Krispy Kreme

Overview of Krispy Kreme Doughnuts, Inc. SEC Proceedings

These notes summarize the proceedings initiated by the Securities and Exchange Commission (SEC) against Krispy Kreme Doughnuts, Inc. pertaining to accounting and auditing misconduct.

I. Introduction

  • The SEC deemed it necessary to commence cease-and-desist proceedings against Krispy Kreme, identified as the respondent.

  • The initiation of these proceedings follows an Offer of Settlement submitted by Krispy Kreme, which the SEC accepted.

  • The SEC found that Krispy Kreme consented to the Order without admitting or denying the findings, except concerning the SEC's jurisdiction.

II. Company Background
A. Corporate Information

  • Krispy Kreme is incorporated in North Carolina with its main office in Winston-Salem, NC.

  • Established in 1937, Krispy Kreme initially operated a single store and later expanded nationally through a franchise model.

  • Shares of Krispy Kreme have been registered with the SEC since April 2000, and listed on the New York Stock Exchange since May 2001.

B. Financial Performance Reporting

  • Between February 2003 and May 2004, Krispy Kreme engaged in fraudulent practices to inflate or misrepresent earnings for:

    • Fourth quarter of fiscal year 2003 (ending February 2, 2003).

    • All quarters of fiscal year 2004 (ending February 1, 2004).

  • The fraudulent actions allowed Krispy Kreme to evade lowering its earnings guidance and to consistently report earnings per share (EPS) that exceeded analyst expectations, specifically by at least one cent.

III. Financial Growth and Expectations
A. Historical Performance

  • Krispy Kreme reported remarkable growth in EPS during its initial years as a public company:

    • Fiscal year 2001: 80% growth.

    • Fiscal year 2002: 67% growth.

    • Fiscal year 2003: 47% growth.

  • In the early years post-IPO, the reported EPS closely matched or exceeded consensus estimates and internal guidance.

B. Market Valuation

  • Krispy Kreme stock traded at a multiple of over 50 times annual EPS in the early 2000s.

  • This multiple was reduced to between 30 and 50 times annual EPS by fiscal year 2004.

IV. Incentive Compensation Plan
A. Overview of the Plan

  • Executives received compensation through salary, stock options, and cash bonuses as per the Senior Executive Incentive Compensation Plan ("Incentive Plan").

  • Bonuses were tied to achieving targeted returns on assets and EPS growth.

B. Earnings Guidance and Accountability

  • EPS target was set to exceed Wall Street expectations or internal guidance by at least one cent to qualify for bonuses.

  • Accruals for bonuses were made quarterly based on the earnings that surpassed the target.

V. Accounting Manipulations
A. Reserve Accounting Mechanism

  • The Incentive Plan operated as a reserve accounting mechanism, creating a cycle where reported earnings were adjusted to meet targets based on previous quarters' performance.

  • GAAP principles required comparative accounting for estimated EPS against annual goals, which Krispy Kreme failed to follow.

B. Specific Instances of Earnings Misrepresentation
1. Q2 Fiscal 2003

  • Experienced delays in franchise openings affecting earnings growth, leading to reduced incentive accruals.

2. Fiscal Year 2003

  • A reversal of $873,261 of previously accrued incentive compensation increased reported earnings by $528,323 to meet EPS guidance.

3. Q1 Fiscal 2004 to Q3 Fiscal 2004

  • EPS disclosures consistently met the guidance plus one cent, primarily due to manipulated incentive accruals and reversals.

VI. Round-Trip Transactions
A. Definition and Context

  • Round-trip transactions were used to create the appearance of enhanced earnings through pre-arranged reimbursement agreements with franchises.

B. Significant Transactions
1. First Round-Trip Transaction

  • June 2003: Krispy Kreme increased the reacquisition price for a Texas franchise, allowing a franchise purchase of doughnut-making equipment which inflated financial results.

2. Second Round-Trip Transaction

  • October 2003: The reacquisition of a franchise in Michigan involved inflating the price in reporting reimbursement of disputed amounts, which increased net income inaccurately.

3. Third Round-Trip Transaction

  • January 2004: A deal in California where payments made were misrepresented as management fees, inflating Q4 earnings by approximately $361,000.

VII. Restatement of Financials
A. Disclosure of Underperformance

  • May 2004: Krispy Kreme reported disappointing earnings for Q1 fiscal 2005 and lowered forward guidance due to prior mismanagement and accounting errors.

B. Impact of Restatement

  • January 4, 2005: Announced restatement of earnings for fiscal years 2003 and 2004, reducing net income by $2,420,000 and $8,524,000 respectively.

VIII. Violations and Remedial Actions
A. Legal Findings

  • Violated Sections 13(a) and 13(b)(2) of the Exchange Act due to failures to maintain accurate records and effective internal controls over financial reporting.

B. Undertakings for Cooperation

  • Krispy Kreme agreed to fully cooperate with SEC investigations, including document production and employee testimonies.

IX. Conclusion

  • The SEC concluded that Krispy Kreme must cease and desist from future violations and committed to ongoing corrective actions to uphold ethical accounting practices.


This case centers on the Securities and Exchange Commission (SEC) proceedings against Krispy Kreme Doughnuts, Inc. for accounting fraud and auditing misconduct between 20032003 and 20042004.

1. Purpose of the Fraud

Krispy Kreme manipulated its financial results to consistently meet or exceed Wall Street earnings per share (EPS) expectations by exactly 11 cent. This allowed the company to maintain a high market valuation and enabled executives to receive cash bonuses under the Senior Executive Incentive Compensation Plan, which were tied to reaching specific earnings targets.

2. Manipulation Techniques

  • Reserve Accounting: The company used incentive compensation accruals as a mechanism to adjust reported earnings. They improperly accrued or reversed these bonuses to ensure the final EPS hit specific targets, rather than following standard GAAP reporting.

  • Round-Trip Transactions: The company engaged in pre-arranged deals with franchises in Texas, Michigan, and California. By inflating the prices paid to reacquire these franchises, Krispy Kreme was able to record "reimbursements" or "management fees" that artificially boosted their net income.

3. Legal and Financial Consequences

  • Violations: The SEC cited Krispy Kreme for violating the Exchange Act, specifically Sections 13(a)13(a) and 13(b)(2)13(b)(2), due to their failure to maintain accurate records and effective internal controls.

  • Restatements: Krispy Kreme was forced to restate its financial results for fiscal years 20032003 and 20042004, which resulted in a decrease of net income by 2,420,0002,420,000 and 8,524,0008,524,000 respectively.

  • Settlement: Krispy Kreme accepted a cease-and-desist order and committed to full cooperation with the SEC to remediate its accounting practices.