Harvard Business Case Krispy Kreme Doughnuts

Content

List of Tables

1. Introduction

2. Growth plans and financial/financing strategy of Krispy Kreme’s Management for the following 2 years

3. Analysis of budgeted financial position and performance of Krispy Kreme Doughnuts for 2003 and 2004
3.1. Adjustment of Income Statement for 2001 until 2004
3.2. Analysis of Sales
3.3. Analysis of Expenses
3.4. Analysis of Profit and Earnings
3.5. Summary of analysis

4. Liability Structure of the Company

5. Advise to the Management about the desired financial strategy and the consequences for the overall strategy of the company

Annex

Sources

List of Tables

Table 1: Growth of Net Sales positions

Table 2: Distribution of Net Sales positions

Table 3: Growth of Expenses

Table 4: Percentile distribution of operation expenses

Table 5: Expenses / Sales Ratio

Table 6: Nominal Margins

1. Introduction

Krispy Kreme Doughnut is an American corporation, which started business in 1937 as a small regional company. It developed quite well in the first years but started it’s big push end of the 90ies. Currently the concept is based on company stores, which produce doughnuts and sell them to supermarkets and bakeries but also within the production facilities. To realise the growth of the past Krispy Kreme offered the business concept as a franchise to interested entrepreneurs within the whole US. The franchise concept has recently changed to an area developer concept under which entrepreneurs have the right to open a defined number stores in a designated area. Krispy Kreme is on one hand equity stakeholder in the franchises to participate in the positive results and on the other hand they request royalties from the area developer and franchisees for every store based on the sales figures. For additional growth the franchise concept will be replaced by the area developer concept in the future. The third profit area is the sales of equipment to the area developer stores, which guarantees a constant quality of the products.

Krispy Kreme Doughnuts went public in April 2000 and had a follow-on public offering in February 2001. Compared with the development of the S&P 500 the stock of Krispy Kreme performed much better and won 375% whereas the S&P 500 lost about 20% in the same time period.

The company has ambitious growth plans for the years 2003 and 2004. Based on these plans of the company, on the business concept, on the opportunities and on the competitive situation two analysts from CIBC World Markets have forecasted the business performance and financial situation of Krispy Kreme Doughnuts in 2003 and 2004. They have developed an Income Statement for these years; the purpose of this paper now is to analyse this forecast statement and give the management of Krispy Kreme Doughnuts an advise regarding their desired financial strategy and on the consequences this strategy might have for the overall strategy of the company.

2. Growth plans and financial/financing strategy of Krispy Kreme’s Management for the following two years

Systemwide Krispy Kreme Doughnuts had 218 stores under it’s brand beginning of 2002. From these stores about 75 were own company stores and 143 were franchise stores. The company management announced that they contractual obligated the area developers to open 200 stores in the US in the period of 2003 to 2006. If linear growth is assumed in 2003 and 2004 100 additional stores under the franchise / area development concept can be expected. In addition to that Krispy Kreme plans to open at least some company owned stores in 2003 from which 12 are fix and for 2004 the same number can be expected. Based on the number of 218 stores in 2002 the number of stores would grow with 28,4% in 2003 and with 22,1% in 2004. The ratio of company owned stores from 34,4% in 2002 would decrease to 28,9% in 2004. Based on the fact that Krispy Kreme is not financing anything for the franchisees and the area developers the growth plan with the area developer concept is a sign that growth will happen with a reduced investment in assets but in long term royalty contracts.

Beside the new own and franchise / area development stores Krispy Kreme Doughnuts is evaluating the possibility of long term growth in countries abroad and the distribution channel enlargement with smaller production equipment, which can be sold to bakeries and coffee shops. But this is still under evaluation and not included in the CIBC forecast. Krispy Kreme is also planning to enlarge the amount of equity stake in franchisees stores, which are profitable. This gives them the possibility to participate in the profits of the stores and do not only rely on royalties and fees.

To cover the needed capital for the planned growth in 2003 and 2004 the management has made a clear statement where it should come from. It is planned to finance the growth with proceeds from the money of the initial public offering in 2000, the follow-up public offering in 2001 and the cash flows generated through the operation in 2003 and 2004. Liabilities are only planned to be used from the borrowing capacity of 40 Mio. $. Only if this is not enough they are planning to rise more capital through private equity or debts. This is a sign that they are willing to finance the whole growth through equity and own money.

Summarised it can be stated that the management of Krispy Kreme Doughnuts has the following growth and financial strategy for the years 2003 and 2004:

- A growth of about 30% p.a. is planned
- Franchise / area developers instead of own company stores
- Test and development of new sales channels
- Participate in franchisees profits via buying equity stakes
- Financing via the equity and cash flow instead of debts and liabilities

3. Analysis of budgeted financial position and performance of Krispy Kreme Doughnuts for 2003 and 2004

Based on the plans of Krispy Kreme Doughnut’s Management the performance for the years 2003 and 2004 were forecasted. These figures are the base for the following analysis.

3.1. Adjustment of Income Statement for 2001 until 2004

In the income statement prepared by the CIBC World Markets analysts a couple of minor mistakes were to be found. These mistakes were mainly in the years 2002 and 2003 and had an impact on the reported and forecasted operating profit and net income of Krispy Kreme. Beside that it would be easier to analyse developments during the years of operation when an additional year with it’s figures would be available. For these reasons Annex 1 shows an adjusted income statement table in which the year 2000 is added and all mistakes from the original one are corrected and marked red. The yellow coloured columns are the forecast periods. Annex 1 is the basis for the following analysis.

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