Krispy Kreme Case Analysis

The purpose of this memo is to give some recommendations about Krispy Kreme. Recently, the stock price is going down and market holds negative attitude toward Krispy Kreme, we thought the reason behind it is as following.

First of all, there must be some governance issues at Krispy Kreme. The primary governance problem is the over expansion. After initial public offering in 2000, Krispy Kreme announced an aggressive strategy to expand the number of stores from 144 to 500 in the next five years. It is obviously in 2004 that Krispy Kreme cannot meet their goals, and then Krispy Kreme claims to decrease the new store to 60 from previous announced 120. The fast expansion brings a lots problems. one of the problems is that it is hard to filter out the qualified franchisee. Krispy Kreme can get a considerable upfront fee from the franchisee new store and share around 5% net income from the franchisee new store, the profit from franchisee store is significant.  It gives them a strong motivation to open new franchisee store and may lead to loose eligibility criteria for the franchisees and new store. The lower standard raises the new store business's risk. The bad performance of new store makes it hard for franchisees to pay the debt to Krispy Kreme. Because of the poor financial status, the number of store transfer to the company is increasing year by year.

Secondly, Krispy Kreme has a low leverage ratio compared to the industry average and has a higher liquidity ratio. It means Krispy Kreme has fewer long-term debt and has enough cash and equivalent in hand. Krispy Kreme can improve their profitability by increasing the financial leverage through issue long-term debt. Furthermore, the increase of inventory year by year decreases the inventory turnover ratio. The reason behind the increasing inventory is that Krispy Kreme overestimated the new store growth rate and the bad performance of some new stores, which may because of the inappropriate location or the unprofessional franchisees, pull down the expansion thus the equipment cannot be sold or the account receivable becomes higher.

Finally, Although Krispy Kreme claims that they accounted their business in accordance with GAAP, the treatment that accounted some purchase of franchisees store as the intangible asset is somehow unreasonable. As an intangible asset, the required franchisees right should be revaluation at least annually to reflect the market value or intrinsic value. Especially for the compensation to the original executive of franchisees store, rather than treat as the intangible asset, it will be more appropriate if the compensation will be amortized. The inappropriate accounting method decreases the reliability and the integrity of Krispy Kreme's financial reports.