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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.

FORM 10-Q

(Mark One)

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934.

For the quarterly period ended December 29, 2002

OR

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934.

For the transition period from                                  to                                 

Commission file number 0-22639

CHAMPPS ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

(303) 804-1333

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Number of shares of Common Stock, $.01 par value, outstanding at January 31, 2003: 12,714,689.

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CHAMPPS ENTERTAINMENT INC.

INDEX

PART I – FINANCIAL INFORMATION

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PART I – FINANCIAL INFORMATION

ITEM 1.    Financial Statements

CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED BALANCE SHEETS

As of December 29, 2002 and June 30, 2002

(In thousands except share data)

(Unaudited)

See notes to unaudited consolidated financial statements.

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CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

The Three and Six Months Ended December 29, 2002 and December 30, 2001

(In thousands except per share data)

(Unaudited)

See notes to unaudited consolidated financial statements.

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CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

The Six Months Ended December 29, 2002 and December 30, 2001

(In thousands)

(Unaudited)

See notes to unaudited consolidated financial statements.

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CHAMPPS ENTERTAINMENT, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

The Six Months Ended December 29, 2002

(In thousands except share data)

(Unaudited)

See notes to unaudited consolidated financial statements.

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CHAMPPS ENTERTAINMENT, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Three and Six Months Ended December 29, 2002 and December 30, 2001

(Unaudited)

1.    Nature of Business and Basis of Presentation

Nature of Business

As of December 29, 2002, Champps Entertainment, Inc. (the “Company,” or “Champps”) owned and operated 38 full-service, casual dining restaurants under the names of “Champps Americana” and “Champps Restaurant.” The Company also franchised 12 restaurants under the name “Champps Americana.” Champps operates in 18 states throughout the United States.

Basis of Presentation of Consolidated Financial Statements

The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of normal recurring adjustments, which are, in the opinion of management, necessary for a fair statement of financial position as of December 29, 2002 and results of operations for the interim periods ended December 29, 2002 and December 30, 2001. These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such SEC rules and regulations. Operating results for the three-month and six-month periods ended December 29, 2002 are not necessarily indicative of the results that may be expected for the year ending June 29, 2003.

The balance sheet at June 30, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto for the fiscal year ended June 30, 2002 included in the Company’s annual report on Form 10-K.

These statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2002. The accounting policies used in preparing these consolidated financial statements are consistent with those described in the Company’s Annual Report on Form 10-K. Certain June 30, 2002 balances have been reclassified to conform to the December 29, 2002 presentation.

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2.    Earnings Per Share

Earnings Per Share

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

3.    Commitments and Contingencies

Restricted Cash

The Company had $687,000 of restricted cash as of December 29, 2002. These funds serve primarily as collateral for insurance claims and other claims against the Company.

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Indemnification for Sale and Spin-off of Predecessor Companies

The Company remains liable for certain indemnifications relative to representations and warranties associated with the sale of its Fuddruckers subsidiary in 1998 (the “Fuddruckers sale”) and a spin-off from DAKA International, Inc. in 1997 (the “DAKA spin-off”).

Such potential liabilities remaining from the Fuddruckers sale principally include, but are not limited to, environmental matters, legal proceedings, liability for taxes, retained insurance risks, other retained or undisclosed liabilities and lease termination and rent adjustment amounts existing prior to the sale. Certain of these potential liabilities expire through agreed upon dates, through expiration of applicable statute of limitations or other agreement expirations. The Company’s maximum potential amount of future payments for any breach of any representation or warranty associated with its Fuddruckers sale is limited to the $43.0 million purchase price, however, there is no limit on liability for other indemnification obligations. If amounts paid for indemnification exceed the sales price, the Company could require the purchaser to reconvey to the Company the ownership of shares and assets originally transferred in the sale at the original sales price plus a stated internal rate of return or pay all the losses associated with the indemnification.

Such potential liabilities remaining from the DAKA spin-off generally relate to responsibility for all taxes through expiration of applicable statute of limitations, environmental matters, liabilities of insurance matters, and liabilities from certain prohibited business practices existing prior to the sale. There is no limit on maximum potential future payments under the DAKA spin-off agreements.

Except as described in the “Tax Contingencies” and “Litigation” sections below for which the potential liabilities arose either before representations and warranties survival expirations or there is no survival expiration, the Company believes the risk of any additional significant liabilities arising from the Fuddruckers sale or DAKA spin-off is remote.

Tax Contingencies

In December 2001, the State of Florida proposed to assess subsidiaries of DAKA International, Inc. (“DAKA”) and its subsidiaries including Daka, Inc. (“Daka”) $2.4 million in unpaid state sales taxes, and an additional $2.9 million in penalties and interest as of December 2001. The Company is contractually obligated to indemnify DAKA for this matter and is actively protesting this proposed assessment. We believe that DAKA has meritorious legal and factual defenses to these matters. On October 11, 2002, Compass Group USA, Inc., a successor to DAKA (“Compass”), filed a complaint for declaratory judgment and temporary and permanent injunction relief with the Ninth Judicial Circuit Court in Orange County, Florida regarding the proposed assessment. The complaint alleges that the Florida Department of Revenue did not have a valid consent to extend the time to issue an assessment and therefore the statute of limitations expired on 77 of the 87 months of the proposed assessment. On December 27, 2002, Compass agreed to withdraw its complaint without prejudice and entered into a Stipulation Agreement pursuant to which Compass may file a protest with the Department of Revenue regarding its proposed assessment by March 27, 2003. At that time, Compass will reassert the invalidity of the Department of Revenue’s consent as well as present a defense relative to the underlying assessment. If the Department of Revenue does not concur with Compass’ position at that time, the Company still has additional remedies including seeking judicial relief.

In addition, the Company and its predecessors, from time-to-time, have been party to various other assessments of taxes, penalties and interest from Federal and state agencies. The Company is in the process of settling several such assessments. Tax reserves are accrued based upon the Company’s estimates of the ultimate settlement of the contingencies. As of December 29, 2002, the Company had $0.4 million accrued for tax liabilities associated with Fuddrucker pre-closing events and DAKA International pre-closing events. Actual amounts required to settle these obligations may exceed these estimates.

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Litigation

In the third quarter of fiscal 2000, a Washington, D.C. superior court jury awarded a former Daka employee $188,000 in compensatory damages, $4.8 million in punitive damages and a subsequent award of $276,000 for legal fees and costs, based on the employee’s claim of negligent supervision and retaliation, due to alleged conduct that occurred in 1996 at a former Daka food service location. The events at issue in the case took place prior to the Daka spin-off. On September 20, 2000, Daka filed a Notice of Appeal with the Court of Appeals for the District of Columbia. On December 17, 2002, Daka filed its appellate brief with the Court of Appeals. The Company may be liable for the payment of any amounts ultimately due by Daka upon final determination of the case. The Company has not accrued any amounts related to the punitive damages in this matter based upon Daka’s meritorious arguments associated with its appeal and relevant legal precedents. Based on Daka’s meritorious arguments and relevant legal precedents the Company believes, and its outside legal counsel concurs, that the probability the punitive damages will be upheld is remote. The Company has accrued approximately $0.4 million associated with this matter based on our estimate of the ultimate compensatory damages and legal fees. Revisions to our estimate may be made in the future and will be reported in the period in which additional information is known. Based upon our analysis, and the advice of outside legal counsel, the Company believes that the ultimate outcome of this matter will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

From time-to-time, additional lawsuits have been filed against the Company in the ordinary course of business. Such lawsuits typically involve claims from customers and others related to operational issues common to the restaurant industry. A number of such claims may exist at any given time. In addition, the Company also encounters complaints and allegations from former and current employees or others from time-to-time that are believed to be common for businesses such as ours. Relative to such matters, the Company is currently not a party to any litigation that could have a material adverse effect on the Company’s consolidated financial position or results of operations, and the Company is not aware of any such threatened litigation.

Build-to-suit and Construction Commitments

The Company has entered into an agreement, as amended, with AEI Fund Management, Inc. (“AEI”) that provides a maximum $35.0 million financing commitment for the completion of up to ten new restaurants. Under the agreement, AEI purchases the land and funds a substantial portion of the construction costs of new restaurants selected by the Company for participation under the agreement. The Company serves as the developer of the site and is responsible for completing the project on time and within budget. Once the project is completed per the terms of the development agreement, the Company enters into a long-term lease with AEI for the property. For accounting purposes, the Company is considered the owner of the property during the construction period due to the Company’s obligation to develop the property and AEI’s option to sell the funded assets to the Company in the event of a default under the development agreement.

As of June 30, 2002 and December 29, 2002, the Company had $1.1 million and $1.0 million, respectively, of construction costs that had been funded by AEI. Since the projects were not complete as of those dates and the Company had additional obligations relative to the development agreement, the Company was considered the owner. These amounts are classified as prepaid expenses and other current assets and accrued expenses on the consolidated balance sheets. At December 29, 2002, the Company estimates that additional construction costs of $3.1 million will be required to finish existing projects being funded under the AEI agreement.

As of December 29, 2002, the Company had $2.0 million of contractual construction commitments outside of the AEI development projects described above.

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4.    Reserve Disclosure

The Company previously recorded liabilities associated with the activities of certain predecessor companies which were either spun-off or sold to other entities. The following table displays the activity and balances relating to these reserves during the six-month period ended December 29, 2002:

The reserves are incorporated into the balances for accrued expenses and other long-term liabilities.

5.    Consolidated Statements of Cash Flows

Total depreciation and amortization expense per the consolidated statement of cash flows includes depreciation and amortization expense on corporate assets of $218,000 and $152,000 that is included in general and administrative expense on the consolidated statements of operations for the six months ended December 29, 2002 and December 30, 2001, respectively.

6.    Notes Payable

On December 16, 2002, the Company issued, through a private placement, $15,000,000 of 5.5% Convertible Subordinated Notes due 2007 (the “Notes”) and related warrants (the “Warrants”) to purchase shares of the Company’s Common Stock (the “Common Stock”) (see Note 7). The securities were sold to accredited investors in reliance on Regulation D under the Securities Act of 1933, as amended. The Notes were recorded at their estimated fair market value of $13,995,000 based upon a $1,005,000 valuation attributable to the Warrants. The Notes’ discount of $1,005,000 will be acreated to interest expense over the term of the Notes. Origination issuance costs of $1,395,000 were incurred with the issuance of the Notes, are classified as an other asset on the accompanying consolidated balance sheet and will be amortized as interest expense over the term of the Notes. The Notes mature on December 15, 2007. Interest is payable semi-annually in arrears on June 1 and December 1, beginning on June 1, 2003.

The Notes are convertible at the option of the holder at any time prior to maturity into shares of Common Stock, at a conversion price of $10.66 per share, subject to adjustment upon certain events. If a holder elects to convert the Notes prior to December 15, 2003, the Company must make an additional cash payment with respect to the Notes in an amount equal to $55.00 per $1,000 principal amount of the Notes converted (representing approximately twelve months of interest), less the amount of any interest actually paid on the Notes prior to the conversion date.

At any time on or after December 15, 2005, the Company may redeem some or all of the Notes at par plus accrued and unpaid interest. All of the Notes will be automatically converted, at the Company’s option, into shares of Common Stock at the then effective conversion price if the closing price of the Common Stock exceeds 150% of the then effective conversion price for any 15 out of 20 consecutive trading days at any time within three years after the first issuance date of the Notes. If the automatic conversion date occurs prior to December 15, 2004, the Company will make an additional cash payment with respect to the Notes in an amount equal to $110.00 per $1,000 principal amount of the Notes converted (representing 24 months of interest), less the amount of interest actually paid on the Notes prior to the automatic conversion date.

Upon certain change in control events or if the Common Stock is no longer traded on a national exchange or an established automated over-the-counter trading market in the United States, a Noteholder may require the Company to repurchase such holder’s Notes in cash at 110% of the principal amount of the Notes, plus accrued but unpaid interest, if any.

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The Notes are subordinated in right of payment to our existing and future senior indebtedness and other liabilities of the Company and its subsidiaries. The Company and its subsidiaries are not prohibited from incurring senior indebtedness or other debt under the Agreement governing the Notes.

In November 2002, the Company received a commitment, subject to final documentation, for bank financing under which it may borrow up to $8,000,000. The commitment has two parts: $2,000,000 is to provide short-term working capital and to support the issuance of letters of credit; the other $6,000,000 is to provide interim financing associated with construction of new restaurant locations. Advances under the $6,000,000 facility will be in the form of individual promissory notes that require assignment of related construction improvement allowance proceeds and will mature 90 days following the estimated restaurant opening date. The agreement will expire in January 2005 at which time all outstanding borrowings are due. Outstanding borrowings will bear interest at the Wall Street Journal Prime Rate and require monthly interest payments. There will be an initial commitment fee of $42,500. The Company will be required to maintain a Funded Debt to EBITDA (earnings before interest, tax, depreciation and amortization) ratio of not more than 2 to 1 and a debt to tangible net worth ratio not to exceed 1.25 to 1. Also, the Company will be limited to $5,000,000 of annual replacement capital expenditures and the $2,000,000 working capital line must be repaid for 10 consecutive days each quarter. The Company is in the process of finalizing the loan documents associated with this commitment.

In December 2002, the Company repaid certain debt with existing balances totaling $5,243,000 before scheduled maturities with the proceeds of the Notes. Related prepayment costs and unamortized debt issuances costs totaling $290,000 were recorded as debt extinguishment costs in the accompanying Consolidated Statement of Operations.

7.    Shareholders’ Equity, Stock Option Plans and Warrants

On September 13, 2002, Mr. William Baumhauer, the Company’s chairman, chief executive officer and president, announced he had entered into a stock trading plan which complies with the requirements of Rule 10b5-1 of the Securities and Exchange Commission. Under the plan, Mr. Baumhauer may sell enough shares of stock which he owns to pay the price to exercise 1,009,000 stock options, pay the withholding taxes associated with the exercise of the stock options and repay a loan to the Company of $550,000. Rule 10b5-1 permits employees to adopt written plans at a time when they are not aware of material nonpublic information and to sell shares according to the plan on a regular basis, regardless of any subsequent nonpublic information they receive or the price of the stock at the time of the sale. Plans permitted under this rule allow an employee to minimize the effects of sales by spreading them over a more extended period than the traditional trading “windows” permitted under typical insider trading policies, and also avoid being prohibited from selling any shares for long periods of time due to nonpublic information they may possess during traditional windows. Mr. Baumhauer’s stock options expire June 30, 2003.

Through December 29, 2002, Mr. Baumhauer exercised options to purchase 728,647 shares of common stock of the Company under this plan with an aggregate exercise price of approximately $3,499,000. Mr. Baumhauer satisfied the exercise price of options to purchase 326,274 common shares and paid certain of his withholding tax liabilities by tendering to the Company (i) 187,073 common shares owned by him for more than six months having a fair market value of approximately $1,890,000 and (ii) 46,048 common shares that he received from the exercise of such options with a fair market value of approximately $465,000.

Through December 29, 2002, Mr. Baumhauer prepaid $350,000 of a $550,000 loan from the Company. The loan was made in fiscal 2001 with an interest rate of 9.0% and is due on September 30, 2003. The proceeds of the loan were used by Mr. Baumhauer to purchase 178,000 shares of the Company’s common stock and pay related tax liabilities. The loan is secured by a pledge of the purchased stock.

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On December 16, 2002, the Company issued Warrants to purchase 386,961 shares of common stock of the Company in conjunction with the issuance of the Notes described in Note 6. Each Warrant is exercisable for one share of Common Stock at an initial exercise price of $11.10 per share, subject to adjustment upon certain events. The Warrants are exercisable (in whole or in part) at any time on or before December 15, 2007, unless earlier terminated at the Company’s option upon certain events. At any time after December 15, 2004, if the closing price of Common Stock exceeds 175% of the then effective exercise price of the Warrants for any 15 out of 20 consecutive trading days, the Company may terminate the Warrants. Any unexercised Warrants as of the date of termination will automatically be deemed exercised in full pursuant to a cashless exercise. The Warrants had an estimated fair market value of $1,005,000 as of the date of issuance and were recorded as additional paid-in capital, net of issuance costs of $100,000.

8.    Income Taxes

The Company has a valuation allowance on its deferred tax assets of approximately $15.3 million at December 29, 2002. The Company evaluates the valuation allowance on a quarterly basis under Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes” utilizing available information regarding historical taxable income, temporary differences, tax law that limit utilization of an operating loss or tax credit carryforwards and estimated future taxable income. The Company is currently performing a detailed analysis of the potential limitations of its carryforwards. Based on the results of this analysis and future changes associated with forecasting future taxable income, net income may be impacted in the future to the extent that the Company believes it is more likely than not such deferred tax assets will be or will not be realized during the carryforward period.

9.    Recent Accounting Pronouncements

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations”. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company does not currently have any obligations falling under the scope of SFAS No. 143, and therefore its adoption did not have a material impact on its results of operations or financial position.

In August 2001, the FASB issued SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 provides new guidance on the recognition of impairment losses on long-lived assets to be held and used or to be disposed of, and also broadens the definition of what constitutes a discontinued operation and how the results of discontinued operation are to be measured and presented. The Company adopted SFAS No. 144 in its fiscal 2003 and the adoption of SFAS No. 144 did not have a material impact on its results of operations or financial position.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”. This Statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, SFAS No. 44, “Accounting for Intangible Assets of Motor Carriers” and SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. This statement amends SFAS No. 13, “Accounting for Leases”, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The Company adopted SFAS No. 145 in its fiscal year 2003. The Company classified its debt extinguishment costs as an expense from continuing operations in its consolidated statement of operations rather than as an extraordinary item as was previously required before the issuance of SFAS No. 145.

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In June 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” The statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between SFAS No. 146 and Issue No. 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. The statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue No. 94-3, a liability for an exit cost (as defined in that issue) was recognized at the date of an entity’s commitment to an exit plan. SFAS No. 146 also establishes that fair value is the objective for initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002 and the Company does not expect the adoption of SFAS No. 146 to have a material impact on its results of operations or financial position.

ITEM 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

The matters discussed in the following Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Company and elsewhere in this Quarterly Report on Form 10-Q, which are not historical information, are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Words such as “believe,” “anticipate,” “estimate,” “project,” “plan,” “expect,” and similar expressions are intended to identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their respective dates. Forward-looking statements involve risks and uncertainties, many of which are beyond the Company’s control. Should one or more of these risks or uncertainties materialize, or should any of the underlying assumptions prove incorrect, actual results of current and future operations may vary materially from those anticipated, estimated or projected. In addition to the factors set forth in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2002, factors that may cause such a difference include, among others, the following:

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This list is intended to identify some of the principal factors that could cause results to differ materially from those described in the forward-looking statements included elsewhere in this report. These factors are not intended to represent a complete list of all risks and uncertainties inherent in the Company’s business, and should be read in conjunction with the more detailed cautionary statements and risk factors identified in the Company’s 2002 Annual Report on Form 10-K under the caption “Item1. Business – Risk Factors,” other Securities and Exchange Commission filings, and press releases. All forward-looking statements attributable to the Company’s officers, directors and employees, or to persons acting on the Company’s behalf, are expressly qualified in their entirety by such factors and other events, many of which are outside of the Company’s control. Any of these factors could have a material adverse effect on the Company’s results of operations. Furthermore, the Company assumes no obligation to publicly release the results of any revisions or updates to any forward-looking statements to reflect future events or unanticipated occurrences.

RESULTS OF OPERATIONS

Overview

As of December 29, 2002, Champps Entertainment, Inc. owned and operated 38, and franchised 12 upscale, full-service, casual dining restaurants under the Champps Americana and Champps Restaurant names. Champps provides an extensive menu of approximately 85 items consisting of high quality ingredients, freshly prepared and served in an exciting environment with exceptional service. Since June 1999, the Company has positioned itself to increase profitability while embarking on a strategic expansion in major metropolitan areas throughout the United States. Prior to June 1999, the Company disposed of all non-Champps operating businesses and began to concentrate solely on the Champps concept. At June 1999, the Company owned 18 restaurants. In fiscal year 2000, the Company opened four restaurants and acquired two franchises. In fiscal 2001, the Company opened four restaurants and in fiscal 2002 the Company opened six restaurants. As of December 29, 2002, the Company had opened four additional locations, had three locations under construction, had fully executed contracts for six additional locations and was negotiating eight additional locations. We intend to open a total of eight restaurants in fiscal 2003 and 10 to 12 restaurants in fiscal 2004.

The Company’s new restaurants will typically range in size from 7,500 square feet to 9,000 square feet. These restaurants will require, on average, a total cash investment of approximately $1.8 million and total invested capital of approximately $2.8 to $3.3 million per restaurant excluding land costs and $4.3 million to $5.1 million including land costs. Pre-opening expenses are expected to average approximately $375,000 per restaurant.

Because the Company is in an expansion phase, the timing of revenues and expenses associated with opening new restaurants is expected to result in fluctuations in the Company’s quarterly and annual results. In addition, the Company’s results, and the results of the restaurant industry as a whole, may be adversely affected by changes in consumer tastes, discretionary spending priorities, national, regional or local economic conditions, the impact of war with Iraq or North Korea, demographic trends, consumer confidence in the economy, traffic patterns, weather conditions, employee availability or the type, number and location of competing restaurants. Changes in any of these factors could adversely affect the Company.

Among other factors, the success of the Company’s business and its operating results are dependent upon its ability to anticipate and react to changes in food and liquor costs and the mix between food and liquor revenues. Various factors beyond the Company’s control, such as adverse weather conditions, may affect food costs and increases in federal, state and local taxes may affect liquor costs. While in the past the Company has been able to manage its exposure to the risk of increasing food and liquor costs through certain purchasing practices, menu changes and price adjustments, there can be no assurance that the Company will be able to do so in the future or that changes in its sales mix or its overall buying power will not adversely affect the Company’s results of operations. Notwithstanding these risks, the Company believes that its near-term strategies, including, but not limited to, continued expansion of the Champps concept, and improving the execution of operating fundamentals should provide the Company with an opportunity for improved overall profitability.

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The Company’s restaurant sales are comprised almost entirely of food and beverage sales. Product costs include the costs of food and beverages. Labor costs include direct hourly and management wages, bonuses, workers’ compensation, taxes and benefits for restaurant employees. Other operating expense consists primarily of restaurant-level expenses for utilities, marketing expenses, repairs and maintenance and supplies such as tableware, cleaning and paper supplies. Occupancy includes rent, property taxes, and property insurance costs. Depreciation and amortization principally includes depreciation on capital expenditures for restaurants. Restaurant level operating profit is composed of restaurant sales less restaurant operating costs, which includes product costs, labor costs, other operating expense, occupancy and depreciation and amortization. General and administrative expense is composed of expenses associated with all corporate, administrative and indirect supervision functions that support existing operations, executive and corporate staff salaries, employee benefits, travel, information systems, training and market research. Pre-opening expense consists of direct costs related to hiring and training the initial restaurant workforce and certain other direct costs associated with opening new restaurants. Interest expense and income, net includes the cost of interest expense on debt offset by interest income and capitalized interest. Other income (expense) primarily includes gains or losses associated with early retirement of assets from replacements.

The Company reported net income of $1,768,000 for the quarter ended December 29, 2002, compared with net income of $973,000 for the comparable quarter last year.

The Company utilizes a 52/53 week fiscal year ending on the Sunday closest to June 30 for financial reporting purposes. Fiscal 2003 will consist of 52 weeks and will end on Sunday, June 29, 2003. The quarters ending December 29, 2002 and December 30, 2001 both had thirteen operating weeks and are referred to as the second quarter of fiscal 2003 and fiscal 2002, respectively.

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Operations

The following table sets forth, for the periods presented, certain unaudited consolidated financial information for the Company (dollars in 000’s).