VideoCurrent finance chief Phalen "is a capable guy," comments Waite. "If you look at his compensation structure, it's mainly stock options. He has incentive to get the ship righted." But Mader is less optimistic about the CFO's chances. "It's very rare to take a company into bankruptcy or a turnaround phase and hold on to the existing CFO to do it," he says. "You need someone with no baggage, no sacred cows, who can look at things with objectivity."
A Missing Ingredient
When Krispy Kreme was a fast-growing private company, it was easy to conceal weaknesses in management and corporate governance. But those weaknesses were magnified by the pressures of the public markets, particularly when the company's growth strategy started to stumble, says Marshall. "When you don't have a fully independent board holding management responsible for operational and strategic shortcomings, a machine moving that quickly is going to fall apart," he says. "They really weren't able to sustain the growth rate."
Until recently, Krispy Kreme's board was stocked with insiders left over from the company's days as a private business, including some, like McAleer and Smith, who owned franchises. And until early 2002, the company maintained a fund through which 35 executives could invest in franchisees, potentially creating conflicts of interest. Management elected to dissolve the fund as part of a push to improve governance.
In another questionable move, in 2003, Krispy Kreme purchased Montana Mills Bread Co., a bakery-café chain at which Tate, then chief operating officer, was a director. Tate has said he was not involved in discussions about the transaction. Krispy Kreme put Montana Mills up for sale a year later, after paying approximately $40 million in stock for the business and then recording a $34 million charge upon closing most Montana Mills stores. Together with the problematic franchise buybacks, the transaction smacks more of an insider deal than simple incompetence.
A further warning sign of weak governance was the outsized compensation package awarded to former CEO Livengood, says Marshall. Livengood's total compensation was more than 20 percent greater than the median for similar-size companies, according to The Corporate Library. Despite the company's decline, Krispy Kreme's board allowed Livengood to retire with a six-month consulting position that will pay him $275,000. He holds $1.7 million in options in addition to nearly 100,000 shares of Krispy Kreme stock. Livengood also continues to receive health benefits through the company, but he will no longer have use of the company jet, since one of new CEO Cooper's first moves was to sell off the aircraft lease.
"When we see patterns of excessive compensation, that is usually an indicator that the board is not sufficiently independent," says Marshall. As a result of the board's coziness, he says, no one stepped in to challenge Krispy Kreme's move away from the fresh-doughnut model, and no one questioned the aggressive accounting for franchise buybacks. "It was a classic governance failure," sums up Marshall.
A Fresh Start
Although Krispy Kreme today looks like a company becalmed, if not sinking, some observers believe it will regain momentum. "Krispy Kreme as a company still has a lot of value in its name and in its product," says attorney Metzger. "There should be a way for the company to continue to grow the business."
With the January 2005 replacement of Livengood with Cooper, the revamped board — in which 8 of 10 directors are fully independent, according to The Corporate Library — has shown it is serious about making a turnaround. Since his arrival, Cooper has lined up $225 million in new debt financing led by Credit Suisse First Boston, Silver Point Finance, and Wells Fargo Foothill Inc. to help Krispy Kreme meet its immediate cash-flow needs. Cooper also announced a cost-cutting program that includes a 25 percent reduction in head count.
UNC's Clark suggests the company may need to go private or sell itself to another large chain, like McDonald's. "But I'm not sure that buyers are exactly lining up at the door," he adds. KeyBanc's Waite calls an acquisition doubtful, in part because he says the company is "not terribly cheap," given the amount of work needed to get it back on track. Indeed, Waite hasn't ruled out the possibility of bankruptcy. "The biggest thing they have to do is bring on an operator," he says. "They need an industry insider who can stem the drop in sales at the unit level — somebody who knows how to drive organic sales growth."
Ultimately, Krispy Kreme needs to get back to what fueled its phenomenal growth in the first place: really good doughnuts. "They need to emphasize the hot-doughnut experience," says Waite, "rather than the cold, old doughnut in a gas station."
Kate O'Sullivan is a staff writer at CFO.
| Half-Baked Krispy Kreme first reported solid growth, but has since announced that its results for 2001-2005 are not reliable. |
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| 2002 | 2003 | 2004 | |
| Total revenue* | $394.4 | $491.6 | $665.6 |
| Net Income* | $26.4 | $33.5 | $57.1 |
| Total long-term debt* | $3.9 | $62.4 | $146.2 |
| Number of stores | 218 | 276 | 357 |
| Note: Figures for fiscal years ended in February *in $ millions Source: www.krispykreme.com |
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