Krispy Kreme is a leading branded retailer and wholesaler of high-quality doughnuts and packaged sweets. Our principal business, which began in 1937, is owning and franchising Krispy Kreme doughnut stores at which over 20 varieties of high-quality doughnuts, including our Original Glazed® doughnut, are made, sold and distributed together with complementary products, and where a broad array of coffees and other beverages are offered.
As of February 1, 2009, there were 523 Krispy Kreme stores operated systemwide in 36 U.S. states and in the District of Columbia, Australia, Bahrain, Canada, Indonesia, Japan, Kuwait, Lebanon, Mexico, the Philippines, Puerto Rico, Qatar, Saudi Arabia, South Korea, the United Arab Emirates and the United Kingdom.
Factory stores (stores which contain a doughnut-making production line) often support multiple sales channels to more fully utilize production capacity and reach various consumer segments. These sales channels are comprised of on-premises sales (sales to customers visiting our factory and satellite stores) and off-premises sales (sales to convenience stores, grocery stores/mass merchants and other food service and institutional accounts) as described further under “Business Operations — Company Stores.” Other factory stores, including small factory stores which have less production capacity than relatively larger factory stores, serve only the on-premises distribution channel. Satellite stores, all of which serve only the on-premises distribution channel and which are supplied with doughnuts from a nearby factory store, consist primarily of the hot shop, fresh shop and kiosk store formats. Hot shops contain doughnut heating equipment that allows customers to have a hot doughnut experience throughout the day. Fresh shops and free-standing kiosk locations do not contain doughnut heating equipment.
Approximately 56% of total domestic store sales (including sales by both Company and franchise stores) represent on-premises sales, and substantially all sales by stores outside the United States are on-premises.
Business Operations
We generate revenues from three distinct sources: stores we operate, which we refer to as Company Stores; development and franchise fees and royalties from our franchise stores, which we refer to as Franchise; and a vertically integrated supply chain, which we refer to as KK Supply Chain. Company Stores, Franchise and KK Supply Chain comprise our three reportable segments under generally accepted accounting principles (“GAAP”).
Company Stores. The principal source of revenue for our stores is the sale of doughnuts. Many of our factory stores are both retail outlets and wholesale producers of our doughnuts and, as a result, can sell their products through multiple channels.
On-premises sales. On-premises sales consist of sales to customers visiting our factory and satellite stores, including sales made through drive-through windows, along with discounted sales to community organizations that in turn sell doughnuts for fundraising purposes. Each of our stores generally offers at least 15 of our more than 20 varieties of doughnuts, including our signature Original Glazed® doughnut. We also sell complementary products and beverages, including drip coffees, espresso-based coffees, both coffee-based and noncoffee-based frozen drinks and packaged and fountain beverages.Off-premises sales. In addition to on-premises sales, we have developed multiple channels of sales outside our stores, which we refer to as off-premises sales. Off-premises sales consist of sales of fresh doughnuts and packaged sweets, primarily on a branded basis (i.e., bearing the Krispy Kreme brand name), to a variety of retail customers, such as convenience stores, grocery stores/mass merchants and other food service and institutional accounts. 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.
These sales channels are designed to generate incremental sales, increase market penetration and brand awareness, increase consumer convenience and optimize utilization of our stores’ production capacity. We accomplish off-premises sales through our direct store delivery system, or DSD, through which we deliver fresh doughnuts, both packaged and unpackaged, to our off-premises customers. Our off-premises customers include Amerada Hess, BiLo/Bruno’s, Exxon/Mobil, Food Lion, Kroger, Speedway SuperAmerica, Wal-Mart and Wilco/Hess. Our route drivers are capable of taking customer orders and delivering products directly to our customers’ retail locations, where they are typically merchandised from Krispy Kreme branded displays. We have also developed national account relationships and implemented electronic invoicing and payment systems with many large DSD customers.
Franchise. Through our Franchise segment, we generate revenues through the collection of development and franchise fees and royalties. Royalties from franchisees are payable based upon a percentage of franchise store sales and, as a result, our royalty revenues are dependent on level of sales by our franchisees. Most of our domestic franchisees sell doughnuts and other products through both the on-premises and off-premises channels, while substantially all sales by franchisees outside the United States are made through the on-premises channel.
KK Supply Chain. KK Supply Chain produces doughnut mixes and manufactures our doughnut-making equipment, which all franchisees are required to purchase. Additionally, KK Supply Chain operates a distribution center that provides Krispy Kreme stores with supplies for the critical areas of their business. KK Supply Chain generates revenues on sales of doughnut mixes, supplies, ingredients and equipment to franchisees. It supports both Company and franchisee stores by providing product knowledge and technical skills, controlling critical production and distribution processes and collective purchasing of certain materials.
KK Supply Chain has three business units:
Mix manufacturing. We produce all of our proprietary doughnut mixes, which our franchisees are required to purchase, at our manufacturing facility in Winston-Salem, North Carolina, but have a backup source to manufacture our doughnut mixes in the event of the loss of our Winston-Salem facility. For certain international franchisees, we produce a concentrate which is shipped internationally where it is then combined with other ingredients sourced locally by contract mix manufacturers pursuant to the terms of agreements with us or with our franchisee. We control production of doughnut mixes and concentrate and monitor the performance of international contract manufacturers in order to ensure that our products meet our high quality standards, which include:
Receiving truckloads of shipment of our main ingredients regularly;
Testing each incoming shipment of key ingredients; and
Testing each batch of mix.
In February 2009, we entered into an agreement with BakeMark USA LLC of Pico Rivera, California, to manufacture certain doughnut mixes for regions outside the Southeastern United States and to provide doughnut mix production in the event of a disruption of business at our Winston-Salem, North Carolina facility.
Equipment. We manufacture doughnut-making equipment, which our franchisees are required to purchase. Our equipment, when combined with our proprietary mixes and operated in accordance with our standard operating procedures, produces doughnuts with uniform consistency and quality.
Our line of doughnut-making machines includes machines that produce doughnuts at rates of approximately 65, 150, 270, 600 and 1,000 dozen doughnuts per hour. The largest of these machines (the 600 and 1,000 dozen per hour machines) are used primarily in a subset of our factory stores called commissaries, which are production facilities used principally to serve off-premises customers domestically and to supplement factory stores focused on on-premises sales internationally.
We also sell smaller machines, which we refer to as tunnel ovens and which are used in hot shops, that are manufactured by others and that complete the final steps of the production process by heating unglazed doughnuts to prepare them for the glazing process.
Distribution. We operate a distribution center in Winston-Salem, North Carolina which supplies key supplies, including doughnut mixes, icings and fillings, other food ingredients, coffee, juices, uniforms and various other items to domestic stores in the Eastern United States and to certain international franchise stores. In May 2008, we subcontracted with an independent distributor to supply the domestic stores not supplied from Winston-Salem, which generally consist of stores west of the Mississippi River. These stores previously were supplied from a distribution center in Southern California, which we closed in August 2008.
We provide many of the beverages offered in our stores, substantially all of which are purchased from third parties. Our beverage program includes drip coffees, both coffee-based and noncoffee-based frozen drinks, packaged and fountain beverages and, in many of our shops, a complete line of espresso-based coffees including flavors.
Most of our domestic franchisees have agreed contractually through our Supply Chain Alliance Program to purchase all of their requirements for the critical areas of their business from KK Supply Chain. We believe that our ability to distribute supplies to our operators produces several advantages, including:
Economies of scale. We are able to purchase key supplies at volume discount prices, which may be lower than those that would be available to our operators individually. In addition, we are selective in choosing our suppliers and require that they meet certain standards with regard to quality and reliability. Also, inventory is managed on a systemwide basis rather than at the store level.
Convenience. Our distribution center and our independent contract distributor carry the key items necessary for store operation. We believe this strategy of having one ordering and delivery system for store operations enables the store operators to focus their time and energies on running their stores, rather than managing multiple supplier and distribution relationships.
Krispy Kreme Brand Elements
Krispy Kreme has several important brand elements which we believe have created a bond with many of our customers. The key elements are:
One-of-a-kind taste. The taste experience of our doughnuts is the foundation of our concept and the common thread that binds generations of our loyal customers. Our doughnuts are made based on a secret recipe that has been in our Company since 1937. We use premium ingredients, which are blended by our custom equipment in accordance with our standard operating procedures, to create this unique and very special product.
Doughnut theater.® Our factory stores typically showcase our Doughnut theater,® which is designed to produce a multi-sensory customer experience and establish a brand identity. Our goal is to provide our customers with an entertainment experience and to reinforce our commitment to quality and freshness by allowing them to see doughnuts being made.Hot Krispy Kreme Original Glazed Now® sign. The Hot Krispy Kreme Original Glazed Now® sign, when illuminated, is a signal that our hot Original Glazed® doughnuts are being made. The Hot Krispy Kreme Original Glazed Now® sign is an impulse purchase generator and an integral contributor to our brand. Our hot Original Glazed® doughnuts are made for several hours every morning and evening, and at other times during the day.
Community relationships. We are committed to local community relationships. Our store operators support their local communities through fundraising programs and the sponsorship of charitable events. Many of our loyal customers have memories of selling Krispy Kreme doughnuts to raise money for their schools, clubs and community organizations.
Store Format and Development
Store Format. We classify a store as either a factory store or a satellite store. Our traditional factory store has the capacity to produce from 4,000 dozen to over 10,000 dozen doughnuts daily, and often engage in both on-premises and off-premises sales. Other factory stores, including small factory stores which have less production capacity than relatively larger factory stores, serve only the on-premises distribution channel. Commissaries, which are production facilities used principally to serve off-premises customers domestically and to supplement factory stores focused on on-premises sales internationally, have the highest production capabilities of our factory stores. As of February 1, 2009, there were 19 commissaries systemwide, six of which were operated by the Company.
Satellite stores consist primarily of the hot shop, fresh shop and kiosk store formats, each of which is substantially smaller than a traditional factory store. Hot shop stores contain tunnel oven doughnut heating and finishing equipment that allows customers to have a hot doughnut experience throughout the day. Our fresh shops and our free-standing kiosk locations do not contain doughnut heating equipment. In each of these formats, we typically sell fresh doughnuts and beverages, with the doughnuts supplied by nearby factory stores. As of February 1, 2009, 141 fresh shops, 49 hot shops and 52 kiosks were open systemwide. We operated 10 of the hot shops. We continue to view the fresh shop, hot shops and kiosk formats as additional ways to achieve market penetration in a variety of market sizes and settings.
Domestic Store Development. As of February 1, 2009, there were a total of 225 domestic stores, of which 187 were factory stores and 38 were satellite stores. These store numbers reflect six domestic store openings and 26 domestic store closings in fiscal 2009. Of the six stores opened in fiscal 2009, five were satellite stores, and all six were franchise stores. Of the 26 stores closed in fiscal 2009, five were Company stores. The Company currently plans to open a modest number of new Company-operated satellite stores in fiscal 2010, and domestic franchisees also may open additional satellite stores as we work to refine our store formats for new domestic stores. However, we do not expect that we or our franchisees will open a significant number of domestic factory stores in the near future.
We have converted six of the stores we operate from traditional factory stores to hot shops using tunnel oven technology to reduce operating costs and increase the number of hours each day we offer our hot Original Glazed® doughnuts. Certain of our franchisees also have converted traditional factory stores to hot shops.
International Store Development. Markets outside the United States are a source of growth. As of February 1, 2009, there were a total of 298 Krispy Kreme stores (including 204 satellites) operated internationally, which were located in Australia, Bahrain, Canada, Indonesia, Japan, Kuwait, Lebanon, Mexico, the Philippines, Puerto Rico, Qatar, Saudi Arabia, South Korea, the United Arab Emirates and the United Kingdom. In fiscal 2009, 114 new international stores were opened, and 20 international stores were closed. Based upon our continued research and experience with our international stores, we are focusing additional international development efforts primarily on opportunities in markets in Asia and the Middle East. We are focusing on these two geographic areas because of their favorable population demographics, relatively high levels of consumer sweet goods consumption and the popularity of Western brands in these markets. Existing development and franchise agreements for territories outside the United States (which include the countries listed above) provide for the development of over 160 additional stores in fiscal 2010 and thereafter. Our ability to expand in these or other international markets, however, will depend on a number of factors, including attracting experienced and well capitalized franchisees, demand for our product, our ability to supply or obtain the ingredients and equipment necessary to produce our products and local laws or policies of the particular countries.