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(Mark one)þ
            
            ANNUAL REPORT PURSUANT TO SECTION
      13 OR 15(d)OF THE SECURITIES
      EXCHANGE ACT OF 1934For the fiscal year ended January
      31, 2010ORo
            
            TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES
      EXCHANGE ACT OF 1934For the transition period
      fromto





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
            (I.R.S. Employer Identification
      No.)incorporation or
      organization)370 Knollwood Street,
            27103Winston-Salem, North
      Carolina
            (Zip Code)(Address of principal executive
      offices)Registrant’s telephone number, including
      area code:(336) 725-2981Securities registered pursuant to
      Section 12(b) of the Act:Name ofEach Exchangeon WhichTitle of Each
      Class
            RegisteredCommon Stock, No Par Value
            New York Stock ExchangePreferred Share Purchase
Rights
            New York Stock ExchangeSecurities registered pursuant to Section 12(g) of the
      Act:None





Indicate by check mark if the registrant
is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No þ




Indicate by check mark if the registrant is not
required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes
oNo þ




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 þNo 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
oNo o




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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  þ





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 the definitions of
“large accelerated filer,” “accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act.





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 Act). Yes oNo þ





The aggregate market value of voting and non-voting common equity of the
registrant held by nonaffiliates of the registrant as of August 2, 2009 was
$205.5 million.





Number of shares of Common Stock, no
par value, outstanding as of March 26, 2010: 67,434,436.




DOCUMENTS INCORPORATED BY
REFERENCE:




Portions of the definitive proxy statement for
the registrant’s 2010 Annual Meeting of Shareholders to be held on June 22, 2010
are incorporated by reference into Part III hereof.






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TABLE OF CONTENTS




PageFORWARD-LOOKING STATEMENTS
            1PART IItem 1.
            
            Business
            2Item 1A.
            
            Risk Factors
            22Item 1B.
            
            Unresolved Staff Comments
            27Item 2.
            
            Properties
            27Item 3.
            
            Legal Proceedings
            28Item 4.
            
            Reserved
            30PART IIItem 5.
            
            Market for Registrant’s Common Equity, Related Stockholder
      Mattersand Issuer Purchases of Equity
      Securities
            31Item 6.
            
            Selected Financial Data
            34Item 7.
            
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            35Item 7A.
            
            Quantitative and Qualitative Disclosures
      about Market Risk
            65Item 8.
            
            Financial Statements and Supplementary Data
            67Item 9.
            
            Changes in and Disagreements with
      Accountants on Accounting and Financial Disclosure
            107Item 9A.
            
            Controls and Procedures
            107Item 9B.
            
            Other Information
            107PART IIIItem 10.
            
            Directors, Executive Officers and
      Corporate Governance
            108Item 11.
            
            Executive Compensation
            108Item 12.
            
            Security Ownership of Certain Beneficial
      Owners and Management and Related StockholderMatters
            108Item 13.
            
            Certain Relationships and Related Transactions, and Director
      Independence
            108Item 14.
            
            Principal Accountant Fees and
      Services
            108PART IVItem 15.
            
            Exhibits and Financial Statement
      Schedules
            109SIGNATURES
            113


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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 2011, fiscal 2010, fiscal 2009 and fiscal
2008 mean the fiscal years ended January 30, 2011, January 31, 2010, February 1,
2009 and February 3, 2008, respectively. Please note that fiscal 2008 contained
53 weeks.




FORWARD-LOOKING STATEMENTS




This Annual Report on Form 10-K 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, 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,” “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;
  and
- other factors discussed below in
  Item 1A, “Risk Factors” and in Krispy Kreme’s periodic reports and other
  information filed with the Securities and Exchange Commission (the
  “SEC”).

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.




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PART I




Item 1. BUSINESS.




Company Overview




Krispy Kreme is a leading branded retailer and wholesaler of high-quality
doughnuts and packaged sweets. The Company’s principal business, which began in
1937, is owning and franchising Krispy Kreme stores, at which over 20 varieties
of high-quality doughnuts, including the Company’s Original Glazed® doughnut, are sold and
distributed together with complementary products, and where a broad array of
coffees and other beverages are offered.




The Company generates revenues from four segments: Company stores,
domestic franchise stores, international franchise stores, and the KK Supply
Chain. The revenues and operating income of each of these segments for each of
the three most recent fiscal years is set forth in Note 17 to the Company’s
consolidated financial statements appearing elsewhere herein.




Company Stores. The Company Stores segment is comprised of the doughnut shops operated by
the Company. These stores sell doughnuts and complementary products through the
on-premises and off-premises sales channels and come in two formats: factory
stores and satellite stores. Factory stores have a doughnut-making production
line, and many of them sell products through both on-premises and off-premises
sales channels to more fully utilize production capacity. Satellite stores,
which serve only on-premises customers, are smaller than most factory stores,
and include the hot shop and fresh shop formats. As of January 31, 2010, there
were 83 Company stores in 18 states and the District of Columbia, including 69
factory and 14 satellite stores.




Domestic Franchise Stores. The Domestic Franchise segment consists of the
Company’s domestic store franchise operations. Domestic franchise stores sell
doughnuts and complementary products through the on-premise and off-premise
sales channels in the same way and using the same store formats as in the
Company Stores segment. As of January 31, 2010, there were 141 domestic
franchise stores in 29 states, including 104 factory and 37 satellite
stores.




International Franchise Stores. The International Franchise segment consists
of the Company’s international store franchise operations. International
franchise stores sell doughnuts and complementary products almost exclusively
through the on-premises sales channel in the same way and using the same store
formats as in the Company Stores segment, and also using a kiosk format. A
portion of sales by the franchisees in the United Kingdom and in Australia are
made to off-premises customers. As of January 31, 2010, there were 358
international franchise stores in 18 countries, including 95 factory and 263
satellite stores.




KK Supply Chain. The KK Supply Chain produces doughnut mixes and manufactures
doughnut-making equipment, which all factory stores, both Company and franchise,
are required to purchase. In addition, KK Supply Chain sells other ingredients,
packaging and supplies principally to Company-owned and domestic franchise
stores.




As of January 31, 2010, there were 224 Krispy Kreme stores operated
domestically in 37 U.S. states and in the District of Columbia, and 358 shops in
other countries around the world. Of the 582 total stores, 268 were factory
stores and 314 were satellites. The ownership and location of those stores is as
follows:




Domestic
              
              International
              
              TotalCompany stores
              
              
              83
              
              
              
              —
              
              
              83Franchise stores
              
              
              141
              
              
              
              358
              
              
              499Total
              
              
              224
              
              
              
              358
              
              
              582


The Company and its franchisees sell
products through two channels:


- On-premises sales: Sales to customers visiting Company and
  franchise factory and satellite stores, including sales made through
  drive-thru windows, along with discounted sales to community organizations
  that in turn sell doughnuts for fundraising purposes. A substantial majority
  of the doughnuts sold in our shops are consumed elsewhere.

2





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- Off-premises sales:Sales of fresh doughnuts and packaged sweets
  primarily on a branded basis to a variety of retail customers, including
  convenience stores, grocery stores/mass merchants and other food service and
  institutional accounts. These customers display and resell the doughnuts from
  self-service display cases, and in packages merchandised on stand-alone
  display units. Products are delivered to customer locations by our fleet of
  delivery trucks operated by a commissioned employee sales force. Distribution
  through off-premises sales channels generally is limited to stores in the
  United States. Only a small minority of sales by international franchisees are
  made to off-premises customers.



Company History




In 1933, Vernon Carver Rudolph, the founder of Krispy Kreme, went to work
for his uncle, who had acquired a doughnut shop in Paducah, Kentucky from a
French chef originally from New Orleans, which included, among other items, the
rights to a secret yeast-raised doughnut recipe. In the mid 1930s, they decided
to look for a larger market, and moved their operations to Nashville, Tennessee.
Shortly thereafter, Mr. Rudolph acquired the business, together with his father
and brother, and they soon opened shops in Charleston, West Virginia and
Atlanta, Georgia. At this time, the business focused on selling doughnuts to
local grocery stores.




During the early summer of 1937, Mr. Rudolph decided to leave Nashville
to open his own doughnut shop. Along with two friends, he set off in a 1936
Pontiac and arrived in Winston-Salem, North Carolina with $25 in cash, a few
pieces of doughnut-making equipment, the secret recipe, and the name Krispy
Kreme Doughnuts. They used their last $25 to rent a building across from Salem
Academy and College in what is now called historic Old Salem.




On July 13, 1937, the first Krispy Kreme doughnuts were made at the new
Winston-Salem shop, with the first batch of ingredients purchased on credit. Mr.
Rudolph was 21 years of age. Soon afterward, people began stopping by to ask if
they could buy hot doughnuts right there on the spot. The demand was so great
that Mr. Rudolph opened the shop for retail business by cutting a hole in the
wall and selling doughnuts directly to customers, marking the beginning of
Krispy Kreme’s restaurant business.




In 1939, Mr. Rudolph registered the Krispy Kreme name with the United
States Patent Office. The business grew rapidly and the number of shops grew,
opened first by family members and later by licensees.




In the 1950s and 1960s, steps were taken to mechanize the doughnut-making
process. Proofing, cooking, glazing, screen loading, and cutting became entirely
automatic. Most of these doughnut-making processes are still used by Krispy
Kreme stores today, although they have been further modernized.




Following Mr. Rudolph’s death, in May 1976 Krispy Kreme became a
wholly-owned subsidiary of Beatrice Foods Company of Chicago, Illinois. In
February 1982, a group of Krispy Kreme franchisees purchased Krispy Kreme from
Beatrice Foods.




With new leadership, a renewed focus on the hot doughnut experience
became a priority for the Company and led to the birth of the Doughnut Theater®,
in which the doughnut-making production line is visible to consumers, creating a
multi-sensory experience unique to Krispy Kreme and which is an important
distinguishing feature of our brand. The Company began to expand outside of the
Southeast and opened its first store in New York City in 1996. Soon afterward,
in 1999, the Company opened its first store in California and began its national
expansion. In April 2000, Krispy Kreme held an initial public offering of common
stock, and in December 2001, the Company opened its first international store,
in Canada, and began its international expansion.




When the Company turned 60 years old in 1997, Krispy Kreme’s place as a
20th century American icon was recognized by the induction of Company artifacts
into the Smithsonian Institution’s National Museum of American
History.




The last decade of the 20th century and the early
years of the 21st
was a period of rapid growth in the number of stores and domestic geographic
reach of Krispy Kreme, particularly following the April 2000 initial public
offering. In many instances, the Company took minority ownership positions in
new franchisees, both domestic and international. Enthusiasm for the brand
generated very high average unit sales volumes as Krispy Kreme stores expanded
into new geographic territories, and the Company generated significant earnings
driven by the domestic store expansion. The initial success of a number of
franchisees led the Company to reacquire several franchise markets in the United
States in 2003 and early 2004, often at substantial premiums. By late 2003,
average unit volumes began to fall as initial sales levels in many new stores
proved to be unsustainable, which adversely affected earnings at both the
Company and franchisees, leading to a period of retrenchment characterized by
over 240 domestic store closings from 2004 through 2009. The Company’s revenues
fell significantly during this period, principally as a result of store closings
by the Company and by franchisees, and the Company incurred significant losses,
including almost $300 million in impairment charges and lease termination costs
over the past six years related principally to store closings and to the
writeoff of goodwill from the franchise acquisitions.





3




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The decline in earnings and in the price of the Company’s shares,
together with questions raised in the financial media about the Company’s
accounting practices, led to the initiation of securities class action and
shareholder derivative litigation and the commencement of investigations by
various governmental entities. These events led to the formation by the Board of
Directors of a Special Committee of newly elected independent directors in
October 2004 to conduct an independent review and investigation of any and all
issues raised by, among other things, the regulatory investigations and the
shareholder derivative actions. Shortly thereafter, the Company announced that
it would restate its financial results for multiple years, a process that was
completed in April 2006. The Special Committee issued its report in August 2005,
concluding, among other things, that top management had devoted too little
attention to establishing accounting controls and an appropriate tone at the
top, and too much attention to meeting Wall Street earnings expectations,
including actions which strongly suggested an intention to manage earnings, and
directing the Company to take remedial actions, including significant changes in
corporate culture and governance. The Company has implemented all of those
directives, and has remediated the 17 material weaknesses in its internal
control over financial reporting that it identified in its initial report on
internal control under the Sarbanes-Oxley Act. All persons who the Special
Committee believed had any substantial involvement in or responsibility for the
accounting errors left the Company in or before June 2005. All of the securities
class action and shareholder derivative litigation and the governmental
investigations have been concluded.




While the 2004 through 2006 period was tumultuous in many respects, it
was not without progress. In particular, the Company greatly increased its
international development efforts. Those efforts, which are continuing, have
resulted in the recruitment of new franchisees in 14 countries since the end of
2004, and those franchisees, together with existing franchisees in four other
countries, have opened a cumulative net total of 337 Krispy Kreme stores since
the end of 2004. As of January 31, 2010, of the 582 Krispy Kreme stores
worldwide, 358 are operated by franchisees outside the United States. Many of
those franchisees pioneered the development of new small Krispy Kreme shop
formats which, in tandem with traditional factory stores or commissaries, serve
as the prototype for the small shop business model and hub and spoke
distribution system the Company currently is developing to serve domestic
markets and reignite growth in the United States.




Today, Krispy Kreme enjoys over 65% unaided brand awareness, and our Hot
Krispy Kreme Original Glazed Now® sign is an integral contributor to the brand’s
mystique. In addition, our Doughnut Theatres® in factory stores provide a
multi-sensory introduction to the brand and reinforce the unique Krispy Kreme
experience in 19 countries around the world.




Industry Overview




Krispy Kreme operates within the quick service restaurant, or QSR,
segment of the restaurant industry. In the United States, the QSR segment is the
largest segment of the restaurant industry and has demonstrated steady growth
over a long period of time. According to The NPD Group, Inc.’s CREST®, which
tracks consumer usage of the foodservice industry, QSR sales have grown at an
annual rate of 3% over the past 10 years. The
National Restaurant Association projects QSR sales to rise 3% in calendar 2010
from the $160 billion posted in calendar 2009.




We believe that the QSR segment is generally less vulnerable to economic
downturns than the casual dining segment, due to the value that QSRs deliver to
consumers, as well as some “trading to value” by consumers from other restaurant
industry segments during adverse economic conditions, as they seek to preserve
the “away from home” dining experience on tighter budgets. However, high
unemployment, low consumer confidence, tightened credit and other factors have
taken their toll on consumers and their ability to increase spending, resulting
in fewer visits to restaurants and related dollar growth. As a result, QSR sales
may continue to be adversely impacted by the current recessionary environment or
sharp increases in commodity or energy prices. The Company believes the
potential for increased prices of agricultural products and energy are more
likely to significantly affect its business than are economic conditions
generally, because the Company believes its products are affordable indulgences
that appeal to consumers in all economic environments.





4




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Our QSR competitors include Dunkin’ Donuts, which has the largest number
of outlets in the doughnut retail industry, as well as Tim Hortons and
regionally and locally owned doughnut shops. Dunkin’ Donuts and Tim Hortons have
substantially greater financial resources than we do and are expanding to other
geographic regions, including areas where we have a significant store presence.
We also compete against other retailers who sell sweet treats such as cookie
stores and ice cream stores. We compete on elements such as food quality,
convenience, location, customer service and value.




In addition to retail doughnut outlets, the domestic doughnut market is
comprised of several other sales channels, including grocery store packaged
products, in-store bakeries within grocery stores, convenience stores,
foodservice and institutional accounts, and vending. Our off-premises
competitors include makers of doughnuts and snacks sold through all of these
off-premises sales channels. Customer service, including frequency of deliveries
and maintenance of fully stocked shelves, is an important factor in successfully
competing for convenience store and grocery/mass merchant business. There is an
industry trend moving towards expanded fresh product offerings at convenience
stores during morning and evening drive times, and products are either sourced
from a central commissary or brought in by local bakeries. In the packaged
doughnut market, we compete for sales with many sweet treats, including those
made by well-known producers, such as Dolly Madison, Entenmann’s and Hostess, as
well as regional brands.




Comprehensive, reliable doughnut industry statistics are not readily
available; however, with regard to specific sales channels within the industry,
data are available. Information Resources, Inc. data indicate that, during
calendar 2009, doughnut sales rose approximately 5% year-over-year in grocery
stores and rose approximately 3% in convenience stores.




Our international franchisees, which serve the on-premises market almost
exclusively, compete against a broad set of global, regional and local retailers
of doughnuts and treats such as Dunkin’ Donuts, Tim Hortons, Mister Donut and
Donut King.




Krispy Kreme Brand
Elements




Krispy Kreme has several important brand elements which we believe have
created a bond with many of our customers. The key elements are:




One-of-a-kind taste. The taste experience of our doughnuts is the foundation of our concept
and the common thread that binds generations of our loyal customers. Our
doughnuts are made based on a secret recipe that has been in our Company since
1937. We use premium ingredients, which are blended by our proprietary
processing equipment in accordance with our standard operating procedures, to
create this unique and very special product.




Doughnut Theater®. Our factory stores typically showcase our Doughnut Theater®, which is
designed to produce a multi-sensory customer experience and establish a brand
identity. Our goal is to provide our customers with an entertainment experience
and to reinforce our commitment to quality and freshness by allowing them to see
doughnuts being made.




Hot Krispy Kreme Original Glazed Now® sign. The Hot Krispy Kreme Original Glazed Now®
sign, when illuminated, is a signal that our hot Original Glazed® doughnuts are
being served. The Hot Krispy Kreme Original Glazed Now® sign is an impulse
purchase generator and an integral contributor to our brand. Our Original
Glazed® doughnuts are made for several hours every morning and evening, and at
other times during the day at our factory stores. We also operate hot shops,
which are satellite locations supplied with unglazed doughnuts from a nearby
factory store or commissary. Hot shops use tunnel ovens to heat unglazed
doughnuts throughout the day, which are then finished using the same glaze
waterfall process used at traditional factory stores.




Sharing. Krispy
Kreme doughnuts are a popular choice for sharing with friends, family, fellow
workers and fellow students. Consumer research shows that approximately 75% of
purchases at our domestic shops are for sharing occasions; and in Company
stores, approximately 60% of retail transactions are for sales of one or more
dozen doughnuts. The strength of our brand in shared-use occasions transcends
international borders. Sales of dozens comprise a significant portion of shop
sales transactions around the world, and the sharing concept is an integral part
of our global marketing approach.




5




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Community relationships. We are committed to local community relationships. Our store operators
support their local communities through fundraising programs and sponsorship of
charitable events. Many of our loyal customers have memories of selling Krispy
Kreme doughnuts to raise money for their schools, clubs and community
organizations.




Strategic Initiatives




We have developed a number of strategic initiatives designed to foster
the Company’s growth and improve its profitability. The major initiatives to
which we have devoted our efforts over the past two years, and which we expect
to be the focus of our efforts in the next two years, are discussed
below.




Developing and Testing Small
Shop Formats To Drive Sales and Profitability




We are working to refine our domestic store operating model to focus on
small retail shops, including both satellite shops to which we supply doughnuts
from a nearby factory store in a hub and spoke distribution model, and shops
that manufacture doughnuts but which are smaller and have less capacity than
traditional factory stores. The objectives of the small retail shop model are,
among other things:


- to stimulate an increase in
  on-premises sales of doughnuts and complementary products by increasing the
  number of retail distribution points to provide customers more convenient
  access to our products;
- to reduce the investment required
  to produce a given level of sales and reduce operating costs by operating
  smaller satellite stores instead of larger, more expensive factory
  stores;
- to achieve greater production
  efficiencies by centralizing doughnut production to minimize the burden of
  fixed costs;
- to achieve greater consistency of
  product quality through a reduction in the number of doughnut-making
  locations;
- to enable store employees to focus
  on achieving excellence in customer satisfaction and in-shop consumer
  experience; and
- to achieve sufficient store
  density to enable cost-effective use of broadcast media advertising to drive
  sales and introduce new menu items to consumers.





We intend to focus development of Company stores in the Southeast in
order to achieve economies of scale and minimize the geographic span of our
Company store operations, and to develop the other domestic markets through
franchising. We view successful development and demonstration of the small shop
hub and spoke economic model as critical to attracting ongoing franchisee
investment.




We have completed initial market research in the following markets in the
Southeast which we have targeted for development of Company stores in the near
term: Piedmont Triad, Raleigh and Charlotte, North Carolina; Columbia, South
Carolina; Lexington and Louisville, Kentucky; Nashville, Memphis and Knoxville,
Tennessee; and Tidewater, Virginia. We believe there is an opportunity to build
over 65 new Krispy Kreme Company shops in these markets.




We chose these markets as our initial focus of small shop development
because (1) they are markets in which our brand has been particularly
successful; (2) they have an existing base of Krispy Kreme factory shops from
which to build; and (3) the number of additional shops necessary to make use of
broadcast media economically feasible is relatively small. By choosing markets
with these characteristics, we hope to develop small shops and implement the hub
and spoke model on a market-wide basis more rapidly than would be possible in
larger markets. In addition, there are large population centers in the Southeast
which we believe have the capacity to absorb a large number of new Company-owned
Krispy Kreme shops, including Washington, D.C. and Atlanta. Moreover, successful
development of small shop economic models could allow us to locate shops in
smaller population towns and areas than has traditionally been possible, which
could significantly increase the potential number of franchise stores
nationwide.




We opened six new small shops in fiscal 2010, and expect to open between
seven and ten additional small shops in each of the next two fiscal
years.





6




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Enhancing Our Focus on Shop
Operations




We believe that we can improve our shop operating margins by improving
our operating methods; creating and deploying management tools, including labor
cost and food cost management tools; enhancing our hospitality, service and
cleanliness standards; and continuously training our people on new methods and
standards. Our goal is to drive same store sales and operate our stores more
efficiently through a focus on operating excellence and world class guest
experience. Late in fiscal 2010, we implemented two new guest experience
measures: a new mystery shopper assessment tool performed on a regular schedule,
and a new guest reporting tool with industry norms that will allow us to compare
ourselves to the best in the QSR industry.




Developing, Testing and Deploying
New Products




Sales of doughnuts comprise over 88% of our retail sales. In addition to
improving consumer convenience by expanding the number of shops in our markets,
we need to develop and deploy a broader range of menu offerings to give
consumers more reasons to visit Krispy Kreme shops and to improve our sales in
relatively less busy dayparts. Toward that end, we are extensively testing a new
semi-frozen concept, Kool Kreme® soft serve, and conducting initial testing of
baked goods. Our goal for product diversification is to raise our on-premises
average unit volumes by 10% by fiscal 2014, notwithstanding expected
cannibalization from resulting from greater store density.




Improving Our Off-Premises
Business




Over half of our Company shops’ sales are sales to grocers, mass
merchants, convenience stores and other off-premises customers. We believe we
have less pricing power to recover higher costs of agricultural commodities in
the off-premises channel than we do in the on-premises channel, and we have the
additional cost pressures associated with generally rising fuel costs and
substantial product returns stemming from the relatively short shelf-life of our
signature yeast-raised doughnut. We are focusing on introducing new longer
shelf-life products and emphasizing marketing of existing long shelf-life
products, as well as modernizing our delivery fleet, rationalizing delivery
routes and enhancing customer service to improve the profitability of
off-premises distribution.




We believe the Krispy Kreme brand should be represented in off-premises
distribution channels. Over time, we expect our off-premises product line to
become increasingly differentiated from the products offered in our shops in
order to improve the economics of this distribution channel.




Building On Our Success
Internationally




Our international franchisees’ expansion in the past three years has been
outstanding, with international stores growing from 123 to 358 and from 31% of
our total store count to 62%. We have been devoting additional resources,
principally people, to supporting the growth of our international franchisees,
and we expect to devote even more resources to supporting international
franchisees in the next two fiscal years. Krispy Kreme is now represented in 18
countries outside the United States, and we view the growth potential as
virtually limitless, at least for the foreseeable future.




Enhancing Franchisee
Support




The success of our franchisees is key to our success. We are devoting
additional resources to franchisee operational support, both domestically and
internationally, and we expect to expand the level of that support over the next
two years. We are increasing the number of personnel devoted to helping our
franchisees succeed, not only franchisee field support employees, but also
additional personnel in the KK Supply Chain to more effectively and rapidly
support an increasingly global business. In addition, many of the operational
tools we are developing for our Company shops also can be deployed by our
franchisees to improve their shop economics.




Company Stores Business
Segment




Our Company Stores segment is comprised of the operating activities of
our Company-owned stores. These stores sell doughnuts and complementary products
through the on-premises and off-premises sales channels described above under
“Company Overview.” Expenses for this business segment include cost of goods
sold, store level operating expenses along with direct general and
administrative expenses, certain marketing costs and allocated corporate
costs.





7






---



Products




Doughnuts and Related Products. We currently make and sell over 20 varieties
of high-quality doughnuts, including our Original Glazed® doughnut. Most of our
doughnuts, including the Original Glazed® doughnut, are
yeast-raised doughnuts, although we also offer several varieties of cake
doughnuts and crullers. In recent years, we have introduced doughnuts in a
variety of non-traditional shapes, which can be seasonally customized using
icings and other toppings, including hearts, pumpkins, footballs, eggs and
snowmen. In addition to specially shaped doughnuts, we periodically offer other
doughnut varieties on a limited time offer basis. Generally, products for
domestic stores are first tested in our Company stores and then rolled out to
our franchise stores, although we have approved for testing at franchise
locations new products which we believe are compatible with our brand image and
which meet our demanding quality standards. Sales of doughnuts comprise
approximately 88% of total retail sales, with the balance comprised principally
of beverage sales.




Many of the doughnut varieties we offer in our doughnut shops also are
distributed through off-premises sales channels. In addition, we offer a number
of products exclusively through off-premises channels, including honeybuns,
fruit pies, mini-crullers, cupcakes and various chocolate enrobed products,
generally packaged as individually wrapped snacks or packaged in snack bags. We
also have introduced non-traditional packaging offerings for distribution
through grocery stores, mass merchants and convenience stores. Sales of
yeast-raised doughnuts comprise approximately 80% of total off-premises sales,
with cake doughnuts and all other product offerings as a group each comprising
approximately 10% of total off-premises sales.




Complementary products. In fiscal 2009, we began initial testing of a
new soft serve menu of traditional cones, shakes and sundaes paired with a
variety of toppings. In fiscal 2010, we expanded our testing of the concept,
called Kool Kreme® soft serve, into all of our new Company shops and into most
existing shops in the markets in which the new shops are located. We expect to
have the soft serve platform fully deployed in approximately 15 shops in four
test markets by the spring of calendar 2010, which should position the product
for meaningful consumer exposure over the summer months, supported by media and
extensive promotional activity. Our Company store tests, combined with testing
by two of our franchisees, will give us additional assessments of consumer
acceptance on which to base a full rollout decision.




We have also begun very limited in-store testing of baked goods,
including sweet rolls, pecan rolls, muffins and bagels, and plan to expand this
testing to franchisees in fiscal 2011.




Beverages. We have a complete beverage program which includes drip coffees, both
coffee-based and noncoffee-based frozen drinks, juices, sodas, milks, water and
packaged and fountain beverages. In addition, many of our stores offer a
complete line of espresso-based coffees, including flavors. We continue to seek
to improve our beverage program and plan to launch a revamped coffee program
late in fiscal 2011. Sales of beverages comprise approximately 11% of our total
retail sales.




Traditional Factory Store
Format




Historically, the Krispy Kreme business has been centered around large
facilities which operated both as quick service restaurants and as consumer
packaged goods distributors, with doughnut-making production lines located in
each shop which served both the on-premises and off-premises distribution
channels. The operation of these traditional factory stores tends to be complex,
and their relatively high initial cost and their location in retail-oriented
real estate results in a relatively high level of fixed costs which, in turn,
results in high breakeven points. In recent years, we have been developing
several new small shop formats to serve on-premises customers exclusively,
with the goal of permitting us to operate a larger number of stores that are
more convenient to our customers; reducing the initial store investment;
reducing our per store fixed costs and lowering breakeven points; and leveraging
the production capacity in the existing installed base of traditional factory
stores. These small shop formats include new small factory stores that
operate independently, as well as satellite stores, which are located in
proximity to existing traditional factory stores which supply finished and
unglazed doughnuts to the satellites using a hub and spoke distribution
system.





8




---



Traditional factory stores generally are located in freestanding suburban
locations generally ranging in size from approximately 2,400 to 8,000 square
feet, and typically have the capacity to produce between 2,400 and 4,000 dozen
doughnuts daily. The relatively larger factory stores often engage in both
on-premises and off-premises sales, with the allocation between such channels
dependent on the stores’ capacities and the characteristics of the markets in
which the stores operate. Relatively smaller traditional factory stores, which
typically have less production capacity, serve only on-premises customers. Our
newest traditional factory store is located in Pensacola, Florida, and serves
both on-premises and off-premises customers. The store was constructed in fiscal
2008; its aggregate cost was approximately $1.8 million, including the core
building, building upfit, equipment, furniture and fixtures and signage, but
excluding the land, which the Company has owned for many years.




When the production line is producing our Original Glazed® doughnut, each
factory store illuminates the Hot Krispy Kreme Original Glazed Now® sign to signal
customers that the Company’s Original Glazed® doughnuts are being
served hot off the line. Our high volume dayparts are mornings and early
evenings. The breakdown of our sales by daypart is approximately as follows
(hours between 11:00 p.m. and 6:00 a.m. have been omitted because very few of
our stores are open to the public during these hours):




Hours
            
            
            Percentage of Retail
    Sales6 a.m.
            
            –
            
            11
      a.m.
            
            
            
            35
            %11 a.m.
            
            –
            
            2 p.m.
            
            
            
            13
            %2 p.m.
            
            –
            
            6
    p.m.
            
            
            
            21
            %6 p.m.
            
            –
            
            11 p.m.
            
            
            
            27
            %


The factory store category also includes six commissaries, five of which
have multiple production lines; each line has the capacity to produce between
4,000 dozen and 10,000 dozen doughnuts daily. The commissaries typically serve
off-premises customers exclusively, although some commissaries produce certain
products (typically longer shelf-life products such as honeybuns) that are
shipped to other factory stores where they are distributed to off-premises
customers together with products manufactured at the receiving
store.




Historically, the relatively large size and high cost of traditional
factory stores limited the density of our stores in many markets, causing many
of our consumers to utilize them as “destination” locations, which limited their
frequency of use. The relatively small number of stores in many markets made use
of broadcast media advertising cost prohibitive, and historically the Company
did little advertising. In addition, each factory store has significant fixed or
semi-fixed costs, and margins and profitability are significantly affected by
doughnut production and sales volume. Many of our traditional factory stores and
commissaries have more capacity to produce doughnuts than is currently is being
utilized.




Small Retail Shop
Format




Our consumer research indicates that the typical Krispy Kreme on-premises
customer visits Krispy Kreme an average of once a month, and a significant
obstacle to more frequent customer visits is our relative lack of convenience.
Our consumer demographics are very much in line with the general
population in which we do business. Our consumer research also indicates that
consumers give us permission to leverage our brand into a variety of
complementary products, so long as the quality of those products is consistent
with the very high quality perception consumers attribute to our Original
Glazed® doughnut.




We are developing a number of small retail shops to more fully
penetrate markets of all sizes. In addition to improving customer convenience by
increasing the number of Krispy Kreme shops in our markets, we believe the
greater store density will make use of broadcast media advertising more
economically feasible and enable us to drive sales through broadcast
advertising. Moreover, we view the ability to utilize broadcast advertising as
essential to promoting and encouraging trial usages of new menu items, including
an enhanced beverage program. Broadening our menu to drive additional sales in
relatively slower dayparts is an important opportunity for us to improve the
economics of our business, as is the opportunity to increase the number of
offerings in the traditionally strong breakfast daypart and the opportunity to
increase sales of beverages, which today represent a small fraction of our
retail sales.




Small Factory Stores. We have developed a small retail-only factory
store which occupies approximately 2,400 square feet and which contains a full
doughnut production line, but on a smaller scale than the production equipment
in a traditional factory store. We operate two of these small factory stores,
and view this format as a viable alternative with which to deliver the Krispy
Kreme Doughnut Theater® experience to consumers in relatively smaller geographic
markets. Each of our two small factory stores has the capacity to produce
approximately 1,000 dozen doughnuts per day, although the small factory store
configuration, with minor modification, can accommodate equipment with the
capacity to produce approximately 2,400 dozen doughnuts per day. The capital
cost of the small factory store we opened in fiscal 2010 was approximately
$850,000, including equipment, furniture and fixtures, signage and building
upfit. We are continuing to refine the small factory model to reduce the initial
capital cost of this format.





9




---



Satellite Stores. In addition, we have developed and are testing satellite stores, all of
which serve only on-premises customers, are smaller than traditional factory
stores, and do not contain a doughnut making production line. Satellite stores
consist of the hot shop and fresh shop formats, and typically range in size from
approximately 900 to 2,400 square feet (exclusive of larger factory stores that
have been converted to satellites). In each of these formats, the Company sells
doughnuts, beverages and complementary products, with the doughnuts supplied by
a nearby traditional factory store or a commissary.




Hot shops utilize tunnel oven doughnut heating and finishing equipment
scaled to accommodate on-premises sales volumes. This equipment heats unglazed
doughnuts and finishes them using a warm glaze waterfall that is the same as that used in a traditional
factory store. Hot shop equipment allows the Company to offer customers our hot
Original Glazed® doughnuts throughout the day, and to signal customers that our
signature product is available using the Hot Krispy Kreme Original Glazed Now®
illuminated sign. Products other than our Original Glazed® doughnut generally
are delivered to the hot shop already finished, although in some locations we
perform some finishing functions at the hot shop, including application of
icings and fillings, to provide consumers with elements of our Doughnut Theater®
experience in hot shop locations.




Fresh shops are similar to hot shops, but do not contain doughnut heating
and finishing equipment. All of the doughnuts sold at fresh shops are delivered
fully finished from the factory hub.




Hot shops and fresh shops typically are located in shopping centers, and
end cap spaces that can accommodate drive-through windows are particularly
desirable. We also intend to build and test hot shops in a freestanding format
on outparcels of shopping centers and other retail centers, as well as shops in
pedestrian-rich environments including urban settings and college and university
campuses. We view the hot shop and fresh shop formats as ways to achieve market
penetration and greater consumer convenience in a variety of market sizes and
settings. Our international franchisees led the initial development of the
satellite shop formats, and we have been working to adapt their work to the
domestic market.




We opened six new Company-operated small retail shops in fiscal 2010,
including one small factory store, three hot shops and two fresh shops. We
converted one traditional factory store to a hot shop using tunnel oven
equipment to reduce operating costs and increase the number of hours each day
the store offers the Company’s hot Original Glazed® doughnuts, and closed
10 traditional factory stores and two factory stores that had been converted to
satellites. We plan to open seven to ten small retail shops in fiscal 2011, all
in the Southeastern United States. The average capital cost of the satellite
stores we opened in fiscal 2010 was approximately $410,000, including equipment,
furniture and fixtures, signage and building upfit. We are continuing to refine
these shop models in order to reduce their initial capital cost.




10




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The following table sets forth
the type and locations of Company stores as of January 31, 2010.




Number of Company
  StoresState
            
            Factory Stores
            
            Hot Shops
            
            Fresh Shops
            
            TotalAlabama
            
            3
            
            
            —
            
            
            —
            
            
            
            3District of Columbia
            
            —
            
            
            1
            
            
            —
            
            
            
            1Florida
            
            4
            
            
            —
            
            
            —
            
            
            
            4Georgia
            
            6
            
            
            4
            
            
            —
            
            
            
            10Indiana
            
            3
            
            
            2
            
            
            —
            
            
            
            5Kansas
            
            3
            
            
            —
            
            
            —
            
            
            
            3Kentucky
            
            3
            
            
            —
            
            
            —
            
            
            
            3Louisiana
            
            1
            
            
            —
            
            
            —
            
            
            
            1Maryland
            
            1
            
            
            —
            
            
            —
            
            
            
            1Michigan
            
            3
            
            
            —
            
            
            —
            
            
            
            3Missouri
            
            4
            
            
            —
            
            
            —
            
            
            
            4Mississippi
            
            1
            
            
            —
            
            
            —
            
            
            
            1North Carolina
            
            11
            
            
            —
            
            
            2
            
            
            
            13Ohio
            
            6
            
            
            —
            
            
            —
            
            
            
            6South Carolina
            
            2
            
            
            1
            
            
            —
            
            
            
            3Tennessee
            
            7
            
            
            4
            
            
            —
            
            
            
            11Texas
            
            3
            
            
            —
            
            
            —
            
            
            
            3Virginia
            
            7
            
            
            —
            
            
            —
            
            
            
            7West Virginia
            
            1
            
            
            —
            
            
            —
            
            
            
            1Total
            
            69
            
            
            12
            
            
            2
            
            
            
            83


Changes in the number of Company
stores during the past three fiscal years are summarized in the table
below.




Number of Company
  StoresFactory Stores
            
            Hot Shops
            
            Fresh Shops
            
            TotalJANUARY 28, 2007
            
            108
            
            
            
            2
            
            
            
            
            3
            
            
            
            
            113Opened
            
            1
            
            
            
            —
            
            
            
            
            —
            
            
            
            
            1Closed
            
            (9
            )
            
            
            —
            
            
            
            
            —
            
            
            
            
            (9
            )Converted to satellites
            
            (3
            )
            
            
            3
            
            
            
            
            —
            
            
            
            
            —FEBRUARY 3, 2008
            
            97
            
            
            
            5
            
            
            
            
            3
            
            
            
            
            105Opened
            
            —
            
            
            
            —
            
            
            
            
            —
            
            
            
            
            —Closed
            
            (4
            )
            
            
            —
            
            
            
            
            (2
            )
            
            
            
            (6
            )Refranchised
            
            (5
            )
            
            
            —
            
            
            
            
            (1
            )
            
            
            
            (6
            )Converted from satellites
            
            1
            
            
            
            (1
            )
            
            
            
            —
            
            
            
            
            —Converted to satellites
            
            (6
            )
            
            
            6
            
            
            
            
            —
            
            
            
            
            —FEBRUARY 1, 2009
            
            83
            
            
            
            10
            
            
            
            
            —
            
            
            
            
            93Opened
            
            1
            
            
            
            3
            
            
            
            
            2
            
            
            
            
            6Closed
            
            (10
            )
            
            
            (2
            )
            
            
            
            —
            
            
            
            
            (12
            )Refranchised
            
            (4
            )
            
            
            —
            
            
            
            
            —
            
            
            
            
            (4
            )Converted to satellites
            
            (1
            )
            
            
            1
            
            
            
            
            —
            
            
            
            
            —JANUARY 31, 2010
            
            69
            
            
            
            12
            
            
            
            
            2
            
            
            
            
            83


Off-Premises
Sales




Off-premises sales accounted for
slightly over half of fiscal 2010 revenues in the Company Stores segment. Of the
83 stores operated by the Company as of January 31, 2010, 45 serve the
off-premises distribution channel, including six commissaries. We sell our
traditional yeast-raised and cake doughnuts in a variety of packages, generally
containing from six to 15 doughnuts. In addition, we offer in the off-premises
distribution channel a number of doughnuts and complementary products that we do
not offer in our restaurants, including honeybuns, mini-crullers, fruit pies and
a variety of snack doughnuts. These products typically have longer shelf lives
than our traditional doughnuts and are packaged in snack bags or as individually
wrapped snacks. Packaged products generally are marketed from Krispy Kreme
branded displays, but occasionally are stocked on customers’ shelves. We
strongly prefer marketing our products from our branded display tables because
those displays give our products substantially greater visibility in the store
than does on-shelf stocking. In addition to packaged products, we sell
individual loose doughnuts through our in-store bakery (“ISB”) program, using
branded self-service display cases that also contain branded packaging for loose
doughnut sales.





11




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The off-premises distribution channel is composed of two principal
customer groups: grocers/mass merchants and convenience stores. Substantially
all sales to grocers and mass merchants consist of packaged products, while a
significant majority of sales to convenience stores consists of loose doughnuts
sold through the ISB program.




We deliver doughnuts to off-premises customers using a fleet of delivery
trucks operated by a commissioned employee sales force. We typically deliver
products to packaged doughnut customers three times per week, on either a
Monday/Wednesday/Friday or Tuesday/Thursday/Saturday schedule. ISB customers
generally are serviced daily, six times per week. In addition to delivering
product, our salespeople are responsible for merchandising our products in the
displays and picking up unsold products for return to the Company shop. Our
principal products are yeast-raised doughnuts having a short shelf-life, which
results in unsold product costs in the off-premises distribution channel, most
of which are absorbed by the Company.




The off-premises channel is highly competitive, and the Company has not
increased selling prices in recent years sufficiently to recover increased
costs, particularly higher costs resulting from rising agricultural commodity
costs and higher fuel costs. In addition, a number of customers, mainly
convenience store chains, have converted from branded doughnut offerings to
vertically-integrated private label systems.




In response to these off-premises trends, the Company has introduced a
small number of new, longer shelf-life branded products manufactured for the
Company by third parties, has reemphasized marketing of existing longer
shelf-life products made by the Company, and has developed order management
systems to more closely match display quantities and assortments with consumer
demand and reduce the amount of unsold product. The goals of these efforts are
to reduce spoilage and to increase the average weekly sales derived from each
off-premises distribution point. In addition, where possible, the Company has
eliminated relatively lower sales volume distribution points and consolidated
off-premises sales routes in order to reduce delivery costs and increase the
average revenue per distribution point and the average revenue per mile
driven.




Store
Operations




General store operations. We outline standard specifications and designs
for each Krispy Kreme store format and require compliance with our standards
regarding the operation of each store, including, but not limited to, varieties
of products, product specifications, sales channels, packaging, sanitation and
cleaning, signage, furniture and fixtures, image and use of logos and
trademarks, training and marketing and advertising. We currently are in the
process of revising and improving these store operating manuals.




Our stores generally operate seven days a week, excluding some major
holidays. Traditionally, our domestic sales have been slower during the winter
holiday season and the summer months.




Quality standards and customer service. We encourage our employees to be courteous,
helpful, knowledgeable and attentive. We emphasize the importance of performance
by linking a portion of both a Company store manager’s and assistant manager’s
incentive compensation to profitability and customer service. We also encourage
high levels of customer service and the maintenance of our quality standards by
frequently monitoring our stores through a variety of methods, including
periodic quality audits, “mystery shoppers” and a toll-free consumer telephone
number. In addition, our customer experience department handles customer
comments and conducts routine satisfaction surveys of our on-premises
customers.




Management and staffing. Our President – U.S. Stores, along with other
corporate officers responsible for store operations, is charged with corporate
interaction with our regional vice presidents, market managers and store
management. Through our regional vice presidents and market managers, each of
whom is responsible for a specific geographic region, we communicate frequently
with all store managers and their staff using store audits, weekly
communications by telephone or e-mail and both scheduled and surprise store
visits.




We offer a comprehensive manager training program covering the critical
skills required to operate a Krispy Kreme store and a training program for all
positions in the store. The manager training program includes classroom
instruction, computer-based training modules and in-store training.





12




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Our staffing varies depending on a store’s size, volume of business and
number of sales channels. Stores, depending on the sales channels they serve,
have employees handling on-premises sales, processing, production, bookkeeping,
sanitation and delivery. Hourly employees, along with route sales personnel, are
trained by local store management through hands-on experience and training
manuals.




In fiscal 2011, we plan to enhance our shops’ timekeeping systems by
deploying new labor scheduling technology to help our shop managers better match
staffing levels with consumer traffic.




We currently operate Company stores in 18 states and the District of
Columbia. Over time, we plan to refranchise all of our stores in markets outside
our 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. Of the 83 stores operated by the Company as of
January 31, 2010, approximately 25 stores having fiscal 2010 sales of
approximately $70.2 million are candidates for refranchising at the appropriate
time.




Domestic Franchise Business
Segment




The Domestic Franchise segment consists of the Company’s domestic store
franchise operations. This segment derives revenue principally from initial
development and franchise fees related to new stores and from royalties on sales
by franchise stores. In October 2007, the Company decided to waive initial
development and franchise fees for all new stores opened prior to October 1,
2010 by existing franchisees as of October 2007. Domestic Franchise direct
operating expenses include costs incurred to recruit new domestic franchisees,
to assist with domestic store openings, to assist in the development of domestic
marketing and promotional programs, and to monitor and aid in the performance of
domestic franchise stores, as well as direct general and administrative expenses
and certain allocated corporate costs.




As of January 31, 2010, domestic franchisees operated 141 stores. During
the year then ended, domestic franchisees opened 12 stores and closed seven
stores. Existing development and franchise agreements for territories in the
United States provide for the development
of approximately 40 additional stores in fiscal 2011 and
thereafter.




Domestic franchise stores include stores that we historically have
referred to as associate stores and area developer stores, as well as franchisee
stores that have opened since the beginning of calendar 2008. The rights of our
franchisees to build new stores and to use the Krispy Kreme trademark and
related marks vary by franchisee type and are discussed below.


- Associates.Associate franchisees are located principally in the Southeast, and
  their stores have attributes that are similar to Company stores located in the
  Southeast. Associates typically have many years of experience operating Krispy
  Kreme stores and selling Krispy Kreme branded products both on-site and
  off-premises in defined territories. This group of franchisees generally
  concentrates on growing sales within the current base of stores rather than
  developing new stores. Under their associate license agreements, associates
  generally have the exclusive right to open new stores in their geographic
  territories, but they are not obligated to develop additional stores. We
  cannot grant new franchises within an associate’s territory during the term of
  the license agreement. Further, we generally cannot sell within an associate’s
  territory any Krispy Kreme branded products, because we have granted those
  exclusive rights to the franchisee for the term of the license
  agreement.Associates
  typically have license agreements that expire in 2020. Associates generally
  pay royalties of 3.0% of on-premises sales and 1.0% of all other sales. Some
  associates also contribute 0.75% of all sales to the Company-administered
  public relations and advertising fund, which we refer to as the Brand
  Fund.
- Area developers.In the mid-1990s, we franchised territories in the United States,
  usually defined by metropolitan statistical areas, pursuant to area
  development agreements. These development agreements established the number of
  stores to be developed in an area, and the related franchise agreements
  governed the operation of each store. Most of the area development agreements
  have expired or have been terminated.Under their franchise agreements, area developers generally have the
  exclusive right to sell Krispy Kreme branded products within a one-mile radius
  of their stores and in off-premises accounts that they have serviced in the
  last 12 months.

13





---



The
franchise agreements for area developers have a 15-year term that may be renewed
by the Company. These franchise agreements provide for royalties of 4.5% of
sales and contributions to the Brand Fund of 1.0% of sales. In fiscal 2009, the
Company elected to reduce temporarily the Brand Fund contribution rate for
domestic area developers to 0.75%. For fiscal 2009, the Company elected to
reduce the royalty rate payable by area developers on off-premises sales from
4.5% to 3.5%, and for fiscal 2010, the Company elected to reduce the royalty
rate on off-premises sales to 2.5%. The Company has informed its domestic area
developers that it will reduce the royalty rate on off-premises sales to 1.75%
for fiscal 2011. Off-premises sales represented approximately 25% of area
developer sales.




As of
January 31, 2010, we had an equity interest in two of the domestic area
developers. Where we are an equity investor in an area developer, we contribute
equity or guarantee debt or lease commitments of the franchisee generally
proportionate to our ownership interest. See Note 18 to the consolidated
financial statements appearing elsewhere herein for additional information on
our franchisee investments. We do not currently expect to own any equity
interests in any future franchisees.


- Recent franchisees.During the past two fiscal years, the
  Company has signed new franchise agreements with respect to 31 stores in the
  United States. Six of these recent franchise agreements resulted from the
  expiration of existing agreements, two were related to new stores opened by
  persons who were franchisees as of the end of fiscal 2008, and two
  resulted from a change in ownership. The remaining 21 agreements were related
  to refranchising, in which the Company refranchised Company markets to
  franchisees. Of the agreements related to refranchising, six were related
  to existing Company stores sold to franchisees and 15 were related to stores
  opened by new franchisees. Some of the recent franchisees have signed
  development agreements, which require the franchisee to build a specified
  number of stores in an exclusive geography within a specified time period,
  usually five years or less. The franchise agreements with this group of
  franchisees have a 15-year term, renewable at the Company’s discretion, and
  they generally do not contemplate off-premises business.Additionally, these franchise agreements
  generally allow the Company to sell Krispy Kreme branded products in close
  geographic proximity to the franchisees’ stores. These franchise agreements
  and development agreements are used for all new franchisees and, in general,
  for the renewal of older franchise agreements and associate license
  agreements. We are charging recent franchisees the same royalty and Brand Fund
  rates as those charged to area developer franchisees.

14




---





The following table sets forth
the type and locations of domestic franchise stores as of January 31,
2010.




Number of Domestic Franchise
      StoresState
            
            Factory
            
            Hot Shop
            
            Fresh Shop
            
            TotalAlabama
            
            5
            
            2
            
            —
            
            7Arkansas
            
            2
            
            —
            
            —
            
            2Arizona
            
            2
            
            —
            
            9
            
            11California
            
            11
            
            —
            
            3
            
            14Connecticut
            
            1
            
            —
            
            3
            
            4Colorado
            
            2
            
            —
            
            —
            
            2Florida
            
            11
            
            5
            
            1
            
            17Georgia
            
            7
            
            4
            
            —
            
            11Hawaii
            
            1
            
            —
            
            —
            
            1Iowa
            
            1
            
            —
            
            —
            
            1Idaho
            
            1
            
            —
            
            —
            
            1Illinois
            
            4
            
            —
            
            —
            
            4Louisiana
            
            3
            
            —
            
            —
            
            3Missouri
            
            3
            
            —
            
            —
            
            3Mississippi
            
            2
            
            —
            
            —
            
            2North Carolina
            
            6
            
            1
            
            —
            
            7Nebraska
            
            1
            
            —
            
            —
            
            1New Mexico
            
            1
            
            —
            
            —
            
            1Nevada
            
            3
            
            1
            
            2
            
            6New York
            
            1
            
            —
            
            1
            
            2Oklahoma
            
            3
            
            —
            
            —
            
            3Oregon
            
            2
            
            —
            
            —
            
            2Pennsylvania
            
            4
            
            1
            
            1
            
            6South Carolina
            
            6
            
            —
            
            2
            
            8Tennessee
            
            2
            
            —
            
            —
            
            2Texas
            
            8
            
            —
            
            1
            
            9Utah
            
            2
            
            —
            
            —
            
            2Wisconsin
            
            1
            
            —
            
            —
            
            1Washington
            
            8
            
            —
            
            —
            
            8Total
            
            104
            
            14
            
            23
            
            141


Changes in the number of domestic franchise stores during the past three
fiscal years are summarized in the table below.




Number of Domestic Franchise
      StoresFactory
            
            Hot Shop
            
            Fresh Shop
            
            Kiosks
            
            TotalJANUARY 28, 2007
            
            137
            
            
            13
            
            
            14
            
            
            1
            
            
            165Opened
            
            —
            
            
            3
            
            
            —
            
            
            —
            
            
            3Closed
            
            (17
            )
            
            (3
            )
            
            (2
            )
            
            (1
            )
            
            (23
            )Converted to satellites
            
            (2
            )
            
            2
            
            
            —
            
            
            —
            
            
            —FEBRUARY 3, 2008
            
            118
            
            
            15
            
            
            12
            
            
            —
            
            
            145Opened
            
            1
            
            
            1
            
            
            4
            
            
            —
            
            
            6Closed
            
            (17
            )
            
            (4
            )
            
            —
            
            
            —
            
            
            (21
            )Refranchised
            
            1
            
            
            —
            
            
            1
            
            
            —
            
            
            2Converted from satellites
            
            2
            
            
            (2
            )
            
            —
            
            
            —
            
            
            —Converted to satellites
            
            (1
            )
            
            1
            
            
            —
            
            
            —
            
            
            —Change in
      store type
            
            —
            
            
            2
            
            
            (2
            )
            
            —
            
            
            —FEBRUARY 1, 2009
            
            104
            
            
            13
            
            
            15
            
            
            —
            
            
            132Opened
            
            3
            
            
            —
            
            
            9
            
            
            —
            
            
            12Closed
            
            (4
            )
            
            —
            
            
            (3
            )
            
            —
            
            
            (7
            )Refranchised
            
            4
            
            
            —
            
            
            —
            
            
            —
            
            
            4Converted from satellites
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Converted to satellites
            
            (3
            )
            
            2
            
            
            1
            
            
            —
            
            
            —Change in
      store type
            
            —
            
            
            (1
            )
            
            1
            
            
            —
            
            
            —JANUARY 31, 2010
            
            104
            
            
            14
            
            
            23
            
            
            —
            
            
            141


15




---



Most of our domestic franchisees serve the off-premises distribution
channel in addition to their on-premises operations, although off-premises sales
by domestic franchisees generally comprise a smaller percentage of total sales
than do off-premises sales at Company stores. For the year ended January 31,
2010, approximately 27% of sales by domestic franchisees were made through
off-premises channels.




We generally assist our franchisees with issues such as operating
procedures, advertising and marketing programs, public relations, store design,
training and technical matters. We also provide an opening team to provide
on-site training and assistance both for the week prior to and during the first
week of operation for each initial store opened by a new franchisee. The number
of opening team members providing this assistance is reduced with each
subsequent store opening for an existing franchisee.




International Franchise Business Segment




The International Franchise segment consists of the Company’s
international store franchise operations. The franchise agreements with
international area developers typically provide for the payment of royalties of
6.0% of all sales, contributions to the Brand Fund of 0.25% of sales and
one-time development and franchise fees ranging from $15,000 to $50,000 per
store. Direct operating expenses for this business segment include costs
incurred to recruit new international franchisees, to assist with international
store openings, to assist in the development of international marketing and
promotional programs, and to monitor and aid in the performance of international
franchise stores, as well as direct general and administrative expenses and
allocated corporate costs.




The operations of international franchise stores are similar to those of
domestic stores, except that substantially all of the sales of international
franchise stores are made to on-premises customers. International franchisees
generally have adopted varieties of the hub and spoke business model, in which
centralized factory stores or commissaries provide fresh doughnuts to satellite
locations. Internationally, the fresh shop satellite format predominates, and
shops typically are located in pedestrian-rich environments, including
transportation hubs and shopping malls. Some of our international franchisees
have developed small kiosk formats, which also are typically located in
transportation hubs.




Our International Franchisees have renewable development agreements
regarding the build-out of Krispy Kreme stores in their territories. Territories
are typically country or region-wide, but for large countries, the development
territory may encompass only a portion of a country. The international franchise
agreements have a renewable 15-year term. These agreements generally do not
contemplate off-premises sales, although our franchisees in Australia and the
United Kingdom make such sales. Under these agreements, the Company retains the
right to use the trademarks at locations other than the franchise stores.




Product offerings at shops outside the United States include our
signature Original Glazed® doughnut, a core set
of doughnut varieties offered in our domestic shops, and a complementary set of
localized doughnut varieties tailored to meet the unique taste preferences and
dietary norms in the market. Often, our glazes, icings and filling flavors are
tailored to meet local palette preferences. We work closely with our franchisees
outside the United States to conduct marketing research to understand local
tastes and usage occasions, which drives development of new products and
marketing approaches.




Internationally, we believe that complementary products such as baked
goods, ice cream and other treat products could play an increasingly important
role for our franchisees as they penetrate their markets and further establish
the Krispy Kreme brand. These items offer franchisees the opportunity to fill
and/or strengthen day part offerings to meet a broader set of customer needs.
Currently, Australia and Mexico offer their customers ice cream products
including cones, cups, sundaes and milkshakes. In fiscal 2010, we developed a
baked platform for international markets designed to meet needs across a broad
set of markets. Testing of a baked program was launched in fiscal 2010 in
Australia, and there are plans to conduct additional testing in international
markets during fiscal 2011.




Beverage offerings at shops outside the United States include a complete
program consisting of hot and iced espresso based beverages, frozen drinks,
teas, juices, sodas, water and bottled or canned beverages. Drip coffee is also
offered in many international markets, but represents a much smaller component
of the beverage program relative to the United States due to international
consumer preferences. In-store consumption occasions often play a key role in
total beverage consumption internationally due to store locations and consumer
habits, and we work closely with international franchisees to adapt the store
environment and product offerings to take advantage of this dynamic. We continue
to look for ways to improve our beverage program and bring cross-market
efficiencies to international franchisees.




16




---



Markets outside the United States have been a significant source of
growth, all of which we plan to develop by franchising. In the past two years,
we have focused our international development efforts primarily on opportunities
in markets in Asia and the Middle East. In addition to ongoing development
efforts in these areas, we plan to begin initial franchisee recruitment efforts
in Europe in fiscal 2011. Existing development and franchise agreements for
territories outside the United States provide for the development of over 155
additional stores in fiscal 2011 and thereafter.




The types and locations of
international franchise stores as of January 31, 2010 are summarized in the
table below.




Number of International Franchise
      StoresCountry
            
            Factory
            
            Hot Shop
            
            Fresh Shop
            
            Kiosk
            
            TotalAustralia
            
            6
            
            
            4
            
            
            24
            
            
            20
            
            
            54Bahrain
            
            2
            
            
            —
            
            
            2
            
            
            4
            
            
            8Canada
            
            5
            
            
            —
            
            
            —
            
            
            —
            
            
            5China
            
            1
            
            
            —
            
            
            —
            
            
            —
            
            
            1Indonesia
            
            3
            
            
            —
            
            
            2
            
            
            3
            
            
            8Japan
            
            9
            
            
            —
            
            
            3
            
            
            —
            
            
            12Kuwait
            
            3
            
            
            —
            
            
            21
            
            
            3
            
            
            27Lebanon
            
            2
            
            
            —
            
            
            4
            
            
            3
            
            
            9Malaysia
            
            2
            
            
            1
            
            
            1
            
            
            —
            
            
            4Mexico
            
            5
            
            
            1
            
            
            22
            
            
            18
            
            
            46Philippines
            
            4
            
            
            3
            
            
            8
            
            
            1
            
            
            16The Commonwealth of Puerto Rico
            
            3
            
            
            —
            
            
            —
            
            
            —
            
            
            3Qatar
            
            2
            
            
            —
            
            
            3
            
            
            1
            
            
            6The Republic of Korea
            
            28
            
            
            1
            
            
            7
            
            
            —
            
            
            36The Kingdom of Saudi Arabia
            
            8
            
            
            —
            
            
            44
            
            
            7
            
            
            59Turkey
            
            1
            
            
            —
            
            
            —
            
            
            1
            
            
            2The United Arab Emirates
            
            2
            
            
            —
            
            
            19
            
            
            1
            
            
            22The United Kingdom
            
            9
            
            
            4
            
            
            20
            
            
            7
            
            
            40Total
            
            95
            
            
            14
            
            
            180
            
            
            69
            
            
            358Changes in the number of international franchise stores during the
      past three fiscal years are summarized in the table below.Number of International Franchise
      StoresFactory
            
            Hot Shops
            
            Fresh Shops
            
            Kiosks
            
            TotalJANUARY 28, 2007
            
            51
            
            
            23
            
            
            26
            
            
            17
            
            
            117Opened
            
            32
            
            
            4
            
            
            27
            
            
            22
            
            
            85Closed
            
            (1
            )
            
            —
            
            
            (2
            )
            
            —
            
            
            (3
            )Converted to satellites
            
            (2
            )
            
            1
            
            
            1
            
            
            —
            
            
            —FEBRUARY 3, 2008
            
            80
            
            
            28
            
            
            52
            
            
            39
            
            
            199Opened
            
            18
            
            
            2
            
            
            75
            
            
            19
            
            
            114Closed
            
            (6
            )
            
            (4
            )
            
            (5
            )
            
            (4
            )
            
            (19
            )Refranchised
            
            4
            
            
            —
            
            
            —
            
            
            —
            
            
            4Converted to satellites
            
            (2
            )
            
            —
            
            
            2
            
            
            —
            
            
            —Change in store
    type
            
            —
            
            
            —
            
            
            2
            
            
            (2
            )
            
            —FEBRUARY 1, 2009
            
            94
            
            
            26
            
            
            126
            
            
            52
            
            
            298Opened
            
            9
            
            
            3
            
            
            52
            
            
            18
            
            
            82Closed
            
            (7
            )
            
            —
            
            
            (9
            )
            
            (6
            )
            
            (22
            )Converted to satellites
            
            (1
            )
            
            —
            
            
            1
            
            
            —
            
            
            —Change in
      store type
            
            —
            
            
            (15
            )
            
            10
            
            
            5
            
            
            —JANUARY 31, 2010
            
            95
            
            
            14
            
            
            180
            
            
            69
            
            
            358


The Company has equity interests in the franchisees operating stores in
Mexico and Western Canada. The Company currently does not expect to own equity
interests in franchisees formed in the future.




17




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KK Supply Chain Business
Segment




The Company operates an integrated supply chain to help maintain the
consistency and quality of products throughout the Krispy Kreme system. The KK
Supply Chain segment buys and processes ingredients it uses to produce doughnut
mixes and manufactures doughnut-making equipment that all factory stores are
required to purchase.




The Company manufactures doughnut mix at its facility in Winston-Salem,
North Carolina. In February 2009, the Company entered into an agreement with an
independent food company to manufacture certain doughnut mixes for regions
outside the Southeastern United States and to provide doughnut mix production in
the event of a disruption of business at the Winston-Salem facility. In
addition, the Company has for several years utilized contract mix manufacturers
in the United Kingdom and in Australia to blend mixes for certain international
franchisees using mix concentrate supplied from Winston-Salem.




The KK Supply Chain segment also purchases and sells key supplies,
including icings and fillings, other food ingredients, juices, signage, display
cases, uniforms and other items to both Company and franchisee-owned stores. In
addition, through KK Supply Chain, the Company utilizes volume-buying power,
which the Company believes helps lower the cost of supplies to stores and
enhances profitability. KK Supply Chain operates a distribution center which
supplies domestic stores in the Eastern United States and certain international
franchise stores with key supplies. The Company has subcontracted with an
independent distributor to supply the domestic stores not supplied from the
Winston-Salem distribution facility, which generally consist of stores west of
the Mississippi River.




Substantially all domestic stores purchase all of their ingredients and
supplies from the KK Supply Chain, while KK Supply Chain sales to international
franchise stores are comprised principally of sales of doughnut mix. The Company
is actively studying its distribution system, including its export practices, to
reduce the delivered cost of products to both Company and franchise stores. The
Company expects to employ increased local sourcing for international franchisees
in order to reduce costs.




The Supply Chain business unit is volume-driven, and its economics are
enhanced by the opening of new stores and the growth of sales by existing
stores.




Revenues by Geographic
Region




Set forth below is a table presenting our revenues by geographic region
for fiscal 2010, 2009 and 2008. Revenues by geographic region are presented by
attributing revenues from customers on the basis of the location to which the
Company’s products are delivered or, in the case of franchise segment revenues,
the location of the franchise store from which the franchise revenue is derived.




Year EndedJan. 31,2010
            
            Feb. 1,2009
            
            Feb. 3,2008(In thousands)Revenues by geographic region:United States
            
            $
            314,528
            
            $
            333,599
            
            $
            382,570Other North America
            
            
            4,231
            
            
            14,513
            
            
            14,995Asia/Pacific
            
            
            15,469
            
            
            18,927
            
            
            15,070Middle East
            
            
            8,852
            
            
            10,477
            
            
            10,210Europe
            
            
            3,440
            
            
            8,006
            
            
            7,525Total revenues
            
            $
            346,520
            
            $
            385,522
            
            $
            430,370


Marketing




Krispy Kreme’s approach to marketing is a natural extension of our brand
equity, brand attributes, relationship with our customers and our
values.




18




---



Domestic




To build our brand and drive our sales in a manner aligned with our brand
values, we have focused our domestic marketing activities in the following
areas:




Store Experience. Our factory stores and hot shops are where most customers first
experience a hot Original Glazed® doughnut. Customers
know that when our Hot Krispy Kreme Original Glazed Now® sign in the store
window is illuminated, they can enjoy a hot Original Glazed® doughnut. We believe
this experience begins our relationship with our customers and forms the
foundation of the Krispy Kreme experience.




Relationship Marketing. Many of our brand-building activities are
grassroots-based and focused on building customer and community relevancy by
developing relationships with our constituents — consumers, local non-profit
organizations and businesses. Specific initiatives include:


- Good neighbor product deliveries
  to create trial uses;
- Sponsorship of local events and
  nonprofit organizations;
- Friends of Krispy Kreme
  eNewsletters sent to customers registered to receive monthly updates about new
  products, promotions and store openings;
- Fundraising programs designed to
  assist local charitable organizations in raising money for their non-profit
  causes; and
- Digital marketing efforts
  including use of social media sites such as Facebook and Twitter to
  communicate product and promotional activity, new store openings and local
  store marketing programs. We have over 1.2 million fans on Facebook and are
  ranked #17 of the Facebook 50,The Big Money’sranking of the 50 companies making best use of Facebook.

Public Relations. We utilize media relations, product placement and event marketing as
vehicles to generate brand awareness and trial usage for our products. Our
public relations activity creates opportunities for media and consumers to
interact with the Krispy Kreme brand. Our key messages are as
follows:


- Krispy Kreme doughnuts are the
  preferred doughnut of choice for people nationwide; and
- Krispy Kreme is a trusted food
  retailer with a long history of providing superior, innovative products and
  delivering quality customer service.

Advertising and Sales Promotions. Grass roots marketing has been central to
building our brand awareness. Although our marketing strategy has not
historically employed traditional advertising, we occasionally utilize
free-standing newspaper inserts, direct mail, radio, television and/or sales
promotions to generate awareness and usage of our products. Advertising and
sales promotion activity center around our limited time offerings and
shaped doughnut varieties, such as Valentine’s Day Hearts, Fall Footballs,
Halloween Pumpkins and Holiday Snowmen. Krispy Kreme encourages its customers to
stay engaged with the Company and its promotions through its Friends of Krispy
Kreme program and social media activity on Facebook and Twitter. We expect
broadcast media advertising will play an increasing role in our advertising
programs as the number of stores in a market increases.





International




Krispy Kreme's approach to international marketing utilizes many of the
same elements as the domestic marketing approach described above to ensure
global consistency. We provide strategic leadership, marketing expertise and
consulting on local market issues through dedicated regional resources. In
partnership with our franchisees, we assist in local marketing planning, product
offering innovation, promotional activation and consumer messaging. In addition,
we develop cross-market product, promotional and store event programs to
supplement local marketing initiatives and bring marketing efficiencies to
international franchisees. During fiscal 2010, we initiated a new occasion-based
brand thematic campaign with tools to drive consumer brand affinity, build the
brand personality and drive purchase frequency. In conjunction with this
campaign, we launched a promotional program entitled the "Krispy Kreme International Fave Fan Search" to
identify our most passionate fans in nine countries around the world. Program
participants submitted entries describing how Krispy Kreme had made their lives
special, with winners selected in each country through online voting. Winners
from each country participated in our Fave Fan Celebration in Winston-Salem in
March 2010, and each designed their own Krispy Kreme doughnut. In addition, we
developed exciting new product promotions for Valentine’s Day, Halloween and
holiday/Winter that were utilized in most international markets.




19




---



Brand Fund




We administer domestic and international public relations and advertising
funds, which we refer to as the Brand Funds. Franchise agreements with domestic
area developers and international area developers require these franchisees to
contribute 1.0% and 0.25% of their sales, respectively, to the Brand Fund.
Company stores contribute to the Brand Fund on the same basis as domestic area
developers, as do some associate franchisees. In fiscal 2009, the Company
reduced the contribution from its associate and domestic area developer
franchisees to 0.75%. Proceeds from the Brand Fund are utilized to develop
programs to increase sales and brand awareness and build brand affinity. Brand
Fund proceeds are also utilized to measure consumer feedback and the performance
of our products and stores. In fiscal 2010, we and our domestic and
international franchisees contributed approximately $2.8 million to the Brand
Funds.




Competition




Our competitors include retailers of doughnuts and snacks sold through
convenience stores, supermarkets, restaurants and retail stores. We compete
against Dunkin’ Donuts, which has the largest number of outlets in the doughnut
retail industry, as well as against Tim Hortons and regionally and locally owned
doughnut shops and distributors. Dunkin’ Donuts and Tim Hortons have
substantially greater financial resources than we do and are expanding to other
geographic regions, including areas where we have a significant store presence.
We also compete against other retailers who sell sweet treats such as cookie
stores and ice cream stores. We compete on elements such as food quality,
convenience, location, customer service and value. Customer service, including
frequency of deliveries and maintenance of fully stocked shelves, is an
important factor in successfully competing for convenience store and
grocery/mass merchant business. There is an industry trend moving towards
expanded fresh product offerings at convenience stores during morning and
evening drive times, and products are either sourced from a central commissary
or brought in by local bakeries.




In the packaged doughnut market, an array of doughnuts is typically
merchandised on a free-standing branded display. We compete for sales with many
sweet treats, including those made by well-known producers, such as Dolly
Madison, Entenmann’s and Hostess, and regional brands.




Internationally, our competitors include a broad set of global, regional
and local retailers of doughnuts and treats such as Dunkin’ Donuts, Mister Donut
and Donut King.




We view the uniqueness of our Original Glazed® doughnut as an
important factor that distinguishes our brand from competitors, both in the
doughnut category and in sweet goods generally.




Trademarks and Trade Names




Our doughnut shops are operated under the Krispy Kreme® trademark, and we use
many federally registered trademarks and service marks, including Krispy Kreme
Original Glazed®
and Hot Krispy Kreme Original Glazed Now® and the logos
associated with these marks. We have also registered some of our trademarks in
approximately 40 other countries. We generally license the use of these
trademarks to our franchisees for the operation of their doughnut shops.




Although we are not aware of anyone else using “Krispy Kreme” or “Hot
Krispy Kreme Original Glazed Now” as a trademark or service mark in the United
States, we are aware that some businesses are using “Krispy” or a phonetic
equivalent, such as “Crispie Creme,” as part of a trademark or service mark
associated with retail doughnut stores. There may be similar uses of which we
are unaware that could arise from prior users. When necessary, we aggressively
pursue persons who use our trademarks without our consent.




Government Regulation




Environmental regulation. The Company is subject to a variety of
federal, state and local environmental laws and regulations. Except for the
legal and settlement costs totaling approximately $2.5 million in fiscal 2010
associated with the settlement of litigation relating to alleged damage to a
sewer system in Fairfax Count, Virginia, as described in Note 12 to the
Company’s consolidated financial statements appearing elsewhere herein, such
laws and regulations have not had a significant impact on the Company’s capital
expenditures, earnings or competitive position.




20




---



Local regulation. Our stores, both those in the United States and those in international
markets, are subject to licensing and regulation by a number of government
authorities, which may include health, sanitation, safety, fire, building and
other agencies in the states or municipalities in which the stores are located.
Developing new doughnut stores in particular areas could be delayed by problems
in obtaining the required licenses and approvals or by more stringent
requirements of local government bodies with respect to zoning, land use and
environmental factors. Our agreements with our franchisees require them to
comply with all applicable federal, state and local laws and regulations, and
indemnify us for costs we may incur attributable to their failure to comply.




Food product regulation. Our doughnut mixes are produced at our
manufacturing facility in Winston-Salem, North Carolina. Production at and
shipments from our Winston-Salem facility are subject to the applicable federal
and state governmental rules and regulations. Similar state regulations may
apply to products shipped from our doughnut stores to convenience stores or
groceries/mass merchants.




As is the case for other food producers, numerous other government
regulations apply to our products. For example, the ingredient list, product
weight and other aspects of our product labels are subject to state and federal
regulation for accuracy and content. Most states periodically check products for
compliance. The use of various product ingredients and packaging materials is
regulated by the United States Department of Agriculture and the Federal Food
and Drug Administration. Conceivably, one or more ingredients in our products
could be banned, and substitute ingredients would then need to be identified.




International trade. The Company conducts business outside the
United States in compliance with all foreign and domestic laws and regulations
governing international trade. In connection with our international operations,
we typically export our products, principally our doughnut mixes (or concentrate
which is combined with other ingredients sourced locally to manufacture mix) to
our franchisees in markets outside the United States. Numerous government
regulations apply to both the export of food products from the United States as
well as the import of food products into other countries. If one or more of the
ingredients in our products are banned, alternative ingredients would need to be
identified. Although we intend to be proactive in addressing any product
ingredient issues, such requirements may delay our ability to open stores in
other countries in accordance with our desired schedule.




Franchise regulation. We must comply with regulations adopted by the
Federal Trade Commission (the “FTC”) and with several state and foreign laws
that regulate the offer and sale of franchises. The FTC’s Trade Regulation Rule
on Franchising (“FTC Rule”) and certain state and foreign laws require that we
furnish prospective franchisees with a franchise disclosure document containing
information prescribed by the FTC Rule and applicable state and foreign laws and
regulations. We register in domestic and foreign jurisdictions that require
registration for the sale of franchises. Our domestic franchise disclosure
document complies with FTC disclosure requirements, and our international
disclosure documents comply with applicable requirements.




We also must comply with a number of state and foreign laws that regulate
some substantive aspects of the franchisor-franchisee relationship. These laws
may limit a franchisor’s ability to: terminate or not renew a franchise without
good cause; interfere with the right of free association among franchisees;
disapprove the transfer of a franchise; discriminate among franchisees with
regard to charges, royalties and other fees; and place new stores near existing
franchises.




Bills intended to regulate certain aspects of franchise relationships
have been introduced into the United States Congress on several occasions during
the last decade, but none have been enacted.




Employment regulations. We are subject to state and federal labor laws
that govern our relationship with employees, such as minimum wage requirements,
overtime and working conditions and citizenship requirements. Many of
our store employees are paid at rates related to the federal minimum
wage. Accordingly, further increases in the minimum wage could increase our
labor costs. Furthermore, the work conditions at our facilities are regulated by
the Occupational Safety and Health Administration and are subject to periodic
inspections by this agency.




Other regulations. We are subject to a variety of consumer protection and similar laws and
regulations at the federal, state and local level. Failure to comply with these
laws and regulations could subject us to financial and other penalties. We have
several contracts to serve United States military bases, which require
compliance with certain applicable regulations. The stores which serve these
military bases are subject to health and cleanliness inspections by military authorities. We are also subject to
federal and state environmental regulations, but we currently believe that these
will not have a material effect on our operations.




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Employees




We employ approximately 3,570 people. Of these, approximately 190 are
employed in our headquarters and administrative offices and approximately 150
are employed in our manufacturing and distribution center. In our Krispy Kreme
stores, we have approximately 3,230 employees. Of our total workforce,
approximately 2,460 are full-time employees, of which approximately 460 are
managers and supervisors, including approximately 330 store managers and
supervisors.




We are not a party to any collective bargaining agreement although we
have experienced occasional unionization initiatives. We believe our
relationships with our employees generally are good.




Available Information




We maintain a website at www.krispykreme.com . The
information on our website is available for information purposes only and is not
incorporated by reference in this Annual Report on Form 10-K.




We make available on or through our website certain reports and
amendments to those reports, if applicable, that we file with or furnish to the
SEC in accordance with the Exchange Act. These include our annual reports on
Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K
and amendments to those reports. We make this information available on our
website free of charge as soon as reasonably practicable after we electronically
file the information with, or furnish it to, the SEC.




In addition, many of our corporate governance documents are available on
our website. Our Nominating and Corporate Governance Committee Charter is
available at www.krispykreme.com/gov_charter.pdf , our Compensation Committee Charter is
available at www.krispykreme.com/comp_charter.pdf , our Audit Committee Charter is available at www.krispykreme.com/audit_charter.pdf , our Corporate Governance Guidelines are
available at www.krispykreme.com/corpgovernance.pdf , our Code of Business Conduct and Ethics is
available at www.krispykreme.com/code_of_ethics.pdf , and our Code of Ethics for Chief Executive
and Senior Financial Officers is available at www.krispykreme.com/officers_ethics.pdf . Each of these documents is available in
print to any shareholder who requests it by sending a written request to Krispy
Kreme Doughnuts, Inc., 370 Knollwood Street, Suite 500, Winston-Salem, NC 27103,
Attention: Secretary.




Item 1A. RISK FACTORS.




Our business, operations and financial condition are subject to various
risks. Some of these risks are described below, and you should take such risks
into account in evaluating us or any investment decision involving our Company.
This section does not describe all risks that may be applicable to us, our
industry or our business, and it is intended only as a summary of certain
material risk factors. More detailed information concerning the risk factors
described below is contained in other sections of this Annual Report on Form
10-K.




RISKS RELATING TO OUR BUSINESS




We have experienced declines in revenues and have incurred net losses in
each of the last three fiscal years and may experience further declines and
losses in the future.




We incurred net losses of $67.1 million, $4.1 million and $157,000 in
fiscal 2008, 2009 and 2010, respectively. We also experienced a decline in
revenues in each of the last three fiscal years. The revenue decline reflects
fewer Company stores in operation, a decrease in off-premises sales at Company
Stores, a decline in domestic royalty revenues and in sales of mixes and other
ingredients resulting from lower sales by the Company’s domestic franchisees.
The reduction in revenues also reflects, to a limited extent, decisions by the
Company to reduce certain royalties and fees charged to franchisees, as well as
decisions to lower selling prices of certain goods sold to franchisees. Lower
revenues have adversely affected operating margins because of the fixed or
semi-fixed nature of many of our direct operating expenses. In addition, we have
recorded significant asset impairment charges, principally related to
underperforming Company stores and, in
fiscal 2008, a manufacturing and distribution facility we divested. We may
experience further revenue declines, asset impairments and net losses in the
future.




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Store profitability is
sensitive to changes in sales volume.




Each factory store has significant fixed or semi-fixed costs, and margins
and profitability are significantly affected by doughnut sales volume. Our
average weekly sales per store have declined over the past three years. We are
in the process of reevaluating our business and have taken steps to improve our
sales. There can be no assurance, however, that these steps will produce the
desired results. Because significant fixed and semi-fixed costs prevent us from
reducing our operating expenses in proportion with declining sales, our earnings
are negatively impacted if sales decline.




A number of factors have historically affected, and will continue to
affect, our sales results, including, among other factors:


- Consumer trends, preferences and
  disposable income;
- Our ability to execute our
  business strategy effectively;
- Competition;
- General regional and national
  economic conditions; and
- Seasonality and weather
  conditions.

Changes in our sales results could
cause the price of our common stock to fluctuate substantially.




We rely in part on our franchisees. Disputes with our franchisees, or
failures by our franchisees to operate successfully, to develop or finance new
stores or build them on suitable sites or open them on schedule, could adversely
affect our growth and our operating results.




Franchisees, which are all independent operators and not Krispy Kreme
employees, contributed (including through purchases from KK Supply Chain)
approximately 29% of our total revenues in fiscal 2010. We rely in part on these
franchisees and the manner in which they operate their locations to develop and
promote our business. We occasionally have disputes with franchisees. Future
disputes could materially adversely affect our business, financial condition and
results of operations. We provide training and support to franchisees, but the
quality of franchise store operations may be diminished by any number of factors
beyond our control. The failure of our franchisees to operate franchises
successfully could have a material adverse effect on us, our reputation and our
brands, and could materially adversely affect our business, financial condition
and results of operations. In addition, although we do not control our
franchisees and they operate as independent contractors, actions taken by any of
our franchisees may be seen by the public as actions taken by us, which, in
turn, could adversely affect our reputation or brands.




Reduced access to financing by our franchisees on reasonable terms, which
the Company believes has occurred in the past two years, could adversely affect
our future operations by limiting franchisees’ ability to open new stores or
leading to additional franchisee store closures, which would in turn reduce our
franchise revenues and KK Supply Chain revenues. Most development agreements
specify a schedule for opening stores in the territory covered by the agreement.
These schedules form the basis for our expectations regarding the number and
timing of new Krispy Kreme store openings. In the past, Krispy Kreme has agreed
to extend or modify development schedules for certain franchisees and may do so
in the future.




Franchisees opened 94 stores and closed 29 stores in fiscal 2010. Royalty
revenues and most KK Supply Chain revenues are directly related to sales by
franchise stores and, accordingly, the success of franchisees’ operations has a
direct effect on our revenues, results of operations and cash flows.




A portion of our growth strategy depends on opening new Krispy Kreme
stores internationally. Our ability to expand our store base is influenced by
factors beyond our and our franchisees’ control, which may slow store
development and impair our strategy.




As we work to stabilize our operations and to refine our store format for
new domestic stores, we do not expect that we or our franchisees will open a
significant number of domestic factory stores in the near future, although we
currently plan to open a modest number
of new Company-operated satellite stores in fiscal 2011, and domestic
franchisees also may open additional satellite stores. Our recent growth
strategy has depended on the opening of new Krispy Kreme stores internationally.
Our ability to expand our store base both domestically and internationally is
influenced by factors beyond our and our franchisees’ control, which may slow
store development and impair our strategy. The success of these new stores will
be dependent in part on a number of factors, which neither we nor our
franchisees can control.




23




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Our new domestic store operating model may not be
successful.




We are working to refine our domestic store operating model to focus on
small retail shops, including both satellite shops and shops that manufacture
doughnuts but which are smaller and have lower capacity than traditional factory
stores. Satellite stores in a market are provided doughnuts from a single
traditional factory store or commissary at which all doughnut production for the
market takes place. The Company currently plans to open a modest number of new
Company-operated satellite stores in fiscal 2011, and domestic franchisees also
may open additional satellite stores and a small number of factory stores, as we
work to refine our store formats for new domestic stores. However, we do not
expect that we or our franchisees will open a significant number of domestic
factory stores in the near future. We cannot predict whether this new model will
be successful in increasing our profitability.




Political, economic, currency and other risks associated with our
international operations could adversely affect our and our international
franchisees’ operating results.




As of January 31, 2010, there were 358 Krispy Kreme stores operated
outside of the United States, all of which were operated by franchisees. Our
revenues from international franchisees are exposed to the potentially adverse
effects of our franchisees’ operations, political instability, currency exchange
rates, local economic conditions and other risks associated with doing business
in foreign countries. Royalties are based on a percentage of net sales generated
by our foreign franchisees’ operations. Royalties payable to us by our
international franchisees are based on a conversion of local currencies to U.S.
dollars using the prevailing exchange rate, and changes in exchange rates could
adversely affect our revenues. To the extent that the portion of our revenues
generated from international operations increases in the future, our exposure to
changes in foreign political and economic conditions and currency fluctuations
will increase.




We typically export our products, principally our doughnut mixes and
doughnut mix concentrates, to our franchisees in markets outside the United
States. Numerous government regulations apply to both the export of food
products from the United States as well as the import of food products into
other countries. If one or more of the ingredients in our products are banned,
alternative ingredients would need to be identified. Although we intend to be
proactive in addressing any product ingredient issues, such requirements may
delay our ability to open stores in other countries in accordance with our
desired schedule.




Our profitability is sensitive to changes in the cost of raw
materials.




Although we utilize forward purchase contracts and futures contracts and
options on such contracts to mitigate the risks related to commodity price
fluctuations, such contracts do not fully mitigate commodity price risk,
particularly over the longer term. In addition, the portion of our anticipated
future commodity requirements that is subject to such contracts varies from time
to time.




Flour, shortening and sugar are our three most significant ingredients.
The prices of wheat and soybean oil, which are the principal components of flour
and shortening respectively, reached record highs in fiscal 2009. Sugar prices
reached a multi-year high in fiscal 2010. Adverse changes in commodity prices
could adversely affect the Company’s profitability and liquidity.




We are the exclusive supplier of doughnut mixes or mix concentrates to
all Krispy Kreme stores worldwide. We also supply other key ingredients and
flavors to all domestic Krispy Kreme Company stores. If we have any problems
supplying these ingredients, our and our franchisees’ ability to make doughnuts
will be negatively affected.




We are the exclusive supplier of doughnut mixes for many domestic and
international Krispy Kreme stores. As to other stores, we are the exclusive
supplier of doughnut mix concentrates that are blended with other ingredients to
produce doughnut mixes. We also are the exclusive supplier of other key
ingredients and flavors to all domestic Company stores, most domestic franchise stores and some international
franchise stores. We manufacture the doughnut mixes and concentrates at our mix
manufacturing facility located in Winston-Salem, North Carolina. We distribute
doughnut mixes and other key ingredients and flavors from our distribution
center in Winston-Salem and using an independent contract distributor for Krispy
Kreme shops west of the Mississippi River. We have a backup source to
manufacture our doughnut mixes in the event of a loss of our Winston-Salem
facility; this backup source currently produces mix for us for distribution in
most Krispy Kreme stores west of the Mississippi River. Nevertheless, an
interruption of production capacity at our manufacturing facility could impede
our ability or that of our franchisees to make doughnuts. In addition, in the
event that any of our supplier relationships terminate unexpectedly, even where
we have multiple suppliers for the same ingredient, we may not be able to obtain
adequate quantities of the same high-quality ingredient at competitive prices.




24




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We are the only manufacturer of substantially all of our doughnut-making
equipment. If we have any problems producing this equipment, our stores’ ability
to make doughnuts will be negatively affected.




We manufacture our custom doughnut-making equipment in one facility in
Winston-Salem, North Carolina. Although we have limited backup sources for the
production of our equipment, obtaining new equipment quickly in the event of a
loss of our Winston-Salem facility would be difficult and would jeopardize our
ability to supply equipment to new stores or new parts for the maintenance of
existing equipment in established stores on a timely basis.




We have only one supplier of glaze flavoring, and any interruption in
supply could impair our ability to make our signature hot Original Glazed®
doughnut.




We utilize a sole supplier for our glaze flavoring. Any interruption in
the distribution from our current supplier could affect our ability to produce
our signature hot Original Glazed® doughnut.




We are subject to franchise laws and regulations that govern our status
as a franchisor and regulate some aspects of our franchise relationships. Our
ability to develop new franchised stores and to enforce contractual rights
against franchisees may be adversely affected by these laws and regulations,
which could cause our franchise revenues to decline.




As a franchisor, we are subject to regulation by the FTC and by domestic
and foreign laws regulating the offer and sale of franchises. Our failure to
obtain or maintain approvals to offer franchises would cause us to lose future
franchise revenues and KK Supply Chain revenues. In addition, domestic or
foreign laws that regulate substantive aspects of our relationships with
franchisees may limit our ability to terminate or otherwise resolve conflicts
with our franchisees. Because we plan to grow primarily through franchising, any
impairment of our ability to develop new franchise stores will negatively affect
us and our growth strategy.




Off-premises sales represent a significant portion of our sales. The
infrastructure necessary to support off-premises sales results in significant
fixed and semi-fixed costs. Also, the loss of one of our large off-premises
customers could adversely affect our financial condition and results of
operations.




The Company operates a fleet network to support off-premises sales.
Declines in off-premises sales without a commensurate reduction in operating
expenses, as well as rising fuel costs, may adversely affect our
business.




We have several large off-premises customers. Our top two such customers
accounted for approximately 12% of total Company store sales during fiscal 2010.
The loss of one of our large national off-premises customers could adversely
affect our results of operations across all domestic business segments. These
customers do not enter into long-term contracts; instead, they make purchase
decisions based on a combination of price, product quality, consumer demand and
service quality. They may in the future use more of their shelf space, including
space currently used for our products, for other products, including private
label products. If our sales to one or more of these customers are reduced, this
reduction may adversely affect our business.




Our failure or inability to enforce our trademarks could adversely affect
the value of our brands.




We own certain common-law trademark rights in the United States, as well
as numerous trademark and service mark registrations in the United States and in
other jurisdictions. We believe that our trademarks and other intellectual
property rights are important to our success and our competitive position. We
therefore devote appropriate resources to the protection of our trademarks and aggressively pursue persons who
unlawfully and without our consent use or register our trademarks. We have a
system in place that is designed to detect potential infringement on our
trademarks, and we take appropriate action with regard to such infringement as
circumstances warrant. The protective actions that we take, however, may not be
sufficient, in some jurisdictions, to secure our trademark rights for some of
the goods and services that we offer or to prevent imitation by others, which
could adversely affect the value of our trademarks and service
marks.




25




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In certain jurisdictions outside the United States, specifically Costa
Rica, Guatemala, India, Indonesia, Nigeria, Peru, the Philippines and Venezuela,
we are aware that some businesses have registered, used and/or may be using
“Krispy Kreme” (or its phonetic equivalent) in connection with doughnut-related
goods and services. There may be similar such uses or registrations of which we
are unaware and which could perhaps arise from prior users. These uses and/or
registrations could limit our operations and possibly cause us to incur
litigation costs, or pay damages or licensing fees to a prior user or registrant
of similar intellectual property.




Loss of our trade secret recipes could adversely affect our
sales.




We derive significant competitive benefit from the fact that our doughnut
recipes are trade secrets. Although we take commercially reasonable steps to
safeguard our trade secrets, should they become known to competitors, our
competitive position could suffer substantially.




Our secured credit facilities impose restrictions and obligations upon us
that significantly limit our ability to operate our business, and in the past we
have sought and received waivers relating to these restrictions and
obligations.




Our secured credit facilities impose financial and other restrictive
covenants that limit our ability to plan for and respond to changes in our
business. Under our secured credit facilities, we are required to meet certain
financial tests, including a maximum leverage ratio and a minimum interest
coverage ratio. In addition, we must comply with covenants which, among other
things, limit the incurrence of additional indebtedness, liens, investments,
dividends, transactions with affiliates, asset sales, acquisitions, capital
expenditures, mergers and consolidations, prepayments of other indebtedness and
other matters customarily restricted in such agreements. Any failure to comply
with these covenants could result in an event of default under our secured
credit facilities.




RISKS RELATING TO THE FOOD SERVICE
INDUSTRY




The food service industry is affected by consumer preferences and
perceptions. Changes in these preferences and perceptions may lessen the demand
for our doughnuts, which would reduce sales and harm our
business.




Food service businesses are often affected by changes in consumer tastes,
national, regional and local economic conditions and demographic trends.
Individual store performance may be adversely affected by traffic patterns, the
cost and availability of labor, purchasing power, availability of products and
the type, number and location of competing stores. Our sales have been and may
continue to be affected by changing consumer tastes, such as health or dietary
preferences that cause consumers to avoid doughnuts in favor of foods that are
perceived as healthier. Moreover, because we are primarily dependent on a single
product, if consumer demand for doughnuts should decrease, our business would
suffer more than if we had a more diversified menu.




The food service industry is affected by litigation, regulation and
publicity concerning food quality, health and other issues, which can cause
customers to avoid our products and result in liabilities.




Food service businesses can be adversely affected by litigation, by
regulation and by complaints from customers or government authorities resulting
from food quality, illness, injury or other health concerns or operating issues
stemming from one store or a limited number of stores, including stores operated
by our franchisees. In addition, class action lawsuits have been filed and may
continue to be filed against various food service businesses (including quick
service restaurants) alleging, among other things, that food service businesses
have failed to disclose the health risks associated with high-fat foods and that
certain food service business marketing practices have encouraged obesity.
Adverse publicity about these allegations may negatively affect us and our
franchisees, regardless of whether the allegations are true, by discouraging
customers from buying our products. Because one of our competitive strengths is
the taste and quality of our doughnuts,
adverse publicity or regulations relating to food quality or other similar
concerns affects us more than it would food service businesses that compete
primarily on other factors. We could also incur significant liabilities if such
a lawsuit or claim results in a decision against us or as a result of litigation
costs regardless of the result.




26




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Our success depends on our ability to compete with many food service
businesses.




We compete with many well-established food service companies. At the
retail level, we compete with other doughnut retailers and bakeries, specialty
coffee retailers, bagel shops, fast-food restaurants, delicatessens, take-out
food service companies, convenience stores and supermarkets. At the wholesale
level, we compete primarily with grocery store bakeries, packaged snack foods
and vending machine dispensers of snack foods. Aggressive pricing by our
competitors or the entrance of new competitors into our markets could reduce our
sales and profit margins. Moreover, many of our competitors offer consumers a
wider range of products. Many of our competitors or potential competitors have
substantially greater financial and other resources than we do which may allow
them to react to changes in pricing, marketing and the quick service restaurant
industry better than we can. As competitors expand their operations, we expect
competition to intensify. In addition, the start-up costs associated with retail
doughnut and similar food service establishments are not a significant
impediment to entry into the retail doughnut business. We also compete with
other employers in our markets for hourly workers and may be subject to higher
labor costs.




RISKS RELATING TO OWNERSHIP OF OUR COMMON
STOCK




The market price of our common stock has been volatile and may continue
to be volatile, and the value of any investment may decline.




The market price of our common stock has been volatile and may continue
to be volatile. This volatility may cause wide fluctuations in the price of our
common stock, which is listed on the New York Stock Exchange (“NYSE”). The
market price may fluctuate in response to many factors including:


- Changes in general conditions in
  the economy or the financial markets;
- Variations in our quarterly
  operating results or our operating results failing to meet the expectations of
  securities analysts or investors in a particular period;
- Changes in financial estimates by
  securities analysts;
- Other developments affecting
  Krispy Kreme, our industry, customers or competitors; and
- The operating and stock price
  performance of companies that investors deem comparable to Krispy
  Kreme.

Our charter, bylaws and shareholder protection rights agreement
contain anti-takeover provisions that may make it more difficult or expensive to
acquire us in the future or may negatively affect our stock
price.




Our articles of incorporation, bylaws and shareholder protection rights
agreement contain several provisions that may make it more difficult for a third
party to acquire control of us without the approval of our board of directors.
These provisions may make it more difficult or expensive for a third party to
acquire a majority of our outstanding voting common stock. They may also delay,
prevent or deter a merger, acquisition, tender offer, proxy contest or other
transaction that might otherwise result in our shareholders’ receiving a premium
over the market price for their common stock.




Item 1B. UNRESOLVED STAFF
COMMENTS.




None.




Item 2. PROPERTIES.




Stores. As
of January 31, 2010, there were 582 Krispy Kreme stores systemwide, of which 83
were Company stores and 499 were operated by franchisees.


- As of January 31, 2010, all of our
  Company stores, except commissaries, had on-premises sales, and 44 of our
  Company factory stores also engaged in off-premises sales.
- Of the 83 Company
  stores as of January 31, 2010, we owned the land and building for 42 stores,
  we owned the building and leased the land for 23 stores and leased both the
  land and building for 18 stores.

27




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KK Supply Chain facilities.  We own a 147,000
square foot mix manufacturing plant and distribution center in Winston-Salem,
North Carolina. Additionally, we own a 103,000 square foot facility in
Winston-Salem, which we use primarily as our equipment manufacturing facility,
but which also includes our research and development and training
facilities.




Other properties. Our corporate headquarters is located in Winston-Salem, North Carolina.
We occupy approximately 59,000 square feet of this multi-tenant facility under a
lease that expires on November 30, 2024, with two five-year renewal
options.




Item 3. LEGAL PROCEEDINGS.




Pending Matters




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




K2 Asia
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 Matters




TAG Litigation




In February 2008, the Company filed suit in the U.S. District Court for
the Middle District of North Carolina against The Advantage Group Enterprise,
Inc. (“TAG”), alleging that TAG failed to properly account for and pay the
Company for sales of equipment that the Company consigned to TAG. Based on these
allegations, the Company asserted various claims including breach of fiduciary
duty and conversion, and it sought an accounting and constructive trust. In
addition, the Company sought a declaration that it did not owe TAG approximately
$1 million for storage fees and alleged lost profits. In March 2008, TAG
answered the complaint, denying liability and asserting counterclaims against
the Company including breach of contract, services rendered, unjust enrichment,
violation of the North Carolina Unfair Trade Practices Act and fraud in the
inducement. TAG sought approximately $1 million in actual damages as well as
punitive and treble damages. The parties settled this matter in March 2010. The
accompanying balance sheet as of January 31, 2010 reflects an accrued liability
of approximately $150,000 for the settlement of this matter, which was recorded
in the second quarter of fiscal 2010 and which is included in Domestic Franchise
operating expenses.




Federal Securities Class Actions and Settlement Thereof and Federal Court
Shareholder Derivative Actions and Settlement Thereof




Beginning in May 2004, a series of purported securities class actions
were filed on behalf of persons who purchased the Company’s publicly traded
securities between August 21, 2003 and May 7, 2004 against the Company and
certain of its former officers in the United States District Court for the
Middle District of North Carolina, alleging violations of federal securities law
in connection with various public statements made by the Company. All the
actions ultimately were consolidated.




In addition to the purported securities class action, three shareholder
derivative actions were filed in the United States District Court for the Middle
District of North Carolina against certain current and former directors of the
Company, certain former officers of the Company, including Scott Livengood (the
Company’s former Chairman and Chief Executive Officer), as well as certain
persons or entities that sold franchises to the Company. The complaints in these actions alleged that the defendants
breached their fiduciary duties in connection with their management of the
Company and the Company’s acquisitions of certain
franchises.




28




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In October 2006, the Company entered into a Stipulation and Settlement
Agreement (the “Stipulation”) with the lead plaintiffs in the securities class
action, the derivative plaintiffs and all defendants named in the class action
and derivative litigation, except for Mr. Livengood, providing for the
settlement of the securities class action and a partial settlement of the
derivative action. The Stipulation contained no admission of fault or wrongdoing
by the Company or the other defendants. In February 2007, the Court entered
final judgment dismissing all claims with respect to all defendants in the
derivative action, except for claims that the Company may assert against Mr.
Livengood, and entered final judgment dismissing all claims with respect to all
defendants in the securities class action.




With respect to the securities class action, the settlement class
received total consideration of approximately $76.0 million, consisting of a
cash payment of approximately $35.0 million made by the Company’s directors’ and
officers’ insurers, cash payments of $100,000 each made by each of a former
Chief Operating Officer and former Chief Financial Officer of the Company, a
cash payment of $4 million made by the Company’s independent registered public
accounting firm, and common stock and warrants to purchase common stock issued
by the Company having an estimated aggregate value of approximately $36.9
million as of their issuance on March 2, 2007. Claims against all defendants
were dismissed with prejudice; however, claims that the Company may have against
Mr. Livengood that may be asserted by the Company in the derivative action for
contribution to the securities class action settlement or otherwise under
applicable law are expressly preserved.




The Company issued 1,833,828 shares of its common stock and warrants to
purchase 4,296,523 shares of its common stock at a price of $12.21 per share in
connection with the Stipulation. The Company recorded a charge to earnings in
fiscal 2006 for the fair value of the stock and warrants, measured as of the
date on which the Company agreed to settle the litigation, and adjusted that
charge in subsequent periods to reflect changes in the securities’ fair value
until their issuance in the first quarter of fiscal 2008. Such subsequent
adjustments resulted in a non-cash charge to fiscal 2007 earnings of $16.0
million and a non-cash credit to fiscal 2008 earnings of $14.9 million.




The Stipulation also provided for the settlement and dismissal with
prejudice of claims against all defendants in the derivative action, except for
claims against Mr. Livengood. The Company settled its claims against Mr.
Livengood in February 2010 in exchange for the payment by Mr. Livengood of
$320,000 and his surrender to the Company of vested options to purchase 905,700
shares of the Company’s common stock.




All litigation surrounding the above
matters has now been settled.




Fairfax County, Virginia
Environmental Matter




Since 2004, the Company has operated a commissary in the Gunston Commerce
Center in Fairfax County, Virginia (the “County”). The County has investigated
alleged damage to its sewer system near the commissary. On May 8, 2009, the
County filed a lawsuit in Fairfax County Circuit Court alleging that the Company
caused damage to the sewer system and violated the County’s Sewer Use Ordinance
and the Company’s Wastewater Discharge Permit. The County sought from the
Company repair and replacement costs of approximately $2 million and civil
penalties of approximately $18 million. The Company removed the case to the U.S.
District Court for the Eastern Division of Virginia, and in December 2009, the
parties reached an agreement to resolve the litigation. During the third quarter
of fiscal 2010, the Company recorded a provision of $750,000 for the settlement
of this matter, which is included in Company Stores direct operating expenses.




California Wage/Hour
Litigation




The Company was a defendant in a wage/hour suit pending in the Superior
Court of Alameda County, California, in which the plaintiffs seek class action
status and unspecified damages on behalf of a putative class of approximately 35
persons. In January 2010, the parties reached an agreement in principle to
resolve the litigation and the Company recorded a provision of $950,000 for the
settlement of this matter, which is included in Company Stores direct operating
expenses and accrued liabilities in the accompanying balance sheet.




29




---



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.




Item 4. RESERVED.




30




---



PART II




Item 5.
            
            MARKET FOR REGISTRANT’S COMMON EQUITY,
      RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
      SECURITIES.


Market Information




Our common stock is listed on the NYSE under the symbol “KKD.” The
following table sets forth the high and low sales prices for our common stock in
composite trading as reported by the NYSE for the fiscal periods
shown.




High
            
            LowYear Ended February 1,
      2009:First Quarter
            
            $
            3.48
            
            $
            2.50Second Quarter
            
            
            5.65
            
            
            3.00Third Quarter
            
            
            4.72
            
            
            1.76Fourth Quarter
            
            
            3.00
            
            
            1.35Year Ended January 31,
      2010:First Quarter
            
            $
            4.38
            
            $
            1.01Second Quarter
            
            
            4.23
            
            
            2.51Third Quarter
            
            
            4.75
            
            
            2.71Fourth Quarter
            
            
            3.94
            
            
            2.56


Holders




As of March 26, 2010, there were
approximately 15,900 shareholders of record of our common stock.




Dividends




We did not pay any dividends in fiscal 2010 or fiscal 2009. We intend to
retain any earnings to finance our business and do not anticipate paying cash
dividends in the foreseeable future. Furthermore, the terms of our secured
credit facilities prohibit the payment of dividends on our common
stock.




Securities Authorized for Issuance Under
Equity Compensation Plans




The following table provides information with respect to securities
authorized for issuance under all of the Company’s equity compensation plans as
of January 31, 2010.




Number ofSecurities RemainingNumber of
            
            
            
            
            Available ForSecurities to
            
            
            
            
            Future IssuanceBe Issued
            
            Weighted Average
            
            Under EquityUpon Exercise
            
            Exercise Price
            
            Compensationof Outstanding
            
            of Outstanding
            
            Plans (ExcludingOptions, Warrants
            
            Options, Warrants
            
            Securities Reflectedand Rights
            
            and Rights
            
            in Column (a))Plan Category
            
            (a)
            
            (b)
            
            (c)Equity compensation plans approved by
      securityholders
            
            6,068,900
            (1)
            
            $
            13.01
            
            2,630,800
            (2)Equity compensation plans not approved bysecurity
    holders(3)(4)
            
            80,000
            (3)
            
            $
            8.06
            
            —Total
            
            6,148,900
            
            
            $
            12.94
            
            2,630,800


(1)
            
            Represents shares of common stock issuable pursuant to outstanding
      options under the 2000 Stock Incentive
Plan.


31




---



(2)
            
            Represents shares of common stock which may be issued pursuant to
      awards under the 2000 Stock Incentive Plan and the Employee Stock Purchase
      Plan. Under the Employee Stock Purchase Plan, each employee of the Company
      or any participating subsidiary (other than those whose customary
      employment was for not more than five months per calendar year) was
      eligible to participate after the employee completed 12 months of
      employment, and each participant could elect to purchase shares of Company
      common stock at the end of quarterly offering periods. The amount of
      shares that could be purchased was based on the amount of payroll
      deductions a participant elected to have withheld and applied at the end
      of the purchase period to the purchase of shares (ranging from 1 to 15% of
      the participant’s base compensation). The purchase price for the shares
      was the lesser of the fair market value of the shares on the first day of
      the purchase period or the last day of the purchase period. Effective
      October 21, 2005, the Company halted purchases under the Employee Stock
      Purchase Plan.(3)
            
            Represents shares of common stock issuable pursuant to outstanding
      options under the 1998 Stock Option Plan. The 1998 Stock Option Plan was
      adopted prior to the initial public offering of the Company’s common
      stock, and it was not submitted for approval by shareholders. The plan
      provides for the grant of stock options to employees, directors and
      consultants, as determined by the Compensation Committee, and it is
      administered by the Compensation Committee. No grants have been made under
      the 1998 Stock Option Plan subsequent to April 5, 2000, and the Company
      will not make any further grants under the plan.(4)
            
            The
      Company maintained a Nonqualified Stock Ownership Plan under which
      management or other highly compensated employees selected by the
      Compensation Committee could participate. The plan was designed to provide
      benefits that could not be provided under the Company’s tax-qualified
      Profit Sharing Stock Ownership Plan due to Internal Revenue Code
      limitations. Each year, the Company credited benefits under the plan based
      on a discretionary percentage of the employees’ compensation in excess of
      Internal Revenue Code limits. Amounts credited under the plan were deemed
      to be invested in Company stock, and benefits were payable in the form of
      Company stock or, at the election of the participant, in cash. No amounts
      were credited to participants in the plan in fiscal 2010, fiscal 2009 or
      fiscal 2008. The Company also maintained a Nonqualified Deferred
      Compensation Plan under which management or other highly compensated
      employees selected by the Compensation Committee could participate. The
      plan was designed to allow participants to defer a portion of their
      compensation. Amounts deferred under the plan could, at the election of
      the participant, be deemed to be invested in Company stock, and benefits
      deemed vested in Company stock were payable in the form of Company stock
      or, at the election of the participant, in cash. The ability of
      participants to deem investments to be in Company stock was suspended
      effective November 8, 2005. Neither the Nonqualified Stock Ownership Plan
      nor the Nonqualified Deferred Compensation Plan was submitted for
      shareholder approval. On December 10, 2008, the Board of Directors merged
      the Nonqualified Stock Ownership Plan with and into the Nonqualified
      Deferred Compensation Plan, effective December 31, 2008, and both plans as
      merged were amended and restated generally effective as of January 1, 2005
      to comply with Section 409A of the Internal Revenue
  Code.




Recent Sales of Unregistered Securities




None.




Purchases of Equity Securities




No purchases were made by or on behalf of the Company of its equity
securities during the fourth quarter of fiscal 2010.




32




---



Stock Performance Graph




The performance graph shown below compares the percentage change in the
cumulative total shareholder return on our common stock against the cumulative
total return of the NYSE Composite Index and Standard & Poor’s Restaurants
Index for the period from January 28, 2005 through January 31, 2010. The graph
assumes an initial investment of $100 and the reinvestment of dividends.









January
            January
            January
            February
            February
            January30, 2005
            29, 2006
            28, 2007
            3, 2008
            1, 2009
            31, 2010Krispy Kreme Doughnuts, Inc.
            $100.00
            $  61.55
            $148.73
            $  33.37
            $  16.05
            $  32.56NYSE
      Composite Index
            100.00
            115.13
            130.18
            131.93
            73.89
            97.89S&P 500 Restaurants Index
            100.00
            117.36
            137.60
            145.24
            138.28
            171.37


33




---



Item 6. SELECTED FINANCIAL
DATA.




The following selected financial data should be read in conjunction with
Item 7, “Management’s Discussion and Analysis of Financial Condition and Results
of Operations,” and the Company’s consolidated financial statements appearing
elsewhere herein.




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,
            
            Jan. 28,
            
            Jan. 29,2010
            
            2009
            
            2008
            
            2007
            
            2006(In thousands, except per share and
      number of stores data)STATEMENT OF OPERATIONS DATA:Revenues
            
            $
            346,520
            
            
            $
            385,522
            
            
            $
            430,370
            
            
            $
            461,195
            
            
            $
            543,361Operating expenses:Direct operating expenses
      (exclusive ofdepreciation shown below)
            
            
            297,185
            
            
            
            346,545
            
            
            
            381,065
            
            
            
            389,379
            
            
            
            474,591General and administrative expenses
            
            
            22,728
            
            
            
            23,458
            
            
            
            26,303
            
            
            
            48,860
            
            
            
            67,727Depreciation and amortization
      expense
            
            
            8,191
            
            
            
            8,709
            
            
            
            18,433
            
            
            
            21,046
            
            
            
            28,920Impairment charges and lease termination costs
            
            
            5,903
            
            
            
            548
            
            
            
            62,073
            
            
            
            12,519
            
            
            
            55,062Settlement of litigation
            
            
            —
            
            
            
            —
            
            
            
            (14,930
            )
            
            
            15,972
            
            
            
            35,833Other operating (income) and expenses, net
            
            
            739
            
            
            
            1,501
            
            
            
            13
            
            
            
            1,916
            
            
            
            (1,741
            )Operating income
    (loss)
            
            
            11,774
            
            
            
            4,761
            
            
            
            (42,587
            )
            
            
            (28,497
            )
            
            
            (117,031
            )Interest income
            
            
            93
            
            
            
            331
            
            
            
            1,422
            
            
            
            1,627
            
            
            
            1,110Interest expense
            
            
            (10,685
            )
            
            
            (10,679
            )
            
            
            (9,796
            )
            
            
            (20,334
            )
            
            
            (20,211
            )Loss on extinguishment of debt
            
            
            —
            
            
            
            —
            
            
            
            (9,622
            )
            
            
            —
            
            
            
            —Equity in losses of equity method franchisees
            
            
            (488
            )
            
            
            (786
            )
            
            
            (933
            )
            
            
            (842
            )
            
            
            (4,337
            )Other non-operating income and (expense), net
            
            
            (276
            )
            
            
            2,815
            
            
            
            (3,211
            )
            
            
            7,021
            
            
            
            (248
            )Income (loss) from continuing operationsbefore income taxes
            
            
            418
            
            
            
            (3,558
            )
            
            
            (64,727
            )
            
            
            (41,025
            )
            
            
            (140,717
            )Provision for income taxes (benefit)
            
            
            575
            
            
            
            503
            
            
            
            2,324
            
            
            
            1,211
            
            
            
            (776
            )Net loss
            
            
            (157
            )
            
            
            (4,061
            )
            
            
            (67,051
            )
            
            
            (42,236
            )
            
            
            (139,941
            )Net loss attributable tononcontrolling interests
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            4,181Net loss attributable toKrispy Kreme Doughnuts, Inc.
            
            
            ($157
            )
            
            
            ($4,061
            )
            
            
            ($67,051
            )
            
            
            ($42,236
            )
            
            
            ($135,760
            )Net loss per common shareBasic
            
            $
            —
            
            
            $
            (.06
            )
            
            $
            (1.05
            )
            
            $
            (.68
            )
            
            $
            (2.20
            )Diluted
            
            $
            —
            
            
            $
            (.06
            )
            
            $
            (1.05
            )
            
            $
            (.68
            )
            
            $
            (2.20
            )BALANCE SHEET DATA (AT END OF YEAR):Working capital (deficit)(1)
            
            $
            21,550
            
            
            $
            36,190
            
            
            $
            32,862
            
            
            $
            (3,052
            )
            
            $
            (6,894
            )Total assets
            
            
            165,276
            
            
            
            194,926
            
            
            
            202,351
            
            
            
            349,492
            
            
            
            410,855Long-term debt, less current maturities
            
            
            42,685
            
            
            
            73,454
            
            
            
            75,156
            
            
            
            105,966
            
            
            
            118,241Total shareholders’ equity
            
            
            62,767
            
            
            
            57,755
            
            
            
            56,624
            
            
            
            78,962
            
            
            
            108,671Number of stores at end of year:Company
            
            
            83
            
            
            
            93
            
            
            
            105
            
            
            
            113
            
            
            
            133Franchise
            
            
            499
            
            
            
            430
            
            
            
            344
            
            
            
            282
            
            
            
            269Systemwide
            
            
            582
            
            
            
            523
            
            
            
            449
            
            
            
            395
            
            
            
            402


(1)
            
            Reflects a liability, net of amounts recoverable from insurance
      companies, of approximately $51.8 million and $35.8 million as of January
      28, 2007 and January 29, 2006, respectively, related to the settlement of
      certain litigation. This liability was satisfied in March 2007 through the
      issuance of shares of common stock and warrants to acquire shares of
      common stock as described in Note 12 to the consolidated financial
      statements appearing elsewhere
herein.


34




---



Item 7. 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.




Results of Operations




The following table sets forth operating metrics for each of the three
fiscal years in the period ended January 31, 2010. The Company’s fiscal year
ends on the Sunday closest to January 31, which periodically results in a
53-week year. Fiscal 2008 contained 53 weeks. To enhance comparability among the
last three fiscal years, amounts in the below table for fiscal 2008 have been
computed based upon the 52-week period ended January 27, 2008.




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008Same Store Sales(on-premises sales only):Company stores
            
            
            3.5
            %
            
            
            (0.7
            )%
            
            
            0.0
            %Domestic Franchise stores
            
            
            0.9
            
            
            
            (3.3
            )
            
            
            (1.9
            )International Franchise
      stores
            
            
            (24.2
            )
            
            
            (23.4
            )
            
            
            (11.0
            )International Franchise stores, in constant dollars (1)
            
            
            (21.1
            )
            
            
            (18.6
            )
            
            
            (17.1
            )Off-Premises Metrics(Company stores only): (2)Average weekly number of doors
      served:Grocers/mass merchants
            
            
            5,634
            
            
            
            6,306
            
            
            
            6,858Convenience stores
            
            
            5,285
            
            
            
            5,985
            
            
            
            6,302Average weekly sales per door:Grocers/mass merchants
            
            $
            242
            
            
            $
            219
            
            
            $
            230Convenience stores
            
            
            208
            
            
            
            217
            
            
            
            243Systemwide Sales(in thousands): (3)Company stores
            
            $
            243,387
            
            
            $
            263,888
            
            
            $
            298,703Domestic Franchise stores
            
            
            220,629
            
            
            
            235,558
            
            
            
            282,122International Franchise
      stores
            
            
            263,601
            
            
            
            273,054
            
            
            
            194,116International Franchise stores, in constant dollars (4)
            
            
            263,601
            
            
            
            261,488
            
            
            
            180,055Average Weekly Sales Per Store(in
      thousands):Company stores:Factory stores:Commissaries — off-premises
            
            $
            155.7
            
            
            $
            164.6
            
            
            $
            167.0Dual-channel stores:On-premises
            
            
            26.1
            
            
            
            23.5
            
            
            
            23.0Off-premises
            
            
            31.4
            
            
            
            29.3
            
            
            
            33.2Total
            
            
            57.5
            
            
            
            52.8
            
            
            
            56.2On-premises only stores
            
            
            31.9
            
            
            
            30.6
            
            
            
            30.1All factory stores
            
            
            57.2
            
            
            
            54.5
            
            
            
            56.7Satellite stores
            
            
            18.1
            
            
            
            17.8
            
            
            
            18.1All stores
            
            
            52.2
            
            
            
            50.8
            
            
            
            53.0Domestic Franchise stores: (5)Factory stores
            
            $
            37.1
            
            
            $
            39.3
            
            
            $
            42.9Satellite stores
            
            
            14.8
            
            
            
            15.4
            
            
            
            15.6


35




---



Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008International Franchise stores (5):Factory stores
            
            $
            36.2
            
            $
            46.7
            
            $
            48.2Satellite stores
            
            
            9.4
            
            
            12.3
            
            
            16.6


(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 all periods.(2)
            
            Metrics exclude off-premises sales by Company stores in Eastern
      Canada, which the Company refranchised in the fourth quarter of fiscal
      2009 as the data for these stores was not available.(3)
            
            Excludes sales among Company and franchise stores.(4)
            
            Represents International Franchise store sales computed by
      reconverting International Franchise store sales for fiscal 2009 and 2008
      to U.S. dollars based upon the weighted average of the exchange rates
      prevailing in fiscal 2010.(5)
            
            Metrics include only stores open at January 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.




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.




36




---





The
following table sets forth data about the number of systemwide stores as of
January 31, 2010, February 1, 2009 and February 3, 2008, and the number of store
operating weeks for each of the years then ended.




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008Number of Stores Open At Year
      End:Company stores:Factory:Commissaries
            
            6
            
            6
            
            6Dual-channel stores
            
            38
            
            51
            
            62On-premises only stores
            
            25
            
            26
            
            29Satellite stores
            
            14
            
            10
            
            8Total Company stores
            
            83
            
            93
            
            105Domestic
      Franchise stores:Factory stores
            
            104
            
            104
            
            118Satellite stores
            
            37
            
            28
            
            27Total Domestic Franchise stores
            
            141
            
            132
            
            145International Franchise stores:Factory stores
            
            95
            
            94
            
            80Satellite stores
            
            263
            
            204
            
            119Total International Franchise stores
            
            358
            
            298
            
            199Total systemwide stores
            
            582
            
            523
            
            449Store Operating Weeks: (1)Company stores:Factory stores:Commissaries
            
            312
            
            312
            
            312Dual-channel stores
            
            2,541
            
            3,191
            
            3,551Retail only stores
            
            1,217
            
            1,196
            
            1,243Satellite stores
            
            592
            
            487
            
            520Domestic
      Franchise stores: (2)Factory stores
            
            5,324
            
            5,098
            
            4,992Satellite stores
            
            1,449
            
            1,085
            
            974International Franchise stores: (2)Factory stores
            
            4,303
            
            3,714
            
            2,523Satellite stores
            
            11,177
            
            7,274
            
            3,623


(1)
            
            Amounts for fiscal 2008 have been computed based upon the 52-week
      period ended January 27, 2008.(2)
            
            Metrics include only stores open at January 31,
  2010.




37




---





FISCAL 2010 COMPARED TO FISCAL 2009
  Overview
  Revenues by business segment (expressed in dollars and as a percentage of
total revenues) and operating income by business segment are set forth in the
table below (percentage amounts may not add to totals due to
rounding).


Year EndedJan. 31,
            
            Feb. 1,2010
            
            2009(Dollars in
  thousands)Revenues by business
      segment:Company Stores
            
            $
            246,373
            
            
            $
            265,890Domestic Franchise
            
            
            7,807
            
            
            
            8,042International
    Franchise
            
            
            15,907
            
            
            
            17,495KK
      Supply Chain:Total revenues
            
            
            162,127
            
            
            
            191,456Less – intersegment sales elimination
            
            
            (85,694
            )
            
            
            (97,361
            )External KK Supply Chain revenues
            
            
            76,433
            
            
            
            94,095Total revenues
            
            $
            346,520
            
            
            $
            385,522Segment revenues as a percentage of
      total revenues:Company Stores
            
            
            71.1
            %
            
            
            69.0
            %Domestic Franchise
            
            
            2.3
            
            
            
            2.1International
    Franchise
            
            
            4.6
            
            
            
            4.5KK
      Supply Chain (external sales)
            
            
            22.1
            
            
            
            24.4100.0
            %
            
            
            100.0
            %Operating income
(loss):Company Stores
            
            $
            2,288
            
            
            $
            (9,813
            )Domestic Franchise
            
            
            3,268
            
            
            
            4,965International
    Franchise
            
            
            9,896
            
            
            
            11,550KK
      Supply Chain
            
            
            25,962
            
            
            
            23,269Total segment operating income
            
            
            41,414
            
            
            
            29,971Unallocated general and administrative expenses
            
            
            (23,737
            )
            
            
            (24,662
            )Impairment charges and lease
      termination costs
            
            
            (5,903
            )
            
            
            (548
            )Consolidated operating income
            
            $
            11,774
            
            
            $
            4,761


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.




Through fiscal 2009, the Company reported its results of operations of
its franchise business as a single business segment. In fiscal 2010, the Company
began disaggregating the results of operations of its franchise business into
domestic and international components in its internal financial reporting. The
Company has made the corresponding changes to its segment reporting, and now
reports the revenues and expenses associated with its domestic and international
franchise operations as separate segments. The Company’s segment disclosures
continue to be consistent with the way in which management views and evaluates
the business. Amounts previously reported for the franchise segment for fiscal
2009 and fiscal 2008 have been restated to conform to the new disaggregated
segment presentation




38




---





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).


Percentage of Total
      RevenuesYear Ended
            
            Year EndedJan. 31,
            
            Feb. 1,
            
            Jan. 31,
            
            Feb. 1,2010
            
            2009
            
            2010
            
            2009(In thousands)Revenues:On-premises sales:Retail sales
            
            $
            103,856
            
            $
            107,142
            
            
            42.2
            %
            
            40.3
            %Fundraising sales
            
            
            13,481
            
            
            13,260
            
            
            5.5
            
            
            5.0Total on-premises sales
            
            
            117,337
            
            
            120,402
            
            
            47.6
            
            
            45.3Off-premises sales:Grocers/mass merchants
            
            
            70,952
            
            
            75,556
            
            
            28.8
            
            
            28.4Convenience stores
            
            
            55,451
            
            
            67,071
            
            
            22.5
            
            
            25.2Other off-premises
            
            
            2,371
            
            
            2,861
            
            
            1.0
            
            
            1.1Total off-premises sales
            
            
            128,774
            
            
            145,488
            
            
            52.3
            
            
            54.7Other revenues
            
            
            262
            
            
            —
            
            
            0.1
            
            
            —Total revenues
            
            
            246,373
            
            
            265,890
            
            
            100.0
            
            
            100.0Operating expenses:Cost of sales:Food, beverage and packaging
            
            
            84,551
            
            
            96,208
            
            
            34.3
            
            
            36.2Shop labor
            
            
            48,714
            
            
            53,113
            
            
            19.8
            
            
            20.0Delivery labor
            
            
            21,280
            
            
            25,419
            
            
            8.6
            
            
            9.6Employee benefits
            
            
            19,145
            
            
            21,269
            
            
            7.8
            
            
            8.0Total cost of sales
            
            
            173,690
            
            
            196,009
            
            
            70.5
            
            
            73.7Vehicle costs (1)
            
            
            11,491
            
            
            16,877
            
            
            4.7
            
            
            6.3Occupancy (2)
            
            
            10,140
            
            
            12,225
            
            
            4.1
            
            
            4.6Utilities expense
            
            
            5,737
            
            
            7,236
            
            
            2.3
            
            
            2.7Depreciation expense
            
            
            6,293
            
            
            6,402
            
            
            2.6
            
            
            2.4Settlement of litigation
            
            
            1,700
            
            
            —
            
            
            0.7
            
            
            —Other operating expenses
            
            
            19,114
            
            
            21,079
            
            
            7.8
            
            
            7.9Total store level costs
            
            
            228,165
            
            
            259,828
            
            
            92.6
            
            
            97.7Store operating income
            
            
            18,208
            
            
            6,062
            
            
            7.4
            
            
            2.3Other segment operating
      costs
            
            
            9,567
            
            
            10,031
            
            
            3.9
            
            
            3.8Allocated corporate overhead
            
            
            6,353
            
            
            5,844
            
            
            2.6
            
            
            2.2Segment operating income
      (loss)
            
            $
            2,288
            
            $
            (9,813
            )
            
            0.9
            %
            
            (3.7
            )%


(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.


A reconciliation of Company Store
segment sales from fiscal 2009 to fiscal 2010 follows:




On-Premises
            
            Off-Premises
            
            Total(In thousands)Fiscal 2009 sales
            
            $
            120,402
            
            
            $
            145,488
            
            
            $
            265,890Less:Effect of
      stores closed and refranchised in fiscal 2009
            
            
            (5,529
            )
            
            
            (5,939
            )
            
            
            (11,468
            )Effect of stores closed and
      refranchised in fiscal 2010
            
            
            (5,436
            )
            
            
            (5,814
            )
            
            
            (11,250
            )Change in sales at mature
    stores
            
            
            4,680
            
            
            
            (4,961
            )
            
            
            (281
            )Sales from fiscal 2010 new stores
            
            
            3,220
            
            
            
            —
            
            
            
            3,220Fiscal 2010
      sales
            
            $
            117,337
            
            
            $
            128,774
            
            
            $
            246,111


39




---





Sales at Company stores
decreased in fiscal 2010 from fiscal 2009 due to store closings and
refranchisings. The increase in on-premises sales from stores opened in fiscal
2010 was offset by a decline in off-premises sales at existing stores. The
following table presents sales metrics for Company stores (off–premises metrics
for fiscal 2009 excludes data for the four stores in Eastern Canada refranchised
by the Company in December 2008):




Year EndedJan. 31,
            
            Feb. 1,2010
            
            2009On-premises:Change in same store sales
            
            3.5
            %
            
            (0.7
            )%Off-premises:Grocers/mass
    merchants:Change in average weekly number of doors
            
            (10.7
            )%
            
            (8.0
            )%Change in average weekly sales per door
            
            10.5
            %
            
            (4.8
            )%Convenience stores:Change in average weekly number of doors
            
            (11.7
            )%
            
            (5.0
            )%Change in average weekly sales per door
            
            (4.1
            )%
            
            (10.7
            )%


On-premises sales




Same store sales at Company stores rose 3.5% in fiscal 2010 over fiscal
2009. Price testing at approximately one-third of the Company’s stores initiated
at the beginning of the second quarter contributed approximately 1.4 percentage
points to the increase. In addition, the improvement in same store sales
reflects generally lower use of couponing and other price promotions in fiscal
2010, as well as generally lower values of coupons and other price promotions.




The Company is implementing programs designed 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




Sales to grocers and mass merchants in fiscal 2009 include approximately
$3.8 million of off-premises sales of four stores in Eastern Canada that the
Company refranchised in December 2008. Exclusive of the sales of the Canadian
stores that were refranchised, sales to grocers and mass merchants decreased
slightly to $71 million, with the 10.7% decline in the average number of doors
served offset by a 10.5% increase in the average weekly sales per door. Convenience store sales fell due
to both a decline in the average number of doors served and in the average
weekly sales per door. Among other reasons, sales to convenience stores have
declined as a result of several large customers implementing in-house doughnut
programs to replace the Company’s products. Declines in the average weekly sales
per door adversely affect profitability because of the increased significance of
delivery costs in relation to sales.




The Company is implementing strategies to increase sales, increase
average per door sales and reduce costs in the off-premises channel. These
strategies include improved route management and route consolidation (including
elimination of or reduction in the number of stops at relatively low volume
doors), new sales incentives and performance-based pay programs, increased
emphasis on relatively longer shelf-life products and has developed order
management systems to more closely match display quantities and assortments with
consumer demand.




Costs and expenses




Cost of sales as a percentage of revenues improved by 3.2 percentage
points from fiscal 2009, falling to 70.5% of revenues in fiscal 2010. Lower
costs for doughnut mix and shortening drove the improvement. Lower costs of
flour and shortening resulting from lower agricultural commodity costs enabled
KK Supply Chain to reduce prices on these key items in fiscal 2010. While the
cost of doughnut mix and other ingredients has been relatively stable during
fiscal 2010, Company Stores’ cost of sugar rose approximately 20% in the fourth
quarter and an additional 5% in the first quarter of fiscal 2011 as a result of
price increases resulting from the expiration of a favorable KK Supply Chain
sugar supply contract. The Company currently estimates that the overall increase
in the cost of materials and ingredients in fiscal 2011 will be approximately $4
million, or approximately 2% of sales. The Company is implementing programs
intended to improve store operations and reduce costs as a percentage of
revenues, including improved employee training and the introduction of food and
labor cost management tools.




40




---



Improved route management and the implementation of performance-based pay
programs in the off-premises channel drove a 1.0 percentage point decrease in
delivery labor as a percentage of off-premises sales in fiscal 2010 compared to
fiscal 2009.




Vehicle costs as a percentage of revenues improved 1.6 percentage points
from 6.3% of revenues in fiscal 2009 to 4.7% of revenues in fiscal 2010. Lower
fuel prices and improved route management and route consolidation drove the
improvement in vehicle costs.




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 Note 1 to the
consolidated financial statements appearing elsewhere herein, and updates
actuarial valuations of its self-insurance reserves at least annually. 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. The Company recorded favorable adjustments to its self-insurance
claims liabilities related to prior policy years of approximately $3.2 million
in fiscal 2010, of which $2.0 million was recorded in the fourth quarter and
$1.8 million in fiscal 2009, of which $1.0 million was recorded in the fourth
quarter. Of the $3.2 million in favorable adjustments recorded in fiscal 2010,
$2.1 million relates to workers’ compensation liability claims and is included
in employee benefits in the table above, $660,000 relates to vehicle liability
claims and is included in vehicle costs in the table above and $390,000 relates
to general liability claims and is included in other operating expenses in the
table above. Of the $1.8 million in favorable adjustments recorded in fiscal
2009, $1.6 million relates to workers’ compensation liability claims and
$240,000 relates to general liability claims.




During fiscal 2010, the Company Stores segment recorded charges totaling
$1.7 million (of which $950,000 was recorded in the fourth quarter) for the
settlement of environmental and wage/hour litigation, as described in Note 12 to
the consolidated financial statements appearing elsewhere herein.




The Company stores segment closed or refranchised a total of 28 stores in
the last two fiscal years, none of which have been accounted for as discontinued
operations because the Company continues to have significant continuing
involvement in the markets in which the stores were or are located, through
either continuing operations of other stores in or serving the market or through
its relationship as a franchisor. In order to assist readers in understanding
the results of operations of the Company’s ongoing stores, the following table
presents the components of revenues and expenses for stores operated by the
Company as of January 31, 2010, and excludes the revenues and expenses for
stores closed and refranchised prior to that date. Percentage amounts may not
add to totals due to rounding.




41




---



Stores in Operation at January 31,
      2010Percentage of Total
      RevenuesYear Ended
            
            Year EndedJan. 31,
            
            Feb. 1,
            
            Jan. 31,
            
            Feb. 1,2010
            
            2009
            
            2010
            
            2009(In thousands)Revenues:On-premises sales:Retail sales
            
            $
            93,982
            
            
            $
            87,028
            
            
            40.6
            %
            
            38.1
            %Fundraising sales
            
            
            12,906
            
            
            
            11,960
            
            
            5.6
            
            
            5.2Total on-premises sales
            
            
            106,888
            
            
            
            98,988
            
            
            46.1
            
            
            43.3Off-premises sales:Grocers/mass merchants
            
            
            68,335
            
            
            
            66,475
            
            
            29.5
            
            
            29.1Convenience stores
            
            
            53,888
            
            
            
            60,256
            
            
            23.3
            
            
            26.4Other off-premises
            
            
            2,326
            
            
            
            2,779
            
            
            1.0
            
            
            1.2Total off-premises sales
            
            
            124,549
            
            
            
            129,510
            
            
            53.8
            
            
            56.7Other revenues
            
            
            262
            
            
            
            —
            
            
            0.1
            
            
            —Total revenues
            
            
            231,699
            
            
            
            228,498
            
            
            100.0
            
            
            100.0Operating expenses:Cost of sales:Food, beverage and packaging
            
            
            79,407
            
            
            
            82,704
            
            
            34.3
            
            
            36.2Shop labor
            
            
            45,014
            
            
            
            43,706
            
            
            19.4
            
            
            19.1Delivery labor
            
            
            20,470
            
            
            
            22,243
            
            
            8.8
            
            
            9.7Employee benefits
            
            
            17,610
            
            
            
            17,517
            
            
            7.6
            
            
            7.7Total cost of sales
            
            
            162,501
            
            
            
            166,170
            
            
            70.1
            
            
            72.7Vehicle costs
            
            
            10,898
            
            
            
            13,866
            
            
            4.7
            
            
            6.1Occupancy
            
            
            8,567
            
            
            
            8,474
            
            
            3.7
            
            
            3.7Depreciation expense
            
            
            6,051
            
            
            
            5,879
            
            
            2.6
            
            
            2.6Utilities expense
            
            
            5,143
            
            
            
            5,694
            
            
            2.2
            
            
            2.5Settlement of litigation
            
            
            750
            
            
            
            —
            
            
            0.3
            
            
            —Other operating expenses
            
            
            17,269
            
            
            
            16,937
            
            
            7.5
            
            
            7.4Total store level costs
            
            
            211,179
            
            
            
            217,020
            
            
            91.1
            
            
            95.0Store operating income-ongoing
      stores
            
            
            20,520
            
            
            
            11,478
            
            
            8.9
            
            
            5.0Store operating loss-closed
      and refranchised stores
            
            
            (2,312
            )
            
            
            (5,416
            )Store operating income
            
            $
            18,208
            
            
            $
            6,062


Domestic Franchise




Year EndedJan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Revenues:Royalties
            
            $
            7,542
            
            $
            7,810Development and franchise fees
            
            
            50
            
            
            3Other
            
            
            215
            
            
            229Total revenues
            
            
            7,807
            
            
            8,042Operating expenses:Segment operating
      expenses
            
            
            4,016
            
            
            2,838Depreciation expense
            
            
            71
            
            
            86Allocated corporate
      overhead
            
            
            452
            
            
            153Total operating expenses
            
            
            4,539
            
            
            3,077Segment operating
income
            
            $
            3,268
            
            $
            4,965


42




---



Domestic Franchise revenues decreased 2.9% to $7.8 million in fiscal 2010
from $8.0 million in fiscal 2009, driven by a decline in domestic royalty
revenues resulting from a decrease in sales by domestic franchise stores from
approximately $236 million in fiscal 2009 to $221 million in fiscal
2010.




Domestic franchise same store sales rose 0.9% in fiscal 2010. Generally,
same store sales at Associate franchise stores, which are located principally in
the Southeast, rose during the year, while same store sales at Area Developer
franchise stores fell.




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. Domestic Franchise operating expenses rose in fiscal 2010
compared to fiscal 2009, primarily due to increased resources devoted to the
development and support of domestic franchisees, higher incentive compensation
provisions of approximately $245,000 and an increase in bad debt provisions to
approximately $125,000 related principally to a single domestic franchisee.
Additionally, during fiscal 2010, the Company recorded charges of approximately
$150,000 to the Domestic Franchise segment for the settlement of litigation as
described in Note 12 to the consolidated financial statements appearing
elsewhere herein.




Domestic franchisees opened 12 stores and closed seven stores in fiscal
2010. 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




Year EndedJan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Revenues:Royalties
            
            $
            14,164
            
            $
            14,942Development and franchise fees
            
            
            1,743
            
            
            2,460Other
            
            
            —
            
            
            93Total revenues
            
            
            15,907
            
            
            17,495Operating expenses:Segment operating
      expenses
            
            
            4,926
            
            
            5,016Allocated corporate overhead
            
            
            1,085
            
            
            929Total operating expenses
            
            
            6,011
            
            
            5,945Segment operating
income
            
            $
            9,896
            
            $
            11,550


International Franchise royalties declined $778,000, driven by a decrease
in sales by international franchise stores from $273 million in fiscal 2009 to
$264 million in fiscal 2010. Changes in the rates of exchange between the U.S.
dollar and the foreign currencies in which the Company’s international
franchisees do business reduced sales by international franchisees measured in
U.S. dollars by approximately $11.7 million in fiscal 2010 compared to fiscal
2009, which adversely affected international royalty revenues by approximately
$700,000. Additionally, the Company did not recognize as revenue approximately
$680,000 and $920,000 of uncollected royalties which accrued during fiscal 2010
and 2009, respectively, because the Company did not believe collection of these
royalties was reasonably assured.




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 21.1%. The decline in International
Franchise same store sales reflects the large number of new stores opened
internationally over the past two years, the cannibalization effects on initial
stores in new markets of additional store openings in those markets, and
the overall softness in global economic conditions, particularly in
more developed markets. International franchisees opened 281 stores in the past
three fiscal years, including 121 stores in markets in which there were no
International Franchise stores at the end of fiscal 2007. Of the 281 openings
over the past three years, 174 stores have been open at least 57 weeks and are
included in the same store sales computation for fiscal 2010. Many of these new
stores experienced very high sales in their initial year or more of operation,
and their average weekly sales are declining to more sustainable levels.




43




---



International development and franchise fees decreased $717,000 in fiscal
2010 due to fewer store openings by international franchisees in fiscal 2010
than in fiscal 2009.




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 rose in
the fiscal 2010 compared to fiscal 2009 primarily due to increased resources
devoted to the development and support of franchisees outside the United States
and to higher incentive compensation provisions of $455,000. These increases
were partially offset by a decrease in the bad debt provision to $605,000 in
fiscal 2010 compared to $1.3 million in fiscal 2009.




International franchisees opened 82 stores and closed 22 stores in fiscal
2010. 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) are set forth in the table below
(percentage amounts may not add to totals due to rounding).




Percentage of Total
      RevenuesBefore IntersegmentSales EliminationYear Ended
            
            Year EndedJan. 31,
            
            Feb. 1,
            
            Jan. 31,
            
            Feb. 1,2010
            
            2009
            
            2010
            
            2009(In thousands)Revenues:Doughnut mixes
            
            $
            58,332
            
            $
            73,312
            
            36.0
            %
            
            38.3
            %Other ingredients, packaging and supplies
            
            
            97,622
            
            
            106,054
            
            60.2
            
            
            55.4Equipment
            
            
            6,173
            
            
            8,749
            
            3.8
            
            
            4.6Fuel surcharge
            
            
            —
            
            
            3,341
            
            —
            
            
            1.7Total revenues before intersegment sales elimination
            
            
            162,127
            
            
            191,456
            
            100.0
            
            
            100.0Operating expenses:Cost of sales:Cost
      of goods produced and purchased
            
            
            108,502
            
            
            131,594
            
            66.9
            
            
            68.7Inbound freight
            
            
            3,483
            
            
            7,550
            
            2.1
            
            
            3.9Total cost of sales
            
            
            111,985
            
            
            139,144
            
            69.1
            
            
            72.7Distribution costs:Outbound freight
            
            
            10,007
            
            
            13,806
            
            6.2
            
            
            7.2Other distribution costs
            
            
            3,372
            
            
            3,357
            
            2.1
            
            
            1.8Total distribution costs
            
            
            13,379
            
            
            17,163
            
            8.3
            
            
            9.0Other segment operating
      costs
            
            
            8,751
            
            
            9,496
            
            5.4
            
            
            5.0Depreciation expense
            
            
            883
            
            
            1,019
            
            0.5
            
            
            0.5Allocated corporate
      overhead
            
            
            1,167
            
            
            1,365
            
            0.7
            
            
            0.7Total operating costs
            
            
            136,165
            
            
            168,187
            
            84.0
            
            
            87.8Segment operating
income
            
            $
            25,962
            
            $
            23,269
            
            16.0
            %
            
            12.2
            %


KK Supply Chain revenues before intersegment sales elimination fell $29.3
million, or 15.3%, in fiscal 2010 compared to fiscal 2009. The decrease reflects
lower unit sales of doughnut mixes, ingredients and supplies by KK Supply Chain
resulting from lower sales by Company and domestic franchise stores. The decline
also reflects selling price reductions for doughnut mixes and certain other
ingredients instituted by KK Supply Chain in fiscal 2010 in order to pass along
to Company and franchise stores reductions in KK Supply Chain’s cost of flour
and shortening. Finally, in fiscal 2009, the Company utilized a fuel surcharge
program to recoup additional freight costs resulting from increased fuel costs.
Charges under the program were based upon the price of diesel fuel; the price
benchmark was reset in fiscal 2010 and no fuel surcharges were made under the
program in fiscal 2010.




44




---



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.




Cost of sales as a percentage of revenues fell in fiscal 2010 compared to
fiscal 2009. The most significant reason for the decrease was the reduced
selling price of doughnut mix in fiscal 2010 resulting principally from lower
flour costs. While the selling prices of doughnut mixes in fiscal 2010 were
lower than in fiscal 2009 as a result of lower raw materials costs, overall
gross margins widened because the Company attempts to maintain the gross profit
on sales of doughnut mixes relatively constant on a per unit basis. Lower
inbound freight costs reflect a decrease in freight rates resulting from lower
fuel prices. In addition, the Company closed its California distribution center
in fiscal 2009 and engaged an independent contractor to supply Company and
franchise stores west of the Mississippi; the inbound freight cost associated
with goods delivered by the contractor is reflected in the fee paid to the
contractor, which is included in other distribution costs.




Outbound freight costs fell in fiscal 2010 compared to fiscal 2009,
reflecting both lower unit sales volumes and reduced costs resulting from lower
fuel prices. In addition, outbound freight in fiscal 2009 includes a charge of
approximately $1.7 million (approximately 0.9% of KK Supply Chain revenues
before intersegment sales elimination) related to payments made by the Company
to its former third-party freight consolidator which were improperly not
remitted to the freight carriers by the freight consolidator. The actions of the
third-party freight consolidator, which filed for bankruptcy protection,
resulted in a loss to the Company which the Company has not recovered.




Other segment operating costs include segment management, purchasing,
customer service and support, laboratory and quality control costs and research
and development expenses. These costs include a net credit of approximately
$935,000 for bad debt expense in fiscal 2010 and a net credit of approximately
$950,000 in fiscal 2009. The net credits principally reflect sustained improved
payment performance and/or reduced credit exposure with respect to a small
number of franchisees and, in fiscal 2009, a recovery of receivables previously
written off. Net credits in bad debt expense should not be expected to occur on
a regular basis. As of January 31, 2010, the Company’s allowance for doubtful
accounts from affiliate and unaffiliated franchisees totaled approximately $1.8
million.




Domestic and international franchisees opened 94 stores and closed 29
stores in fiscal 2010. The majority 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.




General and Administrative
Expenses




General and administrative expenses were $22.7 million, or 6.6% of total
revenues, in fiscal 2010 compared to $23.5 million, or 6.1% of total revenues,
in fiscal 2009. General and administrative expenses in fiscal 2010 include
approximately $2.6 million of incentive compensation provisions to reflect
fiscal 2010 results (with an additional charge of approximately $2.2 million
included in direct operating expenses); there were no incentive compensation
provisions in general and administrative expenses for fiscal 2009. General and
administrative expenses in fiscal 2010 reflect higher legal costs compared to
fiscal 2009, including legal fees of approximately $1.7 million related to the
resolved environmental litigation described in Note 12 to the consolidated
financial statements appearing elsewhere herein.




General and administrative expenses include professional fees and other
costs, together with related insurance recoveries, associated with certain
securities litigation and related investigations, including costs arising from
the Company’s obligation to indemnify certain former officers of the Company for
costs incurred by them in connection with those matters. Those matters are
described under “Other Litigation — Federal Securities Class Actions and Shareholder Derivative Actions and
Settlement Thereof ”  in Note 12 to the consolidated financial
statements appearing elsewhere herein. Those costs and expenses were a net
credit of approximately $1.8 million in fiscal 2010 and a charge of
approximately $1.3 million in fiscal 2009. The net credit in fiscal 2010
reflects insurance reimbursements of approximately $2.5 million of costs
incurred in prior periods in connection with such litigation and investigations,
of which $1.3 million was recorded in the fourth quarter. All matters with
respect to this litigation have been resolved, and the Company does not
anticipate that these expenses will be incurred going forward.




45




---





Impairment Charges and Lease
Termination Costs
  Impairment charges and lease termination costs were $5.9 million in
fiscal 2010 compared to $548,000 in fiscal 2009.




Impairment charges related to long-lived assets totaled $3.1 million in
fiscal 2010 and $1.1 million in fiscal 2009, of which approximately $3.1 million
and $900,000, respectively, related principally to underperforming stores. 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 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. During fiscal 2010, the Company
recorded impairment charges related to long-lived assets, substantially all of
which were real properties; the fair values of these assets were estimated based
on the present value of estimated future cash flows, on independent appraisals
and, in the case of properties which the Company currently is negotiating to
sell, based on the Company’s negotiations with unrelated third-party buyers. The
charges relate to stores closed, refranchised or expected to be closed, as well
as charges with respect 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. In
addition to the foregoing, impairment charges for fiscal 2010 reflect a one-time
cash recovery of $482,000 from the bankruptcy estate of Freedom Rings, LLC, a
former subsidiary of the Company which filed for bankruptcy in fiscal 2006, as
more fully described in Note 13 to the consolidated financial statements
appearing elsewhere herein.




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.




In fiscal 2010, the Company recorded lease termination charges related to
closed stores of approximately $3.2 million, compared to a net credit related to
lease terminations of $502,000 in fiscal 2009. The charges in fiscal 2010 relate
principally to terminations of two leases having rental rates substantially
above current market levels. In fiscal 2009, changes in estimated sublease
rentals on a closed store that was subsequently refranchised and the realization
of proceeds on an assignment of another closed store lease resulted in a credit
in the lease termination provision. This credit, along with the reversal of
previously recorded accrued rent associated with stores closed, partially offset
by charges related to other closed store leases, resulted in a net credit in the
provision for lease termination costs in fiscal 2009.




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.




In fiscal 2010, the Company refranchised three operating Company stores
to a new franchisee, as more fully described under “Basis of Consolidation” in
Note 1 to the consolidated financial statements appearing elsewhere herein, and
a fourth operating store to an existing franchisee. No gain or loss was recorded
on the former transaction, while the second transaction resulted in an asset
impairment charge of $193,000, as well as receipt of cash proceeds of $1.7
million, representing the proceeds of the sale of the store.




In fiscal 2009, the Company refranchised one idled store acquired by the
Company from a failed franchisee, refranchised two domestic operating stores to
a new franchisee, and refranchised the four Company stores in Eastern Canada to
a new franchisee. The Company received no proceeds in connection with any of
these transactions. With the exception of a non-cash pretax gain of $2.8 million
recorded in the fourth quarter of fiscal 2009 related to foreign currency
translation arising from the Canadian disposal (which is included in
non-operating income and expense), no significant gain or loss was recognized as
a result of these 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 impairment losses on the related
assets.




46




---



Interest
Income




Interest income decreased to $93,000 in fiscal 2010 from $331,000 in
fiscal 2009 due to lower short term interest rates and lower average cash
balances in fiscal 2010 compared to fiscal 2009.




Interest
Expense




The components of interest expense are as follows:




Year EndedJan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Interest accruing on outstanding
      indebtedness
            
            $
            5,789
            
            $
            6,402Letter of credit and unused revolver fees
            
            
            1,240
            
            
            1,082Fees associated with credit agreement
      amendments
            
            
            925
            
            
            261Write-off of deferred financing costs associated with credit
      agreement amendments
            
            
            89
            
            
            289Amortization of deferred financing
      costs
            
            
            770
            
            
            543Mark to market adjustments on interest rate derivatives
            
            
            559
            
            
            798Amortization of unrealized loss on
      interest rate derivatives
            
            
            1,151
            
            
            969Payment to (from) counterparty on interest rate cap
      derivative
            
            
            —
            
            
            124Other
            
            
            162
            
            
            211$
            10,685
            
            $
            10,679


The decrease in interest accruing on outstanding indebtedness reflects
the reduction in the past year in the outstanding principal balance of the Term
Loan described in Note 10 to the consolidated financial statements appearing
elsewhere herein. That reduction in interest expense was partially offset by the
effects of higher lender margin and fees resulting from amendments to the
Company’s Secured Credit Facilities in April 2009. The April 2009 amendments to
the credit facilities increased the interest rate on the Company’s outstanding
borrowings and letters of credit by 200 basis points annually, and the Company
incurred fees and costs associated with those amendments and with similar
amendments in April 2008, as described in Note 10.




The interest rate derivative contracts which gave rise to the
mark-to-market adjustments and the amortization of unrealized losses on interest
rate derivatives expire in April 2010. Except for $152,000 of remaining
unamortized losses on those derivative contracts which will be charged to
earnings in the first quarter of fiscal 2011, there will be no significant
additional income statement effects of such contracts. These interest rate
derivative contracts are more fully described in Note 10 to the consolidated
financial statements appearing elsewhere herein.




Equity in Losses of Equity Method
Franchisees




Equity in losses of equity method franchisees totaled $488,000 in fiscal
2010 compared to $786,000 in fiscal 2009. This caption represents the Company’s
share of operating results of equity method franchisees which develop and
operate Krispy Kreme stores.




Other Non-Operating Income and
Expense, Net




Other non-operating income and expense in fiscal 2010 includes a charge
of approximately $500,000 to reflect a decline in the value of an investment in
an Equity Method Franchisee that management concluded was other than temporary,
as described in Note 18 to the consolidated financial statements appearing
elsewhere herein.




Other non-operating income and expense in fiscal 2009 includes a non-cash
gain of approximately $2.8 million relating to the disposition of the Company’s
Canadian subsidiary in connection with the refranchising of the Company’s four
stores in Eastern Canada, substantially all of which represents the cumulative
foreign currency translation adjustment related to the Canadian operations
which, prior to the sale of the stores, had been reflected, net of tax, in
accumulated other comprehensive income.




47




---



In addition, other non-operating income and expense in fiscal 2009
includes a non-cash gain of $931,000 on the disposal of an investment in an
Equity Method Franchisee, largely offset by a $900,000 charge for collectability
risk on a note receivable from another Equity Method Franchisee, as described in
Note 18 to the consolidated financial statements appearing elsewhere
herein.




Provision for Income
Taxes




The provision for income taxes was $575,000 and $503,000 in fiscal 2010
and fiscal 2009, respectively. 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 portion of the income
tax provision represented by taxes estimated to be payable currently was
approximately $900,000 and $1.6 million in fiscal 2010 and fiscal 2009,
respectively, the majority of which represents foreign withholding taxes related
to royalties and franchise fees paid by international franchisees. The current
income tax provision for fiscal 2010 also includes a credit of $560,000
representing anticipated federal tax refunds resulting from an additional
carryback of net operating losses made possible by the Worker, Homeownership and
Business Assistance Act of 2009.




The deferred income tax provision for fiscal 2009 includes $1.2 million
of deferred income tax expense related to the cumulative foreign currency
translation gain associated with the Company’s operations in Eastern Canada
which, prior to the sale of the operations in the fourth quarter of fiscal 2009
and the resulting recognition of the currency gain, was included in accumulated
other comprehensive income. In addition, as a result of the dissolution of one
of the Company’s foreign subsidiaries and the resolution of related income tax
uncertainties during fiscal 2009, the Company recorded a credit of approximately
$1.8 million to the provision for income taxes to the Company’s accruals for
uncertain tax positions.




Net Loss




The Company reported a net loss of $157,000 in fiscal 2010 compared to a
net loss of $4.1 million in fiscal 2009.




FISCAL 2009 COMPARED TO FISCAL
2008




Overview




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




48




---



Year EndedFeb. 1,
            
            Feb. 3,2009
            
            2008(Dollars in
  thousands)Revenues by business
      segment:Company Stores
            
            $
            265,890
            
            
            $
            304,444Domestic Franchise
            
            
            8,042
            
            
            
            8,673International Franchise
            
            
            17,495
            
            
            
            14,285KK Supply Chain:Total revenues
            
            
            191,456
            
            
            
            205,499Less – intersegment sales
      elimination
            
            
            (97,361
            )
            
            
            (102,531
            )External
      KK Supply Chain revenues
            
            
            94,095
            
            
            
            102,968Total
      revenues
            
            $
            385,522
            
            
            $
            430,370Segment revenues as a percentage of
      total revenues:Company Stores
            
            
            69.0
            %
            
            
            70.7
            %Domestic
    Franchise
            
            
            2.1
            
            
            
            2.0International
      Franchise
            
            
            4.5
            
            
            
            3.3KK Supply Chain (external
      sales)
            
            
            24.4
            
            
            
            23.9100.0
            %
            
            
            100.0
            %Operating income
(loss):Company Stores
            
            $
            (9,813
            )
            
            $
            (6,292
            )Domestic
    Franchise
            
            
            4,965
            
            
            
            4,833International
      Franchise
            
            
            11,550
            
            
            
            9,484KK Supply Chain
            
            
            23,269
            
            
            
            24,083Total
      segment operating income
            
            
            29,971
            
            
            
            32,108Unallocated general and
      administrative expenses
            
            
            (24,662
            )
            
            
            (27,552
            )Impairment charges and
      lease termination costs
            
            
            (548
            )
            
            
            (62,073
            )Settlement of
      litigation
            
            
            —
            
            
            
            14,930Consolidated
      operating income (loss)
            
            $
            4,761
            
            
            $
            (42,587
            )


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).




49




---



Percentage of
      TotalYear Ended
            
            Year EndedFeb. 1,
            
            Feb. 3,
            
            Feb. 1,
            
            Feb. 3,2009
            
            2008
            
            2009
            
            2008(In thousands)Revenues:On-premises
    sales:Retail
      sales
            
            $
            107,142
            
            
            $
            116,864
            
            
            40.3
            %
            
            38.4
            %Fundraising
      sales
            
            
            13,260
            
            
            
            14,118
            
            
            5.0
            
            
            4.6Total
      on-premises sales
            
            
            120,402
            
            
            
            130,982
            
            
            45.3
            
            
            43.0Off-premises
    sales:Grocers/mass
      merchants
            
            
            75,556
            
            
            
            89,448
            
            
            28.4
            
            
            29.4Convenience
      stores
            
            
            67,071
            
            
            
            80,621
            
            
            25.2
            
            
            26.5Other
      off-premises
            
            
            2,861
            
            
            
            3,393
            
            
            1.1
            
            
            1.1Total
      off-premises sales
            
            
            145,488
            
            
            
            173,462
            
            
            54.7
            
            
            57.0Total
      revenues
            
            
            265,890
            
            
            
            304,444
            
            
            100.0
            
            
            100.0Operating expenses:Cost of sales:Food,
      beverage and packaging
            
            
            96,208
            
            
            
            100,338
            
            
            36.2
            
            
            33.0Shop
      labor
            
            
            53,113
            
            
            
            60,518
            
            
            20.0
            
            
            19.9Delivery
      labor
            
            
            25,419
            
            
            
            29,574
            
            
            9.6
            
            
            9.7Employee
      benefits
            
            
            21,269
            
            
            
            25,097
            
            
            8.0
            
            
            8.2Total
      cost of sales
            
            
            196,009
            
            
            
            215,527
            
            
            73.7
            
            
            70.8Vehicle
      costs
            
            
            16,877
            
            
            
            19,282
            
            
            6.3
            
            
            6.3Occupancy
            
            
            12,225
            
            
            
            13,361
            
            
            4.6
            
            
            4.4Utilities
      expense
            
            
            7,236
            
            
            
            7,563
            
            
            2.7
            
            
            2.5Depreciation
      expense
            
            
            6,402
            
            
            
            11,558
            
            
            2.4
            
            
            3.8Other
      operating expenses
            
            
            21,079
            
            
            
            25,095
            
            
            7.9
            
            
            8.2Total
      store level costs
            
            
            259,828
            
            
            
            292,386
            
            
            97.7
            
            
            96.0Store operating
      income
            
            
            6,062
            
            
            
            12,058
            
            
            2.3
            
            
            4.0Other segment operating
      costs
            
            
            10,031
            
            
            
            11,024
            
            
            3.8
            
            
            3.6Allocated corporate
      overhead
            
            
            5,844
            
            
            
            7,326
            
            
            2.2
            
            
            2.4Segment operating loss
            
            $
            (9,813
            )
            
            $
            (6,292
            )
            
            (3.7
            )%
            
            (2.1
            )%


Company Stores revenues were $265.9 million in fiscal 2009 compared to
$304.4 million in fiscal 2008. Excluding the 53rd week of fiscal 2008,
Company Stores revenues decreased 11.0% in fiscal 2009 from $298.9 million in
fiscal 2008. The decrease in revenues (measured on a 52-week basis) reflects a
7.8% decline in store operating weeks and a 4.2% decrease in average weekly
sales per store. The decrease in store operating weeks reflects the
refranchising or closure of 18 Company factory stores and three Company
satellite stores since the end of fiscal 2007.




The following table presents sales metrics for Company stores. All
comparisons have been made excluding the 53rd week from fiscal
2008.




Year EndedFeb. 1,
            
            Feb. 3,2009
            
            2008On-premises:Change in same store sales
            
            (0.7
            )%
            
            0.0
            %Off-premises: (1)Grocers/mass
      merchants:Change
      in average weekly number of doors
            
            (8.0
            )%
            
            (4.7
            )%Change
      in average weekly sales per door
            
            (4.8
            )%
            
            (6.1
            )%Convenience
    stores:Change
      in average weekly number of doors
            
            (5.0
            )%
            
            4.3
            %Change
      in average weekly sales per door
            
            (10.7
            )%
            
            (10.8
            )%


(1)
            
            Metrics exclude
      off-premises sales by Company stores in Eastern Canada, which the Company
      refranchised in the fourth quarter of fiscal 2009 as the data for these
      stores was not available.


50




---



On-premises
sales




Same store sales at Company stores declined 0.7% in fiscal 2009 compared
to fiscal 2008 generally reflecting a decrease in customer traffic partially
offset by an increase in the average guest check. The Company increased
on-premises selling prices in late fiscal 2008 to partially offset rising costs,
particularly increased costs of doughnut mixes and shortening due to rising
agricultural commodity prices. The Company believes the selling price increases
adversely affected sales volumes.




Off-premises
sales




Sales to grocers and mass merchants in fiscal 2009 and fiscal 2008
include approximately $3.8 million and $5.9 million, respectively, of
off-premises sales of stores in Eastern Canada that the Company refranchised in
December 2008. Exclusive of the sales of the Canadian stores that were
refranchised and the 53rd week from fiscal
2008, sales to grocers and mass merchants decreased to $72 million in fiscal
2009 from $82 million in fiscal 2008, reflecting an 8.0% decline in the average
number of doors served and a 4.8% decrease in the average weekly sales per door.
Convenience store sales fell due to both a decline in the average number of
doors served and in the average weekly sales per door. Declines in the average
weekly sales per door adversely affect profitability because of the increased
significance of delivery costs in relation to sales. The Company increased
off-premises selling prices in early fiscal 2009 to partially offset rising
costs, particularly increased costs of doughnut mixes and shortening due to
rising agricultural commodity prices. The Company believes the selling price
increases adversely affected sales volumes, particularly in the off-premises
channel.




Costs and
expenses




Cost of sales as a percentage of revenues increased by 2.9 percentage
points from fiscal 2008, to 73.7% of revenues in fiscal 2009. Higher costs for
materials resulting from price increases instituted by KK Supply Chain in fiscal
2009 in order to offset higher raw materials costs were not fully recovered
through price increases to customers. Economic conditions led to significant
reductions in the market prices of agricultural commodities and fuel which
resulted in price reductions by KK Supply Chain in the fourth quarter of fiscal
2009.




The Company is self-insured for workers’ compensation, automobile 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 Note 1 to the
consolidated financial statements appearing elsewhere herein, and updates
actuarial valuations of its self-insurance reserves at least annually. 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. The Company recorded favorable adjustments to its self-insurance
claims liabilities related to prior policy years of approximately $1.8 million
in fiscal 2009, of which $1.0 million was recorded in the fourth quarter, and
$1.7 million in fiscal 2008, of which $980,000 was recorded in the fourth
quarter. Of the $1.8 million in favorable adjustments recorded in fiscal 2009,
$1.6 million relates to workers’ compensation liability claims and is included
in employee benefits in the table above and $240,000 relates to general
liability claims and is included in other operating expenses in the table above.
Of the $1.7 million in favorable adjustments recorded in fiscal 2008, $1.2
million relates to workers’ compensation liability claims, $250,000 relates to
vehicle liability claims and is included in vehicle costs in the table above and
$230,000 relates to general liability claims.




Depreciation and amortization expense decreased to $6.4 million in fiscal
2009 from $11.6 million in fiscal 2008. The decline in depreciation and
amortization expense is attributable principally to the reduction in the number
of Company factory stores operating in fiscal 2009 compared to fiscal 2008, and
to a lower depreciable base of property and equipment resulting from impairment
writedowns.




51




---



Domestic
Franchise




Year EndedFeb. 1,
            
            Feb. 3,2009
            
            2008(In thousands)Revenues:Royalties
            
            $
            7,810
            
            $
            8,301Development and franchise
      fees
            
            
            3
            
            
            174Other
            
            
            229
            
            
            198Total
      revenues
            
            
            8,042
            
            
            8,673Operating expenses:Segment operating
      expenses
            
            
            2,838
            
            
            3,357Depreciation
      expense
            
            
            86
            
            
            92Allocated corporate
      overhead
            
            
            153
            
            
            391Total
      operating expenses
            
            
            3,077
            
            
            3,840Segment operating
income
            
            $
            4,965
            
            $
            4,833


Domestic Franchise revenues decreased 7.3% to $8.0 million in fiscal 2009
from $8.7 million in fiscal 2008. Excluding the 53rd week of fiscal 2008,
Domestic Franchise revenues decreased 5.3% to $8.0 million in fiscal 2009 from
$8.5 million in fiscal 2008. The decrease was driven by a decline in domestic
royalty revenues resulting from a decrease in sales by domestic franchise stores
from approximately $282 million in fiscal 2008 (measured on a 52-week basis) to
$236 million in fiscal 2009, principally due to store closings. Royalty revenues
measured on a 52-week basis declined to $7.8 million in fiscal 2009 from $8.1
million in fiscal 2008. Additionally, the Company did not recognize as revenue
approximately $120,000 and $2.6 million of uncollected royalties which accrued
during fiscal 2009 and 2008, respectively, because the Company did not believe
collection of these royalties was reasonably assured.




Domestic franchise same store sales decreased 3.3% in fiscal 2009,
reflecting declines at both Associate franchise stores, which are located
principally in the Southeast, and at Area Developer franchise
stores.




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. Domestic Franchise operating expenses decreased in fiscal 2009
compared to fiscal 2008, primarily lower marketing costs.




Domestic franchisees opened six stores and closed 21 stores in fiscal
2009. 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




Year EndedFeb. 1,
            
            Feb. 3,2009
            
            2008(In thousands)Revenues:Royalties
            
            $
            14,942
            
            $
            12,076Development and franchise
      fees
            
            
            2,460
            
            
            2,167Other
            
            
            93
            
            
            42Total
      revenues
            
            
            17,495
            
            
            14,285Operating expenses:Segment operating
      expenses
            
            
            5,016
            
            
            3,966Allocated corporate
      overhead
            
            
            929
            
            
            835Total
      operating expenses
            
            
            5,945
            
            
            4,801Segment operating
income
            
            $
            11,550
            
            $
            9,484


52




---



International Franchise royalties increased $2.9 million in fiscal 2009
from $12.1 million in fiscal 2008. Excluding the 53rd week of fiscal 2008,
International Franchise royalties increased 26.5% to $14.9 million in fiscal
2009 from $11.8 million in fiscal 2008. The increase was driven by an increase
in sales by international franchise stores from $194 million in fiscal 2008
(measured on a 52-week basis) to $273 million in fiscal 2009. Changes in the
rates of exchange between the U.S. dollar and the foreign currencies in which
the Company’s international franchisees do business reduced sales by
international franchisees measured in U.S. dollars by approximately $10 million
in the fourth quarter of fiscal 2009 and for fiscal 2009 as a whole, compared to
the comparable periods in fiscal 2008, which adversely affected international
royalty revenues by approximately $600,000. Additionally, the Company did not
recognize as revenue approximately $920,000 of uncollected royalties which
accrued during fiscal 2009 because the Company did not believe collection of
these royalties was reasonably assured.




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 18.6%. The decline in International
Franchise same store sales reflects the large number of new stores opened
internationally in fiscal 2009 and fiscal 2008, the cannibalization effects on
initial stores in new markets of additional store openings in those markets and
the effects of soft economic conditions.




International development and franchise fees increased $293,000 in fiscal
2009 due to an increase in store openings compared to fiscal 2008. Development
and franchise fees did not increase proportionately with the number of store
openings principally because a greater percentage of fiscal 2009 openings were
satellite stores compared to fiscal 2008; development and franchise fees per
store are lower for satellite stores than for factory stores.




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 rose in
the fiscal 2009 compared to fiscal 2008. The increase in International Franchise
operating expenses in fiscal 2009 compared to fiscal 2008 reflects a bad debt
provision of approximately $1.3 million principally related to credit exposure
on international franchisees, partially offset by lower store opening support
expenses. Costs to support franchise store openings decline as individual
franchisees gain experience opening stores and develop internal resources to
assist in store openings.




International franchisees opened 114 stores and closed 19 stores in
fiscal 2009. 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) are set forth in the table below
(percentage amounts may not add to totals due to rounding).




53




---



Percentage of Total
      RevenuesBefore IntersegmentSales EliminationYear Ended
            
            Year EndedFeb. 1,
            
            Feb. 3,
            
            Feb. 1,
            
            Feb. 3,2009
            
            2008
            
            2009
            
            2008(In thousands)Revenues:Doughnut mixes
            
            $
            73,312
            
            $
            71,509
            
            38.3
            %
            
            34.8
            %Other ingredients,
      packaging and supplies
            
            
            106,054
            
            
            118,688
            
            55.4
            
            
            57.8Equipment
            
            
            8,749
            
            
            13,086
            
            4.6
            
            
            6.4Fuel surcharge
            
            
            3,341
            
            
            2,216
            
            1.7
            
            
            1.1Total
      revenues before intersegment sales elimination
            
            
            191,456
            
            
            205,499
            
            100.0
            
            
            100.0Operating expenses:Cost of sales:Cost
      of goods produced and purchased
            
            
            131,594
            
            
            138,374
            
            68.7
            
            
            67.3Inbound
      freight
            
            
            7,550
            
            
            6,062
            
            3.9
            
            
            2.9Total
      cost of sales
            
            
            139,144
            
            
            144,436
            
            72.7
            
            
            70.3Distribution
    costs:Outbound
      freight
            
            
            13,806
            
            
            12,521
            
            7.2
            
            
            6.1Other
      distribution costs
            
            
            3,357
            
            
            1,308
            
            1.8
            
            
            0.6Total
      distribution costs
            
            
            17,163
            
            
            13,829
            
            9.0
            
            
            6.7Other segment operating
      costs
            
            
            9,496
            
            
            15,768
            
            5.0
            
            
            7.7Depreciation
      expense
            
            
            1,019
            
            
            5,586
            
            0.5
            
            
            2.7Allocated corporate
      overhead
            
            
            1,365
            
            
            1,797
            
            0.7
            
            
            0.9Total
      operating costs
            
            
            168,187
            
            
            181,416
            
            87.8
            
            
            88.3Segment operating
income
            
            $
            23,269
            
            $
            24,083
            
            12.2
            %
            
            11.7
            %


KK Supply Chain revenues before intersegment sales elimination fell $14.0
million, or 6.8%, in fiscal 2009 compared to fiscal 2008. Excluding the 53rd week in fiscal 2008,
KK Supply Chain revenues before intersegment eliminations decreased 5.0% from
$201.5 million in fiscal 2008. The most significant reason for the decrease in
revenues (measured on a 52-week basis) was lower unit sales of mixes,
ingredients and supplies resulting from lower sales by Company and domestic
franchise stores. In addition, an increasing percentage of franchisee 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. The decline in the KK Supply Chain revenue due
to lower unit volume was partially offset by an increase in revenue resulting
from price increases for mixes and certain other ingredients instituted by KK
Supply Chain in fiscal 2009 in order to offset increases in the cost of
materials. The KK Supply Chain revenue decrease was also attributable to a
decrease in sales of equipment and equipment services in fiscal 2009 compared to
fiscal 2008. Franchisee expansion in fiscal 2009 was comprised principally of
satellite stores, which require less equipment than do factory
stores.




Cost of sales as a percentage of revenues increased in fiscal 2009
compared to fiscal 2008. The cost of raw materials used in the production of
doughnut mix and of other goods sold to Company and franchise stores was higher
in fiscal 2009 than in fiscal 2008. In particular, the prices of flour and
shortening and the products from which they are made were significantly higher
in fiscal 2009 compared to fiscal 2008. During fiscal 2009, KK Supply Chain
increased the prices charged to Company and franchise stores for doughnut mixes,
shortening and other goods in order to mitigate increases in the cost of these
raw materials. However, while KK Supply Chain increased prices to cover its
increased costs, profit margins as a percentage of sales decreased. In addition,
cost of sales was adversely affected by higher inbound freight costs resulting
from higher fuel prices.




Outbound freight costs increased in fiscal 2009 compared to fiscal 2008.
A significant component of the increase was a charge of approximately $1.7
million (approximately 0.9% of KK Supply Chain revenues before intersegment
sales elimination) related to payments made by the Company to its former
third-party freight consolidator which were improperly not remitted to the
freight carriers by the freight consolidator. For many years, the Company
utilized a third-party freight consolidator to review and pay freight bills on
behalf of the Company. During the second quarter of fiscal 2009, the Company
made routine payments to the third-party freight consolidator which were
improperly not remitted to the freight carriers. The actions of the third-party
freight consolidator, which has since filed for bankruptcy protection, resulted
in a loss to the Company which the Company currently has not
recovered.




54




---



Other segment operating costs include segment management, purchasing,
customer service and support, laboratory and quality control costs and research
and development expenses. These costs include a net credit of approximately
$950,000 for bad debts expense in fiscal 2009 compared to a charge of
approximately $1.5 million in fiscal 2008. The net credit in fiscal 2009
reflects a reduction in the allowance for doubtful accounts resulting
principally from a decrease in credit exposure with respect to certain
franchisees and a recovery of certain receivables previously reserved, partially
offset by bad debt provisions recorded with respect to other franchise
receivables. As of February 1, 2009, the Company’s allowance for doubtful
accounts from franchisees totaled approximately $2.8 million.




Depreciation and amortization expense decreased to $1.0 million in fiscal
2009 from $5.6 million in fiscal 2008. Depreciation and amortization expense
decreased approximately $4.3 million in fiscal 2009 compared to fiscal 2008 as a
result of the Company’s divestiture in January 2008 of its manufacturing and
distribution facility in Effingham, Illinois.




Domestic and international franchisees opened 120 stores and closed 40
stores in fiscal 2009. The majority 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.




General and Administrative
Expenses




General and administrative expenses decreased to $23.5 million in fiscal
2009 from $26.3 million in fiscal 2008. General and administrative expenses in
fiscal 2008 include approximately $2.7 million recorded in the fourth quarter
for severance costs related to the resignation of the Company’s former chief
executive officer, of which approximately $1.6 million was share-based
compensation (including accelerated vesting of certain equity awards). The
decrease in general and administrative expenses in fiscal 2009 also reflects a
decrease in other share-based compensation expense of approximately $700,000 due
principally to executive officer turnover resulting in the forfeiture of stock
and option awards, and the elimination of incentive compensation costs in fiscal
2009 due to the Company’s failure to achieve incentive compensation targets for
the year, which reduced incentive compensation costs by approximately $1.0
million from fiscal 2008. These decreases in general and administrative expenses
were partially offset by a charge of approximately $1.1 million in fiscal 2009
related to changes in the Company’s vacation policy.




General and administrative expenses in fiscal 2009 include an out of
period credit of approximately $600,000 related to the Company’s self-insured
worker’s compensation program, and these costs in fiscal 2008 include unusual
credits of $480,000 relating to the settlement of certain charitable pledge
obligations.




General and administrative expenses include professional fees and
expenses related to the investigations and securities litigation described in
Note 12 to the consolidated financial statements included elsewhere herein,
which totaled approximately $1.3 million in fiscal 2009 and $1.1 million in
fiscal 2008.




Impairment Charges and Lease
Termination Costs




Impairment charges and lease termination costs were $548,000 in fiscal
2009 compared to $62.1 million in fiscal 2008.




Impairment charges related to long-lived assets totaled $1.1 million in
fiscal 2009 and $56.0 million in fiscal 2008, of which approximately $900,000
and $44.1 million, respectively, related to underperforming stores. The charges
relate to stores closed or expected to be closed, as well as charges with
respect 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. The Company closed six stores
in fiscal 2009 and nine stores in fiscal 2008. 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 decisions, the effects of changing costs
(including commodity 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.




55




---



In addition, in fiscal 2008, the Company recorded an impairment charge of
approximately $10.4 million with respect to its KK Supply Chain manufacturing
and distribution facility in Effingham, Illinois. During the second quarter of
fiscal 2008, the Company decided to divest the facility and determined that the
projected cash flows from operation and ultimate sale of the facility were less
than its carrying value; accordingly, the Company recorded an impairment charge
to reduce the carrying value of the facility and related equipment to their
estimated fair value. In the fourth quarter of fiscal 2008, the Company sold
these assets for approximately $10.9 million cash (net of expenses), and
recorded a credit to impairment charges of approximately $600,000, representing
the excess of the ultimate selling price over the previously estimated
disposition value of the facility and equipment. Also during fiscal 2008, the
Company decided to close its KK Supply Chain coffee roasting operation and to
sell the related assets, and recorded an impairment charge of approximately $1.5
million to reduce the carrying value of those assets to their estimated disposal
value of $1.9 million. The Company sold these assets for approximately $1.9
million cash during the third quarter of fiscal 2008.




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. In fiscal
2009, changes in estimated sublease rentals on a closed store that was
subsequently refranchised and the realization of proceeds on an assignment of
another closed store lease resulted in $1.2 million of credits to the provision
for lease termination costs. These credits, in combination with the reversal of
approximately $800,000 of previously recorded accrued rent expense related to
stores closed during the year and approximately $1.5 million of charges related
to other closed store leases, resulted in a net credit in the provision for
lease termination costs of $502,000 in fiscal 2009. In fiscal 2008, the Company
received proceeds of $966,000 on the assignment of leases related to closed
stores, reversed approximately $1.7 million of previously recorded accrued rent
expense related to stores closed during the year and recorded approximately $1.7
million of charges related to other closed store leases, resulting in a net
provision for lease termination costs of $1.0 million in fiscal
2008.




In fiscal 2009, the Company refranchised one idled store acquired by the
Company from a failed franchisee, refranchised two domestic operating stores to
a new franchisee, and refranchised the four Company stores in Eastern Canada to
a new franchisee. The Company received no proceeds in connection with any of
these transactions. With the exception of a non-cash pretax gain of $2.8 million
recorded in the fourth quarter of fiscal 2009 related to foreign currency
translation arising from the Canadian disposal (which is included in
non-operating income and expense), no significant gain or loss was recognized as
a result of the refranchisings.




Settlement of
Litigation




In the first quarter of fiscal 2008, the Company issued common stock and
warrants to acquire common stock in connection with the settlement of a federal
securities class action and to settle, in part, certain shareholder derivative
actions, as more fully described in Note 12 to the consolidated financial
statements appearing elsewhere herein. The Company recorded a charge to earnings
in fiscal 2006 for the fair value of the stock and warrants, measured as of the
date on which the Company agreed to settle the litigation, and adjusted that
charge in subsequent periods to reflect changes in the securities’ fair value
until their issuance in the first quarter of fiscal 2008. Such subsequent
adjustment resulted in a non-cash credit to fiscal 2008 earnings of $14.9
million.




Interest
Income




Interest income decreased to $331,000 in fiscal 2009 from $1.4 million in
fiscal 2008 primarily due to lower short term interest rates in fiscal 2009
compared to fiscal 2008.




56




---



Interest
Expense




The components of interest expense are as follows:




Year EndedFeb. 1,
            
            Feb. 3,2009
            
            2008(In thousands)Interest accruing on outstanding
      indebtedness
            
            $
            6,402
            
            $
            8,418Letter of credit and unused revolver fees
            
            
            1,082
            
            
            736Fees associated with credit agreement
      amendments
            
            
            261
            
            
            —Write-off of deferred financing costs associated with credit
      agreement amendments
            
            
            289
            
            
            —Fees associated with credit agreement
      refinancing
            
            
            —
            
            
            220Amortization of deferred financing costs
            
            
            543
            
            
            522Mark to market adjustments on interest
      rate derivatives
            
            
            798
            
            
            96Amortization of unrealized (gain) loss on interest rate
      derivatives
            
            
            969
            
            
            (69
            )Payment to (from) counterparty on
      interest rate cap derivative
            
            
            124
            
            
            (163
            )Other
            
            
            211
            
            
            36$
            10,679
            
            $
            9,796


Interest accruing on outstanding indebtedness was lower in fiscal 2009
than in fiscal 2008 because of a reduction in outstanding debt since the first
quarter of fiscal 2008. This lower interest on outstanding indebtedness was
partially offset by higher lender margin and fees resulting from the amendments
to the Company’s 2007 Secured Credit Facilities described in Note 10 to the
consolidated financial statements appearing elsewhere herein.




As more fully described in Note 22 to the consolidated financial
statements appearing elsewhere herein, effective April 9, 2008, the Company
discontinued hedge accounting for certain interest rate derivatives as a result
of amendments to its credit facilities. As a consequence of the discontinuance
of hedge accounting, changes in the fair value of the derivative contracts
subsequent to April 8, 2008 are reflected in earnings as they occur. Amounts
included in accumulated other comprehensive income related to changes in the
fair value of the derivative contracts for periods prior to April 9, 2008 are
being charged to earnings through April 2010 when the underlying hedged
transactions (interest expense on long-term debt) affect earnings.




Loss on Extinguishment of
Debt




During the first quarter of fiscal 2008, the Company closed the 2007
Secured Credit Facilities and used the proceeds to retire other indebtedness, as
more fully described in Note 10 to the consolidated financial statements
appearing elsewhere herein. The Company recorded a loss on extinguishment of
debt of approximately $9.6 million, consisting of a $4.1 million prepayment fee
related to the other indebtedness and a $5.5 million write-off of unamortized
deferred financing costs related to that debt.




Equity in Losses of Equity Method
Franchisees




Equity in losses of equity method franchisees totaled $786,000 in fiscal
2009 compared to $933,000 in fiscal 2008. This caption represents the Company’s
share of operating results of equity method franchisees which develop and
operate Krispy Kreme stores.




Other Non-Operating Income and
Expense, Net




Other non-operating income and expense in fiscal 2009 includes a non-cash
gain of approximately $2.8 million relating to the disposition of the Company’s
Canadian subsidiary in connection with the refranchising of the Company’s four
stores in Eastern Canada, substantially all of which represents the cumulative
foreign currency translation adjustment related to the Canadian operations
which, prior to the sale of the stores, had been reflected, net of tax, in
accumulated other comprehensive income. In addition, other non-operating income
and expense in fiscal 2009 includes a non-cash gain of $931,000 on the disposal
of an investment in an Equity Method Franchisee, largely offset by a $900,000
charge for collectability risk on a note receivable from another Equity Method
Franchisee, as described in Note 18 to the consolidated financial statements
appearing elsewhere herein.




Other non-operating income and expense in fiscal 2008 includes a
provision of $3.0 million recorded in the fourth quarter for estimated payments
under the Company’s guarantees of certain debt and leases related to an Equity
Method Franchisee and, in fiscal 2009, the Company paid approximately $250,000
related to these guarantees, which are more fully described in Note 18 to the
consolidated financial statements appearing elsewhere herein. In addition, other
non-operating income and expense in fiscal 2008 includes an impairment charge of
approximately $572,000 to reduce the carrying value of the Company’s investment
in a franchisee to its estimated fair value, partially offset by a gain of
approximately $260,000 resulting from additional proceeds from the prior sale of
an interest in another franchisee.




57




---



Provision for Income
Taxes




The provision for income taxes was $503,000 and $2.3 million in fiscal
2009 and fiscal 2008, respectively. Each of these amounts includes 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, as well as a provision for income taxes estimated to
be payable currently. The deferred income tax provision for fiscal 2009 includes
$1.2 million of deferred income taxes related to the cumulative foreign currency
translation gain associated with the Company’s operations in Eastern Canada
which, prior to the sale of the operations in the fourth quarter of fiscal 2009
and the resulting recognition of the gain, was included in accumulated other
comprehensive income. In addition, the fiscal 2009 income tax provision includes
a credit of approximately $1.8 million to reduce accruals for uncertain tax
positions, principally as a result of the dissolution of one of the Company’s
foreign subsidiaries and the resolution of related income tax
uncertainties.




Net Loss




The Company incurred net losses of $4.1 million and $67.1 million in
fiscal 2009 and 2008, respectively.




Liquidity and Capital
Resources




The following table summarizes the Company’s cash flows from operating,
investing and financing activities for fiscal 2010, 2009 and 2008:




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Net cash provided by operating
      activities
            
            $
            19,827
            
            
            $
            16,593
            
            
            $
            9,712Net cash provided by (used for) investing activities
            
            
            (2,175
            )
            
            
            (4,296
            )
            
            
            13,118Net cash used for financing
      activities
            
            
            (32,975
            )
            
            
            (1,422
            )
            
            
            (34,425
            )Effect of exchange rate changes on cash
            
            
            —
            
            
            
            (72
            )
            
            
            88Net increase (decrease)
      in cash and cash equivalents
            
            $
            (15,323
            )
            
            $
            10,803
            
            
            $
            (11,507
            )


Cash Flows from Operating
Activities




Net cash provided by operating activities was $19.8 million in fiscal
2010, $16.6 million in fiscal 2009 and $9.7 million in fiscal 2008.




The improvement in operating results accounted for all of the increase in
cash provided by operating activities in fiscal 2010; the net loss, adjusted for
non-cash charges and credits, improved by $4.9 million over fiscal 2009. While
operating results improved, the scope of the Company’s operations has decreased
in recent years as it has closed underperforming locations and rationalized
other components of its business, resulting in a decrease in the amount of
working capital funded by accounts payable and accruals, which have had a net
decrease of $5.5 million in the past two years. Most of this decrease was offset
by declines in accounts receivable as off-premises doughnut sales and sales to
franchisees declined, and by decreases in the Company’s investment in
inventories.




58




---



In addition, cash provided by operating activities in fiscal 2008
reflects a cash outflow of approximately $4.1 million for a prepayment fee
associated with the refinancing of the Company’s credit facilities described
under “Cash Flows from Financing Activities” below.




Cash Flows from Investing
Activities




Net cash used for investing activities was approximately $2.2 million and
$4.3 million in fiscal 2010 and 2009, respectively, compared to net cash
provided by investing activities of $13.1 million in fiscal 2008.




Cash used for capital expenditures increased to $8.0 million in fiscal
2010 from $4.7 million in fiscal 2009 and $5.5 million in fiscal 2008,
reflecting the construction of six new stores in fiscal 2010 and increased store
refurbishment efforts.




In fiscal 2010, 2009 and 2008, the Company realized proceeds from the
sale of property and equipment of $5.8 million, $748,000 and $18.3 million,
respectively, which, except for approximately $10.9 million (net of expenses)
received in fiscal 2008 from the sale of a mix manufacturing and distribution
facility, related principally to the sale of closed or refranchised
stores.




Cash Flows from Financing
Activities




Net cash used for financing activities was $33.0 million in fiscal 2010,
$1.4 million in fiscal 2009 and $34.4 million in fiscal 2008.




During fiscal 2010, the Company repaid approximately $31.7 million of
outstanding term loan and capitalized lease indebtedness, consisting of
approximately $1.1 million of scheduled principal amortization, a prepayment of
$20 million in connection with amendments to the Company’s credit facilities in
April 2009 as described in Note 10 to the consolidated financial statements
appearing elsewhere herein, prepayments aggregating $5.6 million from the sale
of assets related to three closed stores and one store which was refranchised,
and a discretionary prepayment of $5 million made on the term loan during the
third quarter of fiscal 2010. During fiscal 2009, the Company repaid
approximately $2.0 million of outstanding term loan and capitalized lease
indebtedness, consisting of approximately $1.2 million of scheduled amortization
and a prepayment of approximately $750,000 from the proceeds of the assignment
of a lease related to a closed store. Additionally, the Company paid
approximately $1.9 million and $728,000 in fees to its lenders in fiscal 2010
and fiscal 2009, respectively, to amend its credit facilities. Of such aggregate
amounts, $954,000 and $467,000, respectively, was capitalized as deferred
financing costs, and the balance of approximately $925,000 and $261,000,
respectively, was charged to interest expense.




In fiscal 2009, the Company received $3.1 million in proceeds from the
exercise of stock options. During the same period, present and former employees
surrendered common shares having an aggregate fair value of $2.1 million to pay
the exercise price of options exercised and to reimburse the Company for the
minimum statutory withholding taxes paid by the Company on behalf of present and
former employees arising from such exercise and from the vesting of restricted
stock awards.




In early fiscal 2008, the Company closed new secured credit facilities
totaling $160 million. At closing, the Company borrowed $110 million under a
term loan, and used the proceeds to retire approximately $107 million of
indebtedness outstanding under its former secured credit facilities (which were
terminated) and to pay prepayment fees under the former secured credit
facilities and fees and expenses associated with the new credit facilities. Also
in fiscal 2008, the Company prepaid approximately $32.8 million of the new term
loan, of which $17.8 million was from the proceeds of sales of certain property
and equipment and $15.0 million represented discretionary
prepayments.




Capital Resources, Contractual Obligations and
Off-Balance Sheet Arrangements




In addition to cash flow generated from operations, the Company utilizes
other capital resources and financing arrangements to fund its business. A
discussion of these capital resources and financing techniques is included
below.




Debt




The Company continuously monitors its funding requirements for general
working capital purposes and other financing and investing activities. In the
last three fiscal years, management focused on reducing or eliminating the
Company’s investments in franchisees and the related guarantees of franchisees’
obligations, and on restructuring the Company’s borrowing arrangements to
maintain credit availability to facilitate accomplishing the Company’s business
restructuring initiatives.




59




---



The Secured Credit Facilities described in Note 10 to the consolidated
financial statements appearing elsewhere herein are the Company’s principal
source of external financing. These facilities consist of a term loan having an
outstanding principal balance of $43.1 million as of January 31, 2010 which
matures in February 2014, and a $25 million revolving credit facility maturing
in February 2013.




The Secured Credit Facilities contain significant financial covenants.
Based on the Company’s current working capital and the fiscal 2011 operating
plan, management believes the Company can comply with the financial covenants
and that the Company can meet its projected operating, investing and financing
cash requirements.




Failure to comply with the financial covenants contained in the Secured
Credit Facilities, or the occurrence or failure to occur of certain events,
would cause the Company to default under the facilities. The Company would
attempt to negotiate waivers of any such default, should one occur. There can be
no assurance that the Company would be able to negotiate any such waivers, and
the costs or conditions associated with any such waivers could be significant.
In the absence of a waiver of, or forbearance with respect to, any such default,
the Company’s lenders would be able to exercise their rights under the credit
agreement including, but not limited to, accelerating maturity of outstanding
indebtedness and asserting their rights with respect to the collateral.
Acceleration of the maturity of indebtedness under the Secured Credit Facilities
could have a material adverse effect on the Company’s financial position,
results of operations and cash flows. In the event that credit under the Secured
Credit Facilities were not available to the Company, there can be no assurance
that alternative sources of credit would be available to the Company or, if they
are available, under what terms or at what cost.




The operation of the financial covenants described above could limit the
amount the Company may borrow under the revolving credit facility. In addition,
the maximum amount which may be borrowed under the revolving facility is reduced
by the amount of outstanding letters of credit, which totaled approximately $15
million as of January 31, 2010, the substantial majority of which secure the
Company’s reimbursement obligations to insurers under the Company’s self-
insurance arrangements. The maximum additional borrowing available to the
Company as of January 31, 2010 was approximately $10 million.




The Secured Credit Facilities also contain customary events of default
including without limitation, payment defaults, breaches of representations and
warranties, covenant defaults, cross-defaults to other indebtedness in excess of
$5 million, certain events of bankruptcy and insolvency, judgment defaults in
excess of $5 million and the occurrence of a change of control.




Leases




The Company conducts some of its operations from leased facilities and
leases certain equipment. Generally, these leases have initial terms of two to
20 years and contain provisions for renewal options of five to 15 years. In
determining whether to enter into a lease for an asset, the Company evaluates
the nature of the asset and the associated lease terms to determine if leasing
is an effective financing tool.




Off-Balance Sheet
Arrangements




The Company’s only off-balance sheet arrangements, as defined by Item
303(a)(4) of SEC Regulation S-K, consist principally of the Company’s guarantees
of indebtedness of certain franchisees, as discussed in Notes 12 and 18 to the
consolidated financial statements appearing elsewhere herein.




60




---



Contractual Cash Obligations at January 31,
2010




The Company’s contractual cash obligations as of January 31, 2010 are as
follows:




Payments Due InLess
            
            
            
            
            
            
            
            MoreThan
            
            
            
            
            
            
            
            ThanTotal
            
            1
            
            1-3
            
            3-5
            
            5Amount
            
            Year
            
            Years
            
            Years
            
            Years(In thousands)Long-term debt (excluding capital lease
      obligations),including current
      maturities
            
            $
            43,054
            
            $
            564
            
            $
            1,128
            
            $
            41,362
            
            $
            —Interest payment obligations (1)
            
            
            22,415
            
            
            5,857
            
            
            11,552
            
            
            5,006
            
            
            —Payment obligations on interest rate
      hedge
            
            
            642
            
            
            642
            
            
            —
            
            
            —
            
            
            —Capital lease obligations
            
            
            393
            
            
            198
            
            
            195
            
            
            —
            
            
            —Operating lease obligations
            
            
            91,524
            
            
            8,866
            
            
            14,741
            
            
            11,250
            
            
            56,667Purchase obligations
            
            
            42,897
            
            
            39,379
            
            
            3,518
            
            
            —
            
            
            —Contingent guarantee obligations
      (2)
            
            
            3,730
            
            
            3,199
            
            
            531
            
            
            —
            
            
            —Other long-term obligations, including current portion,reflected on the
      Company’s balance sheet:Self-insurance
      claims
            
            
            14,682
            
            
            5,355
            
            
            3,824
            
            
            1,777
            
            
            3,726401(k)
      mirror plan liability
            
            
            455
            
            
            —
            
            
            —
            
            
            —
            
            
            455Total
            
            $
            219,792
            
            $
            64,060
            
            $
            35,489
            
            $
            59,395
            
            $
            60,848____________________


(1)
            
            Estimated
      interest payments for variable rate debt are based upon the forward LIBOR
      interest rate curve as of January 29, 2010.(2)
            
            Amounts represent
      100% of the Company’s aggregate exposure at January 31, 2010 under loan
      guarantees related to franchisees in which the Company has an ownership
      interest.




The preceding table of contractual cash obligations excludes income tax
liabilities of approximately $540,000 as of January 31, 2010 for unrecognized
tax benefits due to uncertainty in predicting the timing of any such related
payments.




Capital Requirements




In the next five years, the Company plans to use cash primarily for the
following activities:


- Working capital and other general
  corporate purposes
- Opening new Company stores in
  selected markets, principally small retail shops
- Remodeling and relocation of
  selected older Company shops
- Investing in equipment to support
  the off-premises distribution channel
- Maintaining and enhancing the
  Supply Chain manufacturing and distribution capabilities
- Investing in systems and
  technology

The Company’s capital requirements for these activities may be
significant. The amount of these capital requirements will depend on many
factors including the Company’s overall performance, the pace of store expansion
and Company store remodels and other infrastructure needs. These capital outlays
are subject to limitations contained in the Secured Credit Facilities. The
Company currently estimates that its capital expenditures for fiscal 2011 will
be in the range of from $13 million to $17 million. The most significant capital
expenditures currently planned for fiscal 2011 are between seven and ten new
satellite stores, refurbishments to existing stores, new point-of-sale hardware
to replace existing hardware that is approaching the end of its useful life, and
ongoing maintenance capital expenditures. The Company plans to fund these
expenditures using cash provided by operations and current cash
resources.





61




---



Recent Financial Performance and Business
Conditions
  The Company experienced a decline in revenues and incurred net losses in
each of the last three fiscal years. The revenue decline reflects fewer Company
stores in operation resulting principally from the closure of lower performing
locations, a decrease in off-premises sales at Company stores, a decline in
domestic royalty revenues and lower sales of mixes and other ingredients
resulting from lower sales by the Company’s domestic franchisees. Lower revenues
have adversely affected operating margins because of the fixed or semi-fixed
nature of many of the Company’s direct operating expenses. In addition, the
prices of certain agricultural commodities and of oil, while volatile, have
trended upward in the last fiscal three years, which has adversely affected the
cost of the Company’s principal ingredients and increased the cost of gasoline
consumed by the Company. Sales volumes and changes in the cost of major
ingredients and fuel can have a material effect on the Company’s results of
operations and cash flows. In addition, royalty revenues and most of KK Supply
Chain 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.




The Company generated cash flow from operating activities of $19.8
million, $16.6 million and $9.7 million in fiscal 2010, 2009 and 2008,
respectively, and the Company has reduced its aggregate outstanding debt by
$64.2 million over the past three fiscal years, using both cash generated from
the sale of excess assets and cash generated by operations.




The Company’s credit facilities described above and in Note 10 to the
consolidated financial statements appearing elsewhere herein are the Company’s
principal source of external financing. These facilities consist of a term loan
having an outstanding principal balance of $43.1 million as of January 31, 2010
which matures in February 2014, and a $25 million revolving credit facility
maturing in February 2013. The credit facilities contain significant financial
covenants, which also are described in Note 10. Based on the Company’s current
working capital and the fiscal 2011 operating plan, management believes the
Company can comply with the these financial covenants and that the Company can
meet its projected operating, investing and financing cash
requirements.




Inflation




The Company does not believe that general price inflation has had a
material effect on its results of operations in recent years. However, prices of
agricultural commodities and fuel have been volatile in recent years. Those
price changes, which have generally trended upward, have had a significant
effect on the cost of flour, shortening and sugar, the three most significant
ingredients used in the production of the Company’s products, as well as on the
cost of gasoline consumed by the Company’s off-premises delivery
fleet.




Critical Accounting
Policies




The Company’s discussion and analysis of its financial condition and
results of operations is based upon its financial statements that have been
prepared in accordance with GAAP. The preparation of financial statements in
accordance with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses and
related disclosures, including disclosures of contingencies and uncertainties.
GAAP provides the framework from which to make these estimates, assumptions and
disclosures. The Company chooses accounting policies within GAAP that management
believes are appropriate to accurately and fairly report the Company’s operating
results and financial position in a consistent manner. Management regularly
assesses these policies in light of changes in facts and circumstances and
discusses the selection of accounting policies and significant accounting
judgments with the Audit Committee of the Board of Directors. The Company
believes that application of the following accounting policies involves
judgments and estimates that are among the more significant used in the
preparation of the financial statements, and that an understanding of these
policies is important to understanding the Company’s financial condition and
results of operations.




Allowance for Doubtful
Accounts




Accounts receivable arise primarily from royalties earned on sales by the
Company’s franchisees, sales by KK Supply Chain to our franchisees of equipment,
mix and other supplies necessary to operate a Krispy Kreme store, as well as
from off-premises sales by company stores to convenience and grocery stores and
other customers. During the three fiscal years in the period ended January 31,
2010, some of the Company’s franchisees experienced financial difficulties or
for other reasons did not comply with the normal payment terms for settlement of
amounts due to the Company. The Company has recorded provisions for doubtful
accounts related to its accounts receivable, including receivables from
franchisees, in amounts which management believes are sufficient to provide for
losses estimated to be sustained on realization of these receivables. Such
estimates inherently involve uncertainties and assessments of the outcome of
future events, and changes in facts and circumstances may result in adjustments
to the provision for doubtful accounts.




62




---



Goodwill and Identifiable Intangible
Assets




The Financial Accounting Standards Board (“FASB”) guidance related to
goodwill and other intangible assets addresses the accounting and reporting of
goodwill and other intangible assets subsequent to their acquisition. This
guidance requires intangible assets with definite lives to be amortized over
their estimated useful lives, while those with indefinite lives and goodwill are
not subject to amortization but must be tested annually for impairment, or more
frequently if events and circumstances indicate potential
impairment.




For intangible assets with indefinite lives, the Company performs the
annual test for impairment as of December 31. The impairment test for
indefinite-lived intangible assets involves comparing the fair value of such
assets with their carrying value, with any excess of carrying value over fair
value recorded as an impairment charge. The goodwill impairment test involves
determining the fair values of the reporting units to which goodwill is assigned
and comparing those fair values to the reporting units’ carrying values,
including goodwill. To determine fair value for each reporting unit, the Company
uses the discounted cash flows that the reporting unit can be expected to
generate in the future. This valuation method requires management to project
revenues, operating expenses, working capital investment, capital spending and
cash flows for the reporting units over a multi-year period, as well as
determine the weighted average cost of capital to be used as a discount rate.
The Company also considers the estimated fair values of its reporting units
relative to the Company’s overall market capitalization in connection with its
goodwill impairment assessment. Significant management judgment is involved in
preparing these estimates. Changes in projections or estimates could
significantly change the estimated fair value of reporting units. In addition,
if management uses different assumptions or estimates in the future or if
conditions exist in future periods that are different than those anticipated,
operating results and the balances of goodwill could be affected by impairment
charges. Impairment analyses of goodwill resulted in impairment charges of
approximately $4.6 million in fiscal 2008. There were no goodwill impairment
charges in fiscal 2010 or fiscal 2009. As of January 31, 2010, the remaining
goodwill had a carrying value of $23.5 million, all of which was associated with
the Domestic and International Franchise segments, each of which consists of a
single reporting unit. The risk of goodwill impairment would increase in the
event that the franchise segment operating results were to significantly
deteriorate or the overall market capitalization of the Company were to decline
below the book value of the Company’s shareholders’ equity.




Asset Impairment




When an asset group (typically a store) is identified as underperforming
or when a decision is made to abandon an asset group or to close a store, the
Company makes an assessment of the potential impairment of the related assets.
The assessment is based upon a comparison of the carrying amount of the assets,
primarily property and equipment, to the estimated undiscounted cash flows
expected to be generated from those assets. To estimate cash flows, management
projects the net cash flows anticipated from continuing operation of the asset
group or store until its closing or abandonment, as well as cash flows, if any,
anticipated from disposal of the related assets. If the carrying amount of the
assets exceeds the sum of the undiscounted cash flows, the Company records an
impairment charge in an amount equal to the excess of the carrying value of the
assets over their estimated fair value.




Determining undiscounted cash flows and the fair value of an asset group
involves estimating future cash flows, revenues, operating expenses and disposal
values. The projections of these amounts represent management’s best estimates
at the time of the review. If different cash flows had been estimated, property
and equipment balances and related impairment charges could have been affected.
Further, if management uses different assumptions or estimates in the future or
if conditions exist in future periods that are different than those anticipated,
future operating results could be affected. In addition, the sale of assets
whose carrying value has been reduced by impairment charges could result in the
recognition of gains or losses to the extent the sales proceeds realized differ
from the reduced carrying amount of the assets. In fiscal 2010, fiscal 2009 and
fiscal 2008, the Company recorded impairment charges related to long-lived
assets totaling approximately $3.1 million, $1.1 million and $56.0 million,
respectively. Additional impairment charges may be necessary in future
years.




Insurance




The Company is subject to workers’ compensation, vehicle and general
liability claims. The Company is self-insured for the cost of all workers’
compensation, vehicle and general liability claims up to the amount of stop-loss
insurance coverage purchased by the Company from commercial insurance carriers.
The Company maintains accruals for the estimated cost of claims on an
undiscounted basis, without regard to the effects of stop-loss coverage, using
actuarial methods which evaluate known open and incurred but not reported claims
and consider historical loss development experience. In addition, the Company
records receivables from the insurance carriers for claims amounts estimated to
be recovered under the stop-loss insurance policies when these amounts are
estimable and probable of collection. The Company estimates such stop-loss
receivables using the same actuarial methods used to establish the related
claims accruals, and taking into account the amount of risk transferred to the
carriers under the stop-loss policies. Many estimates and assumptions are
involved in estimating future claims, and differences between future events and
prior estimates and assumptions could affect future operating results and result
in adjustments to these loss accruals and related insurance
receivables.




63




---



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 already 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 income tax
assets in accordance with FASB guidance related to accounting for income taxes.
At January 31, 2010, the Company has recorded a valuation allowance against
deferred income tax assets of $160.6 million, representing the total amount of
such assets in excess of the Company’s deferred income tax liabilities. The
valuation allowance was recorded because management was unable to conclude, in
light of the cumulative losses realized by the Company, that realization of the
net deferred income tax asset was more likely than not. 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 assumed or anticipated, the amount of income tax assets and liabilities,
including valuation allowances for deferred income tax assets, could be
materially affected.




Guarantee
Liabilities




The Company has guaranteed a portion of certain loan obligations of
certain franchisees in which the Company owns an interest. The Company assesses
the likelihood of making any payments under the guarantees and records estimated
liabilities for anticipated payments when the Company believes that an
obligation to perform under the guarantees is probable and the amount can be
reasonably estimated. No liabilities for the guarantees were recorded at the
time they were issued because the Company believed the value of the guarantees
was immaterial. As of January 31, 2010, the Company has recorded liabilities of
approximately $2.5 million related to such loan guarantees. The aggregate
outstanding principal balance of loans subject to the Company’s guarantees was
approximately $3.7 million at that date. Assessing the probability of future
guarantee payments involves estimates and assumptions regarding future events,
including the future operating results of the franchisees. If future events are
different from those assumed or anticipated, the amounts estimated to be paid
pursuant to such guarantees could change, and additional provisions to record
such liabilities could be required.




Investments in
Franchisees




The Company has investments in certain Equity Method Franchisees, the
value of which cannot be verified by reference to quoted market prices. The
Company’s assessment of the realizability of these investments involves
assumptions concerning future events, including the future operating results of
the franchisees. If future events are different from those assumed or
anticipated by the Company, the assessment of realizability of the recorded
investments in these entities could change, and impairment provisions related to
these investments could be required. During the years ended January 31, 2010 and
February 1, 2009, the Company recorded impairment charges of $500,000 and
$957,000, respectively, related to investments in and advances to Equity Method
Franchisees. As of January 31, 2010, the Company’s investment in Equity Method
Franchisees was $781,000.




Stock-Based
Compensation




The Company measures and recognizes compensation expense for share-based
payment awards based on their fair values. Because options granted to employees
differ from options on the Company’s common shares traded in the financial
markets, the Company cannot determine the fair value of options granted to
employees based on observed market prices. Accordingly, the Company estimates
the fair value of stock options subject only to service conditions using the
Black-Scholes option valuation model, which requires inputs including interest
rates, expected dividends, volatility measures and employee exercise behavior
patterns. Some of the inputs the Company uses are not market-observable and must
be estimated. The fair value of stock options which contain market conditions as
well as service conditions is estimated using Monte Carlo simulation techniques.
In addition, the Company must estimate the number of awards which ultimately
will vest, and periodically adjusts such estimates to reflect actual vesting
events. Use of different estimates and assumptions would produce different
option values, which in turn would affect the amount of compensation expense
recognized.




64




---



The Black-Scholes model is capable of considering the specific features
included in the options granted to the Company’s employees that are subject only
to service conditions. However, there are other models which could be used to
estimate their fair value, and techniques other than Monte Carlo simulation
could be used to estimate the value of stock options which are subject to both
service and market conditions. If the Company were to use different models, the
option values would differ despite using the same inputs. Accordingly, using
different assumptions coupled with using different valuation models could have a
significant impact on the fair value of employee stock options.




Recent Accounting
Pronouncements




In March 2008, the FASB issued new disclosure standards about derivative
instruments and hedging activities. The new standards are intended to improve
financial reporting about derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity’s financial position, financial performance and cash flows.
The Company adopted the new standards prospectively as of February 2, 2009;
accordingly, disclosures related to periods prior to the date of adoption have
not been presented. Adoption of these standards did not have any effect on the
Company’s financial position or results of operations. See Note 22 to the
consolidated financial statements appearing elsewhere herein for additional
information about derivative financial instruments owned by the
Company.




In the first quarter of fiscal 2009, the Company adopted new accounting
standards with respect to financial assets and liabilities measured at fair
value on both a recurring and non-recurring basis and with respect to
nonfinancial assets and liabilities measured on a recurring basis. In the first
quarter of fiscal 2010, the Company adopted new accounting standards with
respect to nonrecurring measurements of nonfinancial assets and liabilities.
Adoption of these standards had no material effect on the Company’s financial
position or results of operations. See Note 21 to the consolidated financial
statements appearing elsewhere herein for additional information regarding fair
value measurements.




In May 2009, the FASB issued new accounting standards with respect to
subsequent events which establish general standards of accounting for, and
disclosure of, events that occur after the balance sheet date but before the
financial statements are issued or are available to be issued. The Company
adopted these standards, which did not represent a significant change from
existing practice, during the quarter ended August 2, 2009.




In June 2009, the FASB issued amended accounting standards related to the
consolidation of variable-interest entities. The amended standards require an
enterprise to qualitatively assess the determination of the primary beneficiary
of a variable interest entity (“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 or the right to receive benefits of the
VIE that could potentially be significant to the VIE. The amended standards
require an ongoing reconsideration of the identity of the VIE’s primary
beneficiary, if any, and provide a framework for the events that trigger a
reassessment of whether an entity is a VIE. The amended standards are effective
for the Company in the first quarter of fiscal 2011. Adoption of the new
standards will result in the Company recognizing a divestiture of three stores
that took place in a refranchising transaction in October 2009, as described
under “Basis of Consolidation,” to the consolidated financial statements
appearing elsewhere herein. Adoption of the standards will have no material
effect on the Company’s financial position, results of operations or cash
flows.




Item 7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK.




Interest Rate Risk




The Company is exposed to market risk from increases in interest rates on
its outstanding debt. All of the borrowings under the Company’s secured credit
facilities bear interest at variable rates based upon either the Fed funds 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.




65




---



As of January 31, 2010, the Company had approximately $43.4 million in
borrowings outstanding. A hypothetical increase of 100 basis points in
short-term interest rates would result in no increase in interest expense on the
Company’s term debt due to the operation of an interest rate floor provision in
the Company’s credit agreement. The Company’s credit facilities and the related
interest rate derivatives are described in Note 10 to the consolidated financial
statements appearing elsewhere herein.




Currency Risk




The substantial majority of the Company’s revenue, expense and capital
purchasing activities are transacted in U.S. dollars. The Company’s investment
in its franchisee operating in Mexico exposes the Company to exchange rate risk.
In addition, although royalties from international franchisees are payable to
the Company in U.S. dollars, those royalties are computed based on local
currency sales, and changes in the rate of exchange between the U.S. dollar and
the foreign currencies used in the countries in which the international
franchisees operate affect the Company’s royalty revenues. Because royalty
revenues are derived from a relatively large number of foreign countries, and
royalty revenues are not highly concentrated in a small number of such
countries, the Company believes that the relatively small size of any currency
hedging activities would adversely affect the economics of hedging strategies
and, accordingly, the Company historically has not attempted to hedge these
exchange rate risks.




For the year ended January 31, 2010, the Company’s international
franchisees had sales of approximately $264 million, and the Company’s related
royalty revenues were approximately $14 million. A hypothetical 10% change in
the average rate of exchange between the U.S. dollar and the currencies in which
the Company’s international franchisees do business would have a corresponding
effect on the Company’s international royalty revenues of approximately $1.4
million.




Commodity Price Risk




The Company is exposed to the effects of commodity price fluctuations on
the cost of ingredients of its products, of which flour, sugar and shortening
are the most significant. In order to secure adequate supplies of materials and
bring greater stability to the cost of ingredients, the Company routinely enters
into forward purchase contracts and other purchase arrangements with suppliers.
Under the forward purchase contracts, the Company commits to purchasing
agreed-upon quantities of ingredients at agreed-upon prices at specified future
dates. The outstanding purchase commitment for these commodities at any point in
time typically ranges from one month’s to two years’ anticipated requirements,
depending on the ingredient. Other purchase arrangements typically are
contractual arrangements with vendors (for example, with respect to certain
beverages and ingredients) under which the Company is not required to purchase
any minimum quantity of goods, but must purchase minimum percentages of its
requirements for such goods from these vendors with whom it has executed these
contracts.




In addition to entering into forward purchase contracts, 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 typically assigns the futures contract to a supplier in
connection with entering into a forward purchase contract for the related
ingredient.




The Company operates a large fleet of delivery vehicles and is exposed to
the effects of changes in gasoline prices. In fiscal 2010, the Company began
periodically using futures and options on futures to hedge a portion of its
exposure to rising gasoline prices.





66




---



Commodity Derivatives Outstanding at January
31, 2010




Quantitative information about the Company’s unassigned option contracts
and futures contracts and options on such contracts as of January 31, 2010,
which mature in fiscal 2011 and fiscal 2012, is set forth in the table
below.




Weighted
            
            Aggregate
            
            AggregateAverage Contract Price
            
            Contract Price
            
            FairContract Volume
            
            or Strike Price
            
            or Strike Price
            
            Value(Dollars in thousands, except average
      prices)Futures contracts:Wheat
            
            245,000 bu.
            
            $
            5.44/
            bu.
            
            $
            1,334
            
            $
            (69
            )Gasoline
            
            588,000 gal.
            
            $
            2.02/
            gal.
            
            
            1,191
            
            
            (23
            )




Although the Company utilizes forward purchase contracts and futures
contracts and options on such contracts to mitigate the risks related to
commodity price fluctuations, such contracts do not fully mitigate price risk.
In addition, the portion of the Company’s anticipated future commodity
requirements that are subject to such contracts vary from time to time. Adverse
changes in commodity prices could adversely affect the Company’s profitability
and liquidity.




Sensitivity to Price Changes in Agricultural
Commodities




The following table illustrates the potential effect on the Company’s
costs resulting from hypothetical changes in the cost of the Company’s three
most significant ingredients.




Approximate
            
            Approximate Range
            
            
            
            
            
            Approximate AnnualAnticipated Fiscal 2011
            
            of Prices Paid In
            
            Hypothetical Price
            
            Effect Of
  HypotheticalIngredient
            
            Purchases
            
            Fiscal 2010
            
            Increase
            
            Price Increase(In thousands)Flour
            
            53.6 million lbs.
            
            $0.1401 – $0.2679/lb.
            
            $
            0.01/
            lb.
            
            $
            536Shortening
            
            37.8 million lbs.
            
            $0.3710 – $0.6176/lb.
            
            $
            0.01/
            lb.
            
            
            378Sugar
            
            64.6 million lbs.
            
            $0.2882 – $0.3060/lb.
            
            $
            0.01/
            lb.
            
            
            646Gasoline
            
            2.4 million gal.
            
            $1.82 – $2.61/gal.
            
            $
            0.01/
            gal.
            
            
            24


The ranges of prices paid for fiscal 2010 set forth in the table above
reflect the effects of any forward purchase contracts entered into at various
times prior to delivery of the goods and, accordingly, do not necessarily
reflect the ranges of prices of these ingredients prevailing in the market
during the fiscal year.




Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA.




PageIndex to Financial StatementsReport of Independent Registered Public Accounting Firm
            
            68Consolidated statement of operations for
      each of the three years in the periodended January 31,
    2010
            
            69Consolidated balance sheet as of January 31, 2010 and February 1,
      2009
            
            70Consolidated statement of cash flows for each of the three years in
      the periodended January 31,
    2010
            
            71Consolidated statement of changes in shareholders’ equity for each
      of the three years in the periodended January 31,
    2010
            
            72Notes to financial statements
            
            73


67




---



REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM




To the Board of
Directors and Shareholders of Krispy Kreme Doughnuts, Inc.




In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)1 present fairly, in all material respects, the
financial position of Krispy Kreme Doughnuts, Inc. and its subsidiaries (the
"Company") at January 31, 2010 and February 1, 2009, and the results of their
operations and their cash flows for each of the three years in the period ended
January 31, 2010 in conformity with accounting principles generally accepted in
the United States of America. In addition, in our opinion, the financial
statement schedules listed in the index appearing under Item 15(a)2 present
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. Also in our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of January 31, 2010, based on criteria
established in Internal Control - Integrated
Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). The
Company's management is responsible for these financial statements and financial
statement schedules, for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over
financial reporting, included in Management’s Report on Internal Control over
Financial Reporting under Item 9A. Our responsibility is to express opinions on
these financial statements, on the financial statement schedules, and on the
Company's internal control over financial reporting based on our integrated
audits. We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audits provide a reasonable basis for
our opinions.




As discussed in Note 1 to the consolidated financial statements, the
Company changed the manner in which it accounts for uncertain tax positions
effective January 29, 2007.




A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial
statements.




Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may
deteriorate.




PricewaterhouseCoopers
LLPRaleigh, North CarolinaApril 15, 2010




68




---



KRISPY KREME DOUGHNUTS,
INC.




CONSOLIDATED STATEMENT OF OPERATIONS




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands, except per share
      amounts)Revenues
            
            $
            346,520
            
            
            $
            385,522
            
            
            $
            430,370Operating expenses:Direct operating expenses (exclusive of depreciation and
      amortizationshown below)
            
            
            297,185
            
            
            
            346,545
            
            
            
            381,065General and administrative
      expenses
            
            
            22,728
            
            
            
            23,458
            
            
            
            26,303Depreciation and amortization expense
            
            
            8,191
            
            
            
            8,709
            
            
            
            18,433Impairment charges and lease
      termination costs
            
            
            5,903
            
            
            
            548
            
            
            
            62,073Settlement of litigation
            
            
            —
            
            
            
            —
            
            
            
            (14,930
            )Other operating (income) and
      expense, net
            
            
            739
            
            
            
            1,501
            
            
            
            13Operating income (loss)
            
            
            11,774
            
            
            
            4,761
            
            
            
            (42,587
            )Interest income
            
            
            93
            
            
            
            331
            
            
            
            1,422Interest expense
            
            
            (10,685
            )
            
            
            (10,679
            )
            
            
            (9,796
            )Loss on extinguishment of debt
            
            
            —
            
            
            
            —
            
            
            
            (9,622
            )Equity in losses of Equity Method
      Franchisees
            
            
            (488
            )
            
            
            (786
            )
            
            
            (933
            )Other non-operating income and (expense), net
            
            
            (276
            )
            
            
            2,815
            
            
            
            (3,211
            )Income (loss) before income
    taxes
            
            
            418
            
            
            
            (3,558
            )
            
            
            (64,727
            )Provision for income taxes
            
            
            575
            
            
            
            503
            
            
            
            2,324Net loss
            
            $
            (157
            )
            
            $
            (4,061
            )
            
            $
            (67,051
            )Loss per common share:Basic
            
            $
            —
            
            
            $
            (.06
            )
            
            $
            (1.05
            )Diluted
            
            $
            —
            
            
            $
            (.06
            )
            
            $
            (1.05
            )


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




69




---



KRISPY KREME DOUGHNUTS,
INC.




CONSOLIDATED BALANCE SHEET




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)ASSETSCURRENT ASSETS:Cash and cash equivalents
            
            $
            20,215
            
            
            $
            35,538Trade receivables
            
            
            17,371
            
            
            
            19,229Receivables from Equity Method
      Franchisees
            
            
            524
            
            
            
            1,019Inventories
            
            
            14,321
            
            
            
            15,587Deferred income taxes
            
            
            —
            
            
            
            106Other current assets
            
            
            6,792
            
            
            
            4,327Total current assets
            
            
            59,223
            
            
            
            75,806Property and equipment
            
            
            72,527
            
            
            
            85,075Investments in Equity Method
      Franchisees
            
            
            781
            
            
            
            1,187Goodwill and other intangible assets
            
            
            23,816
            
            
            
            23,856Other assets
            
            
            8,929
            
            
            
            9,002Total assets
            
            $
            165,276
            
            
            $
            194,926LIABILITIES AND SHAREHOLDERS’
      EQUITYCURRENT LIABILITIES:Current maturities of long-term
      debt
            
            $
            762
            
            
            $
            1,413Accounts payable
            
            
            6,708
            
            
            
            8,981Accrued liabilities
            
            
            30,203
            
            
            
            29,222Total current
      liabilities
            
            
            37,673
            
            
            
            39,616Long-term debt, less current
      maturities
            
            
            42,685
            
            
            
            73,454Deferred income taxes
            
            
            —
            
            
            
            106Other long-term obligations
            
            
            22,151
            
            
            
            23,995Commitments and contingenciesSHAREHOLDERS’ EQUITY:Preferred stock, no par value; 10,000 shares authorized; none
      issued andoutstanding
            
            
            —
            
            
            
            —Common stock, no par value; 300,000
      shares authorized; 67,441 and 67,512 sharesissued and outstanding
            
            
            366,237
            
            
            
            361,801Accumulated other comprehensive loss
            
            
            (180
            )
            
            
            (913
            )Accumulated deficit
            
            
            (303,290
            )
            
            
            (303,133
            )Total shareholders’
      equity
            
            
            62,767
            
            
            
            57,755Total liabilities and shareholders’ equity
            
            $
            165,276
            
            
            $
            194,926


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




70




---



KRISPY KREME DOUGHNUTS,
INC.




CONSOLIDATED STATEMENT OF CASH
FLOWS




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)CASH FLOW FROM OPERATING
      ACTIVITIES:Net loss
            
            $
            (157
            )
            
            $
            (4,061
            )
            
            $
            (67,051
            )Adjustments to reconcile net loss to net
      cash provided by operating activities:Depreciation and
      amortization
            
            
            8,191
            
            
            
            8,709
            
            
            
            18,433Deferred income taxes
            
            
            (479
            )
            
            
            651
            
            
            
            889Impairment charges
            
            
            2,666
            
            
            
            1,050
            
            
            
            61,041Settlement of litigation
            
            
            —
            
            
            
            —
            
            
            
            (14,930
            )Accrued rent expense
            
            
            (412
            )
            
            
            (352
            )
            
            
            (663
            )Loss on disposal of property and equipment
            
            
            915
            
            
            
            746
            
            
            
            64Gain on refranchise of
      Canadian subsidiary
            
            
            —
            
            
            
            (2,805
            )
            
            
            —Gain on disposal of interests in Equity Method Franchisees
            
            
            —
            
            
            
            (931
            )
            
            
            (260
            )Impairment of investment in
      Equity Method Franchisee
            
            
            500
            
            
            
            —
            
            
            
            —Unrealized loss on interest rate derivatives
            
            
            559
            
            
            
            798
            
            
            
            96Share-based
    compensation
            
            
            4,779
            
            
            
            5,152
            
            
            
            7,599Provision for doubtful accounts
            
            
            (161
            )
            
            
            270
            
            
            
            1,786Amortization of deferred
      financing costs
            
            
            859
            
            
            
            832
            
            
            
            6,041Equity in losses of Equity Method Franchisees
            
            
            488
            
            
            
            786
            
            
            
            933Other
            
            
            (225
            )
            
            
            1,820
            
            
            
            991Change in assets and liabilities:Trade receivables
            
            
            2,351
            
            
            
            4,158
            
            
            
            284Inventories
            
            
            1,216
            
            
            
            4,263
            
            
            
            1,058Other current and non-current assets
            
            
            394
            
            
            
            590
            
            
            
            2,009Accounts payable and accrued liabilities
            
            
            (1,650
            )
            
            
            (3,817
            )
            
            
            (7,550
            )Other long-term obligations
            
            
            (7
            )
            
            
            (1,266
            )
            
            
            (1,058
            )Net cash provided by operating activities
            
            
            19,827
            
            
            
            16,593
            
            
            
            9,712CASH FLOW FROM INVESTING ACTIVITIES:Purchase of property and
    equipment
            
            
            (7,967
            )
            
            
            (4,694
            )
            
            
            (5,509
            )Proceeds from disposals of property and equipment
            
            
            5,752
            
            
            
            748
            
            
            
            18,314Investments in Equity Method
      Franchisees
            
            
            (325
            )
            
            
            (113
            )
            
            
            —Sale of interests in Equity Method Franchisee
            
            
            —
            
            
            
            —
            
            
            
            300Other investing activities
            
            
            365
            
            
            
            (237
            )
            
            
            13Net cash provided by (used
      for) investing activities
            
            
            (2,175
            )
            
            
            (4,296
            )
            
            
            13,118CASH FLOW FROM FINANCING
      ACTIVITIES:Proceeds from issuance of long-term debt
            
            
            —
            
            
            
            —
            
            
            
            110,000Repayment of long-term debt
            
            
            (31,678
            )
            
            
            (1,989
            )
            
            
            (141,733
            )Deferred financing costs
            
            
            (954
            )
            
            
            (467
            )
            
            
            (2,891
            )Proceeds from exercise of stock
      options
            
            
            —
            
            
            
            3,103
            
            
            
            292Repurchase of common shares (Note 16)
            
            
            (343
            )
            
            
            (2,069
            )
            
            
            (93
            )Net
      cash used for financing activities
            
            
            (32,975
            )
            
            
            (1,422
            )
            
            
            (34,425
            )Effect of exchange rate changes on cash
            
            
            —
            
            
            
            (72
            )
            
            
            88Net increase (decrease) in cash and cash
      equivalents
            
            
            (15,323
            )
            
            
            10,803
            
            
            
            (11,507
            )Cash and cash equivalents at beginning of year
            
            
            35,538
            
            
            
            24,735
            
            
            
            36,242Cash and cash equivalents at end of
      year
            
            $
            20,215
            
            
            $
            35,538
            
            
            $
            24,735Supplemental schedule of non-cash investing and financing
      activities:Assets acquired under capital leases
            
            $
            258
            
            
            $
            143
            
            
            $
            750


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




71




---



KRISPY KREME DOUGHNUTS,
INC.




CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS’ EQUITY




AccumulatedOtherCommon
            
            
            
            ComprehensiveShares
            
            Common
            
            Income
            
            AccumulatedOutstanding
            
            Stock
            
            (Loss)
            
            Deficit
            
            Total(In thousands)BALANCE AT JANUARY 28, 2007
            
            62,670
            
            
            $
            310,942
            
            
            $
            1,266
            
            
            $
            (233,246
            )
            
            $
            78,962Effect of adoption of new accountingstandard (Note 1)
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,225
            
            
            
            1,225Comprehensive income (loss):Net loss for the year
      endedFebruary 3, 2008
            
            
            
            
            
            
            
            
            
            
            
            
            
            (67,051
            )
            
            
            (67,051
            )Foreign currency translation adjustment,net of income taxes of $117
            
            
            
            
            
            
            
            
            
            357
            
            
            
            
            
            
            
            357Unrealized loss on cash flow
      hedge, netof income taxes of $1,006
            
            
            
            
            
            
            
            
            
            (1,542
            )
            
            
            
            
            
            
            (1,542
            )Total comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (68,236
            )Exercise of stock options
            
            111
            
            
            
            292
            
            
            
            
            
            
            
            
            
            
            
            292Issuance of common shares and
      warrants(Notes 12 and 16)
            
            1,834
            
            
            
            36,875
            
            
            
            
            
            
            
            
            
            
            
            36,875Share-based compensation (Note 16)
            
            785
            
            
            
            7,599
            
            
            
            
            
            
            
            
            
            
            
            7,599Repurchase of common shares (Note
      16)
            
            (30
            )
            
            
            (93
            )
            
            
            
            
            
            
            
            
            
            
            (93
            )BALANCE AT FEBRUARY 3, 2008
            
            65,370
            
            
            
            355,615
            
            
            
            81
            
            
            
            (299,072
            )
            
            
            56,624Comprehensive income (loss):Net loss for the year
      endedFebruary 1, 2009
            
            
            
            
            
            
            
            
            
            
            
            
            
            (4,061
            )
            
            
            (4,061
            )Recognition of foreign currencytranslation adjustment upondisposal of subsidiary, net ofincome taxes of $1,173
            
            
            
            
            
            
            
            
            
            (1,797
            )
            
            
            
            
            
            
            (1,797
            )Foreign currency translation
      adjustment,net of income taxes of $153
            
            
            
            
            
            
            
            
            
            239
            
            
            
            
            
            
            
            239Unrealized loss on cash flow hedge,net of income taxes of $14
            
            
            
            
            
            
            
            
            
            (22
            )
            
            
            
            
            
            
            (22
            )Amortization of unrealized
      loss oninterest rate derivative, net ofincome taxes of $383
            
            
            
            
            
            
            
            
            
            586
            
            
            
            
            
            
            
            586Total comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (5,055
            )Exercise of stock options
            
            2,387
            
            
            
            3,103
            
            
            
            
            
            
            
            
            
            
            
            3,103Share-based compensation (Note
    16)
            
            301
            
            
            
            5,152
            
            
            
            
            
            
            
            
            
            
            
            5,152Repurchase of common shares (Note 16)
            
            (546
            )
            
            
            (2,069
            )
            
            
            
            
            
            
            
            
            
            
            (2,069
            )BALANCE AT FEBRUARY 1, 2009
            
            67,512
            
            
            
            361,801
            
            
            
            (913
            )
            
            
            (303,133
            )
            
            
            57,755Comprehensive income (loss):Net
      loss for the year endedJanuary 31, 2010
            
            
            
            
            
            
            
            
            
            
            
            
            
            (157
            )
            
            
            (157
            )Foreign currency translation
      adjustment,net of income taxes of $24
            
            
            
            
            
            
            
            
            
            37
            
            
            
            
            
            
            
            37Amortization of unrealized loss oninterest rate derivative, net ofincome taxes of $455
            
            
            
            
            
            
            
            
            
            696
            
            
            
            
            
            
            
            696Total comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            576Cancellation of restricted
    shares
            
            (52
            )Share-based compensation (Note 16)
            
            57
            
            
            
            4,779
            
            
            
            
            
            
            
            
            
            
            
            4,779Repurchase of common shares (Note
      16)
            
            (76
            )
            
            
            (343
            )
            
            
            
            
            
            
            
            
            
            
            (343
            )BALANCE AT JANUARY 31, 2010
            
            67,441
            
            
            $
            366,237
            
            
            $
            (180
            )
            
            $
            (303,290
            )
            
            $
            62,767


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




72




---



KRISPY KREME DOUGHNUTS,
INC.




NOTES TO FINANCIAL STATEMENTS




Note 1 — Accounting Policies




Krispy Kreme Doughnuts, Inc. (“KKDI”) and its subsidiaries (collectively,
the “Company”) are engaged in the sale of doughnuts and related items 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




The Company prepares its financial statements in accordance with
accounting principles generally accepted in the United States of America
(“GAAP”). The significant accounting policies followed by the Company in
preparing the accompanying consolidated financial statements are as
follows:




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. In October 2009, the Company
refranchised three stores in Northern California to a new franchisee. The
aggregate sales price of the stores’ assets was approximately $1.1 million,
which was evidenced by a promissory note payable to the Company bearing interest
at 7% and payable in weekly installments equal to a percentage of the stores’
retail sales, secured by the all the assets of the three stores. The new
franchisee is a variable interest entity of which the Company is the primary
beneficiary. Accordingly, the Company consolidated the financial statements of
the new franchisee for post-acquisition periods and did not record a divestiture
of the three stores. In the first quarter of fiscal 2011, the Company will adopt
new accounting standards which will require the Company to deconsolidate the
franchisee and recognize a divestiture of the stores; see “Recent Accounting
Pronouncements” below. Except for a guarantee (which dates from fiscal 2002) of
59% of the lease payments related to one of the three stores’ leases, the
Company has no guarantee of any obligation of the new franchisee.




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 20% to 35%
owned and are hereinafter sometimes referred to as “Equity Method
Franchisees.”




REVENUE RECOGNITION. A summary of the revenue recognition policies for each of the Company’s
business segments is as follows:


- Company Stores revenue is derived
  from the sale of doughnuts and complimentary products to on-premises and
  off-premises customers. Revenue is recognized at the time of sale for
  on-premises sales. For off-premises sales, revenue is recognized at the time
  of delivery, net of provisions for estimated product returns.
- Domestic Franchise revenue is
  derived from development and initial franchise fees relating to new domestic
  store openings and ongoing royalties charged to domestic franchisees based on
  their sales. Development and franchise fees for domestic new stores are
  deferred until the store is opened, which is the time at which the Company has
  performed substantially all of the initial services it is required to provide.
  Royalties are recognized in income as underlying domestic franchisee sales
  occur unless there is significant uncertainty concerning the collectibility of
  such revenues, in which case royalty revenues are recognized when
  received.
- International Franchise revenue is
  derived from development and initial franchise fees relating to new
  international store openings and ongoing royalties charged to international
  franchisees based on their sales. Development and franchise fees for
  international new stores are deferred until the store is opened, which is the
  time at which the Company has performed substantially all of the initial
  services it is required to provide. Royalties are recognized in income as
  underlying international franchisee sales occur unless there is significant
  uncertainty concerning the collectibility of such revenues, in which case
  royalty revenues are recognized when received.



73




---



- KK Supply Chain revenue is derived
  from the sale of doughnut mix, other ingredients and supplies and
  doughnut-making equipment. Revenues for the sale of doughnut mix and supplies
  are recognized upon delivery to the customer or, in the case of franchisees
  located outside North America, when the goods are loaded on the transport
  vessel at the U.S. port. Revenue for equipment sales and installation
  associated with new store openings is recognized at the store opening date.
  Revenue for equipment sales not associated with new store openings is
  recognized when the equipment is installed if the Company is responsible for
  the installation, and otherwise upon shipment of the equipment.

FISCAL YEAR. The
Company’s fiscal year ends on the Sunday closest to January 31, which
periodically results in a 53-week year. Fiscal 2010 and fiscal 2009 each
contained 52 weeks, while fiscal 2008 contained 53 weeks.




CASH AND CASH EQUIVALENTS. The Company considers cash on hand, demand deposits in banks and all
highly liquid debt instruments with an original maturity of three months or less
to be cash and cash equivalents.




INVENTORIES. Inventories are recorded at the lower of cost or market, with cost
determined using the first-in, first-out method.




PROPERTY AND EQUIPMENT. Depreciation of property and equipment is provided using the
straight-line method over the assets’ estimated useful lives, which are as
follows: buildings — 15 to 35 years; machinery and equipment — 2 to 15 years;
and leasehold improvements — lesser of the useful life of the improvements or
the lease term. The depreciable life of leasehold improvements ranges from one
to 20 years.




GOODWILL AND OTHER INTANGIBLE ASSETS. Goodwill represents the excess of the purchase
price over the value of identifiable net assets acquired in business
combinations. Goodwill has an indefinite life and is not amortized, but is
tested for impairment annually or more frequently if events or circumstances
indicate the carrying amount of the asset may be impaired. Such impairment
testing is performed for each reporting unit to which goodwill has been
assigned.




Other intangible assets consist principally of franchise rights
reacquired in acquisitions of franchisees, which the Company determined have
indefinite lives and are not subject to amortization. Intangible assets with
indefinite lives are reviewed for impairment annually or more frequently if
events or circumstances indicate the carrying amount of the assets may be
impaired.




STORE PRE-OPENING COSTS. Store pre-opening costs are expensed as incurred in the Company Stores
segment. Such costs were approximately $170,000 in fiscal 2010 and were not
significant in fiscal 2009 or 2008.




LEGAL COSTS. Legal
costs associated with litigation and other loss contingencies are charged to
expense as services are rendered.




ASSET IMPAIRMENT. When an asset group (typically a store) is identified as underperforming
or a decision is made to abandon an asset group or to close a store, the Company
makes an assessment of the potential impairment of the related assets. The
assessment is based upon a comparison of the carrying amount of the asset group,
consisting primarily of property and equipment, to the estimated undiscounted
cash flows expected to be generated from the asset group. To estimate cash
flows, management projects the net cash flows anticipated from continuing
operation of the asset group or store until its closing or abandonment as well
as cash flows, if any, anticipated from disposal of the related assets. If the
carrying amount of the assets exceeds the sum of the undiscounted cash flows,
the Company records an impairment charge in an amount equal to the excess of the
carrying value of the assets over their estimated fair value.




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.




74




---



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




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Numerator: net loss
            
            $
            (157
            )
            
            $
            (4,061
            )
            
            $
            (67,051
            )Denominator:Basic earnings per share — weighted average sharesoutstanding
            
            
            67,493
            
            
            
            65,940
            
            
            
            63,805Diluted earnings per share —
      weighted average sharesoutstanding plus dilutive potential common shares
            
            
            67,493
            
            
            
            65,940
            
            
            
            63,805


Stock options and warrants with respect to 11.0 million, 10.8 million and
12.2 million shares, as well as 1.2 million, 1.4 million and 1.2 million
unvested shares of restricted stock and restricted stock units have been
excluded from the computation of the number of shares used in the diluted
earnings per share for the fiscal years ended January 31, 2010, February 1, 2009
and February 3, 2008, respectively, because the Company incurred a net loss for
each of these periods and their inclusion would be antidilutive.




SHARE-BASED COMPENSATION. The Company measures and recognizes compensation expense for share-based
payment awards by charging the fair value of each award at its grant date to
earnings over the service period necessary for each award to vest.




CONCENTRATION OF CREDIT RISK. Financial instruments that subject the Company
to credit risk consist principally of receivables from off-premises customers
and franchisees and guarantees of leases and indebtedness of franchisees.
Off-premises receivables are primarily from grocery and convenience stores. The
Company maintains allowances for doubtful accounts which management believes are
sufficient to provide for losses which may be sustained on realization of these
receivables. In fiscal 2010, 2009 and 2008, no customer accounted for more than
10% of Company-owned stores’ revenues. The two largest off-premises customers
collectively accounted for approximately 12%, 11% and 10% of Company-owned
stores’ revenues in fiscal 2010, 2009 and 2008, respectively. The two
off-premises customers with the largest trade receivables balances collectively
accounted for approximately 21% and 22% of off-premises doughnut customer trade
receivables at January 31, 2010 and February 1, 2009, respectively.




The Company also evaluates the recoverability of receivables from its
franchisees and maintains allowances for doubtful accounts which management
believes are sufficient to provide for losses which may be sustained on
realization of these receivables. In addition, the Company evaluates the
likelihood of potential payments by the Company under loan and lease guarantees
and records estimated liabilities for payments the Company considers
probable.




SELF-INSURANCE RISKS AND RECEIVABLES FROM INSURERS. The Company is subject to workers’
compensation, vehicle and general liability claims. The Company is self-insured
for the cost of all workers’ compensation, vehicle and general liability claims
up to the amount of stop-loss insurance coverage purchased by the Company from
commercial insurance carriers. The Company maintains accruals for the estimated
cost of claims, without regard to the effects of stop-loss coverage, using
actuarial methods which evaluate known open and incurred but not reported claims
and consider historical loss development experience. In addition, the Company
records receivables from the insurance carriers for claims amounts estimated to
be recovered under the stop-loss insurance policies when these amounts are
estimable and probable of collection. The Company estimates such stop-loss
receivables using the same actuarial methods used to establish the related
claims accruals, and taking into account the amount of risk transferred to the
carriers under the stop-loss policies. The stop-loss policies provide coverage
for claims in excess of retained self-insurance risks, which are determined on a
claim-by-claim basis.




The Company recorded favorable adjustments to its self-insurance claims
liabilities related to prior policy years of approximately $3.2 million, $1.8
million and $1.7 million in fiscal 2010, 2009 and 2008,
respectively.




The Company provides health and medical benefits to eligible employees,
and purchases stop-loss insurance from commercial insurance carriers which pays
covered medical costs in excess of a specified annual amount incurred by each
claimant.




75




---



DERIVATIVE FINANCIAL INSTRUMENTS AND DERIVATIVE COMMODITY INSTRUMENTS. The Company reflects
derivative financial instruments, which consist primarily of interest rate
derivatives and commodity futures contracts and options on such contracts, in
the consolidated balance sheet at their fair value. The difference between the
cost, if any, and the fair value of the interest rate derivatives is reflected
in income unless the derivative instrument qualifies as a cash flow hedge and is
effective in offsetting future cash flows of the underlying hedged item, in
which case such amount is reflected in other comprehensive income. 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 cash flow hedges.




FOREIGN CURRENCY TRANSLATION. The Company has ownership interests in
franchisees in Mexico and Western Canada accounted for using the equity method.
The functional currency of each of these operations is the local currency.
Assets and liabilities of these operations are translated into U.S. dollars
using exchange rates as of the balance sheet date, and revenues, expenses and
the Company’s equity in the earnings or losses of the franchisee are translated
using the average exchange rate for the reporting period. The resulting
cumulative translation adjustments are reported, net of income taxes, as a
component of accumulated other comprehensive income. Transaction gains and
losses resulting from remeasuring transactions denominated in currencies other
than an entity’s functional currency are reflected in earnings.




COMPREHENSIVE INCOME. Accounting standards on reporting comprehensive income requires that
certain items, including foreign currency translation adjustments and
mark-to-market adjustments on derivative contracts accounted for as cash flow
hedges (which are not reflected in net income) be presented as components of
comprehensive income. The cumulative amounts recognized by the Company under
these standards are reflected in the consolidated balance sheet as accumulated
other comprehensive income (loss), a component of shareholders’ equity, and are
summarized in the following table:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Accumulated other comprehensive income
      (loss):Unrealized losses on interest
      rate derivatives
            
            $
            (152
            )
            
            $
            (1,303
            )Cumulative foreign currency translation adjustments
            
            
            (146
            )
            
            
            (207
            )(298
            )
            
            
            (1,510
            )Less: deferred income taxes
            
            
            118
            
            
            
            597$
            (180
            )
            
            $
            (913
            )


USE OF ESTIMATES. The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results will differ from these
estimates, and the differences could be material.




UNCERTAIN TAX POSITIONS. Effective January 29, 2007, the first day of fiscal 2008, the Company
adopted new accounting standards for accounting for uncertainty in income taxes.
The standards prescribe recognition thresholds that must be met before a tax
position is recognized in the financial statements and provide guidance on
de-recognition, classification, interest and penalties, accounting in interim
periods and disclosure. Under these standards, an entity may only recognize or
continue to recognize tax positions that meet a “more likely than not”
threshold. The cumulative effect of applying the new standards was recorded as a
$1.2 million credit to the opening balance of accumulated deficit as of January
29, 2007, the date of adoption.




ERROR CORRECTION. In fiscal 2009 and 2008, the Company reported freight charges billed to
customers by the KK Supply Chain segment as a reduction in direct operating
expenses, rather than as a component of revenues as required by GAAP. Such
charges totaled approximately $3.3 million and $2.2 million in fiscal 2009 and
2008, respectively, of which $1.8 million and $1.2 million, respectively, were
to the Company Stores segment and are eliminated in consolidation; there were no
such charges in fiscal 2010. KK Supply Chain and consolidated revenues for
fiscal 2009 and 2008 as set forth herein have been restated to correct this
error, which had no effect on KK Supply Chain operating income or on
consolidated earnings for either period.




76




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RECENT ACCOUNTING
PRONOUNCEMENTS




In March 2008, the Financial Accounting Standards Board (“FASB”) issued
new disclosure standards about derivative instruments and hedging activities.
The new standards are intended to improve financial reporting about derivative
instruments and hedging activities by requiring enhanced disclosures to enable
investors to better understand their effects on an entity’s financial position,
financial performance and cash flows. The Company adopted the new standards
prospectively as of February 2, 2009; accordingly, disclosures related to
periods prior to the date of adoption have not been presented. Adoption of these
standards did not have any effect on the Company’s financial position or results
of operations. See Note 22 for additional information about derivative financial
instruments owned by the Company.




In the first quarter of fiscal 2009, the Company adopted new accounting
standards with respect to financial assets and liabilities measured at fair
value on both a recurring and non-recurring basis and with respect to
nonfinancial assets and liabilities measured on a recurring basis. In the first
quarter of fiscal 2010, the Company adopted new accounting standards with
respect to nonrecurring measurements of nonfinancial assets and liabilities.
Adoption of these standards had no material effect on the Company’s financial
position or results of operations. See Note 21 for additional information
regarding fair value measurements.




In May 2009, the FASB issued new accounting standards with respect to
subsequent events which establish general standards of accounting for, and
disclosure of, events that occur after the balance sheet date but before the
financial statements are issued or are available to be issued. The Company
adopted these standards, which did not represent a significant change from
existing practice, during the quarter ended August 2, 2009.




In June 2009, the FASB issued amended accounting standards related to the
consolidation of variable-interest entities. The amended standards require an
enterprise to qualitatively assess the determination of the primary beneficiary
of a variable interest entity (“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 or the right to receive benefits of the
VIE that could potentially be significant to the VIE. The amended standards
require an ongoing reconsideration of the identity of the VIE’s primary
beneficiary, if any, and provide a framework for the events that trigger a
reassessment of whether an entity is a VIE. The amended standards are effective
for the Company in the first quarter of fiscal 2011. Adoption of the new
standards will result in the Company recognizing a divestiture of three stores
that took place in a refranchising transaction in October 2009, as described
under “Basis of Consolidation,” above. Adoption of the standards will have no
material effect on the Company’s financial position, results of operations or
cash flows.




Note 2 – Recent Financial Performance and
Business Conditions




The Company experienced a decline in revenues and incurred net losses in
each of the last three fiscal years. The revenue decline reflects fewer Company
stores in operation resulting principally from the closure of lower performing
locations, a decrease in off-premises sales at Company stores, a decline in
domestic royalty revenues and lower sales of mixes and other ingredients
resulting from lower sales by the Company’s domestic franchisees. Lower revenues
have adversely affected operating margins because of the fixed or semi-fixed
nature of many of the Company’s direct operating expenses. In addition, the
prices of certain agricultural commodities and of oil, while volatile, have
trended upward in the last fiscal three years, which has adversely affected the
cost of the Company’s principal ingredients and increased the cost of gasoline
consumed by the Company. Sales volumes and changes in the cost of major
ingredients and fuel can have a material effect on the Company’s results of
operations and cash flows. In addition, royalty revenues and most of KK Supply
Chain 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.




The Company generated cash flow from operating activities of $19.8
million, $16.6 million and $9.7 million in fiscal 2010, 2009 and 2008,
respectively, and the Company has reduced its aggregate outstanding debt by
$64.2 million over the past three fiscal years, using both cash generated from
the sale of excess assets and cash generated by operations.




The Company’s credit facilities described in Note 10 are the Company’s
principal source of external financing. These facilities consist of a term loan
having an outstanding principal balance of $43.1 million as of January 31, 2010
which matures in February 2014, and a $25 million revolving credit facility
maturing in February 2013. The credit facilities contain significant financial
covenants, which also are described in Note 10. Based on the Company’s current
working capital and the fiscal 2011 operating plan, management believes the
Company can comply with the these financial covenants and that the Company can
meet its projected operating, investing and financing cash
requirements.




77




---



Note 3 — Trade Receivables




The components of trade receivables are as follows:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Trade receivables:Off-premises
    customers
            $
            9,010
            
            
            $
            10,413Unaffiliated franchisees
            
            9,636
            
            
            
            11,573Current portion of notes
      receivable
            
            68
            
            
            
            10018,714
            
            
            
            22,086Less — allowance for doubtful
      accounts:Off-premises customers
            
            (307
            )
            
            
            (313
            )Unaffiliated franchisees
            
            (1,036
            )
            
            
            (2,544
            )(1,343
            )
            
            
            (2,857
            )$
            17,371
            
            
            $
            19,229Receivables from Equity Method
      Franchisees (Notes 1 and 18):Trade
            $
            1,263
            
            
            $
            1,268Less — allowance for doubtful
      accounts
            
            (739
            )
            
            
            (249
            )$
            524
            
            
            $
            1,019


The changes in the allowances for
doubtful accounts are summarized as follows:




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Allowance for doubtful accounts related
      to trade receivables:Balance at beginning of
      year
            $
            2,857
            
            
            $
            4,750
            
            
            $
            2,745Provision for doubtful
accounts
            
            (651
            )
            
            
            71
            
            
            
            2,150Chargeoffs
            
            (863
            )
            
            
            (2,064
            )
            
            
            (145
            )Other
            
            —
            
            
            
            100
            
            
            
            —Balance at end of year
            $
            1,343
            
            
            $
            2,857
            
            
            $
            4,750Allowance for doubtful accounts related
      to receivables from EquityMethod Franchisees:Balance at beginning of year
            $
            249
            
            
            $
            1,379
            
            
            $
            2,903Provision for doubtful
accounts
            
            490
            
            
            
            199
            
            
            
            (364
            )Chargeoffs
            
            —
            
            
            
            (1,329
            )
            
            
            (1,160
            )Balance at end of year
            $
            739
            
            
            $
            249
            
            
            $
            1,379


Note 4 — Inventories




The components of inventories are as
follows:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Raw materials
            $
            5,253
            
            $
            5,625Work in progress
            
            4
            
            
            6Finished goods
            
            3,688
            
            
            4,905Purchased merchandise
            
            5,268
            
            
            4,936Manufacturing supplies
            
            108
            
            
            115$
            14,321
            
            $
            15,587




78




---



Note 5 — Other Current
Assets




Other current assets consist of the following:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Closed stores held for sale
            $
            2,574
            
            $
            —Current portion of claims against insurance carriers related to
      self-insuranceprograms (Notes 1, 8, 9 and
      11)
            
            679
            
            
            755Miscellaneous receivables
            
            468
            
            
            416Prepaid expenses and other
            
            3,071
            
            
            3,156$
            6,792
            
            $
            4,327


Note 6 — Property and
Equipment




Property and equipment consists of the
following:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Land
            $
            13,975
            
            
            $
            19,091Buildings
            
            62,812
            
            
            
            64,977Leasehold improvements
            
            9,146
            
            
            
            10,018Machinery and equipment
            
            52,124
            
            
            
            58,987Construction in progress
            
            432
            
            
            
            427138,489
            
            
            
            153,500Less: accumulated depreciation
            
            (65,962
            )
            
            
            (68,425
            )$
            72,527
            
            
            $
            85,075


Depreciation expense was $7.7 million, $8.1 million and $17.8 million in
fiscal 2010, 2009 and 2008, respectively. Machinery and equipment includes
assets leased under capital leases having a net book value of $393,000 and
$451,000 at January 31, 2010 and February 1, 2009, respectively.




Note 7 — Goodwill and Other Intangible
Assets




Goodwill and other intangible assets
consist of the following:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Indefinite-lived intangible
      assets:Goodwill associated with
      International Franchise segment
            $
            15,664
            
            $
            15,664Goodwill associated with Domestic Franchise
      segment
            
            7,832
            
            
            7,832Reacquired franchise rights associated with
      Company Stores segment
            
            320
            
            
            360$
            23,816
            
            $
            23,856




79




---



Note 8 — Other Assets




The components of other assets are as
follows:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Non-current portion of claims against
      insurance carriers related toself-insurance programs (Notes 1, 5, 9 and 11)
            $
            3,116
            
            $
            3,619Deferred financing costs, net of accumulated amortization
            
            2,099
            
            
            2,004Deposits
            
            1,515
            
            
            1,876Computer software, net of accumulated amortization
            
            459
            
            
            676401(k) mirror plan assets (Notes 11 and
      20)
            
            455
            
            
            287Non-current portion of notes receivable from unaffiliated
      franchisees
            
            146
            
            
            178Other
            
            1,139
            
            
            362$
            8,929
            
            $
            9,002


Note 9 — Accrued
Liabilities




The components of accrued liabilities are
as follows:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Accrued compensation
            $
            6,571
            
            $
            1,983Accrued vacation pay
            
            4,814
            
            
            5,001Current portion of self-insurance
      claims, principally worker’s compensation(Notes 1, 5, 8 and 11)
            
            4,245
            
            
            5,086Accrued guarantee liabilities (Notes 12, 14 and 18)
            
            2,702
            
            
            2,922Accrued taxes, other than
    income
            
            2,097
            
            
            2,458Customer deposits
            
            1,319
            
            
            1,881Accrued health care claims
            
            1,110
            
            
            1,030Accrued professional fees
            
            873
            
            
            911Fair value of interest rate
      derivative
            
            641
            
            
            2,348Current portion of lease termination costs (Notes 11 and
    13)
            
            298
            
            
            364Accrued interest
            
            292
            
            
            144Current portion of deferred franchise fee revenue
            
            285
            
            
            708Other
            
            4,956
            
            
            4,386$
            30,203
            
            $
            29,222




Note 10 — Long Term Debt and Lease
Commitments




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




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)2007 Secured Credit Facilities
            $
            43,054
            
            
            $
            74,416Capital lease obligations
            
            393
            
            
            
            45143,447
            
            
            
            74,867Less: current maturities
            
            (762
            )
            
            
            (1,413
            )$
            42,685
            
            
            $
            73,454




80




---



The following table presents maturities
of long-term debt and capital lease obligations:




Fiscal Year
            
            (In thousands)2011
            $
            7622012
            
            6852013
            
            6382014
            
            5642015
            
            40,798$
            43,447


Secured Credit Facilities




In February 2007, the Company closed secured credit facilities totaling
$160 million (the “Secured Credit Facilities”) then consisting of a $50 million
revolving credit facility maturing in February 2013 (the “Revolver”) and a $110
million term loan maturing in February 2014 (the “Term Loan”). The Secured
Credit Facilities are secured by a first lien on substantially all of the assets
of the Company and its subsidiaries.




The Revolver contains provisions which permit the Company to obtain
letters of credit. Issuance of letters of credit under these provisions
constitutes usage of the lending commitments and reduces the amount available
for cash borrowings under the Revolver. The commitments under the Revolver were
reduced from $50 million to $30 million in April 2008, and further reduced to
$25 million in connection with amendments to the facilities in April 2009 (the
“April 2009 Amendments”). In connection with the April 2009 Amendments, the
Company prepaid $20 million of the principal balance outstanding under the 2007
Term Loan. The Company has made other payments of Term Loan principal since
February 2007, consisting of $24.1 million representing the proceeds of asset
sales, $20.0 million representing discretionary prepayments and $2.8 million
representing scheduled amortization which, together with the $20 million
prepayment in April 2009 have reduced the principal balance of the Term Loan to
$43.1 million as of January 31, 2010.




Interest on borrowings under the Revolver and Term Loan is payable either
(a) at the greater of LIBOR or 3.25% or (b) at the Alternate Base Rate (which is
the greater of Fed funds rate plus 0.50% or the prime rate), in each case plus
the Applicable Margin. After giving effect to the April 2009 Amendments, the
Applicable Margin for LIBOR-based loans and for Alternate Base Rate-based loans
was 7.50% and 6.50%, respectively (5.50% and 4.50%, respectively, prior to the
April 2009 Amendments, 3.50% and 2.50%, respectively, prior to amendments
executed in April 2008 and 2.75% and 1.75%, respectively, prior to amendments
executed in January 2008 to permit the sale of certain real estate).




The Company is required to pay a fee equal to the Applicable Margin for
LIBOR-based loans on the outstanding amount of letters of credit issued under
the Revolver, as well as a fronting fee of 0.25% of the amount of such letter of
credit payable to the letter of credit issuer. There also is a fee on the unused
portion of the Revolver lending commitment, which increased from 0.75% to 1.00%
in connection with the April 2009 Amendments.




Borrowings under the Revolver (and issuances of letters of credit) are
subject to the satisfaction of usual and customary conditions, including the
accuracy of representations and warranties and the absence of defaults.




The Term Loan is payable in quarterly installments of approximately
$140,000 (as adjusted to give effect to prepayments of principal under the Term
Loan) and a final installment equal to the remaining principal balance in
February 2014. The 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 and with a percentage of excess cash flow (as defined in the
agreement) on an annual basis.





81




---





The
Secured Credit Facilities require the Company to meet certain financial tests,
including a maximum consolidated leverage ratio (expressed as a ratio of total
debt to Consolidated EBITDA) and a minimum consolidated interest coverage ratio
(expressed as a ratio of Consolidated EBITDA to net interest expense), computed
based upon Consolidated EBITDA and net interest expense for the most recent four
fiscal quarters and total debt as of the end of such four-quarter period. As of
January 31, 2010, the consolidated leverage ratio was required to not be greater
than 4.0 to 1.0 and the consolidated interest coverage ratio was required to be
not less than 2.35 to 1.0. As of January 31, 2010, the Company’s consolidated
leverage ratio was approximately 2.0 to 1.0 and the Company’s consolidated
interest coverage ratio was approximately 4.2 to 1.0. The maximum consolidated
leverage ratio declines and the minimum consolidated interest coverage ratio
increases after fiscal 2010, as set forth in the following tables:




MaximumPeriod
            
            Leverage RatioFiscal 2010
            4.00 to 1.00First Quarter of Fiscal 2011
            3.75 to 1.00Second Quarter of Fiscal 2011
            3.50 to 1.00Third Quarter of Fiscal 2011
            3.25 to 1.00Fourth Quarter of Fiscal 2011
            3.00 to 1.00Fiscal 2012
            2.50 to 1.00Fiscal 2013 and thereafter
            2.00 to 1.00Minimum InterestPeriod
            
            Coverage RatioFourth Quarter of Fiscal 2010
            2.35 to 1.00First Quarter of Fiscal 2011
            2.75 to 1.00Second Quarter of Fiscal 2011
            2.75 to 1.00Third Quarter of Fiscal 2011
            2.95 to 1.00Fourth Quarter of Fiscal 2011
            3.15 to 1.00Fiscal 2012
            3.75 to 1.00Fiscal 2013 and thereafter
            4.50 to
1.00


“Consolidated EBITDA” is a non-GAAP measure and is defined in the Secured
Credit Facilities to mean, generally, consolidated net income or loss, exclusive
of unrealized gains and losses on hedging instruments and amounts accrued with
respect to the interest rate derivative contracts described below, gains or
losses on the early extinguishment of debt and provisions for payments on
guarantees of franchisee obligations plus the sum of net interest expense,
income taxes, depreciation and amortization, non-cash charges, store closure
costs, costs associated with certain litigation and investigations, and
extraordinary professional fees; and minus payments, if any, on guarantees of
franchisee obligations in excess of $3 million in any rolling four-quarter
period and the sum of non-cash credits. In addition, the 2007 Secured Credit
Facilities contain other covenants which, among other things, limit the
incurrence of additional indebtedness (including guarantees), liens, investments
(including investments in and advances to franchisees which own and operate
Krispy Kreme stores), dividends, transactions with affiliates, asset sales,
acquisitions, capital expenditures, mergers and consolidations, prepayments of
other indebtedness and other activities customarily restricted in such
agreements. The Secured Credit Facilities also prohibit the transfer of cash or
other assets to KKDI from its subsidiaries, whether by dividend, loan or
otherwise, but provide for exceptions to enable KKDI to pay taxes and operating
expenses and certain judgment and settlement costs.




The operation of the restrictive financial covenants described above may
limit the amount the Company may borrow under the 2007 Revolver. In addition,
the maximum amount which may be borrowed under the Revolver is reduced by the
amount of outstanding letters of credit, which totaled approximately $15 million
as of January 31, 2010, the substantial majority of which secure the Company’s
reimbursement obligations to insurers under the Company’s self-insurance
arrangements. The restrictive covenants did not limit the Company’s ability to
borrow the full $10 million of unused credit under the Revolver at January 31,
2010.




The Secured Credit Facilities also contain customary events of default
including, without limitation, payment defaults, breaches of representations and
warranties, covenant defaults, cross-defaults to other indebtedness in excess of
$5 million, certain events of bankruptcy and insolvency, judgment defaults in
excess of $5 million and the occurrence of a change of control.




In May 2007, the Company entered into interest rate derivative contracts
having an aggregate notional principal amount of $60 million. The derivative
contracts entitle the Company to receive from the counterparties the excess, if
any, of three-month LIBOR over 5.40%, and require the Company to pay to the
counterparties the excess, if any, of 4.48% over three-month LIBOR, in each case
multiplied by the notional amount of the contracts. The contracts expire in
April 2010. See Notes 21 and 22 for additional information about theses
derivative contracts.




82




---



Lease
Obligations




The Company leases equipment and facilities under both capital and
operating leases. The approximate future minimum lease payments under
non-cancelable leases as of January 31, 2010 are set forth in the following
table:




Operating
            
            CapitalFiscal Year
            
            Leases
            
            Leases(In thousands)2011
            $
            8,866
            
            $
            2202012
            
            7,972
            
            
            1312013
            
            6,769
            
            
            772014
            
            5,830
            
            
            —2015
            
            5,420
            
            
            —Thereafter
            
            56,667
            
            
            —$
            91,524
            
            
            428Less: portion representing interest and
      executory costs
            
            
            
            
            (35
            )$
            393


Rent expense, net of rental income, totaled $9.6 million in fiscal 2010,
$11.8 million in fiscal 2009 and $14.8 million in fiscal 2008.




Cash Payments of
Interest




Interest paid, inclusive of deferred financing costs, totaled $11.2
million in fiscal 2010, $9.2 million in fiscal 2009 and $16.5 million in fiscal
2008.




Note 11 — Other Long-Term
Obligations




The components of other long-term
obligations are as follows:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Non-current portion of self-insurance
      claims, principally worker’scompensation (Notes 1, 5, 8 and 9)
            $
            9,327
            
            $
            11,069Accrued rent expense
            
            5,864
            
            
            6,276Non-current portion of deferred
      franchise fee revenue
            
            3,191
            
            
            3,137Non-current portion of lease termination costs (Notes 9 and
      13)
            
            1,381
            
            
            1,516401(k) mirror plan liabilities (Notes 8
      and 20)
            
            455
            
            
            287Other
            
            1,933
            
            
            1,710$
            22,151
            
            $
            23,995


Note 12 — Commitments and
Contingencies




Pending Matters




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




K2 Asia Litigation




On April 7, 2009, a Cayman Islands corporation, K 2 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.




83




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Other Matters




TAG Litigation




In February 2008, the Company filed suit in the U.S. District Court for
the Middle District of North Carolina against The Advantage Group Enterprise,
Inc. (“TAG”), alleging that TAG failed to properly account for and pay the
Company for sales of equipment that the Company consigned to TAG. Based on these
allegations, the Company asserted various claims including breach of fiduciary
duty and conversion, and it sought an accounting and constructive trust. In
addition, the Company sought a declaration that it did not owe TAG approximately
$1 million for storage fees and alleged lost profits. In March 2008, TAG
answered the complaint, denying liability and asserting counterclaims against
the Company including breach of contract, services rendered, unjust enrichment,
violation of the North Carolina Unfair Trade Practices Act and fraud in the
inducement. TAG sought approximately $1 million in actual damages as well as
punitive and treble damages. The parties settled this matter in March 2010. The
accompanying balance sheet as of January 31, 2010 reflects an accrued liability
of approximately $150,000 for the settlement of this matter, which was recorded
in the second quarter of fiscal 2010 and which is included in Domestic Franchise
operating expenses.




Federal Securities Class Actions and Settlement Thereof and Federal Court
Shareholder Derivative Actions and Settlement Thereof




Beginning in May 2004, a series of purported securities class actions
were filed on behalf of persons who purchased the Company’s publicly traded
securities between August 21, 2003 and May 7, 2004 against the Company and
certain of its former officers in the United States District Court for the
Middle District of North Carolina, alleging violations of federal securities law
in connection with various public statements made by the Company. All the
actions ultimately were consolidated.




In addition to the purported securities class action, three shareholder
derivative actions were filed in the United States District Court for the Middle
District of North Carolina against certain current and former directors of the
Company, certain former officers of the Company, including Scott Livengood (the
Company’s former Chairman and Chief Executive Officer), as well as certain
persons or entities that sold franchises to the Company. The complaints in these
actions alleged that the defendants breached their fiduciary duties in
connection with their management of the Company and the Company’s acquisitions
of certain franchises.




In October 2006, the Company entered into a Stipulation and Settlement
Agreement (the “Stipulation”) with the lead plaintiffs in the securities class
action, the derivative plaintiffs and all defendants named in the class action
and derivative litigation, except for Mr. Livengood, providing for the
settlement of the securities class action and a partial settlement of the
derivative action. The Stipulation contained no admission of fault or wrongdoing
by the Company or the other defendants. In February 2007, the Court entered
final judgment dismissing all claims with respect to all defendants in the
derivative action, except for claims that the Company may assert against Mr.
Livengood, and entered final judgment dismissing all claims with respect to all
defendants in the securities class action.




With respect to the securities class action, the settlement class
received total consideration of approximately $76.0 million, consisting of a
cash payment of approximately $35.0 million made by the Company’s directors’ and
officers’ insurers, cash payments of $100,000 each made by each of a former
Chief Operating Officer and former Chief Financial Officer of the Company, a
cash payment of $4 million made by the Company’s independent registered public
accounting firm, and common stock and warrants to purchase common stock issued
by the Company having an estimated aggregate value of approximately $36.9
million as of their issuance on March 2, 2007. Claims against all defendants
were dismissed with prejudice; however, claims that the Company may have against
Mr. Livengood that may be asserted by the Company in the derivative action for
contribution to the securities class action settlement or otherwise under
applicable law are expressly preserved.




The Company issued 1,833,828 shares of its common stock and warrants to
purchase 4,296,523 shares of its common stock at a price of $12.21 per share in
connection with the Stipulation. The Company recorded a charge to earnings in
fiscal 2006 for the fair value of the stock and warrants, measured as of the
date on which the Company agreed to settle the litigation, and adjusted that
charge in subsequent periods to reflect changes in the securities’ fair value
until their issuance in the first quarter of fiscal 2008. Such subsequent
adjustments resulted in a non-cash charge to fiscal 2007 earnings of $16.0
million and a non-cash credit to fiscal 2008 earnings of $14.9
million.




84




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The Stipulation also provided for
the settlement and dismissal with prejudice of claims against all defendants in
the derivative action, except for claims against Mr. Livengood. The Company
settled its claims against Mr. Livengood inFebruary 2010 in exchange for
the payment by Mr. Livengood of $320,000 and his surrender to the Company of
vested options to purchase 905,700 shares of the Company’s common
stock.




All litigation surrounding the above
matters has now been settled.




Fairfax County, Virginia
Environmental Matter




Since 2004, the Company has operated a commissary in the Gunston Commerce
Center in Fairfax County, Virginia (the “County”). The County has investigated
alleged damage to its sewer system near the commissary. On May 8, 2009, the
County filed a lawsuit in Fairfax County Circuit Court alleging that the Company
caused damage to the sewer system and violated the County’s Sewer Use Ordinance
and the Company’s Wastewater Discharge Permit. The County sought from the
Company repair and replacement costs of approximately $2 million and civil
penalties of approximately $18 million. The Company removed the case to the U.S.
District Court for the Eastern Division of Virginia, and in December 2009, the
parties reached an agreement to resolve the litigation. During the third quarter
of fiscal 2010, the Company recorded a provision of $750,000 for the settlement
of this matter, which is included in Company Stores direct operating expenses.




California Wage/Hour Litigation




The Company was a defendant in a wage/hour suit pending in the Superior
Court of Alameda County, California, in which the plaintiffs seek class action
status and unspecified damages on behalf of a putative class of approximately 35
persons. In January 2010, the parties reached an agreement in principle to
resolve the litigation and the Company recorded a provision of $950,000 for the
settlement of this matter, which is included in Company Stores direct operating
expenses and accrued liabilities in the accompanying balance sheet.




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 franchisee’s store and related
equipment. The Company’s contingent liabilities related to these guarantees
totaled approximately $3.7 million at January 31, 2010, and are summarized in
Note 18. These guarantees require payment by 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 $2.5
million as of January 31, 2010 and $2.7 million as of February 1, 2009, 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. The Company made payments totaling
approximately $650,000 related to guarantees of franchisee obligations during
fiscal 2009. 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
January 31, 2010, additional guarantee payments or provisions for guarantee
payments could be required with respect to any of the guarantees.




In addition, accrued liabilities at January 31, 2010 includes
approximately $200,000 recorded in connection with the Company’s assignment of
operating leases on closed and refranchised stores. The Company is contingently
liable to pay the rents on these stores to the landlords in the event the
franchisees fail to perform under the leases they have assumed. The $200,000
accrual represents the estimated fair value of the Company’s contingent
obligation.




85




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One of the Company’s lenders had issued letters of credit on behalf of
the Company totaling $15 million at January 31, 2010, the substantial majority
of which secure the Company’s reimbursement obligations to insurers under the
Company’s self-insurance arrangements.




The Company is exposed to the effects of commodity price fluctuations on
the cost of ingredients of its products, of which flour, shortening and sugar
are the most significant. In order to secure adequate supplies of product and
bring greater stability to the cost of ingredients, the Company routinely enters
into forward purchase contracts with suppliers under which the Company commits
to purchasing agreed-upon quantities of ingredients at agreed-upon prices at
specified future dates. Typically, the aggregate outstanding purchase commitment
at any point in time will range from one month’s to two years’ anticipated
ingredients purchases, depending on the ingredient. In addition, from time to
time the Company enters into contracts for the future delivery of equipment
purchased for resale and components of doughnut-making equipment manufactured by
the Company. As of January 31, 2010, the Company had approximately $43 million
of commitments under ingredient and other forward purchase contracts. While the
Company has multiple suppliers for most of its ingredients, the termination of
the Company’s relationships with vendors with whom the Company has forward
purchase agreements, or those vendors’ inability to honor the purchase
commitments, could adversely affect the Company’s results of operations and cash
flows.




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 may also purchase futures and options on futures to hedge its
exposure to rising gasoline prices. The Company typically assigns the futures
contract to a supplier in connection with entering into a forward purchase
contract for the related ingredient. See Note 22 for additional information
about these derivatives.




Note 13 — Impairment Charges and Lease
Termination Costs




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




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Impairment charges:Impairment of goodwill –
      Company Stores segment
            $
            —
            
            
            $
            —
            
            
            $
            4,598Impairment of long-lived
assets
            
            3,108
            
            
            
            1,050
            
            
            
            55,963Impairment of reacquired franchise
      rights
            
            40
            
            
            
            —
            
            
            
            480Recovery from bankruptcy estate of former
      subsidiary
            
            (482
            )
            
            
            —
            
            
            
            —Total impairment charges
            
            2,666
            
            
            
            1,050
            
            
            
            61,041Lease termination costs:Provision for termination
costs
            
            4,195
            
            
            
            316
            
            
            
            2,683Less — reversal of previously recorded accrued
      rent expense
            
            (958
            )
            
            
            (818
            )
            
            
            (1,651
            )Net provision
            
            3,237
            
            
            
            (502
            )
            
            
            1,032$
            5,903
            
            
            $
            548
            
            
            $
            62,073


The goodwill impairment charges in fiscal 2008 were recorded to reduce
the carrying value of goodwill to its estimated fair value, which the Company
estimates using the present value of expected future cash flows. Such charges
reflected reductions in the Company’s forecasted sales and earnings in certain
of the reporting units in the Company Stores segment, which caused a reduction
in the estimated fair value of those reporting units. The Company conducts its
annual goodwill impairment testing as of December 31.




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 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. Impairment charges related to
Company Stores long-lived assets were approximately $3.1 million, $900,000 and
$44.1 million in fiscal 2010, 2009 and 2008, respectively. Such charges relate
to underperforming stores, including both stores closed or likely to be closed
and stores which 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. The impaired store assets
include real properties, the fair values of which were estimated based on
independent appraisals or, in the case of properties which the Company currently
is negotiating to sell, based on the Company’s negotiations with unrelated
third-party buyers, leasehold improvements, which are typically abandoned when
the leased properties revert to the lessor, and doughnut-making and other
equipment.




86




---



During the fiscal year ended January 31, 2010, the Company received
$482,000 of cash proceeds from the bankruptcy estate of Freedom Rings, LLC
(“Freedom Rings”), a former subsidiary which filed for bankruptcy in the third
quarter of fiscal 2006. During fiscal 2006, the Company recorded impairment
provisions related to long-lived assets of Freedom Rings under the assumption
that there would be no recovery from the Freedom Rings bankruptcy estate. Had
any such recovery been assumed, the impairment charges would have been reduced
by the amount of the assumed recovery. Accordingly, the amount recovered in
fiscal 2010 has been reported as a credit to impairment charges in the
accompanying statement of operations.




For the fiscal year ended February 3, 2008, the Company also recorded an
impairment charge of approximately $10.4 million with respect to its KK Supply
Chain manufacturing and distribution facility in Illinois. During the second
quarter of fiscal 2008, the Company decided to divest the facility and
determined that the projected cash flows from operation and ultimate sale of the
facility were less than its carrying value; accordingly, the Company recorded an
impairment charge to reduce the carrying value of the facility and related
equipment to their estimated fair value. The Company sold these assets for
approximately $10.9 million cash (net of expenses) in the fourth quarter of
fiscal 2008, and recorded a credit to impairment charges of approximately
$600,000, representing the excess of the ultimate selling price over the
previously estimated disposition value of the facility and equipment.




The Company also recorded an impairment charge of approximately $1.5
million during the fiscal year ended February 3, 2008 to reduce the carrying
value of its KK Supply Chain coffee roasting assets to their estimated disposal
value of $1.9 million. The Company sold these assets for approximately $1.9
million cash during the third quarter of fiscal 2008.




The Company records impairment charges for reacquired franchise rights
when such intangible assets are determined to be impaired as a result of store
closing decisions or other developments.




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.




87




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




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Balance at beginning of year
            $
            1,880
            
            
            $
            2,837
            
            
            $
            1,650Provision for lease
      termination costs:Provisions associated with store
      closings, net of estimated sublease rentals
            
            2,427
            
            
            
            380
            
            
            
            1,961Adjustments to previously recorded
      provisions resulting fromsettlements with lessors and adjustments
      of previous estimates
            
            1,580
            
            
            
            (284
            )
            
            
            526Accretion of discount
            
            188
            
            
            
            220
            
            
            
            196Total provision
            
            4,195
            
            
            
            316
            
            
            
            2,683Proceeds
      from assignment of leases
            
            62
            
            
            
            748
            
            
            
            966Payments
      on unexpired leases, including settlements with lessors
            
            (4,458
            )
            
            
            (2,021
            )
            
            
            (2,462
            )Total reductions
            
            (4,396
            )
            
            
            (1,273
            )
            
            
            (1,496
            )Balance at end of year
            $
            1,679
            
            
            $
            1,880
            
            
            $
            2,837Accrued lease termination costs are
      included in the consolidatedbalance sheet as follows:Accrued liabilities
            $
            298
            
            
            $
            364
            
            
            $
            322Other long-term
    obligations
            
            1,381
            
            
            
            1,516
            
            
            
            2,515$
            1,679
            
            
            $
            1,880
            
            
            $
            2,837


Note 14 — Other Non-Operating Income and
Expense




The components of other non-operating income and (expense) are as
follows:




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Foreign currency transaction gain
      (loss)
            $
            (1
            )
            
            $
            (14
            )
            
            $
            70Gain on refranchise of Canadian subsidiary
            
            —
            
            
            
            2,805
            
            
            
            —Gain on disposal of interests in Equity
      Method Franchisees (Note 18)
            
            —
            
            
            
            931
            
            
            
            260Impairment charges and provisions related to investments in
      EquityMethod Franchisees (Note
      18)
            
            (500
            )
            
            
            (957
            )
            
            
            (572
            )Provision for guarantee
    payments
            
            225
            
            
            
            50
            
            
            
            (2,969
            )$
            (276
            )
            
            $
            2,815
            
            
            $
            (3,211
            )


In fiscal 2010, the Company recorded a charge of approximately $500,000
to reflect a decline in the value of an investment in an Equity Method
Franchisee that management concluded is other than temporary as described in
Note 18 to the consolidated financial statements appearing elsewhere
herein.




In the fourth quarter of fiscal 2009, the Company refranchised its four
stores in Canada. The Company received no proceeds from the transaction. The
Company recognized a non-cash gain on the sale of the stores of $2.8 million
($1.6 million after tax), substantially all of which represents the recognition
in earnings of the cumulative foreign currency translation adjustments related
to the Canadian subsidiary which, prior to its disposition, had been reflected,
net of tax, in accumulated other comprehensive income.




During fiscal 2008, the Company recorded a provision of $3.0 million for
estimated payments under the Company’s guarantees of certain loans and leases
related to KKSF, the Company’s franchisee in South Florida (See “Other
Commitments and Contingencies” in Note 12 and Note 18). In the fourth quarter of
fiscal 2008, the franchisee defaulted on certain of the obligations guaranteed
by the Company and, while there was no demand on the Company to perform under
the guarantees, the Company believed it was probable that the Company would be
required to perform under some, and potentially all, of them. During fiscal
2010, the Company reduced its recorded liability for potential payments under
the KKSF guarantees by $225,000 to reflect a reduction in the aggregate
principal balance of KKSF obligations guaranteed by the Company.




88




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Note 15 — Income Taxes




The components of the provision for income taxes are as follows:




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Current
            $
            1,055
            
            
            $
            (148
            )
            
            $
            1,435Deferred
            
            (480
            )
            
            
            651
            
            
            
            889$
            575
            
            
            $
            503
            
            
            $
            2,324


The components of the income (loss)
before income taxes are as follows:




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Domestic
            $
            444
            
            
            $
            (1,405
            )
            
            $
            (58,491
            )Foreign
            
            (26
            )
            
            
            (2,153
            )
            
            
            (6,236
            )Total income (loss) before income taxes
            $
            418
            
            
            $
            (3,558
            )
            
            $
            (64,727
            )


A reconciliation of a tax provision computed at the statutory federal
income tax rate and the Company’s provision for income taxes follows:




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Income taxes at statutory federal
      rate
            $
            146
            
            
            $
            (1,245
            )
            
            $
            (22,654
            )State income taxes
            
            162
            
            
            
            517
            
            
            
            (3,718
            )Foreign losses with no tax
    benefit
            
            9
            
            
            
            47
            
            
            
            114Change in valuation allowance on deferred income tax
    assets
            
            (257
            )
            
            
            1,811
            
            
            
            27,642Change in accruals for uncertain tax
      positions
            
            74
            
            
            
            (1,472
            )
            
            
            332Change in accruals for interest and penalties
            
            86
            
            
            
            (283
            )
            
            
            220Change in federal tax credit
      carryforwards (principally foreign tax credits)
            
            (1,499
            )
            
            
            (1,557
            )
            
            
            (795
            )Foreign withholding taxes
            
            1,400
            
            
            
            1,361
            
            
            
            773Other
            
            454
            
            
            
            1,324
            
            
            
            410$
            575
            
            
            $
            503
            
            
            $
            2,324


The Company recorded an expense of approximately $160,000 to the
provision for income taxes in fiscal 2010 to increase the Company’s accruals for
uncertain tax positions .




Income tax payments, net of refunds, were $1.5 million, $1.3 million and
$682,000 in fiscal 2010, 2009 and 2008, respectively. The tax payments in all
three fiscal years were comprised largely of foreign withholding taxes on
revenues received from foreign franchisees.




89




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The components of deferred income taxes
are as follows:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Net current assets
            $
            —
            
            $
            106Net noncurrent liabilities
            
            —
            
            
            (106
            )Net
      asset
            $
            —
            
            $
            —


The tax effects of temporary differences
are as follows:




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)Deferred income tax assets:Goodwill and other intangible
      assets
            $
            22,543
            
            
            $
            26,008Accrued litigation settlement
            
            7,315
            
            
            
            7,315Allowance for doubtful
accounts
            
            1,034
            
            
            
            1,432Other current assets
            
            2,293
            
            
            
            2,127Property and equipment
            
            219
            
            
            
            —Other non-current assets
            
            2,829
            
            
            
            1,968Insurance accruals
            
            4,301
            
            
            
            5,060Deferred revenue
            
            2,617
            
            
            
            2,767Other current liabilities
            
            6,958
            
            
            
            4,779Other non-current liabilities
            
            2,862
            
            
            
            3,078Share-based compensation
            
            5,877
            
            
            
            4,818Federal net operating loss
      carryforwards
            
            82,829
            
            
            
            83,811Federal tax credit
    carryforwards
            
            6,247
            
            
            
            5,365Charitable contributions
      carryforward
            
            1,077
            
            
            
            1,051State net operating loss and credit
      carryforwards
            
            11,297
            
            
            
            11,458Other
            
            330
            
            
            
            814Gross deferred income tax
      assets
            
            160,628
            
            
            
            161,851Valuation allowance on deferred income
      tax assets
            
            (160,628
            )
            
            
            (160,885
            )Deferred income tax assets, net of
      valuation allowance
            
            —
            
            
            
            966Deferred income tax
    liabilities:Property, plant and equipment
            
            —
            
            
            
            (966
            )Gross deferred income tax
      liabilities
            
            —
            
            
            
            (966
            )Net deferred income tax
      asset
            $
            —
            
            
            $
            —


Certain amounts set forth in the table above as of February 1, 2009
differ from amounts previously reported. However, the aggregate net deferred
income tax asset at that date is unchanged.




The Company has recorded a valuation allowance against deferred income
tax assets of $160.6 million and $160.9 million at January 31, 2010 and February
1, 2009, respectively, representing the amount of its deferred income tax assets
in excess of its deferred income tax liabilities. The valuation allowances were
recorded because management was unable to conclude, in light of the cumulative
loss realized by the Company for the three year period ended January 31, 2010,
that realization of the net deferred income tax asset was more likely than
not.




The Company has approximately $237.7 million of federal income tax loss
carryforwards expiring in fiscal 2024 through 2029. Of this amount,
approximately $18.2 million is the result of tax deductions related to the
exercise of stock options by employees, the tax benefits of which, if
subsequently realized, will be recorded as an addition to common stock. The
Company also has state income tax loss carryforwards expiring in fiscal 2011
through 2029.




The Company is subject to U.S. federal income tax, as well as income tax
in multiple U.S. state and local jurisdictions and a limited number of foreign
jurisdictions. The Company’s income tax returns periodically are examined by the
Internal Revenue Service and by other tax authorities in various jurisdictions.
The Company assesses the likelihood of adverse outcomes resulting from these
examinations in determining the provision for income taxes. All significant
federal, state, local and foreign income tax matters have been concluded through
fiscal 2006.




90





---



The Company had $1.6 million of unrecognized tax benefits as of January
31, 2010. If recognized, approximately $540,000 of the unrecognized tax benefits
would be recorded as a part of income tax expense and affect the Company’s
effective income tax rate.




The following table presents a
reconciliation of the beginning and ending amounts of unrecognized tax benefits:




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Unrecognized tax benefits at beginning
      of year
            $
            1,680
            
            
            $
            5,130
            
            
            $
            4,540Increases in positions related to the current year
            
            358
            
            
            
            4
            
            
            
            238Increases (decreases) in positions taken
      in prior years
            
            1
            
            
            
            (1,354
            )
            
            
            794Settlements with taxing authorities
            
            —
            
            
            
            (1,994
            )
            
            
            (41
            )Lapsing of statutes of
    limitations
            
            (469
            )
            
            
            (106
            )
            
            
            (401
            )Unrecognized tax benefits at end of year
            $
            1,570
            
            
            $
            1,680
            
            
            $
            5,130


It is reasonably possible that the total amount of unrecognized tax
benefits will decrease in fiscal 2011 by up to approximately $740,000, of which
$16,000 would be recorded as part of income tax expense if recognized. Decreases
in the unrecognized tax benefits may result from the lapsing of statutes of
limitations.




The Company’s policy is to recognize interest and penalties related to
income tax issues as components of income tax expense. The Company’s balance
sheet reflects approximately $470,000 and $385,000 of accrued interest and
penalties as of January 31, 2010 and February 1, 2009,
respectively.




Note 16 — Shareholders’
Equity




Share-Based Compensation for
Employees




The Company’s shareholders approved the 2000 Stock Incentive Plan (the
“2000 Plan”), under which incentive stock options, nonqualified stock options,
stock appreciation rights, performance units, restricted stock (or units) and
common shares may be awarded through June 30, 2012. The maximum number of shares
of common stock with respect to which awards may be granted under the 2000 Plan
is 13.0 million (which reflects a 3.0 million share increase in the number of
authorized shares approved by the Company’s shareholders in fiscal 2010), of
which 2.6 million remain available for grant after fiscal 2010. The 2000 Plan
provides that options may be granted with exercise prices not less than the
closing sale price of the Company’s common stock on the date of grant.




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 render the requisite service necessary for the award to vest
is recognized over the related vesting period. The fair value of SBP awards
which vest in increments and for which vesting is subject solely to service
conditions is charged to expense on a straight-line basis over the aggregate
vesting period of each award, which generally is four years. The fair value of
SBP awards which vest in increments and for which vesting is subject to both
market conditions and service conditions is charged to expense over the
estimated vesting period of each increment of the award, each of which is
treated as a separate award for accounting purposes.




91




---



The aggregate cost of SBP awards charged to
earnings in fiscal 2010, 2009 and 2008 is set forth in the following table. The
Company did not realize any excess tax benefits from the exercise of stock
options during any of the three fiscal years.





Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Costs charged to earnings related
      to:Stock options
            $
            1,254
            
            $
            2,181
            
            $
            2,561Restricted stock and restricted stock
      units
            
            3,525
            
            
            2,971
            
            
            5,038Total costs
            $
            4,779
            
            $
            5,152
            
            $
            7,599Costs included in:Direct operating expenses
            $
            1,673
            
            $
            2,216
            
            $
            2,384General and administrative
      expenses
            
            3,106
            
            
            2,936
            
            
            5,215Total costs
            $
            4,779
            
            $
            5,152
            
            $
            7,599


During each of the last three fiscal years, the Company permitted holders
of restricted stock awards to satisfy their obligations to reimburse the Company
for the minimum required statutory withholding taxes arising from the vesting of
such awards by surrendering vested common shares in lieu of reimbursing the
Company in cash. In addition, the terms of certain stock options granted under
the Company’s 1998 Stock Option Plan which were exercised in fiscal 2009
provided that reimbursement of minimum required withholdings taxes and payment
of the exercise price could, at the election of the optionee, be made by
surrendering common shares acquired upon the exercise of such options. The
aggregate fair value of common shares surrendered related to the vesting of
restricted stock awards was $343,000 in fiscal 2010. The aggregate fair value of
common shares surrendered related to the vesting of restricted stock awards and
the exercise of stock options was $300,000 and $1.8 million, respectively, in
fiscal 2009. The aggregate fair value of common shares surrendered related to
the vesting of restricted stock awards was $93,000 in fiscal 2008. The aggregate
fair value of the surrendered shares of $343,000, $2.1 million and $93,000 in
fiscal 2010, 2009 and 2008, respectively, has been reflected as a financing
activity in the accompanying consolidated statement of cash flows and as a
repurchase of common shares in the accompanying consolidated statement of
changes in shareholders’ equity.




The fair value of stock options subject only to service conditions was
estimated using the Black-Scholes option pricing model. In addition to service
conditions, certain stock options granted in fiscal 2008 also provide that the
price of the Company’s common stock must increase by 20% after the grant date,
and remain at or above the appreciated price for at least ten consecutive
trading days, in order for the options to become vested and exercisable. The
fair value of those stock options was estimated using Monte Carlo simulation
techniques. Options granted generally have contractual terms of 10 years, the
maximum term permitted under the 2000 Plan. The weighted average assumptions
used in valuing stock options in fiscal 2010, 2009 and 2008 are set forth in the
following table:




Year endedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008Expected life of option
            7.0 years
            
            
            7.0 years
            
            
            6.9 yearsRisk-free interest rate
            3.12
            %
            
            2.74
            %
            
            4.42
            %Expected volatility of stock
            50.0
            %
            
            50.0
            %
            
            50.0
            %Expected dividend yield
            —
            
            
            —
            
            
            —


The expected life of stock options valued using the Black-Scholes option
pricing model is estimated by reference to historical experience, published data
and any relevant characteristics of the option. The expected life of stock
options valued using Monte Carlo simulation techniques is based upon the vesting
dates forecasted by the simulation and then assuming that options which vest are
exercised at the midpoint between the forecasted vesting date and their
expiration. The risk-free rate of interest is based on the yield of a
zero-coupon U.S. Treasury bond on the date the award is granted having a
maturity approximately equal to the expected term of the award. Expected
volatility is based on a combination of the historical and implied volatility of
the Company’s common shares and the shares of peer companies. The Company uses
historical data to estimate forfeitures of awards prior to vesting.




92




---



The number of options granted during
fiscal 2010, 2009 and 2008 and the aggregate and weighed average fair value of
such options were as follows:




Year endedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008Weighted average fair value per share of
      options granted
            $
            1.45
            
            $
            1.22
            
            $
            2.95Total number of options granted
            
            870,000
            
            
            2,090,000
            
            
            784,200Total fair value of all options
      granted
            $
            1,260,456
            
            $
            2,557,700
            
            $
            2,309,700


The following table summarizes stock
option transactions for fiscal 2010, 2009 and 2008. Option transactions include
options granted under the 2000 Plan as well as options granted under the
Company’s 1998 Stock Option Plan (the “1998 Plan”) pursuant to which grants may
no longer be awarded.




Weighted
            
            
            
            
            WeightedShares
            
            Average
            
            
            
            
            AverageSubject
            
            Exercise
            
            Aggregate
            
            Remainingto
            
            Price
            
            Intrinsic
            
            ContractualOption
            
            Per Share
            
            Value
            
            Term(Dollars in thousands, except per share
      amounts)Outstanding at January 28,
2007
            7,075,200
            
            
            $
            14.40
            
            $
            35,366
            
            4.8 yearsGranted
            784,200
            
            
            $
            5.21Exercised
            (110,800
            )
            
            $
            2.63
            
            $
            526Forfeited
            (1,352,800
            )
            
            $
            13.76Outstanding at February 3,
2008
            6,395,800
            
            
            $
            13.61
            
            $
            3,796
            
            3.6 yearsGranted
            2,090,000
            
            
            $
            2.25Exercised
            (2,387,300
            )
            
            $
            1.30
            
            $
            7,238Forfeited
            (185,500
            )
            
            $
            11.47Outstanding at February 1,
2009
            5,913,000
            
            
            $
            14.70
            
            $
            —
            
            6.2 yearsGranted
            870,000
            
            
            $
            2.65Exercised
            —
            
            
            $
            —
            
            $
            —Forfeited
            (634,100
            )
            
            $
            15.18Outstanding at January 31,
2010
            6,148,900
            
            
            $
            12.94
            
            $
            1,383
            
            5.9 yearsExercisable at January 31,
2010
            3,835,400
            
            
            $
            18.76
            
            $
            309
            
            4.1 years


Additional information regarding stock
options outstanding as of January 31, 2010 is as follows:




Options OutstandingWeightedAverage
            
            
            
            
            Options ExercisableRemaining
            
            Weighted
            
            
            
            WeightedContractual
            
            Average
            
            
            
            AverageRange of
            
            
            Life
            
            Exercise
            
            
            
            ExerciseExercise Prices
            
            Shares
            
            (Years)
            
            Price
            
            Shares
            
            Price$  1.40 - $3.41
            3,243,400
            
            8.4
            
            $
            2.53
            
            1,189,900
            
            $
            2.79$  5.25 - $9.71
            413,300
            
            5.9
            
            $
            9.13
            
            233,300
            
            $
            8.69$10.20 - $16.94
            877,800
            
            3.1
            
            $
            14.37
            
            797,800
            
            $
            14.56$28.11 - $28.58
            559,900
            
            2.3
            
            $
            28.34
            
            559,900
            
            $
            28.34$30.98 - $44.22
            1,054,500
            
            2.6
            
            $
            37.09
            
            1,054,500
            
            $
            37.09


93




---



In addition to stock options, the Company
periodically has awarded restricted stock and restricted stock units (which are
settled in common stock) under the 2000 Plan. The following table summarizes
changes in unvested restricted stock and restricted stock unit awards for fiscal
2010, 2009 and 2008:


WeightedAverageUnvested
            
            Grant DateShares
            
            Fair ValueUnvested at January 28, 2007
            744,000
            
            
            $
            8.71Granted
            1,552,000
            
            
            $
            4.68Vested
            (795,500
            )
            
            $
            4.96Forfeited
            (315,000
            )
            
            $
            7.24Unvested at February 3, 2008
            1,185,500
            
            
            $
            6.33Granted
            1,347,400
            
            
            $
            2.42Vested
            (483,400
            )
            
            $
            4.91Forfeited
            (215,700
            )
            
            $
            6.11Unvested at February 1, 2009
            1,833,800
            
            
            $
            3.86Granted
            727,200
            
            
            $
            3.14Vested
            (1,111,200
            )
            
            $
            2.96Forfeited
            (63,600
            )
            
            $
            5.65Unvested at January 31, 2010
            1,386,200
            
            
            $
            4.13


The total fair value as of the grant date of shares vesting during fiscal
2010, 2009 and 2008 was $3.3 million, $2.4 million and $3.9 million,
respectively.




As of January 31, 2010, the total unrecognized compensation cost related
to SBP awards was approximately $6.2 million. The remaining service periods over
which compensation cost will be recognized for these awards range from
approximately three months to four years, with a weighted average remaining
service period of approximately 1.2 years.




At January 31, 2010, there were approximately 10.2 million shares of
common stock reserved for issuance pursuant to awards granted under the 2000
Plan and the 1998 Plan.




Common Shares and Warrants Issued in
Connection With Settlement of Litigation




On March 2, 2007, the Company issued 1,833,828 shares of common stock and
warrants to acquire 4,296,523 shares of common stock at a price of $12.21 per
share expiring in March 2012 in connection with the settlement of certain
litigation as described in Note 12. As of that date, the aggregate fair value of
the common shares was approximately $18.4 million and the aggregate fair value
of the warrants was approximately $18.5 million. The estimated fair value of the
warrants was computed using the Black-Scholes option pricing model with the
following assumptions: an exercise price of $12.21 per share; a market price of
common stock of $10.01 per share; an expected term of 5.0 years; a risk-free
rate of 4.46%; a dividend yield of zero; and expected volatility of 50%.




The common stock and warrants had a fair value as of January 28, 2007 of
approximately $51.8 million. The decrease in the estimated fair value of the
common stock and warrants from January 28, 2007 to their issuance on March 2,
2007 of approximately $14.9 million was credited to earnings in the first
quarter of fiscal 2008, at which time the aggregate fair value of the securities
of approximately $36.9 million was reclassified from liabilities to common
stock.




Shareholder Protection Rights
Agreement




Each share of the Company’s common stock is
accompanied by one preferred share purchase right (a “Right”) issued pursuant to
the terms of a Shareholder Protection Rights Agreement, dated as of January 14,
2010 (the “Rights Agreement”).  Each Right entitles the registered
shareholder to purchase from the Company one one-hundredth (1/100) of a share of
Krispy Kreme Series A Participating Cumulative Preferred Stock, no par value
(“Participating Preferred Stock”), at a price of $13.50 (the “Exercise Price”),
subject to adjustment from time to time to prevent dilution.   The
Company may redeem the Rights for a nominal amount at any time prior to an event
that causes the Rights to become exercisable.  The Rights expire on January
14, 2013.  The holders of Rights, solely by reason of their ownership of
Rights, have no rights as shareholders of the Company, including, without
limitation, the right to vote or to receive
dividends.   Under the Rights Agreement, the
Rights are generally not exercisable until (a) the commencement of a tender
offer or exchange offer by a person who, as a result of such transaction, would
become the beneficial owner of 15% or more of the Company’s common stock,
(b) the acquisition by a person or group of 15% or more of the Company’s
outstanding common stock, or (c) a person or group acquires 40% or more of the
Company’s
common stock.





If the exerciseability of Rights is
triggered, each Right (other than Rights beneficially owned by an unapproved
acquirer) will constitute the right to purchase shares of common stock of the
Company at 50% of their market price. In addition, the Board of Directors of the
Company may, under certain circumstances, elect to exchange the Rights (other
than Rights beneficially owned by an unapproved acquirer) for shares of the
Company’s common stock at an exchange ratio of one share of common stock per
Right, appropriately adjusted to reflect any stock split, stock dividend or
similar transaction occurring after the date the Rights become
exercisable.  If the Rights are exercisable and
the Company enters into certain consolidation or asset sale transactions
involving the types of shareholders that trigger the exercisability of Rights,
then the Company will enter into an arrangement for the benefit of the holders
of the Rights, providing that, upon consummation of the transaction in question,
each Right (other than Rights beneficially owned by the unapproved acquirer)
will constitute the right to purchase shares of common stock of the other entity
engaging in the transaction at 50% of their market price.





94




---



Note 17 — 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 majority
of the ingredients and materials used by Company stores are purchased from the
KK Supply Chain segment, which supplies doughnut mix, equipment and other items
to both Company and franchisee-owned stores. The Domestic Franchise and
International Franchise segments consist of the Company’s store 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.




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, ingredients and supplies to the Company Stores segment;
such profit is included in KK Supply Chain operating income. The gross profit
earned by the KK Supply Chain segment on sales of equipment to the Company
Stores segment and eliminated in consolidation is not included in the KK Supply
Chain segment operating income shown below, and depreciation expense charged to
Company Stores operating income reflects the elimination of that intercompany
profit.




Through fiscal 2009, the Company reported its results of operations of
its franchise business as a single business segment. In fiscal 2010, the Company
began disaggregating the results of operations of its franchise business into
domestic and international components in its internal financial reporting. The
Company has made the corresponding changes to its segment reporting, and now
reports the revenues and expenses associated with its domestic and international
franchise operations as separate segments. The Company’s segment disclosures
continue to be consistent with the way in which management assesses the
performance of and allocates resources to its businesses.. Amounts previously
reported for the franchise segment for fiscal 2009 and fiscal 2008 have been
restated to conform to the new disaggregated segment presentation.





95




---



The following table presents the results of operations of the Company’s
operating segments for fiscal 2010, 2009 and 2008. Segment operating income is
consolidated operating income before unallocated general and administrative
expenses, impairment charges and lease termination costs and settlement of
litigation.




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Revenues:Company Stores
            $
            246,373
            
            
            $
            265,890
            
            
            $
            304,444Domestic Franchise
            
            7,807
            
            
            
            8,042
            
            
            
            8,673International
    Franchise
            
            15,907
            
            
            
            17,495
            
            
            
            14,285KK
      Supply Chain:Total revenues
            
            162,127
            
            
            
            191,456
            
            
            
            205,499Less – intersegment sales elimination
            
            (85,694
            )
            
            
            (97,361
            )
            
            
            (102,531
            )External KK Supply Chain revenues
            
            76,433
            
            
            
            94,095
            
            
            
            102,968Total revenues
            $
            346,520
            
            
            $
            385,522
            
            
            $
            430,370Operating income (loss):Company Stores
            $
            2,288
            
            
            $
            (9,813
            )
            
            $
            (6,292
            )Domestic Franchise
            
            3,268
            
            
            
            4,965
            
            
            
            4,833International
    Franchise
            
            9,896
            
            
            
            11,550
            
            
            
            9,484KK
      Supply Chain
            
            25,962
            
            
            
            23,269
            
            
            
            24,083Total segment operating income
            
            41,414
            
            
            
            29,971
            
            
            
            32,108Unallocated general and administrative expenses
            
            (23,737
            )
            
            
            (24,662
            )
            
            
            (27,552
            )Impairment charges and lease
      termination costs
            
            (5,903
            )
            
            
            (548
            )
            
            
            (62,073
            )Settlement of litigation
            
            —
            
            
            
            —
            
            
            
            14,930Consolidated operating income (loss)
            $
            11,774
            
            
            $
            4,761
            
            
            $
            (42,587
            )Depreciation and amortization
      expense:Company Stores
            $
            6,293
            
            
            $
            6,402
            
            
            $
            11,558Domestic Franchise
            
            71
            
            
            
            86
            
            
            
            92International Franchise
            
            —
            
            
            
            —
            
            
            
            —KK
      Supply Chain
            
            883
            
            
            
            1,019
            
            
            
            5,586Corporate
    administration
            
            944
            
            
            
            1,202
            
            
            
            1,197Total depreciation and amortization expense
            $
            8,191
            
            
            $
            8,709
            
            
            $
            18,433


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.




Revenues for fiscal 2010, 2009 and 2008 include approximately $32
million, $52 million and $48 million, respectively, from customers outside the
United States.




Note 18 — Investments in
Franchisees




As of January 31, 2010, the Company had investments in four 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.





96




---



Information about the Company’s ownership in the Equity Method
Franchisees and the markets served by those franchisees is set forth below:




Number ofStores asof Jan. 31,
            
            Ownership%Geographic Market
            
            2010
            
            Company
            
            Third PartiesKremeworks, LLC
            Alaska, Hawaii, Oregon,
            
            11
            
            25.0
            %
            
            75.0
            %WashingtonKremeworks Canada, LP
            Western Canada
            
            1
            
            24.5
            %
            
            75.5
            %Krispy Kreme of South Florida,
    LLC
            South Florida
            
            3
            
            35.3
            %
            
            64.7
            %Krispy Kreme Mexico, S. de R.L. de C.V.
            Mexico
            
            46
            
            30.0
            %
            
            70.0
            %


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




January 31, 2010Investmentand
            
            Trade
            
            LoanAdvances
            
            Receivables
            
            Guarantees(In thousands)Kremeworks, LLC
            $
            900
            
            
            $
            327
            
            
            $
            1,241Kremeworks Canada, LP
            
            —
            
            
            
            16
            
            
            
            —Krispy Kreme of South Florida,
    LLC
            
            —
            
            
            
            138
            
            
            
            2,489Krispy Kreme Mexico, S. de R.L. de C.V.
            
            781
            
            
            
            782
            
            
            
            —1,681
            
            
            
            1,263
            
            
            $
            3,730Less: reserves and allowances
            
            (900
            )
            
            
            (739
            )$
            781
            
            
            $
            524February 1, 2009Investment
            
            
            
            
            
            Loan andand
            
            Trade
            
            LeaseAdvances
            
            Receivables
            
            Guarantees(In thousands)Kremeworks, LLC
            $
            900
            
            
            $
            378
            
            
            $
            1,754Kremeworks Canada, LP
            
            —
            
            
            
            16
            
            
            
            —Krispy Kreme of South Florida,
    LLC
            
            —
            
            
            
            38
            
            
            
            7,256Krispy Kreme Mexico, S. de R.L. de C.V.
            
            1,187
            
            
            
            836
            
            
            
            —2,087
            
            
            
            1,268
            
            
            $
            9,010Less: reserves and allowances
            
            (900
            )
            
            
            (249
            )$
            1,187
            
            
            $
            1,019


The guarantees at January 31, 2010 consist entirely of loan guarantees.
As of February 1, 2009, the aggregate loan and lease guarantees consisted of
$3.5 million of loan guarantees and $5.5 million of lease guarantees. The loan
guarantee amounts were determined based upon the principal amount outstanding
under the related loan and the lease guarantee amounts were determined based
upon the gross amount of remaining lease payments.




The Company has a 25% interest in Kremeworks, LLC (“Kremeworks”), whose
results of operations and operating cash flow have declined and, although
Kremeworks has paid all interest, fees and scheduled amortization of principal
due under its bank indebtedness, it failed to comply with certain financial
covenants related to such indebtedness, a portion of which matured, by its
terms, in January 2009. The Company has guaranteed 20% of such indebtedness.
During the third quarter of fiscal 2010, Kremeworks completed an amendment to
its debt agreement which, among other things, waived the defaults related to the
failure to comply with the financial covenants and extended the maturity of the
indebtedness until July 2010. In connection with that amendment, during fiscal
2010 the Company and the majority owner of Kremeworks (which also is a guarantor
of the indebtedness) made capital contributions to Kremeworks in the aggregate
amount of $1 million (of which the Company’s contribution was $250,000), the
proceeds of which were used to prepay a portion of the indebtedness as required
by the amendment. The aggregate amount of Kremeworks indebtedness as of January
31, 2010 was approximately $6.2 million, of which approximately $1.2 million is
guaranteed by the Company.





97




---



The Company has a $900,000 note receivable from Kremeworks which is
subordinate to the Kremeworks bank indebtedness. The note arose from cash
advances made by the Company to Kremeworks in fiscal 2005 and earlier years.
During fiscal 2009, the Company established a reserve equal to the entire
$900,000 balance of its note receivable in recognition of the uncertainty
surrounding its ultimate collection, the charge related to which is included in
“Other non-operating income and expense, net” in the accompanying consolidated
statement of operations.




Krispy Kreme of South Florida, LLC (“KKSF”) incurred defaults with
respect to certain credit agreements with its lenders, including agreements
related to KKSF indebtedness guaranteed, in part, by the Company. During the
fourth quarter of fiscal 2008, the Company recorded a provision of $3.0 million
for potential payments related to guarantees of KKSF loans and leases. In
September 2008, the Company, KKSF and one of KKSF’s lenders entered into
agreements pursuant to which, among other things, the Company paid approximately
$250,000 to the lender to effect a cure of certain KKSF defaults with respect to
certain of the indebtedness subject to the Company’s guarantee. Such agreements
also provided for a reduction in the amount of the Company’s debt guarantee
obligations of approximately $125,000, and for the Company’s release from KKSF
lease guarantees for which the Company’s potential guarantee obligation was
approximately $4.0 million. In the first quarter of fiscal 2010, KKSF completed
a transaction which resulted in the Company’s release from a lease guarantee for
which the Company’s potential obligation was approximately $5.5 million, but
which increased the Company’s guarantee of KKSF debt obligations by
approximately $1.0 million. The aggregate guarantees of KKSF obligations were
approximately $2.5 million (all of which related to loans), which approximates
the amount of accrued liabilities reflected in the Company’s balance sheet for
its KKSF guarantee obligations as of January 31, 2010.




The Company has a 30% interest in Krispy Kreme Mexico, S. de R.L. de C.V.
(“KK Mexico”), whose operating results have been adversely affected by economic
weakness in that country. The franchisee also has been adversely affected by a
decline in the value of the country’s currency relative to the U.S. dollar,
which has made the cost of goods imported from the U.S. more expensive, and
which has increased the amount of cash required to service the portion of the
franchisee’s debt that is denominated in U.S. dollars. During the second quarter
of fiscal 2010, management concluded that the decline in the value of the
investment was other than temporary and, accordingly, the Company recorded a
charge of approximately $500,000 during that period to reduce the carrying value
of the investment in KK Mexico to its estimated fair value of $700,000. Such
charge is included in “Other non-operating income and expense, net” in the
accompanying consolidated statement of operations. In addition, during fiscal
2010, the Company increased its bad debt reserve related to KK Mexico by
$490,000, of which $109,000 and $381,000 is included in KK Supply Chain and
International Franchise direct operating expenses, respectively; such reserve at
January 31, 2010 is equal to the Company’s aggregate receivables from this
franchisee.




In June 2008, the Company completed an agreement to dissolve Priz
Doughnuts, LP, an equity method franchisee. In connection with this transaction,
the Company conveyed the assets of one of the stores to an existing franchisee
and conveyed the other store to the other partner of franchisee. In connection
with the dissolution of the Company’s investment in this franchisee, the Company
paid $400,000 to settle its loan guarantee related to the
franchisee.




In April 2008, the Company completed an agreement with two franchisees
under common control pursuant to which, among other things, the Company conveyed
to the majority owner of the franchisees the Company’s equity interests in the
franchisees and compromised and settled certain disputed and past due amounts
owed by them to the Company. In connection with this agreement, the Company was
released from its obligations under all of its partial guarantees of certain of
the franchisees’ indebtedness and lease obligations. The Company recorded a
non-cash gain of $931,000 as a result of this transaction which is included in
“Other non-operating income and expense, net” in the accompanying consolidated
statement of operations for the fiscal year ended February 1, 2009.




During fiscal 2008, the Company reevaluated its investment in Kremeworks
Canada, LP (“Kremeworks Canada”) and concluded that the value of such investment
was other than temporarily impaired; accordingly, the Company recorded an
impairment charge of $572,000 to reduce the carrying value of the Company’s
investment in Kremeworks Canada to zero. This charge is included in “Other
non-operating income and expense, net” in the accompanying consolidated
statement of operations for the fiscal year ended February 3, 2008.




The following table summarizes the Company’s obligations under the loan
guarantees as of January 31, 2010 and the scheduled expiration of these
obligations in each of the next five fiscal years and thereafter. The amounts
shown as the scheduled expiration of the guarantees are based upon the scheduled
maturity of the underlying guaranteed obligation.





98




---



TotalGuarantee
            
            Loan
            
            Amounts Expiring in Fiscal
      YearPercentages
            
            Guarantees
            
            2011
            
            2012
            
            2013
            
            2014
            
            2015
            
            Thereafter(In thousands)Kremeworks, LLC
            20
            %
            
            $
            1,241
            
            $
            1,241
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —Krispy Kreme of SouthFlorida, LLC
            100
            %
            
            
            2,489
            
            
            1,958
            
            
            531
            
            
            —
            
            
            —
            
            
            —
            
            
            —$
            3,730
            
            $
            3,199
            
            $
            531
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            —


Current liabilities at January 31, 2010 and February 1, 2009 include
accruals for potential payments under loan guarantees of approximately $2.5
million and $2.7 million, respectively, related to KKSF. There was no liability
reflected in the financial statements for other guarantees of franchisee
obligations because the Company did not believe it was probable that the Company
would be required to perform under such other guarantees.




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 January 31,
2010, additional guarantee payments or provisions for guarantee payments could
be required with respect to any of the guarantees, and such payments or
provisions could be significant.




Information about the financial position and results of operations of the
Equity Method Franchisees in which the Company had an interest as of January 31,
2010, is set forth below:




Summary Financial Information
      (1)Operating
            
            Net
      Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            TotalIncome
            
            (Loss)
            
            Current
            
            Noncurrent
            
            Current
            
            Noncurrent
            
            EquityRevenues
            
            (Loss)
            
            (2)
            
            Assets
            
            Assets
            
            Liabilities
            
            Liabilities
            
            (Deficit)(In thousands)(Unaudited)Kremeworks, LLC2010
            $
            17,091
            
            $
            (2,740
            )
            
            $
            (3,138
            )
            
            $
            1,510
            
            $
            15,961
            
            $
            12,613
            
            $
            1,784
            
            $
            3,0742009
            
            18,504
            
            
            (1,788
            )
            
            
            (2,728
            )
            
            
            1,455
            
            
            19,259
            
            
            8,029
            
            
            8,476
            
            
            4,2092008
            
            20,339
            
            
            (738
            )
            
            
            (1,963
            )
            
            
            1,381
            
            
            22,134
            
            
            7,659
            
            
            10,467
            
            
            5,389Kremeworks Canada, LP2010
            
            1,286
            
            
            (764
            )
            
            
            (862
            )
            
            
            424
            
            
            1,800
            
            
            3,896
            
            
            —
            
            
            (1,672
            )2009
            
            1,388
            
            
            174
            
            
            
            28
            
            
            
            250
            
            
            1,803
            
            
            2,640
            
            
            —
            
            
            (587
            )2008
            
            1,511
            
            
            (190
            )
            
            
            (419
            )
            
            
            290
            
            
            2,560
            
            
            3,576
            
            
            —
            
            
            (726
            )Krispy Kreme of SouthFlorida, LLC2010
            
            11,256
            
            
            1,346
            
            
            
            1,102
            
            
            
            1,173
            
            
            3,991
            
            
            4,793
            
            
            4,592
            
            
            (4,221
            )2009
            
            10,800
            
            
            1,188
            
            
            
            655
            
            
            
            1,095
            
            
            8,164
            
            
            3,557
            
            
            9,672
            
            
            (3,970
            )2008
            
            13,196
            
            
            595
            
            
            
            53
            
            
            
            640
            
            
            8,386
            
            
            2,925
            
            
            10,111
            
            
            (4,010
            )Krispy KremeMexico, S. de R.L. de C.V.2010
            
            15,346
            
            
            1,052
            
            
            
            860
            
            
            
            3,354
            
            
            6,390
            
            
            4,725
            
            
            —
            
            
            5,0192009
            
            17,189
            
            
            (386
            )
            
            
            (618
            )
            
            
            2,425
            
            
            5,877
            
            
            4,365
            
            
            —
            
            
            3,9372008
            
            14,238
            
            
            (25
            )
            
            
            (322
            )
            
            
            3,036
            
            
            7,780
            
            
            5,242
            
            
            —
            
            
            5,574


(1)
            
            The
      revenues and net income (loss) shown for each of these franchisees
      represents the amounts reported by the franchisee for calendar 2009, 2008
      and 2007, and the amounts shown as assets and liabilities represent the
      corresponding amounts reported by each of the franchisees on or about
      December 31, 2009, 2008 and 2007.(2)
            
            The
      net income or loss of each of these entities is includable on the income
      tax returns of their owners to the extent required by law. Accordingly,
      the financial statements of these entities do not include a provision for
      income taxes and as a result pretax income or loss for each of these
      entities is also their net income or
loss.




99









Note 19 — Related Party
Transactions




All franchisees are required to purchase doughnut mix and production
equipment from the Company. Revenues include $7.8 million, $10.4 million and
$14.7 million in fiscal 2010, 2009 and 2008, respectively, of sales to franchise
stores owned by franchisees in which the Company had an ownership interest
during fiscal 2010. Revenues also include royalties from these franchisees of
$1.6 million, $2.3 million and $2.9 million in fiscal 2010, 2009 and 2008,
respectively. Trade receivables from these franchisees are included in
receivables from related parties as described in Note 3. These transactions were
conducted pursuant to development and franchise agreements, the terms of which
are substantially the same as the agreements with unaffiliated franchisees.




The Company’s franchisee for the Middle East is an affiliate of a
shareholder which is the beneficial owner of approximately 13% of the Company’s
common stock. The Company had transactions in the normal course of business with
this franchisee (including sales of doughnut mix and equipment to the franchisee
and royalties payable to the Company by the franchisee based on its sales at
Krispy Kreme franchise stores) totaling approximately $8.9 million in fiscal
2010, $10.6 million in fiscal 2009 and $8.1 million in fiscal 2008. Such
transactions were conducted pursuant to development and franchise agreements,
the terms of which are substantially the same as the agreements with other
international franchisees.




In fiscal 2010, the Company entered into a $357,000 contract to refurbish
the interior and exterior of two Company stores with Cummings Incorporated
(“Cummings”), a store exterior design and remodeling company of which an
independent director of the Company is 66.7% owner. While the unique nature of
the refurbishing services provided by Cummings is not directly comparable to
those provided by competitors, management believes the terms of the contract are
no less favorable than could have been obtained from a non-affiliated entity for
conventional remodeling services.




Note 20 — Employee Benefit
Plans




The Company has a 401(k) savings plan (the “401(k) Plan”) to which
employees may contribute up to 100% of their salary and bonus to the plan on a
tax deferred basis, subject to statutory limitations.




The Company also has a Nonqualified Deferred Compensation Plan (the
“401(k) Mirror Plan”) designed to enable officers of the Company whose
contributions to the 401(k) Plan are limited by certain statutory limitations to
have the same opportunity to defer compensation as is available to other
employees of the Company under the qualified 401(k) savings plan. Participants
may defer from 1% to 15% of their base salary and from 1% to 100% of their bonus
(reduced by their contributions to the 401(k) Plan), subject to statutory
limitations, into the 401(k) Mirror Plan and may direct the investment of the
amounts they have deferred. The investments, however, are not a legally separate
fund of assets, are subject to the claims of the Company’s general creditors,
and are included in other assets in the consolidated balance sheet. The
corresponding liability to participants is included in other long-term
obligations. The balance in the asset and corresponding liability account was
$455,000 and $287,000 at January 31, 2010 and February 1, 2009,
respectively.




The Company currently matches 50% of the first 6% of compensation
contributed by each employee to these plans. Contributions expense for these
plans totaled $730,000 in fiscal 2010, $754,000 in fiscal 2009 and $847,000 in
fiscal 2008.




Note 21 — Fair Value Measurements




Principles of Fair Value Measurements




In the first quarter of fiscal 2009, the Company adopted new accounting
standards with respect to financial assets and liabilities measured at fair
value on both a recurring and non-recurring basis and with respect to
nonfinancial assets and liabilities measured on a recurring basis. In the first
quarter of fiscal 2010, the Company adopted new accounting standards with
respect to nonrecurring measurements of nonfinancial assets and liabilities.




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. This
standard is intended to establish a common definition of fair value to be used
throughout GAAP, which is expected to make the measurement of fair value more
consistent and comparable.





100




---



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.

Adoption of these accounting standards had no material effect on the
Company’s financial position or results of operations.




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 January 31, 2010.




January 31, 2010Level
      1
            
            Level 2
            
            Level 3(In thousands)Assets:401(k) mirror plan
      assets
            $
            455
            
            $
            —
            
            $
            —Liabilities:Interest rate
      derivatives
            $
            —
            
            $
            641
            
            $
            —Commodity futures contracts
            
            92
            
            
            —
            
            
            —Total liabilities
            $
            92
            
            $
            641
            
            $
            —


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




The following tables present the nonrecurring fair value measurements
recorded during the year ended January 31, 2010.




Fiscal Year Ended January 31,
      2010Total gainLevel 1
            
            Level 2
            
            Level 3
            
            (loss)(In thousands)Long-lived assets
            $
            —
            
            $
            10,506
            
            $
            —
            
            $
            (3,108
            )Investment in Equity Method Franchisee
            
            —
            
            
            —
            
            
            700
            
            
            (500
            )Lease termination liabilities
            
            —
            
            
            2,427
            
            
            —
            
            
            (1,469
            )


Long-Lived Assets




During the fiscal year ended January 31, 2010, long-lived assets having
an aggregate carrying value of $13.6 million were written down to their
estimated fair values of $10.5 million, resulting in recorded impairment charges
of $3.1 million, as described in Note 13. During fiscal 2010, the Company
recorded impairment charges related to long-lived assets, substantially all of
which were real properties; the fair values of these assets were estimated based
on the present value of estimated future cash flows, on independent appraisals
and, in the case of properties which the Company currently is negotiating to
sell, based on the Company’s negotiations with unrelated third-party buyers. The
charges relate to stores closed, refranchised or expected to be closed, as well
as charges with respect 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. These
inputs are classified as Level 2 within the valuation hierarchy.





101




---



Investment in Equity Method
Franchisee




During the second quarter of fiscal 2010, the Company concluded that a
decline in the value of an Equity Method Franchisee was other than temporary
and, accordingly, recorded a writedown of $500,000 to reduce the carrying value
of the investment to its estimated fair value of $700,000 as described in Note
18. The fair value of the investment was estimated based upon a multiple of the
investee’s current normalized trailing earnings before interest, income taxes
and depreciation and amortization. These inputs are classified as Level 3 within
the valuation hierarchy.




Lease Termination Liabilities




During the fiscal year ended January 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 13; such provisions were reduced by previously recorded accrued rent
expense related to those stores. The fair value of these liabilities were
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 fiscal year ended January 31, 2010, the fair value of lease termination
liabilities related to closed stores of $2.4 million exceeded the $958,000 of
previously recorded accrued rent expense related to such stores, and such excess
has been reflected as a charge 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 January 31, 2010 and February 1, 2009 were as follows:




Jan. 31, 2010
            
            Feb. 1, 2009Carrying
            
            Fair
            
            Carrying
            
            FairValue
            
            Value
            
            Value
            
            Value(In thousands)AssetsCash and cash
      equivalents
            $
            20,215
            
            $
            20,215
            
            $
            35,538
            
            $
            35,538Trade receivables
            
            17,371
            
            
            17,371
            
            
            19,229
            
            
            19,229Receivables from Equity Method
      Franchisees
            
            524
            
            
            524
            
            
            1,019
            
            
            1,019Liabilities:Accounts payable
            
            6,708
            
            
            6,708
            
            
            8,981
            
            
            8,981Interest rate derivatives
            
            641
            
            
            641
            
            
            2,348
            
            
            2,348Commodity futures
      contracts
            
            92
            
            
            92
            
            
            —
            
            
            —Long-term debt (including current maturities)
            
            43,447
            
            
            41,872
            
            
            74,867
            
            
            58,022


Note 22 — Derivative Instruments




The Company is exposed to certain risks relating to its ongoing business
operations and utilizes derivative instruments as part of its management of
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 derivative instruments. The Company
mitigates this risk of nonperformance by dealing with highly rated
counterparties. The Company did not have any significant exposure to any
individual counterparty at January 31, 2010.




102






---



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, shortening and sugar are the most
significant. In order to bring greater stability to the cost of ingredients,the Company purchases, from time to time, 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 for accounting purposes.
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 cash flow
from operating activities. At January 31, 2010, the Company had commodity
derivatives with an aggregate contract volume of 245,000 bushels of wheat and
588,000 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 or LIBOR. The
interest cost of the Company’s debt is affected by changes in these short-term
interest rates and increases in those rates adversely affect the Company’s
results of operations. In May 2007, the Company entered into interest rate
derivative contracts having an aggregate notional principal amount of $60
million. The derivative contracts entitle the Company to receive from the
counterparties the excess, if any, of three-month LIBOR over 5.40%, and require
the Company to pay to the counterparties the excess, if any, of 4.48% over
three-month LIBOR, in each case multiplied by the notional amount of the
contracts. The contracts expire in April 2010. Settlements under these
derivative contracts are reported as cash flow from operating activities in the
consolidated statement of cash flows.




These derivatives were accounted for as cash flow hedges from their
inception through April 8, 2008. Hedge accounting was discontinued on that date
because the derivative contracts could no longer be shown to be effective (as
that term is defined in GAAP) in hedging interest rate risk as a result of
amendments to the Company’s Secured Credit Facilities, which provided that
interest on LIBOR-based borrowings is payable based upon the greater of the
LIBOR rate for the selected interest period or 3.25%. As a consequence of the
discontinuance of hedge accounting, changes in the fair value of the derivative
contracts subsequent to April 8, 2008 are being reflected in earnings as they
occur. Amounts included in accumulated other comprehensive income related to
changes in the fair value of the derivative contracts for periods prior to April
9, 2008 are being charged to earnings in the periods in which the hedged
forecasted transaction (interest on $60 million of the principal balance of the
Term Loan) affects earnings, or earlier upon a determination that some or all of
the forecasted transaction will not occur. Such charges totaled approximately
$1.2 million in fiscal 2010 and $1.0 million in fiscal 2009. Accumulated other
comprehensive income as of January 31, 2010 includes a remaining unamortized
accumulated loss related to these derivatives of $92,000 (net of income taxes of
$60,000), which will be charged to earnings in the first quarter of fiscal 2011.




The counterparties to the interest rate derivatives are also lenders
under the Secured Credit Facilities described in Note 10. Obligations under
derivative instruments with counterparties that also are lenders under the
Secured Credit Facilities are secured by the collateral that secures the
Company’s obligations under the Secured Credit Facilities.




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 January 31, 2010:




Derivatives Not Designated
      As
            
            Asset Derivatives
            
            Liability
DerivativesHedging
    Instruments
            
            Balance Sheet Location
            
            Fair Value
            
            Balance Sheet Location
            
            Fair Value(In thousands)
            
            
            
            (In thousands)Interest rate contracts
            
            Other current assets
            
            $
            —
            
            Accrued liabilities
            
            $
            641Commodity futures contracts
            
            Other current assets
            
            
            —
            
            Accrued liabilities
            
            
            92Total
            
            
            
            $
            —
            
            
            
            $
            733


103









The effect of derivative instruments on the consolidated statement of
operations for the fiscal year ended January 31, 2010 was as
follows:




Derivatives Not Designated as
      Hedging
            
            Location of Derivative Gain or
      Loss
            
            Amount of Derivative Gain or
      (Loss)Hedging
      Instruments
            
            Recognized in
      Income
            
            Recognized in
      Income(In thousands)Interest rate contracts
            
            Interest expense
            
            $
            (559
            )Commodity futures contracts
            
            Direct operating expenses
            
            
            (211
            )Total
            
            
            
            $
            (770
            )


Note 23 — Selected Quarterly Financial Data
(Unaudited)




The tables below present selected
quarterly financial data for fiscal 2010 and 2009.




Quarter EndedMay 3,
            
            Aug. 2,
            
            Nov. 1,
            
            Jan. 31,2009
            
            2009
            
            2009
            
            2010(In thousands, except per share
      data)Revenues
            $
            93,420
            
            
            $
            82,730
            
            
            $
            83,600
            
            
            $
            86,770Operating expenses:Direct operating expenses (exclusive of depreciationand amortization shown below)
            
            76,968
            
            
            
            71,258
            
            
            
            74,369
            
            
            
            74,590General and administrative
      expenses
            
            6,314
            
            
            
            4,817
            
            
            
            6,128
            
            
            
            5,469Depreciation and amortization expense
            
            1,993
            
            
            
            1,999
            
            
            
            2,154
            
            
            
            2,045Impairment charges and lease
      termination costs
            
            2,357
            
            
            
            1,456
            
            
            
            109
            
            
            
            1,981Other operating (income) and expense, net
            
            10
            
            
            
            257
            
            
            
            207
            
            
            
            265Operating income
            
            5,778
            
            
            
            2,943
            
            
            
            633
            
            
            
            2,420Interest income
            
            14
            
            
            
            14
            
            
            
            10
            
            
            
            55Interest expense
            
            (3,817
            )
            
            
            (2,312
            )
            
            
            (2,295
            )
            
            
            (2,261
            )Equity in income (losses) of equity
      method franchisees
            
            101
            
            
            
            (214
            )
            
            
            (393
            )
            
            
            18Other non-operating income and (expense), net
            
            —
            
            
            
            (500
            )
            
            
            144
            
            
            
            80Income (loss) before income
    taxes
            
            2,076
            
            
            
            (69
            )
            
            
            (1,901
            )
            
            
            312Provision for income taxes
            
            208
            
            
            
            88
            
            
            
            487
            
            
            
            (208
            )Net income (loss)
            $
            1,868
            
            
            $
            (157
            )
            
            $
            (2,388
            )
            
            $
            520Income (loss) per common
share:Basic
            $
            .03
            
            
            $
            —
            
            
            $
            (.04
            )
            
            $
            .01Diluted
            $
            .03
            
            
            $
            —
            
            
            $
            (.04
            )
            
            $
            .01





104









Quarter EndedMay 4,
            
            Aug. 3,
            
            Nov. 2,
            
            Feb. 1,2008
            
            2008
            
            2008
            
            2009(In thousands, except per share
      data)Revenues
            $
            104,050
            
            
            $
            94,726
            
            
            $
            94,827
            
            
            $
            91,919Operating expenses:Direct operating expenses (exclusive of depreciationand amortization shown below)
            
            89,888
            
            
            
            88,793
            
            
            
            87,632
            
            
            
            80,232General and administrative
      expenses
            
            6,847
            
            
            
            4,717
            
            
            
            5,842
            
            
            
            6,052Depreciation and amortization
      expense
            
            2,236
            
            
            
            2,266
            
            
            
            2,107
            
            
            
            2,100Impairment charges and lease termination
      costs
            
            (645
            )
            
            
            (348
            )
            
            
            345
            
            
            
            1,196Other operating (income) and expense,
      net
            
            111
            
            
            
            302
            
            
            
            213
            
            
            
            875Operating income (loss)
            
            5,613
            
            
            
            (1,004
            )
            
            
            (1,312
            )
            
            
            1,464Interest income
            
            126
            
            
            
            96
            
            
            
            65
            
            
            
            44Interest expense
            
            (2,063
            )
            
            
            (2,300
            )
            
            
            (2,978
            )
            
            
            (3,338
            )Equity in losses of equity method
      franchisees
            
            (268
            )
            
            
            (82
            )
            
            
            (335
            )
            
            
            (101
            )Other non-operating income and (expense), net
            
            924
            
            
            
            68
            
            
            
            (921
            )
            
            
            2,744Income (loss) before income
    taxes
            
            4,332
            
            
            
            (3,222
            )
            
            
            (5,481
            )
            
            
            813Provision for income taxes
            
            298
            
            
            
            (1,315
            )
            
            
            404
            
            
            
            1,116Net income (loss)
            $
            4,034
            
            
            $
            (1,907
            )
            
            $
            (5,885
            )
            
            $
            (303
            )Income (loss) per common
share:Basic
            $
            .06
            
            
            $
            (.03
            )
            
            $
            (.09
            )
            
            $
            —Diluted
            $
            .06
            
            
            $
            (.03
            )
            
            $
            (.09
            )
            
            $
            —


105









The following tables display operating income by segment and a
reconciliation of total segment operating income to consolidated operating
income by quarter for fiscal 2010 and 2009.




Quarter endedMay 3,
            
            Aug. 2,
            
            Nov. 1,
            
            Jan. 31,2009
            
            2009
            
            2009
            
            2010(In thousands)Revenues:Company Stores
            
            $
            65,857
            
            
            $
            59,853
            
            
            $
            60,020
            
            
            $
            60,643Domestic Franchise
            
            
            2,051
            
            
            
            1,802
            
            
            
            1,945
            
            
            
            2,009International
    Franchise
            
            
            3,878
            
            
            
            3,806
            
            
            
            3,583
            
            
            
            4,640KK
      Supply Chain:Total revenues
            
            
            44,858
            
            
            
            37,754
            
            
            
            39,314
            
            
            
            40,201Less: intersegment sales elimination
            
            
            (23,224
            )
            
            
            (20,485
            )
            
            
            (21,262
            )
            
            
            (20,723
            )External KK Supply Chain revenues
            
            
            21,634
            
            
            
            17,269
            
            
            
            18,052
            
            
            
            19,478Total revenues
            
            $
            93,420
            
            
            $
            82,730
            
            
            $
            83,600
            
            
            $
            86,770Operating income (loss):Company Stores
            
            $
            2,944
            
            
            $
            1,387
            
            
            $
            (1,380
            )
            
            $
            (663
            )Domestic Franchise
            
            
            1,180
            
            
            
            434
            
            
            
            811
            
            
            
            843International
    Franchise
            
            
            2,435
            
            
            
            1,943
            
            
            
            2,117
            
            
            
            3,401KK
      Supply Chain
            
            
            8,139
            
            
            
            5,687
            
            
            
            5,549
            
            
            
            6,587Total segment operating income
            
            
            14,698
            
            
            
            9,451
            
            
            
            7,097
            
            
            
            10,168Unallocated general and administrative expenses
            
            
            (6,563
            )
            
            
            (5,052
            )
            
            
            (6,355
            )
            
            
            (5,767
            )Impairment charges and lease
      termination costs
            
            
            (2,357
            )
            
            
            (1,456
            )
            
            
            (109
            )
            
            
            (1,981
            )Consolidated operating income
            
            $
            5,778
            
            
            $
            2,943
            
            
            $
            633
            
            
            $
            2,420Quarter EndedMay 4,
            
            Aug. 3,
            
            Nov. 2,
            
            Feb. 1,2008
            
            2008
            
            2008
            
            2009(In thousands)Revenues:Company Stores
            
            $
            72,182
            
            $
            65,071
            
            
            $
            64,708
            
            
            $
            63,929Domestic Franchise
            
            
            2,046
            
            
            
            2,249
            
            
            
            1,882
            
            
            
            1,865International
    Franchise
            
            
            4,466
            
            
            
            4,378
            
            
            
            4,511
            
            
            
            4,140KK Supply Chain:Total revenues
            
            
            51,603
            
            
            
            47,342
            
            
            
            47,804
            
            
            
            44,707Less: intersegment sales elimination
            
            
            (26,247
            )
            
            
            (24,314
            )
            
            
            (24,078
            )
            
            
            (22,722
            )External KK Supply Chain revenues
            
            
            25,356
            
            
            
            23,028
            
            
            
            23,726
            
            
            
            21,985Total revenues
            
            $
            104,050
            
            
            $
            94,726
            
            
            $
            94,827
            
            
            $
            91,919Operating income (loss):Company Stores
            
            $
            (294
            )
            
            $
            (4,221
            )
            
            $
            (4,470
            )
            
            $
            (828
            )Domestic Franchise
            
            
            1,120
            
            
            
            1,523
            
            
            
            1,157
            
            
            
            1,165International
    Franchise
            
            
            3,322
            
            
            
            2,375
            
            
            
            3,031
            
            
            
            2,822KK
      Supply Chain
            
            
            7,992
            
            
            
            3,999
            
            
            
            5,449
            
            
            
            5,829Total segment operating income
            
            
            12,140
            
            
            
            3,676
            
            
            
            5,167
            
            
            
            8,988Unallocated general and administrative expenses
            
            
            (7,172
            )
            
            
            (5,028
            )
            
            
            (6,134
            )
            
            
            (6,328
            )Impairment charges and lease
      termination costs
            
            
            645
            
            
            
            348
            
            
            
            (345
            )
            
            
            (1,196
            )Consolidated operating income (loss)
            
            $
            5,613
            
            
            $
            (1,004
            )
            
            $
            (1,312
            )
            
            $
            1,464


106











Item
      9.
            
            CHANGES IN AND
      DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.


None.




Item 9A. CONTROLS AND
PROCEDURES.




Evaluation of Disclosure Controls and
Procedures




As of January 31, 2010, the end of the period covered by this Annual
Report on Form 10-K, management performed, under the supervision and with the
participation of our Chief Executive Officer and Chief Financial Officer, an
evaluation of the effectiveness of our disclosure controls and procedures as
defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure
controls and procedures are designed to ensure that information required to be
disclosed in the reports we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and that such information is accumulated and communicated
to management, including our Chief Executive Officer and Chief Financial
Officer, to allow timely decisions regarding required disclosures. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of January 31, 2010, our disclosure controls and procedures
were effective.




Management’s Report on Internal Control over Financial
Reporting




Management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Rules
13a-15(f) and 15d-15(f) of the Exchange Act. Internal control over financial
reporting is a process, effected by an entity’s board of directors, management
and other personnel, designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of consolidated financial
statements for external purposes in accordance with GAAP. Internal control over
financial reporting includes those policies and procedures which pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of assets; provide reasonable assurance that
transactions are recorded as necessary to permit preparation of consolidated
financial statements in accordance with GAAP; provide reasonable assurance that
receipts and expenditures are being made only in accordance with management’s
and/or the Board of Directors’ authorization; and provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use or
disposition of our assets that could have a material effect on our consolidated
financial statements.




Because of its inherent limitations, internal control over financial
reporting may not prevent or detect material errors in our financial statements.
Also, projection of any evaluation of the effectiveness of our internal control
over financial reporting to future periods is subject to the risk that controls
may become inadequate because of changes in conditions or because the
degree of compliance with our policies and procedures may deteriorate.




Management assessed the effectiveness of our internal control over
financial reporting as of January 31, 2010, using the criteria established in Internal Control — Integrated
Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based
on our assessment, management has concluded that we maintained effective
internal control over financial reporting as of January 31, 2010, based on the
COSO criteria.




The effectiveness of the Company’s internal control over financial
reporting as of January 31, 2010, has been audited
by PricewaterhouseCoopers LLP, an independent registered public accounting
firm, as stated in their report which appears herein.




Changes in Internal Control over Financial
Reporting




During the quarter ended January 31, 2010, there were no changes in the
Company’s internal control over financial reporting that materially affected, or
are reasonably likely to materially affect, the Company’s internal control over
financial reporting.




Item 9B. OTHER
INFORMATION.





None.





107




---



PART III




Item 10. DIRECTORS, EXECUTIVE OFFICERS AND
CORPORATE GOVERNANCE.




Except as set forth below, the information required by this item is
contained in our proxy statement for our 2010 Annual Meeting of Shareholders to
be held on June 22, 2010, to be filed pursuant to Section 14 of the Exchange
Act, and is incorporated herein by reference.




NYSE and SEC Certifications




In accordance with Section 303A.12(a) of the NYSE Listed Company Manual,
the Chief Executive Officer of the Company submits annual certifications to the
NYSE stating that he is not aware of any violations by the Company of the NYSE
corporate governance listing standards, qualifying the certification to the
extent necessary. The last such annual certification was submitted on June 30,
2009 and contained no qualifications.




We have filed certifications executed by our Chief Executive Officer and
Chief Financial Officer with the SEC pursuant to Sections 302 and 906 of the
Sarbanes-Oxley Act as exhibits to this Annual Report on Form 10-K.




Item 11. EXECUTIVE COMPENSATION.




The information required by this item is contained in our proxy statement
for our 2010 Annual Meeting of Shareholders to be held on June 22, 2010, to be
filed pursuant to Section 14 of the Exchange Act, and is incorporated herein by
reference.




Item 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS.




The information required by this item is contained in our proxy statement
for our 2010 Annual Meeting of Shareholders to be held on June 22, 2010, to be
filed pursuant to Section 14 of the Exchange Act, and is incorporated herein by
reference.




Item 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS, AND DIRECTOR INDEPENDENCE.




The information required by this item is contained in our proxy statement
for our 2010 Annual Meeting of Shareholders to be held on June 22, 2010, to be
filed pursuant to Section 14 of the Exchange Act, and is incorporated
herein




Item 14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES




The information required by this item is contained in our proxy statement
for our 2010 Annual Meeting of Shareholders to be held on June 22, 2010, to be
filed pursuant to Section 14 of the Exchange Act, and is incorporated herein by
reference.





108




---



PART IV




Item 15. EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES




(a)
            
            Financial Statements and
      Schedules1.
            
            Financial Statements. See Item 8, “Financial Statements and
      Supplementary Data.”2.
            
            Financial Statement
      Schedules.Schedule I — Condensed Financial Information of Registrant
            F-1Schedule II — Valuation and Qualifying Accounts and Reserves
            F-43.
            
            Exhibits.


ExhibitNumber
            
            
            
            Description of Exhibits3.1
            *
            
            —
            
            Restated Articles of Incorporation
      of the Registrant3.2
            
            
            —
            
            Amended and Restated Bylaws of the Registrant (incorporated by
      reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K
      filed on December 15, 2008)4.1
            
            
            —
            
            Form of Certificate for Common Stock
      (incorporated by reference to Exhibit 4.1 to the Registrant’s Amendment
      No. 4 to Registration Statement on Form S-1 (Commission File No.
      333-92909), filed on April 3, 2000)4.2
            
            
            —
            
            Shareholder Protection Rights Agreement between the Company and
      American Stock Transfer & Trust Company, LLC, as Rights Agent, dated
      as of January 14, 2010 (incorporated by reference to Exhibit 4.1 to the
      Registrant’s Current Report on Form 8-K filed on January 19,
    2010)4.3
            
            
            —
            
            Warrant to Purchase Common Stock issued
      by Krispy Kreme Doughnuts, Inc. in favor of Kroll Zolfo Cooper LLC, dated
      July 31, 2005 (incorporated by reference to Exhibit 4.1 to the
      Registrant’s Current Report on Form 8-K filed on October 26,
    2005)4.4
            
            
            —
            
            Warrant Agreement, dated as of March 2, 2007, between Krispy Kreme
      Doughnuts, Inc. and American Stock Transfer & Trust Company
      (incorporated by reference to Exhibit 4.1 to the Registrant’s Current
      Report on Form 8-K filed on March 8, 2007)10.1
            
            
            —
            
            Trademark License Agreement, dated May
      27, 1996, between HDN Development Corporation and Krispy Kreme Doughnut
      Corporation (incorporated by reference to Exhibit 10.22 to the
      Registrant’s Amendment No. 1 to Registration Statement on Form S-1
      (Commission File No. 333-92909), filed on February 22, 2000)10.2
            
            
            —
            
            1998 Stock Option Plan
      dated August 6, 1998 (incorporated by reference to Exhibit 10.23 to the
      Registrant’s Amendment No. 1 to Registration Statement on Form S-1
      (Commission File No. 333-92909), filed on February 22,
2000)**10.3
            
            
            —
            
            Employment Agreement, dated as of April
      23, 2007, among Krispy Kreme Doughnuts, Inc., Krispy Kreme Doughnut
      Corporation and Douglas R. Muir (incorporated by reference to Exhibit 10.2
      to the Registrant’s Current Report on Form 8-K filed on April 27,
      2007)**10.4
            
            
            —
            
            Amendment, dated November 8, 2007, to Employment Agreement, dated
      as of April 23, 2007, among Krispy Kreme Doughnuts, Inc., Krispy Kreme
      Doughnut Corporation and Douglas R. Muir (incorporated by reference to
      Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on
      November 13, 2007)**10.5
            
            
            —
            
            Second Amendment, dated December 15,
      2008, to Employment Agreement, dated as of April 23, 2007, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and Douglas R.
      Muir (incorporated by reference to Exhibit 10.2 to the Registrant’s
      Current Report on Form 8-K filed on December 19, 2008)**10.6
            
            
            —
            
            Employment Agreement, dated as of February 27, 2008, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and James H.
      Morgan (incorporated by reference to Exhibit 10.1 to the Registrant’s
      Current Report on Form 8-K filed on March 5, 2008)**10.7
            
            
            —
            
            Amendment, dated December 15, 2008, to
      Employment Agreement, dated as of February 27, 2008, among Krispy Kreme
      Doughnuts, Inc., Krispy Kreme Doughnut Corporation and James H. Morgan
      (incorporated by reference to Exhibit 10.1 to the Registrant’s Current
      Report on Form 8-K filed on December 19,
2008)**




109


---



10.8
            
            —
            
            Employment Agreement, dated as of November 7, 2007, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and Kenneth J.
      Hudson (incorporated by reference to Exhibit 10.18 to the Registrant’s
      Annual Report on Form 10-K filed on April 17, 2008)**10.9
            
            —
            
            Amendment, dated December 15, 2008, to Employment Agreement, dated
      as of November 7, 2007, among Krispy Kreme Doughnuts, Inc., Krispy Kreme
      Doughnut Corporation and Kenneth J. Hudson (incorporated by reference to
      Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on
      December 19, 2008)**10.10
            
            —
            
            Employment Agreement, dated as of November 7, 2007, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and Jeffrey B.
      Welch (incorporated by reference to Exhibit 10.19 to the Registrant’s
      Annual Report on Form 10-K filed on April 17, 2008)**10.11
            
            —
            
            Amendment, dated December 15, 2008, to Employment Agreement, dated
      as of November 7, 2007, among Krispy Kreme Doughnuts, Inc., Krispy Kreme
      Doughnut Corporation and Jeffrey B. Welch (incorporated by reference to
      Exhibit 10.4 to the Registrant’s Current Report on Form 8-K filed on
      December 19, 2008)**10.12
            
            —
            
            Employment Agreement, dated as of October 3, 2008, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and Darryl R.
      Marsch (incorporated by reference to Exhibit 10.1 to the Registrant’s
      Quarterly Report on Form 10-Q filed on December 11, 2008)**10.13
            
            —
            
            Amendment, dated December 15, 2008, to Employment Agreement, dated
      as of October 3, 2008, among Krispy Kreme Doughnuts, Inc., Krispy Kreme
      Doughnut Corporation and Darryl R. Marsch**10.14
            
            —
            
            Employment Agreement, dated as of November 7, 2007, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and M. Bradley
      Wall (incorporated by reference to Exhibit 10.2 to the Registrant’s
      Quarterly Report on Form 10-Q filed on December 11, 2008)**10.15
            
            —
            
            Amendment, dated December 15, 2008, to Employment Agreement, dated
      as of November 7, 2007, among Krispy Kreme Doughnuts, Inc., Krispy Kreme
      Doughnut Corporation and M. Bradley Wall**10.16
            
            —
            
            Employment Agreement, dated as of November 7, 2007, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and Steven A.
      Lineberger (incorporated by reference to Exhibit 10.3 to the Registrant’s
      Quarterly Report on Form 10-Q filed on December 11, 2008)**10.17
            
            —
            
            Amendment, dated December 15, 2008, to Employment Agreement, dated
      as of November 7, 2007, among Krispy Kreme Doughnuts, Inc., Krispy Kreme
      Doughnut Corporation and Steven A. Lineberger**10.18
            
            —
            
            Employment Agreement, dated as of September 14, 2009, among Krispy
      Kreme Doughnuts, Inc., Krispy Kreme Doughnut Corporation and Cynthia A.
      Bay (incorporated by reference to Exhibit 10.1 to the Registrant’s
      Quarterly Report on Form 10-Q filed on December 7, 2009)**10.19
            
            —
            
            2000 Stock Incentive Plan, as amended as of June 16, 2009
      (incorporated by reference Exhibit 10.1 to the Registrant’s Current Report
      on Form 8-K filed on June 22, 2009)**10.20
            
            —
            
            Fifth Amendment to the Krispy Kreme Doughnuts, Inc. 2000 Stock
      Incentive Plan dated December 10, 2008, and effective January 1, 2005 to
      the extent necessary to comply with Section 409A of the Internal Revenue
      Code of 1986, as amended and otherwise effective December 31,
    2008**10.21
            
            —
            
            Krispy Kreme Doughnut Corporation Nonqualified Deferred
      Compensation Plan, effective October 1, 2000 (incorporated by reference to
      Exhibit 10.20 to the Registrant’s Annual Report on Form 10-K for fiscal
      2005)**10.22
            
            —
            
            Credit Agreement, dated as of February 16, 2007, by and among
      Krispy Kreme Doughnut Corporation, Krispy Kreme Doughnuts, Inc., the
      Subsidiary Guarantors party thereto, the Lenders party thereto and Credit
      Suisse, Cayman Islands Branch, as administrative agent, collateral agent,
      issuing lender and swingline lender (the “Credit Agreement”) (incorporated
      by reference to Exhibit 10.1 to the Registrant’s Current Report on Form
      8-K filed on February 23, 2007)10.23
            
            —
            
            Security Agreement, dated as of February 16, 2007, by and among
      Krispy Kreme Doughnut Corporation, Krispy Kreme Doughnuts, Inc., the
      Subsidiary Guarantors party thereto and Credit Suisse, Cayman Islands
      Branch, as collateral agent (incorporated by reference to Exhibit 10.2 to
      the Registrant’s Current Report on Form 8-K filed on February 23,
      2007)10.24
            
            —
            
            Amendment No. 1, dated as of June 21, 2007, to the Credit Agreement
      (incorporated by reference to Exhibit 10.1 to the Registrant’s Current
      Report on Form 8-K filed on June 27, 2007)10.25
            
            —
            
            Amendment No. 2, dated as of January 23, 2008, to the Credit
      Agreement (incorporated by reference to Exhibit 10.1 to the Registrant’s
      Current Report on Form 8-K filed on January 25, 2008)10.26
            
            —
            
            Amendment No. 3, dated as of April 9, 2008, to the Credit Agreement
      (incorporated by reference to Exhibit 10.1 to the Registrant’s Current
      Report on Form 8-K filed on April 15,
2008)




110







10.27
            
            —
            
            Amendment No. 4, dated as of April 15,
      2009, to the Credit Agreement (incorporated by reference to Exhibit 10.26
      to the Registrant’s Annual Report on Form 10-K filed on April 17,
      2009)10.28
            
            —
            
            Form of Indemnification Agreement entered into between Krispy Kreme
      Doughnuts, Inc. and Lizanne Thomas and Michael Sutton (incorporated by
      reference to Exhibit 99.3 to the Registrant’s Current Report on Form 8-K
      filed on October 8, 2004)**10.29
            
            —
            
            Form of Indemnification Agreement
      entered into between Krispy Kreme Doughnuts, Inc. and members of the
      Registrant’s Board of Directors (other than Lizanne Thomas and Michael
      Sutton) (incorporated by reference to Exhibit 10.42 to the Registrant’s
      Annual Report on Form 10-K for fiscal 2005)**10.30
            
            —
            
            Form of Indemnification Agreement entered into between Krispy Kreme
      Doughnuts, Inc. and Officers of the Registrant (incorporated by reference
      to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on
      September 18, 2007)10.31
            
            —
            
            Form of Nonqualified Stock Option
      Agreement (incorporated by reference to Exhibit 10.1 to the Registrant’s
      Current Report on Form 8-K filed on December 17, 2009)**10.32
            
            —
            
            Annual Incentive Plan (incorporated by
      reference to Exhibit 10.32 to the Registrant’s Annual Report on Form 10-K
      filed on April 17, 2008)**10.33
            
            —
            
            Form of Restricted Stock Agreement
      (incorporated by reference to Exhibit 10.33 to the Registrant’s Annual
      Report on Form 10-K filed on April 17, 2009) **10.34
            
            —
            
            Form of Restricted Stock Unit Agreement
      (incorporated by reference to Exhibit 10.3 to the Registrant’s Current
      Report on Form 8-K filed on December 17, 2009)**10.35
            
            —
            
            Form of Director Restricted Stock Unit
      Agreement (incorporated by reference to Exhibit 10.2 to the Registrant’s
      Current Report on Form 8-K filed on December 17, 2009)**10.36
            
            —
            
            Compensation Recovery Policy
      (incorporated by reference to Exhibit 10.35 to the Registrant’s Annual
      Report on Form 10-K filed on April 17, 2009)**21
            *
            —
            
            List of Subsidiaries23.1
            *
            —
            
            Consent of PricewaterhouseCoopers
      LLP23.2
            *
            —
            
            Consent of Ballman Kallick,
  LLP24
            *
            —
            
            Powers of Attorney of certain officers
      and directors of the Company (included on the signature page of this
      Annual Report on Form 10-K)31.1
            *
            —
            
            Certification of Chief Executive Officer
      pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange
      Act of 1934, as amended31.2
            *
            —
            
            Certification of Chief Financial Officer
      pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange
      Act of 1934, as amended32.1
            *
            —
            
            Certification by Chief Executive Officer
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 200232.2
            *
            —
            
            Certification by Chief Financial Officer
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of
2002


*
            
            Filed
      herewith.**
            
            Identifies
      management contracts and executive compensation plans or arrangements
      required to be filed as exhibits pursuant to Item 15(b), “Exhibits and
      Financial Statement Schedules — Exhibits,” of this Annual Report on Form
      10-K.


111




---





(c)
            Separate Financial
      Statements of 50 Percent or Less Owned Persons1.
            
            Financial Statements of Kremeworks,
      LLCIndex to Financial
      Statements
            F-52.
            
            Financial Statements of Krispy Kreme
      Mexico, S. de R L. de C.V.
            *





*  To be filed by amendment.





112





---



SIGNATURES




Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.




Krispy Kreme Doughnuts, Inc.By:
            /s/ Douglas R.
      MuirName:
            Douglas
      R. MuirTitle:
            Executive Vice President and ChiefFinancial Officer


Date: April 15,
2010




POWER OF ATTORNEY




Each person whose signature appears below hereby constitutes and appoints
James H. Morgan and Douglas R. Muir, or either of them, his or her true and
lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for him or her and in his or her name, place and stead, in any
and all capacities, to sign any or all amendments or supplements to this Annual
Report on Form 10-K and to file the same with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorney-in-fact and agent full power and authority to do and
perform each and every act and thing necessary or appropriate to be done with
this Annual Report on Form 10-K and any amendments or supplements hereto, as
fully to all intents and purposes as he or she might or could do in person,
hereby ratifying and confirming all that said attorney-in-fact and agent, or his
or her substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.




Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on April 15, 2010.






Signature
            
            Title/s/  James H. Morgan
            
            Chairman of the Board of Directors, President andJames
      H. Morgan
            
            Chief
      Executive Officer (Principal Executive Officer)/s/  Douglas R. Muir
            
            Executive Vice President and Chief Financial OfficerDouglas
      R. Muir
            
            (Principal Financial and Accounting Officer)/s/  Charles A. Blixt
            
            DirectorCharles
      A. Blixt/s/  Lynn Crump-Caine
            
            DirectorLynn
      Crump-Caine/s/  C. Stephen Lynn
            
            DirectorC.
      Stephen Lynn/s/  Robert S. McCoy, Jr.
            
            DirectorRobert
      S. McCoy, Jr.


113





---



Signature
            
            Title/s/ Andrew J. Schindler
            
            DirectorAndrew J. Schindler/s/ Michael H. Sutton
            
            DirectorMichael H. Sutton/s/ Lizanne Thomas
            
            DirectorLizanne Thomas/s/ Togo D. West, Jr.
            
            DirectorTogo D. West, Jr.




114









SCHEDULE I — CONDENSED FINANCIAL INFORMATION
OF REGISTRANT




KRISPY KREME DOUGHNUTS,
INC. (PARENT COMPANY ONLY)




BALANCE SHEET




Jan. 31,
            
            Feb. 1,2010
            
            2009(In thousands)ASSETSInvestment in and advances to
      subsidiaries
            $
            62,767
            
            
            $
            57,755SHAREHOLDERS’ EQUITYPreferred stock
            $
            —
            
            
            $
            —Common stock
            
            366,237
            
            
            
            361,801Accumulated other comprehensive
      loss
            
            (180
            )
            
            
            (913
            )Accumulated deficit
            
            (303,290
            )
            
            
            (303,133
            )Total
      shareholders’ equity
            $
            62,767
            
            
            $
            57,755


F-1




---



SCHEDULE I — CONDENSED FINANCIAL INFORMATION
OF REGISTRANT




KRISPY KREME DOUGHNUTS,
INC. (PARENT COMPANY ONLY)




STATEMENT OF OPERATIONS




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)Equity in losses of
    subsidiaries
            $
            (157
            )
            
            $
            (4,061
            )
            
            $
            (67,051
            )Miscellaneous expenses
            
            —
            
            
            
            —
            
            
            
            —Loss before income taxes
            
            (157
            )
            
            
            (4,061
            )
            
            
            (67,051
            )Provision for income taxes
            
            —
            
            
            
            —
            
            
            
            —Net loss
            $
            (157
            )
            
            $
            (4,061
            )
            
            $
            (67,051
            )Loss per common share:Basic
            $
            —
            
            
            $
            (.06
            )
            
            $
            (1.05
            )Diluted
            $
            —
            
            
            $
            (.06
            )
            
            $
            (1.05
            )


F-2




---



SCHEDULE I — CONDENSED FINANCIAL INFORMATION
OF REGISTRANT




KRISPY KREME DOUGHNUTS,
INC. (PARENT COMPANY ONLY)




STATEMENT OF CASH FLOWS




Year EndedJan. 31,
            
            Feb. 1,
            
            Feb. 3,2010
            
            2009
            
            2008(In thousands)CASH FLOW FROM OPERATING
      ACTIVITIES:Net loss
            $
            (157
            )
            
            $
            (4,061
            )
            
            $
            (67,051
            )Equity in losses of
    subsidiaries
            
            157
            
            
            
            4,061
            
            
            
            67,051Net cash used by operating activities
            
            —
            
            
            
            —
            
            
            
            —CASH FLOW FROM INVESTING
      ACTIVITIES:Investments in subsidiaries
            
            343
            
            
            
            (1,034
            )
            
            
            (199
            )Net cash provided by (used for)
      investing activities
            
            343
            
            
            
            (1,034
            )
            
            
            (199
            )CASH FLOW FROM FINANCING ACTIVITIES:Proceeds from exercise of stock
      options
            
            —
            
            
            
            3,103
            
            
            
            292Repurchase of common shares
            
            (343
            )
            
            
            (2,069
            )
            
            
            (93
            )Net cash provided by (used for)
      financing activities
            
            (343
            )
            
            
            1,034
            
            
            
            199Net increase in cash and cash equivalents
            
            —
            
            
            
            —
            
            
            
            —Cash and cash equivalents at beginning
      of year
            
            —
            
            
            
            —
            
            
            
            —Cash and cash equivalents at end of year
            $
            —
            
            
            $
            —
            
            
            $
            —


F-3




---



SCHEDULE II – VALUATION AND QUALIFYING
ACCOUNTS AND RESERVES




KRISPY KREME DOUGHNUTS,
INC.




AdditionsBalance at
            
            Charged to
            
            Chargedbeginning
            
            costs and
            
            to other
            
            
            
            Balance atDescription
            
            
            of year
            
            expenses
            
            accounts
            
            Payments
            
            end of year(In thousands)Accrual for self-insurance claims,
      principallyworker’s compensation (current andnon-current portions)Year ended February 3, 2008
            
            $
            12,333
            
            
            $
            3,654
            
            —
            
            $
            (3,684
            )
            
            $
            12,303Accrual included in:Accrued liabilities
            
            $
            5,885
            
            
            
            
            
            
            
            
            
            
            
            $
            4,996Other long-term obligations
            
            
            11,389
            
            
            
            
            
            
            
            
            
            
            
            
            11,754Less: Claims receivable under stop-loss
      insurancepolicies included in:Other current assets
            
            
            (665
            )
            
            
            
            
            
            
            
            
            
            
            
            (609
            )Other assets
            
            
            (4,276
            )
            
            
            
            
            
            
            
            
            
            
            
            (3,838
            )$
            12,333
            
            
            
            
            
            
            
            
            
            
            
            $
            12,303Year ended February 1, 2009
            
            $
            12,303
            
            
            $
            3,707
            
            —
            
            $
            (4,229
            )
            
            $
            11,781Accrual included in:Accrued liabilities
            
            $
            4,996
            
            
            
            
            
            
            
            
            
            
            
            $
            5,086Other long-term obligations
            
            
            11,754
            
            
            
            
            
            
            
            
            
            
            
            
            11,069Less: Claims receivable under stop-loss
      insurancepolicies included in:Other current assets
            
            
            (609
            )
            
            
            
            
            
            
            
            
            
            
            
            (755
            )Other assets
            
            
            (3,838
            )
            
            
            
            
            
            
            
            
            
            
            
            (3,619
            )$
            12,303
            
            
            
            
            
            
            
            
            
            
            
            $
            11,781Year ended January 31, 2010
            
            $
            11,781
            
            
            $
            1,372
            
            —
            
            $
            (3,376
            )
            
            $
            9,777Accrual included in:Accrued liabilities
            
            $
            5,086
            
            
            
            
            
            
            
            
            
            
            
            $
            4,245Other long-term obligations
            
            
            11,069
            
            
            
            
            
            
            
            
            
            
            
            
            9,327Less: Claims receivable under stop-loss
      insurancepolicies included in:Other current assets
            
            
            (755
            )
            
            
            
            
            
            
            
            
            
            
            
            (679
            )Other assets
            
            
            (3,619
            )
            
            
            
            
            
            
            
            
            
            
            
            (3,116
            )$
            11,781
            
            
            
            
            
            
            
            
            
            
            
            $
            9,777


F-4




---



KREMEWORKS, LLC AND SUBSIDIARY




PageIndex to Financial Statements:Independent Auditor’s Report
            F-6Consolidated Balance Sheet as of
      December 30, 2010 and December 31, 2009
            F-7Consolidated Statement of Operations for each of the Three Years in
      the PeriodEnded December 30,
    2010
            F-9Consolidated Statement of Comprehensive
      Loss for Each of the Three Years in the PeriodEnded December 30, 2010
            F-10Consolidated statement of Cash Flows for Each of the Three Years in
      the PeriodEnded December 30,
    2010
            F-11Consolidated Statement of Changes in
      Equity for Each of the Three Years in the PeriodEnded December 30, 2010
            F-12Notes to Consolidated Financial Statements
            F-13


F-5




---



Independent Auditor’s
Report




Members KremeWorks, LLC
and Subsidiary




We have audited the
accompanying consolidated balance sheets of KremeWorks, LLC and Subsidiary as of
December 30, 2009 and December 31, 2008, and the related consolidated statements
of loss, comprehensive loss, cash flows and changes in equity for each of the
years in the three-year period ended December 30, 2009. These consolidated
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.




We conducted our
audits in accordance with auditing standards generally accepted in the United
States of America. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.




In our opinion, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of KremeWorks, LLC and Subsidiary as
of December 30, 2009 and December 31, 2008, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 30, 2009 in conformity with accounting principles generally accepted in
the United States of America (GAAPUSA).




Effective January 1,
2009, KremeWorks, LLC and Subsidiary adopted the guidance on noncontrolling
interests under GAAPUSA.




Blackman Kallick, LLP




March 31,
2010





F-6




---



KremeWorks, LLC and
Subsidiary




Consolidated Balance
Sheets




December 30, 2009 and
December 31, 2008


Assets


2009
            
            2008Current AssetsCash
            $
            866,563
            
            $
            823,990ReceivablesCredit cards
            
            31,405
            
            
            46,000Member contributions
            
            239,800
            
            
            -Other
            
            22,017
            
            
            22,526Inventories
            
            336,513
            
            
            388,783Prepaid expenses
            
            13,521
            
            
            173,664Total Current Assets
            
            1,509,819
            
            
            1,454,963Property and Equipment (Net of accumulateddepreciation and
      amortization)
            
            15,702,599
            
            
            18,949,605Other AssetsDeferred area developmentand franchise fees, net
            
            258,731
            
            
            275,065Deferred financing fee, net
            
            -
            
            
            34,115Total Other Assets
            
            258,731
            
            
            309,180$
            17,471,149
            
            $
            20,713,748


The accompanying notes
are an integral part of the consolidated financialstatements.




F-7




---



Liabilities and Equity




2009
            
            2008Current LiabilitiesNotes payable to
      affiliates
            $
            3,600,000
            
            
            $
            3,600,000Current portion of long-term debt
            
            6,784,635
            
            
            
            2,149,928Accounts payableTrade
            
            89,151
            
            
            
            124,220Affiliated entities
            
            504,721
            
            
            
            580,860Accrued expensesSalaries and wages
            
            348,302
            
            
            
            333,423Sales tax
            
            19,500
            
            
            
            24,117Rent and real estate taxes
            
            14,438
            
            
            
            23,689Accrued legal fees
            
            60,000
            
            
            
            80,000Accrued interest
            
            1,082,520
            
            
            
            980,134Other
            
            110,340
            
            
            
            132,271Total Current Liabilities
            
            12,613,607
            
            
            
            8,028,642Noncurrent LiabilitiesLong-term debt (Net of current
      portion)
            
            -
            
            
            
            6,784,635Deferred rent
            
            1,783,903
            
            
            
            1,691,827Total Noncurrent Liabilities
            
            1,783,903
            
            
            
            8,476,462Total Liabilities
            
            14,397,510
            
            
            
            16,505,104Equity (Deficit)KremeWorks, LLC members' (deficit)
      equity
            
            (170,855
            )
            
            
            318,060Noncontrolling
    interest
            
            3,244,494
            
            
            
            3,890,584Total Equity
            
            3,073,639
            
            
            
            4,208,644$
            17,471,149
            
            
            $
            20,713,748


F-8




---



KremeWorks, LLC and
Subsidiary




Consolidated
Statements of Loss




Years Ended December
30, 2009, December 31, 2008 and December 26, 2007





2009
            
            2008
            
            2007Sales
            $
            17,091,291
            
            
            $
            18,504,101
            
            
            $
            20,339,092Cost of Sales - Food and Beverage
            
            3,656,477
            
            
            
            4,271,443
            
            
            
            4,190,233Gross Profit after Food and
      Beverage
            
            13,434,814
            
            
            
            14,232,658
            
            
            
            16,148,859Store Payroll and Benefits
            
            5,252,585
            
            
            
            5,445,251
            
            
            
            5,627,520Gross Profit
            
            8,182,229
            
            
            
            8,787,407
            
            
            
            10,521,339Store Operating ExpensesDirect operating
            
            1,442,366
            
            
            
            1,458,527
            
            
            
            1,480,428Marketing
            
            670,991
            
            
            
            512,792
            
            
            
            572,215Occupancy
            
            1,910,504
            
            
            
            2,144,062
            
            
            
            2,164,302Depreciation and amortization
            
            2,716,061
            
            
            
            3,003,312
            
            
            
            3,011,953Impairment charge
            
            615,000
            
            
            
            -
            
            
            
            -Store
      general and administrative
            
            507,634
            
            
            
            549,335
            
            
            
            579,321Delivery
            
            23,010
            
            
            
            35,824
            
            
            
            120,554Other
            
            82,039
            
            
            
            84,968
            
            
            
            95,645Total Store OperatingExpenses
            
            7,967,605
            
            
            
            7,788,820
            
            
            
            8,024,418Income from Store Operations
            
            214,624
            
            
            
            998,587
            
            
            
            2,496,921Other Operating ExpensesOther general and administrative
            
            768,100
            
            
            
            352,219
            
            
            
            566,995Divisional payroll and benefits
            
            589,879
            
            
            
            700,639
            
            
            
            719,988Royalty fees
            
            769,140
            
            
            
            832,615
            
            
            
            915,328Management fee
            
            682,599
            
            
            
            741,846
            
            
            
            813,624Franchise expense
            
            16,334
            
            
            
            16,334
            
            
            
            16,334Marketing fees
            
            128,187
            
            
            
            142,674
            
            
            
            203,000Total Other Operating Expenses
            
            2,954,239
            
            
            
            2,786,327
            
            
            
            3,235,269Loss from Operations
            
            (2,739,615
            )
            
            
            (1,787,740
            )
            
            
            (738,348
            )Interest Expense, Net
            
            398,820
            
            
            
            940,583
            
            
            
            1,224,741Net Loss
            
            (3,138,435
            )
            
            
            (2,728,323
            )
            
            
            (1,963,089
            )Less Net Loss Attributable to theNoncontrolling
    Interest
            
            646,090
            
            
            
            562,358
            
            
            
            403,744Net Loss Attributable toKremeWorks, LLC
            $
            (2,492,345
            )
            
            $
            (2,165,965
            )
            
            $
            (1,559,345
            )


The accompanying notes
are an integral part of the consolidated financialstatements.




F-9




---



KremeWorks, LLC and
Subsidiary




Consolidated
Statements of Comprehensive Loss




Years Ended December
30, 2009, December 31, 2008 and December 26, 2007





2009
            
            2008
            
            2007Net Loss
            $
            (3,138,435
            )
            
            $
            (2,728,323
            )
            
            $
            (1,963,089
            )Gain (Loss) on Derivative
            
            -
            
            
            
            25,174
            
            
            
            (96,911
            )Comprehensive Loss
            
            (3,138,435
            )
            
            
            (2,703,149
            )
            
            
            (2,060,000
            )Comprehensive Loss Attributableto Noncontrolling
      Interest
            
            646,090
            
            
            
            557,323
            
            
            
            423,126Comprehensive Loss
Attributableto
      KremeWorks, LLC
            $
            (2,492,345
            )
            
            $
            (2,145,826
            )
            
            $
            (1,636,874
            )


The accompanying notes
are an integral part of the consolidated financialstatements.




F-10




---



KremeWorks, LLC and
Subsidiary




Consolidated
Statements of Cash Flows




Years Ended December
30, 2009, December 31, 2008 and December 26, 2007





2009
            
            2008
            
            2007Cash Flows from Operating
      ActivitiesNet loss
            $
            (3,138,435
            )
            
            $
            (2,728,323
            )
            
            $
            (1,963,089
            )Adjustments to reconcile net loss to netcash provided by operating activitiesDepreciation and amortization
            
            2,766,510
            
            
            
            3,056,472
            
            
            
            3,065,112Impairment charge
            
            615,000
            
            
            
            -
            
            
            
            -Deferred rent
            
            92,076
            
            
            
            222,752
            
            
            
            275,168(Increase) decrease inReceivables
            
            15,104
            
            
            
            23,908
            
            
            
            (18,748
            )Inventories
            
            52,270
            
            
            
            (18,227
            )
            
            
            (89,062
            )Prepaid expenses
            
            160,143
            
            
            
            (143,494
            )
            
            
            3,935Increase (decrease) inAccounts payable
            
            617,222
            
            
            
            897,743
            
            
            
            841,890Accrued expenses
            
            61,466
            
            
            
            265,252
            
            
            
            (76,669
            )Total Adjustments
            
            4,379,791
            
            
            
            4,304,406
            
            
            
            4,001,626Net Cash Provided byOperating Activities
            
            1,241,356
            
            
            
            1,576,083
            
            
            
            2,038,537Cash Flows from Investing ActivitiesCapital expenditures
            
            (84,055
            )
            
            
            (182,820
            )
            
            
            (304,849
            )Proceeds from sale of fixed
      asset
            
            -
            
            
            
            1,692
            
            
            
            -Net Cash Used inInvesting Activities
            
            (84,055
            )
            
            
            (181,128
            )
            
            
            (304,849
            )Cash Flows from Financing ActivitiesPrincipal payments on long-term debt
            
            (2,149,928
            )
            
            
            (1,834,110
            )
            
            
            (2,155,880
            )Member contributions
            
            1,035,200
            
            
            
            375,000
            
            
            
            -Net Cash Used inFinancing Activities
            
            (1,114,728
            )
            
            
            (1,459,110
            )
            
            
            (2,155,880
            )Net Increase (Decrease) in Cash
            
            42,573
            
            
            
            (64,155
            )
            
            
            (422,192
            )Cash, Beginning of Year
            
            823,990
            
            
            
            888,145
            
            
            
            1,310,337Cash, End of Year
            $
            866,563
            
            
            $
            823,990
            
            
            $
            888,145


The accompanying notes
are an integral part of the consolidated financialstatements.




F-11




---



KremeWorks, LLC and Subsidiary




Consolidated  Statements of Changes in Equity




Years Ended December 30, 2009, December 31, 2008 and December 26, 2007





KremeWorks, LLC Members'
    EquityAccumulatedOther
            
            KremeWorks, LLCMember
            
            Accumulated
            
            Comprehensive
            
            Members’
            
            Noncontrolling
            
            TotalContributions
            
            Deficit
            
            Income
      (Loss)
            
            Equity
      (Deficit)
            
            Interest
            
            EquityBalance, December 27,
      2006
            $
            2,536,256
            
            $
            (878,287
            )
            
            $
            57,390
            
            
            $
            1,715,359
            
            
            $
            4,871,033
            
            
            $
            6,586,392Net loss
            
            -
            
            
            (1,559,345
            )
            
            
            -
            
            
            
            (1,559,345
            )
            
            
            (403,744
            )
            
            
            (1,963,089
            )Member contributions
            
            862,616
            
            
            -
            
            
            
            -
            
            
            
            862,616
            
            
            
            -
            
            
            
            862,616Loss on derivative
            
            -
            
            
            -
            
            
            
            (77,529
            )
            
            
            (77,529
            )
            
            
            (19,382
            )
            
            
            (96,911
            )Balance, December 26, 2007
            
            3,398,872
            
            
            (2,437,632
            )
            
            
            (20,139
            )
            
            
            941,101
            
            
            
            4,447,907
            
            
            
            5,389,008Net loss
            
            -
            
            
            (2,165,965
            )
            
            
            -
            
            
            
            (2,165,965
            )
            
            
            (562,358
            )
            
            
            (2,728,323
            )Member contributions
            
            1,522,785
            
            
            -
            
            
            
            -
            
            
            
            1,522,785
            
            
            
            -
            
            
            
            1,522,785Gain on derivative
            
            -
            
            
            -
            
            
            
            20,139
            
            
            
            20,139
            
            
            
            5,035
            
            
            
            25,174Balance, December 31, 2008
            
            4,921,657
            
            
            (4,603,597
            )
            
            
            -
            
            
            
            318,060
            
            
            
            3,890,584
            
            
            
            4,208,644Net loss
            
            -
            
            
            (2,492,345
            )
            
            
            -
            
            
            
            (2,492,345
            )
            
            
            (646,090
            )
            
            
            (3,138,435
            )Member contributions
            
            2,003,430
            
            
            -
            
            
            
            -
            
            
            
            2,003,430
            
            
            
            -
            
            
            
            2,003,430Balance, December 30, 2009
            $
            6,925,087
            
            $
            (7,095,942
            )
            
            $
            -
            
            
            $
            (170,855
            )
            
            $
            3,244,494
            
            
            $
            3,073,639


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




F-12




---



Note 1 - Industry
Operations




KremeWorks, LLC and
Subsidiary (the Company) have franchise rights to develop 23 Krispy Kreme
doughnut stores in the states of Washington, Oregon, Hawaii and Alaska. As of
December 30, 2009, the Company owns and operates 11 Krispy Kreme stores, of
which eight are located in Washington, two are located in Oregon and one is
located in Hawaii. The Company opened its first store on October 30, 2001. The
Company opened one store in 2001, two stores in 2002, five stores in 2003 and
three stores in 2004.




KremeWorks, LLC
(KremeWorks) owns 80% of its subsidiary, KremeWorks USA, LLC (KW USA), which in
turn owns 95% of its subsidiary, KremeWorks Oregon (KWO) and 100% of its
subsidiaries, KremeWorks Washington (KWW), KremeWorks Hawaii (KWH) and
KremeWorks Alaska (KWA).




KremeWorks is owned
67.6% (65.8% in 2008 and 2007) by ICON LLC (ICON), 25% by Krispy Kreme Doughnut
Corporation (KKDC), 3.6% (5.5% in 2008 and 2007) by partners of Lettuce
Entertain You Enterprises, Inc. (Lettuce) and 3.8% (3.7% in 2008 and 2007) by a
member of ICON.




Note 2 - Summary of
Significant Accounting Policies




Principles of Consolidation




The consolidated
financial statements include the accounts of KremeWorks and its 80%-owned
subsidiary, KW USA. All significant intercompany balances and transactions have
been eliminated.




The KW USA operating
agreement contains a provision stating that the amount of loss allocated to a
member cannot create or increase a deficit in a member’s capital account if and
to the extent that any other member has a positive capital account balance. If
losses are ever allocated disproportionately as a result of this arrangement, an
equal amount of subsequent profits will be allocated disproportionately until
the member’s capital account is in accordance with the member’s respective
interest on a cumulative basis. As of December 30, 2009 and December 31, 2008,
KremeWorks’ capital account is in accordance with its ownership interest in KW
USA on a cumulative basis.




In December 2007, the
FASB issued new guidance on noncontrolling interests in consolidated financial
statements. This guidance clarifies that a noncontrolling interest in a
subsidiary, formerly referred to as minority interest, is an ownership interest
in the consolidated entity that should be reported as equity in the consolidated
financial statements. It also requires consolidated net income to be reported at
amounts that include amounts attributable to both the parent and the
noncontrolling interest, rather than only the amounts attributable to the parent
under previous requirements. Lastly, it requires expanded disclosures in the
consolidated financial statements that clearly identify the separate interests
of the parent’s owners and the noncontrolling owners of a subsidiary and
provides guidance when a subsidiary is deconsolidated. At the beginning of 2009,
the Company adopted this guidance on a prospective basis, other than the
presentation and disclosure requirements which have been adopted
retrospectively.





F-13




---



The adoption of the
noncontrolling interest guidance impacted the Company’s consolidated financial
statements as follows:


- The amounts
  previously shown as minority interest in prior consolidated balance sheets
  have been reclassified to equity and re-titled as noncontrolling interests,
  with no change in amount.
- The amounts
  previously titled as loss before minority interest in the consolidated
  statements of loss have been re-titled as net loss, and the amounts previously
  titled as net loss have been re-titled as net loss attributable to KremeWorks,
  LLC.
- The consolidated
  statements of comprehensive loss have been altered to present comprehensive
  loss in total with an allocation of such loss to the noncontrolling interest
  with the remainder attributable to KremeWorks, LLC.
- The consolidated
  statements of members’ equity have been changed to the consolidated statements
  of changes in equity and present the changes in equity attributable to
  KremeWorks, LLC and the noncontrolling interest separately and in
  total.

Fiscal Year




The Company has a
52/53-week fiscal year ending on the last Wednesday in December. The fiscal
years ended on December 30, 2009, December 31, 2008 and December 26, 2007
contained 52, 53 and 52 weeks, respectively.




Reclassifications




For comparability,
the 2008 and 2007 financial statements reflect reclassifications where
appropriate to conform to the financial statement presentation used in 2009.




Revenue Recognition




Sales of food and
beverages are recognized as revenue at the point of sale.




Cash




Substantially all
cash is held at Bank of America, N.A. The cash held in this institution may
exceed federally insured limits from time to time. The Company has not
experienced any losses in this account. The Company believes it is not exposed
to any significant credit risk on cash.




Inventories




Inventories are
valued at lower of cost (first-in, first-out) or market.





F-14




---



Property and Equipment




The Company’s policy
is to depreciate the cost of property and equipment over the estimated useful
lives of the assets using the straight-line method. The cost of leasehold
improvements is amortized over the remaining term of the lease or the useful
lives, if shorter, using the straight-line method. The average estimated
depreciable lives for financial reporting purposes are as follows:




YearsLeasehold improvements
            20Furniture, fixtures and equipment
            7Automobiles
            3Computer equipment
            3


Long-lived assets are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying value of an asset or asset group (typically a store) might not
be recoverable. If the carrying amount of an asset exceeds its estimated future
undiscounted cash flows, an impairment charge is recognized in the amount by
which the carrying amount exceeds the estimated fair value of the asset. The
Company recognized an impairment charge on one of its Washington stores in the
amount of $615,000 in 2009 (see Notes 3 and 11).




Deferred Area Development and Franchise
Fees




KremeWorks has
entered into a development agreement with KKDC to develop and operate 23 Krispy
Kreme stores. The original development agreement required the twenty-third store
to be opened by August 1, 2007. On July 22, 2005, the agreement was amended
effective December 31, 2004 to suspend the development schedule by a 24-month
period for all stores to be opened on or after February 1, 2005. This amendment
extended the due date for opening a new store until February 1, 2007 and the due
date for opening the twenty-third until August 1, 2009.




As of the date of
these consolidated financial statements, KremeWorks has no present plan to open
any new stores and has not received any notice from KKDC of its expectation of
the Company to open additional stores. The Company believes KKDC is addressing
the Krispy Kreme business model in general and the type of retail stores that
best represent the brand in particular, with a focus on retail stores
substantially smaller than the factory stores called for in the current area
development agreement. The Company believes that KKDC does not expect its
franchisees to open any additional stores until a viable small store has been
developed. The amended agreement also waived any requirement for off-premises
sales by the Company pursuant to the Development Agreement and Franchise
Agreement.




KremeWorks originally
paid KKDC a $230,000 development fee, or $10,000 per store. In conjunction with
the development agreement with KKDC, KremeWorks has also entered into a
franchise fee agreement with KKDC whereby KremeWorks is required to pay a
$25,000 franchise fee for each Krispy Kreme store that it opens. The $10,000 per
store development fee is credited toward
this franchise fee. These fees are being amortized over the lives of the
respective stores’ leases on a straight-line basis. As of December 30, 2009 and
December 31, 2008, the Company has capitalized area development and franchise
fees in the amount of $395,000. As of December 30, 2009 and December 31, 2008,
accumulated amortization for area development and franchise fees totaled
$136,269 and $119,935, respectively.





F-15




---



Deferred Financing Fee




The Company
capitalizes fees paid to secure debt financing and amortizes them over the terms
of the respective loans on a straight-line basis. As of December 30, 2009 and
December 31, 2008, the Company has capitalized financing fees in the amount of
$240,000. As of December 31, 2008, accumulated amortization on deferred
financing fees was $205,885. Such fees were fully amortized as of December 30,
2009.




Advertising Costs




Advertising costs are
expensed as incurred. Advertising expense was $248,031, $240,218 and $201,084 in
2009, 2008 and 2007, respectively, and is included in store operating expenses
in the consolidated statements of loss.




Financial Instruments




A financial
instrument is cash, evidence of ownership interest in an entity or certain
contracts involving future conveyances of cash or other financial instruments.
The carrying values of the Company’s financial instruments approximate fair
value.




Comprehensive Loss




Comprehensive loss is
a measure of all changes in equity that result from recognized transactions and
other economic events of the year, other than owner transactions, such as
purchases of ownership interest and distributions. This presentation appears in
the consolidated statement of comprehensive loss.




Aspects of the Limited Liability
Company




The Company is
treated as a partnership for federal income tax purposes. Consequently, federal
income taxes are not payable by, or provided for, the Company. Members are taxed
individually on their shares of the Company’s earnings. Accordingly, the
consolidated financial statements do not reflect a provision for income taxes.
The operating agreement provides for the allocation of profits, losses and
distributions in proportion to each member’s respective interest.




All member units are
identical in rights, preferences and privileges.




The Company has a
limited life and, according to its Articles of Organization, will dissolve no
later than December 31, 2052.





F-16




---



Income Taxes




The Company’s
adoption of the Income Tax Topic regarding uncertain tax positions of GAAPUSA at
the beginning of 2009 had no effect on its financial position as management
believes the Company has no material uncertain tax positions. The Company would
account for any potential interest or penalties related to possible future
liabilities as income tax expense. The Company is no longer subject to
examination by tax authorities for federal, state or local income taxes for
periods before 2006. Prior to adoption of the Income Tax Topic, the Company
accounted for tax positions under a contingent loss model, requiring recognition
of a tax liability when it was both (1) probable that it had been incurred as of
year-end and (2) the amount could be reasonably estimated.




Management Estimates




The preparation of
financial statements in conformity with GAAPUSA requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those
estimates.




Note 3 - Fair Value
Measurements




GAAPUSA defines fair
value as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants as of the
measurement date. GAAPUSA describes three approaches to measuring the fair value
of assets and liabilities: the market approach, the income approach and the cost
approach. Each approach includes multiple valuation techniques. GAAPUSA does not
prescribe which valuation technique should be used when measuring fair value,
but does establish a fair value hierarchy that prioritizes the inputs used in
applying the various techniques. Inputs broadly refer to the assumptions that
market participants use to make pricing decisions, including assumptions about
risk. Level 1 inputs are given the highest priority in the hierarchy while Level
3 inputs are given the lowest priority. Assets and liabilities carried at fair
value are classified in one of the following three categories based on the
nature of the inputs used to determine their respective fair values.


- Level 1 - Observable inputs that
  reflect unadjusted quoted prices for identical assets or liabilities in active
  markets as of the reporting date. Active markets are those in which
  transactions for the asset or liability occur in sufficient frequency and
  volume to provide pricing information on an ongoing basis.
- Level 2 - Observable market-based
  inputs or unobservable inputs that are corroborated by market data.
- Level 3 - Unobservable inputs that
  are not corroborated by market data. These inputs reflect management’s best
  estimate of fair value using its own assumptions about the assumptions a
  market participant would use in pricing the asset or liability.

F-17









As required by
GAAPUSA, assets and liabilities are classified in their entirety based on the
lowest level of input that is significant to the fair value measurement. The
company’s assessment of the significance of a particular input to the fair value
measurement requires judgment, and may affect their placement within the fair
value hierarchy levels.




The following table
sets forth by level within the fair value hierarchy the Company’s assets that
were accounted for at fair value on a nonrecurring basis as of December 31,
2009:




Quoted Price
            
            Significantin Active
            
            Other
            
            Significant
            
            Total GainsFair Values
            
            Market for
            
            Observable
            
            Unobservable
            
            (Losses) for theas of
            
            Identical Asset
            
            Inputs
            
            Inputs
            
            Year EndedDescription
            
            December 31,
      2009
            
            (Level
      1)
            
            (Level
      2)
            
            (Level
      3)
            
            December 31,
      2009Property andequipment heldand used
            
            $
            685,000
            
            $
            -
            
            $
            -
            
            $
            685,000
            
            $
            (615,000
            )


During 2009 the
Company wrote-down its property and equipment associated with its Puyallup,
Washington store. These assets continue to be classified as property and
equipment, rather than assets held for sale, because of the difficulties
encountered by the Company in its efforts to sell and assign this location. The
fair value reflects the current sales price at which the property and equipment
is currently being marketed based on local market conditions.




Note 4 - Inventories




2009
            
            2008Food and beverages
            $
            175,966
            
            $
            199,758Packaging
            
            58,872
            
            
            68,356Merchandise
            
            101,675
            
            
            120,669$
            336,513
            
            $
            388,783




F-18




Note 5 - Property and
Equipment




2009
            
            2008Leasehold improvements
            
            $
            20,622,008
            
            
            $
            21,237,008Furniture, fixtures and equipment
            
            
            14,191,504
            
            
            
            14,125,684Automobiles
            
            
            408,468
            
            
            
            408,468Computer equipment
            
            
            160,175
            
            
            
            141,94035,382,155
            
            
            
            35,913,100Less: Accumulated depreciation and amortization
            
            
            (19,679,556
            )
            
            
            (16,963,495
            )$
            15,702,599
            
            
            $
            18,949,605Note 6 -
      Long-Term Debt


2009
            
            2008Note payable to Bank of America in
      monthly principalinstallments of $50,994 plus interest at
      the 30-day LIBORrate plus 2.75%. A one-time principal
      payment of $500,000is due on December 31, 2009 and a final
      balloon paymentof $3,684,587 is due on July 31,
      2010.
            
            $
            4,541,545
            
            
            $
            5,812,622Note payable to Bank of America in monthly principalinstallments of $29,374 plus interest at the 30-day LIBORrate plus 2.75%. A final balloon payment of $2,037,472 isdue on July 31, 2010.
            
            
            2,243,090
            
            
            
            3,114,713Other notes payable
            
            
            -
            
            
            
            7,228Total long-term debt
            
            
            6,784,635
            
            
            
            8,934,563Less current maturities
            
            
            (6,784,635
            )
            
            
            (2,149,928
            )$
            -
            
            
            $
            6,784,635


The notes payable to
Bank of America are collateralized by substantially all of the Company’s assets
and are guaranteed by the members of ICON and by KKDC up to an aggregate
original amount of $10,666,667. Of that amount, the members of ICON personally
guaranteed $8,000,000 and KKDC guaranteed $2,666,667. The borrowings under these
notes are also subject to certain restrictive covenants including financial
covenants related to leverage and cash flow ratios. It is management’s
expectation that these notes will be refinanced in 2010.




Interest expense on
the above notes was $264,812, $738,573 and $940,825 in 2009, 2008 and 2007,
respectively.




Total interest
expense was $399,023, $945,073 and $1,248,130 in 2009, 2008 and 2007,
respectively.





F-19




---



Note 7 - Derivative
Financial Instrument - Interest Rate Swap Agreement




KW USA had obtained a
derivative financial instrument from Bank of America to reduce its exposure to
market risks from changes in interest rates related to its financing described
in Note 6. The instrument used to mitigate these risks was an interest rate
swap. Under the Derivatives and Hedging Topic of GAAPUSA, derivatives are
recognized in the balance sheet at fair value. Any changes in fair value are to
be recognized immediately in earnings unless the derivatives qualify as hedges
of future cash flows. The derivative instrument held by KW USA was designated as
a highly effective cash flow hedge of interest rate risk on variable rate debt
in accordance with the provisions of the Derivatives and Hedging Topic. As a
result, the change in fair value of this instrument has been recorded as a
component of other comprehensive loss. KW USA’s derivative instrument expired
December 31, 2008.




Fluctuations in the
fair value of the derivative resulted in gains and (losses) of $25,174 and
($96,911), in 2008 and 2007, respectively. The Company’s share of these gains
and (losses) totaled $20,139 and ($77,529) in 2008 and 2007, respectively, and
were included in other comprehensive loss. The remaining portion of these gains
and (losses) had been allocated to the noncontrolling interest.




Note 8 - Operating
Leases




The Company conducts
its operations in facilities under operating leases. Minimum rent is recognized
over the term of the leases using the straight-line method. The Company’s
substantial investment in long-lived leasehold improvements was deemed to
constitute a penalty under GAAPUSA in determining the lease term for each lease.
In addition to minimum rent, the leases require the payment of common area
expenses and real estate taxes. Total rental expense for the facilities was
$1,677,048, $1,746,863 and $1,746,030 in 2009, 2008 and 2007, respectively.
Under certain leases, the Company has options to purchase a 25% interest in the
leased premises after 15 years, if the leases are then in full force and effect.




The following is a
schedule by year of future minimum lease payments required under the operating
leases as of December 30, 2009:




Fiscal Year Ending:2010
            
            
            $
            1,539,9052011
            
            
            
            1,560,4712012
            
            
            
            1,575,6542013
            
            
            
            1,662,0582014
            
            
            
            1,828,177Later years
            
            
            
            16,391,441$
            24,557,706


F-20





---



Note 9 - Related
Party Transactions




The Company is
affiliated through common ownership with KremeWorks Canada, LP, ICON and various
entities associated with Lettuce, as well as Lettuce itself. In the normal
course of business, the affiliated entities transfer inventory and share
personnel and record such transfers at cost.




The Company has
entered into a management agreement with Lettuce and ICON whereby it pays a
management fee for services provided based on 4% of sales. The management fee
amounted to $682,599, $741,846 and $813,624 for 2009, 2008 and 2007,
respectively. Lettuce’s portion of this management fee was $137,500, $183,335
and $183,216 in 2009, 2008 and 2007, respectively, with the remainder payable to
ICON. Services provided include, but are not limited to, accounting and payroll
services, human resources, licensing and marketing. ICON also serves as a
disbursing agent and paymaster for the Company’s payroll. Lettuce serves as a
workers’ compensation and health insurance administrator in a group
self-insurance program.




In conjunction with
the development agreement with KKDC described in Note 2, the Company is required
to pay royalty fees to KKDC on a weekly basis equal to 4.5% of gross sales.
Royalty fees paid to KKDC totaled $769,140, $832,615 and $915,328 in 2009, 2008
and 2007, respectively.




The Company’s
franchise agreement with KKDC requires the Company to purchase furnishings,
fixtures, equipment, signs, doughnut mixes and other supplies that have been
approved by KKDC for Krispy Kreme stores. KKDC is the sole supplier for certain
doughnut production equipment and all doughnut mixes. Purchases from KKDC
totaled $3,136,431, $4,201,283 and $4,163,369 in 2009, 2008 and 2007,
respectively. As of December 30, 2009 and December 31, 2008, the amount due to
KKDC for the previously described purchases totaled $396,792 and $456,069,
respectively. This liability is included in the accounts payable to affiliated
entities in the Company’s consolidated balance sheets. In 2008, the Company
received $270,000 from KKDC relating to consulting services and reimbursement
for concept development costs. This expense is included in other general and
administrative expenses on the statements of loss.




As of December 30,
2009 and December 31, 2008, KW USA had a note payable to ICON in the amount of
$2,700,000. The note is due on demand and bears interest at the prime rate plus
1⁄2%. Interest expense on this note for 2009, 2008 and, 2007 was $100,973,
$154,103 and $229,001, respectively. As of December 30, 2009 and December 31,
2008, KW USA also had a note payable to KKDC, due on demand in the amount of
$900,000, bearing interest at the prime rate plus 1⁄2%. Interest expense on this
note for 2009, 2008 and 2007 was $33,658, $51,368 and $76,334, respectively. The
loans from ICON and KKDC are pursuant to an agreement between the two companies
and are in amounts that approximate the ratio of their respective ownership
interests in KW USA.




A member of ICON is
an attorney and his law firm provides legal services to the Company. The total
expense for these services was $253, $1,279 and $28,571 for 2009, 2008 and 2007,
respectively.





F-21




---



See Note 10 for
additional related party transactions.




Note 10 - Other Cash
Flow Information




Cash paid for
interest amounted to $296,637, $749,915 and $1,231,806 for 2009, 2008 and 2007,
respectively.




During 2009, there
were capital contributions totaling $1,275,000, of which $239,800 was a
receivable at year-end (see Note 12).




During 2009, ICON and
KKDC made capital contributions in the amounts of $546,322 and $182,108,
respectively, by forgiving amounts owed to them by the Company.




During 2008, ICON and
KKDC made capital contributions in the amounts of $860,839 and $286,946,
respectively, by forgiving amounts owed to them by the Company.




During 2007, ICON and
KKDC made capital contributions in the amounts of $646,962 and $215,654,
respectively, by forgiving amounts owed to them by the Company.




Note 11 - Status of
Operations




The Company has
experienced steadily declining revenues and significant losses over the last
five years. While the Company is still generating positive cash flows from
operations, members of KremeWorks made significant cash contributions to enable
the Company to meet its cash flow needs and debt service requirements in 2009
and 2008. The Company’s current debt agreement with Bank of America expires on
July 31, 2010 at which time approximately $5,700,000 in principal payments will
become due. Management believes that it will be able to negotiate a new debt
agreement with Bank of America or a similar institution. Management also
believes operating cash flows will recover in the near future to a level that
will allow the Company to meet its ongoing cash flow needs.




The Company is in
discussions to sell and assign two of its under-performing stores and use the
proceeds to reduce bank debt. Based on negotiations for the sale and assignment
of its Puyallup, Washington location, the Company asked its landlord for consent
to the proposed assignment. The landlord denied the consent and subsequently
filed an action in Ohio (where the landlord is located) for accrued rent (since
paid) and a declaratory judgment upholding its refusal or, alternatively, the
landlord’s right to the proceeds of the sale of the location. The Company has
filed an action in Washington (i) for a declaratory judgment that it has the
right to assign its lease and sell its assets as proposed and (ii) for damages.
With respect to the other under-performing store, the Company does not believe
that it qualifies for held for sale accounting and has therefore continued to
account for its long-lived assets as property and equipment.





F-22




---



In the event that
management’s expectations mentioned above are not realized, alternative sources
of financing might be required for the Company to continue operations beyond the
near term.




Note 12 - Subsequent
Events




The Company has
evaluated subsequent events through March 31, 2010, the date the financial
statements were available to be issued.




Payments for all
$239,800 of the member contributions receivable balance as of December 30, 2009
were received by January 11, 2010.




The Company made a
$500,000 principal payment to Bank of America on January 14, 2010.





F-23




---