Krispy Kreme

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Krispy Kreme Doughnuts

Question 1: Analysts are predicting that Krispy Kreme will be able to perform highly effectively and continue to grow rapidly in the coming two years. Do you agree with their analysis? If so, why? If not, why not?

Key factors underlying growth:
1. Brand based on high quality product, highly differentiated products, high-volume production 2. Fragmented (regional) competition with less brand recognition 3. Strong opportunities to extend network of stores geographically. 4. Great steps to insure customer satisfaction from the use of their proprietary flour recipe to their automated doughnut making machines.

Question 2: What factors did the CIBC analysts examine to forecast sales growth for KKD in the years ended January 2003 and 2004? What assumptions did they implicitly make about number of new stores and weekly sales per store (for both company and franchise stores)? What are their implicit assumptions about revenue growth from franchise operations and KKM&D? Do you agree with these forecasts?

Revenue Forecasts
The CIBC analysts’ forecasts were constructed using per store information. * Company plans to add 62 new stores in 2003, mostly through area developers. * Revenues per new store: Initial boom, followed by leveling off. Also, not all new stores are open for full year. * Revenue growth per new store has been impressive. Franchise store revenue growth is still high, as the number of area developers’ increase, with store revenue patterns comparable to company stores. This is likely to persist for several years until revenues per store are similar for company and franchise stores. * Royalty revenues have been increasing over time since area developers pay higher royalty rates than old associates (5.5% versus 3%).

Question 3: What are the NOPAT margins that the CIBC analysts have forecasted for KKD for the years ended January 2003 and 2004? What assumptions were made about specific expense items (e.g. margins, G&A, D&A, taxes)? Do you agree with these forecasts?

1. Forecast Gross Profits per Store
These vary greatly by business. For company stores they have increased to 18%. Royalty income has a65% margin, and KKM&D is 17%. The CIBC analysts have forecasted that margins increase to 19%for company stores, 70% for franchise operations, and 18-19% for KKM&D.

2. Forecast Other Costs
G&A and Depreciation costs have averaged 9% of sales for the last three years. The CIBC analysts show this 9% declining marginally in 2004 to 8.74%. In addition, minority interest (presumably in franchisees) has been around 0.3% of the franchise revenues for the last two years.

3. Forecast Interest Expense
This requires assumptions to be made about the firm’s capital structure. The beginning capital structure is given, and shows that the company has negative net debt of $20 million. This arises from the prior year’s decision to raise new equity to meet future growth plans. This implies that it will probably drawdown cash for the next year. It seems reasonable to assume that the company expects to draw down its cash ($37 million in Feb. 2002) almost completely to finance its growth. This would imply that net debt would be close to zero in one year’s time, leaving no interest income or expense.

4. Forecast Tax Rate
Rate has been around 38%.
Summary of full effect:

| FEB. 3,| FEB. 3,|
 | 2003| 2004|
| | |
Company Revenues| | |
Company Stores| $302,250| $332,163|
Franchise Operations (4% of franchise sales)| 21,403| 31,975| KKM&D (32% of franchise sales)| 171,226| 255,798|
Revenues| $494,879| $619,936|
Gross Profit| | |
Company Stores (18%)| $54,405| $59,789|
Franchise Operations (65%)| $13,912| $20,784|
KKM&D (17%)| $29,108| $43,486|
| $97,425| $124,059|
Other Expenses (9% of sales)| $44,539| $55,794|
Minority Interest (0.3% of franchise sales)| $1,605|...
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