Krispy Kreme Doughnuts, Inc. (hereinafter, “Krispy Kreme”) seemed poised to become an industry leader and Wall Street chart topper in 2000, however, by 2004 the company’s stock price had plummeted. Krispy Kreme’s stock price one day after the initial public offering in April of 2000, was $40. 63, giving the company a market capitalization of nearly $500 million.
Investors believed Krispy Kreme was the next big money maker to enter the market.By 2005, Krispy Kreme shares were trading at less than $10 a share, the company was in the midst of an SEC investigation into their accounting treatment for franchise acquisitions, and they found themselves on the verge of potentially defaulting on their credit facility. Following the successful IPO, Krispy Kreme announced their aggressive plan to add approximately 350 more stores to their 144 store domestic arsenal and an additional 32 international locations. On May 7, 2004, Krispy Kreme announced adverse financial results for the first time since it became a publicly traded entity.Krispy Kreme told investors to expect earnings to be 10% lower than anticipated for the following three reasons: 1.
the low-carbohydrate diet trend in the US had hurt sales 2. the company would take a $35 to $40 million charge because it was divesting a chain of 28 bakery cafes it had acquired for $40 million in stock the year before and 3. the company had plans to shut down three new doughnut shops at a charge of $7 million to $8 million because they were underperforming.
Following the announcement about the company’s financial standing, shares closed down 30% at $22. 51 a share.On May 25, 2004, the Wall Street Journal published an article which described Krispy Kreme’s questionable accounting practices surrounding the treatment of franchise acquisitions. In July of 2004, when Krispy Kreme announced that the SEC had launched an informal investigation the company’s shares dropped another 15% to $15. 71 a share. Krispy Kreme’s stock fell to less than $10 a share when the company announced in January of 2005 that it would restate its’ previously issued financial statements for FY2004 and that it would delay the filing of its financial reports until the SEC completed its investigation.
Krispy Kreme was generating revenues through four primary sources: on-premises retail sales at company owned stores (27% of revenues), off premises sales to grocery and convenience stores (40%), manufacturing and distribution of product mix and machinery (29%) and franchisee royalties and fees (4%). For the period of 2000 to 2004 the mix of company owned stores to franchises was relatively consistent at a 40% to 60% split respectively. One day after the company’s IPO, Krispy Kreme announced an aggressive plan to open approximately 350 new stores in the United States over a five year period.Because franchisee royalties and fees were generating such a nominal portion of Krispy Kreme’s overall revenues, it does not seem that it was as profitable for the company to continue to open a higher percentage of franchises compared to company factory stores.
Krispy Kreme’s hard line goal to rapidly expand the number of stores was unsuccessful. In 2001, 80% of investors were recommending that people invest in Krispy Kreme. In an efficient market the share price should adjust instantly to new and relevant information as soon as it becomes available to market participants.In the example of Krispy Kreme, it seems that investor speculation and hype drove the stock price up initially, and the company The company’s stock price Krispy Kreme appears to be financially healthy from 2000 to 2004 based on their financial statements and the ratios presented. The company’s net income increased significantly in percentage each year, with the largest increase not surprisingly occurring the year of the much anticipated and publicized IPO (from 2000 to 2001 the percentage change in net income was approximately 147% compared with a 70% increase from 2003 to 2004).The balance sheet reveals that the company recorded 256% more in reacquired franchise rights, goodwill and other intangibles in 2004 compared to 2003, which is the result of the accounting principals that were questioned by the Wall Street Journal.
Additionally, the company recorded no current assets under the same entry in 2000 and 2001. On the balance sheet, Krispy Kreme’s cash and cash equivalents increased each year before decreasing from 2003 to 2004. This decrease appears alarming because in 2004 the amount of cash and cash equivalents compared to the amount of accounts receivable as reported is less than 50%.However, in looking at Krispy Kreme’s liquidity ratios, the company seems to be doing well with their liquidity.
The company’s quick and current ratios increase considerably from 2000 to 2004, indicating Krispy Kreme is in solid financial shape to repay its current liabilities. Compared to its’ competitors, Krispy Kreme is doing extremely well with respect to its liquidity standing. Krispy Kreme’s leverage ratios compared to the industry averages indicate the firm is more prone to using equity to finance than comparable companies in the industry.This could indicate that they are less likely to generate sufficient cash to meet their debt obligations. In light of the above, Krispy Kreme’s leverage ratios demonstrate that the firm is in good standing with respect to long term solvency. In 2004, Krispy Kreme’s receivables turnover decreased slightly from the previous year. Overall for the period of 2000 to 2004, the receivables turnover ratio is fairly consistent. However, compared to its competitors, Krispy Kreme shows large room for improvement in its efficiency in collecting on receivables and not missing out on considerable interest to be earned on outstanding collections.
The asset turnover ratio for Krispy Kreme decreases every year for the four year period of data provided and in 2004 it is less than half the value in 2000. This should be an area of concern for Krispy Kreme as it indicates that they are generating less sales for every dollar of assets each year. Additionally, when compared to its competitors, it appears that Krispy Kreme is doing well in the investment of its assets but is being outperformed by the majority of its competitors.The profitability ratios indicate that Krispy Kreme is a profitable company particularly in comparison to their competitors. The company’s steady return on equity indicates they are consistently and efficiently generating profit with their use of investment funds.
This accompanied with the fact that Krispy Kreme’s earnings per share have increased each year from 2000 to 2004 show that the company is generating value for its shareholders. Compared to its competitors, Krispy Kreme’s return on equity is slightly lower, but not alarmingly so.Additionally, the company’s return on assets indicate that they are doing a good job of using their assets to generate net income. Krispy Kreme’s net profit margin and operating profit margin both increased substantially from 2000 to 2004. This demonstrates that the company is gaining more money in net income per one dollar of sales each year, which is a good indication of their commitment to increasing the company’s profitability. Krispy Kreme’s profit margin and operating profit margin are in good standing compared to their competitors in 2003.Krispy Kreme’s intangible assets are considerably higher than the limited service restaurant averages, which is likely attributable to their accounting practices in repurchasing franchises.
Despite their good liquidity ratios, Krispy Kreme carries significantly less cash and equivalents than the industry average which is a financial aspect they should attempt to improve on. Krispy Kreme has approximately ten times as much trade receivables than the industry average. They need to make an attempt to turn the money their customer’s owe to them which will in turn improve their cash and equivalents.
Krispy Kreme recorded no short term notes payable and their balance sheet contained only 7% long term debt in 2003 while the industry average was close to 6% in the short term and 42% in long term debt tied up on the balance sheet for the same year. Krispy Kreme’s capital structure is designed to maximize more of the firm’s value through its equity than the industry average. Therefore, Krispy Kreme has a significantly higher percentage tied up in equity on the balance sheet than the industry average for 2003.Because of their equity intensive capital structure, Krispy Kreme should work to increase their return on equity. Krispy Kreme is a financially fit company at the end of FY2004 but they have areas that need improvement, most notably in their ability to financially leverage themselves more wisely.
The company has lost such a significant amount in their market value of equity since 2003, which could be turned around by altering their capital structure. In 1989, Krispy Kreme became debt-free and slowly began to expand while under he direction of someone who had a vision for the company and was focused on growing it accordingly. The CEO who took the company public in 2000 and subsequently sought an aggressive expansion clearly did not define the business strategies required to support his vision of the company’s growth. When Shares of Krispy Kreme stock were trading at less than $10 a share in 2005, compared to $40. 63 in 2000. IV.
Recommendations • Key Conclusions (Often tied to last question) • Your Recommendations and Why (This section about 1 page)