KKD Krispy Kreme Doughnuts, Inc.

NOTES TO FINANCIAL STATEMENTS
(Unaudited )

Note 1 — Accounting Policies

Krispy Kreme Doughnuts, Inc. (“KKDI”) and its subsidiaries (collectively, the “Company”) are engaged in the sale of doughnuts and complementary products through Company-owned stores. We also license the Krispy Kreme business model and certain of our intellectual property to franchisees in the United States and over 25 other countries around the world, and derive revenue from franchise and development fees and royalties from those franchisees. Additionally, we sell doughnut mixes, other ingredients and supplies and doughnut-making equipment to franchisees.

Merger Agreement

On May 8, 2016, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Cotton Parent, Inc., a Delaware corporation (“Cotton”), Cotton Merger Sub Inc., a North Carolina corporation and a wholly owned subsidiary of Cotton (“Merger Sub”), and JAB Holdings B.V., a Dutch Besloten Vennootschap met beperkte aansprakelijkheid (private company with limited liability) (“JAB”). Cotton and Merger Sub are affiliates of JAB. Pursuant to the Merger Agreement, and subject to the satisfaction or waiver of certain conditions, Merger Sub will merge with and into the Company, with the Company continuing as the surviving corporation and as a wholly owned subsidiary of Cotton (the “Merger”). Our Board of Directors (the “Board”) unanimously adopted, approved and declared advisable the Merger Agreement, the Merger, and the other transactions contemplated by the Merger Agreement and unanimously resolved to recommend that our shareholders vote to approve the Merger Agreement. The Merger is subject to a vote of our shareholders.

As a result of the Merger, each share of our common stock issued and outstanding immediately prior to the effective time of the Merger (the “Effective Time”) (other than shares held by Cotton, Merger Sub, certain affiliates of Cotton, or direct or indirect wholly owned subsidiaries of the Company) will be canceled and automatically converted into the right to receive $21.00 in cash, without interest and subject to any required tax withholding.

We have made various representations and warranties in the Merger Agreement that are customary for a company in the quick service restaurant industry. The Merger Agreement also contains customary covenants and agreements, including, among others, covenants relating to (1) the conduct of our business between the date of the Merger Agreement and the Effective Time and (2) the efforts of the parties to cause the Merger to be completed.

The completion of the Merger is subject to the satisfaction or waiver of a number of closing conditions, including, among others, (1) approval of the Merger Agreement by the holders of a majority of our outstanding common stock; (2) the absence of any “material adverse effect” on the Company occurring after the date of the Merger Agreement; (3) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended; (4) the absence of any legal prohibitions or certain governmental proceedings affecting the closing of the Merger; and (5) subject to certain materiality qualifications, the continued accuracy of our representations and warranties, and performance by the Company of required covenants and obligations (to be performed at or prior to the closing of the Merger), as of the closing of the Merger.

The Merger Agreement also includes provisions permitting termination by each of the Company and Cotton under certain circumstances, including (1) if the Merger is not completed by November 8, 2016 (the “Termination Date”), (2) if the required approval of our shareholders is not obtained or (3) if the other party breaches its representations, warranties or covenants and such breach would cause the failure of a corresponding closing condition to be satisfied by the Termination Date. In connection with a termination of the Merger Agreement under specified circumstances, including if we enter into an alternative transaction we determine is superior pursuant to the terms of the Merger Agreement, we may be required to pay Cotton a termination fee of $42.0 million.

The foregoing description of the Merger Agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the Merger Agreement, a copy of which was filed with our Current Report on Form 8-K filed with the United States Securities and Exchange Commission (the “SEC”) on May 9, 2016 and is hereby incorporated by reference. During the three months ended May 1, 2016, we recorded approximately $454,000 related to the proposed Merger which is included in general and administrative expenses in the Consolidated Statement of Income.

Significant Accounting Policies

BASIS OF PRESENTATION. The consolidated financial statements contained herein should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended January 31, 2016 (the “2016 Form 10-K”). The accompanying interim consolidated financial statements are presented in accordance with the requirements of Article 10 of Regulation S-X and, accordingly, do not include all the disclosures required by generally accepted accounting principles in the United States of America (“GAAP”) with respect to annual financial statements. The interim consolidated financial statements have been prepared in accordance with our accounting practices described in the 2016 Form 10-K, but have not been audited. In our opinion, the financial statements include all adjustments, which consist only of normal recurring adjustments, necessary for a fair statement of our results of operations for the periods presented. The consolidated balance sheet data as of January 31, 2016 were derived from our audited financial statements.

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BASIS OF CONSOLIDATION. The financial statements include the accounts of KKDI and its subsidiaries. Investments in entities over which we have the ability to exercise significant influence but which we do not control, and whose financial statements are not otherwise required to be consolidated, are accounted for using the equity method.

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

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

Stock options with respect to 244,000 and 302,000 shares for the three months ended May 1, 2016 and May 3, 2015, respectively, and 190,000 and 171,000 unvested restricted stock units for the three months ended May 1, 2016 and May 3, 2015, respectively, have been excluded from the computation of the number of shares used to compute diluted earnings per share because their inclusion would be antidilutive.

Recent Accounting Pronouncements

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2016-09, “Improvements to Employee Share-Based Payment Accounting”, which amends existing guidance related to accounting for employee share-based payments affecting the income tax consequences of awards, classification of awards as equity or liabilities, and classification on the statement of cash flows. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. We are evaluating the impact that adoption of this guidance will have on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, “Leases”, which requires lessees to present right-of-use assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. The guidance is to be applied using a modified retrospective approach at the beginning of the earliest comparative period in the financial statements and is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years and early adoption is permitted. We are evaluating the impact that adoption of this guidance will have on our consolidated financial statements.

In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory”, which changes guidance for subsequent measurement of inventory from the lower of cost or market to the lower of cost and net realizable value. This update is effective for annual and interim periods beginning after December 15, 2016 and early adoption is permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU 2015-15, “Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements.” This guidance states that given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to the line-of-credit arrangements, the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the costs ratably over the term of the arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit. This guidance became effective in the first quarter of fiscal 2017. As all of our debt issuance costs are related to line-of-credit arrangements and are currently classified as assets, the adoption of this guidance did not have any impact on our consolidated financial statements.

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In April 2015, the FASB issued ASU 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement”, which provides guidance about whether a cloud computing arrangement includes a software license. This guidance became effective in the first quarter of fiscal 2017 and did not impact our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers”, to clarify the principles used to recognize revenue for all entities. In March 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations”, which further clarifies the implementation guidance on principal versus agent considerations”, and in April 2016, the FASB issued ASU 2016-10, “Revenue from contracts with customers (Topic 606): Identifying performance obligations and licensing”, an update on identifying performance obligations and accounting for licenses of intellectual property. Additionally, in May 2016, the FASB issued ASU 2016-12, “Revenue from contracts with customers (Topic 606): Narrow-scope improvements and practical expedients”, which includes amendments for enhanced clarification of the guidance. This guidance is effective for fiscal years beginning on or after December 15, 2017 including interim periods within those fiscal years and early adoption is permitted. We are evaluating the impact that adoption of this guidance will have on our consolidated financial statements.

Note 2 — Segment Information

Our operating and reportable segments are Company Stores, Domestic Franchise, International Franchise and KK Supply Chain.

The Company Stores segment is comprised of the stores owned and operated by us. These stores sell doughnuts and complementary products through both on-premises and consumer packaged goods - wholesale (“CPG”) channels, although some stores serve only one of these distribution channels.

The Domestic Franchise and International Franchise segments consist of our franchise operations. Under the terms of franchise agreements, domestic and international franchisees pay royalties and fees to us in return for the use of the Krispy Kreme trademark and ongoing brand and operational support. Revenues and costs related to licensing certain Company-owned trademarks to domestic third parties other than franchisees also are included in the Domestic Franchise segment. Expenses for these segments include costs to recruit new franchisees, to assist in store openings, to support franchisee operations and marketing efforts, as well as allocated corporate costs.

The majority of the ingredients and materials used by Company stores are purchased from the KK Supply Chain segment, which supplies doughnut mix, other ingredients and supplies and doughnut-making equipment to both Company and franchisee-owned stores. All intercompany sales by the KK Supply Chain segment to the Company Stores segment are at prices intended to reflect an arms-length transfer price and are eliminated in consolidation. Operating income for the Company Stores segment does not include any profit earned by the KK Supply Chain segment on sales of doughnut mix and other items to the Company Stores segment; such profit is included in KK Supply Chain operating income.

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The following table presents the results of operations of our operating and reportable segments for the three months ended May 1, 2016 and May 3, 2015. Segment operating income is consolidated operating income before general and administrative expenses, corporate depreciation and amortization expense, impairment charges and lease termination costs, pre-opening costs related to Company Stores, gains on commodity derivatives, net and gain on refranchisings, net of business acquisition charges.

Segment information for total assets and capital expenditures is not presented as such information is not used in measuring segment performance or allocating resources among segments.

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The changes in the allowance for doubtful accounts are summarized as follows:

We also have notes receivable from certain of our franchisees included in “Other assets” in the accompanying consolidated balance sheet, which are summarized in the following table.

Notes receivable at May 1, 2016 and January 31, 2016 consist principally of amounts payable to us related to sales of equipment and to the sale of certain leasehold interests to a franchisee. In addition to the foregoing notes receivable, we had promissory notes totaling approximately $1.2 million at May 1, 2016 and January 31, 2016 principally representing royalties and fees due to us which, as a result of doubt about their collection, we had not yet recorded as revenues.

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The carrying values of the Company’s investments and advances in Kremeworks, LLC (“Kremeworks”) and Kremeworks Canada, LP (“Kremeworks Canada”) were zero at May 1, 2016 and January 31, 2016. In addition, the Company had reserved all of the balance of its advances to Kremeworks and Kremeworks Canada at such dates; accrued but uncollected interest on such advances of approximately $380,000 and $370,000 at May 1, 2016 and January 31, 2016, respectively, had not been reflected in income at such date.

Lease Obligations

We acquire equipment and facilities under capital and operating leases and build-to-suit arrangements. In certain build-to-suit leasing arrangements, we incur hard costs related to the construction of leased stores and we are therefore deemed the owner of the leased stores for accounting purposes during the construction period. We record the related assets and liabilities for construction costs incurred under these build-to-suit leasing arrangements during the construction period. Upon completion of the leased store, we consider whether the assets and liabilities qualify for derecognition under the sale-leaseback accounting guidance. These leasing arrangements do not qualify for sale-leaseback treatment and, accordingly, we record the transactions as financing obligations. A portion of the lease payments is allocated to land and is classified as an operating lease. The remainder of the lease payments is allocated between interest expense and amortization of the financing obligations. The assets are depreciated over their estimated useful lives. At the end of the lease term, the carrying value of the leased asset and the remaining financing obligation are expected to be equal, at which time we may either surrender the leased assets as settlement of the remaining financing obligation or enter into a new arrangement for the continued use of the asset.

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2013 Revolving Credit Facility

On July 12, 2013, we entered into a $40 million revolving secured credit facility (the “2013 Facility”) which matures in July 2018. The 2013 Revolving Credit Facility is secured by a first lien on substantially all of our personal property assets and certain of our domestic subsidiaries. No borrowings were made on the 2013 Facility on the closing date.

Inte rest on borrowings under the 2013 Facility is payable either at the London Interbank Offered Rate (“LIBOR”) or the Base Rate (which is the greatest of the prime rate, the Federal funds rate plus 0.50%, or the one-month LIBOR rate plus 1.00%), in each case plus the Applicable Percentage. The Applicable Percentage for LIBOR loans ranges from 1.25% to 2.15%, and for Base Rate loans ranges from 0.25% to 1.15%, in each case depending on our leverage ratio. As of May 1, 2016, the Applicable Percentage was 1.25%.

The 2013 Facility contains provisions which permit us to obtain letters of credit, issuance of which constitutes usage of the lending commitments and reduces the amount available for cash borrowings. At May 1, 2016, we had approximately $10.3 million of letters of credit outstanding, substantially all of which secure our reimbursement obligations to insurers under our self-insurance arrangements.

We are required to pay a fee equal to the Applicable Percentage for LIBOR-based loans on the outstanding amount of letters of credit. There also is a fee on the unused portion of the 2013 Facility lending commitment, ranging from 0.15% to 0.35%, depending on our leverage ratio. As of May 1, 2016, the fee on the unused portion of the 2013 Facility was 0.15%.

The 2013 Facility requires us to meet certain financial tests, including a maximum leverage ratio and a minimum fixed charge coverage ratio. The leverage ratio is required to be not greater than 2.25 to 1.0 and the fixed charge coverage ratio is required to be not less than 1.3 to 1.0. As of May 1, 2016, our leverage ratio was 0.3 to 1.0 and the fixed charge coverage ratio was 3.4 to 1.0.

The operation of the restrictive financial covenants described above may limit the amount we are able to borrow under the 2013 Facility. The restrictive covenants did not limit our ability to borrow the full $29.7 million of unused credit under the 2013 Credit Facility as of May 1, 2016.

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

The 2013 Facility also contains customary events of default including, without limitation, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to other indebtedness in excess of $5 million, certain events of bankruptcy and insolvency, judgment defaults in excess of $5 million and the occurrence of a change of control. In the event the Merger is consummated, it is expected the 2013 Facility will be terminated.

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

Note 7 — Commitments and Contingencies

Except as disclosed below, we currently are not a party to any material legal proceedings.

Pending Litigation

K ² Asia Litigation

On April 7, 2009, a Cayman Islands corporation, K ² Asia Ventures, and its owners filed a lawsuit in Forsyth County, North Carolina Superior Court against us, our franchisee in the Philippines, and other persons associated with the franchisee. The suit alleges that we and the other defendants conspired to deprive the plaintiffs of claimed “exclusive rights” to negotiate franchise and development agreements with prospective franchisees in the Philippines, and seeks unspecified damages. We therefore do not know the amount or range of possible loss related to this matter. We believe that these allegations are false and continue to vigorously defend against the lawsuit. On July 26, 2013, the Superior Court dismissed the Philippines-based defendants for lack of personal jurisdiction, and the plaintiffs appealed that decision. On January 22, 2015, the North Carolina Supreme Court denied the pl aintiffs’ request to review the case. We moved for summary judgment on May 7, 2015 and are awaiting a decision by the Superior Court. We do not believe it is probable that a loss has been incurred with respect to this matter, and accordingly no liability related to it has been reflected in the accompanying financial statements.

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Merger-Related Litigation

On May 26, 2016, a purported shareholder of the Company, Ronnie Stillwell, filed a putative class action complaint challenging the Merger in Superior Court in the State of North Carolina. The complaint names as defendants JAB, Cotton, Merger Sub and the members of the Board and also names the Company as a nominal defendant. The complaint seeks, among other relief, an order enjoining the Merger, compensatory damages, and an award of attorney's fees and costs on the grounds that, among other things, the members of the Board allegedly breached their fiduciary duties in connection with entering into the Merger Agreement and adopting and approving the Merger. The complaint further alleges that JAB, Cotton and Merger Sub aided and abetted the alleged breaches of fiduciary duties. It is possible that this complaint will be amended to make additional claims and/or that additional lawsuits making similar or additional claims relating to the Merger will be brought.

On May 26, 2016, legal advisors representing Melissa Weers, who is purportedly a shareholder of the Company, submitted a letter through the mail to the Board of the Company demanding legal action against the Board for a purported breach of fiduciary duty related to the Merger. The letter alleges, among other things, that the directors of the Company agreed to inadequate merger consideration and undervalued the Company. Additionally, the letter alleges that measures in the Merger Agreement created unreasonable protective devices to preclude competing offers. The letter further states Ms. Weer’s belief that the Board of the Company was neither independent nor disinterested in the Merger, preventing directors from fulfilling their fiduciary duties to the Company’s shareholders. In closing, the letter demands attention from the Board. The letter further asks the Board to authorize litigation against Cotton and its affiliated entities for aiding and abetting these supposed breaches.

On June 8, 2016, the Company received a demand letter from legal advisors representing Stu Bonnin, who is also purportedly a shareholder of the Company. In addition to alleging a breach of fiduciary duty related to the Merger, the letter also alleges a breach by the members of the Board of their duties of care, candor and good faith by causing the Company to issue materially incomplete and misleading disclosures in the Company’s PREM14A Preliminary Proxy Statement filed on May 31, 2016. Specifically, the letter alleges that the disclosures were deficient and misleading because they did not include information as to the nature and timing of post-merger employment discussions. In closing, the letter demands that the Board take action to disclose the material information allegedly omitted from the Preliminary Proxy Statement.

Other Legal Matters

We are also engaged in various legal proceedings arising in the normal course of business. We maintain insurance policies against certain kinds of such claims and suits, including insurance policies for workers’ compensation and personal injury, all of which are subject to deductibles. While the ultimate outcome of these matters could differ from our expectations, we currently do not believe their resolution will have a material adverse effect on our consolidated financial statements.

Other Commitments and Contingencies

Our primary bank had issued letters of credit on our behalf totaling $10.3 million at May 1, 2016, substantially all of which secure our reimbursement obligations to insurers under our self-insurance arrangements.

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Note 8 — Shareholders’ Equity

Share-Based Compensation for Employees and Directors

We measure and recognize compensation expense for share- based payment (“SBP”) awards based on their fair values. The fair value of SBP awards for which employees and directors render the requisite service necessary for the award to vest is recognized over the related vesting period. The aggregate cost of SBP awards charged to earnings for the three months ended May 1, 2016 and May 3, 2015 is set forth in the following table. We did not realize any excess tax benefits from the exercise of stock options or the vesting of restricted stock units during any of the periods.

Repurchases of Common Stock

In fiscal 2014, our Board authorized the repurchase of our common stock, and subsequently increased that authorization such that it now totals $255 million. The authorization has no expiration date. Through May 1, 2016, we have cumulatively repurchased 8,612,395 shares under the authorization at an average price of $17.56 per share, for a total cost of $151.2 million. Repurchases of approximately $34.2 million and $5.9 million were settled during the three months ended May 1, 2016 and May 3, 2015, respectively. As of May 1, 2016, approximately $103.8 million remains available under the authorization for future share repurchases.

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

The following table summarizes repurchases of common stock for the three months ended May 1, 2016 and May 3, 2015.

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We test long-lived assets for impairment when events or changes in circumstances indicate that their carrying value may not be recoverable. These events and changes in circumstances include store closing and refranchising decisions, the effects of changing costs on current results of operations, unfavorable observed trends in operating results, and evidence of changed circumstances observed as a part of periodic reforecasts of future operating results and as part of our annual budgeting process. Impairment charges generally relate to Company stores expected to be closed or refranchised, as well as to stores we believe will not generate sufficient future cash flows to enable us to recover the carrying value of the stores’ assets, but which we have not yet decided to close. When we conclude that the carrying value of long-lived assets is not recoverable (based on future projected undiscounted cash flows), we record impairment charges to reduce the carrying value of those assets to their estimated fair values. The fair values of these assets are estimated based on the present value of estimated future cash flows, on independent appraisals and, in the case of assets we currently are negotiating to sell, on our negotiations with unrelated third-party buyers. Impairment charges related to our long-lived assets were $500,000 in the first quarter of fiscal 2017 and relate to the refranchising of certain shop locations which was completed during the second quarter of fiscal 2017 as described in Note 14. The fair value of the impaired store assets was estimated based on our negotiations with unrelated third-party buyers.

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

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

The lease termination accrual at May 1, 2016 of $376,000 is expected to be paid within one year.

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Note 10 — Income Taxes

Our effective income tax rate was 39.3% for the three months ended May 1, 2016 compared to an effective income tax rate of 38.1% for the three months ended May 3, 2015. The increase in the effective income tax rate was due primarily to the benefit of specific incentive stock options being reclassified as non-qualified stock options during the three months ended May 3, 2015.

We have established a valuation allowance of $1.4 million at May 1, 2016 and January 31, 2016 that represents the portion of our deferred tax assets that management estimates will not be realized in the future. Such assets are associated principally with state net operating loss carryforwards related to states in which the scope of our operations has decreased. In such states, our ability to realize the net operating loss carryforwards is adversely affected because we are expected to have little income earned in or apportioned to those states in the future.

Realization of net deferred tax assets generally is dependent on generation of taxable income in future periods. While management believes its forecast of future taxable income is reasonable, actual results inevitably will vary from management’s forecasts. Such variances could result in adjustments to the valuation allowance on deferred tax assets in future periods, and such adjustments could be material to the financial statements.

Note 11 — Fair Value Measurements

The accounting standards for fair value measurements define fair value as the price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The accounting standards for fair value measurements establish a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

(1) There were no transfers of financial assets or liabilities among the levels within the fair value hierarchy during the three months ended May 1, 2016 or during the year ended January 31, 2016.

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Long-Lived Assets

During the three months ended May 1, 2016, long-lived assets having an aggregate carrying value of $3.0 million were written down to their estimated fair values of $2.5 million, resulting in recorded impairment charges of $500,000. The charges relate to the refranchising of certain shop locations which was completed during the second quarter of fiscal 2017 as described in Note 14. The fair value of the impaired store assets was estimated based on our negotiations with unrelated third-party buyers. These inputs are classified as Level 2 within the valuation hierarchy.

Lease Termination Liabilities

During the three months ended May 1, 2016, we recorded provisions for lease termination costs related to closed stores based upon the estimated fair values of the liabilities under unexpired leases as described in Note 9; such provisions were reduced by previously recorded accrued rent expense related to those stores. The fair value of these liabilities was computed as the excess, if any, of the contractual payments required under the unexpired leases over the current market lease rates for the properties, discounted at a credit-adjusted risk-free rate over the remaining term of the leases. These inputs are classified as Level 2 within the valuation hierarchy. For the three months ended May 1, 2016, the $250,000 of previously recorded accrued rent expense, related to store closures, exceeded the $202,000 fair value of lease termination liabilities related to such stores, and such excess has been reflected as a credit to lease termination costs during the period.

Note 12 — Derivative Instruments

We are exposed to certain risks relating to our ongoing business operations. The primary risk managed by using derivative instruments is commodity price risk. We do not hold or issue derivative instruments for trading purposes.

Commodity Price Risk

We are exposed to the effects of commodity price fluctuations in the cost of ingredients of our products, of which flour, sugar and shortening are the most significant. In order to bring greater stability to the cost of ingredients, from time to time we purchase exchange-traded commodity futures contracts, and options on such contracts, for raw materials which are ingredients of our products or which are components of such ingredients, including wheat and soybean oil. We are also exposed to the effects of commodity price fluctuations in the cost of gasoline used by our delivery vehicles. To mitigate the risk of fluctuations in the price of our gasoline purchases, we may purchase exchange-traded commodity futures contracts and options on such contracts. The difference between the cost, if any and the fair value of commodity derivatives is reflected in earnings because we had not designated any of these instruments as hedges. Gains and losses on these contracts are intended to offset losses and gains on the hedged transactions in an effort to reduce the earnings volatility resulting from fluctuating commodity prices. The settlement of commodity derivative contracts is reported in the consolidated statement of cash flows as a cash flow from operating activities. We had no commodity derivative contracts as of May 1, 2016.

Interest Rate Risk

We are exposed to market risk from increases in interest rates on any borrowings outstanding under our 2013 Credit Facility. As of May 1, 2016, there were no borrowings outstanding under such facility.

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

There were no derivative instruments in the consolidated balance sheet as of May 1, 2016 or January 31, 2016.

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The effect of derivative instruments on the consolidated statement of income for the three months ended May 1, 2016 and May 3, 2015 was as follows:

Note 13 — Acquisitions

Acquisition of Krispy Kreme Shop

On April 23, 2015, we entered into several legal arrangements with a franchisee, which included an asset purchase agreement and management agreement, whereby we agreed t o operate the franchisee’s Krispy Kreme shop in Little Rock, Arkansas as a Company store. We paid $312,000 in cash for specific assets of the shop and have accounted for the transaction as the acquisition of a business. The acquired shop had fiscal 2015 sales of approximately $2.7 million. The allocation of the purchase price was as follows: $252,000 to property and equipment, $27,000 to inventory, $137,000 to reacquired franchise rights and $104,000 to a liability, related to a lease which included an unfavorable term compared to the market, which will be amortized over the remaining life of the lease agreement. Our results of operations, computed on a pro forma basis assuming the acquisition had been consummated at the beginning of the current and prior year periods, are not materially different from our historical results of operations and, accordingly, have been omitted. The acquired business’s revenues and earnings for periods subsequent to the acquisition are not material to our consolidated financial statements.

Acquisition of Franchise Rights

We acquired the franchise rights to develop certain CPG channels of trade from certain of our franchisees for approximately $185,000 in the first quarter of fiscal 2017 and $1.6 million in fiscal 2016. These transactions represented business acquisitions and the purchase price of each transaction has been allocated to reacquired franchise rights. These reacquired franchise rights will be amortized over the terms of the reacquired franchise agreements.