Krispy Kreme
Depreciation Analysis:
Depreciation is the decline in value of an object over time. Depreciation is calculated using Straight line method. Benefits from asset are likely to be constant over its life, so straight-line method of depreciation is appropriate as it results in a constant annual depreciation charge.
Krispy Kreme uses SFAS-142 for accounting of intangible assets. As per this method, intangible asset with indefinite life is not amortized. They are subject to impairment test. Use of SFAS-142 result in more volatility in reported income as impairment losses may occur irregularly and in varying amounts.
Company Stock Analysis:
No. of common shares outstanding has increased from 54,271 thousand to 56,295 thousand in 2003, a rise of 3.73%.
Krispy Kreme has authorized 10,000 shares of preferential stock but has not issued them.
There is no Treasury stock reported.
Krispy Kreme has not made any dividend payments since 2001. So, Dividend Yield is 0% for 2002 and 2003. The increase in Earnings per share from $0.49 in 2002 to $0.61 in 2003 evidence of the growth potential of the company. Company’s asset has also grown in 2003. This indicates that Krispy Kreme’s stock is a “Growth Stock” and explains why it has not paid any dividend.
“We intend to retain our earnings to finance the expansion of our business and do not anticipate paying cash dividends in the foreseeable future……Dividend Payments are restricted by our bank credit facilities to 50% of our net income for the immediately preceding fiscal year.”[i]
Cash Flow Statement Analysis:
Krispy Kreme uses the Indirect Method of reporting Operating Cash Flows.
In 2001 the cash provided by operating activities was $32,112 (Thousand), while the Cash dividends was $7,005 (Thousand). Cash provided by operating activities exceeded the cash paid for dividends. The company did not pay any cash dividends in 2002 and 2003.
The largest item in reconciling the difference between net income and cash flow from operations is the increase in accrued expenses of $7,966 (thousand), while in 2002, the largest item in reconciling the difference between net income and cash flow from operations is the $13,317 increase in receivables; and finally in 2003, the largest item in reconciling the difference between net income and cash flow from operations is the tax benefit from the exercise of nonqualified stock options of $13,795 (thousand).
In 2002, the largest amount in investing activities is $37,310 for additions to property and equipment. In 2003, the largest amount in investing activities is $83,196 for additions to property and equipment. So, cash outflow in investing activities has increased in 2003.
In 2002, the largest amount in financing activities is the cash inflow of $17,202 which are the proceeds from sale of stock while in 2003, the largest amount in financing activities is the $2,170 cash outflow for repayment of long term debt.
Liquidity has improved from 2002 to 2003 which is evident from the fact that the increase in the cash flow provided by operating activities has increased from $36,210 in 2002 to $51,036 in 2003. Company is funding capital requirements primarily through cash flow generated from operation.
“We funded our capital requirements for fiscal 2000, 2001, and 2002 primarily through cash flow generated from operations….Over the past three years, we have greatly improved the amount of cash we generate from operations. We believe our cash flow generation ability is becoming a financial strength and will aid in the expansion of our business.”
Income Statement Trend Analysis:
Company has been able to control costs of sales. Cost of sales is growing slower than the growth of sales. Growth in operating expenses is less than growth of sales in both 2002 and 2003.
In both 2002 and 2003 % increase in income tax is more than percentage change in sales. But Net profit increase in percentage terms is more than sales increase. It indicates that company is operating efficiently. The reason of steep increase in Net profit as compared to sales is dramatic control of cost of sales.
The increase in percentage term in General and Administrative Expenses has been more than increase in sales in both 2002 and 2003. Company cites that the reason is their expansion for which they have incurred more personnel and related salary and benefit costs.
“The growth in General and Administrative Expenses is due to increased prototype expenses, increased personnel and related salary and benefit costs to support our expansion, and other cost increases necessitated by the growth of the company.”
Management Analysis:
Krispy Kreme is facing many risks that are being faced by almost all companies in the market.
Risks faced by Krispy Krene are:
· The company’s abilities to manage growth
· Possible delays in store openings
· Quality of franchise store operations
· Changes in consumers’ preferences
· Competition
· Compliance with government regulations
Company cites the potential reasons for differences in economic performances and expectations as the company’s ability to continue and manage growth; delays in store openings; the quality of franchise store operations; the price and availability of raw materials needed to produce doughnut mixes and other ingredients.
“Forward-looking statements are based on management’s beliefs, assumptions, and expectations of our future economic performance….Forward-looking statements involve risks and uncertainties that may cause our actual results, performance or financial condition to differ materially from the expectations of future results ….Factors that could contribute to these differences include, but are not limited to: the company’s ability to continue and manage growth; delays in store openings; the quality of franchise store operations; the price and availability of raw materials needed to produce doughnut mixes and other ingredients…”
Financial Ratios Analysis: (Exhibit - Calculation Excel Sheet)
Based on financial ratios, Krispy Kreme can be considered as a healthy company with growth prospects. Ratio Analysis is presented below:
1) Liquidity Ratios: The company’s Current ratio has increased from 1.94 in 2002 to 2.36 in 2003. respectively. Quick ratio has increased from 1.63 in 2002 to 1.96 in 2003. Cash ratio has increased from 0.42 in 2002 to 0.54 in 2003. Company’s increase in liquidity ratios from 2002 to 2003 indicates that company has improved its ability to repay short term debt and it is a positive sign for the company and investors.
2) Long Term Solvency Ratios: Krispy Kreme’s Total Debt ratio has increased from 0.27 in 2002 to 0.33 in 2003, and the Debt-to-Equity ratio has increased from 0.36 in 2002 to 0.50 in 2003. Increase in Debt-to-equity ratio indicates that company is relying more on debt. Cost of debt is less than cost of equity so WACC of the company will come down. At the same time, high deb-to-equity ratio increases company to solvency risk. After a limit, increase in debt increases cost of capital too and risk of bankruptcy increases.
Also, Times Interest earned ratio has dropped from 127.25 in 2002 to 31.75 in 2003.
High increase in debt-to-equity ratio and drop in Times Interest earned ratio indicates that company’s ability to serve long term debt is detoriating.
3) Asset Utilization Ratios: Krispy Kreme’s Inventory Turnover has decreased from 22.49 in 2002 to 18.83 in 2003. Days’ Sales in Inventory has increased from 18.61 in 2002 to 23.31 in 2003. This indicates that company is not managing its inventory as efficiently it was managing in 2002.
The Receivables Turnover ratio has dropped from 16.87 in 2002 to 16.05 in 2003. Days’ Sales in Receivables have increased from 24.89 in 2002 to 25.52 in 2003. The Total Assets Turnover ratio has also deteriorated from 1.85 in 2002 to 1.48 in 2003. These ratio’s indicate that company’s asset utilization efficiency has decreased in 2003.
4) Profitability Ratio: Though company’s Profit Margin has increased marginally from 6.69% in 2002 to 6.81% in 2003, its Return on Assets have declined from 10.33% to 8.16%, and the Return on Equity have also declined from 14.06% to 12.25% for the same period. But company’s EPS has increased significantly from 0.49 in 2002 to 0.61 in 2003 , a rise of 24.5%.
Company’s profit margin as well as EPS has increased in 2003 as compared to 2002, though increase in profit margin has not been significant.
Conclusion:
Krispy Kreme is a growth company. It has made heavy capital investment. Company is generating positive cash flow from operation and as management says, kits capital investments are primarily funded by cash flow from operation. Improvement in liquidity ratio is a positive sign for the company. A jump of 24.5% in EPS justifies growth of the company. Company’s decision to not to pay any dividend in 2002 and 2003 is fully justified as company is involved in expansion activities.
There is concern regarding company’s ability to oblige long term debt. Company should review its policy to rely heavily on debt financing as its debt-equity ratio is increasing. Also, company should revisit its asset utilization as company has not been able to utilize its assets and manage inventory as efficiently as it did in 2002.
Over all, Krispy Kreme is in good financial and having good growth prospects.
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