Krispy Kreme also rolled into the price the costs of closing stores and compensating the operating manager and principal owner of the Michigan franchise to stay on as a consultant. Both of these expenses became part of the intangible “reacquired franchise rights” asset on the company’s balance sheet, rather than costs that would have reduced the company’s reported earnings. Krispy Kreme announced in a December 2004 8-K filing that it will need to make a pretax adjustment of between $3.4 million and $4.8 million to properly record the compensation as an expense. A second adjustment of some $500,000 will reverse the improper recording of interest income.
Krispy Kreme’s repurchase of its northern California stores from a group of investors is also under scrutiny. In February 2004, the company paid $16.8 million to buy the 33 percent of Golden Gate Doughnuts LLC it did not already own. One of the beneficiaries of the buyout was the ex-wife of CEO Scott Livengood. The company failed to disclose this fact, although Adrienne Livengood’s stake was valued at approximately $1.5 million. While the decision not to reveal the connection looks bad, “this is only a significant legal issue if it somehow could be established that [Livengood] was seeking some kind of personal profit or gain through his ex-wife, as opposed to truly serving the company’s interest,” says Carl Metzger, a partner with Goodwin Procter LLP in Boston.
In its December 8-K, Krispy Kreme revealed that there would need to be adjustments made to the accounting for the Golden Gate Doughnuts purchase as well — a total of $3.5 million to correct improperly recorded compensation expenses and management fees that had been included in the purchase price. The company will also make a similar correction to fix errors made in the acquisition of a franchise in Charlottesville, Virginia.
On top of the questionable accounting and the lack of disclosure, Krispy Kreme may have paid inflated prices for some of the franchises it bought back. In 2003, the company spent $67 million to repurchase six stores in Dallas and rights to stores in Shreveport, Louisiana, that were owned in part by former Krispy Kreme board member and chairman and CEO Joseph A. McAleer Jr. Another longtime director, Steven D. Smith, was also part owner. Compared with the $32.1 million paid for the Michigan stores that same year, the number sounds high — $11.2 million versus $4.6 million per store. A civil suit filed by another former franchisee alleges that a higher bid was offered but ignored.
“I asked a lot of questions about why they paid so much for those acquisitions,” says one analyst. “I don’t think I ever truly got an answer. They told me it was a different time in terms of valuation, but those were pretty exorbitant prices.” The SEC, presumably, will insist on an answer in the course of its investigation.
Who Minded the Store?
The company’s own investigation, as detailed in an April notification to the SEC, has turned up accounting problems in other areas, too, involving derivatives, leases, equipment sales, and the consolidation of a bankrupt subsidiary. Even if these turn out to be mostly peccadilloes, they raise a question: Who was minding the store in the finance department?