Krispy Kreme serves up accounting woes

What's more, it said it has guaranteed $52.3-million in loans to its franchisees but warned that if it is forced to honour those guarantees, it may not have enough cash on hand to continue operations.

The Globe and Mail
January 5, 2005

Krispy Kreme serves up accounting woes
Stock battered on news it has to restate profit for the last three quarters of fiscal 2004
Richard Bloom

Shares of Krispy Kreme Doughnuts Inc. were battered yesterday as investors digested news of a large hole in the once-trendy firm's balance sheet.

Krispy Kreme, which has 440 stores, including nearly 20 in Canada, said in a filing with U.S. regulators that accounting errors will force it to restate profit for the last three quarters of fiscal 2004.

The move will wipe between $3.8-million (U.S.) and $4.9-million, or as much as 8 cents a share off the bottom line for the 12-month period ending Feb. 1, 2004.

(The company posted a profit of $56.8-million or 92 cents a share in 2004).

Krispy Kreme shares closed down $1.83 or 15 per cent at $10.48 on the New York Stock Exchange yesterday, on five times the usual volume. They are now within spitting distance of a $9.64-a-share multiyear closing low touched in November, and a fraction of their all time high of nearly $50 in 2003.

The profit restatement is the latest blow in a flurry of bad news from Krispy Kreme since May.

In the past nine months, the company blamed the wildly popular low-carbohydrate craze for its first quarterly loss as a publicly traded concern, was informed of an investigation by securities regulators and was slapped with lawsuits from investors.

The restatement, which stemmed from how it accounted for the repurchase of three franchise restaurants, is also expected to affect the first and second quarters of its 2005 fiscal year, but the adjustments shouldn't have a material impact on those numbers, the company said.

Because of the restatement, the doughnut maker's primary lenders have the option to recall $90.9-million in outstanding loans, the company said. It is now unable to borrow more money, and while it has requested a waiver on the default provisions and is negotiating with lenders "there can be no assurance that the lenders will accede," Krispy Kreme said in a statement yesterday.

What's more, it said it has guaranteed $52.3-million in loans to its franchisees but warned that if it is forced to honour those guarantees, it may not have enough cash on hand to continue operations.

But while the stock plunge is a big concern for investors, there are also worries about the company's liquidity.

"There are many more questions than answers, especially given increased concerns regarding company liquidity," John Ivankoe, an analyst at J.P. Morgan Securities Inc. in New York, said in a research note.

He maintained his "underweight" rating on the stock and said that it is "substantially overvalued" on a price-to-earnings and cash-flow basis.

"We believe down earnings are likely for the next several quarters and do not see any near-term multiple upside … on our calendar 2005 EPS estimate [of 45 cents a share]," he added.

At Legg Mason Wood Walker Inc., analyst Glenn Guard said Krispy Kreme shares should be in the $7-to-$8 range but doesn't think the Street will let them fall to that level, unless, of course, the company hits investors with more negative news.

Meanwhile, Krispy Kreme of Winston-Salem, N.C., which only a few years ago saw its stock skyrocket amid rapid expansion and long lineups at its stores, has had a bona fide reversal of fortunes in recent months.

Last May, the company posted its first quarterly loss since going public in 2000 and slashed its full-year earnings target — pointing to low-carb diets, which forbid nearly all starchy foods such as bread, pasta and doughnuts.

For their part, critics say the company expanded too quickly and saturated its market by making its product available in grocery stores and convenience stores.

In addition to the earnings woes, the company said in July that the U.S. Securities and Exchange Commission is investigating Krispy Kreme's repurchase of franchises, and the company lowered its earnings outlook.

Earlier this week, word surfaced that a recent filing in a shareholder lawsuit against the company alleges that executives routinely padded sales by doubling doughnut shipments to wholesale customers at the end of fiscal quarters.

Unsold doughnuts were then shipped back after the quarters ended, the suit alleges.

The charge, which has not been proved in court, was levelled by two unidentified "confidential witnesses," who are former employees of the company, and is part of a consolidated group of shareholder lawsuits that claim executives at the doughnut maker knew sales were slowing by at least January, 2003, but hid that fact until May.

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