Attached files

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EX-10.1 - AMENDMENT NO. 1, DATED AS OF SEPTEMBER 15, 2011, TO THE CREDIT AGREEMENT - KRISPY KREME DOUGHNUTS INCexhibit10-1.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO RULE 13A-14(A) - KRISPY KREME DOUGHNUTS INCexhibit31-1.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO RULE 13A-14(A) - KRISPY KREME DOUGHNUTS INCexhibit31-2.htm
EX-32.1 - CERTIFICATION BY CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 - KRISPY KREME DOUGHNUTS INCexhibit32-1.htm
EXCEL - IDEA: XBRL DOCUMENT - KRISPY KREME DOUGHNUTS INCFinancial_Report.xls
EX-32.2 - CERTIFICATION BY CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 - KRISPY KREME DOUGHNUTS INCexhibit32-2.htm



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________ 
 
Form 10-Q
 
 
(Mark one)
  þ      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
         For the quarterly period ended October 30, 2011
OR
  o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
      For the transition period from                 to
 
Commission file number 001-16485
KRISPY KREME DOUGHNUTS, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina 56-2169715
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
370 Knollwood Street, 27103
Winston-Salem, North Carolina (Zip Code)
(Address of principal executive offices)  

Registrant’s telephone number, including area code:
(336) 725-2981
 
     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  þ No  o
 
     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  þ No  o
 
     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o                               Accelerated filer  þ 
Non-accelerated filer  o    Smaller reporting company  o 
 
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No  þ
 
     Number of shares of Common Stock, no par value, outstanding as of November 25, 2011: 68,084,290.
 


TABLE OF CONTENTS

Page
FORWARD-LOOKING STATEMENTS 3
 
PART I - FINANCIAL INFORMATION 4
 
Item 1. FINANCIAL STATEMENTS 4
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
       RESULTS OF OPERATIONS 23
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 53
Item 4. CONTROLS AND PROCEDURES 53
 
PART II - OTHER INFORMATION 53
 
Item 1.       LEGAL PROCEEDINGS 53
Item 1A. RISK FACTORS 53
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 53
Item 3. DEFAULTS UPON SENIOR SECURITIES 53
Item 4. (REMOVED AND RESERVED) 53
Item 5. OTHER INFORMATION 53
Item 6. EXHIBITS 53
 
SIGNATURES 54
 
EXHIBIT INDEX 55

2



     As used herein, unless the context otherwise requires, “Krispy Kreme,” the “Company,” “we,” “us” and “our” refer to Krispy Kreme Doughnuts, Inc. and its subsidiaries. References to fiscal 2012 and fiscal 2011 mean the fiscal years ended January 29, 2012 and January 30, 2011, respectively.

FORWARD-LOOKING STATEMENTS

     This quarterly report contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that relate to our plans, objectives, estimates and goals. Statements expressing expectations regarding our future and projections relating to products, sales, revenues, expenditures, costs and earnings are typical of such statements, and are made under the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on management’s beliefs, assumptions and expectations of our future economic performance, considering the information currently available to management. These statements are not statements of historical fact. Forward-looking statements involve risks and uncertainties that may cause our actual results, performance or financial condition to differ materially from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. The words “believe,” “may,” “could,” “will,” “should,” “would,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “strive” or similar words, or the negative of these words, identify forward-looking statements. Factors that could contribute to these differences include, but are not limited to:

  • the quality of Company and franchise store operations;
     
  • our ability, and our dependence on the ability of our franchisees, to execute on our and their business plans;
     
  • our relationships with our franchisees;
     
  • our ability to implement our international growth strategy;
     
  • our ability to implement our new domestic operating model;
     
  • political, economic, currency and other risks associated with our international operations;
     
  • the price and availability of raw materials needed to produce doughnut mixes and other ingredients;
     
  • compliance with government regulations relating to food products and franchising;
     
  • our relationships with off-premises customers;
     
  • our ability to protect our trademarks and trade secrets;
     
  • restrictions on our operations and compliance with covenants contained in our secured credit facilities;
     
  • changes in customer preferences and perceptions;
     
  • risks associated with competition;
     
  • risks related to the food service industry, including food safety and protection of personal information;
     
  • increased costs or other effects of new government regulations relating to healthcare benefits; and
     
  • other factors in Krispy Kreme’s periodic reports and other information filed with the Securities and Exchange Commission (the “SEC”), including under Part I, Item 1A, “Risk Factors,” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 30, 2011 (the “2011 Form 10-K”).

     All such factors are difficult to predict, contain uncertainties that may materially affect actual results and may be beyond our control. New factors emerge from time to time, and it is not possible for management to predict all such factors or to assess the impact of each such factor on the Company. Any forward-looking statement speaks only as of the date on which such statement is made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made.

     We caution you that any forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to differ materially from the facts, results, performance or achievements we have anticipated in such forward-looking statements except as required by the federal securities laws.

3



PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS.

Page
Index to Financial Statements
Consolidated statement of operations for the three and nine months ended October 30, 2011 and October 31, 2010 5
Consolidated balance sheet as of October 30, 2011 and January 30, 2011 6
Consolidated statement of cash flows for the nine months ended October 30, 2011 and October 31, 2010 7
Consolidated statement of changes in shareholders’ equity for the nine months ended October 30, 2011 and October 31, 2010 8
Notes to financial statements 9

4



KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)

Three Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
2011       2010       2011       2010
(In thousands, except per share amounts)
Revenues $       98,708 $       90,228 $       301,260 $       270,277
Operating expenses:
       Direct operating expenses (exclusive of depreciation
              expense shown below) 85,874 79,152 258,554 233,382
       General and administrative expenses 4,941 4,784 15,515 15,509
       Depreciation expense 2,208 1,818 6,233 5,619
       Impairment charges and lease termination costs 135 399 680 1,482
Operating income 5,550 4,075 20,278 14,285
Interest income 30 42 131 164
Interest expense   (385 ) (1,585 ) (1,276 ) (5,023 )
Equity in income (losses) of equity method franchisees (72 ) 190 (69 ) 371
Gain on sale of interest in equity method franchisee -   -   6,198 -
Other non-operating income and (expense), net 89   85 261 247
Income before income taxes 5,212 2,807   25,523 10,044
Provision for income taxes 495 417 2,796 979
Net income $ 4,717 $ 2,390 $ 22,727 $ 9,065
 
Earnings per common share:
       Basic $ 0.07 $ 0.03 $ 0.33   $ 0.13
       Diluted $ 0.07 $ 0.03 $ 0.32 $ 0.13

The accompanying notes are an integral part of the financial statements.

5



KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED BALANCE SHEET
(Unaudited)

October 30, January 30,
2011       2011
(In thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $      37,579 $      21,970
Receivables 22,502 20,261
Receivables from equity method franchisees 680 586
Inventories 16,948 14,635
Other current assets 4,162 5,970
       Total current assets 81,871 63,422
Property and equipment 73,393 71,163
Investments in equity method franchisees - 1,663
Goodwill and other intangible assets 23,776 23,776
Other assets 9,668 9,902
       Total assets $ 188,708 $ 169,926
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt $ 2,220 $ 2,513
Accounts payable 11,154 9,954
Accrued liabilities 29,647 28,379
       Total current liabilities 43,021 40,846
Long-term debt, less current maturities 25,345 32,874
Other long-term obligations 17,912 19,778
 
Commitments and contingencies
 
SHAREHOLDERS’ EQUITY:
Preferred stock, no par value - -
Common stock, no par value 374,327 370,808
Accumulated other comprehensive loss (278 ) (34 )
Accumulated deficit (271,619 ) (294,346 )
       Total shareholders’ equity   102,430 76,428
              Total liabilities and shareholders’ equity $ 188,708 $ 169,926

The accompanying notes are an integral part of the financial statements.

6



KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)

Nine Months Ended
October 30, October 31,
2011       2010
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $     22,727 $     9,065
Adjustments to reconcile net income to net cash provided by operating activities:
       Depreciation expense 6,233 5,619
       Deferred income taxes 159 (90 )
       Impairment charges - 790
       Accrued rent expense 389 (165 )
       Loss on disposal of property and equipment 348 473
       Gain on sale of interest in equity method franchisee (6,198 ) -
       Share-based compensation 3,437 3,197
       Provision for doubtful accounts (397 ) (300 )
       Amortization of deferred financing costs 320 560
       Equity in (income) losses of equity method franchisees 69 (371 )
       Other 490 (316 )
Change in assets and liabilities:
       Receivables (1,794 ) (3,036 )
       Inventories (2,313 ) (816 )
       Other current and non-current assets (261 ) (1,948 )
       Accounts payable and accrued liabilities 1,899 351
       Other long-term obligations (2,196 ) (179 )
              Net cash provided by operating activities 22,912 12,834
CASH FLOWS FROM INVESTING ACTIVITIES:  
Purchase of property and equipment (8,222 ) (5,457 )
Proceeds from disposals of property and equipment   26   2,688
Proceeds from sale of interest in equity method franchisee 7,723 -
Escrow deposit recovery 1,600   -
Other investing activities (52 ) 6
              Net cash provided by (used for) investing activities 1,075 (2,763 )
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt (8,437 ) (8,114 )
Deferred financing costs (23 ) -
Proceeds from exercise of stock options 1,036 -
Proceeds from exercise of warrants - 5
Repurchase of common shares (954 ) (421 )
              Net cash used for financing activities (8,378 ) (8,530 )
Net increase in cash and cash equivalents 15,609 1,541
Cash and cash equivalents at beginning of period 21,970 20,215
Cash and cash equivalents at end of period $ 37,579 $ 21,756

The accompanying notes are an integral part of the financial statements.

7



KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)

Accumulated
Common Other
Shares Common Comprehensive Accumulated
Outstanding       Stock       Income (Loss)       Deficit       Total
(In thousands)
Balance at January 30, 2011 67,527 $     370,808 $           (34 ) $     (294,346 ) $     76,428
Comprehensive income:
       Net income for the nine months ended
              October 30, 2011 22,727 22,727
       Foreign currency translation adjustment, net
              of income taxes of $23 34 34
       Unrealized loss on cash flow hedge, net
              of income taxes of $181 (278 ) (278 )
       Total comprehensive income 22,483
Exercise of stock options 397 1,036 1,036
Cancelation of restricted shares (8 ) - -
Share-based compensation 280 3,437 3,437
Repurchase of common shares (121 ) (954 ) (954 )
Balance at October 30, 2011       68,075 $ 374,327 $ (278 ) $ (271,619 ) $ 102,430
 
 
Balance at January 31, 2010 67,441   $ 366,237 $ (180 ) $ (303,290 ) $ 62,767
Effect of adoption of new accounting standard
       (Note 1)   1,345 1,345
Comprehensive income:    
       Net income for the nine months ended
              October 31, 2010       9,065   9,065
       Foreign currency translation adjustment, net
              of income taxes of $30     46     46
       Amortization of unrealized loss on interest
              rate derivative, net of income taxes of $60   92 92
       Total comprehensive income 9,203
Cancelation of restricted shares (2 ) - -
Exercise of warrants - 5 5
Share-based compensation 148 3,197 3,197
Repurchase of common shares (45 ) (421 ) (421 )
Balance at October 31, 2010 67,542 $ 369,018 $ (42 ) $ (292,880 ) $ 76,096

Total comprehensive income for the three months ended October 30, 2011 and October 31, 2010 was $4.7 million and $2.4 million, respectively.

The accompanying notes are an integral part of the financial statements.

8



KRISPY KREME DOUGHNUTS, INC.

NOTES TO FINANCIAL STATEMENTS
(Unaudited
)

Note 1 — Accounting Policies

     Krispy Kreme Doughnuts, Inc. (“KKDI”) and its subsidiaries (collectively, the “Company”) are engaged in the sale of doughnuts and complimentary products through Company-owned stores. The Company also derives revenue from franchise and development fees and royalties from franchisees. Additionally, the Company sells doughnut mix, other ingredients and supplies and doughnut-making equipment to franchisees.

Significant Accounting Policies

     BASIS OF PRESENTATION. The consolidated financial statements contained herein should be read in conjunction with the Company’s 2011 Form 10-K. The accompanying interim consolidated financial statements are presented in accordance with the requirements of Article 10 of Regulation S-X and, accordingly, do not include all the disclosures required by generally accepted accounting principles (“GAAP”) with respect to annual financial statements. The interim consolidated financial statements have been prepared in accordance with the Company’s accounting practices described in the 2011 Form 10-K, but have not been audited. In management’s opinion, the financial statements include all adjustments, which consist only of normal recurring adjustments, necessary for a fair statement of the Company’s results of operations for the periods presented. The consolidated balance sheet data as of January 30, 2011 were derived from the Company’s audited financial statements but do not include all disclosures required by GAAP.

     BASIS OF CONSOLIDATION. The financial statements include the accounts of KKDI and its subsidiaries, the most significant of which is KKDI’s principal operating subsidiary, Krispy Kreme Doughnut Corporation.

     Investments in entities over which the Company has the ability to exercise significant influence but which the Company does not control, and whose financial statements are not otherwise required to be consolidated, are accounted for using the equity method. These entities typically are 25% to 35% owned and are hereinafter sometimes referred to as “Equity Method Franchisees.”

     EARNINGS PER SHARE. The computation of basic earnings per share is based on the weighted average number of common shares outstanding during the period. The computation of diluted earnings per share reflects the additional common shares that would have been outstanding if dilutive potential common shares had been issued, computed using the treasury stock method. Such potential common shares consist of shares issuable upon the exercise of stock options and warrants and the vesting of currently unvested shares of restricted stock and restricted stock units.

     The following table sets forth amounts used in the computation of basic and diluted earnings per share:

Three Months Ended Nine Months Ended
October 30,       October 31,       October 30,       October 31,
2011 2010 2011 2010
(In thousands)
Numerator: net income $     4,717 $     2,390 $     22,727 $     9,065
Denominator:  
       Basic earnings per share - weighted average shares outstanding 69,384 68,407 69,013 68,232
       Effect of dilutive securities:    
              Stock options and warrants 1,654   1,101 1,796   809
              Restricted stock and restricted stock units 509   515   665   486
       Diluted earnings per share - weighted average shares
              outstanding plus dilutive potential common shares 71,547 70,023 71,474 69,527

     The sum of the quarterly earnings per share amounts does not necessarily equal earnings per share for the year to date.

9



     Stock options and warrants with respect to 7.4 million and 7.3 million shares, as well as 340,000 and 353,000 unvested shares of restricted stock and unvested restricted stock units have been excluded from the computation of the number of shares used to compute diluted earnings per share for the three months ended October 30, 2011 and October 31, 2010, respectively, because their inclusion would be antidilutive.

     Stock options and warrants with respect to 7.4 million and 8.2 million shares, as well as 158,000 and 210,000 unvested shares of restricted stock and unvested restricted stock units, have been excluded from the computation of the number of shares used to compute diluted earnings per share for the nine months ended October 30, 2011 and October 31, 2010, respectively, because their inclusion would be antidilutive.

     INCOME TAXES. The Company recognizes deferred tax assets and liabilities based upon management’s expectation of the future tax consequences of temporary differences between the income tax and financial reporting bases of assets and liabilities. Deferred tax liabilities generally represent tax expense recognized for which payment has been deferred, or expenses which have been deducted in the Company’s tax return but which have not yet been recognized as an expense in the consolidated financial statements. Deferred tax assets generally represent tax deductions or credits that will be reflected in future tax returns for which the Company has already recorded a tax benefit in its consolidated financial statements. The Company establishes valuation allowances for deferred tax assets in accordance with GAAP, which provides that such valuation allowances shall be established unless realization of the income tax benefits is more likely than not.

     Realization of deferred income taxes is dependent upon the Company’s generation of taxable income in future years. As of January 30, 2011, the Company had a valuation allowance against deferred tax assets of $159 million, representing the total amount of such assets in excess of the Company’s deferred income tax liabilities. The Company has maintained an allowance equal to 100% of such excess since fiscal 2005, principally because the substantial losses incurred by the Company indicated that it was more likely than not that the Company’s deferred tax assets would not be realized. The Company generated a cumulative profit over its three most recent fiscal years, although substantially all of that profit was earned in fiscal 2011, the most recently completed year.

     The assessment of the amount of the Company’s deferred tax assets that is more likely than not to be realized, and therefore the amount of the valuation allowance that is appropriate, is a matter that requires significant management judgment. This judgment is largely dependent upon management’s estimate of the amount of taxable income the Company will generate in future periods. The Company incurred significant losses in each of fiscal 2005 through 2009, and did not generate a significant profit until fiscal 2011. As previously disclosed, management believes that it is appropriate that, among other things, the Company achieve at least two full years of significant pretax earnings before concluding that future profitability is sustainable.

     As it does at each reporting period, the Company conducted an assessment of the recoverability of its deferred tax assets as of October 30, 2011, and was unable to conclude that recoverability of those assets was more likely than not. The Company will again conduct an assessment of the recoverability of its deferred tax assets in the fourth quarter of fiscal 2012, and will consider the Company’s operating results and other evidence relevant to the conclusion as to the likelihood of realization of the deferred tax assets. Such assessment could result in a conclusion that reversal of all, or a substantial portion, of the valuation allowance on deferred tax assets is appropriate. Any reversal will have no effect on the Company’s cash flows.

Recent Accounting Pronouncements

     Effective February 1, 2010, the first day of fiscal 2011, the Company was required to adopt new accounting standards related to the consolidation of variable interest entities (“VIEs”). Those standards require an enterprise to qualitatively assess whether it is the primary beneficiary of a VIE based on whether the enterprise has the power to direct matters that most significantly impact the activities of the VIE and has the obligation to absorb losses of, or the right to receive benefits from, the VIE that could potentially be significant to the VIE. An enterprise must consolidate the financial statements of VIEs of which it is the primary beneficiary. Under the new accounting standards, the Company was no longer the primary beneficiary of its franchisee in northern California, which required the Company to deconsolidate the franchisee and recognize a divestiture of the three stores the Company sold to the franchisee in the third quarter of fiscal 2010. The cumulative effect of adoption of the new standards has been reflected as a $1.3 million credit to the opening balance of retained earnings as of February 1, 2010. Adoption of the standards had no material effect on the Company’s financial position, results of operations or cash flows.

     In May 2011, the Financial Accounting Standards Board (the “FASB”) issued an Accounting Standards Update (“ASU”) related to fair value measurements. The ASU clarifies some existing concepts, eliminates wording differences between GAAP and International Financial Reporting Standards (“IFRS”), and in some limited cases, changes some principles to achieve convergence between GAAP and IFRS. The ASU also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. The ASU is effective for the Company in fiscal 2013. The Company does not expect the adoption of the new accounting standards to have a material effect on the Company’s financial condition or results of operations.

10



     In June 2011, the FASB issued new accounting standards which require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. The new accounting rules eliminate the option to present components of other comprehensive income as part of the statement of changes in shareholders’ equity. The new accounting rules will be effective for the Company in fiscal 2013. The Company does not expect the adoption of the new accounting rules to have a material effect on the Company’s financial condition or results of operations.

     In September 2011, the FASB amended the guidance on the annual testing of goodwill for impairment. The amended guidance will allow companies to assess qualitative factors to determine if it is more likely than not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. This guidance is effective for the Company in fiscal 2013, with early adoption permitted. The Company does not expect that this new guidance will have a material impact on its consolidated financial statements.

Note 2 — Receivables

     The components of receivables are as follows:

October 30, January 30,
2011 2011
(In thousands)
Receivables:
       Off-premises customers       $      11,089       $ 9,990
       Unaffiliated franchisees 11,536 9,805
       Other receivables 842 1,565
       Current portion of notes receivable 172 235
   23,639 21,595
       Less — allowance for doubtful accounts:  
              Off-premises customers (322 ) (326 )
              Unaffiliated franchisees (815 ) (1,008 )
(1,137 ) (1,334 )
$ 22,502 $ 20,261
   
Receivables from Equity Method Franchisees (Note 8):
       Trade $ 680 $ 586
   
     The changes in the allowance for doubtful accounts are summarized as follows:
  
Nine Months Ended
October 30, October 31,
2011 2010
(In thousands)
Allowance for doubtful accounts related to receivables:
       Balance at beginning of period $ 1,334 $ 1,343
       Provision for doubtful accounts 15 5
       Chargeoffs (219 ) (177 )
       Recoveries 7 -
       Transfers to allowances for notes receivable - (68 )
       Balance at end of period $ 1,137 $ 1,103
   
Allowance for doubtful accounts related to receivables from Equity Method Franchisees:
       Balance at beginning of period $ - $ 739  
       Provision for doubtful accounts - (35 )
       Chargeoffs - (233 )
       Transfers to allowances for notes receivable -   (471 )
       Balance at end of period $ - $      -

11



     The Company also has notes receivable from franchisees which are summarized in the following table. These balances are included in “Other assets” in the accompanying consolidated balance sheet.

October 30, January 30,
2011 2011
(In thousands)
Notes receivable:
       Note receivable from Equity Method Franchisee (Note 8)       $      -       $      391
       Notes receivable from franchisees 860 1,300
     860 1,691
       Less — portion due within one year (172 )   (235 )
       Less — allowance for doubtful accounts (68 ) (538 )
$ 620 $ 918
  
     The changes in the allowance for doubtful accounts related to notes receivable are summarized as follows:
   
Nine Months Ended
October 30, October 31,
2011 2010
(In thousands)
Balance at beginning of period $ 538 $ 129
Provision for doubtful accounts (412 ) (270 )
Chargeoffs (79 ) (119 )
Recoveries 21 180
Transfers from allowances for trade receivables - 539  
Balance at end of period $ 68 $ 459

     In addition to the foregoing notes receivable, the Company had promissory notes totaling approximately $3.3 million and $3.7 million at October 30, 2011 and January 30, 2011, respectively, representing payment obligations related to royalties and fees due to the Company which, as a result of doubt about their collection, the Company had not yet recorded as revenues. No payments were required to be made currently on any of the October 30, 2011 amount. During the quarter ended May 1, 2011, the Company recognized approximately $375,000 of previously unrecognized revenues related to KK Mexico which were received on May 5, 2011 in connection with the Company’s sale of its 30% equity interest in the franchisee, as more fully described in Note 8. During the quarter ended May 1, 2011, the Company also reversed an allowance for doubtful notes receivable of approximately $391,000 related to KK Mexico; such note also was paid in full on May 5, 2011.

Note 3 — Inventories

     The components of inventories are as follows:

October 30, January 30,
2011 2011
(In thousands)
Raw materials       $      5,321       $      5,265
Work in progress 89 54
Finished goods and purchased merchandise   11,465 9,212
Manufacturing supplies 73   104
$ 16,948 $ 14,635

12



Note 4 — Long Term Debt

     Long-term debt and capital lease obligations consist of the following:

October 30, January 30,
2011 2011
(In thousands)
2011 Term Loan       $      26,775       $      35,000
Capital lease obligations 790   387
    27,565 35,387
Less: current maturities   (2,220 )   (2,513 )
$ 25,345 $ 32,874  

     On January 28, 2011, the Company closed new secured credit facilities (the “2011 Secured Credit Facilities”), consisting of a $25 million revolving credit line (the “2011 Revolver”) and a $35 million term loan (the “2011 Term Loan”), each of which mature in January 2016. The 2011 Secured Credit Facilities are secured by a first lien on substantially all of the assets of the Company and its domestic subsidiaries. The Company used the proceeds of the 2011 Term Loan to repay the outstanding borrowings under the Company’s prior secured credit facilities (the “2007 Secured Credit Facilities”). The 2007 Secured Credit Facilities, which consisted of a $25 million revolving credit facility (the “2007 Revolver”) and a term loan maturing in February 2014, which had an outstanding balance of approximately $35.1 million (the “2007 Term Loan”), were then terminated.

     Interest on borrowings under the 2011 Secured Credit Facilities is payable either at LIBOR or the Base Rate (which is the greatest of the prime rate, the Fed funds rate plus 0.50%, or the one-month LIBOR rate plus 1.00%), in each case plus the Applicable Percentage. The Applicable Percentage for LIBOR loans ranges from 2.25% to 3.00%, and for Base Rate loans ranges from 1.25% to 2.00%, in each case depending on the Company’s leverage ratio. As of October 30, 2011, all outstanding borrowings under the 2011 Secured Credit Facilities were based on LIBOR, and the Applicable Percentage was 2.25%. The Company also pays fees on outstanding letters of credit issued under the 2011 Revolver equal to the Applicable Percentage for LIBOR loans plus 0.125%. Such letters of credit totaled $10.2 million as of October 30, 2011.

     Interest on borrowings under the 2007 Revolver and 2007 Term Loan was payable either (a) at the greater of LIBOR or 3.25% or (b) at the Alternate Base Rate (which was the greater of Fed funds rate plus 0.50% or the prime rate), in each case plus the Applicable Margin. The Applicable Margin for LIBOR-based loans and for Alternate Base Rate-based loans was 7.50% and 6.50%, respectively. The Company also paid fees on outstanding letters of credit issued under the 2007 Revolver equal to the Applicable Margin for LIBOR loans plus 0.25%.

     The 2011 Term Loan is payable in quarterly installments of approximately $470,000, as adjusted to give effect to principal prepayments, and a final installment equal to the remaining principal balance in January 2016. The 2011 Term Loan is required to be prepaid with some or all of the net proceeds of certain equity issuances, debt issuances, asset sales and casualty events. On the closing date, the Company deposited into escrow $200,000 with respect to each of nine properties ($1.8 million in the aggregate) with respect to which the Company agreed to furnish to the lenders certain documentation on or before January 31, 2012, with amounts to be released from escrow upon the Company’s furnishing such documentation. If the Company does not furnish the documentation by January 31, 2012, then the amount remaining in escrow on that date will be used to make a prepayment of principal on the 2011 Term Loan. During the nine months ended October 30, 2011, $1.6 million of the escrowed amount was returned to the Company; amounts remaining in escrow are included in “Other current assets” in the accompanying consolidated balance sheet.

     The 2011 Secured Credit Facilities require the Company to meet certain financial tests, including a maximum leverage ratio and a minimum fixed charge coverage ratio. The leverage ratio is required to be not greater than 2.75 to 1.0 in fiscal 2012, and declines to 2.5 to 1.0 thereafter. The fixed charge coverage ratio is required to be not less than 1.05 to 1.0 in fiscal 2012, increasing to a minimum of 1.1 to 1.0 in fiscal 2013 and to 1.2 to 1.0 thereafter.

     As of October 30, 2011, the Company’s leverage ratio was 0.9 to 1.0, and the fixed charge coverage ratio for the rolling four-quarter period then ended was 2.8 to 1.0. In accordance with the terms of the 2011 Secured Credit Facilities, interest and fees related to these facilities is reflected in the computation of the fixed charge coverage ratio by annualizing amounts incurred under those facilities subsequent to the closing date.

     The operation of the restrictive financial covenants described above may limit the amount the Company may borrow under the 2011 Revolver. The restrictive covenants did not limit the Company’s ability to borrow the full $14.8 million of unused credit under the 2011 Revolver at October 30, 2011.

13



Note 5 — Commitments and Contingencies

     Except as disclosed below, the Company currently is not a party to any material legal proceedings.

Pending Litigation

     On April 7, 2009, a Cayman Islands corporation, K2 Asia Ventures, and its owners filed a lawsuit in Forsyth County, North Carolina Superior Court against the Company, its franchisee in the Philippines, and other persons associated with the franchisee. The suit alleges that the Company and the other defendants conspired to deprive the plaintiffs of claimed “exclusive rights” to negotiate franchise and development agreements with prospective franchisees in the Philippines, and seeks unspecified damages. The Company believes that these allegations are false and intends to vigorously defend against the lawsuit.

Other Legal Matters

     The Company also is engaged in various legal proceedings arising in the normal course of business. The Company maintains customary insurance policies against certain kinds of such claims and suits, including insurance policies for workers’ compensation and personal injury, some of which provide for relatively large deductible amounts.

Other Commitments and Contingencies

     The Company has guaranteed certain loans from third-party financial institutions on behalf of Equity Method Franchisees primarily to assist the franchisees in obtaining third-party financing. The loans are collateralized by certain assets of the franchisee, generally the Krispy Kreme store and related equipment. The Company’s contingent liabilities related to these guarantees totaled approximately $2.7 million at October 30, 2011, and are summarized in Note 8. These guarantees require payment from the Company in the event of default on payment by the respective debtor and, if the debtor defaults, the Company may be required to pay amounts outstanding under the related agreements in addition to the principal amount guaranteed, including accrued interest and related fees.

     The aggregate recorded liability for these loan guarantees totaled $1.9 million as of October 30, 2011, which is included in accrued liabilities in the accompanying consolidated balance sheet. These liabilities represent the estimated amount of guarantee payments which the Company believed to be probable. While there is no current demand on the Company to perform under any of the guarantees, there can be no assurance that the Company will not be required to perform and, if circumstances change from those prevailing at October 30, 2011, additional guarantee payments or provisions for guarantee payments could be required with respect to any of the guarantees.

     In addition, accrued liabilities at October 30, 2011, includes approximately $990,000 related to the Company’s assignment of operating leases on refranchised stores. The Company is contingently liable to pay the rents on these stores to the landlords in the event the assignees fail to perform under the leases they have assumed. During the second quarter of fiscal 2012, the Company recorded a provision of $820,000 for payments the Company expects to make under a lease guarantee related to a franchisee whose franchise rights the Company terminated during the second quarter. During the third quarter of fiscal 2012, the Company reversed a previously recorded lease guarantee accrual of $110,000 as a result of the Company receiving a release from the related guarantee. The aggregate gross guarantee exposure under all such lease guarantees, without reduction for any potential sublease rentals or any other mitigation, was approximately $4.2 million as of October 30, 2011.

     One of the Company’s lenders had issued letters of credit on behalf of the Company totaling $10.2 million at October 30, 2011, all of which secure the Company’s reimbursement obligations to insurers under the Company’s self-insurance arrangements.

     In addition to entering into forward purchase contracts, the Company from time to time purchases exchange-traded commodity futures contracts or options on such contracts for raw materials which are ingredients of the Company’s products or which are components of such ingredients, including wheat and soybean oil. The Company typically assigns the futures contract to a supplier in connection with entering into a forward purchase contract for the related ingredient. The Company may also purchase futures, options on futures or enter into other hedging contracts to hedge its exposure to rising gasoline prices. See Note 11 for additional information about these derivatives.

14



Note 6 — Impairment Charges and Lease Termination Costs

     The components of impairment charges and lease termination costs are as follows:

Three Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
2011 2010 2011 2010
(In thousands)
Impairment of long-lived assets:
       Current period charges       $      -       $      -       $      -       $      899
       Adjustments to previously recorded estimates - 81 - (109 )
              Total impairment of long-lived assets - 81 - 790
Lease termination costs:    
       Provision for termination costs 135   318 680 1,336
       Less — reversal of previously recorded accrued rent expense   - - - (644 )
              Net provision 135 318 680   692
                     Total impairment charges and lease termination costs $ 135 $ 399 $ 680 $ 1,482

     The Company tests long-lived assets for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. These events and changes in circumstances include store closing and refranchising decisions, the effects of changing costs on current results of operations, observed trends in operating results, and evidence of changed circumstances observed as a part of periodic reforecasts of future operating results and as part of the Company’s annual budgeting process. When the Company concludes that the carrying value of long-lived assets is not recoverable (based on future projected undiscounted cash flows), the Company records impairment charges to reduce the carrying value of those assets to their estimated fair values.

     Lease termination costs represent the estimated fair value of liabilities related to unexpired leases, after reduction by the amount of accrued rent expense, if any, related to the leases, and are recorded when the lease contracts are terminated or, if earlier, the date on which the Company ceases use of the leased property. The fair value of these liabilities are estimated as the excess, if any, of the contractual payments required under the unexpired leases over the current market lease rates for the properties, discounted at a credit-adjusted risk-free rate over the remaining term of the leases. The provision for lease termination costs also includes adjustments to liabilities recorded in prior periods arising from changes in estimated sublease rentals and from settlements with landlords.

     The transactions reflected in the accrual for lease termination costs are summarized as follows:

Three Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
2011 2010 2011 2010
(In thousands)
Balance at beginning of period       $      1,152       $      2,100       $      1,995       $      1,679
       Provision for lease termination costs:
              Provisions associated with store closings, net of estimated  
                     sublease rentals - - - 394
              Adjustments to previously recorded provisions resulting    
                     from settlements with lessors and adjustments of previous
                     estimates 119 266 611 795
              Accretion of discount 16   52   69 147
                     Total provision   135 318 680   1,336
       Payments on unexpired leases, including settlements with  
              lessors (563 ) (374 ) (1,951 ) (971 )
Balance at end of period $ 724 $ 2,044 $ 724 $ 2,044

15



Note 7 — Segment Information

     The Company’s reportable segments are Company Stores, Domestic Franchise, International Franchise and KK Supply Chain. The Company Stores segment is comprised of the stores operated by the Company. These stores sell doughnuts and complementary products through both on-premises and off-premises sales channels, although some stores serve only one of these distribution channels. The Domestic Franchise and International Franchise segments consist of the Company’s franchise operations. Under the terms of franchise agreements, domestic and international franchisees pay royalties and fees to the Company in return for the use of the Krispy Kreme name and ongoing brand and operational support. Expenses for these segments include costs to recruit new franchisees, to assist in store openings, to support franchisee operations and marketing efforts, as well as allocated corporate costs. The majority of the ingredients and materials used by Company stores are purchased from the KK Supply Chain segment, which supplies doughnut mix, other ingredients and supplies and doughnut making equipment to both Company and franchisee-owned stores.

     All intercompany sales by the KK Supply Chain segment to the Company Stores segment are at prices intended to reflect an arms-length transfer price and are eliminated in consolidation. Operating income for the Company Stores segment does not include any profit earned by the KK Supply Chain segment on sales of doughnut mix and other items to the Company Stores segment; such profit is included in KK Supply Chain operating income.

     The following table presents the results of operations of the Company’s operating segments for the three and nine months ended October 30, 2011 and October 31, 2010. Segment operating income is consolidated operating income before unallocated general and administrative expenses and impairment charges and lease termination costs.

Three Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
2011 2010 2011 2010
(In thousands)
Revenues:
       Company Stores       $      67,606       $      61,565       $ 203,073       $ 184,069
       Domestic Franchise 2,327 2,040   7,045 6,314
       International Franchise 5,374 4,389 16,362 13,158
       KK Supply Chain:  
              Total revenues 50,277 45,001 154,501   135,798
              Less – intersegment sales elimination (26,876 ) (22,767 ) (79,721 ) (69,062 )
                     External KK Supply Chain revenues 23,401 22,234 74,780 66,736
                            Total revenues $ 98,708 $ 90,228 $ 301,260 $ 270,277
  
Operating income (loss):
       Company Stores $ (574 ) $ (1,449 ) $ 551 $ (3,214 )
       Domestic Franchise 1,114 499 2,477 2,694
       International Franchise   3,313 3,018 10,893 9,004
       KK Supply Chain 6,987 7,342 23,074 23,361
              Total segment operating income 10,840 9,410 36,995 31,845
       Unallocated general and administrative expenses (5,155 ) (4,936 ) (16,037 ) (16,078 )
       Impairment charges and lease termination costs (135 ) (399 ) (680 ) (1,482 )
              Consolidated operating income $ 5,550 $ 4,075 $ 20,278 $ 14,285
    
Depreciation expense:
       Company Stores $ 1,756 $ 1,410 $ 4,982 $ 4,264
       Domestic Franchise 55 56 165 166
       International Franchise - 2 4 5
       KK Supply Chain 183 198 560   615  
       Corporate administration 214 152 522 569
              Total depreciation expense $ 2,208 $ 1,818 $      6,233 $      5,619

     Segment information for total assets and capital expenditures is not presented as such information is not used in measuring segment performance or allocating resources among segments.

16



Note 8 — Investments in Franchisees

     As of October 30, 2011, the Company had investments in three franchisees. These investments have been made in the form of capital contributions and, in certain instances, loans evidenced by promissory notes. These investments are reflected as “Investments in equity method franchisees” in the consolidated balance sheet.

     The Company’s financial exposures related to franchisees in which the Company has an investment are summarized in the tables below.

October 30, 2011
Company Investment
Ownership and Notes Loan
Percentage Advances Receivables Receivable Guarantees
(Dollars in thousands)
Kremeworks, LLC 25.0 % $ 900 $ 419 $ -       $      831
Kremeworks Canada, LP 24.5 % - 34 - -
Krispy Kreme of South Florida, LLC 35.3 % - 227 - 1,900
900 680 - $ 2,731
Less: reserves and allowances (900 ) - -  
$ - $ 680 $ -
   
January 30, 2011
Company Investment
Ownership and Notes Loan
Percentage Advances Receivables Receivable Guarantees
(Dollars in thousands)
Kremeworks, LLC 25.0 % $ 900 $ 270 $ - $ 1,008
Kremeworks Canada, LP   24.5 % - 22 - -
Krispy Kreme of South Florida, LLC 35.3 % - 190 - 2,161
Krispy Kreme Mexico, S. de R.L. de C.V. 30.0 % 1,663 104 391 -
        2,563   586 391 $ 3,169
Less: reserves and allowances (900 ) -   (391 )
      $      1,663       $      586       $      -

     The Company has guaranteed certain loans from third-party financial institutions on behalf of Equity Method Franchisees, primarily to assist the franchisees in obtaining third-party financing. The loans are collateralized by certain assets of the franchisee, generally the Krispy Kreme store and related equipment. The loan guarantee amounts represent the portion of the principal amount outstanding under the related loan that is subject to the Company’s guarantee.

     Current liabilities at October 30, 2011 and January 30, 2011 include accruals for potential payments under loan guarantees of approximately $1.9 million and $2.2 million, respectively, related to Krispy Kreme of South Florida, LLC (“KKSF”). The underlying indebtedness related to approximately $1.6 million of the Company’s KKSF guarantee exposure matured by its terms in October 2009. Such maturity has been extended on a month-to-month basis pursuant to an informal agreement between KKSF and the lender.

     There was no liability reflected in the financial statements for other guarantees of franchisee indebtedness because the Company did not believe it was probable that the Company would be required to perform under such other guarantees.

     The Company has a 25% interest in Kremeworks, LLC (“Kremeworks”), and has guaranteed 20% of the outstanding principal balance of certain of Kremeworks’ bank indebtedness, which, as amended, matures in October 2012. The aggregate amount of such indebtedness was approximately $4.2 million at October 30, 2011.

     On May 5, 2011, the Company sold its 30% equity interest in Krispy Kreme Mexico, S. de R.L. de C.V. (“KK Mexico”), the Company’s franchisee in Mexico, to KK Mexico’s majority shareholder. The Company received cash proceeds of approximately $7.7 million in exchange for its equity interest and, after deducting costs of the transaction, realized a gain of approximately $6.2 million on the disposition. After provision for payment of Mexican income taxes related to the sale of approximately $1.5 million, the Company reported an after tax gain on the disposition of approximately $4.7 million in the quarter ending July 31, 2011. The net after tax proceeds of the sale of approximately $6.2 million were used to prepay a portion of the outstanding balance of the 2011 Term Loan.

17



     In connection with the Company’s sale of its KK Mexico interest, KK Mexico paid approximately $765,000 of amounts due to the Company which were evidenced by promissory notes, relating principally to past due royalties and fees due to the Company. As a consequence of this payment, in the quarter ended May 1, 2011, the Company reversed an allowance for doubtful notes receivable of approximately $391,000 and recorded royalty and franchise fee income of approximately $280,000 and $95,000 respectively. The reserve had previously been established, and the royalties and fees had not previously been recognized as revenue, because of uncertainty surrounding the collection of these amounts.

Note 9 — Shareholders’ Equity

     The Company measures and recognizes compensation expense for share-based payment (“SBP”) awards based on their fair values. The fair value of SBP awards for which employees and directors render the requisite service necessary for the award to vest is recognized over the related vesting period.

     The aggregate cost of SBP awards charged to earnings for the three and nine months ended October 30, 2011 and October 31, 2010 is set forth in the following table. The Company did not realize any excess tax benefits from the exercise of stock options or the vesting of restricted stock or restricted stock units during any of the periods.

Three Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
2011 2010 2011 2010
(In thousands)
Costs charged to earnings related to:
       Stock options $ 375       $      141       $      1,145 $ 645
       Restricted stock and restricted stock units 1,256 1,122 2,292 2,552
              Total costs $ 1,631 $ 1,263 $ 3,437       $ 3,197
   
Costs included in:
       Direct operating expenses       $      1,096 $ 722 $ 2,061 $ 1,510
       General and administrative expenses   535 541 1,376   1,687
              Total costs $ 1,631 $ 1,263 $ 3,437 $      3,197

Note 10 — Fair Value Measurements

     The accounting standards for fair value measurements define fair value as the price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.

     The accounting standards for fair value measurements establish a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

  • Level 1 - Quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities.


  • Level 2 - Observable inputs other than quoted prices included within Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.


  • Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value measurement of the assets or liabilities. These include certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

18



Assets and Liabilities Measured at Fair Value on a Recurring Basis

     The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at October 30, 2011 and January 30, 2011.

October 30, 2011
Level 1 Level 2 Level 3
(In thousands)
Assets:
       401(k) mirror plan assets $ 1,008 $ - $      -
       Interest rate derivative - 143 -
              Total assets $ 1,008 $ 143 $ -
Liabilities:
       Agricultural commodity futures contracts $ 88 $ - $ -
       Gasoline commodity futures contracts 48 - -
              Total liabilities $ 136 $ - $ -
   
January 30, 2011
Level 1 Level 2 Level 3
(In thousands)
Assets:
       401(k) mirror plan assets       $      796       $      -       $ -
       Agricultural commodity futures contracts 144   - -
              Total assets $ 940 $ - $ -

Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis

     The following tables present the nonrecurring fair value measurements recorded during the three and nine months ended October 30, 2011 and October 31, 2010.

Three Months Ended October 30, 2011
Level 1 Level 2 Level 3 Total gain (loss)
(In thousands)
Long-lived assets $ - $ - $ - $ -
Lease termination liabilities $ - $ - $ - $ -
 
Nine Months Ended October 30, 2011
Level 1   Level 2 Level 3 Total gain (loss)
(In thousands)
Long-lived assets $ -       $      -       $      - $      -
Lease termination liabilities       $      - $ - $ -       $ -

19



Three Months Ended October 31, 2010
      Level 1       Level 2       Level 3       Total gain (loss)
(In thousands)
Long-lived assets $ - $ - $ - $                    -
Lease termination liabilities $ - $ - $ - $ -
     
Nine Months Ended October 31, 2010
      Level 1       Level 2       Level 3       Total gain (loss)
(In thousands)
Long-lived assets   $      -   $      3,638 $      -   $                    (899 )
Lease termination liabilities $ - $ 394   $ - $ 250

   Long-Lived Assets

     During the nine months ended October 31, 2010, long-lived assets having an aggregate carrying value of $4.5 million were written down to their estimated fair values of $3.6 million, resulting in recorded impairment charges of $899,000. Substantially all of such long-lived assets were real properties, the fair values of which were estimated based on independent appraisals or, in the case of properties which the Company was negotiating to sell, based on the Company’s negotiations with unrelated third-party buyers. These inputs are classified as Level 2 within the valuation hierarchy.

   Lease Termination Liabilities

     During the nine months ended October 31, 2010, the Company recorded provisions for lease termination costs related to closed stores based upon the estimated fair values of the liabilities under unexpired leases as described in Note 6; such provisions were reduced by previously recorded accrued rent expense related to those stores. The fair value of these liabilities was computed as the excess, if any, of the contractual payments required under the unexpired leases over the current market lease rates for the properties, discounted at a credit-adjusted risk-free rate over the remaining term of the leases. These inputs are classified as Level 2 within the valuation hierarchy. For the nine months ended October 31, 2010, $644,000 of previously recorded accrued rent expense related to a store closure and a store relocation exceeded the $394,000 fair value of lease termination liabilities related to such stores, and such excess has been reflected as a credit to lease termination costs during the period.

Fair Values of Financial Instruments at the Balance Sheet Dates

     The carrying values and approximate fair values of certain financial instruments as of October 30, 2011 and January 30, 2011 were as follows:

October 30, 2011 January 30, 2011
Carrying Fair Carrying Fair
      Value       Value       Value       Value
(In thousands)
Assets:
       Cash and cash equivalents $     37,579 $     37,579   $     21,970 $     21,970
       Receivables 22,502   22,502 20,261 20,261
       Interest rate derivatives   143 143 - -
       Receivables from Equity Method Franchisees 680 680   586 586
       Agricultural commodity futures contracts - - 144 144
                         
Liabilities:  
       Accounts payable 11,154 11,154 9,954 9,954
       Agricultural commodity futures contracts 88 88 - -
       Gasoline commodity futures contracts 48 48 - -
       Long-term debt (including current maturities) 27,565 27,565 35,387   35,387

20



Note 11 — Derivative Instruments

     The Company is exposed to certain risks relating to its ongoing business operations. The primary risks managed by using derivative instruments are commodity price risk and interest rate risk. The Company does not hold or issue derivative instruments for trading purposes.

     The Company is exposed to credit-related losses in the event of non-performance by the counterparties to its over-the-counter interest rate derivative instruments. The Company mitigates this risk of nonperformance by dealing with highly rated counterparties.

     Additional disclosure about the fair value of derivative instruments is included in Note 10.

Commodity Price Risk

     The Company is exposed to the effects of commodity price fluctuations in the cost of ingredients of its products, of which flour, sugar and shortening are the most significant. In order to bring greater stability to the cost of ingredients, from time to time the Company purchases exchange-traded commodity futures contracts, and options on such contracts, for raw materials which are ingredients of its products or which are components of such ingredients, including wheat and soybean oil. The Company is also exposed to the effects of commodity price fluctuations in the cost of gasoline used by its delivery vehicles. To mitigate the risk of fluctuations in the price of its gasoline purchases, the Company may purchase exchange-traded commodity futures contracts and options on such contracts. The difference between the cost, if any, and the fair value of commodity derivatives is reflected in earnings because the Company has not designated any of these instruments as hedges. Gains and losses on these contracts are intended to offset losses and gains on the hedged transactions in an effort to reduce the earnings volatility resulting from fluctuating commodity prices. The settlement of commodity derivative contracts is reported in the consolidated statement of cash flows as a cash flow from operating activities. At October 30, 2011, the Company had commodity derivatives with an aggregate contract volume of 365,000 bushels of wheat and 126,000 gallons of gasoline. Other than the requirement to meet minimum margin requirements with respect to the commodity derivatives, there are no collateral requirements related to such contracts.

Interest Rate Risk

     All of the borrowings under the Company’s secured credit facilities bear interest at variable rates based upon either the Fed funds rate, the lenders’ prime rate or LIBOR. The interest cost of the Company’s debt may be affected by changes in these short-term interest rates and increases in those rates may adversely affect the Company’s results of operations.

     On March 3, 2011, the Company entered into an interest rate derivative contract having an aggregate notional principal amount of $17.5 million. The derivative contract entitles the Company to receive from the counterparty the excess, if any, of the three-month LIBOR rate over 3.00% for each of the calendar quarters in the period beginning April 2012 and ending December 2015. The Company is accounting for this derivative contract as a cash flow hedge.

21



Quantitative Summary of Derivative Positions and Their Effect on Results of Operations

     The following table presents the fair values of derivative instruments included in the consolidated balance sheet as of October 30, 2011 and January 30, 2011:

Fair Value
October 30, January 30,
Derivatives Not Designated as Hedging Instruments       Balance Sheet Location       2011       2011
(In thousands)
Asset Derivatives
Agricultural commodity futures contracts Other current assets $ - $ 144
 
Liability Derivatives
Agricultural commodity futures contracts Accrued liabilities $ 88 $ -
Gasoline commodity futures contracts Accrued liabilities 48   -
$ 136   $ -
 
Asset Derivatives
Fair Value
October 30, January 30,
Derivatives Designated as a Cash Flow Hedge       Balance Sheet Location       2011       2011
  (In thousands)
Interest rate derivative   Other assets   $ 143 $ -
 
The effect of derivative instruments on the consolidated statement of operations for the three and nine months ended October 30, 2011 and October 31, 2010, was as follows:
         
Amount of Derivative Gain or (Loss)
Recognized in Income
Three Months Ended Nine Months Ended
Derivatives Not Designated as Hedging Location of Derivative Gain or (Loss) October 30, October 31, October 30, October 31,
Instruments       Recognized in Income       2011       2010       2011       2010
(In thousands)
Agricultural commodity futures
       contracts   Direct operating expenses $       176   $         (77 ) $         (422 ) $ 164
Gasoline commodity futures
       contracts   Direct operating expenses   (35 )   5     (44 )   135
       Total $ 141 $ (72 ) $ (466 ) $ 299
 
Amount of Derivative Gain or (Loss)
Recognized in Income
Three Months Ended Nine Months Ended
Derivatives Designated as a Cash Flow Location of Derivative Gain or (Loss) October 30, October 31, October 30, October 31,
Hedge Recognized in OCI 2011 2010 2011 2010
(In thousands)
Interest rate derivative Change in fair value of derivative $         (77 ) $         - $         (459 ) $ -
Less - income tax effect 30 - 181 -
Net change in amount recognized
in OCI $ (47 ) $ - $ (278 ) $ -
 
22


Item 2. 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.


     The following discussion of the Company’s financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein.

Income tax matters

     The Company recognizes deferred tax assets and liabilities based upon management’s expectation of the future tax consequences of temporary differences between the income tax and financial reporting bases of assets and liabilities. Deferred tax liabilities generally represent tax expense recognized for which payment has been deferred, or expenses which have been deducted in the Company’s tax return but which have not yet been recognized as an expense in the consolidated financial statements. Deferred tax assets generally represent tax deductions or credits that will be reflected in future tax returns for which the Company has already recorded a tax benefit in its consolidated financial statements. The Company establishes valuation allowances for deferred tax assets in accordance with GAAP, which provides that such valuation allowances shall be established unless realization of the income tax benefits is more likely than not.

     Realization of deferred income tax assets is dependent upon the Company’s generation of taxable income in future years. As of January 30, 2011, the Company had a valuation allowance against deferred tax assets of $159 million, representing the total amount of such assets in excess of the Company’s deferred tax liabilities. The Company has maintained an allowance equal to 100% of such excess since fiscal 2005, principally because the substantial losses incurred by the Company during this period indicated that it was more likely than not that the Company’s deferred tax assets would not be realized.

     The Company generated a cumulative profit over its three most recent fiscal years, although substantially all of that profit was earned in fiscal 2011, the most recently completed year. The Company is encouraged by the favorable trend in the Company’s financial results, including the $8.9 million pretax profit earned in fiscal 2011, and the continued improvement in earnings in fiscal 2012.

     The assessment of the amount of the Company’s deferred tax assets that is more likely than not to be realized, and therefore the amount of the valuation allowance that is appropriate, is a matter that requires significant management judgment. This judgment is largely dependent upon management’s estimate of the amount of taxable income the Company will generate in future periods.

     The Company’s financial results for the first three quarters of fiscal 2012 have continued to build upon the positive results of fiscal 2011. Notwithstanding this improvement, as previously disclosed, in light of the significant losses incurred in fiscal 2005 through fiscal 2009, the significant changes affecting the Company since fiscal 2005, and other factors affecting the business currently, management believes that it is appropriate that, among other things, the Company achieve at least two full fiscal years of significant pretax earnings before concluding that future profitability is sustainable. The fourth quarter of fiscal 2012 therefore remains an important data element for the Company in assessing the recoverability of its deferred tax assets. Accordingly, when the Company conducted an assessment of the recoverability of its deferred tax assets as of October 30, 2011, management remained unable to conclude that recoverability of those assets was more likely than not, notwithstanding the Company’s improved financial results in fiscal 2012.

     If the Company’s favorable operating results are sustained in the fourth quarter, and sufficient other evidence considered necessary to support recoverability of the deferred tax assets is present, then management could conclude that a reversal of some or all of the valuation allowance is appropriate. While the Company cannot presently predict whether a reversal will occur, or whether any reversal would equal the entire $159 million valuation allowance recorded as of January 30, 2011 or some lesser amount, management believes that any reversal is likely to be material to the Company’s results of operations. Any reversal will have no effect on the Company’s cash flows.

23



     While any reversal of a portion of the valuation allowance would have a positive effect on the Company’s results of operations in the period in which any reversal is recorded, any reversal will most likely have the effect of reducing the Company’s earnings in subsequent periods as a result of an increase in the provision for income taxes in such future periods. This negative effect on earnings in subsequent periods occurs because the reversal of the valuation allowance will reflect the recognition of previously generated, but not recognized, income tax benefits in the period in which the reversal is recorded. Absent the reversal of the valuation allowance, any such tax benefits would be recognized in the future periods in which their realization were to occur upon the generation of taxable income. Accordingly, subsequent to any reversal of the valuation allowance, the Company’s effective income tax rate, which currently bears little relationship to pretax income, is likely to more closely reflect the blended federal and state income tax rates in jurisdictions in which the Company operates. Notwithstanding any increase in the Company’s effective income tax rate as a result of a potential future reversal of some or all of the valuation allowance, the Company’s cash payments for income taxes will remain unchanged, and are likely to be insignificant for the foreseeable future because of the Company’s substantial net operating loss carryovers.

     The determination of income tax expense and the related balance sheet accounts, including valuation allowances for deferred income tax assets, requires management to make estimates and assumptions regarding future events, including future operating results and the outcome of tax-related contingencies. If future events are different from those anticipated, the amount of income tax assets and liabilities, including valuation allowances for deferred income tax assets, could be materially affected.

Results of Operations

     The following table sets forth operating metrics for the three and nine months ended October 30, 2011 and October 31, 2010.

24



Three Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
    2011     2010     2011     2010
Change in Same Store Sales (on-premises sales only):
       Company stores 4.0 % 5.0 % 4.2 % 4.6 %
       Domestic Franchise stores 7.9 % 5.7 % 6.2 % 4.4 %
       International Franchise stores (8.5 ) % (8.6 ) % (5.4 ) % (9.2 ) %
       International Franchise stores, in constant dollars(1) (12.2 ) % (12.3 ) % (11.3 ) % (14.8 ) %
 
Change in Same Store Customer Count - Company stores (retail
sales only) (1.3 ) % 2.5 % (0.4 ) % 3.1 %
 
Off-Premises Metrics (Company stores only):
       Average weekly number of doors served:
              Grocers/mass merchants 5,811 5,731 5,851 5,642
              Convenience stores 4,675 5,152 4,889 5,114
 
       Average weekly sales per door:
              Grocers/mass merchants $     291 $     251 $     293 $     259
              Convenience stores 236 207 226 207
 
Systemwide Sales (in thousands):(2)
       Company stores $ 67,126   $ 61,146 $ 201,629 $ 182,936
       Domestic Franchise stores 64,976     58,185       196,502   179,460    
       International Franchise stores   91,928 84,039   279,188     235,850
       International Franchise stores, in constant dollars(3)   91,928   86,971 279,188   249,933  
 
Average Weekly Sales Per Store (in thousands):(4) (5)
       Company stores:
              Factory stores:
                     Commissaries — off-premises $ 203.0 $ 176.6 $ 201.6 $ 173.1
                     Dual-channel stores:
                            On-premises 32.0 30.2 32.0 29.9
                            Off-premises 45.1 39.3 46.1 39.7
                                   Total 77.1 69.5 78.1 69.6
                     On-premises only stores 32.0 31.4 32.0 31.7
                     All factory stores 69.3 64.6 69.7 64.4
              Satellite stores 19.4 17.9 19.7 18.1
              All stores 58.9 55.9 59.9 56.5
 
       Domestic Franchise stores:
              Factory stores $ 42.8 $ 39.5 $ 43.8 $ 40.4
              Satellite stores 16.8 11.6 16.8 12.4
 
       International Franchise stores:
              Factory stores $ 41.3 $ 41.3 $ 44.0 $ 40.9
              Satellite stores 10.5 9.0 10.5 8.9

25



(1)        Represents the change in International Franchise same store sales computed by reconverting franchise store sales in each foreign currency to U.S. dollars at a constant rate of exchange for each period.
(2) Excludes sales among Company and franchise stores.
(3) Represents International Franchise store sales computed by reconverting International Franchise store sales for the three and nine months ended October 31, 2010 to U.S. dollars based upon the weighted average of the exchange rates prevailing in the three and nine months ended October 30, 2011.
(4) Includes sales between Company and franchise stores.
(5) Metrics for the three and nine months ended October 30, 2011 include only stores open at October 30, 2011 and metrics for the three and nine months ended October 31, 2010 include only stores open at October 31, 2010.

     The change in “same store sales” is computed by dividing the aggregate on-premises sales (including fundraising sales) during the current year period for all stores which had been open for more than 56 consecutive weeks during the current year (but only to the extent such sales occurred in the 57th or later week of each store’s operation) by the aggregate on-premises sales of such stores for the comparable weeks in the preceding year. Once a store has been open for at least 57 consecutive weeks, its sales are included in the computation of same store sales for all subsequent periods. In the event a store is closed temporarily (for example, for remodeling) and has no sales during one or more weeks, such store’s sales for the comparable weeks during the earlier or subsequent period are excluded from the same store sales computation. The change in same store customer count is similarly computed, but is based upon the number of retail transactions reported in the Company’s point-of-sale system.

     For off-premises sales, “average weekly number of doors” represents the average number of customer locations to which product deliveries were made during a week, and “average weekly sales per door” represents the average weekly sales to each such location.

     Systemwide sales, a non-GAAP financial measure, include sales by both Company and franchise stores. The Company believes systemwide sales data are useful in assessing the overall performance of the Krispy Kreme brand and, ultimately, the performance of the Company. The Company’s consolidated financial statements appearing elsewhere herein include sales by Company stores, sales to franchisees by the KK Supply Chain business segment, and royalties and fees received from franchise stores based on their sales, but exclude sales by franchise stores to their customers.

     The following table sets forth data about the number of systemwide stores as of October 30, 2011 and October 31, 2010.

October 30, October 31,
      2011       2010
Number of Stores Open At Period End:
       Company stores:
              Factory:
                     Commissaries 6 6
                     Dual-channel stores 35 37
                     On-premises only stores 29 26
              Satellite stores 19 16
                            Total Company stores 89 85
 
       Domestic Franchise stores:  
              Factory stores 103 101
              Satellite stores 38 42
                     Total Domestic Franchise stores 141 143
 
       International Franchise stores:
              Factory stores 112 106
              Satellite stores 336 315
                     Total International Franchise stores 448   421
 
                            Total systemwide stores 678 649
 
26



     The following table sets forth data about the number of store operating weeks for the three and nine months ended October 30, 2011 and October 31, 2010.

Three Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
      2011       2010       2011       2010
Store Operating Weeks:
       Company stores:  
              Factory stores:  
                     Commissaries 78 78 234 238
                     Dual-channel stores 455 481 1,365 1,443
                     On-premises only stores 377   338   1,131   1,014
              Satellite stores 237 205 662 569
 
       Domestic Franchise stores:(1)  
              Factory stores 1,331 1,326 3,921 3,978
              Satellite stores 491 517 1,370 1,452
 
       International Franchise stores:(1)
              Factory stores 1,163 1,154 3,413 3,241
              Satellite stores 4,159 4,009 11,978 11,476

(1)        Metrics for the three and nine months ended October 30, 2011 include only stores open at October 30, 2011 and metrics for the three and nine months ended October 31, 2010 include only stores open at October 31, 2010.

     The following table sets forth the types and locations of Company stores as of October 30, 2011.

Number of Company Stores
Factory
State       Stores       Hot Shops       Fresh Shops       Total
Alabama 3 - - 3
District of Columbia - 1 - 1
Florida 4 - - 4
Georgia 6 4 - 10
Indiana 3 1 - 4
Kansas 3 - - 3
Kentucky 3 1   - 4
Louisiana 1 - - 1
Maryland 2 - - 2
Michigan 3 - -   3
Mississippi 1 -   - 1
Missouri 4   - - 4
New York - - 1 1
North Carolina   11 4 - 15
Ohio 6 - - 6
South Carolina 2 3 - 5
Tennessee 8 3 - 11
Texas 3 - - 3
Virginia 6   1 - 7
West Virginia 1 - - 1
Total            70            18            1            89
 
27



     Changes in the number of Company stores during the three and nine months ended October 30, 2011 and October 31, 2010 are summarized in the table below.

Number of Company Stores
Factory
      Stores       Hot Shops       Fresh Shops       Total
Three months ended October 30, 2011
July 31, 2011            70            17                1            88
Opened - 1 - 1
Closed - - - -
Change in store type - - - -
October 30, 2011 70 18 1 89
 
Nine months ended October 30, 2011
January 30, 2011 69 15 1 85  
Opened - 4 -   4
Closed - - - -
Change in store type 1 (1 ) - -
October 30, 2011 70 18 1 89
 
Three months ended October 31, 2010
August 1, 2010 69 13   2 84
Opened - 1 - 1
Change in store type - 1 (1 ) -
October 31, 2010 69 15 1 85
 
Nine months ended October 31, 2010
January 31, 2010   69   12 2 83
Opened - 3 - 3
Closed - (1 ) - (1 )
Change in store type - 1 (1 ) -
October 31, 2010 69 15 1 85
 
28



     The following table sets forth the types and locations of domestic franchise stores as of October 30, 2011.

Number of Domestic Franchise Stores
Factory
State       Stores       Hot Shops       Fresh Shops       Total
Alabama 6            3 - 9
Arizona 1 - - 1
Arkansas 2 - - 2
California 13 -            4            17
Colorado 2 - - 2
Connecticut 1 - 3 4
Florida            11 6 1 18
Georgia 7 4 - 11
Hawaii 1 - - 1
Idaho 1 - - 1
Illinois 4 - - 4
Iowa 1 - - 1
Louisiana 3   - - 3
Mississippi 2 1 - 3
Missouri   2 1 - 3
Nebraska 1 -   1   2
Nevada 3 1 2 6
New Jersey - 1 - 1
New Mexico 1 - 1 2
North Carolina 7 1 - 8
Oklahoma 3 - 1 4
Oregon 2 - - 2
Pennsylvania 4 2 1 7
South Carolina 6 2 1 9
Tennessee 1 - - 1
Texas 7 1 - 8
Utah 2 - - 2
Washington 8 - - 8
Wisconsin 1 - - 1
Total 103 23 15 141
   
29



     Changes in the number of domestic franchise stores during the three and nine months ended October 30, 2011 and October 31, 2010 are summarized in the table below.

Number of Domestic Franchise Stores
Factory
Stores       Hot Shops       Fresh Shops       Total
Three months ended October 30, 2011
July 31, 2011 103           22             23 148
Opened 1 1 - 2
Closed (1 ) - (8 ) (9 )
October 30, 2011      103 23 15      141
 
Nine months ended October 30, 2011
January 30, 2011 102 17 25 144
Opened 3 7 1 11
Closed (2 ) (1 )         (11 )         (14 )
October 30, 2011 103 23 15 141
 
Three months ended October 31, 2010
August 1, 2010 102 15 23 140
Opened - - 3 3
Closed - - - -
Change in store type (1 ) 1 - -
October 31, 2010 101 16 26 143
 
Nine months ended October 31, 2010
January 31, 2010 104 14 23 141
Opened - 1 4 5
Closed (2 ) -     (1 ) (3 )
Change in store type (1 )   1 -   -
October 31, 2010         101         16 26 143

30



     The types and locations of international franchise stores as of October 30, 2011 are summarized in the table below.

Number of International Franchise Stores
Fiscal
Year First Factory
Country        Store Opened        Stores        Hot Shops        Fresh Shops        Kiosks        Total
Australia   2004 6 1 11 9 27
Bahrain 2009 1 - 2 4 7
Canada 2002 4 -   1 - 5
China 2010 1 - - - 1
Dominican Republic 2011 1 - - - 1
Indonesia 2007 3 - 3 6 12
Japan 2007 15 - 15 - 30
Kuwait 2007 3 - 21 2 26
Lebanon 2009 2 - 6 2 10
Malaysia 2010 2 1 1 1 5
Mexico 2004 5 1 28 33 67
Philippines 2007   5 4 15 2 26
Puerto Rico 2009 5 - - - 5
Qatar 2008 2 - 3 1   6
Saudi Arabia 2008 8 - 64 13 85
South Korea 2005 32   1 18 - 51
Thailand 2011 2 1 - - 3
Turkey 2010 1 - 10 2   13
United Arab Emirates 2008 2 - 18 1 21
United Kingdom 2004 12 4 22 9 47
Total         112         13         238           85          448

31



     Changes in the number of international franchise stores during the three and nine months ended October 30, 2011 and October 31, 2010 are summarized in the table below.

Number of International Franchise Stores
Factory
Stores         Hot Shops         Fresh Shops         Kiosks         Total
Three months ended October 30, 2011
July 31, 2011       111           11           229       82       433
Opened 3 2 11 4 20
Closed (2 ) - (2 ) (1 ) (5 )
October 30, 2011 112 13 238 85 448
 
Nine months ended October 30, 2011
January 30, 2011 106 11 222 78 417
Opened 10 2 27 14 53  
Closed (4 ) - (11 ) (7 ) (22 )
October 30, 2011 112 13 238 85 448
 
Three months ended October 31, 2010
August 1, 2010 103 14 214 78 409
Opened 6 - 8 2 16
Closed (3 ) (1 ) - - (4 )
October 31, 2010 106 13 222 80 421
 
Nine months ended October 31, 2010
January 31, 2010 95 14 180 69 358
Opened 17   -   46     12   75
Closed (6 ) (1 ) (4 ) (1 )   (12 )
October 31, 2010 106 13 222 80 421


Three months ended October 30, 2011 compared to three months ended October 31, 2010

   Overview

     Total revenues rose by 9.4% to $98.7 million for the three months ended October 30, 2011 compared to $90.2 million for the three months ended October 31, 2010.

     Consolidated operating income increased to $5.6 million in the three months ended October 30, 2011 from $4.1 million in the three months ended October 31, 2010. Consolidated net income was $4.7 million in the three months ended October 30, 2011 compared to $2.4 million in the three months ended October 31, 2010.

     Revenues by business segment (expressed in dollars and as a percentage of total revenues) are set forth in the table below (percentage amounts may not add to totals due to rounding).

32



Three Months Ended
October 30, October 31,
2011       2010
(Dollars in thousands)
Revenues by business segment:
       Company Stores $      67,606 $      61,565
       Domestic Franchise 2,327 2,040
       International Franchise 5,374 4,389
       KK Supply Chain:
              Total revenues 50,277 45,001
              Less - intersegment sales elimination (26,876 ) (22,767 )
                     External KK Supply Chain revenues 23,401 22,234
                            Total revenues $ 98,708 $ 90,228
 
Segment revenues as a percentage of total revenues:
       Company Stores 68.5 % 68.2 %
       Domestic Franchise 2.4 2.3
       International Franchise 5.4 4.9
       KK Supply Chain (external sales) 23.7 24.6
  100.0 % 100.0 %
 
Operating income (loss):
       Company Stores $ (574 ) $ (1,449 )
       Domestic Franchise 1,114 499
       International Franchise 3,313 3,018
       KK Supply Chain 6,987   7,342
              Total segment operating income 10,840 9,410
       Unallocated general and administrative expenses (5,155 )   (4,936 )
       Impairment charges and lease termination costs   (135 )   (399 )
                     Consolidated operating income $ 5,550 $ 4,075

     A discussion of the revenues and operating results of each of the Company’s four business segments follows, together with a discussion of income statement line items not associated with specific segments.

   Company Stores

     The components of Company Stores revenues and expenses (expressed in dollars and as a percentage of total revenues) are set forth in the table below (percentage amounts may not add to totals due to rounding).

33



Percentage of Total Revenues
Three Months Ended Three Months Ended
October 30, October 31, October 30, October 31,
2011       2010       2011       2010
(In thousands)                
Revenues:
       On-premises sales:
              Retail sales $      27,190 $      24,886 40.2 % 40.4 %
              Fundraising sales 4,157 4,058 6.1 6.6
                     Total on-premises sales 31,347 28,944 46.4 47.0
       Off-premises sales:
              Grocers/mass merchants 21,716 18,564 32.1 30.2
              Convenience stores 13,793 13,334 20.4 21.7
              Other off-premises 750 723 1.1 1.2
                     Total off-premises sales 36,259 32,621 53.6 53.0
                            Total revenues 67,606 61,565       100.0       100.0
 
Operating expenses:
       Cost of sales:
              Food, beverage and packaging 26,360 22,694 39.0 36.9
              Shop labor 12,436 12,278 18.4 19.9
              Delivery labor 5,731 5,228 8.5 8.5
              Employee benefits 4,717 4,409 7.0 7.2
                     Total cost of sales 49,244 44,609 72.8 72.5
              Vehicle costs(1) 4,258   3,726 6.3 6.1
              Occupancy(2)   2,237 2,165 3.3 3.5
              Utilities expense 1,610 1,475 2.4 2.4
              Depreciation expense 1,756 1,410 2.6   2.3
              Other operating expenses 4,675 4,830 6.9 7.8
                     Total store level costs 63,780 58,215 94.3 94.6
       Store operating income 3,826   3,350   5.7   5.4
       Other segment operating costs (3) 3,275 3,674 4.8 6.0
       Allocated corporate overhead 1,125 1,125 1.7 1.8
Segment operating loss $ (574 ) $ (1,449 ) (0.8 ) % (2.4 ) %

(1)        Includes fuel, maintenance and repairs, rent, taxes and other costs of operating the delivery fleet, exclusive of depreciation.
(2)        Includes rent, property taxes, common area maintenance charges, insurance, building maintenance and other occupancy costs, exclusive of utilities and depreciation.
(3)        Includes marketing costs not charged to stores, segment management costs, off-premises selling expenses and support functions.

     A reconciliation of Company Stores segment sales from the third quarter of fiscal 2011 to the third quarter of fiscal 2012 follows:

On-Premises       Off-Premises       Total
(In thousands)
Sales for the three months ended October 31, 2010 $         28,944 $         32,621 $      61,565
Fiscal 2011 sales at closed stores (94 ) - (94 )
Increase in sales at mature stores (open stores only)   1,263 3,638 4,901
Increase in sales at stores opened in fiscal 2011 59 - 59
Sales at stores opened in fiscal 2012 1,175 -   1,175
Sales for the three months ended October 30, 2011 $ 31,347   $ 36,259 $ 67,606

     Sales at Company Stores increased 9.8% in the third quarter of fiscal 2012 from the third quarter of fiscal 2011 due to an increase in sales from existing stores and stores opened in fiscal 2011 and fiscal 2012. Selling price increases in the on-premises and off-premises distribution channels accounted for approximately 7.2 percentage points of the increase in sales, exclusive of the effects of higher pricing on unit volumes; such effects are difficult to measure reliably. As with all consumer products, however, higher prices may negatively affect sales. The Company believes this phenomenon is more pronounced in the off-premises channel where competing products are merchandised alongside those of the Company.

34



     The following table presents sales metrics for Company stores:

Three Months Ended
October 30, October 31,
2011       2010
On-premises:
              Change in same store sales 4.0 % 5.0 %
              Change in same store customer count (retail sales only)        (1.3 ) % 2.5 %
Off-premises:
       Grocers/mass merchants:
              Change in average weekly number of doors 1.4 % 2.0 %
              Change in average weekly sales per door 15.9   % 4.1 %
       Convenience stores:
              Change in average weekly number of doors (9.3 ) %          (1.5 ) %
              Change in average weekly sales per door 14.0 % (1.4 ) %

   On-premises sales

     The components of the change in same store sales at Company stores are as follows:

Three Months Ended
October 30,       October 31,
2011 2010
Change in same store sales:
       Pricing 8.2 % 3.4 %
       Guest check average (exclusive of the effects of pricing)         (2.4 )         (1.3 )
       Customer count (1.1 )   2.1
       Other (0.7 ) 0.8
       Total 4.0 % 5.0 %

     On March 7, 2011, the Company implemented price increases at substantially all its stores designed to help offset the rising costs of doughnut mixes, other ingredients and fuel resulting from higher commodity prices. The price increases, which affected approximately 60% of on-premises sales, averaged approximately 14%. Additionally, during the third quarter, the Company raised its fundraising prices approximately 8%.

     The Company believes that the expected cannibalization effect of new stores in expansion markets adversely affected same store customer count in the third quarter of fiscal 2012. “Cannibalization effect” means the tendency for new stores to become successful, in part or in whole, by “stealing” sales from existing stores in the same market.

     The Company continues to implement programs intended to improve on-premises sales, including increased focus on local store marketing efforts, improved employee training, store refurbishment efforts and the introduction of new products.

   Off-premises sales

     Off-premises sales increased 11.2% to $36.3 million in the third quarter of fiscal 2012 from $32.6 million in the third quarter of fiscal 2011. Approximately 6.4 percentage points of the sales increase reflects price increases implemented in the first quarter of fiscal 2012. The Company’s sales increase was greater than that of the doughnut industry as a whole, according to industry data. The Company started implementing price increases for some products offered in the off-premises channel mid-April 2011, and substantially completed implementing the increases during the second quarter. Those price increases affected products comprising approximately 60% of off-premises sales, and the average price increase on those products was approximately 11%.

35



     Sales to grocers and mass merchants increased 17.0% to $21.7 million, with a 15.9% increase in average weekly sales per door and a 1.4% increase in the average number of doors served. In addition to pricing, the Company believes that average weekly sales per door in the grocer/mass merchant channel have grown as a result of, among other things, improved customer service, introduction of additional price points, a redesign of product packaging to improve its shelf appeal, and the addition of new relatively higher volume doors. Convenience store sales rose 3.4% to $13.8 million, reflecting a 14.0% increase in the average weekly sales per door partially offset by a 9.3% decline in the average number of doors served. The decline in the average number of doors served in the convenience store channel in the third quarter reflects, among other things, route management efforts to eliminate deliveries to relatively low volume doors. The Company is implementing strategies designed to improve sales through convenience stores, including offering additional price points and increasing the quantity and assortment of packaged products offered in this channel. In addition, the Company is seeking to shift customers in the convenience store channel to sales agreements which provide that the Company will absorb unsold product rather than the retailer. While this strategy will increase the cost of product returns, the Company believes that the increase will be more than offset by higher unit pricing and, because the Company will have much greater control over product assortment and quantities merchandised, increased unit sales from both existing products and packaged products not traditionally offered through convenience stores.

   Costs and expenses

     Cost of sales as a percentage of revenues increased by 0.3 percentage points from the third quarter of fiscal 2011 to 72.8% of revenues in the third quarter of fiscal 2012.

     Before considering the potential loss of unit volume as a result of on-premises and off-premises selling price increases, those increases more than offset higher costs of food, beverages and packaging in the third quarter of fiscal 2012. The effects of price increases on unit volumes are difficult to measure reliably. The combined effects of higher selling prices and increased input costs accounted for all of the increase in the cost of food, beverage and packing as a percentage of revenues for the third quarter of fiscal 2012 compared to the third quarter of last year. Exclusive of the effects of pricing and input costs, food, beverage and packaging costs as a percentage of revenues fell slightly. The Company currently estimates that input costs for the remainder of fiscal 2012 will decline slightly from the levels in the third quarter of this year.

     Except for sugar, the Company currently anticipates the cost of doughnut mix, shortening and other ingredients to remain relatively flat in fiscal 2013. Excluding sugar, the Company has fixed the prices of approximately half of its raw materials and ingredients through the second quarter of fiscal 2013. The Company had entered into contracts covering substantially all of its estimated sugar requirements for fiscal 2013 at average prices somewhat lower than its contract prices for the second half of fiscal 2012, but higher than its average price for fiscal 2012 as a whole. In addition, the Company has entered into contracts for approximately half of its estimated sugar requirements for both fiscal 2014 and fiscal 2015.

     Shop labor as a percentage of revenues declined by 1.5 percentage points from the third quarter of fiscal 2011 to 18.4% of revenues in the third quarter of fiscal 2012, principally due to higher sales resulting from price increases.

     Vehicle costs as a percentage of revenues increased from 6.1% of revenues in the third quarter of fiscal 2011 to 6.3% of revenues in the third quarter of fiscal 2012, principally as a result of higher fuel costs and higher expense of leased delivery trucks in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011. This increase was partially offset by a decrease in repairs and maintenance expense in the third quarter of fiscal 2012 as a result of the Company replacing a portion of its aging delivery fleet.

     Other operating expenses as a percentage of revenues declined by 0.9 percentage points from the third quarter of fiscal 2011 to 6.9% of revenues in the third quarter of fiscal 2012 reflecting, among other things, lower store-level marketing expense.

     Other segment operating costs as a percentage of revenues declined by 1.2 percentage points from the third quarter of fiscal 2011 to 4.8% of revenues in the third quarter of fiscal 2012 reflecting, among other things, a decrease in spending on off-premises selling and support expenses.

36



   Domestic Franchise

Three Months Ended
October 30, October 31,
2011       2010
(In thousands)
Revenues:
       Royalties $      2,144 $      1,929
       Development and franchise fees 75 -
       Other 108 111
              Total revenues 2,327 2,040
 
Operating expenses:
       Segment operating expenses 1,058 1,385
       Depreciation expense 55 56
       Allocated corporate overhead 100 100
              Total operating expenses 1,213   1,541
Segment operating income $ 1,114 $ 499

     Domestic Franchise revenues increased 14.1% to $2.3 million in the third quarter of fiscal 2012 from $2.0 million in the third quarter of fiscal 2011. The increase reflects higher domestic royalty revenues resulting from an increase in sales by domestic franchise stores from $58 million in the third quarter of fiscal 2011 to $65 million in the third quarter of fiscal 2012. Domestic Franchise same store sales rose 7.9% in the third quarter of fiscal 2012.

     Domestic Franchise operating expenses include costs to recruit new domestic franchisees, to assist in domestic store openings, and to monitor and aid in the performance of domestic franchise stores, as well as allocated corporate costs. The decrease in Domestic Franchise operating expenses in the third quarter of fiscal 2012 reflects the reversal of a previously recorded accrual of $110,000 related to a franchisee lease guarantee as a result of the Company receiving a release from the related guarantee. The decrease in operating expenses also reflects a decrease in legal fees of $340,000 in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011. In the third quarter of fiscal 2011, the Company recorded legal costs related to the Company’s termination of the franchise agreements of one of its domestic franchisees.

     Domestic franchisees opened two stores and closed nine stores in the third quarter of fiscal 2012. Of the nine closures, seven were operated by a franchisee whose franchise rights the Company terminated in the second quarter of fiscal 2012. As of November 30, 2011, existing development and franchise agreements for territories in the United States provide for the development of approximately 35 additional stores in the remainder of fiscal 2012 and thereafter. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

   International Franchise

Three Months Ended
October 30, October 31,
2011       2010
(In thousands)
Revenues:
       Royalties $      4,990 $      4,005
       Development and franchise fees 384 384
              Total revenues 5,374 4,389
 
Operating expenses:
       Segment operating expenses 1,736 1,044
       Depreciation expense - 2
       Allocated corporate overhead   325 325
              Total operating expenses 2,061   1,371
Segment operating income $ 3,313 $ 3,018

37



     International Franchise royalties increased 24.6%, driven by an increase in sales by international franchise stores from $84 million in the third quarter of fiscal 2011 to $92 million in the third quarter of fiscal 2012. Changes in the rates of exchange between the U.S. dollar and the foreign currencies in which the Company’s international franchisees do business increased sales by international franchisees measured in U.S. dollars by approximately $3.1 million in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011, which positively affected international royalty revenues by approximately $190,000. The Company did not recognize as revenue approximately $700,000 of uncollected royalties which accrued during the third quarter of fiscal 2011 because the Company did not believe collection of these royalties was reasonably assured. Substantially all of the unrecognized royalties in the third quarter of fiscal 2011 related to the Company’s Australian franchisee, which commenced a voluntary administration process (similar to a bankruptcy filing in the U.S.) in October 2010. In connection with that process, in November 2010, the franchisee closed 24 of the 53 shops the franchisee operated prior to the reorganization.

     International Franchise same store sales, measured on a constant currency basis to remove the effects of changing exchange rates between foreign currencies and the U.S. dollar (“constant dollar same store sales”), fell 12.2%. The decline in International Franchise same store sales reflects, among other things, waning honeymoon effects from the large number of new stores opened internationally in recent years and the cannibalization effects on initial stores in new markets of additional store openings in those markets. “Honeymoon effect” means the common pattern for many start-up restaurants in which a flurry of activity due to start-up publicity and natural curiosity is followed by a decline during which a steady repeat customer base develops.

     Constant dollar same store sales in established markets fell 4.8% in the third quarter of fiscal 2012 and fell 18.9% in new markets. “Established markets” means countries in which the first Krispy Kreme store opened before fiscal 2006. Sales at stores in established markets comprised approximately 51% of aggregate constant dollar same store sales for the third quarter of fiscal 2012. While the Company considers countries in which Krispy Kreme first opened in fiscal 2005 and earlier to be established markets, franchisees in those markets continue to develop their business; these franchisees opened 232 of the 527 international stores opened since the beginning of fiscal 2006.

     International Franchise operating expenses include costs to recruit new international franchisees, to assist in international store openings, and to monitor and aid in the performance of international franchise stores, as well as allocated corporate costs. International Franchise operating expenses increased in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011 as a result of personnel additions, including benefits and travel costs, and other cost increases resulting from the Company’s decision to devote additional resources to the development and support of international franchisees. In addition, International Franchise segment operating expenses in the third quarter of fiscal 2011 include a credit of approximately $130,000 in bad debt expense.

     International franchisees opened 20 stores and closed five stores in the third quarter of fiscal 2012. As of November 30, 2011, existing development and franchise agreements for territories outside the United States provide for the development of approximately 280 additional stores in the remainder of fiscal 2012 and thereafter. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

   KK Supply Chain

     The components of KK Supply Chain revenues and expenses (expressed in dollars and as a percentage of total revenues before intersegment sales elimination) are set forth in the table below (percentage amounts may not add to totals due to rounding).

38



Percentage of Total Revenues
Before Intersegment
Sales Elimination
Three Months Ended Three Months Ended
October 30, October 31, October 30, October 31,
2011       2010       2011       2010
(In thousands)              
Revenues:
       Doughnut mixes $      16,650 $      15,699 33.1 % 34.9 %
       Other ingredients, packaging and supplies 31,357 27,529 62.4 61.2
       Equipment 1,660 1,597 3.3 3.5
       Fuel surcharge 610 176 1.2 0.4
              Total revenues before intersegment sales elimination 50,277 45,001        100.0         100.0
 
Operating expenses:
       Cost of sales:
              Cost of goods produced and purchased 34,281 29,869 68.2 66.4
              (Gain) loss on agricultural derivatives (176 ) 77 (0.4 ) 0.2
              Inbound freight 1,082 887 2.2 2.0
                     Total cost of sales 35,187 30,833 70.0 68.5
       Distribution costs 4,100   3,415 8.2 7.6
       Other segment operating costs 3,545 2,938 7.1 6.5
       Depreciation expense   183   198 0.4 0.4
       Allocated corporate overhead 275 275 0.5   0.6
              Total operating costs 43,290 37,659 86.1     83.7
Segment operating income $ 6,987 $ 7,342 13.9 % 16.3 %

     KK Supply Chain revenues before intersegment sales elimination increased $5.3 million, or 11.7%, in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011. The increase reflects selling price increases for doughnut mix, sugar, shortening and certain other ingredients instituted by KK Supply Chain in order to pass along to Company and franchise stores increases in KK Supply Chain’s cost of sugar, flour and shortening. The unit volumes in most product categories fell in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011.

     The Company utilizes a fuel surcharge program to recoup additional freight costs resulting from increases in fuel costs. Charges under the program are based upon the price of diesel fuel.

     The increase in cost of goods produced and purchased as a percentage of sales in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011 reflects, among other things, an increase in the cost of agricultural commodities used in the production of doughnut mix and of other goods sold to Company and franchise stores. In particular, the prices of flour, shortening and sugar and the products from which they are made were significantly higher in the third quarter of fiscal 2012 compared to the third quarter of fiscal 2011. KK Supply Chain increased the prices charged to Company and franchise stores for doughnut mix, shortening, sugar and other goods in order to mitigate increases in the cost of certain raw materials. However, KK Supply Chain margins were adversely affected because, while the Company increased prices to cover higher costs, the Company did not raise prices to earn a proportionate gross profit on all of its higher costs.

     Distribution costs rose in the third quarter of fiscal 2012 compared to the third quarter of last year as a result of higher fuel costs, a portion of which was recovered through an increase in the fuel surcharge billed to customers. In addition, duplicate facility costs and other conversion expenses associated with the transition of product distribution for stores east of the Mississippi to an outsourced provider which began in June 2011, contributed to the increase.

     Other segment operating costs include segment management, purchasing, customer service and support, laboratory and quality control costs, and research and development expenses. Other segment operating costs as a percentage of revenues increased by 0.6 percentage points from the third quarter of fiscal 2011 to 7.1% of revenues in the third quarter of fiscal 2012. The increase in other segment operating costs reflects, among other things, charges of approximately $330,000 recorded to the KK Supply Chain segment for the settlement of certain sales tax litigation and an increase in segment management costs.

39



     Franchisees opened 22 stores and closed 14 stores in the third quarter of fiscal 2012. A substantial portion of KK Supply Chain’s revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

     An increasing percentage of franchise store sales is attributable to sales by franchisees outside North America. Many of the ingredients and supplies used by international franchisees are acquired locally instead of from KK Supply Chain. Accordingly, KK Supply Chain revenues are less correlated with sales by international franchisees than with sales by domestic franchisees.

   General and Administrative Expenses

     General and administrative expenses remained relatively unchanged at $4.9 million, or 5.0% of total revenues in the third quarter of fiscal 2012 compared to $4.8 million, or 5.3% of total revenues in the third quarter of fiscal 2011. The Company is seeking to minimize general and administrative expenses in order to gain operating leverage as its revenues rise.

   Impairment Charges and Lease Termination Costs

     Impairment charges and lease termination costs were $135,000 in the third quarter of fiscal 2012 compared to $399,000 in the third quarter of fiscal 2011. The components of these charges are set forth in the following table:

Three Months Ended
October 30, October 31,
      2011       2010
(In thousands)
Impairment of long-lived assets:
       Current period charges $ - $ -
       Adjustments to previously recorded estimates - 81
              Total impairment of long-lived assets -   81
Lease termination costs 135   318
  $ 135 $ 399
 
     Impairment charges relate to the Company Stores segment. The Company tests long-lived assets for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. These events and changes in circumstances include store closing and refranchising decisions, the effects of changing costs on current results of operations, observed trends in operating results, and evidence of changed circumstances observed as a part of periodic reforecasts of future operating results and as part of the Company’s annual budgeting process. Impairment charges generally relate to stores expected to be closed or refranchised, as well as to stores management believes will not generate sufficient future cash flows to enable the Company to recover the carrying value of the stores’ assets, but which management has not yet decided to close. When the Company concludes that the carrying value of long-lived assets is not recoverable (based on future projected undiscounted cash flows), the Company records impairment charges to reduce the carrying value of those assets to their estimated fair values. The fair values of these assets are estimated based on the present value of estimated future cash flows, on independent appraisals and, in the case of assets the Company currently is negotiating to sell, based on the Company’s negotiations with unrelated third-party buyers.

     Lease termination costs represent the estimated fair value of liabilities related to unexpired leases, after reduction by the amount of accrued rent expense, if any, related to the leases, and are recorded when the lease contracts are terminated or, if earlier, the date on which the Company ceases use of the leased property. The fair value of these liabilities were estimated as the excess, if any, of the contractual payments required under the unexpired leases over the current market lease rates for the properties, discounted at a credit-adjusted risk-free rate over the remaining term of the leases. The provision for lease termination costs also includes adjustments to liabilities recorded in prior periods arising from changes in estimated sublease rentals and from settlements with landlords.

     In the third quarter of fiscal 2012 and 2011, the Company recorded lease termination charges of $135,000 and $318,000, respectively, principally reflecting a change in estimated sublease rentals and settlements with landlords on stores previously closed.

     The Company intends to refranchise certain geographic markets, expected to consist principally of, but not necessarily limited to, markets outside the Company’s traditional base in the Southeastern United States. The franchise rights and other assets in many of these markets were acquired by the Company in business combinations in prior years.

40



     Since the beginning of fiscal 2009, the Company has refranchised a total of 11 stores and received consideration totaling $2.5 million in connection with those transactions. During this period, the Company recorded impairment charges totaling approximately $490,000 related to completed and anticipated refranchisings. The Company cannot predict the likelihood of refranchising any additional stores or markets or the amount of proceeds, if any, which might be received therefrom, including the amounts which might be realized from the sale of store assets and the execution of any related franchise agreements. Refranchising could result in the recognition of additional impairment losses on the related assets.

   Interest Expense

     The components of interest expense are as follows:

Three Months Ended
October 30, October 31,
      2011       2010
(In thousands)
Interest accruing on outstanding term loan indebtedness $ 180 $ 1,071
Letter of credit and unused revolver fees 79 266
Amortization of deferred financing costs 102 248
Other     24   -
$ 385 $ 1,585
   
     The decrease in interest accruing on outstanding term loan indebtedness and in letter of credit and unused revolver fees reflects the substantial reduction in lender margin on the Company’s credit facilities resulting from the refinancing of those facilities in January 2011, as more fully described in Note 4 to the consolidated financial statements appearing elsewhere herein, as well as the reduction in the principal outstanding under the Company’s term loan.

   Equity in Income (Losses) of Equity Method Franchisees

     The Company recorded equity in the losses of equity method franchisees of $72,000 in the third quarter of fiscal 2012 compared to earnings of $190,000 in the third quarter of fiscal 2011. This caption represents the Company’s share of operating results of equity method franchisees which develop and operate Krispy Kreme stores. On May 5, 2011, the Company sold its 30% equity interest in Krispy Kreme Mexico, S. de R.L. de C.V. (“KK Mexico”), the Company’s franchisee in Mexico, to KK Mexico’s majority shareholder, as more fully described in Note 8 to the consolidated financial statements appearing elsewhere herein. The Company’s equity in earnings of KK Mexico was approximately $260,000 for the three months ended October 31, 2010.

   Provision for Income Taxes

     The provision for income taxes was $495,000 in the third quarter of fiscal 2012 compared to $417,000 in the third quarter of fiscal 2011. Each of these amounts includes, among other things, adjustments to the valuation allowance for deferred income tax assets to maintain such allowance at an amount sufficient to reduce the Company’s aggregate net deferred income tax assets to zero, and a provision for income taxes estimated to be payable or refundable currently, the majority of which represents foreign tax withholdings.

     See “— Income Tax Matters,” above, for additional information about the valuation allowance on deferred income tax assets and the effects on the Company’s future financial condition and results of operations of potential changes in the amount of such valuation allowance.

   Net Income

     The Company reported net income of $4.7 million for the three months ended October 30, 2011 and $2.4 million for the three months ended October 31, 2010.

41



Nine months ended October 30, 2011 compared to nine months ended October 31, 2010

   Overview

     Total revenues rose by 11.5% to $301.3 million for the nine months ended October 30, 2011 compared to $270.3 million for the nine months ended October 31, 2010.

     Consolidated operating income increased to $20.3 million in the nine months ended October 30, 2011 from $14.3 million in the nine months ended October 31, 2010. Consolidated net income was $22.7 million in the nine months ended October 30, 2011 compared to $9.1 million in the nine months ended October 31, 2010.

     Revenues by business segment (expressed in dollars and as a percentage of total revenues) are set forth in the table below (percentage amounts may not add to totals due to rounding).

Nine Months Ended
October 30, October 31,
      2011       2010
(Dollars in thousands)
Revenues by business segment:
       Company Stores $     203,073 $     184,069
       Domestic Franchise 7,045 6,314
       International Franchise 16,362 13,158
       KK Supply Chain:
              Total revenues 154,501 135,798
              Less - intersegment sales elimination (79,721 ) (69,062 )
                     External KK Supply Chain revenues 74,780 66,736
                            Total revenues $ 301,260 $ 270,277
 
Segment revenues as a percentage of total revenues:
       Company Stores 67.4 % 68.1 %
       Domestic Franchise 2.3 2.3
       International Franchise 5.4 4.9
       KK Supply Chain (external sales) 24.8 24.7
  100.0 % 100.0 %
 
Operating income (loss):
       Company Stores $ 551 $ (3,214 )
       Domestic Franchise 2,477 2,694
       International Franchise 10,893 9,004
       KK Supply Chain 23,074 23,361  
              Total segment operating income 36,995 31,845
       Unallocated general and administrative expenses   (16,037 )     (16,078 )
       Impairment charges and lease termination costs   (680 )   (1,482 )
                     Consolidated operating income $ 20,278 $ 14,285

     A discussion of the revenues and operating results of each of the Company’s four business segments follows, together with a discussion of income statement line items not associated with specific segments.

   Company Stores

     The components of Company Stores revenues and expenses (expressed in dollars and as a percentage of total revenues) are set forth in the table below (percentage amounts may not add to totals due to rounding).

42



Percentage of Total Revenues
Nine Months Ended Nine Months Ended
October 30, October 31, October 30, October 31,
      2011       2010       2011       2010
(In thousands)
Revenues:
       On-premises sales:
              Retail sales $     81,720 $     74,315 40.2 % 40.4 %
              Fundraising sales 11,431 11,412 5.6 6.2
                     Total on-premises sales 93,151 85,727 45.9 46.6
       Off-premises sales:
              Grocers/mass merchants 66,197 56,576 32.6 30.7
              Convenience stores 41,472 39,730 20.4 21.6
              Other off-premises 2,253 2,036 1.1 1.1
                     Total off-premises sales 109,922 98,342 54.1 53.4
                            Total revenues 203,073 184,069      100.0        100.0
 
Operating expenses:
       Cost of sales:
              Food, beverage and packaging   78,335 68,113 38.6 37.0
              Shop labor 37,521   36,753 18.5 20.0
              Delivery labor 17,382 15,794 8.6 8.6
              Employee benefits 13,890 13,326 6.8 7.2
                     Total cost of sales 147,128 133,986   72.5 72.8
              Vehicle costs(1) 13,065 10,306 6.4 5.6
              Occupancy(2) 6,822 6,956 3.4 3.8
              Utilities expense 4,449 4,385 2.2 2.4
              Depreciation expense   4,982 4,264 2.5   2.3
              Other operating expenses 13,487 14,068 6.6 7.6
                     Total store level costs 189,933 173,965   93.5 94.5
       Store operating income 13,140 10,104 6.5 5.5
       Other segment operating costs (3) 9,214 9,943 4.5   5.4
       Allocated corporate overhead 3,375 3,375 1.7 1.8
Segment operating income (loss) $ 551 $ (3,214 ) 0.3 % (1.7 ) %
 
(1)        Includes fuel, maintenance and repairs, rent, taxes and other costs of operating the delivery fleet, exclusive of depreciation.
(2) Includes rent, property taxes, common area maintenance charges, insurance, building maintenance and other occupancy costs, exclusive of utilities and depreciation.
(3) Includes marketing costs not charged to stores, segment management costs, off-premises selling expenses and support functions.

     A reconciliation of Company Stores segment sales from the nine months ended October 31, 2010 to the nine months ended October 30, 2011 follows:

      On-Premises       Off-Premises       Total
(In thousands)
Sales for the nine months ended October 31, 2010 $     85,727 $     98,342 $     184,069
Fiscal 2011 sales at closed stores (617 ) - (617 )
Increase in sales at mature stores (open stores only) 3,980 11,580 15,560
Increase in sales at stores opened in fiscal 2011   1,596   - 1,596
Sales at stores opened in fiscal 2012   2,465   -   2,465
Sales for the nine months ended October 30, 2011 $ 93,151   $ 109,922 $ 203,073
 
43



     Sales at Company Stores increased 10.3% in the first nine months of fiscal 2012 from the first nine months of fiscal 2011 due to an increase in sales from existing stores and stores opened in fiscal 2011 and 2012. Selling price increases in the on-premises and off-premises distribution channels accounted for approximately 6.5 percentage points of the increase in sales, exclusive of the effects of higher pricing on unit volumes; such effects are difficult to measure reliably. As with all consumer products, however, higher prices may negatively affect sales. The Company believes this phenomenon is more pronounced in the off-premises channel where competing products are merchandised alongside those of the Company.

     The following table presents sales metrics for Company stores:

Nine Months Ended
October 30, October 31,
      2011       2010
On-premises:
              Change in same store sales 4.2 % 4.6 %
              Change in same store customer count (retail sales only) (0.4 ) % 3.1 %
Off-premises:
       Grocers/mass merchants:
              Change in average weekly number of doors 3.7 % (0.9 ) %
              Change in average weekly sales per door   13.1 % 7.5 %
       Convenience stores:  
              Change in average weekly number of doors (4.4 ) %         (4.8 ) %
              Change in average weekly sales per door        9.2 % (1.4 ) %

   On-premises sales

     The components of the change in same store sales at Company stores are as follows:

Nine Months Ended
October 30, October 31,
      2011       2010
Change in same store sales:
       Pricing 7.4 % 3.6 %
       Guest check average (exclusive of the effects of pricing) (2.5 )   (2.2 )
       Customer count   (0.4 )   2.7
       Other      (0.3 )        0.5
       Total 4.2   % 4.6   %
 
     On March 7, 2011, the Company implemented price increases at substantially all its stores designed to help offset the rising costs of doughnut mixes, other ingredients and fuel resulting from higher commodity prices. The price increases, which affected approximately 60% of on-premises sales, averaged approximately 14%. These price increases are not fully reflected in the same store sales metrics because they were in effect for only 34 of the 39 weeks in the first nine months of fiscal 2012. Additionally, during the third quarter, the Company raised its fundraising prices approximately 8%.

     The Company believes that the expected cannibalization effect of new stores in expansion markets adversely affected same store customer count in the first nine months of fiscal 2012.

     The Company continues to implement programs intended to improve on-premises sales, including increased focus on local store marketing efforts, improved employee training, store refurbishment efforts and the introduction of new products.

   Off-premises sales

     Off-premises sales increased 11.8% to $109.9 million in the first nine months of fiscal 2012 from $98.3 million in the first nine months of fiscal 2011. Approximately 5.8 percentage points of the sales increase reflects price increases, including not only increases implemented in the first quarter of fiscal 2012 but also price increases implemented in fiscal 2011. The Company’s sales increase was greater than that of the doughnut industry as a whole, according to industry data. The Company started implementing price increases for some products offered in the off-premises channel mid-April 2011, and substantially completed implementing the increases during the second quarter. Those price increases affected products comprising approximately 60% of off-premises sales, and the average price increase on those products was approximately 11%.

44



     Sales to grocers and mass merchants increased 17.0% to $66.2 million, with an 13.1% increase in average weekly sales per door and a 3.7% increase in the average number of doors served. In addition to pricing, the Company believes that average weekly sales per door in the grocer/mass merchant channel have grown as a result of, among other things, improved customer service, introduction of additional price points, a redesign of product packaging to improve its shelf appeal and the addition of new relatively higher volume doors. Convenience store sales increased 4.4% to $41.5 million, reflecting a 9.2% increase in the average weekly sales per door, partially offset by a 4.4% decline in the average number of doors served. The Company is implementing strategies designed to improve sales through convenience stores, including offering additional price points and increasing the quantity and assortment of packaged products offered in this channel. In addition, the Company is seeking to shift customers in the convenience store channel to sales agreements which provide that the Company will absorb unsold product rather than the retailer. While this strategy will increase the cost of product returns, the Company believes that the increase will be more than offset by higher unit pricing and, because the Company will have much greater control over product assortment and quantities merchandised, increased unit sales from both existing products and packaged products not traditionally offered through convenience stores.

   Costs and expenses

     Cost of sales as a percentage of revenues declined by 0.3 percentage points from the first nine months of fiscal 2011 to 72.5% of revenues in the first nine months of fiscal 2012.

     Before considering the potential loss of unit volume as a result of on-premises and off-premises selling price increases, those increases more than offset higher costs of food, beverages and packaging in the first nine months of fiscal 2012. The effects of price increases on unit volumes are difficult to measure reliably. The combined effects of higher selling prices and increased input costs accounted for all of the increase in the cost of food, beverage and packing as a percentage of revenues for the first nine months of fiscal 2012 compared to the first nine months of last year. Exclusive of the effects of pricing and input costs, food, beverage and packaging costs as a percent of revenues fell slightly. The Company currently estimates that input costs for the remainder of fiscal 2012 will decline slightly from the levels in the third quarter of this year.

     Except for sugar, the Company currently anticipates the cost of doughnut mix, shortening and other ingredients to remain relatively flat in fiscal 2013. Excluding sugar, the Company has fixed the prices of approximately half of its raw materials and ingredients through the second quarter of fiscal 2013. The Company had entered into contracts covering substantially all of its estimated sugar requirements for fiscal 2013 at average prices somewhat lower than its contract prices for the second half of fiscal 2012, but higher than its average price for fiscal 2012 as a whole. In addition, the Company has entered into contracts for approximately half of its estimated sugar requirements for both fiscal 2014 and fiscal 2015.

     Shop labor as a percentage of revenues declined by 1.5 percentage points from the first nine months of fiscal 2011 to 18.5% of revenues in the first nine months of fiscal 2012, principally due to higher sales resulting from price increases.

     Vehicle costs as a percentage of revenues increased from 5.6% of revenues in the first nine months of fiscal 2011 to 6.4% of revenues in the first nine months of fiscal 2012, principally as a result of higher fuel costs and higher expense of leased delivery trucks in the first nine months of fiscal 2012 compared to the first nine months of fiscal 2011. This increase was partially offset by a decrease in repairs and maintenance expense in the first nine months of fiscal 2012 as a result of the Company replacing a portion of its aging delivery fleet.

     The Company is self-insured for workers’ compensation, vehicle and general liability claims, but maintains stop-loss coverage for individual claims exceeding certain amounts. The Company provides for claims under these self-insured programs using actuarial methods as described in the 2011 Form 10-K, and periodically updates actuarial valuations of its self-insurance reserves. Such periodic actuarial valuations result in changes over time in the estimated amounts which ultimately will be paid for claims under these programs to reflect the Company’s actual claims experience for each policy year as well as trends in claims experience over multiple years. Such claims, particularly workers’ compensation claims, often are paid over a number of years following the year in which the insured events occur, and the estimated ultimate cost of each year’s claims accordingly is adjusted over time as additional information becomes available. As a result of the Company’s periodic update of its actuarial valuation, during the second quarter of both fiscal 2012 and fiscal 2011, the Company recorded favorable adjustments to its self-insurance claims liabilities related to prior policy years of approximately $500,000 in the second quarter of fiscal 2012 and $690,000 in the second quarter of fiscal 2011. Substantially all of the $500,000 in favorable adjustments recorded in the second quarter of fiscal 2012 relates to workers’ compensation liability claims and is included in employee benefits in the table above. Of the $690,000 in favorable adjustments recorded in the second quarter of fiscal 2011, approximately $640,000 relates to workers’ compensation liability claims and approximately $50,000 relates to vehicle liability claims included in vehicle costs in the table above.

45



     Other operating expenses as a percentage of revenues declined by 1.0 percentage point from the first nine months of fiscal 2011 to 6.6% of revenues in the first nine months of fiscal 2012 reflecting, among other things, lower store-level marketing expense.

     Other segment operating costs as a percentage of revenues declined by 0.9 percentage points from the first nine months of fiscal 2011 to 4.5% of revenues in the first nine months of fiscal 2012 reflecting, among other things, a decrease in spending on off-premises selling and support expenses.

   Domestic Franchise

Nine Months Ended
October 30, October 31,
      2011       2010
(In thousands)
Revenues:
       Royalties $     6,466 $     5,937
       Development and franchise fees 255 20
       Other 324 357
              Total revenues 7,045 6,314
 
Operating expenses:
       Segment operating expenses   4,103 3,154
       Depreciation expense 165 166
       Allocated corporate overhead 300   300
              Total operating expenses   4,568 3,620
Segment operating income $ 2,477 $ 2,694
 
     Domestic Franchise revenues increased 11.6% to $7.0 million in the first nine months of fiscal 2012 from $6.3 million in the first nine months of fiscal 2011. The increase reflects higher domestic royalty revenues resulting from an increase in sales by domestic franchise stores from approximately $179 million in the first nine months of fiscal 2011 to $197 million in the first nine months of fiscal 2012. Domestic Franchise same store sales rose 6.2% in the first nine months of fiscal 2012.

     Domestic Franchise operating expenses include costs to recruit new domestic franchisees, to assist in domestic store openings, and to monitor and aid in the performance of domestic franchise stores, as well as allocated corporate costs. The increase in Domestic Franchise operating expenses reflects a provision of $820,000 recorded in the second quarter of fiscal 2012 for payments under a lease guarantee associated with a franchisee whose franchise agreements the Company terminated during the second quarter, as well as an increase in franchisee support costs. The increase also includes an increase in bad debt expense as the result of a credit of $190,000 in the first nine months of fiscal 2011, resulting principally from a recovery of receivables previously written off. These increases were partially offset by the reversal of a previously recorded accrual of $110,000 related to a franchisee lease guarantee as a result of the Company receiving a release from the related guarantee during the third quarter of fiscal 2012. In addition, operating expenses reflect a decrease in legal fees of $390,000 in the first nine months of fiscal 2012 compared to the first nine months of fiscal 2011. In fiscal 2011, the Company recorded legal costs related to the Company’s termination of the franchise agreements of one of its domestic franchisees.

     Domestic franchisees opened 11 stores and closed 14 stores in the first nine months of fiscal 2012. Of the 14 closures, 10 related to a franchisee whose franchise rights the Company terminated in the second quarter of fiscal 2012. As of November 30, 2011, existing development and franchise agreements for territories in the United States provide for the development of approximately 35 additional stores in the remainder of fiscal 2012 and thereafter. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

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   International Franchise

Nine Months Ended
October 30, October 31,
      2011       2010
(In thousands)
Revenues:
       Royalties $ 15,407 $ 11,576
       Development and franchise fees 955 1,582
              Total revenues 16,362 13,158
 
Operating expenses:
       Segment operating expenses 4,490 3,174
       Depreciation expense 4 5
       Allocated corporate overhead 975   975
              Total operating expenses   5,469     4,154
Segment operating income   $ 10,893 $ 9,004
 
     International Franchise royalties increased 33.1% driven by an increase in sales by international franchise stores from $236 million in the first nine months of fiscal 2011 to $279 million in the first nine months of fiscal 2012. Changes in the rates of exchange between the U.S. dollar and the foreign currencies in which the Company’s international franchisees do business increased sales by international franchisees measured in U.S. dollars by approximately $15.7 million in the first nine months of fiscal 2012 compared to the first nine months of fiscal 2011, which positively affected international royalty revenues by approximately $940,000. In the first nine months of fiscal 2012, the Company recognized $280,000 of royalty revenue from the Company’s Mexican franchisee discussed in the second succeeding paragraph below. The Company did not recognize as revenue approximately $1.7 million of uncollected royalties which accrued during the first nine months of fiscal 2011 because the Company did not believe collection of these royalties was reasonably assured. Substantially all of the unrecognized royalties in the first nine months of fiscal 2011 related to the Company’s Australian franchisee, which commenced a voluntary administration process (similar to a bankruptcy filing in the U.S.) in October 2010. In connection with that process, in November 2010, the franchisee closed 24 of the 53 shops the franchisee operated prior to the reorganization.

     International development and franchise fees decreased $627,000 in the first nine months of fiscal 2012, primarily as a result of a decline in the number of store openings from 75 in the first nine months of fiscal 2011 to 53 in the first nine months of fiscal 2012. This reduction in fees was partially offset by the recognition of approximately $95,000 of franchise fees related to the Company’s Mexican franchisee described in the following paragraph.

     Royalties and franchise fees for the first nine months of fiscal 2012 include approximately $280,000 and $95,000, respectively, of amounts relating to the Company’s franchisee in Mexico which accrued in prior periods but which had not previously been reported as revenue because of uncertainty surrounding their collection. Such amounts were reported as revenue in recognition of the payment of such amounts to the Company on May 5, 2011, in connection with the Company’s sale of its 30% equity interest in the franchisee, as more fully described in Note 8 to the consolidated financial statements appearing elsewhere herein.

     International Franchise same store sales, measured on a constant currency basis to remove the effects of changing exchange rates between foreign currencies and the U.S. dollar, fell 11.3%. The decline in International Franchise same store sales reflects, among other things, waning honeymoon effects from the large number of new stores opened internationally in recent years and the cannibalization effects on initial stores in new markets of additional store openings in those markets.

     Constant dollar same store sales in established markets fell 2.5% in the first nine of fiscal 2012 and fell 19.4% in new markets. “Established markets” means countries in which the first Krispy Kreme store opened before fiscal 2006. Sales at stores in established markets comprised approximately 53% of aggregate constant dollar same store sales for the first nine months of fiscal 2012. While the Company considers countries in which Krispy Kreme first opened in fiscal 2005 and earlier to be established markets, franchisees in those markets continue to develop their business; these franchisees opened 232 of the 527 international stores opened since the beginning of fiscal 2006.

     International Franchise operating expenses include costs to recruit new international franchisees, to assist in international store openings, and to monitor and aid in the performance of international franchise stores, as well as allocated corporate costs. International Franchise operating expenses increased in the first nine months of fiscal 2012 compared to the first nine months of fiscal 2011 as a result of personnel additions, including benefits and travel costs, and other cost increases resulting from the Company’s decision to devote additional resources to the development and support of international franchisees. In addition, legal costs rose year-over-year as a result of increased trademark protection expenses, as well as the expense associated with certain litigation described in Note 5 to the consolidated financial statements appearing elsewhere herein. These increases were partially offset by a decrease in bad debt expense to a credit of $380,000 in the first nine months of fiscal 2012 compared to a credit of $200,000 in the first nine months of fiscal 2011. The credit recorded to the bad debt provision in the first nine months of fiscal 2012 related principally to the Mexican franchisee discussed above. A net credit in bad debt expense should not be expected to recur frequently.

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     International franchisees opened 53 stores and closed 22 stores in the first nine months of fiscal 2012. As of November 30, 2011, existing development and franchise agreements for territories outside the United States provide for the development of approximately 280 additional stores in the remainder of fiscal 2012 and thereafter. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

   KK Supply Chain

     The components of KK Supply Chain revenues and expenses (expressed in dollars and as a percentage of total revenues before intersegment sales elimination) are set forth in the table below (percentage amounts may not add to totals due to rounding).

Percentage of Total Revenues
Before Intersegment
Sales Elimination