Krispy Kream Is a Historic and Iconic

Krispy Kream is a historic and iconic franchise. Its products have often resulted in cult like followings that have been very beneficial to shareholders and executives alike. However, like many companies during the early 2000's, the company fell on hard times. Accounting mistakes, coupled with executive turnover, and misplace product changes; all hindered the company's growth. As the case indicates, through the confluence of multiple mistakes, the company quickly went from an analyst's favorite stock to its most despised.

What can the historical income statements (case Exhibit 1) and balance sheets (case Exhibit 2) tell you about the financial health and current condition of Krispy Kreme Doughnuts, Inc.

The company, according to the financial statements seems to be in good health. The company, during fiscal year 2004 had enough cash and cash equivalents to cover the immediate obligations of the business. The company's long-term debt has risen substantial, but given the companies ability to generate earnings, the debt load does not seem too excessive. The company however does have an excessive amount of accounts receivable which may indicate the company is loosening credit terms for its consumers and suppliers. Removing the roughly $45,000 dollars from accounts receivable would still leave the company with roughly $130,000 of current assets. This is more than two and a half times the company's current liabilities of $54,000. This ratio indicates that the company is able to pay many of its short-term obligations to its creditors. However, by loosening credit terms the company will risk not getting paid appropriately for the services it provides. This could result, if a massive wave of defaults occurs triggered by a massive recession or depression like event. Although unlikely, the possibility that the company may not be compensated is real. The overall long-term debt of the company is questionable given the nature of the food and beverage industry. In some instances, the company may attract favorable credit terms which it can then use to expand, repurchase stock, or otherwise pay off other liabilities. In this case, the company, in recent years is expanding overseas operations in an effort to drive same store sales growth. In order to so effectively, the company is taking on debt to fund the expansion into other countries. The company shows tremendous free cash flows relative to overall earnings. This allows the company to allocate capital in a manner that is beneficial for the continued viability of the company. Through the effective use of both free cash flow and debt, the company seems well positioned in regards to it financial health.

Upon reading the financial information in the case, the eventual restatement of earnings and goodwill would have adverse consequences on the financial health of the company. As the article stated, the company misstated the numbers and by doing so, created a more optimistic outlook for the company. What appears to be a very viable company in both the income statement and balance sheet is in actuality overstated and bloated. In this case, the company seems financially strong when in actuality it is not (Tosczak, 2006).

How can financial ratios extend your understanding of financial statements? What questions do the time series of ratios in case Exhibit 7 raise? What questions do the ratios on peer firms in case Exhibits 8 and 9 raise?

Many of the ratios within the case, much like the financial statements, seem to be overly optimistic. When looking at many of the more common financial ratios in isolation, Krispy Kream seems very successful in its operations. Its quick ratio is nearly double that of many of the other competing firms. The company's current ratio is nearly three times that of the nearest competitor. Upon further insights, these ratios are overstated much like the financial statements. For instance, McDonalds, which is highly regarded as one of the most efficient operations in the world has a receivables turnover of 21.56. In comparison Krispy Kream has receivables turnover of half that, meaning its turning is receivables at a much quicker rate. This is not inconceivable; however the numbers seem very optimistic considering other competition in the market place. In many instances, the inability of the company to properly amortize its franchisee costs inflated the ratios of the company.

In regards to the ratios of peer firms, questions regarding the company's efficient operation, use of assets, and collection of receivables should be raised. In each of these instances, Krispy Kream is by far the superior company on paper. However, in the real world, questions should be raised as to how the company is accomplishing this superior performance relative to peers.

Is Krispy Kreme financially healthy at year-end 2004?

The company, on paper, seems financially healthy at year end 2004. It seems that the company put many of the restatement issues of the past behind it. Many key metrics such as total assets, earnings, and debt seem favorable given the market circumstances prevailing at the time. For instance, at the year end of 2004, the company had roughly $660,000 assets, as compared with liabilities of roughly $154,000. Net income also increased substantially over the year. The company also owns much of the land and stores in which it operates providing assets that can be sold in the event of adverse company operations. Finally, in the event that the company needed equity financing, I believe the market would provide the necessary funding, in part, due to its loyal customer following. These aspects, I believe, provide a stable financial foundation by which the company can continue to operate with.

In light of your answer to question 3, what accounts for the firm's recent share price decline?

Human emotions are the primary catalyst for share price decline. In many instances, investors have a herd mentality. Then tend to follow "experts" who are believed to be more adept at financial analysis and stock picking. Trusting these authoritative figures, investors tend to follow their recommendations regarding individual securities. As such, during the period in question 3, the company had numerous sell recommendations from these "experts" As such, the investments community, following the herd mentality elected to sell their shares. This action resulted in the recent decline in the stock price. Instead of looking at the franchise, investors are instead relying on opinions of authoritative figures. This herd mentality often causes extreme movement in regards to over optimism, or extreme pessimism. The latter is prevailing in regards to Krispy Kream's stock price.

What is the source of intrinsic investment value in this company? Does this source appear on the financial statements?

The source of intrinsic value for the company is its brand and loyal customer base. This "asset" will not appear on financial statements because it is difficult to quantify. How valuable is the following of Nike? How valuable is the following of Starbucks? It is hard to put a precise number on this intrinsic value, so many analysts elect not to consider it. In regards to Krispy Kream however, the loyal following and devotion by its customers is an extreme competitive advantage for the firm. Companies can not replicate the overall feeling associated with the Krispy Kream donut experience. This provides value in many forms including a loyal customer base, deeper relationships, and a recurring revenue stream.