Krispy Kreme Doughnuts, Inc.
FNCE 4620 - Financial Analysis and Policy
Table of Contents
1. Executive Summary
2. Problem Statement
3. Data Analysis
4. Key Decision Criteria
5. Alternatives Analysis
7. Action and Implementation Plan
1. Executive Summary:
Krispy Kreme Doughnuts was a successful privately owned business since 1937. In 1982 a group of franchises bought back the company from Beatrice Foods for $24 million, and reintroduced the old recipe of doughnuts and their “hot doughnuts now” system. In 1998 Scott Livengood became Krispy Kreme’s new CEO and took the company public in April of 2000 with one of the biggest IPO’s in recent years. This led to a high share price and a market capitalization of nearly $500 million.
2. Problem Statement:
The problem was Krispy Kreme Doughnut’s (KKD) aggressive strategy of tripling their stores in 5 years after the company just went public in an attempt to impress investors. This is a problem because their franchises began to lose profits, and KKD adjusted their accounting practices in order to tempt investors into thinking the company was better well off.
3. Data Analysis
These issues arose from the number of new franchise openings caused by their over aggressive strategy to expand. This made new franchises open in areas that were not suitable for this type of business. KKD’s opening of new franchises quickly caused the new store managers to have little knowledge of operating their off-premises business which accounts for 40% of their total revenue. KKD shifted their focus from relying on on-premises sales where the customer could watch the doughnut be made to factory stores shipping pre-cooked doughnuts to franchises for them to reheat and sell. Off-premises sales to grocery stores, domestic retail locations, and as private label also accounted for KKD’s revenues. KKD charged high fees for equipment and ingredients to their franchises in order to gain a higher profit and to promote growth. The reacquisition of franchises led to the accounting problem highly stating intangibles with no amortization.
KKD negotiated to repurchase a 7 store struggling franchise in Michigan due to the franchise owing several million dollars in fees and equipment. Consequently KKD recorded the interest paid by the franchisee as interest income meaning an immediate profit. However KKD booked the purchase cost of the franchise as an intangible asset and did not amortize it. This caused the SEC investigation related to “franchise reacquisition and the company’s previously announced reduction in earnings guidance.”
The people affected most by this problem were the shareholders and the future well being of KKD. Franchises were also affected by having to pay high fees and then having to suffer low revenues and not covering cost. Low product diversification and a highly competitive market caused KKD to charge these higher fees and compete more aggressively.
From the Balance Sheet, we can say that property and equipment grew rapidly due to the amount of new franchise openings. Their long term investments dropped to zero in three years due to the change in focus to short term investments which grew adversely. Accounts receivables increased steadily from 2001-04, this shows trouble in receiving money back from the new franchises it financed. Finally, goodwill and intangibles increased greatly between 2002 and 2004 because of the reacquisition of struggling franchises.
On the Income Statement, depreciation and amortization expenses were understated to show a higher net income than what really existed. The income statement appears greater to investors causing them to not see the potential problems of KKD’s improper accounting practices.
From Exhibit 3, large and steady...