AFC ENTERPRISES INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

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 October 6, 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 000-32369

AFC ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)


Minnesota (State or other jurisdiction of incorporation or organization)		58-2016606 (IRS Employer Identification No.)


Six Concourse Parkway, Suite 1700 Atlanta, Georgia (Address of principal executive offices)		30328-5352 (Zip code)

(770) 391-9500
(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 þ No o

As of November 8, 2002, there were 28,405,000 shares of the registrant’s common stock, par value $.01 per share, outstanding.

TABLE OF CONTENTS


PART 1 — FINANCIAL INFORMATION
Item 1. Financial Statements
	Condensed Consolidated Statements of Operations
	Condensed Consolidated Balance Sheets
	Condensed Consolidated Statements of Cash Flows
	Notes to Condensed Consolidated Financial Statements
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 4. CONTROLS AND PROCEDURES.
PART 2. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
CERTIFICATIONS
Exhibit Index
EX-99.1 SECTION 906 CERTIFICATION OF THE CEO
EX-99.2 SECTION 906 CERTIFICATION OF THE CFO

AFC ENTERPRISES, INC.
INDEX


			Page

PART 1 FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Statements of Operations – For the Twelve and Forty-Week Periods Ended October 7, 2001 and October 6, 2002			3
	Condensed Consolidated Balance Sheets – December 30, 2001 and October 6, 2002			4
	Condensed Consolidated Statements of Cash Flows – For the Forty-Week Periods Ended October 7, 2001 and October 6, 2002			5
	Notes to Condensed Consolidated Financial Statements			6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk			37
Item 4.	Controls and Procedures			38
PART 2 OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K			40
		(a) Exhibits		40
		(b) Current Reports on Form 8-K		40
SIGNATURE				41
CERTIFICATIONS				42
EXHIBIT INDEX				46

PART 1 — FINANCIAL INFORMATION

Item 1. Financial Statements

AFC Enterprises, Inc. and subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
(in thousands, except per share data)


				12 Weeks Ended						40 Weeks Ended

				10/07/01			10/06/02			10/07/01			10/06/02

*Revenues:*
	Restaurant sales			$	115,509		$	89,587		$	394,402		$	325,869
	Franchise revenues				24,914			26,496			78,366			89,787
	Wholesale revenues				14,114			14,575			47,333			49,854
	Other revenues				3,605			4,873			11,106			14,960

		Total revenues			158,142			135,531			531,207			480,470

*Costs and expenses:*
	Restaurant cost of sales				33,659			25,802			115,304			92,201
	Restaurant operating expenses				59,443			46,920			202,247			170,824
	Wholesale cost of sales				7,075			9,847			23,451			27,638
	Wholesale operating expenses				3,901			3,788			12,960			12,660
	General and administrative				24,711			22,885			82,672			81,226
	Depreciation				7,337			7,073			24,732			23,980
	Amortization				2,154			81			7,198			223
	Charges for other restaurant closings, excluding Pine Tree				122			46			516			361
	Charges for Pine Tree restaurant closings				600			—			1,278			—
	Charges for asset write-offs from re-imaging				1,793			515			3,190			1,007
	Charges for other asset write-offs				355			433			1,256			690
	Net gain on sale of assets				(2,874	)		(702	)		(6,054	)		(934	)

		Total costs and expenses			138,276			116,688			468,750			409,876

*Income from continuing operations*					19,866			18,843			62,457			70,594
*Other expenses:*
	Interest, net				4,918			2,175			19,158			11,767

*Net income from continuing operations before income taxes*					14,948			16,668			43,299			58,827
	Income tax expense				5,828			6,025			17,168			22,290

*Net income from continuing operations before the extraordinary loss on early extinguishment of debt and loss from a change in accounting principle*					9,120			10,643			26,131			36,537
*Extraordinary loss on early extinguishment of debt, net of income taxes*					(693	)		—			(1,000	)		(5,897	)
*Loss from the cumulative effect of a change in accounting principle*					—			—			—			(17,387	)

*Net income*			$		8,427		$	10,643		$	25,131		$	13,253

*Basic earnings per common share:*
	Net income attributable to common stock from continuing operations			$	0.30		$	0.35		$	0.89		$	1.19
	Net extraordinary loss on early extinguishment of debt				(0.02	)		—			(0.03	)		(0.19	)
	Loss from the cumulative effect of a change in accounting principle				—			—			—			(0.57	)

	Net income			$	0.28		$	0.35		$	0.86		$	0.43

*Diluted earnings per common share:*
	Net income attributable to common stock from continuing operations			$	0.29		$	0.34		$	0.84		$	1.14
	Net extraordinary loss on early extinguishment of debt				(0.02	)		—			(0.03	)		(0.18	)
	Loss from the cumulative effect of a change in accounting principle				—			—			—			(0.54	)

	Net income			$	0.27		$	0.34		$	0.81		$	0.42

See accompanying notes to condensed consolidated financial statements.

AFC Enterprises, Inc. and subsidiaries
Condensed Consolidated Balance Sheets
(in thousands)


				12/30/01			10/06/02

							(unaudited)
*Assets:*
*Current assets:*
	Cash and cash equivalents			$	12,826		$	10,657
	Accounts and current notes receivable, net of allowance for doubtful accounts of $1,608 in 2001 and $2,036 in 2002				24,611			25,619
	Prepaid income taxes				1,610			—
	Inventories				16,080			15,394
	Deferred income taxes				880			1,196
	Prepaid expenses and other				3,202			3,867

		Total current assets			59,209			56,733

*Long-term assets:*
	Notes receivable, net of allowance for doubtful accounts of $227 in 2001 and $0 in 2002				10,034			8,981
	Deferred income taxes				2,353			—
	Property and equipment, net of accumulated depreciation and amortization of $155,480 in 2001 and $161,784 in 2002				255,123			245,222
	Assets under contractual agreement, net				7,230			7,021
	Other assets				14,013			17,078
	Trademarks, net of accumulated amortization of $51,093 in 2001 and 2002				69,707			69,707
	Goodwill, net of accumulated amortization of $11,846 in 2001 and $10,037 in 2002				101,791			84,404
	Other intangible assets, net of accumulated amortization of $1,970 in 2001 and $2,143 in 2002				3,754			4,702

		Total long-term assets			464,005			437,115

			Total assets	$	523,214		$	493,848

Liabilities and Shareholders’ Equity:
*Current liabilities:*
	Accounts payable			$	28,738		$	23,322
	Bank overdrafts				11,656			9,869
	Current portion of long-term debt and capital lease obligations				21,834			9,533
	Revolving credit facility				1,746			33,266
	Current portion of acquisition line of credit				10,000			—
	Income taxes payable				2,564			2,167
	Accrued expenses and other				19,081			16,907

		Total current liabilities			95,619			95,064

*Long-term liabilities:*
	Long-term debt, net of current portion				174,113			163,518
	Capital lease obligations, net of current portion				1,686			1,652
	Deferred income taxes				—			4,915
	Other liabilities				28,075			28,514

		Total long-term liabilities			203,874			198,599

			Total liabilities		299,493			293,663

*Shareholders’ equity:*
	Common stock				304			288
	Capital in excess of par value				212,587			174,179
	Notes receivable — officers, including accrued interest				(7,631	)		(5,996	)
	Accumulated retained earnings				18,461			31,714

		Total shareholders’ equity			223,721			200,185

			Total liabilities and shareholders’ equity	$	523,214		$	493,848

See accompanying notes to condensed consolidated financial statements.

AFC Enterprises, Inc. and subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(in thousands)


			40 Weeks Ended

			10/07/01			10/06/02

*Cash flows provided by (used in) operating activities:*
Net income			$	25,131		$	13,253

Adjustments to reconcile net income to net cash provided by operating activities:
	Depreciation and amortization			31,930			24,203
	Cumulative effect of change in accounting principle			—			17,387
	Extraordinary loss on early extinguishment of debt			1,657			9,601
	Notes receivable — officers accrued interest			(340	)		(226	)
	Compensation expense from stock options			227			301
	Deferred tax expense (benefit)			(3,619	)		6,953
	Other			2,049			2,657
	Increase in operating assets			(18,073	)		(8,906	)
	Increase (decrease) in operating liabilities			988			(2,519	)

		Total adjustments		14,819			49,451

	Net cash provided by operating activities			39,950			62,704

*Cash flows provided by (used in) investing activities:*
	Proceeds from disposition of property and equipment			20,011			18,142
	Investment in property and equipment			(43,317	)		(33,199	)
	Proceeds from sales of turnkey developments			1,229			2,902
	Investments in turnkey developments			(3,133	)		(2,821	)
	Notes receivable additions			(127	)		(75	)
	Payments received on notes			509			711

	Net cash used in investing activities			(24,828	)		(14,340	)

*Cash flows provided by (used in) financing activities:*
	Principal payments of long-term debt			(27,857	)		(95,876	)
	Proceeds from long-term debt			—			200,000
	(Repayments) under acquisition line of credit			(25,000	)		(10,000	)
	Borrowings under revolving credit facility			8,633			31,520
	Decrease in bank overdrafts, net			(6,663	)		(1,786	)
	Principal payments for lease obligations			(2,764	)		(1,399	)
	Payments on senior subordinated notes			(24,255	)		(133,388	)
	Notes and interest receivable — officers payments			283			2,022
	Issuance of common stock from IPO, net			46,186			(89	)
	Issuance of common stock from option plans and other			5,819			4,260
	Stock repurchases			—			(41,433	)
	Debt issuance costs			—			(4,364	)

	Net cash used in financing activities			(25,618	)		(50,533	)

	Net decrease in cash and cash equivalents			(10,496	)		(2,169	)
	Cash and cash equivalents at beginning of period			23,615			12,826

	Cash and cash equivalents at end of period		$	13,119		$	10,657

*Supplemental Disclosure of Cash Flow Information:*
	Cash interest paid (net of capitalized amounts)		$	15,877		$	12,609
	Cash paid for income taxes, net of refunds			20,362			5,069
*Noncash Investing and Financing Activities:*
	Note payable additions			—			110
	Net (decrease) in property and equipment accruals			(4,555	)		(2,302	)
	Cancellation of treasury shares			131			—
	Retirement of officer’s notes from cancellation of common stock			297			—
	Tax benefit from stock option exercises shares			4,025			5,354
	Net increase in stock repurchases payable			—			6,817
	Notes receivable — other			460			377

See accompanying notes to condensed consolidated financial statements.

AFC Enterprises, Inc. and subsidiaries
Notes to Condensed Consolidated Financial Statements

1. Summary of Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements include the accounts of AFC Enterprises, Inc., a Minnesota corporation, and its wholly-owned subsidiaries, AFC Properties, Inc. and Seattle Coffee Company (“SCC”), both Georgia corporations, Cinnabon International, Inc. (“CII”), a Delaware corporation, and Church’s Texas Holdings, LLC and AFC Holdings of Texas, LLC, both Georgia limited liability companies. All significant intercompany balances and transactions are eliminated in consolidation. The consolidated entity is referred to herein as “AFC” or “the Company.”

Nature of Operations and Basis of Presentation

The Company is primarily a multi-concept quick service restaurant company. The Company operates and franchises quick service restaurants, bakeries and cafes primarily under the trade names Popeyes® Chicken & Biscuits (“Popeyes”), Church’s Chicken™ (“Church’s”), Seattle’s Best Coffee® (“SBC”), Torrefazione Italia® Coffee (“TI”) and Cinnabon® (“Cinnabon”). The Company also operates a wholesale coffee business.

The accompanying condensed consolidated financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q and Article 10 of Regulation S-X issued by the Securities and Exchange Commission. The consolidated balance sheet data presented herein for December 30, 2001 was derived from the Company’s audited consolidated financial statements for the fiscal year then ended. Certain information and footnotes required by generally accepted accounting principles in the United States for complete financial statements are not included. The accompanying condensed consolidated financial statements have not been audited by independent certified public accountants, but in the opinion of management contain all adjustments (which are of a normal recurring nature) necessary for a fair presentation of the Company’s financial condition and results of operations for the interim periods presented. Interim period operating results are not necessarily indicative of the results expected for the full fiscal year. Certain items in the financial statements of the previous year have been reclassified to conform to the 2002 presentation. These reclassifications had no effect on reported results of operations.

Significant Accounting Policies

The accounting and reporting policies practiced by the Company are set forth in Note 1 to the Company’s consolidated financial statements for the fiscal year ended December 30, 2001, which are contained in the Company’s Form 10-K, filed with the Securities and Exchange Commission on February 20, 2002.

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 for all goodwill and other intangible assets recognized in an entity’s statement of financial position at that date, regardless of when those assets were initially recognized. The statement changes the accounting for goodwill and other indefinite life intangible assets from an amortization method to an impairment only approach. Upon the Company’s adoption of SFAS No. 142 on December 31, 2001, amortization of goodwill and certain other intangibles determined by management to have indefinite lives, ceased. In addition, in the first quarter of 2002, the Company recorded a non-cash charge of approximately $17.4 million to reduce the carrying value of the goodwill associated with its coffee segment. This charge was non-operational in nature and is reflected as a cumulative effect of a change in accounting principle in the accompanying condensed consolidated statements of operations (See Note 4).

In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” The Statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt,” and an amendment of that Statement, SFAS No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements.” SFAS No. 145 recognizes that the use of debt extinguishment can be a part of the risk management strategy of a company and hence, the classification of all early extinguishment of debt as an extraordinary item may no longer be appropriate. In addition, the 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. Provisions of this Statement, as they relate to Statement No. 13, are to be effective for transactions occurring after May 15, 2002. Provisions which relate to Statement No. 4 are effective for fiscal years beginning after May 15, 2002. The Company’s adoption of SFAS No. 145, as it relates to SFAS No. 13, did not have a material effect on the Company’s financial position or results of operations. Upon the adoption of SFAS No. 145, as it relates to SFAS No. 4 (which for the Company will be the beginning of fiscal year 2003), the Company will reclassify its extraordinary loss on early extinguishment of debt into net income from continuing operations.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The Statement supercedes Emerging Issues Task Force Issue No. 94-3 (Issue 94-3), “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires the fair value of a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred as opposed to the date of an entity’s commitment to an exit plan as required by Issue 94-3. The provisions of this Statement are effective

for exit or disposal activities initiated after December 31, 2002, with early application encouraged. The Company does not anticipate the adoption of SFAS No. 146 will have a material effect on the Company’s financial position or results of operations.

2. Segment and Geographic Information

The Company operates exclusively in the foodservice and beverage industry. Substantially all revenues result from the sale of menu products at restaurants, bakeries and cafes operated by the Company, franchise royalty and fee income earned from franchised restaurant, bakery and cafe operations and wholesale revenues from the sale of specialty coffee and baked good products. The Company’s reportable segments are based on specific products and services within the foodservice and beverage industry. The Company combines Popeyes and Church’s operations to form its chicken segment. The coffee segment consists of SCC’s operations, which include its wholesale operations. The Company’s bakery segment includes Cinnabon’s operations.

The “corporate” component of operating income includes (i) revenues from interest income from notes receivable and rental revenue from leasing and sub-leasing agreements with third parties, less (ii) corporate general and administrative expenses.

Operating income primarily represents each segment’s earnings before income taxes, interest, depreciation, amortization, gains/losses on asset dispositions and write-downs and compensation expense related to stock option activity.

Revenues:


		12 Weeks Ended				40 Weeks Ended

		10/07/01		10/06/02		10/07/01		10/06/02

		(in thousands)				(in thousands)
Chicken		$	118,950	$	100,668	$	401,029	$	355,955
Coffee			21,019		21,205		69,977		71,531
Bakery			17,295		12,415		57,612		49,732
Corporate			878		1,243		2,589		3,252

	Total Revenues	$	158,142	$	135,531	$	531,207	$	480,470

Operating Income:


		12 Weeks Ended						40 Weeks Ended

		10/07/01			10/06/02			10/07/01			10/06/02

		(in thousands)						(in thousands)
Chicken		$	29,132		$	29,158		$	97,825		$	102,577
Coffee			1,398			(137	)		4,069			3,049
Bakery			2,403			850			5,003			2,957
Corporate			(3,533	)		(3,518	)		(12,097	)		(12,361	)

	Total Operating Income		29,400			26,353			94,800			96,222
Adjustments to reconcile to income from continuing operations:
Depreciation and amortization			(9,491	)		(7,154	)		(31,930	)		(24,203	)
Compensation expense related to stock options			(47	)		(64	)		(227	)		(301	)
Gain (loss) on fixed asset and other write-offs			4			(292	)		(186	)		(1,124	)

	Income from continuing operations	$	19,866		$	18,843		$	62,457		$	70,594

As of October 6, 2002, the material changes to the Company’s total assets by reportable segment from the amounts disclosed in the Company’s consolidated financial statements for the fiscal year ended December 30, 2001 include approximately $8.8 million and $4.6 million in fixed asset dispositions from unit conversions for the chicken and bakery segments, respectively, a $17.4 million write-down of goodwill in the coffee segment due to impairment upon the Company’s adoption of SFAS No. 142, and an increase in corporate cash of approximately $23.5 million from net proceeds of debt refinancing and unit conversions.

3. Basic and Diluted Earnings Per Share

The following represents a reconciliation of the Company’s basic and diluted earnings per share as required by the Financial Accounting Standards Board Statement No. 128 “Earnings per Share”:


		12 Weeks Ended					40 Weeks Ended

		10/07/01			10/06/02		10/07/01			10/06/02

		(in thousands)					(in thousands)
Net income from continuing operations before the extraordinary loss on early extinguishment of debt and loss from a change in accounting principle		$	9,120		$	10,643	$	26,131		$	36,537
	Extraordinary loss on early extinguishment of debt		(693	)		—		(1,000	)		(5,897	)
	Cumulative effect of a change in accounting principle		—			—		—			(17,387	)

Net income		$	8,427		$	10,643	$	25,131		$	13,253


	12 Weeks Ended				40 Weeks Ended

	10/07/01		10/06/02		10/07/01		10/06/02

	(in thousands)				(in thousands)
Denominator for basic earnings per share – weighted average shares		30,207		30,402		29,254		30,656
Effect of dilutive securities – employee stock options		1,710		1,277		1,837		1,550

Denominator for diluted earnings per share – weighted average shares adjusted for dilutive securities		31,917		31,679		31,091		32,206

4. Goodwill and Other Intangible Assets

SFAS No. 142 requires the disclosure of what reported income and per-share amounts before extraordinary items and net income would have been had the requirements of SFAS No. 142 been in effect during the earlier periods. The following represents the adjusted values:


		12 Weeks		40 Weeks
		Ended		Ended
		10/07/01		10/07/01

		(in thousands)
Net income, as reported		$	8,427	$	25,131
Add back amortization, net of applicable taxes, for:
	Trademarks		815		2,682
	Goodwill		434		1,434
	Other unamortized intangibles		39		133

Net income, as adjusted		$	9,715	$	29,380


		12 Weeks		40 Weeks
		Ended		Ended
		10/07/01		10/07/01

Basic earnings per common share:
Net income, as reported		$	0.28	$	0.86
Add back amortization, net of applicable taxes, for:
	Trademarks		0.03		0.09
	Goodwill		0.01		0.05
	Other unamortized intangibles		—		—

Basic earnings per common share, as adjusted		$	0.32	$	1.00


		12 Weeks		40 Weeks
		Ended		Ended
		10/07/01		10/07/01

Diluted earnings per common share:
Net income, as reported		$	0.27	$	0.81
Add back amortization, net of applicable taxes, for:
	Trademarks		0.02		0.09
	Goodwill		0.01		0.04
	Other unamortized intangibles		—		—

Diluted earnings per common share, as adjusted		$	0.30	$	0.94

The change in the carrying amount of goodwill, which occurred during the first quarter of 2002, is as follows (in thousands):


Balance as of December 30, 2001	$	101,791
Transition impairment adjustment		(17,387	)

Balance as of October 6, 2002	$	84,404

Indefinite-lived intangible assets as of October 6, 2002 totaled $72.0 million and consist primarily of the Company’s trademarks. Amortizable intangible assets as of October 6, 2002 totaled $2.4 million, net of accumulated amortization of $1.1 million, and consist primarily of the Company’s franchise business values. Amortization expense for the twelve and forty-week periods ended October 6, 2002, was approximately $81,000 and $223,000, respectively.

5. Early Extinguishment of Debt

During the twelve and forty-week periods ended October 7, 2001, the Company repurchased $16.1 million and $23.1 million, respectively, of Senior Subordinated Notes. The 2001 repurchases were at a premium. The Company funded the 2001 repurchases using proceeds from the sale of company-operated units to franchisees, cash from operations and proceeds from the Company’s bank credit facility. During the twelve and forty-week periods ended October 7, 2001, the Company wrote-off unamortized debt cost of $0.3 million and $0.5 million, respectively, in connection with the retirement of the

Senior Subordinated Notes. During the forty-week period ended October 6, 2002, the Company redeemed $126.9 million of Senior Subordinated Notes that remained outstanding at a premium. The 2002 redemptions were funded through the proceeds received from a new bank credit facility (See Note 6). During the forty-week period ended October 6, 2002, the Company wrote-off unamortized debt cost of $2.5 million in connection with the retirement of the Senior Subordinated Notes.

Also during the second quarter of 2002, the Company prepaid $58.6 million under Tranche A and Tranche B term loans under the 1997 Credit Facility. The 2002 prepayments were funded through the proceeds received from the Company’s new bank credit facility (See Note 6). In conjunction with the prepayment, which retired the debt, the Company wrote-off $0.6 million of unamortized debt cost.


	12 Weeks Ended					40 Weeks Ended

	10/07/01			10/06/02		10/07/01			10/06/02

	(in thousands)					(in thousands)
Unamortized debt cost	$	(350	)	$	—	$	(517	)	$	(3,098	)
Premium		(795	)		—		(1,140	)		(6,503	)

Extraordinary loss, before income tax effect		(1,145	)		—		(1,657	)		(9,601	)
Income tax benefit (expense)		452			—		657			3,704

Extraordinary loss, net of income tax effect	$	(693	)			$	(1,000	)	$	(5,897	)

6. Long-Term Debt

On May 23, 2002, the Company entered into a new bank credit facility with J.P. Morgan Chase and Credit Suisse First Boston, and certain other lenders, which consisted of a $75.0 million revolving credit facility, a $75.0 million, five-year Tranche A term loan and a $125.0 million, seven-year Tranche B term loan. Under the terms of the bank credit facility, the Company may also obtain letters of credit.

The revolving credit facility is due in full without installments on May 23, 2007. The outstanding balances of the Tranche A term loan and the Tranche B term loan are due in installments through May 23, 2007 and May 23, 2009, respectively. The Tranche A term loan, the Tranche B term loan and the revolving credit facility bear interest at LIBOR plus an applicable margin based on certain financial leverage ratios which may fluctuate because of changes in these ratios. The margins are currently 2.00% for the revolving credit facility and the Tranche A term loan and 2.25% for the Tranche B term loan. The Company will pay each quarter a facility commitment fee on the undrawn amounts of the Tranche A term loan and the revolving credit facility of 0.5% annually.

At closing, the Company drew the entire $125.0 million Tranche B term loan to refinance its existing bank debt of approximately $62.6 million and invested the excess in certain highly rated short-term investments, in accordance with the new bank credit

facility. In connection with the refinancing of the Company’s existing bank debt, the Company recorded an extraordinary loss on the early extinguishment of debt of approximately $0.6 million, pre-tax, related to a non-cash write-off of unamortized debt issuance costs remaining from its existing bank debt. On June 27, 2002, the Company drew the entire $75.0 million Tranche A term loan and used the proceeds, along with the excess from the Tranche B term loan, to redeem its 10.25% senior subordinated notes, due May 15, 2007 at a price of 105.125. In connection with the redemption, the Company recorded an extraordinary loss on the early extinguishment of debt of approximately $9.0 million, pre-tax, comprised of an estimated $6.5 million cash premium and a non-cash write-off of related unamortized debt issuance costs approximating $2.5 million.

On August 9, 2002, the Company made an optional prepayment of $25.0 million on its Tranche B term loan using cash from operations.

The bank credit facility contains certain financial and other covenants, including covenants requiring the Company to maintain various financial ratios, limiting its ability to incur additional indebtedness, restricting the amount of capital expenditures that may be incurred, and limiting the amount of debt which can be loaned to the Company’s franchisees or guaranteed on their behalf. The bank credit facility also limits the Company’s ability to engage in mergers or acquisitions, sell certain assets, repurchase its stock and enter into certain lease transactions. As of the date of this filing, the Company is in compliance with all required covenants. The bank credit facility is secured by a first priority security interest in substantially all of the Company’s assets. The Company’s subsidiaries are required to guarantee its obligations under the bank credit facility.

In connection with the refinancing, the Company incurred approximately $4.4 million in capitalizable debt issuance costs, which are being amortized over the terms of the new bank credit facility.

7. Shareholders’ Equity

Employee Stock Purchase Program

On February 14, 2002 the Company’s board of directors approved an employee stock purchase plan, the first offering of which was on July 15, 2002. Currently 750,000 shares are available for issuance under the plan. The plan allows eligible employees the opportunity to purchase stock of the Company at a discount during an offering period. Each approximate twelve month offering period consists of two purchase periods of approximately six months duration wherein the stock purchase price under the plan on the last day of each purchase period is the lesser of 85% of the fair market value of a share of common stock of the Company on the first day of the offering period or 85% of such fair market value on the last day of the purchase period. As of October 6, 2002, employees have contributed approximately $0.2 million under this program.

Share Repurchase Program

On July 22, 2002, the Company’s board of directors approved a share repurchase program of up to $50.0 million, effective as of such date. The program, which is open-ended, allows the Company to repurchase shares of the Company’s common stock on the open market from time to time. As of October 6, 2002, the Company had repurchased 2,278,900 shares of common stock for $48.2 million under this program.

On October 7, 2002, the Company’s board of directors approved a $50.0 million increase to the share repurchase program. As of November 8, 2002, the Company had repurchased an additional 441,510 shares of common stock for $8.6 million.

8. Outsourcing Arrangement

Effective September 3, 2002, we entered into an agreement with Deloitte & Touche, LLP (“D&T”) under which D&T will provide certain of our accounting and tax functions. The primary functions to be performed by D&T include transaction processing in the following areas: sales, payroll, accounts receivable, accounts payable, fixed assets, sales and property taxes and internal financial reporting. The services performed by D&T are essentially those services formerly performed by our San Antonio Management Services Center. Virtually all of our former employees in the San Antonio Management Services Center transitioned to employment positions with D&T. In addition, D&T leases our former services center site in San Antonio.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of the federal securities laws. Statements regarding future events and developments and our future performance, as well as management’s expectations, beliefs, plans, estimates or projections relating to the future, are forward-looking statements within the meaning of these laws. These forward-looking statements are subject to a number of risks and uncertainties. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are the cost and availability of our principal food products, labor shortages or increased labor costs, our ability to franchise new units and expand our brands, both our and our franchisees’ ability to successfully operate existing units and open new units, changes in consumer preferences and demographic trends, competition, general economic, political and regulatory conditions and the other risk factors detailed in our Annual Report on Form 10-K for the year ended December 30, 2001 and other documents we file with the Securities and Exchange Commission. You should not place undue reliance on any forward-looking statements, since those statements speak only as of the date they are made.

General

We operate, develop and franchise quick service restaurants, bakeries and cafes, or QSRs, primarily under the trade names Popeyes Chicken & Biscuits, Church’s Chicken, Cinnabon, Seattle’s Best Coffee and Torrefazione Italia. As of October 6, 2002, we operated and franchised 3,970 restaurants, bakeries and cafes in 47 states, the District of Columbia, Puerto Rico and 30 foreign countries. We also sell our premium specialty coffees through wholesale and retail distribution channels under our Seattle’s Best Coffee and Torrefazione Italia Coffee brands.

Consolidated Results of Operations

The following table presents selected revenues and expenses as a percentage of total revenues for our consolidated statements of operations for the twelve and forty-week periods ended October 7, 2001 and October 6, 2002.


			12 Weeks Ended						40 Weeks Ended

			Oct. 7,			Oct. 6,			Oct. 7,			Oct. 6,
			2001			2002			2001			2002

Revenues:
	Restaurant sales			73.0	%		66.1	%		74.2	%		67.8	%
	Franchise revenues			15.8			19.5			14.8			18.7
	Wholesale revenues			8.9			10.8			8.9			10.4
	Other revenues			2.3			3.6			2.1			3.1
		Total revenues		100.0	%		100.0	%		100.0	%		100.0	%
Costs and expenses:
	Restaurant cost of sales (1)			29.1	%		28.8	%		29.2	%		28.3	%
	Restaurant operating expenses (1)			51.5			52.4			51.3			52.4
	Wholesale cost of sales (2)			50.1			67.6			49.5			55.4
	Wholesale operating costs (2)			27.6			26.0			27.4			25.4
	General and administrative			15.6			16.9			15.6			16.9
	Depreciation and amortization			6.0			5.3			6.0			5.0
	Charges for other restaurant closings, excluding Pine Tree			0.1			—			0.1			0.1
	Charges for Pine Tree restaurant closings			0.4			—			0.1			—
	Charges for asset write-offs from re-imaging			1.1			0.4			0.6			0.2
	Charges for other asset write-offs			0.2			0.3			0.2			0.1
	Net (gain) on sale of assets			(1.8	)		(0.5	)		(1.1	)		(0.2	)
		Total costs and expenses		87.4			86.1			88.2			85.3
Income from operations				12.6			13.9			11.8			14.7
Interest expense, net				3.1			1.6			3.6			2.4
Net income from continuing operations before taxes				9.5			12.3			8.2			12.3
Income tax expense				(3.7	)		(4.4	)		(3.2	)		(4.6	)
Net income from continuing operations				5.8			7.9			5.0			7.7
Extraordinary loss on early extinguishment of debt, net (3)				(0.5	)		—			(0.2	)		(1.2	)
Loss from the cumulative effect of a change in accounting principle (4)				—			—			—			(3.6	)
Net income				5.3	%		7.9	%		4.8	%		2.9	%

(1)		Expressed as a percentage of restaurant sales by company-operated restaurants, bakeries and cafes.

(2)		Expressed as a percentage of wholesale revenues.

(3)		Represents impact of the repurchase of our senior subordinated notes in 2002 and 2001 and refinancing of our bank credit facility in 2002.

(4)		Represents impact of our adoption of SFAS No. 142 and related impairment of Seattle Coffee Company’s goodwill.

Selected Financial Data

The following table sets forth certain financial information and other restaurant, bakery and cafe data relating to company-operated and franchised restaurants, bakeries and cafes (as reported to us by franchisees) for the twelve and forty-week periods ended October 7, 2001 and October 6, 2002:


			12 Weeks Ended									40 Weeks Ended

			Oct. 7,			Oct. 6,			% change			Oct. 7,			Oct. 6,			% change
			2001			2002			01-02			2001			2002			01-02

Company Data:					(dollars in millions)
Operating EBITDA, as defined (1)			$	29.4		$	26.4			(10.4	)%	$	94.8		$	96.2			1.5	%
Operating EBITDA margin				18.6	%		19.4	%	0.8 pts				17.8	%		20.0	%	2.2 pts.
Cash capital expenditures			$	13.6		$	9.6			(29.4	)%	$	43.3		$	33.2			(23.3	)%
System-wide restaurant, bakery and cafe data (unaudited):
System-wide sales:
	Popeyes		$	318.3		$	335.0			5.2	%	$	1,014.7		$	1,097.8			8.2	%
	Church’s			211.9			202.8			(4.3	)		694.2			695.9			0.2
	Cinnabon retail			47.1			48.1			2.1			150.2			158.1			5.3
	Cinnabon wholesale			0.0			0.6			n/a			0.0			1.4			n/a
	Seattle Coffee retail			15.6			19.1			22.4			47.6			59.5			25.0
	Seattle Coffee wholesale			14.1			14.0			2.2			47.4			48.5			2.3

		Total	$	607.0		$	619.6			2.1		$	1,954.1		$	2,061.2			5.5	%

System-wide unit openings:
	Popeyes			47			43			(8.5	)%		125			125			0.0	%
	Church’s			9			22			144.4			52			62			19.2
	Cinnabon			30			26			(13.3	)		78			67			(14.1	)
	Seattle Coffee retail			9			13			44.4			33			47			42.4

		Total		95			104			9.5	%		288			301			4.5	%

System-wide units open, end of period:
	Popeyes												1,578			1,672			6.0	%
	Church’s												1,506			1,481			(1.7	)
	Cinnabon												505			600			18.8
	Seattle Coffee retail												161			217			34.8

		Total											3,750			3,970			5.9	%

System-wide percentage change in comparable unit sales:
	Popeyes domestic			5.5	%		(1.8	)%					4.0	%		1.4	%
	Church’s domestic			4.2			(3.6	)					1.9			(0.6	)
	Cinnabon domestic			(3.9	)		(6.6	)					1.3			(5.0	)
	Seattle Coffee domestic			(2.8	)		(1.4	)					(0.4	)		(2.4	)
	Popeyes international			(8.4	)		(6.9	)					(7.6	)		(5.3	)
	Church’s international			2.4			(3.5	)					(0.6	)		(0.6	)
	Cinnabon international			(27.9	)		(18.6	)					(19.5	)		(26.4	)
	Seattle Coffee international			(2.6	)		(8.2	)					2.6			(2.3	)

(1)

Operating EBITDA is defined as income from operations plus depreciation and amortization, adjusted for items related to gains/losses on asset dispositions and write-downs and compensation expense related to stock option activity. Operating

EBITDA is not a measure of performance under generally accepted accounting principles, and should not be considered as a substitute for net income, cash flows from operating activities and other cash flow statement data prepared in accordance with generally accepted accounting principles, or as a measure of profitability or liquidity. We have included information concerning Operating EBITDA as one measure of our cash flow and historical ability to service debt. We believe investors find this information useful. Operating EBITDA, as defined, may not be comparable to similarly titled measures reported by other companies.

Comparable Sales

Domestic system-wide comparable sales at Popeyes and Church’s decreased in the third quarter of 2002. The decrease was due to increased competition within the quick service restaurant sector, the impact of a slowing economic environment and strong prior year comparable store sales. Cinnabon and Seattle Coffee domestic system-wide comparable sales decreased in the third quarter of 2002 primarily due to lower traffic at captive venues such as malls, travel plazas and airports as well as the slowing economy.

International system-wide comparable sales at Popeyes decreased in the third quarter of 2002 primarily due to a decline in sales in Korea and the Middle East. Church’s international system-wide comparable sales decrease in the third quarter of 2002 was mainly due to a decrease in sales in Puerto Rico and Indonesia. Cinnabon’s international system-wide comparable sales decrease in the third quarter of 2002 was primarily due to a decrease in sales in Japan, Saudi Arabia and the Philippines. Seattle Coffee international system-wide comparable sales decreased in the third quarter of 2002 primarily due to a decrease in sales in Japan and the Philippines.

Operating Results

System-Wide Sales

System-wide sales include sales from all restaurants, bakeries and cafes, whether operated by us or our franchisees, and from coffee and bakery wholesale operations. Sales of unconsolidated franchised restaurants, bakeries and cafes result in franchise royalties for us but are not included in our restaurant sales figure we present in our condensed consolidated statements of operations. However, we believe that system-wide sales is useful to investors as a significant indicator of our concepts’ market share and the overall strength of our business as it incorporates all of our revenue drivers, company-operated and franchised unit comparable unit sales as well as net unit development.

Revenues

Our revenues consist primarily of four elements:

• restaurant sales at our company-operated restaurants, bakeries and cafes;

• revenues from franchising;

• revenues from wholesale operations; and

• other revenues.

Restaurant Sales. Our restaurant sales consist of gross cash register receipts at our company-operated restaurants, bakeries and cafes, net of sales tax.

Revenues from Franchising. We earn franchise revenues through franchise agreements, domestic development agreements and international development agreements. Our standard franchise agreement provides for the payment of a royalty fee based on the net restaurant sales of franchisees. We record royalties as revenues when sales occur at franchised units. In addition, we record development fees under domestic and international development agreements, and fees for the purchase of a franchise, as deferred revenues when received. We recognize these fees as revenue when the restaurants, bakeries and cafes for which these fees were paid are opened and all material services or conditions relating to the fees have been substantially performed or satisfied by us.

Revenues from Wholesale Operations. Our revenues from wholesale operations consist primarily of sales of premium specialty coffee and baked goods to our franchisees, foodservice retailers, office and institutional users, supermarkets and others. In 2002, our bakery segment began selling pre-packaged cinnamon rolls to a major retailer for resale. We have included the revenues from this arrangement as wholesale revenues.

Other Revenues. Our other revenues consist of rental revenue from properties owned or leased by us that we lease or sublease to franchisees and third parties, and interest income earned on notes receivable primarily from franchisees and third parties.

Operating Costs and Expenses

Restaurant Cost of Sales. Our restaurant cost of sales consists primarily of food, beverage and food ingredients costs, and also includes the cost of napkins, cups, straws, plates, take-out bags and boxes. The primary element affecting our chicken restaurant cost of sales is chicken prices. The primary elements affecting our bakery and cafe costs of sales are flour and Indonesian cinnamon, and green coffee beans. Other factors such as sales volume, our menu pricing, product mix and promotional activities can also materially affect the level of our restaurant cost of sales.

Restaurant Operating Expenses. Restaurant operating expenses consist of personnel expenses, occupancy expenses, marketing expenses and other operating expenses incurred at the restaurant level.

Wholesale Cost of Sales. Our wholesale cost of sales consists primarily of the cost of green coffee beans, as well as the costs to roast, blend, warehouse and distribute our specialty coffee blends. In 2002, our bakery segment began selling pre-packaged cinnamon rolls to a major retailer for resale. We have included the cost to prepare and package the cinnamon rolls in wholesale cost of sales.

Wholesale Operating Expenses. Our wholesale operating expenses consist of personnel expenses, occupancy expenses and other operating expenses incurred in

connection with our wholesale coffee operations. In 2002, our bakery segment began selling pre-packaged cinnamon rolls to a major retailer for resale. We have included the operating expenses related to these sales in wholesale operating expenses.

General and Administrative Expenses

Our general and administrative expenses consist of personnel expenses, occupancy expenses and other expenses incurred at the corporate level. Corporate level expenses are primarily incurred at our offices in Atlanta, Georgia and Seattle, Washington. Additional expenses include those incurred by field personnel located throughout the United States.

Depreciation

Depreciation consists primarily of the depreciation of buildings, equipment and leasehold improvements.

Amortization

Amortization in 2001 consists of amortization of goodwill and other intangible assets resulting from our emergence from bankruptcy in 1992, acquisitions and other transactions. In conjunction with our adoption of SFAS No. 142 in 2002, amortization in 2002 consists of other intangible assets deemed to have finite useful lives.

Charges for Restaurant Closings

Charges for restaurant closings, including charges for Pine Tree restaurant closings, include the write-down of restaurant, bakery and cafe assets to net realizable value, provisions related to future rent obligations for closed properties, and write-offs of intangible assets identified with the properties.

Charges for Asset Write-Offs from Re-imaging

Charges for asset write-offs from re-imaging include the write-off of restaurant, bakery and cafe assets replaced by assets as part of our re-imaging program.

Charges for Other Asset Write-Offs

Charges for other asset write-offs include the write-off of restaurant, bakery and cafe equipment assets replaced due to normal wear and corporate related asset write-offs.

Net Gain on Sale of Assets

Net gain on sale of assets includes the gain net of the write-off of restaurant, bakery and cafe assets, and related intangible assets and the liabilities incurred by us in connection with the sale of company-operated units to franchisees.

Comparisons of the Twelve Weeks Ended October 6, 2002 and October 7, 2001

System-Wide Sales

System-wide sales increased by $12.6 million, or 2.1%, to $619.6 million in the third quarter of 2002 from $607.0 million in the comparable period in 2001. Our system-wide sales increase was due primarily to new franchise unit growth and coffee wholesale revenue growth. The overall increase was partially offset by comparable sales decreases in all of our segments. In the third quarter of 2002, we and our franchisees opened 42 restaurants, bakeries and cafes domestically, and 62 restaurants, bakeries and cafes in international markets. As of October 6, 2002, there were 3,970 system-wide units open, compared to 3,750 as of October 7, 2001.

Company-Operated Unit Sales

Chicken. Company-operated chicken restaurant sales decreased by $20.2 million, or 21.2%, to $74.7 million in the third quarter of 2002 from $94.9 million in the comparable period in 2001. The decrease was primarily due to a net reduction of 108 company-operated restaurants during the time period from October 8, 2001 to October 6, 2002 and a decrease in company-operated unit comparable sales of 2.3%. In the fourth quarter of 2001 and during the forty-week period ended October 6, 2002, we sold a total of 49 and 62 company-operated chicken restaurants to franchisees, respectively. As of October 6, 2002, we had 430 company-operated chicken restaurants open, compared to 538 as of October 7, 2001.

Bakery. Company-operated bakery sales decreased by $5.8 million, or 40.6%, to $8.5 million in the third quarter of 2002 from $14.3 million in the comparable period in 2001. The decrease was due primarily to a net reduction of 70 company-operated bakeries during the time period from October 8, 2001 to October 6, 2002 and a decrease in company-operated unit comparable sales of 4.9%. In the fourth quarter of 2001, we sold 14 company-operated bakeries to franchisees. We sold an additional 9 company-operated bakeries to a franchisee in the third quarter of 2002. As of October 6, 2002, we had 93 company-operated bakeries open, compared to 163 as of October 7, 2001.

Cafe. Company-operated cafe sales were $6.4 million in the third quarter of 2002 and 2001. Comparable sales decreased by 5.8% in the third quarter of 2002. As of October 6, 2002, we had 76 company-operated cafes open, compared to 71 as of October 7, 2001.

Wholesale Sales

Coffee. Wholesale coffee sales decreased by $0.2 million, or 1.3%, to $13.9 million in the third quarter of 2002 from $14.1 million in the comparable period in 2001. The decrease was primarily due to higher sales discounts and price reductions given to wholesale customers in the third quarter of 2002 compared to the comparable period in 2001. As of October 6, 2002, we had 6,008 wholesale accounts with 12,041 points of distribution.

Bakery. Wholesale bakery sales were $0.6 million in the third quarter of 2002. We began selling pre-packaged cinnamon rolls to a major retailer in fiscal year 2002.

Franchise Royalties and Fees

Chicken. Chicken franchise royalty revenues increased by $1.3 million, or 6.8%, to $21.2 million in the third quarter of 2002 from $19.9 million in the comparable period in 2001. The increase was due to new unit growth, partially offset by a decrease in domestic and international franchise comparable sales. As of October 6, 2002, we had 2,723 domestic and international franchised chicken restaurants open, compared to 2,546 as of October 7, 2001. Chicken franchise fee revenues decreased by $0.1 million, or 7.5%, to $1.5 million in the third quarter of 2002 from $1.6 million in the comparable period in 2001. The decrease was mainly due to zero conversions of company-operated units to franchisees in the third quarter of 2002 compared to 13 conversions in the comparable period in 2001. We opened 24 domestic franchised chicken restaurants in the third quarter of 2002, compared to 32 in the comparable period in 2001, and 39 international franchised chicken restaurants in the third quarter of 2002, compared to 23 in the comparable period in 2001.

Bakery. Bakery franchise royalty revenues increased by $0.3 million, or 20.4%, to $1.9 million in the third quarter of 2002 from $1.6 million in the comparable period in 2001. The increase was due primarily to new unit growth, offset by a decrease in domestic and international franchise comparable sales. As of October 6, 2002, we had 507 domestic and international franchised bakeries open, compared to 342 as of October 7, 2001. Bakery franchise fee revenues decreased by $0.1 million, or 13.7%, to $1.0 million in the third quarter of 2002 from $1.1 million in the comparable period in 2001. The decrease was mainly due to a higher number of franchised bakery openings in the third quarter of 2001 compared to the third quarter of 2002. We opened nine domestic franchised bakeries in the third quarter of 2002, compared to 12 in the comparable period in 2001, and 15 international franchised bakeries in the third quarter of 2002, compared to 16 in the comparable period in 2001.

Cafe. Cafe royalty revenues increased by $0.2 million, or 56.3%, to $0.5 million in the third quarter of 2002 from $0.3 million in the comparable period in 2001. The increase was primarily due to new unit growth, partially offset by a decrease in domestic and international franchise comparable sales. As of October 6, 2002, we had 141 franchised cafes open, compared to 90 as of October 7, 2001. Cafe franchise fee revenues increased by $0.2 million, or 105.1%, to $0.4 million in the third quarter of 2002 from $0.2 million in the comparable period in 2001. The increase was due primarily to the opening of 13 domestic and international franchised cafes in the third quarter of 2002

compared to seven openings in the comparable period in 2001.

Other Revenues

Other revenues increased by $1.3 million, or 35.2%, to $4.9 million in the third quarter of 2002 from $3.6 million in the comparable period in 2001. The increase in other revenues was primarily due to an increase in rental revenues from additional leased properties. Our conversion of company-operated units to franchised units from October 8, 2001 and October 6, 2002 resulted in additional properties that we leased to franchisees.

Company-Operated Operating Profit

Chicken. Company-operated chicken restaurant operating profit decreased by $3.4 million, or 17.6%, to $15.9 million in the third quarter of 2002 from $19.3 million in the comparable period in 2001. The decrease was due primarily to a company-operated net unit decrease of 108 units from the time period from October 8, 2001 to October 6, 2002. Company-operated chicken restaurant operating profit as a percentage of company-operated chicken restaurant sales was 21.2% in the third quarter of 2002, compared to 20.3% in the comparable period in 2001. The 0.9 percentage point increase in operating profit margin was due primarily to lower personnel expenses as a percentage of restaurant sales.

Bakery. Company-operated bakery operating profit decreased by $1.7 million, or 72.4%, to $0.7 million in the third quarter of 2002 from $2.4 million in the comparable period in 2001. The decrease was due primarily to a company-operated net unit decrease of 70 units from the time period from October 8, 2001 to October 6, 2002. Company-operated bakery operating profit as a percentage of company-operated bakery sales was 7.9% in the third quarter of 2002, compared to 17.1% in the comparable period in 2001. The 9.2 percentage point decrease in the operating profit margin was mainly due to a decrease in comparable sales and higher rent, wages and marketing expenses as a percentage of bakery sales.

Cafe. Company-operated cafe operating profit decreased by $0.4 million, or 54.4%, to $0.3 million in the third quarter of 2002 from $0.7 million in the comparable period in 2001. The decrease was primarily due to increased personnel costs and rent expense compared to the same period in the prior year and a decrease of 7.4% in comparable sales. Company-operated cafe operating profit as a percentage of company-operated cafe sales was 5.0% in the third quarter of 2002, compared to 11.1% in the comparable period in 2001. The 6.1 percentage point decrease in the operating profit margin was primarily due to higher personnel costs, rent expense and a decrease in comparable sales.

Wholesale Operating Profit

Coffee. Wholesale coffee operating profit decreased by $2.5 million, or 80.3%, to $0.7 million in the third quarter of 2002 from $3.2 million in the comparable period in 2001. The decrease was primarily due to a $2.0 million (pre-tax) write down of inventory to net realizable value. The write down was due to a correction of errors made in prior periods relating to inventory costing changes, inventory obsolescence issues, package design changes, and a non-integrated inventory accounting system. Wholesale coffee operating profit as a percentage of wholesale coffee sales was 4.5% in the third quarter of 2002, compared to 22.3% in the comparable period in 2001. The 17.8 percentage point decrease in operating profit margin was primarily due to the inventory write down in the third quarter of 2002. Excluding the inventory write down, the coffee operating profit as a percentage of wholesale coffee sales was 19.5% in the third quarter of 2002, compared to 22.3% in the comparable period in 2001.

Bakery. Wholesale bakery operating profit was $0.3 million in the third quarter of 2002. We began selling pre-packaged cinnamon rolls to a major retailer in fiscal year 2002.

General and Administrative Expenses. General and administrative expenses decreased by $1.8 million, or 7.4%, to $22.9 million in the third quarter of 2002 from $24.7 million in the comparable period in 2001. The decrease was primarily due to a reduction in expense at our chicken segment due to conversions of company-operated chicken restaurants to franchised restaurants that have resulted in reduced overhead expenses associated with supporting company-operated units. General and administrative expenses as a percentage of total revenues were 16.8% in the third quarter of 2002, compared to 15.6% in the comparable period in 2001.

Depreciation. Depreciation decreased by $0.3 million, or 3.6%, to $7.0 million in the third quarter of 2002 from $7.3 million in the comparable period in 2001. The decrease was mainly due to the conversion of company-operated units to franchised units in the fourth quarter of 2001 and the forty-week period ended October 6, 2002, partially offset by capital additions during the time period from October 8, 2001 to October 6, 2002. Depreciation as a percentage of total revenues was 5.1% in the third quarter of 2002, compared to 4.6% in the comparable period in 2001.

Amortization. Amortization decreased by $2.1 million to $0.1 million in the third quarter of 2002. The decrease was due to our adoption of SFAS No. 142 in the first quarter of 2002, resulting in the discontinuance of amortization expense on goodwill and our other intangible assets having indefinite lives, which were primarily trademarks.

Charges for Other Restaurant Closings, Excluding Pine Tree. In the third quarter of 2002, we wrote off $46,000 related to previous unit closings. The $0.1 million charge in the third quarter of 2001 related primarily to the closing of seven Cinnabon bakeries.

Charges for Pine Tree Restaurant Closings. There were no Pine Tree closings in the third quarter of 2002. Charges for Pine Tree restaurant closings of $0.6 million in the third quarter of 2001 consisted of additional lease costs for previously closed Pine Tree locations.

Charges for Asset Write-Offs from Re-imaging. The $0.5 million charge in the third quarter of 2002 resulted from the replacement of fixed assets at restaurants, bakeries and cafes that were re-imaged, which were mainly Church’s and Popeyes units. The $1.8 million charge in the third quarter of 2001 resulted from the replacement of fixed assets at restaurants, bakeries and cafes that were re-imaged. These re-images primarily involved Church’s and Cinnabon units.

Charges for Other Asset Write-Offs. The charges for other asset write-offs of $0.3 million in the third quarter of 2002 resulted from the write-off of equipment at our Church’s company-operated units and the accrual of the estimated remaining lease obligation and impairment of certain leasehold improvements at Seattle Coffee’s former headquarters in Seattle. The charges for other asset write-offs of $0.4 million in the third quarter of 2001 resulted from the write-off of equipment at our company-operated chicken restaurants, as well as corporate asset write-offs.

Net Gain on Sale of Fixed Assets. The net gain on sale of fixed assets of $0.7 million in the third quarter of 2002 was primarily due to the gains on the sale of nine Cinnabon company-operated bakeries to franchisees. The net gain on sale of fixed assets of $2.9 million in the third quarter of 2001 was primarily due to the sale of 13 Church’s company-operated restaurants to franchisees and ten Cinnabon company-operated bakeries to franchisees.

Income from Continuing Operations. Excluding charges for restaurant closings, charges for asset write-offs from re-imaging, charges from other asset write-offs and the net gain on sale of fixed assets, income from continuing operations decreased by $0.7 million, or 3.7%, to $19.1 million in the third quarter of 2002 from $19.8 million in the comparable period in 2001. The decrease was mainly due to the inventory write down of $2.0 million (pre-tax) at Seattle Coffee, which was partially offset by the following: a decrease in amortization expense, franchise revenue growth, lower general and administrative expenses, higher rental income and lower depreciation expense.

Interest Expense, Net. Interest expense decreased by $2.7 million, or 55.8%, to $2.2 million in the third quarter of 2002 from $4.9 million in the comparable period in 2001. The decrease was primarily due to lower debt balances and lower interest rates.

Income Taxes. Our effective tax rate in the third quarter of 2002 was 35.8%, compared to an effective tax rate of 39.0% in the comparable period in 2001. Our effective tax rate decreased due to a decrease in our effective state tax rate and the discontinuance of amortization of goodwill, which is not deductible for tax purposes, upon our adoption of SFAS No. 142.

Extraordinary Loss. The extraordinary loss of $0.7 million, net of income taxes, in the third quarter of 2001 represents the partial write-off of debt costs and the payment of a premium related to the repurchases of $16.1 million of our senior subordinated notes.

Comparisons of the Forty-Weeks Ended October 6, 2002 and October 7, 2001

System-Wide Sales

System-wide sales increased by $107.1 million, or 5.5%, to $2,061.2 million in the forty-week period ended October 6, 2002 from $1,954.1 million in the comparable period in 2001. Our system-wide sales increase was due primarily to new franchise unit growth and coffee wholesale revenue growth. The overall increase was partially offset by comparable sales decreases in most of our segments. In the forty-week period ended October 6, 2002, we opened 151 restaurants, bakeries and cafes domestically, and 150 restaurants, bakeries and cafes in international markets. As of October 6, 2002, there were 3,970 system-wide units open, compared to 3,750 as of October 7, 2001.

Company-Operated Unit Sales

Chicken. Company-operated chicken restaurant sales decreased by $55.1 million, or 17.0%, to $268.4 million in the forty-week period ended October 6, 2002 from $323.5 million in the comparable period in 2001. The decrease was primarily due to a net reduction of 108 company-operated restaurants during the time period from October 8, 2001 to October 6, 2002 and a 0.2% decrease in comparable sales. In the fourth quarter of 2001 and during the forty-week period ended October 6, 2002, we sold a total of 49 and 62 company-operated chicken restaurants to franchisees, respectively. As of October 6, 2002, we had 430 company-operated chicken restaurants open, compared to 538 as of October 7, 2001.

Bakery. Company-operated bakery sales decreased by $13.0 million, or 26.0%, to $36.9 million in the forty-week period ended October 6, 2002 from $49.9 million in the comparable period in 2001. The decrease was due primarily to a net reduction of 70 company-operated bakeries during the time period from October 8, 2001 to October 6, 2002 and a 1.1% decrease in comparable sales. In the fourth quarter of 2001, we sold 14 company-operated bakeries to franchisees. We sold an additional 56 company-operated bakeries to franchisees in the forty-week period ended October 6, 2002. As of October 6, 2002, we had 93 company-operated bakeries open, compared to 163 as of October 7, 2001.

Cafe. Company-operated cafe sales decreased by $0.5 million, or 2.2%, to $20.5 million in the forty-week period ended October 6, 2002 from $21.0 million in the comparable period in 2001. The decrease in sales was primarily due to a 7.4% decrease in comparable sales. As of October 6, 2002, we had 76 company-operated cafes open, compared to 71 as of October 7, 2001.

Wholesale Sales

Coffee. Wholesale coffee sales increased by $1.1 million, or 2.2%, to $48.4 million in the forty-week period ended October 6, 2002 from $47.3 million in the comparable period in 2001. The increase was due primarily to growth in the number of points of distribution from our wholesale accounts. As of October 6, 2002, we had 6,008 wholesale accounts with 12,041 points of distribution.

Bakery. Wholesale bakery sales were $1.4 million in the forty-week period ended October 6, 2002. We began selling pre-packaged cinnamon rolls to a major retailer in fiscal year 2002.

Franchise Royalties and Fees

Chicken. Chicken franchise royalty revenues increased by $7.3 million, or 11.5%, to $70.2 million in the forty-week period ended October 6, 2002 from $62.9 million in the comparable period in 2001. The increase was due to new unit growth, partially offset by a decrease in international franchise comparable sales. As of October 6, 2002, we had 2,723 domestic and international franchised chicken restaurants open, compared to 2,546 as of October 7, 2001. Chicken franchise fee revenues increased by $0.6 million, or 10.5%, to $6.9 million in the forty-week period ended October 6, 2002 from $6.3 million in the comparable period in 2001. The increase was primarily due to franchise and conversion fees from the sale of 62 Church’s company-operated restaurants to new and existing franchisees during the forty-week period ended October 6, 2002. We opened 99 domestic franchised chicken restaurants in the forty-week period ended October 6, 2002, compared to 108 in the comparable period in 2001, and 86 international franchised chicken restaurants in the forty-week period ended October 6, 2002, compared to 66 in the comparable period in 2001.

Bakery. Bakery franchise royalty revenues increased by $0.9 million, or 18.6%, to $5.9 million in the forty-week period ended October 6, 2002 from $5.0 million in the comparable period in 2001. The increase was due primarily to new unit growth, offset by a decrease in domestic and international franchise comparable sales. As of October 6, 2002, we had 507 domestic and international franchised bakeries open, compared to 342 as of October 7, 2001. Bakery franchise fee revenues increased by $1.8 million, or 72.7%, to $4.2 million in the forty-week period ended October 6, 2002 from $2.4 million in the comparable period in 2001. The increase was primarily due to franchise and conversion fees from the sale of 56 company-operated bakeries to franchisees during the forty-week period ended October 6, 2002. We opened 27 domestic franchised bakeries in the forty-week period ended October 6, 2002, compared to 34 in the comparable period in 2001, and 35 international franchised bakeries in the forty-week period ended October 6, 2002, compared to 37 in the comparable period in 2001.

Cafe. Cafe royalty revenues increased by $0.7 million, or 76.2%, to $1.6 million in the forty-week period ended October 6, 2002 from $0.9 million in the comparable period in 2001. The increase was primarily due to new unit growth partially offset by a decrease in domestic and international franchise comparable sales. As of October 6, 2002, we had 141 franchised cafes open, compared to 90 as of October 7, 2001. Cafe franchise fee revenues increased by $0.3 million, or 36.9%, to $0.9 million in the forty-week period ended October 6, 2002 from $0.6 million in the comparable period in 2001. The increase resulted from the opening of 47 domestic and international franchised cafes in the forty-week period ended October 6, 2002 compared to 29 openings in the comparable period in 2001.

Other Revenues

Other revenues increased by $3.8 million, or 34.7%, to $14.6 million in the forty-week period ended October 6, 2002 from $11.1 million in the comparable period in 2001. The increase in other revenues was primarily due to an increase in rental revenues from additional leased properties. Our conversion of company-operated units to franchised units from October 8, 2001 to October 6, 2002 resulted in additional properties that we leased to franchisees.

Company-Operated Operating Profit

Chicken. Company-operated chicken restaurant operating profit decreased by $9.2 million, or 13.7%, to $57.9 million in the forty-week period ended October 6, 2002 from $67.1 million in the comparable period in 2001. The decrease was due primarily to a company-operated net unit decrease of 108 units during the time period from October 8, 2001 to October 6, 2002. Company-operated chicken restaurant operating profit as a percentage of company-operated chicken restaurant sales was 21.6% in the forty-week period ended October 6, 2002, compared to 20.7% in the comparable period in 2001. The 0.9 percentage point increase in operating profit margin was due to lower personnel expenses, as a percentage of restaurant sales.

Bakery. Company-operated bakery operating profit decreased by $3.8 million, or 49.8%, to $3.9 million in the forty-week period ended October 6, 2002 from $7.7 million in the comparable period in 2001. The decrease was due primarily to a company-operated net unit decrease of 70 units during the time period from October 8, 2001 to October 6, 2002. Company-operated bakery operating profit as a percentage of company-operated bakery sales was 10.6% in the forty-week period ended October 6, 2002, compared to 15.6% in the comparable period in 2001. The 5.0 percentage point decrease in the operating profit margin was due to a decrease in comparable sales and higher rent, wages and marketing expenses as a percentage of bakery sales.

Cafe. Company-operated cafe operating profit decreased by $0.9 million, or 47.4%, to $1.0 million in the forty-week period ended October 6, 2002 from $1.9 million in the comparable period in 2001. The decrease was primarily due to increased personnel costs

and rent expense compared to the comparable period in the prior year and lower comparable sales. Company-operated cafe operating profit as a percentage of company-operated cafe sales was 5.0% in the forty-week period ended October 6, 2002, compared to 9.4% in the comparable period in 2001. The 4.4 percentage point decrease in the operating profit margin was due to higher personnel costs and rent expense and lower comparable sales.

Wholesale Operating Profit

Coffee. Wholesale coffee operating profit decreased by $2.0 million, or 18.6%, to $8.9 million in the forty-week period ended October 6, 2002 from $10.9 million in the comparable period in 2001. The decrease was primarily due to a $2.0 million (pre-tax) write down of inventory to net realizable value. The write down was due to a correction of errors made in prior periods relating to inventory costing changes, inventory obsolescence issues, package design changes, and a non-integrated inventory accounting system. Wholesale coffee operating profit as a percentage of wholesale coffee sales was 18.4% in the forty-week period ended October 6, 2002, compared to 23.1% in the comparable period in 2001. The 4.7 percentage point decrease in operating profit margin was due to the inventory write down in the third quarter of 2002. Excluding the inventory write down, the coffee operating profit as a percentage of wholesale coffee sales was 22.7% in the third quarter of 2002, compared to 23.1% in the comparable period in 2001.

Bakery. Wholesale bakery operating profit was $0.6 million in the forty-week period ended October 6, 2002. We began selling pre-packaged cinnamon rolls to a major retailer in fiscal year 2002.

General and Administrative Expenses. General and administrative expenses decreased by $1.5 million, or 1.7%, to $81.2 million in the forty-week period ended October 6, 2002 from $82.7 million in the comparable period in 2001. The decrease was primarily due to a reduction in expense at our chicken segment due to conversions of company-operated chicken restaurants to franchised restaurants that have resulted in reduced overhead expenses associated with supporting company-operated units. In addition, our coffee segment’s expenses were lower in the forty-week period ended October 6, 2002 compared to the comparable period in 2001 due to personnel restructuring that occurred in the fourth quarter of 2001. The overall decrease in expense was partially offset by legal and severance costs incurred by our bakery segment. General and administrative expenses as a percentage of total revenues were 16.9% in the forty-week period ended October 6, 2002, compared to 15.6% in the comparable period in 2001.

Depreciation. Depreciation decreased by $0.7 million, or 3.1%, to $24.0 million in the forty-week period ended October 6, 2002 from $24.7 million in the comparable period in 2001. The decrease was mainly due to the conversion of company-operated units to franchised units in the fourth quarter of 2001 and the forty-week period ended October 6, 2002, partially offset by capital additions during the time period from October 8, 2001 to October 6, 2002. Depreciation as a percentage of total revenues was 4.9% in the forty-week period ended October 6, 2002, compared to 4.7% in the comparable period in 2001.

Amortization. Amortization decreased by $7.0 million to $0.2 million in the forty-week period ended October 6, 2002 from $7.2 million in the comparable period in 2001. The decrease was due to our adoption of SFAS No. 142 in the first quarter of 2002, resulting in the discontinuance of amortization expense on goodwill and our other intangible assets having indefinite lives, which were primarily trademarks.

Charges for Other Restaurant Closings, Excluding Pine Tree. The $0.5 million charge in the forty-week period ended October 6, 2002 primarily related to the closing of one Church’s restaurant. The $0.5 million charge in the forty-week period ended October 7, 2001 related primarily to the closing of two Seattle Coffee cafes.

Charges for Pine Tree Restaurant Closings. There were no Pine Tree closings in the forty-week period ended October 6, 2002. Charges for Pine Tree restaurant closings of $1.3 million in the forty-week period ended October 7, 2001 represents the closing of one Pine Tree restaurant upon expiration of its lease and additional lease costs related to previously closed Pine Tree units.

Charges for Asset Write-Offs from Re-imaging. The $1.0 million charge in the forty-week period ended October 6, 2002 resulted from the replacement of fixed assets at restaurants, bakeries and cafes that were re-imaged, which were mainly Church’s and Popeyes units. The $3.2 million charge in the forty-week period ended October 7, 2001 resulted from the replacement of fixed assets at restaurants, bakeries and cafes that were re-imaged. The re-images primarily involved Church’s, Popeyes and Cinnabon units.

Charges for Other Asset Write-Offs. The charges for other asset write-offs of $0.5 million in the forty-week period ended October 6, 2002 resulted primarily from the write-off of equipment at our Church’s and Cinnabon company-operated units as well as corporate asset write-offs and the accrual of the estimated remaining lease obligation and an impairment of certain leasehold improvements at Seattle Coffee’s former headquarters in Seattle. The charges for other asset write-offs of $1.2 million in the forty-week period ended October 7, 2001 resulted from the write-off of equipment at our company-operated chicken restaurants, as well as corporate asset write-offs.

Net Gain on Sale of Fixed Assets. The net gain on sale of fixed assets of $0.9 million in the forty-week period ended October 6, 2002 was primarily due to the gains on the sales of 56 Cinnabon company-operated bakeries and two Church’s company-operated units to franchisees. The overall gain was partially offset by the loss on the sale of 57 company-operated Church’s restaurants to an existing franchisee. The net gain on sale of fixed assets of $6.1 million in the forty-week period ended October 7, 2001 was primarily due to the sale of 49 Church’s company-operated restaurants and 22 Cinnabon company-operated bakeries to franchisees.

Income from Continuing Operations. Excluding charges for restaurant closings, charges for asset write-offs from re-imaging, charges for other asset write-offs and the net

gain on sale of fixed assets, income from continuing operations increased by $9.1 million, or 14.5%, to $71.7 million in the forty-week period ended October 6, 2002 from $62.6 million in the comparable period in 2001. The increase was due to a decrease in amortization expense, franchise and wholesale revenue increases, higher rental income, lower general and administrative expense and lower depreciation expense. The increase was partially offset by the $2.0 million (pre-tax) inventory write down at Seattle Coffee.

Interest Expense, Net. Interest expense decreased by $7.4 million, or 38.6%, to $11.8 million in the forty-week period ended October 6, 2002 from $19.2 million in the comparable period in 2001. The decrease was primarily due to lower debt balances and lower interest rates.

Income Taxes. Excluding the SFAS No. 142 impairment write-down of Seattle Coffee’s goodwill, our effective tax rate in the forty-week period ended October 6, 2002 was 37.8%, compared to an effective tax rate of 39.6% in the comparable period in 2001. Our effective tax rate decreased due to a decrease in our effective state tax rate and the discontinuance of amortization of goodwill, which is not deductible for tax purposes, upon our adoption of SFAS No. 142.

Extraordinary Loss. The extraordinary loss of $5.9 million, net of income taxes, in the forty-week period ended October 6, 2002 represents the premium paid to repurchase all our remaining senior subordinated notes ($126.9 million) and the related write-off of unamortized debt issuance costs at the time of the repurchase. The loss also consists of the write-off of unamortized debt issuance costs related to the old bank credit facility we refinanced in May 2002. The extraordinary loss of $1.0 million, net of income taxes, in the forty-week period ended October 7, 2001 represents the partial write-off of debt issuance costs and the payment of a premium related to the repurchase of $23.1 million of our senior subordinated notes.

Loss from the Cumulative Effect of a Change in Accounting Principle. In the forty-week period ended October 6, 2002, we recorded a $17.4 million impairment write-down of our Seattle Coffee goodwill in connection with our adoption of SFAS No. 142 and related impairment testing under this accounting standard.

Liquidity and Capital Resources

We have financed our business activities primarily with funds generated from operating activities, proceeds from the issuance of our senior subordinated notes, proceeds from the issuance of common stock, and borrowings under our bank credit facility and proceeds from the sale of company-operated units to franchises.

Net cash provided by operating activities for the forty-week periods ended October 7, 2001 and October 6, 2002 was $39.9 million and $62.7 million, respectively. Available

cash and cash equivalents, net of bank overdrafts, as of October 7, 2001 and October 6, 2002 was $0.4 million and $0.8 million, respectively.

Net cash used in investing activities for the forty-week periods ended October 7, 2001 and October 6, 2002 was $24.8 million and $14.3 million, respectively. In the forty-week period ended October 7, 2001, we invested $43.3 million in property and equipment and $3.1 million in connection with our turnkey development program, which was offset by the receipt of $21.2 million in proceeds from the sale of company-operated and turnkey units. In the forty-week period ended October 6, 2002, we invested $33.2 million in property and equipment and $2.8 million in connection with our turnkey development program, which was offset by the receipt of $21.0 million in proceeds from the sale of company-operated and turnkey units.

Net cash used in financing activities for the forty-week periods ended October 7, 2001 and October 6, 2002 was $25.6 million and $50.5 million, respectively. In the forty-week period ended October 7, 2001, we made principal payments of approximately $68.5 million under our bank credit facility and senior subordinated notes, primarily from the receipt of $46.2 million in net proceeds from our initial public offering, $5.8 million from the exercise of stock options to purchase our common stock and internal funds. In the forty-week period ended October 6, 2002, we made principal payments of approximately $207.7 million under our bank credit facility and senior subordinated notes, paid $4.4 million in debt issuance costs and made $41.4 million in stock repurchases under our share repurchase program. We used proceeds of $231.5 million from the refinancing of our bank credit facility in May 2002, $4.3 million from the exercise of stock options to purchase our common stock and internal cash to fund these financing transactions.

Share Repurchase Program

On July 22, 2002, our board of directors approved a share repurchase program of up to $50 million effective as of such date. The program, which is open-ended, allows us to repurchase our shares on the open market from time to time in accordance with the requirements of the Securities and Exchange Commission. On October 7, 2002, our board of directors approved an increase to this program from $50 million to $100 million. As of November 8, 2002, we have repurchased 2,720,410 shares of our stock for $56.8 million under this program. We have funded these purchases using proceeds from our bank credit facility and internal funds.

Capital Expenditures

Our capital expenditures consist of re-imaging activities, new unit construction and development, equipment replacements, maintenance and general capital improvements, capital expenditures related to our Seattle Coffee wholesale operations, the purchase of new restaurant, bakery and cafe equipment, and improvements at various corporate offices. In particular, capital expenditures related to re-imaging activities consist of

significant restaurant, bakery and cafe renovations, upgrades and improvements, which on a per restaurant basis typically cost between $70,000 and $135,000.

During the forty weeks ended October 7, 2001, we invested $43.3 million in various capital projects, including $6.9 million in new restaurant, bakery and cafe locations; $18.0 million in our re-imaging program; $3.5 million in our Seattle Coffee wholesale, production and distribution operations; $8.9 million in other capital assets to replace and extend the lives of restaurant, bakery and cafe equipment and facilities; and $6.0 million to complete other projects.

During the forty-weeks ended October 6, 2002, we invested $33.2 million in various capital projects, including $8.0 million in new, relocated and/or rebuilt restaurant, bakery and cafe locations; $7.6 million in our re-imaging program; $2.3 million in our Seattle Coffee wholesale operations; $10.5 million in other capital assets to replace and extend the lives of restaurant, bakery and cafe equipment and facilities; and $4.8 million to complete other corporate projects.

Substantially all of our capital expenditures have been financed using cash provided from normal operating activities, proceeds from the sale of our company-operated units and borrowings under our bank credit facility.

For the twelve-weeks remaining in our fiscal year ending December 29, 2002, we plan to spend approximately $17.8 million of capital expenditures using cash from operations and our bank credit facility. We estimate $9.7 million will be used for new, relocated and/or rebuilt restaurant, bakery and café locations; $3.1 million will be used for our re-imaging program; $1.1 million will be used in our Seattle Coffee wholesale, production and distribution operations; $1.2 million will be used for replacing and extending the lives of restaurant, bakery and cafe equipment and facilities; and the remaining $2.7 million will be used to complete other projects

Over the next several years, we plan to sell a significant number of our company-operated units to new and existing franchisees who commit to develop additional units in order to fully penetrate a particular market or markets. We will use the proceeds from the sale of these units to accelerate our planned re-imaging activities, fund the construction and development of additional restaurant, bakery and cafe units within our model markets, reduce our outstanding indebtedness and repurchase our common stock.

Based upon our current level of operations and anticipated growth, we believe that available cash provided from operating activities, together with available borrowings under our new bank credit facility, proceeds obtained from the sale of company-operated restaurants, bakeries and cafes to franchisees and proceeds from the exercise of stock options will be adequate to meet our anticipated future requirements for working capital, capital expenditures and scheduled payments under our bank credit facility for the next 12 months.

Long Term Debt

On May 23, 2002, we entered into a new bank credit facility with J.P. Morgan Chase and Credit Suisse First Boston, and certain other lenders, which consisted of a $75.0 million revolving credit facility, a $75.0 million, five-year Tranche A term loan and a $125.0 million, seven-year Tranche B term loan. Under the terms of the bank credit facility, we may also obtain letters of credit.

The revolving credit facility is due in full without installments on May 23, 2007. The outstanding balances of the Tranche A term loan and the Tranche B term loan are due in installments through May 23, 2007 and May 23, 2009, respectively. The Tranche A term loan, the Tranche B term loan and the revolving credit facility bear interest at LIBOR plus an applicable margin based on certain financial leverage ratios, which may fluctuate because of changes in these ratios. The margins are currently 2.00% for the revolving credit facility and the Tranche A term loan and 2.25% for the Tranche B term loan. We will pay each quarter a facility commitment fee on the undrawn amounts of the Tranche A term loan and the revolving credit facility of 0.5% annually.

At closing, we drew the entire $125.0 million Tranche B term loan to refinance our existing bank debt of approximately $62.6 million and invested the excess in certain highly rated short-term investments, in accordance with the new bank credit facility. In connection with the refinancing of our existing bank debt, we recorded an extraordinary loss on the early extinguishment of debt of approximately $0.6 million, pre-tax, in the second quarter of 2002 related to a non-cash write-off of unamortized debt issuance costs remaining from our existing bank debt. We also gave notice to call $126.9 million of our 10.25% senior subordinated notes, due May 15, 2007 at a price of 105.125. We retired these notes on June 27, 2002 by drawing on the Tranche A term loan. In connection with the call, we recorded an extraordinary loss on the early extinguishment of debt in the second quarter of 2002 of approximately $9.0 million, pre-tax, comprised of a $6.5 million cash premium and a non-cash write-off of related unamortized debt issuance costs approximating $2.5 million.

On August 9, 2002, we made an optional prepayment of $25.0 million on our Tranche B term loan using cash from operations.

As of October 6, 2002, we had $33.3 million outstanding under our revolving credit facility.

The bank credit facility contains certain financial and other covenants, including covenants requiring us to maintain various financial ratios, limiting our ability to incur additional indebtedness, restricting the amount of capital expenditures that we may incur, and limiting the amount of debt we can loan to our franchisees or guarantee on their behalf. The bank credit facility also limits our ability to engage in mergers or acquisitions, sell certain assets, repurchase our stock and enter into certain lease transactions. As of the date of this filing, we were in compliance with all required

covenants. The bank credit facility is secured by a first priority security interest in substantially all of our assets. Our subsidiaries are required to guarantee our obligations under the bank credit facility.

In connection with the refinancing, we incurred approximately $4.4 million in debt issuance costs, which we capitalized. We are amortizing these costs over the term of the new bank credit facility.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates that can have a material impact on our results of operations. Sales recognition at company-operated restaurants, bakeries and cafes is straightforward, as customers pay for products at the time of sale, and inventory turns over very quickly, with a complete food inventory taken weekly. Payments to vendors for products sold in the restaurants, bakeries and cafes are generally settled within 21 days. Wholesale coffee products sold by our Seattle Coffee segment are recorded as revenue when shipped to the customer. The earnings reporting process is covered by our system of internal controls, and generally does not require significant management estimates and judgments. However, estimates and judgments are inherent in the calculations of franchise royalties and other franchise related revenue collections, legal matters, medical, pension and other post-retirement benefits, income taxes, insurance liabilities, various other commitments and contingencies and the estimation of the useful lives of fixed assets and other long-lived assets. While management applies its judgment based on assumptions believed to be reasonable under the circumstances, actual results could vary from these assumptions. It is possible that materially different amounts would be reported using different assumptions.

We collect royalties, and in some cases rent, from franchisees and provide for estimated losses for revenues that are not likely to be collected. Although we enjoy a good relationship with our franchisees, and collection rates are currently very high, if average sales or the financial health of our franchisees were to deteriorate, we might have to increase reserves against collection of franchise revenues. Franchise fees and development fees are recorded as deferred revenue when received and are recognized as revenue when the restaurants, bakeries and cafes covered by the fees are opened and/or all material services or conditions relating to the fees have been substantially performed or satisfied by us. With respect to unit conversions, franchise and conversion fees are recognized as revenue upon the effective date of the sale of the company-operated unit to a franchisee. All development fees received in a unit conversion are deferred and recognized as revenue in accordance with our policy described above.

We also sell our wholesale coffee products to both franchisees and third party customers on trade credit and provide an estimated loss for doubtful accounts. If the

financial health of our wholesale customers were to deteriorate, we might have to increase our reserves against the collection of our wholesale revenues.

We are self-insured for most workers’ compensation, general liability, automotive liability losses and health care claims. We record our insurance liabilities based on historical and industry trends, which are continually monitored, and accruals are adjusted when warranted by changing circumstances. Since there are many estimates and assumptions involved in recording insurance liabilities, differences between actual future events and prior estimates and assumptions could result in adjustments to these liabilities. Pension and other retirement benefits, including all relevant assumptions required by generally accepted accounting principles, are evaluated each year. Due to the technical nature of retirement accounting, outside actuaries are used every other year to provide assistance in calculating the estimated future obligations. Since there are many estimates and assumptions involved in retirement benefits, differences between actual future events and prior estimates and assumptions could result in adjustments to pension expenses and obligations.

In the normal course of business we must make continuing estimates of potential future legal matters and liabilities, which requires the use of management’s judgment on the outcome of various issues. Management may also use outside legal advice to assist in the estimating process. However, the ultimate outcome of various legal issues could be different than management estimates, and adjustments to income could be required.

We record income tax liabilities utilizing known obligations and estimates of probable obligations. A deferred tax asset or liability is recognized whenever there are future tax effects from existing temporary differences and operating loss and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to the balance that is more likely than not to be realized. Management must make estimates and judgments on future taxable income, considering feasible tax planning strategies and taking into account existing facts and circumstances, to determine the proper valuation allowance. When we determine that deferred tax assets could be realized in greater or lesser amounts than recorded, the asset balance and income statement reflects the change in the period such determination is made. Due to changes in facts and circumstances and the estimates and judgments that are involved in determining the proper valuation allowance, differences between actual future events and prior estimates and judgments could result in adjustments to this valuation allowance.

Depreciation is recognized using the straight-line method in amounts adequate to depreciate costs over the following estimated useful lives: buildings, up to 35 years; leasehold improvements, up to 15 years; equipment, up to 15 years; and property under capital leases, up to the life of the related lease. We estimate useful lives on buildings and equipment based on historical data and industry trends. Long-lived assets are grouped into operating markets and tested for impairment whenever an event occurs that indicates that an impairment may exist. We test for impairment using the cash flows of the operating markets. A significant deterioration in the cash flows of an operating market or other circumstances may trigger impairment testing. We monitor our capitalization and depreciation policies to ensure they remain appropriate.

With our adoption of SFAS No. 142 at the beginning of our fiscal year 2002, we ceased amortizing goodwill and other intangible assets with indefinite lives, which were primarily trademarks. We tested for impairment under SFAS No. 142 in the first quarter of 2002 in connection with our adoption of SFAS No. 142. We will continue to test for impairment of our goodwill and other intangible assets at least on an annual basis in accordance with SFAS No. 142.

Outsourcing Arrangement

Impact of Inflation

We believe that, over time, we generally have been able to pass along inflationary increases in our costs through increased prices of our menu items, and the effects of inflation on our net income historically have not been, and are not expected to be, materially adverse. Due to competitive pressures, however, increases in prices of menu items often lag inflationary increases in costs.

Seasonality

Our Cinnabon bakeries and Seattle Coffee cafes have traditionally experienced the strongest operating results during the holiday shopping season between Thanksgiving and Christmas. Any factors that cause reduced traffic at our Cinnabon bakeries and Seattle Coffee cafes during this period would impair their ability to achieve normal operating results.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Risk. A portion of our receivables are denominated in foreign currency, which exposes us to foreign exchange rate movements. We enter into hedging contracts with respect to the Korean Won to reduce our exposure to future foreign currency exchange rate fluctuations.

Interest Rate Risk. Our exposure to interest rate risk relates to our borrowings under our bank credit facility. Our bank credit facility borrowings bear interest at rates that are benchmarked to U.S. and European short-term floating-rate interest rates. The balances outstanding under our bank credit facility as of October 6, 2002 totaled $206.1 million. The impact on our annual results of operations of a hypothetical one-point interest rate change on the outstanding balances under our bank credit facility would be approximately $2.0 million. This assumes no change in the amount or composition of the debt at October 6, 2002.

Chicken Market Risk. Our cost of sales is significantly affected by increases in the cost of chicken, which can result from a number of factors, including seasonality, increases in the cost of grain, disease and other factors that affect availability, and greater international demand for domestic chicken products. In order to ensure favorable pricing for our chicken purchases in the future, reduce volatility in chicken prices and maintain an adequate supply of fresh chicken, our purchasing cooperative has entered into two types of chicken purchasing contracts with chicken suppliers. The first is a grain-based “cost-plus” pricing contract that utilizes prices that are based upon the cost of feed grains, such as corn and soybean meal, plus certain agreed upon non-feed and processing costs. The other contract is a market-priced formula contract based on the “Georgia whole bird market value.” Under this contract, we and our franchisees pay the market plus a premium for the cut specifications for our restaurants. The market-priced formula contracts have maximum and minimum prices that we and our franchisees will pay during the term of the contract. Neither contract has minimum purchase requirements and both contracts have terms ranging from one to two years with provisions for certain annual price adjustments as defined in the contracts.

Coffee Bean Market Risk. Our two Seattle Coffee brands’ principal raw material is green coffee beans. The supply and prices of green coffee beans are volatile. Although most coffee beans trade in the commodity market, coffee beans of the quality sought by Seattle Coffee tend to trade on a negotiated basis at a premium above the commodity market coffee pricing, depending upon the supply and demand at the time of purchase. Availability and price can be affected by many factors in producing countries, including weather and political and economic conditions. We typically enter into supply contracts to purchase a pre-determined quantity of green coffee beans at a fixed price per pound. These contracts usually cover periods up to a year as negotiated with the individual supplier.

Item 4. CONTROLS AND PROCEDURES.

(a) Evaluation of disclosure controls and procedures

As required by SEC rules, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures within 90 days of the filing of this quarterly report. This evaluation was carried out under the supervision and with the participation of our management, including our principal executive officer and principal

financial officer. Based on this evaluation, these officers have concluded that the design and operation of our disclosure controls and procedures are effective. There were no significant changes to our internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

(b) Changes in internal controls

The company’s independent auditors assessed the company’s internal controls of its Seattle Coffee Company subsidiary as part of the interim review for the third quarter and have advised the company that there are significant deficiencies in internal controls at the Seattle Coffee Company subsidiary. From that assessment, the company and its audit committee received process improvement recommendations related to the Seattle Coffee Company subsidiary’s systems and processes. The company has plans to address and implement corrective actions as a result of these recommendations.

PART 2. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits


Exhibit 3.1		Articles of Incorporation of Registrant, as amended (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended July 14, 2002)

Exhibit 3.2		Amended and Restated Bylaws of Registrant (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended July 14, 2002)

Exhibit 4.1		Form of Registrant’s common stock certificate (incorporated by reference to the Registrant’s Registration Statement on Form S-1 (Registration No. 333-52608) on December 20, 2000)

Exhibit 11.1*		Statement Regarding Composition of Per Share Earnings.

Exhibit 99.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Exhibit 99.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Data required by Statement of Financial Accounting Standards No. 128, “Earnings per Share,” is provided in Note 3 to the condensed consolidated financial statements in this report.

(b) Current Reports on Form 8-K.

None.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		AFC Enterprises, Inc.

Date: November 19, 2002		By: /s/ Gerald J. Wilkins

		Gerald J. Wilkins Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer)

CERTIFICATIONS

I, Frank J. Belatti, certify that:

1. I have reviewed this quarterly report on Form 10-Q of AFC Enterprises, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


Date: November 19, 2002
		/s/ Frank J. Belatti
		Frank J. Belatti Chairman of the Board and Chief Executive Officer

I, Gerald J. Wilkins, certify that:


Date: November 19, 2002
		/s/ Gerald J. Wilkins
		Gerald J. Wilkins Executive Vice President and Chief Financial Officer

Exhibit Index


Exhibit 3.1		Articles of Incorporation of Registrant, as amended (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended July 14, 2002)

Exhibit 3.2		Amended and Restated Bylaws of Registrant (incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended July 14, 2002)

Exhibit 4.1		Form of Registrant’s common stock certificate (incorporated by reference to the Registrant’s Registration Statement on Form S-1 (Registration No. 333-52608) on December 20, 2000)

Exhibit 11.1*		Statement Regarding Composition of Per Share Earnings.

Exhibit 99.1		Certification of Chief Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Exhibit 99.2		Certification of Chief Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Data required by Statement of Financial Accounting Standards No. 128, “Earnings per Share,” is provided in the Notes to the condensed consolidated financial statements in this report.

	•		restaurant sales at our company-operated restaurants, bakeries and cafes;

	•		revenues from franchising;

	•		revenues from wholesale operations; and

	•		other revenues.

1.		I have reviewed this quarterly report on Form 10-Q of AFC Enterprises, Inc.;

2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.		The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	b)		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	c)		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

	a)		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and