SECURITIES AND EXCHANGE COMMISSION

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 August 9, 2004

OR

o

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 1-11313

CKE RESTAURANTS, INC.

Registrant’s telephone number, including area code: (805) 745-7500

Former Name, Former Address and Former Fiscal Year, if changed since last report.

     Indicate by checkmark 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 o

     Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

     As of September 8, 2004, 57,707,543 shares of the Registrant’s Common Stock were outstanding.

CKE RESTAURANTS, INC. AND SUBSIDIARIES

INDEX

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PART 1. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CKE RESTAURANTS, INC. AND SUBSIDIARIES

(Dollars in thousands, except par values)
(Unaudited)

See Accompanying Notes to Condensed Consolidated Financial Statements

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CKE RESTAURANTS, INC. AND SUBSIDIARIES

(In thousands, except per share amounts)
(Unaudited)

See Accompanying Notes to Condensed Consolidated Financial Statements

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CKE RESTAURANTS, INC. AND SUBSIDIARIES

(In thousands)
(Unaudited)

See Accompanying Notes to Condensed Consolidated Financial Statements

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CKE RESTAURANTS, INC. AND SUBSIDIARIES

See Accompanying Notes to Condensed Consolidated Financial Statements

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CKE RESTAURANTS, INC. AND SUBSIDIARIES

NOTE (1) BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS

CKE Restaurants, Inc. (“CKE” or the “Company”), through its wholly-owned subsidiaries, owns, operates, franchises and licenses the Carl’s Jr.®, Hardee’s®, The Green Burrito® (“Green Burrito”) and La Salsa Fresh Mexican Grill® (“La Salsa”) concepts. Carl’s Jr. restaurants are primarily located in the Western United States. Hardee’s restaurants are located throughout the Southeastern and Midwestern United States. Green Burrito restaurants are located in California, primarily in dual-brand Carl’s Jr. restaurants. La Salsa restaurants are primarily located in California. As of August 9, 2004, the Company’s system-wide restaurant portfolio consisted of:

The accompanying unaudited condensed consolidated financial statements include the accounts of CKE and its wholly-owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America, the instructions to Form 10-Q, and Article 10 of Regulation S-X. These statements should be read in conjunction with the audited consolidated financial statements presented in the Company’s Annual Report on Form 10-K for the fiscal year ended January 26, 2004. In the opinion of management, all adjustments consisting of normal recurring accruals necessary for a fair presentation of financial position and results of operations for the interim periods presented have been reflected herein. The results of operations for such interim periods are not necessarily indicative of results for the full year or for any future period.

For clarity of presentation, the Company generally labels all fiscal year ends as fiscal year ended January 31.

Prior year amounts in the condensed consolidated financial statements have been reclassified to conform with current year presentation.

Stock-Based Compensation

The Company has various stock-based compensation plans that provide options for certain employees and outside directors to purchase common shares of the Company. The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure (“SFAS 148”). SFAS 148 amended the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Disclosures required by this standard are included in the notes to these condensed consolidated financial statements.

For purposes of the following pro forma disclosures required by SFAS 148 and SFAS 123, the fair value of each option has been estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that do not have vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the value of an estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options.

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The assumptions used for grants in the twelve weeks ended August 9, 2004, and August 11, 2003, are as follows:

The assumptions used to determine the fair value of each option granted are highly subjective. Changes in the assumptions used would affect the fair value of the options granted as follows:

The following tables reconcile reported net income (loss) to pro forma net income (loss) assuming compensation expense for stock-based compensation had been recognized in accordance with SFAS 123:

NOTE (2) ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS

On May 17, 2004, the Company completed adoption of FASB Interpretation No. 46, Consolidation of Variable Interest Entities — an interpretation of Accounting Research Bulletin (“ARB”) No. 51 (“FIN 46”).

The FASB issued FIN 46 in January 2003. This interpretation is intended to clarify the application of the majority

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CKE RESTAURANTS, INC. AND SUBSIDIARIES

voting interest requirement of ARB No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 requires the consolidation of these entities, known as variable interest entities (“VIEs”), by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that is subject to a majority of the risk of loss from the VIE’s activities, entitled to receive a majority of the VIE’s residual returns, or both. FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. FIN 46 was applicable immediately to variable interests in a VIE created after January 31, 2003.

During the course of 2003, the FASB proposed modifications to FIN 46 and issued FASB Staff Positions (“FSPs”) that changed and clarified FIN 46. These modifications and FSPs were subsequently incorporated into FIN 46 (revised) (“FIN 46R”), which was issued on December 23, 2003, and replaced FIN 46. FIN 46R excludes operating businesses, as defined, from its scope subject to four conditions, and states the provisions of FIN 46R need not be applied to interests in VIEs created or obtained prior to December 31, 2003, if a company is unable, subject to making and continuing to make an exhaustive effort, to obtain the information necessary to determine whether the entity is a VIE, determine whether the Company is the VIE’s primary beneficiary or perform the accounting required to consolidate the VIE.

The principal entities in which the Company possesses a variable interest include franchise entities, which operate its franchised restaurants. The Company does not possess any ownership interests in its franchisees. Additionally, the Company generally does not provide financial support to its franchisees in a typical franchise relationship. Also, the Company’s franchise agreements do not require its franchisees to provide the timely financial information necessary to apply the provisions of FIN 46R to its franchisees.

Upon the final adoption of FIN 46R on May 17, 2004, the Company consolidated one franchise entity that operates six Hardee’s restaurants. The Company subleases to this franchise entity all of its six operating locations and substantially all of its operating equipment, and this franchise entity received no equity contribution from its principals upon its inception. Because the principals did not invest a significant amount of equity, the legal entity within which this franchise operates is considered to be inadequately capitalized and, as a result, is a VIE. Because of the relatively significant financial support it provides to this franchise, the Company determined it is the primary beneficiary of this VIE. The assets and liabilities of this entity included in the accompanying condensed consolidated balance sheet as of August 9, 2004, are as follows:

The operating results of this franchise entity are included within the Company’s condensed consolidated statement of operations and are not significant. The minority interest in the income of this franchise entity is classified in other expense in the Company’s condensed consolidated statements of operations and in other long-term liabilities in the Company’s condensed consolidated balance sheets and also is not significant.

Although this franchise entity has been included in the condensed consolidated financial statements, the Company has no rights to the assets, nor does it have any obligation with respect to the liabilities, of this franchise entity. None of the Company’s assets serve as collateral for the creditors of this franchisee or any of the Company’s other franchisees.

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There is also a portion of franchised restaurants that are VIEs for which the Company holds a significant variable interest, but for which the Company is not the primary beneficiary. The Company’s significant exposures related to these VIEs and other franchisees relate to the collection of amounts due the Company, which are collected weekly or monthly, guarantees of franchisee debt provided to third party lenders by the Company (see Note 9) and primary lease obligations or fee property ownership underlying sublease and lease arrangements the Company has with several of its franchisees, as more fully described in Note 9 herein and in Note 8 to the Company’s condensed consolidated financial statements presented in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2004.

The Company utilizes various advertising funds to administer its advertising programs. The Carl’s Jr. National Advertising Fund (“CJNAF”) is Carl’s Jr.’s sole cooperative advertising program. The Company has historically consolidated CJNAF into its financial statements on a net basis, whereby contributions from franchisees are recorded as offsets to the Company’s reported advertising expenses.

The Hardee’s cooperative advertising funds consist of the Hardee’s National Advertising Fund (“HNAF”) and many local advertising cooperative funds (“Co-op Funds”). Each of these funds is a separate non-profit association with all proceeds segregated and managed by a third-party accounting service company. Upon final adoption of FIN 46R, the Company consolidated all of the Hardee’s cooperative advertising funds. The Company has included $21,448 of advertising fund assets, restricted, and advertising fund liabilities in its accompanying condensed consolidated balance sheet as of August 9, 2004. Beginning in the second quarter of fiscal 2005, the Hardee’s cooperative advertising funds have been reported in the Company’s condensed consolidated statements of operations on a net basis, whereby contributions from franchisees have been recorded as offsets to the Company’s reported advertising expenses. The Company elected to apply FIN 46R prospectively and, upon final adoption thereof, had no cumulative-effect adjustment.

Advertising fund assets, restricted, and advertising fund liabilities as of June 30, 2004, the most recent date through which financial statements are available, are included in the Company’s accompanying condensed consolidated balance sheet as of August 9, 2004, and consisted of the following:

NOTE (3) INTANGIBLE ASSETS

The table below presents identifiable, definite-lived intangible assets as of August 9, 2004, and August 11, 2003:

Amortization expense related to identifiable definite-lived intangible assets was $710 and $1,412 for the twelve and twenty-eight week periods ended August 9, 2004, and $486 and $1,054 for the twelve and twenty-eight week periods ended August 11, 2003, respectively. These intangible assets are amortized over periods of 6-20 years and are included in other assets in the condensed consolidated balance sheets.

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NOTE (4) INDEBTEDNESS AND INTEREST EXPENSE

On June 2, 2004, the Company amended and restated its senior credit facility (“the Facility”) to provide for a $380,000 senior secured credit facility consisting of a $150,000 revolving credit facility and a $230,000 term loan. The revolving credit facility matures on May 1, 2007, and includes an $85,000 letter of credit sub-facility. The principal amount of the term loan is scheduled to be repaid in quarterly installments, with a balloon payment of the remaining principal balance at maturity on July 2, 2008. The Facility also requires term loan prepayments based upon an annual excess cash flow formula, as defined therein. Subject to certain conditions as defined in the Facility, the maturity of the term loan may be extended to May 1, 2010. The Company used a portion of the proceeds from the $230,000 term loan to repay the $10,137 remaining balance of the prior Facility term loan. On July 2, 2004, the Company used additional proceeds from the $230,000 term loan to redeem $200,000 of its 9.125% Senior Subordinated Notes due 2009 (“Senior Notes”) and pay the related optional redemption premium of $9,126 (which was recorded in other income (expense) during the second quarter of fiscal 2005) and accrued interest. The Company also incurred a charge of approximately $3,400 during the second quarter of fiscal 2005 to write-off unamortized loan fees primarily associated with the Senior Notes and the Facility, which was recorded in interest expense in the accompanying condensed consolidated financial statements.

During the quarter ended August 9, 2004, the Company voluntarily prepaid $30,000 of the $230,000 term loan in addition to the $525 regularly scheduled payment. As of August 9, 2004, the Company had cash borrowings outstanding under the term loan portion of the Facility of $199,475, outstanding letters of credit under the revolving portion of the Facility of $64,697 and availability under the revolving portion of the Facility of $85,303. Subsequent to quarter-end, the Company voluntarily prepaid an additional $34,500 of the term loan, reducing the term loan balance to $164,975.

The terms of the Facility include certain restrictive covenants. Among other things, these covenants restrict the Company’s ability to incur debt, incur liens on its assets, make any significant change in its corporate structure or the nature of its business, dispose of assets in the collateral pool securing the Facility, prepay certain debt, engage in a change of control transaction without the member banks’ consents, pay dividends and make investments or acquisitions. The Facility is collateralized by a lien on all of the Company’s personal property assets and by certain restaurant property deeds of trust. As of August 9, 2004, the applicable interest rate on the term loan was LIBOR plus 3.0%, or 4.56% per annum, and the applicable interest rate on the revolving loan portion of the Facility was LIBOR plus 2.75%. The Company also incurs fees on outstanding letters of credit under the Facility at a rate equal to the applicable margin for revolving loans, which is currently 2.75% per annum.

The Facility also required the Company to enter into interest rate protection agreements in an aggregate notional amount of at least $70,000 for a term of at least three years. Pursuant to this requirement, on July 26, 2004, the Company entered into two interest rate cap agreements in an aggregate notional amount of $70,000. Under the terms of each agreement, if LIBOR exceeds 5.375% on the measurement date for any quarterly period, the Company will receive payments equal to the amount LIBOR exceeds 5.375% multiplied by (i) the notional amount of the agreement and (ii) the fraction of a year represented by the quarterly period. The agreements expire on July 28, 2007. The agreements were not designated as cash flow hedges under the terms of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. Accordingly, the change in the fair value of the $371 of interest rate cap premiums will be recognized quarterly in interest expense in the consolidated statement of operations. During the quarter ended August 9, 2004, the Company recorded $49 of interest expense to reduce the carrying value of the interest rate cap premium to its fair value of $322. As a matter of policy, the Company does not use derivative instruments unless there is an underlying exposure.

Subject to the terms of the Facility, the Company may make capital expenditures in the amount of $50,000, plus 80% of the amount of actual EBITDA (as defined) in excess of $110,000 during the current fiscal year and $45,000, plus 80% of the amount of actual EBITDA (as defined) in excess of $110,000 during each subsequent fiscal year. In fiscal 2005 and thereafter, the Company may carry forward any unused capital expenditure amounts to the following year. The Facility also permits the Company to repurchase its common stock in the amount of $27,000 plus a portion of excess cash flow and certain net asset sale proceeds (as defined) during the term of the Facility. The Company did not repurchase any shares of its common stock during the second quarter of fiscal 2005.

The Facility contains financial performance covenants, which include a minimum EBITDA requirement, minimum fixed charge coverage ratio, and maximum leverage ratios and capital expenditures, and precludes the Company

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from paying dividends. The Company was in compliance with all covenants under the Facility as of August 9, 2004.

On September 29, 2003, the Company completed an offering of $105,000 of its 4% Convertible Subordinated Notes due 2023 (“2023 Convertible Notes’), and used nearly all of the net proceeds of the offering to repurchase $100,000 of its then-outstanding 4.25% Convertible Subordinated Notes due 2004 (the “2004 Convertible Notes”). The 2023 Convertible Notes bear interest at 4.0% annually, are payable in semiannual installments due April 1 and October 1 each year, and are unsecured general obligations of the Company, contractually subordinate in right of payment to certain other Company obligations including the Facility. On October 1 of 2008, 2013 and 2018, the holders of the 2023 Convertible Notes have the right to require the Company to repurchase all or a portion of the notes at 100% of the face value plus accrued interest. On October 1, 2008 and thereafter, the Company has the right to call all or a portion of the notes at 100% of the face value plus accrued interest. Under the terms of the 2023 Convertible Notes, such notes become convertible into the Company’s common stock at a conversion rate of 112.4859 shares per $1,000 principal amount of the notes at any time after the Company’s common stock has a closing sale price of at least $9.78 per share, which is 110% of the conversion price per share, for at least 20 days in a period of 30 consecutive trading days ending on the last trading day of the calendar quarter. As a result of the daily closing sales price levels on the Company’s common stock during the second calendar quarter of 2004, the 2023 Convertible Notes became convertible into the Company’s common stock effective July 1, 2004, and will remain convertible throughout the remainder of their term.

Interest expense consisted of the following:

NOTE (5) FACILITY ACTION CHARGES, NET

The following transactions have been recorded in the accompanying condensed consolidated statements of operations as facility action charges, net:

	(i)		impairment of long-lived assets for restaurants the Company closes;
	(ii)		impairment of long-lived assets for restaurants with net asset values in excess of estimated fair values;
	(iii)		restaurant closure costs (primarily reflecting the estimated liability to terminate leases);
	(iv)		gains (losses) on the sale of restaurants and surplus properties; and
	(v)		amortization of discount related to estimated liability for closing restaurants.

Quarterly, the Company evaluates the adequacy of its estimated liability for closing restaurants and subsidizing restaurant lease payments for franchisees, and modifies the assumptions used based on actual results from selling surplus properties and terminating leases. The Company also assesses the carrying value of closed restaurant properties each quarter based on estimated property values obtained from a related party real estate broker. The Company closed two Hardee’s, one Carl’s Jr. and one La Salsa company-operated restaurants during the twelve weeks ended August 9, 2004. The Company closed 32 Hardee’s, one Carl’s Jr. and one La Salsa company-operated restaurants during the twenty-eight weeks ended August 9, 2004. During the twelve weeks ended August 9, 2004, the Company identified four Hardee’s, four Carl’s Jr. and three La Salsa company-operated restaurants that are still in operation, but whose estimated fair values did not support the related net asset values and, accordingly, an impairment charge was recorded. During the twenty-eight weeks ended August 9, 2004, the Company identified ten Hardee’s, seven Carl’s Jr. and six La Salsa company-operated restaurants that are still in operation, but whose

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estimated fair values did not support the related net asset values and, accordingly, an impairment charge was recorded.

The components of facility action charges (gains), net are as follows:

Facility action charges for new decisions regarding closing restaurants during the twenty-eight weeks ended August 9, 2004, include (i) $2,628 of provisions associated with 28 Hardee’s restaurants the Company closed during the first fiscal quarter, for which the Company had made the decision to close during the fourth quarter of fiscal 2004; and (ii) $1,043 recorded during the first fiscal quarter for six lease obligations, for which the Company remained liable, associated with the bankruptcy filing of a Hardee’s franchisee during December 2003.

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The following table summarizes the activity in the estimated liability for closing restaurants:

The following table summarizes trailing 13-period sales per restaurant as of August 9, 2004 and August 11, 2003, and the total fiscal quarter and year-to-date operating income (loss), for the one Carl’s Jr., 32 Hardee’s and one La Salsa restaurants the Company closed during the twenty-eight weeks ending August 9, 2004:

NOTE (6) INCOME (LOSS) PER SHARE

The Company presents “basic” and “diluted” income (loss) per share. Basic income (loss) per share represents net income (loss) divided by weighted-average shares outstanding. Diluted income (loss) per share represents net income (loss) divided by weighted-average shares outstanding, including all potentially dilutive securities and excluding all potentially anti-dilutive securities.

The dilutive effect of stock options and warrants is determined using the “treasury stock” method, whereby exercise is assumed at the beginning of the reporting period and proceeds from such exercise, including tax benefits therefrom, are assumed to be used to purchase the Company’s common stock at the average market price during the period. The dilutive effect of convertible debt is determined using the “if-converted” method, whereby interest charges, net of taxes, applicable to the convertible debt are added back to income and the convertible debt is assumed to have been converted at the beginning of the reporting period, with the resulting common shares being included in weighted-average shares.

The following table presents the number of potentially dilutive shares, in thousands, of the Company’s common stock excluded from the computation of diluted earnings per share because their effect would have been anti-dilutive:

NOTE (7) SEGMENT INFORMATION

The Company is principally engaged in developing, operating and franchising its Carl’s Jr., Hardee’s and La Salsa quick-service restaurants, each of which is considered an operating segment that is managed and evaluated separately. Management evaluates the performance of its segments and allocates resources to them based on several factors, of which the primary financial measure is segment operating income or loss. General and administrative expenses are allocated to each segment based on management’s analysis of the resources applied to each segment. Interest expense related to the Facility, Senior Notes, 2004 Convertible Notes and 2023 Convertible Notes has been allocated to Hardee’s based on the use of funds. Certain amounts that the Company does not believe would be proper to allocate to the operating segments are included in Other (i.e., gains or losses on sales of long-term investments and the operating results of consolidated variable interest entities). The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 1 of notes to

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the condensed consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended January 31, 2004).

NOTE (8) NET ASSETS HELD FOR SALE

In conjunction with the acquisition of Santa Barbara Restaurant Group, Inc. (“SBRG”) in fiscal 2003, the Company made the decision to divest Timber Lodge as the concept does not fit with the Company’s core concepts of quick-service and fast-casual restaurants. The sale of Timber Lodge was completed on September 3, 2004, during the third quarter of fiscal 2005, as discussed below.

Assets held for sale as of August 9, 2004, consisted of the following:

Net assets of Timber Lodge as of August 9, 2004, consisted of the following:

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Total liabilities of Timber Lodge are included in other current liabilities in the accompanying condensed consolidated balance sheets.

The results of Timber Lodge included in the accompanying condensed consolidated statements of operations as discontinued operations for the twelve and twenty-eight week periods ended August 9, 2004, and August 11, 2003, are as follows:

The operating income (loss) for Timber Lodge for the twelve and twenty-eight weeks ended August 9, 2004 and August 11, 2003, include impairment charges of $281, $898, $0 and $1,566, respectively, to reduce the carrying value of Timber Lodge to fair value.

On September 3, 2004, the Company sold Timber Lodge to T-Lodge Acquisition Corp. for $8,816. The Company received $6,954 in cash and accepted two secured notes aggregating approximately $1,862 from the buyer. The two secured notes are comprised of a $1,000 note maturing on January 1, 2008 and bearing interest of 8.0% and an $862 note maturing on September 3, 2005 and bearing interest of 9.0%. T-Lodge Acquisition Corp. is a privately-held corporation whose owners include certain members of the management team of Timber Lodge and other investors.

NOTE (9) COMMITMENTS AND CONTINGENT LIABILITIES

Pursuant to the Facility, a letter of credit sub-facility in the amount of $85,000 was established (see Note 4). Several standby letters of credit are outstanding under this sub-facility, which secure the Company’s potential workers’ compensation obligations and general and health liability obligations. The Company is required to provide letters of credit each year, or set aside a comparable amount of cash or investment securities in a trust account, based on its existing claims experience. As of August 9, 2004, the Company had outstanding letters of credit of $64,697 under the revolving portion of the Facility.

As of August 9, 2004, the Company had recorded an accrued liability for contingencies related to litigation in the amount of $11,755, which includes $9,000 pertaining to the Carl’s Jr. purported class action matter discussed below in this Note 9. Certain of the matters for which the Company maintains an accrued liability for litigation pose risk of loss significantly above the accrued amounts. In addition, as of August 9, 2004, the Company estimated the liability for those losses related to other litigation claims that, in accordance with SFAS No. 5, Accounting for Contingencies, are not accrued, but that the Company believes are reasonably possible to result in an adverse outcome, to be in the range of $535 to $895.

For several years, the Company offered a program whereby it guaranteed the loan obligations of certain franchisees to independent lending institutions. Franchisees have used the proceeds from such loans to acquire certain equipment and pay the costs of remodeling Carl’s Jr. restaurants. In the event a franchisee defaults under the terms of a program loan, the Company is obligated, within 15 days following written demand by the lending institution, to purchase such loan or assume the franchisee’s obligation thereunder by executing an assumption agreement and seeking a replacement franchisee for the franchisee in default. By purchasing such loan, the Company may seek recovery against the defaulting franchisee. As of August 9, 2004, the principal outstanding under program loans guaranteed by the Company totaled approximately $2.0 million, with maturity dates ranging from 2004 through 2009. As of August 9, 2004, the Company had no accrued liability for expected losses under this program and was not aware of any outstanding loans being in default.

The Company also guarantees a $214 obligation of a former subsidiary to a related party lending institution associated with an equipment leasing transaction. The Company maintains an accrual equal to 50% of this obligation based upon its estimated loss under the guarantee.

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As of August 9, 2004, the Company had unconditional purchase obligations in the amount of $58,335, which include contracts for goods and services primarily related to restaurant operations.

In prior years, as part of its refranchising program, the Company sold restaurants to franchisees. In some cases, these restaurants were on leased sites. The Company entered into agreements with these franchisees but remained principally liable for the lease obligations. The Company accounts for the sublease payments received as franchising rental income and the payments on the leases as rental expense in franchising expense. As of August 9, 2004, the present value of the lease obligations under the remaining master leases’ primary terms is $128,548. Franchisees may, from time to time, experience financial hardship and may cease payment on the sublease obligation to the Company. The present value of the exposure to the Company from franchisees characterized as under financial hardship is $22,232.

The Company is, from time to time, the subject of complaints or litigation from customers alleging illness, injury or other food quality, health or operational concerns. Adverse publicity resulting from such allegations may materially adversely affect the Company and its restaurants, regardless of whether such allegations are valid or whether the Company is liable. The Company is also, at times, the subject of complaints or allegations from employees, former employees and franchisees. On October 3, 2001, an action was filed by Adam Huizar and Michael Bolden, individually and on behalf of all others similarly situated, in the Superior Court of the State of California, Los Angeles County, seeking class action status and alleging violations of California wage and hour laws. Similar actions were filed by Mary Jane Amberson and James Bolin, individually and on behalf of others similarly situated, in the Superior Court of the State of California, Los Angeles County, on April 5, 2002 and November 26, 2002, respectively. The complaints allege that salaried restaurant management personnel at the Company’s Carl’s Jr. restaurants in California were improperly classified as exempt from California overtime laws, thereby depriving them of overtime pay. The complaints seek damages in an unspecified amount, injunctive relief, prejudgment interest, costs and attorneys’ fees. During the quarter ended August 9, 2004, the Company announced that it had reached a preliminary agreement to settle these three lawsuits and fully resolve all complaints contained therein, under which the Company will make a cash payment of up to $9,000 to cover claims by eligible class members, plaintiff attorneys’ fees and costs, payments to the named plaintiffs, and costs of a third-party administrator. A charge of $7,000 was recorded in general and administrative expense during the quarter ended August 9, 2004, to increase the accrued liability for this matter to the estimated settlement amount.

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

Introduction and Safe Harbor Disclosure

CKE Restaurants, Inc. and its subsidiaries (collectively referred to as the “Company”) is comprised of the operations of Carl’s Jr., Hardee’s, La Salsa, and Green Burrito, which is primarily operated as a dual-brand concept with Carl’s Jr. quick-service restaurants. The following Management’s Discussion and Analysis should be read in conjunction with the unaudited condensed consolidated financial statements contained herein, and our Annual Report on Form 10-K for the fiscal year ended January 31, 2004. All Note references herein refer to the accompanying Notes to condensed consolidated financial statements.

Matters discussed in this Form 10-Q contain forward-looking statements relating to future plans and developments, financial goals, and operating performance that are based on our current beliefs and assumptions. Such statements are subject to risks and uncertainties. Factors that could cause our results to differ materially from those described include, but are not limited to, whether or not restaurants will be closed and the number of restaurant closures, consumers’ concerns or adverse publicity regarding our products, the effectiveness of operating initiatives and advertising and promotional efforts (particularly at the Hardee’s brand), changes in economic conditions or prevailing interest rates, changes in the price or availability of commodities, availability and cost of energy, workers’ compensation and general liability premiums and claims experience, changes in our suppliers’ ability to provide quality and timely products, delays in opening new restaurants or completing remodels, severe weather conditions, the operational and financial success of our franchisees, our franchisees’ willingness to participate in our strategy, the availability of financing for us and our franchisees, unfavorable outcomes in litigation, changes in accounting policies and practices, new legislation or government regulation (including environmental laws), the availability of suitable locations and terms for the sites designed for development, and other factors as discussed in our filings with the Securities and Exchange Commission.

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Forward-looking statements speak only as of the date they are made. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as required by law or the rules of the New York Stock Exchange.

Adoption of New Accounting Pronouncements

See Note (2) of notes to condensed consolidated financial statements.

Critical Accounting Policies

Our reported results are impacted by the application of certain accounting policies that require us to make subjective or complex judgments. These judgments involve making estimates about the effect of matters that are inherently uncertain and may significantly impact our quarterly or annual results of operations and financial condition. Specific risks associated with these critical accounting policies are described in the following paragraphs.

For all of these policies, we caution that future events rarely develop exactly as expected, and the best estimates routinely require adjustment. Our most significant accounting policies require:

•		estimation of future cash flows used to assess the recoverability of long-lived assets, including goodwill, and establish the estimated liability for closing restaurants and subsidizing lease payments of franchisees;
•		estimation, using actuarially determined methods, of our self-insured claim losses under our workers’ compensation, property and general liability insurance programs;
•		determination of appropriate estimated liabilities for loss contingencies related to litigation;
•		determination of the appropriate allowances associated with franchise and license receivables and estimated liabilities for franchise subleases;
•		determination of the appropriate assumptions to use to estimate the fair value of stock-based compensation for purposes of disclosures of pro forma net income or loss; and
•		estimation of our net deferred income tax asset valuation allowance.

Descriptions of these critical accounting policies follow.

Impairment of Property and Equipment and Other Amortizable Long-Lived Assets Held and Used, Held for Sale or To Be Disposed of Other Than By Sale

Each quarter we evaluate the carrying value of individual restaurants when the operating results have reasonably progressed to a point to adequately evaluate the probability of continuing operating losses or a current expectation that a restaurant will be sold or otherwise disposed of before the end of its previously estimated useful life. In making these judgments, we consider the period of time since the restaurant was opened or remodeled and the trend of operations and expectations for future sales growth. For restaurants selected for review, we estimate the future estimated cash flows from operating the restaurant over its estimated useful life. We make judgments about future same-store sales and the operating expenses and estimated useful life that we would expect with such level of same-store sales. We employ a probability-weighted approach wherein we estimate the restaurant’s remaining useful life and the effectiveness of future sales and marketing efforts on same-store sales. In scenarios where same-store sales are not expected to increase, we generally assume a shorter than previously estimated useful life.

Quarterly, we update our model for estimating future cash flows based upon experience gained, current intentions about refranchising restaurants and closures, expected sales trends, internal plans and other relevant information. As the operations of restaurants opened or remodeled in recent years progress to the point that their profitability and future prospects can adequately be evaluated, additional restaurants will become subject to review and to the possibility that impairments exist.

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CKE RESTAURANTS, INC. AND SUBSIDIARIES

Same-store sales are the key indicator used to estimate future cash flow for evaluating recoverability. To provide a sensitivity analysis of the impairment that could arise were the actual same-store sales of all mature restaurants we own to grow at only the assumed rate of inflation (same-store sales sensitivity), the aggregate additional impairment loss would be approximately $26,967. The inflation rate assumed in making this calculation generally is 2.0% for both revenue and expenses.

Typically, restaurants are operated for three years before we test them for impairment. Also, restaurants typically are not tested for either two or three years following a major remodel (contingent upon the extent of the remodel). We believe this provides the restaurant sufficient time to establish its presence in the market and build a customer base. If we were to test all restaurants for impairment without regard to the amount of time the restaurants were operating, the total asset impairment would increase substantially. Assuming all restaurants were tested under the same assumptions used in the same-store sales sensitivity analysis, and without regard to the length of time open (time open sensitivity), we would be required to record additional impairment losses of approximately $11,944.

The following tables summarize the sensitivity analyses, as classified by restaurants with positive or negative cash flow during the trailing thirteen periods, for both same-store sales sensitivity and time open sensitivity:

Carl’s Jr.

Hardee’s

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CKE RESTAURANTS, INC. AND SUBSIDIARIES

La Salsa