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What can the historical income statements (case Exhibit 1) and balance sheets (case Exhibit 2) tell you about the financial health and current condition of Krispy Kreme Doughnuts, Inc.?

Krispy Kreme has experienced dramatic growth over the past 5 years based on their income statement. Every line on the income statement has grown rather impressively. Revenues have grown from $220M to $666M and net income has grown from $6M to $57M. Based on the income statement, Krispy Kreme is doing very well.

The balance sheet of Krispy Kreme looks very similar to the income statement. The majority of line items have experienced great growth. On the asset side of the balance sheet Krispy Kreme has eliminated their long-term investments and its tangible assets have increased from $0 to $176M. The increase of intangible assets was due to their aggressive accounting treatment for franchise acquisitions.

On the liabilities and equities side, the most noticeable aspect is the revolving line of credit spike in 2004. Revolving lines of credit are typically used to provide liquidity for a company s day-to-day operations so this is very concerning.

2. How can financial ratios extend your understanding of financial statements? What questions do the time series of ratios in case Exhibit 7 raise? What questions do the ratios on peer firms in case Exhibits 8 and 9 raise?

Financial ratios can be used for a quick comparison to other companies in the industry and to the same company over time. They allow you to ignore the numbers and focus on their relationships.

The liquidity ratios have increased dramatically over the last few years. This is due to the increase in assets (stores, equipment, inventory). The increased liquidity ratios seem much healthier than the other firms.

The times interest earned ratio was 124.29 in 2002 and has fallen to 23.15 by 2004. This indicates that interest payments are catching up to earnings.

The asset turnover ratio has fallen from 2.10 in 2000 to 1.01 by 2004. This can be attributed to the Krispy Kreme s asset accumulation.

Krispy Kreme has increased their returns on asset and returns on equity during the past 5 years. They have also increased their net profit margin from 2.7% to 8.6% during this time.

Compared to their peers for 2003, it seems Krispy Kreme relies less on short-term debt. The leverage ratios suggest Krispy Kreme has much less long-term debt obligations than its peers as well. Krispy Kreme has a lower inventory turnover ratio than its peers which may suggest that the large amount of assets could be attributed to high inventory. Their return on assets is in the middle and the return on equity is low compared to others. This could be an indication that Krispy Kreme is not spending shareholder s dollars appropriately.


Is Krispy Kreme financially healthy at year-end 2004?

No, I do not believe that Krispy Kreme is a financially healthy company. The balance sheet is misleading due to the intangible assets.

4. In light of your answer to question 3, what accounts for the firm s recent share price decline?

The decline is due to an adjustment towards the real market value of the firm. The $176M of intangibles on the balance sheet is a serious problem. This amount is greater than the accumulated net income of the previous 5 years.

Additionally, a contributing factor of share price is future cash flows and growth. The aggressive expansion plans have been eliminated and the company has lost the majority of its capital. Analysts have revealed that Krispy Kreme have not been spending its capital appropriately.

5. What is the source of intrinsic investment value in this company? Does this source appear on the financial statements?

The intrinsic investment value of this company appears to be based on the growth opportunity. Due to the high expectations of growth and results from Wall Street, Krispy

Kreme was pressured to keep releasing great numbers. This caused them to use very aggressive accounting procedures for acquisitions which contributed to a large loss. Instead of being satisfied with steady growth, they tried to get too big too fast.


During the past 5 years, Krispy Kreme lost focus on their core values. They tried to meet Wall Street expectations and essentially collapsed. If we can learn anything from Krispy Kreme, it is that you must stay true to your core values. They expanded too rapidly and quickly oversaturated the market through grocery and other third venue sales. Krispy Kreme moved too far away from what originally provided its appeal, the factory store. Krispy Kreme


PROBLEM STATEMENT Krispy Kreme Doughnut Inc, which is one of the largest doughnut manufacturing companies in the world, has experience historical success since the conception of the firm in 1932 by Vernon Randolph. More so recently the firm continued to experience these historical results until 2004 when questionable accounting practices as well as a fundamental breakdown in management lead the firm into financial scrutiny throughout that year. As a result of these questionable accounting practices and management issues, investors as well as financial analysis have lost faith in the financial health of the firm and are skeptical. As a result of this skepticism Krispy Kreme s share

price has decreased significantly. Therefore management is diligently working on a solution to this problem in order to restore the financial confidence of investors and analysis. Four different options, which are not mutually exclusive, are being considered to remedy the situation. Swift action and implementation of the suggested strategies are needed.

Alternative Solution Considered Implement a less aggressive business strategy to preserve the uniqueness of the Krispy Kreme brand name. The pro is that by doing so this will enable Krispy Kreme to keep the market from becoming saturated with it s products. Also by doing so they will be able to decrease expenses, such as Capital Expenditure and that in turn will have a positive impact on profitability. The con is however, the strategy of being less aggressive in expansion could cause Krispy Kreme to leave money on the table due to the fact that there are always emerging untapped market out there just waiting for different product s or in their case doughnut s. Although there may be some negative backlash, Krispy Kreme is in urgent need of restoring the faith of the financial health of the firm. Initiate less aggressive accounting practices to avoid further inquiries about the companies financial operations. This alternative is expected to restore trust amongst investors and financial analysis. The advantage is that by restoring faith in the firm, demand for the The disadvantage is that due to Krispy Kreme s original aggressive strategy certain aspects of their financial statement were bloated and due to this adjustment they figures will now be decreased. This strategy suggest that they take a good look at it s accounting practices to determine where are their weak links, those weak links is where attention needs to be focused in order to restore faith. Restructure Accounting Department on the account that it is inexcusable that they had to delay their financial filing and in turn become in danger of constituting a credit default as well as putting themselves in danger of being delisted from the NYSE. Expeditious action is needed to. The pro is that by doing so this will enable them to file financial statement before the deadline assisting them to avoid these crisis. However, the con is that failure to do so will result in a significant reduction in cash flow if they default also if they allow themselves to be delisted from the NYSE this could have a domino effect. Develop core principles that all executives must operate by since 1932 there has been 2 examples of what happens when executives follow the recipe as well as 2 examples of when they don t. By implementing a core guideline that top executives must abide by, it will eliminate their tendency or their want to deviate away from the original script and try to come up with innovative way s of there own to increase business. Beatrice Foods is an example of this, she tried to add her own flavor to the business and had disastrous results. Immediately after her departure some people with a more keen business mind came along and assumed control and within a few years had the

firm debt free and looking to expand. The flip side to this is that with such regulations on top executive it might make it hard to potentially sell the firm or to get new executives to come in with new ideas, thereby leaving them with not the most effective management team, some might even consider this a poison pill. So this may be the least attractive option.

RECOMMENDED STRATEGY The best strategy at this point in time is for Krispy kreme to combine strategies one, two, and three in order to remedy this situation. Through the implementation of a less aggressive business strategy the firm will be able to improve their Net Income while at the same time keep the market from becoming saturated with their product. However, this is not the only thing that needs to be done in order to restore investor s and analysis faith in the firm s ability to produce an attractive return. The firm also need to stricken it accounting practices to keep itself inline with GAAP, doing so will accomplish three things, (1) they are putting themselves in a position to answer any and all question concerning the financial operations of the firm (2) this will enable them to satisfy all deadlines as far as financial statement submission (3) keep from having bloated financial statements that could lead to intense scrutiny. Lastly, complete restructure of the accounting department is greatly needed to restore the profession image of Krispy Kreme s accounting department on the account of their current situation has diminished their professional image dramatically. They looks like they don t know what they are doing. A statement should be issued to shareholders to inform them that the company is reconstructing it s accounting department along with implementing new plans to ensure the future financial stability of the firm. Krispy Kreme is going to put more wood behind fewer arrows, or in other words do more with less. It also needs to state that previous questionable accounting errors are being resolved, and leaner more precise strategy implementation is being put into place and that the company will become more conservative will it s accounting practices. Although Krispy Kreme is under intense scrutiny, shareholders can expect the firm to continue to diligently work on this issue in order to reestablish the faith with investors and analysis. Once the market regain trust in the firm, the stock price is will increase significantly.

t of their profit shares came from off-premise shops. KKD did not put much effort in differentiating themselves from the product line of Dunkin Donuts and other competitors. Essentially, the company was not re-investing into the company by offering new products. They tried other sales growth strategies such as opening smaller coffee shops and franchising. The company should have been trying to create a new product for their factory stores to attract return customers to sustain growth.

There is a new trend toward providing healthy choices. Consumers interest on low carbohydrate diet rather than flour based food such as bread, doughnut and pasta is increasing. In spite of the big decline in sales in the domestic market due to such trend, instead of trying to focus more on creating a healthier product line, KKD decided to expand more stores overseas instead. Adding more stores may have seemed to be very profitable to KKD at first. However, consumers were already starting to switch to low carbohydrate diet rather than flour based food. The company failed to realize this trend and was affected profoundly not only in their off-premises sales channels, but also in particular sales