11

CHERYL ORLOV,On Behalf of Herself and All Others ) No .Similarly Situated, )Plaintiff, ) COMPLAINT FOR VIOLATION OF

THE FEDERAL SECURITIES LAWS

UNITED STATES DISTRICT COURT kf63FILED #JUN 1 8 2O4

MIDDLE DISTRICT OF NORTH CAROLINA IN lolls OMC EClerk U . S . tlhtrkt Court

GmnlSero. N. C.

CLASS ACTION a t

vs .

KRISPY KREME DOUGHNUTS, INC .,SCOTT A LIVENGOOD, JOHN W.TATE, MICHAEL C . PHALEN andRANDY S. CASSTEVENS ,

Defendants .

i:04CV0 055 3

JURY TRIAL DEMANDED

1

sr, . -- .T.

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Plaintiff has alleged the following based upon the investigation of plaintiff's

counsel, which included a review of United States Securities and Exchange Commission

("SEC") filings by Krispy Kreme Doughnuts, Inc . ("Krispy Kreme" or the "Company"),

as well as regulatory filings and reports, securities analysts reports and advisories about

the Company, press releases, and media reports about the Company, and plaintiff

believes that substantial additional evidentiary support will exist for the allegations set

forth herein after a reasonable opportunity for discovery .

INTRODUCTION

1 . This is a class action for violations of the federal securities laws brought

on behalf of purchasers of the publicly traded securities of Krispy Kreme between August

21, 2003 and May 7, 2004 inclusive (the "Class Period") against Krispy Kreme and

certain of its officers and directors, pursuing remedies for violations of the Securities

Exchange Act of 1934 (the "1934 Act ") .

2. Krispy Kreme is a leading branded retailer of doughnuts . Krispy Kreme's

principal business is owning and franchising Krispy Kreme doughnut stores, each of

which contains a doughnut factory and supports multiple sales channels, including retail

sales to store customers, wholesale to supermarkets and other outlets, and a direct store

delivery system . Krispy Kreme generates sales and income from three distinct sources :

the Company-owned store sales, franchise fees and royalties and a vertically integrated

supply chain.

3. After its initial public offering in April 2000, when its common stock was

first traded on the NASDAQ market and then began trading on the NYSE on May 17,

2001 under the ticker symbol KKD, the Company grew rapidly and, throughout the Class

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Period, Krispy Kreme has continually touted to its investors its "significant opportunities

for continued growth" which it attributes to "[t]he combination of our well-established

brand, our one-of-a-kind doughnuts, a unique retail experience featuring our stores' fully

displayed production process, including our doughnut-making theater, our vertical

integration and our strong franchise system." (Krispy Kreme's Form 10-K for Fiscal

2004 at p . 3, filed February 2, 2004) .

4 . During the Class Period, defendants portrayal of Krispy Kreme's business

and prospects masked the reality, including the following:

a. The opening of new Krispy Kreme stores created initial consumer

excitement and a corresponding surge in sales . However, sales at those newly-

opened stores quickly tapered off. This was endemic across the chain, especially

in smaller markets with a limited number of potential new customers . Rather than

cultivate a steady customer based, the Company instead attempted to capitalize on

Krispy Kreme's "fad appeal ." Its business model and strategy for increasing sales

was predicated on the perpetual addition of new stores and the hyping of the

Company's entry into new markets ---- a tactic that resulted in unsustainable

surges in sales that fell off once the hype ceased and the novelty of the new store

wore off.

b. the Company's strategy of offsetting slowing retail sales with

wholesale shipments to supermarkets was not working because :

i) the Company's wholesale business was more expensive to

operate and, therefore, resulted in a lower profit margin than in-store sales

and

ii) the Company's wholesale business was saturating the

market with Krispy Kreme products, cannibalizing the company's retail

operations, perhaps undermining them as well, and decreasing the

Company's overall profit margin; and

c . During the Class Period, the Company repurchased several

franchises, which were chacterized to investors as repurchases that were all part

of Krispy Kreme's "acquisition strategy ." In fact, the Company was repurchasing

franchises to prevent franchisees from closing the stores, because this would

damage Krispy Kreme's reputation for ever-increasing growth and as part of a

scheme to wipe franchisee accounts receivable off its books . Moreover, the

Company acquired a struggling franchise in a manner which inflated Krispy

Kreme's results, by including in the purchase price monies for the former owners

to pay Krispy Kreme's franchise fees and/or royalties .

d . As a result of certain transactions, Krispy Kreme consolidated

money-making joint ventures into its financial statements, thereby causing its

earnings to be, in part, misleading .

5. As a result of these false statements, during the Class Period, the

Company's stock climbed as high as $47.50 per share, and, Krispy Kreme insiders sold in

excess of 1 .5 million shares for proceeds of $50 .1 million that were paid to those insiders

(including the Individual Defendants named in this Complaint .

6 . On May 7, 2004, the day the Class Period ends, Krispy Kreme announced

that "it expects fiscal 2005 diluted earnings per share from continuing operations,

excluding certain charges, to be 10% lower than previously announced guidance . "

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(Krispy Kreme Press Release, PRNewsire, May 7, 2004, "In Response to Recent Industry

Dynamics, Krispy Kreme Updates Business Outlook ") Blaming their lackluster results

on the so-called low-carbohydrate ("low-carb") diet trend, Krispy Kreme told the

investing public that ,

For several months, there has been increasing consumer interest inlow-carbohydrate diets, which has adversely impacted several flour-based food categories . . . This trend had little discernable effect onour business last year . However, recent market data suggestsconsumer interest in reduced carbohydrate consumption hasheightened significantly following the beginning of the year and hasaccelerated in the last two to three months . This phenomenon hasaffected us most heavily in our off-premises sales channels, inparticular sales of packaged doughnuts to grocery store customers .

7 . This May 7, 2004 attribution by defendants for Krispy Kreme's financial

results and prospects was false and misleading, as defendants knew or recklessly

disregarded that the trend toward low-fat, low-carb diet was not the sole, or even a

significant, reason for the Company's worsening financial condition . Defendants merely

and conveniently used media attention to low-carb diets as an opportune ruse to obscure

the prior false and misleading public statements regarding Krispy Kreme's store results,

same store sales, acquisitions and growth rates .

8 . Purportedly, as part of Krispy Kreme's effort to "address the current

situation", Krispy Kreme announced that it would : "divest the existing Montana Mills

operation" (an operation that it had bought a year earlier, would result in a write-off of as

much as $40 million, and about which, as recently as mid-April 2004, defendants had

said they intended to refine and expand the operation) ; close certain company-owned

stores; and shedding and trimming plans to open new ones.

9. On this news, shares of Krispy Kreme fell $9 .29, or 29%, to close on May

7, 2004 at $22.51, a new 52-week low and more than 50% below Krispy Kreme's 52-

week high of $49.74. The trading volume on May 7 was 20 .5 million shares, the largest

ever for Krispy Kreme and amounted to a third of the shares outstanding . The stock later

dropped to as low as $19 .00 per share .

JURISDICTION AND VENUE

10. The claims asserted herein arise under and pursuant to § § 10(b) and 20(a )

of the 1934 Act (15 U .S.C. §§ 78j(b) and 78t (a)) and Rule 10b-5 promulgated thereunder

by the SEC (17 C.F.R. ¶240 .1 Ob-5) .

11 . Jurisdiction is conferred on this court over the subject matter of this actio n

pursuant to Section 27 of the 1934 Act (15 U.S.C . §78aa) and 28 U . S .C. §§ 1331 and

1337 .

12 . Venue is proper in this District pursuant to §27 of the 1934 Act . Krispy

Kreme maintains its principal place of business in this District and many of the false an d

misleading statements, and acts and practices complained of herein, were made in, issued

from, or occurred in substantial part in this District .

13. In connection with the acts alleged in this Complaint, defendants, directly

or indirectly, used the means and instrumentalities of interstate commerce, including, bu t

not limited to, the mails, interstate telephone communications and the facilities of the

national securities markets .

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THE PARTIES

14. Plaintiff Cheryl Orlov purchased the publicly-traded securities of Krispy

Kreme during the Class Period as described in the attached Certification, incorporated

herein by reference, and has been damaged thereby .

15. Defendant Krispy Kreme is a specialty retailer of doughnuts . The

Company's principal business is owning and franchising Krispy Kreme doughnut stores,

where it makes and sells more than 20 varieties of doughnuts . It currently operates 374

factory stores in 44 U .S. states, Australia, Canada and Mexico. Krispy Kreme is

incorporated in North Carolina and its principal place of business is located at 370

Knollwood Street, Winston-Salem, North Carolina . Throughout the Class Period, Krispy

Kreme's common stock traded in an efficient market on the New York Stock Exchange

("NYSE") .

16. Defendant Randy S . Casstevens ("Casstevens") was at all relevant times

Chief Financial Officer of Krispy Kreme until his resignation effective December 23,

2003.

17. Defendant Scott A. Livengood ("Livengood") was, at all relevant times,

Chairman of the Board of the Company, President and Chief Executive Officer of Krispy

Kreme.

18 . Defendant Michael C. Phalen ("Phalen") has been Chief Financial Officer

of Krispy Kreme since January 2004 .

19 . Defendant John W. Tate ("Tate") was at all relevant times Chief Operating

Officer of Krispy Kreme.

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20. Defendants Casstevens, Livengood, Phalen and Tate are collectively

referred to herein as the "Individual Defendants."

21 . The Individual Defendants , because of their positions with the Comp any,

possessed the power and autho rity to control the contents of Krispy Kreme 's quarterly

reports , press releases and presentations to securities analysts, money and portfolio

managers and institutional investors . Each Individual Defendant was provided with

copies of the Company 's reports and press releases alleged herein to be misleading prior

to or sho rtly after their issu ance and had the ability and opportunity to prevent their

issuance or cause them to be corrected .

22. Because of their positions of control and authority as officers and/or

directors of the Company, and access to material non-public information, each of the

Individual Defendants were able to and did control the content of the various SEC filings,

press releases and other public statements pertaining to the Company during the Class

Period, knew or recklessly disregarded that the adverse facts specified herein had not

been disclosed to and were being concealed from the public and knew or recklessly

disregarded that the positive representations which were being made were then materially

false and misleading. The Individual Defendants are liable for the false statements

pleaded herein, as those statements were each "group published" information, the result

of the collective actions of the Individual Defendants .

23 . As officers and controlling persons of a publicly held company whose

common stock was, and is, registered with the SEC pursuant to the Exchange Act, traded

on the NYSE, and governed by the provisions of the federal securities laws, the

Individual Defendants each had a duty promptly to disseminate accurate and truthful

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information with respect to the Company's financial condition and performance, growth,

operations, financial statements, business, products, markets, management, earnings, and

present and future business prospects, and to correct any previously issued statements

that had become materially misleading or untrue, so that the market prices of the

Company's publicly traded securities would be based upon truthful and accurate

information . The Individual Defendants' misrepresentations and omissions during the

Class Period violated these specific requirements and obligations.

24. Each Individual Defendant had knowledge of Krispy Kreme's problems

and was motivated to conceal such problems . As Chief Executive Officer, defendant

Livengood reviewed or was responsible for the preparation of many of the internal

reports showing Krispy Kreme's forecasted and actual growth and thus defendant

Livengood, as well as the other Individual Defendants, were aware of the Company's

significant operational and financial problems before these problems became known to

the investing public. The Individual Defendants, as directors and/or officers of Krispy

Kreme, were responsible for the financial results and press releases issued by the

Company. Each Individual Defendant sought to demonstrate that they could lead the

Company successfully and generate the growth expected by the market, 19 . Defendants

knew or deliberately disregarded that the materially false and misleading statements and

omissions complained of herein would adversely affect the integrity of the market for the

Company's securities and would artificially inflate the price of the Company's publicly-

traded securities. Defendants acted knowingly or with such deliberate disregard of such

facts as they should have known in such a manner as to constitute a fraud and deceit upon

plaintiff and other members of the Class .

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25 . Moreover, during the Class Period, insiders sold 1 .5 million Krispy Kreme

shares for proceeds of $50 .1 million. The sale was executed through Jubilee Investments

Limited Partnership, formerly McAleer Investments Limited Partnership ("Jubilee"),

which is a limited partnership established by Krispy Kreme insider John N . McAleer

("McAleer") and members of his family . McAleer is Vice Chairman of the Krispy Kreme

Board and Krispy Kreme's Executive Vice President of "Concept Development ." On

August 26, 2003, when Krispy Kreme was trading at approximately $43 .50, Jubilee

entered into a forward contract for the sale of 1 .5 million Krispy Kreme shares for

delivery in two tranches for an aggregate purchase price of $50,186,618 .

26. Krispy Kreme and each of the Individual Defendants are liable a s

participants in a fraudulent scheme and course of business that operated as a fraud or

deceit on purchasers of Krispy Kreme publicly traded securities by : (i) making false and

misleading statements ; and (ii) failing to disclose adverse facts known to defendants

about Krispy Kreme when they were under a duty to include such disclosures .

Defendants' fraudulent scheme and course of business that operated as a fraud or deceit

on purchasers of Krispy Kreme publicly traded securities were a success, as they (i)

deceived the investing public regarding Krispy Kreme's prospects and business and (ii)

artificially inflated the prices of Krispy Kreme's publicly-traded securities during the

Class Period; and (iii) sold 1 .5 million shares of Krispy Kreme stock to the public for

proceeds of $50.1 million .

CLASS ACTION ALLEGATION S

27. Plaintiff brings this action as a class action pursuant to Rule 23(a) and

(b)(3) of the Federal Rules of Civil Procedure on behalf of a class all persons who

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purchased Krispy Kreme publicly traded securities (the "Class") during the Class Period

and who were damaged thereby . Excluded from the Class are defendants, the officers and

directors of the Company, members of their immediate families and their lega l

representatives, heirs, successors or assigns and any entity in which defendants have or

had a controlling interest .

28. The members of the Class are so numerous that joinder of all members i s

impracticable. The disposition of their claims in a class action will provide substantial

benefits to the parties and the Court . During the Class Period, Krispy Kreme had more

than 150 million shares of stock outstanding, owned by hundreds if not thousands of

persons, and actively traded on the NYSE . While the exact number of Class members is

unknown to plaintiff at this time and can be ascertained through appropriate discovery,

plaintiff believes that there are hundreds, if not thousands, of Class members . Record

owners and other members of the Class may be identified from records maintained by

Krispy Kreme or its transfer agent and may be notified of the pendency of this action by

mail .

29. There is a well-defined community of interest in the questions of law and

fact involved in this case . Questions of law and fact common to the members of the Class

which predominate over questions that may affect individual Class members include ;

a. Whether the 1934 At was violated by defendants ;

b. Whether defendants omitted and/or misrepresented material facts ;

c. Whether defendants' statements omi tted material facts necessary to

make the statements made, in light of the circumstances under

which they were made, not misleading ;

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d. Whether defendants knew or deliberately disregarded that their

statements were false and misleading ;

e. Whether the prices of Krispy Kreme's publicly traded securities

were artificially inflated ; and

f. The extent of damage sustained by Class members and the

appropriate measure of damages .

30. Plaintiffs claims are typical of the claims of the members of the Class a s

all members of the Class are similarly affected by defendants' wrongful conduct i n

violation of federal law that is complained of herein.

31 . Plaintiff will fairly and adequately protect the interests of the members of

the Class and has retained counsel competent and experienced in class action securities

litigation. Plaintiff has no interests which may conflict with other members of the Class .

32. A class action is superior to all other available methods for the fair and

efficient adjudication of this controversy since joinder of all members in impracticable .

Furthermore, as the damages suffered by an individual Class member may be relatively

small, the expense and burden of individual litigation make it impossible for members of

the Class to individually redress the wrongs done to them . There will be no difficulty in

the management of this action as a class action .

BACKGROUND

33. Krispy Kreme's principal business, which began in 1937, is owning and

franchising Krispy Kreme doughnut stores where it makes and sells over 20 varieties of

doughnuts, including the "Hot Original Glazed." Each of the traditional stores is a

doughnut factory with the capacity to produce from 4,000 dozen to over 10,000 doze n

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doughnuts daily. The factory stores support multiple sales channels, including on-

premises sales and offpremises sales.

34. Krispy Kreme was incorporated in North Carolina on December 2, 199 9

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 on April 4, 2000 and

KKDC became a wholly-owned subsidiary of Krispy Kreme .

35. Krispy Kreme went public in April 2000, and by September 2001 operate d

196 stores in 31 U .S . states which surged to 236 stores in 34 U .S . states and Canada by

the end of August 2002, and to 307 stores in 41 U .S . states, Canada and Australia b y

August 2003 .

36. This growth required that Krispy Kreme raise significant amounts of

capital, which, in part, was done through taking on debt of over $137 million at February

1, 2004, compared to no debt in fiscal 2001 .

37. A January 24, 2003 press release (filed with the SEC as a Form 8-K on

January 24, 2004) concerning the acquisition of Montana Mills Bread Co., Inc .

("Montana Mills"), stated in part :

Krispy Kreme Doughnuts, Inc . (NYSE: KKD) announced today thatthe Company has entered into a merger agreement to acquireMontana Mills Bread Co., Inc. (AMEX: MMX), a Rochester, NY-based bakery concept . The small chain of neighborhood bakeriesfeatures fresh, stone ground flour, a highly visual presentation of thebaking process in full view of the customer and customer samplingwith large slices of a variety of fresh-baked breads . The Companyindicated it will issue approximately 1 .2 million shares of KrispyKreme common stock for the acquisition and that the purchasewould be dilutive by about $ .03 per share in the first full year. Theholders of a majority of the outstanding shares of Montana Millshave consented to the merger, and it is contemplated that, subject t o

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the conditions of the merger agreement, the merger will closeapproximately 20 business days following the mailing of aninformation statement/registration statement to the Montana Mill sstockholders .

Scott Livengood, Krispy Kreme's Chairman, President and ChiefExecutive Officer, said, "This acquisition is a natural outgrowth ofthe development of Krispy Kreme over the past five years. As I haveindicated previously, we view Krispy Kreme Doughnuts, Inc ., firstand foremost as a set of unique capabilities which include theabilities to explore and nurture our customers' passion for andconnection to a brand, create an effective franchise network,vertically integrate to provide a complete range of products andservices to a system-wide store network serving flour-based, shortshelf life products, and deliver these products daily across multiplechannels . Applying these core organizational competencies to thedevelopment of a second concept has the potential to createsignificant leverage . "

Livengood added, "The opportunity to create a wholesome, fresh-baked bakery and cafe concept the 'Krispy Kreme way' is obviouslyunique to Krispy Kreme . I have long considered how to capitalizeon this opportunity. In Montana Mills, we found the perfectfoundation for this new concept - passionate bread bakers who havecreated a fiercely loyal customer following around a wide variety offresh-baked goods, bread-baking theater and sampling of large slicesof bread . I have personally observed this passion that each MontanaMills employee carries for their customers and their breads . This is agreat platform on which to build . We will work closely with theMontana Mills team as we try to add value to an already outstandingconcept."

Asked about the timing of this move, Livengood indicated, "I expectwe will spend in the range of two years fully developing the conceptI described. As we have indicated regarding our internationalexpansion, we will always try to prepare for any type of expansionwell before we need the growth . We want the time to do it right. Forthis concept, I think that time is now . "

John Tate, the Krispy Kreme's Chief Operating Officer, has servedon the Montana Mills Board of Directors for the past 14 months .Asked about this, Tate indicated, "I agreed to serve on the board ofMontana Mills after meeting its Chief Executive Officer, GeneO'Donovan and seeing the concept firsthand . I was struck by theremarkable similarities in culture, values and customer relationshipsbetween Krispy Kreme and Montana Mills . The opportunity to help

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such a company in the early stages of its growth was irresistible .When we decided to begin the development of a bakery concept, itwas clear to me that Montana Mills was the natural choice becauseof these similarities . "

The Company also indicated that Gene O'Donovan and his wifeSuzy would assume the positions of President of Montana Mills (adivision of Krispy Kreme Doughnuts, Inc .) and Principal Baker,respectively . Livengood said, "Gene and Suzy have an incrediblepassion for this product and this concept. We are excited aboutworking with them in the years ahead to realize the full potential ofMontana Mills in becoming a beacon brand ."

38. In Krispy Kreme's fiscal 2003 10-K filed on February 2, 2003, the

Company reported in part, concerning the Montana Mills acquisition, that :

We believe Krispy Kreme's unique brand-building and operationalcapabilities represent a significant leverage opportunity . We willspend up to the next 24 months refining and expanding the MontanaMills concept, retaining its core best-in-class breads, but expandingthe offering to include bread-based meals and appropriateaccompaniments in an inviting, fast casual setting. Once developed,we plan to leverage our existing franchise network and theinfrastructures our franchisees have created to roll out the concept .We believe this network will substantially expedite a nationalexpansion. We also believe that this acquisition will provide anopportunity to leverage our existing capabilities, such as ourdistribution chain, off-premises sales and coffee-roasting expertise,to expand Montana Mills' business .

39. On February 14, 2003, Krispy Kreme issued a press release repo rting its

year-end and 4Q 03 sales results .

40. In April 2003, Krispy Kreme completed the acquisition, through an

exchange of stock, of Montana Mills, an owner and operator of "village bread stores" in

the Northeastern and Midwestern United States . Montana Mills' stores produce and sell a

variety of breads and baked goods prepared in an open-view format . In an April 7, 2003

Form 8-K filed with the SEC, Krispy Kreme stated :

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On April 7, 2003, Krispy Kreme Doughnuts, Inc . ("Krispy Kreme")completed its previously announced acquisition of Montana MillsBread Co., Inc . ("Montana Mills") . As previously disclosed, onJanuary 23, 2003, Krispy Kreme signed an agreement and plan ofmerger ("Merger Agreement") to acquire Montana Mills, an ownerand operator of upscale "village bread stores" in the Northeasternand Midwestern United States . Montana Mills' stores produce andsell a variety of breads and baked goods prepared in an open-viewformat. Under the terms of the Merger Agreement, each outstandingshare of Montana Mills' common stock was converted into the rightto receive 0 .1501 shares (the "Exchange Ratio") of Krispy Kremecommon stock and cash in lieu of fractional shares . Uponconsummation of the merger, the Company expects to issueapproximately 1,224,500 shares of Krispy Kreme's common stock inexchange for all outstanding shares of common stock of MontanaMills, valued at approximately $39 .0 million, based on the closingprice of Krispy Kreme's common stock for a range of trading daysaround the announcement date, January 24, 2003 . The Company hasalso reserved approximately 460,500 shares of common stock forissuance upon the exercise of warrants and options for MontanaMills' common stock currently outstanding, all of which willbecome exercisable for shares of the Company's common stockbased upon the Exchange Ratio .

41 . On March 18, 2003, Krispy Kreme issued a press release reporting its fisa l

2003 results and 4Q 2003 results . The release, titled, " Krispy Kreme Announces Strong

Fourth Quarter and Fiscal Year 2003 Results ; Systemwide Comps Up 11 .7%; Ful l

Fiscal Year 2004 Guidance Exceeds Consensus By $0.02" set forth that :

Further commenting on the Company's financial performance,Livengood, added, "Our fourth quarter results cap a year of verystrong execution of our growth strategy. We opened a recordnumber of stores and continue to gain greater market penetrationthrough multiple channels of sales . Our fundamentals remain strongand every segment in our vertically integrated business model isperforming at record levels . The strength of this momentum givesme great confidence for this year and the years to come." TheCompany set new records for unit growth by opening 28 new KrispyKreme stores during the fourth quarter in six new markets in spite ofsevere weather during January in Northern California, New Englandand Washington, DC. New markets entered included Santa Rosa,CA, Beaumont, TX, Tucson, AZ, Philadelphia, PA, Amarillo, TXand Windsor, Canada . Heavy rains associated with El Nino actuallydelayed one projected fourth quarter opening in Northern California

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into mid-February. As a result, the Company opened a total of 63stores and two doughnut and coffee shops during Fiscal Year 2003and entered 18 new markets . Also, the Company opened its firstlocation outside of North America, a commissary, in Sydney,Australia. This brings the total number of stores at the end of fiscal2003 to 276 .

As discussed in the Company's February 14, 2003 press release, theCompany expects total diluted earnings per share for Fiscal Year2004 to be $0 .88, $0.02 above the consensus estimate, withquarterly earnings guidance of $0 .20 in the first quarter; $0.20 in thesecond quarter, $0 .22 in the third quarter; and $0 .26 in the fourthquarter . The quarterly earnings guidance assumes systemwidecomparable store sales to average 10% for fiscal 2004, while eachquarter may be slightly above or below 10%. Also, the Companyexpects to open 77 new factory stores in 17 new markets during thecoming year . Additionally, the Company plans to open 10 otherunits, a combination of Doughnut and Coffee Shops and/or satelliteformat stores .

42. On May 28, 2003, Krispy Kreme issued a press release reporting its

financial results for the three months ended May 4, 2003 and the 151 Q fiscal 2004 (also

set forth in the Company's Form 8-K filed with the SEC on May 28, 2003) :

Net income for the first quarter increased 48 .3% to $13 .1 millioncompared with $8.9 million in the first quarter of Fiscal 2003 .Diluted earnings per share increased to $0 .22 in the first quartercompared with $0.15 for the same period in Fiscal 2003 . Dilutedearnings per share for the quarter includes the effect of a $0 .5million reversal of an accrual related to the arbitration award againstthe Company, discussed in the Company's Form 8-K filing datedFebruary 10, 2003 . The Company's fourth quarter Fiscal 2003results included a $9 .1 million pre-tax charge related to thisarbitration award and in the first quarter of Fiscal 2004, theCompany paid $8 .6 million to settle the award . Excluding the effectof the reversal of the remaining accrual, net income for the quarterincreased 44.7% to $12 .8 million and diluted earnings per share forthe period would have been $0 .01 less than the reported $0 .22 pershare .

Total company revenues, which include sales from company stores,franchise operations, and Krispy Kreme Manufacturing andDistribution (KKM&D), rose 33 .9% to $148 .7 million, compare d

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with $111 .1 million in the prior year comparable period . Sales fromthe company stores increased 37.8% to $102 .2 million; KKM&Dsales increased 26.8% to $41 .4 million; and revenues from franchiseoperations grew to $5.1 million, an 18 .7% increase .

Systemwide sales, including sales of company and franchise stores,advanced 24 .4% to $227 .8 million in the first quarter compared with$183.1 million in the first quarter of Fiscal 2003 . Sales were drivenby an increase in company store sales of 37 .8% to $102.2 millionand an increase in franchise store sales of 15 .3% to $125.6 million .On a comparable store basis, systemwide store sales increased11 .2% and company store sales were up 15 .4%.

Commenting on the Company's financial performance, ScottLivengood, Chairman, President and Chief Executive Officer ofKrispy Kreme Doughnuts, Inc . said, "Our business momentumcontinues and our first quarter results give us a strong start to ourFiscal Year 2004 . In spite of a challenging environment for mostretail businesses, we produced systemwide sales of $228 million andnet income growth of 48% . I am very proud of these results . "

During the quarter, six new Krispy Kreme stores were opened . Newstores opened during the first quarter are located in Elk Grove, CA,Tucson, AZ, Marrero, LA, Melville, NY, Orlando, FL and Tampa,FL. This brings the total number of stores at the end of the firstquarter to 282 . Subsequent to the quarter-end, Krispy Kreme hasopened six additional stores in Rockland, Quebec, Cranston, RI, ElPaso, TX, Seattle, WA, Sioux Falls, SD and San Antonio, TX andone commissary in Brossard, Quebec .

Additionally, the Company announced plans to expand itsdevelopment into the Canadian provinces of Alberta, Manitoba andSaskatchewan . KremeKo, Inc ., the Company's franchisee in EasternCanada, will develop an additional eight stores in the region over thenext five years .

Also, the Company announced its fourth international joint ventureagreement, awarding development rights for Mexico . Krispy KremeMexico, S . de R.L. de C.V. will develop 20 stores over the next sixyears throughout Mexico .

Further commenting on the Company's financial performance,Livengood added, "We are positioned for another year of stronggrowth. The opportunity created by multiple sales channels, ournational expansion and our international growth prospects give megreat confidence for this year and the years to come . "

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The Company indicated that based on its first quarter performance,it now expects to earn $0 .90 per fully diluted share or $0 .02 aboveconsensus for Fiscal Year 2004 . Quarterly earnings guidance is asfollows: Q2 - $0 .20 ; Q3 - $0 .22; Q4 - $0 .26. The Company affirmedits previously announced goals of systemwide comparable sales of10% for the year with quarterly variations . Additionally, theCompany reiterated its store development plans to open 77 newstores in 17 new markets and to open 10 other units, a combinationof Doughnut and Coffee Shops and/or satellite stores during Fiscal2004.

43. Subsequent to this announcement , Krispy Kreme's stock increased to

above $34 per share .

44. On June 30, 2003, Krispy Kreme acquired six stores in Dallas, Texas an d

Shreveport, Louisiana, from franchises for over $67 million, only approximately $13 . 8

million of which was for assets . This sweetheart deal came about because the sellers

were McAleer, a former officer and director of Krispy Kreme, and Steven D. Smith, an

emeritus director. However, during the same time period, another franchisee was

attempting to sell 22 stores for $80 million . Krispy Kreme did not bid on those stores,

and continued to make positive statements about its overall growth rate .

45. On July 8, 2003 www.wallst.net conducted an interview with defendant

Tate. The following was reported about the interview in a Digital Wall Street inc . July S,

2003 Press Release :

A "65-year-old overnight success;' Krispy Kreme Doughnuts isexpanding its market, opening outlets across the Western Seaboardand internationally, Tate told http://www.wallst .net . Recently, thecompany purchased a distribution facility in California that iscapable of facilitating 180 retail outlets, three times that of their oldfacility, which Tate said the company outgrew . "We're growingrapidly in the West," Tate said . "We're still in the early stage ofgrowth, and we've upgraded to support that growth . "

19

6NA

set in Minneapolis . On June 19, Krispy Kreme opened its first retailstore in Australia, and had recently announced a franchise openingin Mexico . The company also opened stores in French- speakingMontreal, which Tate called "a huge success," and plans to open

46.8% to $13 .0 million compared with $8 .9 million in the second quarter of Fiscal 2003,

and that diluted earnings per share increased to $0.21 in the second quarter compared

with $0.15 for the same period in Fiscal 2003 . Reported diluted earnings per share were

$0.01 more than analysts' forecasts . Defendants further reported that total Company

revenues, which include sales from company stores, franchise operations, Krispy Kreme

Manufacturing and Distribution (KKM&D) and Montana Mills, rose 41 .1 % to $161 .8

million, compared with $114.6 million in the prior year comparable period. On a

comparable store basis, systemwide store sales purportedly increased 11 .3% and

company store sales were up 15 .6%.

47. In the release, defendants touted the Company's growth and brigh t

prospects without giving any indication that they had saturated the market with Krispy

Kreme products and that such saturation was having a deleterious effect on the

Company's operating performance and financial results. In this regard, the release stated,

in relevant part, as follows :

"Krispy Kreme had an extremely exciting second quarter thatincluded a number of significant events for the Company," saidScott Livengood, Chairman, President and Chief Executive Officer ."We experienced great success when we opened our first storeoutside North America in Sydney, Australia. We also set newopening day and opening week sales records in our first store in theBoston market . Finally, we served the first-ever Krispy Kremedoughnuts in a French-speaking environment in Montreal, Canadaand were met with great excitement when we opened there in May."

[. . .1 Further commenting on the Company's financial performance,Livengood added, "The results of the second quarter and theinitiatives we have underway create a strong foundation for thebalance of the year . Our broadening platform, which now includesboth large and small US markets, combined with our internationalexpansion plans will create growth opportunities for years to come."In light of the operating performance during the first half of Fiscal2004, the Company today is establishing new long-term operatin g

21

margin targets . These three to five year targets are as follows : totalCompany operating income as a per cent of sales : 20% andCompany store operations segment income as a per cent of sales :25% . These are changes from the previous guidance of 15% and20%, respectively . Also, the Company indicated that based on itssecond quarter performance, it now expects to earn $0 .91 per fullydiluted share or $0.02 above consensus for Fiscal Year 2004 .Quarterly earnings guidance is as follows : Q3 - $0.22; Q4 - $0.26 .

The Company affirmed its previously announced goals ofsystemwide comparable sales of 10% for the year with quarterlyvariations . Additionally, the Company reiterated its storedevelopment plans to open 77 new stores in 17 new markets and toopen 10 other units, a combination of Doughnut and Coffee Shopsand/or satellite stores during Fiscal 2004 .

48 . On this news, Krispy Kreme's stock traded above $47 per share .

49. On August 25, 2003, Livengood and Tate sold 235,500 and 65,000 shares ,

respectively, of their Krispy Kreme stock for proceeds of $13 million.

50. On September 22, 2003, the Company issued a release over the

PRNewswire in which it announced its intention to acquire a majority interest in its

Michigan franchisee, Dough-Re-Mi Co., Ltd. Pursuant to the agreement, Krispy Kreme

would acquire five of the seven Krispy Kreme stores in Michigan, and the franchisee

would close the other two prior to consummation of the acquisition. The release stated, in

pertinent part, as follows :

Scott Livengood, the Company's Chairman, President and ChiefExecutive Officer said, "the success of previous market repurchaseshas validated our acquisition strategy. We will continue to acquire orexpand our interest in markets where such an acquisition is mutuallyadvantageous for Krispy Kreme, our franchisees and our customers .We believe there is tremendous opportunity for growth in Michigan,both in retail and off-premises channels ."

51 . On November 21, 2003, defendants issued a release over PRNewswire i n

which they announced that net income for the third quarter had increased 43 .4% to $14 . 5

22

million compared with $10 .1 million in the third quarter of Fiscal 2003, and that diluted

earnings per share had increased to $0 .23 in the third quarter compared with $0 .17 for the

same period in Fiscal 2003 . With respect to the reported financial results, the releas e

stated as follows :

"Our business momentum continues and our third quarter resultsreflect our focus on opening new stores, establishing strong off-premises relationships and gaining greater market share," said ScottLivengood, Chairman, President and Chief Executive Officer . "Ourfundamentals remain very strong and we delivered solid results in anactive quarter . Despite weather related issues and the grocery storestrike that impacted several of our markets, we producedsystemwide sales of $253 million and grew net income by 43% . Iam very pleased with these results ."

During the quarter, 27 new Krispy Kreme factory stores wereopened in ten new markets . The Company opened its first factorystore in Europe, located in the world-renowned department store,Harrods of Knightsbridge, London. Other new markets enteredincluded Lansing, MI, Evansville and South Bend, IN, Hattiesburg,MS, Chico and Visalia, CA, Boise, ID, and Lubbock and Laredo,TX. This brings the total number of stores at the end of the thirdquarter to 326 . Additionally, during the quarter the Company openedeight satellite units consisting of six fresh shops and two doughnutand coffee shops .

Subsequent to quarter end, the Company opened six new KrispyKreme factory stores and three satellite stores consisting of twofresh shops and one doughnut and coffee shop. Also, the Companyopened its first commissary in Mexico City, Mexico. Krispy KremeMexico, S . de R.L. de C. V., the Company's franchisee in Mexico,will develop 20 stores over the next six years throughout Mexico.Commenting on the Company's outlook, Livengood said, "Themomentum generated by store openings, our broadening platformand growth in both our stores and off premises give me greatconfidence for this year and the years to come . "

Based on its latest review of factory store and satellite developmentplans, the Company now expects Fiscal 2004 store openings willrange between 92 and 97, exceeding the previous guidance of 87that included 77 factory stores and 10 satellites . The Companyexpects to earn $0 .26 per fully diluted share in the fourth quarter ofFiscal 2004 and $0 .92 for all of Fiscal 2004, including the $0 .0 1

23

positive impact of the arbitration settlement recorded in the firstquarter of Fiscal 2004 . Additionally, the Company affirmed itspreviously announced goal for systemwide comparable sales of 10%for the fiscal year ; systemwide comp store sales in the fourth quarterare expected to be slightly above or below 10% .

Based on the performance in the first nine months of Fiscal 2004,the Company today established a new long-term operating margintarget for its Franchise Operations segment. The three to five yeartarget for franchise operating income as a percent of franchiserevenue was increased from 70% to a range between 75% and 85% .

52. On November 21, 2003, Bloomberg News published an article about

reaction to Krispy Kreme's earnings announcement in which it quoted the remarks of

Robert Bender & Associates analyst Reed Bender . In reliance on Krispy Kreme's public

statements, Bender stated as follows : "This is clearly a growth story here and I think you

are still at the early stage in terms of stores, "said Reed Bender, who helps manage $250

million in assets at Robert Bender & Associates, including about 130,000 Krispy Kreme

shares. "I think people are really underestimating the amount of stores this company can

have."

53 . On December 23, 2003, defendants issued a release over the PRNewswire

in which they announced that defendant Casstevens had resigned from Krispy Kreme "to

pursue personal interests," and that defendant Phalen would become Chief Financial

Officer effective January 5, 2004 .

54. On February 4, 2004, defendants issued a release over the PRNewswire in

which they announced that the Company had acquired the remaining 33% minority

interest in Golden Gate Doughnuts, LLC and that the Company now owned 100% of the

rights to develop the Northern California market as well as existing stores and the

24

associated assets. The Company did not disclose the purchase price. Commenting on th e

acquisition, the Company stated in the release as follows :

Scott Livengood, the Company's Chairman, President and ChiefExecutive Officer, said this acquisition is consistent with otherrecent market acquisitions by the Company . "We are excited aboutowning 100 percent of the Northern California market . We believethere are tremendous growth opportunities in Northern California,both in retail and off-premises channels . As we have saidpreviously, we will continue to acquire or expand our interest inmarkets where such an acquisition is mutually advantageous forKrispy Kreme, our franchisees and our customers . "

55. On February 17, 2004, Individual Defendants (not including Defendant

Casstevens, who had resigned by this time) issued a release over the PRNewswire in

which they preliminarily reported on the Company's purportedly strong operating

performance and financial results in the fourth quarter of fiscal 2004 which ended

February 1, 2004. The release stated, in pertinent part :

The Company indicated that business momentum and sales growthcontinued to be strong, driven by increases in comparable store salesand new store openings . Fourth quarter systemwide sales includingsales of company and franchise stores grew 25 .6%. Systemwide andcompany comparable store sales increased 9 .1% and 10.7% ,respectively, for the quarter. Sales momentum increased throughoutthe quarter, but sales were affected by the grocery store strikes andunseasonably warm weather early in the fourth quarter. Systemwidesales including Krispy Kreme stores and Montana Mills increased26,6% in the fourth quarter. The Company opened 35 new stores,including 31 factory stores and 4 satellites, during the quarter. Infiscal 2004, the Company opened 99 stores, comprised of 86 factorystores and 13 satellites .

Systemwide sales including sales of company and franchise storesadvanced 26 .6% for fiscal 2004. On a comparable store basis,systemwide store sales increased 10 .2% for the year and companystore sales advanced 13.6%. Systemwide sales including KrispyKreme stores and Montana Mills increased 27.4% for the year.Commenting on these results, Scott Livengood, the Company'sChairman, President and Chief Executive Officer stated, "We ar e

25

pleased to report record systemwide sales and store openings forboth the quarter and fiscal year. We experienced strong comparablestore sales performance across the system in fiscal 2004, driven bycontinued strength among company stores." Additionally, theCompany estimates that diluted earnings per share will beapproximately $0 .26 in the fourth quarter, consistent with previousguidance . The Company expects to earn approximately $0 .92 perdiluted share for fiscal 2004, including the $0 .01 positive impact ofthe arbitration settlement recorded in the first quarter . Livengoodcommented further, "I am especially pleased with achieving ourearnings guidance in a quarter in which we continued the accelerateddevelopment of company stores. We believe these investments innew company stores, including the related pre-opening costs, willprovide substantial returns to shareholders . "

The Company also issued preliminary guidance for fiscal 2005.Mike Phalen, the Company' s Chief Financial Officer commented,"The forward estimates were developed based on the continuingevolution of our business model . The primary growth drivers infiscal 2005 will continue to be opening new factory stores andimproving existing store productivity . There will be increasedcompany store development, and the forecast anticipates higher pre-opening and operating costs associated with the new stores . We willcontinue to invest in our international operations as well as ouremerging growth initiatives including our satellite concepts andstore-in-store partnerships , which are designed to make the KrispyKreme experience more convenient to customers . "

The Company expects diluted earnings per share of $1.16 to $1.18for fiscal 2005 and systemwide comparable store sales g rowth inthe mid-to -high single digits. The Company estimates thatsystemwide sales will increase approximately 25% in fiscal 2005,while each quarter may be slightly above or below 25% .Additionally, the Company expects to open approximately 120 newstores systemwide, including 20 to 25 satellites, in fiscal 2005.Commenting on the Company's outlook, Liven good stated, "Our

fundamentals remain strong, and we continue to focus ondelivering results and creating value for shareholders . Ourbroadening platform will create significant long-term growthopportunities." [Emphasis added . ]

56. On March 10, 2004, defendants issued a release over the PRNewswire in

which they reported financial results for the fourth quarter and the fiscal year ende d

26

February 1, 2004 . In the release, defendants stated that fourth-quarter net income had

increased to $16.4 million, or $0.26 per share, from $5 .63 million, or $0.09 per share a

year earlier . Defendants stated that fourth-quarter revenues had increased 36% to $185.5

million compared with $136.7 million in the previous fiscal year's fourth quarter. With

respect to the Company' s operating performance, defendants stated in the release as

follows:

Fourth quarter systemwide sales including sales of company andfranchise stores advanced 25 .5%. Systemwide sales were driven byan increase in company store sales of 36 .0% to $124 .7 million. On acomparable store basis, company store sales advanced 10 .7% andsystemwide sales increased 9 .1 %. Systemwide sales includingKrispy Kreme stores and Montana Mills rose 26 .6%.

"We are pleased with our record fourth quarter results," stated ScottLivengood, Chairman, President and Chief Executive Officer ofKrispy Kreme Doughnuts, Inc . "During the quarter, we continued toexecute on our core business model while investing in operatinginitiatives designed for future growth." [. . . 1

Further commenting on the Company's financial performance,Livengood added, "Fiscal 2004 was a year of milestones and ourfourth quarter results cap another year marked by strong executionof our growth strategy . We produced record earnings, opened 99new stores - a record number - and grew systemwide sales 26percent . We plan to leverage this momentum in fiscal 2005 as wecontinue to develop factory stores and invest in internationaloperations and emerging growth initiatives, including satellites andstore-in- store partnerships ."

The Company set a new record in the fourth quarter for unit growthby opening 35 new stores, including 31 factory stores and foursatellites in nine new markets .The Company opened its first store inMexico, located in Interlomas, a suburb of Mexico City . Other newmarkets entered included Altoona, PA, Youngstown, OH, AtlanticCity, NJ, Syracuse, NY, Lexington, KY, Kahului, HI, Onalaska, WIand Florence, AL .

27

57. The statements issued from August 21, 2003 and March 10, 2004 were

materially false and misleading, for the reasons discussed in paragraph 4 above, and

because of the following :

a. Krispy Kreme's business was not performing as well as

represented as sales would cool off in many stores after the initial

opening. For example, according to a Herb Greenberg column

published by CBS Marketwatch.com, Krispy Kreme opened a

franchise in Newington, Connecticut in 2002 . In October 2002, the

franchise recorded sales of $792,745 . Within two months they

were $540,229 and by February 2004 they had fallen to $152,704

per month ;

b. Many cities were becoming saturated with Krispy Kreme stores,

which would hinder Krispy Kreme's growth plans;

c. Krispy Kreme's financial results were misleading due to the non-

consolidations of money-losing joint ventures, but the

consolidation of money-making joint ventures ;

d. Krispy Kreme's financial statements were manipulated through

unusual transactions, including Krispy Kreme's repurchase of

Dough-Re-Mi, which purchase price included extra money so

Dough-Re-Mi could pay Krispy Kreine interest on money Dough-

Re-Mi owed Krispy Kreme . Krispy Kreme recorded this as

income .

28

58. On May 7, 2004 defendants issued a release over the PR Newswire in

which they announced that they expected fiscal 2005 diluted earnings per share from

continuing operations, excluding certain charges, to be 10% lower than previously

announced guidance and blamed the decrease on increased interest in low- carb diets .

(See Paragraphs 6-8, above) . In this regard, the release stated :

Scott Livengood, Chairman, President and Chief Executive Officercommented, "For several months, there has been increasingconsumer interest in low-carbohydrate diets, which has adverselyimpacted several flour-based food categories, including bread, cerealand pasta . This trend had little discernable effect on our business lastyear. However, recent market data suggests consumer interest inreduced carbohydrate consumption has heightened significantlyfollowing the beginning of the year and has accelerated in the lasttwo to three months . This phenomenon has affected us most heavilyin our off-premises sales channels, in particular sales of packageddoughnuts to grocery store customers ."

59. Defendants also announced that the Company was closing its recently-

acquired Montana Mills bread stores, an operation that it had bought a year ago, and that

it was going to write-off as much as $40 million on the venture; as recently as mid-April ,

defendants had said they intended to refine and expand the operation .

60. On this news, shares of Krispy Kreme fell $9 .29, or 29%, to close at

$22.51, a new 52-week low and more than 50% below the 52-week high of $49 .74. The

trading volume was 20.5 million shares, the largest ever for Krispy Kreme and amountin g

to a third of the shares outstanding .

6 1 . Many analysts did not accept the Company's claim that the Atkins/Sout h

Beach low-carb diet phenomenon was the sole reason for the Company's unexpectedl y

poor operating performance and its divesture of the Montana Bread stores, but rathe r

stated that a myriad of, company-specific, undisclosed factors that were known by th e

29

Individual Defendants were responsible for the dramatic change in the Company' s

financial performance and prospects .

62. This May 7, 2004 attribution by defendants for Krispy Kreme's financial

results and prospects was false and misleading, as defendants knew or recklessly

disregarded that the trend toward low-fat, low-carb diet was not the sole, or even a

significant, reason for the Company's worsening financial condition . Defendants merely

and conveniently used media attention to low-carb diets as an opportune ruse to obscure

the prior false and misleading public statements regarding Krispy Kreme's store results,

same store sales, acquisitions and growth rates.

63 . In this regard, on May 7, 2004, Reuters published an article on Krisp y

Kreme's announcement that stated, in relevant part, as follows :

In the face of growing consumer distaste for high-carb foods likebread and pasta, Krispy Kreme cut its full-year earnings forecast by10 percent and said it would shut down or sell off operations ofMontana Mills Bread Co ., a gounnet bread and pastry chain itbought last year .

The company also said that it will restate prior and current financialstatements to recategorize Montana Mills as a discontinuedoperation.

The Winston-Salem, North Carolina, company also plans to closesix less- profitable stores and is working to make its deliveryoperations more efficient due to weakened sales at grocery storesand other retailers.

The popularity of such low-carb diets as Atkins and South Beachhas taken a bite out of food companies in recent months, includingKraft Foods Inc. and Interstate Bakeries Corp . .But analysts were skeptical of Krispy Kreme's efforts to blame adiet for such a broad shift in strategy .

"We believe many issues are internal," J.P_ Morgan analyst JohnIvankoe said in a note .

30

Krispy Kreme's "fad appeal" appears to be waning, Ivankoe said,and the company has become increasingly dependent on sellingdoughnuts in grocery stores and other retailers . But on a conferencecall with investors, Krispy Kreme Chief Executive Scott Livengoodinsisted the low-carb diet trend was to blame for the company'swoes .

"We have used the word phenomenal multiple times , but that's whatit is," Livengood said . "It is the primary variable that is differentfrom anything we have experienced since being a public company."U.S . doughnut sales volume fell 0 .4 percent industrywide in the 12weeks ended April 18 from a year earlier, Krispy Kreme said . In theprevious 12 weeks it had risen 7 .4 percent.

One food industry expert said the low-carb trend was likely a factorfor Krispy Kreme, but added most Americans had not changed theway they eat.

"It's not as if a majority of Americans are changing their diets," saidHarry Baizer, vice-president of market research firm The NPDGroup. "About 6 to 7 percent of the population are on a low-carbdiet."

64 . Similarly , on May 7, 2004, The Street.com published an article which

stated, in pertinent part :

One source who is short Krispy Kreme cited some company-specificissues working against Krispy Kreme, which go beyond the low-carb craze . First, the company's wholesale business is expensive tooperate, requiring trucks and distribution channels (and the costsassociated with that) . Second, the wholesale business iscannibalizing the company's retail operations, and perhapsundermining them as well .

Krispy Kreme doughnuts bought at the wholesale level are ofteninferior to the doughnuts that customers can get at a company store.A consumer who is trying a Krispy Kreme doughnut may beunderwhelmecl by the ones that sell at a grocery store, which mayprevent that consumer from ever going to a retail Krispy Kremestore, where doughnuts have higher margins .

Third, those retail stores -- under pressure from both the company'swholesale business and the low-carb craze -- are expensive anduneconomical in smaller markets .

31

"Each Krispy Kreme store costs about $3 million to open. It's noteconomical in every location," said the short-seller, who requestedanonymity. These stores tend to hit their peak in about 12-1 8months, and if you don't have a fresh supply of consumers to snapup every doughnut that comes off the conveyor belt, you end uphaving problems, he continued. So, the company won't be closingstores in places like Los Angeles or New York, where millions ofpeople live, but it makes little economic sense to continue operatingless profitable stores in smaller markets .

65. On May 7, 2004 Motley Fool published an item about Krispy Kreme

under the headline, "Krispy Kreme : Deep Fried?" The article stated in pertinent part, a s

follows:

A Motley Fool Stock Advisor pick, Krispy Kreme said it nowanticipates fiscal 2005 earnings to be 10% lower than its previousguidance . First-quarter earnings are now seen coming in at $0 .23 pershare, while fiscal 2005 earnings will be $1 .04 to $1 .06 per share;including charges, Krispy Kreme forecasts annual earnings of $0 .93to $0.95 per share .

There are a few things to wonder about here, not least of whichare sudden changes. After all, historically, Krispy Kreme hasdelivered steady revenue and earnings growth despite buildinginterest in carb cutting over the last year [. .J

If investors really thought that this was the crux of the problem,though, they might have relaxed today . Krispy Kreme recently saidit was working to develop a lower-carb, lower-fat doughnut (a moveto which I played devil's advocate, wondering about underminingthe almighty, decadent brand). Right now, though, if low-carb dietsare indeed plaguing Krispy Kreme, I question why it didn't mentionthis development effort in its press release today . At the same time,the company did say it was among the initiatives its pursuing"urgently" in its conference call (transcript courtesy of CCBNStreetEvents) .

The other aspect of today's press announcement that might warranta critical eye, is the company's announcement that it will sellMontana Mills, a bread and pastry concept that Krispy Kremebought for $40 million only a little over a year ago. While we lovecompanies that focus, it seems like a rather sudden development .

32

When Krispy Kreme previously seemed insulated against the low-carb trend, was there more going on than met the eye? While somemight see Krispy Kreme as an exceptional bargain in the event that

the low-carb craze ends up just another passing fad -- which, ofcourse, would give credence to the idea that today's warning is onlya temporary speed bump in the company's long-term growth rate --would-be Krispy Kreme shareholders have a lot of food for thoughtbefore gobbling up shares . [Emphasis added . ]

66. Subsequently, on May 25, 2004, Krispy Kreme announced its first quarte r

results reducing the number of stores to open in 2005 to 100 . The release stated in part :

First quarter systemwide sales including sales of company andfranchise stores advanced 24 .2%. Total revenues for the quarter,which includes sales from company stores, franchise operations andKrispy Kreme Manufacturing and Distribution (KKM&D) increased24.0% to $184.4 million compared with $148 .7 million in the firstquarter of last year . Revenues from franchise operations grew 40.2%to $7.1 million; KKM&D revenues increased 27 .5% to $52.7million and company store sales advanced 21 .8% to $124.5 million.On a comparable store basis, systemwide sales increased 4 .0% andcompany store sales advanced 5 .2%.

Income from continuing operations for the first quarter of fiscal2005 decreased to $9 .8 million, or $0.16 diluted earnings per share,compared with $13 .1 million in the first quarter last year. For thequarter, income from continuing operations and before animpairment charge, increased 11 .9% to $14 .3 million, or $0.23 perdiluted share, compared with $12 .8 million, or $0 .21 per dilutedshare, in the first quarter last year, excluding the $0 .5 million pre-taxbenefit related to the arbitration award .

First quarter earnings include an asset impairment charge primarilyrelated to stores that had closed or were scheduled to close . The non-cash, pre-tax asset impairment charge was $7.5 million, or $0 .07 perdiluted share. Subsequent to quarter-end, seven stores were closed,comprised of four factory stores that did not represent the currentprototype and three doughnut and coffee shops located in in-linestrip malls .

Also during the first quarter of fiscal 2005, the Company reported aloss from discontinued operations of approximately $34 .3 million,or $0.54 per diluted share, related to the pending divestiture of theexisting Montana Mills operation .

33

Commenting on the Company's financial performance, ScottLivengood, Chairman, President and Chief Executive Officer ofKrispy Kreme Doughnuts, Inc. said, "In spite of the changing

industry dynamics, we delivered 24% systemwide sales and revenuegrowth for the quarter. We are focused on our core business andimproving company store operations . We remain excited about ourgrowth prospects, both domestically and internationally . "During the

quarter the Company opened 16 new factory stores . These stores arelocated in Waco, TX ; Albuquerque, NM; Little Rock, AK; Delta,British Columbia; Latham, NY; Quebec City, Quebec ; Phoenix, AZ(2); Dedham and Boston, MA; Langhorne, PA ; Seattle, WA;Calgary, Alberta; Grand Junction, CO; Littleton, C Oand Montreal, Canada. Three satellites also opened during thequarter in Santa Monica, CA ; Las Vegas, NV and Toronto, Canada.This brings the total number of stores at quarter-end to 401,including 372 factory stores and 29 satellites .

The Company signed its fifth international development agreementwith the Lotte Group to develop 25 stores over five years throughoutthe Republic of South Korea . The Lotte Group operates a leadinghamburger chain and is one of the largest convenience storeoperators in South Korea .

"We are focused on the Krispy Kreme brand and are committed toelevating the customer experience," stated Livengood . "We havesales and operational initiatives underway and several new productsin the pipeline . We expect to realize the benefits from theseinitiatives in the second half of the year. We are confident that theseefforts will serve to create value for our employees, customers andshareholders . "

The Company estimates fiscal 2005 earnings per diluted share fromcontinuing operations of between $1 .04 and $1 .06. The Companynow estimates that fiscal 2005 systemwide sales will increaseapproximately 20% to 25% and systemwide comparable store salesgrowth will be in the low to mid-single digits. The Company revisedits fiscal 2005 development plans and estimates openingapproximately 100 new stores systemwide, including approximately80 factory and 20 satellite stores .

67. On May 25, The Wall Street Journal reported that "Krispy Kreme

Franchise Buybacks May Spur New Concerns" in a story that stated in part :

34

Since going public in 2000, Krispy Kreme Doughnuts Inc . has facedquestions about its accounting transparency and potential forconflicts of interest in investments that its executives made in itsfranchises . Investors bought the sugar-fueled stock anyway .

But two recent deals in which Krispy Kreme bought backfranchisees could spark new concerns . Some independentaccounting experts say the Winston-Salem, N .C., company mayhave used aggressive bookkeeping to boost its earnings when itacquired its Michigan franchise last year. In the other buyout,completed in January, Krispy Kreme didn't disclose that one of thesellers was Chief Executive Scott Livengood's ex-wife, whose sharewas valued at about $1 .5 million .

A closer look at the franchise acquisitions may give little comfort toinvestors looking for reassurance as Krispy Kreme reports resultstoday for its fiscal first quarter ended May 2 .

Last year, Krispy Kreme began negotiating to buy back itsstruggling Michigan franchise . The seven-unit operation, Dough-Re-Mi Co., owed Krispy Kreme several million dollars for equipment,ingredients and franchise fees, and was behind on its payments,according to a person familiar with the situation . After reaching apreliminary agreement, this person says, Krispy Kreme askedDough-Re-Mi to close two underperforming stores and pay KrispyKreme accrued interest on past-due loans . Krispy Kreme agreed toboost the purchase price to cover the additional cost of the moves.

Krispy Kreme declines to discuss details, saying only that the finalcontract called for Dough-Re-Mi to cover the new costs . Part of thedeal, company executives add, was that Krispy Kreme woul d"reimburse" Dough-Re-Mi more than $1 million for store-closingexpenses. They decline to provide any figure for the interestpayment. The deal closed in October 2003, for a price that KrispyKreme eventually pegged at $32.1 million .

Why would Krispy Kreme pay its franchisee extra money just so thefranchisee could turn around and repay that same amount in pastinterest? One possible answer, accounting experts say: boostedearnings .

Collecting on the unpaid interest resulted in an immediate profit forKrispy Kreme in the form of "interest income ." The cost was rolledinto the total purchase price, nearly all of which was put on Krispy

35

Kreme's balance sheet as an intangible asset called "reacquiredfranchise rights ." That asset doesn't get amortized, or subtractedfrom earnings over time.

"It looks like they took money from one pocket, put it into anotherpocket, and called it income," says Lori Holder-Webb, anaccounting professor at the University of Wisconsin who specializesin acquisition accounting . "I can't tell you that's illegal, but it's notsomething I would suggest my students get into ." Charles Mulford, aprofessor at Georgia Institute of Technology, says that "if true, that

sounds to me like a flat-out violation" of accounting principles,which he believes may have resulted in earnings being overstated .

Accounting experts also raise questions about how Krispy Kremetreated store-closing costs. Had the company bought the franchiseand then closed the stores by terminating their leases, it would havebeen an operating cost. But by rolling the store-closing costs into the

price of the deal, there was no hit to Krispy Kreme's bottom line --and the costs also became an intangible balance-sheet asset .

Ms. Holder-Webb says one problem is that an asset is supposed tobe something that will provide future economic benefit for thecompany, which a closed store typically doesn't do . "I'm not goingto say it can't be done," she says . "But there would have to be somepretty good justification . "

Krispy Kreme's fiscal third quarter ended less than a week after theMichigan deal closed. The company reported results that exactlymet Wall Street expectations -- net income of $14 .5 million, or 23cents a share . Had the company not gotten the interest income fromthe Michigan deal and recognized the store-closing costs as anexpense, it could well have fallen short of expectations .

There was still another oddity about the Michigan deal . KrispyKreme originally said it was paying the equivalent of $25.4 millionfor the franchise. But it eventually disclosed a purchase price of$32.1 million, a 26% jump, in its securities filings . Mr. Phalen nowsays Krispy Kreme initially gave investors an "incompleteassessment" of the deal's costs . He says it should have included thepotential added costs of a promissory note, under which theMichigan franchise's top executive and major shareholder agreed ineffect to defer his portion of the purchase price while staying on towork for Krispy.

36

Krispy Kreme let the executive go shortly after the deal, and had topay about $5 million more than the sum it had included for thepromissory note in its original estimate . The extra sum was againrolled into "reacquired franchise rights," and so didn't hit KrispyKreme's bottom line .

Accounting experts say such a big increase in the payout in such ashort period raises questions about whether at least some of thedispersal was akin to a severance or settlement cost -- whichtypically is expensed immediately -- not really part of buying the

franchise . At the very least, they say, the big increase raisesquestions about whether the "reacquired franchise rights" asset is

overvalued. Krispy Kreme says its accounting was accurate, addingthat the payment wasn't severance because it was made to Dough-Re-Mi, not directly to the executive .

The ex-wife of Mr . Livengood, the company's chief executive, gother stake in the company's northern California franchise through acomplicated chain of events . Krispy Kreme allowed its executives to

own stakes in franchises, a holdover from the era when the companywas closely held. That practice is unusual and Yuen Brands Inc .,operator of KFC and Pizza Hut, bans employee ownership offranchisees, viewing it as a conflict of interest . Wendy's

International Inc. allows its employees to hold only "nominal"amounts of a publicly traded franchisee's stock .

Krispy Kreme in 2002 bought out the interests of several companyofficers, at no profit to them, in an investment pool that owned apiece of seven franchisees . Mr. Livengood also sold what hedescribed as "my 3% in the same seven franchise operations" backto Krispy Kreme for the "original investment ." While the companydidn't acknowledge any wrongdoing, Mr. Livengood said in March2002 that he hoped "these actions will affirm the trust andconfidence that investors have placed in Krispy Kreme . "

Mr. Livengood and Krispy Kreme didn't tell investors that the 3%stakes hadn't been his entire investment . He actually held 6% stakesuntil reaching a separation agreement with his then-wife, Adrienne,in August 2001, when she "got half of whatever I had," Mr.Livengood says. They divorced in June 2002 . According to acompany spokeswoman, a l Ok filed in May 2002 that reported Mr.Livengood had only "3% investments" in the franchises as ofJanuary 2001 "was incorrect," adding that "whoever proofed that,missed it ." She also noted that Krispy Kreme doesn't plan to correctthe error in a revised filing because "it's not a material issue . "

37

Mr. Tate, the chief operating officer, acknowledges that thefranchise stakes were valued as part of Mr. Livengood's separation-agreement talks, but "because everything was split down the middle,he didn't avoid giving her" other assets .

68 . As a result of the materially false and misleading statements and failures

to disclose as alleged herein, Krispy Kreme common stock traded at artificially inflated

prices during the Class Period. Plaintiff and other members of the Class purchased or

otherwise acquired Krispy Kreme common stock relying upon the integrity of the market

price of Krispy Kreme shares and market information relating to Krispy Kreme and have

been damaged thereby .

69. During the Class Period, defendants materially misled the investing publi c

as alleged herein, thereby inflating the price of Krispy Kreme stock, by publicly issuing

false and misleading statements and omitting to disclose material facts necessary to make

defendants' statements, as set forth herein not false and misleading . Defendants failed to

disclose the material facts alleged herein at the times they made their statements to the

market as concerning the Company's financial condition and operational results .

APPLICABILITY OF PRESUMPTION OF RELIANCEFRAUD-ON-THE-MARKET DOCTRINE

70. At all relevant times , the market for Krispy Kreme's publicly traded

securities was an efficient market for the following reasons, among others ;

a. Krispy Kreme's common stock met the requirements for listing,

and was listed and actively traded on the NYSE, which is a highly

efficient and automated market ;

b. As a regulated issuer, Krispy Kreme filed periodic reports with the

SEC and the NYSE ;

38

c. Krispy Kreme regularly communicated with public investors via

established market communication mechanisms, including through

regular disseminations of press releases on the national circuits of

major news wire services and through other wide-ranging

disclosures, such as communications with the financial press and

other similar reporting services; and

d. Krispy Kreme was followed by several securities analysts

employed by major brokerage firms who wrote reports which were

distributed to the sales force and certain customers of their

respective brokerage firms . Each of these reports was publicly

available and entered the public marketplace .

71 . As a result of the foregoing, the market for Krispy Kreme's publicly

traded securities promptly digested current information regarding Krispy Kreme from all

publicly available sources and reflected such information in the prices of Krispy Kreme's

publicly traded securities. Under these circumstances, all purchasers of Ksispy Kreme's

publicly traded securities at artificially inflated prices and a presumption of reliance

applies .

NO SAFE HARBO R

72. The statutory safe harbor provided for forward-looking statements under

certain circumstances does not apply to any of the allegedly false forward-looking

statements pleaded in this Complaint. The safe harbor does not apply to Krispy Kreme's

allegedly false statements made during the Class Period. None of the written forward-

looking statements made were identified as forward-looking statements, nor was it stated

39

that actual results "could differ materially from those projected ." Nor did meaningful

cautionary statements identifying important factors that could cause actual results to

differ materially from those in the forward-looking statements accompany those forward-

looking statements . Each of the forward-looking statements alleged herein to be false was

authorized by an executive officer of Krispy Kreme and was actually known by each of

the Individual Defendants to be false when made .

FIRST CLAIM FOR RELIEFFor Violation Of 410(b) Of The 1934 Act

And Rule 10b-S Promulgated Thereunder Against All Defendants

73. Plaintiff repeats and realleges each and every allegation contained above

as if fully set forth herein .

74. During the Class Period, Krispy Kreme and the Individual Defendant s

carried out a plan, scheme and course of conduct which was intended to and, throughout

the Class Period, deceived the investing public regarding Krispy Kreme's business,

operations, management and the intrinsic value of Krispy Kreme's publicly traded

securities ; (ii) enable Krispy Kreme to exchange 1 .2 million shares of its common stock

in acquisitions; and (iii) enabled defendants to sell their shares of stock for substantial

proceeds .

75. During the Class Period, defendants disseminated or approved the fals e

statements specified above, which they knew or deliberately disregarded were misleading

in that they contained misrepresentations and failed to disclose material facts necessary in

order to make the statements made, in light of the circumstances under which they were

made, not misleading .

76. Defendants violated § 10(b) of the 1934 Act and Rule I Ob-5 in that they :

40

a. Employed devices, schemes, and artifices to defraud ;

b. Made untrue statements of material facts or omitted to state

material facts necessary in order to make the statements made, in

light of the circumstances under which they were made, not

misleading; and/or

c. Engaged in acts, practices, and a course of business that operated

as a fraud or deceit upon plaintiff and others similarly situated in

connection with their purchases of Krispy Kreme publicly traded

securities during the Class Period .

77 . Defendants, individually and in concert, directly and indirectly, by the use,

means or instrumentalities of interstate commerce and/or the mails, engaged and

participated in a continuous course of conduct to conceal adverse material information

about the business, operations and future prospects of Krispy Kreme as specified herein.

78. These defendants employed devices, schemes and artifices to defraud ,

while in possession of material, adverse, non-public information and engaged in acts,

practices and a course of conduct as alleged herein in an effort to assure investors of

Krispy Kreme's value and performance and continued substantial growth, which included

the making of, or the participation in the making of, untrue statements of material fact

and omitting to state material facts necessary in order to make the statements made about

Krispy Kreme and its business operations and future prospects in light of the

circumstances under which they were made, not misleading, as set forth more particularly

herein, and engaged in transactions, practices and a course of business which operated a s

41

a fraud and deceit upon the purchasers or Krispy Kreme's publicly traded securities

during the Class Period .

79. . Each of the Individual Defendants' primary liability, and controlling

person liability arises from the following facts : (a) the Individual Defendants were high-

level executives and/or directors at the Company during the Class Period and members o f

the Company's Management team or had control thereof; (b) each of these defendants, by

virtue of his responsibilities and activities as a senior officer and/or director of the

Company, was privy to and participated in the creation, development and reporting of the

Company's internal budgets, plans, projections and/or reports ; (c) each of these

defendants was aware of the Company's dissemination of information to the investing

public which they knew or recklessly disregarded was materially false and misleading .

80. The defendants had actual knowledge of the misrepresentations an d

missions of material facts set forth herein, or acted with reckless disregard for the truth

and for the purpose and effect of concealing Krispy Kreme's operation, condition and

future business prospects from the investing public and supporting the artificially inflated

prices of its publicly traded securities . As demonstrated by defendants' overstatements

and misstatements of the Company's business, operations and earning throughout the

Class Period, defendants, if they did not have actual knowledge of the misrepresentations

and omissions alleged, were reckless in failing to obtain such knowledge by deliberately

refraining from taking those steps necessary to discover whether those statements were

false or misleading .

81 . As a result of the dissemination of the materially false and misleading

information and failure to disclose material facts, as set forth above, the market prices of

42

Krispy Kreme's publicly traded securities were artificially inflated during the Class

Period. In ignorance of the fact that the market prices of Krispy Kreme's publicly traded

securities were artificially inflated, and relying directly or indirectly on the false and

misleading statement made by defendants, or upon the integrity of the markets in which

they securities trade, and/or on the absence of material advise information that was

known to or recklessly disregarded by defendants but not disclosed in public statements

by defendants during the Class Period, plaintiff and the other members of the Class

acquired Krispy Kreme publicly traded securities during the Class Period at artificially

high prices .

82. Plaintiff and the Class have suffered damages in that, in reliance on th e

integrity of the market, they paid artificially inflated prices for Krispy Kreme publicly-

traded securities. Plaintiff and the Class would not have purchased Krispy Kreme

publicly-traded securities at the prices they paid, or at all, if they had been aware that the

market prices had been artificially and falsely inflated by defendants' misleading

statements .

83 . By virtue of the foregoing, defendants have violated § 10(b) of the

Exchange Act and Rule 1 Ob-5 promulgated thereunder.

84. As a direct and proximate result of these defendants' wrongful conduct,

plaintiff and the other members of the Class suffered damages in connection with their

purchases of Krispy Kreme publicly traded securities during the Class Period .

43

SECOND CLAIM FOR RELIEFFor Violation Of .420(a) Of The 1934 Ac t

Against Individual Defendant s

85. Plaintiff repeats and realleges each and every allegation contained above

as if fully set forth herein .

86. The Individual Defendants acted as controlling persons of Krispy Kreme

within the meaning of §20(a) of the 1934 Act . By reason of their positions as officers

and/or directors of Krispy Kreme, and their ownership of Krispy Kreme stock, the

Individual Defendants had the power and authority to cause Krispy Kreme to engage in

the wrongful conduct complained of herein . Krispy Kreme controlled each of the

Individual Defendants and all of its employees . By reason of such conduct, the Individual

Defendants and Krispy Kreme are liable pursuant to §20(a) of the 1934 Act .

87. In particular, each of these defendants had direct and supervisory

involvement in the day-to-day operations of the Company and, therefore, is presumed to

have had the power to control or influence the particular transactions giving rise to the

securities violations as alleged herein, and exercised the same .

88 . As set forth above, Krispy Kreme and the Individual Defendants eac h

violated § 10(b) of the Exchange Act and Rule IOb-5 promulgated thereunder by their acts

and omissions as alleged herein . By virtue of their positions as controlling persons, the

Individual Defendants are liable pursuant to §20(a) of the Exchange Act . As a direct and

proximate result of these defendants' wrongful conduct, plaintiff and the other members

of the Class suffered damages in connection with their purchases of Krispy Kreme

publicly traded securities during the Class Period .

44

PRAYER FOR RELIEF

WHEREFORE, plaintiff prays for judgment as follows :

i) Determining that this action to be a proper class action pursuant to Rule 23 of the

Federal Rules of Civil Procedure ;

ii) Awarding Plaintiff and the members of the Class compensatory damages ;

iii) Awarding Plaintiff and the members of the Class prejudgment and post judgment

interest, as well as their reasonable attorneys' fees, expert witness fees and other costs ;

iv) Awarding extraordinary, equitable and/or injunctive relief as permitted by law ,

equity and the federal statutory provisions sued hereunder, pursuant to Rules 64 and 6 5

and any appropriate state law remedies to assure that the Class has an effective remedy ;

and

v) Awarding such other equitable/injunctive relief as this Court may deem just an d

proper .

JURY TRIAL DEMAND

Plaintiff hereby demands a trial by jury .

Dated: Jun $2003

'State Bar #55890. Box 1144

Clemmons , North Carolina 27012

Attorney for Plaintiff:

CHIMICLES & TIKELLIS LLPNicholas E . ChimiclesKimberly M. DonaldsonOne Haverford Centre361 West Lancaster AvenueHaverford, PA 1904 1Tel: (610) 642-8500 - Fax : (610) 649-3633

45

CERTIFICATION OF NAMED PLAINTIFFPURSUANT TO FEDERAL SECURITIES LAW S

Cheryl Orlov declares:

1 . I have reviewed the complaint prepared by counsel, Chimicles & Tikellis LLP, an d

have authorized its filing .

2. I did not purchase or otherwise acquire the security that is the subject of this action at

the direction of plaintiff's counsel or in order to participate in this private action or other litigatio n

arising under the federal securities laws.

I am willing to serve as a representative party on behalf of a class, including

providing testimony at deposition and trial, if necessary .

4. During the proposed Class Period, I made the following transaction of Krispy Krem e

common stock:

Transaction Date Amount of Shares Acquired Price Per Share

BUY May 6, 2004 200 $31 .78

5. During the three years prior to the date of this Certificate, I have not sought to serv e

nor have 1 served as a representative party on behalf of a class in an action filed under the federal

securities laws .

6. 1 will not accept any payment for serving as a representative party on behalf of the

class beyond my pro rata share of any recovery, except such reasonable costs and expenses

(including lost wages) directly relating to the representation of the class as ordered or approved by

the Court .

I declare under penalty of perjury that the foregoing is true and correct. Executed this

day of June, 2004a~' CAJAV

Cheryl ov