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Kremed!

The rise and fall of Krispy Kreme is a cautionary tale of ambition, greed, and inexperience.

What could be more perfect than a Krispy Kreme doughnut? Hot from the fryer and loaded with sugar, the Original Glazed is practically irresistible. For a time, Krispy Kreme’s stock seemed irresistible, too. When the company went public in April 2000, at the peak of the Internet whirlwind, investors flocked to buy into a business they could understand. An old-fashioned franchise based in Winston-Salem, North Carolina, Krispy Kreme Doughnuts Inc. boasted solid fundamentals, adding stores at a rapid clip and showing steadily increasing sales and earnings.

But Krispy Kreme also had a mystique. Its doughnuts, available for many years only in the Southeast, had attracted a devoted, even fanatical, customer base. When the company decided to go national, it opened franchises in locations guaranteed to generate buzz — Manhattan, Los Angeles, Las Vegas — and customers lined up around the block. By August 2003, KKD was trading at nearly $50 on the New York Stock Exchange, up 235 percent from its initial public offering price of $21 on Nasdaq, and Fortune magazine was calling Krispy Kreme the “hottest brand in the land.” For the fiscal year ended in February 2004, the company reported $665.6 million in sales and $94.7 million in operating profit from its nearly 400 locations, including stores in Australia, Canada, and South Korea.

And then, just as rapidly as its popularity spiked, Krispy Kreme pitched into a steep downward spiral that may yet end in bankruptcy. The company’s woes surfaced in May 2004, when then-CEO Scott Livengood blamed low-carbohydrate diet trends for Krispy Kreme’s first-ever missed quarter and first loss as a public company. That raised analysts’ eyebrows, as blaming the Atkins diet for disappointing earnings carried a whiff of desperation.

The Securities and Exchange Commission came knocking in July 2004, making an informal inquiry into Krispy Kreme’s buybacks of several franchises. As the stock price plunged, shareholders filed suit. Franchisees alleged channel stuffing, claiming that some stores were getting twice their regular shipments in the final weeks of a quarter so that headquarters could make its numbers. The SEC upgraded its inquiry to “formal” status in October 2004. Average weekly sales, a key retailing measure, fell even as the company continued to add stores. In January 2005, Krispy Kreme decided to restate its financials for much of fiscal 2004. Livengood was replaced as CEO by turnaround specialist Stephen Cooper, who also kept his other job: interim CEO of Enron Corp.

The following month, the company announced that the United States Attorney’s Office of the Southern District of New York was also joining the fray — a move indicating concern about possible criminal misconduct. In April, Cooper shored up the business by securing $225 million in new financing. The company announced that it expected a loss for its latest quarter, and warned investors not to rely on its published financials for fiscal 2001, 2002, and 2003, and the first three quarters of fiscal 2005, in addition to those for 2004. By early May, Krispy Kreme still hadn’t filed its restated financials, and its shares were trading around $6.

What went wrong? How could a company in business for nearly 70 years, with an almost legendary product and a loyal customer base, fall from grace so quickly? The story of Krispy Kreme’s troubles is, at bottom, a case study of how not to grow a franchise. According to one count, there are at least 2,300 franchised businesses in the United States, and many are extremely successful. But there are pitfalls in the franchise model, and Krispy Kreme — through a combination of ambition, greed, and inexperience — managed to stumble into most of them.

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