Krispy Kreme Doughnuts, Inc.

views updated

Krispy Kreme Doughnuts, Inc.

370 Knollwood St., Suite 500
Winston-Salem, North Carolina 27103-1880
U.S.A.
Telephone: (336) 725-2981
Toll Free: (800) 457-4779
Fax: (336) 733-3791
Web site: http://www.krispykreme.com

Public Company
Incorporated: 1937
Employees: 3,913
Sales: $491.5 million (2003)
Stock Exchanges: New York
Ticker Symbol: KKD
NAIC: 722213 Snack and Nonalcoholic Beverage Bars; 311811 Retail Bakeries; 311812 Commercial Bakeries; 533110 Lessors of Nonfinancial Intangible Assets (Except Copyrighted Works)

Krispy Kreme Doughnuts, Inc. makes what some would argue are one of the highlights of life on this planet: yeast-raised doughnuts. Sweet and impossibly fluffy, the Original Glazed earned a zealous following throughout the southern United States—and then beyond once expansion outside the South began in the mid-1990s. By late 2003, the company was operating more than 300 doughnut shops in 42 states; Ontario, Canada; Sydney, Australia; and the United Kingdom. It was producing 7.5 million doughnuts per day, adding up to 2.7 billion per year. The company's shops sell more than doughnuts, however, offering snack food, fruit pies, cinnamon buns, and beverages, including coffee, espresso, and frozen drinks. In addition to sales to customers entering its stores or using its drivethrough windows, Krispy Kreme also uses its outlets as factories that additionally distribute fresh doughnuts for sale at convenience stores and supermarkets. The company also owns Montana Mills Bread Co., Inc., operator of about two dozen upscale bread stores located in the northeastern and midwestern United States.

Sweet Success in the 1930s

Sometime before the Great Depression, a French chef from New Orleans named Joe LeBeau developed the recipe for yeastraised doughnuts—possibly the first of its kind in the United States—that would later form the basis of the Krispy Kreme empire. Eventually LeBeau established a doughnut shop in Paducah, Kentucky, which he sold in 1933, along with the secret recipe (speculated to contain vanilla and potato flour).

Vernon Rudolph and his uncle were the buyers. They moved the operation to Nashville, Tennessee, in 1935 and, through other family members, opened stores in Charleston, West Virginia, and Atlanta, Georgia. These stores sold their products wholesale to grocery stores.

Rudolph decided to strike out on his own. He brought with him two men, some equipment, and the secret recipe and eventually settled on booming Winston-Salem, North Carolina, as a location (some say a pack of Camel cigarettes sold him on the town). He lacked capital but was able to rent a building and obtain ingredients on credit. The first doughnuts from this new shop—called Krispy Kreme Doughnuts—were made on July 13, 1937. Such was their success that eager customers soon began requesting hot doughnuts directly from the doughnut shop, initiating the company's retail trade. Five cents bought two doughnuts, and a dozen cost a quarter. The company established its national headquarters in Winston-Salem in 1941.

Cold War Standardization

Krispy Kreme initiated an expansion program in 1946 that included producing the mix at a central plant in Winston-Salem to ensure consistency. In 1948 it opened the plant, which also produced equipment for the stores, and relocated its headquarters to the site (Ivy Avenue). During the 1950s mechanization brought an end to hand-cut doughnuts as the company gradually automated the entire doughnut-making process. By the end of the decade, 29 Krispy Kreme shops in 12 states each had the capacity to produce 500 dozen doughnuts per hour via specialized doughnut-making machines.

The distinctive Krispy Kreme decor was standardized in 1960. The shops (which by then populated 12 states) were sheltered by a green roof and red-glazed brick exterior. Inside, a large viewing window revealed doughnuts in production on an overhead conveyor belt—the first incarnation of the "doughnut-making theater" that Krispy Kreme would adopt as the centerpiece of all of its stores. In 1962 the company began to use air pressure to form almost perfectly symmetrical doughnuts. That same year, Krispy Kreme opened two new factories in Charlotte, North Carolina, and one in Richmond, Virginia.

Company founder Vernon Rudolph died in 1973. In 1974 the chain had 94 stores and 25 franchisees. Beatrice Foods Company bought Krispy Kreme two years later. Beatrice, according to one Krispy Kreme official, valued short-term profits at the expense of quality, even changing the traditional formula. To maximize sales, some stores began selling sandwiches. Development capital disappeared, stifling the company's longterm plans, and the company stopped selling franchises. Nevertheless, the company grew to 116 stores by 1980.

After Krispy Kreme was bought back from Beatrice, that growth disappeared to help repay debts of approximately five times the company's equity. Joseph A. McAleer, Sr., led the group of investors who bought the company in 1982 in a $22 million leveraged buyout. McAleer had been one of the chain's most successful franchisees. After grooming his son, Mac, for the CEO position, Joseph McAleer, Sr., retired in 1988. Another son, Jack, served as vice-president of sales and marketing. Scott Livengood, a Winston-Salem native who had joined the company during the Beatrice years, served as president.

Soon afterward, market research convinced the company to focus on the retail market, particularly hot doughnuts. The company reintroduced glowing red "Hot Doughnuts Now" signs, lit when new doughnuts were ready (which was most hours of the day), and guaranteeing a virtually Pavlovian response. The company tried expanding with drive-through only "Express" stores, which were less expensive to build than traditional stores (which cost about $1 million to open), but found customers missed the seating areas. The compact stores also lacked space for wholesale operations.

Northern Expansion in the Mid-1990s

In 1995 Krispy Kreme moved its headquarters and 230 corporate employees to 370 Knollwood Street in Winston-Salem. The headquarters also housed Doughnut University, a training center. New management talent had been drafted in the early 1990s to prepare the chain for its most ambitious expansion yet attempted. Jack and Mac McAleer and Scott Livengood retained the top positions at Krispy Kreme, but other conservative Winston-Salem businessmen were brought in to advise the company. To leverage its growth, Krispy Kreme would rely heavily on franchising: only 100 of 500 new stores would be company owned. Its first venture into northern territory was a shop in Indianapolis. The opening, which stopped traffic for blocks, was a sign of things to come.

The man who would introduce Krispy Kreme to New York, Mel Lev, a garment manufacturer, discovered the doughnuts while visiting friends and relations in Jackson, Mississippi. "Why do we need four dozen doughnuts?" were his reported last words before changing career paths. In June 1996 Lev opened the first store in Manhattan, at 265 West 23rd Street, near the historic Chelsea Hotel. The enterprise was named Harem, not in reference to the decadence of its products, but after the initials of family members. The family planned to open at least 30 stores in New York and New Jersey by 2005.

Reception was superlative. In the style column of the New York Times Magazine, Southern humorist Roy Blount, Jr., said, "When Krispy Kremes are hot, they are to other doughnuts what angels are to people." He had hurried to the store opening and eaten five Original Glazed. New York being the capital of the publishing industry, many other odes by displaced Southerners were published on the hottest snack in town. Television also caught the buzz: Rosie O'Donnell had her own doughnut machine installed on her talk show, complete with conveyor belt and "Hot Doughnuts Now" sign. Late actress Jessica Tandy had already seen to it that the doughnuts had their moment on the silver screen, in such movies as Driving Miss Daisy and Fried Green Tomatoes.

The company's introduction to New York mirrored the sensation caused by the world's first doughnut-making machine, unveiled by Adolph Levitt in Harlem in 1921. Lev would open the second of the New York stores in Harlem, across from the Apollo Theater. Not everyone was delighted with the new stores, however. Some neighbors complained of fryer fumes, which resulted in Lev incurring fines from municipal environmental monitors.

Aside from pleasing transplanted Southerners in the Big Apple, the openings also suited Krispy Kreme's strategic plans. New York's only national doughnut chain was Dunkin' Donuts. Owned by British conglomerate Allied-Lyons plc (later known as Allied Domecq PLC), Dunkin' Donuts, with 115 stores in New York City, had led the market for years and had recently bought its closest competition, Mr. Donut, a West Coast chain. It also sold a range of sandwiches, soups, and muffins; doughnuts accounted for only half of the chain's sales. Krispy Kreme's supporters, though, believed the uniqueness of the yeast-raised products would ensure its success.

Company Perspectives:

Strategic Philosophy: All products we make in our stores will have a taste and quality that are second to none. The starting point in controlling product quality is controlling the quality and freshness of the ingredients. We will be thoroughly prepared to execute growth initiatives when they become needed. We view quality, service, and innovation as keys to creating and maintaining a competitive advantage. We view our company as a set of capabilities, not just a product or brand. We view our growth and success as a company as a natural result of the growth and success of our people.

Stores in Scranton, Pennsylvania; Wilmington, Delaware; and Indianapolis figured into the company's assault on the North. The Indianapolis store overcame a mere 2 percent name recognition factor to set a first day sales record. Louisville, Kentucky, had previously had the northernmost store. Sweet Traditions LLC, a partnership of Canadian expatriate Eric Sigurdson and Chicago native Ken Marino, announced plans to open five St. Louis stores by the end of the decade.

Late 1990s: A New Brew, Going Coast to Coast

Coffee bars had been a feature of Krispy Kreme stores at least since the 1960s. In 1996 Krispy Kreme introduced its proprietary blend, titled "America's Cup of Coffee." One and a half years of extensive research (assisted by 1,200 customers) preceded the introduction. "Americans are drinking more coffee and becoming more knowledgeable about coffee," explained Jack McAleer. The beans were sold by the bag as well.

Convenience stores sold a variety of Krispy Kreme pastries, particularly single-serve items such as fruit pies, Krispy Knibbles (doughnut "holes"), and cinnamon rolls. In 1995 the company tested a cobranding concept with Kroger grocery stores, whereby the doughnuts would be shipped fresh daily and placed in the bakery section, rather than the bread shelves. The Krispy Kreme stores themselves offered 15 varieties of doughnuts; some stores test-marketed bagels. Lowe's hardware superstores began hosting Krispy Kreme shops in 1996 in what turned out to be a short-lived experiment. Reviving a concept tried in the Beatrice days, the outlets also sold sandwiches supplied by an outside source.

Fund-raising traditionally accounted for around 10 percent of the company's sales and brought in more than $12 million in 1995. Half of the trade was wholesale. Before the company placed a new emphasis on retail sales in 1989, they had accounted for only a quarter of sales.

Expansion continued with the opening of new Krispy Kreme shops in Omaha, Nebraska; Las Vegas, Nevada; and the Kansas City area. By the end of 1997 there were 130 stores in 17 states, nearly half of which were franchised outlets. That year, the Smithsonian Institution confirmed Krispy Kreme's place in the American culinary pantheon by honoring it on its 60th anniversary. Artifacts from the company were contributed to the Smithsonian's National Museum of American History.

Remarkably, Krispy Kreme's successful expansion into new markets was accomplished entirely without a traditional media advertising budget. The company found that it could get more effective advertising for next to nothing by giving its doughnuts away; upon entering a new market, Krispy Kreme provided free doughnuts to local television and radio outlets and newspapers, which typically obliged by running puff pieces. From that point, word-of-mouth advertising had proved sufficiently effective to maintain the brand's cult status.

During the final two years of the decade, the chain entered several more major markets, including Houston, Dallas, and Chicago. Perhaps most importantly, the first West Coast store opened in La Habra, California, near Los Angeles, in January 1999. The company announced plans to open more than 40 franchise outlets in southern California over a four- to six-year period. Now operating coast to coast, Krispy Kreme ended the decade with 144 shops (86 franchised) in 27 states, making more than three million doughnuts daily and 1.3 billion per year. Revenues reached $220.2 million for the fiscal year ending in January 2000, a 40 percent increase over the figure from two years earlier. Livengood was named president and CEO in 1998 and then became chairman as well the following year.

Early 2000s: Raising Dough via IPO, Venturing into Foreign Territory

Leveraging its growing cult status to fund further expansion and the remodeling and relocating of some older units, the company went public as Krispy Kreme Doughnuts, Inc. on April 5, 2000. The offering of 3.45 million shares was priced at $21 per share, generating net proceeds of $63 million. In that first day of trading, the stock rose 76 percent, finishing at $37 a share, which placed the market capitalization of the company at nearly $462 million. With the bursting of the technology stock bubble around this time, Krispy Kreme became one of the hottest stocks around, and another 10.4 million shares were sold in a secondary offering in February 2001. A few months later, trading in the stock was transferred to the more prestigious New York Stock Exchange.

Key Dates:

1933:: Vernon Rudolph and his uncle buy a doughnut shop in Paducah, Kentucky, from a French chef from New Orleans who had developed a secret recipe for yeast-raised doughnuts.
1935:: The partners move the operation to Nashville, Tennessee; their initial focus is selling doughnuts wholesale to grocery stores.
1937:: Rudolph leaves Nashville to open his own doughnut shop in Winston-Salem, North Carolina, called Krispy Kreme Doughnuts; after first concentrating on wholesaling, the new operation soon begins retail operations in response to demand from the public.
Late 1950s:: There are 29 Krispy Kreme shops in 12 states.
1973:: Company founder Rudolph dies.
1976:: Beatrice Foods Company purchases Krispy Kreme.
1982:: Group of investors led by franchisee Joseph A. McAleer, Sr., buy Krispy Kreme in a $22 million leveraged buyout.
1995:: First shop outside the South opens in Indianapolis.
1996:: The first New York City Krispy Kreme outlet makes its debut.
1999:: First West Coast store opens in La Habra, California.
2000:: With 141 stores in 27 states, the firm goes public as Krispy Kreme Doughnuts, Inc., raising net proceeds of $63 million on the NASDAQ.
2001:: Krispy Kreme's stock is shifted to the New York Stock Exchange; first store outside the United States opens near Toronto, Canada.
2003:: Montana Mills Bread Co., Inc. is acquired for about $40 million in stock.

Krispy Kreme had long been vertically integrated on the doughnut side, producing its own doughnut mixes and manufacturing its own doughnut-making machinery, in addition to making, retailing, and wholesaling the finished product. During the early 2000s, the firm began adopting a vertical integration model for its beverage offerings. In February 2001 the company acquired Digital Java, Inc., a Chicago-based sourcer and microroaster of premium-quality coffee and producer of a wide line of coffee-based and non-coffee-based beverages. The assets and operation of the acquired firm were subsequently relocated to a brand-new coffee-roasting plant built in Winston-Salem. During 2002 and 2003 Krispy Kreme began rolling out a new beverage program featuring drip coffee, espresso, and frozen beverages. The overall goal was to increase the amount of sales deriving from beverages from 10 percent to about 20 percent by around 2008.

Another new initiative was the late 2001 launch of a new test concept called the "doughnut and coffee shop." These stores aimed to provide customers with the hot doughnut experience that they had come to expect from Krispy Kreme, but in smaller locations—as small as 900 square feet—such as in a food court at a mall, in a downtown area, or at an airport. These outlets featured a new machine called the "Hot Doughnut Machine," which took cooked but unglazed doughnuts that had been prepared at one of the company's "factory" stores, reheated them, and then glazed them. (Krispy Kreme considered each of its standard stores to be a "doughnut factory"; capacity of these "factories" ranged from 4,000 dozen to 10,000 dozen doughnuts per day.) By early 2003 there were five of these outlets, which also offered a full line of coffee and other beverages. During 2003 Krispy Kreme also began experimenting with satellite outlets, which did not make their own doughnuts at all but rather were supplied with fresh—but cold—doughnuts from a nearby factory store. Yet another experiment, harkening back to the failed outlets that had opened in the late 1990s in some Lowe's stores, saw Krispy Kreme testing out stores located within Wal-Mart Stores, Inc. supercenters.

On the expansion front, Krispy Kreme by late 2003 had stores in 42 states, including its first outlets in New England, a stronghold of archrival Dunkin' Donuts, which was based in Randolph, Massachusetts. Among the newer Krispy Kreme franchisees were two celebrities: singer Jimmy Buffett acquired the rights to build outlets in Palm Beach County, Florida, in 2000; and Hank Aaron, baseball's all-time home-run hitter, reached an agreement in mid-2002 to begin opening franchises in the West End of Atlanta, Georgia. Expansion outside the United States began as well, with the first foreign outlet opening near Toronto, Canada, in December 2001. Through a joint venture with a franchise group, the corporation said that it planned to open 32 shops in eastern Canada over a six-year period. Here too, Krispy Kreme was venturing into territory dominated by a major doughnut player, namely Tim Hortons, a ubiquitous Canadian chain owned by Wendy's International, Inc. (Fittingly, Tim Hortons was simultaneously expanding into the U.S. market.) In June 2002 the company announced that it had entered into a joint venture to open 30 Krispy Kreme stores over a five-year period in Australia and New Zealand. Later that year, yet another joint venture was formed with two partnership groups, one of which included legendary television personality Dick Clark, to open 25 stores in the United Kingdom and the Republic of Ireland. In May 2003 the firm formed a joint venture with Grupo AXO to open 20 units in Mexico by 2009. Other markets under consideration for expansion included Japan, South Korea, and Spain.

Early in 2003 Krispy Kreme acquired Montana Mills Bread Co., Inc. for about $40 million in stock. Founded in 1996 and based in Rochester, New York, Montana Mills operated about two dozen upscale bakeries in the Northeast and Midwest that were modeled after old-fashioned neighborhood bakeries. They offered nearly 100 varieties of bread, muffins, cookies, and scones, as well as sandwiches, soups, salads, and specialty coffees. The two chains had some notable similarities, particularly Montana Mills' "bread-baking theater" concept, which was akin to Krispy Kreme's doughnut-making theater. Workers at Montana Mills ground their own wheat every day, and the bakers worked in full view of the customers, mixing and kneading dough on large tables and then placing the loaves into huge ovens that were also visible to customers. By contrast, of course, Montana Mills was at a much earlier stage of development, and Krispy Kreme executives said that they would take a couple of years to refine the concept before beginning to expand it further.

Fiscal 2003 revenues reached $491.5 million, while systemwide sales hit $778.6 million, a 28 percent jump over the previous year. Net income that year totaled $39.1 million, up 51.6 percent over the 2002 level. Systemwide sales were expected to surpass the $1 billion mark during fiscal 2004, a year in which the corporation planned to open 77 new stores, most of them franchise outlets. Krispy Kreme still had plenty of expansion opportunities in the Unites States, through both its traditional formats and its experimental concepts, as well as in wholesaling to convenience and grocery stores, in addition to the great potential for overseas growth. In Montana Mills, it now also had the possibility of seeking growth through a second chain. Although it seemed likely that the stellar growth that Krispy Kreme had been enjoying was bound to taper off, the company and its doughnuts certainly seemed hotter than ever.

Principal Subsidiaries

Krispy Kreme Doughnut Corporation; Krispy Kreme Distributing Company, Inc.; Krispy Kreme Coffee Company, LLC; Krispy Kreme Mobile Store Company; HD Capital Corporation; HDN Development Corporation; Montana Mills Bread Co., Inc.; Panhandle Doughnuts, LLC; Oliver Acquisition Corp.; Krispy Kreme International Ltd. (Switzerland); Hot Doughnuts Now International Ltd. (Switzerland); Krispy Kreme Europe Limited (U.K.).