Does management have any discretion over how the accounts are estimated? ) 2. How can financial ratios extend your understanding of the financial statements? What questions do the time series (trend) of ratios in case Exhibit 7 raise? What questions do the ratios on peer firms (comparables) in case Exhibits 8 and 9 raise? Which of the comparable firms is truly a peer? 3.
Based on both the financial statements and the ratios, evaluate the financial health of KKD as of the year-end 2004. Be sure to address the firm’s liquidity, leverage, activity, and profitability. 4.In light of your answer to question 3, what accounts for the firm’s recent share price decline in 2004? To quote from the concluding paragraph in the case: “Were the revelations about the company’s franchise accounting practices sufficient to drive that much value out of the stock? Were there deeper issues at Krispy Kreme that deserved scrutiny? ” 5. What is the source of intrinsic investment value in this company? Does this source appear on the financial statements? (Hint: Compare the perspectives of finance and accounting. ) 6. Prepare a brief epilogue for this case.
What have been the developments since 2004? Stock Price International Expansion Change in Leadership Marketing Strategy Sales Answer:Krispy Kreme had flourished through the 90s and in April of 2000, had one of the most successful initial public offerings of the time. After the IPO, they launched an overly aggressive expansion plan. They earned revenues from on-premise sales, off-premise sales, manufacturing and distribution, and franchise royalties and fees. Krispy Kreme’s stock was trading for 62 times earnings and it was dubbed the “hottest brand in America”.However, good times quickly came to an end. They could no longer meet the growth expectations set by Wall Street and several accounting revelations caused the stock price to plummet. Krispy Kreme was a very healthy company in the beginning of the decade, but quickly deteriorated by the mid 2000s.
ANALYSIS 1. 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.? Krispy Kreme has experienced dramatic growth over the past 5 years based on their income statement.Every line on the income statement has grown rather impressively. Revenues have grown from $220M to $666M and net income has grown from $6M to $57M. Based on the income statement, Krispy Kreme is doing very well. The balance sheet of Krispy Kreme looks very similar to the income statement.
The majority of line items have experienced great growth. On the asset side of the balance sheet Krispy Kreme has eliminated their long-term investments and its tangible assets have increased from $0 to $176M. The increase of intangible assets was due to their aggressive accounting treatment for franchise acquisitions.On the liabilities and equities side, the most noticeable aspect is the revolving line of credit spike in 2004. Revolving lines of credit are typically used to provide liquidity for a company’s day-to-day operations so this is very concerning. 2. 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? Financial ratios can be used for a quick comparison to other companies in the industry and to the same company over time.
They allow you to ignore the numbers and focus on their relationships. The liquidity ratios have increased dramatically over the last few years. This is due to the increase in assets (stores, equipment, inventory). The increased liquidity ratios seem much healthier than the other firms. The times interest earned ratio was 124. 29 in 2002 and has fallen to 23. 15 by 2004.
This indicates that interest payments are catching up to earnings. The asset turnover ratio has fallen from 2. 10 in 2000 to 1. 01 by 2004. This can be attributed to the Krispy Kreme’s asset accumulation.Krispy Kreme has increased their returns on asset and returns on equity during the past 5 years. They have also increased their net profit margin from 2.
7% to 8. 6% during this time. Compared to their peers for 2003, it seems Krispy Kreme relies less on short-term debt. The leverage ratios suggest Krispy Kreme has much less long-term debt obligations than its peers as well. Krispy Kreme has a lower inventory turnover ratio than its peers which may suggest that the large amount of assets could be attributed to high inventory. Their return on assets is in the middle and the return on equity is low compared to others.This could be an indication that Krispy Kreme is not spending shareholder’s dollars appropriately.
3. Is Krispy Kreme financially healthy at year-end 2004? No, I do not believe that Krispy Kreme is a financially healthy company. The balance sheet is misleading due to the intangible assets. 4. In light of your answer to question 3, what accounts for the firm’s recent share price decline? The decline is due to an adjustment towards the real market value of the firm. The $176M of intangibles on the balance sheet is a serious problem. This amount is greater than the accumulated net income of the previous 5 years.
Additionally, a contributing factor of share price is future cash flows and growth. The aggressive expansion plans have been eliminated and the company has lost the majority of its capital. Analysts have revealed that Krispy Kreme have not been spending its capital appropriately. 5. What is the source of intrinsic investment value in this company? Does this source appear on the financial statements? The intrinsic investment value of this company appears to be based on the growth opportunity. Due to the high expectations of growth and results from Wall Street, Krispy Kreme was pressured to keep releasing great numbers.This caused them to use very aggressive accounting procedures for acquisitions which contributed to a large loss.
Instead of being satisfied with steady growth, they tried to get too big too fast. CONCLUSION During the past 5 years, Krispy Kreme lost focus on their core values. They tried to meet Wall Street expectations and essentially collapsed. If we can learn anything from Krispy Kreme, it is that you must stay true to your core values. They expanded too rapidly and quickly oversaturated the market through grocery and other third venue sales. Krispy Kreme moved too far away from what originally provided its appeal, the factory store.