Krispy Kreme Doughnuts, Inc.

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Krispy Kreme Doughnuts, as discussed in Darden Business Publishing Case UVA-F-1479, appears to be at a crossroads. After years of astronomical growth, the company find its share price plummeting in the midst of discoveries about faulty accounting practices. The following paper examines several issues behind the sudden decline First, the historical income statements and balance sheets are examined to determine the financial health and current condition of the company. This is followed by an analysis of key financial ratios across time and versus industry standards. Next, the paper addresses if Krispy Kreme is financially healthy at year-end 2003 and, if so, what accounts for the firm’s recent share price decline. The paper concludes with a discussion of the intrinsic investment value in the company.

Income Statement and Balance Sheets
Close review of the income statement leads to some noteworthy conclusions. The first quarterly column of the 2004 income statement shows that the company gained thirty-four million dollars in discontinued operations from the sale of the Montana Mills venture. In the same quarter the firm lost approximately twenty-four million dollars. It is likely that this maneuver was made to deflect attention from or make up for the company’s poor performance and mounting losses. Generally, this is not a sign of a healthy company but rather signals an alarm since the loss in that quarter was closer to fifty-eight million dollars when not considering the sale. Krispy Kreme may have been struggling to make ends meet through its operations, and perhaps the company hoped to make up lost income through the sale of a venture. Furthermore, operating expenses were increasing while net income was decreasing. In May 2004, the company had seven million dollars in closing costs and still showed losses. An aggressive expansion strategy did not result in enough income to cover these costs. Additionally, quarterly comps decreased dramatically. From May 2003 to May 2004, operating income dropped from $23,702 million to $18,636 million. This decrease is even more pronounced when examining the quarters ending in August. Krispy Kreme’s balance sheet is no less indicative of poor financial health, particularly with a substantial increase in year over year long-term liability figures. The two major contributors to this increase in long-term liabilities include Krispy Kreme’s revolving lines of credit and its long-term debt. First, the revolving lines of credit greatly increased from nothing in fiscal year 2002 to eighty-seven million dollars in fiscal year 2004, demonstrating a burgeoning dependence by Krispy Kreme on outside finance to support operations. Second, long-term debt increased from 3,912 million in 2002 to 48,056 million in 2004. This anomalous and significant increase in long term debt could mean that Krispy Kreme is having trouble paying off its debt. After analyzing both the income statement and balance sheet an initial assumption can me made that Krispy Kreme does not appear to be financially healthy. The next step of understanding this case is to determine how financial ratios extend our understanding of the abovel statements.

Financial Ratios
The following financial ratios were analyzed: quick ratio, current ratio, return on assets, return on equity, net profit margin, receivables turnover, inventory turnover, asset turnover, cash turnover, debt-to-equity, and times interest earned. These ratios are included in a time series (Case Exhibit 7) raise and in a cross-sectional chart of quick-service restaurants (Case Exhibit 8). To begin, the time series ratios are detailed in Figure 1. Starting with the liquidity ratios we noticed some significance in the changes of the current ratio. The increases in the current ratio in 2003 and 2004 signal that Krispy Kreme is borrowing over the long term, not the short term, resulting in an increase of cash affecting assets. The current...
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