Document/Exhibit Description Pages Size
1: 10-K Krispy Kreme Doughnuts, Inc. Form 10-K HTML 170K
2: EX-3.2 Amended and Restated Bylaws of the Registrant 14 58K
3: EX-10.15 Employment Agreement/Phalen 11 50K
4: EX-13 Portions of 2004 Annual Report to Shareholders 84± 406K
5: EX-21 List of Subsidiaries 2± 10K
6: EX-23 Consent of Pricewaterhousecoopers LLP 1 8K
7: EX-31.1 Certification / CEO 2± 10K
8: EX-31.2 Certification / CFO 2± 10K
9: EX-32.1 Section 906 Certification / CEO 1 8K
10: EX-32.2 Section 906 Certification / CFO 1 8K
EX-13 — Portions of 2004 Annual Report to Shareholders
Exhibit Table of Contents
SELECTED FINANCIAL DATA
The following table shows selected financial data for Krispy Kreme. The selected
historical statement of operations data for each of the years ended, and the
selected historical balance sheet data as of January 30, 2000, January 28, 2001,
February 3, 2002, February 2, 2003 and February 1, 2004 have been derived from
our audited consolidated financial statements. Please note that our fiscal year
ended February 3, 2002 contained 53 weeks.
The consolidated financial statements include the accounts of certain joint
ventures in which Krispy Kreme had a controlling interest for the periods
presented: Freedom Rings, LLC, the area developer in Eastern Pennsylvania,
Delaware and Southern New Jersey, Golden Gate Doughnuts, LLC, the area developer
in Northern California, as well as Glazed Investments, LLC, the area developer
in Colorado, Minnesota and Wisconsin, for periods subsequent to August 22, 2002,
the date Krispy Kreme acquired a controlling interest in this area developer.
Effective January 30, 2004, Krispy Kreme acquired the remaining 33% minority
interest in Golden Gate Doughnuts, LLC.
You should read the following selected financial data in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the consolidated financial statements and accompanying notes and
the other financial data included elsewhere herein. All references to per share
amounts and any other reference to shares in "Selected Financial Data," unless
otherwise noted, have been adjusted to reflect a two-for-one stock split paid on
March 19, 2001 to shareholders of record as of March 5, 2001 and a two-for-one
stock split paid on June 14, 2001 to shareholders of record as of May 29, 2001.
Unless otherwise specified, references in this annual report to "Krispy Kreme,"
the "Company," "we," "us" or "our" refer to Krispy Kreme Doughnuts, Inc. and its
subsidiaries.
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IN THOUSANDS, EXCEPT PER SHARE DATA AND STORE NUMBERS
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FEB. 3, FEB. 2, FEB. 1,
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 2002 2003 2004
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STATEMENT OF OPERATIONS DATA:
Total revenues $ 220,243 $ 300,715 $ 394,354 $ 491,549 $ 665,592
Operating expenses 190,003 250,690 316,946 381,489 507,396
General and administrative expenses 14,856 20,061 27,562 28,897 36,912
Depreciation and amortization expenses 4,546 6,457 7,959 12,271 19,723
Arbitration award -- -- -- 9,075 (525)
----------------------------------------------------------------------
Income from operations 10,838 23,507 41,887 59,817 102,086
Interest and other expense (income),
net 1,232 (1,698) (2,408) 749 3,501
Equity loss in joint ventures -- 706 602 2,008 1,836
Minority interest -- 716 1,147 2,287 2,072
----------------------------------------------------------------------
Income before income taxes 9,606 23,783 42,546 54,773 94,677
Provision for income taxes 3,650 9,058 16,168 21,295 37,590
----------------------------------------------------------------------
Net income $ 5,956 $ 14,725 $ 26,378 $ 33,478 $ 57,087
----------------------------------------------------------------------
Net income per share:
Basic $ .16 $ .30 $ .49 $ .61 $ .96
Diluted .15 .27 .45 .56 .92
Shares used in calculation of net
income per share:
Basic 37,360 49,184 53,703 55,093 59,188
Diluted 39,280 53,656 58,443 59,492 62,388
OPERATING DATA (UNAUDITED):
Number of factory stores at end of
period:
Company 58 63 75 99 141
Franchised 86 111 143 177 216
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Systemwide 144 174 218 276 357
----------------------------------------------------------------------
Average weekly sales per factory store:
Company $ 54 $ 69 $ 72 $ 76 $ 73
Franchised 38 43 53 58 56
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital $ 11,452 $ 29,443 $ 49,236 $ 81,441 $ 85,151
Total assets 104,958 171,493 255,376 410,487 660,664
Long-term debt, including current
maturities 22,902 -- 4,643 60,489 137,917
Total shareholders' equity 47,755 125,679 187,667 273,352 452,207
19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of our financial condition and results of operations
should be read together with the financial statements and the accompanying
notes. This annual report contains statements about future events and
expectations, including anticipated store and market openings, planned capital
expenditures and trends in or expectations regarding the Company's operations
and financing abilities that constitute "forward-looking statements" within the
meaning of 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. Factors that could contribute to these
differences include, but are not limited to: the Company's ability to continue
and manage growth; delays in store openings; the quality of franchise store,
including joint venture, operations; the price and availability of raw materials
needed to produce doughnut mixes and other ingredients; changes in customer
preferences and perceptions; risks associated with competition; risks associated
with fluctuations in operating and quarterly results; compliance with government
regulations; and other factors discussed in Krispy Kreme's periodic reports,
proxy statement and other information statements filed with the Securities and
Exchange Commission. The words "believe," "may," "will," "should," "anticipate,"
"estimate," "expect," "intend," "objective," "seek," "strive," or similar words,
or the negative of these words, identify forward-looking statements. The Company
qualifies any forward-looking statements entirely by these cautionary factors.
All references to per share amounts and any other reference to shares in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," unless otherwise noted, have been adjusted to reflect a two-for-one
stock split paid on March 19, 2001 to shareholders of record as of March 5, 2001
and a two-for-one stock split paid on June 14, 2001 to shareholders of record as
of May 29, 2001.
COMPANY OVERVIEW AND INDUSTRY OUTLOOK
Our principal business, which began in 1937, is owning and franchising Krispy
Kreme doughnut stores where we make and sell over 20 varieties of premium
quality doughnuts, including our Hot Original Glazed. Each of our traditional
stores is a doughnut factory with the capacity to produce from 4,000 dozen to
over 10,000 dozen doughnuts daily. Consequently, each store has significant
fixed or semi-fixed costs, and margins and profitability are significantly
impacted by doughnut production volume and sales. Our doughnut stores are
versatile in that most can support multiple sales channels to more fully utilize
production capacity. These sales channels are comprised of:
- ON-PREMISES SALES. Sales to customers visiting our stores, including the
drive-through windows, along with discounted sales to community
organizations that in turn sell our products for fundraising purposes.
- OFF-PREMISES SALES. Daily sales of fresh doughnuts on a branded,
unbranded and private label basis to convenience and grocery stores and
select co-branding customers. Doughnuts are sold to these customers on
trays for display and sale in glass-enclosed cases and in packages for
display and sale on both stand-alone display units and on our customers'
shelves. "Branded" refers to products sold bearing the Krispy Kreme brand
name and is the primary way we are expanding our off-premises sales
business. "Unbranded" products are sold unpackaged from the retailer's
display case. "Private label" products carry the retailer's brand name or
some other non-Krispy Kreme brand. Unbranded and private label products
are a minor portion of our business.
In addition to our retail stores, we are vertically integrated. We believe our
vertical integration allows us to maintain the consistency and quality of our
products throughout our system. In addition, through vertical integration, we
believe we can utilize volume-buying power, which helps lower the cost of
supplies to each of our stores and enhance our profitability. Our Krispy Kreme
Manufacturing and Distribution business unit, KKM&D, produces doughnut mixes and
coffee and manufactures our doughnut-making equipment, which all of our factory
stores are required to purchase. Additionally, this business unit currently
operates three distribution centers that provide Krispy Kreme stores with
essentially all supplies for the critical areas of their business. In fiscal
2003, we opened our second mix manufacturing and third distribution facility in
Effingham, Illinois. The new facility approximately tripled our mix
manufacturing capacity. The KKM&D business unit is volume-driven, and its
economics are enhanced by the opening of new stores and the growth of
on-premises and off-premises sales channels by existing stores.
One of our focus areas has been on creating a best-in-class beverage program to
complement our doughnut offering. With an acquisition in fiscal 2002, we
acquired significant coffee roasting expertise. We have since formulated and are
in the process of implementing a complete beverage program, including four drip
coffees, a complete line of espresso-based coffees including flavors, and both
coffee-based and noncoffee-based frozen drinks. These drinks are designed to
complement our existing juices, sodas, milks and water. We introduced the first
component of this program, the drip coffee offering, to our stores in fiscal
2003, replacing the previous product sold which was purchased from an unrelated
third party. We anticipate introducing the remaining components of the new
beverage program, including frozen beverages in the next six months and espresso
in most stores over the next twelve to eighteen months. We believe this new
beverage program represents an opportunity to increase beverage sales in a
meaningful way.
20
In our recent store development efforts, we have focused on opening both Company
and franchise factory stores, including commissaries, which are production
facilities used to serve off-premises customers, in major metropolitan markets,
generally markets with greater than 100,000 households. Our objective is to
further enhance our expansion through the opening of factory stores in small
markets, with small markets being defined as those markets having fewer than
100,000 households. Additionally, we have begun testing three additional store
formats, which we refer to broadly as "Satellites." Satellites consist of the
"doughnut and coffee shop" ("DCS"), the fresh shop and the kiosk formats. During
fiscal 2002, we introduced the DCS format. This store uses the new Hot Doughnut
Machine technology, which completes the final steps of the production process
and requires less space than the full production equipment in our traditional
factory store. This technology combines time, temperature and humidity elements
to re-heat unglazed doughnuts, provided by a traditional factory store, and
prepare them for the glazing process. Once glazed, customers can have the same
hot doughnut experience in a DCS as in a factory store. Additionally, the DCS
offers our new full line of coffee and other beverages. As of February 1, 2004,
nine DCS stores were open, six of which are owned by the Company. We plan to
continue our tests of this concept. We believe this technology and future
evolutions of this technology will facilitate our expansion into smaller markets
and densely populated urban areas.
In addition to the DCS format, we are testing both the fresh shop and the kiosk
formats. In these formats, we will sell fresh doughnuts, beverages and Krispy
Kreme collectibles. The doughnuts will be supplied by a nearby factory store,
multiple times per day. Both the fresh shop and the kiosk formats will require
less space than our traditional factory store or the DCS. As the kiosk is a
free-standing facility, it will require significantly less space than the fresh
shop, expanding the number of potential locations where these facilities may be
established. As of February 1, 2004, 20 fresh shops were open. We view the fresh
shop and kiosk formats, which we believe will have attractive financial returns,
as additional ways to achieve market penetration in a variety of market sizes
and settings. We began our tests of the new fresh shop concept during fiscal
2004 and will begin our tests of the kiosk format in fiscal 2005.
As stated above, we intend to expand our concept primarily through opening both
Company-owned and franchise stores in territories across the United States and
Canada, as well as in select other international markets as discussed below. We
also have entered and intend to enter into joint ventures with some of our
franchisees. As of February 1, 2004, there were 357 Krispy Kreme factory stores
consisting of 141 Company-owned stores (including 24 which are consolidated
joint venture stores), 159 Area Developer franchise stores (including 66 in
which we have a joint venture interest) and 57 Associate franchise stores. For
fiscal 2005, we anticipate opening approximately 120 new stores, of which
approximately 20 to 25 will be Satellites. The store format will be determined
by the site opportunities, primarily the space available. The majority of these
new stores are expected to be franchise stores.
In connection with our international expansion plans, we are developing the
capabilities and infrastructure necessary to support our expansion outside the
United States. We currently have twelve stores in Canada, one of which is a
commissary, and will open additional stores in the Canadian market in the coming
years. These stores are owned and operated by a joint venture. We have also
entered into joint ventures to develop the markets in Australia and New Zealand,
the United Kingdom and the Republic of Ireland, and Mexico. Each of these joint
ventures opened its first retail store in fiscal 2004. We also continue to focus
on additional markets outside the United States, including Japan, South Korea
and other potential markets in Asia and Western Europe. Our initial research
indicates that these will be viable markets for the Krispy Kreme concept;
however, further market research and evaluation are ongoing.
In April 2003, we completed the acquisition, through an exchange of stock, of
Montana Mills Bread Co., Inc. ("Montana Mills"), an owner and operator of
upscale "village bread stores" in the Northeastern United States. As of February
1, 2004, 21 Montana Mills stores were in operation. Montana Mills' stores
produce and sell a variety of breads and baked goods prepared in an open-view
format. We believe that this acquisition will provide an opportunity to leverage
our existing capabilities, such as our brand building and operational
capabilities including our distribution chain, off-premises sales and
coffee-roasting expertise, to expand Montana Mills' business. We anticipate
spending up to 24 months refining and expanding the Montana Mills concept,
retaining its core best-in-class breads, but expanding the offering to include
bread-based meals and appropriate accompaniments in an inviting setting.
As we expand our business, we will incur infrastructure costs in the form of
additional personnel to support the expansion and additional facilities costs to
provide mixes, equipment and other items necessary to operate the various new
stores. In the course of building this infrastructure, we may incur unplanned
costs which could negatively impact our operating results.
We expect doughnut sales to grow due to a variety of factors, including the
growth in two-income households and corresponding shift to foods consumed away
from home. We view the fragmented competition in the doughnut industry as an
opportunity for our continued growth. We also believe that the premium quality
of our products and the strength of our brand has enhanced, and will continue to
enhance, the growth and expansion of the overall doughnut market.
21
RESULTS OF OPERATIONS
To facilitate an understanding of the results of operations for each period
presented, we have included a general overview along with an analysis of
business segment activities. In addition to this analysis and the discussion
under Critical Accounting Policies, refer to Note 2 -- Nature of Business and
Significant Accounting Policies in the notes to our consolidated financial
statements. A guide to the discussion for each period is presented below.
OVERVIEW. The discussion of our operating results below includes a discussion
of our consolidated operating results, as well as a discussion of our systemwide
sales and comparable store sales. Our consolidated financial statements
appearing elsewhere in this report include sales of our company stores,
including the sales of consolidated joint venture stores, outside sales of our
KKM&D business segment, royalties and fees received from our franchisees and
sales of our Montana Mills business segment, but exclude the sales of our
franchised stores. Systemwide sales include the sales of both our company and
franchised stores, including Montana Mills stores, and exclude the sales and
revenues of our KKM&D and Franchise Operations business segments. We believe
systemwide sales data is significant because it shows the overall penetration of
the Krispy Kreme brand, consumer demand for our products and the correlation
between systemwide sales and our total revenues. Comparable store sales is a
measure of sales growth. Generally, we add a traditional factory store to our
comparable store base in the store's nineteenth month of operation. In addition,
we utilize a market penetration strategy that often results in transferring the
production opportunity for off-premises sales to a different factory store in
order to enhance operating efficiencies in the market. Off-premises sales at
these stores are included in comparable store sales if there is an existing
factory store in the market that is in the comparable store base.
SEGMENT RESULTS. In accordance with SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," we have four reportable segments. A
description of each of the segments follows.
- COMPANY STORE OPERATIONS. Represents the results of our company stores
and consolidated joint venture stores. These stores make and sell
doughnuts and complementary products through the sales channels discussed
above. Expenses for this business segment include store level expenses
along with direct general and administrative expenses. Consolidated joint
ventures include Freedom Rings, LLC ("Freedom Rings"), the joint venture
with rights to develop stores in Eastern Pennsylvania, Delaware and
Southern New Jersey, and Glazed Investments, LLC ("Glazed Investments"),
the joint venture with rights to develop stores in Colorado, Minnesota and
Wisconsin. Prior to January 30, 2004, consolidated joint ventures also
included Golden Gate Doughnuts, LLC ("Golden Gate"), the joint venture
with rights to develop stores in Northern California. As discussed in Note
20 -- Acquisitions in the notes to our consolidated financial statements,
effective January 30, 2004, the Company acquired the remaining minority
interest in Golden Gate.
- FRANCHISE OPERATIONS. Represents the results of our franchise programs.
We have two franchise programs: (1) the associate program, which is our
original franchising program developed in the 1940s, and (2) the area
developer program, which was developed in the mid-1990s. Associates pay
royalties of 3.0% of on-premises sales and 1.0% of all other sales, with
the exception of private label sales, for which they pay no royalties.
Area developers pay royalties of 4.5% to 6.0% of all sales and development
and franchise fees ranging from $20,000 to $50,000 per store. Most
associates and area developers also contribute 1.0% of all sales to our
national advertising and brand development fund. Expenses for this
business segment include costs incurred to recruit new franchisees, costs
to open, monitor and aid in the performance of these stores and direct
general and administrative expenses.
- KKM&D. Represents the results of our KKM&D business unit. This business
unit buys and processes ingredients used to produce doughnut mixes and
manufactures doughnut-making equipment that all of our factory stores are
required to purchase. This business unit also includes our coffee roasting
operation, which supplies our drip coffee product to all of our stores.
Production in this facility is expected to increase in fiscal 2005 with
the growth in stores and as the other components of our expanded beverage
program are introduced in our existing and new stores. The KKM&D business
unit also purchases and sells essentially all supplies necessary to
operate a Krispy Kreme store, including all food ingredients, juices,
signage, display cases, uniforms and other items. Generally, shipments are
made to each of our stores on a weekly basis by common carrier. All
intersegment transactions between KKM&D and Company Store Operations have
been eliminated in consolidation. Expenses for this business unit include
all expenses incurred at the manufacturing and distribution level along
with direct general and administrative expenses.
- MONTANA MILLS. Represents the results of operations of the recently
acquired Montana Mills, which operates upscale "village bread stores" in
the Northeastern United States. These stores produce and sell a variety of
breads and baked goods prepared in an open-view format. Expenses for this
business unit include store level expenses along with direct general and
administrative expenses.
OTHER. Includes a discussion of significant line items not discussed in the
overview or segment discussions, including general and administrative expenses,
depreciation and amortization expenses, the arbitration award, interest income,
interest expense, equity loss in joint ventures, minority interest in
consolidated joint ventures and the provision for income taxes.
22
OUR FISCAL YEAR IS BASED ON A 52- OR 53-WEEK YEAR. THE FISCAL YEAR ENDS ON THE
SUNDAY CLOSEST TO THE LAST DAY IN JANUARY. THE TABLE BELOW SHOWS OUR OPERATING
RESULTS FOR FISCAL 2002 (53 WEEKS ENDED FEBRUARY 3, 2002), FISCAL 2003 (52 WEEKS
ENDED FEBRUARY 2, 2003) AND FISCAL 2004 (52 WEEKS ENDED FEBRUARY 1, 2004)
EXPRESSED AS A PERCENTAGE OF TOTAL REVENUES. CERTAIN OPERATING DATA ARE ALSO
SHOWN FOR THE SAME PERIODS.
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FEB. 3, FEB. 2, FEB. 1,
YEAR ENDED 2002 2003 2004
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STATEMENT OF OPERATIONS DATA:
Total revenues 100.0% 100.0% 100.0%
Operating expenses 80.4 77.6 76.2
General and administrative expenses 7.0 5.9 5.6
Depreciation and amortization expenses 2.0 2.5 3.0
Arbitration award -- 1.8 (0.1)
------------------------------------------------
Income from operations 10.6 12.2 15.3
Interest and other expense (income), net (0.2) 1.1 1.1
------------------------------------------------
Income before income taxes 10.8 11.1 14.2
Provision for income taxes 4.1 4.3 5.6
------------------------------------------------
Net income 6.7% 6.8% 8.6%
------------------------------------------------
OPERATING DATA:
Increase in comparable store sales:
Company 11.7% 12.8% 13.6%
Systemwide 12.8% 11.8% 10.2%
THE TABLE BELOW SHOWS BUSINESS SEGMENT REVENUES AND OPERATING EXPENSES EXPRESSED
IN DOLLARS. KKM&D REVENUES ARE SHOWN NET OF INTERSEGMENT SALES ELIMINATIONS. SEE
NOTE 15 -- BUSINESS SEGMENT INFORMATION IN THE NOTES TO OUR CONSOLIDATED
FINANCIAL STATEMENTS FOR ADDITIONAL DISCUSSION OF OUR REPORTABLE SEGMENTS.
OPERATING EXPENSES EXCLUDE DEPRECIATION AND AMORTIZATION EXPENSES, INDIRECT
(UNALLOCATED) GENERAL AND ADMINISTRATIVE EXPENSES AND THE ARBITRATION AWARD.
DIRECT GENERAL AND ADMINISTRATIVE EXPENSES ARE INCLUDED IN OPERATING EXPENSES.
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IN THOUSANDS
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FEB. 3, FEB. 2, FEB. 1,
YEAR ENDED 2002 2003 2004
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REVENUES BY BUSINESS SEGMENT:
Company Store Operations $ 266,209 $ 319,592 $ 441,868
Franchise Operations 14,008 19,304 23,848
KKM&D 114,137 152,653 193,129
Montana Mills -- -- 6,747
--------------------------------------------------
Total revenues $ 394,354 $ 491,549 $ 665,592
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OPERATING EXPENSES BY BUSINESS SEGMENT:
Company Store Operations $ 217,419 $ 252,524 $ 343,752
Franchise Operations 4,896 4,877 4,631
KKM&D 94,631 124,088 150,778
Montana Mills -- -- 8,235
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Total operating expenses $ 316,946 $ 381,489 $ 507,396
--------------------------------------------------
23
THE FOLLOWING TABLE SHOWS BUSINESS SEGMENT REVENUES EXPRESSED AS A PERCENTAGE OF
TOTAL REVENUES AND BUSINESS SEGMENT OPERATING EXPENSES EXPRESSED AS A PERCENTAGE
OF APPLICABLE BUSINESS SEGMENT REVENUES. OPERATING EXPENSES EXCLUDE DEPRECIATION
AND AMORTIZATION EXPENSES, INDIRECT (UNALLOCATED) GENERAL AND ADMINISTRATIVE
EXPENSES AND THE ARBITRATION AWARD. DIRECT GENERAL AND ADMINISTRATIVE EXPENSES
ARE INCLUDED IN OPERATING EXPENSES.
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YEAR ENDED FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
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REVENUES BY BUSINESS SEGMENT:
Company Store Operations 67.5% 65.0% 66.4%
Franchise Operations 3.6 3.9 3.6
KKM&D 28.9 31.1 29.0
Montana Mills -- -- 1.0
--------------------------------------------------
Total revenues 100.0% 100.0% 100.0%
--------------------------------------------------
OPERATING EXPENSES BY BUSINESS SEGMENT:
Company Store Operations 81.7% 79.0% 77.8%
Franchise Operations 35.0% 25.3% 19.4%
KKM&D 82.9% 81.3% 78.1%
Montana Mills -- -- 122.1%
--------------------------------------------------
Total operating expenses 80.4% 77.6% 76.2%
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TO FURTHER FACILITATE AN UNDERSTANDING OF OUR OPERATING RESULTS, DATA ON FACTORY
STORE OPENING ACTIVITY ARE SHOWN BELOW. FACTORY STORE COUNTS INCLUDE RETAIL
STORES AND COMMISSARIES AND EXCLUDE SATELLITES. TRANSFERRED STORES REPRESENT
STORES SOLD BETWEEN THE COMPANY AND FRANCHISEES.
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COMPANY FRANCHISE TOTAL
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YEAR ENDED FEBRUARY 3, 2002
Beginning count 63 111 174
Opened 7 41 48
Closed (2) (2) (4)
Transferred 7 (7) --
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Ending count 75 143 218
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YEAR ENDED FEBRUARY 2, 2003
Opened 14 49 63
Closed (3) (2) (5)
Transferred 13 (13) --
------------------------------------------------
Ending count 99 177 276
------------------------------------------------
YEAR ENDED FEBRUARY 1, 2004
Opened 28 58 86
Closed (2) (3) (5)
Transferred 16 (16) --
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Ending count 141 216 357
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Company factory stores as of February 1, 2004 included 24 stores operated by
area developer joint ventures in which Krispy Kreme has a majority ownership
interest.
YEAR ENDED FEBRUARY 1, 2004 COMPARED WITH YEAR ENDED FEBRUARY 2, 2003
OVERVIEW
As noted above, we operate on a 52- or 53-week fiscal year. Our operations for
both fiscal 2004 and fiscal 2003 contained 52 weeks.
Systemwide sales for fiscal 2004 increased 27.4% compared to the prior year.
Excluding the sales of Montana Mills, systemwide sales increased 26.5%. This
increase is primarily the result of an increase in Company store sales of 38.3%,
from $319.6 million to $441.9 million, resulting primarily from sales from new
stores opened during the fiscal year, sales of stores in acquired markets and an
increase in Company store comparable sales of 13.6%. During fiscal 2004, 28 new
Company factory stores and 58 new franchise factory stores were opened and two
Company factory stores and three franchise factory stores were closed, for a net
increase of 81 factory stores. Additionally, eleven Area Developer and six
Associate franchise stores became Company stores as a result of the Company's
acquisition of certain franchise markets in Kansas; Missouri; Dallas, Texas;
Shreveport, Louisiana; Charlottesville, Virginia and Michigan, and one Company
and two Associate franchise stores became Area Developer franchise
24
stores as a result of the acquisition of these stores by an Area Developer
franchisee. As a result, the total number of factory stores at the end of fiscal
2004 was 357, consisting of 141 Company stores (including 24 which are
consolidated joint venture stores), 159 Area Developer franchise stores
(including 66 in which we have a joint venture interest) and 57 Associate
franchise stores. We believe continued increased brand awareness and increased
off-premises sales, as well as selected price increases, contributed to the
10.2% increase in systemwide comparable store sales.
Total Company revenues increased 35.4% to $665.6 million in fiscal 2004 compared
with $491.5 million in the prior fiscal year. This increase was comprised of
increases in Company Store Operations revenues of 38.3% to $441.9 million,
Franchise Operations revenues of 23.5% to $23.8 million and KKM&D revenues,
excluding intersegment sales, of 26.5% to $193.1 million.
Net income for fiscal 2004 was $57.1 million compared to $33.5 million in the
prior year, an increase of 70.5%. Diluted earnings per share was $0.92, an
increase of 62.6% over the prior year. Fiscal 2003 results include a pre-tax
charge of $9.1 million related to an arbitration award against the Company, more
fully discussed in Note 19 -- Legal Contingencies in the notes to our
consolidated financial statements. In fiscal 2004, the Company paid $8.6 million
to settle the award and reversed the remaining accrual of $525,000. Excluding
the effects of the arbitration award, net income for fiscal 2003 and fiscal 2004
would have been $39.1 million and $56.8 million, respectively, diluted earnings
per share for fiscal 2003 would have been $0.10 more than the reported $0.56 and
diluted earnings per share for fiscal 2004 would have been $0.01 less than the
reported $0.92.
COMPANY STORE OPERATIONS
COMPANY STORE OPERATIONS REVENUES. Company Store Operations revenues increased
to $441.9 million in fiscal 2004 from $319.6 million in fiscal 2003, an increase
of 38.3%. Comparable store sales increased by 13.6%. The revenue growth was
primarily due to strong growth in sales from both our on-premises and
off-premises sales channels. On-premises sales grew principally as a result of
the opening of 28 new Company stores during fiscal 2004, as well as due to the
introduction of new products (including featured doughnut varieties) and our
continued increase in brand awareness due in part to the expansion of our
off-premises sales programs. Retail price increases implemented in the fall of
fiscal 2003 and early in fiscal 2004 also increased on-premises sales.
Off-premises sales grew primarily as a result of the addition of several new
convenience and grocery store customers as well as the expansion of the number
of locations served in our existing customer base. Both on-premises and
off-premises sales were positively impacted by the sales of the franchise stores
acquired from the Area Developer and Associate franchisees in the Kansas;
Missouri; Dallas, Texas; Shreveport, Louisiana and Michigan markets, as well as
by the sales of the stores operated by Glazed Investments. In August 2002, the
Company acquired a controlling interest in this franchisee and, as a result, the
revenues of this franchisee are consolidated with the Company Store Operations
revenues for periods subsequent to the acquisition.
COMPANY STORE OPERATIONS OPERATING EXPENSES. Company Store Operations operating
expenses, excluding depreciation and amortization expenses, increased 36.1% to
$343.8 million in fiscal 2004 from $252.5 million in fiscal 2003. Company Store
Operations operating expenses as a percentage of Company Store Operations
revenues were 77.8% in fiscal 2004 compared with 79.0% in the prior year. The
decrease in Company Store Operations operating expenses as a percentage of
revenues was due to increased operating efficiencies generated by growth in
store revenues, selected price increases, improved profitability of our
off-premises sales and a focus on gross margin improvement, particularly labor
utilization, negotiated reductions in packaging costs and a reduction in shrink,
primarily as a result of technology improvements in the production process. The
decrease in operating expenses as a percentage of revenues was offset somewhat
by the impact of increased expenses associated with the opening of new Company
stores, primarily additional labor costs incurred to support the store opening.
During fiscal 2003 and fiscal 2004, the Company opened 14 and 28 new Company
factory stores, respectively. As we expect to open an increasing number of
Company stores in fiscal 2005, we anticipate that operating expenses will
continue to be negatively impacted by costs associated with new store openings.
We constantly evaluate our store base, not only with respect to our stores'
financial and operational performance, but also with respect to alignment with
our brand image and how well each store meets our customers' needs. As a result
of this review, we make provisions to cover closing or impairment costs for
underperforming stores, and for older stores that need to be closed and
relocated. No such provisions were made during fiscal 2004 or fiscal 2003.
FRANCHISE OPERATIONS
FRANCHISE OPERATIONS REVENUES. Franchise Operations revenues, consisting of
franchise fees and royalties, increased 23.5%, to $23.8 million in fiscal 2004
from $19.3 million in the prior year. The growth in revenue was primarily due to
the franchise fees and additional royalties associated with 58 new franchise
factory stores opened in fiscal 2004, net of the impact of three store closings
and the net transfer of 16 stores from Franchise to Company as a result of
acquisitions. The increase in Franchise Operations revenues was also impacted by
the opening of 49 new franchise factory stores, net of the impact of two store
closings and the transfer of 13 stores from Franchise to Company as a result of
acquisitions, during fiscal 2003. A majority of the new franchise stores in
fiscal 2003 were opened in the second half of the fiscal year. Also contributing
to the growth in Franchise Operations revenues was comparable store sales
increases. Sales of franchised stores, as reported by our franchisees, were
$459.0 million in fiscal 2003 and $543.3 million in fiscal 2004.
25
FRANCHISE OPERATIONS OPERATING EXPENSES. Franchise Operations operating
expenses, excluding depreciation and amortization expenses, decreased 5.0% from
$4.9 million in fiscal 2003 to $4.6 million in fiscal 2004. Franchise Operations
operating expenses include costs to recruit new franchisees, costs to open,
monitor and aid in the performance of franchise stores and direct general and
administrative expenses. As a percentage of Franchise Operations revenues,
Franchise Operations operating expenses were 19.4% in the current year compared
with 25.3% in the prior year. The decrease in Franchise Operations operating
expenses as a percentage of revenues is primarily the result of the Company
leveraging the infrastructure put in place to oversee the expansion of our
franchise program. In addition, Franchise Operations operating expenses as a
percentage of Franchise Operations revenues will vary depending on the number of
store openings and the level of opening team support needed to assist with the
openings. The amount of support that we provide for each Area Developer group's
store openings declines with each successive opening. As some of our individual
Area Developer groups are now operating multiple stores, our costs associated
with their additional store openings have declined.
KKM&D
KKM&D REVENUES. KKM&D sales to franchise stores increased 26.5%, to $193.1
million, in fiscal 2004 from $152.7 million in fiscal 2003. The primary reason
for the increase in revenues was the opening of 58 new franchise factory stores,
net of the impact of three store closings and the net transfer of 16 stores from
Franchise to Company as a result of acquisitions, in fiscal 2004; the opening of
49 new franchise factory stores, net of the impact of two store closings and the
transfer of 13 stores from Franchise to Company, as a result of acquisitions,
during fiscal 2003; and comparable store sales increases. Increased doughnut
sales through both the on-premises and off-premises sales channels by franchise
stores translated into increased revenues for KKM&D from sales of mixes, sugar,
shortening, coffee and other supplies. Also, each new store is required to
purchase doughnut-making equipment and other peripheral equipment from KKM&D,
thereby enhancing KKM&D sales. KKM&D sales were also positively impacted by the
mix price increase implemented at the beginning of fiscal 2004, which covered
increased flour and shortening costs.
KKM&D OPERATING EXPENSES. KKM&D operating expenses, excluding depreciation and
amortization expenses, increased 21.5%, to $150.8 million, in fiscal 2004 from
$124.1 million in fiscal 2003. KKM&D operating expenses as a percentage of KKM&D
revenues were 78.1% in the current year compared with 81.3% in the prior year.
The decrease in KKM&D operating expenses as a percentage of revenues was due to
increased capacity utilization, particularly in our mix and distribution
facility in Effingham, Illinois which became operational in the second quarter
of fiscal 2003, and resulting economies of scale of the mix and equipment
manufacturing operations attributable to the increased volume in the facilities.
Start-up costs associated with the facility in Effingham and with our coffee
roasting operation in Winston-Salem, which became operational in the third
quarter of fiscal 2003, had a negative impact on KKM&D operating expenses as a
percentage of KKM&D revenues in fiscal 2003. Also positively affecting KKM&D
operating expenses as a percentage of KKM&D revenues in fiscal 2004 was the
impact of sales to franchisees of certain recently-developed peripheral
equipment designed to enhance the performance of the doughnut-making equipment
used by all our traditional factory stores. While this product is a standard
component for all doughnut-making equipment sold currently, to the extent
franchisees who have not yet acquired this product for existing stores do so,
KKM&D operating expenses as a percentage of operating revenues may be positively
impacted in the future.
MONTANA MILLS
For fiscal 2004, Montana Mills revenues were $6.7 million and its operating
expenses were $8.2 million. These amounts reflect operating results since April
7, 2003, the effective date of the Company's acquisition of Montana Mills. In
addition to store operating costs, the operating expenses reflect administrative
costs associated with the consolidation of operations and the initiation of
concept development work. Operating results were also negatively impacted by
costs associated with Montana Mills off-premises sales program, which was
discontinued in January 2004.
OTHER
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 27.7%, to $36.9 million, in fiscal 2004 from $28.9 million in fiscal
2003. General and administrative expenses as a percentage of total revenues were
5.6% in fiscal 2004 compared with 5.9% in fiscal 2003. The dollar growth in
general and administrative expenses is primarily due to increased personnel and
salary and related benefit costs to support our expansion and other cost
increases necessitated by the growth of the Company, partially offset by lower
provisions for employee benefit costs, primarily incentive provisions determined
under the terms of the plans. General and administrative expenses as a
percentage of total revenues declined during fiscal 2004 primarily as a result
of our 35.4% growth in revenues during the period. In particular, acquisitions
of Associate and Area Developer franchise markets in fiscal 2004 resulted in
revenue gains with minimal incremental general and administrative expenses, as
we were able to leverage our existing infrastructure in many functional areas to
support these acquired operations. In fiscal 2004, we acquired a net 16 stores
from franchisees. In fiscal 2003, we acquired a net 13 stores from franchisees,
the majority of which were acquired in the second half of the fiscal year. In
addition, as a percentage of total revenues, general and administrative expenses
will vary in part depending upon the number of new store openings in a period.
During fiscal 2004, 58 new franchise factory stores were opened, as compared to
49 new franchise factory stores opened in fiscal 2003. As each new store is
required to purchase doughnut-making equipment and other peripheral equipment
from KKM&D, the increased number of store openings generally results in
increased revenues. These increased revenues further leverages the existing
general
26
and administrative expense structure as there is minimal incremental general and
administrative expenses associated with a store opening.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization expenses
increased 60.7%, to $19.7 million, in fiscal 2004 from $12.3 million in the
prior year. Depreciation and amortization expenses as a percentage of total
revenues were 3.0% in fiscal 2004 compared with 2.5% in fiscal 2003. The dollar
growth in depreciation and amortization expenses is due primarily to
depreciation expense associated with increased capital asset additions,
primarily related to the opening of new Company stores, including those opened
by our consolidated joint ventures, and the addition of stores acquired from
Area Developer and Associate franchisees. The dollar growth was also impacted by
depreciation related to our new mix and distribution facility, which became
operational in the second quarter of fiscal 2003. See Liquidity and Capital
Resources for additional discussion.
ARBITRATION AWARD. As discussed further in Note 19 -- Legal Contingencies in
the notes to our consolidated financial statements, in fiscal 2003 the Company
recorded a charge of $9.1 million as a result of an arbitration panel's ruling
against the Company in a lawsuit. The Company settled the award for $8.6
million, which was paid in the first quarter of fiscal 2004, and reversed the
remaining $525,000 accrual.
INTEREST INCOME. Interest income decreased from $2.0 million in fiscal 2003 to
$921,000 in fiscal 2004. This decrease results from generally lower average
invested balances and a reduction in rates of interest earned on excess cash
invested during the current fiscal year.
INTEREST EXPENSE. Interest expense was $4.4 million in fiscal 2004 compared
with $1.8 million in fiscal 2003. Interest expense in fiscal 2003 consisted
principally of interest on the Term Loan used to finance the Company's new mix
and distribution facility in Effingham, Illinois. Prior to completion of the
distribution facility during the second quarter of fiscal 2003, interest on the
borrowings used to finance the facility was capitalized. Interest expense in
fiscal 2003 also includes interest on debt of our consolidated joint ventures,
including debt of Glazed Investments, the joint venture in which we acquired a
controlling interest during the third quarter of fiscal 2003. Interest expense
in fiscal 2004 increased as a result of borrowings to finance the acquisition of
selected franchise markets (see Note 20 -- Acquisitions in the notes to our
consolidated financial statements for further information) and increased
borrowings by our consolidated joint ventures, primarily to fund store
development. On October 31, 2003, the Company entered into a credit facility to
refinance the Term Loan, certain debt of our consolidated joint ventures and the
short-term acquisition financing and to provide additional borrowing
availability. See Note 8 -- Debt in the notes to our consolidated financial
statements for additional information on the Company's outstanding debt.
EQUITY LOSS IN JOINT VENTURES. Equity loss in joint ventures decreased from
$2.0 million in fiscal 2003 to $1.8 million in fiscal 2004. This item represents
the Company's share of operating results associated with our investments in
unconsolidated joint ventures to develop and operate Krispy Kreme stores. These
joint ventures are in various stages of their development of Krispy Kreme
stores. For example, some ventures have multiple stores in operation while
others have none. Each joint venture has varying levels of infrastructure,
primarily human resources, in place to open stores. As a result, the joint
ventures are leveraging their infrastructure to varying degrees, which greatly
impacts the profitability of a joint venture. Losses in both fiscal 2004 and
fiscal 2003 were impacted by our share of the initial start-up expenses of
several joint ventures in markets outside the United States, the joint ventures
with rights to develop stores in Australia and New Zealand, the United Kingdom
and the Republic of Ireland, Mexico and Canada. Note 18 -- Joint Ventures in the
notes to our consolidated financial statements contains further information
about each of our joint ventures. At February 1, 2004, there were 66 factory
stores open by unconsolidated joint ventures compared to 30 factory stores at
February 2, 2003.
MINORITY INTEREST. Minority interest decreased from $2.3 million in fiscal 2003
to $2.1 million in fiscal 2004. This expense represents the net elimination of
the minority partners' share of income or losses from consolidated joint
ventures to develop and operate Krispy Kreme stores. For fiscal 2003 and fiscal
2004, this expense includes the minority partners' share of the results of
operations of Freedom Rings and Golden Gate. In addition, as a result of the
Company's acquisition in the third quarter of fiscal 2003 of a controlling
interest in Glazed Investments, this expense also includes the minority
partners' share of the results of operations of Glazed Investments for periods
subsequent to the effective date of the acquisition. Increases in the minority
interest expense in fiscal 2004, resulting from improved profitability of
Freedom Rings and inclusion of the minority partners' share of operating results
of Glazed Investments for the full fiscal year, were offset by the impact of
decreased profitability of Golden Gate. Golden Gate's operating results were
impacted during the fourth quarter of fiscal 2004 by certain charges incurred by
Golden Gate in connection with the Company's acquisition of the remaining
minority interest in Golden Gate, principally severance costs and other costs
associated with the consolidation of operations with those of the Company. As
the Company acquired the remaining minority interest in Golden Gate effective
January 30, 2004 (see Note 20 -- Acquisitions in the notes to our consolidated
financial statements for further information), minority interest will no longer
include amounts related to Golden Gate.
PROVISION FOR INCOME TAXES. The provision for income taxes is based on the
effective tax rate applied to the respective period's pre-tax income. The
provision for income taxes was $37.6 million in fiscal 2004, representing a
39.7% effective rate, compared to $21.3 million, or a 38.9% effective rate, in
the prior year. Excluding the effect of the arbitration award, which reduced the
provision for income taxes as a result of the tax benefits anticipated from the
award, the provision for income taxes
27
in fiscal 2003 would have been $24.7 million, or a 38.7% effective rate. The
increase in the effective rate is primarily the result of increased state income
taxes, due to expansion into higher taxing states as well as increases in
statutory rates in several jurisdictions. The rate was also impacted by the
Company's share of losses, which are not currently deductible, associated with
our investments in unconsolidated international joint ventures. The Company
expects the effective tax rate for fiscal 2005 to be approximately 39.5% to
40.0%.
NET INCOME AND DILUTED EARNINGS PER SHARE. Net income for fiscal 2004 was $57.1
million compared to $33.5 million in the prior year, an increase of 70.5%.
Diluted earnings per share in fiscal 2004 was $0.92, an increase of 62.6% over
the prior year. Fiscal 2003 results include a pre-tax charge of $9.1 million
related to an arbitration award against the Company, more fully discussed in
Note 19 -- Legal Contingencies in the notes to our consolidated financial
statements. In fiscal 2004, the Company paid $8.6 million to settle the award
and reversed the remaining accrual of $525,000. Excluding the effects of the
arbitration award, net income for fiscal 2003 and fiscal 2004 would have been
$39.1 million and $56.8 million, respectively, diluted earnings per share for
fiscal 2003 would have been $0.10 more than the reported $0.56 and diluted
earnings per share for fiscal 2004 would have been $0.01 less than the reported
$0.92.
YEAR ENDED FEBRUARY 2, 2003 COMPARED WITH YEAR ENDED FEBRUARY 3, 2002
OVERVIEW
As noted above, we operate on a 52- or 53-week fiscal year. Our operations for
fiscal 2003 contained 52 weeks while fiscal 2002 contained 53 weeks. This event
generally occurs every fifth year. When we make reference to fiscal 2002
adjusted for the number of weeks, we have adjusted fiscal 2002 results to
approximate a 52-week year. All references to comparable store sales are on the
basis of comparing the 52 weeks in fiscal 2003 with the comparable 52 weeks in
fiscal 2002.
THE FOLLOWING TABLE PRESENTS A RECONCILIATION OF REVENUE AND NET INCOME FOR
FISCAL 2002 TO MANAGEMENT'S ESTIMATE OF THE AMOUNTS THAT WOULD HAVE BEEN
REPORTED HAD FISCAL 2002 BEEN A 52-WEEK YEAR:
[Enlarge/Download Table]
IN THOUSANDS
---------------------------------------------------------------------------------------------------------------
ADJUSTMENT FISCAL
FISCAL 2002, FOR EXTRA 2002,
AS REPORTED WEEK PRO FORMA
---------------------------------------------------------------------------------------------------------------
REVENUES:
Company Store Operations $ 266,209 $ (5,315) $260,894
Franchise Operations 14,008 (288) 13,720
KKM&D 114,137 (2,291) 111,846
----------------------------------------------------
Total revenues $ 394,354 $ (7,894) $386,460
----------------------------------------------------
NET INCOME $ 26,378 $ (558) $ 25,820
----------------------------------------------------
The Company estimates that the 53rd week impacted diluted earnings per share by
approximately $0.01.
Systemwide sales for fiscal 2003 increased 25.2% compared to fiscal 2002. The
increase included an increase of 20.1% in Company store sales, to $319.6
million. The increase was the result of sales from new stores opened during the
fiscal year and an increase of 12.8% in Company store comparable sales. During
fiscal 2003, 14 new Company stores and 49 new franchise stores were opened and
three Company stores and two franchise stores were closed, for a net increase of
58 stores. Additionally, during fiscal 2003, four Associate franchise stores and
one Area Developer franchise store became Company stores via the acquisition of
franchise markets in Akron, OH, Destin, FL, Pensacola, FL and Toledo, OH, and
nine Area Developer franchise stores became Company stores via the acquisition
of a controlling interest in Glazed Investments. We also sold one Company store
to an Associate franchisee in fiscal 2003. As a result, the total number of
factory stores at the end of fiscal 2003 was 276, consisting of 99 Company
stores (including 29 which are consolidated joint venture stores), 120 Area
Developer franchise stores (including 30 in which we have a joint venture
interest) and 57 Associate franchise stores. We believe continued increased
brand awareness and growth in off-premises sales contributed significantly to
the 11.8% increase in our systemwide comparable store sales. Adjusting for the
number of weeks in fiscal 2002, the increase in systemwide sales was 28.0%.
Total Company revenues increased 24.6% to $491.5 million in fiscal 2003 compared
with $394.4 million in the prior fiscal year. This increase was comprised of
increases in Company Store Operations revenues of 20.1% to $319.6 million,
Franchise Operations revenues of 37.8%, to $19.3 million, and KKM&D revenues,
excluding intersegment sales, of 33.7%, to $152.7 million. Adjusting for the
number of weeks in fiscal 2002, the increase in Company revenues was 27.2%.
Net income for fiscal 2003 was $33.5 million compared to $26.4 million in the
prior year, an increase of 26.9%. Diluted earnings per share was $0.56, an
increase of 24.8% over the prior year. Fiscal 2003 results include a pre-tax
charge of $9.1 million related to an arbitration award against the Company, more
fully discussed in Note 19 -- Legal Contingencies in the notes to our
consolidated financial statements. Excluding the effect of the arbitration
award, net income for fiscal 2003 would have been $39.1 million, an increase of
51.6% over fiscal 2002, as adjusted to approximate a 52-week year. The
arbitration award reduced diluted earnings per share by approximately $0.10.
28
COMPANY STORE OPERATIONS
COMPANY STORE OPERATIONS REVENUES. Company Store Operations revenues increased
to $319.6 million in fiscal 2003 from $266.2 million in fiscal 2002, an increase
of 20.1%. Comparable store sales increased by 12.8%. The revenue growth was
primarily due to strong growth in sales from both our on-premises and
off-premises sales channels. On-premises sales grew principally as a result of
the opening of 14 new Company stores during fiscal 2003, increased customer
visits, the introduction of new products (including featured doughnut varieties)
and our continued increase in brand awareness due in part to the expansion of
our off-premises sales programs. Additionally, a retail price increase was
implemented in the fall of fiscal 2003. Company store on-premises sales were
also positively impacted by the inclusion of the sales of the stores operated by
Glazed Investments for periods subsequent to the Company's acquisition of a
controlling interest in this franchisee in August 2002. Off-premises sales grew
primarily as a result of the addition of several new convenience and grocery
store customers as well as the expansion of the number of locations served in
our existing customer base. We believe excessive summer heat as well as extreme
weather patterns in the winter months, including record levels of rain, ice and
snow in many parts of the United States, put pressure on both on- and
off-premises sales in fiscal 2003. In particular, weather conditions impacted
construction of several stores in the fourth quarter and delayed their openings.
This resulted in fewer operating weeks from these stores and therefore lower
than expected sales. Adjusting for the number of weeks in fiscal 2002, the
increase in Company Store Operations revenues was 22.5%.
COMPANY STORE OPERATIONS OPERATING EXPENSES. Company Store Operations operating
expenses increased 16.1% to $252.5 million in fiscal 2003 from $217.4 million in
fiscal 2002. Company Store Operations operating expenses as a percentage of
Company Store Operations revenues were 79.0% in fiscal 2003 compared with 81.7%
in fiscal 2002. The decrease in Company Store Operations operating expenses as a
percentage of revenues was primarily due to increased operating efficiencies
generated by growth in store sales volumes as demonstrated by the 12.8% increase
in comparable store sales discussed above, selected price increases, improved
profitability of our off-premises sales and a focus on gross margin improvement.
FRANCHISE OPERATIONS
FRANCHISE OPERATIONS REVENUES. Franchise Operations revenues, consisting of
franchise fees and royalties, increased 37.8%, to $19.3 million, in fiscal 2003
from $14.0 million in fiscal 2002. The growth in revenue was primarily due to
the franchise fees and additional royalties associated with 49 new franchise
stores opened in fiscal 2003, net of the impact of two store closings and the
net transfer of 13 stores from Franchise to Company as a result of acquisitions,
as well as the impact of opening 41 new franchise stores, net of the impact of
two store closings and the transfer of seven stores from Franchise to Company,
as a result of acquisitions, during fiscal 2002. Also contributing to the growth
in revenue was comparable store sales increases. Sales of franchised stores, as
reported by our franchisees, were $355.5 million in fiscal 2002 and $459.0
million in fiscal 2003. Adjusting for the number of weeks in fiscal 2002, the
increase in Franchise Operations revenues was 40.7%.
FRANCHISE OPERATIONS OPERATING EXPENSES. Franchise Operations operating
expenses were $4.9 million in fiscal 2003 and fiscal 2002. As a percentage of
Franchise Operations revenues, Franchise Operations operating expenses were
25.3% in fiscal 2003 compared with 35.0% in fiscal 2002. The decrease in
operating expenses as a percentage of Franchise Operations revenues is primarily
the result of the Company leveraging the infrastructure it has put in place to
oversee the expansion of our franchise concept.
KKM&D
KKM&D REVENUES. KKM&D sales to franchise stores increased 33.7%, to $152.7
million, in fiscal 2003 from $114.1 million in fiscal 2002. The primary reason
for the increase in revenues was the opening of 49 new franchise stores, net of
the impact of two store closings and the net transfer of 13 stores from
Franchise to Company, in fiscal 2003; the opening of 41 new franchise stores,
net of the impact of two store closings and the transfer of seven franchise
stores to Company, in fiscal 2002; and comparable store sales increases.
Increased doughnut sales through both the on-premises and off-premises sales
channels by franchise stores translated into increased revenues for KKM&D from
sales of mixes, sugar, shortening and other supplies. Also, each new store is
required to purchase doughnut-making equipment and other peripheral equipment
from KKM&D, thereby enhancing KKM&D sales. Adjusting for the number of weeks in
fiscal 2002, the increase in KKM&D revenues was 36.5%.
KKM&D OPERATING EXPENSES. KKM&D operating expenses increased 31.1%, to $124.1
million, in fiscal 2003 from $94.6 million in fiscal 2002. KKM&D operating
expenses as a percentage of KKM&D revenues were 81.3% in the current year
compared with 82.9% in the prior year. The decrease in KKM&D operating expenses
as a percentage of revenues was due to improved efficiencies in our
Winston-Salem mix and equipment manufacturing facilities. With the opening of
the new mix manufacturing facility in Effingham, Illinois in the second quarter
of fiscal 2003, our Winston-Salem mix manufacturing facility was able to scale
back its mix production levels, improving its efficiency as it had been running
at excessive levels in fiscal 2002 and early fiscal 2003. Additionally, the
relocation of our equipment manufacturing facility during the third quarter of
fiscal 2002 to a facility better designed to facilitate our manufacturing
process resulted in improved manufacturing efficiencies as compared to the prior
year. Start-up costs associated with the new mix and distribution facility in
Effingham, as well as those associated with our coffee roasting operation in
Winston-Salem, which continued to expand operations to support
29
the rollout of our new beverage program, had a negative impact on KKM&D
operating expenses as a percentage of KKM&D revenues.
OTHER
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 4.8%, to $28.9 million, in fiscal 2003 from $27.6 million in fiscal
2002. General and administrative expenses as a percentage of total revenues were
5.9% in fiscal 2003 compared with 7.0% in fiscal 2002. The dollar growth in
general and administrative expenses is primarily due to increased personnel and
salary and related benefit costs to support our expansion and other cost
increases necessitated by the growth of the Company, partially offset by lower
provisions for employee benefit costs, primarily incentive provisions determined
under the terms of the plans. The dollar growth in general and administrative
expenses in fiscal 2003 would have been higher; however, during the second and
part of the third quarter, we implemented strict controls on various general and
administrative expenses as we were concerned about a slow-down in the momentum
of the business, which we believe was caused primarily by the excessive summer
heat and drought in many of our market areas. We imposed controls on salary
expenses, travel expenses and professional fees, among others. General and
administrative expenses as a percentage of total revenues declined during fiscal
2003 primarily as a result of our 24.6% growth in revenues during the period. In
particular, acquisitions of Associate and Area Developer franchise markets in
fiscal 2003, including the acquisition of a controlling interest in Glazed
Investments, resulted in revenue gains with minimal incremental general and
administrative expenses as we were able to leverage our existing infrastructure
in many functional areas to support these acquired operations. In addition, as a
percentage of total revenues, general and administrative expenses will vary in
part depending upon the number of new store openings in a period. During fiscal
2003, 49 new franchise stores were opened, as compared to 41 new franchise
stores opened in the comparable period of the prior year. As each new store is
required to purchase doughnut-making equipment and other peripheral equipment
from KKM&D, the increased number of store openings generally results in
increased revenues. These increased revenues further leverages the existing
general and administrative expense structure as there is minimal incremental
general and administrative expenses associated with a store opening.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization expenses
increased 54.2%, to $12.3 million, in fiscal 2003 from $8.0 million in fiscal
2002. Depreciation and amortization expenses as a percentage of total revenues
were 2.5% in fiscal 2003 compared with 2.0% in fiscal 2002. The dollar growth in
depreciation and amortization expenses is due to increased capital asset
additions, including additions related to the new mix and distribution facility,
which became operational in fiscal 2003, and additions related to new stores,
including new stores opened by our consolidated joint ventures.
ARBITRATION AWARD. In fiscal 2003 we recorded a charge of $9.1 million as a
result of an arbitration panel's ruling against the Company in a lawsuit. The
charge included the arbitration panel's award of approximately $7.9 million and
management's estimate at the time of additional costs to be awarded in
connection with the action, including plaintiff's legal fees, of approximately
$1.2 million. Subsequent to fiscal 2003, the award was paid. See further
discussion of the lawsuit and subsequent settlement in Note 19 -- Legal
Contingencies in the notes to our consolidated financial statements.
INTEREST INCOME. Interest income in fiscal 2003 decreased 34.0% over fiscal
2002 primarily as a result of lower rates of interest earned in fiscal 2003 on
excess cash invested.
INTEREST EXPENSE. Interest expense was $1.8 million in fiscal 2003 compared
with $337,000 in fiscal 2002. This increase is primarily the result of interest
on the Term Loan used to finance the new mix manufacturing and distribution
facility in Effingham, Illinois. Prior to completion of the facility during the
second quarter of fiscal 2003, interest on borrowings used to finance the
facility was capitalized. Additionally, interest expense in fiscal 2003 included
interest on borrowings by Glazed Investments for periods subsequent to our
acquisition of a controlling interest in this joint venture, and interest on
increased borrowings of Golden Gate, as both consolidated joint ventures
financed their expansion, in part, through bank or other third party debt.
EQUITY LOSS IN JOINT VENTURES. This item represents the Company's share of
operating results associated with our investments in unconsolidated joint
ventures to develop and operate Krispy Kreme stores. These joint ventures are in
various stages of their development of Krispy Kreme stores. For example, some
ventures have multiple stores in operation while others have none. Each joint
venture has varying levels of infrastructure, primarily human resources, in
place to open stores. As a result, the joint ventures are leveraging their
infrastructure to varying degrees, which greatly impacts the profitability of a
joint venture. In particular, the increase in the loss in fiscal 2003 was
impacted by the Company's share of the initial start-up expenses of the
Company's first joint ventures in markets outside North America, the joint
venture with rights to develop stores in Australia and New Zealand and the joint
venture with rights to develop stores in the United Kingdom and Ireland. At
February 2, 2003, there were 30 stores open by unconsolidated joint ventures
compared to 18 stores at February 3, 2002.
MINORITY INTEREST. This expense represents the net elimination of the minority
partners' share of income or losses from consolidated joint ventures to develop
and operate Krispy Kreme stores. The increase in this expense is primarily a
result of increased profitability of Golden Gate, which opened four additional
stores in fiscal 2003, and the inclusion of the minority partners' share of the
results of operations of Glazed Investments, subsequent to our acquisition of a
controlling interest in this franchisee in fiscal 2003.
30
PROVISION FOR INCOME TAXES. The provision for income taxes is based on the
effective tax rate applied to the respective period's pre-tax income. The
provision for income taxes was $21.3 million in fiscal 2003, representing a
38.9% effective rate, compared to $16.2 million, or a 38.0% effective rate, in
the prior year. Excluding the effect of the arbitration award, which reduced the
provision for income taxes as a result of the tax benefits anticipated from the
award, the provision for income taxes would have been $24.7 million, or a 38.7%
effective rate. The increase in the effective rate is primarily the result of
increased state income taxes, due to expansion into higher taxing states as well
as increases in statutory rates in several jurisdictions. The rate was also
impacted by the Company's share of losses, which are not currently deductible,
associated with our investments in international joint ventures.
NET INCOME AND DILUTED EARNINGS PER SHARE. Net income for fiscal 2003 was $33.5
million compared to $26.4 million in fiscal 2002, an increase of 26.9%. Diluted
earnings per share was $0.56, an increase of 24.8% over the prior year. Fiscal
2003 results include a pre-tax charge of $9.1 million related to an arbitration
award against the Company, more fully discussed in Note 19 -- Legal
Contingencies in the notes to our consolidated financial statements. Excluding
the effect of the arbitration award, net income for fiscal 2003 would have been
$39.1 million, an increase of 51.6% over fiscal 2002, as adjusted to approximate
a 52-week year. The arbitration award reduced diluted earnings per share by
approximately $0.10.
31
QUARTERLY RESULTS
The following tables set forth unaudited quarterly information for each of the
eight fiscal quarters in the two year period ended February 1, 2004. This
quarterly information has been prepared on a basis consistent with our audited
financial statements and, in the opinion of management, includes all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the information for the periods presented. Our quarterly
operating results may fluctuate significantly as a result of a variety of
factors, and operating results for any quarter are not necessarily indicative of
results for a full fiscal year. In particular, the operating results for the
quarter ended February 2, 2003, the fourth quarter of fiscal 2003, include a
pre-tax charge of $9.1 million as a result of an arbitration panel's ruling
against the Company in a lawsuit. The operating results for the quarter ended
May 4, 2003 include the reversal of the $525,000 accrual remaining after
settlement of this award during this quarter. See Note 19 -- Legal Contingencies
in the notes to our consolidated financial statements for further discussion. In
addition, we have historically experienced seasonal variability in our quarterly
operating results, with higher profits per store in the first and third quarters
than in the second and fourth quarters.
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IN THOUSANDS, EXCEPT PER SHARE DATA
---------------------------------------------------------------------------------------------------------------
MAY 5, AUG. 4, NOV. 3, FEB. 2, MAY 4, AUG. 3, NOV. 2, FEB. 1,
THREE MONTHS ENDED 2002 2002 2002 2003 2003 2003 2003 2004
---------------------------------------------------------------------------------------------------------------
Total revenues $111,059 $114,626 $129,130 $136,734 $148,660 $161,790 $169,629 $185,513
Operating expenses 86,362 90,487 100,295 104,345 112,480 123,705 129,229 141,982
General and
administrative
expenses 7,623 6,589 7,429 7,256 8,902 9,060 9,400 9,550
Depreciation and
amortization expenses 2,546 2,612 3,403 3,710 4,101 4,703 4,964 5,955
Arbitration award -- -- -- 9,075 (525) -- -- --
-------------------------------------------------------------------------------------
Income from operations 14,528 14,938 18,003 12,348 23,702 24,322 26,036 28,026
Interest and other
expenses, net 236 535 1,531 2,742 1,974 2,543 1,880 1,012
-------------------------------------------------------------------------------------
Income before income
taxes 14,292 14,403 16,472 9,606 21,728 21,779 24,156 27,014
Provision for income
taxes 5,431 5,545 6,347 3,972 8,588 8,778 9,634 10,590
-------------------------------------------------------------------------------------
Net income $ 8,861 $ 8,858 $ 10,125 $ 5,634 $ 13,140 $ 13,001 $ 14,522 $ 16,424
-------------------------------------------------------------------------------------
Net income per share:
Basic $ .16 $ .16 $ .18 $ .10 $ .23 $ .22 $ .24 $ .27
Diluted .15 .15 .17 .09 .22 .21 .23 .26
OUR OPERATING RESULTS FOR THESE EIGHT QUARTERS EXPRESSED AS PERCENTAGES OF
APPLICABLE REVENUES WERE AS FOLLOWS:
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MAY 5, AUG. 4, NOV. 3, FEB. 2, MAY 4, AUG. 3, NOV. 2, FEB. 1,
THREE MONTHS ENDED 2002 2002 2002 2003 2003 2003 2003 2004
-------------------------------------------------------------------------------------------------------------------
Total revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Operating expenses 77.7 79.0 77.7 76.3 75.7 76.5 76.2 76.5
General and
administrative
expenses 6.9 5.7 5.8 5.3 6.0 5.6 5.5 5.2
Depreciation and
amortization expenses 2.3 2.3 2.6 2.7 2.8 2.9 2.9 3.2
Arbitration award -- -- -- 6.7 (0.4) -- -- --
----------------------------------------------------------------------------------------
Income from operations 13.1 13.0 13.9 9.0 15.9 15.0 15.4 15.1
Interest and other
expenses, net 0.2 0.5 1.2 2.0 1.3 1.6 1.2 0.5
----------------------------------------------------------------------------------------
Income before income
taxes 12.9 12.5 12.7 7.0 14.6 13.4 14.2 14.6
Provision for income
taxes 4.9 4.8 4.9 2.9 5.8 5.4 5.7 5.7
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Net income 8.0% 7.7% 7.8% 4.1% 8.8% 8.0% 8.5% 8.9%
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32
LIQUIDITY AND CAPITAL RESOURCES
Because management generally does not monitor liquidity and capital resources on
a segment basis, this discussion is presented on a consolidated basis.
We funded our capital requirements for fiscal 2004 primarily through cash flow
generated from operations and the use of existing cash and investment balances,
with the exception of the purchase of the rights as well as the related assets,
which included six stores, to the Dallas, Texas and Shreveport, Louisiana
markets, which was funded, in part, with short-term debt, and the purchase of
the remaining 33% minority interest in Golden Gate, which was funded, in part,
with borrowings under our Credit Facility. The acquisition of Montana Mills and
the rights to the Michigan market were funded primarily through the issuance of
shares of common stock and, with respect to the acquisition of the rights to the
Michigan market, the issuance of a promissory note. Capital requirements for
fiscal 2003 were funded primarily through cash flow generated from operations,
with the exception of the purchase of the new mix and distribution facility in
Effingham, Illinois. The purchase of this facility was funded from borrowings
under a credit agreement with a bank. As discussed below, our consolidated joint
ventures funded their capital requirements through cash flows from operations
and borrowings under various financing arrangements, including revolving lines
of credit, term loans and short-term debt, as well as, in fiscal 2004, from
loans provided by the Company.
CASH FLOW FROM OPERATIONS
OVERVIEW. Net cash flow from operations was $36.2 million in fiscal 2002, $51.0
million in fiscal 2003 and $95.6 million in fiscal 2004. Operating cash flow in
each year has benefited from increased net income, offset by additional
investments in working capital, primarily receivables and inventories, as
discussed in more detail below. In fiscal 2004, net income increased $30.7
million, or 116.4%, compared with fiscal 2002, and it increased $23.6 million,
or 70.5%, compared with fiscal 2003. Net working capital was $49.2 million at
February 3, 2002, $81.4 million at February 2, 2003 and $85.2 million at
February 1, 2004. Accrued expenses in fiscal 2003 decreased primarily as a
result of net lower accruals for employee benefit plans, primarily incentive
plans, as determined under the terms of the plans, at February 2, 2003 as
compared to February 3, 2002. The accrual of $9.1 million for the arbitration
award (see Note 19 -- Legal Contingencies in the notes to our consolidated
financial statements) reduced working capital in fiscal 2003.
Operating cash flows were also favorably impacted by the tax benefit from the
exercise of nonqualified stock options of $42.8 million in fiscal 2004 and $13.8
million in fiscal 2003. The Company's operating cash flows may continue to be
favorably impacted by similar tax benefits in the future; however, the exercise
of stock options is outside of the Company's control.
DETAILED ANALYSIS
ACCOUNTS RECEIVABLE. Our investment in receivables, net of increases resulting
from acquisitions, increased $13.3 million in fiscal 2002, $7.4 million in
fiscal 2003 and $17.6 million in fiscal 2004. Accounts receivable have been
increasing for the following reasons:
1) The expansion of our off-premises sales programs and the corresponding
receivables from grocery and convenience stores and other off-premises
customers. Payment terms for off-premises customers vary depending on
their credit worthiness and the type of off-premises program we offer
them. Sometimes customers do not pay within their credit terms or there
are disputes over amounts owed to us. We use our judgment in deciding
whether to grant additional payment days, intensify collection efforts,
suspend service, write the account off as uncollectible or a combination
of the above. Write-offs of accounts receivable due to uncollectibility
have had a minimal impact on operating cash flow in recent years. As we
expect our off-premises business to continue to grow, accounts receivable
balances from off-premises customers are also expected to grow.
2) An increase in the number of franchise factory stores that are operating:
143 at February 3, 2002; 177 at February 2, 2003; and 216 at February 1,
2004. We generate accounts receivable from franchisees as a result of
royalties earned on their sales as well as our weekly shipments of mix,
other ingredients, coffee and supplies to each store. Therefore, as the
number of franchise stores has grown, so have the corresponding accounts
receivable balances. Accounts receivable balances from franchisees are
shown under the captions accounts receivable and accounts receivable,
affiliates on the consolidated balance sheets. Receivables from
franchisees in which we own no interest are included in the accounts
receivable caption, while receivables from franchisees in which we own a
minority interest or receivables from stores owned by emeritus members of
our Board of Directors, or other related parties, are shown under the
caption accounts receivable, affiliates. Payment terms on these
receivables are 30 or 35 days from the date of invoice, depending on the
franchisee's payment method (traditional check versus electronic payment
arrangements). We also generate accounts receivable from franchise stores
whenever they build a new store, as we supply the doughnut-making
equipment and other capital expenditure items necessary to operate a
store. Payment terms on these items are 54 days from the date of
installation of the doughnut-making equipment. Accounts receivable
generated from a new store opening are typically in excess of $550,000
per store. If franchise store openings are heavily concentrated in a
particular quarter, and depending on when the stores opened in the
quarter, the sales of the doughnut-making equipment and other capital
expenditure items we sell to franchisees can cause an increase in our
accounts receivable balances. We have had minimal
33
experience with uncollectible accounts receivable from our franchisees.
We expect accounts receivable from franchisees will continue to grow over
time as we open new stores and sell to an increasing base of franchise
stores.
INVENTORIES. Our investment in inventories, net of increases resulting from
acquisitions, increased $4.0 million in fiscal 2002, $7.9 million in fiscal 2003
and $3.8 million in fiscal 2004. Inventories have increased primarily as a
result of:
1) An increase in the number of Company-owned factory stores: 75 at February
3, 2002, 99 at February 2, 2003 and 141 at February 1, 2004. Each store
carries an inventory consisting of mix, other ingredients, coffee and
supplies necessary to operate the store. As we add more Company stores in
the future, we anticipate that inventory levels will grow accordingly.
2) An increase in inventory levels at KKM&D -- raw materials,
work-in-progress, finished goods and service parts -- to support the
increased number of stores in the system, as well as anticipated new
store openings. The total number of factory stores in operation at
February 3, 2002, February 2, 2003 and February 1, 2004 was 218, 276 and
357, respectively.
INCOME TAXES. During fiscal 2004, we made $335,000 in estimated state income
tax payments and no estimated Federal income tax payments. Stock option
exercises during the fiscal year resulted in tax deductions for the Company
which offset any current Federal income tax liability for fiscal 2004 from
normal operations and created a net operating loss for income tax purposes. A
portion of the net operating loss is available for carryback to previous tax
years, resulting in an income tax refundable amount of $8.0 million at February
1, 2004. The remaining net operating loss will be carried forward and will
positively impact cash flow in fiscal 2005 by reducing required Federal and
state estimated tax payments for this fiscal year. In addition, during fiscal
2004, cash flow was positively impacted by $3.3 million in tax refunds related
to overpayments of estimated income tax made in fiscal 2003. While we try to
anticipate events which will impact the amount and timing of income tax
payments, it is difficult to anticipate the impact stock option exercises will
have on our overall tax position as stock option exercise decisions are at the
discretion of the option holder. See Note 10 -- Income Taxes in the notes to our
consolidated financial statements for further information.
CASH FLOW FROM INVESTING ACTIVITIES
Net cash used for investing activities was $52.3 million in fiscal 2002, $93.0
million in fiscal 2003 and $186.2 million in fiscal 2004. Investing activities
in each fiscal year primarily consisted of expenditures for property and
equipment, additional investments in joint ventures and the acquisition of
franchise markets, net of cash acquired. In addition to capital expenditures,
investing activities in each fiscal year consisted of the purchases and sales of
investments in marketable securities.
In fiscal 2004, our capital expenditures for property and equipment were $79.6
million, a decrease of $3.5 million, or 4.3%, compared with fiscal 2003 and an
increase of $42.3 million, or 113.5%, compared with fiscal 2002. Capital
expenditures in each fiscal year were primarily related to new store
construction, including stores opened by our consolidated joint ventures, store
remodels, additions or improvements to existing Company stores and expenditures
to support our off-premises sales programs. During fiscal 2004, an increased
amount of capital expenditures related to new store construction, as the
Company, including consolidated joint ventures, opened 28 new factory stores in
the current year as compared to 14 new factory stores opened in fiscal 2003 and
seven in fiscal 2002. Capital expenditures in fiscal 2003 included expenditures
for the new mix manufacturing and distribution facility in Effingham, Illinois
and for the installation of a coffee roasting operation at our Ivy Avenue
facility in Winston-Salem. These expenditures were necessary to support our
efforts of increasing sales of our products throughout North America and for
expansion internationally. Capital expenditures for property and equipment in
fiscal 2005 are expected to be approximately $110.0 million, consisting
principally of expenditures for new stores, including stores to be opened by our
consolidated joint ventures, store remodels, technology and infrastructure in
our KKM&D operations. This amount, however, could be higher or lower depending
on needs and situations that arise during the year.
In fiscal 2004, we also spent $118.3 million, net of cash acquired, and issued
approximately 1.7 million shares of common stock for the acquisition of
Associate and Area Developer franchise markets in Kansas and Missouri; Michigan;
Dallas, TX and Shreveport, LA; the acquisition of the remaining minority
interest in Golden Gate, the joint venture franchisee which had the rights to
develop stores in Northern California, and Montana Mills. See Note
20 -- Acquisitions in the notes to our consolidated financial statements for
more information on these transactions. In fiscal 2003, we spent $5.0 million in
cash, net of cash acquired, and issued approximately 837,000 shares of common
stock for the acquisition of Associate and Area Developer franchise markets and
to acquire a controlling interest in a joint venture. The Associate and Area
Developer franchisee markets we acquired were in Akron, OH, Destin, FL,
Pensacola, FL and Toledo, OH. Primarily through the issuance of common stock, we
acquired a controlling interest in Glazed Investments, our area developer joint
venture with rights to develop stores in the Colorado, Minnesota and Wisconsin
markets. In fiscal 2002, we spent $20.6 million, net of cash acquired, and
issued approximately 115,000 shares of common stock to acquire the Baltimore,
MD, Charleston, SC and Savannah, GA markets from franchisees. We will acquire
markets, in whole or in part under joint venture agreements, from franchisees if
they are willing to sell to us and if there are sound business reasons for us to
make the acquisition. These reasons may include a franchise market being
contiguous to a Company store market where an acquisition would provide
operational synergies; upside opportunity in the market because the franchisee
has not fully developed on-premises or off-premises sales; or if we believe our
acquiring the
34
market would improve the brand image in the market. We will be opportunistic
about the acquisition of additional franchise markets and may acquire, in whole
or in part under joint venture agreements, other markets in fiscal 2005.
Investing activities in fiscal 2002, fiscal 2003 and fiscal 2004 also included
additional investments in area developer joint ventures totaling $1.2 million,
$7.9 million and $7.4 million, respectively, including initial investments in
joint ventures with Area Developers in markets outside North America. The
investment in fiscal 2003 included $1.6 million spent to acquire ownership
interests from the Krispy Kreme Equity Group, a pooled investment fund whose
members were officers of the Company, and from two executive officers of the
Company in certain franchise markets where we already had an interest ranging
from approximately 3% to 59%. We believe acquiring an ownership interest in
franchise markets helps align interests between the Company and the franchisee
and should provide returns for shareholders as the operators of these franchise
markets achieve scale in their operations and become profitable.
CASH FLOW FROM FINANCING ACTIVITIES
Net cash provided by financing activities was $30.9 million in fiscal 2002,
$52.2 million in fiscal 2003 and $79.5 million in fiscal 2004.
Financing activities in fiscal 2004 consisted primarily of borrowings and
repayment of debt and the proceeds from stock option exercises. On October 31,
2003, we entered into a $150.0 million unsecured bank credit facility ("Credit
Facility"). The Credit Facility is comprised of a $119.3 million revolving
credit facility ("Revolver") and a $30.7 million term loan ("Term Loan"). We
borrowed $87.0 million on the Revolver and used the proceeds to pay the
outstanding amounts due under a $55.0 million short-term promissory note we
entered into to partially finance the acquisition of the Dallas, TX and
Shreveport, LA markets from an Associate franchisee, to repay outstanding bank
borrowings of two of our consolidated joint ventures, Golden Gate and Freedom
Rings, and to partially fund the acquisition of the remaining minority interest
in Golden Gate. The proceeds of the Term Loan were used to repay an existing
term loan with similar terms. See Note 8 -- Debt in the notes to our
consolidated financial statements for additional information on the terms of the
Credit Facility. Proceeds from the exercise of stock options in fiscal 2004 were
$19.5 million.
Financing activities in fiscal 2003 consisted primarily of the borrowing of
$33.0 million to finance the Effingham, Illinois mix and distribution facility,
borrowings of long-term debt by consolidated joint ventures to finance store
development of $11.2 million and proceeds from the exercise of stock options of
$7.1 million. In addition, cash flows benefited from the repayment by members of
the Company's management and Board of Directors of loans extended to them in
1998 in connection with the change in terms of an employee benefit plan. These
loans were repaid in full, including accrued interest, in the third quarter of
fiscal 2003.
Financing activities in fiscal 2002 consisted primarily of the completion of our
follow-on public offering which raised $17.2 million of capital, the exercise of
stock options which provided cash of $3.9 million and cash of $4.0 million
provided by outstanding checks which had not yet cleared the bank (book
overdraft). The follow-on public offering was for 10,400,000 shares of common
stock, of which 9,313,300 were sold by selling shareholders and 1,086,700 were
sold by the Company, with net proceeds to the Company of $17.2 million.
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 the expansion of the Krispy
Kreme concept. 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. We also
monitor the funding requirements of our consolidated joint ventures and have
provided financing to them since we believe, given our significant ownership
interest in these operations, we can do so through our sources of funding more
economically than these joint ventures could obtain independently through third
parties and this process is administratively more efficient.
As discussed under "Cash Flow From Financing Activities" above, on October 31,
2003, we entered into a $150.0 million Credit Facility to refinance certain
existing debt and increase borrowing availability. The Credit Facility consists
of a $119.3 million Revolver, which replaced an existing $40.0 million revolving
line of credit, and a $30.7 million Term Loan. Borrowings under the Revolver,
totaling $87.0 million, were used to repay amounts outstanding, including
interest, under a $55.0 million short-term promissory note entered into in June
2003 to partially finance an acquisition, to partially finance the acquisition
of the remaining minority interest in Golden Gate and to repay bank debt of
certain of the Company's consolidated joint ventures. From the proceeds of the
Revolver borrowings, the Company provided loans to these consolidated joint
ventures to enable them to repay this debt. The Company will continue to make
financing available to its consolidated joint ventures to fund their capital
needs. Borrowings under the Term Loan were used to refinance an existing term
loan entered into in fiscal 2003 to fund the initial purchase and completion of
the Company's mix and distribution facility in Effingham, Illinois.
35
The amount available under the Revolver is reduced by outstanding letters of
credit and was $24.9 million at February 1, 2004. The Company may request, on a
one-time basis, an increase in the availability under the Revolver of up to
$50.0 million, which would increase total capacity under the Revolver to $169.3
million.
Under the Credit Facility, the Company may prepay amounts outstanding without
penalty. Amounts outstanding under the Revolver are due in full on October 31,
2007, when the Credit Facility terminates. The Term Loan requires monthly
payments of principal of $137,500 through October 31, 2007, at which time a
final payment of all outstanding principal and accrued interest will be due.
Interest on amounts outstanding under the Revolver is generally payable
quarterly and interest on the Term Loan is payable monthly and is charged, at
the Company's option, at either the Base Rate, as defined within the Credit
Facility, plus an Applicable Margin, as defined, or Adjusted LIBOR, as defined,
plus an Applicable Margin. The Applicable Margin ranges from 0.0% to 0.75% for
Base Rate borrowings and from 1.0% to 2.0% for Adjusted LIBOR borrowings and is
determined based upon the Company's performance under certain financial
covenants contained in the Credit Facility. The interest rate applicable at
February 1, 2004 was 2.57% on the Revolver and 2.38% on the Term Loan. A fee on
the unused portion of the Revolver is payable quarterly and ranges from 0.20% to
0.375%, which is also determined based upon the Company's performance under
certain financial covenants contained in the Credit Facility.
The Company is counterparty to an interest rate swap agreement with a bank which
was entered into to convert variable rate payments due under certain existing
debt to fixed amounts, thereby hedging against the impact of interest rate
changes on future interest expense (forecasted cash flow). The Company formally
documents all hedging instruments and assesses, both at inception of the
contract and on an ongoing basis, whether they are effective in offsetting
changes in cash flows of the hedged transaction. The swap had a notional amount
of $30.1 million at February 1, 2004 and was designated as a hedge against the
variable rate interest payments due under the Term Loan. The notional amount
declines by $137,500 each month, which corresponds with the reduction in
principal of the Term Loan. Under the terms of the swap, the Company makes fixed
rate payments to the counterparty of 5.09% and in return receives payments at
LIBOR. Monthly payments continue until the swap terminates May 1, 2007. The
Company is exposed to credit loss in the event of nonperformance by the
counterparty to the swap agreement; however, the Company does not anticipate
nonperformance. At February 1, 2004, the fair value carrying amount of the swap
was a liability of $2.2 million. Accumulated other comprehensive loss for the
fiscal year ended February 1, 2004 includes a loss, net of related tax benefits,
of $1.3 million related to the swap.
The Credit Facility contains provisions that, among other requirements, restrict
the payment of dividends and require the Company to maintain compliance with
certain covenants, including maintenance of certain financial ratios. At
February 1, 2004, the Company was in compliance with each of these covenants.
In December 2003, Glazed Investments entered into a $12.0 million credit
facility (the "Glazed Credit Facility") to provide working capital and funding
for the construction of stores and the purchase of related equipment. The Glazed
Credit Facility provides a $500,000 working capital line of credit, up to $8.0
million to fund the construction of stores and up to $3.5 million to fund the
purchase of related equipment. Amounts outstanding under the Glazed Credit
Facility bear interest at one-month LIBOR plus 1.50% (2.59% at February 1,
2004), which is payable monthly. Upon completion of a store, amounts advanced to
fund construction are converted to construction term loans ("Construction
Notes") and amounts advanced to fund the related equipment purchase are
converted to equipment term loans ("Equipment Notes"). The Construction Notes
require fixed monthly principal payments, based upon a term of ten years, plus
interest, with a final payment of all outstanding amounts due on the earlier of
June 30, 2010; two months prior to the final maturity of the subordinated debt
discussed below; or five years after commencement of monthly payments of
principal and interest. The Equipment Notes require monthly payments of
principal and interest for a term of five years, with a final payment of all
outstanding amounts due on the earlier of June 30, 2009; two months prior to the
final maturity of the subordinated debt discussed below; or five years after
commencement of monthly payments of principal and interest. The amounts
outstanding under the working capital line of credit are payable in full on June
30, 2004. The loans are secured by the related property and equipment. The
Company has also guaranteed approximately 75% of the amounts outstanding under
the Glazed Credit Facility. At February 1, 2004, $6.3 million had been advanced
under the Glazed Credit Facility, principally to fund store construction.
Prior to entering into the Glazed Credit Facility discussed above, Glazed
Investments typically entered into arrangements with a non-bank financing
institution to provide funding for the construction of stores and the purchase
of the related equipment. While individual promissory notes exist for the
financing of each store and equipment purchase for which funding was provided
through the issuance of debt, the terms of each are substantially the same.
During the construction period, interest on amounts outstanding is payable
monthly, generally at one-month LIBOR plus 4.25%. Upon completion of the store,
the amount advanced for construction funding is converted to a real estate term
loan ("Real Estate Loans") and amounts advanced for equipment purchases are
converted to equipment term loans ("Equipment Loans"). Generally, Real Estate
Loans require monthly payments of principal and interest for a fixed term of
fifteen years and Equipment Loans require monthly payments of principal and
interest for a fixed term of seven years. Interest is payable at rates based on
either a fixed rate, which ranges from 7% to 8.65%, or a variable rate based on
the one-month LIBOR rate or a commercial paper rate, plus a premium. The premium
charged on variable rate loans ranges from 3.05% to 3.6%. At February 1, 2004,
interest rates applicable to the debt range from 4.06% to 8.65%. The loans are
secured by the related property and equipment. The Company has also guaranteed
approximately 75% of the amounts outstanding under the loans. Amounts
outstanding under Real Estate Loans and Equipment Loans totaled $14.3 million at
February 1, 2004.
36
The Glazed Credit Facility and non-bank financing discussed above contain
provisions requiring Glazed Investments to maintain compliance with certain
financial and non-financial covenants, including maintenance of certain
financial ratios. At February 1, 2004, Glazed Investments was in compliance with
these covenants.
In July 2000, Glazed Investments issued $4.5 million in senior subordinated
notes ("Notes") to fund, in part, expenses associated with the start-up of its
operations. The Company purchased $1.0 million of the Notes at the time of the
initial offering. In connection with the Company's acquisition of additional
interests in Glazed Investments in fiscal 2003 (see Note 18 -- Joint Ventures in
the notes to our consolidated financial statements), the Company acquired an
additional $3.4 million in Notes. As a result, approximately $4.4 million of the
Notes issued by Glazed Investments are payable to the Company. Prior to the
acquisition by the Company of a controlling interest in Glazed Investments in
August 2002, the Notes held by the Company were included in investments in
unconsolidated joint ventures. Effective with the consolidation of Glazed
Investments with the accounts of the Company in August 2002, the Notes held by
the Company were eliminated against the amount reflected in Glazed Investments
balance sheet as payable to the Company. Accordingly, the Notes outstanding at
February 1, 2004 as reflected in the consolidated balance sheet totaling
$136,000 represent the total amount of the original $4.5 million issued that
remains payable to a third party. The Notes bear interest at 12.0% payable
semi-annually each April 30 and October 31 through April 30, 2010, at which time
a final payment of outstanding principal and accrued interest is due.
Based on current expansion plans, our consolidated joint ventures will most
likely seek additional borrowing capacity to support planned store openings and
sales growth. The Company may provide loans to fund these needs. If additional
third party financing is obtained, the Company will most likely be required to
guarantee a portion of this additional credit equal to its ownership percentage
of the joint venture.
The Company will continue to consider opportunities to acquire partial or entire
interests in some of our franchise markets as the opportunity arises and there
are sound business reasons to make the acquisition. Depending on the size and
number of these acquisitions, it is likely that we will use, in addition to
excess cash, additional debt and/or equity to accomplish these acquisitions. See
Capital Requirements below for further discussion.
OPERATING LEASES. The Company conducts some of its operations from leased
facilities and, additionally, leases certain equipment under operating leases.
Generally, these leases have initial terms of three to twenty years and contain
provisions for renewal options of five to ten years. In determining whether to
enter into an operating lease for an asset, we evaluate the nature of the asset
and the associated operating lease terms to determine if operating leases are an
effective financing tool. We anticipate that we will continue to use operating
leases as a financing tool as appropriate.
SUMMARIES OF OUR CONTRACTUAL CASH OBLIGATIONS AS OF FEBRUARY 1, 2004 ARE AS
FOLLOWS:
CONTRACTUAL CASH OBLIGATIONS AT FEBRUARY 1, 2004
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IN THOUSANDS
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PAYMENTS DUE IN
----------------------------------------------------
TOTAL MORE THAN
AMOUNT LESS THAN 1 YEAR 2-3 YEARS 4-5 YEARS 5 YEARS
-----------------------------------------------------------------------------------------------------------
Long-term debt $137,917 $ 2,861 $ 8,314 $116,760 $ 9,982
Operating leases 155,726 21,119 34,217 24,791 75,599
Long-term commodity purchase commitments 114,254 50,862 38,323 25,069 --
-----------------------------------------------------------------------------------------------------------
Total Contractual Cash Obligations $407,897 $74,842 $80,854 $166,620 $85,581
-----------------------------------------------------------------------------------------------------------
OFF-BALANCE SHEET ARRANGEMENTS. The Company, in the ordinary course of
business, enters into off-balance sheet arrangements as defined by the SEC's
Final Rule 67, "Disclosure in Management's Discussion and Analysis about
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations," including
guarantees and indemnifications as discussed below and in Note 17 -- Commitments
and Contingencies in the notes to our consolidated financial statements. None of
these off-balance sheet arrangements either has, or is reasonably likely to
have, a material current or future effect on financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources.
In order to open stores and expand off-premises sales programs, our franchisees
incur debt and enter into operating lease agreements. Primarily for those
franchisees in which we have an ownership interest, we will guarantee an amount
of the debt or leases generally equal to our ownership percentage. Because these
are relatively new entities without a long track record of operations, these
guarantees are necessary for our joint venture partners to get financing for the
growth of their businesses. These guarantees are not recorded as liabilities in
our consolidated balance sheet based on our assessment that the fair value of
these guarantees, if any, was not material to the Company's financial position
or results of operations. As of February 1, 2004, we had lease guarantee
commitments totaling $104,000 and loan guarantees totaling $15.3 million. These
amounts do not include guarantees of debt of our consolidated joint ventures, as
the entire amount of the debt of these joint ventures is shown as a liability in
our consolidated balance sheet, nor does it include guarantees of leases of our
consolidated joint ventures, as the gross amount of lease commitments for these
joint ventures is included in the amounts reported above and in Note 9 -- Lease
Commitments in the notes to our consolidated financial statements. Of the total
guaranteed amount of $15.4 million,
37
$14.8 million are for franchisees in which we have an ownership interest and
$541,000 are for franchisees in which we have no ownership interest. The amount
of debt and lease guarantees related to franchisees in which we have an
ownership interest will continue to grow as these joint ventures open more
stores while the amount of debt and lease guarantees related to franchisees in
which we do not have an interest is expected to decrease. To date the Company
has not experienced any losses in connection with these guarantees, and we
consider it unlikely that we will have to satisfy any of these guarantees.
In addition, at February 1, 2004, the Company had outstanding letters of credit
totaling $7.5 million. Letters of credit have terms of one year or less and are
generally renewed on an annual basis.
CAPITAL REQUIREMENTS. In the next five years, we plan to use cash primarily for
the following activities:
- Opening new Company stores in selected markets
- Remodeling and relocation of selected older Company stores
- Adding mix production and distribution capacity to support expansion
- Expanding our equipment manufacturing and operations training facilities
- Investing in all or part of franchisees' operations, both domestically and
internationally
- Working capital and other corporate purposes.
Our capital requirements for the items outlined above may be significant. These
capital requirements will depend on many factors including our overall
performance, the pace of store expansion and Company store remodels, the
requirements for joint venture arrangements and infrastructure needs for both
personnel and facilities. Prior to fiscal 2004, we primarily relied on cash flow
generated from the Company's initial public offering completed in April 2000 and
follow-on offering completed in February 2001, cash flow generated from
operations and borrowing capacity under our lines of credit to fund our capital
needs. In addition, in May 2002 we used term debt to finance our new mix
manufacturing and distribution facility in Effingham, Illinois. In June 2003, we
used short-term debt to partially finance an acquisition. In October 2003, we
entered into a Credit Facility to refinance certain existing debt, including the
term debt entered into in fiscal 2003 and the short-term debt incurred in June
2003, and to provide increased borrowing availability. We believe that cash flow
from operations and, if necessary, the Credit Facility will provide the required
capital to fund operations and store development for the Company in fiscal 2005.
We make borrowings under our Revolver available to our consolidated joint
ventures to provide funding for their operating and store development needs,
although Glazed Investments continues to use external debt for its financing
needs. If additional capital is needed, we may exercise our option to increase
borrowing availability under the Revolver or raise such capital through public
or private equity or debt financing or other financing arrangements. Future
capital funding transactions may result in dilution to shareholders. There can
be no assurance, however, that additional capital will be available or be
available on satisfactory terms. Our failure to raise additional capital could
have one or more of the following effects on our operations and growth plans
over the next five years:
- Slowing our plans to open new Company stores and remodel and relocate
older Company-owned stores
- Reducing the number and amount of joint venture investments in area
developers or acquisitions of franchise markets
- Slowing the building of our infrastructure in both personnel and
facilities.
INFLATION
We do not believe that inflation has had a material impact on our results of
operations in recent years. We cannot predict, however, what effect inflation
may have on our results of operations in the future.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We are exposed to market risk from changes in interest rates on our outstanding
debt. Our $150.0 million Credit Facility bears interest, at the Company's
option, at either the Base Rate, as defined within the Credit Facility
agreement, plus an Applicable Margin, as defined, or Adjusted LIBOR, as defined,
plus an Applicable Margin. The Applicable Margin ranges from 0.0% to 0.75% for
Base Rate borrowings and 1.0% to 2.0% for Adjusted LIBOR borrowings. The Credit
Facility consists of a $119.3 million Revolver and a $30.7 million Term Loan. We
entered into an interest rate swap that converts the variable rate interest
payments due under the Term Loan to a fixed rate of 5.09% (plus the Applicable
Margin) through May 1, 2007. The notional amount of the swap declines by
$137,500 per month, to correspond with the reduction in principal of the Term
Loan. Glazed Investments, a consolidated joint venture, is also party to various
debt agreements used to finance store development. These agreements bear
interest at varying rates, based upon LIBOR or commercial paper rates plus a
premium. We guarantee approximately 75% of amounts outstanding under these
agreements. The interest cost of our debt is affected by changes in either the
prime rate or LIBOR. Such changes could adversely impact our operating results.
Because the majority of our revenue, expense and capital purchasing activities
are currently transacted in United States dollars, the exposure to foreign
currency exchange risk historically has been minimal. As our international
operations grow, however,
38
our foreign currency exchange risks will increase. We invest in most
international joint ventures through a non-U.S. based holding company. Funding
this holding company, as well as its operations, in addition to our investments
in international joint ventures, exposes the Company to foreign currency
exchange risk. We monitor the Company's exposure to foreign currency risk and
will consider strategies to minimize this risk as appropriate.
In the normal course of business, we are exposed to the impact of commodity
price fluctuations affecting the cost of flour, sugar, soybean oil, coffee beans
and other ingredients. In order to secure adequate supplies of product and bring
greater stability to the cost of ingredients, we routinely enter into long-term
purchase agreements and other purchase arrangements with suppliers. We are
subject to market risk in that the current market price of any commodity item
may be below our contractual price. We do not use financial instruments to hedge
commodity prices.
CRITICAL ACCOUNTING POLICIES
The Company's analysis and discussion of its financial condition and results of
operations are based upon its consolidated financial statements that have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("US GAAP"). The preparation of financial statements in
accordance with US GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses,
and the disclosure of contingent assets and liabilities. US GAAP provides the
framework from which to make these estimates, assumptions and disclosures. The
Company chooses accounting policies within US 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 current and forecasted economic conditions and has
discussed the development and selection of critical accounting policies with its
audit committee of the Board of Directors. The Company believes the following
accounting policies are critical to understanding the results of operations and
affect the more significant judgments and estimates used in the preparation of
the consolidated financial statements:
BASIS OF CONSOLIDATION. Our consolidated financial statements include the
accounts of Krispy Kreme Doughnuts, Inc. and all subsidiaries where control
rests with the Company. Investments in affiliates in which the Company has the
ability to exercise significant influence over operating and financial policies
(generally less than 50-percent ownership), all of which are investments in
joint ventures with certain of our franchisees, are accounted for by the equity
method of accounting. Our judgments regarding the level of influence or control
in each equity method investment include considering key factors such as our
ownership interest, representation on the management committee, participation in
policy making decisions and material intercompany transactions. All significant
intercompany accounts and transactions, including transactions with equity
method investees, are eliminated in consolidation.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. Accounts receivable arise primarily from
royalties earned on sales of our franchisees, sales by KKM&D of equipment, mix,
coffee and other supplies necessary to operate a Krispy Kreme store to our
franchisees, as well as from off-premises sales by Company-owned stores to
convenience and grocery stores and other customers. Payment terms generally
range from 30 to 54 days. The Company has experienced minimal uncollectible
accounts receivable from franchisees. The majority of the allowance for doubtful
accounts relates to receivables from convenience and grocery stores and other
customers for off-premises sales in our Company stores. Although collection
efforts continue, the Company establishes an allowance for these accounts
generally when they become past due and are deemed uncollectible.
GOODWILL AND INTANGIBLE ASSETS. Effective fiscal 2003, the Company adopted SFAS
No. 142, "Goodwill and Other Intangible Assets," which addresses the accounting
and reporting of goodwill and other intangible assets subsequent to their
acquisition. SFAS No. 142 requires intangible assets with definite lives to be
amortized over their estimated useful lives, while those with indefinite lives
and goodwill are no longer subject to amortization, but must be tested annually
for impairment, or more frequently if events and circumstances indicate
potential impairment.
Goodwill represents primarily goodwill recorded in connection with the
acquisition of Montana Mills in fiscal 2004 (see Note 20 -- Acquisitions in the
notes to our consolidated financial statements). Intangible assets include the
value assigned to recipes, trademarks and trade names and reacquired franchise
rights recorded in connection with acquisitions. Recipes are generally amortized
over their expected useful lives, which was determined based upon management's
plans as well as general industry experience. Trademarks and trade names were
determined to have indefinite lives based principally upon a history of revenue
and cash flow performance that is expected to continue for the foreseeable
future. Reacquired franchise rights represent the value assigned to certain
franchise markets acquired by Krispy Kreme. Reacquired franchise rights were
determined to have indefinite lives based upon the significant market share of
the Company's core product, a history of strong revenue and cash flow from
franchise markets that is expected to continue for the foreseeable future, and
our ability to refranchise these markets. For intangible assets with indefinite
lives, we perform a test for impairment at least annually as of December 31.
The impairment test involves determining the fair value of the trademarks and
trade names or reporting unit to which the intangible asset or goodwill is
assigned and comparing that fair value to the book value of the trademarks and
trade names or the reporting unit's carrying value, including the intangible
asset or goodwill. To determine fair value for trademarks and trade names, we
estimate the future revenue and cash flows to be derived from the trademarks and
trade names. To determine fair value for goodwill and reacquired franchise
rights, we use a combination of the fair value of the cash flows that the
reporting unit can be expected to generate in the future and the fair value of
the business in comparison to similar publicly traded
39
businesses. These valuation methods require management to make projections of
revenues, operating expenses, working capital investment, capital spending and
cash flows for the respective reporting unit over a multi-year period, as well
as the weighted average cost of capital to be used as a discount rate. The
Company must also identify publicly traded companies in similar lines of
business. Significant management judgment is involved in preparing these
estimates. Changes in projections or estimates could significantly change the
estimated fair value of intangible assets and reporting units and impact the
recorded balances for these intangible assets and goodwill. In addition, if
management uses different assumptions or estimates in the future or if different
conditions occur in future periods, future operating results and the balances of
intangible assets and goodwill in the future could be materially impacted. We
performed impairment analyses in fiscal 2004 and fiscal 2003 and did not
recognize any impairment charges.
ASSET IMPAIRMENT. When a store is identified as underperforming or when a
decision is made 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 store until its closing, as
well as cash flows anticipated from disposal of the related assets, if any. If
the carrying amount of the assets exceeds the sum of the undiscounted cash
flows, the Company records an impairment charge measured as the excess of the
carrying value over the fair value of the assets. The resulting net book value
of the assets, less estimated net realizable value at disposition, is
depreciated over the remaining term that the store will continue in operation.
Disposition efforts on assets held for sale begin immediately following the
store closing.
Determining undiscounted cash flows and the fair value of store assets involves
estimating future cash flows, revenues, operating expenses and disposal values.
The projections of these amounts represent management's best estimates as of the
time of the review. If different cash flows had been estimated, property and
equipment balances could be impacted. Further, if management uses different
assumptions or estimates in the future or if different conditions occur in
future periods, future operating results could be impacted. The Company did not
incur any impairment charges in fiscal 2004 or fiscal 2003.
INSURANCE. The Company is generally self-insured for most employee health care,
workers' compensation, automobile liability and product and general liability
claims and losses. Insurance liabilities are accrued based upon historical and
industry trends and are adjusted when necessary due to changing circumstances.
Outside actuaries are used to assist in estimating insurance obligations.
Because there are many estimates and assumptions involved in recording these
liabilities, differences between actual future events and prior estimates and
assumptions could impact future operating results and result in adjustments to
these liabilities.
INCOME TAXES. The Company recognizes deferred tax assets and liabilities based
upon management's expectation of the future tax consequences of temporary
differences between tax bases for assets and liabilities. Deferred tax assets
generally represent items to be used as a tax deduction or credit in future tax
returns for which we have already recorded the tax benefit in our consolidated
financial statements. We establish valuation allowances for deferred tax assets
when we believe that future taxable income will not likely support realization
of the deduction or credit. Deferred tax liabilities generally represent tax
expense recognized for which payment has been deferred or expense for which we
have already taken a deduction in our tax return but have not yet recognized as
expense in our consolidated financial statements.
The determination of income tax expense and the related balance sheet accounts
requires management to make estimates and assumptions regarding the realization
of deferred tax assets and the outcome of tax-related contingencies. Tax
assessments may arise several years after tax returns have been filed.
Predicting the likelihood, outcome and timing of such assessments involves
uncertainty; however, we believe that liabilities recorded adequately reflect
the most probable outcome of known contingencies.
For further information concerning accounting policies, refer to Note
2 -- Nature of Business and Significant Accounting Policies in our notes to the
consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities," which addresses the consolidation
of business enterprises (variable interest entities), to which the usual
condition of consolidation, a controlling financial interest, does not apply.
FIN 46 requires an entity to assess its equity investments to determine if they
are variable interest entities. As defined in FIN 46, variable interests are
contractual, ownership or other interests in an entity that change with changes
in the entity's net asset value. Variable interests in an entity may arise from
financial instruments, service contracts, guarantees, leases or other
arrangements with the variable interest entity. An entity that will absorb a
majority of the variable interest entity's expected losses or expected residual
returns, as defined in FIN 46, is considered the primary beneficiary of the
variable interest entity. The primary beneficiary must include the variable
interest entity's assets, liabilities and results of operations in its
consolidated financial statements. FIN 46 was immediately effective for all
variable interest entities created after January 31, 2003. Since the release of
FIN 46, the FASB has issued several staff positions ("FSP") regarding FIN 46,
which clarified and modified many provisions of FIN 46. In December 2003, the
FASB issued FIN 46-R, which replaced FIN 46. While retaining many of the basic
concepts of FIN 46, FIN 46-R provided new guidance for determining variable
interests, revised the method of calculating expected losses and residual
returns for determination of the primary beneficiary and introduced new scope
exceptions for certain entities that qualify as a business under FIN 46. FIN
46-R is effective for all non-
40
special purpose variable interest entities for the first interim or annual
period ending after March 15, 2004, including those entities to which FIN 46 was
previously applied.
We currently have equity interests in joint ventures with other entities to
develop and operate Krispy Kreme stores. For those joint ventures where the
Company does not have the ability to control the joint venture's management
committee, we account for our investment under the equity method of accounting.
For certain of these joint ventures, we hold variable interests, such as
providing guarantees of the joint venture's debt or leases. Based on our
analysis of FIN 46-R, we have determined that the Company will be required to
begin consolidating the accounts of New England Dough, LLC ("New England
Dough"), the joint venture with rights to develop Krispy Kreme stores in certain
markets in the Northeastern United States in which the Company holds a 57%
interest, effective in the first quarter of fiscal 2005. Historically, we have
accounted for our investment in New England Dough using the equity method.
Consolidation of New England Dough is not expected to have a material impact on
our net operating results, although it will result in increases in individual
line items in the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
establishes standards for classification and measurement of certain financial
instruments with characteristics of both liabilities and equity, requiring a
financial instrument within its scope be classified as a liability. SFAS No. 150
was effective for financial instruments entered into or modified after May 31,
2003, and otherwise was effective at the beginning of the Company's third
quarter of fiscal 2004. The adoption of this statement did not have a
significant impact on the Company's consolidated financial statements.
In December 2003, the Securities and Exchange Commission staff ("SEC") issued
Staff Accounting Bulletin No. 104 ("SAB 104"), "Revenue Recognition," which
supercedes Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition
in Financial Statements." The primary purpose of SAB 104 is to rescind
accounting guidance contained in SAB 101 related to multiple element revenue
arrangements and to reflect the accounting guidance issued in Emerging Issues
Task Force 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in
Financial Statements Frequently Asked Questions and Answers" ("the FAQ") issued
with SAB 101. Selected portions of the FAQ have been incorporated into SAB 104.
The adoption of SAB 104 in fiscal 2004 did not have an effect on our revenue
recognition policy or revenues recorded.
41
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED BALANCE SHEETS
[Enlarge/Download Table]
IN THOUSANDS
----------------------------------------------------------------------------------------------
FEB. 2, 2003 FEB. 1, 2004
----------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 32,203 $ 21,029
Short-term investments 22,976 --
Accounts receivable, less allowance for doubtful accounts of
$1,453 (2003) and $1,265 (2004) 34,373 45,363
Accounts receivable, affiliates 11,062 20,482
Other receivables 884 2,363
Notes receivable, affiliates -- 458
Inventories 24,365 28,864
Prepaid expenses 3,478 5,659
Income taxes refundable 1,963 7,973
Deferred income taxes 9,824 6,453
-------------------------------
Total current assets 141,128 138,644
Property and equipment, net 202,558 284,716
Long-term investments 4,344 --
Long-term notes receivable, affiliates 1,000 7,609
Investments in unconsolidated joint ventures 6,871 12,426
Goodwill 201 19,865
Reacquired franchise rights 48,502 174,537
Other intangible assets, net 651 13,322
Other assets 5,232 9,545
-------------------------------
Total assets $ 410,487 $ 660,664
-------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 14,055 $ 19,107
Book overdraft 11,375 8,123
Accrued expenses 20,981 23,402
Arbitration award 9,075 --
Current maturities of long-term debt 3,301 2,861
Short-term debt -- related party 900 --
-------------------------------
Total current liabilities 59,687 53,493
-------------------------------
Deferred income taxes 9,849 6,417
Revolving lines of credit 7,288 87,000
Long-term debt, net of current portion 49,900 48,056
Other long-term obligations 5,218 11,168
-------------------------------
Total long-term liabilities 72,255 152,641
Commitments and contingencies (Note 17)
Minority interest 5,193 2,323
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 10,000 shares authorized;
none issued and outstanding -- --
Common stock, no par value, 300,000 shares authorized;
issued and outstanding -- 56,295 (2003) and 61,286 (2004) 173,112 294,477
Unearned compensation (119) (62)
Notes receivable, employees (558) (383)
Nonqualified employee benefit plan assets (339) (369)
Nonqualified employee benefit plan liability 339 369
Accumulated other comprehensive loss (1,486) (1,315)
Retained earnings 102,403 159,490
-------------------------------
Total shareholders' equity 273,352 452,207
-------------------------------
Total liabilities and shareholders' equity $ 410,487 $ 660,664
-------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
42
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
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IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
------------------------------------------------------------------------------------------------------------
FEB. 3, FEB. 2, FEB. 1,
YEAR ENDED 2002 2003 2004
------------------------------------------------------------------------------------------------------------
Total revenues $ 394,354 $ 491,549 $ 665,592
Operating expenses 316,946 381,489 507,396
General and administrative expenses 27,562 28,897 36,912
Depreciation and amortization expenses 7,959 12,271 19,723
Arbitration award (Note 19) -- 9,075 (525)
--------------------------------------------------
Income from operations 41,887 59,817 102,086
Interest income 2,980 1,966 921
Interest expense (337) (1,781) (4,409)
Equity loss in joint ventures (602) (2,008) (1,836)
Minority interest (1,147) (2,287) (2,072)
Other expense, net (235) (934) (13)
--------------------------------------------------
Income before income taxes 42,546 54,773 94,677
Provision for income taxes 16,168 21,295 37,590
--------------------------------------------------
Net income $ 26,378 $ 33,478 $ 57,087
--------------------------------------------------
Basic earnings per share $ 0.49 $ 0.61 $ 0.96
--------------------------------------------------
Diluted earnings per share $ 0.45 $ 0.56 $ 0.92
--------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
43
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
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PREFERRED PREFERRED COMMON COMMON
SHARES STOCK SHARES STOCK
---------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 28, 2001 -- $ -- 51,832 $ 85,060
Comprehensive income:
Net income for the year ended February 3, 2002
Unrealized holding loss, net
Foreign currency translation adjustment, net
Total comprehensive income
Proceeds from public offering 1,086 17,202
Exercise of stock options, including tax benefit
of $9,772 1,183 13,678
Issuance of shares in conjunction with
acquisition of franchise market 115 4,183
Adjustment of nonqualified employee benefit plan
investments
Issuance of restricted common shares 1 50
Amortization of restricted common shares
Issuance of stock for notes receivable 54 879
Collection of notes receivable
---------------------------------------------------
BALANCE AT FEBRUARY 3, 2002 -- $ -- 54,271 $121,052
Comprehensive income:
Net income for the year ended February 2, 2003
Unrealized holding loss, net of tax benefit of
$241
Foreign currency translation adjustment, net
of tax expense of $7
Unrealized loss from cash flow hedge, net of
tax benefit of $982
Total comprehensive income
Exercise of stock options, including tax benefit
of $13,795 1,187 20,935
Issuance of shares in conjunction with
acquisition of franchise markets 837 30,975
Adjustment of nonqualified employee benefit plan
investments
Amortization of restricted common shares
Issuance of stock options in exchange for
services 150
Collection of notes receivable
---------------------------------------------------
BALANCE AT FEBRUARY 2, 2003 -- $ -- 56,295 $173,112
Comprehensive income:
Net income for the year ended February 1, 2004
Unrealized holding loss, net of tax benefit of
$71
Foreign currency translation adjustment, net
of tax expense of $15
Unrealized gain from cash flow hedge, net of
tax expense of $129
Total comprehensive income
Exercise of stock options, including tax benefit
of $42,806 3,300 62,320
Exercise of warrants 4
Issuance of shares in conjunction with
acquisition of business (Note 20) 1,247 40,491
Issuance of shares in conjunction with
acquisition of franchise market (Note 20) 444 18,540
Adjustment of nonqualified employee benefit plan
investments
Issuance of restricted common shares 10
Amortization of restricted common shares
Collection of notes receivable
---------------------------------------------------
BALANCE AT FEBRUARY 1, 2004 -- $ -- 61,286 $294,477
---------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
44
IN THOUSANDS
[Enlarge/Download Table]
----------------------------------------------------------------------------------------------------------
NOTES NONQUALIFIED NONQUALIFIED ACCUMULATED OTHER
UNEARNED RECEIVABLE, EMPLOYEE BENEFIT EMPLOYEE BENEFIT COMPREHENSIVE RETAINED
COMPENSATION EMPLOYEES PLAN ASSETS PLAN LIABILITY INCOME (LOSS) EARNINGS TOTAL
----------------------------------------------------------------------------------------------------------
$(188) $(2,349) $(126) $126 $ 609 $ 42,547 $125,679
26,378 26,378
(111) (111)
(42) (42)
-------
26,225
17,202
13,678
4,183
(12) 12 --
(50) --
52 52
(879) --
648 648
----------------------------------------------------------------------------------------------------------
$(186) $(2,580) $(138) $138 $ 456 $ 68,925 $187,667
33,478 33,478
(385) (385)
11 11
(1,568) (1,568)
-------
31,536
20,935
30,975
(201) 201 --
67 67
150
2,022 2,022
----------------------------------------------------------------------------------------------------------
$(119) $ (558) $(339) $339 $(1,486) $102,403 $273,352
57,087 57,087
(113) (113)
23 23
261 261
-------
57,258
62,320
4
40,491
18,540
(30) 30 --
(10) --
67 67
175 175
----------------------------------------------------------------------------------------------------------
$ (62) $ (383) $(369) $369 $(1,315) $159,490 $452,207
----------------------------------------------------------------------------------------------------------
45
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
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IN THOUSANDS
---------------------------------------------------------------------------------------------------------------
YEAR ENDED FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
---------------------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 26,378 $ 33,478 $ 57,087
Items not requiring cash:
Depreciation and amortization 7,959 12,271 19,723
Deferred income taxes 2,553 1,632 1,643
Loss on disposal of property and equipment, net 235 934 939
Compensation expense related to restricted stock
awards 52 67 67
Tax benefit from exercise of nonqualified stock
options 9,772 13,795 42,806
Minority interest 1,147 2,287 2,072
Equity loss in joint ventures 602 2,008 1,836
Change in assets and liabilities:
Receivables (13,317) (7,390) (17,629)
Inventories (3,977) (7,866) (3,804)
Prepaid expenses (682) (331) (1,047)
Income taxes, net (2,575) 571 (6,010)
Accounts payable 3,884 (33) 4,068
Accrued expenses 4,096 (9,296) (766)
Arbitration award -- 9,075 (9,075)
Other long-term obligations 83 (166) 3,643
----------------------------------------------------
Net cash provided by operating activities 36,210 51,036 95,553
----------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchase of property and equipment (37,310) (83,196) (79,649)
Proceeds from disposal of property and equipment 3,196 701 --
Proceeds from disposal of assets held for sale -- 1,435 --
Acquisition of franchise markets, net of cash acquired (20,571) (4,965) (122,352)
Acquisition of business, net of cash acquired -- -- 4,052
Investments in unconsolidated joint ventures (1,218) (7,869) (7,377)
Purchases of investments (10,128) (32,739) (6,000)
Proceeds from investments 18,005 33,097 33,136
Issuance of notes receivable -- -- (6,613)
Collection of notes receivable -- 1,590 1,147
Increase in other assets (4,237) (1,038) (2,585)
----------------------------------------------------
Net cash used for investing activities (52,263) (92,984) (186,241)
----------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 3,906 7,140 19,514
Proceeds from exercise of warrants -- -- 4
Issuance of short-term debt -- -- 55,000
Issuance of long-term debt 4,643 44,234 44,570
Repayment of short-term debt -- -- (66,286)
Repayment of long-term debt -- (2,170) (46,892)
Net (repayments) borrowings from revolving lines of
credit 345 (121) 79,712
Issuance of short-term debt -- related party -- -- 2,350
Repayment of short-term debt -- related party -- (500) (3,250)
Debt issue costs -- (194) (921)
Proceeds from stock offering 17,202 -- --
Book overdraft 3,960 2,268 (3,252)
Collection of notes receivable 648 2,022 175
Minority interest 227 (432) (1,210)
----------------------------------------------------
Net cash provided by financing activities 30,931 52,247 79,514
----------------------------------------------------
Net (decrease) increase in cash and cash equivalents 14,878 10,299 (11,174)
Cash and cash equivalents at beginning of year 7,026 21,904 32,203
----------------------------------------------------
Cash and cash equivalents at end of year $ 21,904 $ 32,203 $ 21,029
----------------------------------------------------
Supplemental schedule of non-cash investing and
financing activities:
Issuance of stock in conjunction with acquisition of
franchise markets $ 4,183 $ 8,727 $ 18,540
Issuance of stock in conjunction with acquisition of
additional interest in area developer franchisee -- 22,248 --
Issuance of stock in conjunction with acquisition of
business -- -- 40,491
Receipt of promissory notes in connection with sale of
assets -- -- 3,551
Issuance of promissory note in connection with
acquisition of franchise market -- -- 11,286
Issuance of stock options in exchange for services -- 150 --
Issuance of restricted common shares 50 -- 10
Issuance of stock in exchange for employee notes
receivable 879 -- --
The accompanying notes are an integral part of these consolidated financial
statements.
46
KRISPY KREME DOUGHNUTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND PURPOSE
Krispy Kreme Doughnuts, Inc. was incorporated in North Carolina on December 2,
1999 as a wholly-owned subsidiary of Krispy Kreme Doughnut Corporation ("KKDC").
Pursuant to a plan of merger approved by shareholders on November 10, 1999, the
shareholders of KKDC became shareholders of Krispy Kreme Doughnuts, Inc. on
April 4, 2000. Each shareholder received 80 shares of Krispy Kreme Doughnuts,
Inc. common stock and $15 in cash for each share of KKDC common stock they held.
As a result of the merger, KKDC became a wholly-owned subsidiary of Krispy Kreme
Doughnuts, Inc. Krispy Kreme Doughnuts, Inc. closed a public offering of its
common stock on April 10, 2000.
2. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS. Krispy Kreme Doughnuts, Inc. and its subsidiaries (the
"Company") are engaged principally in the sale of doughnuts and related items
through Company-owned stores. The Company also derives revenue from franchise
and development fees and the collection of royalties from franchisees.
Additionally, the Company sells doughnut-making equipment, mix, coffee and other
ingredients and supplies used in operating a store to Company-owned and
franchised stores.
The significant accounting policies followed by the Company in preparing the
accompanying consolidated financial statements are as follows:
BASIS OF CONSOLIDATION. The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions are eliminated in consolidation.
Generally, investments greater than 50 percent in affiliates for which the
Company maintains control are also consolidated and the portion not owned by the
Company is shown as minority interest. As of February 1, 2004, the Company
consolidated the accounts of two joint ventures which the Company controlled:
Freedom Rings, LLC ("Freedom Rings"), the joint venture with the rights to
develop stores in the Eastern Pennsylvania, Delaware and Southern New Jersey
markets; and Glazed Investments, LLC ("Glazed Investments"), the joint venture
with the rights to develop stores in Colorado, Minnesota and Wisconsin. The
accompanying financial statements also include the accounts of Golden Gate
Doughnuts, LLC ("Golden Gate"), which owned the rights to develop stores in
Northern California. The Company acquired the remaining 33% minority interest in
this joint venture effective January 30, 2004. Generally, investments in 20- to
50-percent owned affiliates for which the Company has the ability to exercise
significant influence over operating and financial policies are accounted for by
the equity method of accounting, whereby the investment is carried at the cost
of acquisition, plus the Company's equity in undistributed earnings or losses
since acquisition, less any distributions received by the Company. Accordingly,
the Company's share of the net earnings of these companies is included in
consolidated net income. Investments in less than 20-percent owned affiliates
are accounted for by the cost method of accounting. In January 2003, the FASB
issued Interpretation No. 46, which addresses the consolidation of business
enterprises. See further discussion under "Recent Accounting Pronouncements"
below.
FISCAL YEAR. The Company's fiscal year is based on a fifty-two/fifty-three week
year. The fiscal year ends on the Sunday closest to the last day in January. The
years ended February 3, 2002, February 2, 2003 and February 1, 2004 contained
53, 52 and 52 weeks, respectively.
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles 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 could differ from these estimates.
CASH AND CASH EQUIVALENTS. The Company considers cash on hand, deposits in
banks and all highly liquid debt instruments with a maturity of three months or
less at date of acquisition to be cash and cash equivalents.
INVENTORIES. Inventories are recorded at the lower of average cost (first-in,
first-out) or net realizable value.
INVESTMENTS. Investments consist of United States Treasury notes,
mortgage-backed government securities, corporate debt securities, municipal
securities and certificates of deposit and are included in short-term and
long-term investments in the accompanying consolidated balance sheets.
Certificates of deposit are carried at cost which approximates fair value. All
other marketable securities are stated at market value as determined by the most
recently traded price of each security at the balance sheet date.
Management determines the appropriate classification of investments in
marketable securities at the time of purchase and reevaluates such determination
at each balance sheet date. At February 2, 2003, all marketable securities were
classified as available-for-sale. The Company did not hold any investments at
February 1, 2004. Available-for-sale securities are carried at fair value with
unrealized gains and losses reported as a separate component of shareholders'
equity in accumulated other comprehensive loss. The cost of investments sold is
determined on the specific identification or the first-in, first-out method.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost less
accumulated depreciation. Major renewals and betterments are charged to the
property accounts while replacements, maintenance and repairs which do not
improve or extend
47
the lives of the respective assets are expensed currently. Interest is
capitalized on major capital expenditures during the period of construction.
Depreciation of property and equipment is provided on the straight-line method.
The estimated useful lives of depreciable property are generally as follows:
Buildings -- 15 to 35 years; Machinery and equipment -- 3 to 15 years; Leasehold
improvements -- lesser of useful lives of assets or lease term.
GOODWILL, REACQUIRED FRANCHISE RIGHTS AND OTHER INTANGIBLE ASSETS. Effective
fiscal 2003, the Company adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," which addresses the accounting and reporting of goodwill and other
intangible assets subsequent to their acquisition.
Goodwill represents the excess of the purchase price over the net assets
acquired in connection with business acquisitions. In accordance with SFAS No.
142, goodwill has an indefinite life and is no longer amortized but is reviewed
at least annually for impairment or whenever events or circumstances indicate
the carrying amount of the asset may be impaired.
Reacquired franchise rights result from the acquisition of franchise markets
from existing franchisees. The excess of the net amount assigned to identifiable
assets and liabilities recorded upon the acquisition of franchise markets is
assigned to the value of the asset representing the franchise right to the
market acquired. Reacquired franchise rights have an indefinite life and are
reviewed at least annually for impairment or whenever events or circumstances
indicate the carrying amount of the asset may be impaired in accordance with
SFAS No. 142.
Other intangible assets consist primarily of trademarks and trade names and
recipes acquired in business acquisitions. The Company has evaluated and
determined that trademarks and trade names and certain recipes have indefinite
lives and, in accordance with SFAS No. 142, are not subject to amortization.
Recipes represent primarily the value assigned to the recipes acquired in the
Montana Mills acquisition (see Note 20 -- Acquisitions). Recipes have a definite
life and will be amortized on a straight-line basis over an estimated useful
life of 10 years. Trademarks and trade names are reviewed at least annually for
impairment or whenever events or circumstances indicate the carrying amount of
the assets may be impaired. Recipes are tested for impairment whenever events or
circumstances indicate the carrying amount of the assets may be impaired.
The Company performs its annual test of impairment as of December 31. The
Company completed its impairment test of goodwill, reacquired franchise rights
and indefinite-lived other intangible assets in fiscal 2003 and fiscal 2004 and
found no instances of impairment. Additionally, no events or circumstances
indicated impairment of our definite-lived intangible assets.
REVENUE RECOGNITION. A summary of the revenue recognition policies for each
segment of the Company (see Note 15) is as follows:
- Company Store Operations revenue is derived from the sale of doughnuts and
related items 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.
- Franchise Operations revenue is derived from: (1) development and
franchise fees from the opening of new stores; and (2) royalties charged
to franchisees based on sales. Development and franchise fees are charged
for certain new stores and are deferred until the store is opened and the
Company has performed substantially all of the initial services it is
required to provide. The royalties recognized in each period are based on
the sales in that period.
- KKM&D revenue is derived from the sale of doughnut-making equipment, mix,
coffee and other supplies needed to operate a doughnut store to
Company-owned and franchised stores. Revenue is recognized at the time the
title and the risk of loss pass to the customer, generally upon delivery
of the goods. Revenue from Company-owned stores and consolidated joint
venture stores is eliminated in consolidation.
- Montana Mills revenue is derived from the sale of breads, baked goods and
related items 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.
INCOME TAXES. The Company uses the asset and liability method to account for
income taxes, which requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between tax bases and financial reporting bases for assets and liabilities.
Valuation allowances are recognized to reduce deferred tax assets to amounts
more likely than not to be realized, based on management's estimates of future
taxable income.
FAIR VALUE OF FINANCIAL INSTRUMENTS. Cash, accounts receivable, accounts
payable, accrued liabilities and debt are reflected in the financial statements
at carrying amounts which approximate fair value.
ADVERTISING COSTS. All costs associated with advertising and promoting products
are expensed in the period incurred.
STORE OPENING COSTS. All costs, both direct and indirect, incurred to open
either Company or franchise stores are expensed in the period incurred. Direct
costs to open stores were $1,194,000, $2,062,000 and $4,634,000 in fiscal 2002,
fiscal 2003 and fiscal 2004, respectively.
48
OTHER EXPENSE, NET. Other expense, net includes primarily realized gains and
losses from disposals of property and equipment and foreign currency transaction
gains and losses.
ASSET IMPAIRMENT. When a store is identified as underperforming or when a
decision is made 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 store until its closing as
well as cash flows anticipated from disposal of the related assets, if any. If
the carrying amount of the assets exceeds the sum of the undiscounted cash
flows, the Company records an impairment charge measured as the excess of the
carrying value over the fair value of the assets. The resulting net book value
of the assets, less estimated net realizable value at disposition, is
depreciated over the remaining term that the store will continue in operation.
STOCK-BASED COMPENSATION. The Company accounts for employee stock options in
accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees." Under APB Opinion No. 25, the Company recognizes
no compensation expense related to employee stock options, as no options are
granted below the market price on the grant date. SFAS No. 123, "Accounting for
Stock-Based Compensation," requires the recognition of compensation expense
based on the fair value of options on the grant date, but allows companies to
continue applying APB Opinion No. 25 if certain pro forma disclosures are made
assuming hypothetical fair value method application.
HAD COMPENSATION EXPENSE FOR THE COMPANY'S STOCK OPTIONS BEEN BASED ON THE FAIR
VALUE AT THE GRANT DATE UNDER THE METHODOLOGY PRESCRIBED BY SFAS NO. 123, THE
COMPANY'S INCOME FROM CONTINUING OPERATIONS AND EARNINGS PER SHARE FOR THE THREE
YEARS ENDED FEBRUARY 1, 2004 WOULD HAVE BEEN IMPACTED AS FOLLOWS:
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IN THOUSANDS, EXCEPT PER SHARE AMOUNTS
----------------------------------------------------------------------------------------------------------
FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
----------------------------------------------------------------------------------------------------------
Net income, as reported $ 26,378 $ 33,478 $ 57,087
Add: Stock-based expense reported in net income,
net of related tax effects -- 31 62
Deduct: Total stock-based compensation expense
determined under fair value method for all
awards, net of related tax effects (4,751) (8,653) (11,481)
-----------------------------------------------------
Pro forma net income $ 21,627 $ 24,856 $ 45,668
-----------------------------------------------------
Earnings per share:
Reported earnings per share -- Basic $ 0.49 $ 0.61 $ 0.96
Pro forma earnings per share -- Basic 0.40 0.45 0.77
Reported earnings per share -- Diluted 0.45 0.56 0.92
Pro forma earnings per share -- Diluted 0.37 0.42 0.73
THE FAIR VALUE OF OPTIONS GRANTED, WHICH IS AMORTIZED TO EXPENSE OVER THE OPTION
VESTING PERIOD IN DETERMINING THE PRO FORMA IMPACT, IS ESTIMATED AT THE DATE OF
GRANT USING THE BLACK-SCHOLES OPTION-PRICING MODEL WITH THE FOLLOWING WEIGHTED
AVERAGE ASSUMPTIONS:
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FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
----------------------------------------------------------------------------------------------------------
Expected life of option 7 years 7 years 7 years
Risk-free interest rate 5.0% 4.4% 3.7%
Expected volatility of stock 52.6% 45.9% 41.6%
Expected dividend yield -- -- --
THE WEIGHTED AVERAGE FAIR VALUE OF OPTIONS GRANTED DURING FISCAL 2002, FISCAL
2003 AND FISCAL 2004 IS AS FOLLOWS:
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FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
----------------------------------------------------------------------------------------------------------
Fair value of each option granted $ 14.92 $ 18.91 $ 19.84
Total number of options granted 2,169,600 1,186,200 1,829,200
Total fair value of all options granted $32,370,400 $22,431,000 $36,291,300
CONCENTRATION OF CREDIT RISK. Financial instruments that potentially subject
the Company to credit risk consist principally of accounts receivable. Accounts
receivable are primarily from grocery and convenience stores. The Company
performs ongoing credit evaluations of its customers' financial condition. The
Company had no single customer that accounted for more than 10% of total
revenues in fiscal 2002, fiscal 2003 or fiscal 2004. The Company's two largest
customers accounted for 12.5%, 11.4% and 8.1% of total revenues for fiscal 2002,
fiscal 2003 and fiscal 2004, respectively. Accounts receivable for these two
customers accounted for approximately 13.4% and 10.4% of net accounts receivable
at February 2, 2003 and February 1, 2004, respectively.
49
COMPREHENSIVE INCOME. SFAS No. 130, "Reporting Comprehensive Income," requires
that certain items such as foreign currency translation adjustments and
unrealized gains and losses on certain investments in debt and equity securities
be presented as separate components of shareholders' equity. SFAS No. 130
defines these as items of other comprehensive income which must be reported in a
financial statement displayed with the same prominence as other financial
statements. Accumulated other comprehensive loss, as reflected in the
consolidated statements of shareholders' equity, included a net unrealized
holding loss on marketable securities of $113,000 at February 2, 2003. At
February 2, 2003 and February 1, 2004, accumulated other comprehensive loss also
included foreign currency translation adjustments, net, of $31,000 and $8,000,
respectively and the unrealized loss from a cash flow hedge, net of related tax
benefits, of $1,568,000 and $1,307,000, respectively. Total comprehensive income
for fiscal 2002, fiscal 2003 and fiscal 2004 was $26,225,000, $31,536,000 and
$57,258,000, respectively.
FOREIGN CURRENCY TRANSLATION. For all non-U.S. subsidiaries and joint ventures,
the functional currency is the local currency. Assets and liabilities of those
operations are translated into U.S. dollars using exchange rates at the balance
sheet date. Revenue and expenses are translated using the average exchange rates
for the reporting period. Translation adjustments are reported in accumulated
other comprehensive income (loss), a separate component of shareholders' equity.
Transaction gains and losses resulting from remeasuring transactions denominated
in currencies other than the functional currency are included in other expense,
net.
RECENT ACCOUNTING PRONOUNCEMENTS. In January 2003, the FASB issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities,"
which addresses the consolidation of business enterprises (variable interest
entities), to which the usual condition of consolidation, a controlling
financial interest, does not apply. FIN 46 requires an entity to assess its
equity investments to determine if they are variable interest entities. As
defined in FIN 46, variable interests are contractual, ownership or other
interests in an entity that change with changes in the entity's net asset value.
Variable interests in an entity may arise from financial instruments, service
contracts, guarantees, leases or other arrangements with the variable interest
entity. An entity that will absorb a majority of the variable interest entity's
expected losses or expected residual returns, as defined in FIN 46, is
considered the primary beneficiary of the variable interest entity. The primary
beneficiary must include the variable interest entity's assets, liabilities and
results of operations in its consolidated financial statements. FIN 46 was
immediately effective for all variable interest entities created after January
31, 2003. Since the release of FIN 46, the FASB has issued several staff
positions ("FSP") regarding FIN 46, which clarified and modified many provisions
of FIN 46. In December 2003, the FASB issued FIN 46-R, which replaced FIN 46.
While retaining many of the basic concepts of FIN 46, FIN 46-R provided new
guidance for determining variable interests, revised the method of calculating
expected losses and residual returns for determination of the primary
beneficiary and introduced new scope exceptions for certain entities that
qualify as a business under FIN 46. FIN 46-R is effective for all non-special
purpose variable interest entities for the first interim or annual period ending
after March 15, 2004, including those entities to which FIN 46 was previously
applied.
The Company currently has equity interests in joint ventures with other entities
to develop and operate Krispy Kreme stores. For those joint ventures where the
Company does not have the ability to control the joint venture's management
committee, the Company accounts for its investment under the equity method of
accounting. For certain of these joint ventures, the Company holds variable
interests, such as providing guarantees of the joint venture's debt or leases.
Based on the analysis of FIN 46-R, the Company will be required to begin
consolidating the accounts of New England Dough, LLC ("New England Dough"), the
joint venture with rights to develop Krispy Kreme stores in certain markets in
the Northeastern United States in which the Company holds a 57% interest,
effective in the first quarter of fiscal 2005. Historically, the Company has
accounted for its investment in New England Dough using the equity method.
Consolidation of New England Dough is not expected to have a material impact on
the net operating results of the Company, although it will result in increases
in individual line items in the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
establishes standards for classification and measurement of certain financial
instruments with characteristics of both liabilities and equity, requiring a
financial instrument within its scope be classified as a liability. SFAS No. 150
was effective for financial instruments entered into or modified after May 31,
2003, and otherwise was effective at the beginning of the Company's third
quarter of fiscal 2004. The adoption of this statement did not have a
significant impact on the Company's consolidated financial statements.
In December 2003, the Securities and Exchange Commission staff ("SEC") issued
Staff Accounting Bulletin No. 104 ("SAB 104"), "Revenue Recognition," which
supercedes Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition
in Financial Statements." The primary purpose of SAB 104 is to rescind
accounting guidance contained in SAB 101 related to multiple element revenue
arrangements and to reflect the accounting guidance issued in Emerging Issues
Task Force 00-21, "Accounting for Revenue Arrangements with Multiple
Deliverables." Additionally, SAB 104 rescinds the SEC's "Revenue Recognition in
Financial Statements Frequently Asked Questions and Answers" ("the FAQ") issued
with SAB 101. Selected portions of the FAQ have been incorporated into SAB 104.
The Company's adoption of SAB 104 in fiscal 2004 did not have an effect on our
revenue recognition policy or revenues recorded.
RECLASSIFICATIONS. Certain reclassifications of amounts in the fiscal 2002 and
fiscal 2003 consolidated financial statements and related notes have been made
to conform with the fiscal 2004 presentation.
50
3. INVESTMENTS
THE FOLLOWING TABLE PROVIDES CERTAIN INFORMATION ABOUT INVESTMENTS AT FEBRUARY
2, 2003. THE COMPANY DID NOT HOLD ANY INVESTMENTS AT FEBRUARY 1, 2004.
[Enlarge/Download Table]
IN THOUSANDS
------------------------------------------------------------------------------------------------------------------
AMORTIZED GROSS UNREALIZED GROSS UNREALIZED FAIR
COST HOLDING GAINS HOLDING LOSSES VALUE
------------------------------------------------------------------------------------------------------------------
FEBRUARY 2, 2003
U.S. government notes $16,657 $152 $ (97) $16,712
Federal government agencies 7,485 289 (197) 7,577
Corporate debt securities 1,000 76 (45) 1,031
Certificate of deposit 2,000 -- -- 2,000
-------------------------------------------------------------------------
Total $27,142 $517 $(339) $27,320
-------------------------------------------------------------------------
4. INVENTORIES
THE COMPONENTS OF INVENTORIES ARE AS FOLLOWS:
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IN THOUSANDS
---------------------------------------------------------------------------------------------------------------
DISTRIBUTION EQUIPMENT MIX COMPANY MONTANA
CENTER DEPARTMENT DEPARTMENT STORES MILLS TOTAL
---------------------------------------------------------------------------------------------------------------
FEBRUARY 2, 2003
Raw materials $ -- $3,828 $1,069 $1,922 $ -- $ 6,819
Work in progress -- 234 -- -- -- 234
Finished goods 2,222 3,616 172 -- -- 6,010
Purchased merchandise 10,191 -- -- 966 -- 11,157
Manufacturing supplies -- -- 145 -- -- 145
---------------------------------------------------------------------------------------
Totals $12,413 $7,678 $1,386 $2,888 $ -- $24,365
---------------------------------------------------------------------------------------
FEBRUARY 1, 2004
Raw materials $ -- $3,653 $1,716 $3,263 $ 99 $ 8,731
Work in progress -- 84 -- -- -- 84
Finished goods 2,603 3,918 120 -- 101 6,742
Purchased merchandise 11,957 -- -- 1,142 91 13,190
Manufacturing supplies -- -- 117 -- -- 117
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Totals $14,560 $7,655 $1,953 $4,405 $291 $28,864
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5. PROPERTY AND EQUIPMENT
PROPERTY AND EQUIPMENT CONSISTS OF THE FOLLOWING:
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IN THOUSANDS
------------------------------------------------------------------------------------------
FEB. 2, FEB. 1,
2003 2004
------------------------------------------------------------------------------------------
Land $ 24,741 $ 33,801
Buildings 88,641 131,727
Machinery and equipment 118,332 153,965
Leasehold improvements 19,522 25,254
Construction in progress 1,534 6,550
----------------------------
252,770 351,297
Less: accumulated depreciation 50,212 66,581
----------------------------
Property and equipment, net $ 202,558 $ 284,716
----------------------------
Depreciation expense was $7,398,000, $11,570,000 and $18,797,000 for fiscal
2002, fiscal 2003 and fiscal 2004, respectively.
51
6. GOODWILL, REACQUIRED FRANCHISE RIGHTS AND OTHER INTANGIBLE ASSETS
GOODWILL AND INTANGIBLE ASSETS CONSIST OF THE FOLLOWING:
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IN THOUSANDS
--------------------------------------------------------------------------------------------
FEB. 2, 2003 FEB. 1, 2004
--------------------------------------------------------------------------------------------
Net carrying amount of indefinite-lived intangible assets:
Goodwill $ 201 $ 19,865
----------------------------
Reacquired franchise rights $ 48,502 $ 174,537
----------------------------
Trademarks and trade names $ 651 $ 12,339
----------------------------
Net carrying amount of definite-lived intangible assets:
Recipes $ -- $ 983
----------------------------
During fiscal 2004, the carrying amount of goodwill increased $19,664,000
primarily as a result of the acquisition of Montana Mills in April 2003. The
carrying amount of reacquired franchise rights increased $126,035,000 as a
result of the acquisition from existing franchisees of rights to certain markets
in Kansas, Missouri, Michigan, Dallas, Texas and Shreveport, Louisiana, as well
as from the acquisition of the remaining minority interest in Golden Gate, the
franchisee with rights to develop stores in Northern California (see Note
20 -- Acquisitions). Trademarks and trade names recorded during fiscal 2004,
primarily associated with the Montana Mills acquisition, were determined to have
an indefinite life.
The carrying amount of recipes represents primarily the recipes acquired in the
Montana Mills acquisition in April 2003. Recipes were determined to have a
definite life and are amortized on a straight-line basis over an estimated
useful life of 10 years. Amortization expense associated with recipes was
$73,000 in fiscal 2004. The estimated annual amortization expense for each of
the next five years following fiscal 2004 is $88,000.
7. ACCRUED EXPENSES
ACCRUED EXPENSES CONSIST OF THE FOLLOWING:
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IN THOUSANDS
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FEB. 2, FEB. 1,
2003 2004
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Insurance $ 6,150 $ 8,050
Salaries, wages and incentive compensation 6,034 4,041
Deferred revenue 1,485 1,353
Taxes, other than income 1,865 3,267
Other 5,447 6,691
----------------------------
Total $ 20,981 $ 23,402
----------------------------
52
8. DEBT
THE COMPANY'S DEBT, INCLUDING DEBT OF CONSOLIDATED JOINT VENTURES, CONSISTS OF
THE FOLLOWING:
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IN THOUSANDS
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FEB. 2, FEB. 1,
2003 2004
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Krispy Kreme Doughnut Corporation:
$119.3 million revolving line of credit $ -- $ 87,000
$40 million revolving line of credit -- --
Golden Gate:
$6.75 million revolving line of credit 4,750 --
Freedom Rings:
$5 million revolving line of credit 2,538 --
----------------------------
Revolving lines of credit $ 7,288 $ 87,000
----------------------------
Glazed Investments:
Short-term debt -- related party $ 900 $ --
----------------------------
Krispy Kreme Doughnut Corporation:
$30.7 million term loan $ -- $ 30,113
$33 million term loan 31,763 --
Golden Gate:
$4.5 million term loan 3,926 --
$3 million term loan 2,976 --
Glazed Investments:
$12 million credit facility -- 6,330
Real Estate and Equipment loans 14,400 14,319
Subordinated notes 136 136
Montana Mills:
Other debt -- 19
----------------------------
53,201 50,917
Current maturities of long-term debt (3,301) (2,861)
----------------------------
Long-term debt, net of current portion $ 49,900 $ 48,056
----------------------------
$150 MILLION CREDIT AGREEMENT
On October 31, 2003, the Company entered into a $150,000,000 unsecured bank
credit facility ("Credit Facility") to refinance certain existing debt and
increase borrowing availability for general working capital purposes and other
financing and investing activities. The Credit Facility consists of a
$119,338,000 revolving credit facility ("Revolver") and a $30,662,000 term loan
("Term Loan"). Borrowings under the Revolver, totaling $87,000,000, were used to
repay amounts outstanding, including interest, under a $55,000,000 short-term
promissory note entered into during June 2003 to partially finance an
acquisition, to partially finance the acquisition of the remaining minority
interest in Golden Gate (see Note 20 -- Acquisitions) and to repay bank debt of
Freedom Rings and Golden Gate (see below). From the proceeds of the Revolver
borrowings, the Company provided loans to these consolidated joint ventures to
enable them to repay this debt. Given its significant ownership interest, the
Company will continue to make financing available to its consolidated joint
ventures to fund their capital needs as this process provides a lower cost of
capital and administrative efficiencies. Borrowings under the Term Loan were
used to refinance an existing term loan ("$33 Million Term Loan") entered into
to fund the initial purchase and completion of the Company's mix and
distribution facility in Effingham, Illinois (see below).
The amount available under the Revolver is reduced by letters of credit and was
$24,892,000 at February 1, 2004. Outstanding letters of credit, primarily for
insurance purposes, totaled $7,446,000 at February 1, 2004. The Company may
request, on a one-time basis, an increase in the availability under the Revolver
of up to $50,000,000, which would increase total availability under the Revolver
to $169,338,000.
Under the Credit Facility, the Company may prepay amounts outstanding without
penalty. Amounts outstanding under the Revolver are due in full on October 31,
2007, when the Credit Facility terminates. The Term Loan requires monthly
payments of principal of $137,500 through October 31, 2007, at which time a
final payment of all outstanding principal and accrued interest will be due.
Interest on amounts outstanding under the Revolver is generally payable
quarterly and interest on the Term Loan is payable monthly and is charged, at
the Company's option, at either the Base Rate, as defined within the Credit
Facility agreement, plus an Applicable Margin, as defined, or Adjusted LIBOR, as
defined, plus an Applicable Margin. The Applicable Margin ranges from 0.0% to
0.75% for Base Rate borrowings and from 1.0% to 2.0% for Adjusted LIBOR
borrowings and is determined based upon the Company's performance under certain
financial covenants contained in the Credit Facility. The interest rate
applicable at February 1, 2004 was 2.57% on the Revolver and 2.38% on the Term
Loan. A fee on
53
the unused portion of the Revolver is payable quarterly and ranges from 0.20% to
0.375%, which is also determined based upon the Company's performance under
certain financial covenants contained in the Credit Facility.
The Company is counterparty to an interest rate swap agreement with a bank,
which was initially entered into in May 2002 to convert variable rate payments
due under the $33 Million Term Loan to fixed amounts, thereby hedging against
the impact of interest rate changes on future interest expense (forecasted cash
flow). The Company formally documents all hedging instruments and assesses, both
at inception of the contract and on an ongoing basis, whether they are effective
in offsetting changes in cash flows of the hedged transaction. The swap had an
initial notional amount of $33,000,000. The notional amount declines by $137,500
each month, originally to correspond with the reduction in principal of the $33
Million Term Loan and which now corresponds with the reduction in principal of
the Term Loan. The notional amount of the swap at February 1, 2004 was
$30,113,000. Under the terms of the swap, the Company makes fixed rate payments
to the counterparty of 5.09% and in return receives payments at LIBOR. Monthly
payments continue until the swap terminates May 1, 2007. The Company is exposed
to credit loss in the event of nonperformance by the counterparty to the swap
agreement; however, the Company does not anticipate nonperformance. At February
2, 2003 and February 1, 2004, the fair value carrying amount of the swap was a
liability of $2,550,000 and $2,160,000, respectively. Accumulated other
comprehensive loss for the year ended February 2, 2003 and February 1, 2004
includes, net of related tax benefits, a loss of $1,568,000 and $1,307,000,
respectively, related to the swap.
The Credit Facility contains provisions that, among other requirements, restrict
the payment of dividends and require the Company to maintain compliance with
certain covenants, including the maintenance of certain financial ratios. At
February 1, 2004, the Company was in compliance with each of these covenants.
$40 MILLION REVOLVING LINE OF CREDIT
In December 1999, the Company entered into an unsecured Loan Agreement (the
"Agreement") with a bank to increase borrowing availability and extend the
maturity of an existing revolving line of credit. The Agreement provided a $40
million revolving line of credit that was scheduled to expire on June 30, 2004.
Under the terms of the Agreement, interest on amounts advanced was charged, at
the Company's option, at either the lender's prime rate less 110 basis points or
at the one-month LIBOR plus 100 basis points and a fee of 0.10% was payable on
the unused portion. On October 31, 2003, upon entering into the Credit Facility,
this Agreement was canceled.
$33 MILLION TERM LOAN
In March 2002, the Company entered into a credit agreement with a bank ("Credit
Agreement") to provide funding of up to $35,000,000 for the initial purchase and
completion of the Company's mix and distribution facility in Effingham, Illinois
(the "Facility"). Construction of the Facility began in May 2001 and was
originally funded through a synthetic lease agreement with a bank. The Company
terminated the synthetic lease and purchased the Facility from the bank with the
proceeds from the initial borrowing under the Credit Agreement, $31,710,000.
On May 1, 2002, the outstanding borrowings under the Credit Agreement, totaling
$33,000,000, were converted to a $33 Million Term Loan. The $33 Million Term
Loan required monthly payments of principal of $137,500 and interest through
September 21, 2007, at which time a final payment of all outstanding principal
and accrued interest would be due. Interest was payable at Adjusted LIBOR, as
defined within the Credit Agreement, plus an Applicable Margin, as defined. The
Applicable Margin ranged from .75% to 1.75% and was determined based upon the
Company's performance under certain financial covenants contained in the Credit
Agreement. On October 31, 2003, amounts outstanding under the $33 Million Term
Loan were repaid in full with the proceeds from the Credit Facility Term Loan
and the $33 Million Term Loan was canceled.
CONSOLIDATED JOINT VENTURES -- GOLDEN GATE
In October 2001, Golden Gate entered into a $6,750,000 revolving line of credit
agreement with a bank to provide funding to support store construction, the
growth of off-premises sales and general working capital needs. The line of
credit was scheduled to mature October 12, 2004. In addition, Golden Gate had
entered into term loan agreements with a bank to provide funding for the
construction of stores and the purchase of equipment. Interest on borrowings
under the line of credit and the term loans was charged at one-month LIBOR plus
1.25%. The term loans required monthly payments of principal plus interest
determined based upon fixed terms ranging from seven to ten years, with a final
payment of all remaining outstanding amounts due after five years. The term
loans were scheduled to mature beginning in 2006. On October 31, 2003, amounts
outstanding under the revolving line of credit and the term loans were repaid in
full with proceeds from borrowings under the Credit Facility Revolver and the
agreements were canceled.
CONSOLIDATED JOINT VENTURES -- FREEDOM RINGS
In June 2002, Freedom Rings entered into an unsecured loan agreement with a bank
to provide initial funding of $1,500,000 for construction of a retail store. In
November 2002, Freedom Rings entered into a $5,000,000 revolving line of credit
with the bank to provide funding for the construction of additional retail
stores and general working capital purposes. The line of credit replaced the
$1,500,000 loan, which was repaid in full and canceled. Interest on borrowings
under the line of credit was
54
charged at one-month LIBOR plus 1.25%. The line of credit was scheduled to
mature on August 15, 2004. On October 31, 2003, the amounts outstanding under
the line of credit were repaid in full with proceeds from the Credit Facility
Revolver and the line of credit was canceled.
CONSOLIDATED JOINT VENTURES -- GLAZED INVESTMENTS
In December 2003, Glazed Investments entered into a $12 million credit facility
("Glazed Credit Facility") to provide working capital and funding for the
construction of stores and the purchase of related equipment. The Glazed Credit
Facility provides a $500,000 working capital line of credit, up to $8,000,000
for the funding of the construction of stores and up to $3,500,000 for the
purchase of related equipment. Amounts outstanding under the Glazed Credit
Facility bear interest at one-month LIBOR plus 1.50% (2.59% at February 1,
2004), which is payable monthly. Upon completion of a store, amounts advanced to
fund construction are converted to construction term loans ("Construction
Notes") and amounts advanced to fund the related equipment purchased are
converted to equipment term loans ("Equipment Notes"). The Construction Notes
require fixed monthly principal payments, based upon a term of ten years, plus
interest, with a final payment of all outstanding amounts due on the earlier of
June 30, 2010; two months prior to the final maturity of the subordinated debt
discussed below; or five years after commencement of monthly payments of
principal and interest. The Equipment Notes require monthly payments of
principal and interest for a term of five years, with a final payment of all
outstanding amounts on the earlier of June 30, 2009; two months prior to the
final maturity of the subordinated debt discussed below; or five years after
commencement of monthly payments of principal and interest. Amounts outstanding
under the working capital line of credit are payable in full on June 30, 2004.
The loans are secured by the related property and equipment. The Company has
also guaranteed approximately 75% of the amounts outstanding under the Glazed
Credit Facility.
Prior to entering into the Glazed Credit Facility discussed above, Glazed
Investments entered into arrangements with a non-bank financing institution that
provided funding for the construction of stores and the purchase of the related
equipment. While individual promissory notes exist for the financing of each
store and equipment purchase for which funding was provided through the issuance
of debt, the terms of each are substantially the same. During the construction
period, interest on amounts outstanding is payable monthly, generally at
one-month LIBOR plus 4.25%. Upon completion of the store, the amount advanced
for construction funding is converted to a real estate term loan ("Real Estate
Loans") and amounts advanced for equipment purchases are converted to equipment
term loans ("Equipment Loans"). Generally, Real Estate Loans require monthly
payments of principal and interest for a fixed term of fifteen years and
Equipment Loans require monthly payments of principal and interest for a fixed
term of seven years. Interest is payable at rates based on either a fixed rate,
which ranges from 7% to 8.65%, or a variable rate based on the one-month LIBOR
rate or a commercial paper rate, plus a premium. The premium charged on variable
rate loans ranges from 3.05% to 3.6%. At February 1, 2004, interest rates
applicable to the Real Estate Loans and Equipment Loans range from 4.06% to
8.65%. The loans are secured by the related property and equipment. The Company
has also guaranteed approximately 75% of the amounts outstanding under the
loans.
The Glazed Credit Facility and non-bank financing discussed above contain
provisions requiring Glazed Investments to maintain compliance with certain
financial and non-financial covenants, including maintenance of certain
financial ratios. At February 1, 2004, Glazed Investments was in compliance with
these covenants.
Glazed Investments has also entered into promissory notes with Lawrence E. Jaro,
chief executive officer of Glazed Investments, who holds an approximate 18%
interest in the joint venture, whereby Mr. Jaro provided funding to the joint
venture for general working capital purposes. Borrowings under the promissory
notes were also used to fund store development costs prior to establishment of
permanent financing. Amounts outstanding were unsecured. Interest at 10% was
payable at maturity. The notes generally had terms of less than six months and
were repaid from operating cash flows of the joint venture or proceeds from
permanent financing. During fiscal 2004, all of these notes were repaid and
canceled.
In July 2000, Glazed Investments issued $4,520,000 in senior subordinated notes
("Notes") to fund, in part, expenses associated with the start-up of its
operations. The Company purchased $1,007,000 of the Notes at the time of the
initial offering. In connection with the Company's acquisition of additional
interests in Glazed Investments in fiscal 2003, the Company acquired an
additional $3,377,000 in Notes. As a result, approximately $4,384,000 of the
Notes are payable to the Company. Prior to the acquisition by the Company of a
controlling interest in Glazed Investments in August 2002, the Notes held by the
Company were included in investments in unconsolidated joint ventures. Effective
with the consolidation of Glazed Investments with the accounts of the Company in
August 2002, the Notes held by the Company were eliminated against the amount
reflected in Glazed Investments balance sheet as payable to the Company.
Accordingly, the Notes outstanding at February 1, 2004 as reflected in the
accompanying consolidated balance sheet totaling $136,000 represent the total
amount of the original $4,520,000 issued that remains payable to a third party.
The Notes bear interest at 12.0% payable semi-annually each April 30 and October
31 through April 30, 2010, at which time a final payment of outstanding
principal and accrued interest is due.
For franchisees in which we have an ownership interest, the Company will
sometimes guarantee an amount of the debt or leases, generally equal to the
Company's ownership percentage. The amounts guaranteed by the Company are
disclosed in Note 18 -- Joint Ventures.
55
The aggregate maturities for long-term debt for the five fiscal years ending
after February 1, 2004 are $2,861,000, $4,488,000, $3,826,000, $114,443,000 and
$2,317,000, respectively.
Interest paid was $337,000 in fiscal 2002, $1,855,000 (including $74,000 that
was capitalized) in fiscal 2003 and $4,454,000 (including $45,000 that was
capitalized) in fiscal 2004.
9. LEASE COMMITMENTS
The Company conducts some of its operations from leased facilities and,
additionally, leases certain equipment under operating leases. Generally, these
leases have initial terms of three to twenty years and contain provisions for
renewal options of five to ten years.
AT FEBRUARY 1, 2004, FUTURE MINIMUM ANNUAL RENTAL COMMITMENTS, GROSS, UNDER
NONCANCELABLE OPERATING LEASES, INCLUDING LEASE COMMITMENTS OF CONSOLIDATED
JOINT VENTURES, ARE AS FOLLOWS:
[Download Table]
IN THOUSANDS
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FISCAL YEAR ENDING IN AMOUNT
-------------------------------------------------------------------------
2005 $ 21,119
2006 18,560
2007 15,657
2008 13,099
2009 11,692
Thereafter 75,599
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$ 155,726
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Rental expense, net of rental income, totaled $10,576,000 in fiscal 2002,
$13,169,000 in fiscal 2003 and $19,574,000 in fiscal 2004.
10. INCOME TAXES
THE COMPONENTS OF THE PROVISION FOR FEDERAL AND STATE INCOME TAXES ARE
SUMMARIZED AS FOLLOWS:
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IN THOUSANDS
---------------------------------------------------------------------------------------------------------------
FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
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Currently payable $ 13,615 $ 19,663 $ 35,947
Deferred 2,553 1,632 1,643
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$ 16,168 $ 21,295 $ 37,590
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A RECONCILIATION OF THE STATUTORY FEDERAL INCOME TAX RATE WITH THE COMPANY'S
EFFECTIVE RATE IS AS FOLLOWS:
[Enlarge/Download Table]
IN THOUSANDS
---------------------------------------------------------------------------------------------------------------
FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
---------------------------------------------------------------------------------------------------------------
Federal taxes at statutory rate $ 14,891 $ 19,170 $ 33,137
State taxes, net of federal benefit 1,158 1,405 3,198
Foreign operating losses with no tax benefit -- 714 1,251
Other 119 6 4
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$ 16,168 $ 21,295 $ 37,590
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Income tax payments, net of refunds, were $6,616,000 in fiscal 2002 and
$5,298,000 in fiscal 2003. In fiscal 2004, the Company received a refund, net of
income tax payments, of $2,763,000. The income tax payments in fiscal 2002,
fiscal 2003 and fiscal 2004 were lower than the current provision due to the
income tax benefit of stock option exercises of $9,772,000, $13,795,000 and
$42,806,000 during fiscal 2002, fiscal 2003 and fiscal 2004, respectively.
THE NET CURRENT AND NON-CURRENT COMPONENTS OF DEFERRED INCOME TAXES RECOGNIZED
IN THE BALANCE SHEET ARE AS FOLLOWS:
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IN THOUSANDS
----------------------------------------------------------------------------------------------
FEB. 2, 2003 FEB. 1, 2004
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Net current assets $ 9,824 $ 6,453
Net non-current liabilities (9,849) (6,417)
---------------------------------
Net asset/(liability) $ (25) $ 36
---------------------------------
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THE TAX EFFECTS OF THE SIGNIFICANT TEMPORARY DIFFERENCES WHICH COMPRISE THE
DEFERRED TAX ASSETS AND LIABILITIES ARE AS FOLLOWS:
[Enlarge/Download Table]
IN THOUSANDS
----------------------------------------------------------------------------------------------
FEB. 2, 2003 FEB. 1, 2004
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ASSETS
Compensation deferred (unpaid) $ 756 $ 491
Insurance 2,368 3,180
Deferred revenue 1,165 2,093
Charitable contributions carryforward 714 1,393
Gain/loss on hedging transactions 982 853
Accrued litigation 3,494 --
Other current assets 834 867
Other current liabilities 2,166 1,344
Other non-current assets 323 104
Federal tax credit carryforwards -- 701
Federal net operating loss carryforwards -- 9,241
State tax credit carryforwards 179 539
State net operating loss carryforwards 2,463 5,880
--------------------------------
Gross deferred tax assets 15,444 26,686
--------------------------------
LIABILITIES
Cumulative translation adjustment (19) 426
Property and equipment 11,628 16,361
Intangible assets 1,037 4,064
Other 360 559
--------------------------------
Gross deferred tax liabilities 13,006 21,410
--------------------------------
Valuation allowance -- State net operating loss
carryforwards (2,463) (5,240)
--------------------------------
Net asset/(liability) $ (25) $ 36
--------------------------------
At February 1, 2004, the Company has recorded a valuation allowance against the
state net operating loss carryforwards of $5,240,000. If these carryforwards are
realized in the future, $5,003,000 of the tax benefit would be recorded as an
addition to common stock, as this portion of the carryforwards was a result of
the tax benefits of stock option exercises in fiscal 2002, fiscal 2003 and
fiscal 2004.
The Company records deferred tax assets reflecting the benefit of future
deductible amounts. Realization of these assets is dependent on generating
sufficient future taxable income and the ability to carryback losses to previous
years in which there was taxable income. Although realization is not assured,
management believes it is more likely than not that all of the deferred tax
assets, for which a valuation allowance has not been established, will be
realized. The amount of the deferred tax assets considered realizable, however,
could be reduced in the near term if estimates of future taxable income are
reduced.
11. 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 potential dilution that would occur if
stock options were exercised and the dilution from the issuance of restricted
shares. The treasury stock method is used to calculate dilutive shares. This
reduces the gross number of dilutive shares by the number of shares purchasable
from the proceeds of the options assumed to be exercised, the proceeds of the
tax benefits recognized by the Company in conjunction with nonqualified stock
plans and from the amounts of unearned compensation associated with the
restricted shares.
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THE FOLLOWING TABLE SETS FORTH THE COMPUTATION OF BASIC AND DILUTED EARNINGS PER
SHARE:
[Enlarge/Download Table]
IN THOUSANDS
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YEAR ENDED FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
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Numerator:
Net income $ 26,378 $ 33,478 $ 57,087
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Denominator:
Basic earnings per share -- weighted average shares 53,703 55,093 59,188
Effect of dilutive securities:
Stock options 4,734 4,395 3,197
Restricted stock 6 4 3
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Diluted earnings per share -- adjusted weighted average
shares 58,443 59,492 62,388
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Stock options in the amount of 215,000 shares in fiscal 2002 and 350,000 shares
in fiscal 2003 and stock options and warrants totaling 1,363,000 shares in
fiscal 2004 have been excluded from the diluted shares calculation as the
inclusion of these stock options and warrants would be antidilutive.
12. EMPLOYEE BENEFIT PLANS
The Company has a 401(k) savings plan, which provides that employees may
contribute from 1% to 100% of their base salary to the plan on a tax deferred
basis up to the Internal Revenue Service limitations. The Company ceased making
matching contributions to the plan in fiscal 2001.
Effective October 1, 2000, KKDC established an unfunded Nonqualified Deferred
Compensation Plan (the "401(k) Mirror Plan"). The 401(k) Mirror Plan is designed
to enable the Company's executives 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, on a tax deferred basis up to the Internal Revenue Service
limitations, into the 401(k) Mirror Plan, may direct the investment of the
amounts they have deferred and are always 100% vested with respect to the
deferred amounts. The investments, however, are not a separate fund of assets
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
$617,000 and $1,388,000 at February 2, 2003 and February 1, 2004, respectively.
Effective February 1, 1999, KKDC established the Krispy Kreme Profit-Sharing
Stock Ownership Plan ("KSOP"). Under the terms of this qualified plan, the
Company contributes a discretionary percentage of each employee's compensation,
subject to Internal Revenue Service limits, to each eligible employee's account
under the plan. The expense associated with the KSOP was $3,255,000 and $400,000
in fiscal 2002 and fiscal 2003, respectively, based on a contribution of 7% of
eligible compensation for fiscal 2002 and 1% of eligible compensation for fiscal
2003. The Company made no contribution to this plan in fiscal 2004. Under the
terms of the KSOP, the contribution can be made in the form of cash or newly
issued shares of common stock. Forfeitures of previously allocated shares may
also be used to fund the contribution. If cash is contributed, the KSOP acquires
Krispy Kreme stock on the open market. With the exception of the initial year of
the plan, contributions made are funded annually in April. For fiscal 2002 and
fiscal 2003, contributions to the KSOP were made in cash. Employees become
eligible for participation in the plan upon the completion of one year of
service and vest ratably over five years. Credit for past service was granted to
employees at the inception of the plan.
KKDC established a nonqualified "mirror" plan, comparable to the KSOP, effective
February 1, 1999. Contributions to this nonqualified plan will be made under the
same terms and conditions as the KSOP, with respect to compensation earned by
participants in excess of the maximum amount of compensation that may be taken
into account under the qualified plan. The Company recorded compensation expense
of $201,000 in fiscal 2002 and $30,000 in fiscal 2003 for amounts credited to
certain employees under the nonqualified plan. No amounts were credited to
employees under the nonqualified plan in fiscal 2004.
Effective February 1, 2002, the Company established the Krispy Kreme Doughnuts,
Inc. Employee Stock Purchase Plan ("ESPP") to provide eligible employees of the
Company an opportunity to purchase Company common stock. Under the terms of the
plan, participants may defer between 1% and 15% of their base compensation.
Amounts withheld are accumulated and, at the end of each quarter, used to
purchase shares of common stock of the Company. The purchase price will be the
fair market value on either the first or last day of the quarter, whichever is
lower. If the actual market price of the stock on the date purchased exceeds the
price at which shares can be acquired under the terms of the ESPP, the Company
will make a contribution to fund the shortfall, resulting in a charge to
operations in the period paid. The Company recorded compensation expense of
$2,000 in fiscal 2003 and $54,000 in fiscal 2004 in connection with the ESPP.
Shares may be purchased by the ESPP directly from the Company or in the open
market. There were no shares issued under the ESPP in fiscal 2002 and all shares
purchased by the ESPP in fiscal 2003 and fiscal 2004 were acquired in the open
market. As of February 1, 2004, there were 2,000,000 shares reserved for
issuance under the ESPP.
58
Effective May 1, 1994, KKDC established the Retirement Income Plan for Key
Employees of Krispy Kreme Doughnut Corporation (the "Plan"), an unfunded
nonqualified noncontributory defined benefit pension plan. Benefits were based
on years of service and average final compensation during the employees' career.
The Plan at all times was unfunded as such term is defined for purposes of the
Employee Retirement Income Security Act (ERISA). The actuarial cost method used
in determining the net periodic pension cost was the projected unit credit
method. In fiscal 2001, the Plan was frozen and no additional employees were
covered under the Plan. Effective February 2, 2003, the Company elected to
terminate the Plan. As a result, vested accrued benefits totaling $829,000 were
paid to Plan participants in fiscal 2004. The expense associated with the Plan
in fiscal 2003 was a credit of $669,000.
13. INCENTIVE COMPENSATION
The Company has an incentive compensation plan for certain management and
non-management level employees. Incentive awards are paid based upon the
attainment of certain criteria, financial and non-financial, as outlined in the
plan. Incentive compensation was $6,543,000 in fiscal 2002 and $2,472,000 in
fiscal 2003. Under the terms of the plan, the Company paid no incentive
compensation in fiscal 2004.
Prior to fiscal 1999, the Company had a Long-Term Incentive Plan (the "Plan").
Under the provisions of the Plan, a participant could elect to defer, for a
period of not less than five years, up to 100% of the bonus earned under the
provisions of the incentive compensation plan described above. The deferred
amount was converted to performance units based on the appropriate value (book
value) of the Company's common stock as defined in the Plan. Upon completion of
the deferral period, each participant's account would be distributed in
accordance with the participant's election. The performance units granted under
the Plan were credited with dividends in a manner identical to the common stock
of the Company. The amount payable to a participant at the time benefit payments
were due was equal in amount to the number of performance units credited to a
participant's account multiplied by the current book value of the Company's
common stock as defined in the Plan. Effective with fiscal year-end 1997, the
right to defer additional incentive compensation under the provisions of the
plan was suspended.
In fiscal 1999, participants still employed by the Company were given the option
to convert their performance units earned under the Plan to common shares of the
Company's common stock, subject to certain restrictions. These shares had no
voting rights prior to the initial public offering of the Company's common
stock. The number of performance units converted was 4,717,800 at a conversion
rate of $1.30 per performance unit for a total of approximately $6,112,000 in
common stock issued in connection with the conversion. Due to the Federal and
State income tax consequences of the conversion incurred by each participant,
the Company loaned to participants amounts equal to their tax liability. The
loans were executed via a 10-year promissory note (collateralized by the shares
of common stock issued) with a fixed interest rate of 6%. In fiscal 2003, the
outstanding amounts due under the loans of $1,926,000, including accrued
interest, was paid in full and the loans were canceled.
During fiscal 2002, as part of a compensation arrangement with a former employee
of Digital Java, Inc., a Chicago-based coffee company which the Company acquired
in fiscal 2002, the Company issued 54,000 shares of common stock in exchange for
a note receivable in the amount of $879,000. The note receivable bears interest
at 6%, requires annual payments of principal and interest for its five-year term
and is collateralized by the shares of common stock. Under the terms of the
note, as long as certain employment and performance criteria are met, the
employee will receive a bonus in the amount of the annual payment due. At
February 2, 2003 and February 1, 2004 the balance of this note was $558,000 and
$383,000, respectively, which is recorded in the consolidated balance sheet as a
reduction of shareholders' equity.
14. SHAREHOLDERS' EQUITY
STOCK OPTION PLANS, RESTRICTED STOCK AWARDS AND WARRANTS
STOCK OPTION PLANS. During fiscal 1999, KKDC established the Krispy Kreme
Doughnut Corporation 1998 Stock Option Plan (the "1998 Plan"). Under the terms
of the 1998 Plan, 8,900,000 shares of common stock of the Company were reserved
for issuance to employees and Directors of the Company. Nonqualified stock
options granted under the 1998 Plan were granted at prices equal to the fair
market value on the date of grant.
In July 2000, the Company's shareholders approved the 2000 Stock Incentive Plan
(the "2000 Plan") which was adopted by the Board of Directors on June 6, 2000.
Awards under the 2000 Plan may be incentive stock options, nonqualified stock
options, stock appreciation rights, performance units, restricted stock (or
units) and share awards. The maximum number of shares of common stock with
respect to which awards may be granted under the 2000 Plan is 9,996,000 shares,
including 496,000 shares that were available for grant, but not granted, under
the 1998 Plan. The 2000 Plan provides aggregate limits on grants of the various
types of awards in the amount of 3,000,000 shares for incentive stock options
and 1,200,000 shares, in the aggregate, for stock appreciation rights,
performance units, restricted stock and stock awards. During fiscal 2002,
2,169,600 stock options were issued under the 2000 Plan at exercise prices
ranging from $15.13 to $42.11. During fiscal 2003, 1,186,200 stock options were
issued under the 2000 Plan at exercise prices ranging from $30.98 to $37.25.
During fiscal 2004, 1,829,200 stock options were issued under the 2000 Plan at
exercise prices ranging from $28.11 to $44.22. Stock options were granted at
prices equal to the fair market value on the date of grant. Options under both
plans vest and expire according to terms established at the grant date.
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THE FOLLOWING TABLE SUMMARIZES ALL STOCK OPTION TRANSACTIONS FROM JANUARY 28,
2001 TO FEBRUARY 1, 2004:
[Enlarge/Download Table]
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SHARES SUBJECT WEIGHTED AVERAGE SHARES SUBJECT TO WEIGHTED AVERAGE
TO OPTIONS EXERCISE PRICE PER SHARE EXERCISABLE OPTIONS EXERCISE PRICE PER SHARE
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OUTSTANDING, JANUARY 28, 2001 9,016,800 $ 3.04 936,000 $2.57
Granted 2,169,600 25.06
Exercised 1,182,800 3.30
Canceled 375,300 4.97
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OUTSTANDING, FEBRUARY 3, 2002 9,628,300 $ 7.90 2,976,200 $4.06
Granted 1,186,200 35.11
Exercised 1,187,300 6.01
Canceled 186,400 4.84
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OUTSTANDING, FEBRUARY 2, 2003 9,440,800 $11.60 4,567,800 $5.68
Granted 1,829,200 37.65
Assumed through acquisition 45,100 32.83
Exercised 3,300,000 5.91
Canceled 539,700 29.63
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OUTSTANDING, FEBRUARY 1, 2004 7,475,400 $19.31 4,281,500 $8.56
------------------------------------------------------------------------------------------
At February 1, 2004, there were approximately 5,222,400 shares of common stock
available for issuance pursuant to future stock option grants.
ADDITIONAL INFORMATION REGARDING OPTIONS OUTSTANDING AS OF FEBRUARY 1, 2004 IS
AS FOLLOWS:
[Enlarge/Download Table]
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OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------------------------------------------------------------
RANGE OF WEIGHTED AVERAGE REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICES SHARES CONTRACTUAL LIFE (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
--------------------------------------------------------------------------------------------------------------------
$ 1.30 -- $ 6.66 3,107,100 4.6 $ 1.48 3,000,500 $ 1.35
$13.33 -- $19.99 626,500 6.0 $15.37 480,000 $15.08
$20.00 -- $26.65 110,000 6.9 $21.09 47,500 $20.93
$26.66 -- $33.32 1,340,200 7.6 $29.10 479,800 $30.37
$33.33 -- $39.98 1,401,500 8.6 $35.28 261,200 $35.48
$39.99 -- $46.64 889,600 9.5 $44.18 12,000 $43.34
$59.97 -- $66.63 500 8.1 $66.63 500 $66.63
RESTRICTED STOCK AWARDS. In fiscal 2002 and fiscal 2004, the Company granted
1,187 and 300, respectively, restricted stock awards in the form of the
Company's common stock under the 2000 Plan to certain employees to provide
incentive compensation. The weighted average grant-date fair value of the shares
issued was $40.50. These shares vest ratably over a four-year period from the
date of grant.
WARRANTS. In connection with the Company's acquisition of Montana Mills in
fiscal 2004 (see Note 20 -- Acquisitions), the Company assumed warrants
previously issued by Montana Mills. As of February 1, 2004, these warrants are
exercisable for 422,900 shares of the Company's common stock at exercise prices
ranging from $49.97 to $99.94 per share and generally expire in fiscal 2008.
SHAREHOLDER RIGHTS PLAN
Each share of the Company's common stock has one preferred share purchase right.
Each share purchase right entitles the registered shareholder to purchase one
one-hundredth (1/100) of a share of Krispy Kreme Series A Participating
Cumulative Preferred Stock at a price of $96.00 per one one-hundredth of a
Series A preferred share. The share purchase rights are not exercisable until
the earlier to occur of (1) 10 days following a public announcement that a
person or group of affiliated or associated persons -- referred to as an
acquiring person -- has acquired beneficial ownership of 15% or more of the
Company's outstanding common stock or (2) 10 business days following the
commencement of, or announcement of an intention to make a tender offer or
exchange offer which would result in an acquiring person beneficially owning 15%
or more of the outstanding shares of common stock.
If the Company is acquired in a merger or other business combination, or if 50%
or more of the Company's consolidated assets or earning power is sold after a
person or group has become an acquiring person, proper provision will be made so
that each holder of a share purchase right -- other than share purchase rights
beneficially owned by the acquiring person, which will thereafter be
void -- will have the right to receive, upon exercise of the share purchase
right at the then current exercise price, the number of shares of common stock
of the acquiring company which at the time of the transaction have a market
value of two times the share purchase right exercise price. If any person or
group becomes an acquiring person, proper provision shall be made so that each
holder of a share purchase right -- other than share purchase rights
beneficially owned by the acquiring
60
person, which will thereafter be void -- will have the right to receive upon
exercise, and without paying the exercise price, the number of shares of Krispy
Kreme common stock with a market value equal to the share purchase right
exercise price.
Series A preferred shares purchasable upon exercise of the share purchase rights
will not be redeemable. Each Series A preferred share will be entitled to a
minimum preferential dividend payment of $1 per share and will be entitled to an
aggregate dividend of 100 times the dividend declared per share of common stock.
In the event the Company liquidates, the holders of the Series A preferred
shares will be entitled to a minimum preferential liquidation payment of $1 per
share but will be entitled to an aggregate payment of 100 times the payment made
per share of common stock. Each Series A preferred share will have 100 votes,
voting together with the shares of common stock. Finally, in the event of any
merger, consolidation or other transaction in which shares of common stock are
exchanged, each Series A preferred share will be entitled to receive 100 times
the amount received per share of common stock. These rights are protected by
customary antidilution provisions.
Before the date the share purchase rights are exercisable, the share purchase
rights may not be detached or transferred separately from the common stock. The
share purchase rights will expire on January 18, 2010, unless that expiration
date is extended or unless the share purchase rights are redeemed or exchanged
by the Company. At any time an acquiring person acquires beneficial ownership of
15% or more of the Company's outstanding common stock, the Board of Directors
may redeem the share purchase rights in whole, but not in part, at a price of
$0.001 per share purchase right. Immediately upon any share purchase rights
redemption, the exercise rights terminate and the holders will only be entitled
to receive the redemption price.
15. BUSINESS SEGMENT INFORMATION
The Company's reportable segments are Company Store Operations, Franchise
Operations, KKM&D and Montana Mills. The Company Store Operations segment is
comprised of the operating activities of the stores owned by the Company and
those in consolidated joint ventures. These stores sell doughnuts and
complementary products through both on-premises and off-premises sales channels.
The majority of the ingredients and materials used by Company Store Operations
is purchased from the KKM&D business segment and Company Store operating income
reflects the benefit of the Company's vertical integration. The Franchise
Operations segment represents the results of the Company's franchise program.
Under the terms of the franchise agreements, the licensed operators 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 this business segment
include costs incurred to recruit new franchisees and to open, monitor and aid
in the performance of these stores and direct general and administrative
expenses. The KKM&D segment supplies mix, equipment, coffee and other items to
both Company and franchisee-owned stores. All intercompany transactions between
the KKM&D business segment and the Company Stores Operations segment are at
prices intended to reflect an arms-length transfer price and are eliminated in
consolidation. Profit from KKM&D's sales to Company Store Operations is
classified as a reduction of Company Store operating expenses, generally based
on the proportion of sales to Company Stores relative to total KKM&D sales. The
Montana Mills segment represents the operating activities of the Montana Mills
stores, which produce and sell a variety of breads and baked goods prepared in
an open-view format through both on-premises and off-premises sales channels.
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.
61
THE FOLLOWING TABLE PRESENTS THE RESULTS OF THE COMPANY'S OPERATING SEGMENTS FOR
FISCAL 2002, FISCAL 2003 AND FISCAL 2004. SEGMENT OPERATING INCOME IS INCOME
BEFORE GENERAL CORPORATE EXPENSES AND INCOME TAXES.
[Enlarge/Download Table]
IN THOUSANDS
---------------------------------------------------------------------------------------------------------------
FEB. 3, 2002 FEB. 2, 2003 FEB. 1, 2004
---------------------------------------------------------------------------------------------------------------
Revenues:
Company Store Operations $ 266,209 $ 319,592 $ 441,868
Franchise Operations 14,008 19,304 23,848
KKM&D 212,876 276,152 359,995
Montana Mills -- -- 6,747
Intersegment sales eliminations (98,739) (123,499) (166,866)
------------------------------------------------------
Total revenues $ 394,354 $ 491,549 $ 665,592
------------------------------------------------------
Operating Income:
Company Store Operations $ 42,932 $ 58,214 $ 83,724
Franchise Operations 9,040 14,319 19,043
KKM&D 18,999 26,843 39,345
Montana Mills -- -- (1,987)
Unallocated general and administrative expenses (29,084) (30,484) (38,564)
Arbitration award -- (9,075) 525
------------------------------------------------------
Total operating income $ 41,887 $ 59,817 $ 102,086
------------------------------------------------------
Depreciation and Amortization Expenses:
Company Store Operations $ 5,859 $ 8,854 $ 14,392
Franchise Operations 72 108 173
KKM&D 507 1,723 3,006
Montana Mills -- -- 499
Corporate administration 1,521 1,586 1,653
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Total depreciation and amortization expenses $ 7,959 $ 12,271 $ 19,723
------------------------------------------------------
16. RELATED PARTY TRANSACTIONS
As of February 1, 2004, emeritus members of the Company's Board of Directors own
21 stores and, under the respective franchise agreement, one emeritus member is
committed to open an additional store.
Prior to March 5, 2002 (see Note 18 -- Joint Ventures), several officers were
investors in the Krispy Kreme Equity Group, LLC ("KKEG"), a pooled investment
fund, which held interests in six joint ventures developing Krispy Kreme stores
in new markets. In addition, certain officers of the Company, including Scott
Livengood, Chairman, President and CEO, and John N. McAleer, Vice Chairman, were
individual investors in groups that owned stores and were developing new
markets. Certain of the investments held by these officers were in the same
entities as those invested in by the KKEG. Effective March 5, 2002, the Company
acquired from the members of the KKEG their proportionate shares, which
increased the Company's ownership in six joint ventures. On March 5, 2002, the
Company also acquired the ownership interest in six joint ventures from Mr.
Livengood as well as the ownership interest held by Mr. McAleer in a joint
venture. The acquisition of the interests held by the KKEG, as approved by the
Company's Board of Directors, was in an amount equal to the members' original
investment. Mr. Livengood and Mr. McAleer sold their interests to the Company at
their original cost, as approved by the Company's Board of Directors.
All franchisees are required to purchase mix and equipment from the Company.
Total revenues included $44,870,000 in fiscal 2002, $69,539,000 in fiscal 2003
and $86,718,000 in fiscal 2004 of sales to franchise stores owned, in whole or
in part, by emeritus members of the Board of Directors, employees of the Company
and Company joint venture investments. Total revenues also include royalties
from these stores of $3,646,000 in fiscal 2002, $7,013,000 in fiscal 2003 and
$8,636,000 in fiscal 2004. Trade accounts receivable from these stores, shown as
accounts receivable, affiliates on the consolidated balance sheet, totaled
$11,062,000 and $20,482,000 at February 2, 2003 and February 1, 2004,
respectively.
In fiscal 2004, in connection with a program made available to all franchisees,
the Company extended credit to certain franchisees, in the form of promissory
notes, to provide financing for the purchase from the Company of certain
supplemental equipment to be used in the franchise stores. Notes receivable from
certain franchisees who are emeritus members of the Company's Board of
Directors, as well as franchisees in which we have a minority interest, are
included in notes receivable, affiliates and long-term notes receivable,
affiliates in the accompanying consolidated balance sheet and in total were
$1,323,000 at February 1, 2004. These notes have terms ranging from two to three
years.
As discussed in Note 20 -- Acquisitions, the Company received promissory notes
totaling $3,551,000 from Krispy Kreme of South Florida, LLC, an Area Developer
franchisee in which the Company has a 35.3% ownership interest, in exchange for
the rights to certain franchise markets and the related assets. These promissory
notes are included in long-term notes receivable, affiliates in the accompanying
consolidated balance sheet.
62
In June 2003, the Company extended an interest-bearing loan to Krispy Kreme
Australia Pty Limited, an Area Developer franchisee in which the Company has a
35.0% ownership interest, to provide working capital and funding of store
development. The outstanding balance of the promissory note, included in
long-term notes receivable, affiliates in the accompanying consolidated balance
sheet, totaled $1,599,000 at February 1, 2004 and is due in fiscal 2007.
Effective June 30, 2003, the Company acquired the rights to certain franchise
markets in Dallas, Texas and Shreveport, Louisiana, as well as the related
assets from Associate franchisees, including Joseph A. McAleer, a former officer
and director of the Company, and Steven D. Smith, an emeritus director. See Note
20 -- Acquisitions for further information.
17. COMMITMENTS AND CONTINGENCIES
The Company has guaranteed certain leases and loans from third-party financial
institutions on behalf of franchisees, primarily to assist the franchisees in
obtaining third-party financing. The loans are also collateralized by certain
assets of the franchisee, generally the Krispy Kreme store and related
equipment. The terms of the guarantees range from 2 to 20 years. The Company's
contingent liability related to these guarantees was approximately $7,652,000 at
February 2, 2003 and $15,351,000 at February 1, 2004. For leases, the guaranteed
amount was determined based upon the gross amount of remaining lease payments
due and for debt the guaranteed amount was determined based upon the principal
amount outstanding under the respective agreement. Of the total guaranteed
amount at February 1, 2004, $14,810,000 is for franchisees in which we have less
than a controlling ownership interest and is summarized in Note 18 -- Joint
Ventures. The percentage guaranteed is generally equivalent to the Company's
ownership percentage in the joint venture. The guarantees expire between fiscal
2005 and fiscal 2023. The remaining guarantees of $541,000 are for franchisees
in which we have no ownership interest and expire between fiscal 2007 and fiscal
2014. The expirations of these guarantees for the five fiscal years ending after
February 1, 2004 are $4,791,000, $1,905,000, $1,802,000, $1,814,000 and
$1,591,000, respectively. These guarantees require payment from the Company in
the event of default on payment by the respective debtor. If the debtor
defaults, the Company may be required to pay a proportionate share of other
amounts outstanding under the respective agreements, such as accrued interest
and related fees. The Company cannot estimate the amount of any such additional
payments that could be required. The Company has not experienced any losses in
connection with these guarantees, and management believes the likelihood that
material payments will be required under these guarantees is remote. With
respect to guarantees that the Company issued during fiscal 2004, the Company
assessed the fair value of its obligation to perform under these guarantees if
required to do so by considering the likelihood of certain triggering events or
other conditions requiring performance. The Company determined that the fair
value of these guarantees was not material to the Company's financial position
or results of operations.
The Company also guarantees leases and debt owed to financial institutions for
consolidated joint ventures. The maximum amount guaranteed for these joint
ventures is $16,406,000 at February 1, 2004 and is summarized in Note
18 -- Joint Ventures. At February 1, 2004, the outstanding debt under the loans
guaranteed, which is included in long-term debt and current maturities of
long-term debt in the accompanying consolidated financial statements, is
$20,649,000. The expirations of these guarantees for the five fiscal years
ending after February 1, 2004 are $1,377,000, $3,023,000, $2,251,000, $2,355,000
and $2,361,000, respectively. The individual guarantees expire in fiscal 2009
through fiscal 2019, upon termination of the underlying leases and debt
guaranteed.
The Company issues indemnifications in certain instances when it sells assets or
real estate and in the ordinary course of business with customers, suppliers and
service providers. The Company also indemnifies its directors and officers in
accordance with the terms of its bylaws. The Company cannot predict the maximum
potential amount of future payments, if any, that may be required under these or
similar indemnifications, due to the conditional nature of the Company's
obligations and the unique facts and circumstances involved.
At February 1, 2004, the Company had outstanding letters of credit totaling
$7,471,000. Of this amount, $7,151,000 represents letters of credit issued
primarily to ensure payment by the Company of possible casualty and workers'
compensation claims. The remaining $320,000 represents primarily letters of
credit provided in lieu of security deposits for leases on certain stores
operated by a joint venture. Letters of credit have terms of one year or less.
In connection with the Company's acquisition of an additional interest in Glazed
Investments in fiscal 2003, the Company entered into a put option agreement with
certain members of management of Glazed Investments who collectively own an
approximate 22% interest in the joint venture. The agreement gives each of these
members of management the option to sell to the Company ultimately up to 100% of
their respective interest in Glazed Investments during certain defined exercise
periods, subject to certain limitations. The purchase price for the individual's
respective interest is determined based upon a formula defined in the agreement,
which is generally based upon earnings growth and cash flows of Glazed
Investments' operations. The options become exercisable, in part, beginning in
April 2004. If exercised, the Company has the option to pay the purchase price
in cash or shares of the Company's common stock. The Company cannot estimate the
likelihood of any of the options being exercised or the maximum amount the
Company would be required to pay upon exercise.
In the normal course of business, the Company is exposed to the impact of
commodity price fluctuations affecting the cost of flour, sugar, soybean oil,
coffee beans and other ingredients. In order to secure adequate supplies of
product and bring greater stability to the cost of ingredients, the Company
routinely enters into long-term purchase agreements and other purchase
arrangements with its suppliers. These commitments generally range from one to
three years. As of February 1, 2004, the Company had approximately $114,254,000
in such long-term purchase commitments. Because the Company enters into these
long-term contracts with its suppliers, in the event that any of these
relationships terminate unexpectedly, even where it has
63
multiple suppliers for the same ingredient, the Company's ability to obtain
adequate quantities of the same high quality ingredient at the same competitive
price could be negatively impacted.
18. JOINT VENTURES
From time to time, the Company enters into joint venture agreements with
partners to develop and operate Krispy Kreme stores. Each party's investment is
determined based on their proportionate share of equity obtained. The Company's
ability to control the management committee of the joint venture is the primary
determining factor as to whether or not the joint venture results are
consolidated with the Company. See "Basis of Consolidation" under Note
2 -- Nature of Business and Significant Accounting Policies.
At February 1, 2004, the Company had invested in 17 area developer joint
ventures and held interests ranging from 25.0% to 74.7%. The Company will
continue to seek opportunities to develop markets through joint ventures or to
increase its ownership in existing joint ventures when there are sound business
reasons to do so.
CONSOLIDATED JOINT VENTURES
On March 22, 2000, the Company entered into a joint venture, Golden Gate, to
develop the Northern California market. The Company invested $2,060,000 for a
59% interest and held two of the joint venture's three management committee
seats. Effective March 5, 2002, the Company increased its ownership interest in
Golden Gate to 67% by acquiring the ownership interests of 5% and 3% held by the
KKEG and Mr. Livengood, respectively (see Note 16 -- Related Party
Transactions). Effective January 30, 2004, the Company acquired the remaining
33% minority interest in Golden Gate (see Note 20 -- Acquisitions). Prior to
acquiring the remaining minority interest effective January 30, 2004, the
financial statements of Golden Gate were consolidated with the results of the
Company, with the 33% not owned by the Company included in minority interest.
The Company also guaranteed payments on several of Golden Gate's real estate
leases and provided guarantees of 67% of Golden Gate's outstanding bank debt. As
discussed in Note 8 -- Debt, this bank debt was repaid in full on October 31,
2003 through borrowings under the Company's Revolver.
On February 27, 2000, the Company entered into a joint venture, Glazed
Investments, to develop the Colorado, Minnesota and Wisconsin markets. The
Company invested $500,000 for a 22.3% interest and held two of the joint
venture's six management committee seats. Effective March 5, 2002, the Company
increased its ownership interest in Glazed Investments by acquiring the
ownership interests of 5% and 3% held by the KKEG and Mr. Livengood,
respectively (see Note 16 -- Related Party Transactions). Effective August 22,
2002, the Company acquired an additional 44.4% interest in Glazed Investments,
increasing its total investment in this joint venture to 74.7%. Effective with
the acquisition in August 2002, the Company gained the right to designate four
of the six management committee seats. As a result, the Company gained the
ability to control the operations of the joint venture and, therefore, began
consolidating the financial statements of Glazed Investments with those of the
Company effective August 22, 2002. As a result of the Company's acquisitions of
additional interests in Glazed Investments in fiscal 2003, the interest in the
joint venture not owned by the Company, included in minority interest in the
consolidated balance sheet, was reduced to 25.3%. The Company has guaranteed
74.7% of the amounts outstanding on certain bank and non-bank debt of Glazed
Investments (see Note 8 -- Debt).
On March 6, 2001, the Company entered into a joint venture, Freedom Rings, to
develop the Eastern Pennsylvania, Delaware and Southern New Jersey markets. The
Company invested $1,167,000 for a 70% interest and holds three of four
management committee seats. The financial statements of this joint venture are
consolidated with those of the Company and the 30% not owned by the Company is
included in minority interest. The Company has guaranteed 70% of the payments on
certain real estate leases of Freedom Rings. The original terms of the
guarantees range from seven to ten years. The Company also previously provided
guarantees of 70% of Freedom Rings' outstanding bank debt. As discussed in Note
8 -- Debt, this bank debt was repaid in full on October 31, 2003 through
borrowings under the Company's Revolver.
SUMMARIZED INFORMATION FOR THE COMPANY'S INVESTMENTS IN CONSOLIDATED JOINT
VENTURES AS OF FEBRUARY 1, 2004, INCLUDING OUTSTANDING LOAN AND LEASE
GUARANTEES, IS AS FOLLOWS:
[Enlarge/Download Table]
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NUMBER OF IN THOUSANDS
STORES AS OF OWNERSHIP % ----------------------------
FEBRUARY 1, 2004/ --------------- LOAN/
GENERAL GEOGRAPHICAL TOTAL STORES TO BE THIRD LEASE FISCAL 2004
MARKET DEVELOPED (1) KKDC PARTIES GUARANTEES (2) REVENUES
----------------------------------------------------------------------------------------------------------------------------
Freedom Rings, LLC Eastern Pennsylvania, Delaware, 7/28 70.0% 30.0% $ 1,049 $19,742
Southern New Jersey Manager Allocation 3 1
Glazed Investments, LLC Colorado, Minnesota, 17/46 74.7% 25.3% $15,357 $39,637
Wisconsin Manager Allocation 4 2
(1) The amount shown as "Total Stores to be Developed" represents the number of
stores in the initial development agreement with the joint venture, as
amended, as well as commissary locations which have been opened. The number
of stores in the initial development agreement will be re-evaluated as the
market is developed and the number of stores to be opened may change.
(2) Outstanding debt amounts are reflected in Note 8 -- Debt. The gross amount
of commitments under leases is included in the future minimum annual rental
commitments disclosed in Note 9 -- Lease Commitments.
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EQUITY METHOD JOINT VENTURES
As of February 1, 2004, the Company had invested in 15 joint ventures as a
minority interest party. Investments in these joint ventures have been made in
the form of capital contributions and/or notes receivable. Notes receivable bear
interest, payable semi-annually, at rates ranging from 5.5% to 10.0% per annum,
and have maturity dates ranging from October 2010 to the dissolution of the
joint venture. These investments and notes receivable are recorded in
investments in unconsolidated joint ventures in the consolidated balance sheets.
INFORMATION RELATED TO THE MARKETS, OWNERSHIP INTERESTS AND MANAGER ALLOCATIONS
FOR JOINT VENTURES WHICH ARE ACCOUNTED FOR BY THE EQUITY METHOD IS SUMMARIZED AS
FOLLOWS:
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NUMBER OF
STORES AS OF OWNERSHIP %
FEBRUARY 1, 2004/ ----------------
GENERAL GEOGRAPHICAL TOTAL STORES TO BE THIRD
MARKET DEVELOPED (1) KKDC PARTIES
----------------------------------------------------------------------------------------------------------
A-OK, LLC Arkansas, Oklahoma 4/10 30.3% 69.7%
Manager Allocation 2 4
Amazing Glazed, LLC Pennsylvania (Pittsburgh) 8/9 30.3% 69.7%
Manager Allocation 2 4
Amazing Hot Glazers, LLC Pennsylvania (Erie) 2/5 33.3% 66.7%
Manager Allocation 2 4
Entrepreneurship and Economic North Carolina 1/1 49.0% 51.0%
Development Investment, LLC (Greensboro) Manager Allocation 1 1
KK-TX I, L.P. Texas (Amarillo, Lubbock) 2/2 33.3% 66.7%
Manager Allocation --(2) --(2)
KK Wyotana, LLC Wyoming, Montana 0/4 33.3% 66.7%
Manager Allocation -- 1
KKNY, LLC New York City, 7/25 30.3% 69.7%
Northern New Jersey Manager Allocation 2 4
KremeKo, Inc. Central and Eastern Canada 12/33 40.6% 59.4%
Manager Allocation 2(3) 9(3)
KremeWorks, LLC Alaska, Hawaii, Oregon, 11/31 25.0% 75.0%
Washington, Western Canada Manager Allocation 1 3
Krispy Kreme Australia Pty Limited Australia/ 3/31 35.0% 65.0%
New Zealand Manager Allocation 2 3
Krispy Kreme of South Florida, LLC Southern Florida 5/11 35.3% 64.7%
Manager Allocation 2 3
Krispy Kreme U.K. Limited United Kingdom, 2/26 35.1% 64.9%
Republic of Ireland Manager Allocation 3 3
Krispy Kreme Mexico, S. de R.L. de Mexico 2/21 30.0% 70.0%
C.V. Manager Allocation 2 3
New England Dough, LLC Connecticut, Maine, 6/23 57.0%(4) 43.0%
Massachusetts, Rhode Manager Allocation 2 2
Island,
New Hampshire, Vermont
PRIZ Doughnuts, LP Texas (El Paso) 1/3 33.3% 66.7%
Mexico (Ciudad Juarez) Manager Allocation --(2) --(2)
(1) The amount shown as "Total Stores to be Developed" represents the number of
stores in the initial development agreement with the joint venture as well
as commissary locations which have been opened. The number of stores in the
initial development agreement, as amended, will be re-evaluated as the
market is developed and the number of stores to be opened may change.
Additionally, the Company is in the process of entering into development
agreements for smaller markets with certain of these joint ventures.
(2) KK-TX I, L.P. and PRIZ Doughnuts, LP are limited partnerships. The Company
holds a 33.3% interest in each of these joint ventures as a limited partner.
Under the terms of the partnership agreements, the general partner has full
responsibility for managing the business of the partnership.
(3) KremeKo's shareholders' agreement requires that its board consist of eleven
directors. The Company has the right to designate two of the directors and
three other shareholders each have the right to designate one director. The
remaining six directors are nominated by the board and elected by the
shareholders.
(4) Although the Company's ownership interest in New England Dough exceeds 50%,
the Company has historically accounted for this interest under the equity
method as the Company does not have the ability to designate a majority of
the members of the joint venture's management committee. As discussed in
"Recent Accounting Pronouncements" under Note 2 -- Nature of Business and
Significant Accounting Policies, the Company has determined that the
provisions of FIN 46-R require the Company to begin consolidating the
accounts of New England Dough with those of the Company effective in the
first quarter of fiscal 2005.
65
INFORMATION RELATED TO THE COMPANY'S INVESTMENT, AS WELL AS SUMMARIZED FINANCIAL
INFORMATION AS OF FEBRUARY 1, 2004, FOR EACH JOINT VENTURE ACCOUNTED FOR BY THE
EQUITY METHOD IS AS FOLLOWS:
[Enlarge/Download Table]
In Thousands
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SUMMARY FINANCIAL INFORMATION (1)
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NET INVESTMENT
NET INCOME/ TOTAL TOTAL AND NOTES
SALES (LOSS) ASSETS LIABILITIES IN JV (2)
---------------------------------------------------------------------------------------------------------------
A-OK, LLC $ 13,668 $ 1,466 $ 7,398 $ 7,275 $ 294
Amazing Glazed, LLC 16,076 666 13,732 12,917 326
Amazing Hot Glazers, LLC 2,209 (13) 4,690 4,503 162
Entrepreneurship and Economic Development Investment,
LLC 911 (269) 1,336 224 544
KK-TX I, L.P. 3,357 (66) 3,284 3,512 (156)
KK Wyotana, LLC (3) -- -- -- -- --
KKNY, LLC 25,853 (2,688) 18,545 14,330 238
KremeKo, Inc. 20,926 (2,070) 25,835 12,539 6,599
KremeWorks, LLC 28,326 669 28,165 22,373 338
Krispy Kreme Australia Pty Limited 6,849 (2,692) 12,683 9,467 1,074
Krispy Kreme of South Florida, LLC 12,414 624 9,600 9,753 --
Krispy Kreme U.K. Limited 928 (3,260) 5,834 1,003 1,685
Krispy Kreme Mexico, S. de R.L. de C.V. -- (647) 4,716 1,785 681
New England Dough, LLC 13,832 467 13,418 12,316 641
Priz Doughnuts, LP 306 29 2,298 2,190 --
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Total $145,655 $(7,784) $151,534 $114,187 $12,426
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(1) The net sales and net income (loss) shown for each of these joint ventures
represents the amounts reported by the joint ventures for the period
corresponding with the Company's fiscal year end, February 1, 2004, and the
amounts shown as total assets and total liabilities represent the
corresponding amounts reported by each of the joint ventures at February 1,
2004.
(2) This amount represents the Company's investment in the joint venture plus
the Company's portion of the joint venture's income or loss to date, net of
distributions received. For KK-TX I, L.P., the Company's share of the
cumulative net loss of this joint venture exceeds its capital contribution.
The Company has recorded the full loss attributable to its interest in the
joint venture as it believes operations will become profitable in the
short-term and the investments will be recovered.
(3) Operating activities for KK Wyotana, LLC have not yet commenced.
The Company is a guarantor of debt and lease obligations for various joint
ventures accounted for under the equity method. The debt is also collateralized
by the assets of the joint venture. These guarantees are not recorded as
liabilities in the consolidated balance sheet based on the Company's assessment
that the fair value of these guarantees, if any, was not material to the
Company's financial position or results of operations. To date the Company has
not experienced any losses in connection with these guarantees. The terms of the
guarantees range from four to 20 years.
THE FOLLOWING TABLE SUMMARIZES THE COMPANY'S OBLIGATIONS UNDER THESE GUARANTEES
AS OF FEBRUARY 1, 2004 AND THE AGGREGATE MATURITIES FOR THE FIVE FISCAL YEARS
ENDING AFTER FEBRUARY 1, 2004:
[Enlarge/Download Table]
In Thousands, Except Percentages
----------------------------------------------------------------------------------------------
TOTAL LOAN/ AMOUNTS EXPIRING IN
GUARANTEE LEASE ---------------------------------------
PERCENTAGES GUARANTEES FISCAL 2005 FISCAL 2006 FISCAL 2007
----------------------------------------------------------------------------------------------
A-OK, LLC 22.3% $ 1,320 $ 160 $ 94 $ 102
Amazing Hot Glazers, LLC 33.3% 948 54 82 87
KK-TX I, L.P. 33.3% 612 38 41 44
KremeKo, Inc. 34.0% - 36.2% 2,036 374 427 341
Krispy Kreme Australia
Pty Limited 35.0% 1,994 158 332 333
Krispy Kreme of South
Florida, LLC 35.3% 1,694 148 155 164
New England Dough, LLC 54.0% - 60.0% 6,206 3,755 669 648
--------------------------------------------------------------------
Total $14,810 $4,687 $1,800 $1,719
--------------------------------------------------------------------
In Thousands, Except Percentages
--------------------------------------
AMOUNTS EXPIRING IN
--------------------------------------
FISCAL 2008 FISCAL 2009 THEREAFTER
--------------------------------------
A-OK, LLC $ 112 $ 105 $ 747
Amazing Hot Glazers, LLC 90 93 542
KK-TX I, L.P. 48 52 389
KremeKo, Inc. 348 217 329
Krispy Kreme Australia
Pty Limited 332 332 507
Krispy Kreme of South
Florida, LLC 175 118 934
New England Dough, LLC 648 486 --
--------------------------------------------------------------------
Total $1,753 $1,403 $3,448
--------------------------------------------------------------------
66
19. LEGAL CONTINGENCIES
On March 9, 2000, a lawsuit was filed against the Company, management and Golden
Gate in Superior Court in the State of California. The lawsuit was filed as a
result of joint venture discussions between the Company and the plaintiffs to
develop the Northern California market. The plaintiffs were offered to
participate in the Northern California joint venture but declined. They instead
brought suit contending that they had a right to a larger percent of the joint
venture and on different terms. The plaintiffs alleged, among other things,
breach of contract and sought compensation for damages and punitive damages. In
September 2000, after the case was transferred to Sacramento Superior Court,
that court granted the motion to compel arbitration of the action and stay the
lawsuit pending the outcome of arbitration. In October 2001, after an appeal to
the California appellate courts, plaintiffs filed a demand for arbitration with
the American Arbitration Association against KKDC, Golden Gate and others. In
February 2003, after an extended series of arbitration hearings, the Arbitration
Panel dismissed all claims against all parties, except the claim for breach of
contract against KKDC and Golden Gate. The Arbitration Panel entered a
preliminary award of $7,925,000 against KKDC and Golden Gate, which was
substantially less than the damages claimed. The Company accrued a provision of
$9,075,000 in fiscal 2003, which consisted of the preliminary award and an
estimate of the anticipated award of legal fees and other costs. After further
negotiations, all claims were settled for $8,550,000, and the settlement was
completed in May 2003. The accompanying statement of operations for fiscal 2004
reflects the $525,000 reversal of the accrual in conjunction with the
settlement. While the Company continues to discuss potential joint ventures with
others to develop markets, the Company does not expect to have exposure from
similar situations.
The Company is engaged in various legal proceedings incidental to its normal
business activities. In the opinion of management, the outcome of these matters
is not expected to have a material effect on the Company's consolidated
financial statements.
20. ACQUISITIONS
The Company from time to time acquires market rights from either Associate or
Area Developer franchisees if they are willing to sell to the Company and if
there are sound business reasons for the Company to make the acquisition. These
reasons may include a franchise market being contiguous to a Company store
market where an acquisition would provide operational synergies; upside
opportunity in the market because the franchisee has not fully developed
on-premises or off-premises sales; or if the Company believes an acquisition of
the market would improve the brand image in the market. The purchase price for
each acquisition is based upon an analysis of historical performance as well as
estimates of future revenues and earnings in the respective markets acquired.
Effective February 3, 2003, the Company acquired the market rights to Broward
County, Florida, as well as the related assets, from an Associate franchisee in
exchange for cash of $1,532,000. The Company simultaneously sold these rights
and related assets, as well as the assets associated with another Company store
in Miami, to Krispy Kreme of South Florida, LLC, an Area Developer franchisee in
which the Company has a 35.3% ownership interest. This joint venture has the
market rights for various counties in Southern Florida and the franchise rights
and related assets are in contiguous markets. In exchange for the market rights
and assets sold, the Company received promissory notes totaling $3,551,000. The
notes require monthly payments of interest only until maturity, May 2, 2005, at
which time all outstanding principal and interest is due. The purchase price was
based upon the book value of the market rights and assets sold, which
approximated fair value.
Effective March 10, 2003, the Company acquired the rights to certain franchise
markets in Kansas and Missouri, as well as the related assets, which included
five stores, from an Area Developer franchisee in exchange for cash of
$32,992,000. At the time of the acquisition, this Area Developer franchisee was
owned, in part, by an officer of the Company. The purchase price was allocated
to accounts receivable -- $301,000, inventories -- $128,000, property and
equipment -- $5,068,000, other assets -- $11,000, accrued expenses -- $59,000
and reacquired franchise rights, an intangible asset not subject to
amortization -- $27,543,000.
Effective June 30, 2003, the Company acquired the rights to certain franchise
markets in Dallas, Texas and Shreveport, Louisiana, as well as the related
assets, which included six stores, from Associate franchisees, including Joseph
A. McAleer, a former officer and director of the Company, and Steven D. Smith,
an emeritus director. The total purchase price for this acquisition was
$67,466,000, which was funded through a combination of cash and the proceeds
from a $55,000,000 short-term promissory note with a bank, which has since been
replaced with long-term financing (see Note 8 -- Debt). The purchase price was
allocated to accounts receivable -- $1,526,000, inventory -- $187,000, property
and equipment -- $12,053,000, accrued expenses -- $300,000 and reacquired
franchise rights -- $54,000,000.
Effective October 27, 2003, the Company acquired the rights to certain franchise
markets in Michigan, as well as the related assets, which included five stores,
from an Area Developer franchisee in exchange for 443,917 shares of common
stock, valued at approximately $18,540,000, a promissory note in the amount of
$11,286,000 and cash of $2,280,000. The promissory note was paid in full and
canceled in January 2004. The purchase price was preliminarily allocated to
accounts receivable -- $642,000, inventory -- $144,000, prepaid
expenses -- $157,000, property and equipment -- $2,808,000, accrued
expenses -- $1,131,000 and reacquired franchise rights -- $29,486,000.
Effective January 30, 2004, the Company acquired the remaining 33% minority
interest in Golden Gate, the Area Developer franchisee for Northern California,
for $16,840,000. Prior to the acquisition, the Company consolidated the assets,
liabilities
67
and operating results of Golden Gate with those of the Company, as it owned a
controlling interest in Golden Gate, with the 33% interest that the Company did
not own included in minority interest. As a result of the acquisition, the
Company now owns 100% of the rights to this market. The Company determined that
the fair value of the net assets of Golden Gate as of the effective date of the
acquisition approximated book value. Accordingly, the purchase price was
preliminarily allocated primarily to minority interest, eliminating this
liability related to the Company's investment in Golden Gate prior to the
acquisition, and reacquired franchise rights, which approximated $13,177,000.
On April 7, 2003, the Company completed the acquisition of Montana Mills Bread
Co., Inc. ("Montana Mills"), an owner and operator of upscale "village bread
stores" in the Northeastern United States. Montana Mills' stores produce and
sell a variety of breads and baked goods prepared in an open-view format. In
addition to providing operating synergies, the acquisition of Montana Mills is
expected to provide the Company with the ability to leverage its existing
capabilities, such as its distribution chain, off-premises sales and
coffee-roasting expertise, in order to expand Montana Mills' business.
Under the terms of the Merger Agreement, the Company issued approximately
1,224,400 shares of common stock in exchange for all outstanding shares of
Montana Mills' common stock. The Company also issued approximately 22,500 shares
of common stock to holders of convertible debt previously issued by Montana
Mills. Although Montana Mills had redeemed the convertible debt prior to the
acquisition, the Company agreed to issue the shares that would have been
issuable upon conversion of a portion of the convertible debt in exchange for a
cash payment equal to the principal amount of the debt being converted,
including the prepayment premium, totaling $773,000. The shares issued in
exchange for Montana Mills' outstanding shares were valued at approximately
$37,800,000, based on the closing price of the Company's common stock for a
range of trading days around the announcement date, January 24, 2003. The
Company also assumed options and warrants to purchase approximately 460,500
shares of common stock which were valued at approximately $2,000,000.
The purchase price of Montana Mills was allocated to the assets acquired and
liabilities assumed based upon an independent valuation, as follows: cash and
cash equivalents -- $3,303,000; accounts receivable -- $74,000; inventories --
$294,000; prepaid expenses -- $277,000; income taxes refundable -- $41,000;
current deferred income taxes -- $2,250,000; property and equipment --
$4,207,000; other assets -- $104,000; accounts payable -- $984,000; accrued
expenses -- $1,509,000; current maturities of long-term debt -- $29,000;
long-term debt -- $9,000; other long-term obligations -- $118,000; trademarks
and trade names -- $11,300,000; recipes -- $876,000 and goodwill -- $19,664,000.
The following unaudited pro forma financial information presents the combined
results of Krispy Kreme Doughnuts, Inc., the franchise markets acquired and
Montana Mills as if these acquisitions discussed above had occurred as of the
beginning of the periods presented. The unaudited pro forma financial
information is not intended to represent or be indicative of the consolidated
results of operations of the Company that would have been reported had the
acquisitions been completed as of the dates presented, and should not be taken
as representative of the future consolidated results of operations of the
Company.
[Enlarge/Download Table]
In Thousands, Except Per Share Amounts
----------------------------------------------------------------------------------------------
FEB. 2, 2003 FEB. 1, 2004
----------------------------------------------------------------------------------------------
(Unaudited)
Total revenues $535,442 $679,345
Net income $ 37,486 $ 57,001
Diluted earnings per share $ 0.61 $ 0.91
The unaudited pro forma financial information presented above includes the
revenues and net income or loss of franchise markets acquired and Montana Mills.
Adjustments to the combined amounts were made to eliminate franchise fees and
royalties previously earned by the Company from the acquired franchise
operations for the periods presented, as well as to eliminate KKM&D revenues and
corresponding expenses resulting from sales to these operations. The results of
operations for Montana Mills for fiscal 2004 includes a charge related to
Montana Mills' decision to close eight stores which were either underperforming
or located in markets where Montana Mills' penetration was generally weaker. The
charge included lease termination costs, provisions to reduce the carrying
amount of leasehold improvements and related store furnishings and equipment to
estimated net realizable values and various other expenses associated with the
closing of the stores. All stores were closed prior to April 7, 2003, the
effective date of the Company's acquisition.
68
KRISPY KREME DOUGHNUTS, INC.
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF KRISPY KREME DOUGHNUTS, INC.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Krispy Kreme
Doughnuts, Inc. and its subsidiaries (the Company) at February 2, 2003 and
February 1, 2004, and the results of their operations and their cash flows for
each of the three years in the period ended February 1, 2004, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes 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. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 2 to the consolidated financial statements, effective
February 4, 2002, the Company changed its method of accounting for goodwill and
other intangible assets to conform to Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets."
Greensboro, North Carolina
March 31, 2004
69
Dates Referenced Herein and Documents Incorporated by Reference
| Referenced-On Page |
|---|
| This ‘10-K’ Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 6/30/10 | | 18 | | 37 | | | 10-K/A |
| | 4/30/10 | | 19 | | 37 | | | 4 |
| | 1/18/10 | | 43 |
| | 6/30/09 | | 18 | | 37 |
| | 10/31/07 | | 18 | | 35 |
| | 9/21/07 | | 36 |
| | 5/1/07 | | 18 | | 36 |
| | 5/2/05 | | 49 |
| | 10/12/04 | | 36 |
| | 8/15/04 | | 37 |
| | 6/30/04 | | 18 | | 37 |
| Filed on: | | 4/16/04 |
| | 3/31/04 | | 51 |
| | 3/15/04 | | 23 | | 32 | | | 5 |
| For Period End: | | 2/1/04 | | 1 | | 51 | | | 5 |
| | 1/30/04 | | 1 | | 49 |
| | 10/31/03 | | 9 | | 46 | | | 8-K |
| | 10/27/03 | | 49 |
| | 6/30/03 | | 45 | | 49 | | | 11-K, 4, 8-K |
| | 5/31/03 | | 23 | | 32 |
| | 5/4/03 | | 14 | | | | | 10-Q |
| | 4/7/03 | | 8 | | 50 | | | 8-A12B/A, 8-K |
| | 3/10/03 | | 49 |
| | 2/3/03 | | 49 |
| | 2/2/03 | | 1 | | 51 | | | 10-K, 5 |
| | 1/31/03 | | 22 | | 32 | | | 8-K |
| | 1/24/03 | | 50 | | | | | 8-K |
| | 8/22/02 | | 1 | | 46 | | | 8-K |
| | 5/1/02 | | 36 | | | | | 3 |
| | 3/5/02 | | 44 | | 46 |
| | 2/4/02 | | 51 |
| | 2/3/02 | | 1 | | 44 | | | 10-K, 4/A, 5 |
| | 2/1/02 | | 40 |
| | 6/14/01 | | 1 | | 2 |
| | 5/29/01 | | 1 | | 2 |
| | 3/19/01 | | 1 | | 2 |
| | 3/6/01 | | 46 |
| | 3/5/01 | | 1 | | 2 |
| | 1/28/01 | | 1 | | 42 | | | 10-K, 5, 5/A |
| | 10/1/00 | | 40 |
| | 6/6/00 | | 41 |
| | 4/10/00 | | 29 |
| | 4/4/00 | | 29 | | | | | 3, 3/A, 8-A12G |
| | 3/22/00 | | 46 |
| | 3/9/00 | | 49 |
| | 2/27/00 | | 46 |
| | 1/30/00 | | 1 |
| | 12/2/99 | | 29 |
| | 11/10/99 | | 29 |
| | 2/1/99 | | 40 |
| | 5/1/94 | | 41 |
| List all Filings |
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