The question is what they do wrong for the business that is nearly more than 70 years, what makes them fall so quickly especially in year 2003 and 2004, there are at least 2,300 franchised businesses in Unites States, many that are successful, but there are difficulties in the franchise model, and Krispy Kreme with the combination of ambitions, greed, and inexperience in managed to stumble into most of them.As Krispy Kreme pursued its ambitious growth strategy, it was making mistakes in its finance department as well, except for the company's plan to finance a $35 million mixing plant in Illinois with an off-balance sheet synthetic lease a plan the company scuttled in February 2002, in the face of post-Enron suspicions Krispy Kreme's accounting seemed unremarkable until October 2003. That's when the company reacquired a seven-store franchise in Michigan, called Dough-Re-Mi Co, for $32.1 million. The company booked most of the purchase price as an intangible asset called "reacquired franchise rights," which it did not amortize, contrary to common industry practice.
Krispy Kreme had also agreed to boost its price for Dough-Re-Mi so that the struggling franchise could pay interest owed to the doughnut maker for past-due loans. The company then recorded the subsequent interest payment as income.On their accounting and their lack of expose, Krispy Kreme may have paid overstated prices for some of the franchises it bought back. In 2003, the company spent almost $67 million to repurchase six stores in Dallas and rights to stores in Shreveport, Louisiana, that were owned in part by former Krispy Kreme board member and chairman and CEO Joseph A.
McAleer Jr. Another longtime director, Steven D. Smith, was also part owner. Compared with the $32.1 million paid for the Michigan stores that same year, the number sounds high $11.2 million versus $4.
6 million per store. A civil suit filed by another former franchisee claims, a higher bid was offered but ignored.By august 2003, Krispy Kreme Dounghnut's (KKD) was trading at nearly $50 on the New York Stock Exchange, up 235 percent from its initial public offering (IPO) price of $21 on Nasdaq, for the fiscal year ended in February 2004, the company reported $665.6 million in sales and $94.
7 million in operating profit from its nearly 400 locations, including stores in Australia, Canada, and South Korea. And then, just as rapidly as its popularity rises, Krispy Kreme pitched into a steep downward spiral that will be ending up with bankruptcy.Krispy Kreme's repurchase of its northern California stores from a group of investors is also under scrutiny. The company paid $16.8 million to buy the 33 percent of Golden Gate Doughnuts LLC it did not already own.
One of the beneficiaries of the buyout was the ex-wife of CEO Scott Livengood. The company failed to disclose this fact, although Adrienne Livengood's stake was valued at around $1.5 million. While the decision not to reveal the connection looks really bad and this is only a significant legal issue if it somehow could be established that Livengood was seeking some kind of personal profit or gain through his ex-wife, as opposed to truly serving the company's interest," says Carl Metzger, a partner with Goodwin Procter LLP in Boston.
The Securities and Exchange Commission (SEC) came in July 2004, making an informal inquiry into Krispy Kreme's buybacks of several franchises. As the stock price plunged, shareholders filed suit. Franchisees alleged channel stuffing, claiming that some stores were getting twice their regular shipments in the final weeks of a quarter so that headquarters could make its numbers. The SEC upgraded its inquiry to "formal" status in October 2004. Average weekly sales, a key retailing measure, fell even as the company continued to add stores. In January 2005, Krispy Kreme decided to restate its financials for much of fiscal 2004.
Then Livengood was replaced as CEO by turnaround specialist Stephen Cooper, who also kept his other job: interim CEO of Enron Corp.Krispy Kreme also rolled into the price the costs of closing stores and compensating the operating manager and principal owner of the Michigan franchise to stay on as a consultant. Both of these expenses became part of the intangible reacquired franchise rights asset on the company's balance sheet, rather than costs that would have reduced the company's reported earnings. Krispy Kreme announced in a December 2004 8-K filing that it will need to make an adjustment of between $3.4 million and $4.8 million to properly record the compensation as an expense.
A second adjustment of some $500,000 will reverse the improper recording of interest income.In its December 2004 8-K, Krispy Kreme revealed that there would need to be adjustments made to the accounting for the Golden Gate Doughnuts purchase as well a total of $3.5 million to correct improperly recorded compensation expenses and management fees that had been included in the purchase price. The company will also make a similar correction to fix errors made in the acquisition of a franchise in Charlottesville, Virginia.The following month, the company announced that the United States Attorney's Office of the Southern District of New York was also joining the fray a move indicating concern about possible criminal misconduct.
In April, Cooper shored up the business by securing $225 million in new financing. The company announced that it expected a loss for its latest quarter, and warned investors not to rely on its published financials for fiscal 2001, 2002, and 2003, and the first three quarters of fiscal 2005, in addition to those for 2004. By early May, Krispy Kreme still hadn't filed its restated financials, and its shares were trading around $6.
