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Sour Note for Krispy Kreme

Sour Note for Krispy Kreme Doughnut maker reduces pretax income by $25.6 million

WINSTON-SALEM, N.C. -- Former executives at Krispy Kreme Doughnuts Inc. who oversaw its rise from a regional chain to a highflying sensation used improper, even "egregious," accounting to satisfy Wall Street's hunger for growth, according to a sweeping internal report from the company.

The report, which followed a 10-month investigation of the doughnut maker by a special board committee, provides fresh details of how a team led by former CEO Scott A. Livengood fudged financial results during the company's meteoric rise starting in the late 1990[image-nocss] s, according to a report in The Wall Street Journal.

The internal report marked the company's clearest account yet of its financial and governance shortcomings, which first surfaced last year and led to the ouster of Livengood and other senior executives.

After going public in 2000, Krispy Kreme, Winston-Salem, N.C., sought to capitalize on Wall Street's appetite for growth stocks at the end of the stock-market boom. But the doughnut maker wasn't ready for prime time, according to WSJ. The report, a 24-page summary of which was made public in a regulatory filing Wednesday, says the company lacked internal controls, didn't employ a general counsel for a two-year period and hired three chief financial officers in four years, including one who told the panel he wasn't comfortable in the job.

"The Krispy Kreme story is one of a newly public company, experiencing rapid growth, that failed to meet its accounting and financial reporting obligations to its shareholders and the public," the report said.

Though the report stopped short of accusing former executives of outright fraud, it included a strong condemnation of the former management team led by Livengood, as well as the company's outside directors, noting that senior managers "were profiting greatly" from questionable accounting.

Indeed, the panel said Krispy Kreme's woes stemmed in part from a common 1990s-era practice: Setting earnings-per-share targets for Wall Street analysts and then pushing to beat them by a penny. The panel noted that executive bonuses were tied to exceeding those growth targets.

"While some may see the accounting errors ... as relatively small in magnitude, they were critical in a corporate culture driven by a narrowly focused goal of exceeding projected earnings by a penny each quarter," the report said.

Among other things, the panel slapped Livengood for what it said was his abuse of corporate aircraft, reporting that in two years he racked up at least $320,000 more in personal-flight costs than was permitted by the board, while company filings hid the true costs from shareholders.

The panel also described several methods that it said were used to boost results. For instance, it said Krispy Kreme improperly boosted profits by shipping high-margin doughnut-making equipment to franchisees long before they wanted or needed it. Though the company would book revenue, some of that equipment would then sit unused for months in trailers controlled by Krispy Kreme, and franchisees didn't have to pay until it was actually installed, said one person familiar with the probe's findings.

In another deal cited in the report, Krispy Kreme sold costly equipment to a franchisee and booked it as revenue immediately before it bought the same company for a price that was inflated by the cost of the equipment.

The committee said it has turned over its full report, for which it said it interviewed more than 100 people, to federal officials, who are conducting criminal and civil investigations of Krispy Kreme's accounting. It also ordered a board shake-up, saying that a "substantial majority" of new directors are needed.

Livengood declined to comment to WSJ yesterday. An attorney who is representing him, F. Joseph Warin, said he and his client were "pleased" that the committee had finished its work and that "the report specifically stated that no employee said that they participated in or were directed to manage earnings." He added, "We strongly disagree with the subjective speculation of the report. Mr. Livengood devoted his heart and soul to Krispy Kreme."

As a result of the probe, Krispy Kreme said it would have to restate its results downward back to before it first went public in 2000, slicing an estimated $25.6 million from pretax profits over the years. Of that, $22.2 million would be backed out of pretax profits from fiscal year 2001 through fiscal 2005's third quarter, which ended last October, about 9% of the $241.9 million in pretax profits originally reported over that period.

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