Case Study: Krispy Kreme

Memorandum To: Investors of Krispy Kreme Doughnuts From: Financial consultant Date: January 2005 Subject: Warning signals from Krispy Kreme Doughnuts Historical income statements show that the revenues and net income increased continuously from 2000 to 2004. The first warning signal observed was net loss in May 2004. By comparing income statement in May 2003 with income statement in May 2004, the revenue increased 24 percent, but net income appeared negative. Krispy Kreme spent $40 million in acquiring Montana Mills in 2003. Montana Mills was closed down in mid-2004. It causes around $35 million to be recorded as discontinued operation in the income statement. Therefore, the negative net income is produced. Additionally, we may find that Krispy Kreme uses equity method to record joint venture losses. So, total equity loss in joint ventures is around $5.1 million over the four years period. This method of recording loss cannot directly affect financial stability of Krispy Kreme. Therefore, there are some unstable factors in the financial position of Krispy Kreme. In the historical balance sheets, we can observe that intangible assets were improved hugely from 2002 to 2004. Krispy Kreme set up repurchase of franchise rights. Repurchase of franchise rights are recognized as intangible assets not subject to amortization. Additionally, we cannot find the bad debt account because the company records overdue repurchase of franchise rights as intangible asset to avoiding a bad debt loss. Over last four years period, inventories increased continuously. The growth of inventory implies that Krispy Kreme cannot effectively deal with control of stock. This position can restrain cash flow and the company is likely to face a lack of fund. Cash decreased from 2003 to 2004. The growth of account receivable indicates that the company is difficult to control collection of receivables. During 2002-2004 year period, the long-term liabilities increased. This kind of