Krispy Kreme Doughnuts (KKD) 10-Q 2015 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 November 2, 2014
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. YesþNoo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YesþNoo

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

Large accelerated filer  þ	Accelerated filer   o
Non-accelerated filer  o	Smaller reporting company   o

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

Number of shares of Common Stock, no par value, outstanding as of November 28, 2014: 64,771,004.

1

TABLE OF CONTENTS

		Page
FORWARD-LOOKING STATEMENTS		3
PART I - FINANCIAL INFORMATION		4
Item 1.	FINANCIAL STATEMENTS (UNAUDITED)	4
Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
	RESULTS OF OPERATIONS	26
Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	62
Item 4.	CONTROLS AND PROCEDURES	62
PART II - OTHER INFORMATION		62
Item 1.	LEGAL PROCEEDINGS	62
Item 1A.	RISK FACTORS	62
Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	63
Item 3.	DEFAULTS UPON SENIOR SECURITIES	63
Item 4.	MINE SAFETY DISCLOSURES	63
Item 5.	OTHER INFORMATION	63
Item 6.	EXHIBITS	63
	SIGNATURES	64
	EXHIBIT INDEX	65

2

As used herein, unless the context otherwise requires, “Krispy Kreme,” the “Company,” “we,” “us” and “our” refer to Krispy Kreme Doughnuts, Inc. and its subsidiaries. References to fiscal 2015 and fiscal 2014 mean the fiscal years ending February 1, 2015 and February 2, 2014, respectively.

FORWARD-LOOKING STATEMENTS

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

• the quality of Company and franchise store operations;
   
• our ability, and our dependence on the ability of our franchisees, to execute on our and their business plans;
   
• our relationships with our franchisees;
   
• our ability to implement our domestic and international growth strategies;
   
• our ability to implement our domestic small shop operating model;
   
• political, economic, currency and other risks associated with our international operations;
   
• the price and availability of raw materials needed to produce doughnut mixes and other ingredients, and the price of motorfuel;
   
• our relationships with wholesale customers;
   
• our ability to protect our trademarks and trade secrets;
   
• changes in customer preferences and perceptions;
   
• risks associated with competition;
   
• risks related to the food service industry, including food safety and protection of personal information;
   
• compliance with government regulations relating to food products and franchising;
   
• increased costs or other effects of new government regulations relating to healthcare benefits;
   
• risks associated with the use and implementation of information technology; and
   
• other factors discussed in Krispy Kreme’s periodic reports and other information filed with the United States Securities andExchange Commission (the “SEC”), including under Part I, Item 1A, “Risk Factors,” in the Company’s Annual Report onForm 10-K for the fiscal year ended February 2, 2014 (the “2014 Form 10-K”).

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

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

3

PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS (UNAUDITED).

	Page
Index to Financial Statements
Consolidated statement of income for the three and nine months ended November 2, 2014 and November 3, 2013	5
Consolidated statement of comprehensive income for the three and nine months ended November 2, 2014 and November
3, 2013	6
Consolidated balance sheet as of November 2, 2014 and February 2, 2014	7
Consolidated statement of cash flows for the nine months ended November 2, 2014 and November 3, 2013	8
Consolidated statement of changes in shareholders’ equity for the nine months ended November 2, 2014 and November
3, 2013	9
Notes to financial statements	10

4

KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF INCOME
(Unaudited)

	Three Months Ended						Nine Months Ended
	November 2,			November 3,			November 2,			November 3,
	2014			2013			2014			2013
	(In thousands, except per share amounts)
Revenues	$	122,871		$	114,231		$	364,967		$	347,585
Operating expenses:
Direct operating expenses (exclusive of depreciation and
amortization expense shown below)		101,165			92,466			297,421			282,830
General and administrative expenses		5,553			5,730			19,337			17,440
Depreciation and amortization expense		3,280			2,788			9,486			8,272
Impairment charges and lease termination costs		4			1,531			50			1,543
Operating income		12,869			11,716			38,673			37,500
Interest income		62			341			297			472
Interest expense		(230	)		(131	)		(535	)		(922	)
Loss on retirement of debt		-			-			-			(967	)
Equity in losses of equity method franchisees		(53	)		(61	)		(171	)		(174	)
Other non-operating income and (expense), net		91			29			411			23
Income before income taxes		12,739			11,894			38,675			35,932
Provision for income taxes		4,633			5,114			15,161			16,436
Net income	$	8,106		$	6,780		$	23,514		$	19,496
Earnings per common share:
Basic	$	0.12		$	0.10		$	0.35		$	0.29
Diluted	$	0.12		$	0.09		$	0.34		$	0.27

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

5

KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited)

	Three Months Ended				Nine Months Ended
	November 2,		November 3,		November 2,		November 3,
	2014		2013		2014		2013
	(In thousands)
Net income	$	8,106	$	6,780	$	23,514	$	19,496
Other comprehensive income:
Unrealized gain on cash flow hedge		-		-		-		36
Less income taxes		-		-		-		(14	)
		-		-		-		22
Loss on cash flow hedge reclassified to net income, previously
charged to other comprehensive income		-		-		-		516
Less income taxes		-		-		-		(200	)
		-		-		-		316
Total other comprehensive income		-		-		-		338
Comprehensive income	$	8,106	$	6,780	$	23,514	$	19,834

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

6

KRISPY KREME DOUGHNUTS, INC.

CONSOLIDATED BALANCE SHEET(Unaudited)

	November 2,			February 2,
	2014			2014
	(In thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	44,471		$	55,748
Receivables		28,272			25,268
Receivables from equity method franchisees		787			675
Inventories		17,163			16,750
Deferred income taxes		23,774			23,847
Other current assets		7,220			5,199
Total current assets		121,687			127,487
Property and equipment		108,381			92,823
Investments in equity method franchisees		-			-
Goodwill and other intangible assets		30,251			24,097
Deferred income taxes		70,153			83,461
Other assets		11,006			10,678
Total assets	$	341,478		$	338,546
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of lease obligations	$	336		$	344
Accounts payable		17,801			16,788
Accrued liabilities		27,641			29,276
Total current liabilities		45,778			46,408
Lease obligations, less current portion		8,303			1,659
Other long-term obligations and deferred credits		26,494			25,386
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; 64,771 shares and 64,940 shares
outstanding, respectively		310,431			338,135
Accumulated other comprehensive income		-			-
Accumulated deficit		(49,528	)		(73,042	)
Total shareholders’ equity		260,903			265,093
Total liabilities and shareholders’ equity	$	341,478		$	338,546

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,			November 3,
	2014			2013
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	23,514		$	19,496
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense		9,486			8,272
Deferred income taxes		13,381			14,438
Accrued rent expense		597			578
Loss on retirement of debt		-			967
(Gain) loss on disposal of property and equipment		212			(1,930	)
(Gain) on refranchising		(1,247	)		(876	)
Share-based compensation		3,397			3,160
Provision for doubtful accounts		5			(82	)
Amortization of deferred financing costs		81			258
Equity in losses of equity method franchisees		171			174
Unrealized (gains) losses on commodity derivative positions		593			(131	)
Other		14			22
Change in assets and liabilities:
Receivables		(4,156	)		(2,523	)
Inventories		(312	)		(2,621	)
Other current and non-current assets		(2,366	)		1,393
Accounts payable and accrued liabilities		1,967			(947	)
Other long-term obligations and deferred credits		381			1,363
Net cash provided by operating activities		45,718			41,011
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(21,254	)		(18,089	)
Proceeds from disposals of property and equipment		2,222			1,681
Proceeds from refranchising		1,847			681
Business acquisition, net of cash acquired		(7,152	)		-
Other investing activities		584			305
Net cash used for investing activities		(23,753	)		(15,422	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt and lease obligations		(296	)		(24,546	)
Deferred financing costs		-			(132	)
Proceeds from exercise of stock options		9,921			2,155
Repurchase of common shares		(42,867	)		(2,653	)
Net cash used for financing activities		(33,242	)		(25,176	)
Net increase (decrease) in cash and cash equivalents		(11,277	)		413
Cash and cash equivalents at beginning of period		55,748			66,332
Cash and cash equivalents at end of period	$	44,471		$	66,745
Supplemental schedule of non-cash investing and financing activities:
Assets acquired under leasing arrangements	$	6,919		$	803

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
	Common					Other
	Shares		Common			Comprehensive			Accumulated
	Outstanding		Stock			Income (Loss)			Deficit			Total
						(In thousands)
Balance at February 2, 2014	64,940		$	338,135		$	-		$	(73,042	)	$	265,093
Comprehensive income for the nine months
ended November 2, 2014	-			-			-			23,514			23,514
Exercise of stock options	1,866			9,921			-			-			9,921
Share-based compensation	305			3,397			-			-			3,397
Repurchase of common shares	(2,340	)		(41,022	)		-			-			(41,022	)
Balance at November 2, 2014	64,771		$	310,431		$	-		$	(49,528	)	$	260,903
Balance at February 3, 2013	65,356		$	354,068		$	(338	)	$	(107,298	)	$	246,432
Comprehensive income for the nine months
ended November 3, 2013	-			-			338			19,496			19,834
Exercise of stock options	434			2,155			-			-			2,155
Share-based compensation	333			3,160			-			-			3,160
Repurchase of common shares	(138	)		(2,653	)		-			-			(2,653	)
Balance at November 3, 2013	65,985		$	356,730		$	-		$	(87,802	)	$	268,928

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

9

KRISPY KREME DOUGHNUTS, INC.

NOTES TO FINANCIAL STATEMENTS
(Unaudited)

Note 1 — Accounting Policies

Krispy Kreme Doughnuts, Inc. (“KKDI”) and its subsidiaries (collectively, the “Company”) are engaged in the sale of doughnuts and complementary products through Company-owned stores. The Company also licenses the Krispy Kreme business model and certain of its intellectual property to franchisees in the United States and over 20 other countries around the world, and derives revenue from franchise and development fees and royalties from those franchisees. Additionally, the Company sells doughnut mixes, other ingredients and supplies and doughnut-making equipment to franchisees.

Significant Accounting Policies

BASIS OF PRESENTATION.The consolidated financial statements contained herein should be read in conjunction with the Company’s 2014 Form 10-K. The accompanying interim consolidated financial statements are presented in accordance with the requirements of Article 10 of Regulation S-X and, accordingly, do not include all the disclosures required by generally accepted accounting principles in the United States of America (“GAAP”) with respect to annual financial statements. The interim consolidated financial statements have been prepared in accordance with the Company’s accounting practices described in the 2014 Form 10-K, but have not been audited. In management’s opinion, the financial statements include all adjustments, which consist only of normal recurring adjustments, necessary for a fair statement of the Company’s results of operations for the periods presented. The consolidated balance sheet data as of February 2, 2014 were derived from the Company’s audited financial statements but do not include all disclosures required by GAAP.

BASIS OF CONSOLIDATION.The financial statements include the accounts of KKDI and its subsidiaries.

Investments in entities over which the Company has the ability to exercise significant influence but which the Company does not control, and whose financial statements are not otherwise required to be consolidated, are accounted for using the equity method.

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

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

	Three Months Ended				Nine Months Ended
	November 2,		November 3,		November 2,		November 3,
	2014		2013		2014		2013
	(In thousands)
Numerator: net income	$	8,106	$	6,780	$	23,514	$	19,496
Denominator:
Basic earnings per share - weighted average shares outstanding		66,407		67,543		66,313		67,274
Effect of dilutive securities:
Stock options		1,780		3,173		2,161		2,948
Restricted stock units		467		790		568		836
Diluted earnings per share - weighted average shares
outstanding plus dilutive potential common shares		68,654		71,506		69,042		71,058

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

Stock options with respect to 324,000 and 33,000 shares for the three months ended November 2, 2014 and November 3, 2013, respectively, and 100,000 unvested restricted stock units for the three months ended November 2, 2014, have been excluded from the computation of the number of shares used to compute diluted earnings per share because their inclusion would be antidilutive.

10

Stock options with respect to 264,000 and 309,000 shares for the nine months ended November 2, 2014 and November 3, 2013, respectively, and 70,000 unvested restricted stock units for the nine months ended November 2, 2014, have been excluded from the computation of the number of shares used to compute diluted earnings per share because their inclusion would be antidilutive.

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

Recent Accounting Pronouncements

In June 2014, the Financial Accounting Standards Board (the “FASB”) issued an update to its accounting guidance related to share-based compensation. The guidance requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition, and therefore shall not be reflected in determining the fair value of the award at the grant date. The guidance will be effective for annual and interim periods beginning after December 15, 2015 and is not expected to have any effect on the Company’s consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, to clarify the principles used to recognize revenue for all entities. The guidance is effective for annual and interim periods beginning after December 15, 2016. Early adoption is not permitted. The Company will evaluate the effects, if any, adoption of this guidance will have on the Company’s consolidated financial statements.

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disposals of Components of an Entity, which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. The guidance is effective for annual and interim periods beginning after December 15, 2014, with early adoption permitted. Adoption of this guidance could have an effect on the Company’s presentation and disclosure of a future disposal compared to current GAAP.

Note 2 — Segment Information

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

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

The following table presents the results of operations of the Company’s operating and reportable segments for the three and nine months ended November 2, 2014 and November 3, 2013. Segment operating income is consolidated operating income before general and administrative expenses, corporate depreciation and amortization, and impairment charges and lease termination costs.

11

	Three Months Ended						Nine Months Ended
	November 2,			November 3,			November 2,			November 3,
	2014			2013			2014			2013
	(In thousands)
Revenues:
Company Stores	$	82,579		$	74,886		$	241,562		$	232,496
Domestic Franchise		3,274			3,026			10,069			8,696
International Franchise		6,852			6,205			20,967			18,707
KK Supply Chain:
Total revenues	61,581				58,304			181,396			175,316
Less – intersegment sales elimination	(31,415		)		(28,190	)		(89,027	)		(87,630	)
External KK Supply Chain revenues	30,166				30,114			92,369			87,686
Total revenues	$	122,871		$	114,231		$	364,967		$	347,585
Operating income:
Company Stores	$	2,233		$	2,599		$	7,910		$	9,703
Domestic Franchise		1,989			3,156			6,045			6,121
International Franchise		5,048			4,449			14,439			13,219
KK Supply Chain		9,529			9,098			30,772			28,336
Total segment operating income	18,799				19,302			59,166			57,379
General and administrative expenses	(5,553		)		(5,730	)		(19,337	)		(17,440	)
Corporate depreciation and amortization expense		(373	)		(325	)		(1,106	)		(896	)
Impairment charges and lease termination costs		(4	)		(1,531	)		(50	)		(1,543	)
Consolidated operating income	$	12,869		$	11,716		$	38,673		$	37,500
Depreciation and amortization expense:
Company Stores	$	2,711		$	2,255		$	7,752		$	6,783
Domestic Franchise		26			36			121			72
International Franchise		1			2			4			6
KK Supply Chain		169			170			503			515
Corporate		373			325			1,106			896
Total depreciation and amortization expense	$	3,280		$	2,788		$	9,486		$	8,272

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 3 — Income Taxes

The Company recognizes deferred income tax assets and liabilities based upon management’s expectation of the future tax consequences of temporary differences between the income tax and financial reporting bases of assets and liabilities. Deferred tax liabilities generally represent tax expense recognized for which payment has been deferred, or expenses which have been deducted in the Company’s tax returns but which have not yet been recognized as an expense in the financial statements. Deferred tax assets generally represent tax deductions or credits that will be reflected in future tax returns for which the Company has already recorded a tax benefit in its consolidated financial statements.

The Company establishes valuation allowances for deferred income tax assets in accordance with GAAP, which provides that such valuation allowances shall be established unless realization of the income tax benefits is more likely than not.

The valuation allowance of $2.6 million at November 2, 2014 and $2.7 million at February 2, 2014 represents the portion of the Company’s deferred tax assets management estimates will not be realized in the future. Such assets are associated principally with state net operating loss carryforwards related to states in which the scope of the Company’s operations has decreased, which adversely affects the Company’s ability to realize the net operating loss carryforwards because the Company has little income earned in or apportioned to those states.

In the third quarter of fiscal 2015, the Company recognized additional deferred income tax assets related to state net operating loss carryforwards as a result of taking a previously unanticipated tax position in a fiscal 2014 tax return filed during the quarter, and as a result of entering into an agreement with a state tax authority during the quarter with respect to a new filing position with respect to certain earlier years. These changes increased the Company’s deferred income tax assets by $206,000 and decreased the valuation allowance on deferred tax assets by $109,000. Accordingly, the Company’s aggregate net deferred tax assets increased by $315,000 and deferred income tax expense decreased by the same amount.

12

In the second quarter of fiscal 2014, the North Carolina state legislature enacted a prospective reduction in the corporate income tax rate, which caused the Company to revalue its deferred income tax assets to reflect the lower income tax rate. Such revaluation reduced the Company’s deferred tax assets by approximately $1.0 million. Because a portion of the deferred tax assets was already subject to a valuation allowance, the revaluation of the assets resulted in a reduction in the necessary valuation allowance of $314,000. The effect of the legislation was therefore to reduce the Company’s net deferred tax assets by $686,000; such amount was included in income tax expense for the nine months ended November 3, 2013.

The realization of deferred income tax assets is dependent on future events. While management believes its forecast of the amount of deferred tax assets expected to be realized is reasonable, actual results inevitably will vary from management’s forecasts. Such variances could result in adjustments to the valuation allowance on deferred tax assets in future periods, and such adjustments could be material to the financial statements.

Note 4 — Receivables

The components of receivables are as follows:

	November 2,			February 2,
	2014			2014
	(In thousands)
Receivables:
Wholesale customers	$	10,230		$	9,919
Unaffiliated franchisees		11,912			10,934
Due from third-party distributors		4,791			3,262
Other receivables		741			640
Current portion of notes receivable		952			754
		28,626			25,509
Less — allowance for doubtful accounts:
Wholesale customers		(207	)		(191	)
Unaffiliated franchisees		(147	)		(50	)
		(354	)		(241	)
	$	28,272		$	25,268
Receivables from equity method franchisees (Note 6):
Trade	$	787		$	675
The changes in the allowance for doubtful accounts are summarized as follows:
	Nine Months Ended
	November 2,			November 3,
	2014			2013
	(In thousands)
Allowance for doubtful accounts related to receivables:
Balance at beginning of period	$	241		$	615
Provision for doubtful accounts		102			(30	)
Net recoveries (chargeoffs)		11			(48	)
Balance at end of period	$	354		$	537
Allowance for doubtful accounts related to receivables from equity method franchisees:
Balance at beginning of period	$	-		$	-
Provision for doubtful accounts		(43	)		(47	)
Net recoveries (chargeoffs)		43			47
Balance at end of period	$	-		$	-

13

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

	November 2,			February 2,
	2014			2014
	(In thousands)
Notes receivable:
Notes receivable from franchisees	$	4,349		$	3,980
Less — portion due within one year included in receivables		(952	)		(754	)
Less — allowance for doubtful accounts		-			(54	)
	$	3,397		$	3,172

Notes receivable at November 2, 2014 and February 2, 2014 consist principally of amounts payable to the Company related to a refranchising transaction, to the sale of certain leasehold interests to a franchisee, and to sales of equipment.

The changes in the allowance for doubtful accounts related to notes receivable are summarized as follows:

	Nine Months Ended
	November 2,			November 3,
	2014			2013
	(In thousands)
Balance at beginning of period	$	54		$	62
Provision for doubtful accounts		(54	)		(5	)
Balance at end of period	$	-		$	57

In addition to the foregoing notes receivable, the Company had promissory notes totaling approximately $1.9 million at November 2, 2014 and $2.9 million at February 2, 2014 representing principally royalties and fees due to the Company which, as a result of doubt about their collection, the Company has not yet recorded as revenues. The Company collected approximately $10,000 during the three months ended November 3, 2013 and approximately $900,000 and $370,000, during the nine months ended November 2, 2014 and November 3, 2013, respectively, related to these promissory notes and recorded such collections in revenues as received.

Finally, the Company has a promissory note receivable from Krispy Kreme of South Florida, LLC (“KKSF”) totaling approximately $1.1 million and $1.5 million at November 2, 2014 and February 2, 2014, respectively, arising from the Company’s advance to KKSF of approximately $1.6 million on November 1, 2013 to enable KKSF to retire certain indebtedness with respect to which KKSF had been in default since October 2009, payment of which was demanded by the lender in October 2013. The lender also made demand on the Company to perform under its guarantee of such indebtedness. The Company’s advance to KKSF was charged against a previously recorded liability for potential payments under the guarantee and the remaining balance of the accrual of approximately $30,000 was credited to other non-operating income and expense, net in the third quarter of fiscal 2014. Because of the uncertainty of recovery of amounts advanced to KKSF, the note receivable is not reflected as an asset in the accompanying consolidated balance sheet. The Company is recording payments on the note as they are received from KKSF, and reflecting such amounts as a component of other non-operating income. Such collections were approximately $100,000 and $420,000 in the three and nine months ended November 2, 2014, respectively. KKSF has informed the Company that it is negotiating a new term loan with a third-party lender, the proceeds of which would be used by KKSF to, among other things, expand its business and repay to the Company the amounts owed as described above.

14

Note 5 — Inventories

The components of inventories are as follows:

	November 2,		February 2,
	2014		2014
	(In thousands)
Raw materials	$	7,357	$	6,200
Work in progress		158		114
Finished goods and purchased merchandise		9,648		10,436
	$	17,163	$	16,750

Note 6 — Investments in Franchisees

As of November 2, 2014, the Company had an ownership interest in three franchisees, the net carrying value of which was zero. The Company’s financial exposures related to franchisees in which the Company has an investment are summarized in the tables below.

	November 2, 2014
	Company		Investment
	Ownership		and					Loan
	Percentage		Advances			Receivables		Guarantees
	(Dollars in thousands)
Kremeworks, LLC	25.0	%	$	900		$	348	$	-
Kremeworks Canada, LP	24.5	%		-			41		-
Krispy Kreme of South Florida, LLC	35.3	%		-			398		-
				900			787	$	-
Less: reserves and allowances				(900	)		-
			$	-		$	787
	February 2, 2014
	Company		Investment
	Ownership		and					Loan
	Percentage		Advances			Receivables		Guarantees
	(Dollars in thousands)
Kremeworks, LLC	25.0	%	$	900		$	280	$	140
Kremeworks Canada, LP	24.5	%		-			19		-
Krispy Kreme of South Florida, LLC	35.3	%		-			376		-
				900			675	$	140
Less: reserves and allowances				(900	)		-
			$	-		$	675

The Company has a 25% interest in Kremeworks, LLC (“Kremeworks”), and had guaranteed 20% of the outstanding principal balance of certain of Kremeworks’ bank indebtedness which was paid in full during the second quarter of fiscal 2015.

15 

Note 7 — Credit Facilities and Lease Obligations

Lease obligations consist of the following:

	November 2,			February 2,
	2014			2014
	(In thousands)
Capital lease obligations	$	3,022		$	2,003
Financing obligations under build-to-suit transactions		5,617			-
		8,639			2,003
Less: current portion		(336	)		(344	)
	$	8,303		$	1,659

Lease Obligations

The Company leases equipment and facilities under various leasing arrangements.

In certain leasing arrangements, the Company is involved in the construction of leased stores and is deemed the owner of the leased stores for accounting purposes during the construction period. The Company records the related assets and liabilities for construction costs incurred under these built-to-suit leasing arrangements during the construction period. Upon completion of the leased store, the Company considers whether the assets and liabilities qualify for derecognition under the sale-leaseback accounting guidance. These leasing arrangements do not qualify for sale-leaseback treatment and, accordingly, the Company records the transactions as financing obligations and allocates the lease payments between interest expense and amortization of the obligations and depreciates the assets over their estimated useful lives.

At November 2, 2014, the Company had property and lease obligations related to build-to-suit leasing arrangements of approximately $5.6 million.

2013 Revolving Credit Facility

On July 12, 2013, the Company entered into a $40 million revolving secured credit facility (the “2013 Revolving Credit Facility”) which matures in July 2018. The 2013 Revolving Credit Facility is secured by a first lien on substantially all of the personal property assets of the Company and certain of its domestic subsidiaries. No borrowings were made on the 2013 Revolving Credit Facility on the closing date, and the Company repaid the $21.7 million remaining balance of the 2011 Term Loan and terminated the 2011 Secured Credit Facilities described below. The Company recorded a pretax charge of approximately $967,000 in the second quarter of fiscal 2014 to write off the unamortized deferred debt issuance costs related to the terminated facility and to reflect the termination of a related interest rate hedge.

Interest on borrowings under the 2013 Revolving Credit Facility is payable either at LIBOR or the Base Rate (which is the greatest of the prime rate, the Fed funds rate plus 0.50%, or the one-month LIBOR rate plus 1.00%), in each case plus the Applicable Percentage. The Applicable Percentage for LIBOR loans ranges from 1.25% to 2.15%, and for Base Rate loans ranges from 0.25% to 1.15%, in each case depending on the Company’s leverage ratio. As of November 2, 2014, the Applicable Margin was 1.25%.

The 2013 Revolving Credit Facility contains provisions which permit the Company to obtain letters of credit, issuance of which constitutes usage of the lending commitments and reduces the amount available for cash borrowings. At closing, $9.2 million of letters of credit were issued under the 2013 Revolving Credit Facility to replace letters of credit issued under the terminated credit facilities, all of which secure the Company’s reimbursement obligations to insurers under the Company’s self-insurance programs. At November 2, 2014, the Company had approximately $8.7 million of letters of credits outstanding.

The Company is required to pay a fee equal to the Applicable Percentage for LIBOR-based loans on the outstanding amount of letters of credit. There also is a fee on the unused portion of the 2013 Revolving Credit Facility lending commitment, ranging from 0.15% to 0.35%, depending on the Company’s leverage ratio.

The 2013 Revolving Credit Facility requires the Company to meet certain financial tests, including a maximum leverage ratio and a minimum fixed charge coverage ratio. The leverage ratio is required to be not greater than 2.25 to 1.0 and the fixed charge coverage ratio is required to be not less than 1.3 to 1.0.

As of November 2, 2014, the Company’s leverage ratio was 0.3 to 1.0 and the fixed charge coverage ratio was 3.4 to 1.0.

16

The leverage ratio is calculated by dividing total debt as of the end of each fiscal quarter by Consolidated EBITDA for the Reference Period (each consisting of the four most recent fiscal quarters). For this purpose, debt includes not only indebtedness reflected in the consolidated balance sheet, but also, among other things, the amount of undrawn letters of credit, the principal balance of indebtedness of third parties to the extent such indebtedness is guaranteed by the Company, and any amounts reasonably expected to be paid with respect to any other guaranty obligations. The fixed charge coverage ratio is calculated for each Reference Period by dividing (a) the sum of (i) Consolidated EBITDA, plus (ii) Cash Lease Payments, minus (iii) cash income taxes, minus (iv) unfinanced capital expenditures, minus (v) purchases, redemptions, retirements, and cash dividend payments or other distributions in respect of the Company’s common stock in excess of certain amounts, and minus (vi) the purchase price of all acquisitions of all or substantially all of the assets of any Krispy Kreme store or franchisee shops by (b) Consolidated Fixed Charges.

“Consolidated EBITDA” is a non-GAAP measure and is defined in the 2013 Revolving Credit Facility to mean, for each Reference Period, generally, consolidated net income or loss, exclusive of unrealized gains and losses on hedging instruments, gains or losses on asset dispositions, and provisions for payments on guarantee obligations, plus the sum of interest expense, income taxes, depreciation, rent expense and lease termination costs, and certain non-cash charges; and minus the sum of non-cash credits, interest income, Cash Lease Payments, and payments on guaranty obligations in excess of $1 million during the Reference Period or $3 million in the aggregate.

“Cash Lease Payments” means the sum of cash paid or required to be paid for obligations under operating leases for real property and equipment (net of sublease income), lease payments on closed stores (but excluding payments in settlement of future obligations under terminated operating leases), and cash payments in settlement of future obligations under terminated operating leases to the extent the aggregate amount of such payments exceeds $1.5 million during a Reference Period or $5.0 million in the aggregate.

“Consolidated Fixed Charges” means the sum of cash interest expense, Cash Lease Payments, and scheduled principal payments of indebtedness.

The operation of the restrictive financial covenants described above may limit the amount the Company may borrow under the 2013 Revolving Credit Facility. The restrictive covenants did not limit the Company’s ability to borrow the full $31.3 million of unused credit under the 2013 Revolving Credit Agreement as of November 2, 2014.

The 2013 Revolving Credit Facility also contains covenants which, among other things, generally limit (with certain exceptions): liquidations, mergers, and consolidations; the incurrence of additional indebtedness (including guarantees); the incurrence of additional liens; the sale, assignment, lease, conveyance or transfer of assets; certain investments; dividends and stock redemptions or repurchases in excess of certain amounts; transactions with affiliates; engaging in materially different lines of business; certain sale-leaseback transactions; and other activities customarily restricted in such agreements. The 2013 Revolving Credit Facility also prohibits the transfer of cash or other assets to the Parent Company, whether by dividend, loan or otherwise, but provides for exceptions to enable the Parent Company to pay taxes, directors’ fees and operating expenses, as well as exceptions to permit dividends in respect of the Company’s common stock and stock redemptions and repurchases, to the extent permitted by the 2013 Revolving Credit Facility.

The 2013 Revolving Credit Facility also contains customary events of default including, without limitation, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to other indebtedness in excess of $5 million, certain events of bankruptcy and insolvency, judgment defaults in excess of $5 million and the occurrence of a change of control.

Borrowings and issuances of letters of credit under the 2013 Revolving Credit Facility are subject to the satisfaction of usual and customary conditions, including the accuracy of representations and warranties and the absence of defaults.

2011 Secured Credit Facilities

On January 28, 2011, the Company entered into secured credit facilities (the “2011 Secured Credit Facilities”), consisting of a $25 million revolving credit line (the “2011 Revolver”) and a $35 million term loan (the “2011 Term Loan”), each of which were scheduled to mature in January 2016. The 2011 Secured Credit Facilities were secured by a first lien on substantially all of the assets of the Company and its domestic subsidiaries. On July 12, 2013, the 2011 Term Loan was paid in full and the 2011 Secured Credit Facilities were terminated.

Interest on borrowings under the 2011 Secured Credit Facilities was payable either at LIBOR or the Base Rate (which is the greatest of the prime rate, the Fed funds rate plus 0.50%, or the one-month LIBOR rate plus 1.00%), in each case plus the Applicable Percentage. The Applicable Percentage for LIBOR loans ranged from 2.25% to 3.00%, and for Base Rate loans ranged from 1.25% to 2.00%, in each case depending on the Company’s leverage ratio.

On March 3, 2011, the Company entered into an interest rate derivative contract having an aggregate notional principal amount of $17.5 million. The derivative contract entitled the Company to receive from the counterparty the excess, if any, of the three-month LIBOR rate over 3.00% for each of the calendar quarters in the period beginning April 2012 and ending December 2015. The Company accounted for this derivative contract as a cash flow hedge. The contract was terminated in July 2013 following the retirement in full of the 2011 Term Loan. In the second quarter of fiscal 2014, the $516,000 unrealized loss on the contract previously included in AOCI was reclassified to earnings in the consolidated statement of income because the hedged forecasted transaction (interest on the 2011 Term Loan) would not occur.  

17

The 2011 Revolver contained provisions which permitted the Company to obtain letters of credit, issuance of which constituted usage of the lending commitments and reduced the amount available for cash borrowings.

The Company was required to pay a fee equal to the Applicable Percentage for LIBOR-based loans on the outstanding amount of letters of credit, as well as a fronting fee of 0.125% of the amount of such letter of credit. There also was a fee on the unused portion of the 2011 Revolver lending commitment ranging from 0.35% to 0.65%, depending on the Company’s leverage ratio.

Note 8 — Commitments and Contingencies

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

Pending Litigation

K² Asia Litigation

On April 7, 2009, a Cayman Islands corporation, K² Asia Ventures, and its owners filed a lawsuit in Forsyth County, North Carolina Superior Court against the Company, its franchisee in the Philippines, and other persons associated with the franchisee. The suit alleges that the Company and the other defendants conspired to deprive the plaintiffs of claimed “exclusive rights” to negotiate franchise and development agreements with prospective franchisees in the Philippines, and seeks unspecified damages. The Company therefore does not know the amount or range of possible loss related to this matter. The Company believes that these allegations are false and intends to vigorously defend against the lawsuit. On July 26, 2013, the Superior Court dismissed the Philippines-based defendants for lack of personal jurisdiction. The plaintiffs appealed that decision and the Court of Appeals affirmed that decision on August 19, 2014.

The Company does not believe it is probable that a loss has been incurred with respect to this matter, and accordingly no liability related to it has been reflected in the accompanying financial statements.

Other Legal Matters

The Company also is engaged in various legal proceedings arising in the normal course of business. The Company maintains insurance policies against certain kinds of such claims and suits, including insurance policies for workers’ compensation and personal injury, all of which are subject to deductibles. While the ultimate outcome of these matters could differ from management’s expectations, management currently does not believe their resolution will have a material adverse effect on the Company’s financial condition or results of operations.

Other Commitments and Contingencies

The Company’s primary bank had issued letters of credit on behalf of the Company totaling $8.7 million at November 2, 2014, substantially all of which secure the Company’s reimbursement obligations to insurers under the Company’s self-insurance arrangements.

Note 9 — Shareholders’ Equity

Share-Based Compensation for Employees and Directors

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

The aggregate cost of SBP awards charged to earnings for the three and nine months ended November 2, 2014 and November 3, 2013 is set forth in the following table. The Company did not realize any excess tax benefits from the exercise of stock options or the vesting of restricted stock units during any of the periods.

	Three Months Ended				Nine Months Ended
	November 2,		November 3,		November 2,		November 3,
	2014		2013		2014		2013
	(In thousands)
Costs charged to earnings related to:
Stock options	$	324	$	216	$	885	$	651
Restricted stock units		866		1,077		2,512		2,509
Total costs	$	1,190	$	1,293	$	3,397	$	3,160
Costs included in:
Direct operating expenses	$	561	$	737	$	1,724	$	1,704
General and administrative expenses		629		556		1,673		1,456
Total costs	$	1,190	$	1,293	$	3,397	$	3,160

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Repurchases of Common Stock

In fiscal 2014, the Company’s Board of Directors authorized the repurchase of up to $50 million of the Company's common stock and subsequently twice increased such authorization such that it now totals $105 million. The authorization has no expiration date.

The Company generally permits holders of restricted stock unit awards to satisfy their obligations to reimburse the Company for the minimum required statutory withholding taxes arising from the vesting of such awards by surrendering vested common shares in lieu of reimbursing the Company in cash.

The following tables summarize repurchases of common stock for the three and nine months ended November 2, 2014 and November 3, 2013.

	Three Months Ended
	November 2,			November 3,
	2014			2013
		Common			Common
	Shares	Stock		Shares	Stock
	(In thousands)
Shares repurchased under share repurchase authorization	397	$	6,786	33	$	627
Shares surrendered in reimbursement for withholding taxes	82		1,463	105		2,026
	479	$	8,249	138	$	2,653
	Nine Months Ended
	November 2,			November 3,
	2014			2013
		Common			Common
	Shares	Stock		Shares	Stock
	(In thousands)
Shares repurchased under share repurchase authorization	2,237	$	39,225	33	$	627
Shares surrendered in reimbursement for withholding taxes	103		1,797	105		2,026
	2,340	$	41,022	138	$	2,653

Through November 2, 2014, the Company had cumulatively repurchased approximately 3,422,000 shares under the repurchase authorization at an average price of $17.99 per share, for a total cost of $61.6 million. Repurchases of approximately $41.1 million of the share repurchases were settled during the nine months ended November 2, 2014.

19

Note 10 — Impairment Charges and Lease Termination Costs

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

	Three Months Ended				Nine Months Ended
	November 2,		November 3,		November 2,			November 3,
	2014		2013		2014			2013
	(In thousands)
Impairment of long-lived assets	$	-	$	-	$	-		$	-
Lease termination costs:
Provision for termination costs		4		1,531		52			1,543
Less - reversal of previously recorded accrued rent expense		-		-		(2	)		-
Net provision		4		1,531		50			1,543
Total impairment charges and lease termination costs	$	4	$	1,531	$	50		$	1,543

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

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

In November 2013, a court entered a judgment against the Company in a dispute with a former landlord. The Company subsequently agreed to settle the matter, and recorded an additional lease termination charge of approximately $1.5 million in the three months ended November 3, 2013 related to such resolution.

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

	Three Months Ended						Nine Months Ended
	November 2,			November 3,			November 2,			November 3,
	2014			2013			2014			2013
	(In thousands)
Balance at beginning of period	$	176		$	608		$	178		$	646
Provision for lease termination costs:
Provisions associated with leased properties, net of estimated
sublease rentals		-			-			44			-
Adjustments to previously recorded provisions resulting from
settlements with lessors and adjustments of previous
estimates		(1	)		1,525			(6	)		1,525
Accretion of discount		5			6			14			18
Total provision		4			1,531			52			1,543
Payments on unexpired leases, including settlements with
lessors		(34	)		(20	)		(84	)		(70	)
Balance at end of period	$	146		$	2,119		$	146		$	2,119

Included in the lease termination accrual at November 2, 2014 was $103,000 expected to be paid within one year.

20

Note 11 — Fair Value Measurements

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

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

• Level 1 - Quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities.
   
• Level 2 - Observable inputs other than quoted prices included within Level 1, such as quoted prices for similar assets andliabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or otherinputs that are observable or can be corroborated by observable market data.
   
• Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair valuemeasurement of the assets or liabilities. These include certain pricing models, discounted cash flow methodologies and similartechniques that use significant unobservable inputs.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at November 2, 2014 and February 2, 2014.

	November 2, 2014(1)
	Level 1		Level 2		Level 3
	(In thousands)
Assets:
401(k) mirror plan assets	$	2,470	$	-	$	-
Liabilities:
Agricultural commodity futures contracts	$	906	$	-	$	-
Gasoline commodity futures contracts		-		-		-
Total liabilities	$	906	$	-	$	-
	February 2, 2014(1)
	Level 1		Level 2		Level 3
	(In thousands)
Assets:
401(k) mirror plan assets	$	2,585	$	-	$	-
Liabilities:
Agricultural commodity futures contracts	$	313	$	-	$	-

(1) There were no transfers of financial assets or liabilities among the levels within the fair value hierarchy during the nine months ended November 2, 2014 or the year ended February 2, 2014.

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

There were no material nonrecurring fair value measurements recorded during the three and nine months ended November 2, 2014 and November 3, 2013.

21

Fair Values of Financial Instruments at the Balance Sheet Dates

The carrying values and approximate fair values of certain financial instruments as of November 2, 2014 and February 2, 2014 were as follows:

	November 2, 2014				February 2, 2014
	Carrying		Fair		Carrying		Fair
	Value		Value		Value		Value
	(In thousands)
Assets:
Cash and cash equivalents	$	44,471	$	44,471	$	55,748	$	55,748
Receivables		28,272		28,272		25,268		25,268
Receivables from equity method franchisees		787		787		675		675
Liabilities:
Accounts payable		17,801		17,801		16,788		16,788
Agricultural commodity futures contracts		906		906		313		313
Gasoline commodity futures contracts		-		-		-		-
Lease obligations (including current portion)		8,639		8,639		2,003		2,003

The carrying values of all financial instruments approximate their fair values at November 2, 2014 and February 2, 2014.

Note 12 — Derivative Instruments

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

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

Additional disclosure about the fair value of derivative instruments is included in Note 11.

Commodity Price Risk

The Company is exposed to the effects of commodity price fluctuations in the cost of ingredients of its products, of which flour, sugar and shortening are the most significant. In order to bring greater stability to the cost of ingredients, from time to time the Company purchases exchange-traded commodity futures contracts, and options on such contracts, for raw materials which are ingredients of its products or which are components of such ingredients, including wheat and soybean oil. The Company is also exposed to the effects of commodity price fluctuations in the cost of gasoline used by its delivery vehicles. To mitigate the risk of fluctuations in the price of its gasoline purchases, the Company may purchase exchange-traded commodity futures contracts and options on such contracts. The difference between the cost, if any, and the fair value of commodity derivatives is reflected in earnings because the Company has not designated any of these instruments as hedges. Gains and losses on these contracts are intended to offset losses and gains on the hedged transactions in an effort to reduce the earnings volatility resulting from fluctuating commodity prices. The settlement of commodity derivative contracts is reported in the consolidated statement of cash flows as a cash flow from operating activities. At November 2, 2014, the Company had commodity derivatives with an aggregate contract volume of approximately 1.8 million bushels of wheat and 126,000 gallons of gasoline. Other than the requirement to meet minimum margin requirements with respect to the commodity derivatives, there are no collateral requirements related to such contracts.

Interest Rate Risk

The Company is exposed to market risk from increases in interest rates on any borrowings outstanding under its secured revolving credit facility. As of November 2, 2014, there were no borrowings outstanding under such facility. During the second quarter of fiscal 2014, the Company repaid in full the remaining balance of its 2011 Term Loan.

On March 3, 2011, the Company entered into an interest rate derivative contract having an aggregate notional principal amount of $17.5 million. The derivative contract entitled the Company to receive from the counterparty the excess, if any, of the three-month LIBOR rate over 3.00% for each of the calendar quarters in the period beginning April 2012 and ending December 2015. The Company accounted for this derivative contract as a cash flow hedge. The contract was terminated in July 2013 following the retirement in full of the 2011 Term Loan. In the second quarter of fiscal 2014, as a result of the termination of the contract, the $516,000 unrealized loss on the contract previously included in AOCI was reclassified to earnings in the consolidated statement of income because the hedged forecasted transaction (interest on the 2011 Term Loan) would not occur.

22

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

The following table presents the fair values of derivative instruments included in the consolidated balance sheet as of November 2, 2014 and February 2, 2014:

		Liability Derivatives
		Fair Value
		November 2,		February 2,
Derivatives Not Designated as Hedging Instruments	Balance Sheet Location	2014		2014
		(In thousands)
Agricultural commodity futures contracts	Accrued liabilities	$	906	$	313
Gasoline commodity futures contracts	Accrued liabilities		-		-
Total		$	906	$	313

23

The effects of derivative instruments on the consolidated statement of income for the three and nine months ended November 2, 2014 and November 3, 2013 were as follows:

		Amount of Derivative Gain or (Loss) Recognized in Income
		Three Months Ended						Nine Months Ended
Derivatives Not Designated as Hedging Instruments	Location of Derivative Gain or (Loss) Recognized in Income	November 2, 2014			November 3, 2013			November 2, 2014			November 3, 2013
		(In thousands)
Agricultural commodity futures contracts	Direct operating expenses	$	(681	)	$	(53	)	$	(578	)	$	(633	)
Gasoline commodity futures contracts	Direct operating expenses		-			-			-			-
Total		$	(681	)	$	(53	)	$	(578	)	$	(633	)

		Amount of Derivative Gain or (Loss) Recognized in Income
		Three Months Ended				Nine Months Ended
Derivatives Designated as a Cash Flow Hedge	Location of Derivative Gain or (Loss) Recognized in Income	November 2, 2014		November 3, 2013		November 2, 2014		November 3, 2013
		(In thousands)
Interest rate derivative	Interest expense	$	-	$	-	$	-	$	(39	)
Interest rate derivative	Loss on retirement of debt	$	-	$	-	$	-	$	(516	)

		Amount of Derivative Gain or (Loss) Recognized in OCI
		Three Months Ended				Nine Months Ended
		November 2,		November 3,		November 2,		November 3,
Derivatives Designated as a Cash Flow Hedge	Derivative Gain or (Loss) Recognized in OCI	2014		2013		2014		2013
		(In thousands)
Interest rate derivative	Change in fair value of derivative	$	-	$	-	$	-	$	36
	Less - income tax effect		-		-		-		(14	)
			-		-		-		22
	Loss on cash flow hedge
	reclassified to net income,
	previously charged to other comprehensive income		-		-		-		516
	Less - income tax effect		-		-		-		(200	)
			-		-		-		316
	Net change in amount recognized in
	OCI	$	-	$	-	$	-	$	338

Note 13 — Acquisitions and Divestitures

Acquisition of Krispy Kreme Shops

On June 17, 2014, the Company acquired the business and operating assets of its franchisee in Birmingham, Alabama, consisting of four Krispy Kreme shops that had fiscal 2014 sales of approximately $9 million. The acquired assets also include the seller’s franchise rights for 13 counties in Alabama. The total consideration was approximately $7.5 million cash. In connection with the acquisition, the Company entered into leases with the seller for three of the shops and assumed a lease with an unrelated party on the fourth shop.

The Company recorded charges to earnings related to the acquisition of $431,000 in the quarter ended August 3, 2014, which are included in direct operating expenses. The charges include $343,000 for the settlement of the pre-existing franchise contract between the Company and the franchisee, certain terms of which were unfavorable, from the Company’s point of view, to current market terms. The charge was determined by discounting to present value as of the acquisition date the excess of royalties on the acquired business’s sales at the Company’s current prevailing royalty rates over the lower royalties otherwise payable by the former franchisee pursuant to the terminated franchise agreement. The discount rate used reflected both the time value of money and the level of risk associated with achievement of the related cash flows. The Company also expensed transaction costs related to the acquisition of $88,000.

24

The cost of the acquired business was allocated as follows:

	(In thousands)
Purchase price allocated to:
Working capital, exclusive of cash	$	(5	)
Property and equipment		710
Reacquired franchise rights associated with the Company Stores segment		3,853
Goodwill associated with the Company Stores segment		2,594
	$	7,152

Amounts allocated to reacquired franchise rights are being amortized by charges to earnings on a straight-line basis through March 2020, which was the expiration date of the terminated franchise agreement. All of the goodwill recognized in the acquisition for financial reporting purposes is expected to be deductible for income tax purposes.

The results of operations of the acquired business subsequent to the acquisition had no material effect on the Company’s consolidated results of operations. The Company’s results of operations for the three and nine months ended November 3, 2013, computed on a pro forma basis assuming the acquisition had been consummated at the beginning of those periods, would not be materially different from the Company’s historical results of operations and, accordingly, have been omitted.

In December 2013, the Company acquired the land, building and doughnut-making equipment at a facility in Illinois that had fiscal 2014 sales of approximately $3 million. The aggregate purchase price for the facility was approximately $1.6 million cash, all of which was allocated to property and equipment. The facility was being operated as a Krispy Kreme shop pursuant to a management agreement approved by the Company between the facility’s former owner and one of the Company’s franchisees. The management agreement was terminated in connection with the Company’s acquisition of the facility, and was replaced by an operating agreement between the Company and the franchisee. Pursuant to the operating agreement, the Company agreed to permit the franchisee to continue to operate the facility for its account through June 2014 in exchange for monthly rental payments, and the payment of amounts based on the facility’s sales equivalent to the amounts that would be payable to the Company if the facility were subject to a franchise agreement. The Company assumed operation of the facility for its own account in July 2014. The Company’s results of operations for the three and nine months ended November 3, 2013, computed on a pro forma basis assuming the acquisition had been consummated at the beginning of those periods, would not be materially different from the Company’s historical results of operations and, accordingly, have been omitted.

Asset Divestitures

On September 9, 2014, the Company refranchised its retail Krispy Kreme shop in Rockville, Maryland to a new franchisee for approximately $1.8 million cash. The Company Stores segment realized a gain of $1.2 million on the refranchising transaction, which is reflected in direct operating expenses in the third quarter of fiscal 2015. The refranchising included the execution of a development agreement pursuant to which the new franchisee has agreed to develop an additional 20 retail Krispy Kreme shops in Virginia, Washington, DC and Maryland over the next seven years.

In July 2013, the Company refranchised three Company-owned stores in the Dallas market to a new franchisee. The aggregate purchase price for the assets was $681,000 cash. The three stores had total sales of approximately $7 million in fiscal 2013, of which approximately 45% represented wholesale sales. The franchise agreements with the new franchisee do not include wholesale sales rights. The Company Stores segment realized a gain of $876,000 on the refranchising transaction, which was included in direct operating expenses in the second quarter of fiscal 2014. The gain includes approximately $462,000 related to the sale of equipment, and approximately $414,000 related to the reversal of accrued rent expense related to a store lease assigned to the franchisee where the Company was relieved of the primary lease obligation. The Company leased the other two stores, which the Company owned, to the franchisee. In connection with the refranchising, the Company executed a development agreement with the franchisee to develop 15 additional Krispy Kreme retail shops in the market through fiscal 2019. In October 2014, the franchisee purchased from the Company the two stores it previously leased for $2.1 million cash, which approximated the properties’ aggregate carrying value.

In February 2013, the Company refranchised three stores in the Kansas/Missouri market to a new franchisee who was a former employee of the Company; the Company closed a fourth store in the market in January 2013 in anticipation of the transaction. The aggregate purchase price of the assets was approximately $1.1 million, evidenced by a 7% promissory note payable in installments equal to 3.5% of the stores’ sales beginning in February 2013. The four stores had total sales of approximately $9 million in fiscal 2013. The Company did not record a significant gain or loss on this refranchising transaction.

25

In September 2012, the Company sold to one of its franchisees the leasehold interests and certain other assets, including rights under franchise agreements, of three Krispy Kreme stores operated by the franchisee. The Company acquired the leasehold interests and other assets related to the three stores from the franchisee in August 2006 for $2.9 million cash. After the Company’s acquisition of the assets, the franchisee continued to operate the stores for its own account pursuant to an operating agreement between the Company and the franchisee. The aggregate purchase price of the three stores and the related assets in the September 2012 transaction was approximately $3.6 million, of which approximately $360,000 was paid in cash at closing. The balance of the purchase price was evidenced by a promissory note in the approximate amount of $3.2 million, payable in monthly installments of approximately $51,000, including interest, beginning in November 2012, and a final installment of the remaining principal balance on October 1, 2017. The carrying value of the divested assets was approximately $1.9 million. Because the initial investment made by the franchisee to acquire the assets was less than the 20% minimum amount of the purchase price required by GAAP to recognize a gain on the sale, the Company deferred recognition of the $1.7 million gain, and such deferred gain was reflected as a reduction in the carrying value of the note receivable. Subsequently, the Company reported the principal and interest payments received from the franchisee as a reduction of the carrying value of the note. During the third quarter of fiscal 2014, the cumulative investment made by the franchisee to acquire the assets first exceeded the required 20% of the purchase price and, accordingly, the Company recognized the deferred gain of $1.7 million, which is reflected as a reduction in direct operating expenses of the Domestic Franchise segment for the three and nine months ended November 3, 2013. In addition, coincident with the recognition of the deferred gain, the Company recognized approximately $210,000 of interest income for interest payments received from the franchisee which initially were reported as a reduction in the carrying value of the note.

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

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

Results of Operations

The following table sets forth operating metrics for the three and nine months ended November 2, 2014 and November 3, 2013.

26

	Three Months Ended								Nine Months Ended
	November 2,				November 3,				November 2,				November 3,
	2014				2013				2014				2013
Change in Same Store Sales(on-premises sales only):
Company stores		3.3		%		4.4		%		1.0		%		9.1		%
Domestic Franchise stores		3.9		%		11.0		%		4.1		%		11.6		%
International Franchise stores		(4.1	)	%		(6.4	)	%		(3.3	)	%		(8.5	)	%
International Franchise stores, in constant dollars(1)		(2.9	)	%		(0.9	)	%		(2.5	)	%		(4.2	)	%
Change in Same Store Customer Count- Company stores
(retail sales only)		5.7		%		2.0		%		0.7		%		7.2		%
Average guest check - Company stores(retail sales only)	$	7.45			$	7.59			$	7.52			$	7.52
Wholesale Metrics(Company stores only):
Average weekly number of doors served:
Grocers/mass merchants		5,412				5,146				5,308				5,266
Convenience stores		4,625				4,503				4,641				4,496
Average weekly sales per door:
Grocers/mass merchants	$	345			$	342			$	353			$	354
Convenience stores		256				256				253				261
Systemwide Sales(in thousands):(2)
Company stores	$	81,860			$	74,227			$	239,484			$	230,241
Domestic Franchise stores		81,769				77,725				253,576				237,327
International Franchise stores		119,597				107,827				348,814				321,053
International Franchise stores, in constant dollars(3)		119,597				106,435				348,814				319,533
Average Weekly Sales Per Store(in thousands):(4) (5)
Company stores:
Factory stores:
Commissaries — wholesale	$	217.7			$	203.5			$	214.9			$	203.3
Dual-channel stores:
On-premises		39.2				36.9				38.5				37.6
Wholesale		47.6				47.8				48.7				50.0
Total		86.8				84.7				87.2				87.6
On-premises only stores		34.9				36.4				35.6				37.7
All factory stores		71.7				72.8				72.7				75.7
Satellite stores		22.0				20.8				22.1				21.5
All stores		61.5				62.0				62.6				64.3
Domestic Franchise stores:
Factory stores	$	48.5			$	49.8			$	50.6			$	52.0
Satellite stores		17.2				17.6				18.0				18.1
International Franchise stores:
Factory stores	$	40.7			$	39.4			$	40.8			$	39.8
Satellite stores		9.2				9.8				9.4				9.9

27

(1)	Represents the change in International Franchise same store sales computed by reconverting franchise store sales in each foreign currency to U.S. dollars at a constant rate of exchange for each period.
(2)	Excludes sales among Company and franchise stores.
(3)	Represents International Franchise store sales computed by reconverting International Franchise store sales for the three and nine months ended November 3, 2013 to U.S. dollars based upon the weighted average of the exchange rates prevailing in the three and nine months ended November 2, 2014.
(4)	Includes sales between Company and franchise stores.
(5)	Metrics for the three and nine months ended November 2, 2014 and November 3, 2013 include only stores open at the respective period end.

In the first quarter of fiscal 2015, the Company revised its methodology for computing its same store sales metric. Under the revised methodology, shops are included in the same store sales computation after 18 months of operation, compared to 13 months under the former methodology. The Company believes that deferring stores’ entry into the same store sales metric until week 79 results in a more meaningful measurement of comparable sales because, in most cases, substantially all of the elevated sales levels typically experienced in the initial weeks following the opening of a new Krispy Kreme shop will no longer be reflected in the metric.

All same store sales change metrics in this current report reflect the new methodology for all periods. The Company filed a Current Report on Form 8-K on May 8, 2014 providing quarterly tables showing the change in same store sales for Company, domestic franchise and international franchise shops for fiscal 2012 through fiscal 2014 calculated using the revised computational methodology and using the former methodology.

The change in “same store sales” is computed by dividing the aggregate on-premises sales (including fundraising sales) during the current year period for all stores which had been open for more than 78 consecutive weeks during the current year (but only to the extent such sales occurred in the 79^th or later week of each store’s operation) by the aggregate on-premises sales of such stores for the comparable weeks in the preceding year. Once a store has been open for at least 79 consecutive weeks, its sales are included in the computation of same store sales for all subsequent periods. In the event a store is closed temporarily (for example, for remodeling) and has no sales during one or more weeks, such store’s sales for the comparable weeks during the earlier or subsequent period are excluded from the same store sales computation. The change in same store customer count is similarly computed, but is based upon the number of retail transactions reported in the Company’s point-of-sale system.

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

Systemwide sales, a non-GAAP financial measure, include sales by both Company and franchise Krispy Kreme stores. The Company believes systemwide sales data are useful in assessing consumer demand for the Company’s products, the overall success of the Krispy Kreme brand and, ultimately, the performance of the Company. All of the Company’s royalty revenues are computed as percentages of sales made by the Company’s domestic and international franchisees, and substantially all of KK Supply Chain’s external sales of doughnut mixes and other ingredients ultimately are determined by demand for the Company’s products at franchise stores. Accordingly, sales by the Company’s franchisees have a direct effect on the Company’s royalty and KK Supply Chain revenues, and therefore on the Company’s profitability. The Company’s consolidated financial statements appearing elsewhere herein include sales by Company stores, sales to franchisees by the KK Supply Chain business segment, and royalties and fees received from franchise stores based on their sales, but exclude sales by franchise stores to their customers.

28

The following table sets forth data about the number of systemwide stores as of November 2, 2014 and November 3, 2013.

	November 2,	November 3,
	2014	2013
Number of Stores Open At Period End:
Company stores:
Factory:
Commissaries	7	7
Dual-channel stores	33	31
On-premises only stores	43	37
Satellite stores	21	19
Total Company stores	104	94
Domestic Franchise stores:
Factory stores	113	106
Satellite stores	52	49
Total Domestic Franchise stores	165	155
International Franchise stores:
Factory stores	133	123
Satellite stores	523	440
Total International Franchise stores	656	563
Total systemwide stores	925	812

29

The following table sets forth data about the number of store operating weeks for the three and nine months ended November 2, 2014 and November 3, 2013.

	Three Months Ended		Nine Months Ended
	November 2,	November 3,	November 2,	November 3,
	2014	2013	2014	2013
Store Operating Weeks:
Company stores:
Factory stores:
Commissaries	91	91	273	273
Dual-channel stores	429	403	1,246	1,281
On-premises only stores	553	464	1,589	1,330
Satellite stores	273	252	761	765
Domestic Franchise stores:(1)
Factory stores	1,451	1,352	4,261	3,979
Satellite stores	669	611	2,028	1,747
International Franchise stores:(1)
Factory stores	1,449	1,356	4,211	4,035
Satellite stores	6,519	5,560	18,535	15,927

(1)      Metrics for the three and nine months ended November 2, 2014 and November 3, 2013 include only stores open at the respective period end.

The following table sets forth the types and locations of Company stores as of November 2, 2014.

	Number of Company Stores
	Factory
State	Stores	Hot Shops	Fresh Shops	Total
Alabama	4	3	-	7
District of Columbia	-	1	-	1
Florida	6	-	-	6
Georgia	11	4	-	15
Illinois	1	-	-	1
Indiana	3	1	-	4
Kansas	2	-	-	2
Kentucky	3	1	-	4
Louisiana	1	-	-	1
Maryland	1	-	-	1
Michigan	3	-	-	3
Mississippi	1	-	-	1
Missouri	1	-	-	1
New York	-	-	1	1
North Carolina	14	4	-	18
Ohio	6	-	-	6
South Carolina	6	2	-	8
Tennessee	13	2	-	15
Virginia	6	2	-	8
West Virginia	1	-	-	1
Total	83	20	1	104

30 

Changes in the number of Company stores during the three and nine months ended November 2, 2014 and November 3, 2013 are summarized in the table below.

	Number of Company Stores
	Factory
	Stores		Hot Shops		Fresh Shops	Total
Three months ended November 2, 2014
August 3, 2014	82		20		1	103
Opened	2		-		-	2
Closed	-		-		-	-
Transferred to Domestic Franchise	(1	)	-		-	(1	)
November 2, 2014	83		20		1	104
Nine months ended November 2, 2014
February 2, 2014	76		18		1	95
Opened	5		-		-	5
Closed	-		-		-	-
Change in store type	1		(1	)	-	-
Transferred to Domestic Franchise	(1	)	-		-	(1	)
Transferred from Domestic Franchise	2		3		-	5
November 2, 2014	83		20		1	104
Three months ended November 3, 2013
August 4, 2013	72		20		1	93
Opened	2		-		-	2
Closed	-		(1	)	-	(1	)
Change in store type	1		(1	)	-	-
November 3, 2013	75		18		1	94
Nine months ended November 3, 2013
February 3, 2013	76		20		1	97
Opened	5		-		-	5
Closed	(1	)	(1	)	-	(2	)
Change in store type	1		(1	)	-	-
Transferred to Domestic Franchise	(6	)	-		-	(6	)
November 3, 2013	75		18		1	94

31

The following table sets forth the types and locations of domestic franchise stores as of November 2, 2014.

	Number of Domestic Franchise Stores
	Factory
State	Stores	Hot Shops	Fresh Shops	Total
Alabama	4	-	-	4
Arizona	2	5	-	7
Arkansas	2	-	-	2
California	15	11	3	29
Colorado	2	-	-	2
Connecticut	1	-	3	4
Delaware	1	-	-	1
Florida	12	8	1	21
Georgia	5	3	-	8
Hawaii	1	-	-	1
Idaho	1	-	-	1
Illinois	2	-	-	2
Iowa	1	-	1	2
Kansas	1	-	-	1
Louisiana	2	-	-	2
Maryland	1	-	-	1
Mississippi	3	1	-	4
Missouri	4	1	-	5
Nebraska	1	-	1	2
Nevada	3	-	2	5
New Jersey	-	1	-	1
New Mexico	1	1	1	3
North Carolina	7	1	-	8
Oklahoma	2	-	-	2
Oregon	2	-	-	2
Pennsylvania	4	3	1	8
South Carolina	7	2	-	9
Tennessee	1	-	-	1
Texas	16	2	-	18
Utah	2	-	-	2
Washington	6	-	-	6
Wisconsin	1	-	-	1
Total	113	39	13	165

32

Changes in the number of domestic franchise stores during the three and nine months ended November 2, 2014 and November 3, 2013 are summarized in the table below.

	Number of Domestic Franchise Stores
	Factory
	Stores		Hot Shops		Fresh Shops		Total
Three months ended November 2, 2014
August 3, 2014	109		38		13		160
Opened	3		1		-		4
Closed	-		-		-		-
Transferred from Company Stores	1		-		-		1
November 2, 2014	113		39		13		165
Nine months ended November 2, 2014
February 2, 2014	107		37		15		159
Opened	7		5		-		12
Closed	-		-		(2	)	(2	)
Transferred from Company Stores	1		-		-		1
Transferred to Company Stores	(2	)	(3	)	-		(5	)
November 2, 2014	113		39		13		165
Three months ended November 3, 2013
August 4, 2013	105		31		14		150
Opened	1		4		-		5
Closed	-		-		-		-
November 3, 2013	106		35		14		155
Nine months ended November 3, 2013
February 3, 2013	99		29		14		142
Opened	1		6		-		7
Closed	-		-		-		-
Transferred from Company Stores	6		-		-		6
November 3, 2013	106		35		14		155

33

The types and locations of international franchise stores as of November 2, 2014 are summarized in the table below.

	Number of International Franchise Stores
	Fiscal
	Year First	Factory
Country	Store Opened	Stores	Hot Shops	Fresh Shops	Kiosks	Total
Australia	2004	7	1	6	6	20
Bahrain	2009	1	-	1	-	2
Canada	2002	4	-	2	-	6
Colombia	2015	2	-	-	-	2
Dominican Republic	2011	1	-	3	-	4
India	2013	5	-	9	2	16
Indonesia	2007	1	-	7	7	15
Japan	2007	18	-	39	4	61
Kuwait	2007	1	-	7	6	14
Malaysia	2010	2	-	2	6	10
Mexico	2004	9	1	41	72	123
Philippines	2007	7	3	37	11	58
Puerto Rico	2009	7	-	-	-	7
Qatar	2008	1	-	-	-	1
Russia	2014	2	-	5	4	11
Saudi Arabia	2008	10	-	68	20	98
Singapore	2014	2	-	2	-	4
South Korea	2005	31	-	64	-	95
Taiwan	2014	2	-	1	1	4
Thailand	2011	3	2	7	4	16
Turkey	2010	1	-	11	9	21
United Arab Emirates	2008	2	-	9	7	18
United Kingdom	2004	14	2	27	7	50
Total		133	9	348	166	656

34

Changes in the number of international franchise stores during the three and nine months ended November 2, 2014 and November 3, 2013 are summarized in the table below.

	Number of International Franchise Stores
	Factory
	Stores		Hot Shops	Fresh Shops		Kiosks		Total
Three months ended November 2, 2014
August 3, 2014	128		9	327		157		621
Opened	7		-	23		11		41
Closed	(2	)	-	(2	)	(2	)	(6	)
November 2, 2014	133		9	348		166		656
Nine months ended November 2, 2014
February 2, 2014	125		9	296		144		574
Opened	12		-	57		25		94
Closed	(4	)	-	(5	)	(3	)	(12	)
November 2, 2014	133		9	348		166		656
Three months ended November 3, 2013
August 4, 2013	119		9	280		138		546
Opened	5		-	11		8		24
Closed	(1	)	-	(5	)	(1	)	(7	)
Change in store type	-		-	1		(1	)	-
November 3, 2013	123		9	287		144		563
Nine months ended November 3, 2013
February 3, 2013	120		9	257		123		509
Opened	9		-	38		23		70
Closed	(5	)	-	(10	)	(1	)	(16	)
Change in store type	(1	)	-	2		(1	)	-
November 3, 2013	123		9	287		144		563

Three months ended November 2, 2014 compared to three months ended November 3, 2013

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

Non-GAAP Measures

The Company has substantial net operating loss carryforwards and, accordingly, the Company’s cash payments for income taxes are not significant and are expected to remain insignificant for the foreseeable future. See “Provision for Income Taxes” below.

Management evaluates the Company’s results of operations using, among other measures, adjusted net income and adjusted earnings per share, which reflect the provision for income taxes only to the extent such taxes are currently payable in cash. In addition, management excludes from adjusted net income charges and credits that are unusual and infrequently occurring. Management believes adjusted net income and adjusted earnings per share are useful performance measures because they more closely measure the cash flows generated by the Company’s operations and the trends in those cash flows than do GAAP net income and earnings per share, and because they exclude the effects of transactions that are not indicative of the Company’s ongoing results of operations.

The following presentation of adjusted net income, the related reconciliation of adjusted net income to GAAP net income, and the presentation of adjusted earnings per share are intended to illustrate the material difference between the Company’s income tax expense and income taxes currently payable. These non-GAAP performance measures are consistent with other measurements made by management in the operation of the business which do not consider income taxes except to the extent to which those taxes currently are payable, for example, capital allocation decisions and incentive compensation measurements that are made on a pretax basis.

35

	Three Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands, except per share amounts)
Net income, as reported	$	8,106	$	6,780
Provision for deferred income taxes		3,993		4,388
Adjusted net income	$	12,099	$	11,168
Adjusted earnings per common share:
Basic	$	0.18	$	0.17
Diluted	$	0.18	$	0.16
Weighted average shares outstanding:
Basic		66,407		67,543
Diluted		68,654		71,506

Overview

Total revenues rose by 7.6% to $122.9 million for the three months ended November 2, 2014 compared to $114.2 million for the three months ended November 3, 2013. Consolidated operating income was $12.9 million compared to $11.7 million, and consolidated net income was $8.1 million compared to $6.8 million.

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

36

	Three Months Ended
	November 2,				November 3,
	2014				2013
		(Dollars in thousands)
Revenues by business segment:
Company Stores	$	82,579			$	74,886
Domestic Franchise		3,274				3,026
International Franchise		6,852				6,205
KK Supply Chain:
Total revenues		61,581				58,304
Less - intersegment sales elimination		(31,415	)			(28,190	)
External KK Supply Chain revenues		30,166				30,114
Total revenues	$	122,871			$	114,231
Segment revenues as a percentage of total revenues:
Company Stores		67.2		%		65.6		%
Domestic Franchise		2.7				2.6
International Franchise		5.6				5.4
KK Supply Chain (external sales)		24.6				26.4
		100.0		%		100.0		%
Segment operating results:
Company Stores	$	2,233			$	2,599
Domestic Franchise		1,989				3,156
International Franchise		5,048				4,449
KK Supply Chain		9,529				9,098
Total segment operating income		18,799				19,302
General and administrative expenses		(5,553	)			(5,730	)
Corporate depreciation and amortization expense		(373	)			(325	)
Impairment charges and lease termination costs		(4	)			(1,531	)
Consolidated operating income		12,869				11,716
Interest income		62				341
Interest expense		(230	)			(131	)
Equity in losses of equity method franchisee		(53	)			(61	)
Other non-operating income and (expense), net		91				29
Income before income taxes		12,739				11,894
Provision for income taxes		4,633				5,114
Consolidated net income	$	8,106			$	6,780

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

Company Stores

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

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						Percentage of Total Revenues
	Three Months Ended					Three Months Ended
	November 2,			November 3,		November 2,			November 3,
	2014			2013		2014			2013
	(In thousands)
Revenues:
On-premises sales:
Retail sales	$	37,490		$	32,733	45.4		%	43.7	%
Fundraising sales		4,902			4,473	5.9			6.0
Total on-premises sales		42,392			37,206	51.3			49.7
Wholesale sales:
Grocers/mass merchants		23,838			22,598	28.9			30.2
Convenience stores		14,704			14,246	17.8			19.0
Other wholesale		1,645			836	2.0			1.1
Total wholesale sales		40,187			37,680	48.7			50.3
Total revenues		82,579			74,886	100.0			100.0
Operating expenses:
Cost of sales:
Food, beverage and packaging		31,406			28,489	38.0			38.0
Shop labor		15,080			13,261	18.3			17.7
Delivery labor		6,309			5,930	7.6			7.9
Employee benefits		5,104			4,678	6.2			6.2
Total cost of sales		57,899			52,358	70.1			69.9
Vehicle costs(1)		4,255			4,265	5.2			5.7
Occupancy(2)		2,863			2,408	3.5			3.2
Utilities expense		1,711			1,532	2.1			2.0
Depreciation and amortization expense		2,711			2,255	3.3			3.0
Gain on refranchising		(1,247	)		-	(1.5	)		-
Other store operating expenses		7,797			4,769	9.4			6.4
Total store level costs		75,989			67,587	92.0			90.3
Store operating income		6,590			7,299	8.0			9.7
Other segment operating costs(3)		3,282			3,625	4.0			4.8
Allocated corporate overhead		1,075			1,075	1.3			1.4
Segment operating income	$	2,233		$	2,599	2.7		%	3.5	%

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

Sales at Company Stores increased 10.3% to $82.6 million in the third quarter of fiscal 2015 from $74.9 million in the third quarter of fiscal 2014.

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A reconciliation of Company Stores segment sales from the third quarter of fiscal 2014 to the third quarter of fiscal 2015 follows:

	On-Premises			Wholesale		Total
	(In thousands)
Sales for the three months ended November 3, 2013	$	37,206		$	37,680	$	74,886
Fiscal 2014 sales at closed stores		(122	)		-		(122	)
Fiscal 2014 sales at stores refranchised in fiscal 2015		(566	)		-		(566	)
Fiscal 2015 sales at stores refranchised in fiscal 2015		204			-		204
Increase in sales at established stores (open stores only)		1,141			1,264		2,405
Increase in sales at stores opened in fiscal 2014		477			-		477
Sales at stores acquired in fiscal 2015		2,059			1,243		3,302
Sales at stores opened in fiscal 2015		1,993			-		1,993
Sales for the three months ended November 2, 2014	$	42,392		$	40,187	$	82,579

On-premises sales

The following table presents on-premises sales metrics for Company stores:

	Three Months Ended
	November 2,			November 3,
	2014			2013
On-premises:
Change in same store sales		3.3	%		4.4	%
Change in same store customer count (retail sales only)		5.7	%		2.0	%
Average guest check (retail sales only)	$	7.45		$	7.59

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

	Three Months Ended
	November 2,			November 3,
	2014			2013
Change in same store sales:
Retail menu pricing	1.7		%	3.3		%
Guest check average (exclusive of the effects of menu pricing)	(3.4	)		(1.4	)
Customer count	4.9			1.8
Fundraising pricing	0.9			-
Other	(0.8	)		0.7
Total	3.3		%	4.4		%

Retail and fundraising price increases implemented in the first quarter of fiscal 2015 drove increases in same store sales of 1.7 and 0.9 percentage points, respectively, exclusive of any effects of higher pricing on unit volumes; such effects are difficult to measure reliably. On February 3, 2014, the Company implemented retail price increases affecting items comprising approximately 70% of retail sales; the average price increase on these items was approximately 3%. The Company implemented somewhat larger retail price increases approximately one year earlier. On March 3, 2014, the Company implemented a fundraising price increase of approximately 9%.

An increase in consumer incentives compared to last year more than offset the effects of higher menu pricing in the third quarter and contributed to a decline in the average guest check (exclusive of menu pricing), which reduced same store sales by 3.4 percentage points. A 5.7% increase in same store customer traffic drove a 4.9% increase in same store sales dollars in the third quarter of fiscal 2015. The Company continuously evaluates and adjusts its marketing, promotional and operational activities and techniques with the goal of increasing customer traffic in its shops, which management believes will continue to be an important factor in the profitability of the Company Stores business segment.

The Company believes that normal cannibalization effects from new stores in some markets in which the Company is opening additional stores negatively affected traffic at existing shops in those markets, which adversely affected same store customer traffic during the quarter. “Cannibalization effect” means the tendency for new stores to generate sales, at least in part, by “shifting” sales to new shops from existing shops in the same market. The Company’s goal is to increase total sales of its products and the Company’s profitability in each market it serves by adding additional Krispy Kreme shops in markets the Company believes it has not fully penetrated.

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Wholesale sales

The following table presents wholesale sales metrics for Company stores:

	Three Months Ended
	November 2,		November 3,
	2014		2013
Wholesale:
Grocers/mass merchants:
Change in average weekly number of doors	5.2	%	(8.8	)	%
Change in average weekly sales per door	0.9	%	10.0		%
Convenience stores:
Change in average weekly number of doors	2.7	%	0.8		%
Change in average weekly sales per door	-	%	3.6		%

Sales to grocers and mass merchants increased 5.5% to $23.8 million, reflecting an increase of 5.2% in the average number of doors served and a 0.9% increase in the average weekly sales per door. The door growth in the third quarter of fiscal 2015 reflects new doors at existing customers and an increase in doors resulting from the acquisition of stores in the Birmingham, Alabama market in the second quarter of fiscal 2015. Sales of packaged products comprise substantially all of the Company’s sales to grocers and mass merchants.

Sales to convenience stores increased 3.2% to $14.7 million, reflecting a 2.7% increase in the average number of doors served. The majority of the door growth in the third quarter of fiscal 2015 reflects new doors at existing customers and an increase in doors resulting from the acquisition of stores in the Birmingham, Alabama market in the second quarter of fiscal 2015. Sales of loose unpackaged products comprise approximately 80% of sales to convenience store customers, with the balance comprised of sales of packaged products.

Costs and expenses

Total cost of sales as a percentage of revenues increased by 0.2 percentage points from the third quarter of fiscal 2014 to 70.1% of revenues in the third quarter of fiscal 2015. The increase reflects, among other things, an increase in the level of consumer promotional incentives in the on-premises channel, which offset the generally positive effect of an increase in on-premises sales as a percentage of total sales. The cost of food, beverage and packaging as a percentage of sales is often greater in the wholesale distribution channel compared to the on-premises channel because average product selling prices generally are lower in the wholesale channel and because of the effect of returns in that channel.

KK Supply Chain, which sells doughnut mixes, other ingredients and supplies to Company and franchise stores, has entered into contracts to purchase all its estimated shortening, flour and sugar requirements for the remainder of fiscal 2015. The Company expects that the cost of such goods purchased from KK Supply Chain will be slightly higher in the fourth quarter of fiscal 2015 than in the third quarter.

Vehicle costs as a percentage of revenues decreased from 5.7% in the third quarter of fiscal 2014 to 5.2% in the third quarter of fiscal 2015, reflecting lower fuel costs, a reduction in mileage as a result of account rationalization, and a reduction in wholesale sales as a percentage of total Company Stores sales.

Depreciation expense increased due to construction of new stores and store refurbishments at existing stores.

During the third quarter of fiscal 2015, the Company refranchised its retail Krispy Kreme shop in Rockville, Maryland to a new franchisee as more fully described in Note 13 to the consolidated financial statements appearing elsewhere herein. The Company realized a gain of $1.2 million on the refranchising transaction.

Other store operating expenses increased to $7.8 million (9.4% of revenues) in the third quarter of fiscal 2015 from $4.8 million (6.4% of revenues) in the third quarter of fiscal 2014. The increase reflects, among other things, approximately $700,000 related to redesigned apparel distributed to both on-premises and wholesale personnel at all Company shops during the third quarter of fiscal 2015, an increase of approximately $540,000 in pre-opening costs related to new stores (a portion of which relates to stores which had not yet opened at the end of the third quarter), and higher marketing and promotional costs during the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014. Additionally, during the third quarter of fiscal 2014, the Company realized net gains of approximately $190,000 on the disposal of property and equipment, principally reflecting the disposal of a closed store, which is included in other store operating expense, compared to net losses of $95,000 on the disposal of property and equipment in the third quarter of fiscal 2015.

40 

Other segment operating costs reflect a decrease of approximately $250,000 in provisions for incentive compensation in the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014.

Many other segment operating costs are fixed or semi-fixed in nature and, accordingly, segment profit margins are sensitive to changes in sales volumes.

The Patient Protection and Affordable Care Act (the “Act”) requires large employers to offer health care benefits to all full-time employees, or face financial penalties. To avoid these penalties, the health benefits must provide a specified “minimum value” and be “affordable,” each as defined in the Act. The penalties associated with the Act, also known as the “employer mandate,” have been delayed generally from January 2014 to January 2015. In addition to the employer mandate, under the Act, most persons will be required to obtain health care insurance or face individual financial penalties, which are scheduled to increase over time.

The Company employs persons to whom the Company will be required to offer benefits that meet the minimum value and affordability standards (or pay penalties), but to whom the Company does not currently offer such benefits. In addition, the Company currently offers the required minimum value benefits to certain other employees who do not currently elect to participate in the Company’s insurance plans. Assuming the provisions of the Act are implemented as currently enacted, the number of employees covered by the Company’s health care plans is likely to increase in 2015, which would cause the Company’s health care costs to rise. The Company does not know the amount by which its costs will increase assuming the above provisions of the Act are implemented because, among other reasons, the Company does not know how many additional employees will elect to obtain health insurance benefits from the Company. In addition, certain regulatory guidance which could have an effect on the Company’s incremental costs associated with the Act either has not been issued or, if issued, has been revised. Based on information currently available to the Company, management currently estimates that its incremental cost in fiscal 2016 compared to fiscal 2015 of complying with provisions of the Act becoming effective in January 2015 will be less than $3 million based upon the Company’s number of employees as of the end of the third quarter of fiscal 2015.

Domestic Franchise

	Three Months Ended
	November 2,			November 3,
	2014			2013
	(In thousands)
Revenues:
Royalties	$	2,877		$	2,683
Development and franchise fees		130			175
Other		267			168
Total revenues		3,274			3,026
Operating expenses:
Segment operating expenses		1,197			1,401
Gain on sale of assets to a franchisee		(38	)		(1,667	)
Depreciation expense		26			36
Allocated corporate overhead		100			100
Total operating expenses		1,285			(130	)
Segment operating income	$	1,989		$	3,156

Domestic Franchise revenues increased 8.2% to $3.3 million in the third quarter of fiscal 2015. The increase reflects higher domestic royalty revenues resulting from a 5.2% increase in sales by domestic franchise stores from $78 million in the third quarter of fiscal 2014 to $82 million in the third quarter of fiscal 2015. Domestic Franchise same store sales rose 3.9% in the third quarter of fiscal 2015.

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Certain franchisees’ license agreements provide that the franchisees may develop, with the Company’s consent, additional Krispy Kreme shops within the franchise territory without payment of initial franchise or development fees. Accordingly, some shop openings by domestic franchisees do not result in the recognition of such fees.

Domestic Franchise segment operating expenses include costs to recruit new domestic franchisees, to assist in domestic store openings, and to monitor and aid in the performance of domestic franchise stores, as well as allocated corporate costs. Domestic Franchise segment operating expenses reflect a decrease of approximately $170,000 in provisions for incentive compensation in the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014.

Domestic Franchise operating expenses include a gain of $38,000 in the third quarter of fiscal 2015 and a gain of $1.7 million in the third quarter of fiscal 2014 related to the sale of assets to franchisees. In the third quarter of fiscal 2015, a franchisee exercised its option to acquire the two stores it leased from the Company in connection with the Dallas refranchising transaction in fiscal 2014 for an aggregate purchase price of $2.1 million cash; the Company realized a gain of $38,000 on the closing of the transaction. The $1.7 million gain in the third quarter of fiscal 2014 relates to the sale of leasehold interests to a franchisee that occurred in September 2012. Recognition of such gain previously was deferred because the franchisee’s initial and continuing investment was less than the 20% of the purchase price required by GAAP to permit recognition of a gain on the transaction. In the third quarter of fiscal 2014, the franchisee’s initial and continuing investment first exceeded 20% of the purchase price and, accordingly, the Company recognized the previously deferred gain. See “Asset Divestitures” in Note 13 to the consolidated financial statements appearing elsewhere herein.

Domestic franchisees opened four stores in the third quarter of fiscal 2015. As of November 2, 2014, development agreements for territories in the United States provide for the development of approximately 125 additional stores through fiscal 2022. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

International Franchise

	Three Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands)
Revenues:
Royalties	$	6,307	$	5,810
Development and franchise fees		545		395
Total revenues		6,852		6,205
Operating expenses:
Segment operating expenses		1,503		1,454
Depreciation expense		1		2
Allocated corporate overhead		300		300
Total operating expenses		1,804		1,756
Segment operating income	$	5,048	$	4,449

International Franchise royalties increased 8.6%, driven by a 10.9% increase in sales by international franchise stores from $108 million in the third quarter of fiscal 2014 to $120 million in the third quarter of fiscal 2015. Changes in the rates of exchange between the U.S. dollar and the foreign currencies in which the Company’s international franchisees do business decreased sales by international franchisees measured in U.S. dollars by approximately $1.6 million in the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014, which negatively affected international royalty revenues by approximately $95,000. Excluding the effects of exchange rates, sales by international franchisees rose 12.4%.

International Franchise same store sales, measured on a constant currency basis to eliminate the effects of changing exchange rates between foreign currencies and the U.S. dollar (“constant dollar same store sales”), fell 2.9%. The decline in International Franchise same store sales reflects, among other things, the normal cannibalization effects on initial stores in new markets of additional store openings in those markets.

Constant dollar same store sales in established markets fell 1.5% in the third quarter of fiscal 2015 and fell 4.6% in new markets. “Established markets” means countries in which the first Krispy Kreme store opened before fiscal 2007. Sales at stores in established markets comprised 54% of aggregate constant dollar same store sales for the third quarter of fiscal 2015. While the Company considers countries in which Krispy Kreme first opened before fiscal 2007 to be established markets, franchisees in those markets continue to develop their business. Of the 618 international shops currently in operation that opened since the beginning of fiscal 2007, 256 shops are in these established markets.

42

International Franchise operating expenses include costs to recruit new international franchisees, to assist in international store openings, and to monitor and aid in the performance of international franchise stores, as well as allocated corporate costs. International Franchise operating expenses reflect an increase in operating costs reflecting higher personnel and personnel-related costs and other costs to support continuing and anticipated international growth. Provisions for incentive compensation were approximately $140,000 lower in the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014. Operating expenses include a net credit in bad debt expense of approximately $170,000 in the third quarter of fiscal 2014 resulting principally from recoveries of accounts previously written-off. A net credit in bad debt expense should not be expected to occur frequently.

International franchisees opened 41 stores and closed six stores in the third quarter of fiscal 2015. As of November 2, 2014, development agreements for territories outside the United States provide for the development of approximately 325 additional stores through fiscal 2021. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

KK Supply Chain

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

					Percentage of Total Revenues
					Before Intersegment
					Sales Elimination
	Three Months Ended				Three Months Ended
	November 2,		November 3,		November 2,		November 3,
	2014		2013		2014		2013
	(In thousands)
Revenues:
Doughnut mixes	$	20,223	$	20,191	32.8	%	34.6	%
Other ingredients, packaging and supplies		37,453		33,743	60.8		57.9
Equipment		3,202		3,686	5.2		6.3
Fuel surcharge		703		684	1.1		1.2
Total revenues before intersegment sales elimination		61,581		58,304	100.0		100.0
Operating expenses:
Cost of sales:
Cost of goods produced and purchased		42,669		40,100	69.3		68.8
Loss on agricultural derivatives		681		53	1.1		0.1
Inbound freight		1,819		1,673	3.0		2.9
Total cost of sales		45,169		41,826	73.3		71.7
Distribution costs		3,775		3,521	6.1		6.0
Other segment operating costs		2,639		3,389	4.3		5.8
Depreciation expense		169		170	0.3		0.3
Allocated corporate overhead		300		300	0.5		0.5
Total operating costs		52,052		49,206	84.5		84.4
Segment operating income	$	9,529	$	9,098	15.5	%	15.6	%

Sales of doughnut mixes were flat in the third quarter of fiscal 2015 compared to the third quarter of fiscal 2014, principally resulting from slightly higher unit volumes offset by slightly lower selling prices.

Sales of other ingredients, packaging and supplies, made principally to Company and Domestic Franchise stores, rose 11.0% year-over-year in the third quarter of fiscal 2015 due to higher unit volumes and slightly higher selling prices.

43

While systemwide sales at Company and Domestic Franchise stores rose in the third quarter of fiscal 2015 compared to the third quarter of the preceding fiscal year, a greater percentage of such sales was to on-premises customers compared to wholesale customers. On-premises sales at Company and Domestic Franchise stores generate proportionately lower KK Supply Chain sales than do sales to wholesale customers.

KK Supply Chain utilizes a fuel surcharge program. Charges under the program are based upon the excess, if any, of the price of diesel fuel over a pre-established base level, with the base level generally adjusted annually.

The increase in cost of sales as a percentage of total revenue to 73.3% in the third quarter of fiscal 2015 from 71.7% in the third quarter of the preceding fiscal year principally reflects net losses on agricultural derivative positions of $681,000 in the third quarter of fiscal 2015 compared to net losses of $53,000 in the third quarter of fiscal 2014. The Company has not designated any of its derivative positions as hedges for accounting purposes and, accordingly, changes in the market value of those positions are reflected in earnings as they occur.

Other segment operating costs include segment management, purchasing, customer service and support, laboratory and quality control costs, and research and development expenses. These expenses decreased from 5.8% of revenues in the third quarter of fiscal 2014 to 4.3% of revenues in the third quarter of fiscal 2015, reflecting a decrease of approximately $280,000 in provisions for incentive compensation and a net credit in bad debt expense of approximately $120,000 in the third quarter of fiscal 2015 compared to expense of $220,000 in the third quarter of fiscal 2014. The net credit in the third quarter of fiscal 2015 principally reflects sustained improved payment performance and/or reduced credit exposure with respect to a small number of franchisees. Net credits in bad debt expense should not be expected to occur on a regular basis.

Franchisees opened 45 stores and closed six stores in the third quarter of fiscal 2015. A substantial portion of KK Supply Chain’s revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

A significant portion of franchise store sales is attributable to sales by franchisees outside the United States. The Company sells doughnut mixes, either manufactured by the Company in the United States or blended by contract mix manufacturers using concentrates supplied by the Company, to all its international franchisees. Most of these franchisees purchase substantially all other ingredients, packaging and supplies through sourcing arrangements approved by the Company. Accordingly, KK Supply Chain revenues are less correlated with sales by international franchisees than with sales by domestic franchisees, which purchase substantially all of their ingredients from KK Supply Chain. Like all international businesses, the Company and its international franchisees must address the risks of international trade, including taxes, tariffs, duties and transportation costs, which can affect the franchisees’ product costs and therefore indirectly affect the pace of development. The Company, in cooperation with its international franchisees, continually seeks to mitigate the impact of these factors. For example, the Company has developed premix and concentrate doughnut mix production models, and has been continuously pursuing alternative sourcing arrangements in various markets.

General and Administrative Expenses

General and administrative expenses consist of costs incurred in various functional areas whose activities are not associated exclusively with an individual business segment. Such costs include expenses associated with finance and accounting; internal and external financial reporting, including financial planning and analysis; internal audit; human resources; risk management; information technology; training; corporate office occupancy; public company costs; and executive management. Certain personnel and other costs in some of these functional areas (for example, some of the costs of information technology and human resources) are associated primarily with the operation of individual business segments, and are allocated to those segments as allocated corporate costs. General and administrative expenses in the consolidated statement of income are presented net of such allocated costs, which are reflected in the results of operations of the four operating segments. Such allocated costs totaled $1.8 million in the third quarter of fiscal 2015 and 2014.

General and administrative expenses decreased to $5.6 million in the third quarter of fiscal 2015 from $5.7 million in the third quarter of fiscal 2014, and as a percentage of revenues decreased to 4.5% from 5.0%.

The decrease in general and administrative expenses reflects, among other things, a decrease in provisions for incentive compensation of approximately $760,000 in the third quarter of fiscal 2015 compared to the prior year. This decrease was partially offset by an expected increase in costs related to the implementation of a new enterprise resource planning system to approximately $740,000 in the third quarter of fiscal 2015 from $410,000 in the prior year.

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Impairment Charges and Lease Termination Costs

Impairment charges and lease termination costs were $4,000 in the third quarter of fiscal 2015 compared to $1.5 million in the third quarter of fiscal 2014.

	Three Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands)
Impairment of long-lived assets	$	-	$	-
Lease termination costs		4		1,531
	$	4	$	1,531

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

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

In November 2013, a court entered a judgment against the Company in a dispute with a former landlord. The Company subsequently agreed to settle the matter, and recorded an additional lease termination charge of approximately $1.5 million in the three months ended November 3, 2013 related to such resolution.

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

From fiscal 2009 through fiscal 2013, the Company refranchised a total of 11 stores and received consideration totaling $2.5 million in connection with those transactions. During this period, the Company recorded impairment charges totaling approximately $490,000 related to such refranchisings.

In fiscal 2014 and fiscal 2015, the Company refranchised a total of seven additional shops in three transactions. The total sales price of those transactions was approximately $3.6 million, and the aggregate gain recognized related to those sales was approximately $2.1 million, of which $1.2 million was recorded in the third quarter of fiscal 2015 and is reflected as a reduction in the Company Stores segment’s operating expenses.

The Company cannot predict the likelihood of refranchising any additional stores or markets or the amount of proceeds, if any, which might be received therefrom, including the amounts which might be realized from the sale of store assets and the execution of any related franchise agreements. Asset dispositions associated with future refranchisings could result in the recognition of impairment losses on the related assets.

45

Interest Income

Interest income decreased to $62,000 in the third quarter of fiscal 2015 from $341,000 in the third quarter last year. Interest income in the third quarter last year included approximately $250,000 of previously unrecognized interest income on a note received from a franchisee as part of the consideration for its purchase of leasehold interests from the Company, of which $140,000 accrued in the first two quarters of fiscal 2014 and $70,000 accrued in fiscal 2013. See “Asset Divestitures” in Note 13 to the consolidated financial statements appearing elsewhere herein.

Interest Expense

The components of interest expense are as follows:

	Three Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands)
Letter of credit and unused revolver fees	$	40	$	41
Amortization of deferred financing costs		27		27
Other (including interest on lease obligations)		163		63
	$	230	$	131

Equity in Losses of Equity Method Franchisees

The Company recorded equity in the losses of equity method franchisees of $53,000 and $61,000 in the third quarter of fiscal 2015 and fiscal 2014, respectively. This caption represents the Company’s share of operating results of equity method franchisees which develop and operate Krispy Kreme stores.

Other Non-Operating Income and (Expense), Net

Other non-operating income and (expense), net in the third quarter of fiscal 2015 includes payments of approximately $100,000 received from an equity method franchisee in reimbursement for amounts paid by the Company in fiscal 2014 pursuant to the Company’s guarantee of the investee’s indebtedness. As more fully described in Note 4 to the consolidated financial statements appearing elsewhere herein, in November 2013, following the lender’s demand for payment of the loan, which had matured in by its terms in October 2009, the Company made a loan of approximately $1.6 million to the franchisee, the proceeds of which the franchisee used to retire the debt. Such amount was charged against an accrual for potential payments under the guarantee established several years earlier. The repayments are being reflected in income as received due to the uncertainty of their continued collection.

Provision for Income Taxes

The Company’s effective tax rate for the third quarter of fiscal 2015 was 36% compared to 43% for the third quarter of fiscal 2014.

Income tax expense for the third quarter of fiscal 2015 reflects a reduction in deferred income tax expense of approximately $315,000 (approximately 2.5% of pretax income) related to state net operating loss carryforwards as a result of taking a previously unanticipated tax position in a fiscal 2014 tax return filed during the quarter, and as a result of entering into an agreement with a state tax authority during the quarter with respect to a new filing position with respect to certain earlier years, as described in Note 3 to the consolidated financial statements appearing elsewhere herein.

The remaining decrease in the effective income tax rate in the third quarter of fiscal 2015 compared to the prior year principally reflects an increase in federal tax benefits related to foreign taxes currently payable, as more fully described in Note 3, “Income Taxes,” to the Company’s consolidated financial statements included in the 2014 Form 10-K. In the fourth quarter of fiscal 2014, the Company increased its forecast of pretax income to be earned in future periods; such change in estimate had the effect of increasing the estimated federal tax benefits of foreign income taxes. The impact of the increased federal tax benefit of foreign taxes reduced the effective tax rate in the third quarter of fiscal 2015 compared to the prior year.

46

The portion of the income tax provision representing taxes estimated to be payable currently was $640,000 and $726,000 in the third quarter of fiscal 2015 and fiscal 2014, respectively, consisting principally of foreign withholding taxes related to royalties and fees paid to the Company by international franchisees. The current provision for income taxes also reflects adjustments to accruals for uncertain tax positions, including potential interest and penalties which could result from the resolution of such uncertainties.

The Company’s estimated annual effective income tax rate on GAAP ordinary income for fiscal 2015 is 40%. The actual effective income tax rate for fiscal 2015 will be known following completion of the fourth quarter and the recording of the final provision for income taxes for fiscal 2015.

See “Results of Operations – Three months ended November 2, 2014 compared to three months ended November 3, 2013 – Non-GAAP Measures” above for non-GAAP financial information and related reconciliation to GAAP measures intended to illustrate the material difference between the Company’s income tax expense and income taxes currently payable. These non-GAAP performance measures are consistent with other measurements made by management in the operation of the business which do not consider income taxes except to the extent to which those taxes currently are payable, for example, capital allocation decisions and incentive compensation measurements that are made on a pretax basis.

Net Income

The Company reported net income of $8.1 million for the three months ended November 2, 2014 and $6.8 million for the three months ended November 3, 2013.

Nine months ended November 2, 2014 compared to nine months ended November 3, 2013

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

Non-GAAP Measures

The Company has substantial net operating loss carryforwards and, accordingly, the Company’s cash payments for income taxes are not significant and are expected to remain insignificant for the foreseeable future. See “Provision for Income Taxes” below.

Management evaluates the Company’s results of operations using, among other measures, adjusted net income and adjusted earnings per share, which reflect the provision for income taxes only to the extent such taxes are currently payable in cash. In addition, management excludes from adjusted net income charges and credits that are unusual and infrequently occurring. Management believes adjusted net income and adjusted earnings per share are useful performance measures because they more closely measure the cash flows generated by the Company’s operations and the trends in those cash flows than do GAAP net income and earnings per share, and because they exclude the effects of transactions that are not indicative of the Company’s ongoing results of operations.

In the second quarter of fiscal 2014, the Company recorded a charge of $967,000 related to the retirement of its secured credit facilities, consisting of the writeoff of unamortized deferred financing costs related to the Company’s term loan, which was retired in full, and the termination of an interest rate hedge related to the term loan. Charges of this nature are not expected to recur on a regular basis.

The following presentation of adjusted net income, the related reconciliation of adjusted net income to GAAP net income, and the presentation of adjusted earnings per share are intended to illustrate the material difference between the Company’s income tax expense and income taxes currently payable, and to facilitate comparisons of the first nine months of fiscal 2015 results with the Company’s results for the first nine months of fiscal 2014 in light of the costs incurred in connection with the retirement of the term loan. These non-GAAP performance measures are consistent with other measurements made by management in the operation of the business which do not consider income taxes except to the extent to which those taxes currently are payable, for example, capital allocation decisions and incentive compensation measurements that are made on a pretax basis.

47

	Nine Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands, except per share amounts)
Net income, as reported	$	23,514	$	19,496
Loss on retirement of debt		-		967
Provision for deferred income taxes		13,381		14,438
Adjusted net income	$	36,895	$	34,901
Adjusted earnings per common share:
Basic	$	0.56	$	0.52
Diluted	$	0.53	$	0.49
Weighted average shares outstanding:
Basic		66,313		67,274
Diluted		69,042		71,058

Overview

Total revenues rose 5.0% to $365.0 million for the nine months ended November 2, 2014 compared to $347.6 million for the nine months ended November 3, 2013. Consolidated operating income was $38.7 million compared to $37.5 million, and consolidated net income was $23.5 million compared to $19.5 million.

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

48

	Nine Months Ended
	November 2,				November 3,
	2014				2013
		(Dollars in thousands)
Revenues by business segment:
Company Stores	$	241,562			$	232,496
Domestic Franchise		10,069				8,696
International Franchise		20,967				18,707
KK Supply Chain:
Total revenues		181,396				175,316
Less - intersegment sales elimination		(89,027	)			(87,630	)
External KK Supply Chain revenues		92,369				87,686
Total revenues	$	364,967			$	347,585
Segment revenues as a percentage of total revenues:
Company Stores		66.2		%		66.9		%
Domestic Franchise		2.8				2.5
International Franchise		5.7				5.4
KK Supply Chain (external sales)		25.3				25.2
		100.0		%		100.0		%
Segment operating results:
Company Stores	$	7,910			$	9,703
Domestic Franchise		6,045				6,121
International Franchise		14,439				13,219
KK Supply Chain		30,772				28,336
Total segment operating income		59,166				57,379
General and administrative expenses		(19,337	)			(17,440	)
Corporate depreciation and amortization expense		(1,106	)			(896	)
Impairment charges and lease termination costs		(50	)			(1,543	)
Consolidated operating income		38,673				37,500
Interest income		297				472
Interest expense		(535	)			(922	)
Loss on retirement of debt		-				(967	)
Equity in losses of equity method franchisee		(171	)			(174	)
Other non-operating income and (expense), net		411				23
Income before income taxes		38,675				35,932
Provision for income taxes		15,161				16,436
Consolidated net income	$	23,514			$	19,496

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

Company Stores

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

49

							Percentage of Total Revenues
	Nine Months Ended						Nine Months Ended
	November 2,			November 3,			November 2,			November 3,
	2014			2013			2014			2013
		(In thousands)
Revenues:
On-premises sales:
Retail sales	$	109,721		$	102,331		45.4		%	44.0		%
Fundraising sales		12,577			11,809		5.2			5.1
Total on-premises sales		122,298			114,140		50.6			49.1
Wholesale sales:
Grocers/mass merchants		71,941			71,769		29.8			30.9
Convenience stores		43,697			43,784		18.1			18.8
Other wholesale		3,626			2,803		1.5			1.2
Total wholesale sales		119,264			118,356		49.4			50.9
Total revenues		241,562			232,496		100.0			100.0
Operating expenses:
Cost of sales:
Food, beverage and packaging		90,555			87,900		37.5			37.8
Shop labor		43,437			40,916		18.0			17.6
Delivery labor		18,639			18,378		7.7			7.9
Employee benefits		15,502			15,602		6.4			6.7
��        Total cost of sales		168,133			162,796		69.6			70.0
Vehicle costs(1)		12,792			12,923		5.3			5.6
Occupancy(2)		8,175			7,425		3.4			3.2
Utilities expense		4,856			4,520		2.0			1.9
Depreciation expense		7,752			6,783		3.2			2.9
Business acquisition charges		431			-		0.2			-
Gain on refranchising		(1,247	)		(876	)	(0.5	)		(0.4	)
Other store operating expenses		19,549			15,102		8.1			6.5
Total store level costs		220,441			208,673		91.3			89.8
Store operating income		21,121			23,823		8.7			10.2
Other segment operating costs(3)		9,986			10,895		4.1			4.7
Allocated corporate overhead		3,225			3,225		1.3			1.4
Segment operating income	$	7,910		$	9,703		3.3		%	4.2		%

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

Sales at Company Stores increased 3.9% to $241.6 million in the nine months ended November 2, 2014 from $232.5 million in the nine months ended November 3, 2013.

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A reconciliation of Company Stores segment sales for the nine months ended November 3, 2013 to the nine months ended November 2, 2014 follows:

	On-Premises			Wholesale			Total
	(In thousands)
Sales for the nine months ended November 3, 2013	$	114,140		$	118,356		$	232,496
Fiscal 2014 sales at closed stores		(1,408	)		(892	)		(2,300	)
Fiscal 2014 sales at stores refranchised in fiscal 2014		(2,075	)		(1,715	)		(3,790	)
Fiscal 2014 sales at stores refranchised in fiscal 2015		(1,762	)		-			(1,762	)
Fiscal 2015 sales at stores refranchised in fiscal 2015		1,407			-			1,407
Increase in sales at established stores (open stores only)		614			1,752			2,366
Increase in sales at stores opened in fiscal 2014		4,229			-			4,229
Sales at stores acquired in fiscal 2015		3,091			1,763			4,854
Sales at stores opened in fiscal 2015		4,062			-			4,062
Sales for the nine months ended November 2, 2014	$	122,298		$	119,264		$	241,562

On-premises sales

The following table presents on-premises sales metrics for Company stores:

	Nine Months Ended
	November 2,			November 3,
	2014			2013
On-premises:
Change in same store sales		1.0	%		9.1	%
Change in same store customer count (retail sales only)		0.7	%		7.2	%
Average guest check (retail sales only)	$	7.52		$	7.52

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

	Nine Months Ended
	November 2,			November 3,
	2014			2013
Change in same store sales:
Retail menu pricing	2.0		%	3.3		%
Guest check average (exclusive of the effects of menu pricing)	(1.8	)		(0.8	)
Customer count	0.6			6.3
Fundraising pricing	0.6			-
Other	(0.4	)		0.3
Total	1.0		%	9.1		%

Retail and fundraising price increases implemented in the first quarter of fiscal 2015 drove increases in same store sales of 2.0 and 0.6 percentage points, respectively, exclusive of any effects of higher pricing on unit volumes; such effects are difficult to measure reliably. On February 3, 2014, the Company implemented retail price increases affecting items comprising approximately 70% of retail sales; the average price increase on these items was approximately 3%. The Company implemented somewhat larger retail price increases approximately one year earlier. On March 3, 2014, the Company implemented a fundraising price increase of approximately 9%.

An increase in consumer incentives compared to last year partially offset the effects of higher menu pricing in the first nine months of fiscal 2015 and contributed to a decline in the average guest check (exclusive of menu pricing), which reduced same store sales by 1.8 percentage points. A 0.7% increase in same store customer traffic drove a 0.6% increase in same store sales dollars in the first nine months of fiscal 2015. The Company continuously evaluates and adjusts its marketing, promotional and operational activities and techniques with the goal of increasing customer traffic in its shops, which management believes will continue to be an important factor in the profitability of the Company Stores business segment. The Company also believes that severe and unusual weather in many of the geographic areas in which the Company’s shops are located adversely affected traffic during the first quarter of fiscal 2015.

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In addition, the Company believes that normal cannibalization effects from new stores in some markets in which the Company is opening additional stores negatively affected traffic at existing shops in those markets, which adversely affected same store customer traffic during the first nine months of fiscal 2015. The Company’s goal is to increase total sales of its products and the Company’s profitability in each market it serves by adding additional Krispy Kreme shops in markets the Company believes it has not fully penetrated.

Wholesale sales

The following table presents wholesale sales metrics for Company stores:

	Nine Months Ended
	November 2,			November 3,
	2014			2013
Wholesale:
Grocers/mass merchants:
Change in average weekly number of doors	0.8		%	(6.1	)	%
Change in average weekly sales per door	(0.3	)	%	12.0		%
Convenience stores:
Change in average weekly number of doors	3.2		%	(0.4	)	%
Change in average weekly sales per door	(3.1	)	%	5.7		%

Sales to grocers and mass merchants rose slightly in the first nine months of fiscal 2015 to $71.9 million, reflecting an 0.8% increase in the average number of doors served partially offset by a 0.3% decline in the average weekly sales per door. The slight increase in the average number of doors served in the grocery/mass merchant channel reflects growth in new doors at existing customers and an increase in doors resulting from the acquisition of stores in the Birmingham, Alabama market in the second quarter of fiscal 2015, partially offset by the refranchising of stores in the Kansas/Missouri and Dallas markets in fiscal 2014. Sales of packaged products comprise substantially all of the Company’s sales to grocers and mass merchants.

Sales to convenience stores decreased slightly in the first nine months of fiscal 2015 to $43.7 million, reflecting an increase in the average number of doors served offset by a decrease in average weekly sales per door. The majority of the door growth in the first nine months of fiscal 2015 reflects new doors at existing customers and the increase in doors resulting from the acquisition of stores in the Birmingham, Alabama market in the second quarter of fiscal 2015, partially offset by the refranchising of stores in the Kansas/Missouri and Dallas markets in fiscal 2014. Sales of loose unpackaged products comprise approximately 80% of sales to convenience store customers, with the balance comprised of sales of packaged products.

Costs and expenses

Total cost of sales as a percentage of revenues decreased by 0.4 percentage points from the first nine months of fiscal 2014 to 69.6% in the first nine months of fiscal 2015. The decrease reflects, among other things, a greater percentage of sales derived from on-premises customers compared to first nine months of fiscal 2014. The cost of food, beverage and packaging as a percentage of sales is often greater in the wholesale distribution channel compared to the on-premises channel because average product selling prices generally are lower in the wholesale channel and because of the effect of returns in that channel. This decrease was partially offset by the effects of an increase in the level of consumer promotional incentives in the on-premises channel.

KK Supply Chain, which sells doughnut mixes, other ingredients and supplies to Company and franchise stores, has entered into contracts to purchase all its estimated shortening, flour and sugar requirements for the remainder of fiscal 2015. The Company expects that the cost of such goods purchased from KK Supply Chain will be slightly higher in the fourth quarter of fiscal 2015 than in the third quarter.

The Company is self-insured for workers’ compensation, vehicle and general liability claims, but maintains stop-loss coverage for individual claims exceeding certain amounts. The Company provides for claims under these self-insured programs using actuarial methods as described in the 2014 Form 10-K, and periodically updates actuarial valuations of its self-insurance reserves. Such periodic actuarial valuations result in changes over time in the estimated amounts which ultimately will be paid for claims under these programs to reflect the Company’s actual claims experience for each policy year as well as trends in claims experience over multiple years. Such claims, particularly workers’ compensation claims, often are paid over a number of years following the year in which the insured events occur, and the estimated ultimate cost of each year’s claims accordingly is adjusted over time as additional information becomes available. As a result of the Company’s periodic update of its actuarial valuation, the Company recorded favorable adjustments to its self-insurance claims liabilities related to prior policy years of approximately $780,000 in the second quarter of fiscal 2015 and $550,000 in the second quarter of fiscal 2014. The $780,000 favorable adjustment recorded in the second quarter of fiscal 2015 includes a favorable adjustment relating to workers’ compensation liability claims of approximately $630,000 included in employee benefits, a favorable adjustment relating to vehicle liability claims of approximately $90,000 included in vehicle costs, and a favorable adjustment relating to general liability claims of approximately $60,000 included in other operating costs. The $550,000 favorable adjustment recorded in the second quarter of fiscal 2014 includes a favorable adjustment relating to workers’ compensation liability claims of approximately $390,000, a favorable adjustment relating to vehicle liability claims of approximately $50,000, and a favorable adjustment relating to general liability claims of approximately $110,000.

52

Depreciation expense increased due to construction of new stores and store refurbishments at existing stores.

During the second quarter of fiscal 2015, the Company recorded charges of $431,000 related to the acquisition of the business and operating assets of its franchisee in Birmingham, Alabama as more fully described in Note 13 to the consolidated financial statements included elsewhere herein. The charges include $343,000 for the settlement as part of the acquisition of the pre-existing franchise contract between the Company and the franchisee, certain terms of which were unfavorable, from the Company’s point of view, to current market terms, and transaction costs related to the acquisition of $88,000.

During the third quarter of fiscal 2015, the Company refranchised its retail Krispy Kreme shop in Rockville, Maryland to a new franchisee as more fully described in Note 13 to the consolidated financial statements appearing elsewhere herein. The Company realized a gain of $1.2 million on the refranchising transaction.

During the second quarter of fiscal 2014, the Company refranchised three stores in the Dallas market to a new franchisee as more fully described in Note 13 to the consolidated financial statements appearing elsewhere herein. The Company realized a gain of $876,000 on the refranchising transaction.

Other store operating expenses increased to $19.5 million (8.1% of revenues) in the first nine months of fiscal 2015 from $15.1 million (6.5% of revenues) in the first nine months of fiscal 2014. The increase reflects, among other things, approximately $700,000 related to redesigned apparel distributed to both on-premises and wholesale personnel at all Company shops during the third quarter of fiscal 2015, an increase of approximately $770,000 in pre-opening costs related to new stores (a portion of which relates to stores which had not yet opened at the end of the third quarter), and higher marketing and promotional costs. Additionally, during the first nine months of fiscal 2014, the Company realized net gains of approximately $230,000 on the disposal of property and equipment, principally reflecting the disposal of a closed store, which is included in other store operating expense, compared to net losses of $190,000 on the disposal of property and equipment in the first nine months of fiscal 2015.

Other segment operating costs in the first nine months of fiscal 2014 included approximately $770,000 in legal costs related to the litigation associated with the Company’s former landlord in Lorton, Virginia. In addition, other segment operating costs reflect a decrease of approximately $550,000 in provisions for incentive compensation in the first nine months of fiscal 2015 compared to the first nine months of fiscal 2014.

Many store level operating costs are fixed or semi-fixed in nature and, accordingly, store profit margins are sensitive to changes in sales volumes.

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Domestic Franchise

	Nine Months Ended
	November 2,			November 3,
	2014			2013
	(In thousands)
Revenues:
Royalties	$	8,930		$	8,093
Development and franchise fees		425			200
Other		714			403
Total revenues		10,069			8,696
Operating expenses:
Segment operating expenses		3,641			3,870
Gain on sale of assets to a franchisee		(38	)		(1,667	)
Depreciation expense		121			72
Allocated corporate overhead		300			300
Total operating expenses		4,024			2,575
Segment operating income	$	6,045		$	6,121

Domestic Franchise revenues increased 15.8% to $10.1 million in the first nine months of fiscal 2015. The increase reflects higher domestic royalty revenues resulting from a 6.8% increase in sales by domestic franchise stores from approximately $237 million in the first nine months of fiscal 2014 to $254 million in the first nine months of fiscal 2015, as well as higher development and franchise fees resulting from an increase in store openings. Domestic Franchise same store sales rose 4.1% in the first nine months of fiscal 2015.

Certain franchisees’ license agreements provide that the franchisees may develop, with the Company’s consent, additional Krispy Kreme shops within the franchise territory without payment of initial franchise or development fees. Accordingly, some shop openings by domestic franchisees do not result in the recognition of such fees.

The increase in other revenues reflects rental income charged to two franchisees for stores leased or subleased to the franchisees in connection with the Kansas/Missouri and Dallas refranchising transactions in the first and second quarters of fiscal 2014, respectively, and rental income charged to another franchisee in connection with the Company’s acquisition of the land, building and doughnut-making equipment at a facility in Illinois in December 2013 as more fully described in Note 13 to the consolidated financial statements appearing elsewhere herein. The Company assumed operation of the Illinois facility for its own account in July 2014. The Company’s Dallas franchisee exercised its option to purchase the two stores leased to it by the Company during the third quarter of fiscal 2015 as described below.

Domestic Franchise segment operating expenses include costs to recruit new domestic franchisees, to assist in domestic store openings, and to monitor and aid in the performance of domestic franchise stores, as well as allocated corporate costs. Domestic Franchise segment operating expenses reflect a decrease of approximately $330,000 in provisions for incentive compensation in the first nine months of fiscal 2015 compared to the first nine months of fiscal 2014.

Domestic Franchise operating expenses include a gain of $38,000 in the first nine months of fiscal 2015 and a gain of $1.7 million in the first nine months of fiscal 2014 related to the sale of assets to franchisees. In the third quarter of fiscal 2015, a franchisee exercised its option to acquire the two stores it leased from the Company in connection with the Dallas refranchising transaction in fiscal 2014 for an aggregate purchase price of $2.1 million cash; the Company realized a gain of $38,000 on the closing of the transaction. The $1.7 million gain in the third quarter of fiscal 2014 relates to the sale of leasehold interests to a franchisee that occurred in September 2012. Recognition of such gain previously was deferred because the franchisee’s initial and continuing investment was less than the 20% of the purchase price required by GAAP to permit recognition of a gain on the transaction. In the third quarter of fiscal 2014, the franchisee’s initial and continuing investment first exceeded 20% of the purchase price and, accordingly, the Company recognized the previously deferred gain. See “Asset Divestitures” in Note 13 to the consolidated financial statements appearing elsewhere herein.

Domestic franchisees opened 12 stores and closed two in the first nine months of fiscal 2015. As of November 2, 2014, development agreements for territories in the United States provide for the development of approximately 125 additional stores through fiscal 2022. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

54

International Franchise

	Nine Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands)
Revenues:
Royalties	$	19,599	$	17,672
Development and franchise fees		1,368		1,035
Total revenues		20,967		18,707
Operating expenses:
Segment operating expenses		5,624		4,582
Depreciation expense		4		6
Allocated corporate overhead		900		900
Total operating expenses		6,528		5,488
Segment operating income	$	14,439	$	13,219

International Franchise royalties increased 10.9%, driven by an 8.6% increase in sales by international franchise stores from $321 million in the first nine months of fiscal 2014 to $349 million in the first nine months of fiscal 2015. Changes in the rates of exchange between the U.S. dollar and the foreign currencies in which the Company’s international franchisees do business decreased sales by international franchisees measured in U.S. dollars by approximately $1.7 million in the first nine months of fiscal 2015 compared to the first nine months of fiscal 2014, which negatively affected international royalty revenues by approximately $100,000. Excluding the effects of exchange rates, sales by international franchisees rose 9.2%. The Company recognized royalty revenue of approximately $900,000 and $370,000 collected during the first nine months of fiscal 2015 and 2014, respectively, related to franchisee sales in prior periods which had not previously been recorded as revenue due to the uncertainty surrounding the collection of these royalties. Substantially all of the amounts relate to a single franchisee and were received in the second quarter. There is no prescribed repayment schedule for the remaining $1.9 million owed to the Company by the franchisee and the Company therefore cannot predict the amount or timing of future payments, if any, on this obligation. Accordingly, the Company has not recognized such amount in the financial statements.

International Franchise same store sales, measured on a constant currency basis to eliminate the effects of changing exchange rates between foreign currencies and the U.S. dollar (“constant dollar same store sales”), fell 2.5%. The decline in International Franchise same store sales reflects, among other things, the normal cannibalization effects on initial stores in new markets of additional store openings in those markets.

Constant dollar same store sales in established markets fell 0.5% in the first nine months of fiscal 2015 and fell 4.7% in new markets. “Established markets” means countries in which the first Krispy Kreme store opened before fiscal 2007. Sales at stores in established markets comprised 53% of aggregate constant dollar same store sales for the first nine months of fiscal 2015. While the Company considers countries in which Krispy Kreme first opened before fiscal 2007 to be established markets, franchisees in those markets continue to develop their business. Of the 618 international shops currently in operation that opened since the beginning of fiscal 2007, 256 shops are in these established markets.

International Franchise operating expenses include costs to recruit new international franchisees, to assist in international store openings, and to monitor and aid in the performance of international franchise stores, as well as allocated corporate costs. International Franchise operating expenses increased in the first nine months of fiscal 2015 to $5.6 million compared to $4.6 million in the first nine months of fiscal 2014, principally reflecting higher personnel and personnel-related costs and other costs to support continuing and anticipated international growth. Operating expenses in the first nine months of fiscal 2015 include a provision for potential uncollectible accounts of approximately $130,000 related to a single franchisee, compared to a net credit in bad debt expense of approximately $165,000 in the first nine months of fiscal 2014 resulting principally from recoveries of accounts previously written-off. A net credit in bad debt expense should not be expected to recur frequently. These increases were partially offset by a decrease of approximately $230,000 in provisions for incentive compensation in the first nine months of fiscal 2015 compared to the first nine months of fiscal 2014.

International franchisees opened 94 stores and closed 12 stores in the first nine months of fiscal 2015. As of November 2, 2014, development agreements for territories outside the United States provide for the development of approximately 325 additional stores through fiscal 2021. Royalty revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

55

KK Supply Chain

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

					Percentage of Total Revenues
					Before Intersegment
					Sales Elimination
	Nine Months Ended				Nine Months Ended
	November 2,		November 3,		November 2,		November 3,
	2014		2013		2014		2013
	(In thousands)
Revenues:
Doughnut mixes	$	62,516	$	61,536	34.5	%	35.1	%
Other ingredients, packaging and supplies		107,972		102,714	59.5		58.6
Equipment		8,734		8,886	4.8		5.1
Fuel surcharge		2,174		2,180	1.2		1.2
Total revenues before intersegment sales elimination		181,396		175,316	100.0		100.0
Operating expenses:
Cost of sales:
Cost of goods produced and purchased		123,278		119,868	68.0		68.4
Loss on agricultural derivatives		578		633	0.3		0.4
Inbound freight		5,303		4,909	2.9		2.8
Total cost of sales		129,159		125,410	71.2		71.5
Distribution costs		11,227		10,922	6.2		6.2
Other segment operating costs		8,835		9,233	4.9		5.3
Depreciation expense		503		515	0.3		0.3
Allocated corporate overhead		900		900	0.5		0.5
Total operating costs		150,624		146,980	83.0		83.8
Segment operating income	$	30,772	$	28,336	17.0	%	16.2	%

Sales of doughnut mixes increased 1.6% year-over-year in the first nine months of fiscal 2015, principally due to higher unit volumes partially offset by slightly lower selling prices.

Sales of other ingredients, packaging and supplies, made principally to Company and Domestic Franchise stores, rose 5.1% year-over-year in the first nine months of fiscal 2015 due to higher unit volumes partially offset by slightly lower selling prices.

While systemwide sales at Company and Domestic Franchise stores rose in the first nine months of fiscal 2015 compared to the first nine months of the preceding fiscal year, a greater percentage of such sales was to on-premises customers compared to wholesale customers. On-premises sales at Company and Domestic Franchise stores generate proportionately lower KK Supply Chain sales than do sales to wholesale customers.

KK Supply Chain utilizes a fuel surcharge program. Charges under the program are based upon the excess, if any, of the price of diesel fuel over a pre-established base level, with the base level generally adjusted annually.

Other segment operating costs include segment management, purchasing, customer service and support, laboratory and quality control costs, and research and development expenses. KK Supply operating expenses decreased from 5.3% of revenues in the first nine months of fiscal 2014 to 4.9% of revenues in the first nine months of fiscal 2015. Provisions for incentive compensation were approximately $600,000 lower in the first nine months of fiscal 2015 compared to the prior year. In addition, other segment operating costs reflect a net credit in bad debt expense of approximately $160,000 in the first nine months of fiscal 2015 compared to expense of $190,000 in the first nine months of fiscal 2014. The net credit in the first nine months of fiscal 2015 principally reflects sustained improved payment performance and/or reduced credit exposure with respect to a small number of franchisees. Net credits in bad debt expense should not be expected to occur on a regular basis.

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Franchisees opened 106 stores and closed 14 stores in the first nine months of fiscal 2015. A substantial portion of KK Supply Chain’s revenues are directly related to sales by franchise stores and, accordingly, the success of franchisees’ operations has a direct effect on the Company’s revenues, results of operations and cash flows.

A significant portion of franchise store sales is attributable to sales by franchisees outside the United States. The Company sells doughnut mixes, either manufactured by the Company in the United States or blended by contract mix manufacturers using concentrates supplied by the Company, to all its international franchisees. Most of these franchisees purchase substantially all other ingredients, packaging and supplies through sourcing arrangements approved by the Company. Accordingly, KK Supply Chain revenues are less correlated with sales by international franchisees than with sales by domestic franchisees, which purchase substantially all of their ingredients from KK Supply Chain. Like all international businesses, the Company and its international franchisees must address the risks of international trade, including taxes, tariffs, duties and transportation costs, which can affect the franchisees’ product costs and therefore indirectly affect the pace of development. The Company, in cooperation with its international franchisees, continually seeks to mitigate the impact of these factors. For example, the Company has developed premix and concentrate doughnut mix production models, and has been continuously pursuing alternative sourcing arrangements in various markets.

General and Administrative Expenses

General and administrative expenses consist of costs incurred in various functional areas whose activities are not associated exclusively with an individual business segment. Such costs include expenses associated with finance and accounting; internal and external financial reporting, including financial planning and analysis; internal audit; human resources; risk management; information technology; training; corporate office occupancy; public company costs; and executive management. Certain personnel and other costs in some of these functional areas (for example, some of the costs of information technology and human resources) are associated primarily with the operation of individual business segments, and are allocated to those segments as allocated corporate costs. General and administrative expenses in the consolidated statement of income are presented net of such allocated costs, which are reflected in the results of operations of the four operating segments. Such allocated costs totaled $5.3 million in first nine months of fiscal 2015 and 2014.

General and administrative expenses increased to $19.3 million in the first nine months of fiscal 2015 from $17.4 million in the first nine months of fiscal 2014, and as a percentage of revenues increased to 5.3% from 5.0%.

General and administrative expenses include incremental costs of approximately $2.1 million and $420,000 in the first nine months of fiscal 2015 and fiscal 2014, respectively, related to the implementation of a new enterprise resource planning system. The increase in general and administrative expenses in the first nine months of fiscal 2015 also reflects an increase in executive compensation costs related to the transition to a new chief executive officer, partially offset by a decrease in provisions for incentive compensation of approximately $1.4 million in the first nine months of fiscal 2015 compared to the first nine months of fiscal 2014.

Impairment Charges and Lease Termination Costs

Impairment charges and lease termination costs were $50,000 and $1.5 million the first nine months of fiscal 2015 and fiscal 2014, respectively.

	Nine Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands)
Impairment of long-lived assets	$	-	$	-
Lease termination costs		50		1,543
	$	50	$	1,543

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

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

In November 2013, a court entered a judgment against the Company in a dispute with a former landlord. The Company subsequently agreed to settle the matter, and recorded an additional lease termination charge of approximately $1.5 million in the nine months ended November 3, 2013 related to such resolution.

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

From fiscal 2009 through fiscal 2013, the Company refranchised a total of 11 stores and received consideration totaling $2.5 million in connection with those transactions. During this period, the Company recorded impairment charges totaling approximately $490,000 related to such refranchisings.

In fiscal 2014 and fiscal 2015, the Company refranchised a total of seven additional shops in three transactions. The total sales price of those transactions was approximately $3.6 million, and the aggregate gain recognized related to those sales was approximately $2.1 million, of which $1.2 million was recorded in the third quarter of fiscal 2015 and is reflected as a reduction in the Company Stores segment’s operating expenses.

The Company cannot predict the likelihood of refranchising any additional stores or markets or the amount of proceeds, if any, which might be received therefrom, including the amounts which might be realized from the sale of store assets and the execution of any related franchise agreements. Asset dispositions associated with future refranchisings could result in the recognition of impairment losses on the related assets.

Interest Income

Interest income decreased to $297,000 in the first nine months of fiscal 2015 from $472,000 in the first nine months of fiscal 2014. Interest income in the first nine months of fiscal 2014 included $250,000 of previously unrecognized interest income on a note received from a franchisee as part of the consideration for its purchase of leasehold interests from the Company, of which $70,000 accrued in fiscal 2013. See “Asset Divestitures” in Note 13 to the consolidated financial statements appearing elsewhere herein. In addition, interest income includes $75,000 and $50,000 received in the first nine months of fiscal 2015 and fiscal 2014, respectively, from notes receivable from equity method franchisees, Kremeworks and Kremeworks Canada, which are fully reserved or which were written off in earlier years (see Note 6).

Interest Expense

The components of interest expense are as follows:

	Nine Months Ended
	November 2,		November 3,
	2014		2013
	(In thousands)
Interest accruing on outstanding term loan indebtedness	$	-	$	259
Letter of credit and unused revolver fees		121		176
Amortization of cost of interest rate derivatives		-		39
Amortization of deferred financing costs		81		258
Other (including interest on lease obligations)		333		190
	$	535	$	922

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On July 12, 2013, the Company retired its secured credit facilities and repaid the $21.7 million remaining balance of its term loan as described in Note 7 to the consolidated financial statements appearing elsewhere herein.

Loss on Retirement of Debt

The Company recorded a charge of $967,000 in the first nine months of fiscal 2014 on the retirement of its secured credit facilities, consisting of a $451,000 write-off of unamortized deferred financing costs related principally to the Company’s term loan, which was retired in full, and a $516,000 write-off related to the termination of an interest rate hedge related to the term loan. The $516,000 charge related to the interest rate hedge was reclassified from accumulated other comprehensive income to “Loss on retirement of debt” in the consolidated statement of income because the hedged forecasted transaction (interest on the term loan) would not occur.

Equity in Losses of Equity Method Franchisees

The Company recorded equity in the losses of equity method franchisees of $171,000 and $174,000 in the first nine months of fiscal 2015 and fiscal 2014, respectively. This caption represents the Company’s share of operating results of equity method franchisees which develop and operate Krispy Kreme stores.

Other Non-Operating Income and (Expense), Net

Other non-operating income and (expense), net in the first nine months of fiscal 2015 includes payments of approximately $420,000 received from an equity method franchisee in reimbursement for amounts paid by the Company in fiscal 2014 pursuant to the Company’s guarantee of the investee’s indebtedness. As more fully described in Note 4 to the consolidated financial statements appearing elsewhere herein, in November 2013, following the lender’s demand for payment of the loan, which had matured in by its terms in October 2009, the Company made a loan of approximately $1.6 million to the franchisee, the proceeds of which the franchisee used to retire the debt. Such amount was charged against an accrual for potential payments under the guarantee established several years earlier. The repayments are being reflected in income as received due to the uncertainty of their continued collection.

Provision for Income Taxes

The Company’s effective tax rate for the first nine months of fiscal 2015 was 39% compared to 46% for the first nine months of fiscal 2014.

Income tax expense in the first nine months of fiscal 2015 reflects a reduction in deferred income tax expense of approximately $315,000 (approximately 0.8% of pretax income) related to state net operating loss carryforwards as a result of taking a previously unanticipated tax position in a fiscal 2014 tax return filed during the quarter, and as a result of entering into an agreement with a state tax authority during the quarter with respect to a new filing position with respect to certain earlier years as described in Note 3 to the consolidated financial statements appearing elsewhere herein.

The decrease in the effective income tax rate in the first nine months of fiscal 2015 compared to the prior year also reflects an increase in federal tax benefits related to foreign taxes currently payable, as more fully described in Note 3, “Income Taxes,” to the Company’s consolidated financial statements included in the 2014 Form 10-K. In the fourth quarter of fiscal 2014, the Company increased its forecast of pretax income to be earned in future periods; such change in estimate had the effect of increasing the estimated federal tax benefit of foreign income taxes. The impact of the increased federal tax benefit of foreign taxes reduced the effective tax rate in the first nine months of fiscal 2015 compared to the prior year.

In the first nine months of fiscal 2014, income tax expense includes a charge of approximately $686,000 (approximately 1.9% of pretax income) to revalue the Company’s deferred income tax assets to reflect a reduction in the North Carolina corporate income tax rate enacted by the North Carolina state legislature during the second quarter of 2014, as described in Note 3 to the consolidated financial statements appearing elsewhere herein.The provision for income taxes for the nine months ended November 3, 2013 alsoincludes a charge of approximately $575,000 (2.4% of pretax income) to correct an error in accruals for uncertain tax positions that originated in the fourth quarter of fiscal 2012. The error and its correction were not material to the results of any period; accordingly, the error was corrected in the first quarter of fiscal 2014 and prior financial statements were not restated.

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The portion of the income tax provision representing taxes estimated to be payable currently was $1.8 million and $2.0 million in the first nine months of fiscal 2015 and fiscal 2014, respectively, consisting principally of foreign withholding taxes related to royalties and fees paid to the Company by international franchisees. The current provision for income taxes also reflects adjustments to accruals for uncertain tax positions, including potential interest and penalties which could result from the resolution of such uncertainties.

The Company’s estimated annual effective income tax rate on GAAP ordinary income for fiscal 2015 is 40%. The actual effective tax rate for fiscal 2015 will be known following completion of the fourth quarter and the recording of the final provision for income taxes for fiscal 2015.

See “Results of Operations – Nine months ended November 2, 2014 compared to nine months ended November 3, 2013 – Non-GAAP Measures” above for non-GAAP financial information and related reconciliation to GAAP measures intended to illustrate the material difference between the Company’s income tax expense and income taxes currently payable. These non-GAAP performance measures are consistent with other measurements made by management in the operation of the business which do not consider income taxes except to the extent to which those taxes currently are payable, for example, capital allocation decisions and incentive compensation measurements that are made on a pretax basis.

Net Income

The Company reported net income of $23.5 million for the nine months ended November 2, 2014 and $19.5 million for the nine months ended November 3, 2013.

LIQUIDITY AND CAPITAL RESOURCES

The following table summarizes the Company’s cash flows from operating, investing and financing activities for the first nine months of fiscal 2015 and fiscal 2014.

	Nine Months Ended
	November 3, 2013			November 2, 2014
	(In thousands)
Net cash provided by operating activities	$	45,718		$	41,011
Net cash used for investing activities		(23,753	)		(15,422	)
Net cash used for financing activities		(33,242	)		(25,176	)
Net increase (decrease) in cash and cash equivalents	$	(11,277	)	$	413

Cash Flows from Operating Activities

Net cash provided by operating activities increased $4.7 million in the first nine months of fiscal 2015 from the comparable fiscal 2014 period, reflecting improved financial performance and generally consistent with the increase in net income. The increase in inventory in the first nine months of last year reflects an increase in equipment inventory levels to support an increased number of new shops in operation by the Company and its franchisees. In addition, in the first nine months of fiscal 2014, the Company recovered a cash deposit of $2.0 million related to the lease of its corporate headquarters; such recovery is reflected in the increase in other current and non-current assets in fiscal 2014. In the third quarter of fiscal 2014, the Company also paid a guarantee obligation of $1.6 million related to an Equity Method Franchisee, as described in Note 4 to the consolidated financial statements appearing elsewhere herein; such payment is reflected in the decrease in accounts payable and accrued liabilities for the nine months ended November 3, 2013. The remainder of the change in cash flows from operating activities principally reflects normal fluctuations in the timing of routine cash receipts and disbursements.

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Cash Flows from Investing Activities

Cash used for capital expenditures increased to $21.3 million in the first nine months of fiscal 2015 from $18.1 million in the first nine months of fiscal 2014. The components of capital expenditures were approximately as follows:

	Nine Months Ended
	November 2,			November 3,
	2014			2013
	(In thousands)
New store construction	$	14,628		$	7,542
Store remodels and betterments		3,319			3,119
Capital leases on stores acquired		1,052			-
Other store equipment, including vehicles and point-of-sale and handheld equipment		2,127			3,273
Corporate office remodel		11			1,696
Corporate information technology		4,765			3,291
Other		1,363			487
Total capital expenditures		27,265			19,408
Assets acquired under leasing arrangements		(6,919	)		(803	)
Net change in unpaid capital expenditures included in accounts payable
and accrued liabilities		908			(516	)
Cash used for capital expenditures	$	21,254		$	18,089

The Company currently expects capital expenditures (including assets acquired using capital leases) to range from $30 million to $35 million in fiscal 2015. The Company intends to fund these capital expenditures from cash provided by operating activities, from existing cash balances and, to a lesser extent, through leases.

For the nine months ended November 2, 2014, proceeds from the disposal of property and equipment include approximately $2.1 million of proceeds from the sale of two stores to a franchisee that it previously leased from the Company, as more fully described in Note 13 to the consolidated financial statements appearing elsewhere herein. In addition, the Company refranchised its retail Krispy Kreme shop in Rockville, Maryland to a new franchisee. The aggregate purchase price for the assets was $1.8 million cash, as more fully described in Note 13.

In June 2014, the Company acquired the business and operating assets of its franchisee in Birmingham, Alabama, consisting of four Krispy Kreme shops in exchange for $7.2 million cash, as more fully described in Note 13 to the consolidated financial statements appearing elsewhere herein.

For the nine months ended November 3, 2013, proceeds from the disposal of property and equipment include approximately $1.0 million of proceeds from the disposal of a closed store. In addition, the Company refranchised three Company-owned stores in the Dallas market to a new franchisee. The aggregate purchase price for the assets was $681,000 cash, as more fully described in Note 13 to the consolidated financial statements appearing elsewhere herein.

Cash Flows from Financing Activities

Net cash used by financing activities was $33.2 million in the first nine months of fiscal 2015 compared to $25.2 million in the first nine months of fiscal 2014.

During the first nine months of fiscal 2014, the Company repaid approximately $24.5 million of outstanding term loan and capitalized lease indebtedness. The Company repaid the $21.7 million remaining outstanding balance of its term loan in connection with the retirement of its credit facilities described in Note 7 in the consolidated financial statements appearing elsewhere herein. Additional payments included approximately $1.2 million of scheduled principal amortization, $930,000 of prepayments from the sale of assets, and $730,000 of prepayments from the proceeds from the exercise of stock options.

On July 11, 2013, the Company’s Board of Directors authorized the repurchase of up to $50 million of the Company's common stock and subsequently twice increased such repurchase authorization such that it now totals $105 million. Through November 2, 2014, the Company repurchased 3,422,000 shares under the authorization at an average price of $17.99 per share, for a total cost of $61.6 million. During the nine months ended November 2, 2014, the Company repurchased 2,237,000 shares under the authorization at an average price of $17.54 per share, for a total cost of $39.2 million. Repurchases of approximately $41.1 million of the share repurchases were settled during the nine months ended November 2, 2014. The Company repurchased 33,000 shares of the Company’s common stock during the first nine months of fiscal 2014 at an average cost of $18.88 per share, for a total cost of $627,000.

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Repurchase of common shares also includes $1.8 million and $2.0 million, respectively, for the first nine months of fiscal 2015 and fiscal 2014, for shares surrendered by employees to satisfy their obligations to reimburse the Company for the minimum required statutory withholding taxes arising from the vesting of restricted stock awards by surrendering vested common shares in lieu of reimbursing the Company in cash.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

There have been no material changes from the disclosures in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in the 2014 Form 10-K.

Item 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

As of November 2, 2014, the end of the period covered by this Quarterly Report on Form 10-Q, management performed, under the supervision and with the participation of the Company’s chief executive officer and chief financial officer, an evaluation of the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Company’s chief executive officer and chief financial officer, to allow timely decisions regarding required disclosures. Based on this evaluation, the Company’s chief executive officer and chief financial officer have concluded that, as of November 2, 2014, the Company’s disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

During the quarter ended November 2, 2014, there were no changes in the Company’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS.

Pending Matters

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

K² Asia Litigation

On April 7, 2009, a Cayman Islands corporation, K² Asia Ventures, and its owners filed a lawsuit in Forsyth County, North Carolina Superior Court against the Company, its franchisee in the Philippines, and other persons associated with the franchisee. The suit alleges that the Company and the other defendants conspired to deprive the plaintiffs of claimed “exclusive rights” to negotiate franchise and development agreements with prospective franchisees in the Philippines, and seeks unspecified damages. The Company believes that these allegations are false and intends to vigorously defend against the lawsuit. On July 26, 2013, the Superior Court dismissed the Philippines-based defendants for lack of personal jurisdiction. The plaintiffs appealed that decision and the Court of Appeals affirmed that decision on August 19, 2014.

Item 1A. RISK FACTORS.

There have been no material changes from the risk factors disclosed in Part I, Item 1A, “Risk Factors,” in the 2014 Form 10-K.

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

				Total Number of	Maximum Number (or
				Shares (or units)	Approximate Dollar
				Purchased as Part	Value) of Shares (or
	Total Number of			of Publicly	Units) that May Yet Be
	Shares (or units)	Average Price Paid		Announced Plans	Purchased Under the
	Purchased	per Share (or unit)		or Programs	Plans or Programs
Period	(a)(1)	(b)		(c)	(d)
August 4, 2014 through August 31, 2014	-	$	-	-	$	50,218,298
September 1, 2014 through September 28, 2014	86,523		17.29	86,523		48,722,533
September 29, 2014 through November 2, 2014	309,721		17.08	309,721		43,432,515
Total	396,244	$	17.13	396,244

(1) On July 11, 2013, the Company’s Board of Directors authorized the repurchase of up to $50 million of the Company's common stock and subsequently increased such repurchase authorization on March 12, 2014 and on September 17, 2014, such that it now totals $105 million in the third quarter of fiscal 2015. The authorization has no expiration date. Through November 2, 2014, the Company had repurchased a total of approximately 3,422,000 shares under the repurchase authorization at an average price of $17.99 per share, for a total cost of approximately $61.6 million. During the three months ended November 2, 2014, the Company repurchased 396,244 shares under the authorization at an average price of $17.13 per share, for a total cost of approximately $6.8 million. During the nine months ended November 2, 2014, the Company repurchased 2,236,578 shares under the authorization at an average price of $17.54 per share, for a total cost of approximately $39.2 million. Due to the Company’s incorporation in North Carolina, which does not recognize treasury shares, the shares repurchased are canceled at the time of repurchase.

Item 3. DEFAULTS UPON SENIOR SECURITIES.

Not applicable.

Item 4. MINE SAFETY DISCLOSURES.

Not applicable.

Item 5. OTHER INFORMATION.

None.

Item 6. EXHIBITS.

The exhibits filed with this Quarterly Report on Form 10-Q are set forth in the Exhibit Index on page 65 and are incorporated herein by reference.

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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: December 12, 2014	By:	/s/ Douglas R. Muir
	Name:	Douglas R. Muir
	Title:	Chief Financial Officer
		(Duly Authorized Officer and Principal Financial Officer)

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Exhibit Index

3.1		—	Restated Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K filed on April 15, 2010)
3.2		—	Articles of Amendment dated June 18, 2013 to the Restated Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on June 19, 2013)
3.3		—	Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on December 15, 2008)
10.1	*	—	Form of Director Indemnification Agreement, dated 2014, entered into between Krispy Kreme Doughnuts, Inc. and members of the Board of Directors (incorporated by reference to the Registrant’s Current Report on Form 8-K filed on November 12, 2014)
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
101			The following materials from our Quarterly Report on Form 10-Q for the quarter ended November 2, 2014, formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Statement of Income for the three and nine months ended November 2, 2014, and November 3, 2013; (ii) the Consolidated Statement of Comprehensive Income for the three and nine months ended November 2, 2014 and November 3, 2013; (iii) the Consolidated Balance Sheet as of November 2, 2014 and February 2, 2014; (iv) the Consolidated Statement of Cash Flows for the nine months ended November 2, 2014 and November 3, 2013; (v) the Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended November 2, 2014 and November 3, 2013; and (vi) the Notes to the Condensed Consolidated Financial Statements

* Identifies management contracts and executive compensation plans or similar arrangements required to be filed as exhibits pursuant to Item 6 of this Quarterly Report on Form 10-Q.

Our SEC file number for documents filed with the SEC pursuant to the Securities Exchange Act of 1934, as amended, is 001-16485.

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