Krispy Kreme Case

Once a small doughnut shop in Winston-Salem, North Carolina; Krispy Kreme Doughnuts, Inc. now has sales across the United States and in multiple foreign markets. Krispy Kreme has brought their famous glazed doughnut to the forefront of investor interest everywhere with an assertive expansion plan aimed at quadrupling their quantity of stores in just five years after their initial public offering.

Past financial statements provide an overview into a company's financial performance. However, conclusions made from these records must be "taken with a pinch of salt." In the case of Krispy Kreme, the income statement and balance sheet from years 2000 to 2004 are quite attractive and one may say that this company is in relatively good financial health.

At a glance, one can see Krispy Kreme revenues for year ending from 2000 to 2004 increased year to year on average by roughly 32% while cost of goods sold only increased year to year on average by almost 28%. These numbers are not necessarily great, but factor in the constant increase in operating profit margin and net profit margin, Krispy Kreme appears to have sustainable profit growth. Yes, expenses are growing also, but only slightly relative to revenues. What does draw concern is the decrease in the ROA and ROE in 2003. This could be a signal that the company is growing faster than income can support.

In regards to the balance sheets from 2000 to 2004, Krispy Kreme's current and quick ratio begin higher than a 1:1 and continue to increase to 3.25 and 2.72 in 2004 respectively. Debt to equity in 2000 is about 48%, but then decreases to zero in the next year. After that it fluctuates in between 2.5 and 20% for next three years which is not a cause for concern. What does draw attention is the spite in the cash conversion cycle from 23 days in 2002 to 30 days in 2003 then 35 days in 2004. This illustrates a decrease in efficiency in the operating cycle, which could be the cause for a slower marginal growth of net income relative to the increase in total assets and share holder's equity. All in all, Krispy Kreme's income statement and balance sheet are relatively healthy when compared to industry standards.

While analyzing any financial statements one should be aware of how precise or inexact the data is recorded. When the Wall Street Journal released an article in May of 2004 claiming Krispy Kreme used "aggressive accounting" to record franchise acquisitions this would be a reason to second guess the accuracy of their financial statements. Earnings were being overstated by recording interest income that was built into a purchase price of a reacquired franchise which that franchise owed. On top of that, Krispy Kreme decided to roll the cost of closing some stores (which was part of the deal) into the purchase price, which would avoid recognizing an added operating expense. Management also saw fit to record the purchase price of the deal as "reacquired franchise rights," an asset that is not amortized against earnings, unlike industry standard practice. Now assets are being overstated by millions of dollars. As a result of this creative accounting, Krispy Kreme met the earnings expectation for that quarter, but not without SEC taking notice.

At year end of 2004 Krispy Kreme had positive earnings and steadily improving earnings per share. Their profitability ratios demonstrated company growth through 2004. According to exhibit 7, Krispy Kreme's return on asset (ROA) increased from 5.7% in 2000 to 8.6% in 2004 which means assets were being utilized more efficiently as net income increased from 2000 to 2004. Combine this with an equity multiplier of about 1.5 at year of 2004, Krispy Kreme's return on equity (ROE) continues to increase also. Operating profit margin and net profit margin showed significant growth from 2000 to 2004. This growth in the profit margin indicates that company had better ability to cover its cost from its operation.

Krispy Kreme also has a low financial leverage ratio at year end of 2004. Its debt to equity and debt to capital ratio decreased from 2000 to 2004. Debt to equity went down from about 48% to 11.3% and debt to capital went down from 32.4% to 10.1% (Exhibit-7). This indicates Krispy Kreme's long term debt decreases and shareholder's equity increased making the company solvent in case of emergency.

Liquidity is also an important aspect of financial health. Krispy Kreme's quick ratio increased from 1.05% in 2000 to 2.7% in 2004 and their current ratio increased from 1.39% to 3.25 %. These two ratios showed that Krispy Kreme's cash and cash equivalents, along with current assets as whole, were increasing relative to their current liabilities. Compared to other firms in the quick-service restaurant industry, Krispy Kreme's liquidity ratios are by far the best. So based on a DuPont analysis of Krispy Kreme's performance at year end of 2004; their ROE, ROA, and profit margin displayed increasing growth consistent with a financially healthy firm.