Attached files
UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
___________________
Washington, D.C. 20549
___________________
Form 10-Q
(Mark one) | |||
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the quarterly period ended August 1, 2010 | |||
OR | |||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||
For the transition period from to |
Commission file number
001-16485
KRISPY KREME DOUGHNUTS, INC.
(Exact name of registrant as specified in its charter)
KRISPY KREME DOUGHNUTS, INC.
(Exact name of registrant as specified in its charter)
North Carolina | 56-2169715 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
370 Knollwood Street, | 27103 |
Winston-Salem, North Carolina | (Zip Code) |
(Address of principal executive offices) |
Registrant’s telephone number, including area code:
(336) 725-2981
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. Yes þ No o
Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such
files). Yes o No o
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer þ | |
Non-accelerated filer o | Smaller reporting company o |
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes o No þ
Number of shares of Common Stock, no
par value, outstanding as of August 27, 2010: 67,456,197.
TABLE OF
CONTENTS
Page | |||
FORWARD-LOOKING STATEMENTS | 3 | ||
PART I - FINANCIAL INFORMATION | 4 | ||
Item 1. | FINANCIAL STATEMENTS | 4 | |
Item 2. |
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
|
24 | |
Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 54 | |
Item 4. | CONTROLS AND PROCEDURES | 54 | |
PART II - OTHER INFORMATION | 54 | ||
Item 1. | LEGAL PROCEEDINGS | 54 | |
Item 1A. | RISK FACTORS | 55 | |
Item 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS | 55 | |
Item 3. | DEFAULTS UPON SENIOR SECURITIES | 55 | |
Item 4. | (REMOVED AND RESERVED) | 55 | |
Item 5. | OTHER INFORMATION | 55 | |
Item 6. | EXHIBITS | 55 | |
SIGNATURES | 56 |
2
As used herein, unless the context
otherwise requires, “Krispy Kreme,” the “Company,” “we,” “us” and “our” refer to
Krispy Kreme Doughnuts, Inc. and its subsidiaries. References to fiscal 2011 and
fiscal 2010 mean the fiscal years ended January 30, 2011 and January 31, 2010,
respectively.
FORWARD-LOOKING
STATEMENTS
This quarterly report contains forward
looking statements within the meaning of Section 27A of the Securities Act of
1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”) that relate to our plans, objectives, estimates and
goals. Statements expressing expectations regarding our future and projections
relating to products, sales, revenues, costs and earnings are typical of such
statements, and are made under the Private Securities Litigation Reform Act of
1995. Forward-looking statements are based on management’s beliefs, assumptions
and expectations of our future economic performance, considering the information
currently available to management. These statements are not statements of
historical fact. Forward-looking statements involve risks and uncertainties that
may cause our actual results, performance or financial condition to differ
materially from the expectations of future results, performance or financial
condition we express or imply in any forward-looking statements. The words
“believe,” “may,” “could,” “will,” “should,” “anticipate,” “estimate,” “expect,”
“intend,” “objective,” “seek,” “strive” or similar words, or the negative of
these words, identify forward-looking statements. Factors that could contribute
to these differences include, but are not limited to:
- the quality of Company
and franchise store operations;
- our ability, and our
dependence on the ability of our franchisees, to execute on our and their
business plans;
- our relationships with
our franchisees;
- our ability to implement
our international growth strategy;
- our ability to implement
our new domestic operating model;
- political, economic,
currency and other risks associated with our international
operations;
- the price and
availability of raw materials needed to produce doughnut mixes and other
ingredients;
- compliance with
government regulations relating to food products and
franchising;
- our relationships with
off-premises customers;
- our ability to protect
our trademarks and trade secrets;
- restrictions on our
operations and compliance with covenants contained in our secured credit
facilities;
- changes in customer
preferences and perceptions;
- risks associated with
competition; and
- other factors in Krispy Kreme’s periodic reports and other information filed with the Securities and Exchange Commission (the “SEC”), including under Part I, Item 1A, “Risk Factors,” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2010 (the “2010 Form 10-K”).
All such factors are difficult to
predict, contain uncertainties that may materially affect actual results and may
be beyond our control. New factors emerge from time to time, and it is not
possible for management to predict all such factors or to assess the impact of
each such factor on the Company. Any forward-looking statement speaks only as of
the date on which such statement is made, and we do not undertake any obligation
to update any forward-looking statement to reflect events or circumstances after
the date on which such statement is made.
We caution you that any forward-looking
statements are not guarantees of future performance and involve known and
unknown risks, uncertainties and other factors which may cause our actual
results, performance or achievements to differ materially from the facts,
results, performance or achievements we have anticipated in such forward-looking
statements except as required by the federal securities laws.
3
PART I - FINANCIAL
INFORMATION
Item 1. FINANCIAL
STATEMENTS.
Page | ||
Index to Financial Statements | ||
Consolidated statement of operations for the three and six months ended August 1, 2010 and August 2, 2009 | 5 | |
Consolidated balance sheet as of August 1, 2010 and January 31, 2010 | 6 | |
Consolidated statement of cash flows for the six months ended August 1, 2010 and August 2, 2009 | 7 | |
Consolidated statement of changes in shareholders’ equity for the six months ended August 1, 2010 and August 2, 2009 | 8 | |
Notes to financial statements | 9 |
4
KRISPY KREME DOUGHNUTS,
INC.
CONSOLIDATED STATEMENT OF
OPERATIONS
(Unaudited)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||
Revenues | $ | 87,932 | $ | 82,730 | $ | 180,049 | $ | 176,150 | ||||||||
Operating expenses: | ||||||||||||||||
Direct operating expenses (exclusive of depreciation and | ||||||||||||||||
amortization shown below) | 76,938 | 71,258 | 153,981 | 148,226 | ||||||||||||
General and administrative expenses | 4,926 | 4,817 | 10,676 | 11,131 | ||||||||||||
Depreciation and amortization expense | 1,937 | 1,999 | 3,801 | 3,992 | ||||||||||||
Impairment charges and lease termination costs | (216 | ) | 1,456 | 1,083 | 3,813 | |||||||||||
Other operating (income) and expense, net | 192 | 257 | 298 | 267 | ||||||||||||
Operating income | 4,155 | 2,943 | 10,210 | 8,721 | ||||||||||||
Interest income | 82 | 14 | 122 | 28 | ||||||||||||
Interest expense | (1,567 | ) | (2,312 | ) | (3,438 | ) | (6,129 | ) | ||||||||
Equity in income (losses) of equity method franchisees | (165 | ) | (214 | ) | 181 | (113 | ) | |||||||||
Other non-operating income and (expense), net | 81 | (500 | ) | 162 | (500 | ) | ||||||||||
Income (loss) before income taxes | 2,586 | (69 | ) | 7,237 | 2,007 | |||||||||||
Provision for income taxes | 379 | 88 | 562 | 296 | ||||||||||||
Net income (loss) | $ | 2,207 | $ | (157 | ) | $ | 6,675 | $ | 1,711 | |||||||
Earnings per common share: | ||||||||||||||||
Basic | $ | 0.03 | $ | - | $ | 0.10 | $ | 0.03 | ||||||||
Diluted | $ | 0.03 | $ | - | $ | 0.10 | $ | 0.03 | ||||||||
The
accompanying notes are an integral part of the financial
statements.
5
KRISPY KREME DOUGHNUTS,
INC.
CONSOLIDATED BALANCE
SHEET
(Unaudited)
(Unaudited)
August 1, | January 31, | |||||||
2010 | 2010 | |||||||
(In thousands) | ||||||||
ASSETS | ||||||||
CURRENT ASSETS: | ||||||||
Cash and cash equivalents | $ | 21,235 | $ | 20,215 | ||||
Receivables | 19,172 | 17,839 | ||||||
Receivables from equity method franchisees | 604 | 524 | ||||||
Inventories | 14,427 | 14,321 | ||||||
Other current assets | 5,781 | 6,324 | ||||||
Total current assets | 61,219 | 59,223 | ||||||
Property and equipment | 71,252 | 72,527 | ||||||
Investments in equity method franchisees | 1,089 | 781 | ||||||
Goodwill and other intangible assets | 23,816 | 23,816 | ||||||
Other assets | 10,548 | 8,929 | ||||||
Total assets | $ | 167,924 | $ | 165,276 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
CURRENT LIABILITIES: | ||||||||
Current maturities of long-term debt | $ | 686 | $ | 762 | ||||
Accounts payable | 6,100 | 6,708 | ||||||
Accrued liabilities | 27,362 | 30,203 | ||||||
Total current liabilities | 34,148 | 37,673 | ||||||
Long-term debt, less current maturities | 41,181 | 42,685 | ||||||
Other long-term obligations | 19,807 | 22,151 | ||||||
Commitments and contingencies | ||||||||
SHAREHOLDERS’ EQUITY: | ||||||||
Preferred stock, no par value | - | - | ||||||
Common stock, no par value | 368,131 | 366,237 | ||||||
Accumulated other comprehensive loss | (73 | ) | (180 | ) | ||||
Accumulated deficit | (295,270 | ) | (303,290 | ) | ||||
Total shareholders’ equity | 72,788 | 62,767 | ||||||
Total liabilities and shareholders’ equity | $ | 167,924 | $ | 165,276 | ||||
The
accompanying notes are an integral part of the financial
statements.
6
KRISPY KREME DOUGHNUTS,
INC.
CONSOLIDATED STATEMENT OF CASH
FLOWS
(Unaudited)
(Unaudited)
Six Months Ended | ||||||||
August 1, | August 2, | |||||||
2010 | 2009 | |||||||
(In thousands) | ||||||||
CASH FLOW FROM OPERATING ACTIVITIES: | ||||||||
Net income | $ | 6,675 | $ | 1,711 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 3,801 | 3,992 | ||||||
Deferred income taxes | (70 | ) | (283 | ) | ||||
Impairment charges | 709 | 1,220 | ||||||
Accrued rent expense | (395 | ) | (468 | ) | ||||
Loss on disposal of property and equipment | 279 | 366 | ||||||
Impairment of investment in equity method franchisee | - | 500 | ||||||
Unrealized loss on interest rate derivatives | - | 419 | ||||||
Share-based compensation | 1,934 | 2,070 | ||||||
Provision for doubtful accounts | (193 | ) | (91 | ) | ||||
Amortization of deferred financing costs | 312 | 430 | ||||||
Equity in (income) losses of equity method franchisees | (181 | ) | 113 | |||||
Other | (210 | ) | 1 | |||||
Change in assets and liabilities: | ||||||||
Receivables | (1,113 | ) | 2,336 | |||||
Inventories | (106 | ) | 174 | |||||
Other current and non-current assets | (2,707 | ) | (545 | ) | ||||
Accounts payable and accrued liabilities | (3,055 | ) | (1,414 | ) | ||||
Other long-term obligations | (287 | ) | (462 | ) | ||||
Net cash provided by operating activities | 5,393 | 10,069 | ||||||
CASH FLOW FROM INVESTING ACTIVITIES: | ||||||||
Purchase of property and equipment | (4,029 | ) | (4,377 | ) | ||||
Proceeds from disposals of property and equipment | 1,268 | 32 | ||||||
Other investing activities | 27 | (26 | ) | |||||
Net cash used for investing activities | (2,734 | ) | (4,371 | ) | ||||
CASH FLOW FROM FINANCING ACTIVITIES: | ||||||||
Repayment of long-term debt | (1,599 | ) | (20,638 | ) | ||||
Deferred financing costs | - | (954 | ) | |||||
Proceeds from exercise of warrants | 4 | - | ||||||
Repurchase of common shares | (44 | ) | (24 | ) | ||||
Net cash used for financing activities | (1,639 | ) | (21,616 | ) | ||||
Net increase (decrease) in cash and cash equivalents | 1,020 | (15,918 | ) | |||||
Cash and cash equivalents at beginning of period | 20,215 | 35,538 | ||||||
Cash and cash equivalents at end of period | $ | 21,235 | $ | 19,620 | ||||
The
accompanying notes are an integral part of the financial
statements.
7
KRISPY KREME DOUGHNUTS,
INC.
CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS' EQUITY
(Unaudited)
(Unaudited)
Accumulated | |||||||||||||||||||
Common | Other | ||||||||||||||||||
Shares | Common | Comprehensive | Accumulated | ||||||||||||||||
Outstanding | Stock | Income (Loss) | Deficit | Total | |||||||||||||||
(In thousands) | |||||||||||||||||||
Balance at January 31, 2010 | 67,441 | $ | 366,237 | $ | (180 | ) | $ | (303,290 | ) | $ | 62,767 | ||||||||
Effect of adoption of new accounting standard | |||||||||||||||||||
(Note 1) | 1,345 | 1,345 | |||||||||||||||||
Comprehensive income: | |||||||||||||||||||
Net income for the six months ended | |||||||||||||||||||
August 1, 2010 | 6,675 | 6,675 | |||||||||||||||||
Foreign currency translation adjustment, net | |||||||||||||||||||
of income taxes of $10 | 15 | 15 | |||||||||||||||||
Amortization of unrealized loss on interest | |||||||||||||||||||
rate derivative, net of income taxes of $60 | 92 | 92 | |||||||||||||||||
Total comprehensive income | 6,782 | ||||||||||||||||||
Exercise of warrants | 4 | 4 | |||||||||||||||||
Share-based compensation | 29 | 1,934 | 1,934 | ||||||||||||||||
Repurchase of common shares | (12 | ) | (44 | ) | (44 | ) | |||||||||||||
Balance at August 1, 2010 | 67,458 | $ | 368,131 | $ | (73 | ) | $ | (295,270 | ) | $ | 72,788 | ||||||||
Balance at February 1, 2009 | 67,512 | $ | 361,801 | $ | (913 | ) | $ | (303,133 | ) | $ | 57,755 | ||||||||
Comprehensive income: | |||||||||||||||||||
Net income for the six months ended | |||||||||||||||||||
August 2, 2009 | 1,711 | 1,711 | |||||||||||||||||
Foreign currency translation adjustment, net | |||||||||||||||||||
of income taxes of $20 | 29 | 29 | |||||||||||||||||
Amortization of unrealized loss on interest | |||||||||||||||||||
rate derivative, net of income taxes of $263 | 403 | 403 | |||||||||||||||||
Total comprehensive income | 2,143 | ||||||||||||||||||
Cancellation of restricted shares | (33 | ) | - | - | |||||||||||||||
Share-based compensation | - | 2,070 | 2,070 | ||||||||||||||||
Repurchase of common shares | (12 | ) | (24 | ) | (24 | ) | |||||||||||||
Balance at August 2, 2009 | 67,467 | $ | 363,847 | $ | (481 | ) | $ | (301,422 | ) | $ | 61,944 | ||||||||
Total
comprehensive income for the three months ended August 1, 2010 and August 2,
2009 was $2.2 million and $72,000, respectively.
The
accompanying notes are an integral part of the financial
statements.
8
KRISPY KREME DOUGHNUTS,
INC.
NOTES TO FINANCIAL
STATEMENTS
(Unaudited)
(Unaudited)
Note 1 — Accounting
Policies
Krispy Kreme Doughnuts, Inc. (“KKDI”) and
its subsidiaries (collectively, the “Company”) are engaged in the sale of
doughnuts and related items through Company-owned stores. The Company also
derives revenue from franchise and development fees and royalties from
franchisees. Additionally, the Company sells doughnut mix, other ingredients and
supplies and doughnut-making equipment to franchisees.
Significant Accounting
Policies
BASIS OF PRESENTATION.
The consolidated financial
statements contained herein should be read in conjunction with the Company’s
2010 Form 10-K. The accompanying interim consolidated financial statements are
presented in accordance with the requirements of Article 10 of Regulation S-X
and, accordingly, do not include all the disclosures required by generally
accepted accounting principles (“GAAP”) with respect to annual financial
statements. The interim consolidated financial statements have been prepared in
accordance with the Company’s accounting practices described in the 2010 Form
10-K, but have not been audited. In management’s opinion, the financial
statements include all adjustments, which consist only of normal recurring
adjustments, necessary for a fair statement of the Company’s results of
operations for the periods presented. The consolidated balance sheet data as of
January 31, 2010 were derived from the Company’s audited financial statements
but do not include all disclosures required by GAAP.
BASIS OF
CONSOLIDATION. The financial statements include the accounts of KKDI and its
subsidiaries, the most significant of which is KKDI’s principal operating
subsidiary, Krispy Kreme Doughnut Corporation. In October 2009, the Company
refranchised three stores in Northern California to a new franchisee. The
Company did not report the refranchising as divestiture of the stores and
continued to consolidate the stores’ financial statements for post-acquisition
periods because the new franchisee was a variable interest entity of which the
Company was the primary beneficiary. Effective February 1, 2010, the Company
adopted new accounting standards under which the Company is no longer the
primary beneficiary of the new franchisee, which required the Company to
deconsolidate the franchisee and recognize a divestiture of the stores; see
“Recent Accounting Pronouncements” below.
Investments in entities over which the
Company has the ability to exercise significant influence but which the Company
does not control, and whose financial statements are not otherwise required to
be consolidated, are accounted for using the equity method. These entities
typically are 25% to 35% owned and are hereinafter sometimes referred to as
“Equity Method Franchisees.”
EARNINGS PER
SHARE. The computation of basic earnings per share is based on the weighted
average number of common shares outstanding during the period. The computation
of diluted earnings per share reflects the additional common shares that would
have been outstanding if dilutive potential common shares had been issued,
computed using the treasury stock method. Such potential common shares consist
of shares issuable upon the exercise of stock options and warrants and the
vesting of currently unvested shares of restricted stock and restricted stock
units.
9
The following table sets forth
amounts used in the computation of basic and diluted earnings per
share:
Three Months Ended | Six Months Ended | |||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||
2010 | 2009 | 2010 | 2009 | |||||||||
(In thousands) | ||||||||||||
Numerator: net income (loss) | $ | 2,207 | $ | (157 | ) | $ | 6,675 | $ | 1,711 | |||
Denominator: | ||||||||||||
Basic earnings per share - weighted average shares | ||||||||||||
outstanding | 68,195 | 67,350 | 68,145 | 67,225 | ||||||||
Effect of dilutive securities: | ||||||||||||
Stock options | 658 | - | 662 | 159 | ||||||||
Restricted stock and restricted stock units | 474 | - | 472 | 446 | ||||||||
Diluted earnings per share - weighted average shares | ||||||||||||
outstanding plus dilutive potential common shares | 69,327 | 67,350 | 69,279 | 67,830 | ||||||||
The sum of the quarterly earnings
per share amounts does not necessarily equal earnings per share for the
year.
Stock options and warrants with respect
to 8.7 million and 11.1 million shares, as well as 136,000 and 1.4 million
unvested shares of restricted stock and unvested restricted stock units, have
been excluded from the computation of the number of shares used to compute
diluted earnings per share for the three months ended August 1, 2010 and August
2, 2009, respectively, because their inclusion would be
antidilutive.
Stock options and warrants with respect
to 8.7 million and 10.3 million shares, as well as 139,000 and 605,000 unvested
shares of restricted stock and unvested restricted stock units, have been
excluded from the computation of the number of shares used to compute diluted
earnings per share for the six months ended August 1, 2010 and August 2, 2009,
respectively, because their inclusion would be antidilutive.
Reclassification
Beginning in the first quarter of fiscal
2011, miscellaneous receivables previously classified as a component of other
current assets were reclassified and combined with trade receivables, and the
combined total has been captioned “Receivables” in the accompanying consolidated
balance sheet. Amounts previously reported at January 31, 2010 have been
reclassified to conform to the new presentation.
Recent Accounting Pronouncements
In the first quarter of fiscal 2011, the
Company adopted amended accounting standards related to the consolidation of
variable-interest entities. The amended standards require an enterprise to
qualitatively assess the determination of the primary beneficiary of a variable
interest entity (“VIE”) based on whether the enterprise has the power to direct
matters that most significantly impact the activities of the VIE and has the
obligation to absorb losses of, or the right to receive benefits from, the VIE
that could potentially be significant to the VIE. Adoption of the new standards
resulted in the Company recognizing a divestiture of three stores sold by the
Company in the October 2009 refranchising transaction described under “Basis of
Consolidation,” above. The cumulative effect of adoption of the new standards
has been reflected as a credit of $1.3 million to the opening balance of
retained earnings as of February 1, 2010, the first day of fiscal 2011. Adoption
of the standards had no material effect on the Company’s financial position,
results of operations or cash flows.
In the first quarter of fiscal 2010, the
Company adopted new accounting standards with respect to nonfinancial assets and
nonfinancial liabilities measured at fair value on a non-recurring basis.
Adoption of these standards had no material effect on the Company’s financial
position or results of operations. See Note 9 for additional information
regarding fair value measurements.
10
Note 2 —
Receivables
The components of receivables are as
follows:
August 1, | January 31, | ||||||
2010 | 2010 | ||||||
(In thousands) | |||||||
Receivables: | |||||||
Off-premises customers | $ | 9,479 | $ | 9,010 | |||
Unaffiliated franchisees | 9,414 | 8,974 | |||||
Other receivables | 1,410 | 1,130 | |||||
Current portion of notes receivable | 124 | 68 | |||||
20,427 | 19,182 | ||||||
Less — allowance for doubtful accounts: | |||||||
Off-premises customers | (301 | ) | (307 | ) | |||
Unaffiliated franchisees | (954 | ) | (1,036 | ) | |||
(1,255 | ) | (1,343 | ) | ||||
$ | 19,172 | $ | 17,839 | ||||
Receivables from Equity Method Franchisees (Note 7): | |||||||
Trade | $ | 882 | $ | 1,263 | |||
Notes receivable | 967 | - | |||||
1,849 | 1,263 | ||||||
Less — allowance for doubtful accounts: | |||||||
Trade | (278 | ) | (739 | ) | |||
Notes receivable | (967 | ) | - | ||||
(1,245 | ) | (739 | ) | ||||
$ | 604 | $ | 524 | ||||
Note 3 —
Inventories
The components of inventories are as
follows:
August 1, | January 31, | ||||
2010 | 2010 | ||||
(In thousands) | |||||
Raw materials | $ | 5,254 | $ | 5,253 | |
Work in progress | 57 | 4 | |||
Finished goods | 3,103 | 3,688 | |||
Purchased merchandise | 5,916 | 5,268 | |||
Manufacturing supplies | 97 | 108 | |||
$ | 14,427 | $ | 14,321 | ||
Note 4 — Long Term Debt
Long-term debt and capital lease
obligations consist of the following:
August 1, | January 31, | ||||||
2010 | 2010 | ||||||
(In thousands) | |||||||
Secured Credit Facilities | $ | 41,583 | $ | 43,054 | |||
Capital lease obligations | 284 | 393 | |||||
41,867 | 43,447 | ||||||
Less: current maturities | (686 | ) | (762 | ) | |||
$ | 41,181 | $ | 42,685 | ||||
11
In February 2007, the Company closed
secured credit facilities totaling $160 million (the “Secured Credit
Facilities”) then consisting of a $50 million revolving credit facility maturing
in February 2013 (the “Revolver”) and a $110 million term loan maturing in
February 2014 (the “Term Loan”). The Secured Credit Facilities are secured by a
first lien on substantially all of the assets of the Company and its
subsidiaries.
The Revolver contains provisions which
permit the Company to obtain letters of credit. Issuance of letters of credit
under these provisions constitutes usage of the lending commitments and reduces
the amount available for cash borrowings under the Revolver. The commitments
under the Revolver were reduced from $50 million to $30 million in April 2008,
and further reduced to $25 million in connection with amendments to the
facilities in April 2009 (the “April 2009 Amendments”). In connection with the
April 2009 Amendments, the Company prepaid $20 million of the principal balance
outstanding under the Term Loan. The Company has made other payments of Term
Loan principal since February 2007, consisting of $25.3 million representing the
proceeds of asset sales, $20.0 million representing discretionary prepayments
and $3.1 million representing scheduled amortization which, together with the
$20.0 million prepayment in April 2009 have reduced the principal balance of the
Term Loan to $ 41.6 million as of August 1, 2010.
Interest on borrowings under the Revolver
and Term Loan is payable either (a) at the greater of LIBOR or 3.25% or (b) at
the Alternate Base Rate (which is the greater of Fed funds rate plus 0.50% or
the prime rate), in each case plus the Applicable Margin. After giving effect to
the April 2009 Amendments, the Applicable Margin for LIBOR-based loans and for
Alternate Base Rate-based loans was 7.50% and 6.50%, respectively (5.50% and
4.50%, respectively, prior to the April 2009 Amendments).
The Company is required to pay a fee
equal to the Applicable Margin for LIBOR-based loans on the outstanding amount
of letters of credit issued under the Revolver, as well as a fronting fee of
0.25% of the amount of such letter of credit payable to the letter of credit
issuer. There also is a fee on the unused portion of the Revolver lending
commitment, which increased from 0.75% to 1.00% in connection with the April
2009 Amendments.
Borrowings under the Revolver (and
issuances of letters of credit) are subject to the satisfaction of usual and
customary conditions, including the accuracy of representations and warranties
and the absence of defaults.
The Term Loan is payable in quarterly
installments of approximately $137,000 (as adjusted to give effect to
prepayments of principal under the Term Loan) and a final installment equal to
the remaining principal balance in February 2014. The Term Loan is required to
be prepaid with some or all of the net proceeds of certain equity issuances,
debt issuances, asset sales and casualty events and with a percentage of excess
cash flow (as defined in the agreement) on an annual basis.
The Secured Credit Facilities require the
Company to meet certain financial tests, including a maximum consolidated
leverage ratio (expressed as a ratio of total debt to Consolidated EBITDA) and a
minimum consolidated interest coverage ratio (expressed as a ratio of
Consolidated EBITDA to net interest expense), computed based upon Consolidated
EBITDA and net interest expense for the most recent four fiscal quarters and
total debt as of the end of such four-quarter period. As of August 1, 2010, the
consolidated leverage ratio was required to be not greater than 3.50 to 1.0 and
the consolidated interest coverage ratio was required to be not less than 2.75
to 1.0. As of August 1, 2010, the Company’s consolidated leverage ratio was
approximately 1.9 to 1.0 and the Company’s consolidated interest coverage ratio
was approximately 4.7 to 1.0. In the future, the maximum consolidated leverage
ratio declines, and the minimum consolidated interest coverage ratio increases,
as set forth in the following tables:
Maximum | ||
Period | Leverage Ratio | |
Second Quarter of Fiscal 2011 | 3.50 to 1.00 | |
Third Quarter of Fiscal 2011 | 3.25 to 1.00 | |
Fourth Quarter of Fiscal 2011 | 3.00 to 1.00 | |
Fiscal 2012 | 2.50 to 1.00 | |
Fiscal 2013 and thereafter | 2.00 to 1.00 | |
Minimum Interest | ||
Period | Coverage Ratio | |
Second Quarter of Fiscal 2011 | 2.75 to 1.00 | |
Third Quarter of Fiscal 2011 | 2.95 to 1.00 | |
Fourth Quarter of Fiscal 2011 | 3.15 to 1.00 | |
Fiscal 2012 | 3.75 to 1.00 | |
Fiscal 2013 and thereafter | 4.50 to 1.00 |
12
“Consolidated EBITDA” is a non-GAAP
measure and is defined in the Secured Credit Facilities to mean, generally,
consolidated net income or loss, exclusive of unrealized gains and losses on
hedging instruments, gains or losses on the early extinguishment of debt and
provisions for payments on guarantees of franchisee obligations plus the sum of
interest expense (net of interest income), income taxes, depreciation and
amortization, non-cash charges, store closure costs, costs associated with
certain litigation and investigations, and extraordinary professional fees; and
minus payments, if any, on guarantees of franchisee obligations in excess of $3
million in any rolling four-quarter period and the sum of non-cash credits. In
addition, the Secured Credit Facilities contain other covenants which, among
other things, limit the incurrence of additional indebtedness (including
guarantees), liens, investments (including investments in and advances to
franchisees which own and operate Krispy Kreme stores), dividends, transactions
with affiliates, asset sales, acquisitions, capital expenditures, mergers and
consolidations, prepayments of other indebtedness and other activities
customarily restricted in such agreements. The Secured Credit Facilities also
prohibit the transfer of cash or other assets to KKDI from its subsidiaries,
whether by dividend, loan or otherwise, but provide for exceptions to enable
KKDI to pay taxes and operating expenses and certain judgment and settlement
costs.
The operation of the restrictive
financial covenants described above may limit the amount the Company may borrow
under the Revolver. In addition, the maximum amount which may be borrowed under
the Revolver is reduced by the amount of outstanding letters of credit, which
totaled approximately $13 million as of August 1, 2010, the substantial majority
of which secure the Company’s reimbursement obligations to insurers under the
Company’s self-insurance arrangements. The restrictive covenants did not limit
the Company’s ability to borrow the full $12 million of unused credit under the
Revolver at August 1, 2010.
The Secured Credit Facilities also
contain customary events of default including, without limitation, payment
defaults, breaches of representations and warranties, covenant defaults,
cross-defaults to other indebtedness in excess of $5 million, certain events of
bankruptcy and insolvency, judgment defaults in excess of $5 million and the
occurrence of a change of control.
Note 5 — Impairment Charges and
Lease Termination Costs
The components of impairment charges and
lease termination costs are as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
August 1, | August 2, | August 1, | August 2, | ||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||
(In thousands) | |||||||||||||||
Impairment of long-lived assets: | |||||||||||||||
Current period charges | 50 | 1,058 | 899 | 1,220 | |||||||||||
Adjustments to previously recorded estimates | (190 | ) | - | (190 | ) | - | |||||||||
Total impairment of long-lived assets | $ | (140 | ) | $ | 1,058 | $ | 709 | $ | 1,220 | ||||||
Lease termination costs: | |||||||||||||||
Provision for termination costs | 568 | 948 | 1,018 | 3,333 | |||||||||||
Less — reversal of previously recorded accrued rent | |||||||||||||||
expense | (644 | ) | (550 | ) | (644 | ) | (740 | ) | |||||||
Net provision | (76 | ) | 398 | 374 | 2,593 | ||||||||||
$ | (216 | ) | $ | 1,456 | $ | 1,083 | $ | 3,813 | |||||||
The Company tests long-lived assets for impairment when events or changes
in circumstances indicate that their carrying value may not be recoverable.
These events and changes in circumstances include store closing and
refranchising decisions, the effects changing costs on current results of
operations, observed trends in operating results, and evidence of changed
circumstances observed as a part of periodic reforecasts of future operating
results and as part of the Company’s annual budgeting process. When the Company
concludes that the carrying value of long-lived assets is not recoverable (based
on future projected undiscounted cash flows), the Company records impairment
charges to reduce the carrying value of those assets to their estimated fair
values.
Lease termination costs represent the
estimated fair value of liabilities related to unexpired leases, after reduction
by the amount of accrued rent expense, if any, related to the leases, and are
recorded when the lease contracts are terminated or, if earlier, the date on
which the Company ceases use of the leased property. The fair value of these
liabilities were estimated as the excess, if any, of the contractual payments
required under the unexpired leases over the current market lease rates for the
properties, discounted at a credit-adjusted risk-free rate over the remaining
term of the leases.
13
The transactions reflected in the accrual
for lease termination costs are summarized as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
August 1, | August 2, | August 1, | August 2, | ||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||
(In thousands) | |||||||||||||||
Balance at beginning of period | $ | 1,803 | $ | 3,705 | $ | 1,679 | $ | 1,880 | |||||||
Provision for lease termination costs: | |||||||||||||||
Provisions associated with store closings, net of estimated | |||||||||||||||
sublease rentals | 394 | 134 | 394 | 2,215 | |||||||||||
Adjustments to previously recorded provisions resulting | |||||||||||||||
from settlements with lessors and adjustments of previous | |||||||||||||||
estimates | 124 | 765 | 529 | 1,023 | |||||||||||
Accretion of discount | 50 | 49 | 95 | 95 | |||||||||||
Total provision | 568 | 948 | 1,018 | 3,333 | |||||||||||
Payments on unexpired leases, including settlements with | |||||||||||||||
lessors | (271 | ) | (2,225 | ) | (597 | ) | (2,785 | ) | |||||||
Balance at end of period | $ | 2,100 | $ | 2,428 | $ | 2,100 | $ | 2,428 | |||||||
Note 6 — Segment Information
The Company’s reportable segments
are Company Stores, Domestic Franchise, International Franchise and KK Supply
Chain. The Company Stores segment is comprised of the stores operated by the
Company. These stores sell doughnuts and complementary products through both
on-premises and off-premises sales channels, although some stores serve only one
of these distribution channels. The Domestic Franchise and International
Franchise segments consist of the Company’s franchise operations. Under the
terms of franchise agreements, domestic and international franchisees pay
royalties and fees to the Company in return for the use of the Krispy Kreme name
and ongoing brand and operational support. Expenses for these segments include
costs to recruit new franchisees, to assist in store openings, to support
franchisee operations and marketing efforts, as well as allocated corporate
costs. The majority of the ingredients and materials used by Company stores are
purchased from the KK Supply Chain segment, which supplies doughnut mix,
equipment and other items to both Company and franchisee-owned
stores.
All intercompany sales by the KK Supply
Chain segment to the Company Stores segment are at prices intended to reflect an
arms-length transfer price and are eliminated in consolidation. Operating income
for the Company Stores segment does not include any profit earned by the KK
Supply Chain segment on sales of doughnut mix, ingredients and supplies to the
Company Stores segment; such profit is included in KK Supply Chain operating
income.
14
The following table presents the results
of operations of the Company’s operating segments for the three and six months
ended August 1, 2010 and August 2, 2009. Segment operating income is
consolidated operating income before unallocated general and administrative
expenses and impairment charges and lease termination costs.
Three Months Ended | Six Months Ended | ||||||||||||||
August 1, | August 2, | August 1, | August 2, | ||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||
(In thousands) | |||||||||||||||
Revenues: | |||||||||||||||
Company Stores | $ | 59,970 | $ | 59,853 | $ | 122,504 | $ | 125,710 | |||||||
Domestic Franchise | 2,074 | 1,802 | 4,274 | 3,853 | |||||||||||
International Franchise | 4,009 | 3,806 | 8,769 | 7,684 | |||||||||||
KK Supply Chain: | |||||||||||||||
Total revenues | 44,892 | 37,754 | 90,797 | 82,612 | |||||||||||
Less – intersegment sales elimination | (23,013 | ) | (20,485 | ) | (46,295 | ) | (43,709 | ) | |||||||
External KK Supply Chain revenues | 21,879 | 17,269 | 44,502 | 38,903 | |||||||||||
Total revenues | $ | 87,932 | $ | 82,730 | $ | 180,049 | $ | 176,150 | |||||||
Operating income (loss): | |||||||||||||||
Company Stores | $ | (1,734 | ) | $ | 1,387 | $ | (1,765 | ) | $ | 4,331 | |||||
Domestic Franchise | 1,041 | 434 | 2,195 | 1,614 | |||||||||||
International Franchise | 2,500 | 1,943 | 5,986 | 4,378 | |||||||||||
KK Supply Chain | 7,329 | 5,687 | 16,019 | 13,826 | |||||||||||
Total segment operating income | 9,136 | 9,451 | 22,435 | 24,149 | |||||||||||
Unallocated general and administrative expenses | (5,197 | ) | (5,052 | ) | (11,142 | ) | (11,615 | ) | |||||||
Impairment charges and lease termination costs | 216 | (1,456 | ) | (1,083 | ) | (3,813 | ) | ||||||||
Consolidated operating income | $ | 4,155 | $ | 2,943 | $ | 10,210 | $ | 8,721 | |||||||
Depreciation and amortization expense: | |||||||||||||||
Company Stores | $ | 1,459 | $ | 1,519 | $ | 2,854 | $ | 3,015 | |||||||
Domestic Franchise | 55 | 22 | 110 | 43 | |||||||||||
International Franchise | 2 | - | 3 | - | |||||||||||
KK Supply Chain | 205 | 223 | 417 | 450 | |||||||||||
Corporate administration | 216 | 235 | 417 | 484 | |||||||||||
Total depreciation and amortization expense | $ | 1,937 | $ | 1,999 | $ | 3,801 | $ | 3,992 | |||||||
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.
Note 7 — Investments in Franchisees
As of August 1, 2010, the Company had
investments in four franchisees. These investments have been made in the form of
capital contributions and, in certain instances, loans evidenced by promissory
notes. These investments are reflected as “Investments in equity method
franchisees” in the consolidated balance sheet.
15
The Company’s financial exposures related
to franchisees in which the Company has an investment are summarized in the
tables below.
August 1, 2010 | |||||||||||||||||
Company | Investment | ||||||||||||||||
Ownership | and | Notes | Loan | ||||||||||||||
Percentage | Advances | Receivables | Receivable | Guarantees | |||||||||||||
(Dollars in thousands) | |||||||||||||||||
Kremeworks, LLC | 25.0 | % | $ | 900 | $ | 365 | $ | - | $ | 1,124 | |||||||
Kremeworks Canada, LP | 24.5 | % | - | 21 | - | - | |||||||||||
Krispy Kreme of South Florida, LLC | 35.3 | % | - | 147 | - | 2,328 | |||||||||||
Krispy Kreme Mexico, S. de R.L. de C.V. | 30.0 | % | 1,089 | 349 |
967
|
- | |||||||||||
1,989 | 882 | 967 | $ | 3,452 | |||||||||||||
Less: reserves and allowances | (900 | ) | (278 | ) | (967 | ) | |||||||||||
$ | 1,089 | $ | 604 | $ | - | ||||||||||||
January 31, 2010 | ||||||||||||||||
Company | Investment | |||||||||||||||
Ownership | and | Notes | Loan | |||||||||||||
Percentage | Advances | Receivables | Receivable | Guarantees | ||||||||||||
(Dollars in thousands) | ||||||||||||||||
Kremeworks, LLC | 25.0 | % | $ | 900 | $ | 327 | $ | - | $ | 1,241 | ||||||
Kremeworks Canada, LP | 24.5 | % | - | 16 | - | - | ||||||||||
Krispy Kreme of South Florida, LLC | 35.3 | % | - | 138 | - | 2,489 | ||||||||||
Krispy Kreme Mexico, S. de R.L. de C.V. | 30.0 | % | 781 | 782 | - | - | ||||||||||
1,681 | 1,263 | - | $ | 3,730 | ||||||||||||
Less: reserves and allowances | (900 | ) | (739 | ) | - | |||||||||||
$ | 781 | $ | 524 | $ | - | |||||||||||
The loan guarantee amounts represent
the portion of the principal amount outstanding under the related loan that is
subject to the Company’s guarantee.
Current liabilities at August 1, 2010 and
January 31, 2010 include accruals for potential payments under loan guarantees
of approximately $2.3 million and $2.5 million, respectively, related to Krispy
Kreme of South Florida, LLC (“KKSF”). There was no liability reflected in the
financial statements for other guarantees of franchisee obligations because the
Company did not believe it was probable that the Company would be required to
perform under such other guarantees.
16
The Company has a 25% interest in
Kremeworks, LLC (“Kremeworks”), and has guaranteed 20% of the outstanding
principal balance of certain of Kremeworks’ bank indebtedness, which originally
matured in January 2009 and subsequently was refinanced with the lender through
July 2010. The aggregate amount of such indebtedness was approximately $5.6
million at August 1, 2010. Kremeworks’ lender granted a one-month extension on
the maturity of the bank indebtedness to August 31, 2010 in connection with an
expected refinancing by the lender. While such refinancing has not yet been
completed, the Company believes such refinancing is likely. In the event that
Kremeworks is unable to refinance the indebtedness and the lender declares the
entire indebtedness immediately due and payable, the Company could be required
to perform under its guarantee. Kremeworks could have insufficient cash flows
from its business to service the indebtedness even if it is refinanced, which
might require additional capital contributions to Kremeworks by the Company and
the majority owner of Kremeworks (which has guarantees of the Kremeworks
indebtedness approximately proportionate to those of the Company) in order for
Kremeworks to comply with the terms of any new loan agreement. Kremeworks’
unaudited revenues, operating loss and net loss for the three and six months
ended August 1, 2010 and August 2, 2009, based upon information provided by the
franchisee, are set forth in the following table.
Three Months Ended | Six Months Ended | ||||||||||||||
August 1, | August 2, | August 1, | August 2, | ||||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||||
(In thousands) | |||||||||||||||
Revenues | $ | 4,555 | $ | 4,505 | $ | 8,707 | $ | 9,082 | |||||||
Operating loss | (295 | ) | (467 | ) | (632 | ) | (825 | ) | |||||||
Net loss | (368 | ) | (576 | ) | (785 | ) | (1,047 | ) |
The Company has a 30% interest in
Krispy Kreme Mexico, S. de R.L. de C.V. (“KK Mexico”). In the first half of
fiscal 2010, KK Mexico was adversely affected by economic weakness in that
country as well as by a significant decline in the value of the country’s
currency relative to the U.S. dollar, which made the cost of goods imported from
the U.S. more expensive, and which increased the amount of cash required to
service the portion of the franchisee’s debt that is denominated in U.S.
dollars. In the second quarter of fiscal 2010, management concluded that the
decline in the value of the investment was other than temporary and,
accordingly, the Company recorded a charge of approximately $500,000 in the
quarter then ended to reduce the carrying value of the investment in KK Mexico
to its then estimated fair value of $700,000. Such charge was included in “Other
non-operating income and expense, net” in the accompanying consolidated
statement of operations. In addition, during the second quarter of fiscal 2010,
the Company increased its bad debt reserve related to KK Mexico by approximately
$525,000, of which approximately $145,000 and $380,000 was included in KK Supply
Chain and International Franchise direct operating expenses, respectively. KK
Mexico’s operations have improved in recent quarters, and in the second quarter
of fiscal 2011, the Company converted its past due receivables from the
franchisee to a note in the amount of $967,000 payable in installments, together
with interest. The Company has maintained reserves equal to 100% of amounts due
from KK Mexico, including the balance of the note. KK Mexico’s unaudited
revenues, operating income and net income for the three and six month periods
ending August 1, 2010 and August 2, 2009, based upon information provided by the
franchisee, are set forth in the following table.
Three Months Ended | Six Months Ended | |||||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||
(In thousands) | ||||||||||||||
Revenues | $ | 4,015 | $ | 2,756 | $ | 8,243 | $ | 5,739 | ||||||
Operating income (loss) | (334 | ) | (623 | ) | 1,025 | (83 | ) | |||||||
Net income (loss) | (372 | ) | (630 | ) | 941 | (119 | ) |
Note 8 — Shareholders’ Equity
The Company measures and recognizes
compensation expense for share-based payment (“SBP”) awards based on their fair
values. The fair value of SBP awards for which employees render the requisite
service necessary for the award to vest is recognized over the related vesting
period.
17
The aggregate cost of SBP awards charged
to earnings for the three and six months ended August 1, 2010 and August 2, 2009
is set forth in the following table. The Company did not realize any excess tax
benefits from the exercise of stock options or the vesting of restricted stock
or restricted stock units during either period.
Three Months Ended | Six Months Ended | ||||||||||
August 1, | August 2, | August 1, | August 2, | ||||||||
2010 | 2009 | 2010 | 2009 | ||||||||
(In thousands) | |||||||||||
Costs charged to earnings related to: | |||||||||||
Stock options | $ | 140 | $ | 234 | $ | 504 | $ | 466 | |||
Restricted stock and restricted stock units | 725 | 720 | 1,430 | 1,604 | |||||||
Total costs | $ | 865 | $ | 954 | $ | 1,934 | $ | 2,070 | |||
Costs included in: | |||||||||||
Direct operating expenses | $ | 399 | $ | 377 | $ | 788 | $ | 722 | |||
General and administrative expenses | 466 | 577 | 1,146 | 1,348 | |||||||
Total costs | $ | 865 | $ | 954 | $ | 1,934 | $ | 2,070 | |||
Note 9 — Fair Value Measurements
The accounting standards for fair
value measurements define fair value as the price that would be received for an
asset or paid to transfer a liability in the principal or most advantageous
market for the asset or liability in an orderly transaction between market
participants at the measurement date. These standards are intended to establish
a common definition of fair value to be used throughout GAAP, which is expected
to make the measurement of fair value more consistent and comparable.
The accounting standards for fair value
measurements establish a three-level fair value hierarchy that prioritizes the
inputs used to measure fair value. This hierarchy requires entities to maximize
the use of observable inputs and minimize the use of unobservable inputs. The
three levels of inputs used to measure fair value are as follows:
- Level 1 - Quoted prices
in active markets that are accessible at the measurement date for identical
assets or liabilities.
- Level 2 - Observable
inputs other than quoted prices included within Level 1, such as quoted prices
for similar assets and liabilities in active markets; quoted prices for
identical or similar assets and liabilities in markets that are not active; or
other inputs that are observable or can be corroborated by observable market
data.
- Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value measurement of the assets or liabilities. These include certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
Adoption of these accounting standards
had no material effect on the Company’s financial position or results of
operations.
18
Assets and Liabilities Measured at
Fair Value on a Recurring Basis
The following table presents the
Company’s assets and liabilities that are measured at fair value on a recurring
basis at August 1, 2010 and January 31, 2010.
August 1, 2010 | |||||||||
Level 1 | Level 2 | Level 3 | |||||||
(In thousands) | |||||||||
Assets: | |||||||||
401(k) mirror plan assets | $ | 646 | $ | - | $ | - | |||
Commodity futures contracts | 156 | - | - | ||||||
Total assets | $ | 802 | $ | - | $ | - | |||
January 31, 2010 | |||||||||
Level 1 | Level 2 | Level 3 | |||||||
(In thousands) | |||||||||
Assets: | |||||||||
401(k) mirror plan assets | $ | 455 | $ | - | $ | - | |||
Liabilities: | |||||||||
Interest rate derivatives | $ | - | $ | 641 | $ | - | |||
Commodity futures contracts | 92 | - | - | ||||||
Total liabilities | $ | 92 | $ | 641 | $ | - | |||
Assets and Liabilities Measured at
Fair Value on a Non-Recurring Basis
The following tables present the
nonrecurring fair value measurements recorded during the three and six months
ended August 1, 2010 and August 2, 2009.
19
Three Months Ended August 1, 2010 | |||||||||||||
Level 1 | Level 2 | Level 3 | Total gain (loss) | ||||||||||
(In thousands) | |||||||||||||
Long-lived assets | $ | - | $ | 1,500 | $ | - | $ | (50 | ) | ||||
Lease termination liabilities | $ | - | $ | 394 | $ | - | $ | 250 | |||||
Six Months Ended August 1, 2010 | |||||||||||||
Level 1 | Level 2 | Level 3 | Total gain (loss) | ||||||||||
(In thousands) | |||||||||||||
Long-lived assets | $ | - | $ | 3,638 | $ | - | $ | (899 | ) | ||||
Lease termination liabilities | $ | - | $ | 394 | $ | - | $ | 250 | |||||
Three Months Ended August 2, 2009 | |||||||||||||
Level 1 | Level 2 | Level 3 | Total gain (loss) | ||||||||||
(In thousands) | |||||||||||||
Long-lived assets | $ | - | $ | 2,798 | $ | - | $ | (1,058 | ) | ||||
Investment in Equity Method Franchisee | $ | - | $ | - | $ | 700 | $ | (500 | ) | ||||
Lease termination liabilities | $ | - | $ | 134 | $ | - | $ | 416 | |||||
Six Months Ended August 2, 2009 | |||||||||||||
Level 1 | Level 2 | Level 3 | Total gain (loss) | ||||||||||
(In thousands) | |||||||||||||
Long-lived assets | $ | - | $ | 2,798 | $ | - | $ | (1,220 | ) | ||||
Investment in Equity Method Franchisee | $ | - | $ | - | $ | 700 | $ | (500 | ) | ||||
Lease termination liabilities | $ | - | $ | 2,215 | $ | - | $ | (1,475 | ) |
Long-Lived
Assets
During the three and six months
ended August 1, 2010, long-lived assets with an aggregate carrying value of $1.6
million and $4.5 million, respectively, were written down to their estimated
fair values of $1.5 million and $3.6 million, respectively, resulting
in recorded impairment charges of $50,000 and $899,000, respectively.
During the three and six months ended August 2, 2009, long-lived assets having
an aggregate carrying value of $3.9 million and $4.0 million, respectively, were
written down to their estimated fair values of $2.8 million, resulting in
recorded impairment charges of $1.1 million and $1.2 million, respectively.
Substantially all of such long-lived assets were real properties, the fair
values of which were estimated based on independent appraisals or, in the case
of properties which the Company currently is negotiating to sell, based on the
Company’s negotiations with unrelated third-party buyers. These inputs are
classified as Level 2 within the valuation hierarchy.
Investment in Equity
Method Franchisee
During the three months ended August
2, 2009, the Company concluded that a decline in the value of an Equity Method
Franchisee was other than temporary and, accordingly, recorded a writedown of
$500,000 to reduce the carrying value of the investment to its estimated fair
value of $700,000 as described in Note 7. The fair value of the investment was
estimated based upon a multiple of the investee’s current normalized trailing
earnings before interest, income taxes and depreciation and amortization. These
inputs are classified as Level 3 within the valuation hierarchy.
20
Lease Termination
Liabilities
During the three and six months
ended August 1, 2010 and August 2, 2009, the Company recorded provisions for
lease termination costs related to closed stores based upon the estimated fair
values of the liabilities under unexpired leases as described in Note 5; such
provisions were reduced by previously recorded accrued rent expense related to
those stores. The fair value of these liabilities was computed as the excess, if
any, of the contractual payments required under the unexpired leases over the
current market lease rates for the properties, discounted at a credit-adjusted
risk-free rate over the remaining term of the leases. These inputs are
classified as Level 2 within the valuation hierarchy. For the three and six
months ended August 1, 2010, $644,000 of previously recorded accrued rent
expense related to a store closure and a store relocation exceeded the
$394,000 fair value of lease termination liabilities related to such stores, and
such excess has been reflected as a credit to lease termination costs during the
period. For the three months ended August 2, 2009, $550,000 of previously
recorded accrued rent expense related to closed stores exceeded the $134,000
fair value of lease termination liabilities related to such stores, and such
excess was reflected as a credit to lease termination costs during the period.
For the six months ended August 2, 2009, the fair value of lease termination
liabilities related to closed stores of $2.2 million exceeded the $740,000 of
previously recorded accrued rent expense related to such stores, and such excess
was reflected as a charge to lease termination costs during the
period.
Fair Values of Financial Instruments
at the Balance Sheet Dates
The carrying values and approximate
fair values of certain financial instruments as of August 1, 2010 and January
31, 2010 were as follows:
August 1, 2010 | January 31, 2010 | |||||||||||
Carrying | Fair | Carrying | Fair | |||||||||
Value | Value | Value | Value | |||||||||
(In thousands) | ||||||||||||
Assets: | ||||||||||||
Cash and cash equivalents | $ | 21,235 | $ | 21,235 | $ | 20,215 | $ | 20,215 | ||||
Receivables | 19,172 | 19,172 | 17,839 | 17,839 | ||||||||
Receivables from Equity Method Franchisees | 604 | 604 | 524 | 524 | ||||||||
Commodity futures contracts | 156 | 156 | - | - | ||||||||
Liabilities: | ||||||||||||
Accounts payable | 6,100 | 6,100 | 6,708 | 6,708 | ||||||||
Interest rate derivatives | - | - | 641 | 641 | ||||||||
Commodity futures contracts | - | - | 92 | 92 | ||||||||
Long-term debt (including current maturities) | 41,867 | 40,611 | 43,447 | 41,872 |
Note 10 — Derivative
Instruments
The Company is exposed to certain
risks relating to its ongoing business operations. The primary risks managed by
using derivative instruments are commodity price risk and interest rate risk.
The Company does not hold or issue derivative instruments for trading
purposes.
The Company was exposed to credit-related
losses in the event of non-performance by the counterparties to its derivative
instruments which expired in April 2010. The Company mitigated this risk of
nonperformance by dealing with highly rated counterparties.
Additional disclosure about the fair
value of derivative instruments is included in Note 9.
21
Commodity Price
Risk
The Company is exposed to the effects of
commodity price fluctuations in the cost of ingredients of its products, of
which flour, sugar and shortening are the most significant. In order to bring
greater stability to the cost of ingredients, the Company purchases, from time
to time, exchange-traded commodity futures contracts, and options on such
contracts, for raw materials which are ingredients of its products or which are
components of such ingredients, including wheat and soybean oil. The Company is
also exposed to the effects of commodity price fluctuations in the cost of
gasoline used by its delivery vehicles. To mitigate the risk of fluctuations in
the price of its gasoline purchases, the Company may purchase exchange-traded
commodity futures contracts and options on such contracts. The difference
between the cost, if any, and the fair value of commodity derivatives is
reflected in earnings because the Company has not designated any of these
instruments as hedges. Gains and losses on these contracts are intended to
offset losses and gains on the hedged transactions in an effort to reduce the
earnings volatility resulting from fluctuating commodity prices. The settlement
of commodity derivative contracts is reported in the consolidated statement of
cash flows as cash flow from operating activities. At August 1, 2010, the
Company had commodity derivatives with an aggregate contract volume of 90,000
bushels of wheat and 630,000 gallons of gasoline. Other than the requirement to
meet minimum margin requirements with respect to the commodity derivatives,
there are no collateral requirements related to such contracts.
Interest Rate
Risk
All of the borrowings under the Company’s
secured credit facilities bear interest at variable rates based upon either the
Fed funds rate or LIBOR, with LIBOR subject to a floor of 3.25%. The interest
cost of the Company’s debt may be affected by changes in these short-term
interest rates and increases in those rates may adversely affect the Company’s
results of operations. On May 16, 2007, the Company entered into interest rate
derivative contracts having an aggregate notional principal amount of $60
million. The derivative contracts entitled the Company to receive from the
counterparties the excess, if any, of three-month LIBOR over 5.40%, and required
the Company to pay to the counterparties the excess, if any, of 4.48% over
three-month LIBOR, in each case multiplied by the notional amount of the
contracts. The contracts expired in April 2010. Settlements under these
derivative contracts are reported as cash flow from operating activities in the
consolidated statement of cash flows.
These derivatives were accounted for as
cash flow hedges from their inception through April 8, 2008. Hedge accounting
was discontinued on that date because the derivative contracts could no longer
be shown to be effective in hedging interest rate risk as a result of amendments
to the Company’s Secured Credit Facilities, which provided that interest on
LIBOR-based borrowings is payable based upon the greater of the LIBOR rate for
the selected interest period or 3.25%. As a consequence of the discontinuance of
hedge accounting, changes in the fair value of the derivative contracts
subsequent to April 8, 2008 were reflected in earnings as they occurred. Amounts
included in accumulated other comprehensive income related to changes in the
fair value of the derivative contracts for periods prior to April 9, 2008 were
charged to earnings in the periods in which the hedged forecasted transaction
(interest on $60 million of the principal balance of the Term Loan) affected
earnings, or earlier upon a determination that some or all of the forecasted
transaction would not occur. The derivative contracts expired in April 2010;
thus, no such charges were recorded during the three months ended August 1,
2010. Such charges totaled approximately $152,000 for the six months ended
August 1, 2010, and $263,000 and $666,000 for the three and six months ended
August 2, 2009, respectively.
22
Quantitative Summary of Derivative
Positions and Their Effect on Results of Operations
The following table presents the fair
values of derivative instruments included in the consolidated balance sheet as
of August 1, 2010 and January 31, 2010:
Asset Derivatives | ||||||||
Fair Value | ||||||||
August 1, | January 31, | |||||||
Derivatives Not Designated as Hedging Instruments | Balance Sheet Location | 2010 | 2010 | |||||
(In thousands) | ||||||||
Commodity futures contracts | Other current assets | $ | 156 | $ | - | |||
Liability Derivatives | ||||||||
Fair Value | ||||||||
August 1, | January 31, | |||||||
Derivatives Not Designated as Hedging Instruments | Balance Sheet Location | 2010 | 2010 | |||||
(In thousands) | ||||||||
Interest rate contracts | Accrued liabilities | $ | - | $ | 641 | |||
Commodity futures contracts | Accrued liabilities | - | 92 | |||||
$ | - | $ | 733 | |||||
The effect of derivative instruments
on the consolidated statement of operations for the three and six months ended
August 1, 2010 and August 2, 2009, was as follows:
Derivatives Not Designated as | Location of Derivative Gain or | |||||||||||||||
Hedging Instruments | (Loss) Recognized in Income | Amount of Derivative Gain or (Loss) Recognized in Income | ||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
(In thousands) | ||||||||||||||||
Interest rate contracts | Interest expense | $ | - | $ | (232 | ) | $ | - | $ | (419 | ) | |||||
Commodity futures contracts | Direct operating expenses | 19 | (324 | ) | 371 | (398 | ) | |||||||||
Total | $ | 19 | $ | (556 | ) | $ | 371 | $ | (817 | ) | ||||||
23
Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
The following discussion of the
Company’s financial condition and results of operations should be read in
conjunction with the consolidated financial statements and notes thereto
appearing elsewhere herein.
Results of
Operations
The following table sets forth
operating metrics for the three and six months ended August 1, 2010 and
August 2, 2009.
Three Months Ended | Six Months Ended | |||||||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Same Store Sales (on-premises sales only): | ||||||||||||||||
Company stores | 5.7 | % | 5.9 | % | 4.5 | % | 3.8 | % | ||||||||
Domestic Franchise stores | 5.0 | 0.6 | 3.8 | 1.5 | ||||||||||||
International Franchise stores | (11.4 | ) | (32.6 | ) | (9.5 | ) | (35.2 | ) | ||||||||
International Franchise stores, in constant dollars(1) | (14.3 | ) | (25.0 | ) | (16.0 | ) | (24.8 | ) | ||||||||
Off-Premises Metrics (Company stores only): | ||||||||||||||||
Average weekly number of doors served: | ||||||||||||||||
Grocers/mass merchants | 5,695 | 5,600 | 5,597 | 5,729 | ||||||||||||
Convenience stores | 5,139 | 5,266 | 5,095 | 5,445 | ||||||||||||
Average weekly sales per door: | ||||||||||||||||
Grocers/mass merchants | $ | 263 | $ | 246 | $ | 263 | $ | 241 | ||||||||
Convenience stores | 206 | 208 | 207 | 210 | ||||||||||||
Systemwide Sales (in thousands):(2) | ||||||||||||||||
Company stores | $ | 59,602 | $ | 59,634 | $ | 121,790 | $ | 125,270 | ||||||||
Domestic Franchise stores | 58,797 | 54,050 | 121,275 | 112,050 | ||||||||||||
International Franchise stores | 77,237 | 62,658 | 151,811 | 124,223 | ||||||||||||
International Franchise stores, in constant dollars(3) | 77,237 | 64,477 | 151,811 | 132,810 | ||||||||||||
Average Weekly Sales Per Store (in thousands):(4) (5) | ||||||||||||||||
Company stores: | ||||||||||||||||
Factory stores: | ||||||||||||||||
Commissaries — off-premises | $ | 169.5 | $ | 153.9 | $ | 171.5 | $ | 160.3 | ||||||||
Dual-channel stores: | ||||||||||||||||
On-premises | 27.1 | 25.4 | 29.3 | 27.9 | ||||||||||||
Off-premises | 39.2 | 37.1 | 38.9 | 36.7 | ||||||||||||
Total | 66.3 | 62.5 | 68.2 | 64.5 | ||||||||||||
On-premises only stores | 31.1 | 30.6 | 32.5 | 32.8 | ||||||||||||
All factory stores | 63.1 | 59.9 | 64.6 | 62.6 | ||||||||||||
Satellite stores | 17.7 | 16.7 | 18.2 | 18.2 | ||||||||||||
All stores | 55.6 | 54.3 | 57.0 | 56.9 | ||||||||||||
Domestic Franchise stores: | ||||||||||||||||
Factory stores | $ | 40.0 | $ | 36.7 | $ | 40.8 | $ | 38.2 | ||||||||
Satellite stores | 12.2 | 15.4 | 12.6 | 16.4 | ||||||||||||
International Franchise stores: | ||||||||||||||||
Factory stores | $ | 39.6 | $ | 34.8 | $ | 39.7 | $ | 35.7 | ||||||||
Satellite stores | 8.6 | 9.0 | 8.8 | 9.0 |
24
(1) | Represents the change in International Franchise same store sales computed by reconverting franchise store sales in each foreign currency to U.S. dollars at a constant rate of exchange for all periods. | |
(2) | Excludes sales among Company and franchise stores. | |
(3) | Represents International Franchise store sales computed by reconverting International Franchise store sales for the three and six months ended August 2, 2009 to U.S. dollars based upon the weighted average of the exchange rates prevailing in the three and six months ended August 1, 2010. | |
(4) | Includes sales between Company and franchise stores. | |
(5) | Metrics for the three and six months ended August 1, 2010 include only stores open at August 1, 2010 and metrics for the three and six months ended August 2, 2009 include only stores open at January 31, 2010. |
The change in “same store sales” is
computed by dividing the aggregate on-premises sales (including fundraising
sales) during the current year period for all stores which had been open for
more than 56 consecutive weeks during the current year (but only to the extent
such sales occurred in the 57th or later week of each
store’s operation) by the aggregate on-premises sales of such stores for the
comparable weeks in the preceding year. Once a store has been open for at least
57 consecutive weeks, its sales are included in the computation of same store
sales for all subsequent periods. In the event a store is closed temporarily
(for example, for remodeling) and has no sales during one or more weeks, such
store’s sales for the comparable weeks during the earlier or subsequent period
are excluded from the same store sales computation.
For off-premises sales, “average weekly
number of doors” represents the average number of customer locations to which
product deliveries were made during a week, and “average weekly sales per door”
represents the average weekly sales to each such location.
Systemwide sales, a non-GAAP financial
measure, include sales by both Company and franchise stores. The Company
believes systemwide sales data are useful in assessing the overall performance
of the Krispy Kreme brand and, ultimately, the performance of the Company. The
Company’s consolidated financial statements appearing elsewhere herein include
sales by Company stores, sales to franchisees by the KK Supply Chain business
segment, and royalties and fees received from franchise stores based on their
sales, but exclude sales by franchise stores to their customers.
The following table sets forth data about
the number of systemwide stores as of August 1, 2010 and August 2,
2009.
August 1, | August 2, | |||
2010 | 2009 | |||
Number of Stores Open At Period End: | ||||
Company stores: | ||||
Factory: | ||||
Commissaries | 6 | 6 | ||
Dual-channel stores | 38 | 45 | ||
On-premises only stores | 25 | 26 | ||
Satellite stores | 15 | 12 | ||
Total Company stores | 84 | 89 | ||
Domestic Franchise stores: | ||||
Factory stores | 102 | 100 | ||
Satellite stores | 38 | 33 | ||
Total Domestic Franchise stores | 140 | 133 | ||
International Franchise stores: | ||||
Factory stores | 103 | 93 | ||
Satellite stores | 306 | 233 | ||
Total International Franchise stores | 409 | 326 | ||
Total systemwide stores | 633 | 548 | ||
The following table sets forth data
about the number of store operating weeks for the three and six months ended
August 1, 2010 and August 2, 2009.
25
Three Months Ended | Six Months Ended | |||||||
August 1, | August 2, | August 1, | August 2, | |||||
2010 | 2009 | 2010 | 2009 | |||||
Store Operating Weeks: | ||||||||
Company stores: | ||||||||
Factory stores: | ||||||||
Commissaries | 82 | 78 | 160 | 156 | ||||
Dual-channel stores | 494 | 675 | 988 | 1,385 | ||||
On-premises only stores | 325 | 312 | 650 | 611 | ||||
Satellite stores | 182 | 135 | 364 | 257 | ||||
Domestic Franchise stores:(1) | ||||||||
Factory stores | 1,330 | 1,313 | 2,669 | 2,625 | ||||
Satellite stores | 463 | 360 | 918 | 646 | ||||
International Franchise stores:(1) | ||||||||
Factory stores | 1,108 | 1,066 | 2,164 | 2,134 | ||||
Satellite stores | 3,894 | 2,711 | 7,493 | 5,110 |
(1) | Metrics for the three and six months ended August 1, 2010 include only stores open at August 1, 2010 and metrics for the three and six months ended August 2, 2009 include only stores open at January 31, 2010. |
The following table sets forth the
types and locations of Company stores as of August 1, 2010.
Number of Company Stores | ||||||||
Factory | ||||||||
State | Stores | Hot Shops | Fresh Shops | Total | ||||
Alabama | 3 | - | - | 3 | ||||
District of Columbia | - | 1 | - | 1 | ||||
Florida | 4 | - | - | 4 | ||||
Georgia | 6 | 4 | - | 10 | ||||
Indiana | 3 | 1 | - | 4 | ||||
Kansas | 3 | - | - | 3 | ||||
Kentucky | 3 | 1 | - | 4 | ||||
Louisiana | 1 | - | - | 1 | ||||
Maryland | 2 | - | - | 2 | ||||
Michigan | 3 | - | - | 3 | ||||
Missouri | 4 | - | - | 4 | ||||
Mississippi | 1 | - | - | 1 | ||||
North Carolina | 11 | 1 | 2 | 14 | ||||
Ohio | 6 | - | - | 6 | ||||
South Carolina | 2 | 1 | - | 3 | ||||
Tennessee | 7 | 4 | - | 11 | ||||
Texas | 3 | - | - | 3 | ||||
Virginia | 6 | - | - | 6 | ||||
West Virginia | 1 | - | - | 1 | ||||
Total | 69 | 13 | 2 | 84 | ||||
Changes in the number of Company
stores during the three and six months ended August 1, 2010 and August 2, 2009
are summarized in the table below.
26
Number of Company Stores | |||||||||||
Factory | |||||||||||
Stores | Hot Shops | Fresh Shops | Total | ||||||||
Three months ended August 1, 2010 | |||||||||||
May 2, 2010 | 69 | 12 | 2 | 83 | |||||||
Opened | - | 2 | - | 2 | |||||||
Closed | - | (1 | ) | - | (1 | ) | |||||
August 1, 2010 | 69 | 13 | 2 | 84 | |||||||
Six months ended August 1, 2010 | |||||||||||
January 31, 2010 | 69 | 12 | 2 | 83 | |||||||
Opened | - | 2 | - | 2 | |||||||
Closed | - | (1 | ) | - | (1 | ) | |||||
August 1, 2010 | 69 | 13 | 2 | 84 | |||||||
Three months ended August 2, 2009 | |||||||||||
May 3, 2009 | 80 | 11 | - | 91 | |||||||
Opened | - | - | 1 | 1 | |||||||
Closed | (2 | ) | (1 | ) | - | (3 | ) | ||||
Change in store type | (1 | ) | 1 | - | - | ||||||
August 2, 2009 | 77 | 11 | 1 | 89 | |||||||
Six months ended August 2, 2009 | |||||||||||
February 1, 2009 | 83 | 10 | - | 93 | |||||||
Opened | 1 | 1 | 1 | 3 | |||||||
Closed | (6 | ) | (1 | ) | - | (7 | ) | ||||
Change in store type | (1 | ) | 1 | - | - | ||||||
August 2, 2009 | 77 | 11 | 1 | 89 | |||||||
The following table sets forth the
types and locations of domestic franchise stores as of August 1, 2010.
27
Number of Domestic Franchise Stores | ||||||||
Factory | ||||||||
State | Stores | Hot Shops | Fresh Shops | Total | ||||
Alabama | 5 | 2 | - | 7 | ||||
Arkansas | 2 | - | - | 2 | ||||
Arizona | 2 | - | 9 | 11 | ||||
California | 11 | - | 3 | 14 | ||||
Connecticut | 1 | - | 3 | 4 | ||||
Colorado | 2 | - | - | 2 | ||||
Florida | 11 | 5 | 1 | 17 | ||||
Georgia | 7 | 4 | - | 11 | ||||
Hawaii | 1 | - | - | 1 | ||||
Iowa | 1 | - | - | 1 | ||||
Idaho | 1 | - | - | 1 | ||||
Illinois | 4 | - | - | 4 | ||||
Louisiana | 3 | - | - | 3 | ||||
Missouri | 3 | - | - | 3 | ||||
Mississippi | 2 | - | - | 2 | ||||
North Carolina | 6 | 1 | - | 7 | ||||
Nebraska | 1 | - | - | 1 | ||||
New Mexico | 1 | - | 1 | 2 | ||||
Nevada | 3 | 1 | 2 | 6 | ||||
Oklahoma | 3 | - | - | 3 | ||||
Oregon | 2 | - | - | 2 | ||||
Pennsylvania | 4 | 1 | 1 | 6 | ||||
South Carolina | 6 | 1 | 2 | 9 | ||||
Tennessee | 1 | - | - | 1 | ||||
Texas | 8 | - | 1 | 9 | ||||
Utah | 2 | - | - | 2 | ||||
Wisconsin | 1 | - | - | 1 | ||||
Washington | 8 | - | - | 8 | ||||
Total | 102 | 15 | 23 | 140 | ||||
Changes in the number of domestic
franchise stores during the three and six months ended August 1, 2010 and August
2, 2009 are summarized in the table below.
28
Number of Domestic Franchise Stores | ||||||||||||
Factory | ||||||||||||
Stores | Hot Shops | Fresh Shops | Total | |||||||||
Three months ended August 1, 2010 | ||||||||||||
May 2, 2010 | 103 | 14 | 23 | 140 | ||||||||
Opened | - | 1 | 1 | 2 | ||||||||
Closed | (1 | ) | - | (1 | ) | (2 | ) | |||||
August 1, 2010 | 102 | 15 | 23 | 140 | ||||||||
Six months ended August 1, 2010 | ||||||||||||
January 31, 2010 | 104 | 14 | 23 | 141 | ||||||||
Opened | - | 1 | 1 | 2 | ||||||||
Closed | (2 | ) | - | (1 | ) | (3 | ) | |||||
August 1, 2010 | 102 | 15 | 23 | 140 | ||||||||
Three months ended August 2, 2009 | ||||||||||||
May 3, 2009 | 102 | 13 | 15 | 130 | ||||||||
Opened | - | - | 4 | 4 | ||||||||
Closed | (1 | ) | - | - | (1 | ) | ||||||
Change in store type | (1 | ) | (1 | ) | 2 | - | ||||||
August 2, 2009 | 100 | 12 | 21 | 133 | ||||||||
Six months ended August 2, 2009 | ||||||||||||
February 1, 2009 | 104 | 13 | 15 | 132 | ||||||||
Opened | - | - | 5 | 5 | ||||||||
Closed | (3 | ) | - | (1 | ) | (4 | ) | |||||
Change in store type | (1 | ) | (1 | ) | 2 | - | ||||||
August 2, 2009 | 100 | 12 | 21 | 133 | ||||||||
The types and locations of
international franchise stores as of August 1, 2010 are summarized in the table
below.
29
Number of International Franchise Stores | ||||||||||
Factory | ||||||||||
Country | Stores | Hot Shops | Fresh Shops | Kiosks | Total | |||||
Australia | 6 | 4 | 24 | 20 | 54 | |||||
Bahrain | 2 | - | 2 | 5 | 9 | |||||
Canada | 4 | - | - | - | 4 | |||||
China | 1 | - | - | - | 1 | |||||
Indonesia | 2 | - | 2 | 3 | 7 | |||||
Japan | 12 | - | 6 | - | 18 | |||||
Kuwait | 3 | - | 23 | 2 | 28 | |||||
Lebanon | 2 | - | 6 | 3 | 11 | |||||
Malaysia | 2 | 1 | 1 | - | 4 | |||||
Mexico | 5 | 1 | 22 | 20 | 48 | |||||
Philippines | 4 | 3 | 11 | 1 | 19 | |||||
The Commonwealth of Puerto Rico | 3 | - | - | - | 3 | |||||
Qatar | 2 | - | 3 | 1 | 6 | |||||
The Republic of Korea | 31 | 1 | 8 | - | 40 | |||||
The Kingdom of Saudi Arabia | 10 | - | 60 | 9 | 79 | |||||
Turkey | 1 | - | 10 | 2 | 13 | |||||
The United Arab Emirates | 2 | - | 16 | 4 | 22 | |||||
The United Kingdom | 11 | 4 | 20 | 8 | 43 | |||||
Total | 103 | 14 | 214 | 78 | 409 | |||||
Changes in the number of
international franchise stores during the three and six months ended August 1,
2010 and August 2, 2009 are summarized in the table below.
30
Number of International Franchise Stores | |||||||||||||||
Factory | |||||||||||||||
Stores | Hot Shops | Fresh Shops | Kiosks | Total | |||||||||||
Three months ended August 1, 2010 | |||||||||||||||
May 2, 2010 | 100 | 14 | 201 | 78 | 393 | ||||||||||
Opened | 4 | - | 14 | - | 18 | ||||||||||
Closed | (1 | ) | - | (1 | ) | - | (2 | ) | |||||||
August 1, 2010 | 103 | 14 | 214 | 78 | 409 | ||||||||||
Six months ended August 1, 2010 | |||||||||||||||
January 31, 2010 | 95 | 14 | 180 | 69 | 358 | ||||||||||
Opened | 11 | - | 38 | 10 | 59 | ||||||||||
Closed | (3 | ) | - | (4 | ) | (1 | ) | (8 | ) | ||||||
August 1, 2010 | 103 | 14 | 214 | 78 | 409 | ||||||||||
Three months ended August 2, 2009 | |||||||||||||||
May 3, 2009 | 95 | 24 | 146 | 50 | 315 | ||||||||||
Opened | - | 2 | 10 | 4 | 16 | ||||||||||
Closed | (2 | ) | - | (2 | ) | (1 | ) | (5 | ) | ||||||
August 2, 2009 | 93 | 26 | 154 | 53 | 326 | ||||||||||
Six months ended August 2, 2009 | |||||||||||||||
February 1, 2009 | 94 | 26 | 126 | 52 | 298 | ||||||||||
Opened | 3 | 2 | 29 | 5 | 39 | ||||||||||
Closed | (4 | ) | - | (3 | ) | (4 | ) | (11 | ) | ||||||
Change in store type | - | (2 | ) | 2 | - | - | |||||||||
August 2, 2009 | 93 | 26 | 154 | 53 | 326 | ||||||||||
Three months ended August 1, 2010
compared to three months ended August 2, 2009
Overview
Total revenues rose by 6.3% for the
three months ended August 1, 2010 compared to the three months ended August 2,
2009. The Company refranchised three stores in Northern California and one store
in South Carolina in fiscal 2010. Those refranchisings had the effect of
reducing consolidated revenues because the sales of these refranchised stores
(which are no longer reported as revenues by the Company) exceed the royalties
and KK Supply Chain sales recorded by the Company subsequent to the
refranchisings. Excluding the Company’s revenues related to the refranchised
stores in both periods, total revenues rose 8.2% in the three months ended
August 1, 2010 compared to the three months ended August 2, 2009.
A reconciliation of total revenues
as reported to adjusted total revenues exclusive of the effects of refranchising
follows:
Three Months Ended | |||||||
August 1, | August 2, | ||||||
2010 | 2009 | ||||||
(In thousands) | |||||||
Total revenues as reported | $ | 87,932 | $ | 82,730 | |||
Sales by refranchised stores(1) | - | (2,205 | ) | ||||
Royalties from refranchised stores(1) | (80 | ) | - | ||||
KK Supply Chain sales to refranchised stores(1) | (688 | ) | - | ||||
Adjusted total revenues exclusive of the effects of refranchising | $ | 87,164 | $ | 80,525 | |||
(1) | Adjustments reflect amounts only for stores refranchised in fiscal 2010 because earlier refranchisings do no affect comparability between the periods presented. |
31
The Company believes that adjusted
total revenues exclusive of the effects of refranchising, a non-GAAP measure, is
a useful measure because it enables comparisons of the Company’s revenues that
are unaffected by the Company’s decisions to sell operating Krispy Kreme stores
to franchisees instead of continuing to operate the stores as Company locations.
In addition, this comparison is one of the performance metrics adopted by the
compensation committee of the Company’s board of directors to determine the
amount of incentive compensation potentially payable to the Company’s executive
officers for fiscal 2011.
Consolidated operating income
increased from $2.9 million in the three months ended August 2, 2009 to $4.2
million in the three months ended August 1, 2010. Consolidated net income
increased to $2.2 million in the three months ended August 1, 2010 from a net
loss of $157,000 in the three months ended August 2, 2009.
Revenues by business segment
(expressed in dollars and as a percentage of total revenues) are set forth in
the table below (percentage amounts may not add to totals due to rounding).
Three Months Ended | |||||||
August 1, | August 2, | ||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Revenues by business segment: | |||||||
Company Stores | $ | 59,970 | $ | 59,853 | |||
Domestic Franchise | 2,074 | 1,802 | |||||
International Franchise | 4,009 | 3,806 | |||||
KK Supply Chain: | |||||||
Total revenues | 44,892 | 37,754 | |||||
Less - intersegment sales elimination | (23,013 | ) | (20,485 | ) | |||
External KK Supply Chain revenues | 21,879 | 17,269 | |||||
Total revenues | $ | 87,932 | $ | 82,730 | |||
Segment revenues as a percentage of total revenues: | |||||||
Company Stores | 68.2 | % | 72.3 | % | |||
Domestic Franchise | 2.4 | 2.2 | |||||
International Franchise | 4.6 | 4.6 | |||||
KK Supply Chain (external sales) | 24.9 | 20.9 | |||||
100.0 | % | 100.0 | % | ||||
Operating income (loss): | |||||||
Company Stores | $ | (1,734 | ) | $ | 1,387 | ||
Domestic Franchise | 1,041 | 434 | |||||
International Franchise | 2,500 | 1,943 | |||||
KK Supply Chain | 7,329 | 5,687 | |||||
Total segment operating income | 9,136 | 9,451 | |||||
Unallocated general and administrative expenses | (5,197 | ) | (5,052 | ) | |||
Impairment charges and lease termination costs | 216 | (1,456 | ) | ||||
Consolidated operating income | $ | 4,155 | $ | 2,943 | |||
A discussion of the revenues and
operating results of each of the Company’s four business segments follows,
together with a discussion of income statement line items not associated with
specific segments.
Company Stores
The components of Company Stores
revenues and expenses (expressed in dollars and as a percentage of total
revenues) are set forth in the table below (percentage amounts may not add to
totals due to rounding).
32
Percentage of Total Revenues | ||||||||||||
Three Months Ended | Three Months Ended | |||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||
2010 | 2009 | 2010 | 2009 | |||||||||
(In thousands) | ||||||||||||
Revenues: | ||||||||||||
On-premises sales: | ||||||||||||
Retail sales | $ | 24,023 | $ | 25,022 | 40.1 | % | 41.8 | % | ||||
Fundraising sales | 2,707 | 2,553 | 4.5 | 4.3 | ||||||||
Total on-premises sales | 26,730 | 27,575 | 44.6 | 46.1 | ||||||||
Off-premises sales: | ||||||||||||
Grocers/mass merchants | 19,361 | 17,839 | 32.3 | 29.8 | ||||||||
Convenience stores | 13,232 | 13,894 | 22.1 | 23.2 | ||||||||
Other off-premises | 647 | 545 | 1.1 | 0.9 | ||||||||
Total off-premises sales | 33,240 | 32,278 | 55.4 | 53.9 | ||||||||
Total revenues | 59,970 | 59,853 | 100.0 | 100.0 | ||||||||
Operating expenses: | ||||||||||||
Cost of sales: | ||||||||||||
Food, beverage and packaging | 22,440 | 20,231 | 37.4 | 33.8 | ||||||||
Shop labor | 12,261 | 11,956 | 20.4 | 20.0 | ||||||||
Delivery labor | 5,305 | 5,258 | 8.8 | 8.8 | ||||||||
Employee benefits | 4,185 | 4,543 | 7.0 | 7.6 | ||||||||
Total cost of sales | 44,191 | 41,988 | 73.7 | 70.2 | ||||||||
Vehicle costs(1) | 3,526 | 2,604 | 5.9 | 4.4 | ||||||||
Occupancy(2) | 2,365 | 2,650 | 3.9 | 4.4 | ||||||||
Utilities expense | 1,500 | 1,406 | 2.5 | 2.3 | ||||||||
Depreciation expense | 1,459 | 1,519 | 2.4 | 2.5 | ||||||||
Other operating expenses | 4,413 | 4,392 | 7.4 | 7.3 | ||||||||
Total store level costs | 57,454 | 54,559 | 95.8 | 91.2 | ||||||||
Store operating income | 2,516 | 5,294 | 4.2 | 8.8 | ||||||||
Other segment operating costs | 3,125 | 2,341 | 5.2 | 3.9 | ||||||||
Allocated corporate overhead | 1,125 | 1,566 | 1.9 | 2.6 | ||||||||
Segment operating income (loss) | $ | (1,734 | ) | $ | 1,387 | (2.9 | )% | 2.3 | % | |||
(1) | Includes fuel, maintenance and repairs, rent, taxes and other costs of operating the delivery fleet, exclusive of depreciation. |
(2) | Includes rent, property taxes, common area maintenance charges, insurance, building maintenance and other occupancy costs, exclusive of utilities and depreciation. |
A reconciliation of Company Store
segment sales from the second quarter of fiscal 2010 to the second quarter of
fiscal 2011 follows:
On-Premises | Off-Premises | Total | |||||||||
(In thousands) | |||||||||||
Sales for the three months ended August 2, 2009 | $ | 27,575 | $ | 32,278 | $ | 59,853 | |||||
Fiscal 2010 sales at refranchised stores | (1,521 | ) | (684 | ) | (2,205 | ) | |||||
Fiscal 2010 sales at closed stores | (1,532 | ) | (286 | ) | (1,818 | ) | |||||
Fiscal 2011 sales at closed stores | 72 | - | 72 | ||||||||
Increase in sales at mature stores (open stores only) | 1,281 | 1,932 | 3,213 | ||||||||
Increase in sales at stores opened in fiscal 2010 | 570 | - | 570 | ||||||||
Sales at new stores opened in fiscal 2011 | 285 | - | 285 | ||||||||
Sales for the three months ended August 1, 2010 | $ | 26,730 | $ | 33,240 | $ | 59,970 | |||||
33
Sales at Company Stores increased
0.2% in the second quarter of fiscal 2011 from the second quarter of fiscal 2010
due to an increase in sales from existing stores and stores opened in fiscal
2010 and fiscal 2011 partially offset by store closings and refranchisings.
Excluding the effects of refranchising, Company Stores sales increased 4.0%. The
following table presents sales metrics for Company stores:
Three Months Ended | |||||
August 1, | August 2, | ||||
2010 | 2009 | ||||
On-premises: | |||||
Change in same store sales | 5.7 | % | 5.9 | % | |
Off-premises: | |||||
Grocers/mass merchants: | |||||
Change in average weekly number of doors | 1.7 | % | (11.9 | )% | |
Change in average weekly sales per door | 6.9 | % | 11.8 | % | |
Convenience stores: | |||||
Change in average weekly number of doors | (2.4 | )% | (12.6 | )% | |
Change in average weekly sales per door | (1.0 | )% | (5.5 | )% |
On-premises sales
Same store sales at Company stores
rose 5.7% in the second quarter of fiscal 2011 over the second quarter of fiscal
2010, of which the Company estimates approximately 3.5 percentage points is
attributable to price increases.
The Company is implementing programs
intended to improve on-premise sales, including increased focus on local store
marketing efforts, improved employee training, store refurbishment efforts and
the introduction of new products.
Off-premises sales
Sales to grocers and mass merchants
increased to $19.4 million, with a 6.9% increase in average weekly sales per
door and a 1.7% increase in the average number of doors served. Convenience
store sales fell due to both a decline in the average number of doors served and
in the average weekly sales per door. Among other reasons, sales to convenience
stores have declined in the second quarter of fiscal 2011 as a result of a
large customer implementing an in-house doughnut program to replace the
Company’s products; the loss of doors associated with this customer accounted
for approximately 1.5 percentage points of the 2.4% decline in the average
number of convenience store doors served for the three months ended August 1,
2010. Declines in the average weekly sales per door adversely affect
profitability because of the increased significance of delivery costs in
relation to sales.
The Company started implementing
price increases for some products offered in the off-premises channel late in
the first quarter of fiscal 2011, and substantially completed implementing the
increases during the second quarter. Those price increases affect products
comprising approximately 30% of off-premises sales. The average price increase
on those products is approximately 8%.
The Company is implementing steps
intended to increase sales, increase average per door sales and reduce costs in
the off-premises channel. These steps include improved route management and
route consolidation (including elimination of or reduction in the number of
stops at relatively low volume doors), new sales incentives and
performance-based pay programs, increased emphasis on relatively longer
shelf-life products and the development of order management systems to more
closely match merchandised quantities and assortments with consumer
demand.
Costs and expenses
Cost of sales as a percentage of
revenues rose by 3.5 percentage points from the second quarter of fiscal 2010 to
73.7% of revenues in the second quarter of fiscal 2011. The cost of sugar rose
approximately 27% from the second quarter of fiscal 2010 as a result of price
increases implemented by KK Supply Chain to reflect the expiration of a
favorable sugar supply contract. In addition, the cost of shortening and
other ingredients also rose year over year. While on-premises and
off-premises price increases approximated the amount of the cost increases, the
substantially equal revenue and cost increases resulted in higher material cost
measured as a percentage of revenues. In addition to higher ingredient costs, an
increase in product returns in the off-premises channel also increased product
costs as a percentage of revenues.
The Company is implementing programs
intended to improve store operations and reduce costs as a percentage of
revenues, including improved employee training and the introduction of food and
labor cost management tools.
34
Vehicle costs as a percentage of
revenues rose 1.5 percentage points from 4.4% of revenues in the second quarter
of fiscal 2010 to 5.9% of revenues in the second quarter of fiscal 2011,
principally as a result of higher fuel costs. In addition, losses on gasoline
futures contracts entered into to mitigate the risk of increases in the price of
gasoline were approximately $150,000 in the second quarter of fiscal 2011
compared to a gain of approximately $120,000 in the second quarter of fiscal
2010. The Company also is replacing a portion of its aging fleet of delivery
trucks with newer leased trucks. Rental expense on leased delivery trucks
increased in the second quarter of fiscal 2011, which was partially offset by a
decrease in repairs and maintenance expense in the quarter. Favorable adjustments to
self-insurance reserves for vehicle liability claims in the second quarter of
fiscal 2010 were approximately $300,000 higher than in the second quarter of
fiscal 2011, as described below.
The Company is self-insured for
workers’ compensation, vehicle and general liability claims, but maintains
stop-loss coverage for individual claims exceeding certain amounts. The Company
provides for claims under these self-insured programs using actuarial methods as
described in the 2010 Form 10-K, and updates actuarial valuations of its
self-insurance reserves at least annually. Such periodic actuarial valuations
result in changes over time in the estimated amounts which ultimately will be
paid for claims under these programs to reflect the Company’s actual claims
experience for each policy year as well as trends in claims experience over
multiple years. Such claims, particularly workers’ compensation claims, often
are paid over a number of years following the year in which the insured events
occur, and the estimated ultimate cost of each year’s claims accordingly is
adjusted over time as additional information becomes available. The Company
updated the actuarial valuations of its self-insurance reserves during the
second quarter of fiscal 2011 and during the second quarter of fiscal 2010. The
Company recorded favorable adjustments to its self-insurance claims liabilities
related to prior policy years of approximately $690,000 in the second quarter of
fiscal 2011 and $1.2 million in the second quarter of fiscal 2010. Of the
$690,000 in favorable adjustments recorded in the second quarter of fiscal 2011,
approximately $640,000 relates to workers’ compensation liability claims and is
included in employee benefits in the table above and approximately $50,000
relates to vehicle liability claims and is included in vehicle costs in the
table above. Of the $1.2 million in favorable adjustments recorded in the second
quarter of fiscal 2010, approximately $560,000 relates to workers’ compensation
liability claims, approximately $350,000 relates to vehicle liability claims,
and approximately $240,000 relates to general liability claims and is included
in other operating expenses in the table above.
The Company Stores segment closed or
refranchised a total of 17 stores since the end of fiscal 2009, none of which
have been accounted for as discontinued operations because the Company continues
to have significant continuing involvement in the markets in which the stores
were or are located, through either continuing operations of other stores in or
serving the market or through its role as a franchisor. In order to assist
readers in understanding the results of operations of the Company’s ongoing
stores, the following table presents the components of revenues and expenses for
stores operated by the Company as of August 1, 2010, and excludes the revenues
and expenses for stores closed and refranchised prior to that date. Percentage
amounts may not add to totals due to rounding.
35
Stores in Operation at August 1, 2010 | |||||||||||||
Percentage of Total Revenues | |||||||||||||
Three Months Ended | Three Months Ended | ||||||||||||
August 1, | August 2, | August 1, | August 2, | ||||||||||
2010 | 2009 | 2010 | 2009 | ||||||||||
(In thousands) | |||||||||||||
Revenues: | |||||||||||||
On-premises sales: | |||||||||||||
Retail sales | $ | 23,957 | $ | 22,101 | 40.0 | % | 39.6 | % | |||||
Fundraising sales | 2,701 | 2,421 | 4.5 | 4.3 | |||||||||
Total on-premises sales | 26,658 | 24,522 | 44.5 | 43.9 | |||||||||
Off-premises sales: | |||||||||||||
Grocers/mass merchants | 19,361 | 17,209 | 32.3 | 30.8 | |||||||||
Convenience stores | 13,232 | 13,568 | 22.1 | 24.3 | |||||||||
Other off-premises | 647 | 531 | 1.1 | 1.0 | |||||||||
Total off-premises sales | 33,240 | 31,308 | 55.5 | 56.1 | |||||||||
Total revenues | 59,898 | 55,830 | 100.0 | 100.0 | |||||||||
Operating expenses: | |||||||||||||
Cost of sales: | |||||||||||||
Food, beverage and packaging | 22,410 | 18,892 | 37.4 | 33.8 | |||||||||
Shop labor | 12,219 | 10,898 | 20.4 | 19.5 | |||||||||
Delivery labor | 5,305 | 5,059 | 8.9 | 9.1 | |||||||||
Employee benefits | 4,174 | 4,097 | 7.0 | 7.3 | |||||||||
Total cost of sales | 44,108 | 38,946 | 73.6 | 69.8 | |||||||||
Vehicle costs | 3,522 | 2,461 | 5.9 | 4.4 | |||||||||
Occupancy | 2,236 | 2,209 | 3.7 | 4.0 | |||||||||
Utilities expense | 1,485 | 1,199 | 2.5 | 2.1 | |||||||||
Depreciation expense | 1,455 | 1,421 | 2.4 | 2.5 | |||||||||
Other operating expenses | 4,388 | 3,988 | 7.3 | 7.1 | |||||||||
Total store level costs | 57,194 | 50,224 | 95.5 | 90.0 | |||||||||
Store operating income - ongoing stores | 2,704 | 5,606 | 4.5 | % | 10.0 | % | |||||||
Store operating loss - closed and refranchised | (188 | ) | (312 | ) | |||||||||
Store operating income | $ | 2,516 | $ | 5,294 | |||||||||
36
Domestic
Franchise
Three Months Ended | |||||
August 1, | August 2, | ||||
2010 | 2009 | ||||
(In thousands) | |||||
Revenues: | |||||
Royalties | $ | 1,945 | $ | 1,748 | |
Development and franchise fees | 20 | - | |||
Other | 109 | 54 | |||
Total revenues | 2,074 | 1,802 | |||
Operating expenses: | |||||
Segment operating expenses | 878 | 1,238 | |||
Depreciation expense | 55 | 22 | |||
Allocated corporate overhead | 100 | 108 | |||
Total operating expenses | 1,033 | 1,368 | |||
Segment operating income | $ | 1,041 | $ | 434 | |
Domestic Franchise revenues
increased 15.1% to $2.1 million in the second quarter of fiscal 2011 from $1.8
million in the second quarter of fiscal 2010, driven by an increase in domestic
royalty revenues resulting from an increase in sales by domestic franchise
stores from approximately $54 million in the second quarter of fiscal 2010 to
$59 million in the second quarter of fiscal 2011. Approximately $2.5 million of the
increase in sales by domestic franchisees is the result of refranchising Company
stores. Domestic Franchise same store sales rose 5.0% in the second quarter of
fiscal 2011.
Domestic Franchise operating expenses
include costs to recruit new domestic franchisees, to assist in domestic store
openings, and to monitor and aid in the performance of domestic franchise
stores, as well as allocated corporate costs. The decrease in Domestic Franchise
operating expenses in the second quarter of fiscal 2011 compared to the second
quarter of fiscal 2010 reflects a decrease in bad debt provisions of
approximately $150,000 from the second quarter of fiscal 2010. Substantially all
of the prior year bad debt expense related principally to a single domestic
franchisee. Additionally, during the second quarter of fiscal 2010, the Company
recorded charges of approximately $150,000 to the Domestic Franchise segment for
the settlement of certain litigation.
Beginning in fiscal 2011, the Company
began allocating to the business segments the legal fees and expenses directly
related to their businesses; such costs were included in general and
administrative expenses in prior years and totaled approximately $120,000 in the
Domestic Franchise segment for the three months ended August 1, 2010.
Domestic franchisees opened two stores
and closed two stores in the second quarter of fiscal 2011. Royalty revenues are
directly related to sales by franchise stores and, accordingly, the success of
franchisees’ operations has a direct effect on the Company’s revenues, results
of operations and cash flows.
37
International
Franchise
Three Months Ended | |||||
August 1, | August 2, | ||||
2010 | 2009 | ||||
(In thousands) | |||||
Revenues: | |||||
Royalties | $ | 3,687 | $ | 3,484 | |
Development and franchise fees | 322 | 322 | |||
Total revenues | 4,009 | 3,806 | |||
Operating expenses: | |||||
Segment operating expenses | 1,182 | 1,604 | |||
Depreciation expense | 2 | - | |||
Allocated corporate overhead | 325 | 259 | |||
Total operating expenses | 1,509 | 1,863 | |||
Segment operating income | $ | 2,500 | $ | 1,943 | |
International Franchise royalties
increased 5.8%, driven by an increase in sales by international franchise stores
from $63 million in the second quarter of fiscal 2010 to $77 million in the
second quarter of fiscal 2011. Changes in the rates of exchange between the U.S.
dollar and the foreign currencies in which the Company’s international
franchisees do business increased sales by international franchisees measured in
U.S. dollars by approximately $2.2 million in the second quarter of fiscal 2011
compared to the second quarter of fiscal 2010. Additionally, the Company did not
recognize as revenue approximately $600,000 and $160,000 of uncollected
royalties which accrued during the second quarter of fiscal 2011 and 2010,
respectively, because the Company did not believe collection of these royalties
was reasonably assured. Substantially all of the unrecognized royalties in the
second quarter of fiscal 2011 related to a single franchisee which has
experienced financial and operational difficulties periodically in recent years.
This franchisee currently is not remitting royalties; the Company is in
discussions with the franchisee in an effort to reach an acceptable solution and
has sent operating support personnel to assist the franchisee in an effort to
help improve its operations. The aggregate royalty revenues earned from this
franchisee were approximately $1.9 million for the year ended January 31, 2010,
net of unrecognized royalty amounts and bad debt expense.
International Franchise same store sales,
measured on a constant currency basis to remove the effects of changing exchange
rates between foreign currencies and the U.S. dollar, fell 14.3%. The decline in
International Franchise same store sales reflects the large number of new stores
opened internationally over the past two years and the cannibalization effects
on initial stores in new markets of additional store openings in those
markets.
International Franchise operating
expenses include costs to recruit new international franchisees, to assist in
international store openings, and to monitor and aid in the performance of
international franchise stores, as well as allocated corporate costs.
International Franchise
operating expenses declined in the second quarter of fiscal 2011 compared to the
second quarter of fiscal 2010 primarily due to a decrease in the bad debt
provision of $360,000 in the second quarter of fiscal 2011 compared to in the
second quarter of fiscal 2010. The bad debt expense recorded in the second
quarter of last year related principally to a single franchisee.
International franchisees opened 18
stores and closed two stores in the second quarter of fiscal 2011. Royalty
revenues are directly related to sales by franchise stores and, accordingly, the
success of franchisees’ operations has a direct effect on the Company’s
revenues, results of operations and cash flows.
38
KK Supply
Chain
The components of KK
Supply Chain revenues and expenses (expressed in dollars and as a
percentage of total revenues before intersegment sales elimination) are set
forth in the table below (percentage amounts may not add to totals due to
rounding).
Percentage of Total Revenues | |||||||||||
Before Intersegment | |||||||||||
Sales Elimination | |||||||||||
Three Months Ended | Three Months Ended | ||||||||||
August 1, | August 2, | August 1, | August 2, | ||||||||
2010 | 2009 | 2010 | 2009 | ||||||||
(In thousands) | |||||||||||
Revenues: | |||||||||||
Doughnut mixes | $ | 15,147 | $ | 13,032 | 33.7 | % | 34.5 | % | |||
Other ingredients, packaging and supplies | 28,223 | 23,462 | 62.9 | 62.1 | |||||||
Equipment | 1,333 | 1,260 | 3.0 | 3.3 | |||||||
Fuel surcharge | 189 | - | 0.4 | - | |||||||
Total revenues before intersegment sales elimination | 44,892 | 37,754 | 100.0 | 100.0 | |||||||
Operating expenses: | |||||||||||
Cost of sales: | |||||||||||
Cost of goods produced and purchased | 30,125 | 26,023 | 67.1 | 68.9 | |||||||
Inbound freight | 902 | 845 | 2.0 | 2.2 | |||||||
Total cost of sales | 31,027 | 26,868 | 69.1 | 71.2 | |||||||
Distribution costs: | |||||||||||
Outbound freight | 2,611 | 2,404 | 5.8 | 6.4 | |||||||
Other distribution costs | 883 | 801 | 2.0 | 2.1 | |||||||
Total distribution costs | 3,494 | 3,205 | 7.8 | 8.5 | |||||||
Other segment operating costs | 2,562 | 1,489 | 5.7 | 3.9 | |||||||
Depreciation expense | 205 | 223 | 0.5 | 0.6 | |||||||
Allocated corporate overhead | 275 | 282 | 0.6 | 0.7 | |||||||
Total operating costs | 37,563 | 32,067 | 83.7 | 84.9 | |||||||
Segment operating income | $ | 7,329 | $ | 5,687 | 16.3 | % | 15.1 | % | |||
KK Supply Chain revenues before
intersegment sales elimination increased $7.1 million, or 18.9%, in the second
quarter of fiscal 2011 compared to the second quarter of fiscal 2010. The
increase reflects selling price increases for sugar and certain other
ingredients instituted by KK Supply Chain principally in the first quarter of
fiscal 2011 in order to pass along to Company and franchise stores increases in
KK Supply Chain’s cost of sugar, flour and shortening. The increase also
reflects higher unit volumes of most product categories compared to the second
quarter of last year resulting from higher systemwide sales.
An increasing percentage of franchise
store sales is attributable to sales by franchisees outside North America. Many
of the ingredients and supplies used by international franchisees are acquired
locally instead of from KK Supply Chain. Accordingly, KK Supply Chain revenues
are less correlated with sales by international franchisees than with sales by
domestic franchisees.
Cost of goods produced and purchased
reflects mark-to-market adjustments on agricultural derivative contracts entered
into to hedge the cost of raw materials. Such adjustments reduced cost of
goods produced and purchased by 0.4% in the second quarter of fiscal 2011 and
increased cost of goods produced and purchased by 1.2% in the second quarter of
fiscal 2010.
Distribution costs as a percentage of
total revenues fell in the second quarter of fiscal 2011 compared to the second
quarter of fiscal 2010 as a result of freight cost reductions resulting from
contracting with a third party manufacturer to produce doughnut mix for stores
in the Western United States.
Other segment operating costs include
segment management, purchasing, customer service and support, laboratory and
quality control costs, and research and development expenses. These costs also
include a net credit of approximately $530,000 for bad debt expense in the
second quarter of fiscal 2010. The net credit principally reflected sustained
improved payment performance and/or reduced credit exposure with respect to a
small number of franchisees. Net credits in bad debt expense should not be
expected to occur on a regular basis. As of August 1, 2010, the Company’s
allowance for doubtful accounts from affiliated and unaffiliated franchisees
totaled approximately $2.2 million.
Franchisees opened 20 stores and closed
four stores in the second quarter of fiscal 2011. A substantial portion of KK
Supply Chain’s revenues are directly related to sales by franchise stores and,
accordingly, the success of franchisees’ operations has a direct effect on the
Company’s revenues, results of operations and cash flows.
39
General and Administrative Expenses
General and administrative expenses
were $4.9 million, or 5.6% of total revenues, in the second quarter of fiscal
2011 compared to $4.8 million, or 5.8% of total revenues, in the second quarter
of fiscal 2010. General and administrative expenses in the second quarter of
fiscal 2011 reflect the allocation to the segments approximately $350,000 of
legal fees and expenses directly related to the segments’ operations that were
included in general and administrative expenses prior to fiscal 2011, as well as
a decrease in professional fees and expenses as a result of the settlement in
late fiscal 2010 of certain environmental litigation. General and administrative
expenses in the second quarter of fiscal 2010 reflect a credit of approximately
$1.1 million resulting principally from a one-time receipt of additional
insurance reimbursement of costs incurred in connection with certain securities
and shareholder derivative litigation settled in October of 2006.
Impairment Charges and Lease
Termination Costs
Impairment charges and lease termination
costs were a credit of $216,000 in the second quarter of fiscal 2011 compared to
a charge of $1.5 million in the second quarter of fiscal 2010.
Impairment charges related to long-lived
assets totaled a credit of $140,000 in the second quarter of fiscal 2011 and a
charge of $1.1 million in the second quarter of fiscal 2010. The Company tests
long-lived assets for impairment when events or changes in circumstances
indicate that their carrying value may not be recoverable. These events and
changes in circumstances include store closing and refranchising decisions, the
effects of changing costs on current results of operations, observed trends in
operating results, and evidence of changed circumstances observed as a part of
periodic reforecasts of future operating results and as part of the Company’s
annual budgeting process. Impairment charges generally relate to stores expected
to be closed or refranchised, as well as to stores management believes will not
generate sufficient future cash flows to enable the Company to recover the
carrying value of the stores’ assets, but which management has not yet decided
to close. When the Company concludes that the carrying value of long-lived
assets is not recoverable (based on future projected undiscounted cash flows),
the Company records impairment charges to reduce the carrying value of those
assets to their estimated fair values. The fair values of these assets are
estimated based on the present value of estimated future cash flows, on
independent appraisals and, in the case of assets the Company currently is
negotiating to sell, based on the Company’s negotiations with unrelated
third-party buyers. During the second quarter of fiscal 2011, a long-lived asset
that had been previously written down to a carrying value of $1.0 million was
sold for $1.2 million, resulting in a gain of $190,000 that was recorded as a
credit to impairment charges.
Lease termination costs represent the
estimated fair value of liabilities related to unexpired leases, after reduction
by the amount of accrued rent expense, if any, related to the leases, and are
recorded when the lease contracts are terminated or, if earlier, the date on
which the Company ceases use of the leased property. The fair value of these
liabilities were estimated as the excess, if any, of the contractual payments
required under the unexpired leases over the current market lease rates for the
properties, discounted at a credit-adjusted risk-free rate over the remaining
term of the leases. In the second quarter of fiscal 2011, the Company recorded a
net credit to lease termination costs of $76,000, reflecting charges related to
a store closure and a store relocation, offset by the reversal of previously
recorded accrued rent related to those stores. In the second quarter of fiscal
2010, the Company recorded lease termination charges of $398,000 due to
adjustments to previously recorded provisions principally resulting form
settlements with lessors on stores previously closed.
The Company intends to refranchise
certain geographic markets, expected to consist principally of, but not
necessarily limited to, markets outside the Company’s traditional base in the
Southeastern United States. The franchise rights and other assets in many of
these markets were acquired by the Company in business combinations in prior
years.
Since the beginning of fiscal 2009, the
Company has refranchised a total of 11 stores and received consideration
totaling $2.5 million in connection with those transactions. During this period,
the Company has recorded impairment charges totaling approximately $490,000
related to completed and anticipated refranchisings. The Company cannot predict
the likelihood of refranchising any additional stores or markets or the amount
of proceeds, if any, which might be received therefrom, including the amounts
which might be realized from the sale of store assets and the execution of any
related franchise agreements. Refranchising could result in the recognition of
additional impairment losses on the related assets.
40
Interest Expense
The components of interest expense are as
follows:
Three Months Ended | |||||||
August 1, | August 2, | ||||||
2010 | 2009 | ||||||
(In thousands) | |||||||
Interest accruing on outstanding indebtedness | $ | 1,238 | $ | 1,470 | |||
Letter of credit and unused revolver fees | 185 | 247 | |||||
Amortization of deferred financing costs | 164 | 104 | |||||
Mark-to-market adjustments on interest rate derivatives | - | 232 | |||||
Amortization of unrealized losses on interest rate derivatives | - | 263 | |||||
Other | (20 | ) | (4 | ) | |||
$ | 1,567 | $ | 2,312 | ||||
The decrease in interest accruing on
outstanding indebtedness principally reflects the reduction of the principal
outstanding under the Term Loan described in Note 4 to the consolidated
financial statements appearing elsewhere herein and a reduction in the amount of
outstanding letters of credit. The resulting reduction in interest expense was
partially offset by the effects of higher lender margin and fees resulting from
amendments to the Company’s Secured Credit Facilities in April 2009.
The interest rate
derivative contracts which gave rise to the mark-to-market adjustments and the
amortization of unrealized losses on interest rate derivatives expired in April
2010.
Equity in Income (Losses) of Equity
Method Franchisees
The Company recorded losses in equity
method franchisees of $165,000 in the second quarter of fiscal 2011 compared to
$214,000 in the second quarter of fiscal 2010. This caption represents the
Company’s share of operating results of equity method franchisees which develop
and operate Krispy Kreme stores.
Provision for Income
Taxes
The provision for income taxes was
$379,000 in the second quarter of fiscal 2011 compared to $88,000 in the second
quarter of fiscal 2010. Each of these amounts includes, among other things,
adjustments to the valuation allowance for deferred income tax assets to
maintain such allowance at an amount sufficient to reduce the Company’s
aggregate net deferred income tax assets to zero, and a provision for income
taxes estimated to be currently payable.
Net
Income
The Company reported net income of $2.2
million for the three months ended August 1, 2010 and a net loss of $157,000 for
the three months ended August 2, 2009.
Six months ended August 1, 2010
compared to six months ended August 2, 2009
Overview
Total revenues rose by 2.2% for the six
months ended August 1, 2010 compared to the six months ended August 2, 2009. The
Company refranchised three stores in Northern California and one store in South
Carolina in fiscal 2010. Those refranchisings had the effect of reducing
consolidated revenues because the sales of these refranchised stores (which are
no longer reported as revenues by the Company) exceed the royalties and KK
Supply Chain sales recorded by the Company subsequent to the refranchisings.
Excluding the Company’s revenues related to the refranchised stores in both
periods, total revenues rose 4.1% in the six months ended August 1, 2010
compared to the six months ended August 2, 2009.
41
A reconciliation of total revenues as
reported to adjusted total revenues exclusive of the effects of refranchising
follows:
Six Months Ended | |||||||
August 1, | August 2, | ||||||
2010 | 2009 | ||||||
(In thousands) | |||||||
Total revenues as reported | $ | 180,049 | $ | 176,150 | |||
Sales by refranchised stores(1) | - | (4,579 | ) | ||||
Royalties from refranchised stores(1) | (161 | ) | - | ||||
KK Supply Chain sales to refranchised stores(1) | (1,350 | ) | - | ||||
Adjusted total revenues exclusive of the effects of refranchising | $ | 178,538 | $ | 171,571 | |||
(1) | Adjustments reflect amounts only for stores refranchised in fiscal 2010 because earlier refranchisings do no affect comparability between the periods presented. |
The Company believes that adjusted
total revenues exclusive of the effects of refranchising, a non-GAAP measure, is
a useful measure because it enables comparisons of the Company’s revenues that
are unaffected by the Company’s decisions to sell operating Krispy Kreme stores
to franchisees instead of continuing to operate the stores as Company locations.
In addition, this comparison is one of the performance metrics adopted by the
compensation committee of the Company’s board of directors to determine the
amount of incentive compensation potentially payable to the Company’s executive
officers for fiscal 2011.
Consolidated operating income increased
from $8.7 million in the six months ended August 2, 2009 to $10.2 million in the
six months ended August 1, 2010. Consolidated net income increased from $1.7
million in the six months ended August 2, 2009 to $6.7 million in the six months
ended August 1, 2010.
Revenues by business segment (expressed
in dollars and as a percentage of total revenues) are set forth in the table
below (percentage amounts may not add to totals due to rounding).
42
Six Months Ended | |||||||
August 1, | August 2, | ||||||
2010 | 2009 | ||||||
(Dollars in thousands) | |||||||
Revenues by business segment: | |||||||
Company Stores | $ | 122,504 | $ | 125,710 | |||
Domestic Franchise | 4,274 | 3,853 | |||||
International Franchise | 8,769 | 7,684 | |||||
KK Supply Chain: | |||||||
Total revenues | 90,797 | 82,612 | |||||
Less - intersegment sales elimination | (46,295 | ) | (43,709 | ) | |||
External KK Supply Chain revenues | 44,502 | 38,903 | |||||
Total revenues | $ | 180,049 | $ | 176,150 | |||
Segment revenues as a percentage of total revenues: | |||||||
Company Stores | 68.0 | % | 71.4 | % | |||
Domestic Franchise | 2.4 | 2.2 | |||||
International Franchise | 4.9 | 4.4 | |||||
KK Supply Chain (external sales) | 24.7 | 22.1 | |||||
100.0 | % | 100.0 | % | ||||
Operating income (loss): | |||||||
Company Stores | $ | (1,765 | ) | $ | 4,331 | ||
Domestic Franchise | 2,195 | 1,614 | |||||
International Franchise | 5,986 | 4,378 | |||||
KK Supply Chain | 16,019 | 13,826 | |||||
Total segment operating income | 22,435 | 24,149 | |||||
Unallocated general and administrative expenses | (11,142 | ) | (11,615 | ) | |||
Impairment charges and lease termination costs | (1,083 | ) | (3,813 | ) | |||
Consolidated operating income | $ | 10,210 | $ | 8,721 | |||
A discussion of the revenues and
operating results of each of the Company’s four business segments follows,
together with a discussion of income statement line items not associated with
specific segments.
43
Company Stores
The components of Company Stores revenues
and expenses (expressed in dollars and as a percentage of total revenues) are
set forth in the table below (percentage amounts may not add to totals due to
rounding).
Percentage of Total Revenues | ||||||||||||
Six Months Ended | Six Months Ended | |||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||
2010 | 2009 | 2010 | 2009 | |||||||||
(In thousands) | ||||||||||||
Revenues: | ||||||||||||
On-premises sales: | ||||||||||||
Retail sales | $ | 49,429 | $ | 52,728 | 40.3 | % | 41.9 | % | ||||
Fundraising sales | 7,354 | 7,051 | 6.0 | 5.6 | ||||||||
Total on-premises sales | 56,783 | 59,779 | 46.4 | 47.6 | ||||||||
Off-premises sales: | ||||||||||||
Grocers/mass merchants | 38,012 | 35,741 | 31.0 | 28.4 | ||||||||
Convenience stores | 26,396 | 29,065 | 21.5 | 23.1 | ||||||||
Other off-premises | 1,313 | 1,125 | 1.1 | 0.9 | ||||||||
Total off-premises sales | 65,721 | 65,931 | 53.6 | 52.4 | ||||||||
Total revenues | 122,504 | 125,710 | 100.0 | 100.0 | ||||||||
Operating expenses: | ||||||||||||
Cost of sales: | ||||||||||||
Food, beverage and packaging | 45,419 | 42,336 | 37.1 | 33.7 | ||||||||
Shop labor | 24,475 | 24,492 | 20.0 | 19.5 | ||||||||
Delivery labor | 10,566 | 10,945 | 8.6 | 8.7 | ||||||||
Employee benefits | 8,917 | 9,582 | 7.3 | 7.6 | ||||||||
Total cost of sales | 89,377 | 87,355 | 73.0 | 69.5 | ||||||||
Vehicle costs(1) | 6,580 | 5,466 | 5.4 | 4.3 | ||||||||
Occupancy(2) | 4,791 | 5,675 | 3.9 | 4.5 | ||||||||
Utilities expense | 2,910 | 3,016 | 2.4 | 2.4 | ||||||||
Depreciation expense | 2,854 | 3,015 | 2.3 | 2.4 | ||||||||
Other operating expenses | 9,238 | 9,030 | 7.5 | 7.2 | ||||||||
Total store level costs | 115,750 | 113,557 | 94.5 | 90.3 | ||||||||
Store operating income | 6,754 | 12,153 | 5.5 | 9.7 | ||||||||
Other segment operating costs | 6,269 | 4,669 | 5.1 | 3.7 | ||||||||
Allocated corporate overhead | 2,250 | 3,153 | 1.8 | 2.5 | ||||||||
Segment operating income (loss) | $ | (1,765 | ) | $ | 4,331 | (1.4 | )% | 3.4 | % | |||
(1) | Includes fuel, maintenance and repairs, rent, taxes and other costs of operating the delivery fleet, exclusive of depreciation. | |
(2) | Includes rent, property taxes, common area maintenance charges, insurance, building maintenance and other occupancy costs, exclusive of utilities and depreciation. |
A reconciliation of Company Stores
segment sales from the six months ended August 2, 2009 to the six months ended
August 1, 2010 follows:
On-Premises | Off-Premises | Total | |||||||||
(In thousands) | |||||||||||
Sales for the six months ended August 2, 2009 | $ | 59,779 | $ | 65,931 | $ | 125,710 | |||||
Fiscal 2010 sales at refranchised stores | (3,184 | ) | (1,395 | ) | (4,579 | ) | |||||
Fiscal 2010 sales at closed stores | (4,070 | ) | (1,406 | ) | (5,476 | ) | |||||
Fiscal 2011 sales at closed stores | 247 | - | 247 | ||||||||
Increase in sales at mature stores (open stores only) | 2,199 | 2,591 | 4,790 | ||||||||
Increase in sales at stores opened in fiscal 2010 | 1,527 | - | 1,527 | ||||||||
Sales at new stores opened in fiscal 2011 | 285 | - | 285 | ||||||||
Sales for the six months ended August 1, 2010 | $ | 56,783 | $ | 65,721 | $ | 122,504 | |||||
44
Sales at Company Stores decreased
2.6% in the first six months of fiscal 2011 from the first six months of fiscal
2010 due to store closings and refranchisings, partially offset by an increase
in sales from existing stores and stores opened in fiscal 2010 and fiscal 2011.
Excluding the effects of refranchising, Company Stores sales increased 1.1%. The
following table presents sales metrics for Company stores:
Six Months Ended | |||||
August 1, | August 2, | ||||
2010 | 2009 | ||||
On-premises: | |||||
Change in same store sales | 4.5 | % | 3.8 | % | |
Off-premises: | |||||
Grocers/mass merchants: | |||||
Change in average weekly number of doors | (2.3 | )% | (10.8 | )% | |
Change in average weekly sales per door | 9.1 | % | 8.1 | % | |
Convenience stores: | |||||
Change in average weekly number of doors | (6.4 | )% | (10.6 | )% | |
Change in average weekly sales per door | (1.4 | )% | (5.8 | )% |
On-premises sales
Same store sales at Company stores rose
4.5% in the first six months of fiscal 2011 over the first six months of fiscal
2010, of which the Company estimates approximately 3.7 percentage points is
attributable to price increases.
The Company is implementing programs
intended to improve on-premise sales, including increased focus on local store
marketing efforts, improved employee training, store refurbishment efforts and
the introduction of new products.
Off-premises sales
Sales to grocers and mass merchants
increased to $38.0 million, with a 9.1% increase in average weekly sales per
door more than offsetting a 2.3% decline in the average number of doors served.
Convenience store sales fell due to both a decline in the average number of
doors served and in the average weekly sales per door. Among other reasons,
sales to convenience stores have declined in the first six months of fiscal
2011 as a result of two large customers implementing in-house doughnut
programs to replace the Company’s products; the loss of doors associated with
those two customers accounted for approximately 2.7 percentage points of the
6.4% decline in the average number of convenience store doors served for the six
months ended August 1, 2010. Declines in the average weekly sales per door
adversely affect profitability because of the increased significance of delivery
costs in relation to sales.
The Company started implementing price
increases for some products offered in the off-premises channel late in the
first quarter of fiscal 2011, and substantially completed implementing the price
increases in the second quarter. Those price increases affect products
comprising approximately 30% of off-premises sales. The average price increase
on those products is approximately 8%.
The Company is implementing steps
intended to increase sales, increase average per door sales and reduce costs in
the off-premises channel. These steps include improved route management and
route consolidation (including elimination of or reduction in the number of
stops at relatively low volume doors), new sales incentives and
performance-based pay programs, increased emphasis on relatively longer
shelf-life products and the development of order management systems to more
closely match merchandised quantities and assortments with consumer
demand.
Costs and
expenses
Cost of sales as a percentage of revenues
rose by 3.5 percentage points from the first six months of fiscal 2010 to 73.0%
of revenues in the first six months of fiscal 2011. The cost of sugar rose
approximately 27% from the first six months of fiscal 2010 as a result of price
increases implemented by KK Supply Chain to reflect the expiration of a
favorable sugar supply contract. In addition, the cost of shortening and
other ingredients also rose year over year. While on-premises and
off-premises price increases approximated the amount of the cost increases, the
substantially equal revenue and cost increases resulted in higher material cost
measured as a percentage of revenues. In addition to higher ingredient costs, an
increase in product returns in the off-premises channel also increased product
costs as a percentage of revenues.
The Company is implementing programs
intended to improve store operations and reduce costs as a percentage of
revenues, including improved employee training and the introduction of food and
labor cost management tools.
45
Vehicle costs as a percentage of revenues
rose 1.1 percentage points from 4.3% of revenues in the first six months of
fiscal 2010 to 5.4% of revenues in the first six months of fiscal 2011,
principally as a result of higher fuel costs. Higher fuel costs were partially
offset by a gain of approximately $130,000 in the first six
months of fiscal 2011 on gasoline futures contracts entered into to
mitigate the risk of increases in the price of gasoline. The Company also is
replacing a portion of its aging fleet of delivery trucks with newer leased
trucks. Rental expense on leased delivery trucks increased in the first six
months of fiscal 2011, which was partially offset by a decrease in repairs and
maintenance expense in the first six months of fiscal 2011. Favorable adjustments to
self-insurance reserves for vehicle liability claims in the second
quarter of fiscal 2010 were approximately $300,000 higher than in
the second quarter of fiscal 2011, as described below.
The Company is self-insured for workers’
compensation, vehicle and general liability claims, but maintains stop-loss
coverage for individual claims exceeding certain amounts. The Company provides
for claims under these self-insured programs using actuarial methods as
described in the 2010 Form 10-K, and updates actuarial valuations of its
self-insurance reserves at least annually. Such periodic actuarial valuations
result in changes over time in the estimated amounts which ultimately will be
paid for claims under these programs to reflect the Company’s actual claims
experience for each policy year as well as trends in claims experience over
multiple years. Such claims, particularly workers’ compensation claims, often
are paid over a number of years following the year in which the insured events
occur, and the estimated ultimate cost of each year’s claims accordingly is
adjusted over time as additional information becomes available. The Company
updated the actuarial valuations of its self-insurance reserves during the
second quarter of fiscal 2011 and during the second quarter of fiscal 2010. The
Company recorded favorable adjustments to its self-insurance claims liabilities
related to prior policy years of approximately $690,000 in the second quarter of
fiscal 2011 and $1.2 million in the second quarter of fiscal 2010. Of the
$690,000 in favorable adjustments recorded in the second quarter of fiscal 2011,
approximately $640,000 relates to workers’ compensation liability claims and is
included in employee benefits in the table above and approximately $50,000
relates to vehicle liability claims and is included in vehicle costs in the
table above. Of the $1.2 million in favorable adjustments recorded in the second
quarter of fiscal 2010, approximately $560,000 relates to workers’ compensation
liability claims, approximately $350,000 relates to vehicle liability claims,
and approximately $240,000 relates to general liability claims and is included
in other operating expenses in the table above.
The Company Stores segment closed or
refranchised a total of 17 stores since the end of fiscal 2009, none of which
have been accounted for as discontinued operations because the Company continues
to have significant continuing involvement in the markets in which the stores
were or are located, through either continuing operations of other stores in or
serving the market or through its role as a franchisor. In order to assist
readers in understanding the results of operations of the Company’s ongoing
stores, the following table presents the components of revenues and expenses for
stores operated by the Company as of August 1, 2010, and excludes the revenues
and expenses for stores closed and refranchised prior to that date. Percentage
amounts may not add to totals due to rounding.
46
Stores in Operation at August 1, 2010 | ||||||||||||||
Percentage of Total Revenues | ||||||||||||||
Six Months Ended | Six Months Ended | |||||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||
(In thousands) | ||||||||||||||
Revenues: | ||||||||||||||
On-premises sales: | ||||||||||||||
Retail sales | $ | 49,195 | $ | 45,909 | 40.2 | % | 39.7 | % | ||||||
Fundraising sales | 7,341 | 6,616 | 6.0 | 5.7 | ||||||||||
Total on-premises sales | 56,536 | 52,525 | 46.2 | 45.4 | ||||||||||
Off-premises sales: | ||||||||||||||
Grocers/mass merchants | 38,012 | 34,175 | 31.1 | 29.5 | ||||||||||
Convenience stores | 26,396 | 27,858 | 21.6 | 24.1 | ||||||||||
Other off-premises | 1,313 | 1,097 | 1.1 | 0.9 | ||||||||||
Total off-premises sales | 65,721 | 63,130 | 53.8 | 54.6 | ||||||||||
Total revenues | 122,257 | 115,655 | 100.0 | 100.0 | ||||||||||
Operating expenses: | ||||||||||||||
Cost of sales: | ||||||||||||||
Food, beverage and packaging | 45,318 | 38,917 | 37.1 | 33.6 | ||||||||||
Shop labor | 24,376 | 21,958 | 19.9 | 19.0 | ||||||||||
Delivery labor | 10,565 | 10,404 | 8.6 | 9.0 | ||||||||||
Employee benefits | 8,892 | 8,522 | 7.3 | 7.4 | ||||||||||
Total cost of sales | 89,151 | 79,801 | 72.9 | 69.0 | ||||||||||
Vehicle costs | 6,570 | 5,105 | 5.4 | 4.4 | ||||||||||
Occupancy | 4,548 | 4,525 | 3.7 | 3.9 | ||||||||||
Utilities expense | 2,876 | 2,575 | 2.4 | 2.2 | ||||||||||
Depreciation expense | 2,837 | 2,804 | 2.3 | 2.4 | ||||||||||
Other operating expenses | 9,175 | 8,005 | 7.5 | 6.9 | ||||||||||
Total store level costs | 115,157 | 102,815 | 94.2 | 88.9 | ||||||||||
Store operating income - ongoing stores | 7,100 | 12,840 | 5.8 | % | 11.1 | % | ||||||||
Store operating loss - closed and refranchised | (346 | ) | (687 | ) | ||||||||||
Store operating income | $ | 6,754 | $ | 12,153 | ||||||||||
47
Domestic Franchise
Six Months Ended | ||||||
August 1, | August 2, | |||||
2010 | 2009 | |||||
(In thousands) | ||||||
Revenues: | ||||||
Royalties | $ | 4,008 | $ | 3,745 | ||
Development and franchise fees | 20 | - | ||||
Other | 246 | 108 | ||||
Total revenues | 4,274 | 3,853 | ||||
Operating expenses: | ||||||
Segment operating expenses | 1,769 | 1,977 | ||||
Depreciation expense | 110 | 43 | ||||
Allocated corporate overhead | 200 | 219 | ||||
Total operating expenses | 2,079 | 2,239 | ||||
Segment operating income | $ | 2,195 | $ | 1,614 | ||
Domestic Franchise revenues
increased 10.9% to $4.3 million in the first six months of fiscal 2011 from $3.9
million in the first six months of fiscal 2010, driven by an increase in
domestic royalty revenues resulting from an increase in sales by domestic
franchise stores from approximately $112 million in the first six months of
fiscal 2010 to $121 million in the first six months of fiscal 2011.
Approximately $5.0 million of the increase in sales by domestic franchisees is
the result of refranchising Company stores. Domestic Franchise same store sales
rose 3.8% in the first six months of fiscal 2011.
Domestic Franchise operating
expenses include costs to recruit new domestic franchisees, to assist in
domestic store openings, and to monitor and aid in the performance of domestic
franchise stores, as well as allocated corporate costs. Domestic Franchise
operating expenses declined in the first six months of fiscal 2011 compared to
the first six months of fiscal 2010 primarily due to a decrease in bad debt
expense. Bad debt expense was approximately $130,000 in the first six months of
fiscal 2010 due principally to provisions related to a single domestic
franchisee. In the first six months of fiscal 2011, bad debt expense was a
credit of approximately $170,000, resulting principally from a recovery of
receivables previously written off. Additionally, during the second quarter of
fiscal 2010, the Company recorded charges of approximately $150,000 to the
Domestic Franchise segment for the settlement of certain
litigation.
Beginning in fiscal 2011,
the Company began allocating to the business segments the legal fees and
expenses directly related to their businesses; such costs were included in
general and administrative expenses in prior years and totaled approximately
$310,000 in the Domestic Franchise segment for the six months ended August 1,
2010.
Domestic franchisees opened
two stores and closed three stores in the first six months of fiscal 2011.
Royalty revenues are directly related to sales by franchise stores and,
accordingly, the success of franchisees’ operations has a direct effect on the
Company’s revenues, results of operations and cash flows.
48
International
Franchise
Six Months Ended | ||||||
August 1, | August 2, | |||||
2010 | 2009 | |||||
(In thousands) | ||||||
Revenues: | ||||||
Royalties | $ | 7,571 | $ | 6,954 | ||
Development and franchise fees | 1,198 | 730 | ||||
Total revenues | 8,769 | 7,684 | ||||
Operating expenses: | ||||||
Segment operating expenses | 2,130 | 2,774 | ||||
Depreciation expense | 3 | - | ||||
Allocated corporate overhead | 650 | 532 | ||||
Total operating expenses | 2,783 | 3,306 | ||||
Segment operating income | $ | 5,986 | $ | 4,378 | ||
International Franchise
royalties increased 8.9% driven by an increase in sales by international
franchise stores from $124 million in the first six months of fiscal 2010 to
$152 million in the first six months of fiscal 2011. Changes in the rates of
exchange between the U.S. dollar and the foreign currencies in which the
Company’s international franchisees do business increased sales by international
franchisees measured in U.S. dollars by approximately $9.6 million in the first
six months of fiscal 2011 compared to the first six months of fiscal 2010.
Additionally, the Company did not recognize as revenue approximately $960,000
and $160,000 of uncollected royalties which accrued during the first six months
of fiscal 2011 and fiscal 2010, respectively, because the Company did not
believe collection of these royalties was reasonably assured. Substantially all
of the unrecognized royalties in the first six months of fiscal 2011 related to
a single franchisee which has experienced financial and operational difficulties
periodically in recent years. This franchisee currently is not remitting
royalties; the Company is in discussions with the franchisee in an effort to
reach an acceptable solution and has sent operating support personnel to assist
the franchisee in an effort to help improve its operations. The aggregate
royalty revenues earned from this franchisee were approximately $1.9 million for
the year ended January 31, 2010, net of unrecognized royalty amounts and bad
debt expense.
International Franchise same
store sales, measured on a constant currency basis to remove the effects of
changing exchange rates between foreign currencies and the U.S. dollar, fell
16.0%. The decline in International Franchise same store sales reflects the
large number of new stores opened internationally over the past two years, the
cannibalization effects on initial stores in new markets of additional store
openings in those markets, and the effects of soft economic conditions,
particularly in more developed markets.
International development
and franchise fees increased $468,000 in the first six months of fiscal 2011 due
to more store openings by international franchisees in the first six months of
fiscal 2011 than in the first six months of last year.
International Franchise operating expenses include costs
to recruit new international franchisees, to assist in international store
openings, and to monitor and aid in the performance of international franchise
stores, as well as allocated corporate costs. International Franchise operating
expenses declined in the first six months of fiscal 2011 compared to the first
six months of fiscal 2010 primarily due to a decrease in the bad debt provision
to a credit of $70,000 in the first six months of fiscal 2011 compared to an
expense of $400,000 in the first six months of fiscal 2010.
International franchisees
opened 59 stores and closed eight stores in the first six months of fiscal 2011.
Royalty revenues are directly related to sales by franchise stores and,
accordingly, the success of franchisees’ operations has a direct effect on the
Company’s revenues, results of operations and cash flows.
49
KK Supply Chain
The components of KK Supply Chain
revenues and expenses (expressed in dollars and as a percentage of total
revenues before intersegment sales elimination) are set forth in the table below
(percentage amounts may not add to totals due to rounding).
Percentage of Total Revenues | ||||||||||||
Before Intersegment | ||||||||||||
Sales Elimination | ||||||||||||
Six Months Ended | Six Months Ended | |||||||||||
August 1, | August 2, | August 1, | August 2, | |||||||||
2010 | 2009 | 2010 | 2009 | |||||||||
(In thousands) | ||||||||||||
Revenues: | ||||||||||||
Doughnut mixes | $ | 31,207 | $ | 29,997 | 34.4 | % | 36.3 | % | ||||
Other ingredients, packaging and supplies | 56,061 | 49,448 | 61.7 | 59.9 | ||||||||
Equipment | 3,141 | 3,167 | 3.5 | 3.8 | ||||||||
Fuel surcharge | 388 | - | 0.4 | - | ||||||||
Total revenues before intersegment sales elimination | 90,797 | 82,612 | 100.0 | 100.0 | ||||||||
Operating expenses: | ||||||||||||
Cost of sales: | ||||||||||||
Cost of goods produced and purchased | 59,630 | 55,132 | 65.7 | 66.7 | ||||||||
Inbound freight | 1,772 | 1,882 | 2.0 | 2.3 | ||||||||
Total cost of sales | 61,402 | 57,014 | 67.6 | 69.0 | ||||||||
Distribution costs: | ||||||||||||
Outbound freight | 5,150 | 5,031 | 5.7 | 6.1 | ||||||||
Other distribution costs | 1,824 | 1,906 | 2.0 | 2.3 | ||||||||
Total distribution costs | 6,974 | 6,937 | 7.7 | 8.4 | ||||||||
Other segment operating costs | 5,435 | 3,821 | 6.0 | 4.6 | ||||||||
Depreciation expense | 417 | 450 | 0.5 | 0.5 | ||||||||
Allocated corporate overhead | 550 | 564 | 0.6 | 0.7 | ||||||||
Total operating costs | 74,778 | 68,786 | 82.4 | 83.3 | ||||||||
Segment operating income | $ | 16,019 | $ | 13,826 | 17.6 | % | 16.7 | % | ||||
KK Supply Chain revenues
before intersegment sales elimination increased $8.2 million, or 9.9%, in the
first six months of fiscal 2011 compared to the first six months of fiscal 2010.
The increase principally reflects selling price increases for sugar and certain
other ingredients instituted by KK Supply Chain in the first quarter of fiscal
2011 in order to pass along to Company and franchise stores increases in KK
Supply Chain’s cost of sugar, flour and shortening. The increase also reflects
higher unit volumes of most product categories compared to the first six
months of last year resulting from higher sales by Domestic and International
Franchise stores.
An increasing percentage of
franchise store sales is attributable to sales by franchisees outside North
America. Many of the ingredients and supplies used by international franchisees
are acquired locally instead of from KK Supply Chain. Accordingly, KK Supply
Chain revenues are less correlated with sales by international franchisees than
with sales by domestic franchisees.
Cost of goods
produced and purchased reflects mark-to-market adjustments on agricultural
derivative contracts entered into to hedge the cost of raw materials. Such
adjustments reduced cost of goods produced and purchased by 0.3% in the first
six months of fiscal 2011 and increased cost of goods produced and purchased by
0.7% in the first six months of fiscal 2010.
Distribution
costs as a percentage of total revenues fell in the first six months of
fiscal 2011 compared to the first six months of fiscal 2010 as a result of
freight cost reductions resulting from contracting with a third party
manufacturer to produce doughnut mix for stores in the Western United
States.
Other segment operating
costs include segment management, purchasing, customer service and support,
laboratory and quality control costs, and research and development expenses.
These costs also include a net credit in bad debt expense of approximately
$810,000 in the first six months of fiscal 2010. The net credits principally
reflected sustained improved payment performance and/or reduced credit exposure
with respect to a small number of franchisees. Net credits in bad debt expense
should not be expected to occur on a regular basis. As of August 1, 2010, the
Company’s allowance for doubtful accounts from affiliated and unaffiliated
franchisees totaled approximately $2.2 million.
Franchisees opened 61 stores
and closed 11 stores in the first six months of fiscal 2011. A substantial
portion of KK Supply Chain’s revenues are directly related to sales by franchise
stores and, accordingly, the success of franchisees’ operations has a direct
effect on the Company’s revenues, results of operations and cash
flows.
50
General and Administrative Expenses
General and administrative
expenses were $10.7 million, or 5.9% of total revenues, in the first six months
of fiscal 2011 compared to $11.1 million, or 6.3% of total revenues, in the
first six months of fiscal 2010. General and administrative expenses decreased
in the first six months of fiscal 2011 compared to the first six months of
fiscal 2010, reflecting the allocation to the segments of approximately $920,000
of legal fees and expenses directly related to their operations that were
included in general and administrative expenses prior to fiscal 2011, as well as
a decrease in professional fees and expenses as a result of the settlement in
late fiscal 2010 of certain environmental litigation. General and administrative
expenses in the second quarter of fiscal 2010 include a credit of approximately
$1.1 million resulting principally from a one-time receipt of additional
insurance reimbursement of costs incurred in connection with certain securities
and shareholder derivative litigation settled in October of 2006.
Impairment Charges and Lease
Termination Costs
Impairment charges and lease
termination costs were $1.1 million in the first six months of fiscal 2011
compared to $3.8 million in the first six months of fiscal 2010.
Impairment charges related
to long-lived assets totaled $709,000 in the first six months of fiscal 2011 and
$1.2 million in the first six months of fiscal 2010, relating principally
to underperforming stores. The Company tests long-lived assets for impairment
when events or changes in circumstances indicate that their carrying value may
not be recoverable. These events and changes in circumstances include store
closing and refranchising decisions, the effects of changing costs on current
results of operations, observed trends in operating results, and evidence of
changed circumstances observed as a part of periodic reforecasts of future
operating results and as part of the Company’s annual budgeting process.
Impairment charges relate to stores expected to be closed or refranchised, as
well as to stores management believes will not generate sufficient future cash
flows to enable the Company to recover the carrying value of the stores’ assets,
but which management has not yet decided to close. When the Company concludes
that the carrying value of long-lived assets is not recoverable (based on future
projected undiscounted cash flows), the Company records impairment charges to
reduce the carrying value of those assets to their estimated fair values. The
fair values of these assets are estimated based on the present value of
estimated future cash flows, on independent appraisals and, in the case of
assets the Company currently is negotiating to sell, based on the Company’s
negotiations with unrelated third-party buyers.
Lease termination costs
represent the estimated fair value of liabilities related to unexpired leases,
after reduction by the amount of accrued rent expense, if any, related to the
leases, and are recorded when the lease contracts are terminated or, if earlier,
the date on which the Company ceases use of the leased property. The fair value
of these liabilities were estimated as the excess, if any, of the contractual
payments required under the unexpired leases over the current market lease rates
for the properties, discounted at a credit-adjusted risk-free rate over the
remaining term of the leases. In the first six months of fiscal 2011, the
Company recorded lease termination charges of $374,000 reflecting a change in
estimated sublease rentals on stores previously closed and charges related to a
store closure and a store relocation, offset by the reversal of previously
recorded accrued rent related to those stores. In the first six months of fiscal
2010, the Company recorded lease termination charges of $2.6 million related
principally to the termination of two leases having rental rates substantially
above the current market levels.
The Company intends to
refranchise certain geographic markets, expected to consist principally of, but
not necessarily limited to, markets outside the Company’s traditional base in
the Southeastern United States. The franchise rights and other assets in many of
these markets were acquired by the Company in business combinations in prior
years.
Since the beginning of
fiscal 2009, the Company has refranchised a total of 11 stores and received
consideration totaling $2.5 million in connection with those transactions.
During this period, the Company has recorded impairment charges totaling
approximately $490,000 related to completed and anticipated refranchisings. The
Company cannot predict the likelihood of refranchising any additional stores or
markets or the amount of proceeds, if any, which might be received therefrom,
including the amounts which might be realized from the sale of store assets and
the execution of any related franchise agreements. Refranchising could result in
the recognition of additional impairment losses on the related
assets.
51
Interest Expense
The components of interest expense are as
follows:
Six Months Ended | ||||||
August 1, | August 2, | |||||
2010 | 2009 | |||||
(In thousands) | ||||||
Interest accruing on outstanding indebtedness | $ | 2,408 | $ | 3,080 | ||
Letter of credit and unused revolver fees | 503 | 509 | ||||
Fees associated with credit agreement amendments | - | 925 | ||||
Write-off of deferred financing costs associated with credit agreement amendments | - | 89 | ||||
Amortization of deferred financing costs | 312 | 341 | ||||
Mark-to-market adjustments on interest rate derivatives | - | 419 | ||||
Amortization of unrealized losses on interest rate derivatives | 152 | 666 | ||||
Other | 63 | 100 | ||||
$ | 3,438 | $ | 6,129 | |||
The decrease in interest
accruing on outstanding indebtedness principally reflects the $20 million
prepayment of principal outstanding under the Term Loan described in Note 4 to
the consolidated financial statements appearing elsewhere herein. The resulting
reduction in interest expense was partially offset by the effects of higher
lender margin and fees resulting from amendments to the Company’s Secured Credit
Facilities in April 2009. The April 2009 Amendments to the credit facilities
increased the interest rate on the Company’s outstanding borrowings and letters
of credit by 200 basis points annually. The interest rate derivative
contracts which gave rise to the mark-to-market adjustments and the amortization
of unrealized losses on interest rate derivatives expired in April
2010.
Equity in Income (Losses) of Equity
Method Franchisees
The Company recorded equity
in the earnings of equity method franchisees of $181,000 in the first six months
of fiscal 2011 compared to losses of $113,000 in the first six months of fiscal
2010. This caption represents the Company’s share of operating results of equity
method franchisees which develop and operate Krispy Kreme stores.
Provision for Income
Taxes
The provision for income
taxes was $562,000 in the first six months of fiscal 2011 compared to $296,000
in the first six months of fiscal 2010. Each of these amounts includes, among
other things, adjustments to the valuation allowance or deferred income tax
assets to maintain such allowance at an amount sufficient to reduce the
Company’s aggregate net deferred income tax assets to zero, and a provision for
income taxes estimated to be currently payable.
Net
Income
The Company reported net income of $6.7
million for the six months ended August 1, 2010 and $1.7 million for the six
months ended August 2, 2009.
52
LIQUIDITY AND CAPITAL
RESOURCES
The following table presents a summary of
the Company’s cash flows from operating, investing and financing activities for
the first six months of fiscal 2011 and fiscal 2010.
Six Months Ended | ||||||||
August 1, | August 2, | |||||||
2010 | 2009 | |||||||
(In thousands) | ||||||||
Net cash provided by operating activities | $ | 5,393 | $ | 10,069 | ||||
Net cash used for investing activities | (2,734 | ) | (4,371 | ) | ||||
Net cash used for financing activities | (1,639 | ) | (21,616 | ) | ||||
Net increase (decrease) in cash and cash equivalents | $ | 1,020 | $ | (15,918 | ) | |||
Cash Flows from Operating
Activities
Net cash provided by operating activities
was $5.4 million and $10.1 million in the first six months of fiscal 2011 and
fiscal 2010, respectively.
Net cash provided by
operating activities for the six months ended August 1, 2010 reflects the
payment of approximately $4.8 million of incentive compensation earned in fiscal
2010; there were no corresponding payments in the six months ended August 2,
2009. In addition, cash provided by operating activities in the first six months
of fiscal 2011 reflects the payment of approximately $2.0 million to a landlord
in connection with the renegotiation and renewal of the lease for the Company’s
headquarters. Cash payments on leases related to closed stores were
approximately $2.2 million higher in the first six months of fiscal 2010 than in
the first six months of fiscal 2011. The balance in the change in cash flows
from operating activities reflects normal fluctuations in working
capital.
Cash Flows from Investing
Activities
Net cash used for investing
activities was $2.7 million in the first six months of fiscal 2011 and $4.4
million in the first six months of fiscal 2010.
Cash used for capital
expenditures decreased to approximately $4.0 million in the first six months of
fiscal 2011 from $4.4 million in the first six months of fiscal 2010. The
Company currently expects capital expenditures to range from $13 million to $17
million in fiscal 2011. In addition, the Company realized proceeds from the sale
of property and equipment of $1.3 million in the first six months of fiscal 2011
from the sale of a closed store as compared to $32,000 of proceeds from the sale
of property and equipment in the first six months of fiscal 2010.
Cash Flows from Financing
Activities
Net cash used by financing
activities was $1.6 million in the first six months of fiscal 2011, compared to
$21.6 million in the first six months of fiscal 2010.
During the first six months
of fiscal 2011, the Company repaid $1.6 million of outstanding term loan and
capitalized lease indebtedness, consisting of approximately $400,000 of
scheduled principal amortization and $1.2 million of prepayments from the sale
of assets related to a closed store. During the first six months of fiscal 2010,
the Company repaid approximately $20.6 million of outstanding term loan and
capitalized lease indebtedness, consisting of approximately $600,000 of
scheduled principal amortization and a prepayment of $20 million in connection
with amendments to the Company’s credit facilities as described in Note 4 to the
consolidated financial statements appearing elsewhere herein. Additionally, the
Company paid approximately $1.9 million in fees to its lenders in the first six
months of fiscal 2010 to amend its credit facilities. Of such aggregate amount,
$954,000 was capitalized as deferred financing costs and the balance of
approximately $925,000 was charged to interest expense.
Recent Accounting
Pronouncements
In the first quarter of
fiscal 2011, the Company adopted amended accounting standards related to the
consolidation of variable-interest entities. The amended standards require an
enterprise to qualitatively assess the determination of the primary beneficiary
of a variable interest entity (“VIE”) based on whether the enterprise has the
power to direct matters that most significantly impact the activities of the VIE
and has the obligation to absorb losses of, or the right to receive benefits
from, the VIE that could potentially be significant to the VIE. Adoption of the
new standards resulted in the Company recognizing a divestiture of three stores
sold by the Company in the October 2009 refranchising transaction described
under “Basis of Consolidation,” above. The cumulative effect of adoption of the
new standards has been reflected as a credit of $1.3 million to the opening
balance of retained earnings as of February 1, 2010, the first day of fiscal
2011. Adoption of the standards had no material effect on the Company’s
financial position, results of operations or cash flows.
53
In the first quarter of
fiscal 2010, the Company adopted new accounting standards with respect to
nonfinancial assets and nonfinancial liabilities measured at fair value on a
non-recurring basis. Adoption of these standards had no material effect on the
Company’s financial position or results of operations. See Note 9 for additional
information regarding fair value measurements.
Item 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK.
There have been no material changes from
the disclosures in Part II, Item 7A, “Quantitative and Qualitative Disclosures
About Market Risk,” in the 2010 Form 10-K.
Item 4. CONTROLS AND
PROCEDURES.
Evaluation of Disclosure Controls and
Procedures
As of August 1, 2010, the
end of the period covered by this Quarterly Report on Form 10-Q, management
performed, under the supervision and with the participation of the Company’s
chief executive officer and chief financial officer, an evaluation of the
effectiveness of the Company’s disclosure controls and procedures as defined in
Rules 13a-15(e) and 15d-15(e) of the Exchange Act. The Company’s disclosure
controls and procedures are designed to ensure that information required to be
disclosed in the reports the Company files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms, and that such information is accumulated and
communicated to management, including the Company’s chief executive officer and
chief financial officer, to allow timely decisions regarding required
disclosures. Based on this evaluation, the Company’s chief executive officer and
chief financial officer have concluded that, as of August 1, 2010, the Company’s
disclosure controls and procedures were effective.
Changes in Internal Control Over Financial
Reporting
During the quarter ended
August 1, 2010, there were no changes in the Company’s internal control over
financial reporting that materially affected, or are reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
Part II – Other
Information
Item 1. LEGAL
PROCEEDINGS.
There have been no material
changes from the disclosures in Part 1, Item 3, “Legal
Proceedings,”
in the 2010 Form 10-K.
54
Item 1A. RISK
FACTORS.
Except as described below,
there have been no material changes from the risk factors disclosed in Part I,
Item 1A, “Risk Factors,” in the 2010 Form 10-K.
Recent health reform legislation
could adversely affect our business.
Recent Federal legislation
regarding changes in government-mandated health benefits may increase our
and our domestic franchisees’ costs. Due to the breadth and complexity of the
health reform legislation, the lack of implementing regulations and interpretive
guidance, and the phased-in nature of the implementation, it is difficult to
predict the overall impact of the health reform legislation on our business and
the businesses of our domestic franchisees over the coming years. Possible
adverse effects of the legislation include increased costs, exposure to expanded
liability and requirements for us to revise the ways in which we conduct
business. Our results of operations, financial position and cash flows could be
adversely affected. Our domestic franchisees face the potential of similar
adverse effects.
Item 2. UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS.
None.
Item 3. DEFAULTS UPON SENIOR
SECURITIES.
None.
Item 4. (REMOVED AND
RESERVED).
Item 5. OTHER
INFORMATION.
None.
Item 6.
EXHIBITS.
Exhibit | |||||
Number | Description of Exhibits | ||||
3.1 | — | Amended Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K, filed on April 15, 2010) | |||
3.2 | — | Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed December 15, 2008) | |||
4.1 | — | Warrant to purchase Common Stock issued by Krispy Kreme Doughnuts, Inc. in favor of Marsh & McLennan Risk Capital Holdings Ltd. (supercedes Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on October 26, 2005) | |||
31.1 | — | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended | |||
31.2 | — | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended | |||
32.1 | — | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |||
32.2 | — | Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |||
4.1 | — | KZC Warrant |
55
SIGNATURES
Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly authorized.
Krispy Kreme Doughnuts, Inc. | |||
Date: September 2, 2010 | By: | /s/ Douglas R. Muir | |
Name: | Douglas R. Muir | ||
Title: | Chief Financial Officer | ||
(Duly Authorized Officer and Principal Financial Officer) |
56