INTRODUCTION

Krispy Kreme Douhgnuts, Inc. began as a single doughnut shop in Winston-

Salem, North Carolina in 1937. CEO Scott Livengood took the company public in April

2000 in what was one of the largest initial public offerings (IPO) in recent years; one day

after the offering, Krispy Kreme’s share price was 40.63 dollars, giving the firm a market

capitalization of nearly 500 million dollars. After the company’s IPO, Krispy Kreme

announced an aggressive strategy to expand of stores to 500 over the next five years.

However, by the end of year 2004, Krispy Kreme’s stock price went down as several

accounting misstatements were discovered in the company’s financial statements.

CASE ANALYSIS

The sales of Krispy Kreme have continued to soar high. In fact, the

revenues, income from operations, and net income gradually increased over the

years. The same can be said on the operating, general and administrative and

other related expense. However, the increase is minimal compared to the

increase in revenues. Despite the gradual increase in the expenses, in

percentage form it is actually decreasing.

The share price of the company is fluctuating every year. The recent

problems that the company has been facing are reasons that the price of the

company fluctuates. Over the years, the number of shares outstanding has also
steadily increased. It could be that the company released more shares to gain

additional capital for its expansion.

In general, current assets in the balance sheets increased every year.

However, this not entail that the company is better. It may be observed that the

cash and cash equivalents is fluctuated with year 2003 as its peak. Despite

increasing sales, its cash is actually low. It is also seen that Krispy Kreme has

invested on short-term investments. This is actually good as it adds liquidity on

the company to pay off short-term debt. Accounts receivable continue to increase

every year. This should be normal due to increase in sales; however, it can also

imply that the company is not efficient in collecting its accounts from customers.

The company grows every year, so are its long-term assets. Increase in

fixed assets such as property and equipment may be due to the continuous

growth of the company’s stores over the past five years. Despite franchise stores

dominating over the company factory stores, growth on company stores is faster

than the franchise stores. However, such growth in long-term assets entails

higher expenses such as depreciation for the company which is true in Krispy

Kreme’s case.

Current liabilities of the company have increased over the first three years,

but such obligations are slowly being paid-off starting year 2003. Non-current

liabilities have also increased since year 2001. The expansion plan of the
company may have been the cause of such increase in its long-term liabilities.

One of the notable line items in the company’s long-term liabilities is the

revolving line of credit, defined as a line of credit where the customer pays a

commitment fee to a financial institution to borrow money and is then allowed to

use the funds when needed. Large amounts of revolving credit were borrowed by

the company on the year 2004. The reveal of franchise-reacquisition accounting

practices may have led the company to obtain funds through other means for

stockholders may have been skeptical in purchasing stocks of the company.

Due to the company going public, the shareholders’ equity has also

increased. It can also be observed that the retained earnings have increased

annually. Another factor that may have increased the shareholders’ equity is

retaining its earnings.

Throughout the years, the store growth of Krispy Kreme has been

consistently high. And it can be observed that the longer Krispy Kreme has

continued its operations, the bigger that number of franchised stores. The

change in the composition of stores between company-owned and franchised

may have been one of the factors that affected the overall performance of the

company.
 The liquidity of Krispy Kreme from year 2000 to year 2004 has increased

slightly over the years, this can be seen that the company has been making

progress and cash flow is steadily growing. The same can be said for quick ratio.

Over the years, the current asset of Krispy Kreme has increased exponentially

while its liabilities also increased but not as much as compared to current assets.

A high liquidity ratio indicates that the company have the liquid resources to pay

off its short-term liabilities.

The debt-to-equity and debt-to-capital ratios have dropped significantly

from year 2000 to year 2001 and fluctuate on the next years. It can translate that

the company could be capitalizing its asset through investments from

stockholders or that the company has been paying off its debts. For Krispy

Kreme, the company has gained capitalization through the company going

public, making its debt-to-equity and debt-to-capital low for year 2001 and 2002.

Both ratios have also increased for year 2003 and 2004 due to the company

acquiring long-term debt. The company could have borrowed funds to capitalize

its expansion. Times interest earned is fluctuating and inconsistent. Even though

in average, it is considered high, it is bad for the company because fluctuations in

the times interest earned ratio means the ability of the company to pay its

obligations to its creditors are not consistent. The creditors may think that the

company is not solvent enough and the company may have the hard time to

borrow funds due to this. Krispy Kreme’s asset-to-equity ratio is also fluctuating.

In initial observation, year 2000 has a 2.2 ratio while from 2001 through 2004, it
is equal or below 1.50. Investments from shareholders have been greater than

what the company borrows from the creditors resulting to a lower asset-to-equity

ratio. The company’s composition on debt and equity has been changed

drastically to catch up with its ambition goal of expansion. In general, the

leverage for Krispy Kreme tells us that the company relies more on equity to

capitalize its goal than borrowing funds.

The turnover ratio for Krispy Kreme shows fluctuation over the years. For

receivables turnover, the company has been averaging about 10.69 times which

is almost consistent but gradually decreasing. It means that the collection

efficiency on receivables have not improved for the past five years despite

increase in sales. In fact, the increasing accounts receivable of the company

supports the idea that the company has loose collection policies. For the

company’s inventory turnover, the same can be said. Even though it has

improved in year 2004, there is little to no improvement into the company’s ability

to convert inventory into sales. For the asset turnover, it has gradually decreased

over time for Krispy Kreme. A company such as Krispy Kreme has its sales

reliant on volume, and such companies, in general, have higher asset turnover

asset ratio. For Krispy Kreme, decreasing asset turnover indicates the company’s

performance is declining. Less revenue is generated per dollar of assets. The

company may have acquired assets such as equipment that do not add value in

profit generation. Year 2003 has been the slowest year for the company for its

overall low turnover rates.

 As for the profitability ratio, operating profit margin and net profit margin

has consistently increased annually. There were some improvements that may

have been made in terms of the company operations due to increased sales. And

even though expenses have increased, it can be said that it was well-regulated

and this made both operating profit and net profit improve as well. On the other

hand, the return on asset of Krispy Kreme, in average has been consistent. The

same can be said with the company’s return on equity. However, this consistency

is not entirely good. For instance, the company has been in put in public which

given Krispy Kreme additional capital for expansion. And despite expansion, the

return on asset and return on equity has not improved. The component of return

equity is not just net income and shareholders’ equity. More information can be

retrieved by computing the return on equity using a longer equation, which is net

profit margin multiplied by asset turnover multiplied by equity multiplier. Although

the net profit margin of the company has increased over time, the asset turnover

rate of the company has decreased as discussed on the last paragraph. This low

asset turnover rate is the primary cause why the company’s return on equity has

not improved. This additional capital provided by the stockholders has been

maximized to improve the company’s overall operations and performance. It

solely focused on expansion; it forgot to apply the basic principles of

effectiveness and efficiency.

 Despite the recent discovery on the Krispy Kreme’s financial

statements, the company continue to have high profits and increased

company value. Krispy Kreme financial ratios compared to other

companies in the same industry may tell us a different story. Krispy Kreme

may have not been the company with the highest sales, but in initial look,

there are aspects in operations that Krispy works better than its

competitors.

In terms of liquidity, Krispy Kreme is better than the rest of the

industry having the highest quick and current ratio. This indicates that the

company has enough current assets to cover up current liabilities.

However, a high liquidity ratio in a quick-services restaurant may also not

be good. It may also mean that the company holds its current assets than

utilizing them to generate more profits.

On leverage, Krispy Kreme has comparably lower ratios than the

industry average. Quick-service restaurants have their capitalization relied

on borrowed funds. Krispy Kreme recently becoming a public company,

had most of its capitalization from investors. In the positive side, Krispy

Kreme does not fund its operations through borrowed money. However, a

company should have a right balance of debt and equity so that it can

achieve an acceptable leverage. Krispy Kreme’s lower interest coverage

before tax ratio can indicate that the company is may encounter more

difficulties in paying its obligation to its creditors. Panera bread having

1014 interest coverage before tax rate may have made the industry

average higher than what should be. High interest coverage before tax

ratio also indicates that a company has a lower interest expense

compared than other quick-serve restaurants in the industry. For asset

turnover, the Krispy Kreme is lower than the industry average.

In terms of activity, Krispy Kreme is unable to hold a candle against

the other companies since the ratio greatly differs. This means that other

companies did an impressive job when it comes to business, deals,

income, selling goods quickly and high demand. Krispy Kreme has good

ratio but not much to say compared to others. The industry average for
receivables turnover is 37.51 compared to Krispy Kreme’s 9.71. Krispy

Kreme may have a big portion of credit sales in its profit due to

manufacturing and distribution of product mix and machinery, and large

amount of off-premises sales unlike other companies that relied heavily on

cash sales which made their turnovers high. For inventory turnover, it is

also strikingly low for Krispy Kreme. Quick-service restaurants such as

Krispy Kreme relied on high volume sales and a low inventory turnover

indicates that it weak sales or there is a possible overstocking of

inventories. Overstocking may be true due to gradual increase of inventory

in the company’s balance sheets. Asset turnover is also lower than the

industry average. Inefficiency on asset management may be the issue on

Krispy Kreme’s side and its expansion plan is also factor that affected the

asset turnover rate of the company. For cash turnover, Krispy Kreme also

has a lower ratio than the industry average. Thus other companies in the

same industry are going through its cash cycle quicker than Krispy Kreme.

A company that has nearly all of its sales in cash is tended to have a

higher cash turnover ratio. Krispy Kreme may have lower ratio than the

industry average for the company have large portion of its sales on credit.

For profitability, the return on asset of Krispy Kreme is a little bit

higher than the average industry. Despite the company’s ROA not

consistently increasing, its performance is considered better than the

average quick-service restaurant. The return on equity of Krispy Kreme

 however is lower than the industry average. A reason return on equity ratio

can be smaller is heavy reliance on equity itself. Krispy Kreme has been

paying off its liabilities and its equity has also gradually increased over the

years. Based on the financial ratio performance of Krispy Kreme, it has

maintained its ROE. Despite, the increasing net income per year, the

same goes for the stockholders’ equity. The company is less efficient in

generating profits from its shareholders investments than the other quick-

service restaurants. For both EBIT and net profit margin, Krispy Kreme

has higher ratios than the industry average. It means the company may

have been more efficient in handling its expenses than the usual quick-

service restaurant.

CONCLUSION AND RECOMMENDATION

Krispy Kreme business has somewhat its ups and downs in terms of

financial performance and it be clearly seen its financial ratios. The company is

doing great for its sales, income and assets but when dig deeper, there are

aspects of the company that needs improvement. The company should focus on

improving its overall management style and operations so that the investments of

its stockholders do not put into waste.

One of the concerns in Krispy Kreme is its low turnover rates. The

company should re-asses its collection policies to improve receivables turnover.

This will decrease accounts receivables of the company, at the same time,
increase the cash available for use. This will also improve the cash flow of the

company and be able to meet its obligations to its creditors.

The company should also take action into improving its asset turnover.

Methods to improve one’s asset turnover are to: increase sales, improve

efficiency, sell assets, accelerate collections, and computerize inventory and

order systems. Improving asset turnover will also improve company’s return on

equity. A good return on equity keeps your shareholders at bay.

Krispy Kreme will continue to prosper in term sales given its current

management style. However, the company should take into consideration its

expenses in general. In our financial ratio analysis, the operating profit margin

and net profit margin of the company is lower than the industry average. It means

that Krispy Kreme is may be incurring more expenses than its usual operations.

The company should assess their expenses and implement strategies that will

cut down costs. It should eliminate expenses that do not add value to the

company or minimize its expenses such benchmarking cheaper but better quality

raw materials, equipment and other related fixed assets.

Another downfall of Krispy Kreme is its ambition expansion plan of

500 branches worldwide. Despite having additional capitalization for expansion, it

did not translate well into favourable financial performance. In fact, the

company’s ROA and ROE did not improve over the last five years. The company
has also allowed the franchises to dominate over the company owned stores.

Krispy Kreme does not have total control on franchises compared to company

owned ones. In fact, in one of the exhibits provided in the case, many of the

franchised stores are acquired back by the company. These franchises may have

financial difficulties maintaining the operations, leading to a decline in company

sales. The expansion plan is not a bad idea, but the goal should be given a

longer term to prosper. The company, in terms of expansion, should take it slower

so that the company will not suffer the consequences of rushed decisions.