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Trouble Chars Krispy Kreme

The company outlines some accounting problems that will cause a restatement.
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Updated from 11:17 a.m. EST

Krispy Kreme


will restate its 2004 earnings lower in part to reclassify as compensation some of the money it paid to managers to buy back their store franchises.

The struggling doughnut maker also warned it won't be able to file financial statements for the quarter ended Oct. 31, 2004, before a Jan. 14 deadline with creditors, potentially causing a default under the company's $150 million credit facility. The company said it's seeking a waiver from the lenders.

The restatement, which comes amid a

Securities and Exchange Commission

accounting probe, will cut between $6.2 million and $8.1 million from Krispy Kreme's previously reported pretax income for 2004. Per-share after-tax earnings will be cut by 7 cents or 8 cents for the year.

Krispy Kreme shares were recently down $1.21, or 9.8%, to $11.10 in heavy


trading. The stock lost 66% in 2004, beaten down by word of the SEC probe and a profit warning that lopped about 30% out of the company's market capitalization on a single day last May.

Tuesday's release cast more light on the accounting issues Krispy Kreme is dealing with. The company had previously been vague about what it was investigating, leaving analysts to speculate that the problems have to do with its franchise accounting, where particularly Byzantine standards have caused restatements at other restaurant operators.

Among the items leading to the 2004 restatement were several concerning the ambiguous status of Krispy Kreme employees who are also selling shareholders in franchise repurchases.

For instance, regarding a franchise in Michigan, the company will take a pretax adjustment of up to $4.8 million to record as a compensation expense "the disproportionate consideration paid to a former owner of the Michigan franchise who was its operating manager and subsequently worked for the company for a short period of time."

Two such reversals could total up to $5.8 million, pretax.

Another $500,000 will be erased from pretax earnings "to reverse certain income and record as expense amounts that were improperly accounted for as part of the company's acquisition of the Michigan franchise."

Krispy Kreme also appears to have run into potential trouble in the way it values leases on properties where it has made big capital improvements. The company said it is reviewing its accounting for leases and depreciation of related assets to determine whether generally accepted accounting principles were properly applied.

Krispy Kreme noted that other restaurant companies had recently restated the value of such leases after conducting similar reviews, adding to their depreciation and rent expenses.

"The restatements generally arise from corrections to properly account for lease renewal options and/or rent escalations in computing rent expense for operating leases; to determine properly the depreciable lives of leasehold improvements when renewal options are present in leases; and to require use of the same lease term in determining the operating or capital classification of a lease, rent expense there under and depreciable lives of related leasehold improvements," the company said.

Krispy-Kreme said it currently has about $90.9 million outstanding under the $150 million credit facility and noted that if lenders making up more than half the financing commitment want, they could demand immediate repayment if a default event is confirmed.

"The company believes that its existing cash, combined with cash generated from operations, will be sufficient to fund current operations and presently contemplated capital expenditures," Krispy-Kreme said. "However, borrowings under the credit facility or other additional cash resources may be required if the company is called upon to honor its guarantees of franchisee debt or franchisee operating leases."

At Oct. 31, Krispy-Kreme said, the total guaranteed debt amount was about $52.3 million. While the parent hasn't experienced losses on the guaranteed debt, it said it has been informed that some of its franchisees aren't in compliance with certain covenants of their credit pacts.