The following are the major problems KID were facing: It mistakenly tied up the profit, the number of stores, and the sales of machines and ingredients together. Moreover, it was too aggressive. It was hungry to show its ‘perfect performances’ to investors by beautifying their book value. From non-financial perspective, there are serious drawbacks behind the expanding, and the growing numbers of stores made the K Doughnuts ‘everywhere’, which made customers lost their feelings of freshness of It.
As the case mentioned, KID raised Its purchase price on the Michigan franchise In order to get the Interest of loans back and KID recorded the interest under as an immediate income, profit. In the meanwhile, it booked the cost of buyback the franchise and the payment to the executive as an intangible asset, which the company did not amortize. In my opinion, the interest should be recorded under equity and the cost and payment could be booked as properties, cost, or at least they need to be amortized.
KID got the interest from the franchise and successfully raised Its revenue to attract Investors but it in fact sacrificed Its hardliners’ benefits by offering an over value purchasing prize. Moreover, keeping the previous executive till the trade closed and giving a huge amount of compensation makes me wonder if there was an inside trade. Exhibit 1, 2& 3 shows the unhealthy growth of KID. Compared to the growth of total revenues in the whole company, revenue that each stores contributed (total revenue/ total factory stores) was not increasing accordingly.
On the contrary, the expansion of stores brought the corporation high expenses and venture. The cost of opening a new store, aqualung It and close It was paid in vain. The number of stores grew too quickly. The exhibit also shows the abnormal high value of stock-price patterns compared to the S 500 Composite Index but it was finally down to the earth’ in the end of 2004 influenced by the divesting of Montana Mills and closing down of 3 underperformed stores.
Viewing the company structure, revenues were generated from on-premises retail sales at company-owned stores (accounting for 27% of revenues); off-premises sales to grocery and convenience stores (40%); manufacturing and distribution of product mix and machinery (29%1 and franchisee loyalties and fees (4%). Actually, the ideal revenue resources of this kind of corporation should mainly come from the franchisee royalties and fees but not from distribution of mix and machine. The company supposed to boost the sales of its main product: doughnuts but not to expansion blindly.
Once its doughnuts become popular and profitable, people will be willing to get In to the business and pay KID franchisee royalties and fees. However, the realistic was many units were losing money off-premises, and franchisees were not motivated to grow their sales, which fleets a governance problem in this corporate that the company itself did not has mutual benefits with its franchisees. The stock price of KID was fluctuated severely in recent years and the suggestions of buy, sell or hold from analysts were closely related to the stock price and scandal. ND January 2005, when the stock price was at its peak, at 22. 51 dollars per share (first under estimate), at 15. 71 dollars per share (divested Montana Mills) and at less than 10 dollars per share (credit-facility defaulted). Crispy Seeker’s share price was $40. 63 right after its PIP, giving the firm a market capitalization of nearly $500 lions. The stock price might be over valued at first because KID was so popular at the time and therefore the public drove up the price. After a series of problem, the company restated its financial statements for the PAYOFF, which reduced pretax income by between $6. Million and $8. 1 million. This movement sharply decreased the tax expenses of the company, which is proved by items of income before income taxes, provision for income taxes and income taxes refundable in Exhibit 2. It is strange that given a large amount of amortized intangible asset, the company still ad a high level of tax shield as shows in the depreciation and amortization expenses from Exhibit 1 . Thus, the company might be showing a higher profit for investors but lower income for tax purposes, changing the treatment of amortization between the two.
This practice violated the requests and rules in GAP. Knowing the accounting tricks that KID was playing, people can approximately calculate its book value by amortizing its asset, increasing its cost and tax, which leads to a deduction of profit. Influenced by the divesting of Montana Mills, the interest expenses, income tax refundable, long-term notes receivable, Joint venture ND intangible in 2004 increased dramatically and the share price dipped compared to them in 2003 as we can see from the Exhibit 1&2.
However, it is odd that the interest expense raised so much when then the long-term debt decreased. Furthermore, from the Debit-to- equity ratio in Exhibit 7, we can see that the level of debt and financial distress went down in 2004. Therefore, guess is that the company might use the total long-term liabilities in calculating the interest expenses in order to have more tax benefits. As its known to all that the higher the ratio of liquidity, average, activity and profitability are the better the company’s situation is in.
Compared to other quick-service restaurants in Exhibits, only the receivables turnover and inventory turnover of KID was slightly lower than the average, which means the corporation was not performing absolutely badly. And in Exhibit 9, when comparing to average restaurant, Kid’s cash & equivalents, notes payable, long-term debt, income taxes payable, all other current were much more lower and the trade receivables, intangibles, deferred taxes and shareholder’s equity were higher than the common stores.
Unexpectedly, the net income of KID on May 9, 2004 was negative 24,458, but it went up to positive 5,763 three months later on August 1, 2004. How could the situation be turned around in such a short time? As a matter of fact, an over-valued stock price will eventually go down to what it supposed to be in a high efficient market. This is one of the reasons that the bubble of the stock broke and the price slumped. Along with the revelation about the company’s franchise accounting practices and the wrong operating methods, they explained the devalued of its stock.
I think the doughnuts company should not rely heir profit on the sales of high margin machines but to make its actual product (signature doughnuts) better since it contributed around 60% to the total sales. In the meanwhile, KID should inherit its factory style’, which provides newly baked fresh healthy trend among people influenced the sales of its products, improve their ingredients or explore new recipes are necessary. Furthermore, through research and sufficient preparation are important before exploring overseas market or expansion. KID already had its brand, goodwill and own steady customer group, it still has a chance to fight back.