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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 000-32369

(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           No   ü   

     Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).

Yes   ü        No      

     As of April 18, 2004 there were 28,054,209 shares of the registrant’s common stock, par value $.01 per share, outstanding.

AFC ENTERPRISES, INC.
INDEX

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Part 1.   Financial Information

Item 1.   Financial Statements

AFC Enterprises, Inc.
Condensed Consolidated Statements of Operations (unaudited)
(In millions, except per share data)

See accompanying notes to condensed consolidated financial statements.

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AFC Enterprises, Inc.
Condensed Consolidated Balance Sheets (unaudited)
(In millions, except share data)

See accompanying notes to condensed consolidated financial statements.

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AFC Enterprises, Inc.
Condensed Consolidated Statements of Cash Flows (unaudited)
(In millions)

See accompanying notes to condensed consolidated financial statements.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements

1.   Description of Business

     AFC Enterprises, Inc. and its subsidiaries (“AFC” or “the Company”) develop, operate and franchise quick-service restaurants, bakeries and cafes (generally referred to as “QSRs” or “units” throughout these notes) in two distinct business segments: chicken and bakery. The Company’s chicken segment operates and franchises under the trade names Popeyes® Chicken & Biscuits (“Popeyes”) and Church’s Chicken™ (“Church’s”); its bakery segment operates and franchises under the trade name Cinnabon® (“Cinnabon”) and currently franchises cafes under the trade name Seattle’s Best Coffee® (“SBC”). The Company’s SBC operations are contractually limited to Hawaii, certain international markets and certain U.S. military bases.

     Discontinued Operations.   As discussed in Note 7, on July 14, 2003, the Company sold Seattle Coffee Company (“Seattle Coffee”), a subsidiary which was the parent company for the Company’s SBC and Torrefazione Italia® Coffee brands. In the transaction, the Company retained a portion of SBC’s franchising operations. In the accompanying financial statements, financial results relating to the divested operations are presented as a discontinued operation. Previously reported consolidated financial statement amounts have been restated to present the divested operations in a manner consistent with the 2003 presentation. Unless otherwise noted, discussions and amounts throughout these notes relate to the Company’s continuing operations.

2.   Summary of Significant Accounting Policies

     Principles of Consolidation.   The condensed consolidated financial statements include the accounts of AFC Enterprises, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.

     Basis of Presentation.   The accompanying condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, certain information and footnotes required by generally accepted accounting principles in the United States for complete financial statements are not included. The consolidated balance sheet data as of December 29, 2002, that is presented herein, was derived from the Company’s audited consolidated financial statements for the fiscal year then ended. The accompanying condensed consolidated financial statements have not been audited by independent certified public accountants, but in the opinion of management, they contain all adjustments 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.

     Restatement of Prior Year’s Financial Information.   As more fully discussed in Note 11 herein and in the Company’s 2002 Annual Report on Form 10-K, the Company’s condensed consolidated statements of operations and cash flows for the first quarter of 2002 were restated from amounts previously reported to correct for certain accounting errors. All information relating to 2002 presented in these notes reflects that restatement.

     Significant Accounting Policies.   The accounting and reporting policies practiced by the Company are set forth in Note 2 to the Company’s consolidated financial statements for the fiscal year ended December 28, 2003, which are contained in the Company’s 2003 Annual Report on Form 10-K.

     Fiscal Periods.   The Company has a 52/53-week fiscal year that ends on the last Sunday in December. The Company’s first fiscal quarter contains 16 weeks and its remaining quarters contain 12 weeks (13 weeks in the fourth quarter of a 53-week year). The 2003 and 2002 fiscal years both contain 52 weeks.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

     Accounting Standards Adopted During The Periods Presented.   In the first quarter of 2002, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). At that time, the Company discontinued its prior practice of amortizing goodwill and other indefinite-lived assets. These assets are now being accounted for by the impairment-only approach. The Company’s finite-lived intangible assets continue to be amortized on a straight-line basis. In adopting SFAS 142, the Company recorded a transitional charge of $11.8 million to reduce the carrying value of the goodwill associated with Seattle Coffee. In the condensed consolidated financial statements, this charge is presented as a component of discontinued operations.

     In the first quarter of 2002, the Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”). At the time of adoption, SFAS 144 did not have a material effect on the Company’s consolidated financial statements.

     In the first quarter of 2003, the Company adopted Financial Accounting Standards Board Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). Pursuant to FIN 45 a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. At the time of adoption, FIN 45 did not have a material effect on the Company’s consolidated financial statements.

     In the first quarter of 2003, the Company adopted SFAS No. 143, Accounting for Asset Retirement Obligations (“SFAS 143”). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible, long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset. SFAS 143 requires that the fair value of an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. For obligations under certain leases that are within the scope of SFAS 143, the Company recorded a cumulative effect adjustment of $0.7 million ($0.4 million after tax). The changes in the asset retirement obligation during the quarter were not significant.

     Recent Accounting Pronouncements That The Company Has Not Yet Adopted.    In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 (“FIN 46”). In December 2003, the FASB issued an update, which revised and restated FIN 46 in its entirety (“FIN 46R”).

     FIN 46R clarifies the application of Accounting Research Bulletin No. 51, as it concerns the consolidation of certain entities in which (a) the equity investment at risk does not provide its holders with the characteristics of a controlling financial interest or (b) the equity investments at risk is not sufficient for the entity to finance its activities without additional subordinated financial support. For such entities, a controlling financial interest cannot be identified based upon voting equity interests. FIN 46R refers to such entities as “variable interest entities” (“VIEs”). FIN 46R requires consolidation of VIEs by its primary beneficiary. The primary beneficiary is the entity, if any, that will absorb a majority of the VIE’s expected losses, receive a majority of its expected residual returns, or both, as a result of holding variable interests.

     The Company is currently evaluating the effect of FIN 46R on its accounting for certain franchisee and other relationships. The Company will adopt FIN 46R in the first quarter of 2004. If the Company determines that it is appropriate to consolidate certain of its franchisees, it is possible that consolidation of those franchisees will give rise to a one-time charge for the recognition of minority interest liabilities.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

3.   Long-Term Debt and Other Borrowings

     2002 Credit Facility.   On May 23, 2002, the Company entered into a new bank credit facility (the “2002 Credit Facility”) with J.P. Morgan Chase, Credit Suisse First Boston and certain other lenders, which consists of a $75.0 million, five-year revolving credit facility, a $75.0 million, five-year Tranche A term loan and a $125.0 million, seven-year Tranche B term loan.

     The term loans and the revolving credit facility bear interest at LIBOR plus an applicable margin based on certain financial leverage ratios and the Company’s credit rating. The margins may fluctuate because of changes in these ratios. As of December 29, 2002, the margins were 2.0% for the revolving credit facility and the Tranche A term loan and 2.25% for the Tranche B term loan. On July 14, 2003, the start of the Company’s third quarter for 2003, these margins changed to 2.25% for the revolving credit facility and the Tranche A term loan and 2.50% for the Tranche B term loan due to an amendment to the 2002 Credit Facility. On August 22, 2003, these margins changed to 2.75% for the revolving credit facility and the Tranche A term loan and 3.00% for the Tranche B term loan due to another amendment to the 2002 Credit Facility and remained at those rates through December 28, 2003. The Company also pays a quarterly commitment fee of 0.125% (0.5% annual rate divided by 4) on the unused portions of the revolving credit facility.

     In addition to the scheduled installments associated with the Tranche A and Tranche B term loans, at the end of each year, the Company is subject to mandatory prepayments in those situations when consolidated cash flows for the year, as defined pursuant to the terms of the facility, exceed specified amounts. Amounts reflected in current maturities on long-term debt consider estimated prepayments associated with this provision. In addition, prepayments are due from the proceeds of certain qualifying sales, including the sale of the capital stock of a subsidiary of the Company. Whenever any prepayment is made, subsequent installments are ratably reduced.

     The 2002 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 2002 Credit Facility.

     The 2002 Credit Facility contains 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, restricting the payment of cash dividends and limiting the amount of debt which can be loaned to the Company’s franchisees or guaranteed on their behalf. This 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.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

     Amendments to the 2002 Credit Facility.    On March 31, 2003, May 30, 2003, July 14, 2003, August 22, 2003, October 30, 2003 and March 26, 2004, the Company amended its 2002 Credit Facility. The effect of these amendments was to:

•

Extend, for purposes of the facility, the deadline for providing the Company’s 2002 annual report to its lenders to December 15, 2003 (this requirement was satisfied as of that date).

•

Extend, for purposes of the facility, the deadline for filing the Company’s quarterly financial information to its lenders for the first, second and third quarters of 2003 to February 28, 2004 (this requirement was satisfied as of that date).

•

Raise the interest rate on outstanding indebtedness under the 2002 Credit Facility until such time as the Company has satisfied its 2002 annual reporting requirement, its 2003 quarterly reporting requirements and attained a bank credit rating of Ba3 and BB-, or better, by each of Moody’s and Standard & Poor’s, respectively.

•

Temporarily reduce the Company’s revolving line of credit from $75.0 million to $65.0 million until the Company delivers all of the required quarterly financial statements and demonstrates a total leverage ratio of not greater than two to one for 2003, at which time the revolving line of credit limit will return to the original commitment amount of $75.0 million (this requirement came into effect during the fourth quarter of 2003 and was satisfied during the first quarter of 2004).

•

Approve the Seattle Coffee divestiture.

•

Require the Company to use proceeds from the sale of Seattle Coffee to pay down $31.3 million of the facility’s term loans and deposit $32.0 million in a collateral account. The pay down occurred on July 17, 2003 and the deposit occurred on July 15, 2003.

•

Require the Company to use $29.2 million of the amounts deposited in the aforementioned collateral account to further pay down the facility’s term loans. The pay down occurred on October 31, 2003.

•

Adjust the computation of certain loan covenant ratios in 2003 to exclude from the computations certain fees associated with a productivity initiative performed in the first quarter of 2003, subject to certain monetary limits, and the various costs associated with the restatement of the Company’s previously issued financial statements.

•

Extend, for purposes of the facility, the filing deadline for the Company’s 2003 annual report to its lenders to April 12, 2004 (this requirement was satisfied prior to that date).

     Because the 2003 amendments were necessitated by the delays in filing the Company’s annual report for 2002 and quarterly reports for 2003, a consequence of the restatement and re-audits of previously issued financial information, the related amendment fees are included as a component of the restatement costs discussed at Note 5.

     Without the amendments, the Company would have been in default of the 2002 Credit Facility and the entire amount of the debt would have been subject to acceleration by the facility’s lenders. If the Company is not able to continue to provide timely financial information to the lenders as required under the 2002 Credit Facility, there can be no assurance that such lenders will provide future relief through waivers or additional amendments. If the Company defaults on the terms and conditions of the 2002 Credit Facility and the debt is accelerated by the facility’s lenders, such developments will have a material adverse impact on the Company’s financial condition and its liquidity.

     Under the terms of the revolving credit facility, the Company may also obtain short-term borrowings and letters of credit up to the amount of unused borrowings under that facility. As of July 13, 2003, there

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

were $45.0 million in outstanding borrowings under the revolving credit facility and $6.8 million of outstanding letters of credit, leaving amounts available for short-term borrowings and additional letters of credit of $23.2 million. The revolving credit facility is due in full without installments in May 2007.

4.   Shareholder Litigation

     The Company is involved in several matters relating to its announcement on March 24, 2003 indicating it would restate its financial statements for fiscal year 2001 and the first three quarters of 2002 and its announcement on April 22, 2003 indicating that it would also restate its financial statements for fiscal year 2000.

     On March 25, 2003, plaintiffs filed the first of eight securities class action lawsuits in the United States District Court for the Northern District of Georgia against AFC and several of its current and former directors and officers. By order dated May 21, 2003, the district court consolidated the eight lawsuits into one consolidated action. On January 26, 2004, the plaintiffs filed a Consolidated Amended Class Action Complaint (the “Consolidated Complaint”) on behalf of a putative class of persons who purchased or otherwise acquired AFC stock between March 2, 2001 and March 24, 2003. In the Consolidated Complaint, plaintiffs allege that the registration statement filed in connection with AFC’s March 2001 initial public offering (“IPO”) contained false and misleading statements in violation of Sections 11 and 15 of the Securities Act of 1933 (“1933 Act”). The defendants to the 1933 Act claims include AFC, certain of AFC’s current and former directors and officers, an institutional shareholder of AFC, and the underwriters of AFC’s IPO. Plaintiffs also allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“1934 Act”) and Rule 10b-5 promulgated thereunder. The plaintiffs’ 1934 Act allegations are pled against AFC, certain current and former directors and officers of AFC, and two institutional shareholders. The plaintiffs also allege violations of Section 20A of the 1934 Act against certain current and former directors and officers and two institutional shareholders based upon alleged stock sales. The Consolidated Complaint seeks certification as a class action, compensatory damages, pre-judgment and post-judgment interest, attorney’s fees and costs, an accounting of the proceeds of certain defendants’ alleged stock sales, disgorgement of bonuses and trading profits by AFC’s CEO and former CFO, injunctive relief, including the imposition of a constructive trust on certain defendants’ alleged insider trading proceeds, and other relief. AFC has not yet filed a response to the Consolidated Complaint.

     On June 5, 2003, a shareholder claiming to be acting on behalf of AFC filed a shareholder derivative suit in the United States District Court for the Northern District of Georgia against certain current and former members of the Company’s board of directors and the Company’s largest shareholder. On July 24, 2003, a different shareholder filed a substantially identical lawsuit in the same court against the same defendants. By order dated September 23, 2003, the District Court consolidated the two lawsuits into one consolidated action. On November 24, 2003, the plaintiffs filed a consolidated amended complaint that added as defendants three additional current or former officers of AFC and two other large shareholders of AFC. The consolidated complaint alleges, among other things, that the director defendants breached their fiduciary duties by permitting AFC to issue financial statements that were materially in error. The lawsuit seeks, on behalf of AFC, unspecified compensatory damages, disgorgement or forfeiture of certain bonuses and options earned by certain defendants, disgorgement of profits earned through alleged insider selling by certain defendants, recovery of attorneys’ fees and costs, and other relief. On February 23, 2004, the defendants moved to dismiss the consolidated complaint.

     On August 7, 2003, a shareholder claiming to be acting on behalf of AFC filed a shareholder derivative suit in Gwinnett County Superior Court, State of Georgia, against certain current and former members of the Company’s board of directors. The complaint alleges that the defendants breached their fiduciary duties by permitting AFC to issue financial statements that were materially in error and by failing to maintain adequate internal accounting controls. The lawsuit seeks, on behalf of AFC, unspecified compensatory damages, attorneys’ fees, and other relief. On January 20, 2004, the defendants moved to dismiss or, alternatively, to stay the case. On May 17, 2004, the court entered an order staying the proceedings until October 11, 2004, unless the stay is lifted earlier by any of the parties or by the court.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

     On May 15, 2003, a plaintiff filed a securities class action lawsuit in Fulton County Superior Court, State of Georgia, against AFC and certain current and former members of the Company’s board of directors on behalf of a class of purchasers of the Company’s common stock “in or traceable to” AFC’s December 2001 $185.0 million public offering of common stock. The lawsuit asserts claims under Sections 11 and 15 of the 1933 Act. The complaint alleges that the registration statement filed in connection with the offering was false or misleading because it included financial statements issued by the Company that were materially in error. The complaint seeks certification as a class action, compensatory damages, attorneys’ fees and costs, and other relief. The plaintiff claims that as a result of AFC’s announcement that it was restating its financial statements for fiscal year 2001 (and at the time of the complaint, were examining restating its financial statements for fiscal year 2000), AFC will be absolutely liable under the 1933 Act for all recoverable damages sustained by the putative class. On July 20, 2003, the defendants removed the action to the United States District Court for the Northern District of Georgia. The plaintiff filed a motion to remand the case to state court. The defendants opposed the motion to remand. On November 25, 2003, the federal district court entered an order remanding the case to state court but staying the order to allow the defendants to appeal the decision. The United States Court of Appeals for the Eleventh Circuit agreed to hear the defendants’ appeal.

     On April 30, 2003, the Company received an informal, nonpublic inquiry from the SEC requesting voluntary production of documents and other information. The requests for documents and information relate primarily to the Company’s announcement on March 24, 2003 indicating it would restate its financial statements for fiscal year 2001 and the first three quarters of 2002. The SEC is also investigating whether the disclosure of certain financial information in November 2002 was in compliance with SEC Regulation FD. The Company is cooperating with the SEC in these inquiries.

     AFC maintains directors and officers liability (“D&O”) insurance that may provide coverage for some or all of these matters. The Company has given notice to its D&O insurers of the claims described above, and the insurers have responded by requesting additional information and by reserving their rights under the policies, including the rights to deny coverage under various policy exclusions or to rescind the policies in question as a result of AFC’s announced restatement of its financial statements. There is risk that the D&O insurers will rescind the policies; that some or all of the claims will not be covered by such policies; or that, even if covered, AFC’s ultimate liability will exceed the available insurance.

     The lawsuits against AFC described above present material and significant risk to the Company. Although the Company believes it has meritorious defenses to the claims of liability or for damages in these actions, it is unable at this time to predict the outcome of these actions or reasonably estimate a range of damages. The amount of a settlement of, or judgment on, one or more of these claims or other potential claims relating to the same events could substantially exceed the limits of the Company’s D&O insurance. The ultimate resolution of these matters could have a material adverse impact on the Company’s financial results, financial condition and liquidity.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

5.   Impairment Charges and Other

     Of the $3.8 million of impairment charges recognized in the twenty eight weeks ended July 13, 2003, $2.0 million relates to a new restaurant concept, associated with the Company’s chicken segment, which was abandoned in the Company’s first fiscal quarter of 2003.

     During 2003, the Company incurred costs associated with the re-audit and restatement of its 2001 and 2000 financial statements. Included therein are fees for outside auditors, fees for accountants engaged to assist in the restatement, attorney fees, credit facility amendment fees and various ancillary costs.

     As a consequence of the restatement, the Company also incurred costs associated with an independent investigation commissioned by the Company’s Audit Committee, attorney fees associated with certain shareholder litigation and certain other related costs. While these costs were significant for the balance of 2003, they were insignificant in the first and second quarters of 2003. A discussion of the shareholder litigation can be found at Note 4 to these condensed consolidated financial statements.

6.   Interest Expense, Net

     In conjunction with the early extinguishment of debt, the Company incurred a call premium of $6.5 million and wrote-off additional debt issuance costs of $3.1 million. During 2002, the Company adopted SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. As a result, these amounts are included as a component of “interest expense, net” in the accompanying consolidated statements of operations. Previously, such items had been treated as extraordinary losses.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

7.   Discontinued Operations – Seattle Coffee Company

     On July 14, 2003, the Company sold Seattle Coffee to Starbucks Corporation for $72.0 million. Net proceeds of the sale were approximately $62.1 million. In this transaction, the Company sold substantially all of the continental U.S. and Canadian operations of Seattle Coffee and its wholesale coffee business. Following this transaction, the Company continues to franchise the Seattle’s Best Coffee brand in retail locations in Hawaii, in certain international markets and on certain U.S. military bases.

     For the twelve and the twenty-eight week periods ended July 13, 2003 and July 14, 2002, total revenues and net losses from discontinued operations were as follows:

     Balance sheet data associated with these operations, as of July 13, 2003 and December 29, 2002, were as follows:

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

8.   Stock-Based Employee Compensation

     The Company accounts for stock options issued to employees under the intrinsic value method. Had the Company’s stock option plans been accounted for under the fair value method, the Company’s net income would have been reduced to the following pro forma amounts:

9.   Components of Earnings Per Share Computation

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

10.   Segment Information (Continuing Operations)

     The Company’s operating segments combine Popeyes and Church’s operations to form its chicken segment and its Cinnabon and Seattle’s Best Coffee operations to form its bakery segment.

     Inter-segment revenue is eliminated through corporate revenue. The corporate revenues include rental income from leasing and sub-leasing agreements with third parties. During 2003, the Company allocated certain information technology costs to its chicken and bakery segments, which in previous years had been reported in the Company’s corporate segment. Prior year’s allocations were adjusted to be consistent with the 2003 approach. This had the effect of changing previously reported operating profits for the segments and corporate, but it had no effect on the total.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

11.   Restatement of Financial Statements

     The Company’s previously issued condensed consolidated statement of operations for the twelve and twenty-eight weeks ended July 14, 2002 have been restated to correct certain accounting errors. The aggregate effect of the restatement decreased previously reported net income for the twelve weeks ended July 14, 2002 by $3.6 million and decreased previously reported basic and diluted earnings per share for that period by $0.12 and $0.12, respectively. The aggregate effect of the restatement increased previously reported net income for the twenty-eight weeks ended July 14, 2002 by $3.9 million and increased basic and diluted earnings per share for that period by $0.13 and $0.12, respectively.

     As discussed in Note 23 to the Company’s consolidated financial statements included in the Company’s 2002 Annual Report on Form 10-K, the restatement impacted several years and certain of the issues impact multiple periods. Certain matters giving rise to the restatement and their effect on previously reported earnings for the twelve and twenty-eight weeks ended July 14, 2002 were as follows:

     Gains Associated With Unit Conversions.   The Company’s prior accounting treatment regarding the sale of assets to a franchisee in connection with a unit conversion was, in most cases, to recognize gains immediately. The Company has determined that a portion of such gains should have been deferred in circumstances where the Company maintains some continuing involvement with the assets beyond the customary franchisor role. The calculation of the gain was also decreased by the allocation of goodwill to each unit conversion. The deferred amounts of these gains are being recognized as income over the period of continuing involvement.

     Impairment of Long-Lived Assets.   The Company’s prior accounting treatment regarding impairment of long-lived assets was to evaluate company-operated QSRs on a market basis. The Company has determined that the evaluation should have been performed on a site-by-site basis, which is the lowest level of identifiable cash flows as required by SFAS 121. Accordingly the Company adjusted its long-lived asset impairment charges to reflect the evaluation on a site-by-site basis. These adjustments reduced depreciation expense during the twelve and twenty-eight weeks ended July 14, 2002.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

of identifiable cash flows as required by SFAS 121. Accordingly the Company adjusted its long-lived asset impairment charges to reflect the evaluation on a site-by-site basis.

     Impairment of Goodwill at Seattle Coffee.   Due to the effect of many of the restatement issues as recorded in periods prior to 2002, the Company’s basis in the assets at Seattle Coffee, including goodwill, changed. This resulted in a change in the amount of impairment subsequently recognized in the Company’s adoption of SFAS No. 142.

     Post-Employment Payments to a Former Officer.   Beginning in 2001, the Company expensed certain post-employment payments to a former officer as the payments were made over the term of the ten-year agreement. The Company has determined that the entire obligation to the former officer should have been recorded when the agreement became effective, since no additional services were required to be performed. Accordingly, the Company expensed the entire obligation in 2001.

     Cinnabon Purchase Accounting.   In the 1998 acquisition of Cinnabon, the Company accrued certain costs as acquisition costs and recorded 100% of the purchase price in excess of the fair value of the net assets acquired as goodwill. The Company has determined that certain of the acquisition costs accrued should have been expensed as incurred. In addition, the Company has determined that the allocation of the purchase price to the fair values of acquired bakeries and identifiable intangible assets were understated. The Company has reversed certain costs initially accrued in the acquisition and the expenses are recorded in the Company’s statements of operations as incurred. The purchase price allocation has been adjusted for the respective identifiable assets and the related depreciation and amortization expenses have been adjusted in the statements of operations.

     Inventory Adjustments at Seattle Coffee.   In the third quarter of 2002, the Company identified errors relating to Seattle Coffee’s inventory costing. The Company has determined that the adjustments relate to 2001 and 2000 and, accordingly, has reflected such adjustments in those years.

     Equipment Placed at Seattle Coffee Customers.   Historically, Seattle Coffee had placed certain equipment at customer locations, the cost of which was capitalized. The Company determined that such costs should have been recognized as marketing expenses. Accordingly, the Company recorded adjustments to expense the cost of such equipment in the periods it was placed in service.

     Accrued Liabilities.   The Company corrected accrual accounts for errors in computation and timing of expense recognition. Accounts affected by these adjustments include accruals for business insurance, employee relocations, advertising, management bonuses and other miscellaneous accounts. The Company made adjustments to record the associated accruals based on correct computations and in the appropriate periods.

     Capitalized Interest.   The Company’s computation of interest to be capitalized was based upon applying an interest rate to a group of assets which included completed projects. As a result, the Company determined the calculation should be adjusted using only those assets where construction was in progress and all other amounts were expensed as interest expense.

     Business Taxes and Related Professional Fees.   The Company’s prior accounting treatment was to accrue professional tax fees in the Company’s tax liability accounts. Adjustments were made to reclassify these professional fees to general liability accounts and expense business taxes and related professional fees as incurred.

     Slotting Fees at Seattle Coffee.   Seattle Coffee capitalized amounts paid to its wholesale customers for favorable shelf positioning for its products and amortized the amounts over a two-year period. The Company has determined that when the specified term of the slotting agreement was not expressed in a written contract, the payments made to customers should have been expensed as sales discounts when

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

incurred. Accordingly, the Company has expensed these amounts in the periods incurred unless an underlying written contract supports capitalization and amortization over a specified term.

     Beverage Rebates.   The Company’s prior accounting treatment was to record rebates from beverage vendors when received. The Company has determined that these rebates should have been recorded in the periods earned. Accordingly, adjustments have been made to recognize the rebates in the periods earned.

     Rent Expense.   The Company recorded rent expense on a straight-line basis over the initial lease term for certain of its leases. The Company has determined that rent expense for all leases should have been calculated using the straight-line basis over the lease term (inclusive of renewal options the Company was reasonably expected to exercise).

     Sales Allowances at Seattle Coffee.   Seattle Coffee recorded certain sales discounts and allowances that were offered to customers in the period when such discounts were paid. The Company has determined that such discounts and allowances should have been estimated and accrued in the period of the associated sales. Accordingly, the Company has adjusted its provisions for sales allowances and returns to recognize the expense in the period that the related revenue was earned.

     Recognition of Re-imaging Costs.   The Company’s accounting treatment for the recognition of reimaging costs was based upon accruing those costs on the planned dates of the reimaging activities. The Company determined that the reimaging costs should have been recorded based upon the actual dates of the reimaging activities. Accordingly, the Company adjusted the reimaging costs to record the costs in the period incurred.

     Future Lease Obligations — Closed Units.   The Company recorded lease obligations associated with closed units net of anticipated sublease rental income. The Company determined that the sublease rental income was not reasonably supported. Accordingly, the Company recalculated the estimated future lease obligation for certain closed units using 100% of the remaining lease obligation.

     Leasehold Improvements — Useful Lives.   The Company’s depreciable lives used for leasehold improvements were based upon the useful lives of the assets. The Company determined that for certain leasehold improvements, the depreciable life was longer than the remaining term of the associated lease. Accordingly, the Company adjusted depreciation expense to recognize the effect of reducing the depreciable life to the lease term.

     Group Medical Insurance Accrual.   The Company’s group medical insurance accrual at the end of the first quarter of 2002 was over accrued. The effect of correcting the recorded balance increased income from operations by $0.4 million.

     Capitalized Expenses.   The Company had capitalized certain amounts including construction overhead costs and other amounts which the Company determined should have been expensed as incurred. Accordingly, the Company has made adjustments to expense those items in the period the costs were incurred.

     Other.   Other adjustments were made, none of which were individually material.

     Income Tax Effect.   The income tax effect of the restatement adjustments is calculated using the Company’s statutory income tax rates, adjusted for non-deductible items.

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AFC Enterprises, Inc.
Notes to Condensed Consolidated Financial Statements — (Continued)

     The following table compares previously reported results of operations with restated amounts for the twelve and twenty eight weeks ended July 14, 2002. In addition to the restatement adjustments, the “as restated” columns include certain reclassifications to conform the 2002 statement of operations to the 2003 presentation. These reclassifications have not been made to the “as previously reported” columns. The reclassifications relate to discontinued operations, wholesale revenues, gains and losses and certain fees associated with unit conversions.

     As previously reported, the Company recorded a transitional impairment of goodwill related to Seattle Coffee upon adoption of SFAS 142. As restated, the impairment has been adjusted and is reflected in discontinued operations.

      The following table compares previously reported cash flow amounts with restated amounts for the twenty-eight weeks ended July 14, 2002.

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

     The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q.

     The financial data in this quarterly report on Form 10-Q for the first two quarters of 2002 has been restated from amounts previously reported for the correction of accounting errors. A discussion of the restatement in relation to the affected quarters of 2002, is provided in Note 11 to the Condensed Consolidated Financial Statements. All information presented in this Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects the restatement.

Nature of Business

     AFC Enterprises, Inc. (“AFC”) develops, operates and franchises quick service restaurants, bakeries and cafes (“QSR’s” or “units”) in two distinct business segments: chicken and bakery. Our chicken segment operates and franchises under the trade names Popeyes® Chicken & Biscuits (“Popeyes”) and Church’s Chicken™ (“Church’s”); and our bakery segment operates and franchises under the trade name Cinnabon® (“Cinnabon”) and currently franchises cafes under the trade name Seattle’s Best Coffee®.

     Prior to the July 14, 2003 sale of our Seattle Coffee subsidiary, we also operated a coffee business segment. Seattle Coffee operated and franchised under the names Seattle’s Best Coffee® (“SBC”) and Torrefazione Italia® (“TI”). In the sale of Seattle Coffee, we retained a portion of SBC’s franchising operations. The divested operations are presented as discontinued operations and previously reported financial information has been restated to present the divested operations in a manner consistent with our current year’s presentation. Unless otherwise noted, discussions and amounts throughout this Quarterly Report on Form 10-Q relate to our continuing operations.

     As of July 13, 2003, we operated and franchised 4,150 QSRs in 46 states, the District of Columbia, Puerto Rico and 32 foreign countries. That total, by brand, was as follows:

Fiscal Periods

     The Company has a 52/53-week fiscal year that ends on the last Sunday in December. Our first fiscal quarter contains 16 weeks and the remaining quarters contain 12 weeks (13 weeks in the fourth quarter of a 53-week year). Our 2003 and 2002 fiscal years both contain 52 weeks. In this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the twelve week periods ended July 13, 2003 and July 14, 2002 are referred to as the second quarter of 2003 and the second quarter of 2002, respectively.

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Consolidated Results of Operations

     In reviewing our operating results and the relationships between various components of our statements of operations, we believe the following table can be helpful to readers. The table presents selected revenues and expenses as a percentage of total revenues (or, in certain circumstances, as a percentage of a corresponding revenue line item).

     During 2003 and 2002, we have experienced a changing mix of revenues between sales by company-operated restaurants and franchise revenues. This is a function of our ongoing efforts to grow the franchising side of our business, including the sale of company-operated QSRs to new or existing franchisees (“unit conversions”). As a result of unit conversion transactions, we have experienced a reduction in sales from company-operated restaurants as well as related restaurant costs; but an increase in franchise revenues. We have engaged in these transactions because we believe our profit margins and our returns on investment will be higher if our brands’ systems are predominantly franchised as opposed to company-operated.

(1)

Expressed as a percentage of sales by company-operated restaurants.

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Comparisons of the Second Quarters for 2003 and 2002

Sales by Company-Operated Restaurants

     Chicken.   Of the $13.3 million decrease in sales by company-operated restaurants, approximately $12.3 million was due to the conversion of 111 company-operated Church’s restaurants throughout 2002. Approximately $1.8 million of the decrease was attributable to a net decrease in same-store sales for the second quarter of 2003 compared to the second quarter of 2002 (a 2.9% decline in same-store sales at Church’s company-operated restaurants and a 2.1% decline in same-store sales at Popeyes company-operated restaurants). The remaining fluctuation was due to various influences including the actual number and timing of restaurant openings and closings.

     Bakery.   Of the $4.7 million decrease in sales by company-operated bakeries, approximately $4.2 million was due to the conversion of 63 company-operated bakeries throughout 2002. Approximately $0.6 million of the decrease was due to a 9.0% decline in same-store sales in the second quarter of 2003 compared to the second quarter 2002. The remaining fluctuation was due to various influences including the actual number and timing of bakery openings and closings.

Franchise Revenues

     Within each of our business segments, “franchise revenues” has three basic components: (1) ongoing royalty fees that are determined based on a percentage of franchisee sales; (2) franchise fees associated with new unit openings; and (3) development fees associated with the opening of new franchised units in a given market. Royalty revenues are the largest component of franchise revenues, generally constituting more than 90% of franchise revenues in our chicken segment and more than 70% of franchise revenues in our bakery segment.

     Chicken.   Of the $0.6 million increase in franchise revenues, approximately $1.5 million was due to an increase in royalties resulting from an increase in franchised units, which was partially offset by an approximate $0.6 million decrease in royalties attributable to a decrease in same-store sales for the second quarter of 2003 compared to the second quarter of 2002 and $0.3 million was due to a decrease in franchise fees because of lower franchised unit openings in the second quarter of 2003 compared to the second quarter of 2002.

     Bakery.   Of the $0.4 million increase in franchise revenues, approximately $0.3 million was due to an increase in royalties resulting from an increase in franchised units and $0.2 million was due to an increase in franchise fees primarily from the recognition of deferred development fees associated with terminated development agreements. The overall increase was partially offset by an approximate $0.1 million decrease in domestic and international franchise same-store sales.

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Other Revenues

     Substantially all of the $0.8 million increase in rental income was due to an increase in the number of rental arrangements that resulted from unit conversions transacted during 2002. There were no unit conversions and related fees in the second quarter of 2003, which resulted in the $5.3 million decrease in such fees compared to the comparable period in 2002. The $0.4 million decrease in wholesale revenues was due to the discontinuance of sales in the second quarter 2003 of cinnamon rolls under a wholesale arrangement with a major retailer in our bakery segment.

Restaurants Employee, Occupancy and Other Expenses

     Restaurant employee, occupancy and other costs were $38.8 million in the second quarter of 2003, a $9.7 million decrease from the second quarter of 2002. This decrease is attributable to the reduction in sales from company-operated restaurants from 2002 to 2003 (which is principally due to the conversion of company-operated QSRs to franchised QSRs). These costs constituted approximately 52% of sales from company-operated restaurants in the second quarter of both 2003 and 2002.

Restaurant Food, Beverage and Packaging

     Restaurant food, beverage and packaging costs were $21.6 million in the second quarter of 2003, a $4.6 million decrease from the second quarter of 2002. This decrease is attributable to the reduction in sales from company-operated restaurants from 2002 to 2003 (which is principally due to the conversion of company-operated QSRs to franchised QSRs). These costs constituted approximately 29% and 28%, respectively, of sales from company-operated restaurants in the second quarter of 2003 and 2002. The increase in these costs as a percentage of our restaurant sales was principally due to rising chicken costs.

General and Administrative Expenses

     General and administrative expenses were $23.8 million in the second quarter of 2003, a $0.3 million decrease from the second quarter of 2002. The decrease is primarily due to a $1.4 million decrease in divisional overhead support costs. This was partially offset by higher severance costs.

Depreciation and Amortization

     Depreciation and amortization was $5.6 million in the second quarter of 2003, a $0.4 million decrease from the second quarter of 2002. The decrease was mainly due to reductions in depreciation expense resulting from the sale of company-operated QSRs to franchisees. Depreciation and amortization was approximately 5% of total revenues in the first quarter of both 2003 and 2002.

Impairment Charges and Other

     Impairment charges and other includes (1) impairment charges associated with goodwill balances, other intangible assets and other long-lived assets; (2) professional fees and other related charges associated with the restatement and the re-audit of 2001 and 2000 financial information; (3) costs associated with unit closures and refurbishments; (4) gains and losses on the sale of assets; and (5) wholesale costs associated with bakery wholesale sales. These aggregated to $5.1 million in the second quarter of 2003, a $0.3 million increase from the second quarter of 2002.

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     The increase was mainly due to $4.6 million in restatement related expenses that were incurred in the second quarter of 2003 compared to zero in the second quarter of 2002; partially offset by a $4.1 million increase in net gains on sales of assets.

Operating Profit (Loss)

     During 2003, we modified our approach to allocating corporate overhead costs to our business segments. During 2003, information technology costs were allocated to the segments. Our allocations for 2002 were adjusted to be consistent with the 2003 approach.

     On a consolidated basis, operating profit was $11.4 million in the second quarter of 2003, a $7.2 million decrease from the comparable period in 2002. Fluctuations in the various components of revenue and expense giving rise to this change are discussed above. The following is a general discussion of the fluctuations in operating profit by business segment.

     The $3.3 million decline in operating profit associated with our chicken segment was principally due to a decrease in company-operated units resulting from 2002 unit conversions and declining same-store sales.

     The $2.3 million increase in operating profit associated with our bakery segment was principally due to a $2.7 million decrease in impairment charges within this segment.

     The $6.2 million decline in operating profit associated with our corporate operations was principally due to $4.6 million of restatement expenses that were incurred in the second quarter of 2003 compared to zero in the second quarter of 2002; $1.8 million of higher severance costs; and $1.1 million of higher professional fees.

Interest Expense, Net

     Interest expense was $1.6 million in the second quarter of 2003, an $11.6 million decrease from the second quarter of 2002. The decrease was principally due to $6.5 million of premiums paid in 2002 relating to the extinguishment of our Senior Subordinated Notes and $3.1 million of debt issuance costs that were written off in 2002, in both cases, compared to zero in 2003. The remaining decrease was principally related to lower debt balances and lower interest rates.

Income Taxes

     Our effective tax rate in the second quarter of 2003 was 36.7%, compared to an effective tax rate of 36.9% in the second quarter of 2002.

Loss from Discontinued Operations, Net of Income Taxes

     In the second quarter of 2003, we recognized a net loss of $0.3 million relating to Seattle Coffee compared to breakeven operating results in the second quarter of 2002.

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Comparisons for the Twenty-Eight Weeks Ended July 13, 2003 and July 14, 2002

Sales by Company-Operated Restaurants

     Chicken.   Of the $34.8 million decrease in sales by company-operated restaurants, approximately $32.9 million of it was due to the conversion of 111 company-operated Church’s restaurants throughout 2002. Approximately $3.6 million of the decrease was attributable to a net decrease in same-store sales for the twenty-eight week period ended July 13, 2003 compared to the twenty-eight week period ended July 14, 2002 (a 2.7% decline in same-store sales at Church’s company-operated restaurants and a 1.5% decline in same-store sales at Popeyes company-operated restaurants). The remaining fluctuation was due to various influences including the actual number and timing of restaurant openings and closings.

     Bakery.   Of the $13.0 million decrease in sales by company-operated bakeries, approximately $10.9 million was due to the conversion of 63 company-operated bakeries throughout 2002. Approximately $1.8 million of the decrease was due to an 11.1% decline in same-store sales for the twenty-eight week period ended July 13, 2003 compared to the twenty-eight week period ended July 14, 2002. The remaining fluctuation was due to various influences including the actual number and timing of bakery openings and closings.

Franchise Revenues

     Within each of our business segments, “franchise revenues” has three basic components: (1) ongoing royalty fees that are determined based on a percentage of franchisee sales; (2) franchise fees associated with new unit openings; and (3) development fees associated with the opening of new franchised units in a given market. Royalty revenues are the largest component of franchise revenues, generally constituting more than 90% of franchise revenues in our chicken segment and more than 70% of franchise revenues in our bakery segment.

     Chicken.   Of the $1.7 million increase in franchise revenues, approximately $3.9 million was due to an increase in royalties resulting from an increase in franchised units, which was partially offset by an approximate $1.8 million decrease in royalties attributable to a decrease in same-store sales for the twenty-eight weeks ended July 13, 2003 compared to the twenty-eight weeks ended July 14, 2002 and a $0.4 million decrease in franchise fees because of lower franchised unit openings in the twenty-eight weeks ended July 13, 2003 compared to the twenty-eight weeks ended July 14, 2002.

     Bakery.   Of the $0.5 million increase in franchise revenues, approximately $0.7 million was due to an increase in royalties resulting from an increase in franchised units. This increase was partially offset by an approximate $0.2 million decrease in royalties from a decline in domestic and international franchise same-store sales.

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Other Revenues

     Substantially all of the $2.2 million increase in rental income was due to an increase in the number of rental arrangements that resulted from unit conversions transacted during 2002. There were no unit conversions and related fees in the second quarter of 2003, which resulted in the $5.3 million decrease in such fees compared to the comparable period in 2002. The $0.1 million increase in wholesale revenues was due to an increase in sales of cinnamon rolls under a wholesale arrangement with a major retailer in our bakery segment; this wholesale arrangement was discontinued during the second quarter of 2003.

Restaurants Employee, Occupancy and Other Expenses

     Restaurant employee, occupancy and other costs were $90.7 million in the twenty-eight week period ended July 13, 2003, a $24.4 million decrease from the comparable period in 2002. This decrease is attributable to the reduction in sales from company-operated restaurants from 2002 to 2003 (which is principally due to the conversion of company-operated QSRs to franchised QSRs). Restaurant employee, occupancy and other expenses were approximately 52% of sales from company-operated restaurants in the first twenty-eight weeks of both 2003 and 2002.

Restaurant Food, Beverage and Packaging

     Restaurant food, beverage and packaging costs were $50.9 million in the twenty-eight week period ended July 13, 2003, a $10.8 million decrease from the comparable period in 2002. This decrease is attributable to the reduction in sales from company-operated restaurants from 2002 to 2003 (which is principally due to the conversion of company-operated QSRs to franchised QSRs). Restaurant food, beverage and packaging costs were approximately 29% and 28%, respectively, of sales from company-operated restaurants in the first twenty-eight weeks of 2003 and 2002. The increase in these costs as a percentage of our restaurant sales was principally due to rising chicken costs.

General and Administrative Expenses

     General and administrative expenses were $56.9 million in the twenty-eight week period ended July 13, 2003, a $3.8 million increase from the comparable period in 2002. The increase is primarily due to higher professional fees in the first quarter of 2003, including $2.0 million related to a productivity initiative and $1.8 million in severance costs incurred in the second quarter of 2003 mainly related to the implementation of the productivity initiative in the first quarter of 2003.

Depreciation and Amortization

     Depreciation and amortization was $12.9 million in the twenty-eight week period ended July 13, 2003, a $1.2 million decrease from the comparable period in 2002. The decrease was mainly due to reductions in depreciation expense resulting from the sale of company-operated QSRs to franchisees. Depreciation and amortization was approximately 5% of total revenues in the first twenty-eight weeks of both 2003 and 2002.

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Impairment Charges and Other

     Impairment charges and other includes (1) impairment charges associated with goodwill balances, other intangible assets and other long-lived assets; (2) professional fees and other related charges incurred during 2003 associated with the restatement and the re-audit of 2001 and 2000 financial information; (3) costs associated with unit closures and refurbishments; (4) gains and losses on the sale of assets; (5) costs associated with an independent investigation commissioned by our Audit Committee and certain shareholder litigation; and (6) wholesale costs associated with bakery wholesale sales. These aggregated to $10.0 million in the twenty-eight week period ended July 13, 2003, a $4.7 million increase from the comparable period in 2002.

     The increase was mainly due to $6.2 million in restatement related expenses that were incurred in the twenty-eight week period ended July 13, 2003 compared to zero in the comparable period in 2002; and by a $2.9 million increase in asset impairments; partially offset by $4.5 million of higher net gains on the sale of assets.

Operating Profit (Loss)

     During 2003, we modified our approach to allocating corporate overhead costs to our business segments. During 2003, information technology costs were allocated to the segments. Our allocations for 2002 were adjusted to be consistent with the 2003 approach.

     On a consolidated basis, operating profit was $24.3 million in the twenty-eight period ended July 13, 2003, a $20.7 million decrease from the comparable period in 2002. Fluctuations in the various components of revenue and expense giving rise to this change are discussed above. The following is a general discussion of the fluctuations in operating profit by business segment.

     The $8.2 million decline in operating profit associated with our chicken segment was principally due to a decrease in company-operated units resulting from 2002 unit conversions and declining same-store sales.

     The $1.7 million increase in operating profit associated with our bakery segment was principally due to a decrease of $2.6 million in impairment charges within this segment.

     The $14.2 million decline in operating profit associated with our corporate operations was principally due to $6.2 million of restatement expenses that were incurred in the twenty-eight week period ended July 13, 2003 compared to zero in the comparable period of 2002; $7.1 million of higher professional fees; and $1.8 million of higher severance costs.

Interest Expense, Net

     Interest expense was $4.1 million in the twenty-eight week period ended July 13, 2003, a $14.4 million decrease from the comparable period in 2002. The decrease was principally due to $6.5 million of premiums paid in 2002 relating to the extinguishment of our Senior Subordinated Notes and $3.1 million of debt issuance costs that were written off in 2002, in both cases, compared to zero in 2003. The remaining decrease was principally related to lower debt balances and lower interest rates.

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Income Taxes

     Our effective tax rate in the twenty-eight week period ended July 13, 2003 was 37.7%, compared to an effective tax rate of 37.3% in the comparable period in 2002. Our effective tax rate increased mainly due to an increase in the state tax rate.

Loss from Discontinued Operations, Net of Income Taxes

     In the twenty-eight week period ended July 13, 2003, we recognized a net loss of $0.6 million relating to Seattle Coffee compared to a net loss of $10.1 million in the comparable period of 2002. The net loss in 2002 includes an $11.8 million, pre-tax, charge related to the impairment of Seattle Coffee’s goodwill upon our adoption of SFAS 142, Goodwill and Other Intangible Assets, in the first quarter of 2002.

Loss from the Cumulative Effect of an Accounting Change, Net of Income Taxes

     In the first quarter of 2003, we adopted SFAS No. 143, Accounting for Asset Retirement Obligations (“SFAS 143”). SFAS 143 addresses financial accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. As a result of obligations under certain leases that are within the scope of SFAS 143, we recorded a cumulative effect adjustment of $0.7 million ($0.4 million after tax).

Consolidated Cash Flows: Comparison of the First Twenty-Eight Weeks of 2003 and 2002

     Cash flows provided by operating activities.   Net cash flows provided by operating activities were $28.7 million in the twenty-eight week period ended July 13, 2003, a $23.7 million decrease from the comparable period of 2002. The decrease was principally the result of a $12.9 million decrease in deferred tax expense; a $10.0 million decrease in income from continuing operations before consideration of non-cash charges for accounting changes, depreciation and amortization, asset write-downs, provisions for bad debts, non-cash interest, compensatory stock options, gains and losses; and a $3.9 million use of cash from the operating activities of discontinued operations in the twenty-eight week period ended July 13, 2003 compared to $2.5 million use of cash from the operating activities of discontinued operations in the comparable period of 2002. This was partially offset by a $5.6 million decrease in net operating assets in the forty week period ended in the twenty-eight week period ended July 13, 2003 compared to an $5.0 million decrease in the comparable period of 2002.

     Cash flows used in investing activities.   Net cash flows used in investing activities were $13.6 million in the twenty-eight week period ended July 13, 2003, a $7.7 million increase from the comparable of 2002. The decrease was principally due to lower proceeds from the disposition of property and equipment due to unit conversions, partially offset by lower capital expenditures.

     In the twenty-eight week period ended July 13, 2003, proceeds from the disposition of property and equipment were $0.3 million compared to $18.6 million in the comparable period of 2002. The 2002 proceeds include amounts related to a significant unit conversion associated with the Company’s chicken and bakery segments. In the twenty-eight week period ended July 13, 2003, capital expenditures were $12.5 million compared to $21.4 million in the comparable period of 2002.

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     Cash flows used in financing activities.   Net cash used in financing activities was $19.6 million in the twenty-eight week period ended July 13, 2003. This was principally composed of $14.4 million of principal payments on the term loans associated with our 2002 Credit Facility; $5.0 million of net payments associated with the revolving portion of our 2002 Credit Facility; and $2.2 million decrease in bank overdrafts partially offset by $2.0 million provided by various matters.

     Net cash used in financing activities was $26.9 million in the twenty-eight week period ended July 14, 2002. This was principally composed of $133.4 million of payments associated with our Senior Subordinated Notes which we retired; $78.7 million of payments associated with our 1997 Credit Facility which we retired; $13.0 million decrease in bank overdrafts; and various other matters partially offset by $200.0 million of proceeds from our 2002 Credit Facility.

Liquidity and Capital Resources

     We have financed our business activities primarily with funds generated from operating activities, proceeds from the sale of company-operated QSRs to franchisees, proceeds from the sale of our common stock in our initial public offering and the issuance of debt under our 2002 Credit Facility.

     Based upon our current level of operations, anticipated growth, and assuming compliance with our 2002 Credit Facility, we believe that available cash provided from operating activities, proceeds from the sale of our Seattle Coffee subsidiary, and available borrowings under our lines of credit ($23.2 million available as of July 13, 2003) will be adequate to meet our anticipated future requirements for working capital, including various contractual obligations discussed below, and for capital expenditures throughout 2003 and 2004.

     In Note 4 to our condensed consolidated financial statements included at Part 1, Item 1 herein, we describe several legal proceedings in which we are involved that relate to our announcements on March 24, 2003 and April 22, 2003 that we would restate certain previously issued financial statements. The lawsuits against AFC described therein, present material and significant risk to us. Although we believe that we have meritorious defenses to the claims of liability or for damages in these actions, we are unable at this time to predict the outcome of these actions or reasonably estimate a range of damages. The amount of a settlement of or judgment on one or more of these claims or other potential claims relating to the same events could substantially exceed the limits of our D&O insurance. The ultimate resolution of these matters could have a material adverse impact on our financial results, financial condition and liquidity.

     Due to diminishing availability of fast-food sized chickens and other market forces we expect our chicken costs to rise during 2004. Presently, the SMS chicken pricing contracts are under review as we seek to minimize the effect of these rising chicken costs.

Capital Expenditures

     Our capital expenditures consist of re-imaging activities associated with company-operated QSRs, new unit construction and development, equipment replacements, the purchase of new equipment for our company-operated QSRs, investments in information technology, accounting systems, and improvements at various corporate offices. Capital expenditures related to re-imaging activities consist of significant renovations, upgrades and improvements, which on a per unit basis typically cost between $70,000 and $160,000.

     During the twenty-eight weeks ended July 13, 2003, we invested $13.8 million in various capital projects, including $2.9 million in new and relocated QSRs, $1.5 million in our re-imaging program, $0.7 million in our Seattle Coffee wholesale operations, $3.3 million in other capital assets to maintain, replace and extend the lives of company-operated QSR equipment and facilities and $4.3 million for information technology systems and $1.1 million to complete other projects.

     During the twenty-eight weeks ended July 14, 2002, we invested $24.9 million in various capital projects, including $5.2 million in new and relocated QSRs, $4.8 million in our re-imaging program, $1.4 million in our Seattle Coffee wholesale operations, $7.0 million in other capital assets to maintain, replace and extend the lives of company-operated QSR equipment and facilities, $1.8 million for information technology systems, and $4.7 million to complete other projects.

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     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.

Long Term Debt

     For a discussion of our long-term debt, see Note 3 to our condensed consolidated financial statements at Part 1, Item 1 of this report on Form 10-Q. That note is herby incorporated by reference into this Item 2.

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 have traditionally experienced the strongest operating results during the holiday shopping season between Thanksgiving Day and New Year’s Day. Any factors that cause reduced traffic at our Cinnabon bakeries during this period would impair their ability to achieve normal operating results.

Forward-Looking Statements

     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 adverse effects of litigation or regulatory actions arising in connection with the restatement of our previously issued financial statements, the loss of franchisees and other business partners, failure or our franchisees, the loss of senior management and the inability to attract and retain additional qualified management personnel, a decline in the number of new units to be opened by franchisees, the inability to relist our securities with the Nasdaq National Market or another major securities market or exchange, our inability to address deficiencies and weaknesses in our internal controls, limitations on our business under our credit facility, our inability to enter into new franchise relationships, and a decline in our ability to franchisee new units, increased cost of our principal food products, labor shortages, or increased labor costs, slowed expansion into new markets, changes in consumer preferences and demographic trends, as well as concerns about health or food quality, the ability of our competitors to successfully manage their respective operations in the foodservice industry, unexpected and adverse fluctuations in quarterly results, increased government regulation, growth in our franchise system that exceeds our resources to serve that growth, supply and delivery shortages or interruptions, currency, economic and political factors that affect our international operations, inadequate protection of our intellectual property and liabilities for environmental contamination and the other risk factors detailed in our 2003 Annual Report on Form 10-K 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.

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Item 3.   Quantitative and Qualitative Disclosures About Market Risk

     Chicken Market Risk.   Fresh chicken is the principal raw material for our Popeyes and Church’s operations. It constitutes approximately half of their combined “restaurant food, beverages and packaging” costs. These costs are significantly affected by increases in the cost of chicken, which can result from a number of factors, including increases in the cost of grain, disease, declining market supply of fast-food sized chickens and other factors that affect availability, and greater international demand for domestic chicken products.

     In order to ensure favorable pricing for fresh chicken purchases and maintain an adequate supply of fresh chicken for AFC and its franchisees, SMS (a not-for-profit purchasing cooperative formed by AFC and its franchisees) has entered into chicken pricing contracts with chicken suppliers. These contracts establish pricing arrangements, but do not establish any firm purchase commitments on the part of AFC or its franchisees.

     Due to diminishing availability of fast-food sized chickens and other market forces we expect our chicken costs to rise during 2004. Presently, the SMS chicken pricing contracts are under review as we seek to minimize the effect of these rising chicken costs.

     Foreign Currency Exchange Risk.   We are exposed to currency risk from the potential changes in foreign currency rates that directly impact our revenues and cash flows from our international franchise operations. For the first twenty-eight weeks of 2003 and 2002, foreign-sourced revenues represented 3.9% and 3.1% of total revenues, respectively. As of July 13, 2003, approximately $3.8 million of our accounts receivable were denominated in foreign currencies.

     Due to our international operations, we are exposed to risks from changes in international economic conditions and changes in foreign currency rates. On a limited basis, we have entered into foreign currency agreements with respect to the Korean Won to reduce our foreign currency risks associated with royalty streams from franchised operations in Korea.

     Interest Rate Risk.   Our net exposure to interest rate risk consists of our borrowings under our 2002 Credit Facility. Borrowings made pursuant to that facility include interest rates that are benchmarked to U.S. and European short-term floating-rate interest rates. As of July 13, 2003, the balances outstanding under our 2002 Credit Facility totaled $203.5 million. The impact on our annual results of operations of a hypothetical one-point interest rate change on the outstanding balances under our 2002 Credit Facility would be approximately $2.0 million.

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Item 4.   CONTROLS AND PROCEDURES.

     Disclosure controls and procedures.   Disclosure controls and procedures are controls and other procedures of a registrant designed to ensure that information required to be disclosed by the registrant in the reports that it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) are properly recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include processes to accumulate and evaluate relevant information and communicate such information to a registrant’s management, including its principal executive and financial officers, as appropriate, to allow for timely decisions regarding required disclosures.

     CEO and CFO certifications.   Attached as Exhibit 31.1 and 31.2 to this Quarterly Report on Form 10-Q are certifications by our CEO and CFO. These certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certifications”). This portion of our Quarterly Report on Form 10-Q describes the results of our controls evaluation referred to in the Section 302 Certifications.

     Our evaluation of AFC’s disclosure controls and procedures.   Throughout 2003, we evaluated the effectiveness of the design and operation of AFC’s disclosure controls and procedures, as required by Rule 13a-15 of the Exchange Act. This evaluation was carried out under the supervision and with the participation of our management, including our CEO and CFO. This evaluation included a review of certain deficiencies in internal controls noted during the audit of our 2002 financial statements (and the re-audit of our 2001 and 2000 financial statements). In connection with those audits, our independent auditors, KPMG LLP (“KPMG”), assessed our internal controls and those of our subsidiaries and advised our Audit Committee that certain identified deficiencies constituted material control weaknesses (as defined by standards established by the American Institute of Certified Public Accountants). In their communications with our Audit Committee, KPMG stated that the more significant deficiencies were:

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inadequate and untimely resolution of balance sheet account reconciliation discrepancies,

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absence of appropriate reviews and approvals of transactions and accounting,

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inadequate procedures for appropriately assessing and applying accounting principles, and

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failure of identified controls in preventing or detecting misstatements of accounting information.

     Additionally, during 2003, independent legal counsel to our Audit Committee and a forensic accounting firm performed an independent investigation into several accounting issues that arose in connection with the restatement. That investigation concluded that there was no evidence that our management intentionally used improper accounting practices to manipulate earnings and that there was no evidence of any fraud or intentional misconduct on the part of AFC, our officers or our employees. The Audit Committee, however, also concluded that our accounting, financial reporting and internal control functions needed significant improvement, including our system of documenting transactions. The Audit Committee further concluded that our internal technical accounting expertise was weak, and that enhanced training, staffing and discipline in the accounting and internal audit areas were needed.

     Actions taken in response to our evaluation.   As a result of the findings described above, during 2003 we began implementing the following actions to address the issues we identified in our evaluation of controls and procedures:

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We sought to thoroughly understand the nature of the issues through discussions with KPMG and the independent counsel and forensic accountants engaged by our Audit Committee.

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Our Audit Committee has exercised increased oversight over management’s assessment of internal controls and response to control weaknesses identified in the above assessments.

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We hired outside consultants to assist our internal audit group in documenting our accounting and business processes and identifying areas that require control or process improvement.

	•		We are establishing new internal control processes based on discussions with the Audit Committee’s independent counsel and forensic accountants, KPMG, and other consultants we have engaged to help us in this regard and our own management team seeking to remedy the problems identified.
	•		We initiated a search for a new chief financial officer.
	•		We employed a new Vice President, Finance who has an extensive public accounting background, as a former audit partner of a Big-Four accounting firm, and broad SEC reporting experience.
	•		We hired a Director of Internal Control whose primary responsibilities are to oversee the establishment of formalized policies and procedures throughout our organization and to document and assess our system of internal controls.
	•		We established processes whereby the chief financial officers at each of our brands have responsibility for the accuracy of their brand’s financial statements and other accounting information associated with their brand’s operation.
	•		We hired controllers for each of our brands who are responsible for the daily maintenance of each respective brand’s accounting system (such tasks were previously performed through a centralized corporate function).
	•		We instituted more rigorous procedures for quarter-end analysis of balance sheet and income statement accounts, quarter-end reconciliations of subsidiary ledgers, and the correction of reconciling items in a timely manner. We are also enhancing our accounting documentation policies.
	•		We began upgrading our IT systems throughout our organization including in-store systems, our general ledger packages, our fixed assets, accounts receivable, accounts payable, and payroll systems, and our corporate reporting packages. We are redesigning our internal reporting packages and standardizing our internal reporting tools, all with the purpose of improving the quality and flow of financial information within our organization.
	•		We began instituting new procedures around our quarterly reporting processes whereby significant accounting issues are discussed and documented, reviewed with our external auditors and our Audit Committee, formally approved by our management, and given timely effect in our books and records.
	•		We formed a Disclosure Committee and adopted a Disclosure Committee Manual to assist our CEO and CFO in certifying our public filings, and complying with all SEC rules and regulations.
	•		We broadened the scope of our internal audit function and changed its reporting responsibility. It now reports directly to the Audit Committee and CEO.
	•		We established a whistle-blower policy to accommodate confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters as required by Section 307 of the Sarbanes-Oxley Act of 2002.