Summary

Krispy Kreme Doughnuts, Inc. became a publicly traded company in April 2000 and
expanded over the following years to reach a $49 stock price in August 2003. However,
following 2003 there stock prices sank to less than $10 per share which may have been a direct
result of growing company too fast, oversaturating the market with outlets, questionable
accounting practices and/or incorrect financial statements. The following case study examines
both the historical income statement and balance sheet to determine the financial health and
current condition of the company, analyzes key financial ratios across time and versus industry
standards and addresses if Krispy Kreme is financially healthy at year-end 2004. In addition, the
intrinsic investment value for the company is reviewed.
Income Statement and Balance Sheets
The purpose of the income statement is to provide the financial earnings performance or
how much profit or loss an organization generated during a reporting period. The historical
income statement shows Krispy Kreme’s growth from Jan 2000 to Feb 2004, including an
increase in both total revenue and net income. However, the company’s income was impacted by
equity loss in joint ventures and the increase in operating expenses and decrease in net income.
In 2004, Krispy Kreme lost close to $58 M without counting the $34 M of discontinued
operations from the sale of the Montana Mills venture.
The purpose of the balance sheet is to reveal the financial status of a business at a specific
point in time. The statement shows what an entity owns (assets) and how much it owes
(liabilities), as well as the amount invested in the business (equity). Krispy Kreme’s balance also
indicated poor financial health, particularly with an increase in the year over year long-term
liabilities, including their revolving lines of credit and long-term debt. The revolving lines of
credit increased from zero in fiscal year 2002 to $87 M in fiscal year 2004 and the long-term
debt increased from $3.9 M in 2002 to $48 M in 2004. After analyzing both the income
statement and balance sheet it appears Krispy Kreme was not financially healthy in 2004.
Financial Ratios
It is important understand the financial ratios to help expand our knowledge on the
income statement and balance sheet. Financial ratios are appropriate measure methods to
compare company to itself over a period of time, compare with other companies in the same
industry with give time, and help analysts evaluate company.
The liquidity ratios include both quick and current ratio and we noticed a significant
increase in 2004. The acid-test ratio, like other financial ratios is a test of viability for business
entities but does not give a complete picture of a company’s health. In general, the higher the
ratio is, the greater the company’s liquidity. The current ratio is an indication of a firm’s market
liquidity and ability to meet creditor‘s demands. Acceptable current ratios vary from industry to
industry and are generally between 1.5% and 3% for healthy businesses. However, Krispy
Kreme current rato is increasing and may be a sign they are using current assets, specifically
cash, or its short-term financing options inefficiently and may be a sign of problems in managing
working capital. This matches the balance sheet because we see a gain in cash and cash
equivalents and long term debt.
The leverage ratios include debt-to-equity ratio, debt-to-capital, times interest earned and
assets to equity. The debt-to-equity percentages in 2003 and 2004 increased and may imply the
company using more long-term debt to run the company. In 2004, the balance sheet shows a
jump in the number of shares of common stock, which means Krispy Kreme wants more cash to
finance activities and/or offset some losses. The lower times interest earned ratio is a measure of
a company's ability to honor its debt payments and has declined since 2002, which means fewer
earnings are available to meet interest payments and that the business is more vulnerable to
increases in interest rates.
Activity ratios include receivables turnover, inventory turnover, asset turnover, and cash
turnover. The receivables turnover ratio has been declining since 2001 and implies that Krispy
Kreme is not being efficient in the collection of accounts owed which equals no gaining interest
and basically giving others a free loan. The asset turnover ratio for Krispy Kreme has also been
declining and signals that the company is not doing well in using its assets to generate sales.
Probability ratios include return on assets, return on equity, operating profit margin and
net profit margin. These ratio show positive signs for Krispy Kreme and the return on assets ratio
has been stable and doing well with using current assets to generate income. The operating profit
margin ratio has shown a steady increase, resulting in more operating income for every dollar of
sales, while the increasing net profit margin also shows Krispy Kreme generating more profit for
every dollar of sales.
Examination of the financial ratios between Krispy Kreme and its peers in the quick-
service restaurant industry reveals Krispy Kreme had almost the lowest inventory ratio about
four times less than standard which may indicate poor managament, they had less debt rate than
peer companies, and had a lower effeciency on how to use shareholder’s money than other peer
companies. In addition, Krispy Kreme’s receivables turnover ratio is about four times smaller
than the mean for most quick-service restaurants and possibly indicates there inability to collect
on its due bills. The profitability ratios of Krispy Kreme are comparable to those within the
industry, and a good set of such ratios is a reflection of how efficiently a firm uses its assets and
how well it manages its operations.

4. Perform a DuPont ratio analysis of Krispy Kreme from 2000 to 2004 using the ratios in
Exhibit 7. Remember that Net Profit/Sales x Sales/Assets (this is asset turnover) = Return on
Assets and Return on Assets x Assets/Equity = Return on Equity. Discuss your findings from
this analysis.

5. What does the common size balance sheet for KKD (Exhibit 9) tell you relative to the
industry averages?
6. What does the common size income statement for KKD (Exhibit 9) tell you relative to the
industry averages (note the common size analysis of the IS is only partial)?

7. Is Krispy Kreme financially healthy at year-end 2004?

Krispy Kreme was experiencing a financially unhealthy period at year end 2004 for its loss.

8. In light of your answer to 7, what accounts for the firm's share price decline in 2004?
174.5 million as intangible assets, stockholders lost confidence after accounting scandals became
public, and company’s past income reduced.
Stock Price Evaluation
On May 27, 2004 Krispy Kreme announced poor results for the first time in its history as a
public company. Earnings were down 10% due to the trend toward low carbohydrate diets.
Krispy Kreme decided to divest Montana Mills for $40 million in stock and also planned to close
three of its new Hot Doughnut and Coffee shops. The Wall Street Journal published a negative
story on the accounting principles that Krispy Kreme used for franchise acquisitions. The
company also had to pay Michigan franchise’s top executive $5 million as part of a severance
package. On July 29th, U.S. Securities and Exchange Commision (SEC) launched an informal
investigation on “franchise reacquisition’s and the company’s previously announced reduction in
earnings guidance.” In September 2004, Krispy Kreme announced that it would reduce number
of new stores from 120 to around 60. In the beginning of 2005, the company announced
previously issued financial statements for fiscal year ended 2004 would be restated to correct
certain errors. Krispy Kreme then delayed the filing of its financial reports until the SEC’s
investigation had been resolved. Numerous problems, both salient and hidden, tarnished once-
optimistic forecasts for Krispy Kreme, changing it from a solid company to a risk. Investors have
now lost confidence and the share price has steadily dropped. Although the company’s actual
financial health may have been more benign, public perception has been sullied nearly
irreparably.

9. What is the source of intrinsic value for Krispy Kreme? Does this source appear on their
financial statements?
Intrinsic Investment Value
Barring incisive and insightful financial analysis, there must be a source of intrinsic
investment value in the company which can be gleaned from financial statements. The perceived
quality and expectations of the investors has a strong influence on this innate value. If the
investors feel that a company will be profitable the intrinsic value will likely increase and vice
versa. Intrinsic value also has much to do with brand image, as in Krispy Kreme’s distinctive
green and red vintage logo, it’s “Hot Doughnuts Now” neon sign and the perceived quality of the
doughnuts. The central Krispy Kreme retail concept, The Factory Store, is a prime contributor to
intrinsic value. Krispy Kreme creation of “a doughnut theatre” illustrated by custom machinery
and doughnut viewing areas is a significant point of distinction from its competitors by offering
more than just a product but a complete experience. These subtle differences add to the Krispy
Kreme mystique, which adds a level of perceived quality.
The “hottest brand in America” with neon sign of “Hot Doughnuts Now”, the brand was there
intrinsic investment value, one the largest initial public offerings, share price was $40.63,
intrinsic investment value appears on the balance sheet: goodwill and intangibles