Troubled Krispy Kreme to Restate '04 Results

CHICAGO – Troubled doughnut maker Krispy Kreme (KKD) will restate earnings for the last three quarters of fiscal 2004 in the wake of allegations the company padded shipments to hide declining sales over the last two years. Its shares sank nearly 17 percent.

The once high-flying food company and restaurant franchisor also warned Tuesday it may have to further reduce past earnings reports and that it could be on the brink of major credit problems.

The company filed documents announcing the restatement with the Securities and Exchange Commission (search).

In a news release, the company said its board of directors had concluded that statements for the fiscal year that ended last Feb. 1 should be revised, as well as reports covering the last three quarters of that fiscal year.

The restatements are expected to reduce the company's profit for 2004 — originally reported as $56.8 million — by between $3.8 million and $4.9 million, or 6.6 percent to 8.6 percent. Earnings per share for fiscal 2004 would drop by 7 or 8 cents from their originally reported 66 cents.

Shares of Winston-Salem-based Krispy Kreme Doughnuts Inc. were down $2.07, or 16.8 percent, to $10.24 on the New York Stock Exchange (search). Its shares traded near $40 last March.

Tuesday's statement also warned that Krispy Kreme's current troubles give its primary lenders the option to recall $90.9 million in outstanding loans. The company is now unable to borrow more money and while it has requested a waiver from the default provisions and is negotiating with the lenders "there can be no assurance that the lenders will accede," the statement said.

In addition, the company has guaranteed $52.3 million in franchisee debt; it warned that if it is forced to honor those guarantees, it may not have enough cash on hand to continue operations.

Krispy Kreme also said a full review of accounting practices is ongoing and that it expects to make further adjustments to past statements to change its treatment of leases and depreciation of improvements of leased property.

A recent filing in a shareholder lawsuit against the company alleges the company routinely padded sales by doubling doughnut shipments to wholesale customers at the end of fiscal quarters. Unsold doughnuts were shipped back after the quarters ended.

The charge was leveled by two unidentified "confidential witnesses" who are former employees of the company. It is part of a consolidated group of shareholder lawsuits that claim executives at the once-trendy doughnut maker knew sales were slowing by at least January 2003 but hid that fact until May, when Krispy Kreme reported its first-ever quarterly loss.

That earnings report, which was followed by the revelation that the company was under investigation by the Securities and Exchange Commission, sent Krispy Kreme's stock into a tailspin; it dropped 66 percent in 2004.

Although restating the fiscal 2004 reports will affect reports for the first two quarters of fiscal 2005, Krispy Kreme said it does not expect any material changes to those results.

The newest charges against Krispy Kreme came in a complaint filed Dec. 14 in federal court in Greensboro, where a judge has consolidated a number of shareholder lawsuits against the company.

The suit alleges that between January 2003 and last May, when Krispy Kreme issued a profit warning, "the company issued false and misleading statements, including false financial results" and "repeatedly ratcheted upward its public quarterly and fiscal year revenue and earning projections ... all in the face of slowing sales and market saturation."

At the same time, three top officers named in the lawsuit — chief executive officer Scott Livengood, former chief operating officer John W. Tate and former chief financial officer Randy S. Casstevens — "unloaded more than 475,000 shares of Krispy Kreme stock for proceeds of $19.8 million," the suit charges.

According to one witness cited, Krispy Kreme double-shipped wholesale customer orders at the end of quarters on four separate occasions while the witness worked for the company.

And a former sales manager at a Krispy Kreme plant in Ravenna, Ohio, said a regional manager ordered that customers be sent double orders on the last Friday and Saturday of the 2004 fiscal year, explaining "that Krispy Kreme wanted to boost the sales for the fiscal year in order to meet Wall Street projections." The witness said the manager explained that the doughnuts would be returned for credit the following week — once fiscal 2005 was under way.

The witness "understood that it was commonplace at Krispy Kreme to channel stuff in order to meet Wall Street expectations," according to the complaint.

The plaintiffs in the case are seeking class-action status for investors who bought Krispy Kreme shares between January 2003 and last May. The suit seeks a jury trial and unspecified damages.

Krispy Kreme has blamed its problems on popularity of low-carbohydrate diets (search) and high oil prices. But critics have argued that the company expanded too quickly and saturated its market by making its product available in grocery stores and convenience stores.