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University of St.

La Salle – Bacolod City

CLASS CASE 1: KRISPY KREME DOUGHNUTS, INC.

USLS Graduate School of Business and Management

in partial fulfillment of the requirement in

MBA 207B

COMPREHENSIVE FINANCIAL MANAGEMENT

Submitted to:

Felix D. Cena,CPA, Ph.D.

Submitted by:

Laika I. Lobaton

Shara Mae R. Lucot

August 18, 2018


CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

A. BACKGROUND OF THE CASE

Krispy Kreme Doughnuts, Inc. is a company that does not only boast iconic status, but it
had quickly become a darling of Wall Street. Less than a year after its initial public offering, in
April 2000, Krispy Kreme share were selling for 62 times earnings and, by 2003, it was dubbed
as, “the hottest brand in America”. With ambitious plan to open 500 doughnut shops over the
first half of the decade, the company’s distinctive green-and-red vintage logo and unmistakable
“Hot Doughnuts Now” neon sign had become ubiquitous.

At the end of 2004, however the sweet story begun to sour as the company made several
accounting revelations, after which its stock price sank. From its peak in August 2003, Krispy
Kreme’s share price plummeted more than 80% in the next 16 months. Investors and analysts
began asking probing questions about the company’s fundamentals, but even by the beginning of
2005, many of those remained unanswered.

B. INCOME STATEMENT ANALYSIS

Revenues / Income

Total revenues since year 2000 continually increased for the next 5 years. It is also
observed that in the income statement, operating income and net income of the company is
increasing. It is safe to say that the company is performing well in terms of profitability during
the 5-year operations since the operating income margin and net income margin also correspond
an increase of almost 4 times and 3 times more than the year 2000 performance, respectively.

Expenses

Along with the increase of KKD’s sales, there is also a significant increase in terms of
expenses. Comparing the amount expended from year 2000 to year 2004, the normal observation
basing on the figures is that the expenses had increased rapidly particularly the operating

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CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

expenses (considering the fact that it had also increased the production which is reflected as the
cost of goods sold that is included in the operating expenses). However, if the performance of the
company is viewed using the profitability ratios, it could be identified that despite the increase in
expenses, the percentage of expense is actually declining throughout the 5 years of operations.

Share Price

The price of the shares that are being sold in the market actually fluctuates throughout the
period. Probably because of the difficulties faced by the company like in 2003 where they close
down the operations of a franchise in Michigan for not being able to perform well.

Shares Outstanding

There is a significant increase in the total number of shares outstanding in the market.
Therefore, there is a possibility that the company had released several shares in the market for
sale for additional capital.

C. BALANCE SHEET ANALYSIS

Cash and Cash Equivalents

The cash and cash equivalents as well as the short-term investments of the Krispy Kreme
Doughnuts, Inc. are observed to be fluctuating throughout its 5 years’ operating period.
Comparing to the sales that is presented in the income statement, the cash and cash equivalents
of KKD is relatively small. This means that only a small portion of the products are being
recorded as cash sales. This is actually difficult for the company to have small collections
considering that they will be needing cash in order to operate and fund the necessary activities
that are needed to be funded by the company.

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CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

Trade and Other Receivables

Trade and other receivables on the other hand were observed to be continually increasing
throughout the 5 year period. This just means that a large chunk of the company’s sales are being
sold on credit, which is a disadvantage on the company’s part since there are also expenses that
they have to pay. However, no cash is available since there are less or no collections from the
existing receivables
Long-term Assets

Because of the continuous expansion of the business, the company’s long-term assets
value also increases.

Current Liabilities

From year 2000 to year 2003, there is a significant increase in the total amount of
payables. However, it was slowly paid-off from year 2004 when the company is already
recovering.

Long-term Liabilities

Long-term liabilities had greatly increased since 2001. This is in relationship of the
company’s ambition to expand. There is also a great increase in the revolving lines of credit that
had significantly increased the liabilities for the year 2004.

Shareholders’ Equity

There is a great amount of common stock outstanding especially on the latter years of
operations. And because of the increased income of the company for the last 5 years of
operations, most of the income is put as a part of the retained earnings of the company.

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CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

D. FINANCIAL ANALYSIS

Krispy Kreme Doughnuts, Inc. Financial Ratios


KKD
Fiscal Year Ended Averag
Ratios Ratio Definitions e
2004 2003 2002 2001 2000
Liquidity Ratios
(current assets - inventory) / cur.
2.72 1.96 1.63 1.46 1.05 1.76
Quick (acid-test) ratio liab
Current ratio current assets / current liabilities 3.25 2.36 1.94 1.77 1.39 2.14
Leverage Ratios
Debt-to-equity (book) LT debt / shareholder's equity 11.26% 19.46% 2.47% 0.00% 47.96% 16.23%
LT debt / (shareholder's equity +
10.12% 16.29% 2.41% 0.00% 32.41% 12.25%
Debt-to-capital debt)
Times-interest-earned EBIT / interest expense 23.15 33.59 124.29 38.73 7.11 45.37
Assets-to-equity total assets / shareholder's equity 1.46 1.50 1.36 1.36 2.20 1.58
Activity Ratios
Receivables turnover sales / accounts receivables 9.70 10.61 10.19 12.16 10.81 10.69
Inventory turnover cost of goods sold / inventory 17.76 15.66 19.61 20.84 19.04 18.58
Asset turnover sales / total assets 1.01 1.20 1.54 1.75 2.10 1.52
Cash turnover sales / cash and cash equivalents 32.79 15.26 18.00 42.80 69.19 35.61
Profitability Ratios
Return on assets net income / assets 8.64% 8.16% 10.33% 8.59% 5.67% 8.28%
Return on equity net income / shareholders' equity 12.62% 12.25% 14.06% 11.72% 12.47% 12.62%
Operating profit margin operating income / net sales 15.34% 12.17% 10.62% 7.82% 4.92% 10.17%
Net profit margin net income /sales 8.58% 6.81% 6.69% 4.90% 2.70% 5.94%

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CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

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Liquidity Ratios
Quick (acid-test)
0.96 0.47 0.60 0.23 2.72 0.49 1.34 0.33 0.77 0.76 0.61 0.26 0.80
ratio
Current ratio 1.42 0.76 0.99 0.63 3.25 0.76 1.58 0.77 0.92 1.52 0.88 0.55 1.17
Leverage Ratios
Debt-to-equity -
33.97 262.97 61.82 11.26 77.97 0.00 38.30 62.53 0.21 39.39 183.57 53.41
(book) 131.07
Debt-to-capital 25.36 72.45 421.90 38.20 10.12 43.81 0.00 26.98 38.11 0.21 28.26 64.74 64.18
Times-interest- 1014.1
6.99 -0.09 2.05 5.44 23.15 6.93 8.93 14.09 nmf 9.25 5.79 91.39
earned 0
Assets-to-equity 1.75 5.29 -0.62 2.50 1.46 2.13 1.26 2.18 1.83 1.31 1.80 5.02 2.16
Activity Ratios
Receivables
65.08 35.15 20.63 71.22 9.70 21.56 32.42 50.29 27.49 38.44 28.42 49.73 37.51
turnover
Inventory
133.39 59.30 46.88 52.83 17.76 89.84 38.75 44.87 111.24 10.58 79.58 91.32 64.70
turnover
Asset turnover 1.50 1.75 3.16 1.84 1.01 0.69 1.64 2.57 1.00 1.62 1.08 1.52 1.62
Cash turnover 12.00 38.83 40.90 147.12 32.79 41.64 8.74 110.73 40.31 10.84 17.12 46.04 45.59
Profitability
Ratios
Return on assets 12.23 -5.92 8.66 6.26 8.64 5.91 12.46 9.79 10.75 9.83 7.46 11.00 8.09
Return on equity 21.55 -31.30 nmf 15.65 12.62 12.59 15.64 21.33 19.69 12.89 13.42 55.18 14.11
Operating profit
8.24 3.49 13.20 6.94 15.34 19.62 14.02 6.38 23.42 9.48 13.35 12.77 12.19
margin
Net profit margin 8.32 -3.24 2.91 3.58 8.58 8.80 8.61 3.70 11.70 6.58 7.49 7.37 6.20
Competitors Financial Ratios and Industrial Average

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CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

Comparison of KKDs’ Financial Ratio to Industrial Average


Ratios Industry KKD
Liquidity Ratios Average Average
Quick (acid-test) ratio 0.80 1.76
Current ratio 1.17 2.14
Leverage Ratios
Debt-to-equity (book) 53.41 16.23
Debt-to-capital 64.18 12.25
Times-interest-earned 91.39 45.37
Assets-to-equity 2.16 1.58
Activity Ratios
Receivables turnover 37.51 10.69
Inventory turnover 64.70 18.58
Asset turnover 1.62 1.52
Cash turnover 45.59 35.61
Profitability Ratios
Return on assets 8.09 8.28
Return on equity 14.11 12.62
Operating profit margin 12.19 10.17
Net profit margin 6.20 5.94

a. Liquidity Ratio
The current ratio creates a positive effect on the part of the company considering its’ ratio
is 2.14 and the industry’s 1.17. This indicates that the company can pay its’ short-term liabilities.
Quick ratio on the other hand measures liquidity by comparing current assets minus inventories
divided by current liabilities. Krispy Kreme’s quick ratio is 1.79, while the industry’s 0.80. This
is a very positive ratio for the firm because it indicates that the firm has a competitive advantage
over the industry when it comes to its ability to pay off its debt.

b. Leverage Ratio
The leverage ratios show that the KKD is performing well compared to the industry in
terms of handling its debts. The table shows that KKD has more equity compared to its’
liabilities hence the cost of borrowing the capital will be much lesser and the company could
enjoy more of its’ earnings. However, it would still depend on the company whether it is
acceptable to have a higher contributed capital or would rather have more borrowed funds to
establish the business.
c. Activity Ratios

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CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

In terms of turnover, the KKD is performing well since the inventory turnover indicates
that it could actually sell its inventory faster than how the industry performs. The asset turnover
also indicates that the company is using its assets efficiently to generate more funds. Receivables
turnover are also shows that the company s collecting its’ receivables faster than how the
industry collects their receivables.

d. Profitability Ratios
Profitability ratios show that the return on asset does not really differ much on the
industries average. However it is still advantageous on the part of the KKD, since it has greater
ROA than the industry, at least for a fraction. Return on equity and operating margin however of
KKD is much lesser than the industries average. This means that even though the sales of KKD
is greater than the other companies, its’ expenses are much greater that it had caused a decline on
its operating income. Net profit margin is also lesser than its industry average most probably
because taxes charge and interest paid were both high.

E. RECOMMENDATION

a. Collection Policy
The company could try to reconstruct their receivable collection policy. It may be that instead
of allowing 30 days for the debtor to pay its’ credit, the collection period might be reduced to 15
days. Another is by providing discounts to debtors who could pay their debt before the due date
of their credit. In that way, the collection period will be lesser and the cash will be available for
the company to pay for their operating activities.

b. Franchise Oversight
Krispy Kreme is too ambitious with their goal of expanding their store into 500 branches all
over the world. This is actually one of the reasons why they had failed. Since the company could
not afford to build such great amount of stores, they had relied on the franchisees of the company
making 60% of their company a franchise holding while only owning 40% of the total stores
established. Now the franchisees handling the store (assuming are primers in the field of

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CLASS CASE 1: Krispy Kreme Doughnuts, Inc.

business), may have encountered some difficulties and had poor management decisions that
caused the decline in sales of some particular branches affecting the company as a whole. The
KKD could however try to target goals that are attainable, rather than targeting something so
great that could lead to the downfall of the company.

c. Expenses
Although expenses could be observed to be declining throughout the period, it could not be
denied that the amount for expenses is relatively high. Examples of which is the heavy
equipment that are used in the business. The company could opt to buy a similar type of machine
that is actually cheaper compared to the ones they are currently using. This would save a lot of
money for the franchisees and would even help the company grow by focusing their money on
other necessary operating expenses.

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