EXHIBIT 13
SELECTED FINANCIAL DATA
The following table shows selected financial data for Krispy Kreme. The selected
historical statement of operations data for each of the years ended, and the
selected historical balance sheet data as of February 1, 1998, January 31, 1999,
January 30, 2000 January 28, 2001 and February 3, 2002 have been derived from
our audited consolidated financial statements. Please note that our fiscal year
ended February 3, 2002 contained 53 weeks.
Systemwide sales include the sales by both our company and franchised stores and
exclude the sales by our KKM&D business segment and the royalties and fees
received from our franchised stores. Our consolidated financial statements
appearing elsewhere in this annual report exclude franchised store sales,
include the results of the area developers in Northern California and in
Philadelphia in which Krispy Kreme has a majority ownership interest and include
royalties and fees received from our franchisees.
You should read the following selected financial data in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the consolidated financial statements and accompanying notes and
the other financial data included elsewhere herein. All references to per share
amounts and any other reference to shares in "Selected Financial Data", unless
otherwise noted, have been adjusted to reflect a two-for-one stock split paid on
March 19, 2001 to shareholders of record as of March 5, 2001 and a two-for-one
stock split paid on June 14, 2001 to shareholders of record as of May 29, 2001.
Unless otherwise specified, references in this annual report to "Krispy Kreme",
the "Company", "we", "us" or "our" refer to Krispy Kreme Doughnuts, Inc and its
subsidiaries.
<Table>
<Caption>
IN THOUSANDS, EXCEPT PER SHARE DATA AND STORE NUMBERS
- ----------------------------------------------------------------------------------------------------------------------
YEAR ENDED FEB. 1, 1998 JAN. 31, 1999 JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ----------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Total revenues $ 158,743 $ 180,880 $ 220,243 $ 300,715 $ 394,354
Operating expenses 140,207 159,941 190,003 250,690 316,946
General and administrative expenses 9,530 10,897 14,856 20,061 27,562
Depreciation and amortization expenses 3,586 4,278 4,546 6,457 7,959
Provision for restructuring -- 9,466 -- -- --
--------------------------------------------------------------------------
Income (loss) from operations 5,420 (3,702) 10,838 23,507 41,887
Interest expense (income), net, and
other 895 1,577 1,232 (1,698) (2,408)
Equity loss in joint ventures -- -- -- 706 602
Minority interest -- -- -- 716 1,147
--------------------------------------------------------------------------
Income (loss) before income taxes 4,525 (5,279) 9,606 23,783 42,546
Provision (benefit) for income taxes 1,811 (2,112) 3,650 9,058 16,168
--------------------------------------------------------------------------
Net income (loss) $ 2,714 $ (3,167) $ 5,956 $ 14,725 $ 26,378
--------------------------------------------------------------------------
Net income (loss) per share:
Basic $ .09 $ (.09) $ .16 $ .30 $ .49
Diluted .09 (.09) .15 .27 .45
Shares used in calculation of net
income (loss) per share:
Basic 29,136 32,996 37,360 49,184 53,703
Diluted 29,136 32,996 39,280 53,656 58,443
Cash dividends declared per common
share $ .04 $ .04 $ -- $ -- $ --
OPERATING DATA (UNAUDITED):
Systemwide sales $ 203,439 $ 240,316 $ 318,854 $ 448,129 $ 621,665
Number of stores at end of period:
Company 58 61 58 63 75
Franchised 62 70 86 111 143
--------------------------------------------------------------------------
Systemwide 120 131 144 174 218
--------------------------------------------------------------------------
Average weekly sales per store:
Company $ 42 $ 47 $ 54 $ 69 $ 72
Franchised 23 28 38 43 53
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital $ 9,151 $ 8,387 $ 11,452 $ 29,443 $ 49,236
Total assets 81,463 93,312 104,958 171,493 255,376
Long-term debt, including current
maturities 20,870 21,020 22,902 -- 4,643
Total shareholders' equity 38,265 42,247 47,755 125,679 187,667
</Table>
23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of our financial condition and results of operations
should be read together with the financial statements and the accompanying
notes. This annual report contains statements about future events and
expectations, including anticipated store and market openings, planned capital
expenditures and trends in or expectations regarding the Company's operations
and financing abilities, that constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements are based on management's beliefs, assumptions, and expectations of
our future economic performance, taking into account the information currently
available to management. These statements are not statements of historical fact.
Forward-looking statements involve risks and uncertainties that may cause our
actual results, performance or financial condition to differ materially from the
expectations of future results, performance or financial condition we express or
imply in any forward-looking statements. Factors that could contribute to these
differences include, but are not limited to: the Company's ability to continue
and manage growth; delays in store openings; the quality of franchise store
operations; the price and availability of raw materials needed to produce
doughnut mixes and other ingredients; changes in customer preferences and
perceptions; risks associated with competition; risks associated with
fluctuations in operating and quarterly results; compliance with government
regulations; and other factors discussed in Krispy Kreme's periodic reports,
proxy statement and other information statements filed with the Securities and
Exchange Commission. The words "believe", "may", "will", "should", "anticipate",
"estimate", "expect", "intend", "objective", "seek", "strive", or similar words,
or the negative of these words, identify forward-looking statements. The Company
qualifies any forward-looking statements entirely by these cautionary factors.
All references to per share amounts and any other reference to shares in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", unless otherwise noted, have been adjusted to reflect a two-for-one
stock split paid on March 19, 2001 to shareholders of record as of March 5, 2001
and a two-for-one stock split paid on June 14, 2001 to shareholders of record as
of May 29, 2001.
CRITICAL ACCOUNTING POLICIES
The Company's analysis and discussion of its financial condition and results of
operations are based upon its consolidated financial statements that have been
prepared in accordance with generally accepted accounting principles in the
United States (US GAAP). The preparation of financial statements in accordance
with US GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets, liabilities, revenues and expenses, and the
disclosure of contingent assets and liabilities. US GAAP provides the framework
from which to make these estimates, assumptions and disclosures. The Company
chooses accounting policies within US GAAP that management believes are
appropriate to accurately and fairly report the Company's operating results and
financial position in a consistent manner. Management regularly assesses these
policies in light of current and forecasted economic conditions. The Company's
accounting policies are stated in Note 2 to the consolidated financial
statements. The Company believes the following accounting policies are critical
to understanding the results of operations and affect the more significant
judgments and estimates used in the preparation of the consolidated financial
statements:
BASIS OF CONSOLIDATION. Our consolidated financial statements include the
accounts of Krispy Kreme Doughnuts, Inc. and all subsidiaries where control
rests with the Company. Investments in affiliates in which the Company has the
ability to exercise significant influence over operating and financial policies
(generally 20- to 50-percent ownership), all of which are investments in joint
ventures with certain of our franchisees, are accounted for by the equity method
of accounting. Our judgments regarding the level of influence or control in each
equity method investment include considering key factors such as our ownership
interest, representation on the management committee, participation in policy
making decisions and material intercompany transactions. Investments in other
joint ventures that we do not control and for which we do not have the ability
to exercise significant influence are carried at cost. All significant
intercompany accounts and transactions, including transactions with equity
method investees, are eliminated in consolidation.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. Accounts receivable arise primarily from sales
by KKM&D of equipment, mix and other supplies necessary to operate a Krispy
Kreme store to our franchisees, as well as from off-premises sales by Company
owned stores to convenience and grocery stores and other customers. Payment
terms vary from 30 to 54 days. The Company has experienced minimal uncollectible
accounts receivable from franchisees' purchases. The majority of the allowance
for doubtful accounts relates to receivables from convenience and grocery stores
and other customers for off-premises sales. Although collection efforts
continue, the Company establishes an allowance for these accounts generally when
they become past due and are deemed uncollectible.
STORE CLOSING COSTS. When a decision is made to close a store, the Company
records a charge to recognize the estimated costs of the planned store closing.
The charge includes an estimate of the unrecoverable portion of remaining lease
payments for leased stores, the charge necessary to write-down the book value of
store assets to estimated realizable value and estimates of other costs
associated with the store closing. At the store closing date, the Company
discontinues depreciation on all assets related to closed store properties.
Disposition efforts on assets held for sale begin immediately following the
store closing.
24
RESTRUCTURING. If the Company makes a decision that certain assets and
operations of the Company are not consistent with the Company's strategy, or
whose carrying value may not be fully recoverable, a formal restructuring plan
is created and approved. Once approved, the Company records a charge to
recognize the estimated costs of the restructuring plan. The charge includes an
estimate of the unrecoverable portion of remaining lease payments for leased
stores, the charge necessary to write down the book value of store assets to
estimated realizable value and estimates of other costs associated with store
closings.
CASUALTY INSURANCE. The Company is generally self-insured for most employee
health care claims, workers' compensation, automobile liability and product and
general liability losses. Insurance liabilities are accrued based upon
historical and industry trends and are adjusted when necessary due to changing
circumstances. Outside actuaries are used to assist in estimating insurance
obligations. Because there are many estimates and assumptions involved in
recording these liabilities, differences between actual future events and prior
estimates and assumptions could result in adjustments to these liabilities.
For further information concerning accounting policies, refer to Note 2 to the
consolidated financial statements.
COMPANY OVERVIEW AND INDUSTRY OUTLOOK
We expect doughnut sales to grow due to a variety of factors, including the
growth in two-income households and corresponding shift to foods consumed away
from home, increased snack food consumption and further growth of doughnut
purchases from in-store bakeries. We view the fragmented competition in the
doughnut industry as an opportunity for our continued growth. We also believe
that the premium quality of our products and the strength of our brand will help
enhance the growth and expansion of the overall doughnut market.
Our principal business, which began in 1937, is owning and franchising Krispy
Kreme doughnut stores where we make and sell over 20 varieties of premium
quality doughnuts, including our Hot Original Glazed. Each of our stores is a
doughnut factory with the capacity to produce from 4,000 dozen to over 10,000
dozen doughnuts daily. Consequently, each store has significant fixed or
semi-fixed costs, and margins and profitability are significantly impacted by
doughnut production volume and sales. Our doughnut stores are versatile in that
most can support multiple sales channels to more fully utilize production
capacity. These sales channels are comprised of:
- ON-PREMISES SALES. Sales to customers visiting our stores, including the
drive-through windows, along with discounted sales to community
organizations that in turn sell our products for fundraising purposes.
- OFF-PREMISES SALES. Daily sales of fresh doughnuts on a branded,
unbranded and private label basis to convenience and grocery stores and
select co-branding customers. Doughnuts are sold to these customers on
trays for display and sale in glass-enclosed cases and in packages for
display and sale on both stand-alone display units and on our customers'
shelves. "Branded" refers to products sold bearing the Krispy Kreme brand
name and is the primary way we are expanding our off-premises sales
business. "Unbranded" products are sold unpackaged from the retailer's
display case. "Private label" products carry the retailer's brand name or
some other non-Krispy Kreme brand. Unbranded and private label products
are a declining portion of our business.
In addition to our retail stores, we are vertically integrated. Our Krispy Kreme
Manufacturing and Distribution business unit, KKM&D, produces doughnut mixes and
manufactures our doughnutmaking equipment, which all of our stores are required
to purchase. Additionally, this business unit currently operates two
distribution centers that provide Krispy Kreme stores with essentially all
supplies for the critical areas of their business. In fiscal 2003, we will open
a mix manufacturing and distribution facility in Effingham, Illinois. The new
mix facility, our second, will triple our mix manufacturing capacity while also
adding our third distribution facility. This business unit is volume-driven, and
its economics are enhanced by the opening of new stores. Our vertical
integration allows us to:
- Maintain the consistency and quality of our products throughout our system
- Utilize volume buying power which helps lower the cost of supplies to each
of our stores
- Enhance our profitability
In fiscal 2002, through the acquisition of the assets of Digital Java, we began
to expand our vertical integration to sourcing and roasting our own coffee
beans. Digital Java, a Chicago-based coffee company, was a sourcer and
micro-roaster of premium quality coffee and offered a broad line of coffee-based
and non-coffee beverages. Subsequent to the acquisition, we relocated the assets
acquired and operations to a newly constructed coffee roasting facility at our
Ivy Avenue plant in Winston-Salem. This operation will help support the rollout
of our new beverage program.
During fiscal 2002, we introduced a new concept store, the "doughnut and coffee
shop." This store uses the new Hot Doughnut Machine technology which completes
the final steps of the production process and requires less space than the full
production equipment in our traditional factory store. This technology combines
time, temperature and humidity elements to re-heat unglazed doughnuts, provided
by a traditional factory store, and prepare them for the glazing process. Once
glazed, customers can have the same hot doughnut experience in a doughnut and
coffee shop as in a factory store. Additionally, the doughnut and coffee shop
offers our new full line of coffees and other beverages. During fiscal 2002, we
began our initial tests of the concept in three different markets in North
Carolina and venues and continue to develop and enhance the technology. As of
February 3, 2002, three doughnut and coffee shops were open and all were owned
by the Company. We expect to open between ten and fifteen doughnut and coffee
shops systemwide in fiscal 2003 as we continue our tests of this concept.
25
We intend to expand our concept primarily through opening new franchise stores
in territories across the continental United States and Canada, as well as
select other international markets. We also have entered and intend to enter
into additional joint ventures with some of our franchisees. As of February 3,
2002, there were a total of 218 Krispy Kreme stores systemwide, consisting of 75
company and 143 franchised stores. In fiscal 2003, we anticipate opening
approximately 59 new stores under existing agreements, the majority of which are
expected to be franchise stores. Our franchisees, including the area developers
in Northern California and in Philadelphia in which we have a majority ownership
interest, are contractually obligated to open over 200 new stores in the period
fiscal 2003 through fiscal 2006.
As we expand the Krispy Kreme concept, we will incur infrastructure costs in the
form of additional personnel to support the expansion, and additional facilities
costs to provide mixes, equipment and other items necessary to operate the
various new stores. In the course of building this infrastructure, we may incur
unplanned costs which could negatively impact our operating results.
RESULTS OF OPERATIONS
In order to facilitate an understanding of the results of operations for each
period presented, we have included a general overview along with an analysis of
business segment activities. In addition to this analysis and discussion of
critical accounting policies above, refer to Note 2, Nature of Business and
Significant Accounting Policies, in the notes to our consolidated financial
statements. A guide to the discussion for each period is presented below.
OVERVIEW. Outlines information on total systemwide sales and systemwide
comparable store sales. Systemwide sales includes the sales of both our company
and franchised stores and excludes the sales and revenues of our KKM&D and
Franchise Operations business segments. Our consolidated financial statements
include sales of our company stores, including the sales of any consolidated
joint venture stores, outside sales of our KKM&D business segment and royalties
and fees received from our franchisees; these statements exclude the sales of
our franchised stores. We believe systemwide sales data is significant because
it shows the overall penetration of our brand, consumer demand for our products
and the correlation between systemwide sales and our total revenues. A store is
added to our comparable store base in its nineteenth month of operation. A
summary discussion of our consolidated results is also presented.
SEGMENT RESULTS. In accordance with Statement of Financial Accounting Standards
No. 131 ("SFAS No. 131"), "Disclosures about Segments of an Enterprise and
Related Information," we have three reportable segments. A description of each
of the segments follows.
- COMPANY STORE OPERATIONS. Represents the results of our company stores
and consolidated joint venture stores. Company stores make and sell
doughnuts and complementary products through the sales channels discussed
above. Expenses for this business unit include store level expenses along
with direct general and administrative expenses.
- FRANCHISE OPERATIONS. Represents the results of our franchise program. We
have two franchise programs: (1) the associate program, which is our
original franchising program developed in the 1940s, and (2) the area
developer program, which was developed in the mid-1990s. Associates pay
royalties of 3.0% of on-premises sales and 1.0% of all other sales, with
the exception of private label sales, for which they pay no royalties.
Area developers pay royalties of 4.5% of all sales, contribute 1.0% of all
sales to our national advertising fund and pay franchise fees ranging from
$20,000 to $40,000 per store. Expenses for this business segment include
costs incurred to recruit new franchisees and to open, monitor and aid in
the performance of these stores and direct general and administrative
expenses.
- KKM&D. Represents the results of our KKM&D business unit, located in
Winston-Salem, North Carolina. This business unit buys and processes
ingredients to produce doughnut mixes and manufactures doughnutmaking
equipment that all of our stores are required to purchase. KKM&D is in the
startup phase of coffee roasting operations in a newly constructed
facility in Winston-Salem. Production will be increased in this facility
in fiscal 2003 as our new coffee and expanded beverage program is
introduced in our existing and new stores. Additionally, this business
unit purchases and sells essentially all supplies necessary to operate a
Krispy Kreme store, including all food ingredients, juices, signage,
display cases, uniforms and other items. Generally, shipments are made to
each of our stores on a weekly basis by common carrier. All intercompany
transactions between KKM&D and Company Store Operations have been
eliminated in consolidation. Expenses for this business unit include all
expenses incurred at the manufacturing and distribution level along with
direct general and administrative expenses.
26
OTHER. Includes a discussion of significant line items not discussed in the
overview or segment discussions, including general and administrative expenses,
depreciation and amortization expenses, interest expense (income), net, equity
income (loss) in joint ventures, minority interest in consolidated joint
ventures and the provision for income taxes.
OUR FISCAL YEAR IS BASED ON A 52 OR 53 WEEK YEAR. THE FISCAL YEAR ENDS ON THE
SUNDAY CLOSEST TO THE LAST DAY IN JANUARY. THE TABLE BELOW SHOWS OUR OPERATING
RESULTS FOR FISCAL 2000 (52 WEEKS ENDED JANUARY 30, 2000), FISCAL 2001 (52 WEEKS
ENDED JANUARY 28, 2001) AND FISCAL 2002 (53 WEEKS ENDED FEBRUARY 3, 2002)
EXPRESSED AS A PERCENTAGE OF TOTAL REVENUES. CERTAIN OPERATING DATA ARE ALSO
SHOWN FOR THE SAME PERIODS.
<Table>
<Caption>
DOLLARS IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Total revenues 100.0% 100.0% 100.0%
Operating expenses 86.3 83.4 80.4
General and administrative expenses 6.7 6.7 7.0
Depreciation and amortization expenses 2.1 2.1 2.0
-------------------------------------------------------
Income from operations 4.9 7.8 10.6
Interest expense (income), net, and other 0.5 (0.1) (0.2)
-------------------------------------------------------
Income before income taxes 4.4 7.9 10.8
Provision for income taxes 1.7 3.0 4.1
-------------------------------------------------------
Net income 2.7% 4.9% 6.7%
-------------------------------------------------------
OPERATING DATA:
Systemwide sales $ 318,854 $ 448,129 $ 621,665
Increase in comparable store sales:
Company 12.0% 22.9% 11.7%
Systemwide 14.1% 17.1% 12.8%
</Table>
THE TABLE BELOW SHOWS BUSINESS SEGMENT REVENUES AND OPERATING EXPENSES EXPRESSED
IN DOLLARS. KKM&D REVENUES ARE SHOWN NET OF INTERCOMPANY SALES ELIMINATIONS. SEE
NOTE 14, BUSINESS SEGMENT INFORMATION, IN THE NOTES TO OUR CONSOLIDATED
FINANCIAL STATEMENTS. OPERATING EXPENSES EXCLUDE DEPRECIATION AND AMORTIZATION
EXPENSES AND INDIRECT (UNALLOCATED) GENERAL AND ADMINISTRATIVE EXPENSES. DIRECT
GENERAL AND ADMINISTRATIVE EXPENSES ARE INCLUDED IN OPERATING EXPENSES.
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
REVENUES BY BUSINESS SEGMENT:
Company Store Operations $ 164,230 $ 213,677 $ 266,209
Franchise Operations 5,529 9,445 14,008
KKM&D 50,484 77,593 114,137
------------------------------------------------------
Total revenues $ 220,243 $ 300,715 $ 394,354
------------------------------------------------------
OPERATING EXPENSES BY BUSINESS SEGMENT:
Company Store Operations $ 142,925 $ 181,470 $ 217,419
Franchise Operations 4,012 3,642 4,896
KKM&D 43,066 65,578 94,631
------------------------------------------------------
Total operating expenses $ 190,003 $ 250,690 $ 316,946
------------------------------------------------------
</Table>
27
THE FOLLOWING TABLE SHOWS BUSINESS SEGMENT REVENUES EXPRESSED AS A PERCENTAGE OF
TOTAL REVENUES AND BUSINESS SEGMENT OPERATING EXPENSES EXPRESSED AS A PERCENTAGE
OF APPLICABLE BUSINESS SEGMENT REVENUES. OPERATING EXPENSES EXCLUDE DEPRECIATION
AND AMORTIZATION EXPENSES AND INDIRECT (UNALLOCATED) GENERAL AND ADMINISTRATIVE
EXPENSES. DIRECT GENERAL AND ADMINISTRATIVE EXPENSES ARE INCLUDED IN OPERATING
EXPENSES.
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
REVENUES BY BUSINESS SEGMENT:
Company Store Operations 74.6% 71.1% 67.5%
Franchise Operations 2.5 3.1 3.6
KKM&D 22.9 25.8 28.9
-------------------------------------------------------
Total revenues 100.0% 100.0% 100.0%
-------------------------------------------------------
OPERATING EXPENSES BY BUSINESS SEGMENT:
Company Store Operations 87.0% 84.9% 81.7%
Franchise Operations 72.6% 38.6% 35.0%
KKM&D 85.3% 84.5% 82.9%
-------------------------------------------------------
Total operating expenses 86.3% 83.4% 80.4%
-------------------------------------------------------
</Table>
ADDITIONALLY, DATA ON STORE OPENING ACTIVITY ARE SHOWN BELOW. TRANSFERRED STORES
REPRESENT STORES SOLD BETWEEN THE COMPANY AND FRANCHISEES.
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED COMPANY FRANCHISED TOTAL
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 30, 2000
Beginning count 61 70 131
Opened 2 19 21
Closed (5) (3) (8)
------------------------------------------------
Beginning count 58 86 144
------------------------------------------------
YEAR ENDED JANUARY 28, 2001
Beginning count 58 86 144
Opened 8 28 36
Closed (3) (3) (6)
------------------------------------------------
Ending count 63 111 174
------------------------------------------------
YEAR ENDED FEBRUARY 3, 2002
Beginning count 63 111 174
Opened 7 41 48
Closed (2) (2) (4)
Transferred 7 (7) --
------------------------------------------------
Ending count 75 143 218
------------------------------------------------
</Table>
Company stores as of February 3, 2002 included nine stores in Northern
California and two stores in Philadelphia, both of which are operated by area
developer joint ventures in which Krispy Kreme has a majority ownership
interest. Store counts include retail stores and commissaries, which are
production facilities used to serve off-premises customers and exclude the
doughnut and coffee shops.
YEAR ENDED FEBRUARY 3, 2002 COMPARED WITH YEAR ENDED JANUARY 28, 2001
OVERVIEW
As noted above, we operate on a 52 or 53-week fiscal year. Our operations for
fiscal 2002 contained 53 weeks while fiscal 2001 contained 52 weeks. This event
occurs every fifth year. When we make reference to fiscal 2002 adjusted for the
number of weeks, we have adjusted fiscal 2002 results to approximate a 52-week
year. All references to comparable store sales are on the basis of comparing the
comparable 52 weeks in fiscal 2002 with the comparable 52 weeks in fiscal 2001.
Systemwide sales for the fiscal year increased 38.7% to $621.7 million compared
to $448.1 million in the prior year. The increase was comprised of an increase
of 24.6% in Company Store sales, to $266.2 million, and an increase of 51.6% in
Franchise Store sales, to $355.5 million. The increase was the result of sales
from new stores opened during the fiscal year and an increase in systemwide
comparable sales. During fiscal 2002, 41 new franchise stores and seven new
Company stores were opened and two franchise stores and two Company stores were
closed for a net increase of 44 stores. Additionally, as a result of the
acquisition of an Area Developer market and two Associate markets, four Area
Developer franchise stores and three Associate franchise stores became Company
stores. The total number of stores at the end of the fiscal year was 218. Of
those, 52 are Associate franchise stores, 91 are Area Developer franchise stores
and 75 are Company stores. Systemwide comparable store
28
sales increased 12.8% in the fiscal year. We believe continued increased brand
awareness and growth in off-premises sales contributed significantly to this
increase in our systemwide comparable store sales. Adjusting for the number of
weeks in fiscal 2002, the increase in systemwide sales was 35.8%.
Total Company revenues increased 31.1% to $394.4 million in fiscal 2002 compared
with $300.7 million in the prior fiscal year. This increase was comprised of
increases in Company Store Operations revenue increases of 24.6% to $266.2
million, Franchise Operations revenue of 48.3%, to $14.0 million, and KKM&D
revenue, excluding intercompany sales, of 47.1%, to $114.1 million. Adjusting
for the number of weeks in fiscal 2002, the increase in Company revenues was
28.5%.
Net income for fiscal 2002 was $26.4 million versus $14.7 million a year ago, an
increase of 79.1%. Diluted earnings per share was $0.45, an increase of 64.6%
over the prior year.
COMPANY STORE OPERATIONS
COMPANY STORE OPERATIONS REVENUES. Company Store Operations revenues increased
to $266.2 million in fiscal 2002 from $213.7 million in fiscal 2001, an increase
of 24.6%. Comparable store sales increased by 11.7%. The revenue growth was
primarily due to strong growth in sales from both our on-premises and
off-premises sales channels. Total on-premises sales increased approximately
$25.4 million and total off-premises sales increased approximately $27.1
million. On-premises sales grew principally as a result of more customer visits,
the introduction of new products and our continued increase in brand awareness
due in part to the expansion of our off-premises sales programs. Additionally, a
retail price increase was implemented during the first quarter of fiscal 2002.
Company store on-premises sales were also positively impacted by the sales of
the nine stores in the Northern California market. During fiscal 2002, the
Company had a 59% interest in the Northern California market and a 70% interest
in the Philadelphia market, and as a result, they are consolidated with the
Company Store Operations revenues and results. Adjusting for the number of weeks
in fiscal 2002, the increase in Company Store Operations revenues was 22.1%.
COMPANY STORE OPERATIONS OPERATING EXPENSES. Company Store Operations operating
expenses increased 19.8% to $217.4 million in fiscal 2002 from $181.5 million in
fiscal 2001. Company Store Operations operating expenses as a percentage of
Company Store Operations revenues were 81.7% in fiscal 2002 compared with 84.9%
in the prior year. The decrease in Company Store Operations operating expenses
as a percentage of revenues was primarily due to increased operating
efficiencies generated by growth in store sales volumes as demonstrated by the
11.7% increase in comparable store sales discussed above, selected price
increases, improved profitability of our off-premises sales and a focus on gross
margin improvement, particularly labor utilization and a reduction in shrink.
Slightly offsetting the improved operating efficiencies was an increase in labor
rate costs implemented in order to improve employee retention.
We constantly evaluate our store base, not only with respect to our stores'
financial and operational performance, but also with respect to alignment with
our brand image and how well each store meets our customers' needs. As a result
of this review, we make provisions to cover closing or impairment costs for
underperforming stores, and for older stores that need to be closed and
relocated. No such provisions were made during fiscal 2002.
FRANCHISE OPERATIONS
FRANCHISE OPERATIONS REVENUES. Franchise Operations revenues increased 48.3%,
to $14.0 million, in fiscal 2002 from $9.4 million in the prior year. The growth
in revenue was primarily due to the opening of 39 new franchise stores, net of
store closings (2) and transfers from Franchise to Company (7), as well as the
impact of opening 25 new franchise stores, net of three store closings, during
fiscal 2001. Adjusting for the number of weeks in fiscal 2002, the increase in
Franchise Operations revenues was 45.3%.
FRANCHISE OPERATIONS OPERATING EXPENSES. Franchise Operations operating
expenses increased to $4.9 million in fiscal 2002 from $3.6 million in fiscal
2001. As a percentage of Franchise Operations revenues, franchise operating
expenses were 35.0% in the current year compared with 38.6% in the prior year.
Operating expenses, as a percentage of revenue, have decreased during fiscal
2002 as compared to the prior year as a result of the Company leveraging the
infrastructure it has put in place to oversee the expansion of our franchise
concept.
KKM&D
KKM&D REVENUES. KKM&D sales to franchise stores increased 47.1%, to $114.1
million, in fiscal 2002 from $77.6 million in fiscal 2001. Consistent with the
prior year, the primary reason for the increase in revenues was the opening of
39 new franchise stores, net of store closings (2) and transfers from Franchise
to Company (7), in fiscal 2002; the opening of 25 new franchise stores, net of
three store closings, in fiscal 2001; and comparable store sales increases.
Increased doughnut sales through both the on-premises and off-premises sales
channels by franchise stores translated into additional revenues for KKM&D from
sales of mixes, sugar, shortening and other supplies. Also, each of these new
stores is required to purchase doughnutmaking equipment and other peripheral
equipment from KKM&D, thereby enhancing KKM&D sales. Adjusting for the number of
weeks in fiscal 2002, the increase in KKM&D revenues was 44.1%.
29
KKM&D OPERATING EXPENSES. KKM&D operating expenses increased 44.3%, to $94.6
million, in fiscal 2002 from $65.6 million in fiscal 2001. KKM&D operating
expenses as a percentage of KKM&D revenues were 82.9% in the current year
compared with 84.5% in the prior year. Consistent with the prior year, the
decrease in KKM&D operating expenses as a percentage of revenues was due to
increased capacity utilization and resulting economies of scale of the mix and
equipment manufacturing operations attributable to the increased volume produced
in the facilities. Continued stability in our key ingredient costs also
contributed. Additionally, the relocation of our equipment manufacturing
facility during the second quarter of this year to a facility better designed to
facilitate our manufacturing process has resulted in improved manufacturing
efficiencies as compared to the prior year.
OTHER
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 37.4%, to $27.6 million, in fiscal 2002 from $20.1 million in fiscal
2001. General and administrative expenses as a percentage of total revenues were
7.0% in fiscal 2002 compared with 6.7% in fiscal 2001. The growth in general and
administrative expenses is due to increased prototype expenses, increased
personnel and related salary and benefit costs to support our expansion, and
other cost increases necessitated by the growth of the Company.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization expenses
increased 23.3%, to $8.0 million, in fiscal 2002 from $6.5 million in the prior
year. Depreciation and amortization expenses as a percentage of total revenues
were 2.0% in fiscal 2002 compared with 2.1% in fiscal 2001. The dollar growth in
depreciation and amortization expenses is due to increased capital asset
additions. See Liquidity section for additional discussion.
INTEREST INCOME. Interest income in fiscal 2002 increased 28.2% over fiscal
2001 as a result of the investment of excess proceeds from both our initial
public offering completed in April 2000 and our follow on public offering
completed in February 2001. Approximately $36.0 million was invested in various
government securities, short-term commercial paper instruments, and corporate
bonds at the end of the year resulting in interest income of $3.0 million for
fiscal 2002 compared to $2.3 million for fiscal 2001.
INTEREST EXPENSE. Interest expense of $337,000 in fiscal 2002 decreased 44.5%
from $607,000 in the prior year. This decrease is a result of paying off
substantially all of our debt in mid-April 2000 after the completion of our
initial public offering. The decrease is offset by interest expense recognized
by our Area Developer who is developing the Northern California market. As we
own 59% of this market, the results are consolidated into our financial results.
EQUITY LOSS IN JOINT VENTURES. These expenses consist of the Company's share of
operating results associated with the Company's investments in six
unconsolidated joint ventures, accounted for under the equity method, to develop
and operate Krispy Kreme stores. The decrease in this expense is a result of
increased joint venture store openings. As stores open and infrastructure is
leveraged, the operating results of an individual joint venture generally
improve. At February 3, 2002, there were 18 stores open by unconsolidated joint
ventures compared to five at January 28, 2001.
MINORITY INTEREST. This expense represents the net elimination of the minority
partners' share of income or losses from consolidated joint ventures to develop
and operate Krispy Kreme stores. The increase in this expense is primarily a
result of increased profitability in the Northern California joint venture,
which opened four additional stores in fiscal 2002.
PROVISION FOR INCOME TAXES. The provision for income taxes is based on the
effective tax rate applied to the respective period's pre-tax income. The
provision for income taxes was $16.2 million in fiscal 2002 representing a 38.0%
effective rate compared to $9.1 million, or 38.1%, in the prior year.
YEAR ENDED JANUARY 28, 2001 COMPARED WITH YEAR ENDED JANUARY 30, 2000
OVERVIEW
Operations for fiscal 2001 and fiscal 2000 contained 52 weeks.
Systemwide sales for the fiscal year increased 40.5% to $448.1 million compared
to $318.9 million in the prior year. The increase was driven by an increase of
30.1% in company store sales, which increased to $213.7 million, and an increase
of 51.6% in franchise store sales, which increased to $234.4 million. During
fiscal 2001, the Company opened 28 franchise stores, four stores in Northern
California, one commissary in Northern California, two company stores and one
commissary in Nashville, Tennessee. Three company stores and three franchise
stores were closed, bringing the total number of stores to 174 at the end of
fiscal 2001. We believe increased brand awareness and increased off-premises
sales contributed significantly to the 17.1% increase in our systemwide
comparable store sales.
Total company revenues increased 36.5% to $300.7 million for the fiscal year
compared with $220.2 million for the prior fiscal year. This increase was
comprised of a Company Store Operations revenue increase of 30.1% to $213.7
million, a Franchise Operations revenue increase of 70.8% to $9.4 million and a
KKM&D revenue increase, excluding inter-company sales, of 53.7% to $77.6
million. Net income for fiscal 2001 was $14.7 million versus $6.0 million in the
prior year, representing an increase of 147.2%. Diluted earnings per share were
$0.27, an increase of 80.3% over the prior year.
30
COMPANY STORE OPERATIONS
COMPANY STORE OPERATIONS REVENUES. Company Store Operations revenues increased
to $213.7 million in fiscal 2001 from $164.2 million in fiscal 2000, an increase
of 30.1%. Comparable store sales increased by 22.9%. The revenue growth was
primarily due to strong growth in sales from both our on-premises and
off-premises sales channels. Total on-premises sales increased approximately
$18.0 million and total off-premises sales increased approximately $31.5
million. On-premises sales grew principally as a result of more customer visits
and an increase in brand awareness generated from our national store expansion,
as well as a 6% retail price increase which was implemented during the first
quarter of fiscal 2001. In addition, Company store on-premises sales were
positively impacted by the sales of the five stores in the Northern California
market. The Company has a 59% interest in the Northern California market, and as
a result, it is consolidated with the Company Store Operations sales and
results. Our company stores continued to benefit from both an increase in the
number of outlets we serve via our off-premises sales programs and from efforts
such as the route management computer assisted ordering system to increase sales
per off-premises outlet.
COMPANY STORE OPERATIONS OPERATING EXPENSES. Company Store Operations operating
expenses increased to $181.5 million in fiscal 2001 from $142.9 million in
fiscal 2000, an increase of 27.0%. Company Store Operations operating expenses
as a percentage of Company Store Operations revenues were 84.9% in fiscal 2001
compared with 87.0% in fiscal 2000. The decrease in operating expenses as a
percentage of revenues was due to increased sales levels at our stores. The
margin on off-premises sales benefited from the implementation of a new route
management system during the second quarter of fiscal 2001. These margin
improvements were partially offset by the impact of the stores closed for
remodeling and rebuilding. During the period when some of the stores were closed
for remodeling or rebuilding, we lost the higher margin on-premises sales, which
in turn negatively impacted our margins.
We constantly evaluate our store base, not only with respect to our stores'
financial and operational performance, but also with respect to alignment with
our brand image and how well each store meets our customers' needs. As a result
of this review, we make provisions to cover closing or impairment costs for
underperforming stores, and for older stores that need to be closed and
relocated. We recorded a provision in the amount of $318,000 in operating
expenses in fiscal 2001 to cover costs associated with a store which was damaged
by fire. After evaluating the location, we decided not to reopen the store. The
provision is intended to cover estimated lease liabilities, the net book value
of assets disposed of and other miscellaneous costs associated with this
decision. In fiscal 2000, we recorded a charge of $1.1 million to cover the
closing of two older stores that were replaced on their existing sites in fiscal
2001.
FRANCHISE OPERATIONS
FRANCHISE OPERATIONS REVENUES. Franchise Operations revenues increased to $9.4
million for fiscal 2001 from $5.5 million in fiscal 2000, an increase of 70.8%.
The growth in revenue was primarily due to the opening of 28 franchise stores
during fiscal 2001 and the impact of those franchise stores opened in fiscal
2000 being open for the entire year in fiscal 2001.
FRANCHISE OPERATIONS OPERATING EXPENSES. Franchise Operations operating
expenses decreased to $3.6 million in fiscal 2001 from $4.0 million in the prior
year. As a percentage of Franchise Operations revenues, Franchise Operations
operating expenses were 38.6% in fiscal 2001 compared with 72.6% in fiscal 2000.
Consistent with the prior year, the decrease in Franchise Operations operating
expenses as a percentage of revenues reflects the continued growth in our
franchise system sales with a minimal decrease in related operating expenses. In
prior years, we hired and trained personnel to oversee the expansion of our
franchise concept across the country. In addition to our management training
program, they received field training primarily consisting of working with and
learning from existing personnel who were qualified to oversee store operations.
As our personnel successfully completed their training, we have been able to
open additional stores without incurring significant incremental personnel
costs. Additionally, the amount of support that we provide for each Area
Developer group's store openings decline with each successive opening. As some
of our individual Area Developer groups are now operating multiple stores, our
costs associated with their additional store openings have declined.
KKM&D
KKM&D REVENUES. KKM&D sales to franchise stores increased to $77.6 million in
fiscal 2001 from $50.5 million in fiscal 2000, an increase of 53.7%. The primary
reason for the increase in revenues was the opening of 25 new franchise stores,
net, in fiscal 2001, the impact of franchise stores opened in fiscal 2000 and
comparable store sales increases. Increased doughnut sales through both the
on-premises and off-premises sales channels by franchise stores translated into
increased revenues for KKM&D from sales of mixes, sugar, shortening and other
supplies. Also, each of these new stores is required to purchase doughnutmaking
equipment and other peripheral equipment from KKM&D, thereby enhancing KKM&D
sales.
KKM&D OPERATING EXPENSES. KKM&D operating expenses increased to $65.6 million
in fiscal 2001 from $43.1 million in fiscal 2000, an increase of 52.3%. KKM&D
operating expenses as a percentage of KKM&D revenues were 84.5% in fiscal 2001
compared with 85.3% in fiscal 2000. The decrease in KKM&D operating expenses as
a percentage of revenues was due to increased capacity utilization and resulting
economies of scale of the mix and equipment manufacturing operations
attributable to the increased volume in the facilities. Continued stability in
our key ingredient costs also contributed. The effect of these factors was
offset in part by startup costs associated with our California distribution
center.
31
OTHER
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to $20.1 million in fiscal 2001 from $14.9 million in the prior year,
an increase of 35.0%. General and administrative expenses as a percentage of
total revenues for the fiscal year were 6.7% in both fiscal 2001 and fiscal
2000. The dollar growth in general and administrative expense was due to
increased personnel and related benefit and travel costs needed to support our
national expansion.
DEPRECIATION AND AMORTIZATION EXPENSES. Depreciation and amortization expenses
increased to $6.5 million in fiscal 2001 from $4.5 million in fiscal 2000, an
increase of 42.0%. Depreciation and amortization expenses as a percentage of
total revenues were 2.1% in both fiscal 2001 and fiscal 2000. The dollar growth
in depreciation and amortization expenses was due to capital asset additions, as
well as the accelerated depreciation expense as a result of the shortening of
useful lives related to two anticipated store relocations. The amount of
accelerated depreciation expense recognized was approximately $690,000.
INTEREST INCOME. Interest income increased in fiscal 2001 as a result of the
investment of proceeds from our initial public offering. Proceeds from the
public offering were received in mid-April 2000. After retiring our debt, we
made investments in government securities, short-term commercial paper
instruments and corporate bonds. These amounted to approximately $36.0 million
at January 28, 2001 and resulted in interest income of $2.3 million for fiscal
2001. There were no investments of this nature during fiscal 2000.
INTEREST EXPENSE. Interest expense of $607,000 for fiscal 2001 decreased 60.2%
from $1.5 million in fiscal 2000. This decrease is a direct result of paying off
substantially all of our debt in mid-April 2000 after the completion of our
initial public offering.
EQUITY LOSS IN JOINT VENTURES. These expenses consist of our share of operating
results associated with our investments in unconsolidated joint ventures to
develop and operate Krispy Kreme stores which are accounted for on the equity
method.
MINORITY INTEREST. These expenses represent the elimination of the minority
partner's share of income from a consolidated joint venture to develop and
operate Krispy Kreme stores.
PROVISION FOR INCOME TAXES. The provision for income taxes is based on the
effective tax rate applied to the respective period's pre-tax income. The
provision for income taxes was $9.1 million for fiscal 2001 representing a 38.1%
effective rate compared to $3.7 million, or 38.0%, in fiscal 2000.
32
QUARTERLY RESULTS
The following tables set forth unaudited quarterly information for each of the
eight fiscal quarters in the two year period ended February 3, 2002. This
quarterly information has been prepared on a basis consistent with our audited
financial statements and, in the opinion of management, includes all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the information for the periods presented. Our quarterly
operating results may fluctuate significantly as a result of a variety of
factors, and operating results for any quarter are not necessarily indicative of
results for a full fiscal year. Further, we have historically experienced
seasonal variability in our quarterly operating results, with higher profits per
store in the first and third quarters than in the second and fourth quarters.
The seasonal nature of our operating results is expected to continue. The net
income per share amounts reflect the impact of a two-for-one stock split paid in
the form of a stock dividend on March 19, 2001 and a two-for-one stock split
paid in the form of a stock dividend on June 14, 2001.
<Table>
<Caption>
IN THOUSANDS, EXCEPT PER SHARE DATA
- ---------------------------------------------------------------------------------------------------------------------
APR. 30, JULY 30, OCT. 29, JAN. 28, APR. 29, JULY 29, OCT. 28, FEB. 3,
THREE MONTHS ENDED 2000* 2000* 2000* 2001* 2001 2001 2001 2002
- ---------------------------------------------------------------------------------------------------------------------
Total revenues $70,870 $70,060 $77,897 $81,888 $87,921 $89,545 $99,804 $117,084
Operating expenses 59,164 58,286 65,316 67,924 71,195 72,683 80,177 92,891
General and administrative
expenses 4,435 4,566 5,059 6,001 6,222 5,966 7,023 8,351
Depreciation and amortization
expenses 1,595 1,581 1,811 1,470 1,872 1,952 2,131 2,004
-------------------------------------------------------------------------------------
Income from operations 5,676 5,627 5,711 6,493 8,632 8,944 10,473 13,838
Interest (income) expense,
net, and other expenses 742 (149) (504) (365) (591) (598) 22 508
-------------------------------------------------------------------------------------
Income before income taxes 4,934 5,776 6,215 6,858 9,223 9,542 10,451 13,330
Provision for income taxes 1,901 2,192 2,363 2,602 3,504 3,627 3,971 5,066
-------------------------------------------------------------------------------------
Net income $ 3,033 $ 3,584 $ 3,852 $ 4,256 $ 5,719 $ 5,915 $ 6,480 $ 8,264
-------------------------------------------------------------------------------------
NET INCOME PER SHARE:
Basic $ .07 $ .06 $ .07 $ .08 $ .11 $ .11 $ .12 $ .15
Diluted .07 .06 .07 .07 .10 .10 .11 .14
</Table>
* In December 1999, the Securities and Exchange Commission staff issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements", which, among other guidance, clarifies certain conditions to be
met in order to recognize revenue. Amounts presented for each of the four
quarters of fiscal 2001 have been restated for a change in accounting policy
for revenue recognition, in accordance with SAB 101. The change had an
insignificant impact on annual sales and net income but does result in a shift
in sales and earnings among the quarterly periods. The change has no effect on
earnings per share in any of the quarterly periods. The effect of this change
for each quarter of fiscal 2001 follows:
<Table>
<Caption>
IN THOUSANDS
- --------------------------------------------------------------------------------------------
TOTAL REVENUES NET INCOME
- --------------------------------------------------------------------------------------------
First quarter $ (131) $ (19)
Second quarter 66 9
Third quarter (12) (1)
Fourth quarter (130) (16)
------------------------------
$ (207) $ (27)
------------------------------
</Table>
OUR OPERATING RESULTS FOR THESE EIGHT QUARTERS EXPRESSED AS PERCENTAGES OF
APPLICABLE REVENUES WERE AS FOLLOWS:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------
APR. 30, JULY 30, OCT. 29, JAN. 28, APR. 29, JULY 29, OCT. 28, FEB. 3,
THREE MONTHS ENDED 2000 2000 2000 2001 2001 2001 2001 2002
- ---------------------------------------------------------------------------------------------------------------------
Total revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Operating expenses 83.5 83.2 83.9 82.9 81.0 81.2 80.3 79.3
General and administrative
expenses 6.3 6.5 6.5 7.3 7.1 6.7 7.0 7.1
Depreciation and amortization
expenses 2.2 2.3 2.3 1.8 2.1 2.2 2.1 1.8
------------------------------------------------------------------------------------
Income from operations 8.0 8.0 7.3 8.0 9.8 9.9 10.6 11.8
Interest (income) expense, net,
and other expenses 1.0 (0.2) (0.6) (0.4) (0.7) (0.7) 0.1 0.4
------------------------------------------------------------------------------------
Income before income taxes 7.0 8.2 7.9 8.4 10.5 10.6 10.5 11.4
Provision for income taxes 2.7 3.1 3.0 3.2 4.0 4.1 4.0 4.3
------------------------------------------------------------------------------------
Net income 4.3% 5.1% 4.9% 5.2% 6.5% 6.5% 6.5% 7.1%
------------------------------------------------------------------------------------
</Table>
33
LIQUIDITY AND CAPITAL RESOURCES
Because management generally does not monitor liquidity and capital resources on
a segment basis, this discussion is presented on a consolidated basis.
We funded our capital requirements for fiscal 2000, 2001 and 2002 primarily
through cash flow generated from operations, as well as proceeds from the
initial public offering completed in April 2000 and follow on public offering
completed in early February 2001. Over the past three years, we have greatly
improved the amount of cash we generate from operations. We believe our cash
flow generation ability is becoming a financial strength and will aid in the
expansion of our business.
CASH FLOW FROM OPERATIONS
OVERVIEW. Net cash flow from operations was $8.5 million in fiscal 2000, $32.1
million in fiscal 2001 and $36.2 million in fiscal 2002. Operating cash flow in
each year has benefited from an improvement in our net income and was offset by
additional investments in working capital, primarily accounts receivable and
inventories. In fiscal 2002, net income increased $20.4 million, or 342.9%,
compared with fiscal 2000 and it increased $11.7 million, or 79.1%, compared
with fiscal 2001. Net working capital at January 30, 2000 was $11.5 million,
$29.4 million at January 28, 2001 and $49.2 million at February 3, 2002.
Additional investments in accounts receivable and inventories have been
necessary due to the expansion of our off-premises sales programs and the
opening of new stores that we either own or supply. Partially offsetting the
additional investments in accounts receivable and inventories have been
increases in current liability accounts, primarily accounts payable and accrued
expenses. Additionally, operating cash flows in fiscal 2002 were favourably
impacted by the tax benefit from the exercise of nonqualified stock options in
the amount of $9.8 million. The Company's operating cash flows may continue to
be favourably impacted by similar tax benefits in the future; however, the
exercise of stock options is outside of the Company's control.
DETAILED ANALYSIS
ACCOUNTS RECEIVABLE. Our investment in receivables increased $4.8 million in
fiscal 2000, $3.4 million in fiscal 2001 and $13.3 million in fiscal 2002.
Accounts receivable have been increasing for the following reasons:
1) The expansion of our off-premises sales programs and the corresponding
receivables from grocery and convenience stores and other off-premises
customers. Payment terms for off-premises customers vary depending on
their credit worthiness and the type of off-premises program we offer
them. Sometimes customers do not pay within their credit terms or there
are disputes over amounts owed to us. We use our judgment in deciding
whether to grant additional payment days, intensify collection efforts,
suspend service, write the account off as uncollectible or a combination
of the above. Write-offs of accounts receivable due to uncollectibility
have not had a significant negative impact on operating cash flow. As we
expect our off-premises business to continue to grow, accounts receivable
balances from off-premises customers are also expected to grow.
2) An increase in the number of franchise stores that are operating: 86 at
January 30, 2000; 111 at January 28, 2001; and 143 at February 3, 2002.
We generate accounts receivable from franchisees as a result of our
weekly shipments of mix, other ingredients and supplies to each store.
Therefore, as the number of franchise stores have grown, so have the
corresponding accounts receivable balances. Accounts receivable balances
from franchisees are shown under the captions accounts receivable and
accounts receivable, affiliates on the consolidated balance sheets.
Receivables from franchisees in which we own no interest are included in
the accounts receivable caption, while receivables from franchisees in
which we own a minority interest or receivables from stores owned by
members of our Board of Directors, or other related parties to the
Company, are shown under the caption accounts receivable, affiliates.
Payment terms on these receivables are 30 or 35 days from the date of
invoice, depending on the franchisee's payment method (traditional check
versus electronic payment arrangements). We also generate accounts
receivable from franchise stores whenever they build a new store, as we
supply the doughnut-making equipment and other capital expenditure items
necessary to operate a store. Payment terms on these items are 54 days
from the date of installation of the doughnut-making equipment. Accounts
receivable generated from a new store opening are typically in excess of
$350,000 per store. If franchise store openings are heavily concentrated
in a particular quarter, and depending on when they opened in the
quarter, the sales of the doughnut-making equipment and other capital
expenditure items we sell to franchisees can cause an increase in our
accounts receivable balances. In the fourth quarter of fiscal 2002, we
opened 20 franchise stores, concentrated in the mid to late weeks of the
quarter, which also contributed to the increase in accounts receivable.
We have had minimal experience with uncollectible accounts receivable
from our franchisees. We expect accounts receivable from franchisees will
continue to grow over time as we open new stores and sell mix, supplies
and other ingredients to an increasing base of franchise stores.
INVENTORIES. Our investment in inventories increased $4.0 million in fiscal
2002. Inventories in fiscal 2002 have increased primarily as a result of:
1) An increase in the number of Company-owned stores: 58 at January 30,
2000; 63 at January 28, 2001 and 75 at February 3, 2002. Each store
carries an inventory consisting of mix, other ingredients and supplies
necessary to operate the store. As we add more Company stores in the
future, we anticipate that inventory levels will grow accordingly.
34
2) A planned increase in inventory levels at KKM&D -- raw materials,
work-in-progress, finished goods and service parts -- to support the
increased number of stores in the system, as well as anticipated new
store openings. The total number of stores in operation at January 30,
2000, January 28, 2001 and February 3, 2002 were 144, 174, and 218,
respectively. Additionally, the Company anticipates opening 59 stores,
most of which will be Franchise stores, in fiscal 2003.
INCOME TAXES. During fiscal 2002, we made estimated income tax payments in the
first half of the fiscal year. Stock option exercises during the latter half of
the fiscal year resulted in tax deductions for the Company which significantly
lowered our income tax liability for fiscal 2002, resulting in an income tax
refundable amount of $2,534,000 at February 3, 2002. The timing of these
payments versus the timing of stock option exercises negatively impacted
operating cash flow for fiscal 2002.
Offsetting the additions to accounts receivable and inventories working capital
investments in fiscal 2002 were increases in accounts payable and accrued
expenses. The increase in accounts payable is a result of the overall growth in
operations, as well as increased purchasing, primarily in KKM&D operations, to
support the increased inventory levels maintained. The increase in accrued
expenses is a result of increases in personnel to support our growth in
operations. Additional headcount resulted in increased accruals for salary and
related benefits, insurance costs and the Company's contribution to the
profit-sharing stock ownership plan.
CASH FLOW FROM INVESTING ACTIVITIES
Net cash used for investing activities was $10.0 million in fiscal 2000, $67.3
million in fiscal 2001 and $52.3 million in fiscal 2002. Investing activities in
fiscal 2002 primarily consisted of capital expenditures for property, plant and
equipment (shown as purchase of property and equipment on the consolidated
statements of cash flows) and the acquisition of associate and area developer
markets, net of cash acquired. Investing activities in fiscal 2001 primarily
consisted of capital expenditures and the purchase of approximately $35.4
million of marketable securities with a portion of the proceeds from the initial
public offering and cash flow generated from operations. Investing activities in
fiscal 2000 primarily consisted of capital expenditures.
In fiscal 2002, our capital expenditures were $37.3 million, an increase of
$26.0 million, or 229.2%, compared with fiscal 2000 and an increase of $11.7
million, or 45.4%, compared with fiscal 2001. Capital expenditures in fiscal
2002 included: construction of new factory Company stores, capital expenditures
for Company stores, acquisition and upfit of the new equipment manufacturing
facility, remodels of Company stores, expenditures for the installation of a
coffee roasting operation and construction of doughnut and coffee shops.
Expenditures for some of these projects were not complete at year-end as the
projects were still under construction and were not operational as of February
3, 2002. These expenditures were necessary to support our efforts of increasing
sales of our products throughout North America and for future expansion
internationally. Capital expenditures for property and equipment in fiscal 2003
are expected to be in excess of $43 million; however, this amount could be
higher or lower depending on needs and situations that arise during the year.
This amount excludes capital expenditures related to the Company's new mix
manufacturing and distribution facility under construction in Effingham,
Illinois. As discussed in Note 21, Synthetic Lease, the Company initially
entered into a synthetic lease for this facility under which the lessor, a bank,
would fund construction of the facility and lease it to the Company. On March
21, 2002, the Company terminated the synthetic lease and purchased the facility,
which is still under construction and expected to be completed in the first half
of fiscal 2003, from the bank under a new credit agreement. Capital expenditures
related to the Effingham plant in fiscal 2003 are expected to include
approximately $35 million related to the purchase, completion and furnishing of
this new facility and will be in addition to the $43 million discussed above.
In fiscal 2002, we also spent $20.6 million for the acquisition of associate and
area developer markets, net of cash acquired. As previously discussed, we intend
to acquire franchise markets when the opportunity arises. In fiscal 2002, we
acquired the Savannah, GA, Charleston, SC and Baltimore, MD markets from
franchisees. We will acquire markets from franchisees if they are willing to
sell to us and if there are sound business reasons for us to make the
acquisition. These reasons may include a franchise market being contiguous to a
Company store market where an acquisition would provide operational synergies;
upside opportunity in the market because the franchisee has not fully developed
on-premises or off-premises sales; or if we believe our acquiring the market
would improve the brand image in the market. We have announced plans to acquire,
and are currently in negotiations relating to the acquisition of, the Akron and
Cleveland, Ohio markets, though this acquisition is still in process and has not
yet been finalized. We will be opportunistic about the acquisition of additional
franchise markets and may acquire other markets in fiscal 2003.
In fiscal 2001, investing activities primarily consisted of capital expenditures
for property and equipment and purchases of investments. The capital
expenditures primarily related to expenditures to support our off-premises sales
programs, capital expenditures for existing stores and equipment, development of
new stores and the acquisition of stores from existing franchisees. Net cash
used for investing activities was also used for investments in area developer
joint ventures. We believe acquiring an ownership interest in franchise markets
helps align interests between the Company and the franchisee and should provide
returns for shareholders as the operators of these franchise markets achieve
scale in their operations and become profitable. Additional investment activity
in area developer joint ventures was minimal in fiscal 2002, however we
continually evaluate opportunities to make an initial investment in franchise
markets where we do not have an interest or increase our
35
interest in markets where we do currently have an ownership interest. As
described in Note 15, Related Party Transactions, and Note 19, Joint Ventures,
to our consolidated financial statements, we spent $1.6 million on March 5, 2002
to acquire ownership interests from the Krispy Kreme Equity Group and from two
executive officers of the Company in certain franchise markets where we already
had an interest ranging from 3% to 59%.
Investing activities in fiscal 2001 also included approximately $35.4 million of
purchases of marketable securities with a portion of the proceeds from the
initial public offering and cash flow generated from operations.
In fiscal 2000, investing activities also consisted primarily of capital
expenditures for property and equipment, primarily related to expenditures to
support our off-premises sales programs, capital expenditures for existing
stores and equipment and the development of new stores.
CASH FLOW FROM FINANCING ACTIVITIES
Net cash provided by financing activities was $398,000 in fiscal 2000, $39.0
million in fiscal 2001 and $30.9 million in fiscal 2002.
Financing activities in fiscal 2002 consisted primarily of the completion of our
follow-on public offering which raised $17.2 million of capital, the exercise of
stock options which raised cash of $3.9 million and cash of $4.0 million
provided by outstanding checks which had not yet cleared the bank (book
overdraft). The follow-on public offering was for 10,400,000 shares of common
stock, of which 9,313,300 were sold by selling shareholders and 1,086,700 were
sold by the Company with net proceeds to the Company of $17.2 million.
Our financing activities in fiscal 2001 primarily consisted of the proceeds from
our initial public offering of $65.6 million, the net repayment of debt of $19.4
million and the payment of cash dividends of $7.0 million. The repayment of debt
was one of our stated uses of proceeds in our initial public offering filings
with the Securities and Exchange Commission while the cash dividends paid were
to pre initial public offering shareholders as part of our corporate
reorganization.
Our financing activities in fiscal 2000 primarily consisted of net borrowing of
long-term debt of $1.9 million to support our growth and the payment of $1.5
million of cash dividends declared in fiscal 1999.
CAPITAL RESOURCES, CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
In addition to cash flow generated from operations, the Company utilizes other
capital resources and financing arrangements to fund the expansion of the Krispy
Kreme concept. A discussion of these capital resources and financing techniques
is included below.
BANK FINANCING. On December 29, 1999, the Company entered into an unsecured
Loan Agreement (the "Agreement") with a bank to increase borrowing availability
and extend the maturity of its revolving credit facility. The Agreement provides
a $40 million revolving line of credit which replaced a $28 million line of
credit and $12 million term loan. The Agreement, as amended, expires on June 30,
2004.
Interest on the revolving line of credit is charged, at the Company's option, at
either the lender's prime rate less 110 basis points or at the one-month LIBOR
plus 100 basis points. There is no interest, fee or other charge for the
unadvanced portion of the line of credit until July 1, 2002 at which time we
will begin paying a fee of 0.10% on the unadvanced portion. At January 28, 2001,
the amount outstanding under the line of credit was $91,000. No amounts were
outstanding at February 3, 2002. The amount available under the line of credit
was $34.5 million at February 3, 2002 which is reduced by letters of credit and
certain amounts available or outstanding in connection with credit cards issued
by the lender on behalf of the Company. Outstanding letters of credit, primarily
for insurance liability purposes, totaled $4.0 million while amounts available
under credit cards issued by the Company totaled $1.5 million at February 3,
2002.
Interest on the term loan portion of the Agreement was computed on the same
basis as the revolving line of credit except that the floor and ceiling rates
were 5.5% and 8.125%, respectively. The Company initially entered into the $12
million term loan in July 1996. Repayment of this loan began in August 1996 with
monthly principal payments of $200,000 plus interest. The term loan was repaid
in full on April 10, 2000 without any penalty or premium.
The amended Agreement contains provisions that, among other requirements,
restrict capital expenditures, require the maintenance of certain financial
ratios, place various restrictions on the sale of properties, restrict our
ability to enter into collateral repurchase agreements and guarantees, restrict
the payment of dividends and require compliance with other customary financial
and nonfinancial covenants. At February 3, 2002, the Company was in compliance
with each of these covenants.
Our Northern California joint venture partner, Golden Gate Doughnuts, LLC, also
has a credit agreement with a bank to support its openings of new stores and the
growth of off-premises sales. On October 12, 2001, the Northern California joint
venture entered into a $6.8 million revolving line of credit agreement in which
the Company has guaranteed 59%, its percentage ownership of the joint venture as
of February 3, 2002. The line of credit bears interest at one-month LIBOR plus
125 basis points and matures on October 12, 2002. There is no interest, fee or
other charge for the unadvanced portion of the
36
line of credit. The current line of credit replaces a previous $1.5 million line
of credit established January 25, 2001 with similar terms. As of February 3,
2002, the amount outstanding under the revolving line of credit was $3.9
million.
Also on October 12, 2001, the Northern California joint venture converted its
previous revolving line of credit agreement, in the amount of $4.5 million, to a
term loan. The Company has also guaranteed 59% of the term loan. Under the terms
of the term loan agreement, repayment of the term loan began on November 12,
2001 with 59 equal monthly payments of $53,415 of principal and interest and one
final payment of all remaining principal and interest on October 12, 2006.
Interest on the term loan is charged at the lender's one-month LIBOR plus 125
basis points. At February 3, 2002, the outstanding principal balance was $4.4
million and the interest rate was 3.36%.
Prior to the January 25, 2001 agreement, the Northern California joint venture
had a $5 million revolving line of credit in place. The Company guaranteed all
amounts outstanding under that line of credit. Under the terms of that
agreement, interest on the revolving line of credit was payable monthly and
charged at the one-month LIBOR plus 100 basis points.
Based on our current expansion plans in Northern California, we will most likely
seek additional borrowing capacity to support planned store openings and sales
growth. The Company will most likely be required to guarantee a portion of this
additional credit equal to its ownership percentage of the joint venture.
SYNTHETIC LEASE. On April 26, 2001, the Company entered into a synthetic lease
agreement in which the lessor, a bank, had agreed to fund up to $35 million for
construction of the Company's new mix and distribution facility in Effingham,
Illinois (the "Facility"). Under the terms of the synthetic lease, the bank was
to pay all costs associated with the construction of the building and the
equipment to be used in the manufacturing and distribution processes. No
"special purpose entity" was a party to this transaction.
Under a synthetic lease, neither the cost of the Facility, nor the payment
obligations are shown as an asset or as debt, respectively, on the Company's
consolidated balance sheet. Therefore, the synthetic lease is often referred to
as "off-balance sheet financing." We entered into the synthetic lease: 1) due to
the attractiveness of the interest rate associated with the lease which, because
of competition among the financial institutions proposing on the synthetic lease
transaction, was lower than longer-term financing at the time we began
construction of the Facility; 2) due to the flexibility the synthetic lease
afforded us at the end of its term as we could purchase the facility with cash,
enter into another synthetic lease or enter into traditional financing; and 3)
because it allowed us to preserve cash as our monthly lease payments were only
covering interest costs on the Facility, as opposed to principal and interest,
resulting in a lower monthly payment. Lease payments were to begin upon
completion of the Facility (the "Completion Date"). Construction of the Facility
began in May 2001 and is expected to be completed in the first half of fiscal
2003. The initial term of the lease was five years following the Completion
Date. At the end of the lease, the Company guaranteed a residual value for the
Facility which would approximate 85% of its construction cost. The lease
required the Company to maintain compliance with certain covenants, including
maintenance of certain financial ratios. The Company was in compliance with all
covenants at February 3, 2002.
On February 12, 2002, a commitment letter was signed with the bank to terminate
the synthetic lease and purchase the Facility from the bank. On March 21, 2002,
the Company entered into a new credit agreement ("Credit Agreement") which
enabled the purchase of the Facility from the bank. The Credit Agreement
provides for funding of up to $35 million for the initial purchase and
completion of the Facility. The initial borrowing under the Credit Agreement was
$31.7 million.
Amounts advanced under the Credit Agreement bear interest at Adjusted LIBOR, as
defined within the Credit Agreement, plus an Applicable Margin, as defined
within the Credit Agreement. The Applicable Margin ranges from .75% to 1.75% and
is determined based upon the Company's performance under certain financial
covenants contained in the Credit Agreement. The interest rate applicable on
March 21, 2002 was 2.92%. Interest is payable monthly through the Completion
Date, at which time outstanding advances will convert to a term loan (the
"Loan"). Monthly payments of principal, equal to 1/240th of the principal amount
of the Loan, and interest will commence and continue through September 21, 2007,
at which time a final payment of all outstanding principal and accrued interest
will be due. The Credit Agreement also permits the Company to prepay the Loan in
whole at any time, or from time to time in part in amounts aggregating at least
$500,000 or any larger multiple of $100,000 without penalty.
The Credit Agreement contains provisions that, among other requirements,
restrict the payment of dividends and require the Company to maintain compliance
with certain covenants, including the maintenance of certain financial ratios.
OPERATING LEASES. The Company conducts some of its operations from leased
facilities and, additionally, leases certain equipment under operating leases.
Generally, these leases have initial terms of 5 to 18 years and contain
provisions for renewal options of 5 to 10 years. In determining whether to enter
into an operating lease for an asset, we evaluate the nature of the asset and
the associated operating lease terms to determine if operating leases are an
effective financing tool. We anticipate that we will continue to use operating
leases as a financing tool as appropriate.
DEBT & LEASE GUARANTEES AND COLLATERAL REPURCHASE AGREEMENTS. In order to open
stores and expand off-premises sales programs, our franchisees incur debt and
enter into operating lease agreements. For those franchisees in which we have an
ownership interest, we will guarantee an amount of the debt or leases equal to
our ownership percentage. Because these are relatively new entities without a
long track record of operations, these guarantees are necessary for our joint
venture partners to get financing for the growth of their businesses. In the
past, we have also guaranteed debt amounts or entered into collateral
37
repurchase agreements for Company stock or doughnut-making equipment for certain
franchisees when we did not have an ownership interest in them, though we have
suspended this practice unless there are some unusual circumstances which
require our financial guarantees. In accordance with generally accepted
accounting principles, these guarantees are not recorded as liabilities on our
consolidated balance sheet. As of February 3, 2002, we had lease guarantee
commitments totaling $523,000, loan guarantees totaling $3.3 million and
collateral repurchase agreements totaling $70,000. These amounts do not include
our debt guarantees of our Northern California joint venture partner as the
entire amount of the bank debt of this joint venture is shown as a liability on
our consolidated balance sheet nor does it include lease guarantees as the gross
amount of Northern California's lease commitments are shown in Note 8, Lease
Commitments, to our consolidated financial statements. Of the total guarantee
amounts of $7.2 million, $5.3 million are for franchisees in which we have an
ownership interest and $1.9 million are for franchisees in which we have no
ownership interest. The amount of debt and lease guarantees related to
franchisees in which we have an ownership interest will continue to grow as
these joint ventures open more stores while the amount of debt and lease
guarantees related to franchisees in which we do not have an interest is
expected to decrease. We consider it unlikely that we will have to satisfy any
of these guarantees.
OFF BALANCE SHEET ARRANGEMENTS. Upon termination of the synthetic lease
transaction on March 21, 2002 discussed above, the Company does not have any off
balance sheet debt nor does it have any transactions, arrangements or
relationships with any "special purpose" entities.
SUMMARIES OF OUR CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS AS OF
FEBRUARY 3, 2002 ARE AS FOLLOWS:
CONTRACTUAL CASH OBLIGATIONS AT FEBRUARY 3, 2002
<Table>
<Caption>
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------
PAYMENTS PAYMENTS PAYMENTS PAYMENTS
TOTAL DUE IN DUE IN DUE IN DUE BEYOND
CONTRACTUAL CASH OBLIGATIONS AMOUNT FISCAL 2003 FISCAL 2004 FISCAL 2005 FISCAL 2005
- ------------------------------------------------------------------------------------------------------------------
Long-term debt $ 4,643 $ 731 $ 523 $ 540 $ 2,849
Operating leases $58,001 $ 9,845 $7,478 $5,640 $35,038
-------------------------------------------------------------------------------
Total Contractual Cash Obligations $62,644 $10,576 $8,001 $6,180 $37,887
-------------------------------------------------------------------------------
</Table>
OTHER COMMERCIAL COMMITMENTS AT FEBRUARY 3, 2002
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------
OTHER COMMERCIAL COMMITMENTS TOTAL AMOUNTS COMMITTED AT FEBRUARY 3, 2002
- --------------------------------------------------------------------------------------------------------
Lines of credit $ 3,871
Letters of credit $ 3,955
Guarantees $ 3,875
-----------
Total Other Commercial Commitments $ 11,701
-----------
</Table>
In the next five years, we plan to use cash primarily for the following
activities:
- Adding mix production and distribution capacity to support expansion
- Remodeling and relocation of selected older company stores
- Expanding our equipment manufacturing and operations training facilities
- Investing in all or part of franchisees' operations
- Working capital and other corporate purposes.
Our capital requirements for the items outlined above may be significant. These
capital requirements will depend on many factors including our overall
performance, the pace of store expansion and company store remodels, the
requirements for joint venture arrangements and infrastructure needs for both
personnel and facilities. Prior to fiscal 2001, we primarily relied on cash flow
generated from operations and our line of credit to fund our capital needs. We
believe that the proceeds from the initial public offering completed in April
2000 and our follow-on public offering completed in early February 2001, cash
flow generated from operations and our borrowing capacity under our lines of
credit will be sufficient to meet our capital needs for at least the next 24
months. If additional capital is needed, we may raise such capital through
public or private equity or debt financing or other financing arrangements.
Future capital funding transactions may result in dilution to shareholders.
However, there can be no assurance that additional capital will be available or
be available on satisfactory terms. Our failure to raise additional capital
could have one or more of the following effects on our operations and growth
plans over the next five years:
- Slowing our plans to remodel and relocate older company-owned stores
- Reducing the number and amount of joint venture investments in area
developer stores
- Slowing the building of our infrastructure in both personnel and
facilities.
38
INFLATION
We do not believe that inflation has had a material impact on our results of
operations in recent years. However, we cannot predict what effect inflation may
have on our results of operations in the future.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
We are exposed to market risk from changes in interest rates on our outstanding
bank debt. Our revolving line of credit bears interest at either our lender's
prime rate minus 110 basis points or a rate equal to LIBOR plus 100 basis
points. We can elect the rate on a monthly basis. During fiscal 2002, our
Northern California area developer entered into a new credit facility with a
bank. The facilities under this agreement, a revolving line of credit and a term
loan, bear interest at LIBOR plus 125 basis points. We guarantee 59% of this
facility. Amounts outstanding under our Credit Agreement bear interest at
adjusted LIBOR plus an applicable margin which ranges from .75% to 1.75%. We
entered into an interest rate swap to convert the variable rate payments due
under the Credit Agreement on a notional amount of $33 million to a fixed rate
through May 1, 2007. The interest cost of our bank debt is affected by changes
in either prime or LIBOR. Such changes could adversely impact our operating
results.
We have no derivative financial interests or derivative commodity instruments in
our cash or cash equivalents. On any business day that we have excess cash
available, we use it to pay down our revolving line of credit.
Because the majority of the Company's revenue, expense and capital purchasing
activities are transacted in United States dollars, currently, the exposure to
foreign currency exchange risk is minimal. However, as our international
operations grow, our foreign currency exchange risks may increase.
We purchase certain commodities such as flour, sugar and soybean oil. These
commodities are usually purchased under long-term purchase agreements, generally
one to three years, at fixed prices. We are subject to market risk in that the
current market price of any commodity item may be below our contractual price.
We do not use financial instruments to hedge commodity prices.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS
No. 141, "Business Combinations". SFAS No. 141 addresses financial accounting
and reporting for business combinations and supersedes APB Opinion No. 16,
"Business Combinations", and SFAS No. 38 "Accounting for Preacquisition
Contingencies of Purchased Enterprises". All business combinations in the scope
of this Statement are to be accounted for using one method, the purchase method.
The Company adopted the provisions of this pronouncement for all business
combinations subsequent to June 30, 2001. Its adoption did not have a
significant impact on the consolidated financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", effective for years beginning after December 15, 2001, or the Company's
fiscal year 2003. However, goodwill and other intangibles arising from
acquisitions subsequent to June 30, 2001 will be accounted for under the
provisions of this Statement, including the non-amortization provisions. SFAS
No. 142 addresses financial accounting and reporting for acquired goodwill and
other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets".
It addresses how intangible assets that are acquired individually or with a
group of other assets (but not those acquired in a business combination) should
be accounted for in financial statements upon their acquisition. Goodwill and
some intangible assets will no longer be amortized, but will be reviewed at
least annually for impairment. As compared to previous standards, the provisions
of SFAS No. 142 may result in more volatility in reported income as impairment
losses may occur irregularly and in varying amounts. The Company has adopted the
non-amortization provision for indefinite lived assets for all acquisitions with
a closing date subsequent to June 30, 2001. Prior to the adoption of SFAS No.
142, the Company recorded amortization expense of $100,000 in fiscal 2002
related to indefinite lived intangibles. Management is currently evaluating the
effects of the other provisions of this Statement.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations", effective for years beginning after June 15, 2002, or the
Company's fiscal year 2004. SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. Management is
currently evaluating the effects of this Statement.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", effective for years beginning after December 15,
2001, or the Company's fiscal year 2003. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions". SFAS
No. 144 retains the requirements of SFAS No. 121 to recognize an impairment loss
only if the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows and to measure an impairment loss as the difference
between the carrying amount and the fair value of the asset. However, this
standard removes goodwill from its scope and revises the approach for evaluating
impairment. Management is currently evaluating the impact of the adoption of
this Statement.
39
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
IN THOUSANDS
- -----------------------------------------------------------------------------------------------
JAN. 28, 2001 FEB. 3, 2002
- -----------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,026 $ 21,904
Short-term investments 18,103 15,292
Accounts receivable, less allowance for doubtful accounts of
$1,302 (2001) and $1,182 (2002) 19,855 26,894
Accounts receivable, affiliates 2,599 9,017
Other receivables 2,279 2,771
Inventories 12,031 16,159
Prepaid expenses 1,909 2,591
Income taxes refundable -- 2,534
Deferred income taxes 3,809 4,607
--------------------------------
Total current assets 67,611 101,769
Property and equipment, net 78,340 112,577
Long-term investments 17,877 12,700
Investment in unconsolidated joint ventures 2,827 3,400
Intangible assets -- 16,621
Other assets 4,838 8,309
--------------------------------
Total assets $ 171,493 $ 255,376
--------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 8,211 $ 12,095
Book overdraft 5,147 9,107
Accrued expenses 21,243 26,729
Revolving line of credit 3,526 3,871
Current maturities of long-term debt -- 731
Income taxes payable 41 --
--------------------------------
Total current liabilities 38,168 52,533
--------------------------------
Deferred income taxes 579 3,930
Compensation deferred (unpaid) 1,106 727
Long-term debt, net of current portion -- 3,912
Accrued restructuring expenses 3,109 1,919
Other long-term obligations 1,735 2,197
--------------------------------
Total long-term liabilities 6,529 12,685
Commitments and contingencies
Minority interest 1,117 2,491
SHAREHOLDERS' EQUITY:
Preferred stock, no par value, 10,000 shares authorized;
none issued and outstanding -- --
Common stock, no par value, 100,000 shares authorized;
issued and outstanding -- 51,832 (2001) and 54,271 (2002) 85,060 121,052
Unearned compensation (188) (186)
Notes receivable, employees (2,349) (2,580)
Nonqualified employee benefit plan assets (126) (138)
Nonqualified employee benefit plan liability 126 138
Accumulated other comprehensive income 609 456
Retained earnings 42,547 68,925
--------------------------------
Total shareholders' equity 125,679 187,667
--------------------------------
Total liabilities and shareholders' equity $ 171,493 $ 255,376
--------------------------------
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
40
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
IN THOUSANDS, EXCEPT PER SHARE ACCOUNTS
- --------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- --------------------------------------------------------------------------------------------
Total revenues $220,243 $300,715 $394,354
Operating expenses 190,003 250,690 316,946
General and administrative expenses 14,856 20,061 27,562
Depreciation and amortization expenses 4,546 6,457 7,959
----------------------------------------------
Income from operations 10,838 23,507 41,887
Interest income 293 2,325 2,980
Interest expense (1,525) (607) (337)
Equity loss in joint ventures -- (706) (602)
Minority interest -- (716) (1,147)
Loss on sale of property and equipment -- (20) (235)
----------------------------------------------
Income before income taxes 9,606 23,783 42,546
Provision for income taxes 3,650 9,058 16,168
----------------------------------------------
Net income $ 5,956 $ 14,725 $ 26,378
----------------------------------------------
Basic earnings per share $ 0.16 $ 0.30 $ 0.49
----------------------------------------------
Diluted earnings per share $ 0.15 $ 0.27 $ 0.45
----------------------------------------------
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
41
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<Table>
<Caption>
---------------------------------------- ------------------------------------------
KRISPY KREME DOUGHNUT CORPORATION KRISPY KREME DOUGHNUTS, INC.
- -------------------------------------------------------------------------------------------------------------------------
COMMON COMMON ADDITIONAL PREFERRED PREFERRED COMMON COMMON
SHARES STOCK PAID-IN CAPITAL SHARES STOCK SHARES STOCK
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 31, 1999 467 $ 4,670 $10,805 -- $ -- -- $ --
Net income for the year ended
January 30, 2000
Collections of Long-Term Incentive
Plan shares receivable
Issuance of notes receivable
-------------------------------------------------------------------------------------
BALANCE AT JANUARY 30, 2000 467 $ 4,670 $10,805 -- $ -- -- $ --
Comprehensive income:
Net income for the year ended
January 28, 2001
Unrealized holding gain, net
Total comprehensive income
Proceeds from public offering 13,800 65,637
Conversion of Krispy Kreme
Doughnut Corporation shares to
Krispy Kreme Doughnuts, Inc.
shares (467) (4,670) (10,805) 37,360 15,475
Cash dividend to shareholders
Issuance of shares to employee
stock ownership plan 580 3,039
Contribution to the nonqualified
employee benefit plan
Liability under the nonqualified
employee benefit plan
Issuance of restricted common
shares 12 210
Exercise of stock options,
including tax benefit of $595 80 699
Amortization of restricted common
shares
Collection of notes receivable
-------------------------------------------------------------------------------------
BALANCE AT JANUARY 28, 2001 -- $ -- $ -- -- $ -- 51,832 $ 85,060
Comprehensive income:
Net income for the year ended
February 3, 2002
Unrealized holding loss, net
Foreign currency translation
adjustment
Total comprehensive income
Proceeds from public offering 1,086 17,202
Exercise of stock options,
including tax benefit of $9,772 1,183 13,678
Issuance of shares in conjunction
with acquisition of associate
market 115 4,183
Adjustment of nonqualified
employee benefit plan
investments
Issuance of restricted common
shares 1 50
Amortization of restricted common
shares
Issuance of stock for notes
receivable 54 879
Collection of notes receivable
-------------------------------------------------------------------------------------
BALANCE AT FEBRUARY 3, 2002 -- $ -- $ -- -- $ -- 54,271 $121,052
-------------------------------------------------------------------------------------
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
42
<Table>
<Caption>
IN THOUSANDS
- ----------------------------------------------------------------------------------------------------------
NOTES NONQUALIFIED NONQUALIFIED ACCUMULATED OTHER
UNEARNED RECEIVABLE, EMPLOYEE BENEFIT EMPLOYEE BENEFIT COMPREHENSIVE RETAINED
COMPENSATION EMPLOYEES PLAN ASSETS PLAN LIABILITY INCOME EARNINGS TOTAL
- ----------------------------------------------------------------------------------------------------------
$ -- $(2,099) $ -- $ -- $ -- $28,871 $ 42,247
5,956 5,956
226 226
(674) (674)
- ----------------------------------------------------------------------------------------------------------
$ -- $(2,547) $ -- $ -- $ -- $34,827 $ 47,755
14,725 14,725
609 609
-------
15,334
65,637
--
(7,005) (7,005)
3,039
(126) (126)
126 126
(210) --
699
22 22
198 198
- ----------------------------------------------------------------------------------------------------------
$ (188) $(2,349) $(126) $126 $ 609 $42,547 $125,679
26,378 26,378
(111) (111)
(42) (42)
-------
26,225
17,202
13,678
4,183
(12) 12 --
(50) --
52 52
(879) --
648 648
- ----------------------------------------------------------------------------------------------------------
$ (186) $(2,580) $(138) $138 $ 456 $68,925 $187,667
- ----------------------------------------------------------------------------------------------------------
</Table>
43
KRISPY KREME DOUGHNUTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 5,956 $ 14,725 $ 26,378
Items not requiring (providing) cash:
Depreciation and amortization 4,546 6,457 7,959
Deferred income taxes 258 1,668 2,553
Loss on disposal of property and equipment, net -- 20 235
Compensation expense related to restricted stock
awards -- 22 52
Tax benefit from exercise of nonqualified stock
options -- 595 9,772
Provision for restructuring (127) -- --
Provision for store closings and impairment 1,139 318 --
Minority interest -- 716 1,147
Equity loss in joint ventures -- 706 602
Change in assets and liabilities:
Receivables (4,760) (3,434) (13,317)
Inventories (93) (2,052) (3,977)
Prepaid expenses (1,619) 1,239 (682)
Income taxes, net (2,016) 902 (2,575)
Accounts payable 540 2,279 3,884
Accrued expenses 4,329 7,966 4,096
Deferred compensation and other long-term obligations 345 (15) 83
-----------------------------------------------------
Net cash provided by operating activities 8,498 32,112 36,210
-----------------------------------------------------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchase of property and equipment (11,335) (25,655) (37,310)
Proceeds from disposal of property and equipment -- 1,419 3,196
Proceeds from disposal of assets held for sale 830 -- --
Acquisition of associate and area developer markets,
net of cash acquired -- -- (20,571)
Investments in unconsolidated joint ventures -- (4,465) (1,218)
(Increase) decrease in other assets 479 (3,216) (4,237)
(Purchase) sale of investments, net -- (35,371) 7,877
-----------------------------------------------------
Net cash used for investing activities: (10,026) (67,288) (52,263)
-----------------------------------------------------
CASH FLOW FROM FINANCING ACTIVITIES:
Repayment of long-term debt (2,400) (3,600) --
Net (repayments) borrowings from revolving line of
credit -- (15,775) 345
Borrowings of long-term debt 4,282 -- 4,643
Proceeds from stock offering -- 65,637 17,202
Proceeds from exercise of stock options -- 104 3,906
Minority interest -- 401 227
Book overdraft 482 (941) 3,960
Cash dividends paid (1,518) (7,005) --
Issuance of notes receivable (674) -- --
Collection of notes receivable 226 198 648
-----------------------------------------------------
Net cash provided by financing activities: 398 39,019 30,931
-----------------------------------------------------
Net increase (decrease) in cash and cash equivalents (1,130) 3,843 14,878
Cash and cash equivalents at beginning of year 4,313 3,183 7,026
-----------------------------------------------------
Cash and cash equivalents at end of year $ 3,183 $ 7,026 $ 21,904
-----------------------------------------------------
Supplemental schedule of non-cash investing and
financing activities:
Issuance of stock to Krispy Kreme Profit-Sharing
Stock Ownership Plan $ -- $ 3,039 $ --
Issuance of restricted common shares -- 210 50
Issuance of stock in conjunction with acquisition of
associate market -- -- 4,183
Issuance of stock in exchange for employee notes
receivable -- -- 879
Unrealized gain (loss) on investments -- 609 (111)
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
44
KRISPY KREME DOUGHNUTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND PURPOSE
Krispy Kreme Doughnuts, Inc. was incorporated in North Carolina on December 2,
1999 as a wholly-owned subsidiary of Krispy Kreme Doughnut Corporation ("KKDC").
Pursuant to a plan of merger approved by shareholders on November 10, 1999, the
shareholders of KKDC became shareholders of Krispy Kreme Doughnuts, Inc. on
April 4, 2000. Each shareholder received 20 shares of Krispy Kreme Doughnuts,
Inc. common stock and $15 in cash for each share of KKDC common stock they held.
As a result of the merger, KKDC became a wholly-owned subsidiary of Krispy Kreme
Doughnuts, Inc. Krispy Kreme Doughnuts, Inc. closed a public offering of its
common stock on April 10, 2000 by selling 3,450,000 common shares at a price of
$21 per share.
In February 2001, the Company completed a follow-on public offering of 2,600,000
shares of common stock at a price of $67 per share with the net proceeds
totaling $63.66 per share after underwriters' commissions. The 2,600,000 shares
included a 300,000 share over-allotment option exercised by the underwriters. Of
the 2,600,000 shares, 2,328,325 were sold by selling shareholders and 271,675
were sold by the Company.
All consolidated financial statements prior to the merger are those of KKDC and
all consolidated financial statements after the merger are those of Krispy Kreme
Doughnuts, Inc. For purposes of computing earnings per share, the number of
common shares prior to the merger have been restated to reflect the 20 shares of
Krispy Kreme Doughnuts, Inc. common stock issued for each share of KKDC's common
stock, to reflect a two-for-one stock split effective March 19, 2001 to
shareholders of record as of March 5, 2001 and a two-for-one stock split
effective June 14, 2001 to shareholders of record as of May 29, 2001. All
references to the number of shares (other than common stock issued or
outstanding on the 2000 Consolidated Statement of Shareholders' Equity), per
share amounts, cash dividends and any other reference to shares in the
Consolidated Financial Statements and the accompanying Notes to Consolidated
Financial Statements ("Notes"), except in Note 1 or unless otherwise noted, have
been adjusted to reflect the splits on a retroactive basis. Previously awarded
stock options, restricted stock awards, and all other agreements payable in
Krispy Kreme Doughnuts, Inc. common stock have been adjusted or amended to
reflect the splits.
2. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS. Krispy Kreme Doughnuts Inc. and its subsidiaries (the
"Company") are engaged principally in the sale of doughnuts and related items
through Company-owned stores. The Company also derives revenue from franchise
and development fees and the collection of royalties from franchisees.
Additionally, the Company sells doughnutmaking equipment and mix and other
ingredients and supplies used in operating a doughnut store to Company-owned and
franchised stores.
The significant accounting policies followed by the Company in preparing the
accompanying financial statements are as follows:
BASIS OF CONSOLIDATION. The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions are eliminated in consolidation.
Generally, investments greater than 50 percent in affiliates for which the
Company maintains control are also consolidated and the portion not owned by the
Company is shown as a minority interest. Generally, investments in 20- to
50-percent owned affiliates for which the Company has the ability to exercise
significant influence over operating and financial policies are accounted for by
the equity method of accounting, whereby the investment is carried at the cost
of acquisition, plus the Company's equity in undistributed earnings or losses
since acquisition, less any distributions received by the Company. Accordingly,
the Company's share of the net earnings of these companies is included in
consolidated net income. Investments in less than 20-percent owned affiliates
are accounted for by the cost method of accounting.
FISCAL YEAR. The Company's fiscal year is based on a fifty-two/fifty-three week
year. The fiscal year ends on the Sunday closest to the last day in January. The
years ended January 30, 2000 and January 28, 2001 contained 52 weeks. The year
ended February 3, 2002 contained 53 weeks.
CASH AND CASH EQUIVALENTS. The Company considers cash on hand, deposits in
banks, and all highly liquid debt instruments with a maturity of three months or
less at date of acquisition to be cash and cash equivalents.
INVENTORIES. Inventories are recorded at the lower of average cost (first-in,
first-out) or market.
INVESTMENTS. Investments consist of United States Treasury notes,
mortgage-backed government securities, corporate debt securities, municipal
securities and certificates of deposit and are included in short-term and
long-term investments in the accompanying consolidated balance sheets.
Certificates of deposit are carried at cost which approximates fair value. All
other marketable securities are stated at market value as determined by the most
recently traded price of each security at the balance sheet date.
Management determines the appropriate classification of its investments in
marketable securities at the time of the purchase and reevaluates such
determination at each balance sheet date. As of February 3, 2002, all marketable
securities are classified as available-for-sale. Available-for-sale securities
are carried at fair value with the unrealized gains and losses reported as a
separate
45
component of shareholders' equity in accumulated other comprehensive income. The
cost of investments sold is determined on the specific identification or the
first-in, first-out method.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost less
accumulated depreciation. Major renewals and betterments are charged to the
property accounts while replacements, maintenance, and repairs which do not
improve or extend the lives of the respective assets are expensed currently.
Interest is capitalized on major capital expenditures during the period of
construction.
Depreciation of property and equipment is provided on the straight-line method
over the estimated useful lives: Buildings -- 15 to 35 years; Machinery and
equipment -- 3 to 15 years; Leasehold improvements -- lesser of useful lives of
assets or lease term.
Assets acquired in the first half of the fiscal year are depreciated for a half
year in the year of acquisition. Assets acquired in the second half of the
fiscal year are not depreciated in the year of acquisition but are depreciated
for a full year in the next fiscal year.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
INCOME TAXES. The Company uses the asset and liability method to account for
income taxes, which requires the recognition of deferred tax liabilities and
assets for the expected future tax consequences of temporary differences between
tax bases and financial reporting bases for assets and liabilities.
FAIR VALUE OF FINANCIAL INSTRUMENTS. Cash, accounts receivable, accounts
payable, accrued liabilities and variable rate debt are reflected in the
financial statements at cost which approximates fair value because of the
short-term maturity of these instruments.
ADVERTISING COSTS. All costs associated with advertising and promoting products
are expensed in the period incurred.
STORE OPENING COSTS. All costs, both direct and indirect, incurred to open
either Company or franchise stores are expensed in the period incurred. Direct
costs to open stores amounted to $254,000, $464,000 and $551,000 in 2000, 2001
and 2002, respectively.
STORE CLOSING COSTS. When a decision is made to close a store, the Company
records a charge to cover the estimated costs of the planned store closing
including (1) the unrecoverable portion of the remaining lease payments on
leased stores, (2) the write-down of store assets to reflect estimated
realizable values (recorded as a reduction of the recorded asset on the
Company's consolidated balance sheet), and (3) other costs associated with the
store closing. Other closing costs and the current portion of lease liabilities
are recorded in Accrued Expenses on the Company's consolidated balance sheet.
The long-term portion of lease liabilities is recorded in Other Long-Term
Obligations.
At the store closing date, the Company discontinues depreciation on all assets
related to closed store properties. Disposition efforts on assets held for sale
begin immediately following the store closing. Reductions in the amount accrued
for store closings represent ongoing lease payments on remaining lease
obligations.
REVENUE RECOGNITION. A summary of the revenue recognition policies for each
segment of the Company (see Note 14) is as follows:
- Company Store Operations revenue is derived from the sale of doughnuts and
related items to on-premises and off-premises customers. Revenue is
recognized at the time of sale for on-premises sales and at the time of
delivery for off-premises sales.
- Franchise Operations revenue is derived from: (1) development and
franchise fees from the opening of new stores; and (2) royalties charged
to franchisees based on sales. Development and franchise fees are charged
for certain new stores and are deferred until the store is opened. The
royalties recognized in each period are based on the sales in that period.
- KKM&D revenue is derived from the sale of doughnut-making equipment, mix
and other supplies needed to operate a doughnut store to Company-owned and
franchised stores. Revenue is recognized at the time the title and the
risk of loss pass to the customer, generally upon delivery of the goods.
Revenue from Company-owned stores and consolidated joint venture stores is
eliminated in consolidation.
STOCK-BASED COMPENSATION. The Company accounts for employee stock options in
accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees." Under APB Opinion No. 25, the Company recognizes
no compensation expense related to employee stock options, as no options are
granted below the market price at the grant date.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," requires the recognition of compensation expense
based on the fair value of options on the grant date but allows companies to
continue
46
applying APB Opinion No. 25 if certain pro forma disclosures are made assuming
hypothetical fair value method application. For additional information on the
Company's stock options, including pro forma disclosures required by SFAS No.
123, refer to Note 13, Shareholders' Equity.
CONCENTRATION OF CREDIT RISK. Financial instruments that potentially subject
the Company to credit risk consist principally of accounts receivable. Accounts
receivable are primarily from grocery and convenience stores. The Company
performs ongoing credit evaluations of its customers' financial condition. The
Company had no single customer that accounted for more than 10% of total
revenues in fiscal 2001 nor fiscal 2002. In fiscal 2000, there was one customer
that accounted for 10.2% of total revenues. The Company's two largest customers
accounted for 17.9%, 15.6% and 12.5% of total revenues for fiscal 2000, fiscal
2001 and fiscal 2002, respectively. Accounts receivable for these two customers
accounted for approximately 42.5%, 16.9% and 14.5% of net accounts receivable at
January 30, 2000, January 28, 2001 and February 3, 2002, respectively.
COMPREHENSIVE INCOME. SFAS No. 130, "Reporting Comprehensive Income," requires
that certain items such as foreign currency translation adjustments, unrealized
gains and losses on certain investments in debt and equity securities and
minimum pension liability adjustments be presented as separate components of
shareholders' equity. SFAS No. 130 defines these as items of other comprehensive
income and as such must be reported in a financial statement that is displayed
with the same prominence as other financial statements. Accumulated other
comprehensive income, as reflected in the Consolidated Statements of
Shareholders' Equity, was comprised of net unrealized holding gains on
marketable securities of $609,000 at January 28, 2001 and $498,000 at February
3, 2002, as well as foreign currency translation adjustment of $42,000 at
February 3, 2002.
FOREIGN CURRENCY TRANSLATION. For all non-U.S. joint ventures, the functional
currency is the local currency. Assets and liabilities of those operations are
translated into U.S. dollars using exchange rates at the balance sheet date;
income and expenses are translated using the average exchange rates for the
reporting period. Translation adjustments are deferred in accumulated other
comprehensive income (loss), a separate component of shareholders' equity.
INTANGIBLE ASSETS. Intangible assets include goodwill recorded in connection
with a business acquisition and the value assigned to reacquired franchise
agreements in connection with the acquisition of the rights to certain markets
from franchisees. Goodwill and reacquired franchise agreements associated with
acquisitions completed on or before June 30, 2001 were amortized on a
straight-line basis over an estimated life of 15 years. Reacquired franchise
agreements associated with acquisitions completed after June 30, 2001 were not
amortized. The Company periodically evaluates the recoverability of goodwill and
reacquired franchise agreements and will adjust recorded amounts for impairment
losses. The Company believes that no impairment of intangible assets existed at
February 3, 2002.
RECENT ACCOUNTING PRONOUNCEMENTS. In July 2001, the Financial Accounting
Standards Board (the "FASB") issued SFAS No. 141, "Business Combinations". SFAS
No. 141 addresses financial accounting and reporting for business combinations
and supersedes APB Opinion No. 16, "Business Combinations", and SFAS No. 38
"Accounting for Preacquisition Contingencies of Purchased Enterprises". All
business combinations in the scope of this Statement are to be accounted for
using one method, the purchase method. The Company adopted the provisions of
this pronouncement for all business combinations subsequent to June 30, 2001.
Its adoption did not have a significant impact on the consolidated financial
statements
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", effective for years beginning after December 15, 2001, or the Company's
fiscal year 2003. However, goodwill and other intangibles arising from
acquisitions subsequent to June 30, 2001 will be accounted for under the
provisions of this Statement, including the non-amortization provisions. SFAS
No. 142 addresses financial accounting and reporting for acquired goodwill and
other intangible assets and supersedes APB Opinion No. 17, "Intangible Assets".
It addresses how intangible assets that are acquired individually or with a
group of other assets (but not those acquired in a business combination) should
be accounted for in financial statements upon their acquisition. Goodwill and
some intangible assets will no longer be amortized, but will be reviewed at
least annually for impairment. As compared to previous standards, the provisions
of SFAS No. 142 may result in more volatility in reported income as impairment
losses may occur irregularly and in varying amounts. The Company has adopted the
non-amortization provision for indefinite lived assets for all acquisitions with
a closing date subsequent to June 30, 2001. The Company recorded amortization
expense of $100,000 in fiscal 2002 related to indefinite lived intangibles.
Management is currently evaluating the effects of the other provisions of this
Statement.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations", effective for years beginning after June 15, 2002, or the
Company's fiscal year 2004. SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. It applies to legal
obligations associated with the retirement of long-lived assets that result from
the acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. Management is
currently evaluating the effects of this Statement.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", effective for years beginning after December 15,
2001, or the Company's fiscal year 2003. SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of" and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions". SFAS
No. 144 retains the requirements of SFAS No. 121 to
47
recognize an impairment loss only if the carrying amount of a long-lived asset
is not recoverable from its undiscounted cash flows and to measure an impairment
loss as the difference between the carrying amount and the fair value of the
asset. However, this standard removes goodwill from its scope and revises the
approach for evaluating impairment. Management is currently evaluating the
impact of the adoption of this Statement.
RECLASSIFICATIONS. Certain reclassifications of amounts in the 2000 and 2001
Consolidated Financial Statements and related notes have been made to conform
with the 2002 presentation.
3. INVESTMENTS
THE FOLLOWING TABLE PROVIDES CERTAIN INFORMATION ABOUT INVESTMENTS AT JANUARY
28, 2001 AND FEBRUARY 3, 2002.
<Table>
<Caption>
IN THOUSANDS
- ------------------------------------------------------------------------------------------------------------------
AMORTIZED GROSS UNREALIZED GROSS UNREALIZED FAIR
COST HOLDING GAINS HOLDING LOSSES VALUE
- ------------------------------------------------------------------------------------------------------------------
JANUARY 28, 2001
Certificates of deposit $ 5,000 $ -- $ -- $ 5,000
U.S. government notes 4,996 73 (20) 5,049
Federal government agencies 18,900 458 (50) 19,308
Corporate debt securities 6,475 151 (3) 6,623
-------------------------------------------------------------------------
Total $35,371 $682 $ (73) $35,980
-------------------------------------------------------------------------
FEBRUARY 3, 2002
U.S. government notes $ 9,049 $ -- $ (17) $ 9,032
Federal government agencies 10,959 442 (166) 11,235
Corporate debt securities 6,475 317 (88) 6,704
Other bonds 1,043 -- (22) 1,021
-------------------------------------------------------------------------
Total $27,526 $759 $(293) $27,992
-------------------------------------------------------------------------
</Table>
MATURITIES OF INVESTMENTS WERE AS FOLLOWS AT FEBRUARY 3, 2002:
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------
AMORTIZED FAIR
COST VALUE
- ---------------------------------------------------------------------------------------
FEBRUARY 3, 2002
Due within one year $14,988 $15,292
Due after one year through five years 12,538 12,700
------------------------
Total $27,526 $27,992
------------------------
</Table>
4. INVENTORIES
THE COMPONENTS OF INVENTORIES ARE AS FOLLOWS:
<Table>
<Caption>
IN THOUSANDS
- --------------------------------------------------------------------------------------------------------------
DISTRIBUTION EQUIPMENT MIX COMPANY
CENTER DEPARTMENT DEPARTMENT STORES TOTAL
- --------------------------------------------------------------------------------------------------------------
JANUARY 28, 2001
Raw materials $ -- $1,756 $475 $1,578 $ 3,809
Work in progress -- 248 -- -- 248
Finished goods 880 1,435 13 -- 2,328
Purchased merchandise 4,981 -- -- 641 5,622
Manufacturing supplies -- -- 24 -- 24
-------------------------------------------------------------------------
Totals $5,861 $3,439 $512 $2,219 $12,031
-------------------------------------------------------------------------
FEBRUARY 3, 2002
Raw materials $ -- $3,060 $788 $1,826 $ 5,674
Work in progress -- 28 -- -- 28
Finished goods 1,318 2,867 95 -- 4,280
Purchased merchandise 5,503 -- -- 613 6,116
Manufacturing supplies -- -- 61 -- 61
-------------------------------------------------------------------------
Totals $6,821 $5,955 $944 $2,439 $16,159
-------------------------------------------------------------------------
</Table>
48
5. PROPERTY AND EQUIPMENT
PROPERTY AND EQUIPMENT CONSIST OF THE FOLLOWING:
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------------
JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------
Land $ 11,144 $ 14,823
Buildings 29,637 39,566
Machinery and equipment 65,119 86,683
Leasehold improvements 10,440 13,463
Construction in progress 556 1,949
-------------------------------
116,896 156,484
Less: accumulated depreciation 38,556 43,907
-------------------------------
Property and equipment, net $ 78,340 $ 112,577
-------------------------------
</Table>
Depreciation expense was $4,042,000, $6,571,000 and $7,398,000 for fiscal 2000,
fiscal 2001 and fiscal 2002, respectively.
6. ACCRUED EXPENSES
ACCRUED EXPENSES CONSIST OF THE FOLLOWING:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------
JAN. 30, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------
Salaries, wages and incentive compensation $ 7,067 $ 8,230
Restructuring expenses 1,022 1,195
Deferred revenue 2,042 2,082
Profit-sharing stock ownership plan contribution 2,075 3,456
Advertising fund 1,353 186
Insurance 2,687 4,891
Other 4,997 6,689
------------------------------
$ 21,243 $ 26,729
------------------------------
</Table>
7. REVOLVING CREDIT AGREEMENT AND LONG-TERM DEBT
On December 29, 1999, the Company entered into an unsecured Loan Agreement (the
"Agreement") with a bank to increase borrowing availability and extend the
maturity of its revolving line of credit. The Agreement provides a $40 million
revolving line of credit, which replaced a $28 million revolving line of credit,
and a $12 million term loan. The Agreement, as amended, expires on June 30,
2004.
REVOLVING LINE OF CREDIT. Under the terms of the Agreement, interest on the
revolving line of credit is charged, at the Company's option, at either the
lender's prime rate less 110 basis points or at the one-month LIBOR plus 100
basis points. There is no interest, fee or other charge for the unadvanced
portion of the line of credit until July 1, 2002 at which time the Company will
begin paying a fee of 0.10% on the unadvanced portion. At January 28, 2001, the
amount outstanding under the revolving line of credit was $91,000. No amounts
were outstanding at February 3, 2002. The amount available under the line of
credit is reduced by letters of credit and certain amounts available or
outstanding in connection with credit cards issued by the lender on behalf of
the Company and was $34.5 million at February 3, 2002. Outstanding letters of
credit, primarily for insurance liability purposes, totaled $3,955,000, while
amounts available in connection with credit cards issued by the lender totaled
$1,527,000 at February 3, 2002.
TERM LOAN. The Company initially entered into the $12,000,000 term loan in July
1996. Repayment of this loan began in August 1996, with monthly principal
payments of $200,000 plus interest. Interest on the term loan was computed on
the same basis as the revolving line of credit except that the floor and ceiling
rates were 5.5% and 8.125%, respectively. The term loan was repaid in full on
April 10, 2000 without any penalty or premium.
The amended Agreement contains provisions that, among other requirements,
restrict capital expenditures, require the maintenance of certain financial
ratios, place various restrictions on the sale of properties, restrict our
ability to enter into collateral repurchase agreements and guarantees, restrict
the payment of dividends and require compliance with other customary financial
and nonfinancial covenants. At February 3, 2002, the Company was in compliance
with each of these covenants.
CONSOLIDATED JOINT VENTURES. On October 12, 2001, the Northern California joint
venture entered into a $6,750,000 revolving line of credit agreement in which
the Company has guaranteed 59% of the line of credit. The line of credit bears
interest at one-month LIBOR plus 125 basis points and matures on October 12,
2002. There is no interest, fee or other charge for the unadvanced portion of
the line of credit. The line of credit replaced a previous $1,500,000 line of
credit, established
49
January 25, 2001, with similar terms. As of February 3, 2002, the amount
outstanding under the revolving line of credit was $3,871,000 and the interest
rate was 3.36%. The amount not guaranteed by the Company is collateralized by
buildings and equipment owned by the Northern California joint venture.
Also on October 12, 2001, the Northern California joint venture converted its
previous revolving line of credit agreement, in the amount of $4,500,000, to a
term loan. The Company has also guaranteed 59%, its percentage ownership of the
joint venture as of February 3, 2002, of the outstanding balance of the term
loan. Under the terms of the term loan agreement, repayment of the loan began on
November 12, 2001 with 59 equal monthly payments of $53,415 of principal and
interest and one final payment of all remaining principal and interest on
October 12, 2006. Interest on the term loan is charged at the lender's one-month
LIBOR plus 125 basis points. At February 3, 2002, the outstanding principal
balance was $4,418,000 and the interest rate was 3.36%. The amount not
guaranteed by the Company is collateralized by buildings and equipment owned by
the Northern California joint venture.
Prior to the January 25, 2001 agreement, the Northern California joint venture
had a $5 million revolving line of credit in place. The Company guaranteed all
amounts outstanding under that line of credit. Under the terms of that
agreement, interest on the revolving line of credit was payable monthly and
charged at the one-month LIBOR plus 100 basis points.
On October 29, 2001, the Philadelphia joint venture entered into a non-bank loan
agreement in order to finance a parcel of land. Under the terms of the loan
agreement, repayment of the loan began in November 2001 with 9 equal monthly
payments of principal and interest of $1,930 and one final payment of $222,500
due August 2002. Interest on the loan is charged at 8.0%. The amount outstanding
on this loan at February 3, 2002 is $225,000.
The aggregate maturities for the term loans and the revolvers for the five years
after February 3, 2002 are $4,602,000, $523,000, $540,000, $558,000, and
$2,291,000, respectively.
Interest paid, including interest related to deferred compensation arrangements,
was $1,525,000 in fiscal 2000, $607,000 in fiscal 2001 and $337,000 in fiscal
2002.
8. LEASE COMMITMENTS
The Company conducts some of its operations from leased facilities and,
additionally, leases certain equipment under operating leases. Generally, these
have initial lease terms of 5 to 18 years and contain provisions for renewal
options of 5 to 10 years.
AT FEBRUARY 3, 2002, FUTURE MINIMUM ANNUAL RENTAL COMMITMENTS, GROSS, UNDER
NONCANCELABLE OPERATING LEASES, INCLUDING LEASE COMMITMENTS ON CONSOLIDATED
JOINT VENTURES, ARE AS FOLLOWS:
<Table>
<Caption>
IN THOUSANDS
- -------------------------------------------------------------------------
FISCAL YEAR ENDING IN AMOUNT
- -------------------------------------------------------------------------
2003 $ 9,845
2004 7,478
2005 5,640
2006 4,074
2007 3,562
Thereafter 27,402
-----------
$ 58,001
-----------
</Table>
Rental expense, net of rental income, totaled $6,220,000 in fiscal 2000,
$8,540,000 in fiscal 2001 and $10,576,000 in fiscal 2002.
9. INCOME TAXES
THE COMPONENTS OF THE PROVISION FOR FEDERAL AND STATE INCOME TAXES ARE
SUMMARIZED AS FOLLOWS:
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
Currently payable $ 3,392 $ 7,390 $ 13,615
Deferred 258 1,668 2,553
--------------------------------------------------------
$ 3,650 $ 9,058 $ 16,168
--------------------------------------------------------
</Table>
50
A RECONCILIATION OF THE STATUTORY FEDERAL INCOME TAX RATE WITH THE COMPANY'S
EFFECTIVE RATE IS AS FOLLOWS:
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
Federal taxes at statutory rate $ 3,266 $ 8,321 $ 14,891
State taxes, net of federal benefit 264 673 1,158
Other 120 64 119
--------------------------------------------------------
$ 3,650 $ 9,058 $ 16,168
--------------------------------------------------------
</Table>
Income tax payments, net of refunds, were $5,407,000 in fiscal 2000, $5,894,000
in fiscal 2001 and $6,616,000 in fiscal 2002. The income tax payments in fiscal
2002 were lower than the current provision due to the income tax benefit of
stock option exercises of $9,772,000 during fiscal 2002.
THE NET CURRENT AND NON-CURRENT COMPONENTS OF DEFERRED INCOME TAXES RECOGNIZED
IN THE BALANCE SHEET ARE AS FOLLOWS:
<Table>
<Caption>
IN THOUSANDS
- -----------------------------------------------------------------------------------------------
JAN. 28, 2001 FEB. 3, 2002
- -----------------------------------------------------------------------------------------------
Net current assets $ 3,809 $ 4,607
Net non-current liabilities (579) (3,930)
----------------------------------
$ 3,230 $ 677
----------------------------------
</Table>
THE TAX EFFECTS OF THE SIGNIFICANT TEMPORARY DIFFERENCES WHICH COMPRISE THE
DEFERRED TAX ASSETS AND LIABILITIES ARE AS FOLLOWS:
<Table>
<Caption>
IN THOUSANDS
- -----------------------------------------------------------------------------------------------
JAN. 28, 2001 FEB. 3, 2002
- -----------------------------------------------------------------------------------------------
ASSETS
Compensation deferred (unpaid) $ 826 $ 676
Insurance 1,022 1,859
Other long-term obligations 592 659
Accrued restructuring expenses 1,570 1,183
Deferred revenue 776 791
Accounts receivable 456 449
Inventory 397 436
Charitable contributions carryforward 420 --
State NOL carryforwards 1,117 2,524
Valuation allowance -- State NOL carryforwards (222) (2,524)
Other 1,004 676
----------------------------------
Gross deferred tax assets 7,958 6,729
----------------------------------
LIABILITIES
Property and equipment 4,279 5,589
Goodwill -- 198
Prepaid VEBA contribution 266 --
Prepaid expenses 183 265
----------------------------------
Gross deferred tax liabilities 4,728 6,052
----------------------------------
Net asset $ 3,230 $ 677
----------------------------------
</Table>
At February 3, 2002, the Company has recorded a valuation allowance against the
state NOL carryforwards of $2,524,000. If these carryforwards are realized in
the future, $2,019,000 of the tax benefit would be recorded as an addition to
common stock as this portion of the carryforwards were a result of the tax
benefits of stock option exercises in fiscal 2002.
The Company has recorded a deferred tax asset reflecting the benefit of future
deductible amounts. Realization of this asset is dependent on generating
sufficient future taxable income and the ability to carryback losses to previous
years in which there was taxable income. Although realization is not assured,
management believes it is more likely than not that all of the deferred tax
asset, for which a valuation allowance has not been established, will be
realized. The amount of the deferred tax asset considered realizable, however,
could be reduced in the near term if estimates of future taxable income are
reduced.
51
10. EARNINGS PER SHARE
The computation of basic earnings per share is based on the weighted average
number of common shares outstanding during the period. The computation of
diluted earnings per share reflects the potential dilution that would occur if
stock options were exercised and the dilution from the issuance of restricted
shares. The treasury stock method is used to calculate dilutive shares. This
reduces the gross number of dilutive shares by the number of shares purchasable
from the proceeds of the options assumed to be exercised, the proceeds of the
tax benefits recognized by the Company in conjunction with nonqualified stock
plans and from the amounts of unearned compensation associated with the
restricted shares.
THE FOLLOWING TABLE SETS FORTH THE COMPUTATION OF BASIC AND DILUTED EARNINGS PER
SHARE:
<Table>
<Caption>
IN THOUSANDS, EXCEPT SHARE AMOUNTS
- -----------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- -----------------------------------------------------------------------------------------------------------
Numerator:
Net income $ 5,956 $ 14,725 $ 26,378
--------------------------------------------------------
Denominator:
Basic earnings per share -- weighted
average shares 37,360,880 49,183,916 53,702,916
Effect of dilutive securities:
Stock options 1,918,880 4,471,576 4,734,371
Restricted stock -- -- 5,698
--------------------------------------------------------
Diluted earnings per share -- adjusted
weighted average shares 39,279,760 53,655,492 58,442,985
--------------------------------------------------------
</Table>
Stock options in the amount of 215,000 shares have been excluded from the
diluted shares calculation for fiscal 2002 as the inclusion of these options
would be antidilutive. There were no such antidilutive options in fiscal 2000
and fiscal 2001.
11. EMPLOYEE BENEFITS PLANS
The Company has a 401(k) savings plan, which provides that employees may
contribute from 1% to 100% of their base salary to the plan on a tax deferred
basis up to the Internal Revenue Service limitations. Until March 15, 2000, when
it ceased matching contributions to the 401(k) savings plan, the Company matched
one-half of the first 2% and one-fourth of the next 4% of salary contributed by
each employee. The Company's matching contributions approximated $501,000 in
fiscal 2000 and $64,000 in fiscal 2001.
Effective October 1, 2000, the Company established an unfunded Nonqualified
Deferred Compensation Plan (the "401(k) Mirror Plan"). The 401(k) Mirror Plan is
designed to enable the Company's executives to have the same opportunity to
defer compensation as is available to other employees of the Company under the
qualified 401(k) savings plan. Participants may defer from 1% to 15% of their
base salary, on a tax deferred basis up to the Internal Revenue Service
limitations, into the 401(k) Mirror Plan, may direct the investment of the
amounts they have deferred and are always 100% vested with respect to the
amounts they have deferred. The investments, however, are not a separate fund of
assets and are shown in other assets on the consolidated balance sheet. The
corresponding liability to participants is included in other long-term
obligations. The balance in the asset and corresponding liability account was
$24,000 and $359,000 at January 28, 2001 and February 3, 2002, respectively.
Effective February 1, 1999, the Company established the Krispy Kreme
Profit-Sharing Stock Ownership Plan. Under the terms of this qualified plan, the
Company contributes a percentage of each employee's compensation, subject to
Internal Revenue Service limits, to each eligible employee's account under the
plan. The expense associated with this plan was $2,647,000, $2,056,000 and
$3,255,000 in fiscal 2000, fiscal 2001 and fiscal 2002, respectively, based on a
contribution of 7% of eligible compensation. Under the terms of the plan, the
contribution can be made in the form of cash or newly issued shares of common
stock. If cash is contributed, the plan acquires Krispy Kreme stock on the open
market. With the exception of the initial year of the plan, the contribution is
made annually on April 15 or the closest business day to April 15. The
contribution for fiscal 2000 was made in the form of newly issued shares based
on the initial price of the Company's common stock in the IPO. The contributions
for fiscal 2001 and fiscal 2002 were or will be made in cash. Employees become
eligible for participation in the plan upon the completion of one year of
service and vest ratably over five years. Credit for past service was granted to
employees at the inception of the plan.
The Company established a nonqualified "mirror" plan, effective February 1,
1999. Contributions to this nonqualified plan will be made under the same terms
and conditions as the qualified plan, with respect to compensation earned by
participants in excess of the maximum amount of compensation that may be taken
into account under the qualified plan. The Company recorded compensation expense
of $103,000 in fiscal 2000, $19,000 in fiscal 2001 and $201,000 in fiscal 2002
for amounts credited to certain employees under the nonqualified plan.
Effective February 1, 2002, the Company established the Krispy Kreme Doughnuts,
Inc. Employee Stock Purchase Plan ("ESPP") to provide eligible employees of the
Company an opportunity to purchase Company common stock. Under the terms of the
plan, participants may defer between 1% and 15% of their base compensation each
payroll period. The amounts withheld are accumulated and, at the end of each
quarter, are used to purchase shares of common stock of the Company. The
purchase
52
price will be the fair market value on either the first or last day of the
quarter, whichever is lower. If the actual market price of the stock on the date
purchased exceeds the price at which shares can be acquired under the terms of
the ESPP, the Company will make a contribution to fund the shortfall, resulting
in a charge to operations in the period paid. Shares may be purchased by the
ESPP directly from the Company or in the open market. There were no shares
issued under the ESPP in fiscal 2002. As of February 3, 2002, there were
2,000,000 shares reserved for issuance under the ESPP.
Effective May 1, 1994, the Company established the Retirement Income Plan for
Key Employees of Krispy Kreme Doughnut Corporation (the Plan), an unfunded
nonqualified noncontributory defined benefit pension plan. The benefits are
based on years of service and average final compensation during the employees'
career. The Plan at all times shall be entirely unfunded as such term is defined
for purposes of the Employee Retirement Income Security Act (ERISA). The
actuarial cost method used in determining the net periodic pension cost is the
projected unit credit method. As of February 3, 2002, the Plan was frozen and no
additional employees will be covered under the Plan.
THE FOLLOWING TABLES SUMMARIZE THE STATUS OF THE PLAN AND THE AMOUNTS RECOGNIZED
IN THE BALANCE SHEET:
<Table>
<Caption>
IN THOUSANDS, EXCEPT PERCENTAGES
- -----------------------------------------------------------------------------------------------
YEAR ENDED JAN. 28, 2001 FEB. 3, 2002
- -----------------------------------------------------------------------------------------------
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation at beginning of year $ 950 $ 1,162
Service cost 170 181
Interest cost 71 87
Actuarial (gain) loss 2 211
Benefits paid (31) --
Change in plan provisions -- --
--------------------------------
Projected benefit obligation at end of year $ 1,162 $ 1,641
--------------------------------
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year -- $ --
Actual return on plan assets -- --
Employer contributions 31 --
Benefits paid (31) --
--------------------------------
Fair value of plan assets at end of year $ -- $ --
--------------------------------
NET AMOUNT RECOGNIZED
Funded status $ (1,162) $ (1,641)
Unrecognized transition obligation (asset) -- --
Unrecognized prior service cost -- --
Unrecognized net (loss) gain (86) 125
Contributions from measurement date to fiscal year end -- --
--------------------------------
Net amount recognized $ (1,248) $ (1,516)
--------------------------------
ASSUMPTIONS
Weighted average assumed discount rate 7.50% 7.00%
Weighted average expected long-term rate of return on plan
assets N/A N/A
Assumed rate of annual compensation increases 5.00% 5.00%
NET PERIODIC PENSION COST
Service cost $ 170 $ 181
Interest cost 71 87
Estimated return on plan assets -- --
Amortization of unrecognized transitional liability (asset) -- --
Amortization of prior service cost -- --
Recognized net actuarial (gain) or loss -- --
--------------------------------
Total $ 241 $ 268
--------------------------------
RECONCILIATION OF NET PENSION ASSET (LIABILITY) FOR FISCAL
YEAR
Prepaid (accrued) pension cost as of end of prior year $ (1,038) $ (1,248)
Contributions during the fiscal year 31 --
Net periodic pension cost for the fiscal year (241) (268)
------------------------------
Accrued pension cost as of fiscal year end $ (1,248) $ (1,516)
------------------------------
</Table>
53
12. INCENTIVE COMPENSATION
The Company has an incentive compensation plan for certain management and
non-management level employees. Incentive compensation amounted to $3,146,000 in
fiscal 2000, $5,500,000 in fiscal 2001 and $6,543,000 in fiscal 2002.
In addition, in fiscal 1998, the Company had a Long-Term Incentive Plan (the
Plan). Under the provisions of the Plan, a participant could elect to defer, for
a period of not less than five years, up to 100% of the bonus earned under the
provisions of the incentive compensation plan described above. The deferred
amount was converted to performance units based on the appropriate value (book
value) of the Company's common stock as defined in the Plan. Upon completion of
the deferral period, each participant's account would be distributed in
accordance with the participant's election. The performance units granted under
the Plan were credited with dividends in a manner identical to the common stock
of the Company. The amount payable to a participant at the time benefit payments
are due was equal in amount to the number of performance units credited to a
participant's account multiplied by the current book value of the Company's
common stock as defined in the Plan. Effective with fiscal year-end 1997, the
right to defer additional incentive compensation under the provisions of the
plan was suspended.
In fiscal 1999, participants still employed by the Company were given the option
to convert their performance units earned under the Plan to common shares of the
Company's common stock, subject to certain restrictions. These shares had no
voting rights prior to the initial public offering of the Company's common
stock. The number of performance units converted was 4,717,800 at a conversion
rate of $1.30 per performance unit for a total of approximately $6,112,000 in
common stock issued in connection with the conversion. Due to the Federal and
State income tax consequences of the conversion incurred by each participant,
the Company made a loan to each participant equal to their tax liability. These
loans were executed via a 10-year promissory note (collateralized by the shares
of common stock) with a fixed interest rate of 6%. The amount of such loans
outstanding at January 28, 2001 and February 3, 2002 was $2,349,000 and
$1,845,000, respectively and has been recorded as a deduction from shareholders'
equity.
During fiscal 2002, as part of a compensation arrangement with a former employee
of Digital Java, Inc., a Company acquired in fiscal 2002 (see Note 22,
Acquisitions), the Company issued 54,000 shares of common stock in exchange for
a note receivable in the amount of $879,000. The loan was executed via a 5-year
promissory note (collateralized by the shares of common stock) with a fixed
interest rate of 6%. Under the terms of the note, as long as the employee
remains employed and in good standing with the Company, the employee will
receive a bonus in the amount of the annual payment due. The first note payment
was made in January 2002. At February 3, 2002, the balance of this note is
$735,000 and is recorded in the Consolidated Balance Sheet as a reduction of
shareholders' equity.
13. SHAREHOLDERS' EQUITY
STOCK OPTION PLANS AND RESTRICTED STOCK AWARDS
STOCK OPTION PLANS. During fiscal 1999, the Company established the Krispy
Kreme Doughnut Corporation 1998 Stock Option Plan (the "1998 Plan"). Under the
terms of the 1998 Plan, 7,652,000 shares of common stock of the Company were
reserved for issuance to employees and Directors of the Company. During fiscal
2000, an additional 1,248,000 shares of common stock of the Company were
reserved for issuance under the 1998 Plan. Grants may be in the form of either
incentive stock options or nonqualified stock options. During fiscal 1999,
7,324,000 nonqualified options with a 10-year life were issued to employees and
Directors at an exercise price of $1.30 per share, the fair market value of the
common stock at the grant date. During fiscal 2000, no additional stock options
were issued under the 1998 Plan. In fiscal 2001, 1,128,000 stock options were
issued under the 1998 Plan at an exercise price ranging from $5.25 per shares to
$13.69. Stock options were granted at prices at fair market value on the date of
grant.
In July 2000, the shareholders approved the 2000 Stock Incentive Plan (the "2000
Plan") which was adopted by the Board of Directors on June 6, 2000. Awards under
the 2000 Plan may be incentive stock options, nonqualified stock options, stock
appreciation rights, performance units, restricted stock (or units) and share
awards. The maximum number of shares of common stock with respect to which
awards may be granted under the 2000 Plan is 4,000,000 shares plus 496,000
shares that were available for grant, but not granted, under the 1998 Plan. The
2000 Plan provides aggregate limits on grants of the various types of awards in
the amount of 3,000,000 shares for incentive stock options and 1,200,000 shares,
in the aggregate for stock appreciation rights, performance units, restricted
stock and stock awards. During fiscal 2001, 732,800 stock options were issued
under the 2000 Plan at an exercise price ranging from $14.77 to $20.63. During
fiscal 2002, 2,169,600 stock options were issued under the 2000 Plan at an
exercise price ranging from $15.13 to $42.11. Stock options were granted at
prices at fair market value on the date of grant.
54
OPTIONS UNDER BOTH PLANS VEST AND EXPIRE ACCORDING TO TERMS ESTABLISHED AT THE
GRANT DATE. THE FOLLOWING TABLE SUMMARIZES ALL STOCK OPTION TRANSACTIONS FROM
JANUARY 31, 1999 TO FEBRUARY 3, 2002:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------------------
SHARES SUBJECT WEIGHTED AVERAGE SHARES SUBJECT TO WEIGHTED AVERAGE
TO OPTIONS EXERCISE PRICE PER SHARE EXERCISABLE OPTIONS EXERCISE PRICE PER SHARE
- ---------------------------------------------------------------------------------------------------------------------------------
OUTSTANDING, JANUARY 31, 1999 7,324,000 $ 1.30 364,000 $1.30
Granted -- -- -- --
Exercised -- -- -- --
Canceled 48,000 1.30 -- --
--------------------------------------------------------------------------------
OUTSTANDING, JANUARY 30, 2000 7,276,000 $ 1.30 364,000 $1.30
Granted 1,863,600 9.77 -- --
Exercised 80,000 1.30 -- --
Canceled 42,800 2.58 -- --
--------------------------------------------------------------------------------
OUTSTANDING, JANUARY 28, 2001 9,016,800 $ 3.04 936,000 $2.57
Granted 2,169,600 25.06 -- --
Exercised 1,182,800 3.30 -- --
Canceled 375,300 4.97 -- --
--------------------------------------------------------------------------------
OUTSTANDING, FEBRUARY 3, 2002 9,628,300 $ 7.90 2,976,200 $4.06
--------------------------------------------------------------------------------
</Table>
At February 3, 2002, there were approximately 2,011,700 shares of common stock
available for issuance pursuant to future stock option grants.
ADDITIONAL INFORMATION REGARDING OPTIONS OUTSTANDING AS OF FEBRUARY 3, 2002 IS
AS FOLLOWS:
<Table>
<Caption>
----------------------------------------------------------- -----------------------------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- --------------------------------------------------------------------------------------------------------------------
RANGE OF WEIGHTED AVERAGE REMAINING WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICES SHARES CONTRACTUAL LIFE (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
- --------------------------------------------------------------------------------------------------------------------
$ 1.30-$ 4.21 6,487,900 6.5 $ 1.30 2,493,200 $ 1.30
$ 4.22-$ 8.42 208,000 8.2 $ 5.25 16,000 $ 5.25
$12.63-$16.84 1,054,800 8.2 $15.20 313,200 $15.15
$16.85-$21.06 462,000 8.7 $18.15 68,200 $19.00
$25.27-$29.48 1,017,400 9.5 $28.37 8,700 $28.58
$29.49-$33.69 302,700 7.2 $31.75 76,900 $31.93
$33.70-$37.90 42,000 9.8 $36.24 -- --
$37.91-$42.11 53,500 9.8 $39.45 -- --
</Table>
RESTRICTED STOCK AWARDS. In fiscal 2001 and 2002, respectively, the Company
granted 11,052 and 1,187 restricted stock awards in the form of the Company's
common stock under the 2000 Plan to certain employees to provide incentive
compensation. The weighted average grant-date fair value of the shares issued
was $21.25. These shares vest ratably over either a three or four year period
from the date of grant.
PRO FORMA FAIR VALUE DISCLOSURES
HAD COMPENSATION EXPENSE FOR THE COMPANY'S STOCK OPTIONS BEEN BASED ON THE FAIR
VALUE AT THE GRANT DATE UNDER THE METHODOLOGY PRESCRIBED BY SFAS NO. 123, THE
COMPANY'S INCOME FROM CONTINUING OPERATIONS AND EARNINGS PER SHARE FOR THE THREE
YEARS ENDED FEBRUARY 3, 2002 WOULD HAVE BEEN IMPACTED AS FOLLOWS:
<Table>
<Caption>
IN THOUSANDS, EXCEPT PER SHARE
- ---------------------------------------------------------------------------------------------------------------
JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
Reported net income $ 5,956 $ 14,725 $ 26,378
Pro forma net income 5,843 13,693 21,627
Reported earnings per share -- Basic .16 .30 .49
Pro forma earnings per share -- Basic .16 .28 .40
Reported earnings per share -- Diluted .15 .27 .45
Pro forma earnings per share -- Diluted .15 .26 .37
</Table>
55
THE FAIR VALUE OF OPTIONS GRANTED, WHICH IS AMORTIZED TO EXPENSE OVER THE OPTION
VESTING PERIOD IN DETERMINING THE PRO FORMA IMPACT, IS ESTIMATED AT THE DATE OF
GRANT USING THE BLACK-SCHOLES OPTION-PRICING MODEL WITH THE FOLLOWING WEIGHTED
AVERAGE ASSUMPTIONS:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------
JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
Expected life of option 7 years 7 years 7 years
Risk-free interest rate 4.8% 6.1% 5.0%
Expected volatility of stock -- 49.7% 52.6%
Expected dividend yield 3.1% -- --
</Table>
THE WEIGHTED AVERAGE FAIR VALUE OF OPTIONS GRANTED DURING FISCAL 2000, 2001 AND
2002 IS AS FOLLOWS:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------
JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- -------------------------------------------------------------------------------------------------------------
Fair value of each option granted $ -- $ 11.54 $ 14.92
Total number of options granted -- 1,863,600 2,169,600
Total fair value of all options granted $ -- $21,505,944 $32,370,432
</Table>
SHAREHOLDER RIGHTS PLAN
Each share of the Company's common stock has one preferred share purchase right.
Each share purchase right entitles the registered shareholder to purchase one
one-hundredth (1/100) of a share of Krispy Kreme Series A Participating
Cumulative Preferred Stock at a price of $96.00 per one one-hundredth of a
Series A preferred share. The share purchase rights are not exercisable until
the earlier to occur of (1) 10 days following a public announcement that a
person or group of affiliated or associated persons -- referred to as an
acquiring person -- have acquired beneficial ownership of 15% or more of the
Company's outstanding common stock or (2) 10 business days following the
commencement of, or announcement of an intention to make a tender offer or
exchange offer which would result in an acquiring person beneficially owning 15%
or more of the outstanding shares of common stock.
If the Company is acquired in a merger or other business combination, or if 50%
or more of the Company's consolidated assets or earning power is sold after a
person or group has become an acquiring person, proper provision will be made so
that each holder of a share purchase right -- other than share purchase rights
beneficially owned by the acquiring person, which will thereafter be
void -- will have the right to receive, upon exercise of the share purchase
right at the then current exercise price, the number of shares of common stock
of the acquiring company which at the time of the transaction have a market
value of two times the share purchase right exercise price. If any person or
group becomes an acquiring person, proper provision shall be made so that each
holder of a share purchase right -- other than share purchase rights
beneficially owned by the acquiring person, which will thereafter be
void -- will have the right to receive upon exercise, and without paying the
exercise price, the number of shares of Krispy Kreme common stock with a market
value equal to the share purchase right exercise price.
Series A preferred shares purchasable upon exercise of the share purchase rights
will not be redeemable. Each Series A preferred share will be entitled to a
minimum preferential dividend payment of $1 per share and will be entitled to an
aggregate dividend of 100 times the dividend declared per share of common stock.
In the event the Company liquidates, the holders of the Series A preferred
shares will be entitled to a minimum preferential liquidation payment of $1 per
share but will be entitled to an aggregate payment of 100 times the payment made
per share of common stock. Each Series A preferred share will have 100 votes,
voting together with the shares of common stock. Finally, in the event of any
merger, consolidation or other transaction in which shares of common stock are
exchanged, each Series A preferred share will be entitled to receive 100 times
the amount received per share of common stock. These rights are protected by
customary antidilution provisions.
Before the date the share purchase rights are exercisable, the share purchase
rights may not be detached or transferred separately from the common stock. The
share purchase rights will expire on January 18, 2010, unless that expiration
date is extended or unless the share purchase rights are redeemed or exchanged
by the Company. At any time an acquiring person acquires beneficial ownership of
15% or more of the Company's outstanding common stock, the board of directors
may redeem the share purchase rights in whole, but not in part, at a price of
$0.001 per share purchase right. Immediately upon any share purchase rights
redemption, the exercise rights terminate, and the holders will only be entitled
to receive the redemption price.
14. BUSINESS SEGMENT INFORMATION
The Company has three reportable business segments. The Company Store Operations
segment is comprised of the operating activities of the stores owned by the
Company and those in consolidated joint ventures. These stores sell doughnuts
and complementary products through both on-premises and off-premises sales. The
majority of the ingredients and materials used by Company Store Operations is
purchased from the KKM&D business segment.
The Franchise Operations segment represents the results of the Company's
franchise program. Under the terms of the franchise agreements, the licensed
operators pay royalties and fees to the Company in return for the use of the
Krispy Kreme name.
56
Expenses for this business segment include costs incurred to recruit new
franchisees and to open, monitor and aid in the performance of these stores and
direct general and administrative expenses.
The KKM&D segment supplies mix, equipment and other items to both Company and
franchisee owned stores. All intercompany transactions between the KKM&D
business segment and Company stores and consolidated joint venture stores are
eliminated in consolidation.
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.
Segment operating income is income before general corporate expenses and income
taxes.
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------------------------------
YEAR ENDED JAN. 30, 2000 JAN. 28, 2001 FEB. 3, 2002
- ---------------------------------------------------------------------------------------------------------------
Revenues:
Company Store Operations $ 164,230 $ 213,677 $ 266,209
Franchise Operations 5,529 9,445 14,008
KKM&D 142,215 201,406 269,396
Intercompany sales eliminations (91,731) (123,813) (155,259)
------------------------------------------------------
Total revenues $ 220,243 $ 300,715 $ 394,354
------------------------------------------------------
Operating income:
Company Store Operations $ 18,246 $ 27,370 $ 42,932
Franchise Operations 1,445 5,730 9,040
KKM&D 7,182 11,712 18,999
Unallocated general and administrative expenses (16,035) (21,305) (29,084)
------------------------------------------------------
Total operating income $ 10,838 $ 23,507 $ 41,887
------------------------------------------------------
Depreciation and Amortization Expenses:
Company Store Operations $ 3,059 $ 4,838 $ 5,859
Franchise Operations 72 72 72
KKM&D 236 303 507
Corporate administration 1,179 1,244 1,521
------------------------------------------------------
Total depreciation and amortization expenses $ 4,546 $ 6,457 $ 7,959
------------------------------------------------------
</Table>
15. RELATED PARTY TRANSACTIONS
In March 2000, upon approval by the Company's board of directors, a pooled
investment fund was established, the Krispy Kreme Equity Group, LLC (KKEG), to
invest in joint ventures with new area developers in certain markets. The
Company's officers were eligible to invest in the fund. Members of the board of
directors who were not officers of the Company were not eligible to invest in
the fund. The Company did not provide any funds to its officers to invest in the
fund nor did it provide guarantees for the investment. The fund invested
exclusively in a fixed number of joint ventures with certain new area developers
as approved by its manager, obtaining a 5% interest in them. If any member of
the fund withdrew, the fund had a right of first refusal with respect to the
withdrawing member's interest. The remaining members then had the right to
purchase any interest the fund did not purchase. Finally, the Company was
obligated to purchase any remaining interest. The Company did not own any units
of the KKEG at January 28, 2001 or February 3, 2002. The fund had investments in
five joint ventures as of January 28, 2001 and in six joint ventures as of
February 3, 2002. On March 5, 2002, the members of the KKEG voted to dissolve
the KKEG and agreed to sell their interests in the KKEG to the Company. The
Company paid to each member of the KKEG an amount equal to his or her original
investment, totaling an aggregate of $940,100. On March 6, 2002, the KKEG was
dissolved.
In February, 2000, the Compensation Committee of the Company's Board of
Directors approved investments by Scott Livengood, Chairman, President and CEO,
in joint ventures with certain new area developers in exchange for his giving up
his rights to develop the Northern California market. Krispy Kreme did not
provide any funds to Mr. Livengood to invest in the joint ventures with area
developers nor did it provide guarantees for the investments. Mr. Livengood had
3% investments in joint ventures with five area developers as of January 28,
2001 and six area developers as of February 3, 2002, respectively. On March 5,
2002, Mr. Livengood sold his ownership interests in the joint ventures to the
Company at his original cost of $558,800. Mr. Livengood currently has the right
to develop the Alamance, Durham, and Orange County areas of North Carolina.
In February, 2000, the Compensation Committee of the Company's Board of
Directors approved an investment by John McAleer, Krispy Kreme Executive Vice
President and Vice Chairman of the Board, in a joint venture with a new area
developer. Krispy Kreme did not provide any funds to Mr. McAleer to invest in
the joint venture with an area developer nor did it provide guarantees for the
investment. Mr. McAleer had a 21.7% investment in a joint venture with
KremeWorks, LLC as of
57
January 28, 2001 and February 3, 2002. On March 5, 2002, Mr. McAleer sold his
ownership interest in KremeWorks, LLC to the Company at his original cost of
$75,800.
Prior to purchasing the joint venture interests of the KKEG, Mr. Livengood and
Mr. McAleer, the Company had an interest ranging from 3.3% to 59% in the same
markets as those held by the KKEG, Mr. Livengood and Mr. McAleer. The joint
ventures in which the Company and its officers have invested are more fully
described in Note 19, Joint Ventures.
As of February 3, 2002, certain members of the board own 23 stores and are
committed, under their respective franchise agreements, to open an additional 11
stores. Joint ventures in which the Company invests own 31 stores. These joint
ventures are committed, under their respective franchise agreements, to open an
additional 160 stores. Prior to March 5, 2002 (before the Company acquired the
joint venture interests held by the KKEG, Mr. Livengood and Mr. McAleer), four
officers of the Company were investors in groups that owned 36 stores and were
committed to open 157 additional stores. Certain of these investments were in
the same entities as those invested in by the KKEG.
Subsequent to March 5, 2002 (after the Company acquired the joint venture
interests held by the KKEG, Mr. Livengood and Mr. McAleer), two officers of the
Company were investors in groups that own seven stores and are committed to open
seven additional stores. None of these investments are in the same entities as
those invested in by the Company.
All franchisees are required to purchase mix and equipment from the Company.
Total revenues includes $12,721,000 in fiscal 2000, $22,515,000 in fiscal 2001,
and $44,870,000 in fiscal 2002 of sales to franchise doughnut stores owned, in
whole or in part, by directors, employees of the Company, and Company joint
venture investments. Total revenues also includes royalties from these stores of
$904,000 in fiscal 2000, $1,689,000 in fiscal 2001, and $3,646,000 in fiscal
2002. Trade accounts receivable from these stores, shown as Accounts receivable,
affiliates on the consolidated balance sheet, totaled $2,599,000 and $9,017,000
at January 28, 2001 and February 3, 2002, respectively.
16. COMMITMENTS AND CONTINGENCIES
In order to assist certain associate and franchise operators in obtaining
third-party financing, the Company has entered into collateral repurchase
agreements involving both Company stock and doughnut-making equipment. The
Company's contingent liability related to these agreements is approximately
$1,266,000 at January 28, 2001 and $70,000 at February 3, 2002. Additionally,
primarily for the purpose of providing financing guarantees in a percentage
equivalent to the Company's ownership percentage in various joint venture
investments, the Company has guaranteed certain leases and loans from third-
party financial institutions on behalf of associate and franchise operators. The
Company's contingent liability related to these guarantees was approximately
$2,593,000 at January 28, 2001 and $3,805,000 at February 3, 2002.
Because the Company enters into long-term contracts with its suppliers, in the
event that any of these relationships terminate unexpectedly, even where it has
multiple suppliers for the same ingredient, the Company's ability to obtain
adequate quantities of the same high quality ingredient at the same competitive
price could be negatively impacted.
17. RESTRUCTURING
<Table>
<Caption>
IN THOUSANDS
- --------------------------------------------------------------------------------------------------------------------
YEAR ENDED LEASE LIABILITIES ACCRUED EXPENSES TOTAL ACCRUAL
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 30, 2000 $ 4,782 $ 592 $ 5,374
Reductions (1,130) (113) (1,243)
-------------------------------------------------------------
BALANCE AT JANUARY 28, 2001 $ 3,652 $ 479 $ 4,131
Reductions (954) (63) (1,017)
-------------------------------------------------------------
BALANCE AT FEBRUARY 3, 2002 $ 2,698 $ 416 $ 3,114
-------------------------------------------------------------
</Table>
On January 13, 1999, the Board of Directors of the Company approved a
restructuring plan for assets and operations included in the Company Store
Operations segment determined either to be inconsistent with the Company's
strategy or whose carrying value may not be fully recoverable. Of the total
restructuring and impairment charge of $9.5 million, $7.8 million related to the
closing of five double drive-through stores and the write-down of five other
inactive double drive-=through stores and sites including provisions to
write-down associated land, building and equipment costs to estimated net
realizable value and to cover operating lease commitments associated with these
stores. The Company has no plans to open any new double drive-through stores. An
additional $700,000 related to future lease payments on double drive-through
buildings subleased to franchisees. Also included in the total charge is a $1.0
million write-down of the cost of a facility owned by the Company that produces
fried pies and honey buns. These products are not expected to be a core part of
the Company's strategy going forward. Of the total charge, $5.6 million
represents a charge for future cash outflows for lease payments on land and
buildings while $3.6 million represents the write-down of the book value of land
to its estimated realizable amount and the write-off of the net book value of
related buildings and equipment. The remaining $250,000 represents the accrual
of costs to remove double drive-through buildings from their leased locations.
During fiscal 2000, the Company reassessed certain provisions of its
restructuring accrual. The Company determined that it was under-accrued for
losses associated with operating lease commitments related to double
drive-through buildings by $723,000
58
and over-accrued for certain other exit costs by $175,000. In addition, land
included in Assets Held for Sale with a book value of $325,000 was sold for
$830,000 resulting in a credit to restructuring expense. Together, these
adjustments resulted in a net increase in restructuring expense of $43,000 for
the year ended January 30, 2000. This amount has been included in Operating
Expenses of the Company Store Operations segment. Reductions in Lease
Liabilities in fiscal 2000 represent ongoing lease payments on remaining lease
obligations. Reductions in Accrued Expenses in fiscal 2000 represent the cost of
moving two double drive-through buildings. Accrued property taxes of $487,000,
originally recorded as Lease Liabilities, have been transferred to Accrued
Expenses.
Reductions in Lease Liabilities in fiscal 2001 and fiscal 2002 represent ongoing
lease payments on remaining lease obligations. Reductions in Accrued Expenses in
fiscal 2001 and fiscal 2002 represent the removal of one double drive-through
building, as well as other miscellaneous expenses of three other double
drive-though buildings. There was no additional restructuring expense for the
years ended January 28, 2001 and February 3, 2002.
18. STORE CLOSINGS AND IMPAIRMENT
<Table>
<Caption>
IN THOUSANDS
- ---------------------------------------------------------------------------------------------------
YEAR ENDED LEASE LIABILITIES AND ACCRUED EXPENSES
- ---------------------------------------------------------------------------------------------------
BALANCE AT JANUARY 30, 2000 $ 1,377
Additions 318
Reductions (1,494)
-----------
BALANCE AT JANUARY 28, 2001 $ 201
Reductions (49)
-----------
BALANCE AT FEBRUARY 3, 2002 $ 152
-----------
</Table>
In fiscal 1999, the Company recorded a charge of $2.3 million for store closings
and impairment costs. The charge consisted of $417,000 related to the write-off
of unamortized leasehold improvements for two stores that were closed in the
first quarter of fiscal 2000 and the accrual of $283,000 in remaining lease
costs on a potential store site that will not be used. The remaining $1.6
million relates to the write-down of building and equipment of a facility that
will remain open but whose carrying value was determined not to be fully
recoverable.
In the fourth quarter of fiscal 2000, the Company recorded a $1.1 million charge
for the closing of two stores. These stores were torn down in the second quarter
of fiscal 2001 and new buildings constructed on the same sites. The charge
consisted of the write-off of the net book value of buildings and leasehold
improvements for the two stores, as well as equipment that will be abandoned.
This charge was recorded in Operating Expenses of the Company Store Operations
segment.
In fiscal 2001, the Company recorded a $318,000 charge for the closing of a
store damaged by fire. After a thorough evaluation of the property, the Company
made the decision not to reopen the store. This charge has been recorded in
Operating Expenses of the Company Store Operations segment.
Reductions in the accrual in fiscal 2001 and fiscal 2002 represent ongoing lease
payments on remaining lease obligations. Reductions in the accrual in fiscal
2001 also represent the write-off of the net book value of leasehold
improvements, the liabilities under rent termination agreements and other
miscellaneous costs relating to the store damaged by fire, as well as the
write-off of the net book value of buildings, leasehold improvements, and
equipment for two stores which were torn down in the second quarter of fiscal
2001.
19. JOINT VENTURES
From time to time, the Company enters into joint venture agreements with
partners to develop and operate Krispy Kreme stores. As explained in Note 15,
Related Party Transactions, the KKEG, Scott Livengood, and John McAleer also
invested in some of these joint ventures until these investments were sold to
the Company in the amount of the original investment. Each party's investment is
determined based on their proportionate share of equity obtained. The Company's
ability to control the management committee of the joint venture is the primary
determining factor as to whether or not the joint venture results are
consolidated with the Company. See "Basis of Consolidation" under Note 2,
Summary of Significant Accounting Policies.
CONSOLIDATED JOINT VENTURES
On March 22, 2000, the Company entered into a joint venture to develop the
Northern California market ("Golden Gate Doughnuts, LLC"). The Company invested
$2,060,000 for a 59% interest and holds 2 of 3 management committee seats. At
February 3, 2002, the KKEG and Scott Livengood owned 5% and 3%, respectively, of
Golden Gate Doughnuts, LLC. The financial statements of this joint venture are
consolidated in the results of the Company and the 41% not owned by Krispy Kreme
is included in minority interest. The Company has guaranteed the payments on
several leases and 59% of the line of credit and the term loan for Golden Gate
Doughnuts, LLC. The terms of the guarantees range from 5 to 20 years.
59
On March 6, 2001, the Company entered into a joint venture to develop the
Philadelphia, Pennsylvania market (Freedom Rings, LLC). The Company invested
$1,167,000 for a 70% interest and holds 3 of 4 management committee seats. The
financial statements of this joint venture are consolidated in the results of
the Company and the 30% not owned by Krispy Kreme is included in minority
interest.
SUMMARIZED INFORMATION FOR THE COMPANY'S INVESTMENTS IN CONSOLIDATED JOINT
VENTURES AS OF FEBRUARY 3, 2002, INCLUDING OUTSTANDING LOAN AND LEASE
GUARANTEES, IS AS FOLLOWS:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------------------------------
OWNERSHIP %
NUMBER OF -----------------------------------
STORES AS OF KRISPY
FEBRUARY 3, 2002/ KREME LOAN/
GEOGRAPHICAL TOTAL STORES TO EQUITY SCOTT THIRD LEASE
MARKET BE DEVELOPED KKDC GROUP LIVENGOOD PARTIES GUARANTEES(1)
- -----------------------------------------------------------------------------------------------------------------------
Freedom Rings, LLC Philadelphia, PA 2/17 70.0% 0.0% 0.0% 30.0% --
Manager Allocation 3 -- -- 1
Golden Gate Doughnuts,
LLC Northern California 9/24 59.0% 5.0% 3.0% 33.0% $3,297,000
Manager Allocation 2 -- -- 1
<Caption>
- ----------------------- -----------
FISCAL 2002
REVENUES
-----------
- ----------------------- -----------
Freedom Rings, LLC $ 1,906,000
Golden Gate Doughnuts,
LLC $25,045,000
</Table>
(1) These lease guarantees are included in the future minimum annual rental
commitments disclosed in Note 8, Lease Commitments.
As explained in Note 15, on March 5, 2002, the Company acquired the KKEG and
Scott Livengood's interest in Golden Gate Doughnuts, LLC. As a result, the
Company's investment in Golden Gate Doughnuts, LLC has increased to $2,680,000,
or 67%. Subsequent to March 5, 2002, the minority interest in the results of
Golden Gate Doughnuts, LLC, which are eliminated from the consolidated financial
statements, will be reduced to 33%.
EQUITY METHOD JOINT VENTURES
On January 31, 2000, the Company repurchased the New York City market from an
area developer for approximately $6.9 million. The Company invested an
additional $300,000 in property and equipment. Subsequently, on April 17, 2000,
the Company sold 77.7% of the New York City market for $5.6 million to the KKEG
($360,000 cash, or 5%), Scott Livengood ($216,000 cash, or 3%) and third parties
($2,216,000 cash and a $2,800,000 note receivable, or 69.7%). The Company holds
2 of 6 management committee seats. The Company's remaining investment of
$1,608,000, representing its 22.3% interest, is accounted for using the equity
method. This investment, along with the Company's portion of the joint venture's
net loss is recorded in investments in unconsolidated joint ventures in the
consolidated balance sheets. The remaining balance on the note receivable of
$1,868,000 is included in other assets and other receivables in the consolidated
balance sheets.
As of February 3, 2002, the Company has invested in five additional joint
ventures as a minority interest party. Investments in these joint ventures have
been made in the form of capital contributions as well as notes receivable.
Terms of the notes receivable include interest rates from 5.5% to 12.0% per
annum, payable semiannually with due dates from April 30, 2010 to the
dissolution of the joint venture. These investments and notes receivable are
recorded in investments in unconsolidated joint ventures in the consolidated
balance sheets.
60
INFORMATION RELATED TO THE MARKETS, OWNERSHIP INTERESTS AND MANAGER ALLOCATIONS
FOR JOINT VENTURES, WHICH ARE ACCOUNTED FOR BY THE EQUITY METHOD, IS SUMMARIZED
AS FOLLOWS:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------------------
NUMBER OF
STORES AS OF OWNERSHIP %
FEBRUARY 3, 2002/ -----------------------------------------
GEOGRAPHICAL TOTAL STORES TO KRISPY KREME SCOTT THIRD
MARKET BE DEVELOPED KKDC EQUITY GROUP LIVENGOOD PARTIES
- ---------------------------------------------------------------------------------------------------------------------
KKNY, LLC New York City, 6/24 22.3% 5.0% 3.0% 69.7%
Northern New Jersey Manager Allocation 2 -- -- 4
New England Dough, LLC Massachusetts, 0/16 49.0% 5.0% 3.0% 43.0%
Connecticut, Manager Allocation 2 -- -- 2
Rhode Island
KremeKo, Inc. Ontario, Quebec, Nova 2/34 34.0% 0.0% 0.0% 66.0%
Scotia, New Brunswick, Manager Allocation 2 -- -- 3
Prince Edward Island,
Newfoundland
Glazed Investments, LLC Minnesota 6/27 22.3% 5.0% 3.0% 69.7%
(Minneapolis-St. Paul) Manager Allocation 2 -- -- 4
Colorado (Denver,
Colorado Springs,
Boulder, Pueblo)
Wisconsin (Milwaukee,
Madison,
Appleton-Oshkosh,
Racine)
A-OK, LLC Oklahoma 3/10 22.3% 5.0% 3.0% 69.7%
(Oklahoma City, Tulsa, Manager Allocation 2 -- -- 4
Little Rock,
Fayetteville, Ft.
Springs)
Amazing Glazed, LLC Pennsylvania 1/8 22.3% 5.0% 3.0% 69.7%
(Pittsburgh) Manager Allocation 2 -- -- 4
</Table>
The amount shown as "Total Stores to be Developed" represents the number of
stores in the initial development agreement with the joint venture. This number,
which excludes commissary locations, will be re-evaluated as the market is
developed and the number of stores to be opened may change.
INFORMATION RELATED TO THE COMPANY'S INVESTMENT IN AND GUARANTEES OF LOANS AND
LEASES, AS WELL AS SUMMARIZED FINANCIAL INFORMATION AS OF FEBRUARY 3, 2002, FOR
EACH JOINT VENTURE ACCOUNTED FOR BY THE EQUITY METHOD IS AS FOLLOWS:
<Table>
<Caption>
----------------------------------------------------
SUMMARY FINANCIAL INFORMATION -- UNAUDITED
- ---------------------------------------------------------------------------------------------------------------------------
LOAN TOTAL JV INVESTMENT AND CURRENT NONCURRENT CURRENT NONCURRENT
GUARANTEES (1) DEBT (2) NOTES IN JV (3) ASSETS ASSETS LIABILITIES LIABILITIES
- ---------------------------------------------------------------------------------------------------------------------------
KKNY, LLC $ -- $ -- $1,188,000 $3,448,000 $ 9,559,000 $ 4,839,000 $ --
New England Dough,
LLC -- -- 101,000 122,000 2,000 16,000 --
KremeKo, Inc. 585,000 1,721,000 462,000 2,962,000 3,031,000 2,318,000 1,730,000
Glazed Investments,
LLC 904,000 4,055,000 1,349,000 1,424,000 12,272,000 3,864,000 8,322,000
A-OK, LLC 513,000 2,300,000 194,000 397,000 5,040,000 466,000 4,506,000
Amazing Glazed, LLC -- -- 95,000 793,000 1,595,000 255,000 1,972,000
----------------------------------------------------------------------------------------------------
Total $2,002,000 $8,076,000 $3,389,000 $9,146,000 $31,499,000 $11,758,000 $16,530,000
----------------------------------------------------------------------------------------------------
<Caption>
---------------------------------------
SUMMARY FINANCIAL INFORMATION -- UNAUDITED
- --------------------- ---------------------------------------
NET GROSS NET INCOME/
SALES PROFIT (LOSS)
- --------------------------------------------------------------
KKNY, LLC $14,553,000 $ 6,251,000 $ (837,000)
New England Dough,
LLC -- -- (293,000)
KremeKo, Inc. 528,000 184,000 (1,638,000)
Glazed Investments,
LLC 9,528,000 4,530,000 544,000
A-OK, LLC 4,699,000 1,975,000 997,000
Amazing Glazed, LLC 2,177,000 900,000 29,000
---------------------------------------
Total $31,485,000 $13,840,000 $(1,198,000)
---------------------------------------
</Table>
(1) Represents the Company's guarantee of debt incurred by the joint venture.
The Company has guaranteed the portion of the debt equal to its ownership
percentage in the joint venture.
(2) Represents total debt incurred by the joint venture. The debt is used for
the purchase of buildings, equipment, and other store assets. This debt is
also collateralized by the assets acquired by the joint ventures.
(3) Represents the Company's initial contribution plus the Company's portion of
the joint venture income or loss to date.
As explained in Note 15, on March 5, 2002, the Company acquired the KKEG and
Scott Livengood's interests in these joint ventures. As a result of these
transactions, the Company's ownership interest will increase for these joint
ventures.
61
COST METHOD JOINT VENTURES
On January 13, 2000, the Company entered into a joint venture to develop an area
in the northwestern portion of the United States, KremeWorks, LLC. The Company
invested $11,000 for a 3.3% interest. John McAleer, an officer of Krispy Kreme,
invested $76,000 for a 21.7% interest and has one of four seats on the
management committee. Third parties invested $263,000 for a 75% interest and
have three of four seats on the management committee. As of February 3, 2002,
Kremeworks, LLC had two stores open with a remaining commitment to open 29
additional stores. The Company's investment is accounted for using the cost
method. This investment is included in unconsolidated joint ventures in the
Consolidated Balance Sheet.
INFORMATION RELATED TO THE COMPANY'S INVESTMENT IN KREMEWORKS, LLC, AS WELL AS
SUMMARIZED FINANCIAL INFORMATION OF THE JOINT VENTURE AS OF FEBRUARY 3, 2002, IS
AS FOLLOWS:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------------------------
SUMMARY FINANCIAL INFORMATION -- UNAUDITED
-------------------------------------------------------------------------------------------
INVESTMENT CURRENT NONCURRENT CURRENT NONCURRENT NET GROSS NET INCOME/
IN JV ASSETS ASSETS LIABILITIES LIABILITIES SALES PROFIT (LOSS)
- -------------------------------------------------------------------------------------------------------------------------------
KremeWorks, LLC...... $11,000 $1,751,000 $7,143,000 $1,026,000 $128,000 $2,862,000 $1,490,000 $(298,000)
</Table>
As explained in Note 15, Related Party Transactions, on March 5, 2002, John
McAleer sold his interest in KremeWorks, LLC to the Company. As a result, Krispy
Kreme's investment in KremeWorks, LLC has increased to $87,000, or 25%. Krispy
Kreme now has 1 of 4 seats on the management committee. Subsequent to March 5,
2002, the Company's investment in KremeWorks, LLC will be accounted for by the
equity method.
AS A RESULT OF THE TRANSACTIONS ON MARCH 5, 2002 IN WHICH THE COMPANY ACQUIRED
THE KKEG'S, MR. LIVENGOOD'S AND MR. MCALEER'S INVESTMENTS IN THE JOINT VENTURES
DESCRIBED ABOVE, THE OWNERSHIP PERCENTAGES OF THE COMPANY AND OTHER INVESTORS
(WHICH DO NOT INCLUDE THE KKEG, MR. LIVENGOOD OR MR. MCALEER) IN EACH JOINT
VENTURE ARE AS FOLLOWS:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------------
OWNERSHIP INTERESTS
-----------------------------------------------
PRIOR TO MARCH 5, 2002 POST MARCH 5, 2002
---------------------- ----------------------
KKDC OTHER INVESTORS KKDC OTHER INVESTORS
---- --------------- ---- ---------------
- -------------------------------------------------------------------------------------------------------------
Freedom Rings, LLC.......................................... 70.0% 30.0% 70.0% 30.0%
Golden Gate Doughnuts, LLC.................................. 59.0% 41.0% 67.0% 33.0%
New England Dough, LLC...................................... 49.0% 51.0% 57.0% 43.0%
KremeKo, Inc. .............................................. 34.0% 66.0% 34.0% 66.0%
KKNY, LLC................................................... 22.3% 77.7% 30.3% 69.7%
Glazed Investments, LLC..................................... 22.3% 77.7% 30.3% 69.7%
A-OK, LLC................................................... 22.3% 77.7% 30.3% 69.7%
Amazing Glazed, LLC......................................... 22.3% 77.7% 30.3% 69.7%
KremeWorks, LLC............................................. 3.3% 96.7% 25.0% 75.0%
</Table>
20. LEGAL CONTINGENCIES
On March 9, 2000, a lawsuit was filed against the Company, Mr. Livengood and
Golden Gate Doughnuts, LLC, a franchisee of the Company, in Superior Court in
the state of California. The plaintiffs allege, among other things, breach of
contract and seek compensation for injury as well as punitive damages. On
September 22, 2000, after the case was transferred to the Sacramento Superior
Court, that court granted our motion to compel arbitration of the action and
stayed the action pending the outcome of arbitration. On November 3, 2000, the
plaintiffs petitioned for a writ of mandate overruling the Superior Court. On
December 21, 2000, the Court of Appeals summarily denied the writ petition.
Plaintiffs failed to petition the California Supreme Court for review of the
lower court's decision within the time permitted by law. The lawsuit against Mr.
Livengood was dismissed by the California court for lack of personal
jurisdiction. Plaintiffs have not appealed this judgment, and their time for
doing so has expired. On October 1, 2001, plaintiffs filed a demand for
arbitration with the American Arbitration Association against Krispy Kreme
Doughnut Corporation, Golden Gate Doughnuts, LLC, Mr. Livengood and Mr.
Bruckman. On November 5, 2001, the Company filed a response to the arbitration
demand generally denying all claims and raising numerous affirmative,
dispositive defenses. An arbitration panel has been selected and the arbitration
process is still in its initial stages. The Company continues to believe that
the allegations are without merit and that the outcome of the arbitration will
not have a material adverse effect on its consolidated financial statements.
Accordingly, no accrual for loss (if any) has been provided in the accompanying
consolidated financial statements.
The Company is engaged in various legal proceedings incidental to its normal
business activities. In the opinion of management, the outcome of these matters
is not expected to have a material effect on the Company's consolidated
financial statements.
62
21. SYNTHETIC LEASE
On April 26, 2001, the Company entered into a synthetic lease agreement in which
the lessor, a bank, had agreed to fund up to $35,000,000 for construction of the
Company's new mix and distribution facility in Effingham, Illinois (the
"Facility"). Under the terms of the synthetic lease, the bank was to pay all
costs associated with the construction of the building and the equipment to be
used in the manufacturing and distribution processes. Lease payments were to
begin upon completion of the Facility (the "Completion Date"). Construction of
the Facility began in May 2001 and is expected to be completed in the first half
of fiscal 2003. The initial term of the lease was five years following the
Completion Date. The lease required the Company to maintain compliance with
certain covenants, including maintenance of certain financial ratios. The
Company was in compliance with all covenants at February 3, 2002.
On March 21, 2002, the Company terminated the synthetic lease and purchased the
Facility from the bank. To finance the purchase, the Company entered into a
credit agreement ("Credit Agreement") with the bank. The Credit Agreement
provides for funding of up to $35,000,000 for the initial purchase and
completion of the Facility. The initial borrowing under the Credit Agreement was
$31,710,000.
Amounts advanced under the Credit Agreement bear interest at Adjusted LIBOR, as
defined within the Credit Agreement, plus an Applicable Margin, as defined
within the Credit Agreement. The Applicable Margin ranges from .75% to 1.75% and
is determined based upon the Company's performance under certain financial
covenants contained in the Credit Agreement. The interest rate applicable on
March 21, 2002 was 2.92%. Interest is payable monthly through the Completion
Date, at which time outstanding advances will convert to a term loan (the
"Loan"). Monthly payments of principal, equal to 1/240th of the principal amount
of the Loan, and interest will commence and continue through September 21, 2007,
at which time a final payment of all outstanding principal and accrued interest
will be due. The Credit Agreement also permits the Company to prepay the Loan in
whole at any time, or from time to time in part in amounts aggregating at least
$500,000 or any larger multiple of $100,000 without penalty.
The Credit Agreement contains provisions that, among other requirements,
restrict the payment of dividends and require the Company to maintain compliance
with certain covenants, including the maintenance of certain financial ratios.
On March 27, 2002, the Company entered into an interest rate swap agreement to
convert the variable payments due under the Credit Agreement to fixed amounts.
The swap has a notional amount of $33,000,000 and is effective May 1, 2002.
Under the terms of the swap, the Company will make fixed rate payments to the
counterparty, a bank, of 5.09% and in return receive payments at LIBOR. Monthly
payments begin June 1, 2002 and continue until the swap terminates May 1, 2007.
The Company will be exposed to credit loss in the event of nonperformance by the
counterparty to the swap agreement. However, the Company does not anticipate
nonperformance.
22. ACQUISITIONS
On February 2, 2001, the Company acquired the assets of Digital Java, Inc., a
Chicago-based coffee company for a purchase price of $389,500 cash plus an
earn-out not to exceed $775,000. Digital Java, Inc. is a sourcer and
micro-roaster of premium quality coffees and offers a broad line of coffee-based
and non-coffee beverages.
The Company acquires market rights from either Associate or Area Developer
franchisees if they are willing to sell to the Company and if there are sound
business reasons for the Company to make the acquisition. These reasons may
include a franchise market being contiguous to a Company store market where an
acquisition would provide operational synergies; upside opportunity in the
market because the franchisee has not fully developed on-premises or
off-premises sales; or if the Company believes an acquisition of the market
would improve the brand image in the market.
During the second quarter of fiscal 2002, the Company acquired the Savannah, GA
and Charleston, SC markets by purchasing the rights to these markets from the
Associate Franchisee operators.
Each of these acquisitions was a purchase of assets and was accounted for using
the guidance in APB Opinion No. 16, "Business Combinations" or SFAS No. 141,
"Business Combinations" depending on the date of the acquisition. The total
purchase price paid for these acquisitions was $9,042,000 consisting of cash of
$4,859,000 and stock of $4,183,000. The purchase price was allocated to accounts
receivable, $589,000, inventory, $82,000, property and equipment, $2,573,000,
and reacquired franchise agreements, $5,798,000.
During the third quarter of fiscal 2002, the Company acquired the Baltimore, MD
market by purchasing the stores and the rights to this market from the Area
Developer Franchisee. The total consideration paid was cash of $15,712,000. The
purchase price was allocated to accounts receivable, $43,000, inventory,
$69,000, property and equipment, $4,991,000, and reacquired franchise
agreements, $10,609,000.
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets", the
goodwill and reacquired franchise agreements associated with acquisitions
completed on or before June 30, 2001 were amortized for the remainder of fiscal
2002 based on a 15 year life. Thereafter, the net remaining goodwill and
reacquired franchise agreements will be tested for impairment, generally on an
annual basis. Reacquired franchise agreements associated with acquisitions
completed after June 30, 2001 were not amortized and will also be tested for
impairment, generally on an annual basis. None of these acquisitions has a
material impact on Company Store revenues or Company Store operating income.
63
KRISPY KREME DOUGHNUTS, INC.
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF KRISPY KREME DOUGHNUTS, INC.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Krispy Kreme
Doughnuts, Inc. and its subsidiaries (the Company) at January 28, 2001 and
February 3, 2002, and the results of their operations and their cash flows for
each of the three years in the period ended February 3, 2002, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
Greensboro, North Carolina
March 8, 2002, except Note 21 for
which the date is March 27, 2002
64