Letter from... US

When Krispy Kreme Doughnuts moved from the NASDAQ trading platform to the New York Stock Exchange in 2001, merry Big Board executives donned the company’s white paper caps and handed out 40,000 glazed buns. As far as the experts were concerned, Krispy Kreme held the key to success. They could see it in their charts, the double-digit profit gains, the rosy sales figures, the multiplying stores, but, mainly, they could feel it in their guts. Krispy Kreme Doughnuts, made from a secret recipe and served oven-hot, looked good and tasted good, but even before its launch on the NYSE, something didn’t smell good.

In August this year, the results of an internal investigation proved it wasn’t. Two independent board directors said the company would need to restate pre-tax earnings by $25.6m as far back as 2000.

An internal review released in August reported “egregious reporting errors”, involving round-trip accounting that allowed Krispy Kreme to surpass earnings projections by a penny a share, driving the share price higher. It cited former chief operating officer, John Tate, for failures, along with former chief executive, Scott Livengood. Tate was forced out last August and Livengood in January. Both deny wrongdoing.

There were no accusations of outright fraud, merely errors and “an intent to manage earnings”. No one, said the two-man committee, had been “caught red handed”. State and criminal investigations, which were launched last year, are yet to unearth anything. Unlike federal prosecutors, the committee did not have the power to force co-operation or place its 100 interviewees under oath.

More surprising than the contents of the 24-page report is that it came years after suspicions first arose that something other than doughnuts were cooking over at Krispy Kreme.

As early as 2001, industry watchers began to question the company’s rapid growth and its price to earnings ratio, which was roughly 80 times net income. Krispy Kreme went public in April 2000, 63 years after its birth, for $5.25 a share and watched its stock - adjusted for two splits - soar to an all-time high of $49.74 by 2003. In February 2002, Forbes, the financial magazine, questioned the company’s accounting. The stock fell some 10%, but raised no regulatory eyebrows.

It took a warning by the company itself to get their attention. In May 2004, Krispy Kreme executives blamed low-carbohydrate crazes like the Atkins diet for declining demand, and cut its profit forecasts by 10%. The stock fell 30%, or $9.29, to close at $22.51. Then Krispy Kreme announced its first quarterly loss since it went public - a cool $24.4m - for the first three months of the year.

The following July, Krispy Kreme said the US Securities and Exchange Commission had begun an informal investigation. The stock fell another 15%, or $2.95 to $15.71. In February this year, the US Attorney’s Office for the Southern District of New York announced its investigation, sending the shares down another 7%. By now the stock was trading at opening levels of about $5.

Krispy Kreme managed to conceal its troubles even in the wake of the Enron scandal, which brought accounting questions into sharp focus, but the energy trader’s shocking collapse also enabled companies to cover up when the light of inquiry fell upon them. Executives dismissed allegations as public hysteria and the attempts of regulators to cover up for past negligences. Regulators, meanwhile, were fighting through a storm of shredded documents, with little time to devote to frauds unlikely to make it into the billions.

A more basic reason Krispy Kreme held off scrutiny stems from its appeal. Who doesn’t like Krispy Kreme? They are Homer Simpson’s favourite food, the doughnut of choice on ER, The Sopranos, even Sex and the City, not to mention trading floors around the world. In 1997, Krispy Kreme was awarded American icon status after artefacts from the company were archived by the Smithsonian Institution’s National Museum of American History in DC.

It’s just that attraction that may be Krispy Kreme’s salvation. The company has a strong brand and a well-loved product, a fact evidenced by its continued store openings.

Still it has a long way to go. Aside from its accounting woes, the company must battle declining same-store sales, an unimpressive stock price and a battery of shareholder lawsuits that may multiply when regulators reveal their findings.

Having removed the perceived perpetrators, Krispy Kreme may be over the worst of its troubles. The results of the internal review may even prove a positive. The called-for restatement was well beyond the company’s December indication of $6m-$8m, but investors have long given up on Krispy Kreme’s projections. Evidently relieved to finally be let in on the picture, investors sent the stock up 2% to close at $7.30.

Abigail Rayner is a freelance writer based in New York.