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Good article on Krispy Kreme Doughnuts Inc. ("Kremed!" June), but I think it could have been even harsher. KKD tripled its store base in the five years after going public. Many of the openings were in new markets. As long as the company was opening new stores at huge initial volumes, the sales from the new outlets masked the steep sales declines in existing outlets. In addition, Krispy Kreme management manipulated its calculation of same store sales (not including stores in the base until their 19th month and playing around with the sourcing of off-premise sales) to create the illusion of healthy store economics. Once new markets were exhausted and store openings slowed, overall sales had nowhere to go but down. If you look at IRI data, the year-over-year decline in KKD off-premise sales has been accelerating every month for more than a year.
Another issue you didn't touch on is the massive insider selling of KKD stock. The McAleer family owned well over 30 percent of the stock when the company went public, and has sold more than 90 percent of its holdings. Some of the sales were via collars in 2002 and 2003 that locked in minimum sale prices in the 30s; while those shares are still technically held by the McAleers, they have effectively been sold. Former CEO Scott Livengood also sold more than 90 percent of his KKD stock, much of which was acquired by options.
I think franchisee failures will be what bankrupts Krispy Kreme. KKD guarantees the debt for a number of them, and is heavily dependent on high-margin royalties and doughnut-mix sales to them.
Tim Reason's article "Feeling the Pain" (May) is thought provoking. Sarbanes-Oxley requires public companies to beef up their independent directors. This is akin to putting the cart before the horse, since there is no reliable way to identify independent directors. Not being an employee of the firm or not having any business ties with it does not make a director independent. The Securities and Exchange Commission should require disclosure of directors' voting records on the board. Directors that have voted differently from the firm's CEO in the past can be characterized as independent directors; others are simply nonexecutive directors.
Visiting Professor of Finance
College of Business Administration
Who's Driving This Bus?
At the very least, damaged parties should be able to prosecute for fraud the CEOs and CFOs who claim they didn't know what was going on in their companies (From the Editor, May). The charge: misrepresenting their ability to run the corporations when they were hired. We wouldn't let a bus driver get away with claiming he didn't know how the bus worked after he ran it into a building.
Name Withheld by Request
When Integrity and Honesty Went Missing
In "What Does Your CEO Really Know?" (May) Mike Jackson, chairman and CEO of AutoNation, claims that former Enron CEO Kenneth Lay and the board granted former CFO Andrew Fastow "an exemption from conflict-of-interest rules; then no one tried to make sure the conflict was handled right. They had an extraordinary responsibility to put in a process to manage the exemption."
Contrary to Mr. Jackson's assertions, the former outside directors recognized the importance of ensuring that company management would carefully monitor Mr. Fastow's participation in the LJM partnerships and repeatedly addressed the matter. Company records establish that:
1. The office of the chairman and the board did not give Mr. Fastow an exemption to the company code of conduct. Mr. Fastow was still bound by it, he knew it, and, he even stated so at a board committee meeting.
2. Company management and the outside directors put in place numerous control mechanisms to monitor Mr. Fastow's interest in the partnerships and ensure that all transactions with Enron were fair and in its best interests.
3. The board, particularly its finance and audit committees, received regular reports from management and outside advisers confirming that the controls were in place and working effectively. For example, Mr. Fastow said at a finance-committee meeting that Jeffrey Skilling, Enron's then-COO, had been reviewing his partnerships' transactions with Enron. Arthur Andersen reported to the audit committee that the controls were in place and were working effectively.
Unfortunately, the board later learned that many of these reports and assurances were, in fact, false. Thus, the issue here is not the board's proper oversight of this situation, but the integrity and honesty of key Enron senior officers — which many observers have now concluded were completely absent — and the forthrightness of Enron's advisers, who failed to inform the board about their concerns.
Dimitri J. Nionakis
Howrey Simon Arnold & White
Your article "The Danger of Deferrals" (Newswatch, April) captured our attention. As a provider of customized nonqualified plans, we at TBG Financial believe that your obituary of deferred-compensation plans is premature. While Section 409A of the Internal Revenue Code establishes new rules for the operation of deferred-compensation plans, in many ways it can be viewed as legitimizing and structuring what hitherto had been a gray area.
Your article suggests that Section 409A creates a major disincentive to defer because salary elections need to be made before the beginning of the year, while performance-based compensation must be deferred at least six months before the end of the earning period. Yet, 409A provides a more relaxed standard than that utilized by most of our clients before the legislation, when bonus deferrals were generally solicited in the year prior to being earned. Contrary to your article, 409A still permits participants to schedule distributions while employed — they don't have to wait until separation from service. This feature is an excellent way for participants to schedule and pay for certain planned activities, such as a child's education.
Clearly, by the end of 2005, plans will need to comply with Section 409A for deferrals earned and vested after December 31, 2004. Some company plans and recordkeeping processes may require significant amendment, but for most of our clients, the changes are fairly minor.
Howard J. Wilson
Executive Vice President and Chief Operating Officer
A Simple Yardstick
As a retired chief executive/vice president/general manager with almost four decades of experience in manufacturing for the consumer-electronics industry, I suggest that the Financial Accounting Standards Board adopt the following simple yardstick for revenue recognition ("Proper Recognition," Newswatch, April): "An invoice may be recognized as revenue on the operating statement no sooner than 90 days after the collection of the cash."
Think about it.
Edgar A. Sack
Our June Spotlight on Insurance ("Infinite Risk?") incorrectly described the impact of a finite-insurance transaction with General Reinsurance on American International Group's financial results. The article should have stated that the transaction inflated AIG's reserves and other assets by $495 million, not its shareholder equity by $1.8 billion. Also, the article should have stated that, of the 524 active captive subsidiaries domiciled in Vermont, 5 or 6 were estimated to use finite insurance, not that those 5 or 6 were captives.