Krispy Kreme Doughnuts (KKD) 10-Q 2005 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark one)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 31, 2004

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to

Commission file number 001-16485

KRISPY KREME DOUGHNUTS, INC.

(Exact name of registrant as specified in its charter)

North Carolina	56-2169715
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
370 Knollwood Street,	27103
Winston-Salem, North Carolina	(Zip Code)
(Address of principal executive offices)

Registrant’s telephone number, including area code:
(336) 725-2981

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ       Noo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero      Accelerated filerþ       Non-accelerated filero

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yeso       Noþ

     Number of shares of Common Stock, no par value, outstanding as of December 31, 2006: 62,672,994.

TABLE OF CONTENTS

	Page
EXPLANATORY NOTE		3
FORWARD-LOOKING STATEMENTS		3
PART I — FINANCIAL INFORMATION		5
Item 1. FINANCIAL STATEMENTS		5
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		25
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		36
Item 4. CONTROLS AND PROCEDURES		37
PART II — OTHER INFORMATION		38
Item 1. LEGAL PROCEEDINGS		38
Item 1A. RISK FACTORS		40
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		40
Item 3. DEFAULTS UPON SENIOR SECURITIES		41
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		41
Item 5. OTHER INFORMATION		41
Item 6. EXHIBITS		41
SIGNATURES		42
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION
EX-32.2: CERTIFICATION

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. Fiscal 2004 and fiscal 2005 mean the fiscal years ended February 1, 2004 and January 30, 2005, respectively.

EXPLANATORY NOTE

     The Company filed its Annual Report on Form 10-K for fiscal 2005 (the “2005 Form 10-K”) on April 28, 2006. As more fully described in Note 2 to the consolidated financial statements under Item 8, “Financial Statements and Supplementary Data” in the 2005 Form 10-K, the Company restated its consolidated balance sheet as of February 1, 2004 (the last day of fiscal 2004) and its consolidated statements of operations, of changes in shareholders’ equity and of cash flows for fiscal 2004 and fiscal 2003. Certain restatement adjustments affected periods prior to fiscal 2003. The effect of those restatement adjustments on years prior to fiscal 2003 were reflected as an adjustment to the opening balance of retained earnings as of February 4, 2002, the first day of fiscal 2003.

     In addition, as disclosed in the 2005 Form 10-K in Note 25 to the consolidated financial statements, certain restatement adjustments affected interim financial information for fiscal 2005 and fiscal 2004 previously filed on Form 10-Q (with respect to the first and second quarters of fiscal 2005 and the first three quarters of fiscal 2004) and on Form 8-K (with respect to the third quarter of fiscal 2005, which ended on October 31, 2004). Such restatement adjustments were reflected in the unaudited selected quarterly financial data appearing in the 2005 Form 10-K. The Company had not filed a Quarterly Report on Form 10-Q for the three months ended October 31, 2004 prior to filing this report in January 2007.

     The restatement adjustments corrected certain historical accounting policies to conform those policies to generally accepted accounting principles (“GAAP”) and corrected errors made in the application of GAAP. For a discussion of the significant restatement adjustments and the background leading to the adjustments, see Notes 2 and 25 to the consolidated financial statements in the 2005 Form 10-K.

     The Company has not amended its Annual Reports on Form 10-K or its Quarterly Reports on Form 10-Q for periods affected by the restatement adjustments, and accordingly the financial statements and related financial information contained in such reports should not be relied upon.

     All amounts in this Quarterly Report on Form 10-Q affected by the restatement adjustments reflect such amounts as restated.

     The financial information contained herein is as of October 31, 2004. The Company has filed the following reports for periods subsequent to that date: the 2005 Form 10-K, the Annual Report on Form 10-K for the fiscal year ended January 29, 2006 (the “2006 Form 10-K”) and the Quarterly Reports on Form 10-Q for the first three quarters of fiscal 2007, to which readers are directed for further information.

FORWARD-LOOKING STATEMENTS

     This quarterly report contains statements about future events and expectations, including our business strategy, remediation plans with respect to internal controls and trends in or expectations regarding the Company’s operations, financing abilities and planned capital expenditures that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on management’s beliefs, assumptions and expectations of our future economic performance, considering the information currently available to management. These statements are not statements of historical fact. Forward-looking statements involve risks and uncertainties that may cause our actual results, performance or financial condition to differ materially from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements. The words “believe,” “may,” “will,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “strive” or similar words, or the negative of these words, identify forward-looking statements. Factors that could contribute to these differences include, but are not limited to:

• the outcome of pending governmental investigations, including by the Securities and Exchange Commission and the United States Attorney’s Office for the Southern District of New York;

• the resolution of shareholder derivative and class action litigation;

• potential indemnification obligations and limitations of our director and officer liability insurance;

3

• material weaknesses in our internal control over financial reporting;

• our ability to implement remedial measures necessary to improve our processes and procedures;

• continuing negative publicity;

• significant changes in our management;

• the quality of franchise store operations;

• our ability, and our dependence on the ability of our franchisees, to execute on our and their business plans;

• disputes with our franchisees;

• our ability to implement our international growth strategy;

• currency, economic, political 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 wholesale customers;

• our ability to protect our trademarks;

• risks associated with our high levels of indebtedness;

• restrictions on our operations contained in our senior secured credit facilities;

• our ability to meet our ongoing liquidity needs;

• 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, including under Item 1A, “Risk Factors,” in the 2006 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.

4

PART I — FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

	Page
Index to Financial Statements
Consolidated balance sheet as of February 1, 2004 and October 31, 2004		6
Consolidated statement of operations for the three months and nine months ended November 2, 2003 and October 31, 2004		7
Consolidated statement of cash flows for the nine months ended November 2, 2003 and October 31, 2004		8
Consolidated statement of changes in shareholders’ equity for the nine months ended November 2, 2003 and October 31, 2004		9
Notes to financial statements		10

5

KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED BALANCE SHEET

(Unaudited)

	February 1,			October 31,
	2004			2004
	(In thousands)
	(Restated)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	21,029		$	17,335
Accounts receivable, less allowance for doubtful accounts of $1,265 at February 1, 2004 and $3,830 at October 31, 2004		44,824			41,791
Accounts receivable — related parties		17,835			15,019
Other receivables		2,514			6,245
Notes receivable — related parties		435			5,482
Inventories		29,821			33,250
Prepaid expenses and other current assets		5,659			8,290
Income taxes refundable		7,973			7,494
Deferred income taxes		7,405			1,520
Total current assets		137,495			136,426
Property and equipment		287,492			326,372
Long-term notes receivable — related parties		6,561			2,042
Investments in and advances to equity method franchisees		14,584			5,925
Goodwill and other intangible assets		197,162			34,385
Deferred income taxes		2,941			—
Other assets		10,368			10,787
Total assets	$	656,603		$	515,937
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt	$	8,142		$	23,080
Book overdraft		8,123			9,968
Accounts payable		19,107			19,458
Accrued liabilities		23,302			38,999
Total current liabilities		58,674			91,505
Long-term debt, less current maturities		137,114			118,724
Deferred income taxes		—			1,520
Other long-term obligations		22,258			25,938
Minority interests in consolidated franchisees		2,148			1,856
Commitments and contingencies
SHAREHOLDERS’ EQUITY:
Preferred stock, no par value, 10,000 shares authorized; none issued and outstanding		—			—
Common stock, no par value, 300,000 shares authorized, issued and outstanding — 61,286 at February 1, 2004 and 61,755 at October 31, 2004		294,477			295,608
Unearned compensation		(62	)		(21	)
Notes receivable secured by common stock		(383	)		(383	)
Accumulated other comprehensive income (loss)		(712	)		355
Retained earnings (accumulated deficit)		143,089			(19,165	)
Total shareholders’ equity		436,409			276,394
Total liabilities and shareholders’ equity	$	656,603		$	515,937

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

6

KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF OPERATIONS

(Unaudited)

	Three Months Ended						Nine Months Ended
	November 2,			October 31,			November 2,			October 31,
	2003			2004			2003			2004
	(In thousands, except per share amounts)
	(Restated)						(Restated)
Revenues	$	164,995		$	174,393		$	467,087		$	546,060
Operating expenses:
Direct operating expenses, exclusive of depreciation and amortization shown below		124,115			149,194			353,536			446,922
General and administrative expenses		9,278			12,518			27,877			35,566
Depreciation and amortization expense		5,641			8,554			15,701			23,325
Impairment charges and lease termination costs		—			142,657			—			150,256
Arbitration award		—			—			(525	)		—
Income (loss) from operations		25,961			(138,530	)		70,498			(110,009	)
Interest income		218			174			651			583
Interest expense		(1,219	)		(1,731	)		(3,130	)		(4,838	)
Equity in income (losses) of equity method franchisees		(146	)		190			(1,818	)		(675	)
Minority interests in results of consolidated franchisees		(411	)		4,188			(1,565	)		4,829
Other income (expense), net		(302	)		(1,867	)		2,055			(1,406	)
Income (loss) from continuing operations before income taxes		24,101			(137,576	)		66,691			(111,516	)
Provision for income taxes (benefit)		9,580			(133	)		26,553			9,674
Income (loss) from continuing operations		14,521			(137,443	)		40,138			(121,190	)
Discontinued operations, including income tax effects		(468	)		(5,076	)		(907	)		(39,833	)
Income (loss) before cumulative effect of change in accounting principle		14,053			(142,519	)		39,231			(161,023	)
Cumulative effect of change in accounting principle, net of income taxes		—			—			—			(1,231	)
Net income (loss)	$	14,053		$	(142,519	)	$	39,231		$	(162,254	)
Earnings (loss) per common share — basic
Income (loss) from continuing operations	$	0.24		$	(2.23	)	$	0.69		$	(1.97	)
Discontinued operations		(0.01	)		(0.08	)		(0.02	)		(0.64	)
Cumulative effect of change in accounting principle		—			—			—			(0.02	)
Net income (loss)	$	0.23		$	(2.31	)	$	0.67		$	(2.63	)
Earnings (loss) per common share — diluted
Income (loss) from continuing operations	$	0.23		$	(2.23	)	$	0.65		$	(1.97	)
Discontinued operations		(0.01	)		(0.08	)		(0.02	)		(0.64	)
Cumulative effect of change in accounting principle		—			—			—			(0.02	)
Net income (loss)	$	0.22		$	(2.31	)	$	0.63		$	(2.63	)

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

7

KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

	Nine Months Ended
	November 2, 2003			October 31, 2004
	(In thousands)
	(Restated)
CASH FLOW FROM OPERATING ACTIVITIES:
Net income (loss)	$	39,231		$	(162,254	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		15,999			23,373
Deferred income taxes		(3,786	)		4,337
Impairment charges		—			182,914
Cumulative effect of change in accounting principle		—			1,231
Deferred rent expense		874			1,007
Gain on disposal of property and equipment		(2,055	)		(587	)
Share-based compensation		112			41
Provision for doubtful accounts		629			2,940
Tax benefit from exercise of nonqualified stock options		34,514			—
Amortization of deferred financing costs		10			175
Minority interests in results of consolidated franchisees		1,565			(4,829	)
Equity in losses of equity method franchisees		1,818			675
Cash distributions from equity method franchisees		1,051			1,497
Other		(72	)		(674	)
Change in assets and liabilities:
Receivables		(10,801	)		(9,920	)
Inventories		(5,291	)		(2,762	)
Prepaid expenses and other current assets		(1,556	)		269
Income taxes		(1,799	)		6,826
Accounts payable and accrued expenses		(7,619	)		16,438
Other long-term obligations		1,708			4,573
Net cash provided by operating activities		64,532			65,270
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(50,961	)		(61,136	)
Proceeds from sales of assets leased back		—			16,698
Proceeds from other disposals of property and equipment		158			1,684
Acquisition of franchise markets, net of cash acquired		(103,110	)		(3,618	)
Acquisition of Montana Mills, net of cash acquired		4,052			—
Investments in and advances to equity method franchisees		(7,959	)		(2,401	)
Purchases of investments		(6,000	)		—
Proceeds from sales of investments		33,136			—
Issuance of notes receivable		(6,633	)		(724	)
Collection of notes receivable		4,294			4,139
(Increase) decrease in other assets		(1,708	)		212
Net cash used for investing activities		(134,731	)		(45,146	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options		18,092			1,172
Proceeds from exercise of warrants		4			—
Issuance of short-term debt		55,000			—
Repayment of short-term debt		(57,684	)		—
Issuance of long-term debt		38,240			12,164
Repayment of long-term debt		(48,649	)		(43,368	)
Net borrowings from revolving lines of credit		71,712			1,092
Issuance of short-term debt — related party		2,350			—
Debt issue costs		(837	)		(97	)
Net change in book overdraft		(279	)		1,845
Cash received from (paid to) minority interests		(666	)		22
Net cash provided by (used for) financing activities		77,283			(27,170	)
Effect of exchange rate changes on cash		—			135
Cash balances of subsidiaries at date of consolidation		—			3,217
Net increase (decrease) in cash and cash equivalents		7,084			(3,694	)
Cash and cash equivalents at beginning of period		32,023			21,029
Cash and cash equivalents at end of period	$	39,107		$	17,335
Supplemental schedule of non-cash investing and financing activities:
Assets acquired under capital leases	$	2,683		$	3,811
Issuance of shares in conjunction with acquisitions		57,785			—
Issuance of promissory notes in connection with acquisition of franchise market		11,286			—
Receipt of promissory notes in connection with sale of assets		3,551			—
Issuance of restricted common shares		10			—

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

8

KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

													Accumulated
													other			Retained
													comprehensive			earnings
	Common			Common			Unearned			Notes			income			(accumulated
	shares			stock			compensation			receivable			(loss)			deficit)			Total
	(In thousands)
Balance at February 2, 2003 (restated)		56,295		$	173,112		$	(119	)	$	(558	)	$	(1,522	)	$	94,526		$	265,439
Comprehensive income (loss):
Net income for the nine months ended November 2, 2003 (restated)																	39,231			39,231
Unrealized holding loss, net of tax benefit of $71														(113	)					(113	)
Foreign currency translation adjustment, net of income taxes of $15														469						469
Unrealized gain from cash flow hedge, net of income taxes of $129														249						249
Total comprehensive income (restated)																				39,836
Exercise of stock options		2,993			55,729															55,729
Exercise of warrants					4															4
Issuance of shares in conjunction with acquisition of business		1,247			39,245															39,245
Issuance of shares in conjunction with acquisition of franchise market		444			18,540															18,540
Issuance of restricted shares					10			(10	)											—
Amortization of restricted shares								50												50
Balance at November 2, 2003 (restated)		60,979		$	286,640		$	(79	)	$	(558	)	$	(917	)	$	133,757		$	418,843
Balance at February 1, 2004 (restated)		61,286		$	294,477		$	(62	)	$	(383	)	$	(712	)	$	143,089		$	436,409
Comprehensive income (loss):
Net loss for the nine months ended October 31, 2004																	(162,254	)		(162,254	)
Foreign currency translation adjustment, net of income taxes of $583														854						854
Unrealized gain from cash flow hedge, net of income taxes of $140														213						213
Total comprehensive (loss)																				(161,187	)
Exercise of stock options		471			1,172															1,172
Amortization of restricted shares								41												41
Cancellation of restricted shares		(2	)		(41	)														(41	)
Balance at October 31, 2004		61,755		$	295,608		$	(21	)	$	(383	)	$	355		$	(19,165	)	$	276,394

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

9

KRISPY KREME DOUGHNUTS, INC.

NOTES TO FINANCIAL STATEMENTS
(Unaudited)

Note 1 — Overview

Restatement of Financial Statements

     In its 2005 Form 10-K, the Company restated its consolidated balance sheet as of February 1, 2004 (the last day of fiscal 2004) and its consolidated statements of operations for fiscal 2003, fiscal 2004 and the first three quarters of fiscal 2005. The restatement adjustments corrected certain historical accounting policies to conform those policies to generally accepted accounting principles (“GAAP”) and corrected errors made in the application of GAAP. See Notes 2 and 25 to the consolidated financial statements included in the 2005 Form 10-K for a description of the restatement adjustments, together with reconciliations of revenues, operating income and net income for the first, second and third quarters of fiscal 2004 and 2005 as originally reported with the comparable amounts as restated. The Company reported its results of operations for the three months ended October 31, 2004 in a Current Report on Form 8-K in November 2004, but had not filed a Quarterly Report on Form 10-Q for such period prior to filing this report in January 2007.

Updated financial information

     The financial information contained herein is as of October 31, 2004. The Company has filed the following reports for periods subsequent to that date: the 2005 Form 10-K, the 2006 Form 10-K and the Quarterly Reports on Form 10-Q for the first three quarters of fiscal 2007, to which readers are directed for further information. Some of the more significant matters discussed in such reports are described below.

     The Company incurred a net loss of $198.3 million in fiscal 2005 and $135.8 million in fiscal 2006. These losses reflect impairment and lease termination costs of $197.0 million in fiscal 2005 and $55.1 million in fiscal 2006. Fiscal 2006 results also reflect a non-cash charge of $35.8 million for the anticipated settlement of certain litigation described in Note 5. Cash provided by operating activities declined from $84.9 million in fiscal 2005 to $1.9 million in fiscal 2006.

     Beginning in fiscal 2005, the Company experienced initially a slowing in the rate of growth in sales in its Company Stores segment, followed by declines in sales compared to the prior periods. The Company’s Franchise and KKM&D segments experienced revenue trends similar to those experienced in the Company Stores segment. These sales declines continued in the first nine months of fiscal 2007. While total revenues declined in the first nine months of fiscal 2007, average weekly sales per Company store increased compared to the first nine months of fiscal 2006.

     Investigations of the Company have been initiated by the Securities and Exchange (the “Commission”) and the United States Attorney for the Southern District of New York, and other litigation and investigations are pending as described in Note 5. In October 2004, the Company’s Board of Directors elected two new independent directors and appointed them the members of a Special Committee to investigate the matters raised by the Commission, the allegations in certain litigation, issues raised by the Company’s independent auditors and other matters relevant to the foregoing.

     The Company has incurred substantial expenses to defend the Company and certain of its current and former officers and directors in connection with litigation, to cooperate with the investigations of the Commission, the United States Attorney and the Special Committee of the Company’s Board of Directors, to undertake the Company’s internal investigation of accounting matters, and to indemnify certain current and former officers and directors for certain legal and other expenses incurred by them. These expenses are continuing in fiscal 2007, and could be substantial in future years.

     The Company has undertaken a number of initiatives designed to improve the Company’s operating results and financial position. Such initiatives include closing a substantial number of underperforming stores, reducing corporate overhead and other costs to bring them more in line with the Company’s current level of operations, recruiting new management personnel for certain positions, obtaining the new Secured Credit Facilities described in Note 5 to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 29, 2006, restructuring certain financial arrangements associated with franchisees in which the Company has an ownership interest and with respect to which the Company has financial guarantee obligations, and selling certain non-strategic assets.

10

In March 2006, the Company appointed a new chief executive officer having over 20 years experience in the food industry and with particular experience in consumer packaged goods.

     While the Company believes that these actions have enhanced the likelihood that the Company will be able to improve its business, the Company remains subject to a number of risks, many of which are not within the control of the Company. Among the more significant of those risks are pending litigation and governmental investigations, the outcome of which cannot be predicted, the costs of defending such pending litigation and cooperating with such investigations, and the magnitude of indemnification expenses which the Company will incur under indemnification provisions of North Carolina law, the Company’s bylaws and certain indemnification agreements. The Company has reached a proposed settlement with respect to the federal securities class action and a proposed partial settlement with respect to the shareholder derivative actions. However, these settlements are subject to the approval of the relevant courts. Any of these risks could cause the Company’s operations to fail to improve or to continue to erode.

     In order to fund its business and potential indemnification obligations, including the payment of legal expenses, the Company is dependent upon its ability to generate cash from operations and continued access to external financing.

     The Company’s principal source of external financing is the Secured Credit Facilities obtained in April 2005 to replace the Credit Facility described in Note 4. The Secured Credit Facilities contain significant financial and other covenants which, among other things, limit the total indebtedness of the Company and limit the Company’s ability to obtain borrowings under the facilities, as described in Note 5 to the consolidated financial statements included in the Company’s Quarterly Report on Form 10-Q for the quarter ended October 29, 2006. Failure to generate sufficient earnings to comply with these financial covenants, or the occurrence or failure to occur of certain events, would cause the Company to default under the Secured Credit Facilities. In the absence of a waiver of, or forbearance with respect to, any such default from the Company’s lenders, the Company could be obligated to repay outstanding indebtedness under the facilities, and the Company’s ability to access additional borrowings under the facilities would be restricted.

     The Company believes that it will have sufficient access to credit under the Secured Credit Facilities to continue the restructuring of the Company’s business, and that it will be able to comply with the covenants contained in such facilities. The financial covenants contained in such facilities are based upon the Company’s fiscal 2007 operating plan and preliminary plans for fiscal 2008. There can be no assurance that the Company will be able to comply with the financial and other covenants in these facilities. In the event the Company were to fail to comply with one or more such covenants, the Company would attempt to negotiate waivers of any such noncompliance. There can be no assurance that the Company will be able to negotiate any such waivers, and the costs or conditions associated with any such waivers could be significant.

     In the event that credit under the Secured Credit Facilities were not available to the Company, there can be no assurance that alternative sources of credit will be available to the Company or, if they are available, under what terms or at what cost. The Company currently is planning a potential refinancing of the Secured Credit Facilities in order to reduce the Company’s financing costs, but there can be no assurance that any refinancing will be accomplished.

Significant Accounting Policies

     Basis of Presentation. The consolidated financial statements contained herein should be read in conjunction with the Company’s Annual Reports on Form 10-K for the years ended January 30, 2005 and January 29, 2006. 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 with respect to annual financial statements. The interim consolidated financial statements have been prepared in accordance with the Company’s accounting practices described in such Annual Reports, but have not been audited. In management’s opinion, the financial statements include all adjustments which, except as otherwise disclosed in this Quarterly Report on Form 10-Q, 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 February 1, 2004 were derived from the Company’s audited financial statements, but do not include all disclosures required by generally accepted accounting principles.

     NATURE OF BUSINESS.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 the collection of royalties from franchisees. Additionally, the Company sells doughnut-making equipment, doughnut mix, coffee and other ingredients and supplies to franchisees.

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     BASIS OF CONSOLIDATION.The financial statements include the accounts of KKDI and its wholly-owned subsidiaries, the most significant of which is KKDI’s principal operating subsidiary, Krispy Kreme Doughnut Corporation (“KKDC”).

     As required by Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (“ARB 51”) and Statement of Financial Accounting Standards No. 94, “Consolidation of All Majority-Owned Subsidiaries,” the Company consolidates the financial statements of all entities in which the Company has a controlling financial interest, as defined by ARB 51. As of October 31, 2004, these entities include Glazed Investments, LLC (“Glazed Investments”) and Freedom Rings, LLC (“Freedom Rings”), franchisees of the Company, because the Company’s ownership interests in these entities enable the Company to exercise voting control over them.

     Effective May 2, 2004, the Company adopted the provisions of Financial Accounting Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities” (“FIN 46(R)”), which clarifies the application of ARB 51 to entities that are variable interest entities (“VIEs”). VIEs typically are entities that are controlled through means other than ownership of common stock. FIN 46(R) requires the Company to assess its investments in franchisees and determine if the franchisees are VIEs. For franchisees that are VIEs, the Company must determine whether variable interests owned by the Company absorb a majority of the VIE’s expected losses and expected residual returns, and then consolidate the financial statements of those VIEs with respect to which the Company’s variable interests absorb a majority of those expected losses or returns.

     Adoption of FIN 46(R) caused the Company to begin consolidating the financial statements of New England Dough, LLC (“New England Dough”) and KremeKo, Inc. (“KremeKo”). Prior to May 2, 2004, the Company accounted for its investments in these entities using the equity method. New England Dough and KremeKo, together with Glazed Investments and Freedom Rings, are hereinafter sometimes referred to as “Consolidated Franchisees.”

     One of the differences between ARB 51 and FIN 46(R) is that the latter requires elimination in consolidation of 100% of the profit and revenues on intercompany transactions with less than wholly-owned subsidiaries, while the former requires elimination of such profit and revenues only to the extent of the parent’s ownership interest in the subsidiary. FIN 46(R) provides that upon the initial consolidation of variable interest entities created before December 31, 2003, the assets and liabilities of the variable interest entity should be reported as if FIN 46(R) had been in effect on the date on which the consolidating entity became the primary beneficiary of the variable interest entity and was therefore required to consolidate the entity’s financial statements.

     Prior to adoption of FIN 46(R), the Company eliminated profits on the sale of equipment and the initial franchise fees charged to New England Dough and KremeKo to the extent of its ownership interests in these entities. Had FIN 46(R) been in effect in such pre-adoption periods, the Company would have been required to eliminate 100% of such intercompany profits and revenues. Accordingly, upon adoption of FIN 46(R) in the first quarter of fiscal 2005, the Company eliminated the previously recognized intercompany profits and revenues described above related to New England Dough and KremeKo. Such elimination totaled $1,231,000 (after reduction for income taxes of $803,000), and appears under the caption “Cumulative effect of change in accounting principle, net of income taxes” in the consolidated statement of operations.

     Investments in entities over which the Company has the ability to exercise significant influence, and whose financial statements are not required to be consolidated under ARB 51 or FIN 46(R), are accounted for using the equity method. These entities typically are 20% to 50% owned and are hereinafter sometimes referred to as “Equity Method Franchisees.”

     Except for Freedom Rings, the results of operations of Consolidated Franchisees (as well as the Company’s share of income or loss from Equity Method Franchisees) are reflected in the Company’s results of operations on a one-month lag.

     EARNINGS PER SHARE.The computation of basic earnings per share is based on the weighted average number of common shares outstanding during the period. The computation of diluted earnings per share reflects the potential dilution that would occur if stock options were exercised and the dilution from the issuance of restricted shares, computed using the treasury stock method.

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

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	Three Months Ended					Nine Months Ended
	November 2,		October 31,			November 2,		October 31,
	2003		2004			2003		2004
	(In thousands)
	(restated)					(restated)
Numerator: Income (loss) from continuing operations	$	14,521	$	(137,443	)	$	40,138	$	(121,190	)
Denominator:
Basic earnings per share-weighted average shares outstanding		60,173		61,753			58,543		61,582
Effect of dilutive securities:
Stock options		2,960		—			3,429		—
Restricted stock		3		—			3		—
Diluted earnings per share-weighted average shares outstanding		63,136		61,753			61,975		61,582

     All potentially dilutive securities have been excluded from the number of shares used in the computation of diluted earnings per share for the three months and nine months ended October 31, 2004 because the Company incurred a loss from continuing operations for these periods and their inclusion would be antidilutive to the loss per common share from continuing operations.

     STOCK-BASED COMPENSATION.The Financial Accounting Standards Board (“FASB”) has adopted Statement of Financial Accounting Standards No. 123, “Stock-Based Compensation” (“FAS 123”), which permits, but does not require, the Company to utilize a fair-value based method of accounting for stock-based compensation. For periods covered by this report, the Company has elected to continue use of the APB 25 intrinsic value method of accounting for its stock option plans and accordingly has recorded no compensation cost for grants of stock options. Had compensation cost for the Company’s stock option plans been determined based on the estimated fair value at the grant dates in accordance with the provisions of FAS 123, the Company’s losses would have been affected as set forth in the table below:

	Three Months Ended						Nine Months Ended
	November 2,			October 31,			November 2,			October 31,
	2003			2004			2003			2004
	(In thousands, except per share amounts)
	(restated)						(restated)
Net income (loss), as reported	$	14,053		$	(142,519	)	$	39,231		$	(162,254	)
Add: stock-based expense charged to earnings		33			10			112			41
Deduct: stock-based compensation expense determined under fair value method for all awards		(1,662	)		(8,015	)		(7,408	)		(13,877	)
Pro forma net income (loss)	$	12,424		$	(150,524	)	$	31,935		$	(176,090	)
Earnings (loss) per share:
Reported earnings (loss) per share — Basic	$	0.23		$	(2.31	)	$	0.67		$	(2.63	)
Pro forma earnings (loss) per share — Basic	$	0.21		$	(2.44	)	$	0.55		$	(2.86	)
Reported earnings (loss) per share — Diluted	$	0.22		$	(2.31	)	$	0.63		$	(2.63	)
Pro forma earnings (loss) per share — Diluted	$	0.20		$	(2.44	)	$	0.52		$	(2.86	)

Recent Accounting Pronouncements

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “Fair Value Measurements” (“FAS 157”), which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (“GAAP”). As a result of FAS 157, there is now 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 Company must adopt FAS 157 in fiscal 2009, but has not yet begun to evaluate the effects, if any, of adoption on its consolidated financial statements.

     In July 2006, the FASB released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. The Company must adopt FIN 48 in the first quarter of fiscal 2008, and management currently is evaluating the effect of adoption on the Company’s consolidated financial statements.

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     In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections” (“FAS 154”) to replace Accounting Principles Board Opinion No. 20, “Accounting Changes” and FAS 3, “Reporting Accounting Changes in Interim Periods.” FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections, and establishes retrospective application as the required method for reporting a change in accounting principle. FAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable, and for reporting a change when retrospective application is determined to be impracticable. FAS 154 also addresses the reporting of a correction of an error by restating previously issued financial statements. The Company adopted FAS 154 in fiscal 2007, but adoption had no effect on the Company’s consolidated financial statements.

     In February 2005, the Emerging Issues Task Force reached a consensus in Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations” (“EITF 03-13”). EITF 03-13 provides guidance on how to evaluate whether the operations and cash flows of a disposed component have been or will be eliminated from ongoing operations and the types of continuing involvement that constitute significant continuing involvement in the operations of the disposed component. These evaluations affect the determination of whether the results of operations of a disposed component are reported as discontinued operations. The Company adopted EITF 030-13 in fiscal 2006, but adoption had no effect on the Company’s consolidated financial statements.

     In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (“FAS 123(R)”), which requires the measurement and recognition of compensation expense for all share-based payment (“SBP”) awards. The new standard supersedes the Company’s current accounting under APB 25 and will require the Company to recognize compensation expense for all SBP awards based on fair value. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 relating to the adoption of FAS 123(R). Beginning in the first quarter of fiscal 2007, the Company adopted the provisions of FAS 123(R) using the modified prospective transition method, the Black-Scholes option pricing model and an attribution method which recognizes the fair value of awards in earnings on a straight-line basis over the vesting period of the award. Under the new standard, the Company’s estimate of the fair value of SBP awards, and therefore compensation expense, requires a number of complex and subjective assumptions, including the Company’s stock price volatility, employee exercise patterns influencing the expected life of the options, future forfeitures and related tax effects. Pro forma net income and earnings per share amounts for the three months and nine months ended November 2, 2003 and October 31, 2004, computed as if the Company had used a fair-value based method similar to the methods required under FAS 123(R) to measure compensation expense for employee stock-based compensation awards, are set forth under “Stock-based compensation” above.

     In November 2004, the FASB issued Statement No. 151, “Inventory Costs” (“FAS 151”), which amends the guidance in Accounting Research Bulletin No. 43, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). FAS 151 requires that those items be recognized as current period charges and that the allocation of fixed production overheads to the cost of converting work in process to finished goods be based on the normal capacity of the production facilities. The Company adopted FAS 151 in fiscal 2007, but adoption had no material effect on the Company’s consolidated financial statements.

Note 2 — Inventories

     The components of inventories are as follows:

	February 1,		October 31,
	2004		2004
	(In thousands)
	(restated)
Raw materials	$	8,731	$	9,169
Work in progress		84		100
Finished goods		7,699		9,007
Purchased merchandise		13,190		14,831
Manufacturing supplies		117		143
	$	29,821	$	33,250

Note 3 — Goodwill and Other Intangible Assets

     Goodwill and other intangible assets consist of the following:

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	February 1,		October 31,
	2004		2004
	(In thousands)
	(restated)
Indefinite-lived intangible assets:
Goodwill (by segment):
Company Stores	$	139,386	$	8,983
Franchise		23,496		23,496
KKM&D		213		213
Montana Mills		19,664		—
		182,759		32,692
Reacquired franchise rights associated with Company Stores		2,120		1,520
Trademarks and trade names associated with Montana Mills		11,300		—
		196,179		34,212
Definite-lived intangible assets:
Recipes		983		173
	$	197,162	$	34,385

     As more fully described in Note 6, the Company’s impairment testing of goodwill and reacquired franchise rights resulted in a charge of approximately $131.6 million in the three months ended October 31, 2004 to reduce the carrying value of goodwill associated with certain reporting units within the Company Stores business segment to its estimated fair value, and charges of approximately $600,000 to reduce the carrying value of reacquired franchise rights associated with certain reporting units within the Company Stores segment to their estimated fair value. The impairment charges reflect the substantial decline in operating income in 2005 within the Company Stores business segment. In addition, the Company wrote off approximately $31.8 million of goodwill and other intangibles in the first quarter of fiscal 2005 in connection with its decision to exit the Montana Mills business, as described in Note 9.

Note 4 — Long Term Debt

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

	February 1,			October 31,
	2004			2004
	(In thousands)
	(restated)
Krispy Kreme Doughnut Corporation:
$119.3 million revolving line of credit	$	87,000		$	62,000
$30.7 million term loan		30,113			28,875
Capital lease obligations		7,339			7,776
		124,452			98,651
Glazed Investments:
$12 million credit facility		6,330			7,301
Real estate and equipment loans		14,319			6,525
Capital lease obligations
Subordinated notes		136			136
		20,785			13,962
New England Dough:
$14.4 million term loans		—			13,727
$12 million revolving line of credit		—			1,092
		—			14,819
KremeKo:
Credit facility		—			11,789
Building and equipment loans		—			2,180
Capital lease obligations		—			403
		—			14,372
Montana Mills		19			—
		145,256			141,804
Less: current maturities		(8,142	)		(23,080	)
	$	137,114		$	118,724

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     The following sets forth a description of certain long term debt as it existed at October 31, 2004. Subsequent to October 31, 2004, substantially all of the debt described below was refinanced or discharged, as described below and in Note 6 to the consolidated financial statements included in the 2006 Form 10-K.

$150 Million Credit Agreement

     On October 31, 2003, the Company entered into a $150,000,000 unsecured bank credit facility (“Credit Facility”) to refinance certain existing debt and increase borrowing availability for general working capital purposes and other financing and investing activities. The Credit Facility consists of a $119.3 million revolving credit facility (the “Revolver”) and a $30.7 million term loan (the “Term Loan”). Initial borrowings under the Revolver were used to repay amounts outstanding, including interest, under a $55 million short-term promissory note entered into during June 2003 to finance, in part, an acquisition and to make loans to two Consolidated Franchisees to enable them to repay certain bank debt. Borrowings under the Term Loan were used to refinance an existing term loan (the “$33 Million Term Loan”) entered into to fund the initial purchase and completion of a mix and distribution facility.

     The amount available under the Revolver is reduced by letters of credit and was $48.4 million at October 31, 2004. Outstanding letters of credit, issued primarily for insurance purposes, totalled $8.9 million at October 31, 2004.

     Under the Credit Facility, the Company may prepay amounts outstanding without penalty. Amounts outstanding under the Revolver are due in full on October 31, 2007, when the Credit Facility terminates. The Term Loan requires monthly payments of principal of $137,500 through October 31, 2007, at which time a final payment of all outstanding principal and accrued interest will be due. Interest on amounts outstanding under the Revolver generally is payable quarterly and interest on the Term Loan is payable monthly and accrues at either the Base Rate, as defined within the Credit Facility agreement, plus an Applicable Margin, as defined, or Adjusted LIBOR, as defined, plus an Applicable Margin, at the Company’s election. The Applicable Margin ranges from 0.0% to 0.75% for Base Rate borrowings and from 1.0% to 2.0% for Adjusted LIBOR borrowings and is determined based upon the Company’s performance under certain financial covenants contained in the Credit Facility. The interest rate applicable at October 31, 2004 was 2.93% on the Revolver and 3.09% on the Term Loan. A fee on the unused portion of the Revolver is payable quarterly and ranges from 0.20% to 0.375%, which is also determined based upon the Company’s performance under certain financial covenants contained in the Credit Facility.

     The Company is counterparty to an interest rate swap agreement with a bank, which was initially entered into in May 2002 to convert variable rate payments due under the $33 Million Term Loan to fixed amounts, thereby hedging against the impact of interest rate changes on future interest expense. The Company formally documents all hedging instruments and assesses, both at inception of the contract and on an ongoing basis, whether they are effective in offsetting changes in cash flows of the hedged transaction. The swap had an initial notional amount of $33 million. The notional amount declines by $137,500 each month, originally to correspond with the reduction in principal of the $33 Million Term Loan and now to correspond with the reduction in principal of the Term Loan. The notional amount of the swap at October 31, 2004 was $28.9 million. Under the terms of the swap, the Company makes fixed rate payments to the counterparty of 5.09% and receives payments at one-month LIBOR. Monthly payments continue until the swap terminates on May 1, 2007. At February 1 and October 31, 2004, the fair value carrying amount of the swap was a liability of $2,160,000 and $1,470,000, respectively.

     The Credit Facility contains provisions which, among other things, restrict the payment of dividends and require the Company to maintain compliance with certain covenants, including the maintenance of certain financial ratios. At October 31, 2004, the Company was in compliance with these covenants.

     On April 1, 2005, the Company closed the Secured Credit Facilities described in Note 6 to the consolidated financial statements included in the 2006 Form 10-K, and used a portion of the initial borrowings thereunder to repay all outstanding borrowings under the Credit Facility, which was then retired.

Consolidated Franchisees

     Each of Glazed Investments, New England Dough and KremeKo had various credit facilities to fund their operations and capital expenditures. Those credit facilities bore interest at floating rates and contained various financial and other covenants. Amounts outstanding those facilities were repaid or discharged subsequent to October 31, 2004 as described below and in Note 6 to the consolidated financial statements included in the 2006 Form 10-K.

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     In April 2005, a Canadian court entered an order affording KremeKo protection from its creditors under the Companies’ Creditors Arrangement Act. The Company subsequently reached an agreement with KremeKo’s two secured creditors to settle the Company’s obligations under its guarantees of KremeKo’s indebtedness to such lenders and related equipment repurchase agreements. Pursuant to the agreement, the Company paid approximately $9.3 million to the lenders in settlement of all of the Company’s obligations to them, and the lenders assigned to the Company KremeKo’s notes payable to the lenders (the “KremeKo Notes”). On December 19, 2005, a newly formed subsidiary of the Company acquired from KremeKo all of its operating assets in exchange for the KremeKo Notes pursuant to a sale authorized by the Ontario Court, and thereafter the business has operated as a wholly-owned subsidiary of the Company.

     In December 2005, the Company and the minority investors in New England Dough reached an agreement to reorganize the operations of the business. In connection with that agreement, the Company acquired three New England Dough stores, a fourth store was acquired by the minority investors, and the remaining New England Dough stores were closed. The Company and the minority owners of New England Dough retired its outstanding debt, which was subject to guarantees of the owners in proportion to their ownership interests.

     On February 3, 2006, Glazed Investments filed for bankruptcy protection. Under the supervision of the court, on March 31, 2006, the majority of Glazed Investments’ stores were sold to another of the Company’s franchisees for $10 million cash. Glazed Investments closed the balance of its stores. While the proceeds of the sale and the proceeds from liquidation of Glazed Investments’ other assets were sufficient to retire a substantial majority of Glazed Investments’ outstanding debt, the Company paid approximately $1.1 million of Glazed Investments’ debt pursuant to the Company’s guarantee of a portion of such indebtedness.

Note 5 — Commitments and Contingencies

     In May 2004, a number of purported class action lawsuits alleging violations of the federal securities laws were commenced against the Company and certain of its officers and directors in federal court in North Carolina. Subsequently, the Commission began an informal inquiry concerning the Company, and the Company received requests for information from the Commission’s Division of Corporation Finance, primarily directed at its franchise reacquisitions. In August 2004, the Company’s Audit Committee engaged independent counsel to investigate a matter relating to a 2004 franchise reacquisition and to perform certain additional procedures requested by the Company’s independent auditors. In September 2004, a shareholder derivative lawsuit was filed in federal court in North Carolina against certain current and former officers and directors of the Company and certain former franchisees who had sold their franchises to the Company; additional derivative lawsuits were filed in North Carolina state court in November 2004 and January 2005, and these were consolidated with the federal derivative case. In October 2004, the Commission notified the Company that the Commission had entered a formal order of investigation of the Company.

     Also in October 2004, the Company’s Board of Directors elected two new independent directors and appointed them the members of a Special Committee to investigate the matters raised by the Commission, the allegations in the purported derivative lawsuits, issues raised by the Company’s independent auditors and other matters relevant to the foregoing. The Special Committee engaged its own counsel and accounting professionals to assist the Special Committee in conducting its investigation. In August 2005, the Company’s Board of Directors received the report of the Special Committee, a summary of which was filed as an exhibit to a Current Report on Form 8-K dated August 9, 2005.

     Except as disclosed below, the Company is currently not aware of any legal proceedings or claims that the Company believes could have, individually or in the aggregate, a material adverse effect on the Company’s business, financial condition, results of operations or cash flows. Legal proceedings or claims commenced after October 31, 2004 but which had been resolved as of the date of the filing of this report are not described below.

Litigation and Investigations Settled or Pending Settlement

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

     On May 12, 2004, a purported securities class action was filed on behalf of persons who purchased the Company’s publicly traded securities between August 21, 2003 and May 7, 2004 against the Company and certain of its current and former officers in the United States District Court for the Middle District of North Carolina. Plaintiff alleged that defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder in connection with various public statements made by the Company. Plaintiff sought damages in an unspecified amount. Thereafter, 14 substantially identical purported class actions were filed in the

17

same court. On November 8, 2004, all of these cases were consolidated into one action. The court appointed lead plaintiffs in the consolidated action, who filed a second amended complaint on May 23, 2005, alleging claims under Sections 10(b) and 20(a) of the Exchange Act on behalf of persons who purchased the Company’s publicly-traded securities between March 8, 2001 and April 18, 2005. The Company filed a motion to dismiss the second amended complaint on October 14, 2005 that is currently pending.

     Three shareholder derivative actions have been filed in the United States District Court for the Middle District of North Carolina:Wright v. Krispy Kreme Doughnuts, Inc., et al., filed September 14, 2004;Blackwell v. Krispy Kreme Doughnuts, Inc., et al., filed May 23, 2005; andAndrews v. Krispy Kreme Doughnuts, Inc., et al., filed May 24, 2005.

     The defendants in one or more of these actions include all current and certain former directors of the Company (other than members of the Special Committee and two other directors first elected to the Board in 2006), certain current and former officers of the Company, including Scott Livengood (the Company’s former Chairman and Chief Executive Officer), John Tate (the Company’s former Chief Operating Officer) and Randy Casstevens (the Company’s former Chief Financial Officer), and certain persons or entities that sold franchises to the Company. The complaints in these actions allege that the defendants breached their fiduciary duties in connection with their management of the Company and the Company’s acquisitions of certain franchises. The complaints sought damages, rescission of the franchise acquisitions, disgorgement of the proceeds from these acquisitions and other unspecified relief.

     In orders dated November 5, 2004, November 24, 2004, April 4, 2005 and June 1, 2005, the court stayed theWrightaction pending completion of the investigation of the Special Committee.

     On June 3, 2005, the plaintiffs in theWright,BlackwellandAndrewsactions filed a motion to consolidate the three actions and to name lead plaintiffs in the consolidated action. On June 27, 2005, Trudy Nomm, who, like the plaintiffs in theWright,BlackwellandAndrewsactions, identified herself as a Krispy Kreme shareholder, filed a motion to intervene in these derivative actions and to be named lead plaintiff. On July 12, 2005, the court consolidated theWright,BlackwellandAndrewsshareholder derivative actions under the headingWright v. Krispy Kreme Doughnuts, Inc., et al.and ordered the plaintiffs to file a consolidated complaint on or before the later of 45 days after the plaintiffs receive the report of the Special Committee or 30 days after the court appoints lead counsel. A consolidated complaint has not yet been filed.

     On August 10, 2005, the Company announced that the Special Committee had completed its investigation. The Special Committee concluded that it was in the best interest of the Company to reject the demands by shareholders that the Company commence litigation against the current and former directors and officers of the Company named in the derivative actions and to seek dismissal of the shareholder litigation against the outside directors, the sellers of certain franchises and current and former officers, except for Messrs. Livengood, Tate and Casstevens, as to whom the Special Committee concluded that it would not seek dismissal of the shareholder derivative litigation.

     On October 21, 2005, the court granted Ms. Nomm’s motion to intervene. On October 28, 2005, the court appointed the plaintiffs in theWrightaction, Judy Woodall and William Douglas Wright, as co-lead plaintiffs in the consolidated action.

     On October 31, 2006, the Company and the Special Committee entered into a Stipulation and Settlement Agreement (the “Stipulation”) with the lead plaintiffs in the securities class action, the derivative plaintiffs and all defendants named in the class action and derivative litigation, except for Mr. Livengood, providing for the settlement of the securities class action and a partial settlement of the derivative action, on the terms described below.

     With respect to the securities class action, the Stipulation provides for the certification of a class consisting of all persons who purchased the Company’s publicly-traded securities between March 8, 2001 and April 18, 2005, inclusive. The settlement class will receive total consideration of approximately $75 million, consisting of a cash payment of $34,967,000 to be made by the Company’s directors’ and officers’ insurers, a cash payment of $100,000 to be made by Mr. Tate, a cash payment of $100,000 to be made by Mr. Casstevens, a cash payment of $4,000,000 to be made by the Company’s independent registered public accounting firm and common stock and warrants to purchase common stock to be issued by the Company having an aggregate value of $35,833,000 (based on the market price of the Company’s common stock as of late October and early November 2006). Claims against all defendants will be dismissed with prejudice; however, claims that the Company may have against Mr. Livengood that may be asserted by the Company in the derivative action for contribution to the securities class action settlement or otherwise under applicable law are expressly preserved. The Stipulation contains no admission of fault or wrongdoing by the Company or the other defendants. On November 16, 2006, the court entered an order granting preliminary approval to the settlement. The settlement is subject to final approval of the court.

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     With respect to the derivative litigation, the Stipulation provides for the settlement and dismissal with prejudice of claims against all defendants except for claims against Mr. Livengood. The Company, acting through its Special Committee, settled claims against Mr. Tate and Mr. Casstevens for the following consideration: Messrs. Tate and Casstevens each agreed to contribute $100,000 in cash to the settlement of the securities class action; Mr. Tate agreed to cancel his interest in 6,000 shares of the Company’s common stock; and Messrs. Tate and Casstevens agreed to limit their claims for indemnity from the Company in connection with future proceedings before the SEC or the United States Attorney for the Southern District of New York to specified amounts. The Company, acting through its Special Committee, has been in negotiations with Mr. Livengood but has not reached agreement to resolve the derivative claims against him and counsel for the derivative plaintiffs are deferring their application for fees until conclusion of the derivative actions against Mr. Livengood. All other claims against defendants named in the derivative actions will be dismissed with prejudice without paying any consideration, consistent with the findings and conclusions of the Special Committee in its report of August 2005.

     The Company expects to issue approximately 1,835,000 shares of its common stock and warrants to purchase approximately 4,300,000 shares of its common stock in connection with the Stipulation. The exercise price of the warrants will be approximately $12.21 per share.

     The Company recorded a non-cash charge to earnings in the first quarter of fiscal 2006 of $35,833,000, representing the estimated fair value, as of late October 2006, of the common stock and warrants to be issued by the Company. The settlement is conditioned on the Company’s insurers and the other contributors paying their share of the settlement. The provision for settlement costs will be adjusted in periods after October 2006 to reflect changes in the fair value of the securities until they are issued following final court approval of the Stipulation, which the Company anticipates will occur in early calendar 2007.

State Court Shareholder Derivative Actions

     Two shareholder derivative actions have been filed in the Superior Court of North Carolina, Forsyth County:Andrews v. Krispy Kreme Doughnuts, Inc., et al., filed November 12, 2004, andLockwood v. Krispy Kreme Doughnuts, Inc., et al., filed January 21, 2005. On April 26, 2005, those actions were assigned to the North Carolina Business Court. On May 26, 2005, the plaintiffs in these actions voluntarily dismissed these actions in favor of a federal court action they filed on May 25, 2005 (theAndrewsaction discussed above).

Arbitration Award

     In March 2000, a lawsuit was filed against the Company, management and Golden Gate Doughnuts, the Company’s franchisee in Northern California, in Superior Court in the State of California. The lawsuit was filed as a result of joint venture discussions between the Company and the plaintiffs to develop the Northern California market. The plaintiffs were offered participation in the Northern California joint venture but declined. They instead brought suit contending that they had a right to a larger percentage of the joint venture and on different terms than offered by the Company. The plaintiffs alleged, among other things, breach of contract and sought compensation for damages and punitive damages. In September 2000, after the case was transferred to Sacramento Superior Court, that court granted the motion to compel arbitration of the action and stay the lawsuit pending the outcome of arbitration. In October 2001, after an appeal to the California appellate courts, plaintiffs filed a demand for arbitration with the American Arbitration Association against KKDC and the other defendants. In February 2003, after an extended series of arbitration hearings, the Arbitration Panel dismissed all claims against all parties, except the claim for breach of contract against the Company and Golden Gate, and entered a preliminary award against the Company and Golden Gate. The Company accrued a provision of $9,075,000 in fiscal 2003, which consisted of the preliminary award and an estimate of the anticipated award of legal fees and other costs. After further negotiations, all claims were settled for $8,550,000 in May 2003. The accompanying statement of operations for the nine months ended November 2, 2003 reflects the $525,000 reversal of the accrual remaining after settlement.

Pending Litigation and Investigations

     The Company is subject to other litigation and investigations, the outcome of which cannot presently be determined. The Company cannot predict the likelihood of an unfavorable outcome with respect to these other matters, or the amount or range of potential loss with respect to, or the amount that might be paid in connection with any settlement of, any of these other matters, and, accordingly, no provision for loss with respect to any of the following matters has been reflected in the consolidated financial statements.

19

SEC Investigation

     On October 7, 2004, the staff of the Commission advised the Company that the Commission had entered a formal order of investigation concerning the Company. The Company is cooperating with the investigation.

United States Attorney Investigation

     On February 24, 2005, the United States Attorney’s Office for the Southern District of New York advised the Company that it would seek to conduct interviews of certain current and former officers and employees of the Company. The Company is cooperating with the investigation.

State Franchise/FTC Inquiry

     On June 15, 2005, the Commonwealth of Virginia, on behalf of itself, the FTC and eight other states, inquired into certain activities related to prior sales of franchises and the status of the Company’s financial statements and requested that the Company provide them with certain documents. The inquiry related to potential violations for failures to file certain amendments to franchise registrations and the failure to deliver accurate financial statements to prospective franchisees. Fourteen states (the “Registration States”) and the FTC regulate the sale of franchises. The Registration States specify forms of disclosure documents that must be provided to franchisees and filed with the state. In the non-registration states, according to FTC rules, documents must be provided to franchisees but are not filed. Earlier in 2005, the Company had chosen not to renew its disclosure document in the Registration States because the Company realized that its financial statements would need to be restated and because the Company had stopped selling domestic franchises. The Company is fully cooperating with the inquiry and has delivered the requested documents. Since June 15, 2005, Virginia has indicated that it and a majority of the remaining states would withdraw from the inquiry. The Company has not received any additional information from the FTC or any other state that one or more of them intend to pursue or abandon the inquiry.

State Court Books and Records Action

     On February 21, 2005, a lawsuit was filed against the Company in the Superior Court of North Carolina, Wake County, Nomm v. Krispy Kreme, Inc., seeking an order requiring the Company to permit the plaintiff to inspect and copy the books and records of the Company. On March 29, 2005, the action was transferred to the Superior Court of North Carolina for Forsyth County. On May 20, 2005, the case was assigned to the North Carolina Business Court. On June 27, 2005, plaintiff filed a motion to intervene and be named lead plaintiff in the federal court derivative actions described above. On August 2, 2005, the North Carolina Business Court stayed this action pending a decision on Ms. Nomm’s motion to intervene and to serve as lead plaintiff in the federal court actions described above. On October 21, 2005, the court in the federal court actions granted Ms. Nomm’s motion to intervene and, on October 28, 2005, denied Ms. Nomm’s motion to be named lead plaintiff.

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

Other Contingencies and Commitments

     The Company has guaranteed certain leases and loans from third-party financial institutions on behalf of franchisees, primarily to assist the franchisees in obtaining third-party financing. The loans are collateralized by certain assets of the franchisee, generally the Krispy Kreme store and related equipment. The Company’s contingent liabilities related to these guarantees totaled approximately $20.8 million and $21.4 million at February 1 and October 31, 2004, respectively. For leases, the guaranteed amount was determined based upon the gross amount of remaining lease payments due and, for debt, the guaranteed amount was determined based upon the principal amount outstanding under the related agreement. Substantially all of the guarantees relate to Equity Method Franchisees. The percentage of the aggregate franchisee obligation guaranteed by the Company generally approximates the Company’s percentage ownership in the franchisee. These guarantees require payment from the Company in the event of default on payment by the respective debtor and, if the debtor defaults, the Company may be required to pay amounts outstanding under the related agreements in addition to the principal amount guaranteed, including accrued interest and related fees. At the time the guarantees were issued, the Company determined the fair value of the guarantees was immaterial and, accordingly, no amount was reflected for the liabilities in the consolidated balance sheet.

Note 6 – Impairment Charges and Lease Termination Costs

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

20

	Three Months Ended				Nine Months Ended
	November 2,		October 31,		November 2,		October 31,
	2003		2004		2003		2004
	(In thousands)
	(restated)				(restated)
Impairment charges:
Impairment of goodwill	$	—	$	131,609	$	—	$	131,609
Impairment of long-lived assets		—		9,331		—		15,030
Impairment of reacquired franchise rights		—		600		—		600
Other		—		7		—		556
Total impairment charges		—		141,547		—		147,795
Lease termination costs:
Provision for termination costs		—		1,025		—		2,735
Less — reversal of previously recorded deferred rent expense		—		85		—		(274	)
Net provision		—		1,110		—		2,461
	$	—	$	142,657	$	—	$	150,256

     The Company’s impairment testing of goodwill and reacquired franchise rights resulted in charges of approximately $131.6 million and $600,000 in the three months ended October 31, 2004 to reduce the carrying value of goodwill and reacquired franchise rights, respectively, associated with certain reporting units within the Company Stores business segment to their estimated fair values, which the Company estimates using the present value of expected future cash flows. The impairment charges reflect the substantial decline in operating income in fiscal 2005 within the Company Stores business segment.

     Impairment charges associated with long-lived assets consist principally of charges to reduce the carrying value of leasehold improvements related to closed stores to reflect that the leasehold improvements are abandoned when the leased properties revert to the lessor, and charges to reduce the carrying value of equipment related to closed stores to its estimated fair value, if any. The fair value of equipment is based upon its estimated selling price to franchisees opening new stores, after considering refurbishment and transportation costs.

     Lease termination costs represent the net present value of remaining contractual lease payments related to closed stores, after reduction by estimated sublease rentals.

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

	Three Months Ended					Nine Months Ended
	November 2,		October 31,			November 2,		Oct. 31,
	2003		2004			2003		2004
	(In thousands)
	(restated)					(restated)
Balance at beginning of period	$		$	1,596		$	—	$	—
Provision for lease termination costs:
Provisions associated with store closings, net of estimated sublease rentals		—		812			—		2,522
Adjustments to previously recorded provisions resulting from settlements with lessors and adjustments of previous estimates		—		197			—		197
Accretion of discount		—		16			—		16
Total provision		—		1,025			—		2,735
Payments		—		(414	)		—		(528	)
Balance at end of period	$	—	$	2,207		$	—	$	2,207

Note 7 – Segment Information

     The Company’s reportable segments are Company Stores, Franchise and KKM&D. The Company Stores segment is comprised of the operating activities of the stores owned by the Company and by Consolidated Franchisees. These stores sell doughnuts and complementary products through both on-premises and off-premises sales channels. The majority of the ingredients and materials used by Company Stores is purchased from the KKM&D segment. The Franchise segment represents the results of the Company’s

21

franchise program. Under the terms of the franchise agreements, the 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 this segment include costs incurred to recruit new franchisees and to open, monitor and aid in the performance of these stores and direct general and administrative expenses. The KKM&D segment supplies mix, equipment, coffee and other items to both Company and franchisee-owned stores.

     All intercompany transactions between the KKM&D segment and the Company Stores segment are at prices intended to reflect an arms-length transfer price and are eliminated in consolidation. Profit from KKM&D’s sales to Company Store Operations is classified as a reduction of Company Store Operations direct operating expenses, generally based on the proportion of sales to Company Stores relative to total KKM&D sales.

     The following table presents the results of the Company’s operating segments for the three months and nine months ended November 2, 2003 and October 31, 2004. Segment operating income is consolidated operating income before unallocated general and administrative expenses, impairment and lease termination costs and the arbitration award.

	Three Months Ended						Nine Months Ended
	November 2,			October 31,			November 2,			October 31,
	2003			2004			2003			2004
	(In thousands)
	(restated)						(restated)
Revenues:
Company Stores	$	110,430		$	128,411		$	317,021		$	388,247
Franchise		6,392			5,681			17,287			19,147
KKM&D		92,472			84,702			250,696			277,052
Intersegment sales eliminations		(44,299	)		(44,401	)		(117,917	)		(138,386	)
Total revenues	$	164,995		$	174,393		$	467,087		$	546,060
Operating income (loss):
Company Stores	$	19,964		$	8,694		$	59,199		$	40,029
Franchise		5,293			3,709			13,565			13,558
KKM&D		10,397			4,758			26,297			23,709
Unallocated general and administrative expenses		(9,693	)		(13,034	)		(29,088	)		(37,049	)
Impairment charges and lease termination costs		—			(142,657	)		—			(150,256	)
Arbitration award		—			—			525			—
Total operating income (loss)	$	25,961		$	(138,530	)	$	70,498		$	(110,009	)
Depreciation and amortization expense:
Company Stores	$	4,408		$	7,162		$	12,064		$	19,257
Franchise		43			43			129			129
KKM&D		775			833			2,297			2,456
Corporate administration		415			516			1,211			1,483
Total depreciation and amortization expense	$	5,641		$	8,554		$	15,701		$	23,325

     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 8 – Investments in Franchisees

     Subsequent to October 31, 2004, the Company disposed of its investments in a number of its franchisees; see Note 4 and the notes entitled “Investments in Franchisees” to the consolidated financial statements included in the 2006 Form 10-K and the Quarterly Report on Form 10-Q for the quarter ended October 29, 2006.

CONSOLIDATED FRANCHISEES

     Information about the Company’s Consolidated Franchisees as of October 31, 2004 and the markets served by those franchisees is set forth below:

22

		Ownership %
	Geographic				Third			Loan/Lease
	Market	KKD			Parties			Guarantees
								(In thousands)
Freedom Rings, LLC	Eastern Pennsylvania,
	Delaware, Southern New
	Jersey		70.0	%		30.0	%	$	952
Glazed Investments, LLC	Colorado, Minnesota,
	Wisconsin		85.9	%		14.1	%		10,315
New England Dough, LLC	Connecticut, Maine,
	Massachusetts, Rhode
	Island New Hampshire,
	Vermont		57.0	%		43.0	%		12,221
KremeKo, Inc	Central and Eastern Canada		40.6	%		59.4	%		8,601

     In connection with the Company’s acquisition of an additional interest in Glazed Investments in fiscal 2003, the Company issued two options to the minority owners of Glazed Investments, each of which required the Company to purchase, subject to certain conditions, an approximate 11% interest in Glazed Investments at the option of the minority owners. The Company recorded the option liabilities at their estimated aggregate fair value of $1.3 million as of their issuance. The first of the options became exercisable in April 2004 and was exercised in October 2004. The Company recorded a charge to earnings of approximately $400,000 to increase the option liabilities to their estimated fair value as of the exercise date; such charge is included in “Other income (expense), net” in the accompanying consolidated statement of operations for the three months ended October 31, 2004. The closing of the option exercise took place in October 2004, when the Company paid approximately $3,618,000 cash to acquire the additional 11% interest in Glazed Investments.

Equity Method Franchisees

     As of October 31, 2004, the Company was a minority investor in 13 franchisees. Investments in these franchisees have been made in the form of capital contributions and/or notes receivable. Notes receivable bear interest, payable semi-annually, at rates ranging from 9.0% to 10.0% per annum, and have maturity dates ranging from March 2011 to the dissolution of the joint venture. These investments and notes receivable are reflected in the caption “Investments in and advances to equity method franchisees” in the consolidated balance sheet.

     Information about the Company’s Equity Method Franchisees as of October 31, 2004 and the markets served by those franchisees is set forth below:

		Ownership %
					Third			Loan/Lease
	Geographic Market	KKD			Parties			Guarantees
								(In thousands)
A-OK, LLC	Arkansas, Oklahoma		30.3	%		69.7	%	$	3,048
Amazing Glazed, LLC	Pennsylvania (Pittsburgh)		30.3	%		69.7	%		2,660
Amazing Hot Glazers, LLC	Pennsylvania (Erie)		33.3	%		66.7	%		973
Caribbean Glaze Corporation	Puerto Rico		30.0	%		70.0	%		—
KK-TX I, L.P	Texas (Amarillo, Lubbock)		33.3	%		66.7	%		1,313
KK Wyotana, LLC	Wyoming, Montana		33.3	%		66.7	%		—
KKNY, LLC	New York City,
	Northern New Jersey		30.3	%		69.7	%		—
KremeWorks, LLC	Alaska, Hawaii, Oregon,
	Washington, Western Canada		25.0	%		75.0	%		3,642
Krispy Kreme Australia Pty Limited	Australia/New Zealand		35.0	%		65.0	%		1,942
Krispy Kreme of South Florida, LLC	Southern Florida		35.3	%		64.7	%		6,528
Krispy Kreme U.K. Limited	United Kingdom,
	Republic of Ireland		35.1	%		64.9	%		859
Krispy Kreme Mexico, S. de R.L. de C.V	Mexico		30.0	%		70.0	%		—
Priz Doughnuts, LP	Texas (El Paso),
	Mexico (Ciudad Juarez)		33.3	%		66.7	%		—

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Note 9 – Discontinued Operations

     In the first quarter of fiscal 2005, the Company’s Board of Directors adopted a plan to divest the Montana Mills operations. The Company acquired Montana Mills, an owner and operator of upscale “village bread stores” in the Northeastern United States, in April 2003 and reported the results of operations of Montana Mills as a separate segment of the business. Montana Mills has been accounted for as a discontinued operation, and its results of operations are separately presented in the accompanying consolidated statement of operations. Cash flows associated with Montana Mills have not been segregated from cash flows associated with continuing operations in the accompanying consolidated statement of cash flows.

     In connection with the decision to divest Montana Mills, the Company recorded a loss from discontinued operations of $39.8 million for the nine months ended October 31, 2004. The loss includes impairment provisions totalling $35.1 million recorded to reduce the value of certain of Montana Mills assets, including goodwill, other intangible assets and property and equipment, to their estimated fair values.

     Subsequent to its decision to divest the Montana Mills business, the Company closed twelve Montana Mills locations, and in November 2004 completed the sale of its remaining assets.

     Summarized results from discontinued operations for the three months and nine months ended November 2, 2003 and October 31, 2004 are as follows:

	Three Months Ended						Nine Months Ended
	November 2,			October 31,			November 2,			October 31,
	2003			2004			2003			2004
	(In thousands)
	(restated)						(restated)
Revenues	$	1,867		$	853		$	4,481		$	3,564
Loss before income taxes, including impairment charges of $1,001 and $35,119 for the three months and nine months ended October 31, 2004, respectively	$	(720	)	$	(1,424	)	$	(1,396	)	$	(37,626	)
Provision for income taxes (benefit)		(252	)		3,652			(489	)		2,207
(Loss) from discontinued operations	$	(468	)	$	(5,076	)	$	(907	)	$	(39,833	)

24

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

     As of October 31, 2004, there were 428 Krispy Kreme stores operated systemwide in the United States, Australia, Canada, Mexico and the United Kingdom, of which 184 were owned by the Company (including 55 owned by Consolidated Franchisees) and 244 were owned by franchisees (other than Consolidated Franchisees). Of the 428 total stores, there were 392 factory stores and 36 satellites; 393 stores were located in the United States and 35 were located in other countries. Subsequent to October 31, 2004, the Company sold or otherwise disposed of a number of stores, as described the 2006 Form 10-K and the Quarterly Report on Form 10-Q for the three months ended October 29, 2006.

     Factory stores (stores which contain a doughnut-making production line) typically support multiple sales channels to more fully utilize production capacity and reach additional consumer segments. These sales channels are comprised of on-premises sales (sales to customers visiting stores) and off-premises sales (sales to supermarkets, convenience stores, mass merchants and other food service and institutional accounts). As of October 31, 2004, satellite stores consisted primarily of the fresh shop and kiosk formats.

     The Company generates revenues from three distinct sources: stores operated by the Company, referred to as Company Stores; franchise fees and royalties from franchise stores, referred to as Franchise; and a vertically integrated supply chain, referred to as Krispy Kreme Manufacturing and Distribution, or KKM&D.

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

Results of Operations

     The following table presents the Company’s operating results for the three months and nine months ended November 2, 2003 and October 31, 2004, expressed as a percentage of revenues (amounts may not add to totals due to rounding).

	Three Months Ended						Nine Months Ended
	Nov. 2,			Oct. 31,			Nov. 2,			Oct. 31,
	2003			2004			2003			2004
	(restated)						(restated)
Revenues		100.0	%		100.0	%		100.0	%		100.0	%
Operating expenses:
Direct operating expenses		75.2			85.6			75.7			81.8
General and administrative expenses		5.6			7.2			6.0			6.5
Depreciation and amortization expense		3.4			4.9			3.4			4.3
Impairment charges and lease termination costs		—			81.8			—			27.5
Arbitration award		—			—			(0.1	)		—
Operating income (loss)		15.7	%		(79.4	)%		15.1	%		(20.1	)%

     To facilitate an understanding of the Company’s operating results, data on the number of factory stores appear in the table below. The number of factory stores includes commissaries but excludes satellite stores. Transferred stores for the nine months ended October 31, 2004 represent stores operated by KremeKo and New England Dough, franchisees whose financial statements were first consolidated with those of the Company as of May 2, 2004, the end of the first quarter of fiscal 2005. Transferred stores for the three months ended November 2, 2003 represent stores acquired as part of the Michigan franchise acquisition in October 2003. Transferred stores for the nine months ended November 2, 2003 principally represent stores acquired as part of the Michigan, Dallas/Shreveport and Kansas/Missouri franchise acquisitions in fiscal 2004.

25

	NUMBER OF FACTORY STORES (1)
	COMPANY			FRANCHISE			TOTAL
Three months ended October 31, 2004:
AUGUST 1, 2004		171			216			387
Opened		8			5			13
Closed		(4	)		(4	)		(8	)
OCTOBER 31, 2004		175			217			392
Nine months ended October 31, 2004:
FEBRUARY 1, 2004		141			216			357
Opened		20			31			51
Closed		(10	)		(6	)		(16	)
Transferred		24			(24	)		—
OCTOBER 31, 2004		175			217			392
Three months ended November 2, 2003:
AUGUST 3, 2003		114			188			302
Opened		10			17			27
Closed		(1	)		(2	)		(3	)
Transferred		5			(5	)		—
NOVEMBER 2, 2003		128			198			326
Nine months ended November 2, 2003:
FEBRUARY 3, 2003		99			177			276
Opened		15			40			55
Closed		(2	)		(3	)		(5	)
Transferred		16			(16	)		—
NOVEMBER 2, 2003		128			198			326

(1) Excludes satellites.

     The table below presents average weekly sales per factory store (which represents, on a company or systemwide basis, total sales of all stores divided by the number of operating weeks for factory stores). Operating weeks represents the aggregate number of weeks in a period that factory stores were in operation.

     Systemwide sales, a non-GAAP financial measure, include the sales by both our Company and franchise stores. The Company believes systemwide sales data is 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, including the sales by Consolidated Franchisees’ stores, sales to non-consolidated franchisees by the KKM&D business segment, and royalties and fees received from franchisees, but exclude the sales by franchise stores to their customers.

	Three Months Ended				Nine Months Ended
	Nov. 2,		Oct. 31,		Nov. 2,		Oct. 31,
	2003		2004		2003		2004
	(In thousands, except operating weeks)
	(restated)				(restated)
Average weekly sales per factory store (1):
Company	$	71.5	$	56.1	$	74.4	$	60.8
Systemwide	$	63.3	$	52.6	$	64.0	$	56.3
Factory Store operating weeks:
Company		1,554		2,282		4,257		6,315
Systemwide		3,974		4,981		11,204		14,506

(1) Excludes sales between company and franchise stores.

THREE MONTHS ENDED NOVEMBER 2, 2003 COMPARED TO THREE MONTHS ENDED OCTOBER 31, 2004

Overview

26

     Systemwide sales for the third quarter of fiscal 2005 increased 4.4% compared to the third quarter of fiscal 2004. The increase reflects a 16.9% decrease in average weekly sales per factory store and a 25.3% increase in factory store operating weeks.

     Total revenues increased 5.7% to $174.4 million for the three months ended October 31, 2004 from $165.0 million for the three months ended November 2, 2003. This increase was comprised of a 16.3% increase in Company Stores revenues to $128.4 million, an 11.1% decrease in Franchise revenues to $5.7 million, and a 16.3% decrease in KKM&D revenues to $40.3 million.

     Revenues and direct operating expenses by business segment are set forth in the table below. KKM&D revenues exclude intersegment sales eliminated in consolidation. Direct operating expenses exclude depreciation and amortization expense, indirect (unallocated) general and administrative expenses, impairment charges and lease termination costs and the arbitration award. Direct general and administrative expenses are included in direct operating expenses.

	Three Months Ended
	Nov. 2,		Oct. 31,
	2003		2004
	(In thousands)
	(restated)
REVENUES BY BUSINESS SEGMENT:
Company Stores	$	110,430	$	128,411
Franchise		6,392		5,681
KKM&D		48,173		40,301
Total revenues	$	164,995	$	174,393
DIRECT OPERATING EXPENSES BY BUSINESS SEGMENT:
Company Stores	$	86,058	$	112,555
Franchise		1,056		1,929
KKM&D		37,001		34,710
Total direct operating expenses	$	124,115	$	149,194

     The following table presents business segment revenues expressed as a percentage of total revenues, and business segment direct operating expenses as a percentage of business segment revenues (amounts may not add to totals due to rounding).

	Three Months Ended
	Nov. 2,			Oct. 31,
	2003			2004
	(restated)
REVENUES BY BUSINESS SEGMENT:
Company Stores		66.9	%		73.6	%
Franchise		3.9			3.3
KKM&D		29.2			23.1
Total revenues		100.0	%		100.0	%
DIRECT OPERATING EXPENSES AS A PERCENTAGE OF SEGMENT REVENUES:
Company Stores		77.9	%		87.7	%
Franchise		16.5	%		34.0	%
KKM&D		76.8	%		86.1	%
Total direct operating expenses		75.2	%		85.6	%

Company Stores

     Company Stores Revenues. Company Stores revenues increased 16.3% to $128.4 million in the third quarter of fiscal 2005 from $110.4 million in the third quarter of fiscal 2004. Revenue growth was primarily due to sales from new stores, as well as from the inclusion of sales related to stores acquired as a result of the October 2003 acquisition of the Michigan market from a franchisee and the inclusion of sales from New England Dough and KremeKo, which were consolidated as of the end of the first quarter of fiscal 2005. Lower sales from existing stores, as well as the impact of closing ten factory stores since the end of the third quarter of fiscal 2004, all of which were closed in the current fiscal year, partially offset the increase in sales. From the end of the third quarter of fiscal 2004 through the end of the third quarter of fiscal 2005, the Company opened 33 new Company factory stores and closed ten. In

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addition, 24 factory stores became Company stores as a result of the consolidation of New England Dough and KremeKo as of the end of the first quarter of fiscal 2005.

     Company Stores Direct Operating Expenses. Company Stores direct operating expenses increased 30.8% to $112.6 million in the third quarter of fiscal 2005 from $86.1 million in the same quarter of fiscal 2004, and as a percentage of revenues were 87.7% in the third quarter of fiscal 2005 compared with 77.9% in the same quarter of the prior year. The increase in Company Stores direct operating expenses as a percentage of revenues was primarily due to lower average sales per location at off-premises accounts and lower on-premises sales of higher-margin products at existing stores, resulting in operating inefficiencies and lower operating leverage. In addition, the operating margins of new and acquired stores were generally lower than those of the Company’s existing store base.

Franchise

     Franchise Revenues. Franchise revenues, consisting principally of franchise fees and royalties, decreased 11.1% to $5.7 million in the third quarter of fiscal 2005 from $6.4 million in the third quarter of fiscal 2004. The decrease in revenue reflects lower franchise fees during the fiscal 2005 quarter; franchisees opened five stores in the third quarter of fiscal 2005 compared to 17 stores in the third quarter of fiscal 2004. Franchise revenues also decreased due to reduced royalty revenue in the third quarter of fiscal 2005 compared to the third quarter of fiscal 2004. Increased royalties associated with new franchise stores opened since the end of the third quarter of fiscal 2004 were offset by lower sales by existing franchise stores and the impact of the consolidation of New England Dough and KremeKo, which resulted in 24 franchise stores becoming Company stores as of the end of the first quarter of fiscal 2005. Sales by franchise stores, as reported by the franchisees, were approximately $134 million in the third quarter of fiscal 2005 and approximately $141 million in the third quarter of fiscal 2004.

     Franchise Direct Operating Expenses. Franchise direct operating expenses, which exclude depreciation and amortization expense, increased to $1.9 million in the third quarter of fiscal 2005 from $1.1 million in the third quarter of fiscal 2004. As a percentage of Franchise revenues, Franchise direct operating expenses were 34.0% in the third quarter of the current year compared with 16.5% in the third quarter of the prior year. Direct operating expenses as a percentage of revenues increased as compared to the same quarter of the prior year primarily as a result of increased employee-related and other corporate expenses allocated to the segment in the current fiscal year.

KKM&D

     KKM&D Revenues. KKM&D sales to franchise stores decreased 16.3% to $40.3 million in the third quarter of fiscal 2005 from $48.2 million in the third quarter of fiscal 2004. Revenues decreased during the quarter primarily due to lower new franchise store opening activity, which resulted in lower sales of new doughnut-making and related peripheral equipment. During the third quarter of fiscal 2005, franchisees opened five stores compared to 17 stores in the third quarter of fiscal 2004. In addition, lower sales by franchise stores resulted in reduced sales of mixes, icings, fillings, other ingredients and supplies by KKM&D.

     KKM&D Direct Operating Expenses. KKM&D direct operating expenses, which exclude depreciation and amortization expense, were $34.7 million (86.1% of KKM&D revenues) in the third quarter of fiscal 2005 compared to $37.0 million (76.8% of KKM&D revenues) in the third quarter of fiscal 2004. The increase in KKM&D direct operating expenses as a percentage of revenues reflects the effects of lower sales of equipment, mix and other supplies which resulted in lower operating leverage, as well as the effects of higher fuel and transportation costs. In addition, during the third quarter of fiscal 2005 the Company recorded a provision of $2.3 million for potentially uncollectible receivables from franchisees.

General and Administrative Expenses.

     General and administrative expenses increased 34.9% to $12.5 million in the third quarter of fiscal 2005 from $9.3 million in the third quarter of fiscal 2004. General and administrative expenses as a percentage of total revenues for the third quarter of fiscal 2005 were 7.2% in fiscal 2005 compared with 5.6% in the third quarter of fiscal 2004. General and administrative expenses for the three months ended October 31, 2004 include professional fees related to the internal and external investigations and litigation described in Note 5 to the consolidated financial statements included elsewhere herein totalling approximately $2.4 million (net of estimated insurance recoveries of approximately $1.4 million).

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Depreciation and Amortization Expense

     Depreciation and amortization expense increased 51.6% to $8.6 million in the third quarter of fiscal 2005 from $5.6 million in the third quarter of the prior year. The growth in depreciation and amortization expense is due primarily to capital asset additions, primarily related to the opening of new stores, including new stores opened by Consolidated Franchisees. The increase in depreciation expense in the quarter also reflects depreciation expense associated with stores in the Michigan market, which was acquired in October 2003, as well as approximately $900,000 of depreciation expense associated with stores operated by New England Dough and KremeKo, the financial statements of which were first consolidated with those of the Company as of the end of the first quarter of fiscal 2005.

Impairment Charges and Lease Termination Costs

     In the third quarter of fiscal 2005, the Company recorded impairment charges and store closing costs totalling $142.7 million. The charge consisted principally of a goodwill impairment charge of $131.6 million, charges for impairments of long-lived assets of $9.3 million and store lease termination costs of $1.1 million. The goodwill impairment charge reflects the substantial decrease in profitability of several of the reporting units comprising the Company Stores segment, while the impairments of long-lived assets and the lease termination charges generally reflect store closing decisions.

Interest Expense

     Interest expense was $1.7 million in the third quarter of fiscal 2005 compared with $1.2 million in the third quarter of fiscal 2004. Interest expense in the prior year consisted primarily of interest on the Company’s $33 Million Term Loan and interest on indebtedness of Consolidated Franchisees. Interest expense in the third quarter of fiscal 2004 also included interest on a $55.0 million short-term note entered into during the second quarter of fiscal 2004, the proceeds of which were used to partially finance an acquisition completed during that quarter. Interest expense in fiscal 2005 includes interest on the Company’s Credit Facility entered into in October 2003 as well as interest expense on indebtedness of Consolidated Franchisees. Proceeds of the Credit Facility were used primarily to repay the $55.0 million short-term note, to repay the $33 Million Term Loan, to fund the purchase and construction of a mix and distribution facility and to provide loans to certain Consolidated Franchisees to enable them to repay certain third-party debt. Interest expense in the third quarter of fiscal 2005 includes approximately $550,000 of interest on indebtedness of New England Dough and KremeKo, the financial statements of which were first consolidated with those of the Company as of the end of the first quarter of fiscal 2005.

Equity in Income (Losses) of Equity Method Franchisees

     The Company’s share of income earned by equity method franchisees totaled $190,000 in the third quarter of fiscal 2005 compared to losses of $146,000 in the third quarter of fiscal 2004. This caption represents the Company’s share of operating results of unconsolidated franchisees which develop and operate Krispy Kreme stores. The most significant reasons for the reduced losses were improved results at KK-TX I, L.P. and Krispy Kreme Australia Pty Limited compared to the prior year period, and the elimination of losses recognized related to KKNY, LLC because the Company’s investment in this franchisee was reduced to zero in the first quarter of fiscal 2005.

Minority Interests in Results of Consolidated Franchisees

     Minority interests in the results of operations of Consolidated Franchisees represents the portion of the income or loss of Consolidated Franchisees allocable to other investors’ interests in those franchisees. In the third quarter of fiscal 2005, minority investors shared in $4.2 million of the aggregate net losses incurred by Consolidated Franchisees, the substantial majority of which related to KremeKo, which incurred significant losses in the quarter, including the effects of impairment charges related to retail stores; the balance of the losses were incurred by Glazed Investments and Freedom Rings. In the third quarter of fiscal 2004, minority interests shared in $411,000 of income earned by Glazed Investments, Freedom Rings and Golden Gate Doughnuts, LLC (“Golden Gate,” the Company’s franchisee in Northern California). The Company acquired the remaining minority interest in Golden Gate at the end of fiscal 2004.

Other Income (Expense), Net

     Other expense, net, totaled $302,000 and $1.9 million for the three months ended November 2, 2003 and October 31, 2004, respectively. The most significant components of the fiscal 2005 amount were an impairment charge of approximately $1.5 million related to the Company’s investment in an Equity Method Franchisee resulting from an adverse change in the franchisee’s financial

29

condition, and a charge of $400,000 to reflect an increase in the fair value of a written put option more fully described in Note 8 to the consolidated financial statements appearing elsewhere herein.

Provision for Income Taxes

     The provision for income taxes on continuing operations was a benefit of $133,000 in the third quarter of fiscal 2005. During the quarter, the Company established a valuation allowance with respect to the net deferred income tax assets arising through the third quarter of fiscal 2005. Establishing this allowance resulted in the Company recognizing no income tax benefit on the loss incurred during the quarter, except to the extent of the reversal of income taxes provided on continuing operations during the first two quarters of the year. Such benefit was offset by a valuation allowance established during the quarter with respect to the Company’s net deferred income tax asset as of the beginning of the fiscal year and by a provision for taxes estimated to be payable currently. The valuation allowances were recorded because management was unable to conclude, in light of the losses incurred and anticipated to be incurred by the Company, that realization of the net deferred income tax asset was more likely than not. The provision for income taxes on continuing operations in the third quarter of fiscal 2004 approximated 40% of pretax income from continuing operations, which exceeded the statutory federal income tax rate principally due to the effects of state income taxes and foreign losses for which no income tax benefit was recorded.

Discontinued Operations

     In the third quarter of fiscal 2005, the Company recorded a $5.1 million loss from discontinued operations, including an income tax provision of $3.7 million, as a result of the Company’s decision to divest the Montana Mills operations as discussed in Note 9 to the consolidated financial statements appearing elsewhere herein. The loss from discontinued operations in the quarter consists of the operating loss incurred by Montana Mills of approximately $400,000 and additional asset impairment charges and store closing costs, including severance, of $1.0 million. The income tax provision applicable to discontinued operations consists of the reversal of income tax benefits attributable to Montana Mills recorded during the first two quarters of the fiscal year and a valuation allowance recorded during the quarter equal to the net deferred income tax assets associated with Montana Mills as of the beginning of the fiscal year.

NINE MONTHS ENDED NOVEMBER 2, 2003 COMPARED TO NINE MONTHS ENDED OCTOBER 31, 2004

Overview

     Systemwide sales for the first nine months of fiscal 2005 increased 14.3% compared to the first nine months of fiscal 2004. The increase reflects a 12.0% decrease in average weekly sales per factory store and a 29.5% increase in factory store operating weeks.

     Total revenues increased 16.9% to $546.1 million for the nine months ended October 31, 2004 from $467.1 million for the nine months ended November 2, 2003. This increase was comprised of a 22.5% increase in Company Stores revenues to $388.2 million, a 10.8% increase in Franchise revenues to $19.1 million, and a 4.4% increase in KKM&D revenues to $138.7 million.

     Revenues and direct operating expenses by business segment are set forth in the table below. KKM&D revenues exclude intersegment sales eliminated in consolidation. Direct operating expenses exclude depreciation and amortization expense, indirect (unallocated) general and administrative expenses, impairment charges and lease termination costs and the arbitration award. Direct general and administrative expenses are included in direct operating expenses.

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	Nine Months Ended
	Nov. 2,		Oct. 31,
	2003		2004
	(In thousands)
	(restated)
REVENUES BY BUSINESS SEGMENT:
Company Stores	$	317,021	$	388,247
Franchise		17,287		19,147
KKM&D		132,779		138,666
Total revenues	$	467,087	$	546,060
DIRECT OPERATING EXPENSES BY BUSINESS SEGMENT:
Company Stores	$	245,758	$	328,961
Franchise		3,593		5,460
KKM&D		104,185		112,501
Total direct operating expenses	$	353,536	$	446,922

     The following table presents business segment revenues expressed as a percentage of total revenues, and business segment direct operating expenses as percentage of business segment revenues (amounts may not add to totals due to rounding).

	Nine Months Ended
	Nov. 2,			Oct. 31,
	2003			2004
	(restated)
REVENUES BY BUSINESS SEGMENT:
Company Stores		67.9	%		71.1	%
Franchise		3.7			3.5
KKM&D		28.4			25.4
Total revenues		100.0	%		100.0	%
DIRECT OPERATING EXPENSES AS A PERCENTAGE OF SEGMENT REVENUES:
Company Stores		77.5	%		84.7	%
Franchise		20.8	%		28.5	%
KKM&D		78.5	%		81.1	%
Total direct operating expenses		75.7	%		81.8	%

Company Stores

     Company Stores Revenues. Company Stores revenues increased 22.5% to $388.2 million in the first nine months of fiscal 2005 from $317.0 million in the same period of fiscal 2004. Revenue growth was due to sales from new stores, as well as the inclusion of sales related to stores acquired during the first nine months of fiscal 2004 from franchisees in the Kansas, Missouri, Dallas, Louisiana and Michigan markets and the inclusion of sales from New England Dough and KremeKo, the financial statements of which were first consolidated with those of the Company as of the end of the first quarter of fiscal 2005. Lower sales from existing stores and the impact of closing ten factory stores, all of which were closed in the current fiscal year, partially offset the increase in sales.

     Company Stores Direct Operating Expenses. Company Stores direct operating expenses increased 33.9% to $329.0 million in the first nine months of fiscal 2005 from $245.8 million in the same period of fiscal 2004. Company Stores direct operating expenses as a percentage of Company Stores revenues were 84.7% in the first nine months of fiscal 2005 compared with 77.5% in the same period of the prior year. Company Stores direct operating expenses as a percentage of revenues increased during fiscal 2005 as a result of operating inefficiencies and lower operating leverage at existing stores. In addition, the operating margins of new stores, as well as stores acquired from franchisees in fiscal 2004, generally were lower than those of the Company’s existing store base.

Franchise

     Franchise Revenues. Franchise revenues increased 10.8% to $19.1 million in the first nine months of fiscal 2005 from $17.3 million in the comparable period of fiscal 2004. The growth in revenue was primarily due to the additional royalties associated with the opening of 44 new franchise stores (net of closings) since the end of the third quarter of fiscal 2004, net of the impact of the consolidation of New England Dough and KremeKo, which resulted in 24 franchise stores becoming Company stores. Sales of

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franchise stores, as reported by the franchisees, were approximately $432 million in the first nine months of fiscal 2005 and approximately $400 million in the first nine months of fiscal 2004.

     Franchise Direct Operating Expenses. Franchise direct operating expenses increased to $5.5 million in the first nine months of fiscal 2005 from $3.6 million in the comparable period of fiscal 2004. As a percentage of Franchise revenues, Franchise direct operating expenses were 28.5% in the first nine months of the current year compared with 20.8% in the prior year. Franchise direct operating expenses as a percentage of revenues increased during fiscal 2005 principally as a result of increased employee-related costs, primarily due to increased personnel to support the Company’s franchise programs.

   KKM&D

     KKM&D Revenues. KKM&D sales to franchise stores increased 4.4% to $138.7 million in the first nine months of fiscal 2005 from $132.8 million in the comparable period of fiscal 2004. The primary reason for the modest increase in revenues was the opening of 49 new franchise factory stores since the end of the third quarter of fiscal 2004, reduced by the impact of the transfer of 24 stores from Franchise to Company as a result of the consolidation of the financial statements of KremeKo and New England Dough at the end of the first quarter of fiscal 2005. Increased doughnut sales by franchise stores translated into additional revenues for KKM&D from sales of mixes, icings, fillings, other ingredients and supplies during the first half of the fiscal year, partially offset by moderating sales trends in the third quarter.

     KKM&D Direct Operating Expenses. KKM&D direct operating expenses, which exclude depreciation and amortization expense, were $112.5 million (81.1% of KKM&D revenues) in the first nine months of fiscal 2005 compared to $104.2 million (78.5% of KKM&D revenues) in the first nine months of fiscal 2004. KKM&D direct operating expenses for the first nine months of fiscal 2005 include a provision of $2.3 million (1.7% of KKM&D revenues) for potentially uncollectible receivables from franchisees. Other factors affecting KKM&D direct operating expenses include increased capacity utilization and resulting economies of scale during the first six months of fiscal 2005, largely offset by higher fuel and freight costs associated with distribution operations and moderating sales in the third quarter.

   General and Administrative Expenses

     General and administrative expenses increased 27.6% to $35.6 million in the first nine months of fiscal 2005 from $27.9 million in the comparable period of fiscal 2004. General and administrative expenses as a percentage of revenues for the nine months were 6.5% in fiscal 2005 compared with 6.0% in fiscal 2004. The growth in general and administrative expenses reflects increased personnel and related salary and benefit costs needed to support growth and other cost increases necessitated by the growth of the Company, as well as increased professional fees. General and administrative expenses for the nine months ended October 31, 2004 include professional fees related to the internal and external investigations and litigation described in Note 5 to the consolidated financial statements included elsewhere herein totalling approximately $2.9 million (net of estimated insurance recoveries of approximately $1.4 million).

   Depreciation and Amortization Expense

     Depreciation and amortization expense increased to $23.3 million in the first nine months of fiscal 2005 from $15.7 million in the first nine months of fiscal 2004. The growth in depreciation and amortization expense is due principally to increased capital asset additions, primarily related to new stores, including stores opened by Consolidated Franchisees, the addition of stores acquired from franchisees, and approximately $1.8 million of depreciation expense associated with stores operated by New England Dough and KremeKo, the financial statements of which were first consolidated with those of the Company as of the end of the first quarter of fiscal 2005.

   Impairment Charges and Store Closing Costs

     In the first nine months of fiscal 2005, the Company recorded impairment charges and store closing costs totalling $150.3 million. The charges consisted principally of a goodwill impairment charge of $131.6 million, charges for impairments of long-lived assets of $15.0 million and store lease termination costs of $2.5 million. The goodwill impairment charge reflects the substantial decrease the profitability of a number of the reporting units comprising the Company Stores segment, while the impairments of long-lived assets and the lease termination charges generally reflect store closing decisions.

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   Arbitration Award

     In fiscal 2003, the Company recorded a charge of $9.1 million as a result of an arbitration panel’s ruling against the Company in a lawsuit, as described in Note 5 to the consolidated financial statements appearing elsewhere herein. The Company settled the award for $8.6 million in the first quarter of fiscal 2004 and reversed the remaining $525,000 accrual.

   Interest Expense

     Interest expense was $4.8 million in the first nine months of fiscal 2005 compared to $3.1 million for the comparable period of the prior year. The increase in interest expense primarily reflects interest on $55 million of indebtedness incurred in connection with the June 2003 acquisition of the Dallas/Shreveport franchise (refinanced in October 2003) as well as approximately $900,000 of interest on indebtedness of New England Dough and KremeKo, the financial statements of which were first consolidated with those of the Company as of the end of the first quarter of fiscal 2005.

   Equity in Income (Losses) of Equity Method Franchisees

     The Company’s share of losses incurred by equity method franchisees totaled $675,000 in the first nine months of fiscal 2005 compared to $1.8 million in the first nine months of fiscal 2004. This caption represents the Company’s share of operating results of unconsolidated franchisees which develop and operate Krispy Kreme stores. The most significant components of the reduced losses were improved results at Kremeworks compared to the prior year period, the consolidation of New England Dough and KremeKo as of the end of the first quarter of fiscal 2005, and the elimination of losses recognized related to KKNY, LLC because the Company’s investment in this franchisee was reduced to zero in the first quarter of fiscal 2005.

   Minority Interest in Results of Consolidated Franchisees

     Minority interests in the results of operations of Consolidated Franchisees represents the portion of the income or loss of Consolidated Franchisees allocable to other investors’ interests in those franchisees. For the nine months ended October 31, 2004, minority investors shared in $4.8 million of the aggregate net losses by Consolidated Franchisees, the substantial majority of which related to KremeKo, which incurred significant losses in the period, including the effects of impairment charges related to retail stores. For the nine months ended November 2, 2003, minority investors shared in $1.6 million of income earned by Glazed Investments, Freedom Rings and Golden Gate. The Company acquired the remaining minority interest in Golden Gate at the end of fiscal 2004.

   Other Income (Expense), Net

     Other income, net, totaled $2.1 million for the nine months ended November 2, 2003. The most significant component of the amount was a gain of $2.7 million recorded in the first quarter of fiscal 2004 on the sale to a franchisee of three stores in South Florida. Other expense, net, totaled $1.4 million for the nine months ended October 31, 2004. The most significant components of the amount were an impairment charge of approximately $1.5 million related to the Company’s investment in an Equity Method Franchisee resulting from an adverse change in the franchisee’s financial condition, and a charge of $400,000 to reflect an increase in the fair value of a written put option more fully described in Note 8 to the consolidated financial statements appearing elsewhere herein.

     Provision for Income Taxes

     The provision for income taxes on continuing operations was $9.7 million for the first nine months of fiscal 2005. The income tax provision for the period consists principally of a valuation allowance recorded in the third quarter with respect to the Company’s net deferred income tax asset as of February 1, 2004. The Company also recorded a valuation allowance for the additional net deferred income tax assets arising during the first nine months of fiscal 2005, which resulted in the Company recognizing no income tax benefit on the loss resulting from year-to-date fiscal 2005 operations. The valuation allowances were recorded because management was unable to conclude, in light of the losses incurred and anticipated to be incurred by the Company, that realization of the net deferred income tax asset was more likely than not. The provision for income taxes on continuing operations for the first nine months of fiscal 2004 approximated 40% of pretax income from continuing operations, which exceeds the statutory federal income tax rate principally due to the effects of state income taxes and foreign losses for which no income tax benefit has been recorded.

   Discontinued Operations

     In the first nine months of fiscal 2005, the Company recorded a $39.8 million loss from discontinued operations, including income taxes of $2.2 million, as a result of the decision to divest the Montana Mills operation, as more fully described in Note 9 to the

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consolidated financial statements appearing elsewhere herein. The loss from discontinued operations includes the operating loss incurred by Montana Mills for the first nine months of fiscal 2005 of $1.9 million and impairment charges and store closing costs of $35.7 million. The impairment charges and store closing costs consist of the write-off of goodwill recorded in connection with the acquisition of $19.7 million, the write-off of amounts recorded as the value of trademarks and trade names and recipes acquired of $12.1 million, provisions totalling $3.4 million to reduce the carrying amount of other Montana Mills’ assets and liabilities, primarily property and equipment, to their estimated recoverable value and severance and costs to exit leases for certain closed locations of approximately $0.6 million. The income tax provision applicable to discontinued operations consists of a valuation allowance established during the period equal to the net deferred income tax assets associated with Montana Mills as of the beginning of the fiscal year.

Liquidity and Capital Resources

     The Company funded its capital requirements for the first nine months of fiscal 2005 primarily through cash flow generated from operations, the use of existing cash and, in the case of certain Consolidated Franchisees, through borrowings under various financing arrangements, including revolving lines of credit and long term debt. In addition, in July 2004, Glazed Investments completed a transaction in which property related to six stores was sold and simultaneously leased back from the acquirer. Glazed Investments used the proceeds of the sale to repay debt associated with the properties, with the remaining funds used primarily to repay certain loans provided to Glazed by the Company.

   Cash Flow from Operating Activities

     Net cash provided by operating activities was $65.3 million in the first nine months of fiscal 2005 and $64.5 million in the comparable period of fiscal 2004. Cash provided by operating activities in the fiscal 2004 period included tax benefits of $34.5 million resulting from the exercise of stock options and the use of $8.6 million of cash to settle an arbitration award. Cash provided by operating activities in the fiscal 2005 period reflects approximately $6.8 million of net income tax refunds as well as an increase in accrued liabilities of approximately $16 million. Accrued liabilities increased as a result of additional employee-related accruals, principally incentive compensation accruals and increased accruals for employee benefit costs, including accruals for self-insurance claims. The growth in employee benefit costs was primarily due to increased headcount resulting from the growth in Company stores and other increases in personnel to support the growth in the business. Also contributing to the increase in accrued liabilities were accruals associated with professional fees related to the internal and external investigations and litigation described in Note 5 to the consolidated financial statements included elsewhere herein.

   Cash Flow from Investing Activities

     Net cash used for investing activities was $45.1 million in the first nine months of fiscal 2005 and $134.7 million in the first nine months of fiscal 2004. Investing activities in the first nine months of fiscal 2005 consisted principally of $61.1 million in capital expenditures for property and equipment for store development, partially offset by proceeds from the sale of property and equipment, principally in connection with the sale and leaseback of property by Glazed Investments. In addition, the Company used $3.6 million in cash to acquire an additional approximate 11% interest in Glazed Investments as a result of the exercise by certain members of Glazed Investments’ management of an option they held to sell this interest to the Company, as more fully described in Note 8 to the consolidated financial statements appearing elsewhere herein. Fiscal 2004 investing activities included capital expenditures for property and equipment of $51.0 million, the use of $103.1 million in cash to acquire the businesses of certain of the Company’s franchisees and net sales of investments of $27.1 million.

   Cash Flow from Financing Activities

     Net cash used for financing activities was $27.2 million in the first nine months of fiscal 2005. In the first nine months of fiscal 2004, cash provided by financing activities was $77.3 million. In the third quarter of fiscal 2004, the Company entered into a $150 million Credit Facility consisting of a Revolver and a Term Loan. Initial borrowings on the Revolver of $79.0 million were used to pay amounts outstanding under a short-term promissory note entered into to partially finance an acquisition and to repay certain outstanding borrowings of Consolidated Franchisees. The Company used the proceeds from the Term Loan to repay an existing term loan. Financing activities in the first nine months of fiscal 2005 consisted principally of repayment of borrowings under the Revolver as well as repayments by Consolidated Franchisees of long-term debt, including debt repaid by Glazed Investments in connection with a sale-leaseback transaction. Partially offsetting this activity in fiscal 2005 were new borrowings of long-term debt by Consolidated Franchisees, primarily New England Dough. Financing activities in fiscal 2005 and fiscal 2004 also include the proceeds received from the exercise of stock options, which amounted to $1.2 million and $18.1 million, respectively.

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Updated financial information

     See Note 1 to the consolidated financial statements appearing elsewhere herein for information concerning changes in the Company’s business since October 31, 2004 and periodic reports filed by the Company with the Securities and Exchange Commission with respect to periods ended after that date.

Recent Accounting Pronouncements

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “Fair Value Measurements” (“FAS 157”), which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (“GAAP”). As a result of FAS 157, there is now 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 Company must adopt FAS 157 in fiscal 2009, but has not yet begun to evaluate the effects, if any, of adoption on its consolidated financial statements.

     In July 2006, the FASB released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. The Company must adopt FIN 48 in the first quarter of fiscal 2008, and management currently is evaluating the effect of adoption on the Company’s consolidated financial statements.

     In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections” (“FAS 154”) to replace Accounting Principles Board Opinion No. 20, “Accounting Changes” and FAS 3, “Reporting Accounting Changes in Interim Periods.” FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections, and establishes retrospective application as the required method for reporting a change in accounting principle. FAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable, and for reporting a change when retrospective application is determined to be impracticable. FAS 154 also addresses the reporting of a correction of an error by restating previously issued financial statements. The Company adopted FAS 154 in fiscal 2007, but adoption had no effect on the Company’s consolidated financial statements.

     In February 2005, the Emerging Issues Task Force reached a consensus in Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations” (“EITF 03-13”). EITF 03-13 provides guidance on how to evaluate whether the operations and cash flows of a disposed component have been or will be eliminated from ongoing operations and the types of continuing involvement that constitute significant continuing involvement in the operations of the disposed component. These evaluations affect the determination of whether the results of operations of a disposed component are reported as discontinued operations. The Company adopted EITF 030-13 in fiscal 2006, but adoption had no effect on the Company’s consolidated financial statements.

     In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (“FAS 123(R)”), which requires the measurement and recognition of compensation expense for all share-based payment (“SBP”) awards. The new standard supersedes the Company’s current accounting under APB 25 and will require the Company to recognize compensation expense for all SBP awards based on fair value. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 relating to the adoption of FAS 123(R). Beginning in the first quarter of fiscal 2007, the Company adopted the provisions of FAS 123(R) using the modified prospective transition method, the Black-Scholes option pricing model and an attribution method which recognizes the fair value of awards in earnings on a straight-line basis over the vesting period of the award. Under the new standard, the Company’s estimate of the fair value of SBP awards, and therefore compensation expense, requires a number of complex and subjective assumptions, including the Company’s stock price volatility, employee exercise patterns influencing the expected life of the options, future forfeitures and related tax effects. Pro forma net income and earnings per share amounts for the three months and nine months ended November 2, 2003 and October 31, 2004, computed as if the Company had used a fair-value based method similar to the methods required under FAS 123(R) to measure compensation expense for employee stock-based compensation awards, are set forth under “Stock-based compensation” in Note 1 to the consolidated financial statements appearing elsewhere herein.

     In November 2004, the FASB issued Statement No. 151, “Inventory Costs” (“FAS 151”), which amends the guidance in Accounting Research Bulletin No. 43, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). FAS 151 requires that those items be recognized as current period charges and that the allocation of fixed production overheads to the cost of converting work in process to finished goods be based on the normal

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capacity of the production facilities. The Company adopted FAS 151 in fiscal 2007, but adoption had no material effect on the Company’s consolidated financial statements.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company is exposed to market risk from increases in interest rates on its outstanding debt, substantially all of which bears interest at variable rates. The Company’s Consolidated Franchisees are parties to various debt agreements used to finance store development and working capital needs, substantially all of which bear interest at floating rates. The interest cost of the Company’s debt is affected by changes in short term interest rates and increases in those rates adversely affect the Company’s results of operations.

     As of October 31, 2004, the Company had approximately $98.7 million in cash borrowings (excluding indebtedness of Consolidated Franchisees), and was party to an interest rate swap agreement which fixes the rate of interest on $28.9 million of this indebtedness, leaving approximately $69.8 million of indebtedness bearing interest at floating rates. A hypothetical increase of 100 basis points in short-term interest rates would result in an increase in the Company’s annual interest expense of approximately $700,000, after giving effect to additional payments due to the Company from the interest rate swap agreement.

     Because the substantial majority of the Company’s revenue, expense and capital purchasing activities are transacted in United States dollars, the exposure to foreign currency exchange risk historically has been minor. In addition to operating revenues and expenses, the Company’s investments in franchisees operating in the United Kingdom, Australia, Mexico and Canada expose the Company to exchange rate risk. The Company historically has not attempted to hedge these exchange rate risks.

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

     In addition to entering into forward purchase contracts, from time to time the Company purchases exchange-traded commodity futures contracts for raw materials which are ingredients of its products or which are components of such ingredients, including wheat, soybean oil and coffee. The Company typically assigns the futures contract to a supplier in connection with entering into a forward purchase contract for the related ingredient. Quantitative information about the Company’s unassigned commodity futures contracts as of October 31, 2004, all of which mature in fiscal 2006, is set forth in the table below.

		Weighted		Aggregate		Aggregate
		Average Contract		Contract		Fair
	Contract Volume	Price		Amount		Value
	(Dollars in thousands, except average prices)
Futures contracts:
Wheat	480,000 bushels	$	3.72/bushel	$	1,786	$	10
Soybean oil	12,900,000 lbs.	$	0.21/lb.		2,709		60
						$	70

     Although the Company utilizes forward purchase contracts and futures contracts to mitigate the risks related to commodity price fluctuations, such contracts do not fully mitigate commodity price risk. Adverse changes in commodity prices could adversely affect the Company’s profitability and liquidity.

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Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosures Control and Procedures

     As of October 31, 2004, 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 Commission’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 and the identification of material weaknesses in the Company’s internal control over financial reporting as described in the 2005 Form 10-K and 2006 Form 10-K, the Company’s chief executive officer and chief financial officer have concluded that, as of October 31, 2004, the Company’s disclosure controls and procedures were not effective. Based on a number of factors, including performance of extensive manual procedures to help ensure the proper collection, evaluation, and disclosure of the information included in the consolidated financial statements, management has concluded that the consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, the Company’s financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles.

Changes in Internal Control Over Financial Reporting

     As more fully set forth in Item 9A, “Controls and Procedures,” of the 2005 Form 10-K and the 2006 Form 10-K, management concluded that the Company’s internal control over financial reporting was not effective as of January 30, 2005 or January 29, 2006 because of the existence at those dates of material weaknesses in internal controls. During the quarter ended October 31, 2004, there were no material changes in the Company’s system of internal controls over financial reporting.

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PART II – OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

     From time to time the Company is subject to claims and suits arising in the course of business. The Company maintains customary insurance policies against claims and suits which arise in the course of business, including insurance policies for workers’ compensation and personal injury, some of which provide for relatively large deductible amounts.

     Except as disclosed below, the Company is currently not aware of any legal proceedings or claims that the Company believes could have, individually or in the aggregate, a material adverse effect on the Company’s business, financial condition or results of operations. Legal proceedings or claims commenced after October 31, 2004 but which had been resolved as of the date of the filing of this report are not described below.

Governmental Investigations

     SEC Investigation.On October 7, 2004, the staff of the Commission advised the Company that the Commission had entered a formal order of investigation concerning the Company. The Company is cooperating with the investigation.

     United States Attorney Investigation.On February 24, 2005, the United States Attorney’s Office for the Southern District of New York advised the Company that it would seek to conduct interviews of certain current and former officers and employees of the Company. The Company is cooperating with the investigation.

     State Franchise/FTC InquiryOn June 15, 2005, the Commonwealth of Virginia, on behalf of itself, the FTC and eight other states, inquired into certain activities related to prior sales of franchises and the status of our financial statements and requested that the Company provide them with certain documents. The inquiry related to potential violations for failures to file certain amendments to franchise registrations and the failure to deliver accurate financial statements to prospective franchisees. Fourteen states (the “Registration States”) and the FTC regulate the sale of franchises. The Registration States specify forms of disclosure documents that must be provided to franchisees and filed with the state. In the non-registration states, according to FTC rules, documents must be provided to franchisees but are not filed. Earlier in 2005, the Company chose not to renew its disclosure document in the Registration States because the Company realized that its financial statements would need to be restated and because the Company had stopped selling domestic franchises. The Company is fully cooperating with the inquiry and has delivered the requested documents. Since June 15, 2005, Virginia has indicated that it and a majority of the remaining states would withdraw from the inquiry. The Company has not received any additional information from the FTC or any other state that one or more of them intend to pursue or abandon the inquiry.

Litigation

     Federal Securities Class Actions and Settlement Thereof and Federal Court Shareholder Derivative Actions and Partial Settlement Thereof.On May 12, 2004, a purported securities class action was filed on behalf of persons who purchased the Company’s publicly traded securities between August 21, 2003 and May 7, 2004 against the Company and certain of its current and former officers in the United States District Court for the Middle District of North Carolina. Plaintiff alleged that defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder in connection with various public statements made by the Company. Plaintiff sought damages in an unspecified amount. Thereafter, 14 substantially identical purported class actions were filed in the same court. On November 8, 2004, all of these cases were consolidated into one action. The court appointed lead plaintiffs in the consolidated action, who filed a second amended complaint on May 23, 2005, alleging claims under Sections 10(b) and 20(a) of the Exchange Act on behalf of persons who purchased the Company’s publicly-traded securities between March 8, 2001 and April 18, 2005. The Company filed a motion to dismiss the second amended complaint on October 14, 2005 that is currently pending.

     Three shareholder derivative actions have been filed in the United States District Court for the Middle District of North Carolina:Wright v. Krispy Kreme Doughnuts, Inc., et al., filed September 14, 2004;Blackwell v. Krispy Kreme Doughnuts, Inc., et al., filed May 23, 2005; andAndrews v. Krispy Kreme Doughnuts, Inc., et al., filed May 24, 2005.

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     The defendants in one or more of these actions include all current and certain former directors of the Company (other than members of the Special Committee and two other directors first elected to the Board in 2006), certain current and former officers of the Company, including Scott Livengood (the Company’s former Chairman and Chief Executive Officer), John Tate (the Company’s former Chief Operating Officer) and Randy Casstevens (the Company’s former Chief Financial Officer), and certain persons or entities that sold franchises to the Company. The complaints in these actions allege that the defendants breached their fiduciary duties in connection with their management of the Company and the Company’s acquisitions of certain franchises. The complaints sought damages, rescission of the franchise acquisitions, disgorgement of the proceeds from these acquisitions and other unspecified relief.

     In orders dated November 5, 2004, November 24, 2004, April 4, 2005 and June 1, 2005, the court stayed theWrightaction pending completion of the investigation of the Special Committee.

     On June 3, 2005, the plaintiffs in theWright,BlackwellandAndrewsactions filed a motion to consolidate the three actions and to name lead plaintiffs in the consolidated action. On June 27, 2005, Trudy Nomm, who, like the plaintiffs in theWright,BlackwellandAndrewsactions, identified herself as a Krispy Kreme shareholder, filed a motion to intervene in these derivative actions and to be named lead plaintiff. On July 12, 2005, the court consolidated theWright,BlackwellandAndrewsshareholder derivative actions under the headingWright v. Krispy Kreme Doughnuts, Inc., et al.and ordered the plaintiffs to file a consolidated complaint on or before the later of 45 days after the plaintiffs receive the report of the Special Committee or 30 days after the court appoints lead counsel. A consolidated complaint has not yet been filed.

     On August 10, 2005, the Company announced that the Special Committee had completed its investigation. The Special Committee concluded that it was in the best interest of the Company to reject the demands by shareholders that the Company commence litigation against the current and former directors and officers of the Company named in the derivative actions and to seek dismissal of the shareholder litigation against the outside directors, the sellers of certain franchises and current and former officers, except for Messrs. Livengood, Tate and Casstevens, as to whom the Special Committee concluded that it would not seek dismissal of the shareholder derivative litigation.

     On October 21, 2005, the court granted Ms. Nomm’s motion to intervene. On October 28, 2005, the court appointed the plaintiffs in theWrightaction, Judy Woodall and William Douglas Wright, as co-lead plaintiffs in the consolidated action.

     On October 31, 2006, the Company and the Special Committee entered into a Stipulation and Settlement Agreement (the “Stipulation”) with the lead plaintiffs in the securities class action, the derivative plaintiffs and all defendants named in the class action and derivative litigation, except for Mr. Livengood, providing for the settlement of the securities class action and a partial settlement of the derivative action, on the terms described below.

     With respect to the securities class action, the Stipulation provides for the certification of a class consisting of all persons who purchased the Company’s publicly-traded securities between March 8, 2001 and April 18, 2005, inclusive. The settlement class will receive total consideration of approximately $75 million, consisting of a cash payment of $34,967,000 to be made by the Company’s directors’ and officers’ insurers, a cash payment of $100,000 to be made by Mr. Tate, a cash payment of $100,000 to be made by Mr. Casstevens, a cash payment of $4,000,000 to be made by the Company’s independent registered public accounting firm and common stock and warrants to purchase common stock to be issued by the Company having an aggregate value of $35,833,000 (based on the market price of the Company’s common stock as of late October and early November 2006). All claims against defendants will be dismissed with prejudice; however, claims that the Company may have against Mr. Livengood that may be asserted by the Company in the derivative action for contribution to the securities class action settlement or otherwise under applicable law are expressly preserved. The Stipulation contains no admission of fault or wrongdoing by the Company or the other defendants. On November 16, 2006, the court entered an order granting preliminary approval to the settlement. The settlement is subject to final approval of the court.

     With respect to the derivative litigation, the Stipulation provides for the settlement and dismissal with prejudice of all claims against defendants except for claims against Mr. Livengood. The Company, acting through its Special Committee, settled claims against Mr. Tate and Mr. Casstevens for the following consideration: Messrs. Tate and Casstevens each agreed to contribute $100,000 in cash to the settlement of the securities class action; Mr. Tate agreed to cancel his interest in 6,000 shares of the Company’s common stock; and Messrs. Tate and Casstevens agreed to limit their claims for indemnity from the Company in connection with future proceedings before the Commission or the United States Attorney for the Southern District of New York to specified amounts. The Company, acting through its Special Committee, has been in negotiations with Mr. Livengood but has not reached agreement to resolve the derivative claims against him and counsel for the derivative plaintiffs are deferring their application for fees until conclusion of the derivative actions against Mr. Livengood. All other claims against defendants named in the derivative actions will

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be dismissed with prejudice without paying any consideration, consistent with the findings and conclusions of the Special Committee in its report of August 2005.

     The Company expects to issue approximately 1,835,000 shares of its common stock and warrants to purchase approximately 4,300,000 shares of its common stock in connection with the Stipulation. The exercise price of the warrants will be approximately $12.21 per share.

     The Company recorded a non-cash charge to earnings in the first quarter of fiscal 2006 of $35,833,000, representing the estimated fair value, as of late October 2006, of the common stock and warrants to be issued by the Company. The settlement is conditioned upon the Company’s insurers and the other contributors paying their share of the settlement. The provision for settlement costs will be adjusted in periods after October 2006 to reflect changes in the fair value of the securities until they are issued following final court approval of the Stipulation, which the Company anticipates will occur in early calendar 2007.

     State Court Shareholder Derivative Actions.Two shareholder derivative actions have been filed in the Superior Court of North Carolina, Forsyth County:Andrews v. Krispy Kreme Doughnuts, Inc., et al., filed November 12, 2004, andLockwood v. Krispy Kreme Doughnuts, Inc., et al., filed January 21, 2005. On April 26, 2005, those actions were assigned to the North Carolina Business Court. On May 26, 2005, the plaintiffs in these actions voluntarily dismissed these actions in favor of a federal court action they filed on May 25, 2005 (theAndrewsaction discussed above).

     State Court Books and Records Action.On February 21, 2005, a lawsuit was filed against the Company in the Superior Court of North Carolina, Wake County, Nomm v. Krispy Kreme, Inc., seeking an order requiring the Company to permit the plaintiff to inspect and copy the books and records of the Company. On March 29, 2005, the action was transferred to the Superior Court of North Carolina for Forsyth County. On May 20, 2005, the case was assigned to the North Carolina Business Court. On June 27, 2005, plaintiff filed a motion to intervene and be named lead plaintiff in the federal court derivative actions described above. On August 2, 2005, the North Carolina Business Court stayed this action pending a decision on Ms. Nomm’s motion to intervene and to serve as lead plaintiff in the federal court actions. On October 21, 2005, the court in the federal court actions granted Ms. Nomm’s motion to intervene and, on October 28, 2005, denied Ms. Nomm’s motion to be named lead plaintiff.

Arbitration Award

     In March 2000, a lawsuit was filed against the Company, management and Golden Gate Doughnuts, the Company’s franchisee in Northern California, in Superior Court in the State of California. The lawsuit was filed as a result of joint venture discussions between the Company and the plaintiffs to develop the Northern California market. The plaintiffs were offered participation in the Northern California joint venture but declined. They instead brought suit contending that they had a right to a larger percentage of the joint venture and on different terms than offered by the Company. The plaintiffs alleged, among other things, breach of contract and sought compensation for damages and punitive damages. In September 2000, after the case was transferred to Sacramento Superior Court, that court granted the motion to compel arbitration of the action and stay the lawsuit pending the outcome of arbitration. In October 2001, after an appeal to the California appellate courts, plaintiffs filed a demand for arbitration with the American Arbitration Association against KKDC and the other defendants. In February 2003, after an extended series of arbitration hearings, the Arbitration Panel dismissed all claims against all parties, except the claim for breach of contract against the Company and Golden Gate and entered a preliminary award against the Company and Golden Gate. The Company accrued a provision of $9,075,000 in fiscal 2003, which consisted of the preliminary award and an estimate of the anticipated award of legal fees and other costs. After further negotiations, all claims were settled for $8,550,000 in May 2003.

Item 1A. RISK FACTORS.

     See Item 1A, “Risk Factors,” in the 2006 Form 10-K. Under the caption “Risks Relating to the Food Service Industry” in the 2006 Form 10-K, the Company discussed risks associated with regulation and publicity concerning food quality, health and other issues and a proposed amendment to the New York City Health Code. Recently, the New York City Health Department adopted an amendment to the New York City Health Code that will phase out artificial trans fat (which the Company currently uses in its doughnuts) in all New York City restaurants and other food service establishments by July 1, 2008.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

     None.

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Item 3. DEFAULTS UPON SENIOR SECURITIES.

     None.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

     None.

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 of the Registrant’s Registration Statement on Form S-8 (Commission File No. 333-97787), filed with the Commission on August 7, 2002)
3.2	—	Amended and Restated Bylaws of the Registrant, as amended (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed December 22, 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

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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: January 29, 2007	By:	/s/ Daryl G. Brewster
	Name:	Daryl G. Brewster
	Title:	Chief Executive Officer

Date: January 29, 2007	By:	/s/ Michael C. Phalen
	Name:	Michael C. Phalen
	Title:	Chief Financial Officer

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