Swot Analysis Krispy Kreme

SWOT   ANALYSIS

              STRENGTHS-S

1. Krispy Kreme makes it possible for different organizations throughout the community
to use there product as a fundraiser.
2. Krispy Kreme is most popular in grocery and convenience stores which gives
customers easy access to the product.
3. Employees are better trained.
4. KKD has a unique brand and variety of freshly made donuts.
5. KKD can offer to have customers watch product being made at the donut theater.
6. KKD has a high capacity to make 4,000 to 10,000 donuts daily.
7. KKD prides themselves on high customer satisfaction with fresh quality donuts.
8. KKD offers additional products through businesses acquisitions.
9. KKD offers a product that is second to none, with regards to taste, freshness and the
finest ingredients.
10. KKD has a great desire for growth and success of people and company.
11. KKD has great service and innovation.
12. KKD has e-commerce which gives owners access to real-time information.
13. KKD has a drive through window for sales.
14. KKD
has a new fall product line of donut called Spice.
15. KKD is expanding into Dunkin Donuts territory.      

        WEAKNESS-W

1 Competing against Starbucks coffee and     Dunkin Donuts beverages

2 Lack of more Intl locations in the United kingdom, Japan and Spain
3 Manufactures all equipment internally in its Manufacturing and Distribution Dept 
4Non-interactive website 
5 No online ordering capability 
6 Uncertainty of International markets
7 KKD snacks are not healthy   (need to consider low-calorie donut)

  
              OPPORTUNITIES-O

1 Growth in two-income will increase snack-food consumption

2 On-Premise sales royalties (3%). The higher the sales, the more money received
3 Customer receiving "Hot-Donut" now instead of waiting 
4 All equipment and Uniforms are supplied
5 Penetration into foreign/intl. Markets
6 Acquisition of Atlanta Bread 
7 Expansion of new locations (Maine, Mass)
8 Further expansion...
Journal of Business Case Studies – April 2008 Volume 4, Number 4

Lessons From Krispy Kreme

J. Richard Anderson, Stonehill College

ABSTRACT

The recent decline of Krispy Kreme Doughnuts, Inc. raises a natural question: shouldn’t
investors

(and auditors) have been more wary of this Wall Street darling? Weren’t there tipoffs that
would

have allowed investors to avoid another franchisor “crash and burn” situtation like Boston

Chicken or TCBY frozen yogurt? This paper traces the meteoric rise and fall of Krispy Kreme and

discusses a number of advance indicators of future problems: insider share-dumping, conflicts

of

interest within the Board of Directors and senior management, turnover in the CFO position,
the

use of synthetic leases, repurchased franchises, disappointing join venture results, and the

problems of earnings management in the quarterly reports of a fairly small publicly-owned

business.

Keywords: Corporate Financial Reporting, Investor Awareness, Reading Financial Reports

INTRODUCTION

hould we be surprised when a Wall Street darling like Krispy Kreme Doughnuts crashes and
burns?

Shouldn’t there be warning signals when a company ranked as the best IPO of the 2000-02
period with a

711% stock price runup in three years loses all of that appreciation over the next 18 months?
What causes
a company to go from a market capitalization of just under $3 billion to little more than $300
million in such a short

period?

This paper argues that there were numerous warning signals in the doughnut franchisor’s
accounting and

managerial decisions that investors refused to take seriously as they bid the stock from its
(split-adjusted) IPO price

of $5.25 to its eventual peak of $49.50. The lessons that can be learned from an autopsy of the
Krispy Kreme fiasco

might well make investors more wary about jumping on the next IPO bandwagon.

KRISPY KREME: FROM REGIONAL DELICACY TO CULTURAL PHENOMENON

The Krispy Kreme story began Winston-Salem, N.C. in 1937 when Vernon Rudolph began selling

doughnuts to grocery stores using a secret recipe from a French chef. Strong demand from
customers who wanted to

buy their doughnuts freshly made and still warm caused him to open almost 100 retail outlets
throughout the South.

After Rudolph’s death in 1973, his heirs sold the chain to Beatrice Foods, which immediately
began to tinker with

the successful recipe. By 1982 franchisees were so upset with Beatrice that they joined
together to repurchase the

chain. This created a franchisor owned and dominated by its own franchisees, which would
create serious

difficulties later on.

By the mid-1990’s Krispy Kreme had escaped its Southern heritage and opened shops in the
Midwest and

Northeast, even invading Manhattan, home to many influential writers. But instead of deriding
hot doughnuts as a

provincial culinary fare like hominy or grits, the critics raved. A New York Times columnist even
wrote: “When
Krispy Kremes are hot, they are to other doughnuts what angels are to people.” The product
began to appear on TV

in sitcoms and late-night talk shows; people bragged about their attempts to “score a dozen” of
the treats, and a new

cultural phenomenon was born.

SJournal of Business Case Studies – April 2008 Volume 4, Number 4

THE IPO: HOW TO RUIN A GOOD THING

A part of the plan to escape the South and make Krispy Kreme a national brand was the
decision to take the

company public. In April 2000, $65 million was raised through the sale of 26.7% of the
company’s stock, giving it a

market capitalization of $270 million. By the end of the year, the stock price had almost
quadrupled and CBS

Marketwatch labeled Krispy Kreme the top performing IPO of the year. The company’s ability
to meet or slightly

exceed the optimistic earnings projections of market analysts combined with news stories
describing hour-long lines

outside newly-opened stores to push the stock to a split-adjusted $46 per share by the end of
2001. Investors loved

the concept: this was a brand that seemed to combine high quality, exclusivity, and a gimmick
– customers could

actually watch their doughnuts being made. The opportunities seemed endless, as the company
quickly carved up

geographic regions for expansion and granted exclusive franchising rights, often to board
members and other

existing franchisees.

When Krispy Kreme CEO Scott Livengood was named Restaurants and Institutions magazine’s
Executive
of the Year and Forbes put the firm on its list of “200 Best Small Companies,” the momentum
became almost

impossible to sustain. The stock traded at 65-100 times projected earnings, and the demand
intensified to produce

earnings gains sufficient to justify such an extreme price-earnings multiple.

In May 2004 Krispy Kreme issued its first-ever profit warning, triggering a series of shareholder
lawsuits

alleging that the company had attempted to hide year-to-year declines in same-store sales. In
fall of that year they

announced their first quarterly loss since going public and attempted to blame it on a consumer
trend toward low-fat

foods. But the damage had been done: by the end of 2004 the stock price had slid from $40 to
under $10 and the

SEC had announced a formal investigation of the company’s accounting practices.

In 2005 Krispy Kreme faced default on its main $150 million credit line as it was unable to
produce audited

financial statements. Scott Livengood resigned as CEO only a few months after CFO John Tate
left the firm, and six

other executives were summarily fired for undisclosed improper behavior. By the end of 2005,
weekly same-store

sales had fallen 20% from the prior year, the firm had closed 25% of its stores, and a bankruptcy
filing was rumored

to be imminent. The stock price fell back to its (split-adjusted) IPO price of $5.25 and almost
$2.7 billion of

shareholder value evaporated in a dizzying free fall.

THE WARNING SIGNS

While the Krispy Kreme fiasco left some investors holding the bag and frantically filing lawsuits,
it should
not have surprised more astute observers. At least a half-dozen warning signs appeared in
Krispy Kreme regulatory

filings well before the stock price started to fall:

Churning In The CFO Position

Continued turnover in the CFO position is often a danger signal in a fast-growing public
company. Just

after the IPO in 2000, Krispy Kreme replaced longtime Chief Financial Officer Paul Beitbach with
newcomer John

Tate. Breitbach was a traditional conservative CPA, while Tate was a more aggressive financial
type who was

forced out as CFO of Williams-Sonoma after missing two quarterly earnings forecasts.
(Understandably, he made

sure not to miss any earnings targets while at Krispy Kreme.) Tate was promoted to Chief
Operating Officer in

2002, and longtime controller Randy Casstevens was promoted to the top finance spot.
Casstevens lasted less than

eighteen months and turned in a “purely voluntary” resignation just five months before the
company’s first quarterly

earnings shortfall. To replace Casstevens, the company brought in Michael Phelan, a key
member of the investment

banking team that executed Krispy Kreme’s IPO and follow-on offering, who in turn lasted less
than two years in

the position.

A later report filed with the SEC stated that Tate and Casstevens didn’t provide the “leadership
or

supervision over the accounting and finance functions that one would expect from the CFO
position.” One analyst Journal of Business Case Studies – April 2008 Volume 4, Number 4

3
suggested that “… the real numbers the CFOs were coming up with were numbers the rest of
management didn’t

want to hear. They were looking for a CFO who was going to tell them good news.”

Insider Share Dumping

When Krispy Kreme went public in 2000, about 75% of its shares were “locked up” – insiders
who owned

them were not permitted to sell for an eighteen-month period. As soon as the lockup period
expired, executives and

board members sold 1.85 million shares, or 20% of the shares subject to the lock-up
agreement. By 2004 CEO

Livengood had sold over 1 million shares (about 40% of his holdings) for net proceeds of over
$40 million, despite

having previously made pledges that he wouldn’t sell company stock. The high level of stock
sales by insiders while

the company was issuing glowing financial reports should have alerted shareholders to a
potential problem.

Synthetic Leasing

Soon after it went public, Krispy Kreme arranged to finance a new $35 million factory in
Effingham,

Illinois with a synthetic bank-financed lease, which would allow them to keep a large long-term
debt off their

balance sheet and avoid raising their debt ratio from 26% to 36%. Criticism later forced them to
unwind this lease

and borrow the money to purchase this property from the bank. In the annual report,
Livengood took the moral high

ground: “In the current economic climate, investors understandably are paying closer attention
to the financial

strength of companies and the way they conduct business. We have taken the position that
there is no reason for us
to do anything that could be misinterpreted, regardless of how legal and acceptable it may be.”
Wise investors

should not have “misinterpreted” Krispy Kreme’s intention, which was clearly to avoid
recording debt – at least

until financial analysts caught on.

Executive Conflict Of Interest

Outside shareholders often wonder if senior management has a strong ethical or moral
compass: can they

be relied on to act responsibly as the custodians of a newly-public company? Here two

situations tell a tale:

(1) In early 2003 Krispy Kreme spent $39 million to acquire Montana Mills, a chain of 30
upscale “village

bread stores” based in Rochester, N.Y. Almost $30 million of the purchase price was allocated
to goodwill,

although the concept was unproven and Montana Mills had never previously shown a profit. In
what

appears as an obvious conflict of interest, COO John Tate had served on the Montana Mills
Board of

Directors for 14 months previous to the acquisition. Not surprisingly for a non-core venture,
Montana Mills

showed a $2 million loss in the year after it was acquired, and in mid-2004 the chain was closed
down,

causing a $35 million income statement charge.

(2) In its first two years as a public company, Krispy Kreme had a policy which allowed senior
executives to

make private investments in newly-established area franchisees, and Scott Livengood

eventually had

ownership stakes in seven large franchised operations. In an arrangement reminiscent of old-

fashioned
extortion operations, Livengood and other Krispy Kreme executives were allowed to “muscle
in” on new

franchise deals – they could purchase equity stakes even when the franchisee group did not
want them as

partners.

After many complaints and an $8 million arbitration judgment against them over franchisee
rights, this

arrangement was terminated in 2002 as Livengood announced “The perception and confidence
of our investors is

more important to us than any business practice. I really regret the things that have put us in
this position, but there’s

been a tremendous amount of damage done to the credibility of honest people.” Journal of
Business Case Studies – April 2008 Volume 4, Number 4

Low Materiality Threshold In 10-Q’s

As soon as an interesting young company goes public, attention begins to focus on whether
they can meet

or exceed the consensus EPS estimates of analysts. As the following table shows, for the first
14 quarters of its

public life, Krispy Kreme did not disappoint:

Quarter Ended

Consensus EPS

Estimate

(Split-Adjusted)

Actual EPS

Reported

(Split-Adjusted)
4/30/2000 .0575 .0675

7/31/2000 .045 .0625

10/31/2000 .06 .0675

1/31/2001 .065 .075

4/30/2001 .085 .10

7/31/2001 .09 .10

10/31/01 .10 .11

1/31/02 .13 .14

4/30/02 .14 .15

7/31/02 .14 .15

10/31/02 .16 .17

1/31/03 .18 .19

4/30/03 .20 .21

7/31/03 .20 .21

An independent review team later confirmed that this was not an accident, as they accused
management of

having a “narrowly-focused goal of exceeding estimates by 1 cent each quarter,” and that “…
the number, nature and

timing of the accounting errors (later discovered) strongly suggest that they resulted from an
intent to manage

earnings.”

What investors apparently did not realize was how little additional earnings it took to beat the
estimates by

a penny. In the first two years, a one-cent increase in quarterly EPS could be generated by only
a $150,000 –
$200,000 increase in net income, which could be (and was) achieved by asking just one
franchisee to accept early

delivery of their doughnut-making equipment. Even as late as the summer of 2003, Krispy
Kreme was able to

increase quarterly EPS by a half-cent through an interesting agreement under which it sold
$700,000 of new

equipment to a franchise which was under an existing contract for repurchase, while
simultaneously agreeing to

increase the repurchase price by $700,000 to cover the additional cost.

While the ability to “beat the estimates by a penny” created a very high price-earnings ratio, it
also enriched

senior management, who had an Incentive Compensation plan worth almost $18 million
annually which began to

kick in if EPS performance exceeded estimates by 4 cents per year. Investors who were sensitive
to (1) how much

management compensation was at stake and (2) how small a profit change it took to exceed
EPS projections by a

penny would have placed significantly less importance on quarterly EPS results.

Joint Venture Results

As it expanded rapidly, Krispy Kreme began to finance franchisees by taking minority ownership
interests

in their stores. By the end of fiscal 2003, they had investments in 14 different area franchises
with annual sales

volume of $145 million. Since Krispy Kreme was required to use the equity method of
accounting for these

investments, their financial statements indirectly give evidence of the financial performance of
a selected sample of

their franchisees. As the following table shows, these franchisees reported losses in all but one
of the 16 quarters
between 2000 and 2003, and Krispy Kreme reported equity method losses of $5.1 million over
the four year period.Journal of Business Case Studies – April 2008 Volume 4, Number 4

QUARTER

EQUITY-METHOD PROFIT/(LOSS)

REPORTED BY KRISPY KREME

Q1 2000 $(245,000)

Q2 2000 (355,000)

Q3 2000 (64,000)

Q4 2000 (42,000)

Q1 2001 (171,000)

Q2 2001 (33,000)

Q3 2001 (8,000)

Q4 2001 (390,000)

Q1 2002 (198,000)

Q2 2002 18,000

Q3 2002 (639,000)

Q4 2002 (1,189,000)

Q1 2003 (694,000)

Q2 2003 (802,000)

Q3 2003 (33,000)

Q4 2003 (301,000)

While these were “paper” losses and had no direct effect on the financial stability of Krispy
Kreme, they
did provide evidence of a serious problem – in spite of the favorable publicity and long lines
outside newly-opened

outlets, a lot of the company’s franchisees were not making any money.

Repurchase Of Franchise Rights

While it is not unusual for franchisors to occasionally repurchase franchises from disgruntled
or

underperforming franchisees, few attempt it on such a large scale. From the second quarter of
2001 through the end

of fiscal 2003 (February 2, 2004), the company spent about $210 million in cash and stock to
buy out the stores and

future franchising rights of a number of area franchise developers. Critics found a number of
troublesome issues

here:

Why would so many large franchisees of a supposedly-successful chain want to get out of their
investment

when operations seemed to be going so well?

The largest single franchise buyout ($67 million) was owned by two present and past Krispy
Kreme Board

members. Analysts following the company immediately suspected a “sweetheart” deal for
former corporate

insiders.

The price paid for most of the buyouts seemed outlandish, reaching a peak of $11.2 million per
store at a

time when a new franchise could be set up an equipped for about $1.5 million.

About 85% of the purchase price for franchises ($175 million) was allocated to “repurchased
franchise

rights,”- the right to build new outlets within a given territory- yet by this time the company
was
discovering that further expansion to smaller and less desirable locations within existing
franchise areas

was usually not profitable.

Once acquired, these franchise rights were treated as an intangible asset not subject to
amortization, which

was contrary to the established practice of other franchisors who had made similar
repurchases. Amortizing

these rights over a 10-year period would have cut the company’s reported fiscal 2003 profit by
30%.

They bought out a struggling Michigan franchisee and agreed to raise the purchase price from
$26 million

to $32 million so that the franchisee could afford to close two stores and to settle its overdue
debts owed to

Krispy Kreme, thus avoiding a bad debt loss.

CONCLUSION

During the Krispy Kreme stock price run-up of 2000-03, a series of early warning signs
appeared, but

investors seemed to ignore them. While each of these signs individually do not presage a
coming disaster, when Journal of Business Case Studies – April 2008 Volume 4, Number 4

taken as a whole they should have served as a warning to investors. Publicly-available

documents show extensive

insider share-selling, significant conflicts of interest among senior managers and the Board of
Directors, an unwise

investment in a non-core business, high turnover in the CFO position, a willingness to buy out
the franchise rights of

insiders at premium prices, a history of operating losses at the franchisee level, a willingness to
use accounting
games to avoid putting debt on the balance sheet, and a disturbingly consistent trend of
beating quarterly EPS targets

by just enough to earn significant bonuses for executives. Wise investors should not have been
surprised when the

stock price began to fall precipitously in 2004 and the company (followed quickly by the SEC)
began an

investigation into its management decision-making and accounting practices.

NOTES
KRISPY KREME DOUGHNUTS, INC.: A CASE ANALYSIS2
Table of Contents
Table of Contents
2
III. Executive Summary
3
IV. Situational Analysis
5
A.
Environment................................................................................................................... 5
B. Industry
Analysis............................................................................................................ 5C. The
Organization............................................................................................................ 7D.
The Marketing Strategy................................................................................................. 8
V. Problems Found in Situational Analysis
10
A.Statement of primary
problem. ................................................................................. 10B. Statement
ofsecondary problem................................................................................ 11C. Statement
of tertiary problem. ..................................................................................... 12
VI. Formulate, evaluate, and record alternative course(s) of action
13
A. Strategic Alternative
1................................................................................................ 13
1. Benefits............................................................................................... . . . . . . . . . . . . . .
. . . . . . 13
2. Costs......................................................................................................................... 14
B. Strategic Alternative
2................................................................................................. 15
1. Benefits..................................................................................................................... 15
2. Costs.......................................................................................................................... 17
C. Strategic Alternative
3................................................................................................. 18
1. Benefits..................................................................................................................... 18
2. Costs.......................................................................................................................... 19
VII. Selection of Strategic Alternative and Implementation
20
A. Statement of Selected
Strategy.................................................................................... 20B. Justification of
Selected Strategy................................................................................. 21C. Description
of the implementation of strategy. ........................................................... 21
VIII. Summary
26
IX. Appendices
26
A. Financial Analysis and Selected
Tables....................................................................... 26
B. Reference
List.............................................................................................................. 30
KRISPY KREME DOUGHNUTS, INC.: A CASE ANALYSIS3
III. Executive Summary

Krispy Kreme Doughnuts, Inc.,began as a family-owned business back in 1937, as an

expansion ofa pre-existing business, when Vernon Rudolph purchased a doughnut

shop

along with the now-famous secret recipe for making yeast-raised doughnuts.His
doughnuts, which he delivered to grocery stores in the Winston-Salem, North Carolina

area, quickly became immensely popular with customers. So popular in fact, that he cut

hole in the wall of his shop so that he could sell hot doughnuts to potential customers

passing by on the street. (Peter and Donnelly, 2009, Page 690). Who knows, but this

may

have been one of the first “drive-thru/walk-up” windows in the restaurant business!And

that is just one example ofMr. Rudolph’s and his early partner, Mike Harding’s, forward-

thinking marketing ideas for that era.The idea of making all of the shops look the same,

so

that they would be recognized by patrons wherever they traveled, as well as the viewing

windows for watching the doughnuts being made, were good examples of marketing

promotional strategies.These strategies are still considered by Krispy Kreme to be

“Brand

Elements” as reported in current, annual financial reports. By keeping control of the

recipe

and the doughnut-making process, they also maintained product standards and

reduced,

while not completely eliminating, the competition through the uniqueness of their

product.

In fact, attempts to change the recipe, or even the look of the shops, in later years met
with

negative reactions from customers and the company quickly returned to the original

taste

and feel of the “original” Krispy Kreme.

KRISPY KREME DOUGHNUTS, INC.: A CASE ANALYSIS4

The company and its doughnut became synonymous with a particular look, taste and

feeling.This emotion that became associated with Krispy Kreme, described as “a feel-

good business” and one that “created an experience” as opposed to just selling

doughnuts

(Peter and Donnelly, 2007), became the core of the company’s marketing strategy, and

just

maybe, one of the prime reasons for its subsequent struggles in the early 2000’s.Selling

“feeling” or “experience” can be a successful marketing tool.But that’s just one of the

tools that a successful marketing plan must encompass.The company must also be

prepared to grow with the times and change with that growth. That is, the marketing

strategy of one time and place may not necessarily translate and/or work in another.

Financial systems of one era will not suffice for another and in this age of advanced

access

to information, inaccuracies can be extremely damaging to investor confidence.

This analysis of the Krispy Kreme Doughnut, Inc. case study will attempt to uncover

someof the reasons for the company’s challenges, suggest some potential strategies

and possiblesolutions as well the steps for implementing those strategies.

KRISPY KREME DOUGHNUTS, INC.: A CASE ANALYSIS5
IV. Situational Analysis
A. Environment

Krispy Kreme Doughnuts, Inc. was founded in 1937 and is headquartered in

Winston-Salem, North Carolina.Krispy Kreme isa major competitor in the

restaurant industry, known primarily for its donuts. Near the end of 2004

and the beginning of 2005, the economy began to slow. Other business in

competition with Krispy Kreme began to crowd into its market and

expansion plans that Krispy Kreme had projected had to be scaled back due

to falling sales.Consumer interest in reduced carbohydrate consumption,

including ,but not limited to, the interest in and popularity of low

carbohydrate diets, such asthe “Atkins” and “South Beach” diet plans have

been blamed for declining sales in pre-packaged (grocery store) donuts.

B. Industry Analysis

Their leading competitors are “Dunkin Donuts”, with worldwide sales of

$2.7 billion (2002) 5200 outlets worldwide and a 45% market share based

on dollar sales volume, and “Tim Hortons”, a Canadian-based company,

which has expanded in the U.S. Markets. “Tim Hortons” sales in 2002 in the

U.S. (160 outlets) and Canada (2300 outlets) were a combined $651 million.
A major strategy that “Dunkin Donuts” has used successfully is to

emphasize its coffee sales more than its donut sales.Their drive-thru