Noah restaurant Group, and Starbuck Corporation. Below is the direct competitor comparison. Direct Competitor Comparison| | | KKD| DNKN| BAGL| SBUX| Industry| Market Cap:| 989. 57M| 3. 94B| 253. 09M| 42. 99B| 384. 28M| Employees:| N/A| 1,104| 6,912| 160,000| 10. 87K| Qtrly Rev Growth (yoy):| 0. 16| -0. 04| -0. 04| 0. 11| 0. 30| Revenue (ttm): | 435. 84M| 658. 18M| 427. 01M| 13. 66B| 453. 84M| Gross Margin (ttm):| 0. 17| 0. 79| 0. 21| 0. 57| 0. 31| EBITDA (ttm):| 47. 93M| 304. 86M| 48. 46M| 2. 46B| 47. 5M| Operating Margin (ttm): | 0. 09| 0. 38| 0. 07| 0. 14| 0. 07| Net Income (ttm):| 20. 78M| 108. 18M| 12. 74M| 1. 43B| N/A| EPS (ttm):| 0. 30| 0. 93| 0. 74| 1. 86| 0. 78| P/E (ttm):| 49. 33| 39. 95| 20. 01| 30. 87| 29. 99| PEG (5 yr expected):| 1. 02| 1. 58| 0. 98| 1. 43| 1. 50| P/S (ttm):| 2. 24| 5. 96| 0. 59| 3. 13| 1. 04| | | | | Suggestions for a Krisp/Klean Future Making Doughnuts I three things I might suggest if I were the CFO for Krispy Kreme doughnuts would be to insure open communication with investors and insure them that internal auditing systems are in place.I’m sure that investors lost all trust in the previous management because of the questionable practices that were followed. Krispy Kreme needs to rebuild that trust by having open lines of communication with its investors. I would take a serious look at closing unprofitable stores, and research other markets to open more stores. Some areas may still be underperforming while others are booming. Concentrate on the areas that show better potential and take advantage of that market while it is supporting growth. Because their competitors seem to offer expanded menus I would concentrate on healthy choices for the lunchtime crowd.Everyone is aware of Krispy Kreme’s doughnuts, but I’m not so sure their other menu items are well known as an option for lunch/brunch. Other than the morning rush for doughnuts, they could make their stores more profitable with being the †go toâ€Å" spot for lunch also. References Chin, N. (2005). Krispy Kreme Dougnuts: Empty calories or empty profits? Retrieved from http://www. corporateconflicts. com/index-sb-cases-kk. html Krispy kreme doughnuts. (n. d. ). Retrieved from http://www. google. com/finance? client=ob&q=NYSE:KKD Krispy Kreme INTRODUCTION First, I will discuss the environment of Krispy Kreme and my analysis as to what led to the company’s position in 2004. Second, I will discuss the financial health and current condition based upon the historical income statements and balance sheets. Third, I will discuss the financial ratios in relation to the financial statements. Fourth, I will discuss if Krispy Kreme was financially healthy at the end of 2004. Fifth, I will discuss my assessment of Krispy Kreme’s health and why I think the stock price dropped by 80% between 2003 and 2004.Sixth, I will discuss why I think the market reacted so negatively to the disclosures about adverse results and the revelations in the Wall Street Journal regarding the firm’s accounting methods for the franchise rights. Lastly, I will provide my recommendations for turning around Krispy Kreme Doughnuts’ business. COMPANY POSITION Krispy Kreme Doughnuts started small by selling directly to grocery stores. T heir doughnuts became so popular they began selling directly to customers. They sold a delicious doughnut and a viewing experience.When Beatrice Foods bought the company, her business model did not succeed because it expanded the product line in the opposite direction of what consumers wanted and she inputted cheap ingredients into a popular recipe which sacrificed taste. When she sold the company to the group of franchisees, it pushed the company back into a positive direction by bringing back the original recipe. Krispy Kreme was debt-free by 1989 and their IPO left them with a market capitalization of nearly $500 million in 2000.They appeared to be on the right track but, it seemed they were expanding too rapidly. They allowed franchisees to place their stores in locations that were not favorable, resulting in the franchises not doing well enough and owing Krispy Kreme Doughnuts millions. Krispy Kreme relied on the income from franchised stores purchases of equipment and mixes to o much. They also had their product in too many locations, creating an increase of supply and a decrease in demand. HISTORICAL FINANCIAL STATEMENT ANALYSISOn further analysis of the historical income statement, it seems that Krispy Kreme Doughnuts’ operating expenses are increasing gradually every year and are over 75% of total revenues for each year. The only income statement item that has decreased significantly was interest income from 2002 through 2004. Everything else seemed to point towards a profitably company because both gross profit and net income were increasing by at least 2% every year. On further analysis of the historical balance sheet there we some large red flag items.Property and equipment, net of depreciation was a significant portion of total assets each year. Most of the equipment they created was sold to franchisees and used in each company owned or franchisee owned factory stores. The significant amount on their balance sheet could have meant that they were manufacturing equipment faster than they were selling it to their franchises or due to the fact that they were expecting to expand, but were not able to expand to the extent they wanted to. As a percent of total assets, accounts receivable declined from 17% in 2000 to 7 % in 2004.Inventories were significantly increasing each year, but one would assume that some of their inventory would have to be written of due to the items expiration date (doughnuts can only last so long, so they appear to not be selling as much). Reacquired franchise rights, goodwill and other intangibles significantly increased starting in 2002, and every year after that. It rose in those years to be close to one third (30%) of total assets, which was the biggest item percentage wise other than property and equipment. The most significant item on the liabilities and shareholders’ equity section of the balance sheet is common stock.Every year common stock was close to 50% of total liabilities and shar eholders’ equity. In my opinion, Krispy Kreme Doughnuts, recognized they were in trouble with the increasing failures of franchises and kept issuing more stock in hopes to bail themselves out. FINANCIAL RATIO ANALYSIS In exhibit seven the time series of the ratios raise one specific question. The inventory turnover raises the question as to why it was taking longer for their inventory to sell. When converted to days, the ratio determined that their inventory took over twenty-three days to turnover in 2003.It seems that Krispy Kreme Doughnuts’ inventory was over saturated in the market. With an abundance in supply, it seems that their doughnuts were not as in demand. When comparing Krispy Kreme Doughnuts’ financial ratios to others in the industry, I determined that Krispy Kreme was doing better in some areas than those in the industry such as with their liquidity ratios. Krispy Kreme’s liquidity ratios were significantly higher than any company in its ind ustry. In other areas, such as profitability ratios, Krispy Kreme was about average compared to other companies.Krispy Kreme’s activity ratios were significantly lower than any other company in its industry, meaning their assets are not turning over as much as other companies. In such an industry, product seems to move fast, which further supports my notion that their product was becoming less popular due to the saturated market. It seems a lot more companies in this industry support operations with debt rather than capital, Krispy Kreme was doing the opposite. Exhibit nine supports this position because no other company had a significant amount of shareholders’ equity like Krispy Kreme.Other companies were better able to handle their operating expenses keeping them closer to 50% of net sales, unlike Krispy Kreme who kept theirs closer to 75%, but Krispy Kreme also had a higher percent of net sales in relation to operating profit and profit before taxes. FINANCIALLY HE ALTHY AT YEAR END 2004? In my opinion, Krispy Kreme Doughnuts is not completely healthy at the financial year end of 2004. Their income statement shows an increased net income from the year before, but I believe that increase can only last so long.With the inability to expand further, and current operations decreasing more than they are making, I do not expect their net income to increase by year end 2005. Everything on their balance sheet is increasing, including their inventory. They need to realize that they are simply not selling product. Although their debt is low, that is from the increasing stockholders’ equity in the form of stocks. With the outlook of the company not good, they cannot expect to support their operations with the issuance of new stock. They need to find a new way to finance their operations and ecrease their operating costs. STOCK PRICE DECREASE AND NEGATIVE MARKET REACTION In my opinion investors recognized the same warning signs that I did when analy zing Krispy Kreme Doughnuts’ financial statements and decided to drop their losses while they could still make some kind of profit selling off the stock. When Krispy Kreme announced to investors to expect earnings to be â€Å"10% lower than anticipated, claiming that the recent low-carbohydrate diet trend in the US had hurt wholesale and retail sales,† I think they further expected that something was not right with the picture they were portraying.The Wall Street Journal article, revealed an accounting practice that was not commonly followed by others in Krispy Kreme’s industry. When the SEC launched an informal investigation into the â€Å"franchise reacquisitions,† investors jumped ship as fast as they could. The significant decrease in stock from 2003 to 2004, was investors getting nervous and protecting themselves from their stock being worth near nothing. RECOMMENDATIONS In my opinion Krispy Kreme Doughnuts needs to make radical changes to the way it conducts business.I think they should completely stop off-premise sales, making their product only available in factory stores. This would hopefully decrease their inventory and decrease operating expenses related to the fleet of trucks that deliver product to grocery stores. Selling their product in factory stores only will hopefully recreate the demand for the doughnuts that there once was. I also believe that they should decrease the amount of franchises and refocus to company owned stores.Franchisees might not properly know how to pick a location or be properly trained, as seen with the increase of failing franchises. This would decrease the large amount on their balance sheet from reacquiring franchises. Focusing their business to one or two types of primary sources of income and reducing expenses would be a way to help lower market saturation of their product. Having more company owned factory stores, provides Krispy Kreme a chance to have more control over their operations a nd not depend on franchisees to make a profit for them.