PROBITY INVESTMENTS
MEMORANDUM
To: Alan Palmiter, Probity Investments
From: Joseph R.
Marek, Outside Counsel for
Probity Investments
RE: Krispy Kreme Doughnut Corporation’s Prospectus
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Krispy
Kreme Doughnut Corporation went
public in April 2000.
- Part I of this memorandum
examines whether, and to what extend, Krispy Kreme’s Prospectus complies with the SEC’s Plain English initiative.
- Part II of this
memorandum identified information not included in the prospectus, but that an investor
would find helpful in making a determination as to whether or not to invest in
Krispy Kreme.
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Part I
Background
The goal of the SEC’s Plain English
initiative is to facilitate the creation of SEC documents that are easy for
investors and brokers to understand. As SEC Chairman Arthur Levitt stated,
documents written according to the Plain English initiative allow investors
"…to understand what they are buying and to make informed decisions."
General Overview
The drafters of the Krispy Kreme
prospectus did a great job in the organization and design of the document.
Regarding organization, the drafter put the big picture first, followed by descriptive headers and
subheadings. Additionally, related
information was grouped
together.
Regarding design, the drafters
effectively utilized a hierarchy to distinguish levels of information. They also effectively utilized typography, layout and color. All of these efforts were in
perfect compliance of the SEC’s Plain English Handbook.
They did not, however, use any graphic
representation. Additionally, they failed to consistently use Plain English.
Examples of these shortcomings are discussed below.
Do Not Use Long Sentences
[Under Risk Factors, this information is
found under the heading beginning "We are the exclusive supplier…."]
In addition, as our business continues to
expand on the West Coast and in other geographic areas which are located at
greater distances from our sole manufacturing facility in Winston-Salem, North
Carolina, we may incur greater costs in supplying our doughnut mixes and other
ingredients to these areas and may need to establish one or more additional
manufacturing plants.
After
Since our business continues to grow
nationally, it may be necessary to establish additional manufacturing plants in
order to keep shipping and supply costs down.
[This information was found under
"Dilution."]
All information above reflects an
exchange ratio in the merger in connection with our holding company formation
of 20-for-one, which will have the effect of a 20-for-one stock split, excludes
144,737 shares to be contributed to our stock bonus plans contemporaneously
with this offering and assumes no exercise of stock options outstanding as of
January 30, 2000 under our stock option plan.
After
The exchange ratio between the merger and
the formation of the holding company was 20-for-one. This ratio has the same
effect as a 20-for-one stock split. Excluded will be 144,737 shares. These
excluded shares will be contributed to our stock bonus plan at the same time as
this offering. The contribution of these excluded shares assumes that no stock
options, outstanding as of January 30, 2000, will be exercised under our stock
option plan.
Graphics
[Under Business, this information can be found in the paragraph under the heading "Store Locations and Other Properties."]
As of January 30, 2000, there were 144 Krispy Kreme stores operating in 27 states, 58 of which were owned by us, 37 of which were owned by area developers and 49 of which were owned by associates.
After
As of January 30, 2000, there were 144
Krispy Kreme stores operating in 27 states.
Use Bullet Statements
[Under Business, this information was found in the paragraph under "A balanced financial model."]
Krispy Kreme generates sales and income from three distinct sources -- company stores, franchise fees and royalties and our vertically integrated supply chain -- which we believe provides increased stability to our revenues and earnings and improves our return on investment.
After
Krispy Kreme generates sales and income
from three distinct sources:
- company stores;
- franchise fees and royalties; and
- the vertically integrated supply chain.
These sources provide increased
stability to our revenues and earnings, and improves our return on investments.
Use the Active Voice
[Under MD&A, this information can be found under the heading "Company Overview and Industry Outlook."]
This business unit is volume-driven, and its economics are enhanced by the opening of new stores.
After
The opening of new stores enhances the
economics of this volume driven business unit.
Write in the Positive
[Under Risk Factors, this information can be found under the heading "Our failure or inability to enforce…."]
The protective actions that we take, however, may not be enough to prevent imitation by others which might harm our image or our brand position.
After
Despite protective actions, initiatives by others may harm our image or our brand position.
Use a Single Word Instead of Two
[Under Risk Factors, this information can be found under the heading "Our failure or inability to enforce…."]
Although we are not aware of anyone else who is using…
After
We are unaware of anyone else who is using…
Omit Superfluous Words
[Under MD&A, this information can be found under the heading "Results of Operations."]
In order to facilitate an understanding…
After
To facilitate an understanding…
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Part II
"Doughnuts – is there anything they can’t do?" – Homer
Simpson
The following information was not contained in the prospectus. It would, however, be useful to investors in deciding whether or not to invest in Krispy Kreme.
Quality Control
The Krispy Kreme prospectus identifies the following risk factor: "We
may be harmed by actions taken by our franchisees that are outside of our
control."
The key to Krispy Kreme’s business model is freshness – or "hot doughnuts now." Accordingly, it would be helpful to investors to know exactly how Krispy Kreme intends to ensure that individual franchisees maintain operations in accordance with the freshness business model – that is, that they do not take actions that may be harmful. The need for this information was identified by an online Fool.com article which described an investment analyst’s visit to a very dirty New York City Krispy Kreme, where she received cold doughnuts at 8:45 in the morning.
Maximizing Productivity will Harm the Krispy Kreme Business Model
Krispy Kreme identifies, as part of its growth strategy, that they intend to increase profits by increasing sales to off-premise customers (e.g., grocery and convenience stores). It would be helpful for investors to know exactly how Krispy Kreme will be able to its maintain business model -- freshness and "hot doughnuts now" -- at these off-premise locations. The need for this information was also identified in the Fool.com article.
[Under Business, this information can be found under the heading "Growth Strategy"],
Problems with a Single Distribution Center
The Krispy Kreme prospectus identifies the following risk factor: "We
are the exclusive supplier of doughnut mixes, other key ingredients and flavors
to all Krispy Kreme stores. If we have any problems supplying these
ingredients, our stores’ ability to make doughnuts will be negatively
affected."
Since Krispy Kreme has grown, and continues to grow in locations far from Winston-Salem, N.C., it would be helpful to investors to know exactly how Krispy Kreme would supply its stores in the event that the Winston-Salem location was unable to supply doughnut mixes. Additionally, it would be helpful to know whether this single Krispy Kreme doughnut mix facility can keep pace with their national growth plans. Furthermore, if additional supply locations will be opened, it would be helpful to know when these locations will be opened; where they will be opened; and how much they will cost the company. The need for this information was identified in an online Business Week article.
Health Concerns
The Krispy Kreme prospectus states that "[o]ur sales could also be
affected by changing consumer
tastes – for instance, if prevailing health or dietary preferences cause
consumers to avoid doughnuts in favor of foods that are perceived as more
healthy."
[Under Risk Factors, this information can be found under the heading
"Risks Relating to the Food Service Industry"]
Investors would find it helpful to know what information Krispy Kreme has that would indicate that consumers’ tastes will not change anytime soon, and therefore, it is advantageous for them to continue to expand. The need for this information was identified in an online Business Week and Fools article.
Competition
The Krispy Kreme prospectus identifies the following risk factor: "Our
success depends on our ability to compete with many food service
businesses."
Investors would find it helpful to know who is significant competition for Krispy Kreme. For example, Dunkin’ Donuts has over 4,000 stores located throughout the United States and an additional 1,000 stores located throughout the rest of the world. The need for this information was identified in a Los Angeles Times article located on Lexis.
Explanation of "Substantial Dilution"
The Krispy Kreme prospectus identifies the following risk factor:
"You will experience an immediate and substantial dilution if you purchase common stock in this offering. The initial public offering price is substantially higher than the net tangible book value per share of the outstanding common stock will be immediately after this offering. Any common stock you purchase in this offering will have a post-offering net tangible book value per share of $11.50 less than the initial public offering price, assuming an initial public offering price of $19.00 per share, which is the mid-point of the range shown on the cover page of this prospectus. Future issuances of our common stock, including issuances in connection with stock option exercises, could cause further dilution."
Investors would like clarification as to exactly what this statement means. The need for this information was identified after reading investor postings on the Yahoo and Fool financial bulletin boards.*
Overvalued
Krispy Kreme’s initial public offering price was $21 per share.
Since restaurant stocks generally do not perform well in the IPO market, investors would like to know exactly how Krispy Kreme justified its IPO price of $21.00. The need for this information was identified after reading investor postings on the Yahoo and Fool financial bulletin boards.*
* Bulleting boards are usually not a reliable source of information. In this case, however, since I am trying to determine what information an investor would find useful, I found them useful and reliable.