Krispy Kreme franchise buybacks are questioned

"That would be a factor that would be considered to decrease the value of certain of these franchise rights," he said. "Krispy Kreme is making the case that they don't believe their franchise rights decline in value. That, to me, is a little bit tough to argue."

USA Today
August 4, 2004

Krispy Kreme franchise buybacks are questioned
Nichola Groom, Reuters

NEW YORK — Krispy Kreme Doughnuts (KKD), whose buy-back of franchises is under federal scrutiny, will likely face questions about why its accounting for such deals differs from others in the restaurant industry, experts say.

Investors and accounting experts are questioning Krispy Kreme's repurchase of franchises from executives, directors and other insiders for what some said are hefty sums.

And unlike other restaurant operators, Krispy Kreme does not amortize, or reduce the value of those assets, on its books over time.

Depreciating the assets would both trim the value of assets that Krispy Kreme carries on its balance sheet and reduce profits, because amortization is taken as a non-cash charge against earnings.

"That's what helps earnings," says Peter Kyviakidis, a forensic accountant with risk consulting firm Kroll Inc. "Depending on the periods that are affected there could be a number of years that might need to be restated."

A survey of 18 of Krispy Kreme's peers by Camelback Research Alliance of Scottsdale, Ariz., found that four restaurant operators — Yum Brands (YUM), Schlotzsky's (BUNZ), IHOP (IHP), and Checkers Drive-In Restaurants (CHKR)— recorded reacquired franchise rights. All four amortized those rights over time.

"It's not clear on the surface if it's a violation of GAAP (generally accepted accounting principles), but as far as industry practices go, it's aggressive," says Rob Miceli, an earnings quality analyst with Camelback.

On a conference call with investors in May, Krispy Kreme Chief Executive Scott Livengood defended the treatment of reacquired franchise rights, saying they were in accordance with generally accepted accounting principles.

Officials of Krispy Kreme, whose lowered earnings outlook issued in May is being probed by the U.S. Securities and Exchange Commission, could not be reached to give further details on the company's accounting practices.

Maintaining a set value on the assets is especially troubling in light of the company's statements that low-carb diets have taken a bite out of doughnut sales and Krispy Kreme's ability to increase profits, Kyviakidis says.

"That would be a factor that would be considered to decrease the value of certain of these franchise rights," he said. "Krispy Kreme is making the case that they don't believe their franchise rights decline in value. That, to me, is a little bit tough to argue."

This is not the first time Krispy Kreme's accounting has been questioned.

In 2002, the company decided to use conventional on-balance-sheet financing for a new distribution facility after plans to use a controversial debt instrument were questioned in media reports.

At the time, Livengood said there was "no reason to do anything that could be misinterpreted."

And while the company has defended its treatment of reacquired franchise rights as being in accordance with GAAP, one attorney says that may not matter to the SEC.

"Something can be in accordance with GAAP and yet not be a fair representation of the financial presentation of the company," said Alan Berkeley, a partner at the Washington law firm of Kirkpatrick & Lockhart.

"When Sarbanes-Oxley (federal law) requires the CEO to make a certification, it requires that it be a fair presentation, not that it be a fair presentation in accordance with GAAP," Berkeley said.

Krispy Kreme's chief operating officer, John Tate, said in May that the company would continue to buy back franchises and had a goal of having 750 to 1,000 stores in North America, all company-owned.

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