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
